UK: Weekly Tax Update - Monday 31 October 2011

Last Updated: 3 November 2011
Article by Richard Mannion

1. Private Clients

1.1. Claim for negligible value and valuation of shares

The First Tier Tribunal cases of Messrs Barker, Harper & Wickes v Revenue & Customs (TC01487) concerned the valuation of shares and claim of negligible value.

The taxpayers won their appeals and the very long published decision provides an interesting outline of the points at issue and background detail. The appeals were joined because the issues in each of the three cases were the same, but the claims and the appeals were distinct.

The taxpayers had acquired shares in a company called Diligenti Limited on 19 December 2000 and had made a claim under TCGA 1992 s24(2) on the basis that their holdings had become of negligible value by 5 April 2001. Each holding was of 11,000 ordinary shares of one penny, which were subscribed at par with a premium of £303.0203 per share, so that each taxpayer paid a total of £3,333,333 for his shares.

The first point at issue was whether the term 'value' in section TCGA 1992 s24(2). meant market value as defined in s272? Does it mean market value as defined in s272 as modified by s 273? Or does it have another meaning altogether, and if so what?

The conclusion of the Judges was that to speak of an asset which has become of negligible value as having a market value makes no sense. The very fact that it has no market value is why it is said to be of negligible value; if the asset has a market value, then its value cannot be negligible. That it may nonetheless have a subjective value to its owner is beside the point: an item of sentimental value to a person may well be nearly priceless as far as that person is concerned, but it would be quite unworkable for the tax base to depend on the accident of personal attachment to an asset rather than upon a value evidenced by an actual or hypothesised arm's length transaction.

The test of eligibility for a claim under s24(2) is therefore: does this asset have a market value? If the answer is no, a claim may in principle be made; if the answer is yes, no claim under this provision is appropriate. The draftsman had accordingly no need to specify whether the word 'value' in the phrase 'negligible value' meant 'market value' – or some other type of value - because the reference is to a situation in which there is no objective value. It was rightly accepted by both parties that 'negligible value' meant 'worth next to nothing'; and although it is at first sight odd for a claim for 'negligible' value to be set at nil, it is quite consistent with an approach to the issue which accepts that nil and negligible are so close as to make no difference.

The taxpayers accepted that the provisions of section 24(2)(c), allowing an earlier time than that of the actual claim to be specified as the time when the shares had become of negligible value, does not permit account to be taken of information which was not and could not have been available at the specified time. But they submitted that information which had come to light after the event, and which could have been obtained at the specified date, could be taken into account to show that the circumstances at the time were such that the asset in question would not have had any value at that point, because the later-discovered information would have become apparent in any attempt to sell the asset.

1.2. Spain referred to the Court of Justice over inheritance and gift tax rules

The European Commission has decided to refer Spain to the EU's Court of Justice for discriminatory rules on inheritance and gift tax that require non-residents to pay higher taxes than residents.

The Commission had already formally requested Spain on 5 May 2010 (IP/10/513) and additionally on 17 February 2011 to take action to ensure compliance with the EU rules in regard to inheritance and gift tax provisions. However, no amendments have been made to Spanish legislation on the matter.

Inheritance and gift tax in Spain are regulated at both state level and at the level of autonomous communities. The autonomous communities' legislation grants residents a number of tax benefits that, in practice, allow them to pay much lower taxes than non-residents.

The Commission considers that this discriminatory tax treatment constitutes an obstacle to the free movement of people and capital, fundamental principles of the EU's Single Market, and is in breach of the Treaty on the Functioning of the European Union (Articles 45 and 63 respectively). &guiLanguage=en

2. PAYE and Employment matters

2.1. Discussion document on PAYE pooling

HMRC has issued a discussion document on a proposal to offer businesses a PAYE pooling arrangement. Under this arrangement all connected employing entities would operate under one PAYE employer reference, and make one payment covering all Income Tax and NIC obligations of all entities registered under that pooling reference. P45 and P46 forms would not be needed where an employee transferred from one employer to another within the pooling. It is proposed that only one P11D (b) would need to be submitted by the pool covering all employers within the pool. Also there would be a requirement for only one Class 1A NIC payment. It is envisaged that employers within the pooling arrangements would no longer be permitted to make quarterly payments.

The proposals are at an initial stage and have been issued in the light of the forthcoming RTI project for PAYE, but not all procedural matters are dealt with. For example there are as yet no indications how PAYE settlement arrangements would be dealt with under a pooling arrangement. Other areas highlighted for discussion that have not been finalised include how student loans, statutory payments and construction industry scheme (CIS) arrangements would be dealt with.

It is expected that connected employers for private businesses would involve some commonality in business and ownership, whilst for public employers HMRC would look at those grouped under a particular Local or Health Authority. However, HMRC are clear that PAYE Pooling will not be available to payroll agents or other third parties for the purposes of pooling a number of disparate businesses. pageLibrary_ShowContent&propertyType=document&id=HMCE_PROD1_031686

3. Business tax

3.1. Manufactured Overseas Dividends

A Statutory Instrument (SI2011/2503) and guidance have been issued relating to the administrative procedures associated with manufactured overseas dividends, that amends SI1993/2004.

The main change to SI 1993/2004 introduced by SI 2011/2503 is regulation 5B, which from 10 November 2011 enables Manufactured Overseas Dividends (MODs) in stock loans that are paid via a central counterparty (CCP) to be treated as though they had been made directly by the end borrower (known as the "first CCP payer") to the original lender (known as the "final CCP recipient").

An associated change is the requirement from 10 November 2011 for all notices issued under regulation 5A (chains of payments where last payment made to, or for benefit of registered pension scheme or is linked solely to pensions business) to be in a form provided or authorised by HMRC.

3.2. Film partnerships

The First Tier Tribunal has concluded that two film partnerships designed along similar lines to tax advantaged film leasing arrangements described in HMRC guidance (BIM56000 – 56725 and particularly the sections commencing BIM56400 and BIM56455), were not trading activities and that as the partnership businesses were not undertaken on a commercial basis, the partners were not entitled to sideways loss relief. While the accounting results of the film projects showed an accounting profit, the Tribunal considered the net present value (before tax) of these arrangements to be insufficient to demonstrate a commercial activity was being undertaken with a view to profit.

The film partnerships concerned were Samarkand Film Partnership No 3 and Proteus Film Partnership No 1, both partnerships using the film services of the agent Future Film Capital Partners Limited. The film negatives bought and leased were 'The Queen' (£8.2m) and 'Irena Palm' (£3.0m ) in the case of Samarkand, and 'Oliver Twist' (£46.97m) in the case of Proteus.

Although some of the business practices of the partnerships were described as sloppy, and the title to the film 'The Queen' bought by Samarkand was considered questionable, the Tribunal's analysis of the partnerships' commerciality will attract close scrutiny and further consideration. How closely the film leasing arrangements come within the permissible examples outlined in HMRC's guidance is also likely to be carefully considered in determining whether it would be correct to say the partners and the partnerships had a legitimate expectation that their arrangements would receive the tax treatment outlined in HMRC's guidance.

The Tribunal drew a distinction between the tax position of a leasing company (such as in the case of Barclays Mercantile Business Finance Limited v Mawson ([2004] UKHL 51) - BMBF, where its business could encompass its financing arrangements and the use of tax reliefs and the payment of tax) and that of a partnership such as Samarkand and Proteus. In BMBF it was highlighted that the business of leasing at an acceptable rent was contingent on the company or a company in the group having spare capacity (i.e. taxable profits) sufficient to absorb the available capital allowances. The use and surrender of losses to other group companies was part of its business. However in the case of the partnerships, an individual partner's ability to use sideways loss relief was not part of the partnership's own business. The Tribunal accepted that the transactions undertaken could be trading transactions when conducted by particular businesses, but in the case of these partnerships this did not amount to trading in their opinion.

While it may be that the partners could have wholly unrelated activities against which to offset the partnership loss, it would be equally possible for a company to have a wholly unrelated activity in the year of assessment against which to offset a loss similarly incurred. Group relief for the losses (trade losses or excess capital allowances) of one group company can be surrendered and used against the total profits of another group company in the same accounting period as set out in CTA10 part5. Similar loss relief against general income is provided for individuals under ITA part 4 and TCGA s261B. For corporation tax, income tax and capital gains tax purposes there are anti-avoidance provisions to consider, particularly where the activities are uncommercial or have a tax avoidance purpose.

In the case of BMBF it was recognised that the leasing arrangement could only be made commercial by the availability of capital allowances. In the context of a leasing business involving the purchase and lease of an asset, the capital allowances related to the asset purchased. In the House of Lords the decision included the following comment:

"The finding of the special commissioners that the transaction "had no commercial reality" depends entirely upon an examination of what happened to the purchase price after BMBF paid it to BGE. But these matters do not affect the reality of the expenditure by BMBF and its acquisition of the pipeline for the purposes of its finance leasing trade."

In the High Court case of Barclays Mercantile Industrial Finance v Melluish ((1990) S TC 314, a case involving film leasing), Judge Vinelott said:

"It is probable that BMI would not have been able to offer a lease back to a company in the WBI organisation at an acceptable rent unless it could obtain a capital allowance and unless it had spare capacity in the group sufficient to absorb it. But it does not follow that BMI's object was to obtain an allowance; BMI's object and purpose was to make a profit on a purchase and lease of the plant."

These examples seem to imply it would not be incorrect to take account of tax allowances and reliefs in determining the viability of leasing transactions, on the assumption that there is a real leasing business in the first place. Indeed HMRC's guidance at BIM56455 gives an example of a partnership arrangement undertaking film leasing that computes the overall return to an individual partner as though the arrangement were a cash flow financing arrangement, taking account of sideways loss relief. However in assessing the overall tax impact it ignores any tax relief that might be obtained on the loan interest in respect of the loan used to support the initial capital payment, and assumes the taxpayer remains a higher rate taxpayer for the 15 year term of the lease.

It will be interesting to see whether the First Tier Tribunal's conclusions on commerciality in the Samarkand/Proteus leasing case are upheld in the more senior courts. It may come down to a consideration of the objects and whether the object of the partnerships really was a film leasing activity, or whether it was an arrangement to obtain loss relief to offset against an individual's other income. Other significant factors discussed in the Tribunal's decision that may have a bearing on the eventual outcome include the following:

  • The partnerships undertook only the sale and leaseback of just one or two films.
  • The rights attaching to the film The Queen, ostensibly bought from Pathe Slate, were not demonstrably evident. The Tribunal concluded therefore that instead of the full £8.2m being incurred on the film, only about 1% of that amount was actually incurred on the film.
  • Although independent valuations were obtained in all cases, it turns out these were not independent market values of the films at the time of purchase, but confirmation that the values met the criteria outlined in HMRC's Business Income Manual guidance.
  • The valuation certificate mentioned at the previous bullet for Proteus was adjusted to take account of further capital subscribed to that partnership.
  • The Tribunal considered that in relation to Future's fees (taken as a revenue deduction in each partnership), only 35% in the case of Proteus and 45% in the case of Samarkand were of a revenue nature, the balance being capital.
  • A provision regarding the repayment of a partner's loan to fund their capital contribution in certain circumstances, which meant there was recourse to the film negatives and future income stream in preference to the individual's own resources, meant that a clause in the 2005 film scheme regulations regarding loss relief could be triggered to prevent sideways loss relief being available to the partners.

3.3. EU Commission and proposals for an EU accounting directive

The EU has issued proposals for a consolidated accounting directive along with a number of other measures. Extracts from the announcements include:

First, the Social Business Initiative will help this emerging sector to fulfil its unexploited potential. This is complemented by an ambitious strategy for Corporate Social Responsibility to generate a higher level of trust and consumer confidence and improve companies' contribution to society's well-being. Both initiatives reinforce Commission efforts to engage with the private sector on social and environmental issues, especially relevant in times of public budget constraints.

The Commission is also proposing to improve transparency and promote sustainable business among multinationals. Mining and forestry companies would have to be more open about taxes, royalties and bonuses paid worldwide.

Finally, the Commission is proposing to simplify accounting rules for SMEs, potentially saving them up to €1.7 billion per year. The proposals would also reduce burdensome reporting obligations for listed companies, including SMEs, adding further to cost savings.

To increase transparency to the payments made by the extractive and logging industries to governments all over the world, the Commission has proposed to introduce a system of Country-by-Country Reporting (CBCR).

This system would apply to EU privately-owned large companies or companies listed in the EU that are active in the oil, gas, mining or logging sectors. CBCR is a different concept from regular financial reporting as it presents financial information for every country that a company operates in rather than a single set of information at a global level. Reporting taxes, royalties and bonuses that a multinational pays to a host government will show a company's financial impact in host countries. This more transparent approach would encourage more sustainable businesses. In order to cover the various types of companies active in these industries under the CBCR system, the Commission is proposing to revise both the Transparency Directive (2004/109/EC) to cover listed companies and the Accounting Directives (78/660/EEC and 83/349/EEC) to cover large non-listed companies.

Furthermore, the proposed revision of the Transparency Directive would prevent investors from secretly building up a controlling stake in a listed company ("hidden ownership"). Such practices can give rise to possible market abuse, low levels of investor confidence and misalignment of investor intentions. Under the Commission's proposal, investors would need to notify all financial instruments that have the same economic effect as holdings of shares.

By proposing to amend the Accounting Directives (78/660/EEC and 83/349/EEC), the Commission aims to reduce the administrative burden for small companies. Simplifying the preparation of financial statements would also make these more comparable, clearer and easier to understand. It would also allow users of financial statements such as shareholders, banks and suppliers to gain a better understanding of a company's performance and financial position. Potential cost savings for SMEs are estimated at € 1.7 billion per year.

Furthermore, under the proposed revision of the Transparency Directive (2004/109/EC), listed companies, including small and medium-sized issuers, would no longer be obliged to publish quarterly financial information. This would contribute to further cost savings and should help to discourage short-termism on financial markets.

The proposals to revise the accounting Directives and the Transparency Directive will now (25 October 2011) be passed to the European Parliament and the EU's Council of Ministers for adoption. The Communication on Social Entrepreneurship forms the starting point for a number of legislative and non-legislative initiatives that are to be rolled out over the next two years.

There has been a Directive in place for individual financial statements since 1978 (78/660/EEC), and one for consolidated financial statements since 1983 (83/349/EEC). These two Directives provide a complete set of rules for the preparation and content of statutory financial statements. They are often referred to as the "Accounting Directives". The Commission proposes to replace these two Directives by a single Directive that is better adapted to the present and future needs of preparers and users of financial statements.

IFRS (the International Financial Reporting Standard) for small and medium enterprises was published by the International Accounting Standards Board in 2009 in order to meet the specific accounting needs of SMEs. When examining the various policy options available to replace the existing Accounting Directives, the Commission examined and rejected the option to adopt the IFRS for SMEs at EU level. The Impact Assessment concluded that introducing the IFRS for SMEs would not appropriately serve the objectives of simplification and reduction of administrative burden. For instance, the Directive does not require that a cash flow statement be prepared, whereas this is mandatory under the IFRS for SMEs.

Nevertheless, the Member States would be able to adopt the IFRS for SMEs as their accounting standard for all or some of their unlisted companies provided that the Directive was fully implemented and the standard was modified to comply with any accounting requirement of the Directive that departed from the IFRS for SMEs.

The harmonisation proposed under the CCCTB (see IP/11/319) would only involve the computation of the tax base and would not impact the preparation of financial statements. Therefore, Member States would maintain their national rules on financial reporting as derived from the Directive, and the CCCTB system would introduce autonomous rules for computing the tax base of companies. The CCCTB rules would not affect the preparation of individual or consolidated financial statements. en.pdf

4. Tax Publications

NTD032 - Private client checklist 2011/12

Outline of various tax and other planning points for individuals and trustees to consider before the end of the tax year.

NTD033 - The UK/Switzerland Tax Agreement

Outline of the agreement to disclose details of Swiss accounts of UK residents to HMRC and the imposition of special with holding taxes on existing capital and future income.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Richard Mannion
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