UK: Land Securities: Capital Loss Scheme

Last Updated: 30 November 2011
Article by Ashurst London

The First-tier Tribunal has dismissed the taxpayer's appeal against HMRC's decision to disallow a £200m capital loss created by a tax avoidance scheme which relied on the share matching rules in section 106 TCGA 1992. In doing so, the Tribunal felt unable to ignore certain of the scheme steps on Ramsay principles but nonetheless determined that the scheme failed through the application of the value shifting rules, as modified by the deeming provisions of section 106.

Scheme relied on reacquisition of shares being matched with earlier disposal

The taxpayer was short of funds following a large repayment of capital and therefore approached several banks in order to raise additional capital to fund some planned property acquisitions and to protect its credit rating. Morgan Stanley proposed the scheme in question which was intended to provide the taxpayer with short-term finance but also to create a large capital loss.

An inactive company (LMPI) of which the taxpayer owned 9 shares issued a further 41 shares to another Land Securities group company (RPL), turning it into a joint venture property investment company. Capital contributions of £1.25m and £3.75m were made by the taxpayer and RPL respectively, then the 9 shares were sold by the taxpayer to Canmore (a Morgan Stanley vehicle), with a put option for £1 entitling Canmore to put the shares back onto the taxpayer for market value within the next 12 months.

The following transactions subsequently took place:

  • The taxpayer was granted a call option to repurchase the shares at market value for a premium of £1.4m.
  • Canmore became entitled to an additional payment on exercise of the put or call option, linked to the capital loss created.
  • A forward agreement was entered into between the taxpayer and another Morgan Stanley entity which, broadly, had the effect of allowing the Morgan Stanley entities to exit the scheme at a bankingtype figure, geared to the funds provided and removing risk from movement in value of the properties to be held by LMPI.
  • Canmore contributed £200m to LMPI which was loaned up to the taxpayer at interest.
  • LMPI purchased properties (in part using funds repaid by the taxpayer).

The taxpayer then exercised its call option and repurchased the shares for £202m. The essence of the scheme was to use the matching rules in section 106 TCGA 1992 to claim that the base cost of the shares was the repurchase price of £202m plus the call option premium of £1.4m, with the disposal value being the £1.25m received from Canmore.

HMRC disallowed this loss on the grounds that section 106 did not apply to a reacquisition, but was confined to "bear" transactions where the disposal preceded the initial acquisition.

Purpose of "formalistic and formulaic" provision was impossible to discern for Ramsay purposes

The Tribunal looked first at the Ramsay argument. As is now well rehearsed in case law, the correct approach is to apply the law in a purposive manner and apply that application of the law to the facts, realistically ascertained.

In looking at the statutory provision in question, section 106, the Tribunal considered that the purpose of the section was to create an entirely fictitious basis of calculating gains and losses in circumstances where the taxpayer was likely to be doing something artificial. The issue was likened to that in Mayes where the Court of Appeal found it "impossible to discern the statutory purpose and intent of another formalistic and formulaic set of provisions, namely the 'chargeable event' code for taxing partial surrenders and eventual disposals of insurance policies." The Tribunal therefore considered that it was not able to disapply the section on the argued ground that it "was obviously not meant to apply in that situation".

Steps could not be disregarded despite unrealistic nature

In looking at the facts of the scheme steps, the Tribunal noted a number of features which were clearly unrealistic in the context of a commercial property joint venture, for example, the terms of the forward agreement which demonstrated Morgan Stanley's objective to obtain a banking-style return for the finance provided, the inevitability that the shares would be reacquired by the taxpayer and the fee geared to the loss created.

However, despite these features and the taxpayer freely admitting that this was "first and foremost" a tax avoidance scheme, the Tribunal considered that there was still sufficient reality in the transactions for this not to be a case being window-dressing for a tax scheme. The initial driver was the business plan to acquire the properties which pre-dated the tax scheme and funding of £200m was genuinely produced for a six-week period.

Importantly, an alternative analysis of the transactions was never put forward by HMRC and the Tribunal felt it could not ignore the fact that Canmore owned the shares for a period and made the capital contribution in order to recharacterise this as the taxpayer having a debt liability that "it was plainly not liable for" and having made a capital contribution "which, as a resident company, [it] would never have dreamt of doing."

Reacquisition after capital contribution fell foul of the value shifting provisions

The value shifting provisions normally apply to the receipt of tax-free benefits coupled with reductions in the value of assets, but section 30(9) TCGA extends this to increases in the value of assets where disposals precede acquisitions.

This section provides "(9) In relation to a case in which the disposal of an asset precedes its acquisition, the references in subsections (1)(a) and (2) above to a reduction shall be read as including a reference to an increase."

It was common ground that if this subsection applied, all the other conditions for the value shifting rules to be applied were met.

The Tribunal held that this subsection was in point such that the capital loss would be denied, but not – as the taxpayer contended – because it generally applies to reacquisitions as well as initial acquisitions as in the case of a "bear" transaction. The Tribunal agreed with HMRC that the reference to "its acquisition", rather than using "an acquisition" precluded the application of the section where the asset was owned by the taxpayer prior to the disposal in question.

However, the Tribunal itself raised this issue that section 30 could apply if it is read taking into account the identification rule in section 106 on which the taxpayer was relying. The Tribunal was clear that section 106 is an identification section, such that it matches a particular disposal with a particular acquisition. Once it has been determined that section 106 applies (as here), "its acquisition" in section 30(9) does, for these purposes only, refer to the acquisition which section 106 has linked with the disposal. The Tribunal was also influenced by the fact that the taxpayer's "entire planning, and the very existence of the large, unrealistic and contentious loss were all geared to the very identification that the Appellant now seeks to brush aside."

Accordingly, the capital loss was disallowed.

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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