Baker
| Jurisdiction | UK Non-devolved |
| Judgment Date | 17 July 2013 |
| Neutral Citation | [2013] UKFTT 394 (TC) |
| Date | 17 July 2013 |
| Court | First Tier Tribunal (Tax Chamber) |
[2013] UKFTT 394 (TC)
Judge Kevin Poole, Gareth Jones MBE.
John Brooks of counsel, instructed by Geldards, appeared for the Appellant
Paul Shea, Presenting Officer of HM Revenue and Customs, appeared for the Respondents
Income tax - company distribution - purchase of own shares - failure to comply with Companies Act 1985 ("CA 1985") requirements but payment actually received by director/shareholder - whether valid distribution - whether amounts actually received by director/shareholder taxable as distribution under Income and Corporation Taxes Act 1988 ("ICTA 1988"),Income and Corporation Taxes Act 1988 section 209s. 209(2)(b) - no - appeal allowed.
The First-tier Tribunal allowed a taxpayer shareholder's appeal against HMRC's decision to assess him to income tax in respect of a company's payment for its purchase of its own shares from him. The agreement which implemented the payment fell foul of CA 1985,Companies Act 1985 section 143 subsec-or-para 2s. 143(2) as a result of the provision in the agreement for deferred consideration and of the company's insufficiency of distributable profits. The result was that the purported acquisition was void. The taxpayer was therefore under an obligation, as and when he received cash payments and transfers of assets pursuant to the agreement, to return them to the company. The receipt of such payments and assets was therefore not capable of amounting to a distribution under ICTA 1988, Income and Corporation Taxes Act 1988 section 209s. 209 (Kinlan v CrimminUNK [2006] EWHC 779 (Ch) ("Kinlan"), considered).
The taxpayer was one of two 50 per cent shareholders of a company. Following a falling out between the taxpayer and the other shareholder, in 2006 an agreement was entered into whereby the taxpayer's shares in the company would be purchased by the company for a total payment (in cash and in kind) of £120,000 ("the 2006 agreement"). The taxpayer then resigned as director and company secretary and his employment relationship with the company was terminated. The taxpayer made no mention of the company's purchase in his tax return for the year 2005-06.
HMRC opened an enquiry into the taxpayer's 2005-06 tax return and in February 2010 issued a decision letter informing the taxpayer of their decision to raise an assessment in respect of what they regarded as the £120,000 distribution that the taxpayer had received from the company in 2005-06. The taxpayer appealed, initially on the grounds that the payment was a capital distribution underTaxation of Chargeable Gains Act 1992, Taxation of Chargeable Gains Act 1992 section 122s. 122 which qualified for business asset taper relief. HMRC rejected this argument on the grounds that the taxpayer could not have held his shares for the relevant five year qualifying period. A formal review of HMRC's decision was carried out, during which the taxpayer submitted a copy of a letter from the company's solicitors advising that the transaction was void under company law and that the taxpayer remained a shareholder and indebted to the company for sums paid. HMRC's review letter stated that it was not within the remit of the review to consider the implications of the Companies Act legislation and confirmed the decision to assess the £120,000 as a distribution under ICTA 1988, Income and Corporation Taxes Act 1988 section 209s. 209(2)(b).
Before the Tribunal, HMRC argued that notwithstanding any breach of company law, the transaction had still actually taken place. The tax treatment should follow the economic reality that the company had purchased its own shares from the taxpayer. Even if the purchase of own shares was technically void, the fact of the matter was that the taxpayer had received £120,000 by way of a distribution out of the assets of the company in respect of his shares in it. As a final argument, HMRC contended that if the taxpayer was obliged to repay the £120,000 by reason of breaches of CA 1985, the fact that he had not done so led to the inference that he had in fact received a loan or advance in his capacity as a participator in the company. The loan or advance had subsequently been released or written off and he should, therefore, be liable to tax under theIncome Tax (Trading and Other Income) Act 2005 ("ITTOIA 2005"), Income Tax (Trading and Other Income) Act 2005 section 415s. 415.
The taxpayer contended that company's purchase of its own shares was not carried out in accordance with CA 1985,Companies Act 1985 part V chapter VIIPt. V, Ch. VII. Thus, the purchase was void by virtue of CA 1985, Companies Act 1985 section 143 subsec-or-para 2s. 143(2). Payment in full had not been made on completion, as required by CA 1985, Companies Act 1985 section 159 subsec-or-para 3 section 162 subsec-or-para 2ss. 159(3) and 162(2) since the 2006 agreement included provision for a deferred payment. Furthermore, the company had insufficient distributable reserves to permit the purchase to take place. The company's latest annual accounts showed distributable reserves of £47,044, which was significantly less than the £120,000 in total to be paid under the 2006 agreement. The shares had further not been validly purchased out of capital, an alternative procedure that might have provided a means of validating the purchase which was otherwise void, because no attempt had been made to comply with the necessary requirements involving a statutory declaration of solvency by the directors, supported by an auditor's certificate. As the company's purchase was void, the taxpayer continued to own the shares and the company was entitled to recover the £120,000 from him.
The Tribunal initially discounted entirely HMRC's suggestion that the taxpayer be taxed on the basis of the "economic reality" of what has taken place noting that the nature of a transaction and its effect for tax purposes must be determined by reference to the time the transaction takes place and whilst later events might illuminate history, they did not change it.
The Tribunal continued that it was quite clear that the 2006 agreement fell foul of CA 1985,Companies Act 1985 section 143 subsec-or-para 2s. 143(2) as a result of the provision in that agreement for deferred consideration and also as a result of the company's insufficiency of distributable profits. The result was that the purported acquisition was void. Following Kinlan, that was to be interpreted as meaning that the entitlement to consideration for the purchase, not being sensibly capable of severance from the purported agreement to acquire the shares, was also void.. However, as a fact the company had made payment to the taxpayer which had been retained by him and it was, therefore, for the Tribunal to determine whether such payments amounted in law to a "distribution out of the assets of the company in respect of shares of the company".
In considering the legal effect of the fact that both the company's acquisition of its own shares and the corresponding obligation to pay for them were both void, the Tribunal considered whether the taxpayer was under an obligation to repay the amounts received and found that in general terms the company would have had an unanswerable claim for its repayment followingKleinwort Benson that "there is no principle of English law that money paid under a void contract is not recoverable on the ground of mistake of law because the contract was fully performed." and additionally, citing Belmont Finance Corporation v Williams Furniture (No. 2)UNK [1980] 1 All ER 393 as supporting the view that a constructive trust had arisen of which the taxpayer stood in the position of trustee of the payments and other assets received by him. Either way, the Tribunal's initial view was that the taxpayer was under an obligation to repay the amounts he received from the company pursuant to the 2006 agreement and given the existence of such an obligation, it could not be correct to view the payment he received from the company as a "distribution out of the assets of the company".
However, the Tribunal went on to test this initial view against the apparently contradictory conclusion inKinlan, which had found that, notwithstanding the fact that a payment for a company purchase of own shares was found to be void under CA 1985, Companies Act 1985 section 143 subsec-or-para 2s. 143(2) (by reason of the "deferred payment" element) the departing shareholder was entitled to keep the money he had received. The Tribunal noted, however, that this decision was expressed by Sales J as a departure from the usual principles governing the obligation to repay based on "two important and unusual features of this case": firstly, that if the parties had been made aware of the point in advance, they would have changed the terms of the agreement so that the purchase price had to be paid in full on completion and secondly, that on selling his shares, the shareholder had changed his position in a fundamental respect in good faith in reliance on his assumption that the agreement was valid; that had he realised the money was recoverable, he would have wished to consider how to protect his continuing interest in the company either by resuming his rights as a shareholder or seeking to reformulate the agreement on a basis that was legally valid. Both of these factors provided a good defence to the claim for repayment and as a final point, Sales J stated that, in any event, he would have granted relief under CA 1985, Companies Act 1985 section 727s. 727, exempting the departing director for any liability in respect of the money actually received from the company.
The Tribunal concluded that HMRC were effectively arguing in line withKinlan that if the taxpayer has received a payment from the company for his shares and is not obliged to repay it, he must be regarded as having received a distribution falling within ICTA 1988, Income and Corporation Taxes Act 1988 section 209 subsec-or-para 2s. 209(2)(b). The...
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