Fallon and Another (Executors of Morgan dec'd) v Fellows (HM Inspector of Taxes)

Park J: Abbreviations, etc.

1. CGT - Capital gains tax, or in relation to a company, corporation tax on chargeable gains.

CGTA 1979 - The Capital Gains Tax Act 1979.

F & M - Humphrey and J Fox and RH Morgan Ltd.

FA - Finance Act.

ICTA 1970 - The Income and Corporation Taxes Act 1970.

Locks - Century Locks Ltd.

2. This is a CGT appeal from the special commissioners. They decided in favour of the inspector of taxes, and the taxpayers appeal. They are the executors of Mr Norman Morgan. In his lifetime he and his wife had made the disposals which give rise to the issue. The case is very unusual. At this stage it takes the form of a question of principle, with figures to follow later. It relates to the tax year 1987-88, which means that an exceptionally long time has passed before the case has even reached the High Court on what is still only a preliminary issue of principle. However, nothing turns on the delay, and neither side is blaming the other.

3. The case involves a curious interplay between points of strict CGT law, aspects of practice which may have departed from strict law, and the consequential effects on a later transaction of what may or may not have been a concessionary practice applied to an earlier transaction.

4. In 1987 Mr and Mrs Norman Morgan owned shares in Locks. They sold them for about £1.5m, and that was the disposal the CGT consequences of which are in issue. Nothing arises about the disposal as such. It happened and the consideration for it is known. Working out the chargeable gain on the disposal requires the deduction from the disposal consideration of the CGT base value of the shares, and that turns on how the CGT legislation falls to be applied to a transaction which took place in 1980. Before 1980 Mr and Mrs Morgan did not own shares in Locks. They owned shares in a predecessor company, F & M. I will have to describe the 1980 transaction later, but at this stage I merely say that it was a species of corporate restructuring from which Mr and Mrs Morgan emerged no longer owning shares in F & M, but owning shares in Locks instead. The question of principle is whether the CGT base value for the Locks shares was a value ascertained when Mr and Mrs Morgan acquired them in 1980, which is what they say, or whether it is the original, and lower, base value of the F & M shares which, under the small print of the CGT legislation, was carried over into the Locks shares. That is what the Revenue say.

5. To add a little more detail, the taxpayers say that the CGT analysis of the 1980 transaction was as follows. In strict CGT law it was a disposal by Mr and Mrs Morgan of their F & M shares, regarded as made at market value, and an acquisition of their Locks shares. The CGT base value of the Locks shares was an uplifted figure derived from current 1980 values. In strict law a chargeable gain accrued to them on the disposal of the F & M shares. By concession the Revenue did not charge CGT on that disposal, but the concession did not alter the legal position as to the base value of the Locks shares. Those shares had their own base value which was the uplifted 1980 figure: the original base value of the F & M shares was not carried over into the Locks shares so as to be the deductible base value on a subsequent disposal.

6. The Revenue's position now is, I think, as follows. In 1980 they probably did think that they were applying a non-statutory concession by not claiming CGT on Mr and Mrs Morgan's disposal of their F & M shares. They did not make the concession conditional on Mr and Mrs Morgan accepting that the base value of the F & M shares was to carry over into the Lock shares. Therefore, if they still thought now what they had thought in 1980 the taxpayers would be right. However, they now think that what they thought in 1980 was wrong. They now think that the treatment which they applied then was not concessionary at all, but rather was in accordance with the strict law. If they are right the strict law, as well as having the effect that there was no taxable disposal of the F & M shares, also had the effect that the original base value of the F & M shares was carried over so as to become the base value of the Locks shares.

7. So the question of principle which I have to decide is whether the 1980 treatment of the F & M shares was concessionary, as both sides thought it was then and as the taxpayers still say now, or whether it was in accordance with the strict law, as the Revenue did not think then but as they say now. As I will explain below, this turns on whether or not CGTA 1979, s. 86 applied to the corporate restructuring which happened in 1980. The special commissioners held that it did. I respectfully disagree with them. I consider that it did not, and that the taxpayers are right. Therefore I shall allow this appeal.

8. Section 86, which has now been superseded on consolidation by s. 136 of the Taxation of Chargeable Gains Act 1982, provided as follows:

Reconstruction or amalgamation involving issue of securities

(1) Where-

(a) an arrangement between a company and the persons holding shares in or debentures of the company, or any class of such shares or debentures, is entered into for the purposes of or in connection with a scheme of reconstruction or amalgamation, and

(b) under the arrangement another company issues shares or debentures to those persons in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of shares in or debentures or the first mentioned company, but the shares in or debentures of the first mentioned company are either retained by those persons or cancelled,

then those persons shall be treated as exchanging the first mentioned shares or debentures for those held by them in consequence of the arrangement (any shares or debentures retained being for this purpose regarded as if they had been cancelled and replaced by a new issue), and subsections (2) and (3) of section 85 above shall apply accordingly.

(2) In this section "scheme of reconstruction or amalgamation" means a scheme for the reconstruction of any company or companies or the amalgamation of any two or more companies, and references to shares or debentures being retained include their being retained with altered rights or in an altered form whether as the result of reduction, consolidation, division or otherwise.

(3) This section, and section 85(2) above, shall apply in relation to a company which has no share capital as if references to shares in or debentures of a company included references to any interests in the company possessed by members of the company.

9. As will be seen, where the circumstances described in para. (a) and (b) of subs. (1) exist, the consequences are to be as set out in s. 85. That in its turn takes the matter back into s. 78-81. The effect is that the shareholders whose shares in the original company were involved in the scheme of reconstruction are treated as if there had been no disposal of the shares, and their base value carries over to become the CGT base value of the shares in the successor company which the shareholders own in consequence of the scheme. The section only applies so as to have those results if there is a "scheme of reconstruction or amalgamation". In the present case it is the reference to a reconstruction which is relevant. The question is whether the 1980 restructuring, which I will describe in detail later, was a scheme of reconstruction, or whether it was not, but was treated by the Revenue as if it had been, being so treated as a matter of concessionary practice rather than of law.

10. Section 86 dealt with the CGT position of the shareholders who were involved in a reconstruction. In many reconstructions there are also transactions which affect the underlying assets of the company, and which, absent specific statutory relief, would attract their own CGT consequences. In the present case, for example, F & M transferred to Locks the undertaking and assets of a business carried on by it. Prima facie that was a disposal of any capital assets comprised in the transfer. There was however (and still is) a relieving provision for the company which worked in parallel with s. 86, the relieving provision for the shareholders. If the transfer is part of a scheme of reconstruction or amalgamation, no chargeable gain accrues to the transferring company, and its base value for the assets transferred goes over to become the base value for the successor company. In 1980 the provision which had this effect for the companies was not in CGTA 1979. It was s. 267 of ICTA 1970. Nevertheless, the two sections (s. 86 of the 1979 Act and s. 267 of the 1970 Act) operated in tandem, and need to be approached as such. Indeed, when they were first enacted they were subpara. (1) and (2) of the same paragraph, namely para. 6 of Sch. 7 to the Finance Act 1965. The important point is that both provisions are critically dependent on the transactions to which they respectively fall to be applied being parts of a scheme of reconstruction or amalgamation, and parts of the same scheme of reconstruction or amalgamation.

11. I need at this point to go into some further statutory background in order to make sense of what happened in this case. The CGT provisions giving reliefs for schemes of reconstruction or amalgamation were not the first such provisions which gave fiscal reliefs for such schemes. The first such provision was one which gave reliefs from stamp duty. It was FA 1927, s. 55. It is a long section, which has now been repealed (although it was still...