Khan v R & C Commissioners

JurisdictionUK Non-devolved
Judgment Date02 June 2020
Neutral Citation[2020] UKUT 168 (TCC)
Date02 June 2020
CourtUpper Tribunal (Tax and Chancery Chamber)

[2020] UKUT 168 (TCC)

Upper Tribunal (Tax and Chancery Chamber)

Judge Swami Raghavan, Judge Andrew Scott

Khan
and
R & C Commrs

Laurent Sykes QC, instructed by Markel Tax, appeared for the appellant

Charles Bradley, counsel, instructed by instructed by the General Counsel and Solicitor to Her Majesty's Revenue & Customs, appeared for the respondents

Income tax – Company buyback of own shares – Meaning of ITTOIA 2005, s. 385 – Person receiving or entitled to distribution – Appeal dismissed.

The Upper Tribunal held (re-making an FTT decision that reached the same conclusion on different grounds) that the person who receives and is entitled to receive a distribution is the person liable for the tax charge under ITTOIA 2005, s. 385.

Summary

On 28 June 2013, Mr Khan acquired the entire share capital of Computer Aided Design Ltd (the Company) for £1.95m plus net asset value from the Company's three shareholders and on the same day the Company immediately bought back 98 of the 99 shares for £1.95m. He appealed to the FTT against HMRC's issue of a closure notice that increased his 2013–14 income tax liability on the basis that the share buyback was a distribution taxable under ITTOIA 2005, s. 383. The FTT did not accept his principal argument (the trading argument) that the transaction was a trading transaction and hence under ITTOIA 2005, s. 366 trading profit rules took precedence over the savings and investment income rules (in this case the charge on company distributions), finding that Mr Khan's acquisition of the company was in the nature of an investment.

The FTT had also dismissed Mr Khan's alternative argument that the transactions should be regarded as a single composite transaction, the effect of which was to enable Mr Khan to acquire a single share in the company at a small net cost, consequently the tax charge arose under ITTOIA 2005, s. 687 (income not otherwise charged) on his net receipt of the single share. Although the majority of the FTT decision was concerned with the trading argument, the Upper Tribunal accepted that Mr Khan's appeal on the grounds that the FTT had erred in failing to recognise the true substance of the single composite transaction did not raise a new point and therefore did not require permission to appeal. They did not accept HMRC's contention that this was a point of fact not a point of law because in their view the real question was whether treatment as a single composite transaction or otherwise was relevant to s. 385, thus also raising a question of law.

The Upper Tribunal found as follows:

  • the FTT had erred in law by not considering the question of whether the transactions should be re-analysed as a single composite transaction within the context of ITTOIA 2005 s. 385, given the established principle that a provision should be construed in the light of its statutory purpose;
  • that Mr Khan's submission that, although there had been a distribution under ITTOIA 2005, s. 383 he was not the person liable under s. 385 because that section had to be interpreted having regard to all of the arrangements viewed as a single composite transaction (which would point to the recipients of the distribution as being the three shareholders) should be rejected. It followed that it was only necessary to determine whether Mr Khan was either the actual recipient of the distribution or entitled to receive it, either of which would make him the person liable;
  • that Mr Khan both received the distribution and was entitled to receive it, as the two transactions (the share buy-back that gave rise to the distribution and the payment of £1.95m to the shareholders), although linked, were different transactions giving rise to different legal and factual consequences
  • the net proceeds that Mr Khan received (treating the arrangements as a single composite transaction) could not be charged under s. 687 as that section only imposes a charge on residual income, but the distribution already fell to be taxed under s. 383.

Accordingly the Upper Tribunal remade the FTT's decision according to this analysis, having reached the same conclusion although for different reasons.

Comment

The arrangements between Mr Khan and the shareholders had originally envisaged a share buyback from the shareholders followed by sale of the remaining shares to Mr Khan but this was abandoned because the shareholders wanted a sale of the shares to ensure they benefited from entrepreneurs' relief (presumably they considered that capital treatment on the share buyback was unlikely, as the intention was to wind up the company in the short to medium term). By contrast, Mr Khan's argument depended on recategorizing the arrangement as a single composite transaction whereby he received the remaining share devoid of £1.95m of distributable reserves. It is not difficult to see why this was challenged by HMRC.

DECISION
Introduction

[1] This is an appeal by Mr Bostan Khan against a decision of the First-tier Tribunal (“FTT”) issued on 23 November 2018 (“the FTT Decision”). The FTT Decision concerned the tax treatment of transactions entered into by Mr Khan in relation to a company, Computer Aided Design Limited (the “Company”). Mr Khan, who is an accountant, was familiar with the business of the Company as he had prepared its accounts and the Company rented its premises from him. On 28 June 2013 Mr Khan bought all 99 of the issued shares of the Company from the Company's three shareholders for £1.95m plus the net asset value of the Company over that amount. On the same day the Company immediately bought back 98 of the 99 shares for consideration of £1.95m leaving him with one share in the Company.

[2] Before the FTT, Mr Khan sought to appeal HMRC's closure notice which amended his tax return for the tax year 2013/14. The closure notice increased the income tax due for that tax year by £594,814.57 on the basis that the buy-back of shares was a distribution taxable under s383 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”).

[3] Mr Khan's principal argument before the FTT was that the purchase and sale of shares in the Company was a trading transaction and that the disposal of shares amounted to a disposal of trading stock. The FTT disagreed and upheld HMRC's closure notice. It found Mr Khan's acquisition of the company was in the nature of an investment. The FTT also dismissed Mr Khan's alternative argument that what happened should be viewed as a single composite transaction whose effect was to make Mr Khan the owner of one share in the Company with a small net cost.

[4] With the Upper Tribunal's permission, Mr Khan now appeals to this tribunal. His ground of appeal relates solely to the alternative ground of appeal: that the FTT erred in failing to recognise the true substance of the transaction which was that it was a composite transaction whereby Mr Khan received the remaining share in the Company devoid of £1.95m of distributable reserves in return for entering into the various transactions. His liability to tax accordingly should have been on his net receipt of the single share chargeable under s687 ITTOIA.

The facts and background and the FTT Decision

[5] The FTT had a documents bundle which included copies of the agreements that had been entered into and e-mail correspondence between Mr Khan and his solicitor and between his solicitor and the shareholders' solicitor in the run up to the transaction. It also heard oral evidence from Mr Khan, who had provided a witness statement in advance of the hearing.

[6] The facts found as indicated by paragraph numbers refer to those in FTT Decision unless context requires otherwise.

[7] The Company's business was an employment bureau for consultants. The three shareholders (“the selling shareholders”) no longer wished to work together. In 2013 they approached Mr Khan to see if he was interested in buying the Company with a view to winding it up. Mr Khan had prepared the management accounts of the company since the mid-1990s and the Company rented space in his offices. [3]–[5].

[8] Originally it was planned that the Company would buy back 96 out of the 99 shares from the selling shareholders for £1.8m and then Mr Khan would buy the remaining three shares for £200,000–£300,000 (later reduced to around £35,000–£50,000) and draft documentation was prepared on this basis. On 20 June 2013, the selling shareholders' solicitors referred to accountancy advice that queried whether the selling shareholders might not qualify for entrepreneurs' relief for the purposes of capital gains tax under the proposed deal. A tax indemnity was proposed on 25 June 2013 but was rejected by Mr Khan. On 27 June 2013 Mr Khan's solicitor wrote to Mr Khan to say the revised structure of the deal was in effect to reverse the order of the share purchase and buyback so that Mr Khan would buy all of the selling shareholders' shares and sell all bar one of the shares to the Company. Mr Khan's solicitor recorded that Mr Khan, as accountant for the company was satisfied that there were sufficient distributable reserves for the buyback to take place. The shareholders and Mr Khan had separate legal representation and the deal was fully documented [6].

[9] The deal entered into as described by the FTT was as follows. Mr Khan bought the entire issued capital (99 shares) for cash consideration of £1.95m plus net asset value (ignoring the reserves representing £1.95m). The Company then immediately bought back from Mr Khan 98 of the shares for cash consideration of £1.95m. The share sale and buy-back transactions, both of which completed on 28 June 2013 were documented respectively in a share purchase agreement (“SPA”) and an off-market purchase agreement (“OMPA”) [7].

[10] Most of the cash for the buyback came from the drawdown of an invoice discounting facility made available by NatWest. Mr Khan indemnified the selling shareholders against any liability under that facility and also provided NatWest with a...

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2 cases
  • Khan v Revenue and Customs Commissioners
    • United Kingdom
    • Court of Appeal (Civil Division)
    • 1 January 2021
    ...interpretation of the relevant statutory provisions and their application to the facts. In a decision promulgated on 14 January 2020, [2020] BTC 552, the UT decided that Mr Khan was liable to pay tax on the £1.95 million under s.385(1)(b) of the Income Tax (Trading and other Income) Act 200......
  • Bostan Khan v The Commissioners for HM Revenue and Customs
    • United Kingdom
    • Upper Tribunal (Tax and Chancery Chamber)
    • 2 June 2020
    ...[2020] UKUT 0168 (TCC) Appeal number: Upper Tribunal/2019/0078 INCOME TAX – company buyback of shares – meaning of s385 ITTOIA 2005 – person receiving or entitled to distribution – appeal dismissed UPPER TRIBUNAL TAX AND CHANCERY CHAMBER BOSTAN KHAN Appellant - and THE COMMISSIONERS FOR HER......

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