Bupa loss relief scheme succeeds

Details of the case

A UK company (CX Re) had huge losses. Other members of the group could not use them. The scheme involved a third party, Tawa plc, selling ordinary shares in CX Re to two unrelated groups (BUPA and Nationwide), under which the seller effectively retaining any economic upside and control of CX Re. Relevant aspects of the arrangements were:

• The CX Re shares were sold for $1 plus earn-out consideration to Tawa plc of 100% of any distribution made (whether income or capital) up to a set amount, 95% of distributable profits thereafter
• The new owners would make payment for consortium relief at approx. 14% of the losses surrendered (at that time the main CT rate was 30% so the benefit of the losses was shared roughly 50/50)
• Before implementing the scheme the share capital of CX Re was reorganised with 99.99% of the issued capital re-designated as a non voting class. The purchasing groups held 87% of this class but less than 40% of the very small number of voting shares

The two purchasers made consortium relief claims. In a very thorough and robust judgement the UTT in BUPA Insurance Ltd found for the taxpayers. It was agreed by the parties that the link company, Bupa Finance plc, did have ‘beneficial ownership’ of the shares in CX Re, but the issue in point was whether Bupa Finance plc had beneficial entitlement to any distributions to it from CX Re.

HMRC argued that the earn-out provision in the share sale agreement meant that applying the tests based on beneficial entitlement in what was ICTA Sch 18, the new owners were not entitled to any notional profits of CX Re that might be available for distribution as they had to make onward payments of an equal amount under the earn-out agreement after a period of 10 days. Hence the proportion of losses to which they were entitled under group/consortium relief was nil. As an alternative, HMRC argued that as the transactions were entered into solely for tax avoidance purposes they had to be ignored, basing this argument particularly on the Arrowtown case.

Beneficial entitlement

The UTT considered the meaning of “beneficial ownership” of shares for the purposes of determining where “beneficial entitlement” to distributions lay. The term “beneficial entitlement” referred to in s 403C(2)(b) ICTA 1988 is wider than beneficial ownership as it refers to (notional) future events rather than to the present state (which is ownership). Any references to beneficial ownership by the UTT should also be taken to be references to beneficial entitlement.

HMRC argued that the share purchase agreements’ requirement to pay additional consideration effectively deprived BUPA and Nationwide of beneficial entitlement to any income distribution made by CX Re, thus reducing the proportion of consortium loss entitlement to nil. However, as the UTT noted, the terms of the earn-out applied to distributions of both an income and capital nature. Therefore, it was odd that HMRC accepted that Bupa Finance plc would be beneficially entitled to capital distributions, whilst at the same time contesting beneficial entitlement to income distributions.

The UTT rejected HMRC’s argument. The contractual obligations to pay earn-out consideration in no way deprived Bupa Finance plc of beneficial entitlement to the distribution for the purpose of s 403C(2)(b) ICTA 1988. Bupa was free to spend the cash and use other finance to meet the earn-out payment as it so wished.

Basing their decision on the leading cases of Wood Preservation and Sainsbury the UTT held that the two purchasers had beneficial ownership of all the shares the two companies legally owned. In Wood Preservation, any ownership which amounted to more than a “mere legal shell” amounted to beneficial ownership. In particular the UTT drew on Sainsbury where the option arrangements over the shares in question effectively deprived the owner of any economic return. So the fact that had CX Re made a profit (which it did not – it continued to lose money) all of the profit would pass to the previous owner did not impair beneficial ownership. Indeed the UTT observed that the purchasers would have to be entitled to the whole distribution in order to have the funds to make the additional purchase consideration.

Ramsay argument

The UTT analysed Arrowtown and said the reason Arrowtown failed was that the shares in question, which were issued in an attempt to form a stamp duty group, had no commercial content. The holder of the relevant shares would receive a dividend only if the company’s profits exceeded the GNP of the USA and a distribution in a winding up once the holder of the other shares had received a distribution of HK$100,000 billion per share. The shares had no “commercial content” and this led the Hong Kong Final Court of Appeal to disregard these shares. 

As had been held in Piggott v Staines Investment Co Ltd, “enduring steps” in a preordained series of transactions cannot be disregarded. Applying that approach to this case, a distribution received by Bupa Finance plc from CX Re must be respected as such: the contractual payment made out under the earn-out arrangement did not denature the distribution by CX Re.  Neither could these payments be ignored and simply treated as a payment by CX Re to Tawa plc. But the real question to be addressed was whether Bupa Finance plc had more than a “mere legal shell” of ownership rights to that cash distribution, and the UTT held it did.

The UTT have put down a very strong marker as to the limits of the Ramsay argument. This may be the first significant defeat of HMRC in recent litigation where they have deployed Ramsay against tax avoidance schemes. 

There is a crumb of comfort to HMRC in para 89.  The share purchase agreement required the purchasers to pay on any dividend within 10 days and did not fetter in any way the purchasers’ use of the cash in those 10 days. The UTT stated “of course it might be a very different analysis if the facts were that BUPA had no access to any benefits of ownership of the cash for the 10 days... If these were the facts we would ignore any features of a transaction that sought to disguise the absence of the “benefit” of ownership.” The UTT also suggested that HMRC had mounted too narrow an argument.

Tax avoidance motive

HMRC also attempted to advance the argument that the claim for consortium relief should fail because Bupa Finance plc’s sole motive in acquiring its 46.18% holding in CX Re was tax avoidance. This argument was thrown out by the UTT on the basis that nowhere in any of the relevant provisions was there any mention of “purpose”.

We anticipate that HMRC will appeal this decision.