Do we have a judicial anti-avoidance rule?

Posted by Jennifer at 09:30 on 19 Apr 2016


Following the recent decision of the Supreme Court in UBS AG v HMRC and DB Group Services Limited v HMRC [2016] UKSC 13, it is clear that the Supreme Court is quite happy to advance a far-reaching purposive approach to construing tax legislation where it believes that tax avoidance is the main purpose of those arrangements.

The facts in brief

In 2004, two banks entered into similar (but not identical) arrangements designed to take advantage of the “restricted securities” legislation. Each bank set up a scheme whereby a company was set up merely for the purposes of the scheme, which undertook no activities beyond its participation in the scheme. The articles of these companies contained conditions designed to comply with the “restricted securities” legislation and shares were to be allocated to specified employees in lieu of an annual bonus.

In both cases, once the exemptions from income tax conferred by the sections of the “restricted securities” legislation had accrued, the shares were redeemable by the employees for cash.

This loophole was in fact closed by anti-avoidance legislation in Finance Act 2004 so the particular scheme details are really only of historical interest. However, what was of far greater importance was the way that the Supreme Court decided the case.

The Supreme Court decision

The Supreme Court followed a completely different approach from the Court of Appeal who had applied a literal interpretation to the tax legislation in question. In fact, they followed the approach of the very first court to look at the matter (although in rather more forensic detail!).

Firstly, the Supreme Court decided that it was necessary to adopt a purposive approach to the wording in question. In their view, it was likely that intermediate transactions devoid of business or commercial purpose, as well as commercially irrelevant contingencies, should be disregarded (although naturally each case should be decided on its facts).

Secondly, since the context of the legislation contained in Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) was to facilitate employee share ownership and the “restricted securities” legislation was brought into effect to tax the actual economic gains realised by employees, Parliament had not intended to encourage by exemption from tax the award of share to employees for no purpose other than the obtaining of the exemption and that accordingly the specific exemption relied upon by the banks and their advisers was to be limited to conditions having a business or commercial purpose and did not apply to commercially irrelevant conditions the only purpose of which was the obtaining of the exemption.

Finally, the court decided that the restrictive conditions used by the banks were not “restricted securities” within the meaning of the legislation and that the employees fell to be taxed on their shares in accordance with ordinary taxation principles (although the court held that the employees could take account of the effect that the scheme conditions would have had on the actual value of the shares so the tax was based on their true value).

This analysis clearly follows the cases of Ramsay and Grays Timber with a purely purposive approach to the interpretation of tax legislation.

What does this mean?

Our view is that the Supreme Court’s analysis looks a lot like a judicial anti-avoidance rule.

However, one could argue that this Supreme Court approach is not naturally an HMRC approach which makes things difficult for companies/clients and their advisers. Naturally, this will be a concern for city accountants dreaming up complicated schemes for their clients. However, our view is that the right approach must be to “Keep it simple, stupid”

What does “Keep it simple, stupid” mean in practice? Well, the best advice must be to use the tried and tested HMRC-recognised share plans such as Enterprise Management Incentives (EMI) and Company Share Option Plan (CSOP). Secondly, be mindful of situations where valuation is being manipulated in the context of growth shares where HMRC are likely perhaps to take a keener interest in the future. The reasoning used by the Supreme Court above could easily strike down some of the more aggressive growth share arrangements.

Finally, this case gives a clear indication of where the Supreme Court might be heading in the Rangers case.