Legal Briefing

Recent developments in tax case law

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Corporate and commercial | 01 April 2010

The beginning of 2010 has been marked by several important tax cases, which stand out either because they are indicative of the attitude of tax authorities or concern points of law that might have consequences for all taxpayers.

Davies and anor, R (on the application of) v HM Revenue & Customs [2010]

The judgment of the Court of Appeal in Davies, the judicial review application relating to Gaines-Cooper v HM Revenue & Customs [2007], was published in February 2010. Robert Gaines-Cooper is a British-born entrepreneur who claimed that he had left the UK permanently in the 1970s to establish himself in the Seychelles and was no longer resident in the UK. As with all appeals relating to residence matters, the facts of Davies were complicated. Gaines-Cooper was born in the UK and lived in the country as a permanent resident for about 40 years. In the early 1970s, Gaines-Cooper began to loosen his ties with the country through steps such as transferring his UK assets to an offshore trust and acquiring residences abroad, notably in the Seychelles. However, he retained property in the UK and still had personal ties to the country through his wife, who remained a UK resident. From the mid-1970s Gaines-Cooper claimed to be neither resident nor ordinarily resident in the UK. HM Reveue & Customs (HMRC) disagreed with Gaines-Cooper’s claim and issued him with tax assessments covering 1992-2003.

Gaines-Cooper was first heard by the Special Commissioners (as they then were) in 2005 and their decision was appealed in the Chancery Division in 2007. The Court of Appeal’s recent judgment in Davies dealt with the way in which HMRC had applied IR20, its principal published guidance on residence. Gaines-Cooper lost at every stage, and the Special Commissioners and the High Court found that he had been a UK resident during the relevant period. The Court of Appeal held that HMRC’s interpretation of IR20 had been correct and that it had not, as Gaines-Cooper contended, changed its policy in relation to IR20. Gaines-Cooper has received extensive press coverage and public commentary on the decisions by the Special Commissioners, and the High Court has focused on Gaines-Cooper itself, particularly the day-count issue. Commentary on the Court of Appeal’s ruling, however, has presented Davies as an indication that HMRC is becoming tougher on taxpayers, particularly those who claim to be or have been non-resident. Several newspaper articles have argued that Davies is a precursor to the government legislating to define residence in tax law in the forthcoming pre-budget report. It will be interesting to see whether this occurs. In some ways, HMRC might be quite happy to leave things as they are. What law there is in this area is compatible with contentions by HMRC that taxpayers are resident even where they have made some attempts to loosen ties with the UK.

It is interesting that Gaines-Cooper has caused so much comment. Until recently, taxpayers were instructed by HMRC to ignore both their date of arrival in and departure from the UK when calculating their days spent in the country, but the law now states that presence at midnight is counted as a day of residence. HMRC did not apply this rule in Gaines-Cooper, which led to the taxpayer being treated as having spent more days in the UK than he otherwise would have. However, the facts of Gaines-Cooper were not completely in the taxpayer’s favour and it is likely that HMRC believed that it had a good chance of winning. However, it is not necessarily the beginning of the end for expatriates. The decisions in Gaines-Cooper remind tax lawyers and clients alike of the difficulty of predicting the outcome of cases involving residence because they depend on the courts’ interpretation of the facts. They also remind taxpayers that any case involving residence will stand or fall on the quality of evidence that the taxpayer makes available to the court. It is clear that the burden is on the taxpayer to prove that they are not resident and it appears that the courts will favour HMRC where taxpayers are unable to provide sufficient evidence in support of a claim of non-residence. Gaines-Cooper also demonstrates that while HMRC guidance is useful, it can be dangerous to try and interpret it as a tax statute.

While Gaines-Cooper concerned individual residence, it is clear that HMRC has also been looking closely at non-residency claims by companies. The recent decision in Laerstate BV v HMRC [2009] further underlines the crucial role of evidence in residence appeals and it is likely that there will be increased pressure in this area from HMRC in the future.

Grays Timber Products Ltd v HM Revenue & Customs (sCOTLAND) [2010]

The Supreme Court judgment in Grays Timber was published in February 2010 and concerns a specific point of law. Alexander Gibson, managing director of Grays Timber Products Ltd, was allowed to subscribe for shares in his employer’s holding company. The shares subscribed for were of the same class and had the same rights as the exiting issued shares of the holding company. The parties entered into a shareholders’ agreement that provided that Gibson would get a disproportionately large part of the proceeds of the sale of the company. Following an exit, HMRC assessed Gibson on the basis that he had sold his shares for an amount that exceeded their market value and that this excess amount was taxable as income. The Supreme Court held that the rights that Gibson benefited from under the shareholders’ agreement were not applicable to the shares or an assessment of their market value. Grays Timber is interesting because HMRC presented an argument that contradicted its guidance for taxpayers, which states that rights under a shareholders’ agreement are taken into account in determining the market value of shares. As in Gaines-Cooper, the applicability of guidance to all cases is called into question. This is especially worrying in Grays Timber because legislation on shareholder agreements is complex and the purpose of HMRC guidance is to give taxpayers some certainty about what is taxable. Where HMRC undertakes legal arguments in contradiction of guidance available to the public, a considerable amount of uncertainty will be created among taxpayers.

Grays Timber confirms that including enhanced shareholder rights in a company’s articles of association, where applicable, will be better from a tax point of view. In addition, the rights should be drafted to ensure that they will continue to apply following a sale. This would justify the purchaser in paying more for the relevant shares and should prevent an argument similar to that in Grays Timber. It is likely that there are many companies and taxpayers that will have to review existing arrangements in light of the judgment. Whether existing arrangements can be restructured to avoid a charge will depend on the value of the right when the arrangement is restructured. Restructuring may prove difficult where that value is high. It might be worth considering an argument that rights, such as those held by Gibson in Grays Timber, were a security for the purposes of the charging legislation. Gibson was prevented from putting forward this argument because it had not been made early enough in the appeals process. Where this argument is accepted, many of the unpleasant consequences for the taxpayer, as seen in Grays Timber, may be avoided. Whether the argument would be successful is likely to depend on the drafting of the rights in the shareholders’ agreement. Although the argument is attractive, appellants are unlikely to want to be the first to test such an approach in court.

BAA Ltd v HM Revenue & Customs [2010]

BAA is an important case that considers the ability of acquisition vehicles to recover VAT on M&A transactions. The facts of BAA are complex but essentially relate to whether the bid vehicle in Ferrovial’s takeover of BAA plc (BAA), Airport Development and Investments Ltd (ADIL), was entitled to recover approximately £6.7m of input tax on advisory fees that it incurred during the takeover. The professional fees were invoiced between July-October 2006. In September 2006 ADIL joined the BAA VAT group and the representative member of that group reclaimed the input tax incurred by ADIL on the fees.

HMRC assessed BAA for the reclaimed VAT primarily on the basis that there was no direct or immediate link between the supplies on which the VAT was incurred and any taxable supplies made or to be made by the BAA VAT group. HMRC also raised other arguments at the hearing, including the supposition that ADIL did not carry on an economic activity, which is necessary for the recovery of input tax. HMRC also argued that some of the services, such as the provision of financing by banks to fund the acquisition, were only incurred for the purpose of acquiring shares in BAA and did not relate to the group’s business following completion. The First-Tier Tribunal (Tax) found that ADIL was carrying on an economic activity, notwithstanding the fact that it never actually made taxable supplies. This was because ADIL’s activities went beyond the mere acquisition and holding of shares through schemes such as the arrangement of capital expenditure facilities for its subsidiaries. The tribunal also rejected HMRC’s argument that the services could be split into pre- and post-acquisition categories on the basis that ADIL carried on a single activity from its inception. The tribunal held that ADIL:

‘Was conceived as and operated as the highest level of strategic and final direction for the UK airports business within the BAA group.’

Perhaps the most interesting point raised by BAA is that BAA’s appeal was allowed, notwithstanding that ADIL never made any taxable supplies and there was no evidence that it intended to make taxable supplies at the time it received the relevant services. The tribunal overcame this hurdle by applying the decision by the European Court of Justice in Finanzamt Offenbach am Main-Land v Faxworld Vorgründungsgesellschaft Peter Hünninghausen und Wolfgang Klein GbR [2005], holding that ADIL and the members of the BAA VAT group were a single person for VAT purposes and that the supplies made by the BAA VAT group could be imputed on ADIL. Essentially, the input tax incurred by ADIL could be attributed to the taxable supplies made by the BAA group as a result of ADIL becoming a member of that VAT group.

Comment

Any taxpayers that are involved in disputes with HMRC regarding the ability to recover VAT on M&A transactions should reconsider the basis of any assessments in light of the decision in BAA. However, given that current estimates put the amount of VAT at stake following this decision at more than £100m, it is likely HMRC will seek to appeal BAA. Developments in BAA should be carefully monitored by taxpayers involved in similar disputes. BAA also provides a useful reminder of the need to consider the recoverability of VAT on professional services when undertaking an M&A transaction. Clear structures should be implemented to try to maximise the ability to recover VAT incurred in connection with such transactions. This will include clearly defining the role of the acquisition vehicle in the transaction, and, as part of the business in the future, ensuring that relevant documentation reflects its status and that of any third-party advisers.