Judgment summary
Property 118 Limited (P118) and Cotswold Barristers Limited (CBL) appealed against HMRC's allocation, notified on 9 February 2024, of scheme reference numbers (SRNs) under s 311 of the Finance Act 2004 in respect of two sets of arrangements: the substantial incorporation structure (SIS) and the capital account restructure (CAR) (para 1). Both arrangements effect the incorporation of property letting businesses, typically operated by married couples in partnership (para 1).
HMRC contended that SIS and CAR fell within description 5 of the Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2006 (standardised tax products), and that CAR additionally fell within description 3 (premium fee) and/or description 9 (financial products involving contrived or abnormal steps) (para 7).
The Tribunal heard extensive witness evidence over ten hearing days from the appellants' principals, advisers and numerous individual Users of the arrangements, as well as from two HMRC officers (paras 28-31, and Part F Appendix).
The Tribunal concluded that neither SIS nor CAR fell within description 5, that CAR did not fall within description 3, and that CAR did not fall within description 9 (para 27). Accordingly the appeals were allowed and the SRNs cancelled under s 311B(7) FA 2004 (para 187).
Background
SIS and CAR are structures used to incorporate property letting businesses, usually carried on by husband and wife in partnership. Under SIS, the beneficial ownership (but not legal title) of the properties is transferred to a new company (NewCo), with an indemnity from NewCo to the Users in respect of existing mortgage debt, avoiding the need to obtain lender consent or refinance at the point of incorporation (paras 19-20).
CAR comprises the SIS documents plus a 'Bridging Loan element', under which Users borrow short-term bridging finance, lend an equivalent sum to NewCo, and NewCo repays the Bridging Lender, leaving NewCo owing a director's loan to the Users which can later be repaid free of income tax and NICs (paras 21-22).
The arrangements were developed and promoted by Mr Mark Alexander of P118 and Mr Mark Smith of Cotswold Barristers, following the introduction of s 24 Finance (No.2) Act 2015, which restricted deductibility of finance costs for individual (but not corporate) residential landlords (paras 22, 32, 40-42). Users could potentially obtain incorporation relief (IR) under s 162 TCGA 1992, the tax rate benefit of corporation tax rates, and the ability to 'wash out' accrued capital gains (para 22).
HMRC, having become aware of the arrangements, issued SRNs to P118 and CBL as suspected promoters who had not notified the arrangements under the DOTAS rules (paras 3, 24-25).
Core dispute
The central dispute was whether SIS and CAR constituted 'notifiable arrangements' within s 306 FA 2004, which requires that the arrangements fall within a prescribed description, enable a tax advantage, and have obtaining that advantage as a main benefit (paras 4-5).
HMRC argued that SIS and CAR fell within description 5 (standardised tax products) because a promoter made standardised documentation available for implementation by more than one person, with a main purpose or 'but for' test relating to obtaining a tax advantage (paras 9-14). HMRC further argued CAR fell within description 3 (premium fee) on the basis that the Bridging Fee and Brokerage Fee were attributable to the tax advantage obtained (paras 15-16), and within description 9 on the basis that CAR involved contrived or abnormal steps (paras 17-18).
The appellants argued that the documentation required significant tailoring and additional professional advice for each client, such that the standardised tests were not met; that any tax advantages obtained were not the main purpose of the arrangements, which were principally driven by non-tax commercial considerations such as avoiding refinancing, preserving favourable mortgage terms, succession planning and limited liability; and that the fees charged for CAR were ordinary commercial fees for bridging finance, not premium fees attributable to a tax advantage (paras 119-148, 174-178, 181-182).
Court findings
The Tribunal held that the 'informed observer' test under description 5 did not incorporate HMRC's own DOTAS guidance as a matter of law, since that guidance is not law (para 133). Applying the correct legal test, the Tribunal found that the transaction documents used for SIS and CAR were, in substance, standardised or substantially standardised, and that the substantive provisions did not need material tailoring to enable implementation, notwithstanding the considerable preparatory and advisory work undertaken for each client (paras 129-136).
However, on the main purpose test under para 10(2)(d) of the Regulations, the Tribunal found that the appropriate comparator for assessing whether a 'tax advantage' arose was an economically similar incorporation involving a refinancing of existing debt, not simply non-incorporation (para 150). On that basis, SIS enabled a tax advantage in obtaining incorporation relief (IR) in full, but the informed observer could not reasonably conclude that this, or any of the other tax benefits, constituted the main purpose of SIS, given extensive evidence of significant non-tax commercial reasons for incorporation and for avoiding refinancing (paras 151-166).
Similarly for CAR, the Tribunal found that obtaining the CAR tax benefit and CAR IR benefit was a main purpose but not the main purpose of the arrangements, given evidence of a genuine commercial purpose in preserving access to previously taxed capital (paras 167-173). The 'but for' test was also not satisfied (para 173).
On description 3, the Tribunal found that the Bridging Fee and Brokerage Fee were not, to a significant extent, attributable to the CAR tax advantage, but were ordinary commercial fees for the provision of short-term unsecured finance (paras 179-180).
On description 9, the Tribunal found that the steps comprising the Bridging Loan element were not contrived or abnormal, as they achieved by lawful and commercially rational means (short-term third-party finance and director's loans) the same underlying purpose as conventional capital withdrawal before incorporation (paras 183-185).
The Tribunal also found, on the reliability of witness evidence, that although P118's process for soliciting witness statements fell short of best practice, the individual witnesses were overall honest and credible when assessed against cross-examination and the wider evidence (paras 261-263).
Outcome
The Tribunal allowed the appeals of both P118 and CBL, holding that the requirements for descriptions 3, 5 and 9 of the Regulations were not satisfied in relation to SIS and/or CAR (para 187). Pursuant to s 311B(7) FA 2004, the Tribunal cancelled HMRC's decision to allocate the scheme reference numbers (para 187). The parties were notified of the right to apply for permission to appeal within 56 days (para 188).
Major issues / areas of contention
- Whether SIS and CAR fell within description 5 of the Regulations (standardised tax products), including whether the transaction documentation was 'standardised' and whether its substance required material tailoring.
- Whether the 'informed observer' test for description 5 is to be interpreted by reference to HMRC's own DOTAS guidance, which the Tribunal held was not determinative as a matter of law.
- The correct comparator for identifying a 'tax advantage' under s 318 FA 2004, with the Tribunal preferring a comparison to an economically similar incorporation involving refinancing, rather than to non-incorporation.
- Whether obtaining tax advantages (avoiding s 24 Finance (No.2) Act 2015, incorporation relief, the tax rate benefit, and the CAR tax benefit) was the 'main purpose' of the arrangements, or merely 'a main purpose' among genuine non-tax commercial purposes.
- Whether CAR fell within description 3 (premium fee) on the basis that the Bridging Fee and Brokerage Fee were attributable to the expected tax advantage.
- Whether CAR fell within description 9 on the basis that the Bridging Loan element involved contrived or abnormal steps.
- The reliability of witness evidence from Users of the arrangements, given evidence that P118 solicited and assisted in the preparation of witness statements emphasising commercial (non-tax) motivations.