indirect subscriptions of share capital, www.taxjournal.com, May 2014

Analysis
McLocklin: indirect subscriptions
of share capital
SPEED READ McLocklin v HMRC [2014] UKFTT 042
(TC) involved a successful claim for share loss relief
in circumstances where freshly issued shares were
registered in the name of and paid for by a third
party, and then subsequently sold to the taxpayer.
McLocklin shows a court applying taxing statutes in
a non-avoidance context by reference to the totality
of the arrangements entered into. Such an approach
gives practitioners a helpful tool to use in settlement
negotiations with HMRC, as it arguably provides the
parties with an avenue to avoid the dreaded ‘all or
nothing’ classification under HMRC’s inflexible litigation
and settlement strategy.
Perminder Gainda is a senior associate in Herbert
Smith Freehills LLP’s corporate tax group with
experience in M&A, equity capital markets, property
transactions and financing transactions (both
conventional and Islamic financing). Email: perminder.
[email protected]; tel: 020 7466 2472.
Camilla Grundy is a trainee solicitor at Herbert Smith
Freehills LLP, and is hoping to join the tax team upon
qualification in September. Email: camilla.grundy@hsf.
com; tel: 020 7466 2358.
T
he essential outcome of McLocklin was that
a subscription of shares by a third party,
registered in his own name and utilising his
own funds, followed (ten months later) by a sale of
those shares to the taxpayer (M) was treated as a
subscription of shares by M himself. We consider
here why the decision is not as surprising as it first
sounds and why it is to be welcomed outside of the
specific statutory context within which it arose.
Background facts
In 2005, the company in question (GPL) was
suffering from short-term cash flow issues. As
a result, the directors of GPL (W, S, T and M)
agreed that they would each subscribe for a certain
number of shares in GPL and that S, T and M
would provide personal guarantees for GPL’s
overdraft.
However, M could not participate in the
subscription in the same manner as the other
directors as his assets had been frozen in divorce
proceedings. Therefore, W agreed to subscribe for
the 18 shares originally allocated to M, in addition to
his own. To enable these 18 shares to be transferred
to M once his assets were unfrozen, clause 1.3 of
a shareholders’ agreement (between W, S and T)
provided that W was ‘entitled to sell’ these shares to
M within two years. Personal guarantees were still
provided for GPL’s overdraft, as agreed.
In July 2006, W transferred the 18 shares to M for
£46,000 (this amount being equal to the subscription
price paid by W to GPL for those shares). In
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2008/09, the shares became of negligible value. M’s
subsequent claim for share loss relief was refused by
HMRC. M appealed this decision.
Key provisions
The shares in GPL did not qualify for EIS relief.
However, as GPL was a qualifying trading company,
share loss relief was prima facie available to M if
relevant shares had ‘been subscribed for by [M]’
(ITA 2007 s 131). Section 135 further provided that
‘an individual subscribes for shares in a company if
they are issued to the individual by the company in
consideration of money or money’s worth’.
Looking at the narrow facts of the case, it is clear
that it was W who undertook a transaction, the legal
substance of which constituted a subscription of
shares, not M. Despite this, the tribunal allowed M’s
appeal.
Given the surprising result, it is perhaps to be
expected that the manner in which the tribunal
reached its conclusion is of some interest. Before
looking at the details of the decision, we note that the
tribunal’s analysis was an iterative process. However,
for the purposes of this article, we have simplified
that process into two stages.
The wider arrangements
First, the tribunal considered the subscription
by W within a wider factual and legal context by
attempting to understand the exact nature of the
relationship between W and M.
On the basis of the evidence before it, the
tribunal was willing to infer that there must have
been an undocumented agreement in place between
M and W; this agreement entitled M to the shares
acquired by W. The tribunal was particularly
persuaded in this regard by the existence of M’s
guarantee of GPL’s overdraft, i.e. it was reasonable
to assume that M would only have given the
guarantee in return for an entitlement to the shares
in question.
Having determined that M had an entitlement to
the shares, the tribunal next examined the capacity
in which W was acting at the relevant time. As W
had utilised his own funds to acquire the shares,
it was apparent that W was not acting at all like a
nominee or bare trustee of M.
It seems to have been accepted that it would have
been more natural for W to have used his funds for
M’s benefit by lending them to M for M to acquire
and then charge the shares to W pending repayment
of the loan. The existence of M’s divorce proceedings,
however, prevented such an arrangement.
Nonetheless, the tribunal considered that W
had ‘agreed to provide some form of “temporary
accommodation” to [M] by financing the
subscription of [M’s] agreed share allocation’. W
would be obliged to transfer the shares to M upon
being reimbursed the subscription price. Further,
it was held that W had a right to reimbursement of
his £46,000 once M’s divorce was finalised. On this
basis, the tribunal concluded that the arrangement
between W and M was best understood as a security
www.taxjournal.com ~ 23 May 2014
arrangement; the shares that W had acquired were
security for M’s obligation to reimburse £46,000
once M’s divorce was finalised.
cost of subscribing for the shares. Accordingly, M
was held to have subscribed for the shares within
the meaning, and in accordance with the policy, of
ITA 2007 s 135.
‘Subscription’ and its statutory meaning
The second element of the tribunal’s reasoning was
an analysis of the types of transaction that could
satisfy the concept of ‘subscription’, as used within
the context of the share loss relief rules.
The tribunal began by noting HMRC’s acceptance
that an individual could be entitled to share loss
relief without shares actually having been registered
in the name of that individual, where the shares are
subscribed for by that individual’s nominee.
The tribunal, having noted that it was legitimate
to have regard to the TCGA 1992 for the purposes
of determining the appropriate meaning to be
given to the concept of subscription (given that the
relief in question was a CGT relief), then supported
and further expanded upon the above analysis
by reference to other TCGA 1992 provisions. The
first such provision was s 60, which recognises that
property vested in a nominee or bare trustee should
be treated as property vested in the person for whom
he is nominee or trustee. However, it was plain on
the facts that W was no ordinary nominee or bare
trustee of M, meaning his claim for relief would have
failed if he was limited to relying on s 60.
The tribunal then considered s 26, which, for
example, provides that any dealings with an asset
by a chargee should be treated as dealings by the
chargor as though the chargee were acting as the
chargor’s nominee. The tribunal took the view that
its terms suggested that, as a general principle,
security arrangements should be broadly ‘ignored’
for CGT purposes. Therefore, if an advance had been
provided to subscribe for shares and those shares
were issued as security to the lender, that lender
should be treated as subscribing for the shares as the
borrower’s nominee.
The tribunal next examined why share loss
relief is only available for subscriptions of share
capital and not where shares are acquired from
third parties, notwithstanding that losses can arise
in both such cases. The tribunal noted that where
existing shares are acquired, the consideration given
for them represents the value of the company at the
time of the disposal and that the price paid in such
circumstances may not necessarily represent funds
which have flowed into the company and been used
in the course of its trade.
Turning to the facts of the case, whilst M and
W’s arrangement could not be described as a
‘straightforward loan’, having regard to the wider
factual circumstances in which W’s subscription
took place, it was nonetheless substantially similar
to a loan under which W subscribed for the shares
as security for M’s obligation to reimburse £46,000
to W. Furthermore, as M had agreed to participate
in the issue of shares at the outset, he was not
comparable to a usual third party purchaser. The
totality of the arrangements between the parties
meant that M was intended to ultimately bear the
23 May 2014 ~ www.taxjournal.com
NatWest case
The judgment indicates that HMRC had sought
to rely on National Westminster Bank PLC v IRC
[1994] STC 580, where it was held that shares could
not be treated as ‘issued’ because they had not been
registered by a specific date, meaning that claims
for EIS relief failed even though the shares had
been allotted and subscription monies provided
before the relevant date. We assume HMRC cited
this case in part to persuade the tribunal to take a
narrow approach to the question of whether shares
had been subscribed for.
As the taxpayers in NatWest were effectively
involved in an avoidance scheme, it is perhaps
unsurprising that a narrow approach was taken to
the specific question before the courts, since this
ensured that the avoidance scheme failed. It would,
however, be regrettable if that narrow approach
were to deny relief in non-avoidance cases, where
individuals have ultimately borne the subscription
costs associated with shares held by them. Therefore,
the tribunal’s approach appears to accord more
with the underlying purpose of the relevant rules,
namely that of encouraging equity investment in
certain types of companies. This is to be welcomed,
especially at a time when concerns are constantly
being expressed about the unavailability of funding
for UK SMEs.
Final thoughts
It is disappointing that a case such as this, where
the costs of pursuing it would have greatly
outweighed the tax at stake, was taken to the
tribunal. Given HMRC’s current litigation and
settlement strategy (LSS), which precludes HMRC
from exercising discretion not to take cases forward
on the basis of factors such as costs and litigation
risk, this will not be the last time something like
this happens.
However, the case does provide another useful
example of a court applying taxing statutes, outside
of an avoidance context, by reference to the totality
of the arrangements entered into. Such an approach
is legitimate where the scheme of the legislation
suggests that it permissible to look beyond the
discrete steps undertaken by the taxpayer in
determining whether the provision in question is
satisfied.
That a tribunal will not necessarily confine its
factual enquiries to a specific transaction should
always be borne in mind when seeking to negotiate
a settlement with HMRC, as it may well indicate to
the parties that the range of possible tax outcomes
is much wider than it might first appear. Such an
appreciation at an early stage of the dispute/enquiry
would assist in avoiding the dreaded ‘all or nothing’
LSS classification and provide some much needed
flexibility within the LSS confines.
■
For related
reading, visit
www.taxjournal.com
Cases: McLocklin v
HMRC (22.1.14)
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