In A and T Hancock v HMRC [2017] EWCA Civ 198 (25 May 2017), the Court of Appeal found that a scheme intended to operate as a reorganisation within the scope of TCGA 1992 ss 126 to 130 should be treated as two separate conversions, so that the gain did not disappear ‘in a puff of smoke’.
Mr and Mrs Hancock had sold the entire share capital of their company, Blubeckers Ltd, to another company and the consideration had consisted in loan notes issued by the purchasing company. The loan notes provided for a repayment in US dollars at an exchange rate other than the one prevailing at the date of redemption. They were therefore not qualifying corporate bonds (QCBs) for the purpose of TCGA 1992 s 117. The sale agreement also included provision for further consideration, depending on the subsequent performance of Blubeckers Ltd. The couple received further loan notes under this provision. These further notes initially also included a provision enabling the noteholders to require repayment in US dollars; however, that provision was removed by deeds of variation, with the result that these further notes did constitute QCBs. Both sets of loan notes were then exchanged for two secured discounted loan notes, which were QCBs and were eventually redeemed for cash.
The issue was whether the redemption of the loan notes had generated a chargeable gain in respect of the capital gain accruing on the total value of the secured discounted loan notes or only on a small proportion of that value. This depended on the interpretation of TCGA 1992 s 116. The Hancocks contended that there had been only one conversion, so that the original gain (realised on the disposal of the shares) had been rolled into exempt QCBs.
The Court of Appeal first noted that the reorganisation provisions did not apply directly to the transaction, because the input side (what goes in) of a reorganisation can only include shares and is therefore fiscally homogeneous. It added, however, that s 132(1) provides for the applications of ss 127 to 131 ‘with any necessary adaptations’ in relation to the conversion of securities. The court therefore wondered whether, in a conversion of securities, as distinct from a reorganisation, it is permissible to aggregate securities together, so that the input side of a conversion may include both taxable and exempt securities. When considering whether this was the right approach, it examined the impact of permitting the aggregation of fiscally different inputs on the operation of the scheme as a whole.
If the Hancocks’ argument was correct, transactions which include QCBs and non-QCBs on the input side and QCBs on the output side are excluded from the operation of s116 by s 116(1)(b). The effect would be that the chargeable gain which had accrued on the non-QCBs would escape CGT altogether. This would be, as Neuberger J put it in Jenks [1997] STC 853, ‘contradictory to the evident purpose of the relevant statutory provisions’. This was therefore not the right reading of s 116. This unsuitable result would, however, not be possible if the conversions of QCBs and non-QCBs were treated separately because of their different tax status, as s 116(1)(b) would not block the application of s 116 to those separate transactions. This was justified as a ‘necessary adaptation’.
Why it matters: Lord Justice Floyd accepted that the drafting of s 116(1) is anomalous. However, he considered that s 116(1)(b) is an ‘isolated drafting anomaly inconsistent with the rest of the scheme’ and that it should not be ‘determinative of the proper interpretation of the statutory scheme, in a way which is completely contrary to its overall purpose’.
In A and T Hancock v HMRC [2017] EWCA Civ 198 (25 May 2017), the Court of Appeal found that a scheme intended to operate as a reorganisation within the scope of TCGA 1992 ss 126 to 130 should be treated as two separate conversions, so that the gain did not disappear ‘in a puff of smoke’.
Mr and Mrs Hancock had sold the entire share capital of their company, Blubeckers Ltd, to another company and the consideration had consisted in loan notes issued by the purchasing company. The loan notes provided for a repayment in US dollars at an exchange rate other than the one prevailing at the date of redemption. They were therefore not qualifying corporate bonds (QCBs) for the purpose of TCGA 1992 s 117. The sale agreement also included provision for further consideration, depending on the subsequent performance of Blubeckers Ltd. The couple received further loan notes under this provision. These further notes initially also included a provision enabling the noteholders to require repayment in US dollars; however, that provision was removed by deeds of variation, with the result that these further notes did constitute QCBs. Both sets of loan notes were then exchanged for two secured discounted loan notes, which were QCBs and were eventually redeemed for cash.
The issue was whether the redemption of the loan notes had generated a chargeable gain in respect of the capital gain accruing on the total value of the secured discounted loan notes or only on a small proportion of that value. This depended on the interpretation of TCGA 1992 s 116. The Hancocks contended that there had been only one conversion, so that the original gain (realised on the disposal of the shares) had been rolled into exempt QCBs.
The Court of Appeal first noted that the reorganisation provisions did not apply directly to the transaction, because the input side (what goes in) of a reorganisation can only include shares and is therefore fiscally homogeneous. It added, however, that s 132(1) provides for the applications of ss 127 to 131 ‘with any necessary adaptations’ in relation to the conversion of securities. The court therefore wondered whether, in a conversion of securities, as distinct from a reorganisation, it is permissible to aggregate securities together, so that the input side of a conversion may include both taxable and exempt securities. When considering whether this was the right approach, it examined the impact of permitting the aggregation of fiscally different inputs on the operation of the scheme as a whole.
If the Hancocks’ argument was correct, transactions which include QCBs and non-QCBs on the input side and QCBs on the output side are excluded from the operation of s116 by s 116(1)(b). The effect would be that the chargeable gain which had accrued on the non-QCBs would escape CGT altogether. This would be, as Neuberger J put it in Jenks [1997] STC 853, ‘contradictory to the evident purpose of the relevant statutory provisions’. This was therefore not the right reading of s 116. This unsuitable result would, however, not be possible if the conversions of QCBs and non-QCBs were treated separately because of their different tax status, as s 116(1)(b) would not block the application of s 116 to those separate transactions. This was justified as a ‘necessary adaptation’.
Why it matters: Lord Justice Floyd accepted that the drafting of s 116(1) is anomalous. However, he considered that s 116(1)(b) is an ‘isolated drafting anomaly inconsistent with the rest of the scheme’ and that it should not be ‘determinative of the proper interpretation of the statutory scheme, in a way which is completely contrary to its overall purpose’.
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