Extra care and specialist advice should be taken when dealing with commercial transactions that may have adverse consequences
In Bostan Khan v HMRC [2021] EWCA Civ 624, the Court of Appeal found that Mr Khan was held liable to pay income tax of almost £600,000 on £1.95m that was paid into his bank account and then paid out again almost immediately in respect of connected share sale and buy-back transactions.
He found himself in that situation because he relied upon an assumption that the consequence of his having to expend the £1.95m as soon as it was received, was that the persons to whom he paid it would be liable to pay tax on it instead of him.
The facts of the case are as follows.
Mr Khan agreed to purchase a cash-rich company. Its owners (the vendor shareholders) wished to avoid the unfavourable tax treatment of taking a pre-sale dividend.
Mr Khan bought the entire issued share capital of 99 shares from the shareholders for £1.95m in cash, plus an amount equal to the net book value, ie £18,771. Then, less than 40 minutes later, the company bought back from Mr Khan 98 of those shares for cash consideration of £1.95m, leaving him with one share.
The substance of this back-to-back transaction was that Mr Khan acquired the company and became its sole shareholder at a personal cost to him of £18,771 (though the price he paid was £1.95m more than that), and the vendor shareholders between them received a sum equal to the value of the company's distributable reserves.
HMRC raised an income tax assessment of almost £600,000 on the £1.95m on the basis that Mr Khan did not meet the qualifying five-year ownership condition for a purchase of own shares to be treated as a capital disposal.
The appeal put forward by Mr Khan was that the sale and buyback should be treated as a single composite transaction and consider its overall effect, rather than concentrating on the machinery by which it was effected (ie the legal steps in the chain). In substance and in truth, Mr Khan was no more than a conduit for the selling shareholders to effect the buyback of the 98 shares themselves and his intermediate role in that aspect of the transaction should be ignored.
As a matter of practical reality, the 98 shares were never Mr Khan's to do with as he pleased, nor were the buyback proceeds. He never had the benefit of nor control over the £1.95m, and it was ‘absurd’ to tax him on that sum, all the more so if the selling shareholders were liable to pay CGT on that sum (less their cost of acquiring the shares). So the appeal was on the grounds that the upper tribunal should take a purposive, Ramsay approach and look at the sale and buyback of the shares as a single composite transaction.
However, the upper tribunal did not agree with this argument; the share sale and the share purchase were executed as separate agreements and advised on separately. It concluded that the proceeds of the share buyback were not to be regarded as belonging to the vendor shareholders; that proposition was unsustainable both legally and factually.
As the selling shareholders had sold their shares to Mr Khan and only the shareowner could receive a distribution, it was clear that Mr Khan received the distribution and was entitled to receive it. The appeal was therefore dismissed.
Lady Justice Andrews has stated in her opening line a very important reminder: ‘This is a cautionary tale, which illustrates all too graphically the importance of seeking specialist tax advice before entering into commercial arrangements that might have adverse tax consequences, however remote that risk might appear.’
ACCA has guidance on Company purchase of own shares (including guidance on the tax treatment).