Income tax risk on M&A transactions and corporate restructuring

How Transactions in Securities (TiS) rules increase income tax risk on M&A transactions and corporate restructuring

Most shareholders presume that the disposal of shares will give rise to gains within the capital gains tax (CGT) regime. Capital gains are subject to tax at rates of 20% for most taxpayers, but 10% for basic rate taxpayers and those benefitting from Business Asset Disposal Relief (formerly Entrepreneurs’ Relief). These favourable tax rates can be contrasted with the dividend income tax rates of up to 39.35%, which could otherwise apply on profit extraction from a company. This difference in tax rates often means shareholders have an incentive to turn what would be an income return into a capital return. However, the Transactions in Securities (TiS) rules are designed specifically to allow HMRC to counteract tax advantages arising from certain such transactions. A recent tax tribunal case has now also provided an important reminder of how these rules give rise to income tax risks for shareholders and could result in consideration on a corporate transaction or restructuring being taxed as income rather than capital.

When do the provisions apply?

The TiS rules can apply to “transactions in securities”, widely defined to include share transactions of whatever description, involving a “close company” (i.e. controlled by five or fewer participators or any number of participators who are also directors). A large proportion of privately owned and private equity backed companies are likely to fall within this definition of a close company.

The rules will, generally, apply where the following conditions are met:

• A person is a party to a transaction, or transactions, in securities;
• The person receives “relevant consideration” in connection with the transaction and does not bear income tax on the consideration (this can also apply to indirect consideration);
• One of the main purposes of the transaction is to obtain an income tax advantage; and
• A person actually obtains an income tax advantage in consequence of the transactions.

There are circumstances where the TiS rules would not apply, such as where the transaction results in a fundamental change in ownership of the company with the original shareholders not controlling 25% or more of the share, voting, or distribution rights after the transaction in securities.

Where a transaction is caught under the TiS rules, HMRC can issue a counteraction notice within a six year period to assess the amount of the income tax advantage. This income tax advantage will usually be the difference between the income tax that would have been incurred had the relevant consideration been a qualifying distribution (i.e. a dividend) and the CGT that actually was incurred on that consideration.

This can result in a difference in the rate of taxation for additional rate taxpayers on consideration received in a transaction of 19.35% (or 29.35% if covered by Business Asset Disposal Relief) which, depending on the circumstances, could impact the commercial viability of the transaction.

It is often advisable that parties to a transaction apply to HMRC under the statutory clearance procedure. Successful clearance will usually involve HMRC confirming that they are satisfied that one of the main purposes is not that of obtaining an income tax advantage and therefore the TiS rules do not apply to a transaction. It may be possible to place some reliance on these assurances where all material facts have been disclosed to HMRC.

While clearance is typically recommended, this requires time and forward planning as HMRC have up to 30 days to respond to any clearance application and, if the clearance application is not sufficiently detailed for HMRC to give an opinion then further questions may be asked by HMRC, resetting the 30 day clock. On many M&A transactions a 30 or 60 day process to obtain clearance may not be commercially viable where the parties need to move quickly to complete a transaction. Advance planning where the rules are potentially in force is key to ensuring the clearance process does not become a commercial issue on completing the transaction.

What do we learn from recent case law?

The recent case of Osmond & Anor v HMRC [2024] UKFTT 378 (TC) underlines the breadth of the TiS rules. The taxpayers in this case were investors who subscribed for Enterprise Investment Scheme (EIS) shares which were disposed of to crystalise capital gains which, being EIS shares, were fully exempt from CGT.

In this case, the disposal was a transaction in securities, concerning a close company, and it was accepted that this gave rise to an income tax advantage under the legislation. It is clear from how an “income tax advantage” is defined in the legislation that you assess the capital gains tax position against the income tax position on a hypothetical qualifying distribution, whether that distribution is realistic or not.

The main question was whether there was a main purpose of obtaining that income tax advantage. The tribunal noted that a claim for a CGT relief “is necessarily an income tax advantage and so the main purpose of obtaining that relief must also necessarily be a main purpose of obtaining that income tax advantage.” This formulation, interestingly, raises issues for any taxpayer entering into a transaction in securities where the main purpose is to utilise a CGT relief or realise a CGT advantage. The reasoning of the tribunal in this case seems to then indicate that such taxpayers are likely within the ambit of the TiS rules.

The taxpayers in the case had not sought advance clearance from HMRC and ultimately, the tribunals findings resulted in HMRC assessments of over £6m being upheld on amount which the taxpayers would originally have expected to have given rise to no tax being payable.

The case is an important success from HMRC on the application of the motive test in the transactions in securities rules as, in a number of other recent challenges, HMRC have been unsuccessful in arguing that a taxpayer has a main purpose of obtaining an income tax advantage. HMRC may well use the findings in this case a springboard for further challenges under the TiS rules.

How can Moore Kingston Smith help?

In any transaction potentially within the scope, including M&A transactions and corporate restructurings, it is important that taxpayers consider the application of these rules at an early stage. Where possible we would recommend statutory clearance is sought from HMRC and careful consideration should be given to the content of such clearance requests to avoid potential delays.

Where, due to time or commercial pressures on a transaction it is not feasible to obtain clearance in advance detailed advice should be taken by taxpayers on the application of the rules such that taxpayers can fully understand the potential risk of challenge and financial impact. In the right circumstances, where clearance cannot be obtained, specific tax risk insurance might be able to be considered to mitigate potential risk.

The transactions in securities rules comprise a complex set of anti-avoidance provisions and the above is only intended to provide a brief overview of their main features. The rules can give rise to substantial and unforeseen tax liabilities, so it is important for shareholders to consider these risks and weigh up whether they should apply to HMRC for statutory clearance. If you would like to discuss these rules and how you should approach the income tax risks, please get in touch with our transactional tax experts.