Main purpose and inevitable effects

The Upper Tribunal has overturned the decision of the FTT in Osmond and Allen v HMRC [2025] UKUT 183. The FTT had held that, for the purpose of the transaction in securities anti-avoidance provisions, the fact that the taxpayers had a main purpose of crystallising the CGT exemption on their shareholdings (being concerned that a change of government might remove the benefit) necessarily meant that they also had a main purpose of obtaining an income tax advantage based on a reading of the relevant definition of “income tax advantage”. The Upper Tribunal has now held that obtaining an income tax advantage in these circumstances was merely an effect of the transaction and not a main purpose.

Background

The taxpayers were two of a number of shareholders in Xercise Ltd. Their investment in the company (originally made in 1996) was made with the benefit of EIS relief. Throughout their period of ownership, they had been careful to ensure that they continued to benefit from EIS relief, including CGT exemption. In 2015, the taxpayers became concerned that a change of government might remove their ability to continue to benefit from EIS relief. Therefore, in order to preserve their relief, they entered into arrangements with the company to buy back their shares. As the consideration for the buyback was capital and benefitted from EIS relief, no CGT was payable.

HMRC later enquired into the taxpayers’ returns and considered that they were subject to the transactions in securities anti-avoidance provisions, issuing counteraction notices.

On appeal to the FTT, the FTT accepted that the taxpayers did not have a conscious, subjective motive of obtaining an income tax advantage as required by ITA 2007 section 684(1)(c). Their purpose was to crystallise the CGT relief on their shareholdings. However, the definition of “income tax advantage” (section 687(1)) stated that “a person obtains an income tax advantage if (a) the amount of any income tax which would be payable by the person in respect of the relevant consideration if it constituted a qualifying distribution exceeds the amount of any capital gains tax payable in respect of it or (b) income tax would be payable by the person in respect of the relevant consideration if it constituted a qualifying distribution and no capital gains tax is payable in respect of it”.

The FTT accepted HMRC’s argument that since the main purpose of the arrangements was to obtain the CGT benefit, it necessarily followed (“as a matter of remorseless statutory logic”) that a main purpose was also to obtain an income tax advantage as that term is defined in the legislation, since the amount of income tax which would have been paid had the consideration been paid out by way of a distribution was always going to exceed the CGT payable on the consideration in the light of the benefit of EIS disposal relief. “So, it must necessarily follow that if you have as a main purpose, the obtaining of EIS relief, you must necessarily have as a main purpose, the obtaining of an income tax advantage. A claim for EIS disposal relief if 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.”

Decision of the Upper Tribunal

The Upper Tribunal has allowed the taxpayers’ appeals in this case.

It was accepted that the taxpayers’ subjective intention was to dispose of their shares in the buyback arrangements and, by claiming EIS relief, pay no CGT. The transaction was structured such that it was a capital transaction (by limiting the amounts paid out to the share premium account), the taxpayers had no need to extract other distributable reserves from the company and would not have contemplated taking value out of the company by way of a distribution.

It was not disputed that the taxpayers obtained an “income tax advantage” as defined in section 687, but that was not a main purpose of entering into the arrangements. The income tax advantage that resulted from the transaction was an effect of those arrangements and not a purpose of them. The Upper Tribunal pointed to the recent guidance on purpose or motive provided by Falk LJ in BlackRock Holdco 5 v HMRC. This stressed that purpose must be distinguished from effect and effects, even if inevitable, are not the same as objects or purposes. The FTT’s conclusion that it followed as a matter of statutory construction that this necessarily involved a main purpose of obtaining the income tax advantage was an error of law.

Comment

This is another decision that bears on the determination of a taxpayer’s motive or purpose when entering into transactions. The FTT had accepted that the test was subjective and also accepted that the taxpayers did not have a subjective motivation of avoiding income tax. However, since the result of their intention to obtain EIS CGT relief on the share buyback inevitably meant that they obtained an “income tax advantage”, the FTT essentially held that they must also be taken to have an intention to obtain that advantage. The Upper Tribunal had now applied the approach of Falk LJ in emphasising that effects must be distinguished from motives or purposes and even inevitable effects do not amount to motive or purpose.