The FTT’s recent decision in the case of Osmond and ors v HMRC [2024] UKFTT 00378 (TC) is a noteworthy addition to the ongoing debate on what is an “unallowable purpose” in entering into a transaction which results in a tax benefit. 

The case concerned the application of the main purpose test in the Transactions in Securities (TIS) anti-avoidance rules. The crux of the FTT’s decision was that because the appellants sought to benefit from relief from Capital Gains Tax (CGT) on the disposal of shares through the Enterprise Investment Scheme (EIS), by default, they had a main purpose of obtaining an income tax advantage. That being the case, they were caught by the TIS anti-avoidance rules.

The appellants were serial entrepreneurs who had made successive investments over the years. The appellants had subscribed for shares in a company, Xercise Ltd, in 1996 and 1998 under the EIS. The EIS is a tax incentive investment scheme which enables investors to sell their EIS shares free of CGT provided that the shares have been held for at least three years.

The business of Xercise Ltd was unsuccessful and was sold in 2002 but the company was retained by the appellants because the shares they held in the company qualified for the benefits of the EIS. The company was then subsequently used to invest in another business, the Pearl life assurance and pension group. It was clear that all of these transactions were structured specifically because the appellants wanted to retain the CGT relief that attached to their shares. The Pearl business proved to be much more successful and so, by the mid-2010s, the appellants were holding CGT-exempt shares that were sitting at a sizeable gain.

At that time, the appellants became concerned that the benefits of the EIS could be removed and they would not be able to obtain relief on their gains. Accordingly, in order to crystallise their gain, the appellants entered into a buyback of their shares and argued that the consideration they received on the shares was a return of capital fully exempt from CGT (by reason of EIS disposal relief). 

HMRC did not dispute that EIS disposal relief was available. Instead, HMRC issued counteraction notices and assessments under the TIS regime on the basis that the arrangements were intended to secure an income tax advantage. 

Broadly, the TIS rules will recategorise a transaction in securities as a distribution which is subject to income tax, when the main purpose, or one of the main purposes, of the transaction is to obtain an income tax advantage. The legislation defines an “income tax advantage” as occurring if the CGT payable on the relevant consideration is less than the income tax that would have been payable if that consideration had been paid by way of a qualifying distribution (such as a dividend).

Accordingly, the question for the FTT was whether the appellants had a main purpose of obtaining an income tax advantage in entering into the share buyback transaction. It is a well-established principle that this is a subjective test, based on evidence of the actual intentions of the taxpayer at the time.

As noted above, the appellants were clearly seeking to realise the value of the business without a CGT charge and the FTT found, as a fact, that the appellants entered into the share buyback at that time, over a concern that the EIS disposal relief that attached to their shares might be withdrawn following a change of government. The FTT rejected HMRC’s argument that the appellants subjectively had a main purpose of seeking an income tax advantage.

Notably, the FTT also found that the appellants did not need to extract value from the company, and so taking a dividend from the company (which would have attracted income tax) was not a suitable alternative transaction and was not something that the appellants would have done – it would not have achieved their aim of crystallising the CGT relief on the disposal of the shares. In fact, the FTT agreed with the appellants that it would have been “bonkers” (paraphrasing the appellants’ evidence) for them to have structured the transaction in any other way.

Having found that, subjectively, the appellants did not have income tax in mind when the transaction was structured and that, as a matter of fact, it would not have made any sense to have taken a dividend instead, you might imagine that would be the end of the matter, and the appellants’ appeal would succeed. However, the FTT were swayed by an alternative argument from HMRC, which they noted they “had not seen made by HMRC in any previous case” and which initially “caused the judge to raise a quizzical eyebrow”. HMRC argued that as the appellants had stated unequivocally that their purpose in entering into the share buyback was to secure EIS disposal relief, it followed as a matter of law that they had a main purpose of obtaining an income tax advantage. 

This is because the definition of “income tax advantage” in the legislation captures any situation where the CGT payable is less than the income tax that would have been payable had there been a distribution from the company instead, such as a dividend. Counter-intuitively, therefore, to seek EIS relief was, by definition, to seek an income tax advantage, whether or not the taxpayer would in fact ever have received a dividend in the absence of these arrangements.

Previous case law has stressed the need for the taxpayer to have given conscious thought to an alternative transaction. In this case, the FTT had already found that the appellants had not consciously considered entering into any alternative transaction (as it would not have made any sense for them to do so), but that did not matter. The FTT found that the “alternative transaction” was already built into the definition of income tax advantage – the actual transaction is compared against an equivalent “qualifying distribution”. Surprisingly for a test that depends on purpose and motive, whether the appellants had any intention of carrying out this transaction in place of an income transaction, or whether they even considered such an income transaction in any form whatsoever, was “neither here nor there”. 

Essentially, the FTT found that because the appellants sought to benefit from EIS tax relief then “as a matter of remorseless statutory logic” they had a main purpose of obtaining an income tax advantage and were caught by the anti-avoidance rule in the TIS regime. The FTT acknowledged that this effectively made the anti-avoidance rule a deeming provision, “limited only by the availability of distributable reserves”.

The FTT clearly appreciated that this was a surprising result and justified its decision by reasoning that the TIS regime “deliberately casts its net very widely” and so any scheme which converts income into capital would be caught. However, even that explanation betrays the difficulties with the FTT’s conclusion. If the TIS regime is intended to catch schemes that convert income into capital, then it is difficult to see why the regime should apply when, on the FTT’s own factual findings, the appellants did not have income tax in mind and there was no alternative transaction under which income would have been received.

Main purpose tests are a standard feature of the anti-avoidance rules that overlay the UK tax code, and they are designed to prevent taxpayers from artificially structuring their transactions to gain access to a benefit to which they would not otherwise be entitled. It would be concerning if they were used to block taxpayers from taking advantage of an available relief (such as EIS disposal relief) and, even more so, if an avoidance intention can be deemed, contrary to a taxpayer’s actual intention. 

Nor is it obvious in this case why the definition of an “income tax advantage” should deem anything in relation to the motive of the appellants. Whether or not (as a matter of remorseless mathematics) the tax paid is less than the rate of income tax applied to a particular sum, does not appear to alter the fundamental question of whether or not a taxpayer was motivated to secure that difference. It is surely the aim of a purpose test to ascertain the intention of the taxpayer.

Part of the issue in Osmond may be that the appellants clearly were structuring arrangements in order to pay less tax. It may not have helped that the FTT could not see any commercial motivations. The argument might also be made that it would have been “bonkers” to pay a dividend, in part, precisely because the appellants did not want to pay income tax. It was not unreasonable for the FTT to take into account that, in seeking to mitigate their CGT liability, the appellants chose a mechanism that would not attract income tax. 

Again, it is difficult to see that as being sufficient and, in any event, the FTT’s factual findings are clear: there was no subjective intention to avoid income tax. 

In addition, the FTT mentions, but does not focus on, a different point which is that the real purpose of the arrangements was to take capital out of the company early in order to avoid a potentially worse tax treatment in the future (e.g. as a result of a new government withdrawing relief at some future date). This demonstrates that the actual comparator transaction was not an income transaction but, rather, it was to do nothing until the appellants would have sold the shares in the ordinary course. That, however, is not an avoidance transaction (let alone income tax avoidance). There cannot be a purpose of avoiding a tax that may, but does not yet, exist.

Osmond is also significant because it comprises one of a spate of cases on purpose recently, notably Wroe, Rimmer and Timms v HMRC and Assem Allam v HMRC [1] in the TiS sphere, and the Court of Appeal decisions in BlackRock Holdco 5, LLC v HMRC, Kwik-Fit Group Limited & Ors v HMRC [2] and JTI Acquisition Company (2011) Ltd v HMRC which were concerned with a similar anti-avoidance provision in the loan relationship rules. 

Note the provisions in these cases are new but the surge in case law in this area may reflect the fact that purpose tests are increasingly a staple in legislation and HMRC are prepared to use them in a way that they have not in the past. In particular, HMRC have been seeking to apply these tests in a literalistic way (as is the case here). There has been a divergence of views across the Courts as to how these tests should be applied, with perhaps more willingness in some of the senior courts to consider the wider commerciality of arrangements. This has given rise to some different results across broadly similar cases. 

Of course, some variance is to be expected given that these are meant to be subjective tests which turn on the particular facts of each case. That means that one transaction can fall foul of the rule while a similar one does not, based on the intention of the taxpayer. Indeed, the decisions often seem to turn on quite small differences, such as the performance of witnesses, how the contemporaneous written evidence stacks up, and how a transaction is described. The case law does, however, still put the taxpayer’s subjective purpose at the centre of any assessment and remains guided by understanding the nature of any comparator transaction. Within that context, the decision in Osmond – which found that the taxpayer’s actual intention in entering into the transaction was immaterial – appears to be taking a conspicuously different route. 

[1] See our article on Wroe and Allam here: Memories fade but documents are forever - evidence and the main purpose test - Macfarlanes

[2] See our articles on BlackRock and Kwik-Fit here: BlackRock and Kwik-Fit in the Court of Appeal – where do they leave us? - Macfarlanes and here: Transfer pricing and unallowable purpose: back to BlackRock - Macfarlanes