Corporate Law Update
- HMRC is seeking views on ways to modernise the UK’s framework for tax on share transfers
- The court finds that worked examples of calculations overrode a specific formula in a contract
- The EU paves the way for a new “coronavirus recovery prospectus” regime
- The FRC publishes its first thematic review on company reporting since the start of the Covid-19 pandemic
- The Government publishes guidance on recent changes made to the UK’s merger control regime
- The FCA is proposing to delay the start of reporting under the European Single Electronic Format by one financial year
- The FRC is consulting on changes to FRS 104 to incorporate the going concern basis of accounting
Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.
HM Revenue and Customs has published a call for evidence seeking views on how it could modernise the regime in the UK under which stamp duty or stamp duty reserve tax (SDRT) is charged on transfers of securities.
The call for views follows papers published by the Government and the Office of Tax Simplification (OTS) over the past three years. In another step in the right direction, it builds on recent temporary changes in policy that HMRC has put in place to deal with the Covid-19 pandemic and asks whether these should be retained going forward.
In very broad summary, there are two types of payment requirement that may arise when a person transfers securities, such as shares in a company: stamp duty and stamp duty reserve tax (SDRT).
These taxes should not be confused with stamp duty land tax (SDLT), which is payable on the transfer or creation of an interest in land and which is colloquially referred to as “stamp duty”.
Stamp duty and SDRT are both payable on the transfer of certain types of securities, most notably shares in a UK company.
As noted below, there are some subtle differences in the types of transfer to which each tax applies. However, there is a very large overlap in the types of transaction caught by the two taxes. In effect, the same transaction – for example, the sale and purchase of the shares in a business – will often attract both stamp duty and SDRT.
To avoid a double-payment, the law removes the requirement to pay SDRT if the corresponding amount of stamp duty is paid or the transfer is stamped as exempt from stamp duty. So, in practice, the two taxes usually work in harmony with each other.
However, although the two taxes are very similar, there are a number of differences between them which can make matters unnecessarily and frustratingly complicated:
- Stamp duty is payable on a document that transfers a beneficial interest in securities (usually, an instrument of transfer) and so does not apply to paperless sales, such as sales of listed shares through CREST. SDRT is payable on an unconditional agreement to sell and so applies to both paper and paperless transactions. Indeed, one of the main reasons SDRT was introduced was to cover transfers, such as paperless sales, that do not attract stamp duty.
- Because SDRT is payable on an agreement to sell, rather than the instrument that implements the sale, it often becomes payable earlier in the course of a transaction than stamp duty.
- Stamp duty applies to transfers of “stock” and “marketable securities”, which (generally speaking) includes shares in companies and certain instruments that can be converted into shares in companies. SDRT applies to transfers of “chargeable securities”, which includes certain rights to subscribe for securities that are outside the scope of stamp duty.
- In the main, SDRT does not apply to transfers of shares in non-UK companies. However, in theory, stamp duty can apply to an instrument transferring shares in non-UK companies if the instrument is executed in the UK. Although HMRC’s policy is not to collect stamp duty actively in these circumstances, this detail can lead to transfers needing to be executed “offshore”.
- Both taxes are charged at the rate of 0.5% (or, in certain circumstances, 1.5%). However, stamp duty is payable on the price stated on the instrument and is rounded up to the nearest £5. SDRT is payable on the transaction price and is rounded to the nearest penny. Often the two prices are the same, but they can differ significantly (for example, if the sale involves an earn-out).
- Stamp duty is payable only if the price is payable in cash, marketable securities or the release or assumption of a liability. SDRT is payable on virtually any form of price.
- There are various exemptions from stamp duty and SDRT, but they are not the same for the two taxes. For example, stamp duty is not payable on transfers for £1,000 or less, but SDRT is payable on a transfer at any price or (in very limited circumstances) for no price. Likewise, stamp duty is not payable on transfers of securities within a group a companies, but SDRT (However, as noted above, SDRT will not be due if an exemption from stamp duty is successfully claimed.)
- In addition, apart from a few exemptions, reliefs from stamp duty need to be assessed and confirmed (“adjudicated”) by HMRC, which can cause delays. Generally speaking, exemptions and reliefs from SDRT can be self-assessed by the taxpayer.
- SDRT is payable by the buyer and is mandatory. In the strictest sense, stamp duty is not mandatory and the law does not state who must pay it. However, a “stampable” document cannot be enforced unless it is stamped, and a company registrar or secretary may not register a transfer based on an unstamped instrument (as it is an offence to do so). In practice, therefore, stamp duty is compulsory and is paid by the buyer.
These differences are mostly technical and may seem small, but in practice they can create significant complications. In addition, if a transaction is not configured and documented in the right way, it is possible to create a liability to SDRT which could have been avoided. Finally, administering two separate schemes is naturally burdensome for HMRC.
What is HMRC proposing?
The Government’s view is that it is time for a “fundamental redesign” of the framework for administering and paying stamp duty and (where necessary) SDRT. HMRC is therefore asking for views on how the framework should be re-designed.
HMRC notes that large corporate takeovers represent a significant proportion of stamp duty revenues, but that the time it can take to pay stamp duty can cause unwelcome delays to completing transactions and does not portray the UK in a favourable light as a place to invest.
The Government notes that, because stamp duty and SDRT are interdependent, realistically modernisation of the regime can be achieved only through wholesale change as a longer-term project. In various places, the paper contemplates the possibility of combining the two taxes into a single share transfer tax (which the paper labels “STS”).
HMRC is seeking views on (among other things) the matters set out below.
- Are there any elements of overseas tax systems that could be incorporated so as to make collecting tax on transfers of securities easier?
- Should any elements of the modernisation of stamp duty be prioritised over others?
- What are the potential impacts, benefits and drawbacks of combining stamp duty and SDRT into a single tax?
- Should the stamp duty framework be aligned to the SDRT regime, so that stamp duty is payable on transfers of the same types of securities as SDRT?
- How should the process for notifying payment of stamp duty operate? Should registrars be able to update share registers without having to wait for stamp duty to be paid?
- Should commonly-used reliefs under the stamp duty regime (such as intra-group relief, acquisition relief and reconstruction relief) also apply to SDRT?
- Should any elements of HMRC’s temporary policy for stamp duty during the Covid-19 pandemic (see HMRC’s guidance on completing a stock transfer form) be retained after the pandemic ends? In particular, should HMRC continue to accept electronically signed instruments of transfer?
- What changes should be made to the processes for enforcing and paying stamp duty? Should they be aligned with the corresponding processes for SDRT?
- To what extent should stamp duty be digitised? Should the regime be modernised to dispense with instruments of transfer (such as stock transfer forms) completely? Should it be possible for stock transfer forms to take electronic form?
- What role might smart contracts and distributed ledger technology (DLT) play in stamp duty and share transfers in the future?
What does this mean for me?
The consultation is a welcome next step in the modernisation of share transfer taxes in the UK. That it has taken so long to make progress to date in no small part reflects the complexity of the two different existing systems.
In aligning, streamlining and potentially combining those two systems some valuable aspects of the systems may be lost. However, the prospect of creating a simpler, more efficient and more coherent system must be a step in the right direction.
It is worth noting that several of the possible changes contemplated by the paper would require changes in UK company law. For example, UK law currently does not contemplate that certificated shares (that is, shares that are not held through CREST) can be transferred without an instrument of transfer; section 770(1) of the Companies Act 2006 prevents a company from registering a transfer of certificated shares unless an instrument of transfer is delivered to it. Similar provisions normally appear in a company’s articles of association.
The paper also asks how respondents envisage holding and transferring shares in the future. Again, this is squarely a question of company law, rather than tax law, with any changes requiring amendments to the Companies Act 2006.
This is one reason why we should not expect significant change any time soon.
In addition, the call for views is merely the first step in the established five-step framework for implementing changes to the UK’s tax framework. Following feedback, HMRC will determine the best framework moving forward and draw up a detailed policy design. The Government does not envisage being able to implement any major re-design until Autumn 2021 at the earliest.
The deadline for responding to the call for views should is 13 October 2020.
The High Court has held that worked examples set out in a commercial contract, included to illustrate the results of a formula in the contract, were integral terms and overrode the wording of the formula where there were inconsistencies between the two.
Altera Voyageur Production Ltd v Premier Oil E&P UK Ltd  EWHC 1891 (Comm) concerned a dispute over the interpretation of a formula in the lease of an oil and gas production and storage ship.
Premier had leased the ship question from Altera. Under the contract, Premier was to pay Altera a daily base hire (DBH) fee calculated and amended in accordance with a formula set out in the contract. This was structured as a narrative formula, followed by two worked examples.
However, the narrative formula and the worked examples were not consistent; the worked examples contained two additional steps at the end of the calculation that were not set out in the narrative.
Following the different methodologies in the formula and the worked examples yielded very different results. Altera (using the methodology in the worked examples) claimed it was owed approximately US$12 million. Premier (using the methodology in the formula) argued it owed less and counterclaimed for $3 million in overpaid fees.
Critical to this was the fact that the level of DBH fee was in part determined by the degree to which the ship was available for Premier to use. If availability fell below a particular level, the fee was reduced. This “availability” threshold was set at 95%.
The parties agreed that one of the two additional steps in the worked examples was necessary. However, Premier claimed that the other additional step should not have been included, as it appeared to take the availability threshold into account twice. According to Premier, this meant that, when following the worked examples, the threshold effectively became 90%.
According to Premier, this altered the “pivot point” for the calculations, inflating the DBH fee. Following the methodology in the worked examples therefore produced an illogical result that was inconsistent not only with the formula but also with other terms of the lease.
Altera argued that the worked examples must be an integral part of the contract. The very fact that the parties had explicitly set the method out twice suggested that this was in their minds when settling the commercial arrangements. It also noted that, due to other variables within the formula, it was not a given that the availability threshold would always be 95%; it could in fact be much lower or higher.
What did the court say?
The judge agreed with Altera, finding that the worked examples were an integral part of the contract.
The court was directed to what appeared to be the only previous authority on interpreting worked examples: Starbev GP Ltd v Interbrew Central European Holdings BV  EWHC 1311 (Comm). In that case, the court said that “… in the context of lengthy contracts… illustrations or examples [may] deserve particular attention to which the parties particularly turned their minds”.
Following this, the court examined the contract and worked examples and noted the following:
- The contract stated that the DBH fee was to be “adjusted from time to time by reference to Appendix M”. This suggested that Appendix M, which contained the worked examples, was not merely an “optional extra”.
- The worked examples explicitly set out the additional step in dispute, which appeared at the end of the calculation. This “strongly suggested” that including the disputed step was a “deliberate choice” by the person who drafted the worked examples.
- The fact that there was not one but two worked examples further suggested that the disputed step could not have been a mere mistake.
- The argument that the disputed step was intentional was reinforced by the fact that the other additional step in the worked examples, which the parties agreed had been intended, appeared immediately before and fed into the disputed step.
This was enough to convince the court that the worked examples should take precedence over the formula. The judged dismissed the idea that the worked examples did not represent what a “reasonable person with all the relevant knowledge” would say the parties had intended.
What does this mean for me?
It is common to include worked examples and illustrations in all kinds of commercial contract, particularly where the contract entails complex calculations or formulae.
Although this case concerned a charterparty, worked examples appear frequently in a corporate context. Typical scenarios that might merit worked examples include:
- calculating the purchase price for a business;
- determining a requirement or right to contribute additional equity funding to a company;
- reckoning payments or distributions under a waterfall; and
- converting securities from one kind to another (for example, under share-vesting provisions or on the exercise of an option or warrant).
Worked examples both provide evidence of the commercial context and the parties’ intentions and allow a practical illustration of what might otherwise be a somewhat abstract formula. However, as this case shows, there is a risk of introducing ambiguity when including worked examples.
The following are key points to note when considering including worked examples in a contract.
- Consider the value of including worked examples. Where the formula is simple and straightforward, including a worked example might introduce more uncertainty than it resolves.
- Ensure the examples are consistent with the formula. If the formula is amended during the course of negotiations, reflect those changes in the worked examples. Likewise, if changes are made to the worked examples, the formula should be updated too.
- Make it clear which prevails – the formula or the worked example(s) – in the event of any inconsistency. Contracts often state that worked examples are “by way of illustration only”. But, in our view, it is not inevitable that this wording alone will cause a formula to override a worked example. It is much better to deal with the matter explicitly, such as by stating: “In the event of any inconsistency between the formula and the worked example, the formula shall prevail.”
The European Commission has adopted a Capital Markets Recovery Package as part of its overall Covid-19 recovery strategy.
The package – if implemented – would make changes to various EU securities rules, including the Markets in Financial Instruments Directive (MiFID II) and the EU’s rules on securitisations.
However, of particular interest in a corporate context are the EU’s proposals for a new type of prospectus to allow issuers with a track record to recapitalise quickly. The proposed “EU Recovery Prospectus” would be a temporary and easy-to-produce document that can be produced, scrutinised and published quickly in order to raise capital due to economic urgency resulting from Covid-19.
The key points from the EU’s specific proposals for the EU recovery prospectus are set out below.
- The EU recovery prospectus regime would be available for 18 months.
- The EU recovery prospectus would be available only for secondary issuances by issuers whose securities have been admitted continuously to trading on an EU regulated market or an SME Growth Market for at least 18 months. (An SME Growth Market issuer would need to have published a prospectus previously to take advantage of the new regime.)
- The summary would be a maximum length of two sides of A4 paper (rather than the seven sides permitted for a full prospectus). The precise content requirements that apply to a full prospectus would be disapplied.
- The entire prospectus would be a maximum length of 30 pages and would include reduced information, including risk factors, financial statements covering the preceding 12 months, trend information, the reasons for the offer, and a working capital statement.
- It should take no more than five working days to approve an EU recovery prospectus.
- An EU recovery prospectus could be passported across the EU in the same way as a full prospectus can be at present.
The package would also make changes to the way in which prospectus supplements function. Under the current regime, where, before admission of the securities to which the prospectus relates, there is any significant new factor, material mistake or material inaccuracy relating to the information included in a prospectus, an issuer must publish a prospectus supplement. Any financial intermediaries must inform investors of the supplement on the day the supplement is published. Investors who have taken up the issuer’s offer then have two working days from publication to withdraw.
The Commission is proposing certain changes, which are set out below.
- Financial intermediaries would need to inform only investors that have agreed to purchase and subscribe for securities through them of the possibility of the publication of a supplement.
- When a supplement is published, financial intermediaries would have one working day to inform investors (rather than having to inform investors on the same day). They would need to notify only those investors who benefit from withdrawal rights.
- Investors would have three working days from publication to exercise their withdrawal rights (rather than two).
It is not clear at this point whether the recovery prospectus would be available within the UK after the EU/UK implementation period ends on 31 December 2020. If the changes come into effect before that date, they will be retained in UK law and recovery prospectuses should be available, subject to any changes made by UK legislation. If they do not come into effect before that date, the UK would need to legislate specifically for a recovery prospectus regime.
The Financial Reporting Council (FRC) has published its first thematic review of company reporting since the Covid-19 pandemic began.
The review summarises the FRC’s findings of the financial reporting effects of Covid-19 from a limited desktop review of a sample of listed company interim and annual reports and accounts with a period end date of March 2020.
The key points arising from the FRC’s review are set out below.
- Most companies reviewed provided sufficient information to allow users to understand the impact of Covid-19 on their performance, position and prospects. However, there was room for improvement in some areas.
- Companies should clearly explain the key assumptions and judgments they have taken in their going concern statement. Any significant decisions on whether there is a material uncertainty should be clearly documented.
- Any assumptions made in determining whether the company is a going concern should be consistent with assumptions made in other parts of the financial statements.
- Where any areas are subject to significant estimation uncertainty, companies should provide sensitivity analyses or details of a range of possible outcomes.
- Companies should not arbitrarily split items between Covid-19 and non-Covid-19 financial statement captions, as this is “highly subjective” and unreliable. The FRC gives impairment charges as an example.
- In interim reports, the FRC encourages companies to provide more detailed disclosure in relation to Covid-19 impact than might otherwise be required under IAS 34. (On a related note, the FRC is consulting on changes to FRS 104 (Interim Financial Reporting) to bring it more into line with IAS 34. For more information, see below.)
- Companies should consider making disclosures that are not specifically required by IFRS. This may be needed to enable users to understand the impact of events and conditions on the company’s position and financial performance, as required by IAS 1.
Also this week…
- Government publishes guidance on merger control changes. The Government has published guidance on changes to the UK’s merger control made last week (see our previous Corporate Law Update). The guidance also covers the previous changes to the merger control regime made in 2018, when the new thresholds for “relevant enterprises” were first introduced.
- FCA proposes to delay ESEF implementation. The Financial Conduct Authority (FCA) has published Consultation Paper CP20/12, in which it is proposing to delay the implementation of the European Single Electronic Format (ESEF) for company reporting by one year. Under existing legislation, issuers must publish their annual reports for financial years beginning on or after 1 January 2020 in ESEF format. However, in light of the Covid-19 pandemic, the FCA is proposing to push this requirement back to financial years beginning on or after 1 January 2022. It has asked for views by 28 August 2020.
- FRC consults on going concern basis of interim reports. The Financial Reporting Council has published a consultation on proposed changes to Financial Reporting Standard (FRS) 104, which sets out the basis on which a company must prepare interim financial reports. Although FRS 104 is based on International Accounting Standard (IAS) 34, the FRC has noted that, unlike IAS 34, FRS 104 does not contain requirements covering assessment and reporting on the “going concern” basis of accounting. It is proposing to amend FRS 104 to introduce requirements similar to those in IAS 34. The deadline for responding to the consultation is 1 September 2020.