Is that clear?

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KEY POINTS

• Statutory clearances, time-spans and market sensitivity.
• The purpose behind non-statutory clearances.
• The advantages and disadvantages of ‘loose’ definitions.
• The substantial shareholdings exemption and large cash balances.
• Changes of ownership and corporate losses.
• Corporate restructuring and transfers of company debt.

HMRC specialists are often called upon to provide advice to business taxpayers on significant business tax issues and all practitioners will, we hope, be familiar with the guidance on the HMRC website on applications for non-statutory clearances, statutory clearances, and statutory approvals.

We would like to provide some insights into a few of the issues that arise when HMRC receive a clearance application, based on the practical experience of HMRC specialists, through the example of company reconstructions.

Even relatively straightforward corporate reconstructions can give rise to apparently novel tax issues, either because they are quite different from those normally encountered in the day-to-day running of a business, or because of some genuinely unusual feature or complexity in the reconstruction itself.

It is not surprising then that these constitute a large part of the clearance work that HMRC specialists undertake.

Statutory clearances

Tax legislation provides for a range of statutory clearances including ones that may be critical in the context of a reconstruction, for example those concerning the rules for transactions in securities and share exchanges. As has long been the case, applications for these clearances are dealt with by the Clearance and Counteraction team in HMRC’s Anti-Avoidance Group.

The names and addresses of who to contact can be found on the HMRC website. The time limit for dealing with these applications is commonly 28 days, although in practice HMRC endeavour to deliver a response somewhat faster than this.

Typically, 90% are dealt within 12 days, with an average of about eight days. In the past 12 months the team has received some 5,500 clearance applications.

We will always try to process urgent applications quickly, but even so some requests suggest particularly unrealistic expectations (‘this afternoon’ is one that readily springs to mind).

If a request is urgent it helps to mention – at the head of the application or in the covering email – why the application is urgent and what the deadline is. But we would ask applicants to only ask for urgent treatment where it is absolutely necessary.

Some applications are, of course, market sensitive and HMRC give the highest priority to protecting taxpayer information.

Where there is market sensitivity we will ensure that only those who need to know have access to the clearance material. Again, it is best to indicate sensitivity at the start of the application or in the covering email.

Most Large Business Service taxpayers and some businesses dealt with in Local Compliance now have a customer relationship manager (CRM), to whom non-statutory clearances are sent rather than the central clearance team.

Many businesses and agents are adopting the practice of also sending a copy of statutory clearance applications to the CRM as a matter of routine and we strongly encourage this. The review of the application will be completed more quickly if this is done.

Non-statutory clearances

It is in the sphere of non-statutory clearances where we have seen the largest increase in correspondence in recent years.

The non-statutory business clearance service was introduced following extensive consultation as part of the Links with Business review and the background to current arrangements can be found in HMRC’s guidance.

Principally, the service is available where there is material uncertainty concerning the application of legislation passed in the last four years’ Finance Acts, or earlier legislation where there is an issue of real commercial significance for the business.

HMRC aim to provide a response within 28 days, but as with statutory clearances the average response time is actually much quicker than this.

Where a non-statutory clearance involves a complex area of law that may require the advice of HMRC technical specialists we strongly advise making the application as early as possible, even if some of the precise details of the transactions have not been finalised.

Otherwise there is the risk that the people who need to be consulted may be fully committed to urgent policy development or litigation work and are not able to deal with a complex clearance issue at short notice.

A clearance application should, of course, normally set out all the relevant facts and analysis that is necessary for HMRC to reach a view.

Although it will occasionally be appropriate to ask for additional detail on a particular aspect, we will not normally enter into protracted correspondence or dialogue before making a decision or after turning down an application.

Nor will HMRC give any clearance where the application of the law to proposed transactions is clearly against the spirit of the legislation.

Obviously, the rejection of a clearance is not the end of the matter: additional relevant information may be available which addresses HMRC’s concerns; the proposed transaction may be revised; or the transaction can go ahead and the difference of view can be resolved within the normal statutory framework of the enquiry process.

We do receive a number of applications for clearance where it is difficult to discern any material uncertainty as to the application of the relevant legislation.

The clearance process is not designed to offer a ‘rubber stamp’ facility to approve any transaction in advance and there will be significant consequences for HMRC resources if it is seen in this way.

Nor is it appropriate to use the procedure to request concessionary treatment where it is clear that the law does not apply in the way business would prefer. If the law is not working as well as business wishes then that is a matter for policy representations.

So we would ask that every potential clearance application is reviewed critically to ensure that HMRC resources are applied only to the issues that do cause genuine uncertainty for business.

Some examples of the sort of cases where we receive significant numbers of clearance applications may help to illustrate these points.

Substantial shareholdings

FA 2002 introduced a new exemption for trading companies in respect of chargeable gains arising on the disposal of substantial shareholdings in other trading companies.

Nearly ten years later the substantial shareholdings exemption (SSE) has developed into a key feature of the UK corporate tax regime: by taking tax out of decision making for disposals of shareholdings in trading companies it encourages merger and acquisition activity and enhances the position of the UK as an attractive location for multinational businesses.

The exemption is available to a ‘trading group’, loosely defined as a group that does not have substantial non-trading activities.

This was a deliberate attempt to avoid harsh cut-off points or ‘cliff edges’. It was clear from consultation prior to FA 2002 that business would not welcome a precise approach that might result in the loss of the exemption because of, say, recent poor trading performance.

However, the flip-side of flexibility for business in general is occasional uncertainty for a particular business.

HMRC recognised the need for certainty for individual businesses from the outset and offered to confirm their view on ‘trading status’ before the subsequent introduction of the wider non-statutory business clearance service. That service is one that that has proved popular and it is worth mentioning two issues that commonly arise.

First, we have been told that fewer clearance applications would be needed if HMRC guidance covered a wider range of circumstances in examples. That view is understandable, but the trading status of a particular business will often be dependent on how the group operates.

Perversely, adding more detailed examples may undermine delivery of the exemption by appearing to create cliff edges that are not within the legislation, and which would not be welcome for other businesses.

HMRC are happy to clarify the guidance when this will help the wider business community such as in the recent Revenue & Customs Brief 29/11 on holdings in joint ventures and companies without share capital.

We issued this note following clearance applications where advisers considered trading status was in doubt because they assumed that these holdings should necessarily be regarded as non-trading investments. That is not how HMRC interpret the rules and we were happy to make that clear.

HMRC are also engaging with advisers through the Capital Gains Tax Review Group, which is helping to improve our guidance material on entrepreneurs’ relief where there is a clear read across to that for the exemption on the trading company rules and we will engage more widely if changes are recommended.

Our experience of consulting on draft guidance for the recent corporate gains simplification package has proved the value of working with the tax professions.

Secondly, when the exemption was first introduced there was genuine uncertainty among both advisers and HMRC staff on a number of aspects of the rules.

To address the risk of HMRC providing inconsistent views to business, we created a small network of specially trained inspectors in the Large Business Service and Local Compliance offices with the knowledge and skills to deal with common areas of difficulty, and who now deal with a wide range of corporate gains issues.

For example, large cash balances were a frequent area of doubt. The use of specialists, supported by refined guidance, has enabled HMRC to deliver a consistent message that the normal retention of trading profits is not something that is indicative of a non-trading activity. What was once a major source of clearance applications has greatly diminished.

In a similar vein, some overseas owned companies have approached us because of difficulties in obtaining sufficient information to conduct a detailed review of the worldwide structure to determine whether the overall group is trading.

In almost all cases a detailed review proved unnecessary because publicly available material, such as consolidated accounts, indicates that there is no doubt that the groups involved were engaged overwhelmingly in trading activities.

The experience of the substantial shareholdings exemption suggests that where legislation is designed to avoid harsh cut-off points there are limits to the additional certainty that can be provided in guidance.

In this context this is because a feature that may be the decisive factor in one group may be merely incidental in another.

As a result, there will inevitably be some groups that will want the additional certainty provided by the clearance process.

It is, however, striking that HMRC specialists can only recall one case in recent years where there was significant doubt in their minds as to whether the group would qualify for the exemption.

This case – see Trading or not? – may be a useful illustration of HMRC’s approach.

In practice, the cases in which there is strong disagreement are overwhelmingly ones in which HMRC consider that the exemption should apply, on the grounds that the same criteria should be applied to losses as with gains.

Corporation tax losses

Ownership of existing corporation tax losses is often an issue in a company reconstruction. Losses follow the company and the trade, so if the trade is the same and the company is the same, then losses can go forward to subsequent accounting periods. There are two exceptions to this rule, which may give rise to technical issues.

The first is when a trade, or part trade, is transferred between companies in 75% common ownership. Losses are transferred with the trade.

Terminal losses cannot be claimed by the predecessor company. This legislation is mandatory, no claims are required. Most of the issues that arise concern loss streaming on the transfer of part trades and relevant liabilities restrictions.

The second is when the ownership of a company changes. A company changes ownership for the purposes of this legislation when more than 50% of the shares change hands.

If there is a change in ownership, followed by a major change in the conduct and nature of the trade, investment business, property business, etc. during a six-year period beginning three years before the date of the change in ownership and ending three years after; then any losses brought forward are cancelled at the date of the change.

This is anti-avoidance legislation without a motive test. No clearances are possible as it depends partly on what happens in the three-year period after the change in ownership.

Most of the issues that arise concern whether a change of ownership has taken place, especially when a new Top Co has been inserted in a group, and whether a change is a major change. Statement of practice 10/91 covers the last point.

Both of these areas are examples of circumstances that fundamentally depend on the facts of the case. Neither area should normally require a clearance application to a technical specialist; in most cases discussion with the CRM is the sensible way forward.

Debt restructuring, etc

Company reconstructions may also involve a restructuring of a company’s debt and other financial instruments. The corporation tax rules on loan relationships and derivative contracts contain a number of features to facilitate such restructuring.

• Loans and derivatives may be transferred between two companies in the same group on a ‘no gain, no loss’ basis.
• Where reconstructions involve a release of debt in return for the issue of shares (as will often be the case in a distressed situation), in most cases an accounting credit arising from the release of a loan relationship will not be taxable.
• Where the restructuring involves the acquisition of impaired debt by a new creditor company connected to the debtor, a taxable credit may impose a credit on impaired debt. However, there are exemptions for corporate rescues (where the debtor company is likely to become insolvent) and where the debt is bought in by a fellow group company (provided the debt is not then released intra-group), or exchanged for shares issued by a fellow group company.

There is extensive guidance on these aspects of the tax rules on loan relationships and derivative contracts in HMRC’s Corporate Finance Manual.

However, in the aftermath of the financial crisis, there has been a significant increase in the number of non-statutory business clearance applications received by HMRC relating to debt restructuring, particularly where a debt-equity swap is involved.

In the majority of cases, there will be no doubt that a debt-equity swap that forms part of a commercial debt restructuring, undertaken as an arm’s length transaction, will fall within the exemption for credits arising on the release of a loan relationship.

Where clearance applications are made they can be resource intensive both for HMRC and applicants and their advisers, so we recognise that it is in everyone’s interest for HMRC’s guidance to provide as much certainty as possible.

To this end HMRC have held discussions with external stakeholders and will shortly be publishing revised guidance addressing some of the points of material uncertainty, principally the meaning of the term ‘in consideration of shares’, which have contributed to the increase in clearance applications.

Conclusion

We do understand that corporate restructurings involve complex and interlocking arrangements, and we will do our bit to help reduce the uncertainty that necessarily accompanies them.

However, we also ask practitioners to recognise that our resources are limited and not to see a clearance application as an automatic part of a company reconstruction.

Clearances should only be sought where there is genuine uncertainty about the tax outcome. In the sphere of non-statutory clearances, HMRC’s published guidance, or informal discussion with the CRM, will often give advisers the confidence they need to proceed with a transaction without seeking a formal clearance.

Queries on points raised in this article can be addressed via email to Jeremy Tyler, deputy director corporation tax, international and anti-avoidance, and head of corporation tax and business income tax

Issue: 4322 / Categories: Comment & Analysis , Companies