Background
Vardy Properties (Teeside ) Limited (VPTL) - were advised that they could structure the acquisition of a property without incurring an SDLT bill.
An unlimited company Vardy Properties (VP) was set up for the purposes of contracting to acquire the property. Unlimited companies can reduce their share capital without the (then) difficulties and costs associated with obtaining court approval to do so. VPTL subscribed for shares in the unlimited company and VP used the proceeds of the share capital injection to enter into a contract to purchase the property.
VP then passed a resolution to reduce its share capital creating a reserve which could be repaid to the shareholder VPTL. Before it resolved to repay the capital VP completed the purchase of the property and its was then resolved to transfer the property to VPTL by way of a distribution in specie.
VP claimed it had no SDLT liability because it could claim the benefit of sub sale relief under section 45 Finance Act 2003 and VPTL claimed it had no liability because receiving a property as a shareholder by way of distribution is exempt from SDLT unless actual consideration has been provided.
The Tribunal upheld HMRCs contention to the opposite on the basis that the distribution was unlawful due to the failure to comply with the requirement to prepare accounts under section s270 Companies Act 1985.
Obiter they said that if they were wrong on this point VPTL was liable to SDLT because it had provided actual consideration for the distribution (i.e. the second subsale leg) by way of the injection of share capital.
HMRC are shouting for the rooftops and are clearly delighted with the result! However it is my view that they should only be delighted with the fact that VPTL have, presumably to reduce the impact of any negative publicity, decided not to appeal - and this is why.
The main ratio behind the decision is that the distribution was unlawful and therefore there was no subsale and VP are liable for the SDLT.
Section 270 of the Companies Act only applies to distributions within the definition of section 263 of that same act.
Section 263(2) - states
In this Part, " distribution " means every description of distribution of a company's assets to its members, whether in cash or otherwise, except distribution by way of—
(a) an issue of shares as fully or partly paid bonus shares,
(b) the redemption or purchase of any of the company's own shares out of capital (including the proceeds of any fresh issue of shares) or out of unrealised profits in accordance with Chapter VII of Part V,
(c) the reduction of share capital by extinguishing or reducing the liability of any of the members on any of the company's shares in respect of share capital not paid up, or by paying off paid up share capital, and
(d) a distribution of assets to members of the company on its winding up.
I have highlighted the last two because these are excepted from the ensuing rules about distributions because in actual fact they are not really dividends in the same way as a "normal" dividend would be because neither are really dependent on the company's actual profits. This doesn't detract from the SDLT treatment though. Distributions on a winding up are specifically referred to as exempt in the relevant SDLT provisions and the "or otherwise" references therein ought to cover "distributions" contemplated under subsection (c) too.
c) is the point in case here - the second leg of the subsale was a distribution pursuant to the rights to claim a return of capital after a reduction in share capital.
Accordingly it seems that that section 270 didn't need to be complied with and the tribunal was in fact incorrect on this point.
The tribunal said that if they were wrong then sub sale relief did in fact apply to "relieve" VP from SDLT but due to a "purposive approach" to the application of section 45 (3)(i) (the relevant sub sale taxing provision which governs the amount of consideration deemed to have been given in this case by VPTL) then VPTL through the share subscription had given consideration for their acquisition of the property and thus were chargeable to SDLT.
This bit is the really interesting point. Can section 45(3)(i) be construed in this way?
What section 45 (3)(i) says (and I am paraphrasing here for brevity) is that the consideration deemed to have been given by the person acquiring on the second leg of a sub-sale includes (i) " so much of the consideration under the original contract as is .... to be given directly or indirectly by the transferee" (VPTL).
The tribunal (obiter which means it is not actually part of the judgment) said that the provision of funds through the share subscription could have a dual purpose 1) consideration for the acquisition of the shares but 2) in the context of a scheme where there is an understanding that the property will be onwardly conveyed as consideration indirectly provided for the purchase of the property.
I on the other hand do not think it can be simplified that easily.
When VPTL provided the funds it did so before VP entered into the contract to buy the property and before VP had resolved to reduce its share capital and make a repayment back to the VPTL in specie.
This means if the share capital subscription was consideration, it was paid before any contract existed in favour of itself. This is commonly known in contract law as past consideration. Past consideration is not in law consideration at all.
In a business context however past consideration can be "consideration" for these purposes.
In the case of Pao On v Lau Yiu Long (1980) Lord Scarman said
" An act done before the giving of a promise to make a payment or to confer some other benefit can sometimes be consideration for the promise. The act must have been done at the promisors' request: the parties must have understood that the act was to be remunerated either by a payment or the conferment of some other benefit: and payment, or the conferment of a benefit, must have been legally enforceable had it been promised in advance."
So - when VPTL subscribed for the shares it is probable that there was an understanding (due to the nature of management and control between the parties) that VPTL expected that a reduction in share capital and distribution of the property would be effected.
Was the act (the provision of funds) done at the Promisor's (VP) request - as stated by Lord Scarman must be the case? No it was done at the request of the Promisee (VPTL).
Was the conferment of the benefits, i.e. (a) the reduction in share capital and (b) the transfer of the property - legally enforceable as a promise made in advance. Neither were (a) because a resolution had to have been passed and b) because an agreement to convey title to land has to be in writing under the Law of Property Act or it is unenforceable.
It therefore seems arguable that the funds provided by VPTL through the share subscription could not be deemed to be consideration for anything other than the acquisition and issue of shares in VP.
Given that this aspect of the judgment is obiter and was not in fact fully explored and for the reasons I have stated I cannot see that there is any victory here for HMRC which would not have good grounds for an appeal by VP or VPTL.
Shame that VPTL aren't going to pick up and run with the gauntlet. They may have their commercial reasons for not doing so but I have to say it is only through a proper examination of these principles that we can end up with good and clear tax law. If the law doesn't work and that results in unexpected Tax savings then it should be changed properly.
It may be that it is through these avoidance schemes that clearer tax law is achieved and that has to be for the benefit of everyone. So for anyone else who has done this scheme - have courage, tackle HMRC for their inefficient law drafting and be part of the process of creating clear and workable SDLT law.
Interesting topic to talk about. It's been fun reading your article. I learned a lot.
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