Explainaway: Statutory Interpretation (Tax Newsletter, Summer 2011)

The First Tier Tribunal here looked at a capital gains mitigation scheme involving matching futures and, by construing the legislation purposively and looking at the transactions as a whole, determined that a loss suffered as a result of the reduction in value of shares was not allowable.

Transactions constituted a single and indivisible whole

This case is complicated by the fact that the taxpayers had a Plan A (which was not fully completed) and a Plan B for mitigating a capital gains liability arising from a share sale. Broadly, both involved group companies entering into two futures on matching but opposite terms, one of which would produce a loss and one a profit. The derivatives were based on movements in the FTSE and therefore it was not known which would create a loss and which a profit, nor what the quantum of the desired loss would be. However, it was hoped that the loss achieved would be sufficient to offset the taxable gain realised on the sale of the shares.

A review of anti-avoidance case law led inexorably to the "ultimate question" of "whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically". In doing so, one must ask whether the steps comprising the scheme constitute a single and indivisible whole and is it intellectually possible so to treat them?

Here, the contrast between Plan A and Plan B was interesting. In considering Plan A, no account could be taken of the intention to sell the company to a third party company that would be able to shelter the gain remaining after use of the derivative loss. Similarly, Plan B could not be taken into account as this was not contemplated until after the Plan A steps were executed. As a result, the gains and losses on the derivatives netted out and there was no reason to subsume the tax consequences of the derivatives within a wider context.

By contrast, the culmination of Plan B was a company (Quoform) with a reduced share value, giving rise to a loss when sold which offset the original capital gain. The increased value of the shares deriving from the matching gain on the other derivative contract was then extracted in a tax-free manner by the distribution of an interim dividend, leaving the group in a net loss position. The transaction here had to be looked at as a whole since the reduction in the value of the shares followed "inexorably" from the loss on the contract and it was "the very essence" of the scheme...