Hancock & Anor v Revenue and Customs [2019] UKSC 24

Mr and Mrs Hancock sold their company shares for loan notes, later converted into qualifying corporate bonds. They argued the conversion escaped capital gains tax. The Supreme Court dismissed their appeal, holding the transaction comprised two separate conversions.

Facts

Mr and Mrs Hancock sold their shares in Blubeckers Ltd in exchange for loan notes issued by Lionheart, with an earn-out provision. The disposal was structured in three stages: (1) shares were exchanged for loan notes which, being convertible into foreign currency, were not qualifying corporate bonds (QCBs); (2) the terms of some of these notes were varied so that they became QCBs; (3) both the QCB and non-QCB loan notes were converted together into a single series of secured discounted loan notes (SLNs), which were QCBs. The SLNs were then redeemed for cash.

The appellants contended that the Stage 3 conversion fell outside the rollover relief carve-out in section 116(1)(b) of the Taxation of Chargeable Gains Act 1992 (TCGA), with the result that the redemption of the SLNs was exempt from CGT under section 115 (the general exemption for disposals of QCBs).

Issues

The central issue was the construction of section 116(1)(b) TCGA: specifically, whether the Stage 3 conversion constituted a single conversion of a holding that included both QCBs and non-QCBs (taking it outside both Limb A and Limb B of section 116(1)(b) and thus outside the charge to CGT), or whether it fell to be treated as two separate conversions, one of the non-QCBs (falling within Limb A and attracting rollover relief) and one of the QCBs into further QCBs (outside section 116(1)(b) altogether).

Arguments

Appellants

Mr Sherry argued that the literal wording of section 116(1)(b), particularly the words “or include”, contemplated a single conversion involving a mixed holding of QCBs and non-QCBs. Applying the “clear words principle” articulated by Lord Wilberforce in WT Ramsay Ltd v Inland Revenue Comrs [1982] AC 300, a subject is only to be taxed upon clear words, and there was here a single legal transaction which should not be recharacterised. He also noted the absence of statutory apportionment provisions where QCBs and non-QCBs were converted together.

Respondent

Mr Gibbon QC for HMRC submitted that the Court of Appeal’s construction was principled, conventional, fair and coherent. Stage 3 should be treated as two conversions: conversion of non-QCBs into QCBs (within Limb A, attracting rollover relief) and conversion of QCBs into QCBs (outside section 116(1)(b)).

Judgment

The Supreme Court (Lady Arden giving the leading judgment, with whom Lord Reed, Lord Sumption, Lord Carnwath and Lord Briggs agreed) unanimously dismissed the appeal.

Lady Arden accepted that section 116(1)(b) literally contemplated a single transaction involving a mixed pre-conversion holding and that the Court of Appeal’s reading rendered the words “or include” largely otiose. Nevertheless, the appellants’ interpretation would produce a result “inexplicable in terms of the policy expressed in these provisions”, namely to ensure that all relevant reorganisations attract the same rollover relief. Taxpayers could trivially avoid the charge by including a minimal (even £1) QCB element in a reorganisation.

Crucially, section 132(3) TCGA made clear that Parliament intended each security converted into a QCB to be viewed as a separate conversion. The direction in section 132(1) that sections 127 to 131 apply “with any necessary adaptations” permitted departure from the single-asset fiction in section 127 where necessary. On this construction, Stage 3 comprised two separate conversions. The clear words principle from Ramsay was therefore observed, because, fairly and properly construed, no doubt remained as to the meaning of section 116(1)(b).

Lady Arden addressed, but found it unnecessary to apply, the principle in Luke v Inland Revenue Comrs [1963] AC 557, which permits a strained interpretation where a literal reading would clearly contradict Parliamentary intention. She noted that the principle’s scope is limited to cases of clear contradiction with Parliamentary intention discernible from the wording of the legislation, and that it may be applied both for and against the taxpayer, as in Jenks v Dickinson [1997] STC 853.

Adopting Lewison LJ’s metaphor, the potential gain within the non-QCBs was “frozen on conversion and did not disappear in a puff of smoke”.

Implications

The decision confirms that in construing TCGA provisions on reorganisations and conversions of securities, particularly section 116(1)(b), the courts will adopt a purposive approach consistent with the statutory policy of ensuring that reorganisations attract rollover relief rather than outright exemption from CGT. A conversion involving a mixed holding of QCBs and non-QCBs, even if effected as a single legal transaction, may be treated as two separate conversions for CGT purposes by reason of the “necessary adaptations” direction in section 132(1) and the security-by-security approach signalled in section 132(3).

The judgment is significant for tax practitioners advising on the structuring of share sales with loan note consideration and earn-outs, as it forecloses a planning route that sought to crystallise exemption by combining QCBs and non-QCBs in a single conversion. More broadly, the case reaffirms the orthodox purposive approach to tax statutes (consistent with Ramsay) while recognising that the principle in Luke permits, in limited circumstances, a strained reading to avoid results clearly contrary to Parliamentary intention, and that this principle may operate either in favour of or against the taxpayer. The Court expressly left the application of Luke unnecessary on the facts, thereby leaving the limits of that principle undisturbed.

Verdict: Appeal dismissed. The Stage 3 conversion was to be treated as two separate conversions, with the result that the conversion of the non-QCBs fell within Limb A of section 116(1)(b) TCGA 1992, attracting rollover relief, and the gain on the non-QCBs became chargeable to capital gains tax on redemption of the SLNs.

Source: Hancock & Anor v Revenue and Customs [2019] UKSC 24