Governments across the globe are facing a mountain of debt following the pandemic, with the focus of some now shifting to income generation mode. In the UK, are we already seeing a change of approach with HMRC? Faced with an HMRC U-turn, what can businesses do to challenge decisions?
The UK Government’s attention has been moving towards plugging some of the holes in spending from the pandemic, and this year’s Budget provides a glimpse into what is to come. In addition to the widely publicised plans, departments are naturally going to be under pressure to move into income generating mode - none more so than HMRC.
Substantive changes to the law require changes in legislation. However, there are many more subtle actions that can be taken by HMRC to increase income. For example, HMRC can revisit their views on the scope of taxes already in place, and adapt their practice going forward. They can amend guidance, both general (eg Revenue and Customs Briefs) and specific (eg advance assurance or other specific decisions). HMRC may well also seek to take a much narrower view of existing guidance and/or try to row-back on general or specific guidance previously given.
An example of this arose recently in the context of the Enterprise Investment Scheme (“EIS”), which is a tax relief scheme designed to encourage investment into early-stage and start-up businesses. EIS relief is available for individuals on their subscription of relevant shares, providing the company satisfies a number of conditions in the Income Taxes Act 2007 (“ITA”). EIS relief cannot be claimed until the shares have been subscribed, and it is only after subscription that HMRC will issue a certificate granting the relief. By the time confirmation of whether the relief will or will not be provided is received, it is too late to make any changes to the structure of the investment, as the investment has already taken place. This places a great deal of risk in the hands of prospective investors, discouraging investments from being made. As a result, it is common practice for companies to obtain advance assurance from HMRC in order to confirm that relief will be granted once the investment has taken place, providing details of the proposed investment and effectively getting approval in principle.
In the Foojit case, a company proposed to issue a new class of share (B shares), which attracted a dividend to be paid in priority to any dividend attaching to the existing shares – essentially a preference. The company had adopted Model Articles, so in order to carry out the proposed investment round adopted new articles which (amongst other things) introduced the concept of A and B shares, but continued to adopt the Model Articles, subject to modifications set out in the new Articles.
The company made use of the advance assurance process and HMRC confirmed that EIS authorisation would be provided in respect of the proposed share subscriptions if a satisfactory certificate (in the standard form) was filed once the shares has been subscribed, certifying (amongst other things) that the shares complied with the requirements of the ITA. As part of the advance assurance process, the company should have provided (amongst other things) the applicable Articles together with details of any proposed changes to those Articles. Whilst the advance assurance application was submitted prior to the change in Articles, what is not clear is how much detail was provided relating to the rights that would attach to the new class of B shares. The Company subsequently issued B shares and submitted the form confirming the applicability of EIS relief, which was refused by HMRC on the basis that the right to a preferential dividend on the B shares fell within the exclusions at section 173 ITA and therefore the investment was not subject to EIS relief.
The company challenged the decision before the First-tier Tribunal, then the Upper Tribunal. In deciding for HMRC and against the company, the Upper Tribunal found that the B shares fell foul of one of the exclusions in s.173 ITA which, so far as is relevant here, provides that in order for preference shares to qualify for EIS relief, they must not carry any right to dividends where either the amount, or the dates on which they are payable, depends to any extent on a decision of the company.
The Upper Tribunal held that the B shares fell foul of the second limb, on the basis of Article 30 of the Model Articles, which sets out the procedure for declaring dividends. In particular, that dividends only become “payable” (and therefore the applicable date(s) on which dividends are payable) by a decision of the company, whether through its directors or shareholders. As a result, EIS relief could not be claimed by those who invested and subscribed to the B Shares. This was despite the fact that the company clearly intended EIS relief to apply.
Other options to challenge?
Whilst the precise facts (which are unknown) may have prevented this, the most obvious alternative route of challenge in a scenario like this is by way of judicial review. Unfortunately, it is not clear what details of the proposed new class of B shares were provided to HMRC in the Foojit case at the time of the advance assurance application. However, in circumstances where HMRC has provided a specific decision based on the information and documentation before it, then sought to row-back on its original decision, the new decision is ripe for challenge. Any such challenge would proceed on the basis that HMRC is now correct that EIS relief should not apply, but notwithstanding this HMRC cannot now row-back on the original decision where the business in question has relied upon HMRC’s original decision to its detriment.
Is this an isolated incident?
HMRC will regularly face challenges by way of judicial review and one of the principal bases for challenge will be breach of legitimate expectation. The expectation may have been created through general decisions and guidelines, or a specific decision affecting only the business in question.
In terms of EIS relief, given this decision turned on the interpretation of the Model Articles (which will be adopted by many businesses), this does present a real risk. HMRC’s position on the underlying law would logically seem to be that EIS relief could never be claimed in respect of preference shares where a company has adopted Article 30 of the Model Articles. Any EIS advance assurance involving preference shares where Model Articles are applicable may therefore be at risk.
How this plays out in practice remains to be seen – but where HMRC is under pressure to increase tax revenues, judicial review is often an under-used tool in the toolbox available to businesses faced with unwelcome decisions from HMRC.