Case: Payment under an indemnity did not give rise to allowable CGT loss

[2018] UKFTT 0735 (TC)

Judge Jonathan Richards

Decision released 14 December 2018

Capital gains tax – TCGA 1992, s. 253(4) – Whether payments made under a guarantee of qualifying loans – No – They were made under an indemnity – Appeal dismissed

Dennis [2019] TC 06868

Summary

Mr Dennis entered into a joint venture with TAG Group Holdings SA (TAG Holdings) to develop and manufacture high quality electronic audio and audio-visual equipment. Mr Dennis and TAG Holdings invested in a joint venture company by way of loans and subscriptions for ordinary and preference shares. Although TAG Holdings provided approximately 75% of the finance, it had only 60% of the ordinary shares, hence only 60% of the votes. However, in the event that the shareholders suffered a loss on winding up of the company, the shareholders’ agreement provided that the overall loss should be allocated between them according to their voting rights. There were also preference shares that entitled the holder to vote only on a winding-up resolution. Due to lower than expected demand and difficult market conditions the joint venture was abandoned and on winding up of the company, Mr Dennis made a re-balancing payment to TAG Holdings in accordance with the shareholders’ agreement of £3m. It was argued on behalf of Mr Dennis that the first £2,528,520 of the payment was in respect of TAG Holdings’ qualifying loans and that under TCGA 1992, s. 253(4) the payment under the guarantee generated an allowable loss. This was disputed by HMRC and the parties agreed that there were three relevant issues:

The guarantee issue

HMRC argued that the relevant clause of the shareholders’ agreement did not amount to a guarantee. The FTT agreed that it was a warranty not a guarantee because it only took effect after the final distribution had been made to the shareholders, at which point there could be no further recourse to the company. It therefore followed that the payment could not be said to be made as guarantor of its liability.

The relevant proportion issue

HMRC also argued that, in determining voting rights, the rights attaching to the preference shares should be taken into account (which would give TAG a share of approximately 75%), meaning that Mr Dennis had made a payment he was not required to make, hence it was not made ‘under’ the guarantee. As Mr Dennis had failed on the guarantee issue, the FTT had no need to consider this issue (or the apportionment issue that follows) but nevertheless did not accept HMRC’s argument, on the basis that, on a practical and common-sense interpretation, voting rights should be considered after the final distribution was made, as this was when the balancing payment was calculated, and at that time the preference shares would have no voting rights.

The apportionment issue

The amount claimed by Mr Dennis as attributable to qualifying loans had been calculated on the basis that the payment that he made should be attributed to qualifying loans in preference to equity. The shareholders’ agreement had made no provision for apportionment. The FTT therefore considered that the computational provisions in TCGA 1992, Pt. II, Chap. 3 should be applied and a ‘just and reasonable’ method of apportionment adopted (s. 52(4)). They accepted the method proposed by HMRC, which was to take the amount of the payment required to reduce TAG Holdings’ shortfall on qualifying loans by 15% (75% - 60%) as per the shareholders’ agreement. This would reduce the allowable loss (assuming Mr Dennis had succeeded on the guarantee issue) to £490k.

The appeal was dismissed.

Comment

In this case Mr Dennis had clearly suffered a real economic loss of approximately £3million, and this was not disputed. It therefore illustrates the importance of taking into account the possibility that a venture will fail and, if at all possible, structuring the arrangements with potential capital losses in mind.

For commentary on guarantees of qualifying loans, see In-depth ¶511-250.

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