Introduction
A few years ago, I wrote an article asking whether Property 118’s landlord incorporation structure was really “the worst tax avoidance scheme of all time”.
My conclusion was that IMO it was not a tax avoidance scheme at all.
However, there were / are three separate questions rolled into one:
- Is the arrangement tax avoidance (or, more technically, were there a tax advantage and was the obtaining of that tax advantage a main driver)?
- Was is it notifiable under the Disclosure of Tax Avoidance Schemes (“DOTAS”) rules?
- Does the arrangement actually ‘work?’
These questions are all related… but different.
Well, we now know the First-tier Tribunal has now allowed the appeals brought by Property 118 Limited and Cotswold Barristers Limited against HMRC’s allocation of scheme reference numbers to the Substantial Incorporation Structure (“SIS”) and the Capital Account Restructure (“CAR”).
Subject to any appeal, the scheme reference numbers must therefore be cancelled.
That is a clear victory on the second question above. It might not necessarily provide a definitive answer to both of the others.
I have read the judgement this morning and here are my initial thoughts.
What the Tribunal actually decided
The Tribunal was careful about the limits of the case before it.
It was not deciding, as a free-standing question, whether SIS or CAR amounted to “tax avoidance”. (to the extent that question matters at all).
Instead, it was deciding whether the specific statutory conditions for notification under DOTAS had been met.
As such, we know that, subject to any appeal, the Property 118 arrangements were not notifiable under DOTAS.
On reflection, quite a bit of the Tribunal’s reasoning is close to the analysis in my earlier article.
However, I am not going to gloat about this. My middle name is “Humble”. Instead, I will look at where I was right where I was deficient / wrong and perhaps where this will go from here.
Where I think I was right
My central argument was that critics were attributing to the bare trust structure tax consequences which largely arose from incorporation itself.
Where the assets and business of an unicorporated business are transferred to a company in exchange for shares, then incorporation relief may be available under section 162 TCGA 1992.
Once a property business is operated through a company, so-called clause 24 (the controversial restriction of the deduction for mortgage interest) does not apply and the net profits are subject to corporation tax rather than income tax. Those are consequences of incorporation. They are not tax advantages manufactured by the declaration of trust.
The Tribunal adopted a similar approach when identifying the correct comparison.
[I discuss the meaning of “tax advantage” and “comparators” here in a a two part previous article here – part one and part two]
Rather than comparing SIS with the landlords simply remaining unincorporated, it compared SIS with an economically similar conventional incorporation in which both legal and beneficial ownership were transferred and the existing mortgages were dealt with by novation, refinancing or some other method.
On that basis, the Tribunal concluded that most of the tax consequences relied upon by HMRC were simply the ordinary consequences of incorporating a property business. The distinct tax advantage potentially produced by SIS was narrower. It could preserve full incorporation relief where refinancing might otherwise result in non-share consideration and restrict that relief.
The Tribunal also accepted that retaining legal title temporarily could serve a genuine commercial function.
Immediate refinancing might involve early repayment charges, the loss of favourable interest rates, arrangement and valuation fees, the simultaneous refinancing of a large portfolio, or practical impossibility where properties were affected by cladding or leasehold problems. SIS allowed those issues to be dealt with when it was commercially sensible to do so.
The Tribunal therefore considered the arrangements as a whole. It accepted that users could have substantial commercial, financing and succession reasons for incorporating and for using SIS, alongside the tax considerations.
That is very close to the substance of my earlier analysis.
Where my analysis was deficient
There are, however, several points on where I could have done better.
First, I said that the bare trust did not itself contribute to the tax advantage. That was, perhaps, too absolute.
The Tribunal agreed that most of the supposed advantages arose from incorporation, but it found that SIS could provide a specific additional advantage by preserving full incorporation relief where a refinancing might otherwise prejudice it.
Secondly, in my article, I suggested there was little need to examine the DOTAS hallmarks once the source of the tax advantage had been correctly identified.
Now, I am technically right on this because, if one does not pass through the tax advantage / main purposes gateway (“The DOTAS Gateway”), then there is no need to consider the hallmarks at all.
However, the tribunal did also look at the hallmarks in some detail, and there are some interesting points. So, its worth talking about here.
The Tribunal found that the operative documents were standardised or substantially standardised, that the transactions were substantially standardised in form and that users had to enter into the specific series of transactions forming SIS or CAR. The considerable advice and fact-finding undertaken for individual clients did not prevent the operative transaction documents from being standardised.
That finding is worth noting well beyond this particular case.
A transaction can require extensive professional work and still constitute a standardised product for DOTAS purposes if the substantive documents and transactional steps remain largely templated.
Property 118 did not win because SIS was too bespoke to fall within the standardised product hallmark. It won because it did not pass through The DOTAS Gateway.
Thirdly, the judgment does not support an unqualified proposition that tax was unimportant.
The Tribunal found that obtaining full incorporation relief could be a main purpose of SIS and that avoiding the effects of section 24 was also a main purpose. What it did not accept was that either was the main purpose, meaning the most important purpose of the arrangements as a whole.
The Tribunal reached a similar conclusion on CAR. The tax outcomes associated with preserving incorporation relief and establishing a director’s loan could be main purposes, but they were not the main purpose of the overall arrangements.
It also considered it arguable that the tax-free repayment of the director’s loan was not an additional tax advantage at all when compared with an economically equivalent pre-incorporation withdrawal of capital followed by a loan to the company.
Winning on DOTAS does not mean the arrangements work
This is an important qualification.
DOTAS is a disclosure regime. It is not a technical clearance procedure.
An arrangement can be notifiable under DOTAS and still work. Equally, an arrangement can fall outside DOTAS and fail completely.
The Tribunal did not determine, for each landlord, whether:
- There was a genuine property business qualifying for section 162 incorporation relief.
- A genuine partnership existed for the relevant SDLT treatment.
- The beneficial ownership of each property was effectively transferred.
- The transaction documents accurately reflected the underlying facts.
- The mortgage terms permitted what was done.
- Any associated growth shares, valuations or inheritance tax planning were effective.
That said, it is my opinion that, from a (tax) technical perspective, the use of the bare trust under SIS at the very least, can work in theory.
I am aware that one of the concerns is that some of the participants used a flawed trust deed. Having looked at this, I do not think this makes the arrangements a lost cause if one looks at them as a whole.
Enquiries, discovery etc
I have acted for a number of clients who had received enquiry notices and discovery assessment in relation to their use of the above. This has been extremely concerning for them.
Fortunately, subject to any appeal, this strengthens the position for those who have received discovery assessments. Previously, HMRC had agreed to withdraw assessments beyond the four year period (agreeing that there was no careless or deliberate behaviour by the client). The removal of DOTAS issues also removes another potential extended time limit for HMRC (albeit, they have seemingly not pursued this point).
Enquiries are a different matter. Assuming they were validly opened (do check, seen some horrors here!) then one will need to continue to defend the technicalities of the scheme. In other words, whether the scheme “works” remains a live issue for those particular clients.
Vindicated… with qualifications
So, was my earlier analysis vindicated?
Broadly, yes.
I was right to distinguish the ordinary tax consequences of incorporation from the particular machinery used to implement it. I was also right that the separation of legal and beneficial ownership could have a substantial commercial purpose connected with mortgages, refinancing and the practical difficulties of transferring a property portfolio.
But I was too absolute in suggesting that the bare trust produced no separate tax advantage, and I did not give sufficient attention to the standardised product hallmark.
Slap on the wrists for me.
Conclusion
Property 118 has won the DOTAS case. HMRC was not entitled to impose the scheme reference numbers on these arrangements.
That is a significant result. But it does not prove that every incorporation worked, that every landlord qualified for the claimed reliefs or that every associated piece of planning was effective.
If you are outside the standard discovery window, then whether it was effective is perhaps less relevant.
However, where a valid enquiry was opened, then the battle will continue.
The DOTAS battle is won… but the war is not necessarily over for all users of the arrangements.