The recent Upper Tribunal decision in Shinelock Ltd v HMRC [2023] UKUT 00107 (TCC) examines the tax treatment of gains realized on property disposals. The case provides helpful guidance on issues surrounding distributions versus loan relationship debits and procedural considerations when new arguments are raised during tax tribunal hearings.

Background

The case involved an appeal by Shinelock Ltd (“Shinelock”) against amendments made by HM Revenue & Customs (“HMRC”) to the Company’s self-assessment tax return for the accounting period ended 31 March 2015. HMRC’s amendments increased Shinelock’s corporation tax liability by £18,854. This additional tax arose from a chargeable gain of £94,270 which HMRC considered had accrued to Shinelock on the disposal of a property in December 2014.

The property in question was located at 8 Trumpsgreen Road, Virginia Water (the “Property”). It was purchased by Shinelock at auction in March 2009 for £725,000. The company was beneficially and legally the owner of the Property throughout the relevant period. However, the successful auction bidder and Shinelock’s controlling director and majority shareholder, Mr Ayaz Ahmed, provided a deposit of £72,500 towards the purchase from his personal bank account.

The Property was sold in December 2014 realizing sale proceeds of £1,030,000. This generated a gain of £305,000 prior to deduction of expenses and indexation allowance. Shinelock paid the full amount of this £305,000 gain to Mr Ahmed pursuant to a verbal agreement between them. Under that agreement, Mr Ahmed was entitled to receive any capital gain on Shinelock’s disposal of the Property in return for certain financing or guarantees provided by him.

Shinelock did not declare the £94,270 chargeable gain in its tax return for the year ended 31 March 2015. HMRC subsequently opened an enquiry and issued a closure notice assessing Shinelock for corporation tax of £18,854 on the gain.

Shinelock appealed against the closure notice. Its grounds of appeal evolved during the proceedings but ultimately focused on an argument that the £305,000 payment to Mr Ahmed was an allowable debit under the loan relationships tax code. As such, Shinelock claimed there was no net chargeable gain or corporation tax payable on the property disposal.

The First-tier Tribunal Decision

The First-tier Tribunal (FTT) dismissed Shinelock’s appeal. It decided the £305,000 payment was a distribution under tax legislation and therefore could not be offset as a loan relationship debit against the chargeable property gain.

HMRC argued the payment should be characterized as a distribution under Paragraph F, Section 1000(1) of the Corporation Tax Act 2010 (“CTA 2010”). This paragraph treats as a distribution any amount paid out of company assets in respect of “special securities” where the consideration given for use of the principal secured depends on the results of the company’s business. HMRC said this test was met since the Property was an asset of Shinelock’s property rental business and the payment was calculated by reference to the gain on the Property’s disposal.

The FTT initially rejected this submission, holding that there were no “special securities” and the one-off disposal was not sufficient to constitute a property investment business. However, the Upper Tribunal found the FTT had erred in its interpretation of the relevant legislation. It decided the Property was certainly an asset of Shinelock’s business, and the payment was clearly dependent on the business results, being linked to the disposal gain. Therefore, the Upper Tribunal remade the decision and held the payment fell within Paragraph F.

Consequently, by virtue of Section 465(1) CTA 2009, the payment could not give rise to a loan relationship debit. Instead, it was a non-deductible distribution. Shinelock’s appeal was therefore dismissed.

The Loan Relationship Argument

Shinelock claimed that if the payment was not a distribution, then it should be treated as a loan relationship debit available to offset against the property gain.

The FTT rejected this alternative argument by finding that two key requirements for a loan relationship debit were not satisfied:

Recognition in accounts: Section 307(2) CTA 2009 provides a general rule that debits/credits are those recognized in determining company profit/loss per Generally Accepted Accounting Practice (GAAP).

The FTT reviewed the evidence and concluded that no debit of £305,000 was recognized in Shinelock’s accounts for the March 2015 period in accordance with GAAP. Based on the balance sheet movements described, it found no explicit profit and loss entry had been recorded for the payment per Section 308(2) CTA 2009. This meant the “recognition” requirement was not met.

Payment not in respect of loan relationships: Additionally, the FTT decided the payment did not meet the condition in Section 307(3) CTA 2009 of being “in respect of” Shinelock’s loan relationships with Mr Ahmed or the bank that provided financing. The Upper Tribunal held this conclusion involved a new argument raised by the FTT itself, denying Shinelock procedural fairness to respond. However, the distribution finding made this issue redundant.

Procedural Issues

An interesting aspect of the case is the Upper Tribunal’s commentary on procedural fairness regarding new arguments raised for the first time during tax tribunal hearings.

The decision confirms it is inappropriate for a tribunal to base its decision wholly or partly on a new argument conceived in the judgment itself, without having given the parties any chance to make submissions on it. This would likely leave one or both parties with a profound and justified sense of unfairness.

However, the Upper Tribunal notes tribunals can adopt a more inquisitorial role than the courts in appropriate circumstances. They have wide case management powers to ensure fairness when new arguments arise, such as allowing further submissions following the hearing. The requirements of procedural fairness and case management will determine the appropriate course of action.

Here, the Upper Tribunal held the FTT was entitled to consider the recognition issue regarding Shinelock’s accounts based on Shinelock’s burden of proof to establish its debit claim. But ruling on the “in respect of” condition without notice denied Shinelock procedural fairness.

Analysis and Recommendations

The case provides important guidance on distributions versus loan relationship debits and procedural fairness issues in tax appeals. Some key lessons for taxpayers and advisors include:

• Carefully consider distribution rules when seeking to offset payments to shareholders against taxable corporate income or gains. Distributions are non-deductible, so any amount treated as such under tax legislation will not reduce taxable profits.
• Be aware of all legislation conditions required to claim loan relationship tax debits and credits. Especially critical is accounting recognition in accordance with the statutory requirements.
• Be prepared to address all inherent requirements of any tax reliefs claimed, even if they are not explicitly raised by HMRC until the hearing itself. Tribunals may be more inquisitive regarding the technical rules.
• Raise objections during hearings if HMRC or the tribunal introduces wholly new arguments not previously pleaded nor canvassed in evidence. Request opportunities to make further submissions or lead additional evidence on new issues.
• Consider seeking an adjournment if new arguments are raised which require further evidence to address properly. Procedural fairness is key.

Overall, this case emphasizes the need for careful analysis of complex tax rules when structuring transactions and claiming associated reliefs. Taxpayers should also be alert to procedural issues when new points emerge during disputes with HMRC or tax tribunal appeals. Meticulous attention to legislative conditions coupled with upholding procedural rights will strengthen an appellant’s prospects of success.

For tax resolution or compliance, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.