Hancock & Anor v Revenue & Customs

For conversions of securities, the rollover provisions in Taxation of Chargeable Gains Act 1992 must be applied with the adaptations needed to preserve their fiscal purpose. A conversion cannot aggregate qualifying corporate bonds and non-qualifying securities as fiscally mixed inputs where that would transfer a latent gain on the non-qualifying securities into an exempt bond. Section 116 therefore applies separately to the conversion of non-qualifying securities into qualifying corporate bonds and freezes the latent gain for charge on later disposal. The taxpayer cannot avoid that result merely by documenting the arrangements as one transaction or issuing a single new holding.

The taxpayers held loan notes issued as consideration for the sale of their company. The original 08/00 Loan Notes were non-qualifying corporate bonds because they permitted redemption in US dollars. The Revised 03/01 Loan Notes were qualifying corporate bonds.

In May 2003 both sets of notes were exchanged under one agreement for qualifying corporate bonds, which were redeemed for cash shortly afterwards. The taxpayers contended that the exchange was one mixed conversion, so that section 116 of the Taxation of Chargeable Gains Act 1992 did not freeze the gain on the non-qualifying notes.

The First-tier Tribunal allowed their appeals against closure notices: [2014] UKFTT 695 (TC). The Upper Tribunal allowed HMRC's appeal: [2016] UKUT 0081 (TCC). The central issue was whether the statutory scheme required two separate conversions despite the single contractual transaction.

The appeal was dismissed unanimously. The Upper Tribunal was right that the May 2003 arrangements had to be treated as two conversions for the purposes of section 116 of the Taxation of Chargeable Gains Act 1992.

1. The necessary starting point was section 132, which applies the rollover provisions in sections 127 to 131 to a conversion of securities with necessary adaptations. In a share reorganisation, the input assets are fiscally homogeneous because they are shares. That justification for aggregating holdings does not apply where the input securities include both taxable non-QCBs and exempt QCBs.

2. Section 132(3)(a) identifies conversions between QCB and non-QCB status as unmixed conversions. Although the definition is not exhaustive, it provided a strong indication that a conversion with fiscally mixed inputs was not permitted. Each security had to be treated as the subject of its own conversion. This preserves the rollover scheme's function of deferring, rather than extinguishing, the latent gain.

3. Section 116(1)(b) did not permit its wording to defeat that result. On the taxpayers' construction, combining a QCB with a non-QCB in a single arrangement would allow the gain on the non-QCB to enter an exempt QCB and escape capital gains tax. That result contradicted the statutory distinction between exempt gains on QCBs and taxable gains on other assets, explained in Jenks v Dickinson (Inspector of Taxes) [1997] STC 853. The court construed the statutory fictions restrictively where necessary to avoid that unintended outcome, consistently with Luke v Inland Revenue Commissioners [1963] AC 557 and Marshall (Inspector of Taxes) v Kerr [1993] STC 360.

4. Accordingly, the conversion of the 08/00 non-QCB Loan Notes into QCB SDLs fell within section 116. The latent gain was frozen and became chargeable on redemption of the SDLs. The single agreement and single tranche of SDLs could not alter the statutory character of the separate conversions. Lord Justice Kitchin agreed with Lord Justice Floyd and Lord Justice Lewison; Lord Justice Lewison added that the phrase allowing an asset to be included in section 116(1)(b) could be disregarded in these circumstances.

• Court of Appeal (Civil Division) Dismissed the taxpayers' appeal and upheld the Upper Tribunal's construction of the Taxation of Chargeable Gains Act 1992.
• Upper Tribunal (Tax and Chancery Chamber) Allowed HMRC's appeal from the First-tier Tribunal: [2016] UKUT 0081 (TCC).
• First-tier Tribunal (Tax Chamber) Allowed the taxpayers' appeals against the closure notices: [2014] UKFTT 695 (TC).