Khan v HMRC

The Court of Appeal dismissed the appeal and held that the taxable distribution arising on the company’s buy-back was chargeable to income tax on the person who, at the time the distribution was made, both received and was entitled to it under section 385(1)(b) of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). The court applied a purposive construction of s.385 but emphasised that that provision focuses on the person who received or to whom the distribution belonged at the time of the distribution (s.383 and s.385 ITTOIA; s.1000 and s.1033 Corporation Tax Act 2010 were discussed).

The court accepted the Upper Tribunal’s factual findings that (i) the company had paid £1.95m which effectively funded Mr Khan’s purchase of the shares, (ii) that payment was properly characterised as a loan and was set-off against the later company buy-back price, and (iii) at the moment of the buy-back Mr Khan was the legal and beneficial owner of the shares and was both entitled to and received the distribution. The Court rejected arguments that s.385(1)(b) imports an additional requirement of practical control or a further requirement of benefit beyond legal entitlement.

Background and parties

• Appellant: Mr Bostan Khan (represented by Laurent Sykes QC).
• Respondent: The Commissioners for Her Majesty's Revenue & Customs (represented by Charles Bradley).
• Procedural history: appeal from the Upper Tribunal (Tax and Chancery Chamber) ([2020] UKUT 0168 (TCC)), following an earlier appeal to the First-tier Tribunal. The UT had held Mr Khan liable to income tax on £1.95m under s.383 ITTOIA and that liability fell on him under s.385(1)(b) ITTOIA.

Factual matrix

Mr Khan bought the entire issued share capital of a trading company for £1.95m (plus a small net book value adjustment). Within around 40 minutes the company bought back 98 of the 99 shares for £1.95m, leaving Mr Khan with one share. Most cash flowed via the company’s borrowing facilities; the UT found the company’s payment to Mr Khan that enabled the purchase was properly characterised as a loan which was then discharged by set-off when the company purchased the 98 shares.

Nature of the application and relief sought

Mr Khan appealed against a closure notice issued by HMRC increasing his income tax liability for 2013–14 by approximately £594,814.57. He sought to overturn the UT’s determination that he, rather than the vendor shareholders, was liable under s.385(1)(b) ITTOIA for the tax on the buy-back distribution.

Issues framed

1. Whether the UT was wrong to treat the share sale and buy-back as two separate legal events for the purposes of s.385(1)(b), rather than as a single composite transaction whose economic effect should determine liability.
2. Whether the phrases "receiving" or "entitled to" in s.385(1)(b) should be given an implied gloss requiring practical control over the funds or a requirement of benefit beyond legal entitlement.
3. Whether any alternative charging provision (s.687 ITTOIA) applied.

Court’s reasoning

• The court accepted the UT’s purposive construction of s.385(1)(b): the provision clarifies that income tax on distributions is chargeable on the person who receives or is entitled to the distribution. The statutory focus is on who received or to whom the income belongs at the time the distribution is made.
• Ramsay principles do not require treating the sale and buy-back as one composite transaction for the purposes of s.385(1)(b) because the statute requires inquiry into the specific transaction under which the distribution arises. Even viewed holistically, the component transactions could not lawfully be re-characterised as a distribution to the vendor shareholders.
• The court rejected the submission that "receipt" or "entitlement" carries an implicit requirement of practical control or additional benefit. Authority relied upon by the appellant (including group relief and beneficial ownership cases) did not establish such a gloss in the different statutory context of s.385 ITTOIA.
• The court also endorsed the UT’s findings that the earlier company advance was a loan and the buy-back payment operated by set-off, and that Mr Khan both received and was entitled to the distribution; s.687 did not apply because s.383 already charged the distribution as income.

Result

The appeal was dismissed. The court concluded that Mr Khan was chargeable under s.385(1)(b) on the distribution arising on the buy-back.

The appeal is dismissed. The Court of Appeal held that section 385(1)(b) ITTOIA requires the tax to be charged on the person who received or was entitled to the distribution at the time it was made; there is no implicit additional requirement of practical control or further element of benefit. The UT was correct to treat the company buy-back payment as a distribution to Mr Khan (who at that time was the legal and beneficial owner of the shares) and to uphold the tax assessment.

Appeal from the Upper Tribunal (Tax and Chancery Chamber) (Raghavan and Andrew Scott JJ) [2020] UKUT 0168 (TCC), following an earlier decision of the First-tier Tribunal (no neutral citation stated). Permission to appeal to the Court of Appeal was granted by Nugee LJ.