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Taper relief, and particularly business asset taper relief, is now the most important relief for capital gains tax. One problem area concerns take-overs where vendors of shares receive loan notes, often unsecured, in the acquiring company.
If the loan notes are not qualifying corporate bonds, and either the vendor is employed in the acquiring group or the acquiring company is unlisted, the loan notes will be regarded as a business asset for taper purposes so long as the loan notes constitute securities.
The problem was addressed in an excellent article by Mark Rowland in Taxation, 5 July 2001 at pages 335 to 338 entitled 'What is a Security?' in the course of which he also referred to the rather unhelpful Revenue interpretation in Tax Bulletin 53. Given the importance of the problem, I would like to add my own contribution to this very important debate.
All statutory references are to the Taxation of Chargeable Gains Act 1992 unless otherwise stated and references to debentures are to debentures which do not constitute qualifying corporate bonds.
Origins of the problem
The term 'securities' is not used in the body of the taper relief legislation. It only appears in paragraph 22(1) of Schedule A1 as part of the following definition: '"Shares", in relation to a company, includes any securities of that company'.
However, there is no general definition of securities for capital gains tax. Section 132(3)(b) provides a rather unhelpful definition, which only applies for the purposes of sections 132 and 133. The section 132(3)(b) definition is also applied for the purposes of section 251(1) which provides that no gain on the disposal of a debt by an original creditor will be a chargeable gain except in the case of 'the debt on a security'.
Section 251(6) provides, inter alia, that a debenture received on an exchange to which section 135 applies is deemed to be a security as defined in section 132. However, section 251(6) only applies for the purposes of section 251.
The result is that a debenture received on an exchange to which section 135 applies will result in a chargeable gain accruing to the holder on realisation (assuming it is paid out in full). However, in the Revenue's view, not all debentures are securities for taper relief. Therefore, the possibility exists that they may not constitute business assets.
Meaning of securities
Mark Rowland reviewed other areas of tax law in which the meaning of securities has been examined and demonstrated on the authority of Singer v Williams 7 TC 387 and Commissioners of Inland Revenue v Parker 43 TC 396 that securities could be used in a narrower or wider sense depending on the particular context in which it appears. The narrow sense, and indeed the prima facie meaning, is a debt the payment of which is secured by resort to some specific fund or property; the wider sense embraces a document establishing personal liability only without a charge on property.
Mark Rowland concluded that securities for taper relief was used in the wider sense with the result that unsecured non-marketable debentures qualify for business asset taper relief. I agree.
Relevant context
As appears from the extract from Lord Shaw's speech in Singer v Williams reproduced in Mark Rowland's article, the word 'securities' has no particular legal meaning which can be applied universally. It is an ordinary English word which takes its colour from the context in which it is used.
The assimilation of securities with shares in relation to a company in my view means that it is a commercial concept to which the tests of ordinary business must be applied. Applying such tests, I can see no reason for requiring anything other than an instrument issued by a company evidencing indebtedness of the company and containing a covenant to repay at the latest by a fixed date, with interest thereon.
In particular I can see no justification for implying added characteristics of marketability and the potential for being realised or dealt with at a profit. Such added characteristics are of course necessary to find a debt constituting 'the debt on a security' (see W T Ramsay Ltd v Commissioners of Inland Revenue [1981] STC 174).
However, there is more than a hint of a suggestion in the Revenue interpretation that only a debenture possessing the characteristics of 'the debt on a security' will do.
The debt on a security
'The debt on a security' is a strange composite phrase and clearly a term of art employed by the draftsman, albeit with very little in the way of statutory illumination as to its true meaning. The House of Lords in Ramsay discerned in the relevant statutory words a legislative purpose to deny allowable losses for those types of debt which were unlikely ever to be realised at a profit, but which were all too likely to be realised at a loss. The House of Lords decided that the expression 'the debt on a security' meant debts which had the added characteristics of marketability and the potential for being realised or dealt with at a profit. The contrast was said to be between simple unsecured debts and debts of the nature of an investment.
The necessary characteristics could lead to problems. For instance, one might suppose that a debenture issued by a company with the highest possible credit-rating, freely assignable and carrying interest at a variable rate linked to market rates was the very embodiment of the debt on a security.
Nothing could be more commercial or be said to be anything other than a good investment. However, the potential for increase in value in such circumstances, and therefore the status of the debenture as the debt on a security, was questionable.
Very soon taxpayers were exploiting the restrictive nature of the expression 'the debt on a security' on exchanges by taking debentures which, although fully commercial, lacked one or more of the necessary features, thereby enabling the taxpayers to wipe out the inherent gain on their original shares. The loophole was blocked in the Finance Act 1993 by the insertion of subsection (6) in section 251.
Irrelevance for taper relief
The starting point must be that taper relief only comes into play if there is a chargeable gain. Consequently the underlying rationale of the concept of the debt on a security, namely to prevent allowable losses for debts outside the concept, is of no relevance for taper relief.
Many shares will not be easily marketable, or indeed marketable at all in ordinary circumstances. For instance, many articles of association will contain restrictions on transfer and some may give the directors absolute discretion to refuse to register a transfer of shares. Nevertheless, all such shares can qualify for business asset taper relief.
Again taper relief does not distinguish between different types or classes of share. There may be preference shares with a fixed rate of return at one end of the scale or shares which may only participate in profits after a certain level of profitability has been achieved. Indeed the types or classes of share are endless in view of the variety of rights which may be ascribed to shares. It is entirely possible that some types or classes of share may have little prospect of increase in value save in very exceptional circumstances, say, in the case of a take-over.
Furthermore, as there may be redeemable shares issued by a company redeemable at the instance of the company, there may be a doubt as to the necessary 'structure of permanence' for 'the debt on a security' referred to in Lord Wilberforce's speech in Ramsay in the case of certain redeemable shares.
Given the collocation of securities with shares, it would be irrational in my view to require securities to possess the added characteristics of the debt on a security when such characteristics are not required for shares, remembering also that taper relief only applies if there is a chargeable gain.
Is there any irrationality in the fact that there could be debentures which are securities for taper relief but which are not the debt on a security?
There is none that I can see. If the debt is an original debt (not within section 251(6)), there will be no chargeable gain and so no question of taper relief. If there is a chargeable gain because, say, the debenture holder is an assignee, what is irrational about giving business asset taper relief? In both cases capital has been provided to the company just as in the case of a shareholder (whether the original subscriber or a transferee of an original subscriber).
As Mark Rowland points out, vendors of shares who take debentures which require the deeming provisions of section 251(6) to make them the debt on a security are also providing capital.
Postscript
While I am firmly of the view that securities for taper relief should be construed in the wider sense advocated by Mark Rowland for both the reasons he gives and the additional reasons I have advanced, there may be a concern that the Revenue will be tougher on giving clearances under section 138 in exchanges involving an issue of debentures and perhaps revisit the anti-avoidance provisions of Schedule A1 paragraph 10 ('periods of limited exposure to fluctuations in value not to count'), despite the helpful (and in my view potentially concessionary) indications to the contrary in paragraph 17916 of the Capital Gains Manual.
John Tallon QC is a member of Pump Court Tax Chambers.
