Entrepreneurs’ relief

The Court of Appeal (CoA) has found in favour of the taxpayer in The Quentin Skinner 2005 Settlement L & Ors v The Commissioners for HM Revenue & Customs [2022] EWCA Civ 1222, judging that a beneficiary does not need to have held an interest in possession for a full year (now two years) to claim entrepreneurs’ relief (ER) on a trust disposal of shares.

In reaching his decision, Sir Launcelot Henderson gave much consideration to the modern drafting technique of the ER provisions and how this affects the meaning of ‘qualifying beneficiary’. The decision endorses reading a consolidation act (such as the capital gains act under discussion) as a standalone document and is therefore critical of the need to rely on Explanatory Notes.

Background

The facts of the case were agreed by both sides. While the case involved three settlements (one for each of the taxpayer’s three sons), the fact pattern was the same for each of them. Quentin Skinner settled shares in DPAS Limited into an interest in possession settlement, with the life tenant of the settlement being his son. After four months, the settlement disposed of the shares. The life tenant qualified for ER in his own right due to a personal holding of shares.

HMRC denied the ER claim jointly made by the trustees and the life tenant, based on HMRC’s contention that the qualifying beneficiary must have held the interest in possession for a full year prior to the disposal.

It should be noted that since the events of this case, ER has been renamed business asset disposal relief (BADR), the limit for the amount of chargeable gains on which the relief can be claimed has been reduced from £10m to £1m, and the period for which an individual or qualifying beneficiary must meet the conditions has been extended from one year to two years.

The legislation

The case hinges on the interpretation of the provisions in s168J, Taxation of Chargeable Gains Act 1992 (TCGA 1992) regarding disposal of trust business assets, specifically the definition of a ‘qualifying beneficiary’.

The provisions allow ER where three ingredients are present:

1. there is a disposal of trust business assets;
2. there is a ‘qualifying beneficiary’; and
3. the ‘relevant conditions’ are met.

A ‘qualifying beneficiary’, per s168J(3), is an individual who has an interest in possession (other than for a fixed term) in the trust business assets – in this case the shares in DPAS Ltd.

The ‘relevant conditions’ for ER to apply, per s168J(4), are that throughout a period of one year ending not earlier than three years prior to the disposal of business assets:

• the company is the qualifying beneficiary’s personal company (5% holding) and is either a trading company or the holding company of a trading group; and
• the qualifying beneficiary is an officer or employee of the company or (if the company is a member of a group of companies) of one or more companies that are members of the trading group.

The question is therefore whether an individual must meet the definition of a ‘qualifying beneficiary’ throughout the period of one year (now two years) in which the relevant conditions are satisfied, or whether a ‘qualifying beneficiary’ is simply required at the point of the trust disposal.

HMRC argued for the former understanding, contending that the definition of ‘qualifying beneficiary’ should be informed by additional provisions in s168O regarding the apportionment of ER where there are multiple beneficiaries. This standpoint has historically been echoed in HMRC’s Capital Gains Manual at CG63985. However, it is a position that professional bodies and advisers have long disagreed with, as the additional requirement for claimants to have an interest in possession for a full year (now two years) may lead to unfair and illogical results.

The trustees of the settlements argued instead that s169J requires only that an individual is a ‘qualifying beneficiary’ at the point of the disposal, provided that separately the ‘relevant conditions’ are met for the requisite one year (now two years).

The story so far

A series of appeals have batted success in this matter back and forth between HMRC and the Quentin Skinner 2005 Settlements:

• The First-tier Tribunal (FTT) found that the ER provisions look to ascertain whether there is an “entrepreneurial connection” between the shareholding and the qualifying beneficiary, citing the Explanatory Notes to Finance Bill 2008 to support this position. Judge Guy Brannon considered it was not necessary for the qualifying beneficiary to have held the interest in possession for the full year, as the presence of an “entrepreneurial connection” is considered separately from the requirement for there to be a qualifying beneficiary. He wrote that the “wording of the [primary] statute is, in [his] judgement clear”, and that there was no need to consider s169O.
• The Upper Tribunal (UT) instead found that s169O is needed to clarify the meaning of a ‘qualifying beneficiary’ in s169J, that the meaning of the two provisions must be “consistent and coherent”. Again, although to opposite effect, the UT cited the Explanatory Notes from the introduction of the ER provisions, particularly noting that the ER rules are “broadly based” on the structure of the retirement relief rules.

The UT felt that the use of the term ‘qualifying beneficiary’ (as opposed to ‘individual’) in the provisions regarding the ‘relevant conditions’ requires a person to be a ‘qualifying beneficiary’ throughout the period in which the conditions are met.

The Court of Appeal decision

In the latest judgement, which found in favour of the taxpayer, the Court of Appeal (CoA) closely re-examined the structure and language of the provisions in the context of modern drafting techniques.

Here the CoA felt that the “clear and logical” structure of s169J, the main provision, aided by navigational aids such as signposts, meant that the provision should be understood in itself, without reference to s169O. The CoA also pointed to the fact that as s169O applies only where there is more than one beneficiary with an interest in possession, it would be a “classic instance of letting the tail wag the dog” if it were to govern a case in which s169O can have no application. 

The conditions of s169J should be worked through step by step to determine whether the three ingredients required are present. When read in such a way, the CoA felt that references to the ‘qualifying beneficiary’ within the ‘relevant conditions’, “most naturally read as simply a reference back to the individual who has already been identified” earlier in the provision. It did not import the requirement to be a qualifying beneficiary throughout the period into the relevant conditions. The CoA felt that the UT had erred in its reading of the statute, restoring the decision by the FTT in favour of the taxpayer.

Notably, the CoA also commented that the Explanatory Notes cited by the UT to support its decision were of very limited assistance in interpreting the statute, and that inferring meanings from old legislation (eg, retirement relief) into current legislation “must … be firmly resisted”. Instead, the judgement endorsed Sales J’s description in Eclipse Film Partners (No. 35) LLP v HMRC [2013] UKUT 639 (TCC) of a consolidation statute as a “single integrated body of law, without any need for reference back to the same provisions as they appeared in earlier legislative versions”.

Conclusions

In light of the judgement, professional advisers may feel bolstered in making successful BADR claims for assets held in trust. However, care should be taken in applying the findings of the judgement, as the fact pattern for many trusts will not follow the straightforward nature of the Quentin Skinner 2005 Settlements.

It is worth noting that on 10 October 2022, HMRC amended its Capital Gains Manual at CG63985 to remove its contention that the qualifying beneficiary must hold the interest in possession in the trust business assets throughout the relevant period. The manual now refers to the CoA judgement in Skinner.

The judgement sheds an interesting light on the reading of modern tax legislation. The methodical way each provision and ‘ingredient’ is considered in turn, by reference to signposts and definitions, may help many in their interpretation of the statutes.

About the author

Mei Lim Cooper, Personal Tax Manager, ICAEW