Assumption of debt forms part of share sale consideration

Mr Cooling owned 99.9% of the issued share capital of Shirebrook Care Limited (‘Shirebrook’), which he sold to a third party purchaser, Care Aspirations Developments Limited for a headline price of £21million, subject to a completion account mechanism.

On the day prior to executing and completing the sale of the shares, Mr Cooling had acquired certain assets (mainly properties, plant, office equipment and vehicles) from the company for c£298k. The consideration for this asset transfer was left outstanding, with the debt payable on demand by Mr Cooling to the company.

Within the share purchase agreement, the asset sale was disclosed as a “permitted disposal” and the Buyer undertook that it would not and undertook to procure that Shirebrook would also not seek to recover the debt from Mr Cooling or any his Associates. In addition under the agreement, upon completion of the share sale, the debt from Mr Cooling was to be assumed by the purchaser, Care Aspirations Developments Limited, in accordance with a tripartite deed.

Within the share agreement there was a completion statement mechanism to calculate the consideration price for the shares. This mechanism allowed for adjustments from the headline price of £21million for liabilities such as the Bank borrowings and other minor net assets and liabilities of the Company. For the purposes of the completion statement the documentation provided that debt due by Mr Cooling to the company was to be assumed to be nil. Following agreement of this calculation, cash consideration of £9,976k was paid to Mr Cooling for his shares, which he duly reported on his tax return as the consideration value for the shares.

However, HMRC argued that the assumption of the debt by the Purchaser should also be taken into account in determining the consideration for the share disposal. The First Tier Tribunal agreed with HMRC’s analysis noting that the completion statement mechanism provided the calculation of the cash consideration for the shares, however this was not the end of the matter and the fact that Mr Cooling had also received assets of £298k for which he had not been required to pay could not be ignored. Accordingly, the disposal proceeds for his shares was increased by £298k.

This case acts as a reminder that it is important to look at the transaction as a whole to determine what the consideration received in respect of the disposal of an asset and this may well encompass more than just the matters detailed with the sale agreement itself. Interestingly, within the case the Tribunal judge, Peter Kempster, referred to Spectros International plc v Madden [1997] and the fact that “parties to a proposed transaction can achieve the same practical and economic result by different methods….The law respects the freedom of the parties to a transaction to frame and formulate their agreement as they wish and to suit their own legitimate interests (taxation and otherwise) and as long as the form adopted is genuine, and not a sham, honest and not a fraud on someone else, and does not contravene some established public policy, the court will give effect to the method adopted.” This reinforces the principle that where the transaction has been undertaken in a particular form and the transaction is not a sham then the Courts should respect to the approach taken and accordingly the tax implications arising – it is not possible for them to impute a different tax result where the legal documentation is clear on the approach taken.

However, in determining what is the consideration for capital gains purposes it is necessary to look at all of the value received by the Vendor, whether that be cash consideration or otherwise. Merely examining the amount set out in sale and purchase agreement for the shares may not provide the full story.

For further information please contact the TaxDesk on 0845 4900 509 and ask for Caroline Fleet.