The Supreme Court held that Mr and Mrs Hancock could not use a mixed conversion of loan notes to take the gain on their sale of shares in Blubeckers Ltd outside capital gains tax. Although some notes had become qualifying corporate bonds before all the notes were converted together into further such bonds, the conversion had to be treated as separate conversions. The gain on the non-qualifying notes was therefore preserved by rollover relief and deferred until redemption, rather than exempted.
Mr and Mrs Hancock exchanged their shares in Blubeckers Ltd for redeemable loan notes, with further notes to follow under an earn-out. The exchange was a company reorganisation. The capital gains tax legislation normally defers tax on such a reorganisation until the replacement securities are realised. That deferral, called rollover relief, is less favourable than the exemption for disposals of qualifying corporate bonds, which are essentially sterling-only bonds.
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They arranged the transaction in three stages. They first received Lionheart notes, which were convertible into foreign currency and were not qualifying corporate bonds. The terms of some notes were then varied so that those notes became qualifying corporate bonds. Finally, both sets of notes were converted together, without distinction, into one series of secured discounted loan notes, which were qualifying corporate bonds and were later redeemed for cash. They argued that this final stage was one conversion of a mixed holding. On that basis, neither alternative in section 116(1)(b) of the Taxation of Chargeable Gains Act 1992 applied, so the exemption was available. They said that converting even a nominal amount, such as £1, of qualifying bonds would suffice.
The legislation
Section 115 exempts disposals of qualifying corporate bonds. Sections 127 to 131 provide rollover relief on a reorganisation and treat the original holding and the new securities, each taken as a single asset, as the same asset. Section 132 extends that treatment, with any necessary adaptations, to conversions of securities. Its definition covers a conversion of a non-qualifying security into a qualifying corporate bond and a conversion in the opposite direction. Section 116 preserves rollover treatment where sections 127 to 130 would apply and either the original shares consist of or include a qualifying corporate bond while the new holding would not, or the original shares would not while the new holding would consist of or include such a bond.
The taxpayers accepted that the earlier variation was itself a conversion carrying rollover relief. Their claim therefore depended on treating the final conversion as a single transaction outside both limbs of section 116(1)(b).
Decisions below
The Upper Tribunal held that the final conversion comprised separate transactions for each security. It considered that the taxpayers’ reading went beyond the purpose of encouraging the market in sterling bonds, and noted that section 132 defined the relevant conversions by reference to each security. The Court of Appeal dismissed the taxpayers’ appeal. Floyd LJ accepted that the wording might literally assist them, but said that allowing the non-qualifying notes to escape tax would contradict the purpose of the scheme. The classes of notes should be treated separately, and the single-asset treatment had to be adapted to avoid that result. Lewison LJ agreed, giving greater weight to a purposive reading under which the necessary adaptations could give effect to the statutory policy. Kitchin LJ agreed with both.
The Supreme Court’s decision
Lady Arden, with whom Lord Reed, Lord Sumption, Lord Carnwath and Lord Briggs agreed, said that the appeal would fail if the final stage involved separate conversions. The taxpayers’ use of one transaction did not determine that statutory question. Section 116(1)(b) contemplates a mixed pre-conversion holding, and the Court of Appeal’s interpretation leaves the words “or include” without effect. Those were powerful arguments for the taxpayers.
Their result was nevertheless inexplicable given the policy of giving relevant reorganisations the same rollover relief. Taxpayers could otherwise avoid the intended charge with extreme ease by introducing a minimal qualifying-bond conversion, such as a bond of £1 nominal value. Section 132(3) shows that Parliament intended each security converted into a qualifying corporate bond to be regarded as a separate conversion. The requirement to apply sections 127 to 131 with necessary adaptations permits that separation despite the single-asset language in section 127. On this construction, the meaning is clear, so the principle that tax requires clear words is satisfied. Lady Arden found it unnecessary to invoke the broader principle that a strained interpretation may prevent a result contrary to Parliament’s clearly expressed intention.
The potential gain in the non-qualifying bonds was therefore frozen on conversion. It did not disappear, and tax was deferred until redemption rather than extinguished by the exemption.
Verdict: The Court unanimously dismissed the taxpayers’ appeal. The gain on the non-qualifying loan notes was preserved on conversion and became chargeable on redemption. Combining both kinds of note in one transaction did not extinguish that gain.
Source: Hancock and another v Commissioners for Her Majesty’s Revenue and Customs [2019] UKSC 24
