CAPITAL GAINS TAX | Shares And Securities: Conversions Of QCBs And Non-QCBs To Be Treated Separately

Chargeable gains on shares that had been frozen into loan notes did not escape capital gains tax when the loan notes were converted into other loan notes, which were qualifying corporate bonds.

The appellants held between them 100% of the shares in a company (B). In August 2000, B was sold to another company (L). The initial consideration was loan notes issued by L (the 08/00 loan notes’) which were non­qualifying corporate bonds (non-QCBs), with provision for additional consideration depending on the subsequent performance of the business. Additional consideration was subsequently paid in March 2001 (‘the 03/01 loan notes’) which were also non-QCBs.

In October 2002, the 03/01 loan notes were converted (into ‘revised 03/01 loan notes’) which were QCBs. The effect of the conversion of the 03/01 loan notes into the revised 03/01 loan notes was to freeze the gain on those notes and give rise to a charge to CGT on their subsequent disposal. In May 2003, the 08/00 loan notes and the revised 03/01 loan notes beneficially owned by the appellants were exchanged for secured discounted loan notes 2004 (‘SDLs’) which were QCBs. In June 2003, the SDLs were redeemed for cash.

The First-tier Tribunal (FTT) allowed the appellants’ appeals against closure notices by HM Revenue and Customs (HMRC) for 2003/04 and held that there was a single agreement for the conversion of the 08/00 loan notes and the revised 03/01 loan notes into the SDLs. Neither of the conditions in TCGA 1992, s 116(1)(b) was met and the transaction, therefore, avoided CGT on the gain, which was latent in the 08/00 loan notes. However, the Upper Tribunal (UT) allowed HMRC’s appeal. The appellants appealed.

The Court of Appeal held that the correct approach to conversions of securities (within TCGA 1992, s 132} was that conversions were not permitted to have mixed (i.e. QCBs and non-QCBs) ‘inputs’. It considered that the UT was right to apply section 132 in that way, thereby preventing the deeming effect of section 127 leading to a result not intended by Parliament. Accordingly, section 116(1)(b) did not operate as a barrier to the application of the remainder of that section. The appellants’ transaction fell to be treated as two separate conversions, as contended by HMRC.

The Court rejected the appellants’ argument that the May 2003 transaction was a single transaction and therefore it could not be split into different components, such that the transaction had to be treated as one in which QCBs and non-QCBs were converted into QCBs (gains on which are not chargeable to CGT). The appellants’ appeal was dismissed.

Hancock and Anor v Revenue and Customs [2017] EWCA Civ 198