Khan v Commissioners for HM Revenue & Customs

Factual and Procedural Background

This case concerns an appeal against a tax liability imposed on the Appellant, an accountant who acquired a company ("the Company") by purchasing its entire issued share capital for £1.95 million plus a small additional amount. Shortly after, the Company bought back 98 of those shares from the Appellant for £1.95 million, leaving him with one share. The transactions were structured with the involvement of legal and financial advisers and were intended to be tax-efficient for the vendor shareholders.

The tax authority issued a closure notice increasing the Appellant's income tax liability by approximately £594,815 for the 2013-2014 tax year, treating the Company's buyback payment as a taxable distribution under s.383 of the Income Tax (Trading and other Income) Act 2005 ("ITTOIA"). The Appellant challenged this through the First-Tier Tribunal ("FTT") and the Upper Tribunal ("UT"), both of which ruled against him. The Appellant was held liable to pay income tax on the sum paid to him by the Company under s.385(1)(b) ITTOIA, which identifies who is liable for tax on distributions.

The Appellant appeals the UT decision with permission granted by Nugee LJ, contending that the transactions should be viewed as a single composite transaction and that he was merely a conduit for the vendor shareholders, who should be liable for the tax.

Legal Issues Presented

1. Whether the Appellant, as the recipient of the Company's payment under the buyback agreement, is liable to pay income tax on that distribution under s.385(1)(b) ITTOIA.
2. Whether the sale and buyback transactions should be treated as a single composite transaction for tax purposes, attributing the distribution to the vendor shareholders rather than the Appellant.
3. Whether the concepts of "receipt" and "entitlement" under s.385(1)(b) ITTOIA require an element of control over or benefit from the distribution to impose tax liability.
4. Whether the Upper Tribunal erred in law in its interpretation and application of the statutory provisions and relevant case law.

Arguments of the Parties

Appellant's Arguments

• The share sale and buyback should be considered as one composite transaction, with the Appellant acting only as a conduit for the vendor shareholders.
• The Appellant never had control or benefit over the £1.95 million distribution; it was paid immediately to the vendor shareholders, so it is "absurd" to tax him on that sum.
• Taxing the Appellant would allow easy avoidance of tax by interposing a non-taxable intermediary.
• The statutory terms "received" and "entitled to" require more than bare legal ownership; they require practical control or benefit from the distribution.
• Relied on authorities including Ensign Tankers v Stokes, WT Ramsay v Inland Revenue Commissioners, and case law interpreting "entitlement" in a broad commercial context.
• Distinguished the Appellant’s benefit from the transaction as a whole from benefit from the buyback proceeds specifically, which he argued he did not enjoy.
• Argued that the Upper Tribunal erred in failing to recognize the practical realities and commercial unity of the transactions.

HMRC's Arguments

• The Appellant both received and was entitled to the distribution under s.385(1)(b) ITTOIA as he was the legal and beneficial owner of the shares at the time of the buyback.
• The statutory language does not require any additional element of control or benefit beyond receipt or entitlement.
• The vendor shareholders received a different payment from the Appellant under the share purchase agreement, distinct from the taxable distribution made to the Appellant.
• The timing and legal effect of the transactions support treating the Appellant as the recipient liable for tax on the distribution.
• Any contractual obligation to use the money in a particular way after receipt does not negate receipt or entitlement for tax purposes.
• Relied on established tax principles and case law to support a narrow focus on the transaction giving rise to the distribution, rather than the overall economic outcome of related transactions.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by examining the statutory framework under ITTOIA, particularly sections 383 and 385, which govern the charging of income tax on distributions by UK resident companies and the identification of the person liable to pay that tax. Section 385(1)(b) provides that the person liable is "the person receiving or entitled to the distribution."

The court reviewed relevant legislative history and explanatory notes, confirming that the phrase "receiving or entitled to" is intended to identify the person to whom the distribution belongs, usually the shareholder at the time of distribution.

The court considered established case law interpreting similar language in previous tax statutes, including Aplin v White and Timpson's Executors v Yerbury, which support that either receipt or entitlement suffices to impose tax liability. Importantly, the court rejected the Appellant's argument that receipt or entitlement requires practical control over or benefit from the distribution beyond legal and equitable ownership.

The court analyzed the facts and found that the Appellant was the legal and beneficial owner of the shares at the time of the buyback and that the Company’s payment of £1.95 million was made to him, constituting a distribution. Although the Appellant had contractual obligations to use the money to repay a loan from the Company, this did not negate his receipt or entitlement to the distribution.

The court rejected the Appellant’s submission that the transactions should be treated as a single composite transaction to attribute the distribution to the vendor shareholders. It held that the statutory provisions require focus on the transaction under which the taxable distribution arose and that the legal rights and obligations at the time of that transaction are decisive.

In applying the purposive interpretation endorsed in WT Ramsay and UBS, the court found that the statutory language and purpose do not support treating the series of transactions as one composite transaction for the purpose of determining who is liable for tax on the distribution.

The court further distinguished cases cited by the Appellant concerning "beneficial entitlement" in group tax relief contexts, emphasizing that those principles do not translate into a requirement of benefit or control under s.385(1)(b).

Ultimately, the court concluded that the Appellant both received and was entitled to the distribution and that there was no legal or factual basis to recharacterize the transactions to avoid tax liability.

Holding and Implications

The court DISMISSED the Appellant's appeal, upholding the Upper Tribunal's decision that the Appellant is liable to pay income tax on the £1.95 million distribution under s.385(1)(b) ITTOIA.

The direct effect of this decision is that the Appellant must pay the income tax charged on the distribution made by the Company under the share buyback arrangement. The decision confirms that for the purposes of s.385(1)(b), legal and beneficial ownership at the time of distribution suffices to impose tax liability, without requiring additional elements of control or benefit.

No new precedent was set beyond affirming the existing statutory interpretation and application of established principles to the facts of this case.