Upper Tribunal allows taxpayers' appeals in EIS case

In Hugh Edward Mark Osmond and Matthew Charles Allen v HMRC [2025] UKUT 00183 (TCC), the Upper Tribunal (UT) allowed the taxpayers' appeals concluding that the First-tier Tribunal (FTT) had erred in law and that the main purpose of crystallising Enterprise Investment Scheme (EIS) relief was not the obtaining of an income tax advantage, even though this may have been its effect.

Background

Hugh Edward Mark Osmond and Matthew Charles Allen (the Appellants) were entrepreneurs who had made various investments over a number of years. In particular, they had subscribed for shares in  Xercise Ltd (XL), in 1996 and 1998 under the EIS (which enables investors to sell their EIS shares free of Capital Gains Tax (CGT) provided certain conditions are met, including that the shares have been held for at least three years).

The business of XL was unsuccessful and was sold in 2002, but XL itself was retained by the Appellants because the shares they held in the company qualified for EIS relief. The company was then subsequently used to invest in another business, the Pearl Life Assurance and Pension Group. All of these transactions were carefully structured because the Appellants wanted to retain the CGT relief that attached to their shares in XL. The Pearl business was successful and  by the mid-2010s, the Appellants were holding CGT-exempt shares that had increased substantially in value.

The Appellants became concerned that the benefit of EIS relief might be removed and they would not then be able to obtain relief on their gains. Accordingly, in order to crystallise their gains, the Appellants entered into a share buyback transaction, for consideration no greater than a return of capital, in order to crystallise the EIS disposal relief on their shares. As a result, no income tax was payable, and no CGT was payable owing to the EIS disposal relief. The disposals were included on their 2014/15 tax returns, and EIS disposal relief claimed.

HMRC opened enquiries into the Appellants' tax returns in January 2017 and closed them without amendment in September 2017.

On 31 March 2021, HMRC issued counteraction notices and assessments under the Transactions in Securities (TiS) legislation, contained in Income Tax Act 2007 (ITA 2007).

The Appellants appealed to the FTT. 

FTT's decision

The appeals were dismissed

Central to the case was the determination that one of the main purposes of the Appellants being party to TiS, was to obtain an income tax advantage. The reasoning of the FTT was surprising to most observers, as it applied the main purpose test in a way that effectively ignored the subjective intentions of the parties. 

The FTT concluded that although the transaction was not driven by a desire to avoid income tax, the primary purpose was to crystallise the EIS relief, which, under the legislation, amounted to a main purpose of obtaining an income tax advantage. Therefore, the TiS provisions applied, and the amounts received were taxable as income.

In light of these findings, the FTT dismissed the Appellants' appeals, upholding HMRC’s position that the TiS legislation applied and that the amounts received should be taxed as income rather than exempt capital gains. The Appellants appealed to the UT. 

The FTT's decision can be viewed here. 

UT's decision 

The appeal was allowed.

The unallowable purpose element of the FTT's decision was the only point for determination before the UT.

In the view of the UT, the FTT had erred in law by treating the Appellants' intention to crystallise EIS relief as equivalent to having a main purpose of obtaining an income tax advantage under the TiS rules.

The UT confirmed that there is a critical legal distinction between a purpose and an effect. While the share buyback in question clearly resulted in an income tax advantage (as the gain was exempt from CGT), this did not mean that securing that advantage was a main purpose of the transaction. The UT relied on the principles established by the Court of Appeal in BlackRock HoldCo 5 v HMRC [2024] STC 740, which explicitly recognised that purpose should be distinguished from effect, emphasising that even when a tax outcome is inevitable, it does not follow that it was deliberately sought. In the instant case, the Appellants' aim was to "bank" the CGT relief available under EIS, not to extract profits in a tax-efficient way.

Importantly, the UT rejected HMRC’s argument that the TiS rules should treat any CGT exemption as a proxy for an income tax motive. The UT highlighted that section 687, ITA 2007, does not create a deeming provision that would automatically treat a capital-focused transaction as one with an income tax avoidance purpose. The UT noted that HMRC’s own consultation documents during the 2010 legislative changes, suggested that the TiS rules were not intended to apply where only capital gains reliefs were involved.

The UT also agreed with the FTT that the Appellants were motivated solely by a desire to crystallise EIS relief before any potential legislative changes. The UT agreed that the evidence pointed to a capital motive, not an income extraction strategy.

In conclusion, the UT found that the TiS rules did not apply because the Appellants’ main purpose was to secure a CGT relief, not to obtain an income tax advantage. 

Comment

This decision has prevented HMRC from extending the scope of the TiS regime beyond its intended purpose and reinforces the importance of examining a taxpayer's actual subjective intention - something the UT noted aligns with how practitioners have long understood the rules to operate.

The decision also serves as a reminder that taxpayers should clearly document their commercial intentions at the time the relevant transaction is entered into.

It will be interesting to see if HMRC seek to appeal this decision to the Court of Appeal. 

The UT's decision can be viewed here.