CANCELLATION AND REISSUE SCHEMES IN A TAKEOVER CONTEXT
Martin Moore QC looks at a High Court judgment on whether a scheme of arrangement involving the cancellation and reissue of shares to a new holding company as part of a wider acquisition fell within the exemption to the prohibition on capital reductions used as part of an acquisition scheme of arrangement
In the matter of Home Retail Group Plc  EWHC 2072 (Ch), the High Court was asked to confirm that a reduction of capital involved in the proposed scheme of arrangement was not barred by s 641(2A) CA 2006 because it was exempt under s 641(2B) CA 2006.
Home Retail Group Plc (Home Retail) sought the court’s permission to convene a shareholders meeting to consider a proposed scheme of arrangement and an order sanctioning the scheme (subject to shareholder approval). The scheme formed part of a wider transaction under which, following the disposal by Home Retail f its Homebase business, £220m would be returned to the Home Retail shareholders, and thereafter Sainsbury would acquire control of Home Retail. This would be effected by the following steps:
- consideration and sanction of the scheme of arrangement, whereby the Home Retail shareholders would by the reduction have their shares in Home Retail and receive on a one for one basis shares in;
- a return of capital to Newco shareholders, being the former shareholders of Home Retail of £220m in aggregate; and
- the acquisition of the Newco shares by Sainsbury by way of a mandatory transfer, contingent on the return of capital having taken effect, in accordance with the Newco articles of association in return for 55p in cash and 0.321 of a Sainsbury’s ordinary share(subject to mix and match elections for each share held by the former Home Retail shareholders; being in effect each Home Retail share held by them.
The High Court held that the scheme was exempt because it satisfied the conditions set out in s 641(2B). Further, if the court in interpreting the exemption, were to apply the Ramsay principle and take into account the exemption’s purpose (rather than applying only a literal interpretation), Newey J held that there was no obstacle to the exemption being used. This was because the scheme formed part of a wider transaction that was structured to take advantage of the exemption for a real commercial purpose (ie not solely for obtaining the exemption). However, the court did not definitively confirm whether a literal or purposive approach should be applied to interpreting s 641(2B).
Following the Government’s desire expressed in the 2014 Autumn Statement to end the stamp duty anomaly that a “cancellation and reissue” scheme did not attract stamp duty whereas other methods of acquiring control of a company by a transfer scheme or takeover offer did, s 641(2A) was introduced. S 641(2A) provides that a company cannot reduce its share capital under s 641(1) if the scheme were to result in one person (together with any associates) holding all the shares in the company.
S 641(2B) provides an exemption from the s 641(2A) prohibition if: (a) the company will have a new parent company; (b) all or substantially all of the members will become parent company members; and (c) the shareholdings in the parent company are to be the same or substantially the same shareholdings in the company.
Newey J concluded that it could and, as such, he would include within the order sanctioning the scheme, a confirmation that the scheme fell within the exemption in s 641(2B).
The parties chose to structure the transaction this way because Home Retail did not have sufficient capital in nominal value or share premium account to effect a return which could be treated as a capital distribution and newco was a clean company as regards creditor protection. Furthermore, to have simply increased the cash element of the Sainsbury’s offer would have resulted in the transaction becoming a Class One transaction requiring approval by the shareholders of Sainsbury’s.
On a literal reading of s 641(2B), the present scheme clearly fell within the exemption but, as the scheme was a condition to a very high value, wider transaction, the parties sought confirmation that, given the onward sale of newco, they would not be denied use of the exemption on a more purposive interpretation and application of s 641(2B).
The purposive approach to construing tax legislation, or the Ramsay principle, involves asking “…whether, the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically” (Collector of Stamp Revenue v Arrowtown Assets Ltd  HKCFA 46). It was accepted, in line with the Supreme Court decision in UBS AG v HMRC  UKSC 13, that where tax legislation references ‘contracts, agreements, arrangements or conditions’, that impliedly means those with a commercial or business purpose, and not those made with the sole purpose of obtaining a tax exemption.
It was argued that either the Ramsay principle did not apply or, if it did, the proposed transaction had a real commercial purpose and should not be caught within the prohibition.
It was argued that the Ramsay principle did not apply for the following reasons:
- s 641(2B) does not refer to ‘ultimate parent company’ which it could have done if the Government had intended to capture transactions such as the one before the court;
- the court retains a discretion not to sanction a scheme if it considers that the scheme is purely a stamp duty avoidance device; and
- there is no scope for application of the principle because of the technical language in s 641(2B).
Newey J did not confirm whether or not the Ramsay principle would be applicable, instead preferring to say that it did not matter whether it applied or not as it would present no obstacle to the proposed scheme. The scheme was “…part of a real world transaction having a clear commercial and business purpose…” Therefore, not only was this in keeping with the point in UBS regarding tax exemptions, but if the Ramsay principle did apply and s 641(2B) had to be construed purposively rather than literally, it meant that the scheme did not fall foul of the exemption conditions. The structure of the transaction did not mean that stamp duty was completely avoided; the ultimate purchaser of the shares (Sainsbury) still had to pay stamp duty on the transfer under the mandatory transfer provisions of newco’s articles. Structuring a transaction to facilitate the return of excess cash to shareholders, the intention to effect which had been announced prior to Sainsbury’s approach to Home Retail about a possible offer (and thereby avoiding a situation of effectively paying cash for cash) did not change the fact that the arrangements made by Home Retail were made for legitimate commercial purposes.
The decision does not herald the return of “cancellation and reissue” schemes of arrangement as a means of effecting takeovers. Indeed, a structure such as imposing a newco incorporated in an offshore jurisdiction which does not levy stamp duty and operating a mandatory transfer provision would be at considerable risk of being regarded as abusive. However, the decision does provide comfort that a “cancellation and reissue” scheme will not be ruled unavailable simply because it is used in conjunction with an acquisition of control provided that it is pout forward to facilitate a real commercial objective beyond simply the acquisition. Whilst the precise outlines of the exemption in S641(2B) has not been determined the case indicates a direction of travel with the court taking a pragmatic and realistic approach.