Scheme misused export tax reliefs, High Court finds

A scheme under which two directors of a construction company received some £600,0000 in tax-free dividends was a tax avoidance scheme involving a misuse of export sales tax reliefs, the High Court ruled yesterday.

The Revenue Commissioners had claimed the scheme was "far from being a normal use" of export sales relief provisions.

Mr Justice Thomas Smyth found that a complex arrangement under which Michael O'Flynn and John O'Flynn each received income of £298,000 in January 1992 in the form of tax-free export sales relief (ESR) dividends, funded by the write-off of a loan of £650,000 by their company O'Flynn Construction Company Ltd, was a misuse of the relevant reliefs.

He disagreed with a decision of the Appeals Commissioners of the Revenue Commissioners that the transaction in question was not a tax-avoidance transaction.

The judge was delivering his reserved decision on a challenge by the Revenue Commissioners to that Appeals Commissioners decision of April 2000.

The court was considering whether the Appeals Commissioners were correct in holding that the transaction was not a tax-avoidance transaction under Section 86.3 of the Finance Act 1989 on the grounds that it did not result in a misuse of the ESR provisions.

The judge said his answer to that question was "No", meaning the Appeals Commissioners were incorrect. This transaction, the judge said, involved export sales relief reserves in a company in the Dairygold group being transferred to a construction company not engaged in an export business in order to allow tax relief dividends to be paid to shareholders of that second company.

This scheme was "completely at odds" with the purpose for which the export sales relief was provided and the Revenue was required to have regard to the substance of the transaction, the judge found.

The case arose after O'Flynn Construction and Michael and John O'Flynn, with addresses at Kilcrea, Ovens, Co Cork, appealed to the Revenue Appeals Commissioners against an opinion of a Revenue officer in relation to the scheme.

The Revenue claimed that the company and the O'Flynns had entered into a scheme or arrangement for the purpose of extracting funds from the company in a manner which avoided a liability to advance corporation tax by the company. The Revenue also claimed the purpose of the scheme was to avoid payment of income tax by the O'Flynns on the receipt of dividends funded by their company.

On January 27th, 1992, it was claimed the O'Flynns each received income of £298,000 in the form of tax-free ESR dividends funded by the write-off at the same time of a loan from their company, resulting in a depletion of the assets of the company.

It was claimed the dividends were received by the brothers as a result of an arrangement not undertaken to legitimately avail of tax reliefs, but involving an abuse and misuse of law.

The Revenue had claimed the scheme involved three distinct phases. The first related to the isolation within the Dairygold group of ESR reserves of some £1.2 million. The second phase related to the utilisation of £600,000 of the reserves by unconnected persons and the third phase related to the utilisaiton of the balance of the reserves - £600,000 - by Michael and John O'Flynn.

The Revenue argued the substance of that transaction was that the profits of O'Flynn Construction Ltd were used to fund an ESR dividend payment to its shareholders. It was claimed the transaction, in the form of a complicated and unusual series of steps, was undertaken primarily to give rise to a tax advantage.