Dialog Semiconductor Limited v The Commissioners for HMRC

Dialog say these words imply reciprocity. They say this is evident from British Telecommunications plc v HMRC SpC 535; [2006] STC (SCD) 347 (“BT”), where at [9] Dr John Avery-Jones CBE remarked:

“I think that it is common ground that if the reason for the payment was to give effect to a term of the Merger Agreement rather than because the appellant gave up its rights under the agreement, the sum would not be derived from assets; and if the reason for the payment was in return for the appellant’s giving up its rights under the agreement, the sum would be derived from the asset.”

Dialog say the Termination Fee was not paid for Dialog giving up or refraining from exercising its rights under the Merger Agreement, since:

In summary, HMRC’s case is that (1) Dialog had various contractual rights under the Merger Agreement and these were assets; (2) the Termination Fee was a capital sum; (3) the Termination Fee was paid to release Dialog from its contractual rights and therefore the real source of the capital sum was the termination of the Merger Agreement; and (4) it follows, that the payment was made in return for Dialog forfeiting/surrendering/refraining from exercising its rights.

HMRC note how in Zim Properties Ltd v Proctor [1985] STC 90, 106j, (ChD) (“Zim”) Warner J observed that:

“a capital sum may be derived from assets within the meaning of the general words in s 22(3) even though those assets may not be the immediate source of that sum.”

and whether a capital sum derived from an asset in each case requires consideration of “the real (rather than the immediate) source of the capital sum”: Zim 107b.

HMRC rely on Welbeck Securities Limited v Powlson [1987] STC 468 (CA) (“Welbeck Securities”). There Welbeck had an option to acquire an interest in a property development but proceedings to enforce the option were compromised in the form of a Tomlin order by which Welbeck received £2m and in consideration thereof released and abandoned the option. Welbeck argued (amongst other things) that the £2 million payment was not received in return for disposal of the option. Instead, it was received in return for Welbeck’s right, under the Tomlin order, to receive that sum. The Court of Appeal disagreed, holding that the asset that was disposed of was the option: Welbeck Securities per Slade LJ, 474e.

Similarly HMRC rely on Kirby v Thorn EMI plc [1988] 1 WLR 445; [1987] STC 621 (CA). There Thorn and a wholly owned subsidiary entered into an agreement whereby the subsidiary sold shares in three companies to a third party and Thorn covenanted that for a period of five years neither it nor any of its subsidiaries would engage in any of the businesses carried on by the three companies. Thorn received the sum of £575,000 in return for the covenant. The Court of Appeal held that the promise not to compete could not be an asset at the time of the sale because it did not exist at the time of the agreement. Also, a right to carry out business in the marketplace was not an “asset” within the meaning of the legislation. However, the Court explained that goodwill in a particular business was an “asset” and Thorn’s covenant amounted to a promise not to exploit its goodwill. That promise was a disposal of its goodwill. It followed that the sum paid to Thorn was, at least in part, a capital sum derived from assets and was therefore within the charge to tax.

HMRC say that BT is to be distinguished. In that case BT owned a 20% shareholding in another company, MCI. In 1996, BT entered into a merger agreement with MCI. Unless terminated, the merger agreement required MCI and BT (as a shareholder in MCI) to support the BT/MCI merger. The merger agreement contained an express termination provision which provided for termination (amongst other things):

The payment of a termination fee was a condition for termination pursuant to circumstance (3). MCI subsequently received a superior proposal from another company, Worldcom, with its best and final offer being made on 9 November 1997. On the same day, BT entered into an agreement with MCI and Worldcom. The recitals to the agreement provided expressly that the merger agreement had been terminated “by mutual agreement” and that Worldcom (not MCI) had agreed to pay a sum, equivalent in size.

HMRC note that the Special Commissioner, Dr Avery Jones CBE, found that the payment to BT was made to it (as a shareholder) to support the merger with Worldcom. The relevant paragraph in his decision states:

“17.

What was the real source of the capital sum? Was the appellant paid for giving up the rights it had against MCI under the Merger Agreement, or for being relieved from its obligation to vote its MCI stock in favour of its merger? In my view in reality the appellant was not being paid to surrender its rights against MCI because in the circumstances these were very slight since MCI could in accordance with s 5.7 of the Merger Agreement recommend the Worldcom merger to its stockholders, and so the appellant’s rights were not worth much. The appellant was paid by Worldcom to support the merger with Worldcom for which it was necessary first to terminate the Merger Agreement containing its obligations to MCI support the merger with itself, for which it was worth Worldcom paying the equivalent of the Alternative Transaction Fee. I do not consider that it is a capital sum derived from assets. The appellant was being paid for supporting the Worldcom merger and in consequence for being relieved from an obligation, not for giving up any asset.”

In their written closing HMRC summarise the differences between BT and Dialog’s position as follows:

Dialog say there was no “forfeiture” of rights, “surrender” of rights, or “refraining from exercising” rights, since:

Dialog say, as is normal in a commercial case, where both sides perform their obligations under a contract and thereby discharge it, some of Dialog’s contractual rights were satisfied by the counterparty and other rights fell away in accordance with their terms without Dialog forfeiting them, surrendering them, or refraining from exercising them. The contract was discharged by performance.

Dialog note the analysis would be very different if there were no provision in the Merger Agreement for Atmel to withdraw from the merger and Atmel had subsequently agreed with Dialog, in return for a substantial sum, to discharge the Merger Agreement.

We asked to be addressed, in closing submissions, on whether how the terms surrender and forfeiture are used in English contract and land law may inform the interpretation of this provision. Dialog comment:

“The contract and land law concepts of ‘surrendering’ and ‘forfeiting’ are helpful guides to the interpretation of s 22(1)(c) TCGA. Given s 22(1)(c) is evidently not restricted only to leases, contracts with forfeiture clauses, and so forth, there is a bit more interpretative ‘wriggle-room’. But Parliament chose to use words with significant land law / contract ‘backgrounds’ for a reason. In Dialog’s submission, the consideration of these words’ land law and contract meanings supports the submissions on those words in §47 of Dialog’s skeleton – and indeed, those submissions refer to land law and contract. Bennion, Bailey and Norbury on Statutory Interpretation at 25.2 discusses the position, holding:

‘An Act sometimes uses language which describes a concept in terms that are similar but not identical to an existing legal concept. The question then is whether the legislative intention was to incorporate or attract the common law rules, wholly or in part, or to start afresh’.

In Dialog’s submission, there can be no doubt that the land law and contract meanings were intended to assist in what those words mean in s 22(1)(c) but not limit their meanings only to leases, contracts with forfeiture clauses, or similar.”

At the hearing we pressed HMRC to specify which of the three possibilities contemplated by s 22(1)(c) HMRC said was in issue. In their written closing they say that they “rely primarily” on the phrase “surrender of rights”, continuing:

“As for the meaning of ‘surrender of rights’, in [Welbeck Securities] at 473d, Slade LJ explained that the phrase was intended to bring into charge, among other transactions, ‘surrenders of rights in such manner as to extinguish them or the receipt of capital-sums as consideration for such releases’. A surrender of rights therefore occurs where rights are extinguished in return for capital sums.”

HMRC say the Termination Fee was paid to release Atmel from its obligations to Dialog and to render Dialog’s rights under the agreement void: that is a surrendering of rights.

HMRC say that it is common ground that if the agreement did not contain a break provision then a payment for terminating the agreement after it had been entered into would be a forfeiture or a surrender. It therefore makes no sense that an ex ante agreement to terminate the contract in certain circumstances would not also be a surrender.

HMRC also suggest that there could be a “forfeiture”. The relevant part of their written closing states:

“As for ‘forfeiture’, HMRC says that this connotes losing something because of an act or omission. The concept of ‘refraining to exercise’ refers to a person who chooses not to use a right. Whilst HMRC’s primary position is that this appeal fails because Dialog surrendered its rights, in circumstances where Dialog ultimately lost its rights after decided not to exercise its matching rights, the Termination Fee could also be a capital sum in return for ‘forfeiture’ or ‘refraining to exercise’.”

HMRC say that if it is the case (as Dialog contend) that surrender, forfeiture or refraining from exercising rights requires some kind of positive step by the person losing their rights, agreeing to the termination clauses in the Merger Agreement was a positive step taken by Dialog and the subsequent receipt of money in return for termination was a surrender. Alternatively, Dialog not exercising its matching rights was such a positive act.

Regarding whether how the terms surrender and forfeiture are used in English land and contract law may inform the interpretation of this provision, HMRC comment:

“In accordance with the usual rules of statutory interpretation, when ascertaining the intention of Parliament expressed in the language of a statute, the appropriate starting point is that language is to be taken to bear its ordinary meaning in the general context of the statute. That means that the FTT should approach s 22(1)(c) by having regard to the ordinary and natural meaning of the legislative words. Here, it is not necessary, or appropriate, to import principles and doctrines from land law or contract law in order to interpret the statutory words.”

Dialog say s 22(1) TCGA 1992, of which s 22(1)(c) is a subspecies, requires a capital sum to be “derived from assets”. However the Merger Agreement was not an asset for CGT purposes.

Dialog concede that assets are widely defined in s 21(1) TCGA 1992 and that contractual rights are capable of being an asset for CGT provided they can be turned to account (even if they cannot be transferred or assigned): O’Brien (Inspector of Taxes) v Benson’s Hosiery (Holdings) Ltd [1980] AC 562, 573 (HL) (“O’Brien”).

However, not all contractual rights, even if they can be turned to account, are assets for CGT purposes. In Zim, it was held that the contractual right to payment of a vendor of property is not a CGT asset. In Hardy v HMRC [2016] UKUT 332 (TCC) (“Hardy”) this was taken further, where Arnold J and Judge Sinfield explained (at [40]) that not only is the contractual right to payment of a vendor of property not a CGT asset, but neither is the purchaser’s contractual right to acquire the property. In Sehgal v HMRC [2022] UKFTT 312 (TC); [2023] SFTD 212 (“Sehgal”) at [104(4)] Judge Short summarised the principle from Hardy as:

“When looking at a bi-party contract relating to an underlying asset, the rights arising under the contract cannot be separated from the asset which is the subject of the contract”.

Dialog say that it had contingent rights under the Merger Agreement that were, in essence, those of a purchaser of property. They point especially to § 1.4, 2.1(a), 2.1(c) and 8.9 of the Merger Agreement. Therefore the rights under the Merger Agreement were not an asset for CGT purposes.

Further, to show the impractical consequences that would arise if the contractual rights of a purchaser of property were an asset for CGT purposes, they put forward the example of a taxpayer who contracts to buy rural land for £1m and finds – between exchange of contracts and completion – a gold deposit on the land giving it a new estimated value of £50m.

Contractual rights can be assets: O’Brien at 573C-G per Lord Russell; Marren (Inspector of Taxes) v Ingles [1980] 1 WLR 983 (HL) at 986A, per Lord Wilberforce; Zim at 104d, per Warner J. Not all contractual rights are assets. As Warner J explained in Zim at 108c, the “right of a seller of property to payment of its price” is not an asset. This position is in common with the Dialog.

HMRC suggest that Hardy and Sehgal are of limited relevance because they concern contracts for the purchase of land.

In Zim at 107b and following, Warner J recorded the arguments that were being advanced by the taxpayer’s counsel (including the argument that “a right to compensation for loss is not an asset for capital gains tax purpose”). Warner J did not accept those arguments, explaining at 108c that there could not be “a brute application of verbal formulae”. The outcome of Zim was that a right to sue the taxpayer’s solicitors for damages was an asset – it must follow that a right to compensation for loss can be an asset for capital gains tax purposes.

We do not consider it realistic to describe the Merger Agreement as discharged by performance, in an equivalent way that would have occurred if the merger was consummated, when the Termination Fee was paid.

From a commercial perspective, the purpose of the Merger Agreement was for Dialog and Atmel to set out the steps they would both take to work towards a merger. The business objective was to consummate a merger. The aim of the transaction was not for a termination fee to be paid. That is clear from Dr Bagherli’s testimony. It is also clear from the recitals to the Merger Agreement, which Mrs Dearlove confirmed could be an aid to the construction of the Merger Agreement.

We do not accept that, immediately prior to the termination of the Merger Agreement, the rights of Dialog were slight. At that point they were able to enforce significant contractual restrictions against Atmel: including by specific performance. Those restrictions included limitations on Atmel relating to the payment of dividends, issuing shares, setting the compensation of its directors and employees, making loans to directors, taking out loans, changing accounting standards, making tax elections, acquiring stock and assets, altering material contracts, alienating IP and engaging in litigation. Furthermore, Atmel were not able to enter into the merger agreement with Microchip without paying the Termination Fee “substantially concurrently” with termination. Accordingly Dialog had the right to prevent Atmel’s board from recommending a different proposal.

Given that Dialog had decided not to make a counter-offer to outbid Microchip, immediately prior to the moment of termination these rights were of limited inherent utility for Dialog, aside from the ability to extract payment from Atmel/Microchip to free Atmel of these restrictions. However, these were onerous restrictions on Atmel (see [101] above), and therefore these rights had value. Viewed realistically, the Termination Fee was, at least partly, in return for freeing Atmel from these restrictions.

The Termination Fee also had an important compensatory function. It was not solely to compensate for out-of-pocket expenses. That is clear from the amount of the fee vastly exceeding the out-of-pocket expenses incurred by Dialog. The difference is so large it cannot have been a genuine pre-estimate of just out-of-pocket expenses. Rather, some of it must represent compensation for the loss of opportunity. Indeed, that is consistent with the general position on termination fees (see [60] above).

We acknowledge that the Termination Fee had a deal protection function too, to deter higher bids: see [63(2)] above. However, we find this to be a secondary function as the Merger Agreement specifically states the function of the Termination Fee is compensation (see [42] above) and, as we were repeatedly told in the experts’ testimony, Delaware law supports freedom of contract and seeks to give effect to what the parties have agreed.

We therefore find that the real source of the Termination Fee is as a compensatory payment for the loss of opportunity for pursuing the Merger and also to compensate for out-of-pocket expenses. The timing of the payment of the Termination Fee does not alter this – it is not uncommon in commercial agreements for the price to be paid after delivery of goods or performance of services. Thus, even if the rights under the Merger Agreement were not in existence when the Termination Fee was paid, that does not preclude the Termination Fee from having been paid in compensation for their loss.

Dialog’s arguments seek to characterise payment of the Termination Fee as just an alternative method of performance. Viewed realistically, for the reasons we have stated above, that is inapt characterisation. The Termination Fee is, in essence, a break-fee paid to enable termination of the contract, not an alternative method of performance. We disagree with the arguments made by Dialog in relation to the “in return for” point, for that reason: those arguments are all essentially premised on payment of the Termination Fee being just another form of performance.

We agree with HMRC’s analysis of the case law in relation to the “in return for” point, which we have summarised at [74] to [80] above and therefore do not repeat.

We find that, viewed realistically, the termination fee was paid to compensate Dialog for losing their rights under the Merger Agreement. Viewed realistically it was therefore paid in return for the loss of those rights.

We agree with Dialog’s submission as to the ordinary meaning of “forfeiture”, “surrender”, and “refraining from exercising” rights, being:

HMRC agree with these definitions of “forfeiture” and “refraining from exercising” (see [88] above), but with regard to “surrender” suggest that “[a] surrender of rights therefore occurs where rights are extinguished in return for capital sums”.

We do not agree with that definition, which we note essentially paraphrases the introductory part of s 22(1) TCGA 1992 (“disposal of assets by their owner where any capital sum is derived from assets notwithstanding that no asset is acquired by the person paying the capital sum”), except that it narrows it somewhat, essentially by replacing “notwithstanding that” with “and”. There is no particular reason why a surrender need necessitate rights being extinguished, they may simply be transferred to the person to whom the surrender is made. That is apparent from the general legal use of the term surrender: for example a person surrendering to bail.

HMRC’s definition of surrendered would essentially render redundant the introductory part of s 22(1) TCGA 1992, if it is accepted, as it must be, that surrender does not require property rights to be extinguished. Such a definition would be inconsistent with the structure of the subsection, which specifies “surrender” as a particular example.

More fundamentally we agree that surrender implies that the person making the surrender takes the action that leads to the loss of that right. Such an interpretation is consistent with the structure of subsection s 22(1)(c) TCGA 1992, as it provides a contrasting circumstance to the other two definitions that HMRC agree with.

Applying these definitions to the facts, we first address HMRC’s submission that there was “forfeiture” or “refraining from exercising” a right, as Dialog did not exercise its matching rights (see [89] above).

We find there was no forfeiture, as Dialog was not required to exercise those matching rights, they were just an option available to Dialog. Accordingly, Dialog did not do fail to do something it should have done.

It is true that, for the Termination Fee to be paid, Dialog had to refrain from exercising its matching rights. But we find the Termination Fee was not, viewed realistically, “in return for… refraining from exercising” the matching rights. Indeed, Atmel had no reason to disincentivise Dialog from exercising those rights, as it would drive up the offer price, offering better value to its shareholders. It is not something that they would pay for. Rather, as we have already found, viewed realistically the Termination Fee was paid to Dialog for the loss of their rights under the Merger Agreement.

There was no surrender, as there was no action that Dialog took that led to the loss of their rights under the Merger Agreement. Rather termination came about because it did not exercise its matching rights. HMRC suggest that including the termination provision in the Merger Agreement was an act that amounted to a surrender. However, that cannot be right. Including the termination provisions did not lead to the loss of the rights under the Merger Agreement, it only brought about the possibility of the loss of those rights. Something more was required – an unsolicited superior proposal that Dialog did not match.

It is common ground that if the agreement did not contain a break provision then a payment for terminating the agreement after it had been entered into would be a forfeiture or a surrender. HMRC submit that it makes no sense that an ex ante agreement to terminate the contract in certain circumstances would not also be a surrender. However, the crucial distinction is that one leads to the loss of the rights and the other only possibly does. Further, in Barrett v Morgan [2000] UKHL 1; [2000] 2 AC 264 at 270H, 272B, 273C Lord Millet repeatedly emphasised that a “surrender” takes place other than in accordance with the terms of the agreement. Whilst this was a land law case, we consider that this can legitimately inform the interpretation of s 22(1)(c) TCGA 1992, especially because a lease can be an asset falling within this provision.

Similarly, in Davis v Powell [1977] 1 WLR 258; [1977] STC 32, Templeman J considered a payment of statutory compensation, following a notice to quit, payable pursuant to section 34 of the Agricultural Holdings Act 1948:

“this s 34 compensation is not a capital sum received in return for the surrender of rights. It is not paid as a result of a bargain in which the tenant says, ‘If I get out, will you pay me £591?’ It is a sum paid where a tenant is faced with a notice to quit and must get out.”

This again suggests a surrender requires action on the part of the surrendering party, which leads to the loss of the right.

Our interpretation of “surrender” is reinforced by the fact that, in land law, it is generally treated as a concept distinct from a break clause. This distinction is evident in the treatment of the topics under separate headings in Megarry & Wade, The Law of Real Property (10th Ed, 2024) Chapter 17 and Gray & Gray, Elements of Land Law (5th Ed, 2008) “Termination of leases and tenancies” 4.2.103 et seq., as well as in the passages from Barrett v Morgan to which we have already referred.

Furthermore, we observe that while the inclusion of a break clause is not a “surrender” its operation may, at least arguably, lead to a charge under a part of s 22 TCGA 1992 other than s 22(1)(c) – perhaps the introductory part of s 22(1) TCGA 1992 or perhaps s 22(1)(a) TCGA 1992. At the hearing HMRC explained they did not make the assessment under the introductory part of s 22(1) TCGA 1992 as they wished to take advantage of the timing under s 22(2) TCGA 1992, which did not apply unless the disposal fell within one of the particular examples in s 22(1)(a)-(d) TCGA 1992. At the hearing HMRC also explained that they had not considered s 22(1)(a) TCGA 1992.

We mention this because HMRC’s case is implicitly based on an argument that excluding the exercise of a break clause from the definition of a surrender results in the exercise of a break clause being taxed differently than a payment for terminating the agreement after it had been entered. However, we consider it arguable that this is not the case.

The issue was raised by the panel at the hearing but we have not heard extensive argument on this point. We record this as, for the reason given at [121] above, the issue informs our interpretation of s 22(1)(c) TCGA 1992. However, other than that, it cannot alter the outcome of this appeal – as the preliminary point we have been asked to rule on solely concerns s 22(1)(c) TCGA 1992.

We therefore allow the appeal on the basis that there was no forfeiture, surrender or refraining.

We however disagree with Dialog in that we do not regard the contract as “discharged by performance” (see [82] above), but rather terminated in accordance with the break-clause. This is essentially for the reasons we have discussed in the previous section. We also note that the textbooks we referenced at [119] above treat break-clauses as instances of termination rather than performance, which reinforces our view that a break clause is not simply an alternate means of performance (see [106] above).

It is common ground that assets are widely defined in s 21(1) TCGA 1992 and that contractual rights are capable of being an asset for CGT provided they can be turned to account (even if they cannot be transferred or assigned).

Contractual rights can be assets. However the contractual right to payment of a vendor of property is not a CGT asset. Neither is the purchaser’s contractual right to acquire the property: Hardy. The outcome of Zim shows that a right to compensation for loss can be an asset for capital gains tax purposes.

Here Dialog characterise the Merger Agreement as akin to a contract to acquire property, namely the shares in Atmel. We reject that characterisation. At its simplest this is shown by how the shares were owned by the stockholders, yet the Merger Agreement was with Dialog. The Merger Agreement simply cannot be a contract to acquire property. We accept the Merger Agreement is to facilitate the acquisition of the shares in Atmel. However that is a different matter. It therefore falls outside the ratio of Hardy.

We do not consider it relevant that Hardy and Sehgal concern land. Nothing in those decisions suggest that their reasoning is so restricted.

Rather, the Termination Fee is, as we have already found, compensatory in nature. We therefore find it to be a capital asset in line with HMRC’s submissions on Zim.

We have found the Termination Fee does not fall within s 22(1)(c) TCGA 1992, but have found in Dialog’s favour only in relation to the question of there being no forfeiture, surrender or refraining. This decision is not authority that the Termination Fee would not otherwise fall within s 22 TCGA 1992 – that is a question outside the preliminary issue, other than as potentially relevant as discussed at [119]-[121] above.

It was agreed that if the preliminary issue is resolved finally in Dialog’s favour, then the closure notice will be withdrawn such that there is no additional tax due from Dialog.

It follows that the appeal is allowed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.