England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT
QUEEN'S BENCH DIVISION
Mr. David Foskett Q.C.

		Royal Courts of Justice Strand, London, WC2A 2LL Thursday 14th June 2001

PETER GIBSON L.J.:

1. The Defendants, George Little Sebire & Co., appeal against the order made on 29 September 1999 by Mr. David Foskett Q.C., sitting as a Deputy Judge of the High Court in the Queen's Bench Division, in an accountants' negligence case. By his order the judge ordered the Defendants to pay the Claimants, Richard Little, John Smith and Gerard Wade, £50,946.79 (inclusive of interest) and costs. The Claimants cross-appeal, seeking a variation of the judge's order by the increase of the sum to be paid to them to £51,895.41.
2. Prior to 1987 the Claimants had carried on business in partnership with Gwynne Furlong under the name Derrick Wade and Waters. On 31 March 1987 DWW Holdings Ltd. ("the Company") was incorporated to be the corporate vehicle for conducting the business previously carried on by the partnership, that is to say that of estate agents, surveyors and design consultants in relation to commercial property. Its fortunes were largely dependent on the buoyancy of the commercial property market. The Company had two subsidiaries. The Claimants and Mr. Furlong became directors in and shareholders of the Company, Mr. Furlong taking 26% of the issued shares.
3. The Defendants are a firm of chartered accountants. They acted as auditors and tax advisers to the Company and its subsidiaries and as accountants and tax advisers to each of the Claimants.
4. Two events occurred in 1989 and 1990 which caused the Claimants to seek advice from the Defendants. One was that on 12 October 1989 Mr. Furlong revealed to the Claimants that as a result of his activities in another business, he faced the threat of criminal proceedings. It was mutually agreed between him and the Claimants that he should sever links with them. On 8 November 1989 by a shareholders' agreement it was agreed that Mr. Furlong's shares could be purchased by the Company or the Claimants for £209,000 payable over 5 years. The other event was that the Claimants and Mr. Furlong, who in their personal capacities owned a property in Harlow known as The Old Bakery, decided to sell that property, which they sold on 27 April 1990 for £349,999. That gave rise to a chargeable gain for the purposes of capital gains tax ("CGT") of some £41,000 for each of the Claimants on which he would have to pay about £14,500 tax on 1 December 1991 unless he incurred a loss on other disposals which could be set against the chargeable gain. Before the sale the Claimants sought advice from the Defendants on whether that tax could be avoided.
5. The Defendants devised two schemes to reduce the effective rate of tax on the disposal of The Old Bakery in the following circumstances.
6. First they put forward Scheme 1, which was to be implemented in two stages. Stage 1 was the purchase by the Claimants (and not the Company) pursuant to the shareholders' agreement of Mr. Furlong's shares. Stage 2 was the purchase by the Company from the Claimants of all or some of those shares, which would be treated as a distribution under s. 209(2)(b) Income and Corporation Taxes Act 1988 ("the Taxes Act") so that the difference between the price paid and the nominal value of the shares purchased would be treated as income in the hands of the Claimant vendor. The sale of the shares to the Company would have three tax consequences:

(1) deemed capital losses totalling £196,000 (the price of £209,000 paid to Mr. Furlong less the £13,000 nominal value of the shares) would arise to the Claimants;

(2) a liability on the Claimants to pay income tax at the higher rate on the same amount would arise; and

(3) the Company would be liable to pay advance corporation tax ("ACT") of £65,333 on the deemed distribution within 14 days of the end of the quarter in which the deemed distribution was made.

On the basis that the ACT could be set off against mainstream corporation tax ("MCT") already paid for earlier accounting periods or payable for the then current or future accounting periods, the expected result would be a net tax saving of £39,200 between the Claimants. Scheme 1 would, however, be disadvantageous if no MCT against which ACT could be set were available, but that must have seemed an unlikely possibility, given the MCT which had been paid for the previous two accounting periods and the expectation that a good profit would be made for the accounting period ending 30 April 1990 with a consequent liability for payment of MCT by 31 January 1991.

7. Scheme 1 was flawed because the Defendants failed to take account of the pooling provisions in para. 9 (1) of Sch. 19 to the Finance Act 1985, the effect of which was to require the aggregation of the low cost to the Claimants of the acquisition of their shares other than Mr. Furlong's shares on originally subscribing for them and the higher cost of acquiring Mr. Furlong's shares for the purpose of computing the acquisition cost for CGT purposes of Mr. Furlong's shares. That prevented the scheme from having the desired CGT-saving effect. It is not in dispute that the Defendants were negligent in that they could and should have advised, but did not advise, that steps be taken to avoid the application of the pooling provisions by varying the rights attached to Mr. Furlong's shares. The Defendants were also negligent, as the Claimants alleged by a late amendment, and as the judge found, in failing to give proper advice about the timing of the purchase by the Company of Mr. Furlong's shares from the Claimants. If merely enough shares were purchased before 30 April 1990 to extinguish the chargeable gain on The Old Bakery, an ACT liability of only £34,284 would have arisen for payment by 14 May 1990.
8. Mr. Furlong's shares were purchased by the Claimants in March 1990 but the Company did not purchase those shares from the Claimants on or before 30 April 1990. In January 1991 the Defendants appreciated that the pooling provisions prevented Scheme 1 from operating as intended. The Claimants desired another scheme to reduce their personal tax liabilities. Accordingly the Defendants put forward Scheme 2 in March 1991 which was implemented.
9. Under this scheme each of the Claimants transferred his holding in the Company to a trust for his benefit so as to trigger an allowable loss on the disposal to the trust. But, as other accountants whom the Claimants consulted later in 1991 advised, Scheme 2 could not work because of the effect of s. 62 Capital Gains Tax Act 1979, preventing the deduction of a loss arising on a transaction between connected persons. The shares were transferred back to the Claimants. But the transfers into and out of the trust of the shares, which each Claimant had acquired on subscribing for them originally, prevented him from making a claim under s. 574 of the Taxes Act for income tax relief arising from the loss in value of those shares when ultimately they became of negligible value.
10. The fortunes of the Company changed for the worse towards the end of 1990. There was a sudden deterioration in profitability consequent on the property recession. In the year ended 30 April 1991 the Company and its subsidiaries made a loss of over £300,000, which increased to over £430,000 the following year. The Company was not placed in liquidation, because it was supported by the Claimants and its bankers. Because of the losses made in 1990/91 no MCT was paid in spring 1991. No further payment of MCT was made thereafter. The losses sustained were set off against previous profits so as to permit the recoupment of the MCT previously paid. There was ultimately no MCT liability against which the ACT liability generated by Scheme 1 could be set. On 20 March 1996 the Company was placed in administrative receivership. It was heavily insolvent.
11. On 11 August 1994 the accountants then acting for the Claimants submitted a claim to the Revenue that the shares in the Company were of negligible value at 30 April 1993 so as to be able to claim an allowable loss for CGT purposes pursuant to s. 24 (2) Taxation of Chargeable Gains Act 1992. The claim was not accepted by the Revenue. Eventually however the Revenue by letter dated 26 March 1996 accepted a compromise solution proposed by the accountants that the shares should be treated as of negligible value as at 30 April 1994.
12. The Claimants commenced these proceedings on 25 May 1995, claiming damages for negligence by the Defendants in relation to their advice on Schemes 1 and 2.
13. At the trial it was conceded by the Defendants that they were negligent in relation to Scheme 1 by reason of the failure to avoid the application of the pooling provisions. But once the judge at the trial allowed the amendment so that the Claimants pleaded negligence by the Defendants in failing to give advice as to the timing of the purchase by the Company from the Claimants of the shares of Mr. Furlong, both the question whether there was such negligence and, if so, the question what advice would have been given if the Defendants had addressed the issue of timing and what the Claimants would have done if given that advice became in issue. The judge, in a careful and lucid judgment to which I would pay tribute, found that the Defendants were negligent in failing to advise on timing. They should have advised the Claimants that (1) if stage 2 of Scheme 1 was not properly implemented before 5 April 1991 each Claimant faced a CGT liability of £14,500 payable on 1 December 1991, (2) if stage 2 was implemented before 30 April 1990 by selling only the necessary number of the shares purchased from Mr. Furlong, the CGT liability would be halved but the Company would have to pay approximately £34,000 ACT by 14 May 1990, and (3) if stage 2 was implemented after 30 April 1990 but before 5 April 1991 that would have the same effect on each Claimant's CGT liability as implementing stage 2 before 30 April 1990, the payment of the ACT liability would be postponed to 14 May 1991, but the Company's MCT liability on 31 January 1991 would be payable in full, and the ACT paid would not be recoverable until the payment of such MCT as might be payable on 31 January 1992 in respect of the Company's profits for the period to 30 April 1991. The judge further found on the balance of probabilities that if that advice had been given, the Claimants would have ensured the implementation of stage 2 before 30 April 1990.
14. The judge also expressed his views on what would have happened had the Claimants chosen to delay stage 2, following the giving of the advice which the judge said should have been given, in order to delay paying ACT. He said that they would have considered the implementation of stage 2 in the early months of 1991 by which time it would have been clear to all concerned that the chilly economic winds were affecting the Company's performance.
15. In considering the measure of damages the judge said that subject to a question on ACT it was agreed that the measure was the CGT paid by each Claimant in relation to the chargeable gain on The Old Bakery (plus any interest) less the income tax payable by him arising from the purchase by the Company of the shares bought from Mr. Furlong. The question on ACT was one which it was agreed would arise for consideration whether the Company's purchase from the Claimants of Mr. Furlong's shares was prior to 30 April 1990 or thereafter but before 5 April 1991. That question was whether, if the ACT became irrecoverable, that would have increased the Claimants' liability and, if so, in what amount and, if so, the Defendants were entitled to credit for that amount. The judge said that if an inevitable or integral feature, and thus a foreseeable consequence, of implementing stage 2 was that each Claimant would have had to find from his personal resources a contribution to the ACT liability of the Company, and that liability was ultimately unrecovered by the Company so that the contributions were incapable of being repaid to the Claimants, the amount of that contribution would fall to reduce any damages awarded on the basis of the personal tax saving sought to be achieved by Scheme 1. He noted that ACT was a liability of the Company but said that in that situation it was effectively being discharged from the personal resources of the Claimants and it would be unreal and unrealistic to ignore it in computing the measure of damages. He said "It would have to be seen as an essential feature of the whole transaction" (para. 12.5 of the judgment).
16. The judge then referred to earlier findings which he had made that the effect of paying ACT in the sum of £34,284 by 14 May 1990 from the Company's resources would have had a negligible impact on its cashflow. He said that the Company would have had sufficient resources to meet the ACT liability without calling upon the individual Claimant's personal resources. He continued (in para. 12.6):

"Unless it could be said that any subsequently established liability of the company effectively to recoup that payment could translate into a personal obligation on the part of each Claimant to refund the company with his share of the ACT paid, I am unable to discern a basis for reducing the Claimant's prima facie entitlement to damages for the tax advantage lost."

17. But on the alternative scenario that the Claimants delayed implementing stage 2 until after 30 April 1990 but before 5 April 1991, the judge considered whether the Claimants might have been "obliged" to contribute to the finding of the ACT payment falling due in May 1991 and he reached a different conclusion (para. 12.8). He said that if the purchase by the Company had been of all the shares purchased by the Claimants from Mr. Furlong at the full price paid for them, the £65,000 needed to meet the ACT payment would have had to be funded by the Claimants personally, because the Company's capacity to borrow from its bank was at its limits and the bank would not have lent a further £65,000 simply to reduce the personal tax liabilities of the Claimants. The judge also considered (para. 12.9) what would have happened if a reduced price of £10 per share had been paid by the Company in early 1991 for a reduced number of shares, so that the ACT liability would have been only about £20,000, but he reached the same conclusion that the bank would have been disinclined to advance further money to the Company for what was effectively a personal tax saving arrangement, and the Claimants would have been "obliged" to find between them whatever sum was required to discharge the ACT liability.
18. At the trial it was also conceded that the Defendants were negligent in respect of Scheme 2. The only issue was whether the shares in the Company became of negligible value in 1993/94 or 1994/95, as that would affect the claim for interest on the damages. The judge said that whether the value of an asset has become negligible within s. 24 (2) Taxation and Chargeable Gains Act 1992 depended upon whether "the inspector is satisfied that the value .... has become negligible." The judge said that the fact was that the Inspector of Taxes was not satisfied of that as at 30 April 1993 on the material available to him, and that unless that view was perverse, the judge could not substitute a different conclusion, the decision being entirely that of the Inspector. The judge found that the decision was not perverse and so regarded himself as bound to approach the case on the basis that the shares became of negligible value during 1994/95.
19. The damages were then agreed between the parties at the sum which I have stated. Mr. Patrick Lawrence, appearing for the Defendants before the judge as he does before us, sought by way of further submission in writing, after the draft judgment of the judge had been provided to Counsel, to persuade the judge to allow further argument on the issue of whether the Claimants were obliged to give credit for the ACT liability of £34,284 against the losses for which they were otherwise entitled to compensation arising from the non-implementation of stage 2 of Scheme 1 prior to 30 April 1990. But in a further judgment the judge said that that issue was concluded against the Defendants on the basis of the evidence and argument which he had heard and that it would have been wholly inappropriate for the matter to be revisited at the stage he was being invited to do so.
20. Mr. Lawrence on this appeal does not challenge that decision by the judge not to allow further argument. But he raises before this court points similar to those which he took in his further written submission to the judge. In an attractive and skilful argument, he submitted that the judge misunderstood his argument that, on the basis of the implementation of stage 2 of Scheme 1 before 30 April 1990, the Claimants would in fact have been obliged ultimately to find the ACT liability out of their own personal resources whether it arose in 1990 or 1991. He referred to the use by the judge of the words "personal obligation" in para. 12. 6 in the passage which I have cited (see para. 16 above) and submits that there was never any question of there being a legal obligation on the Claimants to refund to the Company the ACT paid. He pointed out that if the ACT had been paid by the Company in May 1990, the Company would have been out of that money and an equivalent sum would have had to be found from somewhere by spring 1991, when the Company was at its borrowing limits, to keep the Company alive, and he submitted that just as the judge found, on the alternative scenario which he considered, that the money could only have come from the directors' pockets in May 1991, so in spring 1991 the directors would have had to find a sum equal to the ACT.
21. He drew our attention to the acceptance by Mr. Little in cross-examination that the Company had borrowed all that it could borrow from the bank from about spring 1991 and that if it had been necessary to pay a relatively modest corporate debt arising in 1991 and 1992 to keep the Company alive and out of the hands of a liquidator, it would have had to come from the directors' resources. He argued that the real consequence of a spring 1990 completion of Scheme 1 would have been that ultimately the Claimants would have been out of pocket and the money which would have had to be found in spring 1991 would have exceeded the CGT saving. He therefore submitted that nominal damages only should be awarded.
22. Mr. Goodfellow for the Claimants submitted that Mr. Lawrence's argument was a new one and that at no time did the Defendants allege in the Defence or argue that if the Company had paid ACT in May 1990 the Claimants would have had to put an equivalent sum into the Company in spring 1991, nor was the point explored in cross-examination of the Claimants' witnesses. He submitted that there was no parallel between the situation in spring 1991 when the judge found the Claimants would have had to pay the ACT and the situation which would have had arisen if stage 2 had been completed before 30 April 1990.
23. The question whether credit should be given for the ACT paid in May 1990 on the hypothesis of a completion of stage 2 before 30 April 1990 was, in my view, raised in general terms before the judge. But, as Mr. Lawrence frankly conceded, what he has argued before us was not put in detail to the Claimants' witnesses beyond the passage in the cross-examination of Mr. Little to which I have referred nor was it elaborated upon in Mr. Lawrence's closing submissions. The emphasis in his argument before the judge was on a completion of stage 2 after 30 April 1990 but before 5 April 1991. Had the point been taken fairly and squarely and explored with the Claimants' witnesses, they may have been able to give evidence as to whether any remedial measures, such as through cutting costs, could and would have been taken as the Company approached its overdraft limit. The reaching of that limit would have happened earlier than it actually did if the ACT had been paid by the Company in May 1990. Mr. Little's evidence that once the Company reached its overdraft limit the directors were the only source of further funds was directed to a fresh corporate liability arising in circumstances where liquidation was threatened. It does not cover a situation where by reason of a proper payment of tax by the Company in May 1990 at a time when it could easily pay without cashflow problems (even in the year ended 30 April 1991 the Company's turnover exceeded £1.2 million and the group's turnover exceeded £2 million, figures well down on those of the previous year), the Company later in 1990 or in early 1991 approached its overdraft limit somewhat earlier than it would otherwise have done.
24. I do not think it right to accuse the judge of misunderstanding the Defendants' argument. When the judge refers to "obligation" in para. 12.6, I take him to be using that word in the same sense as he uses the word "obliged" in paras. 12.8 and 12.9 when considering whether the Claimants would have been obliged to contribute to the funding of the ACT payment which would have fallen due, on the alternative scenario, in May 1991 and when finding that they would have been so obliged. In each case that refers to a factual necessity. The judge, in his further judgment given in the light of Mr. Lawrence's further written submission taking points similar to those taken before us, was clear that the issue was concluded against the Defendant.
25. The principal reason why in my judgment Mr. Lawrence can obtain no assistance from the judge's finding on the alternative scenario is that the situation considered by the judge then was wholly different from the situation which would have resulted from completion of stage 2 before 30 April 1990. In March 1991 the Company was at its overdraft limit and the judge cogently points out why the bank could not be expected to agree to fund a further loan to the Company to secure for the Claimants a personal tax advantage. The only realistic possibility was therefore that the Claimants would have had to find the money to enable the Company to make the ACT payment. Contrast the position if the Company had paid the ACT in May 1990 in the reasonable expectation that that would be in effect recoverable through being set against MCT. It cannot be said that the Claimants would have been bound through practical necessity to find an equivalent sum more than six months later when in adverse trading conditions the Company approached its overdraft limit. Still less was it an essential feature of the whole transaction. The judge was fully entitled to reject the Defendants' argument on this point.
26. Accordingly I would dismiss the Defendants' appeal.
27. On the Claimants' cross-appeal, Mr. Goodfellow submitted that the judge had misdirected himself when holding that because the Inspector of Taxes had decided that the shares in the Company were not of negligible value as at 30 April 1993 and was not perverse in so deciding, the shares were not of negligible value in 1993/94. He pointed out that if the Inspector could be satisfied that the shares were of negligible value on, say, 5 April 1994, the question which the judge correctly posed in para. 13.6 of the judgment, viz. whether the shares became of negligible value in 1993/94 or 1994/95, would have been answered differently by the judge. But the judge did not consider the matter as at any date other than 30 April 1993 and 30 April 1994, being the dates as at which the accounts and balance sheet of the Company were prepared. Mr. Goodfellow argued that as the Inspector accepted that the shares were of negligible value at 30 April 1994 and there was no material difference between the position of the Company at that date and its position 25 days earlier, the Inspector would probably have been satisfied that the shares were of negligible value at 5 April 1994. Mr. Goodfellow pointed out that two of the principal factors which the Inspector had relied on to contend that he could not be satisfied that the shares were of negligible value at 30 April 1993 had ceased to apply. The Inspector was aware of the fact that another company, Acer Consultants Ltd. ("Acer") which subscribed for new shares in the Company in April 1992, had a call option to acquire further shares. But that had been allowed to lapse and the trading relationship with Acer was terminated in July 1993. The Inspector was also aware that a compensation claim had been brought by the Company against Acer for wrongful termination. But that claim was struck out. The Defendants' expert witness, Mr. Hobbs, accepted in cross-examination that the shares were valueless as at 5 April 1994 and that if the Claimants' accountants had pursued such a claim they would have been successful without recourse to litigation.
28. Mr. Lawrence did not challenge any of these submissions. His sole point was that the Claimants would not have pursued the matter because a simple cost-benefit analysis indicated that it would not have been worth pursuing. The amount at stake was only a very modest sum, a little over £900. Mr. Lawrence relied on the evidence of Mr. Hobbs, which, Mr. Lawrence said, was that further work by the accountants would have been required and that was costed by Mr. Hobbs at £1 - 2,000.
29. There Mr. Lawrence is relying on an answer given by Mr. Hobbs in re-examination. The question asked by Mr. Lawrence was on the hypothesis that further work and investigations would have been needed to persuade the Revenue to accept that the shares had no value for 1993/94, and Mr. Hobbs was asked to cost the further investigations and representations. Mr. Hobbs's answer of "perhaps one to two thousand pounds" was qualified by whether it was necessary to retain a property valuer and whether a meeting with the Revenue was required.
30. I am not able to accept Mr. Lawrence's submission. The Inspector having accepted that the shares were of negligible value at 30 April 1994, there is no reason to think that he would not have been satisfied by a single further letter pointing out that there was no material difference in the position of the Company 25 days earlier, and that there were differences from the position at 30 April 1993. I cannot believe that the cost would have been anything like the figures tentatively suggested by Mr. Hobbs, which proceeded from a different hypothesis, viz. that attempts were to be made to persuade the Inspector to take a different view about the value of the shares on 30 April 1993. As Mr. Goodfellow pointed out, the significant question for the Inspector was whether he should accept that the shares were of negligible value while the Company was still trading. Once he accepted that they were (as at 30 April 1994) there is no reason to think that he would have held out over the position 25 days earlier. That is not a matter which the judge addressed. Had he done so, I think he would have been unable to avoid the conclusion that on the evidence the condition of s. 24(2) would have been satisfied.
31. For these reasons therefore I would allow the cross-appeal and increase the sum to be paid by the Defendants to £51,895.41.

CLARKE L.J.:

32. I agree.

MAURICE KAY J.:

33. I also agree.
ORDER: Appeal dismissed. Cross-appeal allowed. Judgment for the Claimant to be entered in the sum of £51,895.41. The defendants to pay all the claimant's costs, including all the costs of the trial before Deputy Judge Foskett on the standard basis until 19^th June 1999 and thereafter on the indemnity basis until 18^th September 1999 and thereafter on the standard basis. The defendants to pay the claimant's costs of the appeal and the cross-appeal on the indemnity basis. An additional sum of £50 to be added by way of interest on the increase of the Judge's original order. The additional 10 per cent of the trial costs now awarded to the claimant to carry interest at the rate of 8 per cent from the date of the trial judge's Judgment (Order does not form part of approved Judgment)