ON APPEAL FROM THE HIGH COURT OF JUSTICE
MR JUSTICE PETER SMITH
Strand, London, WC2A 2LL
B e f o r e :
LORD JUSTICE KEENE
LORD JUSTICE SULLIVAN
| (1) JOHN ASTALL
(2) GRAHAM EDWARDS
|- and -
|HM REVENUE AND CUSTOMS
David Ewart QC & Michael Gibbon (instructed by Solicitor for HM Revenue & Customs) for the Respondents
Hearing dates : 13-14 May 2009
Crown Copyright ©
Lady Justice Arden:
BACKGROUND AND FACTS AS FOUND BY THE SPECIAL COMMISSIONER
OUTLINE OF THE STATUTORY PROVISIONS RELATING TO RDS
"1—(1) Where a person realises the profit from the discount on a relevant discounted security, he shall be charged to income tax on that profit under Case III of Schedule D or, where the profit arises from a security out of the United Kingdom, under Case IV of that Schedule.
(2) For the purposes of this Schedule a person realises the profit from the discount on a relevant discounted security where—
(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and
(b) the amount payable on the transfer or redemption exceeds the amount paid by that person in respect of his acquisition of the security.
(3) For the purposes of this Schedule the profit shall be taken—
(a) to be equal to the amount of the excess reduced by the amount of any relevant costs; and
(b) to arise, for the purposes of income tax, in the year of assessment in which the transfer or redemption takes place.
(4) In this paragraph "relevant costs", in relation to a security that is transferred or redeemed, are all the following costs—
(a) the costs incurred in connection with the acquisition of the security by the person making the transfer or, as the case may be, the person entitled to a payment on the redemption; and
(b) the costs incurred by that person, in connection with the transfer or redemption of the security;
and for the purposes of this Schedule costs falling within paragraph (a) above shall not be regarded as amounts paid in respect of the acquisition of a security."
"2—(1) Subject to the following provisions of this Schedule, where—
(a) a person sustains a loss in any year of assessment from the discount on a relevant discounted security, and
(b) makes a claim for the purposes of this paragraph before the end of twelve months from the 31st January next following that year of assessment,
that person shall be entitled to relief from income tax on an amount of the claimant's income for that year equal to the amount of the loss.
(2) For the purposes of this Schedule a person sustains a loss from the discount on a relevant discounted security where—
(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and
(b) the amount paid by that person in respect of his acquisition of the security exceeds the amount payable on the transfer or redemption.
(3) For the purposes of this Schedule the loss shall be taken—
(a) to be equal to the amount of the excess increased by the amount of any relevant costs; and
(b) to be sustained for the purposes of this Schedule in the year of assessment in which the transfer or redemption takes place.
(4) Sub-paragraph (4) of paragraph 1 above applies for the purposes of this paragraph as it applies for the purposes of that paragraph."
"3—(1) Subject to the following provisions of this paragraph and paragraph 14(1) below, in this Schedule "relevant discounted security" means any security which (whenever issued) is such that, taking the security as at the time of its issue, the amount payable on redemption—
(a) on maturity, or
(b) in the case of a security of which there may be a redemption before maturity, on at least one of the occasions on which it may be redeemed,
is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain."
"(1A) The occasions that are to be taken into account for the purpose of determining whether a security is a relevant discounted security by virtue of sub-paragraph (1)(b) above shall not include any of the following occasions on which it may be redeemed, that is to say—
(a) any occasion not falling within sub-paragraph (1C) below on which there may be a redemption otherwise than at the option of the person who holds the security;
(b) in a case where a redemption may occur as a result of the exercise of an option that is exercisable—
(i) only on the occurrence of an event adversely affecting the holder, or
(ii) only on the occurrence of a default by any person,
any occasion on which that option is unlikely (judged as at the time of the security's issue) to be exercisable;
but nothing in this sub-paragraph shall require an occasion on which a security may be redeemed to be disregarded by reason only that it is or may be an occasion that coincides with an occasion mentioned in this sub-paragraph.
(1B) In sub-paragraph (1A) above "event adversely affecting the holder", in relation to a security, means an event which (judged as at the time of the security's issue) is such that, if it occurred and there were no provision for redemption, the interests of the person holding the security at the time of the event would be likely to be adversely affected.
(1C) An occasion on which there may be a redemption of a security falls within this sub-paragraph if—
(a) the security is a security issued to a person connected with the issuer; or
(b) the obtaining of a tax advantage by any person is the main benefit, or one of the main benefits, that might have been expected to accrue from the provision in accordance with which it may be redeemed on that occasion.
(1D) In sub-paragraph (1C) above "tax advantage" has the meaning given by section 709(1) of the Taxes Act 1988."
"(3) For the purposes of this Schedule the amount payable on redemption of a security involves a deep gain if—
(a) the issue price is less than the amount so payable; and
(b) the amount by which it is less represents more than the relevant percentage of the amount so payable."
CONCLUSIONS OF THE SPECIAL COMMISSIONER AND THE JUDGE
ISSUES ON THIS APPEAL
ANALYSIS OF THE ISSUES ON THIS APPEAL
The recent approach of the courts to statutory interpretation with reference to tax saving transactions
" Whether the statute is concerned with a single step or a broader view of the acts of the parties depends upon the construction of the language in its context. Sometimes the conclusion that the statute is concerned with the character of a particular act is inescapable: see MacNiven (Inspector of Taxes) v Westmoreland Investments Limited  UKHL 6,  STC 237, 1 AC 311. But ever since WT Ramsay Ltd v IRC  STC 174,  AC 300, the courts have tended to assume that revenue statutes in particular are concerned with the characterisation of the entirety of transactions which have a commercial unity rather than the individual steps into which some transactions may be divided. This approach does not deny the existence or legality of the individual steps but may deprive them of significance for the purposes of the characterisation required by the statute. This has been said so often that citation of authorities since Ramsay's case is unnecessary. "
"would produce the result that exemption from tax could be obtained by a formal step inserted in the transaction from no purpose other than the avoidance of tax. This would not be a rational system of taxation and their Lordships do not accept that it was intended by the legislature. They agree with the majority of the Court of Appeal that the relevant transaction for the purposes of the legislation comprised of the issue and the redemption of the debenture and that such transaction, taken as a whole, could not be appropriately characterised as an exchange of shares for a debenture."
"plain from the terms of the debenture and the timetable that the redemption was not merely contemplated (the redemption of any debenture may be said to be contemplated), but intended by the parties as an integral part of the transaction, separated from the exchange by as short a time as was thought to be decent in the circumstances. The absence of security and interest reinforces this inference. No other explanation has been offered. In this case, their Lordships think that it is inherent in the process of construction that one will have to decide as a question of fact, whether a given act was or was not part of the transaction contemplated by the statute. In practice, any uncertainty is likely to be confined to transactions into which steps have been inserted without any commercial purpose. Such uncertainty is something which the architects of such schemes have to accept." (para. )
"29. The Ramsay case  AC 300 liberated the construction of revenue statutes from being both literal and blinkered. It is worth quoting two passages from the influential speech of Lord Wilberforce. First, at p 323, on the general approach to construction:
"What are 'clear words' is to be ascertained upon normal principles: these do not confine the courts to literal interpretation. There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded."
30. Secondly, at pp 323-324, on the application of a statutory provision so construed to a composite transaction:
"It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded."
31. The application of these two principles led to the conclusion, as a matter of construction, that the statutory provision with which the court was concerned, namely that imposing capital gains tax on chargeable gains less allowable losses was referring to gains and losses having a commercial reality ("The capital gains tax was created to operate in the real world, not that of make-belief") and that therefore:
"To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, there is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function." (p 326)
32. The essence of the new approach was to give the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. Of course this does not mean that the courts have to put their reasoning into the straitjacket of first construing the statute in the abstract and then looking at the facts. It might be more convenient to analyse the facts and then ask whether they satisfy the requirements of the statute. But however one approaches the matter, the question is always whether the relevant provision of the statute, upon its true construction, applies to the facts as found. As Lord Nicholls of Birkenhead said in MacNiven v Westmoreland Investments Ltd  1 AC 311, 320, para 8: "The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case."
33. The simplicity of this question, however difficult it might be to answer on the facts of a particular case, shows that the Ramsay case did not introduce a new doctrine operating within the special field of revenue statutes. On the contrary, as Lord Steyn observed in McGuckian  1 WLR 991, 999 it rescued tax law from being "some island of literal interpretation" and brought it within generally applicable principles.
34. Unfortunately, the novelty for tax lawyers of this exposure to ordinary principles of statutory construction produced a tendency to regard Ramsay as establishing a new jurisprudence governed by special rules of its own. This tendency has been encouraged by two features characteristic of tax law, although by no means exclusively so. The first is that tax is generally imposed by reference to economic activities or transactions which exist, as Lord Wilberforce said, "in the real world". The second is that a good deal of intellectual effort is devoted to structuring transactions in a form which will have the same or nearly the same economic effect as a taxable transaction but which it is hoped will fall outside the terms of the taxing statute. It is characteristic of these composite transactions that they will include elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge.
35. There have been a number of cases, such as Inland Revenue v Burmah Oil Co Ltd 1982 SC (HL) 114, Furniss v Dawson  AC 474 and Carreras Group Ltd v Stamp Comr  STC 1377 in which it has been decided that elements which have been inserted into a transaction without any business or commercial purpose did not, as the case might be, prevent the composite transaction from falling within a charge to tax or bring it within an exemption from tax. Thus in the Burmah case, a series of circular payments which left the taxpayer company in exactly the same financial position as before was not regarded as giving rise to a "loss" within the meaning of the legislation. In Furniss, the transfer of shares to a subsidiary as part of a planned scheme immediately to transfer them to an outside purchaser was regarded as a taxable disposition to the outside purchaser rather than an exempt transfer to a group company. In Carreras the transfer of shares in exchange for a debenture with a view to its redemption a fortnight later was not regarded as an exempt transfer in exchange for the debenture but rather as an exchange for money. In each case the court looked at the overall effect of the composite transactions by which the taxpayer company in Burmah suffered no loss, the shares in Furniss passed into the hands of the outside purchaser and the vendors in Carreras received cash. On the true construction of the relevant provisions of the statute, the elements inserted into the transactions without any commercial purpose were treated as having no significance.
36. Cases such as these gave rise to a view that, in the application of any taxing statute, transactions or elements of transactions which had no commercial purpose were to be disregarded. But that is going too far. It elides the two steps which are necessary in the application of any statutory provision: first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so. As Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd  HKCFA 46, para 35:
"the driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically."
37. The need to avoid sweeping generalisations about disregarding transactions undertaken for the purpose of tax avoidance was shown by MacNiven v Westmoreland Investments Ltd  1 AC 311 in which the question was whether a payment of interest by a debtor who had borrowed the money for that purpose from the creditor himself and which had been made solely to reduce liability to tax, was a "payment" of interest within the meaning of the statute which entitled him to a deduction or repayment of tax. The House decided that the purpose of requiring the interest to have been "paid" was to produce symmetry by giving a right of deduction in respect of any payment which gave rise to a liability to tax in the hands of the recipient (or would have given rise to such a liability if the recipient had been a taxable entity.) As the payment was accepted to have had this effect, it answered the statutory description notwithstanding the circular nature of the payment and its tax avoidance purpose.
38. MacNiven shows the need to focus carefully upon the particular statutory provision and to identify its requirements before one can decide whether circular payments or elements inserted for the purpose of tax avoidance should be disregarded or treated as irrelevant for the purposes of the statute. In the speech of Lord Hoffmann in MacNiven it was said that if a statute laid down requirements by reference to some commercial concept such as gain or loss, it would usually follow that elements inserted into a composite transaction without any commercial purpose could be disregarded, whereas if the requirements of the statute were purely by reference to its legal nature (in MacNiven, the discharge of a debt) then an act having that legal effect would suffice, whatever its commercial purpose may have been. This is not an unreasonable generalisation, indeed perhaps something of a truism, but we do not think that it was intended to provide a substitute for a close analysis of what the statute means. It certainly does not justify the assumption that an answer can be obtained by classifying all concepts a priori as either "commercial" or "legal". That would be the very negation of purposive construction: see Ribeiro PJ in Arrowtown, at paras 37 and 39 and the perceptive judgment of the special commissioners (Theodore Wallace and Julian Ghosh) in Campbell v Inland Revenue Comrs  STC (STD) 396."
"39. The present case, like MacNiven, illustrates the need for a close analysis of what, on a purposive construction, the statute actually requires. The object of granting the allowance is, as we have said, to provide a tax equivalent to the normal accounting deduction from profits for the depreciation of machinery and plant used for the purposes of a trade. Consistently with this purpose, section 24(1) requires that a trader should have incurred capital expenditure on the provision of machinery or plant for the purposes of his trade. When the trade is finance leasing, this means that the capital expenditure should have been incurred to acquire the machinery or plant for the purpose of leasing it in the course of the trade. In such a case, it is the lessor as owner who suffers the depreciation in the value of the plant and is therefore entitled to an allowance against the profits of his trade.
40. These statutory requirements, as it seems to us, are in the case of a finance lease concerned entirely with the acts and purposes of the lessor. The Act says nothing about what the lessee should do with the purchase price, how he should find the money to pay the rent or how he should use the plant. As Carnwath LJ said in the Court of Appeal  STC 66, 89, para 54:
"There is nothing in the statute to suggest that 'up-front finance' for the lessee is an essential feature of the right to allowances. The test is based on the purpose of the lessor's expenditure, not the benefit of the finance to the lessee."
41. So far as the lessor is concerned, all the requirements of section 24(1) were satisfied. Mr Boobyer, a director of BMBF, gave unchallenged evidence that from its point of view the purchase and leaseback was part of its ordinary trade of finance leasing. Indeed, if one examines the acts and purposes of BMBF, it would be very difficult to come to any other conclusion. The finding of the special commissioners that the transaction "had no commercial reality" depends entirely upon an examination of what happened to the purchase price after BMBF paid it to BGE. But these matters do not affect the reality of the expenditure by BMBF and its acquisition of the pipeline for the purposes of its finance leasing trade.
42. If the lessee chooses to make arrangements, even as a preordained part of the transaction for the sale and leaseback, which result in the bulk of the purchase price being irrevocably committed to paying the rent, that is no concern of the lessor. From his point of view, the transaction is exactly the same. No one disputes that BMBF had acquired ownership of the pipeline or that it generated income for BMBF in the course of its trade in the form of rent chargeable to corporation tax. In return it paid £91m. The circularity of payments which so impressed Park J and the special commissioners arose because BMBF, in the ordinary course its business, borrowed the money to buy the pipeline from Barclays Bank and Barclays happened to be the bank which provided the cash collateralised guarantee to BMBF for the payment of the rent. But these were happenstances. None of these transactions, whether circular or not, were necessary elements in creating the entitlement to the capital allowances."
"The scheme in outline
 The central element of the scheme devised by Citibank International plc ('Citibank') to enable SPI to take advantage of the change-over was extremely simple. During the old regime, SPI would grant Citibank an option ('the Citibank option') to buy short-dated gilts, at a price representing a heavy discount from market price, in return for a correspondingly large premium. The premium received on the grant of the option would not be taxable. After the new regime came into force, Citibank would exercise the option. SPI would have to sell the gilts at well below market price and would suffer an allowable loss.
 If that was all there was to the transaction, there would also have been a risk that SPI or Citibank would have made a real commercial profit or loss. The premium would have been fixed by reference to the current market price, but the possibility of a rise or fall in interest rates during the currency of the option created a commercial risk for one side or the other. Neither side wanted to incur such a risk. The purpose of the transaction was to create a tax loss, not a real loss or profit. The scheme therefore provided for Citibank's option to be matched by an option to buy the same amount of gilts ('the SPI option') granted by Citibank to SPI. Premium and option price were calculated to ensure that movements of money between Citibank and SPI added up to the same amount, less a relatively small sum for Citibank to retain as a fee. In addition, SPI agreed to pay Citibank a success fee if the scheme worked, calculated as a percentage of the tax saving.
 The calculation of the SPI option price obviously needed careful thought. In one sense, of course, it did not matter. Whatever price was selected would be reflected in the corresponding premium and subsequent movements in the market price would cancel each other out. But the option price for SPI had to be higher than the option price for Citibank, otherwise the 'profit' realised by SPI on the exercise of its option would cancel out the 'loss' which it suffered on the exercise of the Citibank option and the whole exercise would be futile. Indeed, the greater the difference between the Citibank price and the SPI price, the greater would be the net tax loss created by the scheme. The difference did give rise to a potential cash flow problem because, if Citibank paid the premium for its option, it would be out of pocket in respect of the difference between the two premiums between the date on which the options were granted and the date on which they were exercised. But this was covered by a collateral agreement under which SPI agreed to deposit the difference with Citibank, free of interest, until its option had been exercised or lapsed. This enabled the payment of both premiums to take the form of book entries.
 On the other hand, the purpose of the SPI option was to reduce or eliminate the possibility that the outcome of the transaction would be affected by events in the real world such as movements in interest rates. So the SPI option price had to be sufficiently below market price as to be, for practical purposes, out of the possible range of such movements. There was also a third consideration. Plainly it was inconceivable that Citibank, having parted with a large premium for its option, would not exercise it. Equally, if the SPI price had been very low, it would have been inconceivable that SPI would not have countered by the exercise of its own option. That might have given rise to a doubt about whether in truth there was any transaction in gilts at all. It would have been inevitable that the obligations of Citibank and SPI to deliver gilts would cancel each other out and that none would change hands. So the SPI option price had to be close enough to the market price to allow for some possibility that this would not happen."
"The question of construction
 SPI is entitled to treat the loss suffered on the exercise of the Citibank option as an income loss if the option was a 'qualifying contract' within the meaning of s 147(1)) of the Finance Act 1994 (the 1994 Act). Section 147A(1) (inserted by the Finance Act 1996 (the 1996 Act)) provides that a 'debt contract' is a qualifying contract if the company becomes subject to duties under the contract at any time on or after 1 April 1996. By s 150A(1) (also inserted by the 1996 Act) a 'debt contract' is a contract under which a qualifying company (which means, with irrelevant exceptions, any company: see s 154(1)) 'has any entitlement … to become a party to a loan relationship'. A 'loan relationship' includes a government security. So the short question is whether the Citibank option gave it an entitlement to gilts.
 That depends upon what the statute means by 'entitlement'. If one confines one's attention to the Citibank option, it certainly gave Citibank an entitlement, by exercise of the option, to the delivery of gilts. On the other hand, if the option formed part of a larger scheme by which Citibank's right to the gilts was bound to be cancelled by SPI's right to the same gilts, then it could be said that in a practical sense Citibank had no entitlement to gilts. Since the decision of this House in W T Ramsay Ltd v IRC  STC 174,  AC 300 it has been accepted that the language of a taxing statute will often have to be given a wide practical meaning of this sort which allows (and indeed requires) the court to have regard to the whole of a series of transactions which were intended to have a commercial unity. Indeed, it is conceded by SPI that the court is not confined to looking at the Citibank option in isolation. If the scheme amounted in practice to a single transaction, the court should look at the scheme as a whole. Mr Aaronson QC, who appeared for SPI, accepted before the Special Commissioners that if there was 'no genuine commercial possibility' of the two options not being exercised together, then the scheme must fail."
" Thus there was an uncertainty [in Craven (Inspector of Taxes) v White  AC 398] about whether the alleged composite transaction would proceed to completion which arose, not from the terms of the alleged composite transaction itself, but from the fact that, at the relevant date, no composite transaction had yet been put together. Here, the uncertainty arises from the fact that the parties have carefully chosen to fix the strike price for the SPI option at a level which gives rise to an outside chance that the option will not be exercised. There was no commercial reason for choosing a strike price of 90. From the point of view of the money passing (or rather, not passing), the scheme could just as well have fixed it at 80 and achieved the same tax saving by reducing the Citibank strike price to 60. It would all have come out in the wash. Thus the contingency upon which SPI rely for saying that there was no composite transaction was a part of that composite transaction; chosen not for any commercial reason but solely to enable SPI to claim that there was no composite transaction. It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme.
 We think that it would destroy the value of the Ramsay principle of construing provisions such as s 150A(1) of the 1994 Act as referring to the effect of composite transactions if their composite effect had to be disregarded simply because the parties had deliberately included a commercially irrelevant contingency, creating an acceptable risk that the scheme might not work as planned. We would be back in the world of artificial tax schemes, now equipped with anti-Ramsay devices. The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned.
 It follows that in our opinion the Special Commissioners erred in law in concluding that their finding that there was a realistic possibility of the options not being exercised simultaneously meant, without more, that the scheme could not be regarded as a single composite transaction. We think that it was and that, so viewed, it created no entitlement to gilts and that there was therefore no qualifying contract."
Issue (1): Does paragraph 3 of schedule 13 require the court or tribunal to have regard to all the terms of issue of the security or, as the Special Commissioner held, only those terms whose operation in practice is a real possibility?
Issue (2): Did the Special Commissioner err in disregarding as an uncommercial contingency the chance, found by the Special Commissioner to be 15%, of Mr Edwards exercising his right to redeem the security under condition 3.2/3 if the market change condition was not satisfied?
Issue (3): Did the Special Commissioner err in disregarding as an uncommercial activity the possibility of Mr Edwards exercising his right of early redemption under condition 3.2/3 if a buyer was not found by 24 March 2002?
Issue (4): Did the Special Commissioner apply the wrong test, or alternatively reach a conclusion which no reasonable tribunal could reach, when he found that there was no real possibility that a buyer would not be found within the requisite timescale?
"Neither party drew this error to the attention of the Special Commissioner when he released his determination in draft. That is unfortunate. However in my view I do not think it makes any difference. When one analyses the judgment as a whole he would have come to the same conclusion in my opinion had the correct shortened days been identified to him as opposed to the year ending 5 April 2002. Further if the parties wished to have achieved a redemption by 5 April 2002 and less than seven days was available I have no doubt given the compliant nature of the relationship between all the parties a waiver would have been obtained to abridge time so as to achieve an effective redemption by the shorter date if required." (paragraph 23)
Issue (5): Did the Special Commissioner err in holding that the appellants' securities did not involve a "deep gain" for the purposes of paragraph 3(3) of schedule 13 because the amount payable on redemption was to be funded out of monies previously provided by them as capital of the trusts?
Lord Justice Keene:
Lord Justice Sullivan: