QUEEN'S BENCH DIVISION
Strand, London, WC2A 2LL
B e f o r e :
| THE QUEEN on the application of ROBERT HUITSON
|- and -
|HER MAJESTY'S REVENUE AND CUSTOMS
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Rabinder Singh QC and Clive Sheldon (instructed by Her Majesty's Revenue and Customs) for the Defendant
Hearing dates: 19 & 20 January 2010
Crown Copyright ©
The Hon Mr Justice Kenneth Parker :
The Applicable Legislation pre-Padmore
"The industrial or commercial profits of an Isle of Man enterprise shall not be subject to United Kingdom tax unless the enterprise is engaged in trade or business in the United Kingdom through a permanent establishment situated therein. If it is so engaged, tax may be imposed on those profits by the United Kingdom, but only on so much of them as is attributable to that permanent establishment."
At the time of Padmore the DTA took effect through Section 497(1) of the Income and Corporation Taxes Act 1970. That section is now section 788 of the Income and Corporation Taxes Act 1988 ("ICTA 1988") which provides, so far as is material:
"(1) If Her Majesty by Order in Council declares that arrangements specified in the Order have been [made in relation to any territory] outside the United Kingdom with a view to affording relief from double taxation in relation to -
(a) income tax,
(b) corporation tax in respect of income or chargeable gains, and
(c) any taxes of a similar character to those taxes imposed by the laws of that territory,
And that it is expedient that those arrangements should have effect, then those arrangements shall have effect in accordance with subsection (3) below.
(3) Subject to the provisions of this Part, the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide—
(a) for relief from income tax, or from corporation tax in respect of income or chargeable gains; or
(b) for charging the income arising from sources, or chargeable gains accruing on the disposal of assets, in the United Kingdom to persons not resident in the United Kingdom; or
(c) for determining the income or chargeable gains to be attributed—
(i) to persons not resident in the United Kingdom and their agencies, branches or establishments in the United Kingdom; or
(ii) to persons resident in the United Kingdom who have special relationships with persons not so resident; or
(d) for conferring on persons not resident in the United Kingdom the right to a tax credit under [section 397(1) of ITTOIA 2005] 5 in respect of qualifying distributions made to them by companies which are so resident."
"2. Domestic laws differ in the treatment of partnerships. These differences create various difficulties when applying tax conventions in relation to partnerships. These difficulties are analysed in the report by the Committee on Fiscal Affairs entitled "The Application of the OECD Model Tax Convention to Partnerships", the conclusions of which have been incorporated below and in the commentary on various other provisions of the Model Tax Convention.
3. As discussed in that report, a main source of difficulties is the fact that some countries treat partnerships as taxable units (sometimes even as companies) whereas other countries adopt what may be referred to as the fiscally transparent approach, under which the partnership is ignored for tax purposes and the individual partners are taxed on their respective share of the partnership's income."
"an industrial or commercial enterprise or undertaking carried on by a resident of the Isle of Man";
"Resident of the Isle of Man" was defined as:
"any person who is resident in the Isle of Man for the purposes of Isle of Man tax and not resident in the United Kingdom for the purposes of United Kingdom tax";
and (critically) "Person" was stated to include:
"any body of persons, corporate or not corporate" (my emphasis).
"At the end of section 153 of the Taxes Act (partnerships controlled abroad) there shall be added the following subsections -
(4) In any case where -
(a) a person resident in the United Kingdom (in this subsection and subsection (5) below referred to as "the resident partner") is a member of a partnership which resides or is deemed to reside outside the United Kingdom, and
(a) by virtue of any arrangements falling within section 497 of this Act (double taxation relief) any of the income or capital gains of the partnership is relieved from tax in the United Kingdom,
the arrangements referred to in paragraph (b) above shall not affect any liability to tax in respect of the resident partner's share of any income or capital gains of the partnership."
"shall be deemed always to have been made."
In other words, the amendment had retrospective effect.
"(1) This section applies if -
(a) a UK resident ("the partner") is a member of a firm which -
(i) resides outside the United Kingdom, or
(ii) carries on a trade the control and management of which is outside the United Kingdom, and
(b) by virtue of any arrangements having effect under section 788 of ICTA ("the arrangements") any of the income of the firm is relieved from income tax in the United Kingdom.
The partner is liable to income tax on the partner's share of the income of the firm despite the arrangements."
The Treatment of the Claimant
"Fifty seven other scheme users cannot meet the tax demand, even if they were to sell all of their assets including their family home. Twenty nine scheme users could only settle by selling or re-mortgaging their family home. Several users face personal bankruptcy, and the related financial worry has caused mental health problems and marital breakdown".
The Efficacy of the Arrangements
"The trustee has the full legal property in the whole of the trust fund and the beneficiary has not…. The trustee is not the agent of the beneficiary who can neither appoint nor dismiss him. She cannot require him to change or forbid him to change the particular investments of the fund… It is the trustee alone who can give a discharge for interest, rent or dividends to the parties who have to pay them, in respect of the invested trust estate, nor need they know the beneficiary in the matter. All that the latter can do is to claim the assistance of a Court of Equity to enforce the trust and to compel the trustee to discharge it. This right is quite as good and often is better than any legal right, but it is not in any case one which for all purposes makes the trust fund "belong" to the beneficiary or makes the income of it accrue to him eo instanti and directly as it leaves the hand of the party who pays it. I do not understand that so far there was any contest. The [Crown's] argument is that whatever may be the legal position of the capital and the equitable position of the trustee and the cestui que trust as regards the right to the income, for Income Tax purposes the law is otherwise and that under the Income Tax Act and by virtue of some implication the "accrual" is to the beneficiary."  AC 844, at 850
However, Viscount Sumner continued:
"I have looked without success for either express words or a necessary implication that would enable the Revenue to tax a subject who is only an equitable tenant for life, as if she were both the beneficiary and the trustee in one, or to claim that securities and shares belong to her as to which she has only a right to compel the administration of the trust. [The relevant legislative provisions] clearly apply to legal owners, and if words properly apt to charge them are also to charge equitable owners it can be done only by ignoring the difference between law and equity." (at 851)
Viscount Sumner also pointed out the practical problems of the alternative view:
"There is only one tenant for life …. We hear of no matters in which a conflict between income and capital and their respective interests has arisen, nor of any business carried on by the trustee as to which the more complex case of trading profits would replace the plain case of dividends paid [a somewhat prescient observation, if I may respectfully note, given the issue in this claim]. If there had been annuitants with a prior right to be paid or several beneficiaries entitled to share in the income; if there had been beneficiaries who could claim that part of the annual receipts were in the nature of accretions to capital; if there was a trust for accumulation of a power to vary the amounts payable from time to time as between minors, the impracticability of saying that any or all of the beneficiaries entitled to income owned the whole or any part of that income from the moment it became payable and was paid, and to the full extent of the amount paid, would be evident. The same rule of "Income Tax Law" must, however, be applicable to all these cases." (at 853)
"[Lady Archer-Shee's right is] an equitable right in possession to receive during her life the proceeds of the shares and stocks of which she is tenant for life. Her right is not to a balance sum, but to the dividends subject to deductions….." (at 866)
As one commentator has wryly observed, Lord Wrenbury was clearly conscious of the fiscal consequences of deciding the case differently.
"to express with perfect clearness what we now know is the American law," (as proved by its leading academic expert on trusts, Professor Powell of Columbia University).
" So much is clear. The question before the House, however, requires one to inhabit a new and different world, a world where an election dividend may be paid to a non-resident company. How is art 10 [of the relevant DTA] to be read and understood in this new world? If art 10 is to be read literally I would agreed with Park J (see  EWHC 32 (Ch)  STC 250) and the Court of Appeal (Peter Gibson and Laws LJJ and Sir Martin Nourse) (see  EWCA Civ 1849,  STC 130) that a Netherlands resident parent would be entitled to a convention tax credit on an election dividend. That is the effect of the literal interpretation of art 10. But is this the proper interpretation?
 Article 10, like all documents, must be interpreted purposively….. "
Lord Walker said this:
" …. The evident purpose of S 788(3) (d) and of art 10 of the DTAs is to give a tax credit (of a certain sort) to a non-resident shareholder who receives dividend from a United Kingdom company. It is central to the concept of the United Kingdom granting a tax credit to the shareholder in respect of a dividend that some United Kingdom tax should have been paid (or at least payable) in respect of that dividend. It would be an abuse of language, and contrary to common sense, to speak of granting a tax credit when no such tax has been paid. Moreover the DTAs would not then, in this sort of situation, be relieving double taxation. It is the respondents, to my mind, who seek to adopt a selective reading of the relevant provisions of the 1988 Act by ignoring a central feature of the statutory scheme, that liability to pay ACT is a concomitant of a qualifying distribution".
"739 Prevention of avoidance of income tax
(1) Subject to section 747(4)(b), the following provisions of this section shall have effect for the purpose of preventing the avoiding by individuals ordinarily resident in the United Kingdom of liability to income tax by means of transfers of assets by virtue or in consequence of which, either alone or in conjunction with associated operations, income becomes payable to persons resident or domiciled outside the United Kingdom.
[(1A) Nothing in subsection (1) above shall be taken to imply that the provisions of subsections (2) and (3) apply only if -
(a) the individual in question was ordinarily resident in the United Kingdom at the time when the transfer was made, or
(b) the avoidance of liability to income tax is the purpose, or one of the purposes, for which the transfer was effected.]
(2) Where by virtue or in consequence of any such transfer, either alone or in conjunction with associated operations, such an individual has, within the meaning of this section, power to enjoy, whether forthwith or in the future, any income of a person resident or domiciled outside the United Kingdom which, if it were income of that individual received by him in the United Kingdom, would be chargeable to income tax by deduction or otherwise, that income shall, whether it would or would not have been chargeable to income tax apart from the provisions of this section, be deemed to be income of that individual for all purposes of the Income Tax Acts.
(3) Where, whether before or after any such transfer, such an individual receives or is entitled to receive any capital sum the payment of which is in any way connected with the transfer or any associated operation, any income which, by virtue or in consequence of the transfer, either alone or in conjunction with associated operations, has become the income of a person resident or domiciled outside the United Kingdom shall, whether it would or would not have been chargeable to income tax apart from the provisions of this section, be deemed to be income of that individual for all purposes of the Income Tax Acts.
(4) In subsection (3) above "capital sum" means, subject to subsection (5) below—
(a) any sum paid or payable by way of loan or repayment of a loan, and
(b) any other sum paid or payable otherwise than as income, being a sum which is not paid or payable for full consideration in money or money's worth.
(5) For the purposes of subsection (3) above, there shall be treated as a capital sum which an individual receives or is entitled to receive any sum which a third person receives or is entitled to receive at the individual's direction or by virtue of the assignment by him of his right to receive it.
(6) Income shall not by virtue of subsection (3) above be deemed to be that of an individual for any year of assessment by reason only of his having received a sum by way of loan if that sum has been wholly repaid before the beginning of that year."
"a settler of trusts with the kind of fundamental role in the setting up and operation of the partnership as someone like the Claimant had " (Skeleton, paragraph 48).
"Partnership is the relationship which subsists between persons carrying on a business in common with a view to profit."
This section put the established case law on a statutory footing, the leading case being Smith v Anderson (1880) 15 Ch D 247, where James LJ stated:
"An ordinary partnership is a partnership composed of definite individuals, bound together by contract between themselves to continue combined for some joint object either during pleasure or during a limited time, and is essentially composed of the persons originally entering into the contract with one another."
"The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but the receipt of such a share, or of a payment contingent on or varying with the profits of a business does not of itself make him a partner in the business; and in particular [of relevance to this case] - …..
(b) A contract for the remuneration of a servant or agent of a person engaged in business by a share of the profits of the business does not of itself make the servant or agent a partner in the business or liable as such."
"(1) the partnership is not a legal entity; (2) the partners carry on the business of the partnership in common with a view to a profit …(3) each does so both as principal and (see s.5 of the 1890 Act) as agent for each other, binding the firm and his partners in all matters within his authority; (4) every partner is liable jointly with the other partners for all the debts and other obligations of the firm (see s.9 of the 1890 Act); and (5) the partners own the business, having a beneficial interest in the form of an undivided share in the partnership assets…including any profits of the business."
"The Government believes that a partner for the purposes of that legislation has always included all those persons entitled to a share of income or capital gains of the partnership. As such, the UK individuals remain liable to UK tax despite the elaborate, artificial structure designed to exempt them. This clause will put it beyond doubt that the legislation has always had that effect."
It is on this basis that Mr Singh QC submits that the challenged retrospective legislation does no more than make clear what the earlier legislation meant in any event (see paragraph 75(vii) below). HMRC did not waive any legal professional privilege that attached to any advice that they might have received from counsel on this issue. As I have said, on the material put before me, I have significant doubts whether "member of a firm" could extend to a person in the Claimant's position but, given the background, and the need to interpret anti-avoidance legislation in a strongly purposive manner, I could not rule out the possibility that, if the point had been litigated, HMRC might have succeeded in persuading the courts that its interpretation was correct.
The New Legislation: Section 58(3) of the 2008 Act
"In section 858 of ITTOIA 2005 (resident partners and double taxation agreements), insert at the end -
"(4) For the purposes of this section the members of the firm include any person entitled to a share of income of the firm""
Further, section 58 provides that:
"(4) The amendments made by subsections (1) to (3) are treated as always having had effect.
(5) For the purposes of the predecessor provisions, the members of a partnership are to be treated as having included, at all times to which those provisions applied, a person entitled to a share of income or capital gains of the partnership.
(6) "The predecessor provisions" means -
(a) Section 153(4) and (5) of the Income and Corporation Taxes Act 1970 (c.10) (as it had effect under section 62(2) of F (No 2) A 1987, and
(b) Section 112(4) to (6) and 115(5) of ICTA"
"Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.
The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties"
i) In securing the payment of taxes, a national authority must strike a "fair balance" between the demands of the general interest of the community and the requirements of the protection of the individual's fundamental rights, including the right that a person enjoys to "the peaceful enjoyment of his possessions": see, for example, National & Provincial Building Society and Others v United Kingdom (1998) 25 EHRR 127 at .
ii) In framing and implementing policies in the area of taxation, the State will enjoy "a wide margin of appreciation and the Court will respect the legislature's assessment in such matters unless it is devoid of reasonable foundation" (National & Provincial Building Society at ). The domestic analogue of the margin of appreciation is the discretionary area of judgment and is especially wide in the field of social and economic policy (see, for example, R v DPP, ex p Kebilene  UKHL 43  2 AC 326, at 380E - 381D (Lord Hope). It has been said that "greater deference will be due to the democratic powers where the subject matter in hand is peculiarly within their constitutional responsibility" (International Transport Roth GmbH v SSHD)  EWCA Civ 158;  QB 728, at  per Laws LJ. In Wilson v First County Trust Ltd (No 2) Lord Nicholls stated that the readiness of a court to depart from the views of the legislature depends upon the circumstances, "one of which is the subject matter of the legislation. The more this concerns matters of broad social policy, the less ready will be a court to intervene"  UKHL 40;  1 AC 816, at .
iii) Nonetheless the court will carefully examine all the relevant circumstances, including the history of challenged provisions, to determine whether a fair balance has been struck: see, for example, the detailed analysis by the European Court in James v United Kingdom  8 EHRR 123, at pages 143-148 of the judgment.
iv) These principles apply to tax legislation that is retrospective.
v) As regards retrospective legislation in particular:
"Retrospective legislation is not as such prohibited by [Article 1 of Protocol No 1]. The question to be answered is whether, in the applicants' specific circumstances, the retrospective application of the law imposed an unreasonable burden on them and thereby failed to strike a fair balance between the various interests involved" (MA and 34 Others v Finland (2003) 37 EHRR CD210)."
vi) The imposition of a tax is not devoid of reasonable foundation by reason only that it may have some retrospective effect: see, for example, R (on the application of Federation of Tour Operators, TUI UK Limited, Kuoni Travel Limited v Her Majesty's Treasury  EWHC 2062 (Admin) at 149; affirmed  EWCA Civ 752, where Stanley Burnton J (as he then was) said in that context that "the hurdle for the Claimants on A1P1 is very high" .
vii) Depending upon the specific circumstances of the case, it may be relevant to enquire whether the purpose of the retrospective legislation was to restore and reassert the original intention of the amended legislation (National & Provincial, where the original Parliamentary intent was clear, but the subordinate legislation, through a mere technical flaw, failed to give effect to that intention).
The Application of A1P1 to this Claim
i) It is a truth universally acknowledged that in contemporary society a state is entitled to impose income tax on any person who resides in the state in question and who earns income there (or indeed elsewhere), including income from the exercise of a trade or profession. The Model Tax Convention of the OECD explicitly recognises the importance of residence in the context of taxation of partnerships:
"6.1 One issue is the effect that the application of the provisions of the convention to a partnership can have on the taxation of the partners. Where a partnership is treated as a resident of a Contracting State, the provisions of the convention that restrict the other contracting State's right to tax the partnership on its income do not apply to restrict that other State's right to tax the partners who are its own residents on their share of the income of the partnership. Some states may wish to include in their conventions a provision that expressly confirms a contracting State's right to tax resident partners on their share of the income of a partnership that is treated as a resident of the other State."
No more than a cursory glance at UK fiscal legislation is needed to see that residence is the core connecting factor for the imposition of income tax.
ii) As a correlative to (i), any resident of a state must reasonably expect to be taxed by the state in question on the income that he or she earns there (or indeed elsewhere), including income from the exercise of a trade or profession.
iii) The expectation in (ii) has also an important moral dimension. As Mr Singh QC submitted, those who reside in a state and enjoy the safety and security that it offers, and all the other public goods that it makes available (such as a fair and efficient system of civil justice), can hardly complain if they must by law pay income tax to the state of residence.
iv) DTAs, including the DTA in this case, typically respect the principle of taxation in the state of residence, and seek to ensure that income tax is exacted by the state of residence and that persons are not taxed twice on the same income.
v) The fundamental purpose of DTAs is to avoid double taxation. It is not a purpose of DTAs to facilitate the complete avoidance of income tax in any jurisdiction, or to allow residents of a particular state to reduce the tax on their income to a level below that which would ordinarily be exacted by the state of residence.
vi) It is a legitimate and important aim of UK public policy in fiscal affairs that a DTA should do no more than relieve from double taxation, and that a DTA should not be permitted to become an instrument by which persons residing in the UK avoid, or substantially reduce, the incidence of income tax that they would ordinarily pay on their income, including income earned from the exercise of a trade or profession. That is particularly the case where the means chosen to exploit the DTA in that way comprises artificial arrangements.
vii) Such is the importance of the public policy in (vi) above that the UK legislature is entitled, and can reasonably be expected, to enact legislation to ensure that any relevant DTA does not become an instrument of tax avoidance in the sense identified in (vi) above.
viii) In principle, the policy in (vi) is of such importance that retrospective legislation may be justified, such as that which followed Padmore.
ix) The fact that, following Padmore, Parliament had legislated with retrospective effect put taxpayers and their advisers on notice that it might well do so again, if it believed that such legislation were necessary and appropriate to maintain the important public policy in (vi) above, especially if the means of exploiting the DTA comprised artificial arrangements.
x) On the Claimant's interpretation, the DTA in this case plainly and indisputably did more than relieve from double taxation. It allowed resident taxpayers, like the Claimant, substantially to reduce UK income tax that would otherwise have been payable by them on income from a trade or profession carried on in the UK. Such an interpretation plainly ran counter to the public policy in (vi) above, no less than the interpretation upheld by the courts in Padmore. The means of exploitation comprised artificial arrangements.
xi) At no time did HMRC accept the interpretation advanced by the Claimant, or by other taxpayers who were in a comparable position. On the contrary, HMRC challenged that interpretation.
xii) Nor did HMRC undertake not to bring proceedings in respect of the arrangements, or suggest to taxpayers that no legislation would be enacted in any event to put the matter beyond doubt, or suggest that any such legislation would have only prospective effect.
The Claimant's Case
"28A Completion of enquiry into personal or trustee return
...1) An enquiry under section 9A(1) of this Act is completed when an officer of the Board by notice (a "closure notice") informs the taxpayer that he has completed his enquiries and states his conclusions.
In this section "the taxpayer" means the person to whom notice of enquiry was given.
(2) A closure notice must either-
(a) state that in the officer's opinion no amendment of the return is required, or
(b) make the amendments of the return required to give effect to his conclusions.
(3) A closure notice takes effect when it is issued.
(4) The taxpayer may apply to the Commissioners for a direction requiring an officer of the Board to issue a closure notice within a specified period.
(5) Any such application shall be heard and determined in the same way as an appeal.
(6) The Commissioners hearing the application shall give the direction applied for unless they are satisfied that there are reasonable grounds for not issuing a closure notice within a