Strand, London, WC2A 2LL
B e f o r e :
| JASON DRUMMOND
|- and -
|COMMISSIONERS FOR H M REVENUE AND CUSTOMS
Timothy Brennan QC and Nicola Shaw (instructed by Solictor for HMRC) for the Respondent
Hearing dates: 20th February 2008
Crown Copyright ©
Mr Justice Norris :
"Subject to subsection (2)…the occasion of the surrender of a policy of assurance, shall be the occasion of a disposal of the rights under the policy of assurance."
Section 210 (2) then provides:-
"No chargeable gain shall accrue on the disposal of…the rights under any such policy of assurance…except where the person making the disposal is not the original beneficial owner and acquired the rights…for a consideration in money or money's worth."
There is thus only both a disposal and a chargeable gain in relation to second hand policies. But in this way, the disponor of a relevant second hand policy is brought within the capital gains tax regime.
"…for the purposes of [the] Act a 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…in particular…capital sums received in return for…surrender of rights…".
For these purposes it is necessary to identify the "capital sum" derived. This is done by Section 22(3) which provides that in Section 22:-
"… "capital sum" means any money or money's worth which is not excluded from the consideration taken into account in the computation of the gain…".
This case concerns what is to be so "excluded".
"…shall have effect for the purposes of imposing…charges to tax…in respect of gains to be treated…as arising in connection with policies of life insurance…".
Section 540(1)(a)(iii) then identifies as one of the events which is a "chargeable event" the surrender in whole of the rights conferred by a non qualifying policy. Section 541(1)(b) is then in these terms:-
"On the happening of a chargeable event…there shall be treated as a gain arising in connection with the policy…(b) if the event is…the surrender in whole of the rights thereby conferred, the excess (if any) on the amount or value of the sum payable plus the amount or value of any relevant capital payments arising by reason of the event…over the sum of the following (i) the total amount previously paid under the policy by way of premiums; and (ii) the total amount treated as a gain…on the previous happening of chargeable events."
It will be seen that what is being subjected to tax is a hypothetical or deemed "gain" ("…there shall be treated as a gain…the excess (if any)…"): and that the deemed gain incurred by the disponor is calculated by reference to matters which do not necessarily relate exclusively to him, but may relate in part to previous holders of the policy.
"Where…a gain is to be treated as arising in connection with any policy…(a) if, immediately before the happening of the chargeable event in question, the rights conferred by the policy…were vested in an individual as beneficial owner…the amount of the gain shall be deemed to form part of that individual's total income for the year in which the event happened…".
The deemed gain is thus added directly to the individual's total income for the purpose of assessing the income tax payable by him.
"as may be required for computing the gain to be treated as arising…
(i) the surrender value of the policy…
(ii) the amount or value of any relevant capital payments…
(iii) the amounts previously paid under the policy…by way of premiums…".
"There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money's worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts."
(a) It is first necessary to identify "the consideration for a disposal of assets." Section 22 TCGA 1992 identifies this "consideration" as the surrender proceeds of £1.751 million.
(b) It must then be confirmed that this consideration will be taken into account in the computation of the gain. Section 210(2) TCGA 1992 confirms that the surrender of the AIG policies is a disposal that will give rise to a chargeable gain which must be computed. Mr Drummond in fact paid £1.962 million to acquire the right to the surrender proceeds of £1.751 million, so that he did not make "a gain" but rather incurred a loss. However, Section 16 TCGA 1992 provides that the amount of a loss accruing on a disposal shall be computed in the same way as the amount of a gain accruing on a disposal is computed. So the surrender proceeds will be taken into account in the computation of the gain.
(c) There is then to be excluded from the surrender proceeds taken into account for the purposes of that computation (1) any money or money's worth which is (2) either (a) charged to income tax as income of the person making the disposal or (b) taken into account as a receipt in computing any income or profits or gains of the person making the disposal. This brings me to the heart of the appeal.
"In common with the Revenue, I disagree with Mr Drummond's construction. The calculation required by Section 541(1)(b) brings into the reckoning amounts that may have had nothing to do with the surrendering policyholder. Neither the premiums paid by, nor the chargeable event gain of Ms Sedgley, nor the topping-up premium paid by London & Oxford nor the surrender proceeds of £1,751,376.00 were, in terms of Section 37 (1), moneys taken into account as receipts in computing Mr Drummond's income or profits or gains or losses for income tax purposes. The only amount so taken into account is the actual chargeable event gain ie £1,351.35. That is a discreet (sic) amount produced from the calculation of gain "treated as arising in connection with" the policy; and that amount, as a stand-alone figure of income, is deemed by Section 547(1)(a) to form part of Mr Drummond's total income."
The Special Commissioner went on to amplify the distinction he was drawing between amounts taken into account for the purposes of prior calculations affecting a tax payer and amounts taken into account as receipts in computing the tax payer's income by reference to the decision of Mr Justice Vinelott in Hirsch v Crowthers Cloth Ltd (1989) 62 TC 759.
(a) The surrender of a life policy is an occasion to charge both capital gains tax and income tax.
(b) The methods of calculating the gain chargeable to capital gains and that chargeable to income tax are entirely different, the former being concerned with the actual expenditure incurred by the tax payer in acquiring the policy which is surrendered, and the latter being a calculated figure assessed by reference also to expenditure laid out and to sums received by previous holders of the policy.
(c) The deemed gain is not "money or money's' worth" but an entirely notional figure, the product of a statutory calculation. Thus Mr Drummond has been taxed on the footing that he made a chargeable event gain of £1351 although in truth he made an economic loss of £210,000.
(d) In order to calculate the deemed "gain" which is to be charged to income tax the starting point is to take the actual surrender proceeds (in order to deduct from that sum the premiums paid and earlier gains realised) so that the surrender proceeds are "money…taken into account as a receipt in computing income…or gains…";
(e) Because the surrender proceeds have been so "taken into account" for income tax purposes they must for capital gains tax purposes "be excluded from the consideration…taken into account in the computation of the gain", because that is what Section 37 TCGA 1992 explicitly provides;
(f) In the resulting computation of the capital gain the entirety of the consideration received on the disposal of the asset is excluded, leaving only the acquisition costs of the asset which accordingly constitutes an allowable loss;
(g) Whilst this may appear a surprising result it is the result required by the prescriptive code established in relation to the taxation of life policies, which legislation is entirely without ambiguity, and tells the reader precisely how to compute the deemed gain charged to income tax on the surrender of a second hand policy and then tells the reader precisely how to compute the CGT. The surrender proceeds must be ignored but the acquisition costs must be included. There is no room for doubt;
(h) This was simply another instance of that to which Henderson J referred in Revenue and Customs Commissioners v D'Arcy  EWHC 163 (Ch) (at para. 47),  STC 1329:-
"….. one of those cases, which will inevitably occur from time to time a tax system as complicated as ours, where a well advised taxpayer has been able to take advantage of an unintended gap left by the interaction between two different sets of statutory provisions".
(j) HMRC itself has recognised that this is the case because on 9 April 2003 it issued a Budget Note (REV BN 30 Capital Gains: Second Hand Life Insurance Policies) in which it acknowledged that on the disposal of second hand policies "the computational rules may result in a loss for capital gains tax purposes which exceeds the amount of an economic loss incurred" and it promoted new provisions to "correct two defects in the current tax rule", eventually achieved in the Finance Act 2003 by the substitution of a new Section 210 (in the course of which explanatory Treasury Notes issued in connection with what was then clause 156 of the Bill confirmed that the object was to counter tax-avoidance measures exploiting defects in the current rules ;
( k) Far from supporting the conclusion of the Special Commissioner the decision of Vinelott J in Hirsch demonstrates that the reasoning in the decision under Appeal is erroneous.
"There shall be excluded from the consideration for a disposal of assets…any money or money's worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts…".
The acquisition cost of the plant had been an element in the computation of the balancing charge. Vinelott J held (at p771 D):-
"The words "taken into account" are no doubt capable of being given a very wide construction and as comprehending a sum which is an ingredient in a calculation which gives rise to a further sum which then has to be brought into a corporation tax computation and which may accordingly be said to have been indirectly "taken into account". But these words are capable of being read, and in this context are I think most naturally read, as referring to sums which have to be brought directly into the computation."
As examples of sums being brought "directly" into the computation of profits and losses for the purposes of income tax (and which therefore had to be excluded in ascertaining the consideration for a disposal) Vinelott J cited (1) the deemed annual rent which is brought into the charge to income tax on the disposal of a lease for less than fifty years at a premium and (2) the proportion of the market value of shares acquired by a director or employee under a share incentive scheme. By contrast, the judge considered the value of the plant disposed of was one element of the total disposal value of all machinery during the relevant accounting period, and it was brought into account against a pool of qualifying expenditure. In argument before me Mr Way demonstrated that there were eight steps between the "taking into account" of the proceeds of sale of the plant and the computation of Crowther's profits chargeable to corporation tax: and he submitted that it was unsurprising that Vinelott J should regard the proceeds of sale as having been only "indirectly" taken into account. In the instant case he submitted there were but two steps (the identification of the policy proceeds, the deduction therefrom of the aggregate of the premiums paid and any previous gains, and the carrying of the resulting excess into the computation of Mr Drummond's total income).
"There shall be excluded from the sums allowable….as a deduction in the computation of the gain any expenditure allowable as a deduction in computing the profits or losses of a trade……or allowable as a deduction in computing any other income or profits or gains or losses for the purposes of the Income Tax Acts"
The principle is clear. If a sum has been allowed as a deduction from the income chargeable to tax it should not be allowed as deduction from the gain chargeable to tax. In my judgment the same principle is embodied in and governs the construction of section 37. If a sum of money has been directly treated as part of an individual's total income or been treated as a receipt and thereby inflated the income charged to tax (or reduced the loss otherwise available), it should not also be charged to capital gains tax.
" It would be paradoxical to find that the cost of acquisition is itself to be deducted from the consideration for the disposal of the asset thereby ensuring that the gain escapes the charge to corporation tax on capital gains. If the legislation were to compel that conclusion it would not simply have missed fire; it would have hit the wrong target."
"the sums allowable as a deduction from the consideration…..shall be restricted to …the amount or value of the consideration, in money….given ….wholly and exclusively for the acquisition of the asset……"
Before the Special Commissioner, HMRC contended that in the computation of his capital gain none of the £1.962 million paid by Mr Drummond to London & Oxford for the AIG policies was to be allowed as a deduction since none of it was paid "wholly and exclusively" for the acquisition of the asset.
" The issue of whether the £1.96 million was incurred wholly and exclusively for the acquisition of the five policies can be expressed in terms of this question: were the consideration payments of £1 million on 4 April and £962,233 (which it was a term of the contract should be paid on the 5 April 2001) viewed realistically and taking an unblinkered BMBF approach to the facts, the consideration given wholly and exclusively for Mr Drummond's acquisition and London & Oxford's disposal of the five policies? The answer in my view is – No. The Offer to Sell does not stand alone. The scheme was designed to achieve the tax shelter, not Mr Drummond's acquisition of the five policies."