1. One of the recurring themes in the continuing struggle between taxpayers seeking loopholes in the tax laws and the Revenue striving to close them is the operation of the law of unintended consequences. Parliament not infrequently enacts a provision aimed at a particular type of tax avoidance which has proved successful and which the government of the day wishes to prevent, but frames it in such a way that other persons who have not been attempting to escape tax in the same way are caught by its provisions. The same thing can happen in the related field of company law: the similar drafting of section 54 of the Companies Act 1948 designed to prevent companies from providing financial assistance for the purchase of their own shares was so wide that, as the Jenkins Committee observed, it penalised many unobjectionable transactions. The present case is a good example. It is abundantly clear that the taxpayer company, the respondent in this appeal, and its corporators have not been seeking the type of advantage which the provision which we have to construe was designed to nullify. If we hold that that provision must be construed in the way for which the appellant inspector of taxes contends, it will nevertheless result in the imposition of a charge upon the taxpayer.

2. The present proceedings are brought by the appellant by way of appeal from a decision of the Special Commissioners given on 20 March 2000, allowing an appeal from an assessment in the sum of £7500 under section 419(1) of the Income and Corporation Taxes Act 1988. The case for the appellant is that liability to pay the sum assessed is the consequence of the making of a loan of £30,000 on or about 1 September 1997 by the respondent company The Deanby Investment Co Ltd (Deanby) to its chairman Mr John D McCaughey. The appeal is brought under section 56A (as applied by section 58) of the Taxes Management Act 1970, which provides for an appeal on points of law from the Special Commissioners to this court.

3. Part XI of the 1988 Act, into which section 419 falls, deals with close companies. It is not in dispute that Deanby constitutes a close company and that Mr McCaughey is an associate of a participator, as defined in section 417, his wife being a shareholder in the company. Section 418 provides that certain expenses of close companies are to be treated as distributions to participators. Chapter II of Part XI, which commences with section 419, then imposes tax consequences on the making of certain loans. Section 419(1), so far as material, provides:

4. This is supplemented by section 419(4), which provides:

5. The effect of subsection (4) is that the charge is not a tax in the ordinary sense, since it is refundable on repayment of the loan to the company. Under the pre-1999 law, however, as it applied to the transaction presently in issue, if the loan was not repaid but was released or written off, no refund was made (and the recipient may have been liable under section 421 to pay tax as on a distribution). The issue in this appeal is whether the transaction fell within the exception specified in section 419(1).

6. Deanby was incorporated in 1926 by Mr McCaughey’s father, an estate agent. Its main object was investment, but the objects clause in its memorandum of association included power ”to lend and advance money to such persons, and upon such terms, and subject to such conditions as may seem expedient”. At the time when the loan in question was made the shares in Deanby were held as to 37 per cent by Camden Trust Ltd and 37 per cent by JD Barr Ltd, two close companies of which members of the McCaughey family were the participators, and the remaining 26 per cent were held between Mr McCaughey’s wife and children.

7. During the lifetime of Mr McCaughey’s father, who died in 1972, the main business of the three companies was investment in property which was let to tenants. After his death the properties were sold off when opportunity presented itself and Deanby does not appear to have been involved in any active operations. Mr McCaughey, who was a partner in the firm of consulting engineers Kirk McClure & Morton until his retirement on 31 December 1991, required from time to time to introduce sums of capital into the partnership. In 1978 he took a loan from JD Barr Ltd for this purpose, and over the next few years he increased his borrowings from JD Barr Ltd, Camden Trust Ltd and Deanby until they amounted to quite a substantial sum. His first borrowing from Deanby was the sum of £2980 in 1983. His indebtedness to Deanby rose steadily until in 1989 it was £41,000. It was reduced in 1990 to £31,000 and in 1993 to £21,000 and was paid off in 1994. In respect of all loans Mr McCaughey paid a full commercial rate of interest to the company concerned. He declared all the loans to the Inland Revenue and indeed consulted them through his accountants before he commenced to borrow the moneys. All Mr McCaughey’s transactions have been completely open and recorded clearly in the companies’ accounts, and full and proper information has been given by him to the Revenue at every stage.

8. Following his retirement from his firm Mr McCaughey paid off the loans from the three companies. He subsequently wished to borrow the sum of £40,000 from Deanby in order to purchase shares on his own account in Stranwood Estates Ltd, a company in which Deanby had a shareholding. There was correspondence with the inspector of taxes about possible liability to a charge under section 419 should such a loan be made, and eventually it was decided that Mr McCaughey would borrow a lower sum in order to provide for payment of such a charge if it were made and its validity upheld. Accordingly on 24 September 1997 he borrowed the sum of £30,000 from Deanby, agreeing to pay interest on it at the rate of 16 per cent per annum.

9. Deanby’s balance sheet for the year ended 28 February 1998 show under “Assets” ground rents of £353 and investments of £144,454, which latter figure includes the loan of £30,000 to Mr McCaughey. The only loan made by Deanby, apart from those made to Mr McCaughey or to the related companies, was one of £5000 made in 1994 at a commercial rate of interest to Glendinning, McLeish & Co Ltd, a company unconnected with Deanby of which Mr McCaughey was chairman. This loan was repaid in 1998.

10. The inspector issued an assessment in respect of the loan on 25 June 1998 and Deanby appealed against the assessment on 10 July 1998. The appeal was heard by Mr Commissioner O’Brien on 7 February 2000, and on 20 March 2000 he issued his decision in writing in favour of Deanby. The appellant appealed to this court by notice dated 28 April 2000, raising a number of points of law. When the appeal came on for hearing Mr McCaughey was not represented, having informed the court in advance that because of the relatively modest amount at stake (since he could secure repayment of the charge to Deanby by repaying the loan) he did not wish to contest the appeal. Counsel for the Inland Revenue indicated to the court that the appeal dealt with an issue of some importance to the Revenue, and accordingly we asked for the appointment of an amicus curiae to present the opposing arguments. Mr Hanna QC appeared in this capacity at the hearing of the appeal on 6 December, and we gratefully acknowledge the assistance which he gave to the court.

11. The Commissioner stated at pages 5 to 6 of his decision that the parties were agreed that the questions to be answered were –

12. He was not in doubt that Deanby was an investment company. He stated that to be part of an investment business, loans must be made as investments. He said at page 8:

13. The Commissioner found as a fact that the loans made by Deanby prior to Mr McCaughey’s retirement from the partnership in 1991 were made as investments. He then went on at pages 8 to 9 of his decision:

14. In dealing with the second issue, whether the loans were made in the ordinary course of business, the Commissioner stated:

15. The objective of the anti-avoidance provision contained in section 419 of the 1988 Act is succinctly set out in Simon’s Direct Tax Service, para D3.401:

16. As Goulding J said of the predecessor provisions in the Finance Act 1965 in Stephens v T Pittas Ltd (1983) 56 TC 722 at 735:

17. The Revenue relied in support of its case on the decision of the Privy Council in Steen v Law [1964] AC 287, which concerned the familiar provisions of legislation outlawing the giving of financial assistance by a company for the purchase of its shares. Mr Hanna sought to distinguish the case on the facts, but we consider that it gives a certain amount of guidance on the present issue, bearing in mind the differences in the subject matter and phrasing of the legislation. A private company International Vending Machines Pty Ltd (IVM), of which the appellants were directors, advanced a substantial sum to a public company AM Holdings Ltd as part of an elaborate arrangement for the provision of financial assistance to the latter company to buy shares in IVM. When IVM was subsequently wound up the liquidator sought to hold the appellants liable to pay over to him the money so advanced. Section 148 of the Companies Act 1936 of New South Wales was in substantially similar terms to those of section 54 of the Companies Act 1948, prohibiting the provision of financial assistance by a company for the purchase of its shares, with a number of exceptions. The material exception provided that nothing in the section was to be taken to prohibit –-

18. In delivering the opinion of the Board Viscount Radcliffe pointed to the contrast with the wording of exceptions ( b) and ( c) in the section, which were framed in terms of the purpose of the provision of money by the company. He said at pages 301-2 in relation to proviso ( a):

19. He went on at page 302 to set out the Board’s interpretation of the first part of the proviso:

20. In relation to the second part of the proviso, referring to the ordinary course of business, Viscount Radcliffe said:

21. Mr Commissioner O’Brien sought to distinguish Steen v Law by adopting the thesis that in the passages which we have quoted Viscount Radcliffe was dealing with the second branch of the proviso with which the Privy Council was concerned. The Commissioner’s reasoning appears from a passage at pages 9-10 of his decision:

22. This Lord Radcliffe thought absurd. However, it is clear that he is here addressing the second question (viz, that relating to the impugned loan itself); but he does not suggest that the type of earlier lending mentioned could not qualify for the purpose of satisfying the requirement in the first question. No mention of banks or registered moneylenders here, or of lending in the public domain.”

23. We are unable to agree that in the passages discussed by the Commissioner Viscount Radcliffe had turned to the second limb of the proviso. It seems fairly clear that when he started the passage commencing with the words “This interpretation is supported” which we have quoted he was then turning his attention to the second limb and relying on it as support for the construction which he had put on the first limb. It is true that the interpretation of each of the two limbs does tend to run into that of the other, because of the similarity of wording of the phrases “ordinary business of the company” and “in the ordinary course of business”. But it seems to us tolerably clear that until he commenced the passage commencing “This interpretation is supported” Viscount Radcliffe was engaged in considering the first question, whether the lending of money could properly be described as part of the ordinary business of IVM.

24. There are, however, some features in which the present case differs from Steen v Law . The loan of £30,000 to Mr McCaughey was not a one-off transaction, but followed upon a series of similar earlier loans. It was not earmarked for devotion to any particular purpose, certainly not one linked to the financing of the company’s business or the reduction of its tax liabilities. Moreover, the wording of the exception in section 419(1) of the Income and Corporation Taxes Act 1988 is not the same as that of proviso ( a) to section 148 of the New South Wales Companies Act 1936 or proviso ( a) to section 54 of the Companies Act 1948. It is possible that the draftsman of section 419 intended merely to produce a neater version of the latter proviso, and that the absence of reference to the “ordinary” business of the company is not significant. It might, on the other hand, be argued that by using the wording “a business” the legislature intended it to extend to any activity of the company which could legitimately be termed a business, whether or not it was its ordinary business. The difference in the phrases demonstrates the need to act with some caution in relying on cases decided on other legislation, with different wording and different policy objectives.

25. We have therefore focused on the wording of section 419 and attempted to construe it in the context of the statutory provision of which it forms a part. The object of Chapter II of Part XI of the 1988 Act and its statutory predecessors was to prevent avoidance of tax by the device of companies making loans to participators which if left outstanding indefinitely would in effect constitute distributions. The exception in section 419(1) was designed to omit from the operation of the section loans made to participators by companies all or part of whose business consists of the lending of money. We consider that this exception, if it is not to stultify the operation of the section, cannot be construed as widely as the Commissioner did. The term “business” has been said to be a word of large and indefinite import and to have a wide and flexible meaning. Much may depend on the context in which it is used, and the breadth of the term may often be dependent on the concept with which it is to be contrasted. In that of the Moneylenders Acts it has been held that the word “business” imports the notion of system, repetition and continuity: Edgelow v McElwee [1918] 1 KB 205 at 206, per McCardie J, following Newton v Pyke (1908) 25 TLR 127. In construing a New Zealand taxing statute the court said that underlying it was the fundamental notion of the exercise of an activity in an organised and coherent way which is directed to an end result: Calkin v Inland Revenue Commissioner [1984] 1 NZLR 440.

26. It seems to us that the phrase in section 419(1), “a business carried on by it which includes the lending of money”, connotes a certain regularity of recurrence of such transactions. To carry on the business of doing something ordinarily means that it is done as a regular practice by way of a trading operation, if not with all comers, at least with a variety of customers. We do not consider that the making of loans on some eight occasions over a period of fourteen years to one associate of a participator is capable of amounting to a business, even when one adds in the inter-company loans (which appear to be merely internal arrangements to facilitate cash flow between connected bodies) and the single loan to Glendinning, McLeish & Co Ltd. If it did so amount, a company could make a series of loans to its participators and their associates, the very acts at which the provision is aimed, and then say that the lending of money was included in a business carried on by it. We cannot suppose that that accords with the intention of the legislature.

27. The Commissioner found that the loans to Mr McCaughey were made as investments, which he was in our view entitled to hold. But he moved from that finding to the conclusion that the lending of money had become included in Deanby’s business. In our view he fell into error at that point, in failing to consider what more than making loans by way of investment was required to bring the case within the exception contained in section 419, or in assuming that the making of such loans was sufficient per se to bring it within that exception.

28. We accordingly must conclude that the Commissioner’s decision cannot stand. We do not think that we require to refer the matter to him for reconsideration in the light of the opinions which we have expressed in this judgment. We consider that on the facts established no reasonable tribunal properly directed could hold that the case came within the exception contained in section 419. As we stated at the outset, the legislature did not set out to catch transactions such as those in the present case within the net of section 419, but in order to make the mesh effective to catch those at whom it was aimed it expressed the tax charge in wide terms and the exception in specific terms. In consequence the respondent company Deanby cannot bring itself within the exception and is liable for the charge, even though Mr McCaughey did not seek or obtain any tax advantage from the transaction.

29. We therefore allow the appeal and confirm the assessment.