First-tier Tribunal (Tax)

The Facts

 “We discussed wealth planning in general and the use of trusts. AJS outlined various types of trusts available inc in particular interest in possession [trusts] and discretionary trusts.    

The IiP trust could enable RA to designate who would receive the income from capital settled - which could include himself and/or his wife.  It would designate the ultimate beneficiaries of the capital and would potentially protect the capital. This could be relevant, for example, where he predeceased his wife and she remarried. In this situation it would ensure that both his wife had an income or use of the assets in question and that the capital would still pass to the children.

It would be possible to place other assets into trust but care needs to be taken to ensure that tax costs do not arise on the transfer. If the main home was transferred then CGT would not usually arise as it would be exempt. The PPR exemption would normally continue where the occupier was also the life tenant.”

 “AJS then discussed the Capital Preservation Strategy, which was a potentially tax effective method of funding such a trust.

RA would form and then fund the trust by transferring assets or cash in return for a loan note from the trustees. In order to ensure that the objective of long term wealth planning was met, this would ideally be a long term loan note offering a relatively cheap form of finance.  

If the loan note were to be structured as a "relevant discounted security" then an income tax loss may subsequently arise at a later date if he were to transfer the loan note to a third party.

In these circumstances, the loss would be calculated as the transfer value at that time (which would be an actuarial value) less the price paid for the loan note i.e. the issue price.

In the early life of the loan note, the actuarial value of say a 60 year unsecured loan note would be very little - typically say £20-25k value based on a 60 year zero coupon note, Therefore the bulk of the issue price would crystallise in this instance as an income loss.

The income loss would only be available against current year income and cannot be c/fwd or c/back.

It would also be possible to consider IHT planning in this context. If he were to give the loan note to a discretionary trust then, as well as achieving further potential asset protection, the value of the loan note will grow outside the estate. IHT planning can also be effected by relinquishing the life interest in the IiP trust to another family member.”

“WEALTH PLANNING THROUGH TRUSTS

Further to our meeting you have advised me that you wish to make arrangements to provide for your family in the future. You have, however, advised that your current financial position does not permit you to lose control of your assets at the present time since you wish to continue to enjoy the benefit and enjoyment of them and any income that may be generated going forward. You would, therefore, like to set up a mechanism now to ultimately give away capital (be it cash or property) without actually relinquishing control and any income arising from it, in the short term.

Benefits of using trusts

One way to achieve your objective is by using trusts, which have separate legal and tax status.

A trust allows you to hand over the guardianship of your property for legal and tax purposes whilst delaying the ultimate destination of the funds until some time in the future.

[There follows a general description of trusts.]

You can either gift property into the trust absolutely or, alternatively, you can make a loan of cash into the trust, in consideration of which the trust can provide you with an appropriate security.

Conclusion

Given your circumstances it would seem appropriate that you establish an interest in possession trust and possibly lend funds to the Trustees as this would start the process of managing your wealth in the future whilst giving you control over income and capital. There would be no adverse tax consequences in taking this step.”

Funding an Interest in Possession Settlement

Now that you have established an Interest in Possession (lIP) trust with settled funds of £50, with yourself as the life tenant and your family as remaindermen you now need to consider what additional funds you wish to settle in the trust and how these funds should be settled.

There are two main options:

1. The funds can be gifted to the trust absolutely. ...

2. The funds can be lent to the trust. ... The loan could be a simple term loan or it could .be evidenced by a deep discount bond structured as, in the language of the tax legislation, a "relevant discounted security". This latter option will provide the trustees with the opportunity to obtain a cash-flow advantage as the interest payments could be deferred up to, say, 60 years, thus enabling the trustees to maximise both the income and capital growth on behalf of the beneficiaries.

Having reviewed your circumstances I would recommend that you retain maximum flexibility by lending funds and that this is structured as a relevant discounted security as discussed above. It would appear to me that a period of 60 years could help achieve your objectives.

I should be grateful if you could let me know if you wish to proceed on the suggested basis above and the amount that is to be placed in the trust.”

“I would like to follow your recommendation and transfer my principal residence, valuation £1.8 million, to the trust and I will also be lending £250,000 to the trust.  I will advise the lawyers of the bank account details where the monies will be transferred to the trust, and with regard to my principal residence please arrange for the lawyers to do the necessary paperwork.”

(1)        Date of instrument – 22 March 2002

(2)        Issue price - £2,050,000

(3)        Principal monies (ie amount payable on redemption) - £2,450,000

(4)        Maturity date – 22 March 2062

(5)        Interest rate – 0% p.a.

(6)        Principal monies to be repaid by issuer on maturity date or such earlier date required by the terms of issue.  We find that the circumstances of repayment prior to maturity (set out in condition 2 in the second schedule) have no real substance; they refer to non-payment of interest (there is none), noncompliance with cross-referenced conditions which do not exist in the instrument, and insolvency provisions unlikely to be applicable to trustees of a family trust.

(7)        Condition 4 in the second schedule provides that “The Issuers may from time to time purchase any [Loan Note] at any price by tender (available to all Noteholders alike), private treaty or otherwise.”

“As discussed with Robert today, the Inland Revenue issued a Press Release on 26 March effectively preventing an income tax loss arising on the transfer of relevant discounted securities to connected persons (including therefore discretionary trusts).

I am pleased to say that Robert had executed his deed of gift on 25 March and should therefore not be caught by the proposed new legislation!

For the clients not so fortunate, we have arranged with a third party to purchase clients' loan notes where the terms are agreeable to both parties. Arising out of those discussions, the descriptive terminology used in the loan note has been questioned as it refers to the net value (i.e. amount subscribed) rather than the gross (amount redeemed).

Whilst it is our view that this does not in any way alter the contractual terms, we have nevertheless decided to take a prudent view on this and arrange for a deed of rectification in respect of this, in order to avoid any ambiguity contained within.”

“Further to our telephone conversation, I enclose a package containing:

...

2.  A Deed of Rectification which is intended to clarify certain aspects of the loan note and the deed of gift - namely the descriptive title of the loan note used in the recitals on page one and the certificate on page 5, As I mentioned, the contractual terms of the agreement are unchanged and this approach simply ensures that there is no ambiguity remaining.

This needs to be signed by yourself as holder of the loan note and by the trustees (including yourself again) and witnessed.”

(1)        Mr Audley had no technical understanding of the Scheme.  His brother (a solicitor and a co-trustee of the two trusts about to be formed) may have had a greater understanding of the Scheme.  Kidsons had been Mr Audley’s advisers for some years and he relied on Mr Snowdon as to the appropriateness and effectiveness of the Scheme.  Mr Audley was only interested that the Scheme would work – not in the mechanics of how it would be achieved.

(2)        Mr Audley understood that the Scheme as one of its steps would involve transferring ownership of his family home (the House) to a trust and it was this that caused him great concern at the time.  He wanted to make absolutely sure this did not mean that he and his wife were at risk of losing their home or being prevented from living there for as long as they wanted.  He could not at that time have afforded to give away the House and buy another, so it was very important to him and his wife that they could continue to live in the House.  His wife took separate legal advice on this aspect (she was to give her interest in the House to Mr Audley who in turn would put the House into a trust) but not on the tax effects of the Scheme. 

(3)        Although Mr Audley had no clear recollection of the Scheme documentation or of his execution thereof, this is understandable given the passage of time and his reliance on his advisers to produce the correct documents. 

The Statutory Provisions

“(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 31^st 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)  … ”

“(1) This paragraph applies where a relevant discounted security is transferred from one person to another and they are connected with each other.

(2) For the purposes of this Schedule —

(a) the person making the transfer shall be treated as obtaining in respect of it an amount equal to the market value of the security at the time of the transfer; and

(b) the person to whom the transfer is made shall be treated as paying in respect of his acquisition of the security an amount equal to that market value.

(3) Section 839 of the Taxes Act 1988 (connected persons) shall apply for the purposes of this paragraph.”

The issue for the Tribunal

41.    The parties agreed that the issue for determination by the Tribunal was:

“Taking into account all of the circumstances, and having regard to the purpose of the relevant legislation Schedule 13 Finance Act 1996 (as amended) in computing the loss, if any, realised or sustained from the discount of the security claimed to be issued to him on 22 March 2002 what was the amount paid by him in respect of his acquisition of the security”.

42.    Mr Audley contends that “the amount paid by him in respect of his acquisition of the [Loan Note]” was £2.05 million.  HMRC contend that it was £35,700.

Submissions of the parties

Submissions on behalf of Mr Audley

“86. In this case, we are concerned with the terms of Sch 13, para 2 in circumstances in which the Inland Revenue accepts that the subscription price was entirely paid in respect of the acquisition of the Loan Notes and that there was a transfer by the Appellant to a connected person. Paragraph 2(3) is an entirely mechanistic provision which calculates the 'loss' by deducting the subscription price 'paid in respect of [the] acquisition of [the Loan Notes]', within para 2(2)(b), from the market value deemed by para 8 to be obtained on the 'transfer', within para 2(2)(a), and deducting any relevant costs.

"where as part of a contrived tax avoidance scheme a taxpayer hugely overpays for a loan note and it can be shown that the claimed consideration on a realistic view of the facts refers not to the loan note but to other matters it is right to go behind the stated agreement values and look at the real consideration for the loan notes. Two related parties simply agreeing between them that the value exchanged is £2m. does not make it so".

"Where, on a reorganisation or reduction of a company's share capital, a person gives or becomes liable to give any consideration for his new holding or any part of it, that consideration shall in relation to any disposal of the new holding or any part of it be treated as having been given for the original shares, and if the new holding or part of it is disposed of with a liability attaching to it in respect of that consideration, the consideration given for the disposal shall be adjusted accordingly".

“It is worth first summarising the four possible approaches that might, depending on the findings of fact and the realistic analysis of the transactions undertaken by the parties, apply in this case:

—the first approach would be that the gross capital expenditure incurred was within the range of the genuine and sustained market value of the acquired software; nothing should thus turn on the separate provision of loan finance; and the LLPs should thus be able to claim capital allowances (whether 100%, 50%, 40% or writing down allowances) by reference to the full price paid;

—the second approach would be that the market value of the acquired software might be materially lower than the price paid for it in this case, but that nevertheless the LLPs should still be entitled to claim capital allowances by reference to the full price paid because, whilst the LLPs might only have paid that price because of the non-recourse loans provided to the members to contribute their capital, the LLPs have nevertheless paid the full price for the software and nothing can adjust that analysis for tax purposes;

—the third approach would be that because there is a wide disparity between the price paid for the software by the LLPs and the genuine value of the software, the LLPs must be analysed to have purchased two things, namely software and beneficial finance, with the price being allocated between the software and the beneficial finance filtered back to the contributing members of the LLPs (the suggested split advanced by HMRC in relation to this, their principal case, being 25% and 75%); and

—the fourth approach would be to treat expenditure as incurred for capital allowance purposes as and to the extent that capital was provided by the members to pay the price for the software on an outright basis, initially thus being confined to 25% of the price paid, but subsequently including further amounts as and when and to the extent that 50% of designated revenues paid off the members' borrowings.”

“[80]  The first approach is in my judgment wrong in principle, because it treats the question of market value as determinative of whether the expenditure is allowable. It follows that the discussion of market value in paras 99–109 of the decision is completely irrelevant to the Expenditure Issue, quite apart from the fact that it contains a number of unjustified criticisms of Mr Brewer's evidence.

[81]  The second approach is in my judgment the correct one as a matter of law. The special commissioner was, however, again led to reject it by his view that the price paid was far in excess of the value of the software (paras 111 and 112). The logic of this approach, assuming it to have been justified on the facts, would presumably be that he should then have accepted the third approach. However, in his discussion of the third approach he pointed out a number of difficulties which it faced, and recognised (in my view correctly) that there was (at the lowest) a real possibility that the clearing fees derived from the software would be sufficient to ensure that at least some of the 75% loan finance was repaid: see in particular para 121. Accordingly it would be unrealistic to regard the 25% which was not borrowed as the only consideration paid for the software. As he rightly said at the end of para 121, 'to leave the appellants with potential tax liabilities on all the income, with no hope of sustaining further claims for allowances seems an unrealistically harsh result'; and see too para 65, where the same point is made even more forcibly.

[82]  Having rejected the first, second and third approaches, the special commissioner was left by elimination with his favoured fourth approach. He discussed it at considerable length in paras 122–147, before turning in paras 148–161 to consider whether the authorities precluded him from adopting it. Despite the length of this discussion, however, I have to say that I find it very difficult indeed to understand his reasoning. He appears to have considered that the transaction had an underlying 'reality' which differed from what was actually done. Yet he was not prepared to disregard any of the actual transactions, and he accepted (rightly) that the transaction was not in fact structured as an instalment sale (see para 128). In those circumstances the nature of the supposed underlying reality of the transaction seems to me entirely elusive, and the use of colourful but imprecise metaphors to describe it obscures rather than illuminates the issue (see in particular paras 128, 132 and 138. In para 138 the special commissioner appeals to a supposed 'purposive basis' to justify his conclusion, and talks of the 'legal reality' as opposed to the 'discredited labels attached to the transactions by the parties'. But BMBF shows that the only relevant purpose is that of the party who incurs the expenditure, here LLP 2; and in the absence of any clear and intelligible finding of sham I can discern no proper basis for concluding that LLP 2's expenditure of £27.501m on the software was anything other than what it purported to be. In order to say that the wrong label has been attached to a transaction, it is first necessary to identify with clarity the transaction which is said to have been misdescribed. In my respectful judgment the special commissioner nowhere succeeds in doing that.

“The production company attributed the whole of the consideration of $x+y which it received from the investors as consideration for making the film and nothing as consideration for procuring the loan. Where, however, a single consideration is given for the supply of two or more goods or services the Commissioner is probably entitled even without s 99 to go behind the allocation agreed between the parties and allocate the consideration among the several goods or services for which it was paid on a proper basis. The Commissioner could argue that $x should be treated as paid to the production company as consideration for making the film and $y for procuring the loan. On this basis $y would not form part of the cost of acquiring a depreciating asset and would not qualify for the deduction claimed.”

Submissions on behalf of HMRC

“Correspondence was from 18 March 2002 sent by Mr Snowdon to lay a paper trail indicating that a series of separate steps were considered and decided on.  In fact, all the relevant steps had been decided in advance as a consequence of the single package Mr Audley had signed up to in February.  Mr Snowdon’s sequence of letters was a sham or pretence, and one which Mr Audley was prepared to go along with, relying on Mr Snowdon as to how the scheme should be effected.  There was no realistic prospect that Mr Audley would do anything other than follow the cues or recommendations in the letters.”

“As regards the contention of the plaintiff that the transactions ... were a "sham," it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. But one thing, I think, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co. v. Maclure and Stoneleigh Finance Ltd. v. Phillips), that for acts or documents to be a "sham," with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.”  

 “Both [BMBF] and SPI emphasise the need to interpret the statute in question purposively, unless it is clear that that is not intended by Parliament. The court has to apply that interpretation to the actual transaction in issue, evaluated as a commercial unity, and not be distracted by any peripheral steps inserted by the actors that are in fact irrelevant to the way the scheme was intended to operate. SPI also illustrates another important point, namely that the fact that a real commercial possibility has been injected into a transaction does not mean that it can never be ignored. It can be disregarded if the parties have proceeded on the basis that it should be disregarded.”

(1)        HMRC had accepted that £3.75 million had been paid for the loan note (see ¶¶ 68 & 86).

(2)        When the note was created in 1999 there was a hope that a corporate takeover would happen but it was not definite; accordingly, there was no unitary transaction (see ¶¶ 22 & 25).

(3)        There was a genuine commercial desire for a loan note to be issued (see ¶ 23).

(4)        The terms of the borrowing were commercially driven; the duration of the note was 10 years and it carried a coupon of 2% p.a (see ¶¶ 6 & 8).

(5)        The taxpayer had a direct involvement in the terms of the loan note and how it tied into his own investment plans (see ¶¶ 23 & 24).

(6)        The monies subscribed were invested as intended (see ¶ 27).

(1)        HMRC did not accept that £2.05 million was paid for the Loan Note.

(2)        There was a unitary transaction with no realistic possibility that it would not be carried through.

(3)        The Loan Note was never worth £2.05 million to Mr Audley.

(4)        The House was available to Mr Audley throughout.

(5)        There was no third party involvement; everyone was connected.

(6)        Mr Audley had no involvement in the terms of the Loan Note; Mr Snowdon just did a calculation of the figures required to achieve the desired level of shelter.

(7)        There has been no real activity since 2002; Trust One has lent back £250,000 and allowed the life tenants to live in the house rent-free – while that was permissible under the terms of that trust it was unlike the events in Campbell.

“Moreover, the court is entitled, as in [Carreras], to have regard to the full sequence of the transaction. Vital elements of it were not at arm's length. Accordingly the court can take into account the fact that the appellants are no better off under the transaction if the right of early redemption is exercised. They therefore made no overall gain. What the holder of the security no doubt wished to achieve was a means of unwinding the transaction if the transfer was not to proceed. That was a substantial reason but it could not provide a reason for the premium.”

“In summary, the provisions of paras 2 and 3 of Sch 13 must receive a purposive interpretation. That purpose was that there should be a real possibility of a deep gain if losses incurred on an RDS were to be offsettable for income tax purposes. In this case, terms of issue which on the face were essential for the securities to qualify as RDS had to the extent described above no practical reality and must therefore be disregarded. They do not meet the statutory requirements for an RDS.”

(1)        Sch 13 can be construed purposively – see Astall.

(2)        That statutory purpose is that gains/losses on RDSs should be taxed/relieved as income.  That is an antiavoidance purpose and there was no intention to facilitate the claiming of artificial losses.

(3)        There is no difficulty in looking at the facts as involving two elements: the loan note and the gift.

(4)        The planned unity of the transaction was relevant – see Carreras.

(5)        HMRC do not challenge that the Loan Note was issued and transferred and those events did happen for Sch 13 purposes.  But that is not determinative of the amount paid for the Loan Note.

(6)        It was always intended that on Monday 25 March an asset worth £35,700 would be settled on Trust Two and that must also have been the true worth of the asset on the previous Friday.  The amount of lending was clearly only £35,700 and that must be borne in mind when interpreting the legislation.  The remainder of the value transferred is properly to be recognised as a gift to the trustees  of Trust One.  Accordingly, there was no loss resulting on the transfer of the Loan Note to Trust Two.

Consideration

A purposive view of the legislation

“68. However, since the Inland Revenue accepts that the entire subscription monies of £3.75m were paid for the Loan Notes and were in no part a gift to the Company and that the gift of the Loan Notes by the Appellant to his wife was a 'transfer', the only issue for us to decide is whether the difference between the subscription price for the Loan Notes (£3.75m) and their market value at the time of that transfer by gift (£1.5m) is a 'loss' within the meaning of para 2(2) and para 2(3), or whether the Appellant's tax motivation in subscribing for the Loan Notes in the form in which they were issued to him denies relief on the application of the Ramsay doctrine. …”

“[41] In my judgment, none of the reasons advanced by [the taxpayer] are good reasons for not applying the principles of purposive interpretation to paras 1, 2 or 3 of Sch 13. Quite clearly, the statute requires the court to focus on the terms of issue but that is no different from the need to focus on the acts of the lessor in [BMBF]. Moreover, as [the taxpayer] accepts, para 3(1C) and (1A)(b) proceed on the basis that facts extraneous to the transaction will be relevant, thus confirming that the application of para 3 will not depend only on the terms of issue of the securities. Having said that, I would wish to make it clear that the mere fact that the parties intend to obtain a tax advantage is not in itself enough to make a statutory relief inapplicable.

[42] I see no reason to hold that the new approach to statutory interpretation applies only if there is a composite transaction consisting of several elements destined to lead to a particular result. [The taxpayer] urged us to accept that the language of practical certainty is derived from the jurisprudence on pre-ordained transactions for the purposes of the WT Ramsay v IRC jurisprudence. Thus, he submits, that purposive interpretation should be confined to composite transactions, just as the transaction in SPI was a composite transaction. In my judgment, the principle is that set out in the first sentence of [32] of [BMBF]. This principle is not expressed to be limited to composite transactions. It can thus apply to a single multi-faceted transaction which on its face operates in a particular way but which when examined against the facts of the case does not operate as a transaction to which the statute was intended to apply.

[43] …

[44] Is a purposive interpretation of the relevant provisions possible in this case? In my judgment, there is nothing to indicate that the usual principles of statutory interpretation do not apply and accordingly the real question is how to apply those principles to the circumstances of this case. In my judgment, applying a purposive interpretation involves two distinct steps: first, identifying the purpose of the relevant provision. In doing this, the court should assume that the provision had some purpose and Parliament did not legislate without a purpose. But the purpose must be discernible from the statute: the court must not infer one without a proper foundation for doing so. The second stage is to consider whether the transaction against the actual facts which occurred fulfils the statutory conditions. This does not, as I see it, entitle the court to treat any transaction as having some nature which in law it did not have but it does entitles the court to assess it by reference to reality and not simply to its form.

[45] I have described the processes involving two distinct steps. I have not overlooked that in [BMBF]Lord Nicholls held that the court did not need to force its thinking into two separate compartments (see [32] of his speech set out in para [27] of this judgment). In my judgment, the process is likely to be an iterative one. While one probably starts with determining the purpose of the relevant provision, it may well be necessary to refine that purpose as and when the facts are more closely defined. This may be what Lord Hoffmann had in mind when he spoke in [Carreras] (see para [23] of this judgment) of the need to find facts 'in the process of construction'.

[46] At this juncture of the argument, only the first step needs to be considered. I accept [HMRC’s] submission that the purpose of paras 2 and 3 of Sch 13 is to give income tax relief on a security otherwise fulfilling the statutory conditions on which a deep gain can also be made. [The taxpayer] does not make any counter-suggestions to the relevant statutory purpose. But that is only the start of the matter. In my judgment, it is implicit in the statutory purpose that the agreed terms which might cause a deep gain to arise have to have a reality beyond the printed page. Issues (2) to (5) reflect that facet of the statutory purpose.”

A realistic view of the transaction

“[The Ramsay] 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 authority since Ramsay's case is unnecessary.”

Conclusion

Decision

Appeals

Peter Kempster

TRIBUNAL JUDGE

RELEASE DATE: 1 April 2011