DECISION
1. These
appeals concern the tax consequences of a number of derivative transactions
undertaken by the Appellants, Explainaway Limited (“Explainaway”), Quartfed
Limited (“Quartfed”) and Parastream Limited (“Parastream”), in connection with
a scheme for the mitigation of corporation tax on chargeable gains for which a
company, Paul Rackham Limited (“PRL”) would otherwise have been liable if it
had made a taxable disposal of shares it held in Waste Recycling Group Limited
(“WRG”).
2. In
the accounting period ended 31 December 2001 Explainaway, a wholly-owned
subsidiary of PRL, acquired the WRG shares from PRL and sold those shares to
purchasers in the open market, realising a chargeable gain of £8,595,731. In
the same period Explainaway undertook two derivative transactions, on the
closure of one of which, in September 2001, it claimed an allowable capital
loss of £8,804,846. It also claimed a loan relationship debit of £120,708.
3. In
the accounting period ended 31 December 2002, Quartfed and Parastream, along
with a fourth company, Quoform Limited (“Quoform”), all of which were
wholly-owned subsidiaries of Explainaway, each entered into other derivative
transactions, on the closure of which in June 2002 net allowable capital losses
were claimed. In the same 2002 accounting period Explainaway sold its shares
in Quoform to an unconnected third party, and claimed an allowable capital loss
of £8,864,992 on that disposal. Explainaway also claimed a further loan
relationship debit of £281,993 and a claim was made for a net allowable capital
loss of £209,115 in respect of closure of derivative contracts in February 2002.
4. In
the case of each of the Appellants HMRC issued closure notices on 27 May 2008.
In the case of Explainaway,
(1)
For the period ended 31 December 2001 the results of the conclusions
were:
(a)
The gain of £8,595,731 that Explainaway realised on the disposal of the
shares in WRG was chargeable to corporation tax;
(b)
Explainaway did not incur a capital loss of £209,115 in the period and
the capital losses carried forward became nil; and
(c)
Explainaway had a credit of £17,682 in respect of non-trade loan
relationships for the period.
(2)
The results of the conclusions for the period ended 31 December 2002
were:
(a)
Explainaway did not incur a capital loss of £177,347 in the period and
the capital losses carried forward became nil;
(b)
Explainaway had a credit of £3,292 in respect of non-trade relationships
for the period; and
(c)
The maximum amount available to Explainaway to surrender as group relief
for the period was reduced to £5,171.
5. The
conclusions in the case of each of Quartfed and Parastream were that no
chargeable gain or allowable loss arose on or with respect to the 2002
derivative transactions. As a result, for neither company was there any
capital loss in the accounting period to 31 December 2002 and the capital
losses carried forward became nil.
6. It
is against the conclusions and amendments made by those closure notices that
the Appellants now appeal. The issues, put shortly are:
(1)
(a) Whether the respective derivative transactions undertaken by
Explainaway (in 2001) and by Quoform, Quartfed and Parastream (in 2002),
followed by the disposal of Explainaway’s shares in Quoform gave rise to the
chargeable gains and losses as claimed by the Appellants; or
(b) Whether, as HMRC contend, either (i) all of
the relevant derivative transactions are outside the scope of the Taxation of
Chargeable Gains Act 1992 (“TCGA”) altogether, so that chargeable gains and
allowable losses do not arise as the Appellants contend, or even if such gains
and losses do arise (ii) whether, applying the Ramsay
principle, the loss arising on the disposal by Explainaway of the Quoform
shares was an allowable loss within the meaning of TCGA.
(2)
Whether the interest cost for borrowings undertaken by Explainaway to
effect the various transactions are relievable for corporation tax purposes, or
whether, as HMRC contend, such relief is denied by reason of para 13, Sch 9
Finance Act 1996 (“FA 1996”).
7. Julian
Ghosh QC and Elizabeth Wilson appeared for the Appellants. HMRC were
represented by Malcolm Gammie QC.
The facts
8. We
were helpfully provided with a statement of facts not in dispute, which we
reproduce below. We also heard oral evidence from two witnesses, each of whom
provided a witness statement. The first was Stephen Stuteley, a director and
the company secretary of PRL, and at the material times a director of each of
the Appellant companies and Quoform. The second was George Atterbury, a tax
partner at Deloitte & Touche, responsible for the tax planning in 2001 and
2002 that is the subject of this appeal. As well as the witness evidence we
had a number of bundles of documents.
Statement of facts not in dispute
1. Paul
Rackham Limited (“PRL”) was incorporated on 20th October 1989. At
all material times PRL was a UK resident company carrying on the business of
agriculture, together with property investment, dealing and development. The
directors of PRL throughout the period with which these appeals are concerned
were Messrs Paul Anthony Rackham (Snr), Paul Anthony Rackham (Jnr) and Stephen
Russell Stuteley and Mrs Sheila Rackham. Mr Stuteley was also the company
secretary.
2. On
29th January 2001 Deloitte & Touche gave a presentation entitled
“Capital Gains Tax Mitigation Scheme” to Stephen Stuteley and Michael Fulcher.
3. Explainaway
Limited (“Explainaway”) was incorporated on 20th February 2001. Its
authorised share capital comprised 1000 shares divided into 1000 shares of
£1.00 each. The issued share capital comprised 1 ordinary £1 share.
4. PRL
acquired Explainaway from the formation agents, York Place Company Services
Limited on 1st March 2001. Messrs Stuteley, Rackham Snr and Rackham
Jnr were appointed directors on 1st March 2001.
5. On 1st
March 2001 the directors of Explainaway resolved to increase the authorised share
capital from £1,000 to £500,000 divided into 500,000 shares of £1.00.
6. As
at 1st March 2001 PRL was the beneficial owner of four million
shares in Waste Recycling Group plc (“WRG”).
7. On 1st
March 2001 PRL agreed to sell and Explainaway agreed to buy two million shares
in WRG for £9,700,000 (“the Consideration”). The sale was completed on the
same day. The Consideration was left outstanding with interest payable at 1.5%
over Lloyds TSB base rate on the unpaid amount until payment.
8. On 7th
March 2001 the directors of Explainaway resolved that an application having
been received for 300,000 ordinary shares of £1 each in the share capital of
the company and the pre-emption rights of the company have been complied with,
the said shares be allotted fully paid for cash at par to PRL. PRL had on the
6th March 2001 advanced £300,000 as an intercompany debt to
Explainaway.
9. On 4th
April 2001 Explainaway sold all of its shares in WRG to purchasers in the open
market for £9,400,000 based on a market value of £4.70 per share. A net
chargeable gain accrued to Explainaway on the sale of the WRG shares in the sum
of £8,595,731.
10. On 24th April 2001
Explainaway repaid PRL £9,324,000 of the loan advanced on 1st March
2001.
11. On 25th
April 2001 Deloitte & Touche provided to Mr Stuteley details of three
companies with capital losses which had shown an interest in acquiring
Explainaway.
12. At a board meeting
held on 4th July 2001 the directors of Explainaway, being Paul
Rackham, Steve Stuteley and Paul Rackham Jnr resolved as follows:
‘1. The directors
of the company confirm that they will be entering into transactions with
Kleinwort Benson involving derivatives.
(i) The directors of the company approve the terms
of the agreement letter issued by KB on 3rd July and the
transactions contemplated by the agreement.
(ii) Any two directors are authorised officers of
the company who are able to execute the agreement with Kleinwort Benson.
(iii) Any two directors are authorised officers of
the company who can sign/despatch all documents required under the agreement
with Kleinwort Benson.’
13. On 5th July
2001 Steve Stuteley and Paul Rackham as directors of Explainaway signed a
Client Agreement Letter with Kleinwort Benson Private Bank (“KBIM”).
14. On 17 July 2001 the
directors of Explainaway gave irrevocable instructions to KBIM to acquire an
over the counter (OTC) long position over a notional value of c. £174 million.
The underlying market was the March 2002 FTSE 100 LIFFE contract and the
counter party was KBIM (“the 17th July 2001 Long Contract”). The
key terms were as follows:
(i) The
Trade date was 17th July 2001.
(ii)
The Payment Date was 18th July 2001.
(iii) The
Maturity Date was 15th March 2002.
(iv) The
Nominal Amount was £174,011, 400.
(v) The
market was the London Stock Exchange.
(vi) Counterparty
A was KBIM.
(vii) Counterparty
B was Explainaway.
(viii) The upfront amount was £174,000 of which
£87,000 was attributable to the accounting period ended 31 December 2001, and
£87,000 to the accounting period 31 December 2002.
(ix) Futures
Price was 5545.55.
(x) Initial
Price was 5540.
The Settlement terms were
as follows:-
(xi) The Settlement Price was the Official
Settlement Price of the Exchange Traded Contract as published by the LIFFE at
the Valuation Time on the earlier of the Maturity Date or the Early Termination
Date.
(xii) The Cash Settlement Amount was {Nominal Amount
x (the difference between the Settlement price and the Futures Price divided by
the Initial Price} plus an Additional Amount where applicable.
(xiii) If the Cash Settlement Amount was positive
KBIM would make a payment to Explainaway. If negative, Explainaway would make
a payment to KBIM.
15. On 17 July 2001 the
directors of Explainaway gave irrevocable instructions to KBIM to transact 3141
contracts of the March 2002 FTSE 100 LIFFE futures at a market price of
5540 (equivalent to a notional price of c. £174 million) (“the 17th
July 2001 Short Contract”).
16. On 6th
September 2001 Explainaway gave irrevocable instructions to KBIM to close out
the 17th July 2001 Long Contract.
(i) The
Settlement price was 5268.
(ii) The Cash Settlement Amount was £174,011,400 x
(5268-5545.55/5540) x 0.00 = (£8,717, 845.50).
(iii) Since the Cash Settlement Amount was a
negative number Explainaway was required to pay the absolute value of that sum
on the earlier of the Cash Settlement Payment Date.
(iv) On 7th September 2001 £8,717,845.50
was debited to Explainaway’s bank account number 910633/32B with KBIM.
17. On 6th
September 2001 Explainaway issued irrevocable instructions to KBIM to acquire
an OTC long position over a notional value of £165,467,880. The underlying
market was the March 2002 FTSE 100 LIFFE contract at 5268. The counterparty
was KBIM (“the 6th September 2001 Long Contract”). The key terms were
as follows:
(i) The
Trade Date was 6th September 2001.
(ii)
The Payment Date was 11th September 2001.
(iii)
Counterparty A was KBIM.
(iv)
Counterparty B was Explainaway.
(v)
Initial Price was 5268.
(vi)
The Nominal was £165,467,880.
(vii) The upfront amount was £30,000 payable by
Explainaway to KBIM on the Payment Date.
(viii)
The Maturity Date was 15th March 2002.
(ix) The market was the London Stock Exchange – this
being a March 2002 Futures Contract of the FTSE 100 Index (“the Exchange Traded
Contract”).
The Settlement Terms were
as follows:-
(x) The Settlement Price was the Official Settlement
Price of the Exchange Traded Contract as published by the LIFFE at the
Valuation Time on the earlier of the Maturity Date or the Early Termination
Date.
(xi) The Cash Settlement Amount was {Nominal Amount
x (the difference between the Settlement price and the Initial Price divided by
the Initial Price} plus an Additional Amount where applicable.
(xii) If the Cash Settlement Amount was positive
KBIM would make a payment to Explainaway. If negative, Explainaway would make
a payment to KBIM.
18. On 12th
September Mr Stuteley held a meeting with Deloitte & Touche who outlined an
alternative planning arrangement they were working on.
19. By letter dated 22
October 2001 Deloitte & Touche informed Mr Stuteley that a third party plc
had made an interim offer for the purchase of Explainaway. It was said that
the third party plc had sufficient losses to cover the capital gains on the
second derivative contract “when it is closed out and ultimately realised”. The
letter stated that the terms of the offer required negotiation and were subject
to 5 conditions laid down by the third party.
20. The negotiations with
the third party plc did not come to fruition and instead Mr Rackham Snr, Mr
Rackham Jnr and Mr Stuteley resolved to pursue an alternative idea mentioned by
Deloitte’s. In order to implement the alternative idea Explainaway established
three companies on 16th November 2001:
(i) Parastream Limited was incorporated as a
company limited by guarantee and not having a share capital. Its directors
were Paul Rackham, Steve Stuteley and Paul Rackham Jnr. Mr Stuteley was the
company secretary.
(ii) Quartfed Limited was incorporated as a private
company limited by shares. Quartfed’s authorised share capital was £10,000,000
divided into 10,000,000 shares of £1 each. Its directors were Paul Rackham,
Steve Stuteley and Paul Rackham Jnr. Mr Stuteley was the company secretary.
(iii) Quoform Limited was incorporated as a private
company limited by shares. Quoform’s authorised share capital was £10,000,000
divided into 10,000,000 shares of £1 each. Its directors were Paul Rackham,
Steve Stuteley and Paul Rackham Jnr. Mr Stuteley was the company secretary.
21. On 23rd
November 2001 Deloitte & Touche sent a letter to Mr Stuteley saying that
“we have set up the following • three new companies (S1, S2 and Xco as detailed
on the appendix attached) • we have agreed the financing of £17.4m with
Ansbacher Private bank at a cost of £50,000 • we have now agreed the cost of
the derivative contracts with KB (see below the summary of costs, exclusive of
financing)”.
22. On 19th
December 2001 Paul Rackham, Steve Stuteley and Paul Rackham Jnr met to consider
the financial and tax consequences of proposed trades in derivatives they were
about to enter into. In their capacity as directors of Quoform, Quartfed and
Parastream they resolved to instruct Kleinwort Benson (Channel Islands) Limited
(“KBCI”) and KBIM to close out their respective investment positions
simultaneously. It was acknowledged by the directors that extensive guarantees
and indemnities had been given to the banks for the loan obtained by
Explainaway and in connection with open positions held by Quoform, Quartfed and
Parastream. As directors of Parastream, Quoform and Quartfed they resolved
that those companies would undertake to cross support each other in the context
of their respective liabilities to the banks. It was also noted that the
directors of Explainaway had resolved that funds received from its subsidiaries
would be properly applied to settle liabilities with KBIM while its debts
remained outstanding.
23. By letter dated 20th
December 2001 Deloitte & Touche wrote to Mr Stuteley in the terms set out
therein.
24. On 9th
January 2002 Explainaway subscribed in cash for 165,000 Ordinary £1 shares at
par in each of Quoform and Quartfed.
25. On 18th
January 2002 Explainaway subscribed for a further 8,700,000 ordinary shares at
par in each company. The minutes of the board’s resolutions for this and the
subscription of 9th January 2002 are dated 9th January 2002.
26. On the 28th
January 2002 a £130,000 intercompany loan was advanced to Parastream by
Explainaway.
27. On 31 January 2002
Explainaway as sole member of Quartfed Ltd approved by special resolution that
the company enter into the forthcoming transactions and the agreements to give
them effect.
28. On 31 January 2002
Explainaway as sole member of Quoform Ltd approved by special resolution that
the company enter into the forthcoming transactions and the agreements to give
them effect.
29. The board of
Explainaway met on 31 January 2002 and resolved to enter into the loan facility
and associated agreements with KBIM.
30. The Boards of Quofrom,
Quartfed and of Parastream also met on the 31st January 2002 and
resolved to enter into the necessary agreements to effect the forthcoming
transactions.
31. By letter dated 7th
February 2002 KBIM placed at the disposal of Explainaway a cash loan facility
for an aggregate principal sum not exceeding £17.4 million to
assist with the formation and capitalisation of subsidiary companies.
Explainaway, Quoform, Quartfed and Parastream acknowledged receipt of the
letter and accepted the Facility on 13th February 2002.
32. On the 11th
February Parastream and Quartfed signed a Client Agreement letter with KBCI.
They were originally signed on 20th December 2001.
33. On 13th
February 2002 the Board of Directors of Quoform and Quartfed met to approve
certain documents relating to the proposed subsidiaries guarantees to KBIM to
secure the repayment by Explainaway of the loan. Explainaway as shareholder of
Quoform and Quartfed also signed a special resolution on the 13th
February 2002 approving the provision of financial assistance by these
subsidiaries.
34. On 13th
February 2002 PRL guaranteed and indemnified Explainaway against any
liabilities which it may incur which were in excess of its financial resources.
35. On 13th
February 2002 Quoform, Quartfed and Parastream provided guarantees and
indemnities to KBIM in respect of the loan facility to Explainaway.
36. On 13th
February 2002 Quoform, Quartfed and Parastream signed ISDA Master Agreements
and Schedules with KBIM to enter into derivative transactions. On
the same day Parastream provided a guarantee to KBIM for the obligations and
liabilities of Quoform and Quartfed under the ISDA agreements. Quoform and
Quartfed also provided a guarantee to KBIM for the obligations and liabilities
of Parastream under the ISDA agreements.
37. On 13th
February 2002 Quartfed and Parastream provided cross guarantees to KBCI for all
monies, obligations and liabilities due to the bank in consideration of the
benefit derived from entering into the Client Agreement letters.
38. On 19th
February 2002 Quartfed and Parastream entered into an Inter-Company Side
Agreement with KBCI. Quartfed and Quoform each entered into
Inter-Company Support Agreements with Parastream dated 13th February
2002.
39. On 25th
February 2002 Explainaway drew down £17.4 million. On the following day it
transferred £8.7 million to each of Quoform and Quartfed to pay for the shares
subscribed for on 18th January 2002.
40. On 26th
February 2002 Explainaway gave irrevocable instructions to KBIM to close the 17th
July 2001 Short Contract by buying 3141 contracts of the March 2002 FTSE 100
LIFFE futures at market at 5540. £13,192,000 was credited to its bank account
no 910633/32B on 1st March 2002.
41. Also, on 26th
February 2002 Explainaway closed the 6th September 2001 Long
Contract. £4,648,680 was debited to its bank account no 910633/32B on 1st
March 2002.
42. On 26th
February 2002 Quoform purchased a long FTSE 100 futures contract. The
counterparty was KBIM. The maturity date was 21st June 2002. The
underlying market was the June 2002 Futures Contract of the FTSE 100 Index
(“the Quoform Long Contract”).
(i) The Trade date was 26th February 2002.
(ii) The
Payment Date was 27th February 2002.
(iii) The
Maturity Date was 21st June 2002.
(iv) The
Nominal Amount was £174,040,400.
(v) The underlying market was the June 2002 Futures
Contract of the FTSE 100 Index (“the Exchanged Traded Contract.”)
(vi) Counterparty
A was KBIM.
(vii) Counterparty
B was Quoform.
(viii) The upfront amount was £115,000 payable by
Quoform to KBIM.
(ix) Futures
Price was 5143.4.
(x) The
Initial price was 5140.
(xi) The market was the London International Financial
Futures Exchange.
The Settlement terms were
as follows:-
(xii) The Settlement Price was the Official
Settlement Price of the Exchange Traded Contract as published by the London
Stock Exchange at the Valuation Time on the earlier of the Maturity Date or the
Early Termination Date.
(xiii) The Cash Settlement Amount was {Nominal
Amount x (the difference between the Settlement price and the Futures Price
divided by the Initial Price} plus an additional amount.
(xiv) If the Cash Settlement Amount was positive
KBIM would make a payment to Explainaway. If negative, Explainaway would make
a payment to KBIM.
43. On 26th
February 2002 Parastream gave irrevocable instructions to KBIM to acquire an
over the counter (OTC) short position over a notional value of c. £174
million. The underlying market was the June 2002 Futures Contract of the FTSE
100 Index. The counter party was KBIM (“the Parastream Short Contract”). The
key terms were as follows:-
(i) The
Trade date was 26th February 2002.
(ii) The
Payment Date was 27th February 2002.
(iii) The
Maturity Date was 21st June 2002.
(iv) The
Nominal Amount was £174,040,400.
(v) The underlying market was the June 2002 Futures
Contract of the FTSE 100 Index (“the Exchanged Traded Contract.”)
(vi) Counterparty
A was KBIM.
(vii) Counterparty
B was Parastream.
(viii) The upfront amount was £77,240 payable by
Parastream to KBIM.
(ix) Futures
Price was 5137.70.
(x) The
Initial price was 5140.
(xi) The market was the London International
Financial Futures Exchange – this being a June 2002 Futures Contract of the
FTSE 100 Index (“the Exchange Traded Contract.”)
The Settlement terms were
as follows:-
(xii) The Settlement Price was the Official
Settlement Price of the Exchange Traded Contract as published by the London
Stock Exchange at the Valuation Time on the earlier of the Maturity Date or the
Early Termination Date.
(xiii) The Cash Settlement Amount was {Nominal
Amount x (the difference between the Settlement price and the Futures Price
divided by the Initial Price}.
(xiv) If the Cash Settlement Amount was positive
KBIM would make a payment to Explainaway. If negative, Explainaway would make
a payment to KBIM.
44. Parastream gave
irrevocable instructions to KBCI to purchase the appropriate number of
contracts of June 2002 FTSE LIFFE futures at market to open a long position in
a notional value size of c. £174 m (“the Parastream Long Contract”).
45. On 26th
February 2002 Quartfed gave irrevocable instructions to KBCI to sell the
appropriate number of contracts of the June 2002 FTSE 100 LIFFE futures at
market to open a short position equivalent to the notional amount of £174
million (“the Quartfed Short Contract”). The counterparty was KBCI. The
associated cost to Quartfed of entering into the transaction was £33,020.
46. As at 7th
June 2002, the Quoform Long Contract was standing at a loss. On 7th
June 2002 Quartfed entered into a tripartite novation agreement with Quoform
and KBIM under which Quoform paid Quartfed to acquire the Quoform Long Contract
in consideration of £8,715,564.
47. Parastream gave
irrevocable instructions on 7th June 2002 to close the Parastream
Long and Short Contracts. The contracts were settled on 10 June 2002. On 13th
June 2002 £8,599,802 was credited to Parastream’s bank account 01A/CV/060493/01
and £8,600,440 debited to the same account.
48. Quartfed gave
irrevocable instructions to KBIM on 7th June 2002 to close the
Quoform Long Contract. The contract was settled on 10 June 2002. On 13th June
2002 £8,600,564 was debited to its bank account 01A/CF/060491/01.
49. Quartfed gave
irrevocable instruction to KBCI on 7th June to close the Short
Contract by acquiring 3886 of contracts of June 2002 FTSE LIFFE futures at
market. On 13th June 2002 £8,600,440 was credited to its bank
account 01A/CF/060491/01.
50. On 20th
June 2002 the directors of Quartfed Limited resolved “That…an interim dividend
amounting to £8,550,000…is hereby declared payable forthwith to the
shareholders registered in the books of the Company at the close of business on
19th June 2002”. Also on 20th June 2002 the sum
of £8,550,000 was debited to Quartfed’s Collateral Call Deposit account with
KBIM numbered 01A/CF/060491/01 with the description “TO EXPLAINAWAY LIMITED”.
51. On 20 June 2002, £1
share in Quartfed Limited was transferred to Paul Rackham (Jnr).
52. On 20th
June 2002 Paul Rackham Jnr by deed declared that he held one ordinary £1.00
share in Quartfed Limited as nominee for the directors of Explainaway.
53. On 20th
June 2002 the directors of Quartfed Limited passed the following resolution as
a special resolution:
‘1.
That the Company be re-registered as an unlimited company.
2. That
the name of the Company be changed to Quartfed.
3. That the Memorandum and Articles of Association
be amended to state that the Company is an unlimited liability company and as
necessary to conform in all requirements to be accepted under the Companies Act
Regulations 1985.
4. That the attached new Memorandum and Articles of
Association be adopted.’
54. On 21st
June 2002 the Members of Quartfed passed a Special Resolution ‘That £8,865,001
Ordinary £1 shares be now redeemed at par.’
55. On 21st June
2002 Quartfed redeemed £8,865,001 Ordinary £1.00 shares at par.
56. On 24th
June 2002 the directors of Quartfed resolved “That… an interim dividend
amounting to £41,798…is hereby declared payable forthwith to the shareholders
registered on the books of the Company at the close of business on 23rd
June 2002”. On 24th June 2002 the sum of £8,906,798.63 was
debited to Quartfed’s Collateral Call Deposit account with KBPB numbered
01A/CF01A/CF/060491/01 with the description “TRF TO EXPLAINAWAY LIMITED.
57. On the 20th
June 2002 Explainaway paid £8,550,000 to KBIM and on 24th June
£8,850,000, repaying in full the loan drawn down by it on 25th
February 2002.
58. On 20th
December 2002 Explainaway sold Quoform to Mr & Mrs Austin for £10. Mr and
Mrs Austin are not connected with any of the persons involved in this appeal.
Witness evidence
9. From
the witness evidence we find the following further material facts.
10. In the latter
part of 2000, Mr Stuteley and Mr Michael Fulcher, a chartered accountant and
retired partner of BDO Stoy Hayward, were requested by the board of PRL to
address the tax implications of a possible sale of part of PRL’s holding of
shares in WRG. They met Mr Atterbury and one of his colleagues of Deloitte
& Touche on 29 January 2001. At that meeting a capital gains tax
mitigation plan known as a “Company Derivative Plan” was explained to them, in
the following way:
(1)
PRL would form a new subsidiary (subsequently, Explainaway) using debt
and equity, and the subsidiary would buy the WRG shareholding from PRL with its
accrued gain.
(2)
The subsidiary would sell the asset and repay its debts before buying
two futures. One future would produce a loss and the other a profit, but the
quantum and timing was unknown.
(3)
It was hoped that one of the contracts would be closed prior to the
financial year end (to be 31 December 2001) with the aim of creating a loss
equal to the capital gain on the sale of the WRG shares. Any additional profit
on the second contract would be offset by taking out a further future.
(4)
The subsidiary would then be sold to a third party capital loss company
which could shelter the gain.
11. We find it
convenient to describe this first proposal as Plan A.
12. Mr Stuteley
described the “material” or “significant” risks that were outlined by Deloitte
& Touche and understood by Mr Stuteley and Mr Fulcher. We find that these
were the ability to find a suitable capital loss company (in the event, there
was no such sale to a capital loss company) and the risk that the futures would
not generate the required gains and losses if the market did no achieve the
necessary movement.
13. The proposal
document itself explains Plan A in a little greater detail. The two futures
contracts to be initially acquired by the subsidiary were designed not to be
reciprocal for the purposes of s 143(5) TCGA, but would produce corresponding
gains and losses on a predetermined movement in the FTSE. Effectively, the
proposal was for broadly matching (though not equal and opposite) contracts,
one long and one short, to be entered into, with the aim that a FTSE movement
(in whatever direction) would give rise to a loss on one, substantially matched
by a gain on the other. Once sufficient putative loss had arisen on one of the
contracts, that contract would be closed out, with the aim of giving rise to an
allowable loss to shelter the gain in the subsidiary on the sale of the WRG
shares. The potential corresponding gain on the other contract would be locked
in by the acquisition of another future, and that gain would in turn be sought
to be sheltered by a sale of the subsidiary to a capital loss company.
14. We find that,
although there was a risk that there would be insufficient movement on the FTSE
in the relevant period so that the full amount of the loss sought to be
generated might not arise, and that since the amount of the loss depended
entirely on movement in the FTSE there was nothing that Explainaway or any
other person could do to engineer or affect the position, there was no, or no
material, risk that no loss at all would be generated. It was inevitable that
there would be some movement in the FTSE in the relevant period. The amount of
the loss was simply a question of the timing of the closing out of one of the
contracts. We find that one or other of the contracts was bound to be closed
out at some stage in the relevant period, either when the desired amount of
loss had crystallised on one of the contracts, or at a time when some lesser
loss had arisen, but it was determined that no further risk should be taken of
the FTSE moving in a way that would reduce the loss.
15. The Deloitte
& Touche proposal concludes:
“In the final analysis it would seem that the actual
consequence of entering this type of transaction will be confined to the
professional costs and the cost paid for loss utilisation.”
We find that under Plan A there was no exposure to any
real financial loss. The only risk was that the scheme would not generate
sufficient allowable losses within the period so as to eliminate the whole of
the subsidiary’s (that is, in the event, Explainaway’s) liability to
corporation tax on its chargeable gain.
16. Plan A was put
into effect as described in the statement of agreed facts. Explainaway bought
the WRG shares from its parent company, PRL, for consideration left
outstanding. As that was an intra-group transfer, no chargeable gain arose to
PRL; Explainaway inherited PRL’s base cost for capital gains purposes. Explainaway
then sold those shares into the open market (at a commercial loss to itself,
but thereby triggering the capital gain on the shares) and repaid to PRL a
large part of the outstanding purchase price. Explainaway then, on 17 July
2001, acquired an over the counter (OTC) long derivative contract and sold a
short derivative contract. Each was a standard International Swaps &
Derivatives Association (ISDA) contract (master agreement) and each had a
notional value of £174 million. Both contracts were to mature on 15 March
2002, and overall the two contracts would (because they were not entirely equal
and opposite) produce a small gain or loss.
17. The 17 July 2001
Long Contract was closed out on 6 September 2001 at a loss of £8.8 million. A
further long position, locking in the chargeable gain on the 17 July 2001 Short
Contract, was entered into on the same date. It was that chargeable gain that
Plan A envisaged would be sheltered by selling Explainaway to a capital loss
company.
18. Deloitte &
Touche engaged in negotiations with possible capital loss companies, but became
concerned at the level of fees sought by, and the commitment of, those companies.
A meeting was held on 12 September 2001, at which possible amendments to the
plan were discussed. This was followed by a letter from Deloitte & Touche
to Mr Stuteley of 22 October 2001 in which D&T refer to an “interim offer”
received from a company, Northgate Plc, which had sufficient losses to cover
the capital gains on the 17 July 2001 short contract. Mr Stuteley was advised
by this letter that, subject to negotiation on the level of fees sought by
Northgate, “we do not appear at this stage to be too far away from agreement”.
19. The 22 October
letter also sets out details of an extended scheme which had been discussed
with Mr Stuteley at the September meeting. This extended scheme, with
modifications, which we shall refer to as Plan B, was what was subsequently
implemented.
20. The letter goes
on to summarise the position at that time. Explainaway had through Plan A
generated a loss sufficient to cover the gain on the WRG shares. There would
be a corresponding gain on the 17 July 2001 Short Contract. An offer had been
received (from Northgate) for the purchase of Explainaway, which might prove
acceptable, and it was considered that this should deal with the gain on the
short contract. Plan B could proceed. For this to succeed in full, there
would need to be a loss of £8.7 million generated, which would require a
movement of around 3% in the FTSE. Because of concerns as to possible
legislative changes, it might be the case that the relevant contract would have
to be closed out by 31 December 2001. However, if it appeared that the new
legislation would not adversely affect the contracts in question, closing out
could possibly be deferred until after that time, up to the end of
Explainaway’s own accounting period.
21. The letter also
makes clear that the result of Plan B was dependent on factors outside the
control of the companies and Deloitte & Touche, namely the question of the
movement of FTSE and the draft legislation. We find in respect of the FTSE
movement that the risk was again on the quantum of the loss. There was no, or
no material, risk that no loss at all would be obtained.
22. In early
November 2001 Mr Stuteley was advised that Northgate plc were seeking increased
fees. Although the board was aware of the commercial risk that Plan B would
not produce the required loss (and matching gain) by the maturity date of the
new derivatives to be acquired, Plan B was adopted, with certain modifications,
including the introduction of a guarantee company (this became Parastream) and
a further bank.
23. There was some
delay in implementation, largely due to certain Financial Services Act issues.
The derivatives were entered into on 26 February 2002 by each of Quartfed,
Quoform and Parasteam. Those contracts were standard ISDA contracts each with
a maturity date of 21 June 2002. These transactions were financed by
Explainaway having, on 25 February 2002, borrowed £17.4 million from KBIM
Limited to pay for shares subscribed in Quartfed and Quoform. On 26 February
2002 Explainaway closed its 17 July 2001 short and 6 September 2001 long
positions realising a net gain of £8.7 million.
24. The Quoform Long
Contract and the Quartfed Short Contract were broadly (but not exactly) equal
and opposite in their effect in relation to their relative values to each other.
Any movement on the FTSE index from the nominated futures price would give rise
to a loss on one contract, largely matched by a corresponding gain on the
other.
25. The evidence of
Mr Stuteley was that, over the ensuing three to four months, staff at Deloitte
& Touche provided him with regular updates on the movement of the FTSE 100
Liffe index. He and his fellow directors were aware that there was what he
described as a “real and material commercial risk” that the index would not
produce the requisite movement by the maturity date which would make the whole
or at least a part of the planning ineffective. Mr Stuteley referred in his
evidence to an e-mail dated 27 April 2007 (so some time after the events in
question) from Mr Atterbury, which summarises the movements in the FTSE index
between March and June 2002. This shows, as might be expected, movements
upwards or downwards on almost all days. Due to these fluctuations, the
potential amount of losses and gains on the Plan B contracts fluctuates upwards
and downwards. As the e-mail describes, until the index moved significantly in
one direction (downwards) after 27 May 2002, the contracts would not have
produced the full hoped-for amount of loss to shelter the gain on Explainaway’s
17 July 2001 short contract, although there were occasions when a material loss
(and corresponding gain) would have been generated if the contracts had been
closed at that time, such as on 22 February 2002, when the amount of the loss
and gain would have been in excess of £6 million.
26. The reference to
risk in this evidence is essentially to the risk that, because of an inadequate
movement in the FTSE over the allotted period, the tax planning could have been
ineffective to produce the full amount of the loss required. We accept that
there was such a risk. However, the evidence of Mr Atterbury’s e-mail confirms
our finding that there was no, or no material, risk that no loss would be
obtained, and that the only risk was the amount of the loss that would, in the
event, be realised.
27. We do not accept
that, except in the broadest sense, the risk of the Appellant in this respect
was a commercial risk. The factor that gave rise to the risk, namely the
movement of the FTSE itself, is affected by economic and commercial influences,
but we find that the Appellant was exposed to no commercial risk as such, apart
from the fees it had to pay for the tax planning. Its risk that the tax
planning would not fully succeed in its aim was not a commercial risk.
Furthermore, it was a risk that the boards of the relevant companies were fully
aware of, and accepted, in their decision to proceed with the scheme.
28. Mr Atterbury’s
evidence was directed solely at the final step of Plan B, namely the sale of
the company that, in the event, would give rise to the allowable loss. That,
as Mr Atterbury described, depended on which of the two relevant companies,
Quartfed or Quoform, would realise that loss, and the quantum of the loss, both
of which, at the onset of Plan B, were at large. It made no sense for any
potential purchaser to be identified before the loss had crystallised.
29. Notwithstanding
this uncertainty, Mr Atterbury confirmed, and we find, that a small market of
potential purchasers existed. There was an expectation that the relevant
company would be capable of being sold.
30. In the event, it
was the value of the Quoform Long Contract that gave rise to a loss as a result
of the FTSE index movement. That contract was novated by Quoform to Quartfed,
with Quoform paying Quartfed £8,715,564 to accept the novation. Quartfed used
those funds to meet its inherited obligation on the Quoform Long Contract, and
itself closed out the Quartfed Short Contract so as to realise (broadly) an
equal and opposite (taxable) profit to the loss on the Quoform Long Contract.
31. The effect of
the obligation to meet the loss on the Quoform Long Contract depressed the
value of the shares in Quoform owned by Explainaway. Explainaway sold its
shares in Quoform to Mr and Mrs Austin, third party purchasers introduced by
Deloitte & Touche, for £10, and claimed an allowable capital loss of
£8,864,992 for the accounting period ended 31 December 2002, which is the
subject of this appeal.
The law
32. Section 2 TCGA contains
provision for the persons and gains chargeable to capital gains tax, and
allowable losses. So far as material, it provides:
“(2) Capital gains tax shall
be charged on the total amount of chargeable gains accruing to the person
chargeable in the year of assessment, after deducting—
(a) any allowable
losses accruing to that person in that year of assessment, and
(b) so far as they
have not been allowed as a deduction from chargeable gains accruing in any
previous year of assessment, any allowable losses accruing to that person in
any previous year of assessment (not earlier than the year 1965–66).”
33. A company is
subject to corporation tax on its chargeable gains. In this respect, s 8 TCGA
provides:
“(1) Subject to the
provisions of this section and section 400 of the Taxes Act, the amount to be
included in respect of chargeable gains in a company's total profits for any
accounting period shall be the total amount of chargeable gains accruing to the
company in the accounting period after deducting—
(a) any allowable
losses accruing to the company in the period, and
(b) so far as they
have not been allowed as a deduction from chargeable gains accruing in any
previous accounting period, any allowable losses previously accruing to the
company while it has been within the charge to corporation tax.
(2) For the purposes of
corporation tax in respect of chargeable gains, “allowable loss” does not
include a loss accruing to a company in such circumstances that if a gain
accrued the company would be exempt from corporation tax in respect of it.
…
(3) Except as otherwise
provided by this Act or any other provision of the Corporation Tax Acts, the
total amount of the chargeable gains to be included in respect of chargeable
gains in a company's total profits for any accounting period shall for purposes
of corporation tax be computed in accordance with the principles applying for
capital gains tax, all questions—
(a) as to the amounts
which are or are not to be taken into account as chargeable gains or as
allowable losses, or in computing gains or losses, or charged to tax as a
person's gain; or
(b) as to the time
when any such amount is to be treated as accruing,
being determined in accordance with the provisions
relating to capital gains tax as if accounting periods were years of
assessment.”
34. Section 143 TCGA
provides for gains and losses in the course of dealing in financial futures to
be within the scope of chargeable gains and losses. It provides:
(1) If, apart from section 128 of the Taxes Act,
gains arising to any person in the course of dealing in commodity or financial
futures or in qualifying options would constitute, for the purposes of the Tax
Acts, profits or gains chargeable to tax under Schedule D otherwise than as the
profits of a trade, then his outstanding obligations under any futures contract
entered into in the course of that dealing and any qualifying option granted or
acquired in the course of that dealing shall be regarded as assets to the
disposal of which this Act applies.
(2) In subsection (1) above—
(a) “commodity or financial futures” means
commodity futures or financial futures which are for the time being dealt in on
a recognised futures exchange; and
(b) “qualifying option” means a traded
option or financial option as defined in section 144(8).
(3) Notwithstanding the provisions of subsection
(2)(a) above, where, otherwise than in the course of dealing on a
recognised futures exchange—
(a) an authorised person ... enters
into a commodity or financial futures contract with another person, or
(b) the outstanding obligations under a
commodity or financial futures contract to which an authorised person ... is a
party are brought to an end by a further contract between the parties to the
futures contract,
then, except in so far as any gain or loss arising
to any person from that transaction arises in the course of a trade, that gain
or loss shall be regarded for the purposes of subsection (1) above as arising
to him in the course of dealing in commodity or financial futures.
(4) ...
(5) For the purposes of this Act, where, in the
course of dealing in commodity or financial futures, a person who has entered
into a futures contract closes out that contract by entering into another
futures contract with obligations which are reciprocal to those of the
first-mentioned contract, that transaction shall constitute the disposal of an
asset (namely, his outstanding obligations under the first-mentioned contract)
and, accordingly—
(a) any money or money's worth received
by him on that transaction shall constitute consideration for the disposal; and
(b) any money or money's worth paid or
given by him on that transaction shall be treated as incidental costs to him of
making the disposal.
(6) In any case where, in the course of dealing in
commodity or financial futures, a person has entered into a futures contract
and—
(a) he has not closed out the contract (as
mentioned in subsection (5) above), and
(b) he becomes entitled to receive or liable
to make a payment, whether under the contract or otherwise, in full or partial
settlement of any obligations under the contract,
then, for the purposes of this Act, he shall be
treated as having disposed of an asset (namely, that entitlement or liability)
and the payment received or made by him shall be treated as consideration for
the disposal or, as the case may be, as incidental costs to him of making the
disposal.
(7) Section 46 shall not apply to obligations under—
(a) a commodity or financial futures contract
which is entered into by a person in the course of dealing in such futures on a
recognised futures exchange; or
(b) a commodity or financial futures
contract to which an authorised person ... is a party.]1
(8) In this section “authorised person” means a
person who—
(a) falls within section 31(1)(a), (b)
or (c) of the Financial Services and Markets
Act 2000, and
(b) has permission under that Act to carry on
one or more of the activities specified in Article 14 and, in so far as it
applies to that Article, Article 64 of the Financial Services and Markets
Act 2000 (Regulated Activities) Order 2001.
35. It was accepted
that the derivative transactions subject to this appeal had to fall within the
scope of s 143 TCGA, and that to do so they must fall within s 128 of the
Income and Corporation Taxes Act 1988 (“ICTA”). Section 128, at the material
time, provided as follows:
“Any gain arising to any person in the course of
dealing in commodity or financial futures or in qualifying options, which is
not chargeable to tax in accordance with Schedule 5AA and apart from this
section would constitute profits or gains chargeable to tax under Schedule D
otherwise than as the profits of a trade, shall not be chargeable to tax under
Case V or VI of Schedule D.
In this section “commodity or financial futures” and
“qualifying options” have the same meaning as in section 143 of the 1992 Act,
and the reference to a gain arising in the course of dealing in commodity or
financial futures includes any gain which is regarded as arising in the course
of such dealing by virtue of subsection (3) of that section.”
36. We shall set out
the text of para 13, Sch 9, FA 1996, in the part of this decision where we
consider the issue of the relievability for corporation tax purposes of
interest costs incurred on borrowings taken out by Explainaway to effect the
relevant transactions.
Were the derivative transactions within the scope of TCGA?
37. Issue (1) is
concerned with the transactions in the derivatives themselves, in so far as
they are within the scope of this appeal. Primarily this concerns
Explainaway’s dealings, but it also covers the amendments made by closure
notices in respect of the corporation tax returns of Quartfed and Parastream.
It does not relate to the allowable loss claimed by Explainaway on the disposal
of the Quoform shares.
38. It is common
ground that the derivative transactions must fall within s 128 TA. That
requires that, but for that section, gains arising in the course of dealing
with the derivatives (in this case financial futures) would be chargeable under
Schedule D. In this case the Appellant says that the gains would have been
chargeable to tax under Schedule D, Case VI.
39. Mr Ghosh submitted
that the profits on the derivatives would all have been “annual profits and
gains not falling under any other Case of Schedule D” within s 18(3) ICTA.
They represent the result of speculative transactions by each of Explainaway,
Quartfed and Parastream (and, it may be noted, Quoform). It is accepted that
Explainaway hoped for a loss on one of the derivatives it took out in July
2001, and on one or other of the derivatives taken out by Quoform or Quartfed
in February 2002. But any loss arising out of one of those speculative
transactions would be matched by a profit on another derivative.
40. Mr Ghosh argued
that any such profit could not aptly be described as an accretion to capital;
the profit would arise as the result of the fluctuations of the FTSE index over
a period, which gives a constantly changing right to receive an amount of cash
or a fluctuating liability to pay an amount of cash.
41. Mr Ghosh relied
on Cooper v Stubbs 10 TC 29 and Townsend v Grundy 18 TC 140.
Each of those cases concerned speculative dealings in commodity futures, and in
each case it was found that the transactions were not the carrying on of a
trade, but that the profits arising from the transactions were annual profits
or gains assessable to income tax under Case VI of Schedule D. In Cooper v
Stubbs, it had been found by the special commissioners, firstly that the
speculation was not in the nature of a trade; that was a decision of fact with
which the majority of Court of Appeal declined to interfere. But secondly, the
special commissioners had found that the transactions were in truth gambling
transactions, and thus outside the scope of Case VI. The court (by majority) held
that on the evidence the transactions in question were real transactions,
giving rise to real contractual rights. It was plain that the transactions
were not mere bets; for there to be a bet there had to be two parties, both of
whom had entered into the wager. There was nothing to prevent the profits
arising from being annual profits or gains.
42. We have referred
in particular to Cooper v Stubbs, as it highlights an element of Mr
Gammie’s case as it was put to Mr Stuteley, namely that the decision to go
ahead with the scheme was a bet. For essentially the same reasons as the Court
of Appeal found in Cooper v Stubbs, we find that these transactions were
not gambling transactions. True it is that whether the full amount of the loss
would be crystallised could, in common parlance, be described as a gamble, but there
was no counterparty to a bet to enable that to be regarded as gambling or
wagering in the legal sense. The derivative contracts were real and
enforceable contracts, speculative in nature, with a third party bank.
43. Mr Gammie
submitted that the essential question in determining whether a receipt fell within
Case VI is whether, in the particular circumstances of the case, a cash receipt
or payment has the character of income. He argued that receipts and payments
of cash in transactions entered into without commercial motivation, and solely
as part of a self-cancelling tax planning strategy, could not properly be
characterised as “income profits” or “income losses” within Case VI, and were
instead simply receipts and payments of cash and no more. In support of this
submission he relied on a line of cases including FA & AB Lupton
[1972] AC 634, and on application of the Ramsay principle. We shall address
the Ramsay argument later; in this section we consider whether, leaving Ramsay
aside, the profits from the derivative transactions would fall within Case VI
of Schedule D.
44. In FA &
AB the appellant company was trading as a dealer in stocks and shares. It
entered into certain dividend-stripping transactions, including one under which
it purchased the whole of the share capital of a company, and received an undertaking
from the vendors that profits would be sufficient to pay a net dividend in a
certain amount. Those dividends were received, and the value of the company
diminished. The appellant company claimed a trading loss. It was held that
the transaction was not a share dealing transaction coming within the area of
trade of a dealer in shares. The shares in the company were not bought as
stock-in-trade of a dealer in shares but as pieces of machinery with which a
dividend stripping operation might be carried out.
45. What is made
clear in FA & AB is that, following Griffiths v J P Harrison
(Watford) Ltd [1963] AC 1, trading transactions do not cease to be such
merely because they are entered into in the hope of later taking advantage of
the revenue law by making a claim for recovery of tax (per Lord Morris of
Borth-y-Gest at p 646D). Motive does not alter or transform the essential and
factual nature of the transaction; it is the transaction itself and the form
and content which must be examined and considered (p 646G). The distinction
drawn in FA & AB was that, as in Finsbury Securities Ltd v IRC
[1966] 1 WLR 1402, certain fiscal arrangements were inherently and structurally
part of the transactions sought to be described as trading transactions In FA
& AB, the appellant company purchasing the shares gave an undertaking
to the vendors that they would make a “loss”. The vendors were directly and
financially interested in the result of the loss claim. These “truly strange”
arrangements were not, it was held, the arrangements of a trading transaction
of a dealer in shares (p 650D-F).
46. In relation to
this issue we are concerned only with the derivative transactions themselves.
Those transactions it seems to us were real transactions of a nature commonly
transacted in the market. There were no fiscal arrangements inherently and
structurally built into the derivative transactions themselves. Any claim for
a loss arose as a consequence of the result of those transactions, and was
separate from them. In this connection it is in our view of no consequence
that the derivative transactions were all in essence matched, nor that
settlement was by way of set-off. We find that there is nothing in FA &
AB that could lead to the conclusion that profits and losses on the transactions
were not of an income nature. Accordingly, and subject to the Ramsay
argument to which we shall now turn, as those transactions were not trading
transactions, the profits and losses were, but for s 128 ICTA, within Case VI
of Schedule D, and as a result the derivatives fell within the scope of s 143
TCGA.
Ramsay
47. Here we consider
the application of the Ramsay principle to both the losses on the derivative
transactions, and the loss on the disposal of the Quoform shares. In each case
the question is whether the losses that arose were allowable losses within the
scope of TCGA.
48. At its essence
the Ramsay principle is one of construction. The basic principles were
clarified by the House of Lords in Barclays Mercantile Business Finance Ltd
v Mawson (“BMBF”) [2005] STC 1, a case recently described by Mummery LJ in Revenue
and Customs Commissioners v Mayes [2011] EWCA Civ 407 as a significant
judicial stocktaking of the “new approach”. The position is summarised at
paragraphs 26 – 42 of the Appellate Committee’s unanimous report, from which we
extract what Lord Nicholls said at [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 statute, upon its true construction, applies to the facts as
found. As Lord Nicholls of Birkenhead said in MacNiven (Inspector of Taxes) v Westmoreland
Investments Ltd [2001] UKHL 6 at
[8], [2001] STC 237 at [8],
[2003] 1 AC 311:
'The paramount question always is one of
interpretation of the particular statutory provision and its application to the
facts of the case.'”
49. It is not simply
a case of disregarding transactions or elements of transactions which have no
commercial purpose. It is necessary, as Lord Nicholls describes at [36], to
decide, on a purposive construction of the statutory provision in question,
exactly what transaction will answer to the statutory description, and whether
the transaction in question does so. Lord Nicholls then refers, with approval,
to what Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd
[2003] HKCFA 46 (at [35]):
“[T]he 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.”
50. In Ramsay
itself the taxpayer acquired the whole of the issued shares of C Ltd. The
taxpayer offered and C Ltd accepted two loans (“loan L1” and “ loan L2”) to C
Ltd in the same amount, at the same interest rate of 4% and repayable at par
after 30 and 31 years respectively. Shortly thereafter, the taxpayer reduced
the interest on loan L1 to nil and increased the interest rate on loan L2 to
22%, and sold loan L2 to M ltd at a profit. Loan L1 was in due course, after
further loan and share transactions, repaid at par and the taxpayer incurred a
capital loss on the sale of the shares in C Ltd.
51. It was held by
the House of Lords that it was the task of the courts to ascertain the legal
nature of any transactions to which it was sought to attach a tax or tax
consequence and that if the legal nature was that which emerged from a series
or combination of transactions which were intended to operate as such, it was
the series or combination of transactions rather than the individual
transactions to which regard must be had. The courts are not limited to
considering the genuineness of each individual step or transaction in the
scheme, but can consider the scheme as a whole. If it is found that the scheme
was a composite transaction rather than a number of independent transactions
that produces neither a gain nor a loss, and does not appreciably affect the
taxpayer’s beneficial interest, it can be treated as a nullity for tax
purposes.
52. In respect of
pre-arranged, composite transactions of the nature under consideration in Ramsay,
Lord Wilberforce pointed out that this was not a new principle. It was simply
an application of the power and duty of the courts to determine the nature in
law of the transactions in question and to relate those transactions to
existing legislation. Lord Wilberforce then said (at p182a):
“To force the courts to adopt, in relation to
closely integrated situations, a step by step, dissecting, approach which the
parties themselves may have negated, would be a denial rather than an
affirmation of the true judicial process. In each case the facts must be
established, and a legal analysis made: legislation cannot be required or even
be desirable to enable the court to arrive at a conclusion which corresponds
with the parties' own intentions.”
53. Lord Wilberforce
went on the analyse the particular scheme in Ramsay and said (at p 183c-g):
“Of this scheme, relevantly to the preceding
discussion, the following can be said—
1. As the tax consultants' letter explicitly states
'the scheme is a pure tax avoidance scheme and has no commercial justification
in so far as there is no prospect of T [the prospective taxpayer] making a
profit; indeed he is certain to make a loss representing the cost of
undertaking the scheme'.
2. As stated by the tax consultants' letter, and
accepted by the Special Commissioners, every transaction would be genuinely
carried through and in fact be exactly what it purported to be.
3. It was reasonable to assume that all steps would,
in practice, be carried out, but there was no binding arrangement that they should.
The nature of the scheme was such that once set in motion it would proceed
through all its stages to completion.
4. The transactions regarded together, and as
intended, were from the outset designed to produce neither gain nor loss: in a
phrase which has become current, they were self cancelling. The 'loss'
sustained by Ramsay, through the reduction in value of its shares in Caithmead,
was dependent on the 'gain' it had procured by selling loan 2. The one could
not occur without the other. To borrow from Rubin v United States (1962) 304 F 2d 766 approving the Tax Court in MacRae v Comr of Internal
Revenue (1961) 34 TC 20 at 26, this
loss was the mirror image of the gain. Ramsay would not have entered on the
scheme if this had not been so.
5. The scheme was not designed, as a whole, to
produce any result for Ramsay or anyone else, except the payment of certain
fees for the scheme. Within a period of a few days, it was designed to and did
return Ramsay except as above to the position from which it started.
6. The money needed for the various transactions was
advanced by a finance house on terms which ensured that it was used for the
purposes of the scheme and would be returned on completion, having moved in a
circle.
On these facts it would be quite wrong, and a faulty
analysis, to pick out, and stop at, the one step in the combination which
produced the loss, that being entirely dependent on, and merely a reflection of
the gain. The true view, regarding the scheme as a whole, is to find that there
was neither gain nor loss, and I so conclude.”
54. In Ramsay
the question of statutory construction before the court was, as it is in this
case, concerned with the nature of gains and losses within the scope of capital
gains tax (and, we may add, corporation tax on chargeable gains). In that
regard Lord Wilberforce said (at p182b-c):
“The capital gains tax was created to operate in the
real world, not that of make-belief. As I said in Aberdeen
Construction Group Ltd v Inland Revenue Comrs [1978] 1 All ER 962,
[1978] AC 885, [1978] STC 127, it
is a tax on gains (or I might have added gains less losses), it is not a tax on
arithmetical differences. 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, 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.”
55. Where Ramsay
was, apart from the payment of fees, an example of a self-cancelling series of
transactions where the taxpayer ended up back where it started (but with a
claim for an allowable capital loss), Furniss v Dawson [1984] STC 153
concerned a pre-ordained series of transactions which had a legitimate
commercial end, namely the sale of shares in certain operating companies. But there
were steps inserted into the series of transactions that had no commercial or
business purpose apart from the avoidance of liability to tax. It was held
that those steps could be disregarded for tax purposes.
56. In reaching this
judgment the House of Lords applied Ramsay. Lord Fraser held that,
whilst the cases differed in that Ramsay was self-cancelling and in Furniss
v Dawson the scheme had what Vinelott J in the High Court had described as
“enduring legal consequences” (see [1982] STC 267 at p288), that was not a
sufficient ground for distinguishing Ramsay. The true principle of the
decision in Ramsay was that the fiscal consequences of a pre-ordained
series of transactions, intended to operate as such, are generally to be
ascertained by considering the result of the series as a whole, and not by
dissecting the scheme and considering each individual transaction separately
(see the speech of Lord Fraser at p155e).
57. The leading
speech in Furniss v Dawson was given by Lord Brightman, with whom all
the other law lords agreed. However, in the recent Supreme Court decision in Revenue
and Customs Commissioners v Tower MCashback LLP 1 and another [2011] UKSC 19 (which was released after the hearing of this appeal, and in respect of
which we did not receive any submissions), Lord Walker described Lord
Brightman’s opinion, in which he had appeared to lay down a detailed and fairly
inflexible prescription of how the Ramsay principle works, as one of
those decisions after Ramsay that in his view had rather obscured the
clarity of Lord Wilberforce’s insight in Ramsay itself. Lord Walker
said (at [43]):
“The need to recognise Ramsay as a principle
of statutory construction, the application of which must always depend on the
text of the taxing statute in question, was clearly recognised in Craven v
White [1989] AC 398: see especially, in the House of Lords, Lord Keith of
Kinkel at p 479 and Lord Oliver of Aylmerton at pp 502-503. The House was split
three-two, the dissenters being Lord Templeman and Lord Goff of Chieveley, who
gave the only two full opinions in the House of Lords’ unanimous decision in Ensign
four years later. The drawing back from the rigidity of Furniss v Dawson was continued by the important decisions in Inland Revenue Commissioners v
McGuckian [1997] 1 WLR 991 (discussed by Lord Hoffmann in MacNiven at
paras 51 to 57) and MacNiven itself. There are also many helpful
insights in the judgments in the Court of Final Appeal of Hong Kong in Collector
of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46.”
58. In Craven v
White [1989] AC 398 the House of Lords considered the nature and scope of
the principle that had emerged from Furniss v Dawson as an advance from
what had been laid down in Ramsay. The case concerned three appeals by
separate taxpayers, including IRC v Bowater Property Developments Ltd
and Baylis v Gregory along with Craven v White itself. In Craven
v White the taxpayers owned shares in Q Ltd. In early 1976 they began to
negotiate with C Ltd for a merger of the two companies and steps were taken to
establish an Isle of Man holding company to act as a vehicle for the taxpayers’
shares should the merger materialise. Later in that year the taxpayers were
approached regarding the possibility of a sale of Q Ltd to J Ltd. The merger
negotiations with C Ltd ceased during negotiations to sell Q Ltd. Later, amid
fears that the sale to J Ltd would not materialise, those merger talks were resumed
and M Ltd, an Isle of Man company, was incorporated. However, talks then
started up again with J Ltd, and the taxpayers exchanged their shares in Q Ltd
for shares in M Ltd. Following further negotiation, J Ltd purchased the shares
in Q Ltd from M Ltd.
59. On appeal by the
Crown to the House of Lords, by a majority (Lord Keith of Kinkel, Lord Oliver
of Aylmerton and Lord Jauncey of Tullichettle; Lord Templeman and Lord Goff of
Chieveley dissenting as regards Craven v White), it was held that in
determining whether a number of transactions of which at least one (the
intermediate transaction) had no purpose other than tax avoidance should be
treated for fiscal purposes not as independent but as forming part of one
composite linear transaction from which tax consequences flowed within the
Ramsay principle, as extended by Furniss v Dawson, it had to be shown,
for the principle to be applicable, that:
(1)
the series of transactions in question was, at the time when the
intermediate transaction was entered into, pre-ordained in order to produce a
given result;
(2)
the series of transactions had no purpose other than tax mitigation;
(3)
there was at that time no practical likelihood that the pre-ordained
events would not take place in the order ordained, so that the intermediate
transaction was not even contemplated practically as having an independent
life; and
(4)
the pre-ordained events did in fact take place. On this basis, the
majority held that the share exchange in Craven v White could not be
disregarded and that the Crown’s appeal was dismissed.
60. A critical
factor in Craven v White was the extent to which transactions had to be
pre-ordained in order not to constitute a composite whole. The view of the
majority was encapsulated by Lord Oliver (at p516H – 517D):
“Another identifying feature is that all the stages
of what is claimed as the composite transaction are pre-ordained to take place
in an orchestrated sequence and, in my opinion, that must mean more than simply
'planned or thought out in advance'. It involves to my mind a degree of
certainty and control over the end result at the time when the intermediate
steps are taken. That does not, I think, mean absolute certainty in the sense
that every single term of the transaction which ultimately takes place must
then be finally settled and agreed. But it does seem to me to be essential at
least that the principal terms should be agreed to the point at which it can be
said that there is no practical likelihood that the transaction which actually
takes place will not take place. Nor is it sufficient, in my opinion, that the
ultimate transaction which finally takes place, though not envisaged at the
intermediate stage as a concrete reality, is simply a transaction of the kind
that is then envisaged, for the underlying basis of the Ramsay doctrine
is that it must, on the facts, be possible to analyse the sequence as one
single identifiable transaction and if, at the completion of the intermediate
disposition, it is not even known to whom or upon what terms any ultimate
disposition will be made, I simply do not see how such an analysis is
intellectually possible. It is an essential part of the analysis that there is
but one disposal and not two and that the transfer to the intermediate company
is not a 'disposal' within the meaning of the statute.”
61. Lord Oliver had
earlier referred (at p515B) to the need for the end result of the scheme to be
“so certain of fulfilment that it is intellectually and practically possible to
conclude that there has indeed taken place one single and indivisible
process”. An essential part of the analysis required in Craven v White
was whether there was only one disposal (ignoring the intermediate share
exchange) and not two, and that the share exchange was not a “disposal” within
the meaning of the statute. Lord Oliver held that, on the facts in Craven v
White, on no analysis could it be said that at the stage of the share
exchange, when two mutually exclusive sets of negotiation were in progress,
there was a pre-ordained series of transactions, for it was not even known what
the ultimate transaction would be, if it eventuated at all.
62. Lord Oliver
expressly rejected a wider view of Furniss v Dawson that would interpret
“pre-ordained” as simply preconceived or planned to take place in the future,
and that intermediate transactions should be construed as part of, and
indivisible from, the ultimate disposition whether or not, at the time of the
transaction in question, the ultimate disposition was certain, uncertain, or
merely hoped-for. The test in Ramsay is whether realistically, in
looking at all the circumstances as a whole, those transactions constitute a
single and indivisible whole and whether it is intellectually possible so to
treat them.
63. Craven v
White was distinguished in IRC v Scottish Provident Institution
[2005] STC 15. In that case a scheme had been devised to take advantage of a
proposed new regime for taking advantage of a proposed new regime for taxing
derivative contracts based on gilts and bonds. Two options (option A and
option B) were granted; option A from SPI to C plc, and option B from C plc to
SPI. Both options were exercised on the same day, and SPI claimed a loss, even
though all sums due were netted off and neither stock nor money changed hands.
The special commissioners allowed SPI’s appeal, and held that options A and B,
along with a collateral agreement, could not be regarded as a single composite
transaction since there were various circumstances in which the options might
not be exercised together and the collateral agreement consisted of a genuine
loan or deposit whose purpose was to provide C plc with security and to remove
the incentive for C plc to exercise option A only. The Court of Session had
upheld the special commissioners’ decision.
64. It was held by
the House of Lords that it would destroy the value of the Ramsay principle of
statutory construction if the composite effect of transactions 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. 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. The uncertainty in SPI arose from the fact that the parties
had carefully chosen to fix the strike price for the option B at a level which
gave rise to an outside chance that the option would not be exercised. There
was no commercial reason for choosing that strike price.
65. SPI
relied upon the “no practical likelihood” test from the speech of Lord Oliver
in Craven v White to which we have referred. However, Lord Nicholls,
giving the opinion of the House of Lords, pointed out that in Craven v White
important parts of what was there claimed to be a single composite scheme did
not exist at the relevant date. No composite transaction had been put
together. In SPI, by contrast, the uncertainty arose from the fact that
the parties had chosen the particular strike price. Lord Nicholls concluded:
(at [22]):
“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.”
66. In Astall and
another v Revenue and Customs Commissioners [2010] STC 137 the taxpayers
had entered into the tax avoidance schemes designed to generate a loss from the
discount on a deep gain security. The terms of issue of the securities
included a condition (“the market change condition”) which if satisfied would
enable the holder to transfer the security to a third party and the third party
could redeem the security at 5% of its issue price or redeem after 65 years.
No steps were taken to identify a purchaser until after the securities were
issued. The market change condition occurred and the securities were
transferred to a bank purchaser. The taxpayers claimed relief for the loss on
the transfer of the securities.
67. In the Court of
Appeal it was held that the mere fact that the parties intended to obtain a tax
advantage was not of itself enough to make a statutory relief inapplicable. However,
no account should be taken of artificially contrived possibilities that were
irrelevant to the transaction. The transaction, viewed realistically, had as
its primary objective the devaluation of the security in order to create a tax
loss. The finding of the special commissioner that a purchaser of the
securities was a practical certainty could not be challenged.
68. In her judgment Arden
LJ posed the question whether a purposive interpretation of the relevant
statutory provisions was possible. She said (at [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.”
69. In looking at
the second stage of the process of construction Arden LJ referred to SPI
and said (at [49]):
“It is clear from SPI, in
particular [23] (set out in para [32] of this judgment), that the court should
not at the second stage of purposive interpretation assume that the insertion
of a condition that has a real possibility of operating is necessarily relevant
to the transaction. Here, the special commissioner's finding that the parties
were willing to take the risk of the market change condition not occurring
means that for practical purposes that risk could be ignored. The transaction,
viewed realistically, had as its primary objective the devaluation of the
security in order to create a loss for income tax purposes.”
70. Griffin v
Citibank Investments Ltd [2000] STC 1010 concerned put and call options
which, subject to the argument that the options constituted a single composite
transaction (and that the options transactions were a loan), would have fallen
within s 143 TCGA as qualifying options. The return on the options was linked
to the FTSE 100 index such that a greater or lesser amount would be payable on
the exercise of the call option and the put option respectively depending on
the FTSE 100 index movement. However, the combined amount payable to the
taxpayer company on simultaneous exercise of the options would always be a
predetermined sum consisting of the purchase price and an additional amount.
The taxpayer had capital losses and the aim of the transactions was to realise
a capital gain.
71. The special
commissioners allowed the taxpayer company’s appeal, holding that the two
option contracts did not constitute a composite transaction. There had been no
artificial steps which could subsequently be disregarded for tax purposes.
They also found, as a matter of fact, that there was always the possibility
that one option could have been assigned before exercise (with the consent of
the counterparty – a member of the taxpayer’s group) and that each option did
have an independent existence. The Revenue’s appeal was dismissed in the High
Court. Given the finding of the special commissioners that one option could
have been assigned before exercise, it could not be said that there was no
practical likelihood that the pre-planned events would not take place.
72. Before the
judge, Patten J, the Revenue argued that, in finding that there was always a
possibility that an option could be assigned before exercise, and thus that
each option had an independent existence, the special commissioners had failed
to answer the question whether there was no practical likelihood that the
pre-planned events would not have taken place in the order ordained. Although
whichever option had been deep in the money could have been assigned, this was
no more than a theoretical possibility. Mr Justice Patten did not accept
this. Furthermore, he held that even if the two options were a composite
transaction, then – like the loans in Ramsay – they would nonetheless
retain their individual identity as part of a larger transaction.
Consolidation of the put and call options into a single composite transaction
would make no difference to its legal effect. The composite transaction could
not be converted into something different from its legal nature.
73. We were referred
to the judgments of the Court of Appeal in Mayes, to which we made brief
reference earlier. That case concerned a scheme involving the purchase by a
non-resident company of non-qualifying life assurance policies and the payment
of additional premiums, followed, very shortly afterwards, by their partial
surrender and a withdrawal of funds. The issue was whether, as the special commissioner
found, the additional payment of premiums and the partial surrender were to be
disregarded, applying the Ramsay principle, as a single composite scheme to
which the relevant statutory provisions could have no application, or whether,
as Proudman J had decided in the High Court, the tax avoidance purpose and
self-cancelling nature of the steps did not mean that those steps should be
disregarded, when there was nothing in the statutory provisions in question
indicating or contemplating that, as a matter of construction, such steps were
not to count.
74. Dismissing
HMRC’s appeal from Proudman J, Mummery LJ, with whom Thomas and Toulson LJJ
agreed, said (at [78]):
“… it would be an error, which the judge did not
fall into, to disregard the payment of a premium at Step 3 and the partial
surrender at Step 4, simply because they were self-cancelling steps inserted
for tax advantage purposes. It was right to look at the overall effect of the
composite of the composite Step 3 and Step 4 in the seven step transaction in
the terms of ICTA to determine whether it answered to the legislative
description of the transaction or fitted the requirements of the legislation
for corresponding deficiency relief. So viewed, Step 3 and Step 4 answer the
description of premium and partial surrender. On the true construction of the
ICTA provisions, which do not readily lend themselves to a purposive commercial
construction, Step 3 was in its legal nature a withdrawal of funds in the form
of a partial surrender within the meaning of those provisions. They were
genuine legal events with real legal effects. The court cannot, as a matter of
construction, deprive those events of their fiscal effects under ICTA because
they were self-cancelling events that were commercially unreal and were
inserted for a tax avoidance purpose in the pre-ordained programme …”
75. The basis for
this conclusion was Mummery LJ’s finding (at [77]) that on the proper
construction of the ICTA provisions for the taxation of life policies, the
statutory requirements as to the transactions to which the provisions were
intended to apply were far removed from the kind of case, such as Ramsay,
in which the focus is on an end result, such as a loss. What Mayes
emphasises therefore is the need to consider the legal analysis of the
transactions in the context of the proper construction of the statutory
provisions at issue.
Discussion
76. In this appeal
we are concerned with the application of two particular statutory provisions,
namely, in relation to the derivative transactions, s 128 ICTA and, in relation
to both the derivative transactions and the sale of the Quoform shares, s 2
TCGA. In each case, in contrast to what was found in Mayes, those
provisions are concerned with an end result, namely a profit or gain, or a
loss. In the case of s 2 TCGA, it is clear from Ramsay that, applying a
purposive construction, the transaction in question must give rise to a real
loss, and not merely an arithmetical difference.
77. We find that the
same analysis should be applied to s 128 ICTA, and that the reference in that
section to profits and gains chargeable to tax under Schedule D otherwise that
as the profits of a trade, and in this case therefore the requirement that the
profits and gains on the derivative transactions be within Case VI of Schedule
D, are properly construed as referring to real profits and gains. This is not
a case, such as Mayes, where the statutory provisions do not admit of a
purposive commercial construction.
78. We turn
therefore to the issue whether the losses incurred by Explainaway, in the first
place on the disposal of the 17 July 2001 Long Contract, and secondly on its
disposal of the shares in Quoform, were losses within the relevant statutory
provisions.
79. Mr Gammie
invited us to conclude that the disposal of the 17 July 2001 Long Contract was
part of a self-cancelling, and composite, transaction which included the 17
July 2001 Short Contract and the acquisition by Explainaway of the 6 September
2001 Long Contract, which had locked in the gain on the Short Contract. Mr
Ghosh argued that the 17 July 2001 Short Contract could not aptly be described
as part of any sort of self-cancelling scheme when viewed alongside the 17 July
2001 Long Contract. The Short Contract remained in existence well after the
July Long Contract was closed out. Explainaway put itself into a position
where it hoped for a loss on one or other of the July Long Contract or the
Short Contract (which would give rise to a broadly corresponding gain on the
other) without any reassurance that any such loss would arise or that the
quantum of the loss would be sufficient to reduce the chargeable gain on the
WRG shares to any material extent.
80. Mr Ghosh argued
that there was no transaction (composite or otherwise) which gave rise to the
loss on the 17 July 2001 Long Contract on 6 September 2001. There were, he
submitted, no transactions that were “designed” to give rise to a loss. The
derivatives could not be so designed. The loss was a result of the movement in
the FTSE index, and nothing more. Any loss on either of the derivatives arose
out of an event that was not a transaction at all, and was outside the control
of any party. He submitted further that the Ramsay principle has never been
applied to deny such a loss. The movement in the FTSE index which allowed Explainaway
to realise a loss on the 17 July 2001 Contract is no part of any composite
transaction within Ramsay.
81. Mr Ghosh
accepted, on the basis of SPI, that a composite transaction designed to
yield a tax loss while leaving the parties whole is not prevented from being
viewed as such by the insertion of self-imposed artificial contingencies; a
scheme consisting of a composite transaction ignores such artificial
contingencies. But, he submitted, there is no “scheme” here which produces a
loss. Rather the “scheme” (if so described) put Explainaway into a position
where it might (or might not) realise a loss. The movement in the FTSE index,
argued Mr Ghosh, cannot be described as part of the “scheme” as it cannot be
described as part of a composite transaction.
82. We have found as
a fact that in this case the prospect of the scheme not producing a loss is so
remote that it can be disregarded. Any movement in the FTSE index would have
produced a loss. The only question was the quantum of the loss and the time at
which it would be decided that the loss would be crystallised. The movement in
the FTSE index which created the loss was part of the scheme and of the
composite transaction, and it was so even though the precise amount of that
movement could not be predicted. It is enough that movement could be predicted
so that there was no practical likelihood that no loss, in the relevant period,
would arise on one or other of the July 2001 derivatives. Thus, in our view,
the movement in the FTSE index cannot be characterised as an external feature
segregated from the derivative transactions; it was a key feature of the terms
of the derivatives. Accordingly, the movement in the FTSE index was part and
parcel of the overall scheme that was Plan A, even though its result in terms
of the amount or timing of the loss could not be predicted.
83. It is of no
consequence, in our view, that at the outset it could not be said which of the
two derivatives (the 17 July 2001 Long Contract and the 17 July 2001 Short Contract)
the loss would be realised. That depended on the way in which the FTSE index
moved, but what was certain, as we have found, was that during the period in
question a loss would arise on one or other of those derivatives. That is not,
in our view, any sort of contingency of a nature that could prevent the application
of the Ramsay principle.
84. In particular,
having regard to the reliance placed by Mr Ghosh on Craven v White, it
is not of the nature of the uncertainties which prevented Ramsay from
applying in that case. There, in the case of a linear transaction involving A
– B - C it was necessary for a certain transaction to be identified between B
and C as the end result at the time of the intermediate transaction between A
and B so that, if that intermediate transaction were ignored, a real
transaction between A and C could be found as the transaction to which the
statutory provisions should be applied. The same degree of precision or
certainty is not required when one is required to consider the proper tax
analysis of a consequence of a transaction, such as a loss. If the making of a
loss is pre-ordained, leaving out of account immaterial risks which the parties
themselves chose to accept, then the fact that there are two possible ways of
realising the loss, but which of the two it will be is not known, and that the
amount of the loss is uncertain, does not represent a bar to reaching the
conclusion that it is intellectually possible, to use Lord Oliver’s formulation
in Craven v White, to treat the transactions as a single and composite
transaction.
85. On the basis of
that analysis we turn to consider whether the 2001 transactions should together
be regarded as a composite transaction, and if so whether the loss on the
closing out of the 17 July 2001 Long Contract should not be treated as an
allowable loss. We start by asking ourselves what, in relation to the 2001
transactions, the composite transaction could comprise. At the outset it was
planned that there would be a loss, of an amount which would depend on the
movement in the FTSE index as we have described, on one or other of the 17 July
2001 derivatives, with a concomitant gain on the other. The loss, it was
anticipated, would be an allowable loss that would reduce or, it was hoped,
eliminate the chargeable gain on the disposal of the WRG shares. The gain on
the other derivative contract would, under Plan A, be a chargeable gain, and
Explainaway would have a tax liability in that respect. Plan A therefore
envisaged that Explainaway would be sold to a capital loss company, thus
eliminating, at the cost of a substantial fee, that chargeable gain.
86. The sale to the
capital loss company did not take place, and so cannot form part of the Ramsay
analysis. Only transactions forming part of a scheme that have actually been
carried out can fall to be considered. Furthermore, the 2002 transactions
carried out as part of Plan B must also be left out of account for this
purpose. Those transactions came into contemplation only after the 2001
transactions had been entered into, and indeed after the loss on the 17 July
2001 Long Contract had been realised by that contract having been closed out.
Plan B cannot therefore be part of any pre-ordained transactions taken together
with Plan A.
87. In relation to
the 2001 transactions, therefore, we are left with those transactions that were
planned and actually took place as part of Plan A. We note that it is no part
of Mr Gammie’s argument that the transactions should be recharacterised as
something other than their actual legal nature (such as a loan as was argued
unsuccessfully in Citibank); he simply submitted that the transactions
were self-cancelling, gave rise to no commercial gain or loss, and that the
loss cannot therefore be a loss within Schedule D, Case VI or an allowable loss
within the TCGA.
88. We do not
consider that the fact that two derivative transactions are entered into, one
of which gives rise to a loss and the other a gain, even in circumstances where
they have no commercial purpose and they are so closely linked as to form a
pre-ordained series of transactions, is sufficient to enable the Ramsay
principle to be applied so as to find that the true effect in law of those
transactions is anything other than that they are, and remain, individual
derivative transactions on which gains and losses separately arise. Absent any
constituent part of the scheme of Plan A whereby the gain on the 17 July 2001
Short Contract was somehow eliminated, leaving a tax loss, but no material net
commercial loss, we consider that the true effect is that the statutory
provisions must be applied to the individual gains and losses on the two
derivatives. Accordingly, the loss on the disposal of the 17 July 2001 Long
Contract is an allowable loss, and the gain on the disposal of the 17 July 2001
Short Contract is a chargeable gain.
89. The same
analysis applies, in our view, to the individual derivative transactions that
took effect in 2002 as part of Plan B. Those derivative transactions were a
means to an end – the end being the creation of a capital loss on the sale of
shares in either Quoform or Quartfed – and were part of the overall tax
planning scheme of Plan B, but that does not mean that they must be disregarded
simply because they have no commercial purpose (BMBF). On the contrary,
as with the transactions in the 2001 derivatives, we find that the true legal
effect of the 2002 derivative transactions is that they gave rise to gains and
losses on the disposals of those individual derivatives.
90. We turn now to
HMRC’s case that the loss on the Quoform shares was not an allowable loss
within the meaning of the TCGA. Here Mr Gammie argued that the scheme to
generate that loss in essence did no more than replicate the scheme that failed
in Ramsay. As we have seen, that case involved a self-cancelling
transaction with a loss being generated through a reduction in the value of
shares in a company (C Ltd). Here there is a reduction in the value of shares
in Quoform. Mr Gammie argued that the derivative contracts in this case merely
replicate the function of the loans in Ramsay.
91. In relation to
the Quoform loss, Mr Ghosh essentially repeated and developed the submissions
he had made in respect of the 2001 derivative transactions. The sale of the Quoform
shares, he argued, had no “commercial unity” with the other transactions in
Plan B, namely (ignoring Parastream) the taking out of the Quoform Long
Contract and the Quartfed Short Contract, the novation of the Quoform Long
Contract and the closing out of the Quoform Long Contract and the Quartfed Short
Contract by Quartfed. He submitted, in similar vein to the submissions he made
on the transactions in the 2001 derivatives, that there was no plan or
pre-arranged scheme whereby the loss in value and novation of the Quoform Long
Contract would take place subject to a contrived contingency, where an
artificial loss had already been realised by a transaction effected by any of
the relevant companies. The very loss itself crystallised not by reason of a
“scheme” but by reason of a movement in the FTSE index. The most that could be
said was that a number of steps had been taken with the (albeit expressed)
purpose of putting Explainaway in a position where it hoped to realise a net
allowable loss. Ramsay, he submitted, cannot treat the derivatives as
never having been taken out and cannot treat the Quoform shares as not
consequentially having dropped in value.
92. For the same
reasons we have given in relation to the transactions in the 2001 derivatives,
we do not accept that the effect of the movement in the FTSE index is not part
of the scheme. As we have described, it was of the very essence of the scheme
that an amount of loss, which was we accept at the outset of an indeterminate
amount, would arise on one or other of the Quoform Short Contract and the
Quartfed Long Contract. Once that loss, in whatever amount, had arisen, the
reduction in the value of the relevant shares (in Quoform or Quartfed,
depending on the way in which the FTSE index had moved) followed inexorably,
and was accordingly part of the scheme. It is not necessary for a particular
amount of planned loss to be identified, nor for the particular shares whose
value will be reduced, to be certain at the outset. It is enough that the
scheme encompasses, firstly, that an amount of loss will be realised (the
prospect of no loss not being a material risk, and one that was in any event
accepted by the parties), and secondly that the value of shares that are part
of the scheme will be reduced accordingly. That is the only degree of certainty
or pre-ordination that is required.
93. It is of no
consequence that Explainaway and its advisers could not be certain of the
amount of the loss, nor indeed, in our view (had it been the case here, which
we have found it was not), whether a loss would be obtained at all.
Application of the Ramsay principle is not, on our analysis, confined to cases
where everything is planned with such certainty that all risk is eliminated.
Only if the nature of the risk is such that, as in Craven v White, it
precludes an intellectually sound conclusion that the events comprise a single
composite transaction, will the presence of risk affect the analysis based on a
realistic view of the transactions. As Astall makes clear, what matters
is not the mere presence of risk, but whether that risk can be ignored as one
that the parties themselves consider acceptable. Here we have found that the
risk of the scheme failing to succeed in eliminating the whole of Explainaway’s
chargeable gain was considered acceptable; the parties went ahead with Plan B
on that basis. To the extent that any loss was realised, even if it had not
been in the desired amount, there is no reason in our view why the Ramsay
principle should not be applied to determine the legal analysis of that loss
having regard to all the transactions which resulted in it arising.
94. We have found,
as we have described, that there was no practical likelihood that no loss would
be realised. It follows that there was no practical likelihood that the shares
in one or other of Quoform or Quartfed would not be reduced. We also find that
there was no practical likelihood that the shares in the relevant company,
which in the event turned out to be Quoform, would not be disposed of. No
third party purchaser had been identified at the outset of the scheme, nor at
the time of the reduction in the value of the Quoform shares. However, we have
found on the evidence that there was no real risk that such a disposal would
not be effected. This is not, in our view, of the nature of a commercial
contingency, or uncertainty, as arose in Craven v White. There, in each
of the cases, it was the commercial end result of a series of linear
transactions that was in doubt. Here, by contrast, the disposal of Quoform was
a planned element of a self-cancelling transaction. The ultimate disposition
of Quoform in some manner was in our view certain, and it was indivisible from
the other transactions carried out as part of Plan B. There is no intellectual
difficulty, as was encountered in Craven v White, in treating those
transactions as a single indivisible whole.
95. In summary
therefore we find that the transactions in question were part of an overall
scheme to avoid corporation tax on chargeable gains on a disposal by
Explainaway. The scheme envisaged a reduction in the value of shares held by
Explainaway in one company, that in the event was Quoform, through the effect
of the movement of the FTSE index on a derivative contract, which was as it
turned out the Quoform Long Contract. This was matched by a corresponding (if
not exactly equal) increase in the value of another company, Quartfed, and a
consequential increase in the value of Explainaway’s shares in Quartfed. This
corresponding decrease and increase in value of Explainaway’s shares in these
two companies was pre-planned, even if the amount of the increase and decrease
could not be predicted. Precisely the same result would have been achieved, in
reverse, had the FTSE index moved in the opposite direction at the time the
various contracts were closed out. The increased value of Quartfed was
substantially realised by the closure of the Quartfed Short Contract, and was
extracted in a tax-free manner by the distribution of an interim dividend by
Quartfed to Explainaway. On a realistic view of the Plan B transactions, taken
together, we find that the loss on the Quoform shares was not a real loss
within the meaning of s 2 TCGA, purposively construed.
96. For these
reasons we conclude that the loss on the disposal of the Quoform shares is not
an allowable loss within the meaning of the TCGA.
Unallowable purpose
97. We turn now to
the question whether the interest cost for borrowings undertaken by Explainaway
(which includes its interest costs on intra-group debt as well as the KBIM loan
used to capitalise Quoform, Quartfed and Parasteam) to effect the various
transactions are relievable for corporation tax purposes or whether, as HMRC
contend, such relief is denied by reason of para 13, Sch 9 FA 1996.
The law
98. At the material
time, para 13, Sch 9 FA 1996 provided as follows:
“(1) Where in any accounting period a loan
relationship of a company has an unallowable purpose, the debits which, for
that period fall, in the case of that company, to be brought into account for
purposes of this Chapter shall not include so much of the debits given by the
authorised accounting method used as respects that relationship as, on a just
and reasonable apportionment, is attributable to the unallowable purpose.
(2) For the purposes of this paragraph a loan
relationship of a company shall be taken to have an unallowable purpose in an
accounting period where the purposes for which, at times during that period,
the company—
(a) is a party to
the relationship, or
(b) enters into
transactions which are related transactions by reference to that relationship,
include a purpose (“the unallowable purpose”) which
is not amongst the business or other commercial purposes of the company.
(3) For the purposes of this paragraph the business
and other commercial purposes of a company do not include the purposes of any
part of its activities in respect of which it is not within the charge to
corporation tax.
(4) For the purposes of this paragraph, where one of
the purposes for which a company—
(a) is a party to
a loan relationship at any time, or
(b) enters into a
transaction which is a related transaction by reference to any loan
relationship of the company,
is a tax avoidance purpose, that purpose shall be
taken to be a business or other commercial purpose of the company only where it
is not the main purpose, or one of the main purposes, for which the company is
a party to the relationship at that time or, as the case may be, for which the
company enters into that transaction.
(5) The reference in sub-paragraph (4) above to a
tax avoidance purpose is a reference to any purpose that consists in securing a
tax advantage (whether for the company or any other person).
(6) In this paragraph—
“related transaction” has the same meaning as in
section 84 of this Act; and
“tax advantage” has the same meaning as in
Chapter I of Part XVII of the Taxes Act 1988 (tax avoidance).”
99. Section 709(1)
ICTA contained, at the material time, the definition of “tax advantage”
referred to in para 13:
“In this Chapter “tax advantage” means a relief or
increased relief from, or repayment of or increased repayment of, tax, or the
avoidance or reduction of a charge to tax or an assessment to tax or the
avoidance of a possible assessment thereto, whether the avoidance or reduction
is effected by receipts accruing in such a way that the recipient does not pay
or bear tax on them, or by a deduction in computing profits or gains.”
Discussion
100.Mr Gammie
submitted that paragraph 13 could apply to the debits, that is to say the
interest costs on the relevant debts incurred for the purpose of the scheme in
one of two ways. First, he argued that if we found that the scheme entirely
failed, so as not to produce any profits or gains under the derivative
contracts within the charge to corporation tax and as not involving any
recognised loss on the sale of the Quoform shares, the loan relationships in
question were not in respect of any part of Explainaway’s activities within the
charge to corporation tax. Secondly, he submitted that in any event, the only
purpose (and certainly one of the main purposes) for which Explainaway was a
party to the loan relationships was tax avoidance.
101.As regards Mr
Gammie’s first submission, we have held that the profits and gains under the
derivative transactions were within the charge to corporation tax. We are
concerned therefore, in this respect, only with the loan relationship of
Explainaway taken out to capitalise Quoform, Quartfed and Parastream. The
question therefore is whether the fact that we have found that the loss
incurred by Explainaway on its disposal of shares in Quoform is not an
allowable loss within s 2 TCGA has the effect of taking Explainaway’s
activities out of the scope of the charge to corporation tax. We do not
consider that it does. We agree with the analysis submitted by Mr Ghosh that Ramsay
is concerned with the construction of the statutory provisions, in this
instance s 2 TCGA. It is predicated on the relevant transactions falling
within the scope of the tax; the question is not about application but about scope.
The effect of Ramsay is to enable the transactions, viewed
realistically, to be taxed on the basis of a purposive construction of the
statutory provisions. That cannot take those transactions out of the scope of
the charge to corporation tax; they must necessarily be within that scope.
102.Mr Gammie’s
second submission turns on the scope of the meaning given to “tax advantage”
when applied in the context of paragraph 13. Mr Ghosh described the two
competing analyses. The first is that the expression must be confined to an
advantage in respect of corporation tax on income only, and not an advantage in
terms of corporation tax on chargeable gains. This is based on the
importation of the meaning of “tax advantage” from the provisions concerning
transactions in securities (ICTA, s 703 et seq), and what Mr Ghosh described as
the “tax orthodoxy” that tax in that context includes, in relation to
companies, only corporation tax on income and not corporation tax on chargeable
gains. When imported into a loan relationships regime that is itself concerned
exclusively with income taxation, the conclusion must be that the meaning of
tax advantage is to be restricted to corporation tax on income.
103.The
alternative analysis, and the one supported by Mr Gammie, is that the
importation of the meaning of tax advantage from s 709(1) does not import the
meaning to be attributed to the defined term in the context of the transactions
in securities provisions, but imports only the meaning given by s 709(1) to the
words “tax advantage”. On this basis, the definition would then fall to be
construed in the context of paragraph 13 itself, and the tax orthodoxy attached
to the meaning in connection with transactions in securities would not dictate
the meaning to be given for paragraph 13 purposes.
104.Either of
these competing analyses is intellectually defensible. The words themselves do
not provide a clear answer. We consider that the right approach is to construe
paragraph 13 purposively. In our view, so construed, paragraph 13 cannot be
seen as confined to avoidance schemes concerned only with corporation tax on
income. Whilst it is true that the effect of falling within paragraph 13 is to
deny relief for loan relationship debits, which fall within the scope of
corporation tax on income, that is merely the effect, and cannot confine the
scope of the tax advantage which triggers the effect. Paragraph 13 is
different from s 703. In that latter case it is the tax advantage itself that
is counteracted, so tax advantage takes its meaning from the types of scheme at
which the provisions are aimed. In the case of paragraph 13, by contrast, the
counteraction is not of the tax advantage itself, but of the debits on a loan
relationship to which the company is a party for the purpose of securing a tax
advantage. The tax advantage is not confined to the obtaining of relief for
the loan relationship debit itself.
105.This
conclusion is, in our view, consistent with the scheme of paragraph 13 itself.
Paragraph 13 does not define “tax”. That is left as the meaning found in s
832(3) ICTA, namely “except so far as the context otherwise requires, in the
Tax Acts … ‘tax’, where neither income tax nor corporation tax is specified,
means either of those taxes”. This excludes capital gains tax, but companies
within the charge to corporation tax are not subject to capital gains tax;
corporation tax in general includes tax both on income and on chargeable
gains. Nor is paragraph 13 confined to a tax avoidance purpose that consists
of securing a tax advantage only for the company whose loan relationship is
called into question. Paragraph 13(5) provides that the relevant tax advantage
may be for the company or “any other person”. That tax advantage need not
therefore be confined by the nature of the debits themselves.
106.Accordingly,
we find that the loan relationships undertaken by Explainaway in connection
with the transactions that are the subject of this appeal had an unallowable
purpose and that the debits on those loan relationships are, by virtue of para
13, Sch 9 FA 1996, not to be brought into account for the purposes of Chapter
II of Part IV of that Act.
Decision
107.For the
reasons we have given we decide that:
(1)
The respective derivative transactions undertaken by Explainaway (in
2001) and by Quoform, Quartfed and Parastream (in 2002) gave rise to chargeable
gains and losses.
(2)
The loss arising on the disposal by Explainaway of the Quoform shares
was not an allowable loss within the meaning of TCGA.
(3)
The debits arising on the loan relationships of Explainaway entered into
to effect the various transactions are not relievable for corporation tax
purposes.
108.Accordingly,
these appeals are allowed in part, as to the chargeable gains and allowable
losses on the derivative transactions, but are otherwise dismissed.
Right to apply for permission to appeal
This document contains full findings of fact and reasons
for the decision. Any party dissatisfied with this decision has a right to
apply for permission to appeal against it pursuant to Rule 39 of the Tribunal
Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application
must be received by this Tribunal not later than 56 days after this decision is
sent to that party. The parties are referred to “Guidance to accompany a
Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and
forms part of this decision notice.
ROGER BERNER
TRIBUNAL JUDGE
RELEASE DATE:24 June 2011
