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Commissioners of Inland Revenue, Ex Parte Newfields Developments Limited, R v. [2001] UKHL 27; [2001] 1 WLR 1111; [2001] STC 901 (23rd May, 2001)

HOUSE OF LORDS

Lord Bingham of Cornhill Lord Steyn Lord Hoffmann Lord Cooke of Thorndon Lord Scott of Foscote

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

REGINA

v.

COMMISSIONERS OF INLAND REVENUE

(APPELLANTS

EX PARTE NEWFIELDS DEVELOPMENTS LIMITED

(RESPONDENTS)

ON 23 MAY 2001

[2001] UKHL 27

LORD BINGHAM OF CORNHILL

My Lords,

1. For reasons given by my noble and learned friends, Lord Hoffmann and Lord Scott of Foscote, which I have had the benefit of reading in draft, I would allow this appeal and restore the order of the judge.

LORD STEYN

My Lords,

2. I have had the advantage of reading in draft the speeches of my noble and learned friends, Lord Hoffmann and Lord Scott of Foscote. For the reasons which they have given I would also allow the appeal.

LORD HOFFMANN

My Lords,

3. The Finance Act 1972 introduced a relief for small companies in the form of a reduced rate of corporation tax. The full relief can be claimed if the company's profits in the relevant accounting year do not exceed one specified amount and partial relief can be claimed if they do not exceed another specified amount. The conditions for obtaining the relief and the specified amounts are now contained in section 13 of the Income and Corporation Taxes Act 1988 as amended. The reduced rate is 20%, as against the full rate of 30%.

4. The relief would be open to obvious abuse if a business could be divided among two or more companies so that each earned profits below the specified amount. Section 13(3) therefore provides that if a company has one or more associated companies, the relevant specified amount shall be divided by the number of associated companies plus one. Thus a company with one associated company can claim the relief in full or in part only if its profits in the relevant accounting period do not exceed half the relevant specified amount.

5. The question in the present appeal is whether the taxpayer company (Newfields Developments Ltd, which I shall call "Newfields") has an associated company or not. The revenue contend that it has an associated company as defined in the Act, namely a company called Lawrek Properties Ltd ("Lawrek"). I shall in due course describe what the revenue say is the relevant relationship between the two companies but, in order to explain why the revenue say that their relationship is relevant, I must first go into the details of the rather complicated definition of an associated company.

6. Associated companies are defined in section 13(4) as companies of which one controls or is controlled by the other or which are both under the control of the same person or persons. Crucial to this definition is therefore the concept of control, which the subsection says "shall be construed in accordance with section 416".

7. The primary purpose of section 416 is to define the expressions "associated company" and "control" for the purposes of Part XI of the Act, which deals with close companies. The term "close company" appeared for the first time in the Finance Act 1965, which introduced the corporation tax, but had its roots in earlier concepts: the company "under the control of not more than five persons" in respect of which income could be apportioned to its members for surtax purposes under section 21 of the Finance Act 1922 and the "company whereof the directors have a controlling interest therein" which was limited in the deductions it could make in respect of directors' salaries for the purposes of profits tax by para 11 of Schedule 4 to the Finance Act 1937. The close company is defined by section 414(1), subject to exceptions, as "one which is under the control of five or fewer participators, or of participators who are directors". Part XI provides that in certain respects close companies are to be subject to a special fiscal regime. Thus the definition of control in section 416, which originally appeared in para 3 of Schedule 18 to the Finance Act 1965, was for a purpose quite different from its use in section 13(4), which made its first appearance in the Finance Act 1972.

8. The definition of a close company made it necessary to provide definitions of "participator" and "control". Participator is defined by section 417(1):

9. Control is defined in section 416, of which the relevant subsections are (2) to (6):

10. It will be seen that although this definition starts in subsection (2) with a concept of control which reflects its meaning in ordinary speech ("a person shall be taken to have control of a company if he exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs"), that fairly simple notion is enormously widened by subsequent subsections. Subsection (4) deems the person in question to already have interests which have not yet vested and subsection (5) attributes to him the rights or powers of his nominees. Subsection (6) goes much further in providing that for the purposes of deciding whether a person falls within the definition in (2) (or the definition of joint control in (3)) any person may have attributed to him the rights or powers of any associate or of any company which he or his associates or both have control. The full breadth of this extension can be seen from the definition of "associate" in section 417(3):

11. "Relative" is defined in section 417(4) to mean "husband or wife, parent or remoter forebear, child or remoter issue, or "brother or sister". The effect of these cumulative definitions is that for the purpose of deciding whether a person "shall be taken to have control of a company" under section 416(2), it may be necessary to attribute to him the rights and powers of persons over whom he may in real life have little or no power of control. Plainly the intention of the legislature was to spread the net very wide.

12. Against this statutory background one can turn to what the revenue say is the relevant relationship between Newfields and Lawrek. The issued share capital of Newfields is held by the trustees of the will of the late Mr Walker. Under the trusts of that will, his widow Mrs Walker has a life interest. Her life interest in the shares means that she is a "participator" in Newfields (section 417(1)(c)) and, more to the point, the trustees are her "associates" (section 417(3)(c)). The trustees plainly have power to control Newfields and if that power is attributed to Mrs Walker under section 416(6), she must be taken under section 416(2) to have control of Newfields.

13. The issued share capital of Lawrek is held by the trustees of a discretionary settlement established by the late Mr Walker in his lifetime. Mrs Walker has no interest under that settlement - to avoid the income being deemed to be that of Mr Walker, she was expressly excluded from taking any benefit. She is therefore not a participator. Nevertheless, she is a relative of the settlor and therefore it is said that under section 417(3)(b), as applied to non-participators by the concluding words of the subsection, the trustees of that settlement are also her associates. If their powers are attributed to her under section 416(6), then she must be taken to have control of Lawrek as well. It follows that Newfields and Lawrek are under the control of the same person and are associated companies.

14. The first ground upon which the taxpayer objected to this conclusion was that section 416(6) does not say that the powers of associates must be attributed to Mrs Walker. The subsection says "may". Therefore the taxpayer submits that the revenue has a discretion as to whether to make an attribution or not. The discretion should be exercised to prevent taxpayers from abusing the relief under section 13. In this case, however, the taxpayer says that it would be unfair to make an attribution because there is no abuse. Mrs Walker has no interest in Lawrek and no real control over its affairs. It and Newfields are quite separate companies.

15. The revenue denied that section 416(6) conferred a discretion. They said that the word "may" merely indicated that such an attribution would not always be made. It should be made if the result was that a given person or persons would be taken to have control within the meaning of section 416(2) or (3). Otherwise not. But this depended upon the consequences of the attribution and not upon the discretion of the revenue. On 22 September 1997 the inspector wrote to the taxpayer's accountant saying that the revenue had no discretion and proposed to refuse small companies' relief.

16. Newfields issued proceedings for judicial review of this decision. It sought a declaration that there was a discretion and an order of mandamus requiring it to be exercised.

17. Moses J [1999] STC 373 held that the revenue were right. He recorded, at p 377, that both parties had agreed that "the opening words of subsection (6) of section 416 confer a power and not a duty". But he said, at p 380, that the revenue were obliged to exercise the power for the purpose for which it was conferred. That purpose was "to ascertain whether, in the instant case, two companies are under the control of the same person". If an attribution will produce an affirmative answer, an attribution should be made.

18. The taxpayer appealed to the Court of Appeal [2000] STC 52, where a majority (Peter Gibson and Sedley LJJ) agreed on this point with the judge. Sir Christopher Staughton, on the other hand, thought that the revenue had a discretion which ought to have been exercised. In rejecting the notion of a discretion, Peter Gibson LJ said that it was significant that no one was designated as the person in whom the discretion was vested. Was it the inspector, the Commissioners or the taxpayer? It seemed to him to "provide an instruction to the revenue and the taxpayer alike as to how control of a company for the purposes of section 416(2) and (3) is to be determined.": p 59. Sedley LJ said that, although he was tempted by the notion of discretion, he agreed that the absence of anyone upon whom it purported to be conferred was an irremovable objection.

19. In my opinion the judge and the majority in the Court of Appeal were right. In addition to the absence of any person identified as entrusted with a discretion, there is the absence of any grounds upon which the discretion should be exercised. Even without subsection (6), the definition of control is wide and can apply to people who have no real control over the company's affairs. This makes it difficult to apply the reality of control as a criterion for exercising a discretion. If real control were to be the test, the opening words of section 416(2) would be enough. The purpose of the extended definition appears to be to make it unnecessary for the revenue to have to make detailed factual inquiries.

20. Sir Christopher Staughton, in taking the opposite view, naturally attached importance to the word "may". But the word appears in an impersonal construction - "there may also be attributed" - and I think that its force is not facultative but conditional, as in "VAT may be chargeable". The question of whether VAT is chargeable does not depend upon anyone's choice but on whether the conditions for charging VAT are satisfied: are the goods or services subject to VAT, is the trader registrable and so on. Likewise, the question of whether rights or powers should be attributed depends upon whether the necessary conditions have been satisfied. As Peter Gibson LJ pointed out, at p 59, the draftsman could not sensibly have said "there shall also be attributed" because section 416(6) permits a wide range of attributions. Some will result in a given person or persons being in control within the meaning of subsections (2) or (3) and others will not.

21. It should be noted that while subsection (2) specifies the conditions under which "a person" shall be taken to have control, subsection (6) says that for the purposes of subsection (2), there may be attributed to "any person" all the rights and powers of companies under his control, associates and so forth. The possible subject of attribution is therefore not confined to the candidate for control. Thus, while subsection (6) would permit the attribution to the candidate of powers exercisable by his wife, it would also permit the attribution to his wife of powers exercisable by him. In the first case, the result might be to treat the candidate as being in control when otherwise he would not be. In the second, it might be to treat him as not being in control when otherwise he would be. If all the attributions possible under subsection (6) were mandatory, it could not be applied without absurdity and contradiction.

22. Although the point may be merely verbal, I do not think that it is right to say, as the parties appear to have done before Moses J, that "may" confers a "power". It is true that there are powers which in certain circumstances must be exercised. But I think it is clearer, having regard to the impersonal use of "may" in the subsection, to say that it expresses conditionality.

23. If the force of the word "may" is conditional, the next stage in the argument is to identify the conditions under which an attribution must be made. The argument before the judge seems to have proceeded on the basis that although the conditions were not spelled out in subsection (6), they could be inferred from the purpose of subsection (6) as an adjunct to subsections (2) and (3), namely to specify what counts as being in control of a company. In the same way, if it said in a catalogue "VAT may be chargeable", it would not be necessary to spell out that it would be chargeable if the conditions for charging VAT were satisfied. That would be obvious from the nature of VAT.

24. The judge therefore concluded, as I have already stated, that an attribution should be made if the result would be to treat the candidate or candidates as being in control of the company, but not otherwise. He did say at one point that the purpose of section 416(6) was to "ascertain whether . . . two companies are under the control of the same person pursuant to section 13(4)": p 380. Mr Prosser objected that this involved illegitimately reading the purpose of section 13(4) into a general definition of control which served a number of different provisions, each having its own purpose. But I do not think that the judge meant to say more than that the general purpose of section 416 was to tell one whether a given person could be said to be in control of a given company and that subsection (6) was part of the hypothesis on which one answered that question. Section 13(4) requires one only to ask whether an affirmative answer can be given in respect of both companies.

25. On this point, however, the Court of Appeal disagreed. They said that one could not treat subsection (6) as subject to conditions which could be inferred from subsections (2) and (3) because the conditions under which attributions should be made were already spelled out in the concluding words of the subsection itself:

26. The Court of Appeal treated these words as laying down exhaustively the conditions under which attributions could and should be made. It followed that unless the attributions would result in the company being treated as under the control of five or fewer participators, they could not be made at all. Mrs Walker was not a participator in Lawrek and the effect of an attribution would therefore not result in Lawrek being under the control of five or fewer participators. On the other hand, if coincidentally it would have had that effect, the attribution could have been made for the purposes of refusing small companies' relief.

27. This construction produces a very arbitrary result and would appear to make section 416(6) an unsuitable element in any definition of control for the purposes of section 13(4). Small companies' relief does not depend upon whether the company is a close company or not. No doubt most companies which qualify for the relief will be close companies, but that is not essential. The question, or rather one of the questions, raised by section 13(4) is whether a person who controls a company applying for relief also controls one or more other companies. In deciding what counts as controlling another company, it would be illogical to attribute additional powers only if the effect was to bring that other company within the definition of a close company. That would seem an irrelevant consideration. Mr Prosser said that one could avoid this illogicality by treating the whole of subsection (6) as applicable only to the question of whether a company was a closed company. But this would leave it open to anyone to claim small companies' relief by dividing his business between companies controlled by himself and his wife, or himself and the trustees of discretionary settlements for the benefit of his family. The absence of the attribution provisions of subsection (6) would leave a large gap in the defence which section 13(4) provides for the public revenue.

28. The Court of Appeal were fully aware that their construction produced a rather odd result. Peter Gibson LJ spoke of unease and discomfort and Sedley LJ said he reached the answer with considerable diffidence.

29. In my opinion, if the concluding words were not there, one would have no difficulty in inferring from subsections (2) and (3) that the conditions for attribution are whether or not it resulted in the person or persons under consideration being treated as being in control. Once one has rejected the notion of a discretion, there can be no other intelligible construction. The question is whether this conclusion is displaced by the concluding words or whether those words serve some other purpose.

30. In my opinion, they do serve another purpose. Section 416(2) to (6), up to the commencement of the concluding words, provides a definition of control. If one wants to know of any person or persons whether he or they must be treated as having control of a given company, those parts of the section will provide the answer. For many of the purposes for which the concept of control is used, that is all that one requires. In the present case, for example, all one wants to know is whether Mrs Walker can be said to be in control of Newfields and of Lawrek. But there are cases in which it is not enough to know that it can be said of a certain person, or certain people, that they control company A. An example is the question of whether company A is a close company, which involves not only asking whether participators control the company but also whether they are directors or number five or fewer.

31. There is no difficulty about applying the definition to answer the question of whether the company is controlled by participators who are directors. If one or more people who answer that description control the company within the meaning of section 416(2) or (3), as extended if necessary by the other subsections including (6), the definition is satisfied. But the question of whether the controlling participators are five or fewer is different. If one simply said that an attribution should be made under subsection (6) if it resulted in a given participator or participators being treated as in control, it could yield the result that various numbers of participators were in control. With some attributions it could be five or fewer, without them or with others, more.

32. In my opinion, therefore, the concluding words of subsection (6) do not form part of the definition of "control" which is applied by section 13(4) and other sections. They are a special qualification of that definition for the specific purpose of deciding whether one limb of the definition of a close company is satisfied. The concluding words take effect only when one has applied the general definition of control in section 416(2) or (3) as extended by the preceding part of the subsection and found that it can yield groups of participators of varying numbers who can each be treated as being in control. The concluding words then require one to make only such attributions as will result in the company being treated as under the control of five or fewer participators. But this qualification has no relevance to any case in which the general definition of control, as set out in the rest of section 416(2) to (6), is sufficient to answer the statutory question.

33. In the present case, as I have said, the general definition is sufficient to answer the question. I would therefore allow the appeal and restore the order of Moses J.

LORD COOKE OF THORNDON

My Lords,

34. I have had the advantage of reading in draft the speech of my noble and learned friends Lord Hoffmann and Lord Scott of Foscote. For the reasons which they have given I would also allow the appeal.

LORD SCOTT OF FOSCOTE

My Lords,

35. I have had the advantage of reading in advance the opinion of my noble and learned friend, Lord Hoffmann. I agree with his analysis of the relevant statutory provisions and with his reasons for allowing the appeal.

36. One of the issues of construction that was debated before the Court of Appeal was whether or not section 416(6) of the 1988 Act should be treated as a single provision. The relevance of this issue was that if it were to be treated as a single provision, then, so it was argued, the whole of the subsection, including the passage after the semi-colon, ie "; and such attributions shall be made . . . " etc, would have to be applied when answering the question whether Mrs Walker was to be treated as in control of Lawrek. If that were right, the passage would then have a limiting effect, preventing the attributions prescribed by the subsection from having any function other than to allow a company to be treated as under the control of five or fewer participators and, consequently, a close company. Peter Gibson LJ [2000] STC 52, 59 concluded that the subsection should be treated as a single provision:

37. He held that, since Mrs Walker was not a participator vis-à-vis Lawrek, none of the subsection (6) attributions could be used in order to treat her as in control of Lawrek and to enable Newfields and Lawrek to become, for section 13(4) purposes, associated companies.

38. The purpose of subsection (6) when originally enacted in paragraph 3 of Schedule 18 to the Finance Act 1965 was to enable such attributions to be made as would result in a company becoming a close company for the purposes of that Act. In that context it seems to me accurate to treat the subsection as a single provision. It required, and still does require, to be applied as a single provision for the purpose of enabling a company to be treated as a close company.

39. But section 13(4) of the 1988 Act has nothing to do with close companies. It is concerned with whether or not companies are "associated" with one another. They are to be treated as associated if "one of the two has control of the other or both are under the control of the same person", and, section 13(4) declares, "'control' shall be construed in accordance with section 416."

40. In applying section 416 in order to construe "control" in section 13(4) and to determine whether or not companies are "associated", the whole of section 416 must be applied. To omit subsection (6) would make no sense and defeat an important part of the statutory intention underlying section 13. But, in applying subsection (6), the passage after the semi-colon, which has relevance only to the identification of close companies and no relevance to whether or not companies are "associated", should simply be ignored. It has no part to play.

41. Subsection (2) of section 416 provides that:

The words I have cited prescribe a test of actual control. But section 416 goes on, in the remaining part of subsection (2) and in subsections (4), (5) and (6), to describe circumstances in which, whether or not a person has actual control, the person "shall be taken to have control". It is worth emphasising the word "shall" in subsection (2). There is no element of discretion.

42. Subsection (6) describes a number of circumstances in which, for the purposes of subsection (2), control "may . . . be attributed" to a person. The particular circumstances that permit an attribution of control to a person are not necessarily exclusive of the circumstances that permit an attribution of control of the same company to some other person. The facts relating to two companies may, under subsection (6), permit the attribution of control to several different people.

43. This, in my opinion, explains the use of the word "may" in subsection (6). The use of the word "may" does not lead to the conclusion that the subsection creates a discretionary power. The absence of any indication of the criteria by which the discretion is to be exercised or any identification of the person by whom the discretion is to be exercised seems to me to make that plain. In my opinion, the use of the word "may" was an acceptable linguistic means of indicating that not every permutation of control thrown up by subsection (6) attributions has to be applied when the question whether a particular person has control of a particular company is being considered. Subsection (6) supports subsection (2). Subsection (2) says that "a person shall be taken to have control of a company if . . . " (Emphasis added) This mandatory provision supplemented by subsection (6) attributions requires, in my opinion, that when the circumstances of a particular person are being examined in order to determine whether that person has control of a particular company, that person "shall be taken" to have control if any of the possible subsection (6) attributions give him or her control.

44. For these reasons and those given by Lord Hoffmann I, too, would allow this appeal.