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Cite as: [2005] UKSPC SPC00489, [2005] UKSPC SPC489

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Daniels v Revenue and Customs [2005] UKSPC SPC00489 (12 July 2005)

SPC00489

CAPITAL GAINS TAX / TAXATION OF CHARGEABLE GAINS — computation — interaction between deferral relief for reinvestments under Enterprise Investment Scheme and taper relief — whether taper relief to be applied to chargeable gains in year of assessment before or after deduction of deferral relief — held to the extent that deferral relief applies chargeable gains do not accrue in year of assessment — consequently deduction of deferral relief should take place before and not after application of taper relief — appeal decided in favour of Revenue

THE SPECIAL COMMISSIONERS

KEITH TREVOR DANIELS Appellant

- and -

HER MAJESTY'S REVENUE AND CUSTOMS Respondents

Special Commissioner: Michael Johnson

Sitting in public in Manchester on 17 May 2005

The Appellant appeared in person

June Kennerley, one of Her Majesty's Inspector of Taxes, for the Respondents

DECISION

The issue

This is an appeal concerning the correct interpretation of provisions of the Taxation of Chargeable Gains Act 1992 ("the 1992 Act") as applying for the determination of the Appellant taxpayer's liability to capital gains tax for 2002-03 ("the year of assessment").

For the purposes of this appeal I need to consider the interface between, on the one hand, the various amendments to the 1992 Act introduced by the Finance Act 1995 relating to reinvestment under the Enterprise Investment Scheme ("the EIS"), subsequently themselves amended, and, on the other hand, those introduced by the Finance Act 1998 relating to taper relief for individuals, again subsequently amended.

The issue is whether, when the taxpayer reinvested pursuant to the EIS an amount otherwise chargeable to capital gains tax under the 1992 Act, the tapered amount of his gains taxable under the 1992 Act in the year of assessment fell to be calculated before or after taking into account the deferral relief afforded by the 1992 Act in respect of the reinvestment.

I can illustrate the practicalities of this point by reference to a simple example, which bears no relation to the figures actually in dispute. Say that the taxpayer's chargeable gains in the year of assessment under s 2(2) of the 1992 Act are £100,000. Say also that he is eligible to taper all those gains under s 2A of the 1992 Act to 25 %, so that the chargeable gains amount to £25,000. Say further that his deferral relief for the EIS is £10,000. Does one first deduct the deferral relief and then taper the gains, or vice-versa? If the gains are tapered and then the relief is deducted, the resultant figure is £15,000; alternatively if the relief is first deducted and then the gains are tapered, the resultant figure is (£100,000 - £10,000 = £90,000 x 25 % = ) £22,500.

The Revenue contend for the calculation producing the larger net sum, and the Appellant the smaller. Who is right? That is the sole matter that the tribunal has to decide. I record that, subject to resolving the issue just stated, there is no dispute between the parties as to the Appellant's entitlement in the year of assessment to deferral relief or its amount, nor as to his liability to pay capital gains tax in the year of assessment or the amount of that tax.

Some historical background

Before the introduction of taper relief, indexation allowance applied to individuals as well as companies. In respect of individuals, this was frozen by s 122 of the Finance Act 1998, but was compensated for by the introduction of taper relief, applicable to periods for which assets are held after 5 April 1998.

The case of Quinn (Inspector of Taxes) v Cooper [1998] STC 772, on appeal to the Chancery Division (Lightman J) from the decision of the Special Commissioner, Mr T H K Everett, is instructive. It related to the application of indexation allowance and concerned the correct approach to the situation where the taxpayer had sold at a loss shares which had previously been the subject of business expansion scheme ("BES") relief: see s 150 of the 1992 Act. The narrow issue in that case was whether indexation should be applied to the full acquisition cost of the shares disposed of, or whether the allowable expenditure for the purpose of s 150(3) was restricted by ss 38 and 53(3) of the 1992 Act. The judge held that it was so restricted.

The value of that case for present purposes is limited to what the court had to say about paragraph 16(1) of Schedule 5 to the Finance Act 1983, which was eventually re-enacted as s 150(3) of the 1992 Act. Lightman J said this (at [1998] STC 782a) –

"The purpose behind paragraph 16(1) was that a taxpayer should not have the benefit of a loss on the disposal of his shares to the extent that he had already had the benefit of BES relief on the acquisition cost. But there was no objection to using the whole of the acquisition cost to limit a gain on the shares in question. The taxpayer already had the benefit of being able to set the acquisition cost off against his income for income tax purposes. If he was then able to claim a loss on the sale of BES shares, he would obtain the benefit of all or part of the acquisition cost, which he could then set off against his chargeable gains (which gains might well have arisen from non-BES investments)."

At the periods being considered by the judge, the indexation allowance prima facie operated on both losses and gains. The 1992 Act was amended by the Finance Act 1994 so that, generally, the deduction of indexation allowance could no longer produce or increase an allowable loss. However the Quinn case remains of assistance on the matter, relevant in this appeal, of the interaction between different reliefs arising under the 1992 Act.

On the facts of a case like the Quinn case (see [1998] STC 781e-f), the greater the level of loss on selling the shares, the greater the amount of the reduction required to be applied to the acquisition cost in order to produce a no gain/no loss result: accordingly the greater the difference between the acquisition cost and the sale price, the smaller the amount of indexation allowance and therefore the smaller the amount of allowable loss on the sale. The judge described this as a "surprising" result. Indeed, at the start of his judgment, he said this (at [1998] STC 777c) –

"Both sides in this case have had to concede that the alternative constructions of the legislation which they favour have somewhat surprising consequences. This is unavoidable having regard to the language of the legislation. It is unlikely that the question which has now arisen ever occurred to the draftsman. In the circumstances both sides have with skill and ingenuity proffered their respective speculations as to what the draftsman would have intended if he had addressed his mind to the question. It is, however, common ground that this exercise cannot afford any guidance and the issue before me is one of construction of the legislative language used read in its statutory context".

In this appeal, also, both sides have employed skill and ingenuity in presenting their cases. This is similarly not a case, however, where the result of the interpretation of the 1992 Act which this tribunal is called upon to make will necessarily be regarded as satisfactory in every conceivable circumstance.

The positions of the parties in this appeal

Ms Kennerley, appearing for Her Majesty's Revenue and Customs ("the Revenue"), submits that the issue in this appeal is purely one of construction of the words of the 1992 Act. That is not, however, the position of the Appellant, who has represented himself. His position is that the legislation is only the starting point.

The Appellant describes as "the kernel of the dispute" the question, did Parliament intend that, on the introduction of a new form of relief from capital gains tax, it would restrict a pre-existing relief?

Under paragraph 2(1) of Schedule 5B of the 1992 Act, introduced into the 1992 Act by the Finance Act 1995, an investor's "qualifying expenditure" under the EIS can, on his making a claim, be set against the corresponding amount of a chargeable gain that he has made. "Qualifying expenditure" is unused expenditure on subscribing for "relevant shares", as defined in paragraph 19 of that schedule, that definition having been inserted by the Finance Act 1999.

I pause to note that, whilst Schedule 5B was inserted in 1995, the conditions for relief under that schedule applicable to the Appellant in relation to the year of assessment stand as having been amended both contemporaneously with, and more recently than, the introduction of taper relief in 1998. Indeed it was in 1998 that the former reinvestment relief, replaced by deferral relief, was discontinued, and Schedule 5B amended accordingly.

The Appellant's position is that the introduction of taper relief cannot have been intended to prejudice the operation of the pre-existing EIS relief, enacted to encourage investments in small unquoted trading companies, which would be the effect of calculating the amount of taper relief after, as distinct from before, any deduction attributable to deferral relief.

Determined to try to discover the legislative background to Schedule 5B, the Appellant wrote a letter to the Freedom of Information Unit in Somerset House for information as to the enactment of that schedule and the amendments to it. In replying to this request, the Revenue's Policy Department was helpful, but only in part.

As to the requested information itself, the Revenue withheld that information, as falling under the exemption in s 35(1)(a) of the Freedom of Information Act 2000. The Policy Adviser wrote to the taxpayer to say that, in applying that exemption, the Revenue had had to balance the public interest in withholding the information against the public interest in disclosing it. An annexure with the letter explained the factors considered. In the event, the Appellant has had to be content with this reply for the purposes of this appeal.

The Revenue did, however, send to the Appellant copies of explanatory memoranda dealing with the introduction of Schedule 5B and, separately, taper relief. I have read these documents and have borne them in mind. However they do not, in my opinion, have the status of any kind of gloss upon or interpretative aid to the legislation itself.

One of the authorities cited by the Appellant has been Pepper (Inspector of Taxes) v Hart [1992] STC 898. In that well-known case, the House of Lords opened the door, in limited circumstances, to the consideration of parliamentary material as a guide to the construction of the words of statutes, where, per Lord Browne-Wilkinson at [1992] STC 923b, (a) legislation is ambiguous or obscure, or leads to an absurdity; (b) the material relied on consists of one or more statements by a minister or other promoter of the Bill together if necessary with such other parliamentary material as is necessary to understand such statement and their effect; and (c) the statements relied on are clear. What their Lordships meant by "parliamentary material" appears from the speeches in the case, in particular that of Lord Browne-Wilkinson, at [1992] STC 919b and following, ie "white papers", official reports underlying Bills, and the like.

The memoranda copies of which I have been shown do not appear to be of this nature. Rather they are briefing notes, which do no more than paraphrase the provisions of clauses of the Finance Bills in question. To the extent that those paraphrases may be inconsistent with the Bills as enacted, it seems to me to be entirely wrong in principle to rely upon them in order to interpret the wording of the corresponding provisions of the Acts themselves. That is because Parliament cannot have intended the briefing notes to become law, as distinct from the clauses to which they relate, which might indeed become law, with or without modification.

Ms Kennerley did however draw my attention to what Dawn Primarolo, MP, the Financial Secretary to the Treasury, told Parliament in committee about taper relief on 29 April 1998. The "Hansard" record of Ms Primarolo's remarks appears to show that the maximum taper relief contemplated by the government was 75%. Ms Kennerley handed in calculations showing how the Appellant's case contemplated a potential "double deduction" of taper relief greater than that. The Appellant had researched "Hansard" but did not in the event rely upon any material of the kinds identified in the Pepper case.

The Appellant's position is also that the tribunal should proceed to interpret the legislation relevant to this appeal on the basis of what is logical. If other interpretations are unjust or absurd, he says, they must be wrong.

Logic is not however the strong point of the taxing acts. The result of interpreting the legislation may be a surprising one, as in the Quinn case. Legislation may work an injustice and still be the law. As the Quinn case shows, the result of interpreting and applying the provisions of a taxing act may be to discriminate illogically or unfairly between individual taxpayers in a range of situations, but that does not, in itself, lead to an absurdity.

In summary, with regard to the respective positions of the parties in this appeal as to the interpretation of the 1992 Act, the Appellant has had a difficult task to persuade the tribunal that the decision in this appeal should be arrived at other than on the basis of the construction of the relevant legislative language alone, read in context.

The language of the 1992 Act

Under s 2(2) of the 1992 Act, capital gains tax is to be charged on the total amount of chargeable gains accruing to the person chargeable in the year of assessment, after deducting the losses mentioned in (2)(a) and (b). By s 2A of the 1992 Act, taper relief applies to the excess of the total amount under s 2(2), after the deductions in (a) and (b), where the excess includes the whole or part of any chargeable gain that is eligible for that relief. There is, as indicated above, no dispute in this case as to the taxpayer's eligibility for taper relief.

Section 2A(2) provides that the amount on which capital gains tax is taken to be charged by virtue of s 2(2) is to be reduced to the amount computed by (a), (b) and (c) in that sub-section. First, one applies taper relief to those gains eligible for that relief; then, one aggregates the results of that exercise; finally, one adds the aggregated tapered gains to those gains ineligible for tapering, to produce the amount on which capital gains tax is taken to be charged. Again, as already mentioned, there is no dispute in this case as to that computation.

Section 2A(7) provides that Schedule A1 of the 1992 Act shall have effect for the purposes of that section.

Paragraph 1(1) of Schedule A1 provides that s 2A is to be construed subject to and in accordance with that schedule.

Paragraph 16(2)(e) of Schedule A1 identifies Schedule 5B of the 1992 Act as an enactment having an effect on the accrual of a gain. Paragraph 16(1) of Schedule A1 assumes that, by virtue of Schedule 5B, the gain will be treated as having accrued at a time after that of the disposal.

Paragraph 1(1) of Schedule 5B states that that schedule applies where, inter alia, there would, apart from paragraph 2(2)(a) of that schedule, be a chargeable gain, defined as "the original gain", accruing to an individual at "the accrual time", defined as at any time on or after 29 November 1994 – see paragraph 1(1)(a).

Paragraph 2(2)(a) of Schedule 5B provides that where an amount of qualifying expenditure on relevant shares (see paragraph 14 of this decision) is set under that schedule against the whole or part of the original gain, as defined in paragraph 1(1)(a) of the schedule, then –

"so much of that gain as is equal to that amount shall be treated as not having accrued at the accrual time … ".

Paragraphs 4 and 5 of that schedule then provide for determining at a later stage the amount of gains treated as accruing on the occurrence of chargeable events in relation to the relevant shares.

Analysis

The words quoted in inverted commas in paragraph 32 of this decision show that the "accrual time" in respect of the "original gain" for the purposes of Schedule 5B is later than would otherwise have been the case, where "qualifying expenditure" on "relevant shares" has taken place in an amount that can be set against the "original gain". There is no dispute in this case that there has been such expenditure on relevant shares, and that the Appellant is entitled to an agreed amount of deferral relief.

That later time is determined by the occurrence of one or more chargeable events as provided by paragraphs 4 and 5 of Schedule 5B. The tribunal is not concerned with any such chargeable event for present purposes.

Paragraph 16 of Schedule A1 of the 1992 Act deals with the situation where Schedule 5B treats gains as accruing after the disposal of assets. Section 2A of the 1992 Act is to be construed subject to and in accordance with that schedule. The application of the taper relief under that section must therefore contemplate such later accruals.

By s 2(2) of the 1992 Act, capital gains tax is to be charged on chargeable gains accruing in the year of assessment. Before s 2A was ever enacted, Schedule 5B provided for late accruals of chargeable gains, so that tax would not be payable on such gains in the year of assessment.

Section 2A is dealing with accrued chargeable gains as mentioned in section 2(2). Those chargeable gains do not include ones where accrual has not taken place. The only chargeable gains relevant for s 2A in a given year of assessment are those which have accrued to the chargeable person in the year of assessment.

The basis of construction of the 1992 Act that should be applied

The Appellant submits that the accrual provisions of the 1992 Act just discussed are so-called "deeming" provisions, so that the tribunal should adopt the approach of Peter Gibson J, sitting in the Court of Appeal in the case of Marshall (Inspector of Taxes) v Kerr [1993] STC 360 at 366d-e, quoted by Lord Browne-Wilkinson in the same case in the House of Lords, reported at [1994] STC 638 at 649c-d, viz –

"For my part I take the correct approach in construing a deeming provision to be to give the words used their ordinary and natural meaning, consistent so far as possible with the policy of the Act and the purposes of the provisions so far as such policy and purposes can be ascertained; but if such constructions would lead to injustice or absurdity, the application of the statutory fiction should be limited to the extent needed to avoid such injustice or absurdity, unless such application would clearly be within the purposes of the fiction. I further bear in mind that because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so".

I can well understand the submission that what would otherwise be a chargeable gain accruing in the year of assessment is, by the effect of the 1992 Act, not deemed so to have accrued. But this is really only another way of saying that chargeable gains fall into two categories, one subject to tax now, and the other not. The 1992 Act in its amended form has taken the form it has because it has been altered and expanded in successive Finance Acts to cater for a wider range of situations than initially contemplated. Itself a consolidating act, the 1992 Act will one day be re-enacted in rewritten form which, for the sake of clarity if for no other reason, will ideally spell out more simply which gains come into charge in a particular year of assessment, and which do not.

However, as matters stand, the 1992 Act is not in my opinion unclear as to the provisions which I am called upon to consider. The 1992 Act is not ambiguous. Whilst the position was complicated by the enactment of reinvestment relief, followed by deferral relief and taper relief, the respective provisions relating to those reliefs have been made to interact from time to time in a manner which makes sense. There is no statutory fiction leading to injustice or absurdity of the kind mentioned in the Marshall case.

The Appellant has also referred the tribunal to Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes) [2005] STC 1. This recent House of Lords authority of major importance operates as a qualification to the approach to construing taxing statutes adopted by the House in MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] STC 237. Whilst that approach should be to adopt a purposive construction, it was held in the Barclays Mercantile case that the MacNiven case unduly emphasized the dichotomy between provisions having a commercial and non-commercial (or "legal") purpose respectively. The principle of purposive interpretation, so the House held in the Barclays Mercantile case, required an analysis of what the statute in question meant, and there was to be no prior assumption that concepts might be classified as commercial or "legal" respectively.

The Appellant prays in aid the Barclays Mercantile case in support of the general proposition that legislation should not be construed without regard to its purpose and the intentions of Parliament. I have already mentioned that I have only been referred to one piece of parliamentary material relevant to this submission – and that by the Revenue. However, it seems to me that the only evidence of the purpose and intentions of Parliament in respect of the 1992 Act, as successively amended and added to, must be the statute itself, unless I am satisfied that the exception in the Pepper case applies.

I do not read the Barclays Mercantile case as in any sense departing from the principle well expressed in the words of Lord Wilberforce in the House of Lords case of Black-Clawson International Ltd v Papierwerke Waldhof-Aschaffenburg AG [1975] AC 591 at 629F-G (to which the Pepper case introduced a limited exception), viz –

"Legislation in England is passed by Parliament, and put in the form of written words. This legislation is given legal effect on subjects by virtue of judicial decision, and it is the function of the courts to say what the application of words to particular cases or particular individuals is. This power, which has been devolved on the judges from the earliest times, is an essential part of the constitutional process by which subjects are brought under the rule of law – as distinct from the rule of the King or the rule of Parliament; and it would be a degradation of that process if the courts were to be merely a reflecting mirror of what some other interpretation agency might say … ".