United Kingdom Special Commissioners of Income Tax Decisions

D'Arcy v Revenue & Customs [2006] UKSPC SPC00549 (14 June 2006)

SPC00549

ACCRUED INCOME SCHEME – short sale of gilts – whether the Appellant "becomes and does not cease to be entitled to them on the day" within s 710(7) TA 1988 – no – accordingly on no day did the nominal value of gilts held by her exceed £5,000 and no charge arises under the accrued income scheme

PRACTICE – Revenue stating its conclusion in the closure notice that Ramsay applied to deny a deduction for manufactured interest – whether it is open to them to abandon the Ramsay argument and contend that instead a charge to tax arises under the accrued income scheme – yes – appeal allowed

THE SPECIAL COMMISSIONERS

PHILIPPA D'ARCY Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY'S

REVENUE AND CUSTOMS Respondents

Special Commissioner: DR JOHN F. AVERY JONES CBE

Sitting in public in London on 23 and 24 May 2006

Kevin Prosser QC and Mr James Henderson, counsel, instructed by P E Shirley & o, chartered accountants, for the Appellant

Michael Furness QC, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2006


 


DECISION

1. This is an appeal by Mrs Philippa D'Arcy against the conclusion in a closure notice dated 15 February 2005 and the amendments to her return for 2001-02 to give effect to that conclusion. The Appellant was represented by Mr Kevin Prosser QC and Mr James Henderson, and the Revenue by Mr Michael Furness QC.
2. In brief the Appellant entered into a tax avoidance scheme involving transactions in gilts designed to create a tax deduction for a manufactured interest payment. The Revenue issued a closure notice contending that Ramsay applied with the effect that no deduction was created (and a smaller amount of income was not taxable), but they have since abandoned that contention and now contend that the deduction is allowable but that Appellant is taxable on an amount approximately equal to the deduction under the accrued income scheme. The Appellant raises two points, first that the Revenue cannot change the basis of their conclusion as stated in the closure notice, and secondly, that the accrued income scheme does not give the result for which the Revenue contend. I understand that there are other cases where the taxpayer has entered into a similar scheme but it is only the Appellant who has received a closure notice in relation to it, so that the procedural point will not be relevant to the other cases.
3. I had a bundle of documents and skeleton arguments from both parties including a skeleton in reply from the Appellant. There was an agreed statement of facts as follows to which I have added a few words of clarification between square brackets:

(1) The appellant is Mrs Philippa D'Arcy (formerly Ahern, née Rose) who is the founder and chief executive officer of a company called The Rose Partnership which carries on specialist executive search business in the City of London.

(2) The Appellant was introduced to the relevant transactions by Mr Philip Shirley, a tax adviser. Mr Shirley wrote to the Appellant by letter dated 10 January 2002

(3) Attached to this letter was a projection, prepared by Mr Shirley, of the returns, costs and tax effects of the proposed transactions, subject (as mentioned in the letter) to the possibility of a movement in the value of the gilts.

(4) On 16th January 2002, the Appellant countersigned the letter of 10 January 2002 thereby accepting its terms.

(5) The letter and projection referred to proposed transactions with a nominal value of £33.5m; in the event the actual transactions had a nominal value of £31m

(6) Having been contacted by Mr Shirley, NCL Investments Limited ("NCL"), a firm of agency brokers and members of The Stock Exchange, wrote a letter dated 23 January 2002 addressed to the Appellant and headed "Execution Only Service Terms and Conditions" setting out their standard terms and conditions. This letter was countersigned by the Appellant on 24 January 2002

(7) By a second letter dated 23 January 2002 addressed to the Appellant and headed "Stock Lending Master Loan Agreement," NCL set out the terms on which they would provide a facility to "repo" securities on behalf of the Appellant. This letter was dated and signed for and on behalf of NCL on 24^th January 2002 and countersigned by the Appellant on 25 January 2002.

(8) Annexed to the second letter of 23 January 2002 was a Global Master Repurchase Agreement ("GMRA") between NCL and Royal Bank of Scotland Plc ("RBS") dated as of 13^th August 2001, setting out the standard International Securities Market Association (ISMA) terms on which NCL would enter into "repo" transactions with RBS.

(9) By letter dated 24 January 2002 Mr Shirley told the Appellant that he was expecting to do the transactions around 13/14 February 2002 and that he would contact her shortly before the 12^th February to inform her of the margin to be provided to NCL.

(10) The Appellant transferred £350,000 to NCL on 12 February 2002 by transfer from her account with HSBC Republic.

(11) On 13 February 2002, NCL entered into a "repo" transaction with RBS on the standard ISMA terms whereby NCL agreed to buy £31m nominal value Treasury 9¾ % 2002 gilts (the "Gilts") from RBS for settlement on 14 February 2002 for a purchase price of £33,664,926.15 [at the price of £108.596536 which includes accrued interest]; and NCL agreed to re-sell to RBS equivalent Gilts for settlement on 20 February 2002 for a resale price of £33,683,464.92 (interest element £18,538.77). The Gilts were transferred from RBS's account with the Central Gilts Office (CGO) to NCL's CGO account in accordance with normal practice.

(12) NCL carried out transactions on behalf of a number of other persons at the same time as the Appellant and the aggregate transaction related to gilts with a nominal value of £139.4m and the documentation in relation to the transactions with RBS and JPMS (see below) refer to the aggregate values of the transactions.

(13) Since the term of the "repo" extended over an "Income Payment Date" (as defined as the record date, here corresponding to the ex div date), it was a term of the repo transaction that NCL should pay RBS £1,511,250 by way of "manufactured interest."

(14) By letter to the Appellant dated 19^th February 2002, NCL confirmed the terms of the repo transaction.

(15) On 13 February 2002, NCL agreed with a market maker, JP Morgan Securities ("JPMS") to sell to JPMS £31m nominal value Gilts for settlement on 14^th February 2002 for a sale price of £33,325,176.90 [I have changed this figure to the figure in the contract note from £33,238,276.90 in the agreed statement of facts; this is made up of the price at £102.98 (£31,923,800) plus 171 days of accrued interest (£1,404,476.90) and less commission (£3,100)]. This transaction took place in accordance with the rules of The Stock Exchange with the market maker offering the best price prevailing at the time.

(16) NCL subsequently confirmed to the Appellant the terms of the transaction with JPMS by issuing a Contract Note dated 13 February 2002.

(17) On settlement of this transaction, on 14 February 2002 JPMS paid NCL £33,325,176.90, and this amount was credited by NCL to the Appellant's account. The Gilts were transferred from NCL's CGO account to JPMS's CGO account in accordance with normal practice.

(18) On 20 February 2002, NCL agreed with a market maker, again JPMS, to buy from JPMS £31m nominal value Gilts for settlement the same day for a purchase price of £31,855,456.79 [made up of the price at £102.935 xd (£31,909,850) less 7 days accrued interest (£57,493.21) plus commission (£3,100)]. This transaction took place in accordance with the rules of The Stock Exchange with the market maker offering the best price prevailing at the time.

(19) NCL subsequently confirmed to the Appellant the terms of the transaction with JPMS by issuing a Contract Note dated 20 February 2002.

(20) The purchase price was paid to JPMS by NCL on 20 February 2002 and the Appellant's account with NCL was debited with this amount. The Gilts were transferred from JPMS's CGO account to NCL's CGO account in accordance with normal practice.

(21) Also on 20 February 2002, NCL closed out the repo transaction by transferring the Gilts to RBS for the agreed sale price of £33,683,464.92, which amount was credited to the Appellant's account with NCL. The Gilts were transferred from NCL's CGO account to RBS's CGO account in accordance with normal practice.

(22) On 20 February 2002 Mr Shirley sent a fax to the Appellant informing her of the terms and effects of the closing out of the short position.

(23) On 27 February 2002 the date on which the half yearly coupon was due to be paid on the Gilts, NCL paid the sum of £6,795,750 to RBS and the Appellant's account was debited with her share of that amount (ie £1,511,250).

(24) The Appellant did not, apart from the above, hold any securities within the meaning of s.710 ICTA 1988 in 2000/01 or 2001/02.

(25) The sole reason why the Appellant entered into the Stock Lending Master Loan Agreement with NCL was to reduce her income tax liability.

The procedural question

4. This question is whether the Revenue can argue in this appeal that the accrued income scheme applies, contrary to their conclusion stated in the closure notice that Ramsay applied.
5. I find the following additional facts relating to this question:

(1) The closure notice dated 15 February 2005 stated:

"My conclusion is that the disposal, acquisition and repo over £31,000,000 nominal of Treasury 9¾% 2002 should be regarded as a composite whole which was circular and self cancelling….Your return is amended as follows:

Claim. Your tax return included a claim for income tax relief in respect of manufactured interest of £1,511,250. In my opinion, the claim is not allowable.

Income. In connection with the transaction giving rise to your claim for manufactured interest relief, you returned interest from Royal Bank of Scotland and from NCL Investments Ltd totalling £19,578. In my opinion, the income should be reduced by that amount, in view of the disallowance of your claim for relief for manufactured interest."

The figure for the amended self-assessment to reflect these two amendments was then stated.

(2) On 3 March 2005 the Appellant appealed against both the enquiry conclusions and the amendment made to the self-assessment. In the appeal form the box following the words "I cannot agree the enquiry conclusions because" was left blank. In the box following the words "I cannot agree the amendment because" her agent wrote "The loss of £1,511,250 is allowable for the reasons already set out in correspondence and your conclusion has no basis fact or law." Accordingly that box included the reasons against both with the amendment and the conclusion.

(3) Mr Furness's skeleton stated that "Having considered the witness statement of Mr Mockford, the Revenue no longer wish to run the Ramsay argument." The witness statement had explained that the sale and purchase both being with JPMS was coincidental and it was that they offered the best price on both occasions.

6. The following provisions of the Taxes Management Act 1970 are relevant:

"28A Completion of enquiry into personal or trustee return

(1) An enquiry under section 9A(1) of this Act is completed when an officer of the Board by notice (a "closure notice") informs the taxpayer that he has completed his enquiries and states his conclusions.

In this section "the taxpayer" means the person to whom notice of enquiry was given.

(2) A closure notice must either—

(a) state that in the officer's opinion no amendment of the return is required, or

(b) make the amendments of the return required to give effect to his conclusions.

(3) A closure notice takes effect when it is issued…

(4) The taxpayer may apply to the Commissioners for a direction requiring an officer of the board to issue a closure notice within a specified period….

31 Appeals: right of appeal

(1) An appeal may be brought against—

(a) …

(b) any conclusion stated or amendment made by a closure notice under section 28A or 28B of this Act (amendment by Revenue on completion of enquiry into return),

(c) …

(d) any assessment to tax which is not a self-assessment.

48 Application to appeals and other proceedings

(1) In the following provisions of this Part of this Act, unless the context otherwise requires—

"appeal" means any appeal to the General Commissioners or to the Special Commissioners under the Taxes Acts,

"the Commissioners" means the General Commissioners or the Special Commissioners as the case may be.

(2) The following provisions of this Part of this Act shall apply in relation to—

(a) appeals other than appeals against assessments, and

(b) proceedings which under the Taxes Acts are to be heard and determined in the same way as an appeal,

subject to any necessary modifications, including (except in the case of applications under section 55 below) the omission of section 56 (9) below.

50 Procedure

(1)–(5) ...

(6) If, on an appeal, it appears to the majority of the Commissioners present at the hearing, by examination of the appellant on oath or affirmation, or by other ...evidence,—

(a) that, ...the appellant is overcharged by a self-assessment;

(b) that, ...any amounts contained in a partnership statement are excessive; or

(c) that the appellant is overcharged by an assessment other than a self-assessment,

the assessment or amounts shall be reduced accordingly, but otherwise the assessment or statement shall stand good.

(7) If, on an appeal, it appears to the Commissioners—

(a) that the appellant is undercharged to tax by a self-assessment

(b) …

(c) that the appellant is overcharged by an assessment other than a self-assessment,

the assessment or amounts shall be increased accordingly.

(7A) If, on appeal, it appears to the Commissioners that a claim or election which was the subject of a decision contained in a closure notice under section 28A of this Act should have been allowed or disallowed to an extent different from that specified in the notice, the claim or election shall be allowed or disallowed accordingly to the extent that appears to them appropriate, but otherwise the decision in the notice shall stand good."

7. Mr Furness , for the Revenue, contends:

(1) Section 28A requires the Revenue to state its conclusions and to amend the self-assessment. It is not possible to have alternative amendments in the way the Revenue used to be able to make alternative assessments. The Revenue are therefore entitled to make alternative arguments in the course of an appeal. The way they are prevented from ambushing the taxpayer with new arguments is by way of case management by the Commissioners hearing the appeal.

(2) Section 31(1)(b) is the "gateway" for taxpayers who wish to appeal. It is designed to ensure that the taxpayer can appeal only once there has been an amendment to the self-assessment. It permits appeals against the conclusion or the amendment made by the closure notice. The amount of tax is determined by the amendment. Here the appeal is against both but the reasons for appealing are against the amendments, so that the thrust of the appeal is about the amount of tax.

(3) The appeal Commissioners' duty (and therefore jurisdiction) under s 50 is to determine the amount of tax payable on the assessment under appeal, which may be higher than that in the amendment. The reference in s 50(6) and (7) to the self-assessment must be to the self-assessment in its amended form; the issue is whether the taxpayer is over- or undercharged by a self-assessment as a whole. The Commissioners on appeal must determine the figure; they are not required to adjudicate on the reasons for the amount of tax raised in the assessment. As Lord Wright MR said in R v Special Commissioners ex p. Elmhirst [1936] 1 KB 487, 493:

"…the [appeal] Commissioners are exercising statutory authority and a statutory duty which they are bound to carry out. They are not in the position of judges deciding an issue between two particular parties. Their obligation is wider than that. It is to exercise their judgment on such material as comes before them and to obtain any material which they think is necessary and which they ought to have, and on that material to make the assessment or the estimate that the law requires them to make. 'They are not deciding a case inter partes; they are assessing or estimating the amount on which, in the interests of the country at large, the taxpayer ought to be taxed."

(4) The position was exactly the same before self-assessment; the Special Commissioners' jurisdiction was to determine the amount of the assessment. So that in Glaxo Group Limited v IRC [1996] STC 191 the Court of Appeal held that the Revenue were entitled in the course of an appeal to raise a new issue and the Commissioners hearing the appeal had the duty to increase the assessment if the evidence justified this. In the High Court [1995] STC 1075, Robert Walker J (as he then was) said at p 1088j:

"Moreover he [the Inspector] may support the open assessment both up to and beyond the assessed sum on grounds which were not correctly specified, or were even non-existent, at the time when the assessment under appeal was made."

However, he recognised at p 1090c that this entitlement had to be matched with suitable case management:

"I should perhaps add that this conclusion in principle in no way detracts from the taxpayer's right to know, well in advance of any appeal hearing, the case that he has to meet (or rather, the main points likely to be taken against him at a hearing where the burden of proof rests on him). In practice, inspectors and the Solicitor of Inland Revenue do usually do their best to co-operate with taxpayers in defining the real issues and so making good what may be thoroughly uninformative notices of assessment and notices of appeal. Since the Sch D, Case I computation of a large trading company may include literally hundreds of points of possible dispute, such definition is obviously needed."

(5) Accordingly it was open to him to argue that the accrued income scheme applied in this appeal.

8. Mr Prosser and Mr Henderson, for the Appellant, contend that:

(1) Section 50(7) must be read in the context of the particular appeal. The reference in s 50(7)(a) to the appellant being undercharged to tax by a self-assessment is to an undercharge relating to the subject-matter of the appeal.

(2) In the context of an appeal against a conclusion stated in a closure notice, and an amendment to give effect thereto, the undercharge to which s 50(7)(a) refers is to one relating to that conclusion and to that amendment.

(3) Accordingly s 50(7) requires the Special Commissioner to increase the assessment if he upholds, or varies, the conclusion and decides that the amendment to give effect to the (varied) conclusion is inadequate. This is not an unwarranted modification to the wording of s.50(7), because TMA s.48(2) provides that s.50 (inter alia) applies in relation to appeals other than appeals against assessments subject to any necessary modifications.

(4) The reason why the above interpretation is correct, and also why modifications are necessary, is because it makes no sense to regard an appeal against a particular conclusion as tantamount to an invitation to the Commissioner hearing the appeal to conduct his own inquiry into the taxpayer's return, or to a licence for the Revenue to continue their inquiries into the taxpayer's return even though the officer has completed his inquiries by issue of a formal closure notice subject only to the particular conclusion and amendments to give effect thereto.

(5) In an appeal against an assessment, the subject matter of the appeal is the correctness or otherwise of the assessment. Therefore it is clearly open to the Commissioner hearing the appeal to increase the assessment for any reason, including by reference to additional income not previously part of the assessment. In other words, in deciding whether the assessment is correct the Commissioner must consider the matter generally; he is not limited by the issues formulated by the parties.

(6) By the same token, in an appeal against a conclusion stated in a closure notice, the subject-matter of the appeal is the correctness or otherwise of the conclusions and what amendments should be made to give effect to the conclusion as upheld or varied. By analogy where s 50(7A) applies it is the decision that stands good, subject to variation of the figures.

(7) It follows that the authorities relied on by the Revenue do not help the Revenue at all. They concern the procedure on an appeal against an assessment, and merely confirm that the task of the Commissioner hearing the appeal is to decide on the correctness of the assessment, including by reference to additional income (e.g. the transfer pricing income in Glaxo).

(8) The appeal should be allowed on the basis that the Revenue have abandoned the conclusion on which they based the closure notice.

Reasons for the decision

9. Self-assessment made a major change to the system of appeals. Originally assessments were often estimated and made in the absence of any information. Appeals against such assessments could raise any issues relating to the income assessed, such as trading profits, as Glaxo demonstrates, and the only counter to the Revenue's right to raise new issues subsequent to the assessment was proper case management. Self-assessment is different. The Revenue have the information from the taxpayer first; they may decide to enquire into a return, in which case they give notice to the taxpayer; they consider the return and are obliged (and if necessary can be forced by the taxpayer, see s 28A(4)) to come to, and state, a conclusion in a formal notice (a closure notice); and the closure notice must (assuming that the conclusion is that an amendment to the return is required) make the amendments of the return required to give effect to the officer's conclusions. If the taxpayer does not agree with either the conclusion or the amendment he can appeal against the conclusion or the amendment. It is possible for a conclusion not to lead to an amendment, for example where the taxpayer returns a loss, which the Revenue agrees is a loss so that no amendment to the nil figure in the return is necessary, but the conclusion states an amount of loss to be carried forward which the taxpayer disputes. But normally there will be an amendment to the return to give effect to the Revenue's conclusions stated in the closure notice.
10. Sections 31(1)(b) (that an appeal may be brought against the conclusion or amendment in a closure notice) and s 50(6) and (7) (that the appeal Commissioners' jurisdiction is to determine whether the appellant is over- or undercharged by the self-assessment) do not appear to fit together well. What, for example, is the procedure for an appeal against a conclusion that does not lead to an amendment? And if there is an appeal against both the conclusion and the amendment the appeal Commissioners are apparently not required to adjudicate on the reasons for the amendment; they must either reduce or increase the assessment or allow it to stand good. This apparent mismatch is the basis for Mr Furness's contention that once there is an appeal against something, the appeal Commissioners' jurisdiction is to determine the figure in the whole of the self-assessment, whether or not it has any relationship to the conclusion or amendment that is the subject matter of the appeal. Such a reading could be even wider than the previous system of appeals against an assessment, under which the assessment (on an individual) was limited to the source of income assessed; under self-assessment the figure in the whole of the return could be amended. The logical end result of his contention has to be that if the Revenue come to a conclusion about a trading profit, which the taxpayer appeals, there is nothing to prevent the Revenue from contending in the course of the appeal that the taxpayer is liable to more tax on something quite different, say rent. I do not consider that this is a correct reading. If Parliament had intended a continuation of the system of appeals against assessments there would have been no need to provide that an appeal may be brought against the conclusion or amendment; the equivalent of the former system would have been that the appeal was against the amended self-assessment. Instead Parliament enacted a system under which the Revenue had to state a conclusion and make an amendment, against which an appeal could be brought, necessarily limited to that conclusion or amendment. Accordingly, I consider that s 50(6) (and similarly with (7)) should be read in the context of s 31(1)(b) in this way:

If, on an appeal [against a conclusion or amendment to a self-assessment stated in a closure notice], it appears to the majority of the Commissioners present at the hearing, by examination of the appellant on oath or affirmation, or by other ...evidence,—

(a) that, ...the appellant is overcharged by a[n amended] self-assessment [so far as concerns matters appealed against];…

the assessment… shall be reduced accordingly, but otherwise the assessment …shall stand good.

I prefer to base this on the context rather than Mr Prosser's contention that s 48(2) requires a necessary modification to s 50(7) to deal with appeals other than appeals against assessments because although this is an appeal against a conclusion and amendment it relates to an assessment, namely a self-assessment, hence the closing words that "the assessment…shall be reduced accordingly…". It follows that by starting an appeal, while the taxpayer is still at risk of having the figure in the amendment increased, this is limited to an increase in the figure related to the conclusion or amendment. In contrast, with an appeal under s 31(1)(d) against an assessment other than a self-assessment, where the appeal is against the assessment, the former system that everything covered by the assessment was within the scope of the appeal and the assessment can be increased on account of something not in contemplation at the time it was made (as in Glaxo), continues to apply. The difficulty is that s 50(6) and (7) has to deal with both types of appeal.

11. The scope of an appeal against a conclusion or amendment made by a closure notice will depend on the facts. If the conclusion is that the officer does not believe that the records of the trading profit are complete and he fixes the profit at an estimated amount, the scope of the appeal may be wide enough to include any matters that make up the trading profit. If, on the other hand, the conclusion were that some item in the computation of the trading profit was non-deductible the appeal is restricted to whether or not it is deductible. In this appeal the conclusion was very specific, that "the disposal, acquisition and repo over £31,000,000 nominal of Treasury 9¾% 2002 should be regarded as a composite whole which was circular and self cancelling." The scope of the appeal therefore concerns these transactions in the Gilts and nothing else.
12. I should add that, contrary to Mr Furness's contention I see no reason why alternative conclusions should not be stated in a closure notice with the amendment necessarily giving effect to the Revenue's preferred conclusion. Indeed, if they considered that an individual was liable either to income tax on a trading profit or to capital gains tax, it would seem to be essential that they could keep both options open. There is no need for the appeal system to allow scope for such alternative contentions when they are not stated in the closure notice.
13. The next question is how conclusions of law stated in the closure notice fit into the system of appeals against the conclusion or amendment. Sections 50 (6) and (7) are silent on matters of law. Whether a taxpayer is under- or overcharged is to be decided "by examination of the appellant on oath or affirmation, or by other evidence" and the assessment shall be reduced or increased accordingly (or stand good). (Probably the reason is historical; these words were in 43 Geo.3 c.99 s.26 applying to "assessed taxes," such as taxes on servants, horses, carriages and hair powder, which presumably were not likely to raise issues of law, and were first incorporated into income tax by reference by Addington's Act, 43 Geo.3 c.122 s.2.) Clearly decisions must be made by the tribunal on law and indeed there is an appeal from this tribunal under s 56A if either party "is dissatisfied in point of law." These provisions seem to me to indicate that the jurisdiction of appeal Commissioners is not merely to decide whether the stated conclusion on a point of law in the closure notice is right or wrong and, if wrong, to allow the appeal and reduce the amendment to nil. I agree with Mr Furness that such a result is inconsistent with the tribunal's duty to decide whether the appellant is over- or undercharged by the self-assessment and accordingly to determine the figure for the amendment to the self-assessment, although I have doubts whether the passage he cited from ex p. Elmhirst, with its references to the Commissioners using their judgment in making the assessment and in dealing with the appeals, is still good law after the ending of the Commissioners' assessing functions. It seems to me inherent in the appeal system that the tribunal must form its own view on the law without being restricted to what the Revenue state in their conclusion or the taxpayer states in the notice of appeal. It follows that either party can (and in practice frequently does) change their legal arguments. Clearly any such change of argument must not ambush the taxpayer and it is the job of the Commissioners hearing the appeal to prevent this by case management. That is not an issue here.
14. I would make a distinction between this case and an analogous one, though not dealing with a closure notice, that I dealt with recently which is not yet reported as it dealt with a preliminary issue. There the Revenue had refused a sub-contractors' certificate on the grounds that the taxpayer had not satisfied the statutory conditions relating to the type of business and the amount of turnover, but they did not state that they had not considered whether the taxpayer had satisfied the compliance conditions. The Revenue later accepted that the taxpayer did satisfy the business and turnover conditions and then sought to raise compliance failures. I decided that as they had not refused the certificate on the ground of compliance failures (and had not told the taxpayer that these had not been considered) they could not raise them except to the extent that compliance failures had come to their attention in dealing with the satisfaction of the other conditions. I would regard that as being a case where the Revenue changed the factual basis of their refusal, because it was based on different facts concerning compliance, than the legal basis, even though these new facts raised a different legal basis. I mention this because I understand that my decision is under appeal, which could be relevant if this decision is appealed.
15. Accordingly, on the procedural issue, while I take a narrower view than that contended for by Mr Furness of what the Revenue are permitted to raise in the course of an appeal, I consider that it is open to the Revenue to argue the accrued income scheme issue in this appeal on the basis that it is a new argument of law related to the facts identified by the closure notice.

The accrued income scheme question

16. I shall for convenience refer to the acquisition of the Gilts from RBS as "the first leg of the repo" and their disposal back to RBS as "the second leg of the repo"; to the Appellant's sale of the Gilts to JPMS on 13 February 2002 as "the Sale," and to her purchase of the Gilts from JPMS on 20 February 20032 as "the Purchase."
17. The deduction for the manufactured payment of interest pursuant to the repo arises under paragraph 3 of Schedule 23A to the Taxes Act 1988 (as substituted by Schedule 10 to the Finance Act 1997):

3—(1) This paragraph applies (subject to paragraph 3A below) in any case where, under a contract or other arrangements for the transfer of United Kingdom securities, one of the parties (an "interest manufacturer") is required to pay to the other ("the recipient") an amount ("the manufactured interest") which is representative of a periodical payment of interest on the securities.

(2) For the relevant purposes of the Tax Acts, in their application in relation to the interest manufacturer—

(a) the manufactured interest shall be treated, except in determining whether it is deductible, as if it—

(i) were an annual payment to the recipient, but

(ii) were neither yearly interest nor an amount payable wholly out of profits or gains brought into charge for income tax;

(b) the gross amount of that deemed annual payment shall be taken—

(i) to be equal to the gross amount of the interest of which the manufactured interest is representative; and

(ii) to constitute income of the recipient falling within section 1A; and

(c) an amount equal to so much of the gross amount of the manufactured interest as is not otherwise deductible shall be allowable as a deduction against the total income or, as the case may be, total profits of the interest manufacturer...".

3A—(1) Where any manufactured interest is representative of interest on securities to which this paragraph applies—

(a) paragraph 3(2) above shall not require any deduction of tax to be made on the payment of that manufactured interest; and

(b) without prejudice to any other liability of his to income tax in respect of the manufactured interest, the recipient shall not by virtue of paragraph 3(5) above be liable to account for any income tax in respect of that manufactured interest.

(2) This paragraph applies to—

(a) gilt-edged securities (within the meaning of section 50; and

(b) securities not falling within paragraph (a) above on which the interest is payable without deduction of tax.

18. It should also be mentioned that s 727A (inserted by s 79 of the Finance Act 1995) prevents relief on the rebate amount on the first leg of the repo:

"727A Exception for sale and repurchase of securities

(1) Where securities are transferred under an agreement to sell them, and under the same or any related agreement the transferor or a person connected with him—

(a) is required to buy back the securities, or

(b) acquires an option, which he subsequently exercises, to buy back the securities,

section 713(2) and (3) and section 716 do not apply to the transfer by the transferor or the transfer back."

19. The way the scheme was intended to work is that the Appellant made a tax-free capital gain on the difference between the Sale (cum div) and the Purchase (ex div) to and from JPMS of the Gilts of £1,469,720. Pursuant to the repo she pays manufactured interest of £1,511,250 which is deductible from her total income, but she receives repo interest of £18,538.77 and additional interest of £1,038.86. Accordingly she claims tax relief on the balance of £1,491,672.50. (I should mention that s 108(5) of the Finance Act 2002 now limits the deduction to the extent that the payer is taxable under the accrued income scheme or repos.) Although in principle there is a charge to tax on the Sale under the accrued income scheme, the Appellant contends that the charge does not apply because of s 715(1)(b):

"(1) Section 713(2)(a) or (3)(a) (as the case may be) [which charge tax and give a rebate under the accrued income scheme] does not apply—

…

(b) if the transferor is an individual and on no day in the year of assessment in which the interest period ends or the previous year of assessment the nominal value of securities held by him exceeded £5,000;…".

This contention is at first sight surprising since the nominal value of the Gilts was £31m, but the contention turns on there not being a day on which she held the Gilts within the accrued income scheme legislation.

20. The following provisions of s 710 are relevant to that question:

"(6) Where an agreement for the transfer of securities is made, they are transferred, and the person to whom they are agreed to be transferred becomes entitled to them, when the agreement is made and not on a later transfer made pursuant to the agreement; and "entitled", "transfer" and cognate expressions shall be construed accordingly.

(7) A person holds securities—

(a) at a particular time if he is entitled to them at the time;

(b) on a day if he is entitled to them throughout the day or he becomes and does not cease to be entitled to them on the day.

(8) A person acquires securities when he becomes entitled to them."

21. Mr Prosser and Mr Henderson contend

(1) Subsection (6) treats both legs of the repo as taking place on 13 February 2002, the Sale on 13 February 2002 and the Purchase on 20 February 2002. Applying subs (7)(b) to determine whether the Appellant held the Gilts on any of the relevant days, on no day was she entitled to Gilts throughout the day, and it cannot be said of any of the days that she "becomes and does not cease to be entitled to them on the day."

(2) On 13 February 2002 on a common-sense identification she became entitled to the Gilts under the first leg of the repo and immediately ceased to become entitled to them under the Sale, with the result that she did not hold them on that day. Between 14 and 19 February 2002 she was not entitled to any Gilts. On 20 February 2002 she became entitled to the Gilts under the Purchase but she had ceased to be entitled to the Gilts under the second leg of the repo on 13 February 2002 and so it cannot be said that on 20 February 2002 she "becomes and does not cease to be entitled to them," because this implies first becoming entitled and then ceasing to be entitled. She ceased to be entitled on 20 February 2002 because she only became entitled to them on that day. It is an abuse of language to say that she ceased to be entitled to the Gilts before she became entitled to them.

(3) Section 715(1)(b) applies when the taxpayer buys and sells Gilts on the same day, however large the amount. The same applies where the taxpayer sells and then buys on the same day; in such case the taxpayer's period of ownership is non-existent. The result is the same where the sale is followed by the purchase on different days; the taxpayer's period of ownership is non-existent.

22. Mr Furness contends:

(1) On a purposive interpretation, s 715(1)(b) is designed to prevent individual holders of small amounts of securities from making the calculation required by the accrued income scheme, not to let out large dealings in the course of a day (which do not need excluding because no income accrues in the course of a day).

(2) One should look at both legs of the repo together as both happening on 13 February 2002. Since the Sale took place on 13 February 2002 and the Purchase on 20 February 2002 it cannot be said that she "becomes and does not cease to be entitled to them on the day [20 February 2002] because she had ceased to be entitled to them on 13 February 2002. Accordingly she was treated as being entitled to the Gilts on 20 February 2002 with the result that s 715(1)(b) does not exclude her from the charge.

Reasons for the decision

23. Section 710(7) in paragraph (a) determines that a person holds securities at a particular time if he is entitled to them at the time, thus incorporating the rule in subs (6) that time of entitlement is determined by the time of the agreement. Paragraph (b) envisages two possibilities, first that a person is entitled to securities throughout the day, which means that, again taking the timing from the agreement to buy or sell, he holds them at midnight on day 1 to midnight on day 2; and secondly, that he becomes and does not cease to be entitled to them on the day, meaning that while he was not entitled for the whole of the day, he was for the part of the day from the time of becoming entitled up to the end of the day. The distinction between the two parts is that the first looks at entitlement during the whole of the day and the second to entitlement during part of the day. Both parts of paragraph (b) operate by reference to the position at the end of the day. One determines whether a person holds securities at the end of the day by applying subss (6) and (7)(a). If therefore a person buys and sells (whether in that order or the sale preceding the purchase) securities during the course of a day, he does not hold them on that day. Once the deemed timing rule in subs (6) has been applied, the rules in subs (7) look to the reality of ownership for the whole day or a part of a day up to the end of the day. When applied to a short sale the reality is that the period of ownership is nonexistent. To say that one becomes and does not cease to be entitled on the day, implies that there is a period of ownership that starts during the day and continues until the end of the day. It is a misuse of language to say that the taxpayer ceases to be entitled to them before he became entitled. There is no need for the accrued income scheme to apply to a short sale. Mr Furness explained that if, for example, one sold a security for 100 with 1 of accrued interest and later bought it for 100 with accrued interest of 2, there was a charge on 1 on the sale and a potential rebate of 2 on the purchase, but only 1 of the rebate could be used by setting it against the charge of 1. Mr Prosser pointed out that the net result was the same as if the scheme did not apply to a short sale. It is not therefore surprising that the effect of applying subs (7) to a short sale is that a person does not hold securities on a day.
24. Mr Furness starts with a purposive interpretation of s 715(1)(b), that it is aimed at individuals with small holdings of securities, but when he comes to s 710(7) his interpretation is legalistic rather than purposive: he says that she did not cease to be entitled on the day to the Gilts to which she had become entitled on that day, because she ceased to be entitled to them on an earlier day, even though at the end of the day she was clearly not entitled to any Gilts by the application of subss (6) and (7)(a). On that interpretation the two paragraphs of subs (7) would be in conflict: para.(a) saying that she was not entitled to the Gilts at the end of the day, and para (b) saying that, although she had become entitled to the Gilts during the day she had not ceased to be entitled on the day. I prefer to look at the reality which is evident throughout subs (7). At the end of 20 February 2002 she was not entitled to any Gilts, so it cannot be said that she becomes and did not cease to be entitled to them on that day because that implies that she is still entitled to them at the end of the day. Does this interpretation conflict with a purposive interpretation of s 715(1)(b)? I do not think it does. That provision uses the concept of holding securities on a day, meaning either throughout, or at the end of, the day, thus bringing s 710(7) into play with the necessary consequence that a dealing in the course of a day in securities with a nominal value of more than £5,000 still satisfies the exception in s 715(1)(b). If the draftsman had been concerned about dealings of larger amounts in the course of a day he would not have used the concept of entitlement on a day. But there was no reason for him to have been concerned with dealings during a day because no income accrues during a day.
25. Accordingly, she was not entitled to the Gilts on any day within the meaning of s 710(7) and the relief in s 715(1)(b) applies.
26. Mr Furness has an alternative argument based on the obscure s 715(6):

"(6) In any case where securities are transferred without accrued interest to a person ("the seller") and a contract is made for the sale by the seller of securities of that kind ("the seller's contract") and the seller's contract or any contract under which the securities are transferred to the seller is one in the case of which ... paragraph 3 or 4 of Schedule 23A has effect and in relation to which the seller is the dividend manufacturer, then—

(a) where the nominal value of the securities subject to the seller's contract is greater than or equal to that of the securities transferred, the seller shall not be treated as entitled to any sum to which, but for this subsection, he would be treated as entitled under section 713(3)(b) on the securities transferred;

(b) where the nominal value of the securities subject to the seller's contract is less than that of the securities transferred, any sum (or the aggregate of any sums) to which he is treated as entitled under section 713(3)(b) on the securities transferred shall be reduced by the amount of any part of the sum (or aggregate) attributable to securities ("relevant securities") of a nominal value equal to that of the securities subject to the seller's contract;

and for the purposes of sections 710 to 728 the securities which the seller contracts to sell shall not be treated as transferred by him (though treated as transferred to the person to whom he contracts to sell)."

27. Mr Furness analyses this as applying to the facts as follows:

(6) In any case where securities are transferred without accrued interest [by the Purchase] to a person [the Appellant] ("the seller") and a contract is made for the sale by the seller of securities of that kind [the second leg of the repo] ("the seller's contract") and the seller's contract [this is the relevant alternative] or any contract under which the securities are transferred to the seller [the Purchase] is one in the case of which paragraph 3 or 4 of Schedule 23A has effect and in relation to which the seller is the dividend manufacturer [which is the case with the second leg of the repo]

Paragraph (a) relieves the Appellant from tax on a small amount of rebate interest in respect of the Purchase, but more importantly:

"for the purposes of sections 710 to 728 the securities which the seller contracts to sell [under the second leg of the repo] shall not be treated as transferred by him (though treated as transferred to the person to whom he contracts to sell)."

Sections 710 to 728 comprise the whole of the accrued income scheme. Accordingly since for the purpose for the accrued income scheme the Gilts are not treated as transferred by the Appellant (even though the words in brackets accept that they were in fact transferred), she must still be entitled to them on at the end of 20 February 2002 with the result that s 715(1)(b) is inapplicable.

28. Mr Prosser and Mr Henderson analyse the facts in two possible ways. The first is the same as Mr Furness's, although he draws a different conclusion, that the purpose of not being treated as transferring the securities is merely a way of removing a double charge. He quotes the following from Simon's Taxes §A7.520:

"Provision is made to ensure that no double charge arises under both the accrued income scheme and the manufactured payments rules. The provision applies where a person B acquires securities ex div from A and contracts to sell securities of that kind cum div to C (so that B is required to manufacture a payment in respect of the interest).

In such a case, for the purposes of the accrued income scheme—

(a)   where the nominal value of the securities sold to C is equal to or greater than the nominal value of the securities acquired from A, there is no charge on B in respect of the rebate amount on the securities acquired from A;

(b)…

(c)   the securities sold to C are treated as not involving a transfer by B so that B is not charged on the accrued amount; [my italics]

(d)   the relief to C in respect of the rebate amount on the securities acquired from B is not affected."

According to this explanation the purpose of s 715(6) is merely to avoid a double charge first under the manufactured payment rules, which at the time it was enacted arose because, in place of the current reference to paragraph 3 or 4 of Schedule 23A, it referred to s 737 under which the payer was treated as making an annual payment otherwise than out of taxed profits (so that tax had to be accounted for under s 350 or Schedule 16),^[1] and secondly under the accrued income scheme. It achieves this by deeming there to have been no transfer for the purposes of the accrued income scheme, so that the scheme does not apply. The provision cannot be used to create a charge under the scheme.

29. Mr Prosser's and Mr Henderson's second analysis of the provision applying to the facts is as follows:

(6) In any case where securities are transferred without accrued interest [by the Purchase] to a person [the Appellant] ("the seller") and a contract is made for the sale by the seller of securities of that kind [the Sale] ("the seller's contract") and the seller's contract [not applicable] or any contract under which the securities are transferred to the seller [the first leg of the repo] is one in the case of which ... paragraph 3 or 4 of Schedule 23A has effect and in relation to which the seller is the dividend manufacturer [which is the case with the first leg of the repo] then…

the securities which the seller contracts to sell [under the Sale] shall not be treated as transferred by him.

Accordingly there is no charge under the accrued income scheme on the Sale. Mr Furness contends that this is not a possible analysis because the reference to "any contract under which the securities are transferred to the seller" must be the same contract as is referred to at the beginning under which securities are transferred to the Appellant. In reply Mr Prosser points out that it says "any contract."

30. I consider that the explanation in Simon's Taxes is extremely helpful in determining the purpose of s 715(6), which is to prevent the accrued income scheme from applying in the circumstances stated. It does this by deeming there to have been no transfer. The purpose does not extend to saying that the consequence must be that the person is still entitled to the securities, seemingly for ever so that the Appellant could never rely on s 715(1)(b) in the future. I also raised the possibility of the absurd consequence of her being charged on death (which was applicable at the time) on the accrued income on the £33m of Gilts that she did not then actually own. The situation is closely analogous to that in Davies v Hicks [2005] STC 850 where (to simplify the facts slightly) the trustees (1) originally acquired 100,000 shares, (2) sold 100,000 of the same shares, (3) became non-resident, (4) bought 100,000 of the same shares and (5) sold 100,000 of the same shares. The identification rules for the computation of the gain matched (2) and (4), and matched (1) and (5). If this deeming was taken to its logical conclusion, the result was that the trustees were deemed to own shares at the time of (3) when they did not, thereby enabling there to be a deemed disposal of them under a different provision. As Park J said at [26]:

"But however far a deeming provision may go, I cannot accept in this case that a provision which was intended to identify which shares acquired by a particular taxpayer should be matched with shares sold by the same taxpayer can be deemed to have had effects going far beyond that and requiring it to be imagined, for a quite different statutory purpose, that the assets held by the taxpayer at a different time did not consist of the actual assets then held by him, but rather consisted of different assets altogether."

There the deeming rule relating to identification of shares was being used by the Revenue to argue that the taxpayer owned shares that at the time he did not own for the purpose of giving rise to a charge under a different provision. Here the effect is more extreme: a deeming rule that there has been no transfer of securities having the purpose of eliminating a charge under the accrued income scheme is being used by the Revenue to argue that the Appellant must still be entitled to the securities at the end of the day in order to give rise to a charge under the accrued income scheme. The reason against both arguments is the same, that they go far beyond the purpose of the deeming; indeed, in this case they have the opposite effect from the purpose of the deeming.

31. Accordingly, I consider that s 715(6) is a deeming provision whose purpose is to prevent a double charge by removing any charge under the accrued income scheme by the mechanism of deeming there to have been no transfer (while recognising by the words in brackets that there has in fact been one). It would be going beyond the purpose of the deeming to argue that if since has been no transfer the Appellant must own the Gilts at the end of 20 February 2002 and indeed for ever. I therefore agree with Mr Prosser's first interpretation of the provision. It is not necessary for me to decide whether his alternative analysis also applies.
32. The result is that:

(1) On the procedural point the Revenue are entitled to raise the accrued income scheme issue in the appeal even though the conclusion sated in the closure notice was that Ramsay applied; and

(2) Any charge on the Sale under the accrued income scheme is excluded by s 715(1)(b) because on no day was the Appellant entitled to any Gilts as defined by the accrued income scheme, and nor does the deeming in s 715(6) that there has been no transfer of the Gilts apply to treat her as entitled to them on the day;

and I allow the appeal in principle.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER

RELEASE DATE: 14 June 2006

SC 3305/05

Authorities referred to in skeletons and not referred to in the decision:

Jerome v Kelly [2003] STC 206, [2003] STC 887

Salton v New Beeston Cycle Company [1889] 1 Ch 775

Forbes Case 8 Ch. App. 775

Molineaux v The London, Birmingham and Manchester Insurance Co [1902] 2 KB 589

Note 1   The subsequent history is somewhat complicated. FA 1991 Sch 13 para3 redrafted s 737 and excluded the treatment of manufactured interest as an annual payment where the payer was a UK resident company; and TA 1988 Sch 23A was added, para 3(2) of which treated the manufactured payment by a UK company as one of interest, and in other cases taxed the recipient on it as interest. FA 1994 s 123 added after s 737 in s 715(6) “or paras 3 or 4 of Sch 23A.” FA 1995 added para 3A of Sch 23A to which para 3 was made subject, so that a manufactured interest payment in respect of gilts became for both parties a payment of interest on the gilts. FA 1997 Sch 10 para 8 repealed s 737, and para.11 changed para 3 of Sch 23A to its then current form (see paragraph 17 of this Decision)    [Back]