CAPITAL GAINS TAX – Computation of gain – Second hand life assurance policy – Surrender proceeds brought into computation of chargeable event gain for income tax – Whether surrender proceeds to be excluded as disposal consideration for CGT purposes – No – TCGA 1992 s37(1)
CAPITAL GAINS TAX – Acquisition consideration – Wholly and exclusively for the acquisition of the asset – Second hand life assurance policies acquired for £210,000 above surrender value as part of tax avoidance scheme – Whether entire consideration incurred for acquisition of the policies or as part of pre-ordained tax avoidance scheme – Whether alternatively the £210,000 was consideration for acquisition of the policies – No – Appeal dismissed – TCGA s.38(1)
THE SPECIAL COMMISSIONERS
JASON DRUMMOND Appellant
- and –
THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents
Special Commissioner: SIR STEPHEN OLIVER QC
Sitting in public in London on 17, 18 and 19 April 2007
Patrick Way and Hui Ling McCarthy, counsel, instructed by McKie & Co Ltd, for the Appellant
Timothy Brennan QC and Nicola Shaw, counsel, instructed by the general counsel and solicitor for the Commissioners, for the Respondents
© CROWN COPYRIGHT 2007
(i) On 4 April 2001 he contracted to buy five second hand "non-qualifying" life assurance policies from a company called London & Oxford Capital Markets Plc ("London & Oxford") for a stated consideration of £1,962,233. Those five policies had each been created on 23 February 2001 on payment of single premiums of £250 by the life assured (Ellen Sedgley). On 26 March 2001 Ms Sedgley assigned them to London & Oxford which then topped each of them up with further premiums of £349,750 on 30 March 2001.
(ii) On 5 April 2001, when the surrender value of the five policies was £1,751,376, Mr Drummond requested London & Oxford to surrender the five policies. London & Oxford complied and the same day notified the life assurance company of its wish to encash the policies.
"This policy gain represents income and should, therefore, be included in your tax return for the year coinciding with the event date."
(i) Mr Drummond is wrong about section 37(1) of TCGA. The £1,751,376 paid by the insurance company on surrender was not taken into account in computing Mr Drummond's income or profits or gains. It was brought into the earlier calculation of the gain treated as arising in connection with each of the five policies for the purpose of determining the amount deemed by section 547(1) to form part of Mr Drummond's total income for the year to 5 April 2001. (I refer to this as "the section 37(1) issue".)
(ii) The difference, of some £210,000, between what Mr Drummond agreed to pay for the five policies, i.e. £1,962,233, and the amount paid out to London & Oxford following the surrender the next day, £1,751,376, is to be excluded, by reason of section 38(1)(a) of ICTA as acquisition consideration in computing Mr Drummond's gain or loss on the policies. The £210,00 was not in the circumstances consideration given by him "wholly and exclusively for the acquisition of" the five policies. (I refer to this as "the £210,000 wholly and exclusively issue".)
(iii) No part of the £1,962,233 is, in the circumstances, to be regarded as acquisition consideration. It was not incurred wholly and exclusively for the acquisition of any asset. It was incurred for no purpose other than to facilitate a tax avoidance scheme. (I refer to this as "the wider wholly and exclusively issue".)
(iv) If the Revenue were wrong on the section 37(1) issue and the £1.75 million paid out on surrender came within the expression "taken into account as a receipt in computing income … of the person making the disposal for the purposes of the Income Tax Acts", it would, say the Revenue, follow that the premiums paid should be excluded as acquisition expenditure. This is because the expenditure incurred by Mr Drummond was so closely related to the premiums paid by London & Oxford that, viewed realistically in the context of the tax avoidance scheme, Mr Drummond's expenditure should be regarded as having been allowed for income tax purposes and should, therefore, be excluded from the computation for CGT purposes by virtue of section 39(1) of TCGA.
The section 37(1) issue
(i) The life assured (Ms Sedgley) effects the policy paying an initial premium of £1,250.
(ii) Ms Sedgley then assigns the policy to London & Oxford for £1,275 (producing a "chargeable event gain", see below, of £25).
(iii) London & Oxford pay a further premium of £1,748,750 bringing the total premiums paid up to £1,750,000.
(iv) London & Oxford transfer the policy to Mr Drummond in return for a consideration stated to be £1,962,233.
(v) Mr Drummond surrenders the policy and receives surrender proceeds of £1,751,378.
(Five policies were used: but for simplicity I have explained the scenario with reference to a single policy.)
"There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money's worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts."
The critical question is this. What money or money's worth has been taken into account in computing income or profits or gains of Mr Drummond (the person making the disposal) for income tax purposes? The case for Mr Drummond is that the entire surrender proceeds of the policy will have been taken into account as a receipt in computing Mr Drummond's "chargeable event gain" and is therefore to be excluded from the disposal consideration by reason of section 37(1). This calls for consideration of the chargeable event gain provisions.
"On the happening of a chargeable event in relation to any policy of life insurance, there shall be treated as a gain in connection with the policy …
(b) if the event is … the surrender in whole of the rights thereby conferred, the excess (if any) of the amount or value of the sum payable … by reason of the event … over the sum of the following –
(i) the total amount previously paid under the policy by way of premiums and
(ii) the total amount treated as a gain … on the previous happening of chargeable events."
"Where under section 541 … a gain is to be treated as arising in connection with any policy …
(a) if, immediately before the happening of the chargeable event in question, the rights conferred by the policy … or contract were vested in an individual as beneficial owner … the amount of the gain shall be deemed to form part of that individual's total income for the year in which the event happened;"
It is then the duty of the insurer, where a chargeable event "has happened in relation to any policy", within three months to deliver a certificate specifying the name of the policyholder and the nature and date of the event. The certificate must also specify the surrender value and the amount of the premiums previously paid under the policy. In the scenario set out above, the chargeable event gain was as follows:
Surrender proceeds £1,751,376
Less: initial premium £ 1,250
Less: additional premium paid London & Oxford £1,748,750
Less previously certified gain £ 25
Chargeable event gain £ 1,351
The "wholly and exclusively" issues
The strategy in outline
The transactions in detail
Creating the stock of life policies
KPMG are activated
"London & Oxford have acquired an AIG Premier Access Bond consisting of 20 policies and have arranged finance to capitalise these policies by paying additional premia of £5 million which they expect to do on Monday. I believe that gives us time to implement the strategy with one or two clients before Budget day.
Once the policies are capitalized I would ask you to consider whether you have one or two clients who are likely to benefit from acquiring £5.6 million of policies with the intention of sheltering gains of that amount before Budget day.
I would emphasize that no client should be identified before we have capitalised these particular policies and you should not review your clients' generally so you do not consider the suitability of any clients other than the ones whom you will advise to buy policies before Budget day.
Because of the very tight time constraints I am sending to you for your review documents which I list and comment on below."
An "independent financial adviser" assists Ms Sedgley
Topping up the policies
Jason Drummond comes on the scene
The 4 April meeting
(i) London & Oxford set up with Lloyds a "client account" into which, Mr Newton told Lloyds in a fax, Mr Drummond was to pay £1,155,000 "this morning". The fax went on to say that Mr Drummond "then proposes to transfer these funds to London & Oxford this afternoon".
(ii) £1 million was transferred from Mr Jason Drummond's current account with Barclays Bank to the Lloyds current account.
(iii) Mr Drummond agreed with KPMG to engage KPMG to give advice on the strategy "involving the acquisition and subsequent encashment of second-hand endowment bonds" and to be introduced to MCL. KPMG also agreed to assist Mr Drummond with the reporting of the transaction to the Inland Revenue. KPMG's fee was to be "1% of the value of the bonds you purchase".
"Providing tax legislation and other relevant circumstances have not changed in the intervening period, at some time after this purchase you will ask your investment adviser for their advice on assigning or surrendering the policies. In order to realise a capital loss in accordance with the Mitigation Strategy, it is likely that they will recommend a surrender of the policies. When the policies are surrendered there will be a "chargeable event" under the Income Tax Chargeable Events Legislation. It is likely that you will make a chargeable event gain on the surrender which will be subject to income tax. That chargeable event gain is unlikely to be large because it will be calculated as the difference between the surrender value of the policies and the premia previously paid under the policies. Because it is likely that at the time of the surrender the policies will only have been in existence for a short period of time, that difference is likely to be small.
The surrender of the policies will also be a disposal for capital gains tax … . Provided the Mitigation Strategy is successful, for capital gains tax purposes your disposal proceeds will be the surrender proceeds less any amount taken into account in calculating your chargeable event gain. Because the whole of your surrender proceeds will have been taken into account in calculating the chargeable event gain, your disposal consideration for capital gains tax purposes will be reduced to nil. The expenditure deductible in calculating a capital gain or loss on disposal will be the amount for which you have purchased the policies. Because that amount is not taken into account in calculating a chargeable event gain it will not be excluded from the capital gains computation. For that reason you will make a capital loss equal to your expenditure on the policies.
There is a market in second-hand policies but, I understand, that it is highly unlikely one would be able to identify suitable policies to shelter a gain of the magnitude of the targeted gain in the general market. For that reason London & Oxford has acquired policies of the requisite characteristics and paid additional premia into those policies. The policies are assigned to Lloyds Bank as security for a loan. The security will be released when you purchase these policies. London & Oxford makes a market in these policies."
"Thus the gross benefit of the strategy would be £784,893 and this is reduced to a net benefit of £573,840 by the costs of the strategy. If the strategy were to fail you would have lost £67,869 after allowing for tax relief on the excess of the purchase price of the policies over your estimated proceeds. (You should note that this does not include the cost of establishing the effectiveness of the scheme. These costs would be chargeable against the fighting fund but it is not guaranteed that that fund will be sufficient to meet all costs.)"
The "independent financial adviser" participates again
"We looked at the current interest rate being offered on the bond and saw that deposits in excess of £1 million currently attract an equivalent gross rate for a higher rate taxpayer (such as yourself) amounting to 6.88%. This compares with it favourably with the leading bank and building society rates currently being offered.
No tax advice was given in addition to the above. In particular, no advice was given with regard to the tax implications of the fact that I understand that you will be purchasing an assigned policy from London & Oxford rather than making an investment direct with AIG life. This course of action, and indeed any further action undertaken in respect of the bond, will be on the advice of taxation advice given to you by Simon McKie of McKie & Co."
"Under the strategy, you will purchase an interest in the policies but you will not become the registered owner of the policies with the insurance company. If you were to do so you would pay stamp duty on the purchase of 4%. Instead, the vendor will make a written offer to you to sell the policies and specify that the offer may be accepted by making a payment of the requisite amount to the vendor. It will not go on to complete an assignment to you so that after you accept the contract by making the payment, the vendor will hold the policies to your order."
Analysis of difference between Mr Drummond's "buying costs" and his selling proceeds
(i) "Fixed costs" of 4% of £1,962,233 (the aggregate of the two amounts referred to in the Third Schedule to the Offer to Sell – see paragraph 51 below). These work out at £78,489.
(ii) "Fighting fund" at ½%, i.e. £9,811.
(iii) "Contingent costs" at 5%, i.e. £98,112. (An escrow account for this has retained this amount.)
(iv) "Client adviser's cost" at 1%, i.e. £19,622. That I understand to have been KPMG's commission for introducing Mr Drummond to the strategy.
(v) "IFA's costs" are £5,000.
Mr Drummond decides to go ahead
"… my main focus is what it would cost me if it did not work out and that was £67,000 and what was the gain if it succeeded, which was obviously over £500,000; so that was very much the way I looked at it."
The steps by which Mr Drummond buys into the strategy
"London & Oxford offers to sell the policies … to [Mr Drummond] for a consideration consisting of the Consideration Payments …
Acceptance of the offer to sell shall be effected by [Mr Drummond] paying to London & Oxford an amount equal to [£1 million] on or before 4 April 2001 on which occasion a contract for the sale and purchase of the policies shall be deemed to have come into effect and to have been completed at that time. It shall be a term of the contract that [Mr Drummond] will [pay £962,233] on [5 April 2001].
The said sale shall take effect free of all encumbrances."
The Third Schedule to the Offer to Sell defines the "Consideration Payments as:
"A payment of £1,000.000 made to London and Oxford on 4 April 2001
A payment … of £962,233 made to London and Oxford on 5 April 2001."
Mr Drummond's position overnight
The next day (5 April 2001): the "independent financial adviser" calls again and the strategy is completed
The Chargeable Event Certificate
The "wholly and exclusively issues"
"(1) Except as otherwise expressly provided, the sums allowable as a deduction from the consideration in the computation of the gain accruing to a person on the disposal of an asset shall be restricted to –
(a) the amount or value of the consideration, in money or money's worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset … ,
(b) the amount of any expenditure wholly and exclusively incurred on the asset …".
"First to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so."
"We think that it would destroy the value of the Ramsay principle of construing provisions … if their composite effect had to be disregarded simply because the parties had deliberately included a commercially irrelevant contingency, creating an acceptable risk that the scheme might not work as planned. We would be back in the world of artificial tax schemes, now equipped with anti-Ramsay devices. The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned."
SIR STEPHEN OLIVER QC
RELEASED: 5 July 2007