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United Kingdom Special Commissioners of Income Tax Decisions
You are here: BAILII >> Databases >> United Kingdom Special Commissioners of Income Tax Decisions >> Astall & Anor v Revenue & Customs Rev 1 [2007] UKSPC SPC00628 (14 August 2007)
URL: http://www.bailii.org/uk/cases/UKSPC/2007/SPC00628.html
Cite as: [2008] STC(SCD) 142, [2007] UKSPC SPC628, [2007] UKSPC SPC00628, [2007] SpC 628
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- These are appeals by Mr John Astall and Mr Graham Edwards who are two sample participants in a tax avoidance scheme promoted by KPMG which was based on the definition of relevant discounted securities. They both appeal against amendments to their self-assessment made on 16 January 2007 disallowing losses of £1,989,464 in Mr Astall's case and losses of £4,976,098 in Mr Edwards' case for the year 2001-02. The Appellants were represented by Mr Kevin Prosser QC, and the Revenue by Mr David Ewart QC and Mr Michael Gibbon.
- In outline the scheme consists of each of the Appellants settling a small sum in a trust under which he has a life interest. The settlor lends money to the trust in return for a security issued by one of the trustees, a company. The terms of the security are that it is redeemable in 15 years at 118% of the issue price but the Appellant can redeem the security at 100.1% of the issue price between one and two months after issue. If a condition relating to the dollar-pound exchange rate, which is designed to have an 85% chance of being satisfied, is satisfied within one month and a notice to transfer the security is given, the term of the security becomes 65 years (with the same redemption price) but the purchaser can redeem it at 5% of the redemption price (about 6% of the issue price) on seven days' notice. The redemption terms are designed to satisfy the definition of a relevant discounted security within Schedule 13 to the Finance Act 1996. The object is that the Appellant claims the difference between the issue price and 6% of the issue price (less a turn for the purchasing bank) as a loss on a relevant discounted security, while the difference remains in the trust for the benefit of the Appellant. The same scheme was entered into by 64 people having an income of at least £1m, with total losses claimed of about £156m.
- The agreed issue in the appeals is whether the Appellants have sustained losses from the discount on relevant discounted securities within the meaning of Schedule 13 to the Finance Act 1996.
- There were eight ring binders of documents which were reduced to a core bundle of two binders. There was an agreed statement of facts as follows:
- I heard evidence from both of the Appellants; Mr David Kilshaw, partner of KPMG; Mr Michael Walker, KPMG partner who advised Mr Astall; Mr Greg Limb, director in the Private Client Advisory team in the Leeds office of KPMG; Ms Diviya Gosrani, Kleinwort Benson Trustees Limited; Mr Mark Patterson, partner of KPMG; Mr Stuart Gower Director in the Private Banking division of SG Hambros Channel Island Limited; Mr Alan Milligan, Director of Cambridge Churchill UK Limited (expert witness called by the Appellants); and Mr Andrew Cunnell, formerly of HSBC and Unity Trust Bank (expert witness called by the Revenue).
- I find the following further facts in relation to the actions for finding a purchaser for the Securities:
- In addition to the uncertainties created by the scheme of whether the Market Change condition would be satisfied and whether a purchaser would be found for the Security, there was a further uncertainty affecting Mr Astall only, which was the amount of his income for 2001-02. The question is whether, if this turned out to be smaller than he had estimated when entering into the scheme, he might have redeemed the Security and abandoned the scheme. I find the following facts:
- The statutory provisions relevant to this appeal in Schedule 13 to the Finance Act 1996 as they were in 2001-02 are:
- The former para 3(5), deleted by FA 1999 stated that:
- It is common ground that there is a loss, being the difference between the issue price and the sale price (taking into account the costs referred to in para 2(3)), and that the Security is a security. The point in issue is whether the Security is a relevant discounted security.
- Mr Prosser QC, for the Appellant contends in outline:
- Mr Ewart QC and Mr Gibbon, for the Revenue, contend in outline:
- This appeal raises different questions in relation to (a) the Market Change condition, (b) the decision not to seek purchasers until after the issue of the Security, and (c) the terms of the Security, including in particular the terms for its redemption. I shall deal with these in turn.
- Mr Prosser contends that legislation drafted like this cannot be construed in any way other than by taking all possibilities into account, however unlikely they may be. It follows, he contends, that there is no room for the type of approach in Scottish Provident. Mr Ewart contends that the point is directly within the Scottish Provident principle.
- The legislation in issue in Scottish Provident (see paragraph 12(1) above) was drafted in terms of a "contract under which, whether unconditionally or subject to conditions being fulfilled, a qualifying company has any entitlement…to become a party to a loan relationship"; the legislation I am construing is drafted in terms of a "security which is such that, taking the security as at the time of its issue, the amount payable on redemption… is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain." Both define a type of contract, although the former looks at the effect of the contract, and the latter the contract itself. But the reason for the company having such an entitlement in the former is found in the terms of the contract, so I do not see this as a real distinction. Both look at possibilities; the former would mean exactly the same if it were drafted in terms of has, would have, or might have, an entitlement to become a party to a loan relationship. The House of Lords construed entitlement in the former in a wide practical sense because:
- The Market Change condition in the security was (as is conceded) purely inserted as an intended anti-Ramsay device (see paragraph 6(2) above). The dollar/sterling exchange rate was irrelevant to the Security which was in sterling. The Appellants relied on KPMG for its insertion into the scheme, were duly warned about the risk which the two-part fee arrangement takes into account, but they did not ask whether this uncertainty could be reduced or avoided. They were content to rely on KPMG in finding a purchaser. The 85% chance of the Market Change condition being satisfied was favourable enough to make it a risk which the Appellants were willing to accept in the interests of the scheme.
- In my view the Market Change provision is fully within the principle in Scottish Provident. The Market Change condition was not inserted for any commercial reason. It can equally well be said of the 15% chance of its not being satisfied that "It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme." On the basis that the existence of the Market Change condition can be ignored on the authority of Scottish Provident, the consequences of its not being satisfied, that the early redemption option would be exercised must also be ignored, just as the possibility of the options not being exercised simultaneously was ignored in Scottish Provident. If I am wrong about ignoring the early redemption option I would apply the reasoning set out starting at paragraph 23 below relating to Mr Astall's case.
- The decision by KPMG not to seek a purchaser for the Securities until after their issue is slightly different. I do not agree with Mr Prosser's contention that this aspect is governed by Craven v White because this part of the transaction has not yet occurred. That case concerned a linear transaction in which there were two possible purchasers at the final stage. Lord Oliver said at [1988] STC 476 at 494-5:
- Scottish Provident relied on the Ramsay approach to the extent that it "allows (and indeed requires) the court to have regard to the whole of a series of transactions which were intended to have a commercial unity." That is not relevant to this aspect which relates to the construction of the definition of relevant discounted security. Mr Ewart's contention is that I should ignore the legal possibilities that the security might be redeemed in any of the following events (in addition to the early redemption option that I have decided should be ignored above (subject to considering Mr Astall's position below): (a) after 15 years at 118% of the issue price; or (b) after 65 years at 118% of the issue price. Both of these have been structured to exceed the "relevant percentage." It is common ground that the possibility of redemption on default falls to be excluded from consideration by para 3(1A) as being unlikely.
- For this aspect I turn to Barclays Mercantile and I omit any references to the approach to composite transactions:
- Accordingly I turn to viewing the facts of the transaction realistically. My appreciation of the facts is as follows:
- Mr Prosser contends that the only relevant facts are the terms of the Security. However, that presupposes that the possibilities of redemption written into the Security are within the facts when viewed realistically. In my view, the Ramsay approach as explained in Barclays Mercantile entitles and requires me to construe legislation aimed at considering all possibilities in such a way as to limit those possibilities to real ones. A purposive construction of the definition of relevant discounted security must have regard to real possibilities of redemption, not ones written into the document creating the Security that the parties know, and any reasonable person having the knowledge available to the parties knows, will never occur. Mr Prosser's argument that a purchaser of a security must be able to determine from its terms whether it is a relevant discounted security carries no weight in these circumstances. There will only ever be one purchaser of it who is fully aware of the scheme, who will redeem it within seven days so that the Security will be outstanding for a maximum of two months. The purpose of the legislation is to tax gains on securities that are issued at a deep discount and conversely to relieve losses on such securities. The difference between the issue price and the redemption price must give rise to a possibility of making a gain that can be objectively seen to exist. This Security never had this possibility; it is a practical certainty that there will be a loss of 94. To decide otherwise would be to return "tax law [to] being 'some island of literal interpretation'."
- I have found as a fact that it cannot be said in Mr Astall's case that there was no reasonable likelihood of the early redemption option, enabling him to redeem the Security between one and two months after issue, being exercised. Accordingly I must consider whether the possibility of this being exercised, giving rise to a gain of 0.1% on the issue price (which, being in excess of the relevant percentage of 0.08% referable to a period of two months, constitutes a deep gain) means that the Security is a relevant discounted security thus allowing him to claim a loss of 95% of the redemption price.
- Mr Ewart raises a further argument that the only way in which the premium on early redemption can be paid is the capital of the trust. Any income earned must be paid to Mr Astall as life tenant of the trust. It would not be a proper charge to use income to pay a capital liability. Mr Prosser contends that whether there is a deep gain depends on the formula and the source of the payment of the premium on redemption is irrelevant. In any event, the trustees could use the income to pay the early redemption premium so long as they reimburse the life tenant later.
- The capital of the trust was fixed in Mr Astall's case at £2,700 so that it could meet either the premium on early redemption on default of £2,638 or the early redemption at the holder's option of £2,110. The trust had no other use for the capital, which could otherwise have been nominal. Although I agree with Mr Prosser that the trustees could actually use income, assuming that they had received any, to pay the premium, they would then have to reimburse Mr Astall as life tenant for the whole of the income. Since following redemption the trust will have no funds other than the trust capital with which to pay the income to the life tenant, this is the same as saying that the capital of the trust must meet the early redemption premium and Mr Astall must receive all the income, regardless of whether the income is temporarily spent on the premium. One can discount the possibility of the trust being invested to make a capital gain within the first two months of the life of the Security because the Confidential Information Memorandum to the banks states that "These funds remain invested in readily accessible bank accounts with Kleinwort Benson or Lloyds."
- A realistic view of the facts is as set out above, that the scheme has been designed to fix the capital of the trust so as to meet the premium on early redemption and this is the only possible source of funds. The parties intended that this should be used for the purpose and objectively this is the only possibility when considering the matter at the date of issue of the Security. Early redemption would always require a circular transaction using the capital of the trust. Does the possibility of such a transaction mean that the Security is within the statutory definition of a relevant discounted security? I do not think it does. The terms of the early redemption option have been structured so as to create what is a deep gain according to the formula but one which can be paid only by means of a circular transaction involving the payment by Mr Astall of the capital that he put into the trust for no other purpose (apart from funding the premium on redemption on default). That is very different from Mr Prosser's example of a company happening to pay interest out of capital. The only way in which the early redemption premium can be paid is by using the trust capital. Asking myself whether the relevant statutory provisions, construed purposively, were intended to apply to such a transaction, the answer is no.
- Accordingly I dismiss the appeals in principle.
- In accordance with section 56A(2) of the Taxes Management Act 1970 I hereby certify that my decision involves a point of law relating wholly or mainly to the construction of an enactment that has been fully argued before me and fully considered by me. This means that if both parties consent, and if the leave of the Court of Appeal is obtained, the Appellant may appeal from my decision directly to the Court of Appeal.
RELEVANT DISCOUNTED SECURITIES – tax avoidance scheme – the security was not a relevant discounted security because the terms under which it might possibly be redeemed at a deep gain will never occur – appeal dismissed
THE SPECIAL COMMISSIONERS
JOHN ASTALL and GRAHAM EDWARDS Appellants
- 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 16 to 18 July 2007
Kevin Prosser QC, counsel, instructed by McGrigors LLP solicitors, for the Appellants
David Ewart QC and Michael Gibbon, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents
© CROWN COPYRIGHT 2007
DECISION
Mr Edwards
(1) By deed of settlement dated 28 January 2002 Mr Edwards created the Graham Henry Edwards 2002 Life Interest Trust ("the Edwards Trust"). The initial trust fund was £1,400, and Mr Edwards also settled an additional sum of £5,600.
(2) The trustees were Mr Edwards, Gina Suzanne Edwards and Linkfast Industry Limited ("Linkfast"). At all material times from 21 January 2002 the sole director of Linkfast was Kleinwort Benson Trustees Limited ("KBTL").
(3) Clause 15 of Part 1 of the Trust Deed is headed "Obligation to issue a security." Clause 15.1 of Part I provides:
"Subject only to Clause 8.2 above, if at any time when the Settlor has an Interest in Possession in the whole of the Trust Fund created by Clause 4.1 above, but before 5 April 2002 the Settlor shall request the Trustees (or any of them) to exercise the power conferred by Clause 3 of Part 2 below and borrow from the Settlor by issuing a security to him which is in the form, or substantially in the form, of the draft set out in Schedule 2 hereto and if such a request is accompanied by an Accountant's Letter, such Trustee(s) shall enter into the transactions as requested and all the Trustees shall give their prior approval thereto."
(4) Clause 15.2 of Part 1 provides:
"For the purposes of Clause 15.1, an Accountant's Letter is a letter from a leading firm of chartered accountants to the Trustees to the effect that having regards to the terms of the security and to investment rates of return in their opinion the Trust Fund (including the monies to be borrowed under the transaction) and the income thereof will, in all probability, suffice to meet in full all liabilities incurred or to be incurred under the transaction."
(5) Clause 3.1 of Part II of the Trust Deed, gives the trustees a general power to borrow "for any purpose whatsoever."
(6) Clause 3.2 of Part II provides:
"Without prejudice to the generality of the foregoing the Trustees (or any of them) may on one occasion borrow by issuing a security in the form (or substantially in the form) of the draft set out in Schedule 2 hereto. In no circumstances whatsoever shall the exercise or purported exercise of the powers conferred by this Clause 3 be challenged (whether as a fraud on a power or otherwise) except only in the event of breach of Clause 8.2 in part 1 above."
(7) Kleinwort Benson Private Bank ("Kleinwort Benson") wrote a facility letter dated 28 January 2002 to Mr Edwards. The loan facility was for an aggregate principal sum not exceeding £3,278,276, with repayment to be made within 18 months from drawdown. There was a non-refundable arrangement fee of £16,390. Interest was chargeable in respect of the amount outstanding under the facility at 2% over Kleinwort Benson's published base rate.
(8) On 29 January 2002 the trustees agreed to guarantee Mr Edwards' proposed borrowings from Kleinwort Benson.
(9) By letter dated 29 January 2002, KPMG Tax wrote to the trustees, stating:
"By virtue of Clause 15 of the Trust Deed created on 28 January 2002 by Graham Edwards you are required to issue a security upon certain terms if you receive a suitable letter from a firm of accountants (the Accountant's Letter). This letter is intended to fulfil that condition such that the Trustees can satisfy themselves that they will have sufficient funds to meet their obligations under the security."
(10) They further stated:
"As this letter is complementary to a tax saving arrangement we do not consider that it falls to be treated as investment advice."
(11) The letter stated there were three circumstances which could result in the Security being redeemed at a premium.
(a) By clause 3.7, if there was an adverse financial position in respect of the corporate trustee, the premium would be £6,598 (i.e. £402 less than the initial capital settled).
(b) By clause 3.2, if there was early redemption at the security holder's option, the premium would be £5,279.
(c) Final redemption in either 15 or 65 years time. In either case the premium would be £950,090.
(12) The letter also stated:
"There are other circumstances which could result in the note being redeemed early. We do not consider that these circumstances would result in the redemption proceeds exceeding the subscription sums received."
(13) On 30 January 2002, the trustees of The Edwards Trust approved the borrowing of £5,278,276 from Mr Edwards.
(14) Linkfast (on behalf of the trust) issued a loan note instrument ("the Security") dated 31 January 2002 to Mr Edwards. The instrument constituted £6,228,366 Zero Coupon Loan Notes due 31 January 2017. The issue price in respect of the Loan Note was £5,278,276. The price was paid in two parts - £2,000,000 was paid from Mr Edwards' First Direct account to an account designated 'KBIM Ltd No 1 Account' and £3,278,276 from Mr Edwards' current account with Kleinwort Benson.
(15) The Security was in the form (or substantially in the form) of the draft set out in Schedule 2 to the Trust Deed.
(16) Clause 4 is headed "Redemption" and provides:
"Unless previously redeemed in accordance with conditions 3.2-3.13 of the Second Schedule, the Issuer shall redeem the Notes on the Final Redemption Date in accordance with Condition 3.1 of the Second Schedule hereto."
(17) Clause 5 is headed "Transferability" and provides:
"The notes are transferable, subject however to the Conditions of the Second Schedule."
(18) Condition 1.1 of the Second Schedule is headed "Definitions." The Definitions include the following:
"Early Redemption Default Event" means any event (occurring if at all before a Transfer Event) whereby the issuer:
is or becomes unable to pay its debt as they fall due;
commences negotiations with its creditors with a view to rescheduling its indebtedness or making a general assignment for the benefit of, or a composition with its creditors; or
takes any corporate action or other steps for its winding-up, dissolution or reorganisation or for the appointment of a receiver, administrative receiver, administrator or similar officer of it or all or a material part of its assets or the commencement of legal proceedings in relation to any of the foregoing.
"Final Redemption Date" means (subject to Condition 3.9) the date being 15 years after the issue date;
"Market Change" in relation to a Note shall be deemed to have occurred if the midpoint value of the US$/Sterling exchange rate at 3.00pm on 28 February 2002 as quoted on Reuters under code 1FED is greater than or equal to the Lower Rate and less than or equal to the Upper Rate;
"Third party" in relation to a Noteholder means another person who is not an associate of the Noteholder within the meaning of section 435 of the Insolvency Act 1986;
"Transfer Event" in relation to a Note means, in circumstances where Condition 3.6 below applies to require service of a Transfer Notice upon the Issuer following a Market Change either, (a) the due service of a Transfer Notice which identifies a person who at the time of the Transfer Notice is a Third Party as the or a proposed transferee ("a due Service Transfer Event") or (b) any actual Transfer of the Note to a Third Party without any such due service;"
(19) The probability of the occurrence of the Market Change (as defined) was 85%.
(20) Condition 1.1 also (inter alia) contained formulae for the calculation of the "Upper Rate" and "Lower Rate" for use in the Market Change calculation.
(21) Save in the event of withholding of payment or refusal to pay following redemption, no interest was payable on the Security (Condition 2).
(22) Condition 3 is headed "Final Redemption and Early Redemption." In relevant part it provides as follows:
"3.1 Unless previously redeemed in accordance with these Conditions, the Issuer shall redeem each Note on the Final Redemption Date for an amount equal to the principal amount of such a Note.
3.2 At any time after the expiry of one month from the Issue Date but before the expiry of two months from the Issue Date and in any event prior to the occurrence of a Transfer Event, the Noteholder in relation to the Note shall be entitled to redeem the whole but not part only of that Note upon giving no less than 7 and no more than 14 days' written notice of early redemption. (For the avoidance of doubt any such notice may be given before the expiry of the said one month.)
3.3 The amount payable to the Noteholder upon early redemption of a Note under Condition 3.2 shall be an amount equal to 100.1/118 of the principal amount of such Note. The redemption amount shall be paid upon expiry of the written notice.
3.4 Forthwith upon the occurrence of an Early Redemption Default Event the Issuer shall inform the Noteholder giving full details of the nature of and circumstances surrounding such Early Redemption Default Event.
3.5 No later than 7 days after the occurrence of a Market Change the Issuer will inform the Noteholder in writing of such Market Change.
3.6 If, following the occurrence of a Market Change, a Noteholder proposes to make a Transfer of the Note, the Noteholder shall first, at least 7 days before the proposed date for making a Transfer of the Note (including, for the avoidance of doubt, before entering into any agreement), serve upon the Issuer a Transfer Notice of such proposed Transfer. …
3.7 In the event of the occurrence of an Early Redemption Default Event in circumstances where a Transfer Event has not occurred, the Noteholder shall be entitled to redeem the whole but not part only of any Note held by that Noteholder upon giving to the issuer no less than 7 and no more than 14 days' written notice of such early redemption. Any such notice must be served (if at all) no later than 14 days after the notification upon the Noteholder of the occurrence of such Early Redemption Default Event in accordance with Condition 3.4 above.
3.8 The amount payable to the Noteholder upon redemption of a Note under Condition 3.7 shall be an amount equal to 100.125/118 of the principal amount. The redemption amount shall be paid upon the expiry of the written notice.
3.9 Upon the occurrence of a Transfer Event in relation to a Note, the Final Redemption Date in relation to that Note shall become the date being 65 years (instead of 15 years) after the Issue Date.
3.10 Following the occurrence of a due Service Transfer Event in relation to a Note, the Noteholder (being a Third Party identified in the Transfer Notice as the or a proposed transferee) shall be entitled to redeem the whole but not part only of the Note upon giving to the Issuer no less than 7 or no more than 14 days' written notice of such early redemption. However, any such notice must be served (if at all) by such Noteholder upon the Issuer before the expiry of 14 days from the Transfer of the Note.
3.11 The amount payable to the Noteholder upon early redemption of a Note under Condition 3.10 shall be an amount equal to the greater of the open market value of the Note as at the date of the written notice (but subject to Condition 3.13 below) and 5 percent of the principal amount of such Note. The redemption amount shall be paid upon the expiry of the written notice or (if later) upon determination of the open market value of the Note. For the avoidance of doubt the open market value shall be calculated as if there was no entitlement to redeem early under Condition 3.10 above.
3.13 If the Noteholder shall so state in the written notice, the amount payable upon early redemption of a Note under Condition 3.10 shall be 5% of the principal amount of such Note and accordingly the provisions above concerning the open market value of the Note shall not apply."
(23) The key effects of the above provisions are as follows:
(a) The issue price of £5,278,276 was 15.25% less than the amount payable on redemption of £6,228,366.
(b) A Market Change (as defined) would only occur when the US$/Sterling exchange rate on 28 February 2002 was within a certain range (which was to be calculated in part by reference to the exchange rate at the date of issue).
(c) If a Market Change took place then the redemption date would remain 15 years, unless the Noteholder transferred the Security. If the Security were to be transferred, the term would become 65 years.
(d) Where there was a transfer following a Market Change, and the new Noteholder decided to make use of the early redemption provision, then the amount payable would be the higher of 5% of the principal amount, or market value.
(24) The Security was charged in favour of Kleinwort Benson in respect of Mr Edwards' borrowings. Mr Edwards instructed Kleinwort Benson to release the charge immediately prior to the transfer of the Security. The trustees also entered into a guarantee and indemnity agreement involving the funds in trust with Kleinwort Benson in respect of Mr Edwards' borrowing.
(25) On 4 February 2002 Mr Mark Patterson of KPMG Tax in Nottingham met Mr Stuart Gower of SG Hambros Bank & Trust (Jersey) Limited ("Hambros") at KPMG's office, Farringdon Street, London.
(26) Mr Patterson subsequently sent Mr Gower a letter dated 8 February 2002 and headed "Opportunities to purchase Securities." The securities were the Securities issued to Mr Edwards and other taxpayers who had also utilised the same scheme structure as Mr Edwards had. The letter in particular contained a confirmation, for countersignature by Mr Gower, stating "I confirm that there had been no previous discussion or correspondence regarding the possibility of SG Hambros Bank & Trust (Jersey) Limited purchasing the securities from KPMG clients prior to the meeting at Farringdon Street at 4 pm on Monday 4 February 2002."
(27) A Market Change (as defined) took place at 3pm on Friday 28 February 2002.
(28) Diviya Gosrani of KBTL, director of Linkfast wrote a letter to Mr Edwards dated 5 March 2002 informing him that a Market Change had occurred.
(29) Mr Limb of KPMG Tax wrote a letter to Mr Edwards dated 8 March 2002 which stated:
"I understand that the corporate trustee of your recently formed trust is writing to inform you that the necessary market change occurred in accordance with the terms of the loan note.
Consequently, there are three options open to you, some of which will provide certain tax advantages. The options are:
Redeem the loan notes – this can be done up to one month after the Market Change occurred upon giving the issuer at least 7 days notice.
Transfer the loan notes – as the necessary market change has occurred, if you transfer/sell the loan note to a third party a tax advantage may arise.
Continue to hold the loan notes to their maturity on 31 January 2017.
Please let me know if you wish to redeem early as mentioned in option 1 above, as certain steps will need to be put in place on 31 March 2002."
(30) Mr Edwards sent Linkfast a fax dated the same day giving notice of intention to transfer the Security, and naming the proposed transferee as Hambros.
(31) On 18 March 2002 the Security was sold to Hambros for £302,545.
(32) On 25 March 2002 Hambros redeemed the Security for £311,418 (5% of the principal amount).
(33) This left £4,966,858 (plus any interest which had accrued since 31 January 2002, and less any further costs incurred) in the Edwards Trust.
(34) On or around 24 June 2002 the Edwards Trust purchased 16,668 shares in Sterilox Technologies Inc for a total consideration of US$50,004.
(35) In or around early August 2002, Mr Edwards requested from the trustees of the Edwards Trust an interest free loan of £3,280,000. The trustees resolved on 9 August 2002 to make the loan. Mr Edwards received the money in his account on 12 August 2002. On the same date, Mr Edwards instructed Kleinwort Benson to debit from his personal account sufficient funds to repay his loan account with the bank. An amount of £3,284,742.73 was debited to his account on 12 August 2002. On 21 July 2003 the trust purchased the residential property, Mill Waters in Buckinghamshire.
Mr Astall
(36) Relevant material is only set out in respect of Mr Astall to the extent it differs from Mr Edwards.
(37) By deed of settlement dated 18 January 2002 Mr Astall created the John Astall 2002 Life Interest Trust ("the Astall Trust"). The initial trust fund was £2,700.
(38) The trustees were Mr Astall, Carol Ann Astall and Lifestyle Bars and Lifestyle Limited ("Lifestyle"). At all material times from 14 December 2001 the sole director of Lifestyle was KBTL.
(39) The Trust Deed was in all material respects in the same form as the Trust Deed which constituted the Edwards Trust.
(40) Kleinwort Benson wrote a facility letter dated 21 January 2002 to Mr Astall. The loan facility was for an aggregate principal sum not exceeding £1,477,000, with repayment to be made within 18 months from drawdown. There was a non- refundable arrangement fee of £7,385. Interest was chargeable in respect of the amount outstanding under the facility at 2% over Kleinwort Benson's published base rate.
(41) On 22 January 2002 the trustees agreed to guarantee Mr Astall's proposed borrowings from Kleinwort Benson. They entered into a guarantee and indemnity agreement involving the funds in trust with Kleinwort Benson in respect of Mr Astall's borrowing.
(42) By letter dated 23 January 2002 KPMG Tax wrote to the trustees. The letter was in material terms in the same form as the letter dated 29 January 2002 sent to the trustees of the Edwards Trust.
(43) On 24 January 2002 the trustees of the Astall Trust approved the borrowing of £2,110,043 from Mr Astall.
(44) Lifestyle (on behalf of the trust) issued a loan note instrument ("the Security") dated 25 January 2002 to Mr Astall. The instrument constituted £2,489,851 Zero Coupon Loan Notes due 25 January 2017. The issue price in respect of the Security was £2,110,043. The price was paid in two parts - an amount of £640,428 was paid from Mr and Mrs Astall's account with Coutts & Co and the remainder of £1,477,000 was the loan proceeds paid directly to the trust.
(45) The Security was in the form (or substantially in the form) of the draft set out in Schedule 2 to the Trust Deed. Further, its material terms were the same as those of the Edwards Security (save that the date for the application of the Market Change test was 25 February 2002).
(46) The Security was charged in favour of Kleinwort Benson in respect of Mr Astall's borrowings.
(47) A Market Change (as defined) took place at 3pm on 25 February 2002.
(48) Diviya Gosrani of KBTL, director of Lifestyle wrote a letter to Mr Astall dated 26 February 2002 informing him that a Market Change had occurred.
(49) Mr Limb of KPMG Tax wrote a letter to Mr Astall dated 17 February 2002 which was in all material terms the same as the letter to Mr Edwards dated 8 March 2002 referred to above.
(50) Mr Limb of KPMG Tax wrote a letter to Mr Astall dated 4 March 2002. The letter inter alia stated:
"You may wish to consider a transfer of the Loan Note. KPMG has recently negotiated with SG Hambros Bank & Trust (Jersey) Limited who have expressed an interest in buying loan notes from a number of KPMG clients who are in a similar position.
Although negotiations have not yet been completed, it is likely that the purchase price offered will represent a discount of approximately 2.85% on the revised principal Amount of the Loan Note (following the delivery of the Transfer Notice below and assuming early redemption at 5% of the initial Principal Amount of the Note)."
(51) The letter asked for Mr Astall's approval in principle of the sale to Hambros, and asked him to sign (but not to date) a transfer notice and to return it to KPMG Tax. It was intended that the sale should take place on 18 March 2002.
(52) The notice of intention to transfer the Security is dated 8 March 2002.
(53) On 18 March 2002 the Security was sold to Hambros for £120,946.
(54) On 25 March 2002 Hambros redeemed the Security for £124,493 (5% of the principal amount).
(55) This left £1,985,550 (plus any interest which had accrued since 25 January 2002, and less any further costs incurred) in the Astall Trust.
(56) On 19 March 2002, KPMG informed Kleinwort Benson that Mr Astall was considering repaying his loan early. Kleinwort Benson advised that the amount to be repaid would be principal of £1,477,000 and interest of £17,966.79 and this amount was debited to his account with Coutts & Co on 9 April 2002.
(57) On or around 18 July 2002 a charge was given to Coutts & Co by the trustees over the Astall Trust's assets, in consideration of Coutts & Co giving credit facilities to Mr and Mrs Astall. The charge was limited to £1,500,000.00.
(1) KPMG deliberately did not seek a purchaser for the Security until after it was issued. It was originally intended that they would not do so until two months after the issue of the Security with the result of the Market Change condition being known one month after issue, but because of the shortness of time KPMG approached banks after the issue of the Securities.
(2) The decision of KPMG not to obtain a purchaser for the securities until after their issue was (as is conceded) purely an intended anti-Ramsay device: ie the only purpose of inserting it was in the hope of repelling an anticipated argument by the Revenue based on WT Ramsay v IRC [1980] STC 300. The Appellants relied on KPMG for this decision and understood that it had been inserted by KPMG as part of the scheme, were duly warned about the risk which the two-part fee arrangement (see paragraph 7(3) below) takes into account, and they did not ask for this uncertainty to be reduced or avoided by approaching prospective purchasers at an early stage. They were content to rely on KPMG in finding a purchaser.
(3) Mr Stuart Gower of Hambros was first approached by telephone on 30 or 31 January 2002 by Mr Mark Patterson of KPMG not giving any details of the scheme and requesting that he brought a lawyer to a meeting on the following Monday 4 February 2002. (There had been a previous approach to Mr Gower by Mr Kilshaw of KPMG trying to interest Hambros' clients in the scheme, also without giving any details, on 10 September 2001 which Mr Gower referred to his London office but no further action was taken. No mention of a possible involvement of Hambros as purchaser of the Securities was made then.) Mr Gower duly attended the meeting accompanied by a lawyer from Simmons & Simmons. He signed a confidentiality letter and was told that by 4 February 2002 10 clients had Securities where the Market Change condition was satisfied, and for the remainder of the 64 cases it would be determined whether it was satisfied by mid to late February 2002. He was sent a confidential information memorandum of 7 February 2002 with sample documentation. Mr Gower expressed interest and was asked to quote his level of fees. In a telephone conversation with Mr Patterson on 13 February 2002 he was informed about the other banks' quotes (see paragraph 6(11) below) and asked if he could reduce his quote. Mr Gower suggested £220,000 to £250,000. On 19 February 2002 he finally quoted a discount of £235,066 (2.85%) based on a total principal amount of the 64 securities of £164,958,530, 5% of which is £8,247,927. (The discount figures quoted below for other banks are all based on an issue price of £129m, so that the redemption price would be £152,220,000 and on that basis Hambros' discount would be £216,914.) Further documentation was provided to Hambros on 11, 18 and 20 February 2002.
(4) Hambros relied on KPMG for "know your client" money laundering checks. They performed their due diligence on the documents in a data room at KPMG's offices from 26 February 2002.
(5) Hambros made an offer subject to due diligence for the first batch of 37 cases, which did not include the Appellants, on 25 February 2002, stating that a number of formalities, including due diligence, needed to be completed and so they reserved the right not to proceed at any time before the contract was completed. Due diligence of these cases was completed on 28 February 2002.
(6) Hambros emailed their banking division in Jersey and London for approval of the first 37 transactions on 26 February 2002 saying that one transaction was over their unsecured lending limit (the purchase of the Securities being treated as a loan for internal risk purposes) and was being referred to their head office in Paris. The credit application included the following:
"Credit risk
The underlying assets supporting the loan note consist entirely of cash in the same currency. As such there is no exposure to market movements of any nature. The cash is held with Lloyds and as such there is a risk upon this institution however this is considered entirely acceptable. The cash balances held will be directly confirmed by the trustees. Furthermore as the Bank will only be entitled to claim 5% of the principal value of the Loan Note there will be 20 times cover held by the Trust in respect of the loan note. The client is presently borrowing against the cash deposit the sum of [£3,278,276 for Mr Edwards; £1,477,000 for Mr Astall] and our margin cover is therefore reduced to a level of [13 times for Mr Edwards; 14 times for Mr Astall] as opposed to 20 times.
Performance risk
We rely upon KBTL [Kleinwort Benson Trustees limited] in their capacity as the directors of the corporate trustees to meet their obligations under the terms of the loan note. KBTL are liable under the terms of the loan notes and hence have a corresponding right over the funds held by the trust. In view of the fact that KBTL control the funds (they are the sole signatories of the Bank account and the quality of them as the Trust arm of a major international bank, we have no concerns as to their fulfilling their obligations."
The 20 times cover (before taking the borrowings into account) is slightly exaggerated because the 5% is of the redemption value, which is 118% of the issue price, and not of the issue price as suggested here, but they were still well covered. I suspect that the reduction to 13 and 14 times covered should have been a reduction by these figures. Hambros could rely on KBTL being in control of the funds because a trustee could under the terms of the trust be removed only on 14 days notice, which the Appellants warranted in the contract for the sale of the Security had not occurred. The Appellants signed a statement to KBTL that they would not object to the application of the trust funds to meet the redemption, and that they would authorise the payment as co-signatory of the bank account (the signatories were KBTL and either the settlor or his wife). The credit application also said there were no problems in relation to documentation and structural risks, tax risk, or reputational risks.
(7) Hambros first approached their head office in Paris on 28 February 2002 explaining that they did not have all the facts available until 26 February 2002. Further information was provided on 1 March and verbal approval was obtained on 5 March 2002 with written confirmation of this approval being provided on 7 March 2002. Mr Gower said (and I accept) that if that case has been turned down by his head office he would not have gone ahead with any of the others. The approach to the head office was not known to KPMG, who were not told of the delays in obtaining approval.
(8) Hambros received details of the second batch of 22 cases, including the Appellants, on 7 March 2002 and on the same day made a non-binding offer in principle to purchase them. I notice from paragraph 4(50) above that Mr Astall was told on 4 March 2002 that Hambros had expressed an interest in buying the Security, which was before they had made the offer, and he was asked to sign a transfer notice and let KPMG have it by noon on 7 March 2002.
(9) Hambros were given details of the identities of the clients in the third tranche on 14 March 2002 and made an offer in principle to purchase them on 15 March 2002.
(10) In all cases Hambros elected to redeem the Security at 5% of the redemption value instead of relying on the condition enabling this to be at market value (see condition 3.13 in paragraph 4(22) above).
(11) KPMG also approached a number of other banks (none being UK High Street banks) on 5 February 2002 by telephone to see if they were interested in purchasing the securities. This was followed by a confidentiality letter which the bank was to sign and return by fax. A Confidential Information Memorandum was then sent and the bank was asked to make an indicative offer by 11 February 2002 (extended to 12 February 2002). If the offer was satisfactory KPMG said they would send a set of documents for approval by the bank's advisers. The reactions of the six banks approached, which I have anonymised to protect their confidentiality since they did not take part in the transaction, were:
(a) Bank A (UK: the country stated is the office dealt with, not necessarily the head office or parent company) were not interested.
(b) Bank B (Guernsey) quoted a total purchase price of £6,375,000 on 12 February 2002 which a note of a telephone conversation on 11 February 2002 shows was mistakenly based on 5% of the issue price and on that basis represents a discount of 1.2%. They also quoted 5 to 10 days to obtain credit committee approval. Mr Patterson said in evidence that he thought that the discount was too low and suspected that they had not understood the proposal properly, which is borne out by their miscalculation. He turned them down on 13 February 2002 on the basis that the 5 to 10 days was too long. They replied saying that such transactions needed head office approval and they should talk about mechanics if a future opportunity arose, which demonstrates that they were interested in such business in principle.
(c) Bank C (not clear which office) said it was outside the scope of their normal activities.
(d) Bank D (Isle of Man) quoted a discount of £370,000 (4.8%) based on an issue price of £130m on 11 February 2002 which they reduced to £300,000 (3.9%) on 12 February. KPMG must have tried for a further reduction as they declined to match the price quoted by KPMG and pulled out of the transaction on 13 February 2002. Mr Patterson suspected that they would have needed a lot of approvals and would have not managed to satisfy the time limit.
(e) Bank E (Jersey) quoted a discount of £115,050 (1.5%) based on an issue price of on 12 February 2002 but wanted a secured instrument, saying in a telephone conversation on 13 February 2002 that if it was unsecured the timescale was too challenging.
(f) Bank F (UK) quoted a discount of £967,500 (15%) on 11 February 2002 which KPMG turned down as being too high.
(g) I also record that Mr Astall said (and I accept) that Coutts, who were advising him, told him, without being prompted, that they would not be interested in purchasing the securities. They were never approached by KPMG.
(12) In summary, KPMG treated Hambros as the favoured purchaser by inviting Mr Gower to a meeting, which they did not do for the other banks. Four of the other banks were interested but were turned down by about 13 February 2002, one on the basis of their quoted time scale but this was the excuse rather than the reason. Hambros were not definite about purchasing until after obtaining their head office approval on 7 March 2002 and even then their offer was not legally binding.
(13) The question for me is the likelihood at the date of issue of the Security (25 January 2002 for Mr Astall; and 31 January 2002 for Mr Edwards) of a purchaser being found for the Security within the time limit which was ideally before budget day and by 5 April 2002 at the latest. Budget day was originally expected to be in the second week in March but it was announced on 28 January 2002 that it would be on 17 April 2002; accordingly by 25 January 2002 the time limit was then known to be 5 April 2002. The two expert witnesses gave evidence about the likelihood, based on different instructions. Mr Milligan was asked for an opinion as at the time of issue; and Mr Cunnell on the assumption that the Market Change condition had been satisfied. Mr Milligan concluded that it would be very challenging within the proposed timescale, and Mr Cunnell concluded that Hambros would have been a willing buyer. They met with a view to agreeing a joint statement but despite extensive discussions there was too much difference in the questions put to each of them to be able to agree a joint statement. I am grateful to them for trying but it seems to me that as Mr Milligan could not make the assumption that the Market Change condition had been satisfied before any sale was to take place his approach was more complicated than it need have been. For example, he considered that a purchaser would want to include an analysis of the pricing of the security before satisfaction of the condition, which he described as "non-trivial" which I can well understand. Mr Cunnell, who had, in my view, more realistic instructions to consider the likelihood of a purchaser being found on the assumption that the Market Change condition had been satisfied, had less relevant experience as he had worked almost entirely with Midland Bank and its successor HSBC, which were not the type of banks that would have considered purchasing the Securities. He was essentially commenting that he did not find the actual dealings by Hambros surprising, which Mr Milligan criticised as being based on hindsight.
(14) I am left on my own to draw a conclusion from the facts found. My view is considerably influenced by (a) Hambros' credit application from which I have quoted, in effect taking a realistic view that there were no risks, (b) that four out of the six banks came up with a price at which they would have been prepared in principle to buy the securities, three of which represented a discount of well under 10%, and (c) Hambros obtained approval from their Head Office in Paris in 7 days, which is within the 5 to 10 days quoted by Bank B. Hambros' view about the risk is what I would have expected of a bank prepared to do this type of business, which I accept would not have included a High Street Bank. They are paying a discount based on a price of 5 when 85 was sitting in a bank account controlled by KBTL as sole director of a newly-formed trustee company (although in the case of both the Appellants the Security was charged to secure some borrowings that ranked ahead of Hambros), in circumstances where all parties were knowingly involved in a tax-avoidance scheme and were not likely to take actions that would prejudice its success. They were essentially buying cash at a discount. KPMG had given figures to the Appellants based on a discount of 10% on the basis of which they went ahead with the scheme and so a discount of this amount was acceptable to them. Even if Hambros had been refused permission by their head office on 7 March, KPMG still had until 5 April to find another purchaser. It had taken Hambros from 4 February to 7 March, which does not suggest that it would be impossible to do so within just under a month.
(15) My conclusion is that while the risk of not finding a purchaser existed and the Appellants were warned about it, it was so small as to be a practical certainty that at the time of issue of the securities (and assuming that the Market Change condition had been satisfied when the purchaser was considering the purchase) KPMG would succeed in finding purchasers willing and able to purchase the securities within the time scale at a discount of not more than about 10%, and that this was known to KPMG.
(1) Mr Astall was a member of the senior management of Celestica Inc, which was listed on the New York and Toronto Stock Exchanges. The quotation was volatile, varying between about £50 in early 2001 to £22 in February 2002. His income for 2001-02 was around £1m but he was hoping to exercise unapproved share options. He first saw Celestica's worldwide results for 2001 when they were released to the New York Stock Exchange in the last week in January 2002, when it became clear that targets had not been met and no bonuses were likely to be paid (as they had been in the previous four years). He was an insider as at the end of January 2002, there was a possibility that he would be treated as an insider throughout the period to the end of the tax year on 5 April 2002, and in any event he was not permitted to trade until the first week in February 2002. Trading also required permission from the Board of Directors, and he could recall half a dozen times when permission had been refused, including one in early 2001. Had acquisitions with which he was concerned gone ahead, he was an insider and would have been prohibited from selling while these were taking place, which was likely to have continued after 5 April 2002. However, he had announced that he would retire at the end of 2002 and was in process of handing over his work from the end of 2001, and hoped that his involvement in the acquisitions would have been complete by the end of March 2002, although this was not certain. In fact the acquisitions were aborted in mid February 2002, after which this aspect ceased to be relevant. He was able to exercise his options in early April 2002 and sell the shares. At 25 January 2002, the date of issue of the security, the amount of the income that he wanted to shelter by using the scheme was therefore uncertain.
(2) He gave KPMG details of his estimated income as £2m on 18 January 2002. He also formed the trust on 18 January 2002 and the Security was issued on 25 January 2002 with an issue price of £2,110,043, thus intending to shelter £2m of income. He borrowed the issue price plus fees making a total of £2,139,181 (£1,477,000 from Kleinwort Benson and £662,181 from other sources). He borrowed because the funds available were standing at a loss. In March or April 2002 he decided to sell the assets and buy corresponding ones in the trust.
(3) The KPMG fees were based on the estimated amount of his income of £2m. He had paid the initial 1% (plus VAT) on signing the engagement letter; there was a further fee of 1.5% (plus VAT) payable on sale of the Security; and a success fee of 7.5% (plus VAT). If the scheme were successful in relation to income of £2m he would gain £545,262 after taking fees of £239,288 into account (this includes fees for establishing the trust and trust administration). If it were unsuccessful he would lose £72,708 having taken fees of £66,038 into account. If the scheme failed because of the Market Change condition or the failure to find a purchaser he would lose £29,632 (this figure includes tax on the profit on redemption and winding up the trust). He was prepared to lose such a sum since he could lose that amount in an afternoon on movements in the Celestica share price. He saw this as an acceptable risk and he was very used to taking risks. Mr Michael Walker, the KPMG partner who was advising him said (and I accept) that Mr Astall regarded as important his ability to unwind the scheme by exercising the early redemption option particularly if his income proved to be less than the estimate. If his income were £1m and he went ahead with the sale of the Security he would incur further fees of £37,250 (KPMG's fee of 1.5% plus VAT plus £2,000 legal fees on sale of the Security) and if successful he would gain £400,000 less, namely £145,262. If unsuccessful he would lose £72,708 as before. Alternatively he could abandon the scheme and redeem the Security which would cost him £29,632 as above.
(4) The latest date he could give notice to redeem was 25 March 2002. He would have expected to know the amount of his income by then.
(5) Mr Astall said during cross-examination:
Q. But you think it is quite likely you would not [go ahead if your income was £1m]?
A. I really don't know, I was really hoping that that event would not happen so to me this is a hypothetical conversation, I guess, I would have had to go back to my advisers, both independent advisers at Coutts, gone back to KPMG and said this is all I am going to be able to get because of the various insider issues and my inkling is it is [not[1]] going to change pretty much all year, what do you suggest we do?
I accept this. I do not think that KPMG would have advised him because they had a conflict of interest over their success fee. I consider that the only advice Coutts could have given is that it was a gamble and he had to make up his own mind.
(6) I am therefore unable, even on the balance of probabilities, to say what Mr Astall considered he would do at the date of issue of the Security because he had not considered it. It follows that I find that it cannot be said that in Mr Astall's case there was no reasonable likelihood of the early redemption provision being exercised.
(7) In relation to the early redemption provision entitling him to redeem at 100.1% of the issue price, the Accountant's letter (see paragraph 4(9) above) to the trustees dated 23 January 2002 in Mr Astall's case said:
"By virtue of clause 3.2 the security holder can request early redemption of the note after 1 month. The premium payable on redemption in these circumstances is £2,110.
This too is less tha[n] the initial capital settled. Again therefore the trustees should always have sufficient capital to meet this liability if the proceeds are invested in safe, secure assets."
(8) Looking at the position at the date of issue of Mr Astall's security if the early redemption provision was exercised the only source of funds to meet the premium of 0.1% of the issue price was, as the Accountant's letter says, the capital of the trust. The parties intended that this should be the source, and looking at it objectively there were no other possible funds.
Charge to tax on realised profit comprised in discount
1—(1) Where a person realises the profit from the discount on a relevant discounted security, he shall be charged to income tax on that profit under Case III of Schedule D or, where the profit arises from a security out of the United Kingdom, under Case IV of that Schedule.
(2) For the purposes of this Schedule a person realises the profit from the discount on a relevant discounted security where—
(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and
(b) the amount payable on the transfer or redemption exceeds the amount paid by that person in respect of his acquisition of the security.
(3) For the purposes of this Schedule the profit shall be taken—
(a) to be equal to the amount of the excess reduced by the amount of any relevant costs; and
(b) to arise, for the purposes of income tax, in the year of assessment in which the transfer or redemption takes place.
(4) In this paragraph "relevant costs", in relation to a security that is transferred or redeemed, are all the following costs—
(a) the costs incurred in connection with the acquisition of the security by the person making the transfer or, as the case may be, the person entitled to a payment on the redemption; and
(b) the costs incurred by that person, in connection with the transfer or redemption of the security;
and for the purposes of this Schedule costs falling within paragraph (a) above shall not be regarded as amounts paid in respect of the acquisition of a security.
Realised losses on discounted securities
2—(1) Subject to the following provisions of this Schedule, where—
(a) a person sustains a loss in any year of assessment from the discount on a relevant discounted security, and
(b) makes a claim for the purposes of this paragraph before the end of twelve months from the 31st January next following that year of assessment,
that person shall be entitled to relief from income tax on an amount of the claimant's income for that year equal to the amount of the loss.
(2) For the purposes of this Schedule a person sustains a loss from the discount on a relevant discounted security where—
(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and
(b) the amount paid by that person in respect of his acquisition of the security exceeds the amount payable on the transfer or redemption.
(3) For the purposes of this Schedule the loss shall be taken—
(a) to be equal to the amount of the excess increased by the amount of any relevant costs; and
(b) to be sustained for the purposes of this Schedule in the year of assessment in which the transfer or redemption takes place.
(4) Sub-paragraph (4) of paragraph 1 above applies for the purposes of this paragraph as it applies for the purposes of that paragraph.
Meaning of "relevant discounted security"
3—(1) Subject to the following provisions of this paragraph and paragraph 14(1) below, in this Schedule "relevant discounted security" means any security which (whenever issued) is such that, taking the security as at the time of its issue, the amount payable on redemption—
(a) on maturity, or
(b) in the case of a security of which there may be a redemption before maturity, on at least one of the occasions on which it may be redeemed,
is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain.
(1A) The occasions that are to be taken into account for the purpose of determining whether a security is a relevant discounted security by virtue of sub-paragraph (1)(b) above shall not include any of the following occasions on which it may be redeemed, that is to say—
(a) any occasion not falling within sub-paragraph (1C) below on which there may be a redemption otherwise than at the option of the person who holds the security;
(b) in a case where a redemption may occur as a result of the exercise of an option that is exercisable—
(i) only on the occurrence of an event adversely affecting the holder, or
(ii) only on the occurrence of a default by any person,
any occasion on which that option is unlikely (judged as at the time of the security's issue) to be exercisable;
but nothing in this sub-paragraph shall require an occasion on which a security may be redeemed to be disregarded by reason only that it is or may be an occasion that coincides with an occasion mentioned in this sub-paragraph.
(1B) In sub-paragraph (1A) above "event adversely affecting the holder", in relation to a security, means an event which (judged as at the time of the security's issue) is such that, if it occurred and there were no provision for redemption, the interests of the person holding the security at the time of the event would be likely to be adversely affected.
(1C) An occasion on which there may be a redemption of a security falls within this sub-paragraph if—
(a) the security is a security issued to a person connected with the issuer; or
(b) the obtaining of a tax advantage by any person is the main benefit, or one of the main benefits, that might have been expected to accrue from the provision in accordance with which it may be redeemed on that occasion.
(1D) In sub-paragraph (1C) above "tax advantage" has the meaning given by section 709(1) of the Taxes Act 1988.
…
(3) For the purposes of this Schedule the amount payable on redemption of a security involves a deep gain if—
(a) the issue price is less than the amount so payable; and
(b) the amount by which it is less represents more than the relevant percentage of the amount so payable.
(4) In this paragraph "the relevant percentage", in relation to the amount payable on redemption of a security, means—
(a) the percentage figure equal, in a case where the period between the date of issue and the date of redemption is less than thirty years, to one half of the number of years between those dates; and
(b) in any other case, 15 per cent.;
and for the purposes of this paragraph the fraction of a year to be used for the purposes of paragraph (a) above in a case where the period mentioned in that paragraph is not a number of complete years shall be calculated by treating each complete month, and any remaining part of a month, in that period as one twelfth of a year.
"(5) References in this paragraph to redemption—
(a) do not include references to any redemption which may be made before maturity otherwise than at the option of the holder of the security but
(b) in the case of a security that is capable of redemption at the option of the holder before maturity, shall have effect as references to the earliest occasion on which the holder of the security may require the security to be redeemed."
It had therefore looked at the earliest occasion for redemption. Para 3(1) was also redrafted to refer to at least one of the occasions on which it may be redeemed in place of the earliest occasion, and the reference to "would be" was added. As the Explanatory Note said:
"The change will ensure that holders of discounted securities cannot escape an income charge on the discount by arranging an artificial option—which would never in practice be exercised—for the holder to redeem early at par. In future, the test for deepness of discount will be by reference to any occasion on which the security may be redeemed, except for redemptions triggered by a default which is unlikely to happen."
The last reference is to the new para 3(1A) to (1C).
(1) The words in para 3 "any security which…is such that, taking the security as at the time of its issue" requires one on both a literal and purposive interpretation to have regard to all the terms of the Security. A subsequent holder must know during the lifetime of the Security whether it is a relevant discounted security, which must be determined wholly objectively.
(2) The words "the amount payable on redemption… is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain" cannot take account of the subjective intentions of the parties. "Might" does not require an investigation of the likelihood based on the original parties' expectations.
(3) The words "the amount payable on redemption…(b) in the case of a security of which there may be a redemption before maturity, on at least one of the occasions on which it may be redeemed, is or would…or might be an amount which would involve a deep gain" require considering by reference to the terms of issue every occasion on which the Security may be redeemed before maturity. An occasion for redemption cannot be disregarded because it is unlikely to occur. Nor can a possible occasion be disregarded because it was inserted for tax reasons. The Explanatory Note makes clear that every occasion of redemption must be considered. Paragraph 3(1A) is an exception specifically providing that one occasion which is unlikely to occur is disregarded, thus confirming that in all other cases unlikely occasions are to be considered. Paragraph 3(1C) specifically requires an occasion of redemption not to be disregarded when a tax advantage might be expected, thus confirming that all possible occasions including those inserted for tax purposes to be taken into account.
(4) This is fully consistent with the Ramsay principle which is now clearly based on statutory construction. The position in IRC v Scottish Provident [2005] STC 15 was substantially different. There the statutory provision being construed was:
"A contract is a debt contract for the purposes of this Chapter if,…—
(a) it is a contract under which, whether unconditionally or subject to conditions being fulfilled, a qualifying company has any entitlement…to become a party to a loan relationship;…."
Although drafted in terms of the definition of a type of contract, it actually looked at whether a party to such a contract had an entitlement. The definition of relevant discounted security looked solely at the terms of the security. The relevant factual matrix is determined by the legislation: in MacNiven v Westmoreland Investments Ltd [2001] STC 237 this merely required that the payment of interest be made, and in Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1 only the position of the lessee was relevant. No doubts were cast on Craven v White [1988] STC 476. The principle that two parts of a transaction cannot be considered as one where no arrangements exist for the second, did not apply in relation to the facts of Scottish Provident in which "the contingency upon which SPI rely for saying that there was no composite transaction was a part of that composite transaction."
(5) Accordingly one is required to take the Security (not take some of its terms) and ask whether "it is such that" (looking only at the security, not at extraneous circumstances) the amount payable on redemption, either on maturity, or on at least one of the occasions before maturity on which redemption "may" occur (considering every occasion on which the security might be redeemed), would or "might" involve a deep gain.
(6) The Revenue are trying to prevent relief for an "artificial" loss but the amount of a loss is the result of the mechanistic provisions of para 2. They are trying to narrow the circumstances in which a deep gain is taxable but it is highly unlikely that Parliament so intended (and the Explanatory Note shows that Parliament certainly did not intend) to prevent loss relief by the very indirect route of providing that a redemption involving a deep gain should fall outside the charging provisions merely because redemption on that occasion was unlikely, or unhoped-for, or merely because the terms of the security under which such redemption occurred were inserted for tax or other non-commercial reasons.
(7) Mr Astall might well have exercised the early redemption option if his income turned out to be £1m rather than £2m. In relation to the Revenue's argument, the fact that the source of the premium is the capital of the trust is irrelevant. The premium creates a deep gain according to the legislation. The source may be capital but if say interest is paid out of a company's share capital it is still income. The source of the premium is not limited to the capital of the trust. It could be paid out of the income because the trustees have a lien over the income to meet liabilities so long as there is a later adjustment with the life tenant.
(1) The general approach is that explained in Barclays Mercantile Business Finance Ltd v Mawson but IRC v Scottish Provident is more relevant here. In the latter the statutory provision being construed was the definition of a debt contract in s 150A of the Finance Act 1994:
"A contract is a debt contract for the purposes of this Chapter if,…—
(a) it is a contract under which, whether unconditionally or subject to conditions being fulfilled, a qualifying company has any entitlement…to become a party to a loan relationship;…."
One is apparently directed to the terms of the contract but nevertheless in circumstances where the company had both an option to acquire gilts and was subject to an option to sell them which were expected to be exercised at the same time, although there were circumstances in which they might not be such that it could not be said there was no practical likelihood that they would be, the House of Lords decided that in construing entitlement one must take account of both options. The uncertainty that the options might not both be exercised was one created by the parties: see Scottish Provident at [22]-[23] quoted at paragraph 15 below.
(2) Here the Market Change condition was, as Mr Prosser conceded, inserted as an anti-Ramsay device, as was KPMG's decision not to seek purchasers for the security until after it had been issued. The Appellants relied on KPMG in respect of both and did not ask whether either uncertainty could be avoided. There was a practical certainty that when the security was issued a purchaser would be found. Both should be ignored for the same reason as the uncertainty created in Scottish Provident.
(3) The possibility of early redemption should be ignored for the same reason as the uncertainty created in Scottish Provident. Alternatively since any income from the deposit of the funds by the trustees went to the Appellant as life tenant the only source of the premium on early redemption was the amount originally settled in the trust, as the Accountant's Letter made clear. This could be ignored as the circulation of the Appellant's own funds. This was not a transaction envisaged by the legislation as producing a deep gain. Mr Prosser's reply to this last point was that if income had been paid the trustees had a lien on it to repay borrowings but would have to reimburse the life tenant later.
(4) In relation to the possible early redemption of the Security by Mr Astall the only possible source of funds is the capital of the trust, the amount of which was fixed for that purpose (and for redemption on default). This would be a circulation of funds, not a deep gain in a meaningful sense.
Reasons for the decision
The Market Change condition
[19] … Since the decision of this House in W T Ramsay Ltd v IRC [1981] STC 174, [1982] AC 300 it has been accepted that the language of a taxing statute will often have to be given a wide practical meaning of this sort which allows (and indeed requires) the court to have regard to the whole of a series of transactions which were intended to have a commercial unity.
The way in which the House of Lords did this in relation to the terms of the options designed to create a situation in which it had been found as a fact that there was a practical likelihood that the options would not be exercised at the same time was:
"[22] … Here, the uncertainty arises from the fact that the parties have carefully chosen to fix the strike price for the SPI option at a level which gives rise to an outside chance that the option will not be exercised. There was no commercial reason for choosing a strike price of 90. From the point of view of the money passing (or rather, not passing), the scheme could just as well have fixed it at 80 and achieved the same tax saving by reducing the Citibank strike price to 60. It would all have come out in the wash. Thus the contingency upon which SPI rely for saying that there was no composite transaction was a part of that composite transaction; chosen not for any commercial reason but solely to enable SPI to claim that there was no composite transaction. It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme.
[23] We think that it would destroy the value of the Ramsay principle of construing provisions such as s 150A(1) of the 1994 Act as referring to the effect of composite transactions 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."
The decision not to seek purchasers of the Security
"The transactions which, in each appeal, the Revenue seeks now to reconstruct into a single direct disposal from the taxpayer to the ultimate purchaser were not contemporaneous. Nor were they pre-ordained or composite in the sense that it could be predicated with any certainty at the date of the intermediate transfer what the ultimate destination of the property would be, what would be the terms of any ultimate transfer or even whether an ultimate transfer would take place at all."
In Scottish Provident the House of Lords commented on this passage at [22]:
"Thus there was an uncertainty about whether the alleged composite transaction would proceed to completion which arose, not from the terms of the alleged composite transaction itself, but from the fact that, at the relevant date, no composite transaction had yet been put together."
That is far removed from the present transaction where from the start one can predict with certainty (having ignored the Market Change condition) that the taxpayer puts 100 in, 6 (less a turn) comes back to the taxpayer from a bank which recovers 6 from the trust, leaving the remaining 94 in the trust. The only uncertainty is the amount of the bank's turn. Not seeking purchasers in advance is just as much a course of action, or rather inaction, "chosen not for any commercial reason but solely to enable [the Appellants] to claim that there was no composite transaction." I have found as a fact that it was a practical certainty that at the time of issue of the securities KPMG would succeed in finding purchasers willing and able to purchase the securities within the time scale at a discount of not more than about 10%. It is just as much the case that "It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme." For the same reason as the Market Change condition I shall ignore the possibility of a purchaser not being found.
The terms for redemption
"[29] The Ramsay case ([1981] STC 174, [1982] AC 300) liberated the construction of revenue statutes from being both literal and blinkered. It is worth quoting two passages from the influential speech of Lord Wilberforce. First ([1981] STC 174 at 179, [1982] AC 300 at 323), on the general approach to construction:
'What are 'clear words' is to be ascertained on normal principles; these do not confine the courts to literal interpretation. There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded: …'
…
[32] The essence of the new approach was to give the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. Of course this does not mean that the courts have to put their reasoning into the straitjacket of first construing the statute in the abstract and then looking at the facts. It might be more convenient to analyse the facts and then ask whether they satisfy the requirements of the statute. But however one approaches the matter, the question is always whether the relevant provision of statute, upon its true construction, applies to the facts as found. As Lord Nicholls of Birkenhead said in MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] UKHL 6 at [8], [2001] STC 237 at [8], [2003] 1 AC 311:
'The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case.'
[33] The simplicity of this question, however difficult it might be to answer on the facts of a particular case, shows that the Ramsay case did not introduce a new doctrine operating within the special field of revenue statutes. On the contrary, as Lord Steyn observed in McGuckian [1997] STC 908 at 915, [1997] 1 WLR 991 at 999 it rescued tax law from being 'some island of literal interpretation' and brought it within generally applicable principles.
[34] Unfortunately, the novelty for tax lawyers of this exposure to ordinary principles of statutory construction produced a tendency to regard Ramsay as establishing a new jurisprudence governed by special rules of its own. This tendency has been encouraged by two features characteristic of tax law, although by no means exclusively so. The first is that tax is generally imposed by reference to economic activities or transactions which exist, as Lord Wilberforce said, 'in the real world'. The second is that a good deal of intellectual effort is devoted to structuring transactions in a form which will have the same or nearly the same economic effect as a taxable transaction but which it is hoped will fall outside the terms of the taxing statute. It is characteristic of these composite transactions that they will include elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge.
…
[36] Cases such as these [IRC v Burmah Oil Co Ltd [1982] STC 30, 1982 SC (HL) 114, Furniss (Inspector of Taxes) v Dawson [1984] STC 153, [1984] AC 474 and Carreras Group Ltd v Stamp Comr [2004] UKPC 16, [2004] STC 1377] gave rise to a view that, in the application of any taxing statute, transactions or elements of transactions which had no commercial purpose were to be disregarded. But that is going too far. It elides the two steps which are necessary in the application of any statutory provision: 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. As Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35], (2006) 6 ITLR 454 at [35]:
'[T]he driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.'
[37] The need to avoid sweeping generalisations about disregarding transactions undertaken for the purpose of tax avoidance was shown by MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] STC 237, [2003] 1 AC 311 in which the question was whether a payment of interest by a debtor who had borrowed the money for that purpose from the creditor himself and which had been made solely to reduce liability to tax, was a 'payment' of interest within the meaning of the statute which entitled him to a deduction or repayment of tax. The House decided that the purpose of requiring the interest to have been 'paid' was to produce symmetry by giving a right of deduction in respect of any payment which gave rise to a liability to tax in the hands of the recipient (or would have given rise to such a liability if the recipient had been a taxable entity). As the payment was accepted to have had this effect, it answered the statutory description notwithstanding the circular nature of the payment and its tax avoidance purpose."
(1) The scheme is entirely artificial and the Appellants had no commercial purposes in entering into it other than generating an artificial loss to set against taxable income.
(2) The terms of the Security were, in the words of the KPMG memorandum given to clients interested in the scheme, "structured so that it falls within the definition of a relevant discounted security for tax purposes." The premiums of 0.1% under the early redemption option, and 18% on final redemption after either 15 or 65 years, and in particular the same premium for both periods, do not reflect a market return for a zero-coupon security being the last two being about 1.1% and 0.25% respectively compounded annually. The three alternatives given to the Appellants after the Market Change condition had been satisfied that is set out in paragraph 4(29) above amounted to a choice between (a) redeeming the Security at 100.1 of the issue price (the 0.1 necessarily being paid out of the initial capital of the trust) and accordingly losing the benefit of the fee of 1% plus VAT that had been paid; (b) selling the Security with the hope of a tax loss of 94; and (c) holding the zero-coupon Security for 15 years with an effective annual yield of about 1.1%. Apart from Mr Astall's particular circumstances which I consider below, it was a practical certainty that nobody was going to choose (a) or (c). (This choice reminded me of what in the 1970s became known as the "X sham option." Mr X was a highly respected member of the tax bar who had very reasonably advised the promoter of a tax scheme that it would stand a better chance of success if the taxpayer had a choice of action so that it was not clear that one result was preordained. The promoter took the advice somewhat too literally and wrote an option into the scheme that when one analysed the figures nobody would choose, the name being coined by counsel for the Revenue to pull Mr X's leg about it.)
(3) The choice offered to the purchaser of the Securities was between redeeming them on 7 days notice and realising the discount as a profit, or holding the zero-coupon Securities for 65 years with an effective annual yield of about 4.76% (assuming annual compounding) which Mr Patterson said (and I accept) was about the market rate. It was also a practical certainty that any purchaser would immediately redeem them at 5% of their redemption price, and this was known to KPMG. No purchaser would have considered holding the Securities for 65 years.
(4) The Trustees would not have wished to have the Securities remaining in issue for 65 years. This would have seriously inhibited the investment of the trust funds and might have involved personal liability of the trustees for the whole of this period. They regarded it as a practical certainty that this would not happen, and a reasonable person with the knowledge available to the parties would conclude that the Securities would be immediately redeemed by the purchaser.
(5) It was a practical certainty that the securities would cease to exist within two months of their issue: either (a) the Market Change condition would be satisfied and the securities would be sold and redeemed by the purchaser as above; or (b) in the event of the Market Change condition not being satisfied (the possibility of which I have decided should be ignored, except in relation to Mr Astall), the Appellants would redeem their securities.
(6) Ignoring the existence of the Market Change condition and the possibility of a purchaser not being found, and the consequences of their not being satisfied, as I have already decided, the essence of the scheme is that each of the Appellants subscribes 100 for a Security the terms of which on giving notice to sell it suddenly change so that it is now worth only about 6 (5% of 118). It is then sold to a bank for 6 less a turn for the bank, which redeems it for 6 a week later. The remaining 94 remains in a trust for the benefit of the Appellant (matched by an equivalent tax-free gain in the trust which has had its liability to repay the Security removed).
The uncertainty relating to the amount of Mr Astall's income
JOHN F. AVERY JONES
SPECIAL COMMISSIONER
RELEASE DATE:
SC 3030/07, 3031/07 (corrected version 2)
Authorities referred to in skeletons and not referred to in the decision:
Singer v Williams [1921] AC 41
IRC v Parker [1966] AC 141
Mercury Energy Ltd v Utilcorp NZ Ltd [1997] 1 NZLR 492
Campbell v IRC [2004] STC (SCD) 396
Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896
Note 1 Not in the transcript, but from the sense clearly should be there. [Back]