Astall & Anor v Revenue and Customs

Both parties to this appeal made submissions about the recent approach of the courts to statutory interpretation with reference to tax saving transactions. It is helpful to have the current jurisprudence in mind before examining the issues in this case.

In the Privy Council case of Carreras Group Limited v Stamp Commissioner [2004] STC 1377, the question was whether, for the purposes of Jamaican tax legislation, debentures had been issued in exchange for shares where they were so issued but swiftly redeemed for cash. Lord Hoffmann, delivering the judgment of the Board, made it clear that in interpreting tax legislation the courts have tended to assume that the legislation is concerned with the characterisation of transactions which have a commercial unity rather than the component steps taken individually:

“[8] Whether the statute is concerned with a single step or a broader view of the acts of the parties depends upon the construction of the language in its context. Sometimes the conclusion that the statute is concerned with the character of a particular act is inescapable: see MacNiven (Inspector of Taxes)v Westmoreland Investments Limited [2001] UKHL 6, [2001] STC 237, [2003]1 AC 311. But ever since WT Ramsay Ltd vIRC [1981] STC 174, [1982] AC 300, the courts have tended to assume that revenue statutes in particular are concerned with the characterisation of the entirety of transactions which have a commercial unity rather than the individual steps into which some transactions may be divided. This approach does not deny the existence or legality of the individual steps but may deprive them of significance for the purposes of the characterisation required by the statute. This has been said so often that citation of authorities since Ramsay's case is unnecessary. ”

Lord Hoffmann held that, if a restrictive interpretation of the transaction were adopted, that:

“would produce the result that exemption from tax could be obtained by a formal step inserted in the transaction from no purpose other than the avoidance of tax. This would not be a rational system of taxation and their Lordships do not accept that it was intended by the legislature. They agree with the majority of the Court of Appeal that the relevant transaction for the purposes of the legislation comprised of the issue and the redemption of the debenture and that such transaction, taken as a whole, could not be appropriately characterised as an exchange of shares for a debenture."

Lord Hoffmann dismissed the suggestion that a purposive interpretation rendered the legislation uncertain in its application. Whether the interval of time was acceptable would depend on the facts. His speech disclosed the fine factual inquiry that is sometimes involved. In the instant case, it was:

“plain from the terms of the debenture and the timetable that the redemption was not merely contemplated (the redemption of any debenture may be said to be contemplated), but intended by the parties as an integral part of the transaction, separated from the exchange by as short a time as was thought to be decent in the circumstances. The absence of security and interest reinforces this inference. No other explanation has been offered. In this case, their Lordships think that it is inherent in the process of construction that one will have to decide as a question of fact, whether a given act was or was not part of the transaction contemplated by the statute. In practice, any uncertainty is likely to be confined to transactions into which steps have been inserted without any commercial purpose. Such uncertainty is something which the architects of such schemes have to accept.” (para. [16])

The most recent cases are Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL 51 (“Mawson”) and Inland Revenue Commissioners v ScottishProvident Institution [2004] UKHL 52 (“SPI”). The judgments of the House of Lords were given on the same day.

In Mawson, a gas company (Gas Co) owned a pipeline under the Irish Sea. A subsidiary of Barclays Bank plc, BMBF, entered into agreements to acquire parts of the pipeline by way of sale and leaseback from Gas Co for £91m. Although it paid the price to Gas Co, this sum had to be deposited with a third company (D). Under the arrangements, D had in turn to deposit the £91m with Barclays Bank's Isle of Man subsidiary, which, in turn, deposited the £91m with BMBF. This sum was released in tranches to Gas Co. Gas Co subleased the pipeline to its UK subsidiary, Gas Co UK, which received payments from Gas Co for the transportation of gas through the pipeline. The rent payable to BMBF by Gas Co, and to Gas Co by Gas Co UK, were (so far as material) on similar terms. There was, therefore, circularity in the movement of money between the parties. In the end BMBF was repaid the price it had paid, plus a profit.

The issue was whether BMBF was entitled to capital allowances under section 24(1) of the Capital Allowances Act 1990 for expenditure incurred for the provision of an item of machinery or plant for the purposes of its trade. The House of Lords concluded that BMBF was so entitled. In particular, it concluded that, since the statutory requirements were concerned entirely with the acts and purposes of the lessor, it does not matter what the lessee did ([40]).

Lord Nicholls, giving the opinion of the Appellate Committee, described the correct approach to the interpretation of statues for the purpose of determining whether a particular tax treatment was appropriate in the following terms:

“29.

The Ramsay case [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, at p 323, on the general approach to construction:

"What are 'clear words' is to be ascertained upon 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."

30.

Secondly, at pp 323-324, on the application of a statutory provision so construed to a composite transaction:

"It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded."

31.

The application of these two principles led to the conclusion, as a matter of construction, that the statutory provision with which the court was concerned, namely that imposing capital gains tax on chargeable gains less allowable losses was referring to gains and losses having a commercial reality ("The capital gains tax was created to operate in the real world, not that of make-belief") and that therefore:

"To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, there is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function." (p 326)

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 the statute, upon its true construction, applies to the facts as found. As LordNicholls of Birkenhead said in MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311, 320, para 8: "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] 1 WLR 991, 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.

35.

There have been a number of cases, such as Inland Revenue v Burmah Oil Co Ltd 1982 SC (HL) 114, Furniss v Dawson [1984] AC 474 and Carreras Group Ltd v Stamp Comr [2004] STC 1377 in which it has been decided that elements which have been inserted into a transaction without any business or commercial purpose did not, as the case might be, prevent the composite transaction from falling within a charge to tax or bring it within an exemption from tax. Thus in the Burmah case, a series of circular payments which left the taxpayer company in exactly the same financial position as before was not regarded as giving rise to a "loss" within the meaning of the legislation. In Furniss, the transfer of shares to a subsidiary as part of a planned scheme immediately to transfer them to an outside purchaser was regarded as a taxable disposition to the outside purchaser rather than an exempt transfer to a group company. In Carreras the transfer of shares in exchange for a debenture with a view to its redemption a fortnight later was not regarded as an exempt transfer in exchange for the debenture but rather as an exchange for money. In each case the court looked at the overall effect of the composite transactions by which the taxpayer company in Burmah suffered no loss, the shares in Furniss passed into the hands of the outside purchaser and the vendors in Carreras received cash. On the true construction of the relevant provisions of the statute, the elements inserted into the transactions without any commercial purpose were treated as having no significance.

36.

Cases such as these 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, para 35:

"the 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 v Westmoreland Investments Ltd [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.

38.

MacNiven shows the need to focus carefully upon the particular statutory provision and to identify its requirements before one can decide whether circular payments or elements inserted for the purpose of tax avoidance should be disregarded or treated as irrelevant for the purposes of the statute. In the speech of Lord Hoffmann in MacNiven it was said that if a statute laid down requirements by reference to some commercial concept such as gain or loss, it would usually follow that elements inserted into a composite transaction without any commercial purpose could be disregarded, whereas if the requirements of the statute were purely by reference to its legal nature (in MacNiven, the discharge of a debt) then an act having that legal effect would suffice, whatever its commercial purpose may have been. This is not an unreasonable generalisation, indeed perhaps something of a truism, but we do not think that it was intended to provide a substitute for a close analysis of what the statute means. It certainly does not justify the assumption that an answer can be obtained by classifying all concepts a priori as either "commercial" or "legal". That would be the very negation of purposive construction: see Ribeiro PJ in Arrowtown, at paras 37 and 39 and the perceptive judgment of the special commissioners (Theodore Wallace and Julian Ghosh) in Campbell v Inland Revenue Comrs [2004] STC (STD) 396.”

The principles of purposive construction thus explained were applied by the House to the facts of Mawson as follows:

“39.

The present case, like MacNiven, illustrates the need for a close analysis of what, on a purposive construction, the statute actually requires. The object of granting the allowance is, as we have said, to provide a tax equivalent to the normal accounting deduction from profits for the depreciation of machinery and plant used for the purposes of a trade. Consistently with this purpose, section 24(1) requires that a trader should have incurred capital expenditure on the provision of machinery or plant for the purposes of his trade. When the trade is finance leasing, this means that the capital expenditure should have been incurred to acquire the machinery or plant for the purpose of leasing it in the course of the trade. In such a case, it is the lessor as owner who suffers the depreciation in the value of the plant and is therefore entitled to an allowance against the profits of his trade.

40.

These statutory requirements, as it seems to us, are in the case of a finance lease concerned entirely with the acts and purposes of the lessor. The Act says nothing about what the lessee should do with the purchase price, how he should find the money to pay the rent or how he should use the plant. As Carnwath LJ said in the Court of Appeal [2003] STC 66, 89, para 54:

"There is nothing in the statute to suggest that 'up-front finance' for the lessee is an essential feature of the right to allowances. The test is based on the purpose of the lessor's expenditure, not the benefit of the finance to the lessee."

41.

So far as the lessor is concerned, all the requirements of section 24(1) were satisfied. Mr Boobyer, a director of BMBF, gave unchallenged evidence that from its point of view the purchase and leaseback was part of its ordinary trade of finance leasing. Indeed, if one examines the acts and purposes of BMBF, it would be very difficult to come to any other conclusion. The finding of the special commissioners that the transaction "had no commercial reality" depends entirely upon an examination of what happened to the purchase price after BMBF paid it to BGE. But these matters do not affect the reality of the expenditure by BMBF and its acquisition of the pipeline for the purposes of its finance leasing trade.

42.

If the lessee chooses to make arrangements, even as a preordained part of the transaction for the sale and leaseback, which result in the bulk of the purchase price being irrevocably committed to paying the rent, that is no concern of the lessor. From his point of view, the transaction is exactly the same. No one disputes that BMBF had acquired ownership of the pipeline or that it generated income for BMBF in the course of its trade in the form of rent chargeable to corporation tax. In return it paid £91m. The circularity of payments which so impressed Park J and the special commissioners arose because BMBF, in the ordinary course its business, borrowed the money to buy the pipeline from Barclays Bank and Barclays happened to be the bank which provided the cash collateralised guarantee to BMBF for the payment of the rent. But these were happenstances. None of these transactions, whether circular or not, were necessary elements in creating the entitlement to the capital allowances.”

Accordingly, the House of Lords concluded that the BMBF was entitled to capital allowances.

SPI exemplifies the same approach. Lord Nicholls provided a useful summary of the scheme in that case:

“The scheme in outline

[3] The central element of the scheme devised by Citibank International plc ('Citibank') to enable SPI to take advantage of the change-over was extremely simple. During the old regime, SPI would grant Citibank an option ('the Citibank option') to buy short-dated gilts, at a price representing a heavy discount from market price, in return for a correspondingly large premium. The premium received on the grant of the option would not be taxable. After the new regime came into force, Citibank would exercise the option. SPI would have to sell the gilts at well below market price and would suffer an allowable loss.

[4] If that was all there was to the transaction, there would also have been a risk that SPI or Citibank would have made a real commercial profit or loss. The premium would have been fixed by reference to the current market price, but the possibility of a rise or fall in interest rates during the currency of the option created a commercial risk for one side or the other. Neither side wanted to incur such a risk. The purpose of the transaction was to create a tax loss, not a real loss or profit. The scheme therefore provided for Citibank's option to be matched by an option to buy the same amount of gilts ('the SPI option') granted by Citibank to SPI. Premium and option price were calculated to ensure that movements of money between Citibank and SPI added up to the same amount, less a relatively small sum for Citibank to retain as a fee. In addition, SPI agreed to pay Citibank a success fee if the scheme worked, calculated as a percentage of the tax saving.

[5] The calculation of the SPI option price obviously needed careful thought. In one sense, of course, it did not matter. Whatever price was selected would be reflected in the corresponding premium and subsequent movements in the market price would cancel each other out. But the option price for SPI had to be higher than the option price for Citibank, otherwise the 'profit' realised by SPI on the exercise of its option would cancel out the 'loss' which it suffered on the exercise of the Citibank option and the whole exercise would be futile. Indeed, the greater the difference between the Citibank price and the SPI price, the greater would be the net tax loss created by the scheme. The difference did give rise to a potential cash flow problem because, if Citibank paid the premium for its option, it would be out of pocket in respect of the difference between the two premiums between the date on which the options were granted and the date on which they were exercised. But this was covered by a collateral agreement under which SPI agreed to deposit the difference with Citibank, free of interest, until its option had been exercised or lapsed. This enabled the payment of both premiums to take the form of book entries.

[6] On the other hand, the purpose of the SPI option was to reduce or eliminate the possibility that the outcome of the transaction would be affected by events in the real world such as movements in interest rates. So the SPI option price had to be sufficiently below market price as to be, for practical purposes, out of the possible range of such movements. There was also a third consideration. Plainly it was inconceivable that Citibank, having parted with a large premium for its option, would not exercise it. Equally, if the SPI price had been very low, it would have been inconceivable that SPI would not have countered by the exercise of its own option. That might have given rise to a doubt about whether in truth there was any transaction in gilts at all. It would have been inevitable that the obligations of Citibank and SPI to deliver gilts would cancel each other out and that none would change hands. So the SPI option price had to be close enough to the market price to allow for some possibility that this would not happen.”

The essential issue was whether the Citibank option gave Citibank an “entitlement" to gilts for the purposes of s 154(1) of the Finance Act 1994 (as amended by the Finance Act 1996). Citibank would have this entitlement if the two options were regarded as separate options. There was a possibility that the one might be exercised without the other (for example because of movements in interest rates and gilt prices). Lord Nicholls described the issue of interpretation in these terms:

“The question of construction

[18] SPI is entitled to treat the loss suffered on the exercise of the Citibank option as an income loss if the option was a 'qualifying contract' within the meaning of s 147(1)) of the Finance Act 1994 (the 1994 Act). Section 147A(1) (inserted by the Finance Act 1996 (the 1996 Act)) provides that a 'debt contract' is a qualifying contract if the company becomes subject to duties under the contract at any time on or after 1 April 1996. By s 150A(1) (also inserted by the 1996 Act) a 'debt contract' is a contract under which a qualifying company (which means, with irrelevant exceptions, any company: see s 154(1)) 'has any entitlement … to become a party to a loan relationship'. A 'loan relationship' includes a government security. So the short question is whether the Citibank option gave it an entitlement to gilts.

[19] That depends upon what the statute means by 'entitlement'. If one confines one's attention to the Citibank option, it certainly gave Citibank an entitlement, by exercise of the option, to the delivery of gilts. On the other hand, if the option formed part of a larger scheme by which Citibank's right to the gilts was bound to be cancelled by SPI's right to the same gilts, then it could be said that in a practical sense Citibank had no entitlement to gilts. 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. Indeed, it is conceded by SPI that the court is not confined to looking at the Citibank option in isolation. If the scheme amounted in practice to a single transaction, the court should look at the scheme as a whole. Mr Aaronson QC, who appeared for SPI, accepted before the Special Commissioners that if there was 'no genuine commercial possibility' of the two options not being exercised together, then the scheme must fail.”

The House of Lords held (as in Carreras) that the court could have regard to the whole of a series of transactions that were intended to have a commercial unity. It was conceded by the taxpayer that the court was not confined to examining the scheme in isolation but should look at matters as a whole. It was also accepted that, if there was "no genuine commercial possibility" of the two options not being exercised together, then the scheme must fail. The House held that although there was an outside chance that Citibank might wish to exercise its option without waiting for a corresponding exercise by SPI of its option, the parties were willing to accept that risk in the interests of the scheme, and thus this possibility should be disregarded:

“[22] Thus there was an uncertainty [in Craven (Inspector of Taxes) v White [1989] AC 398] 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. 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.

[24] It follows that in our opinion the Special Commissioners erred in law in concluding that their finding that there was a realistic possibility of the options not being exercised simultaneously meant, without more, that the scheme could not be regarded as a single composite transaction. We think that it was and that, so viewed, it created no entitlement to gilts and that there was therefore no qualifying contract.”

Accordingly, the transaction was to be regarded as a single composite transaction and Citibank had no "entitlement" to the gilts for the purposes of the Finance Act 1994.

Both Mawson and SPI emphasise the need to interpret the statute in question purposively, unless it is clear that that is not intended by Parliament. The court has to apply that interpretation to the actual transaction in issue, evaluated as a commercial unity, and not be distracted by any peripheral steps inserted by the actors that are in fact irrelevant to the way the scheme was intended to operate. SPI also illustrates another important point, namely that the fact that a real commercial possibility has been injected into a transaction does not mean that it can never be ignored. It can be disregarded if the parties have proceeded on the basis that it should be disregarded.

With that summary of the most recent jurisprudence on the interpretation of tax statutes, I turn to the five issues which arise on this appeal.

This is essentially an argument about whether paragraph 3 of schedule 13 is immune from purposive interpretation. Mr Kevin Prosser QC, for the appellants, submits that the court has to have regard to all the terms of issue and cannot ignore any of those terms for whatever reason. He submits in addition, that paragraph 3(1) of schedule 13 defines a RDS by reference to its terms of issue. Accordingly, the question whether a security is a RDS must be determined at the time of issue. If it is, at that point in time, an RDS, the taxpayer can make a claim. It is, moreover, very important that the holder of an RDS knows whether it is an RDS or not. The concept of an RDS is a legal one and not a commercial one. Extraneous facts, such as likelihood to redeem, are not relevant. The question whether a security is an RDS should be considered in isolation from the rest of the transaction and without reference to the motives and intentions of the holder. Mr Prosser places reliance on the use of the word “may" rather than “might", and on the words "whenever issued". These words emphasise the importance of the terms of issue as at the date of issue. Accordingly, the only question is whether the term is capable of operating. If it is capable of operating, the court does not have to consider whether it was realistic to expect it to operate.

Mr Prosser also places reliance on the fact that paragraph 3(1C) contains an express direction that some terms should not be ignored in the determination of whether a security constituted a RDS, even though one of the main aims of the transaction was to obtain a tax benefit. He recognizes that this provision proceeds on the basis that it is necessary to look at extraneous circumstances, but he contends that this is not the general rule: as it were, this is the exception that proves the rule. He emphasises that Parliament did not provide for a security which is issued to obtain a tax advantage to be disregarded.

Mr David Ewart QC, for HM Revenue and Customs (“the Revenue”), submits that the purpose of schedule 13 is to tax to income or to give relief for a loss accruing from a security, where there is at least the possibility of a deep gain accruing on that security. He agrees with Mr Prosser that the concept of profit or loss is different from deep gain because that concerns what may happen on redemption. Therefore it is possible to have a security with no deep gain but which makes a profit. If there is a deep gain, income tax is payable and losses are offsettable in circumstances which are more favourable to the taxpayer than if the gain had merely been subject to capital gains tax.

Mr Ewart submits that there is no basis for contending that the court should simply look at the terms of the security and not apply the normal approach to legislation laid down in Carreras, Mawson and SPI. Moreover, the concluding words of paragraph 3(1) makes it inevitable that the court has to look at the facts. Other features include the fact that the proceeds of issue would remain in cash throughout the transaction. Moreover the House clearly looked at the facts in SPI.

Mr Ewart submits that the clear structure of the relevant provisions of schedule 13 is that where the holder of a security may make a deep gain that should be subject to income tax, the concomitant is that if a loss can be made on the same security that loss should have income tax relief.

In my judgment, none of the reasons advanced by Mr Prosser are good reasons for not applying the principles of purposive interpretation to paragraphs 1, 2 or 3 of schedule 13. Quite clearly, the statute requires the court to focus on the terms of issue but that is no different from the need to focus on the acts of the lessor in Mawson. Moreover, as Mr Prosser accepts, paragraph 3(1C) and paragraph 3(1A)(b) proceed on the basis that facts extraneous to the transaction will be relevant, thus confirming that the application of paragraph 3 will not depend only on the terms of issue of the securities. Having said that, I would wish to make it clear that the mere fact that the parties intend to obtain a tax advantage is not in itself enough to make a statutory relief inapplicable.

I see no reason to hold that the new approach to statutory interpretation applies only if there is a composite transaction consisting of several elements destined to lead to a particular result. Mr Prosser urged us to accept that the language of practical certainty is derived from the jurisprudence on pre-ordained transactions for the purposes of the Ramsay jurisprudence. Thus, he submits, that purposive interpretation should be confined to composite transactions, just as the transaction in SPI was a composite transaction. In my judgment, the principle is that set out in the first sentence of [32] of Mawson. This principle is not expressed to be limited to composite transactions. It can thus apply to a single multi-faceted transaction which on its face operates in a particular way but which when examined against the facts of the case does not operate as a transaction to which the statute was intended to apply.

Mr Prosser puts forward a supplementary argument based on the fact that paragraph 3 of schedule 13 was amended by the Finance Act 1999 so as to broaden the occasions for redemption relevant to determining whether a security is a RDS. All such occasions are made relevant. An explanatory note prepared by the Revenue at the time of the Finance Bill 1999 makes this clear: it states that there had been a device to avoid the income charge by arranging an artificial option to redeem early at par. Mr Prosser submits that this note shows that the approach of the Special Commissioner that account should be taken only at the terms that the parties intended to operate was wrong as a matter of construction. I propose to deal with this point briefly. As we pointed out to Mr Prosser, there are difficulties about this explanatory note. It is undated; it is unclear at what stage of the Parliamentary process the note was produced, it is not accompanied by clause 59 to which it relates, and we are not told whether the note appeared in any explanatory notes published with the Act itself. Leaving those points on one side, I consider that the note provides no real assistance even for the purpose of establishing the context for the enactment and the mischief to which the amendment was directed (which in this case constitute the limited purposes for which such a note can be used as an aid to interpretation: see R (Westminster City Council) v National AsylumService [2002] 1 WLR 2956 at [2] to [6] per Lord Steyn). It did not purport to set out the meaning of clause 59 on a comprehensive basis and it is expressed in very general terms. Mr Ewart seeks to counter Mr Prosser’s reliance on it by submitting that it supports the Revenue’s case that its true meaning is that regard should be had only to those occasions on which there is a real possibility of redemption. I accept this submission. In my judgment, it would be contrary to the policy implicit in the note to treat it as supporting the argument that, once the artificiality referred to in the note is removed, Parliament intended account to be taken of all other events on which redemption could take place, irrespective of their artificiality.

Is a purposive interpretation of the relevant provisions possible in this case? In my judgment, there is nothing to indicate that the usual principles of statutory interpretation do not apply and accordingly the real question is how to apply those principles to the circumstances of this case. In my judgment, applying a purposive interpretation involves two distinct steps: first, identifying the purpose of the relevant provision. In doing this, the court should assume that the provision had some purpose and Parliament did not legislate without a purpose. But the purpose must be discernible from the statute: the court must not infer one without a proper foundation for doing so. The second stage is to consider whether the transaction against the actual facts which occurred fulfils the statutory conditions. This does not, as I see it, entitle the court to treat any transaction as having some nature which in law it did not have but it does entitles the court to assess it by reference to reality and not simply to its form.

I have described the processes involving two distinct steps. I have not overlooked that in Mawson Lord Nicholls held that the court did not need to force its thinking into two separate compartments (see [32] of his speech set out in paragraph [27] of this judgment). In my judgment, the process is likely to be an iterative one. While one probably starts with determining the purpose of the relevant provision, it may well be necessary to refine that purpose as and when the facts are more closely defined. This may be what Lord Hoffmann had in mind when he spoke in Carreras (see paragraph 23 of this judgment) of the need to find facts "in the process of construction".

At this juncture of the argument, only the first step needs to be considered. I accept Mr Ewart’s submission that the purpose of paragraphs 2 and 3 of schedule 13 is to give income tax relief on a security otherwise fulfilling the statutory conditions on which a deep gain can also be made. Mr Prosser does not make any counter suggestions to the relevant statutory purpose. But that is only the start of the matter. In my judgment, it is implicit in the statutory purpose that the agreed terms which might cause a deep gain to arise have to have a reality beyond the printed page. Issues (2) to (5) reflect that facet of the statutory purpose.

Issues (2) to (4) concern the second stage of purposive interpretation. Mr Prosser submits that, once the Special Commissioner concluded that there was a 15% chance of the market change condition being fulfilled, he should have concluded that there was an actual possibility of a deep gain under the early redemption provision, that is condition 3.2. The fact that the market change condition was artificial was beside the point. This was a condition which had a real possibility of operating.

Mr Ewart submits that it follows from SPI that no account should be taken of artificially contrived possibilities which are irrelevant to the true transaction. In other words, the question to be asked is whether there is any real possibility of a redemption at a deep gain. In this case, the Special Commissioner found as a fact that it was practically certain that the security would be redeemed within two months. Either the transaction would go through as it did in fact go through, or the appellant would redeem it within two months. Therefore redemption at the end of fifteen or sixty-five years was not an actual possibility. No bank would hold on to the security, after the market change condition was met, for sixty-five years.

I accept Mr Ewart's submissions. It is clear from SPI, in particular [23] (set out in paragraph [32] of this judgment), that the court should not at the second stage of purposive interpretation assume that the insertion of a condition that has a real possibility of operating is necessarily relevant to the transaction. Here, the Special Commissioner's finding that the parties were willing to take the risk of the market change condition not occurring means that for practical purposes that risk could be ignored. The transaction, viewed realistically, had as its primary objective the devaluation of the security in order to create a loss for income tax purposes.

The question here is whether a different result should follow on issue (3) because, unlike the market change condition, which is admitted to have been uncommercial, there was a real commercial risk of not finding a purchaser. This is not a case where in reality a purchaser had been identified before the securities were issued.

In my judgment, the appellant's argument is unsustainable on the Special Comissioner’s clear factual finding that a purchaser was a practical certainty. The purchaser was effectively buying cash at a discount because the obligors (the trustees in each case) held cash to meet their redemption obligations under condition 3.9. The objection taken by the appellants is therefore on all fours with the insertion of the artificial and uncommercial market change condition.

An appeal to this court from the decision of a Special Commissioner is only on a point of law, and not against findings of fact. Accordingly, Mr Prosser either has to show either that the Special Commissioner applied the wrong test, or that the conclusion that the Special Commissioner reached was not one which a tribunal acting judicially and properly instructed as to the relevant law could have found (see, for example, Hitch v Stone [2001] STC 214). This is a high test. Mr Prosser’s submissions on whether the Special Commissioner applied the wrong test are as I understand it his submissions on the test to be applied to the question of statutory interpretation, and so they are dealt with under the other issues.

Mr Prosser’s principal attack here is to the Special Commissioner’s finding that it was a practical certainty that a purchaser for the notes would be found. He submits that the Special Commissioner overlooked the fact that under condition 3.2 the holder of the security had to give notice by 24 March 2002 if he wished to exercise the right of early redemption. The Special Commissioner thought that he could give notice by 6 April 2002. Accordingly, the Special Commissioner’s finding that a purchaser would have been found is not sound.

The judge made some useful points here. He held:

“Neither party drew this error to the attention of the Special Commissioner when he released his determination in draft. That is unfortunate. However in my view I do not think it makes any difference. When one analyses the judgment as a whole he would have come to the same conclusion in my opinion had the correct shortened days been identified to him as opposed to the year ending 5 April 2002. Further if the parties wished to have achieved a redemption by 5 April 2002 and less than seven days was available I have no doubt given the compliant nature of the relationship between all the parties a waiver would have been obtained to abridge time so as to achieve an effective redemption by the shorter date if required.” (paragraph 23)

In my judgment, the judge's conclusion on waiver is consistent with the decision of the Special Commissioner, read as a whole. The Special Commissioner noted that the parties were concerned with implementing a scheme to obtain a tax benefit, namely a loss available for offset against income. Indeed, in my judgment, it would have been perverse for the Special Commissioner to hold that any different result followed if regard was had to the need to give at least seven days’ notice.

Mr Prosser challenges the decision of the Special Commissioner on other grounds. He submits that the transaction would not have been of interest to high street banks. This group of lenders does not, however, exhaust the class of lenders to whom the Special Commissioner could look. Mr Prosser points out that other banks rejected the transaction. But, as it were, the proof of the pudding was surely in the eating. Hambros did agree to become the purchaser, and there is no reason to think that it was unique. Moreover, an internal memorandum written by Mr Gower of Hambros showed that the transaction was without risk and indeed secured a 5 per cent profit for Hambros. Mr Prosser submits that Mr Gower was not qualified to express an opinion on risk but the Special Commissioner was entitled to draw inferences from the fact that Hambros acted as it did.

In those circumstances, the appellants’ challenge to the Special Commissioner’s findings as to the certainty of finding a purchaser cannot succeed.

Mr Prosser submits that the Special Commissioner was in error on this point. A deep gain is simply an amount resulting from a calculation. He submits that what happens to the proceeds of the issue is irrelevant, just as the activities of the lessees were irrelevant in Mawson. He accepts that in this case the trustees may have to redeem out of capital, but he submits that would also be so if a company had borrowed money to pay off its debts and had continued to make losses.

Mr Ewart submits that any interest on investments would accrue to the appellants as life tenants under the trusts. Accordingly, the trustees would have to pay any redemption premium out of capital. So, in this case, the premium payable on redemption has to be paid out of capital. There was no need to provide for repayment at 100.1. That was done simply to claim that there was a deep gain.

At first sight, there are substantial arguments to support the appellants’ contentions on this issue. Parliament has not inserted any condition that the proceeds of redemption should be funded otherwise than out of the proceeds of issue. The duty of the court is to interpret the provisions that Parliament has enacted. It is emphatically not its function through purposive interpretation to fill in gaps in the legislation.

However, on reflection, I consider that the Special Commissioner was correct on this point. The question was not: is there a statutory restriction on the funds which can be used to redeem the security? The question was whether on the facts the terms of redemption resulted in a redemption at a deep gain for the purposes of paragraph 3 of schedule 13. It follows from the purposive interpretation accepted above that there has to be a provision which might give rise to a gain capable of being subjected to income tax. In my judgment, it is outside the statutory purpose and thus outside the statutory definition of “deep gain” purposively construed if the term relied on does not on the facts entail any real gain to the holder and has been inserted merely to obtain a tax advantage.

Moreover, the court is entitled, as in Carreras, to have regard to the full sequence of the transaction. Vital elements of it were not at arm's length. Accordingly the court can take into account the fact that the appellants are no better off under the transaction if the right of early redemption is exercised. They therefore made no overall gain. What the holder of the security no doubt wished to achieve was a means of unwinding the transaction if the transfer was not to proceed. That was a substantial reason but it could not provide a reason for the premium.

The appellants were already entitled to the income of the trust which they had respectively created. What the trustees had to do was either to pay the premium out of income and then indemnify the life tenant or pay the premium out of capital which the appellants had only just settled on trust. Either route emphasises the lack of reality about the redemption price. Furthermore there was also a remarkable similarity between the amounts of capital settled and the premiums payable under conditions 3.2/3.

In Mawson, the House of Lords ignored the circular movement of the cash. But that was because the statutory conditions related only to acts of the lessors. Accordingly Mawson is distinguishable from this case.

In my judgment the Special Commissioner’s decision on this issue was correct in law.

In summary, the provisions of paragraphs 2 and 3 of schedule 13 must receive a purposive interpretation. That purpose was that there should be a real possibility of a deep gain if losses incurred on a RDS were to be offsettable for income tax purposes. In this case, terms of issue which on the face were essential for the securities to qualify as RDS had to the extent described above no practical reality and must therefore be disregarded. They do not meet the statutory requirements for a RDS.

For the reasons given above, which to a large extent differ from those of the judge, I consider that this appeal should be dismissed.