Drummond v HM Revenue & Customs

This is the adjourned hearing (directed by Mummery LJ) of Jason Drummond’s application for permission to appeal against Norris J’s order of 23 July 2008 dismissing his appeal against a decision of the Special Commissioner (Sir Stephen Oliver QC) dated 5 July 2007. The hearing was on notice to the respondents, the Commissioners for Her Majesty’s Revenue and Customs (‘HMRC’), with a direction for the appeal to follow immediately if permission were to be granted. We have, as is usual on such applications, heard full arguments from both sides as if the hearing were the appeal. Mr Drummond was represented, as below, by Mr Patrick Way and Ms Hui Ling McCarthy. HMRC were represented, as below, by Mr Timothy Brennan QC and Ms Nicola Shaw. The Special Commissioner’s decision is reported at [2007] STC (SCD) 682 and Norris J’s at [2008] STC 2707.

The issue relates to the calculation of Mr Drummond’s liability to capital gains tax (‘CGT’) for the tax year ended 5 April 2001. During that year Mr Drummond made a capital gain of some £4.875m upon the sale of shares. It exposed him to a large CGT liability. He claims to have been entitled to set against that gain an allowable loss of £1,962,233 (‘£1.962m’), so reducing the CGT liability by some £588,000. HMRC challenge his claim to do so. Their reason is that whilst the £4.875m gain was a real economic gain, the claimed loss was not a real economic loss. Mr Drummond’s claim is based on a tax avoidance scheme into which he bought at a cost of some £210,000 (part of the £1.962m). The scheme depends upon a claimed application to the facts of section 37(1) of the Taxation of Chargeable Gains Act 1992 (‘TCGA’). HMRC accept that section 37(1) applies, but their position is that it does not enable Mr Drummond to create the magic he claims to conjure from it.

The issue before the Special Commissioner was Mr Drummond’s appeal against HMRC’s amendment to his self-assessment tax return for the year ended 5 April 2001. The amendment disallowed his claimed allowable loss of £1.962m for CGT purposes.

That claim followed from Mr Drummond’s adoption of a scheme devised by McKie & Co Limited. Its purpose was to enable customers with otherwise unrelieved capital gains to generate capital losses without suffering a corresponding economic loss. The scheme involved the purchase and surrender by the taxpayer of second-hand, non-qualifying life assurance policies. The Special Commissioner provided a detailed account of the facts, but it is sufficient to adopt Norris J’s succinct summary of them, as follows:

The point in issue is how to compute the tax charge on the surrender of non-qualifying, second-hand life policies. There is a complication because the surrender was an event that not only gave rise to a charge to income tax, it was also a disposal for CGT purposes. The appeal concerns the interrelation between the treatment of the surrender for (a) income tax purposes under Chapter II of Part XIII of the Income and Corporation Taxes Act 1988 (‘ICTA’) and (b) CGT purposes under sections 37 to 39 of TCGA. I will go straight to the legislation, setting out only the material parts of the relevant provisions.

Income tax

The income tax position arising on the surrender of life policies was governed at the material time by Chapter II (‘Life Policies, Life Annuities and Capital Redemption Policies’) of Part XIII of ICTA. Section 539 provides:

Section 540 (‘Life policies: chargeable events’) provides:

On the occasion of a chargeable event, section 541 (‘Life policies: computation of gain’) explains the computation of the chargeable event gain:

The calculation of the chargeable event gain upon the surrenderof the policy therefore requires the deduction from (i) the surrender proceeds plusany ‘relevant capital payments’ paid out by the insurer before the surrender of (ii) the total amount of the premiums previously paid under the policy plus the amount of any gain referred to in section 541(1)(b)(ii).

Section 547 (‘Method of charging gain to tax’) finally introduces the taxpayer answerable for income tax in respect of the chargeable event. It provides:

Section 541(1) is therefore the charging provision by which, on the happening of a chargeable event, the amount of the gain will be deemed to form part of the total income of the individual who, immediately before that event, was the beneficial owner of the policy. That is the provision by which in this case the chargeable event gain arising upon the surrender of the policies on 5 April 2001 was deemed to be part of Mr Drummond’s total income for tax purposes.

It is apparent from section 541 that the chargeable event will or may give rise to a gain whose calculation requires access to information that will not be in the possession of the person who was the beneficial owner of the policy immediately before that event – and even though the gain will be treated as part of his total income. In the case (as here) of a surrender, he will know the amount of the surrender proceeds; but if the policy is a second-hand one, he will not necessarily also know the amounts of any previous ‘relevant capital payments’ or premiums, although this information is needed to calculate the gain. The solution to this problem lies in section 552 (‘Information: duty of insurers’), by which the insurers come under an obligation, within three months of a chargeable event, to provide the required information to the Inspector of Taxes, a provision pre-dating the self-assessment era.

The calculation of the chargeable event gain in the present case is agreed. There were no ‘relevant capital payments’ and so it was simply the excess of (i) the surrender proceeds of £1.751m over (ii) the initial premiums paid by Ms Sedgley (£1,250), plus the additional premiums paid by London & Oxford (£1,748,750), plus a small gain arising on the assignment of the policies by Ms Sedgley to London & Oxford (£25). The calculation resulted in a chargeable event gain of £1,351.25 deemed by section 547(1) to be part of Mr Drummond’s total income for the year ended 5 April 2001.

Capital gains tax

Section 210 of TCGA shows why it was essential to Mr Drummond’s scheme that the life policies he acquired and surrendered were second-hand ones. That section (‘Life assurance and deferred annuities’) provides:

The first issue before us concerns a claimed ‘exclusion’ from the consideration for the surrender of the policies. The critical provision is section 37(1), but I must also set out the material provisions of sections 38 and 39. They provide:

The section 37(1) issue

Mr Drummond’s case on this is simple. The surrender of the policies was a disposal. The gain (or loss) for CGT purposes was, in essence, the ‘consideration’ for the disposal of the policies (computed in accordance with section 37) less their allowable acquisition cost (computed in accordance with sections 38 and 39). Apart from section 37(1), the consideration was the surrender proceeds, or £1.751m. The acquisition cost is claimed by Mr Drummond to be £1.962m, but was held by the judge (and for the purposes of the section 37(1) argument can be assumed) to be £1.751m. If the two figures of £1.751m were the relevant ones, the surrender would have resulted in neither a gain nor a loss: and no loss could have been set against the gain on the share sale.

This, however, is to ignore section 37(1). In computing the gain or loss, that subsection requires the exclusion from the ‘consideration’ for the disposal (the surrender proceeds of £1.751m) of (i) ‘any money or money’s worth charged to income tax as income of … [Mr Drummond] for the purposes of the Income Tax Acts’; or (ii) ‘any money or money’s worth … taken into account as a receipt in computing income or profits or gains or losses of, [Mr Drummond] for the purposes of the Income Tax Acts.’ I shall call these alternatives ‘limb (i)’ and ‘limb (ii)’. Mr Drummond’s case is that they are mutually exclusive and that the one that applies here is limb (ii).

If limb (i) applies, the only exclusion from the ‘consideration’ would be the £1,351.25 deemed by section 547 of ICTA to be part of Mr Drummond’s total income for the year ended 5 April 2001. That would, on the figures assumed in the last sentence of paragraph [16], give rise to a loss of £1,351.25 to be set against the gain on the share sale. But Mr Way rejects that and says that limb (i) does not apply because whilst the figure of £1,351.25 was deemed to be part of Mr Drummond’s total income for the year, it was neither ‘money’ nor ‘money’s worth’ within the meaning of limb (i). It was, he said, merely the result of the computation required by section 541(1)(b) of ICTA. Mr Drummond could not, it is said, have gone out and spent what was represented by the figure arrived at by that computation. It is said that ‘money’ within the meaning of limb (i) means, and means only, pure income profit such as, for example, dividends or building society interest which are included as part of the taxpayer’s total income without being arrived at by computing other figures.

That leaves limb (ii) as the applicable one, and it is said by Mr Way to fit the case. There is, he said, no doubt that the ‘consideration’ for the disposal of the policies (the surrender moneys of £1.751m) was ‘taken into account as a receipt in computing [Mr Drummond’s] income or profits or gains …’ for income tax purposes: they were brought into account in the section 541 computation which resulted in the chargeable event gain of £1,351.25 which was treated as part of Mr Drummond’s total income. Therefore it follows that the entirety of the consideration of £1.751m is required by section 37(1) to be excluded from the consideration for the disposal of the policies, which is thus reduced to nil. Mr Drummond remains entitled to deduct from that his acquisition costs under section 38, with the result that he has incurred an allowable loss of at least £1.751m (and he claims it is in fact the full £1.962m).

The Special Commissioner rejected that argument and held that limb (i) applied. His reasons were these:

Norris J also rejected the argument. His reasoning was as follows. The purpose of section 37 was to avoid a taxpayer suffering double taxation in relation to a single event occasioning a charge both to income tax and CGT. It achieves that end by adjusting (for CGT purposes) the consideration for the disposal by excluding amounts already charged to income tax. It was undisputed that the surrender proceeds were ‘money’ and in Norris J’s view the £1,351.25 figure arrived at by the section 541 computation was also ‘money’, being part of the proceeds of £1.751m from which other sums of ‘money’ had been deducted. It did not cease be ‘money’ because it was the product of a calculation. This money was then treated as the chargeable event gain and was directly charged to tax as part of Mr Drummond’s income for the year without any intervening calculation. The £1,351.25 was therefore allowable in full as an exclusion from the consideration received on the surrender of the policies.

The judge considered further that, as this reasoning showed that there was ‘money’ that had been charged to income tax as part of Mr Drummond’s income for the year, there was no warrant in section 37 for seeking some other money that might be used to create a further deduction from the policy proceeds. Limbs (i) and (ii) were mutually exclusive alternatives, which was why Mr Way had been at pains to submit that Mr Drummond’s case did not fall within limb (i). The case was not, however, a limb (ii) one. The policy proceeds were not brought directly into the computation of Mr Drummond’s total income. They merely provided the starting point for a statutory calculation involving the deduction from the proceeds of sums not expended by Mr Drummond. Norris J said that:

Mr Way was politely critical of the judgments below as having been driven by a desired result rather than by an objective analysis of the language of section 37(1). I regard that criticism as unjustified. The interpretation of legislation involves more than black letter literalism. In a case such as the present, in which there is a question as to which of limbs (i) and (ii) applies, it is necessary to give the statute a purposive construction; and ‘… the question is always whether the relevant provision of the statute, upon its true construction, applies to the facts as found’ (Barclays Mercantile Business Finance Ltd v. Mawson (Inspector of Taxes) [2005] 1 AC 684, paragraph 32, per Lord Nicholls of Birkenhead, giving the opinion of the committee). There is no dispute that the purpose of sections 37 to 39 is to prevent the double taxation that might otherwise arise from the circumstance that the disposal of an asset will or may give rise to a charge to income tax and also be a disposal for CGT purposes. Their purpose is to prevent such double taxation by excluding from the computation for CGT purposes amounts that (putting it neutrally) have been taken into account for income tax purposes. It is not their purpose to enable the creation of an imaginary loss that the taxpayer can set against a real gain and so reduce a CGT liability. Their purpose is not the avoidance of taxation, but the avoidance of double taxation. It is important to have that in mind when construing section 37(1).

Mr Way’s submission is that, whilst all that may be so, there is no getting away from the fact that limbs (i) and (ii) in section 37 are mutually exclusive, that the present facts fall more naturally within the language of limb (ii) than that of limb (i), and that the consequences for which he contends therefore necessarily follow. If he is right that this is a limb (ii) case, then no doubt the rest does follow. The consequence is, however, one that can at least be described as anomalous; and one that many would be content to describe as absurd. An interpretation of a statute leading to an anomalous or absurd result may be a correct one. But the court will ordinarily lean against an interpretation that produces such a result on the basis that this is unlikely to reflect the legislative intention.

In my judgment, attractively though he advanced the argument, Mr Way’s submission as to how section 37 applies to the facts of the present case is incorrect. First, I have no difficulty at all in regarding the case as falling naturally within limb (i) of section 37: that is, in regarding the chargeable event gain of £1,351.25 as ‘money … charged to income tax as income of … [Mr Drummond]’. It may be that the figure was arrived at by a statutory computation; but, once the computation had been performed, the resultant figure was ‘money’ charged to income tax as his income. It is that figure that would feature in his tax return, in like manner as any dividends or building society interest. Why is it not ‘money’? Secondly, I do have a real difficulty in regarding this as a limb (ii) case: that is, in regarding the surrender proceeds as having been ‘taken into account as a receipt in computing income … of, [Mr Drummond]’ That formula applies most naturally (although not necessarily exclusively) to the case of a trader whose receipts are brought into account in computing the profits of his trade and against which he is entitled to deduct allowable expenditure in computing the profits chargeable to income tax. In such a case the receipts will be excluded from the disposal consideration under section 37(1) and the expenditure will be excluded by section 39 from being deducted under section 38: thus the two elements by reference to which a computation for income tax will have been made will be excluded from account for CGT purposes and double taxation will be avoided.

The limb (ii) formula does not, however, apply at all naturally to the facts of the present case. Quite apart from the fact that the attempt to force this case into limb (ii) produces a financial result that cannot have been intended by the legislation, it requires an interpretation of the language of section 37(1) that it cannot naturally bear. The surrender proceeds were not taken into account in computing Mr Drummond’s income. Those proceeds would feature nowhere in his tax return, or in any accounts that he might have to prepare for the purpose of its completion. Their amount was, for the purposes of his tax return, a matter of complete irrelevance. The only figure he would require when making his return is the amount of the chargeable event gain. The fact that that figure was at an earlier stage arrived at by a statutory formula in which the surrender proceeds formed one element (and in which the other elements may have had nothing to do with Mr Drummond at all) is neither here nor there. No doubt the surrender proceeds can be regarded as a ‘receipt’ taken into account in that statutory calculation: but they were not a ‘receipt’ taken into account in the computation of Mr Drummond’s income for income tax purposes. That, in my view, is the beginning and end of Mr Drummond’s section 37(1) point.

In my judgment, therefore, the only exclusion from the disposal consideration permitted by section 37(1) is the chargeable event gain of £1,351.25. That produces an entirely just result, namely to avoid the imposing on Mr Drummond of any burden of double taxation arising from the disposal of the policies. It follows that I agree with the Special Commissioner and Norris J on the section 37(1) issue.

The section 38 issue

The other issue argued before the Special Commissioner and, on appeal, before Norris J was what sum, if any, was allowable under section 38 as a deduction from the consideration for the surrender. Mr Drummond claimed that the whole £1.962m was so deductible. HMRC claimed that none was. I have earlier set out the relevant provisions of section 38(1), the key words for the purposes of the argument being that the amount of the claimed deduction had to be ‘given … wholly and exclusively for the acquisition of the asset ….’

The Special Commissioner held that no part of the £1.962m was so given, on the basis that it was paid not to acquire the policies but the tax shelter that it was hoped the scheme would confer. But if he was wrong on that, and the correct analysis was that Mr Drummond had made an acquisition of the policies, he held on the facts that:

On appeal Norris J took a different view from the Special Commissioner on the first point. He held that there was no doubt that Mr Drummond had made a real purchase of the five policies and that he had disposed of them. The task was to calculate the gain on the disposal. In that calculation Mr Drummond was entitled to deduct that which he had expended on the acquisition, confined to ‘the consideration in money … given by him … wholly and exclusively for the acquisition of the asset.’ The total of £1.962m could be broken down into its constituent elements and matched to benefits or services. Norris J’s conclusion was that (in round figures) £210,000 of the £1.962m was plainly not paid ‘wholly and exclusively’ for the acquisition of the policies (see the summary of the facts in paragraph [4] above). (I add that Norris J pointed out that it was not argued that the £210,000 was ‘incidental costs’ within the meaning of section 38(1)). It followed, he held, that the £210,000 could not be deducted under section 38(1). As the Special Commissioner had said in his alternative finding, with which Norris J agreed, it was only the balance of the consideration that could be so deducted. Norris J therefore allowed Mr Drummond’s appeal to this extent.

Mr Way sought to persuade us that Norris J should have allowed Mr Drummond’s appeal to the extent of allowing the whole of the £1.962m as a deduction under section 38(1). In my view that was, with respect, a hopeless endeavour. The Special Commissioner was in error in finding that no part of the £1.962m was incurred in the acquisition of the policies and Norris J was right to correct his decision in that respect. But, in case he was wrong in that respect, the Special Commissioner had also made a reasoned finding that the £210,000 element of the £1.962m was not ‘given … wholly and exclusively for’ their acquisition and Norris J agreed with him. In my judgment that was a finding of fact that was properly open to the Special Commissioner. Mr Drummond’s challenge to this part of Norris J’s decision is, in substance, a challenge to that finding. I see no basis on which this court can, might or should take any different view on it. I would accordingly also express my respectful agreement with Norris J’s decision on the section 38 issue.

The matter before the court is the adjourned application of Mr Drummond’s permission to make a second appeal, with the appeal to follow if permission is given. Success on the application requires the court to be satisfied that one of the two limbs of CPR Part 52.13 is satisfied, namely that (a) the appeal would raise an important point of principle or practice, or (b) that there is some other compelling reason for the court to hear the appeal. Lloyd LJ’s view on the paper application for permission was that he was not satisfied that, in the absence of substantial prospects of success, the point was of sufficient importance to justify a second appeal. Mummery LJ’s view at the renewed oral hearing was that as, so he was told, something in the order of a hundred other cases were dependent on the outcome of this one, there might be a case for saying that the first limb of Part 52.13 was satisfied, although the court’s disposition of the application would be likely to depend on whether it regarded an appeal as having a real prospect of success. In the light of the arguments addressed to us, I would give Mr Drummond permission to appeal, but would dismiss the appeal.

I agree.

I also agree.