Huitson, R (on the application of) v HM Revenue and Customs

This is a very unusual income tax case. The claimant taxpayer initiated it against Her Majesty’s Revenue and Customs (“HMRC”). By way of judicial review the claimant challenges the lawfulness of HMRC’s enforcement of retrospective amendments to legislation in violation of his human rights. The claimant says that, before the legislation was amended with retrospective effect, he was entitled to relief from UK income tax on income received by him from a trust in the Isle of Man. Now HMRC rely on the amendments to deny him, retrospectively, the tax relief previously available.

The arguments range widely over public interest issues: the right to enjoy one’s possessions without unjustified State interference; a taxpayer’s legitimate expectations in such matters; the State’s fiscal policies and financial concerns; principles of legal certainty and proportionality in the context of retrospective legislation; achieving a fair balance between the interests of the community and the rights of the individual; the operation of Double Taxation Arrangements; and changes over recent years in the judicial approach to the construction of tax avoidance schemes and applicable tax legislation.

The prominent features in the litigation landscape are: (a) a marketed tax avoidance scheme locating a trading partnership and an interest in possession trust in the Isle of Man in order to take advantage of a Double Taxation Agreement (“DTA”) made between the United Kingdom and the Isle of Man in 1955 (as subsequently amended), the scheme having no other purpose than the avoidance of UK income tax; (b) legislation in s.58 (3), (4) and (5) of the Finance Act 2008 (“the 2008 Act”) amending retrospectively the long standing double taxation relief provisions, the aim being to render the tax avoidance scheme ineffectual by depriving it of its potential tax advantages for a taxpayer resident in the United Kingdom and in receipt of income here from his Manx trust; and (c) the taxpayer’s claim for judicial review of the unlawful application to him of the amended legislation on the ground that its retrospective effect is incompatible with his fundamental right to the peaceful enjoyment of “possessions” as guaranteed, through the Human Rights Act 1998, by Article 1 to the First Protocol to the European Convention on Human Rights (“the Convention”).

It is common ground that Article 1 of the First Protocol lays down the principle of peaceful enjoyment of property. It covers the deprivation of property, while recognising that the State is entitled to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties. The Convention requires that a measure which interferes with peaceful enjoyment of property should be proportionate to the object for which it is imposed.

The term “possessions” in Article 1 of the First Protocol bears an autonomous meaning: it includes rights in property and rights to property. There is protection for familiar property interests in physical things of significant economic value. There is also protection for rights in judgments, awards and recognised property claims under domestic law, such as a claim to payment of state compensation or a claim to repayment of VAT paid under a mistake.

The particular “possession” for which protection is sought here is a claim for tax relief: not having to pay UK income tax on the profits of an Isle of Man partnership trade paid to the UK taxpayer through and under a Manx trust. HMRC dispute the similarity of such a claim to a claim for compensation. They say that in this case the claimant is not being deprived of an asset or proprietary kind of claim. Rather the claimant is asserting that he should not have to pay the same level of income tax as other taxpayers who, like him, live in the UK and carry on the trade or profession of providing services to clients in the UK. The position of Mr Robert Huitson, the taxpayer claimant, is that the value of the tax relief to him is in the region of £195,000. That, he says, is a right to property of significant value. He says that he has been deprived retrospectively of a proprietary interest in a claim to tax relief in each relevant year of past assessment.

Mr Huitson is the appellant in this court. I will refer to him throughout this judgment as the claimant.

Kenneth Parker J made an order dated 28 January 2010 in accordance with his judgment [2010] EWHC 97 (Admin); [2011] 1 QB 174. He dismissed the claim in judicial review proceedings commenced by the claimant on 21 October 2008. The relief sought was a declaration that the retrospective element of s.58 of the 2008 Act and the claimant’s liability to pay additional tax infringed and was incompatible with Article 1 of the First Protocol to the Convention. The judge held that:-

“96.

….the challenged legislation, although having retrospective effect, is in the relevant circumstances proportionate and compatible with article 1 of the First Protocol to the Convention.”

The judge refused permission to appeal.

By an order dated 26 May 2009 in the case of R (Shiner & Anor) v. HMRC C1/2009/08) an application for judicial review seeking declarations that the retrospective effect of s.58 was incompatible with Article 56 of the EC Treaty, as well as with Article 1 of the First Protocol, was directed to be listed with this appeal before the same constitution. The hearing of the judicial review application in Shiner immediately preceded the hearing of this appeal. The separate judgments handed down on this appeal and on the judicial review application should be read together for the full picture of the proceedings between taxpayers and HMRC about the lawfulness of HMRC enforcing the retrospective provisions in the 2008 Act.

The claimant is an electrical engineer who is resident in the United Kingdom where he works as a self-employed IT consultant. The end users of his services are based in the UK. The claimant would ordinarily pay UK income tax on the taxable profits of his trade. Following the “IR35” legislation in 2000 he could not have obtained any tax advantage by supplying his services to end users through an intermediary, such as a company.

From June 2001, when he became a client of Montpelier Tax Planning (Isle of Man) Limited of Douglas, Isle of Man, the claimant participated in a tax avoidance scheme operated through a partnership and a trust located in the Isle of Man. It was designed to take advantage of the DTA provisions for claiming relief from UK income tax on specified income paid to a UK resident. Under the scheme the claimant provided his services to end users in the UK through an intermediary partnership. It is called the Allenby Partnership. It consists of five companies incorporated and resident in the Isle of Man. Each partner is the trustee of an interest in possession trust established in the Isle of Man. The claimant was the settlor and is the life tenant under one such trust called the Robert Huitson Family Settlement. He paid £1,000 into that trust. The trustee was Crackington Limited. Along with the other ordinary partners Crackington entered into partnership with a managing partner.

The claimant entered into a consultancy agreement with the Allenby Partnership, which arranged for him to provide his IT consultancy services to end users in the UK. The Allenby Partnership received full payment for his services. Under the consultancy agreement the claimant received a fixed annual fee of £15,000, or such lesser sum as might be generated by his work for the partnership. The annual fee was subject to UK tax.

The tax avoidance aspect of the scheme arrangements focused on fee income that was channelled to the claimant through his Manx interest in possession trust. That income, which could well exceed £15,000 a year, was generated by the claimant’s activities through the medium of the Allenby Partnership. The partnership paid profits to the trustee, which then made payments to the claimant in the UK in his capacity as the beneficial owner of an interest in possession under the trust.

The claimant’s case was that, as a result of the DTA provisions and the legislation then in force, the income channelled to him through his Manx trust was not subject to UK income tax nor, it seems, not even subject to Manx tax as a result of concessions made by the fiscal authorities in the Isle of Man. He claimed that the income he received from “the offshore trust, in my capacity as the sole income beneficiary, represents the share of the profit of an Isle of Man Partnership whose profits are excluded from UK tax by virtue of Article 3 of the UK-Isle of Man Double Taxation Agreement. My claim for Double Tax Relief, as the life tenant, is based on Baker v Archer Shee principles. “ (That case is authority for the proposition that a beneficiary under an interest in possession trust has an absolute right to the income and that the income does not belong to the trustee.)

As for his tax treatment by HMRC, the claimant’s position was that from 2002 onwards he submitted tax returns claiming double taxation relief in respect of the trust income. He relied on the scheme, which was devised on the footing that, on its true construction, paragraph 3(2) of the DTA was effective to exempt from UK income tax the share of the partnership profits received by the claimant in that manner. As the judge commented, the tax outcome was paradoxical: by the use of DTA measures aimed at avoiding the imposition of double taxation on UK resident taxpayers, the claimant, as a UK resident, was able to reduce his effective UK income tax rate to an average of 3.5%.

Two different types of double taxation relief should be noted, as the judge is criticised for not observing the distinction between them. One kind is a “tax credit” provision. That means that credit is given by HMRC for tax that has been paid by the taxpayer in the jurisdiction of another fiscal authority, such as the Isle of Man. A different kind of double tax provision, which is relevant here, is “tax relief.” That means that there is a charge to tax in one country only and that the specified income received by the taxpayer in this country is relieved by the DTA provision from liability to pay UK income tax. In this case the claimant’s claim was for tax relief on quantified sums for past years in respect of income which, it is argued, did not fall within the charge to UK income tax, as it was exempt from UK income tax by virtue of the DTA.

HMRC did not intimate any challenge to the validity of the DTA claims by the claimant in his tax returns until June 2004. It gave no reasons for the challenge until February 2006. The claimant was advised by HMRC to make payment of tax on account in respect of the disputed sum, so as to avoid liability for accruing interest and liability for possible penalties. In February 2006 HMRC set out reasons for the challenge to the claims for relief. In May 2007 HMRC informed the claimant that they were preparing a number of representative cases to take to the special commissioners regarding the validity of the claims to double taxation relief. Before the cases were listed for hearing the Government announced in the March 2008 budget that legislation would be enacted to render the tax avoidance scheme ineffective beyond doubt.

On 21 July 2008 s.58 of the 2008 Act came into force. It amended, with retrospective effect, the existing legislation in s.858 of the Income Tax (Trading and Other Income) Act 2005. That section provided that where a UK resident is a member of a foreign partnership firm (i.e. one which resides outside the UK or carries on a trade the control and management of which is outside the UK) and by virtue of DTAs any of the income of the firm is relieved from tax in the UK, the partner is liable to income tax on the partner’s share of the income of the firm despite the DTA.

The section was amended by s.58 of the 2008 Act so as to render the tax avoidance scheme ineffectual and to impose on the claimant and others in a similar position liability to pay UK income tax on the trust income received in past years. That position was achieved first by providing in subsection (3) of s.58 that the members of the firm include “any person entitled to a share of income of the firm.” Subsections (4) and (5) of s.58 then gave retrospective effect to the amendment in subsection (3) by treating it as always having had effect and by treating the members of the partnership firm as having included “at all times” a person entitled to a share of the income of the partnership.

HMRC revised the claimant’s tax assessments accordingly. The revisions and the validity of the legal basis on which they were made are challenged in these proceedings. The ground of challenge is that the retrospective changes made by the amendments are disproportionate and are incompatible with Article 1. The claimed interference is retrospective deprivation of “possessions”: that is, interference with proprietary interests in claims to relief from payment of income tax in the UK in respect of income received by the claimant in his capacity as owner of an interest in possession under his Manx trust. The case rests on legal objections to retrospective legislation, which violate the principle of legal certainty. The retrospective amendments are said to impose an unreasonable burden on the claimant. Issues of fiscal policy and proportionality are also raised. Reliance is placed on the claimed legitimate expectation of the taxpayer that the tax benefits of the scheme would not be removed with retrospective effect.

More generalised objections were made at the hearing below about the distressing personal consequences of the retrospective provisions for individual users of the scheme: some would not be able to meet the tax demands, even if they sold all their assets, including the family home, while others could only settle HMRC’s claims by selling or re-mortgaging the family home. Some taxpayers would face bankruptcy, financial worry, health problems and marital breakdown.

The judge made a considered assessment of the practical and public interest implications of the claimant’s contentions:-

“16.

It is also immediately plain that the tax avoidance scheme, if it worked, would be singularly attractive to any person in the position of the claimant, that is, any resident of the United Kingdom, who, as a self-employed person, carried on a trade or profession here. So long as end users were content to contract with an intermediary, rather than with the actual provider of the services, and so long as professional rules did not preclude such intermediation (barristers, for example, need not apply) any UK self-employed trader could reduce his or her taxable income to a tiny fraction of what it would otherwise have been. I accept that very many would not do so, taking the view that the tax avoidance scheme was wholly artificial and perhaps thinking that as UK residents they should be paying UK income tax on the profits of their trade or profession. But, and the figures produced by HMRC confirm this, a substantial number would be attracted. By the time the challenged legislation was enacted there were about 2,500 taxpayers exploiting similar arrangements, and the amount of income tax at stake had risen to £100m.”

The public interest in the potential distortion for competition was noted by the judge. An IT consultant participating in the Isle of Man scheme had the competitive advantage of an effective income tax rate of 3.5% over a consultant who did not participate in the scheme. He also noted the scheme’s popularity. As appears from the facts in Shiner the Manx partnership/trust scheme has attractions for UK property developers, as well as for self- employed traders and professionals.

The judge explained the legislative background referring specifically to the provisions that preceded the decision in Padmore v Inland Revenue Comrs [1987] STC 36; affirmed [1989] STC 493 and the rapid legislative response to the decision in that case. That decision turned on the interpretation of the Jersey Double Taxation Arrangement. The court ruled that a UK resident in a Jersey partnership could invoke that DTA in order to avoid paying UK income tax on the profits of his or her trade or profession. The judge said that the swift legislative response to block the loophole exposed by that decision was of considerable importance to the present claim, because the result of that decision was plainly unacceptable in terms of UK public policy in fiscal affairs. He said:-

“30.

…Whatever the true meaning of the Jersey Double Taxation Arrangement, there was a wider rationale in terms of public policy: UK residents should pay UK income tax on the profits of any trade or profession; and a double taxation arrangement, intended to relieve from double taxation, should not be used as an instrument either to avoid all taxation or to reduce it to well below the level that would be applicable to the relevant income in the country of residence.”

The judge picked out two other significant features of the parliamentary response to Padmore in1987: first, Parliament did not wait for the outcome of the case in the Court of Appeal before legislating about it, and, secondly, the re-active legislation was given retrospective effect. The judge said:-

“33.

It seems to me that these two features emphasised the importance that Parliament attached to the public policy to which I have referred. In my view, these events sent out a clear signal to taxpayers and their advisers that the legislature would be very likely to take effective and decisive steps to counter, even with retrospective measures, any attempt, through artificial arrangements, to take advantage of a double taxation agreement, in particular paragraph 3(2) of the double taxation arrangements with Jersey and the Isle of Man, in such a way that a UK resident would avoid, or very substantially reduce, the UK income tax on the profits of his or her trade or profession that would, in the absence of the artificial arrangements, otherwise have been payable.”

Turning to the efficacy of the scheme arrangements, the judge concluded, after a detailed and careful analysis of the rival arguments, that it was far from clear cut whether the scheme worked. There were respectable arguments on both sides of that question. He said:-

“72.

… I do not believe that the outcome of any legal proceedings in respect of the arrangements would have been a foregone conclusion. They would, I believe, have been complex, protracted and costly.”

The judge then considered the Convention and Article 1 of the First Protocol as the central plank of the claimant’s challenge. After setting out the provisions of Article 1, he summarised some legal propositions about the Convention that did not appear to be in dispute. He then explained how Article 1 was to be applied to this claim on the basis of some further general propositions that seemed to him to be “incontrovertible.”

The judge identified the “fair balance” principle: in securing the payment of taxes a national authority must strike a fair balance between the general interests of the community and the protection of the individual’s fundamental rights, including the right to possessions in Article 1. In that balancing exercise the national authority has a margin of appreciation under the Convention and a discretionary area of judgment under domestic law. The area of appreciation and judgment is wide in matters of social and economic policy.

The Judge said that the assessment of the fair balance requires examination of all the relevant circumstances. In this case the principle of non-retrospectivity is specially important. While there is a recognised need for legal certainty, retrospectivity of fiscal legislation is not prohibited as such. The critical point is that the balancing of community interests and individual rights should not result in an unreasonable burden being placed on the individual taxpayer.

Account could be taken, too, of the circumstance that the purpose of retrospective operation in the particular case was to restore the original intention of the relevant legislation.

From the judge’s list of incontrovertible propositions on the application of Article 1 to the facts of this case, I will pick out those with greatest impact in evaluating the proportionality and compatibility of the amendments made by s.58.

Of prime significance is the fact of the residence of individuals and partnerships exercising a trade or profession: residence is the connecting factor which entitles a State to impose income tax. The correlative proposition is that the resident of a State, who enjoys the benefits provided by it to its residents, has a reasonable expectation of being taxed by the State in question on the income of a trade or profession.

Secondly, DTAs respect the principle of taxation by the State of residence. They aim to avoid the taxation of residents twice over on the same income. What DTAs do not aim to do is to facilitate the avoidance of tax, or its reduction below the level of tax ordinarily paid by residents. In those circumstances it is a legitimate aim of the public policy of the State in fiscal matters to ensure that DTAs relieve double taxation of residents rather than serve as an instrument used by taxpayers who choose to participate in artificial arrangements to avoid or reduce their level of taxation. In principle retrospective legislation may be justified for the purpose of implementing that policy.

Thirdly, in their conduct towards the claimant and other scheme users in a similar position, HMRC never accepted the interpretation of the legislation relied on by those who asserted the efficacy of the scheme. HMRC challenged those assertions. Further, HMRC had never undertaken not to bring proceedings. They had never suggested that no legislation would be enacted, or that any such legislation would only have prospective effect.

In order to provide an overview I will summarise the judge’s principal conclusions, leaving his detailed reasoning for discussion when considering the claimant’s submissions on the appeal.

The crunch question was whether, on Convention principles, the retrospective effect of s.58 imposed an unreasonable burden on the claimant “and thereby failed to strike a fair balance between the various interests involved”: MA and 34 others v Finland (2003) 37 EHRR CD 210. The judge concluded that the challenged legislation, even though retrospective, did strike a fair balance: it was proportionate and compatible with Article 1 of the First Protocol.

Looking first to the particular situation of the claimant and others similarly affected, the judge accepted the submissions of HMRC that s.58 did not impose an unreasonable burden on individual taxpayers. The claimant had entered into a tax avoidance scheme that was wholly artificial and of doubtful efficacy. It would have been reasonable for the claimant to set monies aside to pay the appropriate tax due. HMRC made it clear that they did not accept that the claimant had paid the amount of tax due and they told him to make payment on account.

Looking next to the wider interests of the community, the judge said that the retrospective amendments prevented a windfall of more than £200m being conferred on those who used the tax avoidance scheme at the expense of the general body of taxpayers. The amendments avoided the costs, delays and uncertainties of litigation about the efficacy of the scheme and re-asserted Parliament’s long standing intention that DTAs would not affect a UK resident’s liability to tax on his share of income from a foreign partnership.

The judge agreed that it was a legitimate aim to ensure that a DTA should do no more than relieve from double taxation and should not be permitted to become an instrument whereby UK residents could reduce the tax they would normally pay on income earned from the exercise of a trade or profession in the UK.

The judge thus concluded that it was within the area of discretionary judgment for Parliament to legislate with retrospective effect to ensure a fair balance between the interests of the great body of resident taxpayers and of the individuals who sought to benefit from the scheme.

In disposing of some particular objections raised by the claimant, the judge held that the State was not obliged, before enacting retrospective legislation about the tax scheme, to test its efficacy in the courts and to allow the claimant, if successful, to keep the fruits of his victory. HMRC had made clear that they challenged the scheme and gave no assurance that there would be no litigation or legislation aimed at recovering the tax that the scheme had been devised to avoid. Those who had failed to make appropriate provision had done so at their own risk.

Finally, the proportionality of the retrospective provision was not affected by the absence of any impact assessment by HMRC of how individuals might be financially affected by the retrospective operation of s.58.

The detailed submissions made by Mr Elvin QC on behalf of the claimant can for convenience be gathered together under four broad heads of appeal. It is difficult to keep the points within any one heading. A degree of overlap and some repetition is unavoidable when assembling arguments relating to concepts such as unreasonable burden, interests of the community, fiscal policy, proportionality and so on.

All of the submissions go to an over-arching general thesis that the retrospective provisions of the 2008 Act failed to achieve a fair balance between the interests of the general body of taxpayers and the rights of the claimant as an individual and that they are disproportionate and incompatible with Article 1.

I will deal with each heading in turn.

Proportionality and policy factors

In holding that there was no basis for the claim that the retrospective effects of s. 58 were disproportionate, the judge said:-

“ 77… Parliament, in my view, was entitled to conclude that a rigorous application of the policy referred to.. above was called for; that legislation was needed to put the effect of the DTA beyond doubt, and to prevent taxpayers resident in the United Kingdom from exploiting the DTA in a way that would enable them substantially to reduce income tax that would otherwise be properly payable on income from the exercise of a trade or profession. Parliament was also entitled, having regard to the background I have set out, to legislate with retrospective effect, particularly in order to ensure a “fair balance” between the interests of the great body of resident taxpayers who paid income tax on their income from a trade or profession in the normal way, and the taxpayers, like the claimant,who had sought to exploit, by artificial arrangements, the DTA, in plain contravention of the important public policy set out above, and in full knowledge of how Parliament had maintained that public policy after Padmore’s case.”

The judge identified the policies underlying the enactment of s.58 and justifying retrospective legislation: the entitlement of the UK to impose UK income tax on the profits of any trade or profession, whether carried on in the UK or elsewhere, residence being recognised internationally as “the core connecting factor for the imposition of income tax”; the intended purpose of the Isle of Man DTA and the artificial use of it to achieve a different and contradictory purpose; and the proper conduct of HMRC in their dealings with and treatment of the claimant and other taxpayers on this matter.

The judge is criticised by Mr Elvin for failing to treat the policies with “the special care” necessary when considering a retrospective change in the law: see Draon v France (2005) 20 BHRC 456. He erred, it is argued, by implicitly treating the Government’s “financial concerns” as a justification for retrospective legislation: see Pressos Compania Naviera SA v Belgium [1995] ECHR 17849/91. Overall the judge afforded too much weight to the public policy considerations relied on by him, in particular the policy of an anti-tax avoidance construction of the scheme. In consequence of his errors in approach the judge failed to strike “a fair balance” having regard, in particular, to the retrospective nature of s.58, the effects of HMRC’s vacillation and delay in challenging the scheme in legal proceedings and the absence of any assessment of the impact of the retrospective extinction of existing claims to DTA tax relief.

In connection with the claim to DTA tax relief as a possession within the meaning of Article 1, Mr Elvin QC points out that a change in taxation or the removal of a relief could itself amount to interference with possessions: R (Federation of Tour Operators) v HM Treasury [2007] EWHC 2062(Admin) at paragraph 105, saying that the Convention looks at the effective financial burden imposed by the tax.

Mr Elvin also submits that a claim to tax relief may generate a legitimate expectation, if a currently enforceable claim is sufficiently established under national law: Kopecky v Slovakia (2005) 41 EHRR 944 at paragraphs 45 to 52. It must be something more concrete than a mere hope. It must be based on a legal provision or legal act, such as a judicial decision, and not be just an arguable claim or a genuine dispute. Mr Elvin submits that the claimant here had a legitimate expectation, when he arranged his affairs to reduce tax liability, that the law would not be changed retrospectively to take away the existing claim for tax relief under the DTA. By vacillating on the matter for a period of 7 years or more HMRC had frustrated the claimant’s legitimate and reasonable expectations and had increased the detriment he would suffer as a result of the legislative reversals.

Mr Elvin contends that the retrospective removal of the relief by s.58 failed to strike a fair balance between the public interest in the prevention of tax avoidance and the private interest in the relief in that there was not proportionality between the means employed and the aim of the legislation. The proportionality had to be determined by a consideration of the facts, the reasons advanced for retrospectivity and the conduct of the parties, including HMRC, to see that the action was taken in an appropriate manner, with utmost consistency and in good time: Beyeler v Italy (2000) 33 EHHR 1224 at paragraphs 98 to 100and 114 to 120.

In this case the retrospective measure involved deprivation of a claim that had crystallised for past years and was the subject of a legitimate expectation. Interference with that possession of a claim to tax relief could only be justified in exceptional circumstances, which did not exist in this case.

It is submitted that the judge also erred by attributing to the DTA a tax avoidance purpose and not the purpose simply of double taxation avoidance according to its plain terms. It is not the purpose of the DTA to alter the basis of taxation adopted in each Member State or to allocate the burden of taxation in the DTA States. Thus, it was for the Isle of Man to decide whether to tax Manx enterprises: see Smallwood v HMRC [2010] EWCA Civ 778at paragraph 29.

The judge is said to be wrong in holding that Padmore had sent out a general signal to tax avoiders about retrospective legislation. That was not a case of a tax avoidance scheme or of annulling a long standing claim for tax relief: the legislation consequent on Padmore was passed to restore the law to what had been the general understanding of what the law was before the court ruling. That is not the case here.

The attractive presentation of Mr Elvin’s submissions has not persuaded me that the judge was wrong to reject the case that the retrospective effect of the 2008 Act was disproportionate.

In my judgment, the judge correctly directed himself on the issue of fair balance and proportionality and fully understood the purpose and structure of DTAs and the way in which the Isle of Man DTA was being used in the scheme for quite a different purpose than its intended double taxation purpose: to provide tax relief of UK residents. Nothing in his judgment was contrary to the true scope of the cited authorities of Draon and MA v Finland.As for Pressos the State in this case was not relying on purely “financial concerns” to justify retrospective legislation and the judge did not base his decision on such concerns. He focused correctly on whether the retrospective measures achieved a fair balance between community interests and individual rights and whether they placed an unreasonable burden on the claimant. He did not give too much weight to the policy justification relied on by HMRC.

Tax efficacy of the scheme and legitimate expectation

The judge rejected the claimant’s case that the efficacy of the arrangements to avoid tax was practically assured under the DTA and the legislation then applicable and that it was for that reason that HMRC did not bring legal proceedings challenging the scheme before s.58 was enacted.

The judge found that neither side’s interpretation of the 2008 Act was manifestly unreasonable, that it was uncertain who was correct and unpredictable which one the court would prefer. There were differences in approach. In claiming DTA relief, the claimant relied on the principle in Baker v Archer-Shee [1927] AC 844that the profits received by the trustee as a partner were not treated as belonging to the trustee but to the beneficiary with an interest in possession under the trust, with the consequence that the income arising from his beneficial interest in possession under the trust cannot be assessed to UK tax. The claimant’s interest in possession under the trust retained the character of profits of a Manx enterprise received by the trust and those profits were not subject to UK income tax.

Against that, HMRC relied on a more purposive approach to construction in the case of tax avoidance schemes with which Mr Elvin disagreed (see below).

In the end the judge found that, even if HMRC would have lost any putative proceedings in respect of these tax arrangements, the outcome of the claim in these proceedings would be no different:-

“83.

…It remained, for all the reasons already stated, within the permissible area of discretionary judgment of Parliament to legislate, with retrospective effect, to prevent taxpayers from using, by wholly artificial arrangements, the DTA for a purpose for which it was not intended, so as to defeat the public policy to which I have referred earlier. The importance of the public policy had already been brought home to taxpayers and their advisers by the legislative response following Padmore’s case. HMRC had given no assurance that any legislative response in this case would be prospective only. In my view, even if the arrangements indisputably worked under the DTA and the legislation then applicable, taxpayers could reasonably have expected that Parliament would respond in a way that ensured fairness generally between all taxpayers resident in the United Kingdom, and that maintained the relevant policy. Given the background, and the need to ensure fairness between all taxpayers, taxpayers could also have reasonably expected that the legislative response would have retrospective effect, as turned out to be the case.”

Mr Elvin’s main criticism is that the judge erred in failing to find that the claimant had a proprietary interest in a sufficiently established claim to tax relief to give rise to a legitimate expectation that would attract the protection of the Convention. The judge had not taken sufficient account of the claim for relief based on the DTA and the application of the Archer-Shee principle and had erred by accepting the approach of HMRC based on its policy position regarding the DTA and its purpose.

Mr Elvin submits that the evidence indicated that HMRC apparently lacked confidence in the points that they now say are good points and thought that they would lose a challenge before the special commissioners.

Further, the judge’s approach to the ineffectiveness of artificial tax avoidance schemes generally relied on a purposive anti-avoidance approach to the interpretation of tax legislation and tax avoidance arrangements which was harsher than that laid down by the House of Lords in MacNiven v Westmoreland Investments Ltd [2001] UKHL 6; [2003] 1 AC 311 at paragraphs 8, 28 to 29, 49 and 58 and Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL 51; [2005] 1 AC 684at paragraphs 26 to 39.

Mr Elvin says that the judge had, without justification, departed from a line of authority on Article 1 which held that depriving a person retrospectively of a proprietary interest in the nature of a claim is inconsistent with preserving a fair balance between the interests at stake. Only in exceptional circumstances can retrospective legislation depriving a person of a claim to relief from taxation be justified.

It is submitted that the judge gave too much weight to the view of HMRC that the scheme did not work and not enough weight to the evidence of the conduct of HMRC indicating that it shared the view of the claimant’s advisers that it did work. There was a lack of clarity and confidence in HMRC’s view that they could defeat the scheme.

I am not persuaded that the judge made any error in his rejection of the case advanced on tax efficacy of the scheme and legitimate expectation.

Before the judge the case was that the claimant had a legitimate expectation that HMRC would carry out their promise to challenge the scheme before the special commissioners in the usual way and that the retrospectivity had deprived him of the right to be heard. On the appeal the emphasis shifted. The claimant’s case now addresses the deprivation by retrospective legislation of his possession in the form of the alleged proprietary interest in the nature of his claim to tax relief.

On that fresh approach to the point on legitimate expectation, the nature of the “claim” asserted has to be examined. The “claim” to tax relief under the DTA is one which has neither been accepted by HMRC nor has it been made out in any tribunal or court. All that has been established is the existence of a genuine dispute about whether the scheme based on the claim for tax relief under the DTA worked.

There were grounds on which HMRC based their view that the income received from the Manx partnership via the Manx trust was taxable in the UK and on which the judge concluded that the “tax efficacy of the arrangements were far from clear cut.” As he observed, there were respectable arguments on both sides of the question.

As for the approach to construction approved by the House of Lords in MacNiven,the current position is that the trenchant dictum of Ribeiro PJ in Collector of Stamp Revenue v Arrowtown Assets Ltd (2003) 6 ITLR 454 at [35] has been approved and applied by the highest court in the UK:-

“The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”

On that approach to the interpretation of the legislation, the DTA and the scheme, the judge was, in my view, entitled to conclude that there was a respectable argument that in s. 858 of the 2005 Act the phrase “member of the firm” included a person in the position of the claimant, who was entitled to a share of the profits of the partnership via the interest in possession trust and that no relief would be available under the DTA in respect of profits earned by activities taking place in the UK, as there was no double taxation to relieve, the profits of the Manx partnership not being liable to Manx tax.

Finally, in taking legitimate expectation into account in striking a fair balance which justified the retrospective legislation, the judge was fully and plainly entitled to take into account the reasonable expectation that, even if the scheme worked, UK residents should have to pay UK income tax on the profits of their trade or business.

HMRC delays and conduct affecting fair balance: retrospective legislation without prior test litigation

The judge held that the failure of HMRC to bring legal proceedings in respect of the scheme before the retrospective legislation was enacted did not render the amending legislation disproportionate. He rejected the claimant’s criticisms of delay on the part of HMRC and of their failure to test the matter in litigation before recommending legislation with retrospective effect.

The judge held that there was no legal obligation on the State to test the matter of the efficacy of the tax avoidance scheme in the courts before enacting legislation, even with retrospective effect. He said:-

“ 85. …The public policy was of such paramount importance that legislation was necessary in any event to put the position beyond all doubt and to maintain the relevant public policy. Furthermore, for reasons already given, such litigation would probably have been protracted, costly and uncertain. At no time did HMRC indicate to affected taxpayers, including the claimant, that they could safely rely upon the arrangements. On the contrary HMRC consistently maintained that the arrangements did not work, and advised taxpayers to pay on account the income tax which HMRC said was properly due. Any prudent taxpayer who followed that advice would not now be prejudiced by the retrospective effect of the legislation. The circumstances are wholly different from those in Beyeler v Italy (2000) 33 EHRR 1224, where the public authorities by their conduct over many years had led the applicant to believe that the state would not exercise a right that it enjoyed, and the later exercise of the right conferred a specific unjust enrichment on the state at the expense of the citizen.

86.

Nor did HMRC represent, expressly or even impliedly that legal proceedings would first be pursued before enactment of any legislation, or that any legislation would not have retrospective effect. In so far as taxpayers may have relied upon the route previously travelled by the Inland Revenue and the legislature in Padmore’s case, they did so at their own election and risk.”

The judge added that the taxpayers were not themselves powerless to bring the issue to a head, if they so chose, under provisions in s.28A of the Taxes Management Act 1970 without waiting for HMRC to bring proceedings in respect of the arrangements. They did not pursue such a course.

Mr Elvin submits that the judge was wrong in failing to take proper account of the unjustified and largely unexplained failure on the part of HMRC to take appropriate action against the tax avoidance scheme based on a disputed interpretation of the DTA. It had knowledge of the scheme from about 1997 and certainly from July 2002. It had not acted in good time, even when all the evidence was assembled. It abandoned within months the test claims proposed in 2007. The delays by HMRC saw a yearly increase in the number of schemes. If HMRC had taken proceedings and lost, as he contended they would have done, Parliament would have allowed the claimant and similarly placed persons to retain the benefits of their litigation success. Mr Elvin cites cases in which swift action had been taken, such as A,B,C,D v.UK (Application No. 8531/79) (1981) DR 203 at page 203; National & Provincial Building Society v. UK (Application No. 21319/93) (1997) 25 EHRR 127at paragraphs 29 to 30 and 33 to 35; Padmore v CIR [1987] STC 36; and MA v Finland (supra) at pages 212 to 213.

The judge also failed, on the claimant’s case, to take proper account of the delay in addressing whether retrospectivity struck a fair balance, bearing in mind the legitimate expectation on the part of the claimant to claim tax relief and the exacerbation of the frustration of the claimant’s legitimate expectation as a result of the delay in introducing the legislation. The delay and continuing uncertainty added to the detriment suffered by the claimant: see Beyeler v Italy (2000) 33 EHRR 1224 at paragraph 119, which the judge cited, but distinguished as a case in which the Italian authorities, by their conduct, had led the taxpayer to believe that the State would not exercise the right that it enjoyed. It is submitted that the judge misapplied that authority, since the detriment, both in that case and in the case of the claimant, is suffered as a result of living through many years of legal uncertainty created by the attitude of the authorities.

Even in the absence of a representation by HMRC about no litigation or no retrospective legislation the claimant had a legitimate proprietary interest in a claim for relief. He was entitled to expect the DTA to be applied to him without himself taking steps.

In my judgment, the judge correctly held that this ground of challenge to the retrospective provisions had not been established.

First, Mr Elvin could not point to any legal requirement on HMRC to test the disputed efficacy of the scheme in litigation before recommending recourse to retrospective legislation. There had been no representation by HMRC that legal proceedings would be pursued before legislation was enacted, or that any legislation enacted would not have retrospective effect.

Secondly, the judge looked in detail at the circumstances of the alleged delay by, and the conduct of, HMRC. The litigation would probably have been protracted, costly and uncertain. There was no evidence about the impact that the delay had on the claimant. HMRC had not given any express or implied indication to the claimant that he could safely rely on the scheme, or to believe or have any expectation that tax would not be payable. There was no other conduct on the part of HMRC that outweighed the other factors affecting the striking of a fair balance.

Thirdly, HMRC had advised the claimant and other taxpayers using the scheme to pay on account the income tax that they said was properly due. The claimant and his fellow taxpayers, who chose not to take that course, took the risk that tax would be payable, despite the scheme.

Fourthly, if the claimant had wished to bring matters to a head, he could have chosen to take his own proceedings without waiting for HMRC to bring theirs. He could have applied to the special commissioners for a direction for a closure notice. He had not done so.

No pre-legislation assessment of impact of retrospectivity on taxpayers

The judge concluded that the absence of any assessment by HMRC of how individual taxpayers, such as the claimant, might be affected financially by the liability that would be imposed by s.58 (4) could not, in the circumstances of this case, affect the proportionality of the retrospective legislation. He said that it was not entirely clear to him what such an assessment would have entailed, or what purpose it would have served. He concluded:-

“93.

Given the background, I see no justifiable basis for saying that HMRC was required to investigate what taxpayers had in fact done: whether they had, for example, prudently reserved for any future liability, or had spent the net income on present consumption or had invested in illiquid assets that, particularly in the light of the fall in asset prices following the credit crisis in 2008, could not now be realised to meet, in whole or in part, the liabilities that would be unequivocally imposed by section 58(4) of the 2008 Act.”

Mr Elvin submits that the failure to carry out an impact assessment made the retrospective response by Parliament disproportionate. That failure should have been weighed in the balance to see whether fairness had been achieved. He says that, in order to safeguard the rights protected by the Convention, it is incumbent on public bodies, such as HMRC, to take into consideration the impact of a measure on the rights of those affected. It was also a factor to be weighed in assessing the fair balance. He contends that the judge erred in law by failing to take account of the lack of a proper assessment of the effect on the claimant and other similarly placed taxpayers of full retrospectivity, given the circumstances of HMRC’s delay, the increase in claims resulting from that delay, the apparent lack of confidence by HMRC in its reserved position and its failure to take steps to resolve the issue in good time. In accepting that he did not even know what the assessment would have entailed, the judge had indulged in impermissible conjecture on the possible results of an assessment.

Further, the repeated suggestions of HMRC to put the money on one side did nothing to avoid the fact that the claimant was ultimately deprived of £195,456 of relief and his tax burden was increased by the same amount. The fact that HMRC may be willing to deal with hardship cases did not answer the point that the claimant was exposed to hardship as a result of the retrospectivity in s.58.

I would reject this ground of appeal. The judge did not err in law in disregarding the absence of an impact assessment of the effects of retrospective legislation on its proportionality.

First, Mr Elvin could not point to any legal requirement that a State should carry out either a formal or an informal impact assessment before enacting retrospective legislation. I agree that an impact assessment may be desirable, that it may lend support to a submission that the State acted proportionately and that a State may be open to criticism for not having done one: but it is not legally obligatory.

Secondly, there is no authority for the proposition that the failure to have, or to consider having, an impact assessment is a factor to be weighed in assessing the fair balance.

Thirdly, on the facts of this case, HMRC knew with reasonable precision the numbers of taxpayers seeking to take advantage of the scheme and the amount of income tax at stake. They had advised them to set aside or to pay the disputed tax in advance. Many of the taxpayers had chosen not to take that precaution. It was neither necessary nor reasonable to impose on HMRC an obligation to investigate what the taxpayers had in fact done with the money that they had decided not to set aside. I agree with the judge that it was for the taxpayers themselves to assess the risk to them inherent in not paying the tax in advance. Although HMRC may decide to take financial hardship into account before seeking to enforce demands for tax and interest, that, in my view, is not relevant to the issue of whether the retrospectivity of s.58 was devoid of the reasonable foundation needed to make it compatible with Article 1.

Fourthly, it has not been established what relevant information would have been yielded by an impact assessment, other than the fact that some taxpayers could afford to pay the tax and that other taxpayers could not. That fact, which was already known to HMRC, would not have tipped the balance in favour of finding that s.58 was disproportionate and incompatible with Article 1 of the First Protocol.

I would dismiss this appeal. The judge was not wrong to conclude in his comprehensive, clear and excellent judgment that the retrospective provisions of the 2008 Act are proportionate and are compatible with Article 1. There are no grounds which would entitle this court to disturb it.

In the circumstances of this case, the liability of the claimant under the retrospective legislation of s.58 to pay the UK income tax that he would have had to pay, if he had not participated in the tax avoidance scheme, is no more an unjustified interference with his enjoyment of his possessions than the ordinary liability that his fellow residents in the UK are under to contribute, by way of UK tax on their income, towards the costs of providing community and other benefits for the purposes of life in a civil society.

In summary, the crucial points on examination of all the relevant circumstances of this case are that the retrospective amendments were enacted pursuant to a justified fiscal policy that was within the State’s area of appreciation and discretionary judgment in economic and social matters. The legislation achieves a fair balance between the interests of the general body of taxpayers and the right of the claimant to enjoyment of his possessions, without imposing an unreasonable economic burden on him. This outcome accords with the reasonable expectations of the taxation of residents in the State on the profits of their trade or profession. The legislation prevents the DTA tax relief provisions from being misused for a purpose different from their originally intended use. There has been no conduct on the part of the State fiscal authorities that has made the retrospective application of the amended legislation to his tax affairs an infringement of his Convention rights.

I agree.

I also agree.