Timothy Watts v The Commissioners for HMRC

The relevant authorities were reviewed by the Supreme Court in Rossendale, from which the following guidance may be drawn:

One of the cases reviewed in Rossendale was the decision of the Supreme Court in UBS. We were referred to various passages of UBS. Paras 62 to 64 state:

“62.

The significance of the Ramsay case was to do away with both those features. First, it extended to tax cases the purposive approach to statutory construction which was orthodox in other areas of the law. Secondly, and equally significantly, it established that the analysis of the facts depended on that purposive construction of the statute. Thus, in Ramsay itself, the terms “loss” and “gain”, as used in capital gains tax legislation, were purposively construed as referring to losses and gains having a commercial reality. Since the facts concerned a composite transaction forming a commercial unity, with the consequence that the commercial significance of what had occurred could only be determined by considering the transaction as a whole, the statute was construed as referring to the effect of that composite transaction. As Lord Wilberforce said:

“The capital gains tax was created to operate in the real world, not that of make-belief. As I said in Aberdeen Construction Group Ltd v Inland Revenue Comrs [1978] AC 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. 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)

63.

“Unfortunately”, the Committee commented in Barclays Mercantile at para 34, “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”. In the Barclays Mercantile case the Committee sought to achieve “some clarity about basic principles” (para 27). It summarised the position at para 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. ... As Lord Nicholls 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.’”

As the Committee commented, this is a simple question, however difficult it may be to answer on the facts of a particular case.

64.

This approach has proved to be particularly important in relation to tax avoidance schemes as a result of two factors identified in Barclays Mercantile at para 34. First, “tax is generally imposed by reference to economic activities or transactions which exist, as Lord Wilberforce said, ‘in the real world’”. Secondly, tax avoidance schemes commonly 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”. In other words, as Carnwath LJ said in the Court of Appeal in Barclays Mercantile, [2002] EWCA Civ 1853; [2003] STC 66, para 66, taxing statutes generally “draw their life-blood from real world transactions with real world economic effects”. Where an enactment is of that character, and a transaction, or an element of a composite transaction, has no purpose other than tax avoidance, it can usually be said, as Carnwath LJ stated, that “to allow tax treatment to be governed by transactions which have no real world purpose of any kind is inconsistent with that fundamental characteristic.” Accordingly, as Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46; (2003) 6 ITLR 454, para 35, where schemes involve intermediate transactions inserted for the sole purpose of tax avoidance, it is quite likely that a purposive interpretation will result in such steps being disregarded for fiscal purposes. But not always.”

Paras 67 and 68 state:

“67.

References to “reality” should not, however, be misunderstood. In the first place, the approach described in Barclays Mercantile and the earlier cases in this line of authority has nothing to do with the concept of a sham, as explained in Snook [1967] 2 QB 786. On the contrary, as Lord Steyn observed in McGuckian [1997] 1 WLR 991, 1001, tax avoidance is the spur to executing genuine documents and entering into genuine arrangements.

68.

Secondly, it might be said that transactions must always be viewed realistically, if the alternative is to view them unrealistically. The point is that the facts must be analysed in the light of the statutory provision being applied. If a fact is of no relevance to the application of the statute, then it can be disregarded for that purpose. If, as in Ramsay, the relevant fact is the overall economic outcome of a series of commercially linked transactions, then that is the fact upon which it is necessary to focus. If, on the other hand, the legislation requires the court to focus on a specific transaction, as in MacNiven and Barclays Mercantile, then other transactions, although related, are unlikely to have any bearing on its application.”

It is helpful to start by considering the purpose of paragraph 14A. As already explained, the UT held that the purpose of paragraph 14A was explained in two earlier decisions, (a) the decision of the UT in Berry and (b) the decision of the FTT in Andrew (Judge Greenbank), which followed Berry.

The appellant contended that Berry went wrong in two specific passages. The first was para 31(viii) where Lewison J said:

“viii)

Although one cannot classify all concepts a priori as “commercial” or “legal”, it is not an unreasonable generalisation to say that if Parliament refers to some commercial concept such as a gain or loss it is likely to mean a real gain or a real loss rather than one that is illusory in the sense of not changing the overall economic position of the parties to a transaction: WT Ramsay Ltd v Commissioners of Inland Revenue (1981) 54 TC 101, 187; Inland Revenue Commissioners v Burmah Oil Co Ltd (1981) 54 TC 200, 221; Ensign Tankers Ltd v Stokes [1992] 1 AC 655, 673, 676, 683; MacNiven v Westmoreland Investments Ltd (§§ 5, 32); Barclays Mercantile Business Finance Ltd v Mawson (§ 38).”

The second passage criticised by the appellant was paras 51 to 52, which stated:

“51.

As I have said, the FTT held that the purpose of para 14A was the general proposition stated in sub-para (1) viz:

‘A person who sustains a loss in any year of assessment from the discount on a strip shall be entitled to relief from income tax on an amount of his income for that year equal to the amount of the loss.’

52.

In my judgment the FTT were right to identify the purpose of the paragraph in that way. This is not a case in which Parliament has used algebra (amount A and B) to create a notional profit or loss. It has used words which have a recognised commercial meaning and it is to be expected that Parliament intended to tax (or relieve) real commercial outcomes. The FTT were right not to adopt a slavish literal ‘tick box’ interpretation of the legislation. This is precisely how the Ramsey principle is meant to operate. I thus conclude that the FTT made no error of law in identifying the purpose of the legislation.”

The appellant contended that the first passage committed the error of applying, a priori, the legal/commercial dichotomy. The appellant said that this was inconsistent with the subsequent Supreme Court statement in UBS at para 65 that “all depends on the construction of the provision in question.”

I do not accept the submission that in para 31(viii) Lewison J wrongly categorised the term “loss”, a priori, as a commercial rather than a legal one. Lewison J simply gave an orthodox summary of the Ramsay principles. The passage closely reflects what Lord Nicholls said in para 38 of Barclays Mercantile. It is also consistent with the later statements of the principles in UBS and Rossendale.

The appellant’s second criticism was that in para 52 of Berry Lewison J failed to recognise that the concept of “loss from the discount on a strip” was defined in sub-paragraph (3) as involving two inputs. In other words that there was a statutory formula. There is some force in this criticism but, as the UT explained in the present case, the inputs themselves are required to be construed in accordance with the Ramsay approach. I agree with the UT’s analysis on this point.

Moreover, the substantial point made by Lewison J in para 52 of Berry was that the purpose of paragraph 14A is to allow a taxpayer to claim relief where he has suffered a real commercial loss as a result of transactions in gilt strip. I agree with that conclusion. The statutory provision is concerned with transactions having real world economic effects. This is shown by the subject matter and wording of the provision. It refers to gilt strips (a recognised form of traded security), uses the concepts of transfer and redemption (both being ways of realising or disposing of value), and refers to “the amount paid for” a strip and “the amount payable on transfer or redemption”, both economic values. Applying the guidance set out above, Parliament must therefore be taken to have intended that the concept of loss and the inputs to the formula for its calculation are concerned with the identification of real losses. Adapting the words of Lord Wilberforce in Ramsay, the provision is concerned with the real world, not that of make-believe, and tax relief is to be allowed on actual losses, not on arithmetical differences. I therefore agree with the description of the purpose of paragraph 14A given in Berry.

In reaching this conclusion I am unpersuaded by Ms Nathan’s argument that the deeming provisions in paragraph 14(4), which are incorporated by paragraph 14A(4), show that paragraph 14A as a whole is not concerned with real world transactions, but is a self-contained code capable of yielding artificial losses. The fact that there may be deemed to be a loss (or gain) for a deemed transfer where the taxpayer holds the strip on the 5^th April in a year of assessment to my mind throws no relevant light on how the loss calculation is to be carried out in the case of an actual transfer under paragraph 14A(3).

The second stage in the analysis is that where, as here, there is a composite transaction comprised of a number of interlinked stages, the court is required to consider whether the composite transaction considered in the round has relevant tax consequences: see para 12 of Rossendale (quoted in para 37 (iii) above). Since the transfer of the gilt strip from the appellant to Investec was effected by means of a unified, composite, transaction, having more than one stage, to apply the statute to only one of those stages would be to take an inadmissibly blinkered view.

Investec needed first to take the assignment of the Option and then second to exercise it. Without taking the first step, it would have had no right to take the second. The amounts payable at each step were predetermined.

The UT put the point well in the following passage (with which I agree):

“49.

However, the grant and assignment of the option were simply two steps, necessary although insufficient, in a composite transaction effecting a transfer of the entire interest in the gilts to Investec. The assignment of the option was a part of the transfer of the gilts under the scheme. On a realistic view, the grant and assignment of an option to purchase the gilt strips, and the exercise of the option were all parts of the means by which the gilt strips were transferred from the Appellant (and eventually purchased or acquired by Investec).

50.

A purposive interpretation of the payment on the ‘transfer’ means that the ‘transfer’ should not be artificially divided or separated so that only the payment in respect of the exercise of the option could be considered the amount payable on the transfer. The payment for the assignment of the option was a necessary step in a composite scheme designed to effect a transfer of the gilt strips for which a series of transactions and payments was required. The payment for the assignment of the option to Investec was properly construed to be part of the amount payable on the transfer of the gilts from the Appellant and to it.”

In my judgment, Parliament cannot realistically be taken to have intended to create a regime under which a taxpayer would be able to generate a relievable loss by transferring a strip to another person in return for an amount payable by the other which matches the amount the taxpayer had paid for it, simply by dividing the amount payable for the transfer into a series of separate sums contracted to be payable by reference to earlier steps in the pre-ordained scheme.

Viewed realistically, both of the amounts payable by Investec to bring about the transfer fall naturally within the scope of the provision.

In reaching this conclusion I am not persuaded by the appellant’s argument that the preposition “on” in the phrase “amount payable on the transfer” can only denote amounts payable on the exercise of the Option, and not on the acquisition of the Option. The word “on”, like other prepositions, has very limited independent semantic content. It takes its meaning from its surrounding words. The word “on” may be used in a wide variety of ways, including as part of the description of a physical position, as a way of identifying a date or time, or to indicate a relationship between two or more things. Ms Nathan accepted that the word “on” did not require the relevant amount to be payable simultaneously with the transfer of property in the security – the amount might be payable before or after that moment. So this is not a case where the word is being used to identify a date of payment. She submitted instead that it was intended to denote amounts payable “on the occasion of the transfer”. She said that reading was narrower than (say) the amounts “payable for the transfer”.

I do not accept this submission. For the reasons given above, the inputs into paragraph 14A(3) are themselves to be given a purposive, practical meaning. The words on either side of the word “on” are “the amount payable” and “the transfer [of a strip]”. There is no difficulty in reading the words purposively as including the amount payable for (or in return for) the transfer. And, for the reasons already given, approaching the facts realistically, in my view it would be unduly artificial to say that Investec only had to pay £150,000 on (in the sense of in return for) the transfer of the strip, when it actually had to pay nearly £1.5 million to acquire them.

I am also unable to accept the appellant’s arguments based on paragraph 4 of Schedule 13 or the ejusdem generis canon of construction. I have no difficulty with the contention that a transfer of a security generally connotes a transfer of property in it. Indeed in the present case there was a transfer of the property. But the question here is not whether, or precisely when, there was a transfer of property in the strip. It is to identify “the amount payable on the transfer”. That is the issue of statutory construction addressed above.

For similar reasons, the principles derived from Wimpey do not assist. The question in the present case is the scope of the phrase “amount payable on the transfer” and its application to the composite transaction. For the reasons given above, paragraph 14A does not call for an examination of the precise moment at which title passed according to the principles of property law.

Nor does paragraph 4(3) assist. I agree with Judge Greenbank in Andrew at para 121 that this provision contains deeming provisions, designed to identify the time at which a transfer occurs. They do not assist in the interpretation of paragraph 14A(3).

Ms Nathan also emphasised the absence of express anti-avoidance provisions in the legislation. I do not think that this assists. Ms Nathan accepted that the absence of any anti-avoidance provisions did not as such exclude the application of the Ramsay approach to interpretation. Barclays Mercantile establishes that it may not be relevant to the construction of a taxing provision that an arrangement was designed to produce a tax advantage. It also shows that, other than where there is specific anti-avoidance wording, it may be irrelevant that a component part of an arrangement may have no commercial advantage and was only inserted for tax reasons. However, as Barclays Mercantile illustrates, the court must construe the relevant provisions purposively and decide whether they were intended to apply to the transaction, viewed realistically. For the reasons already given, following this approach, the phrase “amount payable on the transfer” applies to all the amounts payable by Investec as the transferee of the strip.

Ms Nathan relied on the statutory history and extra-statutory materials (an Inland Revenue Consultative Document dated May 1995 and the Explanatory Notes to the legislation). Other than to demonstrate that paragraph 14A contained no anti-avoidance provisions while other parts of Schedule 13 did, I found nothing in either the history or those materials that threw any helpful light on the purposes of the provision.

I return to the grounds of appeal. For the reasons I have given I agree with the conclusions of the UT and the FTT and would therefore dismiss ground 1(b). Given this conclusion, ground 1(a) does not require separate consideration but, for completeness, in my judgment neither the FTT nor the UT fell into a material error by falling into the trap of pre-categorising the concepts used in paragraph 14A as “legal” or “commercial”. As the UT explained there were some echoes of this approach in the decision of the FTT, but that did not lead it into any material error. I agree with the conclusions of the UT on this point. I have addressed the challenges to the decision of the UT in Berry above. In the light of my conclusions on ground 1(b), ground 2 requires no further elaboration.

I would dismiss the appeal.