West & Ors (HM Inspector of Taxes) v Trennery & Ors

There are five appeals by Graham West (HM Inspector of Taxes) and other inspectors all raising the same issues. For the purpose of these appeals the case of West (HMIT) -v- Trennery (CH 2002 APP 0565) has been taken as the lead appeal. The result of all the other appeals will be decided the same way.

The Appellant Inspector of Taxes appeals by Notice of Appeal issued on 17 July 2002 against the decision of the Special Commissioners dated 23 May 2002 when they allowed the taxpayer’s appeal against an assessment to capital gains for the year 1995/1996 arising out of a “flip-flop” scheme for reducing capital gains tax carried out by different sellers of shares in the same company.

The appeal is on a question of law and involves a consideration of section 77 of the Taxation of Chargeable Gains Act 1992 (“TGA”) as ameded by the Finance Act 1995 as in force prior to the introduction of sectin 92 and Schedule 26 of the Finance Act 2000.

The Special Commissioners heard the taxpayer’s appeal sitting in private in London between 15 – 18 April 2002.

I refer to the agreed statement of facts before the Special Commissioners, a copy of which I annex to this Judgment. The taxpayers were all shareholders in a company Einkorn Limited (“Einkorn”). It was an unquoted UK bus company and there was a possibility of a sale of its shareholding to another company North British Bus Limited. Advice was sought in October 1994 by Brachers Solicitors to the taxpayers from Price Waterhouse Chartered Accountants who were asked to consider various possibilities for structuring the proposed sale to reduce the capital gains tax that would otherwise accrue on that sale. As higher rate taxpayers all the taxpayers would pay capital gains tax at 40%. The purpose of the scheme was to set up arrangements whereby the tax liability would be reduced from 40% to 25%.

On 20 March 1995 Messrs Brachers gave advice in a letter to the taxpayer and explained what was called a “two settlement route”.

On 30 March 1995 each taxpayer applied to National Westminster Bank Plc’s Maidstone branch seeking short-term loans (of a duration of one month maximum) as intended trustee of a proposed life interest settlement trust. The Bank the same day approved a total advance of £9.3 million plus a further sum of £1.938 million to be advanced to another shareholder a Mr Baumann.

Between 31 March and 1 April 1995 each taxpayer executed a life interest settlement (“First Settlement”) with his or her spouse as cotrustee and on 4 April 1995 each taxpayer disposed of a proportion of his or her shareholding in Einkorn to the trustees of his or her First Settlement (that is to say the relevant taxpayer and his or her spouse).

As such trustees the taxpayers and their spouses assumed a personal liability to re-pay the respective loans advanced to the relevant First Settlements.

On 4 April 1995 each taxpayer executed a further deed of settlement on life interest trusts (“the Second Settlement”). The trustees of the Second Settlement were professional trustees and were never liable to the Bank for any of the amounts advanced to the trustees of the First Settlements. The trustees of each First Settlement on that day also provided a letter of authority to Messrs Brachers to hold their respective Einkorn share certificates or the proceeds of sale to the order of the Bank in consideration of the advance made by it relevant set of trustees. Simultaneously, as such trustees by letter of authority given to the Bank they authorised the advance of the funds payable under the borrowing facility to Messrs. Brachers. That firm, on behalf of each set of trustees, provided written undertakings to the Bank to hold the share certificates representing the shares held by the respective sets of trustees or the proceeds of sale of the shares to the Bank’s order in consideration of it making the respective advances to the various trustees, and on that day and in consideration of that undertaking the respective sums of cash were advanced and paid to Brachers.

By deeds of appointment dated 4 April 1995 each set of trustees appointed the relevant sum of cash which had by virtue of the Bank’s advance become comprised in their settlement on trust that it be immediately transferred to the Trustees of the relevant Second Settlement so as to form part of the Trust Fund of the Second Settlement conceived. That was done also on 4 April 1995.

On 5 April 1995 all sets of First Settlement trustees except one (those acting for Mrs Lim) executed a Deed of Exclusion and Appointment irrevocably excluding the relevant taxpayer the life tenant of the relevant First Settlement and his or her spouse from benefit under those settlements and brining into possession the interests in remainder of the children of the respective taxpayers under each of the First Settlements. On 5 April 1995 Mr and Mrs Lim executed a deed of exclusion (but not including an appointment) in similar terms. This distinction between Mrs Lim’s case and that of each other taxpayers is for technical reasons immaterial. The purposes of making all of those steps, as I have said was to reduce the capital gains tax liability in respect of an anticipated sale of the Einkorn shares which sale the taxpayers hoped and expected to be effected and which was in the events which happened effected some twelve days after the establishment of the First Settlement. The sale of course took place in the next tax year 1995/6 whereas the steps before hand took place in the tax year 1994/5.

All of the steps were preordained, but the Inspector of Taxes does not challenge any of the transactions as being artificial on the basis of the well known decisions of W.T. Ramsey -v- IRC [1982] AC 300 and Furniss -v- Dawson [1984] AC 474. The Inspector of Taxes accept that the series of steps taken were all genuine but maintains that notwithstanding that fact the construction of section 77 TGA means that the scheme has failed to achieve the purpose it was intended to achieve so that the taxpayers remain liable to pay Capital Gains Tax at 40%.

Section 77 TGA is the key provision in relation to this appeal. It was amended by the Finance Act 1995. Part of the submissions of Mr Ewart who appears for all the taxpayers involves a consideration of the previous provisions of section 77 TGA. Like the Special Commissioners I set out the text of the old version of section 77 TGA with the new version side by side:-

Mr McCall QC for the Appellants submits that the purpose of section 77 TGA is quite clear, namely to ensure that gains of a settlement in which a settlor retained an interest paid tax at the settlor’s marginal rate of tax as if the settled assets had been retained in his own hands. As he submits, that is the same as saying that it is to negate attempts at using settlements for the purpose of attracting a lower rate of tax than would have been the case if the assets in question had been retained in the settlors’ hands. It is thus not a generalised anti-avoidance provision but, he says, a targeted anti avoidance section ensuring that putting property into certain types of trust does not create inappropriate tax advantages in the same way that many other sections in the tax legislation seek to negate tax advantages which might otherwise flow from the creation of settlements under which the settlor still has the possibility to enjoy the benefits from the settled property.

He submits that any ambiguity in the legislation should be resolved with that purpose in mind (and in particular general words should not be limited so as to defeat that purpose); see IRC –v- McGuckian [1997] 1 WLR 991 at page 998 per Lord Steyn and page 1005 per Lord Cooke of Thorndon.

Thus he submits there are no special restrictive or (for that matter) broad principles of statutory construction that apply peculiarly to the construction of tax statutes. This echoes the speech of Lord Hoffman in Macniven (HM Inspector of Taxes) –v- Westmoreland Investments Ltd [2001] 2 WLR 377 at page 397. One does not start with the steps that are taken for the avoidance of tax and decide what conclusion is drawn from the statutory language. Rather, one applies the statutory language and then sees what the conclusion is.

Finally in this context Mr McCall QC referred me to the rejection of a submission he made in the case of Frankland –v- IRC [1997] STC 1450 where Peter Gibson LJ said this (at page 1464):-

“Mr McCall urges us to adopt a broad or purposive approach to the construction of section 144. I accept, of course, that section 144 of the 1984 Act, like any other legislative provision, must be construed with its statutory context and with due regard to the purpose which the legislator may be taken to have been seeking to achieve. But that purpose must, I think, be identified in the legislation itself and in any other relevant and admissible material. It is not permissible to speculate, a priori, as to what the legislator must or might have intended, and then strain the statutory language used in order to give affect to that presumed purpose”

I agree with that analysis. In the present appeal it seems to me clear that the purpose of section 77 TGA is to ensure that if a settlor at the time the taxable gain arises has directly or indirectly still some form of benefits via the settlement then the gains should be taxed accordingly as if they were his or her own.

Mr Ewart referred me to the notes on clauses provided by the Board of Inland Revenue in relation to what was the 1995 Finance Bill. Paragraph 73 of those notes in respect of section 77 to 79 TGA 1992 merely says that the revised sections bring the wording into line with the new income tax provisions in sections 660A of the Income and Corporation Taxes Act 1988 (“ICTA”) (as amended by the Finance Act 1995).

Under section 660A ICTA the notes provide (see paragraph 6 of the statement) that the provisions are designed to treat income arising under a settlement as the income of the settlor for tax purposes unless the income arises from property in which the settlor has no interest, with the subsidiary provisions providing that the settlor has an interest in the settled property if there is any possibility of the property or income or other property derived from the settled property being paid to him or his spouse or applied for their benefit.

Now it seems to me that the only thing that can be concluded from those notes is that it was intended that the provisions in the two respective sections were designed to have essentially identical effects, the provision of section 660A ICTA dealing with income and the provisions in section 77 TGA dealing with capital gains.

Whether or not the settlor retains an interest for the purpose of section 77 TGA, is to be determined by the construction of section 77 TGA as it now is and no more.

I derive no assistance from comparison with the old section or these notes and the reference to section 660A ICTA. It seems to me that I should simply approach section 77 TGA and see what it means and decide on that meaning whether or not the settlors retain an interest for the purposes of that section.

There is no authority which deals with this particular provision.

The question to be decided therefore is whether or not the settlors at the time of the sale of the shares still retained an interest in their respective First Settlements.

Mr McCall QC on behalf of the Appellants raises three arguments which lead to the conclusion (he submits) that the settlors have retained an interest in their First Settlements. The first of those involves a submission that the funds in the Second Settlement are derived from the First Settlement and as a settlor still maintain interests in the Second Settlement therefore he or she is deemed still to retain an interest in the First Settlement: alternatively the same result follows on the basis that a the Second Settlement benefit is derived from the First Settlement property. The second argument is that the settlor trustees had a right of indemnity in respect of the loan liability and that right of indemnity was a sufficient interest for the purposes of showing they still retained an interest in the First Settlement. His third argument involves a consideration of the Deed of Release and a submission based on the Court of Appeal decision of ICR –v- Botnar 72 TC 205 that the deed of exclusion was ineffectual for tax purposes because it was always open to a donee recipient on its wording to provide funds back to a settlor, Who thus must be deemed to retain an interest.

As set out above section 77 (2) TGA provides that a settlor shall be regarded as having an interest in a settlement if (a) any property which may at any time be comprised in the settlement or any derived property is or will or may become payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever, or (b) the settlor or his spouse enjoys a benefit deriving directly or indirectly from any property which is comprised in the settlement or any derived property.

The key provision is subsection (8) which is set out earlier and which gives a definition of derived property as follows:-

“"derived property" in relation to any property means income from that property or any other property directly or indirectly representing proceeds of or of income from that property or income there from”.

Mr McCall QC submits that the fund comprised in any Second Settlement having been created by funds raised by virtue of the loan made by the Trustees of the First Settlement and paid over to the Trustees of the Second Settlement is derived property and the benefits under the Second Settlement are defived benefits. Mr McCall QC submits that case falls within both S. 77(2) (a) and (b) although he submits rightly that either will be sufficient for the purposes of the Appellant’s claim.

Mr McCall QC submits that the expression “derived property” is designed to cover property outside the settlement so long as there is any property within the settlement in respect of which it can be said the property outside the settlement is “any other property directly or indirectly representing proceeds of, or income from, that property or income therefrom”.

Mr Ewart for the taxpayers submitted (successfully to the Special Commissioners) that any derived property must be found within the settlement and the income therefrom.

The Special Commissioners considered that Mr Ewart’s construction was a more natural use of the language.

Mr McCall QC accepts there must be some limit in point of time to the treatment of property outside the First Settlement as “derived property”, and that limit he submits is that there must at any given time for capital gains purposes still be property within the settlement from which it can be said the derived property (to use a different word) comes. He points to the wide definition of derived property and says that if one looks at the sums that were raised by borrowing on the security of the shares how can it not be said that the proceeds thereby raised are “any other property directly or indirectly representing proceeds of that property…”.

With deference to the Special Commissioners I agree with the submissions of Mr McCall QC. The very wide wording is to catch any property, which is directly, or indirectly representing proceeds of property comprised in the settlement. I do not see how the monies that were raised by the loan can be said to be any thing other than indirectly derived from the utilisation of the shares for the purposes of realising that sum. As Mr McCall QC said in argument re-mortgaging a property is regarded as a classic way of raising capital out of assets. That is what the Trustees of the First Settlements did and those funds were transferred to the Second Settlements in which the settlors still retain benefits.

It also to my mind marries with the wording in the two subsections which refer to “any property which may at any time be comprised in the settlement, or any derived property” (emphasis added). That seems to me to show that the draftsman of the section intended that there would be property in the settlement and derived property would be found outside the settlement. Mr Ewart’s argument involves a submission that the derived property is within the settlement and I do not see how that can survive the wording of those two provisions.

That seems to me to make sense. The provision is designed to ensure that a settlor remains liable for capital gains if he retains a benefit in whatever way in property which is either in a settlement or derived from the settlement at the time of the disposal of the property comprised in the settlement.

Whether or not this has an impact on section 660A ICTA is something which is not of concern for me. The wording of section 77 TGA is clear in my opinion. If Mr Ewart’s arguments are correct, the creation of the structure involving derived property would be surplus. I say that because any property which was still within the settlement cannot be derived property, as it would be property within the settlement. The other side to the coin to that is Mr Ewart’s inability to deal with the question I posed to him “from what source did the funds for the Second Settlement come?”. It seems to me to be evident that the funds were derived from property which is still in the settlement and the assessments were for this reason alone properly raised.

The Appellant therefore wins on ground one.

That makes it unnecessary to deal with what were very much secondary arguments, but I will deal with them as they have been the subject matter of argument.

Mr McCall QC’s argument is that looking at the second tax year the settlor has a benefit, because he has made the borrowing personally and has a right of indemnity from the settled property both for interest and for capital. As the borrowing represented 75% of the assets in the First Settlement leaving approximately 25% for the payment of capital gains tax so there was no margin on capital the result would be that the settlor would lose personally if the proposed sale went off and a subsequent sale was at a lower price. A settlor would have to fund the interest and this was un-commercial and not something a prudent trustee would do. The sale of the shares and the repayment of the borrowing accordingly resulted in the removal of the obligation on the settlor to meet these liabilities personally, which is a benefit. Mr McCall QC would limit this contention to cases where a settlor or trustee does something, which is un-commercial.

Mr Ewart submitted that the right of indemnity is inherent in all obligations of trustees and if Mr McCall QC’s arguments are correct a settlor was caught by the section in all cases unless the settlor is expressly made personally liable being a trustee. The borrowing (he submitted) was for the benefit of the settlement, the borrowed money went into the settlement before it was advanced and the borrowing and the interest were discharged from the sale of the shares.

The Special Commissioners preferred Mr Ewart’s contention and in my opinion they were right to do so. It seems to me that Mr McCall QC’s argument involves attempting to look at the transactions in an anti avoidance way something which he disclaimed at the opening of his case. It is perfectly natural for a trustee to have a right of indemnity. Trustees are personally liable on all contracts and it is for that reason they retain an implied right of indemnity (if it is not excluded) out of the funds of the estate. That does not seem to me to be a derived benefit for the purposes of section 77 TGA; it is a normal right, which is an incident of trusteeship. The settlor has no personal benefit from that right of indemnity as it only vests in him in his capacity as trustee. If Mr McCall QC wished to mount this argument then he should have attacked the transactions as being artificial in some way, but he expressly did not do so.

Accordingly, in my opinion the Appellant’s argument on the second ground fails.

This argument is based on a construction of the Deed of Exclusion and a submission by Mr McCall QC that it is not effective fully for the purposes of section 77 tga because it does not exclude benefits which might be received back by the settlor from individuals or trustees to whom part of the settlement funds may have been appointed. This he based upon the Botnar decision to which I have made reference above.

The wording of the Deed of Exclusion (clause 2) is as follows:-

“The trustees of the settlement …IRREVOCABLY DECLARE that with effect from the execution of this Deed the Life Tenant … shall be excluded as a Beneficiary of the Settlement forthwith and he shall cease to have any of the powers given to him under the Settlement… ”.

Mr McCall QC in his submissions said that the effect of the Deed of Exclusion does not exclude the possibility of funds appointed out being given back to the settlor by such persons without the trustees imposing some restriction on a donee in such case preventing that from happening. Mr Ewart said quite forcibly that the clause was a standard clause and the possibility of having to require donees to do that was unheard of. Even if that was done it could not bind somebody who derived property from a donee himself.

In the course of argument Mr McCall QC was constrained to acknowledge there must be some limit on this submission because is would be absolutely impossible for any document to be drawn by a trustee which would cover every possibility (however faint) of funds deriving back to a settlor. Pursued to its logical conclusion it would mean every settlement would always have the possibility of the settlor having a beneficial interest in it. A settlor would then be faced with the difficulties posed to Mr Vandervell many years ago and his well known difficulties in removing any beneficial interest in a trust.

Mr McCall QC based his argument as I have said on the Botnar case. In that case the argument (one of many) arose out of clause 23 which provided that no excluded person should be capable of taking any benefit in accordance with the terms of settlement and that no part of the capital or income should be paid lent or applied for the benefit of any such excluded person.

Morrit LJ delivered the Judgment on this (paragraphs 28 and 29). He appears to have concluded as a matter of construction that the power of conferring benefits under clause 3(c) might not be exercised for the purposes of conferring a benefit on Mr Botnar because he was excluded from such benefit by virtue of clause 23. However, he said that the power could be properly exercised to transfer capital to another settlement in which he was not then interested but under which he might subsequently obtain an interest therein for example by being added to the class of potential appointees and there is nothing in the clauses to prevent it happening. Aldous LJ delivered a Judgment in similar terms.

I have some difficulty in applying this case. Obviously on the wording of the clauses there the theoretical possibility of Mr Botnar achieving indirect benefits was open. If one applies that to the present deed then Mr McCall QC is right to submit that under the wording of the present deed there is nothing to stop the same potential thing happening. I cannot believe that as a matter of construction section 77 TGA was intended to have such a wide effect in respect of derivative property. It seems to me there must be necessarily some limit on it and if the settlor receives property through such a circular way it has happened as a result of the action of a third party and not the trust and I do not see how such involuntary actions could possibly have been intended to give rise to a tax liability. Of course if artificial transactions are entered into designed to achieve that illusion there is no difficulty in the Inland Revenue challenging those transactions. It seems to me therefore that the effect of the deed is the best that a settlor can do to prevent him being interested in the settlement. I reject Mr McCall QC’s submissions as they were initially phrased.

For those reasons I will allow the appeals in all five cases.