Smith & Ors v HM Revenue & Customs

This is an appeal from a decision (“the Decision”) of the Special Commissioners Nicholas Aleksander (“the SC”) dated the 29^th March 2007. By the Decision the SC dismissed appeals by the appellants Ms Amanda Smith, Mr Andrew Smith, Mr Mark Smith and Mr Duncan Godfrey (“the Appellants”) against four notices of determination each dated the 10^th July 2006. The Notices of Determination determined that the issue of three policies of life assurance to the father of the first, second and third Appellants, Professor Sir John Smith (“Sir John”) at the same time as the purchase by him of three annuities and the vesting of those policies in the first, second and third Appellants should be treated as a transfer of value by Sir John for inheritance tax purposes.

The Decision provides a careful and expert analysis of the relevant facts and law and the appeal is properly confined to very limited issues. In the circumstances I do not propose to repeat what appears in the Decision or go further in my examination of the law and facts than is necessary to determine the limited issues before me. The Decision provides the backcloth to this judgment.

The first, second and third of the Appellants are the children of Sir John and his wife Lady Shirley Smith (“Lady Smith”). The fourth Appellant is a co-executor of Sir John’s estate. Sir John and Lady Smith took out three annuities and three policies of life assurance in October 1996. The annuities and policies were issued by the Equitable Life Assurance Society (“the Equitable”) as part of investment plans called the Equitable Investment Plan With Profits (“the Plan”). Both died within seven years of doing so, Lady Smith on the 23^rd October 2000 and Sir John on the 14^th February 2003. The appeal concerns Sir John’s estate and the issue is whether these arrangements constitute a transfer of value by him to his children for inheritance tax purposes.

The stated objective of the Plan was “to achieve capital growth over a selected period of years in a sound and tax efficient way from the investment of a lump sum”. The lump sum was to be applied as follows:

“A temporary annuity and an endowment assurance are effected. The sum invested is used to meet the first annual premium for the endowment insurance and to purchase the temporary annuity, which turns your capital into income on an attractive basis. That income is designed to provide the remaining premiums for the endowment assurance policy, which converts the income back into capital.”

The couple had ₤100,000 to invest, ₤33,333 in each Plan. Each of the three annuities was purchased for ₤29,126. In each case, this left ₤4,207 which was used to cover the first annual premium payment for each of the three endowment assurance policies. The illustration issued by the Equitable shows that the annuities each had a likely net income per annum of ₤4,207.66. This sum (less 66p) was intended to be used to pay the annual premium for each endowment policy.

The ‘proposal’ (effectively the application form) for the Plan completed by the couple on the 10th October 1996 identified Sir John and Lady Smith as the lives assured and contained the details of the annuity that they were purchasing and of the proposed assurance policy. In section D of this form there were some general ‘yes/no’ questions for the lives assured to answer as to their medical history in the preceding 3 years. On the same day, a Medical Evidence Questionnaire was completed by each of them answering the same questions and a couple of supplementary questions relating to cigarette and alcohol consumption and hazardous occupations.

Prior to issuing the annuities and life policies, the Equitable required Sir John to undergo a medical examination with his GP. No such requirement was made of Lady Smith. The policies and annuities were issued on the 8^th November 1996.

The Equitable has stated in correspondence in 2003 and 2004 that the life policies would have been issued on the same terms had the annuities not been purchased.

The benefit of the policies was vested in the 1^st to 3^rd Appellants.

References in this judgment to sections are to sections of the Inheritance Tax Act 1984. Section 263 specifically relates to the situation where an annuity is purchased in conjunction with a life policy and the benefit of the life policy is vested in a person other than the person purchasing the annuity, and provides that:

“unless it is shown that the purchase of the annuity and the making of the insurance were not associated operations, the person who purchased the annuity shall be treated as having made a transfer of value by a disposition made at the time the benefit of the policy became so vested”

The onus is therefore on the taxpayer to prove on the balance of probabilities that the two actions were not associated operations. The term ‘associated operations’ is defined by section 268(1). The parties agree that the facts do not fall within the wording of 268(1)(a). This leaves section 268(1)(b) which provides that operations are associated where there are:

“(b)

any two operations of which one is effected with reference to the other, or with a view to enabling the other to be effected or facilitating its being effected.”

The question to be determined therefore is whether the two operations (the purchase of the annuity and the purchase of the life insurance) were made (i) by reference to one another; (ii) with a view to enabling the other to be effected; or (iii) with a view to facilitating the other being effected.

HMRC issued a Statement of Practice E4 to provide guidance as to how it would interpret section 263. Statement of Practice E4 provides that:

“Life assurance policies and annuities are regarded as not being affected by the associated operations rule if,

first, the policy was issued on full medical evidence of the assured’s health and,

second, it would have been issued on the same terms if the annuity had not been bought.”

The Equitable has provided confirmation of the second limb of this test which HMRC has accepted.

This appeal is brought under section 225, which provides:

“Any party to an appeal, if dissatisfied in point of law with the determination of that appeal by the Special Commissioners, may appeal against that determination to the High Court.

The High Court shall hear and determine any question of law arising on an appeal under subsection (1) above and may reverse, affirm or vary the determination appealed against, or remit the matter to the Special Commissioners with the court’s opinion on it, or make such order in relation to the matter as the court thinks fit.”

Appeal is therefore only permitted from a decision of the SC if it is an appeal on a point of law.

The role of the court on appeal from the SC is therefore not to give a second opinion as to the issue under determination but to determine whether the SC properly directed himself as to the law in deciding it. Where the subject of the appeal is a question of fact (such as: does the information obtained by the Equitable in respect of Lady Smith constitute ‘full medical evidence’?), the conclusion of the SC is decisive unless it can be shown on appeal that the only reasonable conclusion contradicts the conclusion reached. Unless it can be shown that the SC has come to a conclusion on the facts that no reasonable person could arrive at, the SC’s conclusion must stand. Where this issue is one of fact, the question for the court will be as follows: are the facts found such that no person acting judicially and properly instructed as to the relevant law could have come to the determination under appeal?

The SC held that the life policies and annuities were operations effected with reference to one another and that the annuities were effected with a view to facilitating the insurance policies. The Appellants therefore had failed to satisfy section 268(1)(b).

Although the SC did not find that the Statement of Practice E4 had the status of law or was binding, HMRC had agreed to be bound by it for the purposes of the appeal before the SC. It was accordingly necessary for the SC to decide the meaning of the term used. The SC decided that the term should be interpreted according to the normal and dictionary meaning of ‘full medical evidence’ and not (as the Appellants contended) by reference to the level of medical history disclosure that might be required by the reasonable and prudent insurer. The SC agreed with HMRC that the answers to the questions on Lady Smith’s Medical Evidence Questionnaire “would not give the Equitable a complete picture of the assured’s health at the time of underwriting”. On this basis he concluded that the Equitable did not obtain full medical evidence as it was required to do to satisfy SP E4.

The second Appellant Mr Mark Smith is a practising barrister and, whilst acting in person, represented both himself and the other appellants. He proved his abilities in his skeleton argument and his oral submissions as well as his good judgment in confining the issues on the appeal to the construction and legal effect of the Revenue Statement of Practice E4.

The Revenue accepts that the provisions of the Statement of Practice are binding on them for the purposes of the claim to inheritance tax. The statement provides that life insurance policies and annuities are not to be treated as affected by the associated operations rule if(1) the policy was issued on (or after or subject to) the provision of “full medical evidence” of the assured’s health; and (2) would have been issued on the same terms if the annuity had not been bought.

What is to be borne in mind in construing the Statement is the evident objective of providing an effective means of protecting the Revenue from efforts made to avoid payment of inheritance tax by means of associated transactions in the form of life assurance policies and annuities. This is achieved by requiring that the life policy must be issued on the basis of the provision to the insurer of full medical evidence of the assured’s health. It is not sufficient that it is issued on the basis of information required by the questionnaire and provided by Lady Smith. The contention to the contrary is not maintainable for two reasons. The first is that the criterion for non-disclosure is the safeguarding not of the interests of the insurance company, but of the interests of the Revenue. The second is that the language used goes beyond what the insurance company requires: it spells out the need for “full” medical evidence.

In the circumstances the SC was plainly entitled to hold that the answers to the insurance company’s questionnaire given by Lady Smith did not provide “full medical evidence”. The answers may have provided sufficient medical evidence to the insurance company for its purposes, being the sale of the policy and the annuity, but not sufficient for the purpose of protecting the Revenue. Indeed, not merely was the SC entitled so to hold, but on the material before him the SC was practically bound to reach this conclusion. The say so of the lay patient in answer to the questionnaire provided only a partial and imperfect picture of her health.

Mr Smith argued that the term “full medical evidence” means only the evidence which the insurance company for its own protection in the ordinary course of its insurance business requires to be provided by those applying for insurance. But in my judgment what was sufficient to justify Equitable’s decision to underwrite the annuity and life insurance policy was not, and did not need to be, the full medical evidence required by the Statement to safeguard the Revenue.

In view of the contrary submission of Mr Smith I should underline the fact that there is no inconsistency between my construction of the words “full medical evidence” in the first part of the Statement and the provisions of the second part that the policy must be one which would have been issued “on the same terms” if the annuity had not been bought. Whilst the first part requires that the policy was issued on full medical evidence, the second part requires that that policy (i.e. the policy issued on full medical evidence) is one which would have been issued on the same terms if the annuity had not been bought.

Mr Smith as a second string to his bow contends that, if the meaning of the words “full medical evidence” goes beyond that which the insurer[s] requires for the purposes of determining whether to issue the policy, the ambit of its meaning is uncertain and its application is unworkable.

I fully accept that the formula is wide and clearly designed to embrace a wide category of situation. But I do not see how that assists the Appellants. The formula is perfectly capable of application. What will constitute full medical evidence must depend on the circumstances of the particular case. I suspect that in the great majority of cases a report from the applicant’s medical practitioner familiar with his health record will be called for. On occasion, there may be need for a specialist. There may be exceptional cases when medical evidence can be dispensed with. I have no doubt that the Revenue, the Commissioners and the court can determine without appreciable difficulty in any particular case what is called for and whether what is provided to the insurance company is sufficient. If (contrary to my view) the term were too uncertain to provide a criterion, the Statement (and the concession therein contained) would be devoid of legal effect. In that situation there could be no arguable answer to the claim made by the Revenue.

I therefore dismiss this appeal.