HM Revenue & Customs v Bower (Executors of the Estate of) & Ors

Mrs Marjorie Bower, aged 90 and in poor health, bought an estate planning bond from Axa in 2002. She paid £73,000 for the bond, which she transferred to trustees on the terms of a trust. Under its terms, she was entitled to monthly payments of just over £300 in her lifetime. Although the transfer was potentially an exempt transfer for the purposes of inheritance tax, she died very shortly after taking out the bond. So the question arose: what was the value of the transfer that she made? This was to be calculated by taking the price paid for the bond and subtracting from it the value of the right to a monthly payment. The value of property for the purpose of inheritance tax is governed by section 160 of the Inheritance Tax Act 1984 which provides:

“Except as otherwise provided by this Act, the value at any time of any property shall for the purposes of this Act be the price which the property might reasonably be expected to fetch if sold in the open market at that time, but that price shall not be assumed to be reduced on the ground that the whole property is to be placed on the market at one and the same time.”

HMRC took the position that in the real world there would not have been a buyer for the right to the monthly payment given Mrs Bower’s age and state of health. So a purely nominal figure should be attributed to the value of the rights in order to give effect to the statutory hypothesis that the sale must be assumed. HMRC fixed on a figure of £250. Mrs Bower’s executors did not agree and the matter came before the Special Commissioner for determination. In his decision he came to the conclusion that the right to the monthly payment was worth £4,200. HMRC appeal. The appeal is, of course, restricted to an appeal on a point of law only.

The hypothesis laid down by section 160 of the Inheritance Tax Act 1984 is a familiar one in many areas of the law. It applies equally to the acquisition of land by compulsory purchase and to many other property rights. A general explanation of how this concept works is given by Hoffman LJ in Inland Revenue Commissioners v Gray [1994] STC 360, and in particular at 371 to 372. What the Lord Justice said was:

“The only express guidance which s 38 offers on the circumstances in which the hypothetical sale must be supposed to have taken place is that it was ‘in the open market’. But this deficiency has been amply remedied by the courts during the century since the provision first made its appearance for the purposes of estate duty in the Finance Act 1894. Certain things are necessarily entailed by the statutory hypothesis. The property must be assumed to have been capable of sale in the open market, even if in fact it was inherently unassignable or held subject to restrictions on sale. The question is what a purchaser in the open market would have paid to enjoy whatever rights attached to the property at the relevant date (see IRC v Crossman [1937] AC 26). Furthermore, the hypothesis must be applied to the property as it actually existed and not to some other property, even if in real life a vendor would have been likely to make some changes or improvements before putting it on the market (see Duke of Buccleuch v IRC [1967] 1 AC 506 at 525). To this extent, but only to this extent, the express terms of the statute may introduce an element of artificiality into the hypothesis.”

I pause there to note that in relation to IRC v Crossman what Hoffman LJ says is that the property must be assumed to have been capable of sale, i.e. there is no legal restriction which prevents its sale. He does not say that it must be assumed to have had a particular value. Hoffman LJ goes on:

“In all other respects, the theme which runs through the authorities is that we assume that the hypothetical vendor and purchaser did whatever reasonable people buying and selling such property would be likely to have done in real life. The hypothetical vendor is an anonymous but reasonable vendor, who goes about the sale as a prudent man of business, negotiating seriously without giving the impression of being either over-anxious or unduly reluctant. The hypothetical buyer is slightly less anonymous. He too is assumed to have behaved reasonably, making proper enquiries about the property and not appearing too eager to buy. But he also reflects reality in that he embodies whatever was actually the demand for that property at the relevant time. It cannot be too strongly emphasised that although the sale is hypothetical, there is nothing hypothetical about the open market in which it is supposed to have taken place. The concept of the open market involves assuming that the whole world was free to bid and then forming a view about what in those circumstances would in real life have been the best price reasonably obtainable. The practical nature of this exercise will usually mean that although in principle no one is excluded from consideration, most of the world will usually play no part in the calculation. The enquiry will often focus upon what a relatively small number of people would be likely to have paid. It may have to arrive at a figure within a range of prices which the evidence shows that various people would have been likely to pay, reflecting, for example, the fact that one person had a particular reason for paying a higher price than others but taking into account, if appropriate, the possibility that through accident or whim he might not actually have bought. The valuation is thus a retrospective exercise in probabilities, wholly derived from the real world but rarely committed to the proposition that a sale to a particular purchaser would definitely have happened.”

Mr Bretton QC for the executors stressed that part of the ruling that the hypothetical vendor and purchaser were prudent men of business negotiating seriously, but in my judgment the key point is that there is nothing hypothetical about the market in which the sale takes place. Thus, the hypothetical vendor and purchaser are serious prudent men of business of the kind who buy and sell the asset in question. If in the real world there are no speculators in the kind of asset under consideration, then in my judgment the statutory hypothesis does not require them to be invented.

In Walton v Inland Revenue Commissioners [1996] STC 68 Peter Gibson LJ also returned to the general theme. He said at page 85:

“The statute assumes a sale. That means that however improbable it is that there would ever be a sale of the property in the real world, for example because of restrictions attached to the property, nevertheless the sale must be treated as capable of being completed, the purchaser then holding the property subject to the same restrictions (see IRC v Crossman [1937] AC 26). It also means that the vendor, if he is offered the best price reasonably obtainable in the market, cannot be assumed to say that he will not sell because the price is too low as inadequately reflecting some feature of the property nor can the purchaser be assumed to say that he will not buy because the price is too high. Because the market is the open market, the whole world is to be assumed to be free to bid. But the valuer will inquire into what sort of person will be in the market for the property in question and what price the possible purchaser would be likely to pay.”

Thus, although the whole world is in theory free to bid, there must be an enquiry into who is in the market. This is an enquiry, not an assumption, and in my judgment, an enquiry is an enquiry into the facts.

The Special Commissioner accepted that in the real world the buyer of an interest like Mrs Bower’s right to a monthly income for her lifetime would either wish to lay off the mortality risk by buying back-to-back term insurance or would wish to minimise the mortality risk by pooling a number of such interests where the risks of each would have a self-cancelling effect.

In paragraph 19 of his decision he came to the conclusion that no buyer would be able to lay off the mortality risk by taking out term life assurance. That was a finding of fact which necessarily influenced the way in which the market must be assessed. So far as pooling was concerned, he dealt with that in paragraph 20 of his decision. He decided that the possibility of pooling risks by buying more than one annuity was precluded by the statutory hypothesis which required a sale of Mrs Bower’s rights alone. Thus, the Special Commissioner found that the combination of the real world and the statutory hypothesis was that those who buy interests of this type in the real world would not have bought this particular interest. As he put it in paragraph 26 of his decision:

“Whilst all of these considerations have some bearing on the valuation, it is still fair to summarise that the crucial factor in this case is the experience of Foster & Cranfield to the effect that in valuing life interests in settled property, purchasers almost invariably wish to lay off the mortality risk by taking out genuine term life assurance, and that, I accept and the Appellants accepted, will not be possible in the present case.  The key question thus is whether that means that there would be no potential buyers of the relevant annuity for any figure in excess of the nominal figure that HMRC has suggested, namely £250.”

In paragraph 27 he considered the nature of the open market. He said:

“In answering this question, I must first decide whether in any way the notion of a sale “in the open market” somehow contemplates that the sale must take place in some sort of conventional market manner, so that if sales of life interests almost always involve investors who insist on laying off the mortality risk, and thereafter make a few interest rate and discounting calculations, do I have to postulate how such investors, with those preconceptions, would approach the different proposition in the present case, without considering other possible purchasers. The answer to this, it seems to me, is that the notion of the sale being in the open market involves no such connotation. Sales of shares in private companies invariably assume a buyer just looking at the circumstances of the particular company, and not being in any particular category of buyers. It thus seems realistic in this case to say that the buyer need not necessarily be of the risk-averse category who would lay off the mortality risk, and then run fairly conventional discounting calculations, but might more appropriately be a speculator. The question then for me is whether I consider that speculators would have been tempted to buy the annuity in this case for more than £250.”

In asking whether the sale in the open market contemplates that a sale must take place in “some sort of conventional market manner”, it is not at all clear to me that the Special Commissioner appreciated that the hypothetical sale takes place in the real world. He was of course not wrong in saying that he was entitled to consider other possible purchasers, and I do not consider that the possibility of other possible purchasers is necessarily precluded. There must, of course, be an assumed buyer in order to give effect to the statutory hypothesis that the sale takes place.

But although the Special Commissioner was, in my judgment, entitled to consider possible purchasers, he was not entitled to invent them. The assumption of a buyer in order to give effect to the statutory hypothesis in addition tells you nothing about the price which the buyer is assumed to have paid. If in the real world an asset is worthless, the statutory hypothesis does not make it valuable. It is not, in my judgment, lip service to the hypothesis, as Mr Bretton argued, in those circumstances to ascribe a nominal value to an asset. On the contrary, it is the necessary consequence of a finding of fact that an asset is not commercially, as opposed to legally, saleable coupled with the assumption that a sale must be assumed to have taken place. In my judgment, therefore, Mr Ewart QC is correct in saying that at this point in his decision the Special Commissioner went wrong in law.

The Special Commissioner then went on to consider the price at which the hypothetical willing speculator would have bought the interest. Having considered and rejected the evidence of Mr Murray, the expert for the executors, he said in paragraph 34 of his decision:

“There was absolutely no debate in the hearing as to how a price to be paid by a speculator might be calculated, and in other cases I can well imagine that the parties might contend that the calculation that I am about to give could be improved.”

In paragraph 37 he described his figure as being “little more than uninformed, but hopefully realistic, guesswork”. Thus, the Special Commissioner himself acknowledged that there had been no evidence before him about how a price payable by a speculator might be calculated. Nevertheless, he went on to produce what he described as “my calculation and valuation”. The Special Commissioner’s method of calculation and valuation is not one that had been put forward by anyone and not put by him to any of the witnesses or parties for comment. This in itself was a breach of the rules of natural justice. But more important for present purposes is that it was not based on the evidence before the Special Commissioner. It flowed from the Special Commissioner’s erroneous conclusion that he was required or entitled to populate the real market in which the hypothetical sale took place with hypothetical speculators who did not share the characteristics of real buyers.

In my judgment, therefore, the decision was erroneous in point of law and I must allow the appeal.