William C McDowall v Commissioners of Inland Revenue

Introduction

We are asked to adjudicate in principle upon two sets of appeals against Notices of Determination under section 221 of the Inheritance Tax Act 1984. All the notices relate to gifts made out of the estate of the late William Crocket McDowall within seven years of his death. The gifts were said to have been made on his behalf under a Power of Attorney.

The first set of appeals raises the question whether the gifts were validly made, and, if not, what are the consequences. A separate issue arises in the second set of appeals only if the first set of appeals is determined in favour of the Appellants i.e. that the gifts were validly made or fall to be treated as validly made. That issue is whether five cash payments of £12,000 fall within section 21 of the 1984 Act (normal expenditure out of income etc).

Following sundry procedure, a Hearing took place at Edinburgh on 22^nd and 23^rd April 2003. Both sets of appeals were heard together. Colin Tyre Q.C. appeared on behalf of the Appellants in both sets of appeals and Neil Davidson Q.C. appeared on behalf of the Respondents (the “Revenue”). Both parties lodged bundles of productions and authorities together with written Notes of Argument. The Appellants’ productions included affidavits by Anna Tilsley, Robert McDowall, Judith McDowall, Andrew McDowall and Katherine McNeill, the adult children of the late Mr McDowall. The terms of these affidavits were not challenged. The authenticity and, where appropriate, the transmission and receipt of the documents contained in the bundles were not in dispute.

Facts

Discussion of Evidence

We found Mr McNeill to be a wholly credible and reliable witness. It is within our knowledge that he is a distinguished practitioner at the Bar in Scotland, well versed in Tax and Trust Law. It was obvious to us that throughout his tenure as attorney he took great care in his administration of WCM’s affairs and was scrupulously fair in his distribution of funds to members of WCM’s family. It was plain that during his period of administration he was well aware of the detail of WCM’s finances, his capital, income, and needs. He gave a great deal of thought to the matter and formed the view that the gifts he made were made out of income, and that he was reinstituting the pattern of making gifts which WCM had adopted before he granted the Power of Attorney. We attach considerable weight to these views, and cannot reject them lightly.

With reference to finding-in-fact 12, we have noted Mr McNeill as stating in his examination in chief, with reference to the five payments of £12,000 that he intended these to be the last large gifts; and that thereafter there would be small gifts at birthdays and Christmas. At a later stage in his evidence he stated that if income was left over he would have divided it five ways, though leaving a balance for contingencies; and that he would have continued to monitor income building up. In cross, he accepted that, in the past, the larger gifts made by WCM had been sporadic and for a particular purpose. He was not asked about the £12,000 payments in cross; he was not re-examined. Although it is not entirely clear, we think that the thrust of Mr McNeill’s evidence was that he did not intend to let WCM’s surplus income build up again as it had done in the past, and that when he was completely satisfied that there was a substantial excess of income over expenditure, he would distribute this excess or a substantial part of it among WCM’s five children, although he did not think that these distributions would be as large as the payments of £12,000.

We should also record that we have incorporated the parties’ Statement of Agreed Facts into our own factual findings. Mr Tyre proposed a number of additional findings of fact. Most of these were not challenged and we have taken account of these in our narrative of the facts.

Submissions

Mr Tyre submitted that whether the gifts were validly made did not matter because they were reducible and not void as WCM could have ratified them. He cited Alexander Ward & Co Ltd v Samyang Navigation Co Ltd 1975 SC(HL) 26 at 47, 51-52, Callendar v Callendar 1975 SC 183 at 191,195, 201,205 and 210, Colquhoun’s Trs. v Marchioness of Lorne’s Tr. 1990 SLT 34, Morgan Guaranty Trust Co v Lothian Regional Council 1995 SLT299 at 304K and 309C and General Property Investment Co Ltd v Matheson’s Trs 1888 16R 282 at 290. As they had not been reduced, and it was no longer open, due to the elapse of more than five years, to challenge the validity of the gifts, they must therefore be regarded as validly made. The subject matter of the gifts had become part of the estates of the donees. They were not part of WCM’s estate. He also relied on section 150 of the 1984 Act. If it were necessary to consider the validity of the gifts, then the Power of Attorney, clause 11, properly construed in the light of the non commercial factual background, gave the attorneys power to make gifts. He referred us to Reardon Smith Line Ltd v Yngvar Hansen-Tangen 1976 1 WLR 989 at 997 C, Investors Compensation Scheme Ltd v West Bromwich BS 1998 1 WLR 896 at 912H, Reckitt v Barnett Pembroke & Slater Ltd 1929 AC 176 at 182, Bryant Powis & Bryant v La Banque du Peuple 1893 AC 170 at 177D’s Curator Bonis, Noter 1998 SLT 2 at 4K-5B, IRC v McMillan’s CB 1956 SC 142 (some of these authorities were on Mr Davidson’s list and Mr Tyre referred us to them to distinguish them)and Burn’s CB v Burns’ Trs 1961 SLT 166. He submitted that there was an analogy between the powers of a curator bonis and the powers of attorney. Bryant was not or was no longer good law. The five cash gifts fell within section 21 of the 1984 Act. He adopted the analysis of Lightman J in Bennet v IRC 1995 STC 54. The evidence disclosed an established pattern of gifts out of income for many years. Finally, Mr Tyre reminded us that when WCM became incapable of managing his own affairs, the Power of Attorney continued to have effect by reason of section 71 of the Law Reform (Miscellaneous Provisions) (Scotland) Act 1990.

Mr Davidson, on behalf of the Revenue, submitted that a Power of Attorney should be strictly construed. He referred us to Reckitt in the Court of Appeal 1928 2 KB 244 at 268 and 269 as well as the House of Lords Report at 183 and 195, Bryant at 177, Bowstead on Agency 17^th Edition at section 3.010, and to BCCI v Ali 2001 1 AER 961 at 975, Bank of Scotland v Dunedin Property Investment Co Ltd 1998 SC 657. There was no express provision for gifts. The eiusdem generis rule should be applied; there was thus no basis for reading into the words otherwise deal a power to make gifts however large or small. The Power of Attorney read as a whole was concerned with the deceased’s normal business affairs, not his whole affairs. The gifts made by the attorneys were all invalid and therefore immediately before his death WCM had an unanswerable claim for repayment of all the gifts. Such a right was part of WCM’s property to which he was beneficially entitled immediately before his death -1984 Act section 5(1) and section 272. It did not matter that nobody had actually challenged or would challenge the gifts. Moreover, the Appellants had not discharged the onus of establishing a settled pattern of large gifts to bring the five gifts of £12000 within section 21 of the 1984 Act. Making gifts at Christmas and birthdays was something most people did. The analysis of section 21 in the 1984 Act in Bennett was accepted. However, the larger gifts had no pattern but were sporadic and always had some special event or transaction as the underlying basis for making the gift.

Decision

Proper Construction of the Power of Attorney.

In our opinion, a power of attorney falls to be strictly construed (Reckitt at 1928 2KB 269) This is presumably because the powers delegated by the principal are assumed to be no greater than necessary for his purposes, and that the powers a principal needs to grant will be the subject of express statement or necessary implication. Reckitt concerned the question whether a power of attorney included a power to draw cheques on the principal’s bank account in order to pay his own debts. The Court of Appeal by a majority, Russell J dissenting, held that it did having regard to the terms of a letter written by the principal to his bankers. The House of Lords reversed the decision and adopted the reasoning of Russell J (see 1929 AC at pages 183, and 195). In the course of his judgement, Russell J said that the primary object of a power of attorney is to enable the attorney to act in the management of his principal’s affairs. An attorney cannot in the absence of a clear power to do so, make presents to himself or to others of his principal’s property (at 268). These words are echoed in Hamilton v Dixon 1873 1R 72, (a case with somewhat unusual facts concerning an alleged obligation to deliver pig iron) where at page 78 Lord Justice Clerk Moncrieff observed that it was too plain to require argument that in order to authorise an agent to give away his employer’s goods without consideration, direct and immediate sanction to the individual transaction would be necessary. Russell J was of the view that powers of attorney are to be construed strictly citing Bryant and went on to observe that where authority to do an act purporting to be done under a power of attorney is challenged, it is necessary to show that on a fair construction of the whole instrument the authority in question is to be found within the four corners of the instrument either in express terms or by necessary implication (at 269). Bryant was a decision of the Privy Council on appeal from the Canadian Courts. The advice of the Board was delivered by Lord Macnaghten. The context of the case was commercial and the details of the facts are not important for present purposes. His Lordship noted, at page 177, that it was not disputed that powers of attorney are to be construed strictly. Bowstead on Agency 17^th Edition 2001, states at paragraph 3-010 that powers of attorney are construed strictly citing Bryant. It is also there stated that where authority is given to do particular acts, followed by general words, the general words are restricted to what is necessary for the proper performance of the particular acts; and that General words do not confer general powers, but are limited to the purpose for which the authority is given, and are construed as enlarging the special powers only when necessary for that purpose. The words otherwise deal are general words which follow the granting of authority to buy lease or sell. At paragraph 3-011 it is noted that although well established, the rule of strict construction is inconsistent with the doctrine of apparent authority. However, the point is made that in non-commercial situations such as absence abroad or illness or debility, it may be right to place a duty of inquiry on the third party. No Scottish authority was cited to us to show that Scots law has taken a different approach to construction of deeds granting powers of attorney and we therefore proceed on the basis that Scots and English law are at one on this topic. We do not consider that Lord Hoffman (in Investors Compensation Scheme Ltd), or Lord Wilberforce (in Reardon Smith Line) had deeds granting powers of attorney in mind when laying down guiding principles for the proper construction of contracts.

Each power of attorney will be framed to meet the particular needs of the principal’s circumstances. Many clauses may be common to most powers of attorney. The only words in clause 11 relied upon are and otherwise deal with. The list of powers in this clause contains the words buy, lease and sell. Applying the eiusdem generis rule would exclude gifts. In any event, we consider it difficult to construe a gift making power out of the word deal which to us connotes an arm’s length activity. This seems to us to be entirely consistent with every other power which generally deals with what might be described as an individual’s business affairs. Clause 2 of the Schedule gives the attorney power to execute and deliver deeds and documents. Could it be said that this unqualified clause confers gift making powers? The argument seems to us to be no weaker than the clause 11 argument. There is here no express power within the four corners of the deed authorising the attorneys to make gifts. It is not necessary to imply such a power. If a general power to make gifts can be implied, it must follow that the power would be wide enough to make a gift of any value to any person including the attorney. Implying a more restricted power raises all sorts of difficulties such as the class of donee e.g. members of WCM’s family, the nurses looking after him at the Nursing Home, close friends etc, and the amount; should the amount be restricted in some way and if so how; should it be restricted to a specific amount such as £12,000, or the excess of annual income over expenditure from time to time? We find it impossible to imply anything of this sort into Clause 11 of the Schedule of Powers.

In our view, whether reading these clauses in isolation or in the context of the whole deed, neither clause by necessary implication confers gift making powers on the attorney. It would have been very easy expressly to confer gift making power on the attorneys e.g. to make gifts up to a specific amount for tax planning purposes to members of WCM’s family. Moreover, it does not assist the Appellants’ case to distinguish the authorities on the construction of powers of attorney by reference to their commercial context. As Bowstead has, in effect, pointed out, in a non commercial context it is less important to protect the donee than a third party transacting with the attorney in good faith and for value.

Even if a more benign construction were to be adopted having regard to all the background circumstances which would reasonably have been known at the time the Power of Attorney was granted, we do not consider that this enables us to construe a gift making power out of Clause 11. In particular, it must be remembered that when the Power of Attorney was granted Mrs McDowall became the attorney. The cheque and deposit accounts were already in the joint names of WCM and his wife. She could, quite independently of the Power of Attorney, transfer funds between the accounts and make gifts to family members by drawing cheques on the current account. There was therefore no obvious need in 1993 when the Power of Attorney was executed to give the attorney gift making powers. The fact that in the past WCM had made regular birthday and Christmas gifts to members of his family and larger gifts where there was some underlying need or reason does not persuade us that he intended to confer on his attorneys unlimited power to make gifts out of his estate of unlimited amounts, to an indeterminate class including the attorney, under any circumstances. In our view, therefore, all the gifts listed in the Schedule to the Inventory of WCM’s estate (A/2) made by his attorneys were ultra vires.

We should add that we did not find the analogy drawn between agency and curatory to be helpful for present purposes. We are quite prepared to accept Lord Nimmo Smith’s careful analysis in D’s Curator Bonis based upon dicta in earlier cases such as McMillan’s CB and Burn’s CB which were also cited to us. However, in D’s Curator Bonis, Lord Nimmo Smith granted special power to the Noter to enter into a tax planning arrangement by making gifts to relatives of the ward. This was a special power which the curator bonis would not otherwise possess. The significance of these cases might have been different had the Court refused the Note as unnecessary.

Consequences of Invalidity

Mr Tyre argues that if the attorneys had no power to make the gifts, they were reducible and not void. We agree. As Mr Tyre submitted, by asking whether the principal could have ratified the invalid act of the attorney, it can be determined whether the gifts were void ab initio or voidable. In the present circumstances, WCM could competently have ratified the making of the gifts had he been capable of doing so. The act of the attorney or agent is void if the principal could not validly perform the act or carry out the transaction himself. Here, there is no doubt that it would have been within the power of WCM to make the gifts which the attorneys made. The making of the gifts cannot be void transactions but voidable ones. The authorities cited by Mr Tyre, namely Ward, Callendar, Colquhoun,Morgan and General Property, support this conclusion.

The position therefore is that, immediately before his death, WCM had the right to recover these gifts because they were made by his attorneys acting outwith their powers. Tax is charged on the death of any person as if, immediately before his death, he had made a transfer of value and the value transferred by it had been equal to the value of his estate immediately before his death (1984 Act section 4(1)). A person’s estate is the aggregate of all the property to which he is beneficially entitled (section 5(1)). Property includes rights and interests of any description (section 272). WCM’s right to recover these gifts was part of the property to which he was beneficially entitled immediately before his death. That right had not prescribed immediately before his death, and the fact that no steps have been taken by the executors to recover these gifts within the ensuing five years seems to us to be irrelevant. We can, in any event, envisage difficulties over the operation of prescription as there may be persons interested in the residue of the estate who have not yet reached the age of full legal capacity. WCM’s Trust Disposition and Settlement was not before us but it is a real possibility that part of the estate was left to grandchildren who would have an interest to challenge the gifts. There was some general evidence from Mr McNeill that there were grandchildren who were still relatively young, although we have not found it necessary to make a finding-in-fact about the matter.

What then was the value of this right? Mr Tyre submits that the right has no value because it plainly would never have been exercised by WCM and has not been exercised by the executors. We cannot accept that argument. It is rather like saying that a vintage motor car owned by a deceased has no value for inheritance tax purposes because the deceased would never have sold it as it had sentimental value; or that a loan granted by the deceased and outstanding at his death, should have no value for Inheritance Tax purposes as it would not have been called up by the deceased because it was made by him to an old friend. Valuation of a deceased’s assets does not depend upon what he might have chosen to do with them. We agree with Mr Davidson that immediately before his death WCM had an unanswerable claim to recover the gifts specified in the Schedule to the Inventory of WCM’s estate. That being so, the value of WCM’s claim for recovery of the gifts must equal the value of the gifts themselves. Section 150 of the 1984 Act does not assist the Appellants. That section essentially deals with any chargeable transfer which the taxpayer claims has been set aside as void. It enables tax paid to be repaid. It is not concerned with the value of the right to have a transaction set aside.

In these circumstances, both sets of appeals fall to be rejected and it is not necessary to deal with the separate argument advanced in relation to the second set of appeals. However, lest we be wrong to reject the first set of appeals, we shall give our views on the merits of the second set of appeals as follows.

Section 21 of the 1984 Act (Normal expenditure out of income etc)

For the avoidance of doubt, we confirm that our findings-in-fact apply to both sets of appeals. We refer, in particular, to finding-in-fact 12 above. Section 21(1) provides as follows:-

“Normal expenditure out of income

and

and

Mr Tyre submitted that when money was transferred from the current account to the deposit account, it retained its character as income. Mr Davidson submitted that it lost its character as income. Neither counsel was able to produce authority to support their respective arguments on how income retains or loses its character as income. Both counsel referred us to some of the bank statements relating to the Chequeplus Account and the Premier Investment Account (R/2-5)to support their respective contentions. These bank statements were not, however, analysed in detail in evidence or submissions. It appears to us, from our own consideration of these statements, that (i) between about August 1993 and January 1995, the amounts paid into the current account each month substantially exceeded the amounts withdrawn therefrom; all income, which was principally WCM’s monthly pension and some share dividends, appeared to be paid into the current account; (ii) during that period, the credit balance gradually increased from about £25,235 to £64,572; (iii) in January 1995, £60,000 was transferred from the current account to the deposit account; the balance in the deposit account increased from £30,043 in July 1993 to £35,788 in January 1995, due solely to the accrual of interest, and, with the addition of the £60,000, amounted to £95,788; various withdrawals and transfers back to the current account took place during that month; (iv) over the ensuing few months, sums of between £3,000 and £5,000 were regularly transferred from the current to the deposit account; (v) by March/April 1996 the current account balance varied between about £2,900 and £7,566; (vi) by the beginning of May 1996, the deposit account balance had increased to just over £106,000; (vii) between June and August 1996, various inter account transfers took place, which enabled some £30,000 to be paid out of the current account to family members, leaving the current account with a credit balance at the end of August of some £6,455 and the deposit account with a balance of £99,127; part of the deposit account balance had been enhanced by a payment in August 1996 by Drysdale Anderson of £18,000 which was lodged in the current account and immediately transferred to the deposit account; (viii) by the end of the year the current account balance was £5,448 and the deposit account stood at £102,639, (ix) on 3/1/97, £75,000 was transferred from the deposit to the current account; this was presumably, in part, to enable the five payments of £12,000 to be made; these were made from the current account between January and March 1997. In May 1997 a further £75,000 was transferred from the deposit account to the current account; and a payment of £15,000 was made to each of the five children of WCM. The source of that sum of £75,000 or at least £69,297 of it was the, or the balance of the, net free proceeds of the estate of Margery McDowall paid into the deposit account on 13/5/97 by the solicitors winding up her estate. It is accepted by the Appellants that these payments of £15,000 came out of capital. Whether the Appellants were correct to concede that all of the £75,000 was paid out of capital we need not dwell upon. It can be seen from our analysis that the source of the five payments of £12,000 was in large measure the income paid into the current account and transferred to the deposit account from time to time, where interest accrued thereon.

Our inclination is to conclude that the payments were made out of retained income which remained income in character rather than capital; it was identifiably money which was essentially unspent income and which had been placed on deposit, but not invested in any more formal sense. Mr McNeill had carefully considered matters at the time and took the view that the five payments were being made out of accrued income. It seems to us that that is a reasonable and justifiable view in the circumstances and one which we are prepared to accept. Section 21(1)(b) is therefore satisfied.

We have already made a finding-in-fact which satisfies the requirements of section 21(1)(c); there was no dispute about this. This leaves section 21(1)(a).

In Bennett, (which was concerned only with section 21(1)(a)), trustees were instructed by the life tenant under the trust to distribute the trust income equally among her three sons insofar as it was surplus to her financial requirements. Delays occurred in determining the surplus available for distribution which limited the distributions made before the life tenant’s death. The trust income varied from year to year as did the amounts distributed to the sons. Mr Justice Lightman, sitting in the Chancery Division of the High Court, observed that there was no authority on the meaning of section 21. He considered that “normal expenditure” connotes expenditure which at the time it took place accorded with the settled pattern of expenditure adopted by the transferor (at 58g). He gave as examples of such a settled pattern a payment each year of 20% of all income to charity, or the assumption of a commitment regarding future expenditure, such as a deed of covenant, or supporting aged parents; there was no fixed minimum period over which the expenditure should occur (58h-j); a single payment might be sufficient if the prior commitment could be shown. It must be established that the pattern was intended to remain in place for more than a nominal period and for a sufficient period (barring unforeseen circumstances) in order for any payment fairly to be regarded as a regular feature of the transferor’s annual expenditure. The amount of the expenditure need not be fixed nor need the individual recipient be the same; a formula would suffice (59b). He concluded that the evidence should manifest the substantial conformity of each payment with an established pattern of expenditure by the individual concerned (59d). On the facts of the case before him, he concluded that the life tenant did adopt a pattern of expenditure in respect of surplus and the payments to the sons were in accordance with that pattern and were accordingly part of her normal expenditure within the meaning of section 21. In Bennett, Lightman J held that the life tenant made a considered determination to give all her surplus income from the trust beyond what she reasonably required for maintenance to her sons; this was implemented; a pattern was thus adopted in respect of surplus income; the payments were part of her normal expenditure within the meaning of section 21.

Both parties accepted the guidance given by Lightman J in Bennett. In our view, the pattern of payment of small gifts at birthdays and Christmas is readily distinguishable from the larger payments of £12,000 and can provide no support for establishing a pattern of payment of larger sums; nor do we consider the deceased’s habit of making gifts, including those disguised as loans, on sporadic occasions of need can help the Appellants. However, we consider that the evidence is just sufficient to enable us to conclude that Mr McNeill, as attorney, made a commitment regarding future expenditure, namely to distribute a substantial part of the excess of WCM’s income over the amount required for his maintenance (making due allowance for unforeseen circumstances) equally among WCM’s five children. The payments of £12,000 to each of the five children in 1997 demonstrated that the commitment was being implemented, and we are satisfied from his evidence that, but for WCM’s death, Mr McNeill would have continued to make similar, even if much smaller, payments. The payments in issue were particularly substantial because of the build up of excess income in previous years. The intention to make regular payments, as described and explained by Lightman J, has thus been established. The settled pattern referred to by Lightman J has been established by the prior commitment. There may not have been a clear formula, as Lightman J suggested, but in Bennett itself the arrangement was no more formally prescribed than to pay out the surplus of income over expenditure, as Mr McNeill intended here. We therefore conclude that had Mr McNeill been acting within his powers under the Power of Attorney, when he made these five payments of £12,000 they would have fallen within section 21(1). However, the second set of appeals must also be rejected for the same reasons which give rise to the failure of the first set of appeals.

As these are decisions in principle, we shall not finally determine the appeals meantime but continue them for four weeks to enable parties to make procedural representations as to the final disposal of the appeals.

Summary

J GORDON REID QC, FCIArb

COLIN BISHOPP

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SC 3135/2001