The Dangers of Schemes

The Court considers an application for judicial review regarding an order to produce documents and an unsuccessful application for an inter partes hearing in R (on the application of Morgan Grenfell and Co Ltd) v Special Commissioner of Income Tax

Morgan Grenfell, the well-known merchant bank, devised and operated a tax related scheme which was designed to enable clients to secure extremely low-cost term funding through a tax arbitrage based on property. The Inland Revenue sought to investigate aspects of the scheme and sought documents under section 20(1), Taxes Management Act 1970. These documents included the bank's instructions to and advice received from counsel. The Revenue applied for consent from a Special Commissioner, who received written submissions from the bank, but nevertheless consented to the issuing of the section 20(1) notice. On application for judicial review, the court held against the bank on various grounds. These included the legal professional privilege issue, the failure of the Special Commissioner to agree to an inter partes hearing and the possibility of application of human rights legislation. The application for judicial review was dismissed.

The background and facts

Morgan Grenfell had devised a complicated tax avoidance scheme which it marketed to its clients. Under the scheme the bank's client granted a long lease in a property already owned to the bank who granted a sublease back. The lump sum obtained from the grant was amortised through rental payments made by the client under the sublease. The client received the premium for the long lease as a capital receipt (usually with the shelter of existing capital losses being available) and obtained a deduction for the rental payments which repaid both principal and interest. The bank sought to achieve protection from tax charges by treating the premium it paid for the lease as a trading payment or expense – not as a capital asset.

The matter was discussed with an Inspector of Taxes who expressed concern about the treatment and the premium in the hands of the bank. In order to investigate further he sought to obtain the authorisation from a Special Commissioner to issue a notice under section 20(1), Taxes Management Act 1970. The documents specified included the bank's instructions to and advice received from counsel.

The bank made substantial written submissions to the Special Commissioner objecting to disclosure of documents subject to the protection of legal professional privilege. However, the Commissioner consented to the issuing of the notice. He held that he had no jurisdiction under section 20(7), Taxes Management Act 1970 to permit the bank to attend the consent application and make representations.

Accordingly, the bank applied for judicial review, contending that (i) section 20(1) did not authorise an Inspector to require disclosure of material subject to legal professional privilege and invasion of such confidential material breached its rights under Article 8(1) of the Convention of the Protection of Human Rights and Fundamental Reforms 1950 and could not be justified under Article 8(2) of the Convention; (ii) that the general principle required the application of the rule of audi alteram partem including an oral hearing to the decision of the Commissioner required under section 20(7); and (iii) that the requirement of the Inspector was unreasonable since the circumstances and the terms of the scheme were apparent from the documents already held by him.

(Michael Beloff QC and Giles Goodfellow for Morgan Grenfell; Timothy Brennan and Ingrid Simler for the Crown.)

The Divisional Court judgment

The matter was heard over three days by Lord Justice Buxton and Mr Justice Penry-Davey. Lord Justice Buxton delivered the judgment of the Court, which initially dealt with the background to the case and brief details of the tax related scheme which was called 'Sale With Tax Enhanced Leasing Arbitrage' (STELA). The point at issue with the Inland Revenue was the tax treatment of the premium paid by the bank, which it contended was not a capital sum but a trading payment or expense.

The judges then went on to consider the provisions of the Taxes Management Act 1970 and the general legal provisions regarding legal professional privilege. In this respect quotations were made from a number of cases.

The Court went on to consider the principle of legality and necessary implication. Although neither of the parties was able to offer a definition of this term, counsel for the bank argued that the Court was assisted in this regard by the speeches in the House of Lords in B (a minor) v Director of Public Prosecutions [2000] 2 WLR 452.

Lord Justice Buxton considered that case in detail but it transpired that the Inland Revenue was arguing that the present case needed to be distinguished from B v The Director of Prosecutions.

The judge referred to the current changes in the law which had introduced section 20BA, Taxes Management Act 1970 by section 150, Finance Act 2000. Paragraph 5 of Schedule 1AA to the Taxes Management Act 1970 provides that the provisions of section 20BA do not apply to 'items subject to legal privilege'. Paragraph 5 then proceeds to define the latter concept in some detail but, so far as the judges could see, entirely consistently with the common law definition of legal professional privilege. Lord Justice Buxton found it difficult or impossible to understand why these specific provisions were included in the code, unless the code itself did not recognise the common law rule of legal professional privilege.

Lord Justice Buxton observed that if it were thought necessary to give a special reminder of the importance of legal professional privilege in some particular case or cases, that might be thought more appropriate in a case such as the present, and rising under section 20(1), Taxes Management Act 1970 where no fraud was alleged or suspected.

Accordingly, the Court was driven to conclude that the provisions of the Taxes Management Act 1970 taken as a whole demonstrated a premise that the rule of legal professional privilege is excluded from them save where it is expressly incorporated. Therefore it is a necessary implication that arguments based on legal professional privilege cannot be used to resist an application for disclosure under section 20(1), Taxes Management Act 1970.

The Inland Revenue had, in any case, argued that the Court was bound to reach such a conclusion because of the Court of Appeal judgment in R v Commissioners of Inland Reveue ex parte Taylor (No 2) [1990] STC 379. While the Court was unable to act on Taylor in the terms urged on it by the Revenue, the approach and conclusions of the Court of Appeal in that case were wholly consistent when the conclusion had the construction of the Taxes Management Act 1970 that the Court had reached on other grounds in the current case.

Lord Justice Buxton then went on to consider Article 8 of the Convention for the Protection of Human Rights and Fundamental Reforms 1950. The bank had argued that it was at least materially assisted by the provisions as to private life contained in that Article. Invasion of confidential material, such as the advice of a lawyer, was a breach of the client's rights under Article 8(1) and therefore had to be justified under Article 8(2).

While the Court accepted the fact that interference by the state with material potentially engages Article 8, the judges saw nothing either in authority or in principle to lead them to think that the convention jurisprudence would forbid that interference when it was exercised for the reasons and on the legal grounds that existed in the present case; in particular it had to bear in mind that the material was subject to such stringent protection in national law.

The Court then went on to consider the contention by the bank that the Special Commissioners had refused to entertain an inter partes hearing. Both parties had substantial arguments on this issue, but Lord Justice Buxton stated that the judges were not persuaded that they were cogent reasons why the requirements of natural justice entailed the reading into section 20(7), Taxes Management Act 1970 of a jurisdiction to order an oral hearing, as opposed to giving the taxpayer opportunity to make ex parte submissions.

Finally, the Court went on to consider the Inspector's 'reasonable opinion', and the Commissioner's consent. In the view of the judge, unless the bank could demonstrate that the condition precedent to the decision of the Commissioner (that the Inspector held the reasonable opinion that the material subject to legal professional privilege contained or might contain information relevant to the bank's tax affairs) was not fulfilled, then there was no ground on which the Commissioner's decision could be challenged sensibly in public law.

The real complaint of the bank was not that the information was not potentially irrelevant to its tax liability, but that in the circumstances of the disclosed information it was unreasonable, and excessively disproportionate for the Inspector to seek the information and for the Commissioner to give consent to its being sought.

However, the Court held that none of the contentions put forward could be sustained. The decisions made were for the Inspector and the Commissioner to make, and the Court would only intervene if either of those parties had erred in public law. In the view of Lord Justice Buxton, there were sufficient features of the tax related transaction to attract the notice of the Inspector to make it impossible to argue, simply on the basis of the disclosed information, that it was unreasonable to investigate further.

The decision

The Court dismissed the applications made in their entirety.

(Reported at [2000] STC 965.)

Commentary by John T Newth FCA, FTII, FIIT, ATT

This case is the latest in a series of applications for judicial review in connection with the requirement to produce documents and information to the Inland Revenue. However, in the case of Morgan Grenfell there was also the added and important ingredient of the bank's submission that legal professional privilege had been breached.

In the event this submission did not succeed, although substantial arguments were made to the Court and the two judges must have considered the matter very carefully.

It may well be that, in the light of current political and tax opinion, the fact that the transaction being investigated was a substantial tax avoidance scheme did not help the applicant bank.

Certainly, this case promotes the whole subject of legal professional privilege into the limelight and also human rights legislation. There will undoubtedly be other cases which will test the legislation in the future on both of these issues.

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