Fitting Prelude

Fitting Prelude

JEREMY DE SOUZA says that the Special Commissioners' decision in Campbell is a fitting prelude to the Barclays Mercantile Business Finance case soon to be heard in the House of Lords.

IN W T RAMSAY Ltd v Commissioners of Inland Revenue [1981] STC 174, readers will recall that Lord Wilberforce said that capital gains tax was a tax which operated in the real world, rather than one on arithmetical differences. Accordingly, in that case, a 'loss' under the method of computation prescribed by statute was not given effect when created by a circular series of pre-ordained transactions undertaken for no business purpose.

It is also helpful to recall, in this context, that, subsequently, in Berry v Warnett [1982] STC 396, Lord Wilberforce took account of the scheme of that particular tax in order to construe the phrase 'gift in settlement' to include the creation of one through the medium of a sale.

The Ramsay doctrine was later classified, in Craven v White [1988] STC 476, as a rule of statutory construction. Ever since, the courts have been engaged in the task of ascertaining when that rule can be called in aid by the Inland Revenue against taxpayers engaging in tax avoidance schemes, when a literal reading of the statute would result in the taxpayers in question succeeding in their endeavours.

By the time the House of Lords came to consider the meaning of 'payment' in MacNiven v Westmoreland Investments Ltd [2001] STC 237 and, on the analyses of both Lord Nicholls and Lord Hoffmann (who gave the main speeches), concluded that it should bear its normal meaning, there had been considerable speculation as to the circumstances in which a wider than normal interpretation could be given to statutory phrases.

According to one line of thinking, the Ramsay doctrine was more likely to be applied where vague words of uncertain meaning were used, than those with established import in everyday usage. The concept of 'payment' had come within the latter category in relation to VAT in Faith Construction Ltd v Commissioners of Customs and Excise [1989] STC 539. But, in the two main capital gains cases in which the Inland Revenue had been successful, Ramsay and Furniss v Dawson [1984] STC 153, the statutory words were, respectively, the vaguer 'loss' and 'disposal'.

In Westmoreland , Lord Hoffmann sought to segregate the various precedents into two categories:

• those in which the statutory wording bore a legal meaning, to which, it is now generally understood, Ramsay cannot be applied; and

• those in which it bore a commercial one, when it may be.

Legal meaning of loss

In the context of the recent Special Commissioners' decision in Campbell (SpC 421), it is significant that the former was applied to the word 'loss' when specifically defined in section 155, Finance Act 1994 by the Court of Session in Commissioners of Inland Revenue v Scottish Provident Institution [2003] STC 1035. Indeed, Richard Bramwell QC for the taxpayer in Campbell , submitted that Scottish Provident was virtually indistinguishable, and the Special Commissioners were disposed to hold that it was a relevant precedent, in the context of Lord Hoffmann's dichotomy.

The Inland Revenue is appealing Scottish Provident and it is expected that the House of Lords will hear the case in 2006. Before the Special Commissioners in Campbell , counsel for the Revenue, David Ewart, submitted that the case had been wrongly decided, because a 'commercial' interpretation ought to have been adopted.

Uncertain dividing line

There have also been cases in which the judges have expressed uncertainty as to Lord Hoffmann's dichotomy. In particular, both Lord Justice Peter Gibson and Lord Justice Carnwath had such concerns in Barclays Mercantile Business Finance Ltd v Mawson [2003] STC 66, where the Court of Appeal's decision in favour of the taxpayer in a finance leasing arrangement is to be challenged by the Inland Revenue before the House of Lords in October of this year. One of Lord Justice Carnwath's concerns was that the criteria used for classifying Furniss v Dawson as involving a 'commercial' interpretation were unclear.

Dissent in Arrowtown ?

More materially, puzzlement was expressed by Lord Millett, sitting as a non-permanent judge of the Hong Kong Final Court of Appeal in Collector of Stamp Revenue v Arrowtown Assets Ltd FACV No 4 of 2003, on 3 December 2003.

Indeed, while many commentators have taken Lord Millett to have disapproved of Lord Hoffmann's distinction, the Special Commissioners in Campbell were unable to see him as being in conflict with a case which was binding on them, when Lord Millett had said that he was unsure that Lord Hoffmann had intended to say more than that the Ramsay principle required that:

'the statutory language must be construed in the light of its purpose, and that a provision granting relief is generally (though not universally) to be taken to refer to transactions undertaken for a commercial purpose and not solely for the purpose of complying with the statutory requirements for tax relief.'

In this context it is important to bear in mind that, in the paragraph after setting out the new commercial/legal distinction in Westmoreland , Lord Hoffmann had said:

'Even if the statutory language refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax reasons. Business concepts have their boundaries no less than legal ones.'

Campbell

This lead-in has been necessary in order to explain the problem before the Special Commissioners in Campbell , for which the hearing had taken place in January, and the decision was handed down on 6 July 2004. On the face of it, the taxpayer had an open and shut case, so much so that the Inland Revenue had taken steps to counteract future usage of the scheme adopted by him in Finance Act 2002.

Under the deep gain legislation in operation in 1999-2000 (see paragraph 2 of Schedule 13 to the Finance Act 1996), the computation of a loss was purely a mathematical process. The cost by reference to which it had to be calculated was the subscription price of the loan stock, and the value which had to be deducted in order to arrive at this where the transferee was a connected party, was the open market value (the outcome of which had been conceded by the Inland Revenue).

Moreover a transfer to such a person created an event of computation. In this case, the event was triggered by a gift to the subscriber's wife, the genuineness of which the Inland Revenue conceded.

The structure under which this computation, and hence the loss which could be offset against Schedule E income created by the exercise of employee share options, had been set up shortly before the options were exercised when the employer company was taken over. Such a takeover had not, however, been a certainty at the time of formation of the £2 company for which the loan stock with the relevant valuation characteristics was subscribed.

Nonetheless, the Special Commissioners concluded that the main object of the formation and subscription was to create the relevant tax deduction.

Duality of purpose

The formation and capitalisation of the new company also enabled the taxpayer, who (with his wife) had had a portfolio of £1.6 million managed by a bank on a discretionary basis, to manage a portfolio himself through a limited liability vehicle for which the management expenses were tax deductible, and to include some unlisted investments within that portfolio.

It was noted in this context that, in Commissioners of Inland Revenue v Levy [1982] STC 442, Mr Justice Nourse had taken cognisance of the fact that it is an everyday transaction for owners of companies to lend them money on terms which would be unattractive to non-shareholders.

The Special Commissioners were therefore able to make a finding of fact that the taxpayer had a dual purpose in setting up the company and capitalising it with loan notes. On this basis, it was possible for them to distinguish both Ramsay and Arrowtown on the basis that the artificial arrangements under consideration in both those cases were entered into solely for the purposes of tax avoidance.

The Campbell case is therefore significant in that it is the first recorded instance of a defence of duality being upheld. Back in the early 1980s, the architects of offshore capital gains tax structures were wont to say that there was also an element of duality in them, namely protection from United Kingdom exchange controls. It is not known, however, whether this defence was ever successfully employed in negotiations with the Inland Revenue.

The clear wording of the statute was, however, the main plank of the Special Commissioners' rejection of the Revenue's deployment of Ramsay as a general rule of interpretation in relation to the meaning of 'loss' in a taxing statute, and submission that Scottish Provident was wrongly decided, this being by reference to Lord Hoffmann's commercial/legal dichotomy, which it was submitted was inconsistent with Arrowtown .

Where are we now?

The Special Commissioners gave leave for an appeal against Campbell to be taken direct to the Court of Appeal. It seems very likely that the Revenue will seek to do that. The Revenue no doubt sees itself as in a similar position to Wellington after Quatre Bras, with Waterloo round the corner — in the form of its House of Lords' appeal in October in BMBF .

However, in the period between hearing and decision in Campbell , Lord Hoffmann had participated in another Ramsay doctrine case, giving the Privy Council's advice in Carreras Group Ltd v Stamp Commissioner [2004] UKPC 16, in which it was said:

'… it is inherent in the process of construction that one will have to decide as a question of fact whether a given act was or was not a part of the transaction contemplated by the statute.'

While some commentators have seen this as a retreat from the commercial or legal dichotomy in Westmoreland , it seems to do no more and no less than confirm that the Ramsay doctrine is a rule of statutory construction, and that, in deciding whether to give effect to it, one has to see how the relevant statutory wording and its context fit in with the findings of fact.

While, in Campbell , it is difficult to see how the duality finding could be ignored, there could perhaps be scope for applying the wider (or 'secondary') finding of fact concept advocated by Lord Brightman in Furniss v Dawson to a legal construction situation in other cases. Indeed, the artificialities in both Arrowtown (the terms upon which certain shares were issued) and Carreras (the short redemption date) might perhaps have been so categorised had the courts in question been so minded.

It remains to be seen how, in the context of the concerns raised by Lord Justice Peter Gibson and Lord Justice Carnwath in BMBF (as well as the observations of Lord Millett in Arrowtown ), the problem of deciding whether the given wording is commercial or legal is amplified by the House of Lords when judgment is delivered in BMBF .

Jeremy de Souza is a consultant to White & Bowker.

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