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Inheritance Tax
Associated Operations
BARRY McCUTCHEON BA, LLM, FTII, barrister, considers the emergence of a limiting principle with regard to associated operations.
Inheritance Tax
Associated Operations
BARRY McCUTCHEON BA, LLM, FTII, barrister, considers the emergence of a limiting principle with regard to associated operations.
THE ASSOCIATED OPERATIONS provisions have been the subject of concern since the inception of inheritance tax. Relevant in a variety of IHT contexts, they also apply for purposes of the new pre-owned assets régime (POT), albeit only in the context of the definition in FA 2004, Sch 15 para 11(7) of 'excluded liability'.
Widely drawn, on a literal reading the provisions appear to be capable of applying to a staggering range of transactions, in much the same way that, on one view, we are all related to each other if matters are traced back far enough. Fortunately, the judiciary has over a series of cases limited the scope of the provisions and they may now be regarded as something of a spent force. How has this come about?
The cases
There have been a number of cases in which the Revenue has invoked the associated operations provisions. Some of these cases involved the Revenue contending that a disposition had been effected by associated operations, while others arose in a specific statutory context. What emerges from these cases is that the Revenue entertained a generous view of the application of the provisions which it has generally been incapable of sustaining in litigation. I will begin by reviewing the decided cases and then attempt to extract from them a general principle as to the application of the provisions.
CIR v Brandenburg
Brandenburg [1982] STC 555 involved a taxpayer resisting before the Special Commissioners a Revenue attack on the basis of an extended disposition. In the event, Warner J found for the Revenue on other grounds, and declined to comment on the applicability of the provisions. The case is nevertheless of considerable interest because the submissions made by the taxpayer's counsel (Robert Walker, now Lord Walker of Gestingthorpe) as to the scope of the associated operations provisions make fascinating reading; not least because they anticipate subsequent judicial findings in the Rysaffe case, discussed below, as to the scope of the provisions.
The taxpayer tried to exploit a perceived asymmetry in the legislation. Mrs B, who was domiciled, resident and ordinarily resident in the UK, wished to make a gift free of capital transfer tax to her daughter, R, who was not so domiciled, resident or ordinarily resident. This was supposedly achieved by a chain of trust transactions involving a non-UK domiciled company and exempt gilts.
The Revenue invoked the associated operations provisions to contend that Mrs B had, by an extended disposition, made a transfer of value of the gilts directly to R. Counsel for the taxpayer began with the proposition that the associated operations provisions, if read literally, are impossibly wide and would lead to chaos which could be relieved only at the Revenue's discretion, and that approach had been comprehensively rejected by the House of Lords in Vestey v CIR [1980] STC 10.
The way to avoid this was to limit the circumstances in which the extended definition was capable of applying, and this should be done by regarding the extended definition as inapplicable where dispositions existed in their own right. A disposition by associated operations was not the same as two dispositions which happened to be associated operations. The extended definition could not be used to turn two transactions which were in themselves dispositions into a single composite disposition. The provisions applied where, for example, a taxpayer guaranteed his son's borrowing, with a right of recourse against his son. This disposition did not in itself diminish the taxpayer's estate unless and until the son drew on the facility. Once he did, and the bank enforced its security against the taxpayer, the taxpayer suffered a diminution in the value of his estate, but at that stage made no disposition. But he did make a disposition by associated operations.
Counsel for the taxpayer also gave the following example by way of demonstrating the need to limit the ambit of the provisions. X, domiciled abroad, wants to help his son buy a house in the UK. In Switzerland, he makes a cash gift to his son, who uses it to buy the house. The gift and the purchase are associated operations. Therefore, unless the ambit of the provisions is limited, X has made a gift of UK situs property, i.e. the house, and such a gift would be chargeable. The 'credit limb' in s 268(3) would be of no assistance because since the first gift was of excluded property, it would not have created a transfer of value.
The Revenue argued that what are now ss 268(2) and (3) implied that it was possible to link two separate dispositions to form an extended definition; s 268(2) by referring to the grant of a lease and the gift of a reversion and s 268(3) by referring to two separate transfers of value, each of which would have necessarily involved a disposition. The taxpayer's rejoinder was twofold; first, that two separate dispositions could be relevant in determining if, for example, what is now s 10 applied, but not in relation to the extended disposition of 'disposition'; second, so far as what is now s 263(3) was concerned, there could be an estate-diminishing disposition followed by a diminution caused by an omission.
The Special Commissioners held that there had been an extended disposition by associated operations, but that since it was made at the time of the last disposition, relief given to exempt gilts was available. As was noted above, their decision was subsequently overturned by Warner J on grounds which did not involve the application of the associated operations provisions.
Macpherson v CIR
Macpherson [1988] STC 362 was an attempt by taxpayer trustees of a discretionary trust to avoid the imposition of an exit charge on a depreciatory transaction under what is now IHTA 1984, s 65(1)(b). The trustees had on day 1 entered into a bona fide commercial transaction reducing the value of trust property and, on day 2, appointed a protected life interest in the property. The Revenue imposed an exit charge by reference to the depreciatory transaction.
The trustees sought to rely on what is now s 65(6). This provides that no exit charge can be imposed if the disposition by which the depreciatory transaction was effected was such that, if the trustees were beneficially entitled to the settled property, s 10 would prevent the disposition from being a transfer of value. The Revenue contended that the s 10 relief was unavailable because the appointment of the interest was an operation associated with the depreciatory transaction and that operation conferred a gratuitous benefit.
It was common ground that the appointment of the interest was an associated operation. The House of Lords found for the Revenue but, in doing so, held that had the events been reversed, so that the appointment of the interest in possession preceded the depreciatory transaction then, although the depreciatory transaction would have been an operation associated with the appointment, it would not have been a relevant associated operation because it would have contributed nothing to the gratuitous benefit that had already been conferred by the appointment. Lord Jauncey (with whom the other Law Lords agreed), having commented on the breadth of the provisions, identified the boundaries of the associated operations provisions as follows:
'… Counsel for the trustees informed your Lordships that there was no authority on the meaning of the words "associated operations" in the context of capital transfer tax legislation but he referred to a decision of the Court of Appeal in Northern Ireland, Herdman v CIR [1967] 45 TC 394, in which the tax avoidance provisions of TA 1952, ss 412 and 413 had been considered.
'Read short, s 412(1) provided that a charge to income tax arose where the individual had by means of a transfer of assets either alone or in conjunction with associated operations acquired rights whereby he could enjoy a particular description of income. Lord MacDermott CJ (at 406) upheld a submission by the taxpayer that the only associated operations which were relevant to the subsection were those by means of which, in conjunction with the transfer, a taxpayer could enjoy the income and did not include associated operations taking place after the transfer had conferred upon the taxpayer power to enjoy income.
'If the extended meaning of "transaction" is read into the opening words of (what is now s 10(1)) the wording becomes: "A disposition is not a transfer of value if it is shown that it was not intended, and was not made in a transaction including a series of transactions and any associated operations intended, to confer any gratuitous benefit …". So read, it is clear that the intention to confer gratuitous benefit qualifies both transactions and associated operations. If an associated operation is not intended to confer such a benefit, it is not relevant for the purpose of the subsection ...'
The case thus establishes that regard must be had only to associated operations which are relevant within the statutory context in question — in this case, s 10.
Hatton v CIR
Hatton [1992] STC 140 involved what was known at the time as 'the reverter to settlor scheme'. The facts were that Mrs H, who was seriously ill, wished to pass property free of IHT to her daughter, Mrs C. Towards this end, two settlements were created within 24 hours. Under the first the settlor, Mrs H, reserved an interest in possession for herself for just over 24 hours, with a reversionary interest to Mrs C. In substance, she had thus made a very valuable gift, but her retained interest in possession meant that for IHT purposes she was still treated as owning the whole of the settled property. As a corollary of Mrs H being treated as still owning the settled property, Mrs C's reversionary interest was excluded property. On the following day, Mrs C settled her reversionary interest on terms that Mrs H took an interest in possession in it for a 24-hour period following the termination of Mrs H's interest under the first settlement, with the property then becoming held absolutely for Mrs C. Mrs H died shortly after the scheme had been effected.
The taxpayers argued that:
the original settlement by Mrs H was not a transfer of value because, since she retained an interest in possession in the property she settled, the value of her estate was undiminished;
the subsequent settlement by Mrs C was not a chargeable event because the reversionary interest she settled was excluded property and therefore the settlement did not for IHT purposes diminish the value of her estate;
when Mrs H's interest in possession in the first settlement terminated, no charge to IHT arose because on that occasion she became interested in an interest in possession in the second settlement; and
when Mrs H's interest in possession in the second settlement terminated, no charge to IHT arose because on that occasion Mrs C became absolutely entitled to the property with the result that the reverter to settlor relief in what is now s 53(3) applied.
The gist of the scheme was thus a tax-free gift by Mrs H to Mrs C of the property comprised in the trust fund effected over a few days by a transparent tax avoidance.
Not surprisingly, the Revenue resisted this result.
In the event, Chadwick J decided against the taxpayer on two grounds. The first was that, under the Ramsay principle, the two settlements constituted a pre-ordained series of transactions, the result of which was that Mrs C made a single composite transaction such that the reverter to settlor relief did not apply.
In case he was wrong on this, he also considered the Revenue's argument that for IHT purposes Mrs C was the settlor of the second settlement with the result that, again, but for a different reason, the reverter to settlor relief did not apply. He accepted the Revenue's argument that the first settlement was made with a view to enabling or facilitating the making of the second settlement and that the two settlements were therefore associated operations. That being the case, they were to be regarded as effecting together a single disposition for purposes of the settled property régime, and that single disposition was a settlement for the purposes of what is now s 43(2).
The case therefore established that, depending on the facts, two settlements can be regarded as constituting a single settlement made by a disposition effected by associated operations. As will be seen below in connection with the Rysaffe case, the Revenue may encounter serious difficulties in sustaining such a construction in otherwise than extreme cases such as Hatton.
Reynaud v CIR
In the event, the Revenue chose in its next case to contend that a taxpayer had made a chargeable transfer by a disposition effected by associated operations. In Reynaud [1999] STC (SCD) 185, four brothers each transferred shares qualifying for business relief into four separate discretionary trusts. On the following day, the company in which the shares were held bought back from the trustees some of the shares; the trustees then sold the remaining shares to a third party purchaser.
The Revenue contended that the purchase by the company of the shares was an operation associated with the transfer of the shares into settlement and that therefore there had been an extended disposition the effect of which was that the brothers had transferred cash to the trustees rather than the shares that had been purchased by the company from the trustees, with the result that no business relief was available.
The Special Commissioner agreed that the transfer into settlement and the purchase were associated operations. But in his view in the context of s 278(3) an operation was relevant:
'… only if it is part of the scheme contributing to the reduction of the estate … Here the value of the estates of the brothers were diminished as a result of the gift into settlement alone. The purchase of own shares contributed nothing to the diminution which had already occurred and was not therefore a relevant associated operation.'
His authority for this view was Lord Jauncey's speech in Macpherson: an operation was a relevant operation in the context of determining whether or not there had been a transfer of value only if it contributed to a diminution in the value of the transferor's estate.
Rysaffe Trustee Co (CI) v CIR
In the most recent case, Rysaffe Trustee Co (CI) v CIR [2003] STC 536, a settlor sequentially made five separate discretionary settlements of five parcels of 6,900 shares each. The Revenue contended inter alia that the making of all the settlements were associated operations and that therefore the settlor had made one composite settlement by an extended disposition. The reason was that on that construction more IHT would be due than if each of the settlements was regarded as separate from the others.
The Special Commissioner ([2001] STC (SCD) 225) found for the Revenue, but her decision was overturned by Park J ([2002] STC 872) on the fundamental ground that all of the property comprised within the five settlements was already within the ten-yearly charge because each settlement was created by a 'disposition' in the ordinary sense. Therefore, in order to bring the property within charge, it was neither necessary nor appropriate to consider whether the five settlements were created by associated operations.
Park J then went on to consider what the position would be if this fundamental point was incorrect. While accepting that the point was not clear-cut, Park J thought that, on balance, the making of settlements were not associated operations because they had not been 'effected with reference' to each other even though they were all part of a single plan or scheme:
'Each transfer was effected in the knowledge that the other was being effected as well, but that does not seem to me to be the equivalent of saying that each transfer was effected "with reference" to the other.'
The Court of Appeal ([2003] STC 536) adopted a more robust approach. Mummery LJ, with whom Dyson and Schiemann LJJ concurred, held that the questions 'what is a settlement?' and 'what property is comprised in a settlement?':
'… can be determined without asking any additional questions, such as whether the dispositions were "associated operations" … The inclusion of the "associated operations" in the statutory description of "disposition" is not intended for cases such as this, where there is no dispute that there was a "disposition" of property falling within s 43(2). They are intended for cases where there is a dispute as to whether there was a relevant "disposition" at all. The CIR may be entitled to invoke the extended description to catch a case which would not be regarded as a "disposition" of property in its ordinary and natural sense.' (Author's italics.)
This harks back to the arguments presented on behalf of the taxpayer in Brandenburg and suggests that the associated operations provisions may be of very limited application.
An emerging principle
These cases show that the courts, and in the Reynaud case, the Special Commissioners, have been generally reluctant, but not wholly unwilling, to import the associated operations provisions into the analysis of the IHT effects of a transaction. Besides what may be some judicial reluctance, see Park J in Rysaffe, to conclude that operations are associated with each other, this reluctance has been manifested mainly in the approach that:
associated operations must be relevant within the given statutory context;
in determining whether associated operations are relevant within a given statutory context, the courts, and in the Reynaud case, the Special Commissioners, have had regard to basic IHT consequences only and not to the possibility of an increased charge as a result of, for example, disallowed business relief (Reynaud) or aggregated settlements (Rysaffe).
It is possible to see this reluctance as evidence of a principle which I will attempt to identify. Before doing so, I think it may be helpful to identify the Revenue's approach. This has been to identify all operations that are associated with each other within the statutory definition, to assemble a disposition from them and then, if that extended disposition produces a higher charge to tax than would otherwise be the case, to contend that that is the disposition that has been made for IHT purposes. See Brandenburg, Reynaud and Rysaffe.
Until the Court of Appeal's decision in Rysaffe, the principle that appeared to emerge from the cases was not to adopt the Revenue's approach but, instead, to identify the substantial disposition and then to see whether or not associated operations contributed to it. If they did not, they were not relevant associated operations (Reynaud and Rysaffe); if they did, they were (Hatton). The fact that including associated operations within the extended disposition contended for by the Revenue produces a greater charge to tax does not of itself alter the character of the substantial disposition and so render those operations relevant. The point is brought out neatly in Park J's judgment:
'All the parcels of shares were property comprised in settlements for the purposes of s 64. The associated operations provisions had nothing to do with that analysis. There were ten-yearly charges on all of the parcels of shares. It is (I assume) true that in aggregate the five ten-yearly charges would be lower than the single charge which would have applied if there had been only one settlement. But that is not a valid reason for artificially importing the associated operations provisions into the exercise and using them to impose the false hypothesis that there was only one settlement when in fact and in law there were five.'
The Court of Appeal's decision in Rysaffe has further restricted the position, which now appears to be that an issue will arise as to whether or not there was a relevant disposition only in cases where, in the absence of the associated operations, there would be no disposition at all. In such a case the question will then be whether a disposition was made by associated operations, and not whether operations can be associated with each other in such a way as to produce a charge where one would not otherwise exist or to increase an existing charge. This is the approach espoused by Lord Walker before the Special Commissioners on behalf of the taxpayer in Brandenburg.
This article is adapted from the 4th edition of McCutcheon on Inheritance Tax, to be published by Sweet & Maxwell in December 2004.
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