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Tolley's Practical Tax by Richard Pincher

Richard Pincher comments on the implications of the Scottish Provident Institution case.This article looks at the recent House of Lords decision in IRC v Scottish Provident Institution (see page 32) that has to be read in conjunction with the decision in BMBF Ltd v Mawson (see page 31). Specifically, this article looks at the new limitation on the reinterpretation of the so-called Ramsay [1984] STC 153 principle. To summarize, BMBF reinterpreted Ramsay to reduce its effect on tax avoidance schemes while SPI defines continuing limits on such schemes.

The new Ramsay

Single principle

BMBF has been welcomed as a global restatement of the Ramsay principle. The decision makes several points that can be summarised as follows, Ramsay:

• is not a particular tax rule;

• does not import a business purpose test by which to judge the efficacy of a tax claim; and

• is simply a purposive interpretation of the legislation as applied to all the relevant facts.

On that basis, it might be said that the Ramsay principle has no independent substance; it is merely a restatement of the principles of legislative interpretation. Therefore, the decision in BMBF has removed the conceptual uncertainty underlying the growing jurisprudence based on the dichotomy between legal and commercial interpretations of legislation that has developed in attempts to apply the Ramsay principle (MacNiven v Westmoreland Investments Ltd [2001] STC 237 per Lord Hoffman as applied in eg Campbell v CIR [2004] STC (SCD) 396). BMBF also removes the practical difficulties caused by the varying applications of, or caveats to, the Ramsay principle. Two cases illustrate these difficulties; one of the most recent cases (New Angel Court v Adam [2004] STC 779) and the seminal case (IRC vDuke of Westminster [1936] 19TC 490) both of which, broadly put, held that taxpayers are free to exploit the legislation, and their circumstances, as they wish in order to reduce their tax bill. However, the case-law remains to illustrate the application of that interpretation, particularly in the case of SPI.

As a mere restatement of the principles governing the judicial interpretation of legislation, BMBF reverses the court’s straying into judicial lawmaking by creating an anti-avoidance rule. Thus the comment by Lord Brightman that steps in a transaction may be disregarded if they are inserted merely for tax avoidance purposes (Furniss (Inspector of Taxes v Dawson [1984] STC 153 at page 166) has been reinterpreted.

Purposive interpretation of statutory words

The House of Lords held that, in certain circumstances, the courts should apply a purposive interpretation of statutory words.

An initial observation is that purposive interpretation has, at least, two meanings: that applied by the European Court of Justice and that applied in the UK. For purposes of comparison, suffice it to say that the European principle is much broader.

In United Kingdom, the purposive approach consists of two steps. First, obviously, unambiguous legislation should be given its natural meaning. Second, ambiguous legislation should be interpreted so as to give effect to its ‘purpose’ as divined from the text and scheme of the legislation as supported by reference to Hansard where relevant.

However, the history of the BMBF case contains the seeds of the problem underlying the principle that it has established, namely that Park J and the House of Lords interpreted the legislation’s purpose very differently.
And the legislation has to be read in the context of the relevant facts. For example, the court might ask itself whether the legislation was intended to apply to the circumstances of a particular case. Therefore, the Revenue cannot simply argue that, without more, the legislation’s purpose is to collect tax.

Nor does the purposive interpretation permit the courts to read into the legislation any further words. So it is not possible to impose a ‘business purpose’ precondition to any beneficial tax treatment.

SPI

The facts

The Scottish Provident Institution entered a complex series of transactions. In essence it swapped, with a bank, options to sell gilts. Because this arrangement straddled the introduction of a new tax treatment of such arrangements, The Scottish Provident Institution hoped to generate a capital gains tax loss.

The narrow question for the court was whether the option granted to the bank gave the bank an entitlement to the gilts. If the bank was entitled to the gilts, then the option would be a ‘qualifying contract’ as defined for these purposes (FA 1994 s 147(1)). The Scottish
Provident Institution could claim the loss on a qualifying contract.

The netting arrangements

The cost, and exercise price, of each option was set so that only a relatively small amount was due to the bank. A further fee was due if the arrangement produced a tax loss for Scottish Provident Institution. The initial plan was that each party would deliver gilts as required under the options. However, the parties subsequently agreed to set one against the other.

The netting off arrangements were, possibly, fatal to the success of the scheme. The House of Lords judgment only concedes that The Scottish Provident Institution might have succeeded in its claim if the other option had not existed. The judgment also refers to arguments made by the Revenue that, even then, The Scottish Provident Institution’s claim would have failed. The judgment does not go into any further details.

However, the netting-off arrangements must be one feature of the facts that the courts should take into account. The Lord’s judgment stresses that the first step in applying the normal rules of statutory construction is to take into account all the relevant facts.

Scheme as a whole

The second rule is that, when considering one element of a scheme, all the other elements of the scheme may be take into account.

The Scottish Provident Institution had submitted that the scheme contained an element of uncertainty and could not, therefore, be treated as a whole. The element of uncertainty was whether both options would be exercised.

The House of Lords distinguished the facts in SPI from other cases because the contingency was part of The Scottish Provident Institution’s scheme whereas in those other cases the contingency was beyond the terms of the scheme namely, for example, no buyer had been found (Craven v White [1988] STC 476).

What level of uncertainty

A debate might arise over the level of uncertainty that is required before an uncertain step could be treated as part of an overall transaction. For example, what would be the effect of a change in the level of certainty during the working out of the scheme?

The case concerned much evidence on the certainty which all the steps would be taken resulting in the tax loss. At one stage, the board of The Scottish Provident Institution noted that it carried “no risks” in entering the arrangement with the bank, in other words that both options would be exercised. However, the bank claimed that its minimum fee
(payable whether or not the scheme succeeded) represented a hedging charge against the risk that it was taking. The Special Commissioners held that there was an outside chance that both options would not be exercised albeit that the expectation was that both options would be exercised.

However, the House of Lords moved away from that approach. It noted that: ‘The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned.’

However, that leaves open the question of what is the level of knowledge required of the participants? For example, had The Scottish Provident Institution approached the bank (rather than the other way round, as actually happened) and not told the bank about the expected tax saving, would the scheme have succeeded? (Of course, the bank may not have entered this arrangement without full due diligence, but the same test may apply by analogy to other circumstances.)

Conclusion

The conclusion to this case was predicted in the introduction to the judgment namely that:

‘This appeal concerns an artificial scheme devised in 1995 to take advantage of a prospective change in the system.’

The Holy Grail of tax avoidance might be redefined as the definition of ‘artificial’.
The dictionary defines artificial as the product of artifice, which possibly means that it is akin to defining an elephant: nobody can define it but everyone recognises it when they see it. In the meantime advisors will have to learn how to apply the intended outcomes test.

RICHARD PINCHER

This article first appeared in ‘Tolley’s Practical Tax’ on 11 February 2005, and is reproduced with the kind permission of Lexis Nexis UK.