As part of a continuing lengthy preamble, another piece of my thoughts from 2005 on the emerging jurisprudence at the time
"10. Officials are often unclear themselves about exactly what they are trying to achieve. The debate on tax policy had with Ministers is usually conducted in very general terms, and the detailed law resulting from the drafting and Parliamentary processes often gives a misleading impression of the nature of the decision about what is to be taxed. The result is that however closely the law is scrutinised for evidence of what it intends, these intentions are often couched obliquely or indirectly and rarely do they clearly express the end sought to be achieved. If the end were clear, or if the law only allowed means that would produce the desired end, then there would be very little scope for the undesired results that we call avoidance. The most recent jurisprudence illustrates this well and it is important that any position taken by HMRC in relation to avoidance gives sufficient weight to these developments.
11. In Barclays Mercantile Business Finance Ltd v. HM Inspector of Taxes (BMBF) [2004] UKHL 51, the House of Lords’ Appellate Committee outlined the facts of the case and the decisions of the courts below before noting “26. In treating the legal effect of the acquisition agreements as irrelevant for the purposes of section 24(1), the Special Commissioners and Park J said that they were applying the principles of construction first applied by this House in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300. These principles have since been discussed and explained in numerous cases both in lower courts and in your Lordships' House. But these attempts at clarification appear only to have raised fresh doubts and further appeals. Mr Aaronson QC, who appeared for BMBF, said that he spoke on behalf of the profession when he hoped that the House would take this opportunity to give definitive guidance. It is no doubt too much to expect that any exposition will remove all difficulties in the application of the principles because it is in the nature of questions of construction that there will be borderline cases about which people will have different views. It should however be possible to achieve some clarity about basic principles”.
12. At issue was legislation that sought to ensure that only certain expenditure qualified for capital allowances by describing in mechanistic terms a set of conditions attaching to arrangements put in place by the taxpayer. The court found that fulfilment of these statutory conditions was sufficient to give the taxpayer an entitlement to the allowances. The fact that another criterion had turned out to be significant to the tax authority in practice - what happened to the money expended by BMBF in the hands of another taxpayer – was neither here nor there. It was impossible to infer from a statute that dealt only with the taxpayer who spent the money that things done by any other taxpayer should be taken into account.
13. This demonstrates one consequence of a common approach to drafting tax legislation that tends to describe only the means by which officials believe the intended end is to be achieved. Typically, the analysis will be that to achieve a particular end the taxpayer must do X, subject to Y. And so that is written down in statute. But often X will turn out to be too wide (the action permitted can be used in unforeseen ways to result in unintended consequences – like incorporation) and/or Y turns out to be too narrow (there was no condition in the law in question in BMBF requiring that ‘real’ up-front finance was provided – i.e. that the lessee could use freely to finance transactions or activities of its business).
14. In coming to its decision in the case the House of Lords said that two steps are necessary in the application of any statutory provision: “first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so”.
15. However, in contrast to these two principles the question the tax authority seems to have asked in deciding to embark on litigation to challenge the taxpayer’s treatment of the transaction was different – something like whether the treatment in question gave the result that the tax authority wanted. But the legislation was not couched in terms of any different or wider result than that plant or machinery should belong to the person incurring capital expenditure on it for the purposes of his trade in consequence of his incurring that expenditure. The fact that it might have been intended by someone in the tax authority, sometime in the past, to grant capital allowances to taxpayers engaged in the sale and leaseback arrangements typically carried out by those whose trade was finance leasing only if the lessee was practically put in funds could not possibly be inferred from the words of the statute.
16. On the same day the House of Lords issued its judgement in the case of Her Majesty's Commissioners of Inland Revenue v. Scottish Provident Institution (SPI) [2004] UKHL 52, where the taxpayer entered into arrangements with another party, Citibank, to create an income loss. Essentially, this would succeed if an option granted by SPI to Citibank gave Citibank an entitlement to gilts. The court said “That depends upon what the statute means by "entitlement". If one confines one's attention to the Citibank option, it certainly gave Citibank an entitlement, by exercise of the option, to the delivery of gilts. On the other hand, if the option formed part of a larger scheme by which Citibank's right to the gilts was bound to be cancelled by SPI's right to the same gilts, then it could be said that in a practical sense Citibank had no entitlement to gilts. Since the decision of this House in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300 it has been accepted that the language of a taxing statute will often have to be given a wide practical meaning of this sort which allows (and indeed requires) the court to have regard to the whole of a series of transactions which were intended to have a commercial unity”.
17. These two cases each show one of the two steps said to be necessary in the application of a statutory provision. BMBF was essentially about what transaction would answer to a statutory description. Using purposive construction does not mean looking beyond the legislation. It can – indeed must - take into account what might have been the intention of the legislation, but it is limited to possibilities allowed by the words of the statute. SPI was about whether a transaction actually did answer to a statutory description. In deciding this, a wide practical meaning must be given to it.
18. The principles marked out in these simultaneous decisions can be seen to have been applied in the next (and latest) case decided by the House of Lords. In HM Inspector of Taxes v Dextra Accessories Ltd (Dextra) [2005] UKHL 47 , s.37 of the Finance Act 1989 had changed the basis of assessment for tax paid by an employee on his emoluments from the year in which the money was earned to the year in which it was paid to him. The employer, however, in calculating his own profits for tax could deduct the emoluments in the year that liability to pay them accrued, even if they were not paid then. This created a risk that a closely-connected employer and employee could arrange for a delay in receipt of payment by the employee so that the company could deduct the amount in its profit and loss account, reducing its own liability to tax, while no tax became due from the employee. The risk was covered by s.43 of the Act providing that emoluments could not be deducted unless they were actually paid to the employee within nine months of the year end. If the sums in question were paid to an intermediary “with a view to their becoming relevant emoluments” these were ‘potential emoluments’ and similarly could not be deducted until they were actually received by the employee. The taxpayer tried to get around this by putting the money into an Employee Benefit Trust, and claiming that none of it could be considered to be a potential emolument because the trust had the power to make payments that were not emoluments.
19. The Special Commissioners and the High Court took a fairly literalist view of the case, the former saying that payment of emoluments had to be the sole purpose of the employer, and the latter that payment of emoluments had to be the principal intention of the trust as determined by the terms of the trust deed.
20. The Court of Appeal and House of Lords disagreed, finding that funds were held ‘with a view to becoming relevant emoluments’ if they were held ‘on terms which allowed a realistic possibility that they would become relevant emoluments’.
21. While the latter did not explicitly refer to its own formulation in BMBF - “first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so” – this is clearly the approach that it took. Having described the timing disparity made possible by s.37, Lord Hoffman starts by stating simply “Section 43 of the 1989 Act was intended to deal with this situation”. He reports the taxpayer’s assertion that the statutory description meant that potential emoluments were those payable only upon a contingency such as a bonus payable if a certain profit was met and notes “if that is a correct description of potential emoluments … it would be equally true to say that amounts held by an intermediary were for the payment of emoluments upon a contingency, namely the exercise of a discretion by the trustees. In both cases the sums may or may not be used to pay emoluments but there is at least a realistic possibility that they will be”. In that way he describes what transaction will answer to the statutory description and decides that the transaction in question does so. He then notes that on the taxpayer’s argument immediate deductibility of payments into the trust could be achieved while postponing indefinitely the liability of the employee to tax and says “That would enable the purpose of s.43 to be easily frustrated. I therefore dismiss the appeal”.
22. Thus it seems that where the purpose of the law is clear and the words of the statute will bear a meaning that gives effect to that intention in the case in question the court will simply interpret and apply the statute in that way. That is of course unlikely ever to benefit the taxpayer against the tax authority and that it represents a radical change in approach is demonstrated by the fact that the court made no reference to any case law, but simply looked at the words of the statute and the facts. One commentator, writing about the decision in BMBF, presciently said “What is missing, compared with earlier cases, is the detailed analysis of the existing case law, case by case. However, one of the important points about Barclays Mercantile and Scottish Provident may be just that it is no longer necessary to do so. The principles are now clear” (John Tiley [2005] British Tax Review: No.3 p.277). That was borne out in Dextra.
23. However, this seems to confound expectations in some quarters that the House of Lords might in some way try to put itself into the mind of Parliament and ask itself what Parliament would have intended if it had been faced with the case before the court. For example, Professor Freedman wrote “when the [BMBF] case reaches the House of Lords … whatever formulation is delivered, it seems that a central tenet will be the ascertainment of the intention of Parliament. Since this will almost always be in situations which Parliament did not have in mind when passing the legislation in question the key question is how far the court can go in ‘reconstituting’ the facts and making assumptions about what a rational Parliament would have intended had it considered the issue” (Judith Freedman “Defining Taxpayer Responsibility” [2004] BTR: No.4 at p.352) In fact, the court seems to have rejected any such hypothesising role for itself.
24. The latest jurisprudence suggests that whereas a scheme might previously have succeeded on a literal interpretation of the law (the line of extreme cases from Duke of Westminster to Plummer and beyond), if it is clear that Parliament did intend that a scheme would not succeed, then the courts will seek to give effect to that intention. But the significant limit is that the intention is inferable only from the statute, and so the law cannot be used against schemes that Parliament would have wanted to prevent if it had known about them, but did not. If Parliament did not know about something, it can have had no intention about that thing. The court will draw inferences only about the intentions that Parliament actually had.
25. This is entirely of a piece with Lord Hoffman’s published comments on taxing statutes where he says that a distinction between acceptable and unacceptable tax avoidance depends upon a false assumption that Parliament imposes taxation by reference to economic and other events in the real world (supra at 205-206). Instead, he suggests, “Parliament, for various reasons, sometimes leaves the taxpayer a choice of achieving the same economic result by two different methods, one of which may attract tax and the other not. Worse still, Parliament may not be content to describe the economic event which should attract tax because it does not trust the courts to understand such a concept and apply it in a practical way. Instead it enacts a mass of detailed rules which it is hoped will tie up the taxpayer in a net from which he cannot escape. But sometimes there are holes in the net and the courts find that they cannot plug them by appealing to the economic event which, at a higher level of generality, it appears that Parliament wished to tax. It is one thing to give the statute a purposive construction. It is another to rectify the terms of highly prescriptive legislation in order to include provisions which might have been included but are not actually there”.
26. Taken together, these all point to the need for HMRC to refocus some of its analysis and drafting effort. It suggests that the way to secure the tax intended and to proof the legislation against avoidance is to be clear about the real nature of the taxing provision. It does not mean extensive preambles nor a battery of anti-avoidance clauses. It means actually stating what is to be taxed or what is to be relieved. If this is to be on the basis of a real economic outcome, then that outcome must be clearly stated.
27. For example, returning to BMBF, the relevant legislation in section 24(1) of the Capital Allowances Act 1990 provided:
(1) Subject to the provisions of this Part, where—
(a) a person carrying on a trade has incurred capital expenditure on the provision of machinery or plant wholly and exclusively for the purposes of the trade, and
(b) in consequence of his incurring that expenditure, the machinery or plant belongs or has belonged to him,
allowances and charges shall be made to and on him in accordance with the following provisions of this section."
28. The House of Lords approvingly quoted Carnwath LJ from the Court of Appeal [2003] STC 66, 89, para 54 "There is nothing in the statute to suggest that 'up-front finance' for the lessee is an essential feature of the right to allowances. The test is based on the purpose of the lessor's expenditure, not the benefit of the finance to the lessee”. And Carnwath LJ had preceded these words by saying “the mere fact that the essential purpose of the arrangement was to obtain a tax advantage in the form of capital allowances, cannot, under this statutory scheme, be a ground of objection” (my emphasis).
29. One possible response to a judgement of this kind is to say that HMRC must hedge legislation like this with exceptions for arrangements whose essential purpose is obtaining a tax advantage. But that mistakes the nature of the problem. The capital allowances regime exists to give people a tax advantage that, absent the regime, they would not have. There was a real economic event that Parliament might well have wanted to determine the tax treatment – i.e. whether the lessee was genuinely put in funds or not – but the statutory scheme made no reference at all to it. ‘Improper’ gaining of that tax advantage only has meaning and can only be described by reference to the economic event. The message here is that if the legislation does not mention, let alone focus, on critical economic events, then the courts will not. And in this context general prohibitions on gaining a tax advantage get us no further because they simply beg the question of what economic event should determine the ‘right’ tax treatment. And if the courts can find none in the statute to act as a comparator then an ‘improper’ tax advantage cannot be established.
30. If this is all broadly correct then HMRC need to ensure that it communicates clearly in its strategy what weight is given to the developing jurisprudence and the attitude of the present Lords of Appeal and whether HMRC will seek to work with or against the principles of statutory construction they are now applying to tax cases. For as outlined above the risk to the taxpayer does not arise from the threat of challenge but from the threat of failure in the courts. And it appears that we are now less likely to succeed before the courts with any argument that arrangements should fail because they are avoidance or because Parliament would not have intended them to succeed if it had known about them. These principles cannot be written off as Lord Hoffman’s hobbyhorse, as in both BMBF and SPI the decisions commenced with the unusual words “The following is the opinion of the Committee to which all its members have contributed”. Such pointed unanimity should be given particular weight bearing in mind the Lords’ expressed aim in BMBF of giving clarity to basic principles.
31. The result in Dextra shows that there are positives for HMRC in this. However, it should not be ignored that on the other side of the coin is reduced credibility in any threat to challenge arrangements that give a result that HMRC do not like unless HMRC can clearly demonstrate by reference to the statute that it does not intend the result to flow from the economic events in question. It might be useful to review current challenges and ‘at risk’ legislation in this light to see where the balance lies."
More to come in due course ...
Musings on tax avoidance and most recently on the 'Boys' behind it ... here.
Interesting new paper about perception of risk and influence on avoidance behaviour, here
The Professor. A number of her papers available here
A founder of Tax Justice Network here.