D'Arcy v Revenue & Customs [2006] UKSPC SPC00549 (14 June 2006)
THE SPECIAL COMMISSIONERS
- and -
THE COMMISSIONERS FOR HER MAJESTY'S
REVENUE AND CUSTOMS Respondents
Special Commissioner: DR JOHN F. AVERY JONES CBE
Sitting in public in London on 23 and 24 May 2006
Kevin Prosser QC and Mr James Henderson, counsel, instructed by P E Shirley & o, chartered accountants, for the Appellant
Michael Furness QC, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents
This is an appeal by Mrs Philippa D'Arcy against the conclusion in a closure notice dated 15 February 2005 and the amendments to her return for 2001-02 to give effect to that conclusion. The Appellant was represented by Mr Kevin Prosser QC and Mr James Henderson, and the Revenue by Mr Michael Furness QC.
In brief the Appellant entered into a tax avoidance scheme involving transactions in gilts designed to create a tax deduction for a manufactured interest payment. The Revenue issued a closure notice contending that Ramsay applied with the effect that no deduction was created (and a smaller amount of income was not taxable), but they have since abandoned that contention and now contend that the deduction is allowable but that Appellant is taxable on an amount approximately equal to the deduction under the accrued income scheme. The Appellant raises two points, first that the Revenue cannot change the basis of their conclusion as stated in the closure notice, and secondly, that the accrued income scheme does not give the result for which the Revenue contend. I understand that there are other cases where the taxpayer has entered into a similar scheme but it is only the Appellant who has received a closure notice in relation to it, so that the procedural point will not be relevant to the other cases.
I had a bundle of documents and skeleton arguments from both parties including a skeleton in reply from the Appellant. There was an agreed statement of facts as follows to which I have added a few words of clarification between square brackets:
This question is whether the Revenue can argue in this appeal that the accrued income scheme applies, contrary to their conclusion stated in the closure notice that Ramsay applied.
I find the following additional facts relating to this question:
The following provisions of the Taxes Management Act 1970 are relevant:
Mr Furness , for the Revenue, contends:
Mr Prosser and Mr Henderson, for the Appellant, contend that:
Self-assessment made a major change to the system of appeals. Originally assessments were often estimated and made in the absence of any information. Appeals against such assessments could raise any issues relating to the income assessed, such as trading profits, as Glaxo demonstrates, and the only counter to the Revenue's right to raise new issues subsequent to the assessment was proper case management. Self-assessment is different. The Revenue have the information from the taxpayer first; they may decide to enquire into a return, in which case they give notice to the taxpayer; they consider the return and are obliged (and if necessary can be forced by the taxpayer, see s 28A(4)) to come to, and state, a conclusion in a formal notice (a closure notice); and the closure notice must (assuming that the conclusion is that an amendment to the return is required) make the amendments of the return required to give effect to the officer's conclusions. If the taxpayer does not agree with either the conclusion or the amendment he can appeal against the conclusion or the amendment. It is possible for a conclusion not to lead to an amendment, for example where the taxpayer returns a loss, which the Revenue agrees is a loss so that no amendment to the nil figure in the return is necessary, but the conclusion states an amount of loss to be carried forward which the taxpayer disputes. But normally there will be an amendment to the return to give effect to the Revenue's conclusions stated in the closure notice.
Sections 31(1)(b) (that an appeal may be brought against the conclusion or amendment in a closure notice) and s 50(6) and (7) (that the appeal Commissioners' jurisdiction is to determine whether the appellant is over- or undercharged by the self-assessment) do not appear to fit together well. What, for example, is the procedure for an appeal against a conclusion that does not lead to an amendment? And if there is an appeal against both the conclusion and the amendment the appeal Commissioners are apparently not required to adjudicate on the reasons for the amendment; they must either reduce or increase the assessment or allow it to stand good. This apparent mismatch is the basis for Mr Furness's contention that once there is an appeal against something, the appeal Commissioners' jurisdiction is to determine the figure in the whole of the self-assessment, whether or not it has any relationship to the conclusion or amendment that is the subject matter of the appeal. Such a reading could be even wider than the previous system of appeals against an assessment, under which the assessment (on an individual) was limited to the source of income assessed; under self-assessment the figure in the whole of the return could be amended. The logical end result of his contention has to be that if the Revenue come to a conclusion about a trading profit, which the taxpayer appeals, there is nothing to prevent the Revenue from contending in the course of the appeal that the taxpayer is liable to more tax on something quite different, say rent. I do not consider that this is a correct reading. If Parliament had intended a continuation of the system of appeals against assessments there would have been no need to provide that an appeal may be brought against the conclusion or amendment; the equivalent of the former system would have been that the appeal was against the amended self-assessment. Instead Parliament enacted a system under which the Revenue had to state a conclusion and make an amendment, against which an appeal could be brought, necessarily limited to that conclusion or amendment. Accordingly, I consider that s 50(6) (and similarly with (7)) should be read in the context of s 31(1)(b) in this way:
I prefer to base this on the context rather than Mr Prosser's contention that s 48(2) requires a necessary modification to s 50(7) to deal with appeals other than appeals against assessments because although this is an appeal against a conclusion and amendment it relates to an assessment, namely a self-assessment, hence the closing words that "the assessment…shall be reduced accordingly…". It follows that by starting an appeal, while the taxpayer is still at risk of having the figure in the amendment increased, this is limited to an increase in the figure related to the conclusion or amendment. In contrast, with an appeal under s 31(1)(d) against an assessment other than a self-assessment, where the appeal is against the assessment, the former system that everything covered by the assessment was within the scope of the appeal and the assessment can be increased on account of something not in contemplation at the time it was made (as in Glaxo ), continues to apply. The difficulty is that s 50(6) and (7) has to deal with both types of appeal.
The scope of an appeal against a conclusion or amendment made by a closure notice will depend on the facts. If the conclusion is that the officer does not believe that the records of the trading profit are complete and he fixes the profit at an estimated amount, the scope of the appeal may be wide enough to include any matters that make up the trading profit. If, on the other hand, the conclusion were that some item in the computation of the trading profit was non-deductible the appeal is restricted to whether or not it is deductible. In this appeal the conclusion was very specific, that "the disposal, acquisition and repo over £31,000,000 nominal of Treasury 9¾% 2002 should be regarded as a composite whole which was circular and self cancelling." The scope of the appeal therefore concerns these transactions in the Gilts and nothing else.
I should add that, contrary to Mr Furness's contention I see no reason why alternative conclusions should not be stated in a closure notice with the amendment necessarily giving effect to the Revenue's preferred conclusion. Indeed, if they considered that an individual was liable either to income tax on a trading profit or to capital gains tax, it would seem to be essential that they could keep both options open. There is no need for the appeal system to allow scope for such alternative contentions when they are not stated in the closure notice.
The next question is how conclusions of law stated in the closure notice fit into the system of appeals against the conclusion or amendment. Sections 50 (6) and (7) are silent on matters of law. Whether a taxpayer is under- or overcharged is to be decided "by examination of the appellant on oath or affirmation, or by other evidence" and the assessment shall be reduced or increased accordingly (or stand good). (Probably the reason is historical; these words were in 43 Geo.3 c.99 s.26 applying to "assessed taxes," such as taxes on servants, horses, carriages and hair powder, which presumably were not likely to raise issues of law, and were first incorporated into income tax by reference by Addington's Act, 43 Geo.3 c.122 s.2.) Clearly decisions must be made by the tribunal on law and indeed there is an appeal from this tribunal under s 56A if either party "is dissatisfied in point of law." These provisions seem to me to indicate that the jurisdiction of appeal Commissioners is not merely to decide whether the stated conclusion on a point of law in the closure notice is right or wrong and, if wrong, to allow the appeal and reduce the amendment to nil. I agree with Mr Furness that such a result is inconsistent with the tribunal's duty to decide whether the appellant is over- or undercharged by the self-assessment and accordingly to determine the figure for the amendment to the self-assessment, although I have doubts whether the passage he cited from ex p. Elmhirst , with its references to the Commissioners using their judgment in making the assessment and in dealing with the appeals, is still good law after the ending of the Commissioners' assessing functions. It seems to me inherent in the appeal system that the tribunal must form its own view on the law without being restricted to what the Revenue state in their conclusion or the taxpayer states in the notice of appeal. It follows that either party can (and in practice frequently does) change their legal arguments. Clearly any such change of argument must not ambush the taxpayer and it is the job of the Commissioners hearing the appeal to prevent this by case management. That is not an issue here.
I would make a distinction between this case and an analogous one, though not dealing with a closure notice, that I dealt with recently which is not yet reported as it dealt with a preliminary issue. There the Revenue had refused a sub-contractors' certificate on the grounds that the taxpayer had not satisfied the statutory conditions relating to the type of business and the amount of turnover, but they did not state that they had not considered whether the taxpayer had satisfied the compliance conditions. The Revenue later accepted that the taxpayer did satisfy the business and turnover conditions and then sought to raise compliance failures. I decided that as they had not refused the certificate on the ground of compliance failures (and had not told the taxpayer that these had not been considered) they could not raise them except to the extent that compliance failures had come to their attention in dealing with the satisfaction of the other conditions. I would regard that as being a case where the Revenue changed the factual basis of their refusal, because it was based on different facts concerning compliance, than the legal basis, even though these new facts raised a different legal basis. I mention this because I understand that my decision is under appeal, which could be relevant if this decision is appealed.
Accordingly, on the procedural issue, while I take a narrower view than that contended for by Mr Furness of what the Revenue are permitted to raise in the course of an appeal, I consider that it is open to the Revenue to argue the accrued income scheme issue in this appeal on the basis that it is a new argument of law related to the facts identified by the closure notice.
I shall for convenience refer to the acquisition of the Gilts from RBS as "the first leg of the repo" and their disposal back to RBS as "the second leg of the repo"; to the Appellant's sale of the Gilts to JPMS on 13 February 2002 as "the Sale," and to her purchase of the Gilts from JPMS on 20 February 20032 as "the Purchase."
The deduction for the manufactured payment of interest pursuant to the repo arises under paragraph 3 of Schedule 23A to the Taxes Act 1988 (as substituted by Schedule 10 to the Finance Act 1997):
It should also be mentioned that s 727A (inserted by s 79 of the Finance Act 1995) prevents relief on the rebate amount on the first leg of the repo:
The way the scheme was intended to work is that the Appellant made a tax-free capital gain on the difference between the Sale (cum div) and the Purchase (ex div) to and from JPMS of the Gilts of £1,469,720. Pursuant to the repo she pays manufactured interest of £1,511,250 which is deductible from her total income, but she receives repo interest of £18,538.77 and additional interest of £1,038.86. Accordingly she claims tax relief on the balance of £1,491,672.50. (I should mention that s 108(5) of the Finance Act 2002 now limits the deduction to the extent that the payer is taxable under the accrued income scheme or repos.) Although in principle there is a charge to tax on the Sale under the accrued income scheme, the Appellant contends that the charge does not apply because of s 715(1)(b):
This contention is at first sight surprising since the nominal value of the Gilts was £31m, but the contention turns on there not being a day on which she held the Gilts within the accrued income scheme legislation.
The following provisions of s 710 are relevant to that question:
Mr Prosser and Mr Henderson contend
Mr Furness contends:
Section 710(7) in paragraph (a) determines that a person holds securities at a particular time if he is entitled to them at the time, thus incorporating the rule in subs (6) that time of entitlement is determined by the time of the agreement. Paragraph (b) envisages two possibilities, first that a person is entitled to securities throughout the day, which means that, again taking the timing from the agreement to buy or sell, he holds them at midnight on day 1 to midnight on day 2; and secondly, that he becomes and does not cease to be entitled to them on the day, meaning that while he was not entitled for the whole of the day, he was for the part of the day from the time of becoming entitled up to the end of the day. The distinction between the two parts is that the first looks at entitlement during the whole of the day and the second to entitlement during part of the day. Both parts of paragraph (b) operate by reference to the position at the end of the day. One determines whether a person holds securities at the end of the day by applying subss (6) and (7)(a). If therefore a person buys and sells (whether in that order or the sale preceding the purchase) securities during the course of a day, he does not hold them on that day. Once the deemed timing rule in subs (6) has been applied, the rules in subs (7) look to the reality of ownership for the whole day or a part of a day up to the end of the day. When applied to a short sale the reality is that the period of ownership is nonexistent. To say that one becomes and does not cease to be entitled on the day, implies that there is a period of ownership that starts during the day and continues until the end of the day. It is a misuse of language to say that the taxpayer ceases to be entitled to them before he became entitled. There is no need for the accrued income scheme to apply to a short sale. Mr Furness explained that if, for example, one sold a security for 100 with 1 of accrued interest and later bought it for 100 with accrued interest of 2, there was a charge on 1 on the sale and a potential rebate of 2 on the purchase, but only 1 of the rebate could be used by setting it against the charge of 1. Mr Prosser pointed out that the net result was the same as if the scheme did not apply to a short sale. It is not therefore surprising that the effect of applying subs (7) to a short sale is that a person does not hold securities on a day.
Mr Furness starts with a purposive interpretation of s 715(1)(b), that it is aimed at individuals with small holdings of securities, but when he comes to s 710(7) his interpretation is legalistic rather than purposive: he says that she did not cease to be entitled on the day to the Gilts to which she had become entitled on that day, because she ceased to be entitled to them on an earlier day, even though at the end of the day she was clearly not entitled to any Gilts by the application of subss (6) and (7)(a). On that interpretation the two paragraphs of subs (7) would be in conflict: para.(a) saying that she was not entitled to the Gilts at the end of the day, and para (b) saying that, although she had become entitled to the Gilts during the day she had not ceased to be entitled on the day. I prefer to look at the reality which is evident throughout subs (7). At the end of 20 February 2002 she was not entitled to any Gilts, so it cannot be said that she becomes and did not cease to be entitled to them on that day because that implies that she is still entitled to them at the end of the day. Does this interpretation conflict with a purposive interpretation of s 715(1)(b)? I do not think it does. That provision uses the concept of holding securities on a day, meaning either throughout, or at the end of, the day, thus bringing s 710(7) into play with the necessary consequence that a dealing in the course of a day in securities with a nominal value of more than £5,000 still satisfies the exception in s 715(1)(b). If the draftsman had been concerned about dealings of larger amounts in the course of a day he would not have used the concept of entitlement on a day. But there was no reason for him to have been concerned with dealings during a day because no income accrues during a day.
Accordingly, she was not entitled to the Gilts on any day within the meaning of s 710(7) and the relief in s 715(1)(b) applies.
Mr Furness has an alternative argument based on the obscure s 715(6):
Mr Furness analyses this as applying to the facts as follows:
Paragraph (a) relieves the Appellant from tax on a small amount of rebate interest in respect of the Purchase, but more importantly:
Sections 710 to 728 comprise the whole of the accrued income scheme. Accordingly since for the purpose for the accrued income scheme the Gilts are not treated as transferred by the Appellant (even though the words in brackets accept that they were in fact transferred), she must still be entitled to them on at the end of 20 February 2002 with the result that s 715(1)(b) is inapplicable.
Mr Prosser and Mr Henderson analyse the facts in two possible ways. The first is the same as Mr Furness's, although he draws a different conclusion, that the purpose of not being treated as transferring the securities is merely a way of removing a double charge. He quotes the following from Simon's Taxes §A7.520:
According to this explanation the purpose of s 715(6) is merely to avoid a double charge first under the manufactured payment rules, which at the time it was enacted arose because, in place of the current reference to paragraph 3 or 4 of Schedule 23A, it referred to s 737 under which the payer was treated as making an annual payment otherwise than out of taxed profits (so that tax had to be accounted for under s 350 or Schedule 16), [1] and secondly under the accrued income scheme. It achieves this by deeming there to have been no transfer for the purposes of the accrued income scheme, so that the scheme does not apply. The provision cannot be used to create a charge under the scheme.
Mr Prosser's and Mr Henderson's second analysis of the provision applying to the facts is as follows:
Accordingly there is no charge under the accrued income scheme on the Sale. Mr Furness contends that this is not a possible analysis because the reference to "any contract under which the securities are transferred to the seller" must be the same contract as is referred to at the beginning under which securities are transferred to the Appellant. In reply Mr Prosser points out that it says "any contract."
I consider that the explanation in Simon's Taxes is extremely helpful in determining the purpose of s 715(6), which is to prevent the accrued income scheme from applying in the circumstances stated. It does this by deeming there to have been no transfer. The purpose does not extend to saying that the consequence must be that the person is still entitled to the securities, seemingly for ever so that the Appellant could never rely on s 715(1)(b) in the future. I also raised the possibility of the absurd consequence of her being charged on death (which was applicable at the time) on the accrued income on the £33m of Gilts that she did not then actually own. The situation is closely analogous to that in Davies v Hicks [2005] STC 850 where (to simplify the facts slightly) the trustees (1) originally acquired 100,000 shares, (2) sold 100,000 of the same shares, (3) became non-resident, (4) bought 100,000 of the same shares and (5) sold 100,000 of the same shares. The identification rules for the computation of the gain matched (2) and (4), and matched (1) and (5). If this deeming was taken to its logical conclusion, the result was that the trustees were deemed to own shares at the time of (3) when they did not, thereby enabling there to be a deemed disposal of them under a different provision. As Park J said at [26]:
There the deeming rule relating to identification of shares was being used by the Revenue to argue that the taxpayer owned shares that at the time he did not own for the purpose of giving rise to a charge under a different provision. Here the effect is more extreme: a deeming rule that there has been no transfer of securities having the purpose of eliminating a charge under the accrued income scheme is being used by the Revenue to argue that the Appellant must still be entitled to the securities at the end of the day in order to give rise to a charge under the accrued income scheme. The reason against both arguments is the same, that they go far beyond the purpose of the deeming; indeed, in this case they have the opposite effect from the purpose of the deeming.
Accordingly, I consider that s 715(6) is a deeming provision whose purpose is to prevent a double charge by removing any charge under the accrued income scheme by the mechanism of deeming there to have been no transfer (while recognising by the words in brackets that there has in fact been one). It would be going beyond the purpose of the deeming to argue that if since has been no transfer the Appellant must own the Gilts at the end of 20 February 2002 and indeed for ever. I therefore agree with Mr Prosser's first interpretation of the provision. It is not necessary for me to decide whether his alternative analysis also applies.
The result is that:
and I allow the appeal in principle.
SC 3305/05
Authorities referred to in skeletons and not referred to in the decision:
Molineaux v The London, Birmingham and Manchester Insurance Co [1902] 2 KB 589
Note 1 The subsequent history is somewhat complicated. FA 1991 Sch 13 para3 redrafted s 737 and excluded the treatment of manufactured interest as an annual payment where the payer was a UK resident company; and TA 1988 Sch 23A was added, para 3(2) of which treated the manufactured payment by a UK company as one of interest, and in other cases taxed the recipient on it as interest. FA 1994 s 123 added after s 737 in s 715(6) “or paras 3 or 4 of Sch 23A.” FA 1995 added para 3A of Sch 23A to which para 3 was made subject, so that a manufactured interest payment in respect of gilts became for both parties a payment of interest on the gilts. FA 1997 Sch 10 para 8 repealed s 737, and para.11 changed para 3 of Sch 23A to its then current form (see paragraph 17 of this Decision) [Back]