FIRST DIVISION, INNER HOUSE, COURT OF SESSION
Lord President
Lady Cosgrove
Lord Eassie
XA73/02
OPINION OF THE COURT
delivered by THE LORD PRESIDENT
in
APPEAL TO THE COURT OF SESSION AS THE COURT OF EXCHEQUER IN SCOTLAND
under
section 56A(1) of the Taxes Management Act 1970
from
a decision of the Special Commissioners of Income Tax dated 4 April 2002 and communicated to the appellants on 4 April 2002
by
COMMISIONERS OF INLAND REVENUE
Appellants;
against
THE SCOTTISH PROVIDENT INSTITUTION
Respondents;
_______
Act: Moynihan, Q.C., Paterson; Solicitor of Inland Revenue (Appellants)
Alt: Tyre, Q.C.; Maclay Murray & Spens (Respondents)
July 2003
due 7 December 2000 at an option price of 70% of the par value of the bonds plus accrued interest. The option was exercisable by Citibank at any time between 30 August 1995 and 1 April 1996. The premium for the option was £29,750,000 payable to the respondents on 5 July 1995. Provision was made for notice of the exercise of the option to be given. In that event the bonds were to be delivered in exchange for payment.
"an amount of pounds sterling equal to the bond entitlement of Transaction A multiplied by the difference between the option strike price of Transaction A and the option strike price of Transaction B".
This amounted, in broad terms, to £20m. Under the agreement it fell to be repaid by Citibank, without interest, on the earlier of the day on which the option under Transaction A was exercised and 1 April 1996.
"(1) Where, as regards a qualifying contract held by a qualifying company and an accounting period, amount A exceeds amount B, a profit on the contract of an amount equal to the excess accrues to the company for the period.
(2) Where, as regards a qualifying contract held by a qualifying company and an accounting period, amount B exceeds amount A, a loss on the contract of an amount equal to the excess accrues to the company for the period".
Section 154(1) provides that, subject to certain exceptions, with which we are not concerned, any company is a "qualifying company" for the purposes of chapter II.
"Where as regards a qualifying contract a qualifying company's profit or loss for an accounting period falls to be computed on a mark to market basis incorporating a particular method of valuation -
(a) amount A is the aggregate of -
(i) the amount or aggregate amount of the qualifying payment or
payments becoming due and payable to the company in the period, and
(ii) any increase for the period, or the part of the period for which
the contract is held by the company, in the value of the contract as determined by that method, and
(b) amount B is the aggregate of -
(i) the amount or aggregate amount of the qualifying payment or
payments becoming due and payable by the company in the period, and
(ii) any reduction for the period, or the part of the period for which
the contract is held by the company, in the value of the contract as so determined".
"(a) computing the profits or losses on the contract on that basis is in
accordance with normal accountancy practice;
(b) all relevant payments under the contract are allocated to the accounting
periods in which they become due and payable; and
(c) the method of valuation adopted is such as to secure the contract is
brought into account at a fair value".
"(1) For the purposes of this Chapter a debt contract or option is a qualifying contract as regards a qualifying company if the company becomes entitled to rights, or subject to duties, under the contract or option at any time on or after 1st April 1996.
(2) For the purposes of this Chapter a qualifying company which is entitled to rights, or subject to duties, under a debt contract or option both immediately before and on 1 April 1996 shall be deemed to have become entitled or subject to those rights or duties on that date".
Subsection (3) states that the section has effect subject to the transitional provisions contained in paragraph 25 of Schedule 15 to the 1996 Act.
"(a) a payment of an amount representing the price for becoming a party to
the [loan] relationship;
(b) a payment of an amount determined by reference to the value at any
time of the money debt by reference to which the relationship subsists;
(c) a settlement payment of an amount determined by reference to the
difference at specified times between -
(i) the price for becoming a party to the relationship; and
(ii) the value of the money debt by reference to which the
relationship subsists, or (if the relationship were in existence) would subsist".
"where a qualifying contract -
(a) becomes held by a qualifying company at any time in an accounting
period, or
(c) ceases to be so held at any such time,
it shall be assumed for the purposes of subsection (4) above that its value is nil immediately after it becomes so held or, as the case may be, immediately before it ceases to be so held".
It appears that the general purpose of this provision is to avoid the duplication between payments and changes in value in the accounting which is required by subsection (4). In this connection, as we will explain later in this Opinion, reference was made to section 177(2) of the 1994 Act, as amended by the 1996 Act, which provides:
"For the purposes of this Chapter -
(a) a company becomes entitled to rights or subject to duties under an
interest rate contract or option, a currency contract or option or a debt contract or option when it becomes party to the contract or option; and
(b) a company holds such a contract or option at a particular time if it is
then entitled to rights or subject to duties under it;
and it is immaterial for the purposes of paragraph (b) above when the rights or duties fall to be exercised or performed".
"(1) was it appropriate to compute profit and loss on each of
Transaction A and Transaction B on a mark to market basis?
(2) was each of Transaction A and Transaction B a qualifying contract?
(3) was it appropriate when applying a mark to market basis to attach a nil
value to each of these transactions on the morning of 1 April 1996? and
(4) was it appropriate to exclude from the computation the Collateral
Amount of £20m?".
(1) Was it appropriate to compute profit and loss on each of Transaction A and Transaction B on a mark to market basis?
"The fact that steps taken for the avoidance of tax are acceptable or unacceptable is the conclusion at which one arrives by applying the statutory language to the facts of the case. It is not a test for deciding whether it applies or not".
Mr. Moynihan criticised the Special Commissioners for taking an unduly restrictive view. It was wrong for them to conclude, as they indicated in paragraph 35 of their decision, that a commercial approach was inappropriate simply because the legislation was complex.
"It is a statement of the consequences of giving a commercial construction to a fiscal concept. Before one can apply Lord Brightman's words, it is first necessary to construe the statutory language and decide that it refers to a concept which Parliament intended to be given a commercial meaning capable of transcending the juristic individuality of its component parts".
Further, Lord Nicholls of Birkenhead remarked, at paragraph 7, that observations such as those of Lord Brightman should be read in the context of the particular statutory provisions and sets of facts under consideration:
"In particular, they cannot be understood as laying down factual pre-requisites which must exist before the court may apply the purposive, Ramsay approach to the interpretation of a taxing statute".
He went on to state in paragraph 8 that:
" ... the Ramsay approach is no more than a useful aid. This is not an area for absolutes. The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case".
"there was a genuine commercial possibility of movement of interest rates and gilt prices such that it would be in Citibank's commercial interests to either refrain from exercising option A or exercising or attempting to exercising ( sic ) it on a date different from the exercise by the [respondents] of option B. There was a genuine commercial possibility and a real practical likelihood that the two options would be dealt with separately. Likewise, there was a genuine commercial possibility and a real practical likelihood that option B would not be exercised by the [respondents]". (Paragraph 5/18 cf. paragraph 24).
In paragraph 25 they stated with reference to the options:
"They were genuine transactions under which the parties could make a profit or loss even though the expectation was that they would not".
Mr. Moynihan submitted, however, that the Special Commissioners had failed to consider the substance of the scheme as opposed to its form. They had applied too much weight to the options and not paid attention to the other parts of the scheme which were designed to achieve a nil result.
"they did it for tax reasons, not in any expectation of making a profit from the price of gilt falling below 90, but the point is that they did something that had a sufficient degree of uncertainty attached to it that we cannot ignore what they did".
Mr. Moynihan submitted that it was entirely incorrect to say that Citibank were holding out a profit in return for the fee which they received. The fee was simply a premium for the scheme, including any hedging cost (paragraphs 4, 6 and 24), and it made sense only if it was so considered. It bore no relationship to the possible measure of profit. It was not reasonable for the Special Commissioners to regard it as a fee for the options. It was a part of a wider whole. The Special Commissioners had wrongly attributed to the transactions the appearance of a genuine speculative venture which could lead to profit or loss. It was wrong to categorise the possibility of profit or loss as commercial, since it gave the scheme no more than the semblance of commerciality. Mr. Moynihan also maintained that it was inaccurate for the Special Commissioners to state, as they did in paragraph 5/18, that the premiums were negotiated at market rates, since the fee of £60,000 had been added to the premium for Transaction B.
"lay not in the fact that the object of the exercise was to save tax but in the approach of the court as a matter of construction to a devised combination of events designed to produce an actual result quite different from that which, for fiscal purposes, it was intended to display."
The argument for the appellants in the present case resembled the submission on behalf of the Revenue which had been rejected in MacNiven (see Lord Hoffmann at paragraphs 27-29), and the approach taken by Lord Templeman in his dissenting speech in Craven v. White at page 492 where he said:
"First, the taxpayer must decide to carry out, if he can, a scheme to avoid an assessment of tax on an intended taxable transaction by combining with a prior tax avoidance transaction. Secondly, the tax avoidance transaction must have no business purpose apart from the avoidance of tax on the intended taxable transaction. Thirdly, after the tax avoidance transaction has taken place, the taxpayer must retain power to carry out his part of the intended taxable transaction. Fourthly, the intended taxable transaction must in fact take place".
Accordingly expressions such as "a commercial approach", "commercial validity", and "failure to address the scheme as a whole" indicated an attempt to apply the wrong test (cf. Carnwath L.J. in Barclays Mercantile Business Finance Ltd. v. Mawson [2003] S.T.C.66 at paragraphs 60 et seq ).
"no practical likelihood that the pre-planned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated practically as having an independent life".
The Special Commissioners had been correct in applying this test, which was the basis for the decision in Griffin v. City Bank Investments . The observations of Lord Brightman in Furness v. Dawson remained authoritative in regard to the question whether there was a composite transaction. It was plain that the question of practical likelihood required to be considered as at the time when the transactions were entered into and not, as was suggested by the appellants at one stage of their argument, by reference to the end result.
"If a transaction falls within the legal description, it makes no difference that it has no business purpose. Having a business purpose is not part of the relevant concept".
"unlikely but not so unlikely that one could say that there was no practical likelihood of its occurring, and accordingly that there was a genuine practical likelihood or to put it another way a genuine commercial possibility that the [respondents] would not exercise option B". (Paragraph 24)
As regards the Collateral Amount, while it acted as a disincentive to Citibank's exercise of their option, it did not remove the possibility that Citibank would exercise that option at an early stage.
(2) Was each of Transaction A and Transaction B a "qualifying contract" as at 1 April 1996?
(3) Was it appropriate, when applying a mark to market basis to attach a nil value to each option on the morning of 1 April 1996?
"It seems to us that since by section 177(2)(b) a company holds a contract at a particular time if it is then entitled to rights or subject to duties under it, it follows that where a company is deemed to have become entitled to rights under a contract on 1 April 1996, the contract is deemed to have become held on that date so as to make section 155(7) applicable".
(4) Was it appropriate to exclude from the computation the Collateral Amount of £20m?