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    Commercial concepts in tax legislation

    33. There is nothing new about terms used in tax legislation (or, for that matter, any legislation) being construed as referring to business or commercial concepts which may not be capable of being held within the confines of purely juristic analysis. A good example is the term "profits or gains of the year of assessment" which forms the basis of the charge to tax under Case I of Schedule D: see section 60 of the Income and Corporation Taxes Act 1988. In Sun Insurance Office v Clark [1912] AC 443, 455, Viscount Haldane said:

"It is plain that the question of what is or is not profit or gain must primarily be one of fact, and of fact to be ascertained by the tests applied in ordinary business."

    34. It is thus the statute itself which applies the tests of ordinary business. And for present purposes, the significant feature of applying a test of ordinary business is that it may require an aggregation of transactions which transcends their juristic individuality. In Southern Railway of Peru Ltd v Owen [1957] AC 334 the question was whether, in calculating its profits or gains for a year of assessment, a company could make a provision for severance pay contingently payable to its employees. The revenue argued that each contract of employment had to be separately examined and no liability could be taken into account unless it had fallen due. Lord Radcliffe rejected this approach, at p 357:

"The answer to the question what can or cannot be admitted into the annual account is not provided by any exact analysis of the legal form of the relevant obligation. In this case, as in the Sun Insurance case ([1912] A.C. 443), you get into a world of unreality if you try to solve your problem in that way, because, where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision."

    35. My Lords, it seems to me that what Lord Wilberforce was doing in the Ramsay case [1982] AC 300 was no more (but certainly no less) than to treat the statutory words "loss" and "disposal" as referring to commercial concepts to which a juristic analysis of the transaction. treating each step as autonomous and independent, might not be determinative. What was fresh and new about Ramsay was the realisation that such an approach need not be confined to well recognised accounting concepts such as profit and loss but could be the appropriate construction of other taxation concepts as well.

    The American doctrine

    36. Lord Wilberforce, while cautioning against a facile transposition of American decisions on different statutes, approved the approach of Judge Learned Hand in one of his many judgments dealing with tax avoidance schemes: Gilbert v Commissioner of Inland Revenue (1957) 248 F2d 399. Perhaps the seminal judgment was in Helvering v Gregory 69 (1934) F2d 809, affirmed (1935) 293 US 465, which concerned a scheme of great simplicity. The taxpayer was a stockholder in a corporation which held some shares which she wished to realise without paying tax on the gains. Instead of having the corporation sell the shares directly to the buyer, she caused it to incorporate a subsidiary and exchange the shares for an allotment of shares in the subsidiary. The subsidiary was put into liquidation and distributed the shares to the stockholder as a dividend. She then sold them to the buyer. She claimed that the exchange of shares fell within the tax exemption for a "reorganization" of capital. On the other hand, the exchange was real enough to constitute a realisation of the gain, so that no further gain was realised on the distribution to her. In the Court of Appeals (Second Circuit) Judge Learned Hand said, at p. 811, that the transfer to the subsidiary did not fall within the terms of the statutory exemption:

"we cannot treat as inoperative the transfer of . . . shares by [A] [or] the issue of shares by [B] of its own shares… [B] had a juristic personality…All these steps were real, and, their only defect was that they were not what the statute means." (My emphasis).

    37. What, in that case, did the statute mean? The Supreme Court of the United States affirmed the decision in a single judgment delivered by Sutherland J "Reorganization", he said, meant a reorganization of the business of a corporation, having some business purpose. An exemption from tax could not be construed as applicable to a transaction with no business purpose except to obtain the exemption from tax.

    38. In the Ramsay case [1982] AC 300 both Lord Wilberforce and Lord Fraser of Tullybelton, who gave the other principal speech, were careful to stress that the House was not departing from the principle in the Duke of Westminster's case [1936] AC 1. There has nevertheless been a good deal of discussion about how the two cases are to be reconciled. How, if the various juristically discrete acquisitions and disposals which made up the scheme were genuine, could the House collapse them into a composite self-cancelling transaction without being guilty of ignoring the legal position and looking at the substance of the matter?

    39. My Lords, I venture to suggest that some of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster's case arises out of an ambiguity in Lord Tomlin's statement that the courts cannot ignore "the legal position" and have regard to "the substance of the matter". If "the legal position" is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business "substance" of the matter is not to ignore the legal position but to give effect to it.

    The real world.

    40. The speeches in the Ramsay case [1982] AC 300 and subsequent cases contain numerous references to the "real" nature of the transaction and to what happens in "the real world". These expressions are illuminating in their context, but you have to be careful about the sense in which they are being used. Otherwise you land in all kinds of unnecessary philosophical difficulties about the nature of reality and, in particular, about how a transaction can be said not to be a "sham" and yet be "disregarded" for the purpose of deciding what happened in "the real world". The point to hold onto is that something may be real for one purpose but not for another. When people speak of something being a "real" something, they mean that it falls within some concept which they have in mind, by contrast with something else which might have been thought to do so, but does not. When an economist says that real incomes have fallen, he is not intending to contrast real incomes with imaginary incomes. The contrast is specifically between incomes which have been adjusted for inflation and those which have not. In order to know what he means by "real", one must first identify the concept (inflation adjustment) by reference to which he is using the word.

    41. Thus in saying that the transactions in the Ramsay case were not sham transactions, one is accepting the juristic categorisation of the transactions as individual and discrete and saying that each of them involved no pretence. They were intended to do precisely what they purported to do. They had a legal reality. But in saying that they did not constitute a "real" disposal giving rise to a "real" loss, one is rejecting the juristic categorisation as not being necessarily determinative for the purposes of the statutory concepts of "disposal" and "loss" as properly interpreted. The contrast here is with a commercial meaning of these concepts. And in saying that the income tax legislation was intended to operate "in the real world", one is again referring to the commercial context which should influence the construction of the concepts used by Parliament.

    The Burmah case

    42. There is no doubt that the Ramsay case [1982] AC 300 was widely regarded as some form of judicial legislation and the concerns of taxpayers about its true scope of and its relationship with the Duke of Westminster's case [1936] AC 1 were not set at rest by what some regarded as the proclamation of a revolutionary credo by Lord Diplock in Inland Revenue Commissioners v Burmah Oil Co Ltd (1981) 54 TC 200, 214-215:

"It would be disingenuous to suggest, and dangerous on the part of those who advise on elaborate tax-avoidance schemes to assume, that Ramsay's case did not mark a significant change in the approach adopted by this House in its judicial role to a pre-ordained series of transactions (whether or not they include the achievement of a legitimate commercial end) into which there are inserted steps which have no commercial purpose apart from the avoidance of a liability to tax which in the absence of those particular steps that have been payable.…[T]he approach to tax avoidance schemes of this character sanctioned by Ramsay entitles your Lordships to ignore the intermediate circular book entries and to look at the end result..."

    43. The Burmah case also concerned the question of whether the company had suffered a loss for the purposes of capital gains tax. As in the Ramsay case, it had produced a loss by a circular series of transactions which had no business purpose. A subsidiary owed it a substantial sum which it could not repay. As a bad debt on capital account, this would not have been an allowable loss. Burmah therefore invested the same amount in shares in the subsidiary, which used the money to repay the debt and then went into liquidation. Burmah recovered nothing on its share investment and claimed that it had thereby suffered a loss. The House of Lords held that this was not a loss caused by a disposal within the meaning of the Act. The transaction left Burmah no worse off than it had been before and merely purported to convert a bad debt into an allowable loss.

    44. My Lords, in retrospect the Burmah case is an entirely straightforward application of the construction which the Ramsay case gave to the concept of a disposal giving rise to a loss in the capital gains tax legislation, namely that it meant a loss in commercial terms and not a series of preplanned transactions which had no business purpose. From this construction it followed that, as Lord Diplock said, the House would "ignore the intermediate circular book entries and . . . look at the end result". Lord Diplock would have been the first to acknowledge that his remarks should be read in context. To "ignore" the intermediate stages of the transaction and look at the end result is something which follows logically from the decision to construe "disposal" and "loss" in a commercial sense which transcends the individuality of the "book entries". It is that decision, to give the statutory language such a construction, which I would regard as "the Ramsay principle". But I think that there may have been a tendency to construe Lord Diplock's statement of the consequences of applying the Ramsay principle to the particular provisions with which the House was concerned as if it were itself a general principle, applicable to all tax legislation. Of course such a construction could also be applied to other provisions of the taxing Acts, but this would depend upon their language and purpose. At any rate, the generalising tendency which I have described seems to me the most likely explanation of the proposition which Mr McCall has claimed to be the Ramsay principle in this appeal.

    Furniss v Dawson

    45. My Lords, in Furniss v Dawson [1984] AC 474 the Ramsay construction, which in the Ramsay case itself and the Burmah case had been used to interpret the concept of a disposal giving rise to a loss, was deployed for a different purpose. The difference is occasionally described by saying that whereas Ramsay was a circular transaction, Furniss was a linear transaction. The difference can conveniently be encapsulated in these metaphors, but I think it is more illuminating to concentrate on the question which the legislation required the House to answer. To explain what this was, it is first necessary to give a brief account of the facts. The Dawsons wanted to sell their shares in the family business to a company called Wood Bastow Holdings Ltd. But they wanted to postpone the payment of capital gains tax. So they formed an Isle of Man company ("Greenjacket") and exchanged their shares in the company owning the business for an allotment of shares in Greenjacket. The advantage of this transaction was that by paragraph 6 of Schedule 7 to the Finance Act 1965, a disposal of shares to Greenjacket in exchange for an allotment of its shares was treated as a reorganisation of share capital and by paragraph 4 of the same Schedule a disposal of shares forming part of a reorganisation was not treated as a disposal for the purposes of capital gains tax. By a preplanned transaction, Greenjacket then sold the shares to Wood Bastow for cash. But the Revenue claimed that there had been no "real" disposal to Greenjacket. It was merely a preplanned stage in a disposal from the Dawsons to Wood Bastow and fell outside the exception for a reorganisation of share capital.

    46. Thus, while the question in the Ramsay case had been whether there was a disposal giving rise to a loss, the question in the Furniss case was whether the disposal had been to one person rather than another. But the House decided that the Ramsay construction, involving, as I have said, a commercial characterisation of the relevant concept, could be equally applied to the latter question. Greenjacket was merely an artificially introduced intermediate party which was never intended to own the shares for more than an instant. Commercially, therefore, the transaction was a transfer by the Dawsons to Wood Bastow in exchange for a payment to Greenjacket. In answering the statutory question: "To whom was the disposal made?" the fact that the shares were routed through Greenjacket was irrelevant.

    47. The consequence of adopting this construction was spelled out by Lord Brightman [1984] AC 474, 527 in a passage which paraphrased what Lord Diplock had said in the Burmah case 54 TC 200 and has since been quoted many times. He stated the conditions under which the commercial nature of the transaction as a whole would transcend the juristic individuality of its parts:

"First, there must be a pre-ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (ie business) end. The composite transaction does, in the instant case; it achieved a sale of the shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay. Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax - not 'no business effect'. If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied."

    48. My Lords, this statement is a careful and accurate summary of the effect which the Ramsay construction of a statutory concept has upon the way the courts will decide whether a transaction falls within that concept or not. If the statutory language is construed as referring to a commercial concept, then it follows that steps which have no commercial purpose but which have been artificially inserted for tax purposes into a composite transaction will not affect the answer to the statutory question. When Lord Brightman said that the inserted steps are to be "disregarded for fiscal purposes", I think that he meant that they should be disregarded for the purpose of applying the relevant fiscal concept. In the Furniss case, this was the concept of a disposal by one person to another. For that purpose, and for that purpose only, the disposal to Greenjacket was disregarded. But that does not mean that it was treated, even for tax purposes, as if it had never happened. The payment by Wood Bastow was undoubtedly to Greenjacket and so far as this might be relevant for tax or any other purposes, it could not be disregarded.

    49. For present purposes, however, the point I wish to emphasise is that Lord Brightman's formulation in the Furniss case, like Lord Diplock's formulation in the Burmah case, is not a principle of construction. 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. But there are many terms in tax legislation which cannot be construed in this way. They refer to purely legal concepts which have no broader commercial meaning. In such cases, the Ramsay principle can have no application. It is necessary to make this point because, in the first flush of victory after the Ramsay, Burmah and Furniss cases, there was a tendency on the part of the Inland Revenue to treat Lord Brightman's words as if they were a broad spectrum antibiotic which killed off all tax avoidance schemes, whatever the tax and whatever the relevant statutory provisions.

    50. The distinction between commercial and legal concepts has also been drawn in other areas of legislation. So, for example, the term "financial assistance" in section 151 of the Companies Act 1985 has been construed as a commercial concept, involving an inquiry into the commercial realities of the transaction: see Burton v Palmer (1980) 2 NSWLR 878, 889-890; Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1. But the same is not necessarily true of other terms used in the same section, such as "indemnity". As Aldous LJ said in Barclays Bank Plc v British & Commonwealth Holdings Plc [1996] 1 WLR 1, 14:

"It was submitted that as the words 'financial assistance' had no technical meaning and their frame of reference was the language of ordinary commerce, the word 'indemnity' should be similarly construed. The fallacy in that submission is clear. The words 'financial assistance' are not words which have any recognised legal significance whereas the word 'indemnity' does. It is used in the section as one of a number of words having a recognised legal meaning."

I would only add by way of caution that although a word may have a "recognised legal meaning", the legislative context may show that it is in fact being used to refer to a broader commercial concept.

    Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991

    51. In the McGuckian case a Republic of Ireland company called Ballinamore had substantial distributable reserves. The shareholders, Mr and Mrs McGuckian, wanted to receive this money but not to pay income tax on the dividend. So they entered into a scheme by which they first transferred their shares to an offshore trustee called Shurltrust. By a series of preplanned transactions, it then assigned the right to receive the dividend to a UK company called Mallardchoice in consideration of the payment of a sum equal to 99% of the expected dividend. Ballinamore then declared the dividend and paid it to Mallardchoice, which immediately paid 99% to Shurltrust.

    52. The statutory question was whether Shurltrust had received income or capital. If it was income, the effect of various tax avoidance provisions concerning the transfer of assets abroad was that the payment would be deemed to be income of the McGuckians. If it was capital, the McGuckians would not be liable for tax. The McGuckians said that if Shurltrust had simply received the dividend, it would of course have been income. But Shurltrust did not receive the dividend. It received a payment from Mallardchoice which was a capital payment for an assignment of its right to income.

    53. The Inland Revenue's argument, relying upon the formulation in the Furniss case [1984] AC 474 was that the assignment should be disregarded. The Northern Ireland Court of Appeal said (not, if I may respectfully say so, without justification) that one could not simply "disregard" the assignment. The payment of the money by Mallardchoice to Shurltrust was the consideration for the assignment and an integral part of that transaction. If the assignment had to be disregarded, one could not explain how Shurltrust had received any money at all.

    54. It seems to me that the Crown caused unnecessary difficulties for itself in the McGuckian case by failing to notice that the question was different from that in Furniss v Dawson and therefore did not necessarily respond to precisely the same analysis. In the Furniss case the question was the identity of the disponee. In the McGuckian case it was the nature of the payment received by Shurltrust - capital or income? In the former case, it is reasonable to speak of the middle stage of a chain of disposals being "disregarded". In the latter case, it makes much less sense. The question was not whether the assignment should be disregarded but whether, from a commercial point of view, it amounted to an exchange of income for capital. Such exchanges usually have a commercial reality: the purchase or sale of an annuity, for example, is an exchange of capital for an income stream, involving a transfer of risk. But the transaction in the McGuckian case was nothing more than an attempt to relabel a sum of money. The fact that the assignment had no commercial purpose did not mean that it had to be disregarded. But it failed to perform the alchemy of transforming the receipt of a dividend from the company into the receipt of a capital sum from someone else. For the purpose of the fiscal concept at stake, namely the character of the receipt as income derived from the company, it made no difference.

    55. My Lords, I think that it was for these reasons that their Lordships in the McGuckian case went back to Lord Wilberforce's analysis in the Ramsay case [1982] AC 300 and tried to identify the principle of construction in play. Lord Steyn said that the decision marked a shift away from literalism to a "broad purposive interpretation" and from "formalistic insistence on examining steps in a composite scheme separately" to "a more realistic legal analysis": [1997] 1 WLR 991, 999-1000. Lord Cooke of Thorndon suggested, at p 1005, that it was:

"an application to taxing Acts of the general approach to statutory interpretation whereby, in determining the natural meaning of particular expressions in their context, weight is given to the purpose and spirit of the legislation."

    56. My Lords, these are valuable insights and I respectfully suggest that particular attention should be paid to the way Lord Cooke of Thorndon dealt with the criteria stated by Lord Brightman in Furniss v Dawson:

"Lord Brightman spoke of certain limitations (a pre-ordained series of transactions including steps with no commercial or business purpose apart from the avoidance of a liability to tax). The present case does fall within these limitations, but it may be as well to add that, if the ultimate question is always the true bearing of a particular taxing provision on a particular set of facts, the limitations cannot be universals. Always one must go back to the discernible intent of the taxing Act. I suspect that the advisers of those bent on tax avoidance...do not always pay sufficient heed to the theme in the speeches in the Furniss case...to the effect that the journey's end may not yet have been found."

    57. I would only add that it is not only tax avoiders who may not pay sufficient heed to the necessity of concentrating on the application of the particular taxing provision to the particular facts. The Inland Revenue sometimes also fails to do so. The journey's end may be different because the journey itself is not the same.

    The limits of Ramsay.

    58. The limitations of the Ramsay principle therefore arise out of the paramount necessity of giving effect to the statutory language. One cannot elide the first and fundamental step in the process of construction, namely to identify the concept to which the statute refers. I readily accept that many expressions used in tax legislation (and not only in tax legislation) can be construed as referring to commercial concepts and that the courts are today readier to give them such a construction than they were before the Ramsay case. But that is not always the case. Taxing statutes often refer to purely legal concepts. They use expressions of which a commercial man, asked what they meant, would say "You had better ask a lawyer". For example, stamp duty is payable upon a "conveyance or transfer on sale": see Schedule 13, paragraph 1(1) to the Finance Act 1999. Although slightly expanded by a definition in paragraph 1(2), the statutory language defines the document subject to duty essentially by reference to external legal concepts such as "conveyance" and "sale". 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. If the "disregarded" steps in Furniss v Dawson [1984] AC 474 had involved the use of documents of a legal description which attracted stamp duty, duty would have been payable.

    59. Even if a statutory expression refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax reasons. Business concepts have their boundaries no less than legal ones. Thus in two of the cases considered in Craven v White [1989] AC 398 the House was unanimously of the view that although there had been an initial disposal with no commercial purpose, except to lay the ground for an avoidance of tax if and when there should be a further disposal to a third party, the transactions were so separate in fact as well as in law as to make it impossible to treat them, even in a commercial sense, as a single disposal to the third party. The lapse of time between the two transactions, the lack of contemplation of any specific later disposal at the time of the first transaction, were commercial realities. The division of opinion in the House over how the third transaction should be categorised did not detract from the agreement that it had to fall within the statutory language.