(back to preceding text)

    60. Likewise the use of business concepts like "income" and "capital" may give the taxpayer a choice of structuring a commercial transaction so as to come within one concept or the other. As Lord Greene MR said in a celebrated passage in Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11, 16:

"In dealing with income tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted, tax will be payable. If the other method is adopted, tax will not be payable. It is sufficient to refer to the quite common case where property is sold for a lump sum payable by instalments. If a piece of property is sold for £1,000 and the purchase price is to be paid in ten instalments of £100 each, no tax is payable. If, on the other hand, the property is sold in consideration of an annuity of £100 a year for ten years, tax is payable. The net result from the financial point of view is precisely the same in each case, but one method of achieving it attracts tax and the other method does not."

    61. It follows that a transaction which, for the avoidance of tax, has been structured to produce, say, capital, and does produce capital in the ordinary commercial sense of that concept (unlike the payment in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991) cannot be "recharacterised" as producing income: see Commissioner of Inland Revenue v Wattie [1999] 1 WLR. 873.

    Tax mitigation and tax avoidance.

    62. My Lords, it has occasionally been said that the boundary of the Ramsay principle can be defined by asking whether the taxpayer's actions constituted (acceptable) tax mitigation or (unacceptable) tax avoidance. In Inland Revenue Commissioners v Willoughby [1997] AC 1071, 1079 Lord Nolan described the concept of tax avoidance as "elusive". In that case, the House had to grapple with what it meant, or at any rate what its "hallmark" was, because the statute expressly provided that certain provisions should not apply if the taxpayer could show that he had not acted with "the purpose of avoiding liability to taxation". The same question arises on the interpretation of the anti-avoidance provisions to which Lord Cooke of Thorndon referred in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1005. But when the statutory provisions do not contain words like "avoidance" or "mitigation", I do not think that it helps to introduce them. 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. If I may be allowed to repeat what I said in Norglen Ltd v Reeds Rains Prudential Ltd [1999] 2 AC 1, 13-14:

"If the question is whether a given transaction is such as to attract a statutory benefit, such as a grant or assistance like legal aid, or a statutory burden, such as income tax, I do not think that it promotes clarity of thought to use terms like stratagem or device. The question is simply whether upon its true construction, the statute applies to the transaction. Tax avoidance schemes are perhaps the best example. They either work (Inland Revenue Commissioners v Duke of Westminster [1936] AC 1) or they do not (Furniss v Dawson [1984] AC 474.) If they do not work, the reason, as my noble and learned friend, Lord Steyn, pointed out in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1000, is simply that upon the true construction of the statute, the transaction which was designed to avoid the charge to tax actually comes within it. It is not that the statute has a penumbral spirit which strikes down devices or stratagems designed to avoid its terms or exploit its loopholes."

    The present case: the appeal to Carnwath J [1997] STC 1103

    63. My Lords, after what I fear was a lengthy analysis of the Ramsay principle I return to the present appeal. Carnwath J, who allowed an appeal from the Special Commissioners, said that the case was very much like Inland Revenue Commissioners v Burmah Oil Co. Ltd 54 TC 200. In that case, the transaction left Burmah no worse off than it had been before and merely purported to convert a bad debt into an allowable loss. Similarly in this case, said Carnwath J, the transaction made no difference to the scheme or WIL but merely purported to convert an unpaid interest debt into a payment which could be deducted. In so doing, he treated the passage in the speech of Lord Diplock which I have already quoted (and the similar passage in the speech of Lord Brightman in the Furniss case) as being of general application, irrespective of the nature of the concept to which the statute refers.

    64. My Lords, I can see that one could read these passages in such broad terms. But I do not think that it would be consistent with treating Ramsay as a principle of construction. In my opinion, what the Burmah case decided was that the statutory concept of a loss accruing upon a disposal has a business meaning and that the "disposal" and "loss" suffered by Burmah did not fall within it. To apply this reasoning to the present case, it would be necessary to construe the concept of payment in section 338 as having some business meaning other than the simple discharge of a debt. Otherwise one is not giving effect to the statutory language.

    The Court of Appeal [1998] STC 1131

    65. The Court of Appeal unanimously allowed the appeal. Peter Gibson LJ said that the question of whether the interest in this case had been "paid" could not be solved by using the same technique as had been used to decide whether there had been a "loss" in the Burmah case:

"In other areas where fiscal legislation has provided for payment as an act significant for tax purposes and payment, within the meaning which the law would ordinarily give to it, has occurred, the courts have been reluctant to accept that the Ramsay principle required the fact of payment to be ignored." (p 1144)

    66. He referred to Cairns v MacDiarmid (1982) 56 TC 556, 576 and Customs and Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905. I shall return to these cases later. Peter Gibson LJ said there was nothing in the Taxes Act to suggest that "paid" should be construed to mean anything more than that the interest obligation had been discharged, wherever the money had come from. Pill LJ delivered a concurring judgment and Mummery LJ agreed.

    67. My Lords, payment of a debt such as interest ordinarily means an act, such as the transfer of money, which discharges the debt. It is accepted that in this case the interest debt was indeed discharged. So why did this not count as payment for the purposes of the Act? One of the difficulties which I have with the argument for the Crown is that I find the alternative concept of payment for which it contends completely elusive. It is easy to understand a commercial sense of a loss which treats as irrelevant the fact that one part of a composite transaction produced a loss which was never intended to be more than momentary and theoretical. But what is the commercial concept of payment of a debt which treats as irrelevant the fact that the debt has been discharged? Mr McCall does not contend that payment must involve a negative cash flow which is not compensated by a cash flow in the opposite direction. He accepts, for example, that many commercial refinancing operations discharge old debts and create new ones without any cash flow either way. Nor is there any apparent policy to be found in section 338 which would require a negative cash flow. Otherwise, why should bank interest be deductible without any payment at all? As I have already said, the only apparent reason for the insistence on payment of yearly interest is that payment gives rise to an obligation to deduct tax. In the present case, WIL complied with that obligation. The Crown's real complaint is that the scheme, as an exempt fund, was able to reclaim the tax. But this cannot be remedied by giving the word "paid" a different meaning in the case of a payment to an exempt lender. The word must mean the same, whatever the status of the lender.

    68. What the Crown finds objectionable is the circularity of the cash flow combined with the fact that the transaction took place entirely for tax purposes. And I accept that for the purposes of some concepts used in tax legislation, these two features would stamp the transaction as something different from that contemplated by the legislature. For example, I have no doubt that Langley J was right when he recently decided in NMB Holdings Ltd v Secretary of State for Social Security (unreported) 14 July 2000 that a payment of bonuses to directors in the form of platinum sponge held in a bank, accompanied by arrangements under which they could immediately sell it for cash to the bank, was not a "payment in kind" which fell to be disregarded for the purpose of National Insurance Contribution. In commercial terms the directors were paid in money. It is obvious that such a transaction was not what the Social Security (Contributions) Regulations 1979 (SI 1979/591) contemplated as a payment in kind. But there can be equally little doubt that the bonuses were "paid" and, in the absence of some contrary context, I can see no reason not to treat them as paid when the directors were credited with platinum sponge and the employer's obligation to pay them was discharged.

    The authorities

    69. My Lords, like Peter Gibson LJ in the Court of Appeal, I think that the taxpayer's case is supported by the authorities in which the concept of payment in a tax case has been considered. Cairns v MacDiarmid 56 TC 556 concerned an artificial scheme in which the taxpayer (Mr Cairns) claimed to have paid £5,000 "annual interest" on a loan of £37,740 from his employer, Rossminster. The loan was in fact intended to last no more than four days. Mr Cairns gave Rossminster a cheque for £5,000 in exchange for its cheque for £37,740. Nourse J and the Court of Appeal held that the payment was not "annual interest" within the meaning of the Act. But the Crown also raised before Nourse J the question of whether the £5,000 could be said to have been "paid". He said, at pp 576-577:

"It is accepted by the Crown that the agreement between Mr Cairns and Rossminster was not a sham, but a genuine transaction having the legal effect which it was expressed to have. On that footing I cannot see that Mr Cairns ceased to 'pay' the £5,000 merely because he did so conditionally on receiving the £37,740 in exchange. If Mr Potter's argument was correct it might have surprising results in its application to other genuine transactions. For example, there must be many loans where interest is payable in advance and where there is either, as there was in this case, an exchange of cheques or, perhaps more frequently, a payment by the lender to the borrower of a net amount representing principal less the first instalment of interest. It would be very strange if in either of those cases there was not a payment of interest for the purposes of [the Taxes Act], and to say that there was not would in my judgment attach to the word 'pays' a significance which in the context it cannot possibly bear."

    The other case to which Peter Gibson LJ referred was Customs and Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905. The question there was whether builders had received a "payment" in respect of a supply of services within the meaning of section 5(1) of the Value Added Tax Act 1983. That section provided that a supply of services was deemed to take place when the supplier received payment in respect of it. The facts were that in early 1984 a building company had entered into an agreement to erect a building but had not yet begun work. It was then announced in the March budget that with effect from 1 June 1984 the rate of VAT on building services would be increased from zero to the standard rate. To avoid payment of VAT, the customer paid the builder in advance. The builder then lent the money back to the customer on terms that it would be repayable only against architect's certificates for work done. The Commissioners of Customs and Exercise, relying on the Ramsay case [1982] AC 300, argued that there had been no payment within the meaning of the Act or that if it had been, it was for the purposes of tax avoidance and should be "disregarded". The Court of Appeal said that there was no reason to construe "payment" in section 5(1) as meaning anything other than payment in discharge of the customer's obligation to pay for the services. Properly analysed, that obligation had been discharged and replaced by an obligation to repay money lent. Bingham LJ said, at p 921:

"If we were entitled to disregard the legal effect of what was done here and give effect to the underlying substance, it might be possible to say that these payments were not really payments because they were made for the purpose of avoiding VAT and without any (or any other) commercial justification. But that is an approach which Lord Tomlin's well-known speech in Inland Revenue Commissioners v Duke of Westminster [1936] AC 1, 19-21, roundly condemned where the transaction in question is genuine and I do not understand the principle there laid down, described as 'cardinal' by Lord Wilberforce in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300, 323, to have been diluted or abrogated by later decisions. If the payments are to be disregarded the commissioners would, I think, have to show them to be a sham, and this they have not sought to do. If, as I have concluded, these were in law good contractual payments, then I do not think we are entitled to disregard their legal effect and treat them as something else."

    In other words, Bingham LJ was saying that "payment" in section 5(1) was a legal concept and did not have some other commercial meaning. In my opinion the same is true of "paid" in section 338 of the Taxes Act.

    Specific tax avoidance provisions

    70. The revenue rely in the alternative upon three provisions which they say nullify the effect of the payment of interest. On all three I am in full agreement with the Court of Appeal and can therefore be very brief.

    (a) Section 338(5)(a)

    71. This provides that a payment of interest under section 338(3) shall not be treated as a charge on income if it is "not ultimately borne by the company". There appears to be no case in which the meaning of this provision has been considered. It seems to contemplate some arrangement by which the burden of the interest payment is transferred to someone else. But there was no such arrangement in this case. The burden of the interest payment never shifted from WIL. The revenue submits that there was no burden because the interest payment was cancelled by the loan. This amounts to collapsing the two transactions and treating the interest as never having been paid at all. But this would be contrary to the findings of fact. Once it is accepted that the interest was paid, it seems to me that the burden of payment could only have been borne by WIL.

    (b) Section 75(3)

    72. This provides that charges on income in a given accounting period can be carried forward to succeeding accounting periods only if they were paid "wholly and exclusively for purposes of the company's business." The revenue says that the interest payments were not paid for the purposes of the company's business but to make it more attractive to a purchaser. It was conceded that the loans upon which the interest was payable had been borrowed wholly and exclusively for the purposes of the company's business. The Special Commissioners said that one did not need to inquire into the purpose for which the taxpayer paid a legitimate debt which he had incurred for the purposes of his business. It is sufficient that the debt has been so incurred: see Hyett v Lennard [1940] 2 KB 180. Like the Court of Appeal, I can see no error in this reasoning.

    (c) Section 787(1)

    73. This denies relief for payment of interest to a person who has paid pursuant to a scheme:

"such that the sole or main benefit that might be expected to accrue to that person from the transaction under which the interest is paid was the obtaining of a reduction in tax liability by means of any such relief."

    74. The revenue say that the interest was paid under a transaction from which the sole or main benefit which would accrue to WIL was the obtaining of a reduction in tax liability. Again, I have little to add to what the Court of Appeal said on this point. In my opinion it is plain that the "transaction under which the interest was paid" is the original loan and not the arrangements which enabled WIL to pay it.

    75. I would dismiss the appeal. For the reasons given by my noble and learned friend Lord Hope of Craighead, I would also dismiss the cross-appeal.

LORD HOPE OF CRAIGHEAD

My Lords,

    76. I have had the advantage of reading in draft the speech which has been prepared by my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons which he has given I too would dismiss the appeal.

    77. The transaction with which your Lordships are concerned in this case, when taken as a whole, has an odd aspect and it invites careful scrutiny. The movement of funds from the Electricity Supply Pension Scheme to WIL, which it owned, as capital and back again to the Scheme as interest was undoubtedly circular. And each step in the transaction was obviously pre-ordained. Its purpose was to create a tax benefit to WIL without any loss to the Scheme, which was exempt from income tax. But for the exempt status which the Scheme enjoyed, the lender would have had to bear tax on the interest paid to it by WIL. For this reason the capital which WIL was able to obtain from the Scheme was unlikely to have been available to it from another source. Nevertheless the question which has to be resolved depends on the meaning of the words used in the statute which are said to allow the deduction. It is one of statutory interpretation. I would approach it without any preconceived notions as to whether this is a case of tax mitigation or of tax avoidance. The only relevant questions are: (1) the question of law: what is the meaning of the words used by the statute? and (2) the question of fact: does the transaction, stripped of any steps that are artificial and should be ignored, fall within the meaning of those words?

    78. Section 338(1) of the Income and Corporation Taxes Act 1988 provides that there shall be allowed as deductions for the relevant accounting period "any charges on income paid by the company in the accounting period, so far as paid out of the company's profits brought into charge to corporation tax". Subsection (2)(a) of that section provides that "charges on income" means for the purposes of corporation tax "payments" of any description mentioned in subsection (3). Subsection (3)(a) states that the payments referred to in subsection (2) include "any yearly interest". Those are the provisions on which WIL's claim to an allowable deduction in the end depends. There is no question in this case of the taxpayer having to demonstrate that it has sustained a "loss" or achieved a "gain" in circumstances where the result of the transaction was to leave it in no different position from that which it was in before. Had that been the question, the issue, as in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300, would have been whether at the end of the day there was a real loss or a real gain. But those are not the concepts which are used in the statutory provisions that are in issue in this case. They do not depend upon an assessment of the result of the transaction. They depend upon the taxpayer being able to demonstrate that a charge on income has been "paid" by the company.

    79. The Special Commissioners found as a fact that the loans which were made by the Scheme to WIL were real loans. It is clear that, but for the loans, WIL could not have afforded to pay the interest which it owed to the Scheme. Nevertheless the fact is that the loans were made and the interest was paid. WIL's claim is therefore based upon transactions which have been found by the Special Commissioners to be genuine. There was no step that falls to be ignored because it was artificial. It cannot be said that there was no business or commercial reason for the interest to be paid. The payment reduced the amount of WIL's accrued liability to pay interest. It was received as interest in the hands of the payee. WIL's obligation to pay interest to that extent was discharged. Nothing was inserted into the transaction to make it appear to be different from what it was. It was a payment of yearly interest which was paid out of the company's profits for the relevant accounting period.

    80. The question that has to be addressed in these circumstances relates, as Lord Steyn said in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1001G, to the fiscal effectiveness of the transaction entered into by the taxpayer. The answer to the question is to be found in the words used by the statute. A course of action that was designed to defeat the intention of Parliament would fall to be treated as tax avoidance and dealt with accordingly. But one must discover first what the statute means. The ordinary principles of statutory construction must then be applied to the words used by Parliament which describe the effect of the transaction for tax purposes.

    81. On this approach the case does not seem to me, in the end, to give rise to any real difficulty. The words "paid" and "payment" are to be construed according to their ordinary meaning. The question whether a payment has been made is a question of fact. That question has been answered by the findings made by the Special Commissioners. The evidence established to their satisfaction that a loan was in fact made by the Scheme to WIL and that WIL used that loan to pay interest to the Scheme. The interest was a charge on income because it was a payment of a description mentioned in section 338(3) of the 1988 Act. That point having been established, the rule in section 338(1) determines the fiscal effectiveness of the that transaction for the purposes of WIL's liability to corporation tax.

    82. There remains for disposal WIL's cross-appeal. It was directed to WIL's alternative argument that an agreement which it entered into with the Inspector of Taxes under section 54 of the Taxes Management Act 1970 for the year ended 31 March 1988 determined not only the question what tax was payable in respect of the period covered by the assessment under appeal but also the amount of charges on income which were available for carry forward to subsequent accounting periods. Carnwath J rejected this argument: [1997] STC 1103, 1133. In the Court of Appeal, [1998] STC 1131, 1147A-B, Peter Gibson LJ said that it was unnecessary in the light of his conclusion on the inapplicability of the Ramsay principle for him to deal with it. However he thought it right to say, having heard full argument on the point, that in his judgment the judge was plainly right in rejecting the argument for the reasons given by him.

    83. WIL returned to this issue in your Lordships' House. It is not an issue on which WIL need now rely, in view of your Lordships' decision that the appeal must be dismissed. Nevertheless the point was once again fully argued. I should like to make the following observations about it in order to explain briefly why I would dismiss the cross-appeal.

    84. Section 54 of the 1970 Act provides:

"Subject to the provisions of this section, where a person gives notice of appeal and, before the appeal is determined by the Commissioners, the inspector or other proper officer of the Crown and the appellant come to an agreement, whether in writing or otherwise, that the assessment or decision under appeal should be treated as upheld without variation, or as varied in a particular manner or as discharged or cancelled, the like consequences shall ensue for all purposes as would have ensued if, at the time when the agreement was come to, the Commissioners had determined the appeal and upheld the assessment or decision without variation, had varied it in that manner or had discharged or cancelled it, as the case may be."

    85. In his letter of 29 September 1989, which he wrote under the heading "Year ended 31 March 1988", the Inspector of Taxes said:

"I have carefully considered the further information and your contentions and I am now prepared to accept your computation. The appeal is therefore determined under section 54 TMA 1970 in the sum of nil profits chargeable to Corporation Tax."

    86. Mr Milne QC submitted that it was important to bear in mind the context in which this agreement was reached. Section 75 of the 1988 Act required the figure of management expenses and charges on income to be determined for the accounting period in which they were incurred. One of the purposes of this exercise was to identify the amount of the excess to be carried forward to the succeeding accounting period. A determination of the amount of management expenses and charges on income for one accounting period automatically resulted in any excess being treated as expenses of management for the next. It would be absurd if, despite its determination by agreement for one accounting period, that figure had to be relitigated each year. Except in cases of manifest error, both parties to the section 54 agreement should be bound by the agreement that they had made.

    87. The effect of a section 54 agreement is however to be found in the words of the statutory provision under which it is made. Section 54 states that the like consequences shall ensue for all purposes as would have ensued if the Commissioners had determined the appeal. The procedure for appeals forms part of the process which has been laid down by the statute for the assessment and collection of tax. Section 30A of the 1970 Act (as inserted by sections 196, 199 and Schedule 19 to the Finance Act 1994) provides that after the notice of assessment has been served on the person assessed, the assessment shall not be altered except in accordance with the express provisions of the Taxes Acts. Section 31 of the Act enables an appeal to be brought against an assessment within 30 days after it was issued to the General Commissioners or the Special Commissioners. Section 46(2) (has been amended by regulation 2(1) and Schedule 1 to the General and Special Commissioners (Amendment of Enactments) Regulations 1994 (SI 1994/1823.) As so amended it, provides that, save as otherwise provided in the Taxes Acts or in regulations under section 56B, the determination of the General Commissioners or the Special Commissioners in any proceedings under the Taxes Acts shall be final and conclusive. The effect of section 54 is to attach the same finality to the settling of appeals by agreement under that section as attaches to the determination of the appeal by the General Commissioners or the Special Commissioners.