Judgments - Trennery (Respondent) v. West (Her Majesty's Inspector of Taxes) (Appellant) and four other actions

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    33.  At step four the trustees of the first settlement made a highly-geared borrowing on the security of their Einkorn shares. This was not a disposal of the shares, which still had to be regarded, for CGT purposes, as retaining their full value (section 26 of the 1992 Act). The trustees of the first settlement then transferred £770,000 to the trustees of the second settlement, but there was no immediate capital gains tax consequence as it was cash that was transferred.

    34.  At step five (still, it is to be noted, within the 1994-5 year of assessment) Mr and Mrs Trennery were excluded from any beneficial interest under the first settlement (the effectiveness of their exclusion was previously in issue, but that point is no longer taken by the Inland Revenue). It is common ground that, had section 77 not referred to "derived property", that section would have ceased to apply to the first settlement at the end of the 1994-5 year of assessment. The issue is whether the "derived property" provisions produce a different result.

    35.  At step six the trustees of the first settlement disposed of their 8,000 Einkorn shares for a total of about £1 million. They accept that they must pay CGT of the order of £250,000 (more precise figures are set out in paragraph 10 of the Special Commissioners' decision) but they resist the Inland Revenue's claim that Mr Trennery must pay CGT of the order of £400,000, with a right to reimbursement (under section 78 of the 1992 Act) from himself and his wife in their capacity as trustees of the first settlement. If CGT is payable at the higher rate, the remaining resources of the first settlement are insufficient to make reimbursement in full. But Mr Trennery remains a beneficiary who can receive income or capital under the second settlement.

    36.  The issue of construction has already been argued and decided three times, and the parties' fortunes have fluctuated. The Special Commissioners (Dr J F Avery Jones CBE and Mr Malcolm Gammie QC) decided it in favour of the taxpayers: [2002] STC (SCD) 370, 380. On appeal by the Inspectors of Taxes, Peter Smith J reached the opposite conclusion: [2003] STC 580, 599-600. On further appeal by the taxpayer the Court of Appeal (Kennedy, Jonathan Parker and Longmore LJJ) reversed Peter Smith J and restored the decision of the Special Commissioners. It is unnecessary to embark on a summary of their reasons, since (apart from Mr Green's primary submission to your Lordships, mentioned below) essentially the same arguments have been put forward at every level. They centre on whether the correct interpretation of section 77 is that any "derived property" must remain comprised in the relevant settlement, and ceases to be derived property if it passes out of that settlement.

    37.  The structure of section 77 is rather awkward (Jonathan Parker LJ, who gave the leading judgment in the Court of Appeal, used stronger language) and it is important to keep in mind how the different subsections fit together. Subsection (1) focuses on a year of assessment (in these appeals, 1995-6) in which chargeable gains accrue to trustees and lays down the general rule that the settlor of the relevant settlement ("the chargeable settlement") is to be liable to CGT if

    "at any time during the year the settlor had an interest in the settlement."

    Subsection (2) explains the meaning of those words by reference to two paragraphs, (a) and (b), which broadly correspond to (a) the settlor's entitlement to any sort of beneficial interest, whether present or future and whether fixed or discretionary; and (b) the settlor's actual receipt of a benefit. (Each of these references to the settlor must be taken as including the settlor's wife or husband; this extension should be read in throughout the following discussion.) It is hard to see what paragraph (b) adds to the very wide language of paragraph (a). Mr Green suggested that it covered a benefit conferred in breach of trust, and that may well be so. The paragraph may also cover the possibility of an assignment of a beneficial interest made to the settlor (without any impropriety) by a beneficiary (that possibility is to be disregarded, unless and until it happens, under section 77 (4) (b), a provision which was not referred to in the course of argument and which may reduce the disquiet engendered by some of Mr Green's more extreme examples). On any view, however, there is probably an overlap between paragraphs (a) and (b). Such an overlap is not unusual in taxing statutes (see for instance, out of many possible examples, subsections (2) and (3) of section 739 of the 1988 Act, relating to transfers of assets abroad). To my mind the important point about section 77 (2) is that (the chargeable settlement and the relevant year of assessment having been identified) it requires beneficial entitlement of some sort, in that year, in respect of property comprised in the settlement "or any derived property." That sends the reader to the definition in subsection (8), which I repeat:

    "In this section 'derived property', in relation to any property, means income from that property or any other property directly or indirectly representing proceeds of, or of income from, that property or income therefrom.'"

    38.  Mr Green's primary submission was that in this definition the words "income from" (where they first occur) govern all the following phrases. He advanced this argument in the Court of Appeal, although it had not been advanced before the Special Commissioners, and indeed a different analysis had apparently been conceded (see paragraph 17 of the Special Commissioners' decision and paragraph 49 of the judgment of Jonathan Parker LJ). I agree with the Court of Appeal in rejecting it, for the reasons which they gave. The only natural reading of subsection (8) is that its structure has five elements: that "derived property" in relation to any property ("P"), means

    (i)  income from P;

    (ii)  any other property directly or indirectly representing proceeds of P;

    (iii)  income from any such other property at (ii) above;

    (iv)  any other property directly or indirectly representing proceeds of income from P; and

    (v)  income from such other property at (iv) above.

    39.  The taxpayers' next main point is that if section 77 is to apply through any of these five elements the property or income in question must, in the relevant year of assessment, be comprised in the chargeable settlement. Any other interpretation would, it is said, give section 77 an almost unrestricted reach, leading to extraordinary results and possible hardship to taxpayers.

    40.  Mr Green developed this argument with great skill, but to my mind it faces an insuperable objection. If he is right, the whole elaborate definition in subsection (8) could have been replaced by a simple reference to any capital or income of the property comprised in the chargeable settlement. Section 77 (2) (a) and (b) already refer to property comprised in the settlement, before the reader ever gets to derived property. So the taxpayers' contention deprives the latter expression of any force. But Parliament must be taken to have intended the expression to add something to the effect of section 77, and it would occasion no great surprise if the addition were found to be a category of property which is settled property, and is derived from settled property comprised in the chargeable settlement, but is not itself still comprised in the chargeable settlement.

    41.  Mr Green put forward various imaginary scenarios in which, on totally different facts, taxpayers might be faced with tax claims which might appear oppressive. He was understandably rather reluctant to spend long on analysing the sequence of events which actually occurred in these appeals. But he did (as I understand it) accept that the £770,000 borrowed by Mr and Mrs Trennery on the security of the settled Einkorn shares was initially "derived property" in relation to those shares. However the £770,000 did (in his submission) cease to be derived property within hours or even minutes of the draw-down of the loan, when the money was (by the deed executed at step four and the simultaneous ledger entries in the solicitors' client account) transferred to the trustees of the second settlement. It was in consequence, at the dawning of the 1995-6 year of assessment, comprised in a settlement separate from the first settlement. (To state, as the respondents' printed case does, that it was an entirely separate settlement might be said to overlook the effect of the rule against perpetuities, as explained by this House in Pilkington v IRC [1962] AC 612; the trust law analysis is that the second settlement served as a vehicle to receive and continue the act of bounty effected by the first settlement, with the rule against perpetuities acting as a sort of umbilical cord between the two settlements; the fact remains, however, that it was a separate settlement for CGT purposes.) Mr and Mrs Trennery were then excluded from the first settlement, which at that stage comprised 8,000 Einkorn shares and £10, subject to the trustees' liability to service and repay the loan of £770,000. That loan was secured on the shares, and Mr and Mrs Trennery, in their capacity as trustees, were entitled to be indemnified for the liability against the whole trust fund (the shares and £10).

    42.  In my opinion the £770,000 started off as derived property (and was also, for a matter of hours or minutes, property comprised in the first settlement). It continued to be derived property after it was appointed out of the first settlement. The effect of the taxpayers' argument would be to cut off the operation of the "derived property" provision at the very moment when it started to have some work to do. The economic effect of the arrangements was to transfer about three-quarters of the value of the shares to the second settlement, but without any disposal of the shares for CGT purposes. Mr Trennery was a beneficiary under the second settlement, and continued to be a beneficiary in 1995-6. Both on the natural meaning of section 77 (2) and (8) and in normal parlance, Mr Trennery was in 1995-6 beneficially interested in property derived from (that is, representing proceeds of) the shares which remained in the first settlement. The only property in the second settlement which was not "derived property" was the second nominal sum of £10 which Mr Trennery settled on 4 April 1995.

    43.  That construction seems to me well within Parliament's likely intention in enacting section 77 in its amended form. By 1995 it was well known that (under the rule then embodied in section 26 of the 1992 Act) secured borrowing could be used to produce economic results which were, at least in the short term, at odds with the analysis of the transaction for CGT purposes. It was also well known, and had been since the decision of this House in Roome v Edwards [1982] AC 279, that special powers of appointment and advancement could be used to make settled property pass from one settlement to another, without any intervening period of absolute ownership, and that such transfers might have important CGT consequences. In my opinion the transactions on which the taxpayers embarked fall squarely within the language, and the likely legislative intendment, of section 77 as amended.

    44.  In the end the taxpayers' case is based, as it seems to me, not on the way in which the Inland Revenue seek to apply the statutory provisions in these cases, but on the anomalous and oppressive effect which they might have in other hypothetical circumstances far removed from those of the present case. Section 77's requirement that the chargeable settlement should, in the year of assessment in question, contain some property (what I have referred to above as "P") to which the derived property can be linked, provides some restriction on its scope, but I would accept that it does not meet every possible hard case. One possible answer to the alleged anomaly and oppression is that in 2000 Parliament enacted the far more detailed code now found in Schedule 4B to the 1992 Act. But a more complete answer was given by Lord Wilberforce (with whom Lord Scarman, Lord Roskill and Lord Brandon agreed) in Leedale v Lewis [1982] 1 WLR 1319, 1330,

    "I would only refer to one other argument, that based on the alleged 'hardship' of accepting the Revenue's contention. I do not think that this is a relevant consideration at all. If there were two equally possible constructions of this subsection, it might be correct to choose that which is the more favourable to the taxpayer, on the basis that subjects can only be taxed by clear words. This principle cannot apply where there are decisive legal reasons for preferring one construction rather than another. Once this step has been taken considerations of 'hardship' do not enter into the discussion."

    Parliament has for very many years passed many enactments aimed at settlors who seek to use settlements to shelter assets from high rates of tax, and later to enjoy the benefit of the settled property themselves. The possibility of even a small benefit may have severely adverse consequences. That is well understood by those who advise settlors. As Lord Wilberforce added after the passage just quoted,

    "Settlors, after 1965, make their settlements with knowledge of the legislation and of its consequences."

    45.  I wish to add a few comments (which can be regarded as an appendix, and not required reading) on the legislative history of section 77. This is a point noted by the Special Commissioners (who have great experience and learning in these matters), and Mr Green attached some (but not much) importance to it in his printed case and his oral submissions.

    46.  The expression "derived property" seems to have appeared first in a taxing statute in section 28 of the Finance Act 1946, in provisions designed to charge higher rates of income tax on some categories of income covenants and other settlements of property in which the settlor retained a beneficial interest. It was, I think, the third round of amending legislation aimed at curbing income covenants, and the proviso to section 28 (1) responded to the decision of this House in IRC v Duke of Westminster [1936] AC 1. The section went through various consolidations, emerging (with later accretions) as sections 683 to 685 of the Income and Corporation Taxes Act 1988 ("the 1988 Act"). Section 685 (1) provided:

    "For the purposes of section 683 and 684, the settlor shall not be deemed to have divested himself absolutely of any property if that property or any derived property is, or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the settlor or, in the case of a settlement made after 6 April 1965, the wife or husband of the settlor."

    Subsection (3) provided (apart from an immaterial amendment made by the Finance Act 1989):

    "In subsections (1) and (2) above 'derived property', in relation to any property, means income from that property or any other property directly or indirectly representing proceeds of, or of income from, that property or any income therefrom."

    47.  The obvious similarity of wording suggests that this definition provided the model for the amended version of section 77 enacted in 1995. But it was at best an imperfect model, because the relevant definition of "settlement" was quite different, and because the notion of the settlor having "divested himself absolutely of any property" naturally focused on the particular property which he had settled (whereas section 77 referred more generally to the property comprised in the settlement).

    48.  In 1995 Parliament decided to rationalise the ragged patchwork of provisions which had come to be included in Part XV (Settlements) of the 1988 Act. Chapters I and II and part of Chapter III (including sections 683 to 685) were repealed. Instead sections 660A to 660G were enacted. Section 660A (1) and (2) provide as follows:

    "(1)  Income arising under a settlement during the life of the settlor should be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest.

    (2)  Subject to the following provisions of this section, a settlor shall be regarded as having an interest in property if that property or any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever."

    Section 660A (10) contains the now familiar definition of "derived property". These amendments were made by the 1995 Act, which also amended section 77 of the 1992 Act. The amendments to section 77 (in form, though not in substance, the substitution of a whole new section) were made by section 74 of and Schedule 17, Part III, paragraph 27 of the 1995 Act, in a part of the Schedule headed "Consequential amendments of other enactments". Previously section 77 had not referred to derived property.

    49.  So the income tax provisions were in 1995 recast to ask the question (much as section 77 does) whether there is a settlement of property "in which the settlor has no interest," and that question is explained in terms of "that property or any derived property". But the model is still far from perfect because the meaning of settlement for income tax purposes (now in section 660G (1)) is still far wider, and much further from the traditional language of chancery lawyers, than the fairly traditional meaning given to the expression for CGT purposes. For income tax purposes the transfer from the first settlement to the second settlement was a non-event; the £770,000 was derived from Mr Trennery's original disposition and he did not cease to be the settlor of it (and would not have ceased to be the settlor even if some other individual had provided the second nominal sum, and had been named as settlor of the second settlement). So any apparent parallel between the income tax provisions and the CGT provisions may be misleading.

    50.  Mr Green submitted that on the Inland Revenue's argument Parliament did in 1995 make a fundamental change in section 77, and that it is remarkable to see it described as a consequential amendment. I see some force in that. But it is possible that the in-depth review which must have preceded the 1995 Act led to this point being identified as one on which a significant change in the CGT legislation was expedient. In any event the use of the label "consequential amendments", even if rather inappropriate, cannot alter the construction of the amended section 77. With all respect to the Court of Appeal I consider that the construction which they adopted is clearly wrong. I would allow the appeal, set aside the order of the Court of Appeal, and restore the order of Peter Smith J. But (in accordance with the terms on which leave to appeal was granted) the appellants must pay the respondents' costs in this House. I would order the respondents to pay the costs in the Court of Appeal.

 
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