‘taxing statutes draw their life-blood from real world transactions with real world economic effects’
In 1936, Lord Tomlin made the (now) infamous statement which gave tax payers a decisive advantage over HMRC. In effect, this was an approval for tax professionals to exercise their ingenuity in the pursuance of a legal tax saving.
“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Act is less than it otherwise would be…However unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax”
The modern-day approach to tax law requires courts to consider not only the wording of the legislation, but also its purpose, often extending the wording of the legislation to meet that purpose. This approach has come to be known as the Ramsay principle – a principle of construction developed over a number of years.
The modern approach to tax law, as summarised in Barclays Mercantile Business Finance Ltd v Mawson ‘is to have regard to the purpose of a particular provision and interpret its language…in the way which best gives effect to that purpose’
This approach continues to be developed with the principle often facing scrutiny in avoidance cases where the stakes are high. However, the common thread which is generally accepted is that tax law intends to tax transactions in the ‘real world’.
In Project Blue, the appellants made use of an SDLT sub-sale scheme to transfer an SDLT liability from the purchaser (Project Blue Ltd) to a financier Qatari bank.
The Bank obtained the freehold title and immediately granted a long-lease to PBL. This structure was used in the place of ordinary financing arrangements which are not compliant with Sharia Law.
Sub-sale relief was claimed by the purchaser, which applied to transfer the obligation to pay SDLT to the bank. However, the bank was able to claim alternative financing relief. The result? There was no SDLT due on a land transaction worth over £959m.
Anti-avoidance provisions were held to apply. In order to apply these provisions, the courts needed to identify the purchaser, the vendor and the chargeable interest.
Identifying the purchaser, and therefore the person liable for SDLT, was particularly important and HMRC were out of time to pursue the bank for any liability. Naturally, Project Blue sought to argue that the bank is the purchaser, as it acquired the freehold.
The courts distinguished between a ‘real world’ and an ‘SDLT world’, in identifying the purchaser which was found to be Project Blue Ltd. Lord Hodge stated that ‘In the real world the nature of the transaction is clear: PBL acquired the barracks with the benefit of finance from MAR’
However, interestingly, the chargeable interest was held to be the long-lease, which meant that SDLT was essentially charged on the purchase price plus the return for the bank.
The First De Sales Partnership
This case involved trading partnerships making excessive payments to employees in return for restrictive undertakings. The payments were disproportionate to the value of the undertaking, generating significant trading losses which could be offset against other income.
In calculating the profits of a trade, relief is afforded for payments in respect of restrictive undertakings, which is taxed as earnings in the hands of the employee. In this case, the employees were non-resident, and did not carry out their duties in the UK. Therefore, the receipt by the employees was not subject to UK income tax.
It is also worth noting that the payments were not made to the employees, nor were they required to be, as the legislation explicitly states this.
The appellants exploited this by making a disproportionately large payment to the non-resident administrative clerks under a non-compete agreement. The payments totalled £950m and clearly did not reflect the value of the non-compete agreement.
The FTT decided in favour of the HMRC, stating that the payments were not ‘in respect of’ the restricted undertakings and were, instead ‘in respect of’ a tax avoidance motive
The appellants appealed to the Upper Tribunal on the basis that:
- The FTT erred in its construction of the legislation; and
- The FTT had wrongly concluded that the appellants had no reasonable prospect of establishing that the payments are deductible in whole or in part
In respect of the first, the appellants argued that:
- the payments were solely in consideration of the restrictive undertakings, as documented in the various legal documents and contracts.
- The FTT misunderstood case law on purposive construction, which generally applies to transactions which have some real-world purpose. Tax provisions have been held not to apply to transactions which have no commercial purpose. Therefore, A transaction with some commercial purpose, should not be disregarded.
- The transaction had some commercial purpose, albeit the payments for the undertakings were uncommercial
- There was nothing in the legislation which restricts its application to the market value for restrictive undertakings
However, the appellants arguments were set aside. The courts homed in to whether the payments were made ‘in respect of’ a restrictive undertaking.
The taxpayers relied on the fact that the deeds explicitly stated that the payments were made for the restrictive undertaking.
However, the courts looked at the ‘real’ reason for the payment, and not simply what the deed says. It was found that the payments were ‘in respect of’ or ‘for’ generating a tax loss, and in turn tax avoidance, not for the restrictive undertakings.
Although, it was suggested that the taxpayers could have an element of relief as it was not disregarded that some of the payment was ‘for’ the restrictive undertakings, though this was not considered in any great detail.
It is becoming clearer that things need to stack up in real life, and that the stated and documented position is not necessary final and determinative.
Tax professionals will understand the importance of commerciality. Whilst the legal position will be relevant, the courts are likely to construe the legislation in a manner which seeks to tax real world transactions, not merely a legal agreement where the cause and effect do not stack up with the economics and purpose.
However, this approach can often lead to inconsistencies in tax law. For example, in Project Blue the amount on which SDLT was charged was held, on a technical reading, to be the value of the long-lease, not the ‘real world’ purchase price.
A similar consequence can be found in the landmark Rangers ruling, which treated non-taxable loans as taxable earnings for income tax purposes, but for inheritance tax purposes, the loans are real. This potentially means that the same amount is subject to tax twice, where in most circumstances the legislation would provide an element of relief.
The disparity in tax treatment here seems unfair but is an unforeseen by-product of the modern-day approach to interpretation, which current legislation appears unequipped to deal with.
In the context of aggressive tax avoidance, it should be reasonably clear whether the ‘real world’ aligns with the intention of parliament. However, in the context of acceptable tax planning, whether the ‘real world’ and aligns with the intentions of parliament will remain a relevant consideration, and particularly whether it is the type of planning in relation to which HMRC would seek to ‘take the point’.
For more information on any of the topics raised above, please contact our helpful team of tax advisers, you can also read more about tax avoidance below.