Lord Wilberforce
The first of these appeals is an appeal by W. T. Ramsay Ltd,a farming company. In its accounting period ending 31 May 1973 it made a " chargeable gain " for purposes of corporation tax by a sale-leaseback transaction. This gain it desired to counteract, so as to avoid the tax, by establishing an allowable loss. The method chosen was to purchase froma company specialising in such matters a ready-made scheme. The general nature of this was to create out of a neutral situation two assets one ofwhich would decrease in value for the benefit of the other. The decreasing asset would be sold, so as to create the desired loss; the increasing asset would be sold, yielding a gain which it was hoped would be exempt from tax.
In the courts below, attention was concentrated upon the question whether the gain just referred to was in truth exempt from tax or not. The Court of Appeal, reversing the decision of Goulding J., decided that it was not. In this House, the Crown, while supporting this decision of the Court of Appeal, mounted a fundamental attack upon the whole of the scheme acquired and used by the appellant. It contended that it should simply be disregarded as artificial and fiscally ineffective.
Immediately after this appeal there was heard another taxpayer'sappeal—Eilbeck v. Rawling. This involved a scheme of a different character altogether, but one also designed to create a loss allowable for purposes of capital gains tax, together with a non-taxable gain, by a scheme acquiredfor this purpose. Similarly, this case was decided, against the taxpayer, inthe Court of Appeal upon consideration of a particular aspect of the scheme:and similarly, the Crown in this House advanced a fundamental argument against the scheme as a whole.
I propose to consider first the fundamental issue, which raises arguments common to both cases. This is obviously of great importance both inprinciple and in scope. I shall then consider the particular, and quite separate arguments, relevant to each of the two appeals.
I will first state the general features of the schemes which are relevant to the wider argument.
In each case we have a taxpayer who has realised an ascertained and quantified gain: in Ramsay £187,977, in Rawling £355,094. He is then advised to consult specialists willing to provide, for a fee, a preconceived and ready made plan designed to produce an equivalent allowable loss.The taxpayer merely has to state the figure involved i.e. the amount of the gain he desires to counteract, and the necessary particulars are inserted into the scheme.
The scheme consists, as do others which have come to the notice of the courts, of a number of steps to be carried out, documents to be executed,payments to be made, according to a timetable, in each case rapid (see the attractive description by Buckley L.J. in Rawling). In each case two assets appear, like particles in a gas chamber with opposite charges, oneof which is used to create the loss, the other of which gives rise to an equivalent gain which prevents the taxpayer from supporting any real loss,and which gain is intended not to be taxable. Like the particles, these assets have a very short life. Having served their purpose they cancel each other out and disappear. At the end of the series of operations, the taxpayer's financial position is precisely as it was at the beginning, except that he has paid a fee, and certain expenses, to the promoter of the scheme.
There are other significant features which are normally found in schemes of this character. First, it is the clear and stated intention that once started each scheme shall proceed through the various steps to the end—they are not intended to be arrested half-way (cf. Chinn v. Hochstrasser[1981]W.L.R. 14). This intention may be expressed either as a firm contractual obligation (it was so in Rawling) or as in Ramsay as an expectation without contractual force.
Secondly, although sums of money, sometimes considerable, are supposed to be involved in individual transactions, the taxpayer does not have to put his hand in his pocket (cf. I.R.C. v. Plummet; [1980] AC 896. Chinn(supra.)). The money is provided by means of a loan from a finance house which is firmly secured by a charge on any asset the taxpayer may appear to have, and which is automatically repaid at the end of the operation. In some cases one may doubt whether, in any real sense, any money existed at all. It seems very doubtful whether any real money was involved in Rawling: but facts as to this matter are for the commissioners to find. I will assume that in some sense money did pass as expressed in respect of each transaction in each of the instant cases. Finally, in each of the present cases it is candidly, if inevitably, admitted that the whole and only purposeof each scheme was the avoidance of tax.
In these circumstances, your Lordships are invited to take, with regard to schemes of the character I have described, what may appear to be a new approach. We are asked, in fact, to treat them as fiscally, a nullity, not producing either a gain or a loss. Mr. Potter, Q.C. described this as revolutionary, so I think it opportune to restate some familiar principles and some of the leading decisions so as to show the position we are now in.
A subject is only to be taxed upon clear words, not upon" intendment" or upon the " equity" of an Act. Any taxing Act of Parliament is to be construed in accordance with this principle. What are"clear words" is to be ascertained upon normal principles: these donot confine the courts to literal interpretation. There may, indeed should,be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded, (see—I.R.C. v. Wesleyan andGeneral Assurance Society (1948) 30 T.C.11,16 per Lord Greene: Manginv. I.R.C. [1971] AC 739,746 per Lord Donovan. The relevant Act in these cases is the Finance Act 1965. the purpose of which is to impose a tax on gains less allowable losses, arising from disposals.
A subject is entitled to arrange his affairs so as to reduce his liability to tax. The fact that the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides. It must beconsidered according to its legal effect.
It is for the fact-finding commissioners to find whether a document,or a transaction, is genuine or a sham. In this context to say that adocument or transaction is a " sham " means that while professing to be one thing, it is in fact something different. To say that a document or transaction is genuine, means that, in law, it is what it professes to be, and it does not mean anything more than that. I shall return to this point.
Each of these three principles would be fully respected by the decision we are invited to make Something more must be said as to the next principle.
4. Given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance. This is the well known principle of I.R.C. v. Duke of Westminster [1936] AC 1. This is a cardinal principle but it must not be overstated or overextended. While obliging the court to accept documents or transactions, found to be genuine, as such,it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect aspart of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded: to do so is not to prefer form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded. For this there is authority in the law relating to income tax and capital gainstax—see Chinn v. Hochstrasser [1981] 2 WLR 14, I.R.C. v. Plummer[1980] AC 896.
For the commissioners considering a particular case it is wrong, and an unnecessary self limitation, to regard themselves as precluded by their own finding that documents or transactions are not " shams ", from considering what, as evidenced by the documents themselves or by the manifested intentions of the parties, the relevant transaction is. They are not, under the Westminster doctrine or any other authority, bound to consider individually each separate step in a composite transaction intended to be carried through has a whole. This is particularly the case where (as in Rawling) it is proved that there was an accepted obligation once a scheme is set in motion, tocarry it through its successive steps. It may be so where (as in Ramsay or inBlack Nominees Ltd v.Nicol (1975) 50T.C.229) there is an expectation that it will be so carried through, and no likelihood in practice that it will not. In such cases (which may vary in emphasis) the commissioners should find the facts and then decide as a matter (reviewable) of law whether what is in issue is a composite transaction, or a number of independent transactions.
I will now refer to some recent cases which show the limitations of the Westminster doctrine and illustrate the present situation in the law.
Floor v. Davis [1978] Ch. 295 (1979) 2 W.L.R. 830 (H.L.). The key transaction in this scheme was a sale of shares in a company called IDM to one company (FNW) and a resale by that company to a further company (KDI). The majority of the Court of Appeal thought it right to look at each of the sales separately and rejected an argument by the Crown that they could be considered as an integrated transaction. But Eveleigh L.J. upheld that argument. He held that the fact that each sale was genuine did not prevent him from regarding each as part of a whole,or oblige him to consider each step in isolation. Nor was he so prevented by the Westminster case. Looking at the scheme as a whole, and finding that the taxpayer and his sons-in-law had complete control of the IDM shares until they reached KDI, he was entitled to find that there was adisposal to KDI. When the case reached this House it was decided on a limited argument, and the wider point was not considered. This same approach has commended itself to Templeman L.J. and has been expressed by him in impressive reasoning in the Court of Appeal's judgment in Rawling. It will be seen from what follows that these judgments, and their emerging principle, commend themselves to me.
I.R.C. v. Plummer [1980] AC 896. This was a pre arranged scheme,claimed by the Revenue to be " circular "—in the sense that its aim and effect was to pass a capital sum round through various hands back to its starting point. There was a finding by the Special Commissioners that the transaction was a bona fide commercial transaction, but in this House their Lordships agreed that it was legitimate to have regard to all the arrangements as a whole. The majority upheld the taxpayer's case on the ground that there was commercial reality in them: as I described them they amounted to " a covenant, for a capital sum, to make annual payments, coupled with" security arrangements for the payments " and I attempted to analyse the nature of the bargain with its advantages and risks to either side.
The case is no authority that the court may not in other cases and with different findings of fact reach a conclusion that, viewed as a whole, a composite transaction may produce an effect which brings it within a fiscal provision.
3. Chinn v. Hochstrasser [1981] 2 WLR 14. This again was a prearranged scheme, described by the special commissioners as a single scheme. There was no express finding that the parties concerned were obliged to carry through each successive step: but the commissioners found that" there was never any possibility that the appellant taxpayers and another party would not proceed from one critical stage to another. I reached the conclusion, on this finding and on the documents, that the machinery, once started, would follow out its instructions without further initiative and the same point was mad graphically by Lord Russell ofKillowen (1.c. p.22). This case shows, in my opinion, that although separate steps were " genuine" and had to be accepted under the Westminster doctrine, the court could, on the basis of the findings made and of its own analysis in law, consider the scheme as a whole and was not confined to a step by step examination.
To hold, in relation to such schemes as those with which we are concerned, that the court is not confined to a single step approach, is thus a logical development from existing authorities, and a generalisation of particular decisions.
Before I come to examination of the particular schemes in these cases,there is one argument of a general character which needs serious consideration. For the taxpayers it was said that to accept the Revenue'swide contention involved a rejection of accepted and established canons, andthat if so general an attack upon schemes for tax avoidance as the Revenue suggest is to be validated, that is a matter for Parliament. The function of the courts is to apply strictly and correctly the legislation which Parliament has enacted: if the taxpayer escapes the charge, it is forParliament, if it disapproves of the result, to close the gap. General principles against tax avoidance are, it was claimed, for Parliament to lay down. We were referred, at our request, in this connection to the various enactments by which Parliament has from time to time tried to counter tax avoidance by some general prescription. The most extensive of these is Income and Corporation Taxes Act 1970 sections 460 et seq. We referred also to well known sections in Australia and New Zealand(Australia. Income Tax Assessment Act 1936 51 section 260; New Zealand,Income Tax Act 1976 section 99, replacing earlier legislation). Further it,was pointed out that the Capital Gains Tax legislation (starting with theFinance Act 1965) does not contain any provision corresponding to section460. The intention should be deduced therefore, it was said, to leave Capital Gains Tax to be dealt with by "hole and plug " methods: that such schemes as the present could be so dealt with has been confirmed by later legislation as to "value shifting" (Capital Gains Tax Act 1979 section 25 et seq.).These arguments merit serious consideration. In substance they appealed to the Chief Justice of Australia in the recent case of F.C.T. v. Westraders Pty Ltd (1980) 30 ALR 353, 354-5.
I have a full respect for the principles which have been stated but I do not consider that they should exclude the approach for which the Crown contends. That does not introduce a new principle: it would be to apply to new and sophisticated legal devices the undoubted power and duty of the courts to determine their nature in law and to relate them to existing legislation. While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand still. Such immobility must result either in loss of tax, to the prejudice of other taxpayers, or to Parliamentary congestion or (most likely) to both. To force the courts to adopt, in relation to closely integrated situations, a step by step,dissecting, approach which the parties themselves may have negated, would be a denial rather than an affirmation of the true judicial process. In each case the facts must be established, and a legal analysis made: legislation cannot be required or even be desirable to enable the courts to arrive at a conclusion which corresponds with the parties' own intentions.
The Capital Gains Tax was created to operate in the real world, not that of make-belief. As I said in Aberdeen Construction Group Ltd. v. I.R.C.[1978] AC 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation,is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function.
We were referred, on this point, to a number of cases in the United States of America in which the courts have denied efficacy to schemes or transactions designed only to avoid tax and lacking otherwise in economic or commercial reality. I venture to quote two key passages, not as authority,but as examples, expressed in vigorous and apt language of a process of thought which seem to me not inappropriate for the courts in this country to follow. In Knetsch v. U.S. (1960) 364 U.S. 361 the Supreme Court found that a transaction was a sham because it:
" did not appreciably affect the [taxpayer's] beneficial interest . . . there" was nothing of substance to be realised by (him) from this transaction" beyond a tax deduction ... the difference between the two sums was" in reality the fee for providing the facade of ' loans ' ".
In Gilbert v. Commissioner (1957) 248 Fed. 2 nd 399. Judge Learned Hand(dissenting on the facts) said:
" The Income Tax Act imposes liabilities upon taxpayers based upon" their financial transactions. ... If, however, the taxpayer enters" into a transaction that does not appreciably affect his beneficial interest" except to reduce his tax. the law will disregard it ".
It is probable that the U.S. courts do not draw the line precisely where we with our different system allowing less legislative power to the courts than they claim to exercise, would draw it, but the decisions do at least confirm me in the belief that it would be an excess of judicial abstinence to withdraw from the field now before us.
I will now try to apply these principles to the cases before us.
W. T. Ramsay Ltd v. Commissioner of Inland Revenue
This scheme, though intricate in detail, is simple in essentials. Stripped of the complications of company formation and acquisition, it consisted of the creation of two assets in the form of loans, called L.1. and L.2, each of£218,750. These were made by the taxpayer, by written offer and oral acceptance, on 23rd February, 1973 to one of the intra scheme companies Caithmead Ltd. The terms are important and must be setout. They were:
(a) L.1 was repayable after 30 years at par and L.2 was repayable after 31 years at par. in each case with the proviso that Caithmead could (but on terms) make earlier repayment if it so desired and would be obliged to do so if it went into liquidation;
If either loan were repaid before its maturity date, then it had to be repaid at par or at its market value upon the assumption that it would remain outstanding until its maturity date—whichever was the higher;
Both loans were to carry interest at 11%, per annum payable quarterly on 1st March, 1st June, 1st September and 1st December in each year, the first such payment to be on 1st March 1973;
The appellant was to have the right, exercisable once and once only, and then only if it was still the beneficial owner of both L.1and L.2, to decrease the interest rate on one of the loans and to increase correspondingly the interest rate on the other.
A few days later, on 2nd March 1973, the appellant, under (d) above,increased the rate of interest on L.2 to 22%, and decreased that on L.1 tozero. The same day the appellant then sold L.2 (which had naturally increased in value) for £391,481. This produced a "gain" of £172,731 which the appellant contends is not a chargeable gain for corporation tax purposes (as to this see below). L.2 was later transferred to a wholly owned subsidiary of Caithmead and extinguished by the liquidation of that subsidiary. On 9th March, 1973 Caithmead itself went into liquidation, on which L.1 was repayable, and was repaid to the appellant. The shares in Caithmead, however, for which the appellant had paid £185,034, became of little value and the appellant sold them to an outside company for £9,387.So the appellant made a " loss " of £175,647. It may be added, as regards finance, that the necessary money to enable the appellant to make the loans was provided by a finance house on terms which ensured that it would be repaid out of the loans when discharged. The taxpayer provided no finance.
Of this scheme, relevantly to the preceding discussion, the following can be said—
As the tax consultants' letter explicitly states "the scheme is a pure" tax avoidance scheme and has no commercial justification in so far as" there is no prospect of T [the prospective taxpayer] making a profit; indeed" he is certain to make a loss representing the cost of undertaking the" scheme ".
As stated by the tax consultants' letter, and accepted by the special commissioners, every transaction would be genuinely carried through and in fact be exactly what it purported to be.
It was reasonable to assume that all steps would, in practice, be carried out, but there was no binding arrangement that they should. The nature of the scheme was such that once set in motion it would proceed through all its stages to completion.
The transactions regarded together, and as intended, were from the outset designed to produce neither gain nor loss: in a phrase which has become current, they were self cancelling. The " loss " sustained by the appellant, through the reduction in value of its shares in Caithmead, was dependent upon the "gain " it had procured by selling L.2. The one could not occur without the other. To borrow from Rubin v. U.S. (1962) 304 Fed.2nd 766 approving the Tax Court in MacRae 34 T.C. 20. 26, this loss was the mirror image of the gain. The appellant would not have entered upon the scheme if this had not been so.
The scheme was not designed, as a whole, to produce any result for the appellant or anyone else, except the payment of certain fees for the scheme. Within a period of a few days, it was designed to and did return the appellant except as above to the position from which it started.
The money needed for the various transactions was advanced by a finance house on terms which ensured that it was used for the purposes of the scheme and would be returned on completion, having moved in a circle.
On these facts it would be quite wrong, and a faulty analysis, to pick out,and stop at, the one step in the combination which produced the loss, that being entirely dependent upon, and merely a reflection of the gain. The true view, regarding the scheme as a whole, is to find that there was neither gain nor loss, and I so conclude.
Although this disposes of the appeal, I think it right to express an opinion upon the particular point which formed the basis of the decisions below.This is whether the gain made on 9th March 1973 by the sale of L.2 was a chargeable gain. The assumption here, of course, is that it is permissible to separate this particular step from the whole.
The appellant claims that the gain is not chargeable on the ground that the asset sold was a debt within the meaning of the Finance Act 1965,Schedule 7, paragraph 11. In that case, since the appellant was the original creditor, the disposal would not give rise to a chargeable gain. The Crown on the other hand contends that it was a debt on a security, within the meaning of the same paragraph, and of paragraph 5(3)(b) of the same Schedule. In that case the exemption in favour of debts would not apply.
The distinction between a debt, and a debt on a security, and the criteria of the difference, have already been the subject of consideration in the Court of Session in Cleveleys Investment Trust Co. v. I.R.C. 47 T.C. 300:
Aberdeen Construction Group Ltd v. I.R.C. 1977 S.C 302, and in this House in the latter case [1978] AC 885. I think it no overstatement to say that many learned judges have found it baffling, both on the statutory wording and as to the underlying policy. I suggested some of the difficulties of paragraph 11 (supra) and of the definition in paragraph 5(3)(b) of the same Schedule in Aberdeen Construction and I need not recapitulate them.Such positive indications as have been detected are vague and uncertain.It can be seen, however, in my opinion, that the legislature is endeavouring to distinguish between mere debts, which normally (though there are exceptions), do not increase but may decrease in value, and debts with added characteristics such as may enable them to be realised, or dealt with at a profit. But this distinction must still be given effect to through the words used.
Of these, some help is gained from a contrast to be drawn between debts simpliciter, which may arise from trading and a multitude of other situations,commercial or private, and loans, certainly a narrower class, and one which presupposes some kind of contractual structure. In Aberdeen ConstructionI drew the distinction between " a pure unsecured debt as between the" original borrower and lender on the one hand and a debt (which may be" unsecured) which has, if not a marketable character, at least such" characteristics as enable it to be dealt in and if necessary converted into" shares or other securities ".
To this I would now make one addition and one qualification. AlthoughI think that, in this case, the manner in which L.2 was constituted, viz., by written offer, orally accepted together with evidence of the acceptance by statutory declaration, was enough to satisfy a strict interpretation of" security ", I am not convinced that a debt, to qualify as a debt on a security, must necessarily be constituted or evidenced by a document. The existence of a document may be an indicative factor, but absence of one is not fatal. I would agree with the observations of my noble and learned friend, Lord Fraser of Tullybelton, in relation, in particular, to Cleveleys'case. Secondly, on reflection, I doubt the usefulness of a test enabling the debt to be converted into shares or other securities. The definition inparagraph 5(3)(b) (supra) is, it is true, expressed to be given for the purposes of paragraph 3 which is dealing with conversion: but I suspect that it was false logic to suppose that, because of this, " securities " are to be so limited,and in any event I doubt whether the test supposed, if a necessary one, is useful, for even a simple debt can, by a suitable contract, be converted into shares or other securities.
With all this lack of certainty as to the statutory words, I do not feel any doubt that in this case the debt was a debt on a security. I have already stated its terms. It was created by contract whose terms were recorded in writing; it was designed, from the beginning, to be capable of being sold,and, indeed, to be sold at a profit. It was repayable after 31 years, or on the liquidation of Caithmead. If repaid before the maturity date, it had to be repaid at par or market value whichever was the higher. It carried a fixed, though (once) variable rate of interest.
There was much argument whether with these qualities it could be described as " loan stock " within the meaning of paragraph 5(3)(b) ofSchedule 7 (supra). I do not find it necessary to decide this. The paragraph includes within " security " any " similar security " to loan stock: in my opinion these words cover the facts. This was a contractual loan, with a structure of permanence such as fitted it to be dealt in and to have a market value. That it had a market value, in fact, was stated on 1st March 1973 by Messrs. Hoare and Co. Govett Ltd., Stockbrokers. They then confirmedthat an 80% premium would be a fair commercial price having regard to the prevailing levels of long term interest rates. I have no doubt that, on these facts, the loan L.2 was a debt on a security and therefore an asset which, if disposed of, could give rise to a chargeable gain.
I would dismiss this appeal.
I now deal with the Rawling appeal.
The scheme here was quite different from any of the others which I have discussed. It sought to take advantage of paragraph 13(1) of Schedule 7 tothe Finance Act, 1965: this exempts from capital gains tax any gain made on the disposal of (inter alia) a reversionary interest under a settlement by the person for whose benefit the interest was created or by any other person other than one who acquired the interest for consideration in money.The scheme was, briefly, to split a reversion into two parts so that one would be disposed of at a profit but would fall under the exemption and the other would be disposed of at a loss but could be covered by the exception. Thus there would be an allowable loss but a non-chargeable gain.
The scheme involved the use of a settlement set up in Gibraltar, another settlement set up in Jersey, and six Jersey companies—namely, to use their short titles Thun, Goldiwill, Pendle, Tortola, Allamanda and Solandra,which were part of the same organisation, under the same management and operating from the same address: The Gibraltar settlement was made in 1973 by one Isola of a sum of £100. When the appellant came into the scheme in 1975 the fund consisted of £600,000, all of which was said to be deposited in Jersey with Thun. The trusts were to pay the income to one Josephine Isola until 19th March 1976. Subject thereto the fund was to be held in trust for the settlor, Isola, his heirs and assignees. There was a power in clause 5 of the settlement to advance any part of the capital of the trust fund to the Reversioner or to the trustees of any other settlement.But it was a necessary condition, in the latter case, that the Reversioner should be indefensibly entitled to a corresponding interest under such other settlement falling into possession not later than the vesting day (19th March 1976) under the Gibraltar Settlement. On the exercise of any such power a compensating advance had to be made to the income beneficiary.
On 20th March 1975 the settlor's reversionary interest was assigned to Pendle. On 24th March 1975 Thun agreed to lend the appellant £543,600to enable him to buy the Gibraltar settlement reversion and agreed with the appellant that Tortola would, if required within 6 months, introduce to the appellant a purchaser for the reversion. Pendle then agreed to sell and the appellant to buy the reversion for £543,600 and this sale was completed.So the appellant (conformably with paragraph 13(1) supra) had acquired a reversion for consideration in money. The appellant directed Thun to pay the £543,600 to Pendle: he also charged his reversionary interests under the Gibraltar settlement and under the Jersey settlement, next mentioned, to Thun to secure the loan of £543,600.
The Jersey settlement was executed, as found by the General Commissioners, as part of the scheme. It was dated 21st March 1975 and made by the appellant's brother for £100 with power to accept additions.The trustee was Allamanda. The trustee was to apply the income for charitable or other purposes until the " Closing Date " and subject thereto for the appellant absolutely. The closing date was fixed on 24th March 1975 as a date not later than 19th March 1976—the vesting date under theGibraltar settlement (the exact date seems not to be proved).
On 25th March 1975 the appellant requested the Gibraltar trustee to advance £315,000 to the Jersey settlement, to be held as capital of that settlement. On 27th March 1975 the Gibraltar trustee appointed £315,000 accordingly, and also appointed £29,610 to compensate the income beneficiary, which had become Goldiwill. These appointments were giveneffect to by Thun transferring money in Jersey to Allamanda, the Jersey trustee, and Goldiwill. So the appellant was now a person for whose benefit a reversion had been created under the Jersey settlement (see again paragraph 13(1) supra). There was left £255,390 unappointed in the Gibraltar settlement.
On 1st April 1975 the appellant requested Thun to cause Tortola to nominate a purchaser of his interest under the Gibraltar settlement and on 3rd April Tortola nominated Goldiwill. Also on 3rd April the appellant agreed to sell his reversion under the Gibraltar settlement to Goldiwill for £231,130: the agreement recited that the trust fund then consisted of£255,390. The appellant assigned his reversion accordingly. This is the trans action supposed to create the loss. Also on 3rd April 1975, the appellant agreed to sell his reversion under the Jersey settlement to Thun for£312,100. The agreement recited that the trust fund then consisted of£315,100. Payment for these various transactions was effected by appropriations by Thun. The price for the two reversions (£231,130 and£312,100) making £543,230 due to the taxpayer was set off against the loan of £543,600 made by Thun, leaving a balance due to Thun of £370.The appellant paid this and Thun released its charges. The only money which passed from the appellant was the £370, £3,500 procuration fee, and£6,115 interest.
Of this scheme the following can be said:
The scheme was a pure tax avoidance scheme, designed by Thun and entered into by the appellant for the sole purpose of manufacturing a loss matched by a corresponding but exempt capital gain. It was marketed by Thun as a scheme available to any taxpayer who might purchase it, the sums involved being adapted to the purchaser'srequirements.
Every individual transaction was, as found by the general commissioner's, carried through and was exactly what it purported to be.
It was held by the judge and not disputed by the Court of Appeal that by its agreement with the appellant, Thun agreed to procure the implementation of all the steps comprised in the scheme and was in aposition to obtain the co-operation of the associated companies Pendle and Goldiwill.
The scheme was designed to return all parties within a few daysto the position from which they started, and to produce for the appellant neither gain nor loss, apart from the expenses of the scheme, the gain and the loss being " self-cancelling " The loss could not be incurred without the gain, because it depended upon the reversion under the Gibraltar settlement being diminished by the appointed sum of £315,000 which produced the gain. The appellant would not have entered into the scheme unless this had been the case.
The scheme required nothing to be done by the appellant except the signing of the scheme documents, and the payment of fees. The necessary money was not provided by the appellant but was " provided "by Thun on terms which ensured that it would not pass out of its control,and would be returned on completion having moved if at all in a circle.
On these facts, it would be quite wrong, and a faulty analysis, to segregate,from what was an integrated and interdependent series of operations, in one step, viz. the sale of the Gibraltar reversion on 3rd April 1975, and to attach fiscal consequences to that step regardless of the other steps and operations with which it was integrated. The only conclusion, one which is alone consistent with the intentions of the parties, and with the documents regarded as interdependent, is to find that, apart from a sum not exceeding £370, there was neither gain nor loss and I so conclude.
Although this disposes of the appeal I think it right to deal with theparticular point which, apart from the judgment of Templeman L.J.,formed the basis of the decisions below. This is whether the sale of the reversion under the Gibraltar settlement on 3rd April 1975 gave rise to an allowable loss if regarded in isolation. I regard this, with all deference, as a simple matter. What was sold on 3rd April 1975 was the appellant's reversionary interest in £255,390: for this the appellant received £231,130
certified by Solandra to be the market price. Not only was this the fact the trust fund at that time was of that amount—but the agreement for sale specifically so stated. It recited that the vendor, the appellant, was beneficially entitled to the sole interest in reversion under the Gibraltar settlement, " being a settlement whereof the trust fund presently consist (sic)" of £255,390 ". What he had bought, on the other hand, for £543,600 was a reversionary interest in £600,000, subject to the trustee's power to advance any part to him or to a settlement in which he had an equivalent reversionary interest. After the advance of £315,000 was made (effectively to the appellant so that to this extent he had got back part of his money), all he had to sell was the reversionary interest in the remainder: this he sold for its market price. Alternatively, if the £315,000 is to be considered as in some sense still held under the Gibraltar settlement, the sale on 3rd April 1975 to Goldiwill for £231,130 did not include it. On no view can he say that he sold what he had bought: on no view can he demonstrate any loss.I think that substantially this view of the matter was taken by Buckley L.J.and Donaldson L.J., and I agree with their judgments.
I would dismiss this appeal.
Lord Fraser of Tullybelton
My Lords,
Each of these appeals raises one separate question of its own and one wider question common to both. I shall consider the separate questionsfirst.
Ramsay
The appellant is a farming company. During its accounting period ended 31st May 1973 it sold the freehold of its farm, and made a gain of £187,977 which was chargeable for corporation tax purposes, on the same principles as it would have been charged to capital gains tax in the caseof an individual.
Having taken expert advice, the appellant entered into a scheme to create a capital loss which could be set off against that chargeable gain.The essence of the scheme was that the appellant acquired two assets, one of which increased in value at the expense of the other, and both which were then disposed of. The asset which decreased in value consisted of shares in a company called Caithmead Ltd., and the loss on that asset was intended to be allowable for corporation tax purposes, and therefore available to be set off against the gain on the farm. If that part of thescheme is considered by itself, it worked as intended and produced an allowable loss. The asset which increased in value was a loan to CaithmeadLtd. It was one of two loans, and was referred to as L.2, and it was intended to be exempt from corporation tax on chargeable gains. Thequestion in this appeal is whether that intention has beensuccessfully realised
The answer depends entirely on whether L.2 was " the debt on a"security" in the sense of the Finance Act 1965, Schedule 7 paragraph11(1). If it was, the gain on its disposal was chargeable. If it was not,the gain is not chargeable. The very unusual terms on which L.2 was made by the appellant to Caithmead Ltd., have been described by my noble and learned friend Lord Wilberforce and I need not repeat them.
The expression " the debt on a security " is not one which is familiar to either lawyers or, I think, business men. Its meaning has been considered in two cases to which we were referred. In Cleveleys Investment Trust Co.v. I.R. 1971 S.C. 233, Lord Cameron pointed out at page 244 that whatever else it may mean it " is not a synonym for a secured debt ", and that is generally agreed. Lord Migdale thought that it meant "an obligation to" pay or repay embodied in a share or stock certificate ..." Lord Migdale's view was accepted by all the learned judges of the First Division in Aberdeen Construction Group Ltd. v. I.R. 1977 S.C. 265, but when the Aberdeen case reached this House, the existence of a certificate was not treated as the distinguishing feature of the debt on a security. Lord Wilberforce at 1978 SC (HL) 72, 81 expressed the view that the distinction was " between a pure unsecured debt as between the original" borrower and lender on the one hand and a debt (which may be" unsecured) which has, if not a marketable character, at least such " characteristics as enable it to be dealt in and if necessary converted into" shares or other securities." Lord Russell of Killowen at page 89 said that loan stock " suggests to my mind an obligation created by a company" of an amount for issue to subscribers for the stock, having ordinarily" terms for repayment with or without premium and for interest." No disapproval of the observations in the Court of Session was expressed,and I expressed general agreement with them. The authors of the scheme in this appeal may have had these observations in mind when they devised the scheme, as they went to some trouble to avoid having any certificate or voucher of the debt, and relied instead on a statutory declaration setting out the terms and conditions of the loan.
Further consideration has satisfied me that the existence of a documentor certificate cannot be the distinguishing feature between the two classes of debt. If Parliament had intended it to be so, that could easily have been stated in plain terms and there would have been no purpose in using the strange phrase "the debt on a security" in paragraph 11(1) of schedule 7, or in referring to the " definition " of security in paragraph 5.The distinction in paragraph 11(1) is, I think, between a simple unsecured debt and a debt of the nature of an investment, which can be dealt in and purchased with a view to being held as an investment. The reason forthe provision that no chargeable gain should accrue on disposal of asimple debt by the original creditor must have been to restrict allowable losses (computed in the same way as gains—Finance Act 1965, section 23,which was the relevant statute in 1973) because the disposal of a simple debt by the original creditor or his legatee will very seldom result in again. No doubt it is possible to think of cases where a gain may result,but they are exceptional. On the other hand it is all too common for debts to be disposed of by the original creditor at a loss, and if such losses were allowed for capital gains tax it would be easy to avoid tax by writing off bad debts—for example those owed by impecunious relatives.But debts on a security, being of the nature of investments, are just aslikely to be disposed of by the original creditor at a gain as they are at aloss, and they are subject to the ordinary rule.
The features of the debt L.2 in the present case which in my opinion take it out of the class of simple debts into the class of debts on a security are these. First and foremost, the debtor was not bound to repay it for 31 years. Such a long fixed term is unusual for a debt, but it is typical of a loan stock (a term which I use hereafter to include similar securities).Secondly, the debtor was entitled to repay it sooner, and bound to repay it on liquidation, but in either of these cases only at the higher of face value or market value, market value being calculated on the assumption that it would remain outstanding for the full period of 31 years. Conditions of that sort are very unusual when attached to a debt, but are characteristic of a loan stock. Thirdly, it bore interest and thus produced income to the creditor, as an investment such as loan stock normally does but as debts normally do not. For example, the debt owed by a subsidiary company to its parent company in the Aberdeen case did not carry interest.It is to be observed that paragraph 11(1) refers not to loan but to" debt " and thus includes ordinary trade debts which rarely carry interest.Fourthly, being a long term interest-bearing debt, it possessed the characteristic of marketability. Indeed, L.2 was created only in order to be sold at a profit and it was so sold. It could have been sold and assigned in part like loan stock, although an action to enforce payment might have required the concurrence of the original creditor.
If L.2 had been surrendered and its proceeds used to pay for shares,it could in a loose sense be said to have been " converted " into shares or a new loan. But it was no more, and no less, convertible than a simple debt, and I do not consider that convertibility is a distinguishing factor of a loan on a security.
Counsel for the appellant said that a loan stock had to be capable of being " issued " and " subscribed for " and that L.2 did not satisfy these requirements. But I agree with Templeman L.J. that L.2 was in fact issued and subscribed for although the processes were simple because only one lender was involved.
For these reasons I agree with the Court of Appeal that L.2 fell within the description of a debt on a security and that the appellant's gain on disposal of it was chargeable. I would dismiss this appeal on that ground.
Rawling v. Eilbeck
This is another scheme designed to eliminate or reduce a capital gain.In this case the gain arose from sales of shares and amounted to about £355,000. Again, the details of the scheme have been explained by my noble and learned friend Lord Wilberforce, and I refer only to its essential elements. On 24th March 1975 the appellant acquired for £543,600 an asset, consisting of the reversionary interest under a settlement made in Gibraltar and administered by a trustee in Gibraltar. The appellant claims that on 3rd April 1975 he sold the same asset for £231,130 thereby making a loss of £312.470. The reason why the sale price was so much lower than the cost price of what is said to be the same asset only ten days earlier was that the trustee, in the exercise of a power under clause 5(2)of the settlement, had appointed £315.000 out of the capital trust fund to the trustees of another settlement. The other settlement had been made in Jersey and was administered by a trustee in Jersey. (The geographical location of these trusts is entirely irrelevant to the question raised in this appeal, which would be the same if both trusts had been in England).The appellant maintains that the reduction in the amount of the Gibraltar trust fund, and hence in the value of his reversionary interest in it, did not affect the continuing identity of the fund or of his interest. He says that his interest was in the assets of the fund, as they existed from time to time, and that it remains the same interest notwithstanding a change in the individual assets or in their value.
My Lords. I do not accept that contention. No doubt it would have been correct if the fall in value of the Gibraltar trust fund had been brought about merely by a fall in the value of its component assets, for instance, if the total value of the trust investments had fallen, or even if some of the investments have been altogether lost. But the position is entirely different in this case where the trust fund was divided into two parts, of which one was handed over to the Jersey trustee and the other was retained by the Gibraltar trustee. The retained fund was not the whole fund in which the appellant had bought an interest. It was only part of the fund and the reversionary interest in the retained part was only part of the reversionary interest which the appellant had bought. If the fund had been invested in stocks and shares, or other assets, it wouldhave been necessary to apportion the assets to one or other part of thefund. This would have been more obvious if the retained fund had been sold before the appointment in favour of the Jersey settlement had been made; in that case the sale would expressly have been of part only of the total fund. It follows therefore that the appellants claim to have sustained a loss measured by the difference between the cost of the whole reversionary interest and the price realised for part of it must fail.
That is enough to negative the appellant's claim as put forward, but I would go further and would adopt the analysis by Buckley L.J. of the true position. In the circumstances of this case, where the appointment by the Gibraltar trustee was made under a special power, I agree with Buckley and Donaldson L.JJ. that the appellant's reversionary interest in the appointed fund is properly to be regarded as part of his interest inthe Gibraltar fund. Buckley L.J. (but not Donaldson L.J.) assumed that the " closing date " appointed by the trustee of the Jersey settlement was the same as the " vesting day " under the Gibraltar settlement—that is 19th March 1976. There is no finding to that effect and we were told that the " closing date " probably was 6th May 1975. But the identity of dates was not essential to the reasoning on which Buckley L.J. proceeded.The position was that, after the appointment, the appointed fund was held by the Jersey trustee for purposes which, although in some respects different from those of the Gibraltar settlement (the tenant for life being different and the closing date probably being different), were within thelimits laid down in the Gibraltar settlement. In particular the reversioner was the same and the closing date was not later than the vesting date in the Gibraltar settlement. If the differences had not been within the permitted limits the appointment would of course not have been intra vires the Gibraltar trustee. Accordingly the true price realised on disposal ofthe appellant's interest was in my opinion the sum of the price of the retained fund in Gibraltar (£231,130) and of the appointed fund in Jersey(£312,100), amounting to £543,230. His loss was therefore about £370.
For these reasons I would dismiss this appeal.
Wider Question—Was there a disposal in either of these cases?
The Inland Revenue maintain that they are entitled to succeed in both these appeals on the wider ground that in neither case was there a disposal of the loss-making asset in the sense in which disposal is used in the Finance Act 1965 Schedule 7. On behalf of the taxpayer in each case reliance was placed on the finding by the special commissioners that thevarious steps in the scheme were not shams. The meaning of the word" sham " was considered by Diplock L.J. in Snook v. London and WestRiding Investments Ltd. [1967] 2 Q.B. 786, 802, where he said that " it" means acts done or documents executed by the parties to the ' sham '" which are intended by them to give to third parties or to the court the" appearance of creating between the parties legal rights and obligations" different from the actual legal rights and obligations (if any) which the" parties intend to create." Thus an agreement which is really a hirepurchase agreement but which masquerades as a lease would be a sham.Although none of the steps in these cases was a sham in that sense, there still remains the question whether it is right to have regard to each step separately when it was so closely associated with other steps with which it formed part of a single scheme. The argument for the Revenue in both appeals was that that question should be answered in the negative and that attention should be directed to the scheme as a whole. This question must, of course, be considered on the assumption that the taxpayer would have been entitled to succeed on the separate point in each case.
In my opinion the argument of the Inland Revenue is well founded and should be accepted. Each of the appellants purchased a complete prearranged scheme, designed to produce a loss which would match thegain previously made and which would be allowable as a deduction for corporation tax (capital gains tax) purposes. In these circumstances thecourt is entitled and bound to consider the scheme as a whole, see Plummer v. C.I.R. [1980J A.C. 896, 907, Chinn v. Hochstrasser [1981]2 W.L.R. 14. The essential feature of both schemes was that, when they were completely carried out, they did not result in any actual loss to the taxpayer. The apparently magic result of creating a tax loss that would not be a real loss was to be brought about by arranging that the scheme included a loss which was allowable for tax purposes and a matching gain which was not chargeable. In Ramsay the loss arose on the disposal of the appellant's shares in Caithmead Ltd. In Rawlings it arose on the disposal of the appellant's reversionary interest in the retained part of the Gibraltar settlement. But it is perfectly clear that neither of these disposals would have taken place except as part of the scheme, and, when they did take place, the taxpayer and all others concerned in the scheme knew and intended that they would be followed by other prearranged steps which cancelled out their effect. In Rawlings the intention was made explicit as the supplier of the scheme, a company called Thun Holdings Ltd., bound itself contractually, if the scheme was once embarked upon,to carry through all the steps. There is, therefore, no reason why the court should stop short at one particular step. In Ramsay the supplying company, Dovercliffe Ltd., did not undertake any contractual obligation to carry the scheme through, but was a clear understanding between the taxpayer and Dovercliffe that the whole scheme would be carried through;that was why the taxpayer had purchased the scheme. The absence of contractual obligation does not in my opinion make any material difference.
The taxpayer in both cases bought a complete scheme for which he paid a fee. Thereafter he was not required to produce any more money,although large sums of money were credited and debited to him in the course of the complicated transactions required to carry out the scheme.The money was lent to the taxpayer at the beginning of the scheme, by Thun in the Rawlings case and by a finance company, Slater Walker, inthe Ramsay case, and was repaid to the lender at the end. The taxpayer never at any stage had the money in his hands nor was he ever free to dispose of it otherwise than in accordance with the scheme. His interest in the assets, the shares and loans in the Ramsay case and the trust funds in the Rawlings case, were charged in favour of the lenders by way of security, so that he was never in a position to require the price of any asset that was sold to be paid to him. Throughout the whole series of transactions the money was kept within a closed circuit from which it could not escape.
In Rawlings there was not even any need for real money to be involved at all. On 24th March 1975 Thun agreed to lend the taxpayer £543,600 to enable him to purchase the reversionary interest in the Gibraltar settlement. On the same day the taxpayer agreed to purchase, and Pendle(a subsidiary company of Thun) agreed to sell the reversionary interest to him and assign it to him, and the taxpayer directed Thun to pay the£543,600 to Pendle. The taxpayer never handled the money, and presumably the payment to Pendle was effected by an entry in the books of Thun, though it was not proved that such an entry was made. When the taxpayer sold his reversionary interest in the Gibraltar settlement to another subsidiary of Thun, it was already charged to Thun in security and the purchase price was paid by the subsidiary to Thun, again presumably by an entry in Thun's books. His reversionary interest in the Jersey settlement was sold direct to Thun and the balance of Thun'soriginal loan to the taxpayer was extinguished. There was apparently no evidence before the special commissioners that Thun actually possessedthe sum of £543,600 which they lent to the taxpayer to set the scheme in motion, not to mention any further sums that they may have lent to other taxpayers for other similar schemes which may have been operating at the same time, and it might well have been open to the special commissioners to find that the loan, and all that followed upon it, was a sham. But they have not done so. In Ramsay " real " money in the form of a loan from Slater Walker was used so that a finding of sham in that respect would not have been possible.
Counsel for the taxpayer naturally pressed upon us the view that if we were to refuse to have regard to the disposals which took place in the course of these schemes, we would be departing from a long line of authorities which required the courts to regard the legal form and natureof transactions that have been carried out. My Lords, I do not believethat we would be doing any such thing. I am not suggesting that the legal form of any transaction should be disregarded in favour of its supposed substance. Nothing that I have said is in any way inconsistent with the decision in the Duke of Westminster's case [1936] AC 1 where there was only one transaction—the grant of an annuity—and there was no question of its having formed part of any larger scheme. The view that I take of this appeal is entirely consistent with the decision in Chinn v. Hochstrasser, supra, and it could in my opinion have been the ground of decision in Floor v. Davis[1980] A.C. 695 in accordance with the dissenting opinion of Eveleigh L.J. in the Court of Appeal with which I respectfully agree. In that case the taxpayer wished to dispose of shares in a company to an American company called KDI at a price which would have produced a large chargeable gain. In order to avoid the liability to capital gains tax he adopted a scheme which involved the incorporation of another company, FNW, to which he transferred his shares in order that they could subsequently be transferred by FNW to KDI Eveleigh LJ. said at [1978] 3 W.L.R. 360, 376C:
" I see this case as one in which the court is not required to" consider each step taken in isolation. It is a question of whether" or not the shares were disposed of to KDI by the taxpayer. I" believe that they were. Furthermore, they were in reality at the" disposal of the original shareholders until the moment they reached" the hand of KDI, although the legal ownership was in FNW. I" do not think that this conclusion is any way vitiated by Inland Revenue" Commissioners v. Duke of Westminster. In that case it was sought" to say that the payments under covenant were not such but were" payments of wages. I do not seek to say that the transfer to FNW" was not a transfer. The important feature of the present case is" that the destiny of the shares was at all times under the control of" the taxpayer who was arranging for them to be transferred to KDI." The transfer to FNW was but a step in that process."
In my opinion the reasoning contained in that passage is equally applicable to the present appeals.
Accordingly I would refuse both appeals on the additional ground that the relevant asset in each case was not disposed of in the sense required by the statutes.
Lord Russell of Killowen
my lords,
I find myself in full agreement with what has fallen from My Lords Wilberforce and Fraser of Tullybelton both on the features peculiar to these cases and on the general principles enunciated by them. I cannot hope for and will not attempt any improvements.
I am however unable to resist the temptation to a brief comment on theRawling case. That comment is that I wholly fail to comprehend the contention that the taxpayer sustained a loss (unless it be £370). The moneys advanced into the Jersey settlement, out of the Gibraltar settlement funds in which the taxpayer had acquired an absolute reversionary interest,conferred upon the taxpayer an absolute reversionary interest in the advanced funds which could not fall into possession later than it would have done under the Gibraltar settlement. The power of advancement was so framed that no other outcome was possible. Thus the taxpayer remained absolutely entitled in reversion to the funds. When the taxpayer sold his interest in the remaining unadvanced fund he sold only part ofhis reversionary interest. If the sequence of events had been sale of his reversionary interest in £255,390 to Goldiwill, followed by advancement of the remaining £315,000 into the Jersey settlement, nobody could begin to suggest that there was a loss made on the sale of Goldiwill. This to my mind demonstrates the absurdity of the suggestion that a loss was incurred by the taxpayer by a reverse of that sequence. There was a further power under the Gibraltar settlement to advance directly into the taxpayer's pocket,and it was found necessary to the taxpayer's claim of a loss that, if that had happened, there would nevertheless have been the loss asserted on the disposal of his reversionary interest in the remainder to Goldiwill. That cannot possibly be right.
Lord Roskill
my lords,
I have had the advantage of reading in draft the speeches of my noble and learned friends Lord Wilberforce and Lord Fraser of Tullybelton in these two appeals. I agree entirely with what my noble and learned friends have said and for the reasons they give I would dismiss both appeals.
Lord Bridge of Harwich
my lord,
I have had the advantage of reading in draft the speech of my noble and learned friend Lord Wilberforce. I am in complete and respectful agreement with it and cannot usefully add anything to it: accordingly I, too, would dismiss both these appeals.