Special Commissioners' Decision

THE PRINCIPAL SUBJECT matter of five appeals heard together over nine days and now reported at SpC295 will concern a small proportion of the tax profession. However, the case is of wider significance since it affords the first opportunity for the courts to review the Ramsay principle following its restatement by Lord Hoffmann in MacNiven v Westmoreland Investments Limited [1998] STC 1131 and also the extent to which extra-statutory sources can be used as aids to the interpretation of statutes.

The case concerns the relationship between certain derivatives and the loan relationship rules that were introduced by Finance Act 1996. The appellants were life companies who had offered to the public bonds that gave a return based on the results of a share index, but subject to a minimum guaranteed return. As the investments were life assurance policies, the death of the investor before maturity would trigger the payment of the amount due at maturity but by reference to the index at the date of death. In order to honour their obligations to their customers, the life offices usually took a number of steps involving:

(1) the purchase of a derivative;

(2) the deposit by the derivatives dealer of the cash price paid for the derivative;

(3) the redeposit by the life office of the cash deposited;

(4) the grant of a put option enabling the life office to sell shares back to the derivatives dealer; and

(5) an agreement between the life office and the derivatives dealer under which the dealer would (if requested) sell the shares as the life office's agent.

A further complication was that in the different cases presented to the Commissioners, some were settled in shares and some were settled in cash. On top of this, others were settled in cash but with the option to take shares, and others were settled in shares with a cash option.

The question that had to be addressed by the Commissioners was not the tax treatment in the hands of the investors, but whether the life offices' receipts from the various transactions were subject to the Finance Act 1996 rules. If the loan relationship régime applied, the receipts were therefore taxed under Schedule D, Case III; the life offices argued that instead they could account for the receipts on the income minus expenditure (I - E) basis according to capital gains rules when realised.

It was agreed by the life offices that the various transactions had been structured in order to avoid the loan relationship rules. Further, they relied upon a letter from the Inland Revenue's Financial Institutions Division and a clear statement in the Inland Revenue's Life Assurance Manual. Both of these made it clear that steps taken to meet a life office's obligations to investors would give rise to chargeable gains rather than income assessable as a loan relationship. For this treatment to apply, it was conditional that the underlying asset was subject to the capital gains rules.

The Finance Act 1996 rules require two conditions to be met for there to be a loan relationship. First, there has to be a money debt (section 81(1)(a)). A money debt is one which falls to be settled either by the payment of money (section 81(2)(a)) or the transfer of a right to settlement under a money debt (section 81(2)(b)).

Once it is shown that there is a money debt, the loan relationship rules then require the debt to arise from the lending of money (section 81(1)(b)). This is widely defined to include 'any advance of money' (section 103(1)).

In total, the Commissioners asked six questions:

(1) Whether the transactions created money debts (the section 81(1)(a) point).

(2) Whether the transactions are for the lending of money (the section 81(1)(b) point).

(3) Whether the transactions fall within the extended meaning of loan provided by section 103.

(4) Whether such meanings could be applied to the transactions if the Ramsay principle were applied.

(5) Whether the letter from the Inland Revenue Financial Institutions Division and the Life Assurance Manual could be admitted as aids to the interpretation of the statute; and

(6) Whether section 128, Taxes Act 1988 was of any relevance.

The section 81(1)(a) point)

The Commissioners considered whether the words 'falls to be settled [by money]' in section 81(2) should be applied when the transaction was entered into, when it was finally carried out, or perhaps at some other time.

In the end, they held that this should be decided by looking at the legal obligations and rights that the relationship offered. As a result, a cash settlement created a money debt and a settlement by shares did not. In cases where there were options for alternative settlements, the issue whether or not a money debt existed was not affected unless and until the option was actually exercised. So if there was to be a shares settlement, there was not a money debt unless the election to settle in cash was exercised.

The section 81(1)(b) point)

Having established that some of the contracts were money debts, the Commissioners then considered whether or not the transactions were for the lending of money. The Commissioners were not invited to decide whether the transactions fell within the extended meaning of such a transaction under section 81(3) and therefore confined themselves to a normal meaning of the words (subject to the section 103 point below).

The Commissioners considered the implications of section 81(4). That provision states that debts arising from rights conferred by shares in a company are not treated as a transaction for the lending of money, and the Commissioners considered whether such an explicit exclusion was implicitly stating that such debts did fall within the loan relationship rules. The Commissioners decided that section 81(4) was there to avoid doubt about some common commercial relationships and did not imply that any similar debt (not explicitly excluded) fell within the rules.

Instead, the Commissioners considered the normal implications of a transaction for the lending of money (viz the existence of a borrower and a lender). Having heard extensive witness statements, the Commissioners found that none of the parties considered their relationship to be categorised in these terms, but rather as buyer and seller. So subject to an alternative finding under the extended meaning of section 103 or the Ramsay principle, the transactions did not satisfy the second leg of section 81(1).

Section 103, Finance Act 1996

The Commissioners considered judicial dicta on the meaning of advance, but considered that it generally related to a payment made in connection with a loan or on account of a loan. As a result, they held that in the current case, section 103 did not make the transactions 'for the lending of money'.

Applying Ramsay

Having held that the transactions were individually within the loan relationship rules, it was necessary to consider whether the Ramsay principle (or the 'Ramsay approach' as suggested by Lord Nicholls in MacNiven) made any difference. The restated approach requires courts to consider whether the words in tax statutes are being used with their normal or commercial meaning or with a particular legal meaning. (The former will allow artificial steps inserted for tax purposes to be ignored when applying the statutory provisions.)

The Commissioners focused their decision on whether section 81(1)(b) could be reinterpreted applying Ramsay. First, they held that the words 'lending of money' did not have a significantly different legal meaning from its commercial meaning. Further, as noted above, there was no evidence to suggest that the transactions being considered were commercially considered to be 'for the lending of money'. As a result Ramsay was of no application here.

The Commissioners added that the loan relationship rules were not intended as an anti-avoidance measure, nor were they intended to be at odds with the complex realities of the financial world. However, complexity (and the corresponding need for specialist legal advice concerning transactions) did not imply artificiality. As a result, even if there were sufficient differences in meaning, the Commissioners held that there were no artificially inserted transactions to which the Ramsay approach could be applied.

Admission of non-statutory material

The taxpayers (assuming the other arguments went against them) argued that the letter from the Inland Revenue and the extract from the manuals could be used to indicate the statutory intention. (This was an attempt to extend the principle in Bibby v Prudential Assurance Co Ltd [2000] STC 459 that explanatory press releases issued at the time of legislation could be admitted.)

As both were written (or presumed to have been written) after the enactment of the legislation, the Commissioners decided that they were not evidential of Parliament's intention.

Whether or not they gave rise to legitimate expectations was not an issue that the Commissioners could decide on, as that is a matter for judicial review.

Section 128, Taxes Act 1988

Finally, for completeness, the Commissioners considered whether (assuming that a court on appeal holds the transactions to fall within the loan relationship rules) section 128 takes the transactions in financial futures (as defined in section 143, Taxation of Chargeable Gains Act 1992) out of the Schedule D charge.

For this to apply, the amounts subject to the Schedule D charge must arise 'otherwise than as the profits of a trade'. The Commissioners decided that the taxation of life offices under the income minus expenditure basis did not prevent these profits from being from a trade. As a result, section 128 would be of no assistance to the taxpaying companies.

The future

Should the case be taken to appeal, the Commissioners certified (in accordance with section 56A(2), Taxes Management Act 1970) that the case is one suited for leapfrogging the High Court and to be heard by the Court of Appeal. But that would depend on the Court of Appeal and the parties themselves.

Keith Gordon is a director of ukTAXhelp Ltd and can be contacted by e-mail on keith.gordon@ukTAXhelp.co.uk. The views expressed in this article are those of the author.

Issue: 3842 / Categories: Comment & Analysis