Still in Luck!

The rule that gambling winnings are free of tax is well known. Identifying the basis of that rule and delineating its precise scope is altogether different. JOLYON MAUGHAM, barrister, explains.

ONE OF THE fastest developing sectors of the economy, and one whose growth looks set to continue following the Government's liberalisation of gaming laws, is the betting industry. Casinos will soon join bookmakers and spread betting firms as convenient places for punters to lose money (tax free of course).

But what about those who win, not just once but consistently? What about those who gamble as a vocation, such as professional spread bettors? Do their 'earnings' escape tax?

Underlying principle

Winnings from gambling are generally accepted to be outside the scope of United Kingdom taxation. Broad statements to this effect are commonplace in the professional literature. The Revenue manuals, although somewhat more circumspect on the subject than the professional literature, contain nothing which could be read as explicitly or implicitly dissenting from this assertion.

The juridical basis for the rule that gambling winnings are not subject to tax lies in a line of cases beginning with Graham v Green 9 TC 309. However, a careful reading of those authorities tends to obscure, rather than illuminate, that which conceptually underpins the rule. As Mr Justice Rowlatt put the matter in that case, somewhat bashfully: 'The subject is involved in great difficulty of language, which I think represents great difficulty of thought'.

The facts of that case were that for a number of years a gambler derived substantially the entirety of his income from gambling on horses. The Revenue sought to charge those winnings to tax. Mr Justice Rowlatt considered both Case II (which, at the time, taxed profits or gains from any 'trade, adventure, employment, or vocation') and Case IV (which applied to any 'annual profits or gains' not falling under any other Case).

In respect of Case IV, he held that betting winnings were analogous to a mere gift or a receipt from finding an object of value. There was no connection between the 'irrational agreement' and the acquisition of the money. In respect of Case II, he held that gambling was a 'habit' rather than a trade or vocation.

Both of these holdings are some way short of being satisfactory. In what sense is betting an 'irrational' agreement? How does one thereby distinguish the situation of a bookmaker whose profits are taxable (see Partridge v Mallendine [1886] 2 TC 179)?

As to the question whether gambling is a 'vocation,' it is difficult to see what more is required than that an individual should apply himself, for a period of time and in an organised fashion, to a particular purpose, such as the making of money through gambling.

What that line of cases comes down to is that there are certain activities which are so inherently uncommercial that the proceeds therefrom are not subject to tax. The argument of counsel for the taxpayer in Green: that taxing betting winnings makes the state an unwitting partner in one's gambling activities, was also bound to have figured sub silentio in Mr Justice Rowlatt's reasoning. Although certain gamblers will make a profit, most gamblers will, as is demonstrated by the existence of bookmakers, suffer losses. Gamblers, considered as a class, have a negative expectation of profit. Therefore, any attempt on the part of the Revenue to subject to tax the profits of the exceptional individual who does make a profit, will lead to a net diminution in tax revenues.

Spread betting

Although this might explain the non-taxability of gains from traditional bookmakers, it is of limited assistance when one turns to consider a sector of the betting industry which does produce consistent profits for a substantial number of individuals: spread betting.

If I place a down bet on the future performance of, say, British Airways shares by purchasing a put option (a right to sell those shares at a specified time in the future at a specified price), the gains therefrom (assuming the share price at the specified time is below the specified price) will be taxable in my hands. However, if I place a down bet with a spread betting firm on the same shares, any profits therefrom will escape tax entirely.

Distinguishing between these two situations is difficult, to say the least. Unlike bets placed with traditional bookmakers, spread betting contracts are enforceable: see City Index v Leslie [1992] QB 98. It is, moreover, questionable whether the profit expectation of spread-bettors, considered as a class, is any different from the profit expectation of individuals who gamble with bookmakers. It is highly questionable whether it differs from the expectation of those who enter into contracts for financial derivatives. Nor can the gambler's level of organisation supply the basis for any distinction: if I enter into a highly organised pattern of spread betting contracts, my profits therefrom will escape tax. However, a single ill-considered, but lucky, foray into financial derivatives will generate a taxable profit.

The decision of the Court of Appeal in Cooper v Stubbs 10 TC 29 suggests one possible explanation for a difference in treatment. Pollock, Master of the Rolls argues, in that case, that unlike betting, contracts for financial derivatives are 'real' (as he puts it), in that they may lead to the underlying contract being implemented. Spread betting contracts, by contrast, do not possess this feature.

However, even this distinction fails to bear close examination. It is difficult to see why a theoretical possibility of a contract being implemented should, if it is clear that that possibility will never fructify, as in (Cooper v Stubbs), bring profits from such contracts into tax. Moreover, it is far from clear whether, for example, a call option on the FTSE 100 is capable of leading, on its expiration, to the purchase of the constituent shares in that index.

The status of the rule

What reliance, then, can be placed on the rule that gambling winnings, including those from spread betting, are free of tax?

Despite the absence of a satisfactory explanation for the non-taxability of gambling winnings, the rule that they escape tax is indubitably one which is entrenched in the United Kingdom tax system. In my opinion, it could not be overturned without legislation and/or judicial dicata at an appellate level.

I am not aware of any indication that the Revenue might seek to revisit the rule. The question of the taxation of gambling was reviewed by HM Customs and Excise in 2001 when general betting duty was introduced. Although the focus of that exercise was on the taxation of the betting industry, the various published papers did not question the notion that winnings from spread betting, together with more traditional forms of gambling, fell outside the charge to tax.

In the circumstances, despite the considerable difficulties inherent in any attempt conceptually to delineate the scope of the exemption, it does look set to remain for the foreseeable future.

Exploitation of the rule

Proceeding from this premise, professional advisers have designed various mechanisms to use this exemption. Unprofitable financial derivatives may be used to hedge profitable spread betting contracts generating taxable losses and non-taxable profits. Contracts can be designed to produce certain (albeit small) profits over a long period of time, and so on.

So long as the juridical basis for the exemption remains opaque, advisers will find it difficult to opine as to the level of risk associated with such mechanisms. However, careful planning will minimise the risk of successful challenge.

Jolyon Maugham, barrister, practises at 11 New Square, Lincoln's Inn.

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