Human Rights

Human Rights

Inhuman Act?

JEREMY WOOLF considers whether the FA 2004 is compatible with the European Convention on Human Rights.

HUMAN RIGHTS ACT 1998, s 19 requires ministers to make declarations of compatibility when they promote legislation. Despite this requirement, the FA 2004 contains provisions whose compatibility with the European Convention on Human Rights must be open to serious doubt. Probably the two best illustrations are provided by s 320, which retrospectively seeks to shorten the limitation period for claims to recover tax that has been overpaid as a result of a mistake of law, and the pre-owned asset provisions, in Sch 15, which are a disguised penalty for having made past gifts.

Mistakes of law

FA 2004, s 320 was introduced in the light of the High Court's decision in Deutsche Morgan Grenfell Group v CIR [2003] STC 1017. In that case, Deutsche Morgan Grenfell launched a claim to recover tax that it has overpaid in the light of the European Court decision in Hoechst AG v CIR [2001] STC 452. It sought to extend the limitation period, relying on Limitation Act 1980, s 32(1)(c). That provision extends the limitation period in cases where an 'action is for relief from the consequences of a mistake'. If a claim falls within Limitation Act 1980, s 32(1)(c), it can be brought within six years of the date when the claim could, with reasonable diligence, have been discovered, as opposed to within six years of when it arose.

FA 2004, s 320(1) amends Limitation Act 1980, s 32(1)(c) so that it does not apply to actions brought on or after 8 September 2003, if the claims relate to a mistake of law relating to taxation. No transitional period was allowed to enable taxpayers to make claims before the law was changed.

The decision to enact s 320 without permitting a transitional period in which fresh claims can be made is difficult to reconcile with the decision of the European Court of Justice in Marks and Spencer v CCE [2002] STC 1936. In that case, the European Court held that the introduction, without a transitional period in which claims could be brought, of a three-year cap on claims to recover overpaid VAT was contrary to EC law. The retrospective change in the period for bringing claims was not consistent with the EC law principles of effectiveness or legitimate expectation. Most of the actions brought in the High Court to recover overpayments of tax on the basis of mistake are likely to be based on European law, and the Marks and Spencer decision is going to be of direct relevance. At paragraph 75 of his opinion in the Marks and Spencer case, Advocate General Geelhoed also indicated that the retrospective introduction of the three year cap almost certainly also breached the European Convention of Human Rights. In particular, he noted that in Pressos Compania Naviera SA v Belgium (1995) 21 EHRR 301 the European Court of Human Rights considered that the need to protect the financial interests of the state could not be an adequate justification for retroactively extinguishing monetary claims.

During the standing committee debates on 24 June 2004, Dawn Primarolo, the Paymaster General, suggested that s 320 was distinguishable from the Marks and Spencer case. She said that in the Marks and Spencer case the limitation period was clear, while in the direct tax context this was not the position. In the Pressos case, similar arguments were raised without success. However, the Court in Pressos considered that the law had been clear for many decades.

In National & Provincial Building Society v UK [1997] STC 1466, the European Court assumed, without finally deciding, that the claims by the applicants to recover overpaid tax were sufficiently certain to constitute 'possessions'. Assuming any claims do constitute possessions, it is difficult to see why past uncertainty in the law can justify retrospective changes to the law. The Government would otherwise be able to alter the law retrospectively every time it loses a case in the courts.

If a change in the law is justified, it is difficult to see why it should be limited to claims relating to taxation. The Government's reliance on the uncertain state of the law is unlikely to be assisted by the fact that there was no reason why legislation could not have been introduced a number of years ago. Deutsche Morgan Grenfell Group commenced its claims in October 2000. The decision of the House of Lords in Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349 in 1998 would have made it clear that claims might be brought. Although observations by Lord Goff left open the possibility that different considerations might apply to claiming to recover overpaid tax, that decision made it clear that claims could be brought to recover payments on the basis of mistake of law. It also made it clear that Limitation Act 1980, s 32(1)(c) could extend the limitation period when a claim was made on the basis of mistake of law. If the public finances required protection, there was therefore no reason why legislation could not have been introduced with proper transitional provisions much sooner. It is therefore not surprising that proceedings have been commenced challenging the provisions.

Pre-owned assets

The objective of the pre-owned asset provisions in FA 2004, Sch 15 is to penalise taxpayers for inheritance tax planning that they have undertaken in the past. Rather than retrospectively altering the inheritance tax reservation of benefit provisions, Sch 15 imposes income tax charges on people who enjoy benefits from property when they have disposed of an interest in property. Exceptions apply if the gifts are subject to the reservation of benefit provisions or if the donor elects for those provisions to apply.

The Government contends that the provisions are not retrospective. It argues that no income tax charge arises in relation to past occupation. The charge is instead imposed on future occupation.

The House of Lords and House of Commons Joint Committee of Human Rights considered whether Sch 15 was compatible with the European Convention of Human Rights in its twelfth report of 23 May 2004. The committee criticised the explanatory notes that accompanied the Bill for not explaining the reasons why provisions were compatible. It correctly noted that, under the convention, the state has a broad, but not completely unfettered, discretion on tax matters.

The committee considered that the provisions in Sch 15 'cannot strictly be said to be retrospective'. It also noted that the requirement of legal certainty does not amount to an outright prohibition on retrospective taxation. It considered that 'imposing a charge to tax in respect of the benefit derived from continued use of assets which have been disposed of in order to avoid liability to inheritance tax cannot be characterised as an arbitrary confiscation, devoid or reasonable foundation'.

There can be no doubt that Parliament is in general entitled to change the law and to impose new tax charges. If Parliament had altered the law to create an across the board taxation on land occupation, there could be no human rights objections. However, the legislation in this case is not of that nature. It is instead specifically targeted and intended to penalise individuals for having made gifts or, in some instances, sold interests in property many years beforehand. The charge arises even though the donor is not occupying the property by virtue of the interest that he gifted or sold, but instead occupies it by virtue of independent interests that he retained. To impose a targeted charge in such circumstances can only fairly be regarded as a retrospective penalty. The committee's analysis does not give sufficient weight to the substance of the position. The Court in Jokela v Finland (application 28856/95) (21 May 2002) stressed that the Convention is intended to give protection for rights that is 'practical and effective' and that it is therefore necessary to look at the de facto position.

The committee correctly recognised that there may be circumstances when retrospective tax legislation is compatible with the Convention. An example is provided by National & Provincial Building Society v UK. In that case the European Court of Human Rights considered that retrospective legislation that deprived the applicants of a right to recover income tax that had been paid under ultra vires regulations was compatible. However, that case clearly does not mean that any retrospective measure is compatible. Special circumstances must be established. The retrospective legislation in that case was justified by reference to a clearly expressed legislative intent to tax the income and a desire to prevent a windfall. The measure had some similarities to the provisions, frequently introduced into Finance Bills, that close tax avoidance strategies from a date announced in earlier Revenue press releases. No similar expressions of intent can justify the pre-owned asset legislation.

The compatibility of retrospective tax legislation has also recently been considered by the European Court of Human Rights in its admissibility decision in MA v Finland (application 27793/95) (10 June 2003). In that case, Finland introduced legislation to impose an income tax charge on gains made from share options. The intention to change the law was announced in September 1994. The charge was initially intended to apply when gains were realised after 1 January 1995. However, it became apparent that the terms of options were being changed with a view to avoiding the proposed change to the law. The legislation was therefore applied retrospectively to September 1994 in cases where the terms of the options had been varied to permit gains to be realised before 1 January 1995.

The European Court of Human Rights considered that the provisions were compatible with the Convention. It noted that the options had always been subject to tax and that the changes were just increasing the rate at which the options were taxed. The charge was also on 'real profits'. The taxpayer did not have a legitimate expectation that the rate of tax might not be increased after the options were granted and before they were exercised. Against this background, the Court considered that the retrospective changes, that were intended to counter attempts to avoid the proposed provisions, were within the state's margin of appreciation. The Court observed that different considerations might have applied if the retrospective changes had applied to cases where no attempt had been made to vary the terms of the options.

Although the National & Provincial Building Society and MA v Finland cases are not encouraging, they do make it clear that there may be cases where tax legislation is contrary to the Convention because it does not have a reasonable foundation. The provisions in FA 2004, Sch 15 are not taxing 'real profits' nor could such targeted charges be legitimately expected by a person who made disposals many years ago. The arguments for considering that the provisions are not 'fair' and do not have a 'reasonable foundation' are likely to be strengthened by the fact that the Revenue has been aware of many of the schemes for avoiding the inheritance tax reservation of benefit provisions for a number of years. Changes to the law were made after Ingram v CIR [1999] STC 37 and Eversden v CIR [2002] STC 1109. However, no changes were otherwise made to the legislation. The Government's past inaction ought to be a relevant consideration when assessing whether the measures can be regarded as proportionate and strike a fair balance. Nor is the unfairness removed by the fact that an election can be made to apply the reservation of benefit provisions. Such an election is an election for retrospective taxation. Making such an election could also result in charges on both spouses' deaths if planning based on the Eversden case has been implemented. It also does not secure a capital gains tax uplift on death.

The unfairness of the provisions is probably particularly significant in cases where there has been an arm's length sale, since in these situations the owner would have been acting entirely reasonably in considering that he had done nothing provocative in disposing of the interest. Similar considerations probably apply to a person who made a gift of a freehold subject to a lease in circumstances that were similar to those in Munro v Stamp Duty Commissioner [1934] AC 61 or who granted the lease after the decision was delivered by the House of Lords in Ingram v CIR.

Challenge now!

While the wide margin of appreciation given to the authorities means that a successful challenge is not assured, there are arguments of force for considering that the provisions in Sch 15 do not create a fair balance and do not have a 'reasonable foundation'. It is to be hoped that the compatibility of Sch 15 with the European Convention of Human Rights will be challenged in the courts. If the provisions are not challenged, there will no doubt be future occasions when the Government will seek to devise similar new tax charges. No one individual may be prepared to mount such a challenge. However, it should be open to a group of taxpayers to commence judicial review proceedings for a declaration of incompatibility.

Jeremy Woolf is a barrister specialising in tax law practising from Pump Court Tax Chambers, London, and Park Court Chambers, Leeds. He was junior counsel for the taxpayers in CIR v Eversden [2003] STC 822 and has been representing the applicant before the European Court of Human Rights in King v United Kingdom [2004] STC 911. He is co-author of Zamir and Woolf: The Declaratory Judgment.

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