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Is it surprising that taxpayers feel resentful when the tax system contains such manifest unfairness, asks JOHN TALLON QC.
Is it surprising that taxpayers feel resentful when the tax system contains such manifest unfairness, asks JOHN TALLON QC.
HOW CAN YOU decide whether the tax system is working well or whether it is flawed by reason of unfairness? Based on Vestey v CIR 54 TC 503, two simple tests suggest themselves. First, do the effects give rise to a brooding resentment (beyond simply aversion to paying taxes) felt by affected taxpayers? Secondly, is it felt necessary to relieve unintended victims from taxation by concession?
The Vestey Case
Vestey was concerned with what is now TA 1988, s 739 (transfer of assets abroad). The original legislation was contained in FA 1936, s 18. In Vestey, assessments were made on several discretionary beneficiaries of a settlement who had received capital sums. They were not transferors of assets. The application of the principles established by the House of Lords in Congreve v CIR 30 TC 163 to those bare facts meant, on the Revenue's contentions, that each of them was assessable on the entirety of the income of the settlement for so long as they remained beneficiaries, and whether or not they ever benefited from income. However, in the exercise of a purported administrative discretion, the Revenue apportioned the income of each year arising to the settlement between the beneficiaries on a just and reasonable basis, and assessed them accordingly. The House of Lords in 1979 overruled the earlier decision in Congreve and held that s 739 only applied to an individual who either personally made, 'or maybe was associated with', a transfer of assets abroad. To complete the picture, FA 1981 introduced what is now TA 1988, s 740 to deal with non-transferors in receipt of capital benefits.
Brooding resentment
It is well worth repeating the comments of Mr Justice Walton at first instance in the Vestey case:
'… I feel constrained to make one general observation. I conceive it to be in the national interest, in the interest not only of all individual taxpayers — which includes most of the nation — but also in the interests of the Revenue authorities themselves, that the tax system should be fair. Absolute equity is, of course, impossible to achieve, and nobody would cry for the moon. But rank, blatant injustice, of the kind and on the scale exemplified in s 408 of the 1952 Act, s 412(1) in some circumstances, and s 412(2) on the Crown's construction of it, is another matter. Like Lord Upjohn in CIR v Bates 44 TC 225, at page 268, I am quite unable to understand upon what principle of the law the Crown, as he said, "realising the monstrous result of giving effect to the true construction", or what it assumes to be the true construction, of these sections, feels itself entitled to mitigate their monstrosity by such concessions as it chooses to make. One should be taxed by law, and not be untaxed by concession. This has now proceeded for such a long time without the Revenue authorities taking one of the numerous opportunities which they have — at least once a year — to put the matter right that I am afraid they must have failed to realise the deep, brooding resentment felt by every taxpayer who is not charged simply upon his own income (including, of course, what he himself could have had by way of his own income had he so chosen). A tax system which enshrines obvious injustices is brought into disrepute with all taxpayers accordingly, whereas one in which injustices, when discovered, are put right (and with retrospective effect where necessary) will command respect and support.'
Section 412 is a predecessor provision to s 739.
In the House of Lords, Lord Wilberforce described the results of the Revenue's contentions, based on Congreve, as 'arbitrary, unjust, and in my opinion unconstitutional'. Of the panel of Law Lords who decided Congreve, he said:
'If these [results] had been seen in 1949 — within the ambit of proper argument they would not reasonably have been seen — I cannot believe that the eminent Lords who decided the case would have been willing to ascribe to Parliament an intention to produce such a result.'
In adopting the alternative construction of confining s 739 to transferors, the House of Lords gave (unwittingly) judicial approval to the statement of the Financial Secretary to the Treasury in the House of Commons in 1936, who, when commenting on clause 16 of the Finance Bill which became FA 1936, s 18, summarised the conditions precedent to the operation of clause 16 as follows:
'Under the clause … there have to be three conditions present. In the first place there has to be a transfer of assets abroad by an individual resident in this country. Secondly, that transfer must have given rise to rights to an individual who makes it. Thirdly, the individual must have power to enjoy the income of the foreign company. It is not until these three conditions are present that the clause comes into operation.'
However, the decision of the House of Lords preceded by some 13 years its decision in Pepper v Hart [1992] STC 898, pursuant to which recourse may be had to clear statements of ministers or other promoters of bills in cases where the legislation is ambiguous or obscure, or leads to absurdity.
Lessons of Vestey
It was the particularly draconian results flowing from an application of Congreve that led the House of Lords to overrule it in Vestey on the basis that Parliament could not have possibly intended such results. We are all too used in recent times to lengthy, complex and badly-drafted legislation, often hastily introduced with no or no adequate consultation. Indeed, in a recent interview, Lord Butler said these were the common features of all this Government's legislation. Sometimes the results are unfair and even draconian. However, I fear that there may be scant comfort to be drawn from the ringing denunciation in Vestey of draconian legislation.
First, even if the Pepper v Hart principle had been available, I doubt whether the House of Lords would have invoked it in 1979 in Vestey. I am absolutely sure it would not have done so in 1949 in Congreve. But we know, as we always knew, from Hansard that Parliament had no such intention as was ascribed to it in 1949 in Congreve.
That means that the Revenue, which certainly knew what Parliament intended, must have chosen deliberately to ignore it. While Pepper v Hart reduces the chances of that happening, it cannot be ruled out, particularly if ministers with little or no knowledge of the practical operation of a proposed tax use imprecise language. The problem is exacerbated by the modern purposive approach adopted by the courts, with the emphasis on ascertaining the intention of Parliament. Many commentators are wary of that laudable aim since it means that, in some cases at least, an intention is simply divined in circumstances where there are no clear words in the statute to that effect. The lesson of Vestey is that our wariness is not misplaced; if the House of Lords could get it so wrong in 1949, it could happen again.
Secondly, many (myself included, see 'Is Anyone Out There Listening?', Taxation, 24 June 2004, page 319 — answer, predictably — no!) believe the pre-owned assets legislation to be, at the very least, arbitrary and unjust. The reasons for such a view are well-known to readers of this magazine. So I will not repeat them. But 'brooding resentment' is certainly abroad in the land again.
Is it, however, 'unconstitutional' in the sense that income tax is, or rather is commonly understood nowadays, to be concerned with taxing actual income whether received in cash or in kind? The thrust of the pre-owned assets legislation is not to tax the donee, who might at least be said to be foregoing income, but the donor, who has no recognisable income source. However, perhaps even this Government thought that taxation of donees was a step too far.
My own view is that the pre-owned assets legislation is the most shameful piece of tax legislation ever to find its way on to the statute book. But it is difficult to call it 'unconstitutional' since, unlike the circumstances in Vestey and Congreve, Parliament, and in particular the minister promoting the relevant clauses of the Finance Bill, i.e. Dawn Primarolo, made it clear that its predictable effects are intended (but see later below).
So a tax such as the pre-owned assets legislation may be introduced which is arbitrary and unfair to the point of being draconian (and most particularly in its retrospective application to past events). But whatever the sympathies of the court, it is in practical terms powerless to interfere if those results are intended by Parliament.
Untaxing by concession
The other relevant strand of Vestey lies in the comments of the court regarding untaxing by concession, one example of which appears from the extract of Mr Justice Walton's judgment reproduced above. In the House of Lords, Lord Wilberforce returned to this theme:
'When Parliament imposes a tax, it is the duty of the Commissioners to assess and levy it upon and from those who are liable by law. Of course they may, indeed should, act with administrative commonsense. To expend a large amount of taxpayers' money in collecting, or attempting to collect, small sums would be an exercise in futility; and no-one is going to complain if they bring humanity to bear in hard cases.'
I doubt whether Lord Wilberforce's reference to 'humanity' in the context of 'hard cases' was meant to extend to exempting whole sections of taxpayers from charge simply because the legislation went too far.
Extra-statutory concessions may have their proper place. It may be that, in appropriate cases, to incorporate the appropriate restrictions within the legislation would be disproportionate in terms both of complexity and in the numbers of affected taxpayers, and possibly in terms of parliamentary time, to the object sought to be achieved. But that sort of circumstance should be a true exception. If concessions, in whatever guise presented, become a norm, it means that the primary legislation is defective and to that extent, at the very least, unfair. While concessions to cure obvious defects or injustices are to be welcomed, we must not lose sight of the fact that their necessity stems from defective legislation. It seems to me that there is a danger in present days of such concessions becoming the norm and I will give two topical examples, neither of which have been presented for what they truly are, namely concessions.
Earn-out 'concession'
I sell my shares in X, for whom I work, to Y for an initial sum of £1 million. However, I agree to stay on as an employee of X and as part of the terms of sale of my shares I am given a right to an earn-out in the form of shares in Y in three years' time, the number of which will be determined according to the amount of post-tax profits of X over that three-year period.
Such a right is a 'securities option' for the purposes of Chapter 5 of Part 7 of ITEPA 2003, introduced without consultation by the infamous FA 2003, Sch 22. Furthermore, the relevant deeming provisions of Part 7 mean that my securities option is acquired by reason of employment.
The right to further consideration in the form of shares in Y can never be equivalent at the time of sale of my shares in X to the value of the actual number of shares in Y which I will eventually receive. In some cases, my right will be very speculative, and even in cases where it is less speculative there will be a discount for the postponement of the right to receive the shares.
Put shortly, the effect of Chapter 5 is that I am charged to income tax on the excess of the value of the shares actually received in Y over the value at the date of acquisition of my right to receive them, which is reflected in the value of my shares in X at the date of sale.
When this was pointed out to the Revenue, it came as a surprise to it and it promised to issue 'guidance'. The guidance, when it came, took the form of what I shall call an 'approved' earn-out and an 'unapproved' earn-out. So in my example, the proper categorisation would turn on whether I was properly remunerated and whether I would receive the earn-out even if I had ceased to work for X. Other factors were also mentioned. In the case of the approved earn-out, my shares in X will be regarded at the date of sale as having a value equal to the aggregate of £1 million plus an amount equal to the value of the shares in Y I eventually receive. Consequently, I will suffer no charge to income tax. In unapproved cases, the legislation applies in its full rigour. In mixed cases, an apportionment apparently has to be made on some kind of just and reasonable basis.
The guidance simply takes the form of ignoring the proper application of the relevant law and introduces in a non-statutory form criteria for reducing or eliminating the charge in certain cases. There is no question here of 'humanity' being brought to bear in 'hard cases'. This is pure administrative diktat to avoid an obvious defect in the legislation.
Pre-owned assets
If I sell a 50% interest in my freehold house to an insurance company as part of an equity release program to provide for my old age, and continue to occupy my house, I fall four square within the pre-owned assets legislation (FA 2004, Sch 15 para 3). Unfortunately, even though I have no inheritance tax avoidance motive (totally irrelevant to the application of the legislation) and have entered into a commercial bargain with a third party for full consideration, my transaction is not an excluded transaction within Sch 15 para 10(1) because I have made only a partial disposal of my freehold interest.
When this was pointed out by many commentators, a Revenue spokesperson was reported in the national press as saying that such comments were 'scare-mongering' and that the pre-owned assets legislation was never intended to effect such transactions. Well it does; we all know it does; and that Revenue spokesperson knows (or ought to know) that it does. To call that Revenue spokesperson disingenuous is too mild; but editorial sensibilities prevent me from using a stronger adjective.
The Government has said it is still considering partial sales for full consideration. Perhaps we shall see changes generally, or with regard to partial equity release schemes in particular, before the charge bites on 5 April 2005. If not, and the Revenue spokesperson's word can be taken at face value, we shall have another 'concession' to cure another obvious injustice.
Conclusion
It seems to me the clear lesson is that our system of promotion of, consulting on, and finally scrutiny by Parliament of, proposed new legislation is in urgent need of overhaul. I doubt not Lord Butler when he said that the same can be said of all this Government's legislation. It is not enough in my opinion to say that there is inadequate time for such matters and that anyway tax is not 'special'. It is special. Every year we have fresh legislation resulting from an annual Budget; and taxation law, perhaps more than any other kind of law, has a wider impact on the lives of citizens.
While life is not always fair (mother was right on that one!), that is no reason to accept a status quo which acts as a breeding ground for unfairness with consequential resentment on the part of taxpayers. A Government which ignores those effects will eventually forfeit respect and support, not least from tax advisers, upon whom the burden falls of explaining to taxpayers the unfairness, and upon whom much of the administration of the tax system depends for its smooth running.
Postscript — pots and kettles
Since my first draft of this article, we have had the Chancellor's Pre-Budget Report on 2 December 2004. In relation to Schedule E and NIC, the Paymaster General, Dawn Primarolo, in a separate written statement gave a stark warning that where the Government became aware of arrangements which result in employers and employees not paying the 'proper' amount of tax and NICs, legislation will be introduced 'to close them down, where necessary from today'.
Leaving aside issues as to human rights challenges and as to the constitutional propriety (or rather impropriety) of retrospective legislation, that is an astonishing statement for any Government to make. Who exactly is the arbiter of what is 'fair' or what is 'proper', and where now is the (previously) fundamental principle that every citizen should be able to conduct his or her business affairs in full knowledge of any relevant legislation that may impact on it? How can professional advisers know how to advise? Is an idea a 'good' or 'bad' thought?
Parliament recently took steps to secure its own pension arrangements for MPs; this at a time when the right of private citizens to make such provision is circumscribed and when the pension arrangements of the Civil Service are proposed to be adversely changed. Because MPs are inadequately paid, Parliament gives MPs a range of tax-free allowances. To ordinary citizens these appear on occasions to be over-generous and over-used. Nevertheless, they are (so we are assured) lawfully claimed.
There is a distinctly Orwellian feel to this Government. All are, or are to be made, equal, only some are more equal than others. Yet our rulers lay claim to the high moral ground to tell us what is 'proper' and 'fair'!
Try as I may to prevent it, something to do with pots and kettles keeps coming into my mind …
John Tallon QC is a member of Pump Court Tax Chambers.
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