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Since the merger of the Inland Revenue and Customs in 2005, the new organisation has become more active and aggressive in its approach to tax planning. This has recently manifested itself in Andrew Berry (TC321), a case decided by the First-tier Tribunal (Tax).
Mr Berry participated in what is described in the decision as ‘gilt strip planning’ (GSP). The issue for determination in the appeal was whether Mr Berry had realised an income tax loss, representing the difference between the amount paid by him for a particular gilt strip and the amount payable on subsequent transfer of that strip, for the purposes of FA 1996, Sch 13 para 14A (now ITTOIA 2005, s 446).
Mr Berry claimed that the GSP created a loss of £400,000, which was available to set off against his other income. HMRC denied that there was any such loss.
Mechanics of the arrangements
The GSP was marketed and implemented by Abacus Wealth Planning. Mr Berry became aware of the scheme in November 2003.
The documents supplied to Mr Berry made it clear that the arrangements made use of a ‘principal strip’ of a government gilt, being the right to receive the capital due on redemption of the gilt and stressed that there was uncertainty as to the outcome. It was explained that:
‘Under the planning, the taxpayer realises a capital gain that is exempt from capital gains tax and a loss that is allowable as a deduction for income tax purposes. The planning… involves the sale and purchase of gilt strips to and from a special purpose vehicle provided by the bank.’
The documents set out the steps to be taken. Essentially, the customer would decide the amount of losses he wished to make and would pay Abacus a fee of 1% of the required shelter.
He would then complete a call option agreement and a purchase contract. The option premium would be deposited in an account with SG Hambros. The customer was then told:
‘At the end of the option/contract period, your purchase of the gilt strip, and its sale under the option agreement, will occur in quick succession (it is anticipated the interval will be mere minutes). Because you will buy the gilt strip before selling it, you will need to borrow funds from the bank for a short period… The loan will be repaid from the proceeds of sale of the gilt strip under the option agreement. The transaction costs will also be taken by the Bank at this time, from the funds already deposited by you for this purpose … After the transactions are completed the bank will supply you with the relevant contract notes.’
The arrangements were intended to produce an allowable loss for Mr Berry. Using simple figures for illustrative purposes, the customer would buy gilts for £100.
He would grant a call option, at a strike price of £30, over gilts entitling the special purpose vehicle to buy the gilts back for £70. He would therefore make a ‘loss’ of £30 equal to the strike price.
Implementation
Mr Berry signed powers of attorney in favour of Abacus and the scheme was duly executed on his behalf. Funding was provided by the bank. In brief:
- A special purpose vehicle, owned by a charitable trust, was used for the scheme.
- The bank received permission from the Jersey authorities to make a £62 million overnight facility available to the special purpose vehicle.
- Approval was given on 2 December 2003.
- On 3 December 2003, the bank opened an account in Mr Berry’s name. Two loans were made to the special purpose vehicle. Loan 1 funded the call option premium payable to Mr Berry. This was for £390,000. Loan 2 was lent overnight to the special purpose vehicle to buy strips in the market. The credit application under which these loans were made available was designed to address concerns made by counsel that HMRC might argue under pre-ordination principles that the existence of the option could be ignored if there was no likelihood that it would not be exercised. It therefore addressed the issue as to what would happen should the market price of the gilt strip fall below ‘the waterline’, i.e. to a price lower than the strike price under the option.
- The scheme was implemented over the next five business days. On the first business day Mr Berry entered into a forward purchase contract to purchase the gilt strips for a total of £6,496,308. Clause 2.1 of the contract required Mr Berry to deliver a purchase notice to the special purpose vehicle by 5pm on the fourth business day, with evidence of the receipt of the purchase price payable. In the event that a purchase notice was not delivered, Mr Berry was liable to repay the special purpose vehicle the £390,000 paid under the call option. On the same day Mr Berry sold the call option to the special purpose vehicle for £390,000. The bank then immediately granted Mr Berry the necessary credit facility to buy the strips.
- On the third business day the special purpose vehicle bought the gilt strips for delivery the next day, and immediately sold them with a delivery date on the following day.
- Just before 5pm on the fourth business day, the purchase notice was served. The purchase price was stipulated at £6,502,308. The special purpose vehicle immediately exercised its call option for a price of £6,102,308, producing a loss of £400,000.
Defeat for the taxpayer
The tribunal decided against Mr Berry. In its view, all the parties were perfectly hedged and there was no actual risk to anyone.
Mr Berry was protected because if, at the time of serving the purchase notice, the value of the gilt strips had fallen below the waterline, he would simply not have served the notice and proceeded with the schedule.
The special purpose vehicle would then not have proceeded with the call option. All that would have happened is that Mr Berry’s credit of £390,000 for the call option premium would be debited in the same amount.
The only real cash he would lose would be the £12,000 which he paid to the organiser of the scheme. The special purpose vehicle and the bank were similarly hedged.
The question for the tribunal’s determination was whether FA 1996, Sch 13 para 14A, construed purposefully, applied to the GSP transactions. The tribunal held that because no risk was borne by Mr Berry, the special purpose vehicle or the bank, it did not. Mr Berry failed on the law as applied to the facts of his case.
The story, however, does not end there. HMRC also alleged that the scheme was based on a sham. This argument rested on the fact that the documentation was designed to suggest two possible outcomes that could not be taken at face value and were never intended by the parties.
Although the tribunal did not need to consider the sham argument in order to dismiss the appeal, it did conclude that:
‘ …[the] transactions and the documentation were not a sham, either in their entirety or in part, in the Snook v London and West Riding Investments Ltd [1967] 2 QB 786 sense. There was sufficient legal reality to displace a conclusion of sham.’
Avoidance or evasion?
Unfortunately, HMRC seem to use tax avoidance and tax evasion interchangeably these days. There is, however, a fundamental and critical distinction between the two. Tax avoidance is lawful, however much HMRC might object to taxpayers structuring their affairs so as to mitigate their tax liability.
Tax evasion, on the other hand, is unlawful and will normally involve an element of fraud. Those involved in tax evasion will quite rightly be pursued by HMRC through the criminal courts.
The key difference is that in order to be found guilty of a criminal charge, such as fraudulent evasion of income tax under FA 2000, s 144, a person must have acted dishonestly.
Key indicators of dishonesty are concealment from HMRC of details of the arrangements entered into and/or falsification of documents. Both elements were found to be present in the case of R v Charlton and others [1996] STC 1418, in which a successful criminal prosecution was brought against a tax barrister and three accountants.
When s 144 was first introduced, the then Paymaster General said:
‘No one could be convicted as a matter of general law unless it was proved that he or she had a dishonest intention… A failed (tax) scheme whose details are not hidden from the Revenue amounts not to tax evasion but to tax planning… The Government may not like some of that planning and may legislate against it, but as it is not hidden, it does not fall within the remit of the measure…’
In Snook the plaintiff bought a new car from a dealer on hire purchase terms. The hire purchase company was called Totley Investments Ltd. He then contacted another company, Auto Finance Ltd, with a view to arranging refinancing.
Auto provided documents to Mr Snook to sign which presented a refinancing operation as a hire purchase transaction. The effect was described by Lord Denning Master of the Rolls:
‘The first document was a letter addressed to Totley. It said: “I have sold my rights in the above vehicle to Auto Finance Ltd, subject only to your lien which they will discharge. Would you please inform Auto Finance how much you require to settle my obligations to you and to pass title absolutely to them in the vehicle.”
‘On the bottom half there was a reply ready for Totley to sign… But it does not appear that they ever forwarded it to Totley. They seem to have kept it in their office. The bottom half was never signed by Totley… Most important of all, the statement in the top half “I have sold my rights… to Auto Finance” was not true.’
Had the facts in Snook appeared in a criminal case, a court might well have had little difficulty in concluding that there had been an element of dishonesty.
The situation in Berry was far removed from that found in Snook.
In Berry, documentation was designed with the intention of introducing an effective and genuine element of uncertainty into the transactions. The fact that the documentation may have been ineffective does not mean that they were a pretence or sham.
The key documentation described the nature of the transaction clearly and was not hidden in any way from HMRC. Nor did the documentation seek to misrepresent the reality of the situation. It is therefore difficult to comprehend why HMRC sought to argue sham in the Berry case.
Worrying trend
In the past, HMRC rarely raised sham arguments in the context of civil litigation relating to direct taxes. Raising them in the context of tax avoidance cases is a worrying trend, which reflects HMRC’s attack on certain behaviour which they consider to be unacceptable.
It appears to be part of a concerted campaign by HMRC against advisers associated with tax mitigation structures and those who use such arrangements.
This campaign has also led recently to HMRC using their criminal powers available under the Police and Criminal Evidence Act 1984 to conduct searches of premises of tax advisers who are known to have provided professional assistance to promoters in the context of civil investigations.
Jonathan Levy is a partner and head of the tax disputes resolution team at Reynolds Porter Chamberlain LLP. He can be contacted on 020 3060 6472 or by email. Adam Craggs is a senior associate in the team. He can be contacted on 020 3060 6421 or by email.
