Tax Advisor 2010 tax avoidance case law review - Olswang

Tax Advisor
2010 tax avoidance case law review
Matthew Wentworth considers the key tax avoidance case law
developments of 2010.
Matthew Wentworth is a Barrister (Senior Associate) in the tax group at Olswang LLP. Matthew
advises on a broad range of contentious and non-contentious matters, and has expertise in
respect of both direct and indirect taxation. Email: matthew.wentworth@olswang.com Tel: 0207
067 3372.
INTRODUCTION
2010 has been a year of consolidation. The courts have continued to explore the scope of the
Ramsay (in direct tax cases) and Halifax (in VAT cases) principles.
HM Revenue and Customs (“HMRC”) have not had been successful in all cases. Properly
structured (and implemented) commercial arrangements can still succeed in mitigating tax. In
general terms, the courts have shown a willingness to adopt a purposive approach to interpret
coherent sets of tax rules, but a reluctance to fill the gaps in rules that lack such coherence.
DIRECT TAXES
PA Holdings v Revenue and Customs Commissioners [2010] STC 2343
This case concerned whether the payment of dividends via a tax avoidance structure to
employees should be taxed as dividends (under the old Schedule F rules) or employment income
(under the old Schedule E rules). The taxpayer argued that the payments should be taxed as
dividends and so it should not be liable to any PAYE or national insurance contributions ("NICs")
on the payments.
The Upper Tribunal ("UT") has now confirmed the decision of the First Tier Tribunal (Tax) ("FTT")
that:
(i) The payments were both dividends and employment income. However, section 20(2)
Income and Corporation Taxes Act 1988 (“ICTA”) provided that the distribution rules (in
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(ii)
Schedule F) took precedence. Accordingly, the dividends could not be taxed as
employment income, and PAYE did not apply.
The dividends were earnings for NICs purposes and, because there is no equivalent to
section 20(2) ICTA in the NICs legislation, a NICs liability arose for the employer.
The UT’s reasoning in relation to the Ramsay decision is of particular interest. The UT confirmed
that Ramsay could apply to determine whether a payment was in fact an emolument, and
therefore an amount of employment income, and so within the charge to tax in what is now
Income Tax (Earnings and Pensions) Act 2003 ("ITEPA"). This makes sense; Ramsay has
frequently been applied to determine whether a profit or loss really exists from a commercial
perspective, and hence there is no logical reason why it should not apply to determine whether a
payment, viewed realistically, is an amount of employment income, given that an “emolument” is
also a commercial concept.
However, the UT decided that the application of Ramsay could not exclude the dividend from the
distribution rules; the payment was clearly in fact a dividend, and so it was not possible to
interpret the distribution rules in a way which prevented them from applying here. Therefore the
taxpayer could rely on section 20(2) ICTA for the proposition that the payment could not be taxed
as employment income. HMRC have sought permission to appeal this decision.
UBS AG v Revenue and Customs Commissioners [2010] UKFTT 366 (TC)
UBS established a scheme to incentivise employees through paying them bonuses in the form of
restricted securities. The intention was to avoid any income tax or NICs on the payment, relying
on the detailed provisions of section 425 and 429 ITEPA, as in force at the time of the scheme
(subsequent legislative amendments have removed the possibility of implementing similar tax
planning). The shares could, on the face of it, be forfeited for 90% of their market value, although
additional option arrangements ensured that the actual amount of exposure faced by the
employees was minimal.
The FTT first decided that the securities issued were not "restricted securities", as defined in
section 423 ITEPA. It seems that the Tribunal considered that the existence of the option
arrangements meant the forfeiture provisions did not reduce the market value of the shares.
More interestingly, the Tribunal commented obiter that, if it was wrong on this point, the scheme
as a whole was a preordained structure designed to deliver a tax efficient bonus to employees.
Thus, Ramsay, the arrangements should be viewed realistically and so the cash that the
employees received should be taxed as an emolument.
This decision has a potentially wide impact, especially in relation to employee incentivisation
structures. Viewed realistically, any such structure could be said to have the intention to deliver
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earnings to employees in a tax efficient manner. It is surprising that the FTT decided that the
Ramsay doctrine can apply in relation to the interpretation of highly prescribed technical code
such as that contained in Part 7 ITEPA.
Peter Schofield v Revenue and Customs Commissioners [2010] UKFTT 196 (TC)
This decision concerned a complicated structure for the artificial creation of a capital loss
involving four interlinked options. Viewing each option in isolation, a significant capital loss was
made on the "closing out" of the first option, whilst a significant capital gain was made on the
"closing out" of the third option. The taxpayer argued that the capital loss on the first option was
tax deductible whilst the capital gain on the third option was exempt from charge because it was
an option over gilt-edged securities.
The FTT had little difficulty in finding that the four options needed to be viewed as a single
composite transaction under which no actual loss had arisen. The scheme had built in the
possibility that, due to fluctuations in the FTSE 100, the scheme would only realise a small profit
or a small loss, but this was not enough to stop Ramsay applying.
This would appear to be a straightforward application of the House of Lords decision in Scottish
Provident Institution v Revenue and Customs Commissioners [2005] STC 15; interlinked financial
instruments should be viewed as a single transaction for the purposes of determining whether a
loss has arisen, and the artificially inserted slim possibility of the scheme not working as planned
can be ignored. Following the Court of Appeal’s restatement of this principle last year in Astall v
Revenue and Customs Commissioners [2010] STC 137 this decision appeared inevitable.
Andrew Berry v Revenue and Customs Commissioners [2009] UKFTT 386 (TC)
This decision concerned gilt strip planning, which was a popular way of artificially creating an
income loss through the acquisition of a gilt strip and the granting of an option over the gilt strip to
a third party. The planning relied on creating a loss under paragraph 14A of Schedule 13 Finance
Act 1996. To succeed the taxpayer had to show that the scheme was not self-cancelling, in the
sense that there was a realistic possibility that the option would not be exercised and Mr Berry
would be left owning the gilt strips. To this end the scheme had built in to it a possibility (agreed
by the parties as being 7%) that the option would not be exercised, such that Mr Berry was left
owning the gilt strips.
Unsurprisingly, the FTT applied Astall. The tribunal held that the possibility of the option not being
exercised was part of the scheme, the parties proceeded on the basis that this possibility could
be ignored, and so the possibility should be ignored in applying the legislation. In essence, this
was a self-cancelling scheme in which Mr Berry never really owned the gilt strips and therefore
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never realised a commercial loss for the purposes of paragraph 14A. The decision is being
appealed to the UT.
VAT
GMAC UK Plc v Revenue and Customs Commissioners [2010] UKFTT 202 (TC)
The decision in GMAC UK Plc is interesting in that it did not involve tax avoidance, yet HMRC
stilltried to apply the Halifax decision. GMAC bought cars and resold them under hire purchase
agreements. GMAC would repossess the cars of defaulting customers and resell them. At the
relevant time this resale was not a supply for VAT purposes. GMAC made claims for bad debt
relief in connection with the sale of cars to defaulting customers in relation to periods before 1997
on the basis that UK law (as it then stood) was incompatible with the VAT Directive, in that it
required the customer to be insolvent and property in the goods had to have passed to the
customer in order for the supplier to claim bad debt relief.
GMAC successfully argued that the UK law as it stood before 1997 was incompatible with the
VAT Directive such that, on the face of it, it should be entitled to make bad debt claims. However,
HMRC argued that, where GMAC bought a car, resold it under a hire purchase agreement, then
repossessed it and sold it again, the transactions should be redefined, following Halifax, as a
single supply to the final customer, with output tax being due on this supply. Otherwise, GMAC
would be at a competitive advantage as compared with other car dealers, which would distort
fiscal neutrality.
The FTT rejected HMRC’s argument and allowed the taxpayer’s appeal. Halifax could not apply
outside the context of a tax avoidance scheme. This conclusion is a sensible one and restricts the
role of Halifax to policing the "wild west" of VAT avoidance (which was clearly the intention of the
ECJ).
Paul Newey T/A Ocean Finance v Revenue and Customs Commissioners [2010] UKFTT 183
In this case the FTT had to consider how Halifax would apply where a taxpayer had migrated his
loan broking business to Jersey. The clear intention of the reorganisation was that irrecoverable
VAT on advertising costs would be avoided, because the advertising services would be supplied
to the new Jersey entity (Alabaster) in Jersey, and so would be outside the scope of VAT.
HMRC argued that, applying Halifax, the taxpayer should be seen as still supplying the loan
broker services, and so the advertising services should be viewed as supplied to him. However,
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the FTT determined that, as a question of fact, Alabaster was a genuine commercial entity which
was not simply "rubber stamping" decisions of the taxpayer; it was carrying out the business of
loan broking itself.
In light of these determinations of fact the FTT held that Halifax could not apply to recharacterise
the transactions in terms of the entity supplying the loan broking services so that the recipient of
the advertising services changed. This was a wholesale reorganisation of the business, which it
was legitimate for the taxpayer to undertake, and was not contrary to the purpose of the VAT
Directive. The fact that the essential aim of the reorganisation was to ensure that a VAT saving
was achieved did not alter this conclusion. The taxpayer’s appeal therefore succeeded. HMRC
are appealing the decision to the UT.
Moorbury Limited v Revenue and Customs Commissioners [2020] UKUT 360 (TCC)
The taxpayer in this case accepted that Halifax could apply where it had implemented a scheme
to try to ensure that the VAT costs on the development of a piece of land could be recovered in
circumstances where the taxpayer would itself not be able to recover this VAT, because it was
making exempt supplies of land.
However, the taxpayer argued that, because the transactions were redefined in accordance with
Halifax, it had wrongly accounted for output tax as part of the scheme. HMRC argued that to
recover this output tax the taxpayer had to make a claim under section 80 VAT Act 1994, which
the taxpayer was out of time to do. The UT allowed the taxpayer’s appeal, finding that the
consequence of a Halifax redefinition was that the taxpayer was automatically entitled to recover
any output tax it had accounted for which was no longer due under the redefined transaction.
This conclusion is a sensible one and ensures that Halifax applies in an even-handed way as
between taxpayer and HMRC.
Weald Leasing v Revenue and Customs Commissioners (Case C-103/09) (Opinion of A-G
Mazak)
The Advocate General delivered his long awaited opinion in this case On 26 October 2010. The
taxpayer had put in place a structure to try to defer irrecoverable VAT by acquiring goods into one
company, which leased them at less than market value to an unconnected third party, which then
leased them on to a member of the same group (but not VAT group) as the first company, making
a small profit. The intention of the structure was to allow the recovery of VAT on the supply of the
goods, with irrecoverable VAT accruing on the lease of the goods to the second group company.
The interposition of the third party was to ensure that a market value rent under the lease to the
second company could not be directed by HMRC under Schedule 6 VAT Act 1994.
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The Advocate General agreed with the taxpayer that it was free to decide whether to purchase or
lease goods, even where its reason for doing so was to reduce irrecoverable VAT. This was not
contrary to the VAT Directive. However, the Advocate General decided that it was an abusive
practice for a taxpayer to interpose an unconnected company in a series of leases in order to
prevent a direction that the lease should be treated for VAT purposes as having a market value
rent. The redefinition which was needed to remedy this abuse was to ignore the third party and
impute a market value lease between the two connected companies.
If the ECJ agrees with the Advocate General then this will be a victory in part for both HMRC and
the taxpayer. The reasoning of the Advocate General is highly persuasive. Taxpayers should be
free to choose the form of transactions they undertake, but wholly artificial elements included in
those transactions to achieve a VAT saving are abusive.
CONCLUSIONS
2010 has seen the courts developing and refining the Ramsay principle. The courts continue to
be hostile to artificial schemes, and appear unlikely to accept any scheme in which a taxpayer
seeks to create a loss artificially where it has not made an economic loss. Taxpayers cannot
escape this conclusion by artificially including within the scheme a slim possibility that the scheme
will not proceed as planned.
The limitations of Halifax have also been explored, and both HMRC and the taxpayer have had
successes. Taxpayers cannot implement wholly artificial schemes without them being redefined,
but that redefinition cannot work only in HMRC’s favour. Equally, if taxpayers make commercial
decisions to operate their business in a different manner, and accept the commercial
consequences of those decisions, then Halifax should not come into play, even where these
commercial decisions are motivated by the VAT savings which will be achieved.
2011 is shaping up to be a bumper year for tax avoidance cases. We await the decision of the
Supreme Court in DCC Holdings v Revenue and Customs Commissioners [2010] STC 80 with
interest. It should help clarify whether a purposive interpretation of legislation can be adopted
even where the legislation in question contains complex and precisely detailed rules on how repo
transactions should be taxed. The Court of Appeal in Mayes v Revenue and Customs
Commissioners [2010] STC 1 will consider a similar question: can you apply a purposive
interpretation to part of a piece of legislation for which no discernable overarching purpose can be
determined? Finally, in the Tower MCashback LLP1 v Revenue and Customs Commissioners
[2010] STC 809 case, the Supreme Court (sitting as a panel of seven) will revisit its decision in
BMBF v Mawson [2005] STC 1 to consider in what circumstances a taxpayer can argue it has
made a “payment” for capital allowances purposes, when the monies used in making the
payment appear to go round in a circle, beginning and ending with the same party.
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