I wrote the following article for the Indian tax website Taxsutra, but I'll share it here. It does, of course, consider India's recent loss in its case against Vodafone:
The Supreme Court decision in the recent Vodafone case must be considered a body blow for Indian taxation, India as a whole and the necessary onslaught on tax haven abuse that I and many others are involved in.
First, it is important to note that this was always an unusual case: Vodafone was being sued for tax which it was said it should have withheld from a payment it made to Hutchison Essar Limited for a stake in that company's Cayman subsidiary that in turn owned its Indian mobile phone operations. Vodafone did not, as a result, ever make a profit in this matter: it was being sued for tax that might have been due by a third party if that third party had made its gains in India. It did not make that gain in India for what might (to simplify matters) be considered a straightforward reason, and that was because it had ensured that ownership of the Hutchison Essar mobile phone network in India was not recorded in India at all, but in the Cayman Islands. The claim was Vodafone should have withheld the tax due on the capital gain as a result.
The ruling on this case is over 250 pages long and cannot all be considered in detail here. What is interesting to me is the discussion on whether the structure used by Hutchison was reasonable tax planning or an unreasonable arrangement subject to challenge by India. The principles on which this decision was made where all defined in English taxation law and effectively required comparison of three cases and the principles within them. Everything effectively turned on whether the legal form of the transaction in Cayman should prevail or its substance in India should be taxed.
The first critical case considered was, as a result, the 1936 decision in what has become known as the Duke of Westminster case. In this now notorious decision the House of Lords defended the right of a person to arrange their affairs howsoever they wished so long as it was legal and there was, they said, nothing the tax authorities could do to challenge the outcome in that case. This is in turn built on an 1869 decision which confirmed that tax in the UK has to be charged in accordance with “law”[1] as a result of it being said in the House of Lards that:
If the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute what is called an equitable construction, certainly such a construction is not admissible in a taxing statute.
This was the issue at stake in the Westminster case, and this was the matter also at stake in the Ramsey and Dawson cases from the 1980s also discussed in the decision on Vodafone, both of which were considered to have to some degree over-turned the Westminster ruling (although with subsequent restrictions also being applied in the UK, it should be noted). The unfortunate fact is that the judge in this case has, I think, clearly favoured Westminster over Ramsey, calling the latter a simple ruling on interpretation and treating the former as being law. Given the facts of this case, and their relative similarity with Dawson, that is surprising, but it seems he refused to see beyond the law of contract and address the underlying issue as both Ramsey and Dawson allowed.
In that case his failure to interpret the law in what seems to me to be the correct way leads us straight into consideration of whether India now has need for a general anti-avoidance rule (GAAR).
If all tax were about one action and one consequence then tax law would be easy, and determining if tax law applied or not would generally be relatively straightforward. But some tax is not like that at all. Aggressive tax planning is about putting together a string of transactions, each legal in their own right (or they would not be tax avoidance but would become tax evasion) but with the series, in combination, achieving a result quite different from that which parliament might ever have intended. It is this unintended outcome in combination that a GAAR is designed to tackle, especially in those cases where, despite the best will of judges, there is nothing at all to make the resulting tax avoidance illegal.
Graham Aaranson QC has suggested the UK should have a limited form of GAAR. Personally, I would have liked him to go further: stopping the most egregious schemes a he suggests such a GAAR should be limited to is not, in my opinion, enough. I was consulted by Graham Aaronson during the course of his review.
What is more worrying is that I am not sure as yet that Aaranson's tackled the biggest problem, internationally, with these GAARs, and that's simply whether or not the judges will embrace them or not. In Australia they by and large have and so they've made some gains. In Canada the judges virtually refused to operate a GAAR. The result has been a GAAR that's failed to deliver. All of which has always left me thinking that an essential component of a GAAR is a change to the basis on which tax law is interpreted from a legal (literal) basis to an equitable (common law) basis.
The Australians almost got there (but not for tax) a long time ago with their law of 1901[2] on legal interpretation which said:
In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.
This seems to get to the very core of the problem in the Vodafone case. It seems to me that what we want our judges to do when looking at tax law is to assess the substance of the transaction and to ignore its form. The result has a massive advantage: it is about as comprehensible as most law can ever be. If the man on the Clapham Omnibus could see that the substance and form of the transaction were the same (an asset in India is sold and tax is payable in India) then they'd know they would have complied with the law. If the substance and form do not coincide i.e. an asset is sold in India and tax is payable, if at all, in Cayman, they'd know they were in trouble. What can be more certain that that?
Ancient law, designed in an age of steam ships, is crippling India as it is crippling other countries in the age of the internet. It's time we changed these laws now. Only that way can we get tax justice — and that's a situation where the right amount of tax (but no more) is paid in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.
[1] Partington v. Attorney-General (1869), L.R. 4 E. & I. App. 100, per Lord Cairns at p. 122.
[2] Section 15 AA of the Acts Interpretation Act, 1901 downloaded from http://www.austlii.edu.au/au/legis/cth/consol_act/aia1901230/s15aa.html
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
It is astonishing that governments refuse to pass legislation to reduce tax avoidance, and the judiciary do not use the powers available to them. It stinks.
LORD TEMPLEMAN, ‘Tax and the taxpayer’ Law Quarterly Review 2001, 117(Oct), 575-588
TAXES are universally unpopular though they have been described as the price we pay
for civilisation. There are three methods by which an individual taxpayer may seek to reduce his burden of tax. The first method is tax evasion and is a criminal offence. The taxpayer conceals or fraudulently misrepresents to the Revenue the incidence and ambit of his tax affairs. Tax evasion, apart from being unfair to the public by reducing the size of the public purse and unfair to fellow taxpayers who pay their fair share of tax, may lead to corruption and lawlessness. Vigorous efforts are made by the law enforcement authorities to detect and convict tax evaders.
The second method is tax avoidance, which does not involve unlawful conduct. The taxpayer’s advisers invent a scheme whereby he can hope to enjoy the benefit of a taxable event without becoming liable to pay the tax. A tax avoidance scheme includes one or more interlinked steps which have no commercial purpose except for the avoidance of tax otherwise payable, and can conveniently be described as artificial steps. A tax avoidance scheme does not leave the taxpayer any better or worse off but leaves the Revenue worse off. The question is whether the law should treat taxpayers differently depending on whether or not artificial steps are included in an otherwise clearly taxable transaction.
On the one hand a taxpayer is free to organise his affairs so as to pay the least tax. On the other hand tax avoidance schemes which involves artificial steps are unfair to the public purse and may involve millions of pounds of lost revenue; specific legislation passed to outlaw a type of avoidance scheme is not retrospective and complicates a law which is already complicated. General anti-tax avoidance legislation has so far not been adopted. Tax avoidance schemes are also unfair to wage and salary earners and the generality of taxpayers because such schemes require the inventive genius of expensive lawyers and accountants studying the fine print of tax legislation to find loopholes and juggling with subsidiary companies and captive shareholdings. Tax should depend on facts and
consequences and not on language or documents designed to enable a taxpayer to claim a tax advantage without paying the price.
The third method is tax mitigation whereby a taxpayer incurs expenditure which reduces his taxable income or his taxable assets or whereby a taxpayer incurs expenditure which Parliament wishes to encourage or reward by a tax allowance or deduction. Tax mitigation may take a variety of forms but is distinguishable from tax avoidance; tax mitigation does not include any artificial step though the motive which inspires a taxpayer may be mainly or wholly the desire to reduce tax. A taxpayer may consider that premium bonds are a bad investment or that an ISA has a poor chance of increasing in value or that his children do not deserve his bounty. Nevertheless if he makes an investment or divests himself of property and otherwise fulfils the requirement of the legislation, then even though he may do so to reduce his tax, his motive is irrelevant.
The object of a tax avoidance scheme is to enable the taxpayer to enjoy a taxable event without paying the tax. The taxpayer plans and implements a scheme which includes one or more artificial steps which have no commercial purpose except the avoidance of tax which would otherwise be payable. Three decisions of the House of Lords applied to tax avoidance schemes the principle that the fiscal effect and consequences of a scheme are determined by the end results of the scheme.
Those three decisions are W.T. Ramsay Ltd v. I.R.C. (“Ramsay ”), I.R.C. v. Burmah Oil Co Ltd (“Burmah ”) and Furniss v. Dawson (“Furniss ”). But in the recent case of MacNiven v.
Westmoreland Investments (“Westmoreland ”) the House of Lords declined to recognise that the principle applied by their predecessors in the earlier trio of tax avoidance cases had any general application.
In Ramsay the taxable event was the sale of property (“the first transaction”) which resulted in a gain liable to Capital Gains Tax. The scheme consisted of two artificial steps. The taxpayer bought and sold an asset which was bound to produce a loss. The taxpayer also bought and sold an asset which was bound to produce a gain equal to the loss but was a gain of a kind which did not attract Capital Gains Tax. The only purpose was to avoid tax on the gain produced by the first transaction. The taxpayer claimed to set off the loss which he made in the course of the scheme against the gain which he had made on the first transaction, thus aiming to enjoy the taxable event, the gain made in respect of the first transaction, without paying the tax. The claim failed. Lord Wilberforce said : “a loss
or gain which appears to arise at one stage in an indivisible process and which is intended to be and is cancelled out at a later stage … is not such a loss or gain as the legislature is dealing with”.
In Ramsay, when the taxpayer bought and sold an asset in the course of a tax avoidance scheme, the purchase and sale of that asset undoubtedly produced a loss, and if the purchase and sale of that asset had been independent the resulting loss would have been deductible in the computation of Capital Gains Tax against the gain made by the first transaction. The House of Lords however recognised that the loss was part of a scheme whereby the taxpayer planned to enjoy the taxable event constituted by the gain on the first transaction without paying the tax. The scheme did not involve a sham; a real loss was made as a result of a real purchase and sale. Under the scheme however a planned and real deductible loss was cancelled out by a planned and real non-chargeable gain. When the scheme was considered as a whole the taxpayer had not made a loss. Ramsay established that a tax avoidance scheme must be judged by its end results.
After Ramsay, the tax avoidance industry argued that Ramsay had no general application but was confined to schemes which involved self-cancelling transactions. This argument was rejected in Burmah. In that case the taxable event was the making of profits of £160 million liable to Corporation Tax. The scheme was designed to enable the profits to be enjoyed without tax being paid.
Burmah was owed £160 million by its wholly owned and insolvent subsidiary company “Holdings”.That debt, which the subsidiary could not repay, was not an allowable loss in the computation of Corporation Tax payable by Burmah. A tax avoidance scheme was invented. New shares were issued in Holdings. Burmah subscribed £160 million for those shares. Holdings used the £160 million it received for the shares to discharge the debt of £160 million which it owed to Burmah. Holdings then went into liquidation. Burmah received nothing in the liquidation for its shares in Holdings and Burmah lost the £160 million which it had subscribed for the shares. Burmah claimed to deduct this loss against its profits in the computation of Corporation Tax. The claim was rejected by the House of
Lords. The scheme did not involve a sham; real money was paid for shares, real shares were issued, the liquidation of Holdings was properly carried out; a loss on the shares amounting to £160 million was incurred by Burmah. If the purchase of the shares had been an independent transaction the loss made on the shares would have been deductible.
Lord Diplock said
“A bad debt is not a deductible loss … so a scheme was devised to convert the debt into a loss on Burmah’s shares in Holdings on the liquidation of that company … it would be disingenuous to suggest and … dangerous to assume that Ramsay ‘s case did not make a significant change in the approach adopted by this House in its judicial role to a pre-ordained series of transactions into which there are inserted steps that have no commercial purpose apart from the avoidance of a liability to tax which in the absence of those particular steps would be payable … the approach to tax avoidance schemes of this character sanctioned by Ramsay entitles your Lordships to ignore the intermediate
book entries and to look at the end result which was that Burmah wrote off Holding’s debt of £160m by itself providing the money to pay it, ostensibly in the form of fresh capital.”
In Burmah it was argued that Burmah was only ordering its affairs so as to pay less tax.
Lord Diplock rejected this argument and pointed out that the dictum in I.R.C. v. Duke of Westminster That “every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Act is less than it otherwise would be tells us little or nothing as to what methods of ordering one’s affairs would be required by the courts as effective to lessen the tax that would otherwise attach to them if business transactions were conducted in a straightforward manner … The kinds of tax avoidance schemes that have occupied the attention of the courts in recent years … involve inter-connected transactions between inter-connected persons, limited companies without minds of their own but controlled by a single master mind.”
After Burmah the tax avoidance industry argued that Burmah and Ramsay had no general application and did not apply to a tax avoidance scheme which produced enduring results. This argument, which succeeded at first instance and in the Court of Appeal in Furniss, was firmly rejected by the House of Lords.
In Furniss the taxable event was the projected sale of all the shares in a subsidiary company by the parent company to a purchaser Wood Bastin, resulting in a gain liable to Capital Gains Tax payable by the taxpayer vendor. A scheme was invented to enable the taxpayer to avoid or postpone the payment of that tax. The taxpayer transferred the shares to another subsidiary, Greenjacket. The transfer to a subsidiary did not attract Capital Gains Tax. Greenjacket then sold the shares to the purchaser Wood Bastin for cash. This sale did not attract Capital Gains Tax because Greenjacket was a company incorporated in the Isle of Man and not liable to Capital Gains Tax. The purpose of the transfer to Greenjacket was to avoid the payment of Capital Gains Tax which would have been payable if the taxpayer had transferred the shares to Wood Bastin. The transfer and sale whereby the shares arrived with Wood Bastin were not shams. Genuine shares were issued, a genuine sale of the shares was made by Greenjacket to Wood Bastin and at the end of the scheme the taxpayer did not receive the purchase price but held shares in the Isle of Man company Greenjacket. But the end result of the scheme was a disposal of the shares by the taxpayer to Wood Bastin and this disposal created a gain which was liable to Capital Gains Tax. The taxpayer failed to enjoy the benefit of a taxable event, namely the gain on a disposal of the shares without paying the tax. Furniss reaffirmed the principle that all tax avoidance schemes must be judged by their end result. The scheme resulted in the taxpayer acquiring * the shares in Greenjacket and in Greenjacket receiving the purchase price from Wood Bastin. These enduring results were not affected by the fact that the taxpayer was held liable to pay Capital Gains Tax which would have been exigible if the taxpayer had transferred the shares directly to Wood Bastin. If the scheme had involved the creation
of documents liable to be stamped or the creation of taxable income then stamp duty and income tax would have been payable accordingly.
Lord Brightman summed up the position as follows :
“First, there must be a pre-ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. ) business end … Secondly there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax–not ‘no business effect’. If those two ingredients exist the inserted steps are to be disregarded for fiscal purposes …”
This formulation by Lord Brightman, developed from the speech of Lord Diplock in Burmah, enables the differences between tax evasion, tax avoidance and tax mitigation to be perceived. The difference between tax evasion and tax avoidance is that tax evasion involves fraud and sham whereas tax avoidance does not involve fraud, sham or any other unlawful conduct. The difference between tax avoidance and tax mitigation is that tax avoidance involves steps which have no commercial purpose apart from the avoidance of a liability to tax which in the absence of those particular steps would be payable; in tax mitigation on the other hand each of the steps involved has a commercial purpose apart from tax advantage although singly or jointly those steps may also result in reducing the burden of tax.
In the Westmoreland case the taxable event was the making of future profits of £40 million by the taxpayer and the tax sought to be avoided was Corporation Tax on those profits. The scheme consisted of the simultaneous exchange of £40 million by and between the insolvent taxpayer Westmoreland and the Pension Trustees who were the sole creditors and shareholders of the taxpayer.
At the time of the tax avoidance scheme Westmoreland owed the Pension Trustees £70 million. In the books of the taxpayer £40 million part of the debt of £70 million was recorded as originating in arrears of interest. By section 338 of the Interest and Corporation Taxes Act 1988, the interest due from Westmoreland to the Pension Trustees could be deducted against future profits in the computation of Corporation Tax, but only if Westmoreland first paid that interest. Westmoreland could not pay the interest because Westmoreland had no assets with which to pay and no credit upon which to borrow. By a tax avoidance scheme, the Pension Trustees paid Westmoreland by three instalments sums totalling £40 million. Simultaneously with the receipt of each instalment, or after a short interval, Westmoreland returned to the Pension Trustees an identical amount.
The exchange of payments of £40 million by and between the Pension Trustees and Westmoreland seems pointless and indeed had no purpose, let alone a commercial purpose, save as a tax avoidance scheme which aimed to avoid tax which would otherwise be payable. Following the exchange of payments of £40 million Westmoreland made entries in its books whereby a debt of £70 million including £40 million originating in arrears of interest was changed into a debt of £70 million wholly attributable to capital. The change could not make any difference to anybody except the Revenue. Following the exchange and the book entries the Pension Trustees sold their worthless shares and bad debt of £70 million to a purchaser who intended to make and did procure Westmoreland to make £40 million taxable profits. The purchaser paid £2 million to the Pension Trustees not for the shares or the debt but for the claim that in the course of the tax avoidance scheme Westmoreland had paid interest of £40 million which could be deducted against the profits of £40 million for the purpose of Corporation Tax. The House of Lords allowed the claim whereby Westmoreland directly, and the purchaser indirectly, enjoyed the taxable event of making profits of £40 million liable to Corporation Tax without paying the tax. The exchange of £40 million by and between the Pension Trustees and Westmoreland was incapable
of redeeming the prior debt of £40 million. Westmoreland only received from the Pension Trustees £40 million on condition that the £40 million was returned. Neither the payment of £40 million by Westmoreland to the Pension Trustees nor the book entries could constitute “payment of interest” within the meaning and intention of section 338. The amendments to the books of account could not constitute payment or record a payment of interest which Westmoreland was never in a position to pay and did not pay.
The payment of £40 million by the Pension Trustees to Westmoreland and the payment back of £40 million by Westmoreland to the Pension Trustees were payments which were not sham. In Ramsay, Burmah and Furniss the tax avoidance schemes were not shams. They failed because they included artificial steps which fell to be ignored. The taxpayer Westmoreland must have been advised by the authors of the tax avoidance scheme themselves acting in good faith that the books of account could properly be amended to show that interest of £40 million had been paid. But the exchange of payments of £40 million was incapable of constituting payment of the interest owed before the exchange.
When Westmoreland paid £40 million back to the Pension Trustees, Westmoreland deducted tax for which it accounted to the Revenue. Westmoreland gave the Pension Trustees certificates of deduction of tax which the Pension Trustees accepted as payment. The tax was recovered by the Pension Trustees from the Revenue because of their tax exempt status.
In Ramsay the scheme which matched a profit and a loss made no difference to the taxpayer apart from the creation of a claim to avoid tax; the claim was disallowed. In Burmah the scheme which converted a bad debt into valueless shares made no difference to the taxpayer apart from the creation of a claim to avoid tax; the claim was disallowed. In Furniss the scheme which converted a purchase price from money into shares achieved the dual purpose of transferring property to the purchaser and creating a claim to avoid tax; the claim was disallowed. In the Westmoreland case self-cancelling payments made no difference to the taxpayer apart from the creation of a claim to avoid tax. The claim should have been disallowed. Before and after the scheme Westmoreland had no assets and owed £70 million which it could not repay. The only purpose and effect of the scheme
was to create a claim to avoid tax on £40 million which would otherwise be payable. This is illustrated by what happened. Before the scheme the Pension Trustees were unable to sell Westmoreland or the debt which Westmoreland owed. After the scheme a purchaser who was able to procure Westmoreland to make profits of £40 million paid £2 million for the valueless shares in Westmoreland and for the bad debt of £70 million owed by Westmoreland. The purchaser had paid £2 million for the opportunity to persuade the House of Lords that a tax avoidance scheme consisting of self-cancelling
payments of £40 million constituted payment by Westmoreland of an old debt of £40 million
originating in arrears of interest. The scheme made no difference to the taxpayer and therefore should have made no difference to the Revenue.
The speeches in the Westmoreland case do not address the mischief inherent in tax avoidance schemes which comprise or include steps which have no commercial purpose save for the avoidance of tax otherwise payable. The principles of Ramsay, Burmah and Furniss were denied or ignored but no principles were substituted. In the Westmoreland case the requirements of section 338 and the intention of Parliament that interest should only be deductible if it were paid were not satisfied by matching and self-cancelling payments of £40 million which left no scope for a reduction in the interest debt incurred before the scheme was conceived. The consequences of giving effect to this and other artificial steps, which have no purpose or consequence apart from the avoidance of tax
otherwise payable, were not taken into account.
Lord Nicholls of Birkenhead, delivering the first speech in Westmoreland, denied that Ramsay enunciated any new legal principle. “What the House did was to highlight that, confronted with new and sophisticated tax avoidance devices, the courts’ duty is to determine the legal nature of the transactions in question and then relate them to the fiscal legislation.”11 No one would quarrel with this proposition. Ramsay applied to a planned composite transaction or planned series of transactions the principle which applies also to a single transaction and to landlords and others as well as taxpayers the principle that the legal nature of a transaction is determined by its end result and not by its form or language. Lord Nicholls downgraded this principle by saying that “The Ramsay principle, or as I prefer to say, the Ramsay approach to ascertaining the legal nature of transactions and to interpreting taxing statutes … is no more than a useful aid.”
But the language of Lord Wilberforce, Lord Diplock and Lord Brightman, and the powerful supporting speeches of Lord Fraser of Tulleybelton, Lord Scarman, Lord Roskill and Lord Bridge of Harwich, do not permit this deduction. The three decisions and 15 speeches in Ramsay, Burmah and Furniss, the considered pronouncements of an eminent generation of modern Law Lords applying principles to tax avoidance schemes, cannot be downgraded to a mere useful aid.
Lord Nicholls was at first inclined to reach the conclusion which follows from an application of the Ramsay principles or approach and Lord Brightman’s formulation. He said: “my initial view, which remained unchanged for some time, was that a payment comprising a circular flow of cash between borrower and lender, made for no commercial purpose other than to gain a tax advantage, would not constitute payment within the meaning of section 338.” Lord Nicholls explained his change of mind:
“Prima facie, payment of interest in section 338 has its normal legal meaning and connotes simply satisfaction of the obligation to pay. In the present case Westmoreland’s obligation to pay the accrued interest was discharged by satisfaction. Thus, if the Revenue are to succeed, ‘payment’ must bear some other meaning.”
In Ramsay, Burmah and Furniss, the words “loss” and “disposal” had their legal meanings, but the schemes as a whole did not produce a loss or produced a different disposal. In Westmoreland the scheme did not result in a payment of interest by Westmoreland.
Lord Nicholls treats the payment of £40 million by the Pension Trustees and the payment of £40 million by Westmoreland as if these payments were coincidental and accidental and served some purpose other than the avoidance of tax otherwise payable. Applying the test accepted by Lord Nicholls, the “legal nature of the scheme” was nil because the steps in the scheme were designedly self-defeating. The complicated scheme in Burmah and the simple scheme in Westmoreland only attached a different label to the bottle without changing the contents of the bottle. In Burmah the scheme attached the label “loss” which replaced the label “debt”. In Westmoreland the scheme attached the label “fresh debt” which replaced the label “interest debt”. The “legal nature” of a scheme is not governed by labels. Applying the test formulated by Lord Brightman both payments were steps which had no commercial purpose apart from the avoidance of tax which would apart from
those steps be payable, and both payments fell to be ignored in the computation of the tax sought to be avoided. Lord Brightman’s formulation explains the application of the Ramsay principle or approach to a tax avoidance scheme.
Lord Nicholls and his colleagues were impressed by the fact that “a debt may be discharged and replaced by another when the only persons involved are the debtor and the creditor”. But a debt can be discharged and replaced without payment of the old debt. And the discharge and replacement may or may not serve a commercial purpose. The creditor may reduce a rate of interest, a debtor may provide security. In Westmoreland the ostensible replacement of an old debt with money provided by the creditor did not constitute payment of the old debt and was made for no commercial purpose. It was a pointless exercise save for the avoidance of tax otherwise payable. A pointless exercise should
not produce a tax advantage.
Lord Hoffmann in a diffuse speech dealt with the three tax avoidance cases Ramsay, Burmah and Furniss as follows:
“The innovation in the Ramsay case was to give the statutory concepts of ‘disposal’ and ‘loss’ a commercial meaning. The new principle of construction was a recognition that the statutory language was intended to refer to commercial concepts, so that in the case of a concept such as a ‘disposal’ the court was required to take a view of the facts which transcended the juristic individuality of the various parts of a preplanned series of transactions.”
Burmah was “an entirely straightforward application which the Ramsay case gave to the concept of a disposal giving rise to a loss in the capital gains tax legislation, namely that it meant a loss in commercial terms and not a series of preplanned transactions which had no business purpose” ; and again what the “Burmah case decided was that the statutory concept of a loss accruing on a disposal has a business meaning and that the ‘disposal’ and ‘loss’ suffered by Burmah did not fall within it”. Lord Brightman’s formulation in Furniss “is a statement of the consequences of giving a commercial construction to a fiscal concept”. Lord Hoffmann held that these cases did not apply to a legal concept such as payment in section 338.
There is no principle which either requires or permits a court to divide tax avoidance into two
categories, namely one category where the courts have regard to the entire transaction and look to see if any steps within it should be disregarded as having no commercial purpose except for the avoidance of tax otherwise payable, and another category where the courts look at steps which form part of a transaction but without regard to the entire transaction.
The argument of Lord Hoffmann, which attempts to create such categories, and then asserts that the Westmoreland scheme falls into the second category, reflects ingenuity but not principle.
Lord Hoffmann seeks to draw a distinction between a commercial concept which he admits to apply in Ramsay and other cases and a legal concept which he applies to Westmoreland. This analysis has the effect of dividing taxpayers into three classes. The first class for reasons of principle, poverty or ignorance do not indulge in steps which have no commercial purpose other than the avoidance of tax. The second class invent tax avoidance schemes but fall foul of Ramsay. The third class invent tax avoidance schemes which succeed. Lord Hoffmann sought to reduce Ramsay to a principle of
statutory construction and asked what it is. The principle is that when Parliament enacts tax
legislation, Parliament intends all taxpayers to be treated the same whether they insert artificial steps into transactions or not and irrespective of the type of artificial step. The application of that principle by Lord Brightman in Furniss accords with the intention of Parliament and is neither revolutionary nor evolutionary. Following Ramsay and Burmah, Lord Brightman reaffirms the duty of the courts to judge a scheme as a whole and to disregard artificial steps which have no commercial purpose apart from the avoidance of a liability to tax which would otherwise be payable.
Finally Lord Hoffmann returns to the argument which ignores the existence of a scheme. To apply Burmah to Westmoreland “it would be necessary to construe the concept of payment in section 338 as having some business meaning other than the simple discharge of a debt. Otherwise one is not giving effect to the statutory language.” The question is not whether Westmoreland made a payment but whether Westmoreland paid the interest debt. If Westmoreland had paid the interest debt then in the absence of any third party the debt of £70 million would have been reduced to £30 million; the interest was never paid and the debt was not reduced. There are ways of discharging a debt otherwise than by payment. A debt can be discharged by forgiveness or agreement. In this case the debt was not discharged but given a new description. The exchange of payments of £40 million by and between the Pension Trustees and Westmoreland did not discharge the interest debt, but the Pension Trustees and Westmoreland altered the description of the debt of £70 million so
that £40 million was no longer attributed to arrears of interest. This change of description was lawful but did not amount to payment. The contents of a bottle cannot be changed by affixing a different label.
The Appellate Committee relied on a concession by the Revenue; thus Lord Hoffmann prefaced a series of rhetorical questions by the statement that “It is accepted that in this case the interest debt was indeed discharged.” House of Lords authorities are decided on principle not on concession. Common sense, principle and precedent and the application of Lord Brightman’s formula lead to the same conclusion, namely that the planned exchange of payments of £40 million, by and between the Pension Trustees and Westmoreland, accomplished nothing and did not discharge the interest debt. The concession in Westmoreland may have been due to a misunderstanding between counsel and
the court or to a failure of counsel or may, as in some other cases, reflect haste and failure on the part of the Revenue to present before the Commissioners well principled submissions of fact or law thus prejudicing the argument before the appellate courts.
The Revenue should have succeeded, firstly because on the true construction of the tax avoidance scheme Westmoreland did not pay the interest debt and secondly because the scheme consisted of artificial steps which had no commercial purpose apart from the avoidance of a tax which would in the absence of those steps be payable and therefore fall to be disregarded in order to comply with the intentions of Parliament that tax shall be paid on taxable events and that all taxpayers shall be treated alike.
Lord Hoffmann quotes from an earlier speech of his own: “It is not that the statute has a penumbral spirit which strikes down devices or stratagems designed to avoid its terms or exploit its loopholes.” In the interpretation of a statute the intention of Parliament is paramount. Ramsay, Burmah and Furniss are based not on a “penumbral spirit” but on the certainty that when Parliament enacts a statute which provides for transactions to be subject to taxation or eligible for relief from taxation Parliament has no intention that taxpayers who insert artificial steps into transactions should be treated differently from taxpayers who do not. When the courts are required to decide the effect of tax statutes on transactions, any decision which treats transactions which contain artificial steps
differently from transactions which do not is certain to be contrary to the intention of Parliament.
Lord Hope of Craighead and Lord Hutton were of the opinion that accrued interest of
£40 million was paid and that there were no steps which fell to be disregarded on the grounds of artificiality. But the whole scheme in Westmoreland was artificial and achieved nothing save the invention of a claim to be able to make a profit of £40 million free of tax.
Westmoreland, which had no assets and whose sole shareholders and creditors were the Pension Trustees, owed £70 million to the Pension Trustees. Of this debt £40 million was entered in the books, as being in respect of arrears of interest. The tax avoidance scheme took the form of payments by the Pension Trustees to Westmoreland of £40 million and simultaneous payments of £40 million by Westmoreland to the Pension Trustees. The two payments by the Pension Trustees and Westmoreland cancelled each other out and they were both artificial. The payment of money which was one payment out of two planned self-cancelling payments was not the “payment of interest” on a preceding debt within the meaning of section 338. Lord Hope said that the self-cancelling payments reduced the amount of Westmoreland’s accrued liability to pay interest but the accrued liability was a liability to pay £40 million and that liability was not reduced. Before and after the tax avoidance scheme Westmoreland owed £70 million to the Pension Trustees, at such rate
of interest (if any) on such part of the debt (if any) of £70 million as the Pension Trustees chose from time to time to dictate. The two payments of £40 million under the scheme accomplished nothing but they were used to justify a change in book entries. The exchange of payments were steps which fall to be disregarded in accordance with the formulation by Lord Brightman in Furniss.
The decisions and speeches in Ramsay, Burmah and Furniss affirm the principle that the end result of a scheme determines the effect and consequences of the scheme. The explanation by Lord Brightman in Furniss shows how that principle operates in tax avoidance schemes. It is impossible to quarrel with the principle or with its application to tax avoidance schemes. The principle and its operation do not involve, as has been claimed, a strained construction of legislation, or judicial interference with the legislature, or with the freedom of a taxpayer to order his affairs so as to pay less tax. The principle simply obliges the court to look at the results of a scheme. In Ramsay the taxpayer made a loss in the course of a scheme but the end result of the scheme was that he did not make a
loss. In Furniss the taxpayer made a disposal to Greenjacket in the course of the scheme but the end result of the scheme was that the taxpayer had disposed of the property to Wood Bastin. The most illuminating precedent for present purposes is Burmah. The taxpayer, Burmah, made a loss on shares in the course of the scheme; but in the words of Lord Diplock, who never chose his words lightly or expressed his meaning badly, “the end result was that Burmah wrote off Holding’s debt of £160 million by itself providing the money to pay it, ostensibly in the form of fresh capital”.
Westmoreland owed the Pension Trustees a debt of £40 million. Westmoreland made a payment of £40 million to the Pension Trustees in the course of a tax avoidance scheme with monies provided by the Pension Trustees ostensibly in the form of a fresh loan, but the end result of the scheme was that the debt of £40 million remained unpaid and no different or additional liability had been incurred. The debt was reclassified in the books of Westmoreland and the Pension Trustees so that it no longer appeared to have originated in arrears of interest, but this reclassification was not a result of the scheme but rather of the advice tendered as to the fiscal consequences of the scheme: only the labels were changed.
The formulation by Lord Brightman in Furniss, which defeats a tax avoidance scheme based on artificial steps, is founded on fairness. A taxpayer who avoids tax by artificial means frustrates the intention of Parliament that a taxable event shall be taxed. The scheme reduces the yield of tax to the Treasury and thus to the public. After the decision of the House of Lords in Ramsay, the Chancellor of the Exchequer announced that the decision had saved the Revenue £300 million a year. Tax avoidance schemes are also unfair to taxpayers who accept the fiscal consequences of taxable events, or who do not know or cannot afford or are not in a position to indulge in such schemes.
No one has ever advanced a convincing reason for allowing tax avoidance schemes based on artificial steps to distort the operation of taxing statutes and frustrate the intentions of Parliament.
The Westmoreland case fails to apply the principles and precedents established by Ramsay, Burmah and Furniss. The future is uncertain because of the attempt by Lord Hoffmann to distinguish that which cannot logically be distinguished. It is sometimes alleged that the trio of cases which introduced the judicial approach to tax avoidance schemes in 1982 and 1984 led to uncertainty. It is true that corporations and their advisers were deterred from inventing fresh artificial steps for fear of their being unsuccessful. But there never was any difficulty in identifying steps which had no business purpose
save for the avoidance of tax which would otherwise be payable, until the Westmoreland case muddied the waters. Reliance can no longer be placed on the judiciary to deter corporations and other wealthy taxpayers, from avoiding the taxation consequences of taxable events by means of artificial steps which have no purpose or effect save avoidance. Parliament has recently taken up the battle against fraud on the Revenue. The tax evader commits a criminal offence punishable with prison, penalties and fines. The tax avoider commits no offence and only risks failure to avoid the tax.
Parliament could by legislation restore the certainty that steps with no business purpose
except the avoidance of tax shall be ignored in the computation of the tax sought to be avoided thus restoring the principles which were established in the past and the precedents which have been discarded. Now that Parliament is concerned to draft tax legislation in a language which is intelligible, the definition of tax avoidance and the consequences of tax avoidance formulated by Lord Brightman in Furniss form a solid foundation for restoring logic and certainty to the law.
Now Templeman was a good judge – who wrote to me very approvingly of my work on this issue – a letter I value
Lord Templemann carried on from where Lord Denning stopped and managed to convert more of his peers than Lord Denning to give us the Ramsay principle. But the tax avoidance industry fought back, through good old Lord Hoffmann who is now involved in giving us a very dubious GAAR.
In that article, Lord Templeman exposed Lord Hoffman for what he is.
The distinction you make between “legal” and “equity (common law)” is erroneous. The system in which we live is a common law system. That makes up the legal context in which we operate, as does equity. The Common law system is one of judicial interpretation unlike the civil system used in many countries that derived their laws from the Roman system (ie, South Africa, or much of Europe).
Keep to the point
What’s wrong with having an Interpretation of Taxes Act as per the Australian more general precedent?