Composite transaction fails

In HP Schofield v HMRC [2012] EWCA Civ 927, the Court of Appeal has recently dismissed an appeal made by a taxpayer (the test case for over two hundred appeals) in relation to a tax mitigation strategy designed by PricewaterhouseCoopers (‘PwC’), which was intended to assist the taxpayer in mitigating a capital gain that would otherwise become due.

The court held that four options forming part of a capital gains tax (‘CGT’) mitigation strategy formed a single, composite transaction and that the chargeable gains legislation should be applied to the arrangements as a whole, rather than to the individual steps, in accordance with the principles laid down by the House of Lords in WT Ramsay Ltd v CIR [1981] STC 174(“Ramsay“).

Background

In December 2002, the taxpayer incurred a liability to CGT arising from a gain in the sum of £10,726,438 accruing to him on the redemption of loan notes issued as consideration for his disposal of shares in a consulting company, PL.Schofield Ltd.

In early 2003, the taxpayer received advice from PwC who advised him that it may be possible to defer, or completely avoid, any such liability by creating an allowable capital loss in an amount equivalent to or greater than his chargeable gain. The taxpayer accepted this advice and implemented certain arrangements.

The planning operated by establishing a sequence of four ‘put’ and ‘call’ options (staggered over a four year period) with Kleinwort Benson Private Bank Ltd (‘KBPB’). This was based on the assumption that the taxpayer would cease to be resident in the UK for tax purposes before 6 April 2003 and become a UK non-resident for a five year period thus circumventing the temporary non-residence anti-avoidance rules.

The Ramsay principle

Although tax avoidance case law has developed significantly over the past thirty years since the Ramsay decision, that case remains a seminal authority in this area of the law. The Ramsay principle applies exclusively to the interpretation of tax legislation and is essentially a mechanism of statutory construction which allows the courts, in certain circumstances, to disregard artificially inserted steps which serve no purpose in a transaction other than to avoid tax, particularly where the legislation is ambiguous or makes reference to commercial terms. The effect of this principle is that a transaction can be re-characterised and taxed accordingly.

The parties were in agreement that the decisions of the tax tribunals below were correct if Ramsay applied (as argued on behalf of HMRC) but incorrect if Ramsay was found not to apply (as argued on behalf of the taxpayer).

The decision

The taxpayer argued that the Upper Tribunal was wrong not to recognise that each option was a separate transaction giving rise to four separate assets. It was argued that options 1 and 2 were assets belonging to the taxpayer whereas options 3 and 4 were assets of KBPB but liabilities belonging to the taxpayer – each was a separate transaction and must be regarded as such when applying the provisions of the Taxation of Chargeable Gains Act 1992 (‘TCGA’).

The taxpayer argued that the applicability of principles established in Ramsay were limited and cited Lord Hoffman’s judgment in MacNiven v Westmoreland Developments Ltd [2003] AC 311 in which the need to give effect to the statutory language was emphasised. In Westmoreland it was held that “even if a statutory expression refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax reasons. Business concepts have their boundaries no less than legal ones.”

The Court of Appeal dismissed the taxpayer’s appeal and upheld the decision of the Upper Tribunal (who in turn had upheld the decision of the First-tier Tribunal). The court was not impressed with the strategy and said:

“this appeal was a thinly disguised attempt to undermine the Ramsay principle. Once it was accepted that the principle remains valid, and once the findings of the First Tier Tribunal were accepted, this appeal was doomed to fail.

The relevant transaction here is plainly the scheme as a whole: namely a series of interdependent and linked transactions, with a guaranteed outcome….. They were self-cancelling……There is in truth no significant difference between this scheme and the scheme in Ramsay, other than the nature of the ‘asset’.”

Comment

This case confirms, if confirmation was needed, that the Ramsey principle is alive and well and that  the courts are content to rely upon the Ramsay principle in order to find in favour of HMRC. Given that the success, or otherwise, of a Ramsay argument will depend upon the facts of the case under consideration, it was always going to be difficult for the taxpayer to overturn the decision of the fact finding First-tier Tribunal who, in dismissing the appeal, held on the evidence that the options “were inextricably linked with each other to form a continuous process which could be viewed commercially as a single or composite transaction”.