Andrew Scott v The Commissioners for HM Revenue and Customs

JurisdictionEngland & Wales
JudgeNicola Davies LJ,Lord Justice Henderson
Judgment Date22 January 2020
Neutral Citation[2020] EWCA Civ 21
Date22 January 2020
Docket NumberCase No: A3/2018/2386
CourtCourt of Appeal (Civil Division)

[2020] EWCA Civ 21

IN THE COURT OF APPEAL (CIVIL DIVISION)

ON APPEAL FROM THE UPPER TRIBUNAL

TAX AND CHANCERY CHAMBER)

[2018] UKUT 236 (TCC)

Royal Courts of Justice

Strand, London, WC2A 2LL

Before:

THE MASTER OF THE ROLLS

Lord Justice Henderson

and

Lady Justice Nicola Davies

Case No: A3/2018/2386

Between:
Andrew Scott
Appellant
and
The Commissioners for her Majesty's Revenue and Customs
Respondents

Mr Michael Furness QC and Mr Michael Firth (instructed by Humphries Kerstetter LLP) for the Appellant

Mr Simon Pritchard (instructed by the General Counsel and Solicitor for HMRC) for the Respondents

Hearing date: 10 December 2019

Approved Judgment

Lord Justice Henderson

Introduction

1

In 1988, Parliament legislated to unify the rates of tax on income and capital gains: see section 98 of the Finance Act 1988. In principle, that then remained the position for 20 years until 2008, when a single rate of capital gains tax (“CGT”) of 18% was introduced with effect from the tax year 2008/09.

2

This case concerns a relief from the higher rates of income tax, usually known as corresponding deficiency relief (“CDR”), in the tax years 2006/07 and 2007/08. At that time, there was no upper limit to the amount of CDR which a taxpayer could use, in the year in which it arose, to set against his income for that year which would otherwise have been chargeable to higher rate income tax. The effect of the relief was that the income in question was instead charged to income tax at the basic rate. The issue, in short, is whether the taxpayer was also entitled to a similar reduction in the amount of his chargeable gains for the same year which would otherwise have been liable to CGT at the higher rate of 40%, with the result that those gains were instead charged to CGT at the lower rate of 20%.

3

The taxpayer is Mr Andrew Scott. In 2006/07 he had chargeable gains of approximately £8.84 million, and in 2007/08 of approximately £14.71 million. On the assumption that his liability to CGT at the higher rate could not be reduced by CDR in the same way as his liability to higher rate income tax was admittedly reduced, the Commissioners for Her Majesty's Revenue and Customs (“HMRC”) issued closure notices on 13 February 2015 requiring Mr Scott to pay CGT of approximately £9.42 million for the two years.

4

Mr Scott's appeals to the First-tier Tribunal (“the FTT”, Judge Ashley Greenbank, [2017] UKFTT 385 (TC), [2018] SFTD 42) and thence to the Upper Tribunal (“the UT”, Nugee J and Judge Nicholas Aleksander, [2018] UKUT 236 (TCC), [2018] STC 1589), were dismissed. Mr Scott now appeals to this court, with permission granted by Lewison LJ.

5

For the reasons which follow, I consider that the FTT and the UT came to the right conclusion. Accordingly, if the other members of the court agree, Mr Scott's appeal will be dismissed.

Background

(1) The statutory regime for taxing gains on life assurance policies

6

Gains arising from policies of life assurance are charged to income tax under Chapter 9 of Part 4 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA 2005”), which runs from sections 461 to 546. For the purposes of Chapter 9, a gain is treated as arising on the occurrence of specified “chargeable events”, including the surrender or part surrender of the policy: sections 462 and 484. The amount of the gain is calculated in accordance with a detailed and rigid set of rules, contained in sections 491 and following. It has often been observed that those rules are capable of operating in a way which produces apparently arbitrary results contrary to commercial reality: see, for example, Mayes v Revenue and Customs Commissioners [2011] EWCA Civ 407, [2011] STC 1269, at [38] and [49] (Mummery LJ) and [102] to [104] (Toulson LJ), referring to the legislation as it stood before its restatement with minor changes in ITTOIA 2005.

7

In particular, as Mummery LJ noted in Mayes at [49]:

“The legislation operates in a way that encourages the retention of life policies as long-term investments. If a large part of the value of a policy is surrendered in the early years, disproportionately large gains will be attributed.”

8

An individual is liable for income tax under Chapter 9 if he is the beneficial owner of the rights under the policy, and UK resident in the year when the gain arises: section 465(1), (2). The charge to tax is at the higher rate only, because section 530(1) confers a credit for basic rate tax on the chargeable amount. This credit reflects the fact that the insurance company is in principle liable for tax at the basic rate on the investment gain attributable to the policy which accrues while it remains in force.

9

Section 539 of ITTOIA 2005 is headed “Relief for deficiencies”. Its purpose (broadly stated) is to confer relief from higher rate income tax in circumstances where a final chargeable event gives rise, not to a gain, but (by application of the same computational rules) to an arithmetical loss, or “deficiency”. This is likely to happen, for example, on the surrender or termination of a policy, after an earlier part surrender has generated a heavily “front-loaded” gain of the type described by Mummery LJ in Mayes. The earlier gain is allowed as a deduction in the computation of the deficiency under section 541, and if the amount realised on termination is comparatively small (because the part surrender exhausted much of the value of the policy), the deficiency may be correspondingly large.

10

Since the provisions of section 539 are of central importance to this appeal, I will set out the section as it stood in 2006/07. Ignoring the complication of the charge to income tax at the lower rate on income from savings and distributions, which in this context can be ignored, the section reads:

539 Relief for deficiencies

(1) A deficiency from a policy or contract arising on a chargeable event is allowable as a deduction from an individual's total income for a tax year if, had a gain arisen instead on that event –

(a) the individual would have been liable to income tax on the gain for that year, or

(b) the individual would have been so liable apart from the requirement in section 465(1) that the individual must be UK resident in the tax year in which the gain arises.

(2) See section 540 for the cases in which such a deficiency is treated as arising, section 541 for how the deficiency is calculated and section 469(5) for the apportionment of deficiencies in cases where two or persons are interested in a policy or contract.

(3) Subsection (1) only applies for the purpose of determining the individual's extra liability.

(4) For this purpose, an individual's extra liability is the amount by which the individual's liability to income tax exceeds the amount it would be on the assumptions specified in subsections (5) and (6).

(5) It is assumed that income charged to tax at the higher rate is charged –

(b) … at the basic rate.

(6) It is assumed that income charged to tax at the dividend upper rate is charged at the dividend ordinary rate.”

11

Although section 539(1) says that CDR is “allowable as a deduction from an individual's total income”, it should be noted that, by virtue of subsection (3), the relief “only applies for the purpose of determining the individual's extra liability”. The effect of the definition of “extra liability” in subsections (5) and (6) is that the relief applies only from income tax at the higher or dividend upper rates, just as the charge to tax under Chapter 9 is confined to a charge at the higher rate. Accordingly, it is only for the limited purpose of providing relief from the higher rate of income tax (an expression which I will use to include the dividend upper rate) that the taxpayer's total income is reduced by the amount of the deficiency under section 539(1).

12

It should also be noted that CDR is available only in the year of assessment in which it arises. There is no facility to carry the relief either forwards or backwards into other years.

(2) To what extent can CDR reduce the rate of CGT payable on chargeable gains in the same year of assessment?

13

CDR is a relief from the higher rate of income tax. Without special provision, it would not afford any relief from CGT. In the years with which we are concerned, the starting point (and default position) was that chargeable gains were taxable at a rate equivalent to the lower rate (not the basic rate) of income tax. This was the effect of section 4(1) of the Taxation of Chargeable Gains Act 1992 (“ TCGA 1992”), which provided that:

“(1) Subject to the provisions of this section…, the rate of capital gains tax in respect of gains accruing to a person in a year of assessment shall be equivalent to the lower rate of income tax for the year.”

14

Section 4(2) then provided:

“(2) If income tax is chargeable at the higher rate or the dividend upper rate in respect of any part of the income of an individual for a year of assessment, the rate of capital gains tax in respect of gains accruing to him in the year shall be equivalent to the higher rate.”

Accordingly, if the taxpayer was subject to higher rate income tax in respect of any part of his income for the year, he would be liable to pay CGT on the whole of his chargeable gains for the year at a rate equivalent to the higher rate of income tax.

15

Subsections (3) and (4) then dealt with the position where the taxpayer was not liable to income tax at the higher rate on any of his income for the year, and part of his “basic rate band” was unused. The broad effect of the subsections was that an amount equivalent to the unused portion of the taxpayer's basic rate band was set against his chargeable gains and charged to CGT at the lower rate, while the higher rate was chargeable only to the extent that his total chargeable gains exceeded the unused portion of the basic rate band. The subsections...

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