HM Revenue and Customs v Smallwood and Another
| Jurisdiction | England & Wales |
| Judge | MR JUSTICE MANN,Mr Justice Mann |
| Judgment Date | 08 April 2009 |
| Neutral Citation | [2009] EWHC 777 (Ch) |
| Docket Number | Case No: CH/2008/APP/0260 |
| Court | Chancery Division |
| Date | 08 April 2009 |
[2009] EWHC 777 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Before: Mr Justice Mann
Case No: CH/2008/APP/0260
MR. K. PROSSER Q.C. and MS. E. WILSON (instructed by Messrs. Gregory Rowcliffe Milners) for the Appellants.
MR. T. BRENNAN Q.C. and MR. A. NAWBATT (instructed by The Solicitor to HM Revenue & Customs) for the Respondents.
Hearing dates: 27 th and 28 th January 2009
Approved Judgment
I direct that pursuant to CPR PD 39A para 6.1 no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic.
Mr Justice Mann:
Introduction
This is an appeal from the Special Commissioners (Dr A.N. Brice and Dr. J.F. Avery-Jones), released on 19 th February 2008, dismissing the appeals of taxpayers against amendments to their returns for the year 2000 – 2001 which included chargeable gains of over £6m arising on a disposal of assets by trustees. In short the position is this. Mr Smallwood was the settlor of a number of shares in companies known as FirstGroup and Billiton. He settled them for the benefit of himself and his family on 24 th February 1989. The settlement gave him the power of appointing the trustees. He remained a beneficiary of the trust. The trust contained other assets, but the bulk of the assets were the two shareholdings referred to and I am not concerned with any of the others. By 2000 a Jersey company, Lutea Trustees Limited (“Lutea”) was the trustee. The shares had increased significantly in value, and the view was taken by financial advisers to Mr Smallwood and the trustees that it would be wise to reduce such a major exposure. In short, it was thought to be a good idea to sell them. A sale of those shares by Lutea would have led to a charge on Mr Smallwood (as a resident settlor having a beneficial interest under the trust) pursuant to s.86 of the Taxation of Capital Gains Act 1992 (“ TCGA”). In order to avoid such a charge a scheme was devised with the following elements. First, new trustees would be appointed to replace Lutea, those trustees being offshore trustees in a country which did not tax capital gains and which has a double taxation agreement with the UK. The shares would thereby vest in the new trustees. Those trustees would sell them, and having done so they would be removed as trustees and English trustees would be appointed before the end of the fiscal year. The combined effect of those steps, if the trick worked, would be that the sale would attract no capital gains tax by virtue of detailed provisions to which I shall come in due course. That scheme was put into operation. Mauritius was chosen as the relevant new jurisdiction. On 19 th December 2000 a Mauritius company, namely KPMG Peat Marwick International Limited (“PMIL”) was appointed to be the new trustee. They sold the shareholdings in question in January 2001. On 2 nd March 2001 PMIL ceased to be trustees and Mr and Mrs Smallwood became trustees (resident in this jurisdiction). When in due course tax returns were filed, HMRC (or its predecessor) sought to charge the tax above referred to on the basis of the sale. It is that tax which is disputed.
The legislation – detail
The provision under which Mr Smallwood as settlor would be charged in relation to a transaction carried out by foreign trustees is TCGA s.86. It provides:
“1. This section applies where the following conditions are fulfilled as regards a settlement in a particular year of assessment –
(a) the settlement is a qualifying settlement in the year;
(b) the trustees of the settlement fulfil the condition as to residence specified in subsection (2) below;
(c) a person who is a settlor in relation to the settlement ('the settlor') is domiciled in the United Kingdom at some time in the year and is either resident in the United Kingdom during any part of the year or ordinarily resident in the United Kingdom during the year;
(d) at any time during the year the settlor has an interest in the settlement;
(e) by virtue of disposals of any of the settled property originating from the settlor, there is an amount on which the trustees would be chargeable to tax for the year under s.2(2) if the assumption as to residence specified in subsection (3) below were made.
…..
(2) The condition as to residence is that –
(a) the trustees are not resident or ordinarily resident in the United Kingdom during any part of the year….
…..
(4) Where this section applies –
(a) chargeable gains of an amount equal to that referred to in subsection (1)(e) above shall be treated as accruing to the settlor in the year.”
The conditions required by that section would have been fulfilled if Lutea had sold the shares thus:
(a) the settlement was a qualifying settlement in the relevant year.
(b) Lutea would have been non-resident throughout the year.
(c) Mr. Smallwood, the settlor, was resident and domiciled in the UK during the relevant year.
(d) He has retained an interest in the settlement.
Other parts of the legislation give the paying settlor an indemnity against the trustees in respect of any tax paid. Since the trustees could claim to be indemnified out of the assets, at the end of the day the trust bears the charge to tax; but the important point is that there would be a charge to tax under this section.
Section 86 does not apply if, for example, the trustees are resident in the UK for some part of the resident year. However, in that event s.77 applies to impose a charge. Insofar as material it provides:
“(1) Where in a year of assessment –
(a) chargeable gains accrue to the trustees of a settlement from the disposal of any or all of the settled property,
(b) after making any deduction provided for by s.2(2) in respect of disposals of the settled property, there remains an amount on which the trustees would, disregarding s.3, be chargeable to tax for the year in respect of those gains, and
(c) at any time during the year the settlor has an interest in the settlement;
the trustees shall not be chargeable to tax in respect of those but instead chargeable gains of an equal amount to that referred to in paragraph (b) shall be treated as accruing to the settlor in that year.”
Accordingly, under this section, without the effect of any double taxation arrangements, Mr Smallwood would again be treated as having made any chargeable gains which prima facie the trustees could be seen to have made (again with a right of indemnity against the trustees, who can in turn meet the liability from the trust assets). The way in which the avoidance scheme in the present case works is by operating at the level of s.77(1)(b). It is said that the effect of the double taxation arrangements is that the trustees of the Smallwood settlement would not be chargeable to tax for any gains made on the sale of the relevant shares for the purposes of that sub-subsection, because the relevant gains are taxable only in Mauritius and not in the UK. There would therefore be no chargeable gain to be attributed to Mr Smallwood as settlor.
The only other relevant provision of English taxation law to which it is necessary to refer is s.69, which provides:
“69. (1) In relation to settled property, the trustees of the settlement shall, for the purposes of this Act, be treated as being a single and continuing body of persons (distinct from the persons who may from time to time be the trustees)…”
As I have just said, the taxpayer contends that the chargeable gains which would otherwise fall within s.77(1)(b) are not chargeable gains because of the effect of the double taxation arrangements with Mauritius which are contained in the Double Taxation Relief (Taxes on Income)(Mauritius) Order 1981 ( SI 1981 no.1121) which I will call the Treaty or the order. The order was made under the Income and Corporation Taxes Act 1988 s.788, and despite its name it now applies to capital gains as well as to income. S.788 permits the making of arrangements and subsection 3, as originally enacted, provides:
“(3) Subject to the provisions of this Part, the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax insofar as they provide –
(a) for relief from income tax, or from corporation tax in respect of income or chargeable gains…”
By subsequent legislation, capital gains tax was added to that catalogue of taxes. I do not need to go into the details of that.
The order itself, in article 2, declares that it is expedient that the arrangements in the Convention set out in the schedule to the order should have effect. That is sufficient, by virtue of statute, to give it effect. The relevant provisions of the schedule or Convention are as follows.
Article 1 provides:
“This Convention shall apply to persons who are residents of one or both of the Contracting States.”
The contracting states are the UK and Mauritius.
Article 3 contains definitions, and they in turn include:
“(e) The term 'person' includes an individual, a company and any other body of persons, corporate or not corporate.”
By virtue of that provision, combined with s.69, the trustee or trustees of the Smallwood settlement are treated as a person within the meaning of the Convention.
Article 4 deals with the all-important subject of “residence” around which this case turns. It reads as follows:
“4.(1) For the purposes of this Convention, the term 'resident of a Contracting State' means, subject to the provisions of paragraphs (2) and (3) of this Article, any person who, under the law of that...
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