HM Revenue and Customs v Smallwood and Another
| Jurisdiction | England & Wales |
| Judge | Lord Justice Patten,Lord Justice Hughes,Lord Justice Ward |
| Judgment Date | 08 July 2010 |
| Neutral Citation | [2010] EWCA Civ 778 |
| Docket Number | Case No: A3/2009/1047 |
| Court | Court of Appeal (Civil Division) |
| Date | 08 July 2010 |
[2010] EWCA Civ 778
Mr Justice Mann
Before: Lord Justice Ward
Lord Justice Hughes
and
Lord Justice Patten
Case No: A3/2009/1047
CH/2008/APP/0260
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT, CHANCERY DIVISION
Mr Timothy Brennan QC and Akash Nawbatt (instructed by Counsel-General & Solicitors of HMRC) for the Appellants
Mr Kevin Prosser QC and Ms Elizabeth Wilson (instructed by Messrs Gregory Rowcliffe Milners) for the Respondents
Hearing dates: 8 th and 9 th March 2010
Lord Justice Patten:
Introduction
This is an appeal by The Commissioners for HM Revenue and Customs (“HMRC”) against a decision of Mann J dated 8 th April 2009 ( [2009] EWHC 777 (Ch)). He allowed an appeal by Mr and Mrs Smallwood against the decision of the Special Commissioners (Dr A.N. Brice and Dr J.F. Avery-Jones) released on 19 th February 2008 who dismissed the taxpayers appeals against two closure notices issued by HMRC on 31 st January 2005 which relate to the Respondents' tax returns for the year ending on 5 th April 2001.
The first of these notices concerns the tax return made by Mr and Mrs Smallwood in their capacity as trustees of what has been referred to as the Trevor Smallwood Settlement (“the Settlement”) dated 24 th February 1989. This is a settlement made by Mr Smallwood for the benefit of himself and members of his family. During the tax year in question the bulk of its assets comprised shares in two quoted companies, FirstGroup plc (“FirstGroup”) and Billiton plc (“Billiton”). As of April 2000 the trustee of the Settlement was a Jersey company called Lutea Trustees Limited (“Lutea”). The shares in both companies had increased considerably in value and Mr Smallwood and the trustee were advised to dispose of them and to diversify the trust investments.
Liability for capital gains tax depends upon residence in the United Kingdom and applies to chargeable gains accruing to the taxpayer in a year of assessment during any part of which he is so resident: see s.2(1) of the Taxation of Chargeable Gains Act 1992 (“ TCGA”). There are, however, special provisions which apply to chargeable gains on disposals by the non-resident trustees of settlements in which the settlor retains an interest and where he is himself UK resident in the relevant year of assessment. These are contained in s.86 TCGA which (so far as material) provides as follows:—
“86. Attribution of gains to settlors with interest in non-resident or dual resident settlements
(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….
(3) Where subsection (2)(a) above applies, the assumption as to residence is that the trustees are resident or ordinarily resident in the United Kingdom throughout 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.”
Mr and Mrs Smallwood have always been domiciled and resident in the UK. If therefore Lutea had remained the trustee throughout the year of assessment and so satisfied the condition as to residence in s.86(2)(a) the provisions of subsection (4)(a) would apply. As a consequence, Mr Smallwood as the settlor would have become liable for capital gains tax on the chargeable gain in accordance with ss.2(4) and (5) TCGA. Although he would be entitled to an indemnity against the trustees for the tax paid under paragraph 6 of Schedule 5 TCGA, the net result would be that capital gains tax would be payable on the gains resulting from the sale of the shares.
In an attempt to avoid the effects of s.86 the trustees entered into what is commonly referred to as a “Round the World” tax scheme recommended by KPMG Bristol which is designed to take advantage of the provisions of s.77 TCGA which govern the tax treatment of chargeable gains accruing to UK resident trustees of a settlement in which the settlor retains an interest. So far as material, s.77 provides that:—
“(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.”
The scheme centres on the condition contained in s.77(1)(b) which requires the gains to be chargeable to tax in the trustees' hands under s.2(1) TCGA. What was proposed was the appointment of new non-resident trustees in place of Lutea based in a country which did not itself tax capital gains and which had entered into a double taxation agreement (“DTA”) with the UK under which chargeable gains on the shares would be taxable only in the contracting state in which the trustees were then resident. The shares would then be disposed of by the new trustees who would subsequently be replaced by UK resident trustees within the same year of assessment. The appointment of UK resident trustees within the same year of assessment would exclude the operation of s.86 which requires the trustees to remain non-resident throughout the relevant year: see s.86(2). The intended effect of the scheme was that the application of the DTA would prevent the satisfaction of the s.77(1)(b) conditions because the trustees would in that year of assessment not be chargeable to tax in the UK in respect of the gains on the shares. As a consequence, there would be no chargeable gain that could accrue to Mr Smallwood as settlor even though he and the trustees were UK resident within the year of assessment and would otherwise have been chargeable to tax on the gains under s.77 and s.2 TCGA.
The scheme was implemented in the following manner. In December 2000 KPMG Bristol received confirmation from Lutea that it was going to retire as trustee in favour of a Mauritian company, KPMG Peat Marwick International Limited (“PMIL”). The necessary deeds of retirement and appointment were prepared and on 19 th December 2000 Lutea retired and Mr Smallwood exercised the power of appointment vested in him under the Settlement in favour of PMIL. It is common ground that PMIL was at all material times tax resident in Mauritius and on 29 th December 2000 the Settlement was registered as an offshore trust in the Register of Offshore Trusts in accordance with s.29 of the Mauritius Offshore Business Activities Act 1992.
On 10 th January 2001 the FirstGroup shares were sold. The Billiton shares were sold on 26 th January 2001. On 2 nd March 2001 PMIL resigned as trustee in favour of Mr and Mrs Smallwood. From then until 5 th April 2001 the trustees were therefore resident and ordinarily resident in the UK. Following its retirement as trustee, PMIL arranged for the Settlement to be de-registered as an offshore trust in Mauritius. On 21 st September 2001 PMIL submitted a tax return to the revenue authorities in Mauritius in respect of the income of the Settlement. The UK return by Mr and Mrs Smallwood as trustees of the Settlement for the 2000–2001 year of assessment claimed double taxation relief in respect of the gains which accrued on the sale of the shares. The claim was disallowed by HMRC and the closure notice served on the trustees amended their return to include the full amount of the gain of £6,818,390. The second closure notice was served on Mr Smallwood and amended his personal tax return by including the chargeable gain on the shares in accordance with s.77(1) TCGA.
The appeal against these notices therefore turns on the validity of the claim by the trustees for double taxation relief. Section 277 TCGA makes provision for relief from double taxation in relation to capital gains tax by reference to the equivalent provisions in Part XVIII of the Taxes Act. Relief is therefore available once an Order in Council declares that the arrangements specified in the Order have been made with the government of the relevant country outside the UK: see s.788(1) TA 1988.
In the case of Mauritius, these provisions are contained in the Double Taxation Relief (Taxes on Income) (Mauritius) Order 1981 ( SI 1981 No....
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