Schofield v HMRC
| Jurisdiction | UK Non-devolved |
| Judgment Date | 30 April 2010 |
| Neutral Citation | [2010] UKFTT 196 (TC) |
| Date | 30 April 2010 |
| Court | First Tier Tribunal (Tax Chamber) |
[2010] UKFTT 196 (TC)
Michael Tildesley Obe (Chairman), Richard Thomas (Member)
David Goldberg QC instructed by PriceWaterhouseCoopers Legal for the Appellant
Julian Ghosh QC and Raymond Hill counsel instructed by the Solicitor's office of HM Revenue & Customs, for HMRC
Capital gains tax - allowable loss - tax scheme involving options - the options entered into were interlinked - no separate commercial existence - part of an indivisible process - planned as a single continuous operation - disputed loss construed against the whole transaction involving the four options - no allowable loss - appeal dismissed on substantive dispute Capital gains tax - options over gilts - whether exempt under Taxation of Chargeable Gains Act 1992 section 115s. 115 TCGA - yes
The capital loss claimed by the taxpayer in his 2002-03 tax return arising from certain option transactions was not an allowable loss within the meaning of TCGA 1992.
The taxpayer appealed against an HMRC decision amending the taxpayer's self-assessment return for the year ending 5 April 2003. The amendment resulted in an increase of £1,357,568 in the capital gains tax due.
In November 2000 the taxpayer sold his shares in PL Schofield Ltd to Cattles plc for consideration of £11,840,000 in the form of bank guaranteed loan notes redeemable in December 2002. On 31 December 2002 the taxpayer redeemed the loan notes realising a chargeable gain of £10,726,438. The taxpayer, however, declared in his 2002-03 return an allowable loss of £11,305,017 to offset the chargeable gain arising from the redemption of loan notes.
The taxpayer was both resident and ordinarily resident for tax purposes in the UK for the year of assessment 2002-03. Since 29 March 2003 the taxpayer had been resident in Spain. He had not been resident or ordinarily resident in the UK for any year of assessment from and including 2003-04.
Knowing that he would be facing a substantial capital gains tax liability on the redemption of the loan notes the taxpayer went ahead with a scheme prepared by PWC and involving the sale and purchase of options from a bank, KBPB. The taxpayer entered into an International Swap Dealers Association master agreement and a security agreement with KBPB. Under the ISDA master agreement the taxpayer entered into four option contracts with KBPB as follows: options 1 and 2 were cash-settled FTSE options over a nominal amount of £333m of the FTSE 100 Index with an expiry date of 7 April 2003. Options 3 and 4 were gilt options. The taxpayer received premiums of £12,153,834 and £11,915,073 for the grant to KBPB of European style put and call options over £333m of Treasury Stock with expiry dates of 7 April 2003.
The £24m paid by KBPB to the taxpayer for the purchase of the two gilts options (3 and 4) provided the taxpayer with the funds for the purchase of the two cash settled FTSE options (1 and 2).
The strike prices of the options were such that taken together each pair (the two cash-settled FTSE options and the two gilts options) formed a "digital collar" of which the strike prices formed the upper and lower boundary and within which the reference value for the strike prices was expected to stay. If, on the expiry date, the FTSE 100 Index had moved below the digital collar the put options would be in the money, whilst the call options would be out of the money. The converse would apply if the FTSE 100 Index was above the digital collar on the expiry date. A small difference between the FTSE Index reference points for the strike price of the cash-settled FTSE options and of the gilt options ensured that in the case where the FTSE 100 Index was outside the digital collar, there would be a small overall profit or loss to the customer.
In the taxpayer's case where the FTSE 100 Index did not move outside the digital collar, the four options would all be closed out before 6 April 2003 realising a loss of about £24m subject to any payments on close out on both cash-settled FTSE options, the corresponding gains on the gilt options being exempt. If, as in fact occurred, the FTSE 100 Index was outside the digital collar, the out-of-the-money options would be closed out before 6 April, whilst the in-the-money options would be exercised on the agreed date of 7 April 2003. That would produce an allowable loss of about £12m in 2002-03 (subject to any payments on close out) on one of the cash-settled FTSE options, the gain on the corresponding gilt option being exempt, with the taxpayer incurring no capital gains tax consequences from the expiry of the options in the subsequent tax year because of his non-resident status.
The taxpayer submitted his tax return for the year ended 5 April 2003 showing an allowable loss of £11,305,017. The loss arose from disposal of the cash settled put option which he had purchased for £12,153,834 and surrendered on 4 April 2003 for £732,600 creating the loss of £11,305,017.
HMRC amended the return on the basis that the avoidance scheme involving the purchase and sale of put and call options was ineffective.
(1) Whether the surrender of the option created an allowable loss for the purposes of the TGCA 1992; and (2) whether the two options to buy and sell gilt-edged securities were true options to sell or acquire gilt-edged securities.
The tribunal judges (Michael Tildesley OBE and Richard Thomas) (dismissing the appeal) said that the correct tax analysis was to regard the whole composite transaction as a fiscal nullity.
The statutory term "allowable loss" had a business meaning and referred to real loss not an arithmetical difference (WT Ramsay Ltd v IR CommrsELR[1982] AC 300; 54 TC 101 applied).
On the facts the four options entered into on 7 February 2003 were interlinked and did not have a separate commercial existence. They were part of an indivisible process and planned as a single continuous operation. The steps to realise the stated aim of the process were "cut and dried" from the outset. The transactions were bereft of a commercial purpose, and entered into for the sole purpose of the avoidance of tax. In view of those findings the tribunal held that the disputed loss should be construed against the whole transaction involving the four options rather than the single transaction dealing with option 1. (Furniss (HMIT) v DawsonTAX[1984] BTC 71; [1984] AC 474, Craven (HMIT) v WhiteTAX[1988] BTC 268, IR Commrs v Scottish Provident InstitutionUNK [2004] UKHL 52; [2004] BTC 426 and Barclays Mercantile Business Finance Ltd v Mawson (HMIT)UNK [2004] UKHL 51; [2004] BTC 414 applied.)
When viewed as whole the basic structure of the arrangements was that options 3 and 4 funded the taxpayer's purchase of options 1 and 2 with the result that a cash flow, as represented by book entries in relation to four premiums, went from and immediately back to the bank on 7 February 2003. On 4 April 2003, on the closing out of options 1 and 3, a cash flow as represented by book entries in relation to two close out payments went from and immediately back to the bank. On 7 April 2003, a cash flow as represented by book entries in relation to the cash payments under option 2 and the sale of assets acquired under option 4 went from and immediately back to the bank. The combined effect of all the options ensured that the taxpayer did not suffer the economic consequences of either the grant or the exercise of the options. At the end of the planned arrangements the taxpayer's financial position was precisely the same as it was at the beginning, except for the fees he paid to PWC and KBPB, and the security of £50,000 lodged with KBPB to cover the contrived loss. The taxpayer, therefore, suffered no real loss.
The decision that the taxpayer suffered no real loss was not upset by the incorporation of a potential actual profit or loss within the structure of the scheme by allocating marginally different strike prices between the set of cash settled options and the set of gilts options. That contrived profit or loss fitted the description of a commercially irrelevant contingency as defined in Scottish Provident Institution and could properly be disregarded in assessing the net effect of the composite options transaction.
Therefore the loss of £11,305,017 claimed by the taxpayer in his 2002-03 return was not an allowable loss within the meaning of TCGA 1992. The appeal in respect of the loss dispute was dismissed.
The alternative dispute was hypothetical in view of the tribunal's decision in respect of the claimed loss. In its alternative argument HMRC was impugning the legal character of option 3 as an option to dispose of gilt-edged securities. If HMRC was correct, the gain made by the taxpayer on the disposal constituted by the grant of option 3 on 4 February 2003 would lose its exempt status under Taxation of Chargeable Gains Act 1992 section 115s. 115 of TCGA 1992, and be a chargeable gain which would cancel out the presumed allowable loss under option 1.
The tribunal's view was that it would be bound by the ordinary meaning of the contract notes which showed that the parties on 7 February entered into options to acquire or dispose of gilt-edged securities. Thus the gain on option 3 was exempt pursuant to Taxation of Chargeable Gains Act 1992 section 115s. 115 of TCGA 1992.
1. The Appellant was appealing against an HMRC decision dated 28 May 2008 amending the Appellant's self assessment return for the year ending 5 April 2003. The amendment resulted in an increase of £1,357,568 in the capital gains tax due.
2. On 15 November 2000 the Appellant sold his shares in PL Schofield Limited to Cattles Plc for consideration of £11,840,000 in the form of bank guaranteed loan notes redeemable in December 2002. On 31 December 2002 the Appellant redeemed the loan notes realising a chargeable gain of £10,726,438. The Appellant, however, declared in his 2002/03 return an allowable...
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