West and Others (Inspectors of Taxes) v Trennery and Others
| Jurisdiction | England & Wales |
| Judge | LORD STEYN,LORD HOFFMANN,LORD MILLETT,LORD RODGER OF EARLSFERRY,LORD WALKER OF GESTINGTHORPE |
| Judgment Date | 27 January 2005 |
| Neutral Citation | [2005] UKHL 5 |
| Court | House of Lords |
| Date | 27 January 2005 |
[2005] UKHL 5
HOUSE OF LORDS
The Appellate Committee comprised:
Lord Steyn
Lord Hoffmann
Lord Millett
Lord Rodger of Earlsferry
Lord Walker of Gestingthorpe
and four other actions
My Lords,
I have read the opinions of my noble and learned friends Lord Millett and Lord Walker of Gestingthorpe. I agree with their opinions. I would allow the appeal and make the order which Lord Walker proposes.
My Lords,
I have had the privilege of reading the speeches of my noble and learned friends, Lord Millett and Lord Walker of Gestingthorpe in draft. I too would allow the appeal and make the order which Lord Walker proposes.
My Lords,
The question in this appeal is whether a tax avoidance scheme known as "the flip-flop scheme" or "the two settlement route" to reduce the rate of capital gains tax payable in respect of a chargeable gain succeeded in its object or was struck down by statutory provisions which, at least at first sight, appear designed to counter just such arrangements.
Capital gains tax on chargeable gains accruing to an individual is charged at the taxpayer's highest rate of income tax, usually 40%. Tax on chargeable gains accruing to the trustees of a settlement, however, is charged at the lower rate of 25%. In order to protect the revenue, it is obviously necessary to prevent taxpayers from obtaining the benefit of the lower rate of tax by transferring assets pregnant with capital gains into a settlement in which they retain an interest before procuring the trustees to dispose of them.
This stratagem is dealt with by Section 77(1) of the Taxation of Chargeable Gains Act 1992 ("the Act"). This provides that where (i) in any year of assessment the trustees of a settlement make a chargeable gain from the disposal of all or any of the settled property and (ii) the settlor has an interest in the settlement at any time during that year then the trustees are not to be chargeable to tax in respect of the gain but the settlor is to be chargeable as if the gain had accrued to him.
There is no necessary connection between (i) the settlor's interest, which may be remote, or its value, which may be small, and (ii) the property disposed of, in which the settlor may have no interest and the value of which may be very great. To this extent the Section may be said to operate harshly: a settlor who has any interest however small in a settlement is at risk of being charged to tax in respect of capital gains accruing to the trustees even from the disposal of assets in which he has no interest at all. Section 78, however, entitles the settlor to recover the amount of any tax which he has paid from the trustees, so the effect of the section is not to alter the ultimate incidence of the tax but to ensure that the tax is charged at the appropriate rate. The appropriate rate depends on whether the settlor has an interest in any of the settled property during the relevant year of assessment.
Section 77(2) is an anti-avoidance provision which extends the scope of Section 77(1) in order to prevent taxpayers circumventing it. It does this by directing that a settlor shall be regarded as having an interest in a settlement in a number of situations in which, absent the Subsection, he would not be so regarded. Thus it provides at a settlor is to be regarded as having an interest in a settlement if any property which may at any time be comprised in the settlement is or will or may become payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever. The relevant provisions on which the Revenue rely in the present case are those which bring in "derived property". Omitting words which are immaterial for present purposes, a settlor is to be regarded as having an interest in a settlement if (a) any property …… comprised in the settlement or any derived property is ….. payable to or applicable for the benefit of the settlor; or (b) the settlor ……… enjoys a benefit deriving directly or indirectly from any property which is comprised in the settlement or any derived property.
"Derived property" is defined by Section 77(8) as follows:
"(8). In this section "derived property", in relation to any property, means income from that property or any other property directly or indirectly representing proceeds of, or income from, that property or income therefrom."
The taxpayer submitted that the Subsection merely extends the scope of the Section to income. "Derived property", he submitted, means income from (i) that property ….. or (ii) any other property …….
This is a possible way of reading the Subsection, but I have no doubt that the Court of Appeal were right to reject it. The Subsection is concerned with the extraction of value from a settlement for the benefit of the settlor or his spouse before the year in which a chargeable gain accrues to the trustees of the settlement. On the taxpayer's construction the Subsection catches the extraction of value in the form of income but not of capital. It is impossible to ascribe to Parliament so capricious an intention, which not only leaves a gaping hole in the protection which the Section is intended to afford the revenue but makes no sense. It is more natural, as well as making more sense, to read the Subsection as referring to (i) income from that property or (ii) any other property directly or indirectly representing proceeds from, or income of, that property or (iii) income therefrom.
In my opinion the provisions of the Section are carefully crafted to catch the extraction of value in any form for the benefit of the settlor or his spouse without introducing an undesirable degree of overkill. The Revenue must work their way through the Section and satisfy a number of requirements before they can charge the tax at the settlor's rate.
The first question is whether a chargeable gain has accrued to the trustees of a settlement from the disposal of all or any part of the settled property (Section 77(1)(a)). In the present case the answer is "yes": a chargeable gain accrued to the trustees of the first (or "flip") settlement during the 1995-6 tax year when they sold the Einkorn shares. This disposal identified the first settlement as the relevant settlement and the 1995-6 tax year as the relevant year.
The next question is whether the settlor had an interest in that settlement during the relevant year. The answer is "no": he had divested himself of all interest in the first settlement before the year began.
That is not, however, an end of the story. The next question is whether the settlor is to be regarded as having an interest in the first settlement during the relevant year even though he did not have one in fact. The Revenue say that the answer to this question is "yes": he was entitled to receive derived property (Section 77(2)(a)) or was enjoying a benefit derived directly or indirectly from the property comprised in the first settlement (Section 77(2)(b)) during the relevant year.
To make this good the Revenue must first identify the property which they allege was payable to or applicable for the benefit of the settlor or from which he was deriving a benefit during the relevant year. For this purpose they identify the income of the moneys comprised in the trust fund of the second (or "flop") settlement which was payable to the settlor. Secondly they must identify the property which was still comprised in the first settlement during the relevant year in which they allege the settlor is to be regarded as having an interest. The only property which was still comprised in the first settlement during the relevant year (pending their disposal) was the Einkorn shares. The Revenue identify these as the property in relation to which ("in relation to any property") the moneys comprised in the trust fund of the second settlement and the income therefrom were derived property: (Section 77(8)).
The final question is whether the Revenue are correct in contending that the moneys comprised in the trust funds of the second settlement during the relevant year and the income therefrom which was payable to the settlor constituted derived property within the meaning of Section 77(8) in relation to the Einkorn shares. There can be only one answer to this: of course they do. The moneys comprised in the trust fund of the second settlement directly represented the proceeds of a mortgage of the Einkorn shares and the income payable to the settlor during the relevant year represented the income therefrom. If the trustees of the second settlement had invested the moneys in stocks and shares, these would have indirectly represented those proceeds. It will be observed that I have equated the proceeds of a mortgage of property with the proceeds of the property itself. But the Subsection does not refer to "the proceeds of a sale of that property", but to "the proceeds of that property"; and this covers any process, whether sale or mortgage or otherwise howsoever, by which value is extracted from one property and transferred to another.
The taxpayer contended that he did not derive any benefit from the proceeds of the mortgage of the Einkorn shares during the relevant year. He had obtained the benefit of those proceeds once and for all when they were transferred to the trustees of the second settlement during the previous year. Thereafter he derived benefit exclusively under the trusts of the second settlement. The difficulty with this argument is that it does not deal with the relevant question: whether in relation to the proceeds of the mortgage of the Einkorn shares the moneys comprised in the second settlement constituted derived...
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