Jonathan Crowther on how the results of a court case held 24 years ago are still affecting tax planning strategies and HM Revenue & Customs' approach
In the early 1970s the UK's punitive levels of taxation lead to the development of tax planning schemes, which set in motion a series of transactions that helped save tax without affecting the economic position of the taxpayer.
Firstly, there was a scheme or plan to avoid the payment of tax otherwise payable. Secondly, the scheme included artificial steps for which there was no commercial justification. Thirdly, if each artificial step was considered in isolation, the tax liability had been expunged, but if the scheme was regarded as a whole, the liability had only been disguised.
The Ramsay case
In the Ramsay case (1982), two separate schemes were involved. The first created an equal and opposite gain and loss using offshore companies and inter-company loans. The second did the same using reversionary interests in offshore trusts.
Under the capital gains tax law, the gains were not taxable while the losses were allowable and so the losses became available for offset against the genuine gains of the taxpayer. Any quantum of allowable loss could be generated and so the scheme opened the door to 100% tax-efficient post hoc capital gains tax planning.
The letter sent to taxpayers by the scheme's sponsors stated:
"(i) The scheme is a pure tax avoidance scheme and has no commercial justification in so far as there is no prospect of the taxpayer making a profit; indeed he is certain to make a loss representing the cost of undertaking the scheme.
(ii) Nevertheless, every transaction in the scheme will be genuinely carried through, and will in fact be exactly what it purports to be.
(iii) Although this is a scheme in the sense of a preconceived series of steps, the taxpayer should understand before deciding to embark on the scheme that there is no binding arrangement or undertaking to the effect that once the first step has been taken, then every other must be taken in its appointed order. It is reasonable for the taxpayer to assume that all steps will in practice be carried out, but as a matter of law, the taxpayer is free to withdraw at any time and so are all the other contemplated parties to the scheme. If any party does withdraw, the taxpayer will have no redress.
(iv) It will be essential for the taxpayer to provide the necessary finances for the share subscriptions and the loans, either out of his own resources or by entering into suitable borrowing arrangements."
The conclusion of the court in Ramsay was that:
"1. Where there is a composite transaction intended to be carried through as a whole (whether there is a binding obligation to carry it through or merely an expectation and no likelihood in practice that it will not) the appeal commissioners are not bound to consider individually each separate step, notwithstanding that no such step is a sham.
2. In such a case, where the transactions are designed to produce no economic gain or loss for the taxpayer, it would be wrong to pick out and stop at the one step in the combination that produces the loss; and that, on a true analysis, it may be right to find there was no gain or loss for the purposes of capital gains tax.
3. In construing a taxing statute, particularly in relation to sophisticated tax avoidance schemes, the courts are not limited to a strict literal construction, but are permitted to arrive at a conclusion corresponding with the parties' own intentions."
This approach has become known as the Ramsay principle. It has taken hundreds of thousands of words and many subsequent cases over the last 24 years to decipher the meaning of this judgement and the limits of its applicability. Indeed, there is a question as to whether there is a Ramsay principle at all. Lord Nicholls in MacNiven says:
"An initial point to note is that the very phrase "the Ramsay principle" is potentially misleading. In the Ramsay case the House did not enunciate any new legal principle."
For a time Ramsay was extended, especially in the case of Furniss v Dawson (1984), but following the case of Craven v White (1989), the courts retreated from a substance-over-form approach to a more "strict literal construction" one limiting the role of the courts to construing the real meaning of the legislation and the intention of Parliament behind it.
This culminated in MacNiven, which has been referred to as the taxpayer's charter and of which Lord Templeman, who provided the definitions of tax evasion, sham, avoidance and mitigation in a previous article, has said that "the courts which formerly kept tax avoidance in check have now abdicated that responsibility".
for and against
In Westmoreland (2001) losses trapped in a pension trust were released by the payment of £40m by the trustees to Westmoreland followed by the payment of £40m by Westmoreland to the trustees. This entirely circular and pre-ordained series of artificial transactions was accepted by the court.
In the cases of Arrowtown (2003) and Careras (2003) the tide turned again against the taxpayer, with the court being willing to recharacterise statutory facts, in these cases issued share capital and a debenture respectively, so as to fall outside the relieving statute on which the planning sought to rely.
It is therefore safe to say the cycle of cases examining the use of artificial transactions over the last 24 years has not resulted in either clarity or the end of tax avoidance. It is still possible to implement a successful scheme that includes steps with no commercial purpose bar the avoidance of tax.
The problem lies in three facts: (1) all transactions are to a degree artificial, (2) the minimising of tax is itself a genuine commercial motive and (3) the state attempts to influence commercial behaviour through the tax system. The effects of these facts are: (1) it is difficult, if not impossible, to draw the line between commercial and artificial transactions, (2) the mere fact tax has been expunged is not sufficient to determine tax avoidance is taking place and (3) taxpayers will attempt to make their preferred economic behaviour as tax-efficient as possible regardless of the tax-efficient economic behaviour "sanctified" by the state.
A recent case in which HM Revenue & Customs (HMRC) mounted an unsuccessful Ramsay attack was D Campbell v The Commissioners of the Inland Revenue (2004) held before the Special Commissioners. The case involved a tax scheme in which the taxpayer formed a UK company, which issued a redeemable discounted security (RDS) in favour of the taxpayer for a transfer of securities into the company. The terms of the RDS were such that its market value was less than the market value of the securities. The taxpayer gifted the RDS to his wife, which triggered a loss (offsetable against his general income) equal to the difference between the market value of the RDS and the market value of the securities.
The Special Commissioner said: "We reject HMRC's counsel's submission, which he made by reference to Ramsay itself, that because the capital gains tax legislation definition of "loss" is detailed and technical, this shows that the construction of "sustains a loss" is affected by the purpose of those effecting particular transactions.
"The reason why no "loss" arose in Ramsay was because the series of pre-ordained self-cancelling transactions were ignored. Ramsay was not decided upon a construction of the term "loss" or a construction of the detailed computational provisions that quantify a loss for capital gains tax purposes in circumstances in which that series of transactions were respected for capital gains tax purposes.
"Here, as we have already observed, counsel accepts there has been a subscription for the loan notes for the entire subscription price, and a transfer of the RDS by the taxpayer to a connected person, namely his wife. It is no part of counsel's case that the RDS was issued directly to the taxpayer's wife, or that there was no transfer of the RDS by the taxpayer to his wife. The analogy drawn by counsel of this case to Ramsay does not, therefore, hold good."
A leading tax counsel, Patrick Soares, has hypothesised what Ramsay as it stands would look like if enacted in statutory form and this can be viewed at www.taxbar.com/gitc.html, entitled If Ramsay were in Statutory Form.
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