The High Court confirmed a decision of a special commissioner that any charge to tax on the sale of giltsunder an accrued income scheme was excluded by ICTA 1988, s. 715(1)(b) because on no day was the taxpayer entitled to any gilts as defined by the scheme; nor did the deeming provision in s. 715(6), that there had been no transfer of the gilts, apply to treat her as entitled to them on the day.

Facts

The taxpayer was the founder and chief executive officer of a company which carried on a specialist executive search business. She entered into a tax avoidance scheme involving a series of transactions in gilts designed to create a tax deduction for a manufactured interest payment. The way the scheme was intended to work was that the taxpayer made a tax-free capital gain on the difference between the sale (cum div) and the purchase (ex div) to and from a market maker (JPMS) of certain gilts of £1,469,720. Pursuant to a ‘repo’ transaction she paid manufactured interest of £1,511,250 which was deductible from her total income, but she received repo interest of £18,538.77 and additional interest of £1,038.86. Accordingly she claimed tax relief on the balance of £1,491,672.50.

Although in principle there was a charge to tax on the sale under the accrued income scheme under s. 714(2) on the accrued amount of interest attributable to a sale of gilts on 14 February 2002, the taxpayer contended that the charge did not apply because of ICTA 1988, s. 715(1)(b) which provided for no charge: ‘if the transferor is an individual and on no day in the year of assessment in which the interest period ends or the previous year of assessment the nominal value of securities held by him exceeded £5,000.’

Section 715(1)(b) had to be construed and applied in the light of the interpretation provisions in s. 710(7) under which a person was deemed to hold securities on a particular day if he was entitled to them throughout the day or he became and did not cease to be entitled to them on the day.

It was common ground that the only day on which she might arguably have held any gilts within the meaning of s. 710(7)(b) was 20 February 2002 when she became entitled to, and therefore acquired, a further holding of £31.1m nominal gilts. She would therefore have ‘held’ those gilts on 20 February within the meaning of s. 710(7)(b) if either she was entitled to them throughout that day, or she became, and did not cease to be, entitled to them on that day. There could be no question of her having been entitled to the gilts throughout 20 February, because she both bought them and sold them back during the course of that day.

Accordingly the only question was whether, having admittedly become entitled to the gilts on 20 February, she also ceased to be entitled to them on that day. The Revenue issued a closure notice contending that the Ramsay principle applied with the effect that no deduction was created (and a smaller amount of income was not taxable). They subsequently abandoned that contention and argued that the deduction was allowable but that the taxpayer was taxable on an amount approximately equal to the deduction under the accrued income scheme. The taxpayer appealed against the conclusion in the closure notice and amendments to her return for 2001-02 to give effect to that conclusion. She argued that the Revenue could not change the basis of their conclusion as stated in the closure notice; and that the accrued income scheme did not give the result for which the Revenue contended. A special commissioner allowed the taxpayer's appeal in principle ((2006) Sp C 549). The Revenue appealed to the High Court.

Issue

Whether the special commissioner had erred in law in concluding that no charge to tax arose under the accrued income scheme.

Decision

Henderson J (dismissing the appeal) said that a person could not cease to be entitled to securities before he had become entitled to them. There was no special definition of the concept of ceasing to be entitled in s. 710, so the word ‘cease’ had to be given its ordinary and natural meaning; and more particularly so because the draftsman himself had used the expression ‘becomes and does not cease to be entitled’, which both in its word order and in its use of language presupposed that becoming entitled had to precede the ceasing to be entitled. In the context of a ‘short’ sale, the result was that the vendor ceased to be entitled to the securities which he had agreed to sell at the moment when he first became entitled to them, but not before.

Although that did not sit altogether easily with the deeming in s. 710(6), the focus of that provision was different from that of s. 710(7). Section 710(6) was a general rule which dealt with all cases where securities were transferred pursuant to an agreement. Such a rule was clearly needed to deal with the uncertainties to which two-stage transactions, with a contract followed by completion, would otherwise give rise. By contrast, s. 710(7) was a more closely focused provision which applied only for the purposes of ascertaining whether a person held securities either at a particular time, or on a given day.

In so far as s. 710(7) used the concepts of entitlement and becoming entitled, those concepts had to be understood in accordance with the general rule laid down in s. 710(6). However, the tests for the holding of securities were specific and self-contained, and it was important not to lose sight either of the concept being defined (holding securities) or of the general nature of the tests and the language in which they were formulated.

It was a striking feature of the tests for holding securities ‘on a day’ in s. 710(7)(b) that they would not be satisfied if entitlement to the securities ceased during the day, whereas they would be satisfied if entitlement to the securities continued throughout the day, or if entitlement began during the day and then continued for the rest of the day. The position at the end of the day was important because there would then be an accrual of interest, and therefore something for the accrued interest scheme to bite on. If, however, person both became and ceased to be entitled to securities during the course of a single day, no income on the securities would accrue during his period of ownership and there would accordingly be no reason why the accrued income scheme should apply to him.

The construction of s. 710(7)(b), and the availability or otherwise of the exception in s. 715(1)(b), could not depend on whether the taxpayer happened to have a tax-avoidance motive. The Revenue's real complaint seemed to be that the accrued income scheme did not throw up a charge to counterbalance the deduction admittedly available to the taxpayer for her manufactured interest payment. But the accrued income scheme and the provisions relating to manufactured interest were enacted at different times and with different statutory purposes. They did not form part of a single unified code, and their separation was indeed emphasised by s. 727A. This was one of those cases, which would inevitably occur from time to time in a complicated tax system, where a well-advised taxpayer had been able to take advantage of an unintended gap left by the interaction between two different sets of statutory provisions.

Chancery Division.
Judgment delivered 7 February 2007.