UK House of Lords

Boake Allen Ltd & Ors (including NEC Semi – Conductors Ltd) vR&C Commrs [2007] UKHL25

Treaties – Non-discrimination article

Under UK legislation, a UK parent and subsidiary could make an election which meant that the subsidiary did not have to pay ACT on dividends. The ECJ had held that limiting group elections to UK parents was contrary to the freedom of establishment.

This test case deals with challenging ACT elections where the parent company is resident in Japan or the US. The non-discrimination article in the UK/Japan Double Tax Convention and UK/US Double Tax Convention is the vehicle used in making the challenge. The article provides that

• “Enterprises of a contracting state [UK], the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other contracting state [Japan or US], shall not be subjected in the first-mentioned contracting state [UK] to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of that first-mentioned state [UK] are or may be subjected.”

It was decided that the denial of the right of election to groups with non-resident parents did not infringe the non-discrimination article of the UK/Japan Double Tax Convention and the UK/US Double Tax Convention.

The key issue in the judgement is the difference between the EC Treaty freedom of establishment and the non-discrimination in a Double Tax Convention: the non-discrimination article does not give a company or individual resident in one country a right of establishment in the other. As the commentary on the OECD model says, the equality it ensures is only that any enterprise it owns in the other country will not be subject to taxation which discriminates on the ground of its foreign control. In the opinion of their lordships, the denial of the right of election was not on the ground of the company's foreign control but on the ground that the relevant provision could not be applied to a case in which the parent company was not liable to ACT. If a group with a foreign parent had been allowed to make the election, then this would have the effect of not paying ACT and hence put it in a better position that a group with a UK parent.

For further information, see page 27.

UK Court of Appeal

Allnutt &Anor v Wilding & Ors [2007] EWCA Civ 412

Inheritance tax – settlement

The deceased had instructed the respondent solicitor to draft a trust settlement in order to mitigate inheritance tax. As no distribution had been made by the trust since its creation (which was outside the seven year period for a potentially exempt transfer), Revenue pointed out that the transfer to the settlement was a chargeable transfer.

The respondent solicitor claimed he had acted in haste in drafting the settlement and applied to the High Court to rectify the settlement to have it redrafted. The High Court dismissed the appeal and the appellants appealed to the Court of Appeal.

The Court of Appeal upheld the High Court's refusal to rectify the settlement. The reason for the refusal was that there was no evidence that the deceased's true intention had been to execute a settlement in a different form, even though the actual settlement failed to achieve the object of avoiding inheritance tax.

For further information, see page 28.

Barclays Bank plc v R & C Commrs [2007] EWCA Civ 442

Benefits under non-approved retirement benefits scheme

The taxpayer bank had previously provided pensioners with certain free tax-related services on a concessionary basis. The taxpayer withdrew the services and made ‘goodwill’ payments to the pensioners.

Revenue argued that the payments were taxable as benefits provided under a non-approved retirement benefits scheme. The taxpayer argued that the payments were not taxable as they were not made ‘in connection with past service’.

The Court of Appeal held that the payments were made in connection with past service and hence taxable as benefits provided under a non-approved retirement benefits scheme.

The key issue in the judgement was the proper meaning of the words’ in connection with past service'. Substantial weight was given to the class of recipients in making the decision. In this case, the class of recipients was limited to those who had been employees or who had connections through an employee by being the surviving spouse or personal representative. Hence it was concluded that the payments were made in connection with past service.

For further information, see page 29.

Smallwood vR&C Commrs [2007] EWCA Civ 462

Restriction of allowable losses – investments

This is an interesting case which explores the link between an investment and underlying assets in the investment through numerous legislative provisions.

The taxpayer invested in a unit trust (enterprise zone property unit trust). The trustees invested the money in land and property and the taxpayer was entitled to the capital allowances which were available on those assets. Almost ten years later the property was realised in a way which did not give rise to a balancing charge and the taxpayer received distributions in respect of his trust. The taxpayer made a claim for capital losses incurred.

The Revenue disallowed the claim for allowable losses on the grounds that most of the sum subscribed by him for units was expenditure in respect of which capital allowances had been claimed. The taxpayer appealed on the basis that it was the expenditure of the trustees (and not his expenditure) that had given rise to the capital allowances.

The Court of Appeal found in favour of the taxpayer, i.e. allowable losses accruing to the taxpayer were not restricted, since the sum subscribed by the taxpayer for the units was not expenditure in respect of which a capital allowance had been made. While the holders of the unit trusts were allowed to claim capital allowances on the asset, the asset remained the property of the unit trust scheme.

For further information, see page 30.

UK High Court (Chancery Division)

Bank of Ireland Britain Holdings Ltd vR& C Commrs [2007] EWHC 941 (Ch)

Tripartite ‘repo’ transaction – interest

The taxpayer company was a private limited company, incorporated and registered in the UK and resident for tax purposes in the UK. It was a wholly owned subsidiary of an Irish resident and incorporated company.

The key question in the case was whether a tax avoidance scheme succeeded in its object of generating a loss for tax purposes in a situation where the taxpayer suffered no corresponding commercial loss.

The scheme involved a transaction for the sale and repurchase of securities, generally known to tax specialists as a “repo”. This particular “repo” involved three parties, and dividends were paid on the securities during the period for which it operated. The amount of the loss, if the scheme worked, was equivalent to the dividends actually paid to the Irish resident company during its period of ownership of the relevant securities, a sum of approximately £3.6 million. This sum also comprised most of a so-called “manufactured overseas dividend” which is deemed to have been paid by the taxpayer, and which is prima facie deductible by the taxpayer as a charge on income in computing its taxable profits.

The taxpayer simply submitted that the relevant legislation admits of only one construction, and if the result was not to the Revenue's liking, they said, that the Revenue had only itself to blame for procuring the enactment of such complex deeming provisions without giving enough thought to the consequences.

The issues are:

1. Whether the taxpayer was also deemed to have received a matching payment of interest of the same amount pursuant to relevant legislation; and
2. Whether the payment of the manufactured overseas dividend deemed to have been made by the taxpayer was deductible as a charge on income.

Issue 1

The deemed interest of £3,975,473 was not income of the taxpayer. It was income of the interim holder, the Irish resident parent. The relevant legislation clearly failed in its object of replacing what would otherwise be a capital gain with a flow of taxable income. However, the key step was that the arrangements had been framed in such a way that the income accrued to a non-resident company outside the charge to corporation tax.

Issue 2

It was common ground that the taxpayer received valuable and sufficient consideration for the transactions which it entered into. The Court concluded that parliament could not sensibly have contemplated an investigation of the value and sufficiency of the consideration for a transaction which is only deemed to have occurred. Hence the manufactured interest was treated as a charge on income.

As advised in Section 1.10 of the July 2006 edition of tax.point, legislation was introduced to amend the Repo rules in the 2006 Finance Bill.

For further information, see page 31.

R & C Commrs v Decadt

Wholly, exclusively and necessarily

The taxpayer was a qualified registrar in general surgery employed at an NHS Trust. He was required under the terms of his contract of employment to attend specific training courses for the purposes of obtaining a Certificate of Completion of Specialist Training (CCST).

The taxpayer sought to deduct his examination fees, accommodation and related expenses from his earnings. Revenue rejected his claim on the basis that the expenses had not been incurred ‘wholly, exclusively and necessarily in the performance of the duties of employment’.

The High Court held that the expenses were not deductible from his earnings as they had not been incurred wholly, exclusively and necessarily in the performance of the duties of his employment.

The key issue in this judgement was the difference between taking the examinations as a contractual requirement and the attendance at the examinations as ‘wholly, exclusively and necessarily in the performance of the duties’ of his employment as a specialist registrar. The expenses had to be incurred not only as an obligation of his employment but also because they had to be necessarily incurred due to the nature of the duties of employment. The purpose of the examinations and the CCST qualification was to better qualify the registrar for his duties and enable him to apply for a more senior post. Therefore, the expenses were not deductible.

For further information, see page 32.

CMS Periperals Ltd v C & E Commrs [2007] EWHC 1128 (Ch)

VAT – surcharge on return

The taxpayer was involved in the wholesale supply of computer peripherals and other electronic products. For the VAT period in question, an incorrect figure was entered in the ‘Net VAT to be paid to Customs or reclaimed by you’ section of return was incorrect, but corrected in manuscript on the face of the return before submission. It was acknowledged that the figure in the relevant box on the return was incorrect. It subsequently transpired that the VAT paid on imports required correction and the taxpayer made a voluntary disclosure in this regard.

Customs issued a surcharge liability notice on the default. The taxpayer appealed on the grounds that it had a reasonable excuse for failing to dispatch the sum shown to be due to Customs.

The High Court found in favour of the taxpayer, with the following logic:

• The taxpayer made a clerical error, but attempted to correct the error in manuscript on the return;
• The taxpayer paid the amount it thought was due;
• It furnished the return and payment in good time;
• Having made the manuscript alterations to the return, it had a reasonable excuse for acting as it did.

For further information, see page 33.

Morris &Anor v R & C Commrs [2007] EWHC 1181 (Ch)

Time limit for making an assessment

The taxpayers disposed of shares in the tax year 1997–98. In the return for that year, they claimed that they were neither resident nor ordinarily resident in that year. They did not provide information on their country of residence in the tax year which is required in the tax return. The Revenue served notices on the taxpayers requesting further details on their residence status.

When no information was forthcoming, the Revenue served notices on the taxpayers to amend their tax returns to include a liability for capital gains tax, penalty notices were also issued; and also assessments for income tax in the prior year. The taxpayer appealed against the notices and assessments.

• The taxpayers’ contention was that because a closure notice operates to amend the return and in particular the assessment to tax contained within the return, it constitutes an assessment within the meaning of the relevant legislation and must therefore be made within the time prescribed.
• The Revenue's case was that the statute draws a clear distinction between assessments properly so-called and other mechanisms for adjusting the liabilities of the taxpayer and that the amendment of a return effected by a closure notice is so described in the relevant legislation in order to distinguish it from an assessment which would be subject to the time limits in other legislative provisions.

The High Court ruled that the ordinary six-year time-limit for raising an assessment to income tax or capital gains tax did not apply in this situation. The key issue was that the closure notice provisions were not affected by the time limits in the provisions to allow Revenue to issue assessments.

For further information, see page 34.

UK High Court (Administrative Court)

R (on the application of Software Solutions Partners dvR&C Commrs [2007] EWHC 971 (Admin)

VAT – Insurance Industry

The taxpayer carried on the business of supplying, installing and maintaining computer hardware and software to the insurance industry. The taxpayer claimed that Customs had ruled that the relevant supplies were exempt from VAT. The taxpayer contended that it had relied to its detriment on the ruling and that under public law Customs might not assess the taxpayer on relevant supplies made during the period of the ruling.

The High Court decided that the supply of the hardware and software to the insurance industry did not come within the Customs’ ruling.

The key issue in the judgement was that the taxpayer failed to show that its activities during the relevant period fell within the terms of the ruling. The ruling was clear that it was the taxpayer as a business entity that had to have the authority to enter into contracts on behalf of insurers: it was not sufficient that insurers entered into contracts through computer programs designed by, and running on the taxpayer's information system. The taxpayer was merely an electronic conduit for the transmission of the information.

There was detailed discussion in the case on the binding nature of a Revenue ruling: if a statement is issued formally by the Revenue to the world, then it should be regarded as binding, subject to its terms, in any case falling within them. Where the Revenue approach is less formal, it would be necessary for the taxpayer to show certain conditions had been fulfilled.

For further information, see page 36.

R (on application of R & C Commrs) v General Commissioners of Income Tax for Berkhire [2007] EWHC 871 (Admin)

Agreement between Revenue and taxpayer – enquiry

In this case, the taxpayer had reached an agreement with the Revenue following an investigation by Revenue into the taxpayer's tax affairs. Shortly after agreement was reached the Revenue wrote to the taxpayer advising that they would be opening an enquiry into the year ended 5 April 2003. The taxpayer appealed on the grounds that Revenue were precluded from raising enquires as a result of the agreement reached on 24 May 2004.

The High Court held that the Revenue were not precluded in raising enquiries in relation to a subsequent tax year as a result of the agreement reached between the Revenue and the taxpayer. The key issue in the judgement was that the agreement related to the tax years between 1998 and 2002. In addition, a clause in the agreement contemplated further enquiries being raised. Hence the taxpayer's interpretation of the agreement was not incorrect.

For further information, see page 37.

Special Commissioners

Kato Kagaku Co Ltd v R & C Commrs

Deductibility of indemnity payment

In the decision, the taxpayer was a Japanese resident company which borrowed sterling to finance the purchase of land in the UK. The bank entered into a swap agreement with the taxpayer. Following interest rate movements the interest rates became higher than the rental yield and the taxpayer repaid the loan. The taxpayer had indemnified the bank against the liability on termination of the swap transaction which resulted in a payment of £21m.

The Special Commissioner decided that the indemnity payment under the loan agreement was a capital payment and in general was not deductible in computing income.

The categorisation of the payment depended on the true analysis of the transaction. The making of the indemnity payment was a necessary part of the prepayment of the loan – the prepayment could not have been achieved without it. The question then was whether the indemnity payment was a capital payment as defined as ‘the incidental cost of obtaining finance’ and not a premium.

• On the basis that the purpose and effect of the payment was to achieve the prepayment of the loan, it was decided that the indemnity payment was an incidental cost of obtaining finance.
• Also, the loan was not repayable at a premium because the indemnity payment for terminating the swap transaction was required to be made in consequence of the prepayment.

Accordingly, it was decided that the payment was not deductible-Beauchamp v Woolworth [1989 BTC 233] was cited in the decision.

For further information, see page 38.

Parade Park Hotel & Anor v R & C Commr

NICs – contract for service or contract of service?

In this decision a hotel hired an individual to carry out various maintenance jobs. The Revenue contended that the individual was employed by the hotel and issued assessments to income tax and National Insurance contributions (NICs).

The Special Commissioner decided that the individual was not an employee of the hotel as the conditions necessary for a contract of service were not fulfilled:

• There was no written contract between the parties;
• The provision of personal services for payment did not automatically lead to the conclusion that the relationship was a contract of employment.
• There was no mutuality of control either extending over the whole period or in respect of separate engagements; the work was casual; the work was not guaranteed – the individual was not obliged to carry out work but could choose to do so; the hotel was not obliged to offer work but could choose to do so.

On the basis that mutuality of obligation is an essential element, the relationship between the parties could not amount to a contract of service.

The Irish Revenue published a Code of Practice in July 2004 for determining employment or self-employment status of individuals. It is our understanding that the Revenue propose to amend the criteria.

For further information, see page 39.

Patch v R & C Commrs

Inheritance tax – deed of partition

This was an appeal against a determination for inheritance tax payable on the death of the taxpayer.

The determination arose because the Inland Revenue Account submitted by the executors failed to take account of a Deed of Partition dated 26 July 2000 under which the deceased had assigned two-thirds of the trust fund under her late husband's estate to the reversioners and her life interest in the remaining of one-third was enlarged to an absolute interest. This partition resulted in a transfer of value under section 52(1) of the Inheritance Tax Act 1984 which absorbed most of the nil slice of the deceased; her free estate was increased by the inclusion of the assets to which she became absolutely entitled, which included the property in which she was living, subject to a balancing payment.

It was agreed at the hearing that inheritance tax was due. However it was argued that full disclosure had been made to the Revenue and as the estate had been distributed, the Revenue were estopped from claiming additional tax.

The Special Commissioner decided that there was a charge and the value transferred should have been included in the Inland Revenue Account. The charge to inheritance tax on death was express. The Inheritance Tax Act did not merely give a power to charge tax: it provided that tax should be charged.

For further information, see page 41.

McQueen v R & C Commrs

Expenses – wholly and exclusively

The taxpayer carried on the business of taxi and coach hire, initially under the name of Garelochhead Minibuses and then Garelochhead Coaches. The taxpayer had been driving in motor rallies, quite actively but in a relatively small way, from 1986 onwards. This had been a private activity.

By 1999 the taxpayer, according to his evidence (which was accepted by the Special Commissioner), had decided that motor rallying was a means of marketing the Garelochhead Minibuses (shortly to be changed to Garelochhead Coaches) business. He believed that it attracted media interest; he was aware of the newspaper and TV coverage of motor rallying; the TV coverage got frequent repeats on certain channels. By then the minibuses and coaches were painted in a professionally designed livery and lettering. A series of 4-wheel drive cars were used for the rallying from 1999 onwards. It is the expenditure on the rallying, both capital and revenue, that is in dispute in the present appeal. The first (the Mitsubishi EVO5) was used for rallying from 1999 until 2001. The second, a Mitsubishi EVO7, was used until 2002 when it was exchanged for a Subaru Impreska WRC. All the rally cars were painted in Garelochhead Coaches livery and carried the Garelochhead Coaches name and telephone number prominently displaced.

The Special Commissioner decided that the rallying activities from 1999 onwards were for the purposes of the Garelochhead Coaches trade. The following facts were taken into account in reaching this conclusion:

1. the use of the business livery and lettering on the rally cars;
2. the sponsorship of events on a wide scale and the exclusive promotion of the Garelochhead Coaches Rally;
3. the use of those events to entertain customers and potential users of the Garelochhead Coaches facilities;
4. the publicity derived from newspaper coverage and TV features including repeats and
5. the daily display of the cars outside the Garelochhead Coaches premises.

In reading the report of this decision, I couldn't help but wonder about duality of purpose. It is dealt with by the Special Commissioner as follows:

• “My conclusion therefore is that Mr McQueen was using his skill and enthusiasm for motor rallying as the best means available to him for promoting the Garelochhead Coaches business. He enjoyed it and it has given him satisfaction in just the same way as running an evidently successful business has done. Nonetheless the securing of the private satisfaction of success on the rally circuit can, in my view, properly be described as an incidental effect of the payment.”

For further information, see page 42.

Company A v R & C Commrs

Disposal of shares – employment related securities

In this case, the taxpayer's managing director had been allotted shares in the taxpayer's holding company. Then later the shares in the holding company were purchased by a third party.

The real dispute between the parties was the market value of the shares in the holding company held by the managing director and how that value is to be determined – if the shares had been sold for more than the market value then the company would be liable to account for income tax as though it had been a payment of income to the managing director by the taxpayer. The taxpayer would then be required to account for tax on the notional payment under the PAYE provision. If the shares were sold for the market value, then the managing director only must account for tax on the disposal of his shares (i.e. capital gains tax).

It was decided by the Special Commissioner that shares had been sold for more than market value. The key issue in the decision was that in considering market value, the value of the managing director's shares must be treated the same as all the other shares, even though a separate formula had been included in the subscription agreement for the managing director.

The following is a quote from the Special Commissioner which summarises the decision:

• “My judgment simply takes the total paid by Company C for Company B, namely £5,903,219, and divides that figure by the number of ordinary shares issued, 222,037. That results in a market value of £26.59 per share.”

For further information, see page 43.