The High Court upheld the decision of a special commissioner that a tax avoidance scheme involving a deep discount on the redemption of securities did not fall within the statutory definition of a relevant discounted security for purposes of FA 1996, Sch. 13, para. 3.

Facts

These were appeals by two taxpayers (J and G) who were two sample participants in a tax avoidance scheme promoted by KPMG which was based on the definition of relevant discounted securities. The scheme consisted of each of the taxpayers settling a small sum in a trust under which he had a life interest. The settlor lent money to the trust in return for a security issued by one of the trustees, a company. The terms of the security were that it was redeemable in 15 years at 118 per cent of the issue price but the taxpayer could redeem the security at 100.1 per cent of the issue price between one and two months after issue. If a condition relating to the dollar-pound exchange rate, which was designed to have an 85 per cent chance of being satisfied (‘the market change condition’), was satisfied within one month and a notice to transfer the security was given, the term of the security became 65 years (with the same redemption price). However, the purchaser could redeem it at five per cent of the redemption price (about six per cent of the issue price) on seven days’ notice. The taxpayers could then claim the difference between the issue price and six per cent of the issue price as a loss on a relevant discounted security, while the difference remained in the trust for his benefit. The redemption terms were designed to satisfy the definition of a relevant discounted security within FA 1996, Sch. 13, para. 3. The taxpayers conceded that the market change condition had been inserted to repel an anticipated argument by the Revenue based on WT Ramsay Ltd v IR Commrs [1982] AC 300.

The taxpayers both appealed against amendments to their self-assessment disallowing losses of £1,989,464 in J's case and of £4,976,098 in G's case for 2001–02 which had been claimed on the basis that they were losses incurred under the scheme and fell within FA 1996, Sch, 13, para. 3.

The special commissioner dismissed the appeals, deciding that for purposes of construing the definition of ‘relevant discounted securities’ in FA 1996, Sch. 13, para. 3, regard should be had only to real possibilities of redemption, not those written into the security which the parties, and any reasonable person with the knowledge available to the parties, knew would never happen. The difference between the issue price and the redemption price had to give rise to the possibility of making a gain that, objectively, could be seen to exist. There was never such a possibility in the present case since it was a practical certainty that there would be a loss. Adopting that approach in the present case, the market change condition in the security was (as was conceded) inserted purely as an anti-Ramsay device. The 85 per cent chance of the market change condition being satisfied was favourable enough to make it a risk which the taxpayers were willing to accept in the interests of the scheme. The existence of the market change condition and the possibility that a purchaser for the security would not be found, with the consequence that the early redemption option would be exercised, should be ignored on the authority of IR Commrs v Scottish Provident Institution [2004] BTC 426 (‘SPI’). The condition was not inserted for any commercial reason. The consequence of the market change condition not being satisfied was that the early redemption option had also to be ignored, just as the possibility of the options not being exercised simultaneously was ignored in SPI. The commissioner had found as a fact that it was a practical certainty that at the time of issue of the securities purchasers could have been found who were willing and able to purchase the securities within the time scale at a discount of not more than about ten per cent. Thus the possibility of a purchaser not being found would be ignored for the same reason as the market change condition ((2007) Sp C 628). The taxpayers appealed.

Issue

Whether the commissioner had erred in concluding that the taxpayers had not sustained losses from the discount on relevant discounted securities within the meaning of FA 1996, Sch. 13.

Decision

Peter Smith J (dismissing the appeal) said that there were no grounds for suggesting that the special commissioner had come to factual conclusions which he was not entitled to do and there was nothing to suggest that he incorrectly applied the law. In all the circumstances, it could not be said that the special commissioner's conclusion that a sale within the time limit was ‘practically certain’ was one which no reasonable tribunal could have reached and therefore was erroneous in law, relying on Edwards v Bairstow [1956] AC 14.

In the light of his findings of fact and his consideration of the legal principles, the commissioner had been led to the conclusion that the purpose of the legislation was to tax gains on securities that were issued at a deep discount and conversely to relieve losses on such securities. On the facts found there was never a possibility of these securities making a gain looked at objectively. Thus it was a practical certainty that there would be a loss. Given that analysis his decision was that the security in question was not within the regime for relief because it was not a ‘relevant discounted security’. The special commissioner had come to that conclusion on the facts and there was no basis for challenging his factual findings.

That fatally flawed the taxpayers’ appeals because it showed that the commissioner had come to his conclusion whether or not the security was within the legislation by determining the facts that were applicable to that security. His conclusion could not be faulted and therefore his decision could not be faulted that on the facts of the security and in the light of all the evidence the taxpayers had not established that the security fell within the definition ‘relevant discounted security’.

As there was no realistic possibility of a deep gain there could be no basis on which to allow the taxpayer to manufacture allowable losses by the expedient of inserting mechanisms giving a theoretical possibility of deep gains but in circumstances where the parties intended that instead far deeper losses should be made. The commissioner was plainly alive to that prospect and on his findings that was an inevitable conclusion. SPI addressed both the points that the special commissioner considered, namely the lack of commercial reason for choosing the market change condition by reference to changes in the dollar/sterling exchange rate, and the fact that whilst there was a commercial risk that that would not be achieved the odds were favourable enough to make it a risk which the parties were willing to accept in the interest of the scheme. The commissioner was equally entitled to take into account as part of the facts that the creation of the market change condition was inserted as an anti- Ramsay device just like KPMG's decision not to seek purchasers for the security until after it had been issued. Both those had to be ignored for the same reason as the uncertainty created in the SPI case.

Chancery Division.
Judgment delivered 27 June 2008.