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You are here: BAILII >> Databases >> United Kingdom Supreme Court >> UBS AG & Anor v Revenue and Customs [2016] UKSC 13 (9 March 2016) URL: http://www.bailii.org/uk/cases/UKSC/2016/13.html Cite as: [2016] WLR(D) 133, [2016] 3 All ER 1, [2016] STI 513, [2016] UKSC 13, [2016] 1 WLR 1005, [2016] BTC 11, [2016] STC 934 |
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[2016] UKSC 13
On appeal from: [2014] EWCA Civ 452
JUDGMENT
UBS AG (Respondent) v Commissioners
for Her Majesty’s Revenue and Customs (Appellant)
DB Group Services (UK) Ltd (Respondent) v Commissioners for Her Majesty’s Revenue and Customs (Appellant)
before
Lord Neuberger, President
Lord Mance
Lord Reed
Lord Carnwath
Lord Hodge
JUDGMENT GIVEN ON
9 March 2016
Heard on 3 December 2015
Appellant Paul Lasok QC Richard Vallat Anneliese Blackwood (Instructed by The General Counsel and Solicitor for HM Revenue and Customs) |
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Respondent (UBS AG) Kevin Prosser QC (Instructed by Pinsent Masons LLP) |
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Respondent (DB Group Services (UK) Ltd) David Goy QC Nicola Shaw QC (Instructed by Slaughter and May) |
LORD REED: (with whom Lord Neuberger, Lord Mance, Lord Carnwath and Lord Hodge agree)
1. In our society, a great deal of intellectual effort is devoted to tax avoidance. The most sophisticated attempts of the Houdini taxpayer to escape from the manacles of tax (to borrow a phrase from the judgment of Templeman LJ in W T Ramsay Ltd v Inland Revenue Comrs [1979] 1 WLR 974, 979) generally take the form described in Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL 51; [2005] 1 AC 684, para 34:
“... structuring transactions in a form which will have the same or nearly the same economic effect as a taxable transaction but which it is hoped will fall outside the terms of the taxing statute. It is characteristic of these composite transactions that they will include elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge.”
2. The present appeals are concerned with composite transactions of this nature, designed to avoid the payment of income tax on bankers’ bonuses. They are among a number of cases concerning broadly similar schemes. In each case, the scheme was intended to take advantage of Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”), as amended by Schedule 22 to the Finance Act 2003 (“Chapter 2”). Although the schemes were also designed to avoid the payment of national insurance contributions, it is unnecessary to discuss that aspect, as it is common ground that the position in that regard is the same as in relation to income tax.
The background and context of Chapter 2
4. Under ordinary principles of tax law, where an employee receives shares as part of his remuneration, he is liable to income tax on the value of the shares, less any consideration which he may have given for them, in accordance with the decision of the House of Lords in Weight v Salmon (1935) 19 TC 174, [1935] UKHL TC_19_174. That case concerned a situation where the managing director of a company had been allowed to subscribe for shares at par as a reward for successful performance. The position where an employee is granted a conditional share option was considered by the House of Lords in Abbott v Philbin [1961] AC 352. That was a case where a company’s senior employees had been given an option to subscribe for its shares at the then current market price, the option being exercisable at any time within the next ten years. The employees were thus incentivised to increase the company’s prosperity. The option was non-transferable and would expire on the employee’s death or retirement. It was held that income tax was chargeable on the realisable monetary value of the option at the date of its acquisition, rather than on the value realised when it was subsequently exercised, as the Revenue had argued. Lord Reid said at p 376:
“I can sum up my view by saying that conditions and restrictions attached to or inherent in an option may affect its value, but are only relevant on the question whether the option is a perquisite if they would in law or in practice effectively prevent the holder of the option from doing anything when he gets it which would turn it to pecuniary account.”
12. Part 7, as amended, was considered by this court in Grays Timber Products Ltd v Revenue and Customs Comrs [2010] UKSC 4; [2010] 1 WLR 497. That case concerned Chapter 3D of Part 7, but, in a judgment with which the other members of the court agreed, Lord Walker discussed the wider context. As he explained, the provisions of Part 7 reflect three different legislative purposes. Those purposes have already become clear from the discussion of the historical background:
“4. ... First there is Parliament’s recognition that it is good for the economy, and for social cohesion, for employees to own shares in the company for which they work. Various forms of incentive schemes are therefore encouraged by favourable tax treatment ...
5. Second, if arrangements of this sort are to act as effective long-term incentives, the benefits which they confer have to be made contingent, in one way or another, on satisfactory performance. This creates a problem because it runs counter to the general principle that employee benefits are taxable as emoluments only if they can be converted into money, but that if convertible they should be taxed when first acquired. That principle was stated by Lord Radcliffe in Abbott v Philbin [1961] AC 352, 379 ...
6. The principle of taxing an employee as soon as he received a right or opportunity which might or might not prove valuable to him, depending on future events, was an uncertain exercise which might turn out to be unfair either to the individual employee or to the public purse. At first the uncertainty was eased by extra-statutory concessions. But Parliament soon recognised that in many cases the only satisfactory solution was to wait and see, and to charge tax on some ‘chargeable event’ (an expression which recurs throughout Part 7) either instead of, or in addition to, a charge on the employee’s original acquisition of rights.
7. That inevitably led to opportunities for tax avoidance. The ingenuity of lawyers and accountants made full use of the ‘wait and see’ principle embodied in these changes in order to find ways of avoiding or reducing the tax charge on a chargeable event, which might be the occasion on which an employee’s shares became freely disposable (Chapter 2) or the occasion of the exercise of conversion rights (Chapter 3). The third legislative purpose is to eliminate opportunities for unacceptable tax avoidance. Much of the complication of the provisions in Part 7 (and especially Chapters 3A, 3B, 3C and 3D) is directed to counteracting artificial tax avoidance.”
In the only other judgment delivered in that case, Lord Hope commented at para 56 that “if there is any theme in the Act it is one of anti-avoidance and the closing down of perceived tax loopholes”.
The provisions of Chapter 2
“(a) shares in any body corporate (wherever incorporated) ...
(b) debentures, debenture stock, loan stock, bonds, certificates of deposit and other instruments creating or acknowledging indebtedness …”
In terms of section 420(5), the following (amongst other things) are not “securities”:
“(b) money and statements showing balances on a current, deposit or savings account …”
“(1) For the purposes of this Chapter employment-related securities are restricted securities or a restricted interest in securities if -
(a) there is any contract, agreement, arrangement or condition which makes provision to which any of subsections (2) to (4) applies; and
(b) the market value of the employment-related securities is less than it would be but for that provision.”
16. In relation to section 423(1)(a), it is argued on behalf of the banks in the present appeals that the shares in question are “restricted securities” by virtue of section 423(2). It provides:
“This subsection applies to provision under which
(a) there will be a transfer, reversion or forfeiture of the employment-related securities, or (if the employment-related securities are an interest in securities) of the interest or the securities, if certain circumstances arise or do not arise;
(b) as a result of the transfer, reversion or forfeiture the person by whom the employment-related securities are held will cease to be beneficially entitled to the employment-related securities, and
(c) that person will not be entitled on the transfer, reversion or forfeiture to receive in respect of the employment-related securities an amount of at least their market value (determined as if there were no provision for transfer, reversion or forfeiture) at the time of the transfer, reversion or forfeiture.”
17. Section 424 sets out a number of exceptions. It is relevant to note subsections (b) and (c):
“Employment-related securities are not restricted securities or a restricted interest in securities by reason only that any one or more of the following is the case -
…
(b) that person [ie, the person by whom they are held] may be required to offer for sale or transfer the employment-related securities on the employee ceasing, as a result of misconduct, to be employed by the employer or a person connected with the employer, or
(c) the employment-related securities (or the securities in which they are an interest) may be redeemed on payment of any amount.”
Other Chapters
The schemes in outline
24. Before considering in detail the facts of the individual appeals, it may be helpful to explain briefly how, in broad terms, schemes of the kind in issue were designed to work. The modus operandi can be summarised as follows. The bank decided to award discretionary bonuses to certain of its employees, but to pay the amount of the bonuses into a scheme designed to take advantage of the provisions of Chapter 2, so that the employees would avoid liability to income tax. Rather than paying the bonuses directly to the employees, the bank instead used the amount of the bonuses to pay for redeemable shares in a special purpose offshore company set up solely for the purpose of the scheme. The shares were then awarded to the employees in place of the bonuses. Conditions were attached to the shares which were intended to enable them to benefit from the exemptions from income tax conferred by sections 425(2) and 429. Once the exemptions had accrued, the shares were redeemable by the employees for cash. Employees resident and domiciled in the United Kingdom, who were liable to capital gains tax, could however defer the redemption of their shares until they had held them for two years, by which time the rate of tax chargeable, with the benefit of business taper relief, was only 10%.
25. A typical scheme therefore involved carrying out the following pre-ordained steps:
(1) The bank decided which of its employees would receive discretionary bonuses, and the amount of those bonuses.
(2) Company Z was created in an offshore jurisdiction. Care was taken that Company Z was not an associated company of the bank for the purposes of section 429.
(3) A special class of redeemable shares in Company Z was created. As shares, these were “securities” as defined in section 420(1)(a). The shares were subject to a short-term restriction designed to satisfy the requirements of section 423(2).
(4) The restriction involved a contingency which was unlikely to occur but might conceivably do so. In cases where the occurrence of the contingency lay beyond the control of those involved in the scheme, hedging arrangements were entered into so that the employees were compensated in the event of the restriction being activated.
(5) Directly or indirectly, the bank paid the aggregate amount of the bonuses to Company Z as the price of the shares.
(6) The purchaser received the shares and allocated beneficial interests to the employees identified at step (1) in amounts equal to the amounts that the bank had decided to award them as bonuses. Exemption from a charge to income tax on the employees’ acquisition of the shares was asserted under section 425(2), on the basis that the shares were restricted securities by virtue of section 423(2).
(7) A short time later, the restriction was removed from the shares. Exemption from a charge to tax on this event was asserted under section 429.
(8) A short time after that, the employees became entitled to redeem their shares, and many did so. No liability to income tax arose by reason of the redemption.
(9) Some employees who were resident and domiciled in the UK continued to hold their shares for the two years necessary to mitigate a charge to capital gains tax using taper relief. They then redeemed their shares.
(10) In due course Company Z was wound up.
The UBS case
27. During the tax year 2003/2004 UBS AG, a well-known bank, devised an employee bonus scheme which was designed to take advantage of the provisions of Chapter 2 as explained above. It had no purpose other than tax avoidance, and such consequential advantages as would flow from tax avoidance. The scheme involved the carrying out of a number of pre-ordained steps according to a detailed timetable. Once the structure of the scheme had been finalised, a brochure was sent to the employees explaining it in detail and inviting their participation. 426 employees agreed to participate. Some of the documentation required under the scheme, such as board minutes of the vehicle company, was pre-drafted. The scheme was then implemented as planned.
28. On 23 January 2004 UBS agreed which of its employees were to be awarded a discretionary bonus for the tax year 2003/2004, and the amount of their bonuses. On 28 January, UBS subscribed £91,880,000 (£1,000 per share) for 91,880 non-voting shares in a company called ESIP Ltd, incorporated in Jersey a few days earlier for the purposes of the scheme. That sum was the equivalent of the cash payments which the employees would otherwise have received as cash bonuses. The following day UBS awarded 91,856 shares to the employees who had agreed to participate, in amounts corresponding to the amounts of their bonuses, and the remaining shares to trustees of a UBS employee benefit trust. The employees were notified of the face value of their awards. ESIP was required, as a condition of UBS’s subscription for the shares, to deposit the subscription price in an interest-bearing account until 20 February 2004.
30. Article 2(14) provided for an immediate and automatic sale of the shares to the UBS employee benefit trust if on any date during the three week period from 29 January to 19 February 2004 the closing value of the FTSE 100 Index exceeded a “trigger level”, defined as 6.5% above its closing value on 28 January. In that event, the shares were to be sold for a price equal to 90% of their market value on the date of the sale “if no restrictions (including for the avoidance of doubt under [article 2(14)]) applied to those shares”. It was not likely that the FTSE 100 would exceed the trigger level during the relevant period, but there was a genuine possibility that it might: the trigger level was set so as to create a probability of between 6 and 12%. It is a matter of agreement that the forced sale provision had the effect of reducing the market value of the shares when they were acquired by the employees by an amount which was more than de minimis.
32. As a condition of UBS’s subscription for the shares, ESIP applied about 3% of the £91,880,000 in purchasing call options from UBS relating to the FTSE 100 with an expiry date of 20 February 2004. The effect of the call options was that, if the FTSE 100 exceeded the trigger level, ESIP would make a gain, resulting in an increase of about 10% in its net assets. It followed that, if the forced sale provision were triggered, although the employees would be required to sell their shares for 90% of their unrestricted market value, they would not be materially worse off as a result, since the unrestricted market value of the shares would be equal to approximately 110% of the value they would have had if the trigger event had not occurred. The amount they would receive would thus be approximately equivalent to the original subscription price, which in turn was equal to the cash bonuses which the employees would otherwise have received. The words “not be materially worse off” are taken from the agreed statement of facts and issues. More precisely, the First-tier Tribunal found that the effect of the hedging was that, if the trigger event occurred, the employees would receive 99.2% of the value which their shares would otherwise have had. There was a remote possibility that the employees might even receive slightly more than 100%.
“The aim was at first that there should be a complete offset between the loss to an employee if the trigger event occurred with the result communicated to senior management that there would be no reduction in value in the payout to the employee. He or she would receive the same whether or not the trigger event occurred. At some point someone thought a deliberate near miss was better than an exact hit in terms of offsetting the loss. As the trigger event did not occur, this was not tested ... [T]he reality was that the scheme as a whole was carefully designed so that employees could not suffer any significant loss if the trigger event was realised. The reality of the risk was that an employee stood about a 10% chance of losing 0.8% of the bonus amount to be weighed against the opportunity to remove a 41% tax charge.” (para 105)
34. The First-tier Tribunal summarised the effect of the scheme as follows, at para 135:
“The effect was that, at the close of the relevant period, ESIP Ltd would either have shares unaffected by the trigger event, or shares affected by the trigger event plus the benefits from the options. The scheme was originally so constructed that the values of the beneficial interests of individuals in the shares would have been the same under either of those two outcomes. This was then altered to create a small ‘loss’. The effect of the trigger event was the reduction in the value of the [shares] by a predetermined amount. The options purchased were of such a value that the sums received under the options if the trigger event occurred totalled slightly less than the loss in the value of the shares, again by a predetermined amount. Both figures were artificial in the sense that neither was determined by, or could be influenced by, any event outside the control of those establishing the scheme, or could alter once the shares and options were purchased. UBS as employer and the individual recipients as employees knew from the start of the scheme that the employees, as shareholders, would receive the money paid in by UBS from one or both of the parallel elements a few weeks later save, in the unlikely occurrence of the trigger event, to a deliberately determined and insignificant extent.”
36. Once the relevant period had expired without a forced sale taking place, ESIP was required, as a further condition of UBS’s subscription for the shares, to buy shares in UBS during the last five days of February 2004, so that the value of each ESIP share was then linked to the performance of the UBS share price. On 26 February 2004 UBS reminded the employees of their entitlement to redeem the shares during the following month, and explained how to do so. On 22 March 2004, about 50% of the shares were redeemed for £977.50 per share. Almost all the remaining shares continued to be held by employees. Dividends were paid on the shares in November 2004 (£13 per share) and December 2005 (£20 per share). On 22 March 2006 and 22 June 2006, further shares were redeemed, for about £1,519 per share and £1,429 per share respectively, reflecting a large increase in the value of UBS shares. The remaining 44 shares were redeemed in November 2006 when a resolution was passed to wind up ESIP.
39. In considering whether the shares were “restricted securities” within the meaning of section 423, the First-tier Tribunal initially left to one side what has been described in these proceedings as the Revenue’s broad Ramsay argument (by reference to the case of W T Ramsay Ltd v Inland Revenue Comrs [1982] AC 300), to the effect that the scheme should be ignored and the employees held liable to income tax as if they had received cash payments directly. On that basis, it accepted that the scheme was an “arrangement” for the purposes of section 423(1)(a). It accepted that the forced sale provision was not a sham. It also accepted that the effect of that provision was to reduce the market value of the shares at the time of their acquisition by the employees by a small amount, so as to satisfy the requirements of section 423(1)(b). It did not, however, accept that it was an arrangement which made provision to which section 423(2) applied.
43. Returning to the decision of the First-tier Tribunal, it next considered whether, applying the Ramsay approach and on a realistic appraisal of the facts, the scheme fell outside the intended scope of Chapter 2 altogether. It concluded that it did. It observed that Chapter 2 was intended to deal with a real, practical problem, and that in examining whether the scheme was within Chapter 2 it was necessary, following the speech of Lord Nicholls of Birkenhead in Inland Revenue Comrs v Scottish Provident Institution [2004] UKHL 52; 2005 1 SC (HL) 33; [2004] 1 WLR 3172, to look at the commercial reality of what was happening, and to be alert to a situation where the arrangements, viewed realistically and as a whole, did not create restricted securities.
45. In short, but for the scheme, an employee would have received 59 from UBS if paid earnings, but under the scheme would probably receive 100, and in any event over 99. The scheme therefore delivered a significant gain in the bonus receivable by employees as compared with the receipt of earnings, whatever the outturn of the scheme arrangements, although there was the possibility of an insignificant difference as between the outturns under the probable and improbable alternatives. Further, if employees so chose, the timetable of the arrangements was much the same as applied to the receipt of earnings. The scheme had no purpose other than tax avoidance. In those circumstances, the scheme could not be regarded as one providing restricted securities within the scope of Chapter 2. It was in reality a mechanism for the payment of cash bonuses, and the employees should therefore be taxed as if they had received cash rather than securities.
46. The Upper Tribunal disagreed with the First-tier Tribunal’s conclusion. It observed that it was incorrect to say that the employees received the same sums when their shares were redeemed as they would have received as earnings: by that time, ESIP had invested its assets in UBS shares, with the result that the sums received reflected the performance of those investments. This had only a limited effect on those who redeemed their shares at the earliest opportunity, because of the short period of time during which the assets had been invested, but it had a greater effect on those who held their shares for longer: see para 36 above. The Upper Tribunal concluded that there was no intellectually coherent way of equating the payment in by the employer with the ultimate payment out to the employee. The scheme could not be treated as merely an artificially contrived method of paying money to employees. The Upper Tribunal therefore allowed UBS’s appeal.
47. The Court of Appeal agreed that the argument that the scheme should be treated as merely a mechanism for the payment of cash should be rejected. It also heard argument on a narrower Ramsay argument in respect of which the Revenue sought permission to appeal. That argument, which had been raised before the First-tier Tribunal but was not argued before the Upper Tribunal, proceeded on the basis that the ESIP shares were “securities”, but not “restricted securities” within the meaning of section 423, with the consequence that a charge to tax arose in respect of the market value of the shares at the time when they were acquired by the employees. The argument centred on UBS’s admission that the forfeiture condition had no commercial purpose and had been inserted purely for the purpose of tax avoidance, and on the contention that the hedging provisions rendered the forfeiture condition unreal from a commercial perspective.
The DB case
49. During the tax year 2003/2004 DB Group Services (UK) Ltd (“DB”), the main employer in the group headed by Deutsche Bank AG, another well-known bank, decided to pay discretionary bonuses to employees by means of a scheme designed to take advantage of the provisions of Chapter 2. This was an off-the-shelf scheme devised by Deloitte and Touche LLP and marketed by them to DB. Deloitte also played a central role in coordinating its implementation by all involved in accordance with a detailed timetable. The scheme was generically similar to the UBS scheme, but differed from it in some respects.
55. The case came before the First-tier Tribunal as an appeal from a determination that the sums allocated to the employees as bonuses at the start of the scheme were liable to income tax and national insurance contributions as earnings from their employment. The First-tier Tribunal heard the appeal immediately before that of UBS, and dismissed it.
56. The First-tier Tribunal again considered the case initially by leaving the Revenue’s broad Ramsay argument out of account. On that basis, it accepted that the shares were “securities”, on the same grounds as in the UBS case. It accepted that the forfeiture provision satisfied the requirements of section 423(1)(a), being one to which section 423(2) applied. The market value of the securities was less than it would be but for that provision, as required by section 423(1)(b). It followed that, leaving aside the wider challenge to the scheme, the shares met the definition of restricted securities by virtue of section 423(2).
58. In the view of the First-tier Tribunal, Parliament had not intended to provide the double exemption from income tax under sections 425 and 429 for artificial arrangements with no commercial purpose. It therefore concluded that the scheme was not within Chapter 2. As in the UBS case, it passed directly from that conclusion to a decision that the employees should be taxed as if they had received cash.
59. The Upper Tribunal heard the appeal together with that in the UBS case. It agreed that, leaving the Ramsay argument to one side, the shares were restricted securities qualifying for exemption under section 425. For similar reasons to those which it had given in the UBS case, however, it considered that the First-tier Tribunal had pushed the Ramsay principle well beyond permissible bounds. There was in its view no permissible construction of Chapter 2 which could lead to the conclusion that it was inapplicable to the facts of the case. It concluded, however, that notwithstanding the great pains which had been taken to ensure that Dark Blue was not formally controlled by DB, nevertheless actual control existed on the facts. DB was therefore an “associated company” of Dark Blue, with the consequence that the scheme did not qualify under section 429 for exemption from the charge imposed under section 426 on the lifting of the restrictive condition.
60. The Court of Appeal also heard the appeal together with that in the UBS case. It reversed the Upper Tribunal’s decision on the question of control, but agreed with it that the Revenue’s broad Ramsay argument should be rejected. As in the UBS case, it permitted the Revenue to present a narrower Ramsay argument to the effect that the shares were not “restricted securities” within the meaning of Chapter 2, so that the employees should be taxed on their receipt of the shares. That argument was however rejected for the same reasons as in the UBS case, and permission to appeal on that ground was refused.
The Ramsay approach
61. As the House of Lords explained in Barclays Mercantile Business Finance Ltd v Mawson, in a single opinion of the Appellate Committee delivered by Lord Nicholls, the modern approach to statutory construction is to have regard to the purpose of a particular provision and interpret its language, so far as possible, in the way which best gives effect to that purpose. Until the case of W T Ramsay Ltd v Inland Revenue Comrs [1982] AC 300, however, the interpretation of fiscal legislation was based predominantly on a linguistic analysis. Furthermore, the courts treated every element of a composite transaction which had an individual legal identity (such as a payment of money, transfer of property, or creation of a debt) as having its own separate tax consequences, whatever might be the terms of the statute. As Lord Steyn said in Inland Revenue Comrs v McGuckian [1997] 1 WLR 991, p 999, in combination those two features - a literal interpretation of tax statutes, and an insistence on applying the legislation separately to the individual steps in composite schemes - allowed tax avoidance schemes to flourish to the detriment of the general body of taxpayers.
“The capital gains tax was created to operate in the real world, not that of make-belief. As I said in Aberdeen Construction Group Ltd v Inland Revenue Comrs [1978] AC 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, there is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function.” (p 326)
“The essence of the new approach was to give the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. ... As Lord Nicholls of Birkenhead said in MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311, 320, para 8: ‘The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case.’”
As the Committee commented, this is a simple question, however difficult it may be to answer on the facts of a particular case.
64. This approach has proved to be particularly important in relation to tax avoidance schemes as a result of two factors identified in Barclays Mercantile at para 34. First, “tax is generally imposed by reference to economic activities or transactions which exist, as Lord Wilberforce said, ‘in the real world’”. Secondly, tax avoidance schemes commonly include “elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge”. In other words, as Carnwath LJ said in the Court of Appeal in Barclays Mercantile, [2002] EWCA Civ 1853; [2003] STC 66, para 66, taxing statutes generally “draw their life-blood from real world transactions with real world economic effects”. Where an enactment is of that character, and a transaction, or an element of a composite transaction, has no purpose other than tax avoidance, it can usually be said, as Carnwath LJ stated, that “to allow tax treatment to be governed by transactions which have no real world purpose of any kind is inconsistent with that fundamental characteristic.” Accordingly, as Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 52; (2003) 6 ITLR 454, para 35, where schemes involve intermediate transactions inserted for the sole purpose of tax avoidance, it is quite likely that a purposive interpretation will result in such steps being disregarded for fiscal purposes. But not always.
65. As was noted in Barclays Mercantile at para 35, there have been a number of cases since Ramsay in which it was decided that elements inserted into a transaction without any business or commercial purpose did not prevent the composite transaction from falling within a charge to tax, or bring it within an exemption from tax, as the case might be. Examples include Inland Revenue Comrs v Burmah Oil Co Ltd 1982 SC (HL) 114, Furniss v Dawson [1984] AC 474, Carreras Group Ltd v Stamp Comr [2004] UKPC 16; [2004] STC 1377, Inland Revenue Comrs v Scottish Provident Institution and Tower M Cashback LLP 1 v Revenue and Customs Comrs [2011] UKSC 19; [2011] 2 AC 457. In each case the court considered the overall effect of the composite transaction, and concluded that, on the true construction of the relevant statute, the elements which had been inserted without any purpose other than tax avoidance were of no significance. But it all depends on the construction of the provision in question. Some enactments, properly construed, confer relief from taxation even where the transaction in question forms part of a wider arrangement undertaken solely for the purpose of obtaining the relief. The point is illustrated by the decisions in MacNiven v Westmoreland Investments Ltd [2001] UKHL 6; [2003] 1 AC 311 and Barclays Mercantile itself.
“The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”
Scottish Provident
69. On the same date as Barclays Mercantile, Lord Nicholls also delivered the opinion of the Committee, similarly constituted, in the Scottish Provident case. The case concerned a scheme designed to take advantage of a change in the law governing the taxation of gains and losses made by mutual life offices on the grant or disposal of options to buy or sell gilts. Under the scheme, the life office, SPI, granted Citibank the option to buy a quantity of gilts from it at a “strike price” of 70, well below their anticipated market value at the time the option was exercised, in return for a premium. Under the law then in force, the premium was exempt from tax. After the law had changed, Citibank exercised the option, requiring SPI to sell the gilts to it at a loss. Under the law then in force, the loss was allowable for tax purposes. In order to ensure that no real loss could be suffered by either party, the scheme also provided for Citibank to grant an option to SPI, entitling it to buy a matching quantity of gilts from the bank at a strike price of 90, calculated so that the overall movements of money between the parties were equivalent. It was anticipated that both options would be exercised, but there was a possibility that they might not be. In the event, both options were exercised, and neither gilts nor money changed hands.
“22. ... the uncertainty arises from the fact that the parties have carefully chosen to fix the strike price for the SPI option at a level which gives rise to an outside chance that the option will not be exercised. There was no commercial reason for choosing a strike price of 90. From the point of view of the money passing (or rather, not passing), the scheme could just as well have fixed it at 80 and achieved the same tax saving by reducing the Citibank strike price to 60. It would all have come out in the wash. Thus the contingency upon which SPI rely for saying that there was no composite transaction was a part of that composite transaction; chosen not for any commercial reason but solely to enable SPI to claim that there was no composite transaction. It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme.
23. We think that it would destroy the value of the Ramsay principle of construing provisions such as [the provision in question] as referring to the effect of composite transactions if their composite effect had to be disregarded simply because the parties had deliberately included a commercially irrelevant contingency, creating an acceptable risk that the scheme might not work as planned. We would be back in the world of artificial tax schemes, now equipped with anti-Ramsay devices. The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned.”
The present appeals
Purposive construction
73. As counsel for UBS and DB emphasised, ITEPA contains no explanation of the purpose of Chapter 2 upon which a purposive interpretation might be based. Nor do its provisions anywhere indicate that restrictive conditions attached to securities purely for tax avoidance purposes fall outside the scope of Chapter 2. Furthermore, Parliament dealt with certain kinds of tax avoidance in Chapters 3A to 3D, but made no provision in respect of schemes of the kind with which these appeals are concerned. In the light of these considerations, and bearing in mind that Part 7 generally, and Chapter 2 in particular, are extensive and highly detailed, counsel argued that it was impossible to attribute to Parliament an unexpressed intention to exclude schemes of the present kind from the ambit of Chapter 2. It cannot be denied that these are forceful arguments, and the Court of Appeal found them persuasive.
(1) to promote employee share ownership, particularly by encouraging share incentive schemes;
(2) since such schemes require benefits to be contingent on future performance, creating a problem if tax is charged on the acquisition of the shares in accordance with Abbott v Philbin, to wait and see in such cases until the contingency has fallen away; and
(3) to counteract consequent opportunities for tax avoidance.
79. One answer which counsel for UBS and DB give to that argument is based on the supposed absence of any rationale for the exemption conferred by section 429. This point impressed the Court of Appeal: understandably so, since although these appeals are not directly concerned with section 429, the absence of any rationale for the exemption conferred by that provision would undermine an analysis based on the premise that Parliament possessed some rational intention in enacting sections 423 and 425.
The counter-argument based on Chapter 3A
81. As explained earlier, in arguing against a construction of Chapter 2 which would exclude tax avoidance schemes of the present kind, counsel for UBS and DB emphasised that Parliament had dealt expressly and in detail with tax avoidance in Chapters 3A to 3D, the first of those chapters being the most directly relevant to the present case. In those circumstances, it was argued, Parliament could not be taken to have had any wider, unexpressed, intention to counter tax avoidance. That argument was accepted by the Court of Appeal.
84. As was pointed out on behalf of UBS and DB, section 446B(3) presupposes that securities can be restricted securities for the purposes of section 425 even though their value has been reduced by measures taken as part of a tax avoidance scheme. That is indeed obvious. A share incentive scheme with performance-related conditions, for example, could fall within section 425, on the basis that the shares were restricted securities, even though the share price on the date of acquisition had been artificially depressed. Whether a condition attached to the shares renders them restricted securities, and whether the share price has been artificially depressed, are two separate questions. In other words, section 446B is concerned with the artificial manipulation of the market value of shares at the time of their acquisition by measures taken during the preceding seven years. It does not entail that all securities whose value has been reduced by tax avoidance measures are necessarily restricted securities. It has nothing to say about the circumstances in which the exemption conferred by section 425(2) should be granted, or specifically about the circumstances in which securities are to be treated as “restricted securities” as defined in section 423. That question depends on the proper interpretation and application of section 423. Mutatis mutandis, the same applies to the similar argument advanced by UBS and DB on the basis of section 446E, discussed at para 22 above.
Conclusion on purposive construction
Application to the facts
86. In the UBS case, the condition - whether the FTSE 100 rose by a specified amount during a three week period - was completely arbitrary. It had no business or commercial rationale beyond tax avoidance. Such a condition is simply not relevant to the application of section 423, if, for the reasons already explained, that section is concerned with “provision” having a genuine business or commercial purpose. Applying section 423 to the facts, viewed from a commercially realistic perspective, it follows that the condition to which the UBS shares were subject should be disregarded, with the consequence that the shares are not “restricted securities” within the meaning of that section.
87. That conclusion is fortified by another aspect of the facts of the UBS case. The economic effect of the restrictive condition was in any event nullified by the hedging arrangements, except to an insignificant and pre-determined extent (namely 0.8% at most - see para 32 above). The fact that what the First-tier Tribunal described as “a deliberate near miss” was designed into the scheme, rather than a complete offsetting of the risk, is immaterial. Paras 22 and 23 of the opinion in Scottish Provident, cited at para 70 above, are in point. As the Committee stated, the effect of the scheme should be considered as it was intended to operate. So considered, the benefit to the employee was not truly dependent on the contingency set out in the condition.
“... the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied.”
The proper basis of taxation: shares or cash?
92. In agreement with the Upper Tribunal and the Court of Appeal, I find this argument unpersuasive. In the first place, the employees actually received shares, not cash. Subject to one qualification, the vehicle companies did not hold cash. The qualification is that ESIP held cash during the period prior to 27 February 2004; but the cash was not at the disposal of the employees, since they could not redeem their shares until almost four weeks later. Throughout the intervening period, ESIP’s funds were invested in UBS shares. Dark Blue’s assets were invested in low-risk investments. In both cases, therefore, the realisable value of the shares depended on the performance of the assets in which the companies’ funds were invested, as shares normally do. The amount of cash for which the shares might be redeemed was neither fixed nor ascertainable when the shares were acquired, and was unlikely to be the same as the bonus which had initially been allocated to the employees. In the event, the difference turned out to be modest in the case of the employees who redeemed their shares at the earliest opportunity, but matters could have turned out differently.
93. I would not, however, attach the significance which the Upper Tribunal did to the fact that, in the case of the UBS employees who held their shares for longer, the redemption price diverged more widely from their initial bonus allocation. If the shares were properly treated as equivalent to cash on the first redemption date, that cash was then at the disposal of the employees, and their choice to leave it invested in shares could not affect that position.
94. If the shares were not restricted securities, their recipients therefore fall to be taxed in respect of their receipt of the shares in accordance with ordinary taxation principles. That is broadly as the Revenue contended in the narrower version of their argument, subject to one qualification. The Revenue argued that the shares should be valued for income tax purposes without regard to the restrictive conditions, since those conditions were not intended to be commercially relevant. I am unable to agree. The shares were subject to conditions which, as the First-tier Tribunal found, had the effect of reducing their value on the date of acquisition by a small amount (below the 10% threshold which would bring section 446B into play). Applying ordinary taxation principles, as laid down in Abbott v Philbin, the value of the shares has to be assessed as at the date of their acquisition, taking account of those conditions. To disregard the conditions would be to treat the employees as having received a more valuable perquisite than they actually received. It is however also necessary to take account of the call options purchased by ESIP out of the sum paid by UBS for its subscription for the shares. Since the options offset the risk to shareholders arising from the conditions, they presumably enhanced the value of the shares and are therefore relevant to the valuation of the perquisite received by the employees.
Money?
Conclusion