Macniven (Her Majesty's Inspector of Taxes) v. Westmoreland Investments Limited [2001] UKHL 6

House of Lords
[2001] UKHL 6
Between
Macniven (Her Majesty's Inspector of Taxes)AppellantWestmoreland Investments LimitedRespondent
Before
Lord Nicholls of BirkenheadLord HoffmannLord Hope of CraigheadLord HuttonLord Hobhouse of WoodboroughDate 8 February 2001
[1]On this appeal the Inland Revenue Commissioners pray in aid what is loosely called the Ramsay principle. This is a reference to the decision in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300. So it is necessary first to remind oneself what the House decided in that case. An initial point to note is that the very phrase 'the Ramsay principle' is potentially misleading. In Ramsay the House did not enunciate any new legal principle. What the House did was to highlight that, confronted with new and sophisticated tax avoidance devices, the courts' duty is to determine the legal nature of the transactions in question and then relate them to the fiscal legislation: see Lord Wilberforce, at [1982] AC 300, 326.[2]Ramsay brought out three points in particular. First, when it is sought to attach a tax consequence to a transaction, the task of the courts is to ascertain the legal nature of the transaction. If that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded. Courts are entitled to look at a pre-arranged tax avoidance scheme as a whole. It matters not whether the parties' intention to proceed with a scheme through all its stages takes the form of a contractual obligation or is expressed only as an expectation without contractual force.[3]This development had already been foreshadowed in the dissenting judgment of Eveleigh LJ in Floor v Davis [1978] Ch 295 and in decisions of the House in Inland Revenue Commissioners v Plummer [1980] AC 896 and Chinn v Hochstrasser [1981] AC 533. In Furniss v Dawson [1984] AC 474, 526, Lord Brightman set out his understanding of the rationale of this approach in these terms:
'In a pre-planned tax-saving scheme, no distinction is to be drawn for fiscal purposes, because none exists in reality, between (i) a series of steps which are followed through by virtue of an arrangement which falls short of a binding contract, and (ii) a like series of steps which are followed through because the participants are contractually bound to take each step seriatim. In a contractual case the fiscal consequences will naturally fall to be assessed in the light of the contractually agreed results. … Ramsay says that the fiscal result is to be no different if the several steps are pre-ordained rather than pre-contracted.'
[4]Second, this is not to treat a transaction, or any step in a transaction, as though it were a 'sham', meaning thereby, that it was intended to give the appearance of having a legal effect different from the actual legal effect intended by the parties: see the classic definition of Diplock LJ in Snook v London and West Riding Investments Ltd [1967] 2 QB 786, 802. Nor is this to go behind a transaction for some supposed underlying substance. What this does is to enable the court to look at a document or transaction in the context to which it properly belongs.[5]Third, having identified the legal nature of the transaction, the courts must then relate this to the language of the statute. For instance, if the scheme has the apparently magical result of creating a loss without the taxpayer suffering any financial detriment, is this artificial loss a loss within the meaning of the relevant statutory provision ? Thus, in Ramsay the taxpayer company sought to create an allowable loss to offset against a chargeable gain it had made on a sale-leaseback transaction. It sought to do so without suffering any financial detriment, by embarking on and carrying through a scheme which created both a loss which was allowable for tax purposes and a matching gain which was not chargeable. In rejecting the efficacy of this contrived 'loss-creating' scheme, Lord Wilberforce, at [1982] AC 300, page 326, observed that a loss which comes and goes as part of a pre-planned, single continuous operation 'is not such a loss (or gain) as the legislation is dealing with'. In Inland Revenue Commissioners v Burmah Oil Co Ltd (1981) 54 TC 200, 220, Lord Fraser of Tullybelton described this passage as the ratio of the decision in Ramsay .[6]As noted by Lord Steyn in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1000, this is an exemplification of the established purposive approach to the interpretation of statutes. When searching for the meaning with which Parliament has used the statutory language in question, courts have regard to the underlying purpose that the statutory language is seeking to achieve. Likewise, Lord Cooke of Thorndon regarded Ramsay as an application to taxing Acts of the general approach to statutory interpretation whereby, in determining the natural meaning of particular expressions in their context, weight is given to the purpose and spirit of the legislation: see [1997] 1 WLR 991, 1005.[7]The Ramsay principle or, as I prefer to say, the Ramsay approach to ascertaining the legal nature of transactions and to interpreting taxing statutes, has been the subject of observations in several later decisions. These observations should be read in the context of the particular statutory provisions and sets of facts under consideration. In particular, they cannot be understood as laying down factual pre-requisites which must exist before the court may apply the purposive, Ramsay approach to the interpretation of a taxing statute. That would be to misunderstand the nature of the decision in Ramsay . Failure to recognise this can all too easily lead into error. In particular, the much-quoted observation of Lord Brightman in Furniss v Dawson [1984] AC 474, 527, seems to have suffered in this way. Lord Brightman described, as the 'limitations of the Ramsay principle', that there must be a pre-ordained series of transactions, or a single composite transaction, containing steps inserted which have no business purpose apart from the avoidance of a liability to tax. Where those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes.[8]My Lords,[8]I readily accept that the factual situation described by Lord Brightman is one where, typically, the Ramsay approach will be a valuable aid. In such a situation, when ascertaining the legal nature of the transaction and then relating this to the statute, application of the Ramsay approach may well have the effect stated by Lord Brightman. But, as I am sure Lord Brightman would be the first to acknowledge, the Ramsay approach is no more than a useful aid. This is not an area for absolutes. The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case. Further, as I have sought to explain, Ramsay did not introduce a new legal principle. It would be wrong, therefore, to set bounds to the circumstances in which the Ramsay approach may be appropriate and helpful. The need to consider a document or transaction in its proper context, and the need to adopt a purposive approach when construing taxation legislation, are principles of general application. Where this leads depends upon the particular set of facts and the particular statute. I have already mentioned where this led in Ramsay . In Furniss v Dawson [1984] AC 474 it led to the conclusion that, within the meaning of the Finance Act 1965, the disposal of shares was in favour of Wood Bastow and not, as the taxpayer contended, in favour of Greenjacket. The present case[9]On the present appeal the relevant question is whether the transactions between the taxpayer, Westmoreland Investments Ltd, and the sole shareholders of its parent company, the trustees of the Electricity Supply Pension Scheme, constituted payments of interest within the meaning of section 338 of the Income and Corporation Taxes Act 1988. Westmoreland suffered badly in the commercial property slump of the 1970s. It borrowed heavily from the pension scheme trustees. By the late 1980s it owed the trustees over £70 million, including more than £40 million accrued interest. Its liabilities greatly exceeded its assets. All the liabilities were due to the pension scheme trustees.[10]As matters stood, Westmoreland was valueless. But it had one potential asset: its substantial accrued interest liability. Under section 338 payments of interest, other than interest on bank loans, may be set against profits, and any unused excess may be carried forward under section 75 of the Taxes Act 1988. If Westmoreland could pay to the pension scheme trustees the £40 million arrears of interest, the company would have value as a company with substantial established tax losses. Others might be interested in acquiring Westmoreland, and using it as a vehicle for making profits. The purchaser of Westmoreland could transfer income producing assets to Westmoreland and take advantage of Westmoreland's losses to shelter against tax any future profits on which tax would otherwise be payable.[11]But first Westmoreland had to pay the arrears of interest to the pension scheme trustees. Obviously, Westmoreland was quite unable to make any such payments out of its own resources, or to borrow money for this purpose from a third party. So, the trustees of the pension scheme, to whom Westmoreland was indebted, passed money round in a circle. The genesis of the scheme, and details of its implementation in three instalments, are set out in the judgment of Peter Gibson LJ at [1998] STC 1131, 1137-1139. For present purposes it suffices to note that the trustees loaned the necessary money to Westmoreland; Westmoreland used this in paying the outstanding arrears of interest to the trustees, having deducted tax for which it accounted to the Inland Revenue; and the trustees, as the trustees of a tax exempt superannuation scheme, reclaimed this tax from the Inland Revenue.[12]The Special Commissioners found that the steps involved in these transactions were genuine. There was no question of any of the steps being sham. Carnwath J held in favour of the Crown. The payments of interest in 1988 to 1990, made wholly out of money borrowed from the trustees, were not payments of interest for the purpose of section 338, and the commissioners were wrong to allow them as charges on income. The Court of Appeal, comprising Peter Gibson, Pill and Mummery LJJ, reversed the judge's decision.[13]My Lords,[13]I confess that during the course of this appeal I have followed the same road to Damascus as Peter Gibson LJ. Like him, my initial view, which remained unchanged for some time, was that a payment comprising a circular flow of cash between borrower and lender, made for no commercial purpose other than gaining a tax advantage, would not constitute payment within the meaning of section 338. Eventually, I have found myself compelled to reach the contrary conclusion. My reasons are as follows.[14]Section 338(1) provides, in short, that charges on income shall be allowed as deductions against profits in computing the corporation tax of a company. 'Charges on income' are defined in section 338(2) as 'payments of any description mentioned in subsection (3) below'. So far as relevant, subsection (3) provides that 'the payments referred to in subsection (2)(a) above are - (a) any yearly interest ...'. Prima facie, payment of interest in section 338 has its normal legal meaning, and connotes simply satisfaction of the obligation to pay. In the present case, Westmoreland's obligation to pay the accrued interest to the trustees was discharged by satisfaction. Thus, if the Inland Revenue are to succeed, payment in section 338 must bear some other meaning. Ultimately, applying in full the purposive Ramsay approach to interpretation, I can find no justification for giving payment in section 338 some other meaning. Moreover, I am unable to see what that other meaning could be.[15]I must elaborate a little. In the ordinary case the source from which a debtor obtains the money he uses in paying his debt is immaterial for the purpose of section 338. It matters not whether the debtor used cash in hand, sold assets to raise the money, or borrowed money for the purpose. Does it make a difference when the payment is made with money borrowed for the purpose from the very person to whom the arrears of interest are owed? In principle, I think not. Leaving aside sham transactions, a debt may be discharged and replaced with another even when the only persons involved are the debtor and the creditor. Once that is accepted, as I think it must be, I do not see it can matter that there was no business purpose other than gaining a tax advantage. A genuine discharge of a genuine debt cannot cease to qualify as a payment for the purpose of section 338 by reason only that it was made solely to secure a tax advantage. There is nothing in the language or context of section 338 to suggest that the purpose for which a payment of interest is made is material.[16]This is not surprising. Payments of interest, other than interest on a bank loan, have the advantageous tax consequence of constituting charges on income. But, hand in hand with this, they have the consequence that tax must be deducted from the payment and paid to the Inland Revenue. In the ordinary course, therefore, an exchange of cheques between creditor and debtor does not give rise to a tax advantage. The tax benefit of being able to treat the payment as a charge on income is offset by the obligation to account to the Inland Revenue for tax on the payment. This being so, there is no basis on which Parliament can be taken to have intended that payment in section 338 should bear some special meaning which would exclude the case where the interest debt is satisfied with money borrowed for the purpose from the creditor.[17]This is confirmed by noting that this, indeed, is not the feature which makes the Westmoreland transactions themselves unattractive to the Inland Revenue. The feature which makes the Westmoreland transactions unattractive to the Inland Revenue is different. It is the ability of the pension scheme trustees to reclaim the tax deducted by Westmoreland from the payments. But that is the consequence of the tax exempt status of the pension scheme. The concept of payment in section 338(3)(a) cannot vary according to the tax status of the person to whom the interest is owed.[18]For these reasons, and those set out in the speech of my noble and learned friend Lord Hoffmann, I would dismiss this appeal. I also agree with Lord Hoffmann's reasons for rejecting the three subsidiary points on which the Inland Revenue sought to place some reliance. Westmoreland's cross-appeal does not arise. LORD HOFFMANN My Lords, The issue[19]The question in this appeal is whether certain payments of interest made by a property investment company named Westmoreland Investments Ltd ("WIL") in the years 1988 to 1990 were "charges upon income" within the meaning of section 338 of the Income and Corporation Taxes Act 1988 and therefore allowable deductions in computing its profits or losses for the purposes of corporation tax. I speak of them as payments in the sense that there is no dispute that WIL transferred money to the lender and that its liability for interest was thereby discharged. As between the parties, the interest was paid. But the dispute between the taxpayer and the Crown is whether the interest was "paid" within the meaning of section 338. It arises because WIL paid the interest out of money which it had been lent by the lender for the specific purpose of enabling it to pay. The interest liability was replaced by a liability for an additional capital sum. The transaction was circular: WIL borrowed capital and paid it back as interest. And the only purpose of the transaction was to produce an allowable deduction for corporation tax. The Crown says that this does not count as a payment for the purposes of the Act. It must be disregarded under the principle in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300. The main issue in this appeal is therefore the meaning, scope and applicability of that principle. The Crown also says that the taxpayer's claim is defeated by three specific anti-avoidance provisions in the Taxes Act. I shall deal with these after considering the main point. The statutory provisions.[20]My Lords,[20]I set out first the relevant provisions of section 338 as it stood at the relevant time. It has since been substantially amended. "(1) . . . in computing the corporation tax chargeable for any accounting period of a company any charges on income paid by the company in the accounting period, so far as paid out of the company's profits brought into charge to corporation tax, shall be allowed as deductions against the total profits for the period… "(2) . . . 'charges on income' means for the purposes of corporation tax -(a) payments of any description mentioned in subsection (3) below. . . "(3) Subject to subsections (4) to (6) below, the payments referred to in subsection 2(a) above are - (a) any yearly interest . . . and(b) any other interest . . . payable in the United Kingdom on an advance from a bank carrying on a bona fide banking business in the United Kingdom… and for the purposes of this section any interest payable by a company as mentioned in paragraph (b) above shall be treated as paid on its being debited to the company's account in the books of the person to whom it is payable."[21]A company is therefore allowed a deduction in respect of bank interest immediately it is debited in the books of the bank. It does not matter whether the liability has been discharged or not. But other yearly interest is deductible only when it has been paid. Why the distinction? It reflects the difference in the way in which the Crown recovers tax from the recipient of the interest. In the ordinary case of yearly interest, the person who pays must deduct the tax and account to the revenue: see section 349(2). But this rule does not apply to banks: see section 349(3)(a). A person who pays interest to a bank does not deduct tax. The interest is part of the bank's trading income and must be brought into account in the computation of profits when it falls due and is debited to the borrower in its books. In both cases, therefore, the provisions of section 338 and 349 synchronise the payer's right to a deduction and Crown's right to treat the interest as a taxable receipt of the payee. The facts[22]My Lords,[22]the relevant facts can be briefly summarised. WIL was owned by the Electricity Supply Pension Scheme ("the scheme"), an approved superannuation scheme which is exempt from income tax. In the early 70's it used WIL as a vehicle for some very ill-advised property investments. These were financed by money lent to WIL by the scheme. After the final liquidation of its properties in 1988, WIL had virtually no assets and a huge indebtedness to the scheme. This included over £40 million arrears of interest.[23]It might have been thought that the scheme had no option but to allow WIL to go quietly into liquidation. But even in its moribund state, WIL was not without its attractions. There was at the time a market in companies with established tax losses. If profit-earning assets were transferred to such companies, they could avoid tax until they had exhausted the right of set-off against losses carried forward from the earlier years. People were prepared to pay for tax loss companies, which were on offer at a very substantial discount to the expected savings they could provide. The difficulty for the scheme was that although WIL's losses were only too real, they were partially represented in the company's accounts by unpaid arrears of interest. Under section 338, these sums became deductable only when paid. But WIL had no money with which to pay the interest and no assets upon which money could be raised.[24]The scheme therefore lent WIL the money with which to pay the interest. On 28 January 1988 it lent £20m, repayable "as and when the company is able" with interest at 2% over base rate. On the same day WIL paid the scheme £14,760,600 net of tax (representing a gross payment of £20,220,000 interest) and accounted to the Inland Revenue for £5,459,400 tax. If nothing more had happened, the Crown would no doubt have viewed matters with equanimity. Any deduction allowed to WIL, giving rise to established losses which could be set off against such profits as might be earned at some future date, would have been more than compensated by a solid and immediate payment of tax in the same amount. But the scheme was exempt from income tax and therefore entitled to reclaim the tax from the Inland Revenue. On 17 October 1989 and 3 January 1990 the exercise was repeated. The scheme made loans to WIL which it immediately used to pay arrears of interest due under the earlier loans, accounting to the Inland Revenue for tax which was then reclaimed by the scheme.[25]As a result of these transactions, the scheme was able to find a purchaser for the shares and loan debts of WIL. On 20 December 1990 a development company bought the shares for a nominal sum and the indebtedness of over £100m for 2p in the £. The scheme realised £2m for assets which otherwise would have been worth nothing. The findings of the Special Commissioners.[26]The Special Commissioners made the following findings:
"We find that all the loans made to WIL from 1980 onwards were real loans and WIL used them for real purposes, viz the discharge of real earlier outstanding loans and the payment of real accrued interest, temporary investment in part and the payment of income tax in pursuance of the statutory obligation in that behalf... We do not find that the interest free loans made by the scheme in 1988/89 and 1989/90 were different in character from the earlier loans…[A]s Mr Milne QC submits on behalf of WIL, the object of the refinancing was to crystallise the actual loss by paying interest which hitherto had merely been accrued and had not been paid. There is no question but that that accrued interest was real."
The Commissioners therefore held that the interest had been "paid" within the meaning of section 338(1) of the Act and gave rise to an allowable deduction. The case for the Crown[27]Mr McCall QC, who appeared for HM Inspector, said he did not challenge the findings of the Commissioners that the loans and payments were real in the sense that the interest debt was discharged and replaced by a loan. The transactions were not a pretence. But they had no commercial purpose. They were purely for the purpose of avoiding tax and therefore fell within the Ramsay principle. Under that principle, they should be disregarded. Whatever might be their legal effect as between the parties, the absence of a commercial purpose meant that they did not count as payments within the meaning of section 338. Ramsay : a principle of construction?[28]Everyone agrees that Ramsay is a principle of construction. The House of Lords said so in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991. But what is that principle? Mr McCall formulated it as follows in his printed case:
"When a court is asked (i) to apply a statutory provision on which a taxpayer relies for the sake of establishing some tax advantage (ii) in circumstances where the transaction said to give rise to the tax advantage is, or forms part of, some pre-ordinained, circular, self-cancelling transaction (iii) which transaction though accepted as perfectly genuine (i.e. not impeached as a sham) was undertaken for no commercial purpose other than the obtaining of the tax advantage in question then (unless there is something in the statutory provisions concerned to indicate that this rule should not be applied) there is a rule of construction that the condition laid down in the statute for the obtaining of the tax advantage has not been satisfied."
[29]My Lords,[29]I am bound to say that this does not look to me like a principle of construction at all. There is ultimately only one principle of construction, namely to ascertain what Parliament meant by using the language of the statute. All other "principles of construction" can be no more than guides which past judges have put forward, some more helpful or insightful than others, to assist in the task of interpretation. But Mr McCall's formulation looks like an overriding legal principle, superimposed upon the whole of revenue law without regard to the language or purpose of any particular provision, save for the possibility of rebuttal by language which can be brought within his final parenthesis. This cannot be called a principle of construction except in the sense of some paramount provision subject to which everything else must be read, like section 2(2) of the European Communities Act 1972. But the courts have no constitutional authority to impose such an overlay upon the tax legislation and, as I hope to demonstrate, they have not attempted to do so. Ramsay: the fountainhead[30]As is well known, the Ramsay case [1982] AC 300 was concerned with a tax avoidance scheme designed to manufacture a capital loss to set off against a capital gain. The question before the House was whether a transaction by which the taxpayer company acquired certain shares for £185,034 and almost immediately sold them for £9,387, gave rise to a "loss accruing on a disposal of an asset" within the meaning of section 23(1) of the Finance Act 1965. Both the acquisition and sale of the shares formed part of a pre-planned series of transactions by which the alleged loss was exactly balanced by a gain which was alleged to fall within an exemption from the charge. The aggregate effect was that the taxpayer suffered no loss except the payment of a fee to the promoters of the scheme.[31]It was not disputed that the transaction included a genuine purchase of the shares for £185,034 and a genuine sale of the same shares for £9,387. The taxpayer said that that was the end of the matter. To look at the transaction as a whole would be to commit the heresy condemned by Lord Tomlin in Inland Revenue Commissioners v Duke of Westminster [1936] AC 1, 19 as the "doctrine that the Court may ignore the legal position and regard what is called 'the substance of the matter". At first, the revenue agreed. Its attack on the scheme concentrated on whether the counterbalancing gain really was outside the charge to tax. In the House of Lords, however, Mr Millett QC argued that no loss within the meaning of the Act had accrued at all. The House accepted the argument. Lord Wilberforce said, at p 323, that while Lord Tomlin's statement was a "cardinal principle", it did not require a court to "look at a document or a transaction in blinkers". The capital gains tax was, see p 326: "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." (My emphasis).[32]My Lords,[32]it is worth pausing at this point to examine the characteristically compressed reasoning in a little more detail. A loss which arises at one stage of an indivisible process and cancelled out at a later stage of the same process is "not such a loss as the legislation is dealing with". The tax was not imposed "on arithmetical differences". In that case, what kind of loss was the legislation dealing with? The contrast being made throughout Lord Wilberforce's speech is between juristic or arithmetical realities on the one hand and commercial realities on the other. He is construing the words "disposal" and "loss" to refer to commercial concepts which are not necessarily confined by the categories of juristic analysis. In the Ramsay case [1982] AC 300, a director, or an accountant concerned to present a true and fair view of the taxpayer's dealings, would not have said that the company had entered into a transaction giving rise to a loss which happened to have been offset by a corresponding gain. There had never been any commercial possibility that the transactions would not have cancelled each other out. Therefore, notwithstanding the juristic independence of each of the stages of the circular transaction, the commercial view would have been to lump them all together, as the parties themselves intended, and describe them as a composite transaction which had no financial consequences. The innovation in the Ramsay case was to give the statutory concepts of "disposal" and "loss" a commercial meaning. The new principle of construction was a recognition that the statutory language was intended to refer to commercial concepts, so that in the case of a concept such as a "disposal", the court was required to take a view of the facts which transcended the juristic individuality of the various parts of a preplanned series of transactions. Commercial concepts in tax legislation[33]There is nothing new about terms used in tax legislation (or, for that matter, any legislation) being construed as referring to business or commercial concepts which may not be capable of being held within the confines of purely juristic analysis. A good example is the term "profits or gains of the year of assessment" which forms the basis of the charge to tax under Case I of Schedule D: see section 60 of the Income and Corporation Taxes Act 1988. In Sun Insurance Office v Clark [1912] AC 443, 455, Viscount Haldane said:
"It is plain that the question of what is or is not profit or gain must primarily be one of fact, and of fact to be ascertained by the tests applied in ordinary business."
[34]It is thus the statute itself which applies the tests of ordinary business. And for present purposes, the significant feature of applying a test of ordinary business is that it may require an aggregation of transactions which transcends their juristic individuality. In Southern Railway of Peru Ltd v Owen [1957] AC 334 the question was whether, in calculating its profits or gains for a year of assessment, a company could make a provision for severance pay contingently payable to its employees. The revenue argued that each contract of employment had to be separately examined and no liability could be taken into account unless it had fallen due. Lord Radcliffe rejected this approach, at p 357:
"The answer to the question what can or cannot be admitted into the annual account is not provided by any exact analysis of the legal form of the relevant obligation. In this case, as in the Sun Insurance case ([1912] A.C. 443), you get into a world of unreality if you try to solve your problem in that way, because, where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision."
[35]My Lords,[35]it seems to me that what Lord Wilberforce was doing in the Ramsay case [1982] AC 300 was no more (but certainly no less) than to treat the statutory words "loss" and "disposal" as referring to commercial concepts to which a juristic analysis of the transaction. treating each step as autonomous and independent, might not be determinative. What was fresh and new about Ramsay was the realisation that such an approach need not be confined to well recognised accounting concepts such as profit and loss but could be the appropriate construction of other taxation concepts as well. The American doctrine[36]Lord Wilberforce, while cautioning against a facile transposition of American decisions on different statutes, approved the approach of Judge Learned Hand in one of his many judgments dealing with tax avoidance schemes: Gilbert v Commissioner of Inland Revenue (1957) 248 F2d 399. Perhaps the seminal judgment was in Helvering v Gregory 69 (1934) F2d 809, affirmed (1935) 293 US 465, which concerned a scheme of great simplicity. The taxpayer was a stockholder in a corporation which held some shares which she wished to realise without paying tax on the gains. Instead of having the corporation sell the shares directly to the buyer, she caused it to incorporate a subsidiary and exchange the shares for an allotment of shares in the subsidiary. The subsidiary was put into liquidation and distributed the shares to the stockholder as a dividend. She then sold them to the buyer. She claimed that the exchange of shares fell within the tax exemption for a "reorganization" of capital. On the other hand, the exchange was real enough to constitute a realisation of the gain, so that no further gain was realised on the distribution to her. In the Court of Appeals (Second Circuit) Judge Learned Hand said, at p. 811, that the transfer to the subsidiary did not fall within the terms of the statutory exemption: "we cannot treat as inoperative the transfer of . . . shares by [A] [or] the issue of shares by [B] of its own shares… [B] had a juristic personality…All these steps were real, and, their only defect was that they were not what the statute means ." (My emphasis).[37]What, in that case, did the statute mean? The Supreme Court of the United States affirmed the decision in a single judgment delivered by Sutherland J "Reorganization", he said, meant a reorganization of the business of a corporation, having some business purpose. An exemption from tax could not be construed as applicable to a transaction with no business purpose except to obtain the exemption from tax. The Duke of Westminster's case[38]In the Ramsay case [1982] AC 300 both Lord Wilberforce and Lord Fraser of Tullybelton, who gave the other principal speech, were careful to stress that the House was not departing from the principle in the Duke of Westminster's case [1936] AC 1. There has nevertheless been a good deal of discussion about how the two cases are to be reconciled. How, if the various juristically discrete acquisitions and disposals which made up the scheme were genuine, could the House collapse them into a composite self-cancelling transaction without being guilty of ignoring the legal position and looking at the substance of the matter?[39]My Lords,[39]I venture to suggest that some of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster's case arises out of an ambiguity in Lord Tomlin's statement that the courts cannot ignore "the legal position" and have regard to "the substance of the matter". If "the legal position" is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business "substance" of the matter is not to ignore the legal position but to give effect to it. The real world.[40]The speeches in the Ramsay case [1982] AC 300 and subsequent cases contain numerous references to the "real" nature of the transaction and to what happens in "the real world". These expressions are illuminating in their context, but you have to be careful about the sense in which they are being used. Otherwise you land in all kinds of unnecessary philosophical difficulties about the nature of reality and, in particular, about how a transaction can be said not to be a "sham" and yet be "disregarded" for the purpose of deciding what happened in "the real world". The point to hold onto is that something may be real for one purpose but not for another. When people speak of something being a "real" something, they mean that it falls within some concept which they have in mind, by contrast with something else which might have been thought to do so, but does not. When an economist says that real incomes have fallen, he is not intending to contrast real incomes with imaginary incomes. The contrast is specifically between incomes which have been adjusted for inflation and those which have not. In order to know what he means by "real", one must first identify the concept (inflation adjustment) by reference to which he is using the word.[41]Thus in saying that the transactions in the Ramsay case were not sham transactions, one is accepting the juristic categorisation of the transactions as individual and discrete and saying that each of them involved no pretence. They were intended to do precisely what they purported to do. They had a legal reality. But in saying that they did not constitute a "real" disposal giving rise to a "real" loss, one is rejecting the juristic categorisation as not being necessarily determinative for the purposes of the statutory concepts of "disposal" and "loss" as properly interpreted. The contrast here is with a commercial meaning of these concepts. And in saying that the income tax legislation was intended to operate "in the real world", one is again referring to the commercial context which should influence the construction of the concepts used by Parliament. The Burmah case[42]There is no doubt that the Ramsay case [1982] AC 300 was widely regarded as some form of judicial legislation and the concerns of taxpayers about its true scope of and its relationship with the Duke of Westminster's case [1936] AC 1 were not set at rest by what some regarded as the proclamation of a revolutionary credo by Lord Diplock in Inland Revenue Commissioners v Burmah Oil Co Ltd (1981) 54 TC 200, 214-215:
"It would be disingenuous to suggest, and dangerous on the part of those who advise on elaborate tax-avoidance schemes to assume, that Ramsay's case did not mark a significant change in the approach adopted by this House in its judicial role to a pre-ordained series of transactions (whether or not they include the achievement of a legitimate commercial end) into which there are inserted steps which have no commercial purpose apart from the avoidance of a liability to tax which in the absence of those particular steps that have been payable.…[T]he approach to tax avoidance schemes of this character sanctioned by Ramsay entitles your Lordships to ignore the intermediate circular book entries and to look at the end result..."
[43]The Burmah case also concerned the question of whether the company had suffered a loss for the purposes of capital gains tax. As in the Ramsay case, it had produced a loss by a circular series of transactions which had no business purpose. A subsidiary owed it a substantial sum which it could not repay. As a bad debt on capital account, this would not have been an allowable loss. Burmah therefore invested the same amount in shares in the subsidiary, which used the money to repay the debt and then went into liquidation. Burmah recovered nothing on its share investment and claimed that it had thereby suffered a loss. The House of Lords held that this was not a loss caused by a disposal within the meaning of the Act. The transaction left Burmah no worse off than it had been before and merely purported to convert a bad debt into an allowable loss.[44]My Lords,[44]in retrospect the Burmah case is an entirely straightforward application of the construction which the Ramsay case gave to the concept of a disposal giving rise to a loss in the capital gains tax legislation, namely that it meant a loss in commercial terms and not a series of preplanned transactions which had no business purpose. From this construction it followed that, as Lord Diplock said, the House would "ignore the intermediate circular book entries and . . . look at the end result". Lord Diplock would have been the first to acknowledge that his remarks should be read in context. To "ignore" the intermediate stages of the transaction and look at the end result is something which follows logically from the decision to construe "disposal" and "loss" in a commercial sense which transcends the individuality of the "book entries". It is that decision, to give the statutory language such a construction, which I would regard as "the Ramsay principle". But I think that there may have been a tendency to construe Lord Diplock's statement of the consequences of applying the Ramsay principle to the particular provisions with which the House was concerned as if it were itself a general principle, applicable to all tax legislation. Of course such a construction could also be applied to other provisions of the taxing Acts, but this would depend upon their language and purpose. At any rate, the generalising tendency which I have described seems to me the most likely explanation of the proposition which Mr McCall has claimed to be the Ramsay principle in this appeal. Furniss v Dawson[45]My Lords,[45]in Furniss v Dawson [1984] AC 474 the Ramsay construction, which in the Ramsay case itself and the Burmah case had been used to interpret the concept of a disposal giving rise to a loss, was deployed for a different purpose. The difference is occasionally described by saying that whereas Ramsay was a circular transaction, Furniss was a linear transaction. The difference can conveniently be encapsulated in these metaphors, but I think it is more illuminating to concentrate on the question which the legislation required the House to answer. To explain what this was, it is first necessary to give a brief account of the facts. The Dawsons wanted to sell their shares in the family business to a company called Wood Bastow Holdings Ltd. But they wanted to postpone the payment of capital gains tax. So they formed an Isle of Man company ("Greenjacket") and exchanged their shares in the company owning the business for an allotment of shares in Greenjacket. The advantage of this transaction was that by paragraph 6 of Schedule 7 to the Finance Act 1965, a disposal of shares to Greenjacket in exchange for an allotment of its shares was treated as a reorganisation of share capital and by paragraph 4 of the same Schedule a disposal of shares forming part of a reorganisation was not treated as a disposal for the purposes of capital gains tax. By a preplanned transaction, Greenjacket then sold the shares to Wood Bastow for cash. But the Revenue claimed that there had been no "real" disposal to Greenjacket. It was merely a preplanned stage in a disposal from the Dawsons to Wood Bastow and fell outside the exception for a reorganisation of share capital.[46]Thus, while the question in the Ramsay case had been whether there was a disposal giving rise to a loss, the question in the Furniss case was whether the disposal had been to one person rather than another. But the House decided that the Ramsay construction, involving, as I have said, a commercial characterisation of the relevant concept, could be equally applied to the latter question. Greenjacket was merely an artificially introduced intermediate party which was never intended to own the shares for more than an instant. Commercially, therefore, the transaction was a transfer by the Dawsons to Wood Bastow in exchange for a payment to Greenjacket. In answering the statutory question: "To whom was the disposal made?" the fact that the shares were routed through Greenjacket was irrelevant.[47]The consequence of adopting this construction was spelled out by Lord Brightman [1984] AC 474, 527 in a passage which paraphrased what Lord Diplock had said in the Burmah case 54 TC 200 and has since been quoted many times. He stated the conditions under which the commercial nature of the transaction as a whole would transcend the juristic individuality of its parts:
"First, there must be a pre-ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (ie business) end. The composite transaction does, in the instant case; it achieved a sale of the shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay . Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax - not 'no business effect' . If those two ingredients exist, 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."
[48]My Lords,[48]this statement is a careful and accurate summary of the effect which the Ramsay construction of a statutory concept has upon the way the courts will decide whether a transaction falls within that concept or not. If the statutory language is construed as referring to a commercial concept, then it follows that steps which have no commercial purpose but which have been artificially inserted for tax purposes into a composite transaction will not affect the answer to the statutory question. When Lord Brightman said that the inserted steps are to be "disregarded for fiscal purposes", I think that he meant that they should be disregarded for the purpose of applying the relevant fiscal concept. In the Furniss case, this was the concept of a disposal by one person to another. For that purpose, and for that purpose only, the disposal to Greenjacket was disregarded. But that does not mean that it was treated, even for tax purposes, as if it had never happened. The payment by Wood Bastow was undoubtedly to Greenjacket and so far as this might be relevant for tax or any other purposes, it could not be disregarded.[49]For present purposes, however, the point I wish to emphasise is that Lord Brightman's formulation in the Furniss case, like Lord Diplock's formulation in the Burmah case, is not a principle of construction. It is a statement of the consequences of giving a commercial construction to a fiscal concept. Before one can apply Lord Brightman's words, it is first necessary to construe the statutory language and decide that it refers to a concept which Parliament intended to be given a commercial meaning capable of transcending the juristic individuality of its component parts. But there are many terms in tax legislation which cannot be construed in this way. They refer to purely legal concepts which have no broader commercial meaning. In such cases, the Ramsay principle can have no application. It is necessary to make this point because, in the first flush of victory after the Ramsay , Burmah and Furniss cases , there was a tendency on the part of the Inland Revenue to treat Lord Brightman's words as if they were a broad spectrum antibiotic which killed off all tax avoidance schemes, whatever the tax and whatever the relevant statutory provisions.[50]The distinction between commercial and legal concepts has also been drawn in other areas of legislation. So, for example, the term "financial assistance" in section 151 of the Companies Act 1985 has been construed as a commercial concept, involving an inquiry into the commercial realities of the transaction: see Burton v Palmer (1980) 2 NSWLR 878, 889-890; Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1. But the same is not necessarily true of other terms used in the same section, such as "indemnity". As Aldous LJ said in Barclays Bank Plc v British & Commonwealth Holdings Plc [1996] 1 WLR 1, 14:
"It was submitted that as the words 'financial assistance' had no technical meaning and their frame of reference was the language of ordinary commerce, the word 'indemnity' should be similarly construed. The fallacy in that submission is clear. The words 'financial assistance' are not words which have any recognised legal significance whereas the word 'indemnity' does. It is used in the section as one of a number of words having a recognised legal meaning."
I would only add by way of caution that although a word may have a "recognised legal meaning", the legislative context may show that it is in fact being used to refer to a broader commercial concept. Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991[51]In the McGuckian case a Republic of Ireland company called Ballinamore had substantial distributable reserves. The shareholders, Mr and Mrs McGuckian, wanted to receive this money but not to pay income tax on the dividend. So they entered into a scheme by which they first transferred their shares to an offshore trustee called Shurltrust. By a series of preplanned transactions, it then assigned the right to receive the dividend to a UK company called Mallardchoice in consideration of the payment of a sum equal to 99% of the expected dividend. Ballinamore then declared the dividend and paid it to Mallardchoice, which immediately paid 99% to Shurltrust.[52]The statutory question was whether Shurltrust had received income or capital. If it was income, the effect of various tax avoidance provisions concerning the transfer of assets abroad was that the payment would be deemed to be income of the McGuckians. If it was capital, the McGuckians would not be liable for tax. The McGuckians said that if Shurltrust had simply received the dividend, it would of course have been income. But Shurltrust did not receive the dividend. It received a payment from Mallardchoice which was a capital payment for an assignment of its right to income.[53]The Inland Revenue's argument, relying upon the formulation in the Furniss case [1984] AC 474 was that the assignment should be disregarded. The Northern Ireland Court of Appeal said (not, if I may respectfully say so, without justification) that one could not simply "disregard" the assignment. The payment of the money by Mallardchoice to Shurltrust was the consideration for the assignment and an integral part of that transaction. If the assignment had to be disregarded, one could not explain how Shurltrust had received any money at all.[54]It seems to me that the Crown caused unnecessary difficulties for itself in the McGuckian case by failing to notice that the question was different from that in Furniss v Dawson and therefore did not necessarily respond to precisely the same analysis. In the Furniss case the question was the identity of the disponee. In the McGuckian case it was the nature of the payment received by Shurltrust - capital or income? In the former case, it is reasonable to speak of the middle stage of a chain of disposals being "disregarded". In the latter case, it makes much less sense. The question was not whether the assignment should be disregarded but whether, from a commercial point of view, it amounted to an exchange of income for capital. Such exchanges usually have a commercial reality: the purchase or sale of an annuity, for example, is an exchange of capital for an income stream, involving a transfer of risk. But the transaction in the McGuckian case was nothing more than an attempt to relabel a sum of money. The fact that the assignment had no commercial purpose did not mean that it had to be disregarded. But it failed to perform the alchemy of transforming the receipt of a dividend from the company into the receipt of a capital sum from someone else. For the purpose of the fiscal concept at stake, namely the character of the receipt as income derived from the company, it made no difference.[55]My Lords,[55]I think that it was for these reasons that their Lordships in the McGuckian case went back to Lord Wilberforce's analysis in the Ramsay case [1982] AC 300 and tried to identify the principle of construction in play. Lord Steyn said that the decision marked a shift away from literalism to a "broad purposive interpretation" and from "formalistic insistence on examining steps in a composite scheme separately" to "a more realistic legal analysis": [1997] 1 WLR 991, 999-1000. Lord Cooke of Thorndon suggested, at p 1005, that it was:
"an application to taxing Acts of the general approach to statutory interpretation whereby, in determining the natural meaning of particular expressions in their context, weight is given to the purpose and spirit of the legislation."
[56]My Lords,[56]these are valuable insights and I respectfully suggest that particular attention should be paid to the way Lord Cooke of Thorndon dealt with the criteria stated by Lord Brightman in Furniss v Dawson :
"Lord Brightman spoke of certain limitations (a pre-ordained series of transactions including steps with no commercial or business purpose apart from the avoidance of a liability to tax). The present case does fall within these limitations, but it may be as well to add that, if the ultimate question is always the true bearing of a particular taxing provision on a particular set of facts, the limitations cannot be universals. Always one must go back to the discernible intent of the taxing Act. I suspect that the advisers of those bent on tax avoidance...do not always pay sufficient heed to the theme in the speeches in the Furniss case...to the effect that the journey's end may not yet have been found."
[57]I would only add that it is not only tax avoiders who may not pay sufficient heed to the necessity of concentrating on the application of the particular taxing provision to the particular facts. The Inland Revenue sometimes also fails to do so. The journey's end may be different because the journey itself is not the same. The limits of Ramsay .[58]The limitations of the Ramsay principle therefore arise out of the paramount necessity of giving effect to the statutory language. One cannot elide the first and fundamental step in the process of construction, namely to identify the concept to which the statute refers. I readily accept that many expressions used in tax legislation (and not only in tax legislation) can be construed as referring to commercial concepts and that the courts are today readier to give them such a construction than they were before the Ramsay case. But that is not always the case. Taxing statutes often refer to purely legal concepts. They use expressions of which a commercial man, asked what they meant, would say "You had better ask a lawyer". For example, stamp duty is payable upon a "conveyance or transfer on sale": see Schedule 13, paragraph 1(1) to the Finance Act 1999. Although slightly expanded by a definition in paragraph 1(2), the statutory language defines the document subject to duty essentially by reference to external legal concepts such as "conveyance" and "sale". If a transaction falls within the legal description, it makes no difference that it has no business purpose. Having a business purpose is not part of the relevant concept. If the "disregarded" steps in Furniss v Dawson [1984] AC 474 had involved the use of documents of a legal description which attracted stamp duty, duty would have been payable.[59]Even if a statutory expression refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax reasons. Business concepts have their boundaries no less than legal ones. Thus in two of the cases considered in Craven v White [1989] AC 398 the House was unanimously of the view that although there had been an initial disposal with no commercial purpose, except to lay the ground for an avoidance of tax if and when there should be a further disposal to a third party, the transactions were so separate in fact as well as in law as to make it impossible to treat them, even in a commercial sense, as a single disposal to the third party. The lapse of time between the two transactions, the lack of contemplation of any specific later disposal at the time of the first transaction, were commercial realities. The division of opinion in the House over how the third transaction should be categorised did not detract from the agreement that it had to fall within the statutory language.[60]Likewise the use of business concepts like "income" and "capital" may give the taxpayer a choice of structuring a commercial transaction so as to come within one concept or the other. As Lord Greene MR said in a celebrated passage in Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11, 16:
"In dealing with income tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted, tax will be payable. If the other method is adopted, tax will not be payable. It is sufficient to refer to the quite common case where property is sold for a lump sum payable by instalments. If a piece of property is sold for £1,000 and the purchase price is to be paid in ten instalments of £100 each, no tax is payable. If, on the other hand, the property is sold in consideration of an annuity of £100 a year for ten years, tax is payable. The net result from the financial point of view is precisely the same in each case, but one method of achieving it attracts tax and the other method does not."
[61]It follows that a transaction which, for the avoidance of tax, has been structured to produce, say, capital, and does produce capital in the ordinary commercial sense of that concept (unlike the payment in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991) cannot be "recharacterised" as producing income: see Commissioner of Inland Revenue v Wattie [1999] 1 WLR. 873. Tax mitigation and tax avoidance.[62]My Lords,[62]it has occasionally been said that the boundary of the Ramsay principle can be defined by asking whether the taxpayer's actions constituted (acceptable) tax mitigation or (unacceptable) tax avoidance. In Inland Revenue Commissioners v Willoughby [1997] AC 1071, 1079 Lord Nolan described the concept of tax avoidance as "elusive". In that case, the House had to grapple with what it meant, or at any rate what its "hallmark" was, because the statute expressly provided that certain provisions should not apply if the taxpayer could show that he had not acted with "the purpose of avoiding liability to taxation". The same question arises on the interpretation of the anti-avoidance provisions to which Lord Cooke of Thorndon referred in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1005. But when the statutory provisions do not contain words like "avoidance" or "mitigation", I do not think that it helps to introduce them. The fact that steps taken for the avoidance of tax are acceptable or unacceptable is the conclusion at which one arrives by applying the statutory language to the facts of the case. It is not a test for deciding whether it applies or not. If I may be allowed to repeat what I said in Norglen Ltd v Reeds Rains Prudential Ltd [1999] 2 AC 1, 13-14:
"If the question is whether a given transaction is such as to attract a statutory benefit, such as a grant or assistance like legal aid, or a statutory burden, such as income tax, I do not think that it promotes clarity of thought to use terms like stratagem or device. The question is simply whether upon its true construction, the statute applies to the transaction. Tax avoidance schemes are perhaps the best example. They either work ( Inland Revenue Commissioners v Duke of Westminster [1936] AC 1) or they do not ( Furniss v Dawson [1984] AC 474.) If they do not work, the reason, as my noble and learned friend, Lord Steyn, pointed out in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1000, is simply that upon the true construction of the statute, the transaction which was designed to avoid the charge to tax actually comes within it. It is not that the statute has a penumbral spirit which strikes down devices or stratagems designed to avoid its terms or exploit its loopholes."
The present case: the appeal to Carnwath J [1997] STC 1103[63]My Lords,[63]after what I fear was a lengthy analysis of the Ramsay principle I return to the present appeal. Carnwath J, who allowed an appeal from the Special Commissioners, said that the case was very much like Inland Revenue Commissioners v Burmah Oil Co. Ltd 54 TC 200. In that case, the transaction left Burmah no worse off than it had been before and merely purported to convert a bad debt into an allowable loss. Similarly in this case, said Carnwath J, the transaction made no difference to the scheme or WIL but merely purported to convert an unpaid interest debt into a payment which could be deducted. In so doing, he treated the passage in the speech of Lord Diplock which I have already quoted (and the similar passage in the speech of Lord Brightman in the Furniss case) as being of general application, irrespective of the nature of the concept to which the statute refers.[64]My Lords,[64]I can see that one could read these passages in such broad terms. But I do not think that it would be consistent with treating Ramsay as a principle of construction. In my opinion, what the Burmah case decided was that the statutory concept of a loss accruing upon a disposal has a business meaning and that the "disposal" and "loss" suffered by Burmah did not fall within it. To apply this reasoning to the present case, it would be necessary to construe the concept of payment in section 338 as having some business meaning other than the simple discharge of a debt. Otherwise one is not giving effect to the statutory language. The Court of Appeal [1998] STC 1131[65]The Court of Appeal unanimously allowed the appeal. Peter Gibson LJ said that the question of whether the interest in this case had been "paid" could not be solved by using the same technique as had been used to decide whether there had been a "loss" in the Burmah case:
"In other areas where fiscal legislation has provided for payment as an act significant for tax purposes and payment, within the meaning which the law would ordinarily give to it, has occurred, the courts have been reluctant to accept that the Ramsay principle required the fact of payment to be ignored."
(p 1144)[66]He referred to Cairns v MacDiarmid (1982) 56 TC 556, 576 and Customs and Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905. I shall return to these cases later. Peter Gibson LJ said there was nothing in the Taxes Act to suggest that "paid" should be construed to mean anything more than that the interest obligation had been discharged, wherever the money had come from. Pill LJ delivered a concurring judgment and Mummery LJ agreed. The concept of payment[67]My Lords,[67]payment of a debt such as interest ordinarily means an act, such as the transfer of money, which discharges the debt. It is accepted that in this case the interest debt was indeed discharged. So why did this not count as payment for the purposes of the Act? One of the difficulties which I have with the argument for the Crown is that I find the alternative concept of payment for which it contends completely elusive. It is easy to understand a commercial sense of a loss which treats as irrelevant the fact that one part of a composite transaction produced a loss which was never intended to be more than momentary and theoretical. But what is the commercial concept of payment of a debt which treats as irrelevant the fact that the debt has been discharged? Mr McCall does not contend that payment must involve a negative cash flow which is not compensated by a cash flow in the opposite direction. He accepts, for example, that many commercial refinancing operations discharge old debts and create new ones without any cash flow either way. Nor is there any apparent policy to be found in section 338 which would require a negative cash flow. Otherwise, why should bank interest be deductible without any payment at all? As I have already said, the only apparent reason for the insistence on payment of yearly interest is that payment gives rise to an obligation to deduct tax. In the present case, WIL complied with that obligation. The Crown's real complaint is that the scheme, as an exempt fund, was able to reclaim the tax. But this cannot be remedied by giving the word "paid" a different meaning in the case of a payment to an exempt lender. The word must mean the same, whatever the status of the lender.[68]What the Crown finds objectionable is the circularity of the cash flow combined with the fact that the transaction took place entirely for tax purposes. And I accept that for the purposes of some concepts used in tax legislation, these two features would stamp the transaction as something different from that contemplated by the legislature. For example, I have no doubt that Langley J was right when he recently decided in NMB Holdings Ltd v Secretary of State for Social Security (unreported) 14 July 2000 that a payment of bonuses to directors in the form of platinum sponge held in a bank, accompanied by arrangements under which they could immediately sell it for cash to the bank, was not a "payment in kind" which fell to be disregarded for the purpose of National Insurance Contribution. In commercial terms the directors were paid in money. It is obvious that such a transaction was not what the Social Security (Contributions) Regulations 1979 (SI 1979/591) contemplated as a payment in kind. But there can be equally little doubt that the bonuses were "paid" and, in the absence of some contrary context, I can see no reason not to treat them as paid when the directors were credited with platinum sponge and the employer's obligation to pay them was discharged. The authorities[69]My Lords,[69]like Peter Gibson LJ in the Court of Appeal, I think that the taxpayer's case is supported by the authorities in which the concept of payment in a tax case has been considered. Cairns v MacDiarmid 56 TC 556 concerned an artificial scheme in which the taxpayer (Mr Cairns) claimed to have paid £5,000 "annual interest" on a loan of £37,740 from his employer, Rossminster. The loan was in fact intended to last no more than four days. Mr Cairns gave Rossminster a cheque for £5,000 in exchange for its cheque for £37,740. Nourse J and the Court of Appeal held that the payment was not "annual interest" within the meaning of the Act. But the Crown also raised before Nourse J the question of whether the £5,000 could be said to have been "paid". He said, at pp 576-577:
"It is accepted by the Crown that the agreement between Mr Cairns and Rossminster was not a sham, but a genuine transaction having the legal effect which it was expressed to have. On that footing I cannot see that Mr Cairns ceased to 'pay' the £5,000 merely because he did so conditionally on receiving the £37,740 in exchange. If Mr Potter's argument was correct it might have surprising results in its application to other genuine transactions. For example, there must be many loans where interest is payable in advance and where there is either, as there was in this case, an exchange of cheques or, perhaps more frequently, a payment by the lender to the borrower of a net amount representing principal less the first instalment of interest. It would be very strange if in either of those cases there was not a payment of interest for the purposes of [the Taxes Act], and to say that there was not would in my judgment attach to the word 'pays' a significance which in the context it cannot possibly bear."
The other case to which Peter Gibson LJ referred was Customs and Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905. The question there was whether builders had received a "payment" in respect of a supply of services within the meaning of section 5(1) of the Value Added Tax Act 1983. That section provided that a supply of services was deemed to take place when the supplier received payment in respect of it. The facts were that in early 1984 a building company had entered into an agreement to erect a building but had not yet begun work. It was then announced in the March budget that with effect from 1 June 1984 the rate of VAT on building services would be increased from zero to the standard rate. To avoid payment of VAT, the customer paid the builder in advance. The builder then lent the money back to the customer on terms that it would be repayable only against architect's certificates for work done. The Commissioners of Customs and Exercise, relying on the Ramsay case [1982] AC 300, argued that there had been no payment within the meaning of the Act or that if it had been, it was for the purposes of tax avoidance and should be "disregarded". The Court of Appeal said that there wa[70]The revenue rely in the alternative upon three provisions which they say nullify the effect of the payment of interest. On all three I am in full agreement with the Court of Appeal and can therefore be very brief.

(a) Section 338(5)(a)

[71]This provides that a payment of interest under section 338(3) shall not be treated as a charge on income if it is "not ultimately borne by the company". There appears to be no case in which the meaning of this provision has been considered. It seems to contemplate some arrangement by which the burden of the interest payment is transferred to someone else. But there was no such arrangement in this case. The burden of the interest payment never shifted from WIL. The revenue submits that there was no burden because the interest payment was cancelled by the loan. This amounts to collapsing the two transactions and treating the interest as never having been paid at all. But this would be contrary to the findings of fact. Once it is accepted that the interest was paid, it seems to me that the burden of payment could only have been borne by WIL.

(b) Section 75(3)

[72]This provides that charges on income in a given accounting period can be carried forward to succeeding accounting periods only if they were paid "wholly and exclusively for purposes of the company's business." The revenue says that the interest payments were not paid for the purposes of the company's business but to make it more attractive to a purchaser. It was conceded that the loans upon which the interest was payable had been borrowed wholly and exclusively for the purposes of the company's business. The Special Commissioners said that one did not need to inquire into the purpose for which the taxpayer paid a legitimate debt which he had incurred for the purposes of his business. It is sufficient that the debt has been so incurred: see Hyett v Lennard [1940] 2 KB 180. Like the Court of Appeal, I can see no error in this reasoning.

(c) Section 787(1)

[73]This denies relief for payment of interest to a person who has paid pursuant to a scheme:
"such that the sole or main benefit that might be expected to accrue to that person from the transaction under which the interest is paid was the obtaining of a reduction in tax liability by means of any such relief."
[74]The revenue say that the interest was paid under a transaction from which the sole or main benefit which would accrue to WIL was the obtaining of a reduction in tax liability. Again, I have little to add to what the Court of Appeal said on this point. In my opinion it is plain that the "transaction under which the interest was paid" is the original loan and not the arrangements which enabled WIL to pay it.[75]I would dismiss the appeal. For the reasons given by my noble and learned friend Lord Hope of Craighead, I would also dismiss the cross-appeal. LORD HOPE OF CRAIGHEAD My Lords,[76]I have had the advantage of reading in draft the speech which has been prepared by my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons which he has given I too would dismiss the appeal.[77]The transaction with which your Lordships are concerned in this case, when taken as a whole, has an odd aspect and it invites careful scrutiny. The movement of funds from the Electricity Supply Pension Scheme to WIL, which it owned, as capital and back again to the Scheme as interest was undoubtedly circular. And each step in the transaction was obviously pre-ordained. Its purpose was to create a tax benefit to WIL without any loss to the Scheme, which was exempt from income tax. But for the exempt status which the Scheme enjoyed, the lender would have had to bear tax on the interest paid to it by WIL. For this reason the capital which WIL was able to obtain from the Scheme was unlikely to have been available to it from another source. Nevertheless the question which has to be resolved depends on the meaning of the words used in the statute which are said to allow the deduction. It is one of statutory interpretation. I would approach it without any preconceived notions as to whether this is a case of tax mitigation or of tax avoidance. The only relevant questions are:(1) the question of law: what is the meaning of the words used by the statute? and(2) the question of fact: does the transaction, stripped of any steps that are artificial and should be ignored, fall within the meaning of those words?[78]Section 338(1) of the Income and Corporation Taxes Act 1988 provides that there shall be allowed as deductions for the relevant accounting period "any charges on income paid by the company in the accounting period, so far as paid out of the company's profits brought into charge to corporation tax". Subsection (2)(a) of that section provides that "charges on income" means for the purposes of corporation tax "payments" of any description mentioned in subsection (3). Subsection (3)(a) states that the payments referred to in subsection (2) include "any yearly interest". Those are the provisions on which WIL's claim to an allowable deduction in the end depends. There is no question in this case of the taxpayer having to demonstrate that it has sustained a "loss" or achieved a "gain" in circumstances where the result of the transaction was to leave it in no different position from that which it was in before. Had that been the question, the issue, as in W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300, would have been whether at the end of the day there was a real loss or a real gain. But those are not the concepts which are used in the statutory provisions that are in issue in this case. They do not depend upon an assessment of the result of the transaction. They depend upon the taxpayer being able to demonstrate that a charge on income has been "paid" by the company.[79]The Special Commissioners found as a fact that the loans which were made by the Scheme to WIL were real loans. It is clear that, but for the loans, WIL could not have afforded to pay the interest which it owed to the Scheme. Nevertheless the fact is that the loans were made and the interest was paid. WIL's claim is therefore based upon transactions which have been found by the Special Commissioners to be genuine. There was no step that falls to be ignored because it was artificial. It cannot be said that there was no business or commercial reason for the interest to be paid. The payment reduced the amount of WIL's accrued liability to pay interest. It was received as interest in the hands of the payee. WIL's obligation to pay interest to that extent was discharged. Nothing was inserted into the transaction to make it appear to be different from what it was. It was a payment of yearly interest which was paid out of the company's profits for the relevant accounting period.[80]The question that has to be addressed in these circumstances relates, as Lord Steyn said in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 1001G, to the fiscal effectiveness of the transaction entered into by the taxpayer. The answer to the question is to be found in the words used by the statute. A course of action that was designed to defeat the intention of Parliament would fall to be treated as tax avoidance and dealt with accordingly. But one must discover first what the statute means. The ordinary principles of statutory construction must then be applied to the words used by Parliament which describe the effect of the transaction for tax purposes.[81]On this approach the case does not seem to me, in the end, to give rise to any real difficulty. The words "paid" and "payment" are to be construed according to their ordinary meaning. The question whether a payment has been made is a question of fact. That question has been answered by the findings made by the Special Commissioners. The evidence established to their satisfaction that a loan was in fact made by the Scheme to WIL and that WIL used that loan to pay interest to the Scheme. The interest was a charge on income because it was a payment of a description mentioned in section 338(3) of the 1988 Act. That point having been established, the rule in section 338(1) determines the fiscal effectiveness of the that transaction for the purposes of WIL's liability to corporation tax.[82]There remains for disposal WIL's cross-appeal. It was directed to WIL's alternative argument that an agreement which it entered into with the Inspector of Taxes under section 54 of the Taxes Management Act 1970 for the year ended 31 March 1988 determined not only the question what tax was payable in respect of the period covered by the assessment under appeal but also the amount of charges on income which were available for carry forward to subsequent accounting periods. Carnwath J rejected this argument: [1997] STC 1103, 1133. In the Court of Appeal, [1998] STC 1131, 1147A-B, Peter Gibson LJ said that it was unnecessary in the light of his conclusion on the inapplicability of the Ramsay principle for him to deal with it. However he thought it right to say, having heard full argument on the point, that in his judgment the judge was plainly right in rejecting the argument for the reasons given by him.[83]WIL returned to this issue in your Lordships' House. It is not an issue on which WIL need now rely, in view of your Lordships' decision that the appeal must be dismissed. Nevertheless the point was once again fully argued. I should like to make the following observations about it in order to explain briefly why I would dismiss the cross-appeal.[84]Section 54 of the 1970 Act provides:
"Subject to the provisions of this section, where a person gives notice of appeal and, before the appeal is determined by the Commissioners, the inspector or other proper officer of the Crown and the appellant come to an agreement, whether in writing or otherwise, that the assessment or decision under appeal should be treated as upheld without variation, or as varied in a particular manner or as discharged or cancelled, the like consequences shall ensue for all purposes as would have ensued if, at the time when the agreement was come to, the Commissioners had determined the appeal and upheld the assessment or decision without variation, had varied it in that manner or had discharged or cancelled it, as the case may be."
[85]In his letter of 29 September 1989, which he wrote under the heading "Year ended 31 March 1988", the Inspector of Taxes said:
"I have carefully considered the further information and your contentions and I am now prepared to accept your computation. The appeal is therefore determined under section 54 TMA 1970 in the sum of nil profits chargeable to Corporation Tax."
[86]Mr Milne QC submitted that it was important to bear in mind the context in which this agreement was reached. Section 75 of the 1988 Act required the figure of management expenses and charges on income to be determined for the accounting period in which they were incurred. One of the purposes of this exercise was to identify the amount of the excess to be carried forward to the succeeding accounting period. A determination of the amount of management expenses and charges on income for one accounting period automatically resulted in any excess being treated as expenses of management for the next. It would be absurd if, despite its determination by agreement for one accounting period, that figure had to be relitigated each year. Except in cases of manifest error, both parties to the section 54 agreement should be bound by the agreement that they had made.[87]The effect of a section 54 agreement is however to be found in the words of the statutory provision under which it is made. Section 54 states that the like consequences shall ensue for all purposes as would have ensued if the Commissioners had determined the appeal. The procedure for appeals forms part of the process which has been laid down by the statute for the assessment and collection of tax. Section 30A of the 1970 Act (as inserted by sections 196, 199 and Schedule 19 to the Finance Act 1994) provides that after the notice of assessment has been served on the person assessed, the assessment shall not be altered except in accordance with the express provisions of the Taxes Acts. Section 31 of the Act enables an appeal to be brought against an assessment within 30 days after it was issued to the General Commissioners or the Special Commissioners. Section 46(2) (has been amended by regulation 2(1) and Schedule 1 to the General and Special Commissioners (Amendment of Enactments) Regulations 1994 (SI 1994/1823.) As so amended it, provides that, save as otherwise provided in the Taxes Acts or in regulations under section 56B, the determination of the General Commissioners or the Special Commissioners in any proceedings under the Taxes Acts shall be final and conclusive. The effect of section 54 is to attach the same finality to the settling of appeals by agreement under that section as attaches to the determination of the appeal by the General Commissioners or the Special Commissioners.[88]In Caffoor v Income Tax Commissioner [1961] AC 584 the Board of Review constituted under the Ceylon Income Tax Ordinance 1932 had decided on an appeal by the appellants in respect of an assessment for the year 1949-50 that trust income was exempt from income tax on the ground that the trust was of a public character established solely for charitable purposes. When assessments to income tax were again made on the trust for the years 1950-51 to 1954-55, it was held that the respondent was not estopped by the decision of the Board of Review from challenging the appellants' claim to exemption for subsequent years. Lord Radcliffe, who delivered the judgment of the Board, said at p. 598:
"The critical thing is that the dispute which alone can be determined by any decision given in the course of these proceedings is limited to one subject only, the amount of the assessable income for the year in which the assessment is challenged. It is only the amount of that assessable income that is concluded by an assessment or by a decision on an appeal against it. . . Although, of course, the process of arriving at the necessary decision is likely to involve the consideration of questions of law, turning upon the construction of the Ordinance or of other statutes or upon the general law, and the tribunal will have to form its view on those questions, all these questions have to be treated as collateral or incidental to what is the only issue that is truly submitted to determination. . ."
[89]I would apply that reasoning to the present case. The Ceylon Ordinance was closely modelled on the legislation that applies in the United Kingdom. The purpose of an appeal under section 31 of the 1970 Act is to challenge the amount charged to tax by an assessment. The finality that attaches to the determination of the appeal by the General Commissioners or by the Special Commissioners or to the settling of the appeal by agreement relates only to the amount chargeable under that assessment. The question as to the amount of any reliefs carried forward to subsequent periods remains open for examination as the assessment for each subsequent period is issued. This is because the Taxes Acts do not provide any means by which that amount may be determined conclusively, whether by appeal or by agreement, for any period other than that to which the assessment relates.[90]For these reasons I would hold that an agreement made under section 54 has no wider effect upon the position of either party than that which has been provided for by the statute. As Carnwath J indicated, [1997] STC 1103, 1133E-F, the issue turns simply and solely upon the machinery which the Taxes Acts provide for determining the amount in question between the Commissioners and the taxpayer. That machinery is limited to determining conclusively the amount of tax chargeable for the year of assessment. It does not enable such determinations to be made, either on appeal or by agreement, as to the amounts of tax chargeable in future years. LORD HUTTON My Lords,[91]I have had the advantage of reading in draft the speeches of my noble and learned friends Lord Nicholls of Birkenhead and Lord Hoffmann. I agree that the appeal of the Crown should be dismissed for the reasons which they give, and I add a few observations of my own on the application of the Ramsay principle to the present case.[92]The submission of the Crown is that, applying the Ramsay principle, there have been no payments of yearly interest within the meaning of section 338(1) and (3) of the Income and Corporation Taxes Act 1988 because all that has taken place is a pre-ordained artificial circulation of funds, which had no commercial purpose apart from the gaining of a tax advantage. Accordingly the payments should be disregarded and do not constitute payments within the meaning of section 338.[93]I consider that an essential element of a transaction to which the Ramsay principle is applicable is that it should be artificial. The requirement that there must be artificiality, and the importance of distinguishing between the real world and the world of make-belief, between a real gain (or loss) and a contrived and unrealistic gain (or loss) have been stressed in a number of judgments of the House where the application of the Ramsay principle have been considered. In his judgment in Ramsay itself [1982] AC 300, 326D Lord Wilberforce said:
"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 Commissioners [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."
In Inland Revenue Commissiioners v Burmah Oil Co Ltd (1981) 54 TC 200, 221H Lord Fraser of Tullybelton stated:
"If the argument for Burmah is right, this would be one more case in which the taxpayer had achieved the apparently magic result of creating a tax loss that was not a real loss. In my opinion they have not achieved that result because, in the same way as in Ramsay's case, when the scheme was carried through to completion there was here no real loss and no loss in the sense contemplated by the legislation."
The same theme was stated by Lord Goff of Chieveley in Craven v White [1989] AC 398, 519F:
"What the courts have established, however, is that certain tax avoidance schemes, although not shams in the sense of not being what they purport to be, are nevertheless unacceptable because they embrace transactions which are not 'real' disposals or do not generate 'real' losses (or gains) and so are held not to attract certain fiscal consequences which would normally be attached to disposals or losses (or gains) under the relevant statute."
Lord Goff of Chieveley reiterated this theme in Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655, 681C:
"Unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed. These structures are designed to achieve an adventitious tax benefit for the taxpayer, and in truth are no more than raids on the public funds at the expense of the general body of taxpayers, and as such are unacceptable."
And in his speech in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 998C Lord Browne-Wilkinson laid emphasis on the need to identify artificial steps and said that under the Ramsay principle: "the statutory provisions are to be applied to the substance of the transaction, disregarding artificial steps in the composite transaction or series of transactions inserted only for the purpose of seeking to obtain a tax advantage. The question is not what was the effect of the inser[94]Therefore I turn to the facts of this case to see whether the Crown can contend that the payments of interest claimed as allowances by Westmoreland Investments Limited ("Westmoreland") are artificial or unreal or conjured out of the air. In my opinion they are not because the obligation undertaken by Westmoreland to pay interest on the sums it had been lent by the scheme trustees was a genuine one which existed in the real world.[95]The Special Commissioners found [1997] STC 1103, 1116G that:
"all the loans made to the taxpayer company from 1980 onwards were real loans and the taxpayer company used them for real purposes, viz the discharge of real earlier outstanding loans and the payment of real accrued interest…. "
Therefore by undertaking to pay the interest Westmoreland had incurred the economic burden which Parliament intended should give rise to the allowances given by section 338, and I consider that Westmoreland was entitled to take steps to obtain the advantage which Parliament gave to it in respect of that burden. As Lord Templeman said in Ensign Tankers (Leasing) Ltd v Stokes at page 676D:
"the taxpayer is entitled to any reduction in tax which Parliament has attached to each transaction."
This was not a case, as in Inland Revenue Commissioners v McGuckian , where a tax payer was on the point of incurring a tax liability and took an artificial step to avoid the liability: rather this was a case where Westmoreland had incurred a genuine loss for tax purposes and then took a step to enable it to claim the tax allowance for that loss. Accordingly I am in respectful agreement with Peter Gibson LJ ([1998] STC 1131, 1143B) that:
"In the present case the accrued interest liability was real and always possessed the potentiality of being converted into a charge on income by payment. What occurred was the crystallisation of the tax loss through payment of the accrued interest."
[96]The fact that in order to pay the accrued interest so as to claim the allowances given by section 338 Westmoreland had to use money lent to it by the trustees of the scheme who had lent it the capital sums on which the interest was to be paid, does not mean, in my opinion, that the payment of the interest was not a genuine payment. In Ensign Tankers (Leasing) Ltd v Stokes [1989] 1 WLR 1222, 1241, Millett J stated:
"Money raised by borrowing belongs to the borrower. It is as much his money as any other money of his. Expenditure is incurred by the taxpayer whatever the source of the finance with which he intends to meet it."
And in Customs and Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905, 921G Bingham LJ said:
"If the payments are to be disregarded the commissioners would, I think, have to show them to be a sham, and this they have not sought to do. If, as I have concluded, these were in law good contractual payments, then I do not think we are entitled to disregard their legal effect and treat them as something else."
[97]Therefore I consider that the payment of interest by Westmoreland was a real payment and not an artificial transaction, and accordingly that the Ramsay principle is not applicable to it. Accordingly I would dismiss the appeal. LORD HOBHOUSE OF WOODBOROUGH My Lords,[98]I agree that this appeal should be dismissed for the reasons given by my noble and learned friend Lord Hoffmann.

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