UK: Explainaway: Statutory Interpretation (Tax Newsletter, Summer 2011)

Last Updated: 17 November 2011
Article by John Watson, Alexander Cox, Paul Miller, Richard Palmer and Simon Swann

The First Tier Tribunal here looked at a capital gains mitigation scheme involving matching futures and, by construing the legislation purposively and looking at the transactions as a whole, determined that a loss suffered as a result of the reduction in value of shares was not allowable.

Transactions constituted a single and indivisible whole

This case is complicated by the fact that the taxpayers had a Plan A (which was not fully completed) and a Plan B for mitigating a capital gains liability arising from a share sale. Broadly, both involved group companies entering into two futures on matching but opposite terms, one of which would produce a loss and one a profit. The derivatives were based on movements in the FTSE and therefore it was not known which would create a loss and which a profit, nor what the quantum of the desired loss would be. However, it was hoped that the loss achieved would be sufficient to offset the taxable gain realised on the sale of the shares.

A review of anti-avoidance case law led inexorably to the "ultimate question" of "whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically". In doing so, one must ask whether the steps comprising the scheme constitute a single and indivisible whole and is it intellectually possible so to treat them?

Here, the contrast between Plan A and Plan B was interesting. In considering Plan A, no account could be taken of the intention to sell the company to a third party company that would be able to shelter the gain remaining after use of the derivative loss. Similarly, Plan B could not be taken into account as this was not contemplated until after the Plan A steps were executed. As a result, the gains and losses on the derivatives netted out and there was no reason to subsume the tax consequences of the derivatives within a wider context.

By contrast, the culmination of Plan B was a company (Quoform) with a reduced share value, giving rise to a loss when sold which offset the original capital gain. The increased value of the shares deriving from the matching gain on the other derivative contract was then extracted in a tax-free manner by the distribution of an interim dividend, leaving the group in a net loss position. The transaction here had to be looked at as a whole since the reduction in the value of the shares followed "inexorably" from the loss on the contract and it was "the very essence" of the scheme that an amount of loss (albeit indeterminate) would arise via FTSE movements of some sort. It was also of no practical likelihood that the shares in Quoform would not be disposed of.

Commercial risk and uncertainties do not prevent transactions being considered as a whole

The Tribunal noted that the transactions in this case were concerned with an end result, i.e. a gain or a loss, and it was a real loss not just an arithmetical difference. However, the prospect of the scheme not producing a loss was so remote as to be disregarded (any movement in the FTSE would give a loss somewhere) and the Tribunal did not accept that the taxpayer took any commercial risk. Even though the FTSE is affected by economic and commercial influences, the taxpayer was not exposed other than to the fees payable for the scheme and the risk that the loss would not be great enough to shelter all of the gain. "Its risk that the tax planning would not fully succeed in its aim was not a commercial risk. Furthermore it was a risk that the boards of the relevant companies were fully aware of, and accepted, in their decision to proceed with the scheme."

The fact that it was not known which of the derivatives would produce a loss was similarly not relevant. The making of a loss was pre-ordained regardless of there being two possible ways of this occurring and therefore it was intellectually possible to treat the transactions as a single and composite transaction. However, as noted in the context of Plan A, even where transactions "have no commercial purpose and are so closely linked as to form a pre-ordained series of transactions, this is not sufficient to enable the Ramsay principle to be applied so as to find that the true effect in law of those transactions is anything other than that they are ... individual derivative transactions on which gains and losses separately arise".

This is presumably the sort of scheme that Aaronson QC has in mind as the target of a GAAR. The outcomes of recent cases show that judges are more than capable of coming to the same result by way of statutory interpretation but if a clear and open statement of the approach to be taken to anti-avoidance can be made, it could help create more certainty in this area.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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