SPC00555

INHERITANCE TAX – relief for relevant business property -  deceased owned shares in a company which lent money to other related family companies some of which invested in property – whether the business carried on by the company which made the loans consisted wholly or mainly of making or holding investments  - no – appeal allowed – IHTA 1984 s105(3)

THE SPECIAL COMMISSIONERS

PETER PHILLIPS, STACEY PHILLIPS AND JANICE PHILLIPS
THE EXECUTORS OF
RHODA PHILLIPS DECEASED
Appellants

-	and -

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS
Respondents

SPECIAL COMMISSIONER: Dr A N Brice

Sitting in London on 14 June 2006 

Peter Phillips FRICS, one of the Appellants, for all the Appellants

Colin Ryder, Assistant Director of the Capital Taxes Office, for the Respondents 

© CROWN COPYRIGHT 2006

DECISION

The appeal
1	Mr Peter Anthony Myles Phillips, Miss Stacey Andrea Mia Phillips and Miss Janice Marilynn Phillips (the Appellants) are the executors of Mrs Rhoda Phillips deceased (the deceased). They appeal against a Notice of Determination dated 7 October 2005 which was given by The Commissioners for Her Majesty’s Revenue  and Customs (the Revenue) under section 221 of the Inheritance Tax Act 1984 (the 1984 Act). 

2.	The Notice of Determination was in the following form:

“The Commissioners for Her Majesty’s Revenue and Customs have determined:

In relation to the deemed disposal for the purposes of inheritance tax on the death on 27 June 2001 of Mrs Rhoda Phillips (“the Deceased”), 

That the Deceased’s holding of 245,000 £1 ordinary shares in P P Investments Ltd was not relevant business property for the purposes of section 104 Inheritance Tax Act 1984, having regard to the requirements of section 105(3) of that Act.”

The legislation
3.	Section 104 of the 1984 Act provides that, where the whole or part of the value transferred is attributable to the value of any relevant business property, the whole or that part of the value transferred shall be treated as reduced by, in this appeal, 100%. Section 105 defines relevant business property and section 105(1)(bb) provides that the definition includes any unquoted shares in a company. However, section 105(3) provides that shares in a company are not relevant business property if the business carried on by the company consists wholly or mainly of making or holding investments.  

The issue
4.	At the date of her death the deceased held 245,000 £1 ordinary shares in P P Investments Ltd which was an unquoted company. The Appellants argued that the shares were relevant business property, and thus entitled to 100% relief, because the business carried on by P P Investments Ltd consisted entirely of the lending of money to related family companies and did not consist wholly or mainly of making or holding investments. The Revenue accepted that P P Investments Limited was carrying on a business but argued that the business consisted wholly or mainly of making or holding investments and so the shares held by the deceased were not relevant business property.

5.	Thus the issue for determination in the appeal was whether the business carried on by P P Investments Limited at the date of the death of the deceased consisted wholly or mainly of making or holding investments.  

The evidence 
6.	There was a statement of agreed facts. A bundle of documents was produced on behalf of the Appellants and another bundle was produced on behalf of the Revenue. Mr Peter Phillips, one of the Appellants who appeared on behalf of the Appellants, also gave evidence on their behalf. 

The facts
7.	From the evidence before me I find the following facts.

The eight related family companies
8.	Mr Philip Phillips, the father of the Appellants, was a valuer and estate agent. He started in business in the 1950s and over the years he acquired some companies and established others until, at the date of his death on 22 March 2000, he owned shares in eight related family companies. On his death all the shares he owned passed to his widow, the deceased. On the death of the deceased on 27 June 2001 her property passed to the Appellants as her executors. Mr Peter Phillips and Miss Stacey Phillips are the children of the deceased and Miss Janice Phillips is her step-daughter. 

9.	The eight related family companies established or acquired by Mr Philip Phillips were: 

(1)	A F Heath & Co (Builders) Limited. This company was established on 1 March 1945 and its principal activity is that of property dealing. As at 1 January 1990 there were 50 ordinary shares in issue of which 48 were held by Mr Philip Phillips and 2 were held by the deceased; they were both directors. In 1990 changes in the shareholdings took place and at 1 December 1993 there were 10,000 ordinary shares in issue of which Mr Philip Phillips held 2,502; the deceased held 2,500; Miss Stacey Phillips held 2,499 and Mr Peter Phillips held 2,499. All four were directors. No further changes took place until the death of Mr Philip Phillips when his shares passed to the deceased.  Relief for relevant business property was not claimed in respect of the deceased’s shareholding in this company.

(2)	P P Investments Limited. This is the company the shares of which are at issue in this appeal. It was established in 1958. The principal object of the company was stated in its memorandum of association at article 3(a) to be to acquire land and buildings for the purposes of investment only and with a view to receiving income. Article 3(h) provided that another object was to invest and deal with the moneys of the company not immediately required for the purposes of the company in or upon such securities and subject to such conditions as might seem expedient. Article 3(i) provided that another object was to lend money to such persons, upon such terms and with or without security and subject to such conditions as might seem desirable. The number of issued ordinary shares was 275,000. The deceased acquired 235,000 shares on the death of Mr Philip Phillips on 22 March 2000. At the date of her death the deceased owned  245,000 shares (89.09%) and Miss Stacey Phillips, Mr Peter Phillips and Miss Janice Phillips owned 10,000 shares (3.66%) each.  

(3)	Phillips (Family Properties) Limited. This company was established on 25 August 1959 and its principal activity is that of property investment. As at 1 January 1990 there were 100 ordinary shares in issue of which Mr Philip Phillips held 75 and Mr Peter Phillips held 25. In 1990 changes in the shareholdings took place until, on 8 April 1996, each of Mr Philip Phillips, the deceased, Mr Peter Phillips and Miss Stacey Phillips held 25 shares. No further changes took place until the death of Mr Philip Phillips when his shares passed to the deceased. All four shareholders were directors. Relief for relevant business property has not been claimed in respect of the deceased’s shareholding in this company. 

(4)	Crossmill Securities Limited. This company was established on 8 May 1972 and its principal activity is that of property dealing and investment. As at 1 January 1990 there were 10,000 ordinary shares in issue of which Mr Philip Phillips held one, the deceased held 3,333 and the remaining 6,666 were held jointly by the three Appellants. All five shareholders were directors. No changes were made before the death of Mr Philip Phillips when his share passed to the deceased. The Appellants agreed that the shareholding of the deceased in this company did not qualify for relief for relevant business property.

(5)	Philip Phillips & Co Ltd (the estate agency company) was incorporated on 20 February 1978. Its  principal activity is that of surveyors, valuers, auctioneers, estate agents and property dealers. As at 31 March 1998 there were 1,000,000 ordinary shares in issue of which Mr Philip Phillips held 235,000; the deceased held 350,000; Miss Stacey Phillips and Mr Peter Phillips held 200,000 each and a Ms Ingram held 15,000. All five shareholders were directors. On the death of Mr Philip Phillips his shares passed to the deceased. The Revenue agreed that relief for relevant business property at the rate of 100% applied to the shareholding of the deceased in this company.  

(6)	Brolaw Properties Limited. This is a property investment company about which I received very little evidence save that at the date of her death the deceased owned 50% of the shares.   

(7)	Kirphil Properties Limited. This is a property investment company. At the date of her death the deceased owned 75% of the shares and the rest were held by Miss Janice Phillips. 

(8)	Management Investments Limited. This company provided property  and management services to the other related family companies and ran an insurance agency. At the date of her death the deceased owned 60% of the shares with 20% being owned by each of Mr Peter Phillips and Miss Stacey Phillips. 

10.	Thus at the date of her death the deceased had the following interests in the shares of the eight companies:

A F Heath & Co (Builders) Limited				50.02%
P P Investments Limited 					89.09%
Phillips (Family Properties) Limited	 			50%
Crossmill Securities Limited   				33.34%
Philip Phillips & Co Limited (the estate agency company)  	58.5%
Brolaw Properties Limited  					50%
Kirphil Propreties Limited  					75%
Management Investments limited 				60%

11.	It will be seen that the eight companies, although not a formal group of companies, were related in the sense that they had shareholders and/or directors in common. However, each company was taxed and run separately. I accept the evidence of Mr Peter Phillips that Mr Philip Phillips was a self-made man and was autocratic; he wanted to keep control of his companies. Although, for example, he was not the majority shareholder in Crossmill Securities Limited the combined shareholding of the family was a controlling shareholding and Mr Philip Phillips made the decisions on behalf of all the family. 

The events of 1989
12.	By April 1989 P P Investments Limited held at least eighteen investment properties and possibly more. In the company’s accounts for the year ending on 5 April 1990 the properties were valued at a historical cost of £307,190. However, the business of Philip Phillips & Co Ltd (the estate agency company) was struggling; it was making losses and “there was no light at the end of the tunnel”. Although Mr Philip Phillips did not have to rely on any income received from the estate agency company the other directors and the executives of that company, including Miss Stacey Phillips, wanted to turn the estate agency company into a profitable business. 

13.	Accordingly in July 1989 Mr Philip Phillips decided to sell all the investment properties held by P P Investments Limited. Four were sold to independent third parties and fourteen were sold to the estate agency company for the sum of £450,000. The properties were valued by independent chartered surveyors and the amount of the purchase price payable by the estate agency company to P P Investments Limited was raised by loans. £300,000 was borrowed from Barclays Bank, who had a first charge on the properties transferred, and the remaining £150,000 was left outstanding as a loan by P P Investments Limited to the estate agency company.   

14.	At the time of the transfer of the fourteen properties to the estate agency company the properties were let to protected tenants and so the values were not open market values. The arrangement was that, as and when each property became available with vacant possession, the new owner (the estate agency company) would sell the property on the open market and repay part of the loan from Barclays Bank. When the whole of the loan from Barclays Bank had been repaid then the amount owing to P P Investments Limited would be repaid. Meanwhile no interest was charged to the estate agency company by P P Investments Limited until the loan from Barclays Bank had been repaid. 

15.	At the same time that he decided to sell fourteen of the investment properties held by P P Investments Limited to the estate agency company, Mr Philip Phillips also decided that P P Investments Limited would not invest in any other property but would continue to make loans to other related companies; it would become “a banking arm for in-house transactions” which was a phrase used by Mr Philip Phillips in a letter dated 24 April 1990 to the company’s accountants.  

16.	I accept the evidence of Mr Peter Phillips that the decisions made by Mr Philip Phillips in 1989 were not a strategy to avoid inheritance tax but were made in order to support the estate agency company. 

The business of P P Investments Limited since 1989
17.	Accordingly, since 1989 P P Investments Limited has not purchased or held any investment property but has only made loans. Shortly after 1989 two loans were made to individuals but otherwise all the loans made since that date were made to related companies. The accounts of P P Investments Limited showed that, in years after 1989, its only assets were cash at the bank and amounts owed to it, mainly by its related companies. Over the years loans to related companies increased and cash at the bank and in hand decreased in the following way: 

Year ending		Loans to related companies		Cash

30 April 1989 	 	£264,414  			£1,238,001  
30 April 1990 		£746,001			£   890,707.   
      30 April 1991		£526,142			£   792,452

As at 5 April 1994		£472,995			£   471,265		
As at 5 April 1995		£646,912			£   295,530
As at 5 April 1996		£858,907			£   117,615
As at 5 April 1997		£678,230			£   304,806
As at 5 April 1998		£902,063			£   185,546		
As at 5 April 1999		£943,792			£   121,479
As at 5 April 2000		£866,295			£   186,038
As at 5 April 2001		£762,964			£   305,572		
As at 5 April 2002		£775,083			£   323,218

18.	The loans made to the related companies by P P Investments Limited were made to finance the purchase by the related companies of property to be held as  investment. The loans were repayable at will and were very informal in character; they were only recorded by memoranda prepared by Mr Philip Phillips and/or letters to other persons, copies of which were kept on his file. For example, in 1998 Crossmill Securities Limited purchased a property in Westcliffe-on–Sea for £25,000. A memorandum prepared by Mr Philip Phillips appeared on the file; it stated that the purchase price had been funded through P P Investments Limited and that interest would be paid by Crossmill Securities Limited at 2.5% above base rate. Another example is that in 1998 A F Heath & Co (Builders) Limited purchased a flat in Sheringham for £19,500. The flat was the subject of a regulated tenancy. In a letter to another firm Mr Philip Phillips wrote that the purchase had been funded by a loan from P P Investments Limited and the interest payable was at the rate of 2.5% above the base rate. There was no charge on the property in favour of P P Investments Limited. A third example, which also relates to 1998, occurred when Mr Philip Phillips wrote to another firm about a property in Kettering and stated that it had been purchased by Crossmill Securities Limited and that the purchase had been financed by a loan from P P Investments Limited at a rate of interest of 2.5% above base rate; the title deeds were uncharged. 

19.	I accept the evidence of Mr Peter Phillips that the criteria for the making of each loan were whether the borrowing company could afford to make the interest payments and whether the value of the property to be purchased by the borrowing company was commensurate with the amount of the loan. Decisions about the making of loans were made by Mr Philip Phillips or the other directors. With each loan P P Investments Limited did not acquire any formal legal charge over any property purchased by the borrowing company, nor did it take a floating charge over the property of the borrowing company.  No other form of security or guarantee was provided and P P Investments Limited never owned any shares in the borrowing companies. 

20	P P Investments Limited always charged the borrowing companies interest at 2.5% above base rate. Monthly interest statements were usually prepared. P P Investments Limited did not have any employees. There was one single head office for all the related companies; all the files were kept there; all correspondence took place from there; and all banking and treasury functions were operated from there. 

The extent of the lending activity
21.	Very little lending activity appeared to take place from one year to another. In the year ending on 5 April 1998 twelve loans were outstanding from the following borrowers:

A F Heath & Co (Builders) Limited		3 properties and core lending	
Phillips (Family Properties) Limited	 	1 property and core lending
Crossmill Securities Limited   		4 properties
Philip Phillips & Co Limited 			Core lending only 
V Baker deceased 				One loan 

22.	No new loans were made in the years ending on 5 April 2000 or 2001 or in the period ending on 27 June 2001 although some repayments were made. At the date of the death of the deceased loans were outstanding from P P Investments Limited to the following companies in respect of the number of properties stated: 

A F Heath & Co (Builders) Limited		3 properties	
Phillips (Family Properties) Limited	 	1 property and core lending
Crossmill Securities Limited   		5 properties
Philip Phillips & Co Limited 			Core lending only 

23.	Of the loans outstanding at the date of death, the three loans to A F Heath & Co (Builders) Limited were in respect of two of the same properties as in 1998 and one new property; the loan to Phillips (Family Property) Limited was in respect of the same property as in 1998; and the five loans to Crossmill Securities Limited were in respect of three of the same loans as in 1998 with two new ones. 

24.	I was informed that core lending was the phrase used to refer to the loan of £150,000 made by P P Investments Limited in 1989 to enable the estate agency company to purchase the fourteen properties but it was not explained how this applied to the other companies   

The consumer credit licence
25.	On 21 June 1989 the Office of Fair Trading issued to P P Investments Limited a standard licence under the Consumer Credit Act 1974; the licence was valid for fifteen years. Subsequently two loans were made to individuals who were independent third parties. I accept the evidence of Mr Peter Phillips that there were no documents which recorded the strategy behind the loans to the two individuals. There was a possibility that Mr Philip Phillips had had the intention to lend to individuals on a wider basis, and for that reason had obtained the consumer credit licence, but the fact was that only two loans had been made to individuals, one of whom was a personal friend of Mr Philip Phillips. Each loan to an individual was written off when the borrower died. 

The descriptions in the directors’ reports
26.	Up to and including 1997 the directors’ reports of P P Investments Limited within the annual accounts recorded the principal activity of the company as “property investment”. From 1998 to 2002 this was amended to “property investment and providing finance”. 	

The treatment of the company for corporation tax purposes
27.	In 1999 there was correspondence between the Revenue and the auditors of P P Investments Limited about whether the company qualified for the small companies’ rate of corporation tax. On 6 December 2000 the Revenue accepted that “the company’s activities had changed and the company should no longer be treated as a close investment holding company”. The company was therefore treated, for corporation tax purposes, as a trading company from the tax year ending on 5 April 1998. 

The views of the Capital Taxes Office
28.	The deceased died on 27 June 2001 and probate of her will was granted on 22 April 2002 to the Appellants as her executors. On 1 April 2005 Mr Cartwright of the Capital Taxes Office wrote to the Appellants’ representatives to say that in the context of this company the loans were best regarded as investments. He would have taken a different view if the company had lent more widely so that the analogy with a bank could be more readily appreciated.  

Reasons for Decision
29.	The issue for determination in the appeal was whether the business carried on by P P Investments Limited at the date of the death of the deceased consisted wholly or mainly of making or holding investments. 

30.	Of the authorities cited by the parties I have been most assisted by Inland Revenue Commissioners v George and another [2004] STC 147. This is a judgment of the Court of Appeal which is binding on the Special Commissioners and not only does it concern inheritance tax but it also concerns section 105(3) of the 1984 Act. The issue in that appeal was whether a business which operated a caravan site consisted mainly of the making or holding of investments (which is not the issue in this appeal). The Court of Appeal held that it was not. The business was an active family business and there was no principle why it should be excluded from business property relief merely because it involved the use of land.  

31.	In his judgment Carnwarth LJ identified a number of principles. First, at [5], that the decision in a particular case is a matter of fact for the Special Commissioners. Next, at [12], that cases relating to different taxes and different subject matter are unlikely to be helpful. Also, at [12], that there can be a spectrum (in that case of the exploitation of land) at one end of which the business of a company could be that of investment but at the other end of which the facts would point away from a finding that a similar activity was investment. Then, at [13], that previous decisions of the Special Commissioner are generally distinguishable either on the facts or because the arguments were different. Fifthly, also at [13], that the business should be considered in the round and that there was no decisive factor which would indicate whether a business consisted “wholly or mainly” of the making or holding of investments (although that is not the issue in the present appeal). The remainder of the judgment dealt with the facts of the particular appeal, which are not relevant in this appeal, save that it is interesting to note from [31] and [32] that it appeared to be accepted that interest on cash balances was regarded as non-investment income as “obtaining interest was not a business in itself”.   

32.	No previous decision has addressed the issue in this appeal which is whether the making of loans is the making or holding of investments. P P Investments Limited, in making loans to related companies could be said to be laying out money in anticipation of a profitable income return which could point to the conclusion that it was making or holding investments. However, in my view it cannot be said either that the making of loans is always the making of an investment or that it never is. Many would regard the purchase of a bond or debenture as an investment when in fact it is the making of a securitised loan but on the other hand few would regard the activities of a money-lender as investment. At one end of the spectrum of lending could be investment in bonds or debentures but at the other end of the spectrum could be the making of informal unsecured loans which activity amounts to no more than money-lending.  

33.	Thus, in determining what was the business of the company it is necessary to have regard to all the facts in the round. If one starts with the definition (making or holding investments), and asks whether on its ordinary meaning the business of the company fell within it, I think the answer is no. P P Investments Limited did not make or hold investments; it made informal loans to its related companies and money lending is not normally regarded as investment.

34.	I accept that the main object of the company, as set out in its memorandum of association, is to acquire land and buildings for the purposes of investment only but the fact is that, since 1989, that is not what the company has done. What it has done is to concentrate on another object which is to lend money to its related companies. That was the actual activity of the company at 27 June 2001 which is the relevant date for the purposes of this appeal. Also, at the relevant date, the company’s main purpose was to support the related family companies by providing them with unsecured finance without fees or delays. All the loans were repayable on demand with no security and that also indicates that the loans were not in the nature of investments. 

35	In my view P P Investments Limited was in the business of making loans and not in the business of investing in loans. The loans were not assets acquired or held by the company for the purpose of making profits for division among the shareholders but were rather made for the purpose of providing a benefit to the other companies. The loans were not investments for their own sake but the provision of a finance facility to the other companies. P P Investments Limited did not acquire any interest in the shares of the borrowing companies nor in the properties acquired by the borrowing companies. Neither did it acquire any rights in the increases in value of the properties purchased by the borrowing companies. All it was entitled to was the interest payable to it by the borrowing companies. The evidence about the loans to the two individuals was that those two loans were made early in or shortly after 1989 and they were both written off. 

36.	The Revenue argued that the loans were investments because the companies to which the loans were made were themselves investment companies and were in common ownership and control and were controlled by the deceased, either alone or with her husband and children. However, the first loan was made to Philip Phillips & Co Limited (the estate agency company) which was accepted by the Revenue to be a trading company. Also, if making a loan is not an investment I do not think that it can be made into an investment by the fact that the company to whom the loan was made was in common ownership and control or was controlled by the deceased and her family.  I bear in mind that P P Investments Limited did not itself own any shares in the related companies. 

37.	The Revenue also argued that the sole purpose of P P Investments was to provide the other family-owned investment businesses with the means to acquire investments and so the activities of P P Investments Limited were an extension of the family’s investment activities. This argument ignores that fact that a loan was also made to the family trading company (Philip Phillips & Co) but, in any event, the fact that a loan is made to an investment company does not make the making of the loan an investment. 

38.	Finally the Revenue argued that the loans made by P P Investments Limited were not made on the same terms as loans made by a third party; a third party would have assessed the risks of the loan by reference to the history of the borrowing company; the purposes of the loan, the credit-worthiness of the borrowing company; the terms of the repayment and the security offered. Because of the links between P P Investments Limited and the borrowing companies such assessment was unnecessary because there was minimal risk. I have already found that the purposes of the loans was to enable the borrowing companies to invest in real properties and that the criteria for the making of each loan were whether the borrowing company could afford to make the interest payments and whether the value of the property to be purchased by the borrowing company was commensurate with the amount of the loan. However, I have also found that P P Investments Limited took no security for the loans and this differs markedly from any loan which might have been made by a third party. However, in my view that does not convert the business of making loans to the making or holding of investments. 

39.	In reaching my view I have not been influenced by the description of the activities of the company in the directors’ reports but rather have had regard to the facts I have found on the evidence before me.  Neither have I been influenced by the  treatment of the company for the purposes of corporation tax, bearing in mind the views of Carnwarth LJ in George that cases relating to different taxes and different subject matter are unlikely to be helpful  Neither have I found comparisons with banks to be helpful. Although  P P Investments Limited made loans it could not be said to act in that respect like a bank because it did not take security for the repayment of the loans and it did not act in other respects like a bank. Finally, although I  accept the argument of the Appellant that if P P Investments Limited were investing in loans it would have been better to invest directly in property where the return was much greater, in my view this does not assist in determining whether the business of P P Investments Limited consisted wholly or mainly of making or holding investments. 

Decision
38	My decision on the issue for determination in the appeal is that the business carried on by P P Investments Limited at the date of the death of the deceased did not consist wholly or mainly of making or holding investments.  

39.	The appeal is therefore allowed

40.	Section 224(5) of the 1984 Act provides that  the Special Commissioners shall on an appeal to them confirm the determination appealed against unless they are satisfied that the determination ought to be varied or quashed. I am satisfied that the determination should be quashed. 

DR A N BRICE

SPECIAL COMMISSIONER

RELEASE DATE: 26 July 2006

Authorities cited by the parties but not mentioned in this Decision:

Inland Revenue Commissioners v 1933 Housing Society Limited (1946) 25 ATC 355 at 361

Tootal Broadhurst Lee Co Ltd v Inland Revenue Commissioners  [1949] 1 All ER 261 at 264B

Martin and another v Inland Revenue Commissioners [1995] STC (SCD) 5 at paragraphs 27 to 27

Burkinyoung v Inland Revenue Commissioners [1995] STC (SCD) 29 at paragraphs 11-15

Cook v Medway Housing Society [1997] STC 90.

Powell and another v Inland Revenue Commissioners [1997] STC (SCD) 181 at 185e

Clark and another v Revenue and Customs Commissioners [2005] STC (SCD) 824

SC 3311/2005
24.07.06