Spc00737

NOTIFICATION OF TAX AVOIDANCE SCHEMES – penalty –whether scheme notifiable – no  

THE SPECIAL COMMISSIONERS

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Applicant

	- and -

	MERCURY TAX GROUP LIMITED	Defendant

		Special Commissioner: 	DR JOHN F. AVERY JONES CBE 

Sitting in public in London on 12 February 2009

Mario Angiolini, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Applicant

Andy Wells, Mercury Tax Group Limited, for the Defendant

© CROWN COPYRIGHT 2009

DECISION

1.	An officer of the Applicant (“HMRC”) laid an information against Mercury Tax Group (“Mercury”) alleging that as promoter of a tax avoidance scheme Mercury had failed to notify it under s 308 of the Finance Act 2004 and the Tax Avoidance Schemes (Information) Regulations 2004 (“the Regulations”).  The Applicant was represented by Mr Mario Angiolini, and Mercury by Mr Andy Wells.
2.	The scheme in outline consists of high income individuals forming a Jersey limited partnership (Liberty 1) for carrying on a financial trade and contributing capital equal to the tax loss they wish to create.  An offshore parent company (SPV1) has a subsidiary (SPV2).  SPV2 declares a large dividend out of its share premium account.  SPV1 sells the right to the dividend to Liberty 1 for an amount equal to the dividend, which is paid for by the partners’ contributions, following which Liberty 1 receives the dividend.  The scheme is said to work (it is no part of these proceedings to decide whether it does work) because s 730 of the Taxes Act 1988 provides that the seller of the right to the dividend (SPV1) is taxable on it and not the recipient (Liberty 1), while the cost of purchasing the dividend is deductible on general principles as being in expenditure incurred in the course of the financial trade of Liberty 1.  The issue in these proceedings is whether the scheme is notifiable within the Regulations (which have been superseded by 2006 regulations).
3.	Section 730 of the Taxes Act 1988 provides:
“730 Transfers of rights to receive distributions in respect of shares
(1) Where in any chargeable period the owner of any shares (“the owner”) sells or transfers the right to receive any distribution payable (whether before or after the sale or transfer) in respect of the shares without selling or transferring the shares, then, for all the purposes of the Tax Acts, that distribution, whether it would or would not be chargeable to tax apart from the provisions of this section—
(a)     shall be treated as the income of the owner or, in a case where the owner is not the beneficial owner of the shares and some other person (“a beneficiary”) is beneficially entitled to the income arising from the shares, the income of the beneficiary, and
(b)     shall be treated as]the income of the owner or beneficiary for that chargeable period, and
(c)     …
(2) This section does not have effect in relation to a sale or transfer if the proceeds of the sale or transfer are chargeable to tax…”
4.	Finance Act 2004 provides:
“306 Meaning of “notifiable arrangements” and “notifiable proposal”
(1) In this Part “notifiable arrangements” means any arrangements which—
(a)     fall within any description prescribed by the Treasury by regulations,
(b)     enable, or might be expected to enable, any person to obtain an advantage in relation to any tax that is so prescribed in relation to arrangements of that description, and
(c)     are such that the main benefit, or one of the main benefits, that might be expected to arise from the arrangements is the obtaining of that advantage.
(2) In this Part “notifiable proposal” means a proposal for arrangements which, if entered into, would be notifiable arrangements (whether the proposal relates to a particular person or to any person who may seek to take advantage of it).”
It is common ground that s 306(1)(b) and (c) are satisfied, and that Mercury is a promoter and is under an obligation to notify the arrangements under s 308 if s 306(1)(a) is satisfied.  The penalty for not notifying the scheme is contained in s 98C of the Taxes Management Act 1970:
 “98C Notification under Part 7 of Finance Act 2004
(1) A person who fails to comply with any of the provisions of Part 7 of the Finance Act 2004 (disclosure of tax avoidance schemes) mentioned in subsection (2) below shall be liable—
(a)     to a penalty not exceeding £5,000, and
(b)     if the failure continues after a penalty is imposed under paragraph (a) above, to a further penalty or penalties not exceeding £600 for each day on which the failure continues after the day on which the penalty under paragraph (a) was imposed (but excluding any day for which a penalty under this paragraph has already been imposed).
(2) Those provisions are—
(a)     section 308(1) and (3) (duty of promoter in relation to notifiable proposals and notifiable arrangements)…”
The Regulations contain the following:   
“2—(1) For the purposes of Part 7, the arrangements specified in the Schedule to these Regulations are prescribed in relation to income tax, corporation tax and capital gains tax.
(2) Part 1 of the Schedule specifies arrangements connected with employment.
(3) Part 2 of the Schedule specifies arrangements in relation to financial products.”
The following paragraph is contained in Part 1 of the Schedule
“3—(1) This paragraph applies to any arrangements under which—
 (a)     securities,
  (b)     interests in securities,
 (c)     securities options,
 (d)     anything the right to which is derived from securities, or
 (e)     anything the value or amount of which is calculated by reference to securities, interests in securities or securities options, or something the right to which is derived from securities,
are obtained by an employee or any other person, by reason of the employee's employment, but this is subject to sub-paragraphs (3), (5) and (6).”
The following paragraphs are contained in Part 2 of the Schedule
“6—(1) The arrangements specified in this Part are those which—
(a)     satisfy the condition in sub-paragraph (2); and
(b)     include one or more of the financial products to which paragraph 7 applies,
unless they are arrangements that are excluded by paragraph 8 [it is common ground that para 8 does not apply].
(2) The condition is that the tax advantage expected to be obtained under the arrangements arises, to a significant degree, from the inclusion in those arrangements of the financial product or any of the financial products to which paragraph 7 applies.
Specified financial products
7—(1) The financial products to which this paragraph applies are—
(a)     a loan;
(b)     a contract which—
(i)     is a derivative contract for the purposes of Schedule 26 to the Finance Act 2002;
(ii)     would be such a derivative contract if paragraph 4 of that Schedule (contracts excluded by virtue of their underlying subject matter) were omitted; or
 (iii)     would be a derivative contract falling within sub-paragraph (i) or (ii) if it were a contract of a company;
(c)     an agreement for the sale and repurchase of securities of the kind described in paragraphs (a) to (c) of subsection (1) of section 730A of ICTA 1988;
(d)     a stock lending arrangement within the meaning given by section 263B(1) of the Taxation of Chargeable Gains Act 1992;
(e)     a share; and
(f)     a contract, not being one of the above, which, whether alone or in combination with one or more other contracts (including any of the above), in substance represents the making of a loan, or the advancing or depositing of money, whatever its form and falls to be accounted for on that basis.
This sub-paragraph is subject to the following qualifications.
(2) This paragraph does not apply if the only financial products involved in the arrangements are one or both of the following—
(a)     assets which are held within an account which satisfies the conditions in the Individual Savings Accounts Regulations 1998; and
(b)     assets which are held as plan investments in a personal equity plan within the meaning of the Personal Equity Plan Regulations 1989.
(3) For the purposes of this paragraph, a contract, or a combination of contracts, falls to be accounted for as a loan, or as the advancing or depositing of money, if the person entering into the arrangements is, in accordance with generally accepted accounting practice, required to treat the contract, or the combination of contracts, as a loan, deposit or other financial asset or obligation (as to which, see section 43A(1) of ICTA 1988), or would be so required if the person were a company to which the Companies Act 1985 applied.
This is subject to the following qualification.
(4) Anything which is a finance lease for the purposes of generally accepted accounting practice does not fall to be accounted for as a loan for the purposes of this paragraph.
(5) In this paragraph “generally accepted accounting practice” has the meaning given by section 836A of ICTA 1988.”
5.	The following facts are not in dispute:
(1)	The scheme was not notified within the relevant time limit which expired on or before 2 February 2006.
(2)	It was voluntarily notified in September 2006 after the Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2006 came into force on 1 August 2006 but before it had been used after that date on the basis that if it were then used it would be notifiable anyway as a loss scheme.
(3)	HMRC have been informed of the names of the individuals who have used the scheme having entered into a representative sample agreement.  (the representatives of HMRC at the hearing were unaware of this and Mr Angiolini had been arguing that Mercury were intent on preventing HMRC from knowing the identity of the users of the scheme; an officer present was able to obtain confirmation during the hearing that the representative sample agreement had been entered into but not whether all the names had been disclosed, but Mr Angiolini made his submissions on the basis that it was true.  I am accepting as a fact that the names had been so disclosed.)  
(4)	Mercury obtained counsel’s opinion that the scheme was not notifiable.  I was given an extract from the opinion but was not informed about counsel’s identity.
6.	Mr Angiolini for HMRC contends:
(1)	There is no doubt that the scheme includes shares (the shares in SPV2 held by SPV1).
(2)	The Regulations are drafted in the widest possible manner by reference to widely-defined characteristics, such as the “inclusion” of a financial product in them.  This was because the Regulations had to cover tax avoidance schemes that by definition were unknown to HMRC.  The word include does not imply that the shares are sold; they need only be part of the arrangements.
(3)	Without the inclusion of the shares in SPV2 as part of the arrangements no tax advantage could ever have been obtained.  It is only because the arrangements relate directly to those underlying shares that any tax advantage could potentially be obtained.  Shares in SPV2 are essential to the reliance on s 730, as is the fact that the shares must not be transferred.  
(4)	It is irrelevant that there is no transaction in the shares; the test is whether it is the inclusion of the shares in the scheme that gives rise to the tax advantage.  The right to the distribution can exist only by reference to the shares in SPV2 and it is only because that right to income arises out of share ownership that s 730 is potentially relevant; if a right to any other type of income had been transferred s 730 would not apply and no tax advantage could arise.  The fact that no transfer of the shares need take place is shown by the comparison between the inclusion of “a share” in para 7(1)(e) and, for example, para (c) relating to “an agreement for the sale and repurchase of securities.”  The expected tax advantage therefore arises entirely (or at least to a significant degree) from inclusion of the shares within the scheme.  While the mechanism of obtaining the expected tax advantage may be the interaction of s 730 with the general principle of deductibility of the expenses of a financial trade so will any avoidance depend on statutory provisions.  To argue that the tax advantage arises out of the legislative provision rather than the underlying financial product would deprive the Regulations of any effect. 
(5)	Even though the names of individuals using the scheme were now known to HMRC the maximum penalty should be payable as HMRC lost time in which the scheme could have been legislated against (as did subsequently happen).  Counsel’s advice contains no detailed analysis of the Regulations and should be disregarded in relation to any mitigation of the penalty.
7.	Mr Wells for Mercury contends:
(1)	The scheme involves the purchase of the right to a dividend, which is not within the definition of a financial product in para 7 of the Regulations: compare para 3(1) which makes a distinction between securities and “anything the right to which is derived from securities.”  Because a dividend arises from a share this does not mean that the expected tax advantage arises from a share; it arises because of the effect of s 730.
(2)	Regulation 7(1)(c) refers to “agreements for the sale and repurchase of securities.”  The applicable definition of securities in s 737B(1) and para 1(1) of Sch 23A defines separately overseas securities (which includes shares) and overseas dividend, demonstrating that a dividend is separate from securities.
(3)	A dividend is a different asset from a share.  It is but one of the bundle of rights that characterises a share.  By analogy, dividends are not transactions in securities for s 703 of the Taxes Act 1988, see IRC v Laird Group plc [2003] STC 1349, thus making a distinction in another context between a dividend and a share.
(4)	Although Mercury took the view that the scheme was not notifiable it took counsel’s opinion and behaved in a responsible manner.  There is nothing in the published guidance that suggests that disclosure is required in this case.  Indeed in relation to employment products the guidance states that securities includes any right derived from securities, reflecting para 3(1)(d), but there was no similar statement in relation to financial products.  Being part of a penalty regime the Regulations should be construed strictly.  
(5)	If Mercury were wrong they should not suffer any penalty in the absence of clear guidance having taken counsel’s opinion.
8.	I do not find the Regulations easy to interpret.  It contains the definition of arrangements that are prescribed.  There are apparently two conditions: (1) that the arrangements include one or more of the financial products to which para 7 applies, and (2) that the tax advantage expected to be obtained under the arrangements arises, to a significant degree, from the inclusion in those arrangements of the financial product (or any of the financial products) to which para 7 applies.  I find it difficult to see how, if (2) is satisfied, (1) could not be.  However, (1) seems to ask whether or not the arrangements include the financial product.  On the other hand (2), clearly contemplates that a financial product can be included in the arrangements without giving rise to the tax advantage, or not doing so to a significant degree.  A distinction is made between the expected tax advantage obtained under the arrangements, and the inclusion of the financial product in the arrangements.  It is only when the former arises (to a significant degree) from the latter that one has a prescribed arrangement.  The “from” implies that the cause of the tax advantage is the inclusion of the financial product in the arrangements.  It does not seem to be a “but for” test, that but for the inclusion of the financial product there would be no expected tax advantage.
9.	The list of financial products is somewhat strange, comprising in (a) loans, in (f) contracts treated by generally accepted accounting practice as loans (not being something that has already been included), and in (e) a share; and then three items that might have loans or shares underlying them: in (b) derivative contracts, in (c) repos and in (d) stock lending arrangements.  If therefore a share is a financial product why was it necessary to include derivatives, repos and stock lending where these relate to shares, and the same with loans?  Also, as Mr Wells points out, para 3, in the other part of the Schedule to the Regulations dealing with arrangements connected with employment, makes a distinction between securities and “anything the right to which is derived from securities.”
10.	Applying that approach to the facts of this case, it seems to me that condition (1) is satisfied.  It cannot be said that the arrangements do not include a share when one party to the arrangements, SPV1 holds, and is required to continue to hold the shares of SPV2.  I find condition (2) more difficult to apply.  Does the expected tax advantage arise from the inclusion of a share in the arrangements, or from something else?  The more proximate cause of the expected tax advantage is the purchase of the right to the dividend.  The inclusion of the share in the arrangements is much more a “but for” cause, that but for the inclusion of the share there would be no dividend and therefore no expected tax advantage.  I consider that the Regulation is looking at the proximate cause of the expected tax advantage, which is not therefore from the inclusion of a share in the arrangements. 
11.	Accordingly, I do not consider that condition (2) is satisfied and so the scheme is not notifiable and there can be no penalty.
12.	However, if I am wrong about that, and I do not reach the conclusion without doubts, I should consider what the penalty should be if the scheme is in fact notifiable.  The fact that Mercury took counsel’s opinion is clearly relevant.  Counsel’s view was:
“10.  A further prescribed financial product is a share and whilst, of course, shares are involved in the Liberty proposal, it is not, in my opinion, the involvement of a share that produces to a significant degree the tax advantage in question.
…
13.  More particularly, I am of the opinion that the tax advantage arises by virtue of the clear wording of s 730 of the Taxes act 1988 which provides that in certain circumstances, within which the Liberty arrangement falls, the receipt of a distribution is not charged to tax in the hands of the recipient.  Further a payment for such a dividend right, under general tax principles is deductible.  It is the mismatch between the tax free receipt and the tax deductible payment which produces a loss which may be accessed to the individual members pursuant to sections 380 and 381 Taxes Act 1988: no financial product produces the advantage per se in my opinion.”
13.	Although Mr Angiolini contends that the opinion is short on analysis, the more important point is that Mercury went to the trouble and expense of taking counsel’s opinion.  Counsel addresses his or her mind to the point and reaches a justifiable conclusion, with which I happen to agree.  The contrary point of view is not set out but is mentioned in para 10.  I consider that it would be wrong to penalise Mercury if (on the assumption I am now making that my decision is wrong) that opinion was also wrong.  Other than to take advice there is nothing else they could do; they could hardly ask HMRC whether they agreed without disclosing the scheme in the process.  In my view Mercury acted properly in relying on counsel’s opinion and arguing the case as a matter of principle rather than taking a view themselves and paying the penalty if they were found to be wrong, which I suspect would have been cheaper.  If therefore I am wrong in deciding that the scheme is not notifiable and a penalty is payable I would fix the amount at nil.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 17 February 2009

SC 2030/08