In this case the UK Supreme Court addressed the Ramsay approach, when it considered tax avoidance schemes which involved composite transactions designed to avoid payment of income tax on bankers’ bonuses.
According to the Supreme Court the Ramsay case did not develop a special rule for tax avoidance schemes; instead it extended to tax cases the purposive approach to statutory construction which was orthodox in other areas of the law.
The Ramsay principle established that the analysis of the facts depended upon the purposive construction of the statute. While this was not a new special rule for tax avoidance cases, the approach had proved particularly important in such cases.
Excerpts from the Supreme Court Judgment
“The Ramsay approach
61. As the House of Lords explained in Barclays Mercantile Business Finance Ltd v Mawson, in a single opinion of the Appellate Committee delivered by Lord Nicholls, the modern approach to statutory construction is to have regard to the purpose of a particular provision and interpret its language, so far as possible, in the way which best gives effect to that purpose. Until the case of W T Ramsay Ltd v Inland Revenue Comrs [1982] AC 300, however, the interpretation of fiscal legislation was based predominantly on a linguistic analysis. Furthermore, the courts treated every element of a composite transaction which had an individual legal identity (such as a payment of money, transfer of property, or creation of a debt) as having its own separate tax consequences, whatever might be the terms of the statute. As Lord Steyn said in Inland Revenue Comrs v McGuckian [1997] 1 WLR 991, p 999, in combination those two features – a literal interpretation of tax statutes, and an insistence on applying the legislation separately to the individual steps in composite schemes – allowed tax avoidance schemes to flourish to the detriment of the general body of taxpayers.
62. The significance of the Ramsay case was to do away with both those features. First, it extended to tax cases the purposive approach to statutory construction which was orthodox in other areas of the law. Secondly, and equally significantly, it established that the analysis of the facts depended on that purposive construction of the statute. Thus, in Ramsay itself, the terms “loss” and “gain”, as used in capital gains tax legislation, were purposively construed as referring to losses and gains having a commercial reality. Since the facts concerned a composite transaction forming a commercial unity, with the consequence that the commercial significance of what had occurred could only be determined by considering the transaction as a whole, the statute was construed as referring to the effect of that composite transaction. As 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 Comrs [1978] AC 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, there is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function.” (p 326)
63. “Unfortunately”, the Committee commented in Barclays Mercantile at para 34, “the novelty for tax lawyers of this exposure to ordinary principles of statutory construction produced a tendency to regard Ramsay as establishing a new jurisprudence governed by special rules of its own”. In the Barclays Mercantile case the Committee sought to achieve “some clarity about basic principles” (para 27). It summarised the position at para 32:
“The essence of the new approach was to give the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. … As Lord Nicholls of Birkenhead said in MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311, 320, para 8: ‘The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case.’”
As the Committee commented, this is a simple question, however difficult it may be to answer on the facts of a particular case.
64. This approach has proved to be particularly important in relation to tax avoidance schemes as a result of two factors identified in Barclays Mercantile at para 34. First, “tax is generally imposed by reference to economic activities or transactions which exist, as Lord Wilberforce said, ‘in the real world’”. Secondly, tax avoidance schemes commonly include “elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge”. In other words, as Carnwath LJ said in the Court of Appeal in Barclays Mercantile, [2002] EWCA Civ 1853; [2003] STC 66, para 66, taxing statutes generally “draw their life-blood from real world transactions with real world economic effects”. Where an enactment is of that character, and a transaction, or an element of a composite transaction, has no purpose other than tax avoidance, it can usually be said, as Carnwath LJ stated, that “to allow tax treatment to be governed by transactions which have no real world purpose of any kind is inconsistent with that fundamental characteristic.” Accordingly, as Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46; (2003) 6 ITLR 454, para 35, where schemes involve intermediate transactions inserted for the sole purpose of tax avoidance, it is quite likely that a purposive interpretation will result in such steps being disregarded for fiscal purposes. But not always.
65. As was noted in Barclays Mercantile at para 35, there have been a number of cases since Ramsay in which it was decided that elements inserted into a transaction without any business or commercial purpose did not prevent the composite transaction from falling within a charge to tax, or bring it within an exemption from tax, as the case might be. Examples include Inland Revenue Comrs v Burmah Oil Co Ltd 1982 SC (HL) 114, Furniss v Dawson [1984] AC 474, Carreras Group Ltd v Stamp Comr [2004] UKPC 16; [2004] STC 1377, Inland Revenue Comrs v Scottish Provident Institution and Tower M Cashback LLP 1 v Revenue and Customs Comrs [2011] UKSC 19; [2011] 2 AC 457. In each case the court considered the overall effect of the composite transaction, and concluded that, on the true construction of the relevant statute, the elements which had been inserted without any purpose other than tax avoidance were of no significance. But it all depends on the construction of the provision in question. Some enactments, properly construed, confer relief from taxation even where the transaction in question forms part of a wider arrangement undertaken solely for the purpose of obtaining the relief. The point is illustrated by the decisions in MacNiven v Westmoreland Investments Ltd [2001] UKHL 6; [2003] 1 AC 311 and Barclays Mercantile itself.
66. The position was summarised by Ribeiro PJ in Arrowtown Assets, para 35, in a passage cited in Barclays Mercantile:
“The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”
67. References to “reality” should not, however, be misunderstood. In the first place, the approach described in Barclays Mercantile and the earlier cases in this line of authority has nothing to do with the concept of a sham, as explained in Snook. On the contrary, as Lord Steyn observed in McGuckian at p 1001, tax avoidance is the spur to executing genuine documents and entering into genuine arrangements.
68. Secondly, it might be said that transactions must always be viewed realistically, if the alternative is to view them unrealistically. The point is that the facts must be analysed in the light of the statutory provision being applied. If a fact is of no relevance to the application of the statute, then it can be disregarded for that purpose. If, as in Ramsay, the relevant fact is the overall economic outcome of a series of commercially linked transactions, then that is the fact upon which it is necessary to focus. If, on the other hand, the legislation requires the court to focus on a specific transaction, as in MacNiven and Barclays Mercantile, then other transactions, although related, are unlikely to have any bearing on its application.
Scottish Provident
69. On the same date as Barclays Mercantile, Lord Nicholls also delivered the opinion of the Committee, similarly constituted, in the Scottish Provident case. The case concerned a scheme designed to take advantage of a change in the law governing the taxation of gains and losses made by mutual life offices on the grant or disposal of options to buy or sell gilts. Under the scheme, the life office, SPI, granted Citibank the option to buy a quantity of gilts from it at a “strike price” of 70, well below their anticipated market value at the time the option was exercised, in return for a premium. Under the law then in force, the premium was exempt from tax. After the law had changed, Citibank exercised the option, requiring SPI to sell the gilts to it at a loss. Under the law then in force, the loss was allowable for tax purposes. In order to ensure that no real loss could be suffered by either party, the scheme also provided for Citibank to grant an option to SPI, entitling it to buy a matching quantity of gilts from the bank at a strike price of 90, calculated so that the overall movements of money between the parties were equivalent. It was anticipated that both options would be exercised, but there was a possibility that they might not be. In the event, both options were exercised, and neither gilts nor money changed hands.
70. The question which arose under the relevant statutory provision was whether the option which SPI granted gave Citibank an entitlement to gilts. If the option was considered in isolation, then plainly it did. If, however, the option was viewed as part of a larger scheme by which Citibank’s right to buy the gilts from SPI was cancelled by SPI’s right to buy the same gilts from Citibank, then in a commercial sense Citibank had no real entitlement to gilts. The special commissioners found in favour of SPI, on the basis that there was a genuine possibility that both options would not be exercised. That was held by the Committee to be an error of law. It stated:
“22. … the uncertainty arises from the fact that the parties have carefully chosen to fix the strike price for the SPI option at a level which gives rise to an outside chance that the option will not be exercised. There was no commercial reason for choosing a strike price of 90. From the point of view of the money passing (or rather, not passing), the scheme could just as well have fixed it at 80 and achieved the same tax saving by reducing the Citibank strike price to 60. It would all have come out in the wash. Thus the contingency upon which SPI rely for saying that there was no composite transaction was a part of that composite transaction; chosen not for any commercial reason but solely to enable SPI to claim that there was no composite transaction. It is true that it created a real commercial risk, but the odds were favourable enough to make it a risk which the parties were willing to accept in the interests of the scheme.
23. We think that it would destroy the value of the Ramsay principle of construing provisions such as [the provision in question] as referring to the effect of composite transactions if their composite effect had to be disregarded simply because the parties had deliberately included a commercially irrelevant contingency, creating an acceptable risk that the scheme might not work as planned. We would be back in the world of artificial tax schemes, now equipped with anti-Ramsay devices. The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned.”
71. Thus, on the basis that the statutory provision was properly construed as being concerned with a real and practical entitlement to gilts, it did not apply to a legal entitlement which was intended and expected to be cancelled by an equal and opposite obligation, even if there was a risk that the arrangement might not work as intended.”