Tax avoidance and commercial purpose

Introduction

This Special Commissioner's Decision dealt with whether transactions were carried out for the purposes (or one of the main purposes) of avoiding tax.

The Facts

The facts of this case span three generations. The first generation, Sidney Sheldon, was a successful builder, and director of building companies. He built up a very considerable investment in farms and other real property to the west of Birmingham. Two properties are the subject of this appeal:

• An industrial estate, which had been purchased, it would seem in equal shares, by Mr. Sheldon, his wife and their daughter (second generation) in 1966. In 1971 the three owners created between them six settlements under which each of them transferred half their interest in the relevant land to a UK settlement, one for each of the two granddaughters, (third generation). The result of this was that the six settlements owned the entirety of the industrial estate. Under the terms of the settlements, the land was to vest absolutely in the ownership of the two girls when each became 18 years of age.
• The other property was one of three farms. According to the decision, it appeared that this farm or at least the farming business at this farm, probably along with the business at the other twofarms, was transferred to a UK company. By 2002, the shares of the UK company were held by three Jersey companies. At the time of the decision, one of the granddaughters lived at the farm and the other lived at another farm. Both houses were owned by the offshore companies, and no rent was paid to those offshore companies for the benefit of occupation.

On 1 April 1980 (about 4 months before the 18^th birthday of one of the granddaughters), the UK resident trustee of the 6 settlements resigned, and was replaced by the daughter (who was resident in Jersey), with the two trustees then being the daughter and her husband, neither of whom were resident in the UK. It was conceded, in the course of discussion, that this was done so that there would not be a UK capital gains charge on the occasion of the granddaughter becoming absolutely entitled to the trust property.

On the actual day of the 18^th birthday of each of the granddaughters, each of the girls signed assignments of their interest in the Industrial Estate to Jersey companies.

Whilst at the time of the transfers, respectively in 1980 and 1982, the granddaughters were resident with their parents in Jersey, they were resident in the UK in the two tax years, 1999/2000 and 2000/2001, for which assessments had been made on them under the anti-avoidance transfer of assets abroad provision of section 739 Taxes Act 1988.

The Issue

Whether the Appellants (the granddaughters) could demonstrate that when each of them turned 18, and thereupon became absolutely entitled to an interest in the industrial estate, their immediate transfer of their interests to Jersey companies was made without UK tax avoidance being one of their purposes.

The Decision

According to the HMRC website, Section 739 of the Taxes Act 1988, imposes an income tax charge on an individual where the following conditions are satisfied:

• the individual transfers, or is associated with the transfer of, assets and
• by virtue or in consequence of the transfer (either alone or in conjunction with associated operations), income becomes payable to a person resident or domiciled outside the UK and
• the individual (while ordinarily resident in the UK) has the ‘power to enjoy’ that income and/or receives, or is entitled to receive, a capital sum.

Income which becomes payable to the offshore person is deemed to be that of the UK resident individual for all purposes of the Income Tax Acts.

There were two bona fide defences available:

• One required each Appellant to demonstrate, as regards the transfer made by her, that “the purpose of avoiding liability to taxation was not the purpose or one of the purposes for which the transfer [was] effected”.
• The other applied in relation to “bona fide commercial transactions” and applied if the Appellants could demonstrate that the transfer … [was] not designed for the purpose of avoiding liability to taxation”.

Either one was sufficient to eliminate liability to tax under section 739.

The Appellants contended that the purposes sought to be achieved by the transfers in 1980 and 1982 were the separation of management from ownership, and some protection of the girls’ or the family's assets from dissipation by unsuitable partners, and later possible divorce; although advice would probably have been taken from the family's UK and Jersey lawyers, tax avoidance was not one of the purposes of the transfers, but rather they were made to achieve the above purposes.

The Revenue contended that as it had emerged that the management of the UK real properties continued to be dealt with by the grandfather and by UK managing agents and not by either of the directors of the two companies to which the Appellants had assigned their UK real property interests, the contention that the transfers were made to separate ownership from management was not sustained. In addition, the only remaining purpose (that of protecting the girls’ assets) was personal and not commercial.

The Special Commissioner dismissed the taxpayers appeals.

It was the Special Commissioner's view that settled law meant that he must address “purpose”, rather than objectively ascertained effect, or presumed effect. In addition, if the Special Commissioner considered that there was some taxation, then he had to address the difficult task of distinguishing between tax avoidance and tax mitigation, as only tax avoidance was fatal to the section 741 defence.

The contention of the Revenue on the management of the companies was agreed. In addition, the defence in relation to unsuitable boyfriends or husbands was rejected on the basis that the transfer to the companies gave the granddaughters absolute control over the assets. On this basis, the Appellants had not satisfied the burden of proof in establishing, on the basis of reasonable probability, that tax advantages were not amongst their parents’ purposes in suggesting, and their purposes in making, the transfers.

The question of whether tax planning fell into the category of tax avoidance or mere mitigation was then dealt with. This important aspect of the case specifically distinguishes between avoidance and mitigation. In the context of section 739, the Special Commissioner stated that it seemed to be difficult to argue that a transaction designed to reduce income tax by the mechanism of the transfer of UK property to a non-resident person was mere mitigation.

The judgment is available online at http://www.bailii.org/uk/cases/UKSC/2009/SPC00728.html.