Spc00729
Income tax – Income and Corporation Taxes Act 1988 sections 539 – 549 - whether payments into and out of life policies produced a corresponding deficiency under section 549 – capital gains tax – whether sum paid for second hand life insurance life policies purchased with a view to claiming an income tax relief produced an allowable loss for capital gains tax - Carreras Group Ltd v Stamp Commissioner applied – HMRC v Drummond applied
THE SPECIAL COMMISSIONERS
DAVID MAYESAppellant
-and –
THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS Respondents
Special Commissioner: DR DAVID WILLIAMS
Sitting in public in London on 29 September and 1 October 2008
Kevin Prosser QC, instructed by McGrigors, solicitors, for the Appellant
David Ewart QC, instructed by the Solicitor to HMRC, for the Respondents
© CROWN COPYRIGHT 2008
1
DECISION
1This case concerns a tax avoidance scheme marketed as SHIPS 2. It is a scheme using what are said to be the payments of premiums to and subsequent surrenders in part and then fully of existing non-qualifying life assurance policies (or Second Hand Insurance Policies) with the objective of providing relief against higher rate income tax for UK resident individuals in 2003-04. David Mayes, the Appellant, claims that by use of this scheme he becomes entitled to a deduction of £1,876, 134 against other income for higher rate income tax purposes in 2003-04. This is because of a relief known as corresponding deficiency relief. He also claims relief of £131,323 against gains liable to capital gains tax for losses on the disposal of policies during that year.
2In a letter closing an enquiry into Mr Mayes’ tax return for that year, an officer of Revenue and Customs concluded that there was no capital loss arising from the disposal of the policies. The officer also concluded that there was no corresponding deficiency on which to claim relief from higher rate income tax.
3I am asked by the parties to decide if that officer is right on both or either of those points. Mr Prosser argued that the appellant is entitled both to income tax losses and capital gains tax losses in respect of the same assets. Mr Ewart contended initially that the appellant was not entitled to relief for either kind of loss. It is agreed that I should decide in principle whether either loss is allowable but should leave the precise amounts of any reliefs that are relevant to Mr Mayes’ 2003-04 tax return for the parties to agree.
4The parties provided me with a full set of documents with which to decide the decisions in principle but not the individual figures. I heard evidence from one witness only for the appellant: Mark Hawthorne, a senior director of AIG Life (UK), part of the American Insurance Group Inc. group of companies. He appeared under a witness summons to give evidence on affirmation about his involvement in the bonds involved in this appeal. I neither heard nor read evidence from Mr Mayes or from any other of the several people involved at various times in the scheme he used. But I had the benefit of documents disclosed by several third parties upon formal request by the Respondents.
A summary of SHIPS 2
5SHIPS 2, as applied here, concerns various steps taken with a product sold by the American Insurance Group. That company traded in the United Kingdom at the time through the style “AIG Life” among others. I use that style in this decision. The product used in this scheme was AIG Life’s Premier Access Bond (referred to as the “Bond”). The Bonds were marketed as bonds combining the tax efficiency of a life assurance policy with the security of the “billions we have to invest” and a competitive return on the investment. An individual Bond is a group of 20 single premium life assurance policies sold together, the premiums from which are invested by AIG Life in a range of unit-linked funds. Nothing turns in this decision on the multiple-policy aspect of a Bond or on the way the funds were invested under the general investment policies of AIG Life.
6Mr Hawthorne gave evidence that he regarded “bond” and “policy” as interchangeable in the current context and I accept that. I shall for simplicity refer to a Bond, not a policy, as that is the formal name of the instrument. I use the singular save where I am referring deliberately to a multiple of Bonds. It is, however, central to the appellant’s case that the Bonds are life insurance policies. I note the approach taken by Mr Hawthorne to the language used in the relevant statutory provisions as a relevant comparator to submissions made for the Appellant about the proper meaning to be given to the relevant terms in the statute.
7Mr Ewart presented the scheme me as involving seven steps (“the Steps”). It is useful to adopt that summary as a basis for analysing events. In his view the Steps, the dates on which they occurred, and the parties involved, were:
Step 12 04 2002Christopher Henry Lovell, a Jersey resident purchased, by means of single premiums of £5,000 two Bonds from AIG Life.
Step 26 03 2003Mr Lovell assigned the Bonds to January Storm Investments SA, a Luxembourg company, (“JSI”) for value.
Step 37 03 2003JSI paid £375,000 to AIG Life in respect of each policy in the first Bond and £50,000 in respect of each policy in the second Bond.
Step 431 03 2003JSI withdrew from the Bonds the sums paid in on 7 03 2003 in their entirety.
Step 56 11 2004JSI assigned the Bonds to P E Shirley & Co LLP (“PES LLP”) for value.
Step 618 12 2003PES LLP assigned the Bonds to Mr Mayes for value.
Step 713 02 2004Mr Mayes surrendered both Bonds to AIG Life,
receiving in return the remaining proceeds in the Bonds.
Mr Mayes then claimed income tax relief and a capital gains tax loss in 2003-04 as arising from the surrender.
The parties’ positions
8The scheme under which the Steps were executed is set out in detail in several documents disclosed in the appeal. Mr Prosser did not shrink from accepting that it was a scheme to reduce tax and that the scheme was followed. But he contended that much of the detail of the scheme was irrelevant to Mr Mayes and to his claims for tax relief. Mr Mayes was not aware of these details. He had conducted himself within the law, and was entitled to the income tax relief given by Part XIII, Chapter II of the Income and Corporation Taxes Act (“ICTA”) 1988.
9Mr Ewart contended that on a proper interpretation and application of that legislation to the facts it was clear that Steps 3 and 4 should be seen together as a preordained composite transaction devoid of commercial content. Accordingly, Mr Mayes’ income tax relief claim should be looked at on the basis that those Steps did not form part of the background to his claim. If those Steps were removed from the scheme, then there was no corresponding deficiency relief and no chargeable loss.
10It is common ground that the approach to be taken to the second aspect of the case, the claim of a capital gains tax loss, is to be considered in the light of the recent decision of Norris J in Drummond v Revenue and Customs Commissioners [2008] STC 2707, [2008] EWHC (Ch) 1758. That case concerned another scheme involving life assurance policies. But that scheme concentrated on the creation of a capital gains tax loss. It was understood by both parties that that decision was under appeal to the Court of Appeal, but it was agreed by both parties that I should proceed to decide this appeal based on current authority. There is, however, little in Drummond of relevance to the main issue in this case, that of the income tax relief.
The background to implementing the initial part of the scheme
11Although this was presented as a scheme with a short series of steps, the documents show that Mr Ewart’s Steps are, to mix a metaphor, what might be termed the “tip of the iceberg” in the way the scheme as a whole was implemented. It is necessary to look chronologically at what happened in more detail than simply the Steps to obtain a fuller picture of how the scheme ran. That brings out the full involvement of relevant parties at each stage, and it shows that Mr Mayes’ Bonds were a small part of a larger scheme. This is because the Bonds that are at the heart of this decision were, at most stages of these arrangements, handled as an unallocated part of significantly larger blocks of Bonds.
Step 1
12Mr Lovell applied for 50 Bonds in March 2002 at the same time as the other individual. The premium paid on each policy within the Bonds was £250, so Mr Lovell paid a composite premium of £250,000 with the other individual purchasing a similar value of Bonds. In other words, this was not a simple purchase of a small Bond. I am satisfied from the documents that it was a major coordinated purchase of Bonds that required the deployment of significant third party funding. The Bonds purchased were PAB0010351 to PAB001401 purchased by the other individual and PAB0010401 to PAB0010452 purchased by Mr Lovell.
13The £500,000 needed to finance the purchases was provided by SG Hambros Bank and Trust (Jersey) Ltd, (“SGHJ”). To protect its investment, SGHJ took a charge over, and assignment of, the Bonds. The interest payable on the loans under the financing agreements was determined by the income generated on the Bonds. Details are not entirely clear from the papers, but a deed of reassignment dated 6 03 2003 between SGHJ and Mr Lovell reassigning the Bonds to Mr Lovell on that date indicates that there was an assignment from Mr Lovell to SGHJ as part of the funding arrangements for the purchase of the Bonds. The terms of these arrangement indicated by other documents in evidence suggest that Mr Lovell and his colleague made no net profit from the purchase of the Bonds. They paid out in interest to SGHJ precisely the sums they received in interest from AIG Life. See the paper prepared by Stuart Gower and circulated by an internal email within the Hambros Group dated 3 02 2003 which states:
“In March 2002 SGHJ provided funding for two individuals resident and domiciled in Jersey to invest a sum of £500,000 in a number of life assurance policies issued by AIG Life within the AIG Premier Asset Bond… The individuals are professionals working in the finance Industry in Jersey and are well known to SGHJ having assisted SGHJ in the past on various tax-based transactions.
SGHJ have taken out a security interest agreement over the life policies in support of its loan and the interest payable on the loan is determined by the income generated on the policies. To date this has amounted in a small (less than £5,000) funding cost.”
14The result of Step 1 is that Mr Lovell purchased Bonds on terms that could not make him a profit as he was paying out in loan interest what he was earning from the Bonds. Nor were those financing the loan making a profit either, as they record that they were making a small loss on the loan. If Mr Lovell entered these arrangements for commercial reasons, then they are not evidenced in the papers available to the tribunal. But the papers show that SGHJ was aware at that time of the potential market for the Bonds in due course in connection with tax planning arrangements.
Steps 2 to 5
15SGHJ were also behind the next Steps in the scheme. So were other companies in the same group (“SGH” when acting as a group) brought to share the risks. Details are set out in an internal paper prepared within SGH by Stuart Gower in February 2003. As the evidence before me is that the planning essentially followed the course laid down in this paper, I set it out in full:
“Transaction steps
1A small number (six) of fully taxable companies (LuxCos) are established in Luxembourg whose centre of management and control will rest in Luxembourg. We anticipate that PRIV/Lux will provide the necessary management services.
2The ordinary shares in LuxCos will be held by independent third parties.
3SGHJ will provide a No 1 loan facility for each LuxCo (in total circa £600,000) to finance the establishment of the LuxCos and the purchase by LuxCos from the individuals in Jersey of the existing life policies at their current market value (circa £5000 per policy plus accrued interest to date)
4The existing loan facility of £500,000 to the individuals in Jersey will be repaid in full.
5SGHJ will then provide a No 2 loan facility to each LuxCo (in total circa £300m) to finance LuxCos investment on 1 March 2003 in the life policies. The term of the investment will be exactly one month.
6LuxCos will withdraw their investments in the policies including all accrued interest earned on the life policies since 1 March at the end of the 1 month term. The balance of cash remaining in the life policies after the withdrawal will therefore equate to the purchase price in step 3.
7LuxCos will use the funds withdrawn from the policies in order to repay in full their no 2 loan facility from SGHJ.
8LuxCos will then arrange for the sale of the life policies in the market.
9The proceeds from the sale of the policies will be used by LuxCos to repay in full the no 1 loan facilities.
10The premiums earned on the sale of the policies will be used by LuxCos to repay outstanding arrangement fees charged under the No 2 Loan facilities.”
16To minimise any risk, SGH took legal charges over the Bonds and over the shares in JSI (and, I assume, the other LuxCos). SGH took comfort from the fact that “the companies are at all times controlled by directors within SG Priv” and that “since SG Priv/Lux as the directors of the Luxembourg companies will be able to ultimately control how the sale of the life policies is conducted and can ensure that this is to the satisfaction of SG Priv.” I received no evidence as to the identity or ownership or control of SG Priv/Lux.
Other participants
17The documentation indicates links to another participant in the arrangements:
“Funding risks
The cost of funds in respect of the loan facilities is expected to exceed the interest rate applied to the loan facilities by approximately £175,000. Philip Shirley has agreed to underwrite the funding cost deficit and will provide cash security with the Bank to support this.”
The first mention of Mr Shirley in this paper is in the introduction:
“Introduction
This tax proposal was brought to us by Philip Shirley, a specialist tax adviser in the UK, who we have worked with on numerous tax transactions in the past. The first step in this proposal involved SGHJ providing a finance facility of £500,000 and it is now proposed to SGHJ make available a finance facility of circa £300 million.”
Mr Shirley is mentioned several other times in the paper. Under the heading “reputational risks” it comments: “whilst our activities are in legal terms strictly limited to lending it is recognised from a reputational point of view that we are assisting Philip Shirley with the structure in setting up the Luxembourg companies and funding the AIG policies.” Under the heading “Reward for SG Hambros” an estimated charge is stated together with the comment: “This reward is obviously dependent on the sale of the life policies. Philip Shirley has advised that he is aware of substantial interest in this planning idea and is confident that £300 million is a realistic figure to work to.” I have set out these references fully as I have received no evidence about the involvement of Mr Shirley and SGHJ that contradicts this evidence and no direct evidence from either of them.
18The other party involved in these Steps was AIG Life. On 4 03 2003, a month after circulation of his paper within SGH, Mr Glover faxed one of Mr Hawthorne’s staff at AIG Life with details of the SGH proposed actions (“the Fax”). He wrote “ to confirm the source of the proposed additional £300 million investment and to explain matters in more detail but also to draw to your attention to certain matters that we relied on in good faith in making the original investment in the policies”. The Fax also states:
“You will note that the policies were taken out last year. It is planned to make large investment into the policies and make partial surrenders before the end of the current policy year. It is expected that the policies will be surrendered in the next tax year.”
19AIG Life was concerned about some activities relating to its Bonds at that time. It disclosed a letter dated 12 02 2003 in evidence, the recipient of which is redacted, expressing AIG Life’s concern about the suggestion that an agency was using the Bonds for a purpose other than that intended. The agency is cancelled by the letter. It disclosed another letter, dated 1 03 2003 and again with the recipient redacted, that agrees to an agency being continued on the basis that the Bonds are not being used as “an accessory to aggressive tax planning”. That may explain the comment in the Fax from Mr Gower that “we would respectfully point out that we are equally concerned with reputation.”
Steps 3 and 4
20Mr Hawthorne gave evidence that Mr Glover telephoned him to talk about the proposed additional investments into the Bonds. The outcome of these approaches was that AIG Life and SGH agreed special terms for the investments into, and the subsequent partial surrenders of, the Bonds. These were confirmed in a series of faxed documents and letters on 5 03 2002 and 6 03 2003.