In 2000 – 2001 Jason Drummond made a gain of approximately GBP4.8 million on the sale of shares in a company. He adopted the following tax avoidance strategy to reduce his tax bill.
On 4 April 2001 (the penultimate day of the tax year) he contracted to buy five ‘second hand’ life assurance bonds from a company called London & Oxford Capital Markets plc, for GBP1,962,233. The bonds were originally issued by AIG. The next day (the last day of the tax year) the bonds were surrendered and Mr Drummond received proceeds of GBP1,751,376.
The bonds had originally been issued to Ellen Sedgley (an employee of London & Oxford) for a total premium of GBP1,250 and she had assigned them to London & Oxford for GBP1,275. London & Oxford then paid further premiums of GBP1,748,750 to bring the total premiums for the five policies to GBP1,750,000.
For income tax purposes, Mr Drummond made a chargeable event gain of GBP1,351 on surrender calculated as follows:
Total premiums: 1,750,000
Less: previous gain on same bonds (Mrs Sedgley’s gain) 25
Taxable chargeable event gain: GBP 1,351
The chargeable events legislation prescribes that:
‘Where…a gain is to be treated as arising in connection with any policy…the amount of the gain shall be deemed to form part of that individual’s total income for the year in which the event happened.’ [ICTA section 547(1)]
Thus the GBP1,351 fell to be treated as Mr Drummond’s income. This fact was not in dispute.
He had also made a disposal for capital gains tax purposes. Gains on life assurance policies are primarily subject to income tax and are excluded from the scope of capital gains tax. Taxation of Chargeable Gains Tax Act 1992 section 210 as it then stood stated:
- ‘This section has effect as respects any policy of assurance or contract for a deferred annuity on the life of any person.
- No chargeable gain shall accrue on the disposal of, or of an interest in, the rights under any such policy of assurance or contract except where the person making the disposal is not the original beneficial owner and acquired the rights or interest for a consideration in money or money’s worth.
- Subject to subsection (2) above, the occasion of
- the payment of the sum or sums assured by a policy of assurance, or
- the transfer of investments or other assets to the owner of a policy of assurance in accordance with the policy, and the occasion of the surrender of a policy of assurance, shall be the occasion of a disposal of the rights under the policy of assurance.’
However the exclusion did not apply in this case – the policy was a ‘second hand’ one having been taken out by Ellen Sedgely.
Mr Drummond claimed that his payment of GBP1,962,233 represented an allowable loss for capital gains tax purposes and sought to offset this against his GBP4.8 million gain.
He based this claim on Taxation of Chargeable Gains Tax Act sections 37(1) and 38(1).
Section 37(1) deals with consideration:
‘There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money’s worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts.’
Section 38 (1) deals with allowable expenditure:
‘Except as otherwise expressly provided, the sums allowable as a deduction from the consideration in the computation of the gain accruing to a person on the disposal of an asset shall be restricted to
- the amount or value of the consideration, in money or money’s worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset, together with the incidental costs to him of the acquisition or, if the asset was not acquired by him, any expenditure wholly and exclusively incurred by him in providing the asset,
- the amount of any expenditure wholly and exclusively incurred on the asset by him or on his behalf for the purpose of enhancing the value of the asset, being expenditure reflected in the state or nature of the asset at the time of the disposal, and any expenditure wholly and exclusively incurred by him in establishing, preserving or defending his title to, or to a right over, the asset,
- the incidental costs to him of making the disposal.’
Section 38(1) is governed by section 39(1):
‘(1) There shall be excluded from the sums allowable under section 38 as a deduction in the computation of the gain any expenditure allowable as a deduction in computing the profits or gains or losses of a trade, profession or vocation for the purposes of income tax or allowable as a deduction in computing any other income or profits or gains or losses for the purposes of the Income Tax Acts and any expenditure which, although not so allowable as a deduction in computing any losses, would be so allowable but for an insufficiency of income or profits or gains; and this subsection applies irrespective of whether effect is or would be given to the deduction in computing the amount of tax chargeable or by discharge or repayment of tax or in any other way.’
Mr Drummond’s argument was that the full surrender proceeds of the bond (GBP1,751,376) were taken into account in computing his chargeable event gain of GBP1,351 – an income tax charge. Those proceeds should not therefore be taken into account in computing the capital gain on the policy. His capital gains tax computation on the disposal (surrender) of the life assurance bond was thus:
Less: acquisition cost (from London & Oxford) GBP1,962,233
Capital gains tax loss: GBP1,962,233
The Special Commissioner rejected this approach. ‘Neither the premiums paid by, nor the chargeable event gain, of Ms Sedgley, nor the topping-up premium paid by London & Oxford, nor the surrender proceeds of GBP1,751,376 were, in terms of s 37(1), moneys taken into account as receipts in computing Mr Drummond’s income or profits or gains or losses for income tax purposes. The only amount so taken into account is the actual chargeable event gain, i.e. GBP1,351.25. That is a discrete amount produced from the calculation of gain “treated as arising in connection with” the policy; and the amount, as a stand-alone figure of income, is deemed by s 547(1)(a) to form part of Mr Drummond’s total income.’
Mr Drummond was also unsuccessful on appeal to the High Court. The reasoning behind the High Court decision was that section 37 is designed to avoid double taxation in relation to an event potentially causing a charge to both income tax and capital gains tax. That was achieved by excluding from disposal consideration amounts charged to income tax. The GBP1,351 chargeable event gain charged to income tax was ‘money’ (it was part of the surrender proceeds of the life assurance bond) and was directly charged to income tax as part of Mr Drummond’s income without any intervening calculation. It was therefore ‘any money or money’s worth charged to income tax as income of…the person making the disposal for the purposes of the Income Tax Acts.’
Section 37 has two mutually exclusive limbs, excluding any money or money’s worth which is;
- charged to income tax as income, or
- taken into account as a receipt in computing income or profits or gains or losses
‘…taken into account as a receipt’ is not the equivalent of ‘featuring in some prior calculation which results in a figure to be added to income’. If limb (i) applied then limb (ii) could not.
In the Court of Appeal it was pointed out that the purpose of sections 37 to 39 was to avoid double taxation; not to create an imaginary loss that could be set against a real gain.
However it was not necessary to adopt a purposive construction to deal with the appeal.
It was clear that the surrender proceeds were not taken into account in computing Mr Drummond’s income. They would not appear in his tax return, or in any accounts prepared for the purpose of its completion. The only figure required was the chargeable event gain. The fact that that figure was arrived at by using a statutory formula in which the surrender proceeds formed one element (and in which the other elements may have had nothing at all to do with Mr Drummond) was irrelevant. The proceeds might be regarded as a ‘receipt’ taken into account in that statutory calculation: but they were not a ‘receipt’ taken into account in the computation of Mr Drummond’s income for income tax purposes. His loss claim must fail.
Schemes of this nature were widely promoted and used. Anti-avoidance legislation introduced in Finance Act 2003 effectively ended their use for disposals after 9 April 2003. Presumably the Court of Appeal decision brings finality to loss claims on earlier disposals.
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