Drummond v HM Revenue & Customs

Tax legislation must be construed purposively by asking whether the relevant provision, on its true construction, applies to the facts found. Sections 37 to 39 of the Taxation of Chargeable Gains Act 1992 prevent double taxation; they do not permit the creation of an artificial capital loss.

On surrender of a second-hand life policy, only the chargeable event gain treated as the taxpayer’s income falls within the first limb of section 37(1). The gross surrender proceeds do not fall within the second limb merely because they featured in an earlier statutory calculation of that gain.

Under section 38(1), expenditure is deductible only so far as given wholly and exclusively to acquire the asset. Amounts paid for scheme services and other benefits do not qualify.

The taxpayer purchased five second-hand, non-qualifying life assurance policies for £1.962 million and surrendered them the following day for £1.751 million. The transaction formed part of a tax avoidance scheme intended to generate an allowable capital loss without a corresponding economic loss.

HM Revenue and Customs amended the taxpayer’s self-assessment return to disallow the claimed loss. The Special Commissioner dismissed his appeal. Norris J, in [2008] EWHC (Ch) 1758, held that £1.751 million was deductible as acquisition expenditure but that approximately £210,000 of scheme costs was not.

The taxpayer sought permission for a second appeal. The central issues were whether section 37(1) of the Taxation of Chargeable Gains Act 1992 excluded the whole surrender proceeds from the capital gains computation and whether the entire purchase price was deductible under section 38(1).

1. Permission to appeal was granted, but the appeal was dismissed unanimously. Rimer LJ gave the judgment, with which Longmore LJ and Arden LJ agreed.

2. Sections 37 to 39 of the Taxation of Chargeable Gains Act 1992 have the purpose of preventing double taxation where a disposal may attract both income tax and capital gains tax. They do not exist to create an imaginary loss capable of sheltering a real gain. The legislation therefore required a purposive construction. The relevant question was whether the statutory provision, on its true construction, applied to the facts found, consistently with Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes) [2005] 1 AC 684.

3. The chargeable event gain of £1,351.25 was “money” charged to income tax as the taxpayer’s income within the first limb of section 37(1). Its character as money was unaffected by its derivation through the statutory computation under section 541 of the Income and Corporation Taxes Act 1988. It was therefore excluded from the disposal consideration for capital gains tax purposes.

4. The gross surrender proceeds of £1.751 million were not receipts taken into account in computing the taxpayer’s income within the second limb of section 37(1). They merely formed one element of an earlier statutory calculation involving sums which might have been paid by other policyholders. They would not appear in the taxpayer’s return or accounts. Excluding the entire proceeds would produce an unintended artificial loss rather than prevent double taxation. The only permitted exclusion was consequently £1,351.25.

5. Section 38(1) permitted deduction only of consideration given wholly and exclusively to acquire the policies. The Special Commissioner was entitled to find that approximately £210,000 represented payment for scheme services and other benefits rather than acquisition of the policies. That factual finding disclosed no basis for appellate interference. Only the balance of approximately £1.751 million was deductible.

1. Court of Appeal (Civil Division): Permission for a second appeal was granted, but the taxpayer’s appeal was dismissed unanimously. The decision of Norris J was upheld.
2. High Court, Chancery Division: Norris J, [2008] EWHC (Ch) 1758, rejected the section 37(1) argument but allowed the appeal in part by holding that approximately £1.751 million was deductible under section 38(1), while approximately £210,000 was not.
3. Special Commissioner: The taxpayer’s appeal against HMRC’s amendment of his self-assessment return was dismissed. The decision is reported at [2007] STC (SCD) 682.