Chappell v HM Revenue and Customs

Tax relief under the manufactured overseas dividend regime must be construed purposively, by reference to the transaction viewed realistically and as a whole. The regime is directed to genuine commercial securities lending involving marketable overseas securities. It does not extend to a circular arrangement created solely to generate deductions, even where the documents and payments are genuine and the scheme is not a sham.

The court distinguished relief for genuine commercial liabilities from relief claimed through transactions lacking any commercial purpose. It also gave alternative observations on the interaction between regulation 2B(3) and section 3, but those observations were unnecessary to the dismissal of the appeal.

Mr Chappell appealed against an amendment to his 2005–06 self-assessment disallowing deductions for two payments made to Barsbury Limited. He claimed that the payments were manufactured overseas dividends under paragraph 4(1) of Schedule 23A to the Income and Corporation Taxes Act 1988 and were deductible annual payments under regulation 2B(3) of the Income Tax (Manufactured Overseas Dividends) Regulations 1993.

The First-tier Tribunal dismissed the claim: [2013] UKFTT 098 (TC). The Upper Tribunal upheld the result and also considered whether any relief would be limited by section 3 of the 1988 Act: [2014] UKUT 0344 (TCC). The central issue was whether the statutory regime applied to a tax scheme involving circular transactions with no commercial purpose.

1. Appeal dismissed. The payments were not within the statutory regime because the relevant securities-lending arrangement was an artificial tax scheme with no commercial purpose. The conclusion followed from the proper construction of paragraph 4(1) of Schedule 23A and regulation 2B.
2. Purposive construction. The Ramsay line of authority requires the statutory provision to be construed purposively and the transaction to be viewed realistically. Genuine documents are not treated as shams, but individual steps may be analysed in the context of a composite transaction. The ultimate question is whether the legislation was intended to apply to the transaction so viewed. This approach was reflected in [1982] AC 300, [2005] STC 1, [2003] HKCFA 46 and [2016] UKSC 13.
3. Application to regulation 2B. Regulation 2B creates a special regime for real-world securities lending. It gives the borrower relief in respect of dividends or interest received during the loan and taxes the corresponding manufactured dividend in the lender’s hands. Its purpose does not extend to transactions lacking the commercial characteristics of securities lending and entered into only to obtain tax relief. The court distinguished MacNiven v Westmoreland Investments Ltd, [2001] UKHL 6, because that case concerned genuine commercial liabilities arising from ordinary business activities.
4. Alternative issue. The court rejected the argument that the removal of withholding obligations under regulation 2B(3) deprived the payer of the deduction. The point had been conceded by HMRC and did not arise for decision. The court nevertheless observed that section 3 could ordinarily apply to a section 349 payment made from taxable income, but that regulation 2B(3) excluded its operation in this context to avoid double taxation.

• Court of Appeal (Civil Division): dismissed the taxpayer’s appeal.
• Upper Tribunal (Tax and Chancery Chamber): upheld the First-tier Tribunal’s dismissal and considered the alternative section 3 issue, [2014] UKUT 0344 (TCC).
• First-tier Tribunal: rejected the taxpayer’s claim, [2013] UKFTT 098 (TC).