Her Majesty's Commissioners of Inland Revenue v Scottish Provident Institution

The House of Lords applied the Ramsay principle of construing tax legislation by reference to the practical effect of a composite scheme. The court held that where a series of pre‑ordained steps operates as a single composite transaction, the statute must be read to reflect that composite effect rather than the isolated formal steps. Applying this approach to the cross‑option scheme entered into by Scottish Provident Institution, the Committee concluded that, viewed as a whole, the scheme left Citibank with no practical entitlement to gilts and therefore the Citibank option did not give rise to an "entitlement" for the purposes of section 150A(1) and related provisions. Accordingly the option was not a qualifying contract under section 147(1) (as read with section 147A and section 150A) and the claimed income loss was not available.

This appeal concerned a scheme executed in 1995 by which the mutual life office, Scottish Provident Institution (SPI), and Citibank entered matching in‑the‑money call options on UK gilts with differing strike prices and a collateral deposit so that, after a change in tax law taking effect on 1 April 1996, SPI would realise a loss treated as an income loss under the new regime. SPI sought to treat the loss arising on exercise of the option it had bought as an income loss deductible against taxable income.

The factual findings at first instance by the special commissioners were that the documents and transactions were negotiated at arm's length, that there was a real (if small) commercial possibility that the two options might not be exercised so as to cancel one another out, and that the collateral agreement was a separate genuine deposit or loan. The Inner House upheld those conclusions and dismissed the Revenue's appeal.

The principal issue before the House was one of statutory construction: whether the Citibank option gave SPI an "entitlement" to become a party to a loan relationship for the purposes of section 150A(1) and thus was a qualifying contract under section 147(1) (as affected by sections 147A and 150A as inserted by the Finance Act 1996). The House considered whether the series of documents should be treated as a single composite transaction and applied the Ramsay principle, rejecting an approach that would give legal effect to contingencies deliberately introduced solely to avoid the composite character of the scheme.

The Committee held that the special commissioners had erred in law in treating their factual finding of a small but real possibility of non‑exercise as sufficient to require treating the options as separate transactions. The composite effect, as intended and as in fact operated, left no practical entitlement to gilts and so there was no qualifying contract. The House allowed the Revenue's appeal on that ground and did not need to resolve several technical arguments about transitional provisions.

• Nature of relief sought: SPI sought to treat the loss arising on the exercise of its option as an income loss deductible under the new tax regime.
• Issues framed: (i) whether the cross‑option arrangement should be viewed as a composite transaction; (ii) whether the Citibank option gave an "entitlement" to gilts so as to constitute a qualifying contract under the relevant statutory provisions; (iii) the effect of transitional provisions (Paragraph 25 of Schedule 15) and related technical points.
• Court’s reasoning: the Ramsay principle requires construing the statute by reference to the practical effect of the composite scheme; artificially introduced contingencies not genuinely commercial cannot defeat this construction; viewed as a whole the arrangement created no practical entitlement to gilts and so did not meet the statutory test for a qualifying contract.

Appeal allowed. The House held that the series of pre‑ordained transactions formed a single composite scheme and must be considered in their practical effect. Read in that way the Citibank option did not create a practical entitlement to gilts within the meaning of section 150A(1) and related provisions, so it was not a qualifying contract and SPI could not claim the purported income loss. The special commissioners were held to have erred in law in treating a small contingent possibility of non‑exercise as decisive to the contrary.

Special Commissioners (first instance) decision reported at [2002] STC (SCD) 252; appeal to the Inner House of the Court of Session dismissed (Lord President Cullen delivering the reserved opinion) reported at [2003] STC 1035; House of Lords allowed the Revenue's appeal ([2004] UKHL 52).