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Inland Revenue Commissioners v McGuckian, June 20th 1997

Ref.: Transfer to a trust ignored for tax purposes

The taxpayer was involved in a tax the avoidance scheme involving a transfer to an offshore trust which the House of Lords declared to be ineffective under the Ramsay principle (whereby the court is entitled for tax purposes to ignore stages in a series of transactions which have been entered into solely for the purposes of tax avoidance).

The taxpayer, Mr J B McGuckian, lived in Northern Ireland, was ordinarily resident in the United Kingdom, Northern Ireland, and carried on the business of a clothing manufacturer in the Republic of Ireland through a company, Ballinamore Textiles Limited (Ballinamore) which was incorporated in the Republic in 1972.

The company was successful but, because he expected that the governments of the Republic of Ireland and of the United Kingdom might introduce a wealth tax, Mr McGuckian decided that he and his wife should divest themselves of the assets represented by the shares in Ballinamore but retain control of the company‘s affairs.

The chosen strategy, as described by Carswell LJ in the the Court of Appeal (Northern Ireland) ((1994) STC 888 at 909):

‘... appears to have been to reduce the assets held by Ballinamore and the value of the company, so reducing the McGuckians’ exposure if a wealth tax should be imposed, while attempting to avoid liability to income tax on the moneys paid out by Ballinamore by receiving the proceeds in the form of capital rather than income payments’.

The means employed were complex. Essentially these involved:

1) The shares of Ballinamore being transferred to the trustees of a settlement, Shurltmst Ltd, in Guernsey. This was by a circuitous route. A settlement had been made earlier with the taxpayer’s mother as settler and with trustees who were employees of the advising English solicitor. Shurltrust replaced the trustees of the settlement and, by a series of share transactions using an Isle of Man company, the shares in Ballinamore were transferred to Shurltrust. These share transactions were obviously, according to Carswell LJ, non-commercial transactions;

2) Six annuity contracts being acquired by the trustees for the purpose of which was not clear. ‘... they may have added to growing impenetrability of the web of transactions and made it more difficult for the Revenue...’ according to Carswell LJ.

3) Shurltrust selling its entitlement to the dividend of Ballinamore to a UK company, Mallardchoice Ltd incorporated in 1979 and controlled by the English solicitor. No original of this assignment was produced. The consideration for this assignment was £396,054 This was on 23rd November.

4) Four days later Ballinamore declaring a dividend of £400,055 of which, after one per cent had been paid to Dublin accountants for the account of Mallardchoice, the balance of £396,054 was paid to Shurltrust.

5) Another company, also with the name Shurltrust, incorporated in the Isle Man being appointed trustee of the settlement in place of the Guernsey company.

6) a further dividend of £492,649.26 being declared and paid to Mallardchoice by a similar procedure.

The Revenue assessed the taxpayer to tax in respect of both payments as dividends of Ballinamore. On appeal the Special Commissioners allowed the taxpayer’s appeal in respect of the first payment but dismissed the appeal in respect of the second.

In the Court of Appeal (Northern Ireland) the Crown’s case was that the taxpayer and his wife transferred assets, and income from those assets became payable to the trustees abroad and, at the same time, Mrs McGuckian had power to enjoy the income received by the trustees.

The taxpayer and his wife were resident in the UK and if the income had been received by the wife in the UK it would have been taxable (under Case V, Sch. D) and if income had been received by trustees outside the UK it would be deemed to be income in the hands of the beneficiaries as soon as it was received by the trustees.

As a consequence a charge to tax arose under s478 Income and Corporation Taxes Act 1970. This section provides that income which has been transferred, either alone or in conjunction with associated operations, and can be enjoyed by an individual or spouse, and if received by a person in the UK would be taxable, is deemed to be the income of the person who has the power to enjoy it for the purpose of taxation.

There is a saving provision in s478(3) for transactions which can be shown to have taken place without tax avoidance being the main purpose. Counsel for the taxpayer did not rely on this, however, rather arguing that s478 did not come into operation because, following their assignment of the right to receive the dividends, the trustees of the settlement received capital and not income and so there was a transfer of capital and not income as required for s478 to apply.

After reviewing the anti-avoidance decisions (based on W T Ramsay Ltd v ZRC (1981) STC 174 in which the House of Lords held that the proper approach to a series of transactions was to consider the result of the series as a whole and not to dissect the scheme and consider each transaction separately), Carswell LJ decided that these cases were inappropriate to the present circumstances. Although the assignment was an artificial device it was the whole substance and raison d’etre of the transaction and could not be regarded as an inserted step. The assignment had some fiscal consequences. If they were disregarded there would be a material alteration to the parties’ financial arrangements.

There was no doubt as to the lengths that some tax advisers will go to keep material facts and documents from the Revenue and the Chief Justice remitted the case back to the Commissioners with the instruction that the assessment should be taken as having been made under s470.

Lord Justice Kelly dissented on the tax avoidance principles.

The Crown appealed to the House of Lords. Their Lordships were not having anything to do with clever argument. Lord Brown-Wilkinson simply stated that, to come within the Ramsay principle, there had to be an ordained series of transactions, or one composite transaction, which might or might not incorporate a legitimate business end. Second, there had to be steps inserted which had no commercial purpose apart from the avoidance of a tax liability, If these two ingredients existed then the inserted steps must be disregarded and the court would look at the end result and tax it on the terms of the relevant taxing statute.

In this case there was no business purpose in the assignment of the dividend rights to Mallardchoice. The only possible inference was that the assignment had been entered into for the sole purpose of gaining a tax advantage.

Comment (by J.G.Goldsworth): this case continues the line of anti-avoidance cases, starting with the Ramsay case, with a simplification of the criteria applied. Some earlier cases attempted to make fine distinctions in the analysis of particular steps taken within the transactions. Here Lord Browne-Wilkinson took a more straightforward approach.

The transfer of assets to a trust in these circumstances offers a taxpayer little protection when the main purpose is tax avoidance. The separate role of trustees from that of the settler helps not at all if the transfer to trustees is the step which is ignored by the court and this is likely, in a circular transaction, to be seen as the most artificial step.