Commissioners of Inland Revenue v. John Lewis Properties Ltd [2001] EWHC Ch 409 (13th June, 2001)

JUDGMENT I direct that pursuant to CPR PD 39A para 6.1 no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic. Mr Justice Lightman: INTRODUCTION This is an appeal by the Commissioners of Inland Revenue ("the Revenue") under Section 56A of the Taxes Management Act 1970 against the decision ("the Decision") given on the 5th September 2000 by the Special Commissioner Mr THK Everett ("the Commissioner") whereby he allowed in principle an appeal by John Lewis Properties Plc ("JLP") against an assessment to corporation tax ("CT") for its accounting period ended 31st January 1996 in the sum of £31 million. The appeal raises for the first time the efficacy as a tax avoidance scheme of a rent factoring scheme of a type widely marketed during the mid 1990s for obtaining relief from liability for tax. In essence the scheme involved the assignment by JLP of its entitlement to rent over a five year period (from the 23rd January 1996 to the 23rd January 2001) due to it as reversioner under leases granted to associated companies and the payment in return by the assignee of a sum reflecting their discounted value. The aim was to relieve JLP of the liability for the tax it would have had to pay each year on the rents assigned and obtain in place of the rents a capital receipt which in economic substance was the equivalent of an amortising loan at a negative rate of interest repayable by instalments equal in amount to the assigned rents over the five year period. By the Decision the Commissioner held that the scheme was effective in achieving this aim. The Revenue challenges the correctness in law of that holding. Section 110 of the Finance Act 2000 contains provisions directed at rent factoring schemes such as the present which have the effect of taxing the price obtained on such assignments, but that section does not have retrospective effect. FACTS JLP is the property holding company for the John Lewis Partnership Group of Companies ("JLPG"). JLP owns the freehold or long leasehold interest in some five substantial properties ("the Properties") which have been let for a number of years for the purpose of its trade to the trading company of JLPG, namely John Lewis Plc ("JL"). In 1995 the Board of JLP agreed with a Dutch bank Rabobank ("the Bank") to adopt a tax saving scheme proposed by the Bank on terms which provided that the Bank should receive a fee of about £480,000 (later reduced to £425,000) if the scheme was not successfully challenged by the Revenue and of £120,000 if it was. Pursuant to this scheme by a Deed of Assignment dated the 20th November 1995 ("the Deed of Assignment") JLP assigned to the Bank the right to receive the rents payable by JL in respect of the Properties (totalling £5,140,000 per annum) for each of the 5 years between the 23rd January 1996 up to and including the 23rd January 2001 ("the Rental Assignment"), in return for which the Bank paid JLP a lump sum of £25,556,762.55 ("the Price"). This figure was calculated as being the value of those rents on the date of the Rental Assignment using a discount rate of 7.56804534%. The term "rents" was defined as including the benefit of the covenant and the right to enforce the covenant and sue for rents. By a Notice of Assignment JLP gave notice of the Rental Assignment to JL on the 20th November 1995 and authorised and requested JL to pay the rents the subject of the Rental Assignment directly to the Bank. By an acknowledgement also of the same date JL acknowledged receipt of the Notice of Assignment and undertook to pay the rents to the Bank. By a further agreement of the same date ("the Guarantee and Indemnity") made between JLP, JL and the Bank, JL gave certain warranties and undertakings to the Bank in relation to its and JLP's financial position, guaranteed to the Bank that JLP would duly perform its obligations under the Deed of Assignment and agreed to indemnify the Bank against various matters including the non payment of the rents. Following the Rental Assignment, JL claims that expenditure equal to the bulk of the consideration received from the Bank on the Rental Assignment has been incurred by it in opening new stores and upgrading its existing stores, and this expenditure is the subject of claims to "roll over relief" made by JLP and JL (as members of a group for the purposes of taxation of chargeable gains) pursuant to Section 175 of the Taxation of Chargeable Gains Act 1992 ("the TCGA 1992"). Pursuant to the accounting standard Financial Reporting Standard 5 ("FRS5") JLP has been required to show the Rental Assignment in its statutory accounts as a loan and accordingly to show the rents the subject of the Rental Assignment as continuing to be receivable. But it is common ground that the Deed of Assignment effected an assignment (at the least) of the contractual right of JLP to receive the rents. Whether the Deed of Assignment effected a transfer of an interest in land is a preliminary issue of importance which I must decide before I turn to the revenue law issue. That revenue law issue is how the receipt by JLP of the Price paid by the Bank in return for the Rental Assignment under the Deed of Assignment is to be taxed. In particular: (1) was it an income or capital receipt in the hands of JLP? (2) if it was an income receipt, was it chargeable to corporation tax ("CT") (which is to be computed in accordance with income tax principles and under the same Schedules and Cases as apply for income tax purposes: see Section 9(1) and (3) of the Income and Corporation Taxes Act 1988): (a) under Schedule A as a receipt arising from or by virtue of JLP's ownership of an estate or interest in the Properties? Or alternatively; (b) under Case VI of Schedule D as an annual profit or gain of an income nature not falling under any other Case of Schedule D and not charged by virtue of Schedule A? (3) if it was a capital receipt for the purposes of CT on chargeable gains (which are to be computed on capital gains tax principles: see Section 8(3) of the TCGA 1992); (a) did JLP by the Rental Assignment make a part disposal of the Properties? or (b) did JLP make an entire disposal (or series of disposals) of rights to the assigned rents? The Commissioner upheld the contentions of JLP that the Price was a capital receipt and that for the purposes of CT on chargeable gains JLP had made part disposals of the Properties. The significance of these findings is that the consequences follow that instead of having to pay CT on the Price: (1) JLP is entitled to deduct part of its acquisition cost of the Properties in computing the chargeable gains accruing to it on the part disposals; and (2) JLP and JL are in principle entitled to claim roll-over relief under Sections 152 and 175 of the TCGA 1992 on the footing that the assets partly disposed of were buildings occupied and used for the purposes of JL's trade within Section 155 Class I, Head A. LEGAL EFFECT OF ASSIGNMENT The preliminary question arises as to whether or not the Rental Assignment effected a transfer of an interest in land or merely a contractual right. It is common ground that: (a) the answer to this question is not decisive either way of the question whether the Price is a capital or income receipt, but if the answer is that it is an interest in land this might be a pointer towards a capital receipt; and (b) the answer is relevant in deciding whether, if the Price is a capital receipt, JLP by the Rental Assignment made a part disposal of the Properties. The legal position prior to the enactment of Section 10 of the Conveyancing Act 1881 ("Section 10"), was that the right to the payment of rent from a lessee was an interest in land for the purposes of the requirement under Section 4 of the Statute of Frauds that a contract to assign or charge an interest in land had to be evidenced in a writing signed by the party to be charged: see Ex p Hall (1879) 10 Ch D 615 (CA); that the assignee could sue the tenant for the rent: see Knill v. Prowse (1884) 33 WR 163; and that on a transfer of the reversion on the lease (a term which in this judgment includes an assignment of a leasehold, and conveyance of a freehold reversion in unregistered as well as a transfer of the leasehold or freehold, reversion in registered land) the right to sue in respect of any breaches of covenant occurring prior to the date of the transfer remained vested in the transferor. Section 10 (which only applied to leases granted after the commencement of the 1881 Act) had the effect of vesting the right to sue in respect of all breaches of covenant occurring before as well as after the date of the transfer in the transferee. Section 10 was re-enacted in the same terms by Section 141 ("Section 141") of the Law of Property Act 1925 ("the LPA") which provides as follows: "(1) The rent reserved by the lease and the benefit of every covenant or provision therein contained, having reference to the subject matter thereof and on the lessee's part to be observed or performed... shall be annexed and incident to and shall go with the reversionary estate in the land .... (2) Any such rent, covenant or provision shall be capable of being recovered, received, enforced and taken advantage of by the person from time to time entitled , subject to the term , to the income of the whole or any part, as the case may require, of the land leased." Subsection (4) provides that the operation of the section is retrospective (and accordingly the section applies in case of pre 1881 leases), but there is a saving of any acquisition by conveyance or otherwise of the right to receive or enforce any rent covenant or provision effected before 1926. Section 205 of the LPA (extending the definition clause in Section 2 of the 1881 Act) provides that in the LPA unless the context otherwise requires, the terms "land and rent" shall have the following meanings: "(ix) 'Land' includes ... a rent or other incorporeal hereditament ... (xix) 'Possession' includes the receipt of rents and profits or the right to receive the same ... (xxiii) 'Rent' includes a rent service or a rentcharge ... reserved or issuing out of or charged upon land." The issue raised is whether the right to a reserved rent, which was an interest in land prior to Section 10, ceased to be such by reason of the provisions of Section 10 and Section 141. The Revenue submit that there is such a change of status. For this purpose reliance is placed on the well established principle that for a right to be recognised as an interest in land, it must be a proprietary interest which is capable of enduring through different ownerships of the land: see National Provincial Bank Ltd v. Hastings Car Mart Ltd [1965] AC 1175 . The Revenue contend that since the enactment of Section 10 the benefit of the tenant's covenant to pay rent ceases to answer this description, because Section 10 and its successor Section 141 preclude a rental assignment binding a transferee of the reversion: they automatically vest the right to the rent in the transferee of the reversion irrespective of any previous assignment of the right by the transferor. Reliance is placed on passages in Re King Decd [1963] Ch 459 ("Re King") and Kataria v. Safeland plc [1998] 1 EGLR 39 ("Kataria") which can be read to this effect. For example, in Re King Diplock LJ says: "The expression 'go with' must be intended to add something to the concept involved in the expression 'annexed and incident to' and in my view connotes the transfer of the right to enforce the covenant from the assignor to the assignee with the consequent cessation of the right to enforce the covenant against the tenant." (at p.497). I reject this submission for five reasons. First the question raised in those cases was the effect of a transfer of the reversion as between transferor and transferee where there was no intention expressed on the face of the transfer or otherwise that the right to enforce the covenant should not pass. In those circumstances the provisions of Section 141 operated according to their terms. The only judge who specifically considered whether the operation of Section 141 could be excluded was Upjohn LJ who said (at p.488): "Of course the assignor and assignee [of the reversion] can always agree that the benefit of the covenant shall not pass, in which case the assignor can still sue, if necessary, in the name of the assignee." Referring to this dictum, Mr Charles Harpum in the sixth edition of Megarry & Wade, The Law of Real Property, comments: "... in a case where, at the time of the assignment of the reversion there were outstanding breaches of covenants to repair and reinstate the property, the assignee and not the assignor is the person entitled to sue. But this rule will, it seems, yield to any contrary intention in the assignment." It is however fair to say that the weight to be given to the dictum for this purpose is limited in view of the concluding words which appear to contemplate that the legal title to the benefit may nonetheless vest in the transferee of the property, occasioning the need for the transferor to sue in the name of the transferee. In Kataria the Court of Appeal held that on transfer of the reversion the transferee could assign back to the transferor the right to recover arrears of rent. No suggestion was made that the assignment could only be effective for the period before the transferee made a transfer of his reversion. Secondly the first stated purpose of the 1881 Act in its Long Title was "Simplifying and improving the practice of Conveyancing": the third stated was "amending in various particulars the Law of Property". The decisions in Re King (and in particular the dictum of Upjohn LJ) and Kataria are (for the reasons I have given) consistent with reading Section 10 and Section 141 as intended merely to simplify and improve the practice of conveyancing by the means (adopted elsewhere in the 1881 Act and the LPA) of incorporating in transfers of reversions provisions which previously needed to be spelt out in terms. The analogy can be drawn with Section 78 of the LPA ("Section 78") which provides: "(1) A covenant relating to any land of the covenantee shall be deemed to be made with the covenantee and his successors in title and the persons deriving title under him or them and shall have effect as if such successors and other persons were expressed." Section 79 of the LPA ("Section 79") provides: "(1) A covenant relating to any land of a covenantor or capable of being bound by him shall, unless a contrary intention is expressed, be deemed to be made by the covenantor on behalf of himself his successors in title and the persons deriving title under him or them and, subject as aforesaid shall have effect as if such successors and other persons were expressed." Although Section 78 (like Section 141 and unlike Section 79) makes no provision for its exclusion by an expression of contrary intention, nonetheless the authorities establish that the benefit will not be annexed if it is made clear expressly or by necessary implication that the benefit is to pass only by express assignment: see Megarry & Wade, 6th ed. p.1030 and cases cited. I can find, and there certainly have been cited to me, no authority since 1881 which suggests: (a) that either Section 10 or Section 141 changed the substantive law in respect of the recognition of the right to rent as an interest in land; or (b) that those sections placed a limit on the right of the proprietor of a reversion to grant rights in respect of the reserved rent which can bind his successors in title; or (c) that Section 141 automatically vested, irrespective of the wishes of the parties, the right to the reserved rent in the transferee of the reversion. Thirdly, amongst the well-established forms of security are the assignment of the right to future rent and the right of a superior landlord whose tenant is in arrears of rent under Section 6 of the Law of Distress Amendment Act 1908 to a transfer of the future rent payments by the under tenants; see e.g. Rhodes v. Allied Dunbar [1989] 1 All ER 1161 and in particular see at p.1166 the reference with apparent approval to Knill v. Prowse above. Their value and purpose would be undermined if the security was always defeasible on a transfer of his reversion by the reversioner. Fourthly in 1911 (long after the 1881 Act) the Court of Appeal held that a transfer of the reversion does not vest the benefit of the lessee's covenants in the transferee free of equities: the vesting is subject to all equities existing between the transferor and the tenant e.g. the discharge of the tenant's liability to pay future rent arising from the acceptance by the transferor from the tenant of a lump sum: see Green v. Rheinberg (1911) 104 LT 149 (CA) and see also Brikom v. Carr [1979] 1 QB 467 at 484F; these authorities establish that a reversioner can grant rights in respect of covenants in the lease which do bind reversioners notwithstanding Section 10 and Section 141. Fifthly it is quite clear that Section 205 treats the right to reserved rent as an interest in land. This both confirms the view I have expressed that Section 10 and Section 141 do not remove the proprietary character of the right to reserved rent; and beyond that it is an independent ground for holding that the law remains the same as it always has been that the right to reserved rent is indeed an interest in land. I accordingly (in agreement with the Commissioner) hold that the Deed of Assignment transferred to the Bank an interest in land. I should add that I reject the argument of Mr Goldberg that Section 141(2) expressly confers on the Bank as assignee of the right to the rents the right to sue for breach of covenant. Mr Goldberg argues that this entitlement arises because the Bank is (within the meaning of the subsection) "entitled subject to the term to the income ... of the land leased"; and it is established this language extended prior to 1926 to a mortgagor who had conveyed or assigned the reversion to a mortgagee see Rickett v. Green [1910] 1 KB 253 approved in London & County Ltd v. Wilfred Sportsman [1971] Ch 764 at 784. The short answer is that the Bank was only entitled to the rent reserved by the lease but not ("subject to the lease" or otherwise) to the income of the land. CAPITAL OR INCOME RECEIPT The first question raised is whether the Price was capital or income in the hands of JLP. This must be answered by reference to what may be called the common law of tax rather than by reference to any particular statutory provision. The starting point in the search for the answer is provided by the celebrated dictum of Dixon J in Hallstroms Pty Ltd v. Federal Commissioner of Taxation [1946] 72 CLR 634 at 648 ("Hallstroms") which Lord Nolan quoted with approval giving the judgment of the Privy Council in CIR v. Wattie [1999] 1 WLR 873 at 880 ("Wattie"). Lord Nolan said: "It is well settled that in considering whether a particular item of receipt or expenditure is of a capital or revenue nature, the approach to be adopted should be that described by Dixon J in [Hallstroms] where he said that the answer to the question: 'depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights if any, secured, employed or exhausted in the process.'" This approach entirely accords with the approach adopted by Browne-Wilkinson V-C in McClure v. Petre [1988] 1 WLR 1386 ("McClure") and by Lord Hoffmann in his speech (with which the other law lords agreed) in Macniven v. Westmoreland [2001] 2 WLR 377 ("Macniven"). I shall subsequently quote passages from both cases. The authorities offer as a guide the principle that a receipt for the recurrent produce of an asset and compensation for the loss of such produce or to make good a hole in the receipts from such produce constitute income, whilst a receipt for the asset or part of the asset or for the permanent impairment or sterilisation of an asset constitutes capital. On the capital side of the line it is sufficient to refer to four cases. In Glenboig Union Fireclay Co Ltd v. IRC 12 TC 427 ("Glenboig") compensation paid to a fire-clay company whose business consisted in mining fire-clay for sterilisation of fire-clay on its land was capital. In Trustees of Earl Haig v. CIR [1939] SC 676, the consideration received in return for the grant of access to the diaries of Earl Haig was held capital because the grant constituted the realisation of the full commercial value of the diaries. In Nethersole v. Withers 28 TC 501 , the price received for the assignment of the film rights (a partial assignment of the copyright) in a work constituted capital. In McClure consideration for the grant of a licence to deposit subsoil on land was held to be capital on the ground that the licence exhausted the potential of the land for this purpose. On the income side of the line, it is sufficient to cite three cases. In Deeny v. Gooda Walker [1996] 1 WLR 426 compensation for the failure of an agent to receive a sum of money which (if received) would have borne the character of income is to be treated in the same way as the money would have been treated i.e. as income. In Lowe v. Ashmore [1971] Ch 545 a payment in consideration of the right to remove turf from land was held to be income, because there remained vested in the landowner the right recurrently to grow and sell turf in the future. In Raja's Commercial College v. Gian Singh & Co Ltd [1977] AC 312 damages for trespass were held to constitute income receipts. The general principle is conveniently and authoritatively stated by Browne-Wilkinson V-C in McClure at 1389 and 1392-1393: "In my judgment it is equally established by authority that to decide whether a particular receipt is in the nature of income or in the nature of capital one has to look at all the circumstances of the particular case and apply judicial common sense in reaching a conclusion as to how the receipt is to be classified.... In my judgment Lowe v. JW Ashmore Ltd is only authority for the proposition that a receipt in consideration of the right to exploit one aspect of the land is income when there is a possibility that such exploitation may again be possible in the future and that accordingly payments of the same nature may recur. It is obviously also limited to the case where there has been no disposal of the land or any interest in it. In my judgment it does not cover the present case where, as I have held, there is a finding that there is no possibility of a recurrence of the receipt of a payment in consideration of permission to dump soil on land .... The substance of the present matter is that the payments were received by the taxpayer as consideration for a once-and-for-all disposal of a right or advantage appurtenant to the land - namely the right or advantage of using it for dumping.... That strikes me as a disposal of a capital nature, whether it was effected, by a licence, involving a contractual arrangement without the disposal of a legal right or whether it was effected, as it could have been, by the grant for a lump sum of a long term of years to the company with a lease back. The liability to tax in such a case should in my judgment depend not on the technical machinery by which the transaction is carried through, but on the substance of what was done." The nature of the transaction effected by the Rental Assignment was the sale of the benefit of covenants for the payment of rent for a five year period. Whether the transaction operated to sell an interest in land is of limited (if any) importance on this issue, for (as Browne-Wilkinson V-C said in McClure), the legal character of the receipt depends, not on the technical machinery by which the transaction is carried through, but on the substance of what was done. It is clear that the payment of a lump sum in consideration of the sale of an income stream together with the underlying asset producing such income stream is a capital receipt, and likewise is a lump sum in consideration of an income stream when there is no underlying asset (e.g. an annuity). The question raised is whether the position is the same where the lump sum is paid in consideration for an income stream where the underlying asset is retained by the vendor. Mr Goldberg submits that it is a fundamental principle of income tax law that the sale of an asset or part of an asset, or a transaction having the effect of a sale, not in the course of trade produces a capital receipt outside the scope of taxes on income. The primary authority relied on by Mr Goldberg, and the authority on which the Commissioner decided this issue in favour of JLP, was the decision of the Court of Appeal in Paget v. IRC 21 TC 677 ("Paget"). The relevant facts are concisely stated in the headnote: "Miss Paget held certain Hungarian Bearer Bonds the interest coupons of which were payable in London in Sterling and in certain other countries in the respective currencies of those countries. By a Decree dated 22 December 1931 the Hungarian Government directed that the interest on the Bonds should not be paid direct to creditors but that its equivalent in pengos should be deposited with the Hungarian National Bank and placed in a foreign creditors' fund, out of which Bondholders might obtain payment of interest coupons in pengos, but only for use for certain purposes in Hungary. Miss Paget did not obtain payment in this way, but sold certain coupons, after they had fallen due, through agents or coupon dealers in London, who deducted income tax on payment to her of the proceeds of such sales. Miss Paget also held certain Bearer Bonds of the Kingdom of Jugoslavia the coupons of which were payable in American Dollars in New York. On 24 July 1933, the Jugoslavian Government gave notice of its inability to pay the interest in full and offered to meet the coupons maturing from 1 November 1932 to 1 May 1935 either by payment in 'blocked' dinars in Belgrade or by payment of 10 per cent of their face value in dollars and by the issue of funding Bonds for the balance. Miss Paget did not accept this scheme but in September 1933 sold the interest coupons due on 1 November 1932 and 1 May 1933 through agents or coupon dealers in London, who deducted income tax on payment to her of the proceeds of such sale." The question raised was whether the purchase price for the coupons was "income arising from securities" chargeable to income tax under Case IV of Schedule D. The Court of Appeal unanimously held that it was not. At page 692 Sir Wilfred Greene, MR said: "The purchase price received by Miss Paget was not income arising from the Bonds at all. It arose from contract for sale and purchase whereby Miss Paget sold whatever right she had to receive such income in the future, as well as her right to take what was offered by the defaulting debtors. It is, in my opinion, quite impossible to treat this as equivalent in any sense to 'income arising from' the Bonds." At page 699 Lord Romer said: "In these circumstances, the only question to be decided is whether the proceeds of sale of a right to receive income in the future can be treated as income for the purpose of the Income Tax Acts. The question thus broadly stated plainly admits of but one answer, and that answer must be in the negative. The proceeds of sale for a lump sum of an annuity, for instance, are capital in hands of the vendor and not income. And this is true even when the subject of the sale is not the annuity for its whole duration, but the right to be paid the annuity for a number of years, or even for one year." At page 700 he continued: "The transactions appear to have been bona fide transactions of sale and purchase. The moneys received from them by Miss Paget were held by Finlay J to be simply the purchase price of the coupons, and in no sense income from foreign securities. In my judgment he was right in so holding, and the appeals should be dismissed with costs." At page 702 Mackinnon LJ said: "In both these cases the foreign debtors had defaulted and refused to pay the interest promised by the bonds. Budapest offered to pay instead a certain amount of pengos ... Yugoslavia offered instead to pay in dinars ... What Miss Paget sold was the possibility of making some money abroad upon the acceptance of these offers ... The fundamental fact is that no interest or dividends have been paid on these securities ..." Accordingly the ratio decidendi of all three judges was that the price received did not arise from the securities, but from the contracts for sale, and accordingly fell outside the charging provision. Lord Romer at p.700 reached the same conclusion, but (at p.699) did so expressly on the basis that the proceeds of sale of a right to receive income in the future cannot be treated as income for income tax purposes. Section 24 of the Finance Act 1938 (later re-enacted in Section 730 of the Income and Corporation Taxes Act 1988) reversed the effect of the decision in Paget and for the future the recipient of the payments which Mrs Paget received is deemed to have been in receipt of income. This statutory amendment of the legislation does not however affect any statement of principle to be deduced from the decision. The question before me is whether I (like the Commissioner) should follow the principle stated by Lord Romer. In answering this question the submissions have concentrated on three suggested sources of guidance: (1) the judicial views of Paget expressed in two recent Australian authorities; (2) the principles to be deduced from a wide range of domestic authorities on the distinction between capital and income; and (3) the related provisions (and the premise for the provisions) of the Finance Act 2000. THE AUSTRALIAN AUTHORITIES The Australian cases were concerned with Sections 25 and 26 of the Australian Income Tax Assessment Act 1936-1973 which (so far as material) provide as follows: "25(1) The assessable income of a taxpayer shall include— (a) where the taxpayer is a resident—the gross income derived directly or indirectly from all sources whether in or out of Australia; ... 26 The assessable income of a taxpayer shall include— (a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale or from the carrying on or carrying out of any profit-making undertaking or scheme; ..." In Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 18 ATR 696 ("Myer") the full Court of the High Court of Australia had to consider the revenue consequences of a scheme similar to that under consideration in this case. A company in need of working capital under a scheme designed to provide finance at a negative cost lent $80 million at a commercial rate of interest to an associated company for a period exceeding seven years and then sold for $45.3 million to a bank the interest due over seven years on the loans. The court held because the company entered into the two transactions as part of one scheme with the intention or purpose of making a relevant profit gain from the transaction the sale price constituted income falling within Section 26(a); and it also constituted income falling within Section 25(1) because the sale of a mere right to interest for a lump sum representing the present value of the future interest is a revenue, and not a capital, item. In respect of the latter holding the Court stated: "If a lender sells his mere right to interest for a lump sum the lump sum is received in exchange for, and ordinarily as the present value of, the future interest which he would have received. This is a revenue, not a capital item—the taxpayer simply converts future income into present income." The Court went on to distinguish Paget (at p.704) "Unlike the sale of the coupons in Paget , the sale of a right to interest severed from the debt is not a sale of a tree of which the future payments are the fruit. The present case may thus be distinguished from the view of the facts which was the foundation of the decision in Paget . If Paget is not to be distinguished in this way, we should be unable to accept its authority for the purposes of the Act." The decision in Myer was followed by Henry Jones (IXL) Ltd v Federal Commissioner of Taxation (1991) 22 ATR 328 ("Henry Jones"). In Henry Jones under a scheme to convert taxable income into a tax-free capital sum, the taxpayer sold to a bank the right to royalty payments under an agreement for the use of registered trademarks for a lump sum. Hill J said (at p.341): "Notwithstanding some doubt, I think Myer must be taken as establishing that, except in the case of an assignment of an annuity where the income arises from the very contract assigned, an assignment of income from property without an assignment of the underlying property will, no matter what its form, bring about the result that the consideration for that assignment will be on revenue account, as being merely a substitution for the future income that is to be derived." Hill J went on to point out that the principle as so stated was consistent with the case law on compensation for loss of income rights and concluded (at p.342) that he could: "see no reason why the 'compensation principle' should not apply to a realisation of assets case." The principle reached in Australia, namely that the income character of income sold for a lump sum attaches to the lump sum is in total conflict with the view expressed by Lord Romer. The decision in Myer was the subject of a brief mention by the Privy Council in Wattie, an appeal from New Zealand. The issue which arose was whether a negative premium paid to a firm of accountants to take a lease and become anchor tenants in a development was a capital or income receipt. The Privy Council (affirming the decision of the New Zealand Court of Appeal) held that the receipt of a negative premium (like the receipt by the landlord of a positive premium) was (in the absence of special circumstances) a capital receipt. The reference made to Myer was to the part of the decision resting on Section 26(a). No consideration was given to the passages in the judgment in Myer relating to Section 25(1) which alone are of any relevance in this case. DOMESTIC AUTHORITIES I have been referred to no domestic authorities where Paget (still less the judgment of Lord Romer) has been further considered. I am told that the explanation for this is that until this case the Revenue was content to accept the proposition of law stated by Lord Romer to be good law; that in IRC v. McGuckian [1997] 1 WLR 991 ("McGuckian") counsel for the Revenue informed the House of Lords that the Revenue might at some time wish to invite the re-examination of that proposition; but the Revenue declined the opportunity offered by Lord Steyn to have that re-examination in that case because they were not prepared for this exercise. It is I think convenient to consider together McGuckian and the later decision of the House of Lords in Macniven where McGuckian and the principles stated by the House of Lords in Ramsay v. IRC [1982] AC 300 ("Ramsay") and following cases were the subject of a definitive analysis by Lord Hoffmann (with whose speech the other law lords agreed). In Macniven Lord Hoffmann held that the principle laid down in Ramsay and succeeding cases requires the court as the first step in a purposive construction of the statute in question to identify the concept to which the statute refers and to determine whether the concept is a legally defined concept or a commercial concept i.e. "a concept which Parliament intended to be given a commercial meaning". If the concept is a legally defined concept (e.g. "payment" of interest), the concept cannot (in the absence of expression of some statutory policy to the contrary) be given a wider or narrower meaning so as to disregard or cancel the effect of transactions answering that description because they have no commercial purpose other than to avoid tax. But if the concept is a commercial concept (e.g. "disposal" or "loss") and accordingly the statute applies the test of ordinary business, the court is required to look beyond the juristic individuality of component parts of a transaction: steps which have no commercial purpose but have been artificially inserted for tax purposes into a composite transaction will not affect the answer to the question of statutory construction (e.g. whether there has been a profit or loss). Lord Hoffmann went on to analyse McGuckian: "51. In the McGuckian case [1997] 1 WLR 991 a Republic of Ireland company called Ballinamore had substantial distributable reserves. The shareholders, Mr and Mrs McGuckian, wanted to receive this money but not to pay income tax on the dividend. So they entered into a scheme by which they first transferred their shares to an offshore trustee called Shurltrust. By a series of pre-planned transactions, it then assigned the right to receive the dividend to a UK company called Mallardchoice in consideration of the payment of a sum equal to 99% of the expected dividend. Ballinamore then declared the dividend and paid it to Mallardchoice, which immediately paid 99% to Shurltrust. 52. The statutory question was whether Shurltrust had received income or capital. If it was income, the effect of various tax avoidance provisions concerning the transfer of assets abroad was that the payment would be deemed to be income of the McGuckians. If it was capital, the McGuckians would not be liable for tax. The McGuckians said that if Shurltrust had simply received the dividend, it would of course have been income. But Shurtltrust did not receive the dividend. It received a payment from Mallardchoice which was a capital payment for an assignment of its right to income. 53. ... The payment of the money by Mallardchoice to Shurltrust was the consideration for the assignment and an integral part of that transaction. 54. ... In the McGuckian case [the question] was the nature of the payment received by Shurltrust—capital or income? ... The question was not whether the assignment should be disregarded but whether, from a commercial point of view, it amounted to an exchange of income for capital. Such exchanges usually have a commercial reality: the purchase or sale of an annuity, for example, is an exchange of capital for an income stream, involving a transfer of risk. But the transaction in the McGuckian case was nothing more than an attempt to relabel a sum of money. The fact that the assignment had no commercial purpose did not mean that it had to be disregarded. But it failed to perform the alchemy of transforming the receipt of a dividend from the company into the receipt of a capital sum from someone else. For the purpose of the fiscal concept at stake, namely the character of the receipt as income derived from the company, it made no difference. ... 59. Even if a statutory expression refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax reasons. Business concepts have their boundaries no less than legal ones.... 60. Likewise the use of business concepts like 'income' and 'capital' may give the taxpayer a choice of structuring a commercial transaction so as to come within one concept or the other. As Lord Greene MR said in a celebrated passage in Inland Revenue Comrs v. Wesleyan and General Assurance Society [1946] 2 All ER 749,751: 'In dealing with income tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted, tax will be payable. If the other method is adopted, tax will not be payable. It is sufficient to refer to the common case where property is sold for a lump sum payable by instalments. If a piece of property is sold for £1,000 and the purchase price is to be paid in ten instalments of £100 each, no tax is payable. If, on the other hand, the property is sold in consideration of an annuity of £100 a year for ten years, tax is payable. The net result, from the financial point of view, is precisely the same in each case, but one method of achieving it attracts tax and the other method does not.' 61. It follows that a transaction which, for the avoidance of tax, has been structured to produce, say, capital, and does produce capital in the ordinary commercial sense of that concept (unlike the payment in Inland Revenue Comrs v. McGuckian [1997] 1 WLR 991 ) cannot be 'recharacterised' as producing income: see Comr of Inland Revenue v Wattie [1999] 1 WLR 873 ." 37. The guidance afforded by Lord Hoffmann in my view supports the approach of Lord Romer in Paget and reinforces the view that the Price received by JLP was capital and not income: (1) JLP was perfectly entitled for the avoidance of tax to structure its commercial transaction with the Bank so that in place of an income receipt of rent it received a capital sum. There is no broad "economic equivalence test" entitling the court to treat a capital item as income because it is the economic equivalent of income; (2) the transaction produced in the hands of JLP, in place of an income stream, an up-front capital sum. (3) the Price was not merely (as in McGuckian) the Bank's receipt of the rents from the lessees "re-labelled": it was a distinct sum paid out of the resources of the Bank under a transaction which had commercial reality; (4) in these circumstances it is not open to the court to recharacterise the Price as income; (5) the reference by Lord Hoffmann to exchanges of income for capital involving a transfer of risk does not mean that there can be no such exchange for tax purposes in any particular case unless there arises a substantial risk of loss through non-payment which is unsecured or unprovided for. In any event there is in this case a theoretical risk of loss undertaken by the Bank if JLPG, JLP and JL went into insolvent liquidation. 38. Further support for this view is to be found in the premise on which McGuckian was decided and McGuckian was reviewed in Macniven. That premise was that a lump sum payment received in return for the sale of an income stream where the underlying asset is retained by the vendor at least prima facie constitutes capital. The premise is spelt out in the speech of Lord Browne-Wilkinson in McGuckian at pages 995-6 where he said: "The crucial question, therefore, is whether in the present case the moneys received by Shurltrust as consideration for the assignment of the right to the dividends from Ballinamore fall to be treated as "income" of Shurltrust. Prima facie those moneys, being the price of the sale by Shurltrust of its right to the future dividends of Ballinamore, constitutes capital, not income." I fully recognise that I may not technically be bound by a proposition assumed to be correct by the House of Lords, but in this context it must reinforce the view expressed by Lord Romer and I should accept that view so reinforced. 39. I reach this conclusion with reluctance. I have sympathy with the approach of the Revenue that the price obtained for a temporary disposal of "the fruit of a tree" or of the produce of an income producing asset should be taxed as income. That is the approach adopted by the Australian cases. The approach has the attraction that it will strike down attempts to exploit devices to exempt from income tax which can only have the effect of transferring the tax burden on to others. The approach might have been thought justified in this case by certain of the very wide dicta in Ramsay and succeeding cases, but the constraints imposed by the reformulation of the principles to be derived from those cases expounded in Macniven to my mind are indicative that for that approach to be adopted here legislative rather than judicial action is required. (I may add that this would appear to have been the approach of the legislature in enacting the Finance Act 2000: see below). A premium paid for a lease is capital even though in reality it may only constitute and be calculated as a prepayment of rent. So also is the Price in this case. 40. I accordingly hold that the Price constituted capital and not income. THE FINANCE ACT 2000 ("the FA 2000") 41. It is accordingly unnecessary to decide this case by reference to the provisions of the FA 2000. But I shall add that its provisions give some comfort to the decision which I have reached, for it is clear that Parliament in enacting the FA 2000 proceeded on the basis that the law is as I have held. 42. Section 43B of the FA 2000 provides that in the case of a rental assignment agreement such as the one under consideration taking place after the date of the Act, the consideration received will be 'taken into account in computing the profits of the schedule A business for the chargeable period in which the agreement is made.' Section 43C however provides that Section 43B shall not apply to medium and long term transactions involving finance agreements 'if the term over which the financial obligation is to be reduced exceeds fifteen years.' The inference drawn by Mr Goldberg from this legislation is that in enacting the FA 2000 the legislature proceeded on the basis that transactions such as the Deed of Assignment gave rise to a consideration which was to be viewed as capital rather than as income, that Section 43B would alter the position in respect of future similar arrangements involving periods of 15 years or less, but that the receipts in respect of arrangements involving periods of longer than 15 years should continue to be treated as capital rather than sums chargeable to income tax under Schedule A. I agree that this is the fair inference to be drawn, but I do not think that this statutory provision can shed much (if any) light on the relevant law in force five years previously. HEAD OF CHARGE 43. If I had held that the Price was an income, and not a capital receipt I would have held that it fell within one or other of the suggested heads of charge. Since on my view of the capital character of the receipt the question does not arise, I can express my view very shortly. In 1995/6, the Schedule A charge in ICTA 1988 Section 15 applied to: "the annual profits or gains arising in respect of any such rents or receipts as follows, that is to say— ... (c) other receipts arising to a person from or by virtue of his ownership of an estate in or right over such land [i.e. land in the United Kingdom]." 44. For the Price to fall to be charged under paragraph 1(c) of Schedule A depends on whether (i) it was a receipt which arose to JLP "from or by virtue of [its] ownership of an estate ... in land" and (ii) that receipt gave rise to an annual profit or gain of an income nature. 45. The Revenue submit that the Price arose from or by virtue of JLP's ownership of the freehold or long leasehold reversions in the Properties, for it was the consideration for the assignment of rents annexed to or issuing out of such reversions and accordingly incidents of its ownership of them. Reliance is placed on the decision of the Privy Council in Raja's Commercial College v. Gian Singh & Co Ltd [1977] AC 312 at 318 where it held that damages for trespass to land fall within the expression "other profits arising from property" in Section 10 of the Income Tax Act of Singapore. JLP submit that the Price does not arise from or by virtue of the ownership of land, for by the transaction JLP ceased to be owners of the right to the rents. 46. In my view the wording of (c) is wide and general (see Lowe v. Ashworth supra at p.554D and 561D) and ample enough to embrace the Price. 47. The alternative suggested head of charge is Case VI of Schedule D which is set out in Section 18(3) of the ICTA 1988: "Case VI: tax in respect of any annual profits or gains not falling under any other Case of Schedule D and not charged by virtue of Schedule A ... C or E." I am satisfied that if the Price were to be treated as an income receipt not falling within any other head, it should be treated as a prepayment of the rents which falls within this head as annual profits attributable to the year of receipt. THE CAPITAL GAINS TAX QUESTION 48. On the basis (as I have held) that the Price was a capital receipt, the question arises whether JLP in entering into the Rental Assignment made a part disposal of the Properties or an entire disposal of rights to the assigned rents for the purposes of Section 21(2) of the TCGA 1992. This section reads as follows: "(2) For the purposes of this Act— (a) references to a disposal of an asset include, except where the context otherwise requires, references to a part disposal of an asset, and (b) there is a part disposal of an asset where an interest or right in or over the asset is created by the disposal, as well as where it subsists before the disposal, and generally there is a part disposal of an asset where, on a person making a disposal, any description of property derived from the asset remains undisposed of." 49. The Revenue concede that, if the right disposed of by the Rental Assignment was an interest in land, there was a part disposal of the Properties for capital gains tax purposes. Since I have held that the right disposed of did constitute an interest in land, JLP accordingly succeed on this issue: there was a part disposal of the Properties. If I am wrong and the right disposed of did not constitute an interest in land, but only a contractual right, it would be necessary to identify from which asset the Price was derived. In the circumstances I can deal with this question very shortly. JLP say it was the underlying Properties; the Revenue say it was JLP's contractual rights to the rents assigned. It is common ground that this question must be approached as a matter of business reality (see Aberdeen Construction Group Ltd v. CIR [1978] AC 885 ; Zim Properties v. Proctor 58 TC 371 at 391-2; and Pennine Raceway Ltd v. Kirklees Metropolitan Council [1989] STC 122 at 130h-j, 133 g-h and 137a). The answer is that the disposal reduced the value of the Properties in the hands of JLP; JLP did not own the Properties unaffected and unimpaired, even if (because the rights sold did not constitute an interest in land) a purchaser would acquire the Properties unaffected and unimpaired. That it seems to me is sufficient for the Price to be regarded as a matter of business reality and common sense as being derived from the Properties. CONCLUSION 50. Accordingly I agree with the conclusions of the Commissioner that the Price was capital derived from the Properties and I dismiss this appeal. © 2001 Crown Copyright BAILII: Copyright Policy | Disclaimers | Privacy Policy | Feedback | Donate to BAILII