Case Comment: UBS AG v Commissioners for Her Majesty’s Revenue and Customs  UKSC 13
22 Friday Jul 2016
Cases about tax avoidance attract attention, particularly in the current political climate. But when a case concerns big banks setting up schemes to avoid paying income tax on bankers’ bonuses, that attention is, perhaps unsurprisingly, magnified. This was one such case.
Unanimously allowing HMRC’s appeal and adopting a particularly broad, purposive approach to its analysis of the relevant legislation, the Supreme Court held that the two schemes in question, set up by UBS and Deutsche Bank respectively, could not benefit from the statutory exemption of which they sought to take advantage, since the schemes had no business or commercial purpose. Their purpose was simply to avoid tax.
The schemes set up by UBS and Deutsche Bank differed slightly in some respects, but were sufficiently close that the two cases were held together. Both sought to take advantage of an exemption in the Income Tax (Earnings and Pensions) Act 2003, Chapter 2 of Pt 7, as amended by the Finance Act 2003, Sch 22. Prima facie, the receipt of shares by an employee as part of their remuneration package is liable to income tax on the value of the shares, less any consideration given for them. However, Chapter 2 provides an exemption in cases of employment-related restricted securities.
Seeking to take advantage of this exemption, the two banks, instead of paying cash bonuses to their employees, each bought redeemable shares in an offshore company set up for the sole purpose of the scheme. These shares were then offered to the employees to whom a bonus had been earmarked. In order to fall under the statutory exemption, the shares had to come with certain conditions and restrictions. In both cases, the forfeiture restrictions were contingent on events that, whilst possible (they had to be, otherwise the entire arrangement would be a sham), were highly unlikely. These restrictions would later be lifted, avoiding the triggering of a tax charge. The shares would then become redeemable by the employees for cash, which they could pocket immediately or wait a further two years and pay Capital Gains Tax at a rate of only 10%.
The FTT, UT, and Court of Appeal
As far as the banks and their advisers were concerned, both schemes fell squarely within the statutory exemption. The First-Tier Tribunal, however, thought otherwise. Viewing the schemes as a whole, taking account of their purpose and the surrounding facts (adopting what is known in the tax experts’ lexicon as a “Ramsay” approach, so-called after a landmark case that introduced purposive construction to tax legislation), the Tribunal concluded that they fell outside the exemption contained in the legislation. When passing the legislation, Parliament had not envisaged that schemes such as this, which lacked any commercial purpose, would fall under the exemption. The schemes had only one purpose: to avoid tax.
The Upper Tribunal and the Court of Appeal adopted, in the later words of the Supreme Court, a more “literal construction of Chapter 2…applying it to a correspondingly formal analysis of the facts”. In their view, there was no doubt that the schemes followed the letter of the legislation. A more purposive approach was inappropriate, not least because there was no obvious purpose to Chapter 2 to which such an approach could even be attached.
The Supreme Court
HMRC appealed to the Supreme Court, still advocating for the adoption of a broader Ramsay approach. The Supreme Court duly obliged, signalling a preparedness to adopt a purposive interpretation of the legislation despite the lower court’s observation of “the inability of all counsel to explain the rationale of the tax exemption” at issue.
The Supreme Court analysed the background to Chapter 2 and its context. Pt 7 was clearly concerned with the promotion of employee share ownership. However, the court’s view, supported by previous case law, was that its purpose was also to counter tax avoidance. That being so, it would be difficult to attribute to Parliament an intention to include within the exemption those schemes that, whilst falling within its scope on a purely technical approach, were, in fact, solely created for the purpose of avoiding tax. The court concluded, therefore, that the relevant provisions of the legislation applied only to those arrangements that had a business or commercial purpose.
With that in mind, the court took a further look at the schemes in question. The court held that it was difficult to attribute any commercial or business purpose to them. The conditions that were placed on the securities were “completely arbitrary” “artificial”, and “existed solely to bring the securities within the scope” of the statutory exemption. The exemption, therefore, did not apply. The result was that income tax was due on the value of the shares at the point of acquisition. HMRC had also attempted to argue that the shares should, in fact, be treated as cash and taxed accordingly. Perhaps this was one step too far: although the Supreme Court was prepared to accept that the shares were not restricted securities, they were clearly shares.
The Supreme Court’s judgment represents a significant step in the interpretation of fiscal legislation post-Ramsay. The willingness of the court to adopt a purposive approach to interpreting a provision that, on the face of it, has no declared purpose, perhaps signals the lengths the court is prepared to go to ensure that schemes set up for the sole purpose of avoiding tax do not survive. The judgment will divide opinion. To the layman, it will be welcomed: the Supreme Court coming to the rescue to stop bankers avoiding tax. To tax lawyers and advisers, it is a cautionary reminder of the uncertainty that lies at the heart of purposive construction: whether any scheme will survive the court’s fine toothcomb will turn on the facts of each individual case.