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On 19 October 2011, the Supreme Court (Lord Hope, Lord Walker, Lord Mance, Lord Clarke and Lord Wilson) released its decision in the joined cases of R (Davies & Anor) v The Commissioners for Her Majesty’s Revenue & Customs and R (Gaines-Cooper) v The Commissioners for Her Majesty’s Revenue & Customs [2011] UKSC 47.

All three taxpayers were unsuccessful in their public law challenges to HMRC’s decision to treat them as UK-resident for tax purposes during the relevant tax years. This case comment examines the decision and its ramifications, including the need for caution when relying on HMRC guidance as a taxpayer and the need for a clear statutory test for determining residence.

Background facts

The Appellants

Mr Davies and Mr James (the “First Appellants”) are British citizens who were born in the UK and lived and worked in Wales until 2001. In March 2001 they took out leases over furnished apartments in Brussels and began to reside in them. At the same time, they incorporated and became directors of a Belgian company (“Beaufort”), in which each held one-third of the share capital. They also entered into contracts of employment for full-time work with Beaufort covering a period of three years from 1 April 2001. In fact, the Appellants did not commence working for Beaufort until after 5 April 2001. Neither of the First Appellants sold their homes in Swansea; their wives (and, in the case of Mr Davies, his daughters) continued to live in Wales; and the First Appellants returned frequently to Swansea in order to see their families, or in connection with their UK business interests or their ties to local sporting institutions. In December 2001, the First Appellants realised capital gains by disposing of their shares in a UK company in a share buy-back.

Mr Gaines-Cooper (the “Second Appellant”) is a British citizen who was born in England and lived and worked in the U.K. until the mid-1970s. In 1975 he bought a house in the Seychelles and from 1976 onwards he spent, on average, several weeks a year in the Seychelles. Between 1976 and 2004 he led an international existence, establishing and managing business interests in several different countries. However, throughout almost all of this period he had a house available for his use in the UK and he spent, on average, about three months a year in the UK. In 1993 he married a woman who was a Seychellois citizen, but who had lived in the UK since 1977. In 1998 they had a son, who was born in the UK. The Second Appellant’s wife and son lived in the UK during term-time, but joined him in the Seychelles (or wherever he happened to be) during school holidays.

IR20

The status of being “resident” in the UK renders individuals liable to UK income tax and capital gains tax. However, the concept of residence is not currently defined in statute (although the government’s proposal to introduce a comprehensive statutory definition of residence for individuals is presently under consideration). As such, it has been left to the courts to provide guidance on the meaning of “residence”. Unfortunately, the case law on this topic is complex and has failed to yield tests of easy or certain application.

Against this background, the Inland Revenue published a booklet providing guidance on the circumstances in which individuals would be treated as resident in the UK for tax purposes, known as IR20. IR20 existed in various guises from 1973 until April 2009, when it was replaced by HMRC6.

The issues

HMRC had determined that the Second Appellant was resident in the UK for the tax years 1993/94 to 2003/04; and also that the First Appellants were so resident for the tax year 2001/02. Both the First Appellants and the Second Appellant (together “the Appellants”) sought judicial review of these determinations.

The primary contention of the Appellants was that, on its correct construction, the guidance in IR20 contained a more benevolent interpretation of the circumstances in which an individual becomes non-resident in the UK than is reflected in the ordinary law and that the Appellants had a legitimate expectation, which the courts should enforce, that this more benevolent interpretation would be applied when determining their status for tax purposes. The secondary (and alternative) contention of the Appellants was that, even if, when properly construed, IR20 did not contain a more benevolent interpretation of residence than is reflected in the ordinary law, it was the settled practice of HMRC to adopt such a benevolent interpretation of the booklet and that this practice was such as to give rise to a legitimate expectation, which the courts should enforce, that this interpretation would be applied when determining their status for tax purposes.

The decisions below

The most relevant passages in IR20, on which the Appellants primarily founded their case before the Court of Appeal, are set out below.

“Leaving the UK permanently or indefinitely

2.7        If you go abroad permanently, you will be treated as remaining resident and ordinarily resident if your visits to the UK average 91 days or more a year …

2.8        If you claim that you are no longer resident and ordinarily resident, we may ask you to give some evidence that you have left the UK permanently, or to live outside the UK for three years or more. This evidence might be, for example, that you have taken steps to acquire accommodation abroad to live in as a permanent home, and if you continue to have property in the UK for your use, the reason is consistent with your stated aim of living abroad permanently or for three years or more. If you have left the UK permanently or for at least three years, you will be treated as not resident and not ordinarily resident from the day after the date of your departure providing…[viz the “day-count proviso” set out in paragraph 2.9 below].

2.9        If you do not have this evidence, but you have gone abroad for a settled purpose (this would include a fixed object or intention in which you are going to be engaged for an extended period of time), you will be treated as not resident and not ordinarily resident from the day after the date of your departure providing:

– your absence from the UK has covered at least a whole tax year and;

– your visits to the UK since leaving:

– have totalled less than 183 days in any tax year and;

– have averaged less than 91 days a tax year . . . [the “day-count proviso”]”

The Appellants contended that, on their correct construction, these paragraphs gave rise to a legitimate expectation that an individual would be treated as non-UK resident if they could adduce evidence of having left the UK permanently or indefinitely, or for a settled purpose, and also meet the “day-count” proviso. HMRC contended that, viewing these paragraphs in the context of the entirety of the guidance provided in IR20, they are subject to a requirement that taxpayers first demonstrate that they have made a distinct break from their ties in the UK, in order to establish that they had left permanently or indefinitely.

The Appellants also argued that, prior to 2004/5, HMRC had customarily applied their (correct) construction of these paragraphs in IR20. HMRC’s practice of applying this construction had itself given rise to a legitimate expectation, on the part of the Appellants, that their cases would be dealt with in accordance with this construction. However, from 2004/05, HMRC had changed its approach by (incorrectly) beginning to construe these paragraphs as requiring taxpayers to first demonstrate that they had made a distinct break from their social and family ties in the UK, in order to establish that they had left permanently or indefinitely.

In February 2010, the Court of Appeal rejected the Appellants’ interpretation of IR20. The adverbs “permanently” and “indefinitely”, as used in paragraphs 2.7 to 2.9 of IR20, demonstrated that social and family ties in the UK had to be “severed” in order for residence to come to an end. This was because the extent to which an individual retains social and family ties within the UK must have a significant and often dispositive impact on the question whether a taxpayer has left the UK permanently or indefinitely.

Regarding the Appellants’ second argument, the Court of Appeal accepted that there was some correspondence that supported their case that, in 1999, HMRC did not insist on the severance of social and family ties within the UK, in cases falling under paragraphs 2.7 to 2.9 of IR20. However, that correspondence was of insufficient evidential weight to support the Appellants’ contention and, in general, the evidence showed that HMRC’s approach to IR20 had not changed.

It is noteworthy that the Court of Appeal held that, should a taxpayer fall squarely within the terms of an assurance given by HMRC in guidance documents such as IR20, HMRC will not be permitted, as a matter of public law, to resile from that assurance unless and until it announces that it proposes, for the future, to alter the relevant policy.

The Supreme Court decision

In the Supreme Court, the First Appellants primarily relied upon paragraph 2.9 of IR20. They contended that, on the correct construction this sub-paragraph, HMRC had given a binding assurance that if (as appeared to be the case) they went abroad for a settled purpose for at least one tax year, and also satisfied the day-count proviso, HMRC would treat them as non-UK resident. The Second Appellant, on the other hand, contended that HMRC had, in IR20, given a binding assurance that an individual would be treated as non-UK resident if he went to live abroad for at least three years and also satisfied the day-count proviso.

In the alternative, the Appellants once again argued that, even if, on the correct construction of IR20, HMRC did not thereby give the assurances for which they had respectively contended, its settled practice over many years was nevertheless to apply the guidance in IR20 as though it did contain such assurances, and it had thus raised enforceable legitimate expectations on the part of the Appellants that their residence status would be determined on this basis.

HMRC also maintained its position that, viewing these paragraphs in the context of the entirety of the guidance provided in IR20, they are subject to a requirement that taxpayers first demonstrate that they have made a distinct break from their ties in the UK. However, it is noteworthy that HMRC accepted that, were it in IR20 to have made the assurances about the circumstances in which an individual will be treated as non-UK resident for which the Appellants contended, then, so long as those assurances remained operative, a taxpayer would have had an enforceable legitimate expectation that HMRC would appraise its case in accordance with those assurances.

The majority of the Supreme Court (Lord Mance dissenting) rejected both of the Appellants’ arguments. The leading judgment was given by Lord Wilson, with whom the rest of the majority concurred.

Regarding the Appellants’ primary argument, Lord Wilson first emphasised that, if IR20 was to be capable of giving rise to any enforceable legitimate expectations, the representations relied on would have to be clear. Furthermore, the clarity of the representations relied on would have to be judged in the light of all relevant statements contained in the booklet, read as a whole. Lord Wilson then proceeded to emphasise several preliminary statements in IR20, which conveyed, inter alia, that the guidance contained therein was general in nature and that a decision in relation to residence could be made only upon an evaluation of the facts of each case. Ultimately, Lord Wilson concluded that, when all the relevant passages in IR20 were considered together, they served to inform the ordinarily sophisticated taxpayer that:

(a) he was required to “leave” the UK in a more profound sense than that of travel, namely permanently or indefinitely or for fulltime employment;

(b) he was required to do more than to take up residence abroad;

(c) he was required to relinquish his “usual residence” in the UK;

(d) any subsequent returns on his part to the UK were required to be no more than “visits”; and

(e) any “property” retained by him in the UK for his use was required to be used for the purpose only of visits rather than as a place of residence.

Having been so informed, Lord Wilson reasoned, the ordinarily sophisticated taxpayer would surely conclude that these general principles of IR20 demanded – and might well in practice generate – a multifactorial evaluation of his circumstances on the part of HMRC. The object of this multifactorial evaluation would be to determine whether the individual purporting to have become non-resident had made a sufficiently distinct break in the pattern of his life in the UK. However, Lord Wilson deprecated the references in Moses LJ’s judgment, in the Court of Appeal, to the need for “severance of social and family ties”. Lord Wilson opined that “severance” was too strong a word in this context, though a distinct break in the pattern of an individual’s life in the UK undoubtedly involves a substantial “loosening” of family and social ties there. Lord Wilson also held that, were he incorrect to conclude that IR20, read as a whole, implicitly conveyed the requirement for a distinct break in the pattern of an individual’s life in the UK, nonetheless “the treatment in (IR20) of the means of becoming non-resident was so unclear as to communicate to its readers nothing to which legal effect might be given.”

As to the Appellants’ alternative argument, Lord Wilson and the rest of the majority simply upheld the Court of Appeal’s finding that the Appellants had failed, on an evidential level, to show that HMRC had adopted the settled practice for which they contended. The Appellants’ evidence on this point was said to be “far too thin and equivocal”.

Comment

Perhaps the most important lesson to be learned from the Davies and Gaines-Cooper sagas is that taxpayers should be extremely cautious when seeking to rely on poorly drafted guidance issued by HMRC. In particular, taxpayers and their advisers should attempt to interpret such guidance ‘in the round’ and also consider whether any overriding requirements might be said to be implicit throughout the guidance.

It is also significant that the Supreme Court hearing proceeded on the basis of HMRC’s acceptance that an enforceable legitimate expectation will arise in circumstances where a taxpayer falls clearly within the terms of an assurance given by HMRC in published guidance.

As regards the ordinary law of residence for tax purposes, Lord Wilson’s judgment underscores the requirement that, in order to become non-UK resident, an individual must effect a distinct break in the pattern of his life in the UK.

Lastly, that these appeals have gone all the way to the Supreme Court serves to reinforce the need for a clear statutory test of residence for individuals (such a test is currently under consideration). Moreover, such a statutory test should ideally be drafted in sufficiently objective terms as to obviate the need for potentially misleading ‘general guidance’ booklets such as IR20.