Special Commissioners Decision
 STC (SCD) 143
SOLICITORS: Slaughter & May; Solicitor of Inland Revenue.
JUDGE: Special Commissioner: Dr J F Avery Jones CBE
DATES: 8, 9, 10, 11, 12, 15, 16, 17, 18, 19 November 1999, 2, 3, 4 February, 20 March 2000
1. This is an appeal by Mr R C Carvill (the taxpayer) against assessments made under s 739 of the Income and Corporation Taxes Act 1988 (the 1988 Act) for the years 1993-94 to 1995-96. There have been previous proceedings in 1994 before a Special Commissioner (Mr Everett) relating to the same issue for the years 1987-88 to 1992-93, which were decided in favour of the Crown. Following those proceedings the taxpayer applied to the court for a number of amendments to be made to the case stated, which the court declined to make (see  STC 126). In consequence, the taxpayer abandoned any appeal from the earlier decision. Although this appeal covers the same ground as the earlier one, I have had the benefit of seeing two ring binders of additional documents which have been found since the earlier hearing and I have also heard several additional witnesses.
2. I shall use the following abbreviations. International Holdings: R K Carvill (International Holdings) Ltd; Holdings: R K Carvill (Holdings) Ltd; International: R K Carvill (International) Ltd; Limited: R K Carvill & Co Ltd; Inc: R K Carvill Inc; Personal Services: R K C Personal Services Ltd.
3. I had evidence in the form of witness statements from the taxpayer, Mr Keith Tuson, the taxpayers and his companies tax adviser, Mr Peter Kirby, joint managing director of Limited, Mr Kenneth Copelston, a founder director of Limited, Mr Thomas Hearn, former president of G L Hodson & Sons and later a director of International Holdings, Mr Robin Jackson, Lloyds underwriter, Mr Raymond Salter, Lloyds reinsurance broker, Mr Donald Koziol Jr, director of Inc, Mr Robin Spencer-Arscott, from the Bermuda insurance industry. All of them except for Mr Copleston, Mr Koziol and Mr Spencer-Arscott gave oral evidence. The Revenue called two expert witnesses, Mr John Stoker and Mr Roy Harris who gave oral evidence.
4. The documentary evidence consisted of 12 ring binders.
5. In brief, in 1982 the taxpayer transferred his 59% shareholding in Holdings, a United Kingdom resident company, to International Holdings, a company resident in Bermuda.
The issue in this appeal is the liability of the taxpayer to tax under s 739 of the 1988 Act on dividends paid by Holdings to International Holdings in the years under appeal, and in particular, whether the defence in s 741 applies.
REINSURANCE BROKING AND THE TAXPAYERs COMMERCIAL STRATEGY
6. I shall start by setting out my understanding of how, in broad outline, the taxpayer and his companies operated. The operating companies are reinsurance brokers and Limited is a Lloyds reinsurance broker specialising in the United States market. The particular business on which it concentrates is treaty excess of loss reinsurance, that is to say reinsurance of losses over a limit, rather than a proportion of the total risk (quota share), on the casualty side ie dealing with claims like medical negligence rather than claims for physical damage. An insurance company in the United States will approach a United States reinsurance broker to reinsure risks which it has taken on by writing insurance policies. A proportion of the risks will be reinsured outside the United States, principally at the time at Lloyds but also with European reinsurers. The United States reinsurance broker will approach a Lloyds reinsurance broker such as Limited to place a proportion of the risks at Lloyds or elsewhere outside the United States. Limited therefore obtained its business from United States reinsurance brokers (the producing side of its business) and used its expertise in placing the risks at Lloyds and elsewhere in Europe (the placing side of its business). The reinsurance business is a people business which requires the building up of a relationship with the United States broker being able to reinsure their risks, and also building up a relationship of trust with the underwriters as a person who does not mislead the underwriter about the risk. It is obvious that Limited was completely dependent on United States reinsurance brokers for its business.
7. The taxpayers business strategy was to put his companies in a position to compete for the entire reinsurance business of the United States insurance company. This involved not only being in a position to compete with the United States reinsurance brokers on the production side, but also on the United States placing side, since, if they took over the entire business previously carried on by the United States reinsurance brokers, they would need to be able to place about half of the reinsurance in the United States as well as the half in the United Kingdom and Europe which they were already doing. This strategy was a dangerous process because at the beginning their entire business came from a small tight community of United States reinsurance brokers. The taxpayer and his companies wanted to be in a position to compete with any United States reinsurance broker which was part of an organisation that linked up with a United Kingdom reinsurance broker with the result that in future it sent all its Lloyds reinsurance business to its United Kingdom affiliate. At the same time they also wished to continue to receive business from the other independent United States reinsurance brokers. If these United States reinsurance brokers thought that the taxpayers companies were putting themselves in a position to compete on an equal footing with the United States reinsurance brokers, the taxpayers companies would be in danger of losing their business immediately. The danger was not only in the United States. Rival United Kingdom reinsurance brokers were also keen to stir up trouble in the hope of getting business for themselves. A necessary part of the strategy consisted of getting close to the United States insurance companies so that, if the United States reinsurance broker merged with a United Kingdom broker, Limited was in a position to go to the United States client insurance company and compete for the business. While there was a United States broker whom the taxpayer could not afford to upset, this was difficult. A further difficulty was that the ability to place risks in the United States required a United States presence, but this would be construed by the United States reinsurance brokers as a clear indication that they were preparing to compete. The taxpayers group was the only reinsurance broker to attempt this strategy. It was described by Mr R A G Jackson, a Lloyds underwriter who wrote a lot of business for the taxpayer, as a very risky venture. He also regarded the strategy as risky to himself because he would have lost the underwriting business if the taxpayer had not succeeded.
8. In commercial terms, if the strategy succeeded the benefit was that the taxpayers companies would gain the entire brokerage (15% of the reinsurance premium), rather than the one-third of the brokerage that Limited obtained (the United States reinsurance broker customarily taking two-thirds). Limiteds one-third related only to reinsurance placed in London, which was about half the risk, so that Limited received about 2.5% out of the reinsurance premium of 15% paid by the United States insurance company. If the strategy failed, the taxpayers companies would lose their business, either immediately, if they upset the United States reinsurance brokers, or in the longer term, if the United States reinsurance broker merged with a United Kingdom reinsurance broker which would in future receive all the United States brokers business.
WHETHER THE TEST IN S 741 IS SUBJECTIVE OR OBJECTIVE
9. The taxpayers case is that it is accepted that s 739 applies in one respect although the Revenue contend that there are other relevant transfers and associated operations, which I shall deal with below. The taxpayer contends, however, that the defence in s 741 applies. I shall look at whether the test in s 741 is subjective or objective as an initial question since it will determine what facts are relevant. This section provides:
Sections 739 and 740 shall not apply if the individual shows in writing or otherwise to the satisfaction of the Board either
10. Miss Elizabeth Gloster QC for the taxpayer submits that s 741 imposes a subjective test of what was in the taxpayers mind in carrying out the relevant transactions. Mr Philip Vallance QC for the Revenue contends that the test is an objective one, relying on the following passage in Lord Nolans speech in IRC v Willoughby  STC 995 at 1003-1004,  1 WLR 1071 at 1079:
Where the taxpayers chosen course is seen upon examination to involve tax avoidance (as opposed to tax mitigation), it follows that tax avoidance must be at least one of the taxpayers purposes in adopting that course, whether or not the taxpayer has formed the subjective motive of avoiding tax [emphasis added].
11. This statement seems, with respect, hard to fit with Lord Nolans definition of tax avoidance ( STC 995 at 1004,  1 WLR 1071 at 1079): Tax avoidance within the meaning of s 741 is a course of action designed to conflict with or defeat the evident intention of Parliament. One would expect that evidence of the designer of the course of action was relevant. Lord Nolan in the passage quoted may have been merely summarising the Revenues contentions. The paragraph from which it is taken begins ( STC 995 at 1004,  1 WLR 1071 at 1079):
In order to understand the line thus drawn, submitted Mr Henderson [counsel for the Crown], it was essential to understand what was meant by tax avoidance for the purposes of s 741.
The passage quoted above may have been a recital of the Revenues argument. It certainly does not fit with Lord Nolans summarising the findings of what was in the taxpayers mind only two paragraphs earlier (see  STC 995 at 1003,  1 WLR 1078-1079). The issue in Willoughby was whether the Special Commissioner was correct in law in applying a subjective test.
12. My reasons for preferring Miss Glosters contention that the test is subjective are first that this is supported by authority, including IRC v Herdman  NI 74 at 84, 45 TC 394 at 405, Philippi v IRC  1 WLR 1272 at 1276-1277, 47 TC 75 at 111-112 (dealing with how an infirm taxpayer could provide evidence of his purpose) and IRC v Pratt  STC 756 at 791 (a person who has sought to avoid liability to income tax). There are also numerous dicta supporting a subjective test, including Vestey v IRC (Nos 1 and 2)  STC 10,  AC 1148, and I am not aware of any case before IRC v Willoughby  STC 995,  1 WLR 1071 in which there is any suggestion of the test being objective. Secondly, the ordinary meaning of a purpose test is that it is subjective. If it is not subjective it is hard to understand why Parliament should have defined in s 739 that the individual is taxed if he has the necessary power to enjoy the income of the non-resident (assuming that the terms of the section are otherwise satisfied), and then said in s 741 that that did not apply if the individual did not have the purpose of avoiding tax. It would have been simpler to say that s 739 applied if the circumstances were such that the individual avoided tax (s 776 may be an example of such an approach). In many cases it may be obvious why a taxpayer does something but this case is concerned with the creation of a Bermuda holding company and in order to know whether this is conduct conflicting with the evident intention of Parliament one needs to know why the taxpayer set it up. In applying a subjective test I am following the same approach as this tribunal in Beneficiary v IRC  STC (SCD) 134. I should also record that Miss Gloster referred to Hansard in 1938 to show that the Solicitor General told Parliament that the test was subjective. Although this was not objected to by Mr Vallance I do not see any ambiguity in the section which would entitle me to rely on Hansard.
13. I propose therefore to approach this case by determining what was the purpose in the taxpayers and his fellow directors minds in carrying out a particular transaction. Any other approach seems impossible to apply in the circumstances of this case.
14. Before setting up on his own, the taxpayer worked for C T Bowring & Co Ltd (Bowring) from 1962 to 1967 in their United States reinsurance side dealing mainly with the six largest United States reinsurance brokers. He then worked in Seattle from 1967 to 1969 for John F Sullivan & Co, then the fourth or fifth largest United States reinsurance broker, in the casualty market in the United States, during which he acquired his knowledge of the United States market and, more importantly, met their client insurance companies. He then returned to Bowring and became a senior director on the North American side. He foresaw that Bowring were likely to be taken over by Marsh McLennan which would mean that, while Bowring would be the recipient of all the Marsh McLennan group United States business, including the reinsurance business of Guy Carpenter, the reinsurance broker owned by Marsh McLennan, other United States reinsurance brokers would no longer do business with Bowring as they were part of a rival United States reinsurance broker. The opportunity for selling their services to other United States reinsurance brokers would therefore become negligible.
Limited and Holdings
15. The taxpayer decided to set up on his own with two colleagues from Bowring, Mr Coppleston and Mr Innocenti, and they formed Limited in March 1977, starting business in that company after their notice period expired on 21 April 1977. Holdings took over Limited on a share exchange in July 1977 and some Americans mainly from John F Sullivan & Co, including Mr Jack Sullivan and Mr Gerry Sullivan, made a small investment in Holdings. The business started slowly, partly because it took them two years to become Lloyds brokers owing to objections made by Bowring. The taxpayer was earning less than he had done at Bowring. In the first accounting period of the 16 months to 30 June 1978 he earned £22,695 and the group made a loss of £28,391. In fact, the Marsh McLennan-Bowring merger did not happen until 1979, but the taxpayers prediction about the market was correct. As a result of the merger, much business from 30 to 40 United States brokers was lost to Bowring, and Limited managed to acquire some of it. A large matter came to Limited from G J Sullivan and Associates, the Californian Hospital Association.
16. It was also clear to the taxpayer that other such mergers could take place in which case Limited would lose the business of the United States reinsurance brokers that acquired a United Kingdom affiliate, ie that the United States reinsurance broker which merged with a United Kingdom reinsurance broker would no longer send business to Limited but would channel all their business to their United Kingdom associate. There would be exceptions if the United States insurance company insisted that the United States reinsurance broker continued to use Limited, but in the long term, it was likely that all the business would end up with the United Kingdom associate of the United States reinsurance broker. United States reinsurance brokers actually tried to acquire the taxpayers companies threatening that if he did not sell they would divert all the business to a United Kingdom associate, but the taxpayer wished to remain independent. There were a small number of United States reinsurance brokers described by one of the witnesses, Mr Hearn (former president of G L Hodson & Son), as a tight, small community of a dozen or so specialist firms. Most of them, perhaps ten, dealt with Limited, and if they all merged with United Kingdom brokers, Limited would have no business. In fact, mergers of all the main United States reinsurance brokers later took place. In 1982 about 85% of the taxpayers business came from the main United States reinsurance brokers; today it is less than 3%.
17. The first Bermudan company set up by the taxpayer was International in which the taxpayer had 51% of the shares and Holdings the remaining 49%. Originally Holdings had acquired all the shares and retrospective consent was obtained under s 482 of the Income and Corporation Taxes Act 1970 (the 1970 Act) for 51% to be transferred to the taxpayer. International was formed in 1980 to enter into the Californian Hospital Association contract because the United States reinsurance broker, G J Sullivan and Associates, who had moved the business from Bowring to Limited, were reluctant for Limited to take the whole brokerage immediately when the work might have to be done over the next ten or more years and there was no certainty that Limited, a new company, would be there in ten years time. The reason why it was necessary for Limited to continue to handle the business in the future was that all communications relating to the reinsurance which will have been placed in many different markets go through the reinsurance broker.
18. About this time, the taxpayer and the other directors of Limited were considering their future strategy and decided in some way to move the strategic centre of their operations to Bermuda.
19. On 11 January 1982 Neville Russell, Limiteds auditors and the taxpayers accountants, sent the Revenue a domicile questionnaire which had been signed by the taxpayer on 15 December 1981 asking the Revenue for confirmation that the taxpayer was domiciled in Ireland. There was no evidence about what was the trigger for making this application. The Revenue asked some further questions in connection with the application on 19 March 1982 which Neville Russell answered on 22 June 1982. The Revenue confirmed their acceptance of the taxpayers non-domiciled status on 2 September 1982.
Engagement of Mr Tuson
20. On 29 January 1982 Limited placed an advertisement in the Financial Times for a corporate taxation consultant stating:
We are looking for a specialist to advise on UK and international tax matters and help develop long-term strategy in this area . . . Applicants must show the ability to provide constructive taxation advice and implement their proposals . . .
Mr Keith Tuson, who was then group taxation manager, Hill Samuel Group plc, applied for the post and following two interviews, the second of which included an interview with the taxpayer, started on a part-time basis of about one late afternoon and early evening, say three hours, a week from 1 April 1982. From September 1982 he set up on his own with Limited as his main client. He started acting for the taxpayer personally as well as Limited in October 1982.
21. There is an unsigned board minute of Holdings of 5 July 1982 at which it is stated that Mr Tuson presented a paper which suggested that a new international holding company should take control of Holdings. It was resolved to make clearance applications under ss 464 and 482 of the 1970 Act and s 88 of the Capital Gains Tax Act 1979. No copy of this paper has been found and Mr Tuson considered that it consisted of his speaking notes. Mr Tuson prepared a memorandum on 12 July setting out a possible tax strategy and suggesting Bermuda as the location for a new holding company (International Holdings). He was under the impression at the time of writing this paper that the groups purpose was to have a money box company overseas out of which investments could be made from dividends received from subsidiaries, rather than the active holding company which occurred, and which distributed dividends to the taxpayer much later. It was not the taxpayers intention to have a money box company and the lack of understanding seems to have been caused by Mr Tuson being new to the job. The memorandum contains the following passage:
Although the objective of the revised structure would be to enable profits to be earned free of tax or invested free of UK tax, it is not essential that the ultimate holding company should itself be based in a tax haven. It is conceivable that the ultimate holding company could itself be based in a respectable tax jurisdiction which would not tax foreign income and that the profit making activities could be established under a tax haven company. Although there are a number of respectable locations which would be suitable, none has any logical or commercial justification . . . I suggest that we proceed on the basis that Bermuda would be the location for International Holdings.
22. Mr Tuson sent this memorandum to Neville Russell on 14 July 1982 and had a meeting with them on 23 July. Further drafts of the clearance applications were sent by Mr Tuson to Neville Russell on 4 August saying that he hoped to submit them in two weeks time. There is a file note that they met on 9 September and amongst the points made was whether the taxpayers possible non-domicile status should be mentioned in the applications, which shows that the Revenues domicile letter of 2 September had not reached Mr Ingmire, the corporate tax partner in Neville Russell, although it had presumably then been received by the partner responsible for the taxpayers personal affairs. The clearance applications were made on 9 September 1982. The applications contain the following commercial reasons:
In view of these factors [the factors referred to included that the company was increasingly involved in procuring business from the US, and the risk of losing its business through associations between US and UK brokers], it is considered that in order to create further opportunities for the growth of the Group as a whole and of the Companys [Limiteds] business in particular, the Group should become more directly involved in the procurement of business in the United States. However, given the existing connections which [Limited] has with US brokers and the severely detrimental effect which a precipitate breaking of those links would have on [Limiteds] business, the Group cannot openly and directly establish a US broking activity in competition with existing brokers. It is proposed, therefore, that to overcome this problem while still achieving the desired result, International Holdings should be formed and located in Bermuda and should issue its shares in exchange for the existing shares in Holdings. From its base in Bermuda, International Holdings would then be able to procure in the United States business for [Limited] without being seen to compete with established US brokers.
23. Clearances were duly received on 23, 27 and 30 September 1982.
24. A letter was sent to Lloyds on 2 August 1982 asking for their approval for Holdings to be owned by International Holdings. It was also proposed that International should be owned by International Holdings. Lloyds replied that they had no objections on 11 August 1982.
Formation of International Holdings
25. An initial approach was made to Conyers Dill and Perman, the Bermuda lawyers, on 6 October 1982 for the formation of International Holdings in Bermuda which was incorporated on 10 December 1982. On the same day, it was resolved to carry out a share exchange issuing shares in International Holdings in exchange for the shares in Holdings held by the taxpayer (the old majority shares) and the executives (the old minority shares), the shares in International Holdings being referred to as the new majority and new minority shares respectively. At the same time the taxpayer bought the shares of the United States shareholders in Holdings, giving him 59% of the equity and 63% of the votes. The exchange was completed on 4 January 1983. The decision to transfer their shares was a collective one taken after discussion with some of the shareholders needing to be convinced of the merits of the reorganisation. As the taxpayer said in his witness statement:
I had a lot of persuading to do on this, because it was a risky undertaking and, of course, I had no legal right to compel anyone to exchange their shares, but the decision that we took to go to Bermuda was agreed by all and the exchange of shares really just followed thereafter.
26. On 29 December 1982 Limited entered into a brokerage sharing agreement by which International Holdings was entitled to one-third of the brokerage. In relation to business specified in the schedule, which included the California Hospital Association, payment to Limited was to be made by instalments. Part of the consideration for that agreement was that International Holdings procured that the taxpayers services were made available to Limited without charge.
27. The first directors of International Holdings were the taxpayer, Mr Copleston, Mr Charkin (all directors of Limited), the taxpayers father Mr W V Carvill, Mr Jack Sullivan, Mr J A Perman and Mr R S L Pearman, both partners in Conyers, Dill & Pearman and Mr N J Holbrow (Bank of Bermuda). Jack Sullivan who was a leading United States reinsurance broker who had then taken early retirement, joined the board of International Holdings, accepting the offer of appointment as a director on 21 December 1982. His directors fee was US$10,000 plus a bonus at the directors discretion. He was responsible for bringing very considerable business to the group, including one of their largest clients, the Farmers Insurance Co, the largest insurer in California of which his father was chairman. The board meeting of 23 May 1983 mentions that he had made introductions to Holborn Agencies of New York, Hartford Speciality and Terra Nova. A bonus of US$300,000 was voted to him at the meeting of 20 October 1983.
28. The board of International Holdings met four times a year, meetings normally lasting three days, including management meetings and a formal board meeting, although there were some other meetings at which mainly formal business was carried out which were attended only by the Bermuda resident directors. At an early meeting on 23 May 1983 it was decided that a stronger presence in North America was needed and consideration was given to acquiring an established intermediary about which Mr Sullivan said great care was needed in case United States intermediaries tried to retaliate. Instead, Mr Wybar and another executive were to be employed by (but not as directors of) International Holdings spending time in the United States but without the company having any office there. Mr Wybar would spend a minimum of 90 days pa in the United States. The taxpayer described Mr Wybar as very influential. At the same meeting Mr Wybar had reported that there was a reduction in confidence in Lloyds in the United States on account of recent disclosures. Another aspect discussed was reinsuring United States risks back into the United States. Mention was made of other introductions by Mr Sullivan which could lead to business. Finally, there was a discussion of a report in the Wall Street Journal concerning Bermuda and the view was expressed that if there was increased adverse publicity for Bermuda the company might need to relocate to the United States.
29. At the International Holdings board meeting on 27 September 1983 Mr Tom Welstead was appointed a director. He was an influential person in insurance (rather than reinsurance) in the United States having been president of his own company; his reinsurance experience was in the field of marine reinsurance. The meeting of 20 October 1983 records that Mr Welstead had been influential in arranging a meeting with Home Re which had resulted in business for Limited. The first direct business, which I understand to mean business not obtained through a United States broker, with Western Employers of Chicago, obtained through Mr Sullivan, was reported to that meeting.
30. By the end of the first year of International Holdings four Americans had been appointed directors or employees, and substantial business had been attracted through their work.
The taxpayers remuneration arrangements
31. At the time of setting up International Holdings the method of remunerating the taxpayer was changed. It is first necessary to describe the previous arrangements. The taxpayer did not want to disclose his remuneration in the accounts of Holdings. The reason was that competitors would be able to draw the clients attention to the high level of remuneration and suggest that they should not do business with the taxpayers companies. The way this was achieved was that he was not a director of Holdings and he received his remuneration through a company called The Cut Ltd (Cut) which charged the remuneration to Limited. There is no figure for the taxpayers remuneration in the accounts of Holdings for the 18 months to 31 December 1981, or thereafter. The Revenue were made aware of the arrangement which had no tax effect. Before the Revenue confirmed his non-domiciled status the taxpayer was claiming the 25% deduction for the proportion of his time spent outside the United Kingdom under para 2 of Sch 7 to the Finance Act 1977. Doubts seem to have arisen in about 1982 about the taxpayer being a shadow director of Holdings which I presume would mean that the remuneration had to be shown in Holdings accounts. After the reorganisation, it was determined that all his remuneration should be funded from International Holdings and no disclosure is made in the accounts of that company presumably because Bermudan law does not require it.
32. The taxpayer entered into an employment contract with International in September 1980. No copy of this is available but it is clear from the accounts of International, which were produced for the first time at the hearing, that salaries were paid and I find that payments were made to the taxpayer. I also find that the contract was for duties performed abroad because the tax returns (form 11K for a non-domiciled person) covering income for the year ended 5 April 1982 show nil against International in the column headed amount received in the UK but with the column headed amount paid left blank, implying that the remittance basis was considered to apply, and no remittances had been made. Mr Tuson produced a schedule showing figures for remuneration from International of £43,340 for 1981-82 and £123,489 for 1983-84 but he could not produce any supporting documents for this information. Such figures were capable of being within the salaries shown in the accounts and I accept them. The figures were not known to the Revenue before the hearing.
33. On 4 October 1982, which was after he knew that the Revenue had confirmed the taxpayers non-domiciled status, Mr Tuson wrote to Mr Moscrop of Neville Russell suggesting that the taxpayer be employed by International Holdings for non-United Kingdom duties, on which he expected to be taxed on the remittance basis, and by a new non-resident company incorporated in Jersey, Personal Services, for United Kingdom duties, on which he expected to receive the foreign emoluments deduction of 25%. That deduction was abolished for a person in the taxpayers position in the Finance Act 1984 with effect from 6 April 1984. In fact that deduction was refused by the Revenue and as it had been abolished for the future the taxpayer did not pursue the claim. Mr Tusons letter does not deal with which company bore the cost of his remuneration. A note of a meeting between the auditors of the United Kingdom and Bermuda companies of 13 December 1982 dealing with Cut mentions that the existing problem about shadow directors would disappear since all the taxpayers income would be derived from International Holdings. A corollary of this is that no deduction could be obtained against Limiteds profits for the taxpayers remuneration for United Kingdom duties which directly benefited Limited. On 29 December 1982 the taxpayer entered into employment contracts with International Holdings for non-United Kingdom duties and with Personal Services for United Kingdom duties. On the same day a secondment agreement was entered into between Personal Services and International Holdings stating that Personal Services would make the taxpayers services available to Limited and that International Holdings would pay Personal Services 105% of the expenses incurred by Personal Services in employing the taxpayer. International Holdings obligation to make the taxpayers services available to Limited without charge is dealt with in the brokerage sharing agreement (see para 26 above).
34. There is a note of a meeting on 25 June 1985 in Bermuda in which the suggestion is noted that the taxpayers United Kingdom services should be provided in future by Cut instead of Personal Services. It appeared that no disclosure of names would be required in the International Holdings accounts. Nothing came of this proposal.
Formation of Inc
35. The International Holdings board meeting on 20 October 1983 resolved to take United States tax advice on opening an office in the United States. A note by the taxpayer to Mr Passmore, the financial controller in London, a few days later records that they were thinking of opening an office in the Chicago area as the home of their first direct client. This would, he stated, appear less aggressive than opening in New York. In November 1983, an offer was made to Mr Koziol who was an insurance rather than reinsurance executive, of a consultancy with International Holdings for four weeks during which he could visit London. This was followed up on 8 December with a proposal of a 12 months consultancy to give consideration to the opening of a servicing office in the United States at a fee of US$90,000 plus a share of the groups profits.
36. At the International Holdings board meeting of 15 February 1984, it was resolved to open a United States office and establish a United States corporation which for United States regulatory reasons would be a subsidiary of Limited but would become a subsidiary of International Holdings (this happened in 1985 following consent under s 482 of the 1970 Act). The office was in Itasca, a suburb of Chicago. At the meeting of 17 July 1984 it was recorded that the United States subsidiary had been accepted by the United States insurance market but without enthusiasm. Mr Welstead said that for some time the opening of the office had been the talk of the United States insurance market. During 1984 further introductions made by Mr Welstead were noted and it was recorded that he was spending over one-quarter of his time on the business of the company. He was later employed full-time by Inc. An agreement was made between Inc and Limited under which Limited agreed to pay Inc 110% of the costs incurred by Inc plus a fee based on brokerage earned over US$1m. International Holdings took over Limiteds obligations under that agreement. By the meeting of 9 October 1984 it was reported that Inc had an office with three staff.
37. The meeting of 15 January 1985 discussed a draft letter the taxpayer had written to seek to reassure United States reinsurance brokers that Inc would not try to solicit the United States client but Mr Sullivan thought that sending it was too dangerous.
38. An exchange of correspondence in March 1985 restricted Internatonal Holdings share of brokerage to 110% of the costs (which included payment for the taxpayers services), any excess profit being paid to Limited. The reason for this change was so as not to restrict the profits available for distribution to employees of Limited. This was formalised in a contract between the two companies dated 22 July 1985 which also provided that the brokerage split between them was two-thirds of the brokerage on risks placed in the United Kingdom and European markets to Limited and the balance to International Holdings subject to the cap of 110% of expenses. In relation to certain contracts produced through G J Sullivan & Associates Inc (which included the California Hospital Association) and through G L Hodson & Son Inc the brokerage was to be spread over a period with Limited receiving in total two-thirds in the first year and the whole thereafter.
39. Mr Jack Sullivan resigned as a director of International Holdings at the meeting on 16 July 1985 as he had become a director of a new United States reinsurance broking company with his brother Jerry Sullivan which could be perceived as a conflict of interest.
40. The International Holdings board meeting of 15 April 1985 recorded that the Sedgwick Group was taking over the Fred S James Group which included John F Sullivan Co. This was likely to result in loss of business for the taxpayers group. The taxpayer said that they lost 88 contracts in one week as a result of this merger. Mr Striffler of John F Sullivan was offered employment. This was the first sign of open competition with United States reinsurance brokers because Mr Striffler was well known: it was no longer possible to disguise what Inc was doing. This point came to be described during the hearing as gloves off.
41. The group was extremely successful in competing with United States reinsurance brokers after gloves off as can be seen from the following figures extracted from the group consolidated figures in £000:
1984 1985 1986 1987
42. There is a large rise in both income and expenses starting in 1985 and becoming much more pronounced in 1986, presumably because there was less than a full year from gloves off in 1985 and the business was building up from then. The effect of capping bonuses (see below) is that salaries rose much more slowly than income and other expenses, resulting in significant profits for the first time from 1986. The dividend paid was funded almost entirely from dividends received from Holdings of £3,380,000 provided for in the 1986 accounts of Holdings and £3,450,000 provided for in the 1987 accounts, total £5,830,000.
Further events relating to International Holdings
43. Sir Michael Edwardes became a consultant to International Holdings from 7 January 1986. Mr Colm Carvill, the taxpayers brother who is a Dublin lawyer was appointed a director from 10 November 1986. At the meeting on 4 November 1988 the appointment of Mr Lyman Baldwin who was about to retire as chairman of Hartford Re was discussed and in view of the sensitivity of the appointment with United States companies it was resolved to offer a three-month consultancy. His appointment as a director was approved at the meeting on 3 February 1989. The meeting of 25 July 1990 resolved to offer a directorship to Mr Tom Hearn previously president of G L Hodson in the Corroon & Black group.
44. Thomas A Greene, the United States intermediary, severed relationships with the group in January 1990 as the result of the activities of Inc. The board of International Holdings noted at the meeting of 8 February 1990 that the way was open to approach their clients, and that they were well placed to fulfil the aspirations of the American clients.
45. Following a memorandum of 18 October 1985 from Mr Tuson the brokerage split was amended, where there was no other United States intermediary, to one-third to Inc, four-ninths to Limited, and two-ninths to International Holdings.
46. Throughout its existence, the board of International Holdings determined the group policy with each of the subsidiaries reporting to it.
Payment of bonuses and the decision to pay dividends
47. From the start of Limited, all the profits other than those needed for the business had been distributed as bonuses to employees. Originally shares were issued to employees and bonus distributions were in proportion to the number of shares held. At first these were voting shares but from 1979 non-voting shares were issued so that the taxpayer could keep control of the company. In 1980 it was decided not to issue any more shares, and profit-sharing units were given to employees. By 1984 the results of the business meant that very large amounts were being distributed as bonuses. The taxpayer said that an employees half-year bonus could be sufficient to buy a house.
48. Mr Tuson wrote a memorandum on 29 October 1984 proposing fixed and variable profit-sharing units. He was concerned about the deductibility of large bonus payments and put forward the suggestion of paying dividends. On 7 March 1985 the taxpayer wrote a memorandum entitled super profit plan stating that he would assign super profit-sharing percentages in advance. In a memorandum of 25 April 1985 Mr Tuson pointed out that because of the phased reduction in corporation tax and the ending of the earnings ceiling for employers national insurance contributions it would become more tax effective to pay dividends rather than bonuses from 1986. This seems to be a theoretical exercise since at the time no employees held shares in a United Kingdom resident company. It was not directed to the taxpayers position taking dividends from International Holdings since United Kingdom tax is taken into account in the dividends suggested. That note also looks at changing the policy of paying out all the profits as bonuses and consequently the possibility of Limited paying dividends to International Holdings where the funds could be invested to produce a return free of tax'. At this stage therefore there was no suggestion of International Holdings distributing any dividends to the taxpayer. In an accompanying memorandum Mr Tuson looked at the possibility of the employees other than the taxpayer selling their shares in International Holdings to an employee trust from which bonuses would be paid. There is another memorandum from Mr Fewster, the finance director of Limited, suggesting a redemption of the non-voting shares in International Holdings as part of changing the profit-sharing arrangements.
49. Next the taxpayer wrote a memorandum on 2 July 1985 to the founder shareholders proposing compensating them by an earnings stream for life in exchange for the taxpayer owning all the shares in International Holdings. He makes the point that there was no intention to sell the company but if it were sold founder members would retain the right to share in the proceeds. Mr Tuson followed this up the next day with a memorandum setting out how the reorganisation could be implemented. He included a statement that it was anticipated that the minority shareholders would accept the offer, which turned out not to be the case. A note by the taxpayer following discussions on 8 August 1985 records that it is extremely unlikely that the company be sold but, if it were sold, profit-sharing units would rank equally with the shares. Negotiations over profit sharing must have continued as Mr Tuson wrote a memorandum on 30 October 1985 suggesting that an employee trust acquire the employees shares in International Holdings. At the board meeting of International Holdings of 7 January 1986 it is recorded that it was not acceptable to the employee shareholders that the company should acquire their shares and that an employee trust was being considered which Conyers, Dill & Pearman were instructed to draft. A further note by Mr Tuson of 15 February 1986 again refers to a proposed employee trust and a note of 22 September 1986 again looks at the alternative of the company purchasing its own shares. The final proposal is contained in an undated memorandum from Mr Tuson which was apparently written in November 1986. This consisted of the purchase by International Holdings of its shares held by employees other than the taxpayer at their asset value, plus an undertaking given by the taxpayer to an employee trust that, before entering into any transaction by which his shareholding would be reduced below 50%, he would sell at par the same proportion of his shares as the proportion of the group profits distributed to employees other than the taxpayer. He would also leave by will more than 50% of the shares to the employee trust. A draft of an employee trust was tabled at the board meeting of International Holdings on 9 February 1987 and an engrossment for execution was tabled at the meeting on 27 April 1987. The trust is dated 17 June 1987. The taxpayers undertaking was given on 26 November 1987.
50. The purchase of own shares required an alteration to the memorandum of association of International Holdings which required the votes of the voting shareholders. This took place on 30 December 1986.
51. Following the purchase of the new minority shares bonuses to the former shareholders were capped at the 1985 level increased by inflation.
52. At the International Holdings board meeting on 17 July 1984 it was declared that Mr Bassett, a director of Limited, had announced that he intended to resign within the next 12 months to pursue business interests outside the insurance field. At the meeting on 16 July 1985 the purchase by the taxpayer of Mr Bassetts shares was recorded.
53. On 19 December 1986, Mr Tuson wrote a memorandum suggesting that, now that the taxpayer was sole shareholder in International Holdings, they should reconsider paying the taxpayer by way of dividend from International Holdings rather than bonus. This would give approximately an 11% increase in after-tax income. There were some complications such that, if he did not take a bonus from International Holdings its profits would be increased above 10% of its expenses and so further profit would be made by Holdings, and that advance corporation tax would be payable on dividends paid by Limited. The taxpayer did not take the opportunity of increasing his income in this way. Secondly, Mr Tuson suggested that as Limited will make profits, now that the whole profits will not be paid as bonuses, dividends be paid to International Holdings in order to avoid corporation tax on the income generated from such profits. The benefit in terms of retained profits of paying dividends was minimal after one year if minimum advance corporation tax was payable, and worse than retaining profits in Limited if maximum advance corporation tax was payable, although in such case by the end of the second year it roughly broke even. The calculations were on the basis that International Holdings retained those dividends rather than pay them to the taxpayer. A further memorandum of 13 February 1987 discusses whether to pay dividends from International Holdings or to retain the profits for reinvestment in which case a further holding company is suggested.
54. At the International Holdings board meeting on 27 April 1987 it was reported that a profit for 1986 of £3m was expected in Limited and that a dividend would probably be paid for the first time. It was decided to wait until the United Kingdom position was finalised before considering International Holdings own dividend policy. At the meeting on 24 July 1987 it was in fact resolved not to pay a dividend. An interim dividend for 1987 was, however, resolved to be paid on 16 November 1987 of £2,381,880 (the 1986 dividend from Holdings was £2,380,000).
FINDINGS OF THE TAXPAYERs PURPOSE FROM THE FACTS
55. The essence of the dispute between the parties is how International Holdings contributed to the taxpayers commercial strategy. The Revenue accept the whole of the taxpayers strategy as being commercial but, as they cannot understand how International Holdings fits into it, they contend that International Holdings was something inserted by Mr Tuson for tax reasons which may have come to play a commercial part later. These tax reasons were said to be the obtaining of the remittance basis for the employment income for non-United Kingdom duties, the foreign emoluments deduction for the employment income for United Kingdom duties, the remittance basis for dividends paid by International Holdings out of dividends paid by Holdings, and a corporation tax reduction which was not made clear to me (originally the avoidance of capital gains tax was put forward but this is not now pursued). As I understood the Revenues position by the end of the case it was that they accept that, if there was a good commercial reason for setting up International Holdings in Bermuda, obtaining these tax benefits would not be tax avoidance. Accordingly, the main point I have to determine is whether International Holdings was set up for commercial or tax reasons. I shall at this stage make my findings of fact without regard to whether something is a bona fide commercial transaction or is tax avoidance within s 741, and I shall return to consider these points later.
56. I can understand the Revenues difficulty in following the reasons given in the clearance application set out in para 22 above, particularly the last sentence ('From its base in Bermuda, International Holdings would then be able to procure in the United States business for [Limited] without being seen to compete with established U.S. brokers'). It is difficult to see how International Holdings solves the problem of competing in the United States without being noticed. Mr Vallances much repeated question why Bermuda? was trying to obtain an answer to this question. To the taxpayers side, no doubt because they did not come to the problem starting from the clearance application, the relevant question was why not Bermuda? Indeed Mr Kirby said in reply to a question from Mr Vallance you keep asking the question why Bermuda? I am afraid I ask the question, where else would you have us put it? I shall return to this point.
57. The taxpayer set out his reasons for needing a Bermuda holding company in his witness statement as follows:
We decided that if we were to succeed in our attempt to source our own business as well as place it, it could only be done by establishing the Group as an international group and one that was perceived as being located either in London or the USA. Certainly, we had to operate in both territories but I wanted the companies to operate as sister companies under an international board. I did not want either London or the USA to be seen as the master with the other as servant. From my own experience of working in the USA and the UK, I knew that that was just a recipe for trouble with American and British personnel. I saw this happen when March [sic] McLennan took over Bowrings.
58. I think that the important words are perceived and seen. The taxpayer explained the rationale for a Bermuda holding company that he intended to have a board of International Holdings comprising American producers and London placers of reinsurance, and because the Americans regarded production as the more important part of the business, it would not have worked if the Americans had been subordinated to a London board. Mr Vallance made much in cross-examination of the apparent lack of logic of the taxpayers position since he was the owner of a private company and he was well known to be based in the United Kingdom and so the reality was that the United Kingdom predominated. As I am applying a subjective test, what matters is what the taxpayer thought, not whether this could be justified logically. In determining the taxpayers purpose, I have to put myself in his mind which is particularly difficult as he was pursuing a strategy unique among Lloyds reinsurance brokers and which was obviously highly risky. It is therefore particularly helpful to have a description of the taxpayer by others who worked with him. Mr Kirby described the taxpayers management style as closer to Churchill than Hitler and described him as a thoughtful man with a well-thought-through vision of what he was trying to achieve. He also described the taxpayer as a very powerful personality who likes to get his own way but will listen to others. Having heard the taxpayer in the witness box for over two-and-a-half days and having heard the other witnesses, I accept that the above business strategy was the real reason for the Bermuda holding company, and that it was not set up to avoid tax. If one looks at the minutes of the board meeting of International Holdings, which is particularly important as a contemporary record, a strong impression is given of senior American and British directors meeting on neutral territory and determining the strategy of the group in circumstances where the strategy was difficult to achieve and a mistake could have ruined the business. I did not see anything suggesting that the taxpayer used his shareholding control to achieve a particular result. In this way the perception had become the reality. Another example where the perception was regarded as important by others can be seen in the proposal made in the board meeting of International Holdings on 8 August 1983 for a joint venture with G J Sullivan & Associates Inc (which in fact never happened) to develop new classes of reinsurance business including financial guarantee business, where it was recorded that Mr Jerry Sullivan felt that by using Bermuda it would not be politically embarrassing to one or both of them'. This was explained by the taxpayer as meaning that neither would be seen as the junior partner.
59. The conclusion I have reached was that the taxpayer from the beginning saw the end result as it is today clearly but did not clearly see how to reach it. He certainly foresaw the link-ups between United States and United Kingdom reinsurance brokers and the loss of business to which this would lead. He foresaw the need for a United States operation with a placing ability in the United States reinsurance market. This required two types of Americans, those who could open doors to facilitate procuring business, and those who would work in placing the risks in the United States market. I heard a lot of evidence about who was or was not regarded as a big hitter', that is, a leading producer of reinsurance business for the group. It seems to me that the taxpayer and his co-directors employed those whom he considered would best further his commercial strategy and it should not matter to me how they were categorised. He considered that for commercial success the end product needed to have a holding company in a neutral country which was neither the United States nor the United Kingdom when all the other competing reinsurance brokers were, or would later become, United States companies owning United Kingdom subsidiaries or (to a much smaller extent) vice versa. It would not have worked if the Americans had been subordinated to a London board. The Americans who would open doors would, he considered, not wish to be seen to be working for a United Kingdom organisation. As the taxpayer put it, they would not easily be characterised by their fellow Americans as selling out to the United Kingdom opposition if they were on the board of a Bermuda company. There was serious rivalry between United States and United Kingdom reinsurance brokers at the time because United Kingdom brokers had access to the important Lloyds market. Meetings of International Holdings would be meetings on neutral terrritory of United States and United Kingdom people where neither country dominated. A holding company in Bermuda was a feature in attracting Mr Sullivan, Mr Welstead and later Mr Hearn. I accept that this, rather than any tax benefits, was the reason for setting up International Holdings.
60. Bermuda had an additional advantage that at the margins it was possible to place business in the United States market from there without going through a United States broker. This was a subsidiary purpose of having a holding company in Bermuda before the formation of Inc.
61. In accepting the evidence of the witnesses in the light of the contemporary documents, particularly the board minutes of International Holdings, I should set out my reasons for accepting that tax did not feature in the taxpayers decision. So far as dividends are concerned the choice was between paying bonuses or dividends. In 1982 this meant that either the employee paid income tax at 60% (we can assume that all the senior employees paid tax at the top rate), or that dividends were paid out of profits which had borne tax at 52%. If one looks at a marginal £100 of profit in Limited and takes the taxpayers shareholding to be 60%, instead of his actual 59%, by paying dividends via International Holdings which he did not remit he could increase his after-tax income from £24 (a bonus of £60 less tax of £36) to £28.80 (a dividend of 60% of the after-tax profit of £48) a 20% increase in income so long as he did not need to remit it. On the other hand, the other employees with their 40% holding in total paid the investment income surcharge and lost the benefit of the dividend tax credit resulting in £4.80 after tax as dividend instead of £16 after tax as bonus, a loss of 70%. I cannot believe that the taxpayer, who, I have found, set up International Holdings in order to have a management structure designed to motivate his staff, would have put them at this disadvantage if dividends had been in his mind. I do not think that dividends can have been in his mind when Limited had never paid any in the past; the first time that Holdings paid dividends was after the commercial success following gloves off'. If the taxpayer foresaw that the result of his success was that bonuses would be capped with the consequence that dividends would be paid, which I do not find that he did, he would surely not have allowed the employees to transfer their shares to International Holdings. So far as the purchase of own shares by International Holdings is concerned, it is clear from the facts I have outlined in para 48 onwards that this was not done in order to enable dividends to be paid to the taxpayer but as part of the lengthy process of tidying up the bonus arrangements. The process started in 1984 well before there were profits out of which dividends could be paid. It is relevant that when, much later, it was pointed out to the taxpayer that he would be better off by 11% by taking his remuneration as dividends (see para 53) he did nothing about it.
62. Nor do I find that obtaining the tax benefits of the employment arrangements were any part of the purpose of the transfer of the taxpayers shares to International Holdings. The income out of which the taxpayers remuneration was paid was derived from profits of International Holdings. While there is some artificiality in Personal Services employing him for United Kingdom duties, as there had been earlier with Cut, the result was that there was no corporation tax deduction at 52% (of which the taxpayer bore 59% of the additional corporation tax), he expected to obtain the foreign emoluments deduction of 25% of 60% tax, so it was extremely tax inefficient. The only rational reason for it was that the taxpayer was keen not to have to disclose his remuneration in the accounts of the United Kingdom companies. If Personal Services had not existed, he would still have obtained the foreign emoluments deduction for his employment by International Holdings.
63. The arrangements for employing him outside the United Kingdom were a successor of his employment with International and a new holding company was not necessary in order to achieve them. Therefore it cannot have been a purpose of the transfer of the taxpayers shares to International Holdings to enable him to obtain the remittance basis for his remuneration for non-United Kingdom duties; he was already receiving that benefit. (The application of the remittance basis to this income is still, I understand, in dispute.)
64. There are other features which do not suggest that the reorganisation was tax driven, the most striking being the capping of International Holdings profits to 110% of its expenses. Mr Vallance suggested that these points showed that the taxpayer was being careful not to take the tax savings to excess in order to reduce the danger of attack by the Revenue. I do not think that this is a correct description of the taxpayers approach.
65. Finally, the passage I have quoted from Mr Tusons memorandum of 12 July 1982 in para 21 above: Although there are a number of respectable locations which would be suitable, none has any logical or commercial justification . . . I suggest that we proceed on the basis that Bermuda would be the location for International Holdings. confirms what all the witnesses said, that Bermuda was not Mr Tusons choice as a location for a holding company but something which the directors had already decided. I understand him to be saying that on tax grounds he would have chosen a different jurisdiction for a holding company, presumably one with tax treaties, but that there were no jurisdictions which had the commercial justification of Bermuda and so he was approving the directors choice of Bermuda.
66. In summary in relation to the tax benefits, the taxpayers purpose, that is the end result which he wanted to achieve, was to have a holding company in a neutral country to direct the groups strategy. International Holdings provided a vehicle for his non-United Kingdom employment which would be taxed on the remittance basis. That was a natural consequence of having the company, rather than the', or even a', reason for it. Personal Services was not a necessary part of that transaction but, because it gave him the foreign emoluments deduction at the cost of no corporation tax relief against United Kingdom profits, its purpose cannot have been to save tax, but must have been in order to avoid disclosure of his remuneration in the accounts of the United Kingdom companies. The payment of dividends in the future was not something which the taxpayer had in mind at the time of setting up International Holdings.
67. Since I am disagreeing with the more experienced Special Commissioner who decided the case at the earlier hearing I have re-read his decision to see if there is anything in it which suggests to me that I am wrong in making these findings on the evidence before me. I had several advantages over Mr Everett. First, I had access to many of Mr Tusons documents which were found by the auditors after the earlier hearing; missing documents of the tax adviser must have raised suspicions when a major issue in the case is whether the arrangements were wholly commercial or partly inserted by Mr Tuson for tax reasons. I found Mr Tuson a very helpful witness who did not say anything other than what I expected to hear from a tax adviser, as opposed to the architect of a tax avoidance scheme, whereas Mr Everett said that he could not accept his oral testimony at face value. A possible reason was that Mr Tuson said that he was called as a witness at the previous hearing at the last minute and was dealing in 1994 with his recollection of events of 1982 without the benefit of his documents. I have also had the benefit of hearing more witnesses. I would single out Mr Kirby as being particularly helpful as he could explain the strategy in a way the taxpayer never seemed quite able to do. Finally, the previous hearing lasted eight days whereas mine lasted thirteen and with the benefit of Mr Vallances extremely detailed cross-examination I have been able to go into the facts in greater depth. I have fully taken into account Mr Vallances contention that the previous decision means that I should approach the evidence with a degree of caution and rely more on common sense, probability and contemporary documents than on peoples recollection of events of 1982.
68. I must, however, return to the why Bermuda? question and the meaning of the sentence in the clearance application setting out the commercial reasons for the reorganisation:
From its base in Bermuda, International Holdings would then be able to procure in the United States business for [Limited] without being seen to compete with established U.S. brokers.
I do not think that Mr Vallance ever received a satisfactory answer to the question how International Holdings achieved this, probably because there is no answer. It is logically true that, as a known United Kingdom figure, it did not make any difference whether the taxpayer approached the United States directly or via a Bermuda company, particularly a Bermuda holding company whose main function was to direct operations in both countries, rather than one having any facilities to assist in procuring business in the United States. The real need for the Bermuda company before gloves off was to attract such people as Mr Sullivan and Mr Welstead who would help form the strategy for the group to penetrate the United States market without losing their business, and, having successfully achieved that, its function was to direct the strategy of the group from a neutral place with United States and United Kingdom directors in which neither country dominated. The statement in the clearance application is misleading in suggesting that the purpose of the holding company was to procure business in the period before gloves off when it seems to me that its important function was deciding how to set about procuring business and it is also misleading in making no reference to its directing function after Inc had been formed. A lot of subsequent problems might have been saved if the clearance application had explained the commercial reasons in the way that came out in the evidence. The moral is that explaining commercial reasons should not be left to newly appointed tax advisers and the auditors.
SECTION 739 OF THE 1988 ACT
Section 739 provides:
(1) Subject to section 747(4)(b), the following provisions of this section shall have effect for the purpose of preventing the avoiding by individuals ordinarily resident in the United Kingdom of liability to income tax by means of transfer of assets by virtue or in consequence of which, either alone or in conjunction with associated operations, income becomes payable to persons resident or domiciled outside the United Kingdom.
69. The taxpayer agrees that the transfer of the old majority shares to International Holdings is a transfer of assets by the taxpayer within the section by virtue of which income became payable to International Holdings in the form of dividends on the old majority shares which the taxpayer as holder of the new majority shares had power to enjoy. The taxpayer contends that there are no other associated operations. The taxpayer also contends that the exemption in s 741, which I have set out above, applies.
REASONS FOR THE DECISION
70. Miss Gloster in her closing submissions helpfully listed the issues which needed to be determined and I shall follow these with some variations caused by my findings of fact.
Issue 1. Whether, as a matter of law, the taxpayer can be treated as the transferor for the purposes of s 739 in relation to all the shares in Holdings
71. In other words, was the taxpayer the transferor of the old minority shares owned by other directors and employees which were transferred to International Holdings as Mr Vallance contends. It is clear that transferor for the purposes of the section can in some circumstances be wider than merely the person who makes the transfer himself. An example is a transfer by a company which is wholly owned by the person concerned, as occurred in Congreve v IRC (1946) 30 TC 163. In IRC v Pratt  STC 756, the issue arose whether the three taxpayers who between them owned 12,268 out of 42,400 shares in a company and of which they were three of the eight directors of the company, were the transferors for the purposes of this section of an asset sold by the company. The Revenue contended that each of them as a shareholder and director had concurred with the disposal to sell the asset and therefore had a hand in and was associated with the transfer and had procured the transfer. This was rejected by Walton J on the ground that the three could not on their own, either as directors or shareholders, have procured the company to do anything. For an individual to be the transferor in relation to a transfer by another individual would be a considerable extension of this principle. However, there might be cases where, as a matter of fact, one individuals influence over another was so strong that he was the transferor of the others shares but this would clearly be an exceptional case. Accordingly, I propose to proceed on the basis that it may be possible in law for one individual to be the transferor of an asset transferred by another individual, and move on to consider the facts.
Issue 2. Whether, as a matter of fact, on the evidence the taxpayer did bring about the transfer of the old minority shares
72. Mr Vallance contends that the taxpayer was the transferor of the old minority shares. In order to find that this was an exceptional case where the taxpayer did in effect force his will on the other shareholders so as to become the transferor of their shares, one would need strong evidence that this was so. Of course, the taxpayer as majority shareholder and one of the founders of a company bearing his name was in a position of some influence. However, the influence did not go as far as telling other shareholders what to do with their shares. Here the decision by the old minority to transfer their shares was one which they came to after discussion, having started with different points of view as to the merits of the transfer. There is no evidence that the taxpayer leaned on any of them heavily, for example, by threatening to sack them if they did not. It is also clear that this was not the taxpayers management style. Accordingly, there is no evidence that the taxpayer did anything in relation to the old minority shares which would make him the transferor of them, and I find that he was not the transferor of the old minority shares. The only relevant transfer for the section, which is admitted by the taxpayer, is the taxpayers transfer of the old majority shares (I shall consider the 1986 repurchase of the new minority shares separately in issue 6).
Issue 3. In relation to the taxpayers transfer of shares in Holdings to International Holdings, what, as a matter of law, are the associated operations?
73. Mr Vallance separates the transfers to International Holdings into two: first the incorporation of and subscription of shares in International Holdings, and secondly, the acquisition by International Holdings of the shares in Holdings in exchange for its own shares. Miss Gloster treats this as a single transfer. I see little difference between the two approaches in relation to transactions which are almost simultaneous and I shall therefore treat these as effectively the same transfer, having already decided that the only relevant transfer is by the taxpayer in relation to the old majority shares. The Revenue contend that the associated operations in relation to that transfer are first the purchase by International Holdings of the new minority shares in 1986 and the acquisition by the taxpayer of Mr Bassetts shares in July 1985. In the alternative, the Revenue contends that there are the following additional six associated operations.
74. (1) The incorporation of Personal Services.
75. (2) The taxpayers contract of employment with Personal Services.
76. (3) The provision of services by the taxpayer to Personal Services.
77. (4) The taxpayers contract of employment with International Holdings.
78. (5) The performance of duties by the taxpayer for International Holdings.
79. (6) The brokerage sharing agreement of December 1982.
80. The definition of associated operations in s 742(1) is
. . . an associated operation means, in relation to any transfer, an operation of any kind effected by any person in relation to any of the assets transferred or any assets representing, whether directly or indirectly, any of the assets transferred, or to the income arising from any such assets, or to any assets representing, whether directly or indirectly, the accumulations of income arising from any such assets.
81. In construing this provision I bear in mind that: It has been said more than once that [s 739] is a broad spectrum anti-avoidance provision which should not be narrowly or technically construed (see IRC v Brackett  STC 521 at 539 per Hoffmann J) and also that the definition of associated operations is extremely broad. In Fynn v IRC  1 WLR 585 at 592, 37 TC 629 at 637 Upjohn J applied the ordinary use of language to determine whether there was any relationship between two transactions. The assets transferred are the taxpayers shares in Holdings (the old majority shares); the assets representing them are the taxpayers shares in International Holdings (the new majority shares). On the ordinary use of language, and, indeed, however wide a meaning one gives to the expression in relation to', it is difficult to see how any of these transactions are operations which relate to either the old or the new majority shares. They either relate to different shares (such as the repurchase of the new minority shares or the purchase of Mr Bassetts shares) or they do not relate to any shares at all (such as the employment arrangements or the brokerage sharing agreement). If I am wrong about this, they are not associated operations which are relevant because no income becomes payable to International Holdings by virtue or in consequence of any of these transactions; the income, ie the dividends on the old majority shares becomes payable to International Holdings solely by virtue of the transfer of the old majority shares to International Holdings. Nor do any of these transactions give the taxpayer power to enjoy the income of International Holdings; he has that power by virtue of holding the new majority shares which he obtained solely as a result of the transfer.
82. In particular, the purchase by the taxpayer of Mr Bassetts shares in International Holdings (see para 52 above) did not relate in any way to the old or new majority shares. Nor did any income become payable to International Holdings by virtue of the purchase; all International Holdings income continued to be payable to it.
83. The repurchase of the new minority shares in 1986 has no relationship with the old majority shares and the asset representing them, being the new majority shares. The new majority shares owned by the taxpayer remained as they were before and after the repurchase of the new minority shares and therefore the repurchase is not an operation of any kind in relation to either the old or new majority shares. The new majority shares carried with them, rights which varied in extent according to the number of other shares in issue but that was an economic relationship not a legal relationship. Mr Vallance on the other hand, contended that the result of the repurchase of the new minority shares was that the taxpayer became entitled to the whole of the income of International Holdings, thus emphasising the economic relationship. I agree with the taxpayer that the repurchase of the new minority shares is not an operation relating to the taxpayers new majority shares. The reason why the taxpayer can enjoy all the dividends paid by Holdings to International Holdings is not because of anything which has happened to his shares but because the other shares have been repurchased so that his entitlement relates to a smaller cake. The taxpayer also contends that, even if the repurchase of the new minority shares is an associated operation, it is not a relevant one for the section because first the income which became payable to International Holdings by virtue of the transfer of the old majority shares, being the dividends on the old majority shares, remained unchanged, and secondly, the taxpayers power to enjoy that income was unchanged by the purchase of the new minority shares. I also agree that even if it were an associated operation it would not be a relevant one for the purpose of the section. The change relates to the taxpayers power to enjoy the income from the old minority shares but since he was not the transferor of those shares this is not within the section.
84. Nor is there any relationship between the six items listed above and the transfer of the old majority shares and the asset representing them, the new majority shares, because none of them relates to shares at all.
85. Accordingly, I hold that none of the transactions is an associated operation as a matter of law and even if they are they are not relevant transactions because they do not contribute to income becoming payable to International Holdings or to the taxpayers power to enjoy that income. However, I should add that if, contrary to my findings, that the purpose of the transfer was to avoid tax (assuming that these constitute tax avoidance within the meaning of the section) by means of any of the six listed items, then that would inevitably be at least one of the purposes of the transfer and therefore it makes little difference to the result under s 741 whether or not they are associated operations.
Issue 4. What, as a matter of law, are the constituent elements of the test which the taxpayer has to satisfy in order to claim the exemption under s 741?
86. I have already dealt with the question whether the test in s 741 is subjective or objective. The taxpayers primary contention is that para (b) is applicable
. . . that the transfer and any associated operations were bona fide commercial transactions and were not designed for the purpose of avoiding liability to taxation.
In view of my decision that there are no operations associated with the transfer of the old majority shares to International Holdings I apply this test to the transfer only (I shall deal with the question whether the 1986 repurchase is a transfer below).
87. There was not much difference between the parties about what constituted a bona fide commercial transaction. Miss Gloster contended that this was any genuine transaction which implements or facilitates a business end; Mr Vallance contended that the transaction must be in furtherance of commerce, ie a trade or business. I shall follow these two meanings. Because of the dual test in para (b) such a transaction may have the effect of avoiding tax.
88. There was less agreement between the parties about the degree of tax avoidance permitted in the expression not designed for the purpose of avoiding liability to taxation'. There is a significant contrast between para (a) of s 741, which refers to the purpose or one of the purposes being tax avoidance, and para (b) which refers to the purpose being tax avoidance. Miss Gloster contended that the purpose implied that this had to be the sole purpose of the design of the transfer. Mr Vallance contended that the method chosen to achieve the commercial objective must not be structured ('designed') for the purpose of tax avoidance so that if tax avoidance were a significant purpose of the design the taxpayer would not be able to satisfy the test.
89. The history of the legislation was referred to. Originally, in 1936 there was a single let-out provision exempting a transfer of assets effected mainly for some purpose other than the purpose of avoiding liability to taxation'. Section 28 of the Finance Act 1938 changed this to the present wording of s 741 which in para (a) applies a more stringent test of one of the purposes of the transfer (and associated operations) not being tax avoidance, and in para (b) merely refers to the transfer (and associated operations) not being designed for that purpose. Clearly, this cannot mean one of the purposes for which it was designed being tax avoidance, because otherwise para (b) would add nothing to para (a). It is odd that Parliament did not lay down any level of purpose in para (b) when it was replacing a test which depended mainly on tax avoidance with a test in para (a) depending on none of the purposes being tax avoidance. It was obviously clear from para (a) that a transfer could have more than one purpose and therefore in para (b) could be designed for more than one purpose. One must ask in para (b) whether the transfer was designed for the purpose of avoiding tax or not. This seems to me to require that the main purpose was not tax avoidance because if one has to categorise a transaction as being either designed for the purpose of tax avoidance or not, when it is clearly accepted that a transaction may be designed for more than one purpose, the only way to categorise the design into one purpose is to look at the main purpose of the design. I think, therefore, that the taxpayers contention of sole purpose is too loose a test and the Revenues contention of significant purpose is too stringent a test although it will in practice be difficult to determine the difference between a significant and a main purpose. In view of my finding that tax was not a purpose of the transfer it makes no difference to my decision what degree of purpose is required.
90. There was also disagreement between the parties about what is tax avoidance, although both accepted the distinction between tax avoidance and tax mitigation originally proposed in Comr of Inland Revenue v Challenge Corp Ltd  STC 548,  AC 155. In IRC v Willoughby  STC 995 at 1004,  1 WLR 1071 at 1079 when construing para (a) of s 741, Lord Nolan said: Tax avoidance within the meaning of s 741 is a course of action designed to conflict with or defeat the evident intention of Parliament. Mr Vallance pointed to the difficulty of this formulation that the taxpayer needs to show more than that he has done something which the statute permits him to do. Although he did not put it in this way, Furniss (Inspector of Taxes) v Dawson  STC 153,  1 AC 474 would be an example of a taxpayer using a relieving provision in a statute but still avoiding tax because he was trying to use the relieving provision in circumstances for which it was intended. With this in mind, Mr Vallance contended for a somewhat narrow meaning of tax mitigation building on Lord Templemans examples in Comr of Inland Revenue v Challenge Corp Ltd  STC 548,  AC 155 which were all cases where the taxpayers expenditure reduces his income and entitles him to a reduction in his tax liability. Miss Gloster contended that tax mitigation is not limited to cases where there are specific relieving provisions because there was no such relieving provision for bed and breakfast transactions which were accepted in Ensign Tankers (Leasing) Ltd v Stokes (Inspector of Taxes)  STC 226,  1 AC 655 as being mitigation on the basis that a genuine loss had been suffered.
91. Tax avoidance is an extremely elusive concept and I propose to follow Lord Nolans meaning of a course of action designed to conflict with or defeat the evident intention of Parliament. My understanding of what he was saying is not, I think, much different from what Mr Vallance is contending. It is not enough to say that if you find a relieving provision then it is the evident intention of Parliament that the taxpayer should be entitled to use it whatever the circumstances. As Furniss (Inspector of Taxes) v Dawson shows it is quite possible to misuse a relieving provision. To give an example in the same area as this case, suppose the taxpayer had formed Personal Services solely to give him a non-resident employer in order to obtain the foreign emoluments deduction. If that company had been funded entirely by the United Kingdom companies and had done nothing other than employ the taxpayer, it might be the case that the taxpayer would have been avoiding tax because he was misusing a relieving provision. That example of course is deliberately different from the facts of this case where Personal Services was funded from non-United Kingdom profits with no corporation tax deduction for services which benefited the United Kingdom companies. Mr Vallance went as far as claiming that Parliaments purpose in enacting the foreign emoluments deduction was to encourage, or at least not discourage, people from abroad to work in the United Kingdom so that someone in the taxpayers position who had spent all his working life in the United Kingdom, could never qualify. While this may have been in Parliaments mind, I cannot accept that the relief was not available to a non-domiciled person working for a non-United Kingdom resident employer whose remuneration is borne by a non-resident, however long the non-domiciled person has been resident (I note that the amount of relief was reduced after nine years residence). All this shows is how difficult it is to discern the evident intention of Parliament but I do not think there is any substantial disagreement between the parties if Lord Nolans dictum is understood in the way I have suggested that the taxpayer must do more than point to the existence of a relieving provision; he must be using, rather than misusing, the relieving provision in a way consistent with Parliaments evident intention.
Issue 5. Whether, as a matter of fact, the taxpayer has satisfied the exemption under s 741(b)
92. In the light of my findings above, I can summarise that the purpose of setting up International Holdings, and accordingly the purpose of the taxpayers transfer of the old majority shares to it, was to create a vehicle for the ultimate management of the group from a neutral territory and in the meantime it was the vehicle for determining the strategy for setting up in the United States. I have no hesitation in finding that this was a bona fide commercial transaction. I find both that there was no tax avoidance purpose in the sense I have described, and that tax considerations did not form any of the taxpayers purposes in designing the transaction. Obtaining any tax benefits from the employment arrangements were not a purpose of the transfer but were matters which followed from it and for which a holding company was not necessary. None of the potential tax benefits, such as payment of dividends, was a purpose of the transfer. Accordingly I hold that the taxpayer has satisfied the exemption in s 741(b).
Issue 6. Whether, as a matter of law, the repurchase of the new minority shares by International Holdings was a transfer of assets
93. The reason why Mr Vallance contends that the repurchase of the new minority shares in 1986 is a transfer of assets is in order to contend that the taxpayer is the transferor of it by procuring the transfer by the new minority shareholders. The way this is put is that by virtue of this transfer together with the associated operations of the original transfer (or, as the Revenue say, two transfers, see para 73 above) in 1982, income becomes payable to International Holdings in the form of dividends from Holdings. This seems rather a strained construction because all the income becoming payable to International Holdings had already done so by virtue of the transfer of the old majority shares in 1982 which for this purpose the Revenue have to regard as an associated operation. I need not pursue this because I am against the Revenue on their contention that the taxpayer was the transferor in relation to the new minority shares (see issues 7 and 8) but had it been necessary for me to make a decision on this point I would have concluded that this was not a transfer within the meaning of the section because it strains the meaning of the section too far to say that income becomes payable to International Holdings by virtue of this transfer in conjunction with the associated operation when it was the associated operation (on the assumption that the 1982 transfer was an associated operation) on its own which had caused the income to become payable to International Holdings.
Issue 7. Whether, as a matter of law, the taxpayer can be treated as the transferor in relation to the new minority shares
94. This is the same point of law as issue 1 in which I decided that it might be possible in an exceptional case for an individual to be regarded as the transferor in relation to a transfer by another individual.
Issue 8. Whether, as a matter of fact, the taxpayer did bring about the transfer of the new minority shares
95. The evidence on this point is strongly that the taxpayer did not exert any influence over the new minority shareholders to make this transfer. Indeed, negotiations went on between the decision to buy back the shares in July 1985 and its completion in December 1986 before the shareholders made their decision to transfer their shares. Before the shareholders decided to do so the taxpayer had to undertake to sell to an employee trust at par (an enormous undervalue) the same proportion of his shares as the proportion of the group profit which had at the time been distributed to employees other than the taxpayer. He also agreed to leave by will more than 50% of his shares to the employee trust. It is clear that the employees transferred their shares as a result of a commercial bargain under which they were satisfied that the terms were right. This was an independent decision made by the new minority shareholders after much discussion and it was certainly not a case of the taxpayer influencing them into making the transfers to such an extent that he could be regarded as procuring the transfers. I find that the taxpayer was not as a matter of fact the transferor of the new minority shares.
Issue 9. What, as a matter of law, are the associated operations relating to the 1986 repurchase?
96. This issue does not arise as I have decided that the taxpayer was not the transferor of the 1986 repurchase of shares and accordingly it is not a relevant transfer for the purposes of the section. However, I would have decided that none of the operations which the Revenue contend are associated operations are operations in relation to the new minority shares because however widely one construes in relation to I cannot see any relationship.
Issue 10. The quantum of taxation
97. This does not arise in the light of my decision that s 741 is applicable but I will briefly deal with it. The taxpayer contended that having decided that the only transfer bringing the section into operation is the transfer of the old majority shares to International Holdings, the only income caught by the section is the income which became payable to International Holdings on such shares. The remainder of the dividend income became payable to International Holdings by virtue of the transfer by someone else and is, accordingly, not relevant to taxing the taxpayer.
98. I agree with this. The income which is potentially taxable on the taxpayer is the income which has become payable to International Holdings as a result of the transfer by him of the old majority shares which he has power to enjoy by virtue of his holding of the new majority shares.
99. Mr Giles Goodfellow for the taxpayer and Mr Rabinder Singh for the Revenue addressed me on the issue of whether the dividends on these shares should be grossed-up.
100. Mr Singh contended that the income which the section deems to be income of the taxpayer is the dividends. Section 743(2) provides that:
In computing the liability to income tax of an individual chargeable by virtue of section 739, the same deductions and reliefs shall be allowed as would have been allowed if the income deemed to be his by virtue of that section had actually been received by him.
It follows that the position is the same as if the taxpayer had actually received those dividends. They would be grossed-up by the amount of the tax credit and he would be entitled to the benefit of the tax credit. The position is just as if International Holdings had never existed.
101. Mr Goodfellow contended that the income which was deemed to be the taxpayers was the net income of the company from all sources after deduction of any reliefs which would have been available to an individual in a comparable position. The income lost its original characteristics and became charged under Case VI of Sch D. As an example of why this approach was necessary, suppose that there were a trading loss and some investment income. If it were only the investment income which was attributed to the taxpayer and the loss could not be attributed because it was not income, the result was unjust. There was still scope for the operation of s 743(2) in giving effect to reliefs which were available against total income. The effect of this approach is that because International Holdings is not entitled to the tax credit, the income is not grossed up but is not charged to income tax at the lower rate.
102. It is not necessary for me to decide this point but I find Mr Singhs approach more attractive particularly as it precisely gives effect to counteracting the advantage of the transfer. I agree, however, with Mr Goodfellow that this approach does not deal well with losses, but that does not arise in this case.
FURTHER FINDINGS OF FACT
103. I am anxious, having regard to the history of this case, to avoid the need for the case to be remitted to me for further findings of fact if a court should disagree with any points of law which I have decided. I propose, therefore, to make findings of fact based on the items which the Revenue contend are associated operations. If one takes the transfer of the old majority shares and all the items in para 73 which the Revenue contend are associated operations together, I would still find under s 741(b) that they were bona fide commercial transactions and were not designed for the purpose of avoiding liability to taxation. The transfer was made for the reasons set out above and in coming to my conclusion I have taken into account all the contemporaneous other transactions even though I had decided that they were not associated operations.
104. The purchase of Mr Bassetts shares was a separate transaction caused by his leaving and was a commercial transaction not designed for the purpose of avoiding liability to taxation.
105. I find for the reasons given above, that the 1986 repurchase was a bona fide commercial transaction to enable the profit-sharing arrangements to be rationalised and was not designed for the purpose of avoiding liability to taxation. The Revenues interpretation of the 1986 repurchase is that it was a prelude to enabling dividends to be paid by Holdings to International Holdings and thence to the taxpayer. While the other shareholders remained as shareholders of International Holdings, the effect of paying a dividend was disadvantageous to them because they would lose the tax credit attaching to the Holdings dividend since the dividend paid by International Holdings was a dividend from a non-resident company. This is an aspect of the arrangements which is extremely well documented. In the light of my findings above, the purpose was not to enable dividends to be paid. None of the purposes of the 1986 repurchase was the avoidance of liability to taxation. My decision about the purpose of the transfer is not therefore affected by the inclusion of these later transactions.
106. If on the same basis I were applying para (a) of s 741 and I need to find whether avoidance of taxation was one of the purposes of any of these transactions looked at separately, my findings are that the brokerage sharing agreement was a commercial agreement without any tax avoiding purpose (no attack was made on the arms length nature of this agreement); the purchase of Mr Bassetts shares was a commercial agreement without any tax avoiding purpose; my finding in relation to the 1986 repurchase is in para 105 above. One of the purposes of the employment arrangements with Personal Services looked at separately was in order to obtain the remittance basis for the remainder of his remuneration from International Holdings because if they had not existed and International Holdings had paid all his remuneration that would have qualified for the foreign emoluments deduction; one of the purposes of the employment arrangements with International Holdings looked at separately was to obtain the remittance basis for his remuneration for non-United Kingdom duties. In the context of the arrangements generally, particularly that International Holdings bore the whole of the cost of his remuneration, obtaining these tax benefits were not a tax avoidance purpose, but was tax mitigation. The reliefs are available to persons in the taxpayers circumstances and he was not misusing the reliefs.
107. I therefore find that the taxpayer has satisfied the provisions of s 741(b) in relation to the transfer (and, if it had been necessary to decide, every operation alleged to be an associated operation) and, accordingly, I allow the appeal.