[HOUSE OF LORDS]

AND

Revenue - Tax avoidance - Sale of annuity to charity - Surtax payer selling five-year annuity to registered charity - Yearly sum equalling £500 after deduction of income tax paid by taxpayer in consideration for receiving £2,480 from charity - Whether payment of any annuity or other annual payment - Whether yearly payments made for "valuable and sufficient consideration" - Whether scheme expressly designed to avoid tax falling within statutory definition of "settlement" - Whether yearly payments deductible from total income for tax purposes - Income and Corporation Taxes Act 1970 (c. 10), ss. 52 (1), 434, 454 (3), 457

The taxpayer, a taxation manager, supervised and participated in a taxation saving scheme aimed at surtax payers.

The scheme provided for a registered charity to purchase annuities from those wishing to participate in the scheme. The charity was thought to be able to recover the tax deducted when the surtax payers paid the annuity to it and the surtax payers would be able to deduct the amount of the annuity from their income for tax purposes. In 1971 the taxpayer personally took advantage of the scheme; he agreed that in consideration of payment to him of £2,480 by the charity he would make to the charity five yearly payments of a sum which after deduction of standard rate tax would each equal £500. To provide the charity with sufficient funds to make the capital payments to the taxpayer and to give it security against possible failure by the taxpayer to pay a due instalment, financing arrangements were made which complicated an otherwise simple scheme. Additionally, the charity took out a life insurance to protect it against the possibility of the taxpayer's death before all five payments had been made. The taxpayer appealed against three assessments to surtax for the years from 1970 to 1973 on the ground that no deductions had been made under the provisions of section 52 (1) of the Income and Corporation Taxes Act 1970 ¹ from his total income in respect of the annuity payments made to the charity. The special commissioners, allowing the appeal, held that the payments were payments of "any annuity or other annual payment" within section 52 (1) and were deductible.

Walton J., dismissing an appeal by the Crown upheld the commissioners' decision that the payments fell within section 52 (1), and were not disallowed as deductions under the provision either of section 434 or of section 457. On appeal, the Court of Appeal affirmed that decision.

On appeal by the Crown: -

Held, dismissing the appeal (Viscount Dilhorne and Lord

1 Income and Corporation Taxes Act 1970. s. 52 (1): "(1) Where any annuity or other annual payment charged with tax under Case III of Schedule D, not being interest, is payable wholly out of profits or gains brought into charge to income tax - (a) no assessment to income tax (other than surtax) shall be made on the person entitled to the annuity or other annual payment, and (b) the whole of the profits or gains shall be assessed and charged with income tax on the person liable to the annuity or other annual payment, without distinguishing the annuity or other annual payment, and (c) the person liable to make the payment, whether out of the profits or gains charged with income tax or out of any annual payment liable to deduction, or from which a deduction has been made, shall be entitled on making the payment to deduct and retain out of it a sum representing the amount of income tax thereon at the standard rate for the year in which the amount payable becomes due, and (d) the person to whom the payment is made shall allow the deduction on receipt of the residue of the payment, and the person making the deduction shall be acquitted and discharged of so much money as is represented by the deduction, as if that sum had been actually paid."

S. 434:"(1) Any income which, by virtue or in consequence of any disposition made, directly or indirectly, by any person (other than a disposition made for valuable and sufficient consideration), is payable to or applicable for the benefit of any other person for a period which cannot exceed six years shall be deemed for all the purposes of the Income Tax Acts to be the income of the person, if living, by whom the disposition was made, and not to be the income of any other person. (2) In this chapter, unless the context otherwise requires, 'disposition' includes any trust, covenant, agreement or arrangement."

S.454 (3): see post, p. 911-D.

S. 457: "(1) Where, during the life of the settlor, income arising under a settlement made on or after April 7 1965, is, under the settlement and in the events that occur, payable to or applicable for the benefit of any person other than the settlor, then,... the income shall be treated for the purposes of surtax as the income of the settlor and not as the income of any other person."

Diplock dissenting), (1) that in order to ascertain whether the payments made by the taxpayer were "payments of any annuity" it was necessary to look at the whole transaction to determine their true character; that the Crown's contention that the payments represented nothing but a repayment in instalments to the charity of its own capital and were thus of a capital nature was not supported by the facts with the result that the character of "annuity payments" had to be attributed to them and that as under the scheme the payments were to be treated as paid out of the taxpayer's taxed income section 52 (1) of the Act did operate to allow deduction of income tax from those payments (post, pp. 907D-F, 908C-G,909F, 910F-G, 925D - 926A, D-G, G - 927B, D-G, 929E).

Sothern-Smith v. Clancy [1941] 1 K.B. 276, C.A. and Chancery Lane Safe Deposit and Offices Co. Ltd. v. Inland Revenue Commissioners [1966] A.C. 85, H.L.(E.) applied.

(2) That as the transaction between the parties was a bona fide commercial transaction devoid of any element of bounty, notwithstanding that its sole object was to avoid payment of tax, the only possible conclusion that could be reached was that the price paid for the annuity, albeit viewed as an amount paid net of tax, was "valuable and sufficient consideration" and that accordingly section 434 of the Act could not operate to disallow the deductions (post, pp. 910G - 911A, 927G-H, 929E).

(3) That as the transaction was effected for full consideration it could not come within the definition of a "settlement" for throughout Part XVI of the Act that expression connoted a transaction containing an element of bounty and that accordingly section 457 could not be applied to disallow the deduction and thus the annual payments were deductible in computing the taxpayer's income for surtax purposes (post, pp. 912D - 913E, 927G-H, 928C-F, 929E).

Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 and Inland Revenue Commissioners v. Leiner (1964) 41 T.C. 589 applied.

Decision of the Court of Appeal [1979] Ch. 63; [1978] 3 W.L.R. 459; [1978] 3 All E.R. 513 affirmed.

The following cases are referred to in their Lordships' opinions:

Allchin v. Coulthard [1942] 2 K.B. 228; [1942] 2 All E.R. 39, C.A.; [1943] A.C. 607; [1943] 2 All E.R. 352, H.L.(E.).

Bulmer v. Inland Revenue Commissioners [1967] Ch. 145; [1966] 3 W.L.R. 672; [1966] 3 All E.R. 801; 44 T.C. 1.

Central London Railway Co. v. Inland Revenue Commissioners [1937] A.C. 77; [1936] 2 All E.R. 375, H.L.(E.).

Chamberlain v. Inland Revenue Commissioners [1943] 2 All E.R. 200; 25 T.C. 317, H.L.(E.).

Chancery Lane Safe Deposit and Offices Co. Ltd. v. Inland Revenue Commissioners [1966] A.C. 85; [1966] 2 W.L.R. 251; [1966] 1 All E.R. 1; 43 T.C. 83, H.L.(E.).

Copeman v. Coleman [1939] 2 K.B. 484; [1939] 3 All E.R. 224; 22 T.C. 594.

Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59; [1936] 1 All E.R. 116, C.A.

Foley v. Fletcher (1858) 3 H. & N. 769.

Hood Barrs v. Inland Revenue Commissioners (1946) 27 T.C. 385, C.A.

Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329; [1976] 3 W.L.R. 214; [1976] 2 All E.R. 1037, H.L.(E.).

Inland Revenue Commissioners v. Duke of Westminster [1936] A.C. 1; 19 T.C. 490, H.L.(E.).

Inland Revenue Commissioners v. Goodwin [1975] 1 W.L.R. 640; [1975] 1 All E.R. 708, C.A.

Inland Revenue Commissioners v. Leiner (1964) 41 T.C. 589.

Lupton v. F.A. & A.B. Ltd. [1972] A.C. 634; [1971] 3 W.L.R. 670; [1971] 3 All E.R. 948; 47 T.C. 580, H.L.(E.).

Perrin v. Dickson [1929] 2 K.B. 85; [1930] 1 K.B. 107; 14 T.C. 608, C.A.

Sothern-Smith v. Clancy [1941] 1 K.B. 276; [1941] 1 All E.R. 111; 24 T.C. 1, C.A.

Thomas v. Marshall [1953] A.C. 543; [1953] 2 W.L.R. 944; [1953] 1 All E.R. 1102; 34 T.C. 178, H.L.(E.).

The following additional cases were cited in argument:

Campbell v. Inland Revenue Commissioners [1970] A.C. 77; [1968] 3 W.L.R. 1025, [1968] 3 All E.R. 588; 45 T.C. 427, H.L.(E.).

Chinn v. Hochstrasser [1979] Ch. 447; [1979] 2 W.L.R. 411; [1979] 2 All E.R. 529, C.A.

Crossland v. Hawkins [1961] Ch. 537; [1961] 3 W.L.R. 202; [1961] 2 All E.R. 812, C.A.

Finsbury Securities Ltd. v. Inland Revenue Commissioners [1966] W.L.R. 1402: [1966] 3 All E.R. 105, 43 T.C. 591 H.L.(E.).

Hinton v. Maden and Ireland Ltd. [1959] 1 W.L.R. 875; [1959] 3 All E.R. 356, H.L.(E.).

Inland Revenue Commissioners v. Frere [1965] A.C. 402; [1964] 3 W.L.R. 1193; [1964] 3 All E.R. 796; 42 T.C. 125, H.L.(E.).

Inland Revenue Commissioners v. Wesleyan and General Assurance Society [1948] 1 All E.R. 555, H.L.(E.).

Ridge Securities Ltd. v. Inland Revenue Commissioners [1964] 1 W.L.R. 479, [1964] 1 All E.R. 275; 44 T.C. 373.

Secretary of State in Council of India v. Scoble [1903] A.C. 299, H.L.(E.).

APPEAL from the Court of Appeal.

This was an appeal by the appellants, the Inland Revenue Commissioners, from an order dated May 5, 1978, of the Court of Appeal (Buckley and Bridge L.JJ., and Foster J.) dismissing an appeal by the appellants from an order dated July 1, 1977, of Walton J., whereby he dismissed an appeal by way of case stated under section 56 of the Taxes Management Act 1970, from a decision of the Commissioners for the Special Purposes of the Income Tax Acts in favour of the respondent, Ronald Anthony Plummer.

The question in this appeal was whether certain payments made to Home and Overseas Aid Services Ltd. by the respondent were deductible in computing the total income of the respondent for surtax purposes. It was common ground in the courts below that the payments were so deductible if they were:

(i) payments of an "annuity or other annual payment charged with tax under Case III of Schedule D (not being interest)" within the meaning of section 52 of the Income and Corporation Taxes Act 1970;

(ii) "payable wholly out of profits or gains brought into charge to income tax" within the meaning of section 52 of the Income and Corporation Taxes Act 1970;

(iii) not caught by the provisions of section 434 of the Income and Corporation Taxes Act 1970 and

(iv) not caught by the provisions of section 457 of the Income and Corporation Taxes Act 1970.

The facts are set out in the opinions of Lord Wilberforce and Viscount Dilhorne.

G. B. H. Dillon Q.C., Patrick Medd Q.C., Peter Gibson and Brian Davenport for the appellants. First, a general observation. The nature and effect of the scheme as a whole has to be taken into account: see Ransom v. Higgs [1974] 1 W.L.R. 1594, 1612E-F, per Lord Wilberforce.

Four main issues of law arise in testing the efficacy of this scheme: (1) Whether (as contended by the respondent) the sums paid by him under the agreement were payments of "any annuity or other annual payment," so that the amount of each payment could be deducted by him in computing his total income. If the respondent fails on this issue, none of the remaining issues arise. (2) Whether such sums were payable by him wholly out of profits and gains brought into charge to Income Tax. (3) Whether such payments were made otherwise than for valuable and sufficient consideration within the meaning of section 434 of the Income and Corporation Taxes Act 1970 ("the Act"). (4) Whether such payments were income arising in consequence, or by virtue, of a "disposition" within section 434 (1) of the Act as defined in section 434 (2) thereof, or whether they were income arising under a "settlement" within section 457 of the Act as those words are defined in section 454 (3) of the Act. This issue raises the question whether the limitation attributed to the meaning of the word "settlement" in section 457 by Pennycuick J. in Bulmer v. Inland Revenue Commissioners [1967] Ch. 145, should likewise be held to apply to the word "disposition" in section 434, and whether in either case the limitation on the meaning of the words had the effect of causing the agreement in this case to be held not to be, respectively, a "settlement" or a "disposition."

The first two questions arise under section 52 of the Act. Are the payments of £500 each which the respondent made to H.O.V.A.S. within the expression "annuity or other annual payment"? If so, were they payable wholly out of profits or gains brought into charge to income tax within section 52? "Payable" is not the same as "paid," though not necessarily different. Questions 3 and 4 which concern sections 434 and 457 of the Act are quite separate from questions 1 and 2 and questions 3 and 4 are separate from each other.

(1) "Any annuity or other annual payment...." If the payments are of a capital nature they are not income in the hands of the recipient and not deductible in the hands of the payer. The court has to look at the surrounding facts admitting extrinsic evidence to ascertain what was the real nature of the payment: see Inland Revenue Commissioners

v. Church Commissioners for England [1977] A.C. 329. In considering whether a capital sum has been used in the purchase of an annuity the test has been whether the capital sum has gone and has been replaced by an income: Foley v. Fletcher (1858) 3 H. & N. 769, 784-785, perWatson B. See also Perrin v. Dickson [1929] 2 K.B. 85; [1930] 1 K.B. 107, 144 et seq., 121 et seq., 124, 127, and Sothern-Smith v. Clancy [1941] 1 K.B. 276, 282 et seq., 288, 289, where all three members of the Court of Appeal commenting on Perrin v. Dickson [1930] 1 K.B. 107, applied Watson B.'s test.

In the present case the capital sum paid by H.O.V.A.S. is not lost sight of. It has been borrowed by H.O.V.A.S. from Baldrene. The £2,480 was provided for the respondent to enable him to pay the annuity. It is emphasised that in the present case the capital is never lost sight of for the annual payments were paid by the respondent out of the price that he has received and the above test ought to be applied in that the payments were of a capital and not of an income nature.

(2) Whether the sums paid each year by the respondent were properly to be regarded as having been paid wholly out of profits and gains brought into charge to Income Tax within the meaning of section 52 of the Act. The classic exposition of what is meant by the words "payable out of profits or gains brought into charge to income tax" and of the basis upon which the deduction of an annual payment is allowed, if the payment is within section 52 of the Act and there is no provision in the Income Tax Acts disallowing it, is to be found in the opinion of Viscount Radcliffe in Inland Revenue Commissioners v. Frere [1965] A.C. 402, 419, with which all other members of this House agree. The basis for the deduction is that under section 52 the payer may deduct and retain the tax paid on the amount of the annuity or annual payment which is treated as not being part of his income but that of the recipient. Prima facie, if a taxpayer is found to have, in the relevant year, taxable income larger than the gross amount paid as an annuity he is entitled to say that he made the payment out of the profits and gains brought into charge to income tax.

It has long been recognised that there are exceptions to the above proposition. Thus in Chancery Lane Safe Deposit and Offices Co. Ltd. v. Inland Revenue Commissioners [1966] A.C. 85, 131, it was recognised by Lord Wilberforce that the taxpayer loses the right of allocation if he has made a decision which has practical results inconsistent with the actual claim to attribute the payment to taxed profits. True, that case concerned a corporation, the relevant case concerning an individual tax payer is Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59, where the facts are closely analogous to the transaction in question here. Fenton governs the present case and the judgment of Romer L.J. was right. The reasoning in the judgment of Lord Wright M.R. is in line with that of Romer L.J. The dissenting judgment of Greene L.J. was in substance repeated in Allchin v. Coulthard [1942] 2 K.B. 228, and the judgment of Lord Greene M.R. in Allchin was approved in this House [1943] A.C. 607. But in Allchin v. Coulthard [1942] 2 K.B. 228, Lord Greene M.R. did not refer to what he said in

Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59, 89, that the exemptions only apply to companies and not individuals for this point did not arise on the facts of Allchin v. Coulthard. There is nothing in what this House stated in Allchin v. Coulthard [1943] A.C. 607 which is contrary to what Romer L.J. and Lord Wright M.R. said in Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59.

In Chancery Lane Safe Deposit and Offices Co. Ltd. v. Inland Revenue Commissioners [1966] A.C. 85, Lord Morris of Borth-y-Gest, Lord Wilberforce and Lord Pearson all refer to Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59, but there is nothing in the Chancery Lane case which is inconsistent with what was stated in the majority judgments in Fenton's Trustee. Fenton's Trustee v. Inland Revenue Commissioners was rightly decided and should be applied to the present question.

In the present case the yearly payments of £500 were made out of the respondent's special account with Slater Walker Ltd. which account contained only capital sums, namely the £2,480 received from H.O.V.A.S. and the yearly proceeds of the promissory notes together with £40 paid in by him to cover the charge made by Cardale for negotiating the agreement and the cost of insuring his life. In an ordinary case, having paid the annuity out of a capital fund he would, if he wished to maintain his capital, have had to pay into the fund (that is in this case the Slater Walker Ltd. bank account) an equivalent sum from his income but in this case because of the way in which the scheme worked, it is not necessary for the respondent to repay this capital payment from his income. The depletion of his capital was immediately made good by the release to him of another capital sum, namely, £500, the proceeds of the promissory note. Thus it is true both in fact and in principle that the payments were not made out of the profits and gains brought into charge to income tax.

(3) Whether the payments were made otherwise than for valuable and sufficient consideration within the meaning of section 434 of the Act. The respondent has always conceded that unless the limitation on the definition of "settlement" laid down in Bulmer v. Inland Revenue Commissioners [1967] Ch. 145, applied equally to the definition of "disposition" in section 434, the agreement, being an agreement or covenant, was a disposition within the meaning of the section. Moreover, that the payments made under it were payable or applicable for the benefit of a person (namely H.O.V.A.S.) other than the respondent and were so payable or applicable for a period which could not exceed six years. Accordingly, unless (a) "disposition" in section 434 is to be given a similar limited meaning to that of "settlement," or (b) the agreement was one made by the respondent for valuable and sufficient consideration, the payments made by him under the agreement fall within the section, and he would not be entitled to deduct the amount of them in computing his total income from all sources. It is (a) which has now become of primary importance on this question and it follows in the circumstances that if the gloss given to the word "settlement"

by Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 applied to section 434 then questions 3 and 4 are linked.

(4) Whether the payments made under the agreement were income arising in consequence, or by virtue, of a "disposition" within section 434 (1) of the Act as defined in section 434 (2) or whether they were income arising out of a "settlement" within section 457 of the Act as those words are defined in section 454 (3) of the Act. The language of section 457 makes it necessary to refer to the definition of "settlement" in section 453 which is similar to the definition, save in one respect, to that found in section 444. There is no room for the application of the euisdem generis rule to an interpretation provision: Hood Barrs v. Inland Revenue Commissioners (1946) 27 T.C. 385 and Thomas v. Marshall [1953] A.C. 543.

In Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 Pennycuick J. held that a series of transactions which were bona fide commercial transactions and contained no element of bounty did not constitute a "settlement" within the meaning of what is now section 454 (3) of the Income and Corporation Taxes Act 1970. It was held that where the context so requires the court may imply some restriction upon the scope of general words in a statute; and that in the case of the definition of "settlement" it was legitimate to hold that a sufficient context existed for the restriction in the scope of the definition. In these circumstances it was held on the basis of certain observations in Inland Revenue Commissioners v. Leiner (1964) 41 T.C. 589 and Copeman v. Coleman [1939] 2 K.B. 484 that the "arrangement" which was the subject of decision in Bulmer was not a "settlement" within the section because it was a bona fide commercial transaction containing no element of bounty.

The Crown do not dispute that Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 was correctly decided on its facts for it is accepted that some limitation must be imposed on the very wide literal meaning of the word "settlement" given to it by the interpretation provision in section 454 (3). But it cannot have been intended by the legislature when enacting a section specifically aimed at tax avoidance that the word "settlement" should be so limited as to except from the provisions of the section a transaction such as the present of which the sole purpose was tax avoidance. The Crown do not accept the conclusion that has been drawn from Bulmer by Walton J. and the Court of Appeal in the present case. Given that some limitation on the meaning of the word "settlement" is necessary to effect the intention of the legislature it is important to see which side of the boundary particular cases fall. The boundary should be drawn in such a way as not to take out of the provisions of the section a transaction whose only purpose is the avoidance of tax. Bulmer v. Inland Revenue Commissioners was not such a case and the judgment does not support the proposition that had Pennycuick J. been considering a case such as the present he would have held that there was not a settlement.

The Crown accept that when a genuine commercial transaction is to be carried out and there are two ways of carrying it out-one by paying

the maximum amount of tax, the other by paying none, or much less tax, it is legitimate for commercial men to adopt the method by which less tax is paid. When such a course is adopted it may well be right in some circumstances to call such transactions "bona fide commercial" transactions. But it would be a mis-use of language to describe the present transaction as "commercial." There is all the difference between a bona fide commercial transaction which involves a tax advantage and that type of transaction which has been described as a "planned raid on the Revenue." See Finsbury Securities Ltd. v. Inland Revenue Commissioners [1966] 1 W.L.R. 1402 and Lupton v. F.A. & A.B. Ltd. [1972] A.C. 634.

Medd Q.C. following. On the approach to the annuity problem, all the words in question are ordinary English words and therefore should be given their ordinary meaning: See Hinton v. Maden and Ireland Ltd. [1959] 1 W.L.R. 875, 885, per Lord Reid. There are two further principles which are relevant: (a) What the parties call the transaction is not conclusive: Secretary of State in Council of India v. Scoble [1903] A.C. 299 and Ridge Securities Ltd. v. Inland Revenue Commissioners [1964] 1 W.L.R. 479. (b) A transaction entered into with the motive of obtaining a tax advantage does not make the transaction ipso facto not a trading transaction; Inland Revenue Commissioners v. Wesleyan and General Assurance Society [1946] 2 All E.R. 749, 751, per Lord Greene M.R. See also Lupton v. F.A. & A.B. Ltd. [1972] A.C. 634, 647F, per Lord Morris of Borth-y-Gest; 650H-651, per Lord Guest; 657, perViscount Dilhorne; 655G. That approach can be applied in the present case. Reliance is also placed on the observations of Lord Donovan in Campbell v. Inland Revenue Commissioners [1970] A.C. 77, 110, in relation to the approach to be adopted in determining whether the payment in question was an annuity. Here as in Campbell the question is not answered by the document alone; it is necessary to look at the other evidence. The present is a case of a person who wished to make payments to another person but he did not wish to make such payments out of his own pocket, that is, out of his own spendable income and therefore he had to receive monies from that other person first. This is not merely a strange type of annuity but the transaction is so strange that it ceases to be an annuity at all. The present transaction is analogous to the illustration given by Lord Morris of Borth-y-Gest in Lupton v. F.A. & A.B. Ltd. [1972] A.C. 634, 645.

Michael Nolan Q.C., R.S. Alexander Q.C. and David Milne for the respondent.

[LORD WILBERFORCE stated that their Lordships desired to hear argument primarily on the fourth issue.]

As to the fourth issue, bounty is the test to be applied in this part of the Act, which is concerned with settlements. A settlement connotes bounty. Sections 435,441 and 449 which transfer the tax burden to the recipient are only intelligible if confined to bountiful transactions. If one moves out of the field of bounty then one has to find other criteria. It was said by the Crown that the present transaction was one of tax avoidance. But in none of the cases, which are many, relating to settlements has this

point been raised. There is no difference in commercial terms between this transaction and the sale of an annuity payable under a settlement to those companies which buy such annuities. In the present case there were practical benefits apart from the avoidance of tax. Thus the respondent obtained £2,480. If he died during the currency of the agreement his estate would have benefited provided he did so before all the annual payments had been made. The settlement provisions in the Act nowhere bring in motive. They are to be contrasted in this respect with sections 460 and 478. The contention that section 457 applies to arms length transactions is not supported by the authorities and entails reading words into the Act. It is assumed in passages in the speech of Lord Macmillan in Chamberlain v. Inland Revenue Commissioners [1943] 2 All E.R. 200, 204, that this legislation only applies to gifts.

As to Bulmer v. Inland Revenue Commissioners [1967] Ch. 145, it is to be observed that the expression "bona fide commercial transaction" is not to be found in the Act. The Crown state that Parliament must have been expected to spare the well-intentioned. What is meant by "bona fide" in this connection? Does the expression bona fide commercial transaction exclude the benefit of obtaining a tax advantage? The respondents adopt the words of Russell L.J. in Inland Revenue Commissioners v. Goodwin [1975] 1 W.L.R. 640, 647: "Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 was a case indicating that the expression 'bona fide commercial transaction' was used judicially to describe something lacking an element of a bounty, in determining whether there was a 'settlement'... it indicates, as one would expect, that there can be a bona fide commercial transaction with the obtaining of a tax advantage as a main object."

In the present case the special commissioners state as a finding of fact that the present transaction was a bona fide commercial transaction. The special commissioners are in a unique position to decide what is a bona fide commercial transaction. There is no need for the law to invent a mens rea test for this provision. The Crown's construction of section 457 leads to a cutting across of the provisions relating to settlements.

As to (3), the definition of "settlement" in section 457 is the same as that of "disposition" in section 434. This is a disposition containing no element of bounty and therefore is not a disposition within the meaning of the Act. This whole fasisculus of sections relates to gifts and on that interpretation there is no difficulty. As to the expression "valuable and sufficient consideration" in section 434, the respondent obtained valuable and sufficient consideration in the circumstances for his disposition: see per Walton J. [1977] 1 W.L.R. 1227, 1238D.

On questions (1) and (2), there are powerful arguments that can be adduced against the Crown's contentions. If the respondent had died on March 16, 1971, plainly the money would have gone to his estate and not returned to H.O.V.A.S. As to whether there was here an annuity, this was an income payment. It was not part of any capital sum. Here there was nothing in the payments by the respondent which were repayments of any capital sum. The present case is wholly different

from Perrin v. Dickson [1929] 2 K.B. 85 where the whole of the capital sum was to be returned to the company. Reliance is placed on the observations of Sir Wilfrid Greene M.R. in Sothern-Smith v. Clancy [1941] 1 K.B. 276, 282. From early days of tax legislation it has not been disputed that an annuity can be bought for a lump sum and that it will be purely income in the purchaser's hands: see Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329, 340, 341, per Lord Wilberforce

On the meaning of the words in section 52, "wholly out of profits or gains brought into charge to income tax," Lord Wright M.R.'s observations thereon in Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59, 66 et seq., are inconsistent with what Lord Greene M.R. said in Allchin v. Coulthard [1942] 2 K.B. 228 whose judgment was approved in this House [1943] A.C. 607. [Reference was also made to Crossland v. Hawkins [1961] Ch. 537 and Chinn v. Hochstrasser [1979] Ch. 447.]

Alexander Q.C. following. It is common ground that "settlement" has a wide general meaning and must be read subject to some limitations. The limitations suggested have been in terms of bounty or that of a bona fide commercial transaction. The concept of bounty is the correct test. If bounty be the test then the appellants concede that in the present case there is no element of bounty.

Buckley L.J. [1979] Ch. 63, 79H - 80B adopted the right approach to what constitutes a bona fide commercial transaction. If bona fide commercial transaction be the test then the appellants contend that if the sole purpose of the present transaction was tax avoidance this was neither bona fide nor a commercial transaction. But see the observations of Russell L.J. in Inland Revenue Commissioners v. Goodwin [1975] 1 W.L.R. 640, 647. The House is asked to reject the contention put forward by the appellants in paragraph 34 of their printed case. The concession there contained does not go far enough. There can be a bona fide commercial transaction albeit a main purpose of it is to obtain a fiscal advantage, for example, the single premium pension payment made by the self-employed person. The Crown seek to construe section 457 as a general anti-tax avoidance section, but it cannot be so construed.

Dillon Q.C. in reply. On question (4), it was said that the Crown's construction leads to a cutting across other provisions of the Act of 1970. But there are various sections in that Act where there is a choice of charging section. The bounty test is wrong. The words of section 457 are quite general. The observations of Lord Greene M.R. in Hood Barrs v. Inland Revenue Commissioners, 27 T.C. 385, 399 et seq., assist the appellants. Further in Yates v. Starkey [1951] Ch. 465 where there was an order by the Divorce Court for the taxpayer to make payments annually to his three children it was held that although there was no act of bounty nevertheless the payments constituted a settlement for present purposes.

As to question (1), in Sothern-Smith v. Clancy [1941] 1 K.B. 276 the Court of Appeal was applying the same test as that propounded in Perrin v. Dickson [1929] 2 K.B. 85 which in its turn was applying that

propounded by Watson B. over a century ago in Foley v. Fletcher, 3 H. & N. 769, namely, has the capital sum disappeared and been replaced by an income? In the present case it is plain beyond peradventure that the capital sum has not disappeared. The capital sum goes round in a circle. It does not cease to exist and therefore these are not annual payments of an income nature.

Nolan Q.C. in rejoinder. There is nothing in Lord Greene's judgment in Hood Barrs v. Inland Revenue Commissioners, 27 T.C. 385, to suggest that he was concerned with anything apart from acts of bounty.

Their Lordships took time for consideration.

November 1, 1979.LORD WILBERFORCE. My Lords, this case arises out of a "tax saving scheme" devised by a firm of insurance and investment brokers. They sent out to a number of persons thought likely to be interested, under the heading "Most confidential," details of what they called a "capital income plan." The general nature of this was to enable taxpayers paying income tax at a high marginal rate to turn some of this income into capital. while, conversely, enabling a non income-taxpayer (viz. a charity) to convert some capital into income. Operations of this general description are quite common, and legal, indeed many investors in annuities or in insurance policies do just this in the normal course of prudent investment. This particular operation is perhaps an extreme case.

The plan now involved was explained by the brokers in great detail, and its intended accomplishment set out, with timetables, in almost military precision. This (as I ventured to suggest in Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329) entitles and requires us to look at the plan as a whole. It does not entitle us to disregard the legal form and nature of the transactions carried out. It was not suggested that any part of the plan as executed was a sham - indeed the special commissioners found to the contrary. It is entitled to a fair, if not a particularly benevolent, analysis.

The respondent decided to enter into the plan in a modest way. By an annuity agreement made on March 15, 1971, with Home and Overseas Voluntary Aid Services Ltd. ("H.O.V.A.S."), a body with charitable status, he agreed, in consideration of £2,480 paid by H.O.V.A.S., to pay H.O.V.A.S. for five years, or the lesser duration of his life, an annual sum of such an amount as after deduction of income tax at the standard rate for the time being would equal £500. This amounted in fact to £851.06. H.O.V.A.S. paid £2,480 to an account which the respondent had opened shortly before, with a credit of £40, with Slater Walker Ltd. The respondent had instructed Slater Walker Ltd. when they received the £2,480 to pay £15 to the brokers as their fee and to pay £2,500 to Old Change Court (Investments) Ltd. - "O.C.C." - a company in the Slater Walker group, in exchange for five promissory notes of £500 each. These notes were then to be lodged with H.O.V.A.S. as security for payment of the annual sums, and were to be released as the respondent paid the latter. O.C.C. agreed to pay interest at 6½ per cent. on the amounts of the notes. There were further arrangements involving the borrowing by H.O.V.A.S. of the

money they needed in order to pay the capital sum, and insurance of the respondent's life which I need not detail: they are neutral as regards the issues under consideration. What happened thereafter was that the respondent, by means of a standing order on Slater Walker Ltd., paid the annual sums to H.O.V.A.S. on overdraft, which was liquidated a few days later by the release of a promissory note. The respondent signed each year and sent to H.O.V.A.S. the usual certificate as to deduction of tax and H.O.V.A.S. applied for the repayment of this tax. But this part of the plan miscarried: the Inland Revenue refused to make the refund and on appeal to the special commissioners their refusal was upheld. H.O.V.A.S. has not taken the matter further. Then the respondent claimed to deduct the amount of each payment as an "annuity or other annual payment" in computing his total income for surtax purposes. This claim has succeeded before the special commissioners and in both courts below.

In the courts the plan has been subjected to a four-way attack.

1. The first is based upon the terms of section 52 of the Income and Corporation Taxes Act 1970 which opens with the words "Where any annuity or other annual payment charged with tax under Case III of Schedule D ..." (Then the maker of the payment is entitled to deduct tax at the standard rate).

It is common ground that these words cover, and cover only, payments having the character of income and do not cover capital payments even if made annually. The argument for the Crown was that the payments of £500 per annum made by the respondent were in reality capital payments and not payments having the character of income. In the courts below this argument took the form of a contention that the £2,480 was paid to the respondent by way of loan, and that the "annuity" payments were nothing other than repayments of this loan. This argument having been rejected (rightly in my opinion) in both courts, the revenue presented a reconstructed form. This, as I understood it, was that the payments represented nothing but a repayment to H.O.V.A.S. of its own capital. While it may be true that an annuity bought for a capital sum has the character of income, and while there was such an annuity in this case, it was said that the concomitant arrangements, in particular the arrangements for security, changed the character of the payments. The capital sum of £2,480 paid by H.O.V.A.S. remained in existence - in the form of promissory notes - and it was this sum, in that form, which was paid back to H.O.V.A.S. H.O.V.A.S. instead of receiving an annuity was simply receiving back its own capital in instalments.

My Lords, if it were possible to disregard the legal form of the documents and look behind them for an underlying substance, there would be attractions - beyond those of ingenuity - in this argument. But I do not find it possible to do this. The classic analysis of this type of transaction is the judgment of Sir Wilfrid Greene M.R. in Sothern-Smith v. Clancy [1941] 1 K.B. 276. There, on the facts, there was a strong case for saying that the annuitant or the annuitant plus the named recipient was simply receiving his capital back. But the Court of Appeal would not have this. Sir Wilfrid Greene M.R. thought that there could

be much to be said for regarding a purchase of an annuity for a term of years as being one for purchase of instalments consisting mainly of capital and partly of interest, but did not feel himself at liberty to adopt any such principle.

"I feel bound to regard the purchase of an annuity of the kind to which I have referred as the purchase of an income and the whole of the income so purchased as a profit or gain notwithstanding the way in which the payments are calculated." (p. 285).

If this is the general rule, is there anything in the present case which causes it not to apply? In my opinion there is not. The £2,480 when paid became the property of the respondent. It remained his property none the less though he invested it, plus £20, in promissory notes and deposited them by way of security. He became entitled to release of a portion of it each year as he paid the annuity, each portion coming to him with interest: at the end of the five years he had received the whole, with interest. During the five years the respondent had a right - a limited one it is true - to select the manner in which the money should be invested.

Looked at from the other side, H.O.V.A.S.'s right was to receive an annual sum under covenant. If the respondent did not pay, they could sue him on his covenant. There was no identity between the amount they paid and that which they might receive back. In the first place the sums they were entitled to were the gross amount of the "annuity" which, assuming that the value remained unchanged, would be five times £851.06, i.e. £4,255.30 subject, or not, to tax at the standard rate. In the second place, if the respondent died during the five years they would receive from the respondent only those annuity payments which he made during his life. (In addition they would recover something on the insurance policy they took out.) Such rights as they might have over the promissory notes were rights by way of security only. In short, unless we are prepared to disregard the legal structure of these transactions, their nature is clear: a covenant, for a capital sum, to make annual payments, coupled with security arrangements for the payments. But no attack was made on the transactions as a sham and we must accept the consequences of them.

2. The second argument arises also out of section 52 (1) (c) which, if the payer of an annual sum is to be entitled to deduct and retain income tax on it, requires the annual payments to be payable wholly out of profits or gains brought in to charge to income tax. It is not disputed that the respondent had in each relevant year sufficient taxed income to cover the payments. What is said is that the respondent in fact made the payments out of the moneys provided by the promissory notes, which were not taxed income, or, if this is not accurate, out of an overdraft provided by Slater Walker which was fed by the proceeds of the promissory notes. My Lords, upon the authorities which have dealt with this difficult branch of income tax law, the position as regards this taxpayer is clear. The general rule, in the case of an individual at least, is that what is significant, when one is considering the application of the statutory rule, is not the

actual source out of which the money is paid, nor even the way in which the taxpayer for his own purposes keeps his accounts, if indeed he keeps any, but the status of a notional account between himself and the revenue. He is entitled, in respect of any tax year, to set down on one side his taxed income and on the other the amount of the annual payments he has made and if the latter is equal to or less than the former, to claim the benefit of the section.

To this general rule some exceptions have recently been introduced and explained at length in this House: see Central London Railway Co. v. Inland Revenue Commissioners [1937] A.C. 77 and Chancery Lane Safe Deposit and Offices Co. Ltd. v. Inland Revenue Commissioners [1966] A.C. 85. Very briefly and summarily these apply - so that the taxpayer cannot claim the benefit of the section - inter alia, if he has treated the payments in accounts in such a way as to produce consequences inconsistent with their being treated as income. The above two cases are both cases of corporations, which are limited by law and by their own vires as to the preparation of their accounts and their treatment of income in a way in which individuals are not limited. Whether an individual by his conduct may prevent himself from preparing his notional account with the revenue has not, I think, been the subject of reliable decision. The case of Fenton's Trustee v. Inland Revenue Commissioners [1936] 2 K.B. 59 is sometimes relied upon by the Crown as an authority on this point, and though not invoked in the courts below, was deployed in this House: I hope that this may be for the last time. The appeal was made to the judgment of Romer L.J. - and that of Lord Wright M.R. was to the same effect - that if a payment of interest is made out of money borrowed for the purpose of paying it, and is then added to the amount of the capital borrowed, the taxpayer is to be treated as having made an election which precludes him from taking the benefit of the section (then section 36 of the Income Tax Act 1918). But, in my opinion, the judgments of Lord Wright M.R. and Romer L.J. in that case, from which Greene L.J. dissented, can no longer be considered to state the law. Greene L.J. restated his opinion (which in any event I would find unanswerable) in Allchin v. Coulthard [1942] 2 K.B. 228 and that judgment in turn was approved by this House [1943] A.C. 607 and again in the Chancery Lane case [1966] A.C. 85: it has now become established doctrine. On this view of the law, the position is clear. The respondent here did nothing (even assuming that he could have done anything) to prevent himself from claiming the benefit of the section. On the contrary, the whole nature of the plan involved him in an intention to make the payments out of income and if he had drawn up any accounts he would have shown them as so paid. The manner in which he chose to provide the cash - itself open to modification at any time - is completely irrelevant. In my opinion this argument fails.

3. This argument arises under section 434 (1) of the Income and Corporation Taxes Act 1970 which in the case of payments made for a period which cannot exceed six years, deems income to be the income of the payer unless made for valuable and sufficient consideration. On this point the special commissioners were in favour of the revenue. But

Walton J. [1977] 1 W.L.R. 1227 in his judgment effectively demonstrated, in my opinion, that they had fallen into error on the mathematics, and, further, that there was no ground for holding that the consideration for the payments was not valuable and sufficient. The Court of Appeal [1979] Ch. 63 agreed, and I do not find it necessary to do more than to accept their reasoning.

4. The final argument for the revenue arises under section 457 of the Income and Corporation Taxes Act 1970:

"(1) Where, during the life of the settlor, income arising under a settlement made on or after April 7, 1965, is, under the settlement and in the events that occur, payable to or applicable for the benefit of any person other than the settlor, then, unless, under the settlement and in the said events, the income either" - and then there is a whole list of matters, none of which applies here - "the income shall be treated for the purposes of surtax as the income of the settlor and not as the income of any other person."

The applicable definition of a "settlement" is to be found in section 454 (3): it is "any disposition, trust, covenant, agreement or arrangement." It is not disputed that if the agreement in this case (of March 15, 1971) was a "settlement" within this definition, section 457 would apply and the income, i.e. the annuity payments, would be treated as the income of the settlor, i.e. of the respondent and not as the income of any other person.

This raises a question of some difficulty and general importance. Are the words of the definition to be given the full unrestricted meaning which apparently they have, or is some limitation to be read into them, and if so what limitation? If given the full unrestricted meaning, the section would clearly cover the present agreement, and would also cover a large number of ordinary commercial transactions.

My Lords, it seems to me to be clear that it is not possible to read into the definition an exception in favour of commercial transactions whether with or without the epithet "ordinary" or "bona fide." To do so would be legislation not interpretation: if Parliament had intended such an exception it could and must have expressed it.

But it still becomes necessary to inquire what is the scope of the words "settlement" and "settlor" and of the words which are included in "settlement" in the context in which they appear. If it appears, on the one hand, that a completely literal reading of the relevant words would so widely extend the reach of the section that no agreement of whatever character fell outside it, but that, on the other hand, a legislative purpose can be discerned, of a more limited character, which Parliament can reasonably be supposed to have intended, and that the words used fairly admit of such a meaning as to give effect to that purpose, it would be legitimate, indeed necessary, for the courts to adopt such a meaning.

Part XVI of the Act of 1970, which includes sections 434 to 459 is headed "Settlements." It includes a number of provisions which have been enacted at different times, the general effect of which is to cause income of which a person has disposed in various ways to be treated,

in spite of the disposition, as the income of the disposer. These had been successively enacted in the Finance Acts 1922, 1936, 1938, 1946, inter alia, with increasing severity. Chapter I of Part XVI is headed "Dispositions for short periods": exempting dispositions for valuable and sufficient consideration, it treats dispositions of income for a period which cannot exceed six years as the income of the disponer. Chapter II deals with settlements on children - the general purpose being to prevent (i.e. to tax if they are made) dispositions the effect of which is to spread income among the children of a settlor. This chapter has its own definition of "settlement" as "any disposition, trust, covenant, agreement, arrangement or transfer of assets" (section 444 (2)). Chapter III deals with revocable settlements, settlements in which a settlor retains an interest and capital payments made to a settlor or his spouse, the effect of which is to tax income from which a settlor, or his wife, may benefit as the settlor's income. The definition of "settlement" (section 454 (3)) is that which I have quoted as applicable in the present case. Lastly Chapter IV, headed "Surtax liability of settlors in certain cases" contains (briefly) a broad sweeping-up provision for taxing any income of a settlement except income from property of which the settlor has divested himself absolutely by the settlement. The definition of "settlement" (section 459) is that which I have quoted.

My Lords, it can, I think, fairly be seen that all of these provisions, in Part XVI, have a common character. They are designed to bring within the net of taxation dispositions of various kinds, in favour of a settlor's spouse, or children, or of charities, cases, in popular terminology, in which a taxpayer gives away a portion of his income, or of his assets, to such persons, or for such periods, or subject to such conditions, that Parliament considers it right to continue to treat such income, or income of the assets, as still the settlor's income. These sections, in other words though drafted in wide, and increasingly wider language, are nevertheless dealing with a limited field - one far narrower than the field of the totality of dispositions, or arrangements, or agreements, which a man may make in the course of his life. Is there then any common description which can be applied to this?

The courts which, inevitably, have had to face this problem, have selected the element of "bounty" as a necessary common characteristic of all the "settlements" which Parliament has in mind. The decisions are tentative, but all point in this direction. The first clear indication of this was given by Lord Macmillan in Chamberlain v. Inland Revenue Commissioners [1943] 2 All E.R. 200. Dealing with a case arising under the predecessor of section 447 of the Act of 1970 he said, at p. 204, that he agreed that the settlement or arrangement

"... must be one whereby the settlor charges certain property of his with rights in favour of others... it must confer the income of the comprised property on others, for it is the income so given to others that is to be treated as, nevertheless, the income of the settlor."

(I do not think that this passage is affected by the observations of Lord Greene M.R. in Hood Barrs v. Inland Revenue Commissioners (1946) 27

T.C. 385.) In Inland Revenue Commissioners v. Leiner (1964) 41 T.C. 589, 596, Plowman J. said that it was common ground - i.e. accepted by the revenue - that "it is implicit in the fasciculus of sections of which [Chapter II of Part XVI of the Act of 1970] forms a part that some element of bounty is necessary to make the sections apply..." and this point was made explicit by Pennycuick J. in Bulmer v. Inland Revenue Commissioners [1967] Ch. 145. Dealing with a case under the predecessor of Chapter III of Part XVI of the Act of 1970 he followed the previous cases in holding that a sufficient context existed for a restriction in the scope of the definition and that he accepted the "element of bounty" test.

My Lords, I think that in so doing the learned judge was well within the limits of permissible interpretation, and that with the "element of bounty" test we have a definition which is in agreement with the intention of Parliament as revealed through the whole miniature code of Chapter XVI. I would compare with this the reasons of this House in Thomas v. Marshall [1953] A.C. 543. In that case the contention was that the word "settlement" did not extend to an outright gift. Their Lordships rejected this, holding that the intention was clearly to enlarge the meaning of settlement so as to include gifts. Enlargement in one direction and restriction in another are both part of a balanced process of judicial interpretation directed towards implementing but not exceeding the general legislative purpose.

My Lords, there cannot be any doubt that in this case no element of bounty existed. The special commissioners indeed said that they regarded the transaction as a bona fide commercial transaction without any element of bounty. The taxpayer therefore succeeds on this point.

One final point: the familiar argument was used that Parliament can never have intended to exempt from the taxing provisions an arrangement solely designed to obtain fiscal advantages. But this is not the question, nor is a canon of interpretation of this kind an admissible - or indeed a workable canon. The question is whether a certain series of transactions in a certain legal form do or do not fall within the taxing words. If they do not, and if Parliament dislikes the consequences, it can change the law - as in fact it has done since the scheme in question was operated. The subject is entitled to be judged under the law as it stood at the relevant time.

I would dismiss the appeal.

VISCOUNT DILHORNE. My Lords, in this appeal we are concerned with an ingenious, complicated and well thought out scheme which had two objects, first, as the special commissioners found, to reduce the surtax liability of payers of a high rate of surtax, and secondly, to build up a tax free fund in a company called Home and Overseas Voluntary Aid Services Ltd. ("H.O.V.A.S.") by that company securing payment by the Inland Revenue of sums equivalent to those deducted by the individual participants in the scheme on their making annual payments to H.O.V.A.S.

It was, to adapt the words of Lord Donovan in Lupton v. F.A. & A.B. Ltd. [1972] A.C. 634, 657, a scheme to avoid the payment of tax by

those who participated and to raid the Treasury using the technicalities of revenue law as the necessary weapon.

It was called the "capital income plan" and details of it were sent in a letter marked "most confidential" to a number of people by S. Cardale & Co. Ltd. ("Cardale"), insurance and investment brokers.

Although in some minor respects there were departures from the scheme in the case of the respondent, as the letter states very clearly what was involved, I propose to cite its relevant parts. It reads as follows:

"MOST CONFIDENTIAL

CAPITAL INCOME PLAN

"1. Situation

"Mr. X has a taxable income of £30,000 a year. The following example assumes that, in addition to income tax at the standard rate, the top £14,694 of this income suffers surtax at 10s. in the pound: i.e. £7,347.

"2. Investment plan

"(a) A charity purchases an annuity from Mr. X at a purchase price of say £44,800. The exact purchase price will depend on his age and health. (b) In return, Mr. X agrees to pay the charity five net annual payments of £9,000 (i.e. a gross sum of £14,694 before deduction of income tax at 7s. 9d. in the pound). (c) The charity requires a guarantee that Mr. X will make his annual payments as agreed. To effect this, with the £44,800 received from the charity, Mr. X purchases promissory notes for a total value of £45,000 (5 X £9,000) from a reputable finance company. The difference between the purchase price (£44,800) and the cost of the promissory notes (£45,000) must be found by Mr. X: i.e. £200. The promissory notes are payable over the five years - £9,000 each year on the same day each year. These notes are accepted by the charity by way of guarantee. Further security is required as the total value of security must be worth a minimum of 110 per cent. of the net unpaid annuities (not including the first annuity payment).

"3. Operation

"(a) On the day Mr. X signs his annuity agreement, he is required to take the following action:

"1. Open a deposit account with a merchant bank and deposit say £15 in this account.

"2. Pay stamp duty of £73 to the Inland Revenue based on the gross amount of the annual payment.

"3. Pay an amount equal to five per cent. of the purchase price (£2,240) by way of initial charge.

"4. On receipt of the purchase price (£44,800), purchase promissory notes for £45,000 which are lodged with the charity. The promissory notes will earn interest at 6½ per cent. Per annum.

"5. Deposit short dated gilt edged securities equivalent in value to 10 per cent. (a minimum of 15 per cent. in the case of acceptable equities) of four net annual payments 10 per cent. X (4 X £9,000) = £3,600.

"(b) 28 days after receiving the purchase price, Mr. X makes his first payment of £9,000 to the charity which releases the same amount to him from the promissory notes a day later. Overdraft facilities will be available for this one day.

"(c) the promissory notes are repaid to Mr. X as he pays his future annual payments. At the same time, any security surplus to the requirements of the charity is available for release to Mr. X.

"(d) If Mr. X should die at any time before making his final payment, no further payment is due. All remaining promissory notes are converted into cash at par and this is released to his estate with any interest due together with all additional security.

"4. Result

"(a) The gross equivalent of the £9,000 a year is £14,694. Mr. X deducts this latter sum each year in computing his total income for surtax. With surtax at 10s. in the pound his annual surtax saving is £7,347.

"(b) On the basis that Mr. X survives the five years and fulfils all his commitments, his estimated final position is:

     Cost                                Benefit 
     Initial charge      £2,240          Surtax saving 
                                         (5 X £7,347)              £36,735 
     Cash                   200          Net interest 
     Stamp duty              73          (promissory notes)            683 
                        -------                                    ------- 
                         £2,513                                    £37,418 
                        -------                                    ------- 

His profit on the transaction is thus £34,905 FREE OF TAX."

This so-called profit is, it will be appreciated, the amount of tax Mr. X will avoid less the cost of participating in the scheme.

The charity concerned was H.O.V.A.S., a company incorporated on December 30, 1970, with an authorised share capital of £10 and at all material times an issued share capital of 10 shares of £1 each. It was registered as a charity.

On March 10, 1971, H.O.V.A.S. borrowed from a company called Baldrene Ltd. £1,430,000 with interest at 12 per cent. At that time bank rate stood at 6½ per cent. Baldrene was a company in the Slater Walker group and the respondent was one of its directors. At all material times he was employed as taxation manager by Slater Walker Ltd., and he acted in that capacity for the whole of the Slater Walker group. One of his duties was to ensure the efficient working of the capital income plan. H.O.V.A.S. held itself out as prepared to buy annuities on terms attractive to payers of a high rate of surtax, the money borrowed from Baldrene being available for the purpose.

The respondent decided to participate in the scheme and on March 9, 1971, Cardale wrote to him telling him that H.O.V.A.S. had agreed to purchase an annuity from him and that their charge for negotiating the contract would be five per cent. of the purchase price of the annuity. Later they reduced this to £15.

On March 11 H.O.V.A.S. wrote to the respondent telling him that they would accept as security for the payment of the net annuity payments outstanding of £2,500, promissory notes to that value and a cheque for £300 to be used for the purchase of Midland Bank Ltd. Ordinary Stock. The next day the respondent wrote to Slater Walker Ltd. asking them to open an account in his name and enclosing a cheque for £40 for the credit of his account. He told them that on March 15, they would receive a cheque for £2,480 from H.O.V.A.S., which they did, and that it was to be credited to his account and that as soon as it was received, they were to pay £15 to Cardale and £2,500 to Old Change Court (Investments) Ltd. ("O.C.C.") and for that sum that company, also one of the Slater Walker group, would issue to him 10 promissory notes payable to bearer which they were to lodge with H.O.V.A.S. as security for the due performance of his obligations under the annuity agreement. He told them that as his obligations under that agreement were fulfilled, a proportion of the security given by him would be released and that if at any time when a release of any promissory note was made to them his account was overdrawn, they were to present the note as soon as possible to O.C.C. and to credit the sums paid by O.C.C. to his account.

The same day, March 12, he gave Slater Walker Ltd. a standing order for the payment of £500 to H.O.V.A.S. on March 29, 1971, and annually on that date up to and including March 19, 1975, or until the order was cancelled.

On March 15 the annuity agreement was entered into. Under it in consideration for the payment of £2,480 by H.O.V.A.S. he undertook to pay that company for five years or during the remainder of his life, whichever should be the shorter, an annuity "at such rate as shall after deduction of income tax at the standard rate for the time being in force be equal to £500 per annum ..."

He also warranted to H.O.V.A.S. that statements made by him to the Royal Insurance Co. for the purpose of enabling H.O.V.A.S. to insure his life were true and that he had made full disclosure of all material information and he agreed to indemnify them should that not prove to be the case and they suffered loss or damage in consequence. H.O.V.A.S. insured his life until April 16, 1975, for a premium of £16.97.

On March 15 the respondent also wrote to H.O.V.A.S. saying that he had authorised Slater Walker to deposit with them 10 promissory notes of the value of £2,500. H.O.V.A.S. in turn lodged the notes with Baldrene as part security for the money they had borrowed from that company. O.C.C. agreed to pay 6½ per cent. interest less tax on the outstanding notes and the respondent assigned that interest to H.O.V.A.S. to hold as security for the fulfilment of his obligations.

The same day he sent to Slater Walker Nominees a cheque for £300 and asked H.O.V.A.S. to purchase with that sum equities acceptable to them as security. He also sent five forms which he had signed but not completed to Slater Walker Ltd. and asked them to complete them as the annual payments were made and to send each completed form to H.O.V.A.S. Each form would then show the sum alleged to have been deducted on the payment of each £500.

It will be noted that under the arrangements made by the respondent there were minor departures from the capital income plan outlined in Cardale's letter, the most important of them being the insurance of the respondent's life for five years by H.O.V.A.S. Five annual payments amounting in total to £2,500 were to be paid to H.O.V.A.S. in return for the payment by them of £2,480, the difference between the two figures presumably being to make provision for the payment by the respondent of the life insurance premium.

The effect of these operations was that this part of the money borrowed by H.O.V.A.S. from Baldrene never passed out of the control of the Slater Walker group. It was a term of the arrangements made by the respondent with H.O.V.A.S. that on receipt of the purchase price, it would be used with the addition of £20 to buy promissory notes of a total value of £2,500 from O.C.C. It was a stipulation in the capital income plan that the purchase money should be applied in the purchase of promissory notes. £2,500 was so used and the notes were lodged with H.O.V.A.S. and by them with Baldrene as part security for the loan from Baldrene to H.O.V.A.S. It may be that the respondent could have bought the notes with other monies but that would have been a departure from the capital income plan and his arrangements with H.O.V.A.S.

When the time came for payment of an annual payment, it was paid out of his account with Slater Walker Ltd. and the temporary overdraft that created would be discharged by the release by Baldrene to H.O.V.A.S. and by them to Slater Walker Ltd. of promissory notes to the value of £500 which were presented for payment by Slater Walker to O.C.C. and paid.

The cost to the respondent was consequently the £15 paid to Cardale, the £20 to cover the payment of the insurance premium on his life and a small amount of interest on the overdrafts. If the scheme worked, he would as a result be relieved of a considerable liability for surtax.

The cost to H.O.V.A.S. was the interest at 12 per cent. payable to Baldrene. If they succeeded in obtaining a refund from the revenue of the amount deducted by the respondent from the annual payments, they would, the special commissioners found, receive a return the equivalent of compound interest at the rate of some 36 per cent. on their outlay, assuming no undue delay in repayment of tax or 27 per cent. assuming a delay of one year; and at the end of the five years they would have received back the £2,480 credited to the respondent and £20.

On various dates between its incorporation on December 30, 1970, and March 30, 1971, H.O.V.A.S. entered into similar transactions with 40 individuals. H.O.V.A.S.'s income and expenditure account for the period December 30, 1970, to April 5, 1972, showed an income of £954,982.45 of which £919,461.65 represented "annuities (gross)" and their expenditure during that period showed that they had spent on "charitable work" £19.55.

In these circumstances it is hardly surprising that the revenue should challenge the respondent's right to deduct tax from the annual payments of £500 and H.O.V.A.S.'s right to obtain payment from them of the amount deducted. Before the special commissioners, Walton J. and the Court of Appeal, they were not successful. They, however, succeeded in resisting

H.O.V.A.S.'s claim for a refund on the ground that that company had not applied its income for charitable purposes only. From the special commissioners' decision H.O.V.A.S. has not appealed.

The appellants contended:

(1) that the payments to H.O.V.A.S. were not payments of an annuity or other annual payment, with the consequence that the respondent was not entitled to deduct therefrom tax at the standard rate;

(2) that the sums were not payable by him out of profits or gains brought into charge to income tax;

(3) that section 434 of the Income and Corporation Taxes Act 1970 applies as the payments were not made for valuable and sufficient consideration; and

(4) that section 457 of that Act applies with the consequence that for the purposes of surtax the payments were to be treated as the income of the respondent.

It will, I think, be convenient to consider the fourth contention first.

Does section 457 apply?

So far as material that section reads as follows:

"(1) Where, during the life of the settlor, income arising under a settlement made on or after April 7 1965 is, under the settlement and in the events that occur, payable to or applicable for the benefit of any person other than the settlor, then, unless, under the settlement and in the said events, the income either - ... (e) is income which, by virtue of some provision of the Income Tax Acts not contained in this Chapter, is to be treated for the purposes of those Acts as income of the settlor, the income shall be treated for the purposes of surtax as the income of the settlor and not as the income of any other person."

This section is the first section of Chapter IV of Part XVI of the Act, headed "Surtax liability of settlors in certain cases" and section 459 of this Chapter states that "In this Chapter ... 'settlement' and 'settlor' have the meanings assigned to them for the purposes of Chapter III" by section 454.

Section 454 (3) provides that "... 'settlement' includes any disposition, trust, covenant, agreement or arrangement, and 'settlor,' in relation to a settlement, means any person by whom the settlement was made;..."

This definition of "settlement" and "settlor" is the same as that in section 41 (4) (b) of the Finance Act 1938 and corresponds with that in section 21 (9) (b) of the Finance Act 1936 save that in the latter Act the definition includes the words "transfer of assets."

In Chamberlain v. Inland Revenue Commissioners [1943] 2 All E.R. 200, 204 Lord Macmillan accepted the view that: "the statutory expansion of the term 'settlement,'" (in section 41) "which includes an 'arrangement,' justifies and, indeed, requires a broad application ..." and then added: "but a settlement or arrangement to come within the statute must still be of the type which the language of the section contemplates."

These observations were considered by Lord Greene M.R. in Hood Barrs v. Inland Revenue Commissioners (1946) 27 T.C. 385. He rejected

the argument that Lord Macmillan had meant that to come within the statute a settlement or arrangement must be of the type which the word "settlement" in the section contemplated. He thought, at p. 402, that Lord Macmillan's proposition said no more than what was obvious, namely: "You never construe a word in a statute, whether it be in the body of the statute or in an interpretation clause, without reference to the context in which it appears." In Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 Pennycuick J. at p. 165 said that unless one implied some restriction to the width of the definition, it: "represents as odd a provision as one would anywhere find in a taxing statute."

It cannot, in my opinion, be right for the courts to amend the definition by adding words to it limiting its scope. That would be legislating. On the other hand, it is open to the courts when considering particular transactions and whether they come within the definition, to conclude that Parliament cannot have intended that they should be treated as doing so; and to decide, if that conclusion is reached, that they do not. There must be a number of cases in which it cannot have been the intention of Parliament that income transferred to another pursuant to an agreement or arrangement should nevertheless continue to be treated as the income of the transferor. In Copeman v. Coleman [1939] 2 K.B. 484 Lawrence J. held that there was a disposition or an arrangement in the nature of a disposition coming within section 21 of the Finance Act 1936. In the course of his judgment he said that what had been done was not a bona fide commercial transaction. In Inland Revenue Commissioners v. Leiner, 41 T.C. 589 it was common ground that it was implicit in Chapter II of Part XVIII of the Income Tax Act 1952 dealing with "Settlements on children" that some element of bounty was necessary to make the sections in the Chapter apply and that a bona fide commercial transaction would be excluded from them. For this latter proposition Copeman v. Coleman [1939] 2 K.B. 484 was cited. In Bulmer v. Inland Revenue Commissioners [1967] Ch. 145 Pennycuick J. followed what was said in these two cases. He held that the transaction he had to consider was a bona fide commercial transaction and that there was no element of bounty and so he allowed the taxpayer's appeal.

My Lords, if Parliament had intended that the definition in section 454 (3) should only apply to a settlement, a disposition, trust, covenant, agreement or arrangement in which there was an element of bounty, that could easily have been stated. Similarly if Parliament intended that despite the width of the definition, bona fide commercial transactions should be excluded, that also could easily have been stated. For my part I decline to construe the definition as if it contained these words. It may well be that in a great many cases there will be an element of bounty but to hold, when Parliament has not so enacted, that section 457 only applies when there is an element of bounty may be to restrict its operation far beyond Parliament's intention - and the width of the definition is a clear indication that its scope was intended to be wide. What exactly is comprehended in the phrase culled from Lawrence J.'s judgment "a bona fide commercial transaction," I do not know. Bona fide means, I suppose, that it was not a sham. A wide variety of transactions may be called commercial

transactions. As Russell L.J. said in Inland Revenue Commissioners v. Goodwin [1975] 1 W.L.R. 640, 647: "there can be a bona fide commercial transaction with the obtaining of a tax advantage as a main object." (Emphasis supplied.)

My Lords, the Income and Corporation Taxes Act 1970 must be construed like any other Act and in my opinion the right approach to construing section 457 and the definition is to consider first, whether in its ordinary natural meaning the language of these provisions applies to the matters under consideration; and then, if it does, to consider whether or not Parliament can have intended that the transactions in question should come within their scope.

In the present case Mr. Nolan for the respondent conceded in the Court of Appeal that section 457 applied apart from the decision in Bulmer v. Inland Revenue Commissioners [1967] Ch. 145. I do not, for the reasons I have stated, consider that decision prevents the section from applying. That there are some who carry on the business of devising schemes for tax avoidance is well known. Their activities may well be described as commercial. The question to be decided is whether Parliament can have intended that the arrangement of which the main object was the obtaining of tax advantages should be outside the operation of section 457. In my opinion the answer is in the negative and so the answer to the question "Does section 457 apply?" is yes, if the payments of £500 a year are to be regarded as income, a subject to which I shall return later.

I now turn to the revenue's third contention and the question:

Does section 434 apply?

That section reads as follows:

"(1) Any income which, by virtue or in consequence of any disposition made, directly or indirectly, by any person (other than a disposition made for valuable and sufficient consideration), is payable to or applicable for the benefit of any other person for a period which cannot exceed six years shall be deemed for all the purposes of the Income Tax Acts to be the income of the person, if living, by whom the disposition was made, and not to be the income of any other person. (2) In this Chapter, unless the context otherwise requires, 'disposition' includes any trust, covenant, agreement or arrangement."

While in my opinion a court can conclude that a disposition, trust, covenant, agreement or arrangement which prima facie is one to which the section applies, is not one to which Parliament can have intended it to apply, as I see no grounds for such a conclusion in this case, the section applies unless the disposition, agreement or arrangement was made for valuable and sufficient consideration.

The special commissioners were not satisfied that it was, saying that the respondent was to receive £2,480 in return for gross payments before deduction of tax of some £4,255 over five years. Walton J. and the Court of Appeal did not agree. I agree with them. H.O.V.A.S. in return for £2,480 were to receive in the five years £2,500 in circumstances in which

they hoped to recover from the revenue the difference between the grossed up equivalent of £500 before deduction of income tax at the standard rate, i.e. in March 1971 £351.06. The only money which notionally or actually would be paid by the respondent over the five years was £2,500 and for that he had £2,480 credited to his bank account.

If the payments of £500 are properly to be regarded as income payable to H.O.V.A.S., a question to which I shall come later, the arrangement or agreement to pay those sums was in my opinion made for valuable and sufficient consideration.

The answer, therefore, to this question is in my view that section 434 does not apply.

I now turn to the revenue's first two contentions which can conveniently be considered together. The questions to be answered are:

(1) Were the payments to H.O.V.A.S. payments of an annuity or other annual payment coming within section 52 of the Income and Corporation Taxes Act 1970? and

(2) If so, were they payable wholly out of profits or gains brought into charge to income tax?

If the answers to these questions are in the affirmative, then the section provides that no assessment to income tax, other than surtax, is to be made on the recipient of the annuity or annual payment and that the payer is entitled to deduct and retain a sum representing the amount of income tax thereon at the standard rate.

Section 52 begins as follows:

"(1) Where any annuity or other annual payment charged with tax under Case III of Schedule D ... is payable wholly out of profits or gain brought into charge to income tax ..."

Payments charged with income tax under Case III are payments of income. Profits or gains brought into charge to income tax must also be income. So is it the case that the payments of £500 were income in the hands of H.O.V.A.S. and were payable wholly out of income of the respondent?

The £2,480 paid into the respondent's bank account was clearly a payment of a capital nature. The difference between that and the value of the promissory notes bought was obviously to secure that the respondent paid for the insurance of his life. Did H.O.V.A.S. thereby secure an income for themselves for five years or was each payment a repayment of part of the capital they had expended? In considering this question one is entitled to have regard to all the arrangements made and not only to the document called the annuity agreement: see Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329 per Lord Wilberforce at p. 344 and per Lord Morris of Borth-y-Gest at p. 348, who said:

"If a receipt of money might be of an income nature or might be of a capital nature or might be partly the one and partly the other then in the search for truth and reality all established facts should in my view be brought into survey"

and Perrin v. Dickson [1930] 1 K.B. 107.

Although in the annuity agreement the £2,480 was referred to as the purchase price of the annuity, it was a term of the capital income plan in which the respondent was engaging that the price paid for the annuity should be spent on the purchase of promissory notes of a value equal to the total of the annual payments to be made; and before the £2,480 had been credited to his account, the respondent had instructed his bankers, Slater Walker Ltd., to pay £2,500 to O.C.C. for notes of that value.

When a payment of £500 fell to be made to H.O.V.A.S., Slater Walker paid it, debiting his account with the amount and allowing his account to be overdrawn for a day or two for the purpose. Immediately on payment to H.O.V.A.S., Baldrene released notes to the value of £500 to H.O.V.A.S., presumably, though the case stated does not say so, on payment to them of £500 in part repayment of their loan to H.O.V.A.S., and H.O.V.A.S. released the notes to Slater Walker. They were then met by O.C.C. and the respondent's account credited with £500.

Throughout the whole operation the £2,480 and the notes of the value of £2,500 remained under the control of the Slater Walker group and H.O.V.A.S. It was never a sum of which the respondent was free to dispose as he might wish. It was his duty as taxation manager of Slater Walker Ltd. to ensure the efficient working of the capital income plan. If anyone had sought to spend the sum received from H.O.V.A.S. on anything other than the purchase of promissory notes from O.C.C., one wonders whether he would have been allowed to do so.

It was at one time contended by the revenue that the payments made to H.O.V.A.S. were in repayment of a loan by them to the respondent. This contention was rejected, I think rightly. The £2,480 went with an additional £20 immediately on its being credited to his bank account to O.C.C.

In Perrin v. Dickson [1929] 2 K.B. 85 Rowlatt J., whose judgment was affirmed on appeal, said, at p. 88:

"The substance of the present transaction is that the appellant does not really adventure his capital at all. Under the terms of the policy the capital is in any event to be returned to him."

So here in my view the substance of the capital income plan did not involve H.O.V.A.S. or any member of the Slater Walker group in adventuring their capital at all by the making of payments to individuals in return for five annual payments totalling the same amount. The £2,480 credited to the respondent's account was part of the sum loaned by Baldrene to H.O.V.A.S. It had to be paid with an additional £20 to O.C.C. and then on £500 being debited to the respondent's account by Slater Walker Ltd., on presentation of promissory notes, O.C.C. paid £500 into the respondent's account with Slater Walker and were to continue to do so until the whole £2,500 had been repaid. In the circumstances I am unable to regard each payment of £500 as anything other than repayment by O.C.C. of part of the £2,500 paid to that company, and to adapt Rowlatt J.'s sentence, one can say that under the terms of the capital income plan the capital sum provided initially by Baldrene and then by H.O.V.A.S. was in any event to be returned to them.

The special commissioners thought that it was a fair description of the transactions to say that it was a bona fide commercial transaction without any element of bounty. That it had no element of bounty is clear. Attaching that label to it does not in my view exclude the operation of section 457. I would agree that that is a fair description if it is one that can properly be applied to a scheme operated by the Slater Walker group, no doubt as part of their business, solely designed to secure without their adventuring any capital the obtaining of tax advantages.

In my view the payments of £500 emanating from O.C.C. were payments of capital and the fact that one or two days before they were made, the sums were paid to H.O.V.A.S. by overdrawing the respondent's bank account was a mere matter of machinery which does not disguise the true character of the operation.

If, contrary to my view, the sums of £500 were income in the hands of H.O.V.A.S., I see no reason to conclude that they were not payable out of profits or gains brought into charge.

For these reasons this appeal should in my opinion be allowed. It follows from what I have said that the respondent was not entitled to deduct tax at the standard rate from the gross payments. His taxable profits or gains remain unaffected by the payments. If, on the other hand, the payments were income and not paid out of income which formed part of his profits or gains, they are by virtue of section 457 to be treated for the purposes of surtax as his income.

LORD DIPLOCK. My Lords, I have had the advantage of reading in draft the speeches of my noble and learned friends Lord Wilberforce and Viscount Dilhorne. Of the four grounds on which the revenue has sought the reversal of the judgment of the Court of Appeal I propose to examine only that one which Lord Wilberforce deals with last and Viscount Dilhorne first: the application of section 457 of the Income and Corporation Taxes Act 1970, to a transaction whose avowed and only purpose was the avoidance of surtax.

It is common ground between my noble and learned friends that upon a literal interpretation of what, according to section 454, is to be understood as included in the expression "settlement," the transaction would fall within it. It is likewise common ground that Parliament must have intended some narrower construction than this to be placed on the word "settlement" in the context of section 457; for, unless it is, it is difficult to think of any transaction in consequence of which income paid by one person to another that would not fall within the section. The competing views are, on the one hand, that the context in which the word "settlement" appears in Part XVI of the Act shows a parliamentary intention to exclude from its meaning bona fide business transactions only, and, on the other hand, that it shows an intention to include only transactions in which there is an element of bounty.

My Lords, I do not find either of these limitations upon the meaning of the word easy to justify upon the language of the section itself or of Part XVI of the Act considered as a whole. In the section itself the draftsman

has thought it necessary by paragraph (a) of subsection (1) and by subsections (2) to (4) to exclude expressly from the operation of the section particular kinds of transactions in which there is clearly no element of bounty and which would also merit the description of bona fide business transactions. If one considers also the other sections in this Part of the Act in which the expressions "settlement" or "disposition" (to which a similar unrestricted meaning is assigned in section 434) appear there is nothing there that calls for a more restricted meaning to be given to either of those words than is ascribed to them by sections 454 and 434 respectively, since the nature of the particular transaction to which each of those other sections in Part XVI apply is limited by the description in the section of the legal effects of the transaction.

So it seems to me that in order to reach a conclusion whether in addition to those transactions which are expressly excluded from section 457 by subsections (1) to (4) any other kinds of transaction whereby income is paid by one person to another were intended to be excluded from its operation, it is necessary to apply to this Part of the Act a purposive construction and to ask oneself the question in relation to the particular kind of transaction which is under consideration. "Can Parliament really have intended to tax this particular kind of transaction by the wide words that the draftsman has used?" If the only sensible answer to that question is "No" the words of the Act should be understood as inapplicable to the transaction.

That question when asked about a transaction which not only falls within the literal meaning of the words used in the section but has no other object than to enable the settlor to avoid a liability to surtax on his income which he would otherwise be obliged to pay, so far from inviting the answer: "No," invites the answer: "Whatever kind of transaction Parliament may have intended to exclude it cannot have been this one."

The earlier sections in Part XVI of the Act deal with the liability of the settlor to income tax as well as surtax on income payable to persons other than himself. Section 457 deals with his liability to surtax alone. As respects this element of tax, it is a sweeping-up section dealing, as subsection (1) (e) makes clear, with surtax on income from settlements that do not comprise transactions of any of the particular kinds described in those earlier sections. That Parliament cannot have intended to sweep into its maw every transaction, even though entered into in the ordinary course of business, if it resulted in income being paid by one person to another, would seem self-evident; but as between giving to it a purposive construction which involves excluding bona fide business transactions and one which involves excluding transactions in which there is no element of bounty, it does not seem to me to be correct to distinguish between these rival views by describing the former as involving judicial legislation and the latter as consisting of judicial construction only.

For my part, in agreement with Viscount Dilhorne, I too, for the reasons that he gives, prefer the former; but even assuming that the latter be correct, it seems to me that upon the face of the document under

which annual payments were made the transaction under consideration did involve an element of bounty. If one is to disregard the underlying realities of the whole tax avoidance scheme in which that document played an essential part and recognise only the legal obligations which it imposed upon the parties to it, Mr. Plummer undertook an obligation to pay to H.O.V.A.S. in return for a payment of £2,480, five sums of £851 each over a period of just over four years or a total sum of £4,255. This, as it seems to me, involves a substantial element of bounty. The fact that if he chooses to pay the sum out of his own profits or gains brought into tax, he can discharge his obligation in part by assuming (under section 52 of the Act) the liability of the payee to pay income tax at the standard rate upon it and so, in the case of a charity such as H.O.V.A.S., transfer to the revenue the ultimate burden of the element of bounty is a matter which the blinkers that the court by Inland Revenue Commissioners v. Duke of Westminster [1936] A.C. 1 and cases that have followed it is enjoined to wear in revenue cases, compels it to ignore.

For these reasons I would allow this appeal.

LORD FRASER OF TULLYBELTON. My Lords, the details of the complicated tax avoidance scheme with which this appeal is concerned have already been described by my noble and learned friends Lord Wilberforce and Viscount Dilhorne, and I need not repeat what they have said. The questions that arise for decision are four:

1. Were the five annual payments made by the respondent to H.O.V.A.S. payments of "an annuity or other annual payment charged with tax under Case III of Schedule D" within section 52 (1) of the Income and Corporation Taxes Act 1970?

2. Were they "payable wholly out of profits or gains brought into charge to income tax" within the meaning of that subsection?

3. Were the payments made otherwise than for valuable and sufficient consideration in the sense of section 434 of that Act? and

4. Were the payments income arising under a "settlement" within section 457 and the definition in section 454 (3), applied by section 459 (1) of that Act?

1. On the first question the contention of the appellants was that the five sums of £500 each paid to H.O.V.A.S., notwithstanding that they were called payments of an annuity, were in reality of a capital nature. The name given to payments by the parties to the transaction is of course not conclusive as to their true nature and in considering whether they are of an income or of a capital character the court is entitled to have regard not only to the contractual documents, but to all the facts which are relevant for determination of the question: see Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329. In the Court of Appeal the appellants argued that the purchase price of £2,480 paid by H.O.V.A.S. should be regarded as a loan and that the "annuity" payments were truly instalments of capital in repayment of the loan. This argument was rejected by Buckley L.J. on two grounds, with both of which I agree, and it was not repeated in your Lordships'

House. The argument for the appellants here was that they did not have to attach any particular label to the payments and that it was enough for them if they could show that the payments were of a capital nature. It is of course true that purchase of an annuity always consists of paying out capital and receiving back in exchange money which, in a general sense, represents, at least in part, the capital purchase price. But it is accepted that in principle the whole annuity is income in the hands of the recipient - see Sothern-Smith v. Clancy [1941] 1 K.B. 276 - and I did not understand that counsel for the appellants disputed that that was the general rule. It continues to be so notwithstanding the statutory provisions for taxation of purchased life annuities originating in the Finance Act 1956, section 27. The argument for the appellants sought to distinguish the present transaction from a normal purchase of an annuity in various respects so as to take it out of the general rule. The case of Perrin v. Dickson [1930] 1 K.B. 107 was cited as an example of a case which escaped the general rule partly because of the method of calculating the payments to be made in that case, and partly because of a term in the contract whereby in the event of the purpose for which the policy was effected failing either wholly or partly the assurance company was to repay to the respondent the whole or part as the case might be of the money paid by him. (In Inland Revenue Commissioners v. Church Commissioners for England [1977] A.C. 329, I was guilty of inaccuracy in referring to Perrin v. Dickson as a case where there had been a pre-existing relation of debtor and creditor between the parties.) The argument in the present case was that the obligation of the respondent, like that of the company in Perrin's case, was simply to repay the money paid by the annuitant and that that money had never "ceased to exist" so as to satisfy the test by Watson n. in Foley v. Fletcher (1858) 3 H. & N. 769, 784-785, thus:

"... an annuity means where an income is purchased with a sum of money, and the capital has gone and has ceased to exist, the principal having been converted into an annuity."

I cannot accept that contention. The transaction in the present case was exceptional in respect that the annuity payer was a private individual and not an established insurance company, and for that reason security for the payments was required. It was the provisions made for securing the payments that afforded the principal basis for the appellants' argument on this part of the case. The argument was that the purchase price of £2,480 was never handed over to the respondent so as to be under his control, but that it remained as a separate fund and was simply paid back to H.O.V.A.S. by instalments. It is true that the respondent never had unfettered control of the money. But that was only because it was earmarked from the beginning as security for his obligation to pay the annuity, and the investments which were acceptable as security were stipulated by H.O.V.A.S. The money belonged to the respondent, and with the agreement of H.O.V.A.S. he could have changed the way in which it was invested. It was actually invested (along with a further £20 provided by the respondent from his own resources) in promissory notes issued by Old Change Court (Investments) Ltd. That was in accordance with the

suggestion in the scheme for the capital income plan. But it might have been invested in short-term gilt edged securities, as H.O.V.A.S. explained in their letter of March 11, 1971, to the respondent. Subsequently on July 26, 1971, the respondent wrote to H.O.V.A.S. asking them to accept British Transport stock 1968/73 in place of the promissory notes and H.O.V.A.S. agreed to do so. For some unexplained reason, the change was not made. But the respondent was the owner of the money and if it had been invested in a security which had either appreciated or depreciated in value, any profit or loss would have accrued to him.

Apart from the limit imposed on the respondent's freedom to use the money, another unusual feature of the scheme was that H.O.V.A.S. insured the life of the respondent for annually reducing amounts to cover the possibility that he might die before he had paid all five sums of £500. This life assurance was not part of the contractual arrangement between H.O.V.A.S. and the respondent, though its existence is one of the facts which can properly be taken into consideration for the purpose of determining whether the annuity payments were truly of an income character. It was argued for the appellants that the life assurance was effected by H.O.V.A.S. to safeguard its capital and that its existence showed that the capital was not being risked. In my opinion the fact that H.O.V.A.S. chose to insure the respondent's life is completely neutral for this purpose. The life policy would have provided the appropriate number of annual sums of £500 in the event of the respondent dying before he had paid all the five sums that he had contracted to pay, but I cannot see that it throws any light on the question of whether these sums were income or capital in the hands of H.O.V.A.S. Once they were received by H.O.V.A.S. it was free to use them in any way it thought fit. They were not instalments of the price of any property sold by H.O.V.A.S. nor were they stamped in any other way as capital in its hands.

In practice, of course, the £2,500 invested in promissory notes was the obvious source from which the annuity payments were to be made, but it was only a matter of convenience and if the respondent had chosen to make all or any of the payments from some other source, he was free to do so. For example, if he had wished to save the small amount of interest on the overdraft which he incurred between the date of paying the annuity and receiving the proceeds of promissory notes repaid, he could have paid the annuity out of any other funds that he might have had available.

In these circumstances I am of the opinion that the payments of annuity were income in the hands of H.O.V.A.S. and therefore answer the first question in the affirmative.

2. and 3. On these questions I have nothing to add to what my noble and learned friend Lord Wilberforce has already said.

4. The answer to this question turns upon the meaning given to the word "settlement" in section 457 of the Income and Corporation Taxes Act 1970. The meaning is defined in section 454 (3) (applied by section 459) thus: "... 'settlement' includes any disposition, trust, covenant, agreement or arrangement."

The contract between the respondent and H.O.V.A.S. was not a settlement in the ordinary sense of that word, but it was an agreement and it is therefore within the extended meaning of settlement if the extended meaning is read literally. But if it were read literally it would include a large number of business agreements and would produce results so inconvenient and surprising as to lead to a strong presumption that they cannot have been intended. The courts have therefore recognised that some limit must be placed on the width of the words, and the need for some limit was accepted by both parties to this appeal. The limit must be fixed by some rule capable of general application. I do not think it is enough for the court simply to decide the case on the view that Parliament could never have intended this transaction to escape taxation; a decision on that ground would approach too closely to arbitrariness.

The argument on this part of the appeal was about what was the proper rule to apply. The appellants contended that the definition in section 454 (3) applied to all transactions that did not have a bona fide commercial reason, and that it applied to the present transaction, the sole reason for which was to avoid tax. The respondent contended that the definition applied only to transactions which included an element of bounty. In many cases the two contentions might lead to the same result, but not in the present case. In my opinion the true rule is that the definition applies only where there is an element of bounty. One reason is that the commercial transaction test seems to go too far; many transactions which would be generally regarded as perfectly legitimate forms of investment, are entered into solely, or at least predominantly, for tax reasons, and I think it would be wrong to suggest that they might be taxable for that reason alone. But the main reason in favour of the bounty test is that the word "settlement," even allowing for its extended definition in section 454 (3), seems to me to be used throughout Part XVI of the Act with a flavour of donation or bounty. I agree with the observations of my noble and learned friend Lord Wilberforce that the various provisions in Part XVI, to which he has referred, have a common characteristic of bounty. I would add that the same characteristic seems to apply to the first three exceptions to section 457 (1) itself. Section 457 (1) provides that:

"Where, during the life of the settlor, income arising under a settlement ... is, under the settlement ... payable to ... any person other than the settlor, then, unless ... the income either -" here follow five exceptions "the income shall be treated for the purposes of surtax as the income of the settlor and not as the income of any other person."

The first exception in paragraph (a) is for (in effect) a pension to a former member of a partnership or his widow or dependants "being payments made under a liability incurred for full consideration." Gratuitous payments to such persons are not excepted from the subsection. Secondly, by paragraph (b) (which incorporates subsection (2)) there is a corresponding, exception for (in effect) pensions paid by an individual who has acquired a business to a former owner or partner in the business or to the widow or dependants of such persons. and again the exception is limited by a provision "being payments made under a liability incurred for full consideration."

Thirdly, paragraph (c) makes an exception for income arising under a settlement in favour of a former spouse of the settlor, or in favour of a spouse living apart from the settlor under a separation order of a court or under a separation agreement or when the separation is likely to be permanent. There is no express requirement in paragraph (c) for full consideration, as that would clearly be inappropriate, but it is reasonable to assume that payments in the circumstances mentioned in this paragraph would usually be motivated by obligation, legal or moral, rather than by bounty. The other two exceptions in subsection 457 (1) are not relevant to this question, but the three to which I have referred seem to reinforce the argument that in the context of Part XVI the word "settlement" is used in the limited sense of settlements containing an element of bounty.

This view of the Act receives some support from the speech of Lord Macmillan in Chamberlain v. Inland Revenue Commissioners [1943] 2 All E.R. 200, 204 in a passage which, as Lord Greene M.R. pointed out in Hood Barrs v. Inland Revenue Commissioners, 27 T.C. 385, draws attention to the importance of the statutory context. The bounty test was accepted without argument in Inland Revenue Commissioners v. Leiner, 41 T.C. 589. In Bulmer v. Inland Revenue Commissioners [1967] Ch. 145, 166, it was applied by Pennycuick J., but he evidently thought that in the circumstances of that case there was no material difference between the bounty test and the commercial transaction test and did not have to decide between them.

I would dismiss the appeal.

LORD KEITH OF KINKEL. My Lords, I have had the advantage of reading in draft the speech prepared by my noble and learned friend Lord Wilberforce. My own views upon all the points argued in this appeal accord so closely with those which he has there expressed that no useful purpose would be served by my adding anything. I too would dismiss the appeal.

Solicitors: Solicitor of Inland Revenue; Roney, Vincent & Co.

J. A. G.