The “blue box” tax avoidance scheme and gifts to charities

A tax scheme, designed to secure a tax advantage by exploiting the rules on gifts to charities, has failed in the First-tier Tax Tribunal.

A recent tax scheme, designed to secure a tax advantage by exploiting the rules on gifts to charities, has failed in the First-tier Tax Tribunal (William Ferguson v HMRC).

William Ferguson had earnings from employment in the tax year 2003/2004 of over £800,000. He didn’t want to pay income tax on £500,000 of those earnings and (attitudes to tax avoidance in 2004 being materially different to attitudes nowadays) entered into a tax planning scheme.

In essence the scheme was intended to work as follows:

  • Mr Ferguson acquired approximately £500,000 worth of gilts (using third party borrowing).
  • These gilts were gifted by Mr Ferguson to the Somerton Charitable Trust – the intention being that Mr Ferguson would claim tax relief for this gift to a charity.
  • The Somerton Charitable Trust then transferred the gilts (for only one per cent of their market value) to one of Mr Ferguson’s family trusts, pursuant to option arrangements entered into at an earlier stage.
  • The family trust sold the gilts for their full value, and lent the proceeds to Mr Ferguson (a beneficiary of the trust) on an interest free basis.
  • Mr Ferguson used that money to repay the third party lender. According to the Tribunal decision, as of 10 June 2013 the loan from the family trust to Mr Ferguson remained outstanding.

The broad effect of the overall arrangements was intended to be that Mr Ferguson’s private trust would end up with the benefit of the gilts, but that Mr Ferguson would be able to claim tax relief on the initial gift of the gilts into the Somerton Charitable Trust.

It was common ground that the Somerton Charitable Trust was indeed a charity, and that the gilts which were transferred by Mr Ferguson were investments of a kind which could qualify for the relevant relief. However, HMRC denied the tax relief on the basis that it was always intended that 99 per cent of the value of the “gift” would in fact end up not with the charity but instead with Mr Ferguson’s family trust. On that basis, and looking at the overall arrangements in their totality, this case did not really involve a gift to a charity in respect of which relief should be given.

The main debate between the parties in the decision was whether or not a “gift” had in fact been made by Mr Ferguson, and whether or not this step of the arrangements should be regarded in isolation or whether a broader view of the scheme should be taken.

The Tribunal had no real difficulty in concluding that no tax relief was due to Mr Ferguson as a result of the transfer of the gilts to the Somerton Charitable Trust. Notwithstanding detailed arguments from counsel for Mr Ferguson, the Tribunal denied tax relief on two grounds.

Grounds for the decision

First, it was appropriate to look at the overall arrangements taken together and their commercial purpose – and in doing so to apply what is known as the Ramsay principle (derived from a case of that name and subsequent decisions). The precise parameters of this principle, and its application to specific fact patterns, can be complex. It involves a purposive construction of the relevant statutory provision(s) in assessing whether or not the particular scheme or transaction in question is within the statute. The facts must be viewed realistically, and that includes looking at the overall effect of the totality of the arrangements rather than a consideration of each step on a piecemeal basis if the series of transactions is expected to be carried through as a whole.

The Tribunal found that the “expectation” in this case was that the Somerton Charitable Trust would only end up with one per cent of the value of the gilts, and that there was no realistic prospect that the arrangements facilitating this would not be carried out as planned. Accordingly, it felt entitled to view the overall arrangements as a composite whole (rather than just focusing in on the initial transfer from Mr Ferguson to the charity). On this overall view, 99 per cent of the transfer of the gilts was in fact by Mr Ferguson to his family trust, and not to the Somerton Charitable Trust – and so no tax relief was available.

Additionally, the Tribunal concluded that no tax relief was due to Mr Ferguson even on the one per cent of remaining value. This was on the basis that a realistic view of this element of the transaction was that it was effectively a fee charged by the Somerton Charitable Trust for its agreement to participate in the scheme. There was no element of gift here as the arrangements were described as a “fiercely-negotiated arm’s length transaction” between the parties.

The second ground on which the Tribunal concluded that no tax relief was due to Mr Ferguson was that the overall disposal of the gilts was not made “otherwise than by way of bargain made at arm’s length” as is required by the tax relief provisions. The arrangements were made “on tightly agreed terms” negotiated between Mr Ferguson and the charity, so actually constituted an arm’s length bargain between the parties. So the Tribunal concluded that, even if its analysis of the Ramsay principle (the first ground for rejecting the relief claim) was wrong, no tax relief would be due anyway. One suspects that this is the Tribunal attempting to insert an “anti-appeal” element to the decision (an appeal by Mr Ferguson against this finding of fact being potentially more difficult that an appeal against the legal analysis of the Ramsay principle).

The implications

The decision is interesting for a number of reasons.

First, it demonstrates how far attitudes to tax avoidance have shifted in the last ten years – it is difficult to imagine any reputable adviser recommending now a taxpayer enter into this kind of arrangement.

Second, it is another win for HMRC in a tax avoidance case, continuing a series of recent successes. To some extent, the Ramsay principle of statutory construction has become less important than it used to be (given the DOTAS disclosure regime and the GAAR, and the ever increasing amount of anti-avoidance legislation), but the case is a useful reminder of its ongoing importance in cases of tax avoidance, not least for cases involving transactions prior to the introduction of the GAAR (as in this case).

Third, it feeds into HMRC’s proposed reforms in the charity sector generally (as with the Cup Trust case and other arrangements). It was estimated by the Tribunal (based on all the one per cent “fees” payable to the charity) that approximately £60 million to £70 million was passed through the charity using these arrangements, giving rise to tax savings of approximately £25 million (and HMRC has subsequently said that in fact £100 million was passed through with £45 million of tax avoided). Added to the Cup Trust – which received £176 million of donations and claimed £46 million in tax relief (with users potentially entitled to another £56 million) – HMRC’s interest in tax avoidance in the charity sector is understandable and increasing.

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