JUDGMENT
Scottish Widows plc (Appellant) v Commissioners
for Her Majesty’s Revenue and Customs
(Respondent) (Scotland)
Scottish Widows plc No 2 (Appellant) v
Commissioners for Her Majesty’s Revenue and
Customs (Respondent) (Scotland)
Scottish Widows plc (Respondent) v Commissioners
for Her Majesty’s Revenue and Customs
(Appellant) (Scotland)
before
Lord Hope, Deputy President
Lord Walker
Lady Hale
Lord Neuberger
Lord Clarke
JUDGMENT GIVEN ON
6 July 2011
Heard on 16 and 17 May 2011
Appellant Respondent
John Gardiner QC Andrew Young QC
David Johnston QC
Philip Walford
Kenneth Campbell
(Instructed by Maclay
Murray & Spens LLP)
(Instructed by Office of
the Solicitor to the
Advocate General for
Scotland)
Cross Appellant Cross Respondent
Andrew Young QC John Gardiner QC
Kenneth Campbell David Johnston QC
Philip Walford
(Instructed by Office of
the Solicitor to the
Advocate General for
Scotland)
(Instructed by Maclay
Murray & Spens LLP)
Page 2
LORD HOPE
1. This is an appeal from an interlocutor of the First Division of the Inner
House of the Court of Session (the Lord President (Hamilton), Lord Reed and Lord
Emslie) in a joint referral to the Special Commissioners by Scottish Widows Plc
(“the Company”) and Her Majesty’s Revenue and Customs (“HMRC”) under para
31 of Schedule 18 to the Finance Act 1998: [2010] CSIH 47, 2010 SLT 885, 2010
STC 2133. The question that was referred to the Special Commissioners for their
determination was in these terms:
“Whether in computing the Case 1 profit or loss of Scottish Widows
plc for the accounting periods ending in 2000, 2001 and 2002,
amounts described by the company as ‘transfers from Capital
Reserve’ and included as part of the entries at line 15 of Form 40 for
each period fall to be taken into account [as receipts] in computing
the profit or loss as the case may be.”
It is agreed that the words “as receipts”, which were not in the question as referred,
may be understood as following after the words “into account.” The Special
Commissioners answered that question in the affirmative. The Company appealed
against that decision and HMRC cross-appealed. The Court of Session by a
majority (Lord Emslie dissenting) refused the appeal and unanimously refused the
cross-appeal. Both sides have appealed against its decisions to this court.
2. The essence of the dispute between the parties is whether, in each of the
three consecutive years in question, part of the entry in line 15 of the Company’s
form 40 must be taken as falling within the scope of either section 83(2) or section
83(3) of the Finance Act 1989, as substituted by paragraph 16 of Schedule 8 to the
Finance Act 1995 and paragraph 4 of Schedule 31 to the Finance Act 1996. If it
falls within the scope either of these two subsections, the sum concerned will fall
to be treated as a chargeable receipt for the purposes of Case 1 of Schedule D in
ascertaining whether, and if so to what extent, the Company made a loss during
those years.
3. The Company carries on business as a life assurance company. Insurance
business is a trade within the meaning of Case 1 of Schedule D: Income and
Corporation Taxes Act 1988, section 18. The amounts to be taken into account in
computing its profits include its investment income from its long term business
fund and any increase in the value of its assets during the accounting period. Those
profits may be computed for tax purposes in one or other of two ways. They may
Page 3
be computed on the Schedule D, Case 1 basis, the actuarial surplus being a suitable
starting point for dealing with cases of this description: see Scottish Union and
National Insurance Co v Inland Revenue (1889) 16 R 461, 475, per Lord President
Inglis. Or they may be computed on the basis of the income which the insurer
receives on its investments less management expenses, known as the “I – E” basis.
HMRC are entitled to elect to charge tax on the investment income, and they
almost invariably do so as it nearly always pays the Crown to take the interest on
the investments and not to trouble with the profits: Revell v Edinburgh Life
Insurance Co (1906) 5 TC 221, 227 per Lord President Dunedin. But a Case 1
computation is nevertheless required in every case.
4. The dispute between the parties arises from the demutualisation in 2000 of
the Scottish Widows Fund and Life Assurance Society (“the Society”) and the
transfer, under a scheme sanctioned by the Court, of its business to the Company.
The scheme came into effect on 3 March 2000. In para 22.1 it was provided that on
or after the effective date the Company was to maintain a memorandum account
within its long term fund, designated as the capital reserve, which was to represent
the amount of the shareholders’ capital held within the long term business fund.
The capital reserve was to be divided between the Company’s with profits fund
and its non participating fund. Para 22.4 provided that the Company was to
maintain records of the capital reserve and of the parts of it allocated to each of
these two funds. While the funds comprised identifiable assets with all the
qualities that attach to items of that kind, the capital reserve was a device or, as
Lord Walker says in para 55, an abstraction. It was created for accounting
purposes only and had no real life of its own.
5. At the time of the transfer to the Company the value of the Society’s assets
was substantially in excess of its liabilities. But the Company sustained trading
losses in each of the relevant accounting periods. The market value of its assets
decreased from the inception of its long term business fund, due principally to falls
in the value of the stock market. The Company claims that account should be taken
of its commercial losses in its non participating fund during the relevant
accounting periods. It has included Case 1 losses in its tax returns and
computations for those periods equal to £28,689,437, £612,583,866 and £431,261,
757 respectively.
6. HMRC maintain that, on a proper construction of section 83(2) of the 1989
Act, which failing of section 83(3), and having regard to entries in the Company’s
statutory returns for the relevant periods in which it was required to show that it
had a surplus in excess of its liabilities for regulatory purposes, these claims should
be disallowed. The Company brought various sums into account, described as
transfers from the capital reserve, in the years in which they sustained losses.
HMRC submit that each increase in the regulatory value selected by the Company
falls to be treated as an increase in the value of its assets within the meaning of
Page 4
section 83(2)(b). In any event the amounts brought into account and recorded as
transfers from the capital reserve fall to treated as receipts under section 83(3)
because they were amounts which had previously been added to the long term
business fund as part of the transfer of business to the Company from the Society.
The statutory provisions
7. Section 83, as amended, so far as relevant to this case provides as follows:
“(1) The following provisions of this section have effect where the
profits of an insurance company in respect of its life assurance
business are, for the purposes of the Taxes Act 1988, computed in
accordance with the provisions of that Act applicable to Case 1 of
Schedule D.
(2) So far as referable to that business, the following items, as
brought into account for a period of account (and not otherwise),
shall be taken into account as receipts of the period –
(a) the company’s investment income from the assets of its long term
business fund, and
(b) any increase in value (whether realised or not) of those assets.
If for any period of account there is a reduction in the value referred
to in paragraph (b) above (as brought into account for the period),
that reduction shall be taken into account as an expense of that
period.
(3) In ascertaining whether or to what extent a company has incurred
a loss in respect of that business in a case where an amount is added
to the company’s long term business fund as part of or in connection
with –
(a) a transfer of business to the company, or
(b) a demutualisation of the company not involving a transfer of
business,
Page 5
that amount shall (subject to subsection (4) below) be taken into
account for the period for which it is brought into account, as an
increase in value of the assets of that fund within subsection (2)(b)
above.
(4) Subsection (3) above does not apply where, or to the extent that,
the amount concerned –
(a) would fall to be taken into account as a receipt apart from this
section,
(b) is taken into account under subsection (2) above otherwise than
by virtue of subsection (3) above, or
(c) is specifically exempted from tax.”
8. In section 83(8) of the 1989 Act, as amended it is provided that the word
“add” in that section, in relation to an amount and a company’s long term business
fund, includes transfer (whether from other assets of the company or otherwise).
Section 83A(1), which was inserted by section 51 of and paragraph 16 of Schedule
8 to the Finance Act 1995 and amended by paragraph 6 of Schedule 31 to the
Finance Act 1996, provides that “brought into account” in sections 83 to 83AB (as
inserted by paragraph 5 of Schedule 31 to the 1996 Act) means brought into
account in an account which is recognised for the purposes of those sections.
Section 83A(2) provides:
“Subject to the following provisions of this section and to any
regulations made by the Treasury, the accounts recognised for the
purposes of those sections are –
(a) a revenue account prepared for the purposes of the Insurance
Companies Act 1982 in respect of the whole of the company’s long
term business;
(b) any separate revenue account required to be prepared under that
Act in respect of a part of that business.
Paragraph (b) above does not include accounts required in respect of
internal linked funds.”
Page 6
The revenue account that section 83A(2)(b) refers to is the regulatory return in
form 40: see para 12, below.
9. Section 431 of the 1988 Act contains a list of interpretative provisions
relating to insurance companies. They include a definition of the word “value”: see
section 83(2)(b) of the 1989 Act. It is in these terms:
“‘value’, in relation to assets of an insurance company, means the
value of the assets as taken into account for the purposes of the
company’s periodical return.”
10. Insurance companies are under an obligation to submit annual returns to the
Financial Services Authority (“FSA”) for regulatory purposes. The purpose of
these returns is to demonstrate that the insurer meets the regulatory standard of
solvency. They are required to show the results of a statutory actuarial
investigation, which calculates the value of the insurer’s liabilities and identifies
the amount of surplus in excess of those liabilities. They must show that there is a
sufficient surplus to cover any declared bonuses. At the time of the
demutualisation the relevant regulations were to be found in the Insurance
Companies Act 1982, the Insurance Companies Regulations 1994 (SI 1994/1516)
and the Insurance Companies (Accounts and Statements) Regulations 1996 (SI
1996/943).
11. Section 17 of the 1982 Act provides that every insurance company carrying
on insurance business in the United Kingdom must prepare a revenue account for
each financial year of the company, a balance sheet and a profit and loss account,
the contents of which are to be such as may be prescribed by regulations. Section
18 provides for an actuarial investigation once in every period of twelve months of
every insurance company which carries on long term business. Section 28 provides
that it must maintain an account of the assets and liabilities attributable to its
ordinary long-term insurance business. Regulation 45(6) of the 1994 Regulations
provides that an insurance company may, for the purposes of an investigation to
which section 18 of the Act applied, elect to assign to any of its assets the value
given to the asset in question in the books or other records of the company. This
was already a practice of long standing in the insurance industry.
12. For a detailed description of the background to these requirements and to
the provisions of the Finance Act 1989 about the taxation of the life assurance
business of an insurance company, reference may be made to Lord Reed’s opinion
in the Court of Session to which, like Lord Walker, I would pay tribute: 2010 SLT
885, paras 91-126. A useful summary of the FSA regime that was in force at the
relevant time is to be found in Lord Emslie’s opinion, para 198 (ix) to (xii); see
Page 7
also Lord Walker, at paras 49 – 53, below. In short, the regulatory returns which a
company carrying on long term life insurance was required to complete and submit
included a series of numbered forms. Form 13 set out an analysis of all the
company’s admissible assets, entered at a value which broadly corresponded to
their year end market value. Form 14 set out in line 51 the amount by which the
net admissible assets exceeded the company’s long term business liabilities. Form
40, which was headed “Revenue account”, set out revenue flows and expenditure
for the Company’s long term business fund, its with profits fund and its non
participating fund, and the amount of each fund to be carried forward to form 58.
Form 58, which was headed “Valuation result and distribution of surplus”,
determined the amount of the actuarial surplus by comparing the value of the
insurer’s liabilities under the policies that it has issued with the fund shown on
form 40.
13. The data that were used to prepare these regulatory returns were the same as
those used to prepare the Company’s statutory accounts. The amounts that were
calculated by the Company as the commercial losses of its non-participating fund
were derived from decreases in the market value of the admissible assets less
liabilities in that fund during the relevant accounting periods. For each of these
periods, however, there were included in the figure entered as “other income” in
line 15 of form 40 amounts described as “transfers from capital reserve” which
reduced the capital reserve by an equivalent amount. They should perhaps have
been included as an increase in the value of assets brought into account in line 13.
But it is agreed that the way they fall to be treated does not depend on whether
they were entered there or in line 15. The Special Commissioners said there is no
difference in principle, as both lines are brought into account in the total shown at
line 19: para 51. The amounts in aggregate for the relevant accounting periods
were £33,410,000, £472,724,000 and £370,000,000 respectively.
The approach to construction
14. It is well understood that statutory provisions which bring profits and gains
into charge to tax are to be construed as directed towards profits and gains in their
natural and proper sense – in a sense which no commercial man would
misunderstand – and that those words are equally applicable whatever the
commercial concern may be: Gresham Life Assurance Society v Styles [1892] AC
309, 315, per Lord Halsbury LC. The objective is to ascertain and charge the true
profits and gains of the business in question. The requirement that there should be
a true and fair view involves the application of a legal standard. The courts are, in
general, guided as to the content of the computation by expert opinions of
accountants as to what the best current accounting practice requires: Revenue and
Customs Commissioners v William Grant & Sons Distillers Ltd [2007] UKHL 15,
2007 SC (HL) 105, [2007] 1 WLR 1448, para 2, per Lord Hoffmann. The special
rules that section 83 of the 1989 Act lays down for the calculation of the profits of
Page 8
life assurance companies in respect of their life insurance business for the purposes
of corporation tax are, in this respect, no different from the rules that apply to
companies generally. They provide a legal standard according to which these
profits are to be ascertained.
15. As has already been noted, that section has been amended more than once.
But I do not think that it is helpful to look back into the legislative history. Lord
Wilberforce said in Farrell v Alexander [1977] AC 59, 73 that self-contained
statutes, whether consolidating previous law or so doing with amendments, should
be interpreted, if reasonably possible, without recourse to antecedents, and that the
recourse should only be had when there is a real and substantial difficulty or
ambiguity which classical methods of construction cannot solve. Further
amendments to section 83 were introduced by section 170 and paragraph 2 of
Schedule 33 to the Finance Act 2003. In Inland Revenue Commissioners v Joiner
[1975] 1 WLR 1701, 1715-1716 Lord Diplock said that it was a legitimate purpose
of legislation by Parliament to clarify the law by making it clear in which of two
alternative meanings the ambiguous language of an earlier statute was to be
understood, but that it would only be if the language of a provision in an existing
statute was ambiguous that it would be legitimate to infer that a purpose of the
subsequent statute was to remove doubts as to what the law had always been. So
the proper approach is to concentrate on the wording of sections 83(2) and 83(3) as
they were at the relevant accounting periods.
16. With that background, and with the benefit of the much more
comprehensive description of the facts that Lord Walker has provided and of the
carefully reasoned opinions of all the judges in the Inner House, I now turn to the
provisions of the 1989 Act which are under scrutiny in this case.
Section 83(2)
17. This subsection directs that there must be taken into account as receipts of
the period for the purposes of Case 1 of Schedule D (a) the Company’s
“investment income” from the assets of its long term business fund and (b) any
increase in value of “those assets”, in so far as these items have been “brought into
account” by the Company. The question is whether its language permits the
Company to claim that it in fact sustained an allowable loss during the relevant
period when the values “as brought into account” for that period indicate the
contrary.
18. It is common ground that the reference to “investment income” in
paragraph (a) of the subsection is a reference to actual income from assets actually
comprised in the long term business fund. The Company submits that, by parity of
Page 9
reasoning, the reference to “any increase in value” in paragraph (b) must be taken
to be a reference to something that can be recognised on a commercial basis as a
real increase in real assets. So the word “assets” in both paragraphs meant assets of
the long term business fund which had the capacity to earn income and to grow in
value. The fact was that its assets had decreased, not increased, in each of the
relevant accounting periods. The amounts included in line 15 of form 40 were
there for regulatory purposes only. They were book entries which had no
commercial validity. The fact was that the assets of the long term business fund
had decreased, not increased, in each of the relevant accounting periods. The mere
fact that an amount, such as interest on unpaid tax, was entered in form 40 did not
mean that it was taxable. To arrive at a true and fair view it was necessary to go
behind the entries on the forms and look at the facts.
19. In the Court of Session the judges of the First Division were unanimous in
accepting this argument and rejecting the argument for HMRC. The Lord President
said that he was unable to accept that the contents of the revenue account that had
been prepared for regulatory purposes had the definitional character for which
HMRC contended. The fact that the investment income was inevitably an actual
receipt suggested that the increase in value should be an actual sum, as opposed to
an accounting element: para 54. Lord Reed made the same point in para 181,
adding that the words “whether realised or not” were a strong indication that
section 83(2) was concerned with real gains rather than a change in notional
values. Lord Emslie said that, consistent with the long established distinction
between “assets” and “fund”, the reference to an increase in value of assets should
be taken as reflecting commercial reality in the form of actual increases in the
value of assets: para 204.
20. As Mr Andrew Young QC for HMRC pointed out, however, that section
83(2) is a special rule for the computation of the profits of an insurance company
in respect of its life assurance business. The general rules for the computation of
profits and gains for the purposes of Case 1 of Schedule D must be taken to have
been modified to the extent provided for in this subsection. The Company was
being taxed on the I minus E basis and it is this subsection, not the rules that are
generally applicable, that must be construed. An insurance company is entitled to
elect, under regulation 45(6) of the 1994 Regulations, to assign to any of its assets
the value given to the asset in the books or other records of the company. Section
83(2) can be taken to have been drafted in the light of the fact that insurance
companies almost always, if not invariably, choose to use book values (in the
sense indicated by regulation 45(6)) to arrive at the necessary balance in form 40
to demonstrate solvency to the regulatory authority.
21. Once this point is grasped, it seems to me that the meaning to be given to
section 83(2)(b) falls fairly easily into place. The wording of the subsection
follows that of the forms. While the investment income in paragraph (a) is real
Page 10
income, the increase in value referred to in paragraph (b) may or may not be a real
increase. The assets which gave rise to this increase in value may or may not be
the same assets as those referred to in paragraph (a). It depends on the content of
the amounts shown in lines 13 and 15 of form 40. Amounts taken from its long
term business fund were used by the Company to supplement its trading income in
each of the three years in question. It chose to use its own book values, not values
computed according to the current value of the assets of its long term business
fund, to arrive at the final values that were brought into account on form 40. In the
absence of further directions in the statute as to how the increase in value is to be
computed in cases where that option has been chosen – and there are none – I
would hold that the increase in value referred to in paragraph (b) must be taken to
be the amount which has been brought into account on the form.
22. The phrase “as brought into account for a period of account” in the opening
words of the paragraph lies at the heart of this interpretation. It was suggested by
the Company that this phrase determined the period for which items were to be
treated as taxable receipts but not the items which were taxable. But this
interpretation of the phrase does not, I think, give full weight to the word “as”.
Linked to the words “the following items” which precede it, the phrase indicates
that the computation must proceed on the basis of the way the items have actually
been entered on the forms. If values shown in the books or other records of the
company have been used, instead of market values, it will be the book values that
will determine whether or not there has been any increase in value during the
relevant period and, if so, how much that increase is.
23. The phrase “and not otherwise” was said to support the Company’s
interpretation of paragraph (b) because it indicated that it was being assumed that
the items that were being brought into account when any increase in value was
being assessed were items that could be realised, not notional ones. But I think that
their purpose is to make it clear that the basis of computation referred to in
subsection (2) is the only basis that is relevant for the purposes referred to in
subsection (1). The words “whether realised or not” are there to indicate a change
from the computation indicated by the original wording of section 83. If the
company chooses to bring unrealised increases in value into account, those
increases in value must be taken into account as receipts for the period in the same
way as increases that have been realised.
24. For these reasons I am unable to agree with the judges of the Court of
Session as to the meaning and effect of section 83(2)(b). But in para 205 of his
opinion Lord Emslie made some further points which, as they were attractively
put, need to be answered too. He said that a factor which favoured the Company’s
construction of section 83(2) was that it accorded well with the general principles
(1) that the ascertainment of receipts or gains for tax purposes should prima facie
reflect commercial reality; (2) that income or gains to be taxed should prima facie
Page 11
be the taxpayer’s and not those of a third party; and (3) that the ordinary
recognition of shareholders’ capital to cover actual trading should not prima facie
be a chargeable receipt. He described these principles in more detail in paras 197
and 198, and I agree with him that prima facie they can be taken to be a reliable
guide as to how tax legislation ought to be construed. But his use of the phrase
“prima facie” indicates, if I may say so quite correctly, that these are not absolute
rules that are incapable of being disapplied by the statute. In this case we are
dealing with special rules that have been designed to take account of the unique
nature of the business carried on by life assurance companies. That in itself
suggests that it is the language of the statute, rather than these general rules, that
should be the determinative factor in this case.
25. Taking Lord Emslie’s three points in turn, I would hold, firstly, that the
language of section 83(2) shows conclusively that, if the insurance company
chooses to use book values to arrive at the final values shown on form 40, it is on
those values that the computation referred to in section 83(1) must be based. This
can be said to reflect the commercial reality of the life assurance industry, as the
Company’s taxable receipts were based on its own figures as submitted to the
regulatory authorities to justify the surplus of assets that it wished to recognise.
Secondly, there is no question, in this case, of taxing the income or gains of a third
party. The values brought into account on form 40 are the product of assets that
were vested in the Company when it established its long term business fund. Their
link with the Society was entirely broken when the transfer under the scheme took
effect.
26. As to Lord Emslie’s third point, it must be appreciated that the capital
reserve was not, as he said in para 202, ordinary shareholders’ capital. The words
themselves might be taken as suggesting otherwise, but I think that the name that
was given to what the scheme described as a memorandum account is a distraction.
The reality is that the reserve had no life of its own separate from the long term
business fund. It was an accounting mechanism which the Company had
established for its own internal accounting purposes as part of its long term
business fund. It did not consist of particular assets but was a financial structure
which was subject to all the statutory restrictions and requirements to which that
fund was subject. In para 205 he said that, as the capital reserve was shareholders’
capital, its ordinary recognition to cover actual trading receipts should not prima
facie be deemed a chargeable receipt. But, as the capital reserve had no life of its
own, amounts that were described as transfers from the reserve fell to be treated in
the same way as any other assets comprised within the long term business fund for
regulatory purposes and, in consequence, for the purposes of section 83(2) too.
27. For these reasons, and those given by Lord Walker, I would allow the
HMRC’s cross-appeal.
Page 12
Section 83(3)
28. As I would answer the question in the reference in favour of HMRC on the
ground that the amounts in question fall to be taken into account as receipts under
section 83(2) with the result that there was a corresponding increase in the assets
of the long term business fund for each of the relevant accounting periods within
the meaning of paragraph (b) of that subsection, the question whether section 83(3)
applies to those amounts does not arise. This is because section 83(4) provides that
subsection (3) of that section does not apply where, or to the extent that, the
amount concerned is taken into account under subsection (2). But, as the judges of
the Court of Session were divided in this issue and out of respect for the care
which they took to examine it, I would like to make these few brief comments.
29. The exercise to which section 83(3) is directed proceeds in two stages
which are, as Lord Reed said in para 191(1), conceptually distinct from each other.
First, there is the question whether an amount has been added to the company’s
long term business fund as a part of or in connection with a transfer of business to
the company. Section 83(8) provides that the word “add” includes “transfer”. As
for the facts of this case, amounts were added to the Company’s long term
business fund when the scheme took effect as part of the transfer of the Society’s
business to the Company. The whole of the amount that was to be treated as the
capital reserve for accounting purposes was added or transferred to the Company’s
long term business fund as an integral part of the scheme. It seems to me to be
plain, having regard to the terms of the scheme, that the addition to the Company’s
long term business fund was as part of or in connection with the transfer of the
Society’s business to the Company. The fact that it was only later that some
amounts were brought into account by way of what were called transfers from the
capital reserve does not matter.
30. The second stage is the bringing of the amount into account for the period
in question. It seems to me that this occurs as and when, and indeed whenever, the
amount is brought into account as an increase in value to reduce or eliminate a loss
that would otherwise have occurred during the relevant period. As Lord Reed said
in para 191(2), there are understandable reasons why Parliament might consider
that the use of amounts acquired on a transfer of business to offset liabilities
resulting from normal patterns of trading which were not otherwise chargeable to
tax should be disallowed. I agree with him that, when the amounts were
subsequently brought into account on form 40, they would – but for the fact that
they were already caught by section 83(2) – have fallen to be treated by section
83(3) as chargeable receipts for the purpose of ascertaining whether or to what
extent the Company had incurred a loss in each of the relevant periods. Lord
Emslie’s point, which he made in para 228 of his dissenting opinion, that the
transfers were made in a non-chargeable context is answered by the two-stage
nature of the exercise to which section 83(3) is directed. It is not the context in
Page 13
which the transfer was made at the outset that determines the way in which the
amounts fall to be treated when, at some later stage, they are brought into account.
31. Had it been necessary to do so to arrive at an answer to the question that
was referred to the Special Commissioners, I would have affirmed the decision of
the majority in the Inner House on this issue and dismissed the Company’s appeal.
Conclusion
32. I would recall the interlocutor of the Inner House of the Court of Session,
allow the cross-appeal by the HMRC and answer the question referred to the
Special Commissioners in the affirmative.
LORD WALKER
Introduction
33. On 3 March 2000 Scottish Widows plc (“the Company”), a new company
within the Lloyds TSB banking group, acquired the principal assets and liabilities
of the life assurance business of the Scottish Widows’ Fund and Life Assurance
Society (“the Society”). The Society had a long and distinguished history. It was
established in Edinburgh in 1814 “upon the principle of mutual assurance”. It was
incorporated by statute in 1861 as a company without a share capital and it
remained a mutual life office – that is an entity owned by its members, the
policyholders, with no outside shareholders – until the change in 2000, which has
been referred to as ‘demutualisation’.
34. The process of demutualisation was achieved by a scheme of transfer
approved by the Court of Session under section 49 of and Schedule 2C to the
Insurance Companies Act 1982 (“ICA 1982”). Some of the provisions of the
scheme are of central importance to this appeal. The transfers which it effected
were on a very large scale: the Company acquired, in round terms, assets with a
market value of the order of £25bn and became subject to actuarial liabilities of the
order of £19bn. The qualifying members of the Society received compensation of
approximately £5.846bn, representing the difference (with various adjustments and
enhancements) between the assets and the liabilities. This compensation was paid
by the Company’s holding company, Scottish Widows Financial Services
Holdings Limited (“Holdings”), which owns the whole of the Company’s issued
share capital.
Page 14
35. The Society’s assets included large holdings of equities as well as fixedinterest securities, immovable property and other investments. As it happens the
United Kingdom stock market reached what was (and remains) an all-time high in
the new year of 2000, and in the first years of the Company’s business the market
value of its holdings of equities was substantially reduced. This unexpected and
unwelcome turn of events has led to a dispute between the Company and HM
Revenue and Customs (“the Revenue”) as to the tax consequences.
36. On 11 October 2006 the Company and the Revenue joined in making a
referral to the Special Commissioners under Schedule 18, para 31 of the Finance
Act 1998. The agreed question to be determined was as follows (with a small
agreed explanatory addition):
“Whether in computing the Case 1 profit or loss of [the Company]
for the accounting periods ending in 2000, 2001 and 2002, amounts
described by the company as “transfers from Capital Reserve” and
included as part of the entries at line 15 of Form 40 for each period
fall to be taken into account [as receipts] in computing the profit or
loss as the case may be.”
37. It is common ground that the answer to this question depends on two issues,
one turning on the meaning and application of a general provision in subsection
83(2) (read with subsection (1)) of the Finance Act 1989 as amended (“FA 1989”),
and the other turning on the meaning and application of a more particular
provision in subsection 83(3) (read with subsection (4)) of the same section. The
Company must win on both issues in order to succeed. Conversely it is sufficient
for the Revenue to succeed if it wins on either issue.
38. The first issue, once understood, is a short point of construction. But for the
non-specialist a lot of background, some of it quite technical, is required in order
to understand the point, and to be able to weigh the linguistic arguments against
more general considerations based on the legislative scheme and purpose. The
second issue (which arises only if the Company is successful on the first issue) is a
rather more intricate point of construction.
39. The complex background, and the large amounts of tax at stake, help to
explain why these two points of construction took four and a half days before the
Special Commissioners, and no less than seven and a half days before the Court of
Session. The Special Commissioners (Mr J Gordon Reid QC and Dr John F Avery
Jones CBE) decided the first issue in favour of the Company and the second issue
in favour of the Revenue, so that the Revenue was successful. The First Division
of the Inner House of the Court of Session (the Lord President (Hamilton), Lord
Page 15
Reed and Lord Emslie) reached the same conclusions on both issues, unanimously
on the first and with Lord Emslie dissenting on the second: [2010] CSIH 47; 2010
SLT 885; [2010] STC 2133. The Company now appeals on the second issue and
the Revenue cross-appeals on the first issue.
The historical background.
40. The first issue (the subject of the Revenue’s cross-appeal) comes naturally
before the second issue (the subject of the Company’s appeal). But before getting
to the detailed arguments on either issue it is necessary to say something about the
historical background, and to cover regulatory as well as taxation aspects, since
these two aspects have become closely interrelated. The background has already
been covered with conspicuous thoroughness and clarity in the judgment of Lord
Reed (paras 87-104), to which I gratefully acknowledge my indebtedness. This
part of my judgment is largely based on the fuller description by Lord Reed, with
the addition of a few points of my own.
41. Life assurance, in its many different forms, has played an important part in
British social and economic history. Actuarial science was already developing by
the beginning of the eighteenth century (one of the founding fathers, Edmund
Halley, published a paper on ‘The Degrees of the Mortality of Mankind’,
commissioned by the Royal Society, in 1693). The Life Assurance Act 1774
addressed the problem of insurable interest and curbed the scandal of tontines, then
fashionable in some wealthy circles.
42. Interest in life policies was by no means restricted to the wealthy. The
Society was only one (and among the most prominent in Scotland) of many mutual
societies by which working men could insure against the risk of their families
being left in penury in the event of the early death or disablement of the main
breadwinner. In England the most prominent comparable body was probably the
Friends Provident Society, founded in 1832 (it was a registered friendly society,
regulated by a different statutory system). The growth of these mutual societies
was remarkable: they had just over 700,000 members in 1803, over 3½ million in
1887, and over 6½ million in 1910 (there are fuller statistics in D. Green,
Reinventing Civil Society, 1993). The mutual movement went into decline after
Lloyd George introduced a system of compulsory national insurance in 1911. The
public interest in life assurance as encouraging prudent self-reliance was reflected
in its tax treatment, though for the most part the incentives were directed to
policyholders rather than life offices.
43. In 1870, after several life offices had run into difficulties, Parliament
introduced a new system of regulation. It was the foundation of the more elaborate
Page 16
system that we have today. The Life Assurance Companies Act 1870 (“LACA
1870”) required life offices (whether mutual or proprietary) to keep proper
accounts and to prepare annual financial statements consisting of a revenue
account and a balance sheet in a prescribed form. Regular actuarial investigations
were made mandatory. Lord Reed explains in his judgment (paras 91-94) how
section 4 of LACA 1870 introduced for the first time the statutory concept of a
‘life assurance fund’ held as security for the rights of holders of life policies and
annuities. This was the origin of what is now referred to as a life office’s long term
business fund (“LTBF”).
44. As regards taxation, during the 19th century and the first two-thirds of the
20th century there was no corporation tax and no capital gains tax. Companies were
subject, in much the same way as individuals, to income tax assessed and charged
under the various schedules and cases defined in the Income Tax Acts. If a
taxpayer received income which could be regarded as falling within more than one
schedule or case, the Revenue could not claim tax twice, but could choose which
schedule to apply. This choice (sometimes referred to as the ‘Crown option’) was
available to the Revenue in relation to proprietary life offices, which held large
reserves of income-producing investments in order to meet their actuarial liabilities
and provide for unforeseen contingencies. They could be taxed either on the profits
of a trade under Schedule D Case I, or on their investment income as such. It was
usually more advantageous for the Revenue to make an assessment on the
company’s investment income, as Lord President Dunedin noted in Revell v
Edinburgh Life Insurance Co (1906) 5 TC 221, 227. The Crown option was
abolished by the Finance Act 2007 and replaced by mandatory provisions. With a
mutual life office the Revenue never had a choice, since mutual trading does not
produce profits taxable under Schedule D Case I.
45. The first statutory provisions giving special tax treatment to life offices
were in the Finance Act 1915. Life assurance was to be treated as a separate
business. Annuity funds were to be taxed separately from life funds. Life offices
taxed on their investment income were to be allowed a deduction for management
expenses (including commission paid to brokers). This system of taxation is
generally referred to as the ‘I minus E’ (that is, income minus expenses) basis of
assessment.
46. It remained open to the Revenue to choose to assess a life office to tax
under Schedule D Case I, but the basis of that assessment was altered (and the
likelihood of its actually being adopted by the Revenue was reduced) by section 16
of the Finance Act 1923 (“FA 1923”), which gave effect to a recommendation in
the report, published in 1920, of the Royal Commission on Income Tax (Cmd
615). Profits allocated to with-profits policies were to be excluded from the life
office’s taxable profits. This was not unprincipled, since on allocation the profits
became liabilities. This provision has been re-enacted in successive consolidating
Page 17
statutes, and finally in section 433 of the Income and Corporation Taxes Act 1988
(“ICTA 1988”), the terms of which are set out in para 103 of Lord Reed’s
judgment. Section 433 of ICTA 1988 was repealed and replaced by FA 1989.
47. The change made by FA 1923 was an important change. In practical terms
it diminished the difference in tax treatment as between proprietary and mutual life
offices. Its importance increased with changes in economic conditions in Britain
during the second half of the 20th century (in brief, monetary inflation and the
prospect of substantial capital gains from investment in equities and property). The
Society was required by its constitution and regulations (to be found in their final
form in the Scottish Widows’ Fund and Life Assurance Act 1980), as the
Company is required under the scheme, to allocate to the holders of its with-profits
whole-life and endowment policies nine-tenths of the with-profits part of the gains
which it recognised, or brought into account (the expressions mean the same), in
the revenue account of its LTBF. After the introduction of capital gains tax and
corporation tax on chargeable gains, realised gains made by the Society were taxed
at differential rates, the details of which are not material. But unrealised gains
could be recognised (or brought into account) in order to enable larger bonuses to
be allocated and paid to with-profits policyholders without having been taxed in
the Society’s hands.
48. This was perceived by the Revenue as a serious defect in the system, as
appears from an official consultation document published in 1988, The Taxation of
Life Assurance, (summarised in paras 123-126 of Lord Reed’s judgment). This
document gives a summary of how during the 1980’s the life assurance industry
was rapidly evolving into being part of a larger savings industry, in competition
with unit trusts and other savings media, and itself increasingly making use of unitlinked policies rather than traditional with-profit policies (investment by small
savers in authorised unit trusts and approved investment trusts was encouraged in a
different way, by deferring tax on capital gains until individual unitholders or
shareholders realised their gains). Section 83 of FA 1989, which is at the heart of
this appeal, was part of the changes which Parliament made in consequence of this
review. It makes an express link between the imposition of liability to tax (or the
creation of an allowable loss) under Schedule D Case I and the regulatory regime
under ICA 1982. It is therefore necessary, before coming to section 83, to give a
short account of the regulatory regime in ICA 1982 and regulations made under it.
ICA 1982 and regulations under it
49. The regulatory system introduced by LACA 1870 had been re-enacted and
modified from time to time. ICA 1982 replaced it with a similar but much more
detailed system, elaborated in a number of statutory instruments, of which the most
relevant for present purposes are the Insurance Companies Regulations 1994 (SI
Page 18
1994/1516) (“the 1994 regulations”) and the Insurance Companies (Accounts and
Statements) Regulations 1996 (SI 1996/943) (“the 1996 regulations”).
50. Section 17 of ICA 1982 required every insurance company to which Part II
applied to prepare with respect to each financial year of the company, a revenue
account for the year, a balance sheet as at the end of the year and a profit and loss
account (or for a mutual an income and expenditure account) for the year. Each of
these was to be in a form prescribed by regulations. Under the 1996 regulations (as
amended down to the year 2000) different forms were prescribed for different
types of insurance companies, and they were still required by the new regulatory
system mentioned in para 55 below. The form of balance sheet prescribed (by
regulation 6) for companies carrying on long term business were forms 13 (relating
to assets) and 14 (relating to liabilities). These together made up the two sides of
the balance sheet. The form prescribed (by regulation 8) for companies carrying on
long term business was form 40; if the company had more than one LTBF a
separate account was required for each LTBF, and a consolidated form for all of
them. The Company has three LTBFs, a with-profits fund, a non-participating fund
for business taken over from the Society, and a non-participating fund for new
business.
51. Section 18 of ICA 1982 required every insurance company to which it
applied, and which carried on long term business, to cause its actuary to make an
annual investigation of its financial condition, and to cause an abstract of the
actuary’s report to be made. Assets were to be valued and liabilities determined in
accordance with valuation regulations, and the abstract was to be in a form
prescribed by regulations. Under regulation 25 of the 1996 regulations (as under
the new regulatory system) the most relevant of the prescribed forms to be
included in the abstract was form 58.
52. Regulation 45 of the 1994 regulations (as amended down to the material
time) dealt with valuation of assets. After some general provisions in paras (1) to
(5) it dealt specifically with actuarial investigations under section 18 of ICA 1982:
“(6) Notwithstanding paragraph (1) above (but subject to the
conditions set out in paragraph (7) below), an insurance company
may, for the purposes of an investigation to which section 18 of the
Act applies or an investigation made in pursuance of a requirement
under section 42 of the Act, elect to assign to any of its assets the
value given to the asset in question in the books or other records of
the company.
(7) The conditions referred to in paragraph (6) above are –
Page 19
(a) that the election shall not enable the company to bring into
account any asset for the valuation of which no provision is
made in this Part of these Regulations;
(b) that the value assigned to the aggregate of the assets shall
not be higher than the aggregate of the value of those assets as
determined in accordance with regulations 46 to 57 of these
Regulations.”
53. Section 28 and 29 of ICA 1982 required separate accounts and funds to be
maintained for long term business, and for the assets representing those funds to be
applicable only for the purposes of the appropriate business, except so far as the
value of the assets was shown, on a statutory actuarial investigation, to exceed the
liabilities attributable to the fund.
54. I shall have to come back to the prescribed forms. I add one comment. Lord
Reed observed (para 112), and I agree, that the use of the word ‘fund’ in ICA 1982
is not entirely consistent. Lord Reed had earlier quoted an observation of Lord
Greene MR in Allchin v Coulthard [1942] 2 KB 228, 234:
“The word ‘fund’ may mean actual cash resources of a particular
kind (e.g. money in a drawer or a bank), or it may be a mere
accountancy expression used to describe a particular category which
a person uses in making up his accounts.”
This is an important distinction, although Lord Greene’s reference to ‘cash
resources’ is a little surprising and may have been influenced by the context of the
particular case before him (it concerned the taxation of a local authority’s general
rate fund).
55. In the context of life assurance a LTBF is a fund of investments of various
types, and it falls within Lord Greene’s first category. The investments (the assets
of the fund) change from time to time, as and when the investment managers need
to raise money or exercise their judgment to switch investments, and the values of
the assets fluctuate constantly. But at any time it is possible to identify the assets
for the time being constituting the fund, which is a continuing entity. By contrast
the Capital Reserve established by the scheme approved by the Court of Session
and put into effect in 2000 (and here I am putting down a marker for later parts of
this judgment), if it was a fund at all, was a fund in Lord Greene’s second sense. It
was an accounting abstraction and it never consisted of identifiable assets.
Page 20
56. Before going on to the scheme it is convenient to record, out of
chronological sequence, that ICA 1982 was repealed by a statutory instrument
made under the Financial Services and Markets Act 2000 which came into full
force on 1 December 2001 (having come into force at earlier dates for limited
purposes including rule-making powers). In consequence the new regime applied
to the second and third of the Company’s accounting periods relevant to this
appeal that is, the calendar years 2001 and 2002; the Financial Services Authority
(“FSA”) became the regulator, and the system of regulation was prescribed by
rules made by the FSA rather than by statutory instrument. But the substance of
the system, and the identifying numbers of the forms, were unchanged. In
particular, rule 9.10(c) of the FSA’s Interim Prudential Sourcebook for Insurers
Instrument 2001 reproduced the effect of regulation 45(6) of the 1994 regulations.
There were some minor changes of terminology in the forms, which were set out
in Appendices 9.1 (forms 13 and 14), 9.3 (form 40) and 9.4 (form 58) of the 2001
instrument.
The scheme
57. The scheme for the transfer of the Society’s business to the Lloyds TSB
group was preceded by an agreement dated 23 June 1999 between the Society and
Lloyds TSB Group plc. The agreement provided for the scheme to be approved by
a special resolution of the Society in general meeting (which duly occurred) and
for an application to be made to the Court of Session for sanction of the scheme
under section 49 of and Schedule 2C to ICA 1982. The Court of Session (Lord
Nimmo Smith) sanctioned the scheme by an order made on 28 February 2000, and
the scheme took effect on 3 March 2000. The scheme also obtained regulatory
approval and tax clearances.
58. The scheme is lengthy and in parts very technical. It runs to 41 clauses and
12 schedules. In bare outline, the bulk of the assets and liabilities of the Society
were transferred to the Company; pension policies and assets and liabilities
associated with them were transferred to another Lloyds TSB group company and
are not relevant to this appeal. Payment of the membership compensation to
qualifying members of the Society (later quantified at £5,846m) was undertaken by
Holdings, which is the owner of all the Company’s issued share capital. The
provisions of the scheme which call for most attention are in Part D (Fund
Structure) and Part E (operation of the Funds). Clause 22 in Part E (Capital
Reserve) is of particular importance.
59. Under Part D (Fund Structure) the most basic division was between the
LBTF (defined as the Long Term Fund) and the Shareholders’ Fund. The latter
fund was to have allocated to it infrastructure assets and shares in seven
subsidiaries and any joint venture companies (clause 15.1 and relevant definitions
Page 21
in Schedule 1). All other assets (other than pension assets as mentioned above)
were to be allocated to the LTBF, which was to be divided into two separate
subfunds, the With Profits Fund and the Non Participating Fund (respectively the
“WPF” and the “NPF”), with an appropriate allocation of existing policies (clauses
13 and 14.1). The allocation of assets between the WPF and NPF was to be
determined by the actuary in accordance with the detailed provisions of clause
15.2 to 15.6, 15.10 and 15.11. Liabilities were to be similarly matched, subject to
some special exceptions (clause 16).
60. In part E (Operation of the Funds) clause 18 deals with allocation of surplus
arising in the WPF. One-ninth of the amount of bonuses allocated to conventional
(that is, not unit-linked) with-profits policies (in other words one-tenth of the gross
allocation) is to be allocated to the NPF or the Shareholders’ Fund, as the board
directs. All other surplus is to be applied as bonus for the benefit of holders of
with-profits policies. This replicates the position under the Society’s constitution
and regulations (para 47 above). In life offices’ shorthand the WPF is a ‘90/10
fund.’ The NPF, by contrast, is a ‘0/100 fund’. Following each actuarial valuation
of the NPF the board may transfer to the WPF statutory surplus arising in the NPF
(clause 21).
61. Finally I come to the Capital Reserve, provided for in clause 22. Clause
22.1 is as follows:
“On and after [3 March 2000], [the Company] shall maintain a
memorandum account within the [LTBF] designated as the Capital
Reserve (the Capital Reserve). At [3 March 2000] the Capital
Reserve shall represent the amount of the shareholders’ capital held
within the [LTBF].”
Clause 22.2 provides for the Capital Reserve to be “credited with an amount”
arrived at by a complicated formula. It is common ground that this amount was
£4,455m. Clause 22.3 (headed ‘Maintenance of Capital Reserve’) provides that no
more may be added to the Capital Reserve and that it may be reduced only by
being brought into account in the revenue account of the WPF (up to a limit
arrived at by a formula) or the revenue account of the NPF (without limit). There
does not seem to have been a finding or formal agreement as to the amount of the
WPF limit, but the unchallenged evidence of Mr Adrian Eastwood, the Company’s
actuarial director at the material time, was that the amount was £432m. Clause
22.4 to 22.6 provided for the Capital Reserve to be notionally allocated between
the WPF and the NPF. The initial division was £1,895m to the WPF and £2,560m
to the NPF. Tables B and C annexed to the agreed statement of facts and issues
(“SFI”) show how the Company’s opening capital of £4,769m in its LTBF can be
Page 22
reconciled with the opening Capital Reserve (£4,455m) and the membership
compensation (£5,846m).
62. Clause 22A of the scheme provided for what was described as a contingent
loan, free of interest, from the NPF to the WPF, repayable as mentioned in that
clause. Its purpose was to compensate the WPF for the fact that its right to future
profits could not be included, for regulatory purposes, as an asset with an
admissible value. This inter-subfund loan (described in SFI, para 29) hardly
featured in the parties’ written and oral submissions, but it is a further
complication in understanding the regulatory forms, to which I now turn.
The forms
63. The balance sheet consists of forms 13 and 14. Form 13 sets out the values
of the assets of the fund (that is, the LTBF or a subfund of it) at their admissible
values (a technical term which in practice was not less than 99% of market value).
The effective bottom line of form 13 is line 89, Grand total of admissible values.
64. Form 14 sets out liabilities and margins. For present purposes the most
important lines are: 11, mathematical reserves (that is, actuarial liabilities which
have not yet been finally quantified); 13, balance of surplus (or valuation deficit);
14, LTBF carried forward; 49, total other (ie non-actuarial) liabilities; 51, excess
of the value of net admissible assets; and 59, total liabilities and margins. The
entries at line 89 of form 13 and line 59 of form 14 must be the same. The
balancing items on form 14 are the figures entered at line 13 (balance of surplus)
and line 51 (excess of the value of net admissible assets, which is also called the
‘investment reserve’: SFI para 53(2)).
65. The interrelation between the figures at lines 13 and 51 of form 14 is that
the line 13 figure is generally a relatively small amount representing value that has
been brought into account but not yet finally appropriated. The line 51 figure is the
true balancing figure, and is the last figure to be entered on the form. It represents
the (generally very much larger) value that has not yet been brought into account at
all – the amount by which the admissible value of the LTBF assets exceeds the
book value that has been brought into account. It illustrates the proposition stated
(perhaps in rather question-begging terms) in para 9 of the Revenue’s written
case, that life offices are treated differently from most businesses in that they can
shelter profits from taxation to meet unforeseen future liabilities. This point is
discussed further in paras 82 to 86 below headed ‘Bringing assets into account at
book value’.
Page 23
66. Form 40, the revenue account, shows movements during the accounting
period. The most important lines for present purposes are 11, earned premiums;
12, investment income; 13, increase (or decrease) in the value of non-linked assets
brought into account; 14, increase (or decrease) in the value of linked assets; 15,
other income; 19, total income; 29, total expenditure; 39, increase (decrease) in
fund in financial year; 49, fund brought forward; and 59, fund carried forward (39
+ 49). The entry at line 49 must be the same as line 14 on form 14 for the previous
accounting period, and the entry at line 59 must be the same as line 14 on form 14
for the current period. As to lines 13 and 14, Lord Reed explains in his judgment
(para 116) that any increase or decrease in the value of linked investments (line 14)
is required to be brought into account automatically, but unrealised increases in the
value of non-linked assets (line 13) need not be brought into account.
67. Form 58 (valuation result and distribution of surplus) shows the actuarial
surplus (line 29), its movement during the accounting period (lines 31, 34 and 35),
and its distribution as between policyholders (line 46), shareholders (line 47) and
balance (line 49, this being the same as line 13 on form 14). The term
‘distribution’ as used in lines 41-48 does not imply that sums necessarily leave the
Company’s hands; it refers to an allocation as between policyholders and
shareholders. Three separate forms 58 were completed for the WPF, the
transferred business in the NPF and the new business in the NPF.
How the forms were completed by the Company
68. Volume V of the papers before the Court contains over 500 pages of the
Company’s regulatory returns for the three relevant accounting periods, including
completed forms 13, 14, 50 and 58 for the LTBF and its sub-funds (except that
form 58 was completed, as already noted, for three sub-funds and not for the LTBF
as a whole). From these forms the following information as to the whole LTBF can
be extracted (in £bn, rounded to the nearest £1m, and with some rounding
adjustments in the computations).
2000 2001 2002
Form 13
line 89: total assets at
admissible value 23.066 22.427 20.962
Form 14
line 11: mathematical reserves 19.128 19.807 18.645
line 13: balance of surplus 0.033 0.064 0.181
——— ——— ———
line 14: LTBF carried forward 19.162 19.871 18.827
Page 24
line 49: total non-actuarial liabilities 0.441 0.386 0.468
line 51: excess of value of net 3.462 2.107 1.668
admissible assets ——— ——— ———
line 59: total liabilities and margins 23.066 22.427 20.962
Form 40
line 11: earned premiums 2.445 2.540 2.000
line 12: investment income 0.633 0.787 0.922
line 13: increase (decrease) in value of
non-linked assets brought
into account 1.273 (1.168) (2.254)
line 14: increase (decrease) in value of
linked assets (0.011) (0.031) (0.036)
line 15: other income 16.875 0.502 0.408
——— ——— ———
line 19: total income 21.216 2.631 1.040
line 29: total expenditure 2.054 1.921 2.084
——— ——— ———
line 39: increase (decrease) in LTBF 19.162 0.709 (1.045)
line 49: fund brought forward .000 19.162 19.871
line 59: fund carried forward 19.162 19.871 18.827
Form 58 (WPF)
line 59: distributed surplus 0.633 0.915 0.576
line 61: percentage distributed to
policyholders 94.72 96.64 97.05
69. It would be imprudent to attempt any sophisticated commentary on these
figures. The entry on form 40, line 15 for 2000 is obviously exceptional,
representing the effect of a change of ownership of a long-established business; no
one has suggested that the whole sum is taxable. But we know that it included a
sum of £33.410m as a transfer from Capital Reserve (see para 70 below). Taken
overall, the figures illustrate the effect of bringing into account value which, for
prudential reasons, has not previously been recognised.
70. During the three accounting periods the admissible (for practical purposes,
market) value of the assets of the LTBF fell by about £4bn (the figures can be
collected from SFI, Table A and the Company’s completed forms 13 for the three
accounting periods). The mathematical reserves decreased by a little under £0.5bn
and the recognised value of the LTBF, tracking as it did the mathematical reserve
and the unappropriated surplus, went down by about £0.3bn. But the investment
reserve, that is the excess of admissible value over the recognised value of the
LTBF (line 51 on form 14) was reduced by almost £1.8bn. The successive entries
Page 25
on line 13 of form 40 are noteworthy. In the accounting period ending on 31
December 2000 the value of non-linked assets brought into account increased by
over £1.2bn although their admissible value decreased during that period. This
disparity was reversed in the two following accounting periods, during which
(taken together) admissible value fell further by about £1.6bn but the form 40, line
13 decrease was a good deal larger, about £3.4bn. During the whole period the
Company declared bonuses of significant amounts, and allocated more than the
mandatory 90% to with-profits policyholders.
71. Part of the form 40, line 15 amounts included sums described in the notes
submitted with the statutory forms (volume V, pp1756, 2035-2036 and 2319) as
transfers from Capital Reserve. The amounts were as follows (SFI, paras 56-60):
£m
to WPF to NPF total
2000 33.410 33.410
2001 30.724 442.000 472.724
2002 17.000 353.000 370.000
——— ———- ———-
81.134 795.000 876.134
Whether they should nevertheless have been brought into the computation of the
Company’s profit or loss under Schedule D Case I under section 83(1) and (2) of
FA 1989 is the first issue. Line 15 of form 40 is, it will be recalled, specifically
mentioned in the referred question (set out at para 36 above).
The statutory provisions
72. The provisions which this Court has to construe are in a single section,
section 83 of FA 1989. A rapid survey of the landscape in which that section is
found shows that in the consolidating statute, ICTA 1988, Part XII dealt with
special classes of companies and businesses, and Chapter 1 of Part XII dealt with
insurance companies, underwriters and capital redemption businesses. I have
already mentioned section 433, which was repealed by FA 1989 and replaced by
similar (but more complex) provisions in section 82 of FA 1989. Section 444A,
inserted into ICTA 1988 by the Finance Act 1990, applies to a transfer of longterm business in accordance with a scheme sanctioned under section 49 of ICA
1982, but neither side placed any reliance on this section. At the time when the
consolidating statute was enacted the government was engaged in a far-reaching
Page 26
review of the taxation of life offices, as already noted (para 48 above). The
outcome was sections 82 to 90 of FA 1989 (together with Schedule 8 to that Act,
amending Part XII of ICTA 1988).
73. These sections, and Schedule 8, were frequently amended between 1989
and 2000, especially by the Finance Acts of 1995 and 1996. The details are set out
in Lord Reed’s judgment (paras 134 to 163). But I agree with Lord Hope (in para
15 of his judgment) that it is unnecessary, and maybe unhelpful, to go into the
legislative history. What matters is the statutory provisions as they were in 2000,
2001 and 2002.
74. During that period section 83(1) to (4) was in the following terms:
“(1) The following provisions of this section have effect where the
profits of an insurance company in respect of its life assurance
business are, for the purposes of the Taxes Act 1988, computed in
accordance with the provisions of that Act applicable to Case 1 of
Schedule D.
(2) So far as referable to that business, the following items, as
brought into account for a period of account (and not otherwise),
shall be taken into account as receipts of the period –
(a) the company’s investment income from the assets of its long term
business fund, and
(b) any increase in value (whether realised or not) of those assets.
If for any period of account there is a reduction in the value referred
to in paragraph (b) above (as brought into account for the period),
that reduction shall be taken into account as an expense of that
period.
(3) In ascertaining whether or to what extent a company has incurred
a loss in respect of that business in a case where an amount is added
to the company’s long term business fund as part of or in connection
with
–
Page 27
(a) a transfer of business to the company, or
(b) a demutualisation of the company not involving a transfer of
business,
that amount shall (subject to subsection (4) below) be taken into
account for the period for which it is brought into account, as an
increase in value of the assets of that fund within subsection (2)(b)
above.
(4) Subsection (3) above does not apply where, or to the extent that,
the amount concerned –
(a) would fall to be taken into account as a receipt apart from this
section,
(b) is taken into account under subsection (2) above otherwise than
by virtue of subsection (3) above, or
(c) is specifically exempted from tax.”
75. Section 83A(1) to (3) of FA 1989 was in the following terms:
“(1) In sections 83 to 83AB ‘brought into account’ means brought
into account in an account which is recognised for the purposes of
those sections.
(2) Subject to the following provisions of this section and to any
regulations made by the Treasury, the accounts recognised for the
purposes of those sections are –
(a) a revenue account prepared for the purposes of the Insurance
Companies Act 1982 in respect of the whole of the company’s longterm business;
(b) any separate revenue account required to be prepared under
that Act in respect of a part of that business.
Page 28
Paragraph (b) above does not include accounts required in respect of
internal linked funds.
(3) Where there are prepared any such separate accounts as are
mentioned in subsection (2)(b) above, reference shall be made to
those accounts rather than to the account for the whole of the
business.”
It is common ground that the relevant revenue accounts are forms 40 for the whole
LTBF and its constituent parts, the WPF and the NPF.
76. The first point of construction (which I have already described as a short
point, but one which takes some getting to) is the meaning of “value (whether
realised or not) of those assets” in section 83(2)(b). The Company contends that it
means market value, and that any reduction in their value (the form of words at the
end of the subsection) is to be treated as an expense capable of giving rise to an
allowable loss. The Revenue contends that section 83(2) is referring to a difference
in value (whether it be an increase or a reduction) as brought into account for the
relevant period of account, and that section 83(A)(2) leaves no room for doubt as
to what that means. It directs attention to the appropriate regulatory account, in this
case form 40. The Lord President (para 54) described this approach as
‘definitional.’
Taxing a loss?
77. The Company’s written case before this Court, and Mr Gardiner QC’s
robust oral submissions, characterised the Revenue’s position as unnatural,
uncommercial and contrary to fundamental principles of tax law. The Court was
reminded of some famous judicial observations made more than a century ago,
including Lord Halsbury LC in Gresham Life Assurance Society v Styles [1892]
AC 309, 315:
“The word ‘profits’ I think is to be understood in its natural and
proper sense – in a sense which no commercial man would
misunderstand”
and Lord Macnaghten in London County Council v Attorney General [1901] AC
26,35:
Page 29
“Income tax, if I may be pardoned for saying so, is a tax on income.
It is not meant to be a tax on anything else.”
In this case, Mr Gardiner submitted, the Revenue was attempting to tax what was
in reality a loss of capital.
78. These submissions call for careful consideration. The massive volume of
documents and figures put before the Special Commissioners and the Court of
Session, and now before this Court, creates a risk of getting lost in a labyrinth of
abstractions. Actuaries, accountants and lawyers are trying to converse in the same
language, but it is not easy going. It is a case in which there is a real danger, in the
hackneyed phrase, of not seeing the wood for the trees. It may help to avoid
confusion to start with three simple points.
79. The first point is that the Revenue is not seeking to exact tax from the
Company under Schedule D Case I either on profits or on losses incurred by the
Company; it is taxing the Company on the I minus E basis. Simultaneously the
Company is seeking to establish large Schedule D Case I losses in order to have
them available for surrender to obtain group relief. The second point is that it is,
and always has been, standard practice for life offices to bring the assets of their
LTBFs into account, not at market values that fluctuate from year to year, but at a
book value (though in practice that expression is applied to LTBFs in a way that an
outsider may find surprising). The third point is that the Capital Reserve is not, and
never has been, a separate fund distinct from the Company’s LTBF. It has always
been part of the LTBF. Each of these three points calls for some further
explanation.
The Crown option as it applies to this case
80. The Revenue is not seeking to charge tax under Schedule D Case I on losses
incurred by the Company. It is common ground (SFI, para 61) that at all material
times since 3 March 2000 the Company has been taxed on the I minus E basis (the
detailed computations for 2000 and 2002 can be seen in volume VII at pages 3211
and 3290; the relevant page for 2001 seems to have been inadvertently omitted).
Nevertheless (SFI paras 62 and 63) the Company seeks to claim an allowable loss
under Schedule D Case I which would be available for surrender to other Lloyds
TSB group companies by way of group relief.
81. The Revenue accepts (SFI, paras 62 and 63) that if the Company succeeds
in this appeal the losses available for surrender would be approximately £28.7m
for 2000, £612.6m for 2001 and £431.3m for 2002 (the relevant computations are
Page 30
at volume VII pages 3216, 3255 and 3295). The fact that a proprietary life office
can simultaneously pay tax on the I minus E basis and have an allowable loss
under Schedule D Case I shows that whatever the position a century ago, when
there were no special statutory provisions, the taxation of long term life assurance
business is now a very specialised area.
Bringing assets into account at book value
82. Regulation 45(6) of the 1994 Regulations (set out in para 20 above, and
later reproduced in Rule 9.10(c) of the FSA’s 2001 instrument) allowed a life
office, for the purposes of an actuarial investigation, to take the value of any of its
assets as its value “in the books or other records of the company”. This had been
expressly permitted by the regulatory system since 1980, when Regulation 3 of the
Insurance Companies (Valuation of Assets) Regulations 1976 (SI 1976/87), was
amended by the Insurance Companies (Valuation of Assets) (Amendment)
Regulations 1980 (SI 1980/5). But the two expert witnesses agreed that it was a
very long-standing and well-established practice, and the Special Commissioners
made a finding to that effect (para 16 of their decision).
83. It would be potentially misleading to say that a life office is permitted to
bring the assets of its LTBF into account at book value, since that is normally
understood to mean historic cost. In a LTBF some assets are normally brought into
account at the full admissible value, and others at nil (Special Commissioners’
decision, para 48; also para 122 of Lord Reed’s judgment). It is unnecessary to go
into the reasons for this practice, as to which there was no dispute.
84. The reasons for maintaining an investment reserve of unrecognised value
are fundamental to the way in which long term life business, and especially withprofits business, has been conducted in the United Kingdom. It is the mechanism
by which the life office, relying on the professional skills of its chief actuary and
his staff, can achieve a balance between competing considerations and interests.
First and foremost is the overriding need for a sufficient margin of solvency.
Subject to that the life office will wish to produce consistently good results for its
with-profit policyholders, both in the policyholders’ interests and to preserve and
enhance the company’s reputation. It must also achieve fairness between different
classes of policyholders in accordance with their rights and expectations (the
difficulties of which are illustrated by Equitable Life Assurance Society v Hyman
[2002] 1 AC 408). Finally there are tax considerations. No company likes to pay
more tax than it has to, or to pay it sooner than it has to. Before 1989 the tax
system allowed life offices to defer taxation, especially on unrealised capital gains.
It is common ground that section 83 of FA 1989 was intended to change that; the
controversy is as to the extent of the change.
Page 31
85. These points were well made by Mr Brian Drummond, an accountant, in an
article entitled ‘Making Sense of the FSA Return in Life Company Tax
Computations’ (Tax and Accountancy Review, June 2006, p6). Some changes had
taken place by then (both on the regulatory front and the taxation front) but the
article is nevertheless instructive. After mentioning recent changes the author gives
a brief overview of the forms:
“In broad terms, however, the overall structure remains unchanged.
Form 13 remains a reasonably straightforward analysis
of the total admissible value of the assets of the
company by category with narratives that are
commendably clear;
Form 40 demonstrates how much of the Form 13
value is brought into account for the purposes of
calculating surplus;
Form 58 deals with the calculation, composition and
distribution of the surplus; and,
Form 14 then links that exercise back to Form 13 by
showing how much of that original Form 13 value is
covering liabilities and bonuses and how much of it is
being held in reserve.”
He describes form 14 as ‘an area of linguistic opacity’, and comments:
“This confusion is carried across into form 14 of the FSA return
where it increases further. The first line in form 14 is described as
‘mathematical reserves, after distribution of surplus’ and in this one
narrative only two of the six words (‘after’ and ‘of’) take their
conventional or even accounting meaning.”
86. The most relevant passage is on the general philosophy of with-profits
business (at pp 9-10):
“Form 40 is described as ‘revenue account’ but in conventional
terms it is a very partial one. By reference to normal accounting
Page 32
convention it is surprising to have a revenue account that makes no
explicit reference to a movement in liabilities to third parties. The
layout of Form 40 and its interaction with Form 58 reflects much
more of the history of with profit funds than it reflects normal
accounting principles.
In with profits funds the starting point in determining the extent to
which surplus is recognised is establishing what bonus should be
recommended. This will be driven by a combination of the results of
the company (in terms of investment return and underwriting profit)
together with policyholder reasonable expectations and the need to
treat customers fairly. One of the principles of UK with profits
business is smooth bonuses from year to year.
Having established what bonus it is appropriate to declare for the
year it is then possible, depending on the structure of the fund, to
calculate the minimum extent to which surplus must be recognised –
both to meet the bonus requirement and any corresponding
entitlement of the shareholders to participate in surplus as a fraction
of the amount allocated to policyholders (very often one-ninth the
90:10 structure). Historically with profit funds hesitated to recognise
any more surplus than was required to meet the bonus, and
associated shareholder entitlement, and hence the fund would
generally be approximately equal to the liabilities (after current year
bonus) plus any residual surplus not allocated.”
The nature of the Capital Reserve
87. The third point mentioned in para 78 above is that the Capital Reserve is
not, and never has been, an appropriated fund separate from the Company’s LTBF.
It is, as para 22.1 of the scheme makes clear, part of the LTBF. It is an account
falling within Lord Greene MR’s second category in Allchin v Coulthard [1942] 2
KB 228, 234-235 – “merely an accounting category”.
88. Abstract though it is, the Capital Reserve is on the Company’s case of
central importance to this appeal. It is not easy to discern its purpose. The
Company’s own independent actuarial expert, Mr Chamberlain, stated in his report
dated 18 September 2007, para 5.1:
“The Scheme by which [the Society] demutualised established
something it refers to as a Capital Reserve. This ‘Reserve’ is a
Page 33
financial structure whose form and operation is defined by the
Scheme, and does not meet any particular regulatory or other
requirement, other than that emanating directly from the Scheme. It
is a memorandum account and does not consist of particular assets.”
Mr Allen, the Revenue’s independent expert, stated in his report dated 5 October
2007, para 6.1:
“Within the notes to their returns I understand that [the Company]
created a memorandum account (the Capital Reserve) with an initial
balance of approximately £4.5bn. Notwithstanding that this account
was referred to in the Scheme which obtained approval from the
Court of Session, in my opinion this memorandum account had no
meaning or relevance, other than as an item of information, as
regards either the Company’s statutory report and accounts or its
regulatory returns. The memorandum account did not represent any
particular assets, nor did it reflect any actual profit or loss incurred
by the Company, it was simply a note of a particular transaction.”
89. The experts did not give a further explanation of the expression
‘memorandum account’, nor did counsel offer any. The Special Commissioners
made a finding that reflects the natural meaning of ‘memorandum’ (para 45): “The
purpose of the Capital Reserve was to keep a record of this initial value created by
[Holdings] and to distinguish it from subsequent profits.” The notion that it was an
item of information that ought to be remembered comes out most clearly in the
witness statement of Mr Michael Ross. He was an actuary who was employed by
the Society for most of his career, becoming chief actuary of the Society in 1986
and the first chief executive of the Company in 2000. In his witness statement
(paras 18 to 27, not challenged in cross-examination) he described how
demutualisation involved a strategic choice between ‘ring-fencing the estate’ and
‘monetising the estate’ (the estate is a term used to describe a mutual’s excess of
assets over liabilities, or investment reserve).
90. After careful thought the Lloyds TSB group and the Society opted for
monetising the estate. This course was likely to be more attractive to the Society’s
members but required the Lloyds TSB group to find a very large sum to pay the
membership compensation. But the payment of that compensation gave the Lloyds
TSB group the advantage that the Company had a comfortable investment reserve
at the inception of its business (whereas with ring-fencing the group might have
had to inject further capital). The group wanted to earmark what Mr Ross (para 27)
regarded as “shareholder-owned capital, held within the [LTBF]” in order to be
able, in the long term, to benefit from it.
Page 34
91. That provides a clue, I think, to the purpose of the restriction on reduction
of the Capital Reserve in para 22.3 of the Scheme (summarised in para 60 above).
Only a limited amount (£432m out of £4,455m) of the Capital Reserve could be
brought into account in the revenue account of the WPF, because it was a 90/10
fund and nine-tenths of the distributed surplus were to go for the benefit of holders
of with-profit policies; only one-tenth (at most) could find its way to the
shareholder, Holdings. There was no restriction (beyond the total amount of the
Capital Reserve) on bringing it into account in the NPF, which was a 0/100 fund.
The decision of the Special Commissioners and the judgments in the Court of
Session
92. The Special Commissioners decided the first issue in favour of the
Company, and the Court of Session unanimously upheld that decision (Lord
Emslie’s dissent was on the second, narrower issue as to section 83(3)). All three
members of the Court delivered full judgments, so this Court has four separately
reasoned routes to the same conclusion on the first issue. The reasoning can be
imprecisely classified under three heads: the correct approach to the construction
of taxing statues, arguments based on the legislative scheme and purpose, and
detailed linguistic arguments.
93. The Lord President dealt most fully with statutory construction (paras 45 to
49). He cited the well-known speech of Lord Steyn in Inland Revenue
Commissioners v McGuckian [1997] 1 WLR 991, 999–1000, in which Lord Steyn
referred to Lord Wilberforce’s seminal speech in W T Ramsay Ltd v Inland
Revenue Commissioners [1982] AC 300, 323:
“Lord Wilberforce restated the principle of statutory construction
that a subject is only to be taxed upon clear words . . . To the
question ‘What are clear words?’ he gave the answer that the court is
not confined to a literal interpretation. He added ‘There may, indeed
should, be considered the context and scheme of the relevant Act as
a whole, and its purpose may, indeed should, be regarded.’ This
sentence was critical. It marked the rejection by the House of pure
literalism in the interpretation of tax statutes.”
The Lord President ultimately decided the issue by applying the ‘clear words’
principle in the light of his view of the statutory purpose (paras 55 and 56).
94. Lord Emslie relied on the same principle, and some other principles which
he set out at para 197:
Page 35
“Since this appeal concerns the construction of tax legislation,
certain fundamental rules, principles and presumptions may be
thought to apply.
First, as Lord Wilberforce explained in Vestey v Inland Revenue
Commissioners [1980] AC 1148, 1172:
‘Taxes are imposed upon subjects by Parliament. A
citizen cannot be taxed unless he is designated in clear
terms by a taxing Act as a taxpayer and the amount of
his liability is clearly defined.’
Second, in the absence of specific charging provisions, capital and
capital receipts do not fall to be taxed as revenue and vice versa.
Third, corporation tax being an annual tax on the profits of a
company, it is prima facie reasonable and appropriate to construe
statutory charging provisions as directed towards real receipts and
gains ‘ . . . in a sense which no commercial man would
misunderstand’: Gresham Life Assurance Society v Styles [1892] AC
309, 315, per Lord Halsbury LC. And fourth, as reflected in
countless provisions of the taxing statutes, a subject is in general
assessable to tax on his own profits and gains, and not on those of
any third party.’”
The second, third and fourth of these principles (and especially the second) may be
what the Special Commissioners had in mind (in para 79 of their decision) in a
more general reference to ‘tax principles’ as predisposing them in the Company’s
favour, and in characterising the transfer from the Capital Reserve as a capital
receipt (para 80).
95. Arguments based on the legislative scheme and purpose move from the
very general to the rather more particular. What was the underlying purpose of
section 83? In particular was it intended, as the Lord President stated in para 55 of
his judgment, to reverse the effect of section 433 of ICTA 1988? Is there a ‘key
conceptual distinction’ (Lord Emslie, para 201) between the Company’s LTBF and
the assets representing that fund? Was a transfer from the Capital Reserve a capital
receipt comparable to an injection of new capital (Special Commissioners, para
80)? How cogent is the argument (Lord Reed, para 183; Lord Emslie, para 197,
fourth point, and para 205, second point) that one taxpayer should not be taxed on
another taxpayer’s profits or gains? What practical results do the statutory
Page 36
provisions produce if construed (Lord Emslie, para 200) as a one-stage or
alternatively a two-stage process? I shall consider these points in turn.
Legislative scheme and purpose
96. It is permissible, without getting into the territory of Pepper v Hart [1993]
AC 593, to look at the official consultation paper published in 1988, The Taxation
of Life Assurance, to see the general nature of the problem perceived by the
Revenue. The most relevant paragraphs are paras 6.2 to 6.7, 6.12 to 6.21, 6.33 and
7.1 to 7.8 A life office might have a large capital gain on a long-term incomeproducing investment (such as a fully-let office block or a strategic holding of
shares in an oil company) as part of the with-profits part of its LTBF. Before 1989
this gain could be recognised (or brought into account) in its revenue account
without being realised so as to give rise to a chargeable gain. Value representing at
least nine-tenths of the gain could then be distributed (in the form 58 sense, that is
allocated) to the holders of with-profits policies so as to obtain the protection of
section 433 of ICTA 1988, as well as escaping income tax or capital gains tax in
the policyholder’s hands on the maturity of their policies (assuming them to be
qualifying policies). Section 83 of FA 1989 made the recognition of an unrealised
capital gain a receipt to be brought into the Schedule D Case I computation, while
section 82 of FA 1989 re-enacted the substance of section 433 in a more
satisfactory form.
97. All this is very clearly set out, in a good deal more detail, in paras 123 to
133 of Lord Reed’s judgment (which refer to section 83 in the form in which it
was originally enacted). I respectfully think that in para 55 of his judgment the
Lord President was to some extent running together the functions of sections 82
and 83, and misunderstanding the purpose of the two sections in tandem. Lord
Emslie referred to section 433 (para 200) but not to section 82. In my opinion Lord
Reed’s analysis is to be preferred. Section 83 is concerned with the immediate
implications, in making the necessary Case I computations, of bringing into
account all or part of the difference between book value and market value, and
section 82 is concerned with the next stage of the computations, that is adjustments
in respect of the distribution of surplus to holders of with-profits policies (covered
by form 58, lines 41 to 59).
98. The next point is the term ‘fund’. It is, as both Lord Reed (para 112) and
Lord Emslie (para 199) observed, used inconsistently both in ICA 1982 and in the
regulatory forms. But the two principal and relevant meanings, in this context, are
clear (and here I am repeating ground I have already covered). The LTBF is an
actual, appropriated fund of identifiable investments, the constituent assets of
which (with their admissible values) appear in form 13. The Capital Reserve is a
notional part of that fund to an initial amount of £4,455m; the independent
Page 37
actuarial experts agreed that it serves no regulatory purpose. The fund for the
purposes of lines 39, 49 and 59 of form 40, and for all the purposes of form 58, is
the same fund, but valued in a special way (that is at book values in the sense that
actuaries use that term) in order to produce the life office’s objectives – solvency
and prudent preservation of the investment reserve, but at the same time smooth
progress in the allocation of bonuses to with-profits policies.
99. I am not sure that I understand para 201 of Lord Emslie’s judgment. In that
paragraph he is (as I understand it) setting out part of the submissions made on
behalf of the Company. But later (para 204) Lord Emslie himself accepted that
there is a significant distinction between the assets and the fund itself. Of course
there is a difference, the difference between the parts and the whole. But the value
of the whole is in this case the sum of the values of the parts, and the significant
distinction, affecting both, is the basis of valuation.
100. It is common ground that if in 2001 or 2002 the Lloyds TSB Group had
decided to inject fresh capital into the Company’s LTBF (as might have been done
by the Company issuing new shares to Holdings, paid for in cash that was
appropriated to the LTBF) it would not have been treated as a receipt under section
83(2). The new money would have appeared on line 26 of form 40 (transfer from
non-technical account). The admissible value of the LTBF would have been
increased, and so (if it was needed for solvency purposes) would its value as
brought into account (lines 39 and 59 of form 40). A transfer from the Capital
Reserve, by contrast, costs the group nothing (although it may be an indication that
the state of the business is disappointing). The transfer does not increase the
market value of the LTBF. Nor has it any regulatory significance, as the experts
agreed. What happens is that part of the value held in the investment reserve is
brought into account, a familiar event generally recorded (as Mr Allen stated,
though Mr Chamberlain disagreed) on line 13 of form 40.
101. I respectfully consider that the Special Commissioners, and to some extent
the Court of Session also, attached too much weight to the label ‘Capital Reserve’
and to the notion that capital gains ought not to be taxed under Schedule D, Case I.
It could not be clearer that under section 83(2)(b) “any increase in value (whether
realised or not)” of investments constituting a LTBF, as brought into account, is to
come into the Case I computation.
102. The argument that (in the absence of very clear words) one taxpayer ought
not to be taxed on another taxpayer’s profits or gains is, on the face of it, a strong
one. It is not satisfactorily answered simply by pointing out (though this should not
be forgotten) that this appeal is not about taxing profits. It is about allowing losses
capable of being surrendered for the benefit of other group companies. But the
Company acquired a long-established mutual business and a LTBF with a healthy
Page 38
investment reserve. That reserve may have been built up by the Society largely by
means of unrealised gains. But it was the Company and the Lloyds TSB Group
that decided, for entirely understandable reasons, to bring part of the investment
reserve into account, rather than making an injection of new capital. The language
of section 83(3)(b) (as amended in 1996) shows that Parliament had
demutualisation well in mind as a situation for which the legislation should make
provision.
103. The last general point to be considered, before getting to linguistic
arguments, is the implication of Lord Emslie’s illuminating distinction (para 200,
summarising the Company’s argument, and para 204, accepting it) between a twostage process (asking whether there are any real gains, and then how far they have
been brought into account) and a one-stage process (asking simply what increase
in value, if any, has been brought into account). Again, it is necessary to be
reminded that this appeal is about losses, not gains; and the three accounting
periods have to be considered separately, and not as a whole.
104. In any accounting period the operation of the statutory provisions, if
analysed as a two-stage process, allows six different combinations, although some
of them may be fairly improbable in practice, as follows (AV denoting admissible
value, and RV value recognised and brought into account):
(1) AV up, RV up by less
(2) AV up, RV up by more
(3) AV up, RV down
(4) AV down, RV down by less
(5) AV down, RV down by more
(6) AV down, RV up.
105. It is easy to see how the competing interpretations work in situations (1),
(2), (4) and (5). On the Company’s two-stage approach the lower figure (whether
an increase or a reduction) will be brought into the computations; on the
Revenue’s one-stage approach the difference in RV will always be taken. But it is
Page 39
not so easy to see how either side’s interpretation would apply to situations (3) and
(6); and the Company’s regulatory return for 2000 disclosed situation (6).
106. It might be thought that though neither side’s interpretation fits easily, the
Company’s two-stage approach is distinctly more difficult to reconcile with the
situation in which there is a reduction in admissible value, but an increase in value
brought into account, in an accounting period, and the Company is seeking to
establish an allowable loss during that period. But so far as I can see that
submission was not made either to the Special Commissioners or to the Court of
Session, nor do I recollect it being put forward in this Court. The terms of the
agreed question do not positively require the point to be resolved. Indeed SFI, para
63 suggests that the point may already have been agreed between the parties. So
the best course is, I think, to exclude that point, which was not argued, from any
consideration of the statutory scheme and purpose. Nevertheless, unlike the
Special Commissioners and (to some extent) the Court of Session, I do not
approach the narrower linguistic points with any predisposition in favour of the
Company’s case. I approach them disposed towards the Revenue’s case as being
more in accordance with the statutory scheme and purpose.
Linguistic points on the first issue
107. I can take these more shortly, and it is convenient to do so by reference to
the numbered sub-paragraphs at the end of para 181 of Lord Reed’s judgment.
108. The first point is that “an increase in value . . . of . . . assets” is said to refer
most naturally to capital gains. In some contexts it might do so. In the context of
a system of computation which is closely and explicitly linked to the regulatory
returns in respect of LTBFs I see little force in this point. What is important is how
value is to be measured, and to my mind sections 83(2) and 83A leave no doubt
about that.
109. The second point is on the words “(whether realised or not)” in section
83(2)(b). The section was making an important change in the law in that unrealised
increases in value, so far as brought into account, were to come into the tax
computation. To my mind it would have been surprising if the draftsman had not
inserted this parenthesis so as to leave no doubt as to the character of the change in
the law.
110. The third point is on another parenthesis in section 83(2), “(and not
otherwise)”, though these words have come out in the text of Lord Reed’s
judgment before us as “or otherwise”. Again, I have to say that I think the
Page 40
draftsman is being rather unfairly criticised for his efforts to leave no doubt about
the intended meaning. The preceding word “as” means “in the manner that” and
the parenthesis means “and in no other manner”. To my mind it is a bit hard to
dismiss this as otiose.
111. Lord Reed’s fourth point is that the expression ‘brought into account’ is not
apt to describe ‘the overall effect of those entries’. I confess that I simply do not
understand this point. The critical entry is line 13 on form 40 (‘increase (decrease)
in the value of non-linked assets brought into account)’. That is the only line on
form 40 in which the words ‘brought into account’ are found. It was conceded that
the line 15 entry could have been on line 13. The bottom lines (39, 49 and 59)
show the overall position, and do not use the words ‘brought into account’.
112. Lord Reed’s remaining points on the first issue (in para 181(5) and (6) and
para 183) are more general and I will not revisit them.
Conclusion
113. In my judgment the Revenue’s submissions on the first issue are correct,
both as to the statutory scheme and purpose and as to the linguistic points just
mentioned. I have gone into the matter at some length because I am conscious that
I am differing both from the Special Commissioners and from the unanimous view
of the Court of Session. But in the end I consider that it is simply a question of
giving section 83(1) and (2) of FA 1989, as amended, their natural meaning. On
that basis the second issue does not arise and I prefer to say nothing about it. I
would allow the Revenue’s cross-appeal and treat the Company’s appeal as moot.
LADY HALE
114. As so often happens, what appears at first sight to be a very complicated
question turns out on closer analysis to be quite a simple one. When calculating the
profits of an insurance company in respect of its life assurance business under
Case 1 of Schedule D to the Taxes Act, does an “increase in value” – or conversely
a “reduction in the value” – of the assets of its long term business fund refer to an
increase or decrease in their actual value? Or does it refer to an increase or
decrease in their value “as brought into account for a period of account” in the
company’s revenue account prepared for the purpose of the Insurance Companies
Act 1982?
Page 41
115. We know that the words “as brought into account for a period of account
(and not otherwise)” in section 83(2) of the Finance Act 1989 (set out by Lord
Walker at para 41 above) describe the words “the following items”; we know that
the following items are “(a) the company’s investment income from the assets of
its long term business fund, and (b) any increase in value (whether realised or not)
of those assets”; we know from section 83A (set out by Lord Walker at para 74
above) that “brought into account” means brought into account in the revenue
account (or accounts) prepared for the purposes of the Insurance Companies Act
1982 in respect of the company’s long term business (or part of it); so the
linguistic question boils down to what is meant by “as” in section 83(2).
116. The Company would have it that “as” means “when”. The link to the
regulatory returns is a purely temporal one. Value means real value not whatever
the company chose to put in the forms. The Revenue would have it that “as” means
“as”. What is taken into account in computing the company’s profits for income
tax purposes is what the company brings into account in completing its revenue
accounts for regulatory purposes. In my experience, if Parliamentary counsel mean
“when”, they write “when”, and if they mean “as”, they write “as”. We should be
slow to re-write what they have written.
117. The words “and not otherwise”, if nothing else, make it clear that there
might have been some other way of taking items (a) and (b) into account for
income tax purposes, but this is the way it is to be done. They are making a special
rule for life insurance business. This is not surprising, for all the reasons that Lord
Walker has so clearly and carefully explained. The words “whether realised or
not” point to the real change which was being made by the 1989 Act. Otherwise it
was business as usual. It was not until 1995 that these insurance companies were
required to file any other sort of accounts than those which they had to file for
regulatory purposes. It was natural for the Revenue to use the figures in the
regulatory revenue account as their starting point.
118. In full agreement with Lord Walker, and Lord Hope and Lord Neuberger,
therefore, I would allow the Revenue’s cross-appeal and regard the Company’s
appeal as moot.
LORD NEUBERGER
119. I too would recall the interlocutor of the Inner House of the Court of
Session and allow HMRC’s cross-appeal. Having had the great benefit of reading
in draft the judgments of Lord Hope and Lord Walker, I can express my reasons
shortly.
Page 42
120. The cross-appeal raises an issue as to the meaning of section 83(2) of the
Finance Act 1989 (as substituted by paragraph 16 of Schedule 8 to the Finance Act
1995). It is unnecessary for me to set out section 83, as it is fully quoted in para 7
of Lord Hope’s judgment and para 73 of Lord Walker’s judgment.
121. As will be clear to anyone who has read those judgments, the difficulty in
this case arises from the fact that the issue of interpretation arises in the context of
a very complex background. That complexity is attributable to a number of
different factors, namely (i) the technical rules as regards the regulatory returns to
be made by life assurance offices, (ii) the many changes in the legislation
embodying those rules since they were first introduced in 1870, (iii) the many
changes in the statutory provisions governing the taxation of life assurance offices,
(iv) the extensive contractual provisions in the documentation governing the
scheme (“the scheme”) for transferring of the business of Scottish Widows’ Fund
and Life Assurance Society to Scottish Widows plc (“the Company”), and (v) the
details of the regulatory returns made by the Company in the three accounting
years in issue.
122. When considering the application of section 83(2) to the facts of this case, I
am sceptical about the value of analysing the history of the statutory provisions
governing either the returns to be made by life assurance offices or the taxation of
profits made by life assurance offices – i.e. what I have characterised as factors (ii)
and (iii). This cross-appeal concerns the meaning of the statutory provision in
force during the three relevant years, section 83(2), and its impact on the returns
actually made in respect of those years, in the then stipulated form by the
Company. Particularly as the provisions of the scheme, the prescribed forms for
returns, and the contents of the Company’s returns for the three years in question,
all require careful analysis, it seems to me that to focus in addition on the rather
intricate history, as opposed to the present provisions, of the regulations, risks
taking one’s eye off the ball (or, as Lord Walker puts it, not seeing the wood for
the trees).
123. Legislative archaeology has its place in statutory interpretation, but its role
is limited. Where a statutory provision, when read in its immediate statutory and
practical context, has a meaning which is tolerably clear as a matter of language,
and not unreasonable or unfair in terms of its consequences, it seems to me that
little is to be gained, and much may be lost (in terms of time, expense and eventual
confusion) by going into the genesis and development of the provision in earlier
legislation. As Lord Hope points out, such an approach is consistent with what was
said both by Lord Wilberforce in Farrell v Alexander [1977] AC 59, 73 and by
Lord Diplock in Inland Revenue Commissioners v Joiner [1975] 1 WLR 1701,
1715-6.
Page 43
124. Once one understands the scheme, the relevant regulations, the forms, and
the Company’s returns for the three years in question, it appears to me that the
answer to the question posed on the cross-appeal, namely the meaning and effect
of section 83(2), is tolerably clear. I could not hope to equal the clarity of Lord
Walker’s analysis in paras 49 to 53, 57 to 70, and 82 to 91, and, very gratefully,
adopt the benefit of his distillation of the various complex matters which he there
explains.
125. Turning to the central issue on the cross-appeal, the meaning of section
83(2), it may be a little glib to suggest that HMRC’s case is ultimately vindicated
by a single word. However, if one was to isolate a single crucial point, it seems to
me that it would involve focussing on the word “as” in that subsection, as Lady
Hale suggested during argument. Section 83(2) stipulates that the “items” which
should be “taken into account as receipts of [a particular accounting] period” are to
be those items identified in paras (a) and (b) “as brought into account for [that]
period of account”. The obvious and natural effect of the words which I have
emphasised is that those items are to be “taken into account” for the period in
question in the same way and to the same extent as they are “brought into account”
for that period.
126. It was argued on behalf of the Company that the expression “as brought into
account for a period of account” should be treated simply as a reference to the
period in which the item was brought into account, and was not concerned with
how the item was brought into account. Particularly in the light of the inclusion of
the word “as”, that does not seem to me to accord with the natural reading of the
expression.
127. Although both the Company and HMRC relied on other provisions in the
1989 Act to support their respective cases on the meaning of the expression, I am
unconvinced that they are of any real assistance. Thus, it was suggested that the
words “(and not otherwise)” in the subsection assisted the Company’s
interpretation. I do not see how that is so: they are there simply to emphasise that
an item is only to be brought into account if it falls within the expression, and
therefore they can take the issue of what the expression means no further. Equally,
the fact that section 83A(1) (as inserted by paragraph 16 Schedule 8 to, the 1995
Act and amended by paragraph 6 of Schedule 31 to the 1996 Act) defines the term
“brought into account” does not take matters further, as the position of each party
is consistent with that definition.
128. The conclusion that HMRC’s construction of section 83(2) is correct seems
to me to be supported, rather than undermined, by the normal approach to taxation
of business profits as explained by Lord Halsbury LC in Gresham Life Assurance
Society v Styles [1892] AC 309, 315 and by Lord Hoffmann in Revenue and
Page 44
Customs Commissioners v William Grant & Sons Distillers Ltd [2007] UKHL 15,
[2007] SC (HL) 105, [2007] 1 WLR 1448, para 2. In connection with taxing
business profits, the concept of a profit should normally be accorded its proper
meaning, which will obviously depend on the specific context, but current
accountancy practice is generally a good, and often the best, guide as to the precise
quantification of any profit.
129. In the case of a life assurance business, HMRC’s case is that, in effect,
statute requires the profit to be assessed by a rather unusual means, namely by
reference to the returns in the regulatory forms. This is entirely consistent with the
normal approach to assessing the profits of companies for taxation purposes, as
these returns effectively take the place of the statutory audited accounts, which are
relied on to define the profits of the overwhelming majority of other businesses
owned by limited companies. Furthermore, although there is, at first sight, real
force in the Company’s argument that HMRC’s case results in its business being
taxed on some figure which cannot sensibly be said to be a profit, a closer analysis
of the situation, as provided by Lord Walker in paras 81 to 90 and 95 to 105,
shows that this is incorrect.
130. Accordingly, and in agreement with the fuller reasoning of Lord Hope and
Lord Walker, I would allow HMRC’s cross-appeal.
131. As the cross-appeal succeeds, it is unnecessary to consider the Company’s
appeal. I agree with Lord Walker that it would be better not to go into the question
whether the majority of the Inner House was right in finding for HMRC on section
83(3). It is tempting to do so, given that there is a decision of the Inner House on
the point. However, at least on the basis of the argument we have heard on this
appeal, it does seem to me that the interpretation of subsection (3) is rather
difficult, and I think it would be better to wait for a case where the issue matters,
not least as it may be that some assistance would be gleaned from the facts of such
a case, which may throw light on the practical consequences of the rival
interpretations.
LORD CLARKE
132. I confess that I was initially attracted by the approach of Lord Emslie to the
issues in relation to both the cross-appeal and the appeal. However, having
considered the masterly judgment of Lord Walker, I have found his reasoning
compelling and agree with him (and indeed Lord Hope, Lady Hale and Lord
Neuberger) that the Revenue’s cross appeal on the true construction of section
83(2) of the Finance Act 1989 as amended should be allowed. Like Lord Walker,
Page 45
Lady Hale and Lord Neuberger, I prefer to express no view on the issue of the true
construction of section 83(3). I too would therefore allow the Revenue’s crossappeal and treat the Company’s appeal as moot.
