HMRC loses appeal against life bonds scheme designed to create tax loss

14 April 2011

The England & Wales Court of Appeal has rejected HM Revenue & Customs’ attempt to disallow the SHIPS-2 tax planning scheme, in the case HMRC v Mayes.

The legal struggle over SHIPS has been a roller-coaster ride. Marketed by tax advisers Matrix Tax Solutions, the scheme required clients to pay into so-called “non-qualifying” life assurance policies, and then surrender them in two stages.

Although the taxpayer did not lose anything by this complex seven-step process, it created a tax loss which he could then use to claim “corresponding deficiency relief” against the higher rate of income tax, under s.549 of ICTA 1988. It also generated capital sums that the scheme’s architects said would be allowable as deductions against CGT under s.38 of TCGA 1992.

SHIPS was operated mostly in the tax year 2003-04. HMRC, which calculates the resulting loss to tax revenue at about GBP24 million, reacted by declaring it ineffective for tax purposes. Its verdict was appealed to the Special Commissioners, who in February 2009 supported HMRC’s view (Mayes v HMRC, SpC 729). The Commissioners decided that two of the steps in the transactions were purely for tax avoidance and so should be ignored as if they never happened. This meant that no loss arose that could be set against the taxpayer’s income tax – although they agreed the amounts paid did count as a loss for capital gains calculations.

Mayes – who is the lead applicant in litigation funded by 70 participants with a similar interest – then took his appeal to the High Court. The case was heard in October 2009: it  resulted in a victory for Mayes et al. The judge, Proudman J, decided that there was corresponding deficiency relief against income tax, but that the CGT issue was still unclear.

Inevitably HMRC appealed against the High Court ruling. That appeal has just been heard and rejected by the EWCA, although the judges admitted “this case is not a simple one, even for the tax experts.” They ruled that the Special Commissioners had erred in law when they initially found for HMRC.

The appeal judges’ final comment is worth quoting at length: “Unattractive as the result is for other taxpayers and the rest of society, … the court cannot lawfully hold … that because the sole purpose of steps 3 and 4 [of SHIPS] was to avoid tax by the creation of a corresponding deficiency unrelated to any underlying commercial loss, those events are therefore to be treated as if they had not occurred.”

However, as the EWCA admitted in its judgement, HMRC will probably appeal yet again.

• The Mayes faction lodged a cross-appeal claiming CGT relief as well as income tax relief. The EWCA remitted that appeal to the First Tier Tribunal.






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