Clavis Liberty 1 v HMRC – anti-avoidance provisions cannot be used to avoid tax

The First Tier Tribunal (FTT) continues to adopt a strict approach to tax avoidance cases. The case concerned a tax avoidance scheme involving the purchase of the rights to dividends from shares held by another party. The scheme was designed to create artificial losses for the members, mitigating their liability to income tax. HMRC disregarded the scheme, reducing their losses to nil. The members appealed to the FTT, which held that the scheme was ineffective as the transactions were not trading transactions and a provision introduced to counter avoidance could not be used for avoidance purposes.

The appellant partnership sought to capitalise on an anti-avoidance provision (s.730 Income and Corporation Taxes Act 1998 – now repealed) by entering into a complex set of transactions including acquiring the rights to dividends from shares for approximately £60 million without acquiring the shares themselves. The intended result of this was that the income from the partnership's dividend rights would be deemed to be the income of the shareholders for tax purposes by virtue of s.730. The partnership claimed that the payment of £60m qualified as a trading loss, which could be offset against other income sources to reduce the partners' overall tax bills.

Although the FTT accepted that the partnership carried on a trade, the partners could only recognise losses if the relevant transactions were trading transactions. The FTT pointed to the decision in FA and AB Ltd v Lupton [1972] AC 634 and the distinction between trading transactions carried out with a tax avoidance motive, and artificial arrangements that were entered into purely to secure a tax advantage. The tribunal held that the activities here clearly fell within the latter category and were not trading activities.

Furthermore, the FTT held that s.730 does not have the effect claimed by the partnership. Firstly, using an anti-avoidance provision as an engine of tax avoidance is clearly outside the policy and purpose of that provision. Furthermore, the FTT agreed with HMRC's argument that a previous amendment to s.730, which removed the prohibition on treating the distribution as the income of any person other than the owner of the shares, clearly demonstrated that HMRC was not precluded from pursuing other parties for the tax.

There are some general points of interest arising from the FTT's analysis of the issues raised:

1. Considering the motivation behind legislation is particularly important for anti-avoidance provisions. Since the purpose of s.730 was to prevent tax-avoidance, the courts will not allow an interpretation of that legislation that provides the basis for a tax-avoidance scheme.
2. Where legislation is amended the courts will look to the likely motivation behind making that amendment. This means that where even a small subsection of a law is repealed it can profoundly affect the interpretation of the provision as a whole.
3. Schemes that are entered into purely with the motivation of securing a tax advantage are not trading transactions.
4. Where an appellant cannot demonstrate to the court a transaction’s “connection to the real world of business” beyond qualifying for a tax exemption, that exemption will not apply.