David v Goliath: Anti avoidance and the long arm of the Revenue. The recent High Court case of The Revenue Commissioners v O Flynn Construction Co Ltd, John O Flynn and Michael O Flynn 1 (the O Flynn Construction Case) has once again pitted the tax-payer against Revenue in the battle for effective tax avoidance transactions. The first respondent was a company involved in the construction business. The second and third respondents were shareholders in the first respondent. An unrelated company, Mitchelstown Export Company Ltd (part of the Dairygold Group) was involved in the manufacture of goods for export and had accumulated reserves of export sales relief (ESR). 2 By virtue of a number of separate legal transactions the first respondent and another company, O Brien and O Flynn Ltd, acquired the ESR from the Dairygold Group for IR 117,668. The ESR reserves equated to a tax deduction of IR 1,200,000. The result of the separate transactions was that the first respondent avoided a liability to corporation tax and the second and third respondents received tax free dividends of IR 590,000. as shareholders of the first respondent. Section 811 of the Taxes Consolidation Act, 1997 (section 811) provides that a transaction is a tax avoidance transaction where Revenue form the opinion that the transaction gives rise to a tax advantage and the transaction was not undertaken for purposes other than to give rise to a tax advantage. There are two exceptions to the rule: a) where a transaction is undertaken to realise profits in the course of a business and not primarily to give rise to a tax advantage (the business profits exclusion) and b) where the transaction was undertaken to benefit from a relief and would not result in a misuse or abuse of that relief (misuse/abuse exclusion). 3 Revenue formed the opinion that the above transactions constituted a tax avoidance transaction and notice thereof was duly served on the respondents. At first instance the Appeal Commissioners concluded that the transaction resulted in a tax advantage but that it came within the misuse/abuse exclusion exemption. Revenue appealed to the High Court. Smith J undertook a comprehensive review of the so-called doctrine of fiscal nullity cases. 4 He referred to the Duke of Westminster s case 5 where Lord Tomlin stated that: 1 2006 ITR 81 2 Reserves of export sales relief are exempt from corporation tax and dividends derived from such reserves are also relieved of Schedule F (dividends from Irish resident companies) income tax charge for private individuals. 3 The terms misuse and abuse are not defined. Guidance can be obtained from the Canadian Supreme Court in Canada Trustco Mortgage Company v Canada [2005] SCC 54. See note 13 below. 4 In McGrath V McDermot [1988] 1 IR Carroll J noted that the doctrine of fiscal nullity had been developed by the UK House of Lords in W.T. Ramsey Ltd. v Inland Revenue Comrs [1982] A.C. 300 and Furniss v. Dawson [1984] A.C. 474 and advanced for the first time in Ireland in the McGrath case. The doctrine provided that if steps inserted in a pre-ordained series of transactions have no commercial business purpose apart from the avoidance to tax then those steps should be disregarded for fiscal purposes even if the transactions were intended to achieve a legitimate commercial end. In other words a transaction should be assessed from a substantive and not a formative viewpoint. 5 [1936] A.C. 1
it is said that in revenue cases there is a doctrine that the Court may ignore the legal position and regards what is called the substance of the matter.every [person] is entitled if [he/she] can to order [his/her] affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If [he/she] succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners or his fellow taxpayers may be of [his/her] ingenuity, [he/she] cannot be compelled to pay an increased tax. This so called doctrine of the substance seems to me to be nothing more than an attempt to make a [man/woman] pay notwithstanding that he has so ordered [his/her] affairs that the amount of tax sought from [him/her] is not legally claimable. Reference was also made to the English case of Lord Vestey s Executors and Vesty v Comrs. of Inland Revenue case 6 where it was held that: Parliament in its attempts to keep pace with the ingenuity devoted to tax avoidance may fall short of its purpose. That is a misfortune for the taxpayers who do not try to avoid their share of the burden and it is disappointing to the Inland Revenue, but the Court will not stretch the terms of taxing Acts in order to improve on the efforts of Parliament and to stop gaps which are left open by the statute. Tax avoidance is an evil, but it would be the beginning of much greater evils if the courts were to overstretch the language of the statute in order to subject to taxation people of whom they disapproved. Smyth J noted that the Duke of Westminster s case was also followed in the English case of Potts Executors v. Inland Revenue Commissioners 7 where the House of Lords declined to look at the substance of a transaction and also in the Irish case of O Sullivan v. P Ltd. 8 However, the writer submits that it is generally accepted that the 1980 s witnessed a change of attitude of the English courts. Smyth J referred to the English case of Chinn v Collins 9 where the House of Lords took the view that where there was a pre-arranged pre-drafted tax avoidance scheme the court was entitled to look at the plan as a whole without disregarding the legal form and nature of the transactions carried out. In the instant case Smyth J noted the comments of Lord Wilberforce in the English case of W.T. Ramsay Ltd v. Inland Revenue Comrs 10 when referring to the principle in the Duke of Westminster s case (at p. 323) he stated that: While obliging the court to accept documents or transactions found to be genuine as such it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If a transaction was intended to have effect as part of a nexus or series of transactions there is nothing in the doctrine to prevent it being so regarded; to do so is not to prefer form to substance or substance to form.whether what is in issue is a composite transaction or a number of independent transactions. 6 (1949) 31 T.C I Lord Normand at p. 90 7 [1951] A.C.443 8 (1962) 3 ITC 355 Kenny J. 9 [1981] A.C. 533 10 [1982] A.C. 300
Ramsay was followed in the English case of Furniss v Dawson 11 where the House of Lords held that where steps in a commercial transaction had no commercial business purpose save the avoidance of tax then those steps should be disregarded and the end result of the scheme should be looked at. Smyth J confirmed that the doctrine of fiscal nullity had been comprehensively reviewed before an Irish court by Carroll J in the McGrath case. 12 The facts were as follows: PMcG purchased the issued preference share capital of P Ltd thereby becoming connected with it for capital gains tax purposes. He then purchased the entire ordinary share capital from G Ltd for 1. per share subject to an option in favour of the owners of the preference share capital (P Ltd) which allowed the option holder to purchase the ordinary share capital at a price of 2. (non-market value figure) per share. As this purchase was between connected persons the shares were deemed to have been purchased at a price undiminished by the option. Accordingly, the deemed cost of the shares in G Ltd was considerably in excess of the price actually paid. PMcG then disposed of the shareholdings for market value to an unconnected purchaser. PMcG then claimed to have suffered a loss on the disposal of the shares being the difference between the deemed cost and the actual sale proceeds. Revenue disagreed. The Appeal Commissioners upheld Revenue s finding. PMcG appealed to the High Court. Carroll J in allowing the appeal held that in determining a liability to tax one must look at the actual legal effect of the transaction and the legal rights of the parties. In the instant case the steps were implemented commercially and legally. The UK doctrine of fiscal nullity was not a part of Irish law. The imposition of tax and the granting of relief is solely a matter for the legislature. It is not up to the courts to impose a charge to tax in the absence of specific legislation. Revenue appealed to the Supreme Court. It was unanimously held that the appeal should be dismissed. The doctrine of fiscal nullity did not form part of Irish law. Finlay CJ stated that: Successful tax avoidance schemes can result in unfair burdens on other taxpayers and that unfairness is something against which courts naturally lean.the function of the courts in interpreting a statute is, however, strictly confined to ascertaining the true meaning of each statutory provision, resorting in cases of doubt or ambiguity to a consideration of the purpose and intention of the legislature to be inferred from other provisions of the statute involved.the courts have not got a function to add to or delete from express statutory provisions so as to achieve objectives which the courts appear desirable. In rare and limited circumstances words or phrases may be implied into statutory provisions solely for the purpose of making them effective to achieve their expressly avowed objective. In short, the Supreme Court endorsed the High Court s view that the form of a transaction was crucial and not simply the substance or end result. Finlay CJ said that other jurisdictions such as Canada and Australia have general anti avoidance provisions but in the absence of such a provision there were no grounds from departing for the plain meaning of the statute in question. 11 [1984] A.C. 474 12 See note 4
Smyth J confirmed that where section 811 is invoked by Revenue and an exemption thereto is claimed by the taxpayer the onus is on the taxpayer to show that the transaction comes within either the business profits exemption or the misuse/abuse exemption. Smyth J referred to the Canadian case of Canada Trustco Mortgage Company Case 13 and quoted the following with approval: Abuse of tax avoidance may be found where the relationships and transactions as expressed in the relevant documentation lack a proper basis relative to the object, spirit or purpose of the provisions that are purported to confer the tax benefit or where they are wholly dissimilar to the relationships contemplated by the provisions. The reserves in the Dairygold Group were transferred to a company that was not engaged in the manufacture of goods for export to enable tax relieved dividends to be paid to the shareholders of what is a construction company. Smyth J concluded that this was completely at odds with the purpose for which the export sales relief was provided. Smyth J held that the transaction constituted a tax avoidance transaction and did not come within terms of either of the exemptions. In the writer s opinion, Smyth J adopted a purposeful and interpretive approach to the transaction in issue apparently facilitated by section 811. The writer submits that the approach is similar to the attitude adopted in the McGrath case where Finlay CJ stated that the courts could ascertain the true meaning of each statutory provision and, in cases of doubt, consider the purpose and intention of the legislature. It is arguable that Smyth J may have reached the same conclusion in the absence of section 811. Since the McGrath case Ireland has witnessed unprecedented growth with consequent increases in exchequer revenue. To a large extent this increased wealth is concentrated within certain business and social sectors. Prior to 2006 the legislature had provided for a multitude of tax mitigation schemes such as urban renewal and the other types of capital allowance type schemes 14. Such allowances enable large amounts of what was taxable income to be sheltered from tax. These schemes were utilised fully by the financially independent to such an extent that the present executive, which controls the legislature, enacted the Finance Act, 2006 which brought to an end most of these allowance schemes 15. The writer submits that this reflects a changed of attitude of the executive consistent with predicted moderated growth rates over the short term. 13 Above note 3. 14 Under such schemes an individual can offset a certain percentage of the purchase price of a qualifying property constructed, renovated etc. within a certain period of time against other taxable income (typically rental income) over a certain period of time. For example, expenditure by an individual on a qualifying hotel facilitated an annual reduction in ones income tax liability of 15% of the amount of hotel expenditure actually incurred for the first 6 years post expenditure and 10% in the 7 th year. The only 15% schemes remaining relate to registered nursing homes, private convalescent facilities, private hospitals, sports injury clinics, third level educational buildings and childcare facilities which are obviously facilities which the legislature wishes to be developed by the private sector. 15 Also since the 1 st of January, 2006 if an individual s income, including taxable income with property and other incentive reliefs added back) exceeds 250,000 the maximum amount of relief that tone can shelter is 50% of that adjusted income.
The courts do not operate in a vacuum and must determine, from time to time, various issues with reference to prevailing economic and social conditions 16. The writer submits that if the McGrath case was decided today, in the absence of section 811, the Supreme Court would hold in favour of Revenue on the basis of a purposeful interpretation of the relevant statute. Section 811 allows Revenue to look at the result of the transaction/series of transactions and form an opinion. The McGrath case allows the courts to do the same and form a judgment. Section 811 appears to have added little to the courts interpretative armoury (at present). It has imposed procedural requirements on Revenue but yet has provided the tax-payer with two valuable and often claimed exemptions. Attribute to Cian O Sullivan, Senior Associate, Mason Hayes+Curran. Cian is a senior associate in MH+C Private, the specialist private client department of Mason Hayes+Curran. For more information, please contact Cian at cosullivan@mhc.ie or + 353 1 614 5000. The content of this article is provided for information purposes only and does not constitute legal or other advice. Mason Hayes+Curran (www.mhc.ie) is a leading business law firm with offices in Dublin, London and New York. Copyright Mason Hayes+Curran 2008. All rights reserved. 16 Such decisions are sometimes referred to as policy decisions made to avoid floodgate consequences.