The Mayes case involved consideration of the SHIPS 2 scheme. The primary objective of the scheme was to use corresponding deficiency relief to reduce the liability to higher rate income tax for UK resident individuals.
A Jersey resident individual invested in two life assurance bonds with a total premium of £10,000. He then assigned them, for value, to a Luxembourg company. Although this was a chargeable event in relation to the bonds, there was no actual charge to tax in view of the policyholder’s residence status. The Luxembourg company (JSI) then paid very significant additional premiums using borrowed money. The amounts paid in were then withdrawn – within a month. This withdrawal triggered a chargeable event but, again, there was no actual tax charge. Finally the bonds were assigned, again for value, to Mayes – a UK resident individual – who surrendered them for £1,781. Mayes claimed deficiency relief in a sum in excess of £1.8 million.
In his computation of the chargeable event gain, the premiums paid by JSI and the amounts withdrawn shortly afterwards cancelled each other out. Ignoring the £10,000 premium and the final surrender proceeds, the deficiency equalled the chargeable event gain accruing to JSI (which wouldn’t have been subject to UK tax).
Artificial tax avoidance
Mayes’ advisers freely admitted that he had participated in an artificial tax avoidance scheme. However, the Court of Appeal held that although the deficiency was “created” solely to save tax, that alone did not entitle the court to ignore what were real payments of premiums and real part-surrenders.
Making its ruling, the Court of Appeal said: “If a taxpayer takes out a policy while non-resident, and effects a partial surrender while non-resident, but then becomes UK resident before effecting a total surrender, the gain made on the partial surrender falls outside the charge to tax but he is still entitled to claim corresponding deficiency relief from UK tax on the total surrender.
Conversely, if he takes out the policy and effects the partial surrender while UK resident, but then, because of initially unforeseen force of circumstances becomes non-resident, he pays tax on the large gain on partial surrender, but loses the benefit of the compensating corresponding deficiency on total surrender. The former situation is capable of apparently legitimate avoidance possibilities; the latter is capable of causing hardship. Both illustrate the formulaic and prescriptive nature of the legislation.”
“The statute does not tax actual losses. If the transaction had proceeded in exactly the same way but JSI had been a UK taxpayer the gain and loss would have been offset and there would and could have been no HMRC objection.”
This strategy won’t work now, as the ‘loophole’ has been closed.
It is likely that this will end up in the Supreme Court.
Gerry Brown is Technical Manager at Prudential
