Taxing time for the Inland Revenue

Karen Methold questions whether the Inland Revenue should take a more conventional approach to constitutional matters by letting Parliament decide when we pay our taxes. Karen Methold is a partner at Rooks Rider.

The House of Lords judgment in the case of Commissioners of Inland Revenue v Willoughby last month was excellent news for tax practitioners in all disciplines and, as it happens, for Professor Willoughby himself.

Such was the strength of Professor Willoughby's case that the House of Lords, having heard counsel's submissions for the taxpayer, declined to hear submissions on behalf of the Revenue.

Essentially, the case revolved around an income tax anti-avoidance provision now found in s.739 of the Taxes Act 1988.

Broadly speaking, where an individual makes a transfer of assets resulting in income being paid to a non-resident and retains power to enjoy that income, the income is deemed to be that of the individual for all the purposes of the Income Tax Acts. Sensible enough.

Practitioners have taken the view that s.739 could only operate if the transfer was made while the individual was ordinarily resident in the UK, but this view was not shared by the Inland Revenue.

One of the transfers under consideration in this case was made while Professor Willoughby was not resident. Sure enough, the House of Lords held that s.739 did not apply to the transfer. Therefore, he was not chargeable to income tax under s.739.

A victory for Professor Willoughby and his advisers, but was it a victory for the taxpayer? Probably not. What about all those taxpayers in the interim who have paid income tax based on the Inland Revenue's view of what the law should be, rather than on what the legislation said, because they had neither the funds nor the time to take the Revenue to the House of Lords? Is there a right to reimbursement?

The Inland Revenue is entitled to apply its interpretation of the Taxes Acts, just as practitioners advise taxpayers based on their interpretation of the legislation. Yet s.739 states that the section shall "have effect for the purpose of preventing the avoiding by individuals ordinarily resident in the UK of liability to income tax…". So when is the residence status important, at the time of the transfer or when the income arises?

Here a little background is useful. The section has its origins in the Finance Act 1936 and the House of Lords decision in Willoughby refers to the comment made by the Financial Secretary to the Treasury during the debates on the Finance Bill of 1936. This was that "the Financial Secretary went further and said that there has to be a transfer of assets abroad by an individual resident in the country".

In his judgment Lord Nolan points out that Hansard would not be admissible in Willoughby under Pepper and Hart principles because there is no ambiguity in the section. Nevertheless, it does suggest that the Inland Revenue was off on an interpretation frolic of its own on this one.

Further, this "victory" has been to no permanent avail. The amendment that was made to s.739 by the Finance Act 1997 – so that nothing "shall be taken to imply that the provisions… apply only if the individual in question was ordinarily resident in the UK at the time the transfer was made…" (s. 739 {1A}) – applies to income arising on or after 26 November 1996.

It does seem a rather remarkable way to collect tax. Parliament introduces a piece of legislation and the Inland Revenue applies that legislation based on its opinion of what the law should be, rather than on what the section actually says.

Parliament then changes the law, despite the Inland Revenue having been proved wrong by the Special Commissioners, the Court of Appeal and the House of Lords.

A more conventional approach to constitutional matters would be that Parliament decides the circumstances in which we should pay our dues to the Exchequer and the Inland Revenue collects the tax. Not so, it seems.