Supreme Court on the ‘Houdini Taxpayer’

24 04 2016

UBS AG & Deutsche Bank v Revenue and Customs [2016] UKSC 13 (9 March 2016)

As infamously explained by jailed fraudster Tom Hayes, UBS must be credited with issuing a “handbook” on rigging LIBOR. Doubling Hayes up, in the ongoing LIBOR trial, Jonathan Mathew, one of five charged Barclays traders, says that he was merely following orders and just did what his boss taught/told him to do. The five men say everyone in the big banks “knew LIBOR was rigged”. As seen in an earlier post, along with Barclays traders, Deutsche Bank traders are facing criminal charges for EURIBOR manipulation and proceedings are ongoing in the case of R v Christian Bittar & Ors – first appearances were made at Westminster Magistrates’ Court on 11 January 2016 and a mention hearing was held on 18 March 2016. Former Deutsche trader Martyn Dodgson has also been convicted for insider trading in Operation Tabernula. In the instant case, echoing Templeman LJ in W T Ramsay Ltd v Inland Revenue Comrs [1979] 1 WLR 974, Lord Reed described UBS and Deutsche Bank’s behaviour as “the most sophisticated attempts of the Houdini taxpayer to escape from the manacles of tax.” The banks, which Lord King calls “the Achilles heel of capitalism”, may be disappointed with the Supreme Court’s ruling but most people will only be too delighted that top executives should become acquainted with some degree of retributive justice. The dry issue of tax is a hot political topic these days and the Panama Papers (see here) culminated in calls for the prime minister to resign for being a hypocrite.

Though this post is about the Supreme Court’s judgment, I use the opportunity to discursively expose other important tax issues reported in the media. Of course, Deutsche Bank announced last October that it would axe 9,000 full-time jobs and it has just recent lost its global position as a top-three investment bank. Research from Coalition, that ranks global investment banks by total revenue from fees and trading, shows that Citigroup and Bank of America are ahead of Deutsche Bank. JPMorgan Chase and Goldman Sachs retained their positions in first and second place respectively. Tim Wallace writes in today’s The Sunday Telegraph that once a cash cow, investment banking is now is serious crisis and jobs and pay across the sector has declined. It is a vicious cycle and the following insightful analogy is invoked “shrinking an investment bank is hard. It is like unravelling a jumper – once you start pulling on the thread it is hard to stop … then all of a sudden, you haven’t got a jumper at all.”

Though Deutsche Bank claims a “rock solid” balance sheet, its shares slumped 13 per cent in February but bounced back 11 per cent on bond buyback speculation. Its chairman Paul Achleitner explained it has an “intense dialogue” with investors, and that none of them have proposed that he should not run again in 2017. Part of the controversy is that the business secretary Sajid Javid has come under fire from the likes of Caroline Flint, Labour member of the House of Commons Public Accounts Committee who insists that “there are more questions he needs to answer.” Javid, who formerly held high-level positions in Deutsche Bank, declined to comment on whether or not he paid tax on bonuses.

Things are made all the more scandalous in light of calls for Javid to resign because he was “missing in action” over the mess with the steel industry which is facing total meltdown. To calm things down, Javid contends a multiplicity of potential buyers/choices exists for the steel industry but his reputation is in the doldrums nonetheless. From that angle, he is doing well to follow in his boss George Osborne’s footsteps, whose unpopularity may have reached its zenith. Indeed, people want both of them to resign. The SFO has also begun a criminal investigation into Tata Steel as it is thought that certificates detailing product composition had been falsified. Scampering all over the place, Javid has tried to ensure that Tata behaves like a “responsible seller”. Tata has suspended 10 members of staff, including some high-ranking officials, amid the furore that certificates of fitness had been forged.

Another point of intrigue for the buccaneer character of Javid is that his own throne – as embodied in the Department of Business Innovation and Skills – is under threat and a leaked “strategy paper” shows that it is planning on shedding at least 1,526 jobs (or even 4,103 of them) to cater for cost-cutting measures to the tune of £100 million required to keep the treasury afloat. But Javid will be relieved to see the report in The Sunday Telegraph that Tata’s steel plant is “almost back in profit” and that the reports of daily losses of £1 million are “overblown”.


In 2004, UBS and Deutsche entered into arrangements devised to benefit from the provisions of Chapter 2 of Part 7 of the lncome Tax (Earnings and Pensions) Act 2003, as substituted, which placed on a statutory footing a special regime for employment-related securities. Under the system “restricted securities” were, by section 425(2) and 429, exempt from income tax. By section 423(2), the expression included shares; which were subject to a condition providing for their forfeiture in certain circumstances so as to render their market value less than it otherwise would be but for that condition.

Both UBS and Deutsche invoked a scheme whereby (i) they set up a company merely for the purposes of the scheme, which undertook no activities beyond its participation in the scheme, was to be liquidated upon the termination of the scheme, and the memorandum and articles of which contained conditions designed to comply with Chapter 2, and (ii) the shares of the company were to be allocated to specified employees in lieu of a cash bonus.

Discretionary bonuses were awarded to employees by banks but the bonus amounts were paid indirectly as redeemable shares in offshore companies set up for the purposes of the schemes and those shares were then awarded to the employees in place of the bonuses. By virtue of attached conditions, the shares were made subject to forfeiture if a contingency occurred, so as to qualify for the exemption. In relation to UBS, the contingency was a specified rise in the FTSE 100 within the next three weeks. The contingency was unlikely to occur, and it was also hedged against so that the employees would lose out slightly, but not significantly, in the event it did occur. In the Deutsche Bank case, the contingency was the employees being dismissed for misconduct or voluntarily resigning within the next six weeks. Once the exemptions had accrued, the shares were redeemable by the employees for cash.

HMRC took the view that tax should be assessed as if the employees had been paid in cash the amount of the bonuses allocated to them. Both UBS and Deutsche’s appeals to the First-tier Tribunal were dismissed because it held that Parliament could not have intended that the exemption should apply to arrangements contrived purely in order to obtain the exemption but having no other business or commercial purpose. However, hearing the cases together the Upper Tribunal dismissed Deutsche’s appeal because the scheme failed to comply with a technical requirement for exemption. Later, Court of Appeal dismissed HMRC’s appeal in the UBS case, and allowed DB’s appeal.

The Supreme Court

Lord Neuberger (President), Lord Mance, Lord Reed, Lord Carnwath and Lord Hodge unanimously allowed HMRC’s appeal and held that the fact that Parliament has expressly dealt with tax avoidance in Chapters 3A to 3D of ITEPA 2003 does not support the inference that Parliament’s intentions in relation to anti-avoidance had been exhaustively expressed.

Reversing the Court of Appeal’s [2014] EWCA Civ 452 decision, in a judgment given by Lord Reed, the Supreme Court held that tax statutes were concerned with real world transactions with real world economic effects. It was clear that Parliament could not have intended to encourage by exemption from tax the award of shares to employees where the award of shares had no purpose whatsoever other than the obtaining of the exemption itself, a matter reflected in the fact that the shares were in a company which had been brought into existence merely for the purposes of the scheme, undertook no activities beyond its participation in the scheme and was liquidated upon the termination of the scheme. Of course, Lord Reed’s eloquent analysis of statute and case law is formidable and he held at para 7:

The encouragement of such schemes, unlike the encouragement of employee share ownership or share incentive schemes, would have no rational purpose.

According to his Lordship, the provision in section 423 of ITEPA 2003 conferring the exemption was to be construed as being limited to conditions having a business or commercial purpose and did not apply to commercially irrelevant conditions the only purpose of which was the obtaining of the exemption. Therefore, income tax was payable on the bonuses, based on the value of the shares awarded to the employees.

Lord Reed said the purposive approach to statutory construction, which was orthodox in other areas of the law, is extended to tax cases under the principle in W T Ramsay Ltd and that that case also held that the analysis of the facts depends on that purposive construction of the statute. Invoking the Court of Appeal’s analysis in Barclays Mercantile, [2002] EWCA Civ 1853, where Carnwath LJ (as he then was) held at para 66 tax statutes generally “draw their life-blood from real world transactions with real world economic effects”, Lord Reed held at para 64 where an enactment is of that character, and a transaction, or an element of a composite transaction, has no purpose other than tax avoidance, it can usually be said that to allow tax treatment to be governed by transactions which have no real world purpose of any kind is inconsistent with that fundamental characteristic. His Lordship said where schemes involve intermediate transactions inserted for the sole purpose of tax avoidance, it is quite likely that a purposive interpretation will result in such steps being disregarded for fiscal purposes.

According to the Supreme Court, the background to the enactment of Chapter 2 indicates that it was intended to address practical problems, and to forestall opportunities for tax avoidance. Lord Reed observed that the purposes of Part 7 of the ITEPA 2003 were broadly identified in Grays Timber Products Ltd v Revenue and Customs Commissioners [2010] UKSC 4 as being:

  • to promote employee share ownership by encouraging share incentive schemes
  • since such schemes require benefits to be contingent on future performance, creating a problem if tax is charged on the acquisition of the shares, to wait and see in such cases until the contingency has fallen away; and
  • to counteract consequent opportunities for tax avoidance.

Difficulties arose in accepting that Parliament intended to encourage, by exemption from taxation, the award of shares to employees, when the award of such shares has no purpose other than the obtaining of the exemption itself. The court held that the section 425(2) exemption, in respect of the acquisition of securities which are “restricted securities” by virtue of section 423(2), was designed to address practical problems arising from valuing a benefit which was, for business or commercial reasons, subject to a restrictive condition involving a contingency. Nothing supported the proposition that Parliament intended that section 423(2) should also apply to restrictive conditions that have no business or commercial purpose, but are deliberately contrived solely to take advantage of the exemption. The section 429 exemption did not undermine that analysis and was confined to two specific situations falling within the broader section 425 exemption, whose purposes are consistent with the general approach to Chapter 2 of ITEPA 2003.

The fact that Parliament expressly dealt with tax avoidance in Chapters 3A to 3D does not support the inference that its intentions in relation to anti-avoidance had been exhaustively expressed. Lord Reed held at para 85 that the reference in section 423(1) to “any contract, arrangement or condition which makes provision to which any of subsections (2) to (4) applies” is to be construed as being limited to provision having a business or commercial purpose, and as not applying to commercially irrelevant conditions whose only purpose is the obtaining of the exemption.

As regards UBS, his Lordship found that the condition was completely arbitrary, and had no business or commercial rationale. Moreover, the economic effect of the restrictive condition was nullified by the hedging arrangements, except to an insignificant and pre-determined extent. Therefore, the condition needed to be disregarded, with the consequence that the shares are not “restricted securities” within the meaning of section 423. In relation to Deutsche Bank, the condition in its case operated only for a very short period, during which the possibility that it might be triggered lay largely within the control of the employee who would be adversely affected. It had no business or commercial purpose, and thus fell outside section 423.

Having found that the exemption does not apply, Lord Reed proceeded to hold that the proper basis for taxation of the bonuses is as shares, and not as cash. The shares did not simply function as a cash delivery mechanism: the amount of cash for which the shares might be redeemed was neither fixed nor ascertainable when the shares were acquired. His Lordship found at paras 94 and 95 that the value of the shares has to be assessed as at the date of their acquisition, and the restrictive conditions must be taken into account, as ordinary taxation principles require the tax to be based on the shares’ true value.


Interest in ostensibly boring tax law is amplified in light of the purported “crackdown” on tax avoidance laid down in the budget; which looks completely ridiculous because of the pressure on David Cameron from the fallout of the Panama Papers. At the root of the prime minister’s woes was his belated admission that Samantha Cameron and him profited from off shore arrangements by virtue of Blairmore Holdings. The fact that his mother Mary Cameron gave him £200,000, allegedly with a view to dodge tax was unhelpful to him and such events have led people to question his devotion to transparency. Indeed, his suitability to remain prime minister is further undermined by the fact that he faces serious questions over these highly damaging revelations.

Cameron admitted that it has “not been a great week”. Candidly, he accepted that he could have handled things better but at least for now president Obama’s helpful/timely visit has taken the heat off the prime minister. In light of Labour leader Jeremy Corbyn’s taunts that he had “misled the public” and “lost the trust of the British people”, Cameron has also established a taskforce under the aegis of HMRC and the NCA, SFO and the FCA to investigate/evaluate the legality of his financial affairs in light of the details found in the Panama Papers.

It is beyond doubt that in the aftermath of the Panama Papers, the explosive subject of tax avoidance is even more in the spotlight than it used to be. The FCA gave 20 banks and financial institutions until 15 April 2016 to investigate their affairs and the SRA has also written to three law firms to scrutinise their links to Mossack Fonseca, the dodgy Panamanian law firm which services 300,000 companies involved in tax avoidance through “wealth management”. But the FCA also warned that prosecutions over the Panama Papers are not straightforward or easy and its head of enforcement Mark Steward has posited that the hype generated by the headlines are “quite different from prosecutions – the two don’t necessarily go together”.

As noted above, FCA, HMRC and the SFO have been given the task – by the prime minister, who once promised to lift the “cloak of secrecy” from tax havens – to look at cases linked to the revelations which show that HSBC, Coutts, Rothschild, Credit Suisse and UBS are among the banking groups which have used Mossack Fonseca to establish off shore entities to service their clients. Apparently, things are presently under assessment by the agencies but as Ramón Fonseca says his firm is the subject of a “witch hunt” and it has done nothing wrong; there is “more dirty money in New York and London,” he says.

It is important to note that reporting on the Panama Papers refers to “letter box” companies. In that regard, Professor Mathias Siems has noted two variants:

  • Type A: companies that do business in one country, but are incorporated with only a “letterbox” in another jurisdictions.
  • Type B: companies that are mere “special purpose entities”, i.e. those too merely have a “letterbox” in the country of incorporation, but they only hold financial assets and are not involved in any business activity in any country.

Professor Mathias Siems explains the Panama Papers interlink with the latter species, i.e. Type B companies. Just the other week, the chancellor George Osborne urged world leaders at the IMF to create a list of jurisdictions still allowing the wealthy and powerful to avoid paying fair share of tax. Of course, paradoxically, despite disagreement with Boris Johnson over Brexit, one thing that he has in common with the outgoing London Mayor is that both their chances of succeeding Cameron as leader are damaged because of their silence on their personal finances.



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