B e f o r e :
THE HONOURABLE MR JUSTICE MANN
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Between:
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PETER JOHN St. BARBE GREEN
DAVID ROBERT MITSON
(Trustees of
The Will of Consuelo Dowager Duchess of Manchester
A Settlement dated 6 July 1953
A Settlement dated 7 November 1969)
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Appellants
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- and -
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THE COMMISSIONERS OF INLAND REVENUE
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Respondent
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Tony Oakley (instructed by Gisby Harrison, Cheshunt) for the Appellants
Rupert Baldry (instructed by The Solicitor of Inland Revenue) for the Respondent
Hearing date: 14 December 2004
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HTML VERSION OF JUDGMENT
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Crown Copyright ©
Mr Justice Mann :
Introduction
- This is an appeal under Section 222 of the Inheritance Tax Act 1984 ("the 1984 Act") against a determination of the Commissioners of Inland Revenue concerning the valuation of a person's estate for inheritance tax chargeable on his death. The relevant person died with an insolvent estate (i.e. his liabilities exceeded his assets). Immediately before his death he was also interested as life tenant in certain assets under three settlements, and under the Act the assets in which he was thus interested fall to be treated as part of his estate for inheritance tax purposes. The short question in this case is whether the excess of his liabilities over the assets in his personal or free estate can be used to reduce the value of the assets comprised in the settlements for the purpose of computing the amount chargeable to tax.
The Facts
- These can be shortly stated with a minimum of detail. The deceased was Angus Charles Drogo Montagu, 12th Duke of Manchester. He died on 25th July 2002. No grant of representation has been taken out in respect of his estate. The evidence shows that he apparently died with virtually no assets, or no assets of any value. The value of his personal assets has been estimated at just over £4,600, most of which is the value attributed to personal chattels. His liabilities were rather more considerable. It has been agreed that for the purposes of this appeal I can assume that there was a net deficiency in his estate of £44,671. No more needs to be said about his estate than that.
- The Duke was interested as tenant for life in certain assets or funds under each of three settlements. Under the first of them, he was interested for life in certain jewellery, which is currently on loan to the Victoria and Albert Museum. There is a question mark as to whether that jewellery falls to be treated as heritage property and would thereby be conditionally exempt from inheritance tax. Because of that question mark, the assets in that settlement have been left out of the reckoning in relation to the issues before me and I shall ignore it hereafter, but that makes no difference to the issues because they still have to be decided in relation to the second and third trusts. In the second settlement, the Duke had a life interest in securities whose net capital value was £50, 594 (£52,759 gross less debts of £2,165 payable out of capital). In the third settlement, the Duke had a revocable life interest in certain sums which were used to acquire the house in which he lived. The open market value of that property was assessed at £290,000 as at the date of his death.
- Under the statutory provisions relating to inheritance tax, to which I will come in due course, the value of the property comprised in the Duke's life interests falls to be treated as property to which he was beneficially entitled and that value forms part of the sum in relation to which inheritance tax is calculated. In due course the trustees of the latter two settlements submitted appropriate inheritance tax returns in which they claimed to be able to deduct from the values of each settlement the amount of the deficiency in the Duke's free estate. The Inland Revenue did not accept that deduction and issued a Notice of Determination accordingly. It is from that decision that the trustees of those settlements now appeal to this court via a statutory mechanism which I need not go into. The question which I have to decide is whether the trustees were right in accepting that the trustees were entitled to deduct the deficiency of £44,000 odd from the values of the settled funds so as to arrive at a net sum in respect of which inheritance tax had to be calculated.
The statutory scheme and the relevant statutory provisions.
- The relevant provisions are to be found in various sections of the Act. The terminology has now changed in that all references in the Act to capital transfer tax should be read as being references to inheritance tax; I shall set out the provisions of the statutes in their original form; appropriate mental substitutions should be made. Otherwise I shall continue to refer to the relevant tax as inheritance tax.
- Inheritance tax is charged on "chargeable transfers" as provided in section 1:
"1. Capital transfer tax shall be charged on the value transferred by a chargeable transfer."
The concept of a "chargeable transfer" is dealt with in section 2:
"2. A chargeable transfer is a transfer of value which is made by an individual but is not (by virtue of Part II of this Act or any other enactment) an exempt transfer."
Section 4 provides that on death there is a deemed transfer of value:
"4(1) On the death of any person tax shall be charged as if, immediately before his death, he had made a transfer of value and the value transferred by it had been equal to the value of his estate immediately before his death."
The key concept for present purposes is "his estate". "Estate" is defined in section 5(1):
"5(1) For the purposes of this Act a person's estate is the aggregate of all the property to which he is beneficially entitled …".
By virtue of section 49, the value of the property which is subject to the life interests is brought into this aggregation:
"49(1) A person beneficially entitled to an interest in possession in settled property shall be treated for the purposes of this Act as beneficially entitled to the property in which the interest subsists."
Thus on a person's death the property in his free estate is aggregated with the trust assets in which he has an interest in possession such as a life interest so as to form one overall estate on which inheritance tax is then charged.
- Liabilities are apparently provided for in section 5(3):
"5(3) In determining the value of a person's estate at any time his liabilities at that time shall be taken into account, except as otherwise provided by this Act."
This is the key provision in the present case.
The arguments of the parties and their resolution
- The question that arises in the present case arises out of how and in relation to what section 5(3) operates. Mr Oakley for the trustees submits that the effect of section 5(3) is simple. It contains the mandatory word "shall", which means it must be given effect to. It operates in relation to "a person's estate" which means the aggregated estate which arises as a result of the operation of section 5(1), which in turn means (in the present case) the free estate aggregated with the two settled funds, so that after exhausting the very limited assets in the free estate the balance is available to reduce the assets in those two funds which are used as the basis for the tax calculation (which was the way Mr Oakley put it). Although section 5(3) is qualified by the words "except as otherwise provided by this Act", there is no provision of the Act which provides to the contrary; section 162 deals with liabilities, but there is nothing in it which is capable of operating to prevent section 5(3) operating as Mr Oakley maintained it does.
- Mr Baldry for the Inland Revenue disputed this. His first line of approach was to say that section 5(3) was concerned with determining value. It did not require a mechanistic approach of setting off negative figures against positive figures. It contemplated a deduction being made in relation to liabilities of an estate so far as those liabilities fell to be met out of that estate. This, he said, was the fair and ordinary meaning of the words. I confess to having had some difficulty in following why this was said to be so on the argument advanced thus far. However, his argument developed from this during the course of his submissions. He said that in determining the value of the estate one takes into account liabilities. The way one takes liabilities into account is to deduct them from the value of the property which is answerable to those liabilities. So far as the liabilities in the present case are concerned, only the assets in the free estate were answerable in law for the free estate's liabilities, so once those assets were exhausted there were no other assets answerable to them. Since the trust assets were not available to pay the deceased's personal liabilities, those liabilities could not be offset against them for inheritance tax purposes. He criticised the trustees' case as failing to give effect to what he said was the purpose of section 5(3) (which was to ensure that account was taken of liabilities which reduce the value of the property in a person's estate) and section 49(1) (which was to ensure the value of settled property was brought within the charge to tax on death). Then he said that he had support for this approach in authority in the form of Re Barnes [1938] 2 K.B. 684, which he said had given effect to the Revenue's construction in relation to the old estate duty legislation and which he said Parliament cannot be said to have intended to change when capital transfer tax and inheritance tax were introduced. In addition, he said that the trustees' case could not be correct because it was not possible to see how the liabilities would be apportioned between the various trust estates – the statutory provisions for apportionment or attribution could not be operated satisfactorily or sensibly.
- Before going further I should deal with one question that arose as to the correct approach to the interpretation of this statute. At one point the trustees were arguing that clear words were necessary to tax the subject, and that the only words in this case that were clear were words which clearly reduced the tax – those words were the literal words of section 5(3). There were no clear words the other way. Reliance was placed on Cape Brandy Syndicate v IRC [1921] 1 KB 64 at 71:
"There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied" (per Rowlatt J).
However, their position changed as a result of citations by Mr Baldry for the Revenue. In the end it was, I think, accepted by Mr Oakley (and so far as it was not accepted I nevertheless find) that the correct modern approach to taxing statutes is the same as the approach to other statutes – purposive, ordinary methods of construction are available and are applied (see IRC v McGuckian [1997] 1 WLR 991 at page 998-9).
- I therefore turn to the arguments and the cases of the parties. Much of the Revenue's argument does not work, in my view. For some of its course it assumed that which it set out to prove. Its reliance on the apparent purpose of section 49(1) as being a provision intended to ensure that settled estates are brought into account for inheritance tax purposes does not answer the point. The question in this case concerns the manner in which that is to be achieved. Given that purpose, there is nothing inherently illogical or contrary to that purpose in allowing personal liabilities to be used to reduce the overall (aggregated) estate because it might be said that that is consistent with the aggregation mechanism that Parliament chose. The statute has created its own logical world by deeming trust property to be owned by the deceased. Given that, the position in the personal estate is inevitably to some extent going to affect the tax position of the trust (and vice versa) - trust estates are aggregated with the free estate (and with each other) so that the value of each part is capable of affecting the tax charged on the others by means of their varying values and the attribution provisions. Since they are linked together in that way, there is no inherent reason in the logical world created by the statute why they should not also be linked together by allowing the liabilities in the free estate to be set off against the aggregated assets of all the relevant trusts and the free estate which occurs as a result of section 5(1). Furthermore, it might be said that the approach of the trustees has the literal wording of section 5(3) on their side. The liabilities are taken account of in order to determine "the value of a person's estate", and the word "estate" ought to mean the same as it means in subsection (1) – ie the aggregate of the various free estate and trust interests. That could mean that the personal liabilities go to reduce the value of the whole estate.
- Having said that I consider that the Inland Revenue's overall contention (that the net liabilities are not available to reduce the estate beyond the value of the free estate's assets that are liable to meet them) is right when the statute is looked at correctly. Inheritance tax is charged on death by virtue of the deemed transfer of value in section 4. That is a transfer of value "equal to the value of [the deceased's] estate immediately before his death". His estate is the "aggregate of all property to which he is beneficially interested". The word "property" is important here. It is not defined for these purposes (section 272 of the Act contains a partial definition in it that states what the expression includes but not what it means), but it is important to note that section 49(1) (which brings in the settled assets) does so by deeming the deceased to be beneficially entitled to "the property" in which his life interest subsists. It does not say "net property" (ie the value of the property net of trust liabilities) but that is what it must mean, and the parties to this appeal both agree that in practice that is the effect the Revenue gives to the section. Thus in section 49(1) we have the notion of property from which liabilities have been notionally deducted. That notion can be applied in section 5(1), so that the property of the deceased which is brought into the aggregation is his personal estate net of his liabilities. In other words, it is at that stage that the liabilities are dealt with. It is not necessary for section 5(3) to provide for a second time that the debts are to be deducted in arriving at the value of the deceased's property (or estate) and in my view it is not really doing that. It is in part confirmatory, but in the main it is intended to provide a qualification or qualifications to the principle that debts are deductible – the meat of the subsection is in the closing words "except as otherwise provided by this Act". One finds provisions in the Act which qualify that right in sections 5(4), 5(5) and 162. Its confirmatory nature is supported by the use of the phrase "taken into account", which is more general than "shall be deducted". I accept that the nature of section 5(3) would be clearer without the comma, but nevertheless it seems to me to be clear enough. This way of reading the Act enables consistency to be achieved in relation to the use of the word "property" in section 49 and section 5(1). It means that section 5(3) does not have the effect contended for by the trustees, and the Revenue is right in its conclusion. The personal estate comprises the property in it net of liabilities; once it is reduced to zero by those liabilities its value cannot decline further, and any additional liabilities have nothing against which they can be offset. The zero sum is aggregated with the settled property (net of trust liabilities) which is brought in by section 49(1).
- This is not the line of the reasoning of the Inland Revenue, though it arrives at the result that it contends for. However, if my reasoning is wrong, then I nevertheless consider that the approach of the Revenue, which is to consider the words "taken into account" is correct in the alternative, and this leads to the same conclusion. The argument of the Revenue, it will be remembered, is that one takes liabilities into account by off-setting them against assets out of which they can properly be met, but no further because that is what section 5(3) provides. This approach is consistent with authority. Re Barnes [1939] 1 KB 316 was an estate duty case which concerned a gift within three years of death. Under the legislation of the time this gift fell to be treated as property passing on the death. The deceased's estate was heavily insolvent (there was a deficit of over £90,000 if one included funeral expenses) and the executrix claimed that the aggregate of the (virtually negligible) personal estate and the preceding gift should be reduced by the total amount of the debts. This contention was rejected by Lawrence J. His decision and his reasoning was approved by the Court of Appeal ([1939] 1 KB 316) without adding any reasoning of its own, so it is the express reasoning of Lawrence J that has to be considered. It turned on the wording of section 7 of the Finance Act 1894, which (so far as material) provided:
"7(1) In determining the value of an estate for the purpose of Estate duty allowance shall be made for reasonable funeral expenses and for debts and incumbrances; but an allowance shall not be made:
(a) for debts incurred by the deceased, or incumbrances created by a disposition made by the deceased, unless such debts or incumbrances were incurred or created bona fide for full consideration in money or money's worth wholly for the deceased's own use and benefit and take effect out of his interest, nor
(b) for any debt in respect whereof there is a right to reimbursement from any other estate or person, unless such reimbursement cannot be obtained, nor
(c) more than once for the same debt or incumbrance charged upon different portions of the estate;
and any debt or incumbrance for which an allowance is made shall be deducted from the value of the land or other subjects of property liable thereto."
- In his judgment Lawrence J expressly rejected an argument that "in determining the value of this aggregated estate allowance shall be made for debts" so that the free estate deficiency could be set off against this aggregate. He said:
"I am unable to agree with the construction of s.7, sub-s. I, contended for by the appellant. I think the words of the section contemplate liabilities of the estate which are met out of the estate, and I think that the last three lines of s.7, sub-s 1, in their natural meaning are inconsistent with the appellant's case. I do not see how, in determining the value of an estate, allowance can be made for debts beyond the value of the assets out of which the debts are to be met. It is an unnatural use of words, in my view, to speak of making an allowance for a minus quantity in determining value. The appeal will therefore be dismissed, with costs."
The Revenue contended that this was applicable to the present case because although the wording of the modern statutory provisions was different, it was still reflected in the modern provisions and Parliament should not be taken to have intended to change the law as it had stood for very many decades. The trustees do not accept that. Inheritance tax is a new tax, they say, and the wording of the relevant provisions is different. In particular they rely on the omission of any reference to debts in section 162(4) which (as will be seen) is the modern counterpart of the closing words of section 7 of the 1894 Act. The statutory language is clear and mandatory, and should be applied according to its terms.
- Before considering the modern wording it is important to see what it is that Lawrence J was actually deciding in his very short reasoning. I am afraid that I do not find it wholly easy. The word "estate" had a technical meaning in the 1894 Act as it does in the 1984 Act, because section 4 of the earlier Act provides for the aggregation of all property passing in respect of death (including that comprised in recent inter vivos gifts)
"so as to form one estate, and the duty shall be levied at the proper graduated rate on the principal value thereof".
It therefore meant the aggregated estate, not the separate free estate. This means that it is not easy to accept what appears to be the thrust of the words "I think the words of the section contemplate liabilities of the estate which are met out of the estate" because Lawrence J appears to be using "estate" in a sense other than that apparently referred to in section 7 (because he seems to mean some sub-estate of the overall estate referred to in section 7). His reliance on the closing words of the section is easier to grasp, but that part of his reasoning cannot be directly transposed into the modern environment because they have no precise equivalent there. However, it is his next sentence which contains a point which is a candidate for transposition into other statutory environments - "I do not see how … allowance can be made for debts beyond the value of the assets out of which the debts are to be met." Although he does not stress it, what those words are doing is construing "allowance shall be made". The wording of the 1894 Act required that "allowance be made". It did not require that "deductions shall be made". The question therefore arose: How does one "make allowance" for debts? The answer provided by Lawrence J was that one does so by offsetting them against assets which were in law available to meet them but no further. This appears from that sentence and from the next following sentence – "It is an unnatural use of words, in my view, to speak of making an allowance for a minus quantity in determining value". That does seem to me to be a point of construction or principle in relation to section 7, and I find that that is what he was intending to convey.
- With that in mind I can turn to the modern wording. At first sight the modern wording might be thought to be different so that Lawrence J's reasoning does not apply, and that is indeed the trustees' argument on the point. However, closer scrutiny reveals that the Acts are not so different and I consider that its reasoning can and should be applied to section 5(3). . What has happened is that the concept of one aggregated estate has been retained, various of the 1894 provisions have been scattered over various parts of the 1984 Act and there has been a modernising of the text. [1] The concept of forming an aggregated estate is present in both statutes – see section 4 of the 1894 Act and section 5(1) of the 1984 Act. "Debts and incumbrances" in the opening words of section 7 have become "liabilities" – see section 5(3), (4) and (5) and section 162. Section 7(1)(a) is now section 5(5); section 7(1)(b) is now section 162(1). The closing words of section 7(1) are not reproduced as such, but there is a partial equivalent in section 162(4):
"A liability which is an incumbrance on any property shall, so far as possible, be taken to reduce the value of that property."
It will be noted that the thrust is now different. It confines itself to incumbrances on property, which is why the part of Lawrence J's reasoning which relies on the closing words of section 7 can no longer be applied.
- Although the wording of the 1984 Act is different, I consider the Revenue is right about Re Barnes and its application. The reasoning in the case is short and, for the reasons that I have given, not altogether satisfactory. The wording of the modern statute is different in detail but similar in concept. Although in the modern equivalent the closing words of the old section 7 are not repeated so far as general debts are concerned, I do not consider that Lawrence J's reasoning depended entirely on the presence of the now omitted words. He was construing the word "allowance", and he considered that one takes due allowance of debts by allowing them to reduce the assets out of which they ought to be paid. The wording in section 5(3) which has to be construed is different ("shall be taken into account"), but in my view they have the same effect. The statute does not say precisely how they are to be taken into account, but it is obvious that they have to be deducted from something. In my view what they have to be deducted from is the assets which are liable to bear them. That makes sense as a matter of principle, and the wording is not sufficiently different from the wording of section 7 of the 1894 Act so as to lead me to apply different reasoning from that of Lawrence J. While inheritance tax is a different tax from estate duty, with many very different provisions, the concept of aggregating other property interests with the free estate is a concept they share to some extent, as is the concept of dealing appropriately with the debts within the context of that aggregation. I think it unlikely that Parliament intended to change the application of the relevant principles in the wording that was in fact adopted. I therefore find, so far as necessary, that Lawrence J's reasoning in relation to section 7 should be applied to section 5(3) of the 1984 Act, with the result that the trustees' argument fails and the Revenue's argument succeeds.
- For the sake of completeness I should add that I did not find the Inland Revenue's arguments based on the difficulty of attributing the deficit across more than one trust estate, which would have to happen if the trustees' arguments were right, to be particularly persuasive. I was not convinced that there were serious difficulties, and in any event I would not have regarded such difficulties as being particularly compelling support for the Revenue's case. However, I do not have to consider this point further, and I do not do so.
- Accordingly, on either (or both) of the lines of reasoning referred to above the trustees' arguments fail, and in the circumstances I dismiss this appeal.
