FIRST DIVISION, INNER HOUSE, COURT OF SESSION
Lord President Lord Reed Lord Emslie	[2010] CSIH 47 XA31/08 OPINION OF THE LORD PRESIDENT in the Appeal by SCOTTISH WIDOWS plc Appellant: against THE COMMISSIONERS FOR Her Majesty's Revenue and Customs Respondents: under section 56A of the Taxes Management Act 1970 _______

Act: Johnston, Q.C.; Maclay Murray & Spens LLP

Alt: Tyre, Q.C., K Campbell; Solicitor (Scotland), HM Revenue & Customs

28 May 2010

The question referred

[1] Scottish Widows plc ("the Company") and the Commissioners for Her Majesty's Revenue and Customs ("HMRC") made a joint referral under paragraph 31A of Schedule 18 to the Finance Act 1998 of a question which had arisen in connection with an enquiry into the Company's tax returns for the accounting periods ending 31 December 2000, 2001 and 2002. The agreed question for determination was:

"Whether in computing the Case I profit or loss of [the Company] for the accounting periods ending in 2000, 2001 and 2002, amounts described by the Company as 'transfers from Capital Reserve" and included as part of the entries at line 15 of Form 40 for each period fall to be taken into account in computing the profit or loss as the case may be".

It is agreed that the words "as receipts" can appropriately be read in after the words "into account".

[2] The Special Commissioners (J Gordon Reid, Q.C. and John F Avery Jones) answered the question in the affirmative. Against that determination the Company has appealed, under section 56A of the Taxes Management Act 1970, to this court.

The Statement of Agreed Facts

[3] In the course of the proceedings before the Special Commissioners the parties entered into a Statement of Agreed Facts. It was in the following terms:

"The Society

(1) In 1814 the Scottish Widows' Fund and Life Assurance Society ('the Society') was formed at Edinburgh 'upon the Principle of mutual Assurance'. Subsequently, the Society was incorporated under the Scottish Widows Fund and Life Assurance Society's Incorporation Act 1861.

(2) At all times material to this referral, the Society was governed by the Scottish Widows' Fund and Life Assurance Society Act 1980, which provided its constitution and regulations.

(3) At all material times, the Society was a company without share capital owned by its members.

(4) As permitted by its regulations, the Society wrote both 'with profits' policies (or 'participating' policies), which entitled a member holding such a policy to participate in the Society's distributed profits, and also 'without profits' policies (or 'non-participating' policies).

(5) By section 17 of the Scottish Widows' Fund and Life Assurance Society Act 1980, it was provided that, on a dissolution, surplus assets were to be distributed among its members.

(6) The Society was authorized under section 4 of the Insurance Companies Act 1982 to transact long-term insurance business in the UK in the following classes (as specified in Schedule 1 to that Act): Class I (Life and annuity); Class II (Marriage and birth); Class III (Linked long term); Class IV (Permanent health); Class VI (Capital redemption); and Class VII (Pension fund management).

(7) The Society maintained a single long-term fund in respect of its long-term business pursuant to section 28 of the Insurance Companies Act 1982.

The Company and the Scheme of Transfer

(8) Early in 1999, the Lloyds TSB group (of which Lloyds TSB Group plc is the ultimate parent) approached the Society with a view to acquiring the latter's business and, on 23 June 1999, the Society and Lloyds TSB Group plc entered into an agreement for the transfer of the Society's business to subsidiaries of the Lloyds TSB group.

(9) That transfer was conditional on, inter alia: an order by the Court, pursuant to section 49 and Part 1 of Schedule 2C to the Insurance Companies Act 1982, sanctioning a scheme of transfer; requisite regulatory approvals (including approval by the Financial Services Authority ('the FSA')); and approval by the Society's members.

(10) The acquisition of the business was proposed entirely for bona fide commercial reasons and neither party had any tax-avoidance or tax-mitigation motive for it.

(11) Scottish Widows plc ('the Company'), Scottish Widows Financial Services Holdings Limited ('the Parent Co'), and Scottish Widows Annuities Limited ('the Subsidiary Co') were each incorporated in 1999 and were acquired 'off-the-shelf' by and ultimately owned by the Lloyds TSB group.

(12) The Company is a UK-resident company, incorporated in Scotland and is a wholly-owned subsidiary of the Parent Co. The Subsidiary Co is a wholly-owned subsidiary of the Company.

(13) On 28 February 2000, the Court of Session sanctioned, pursuant to section 49 and Part 1 of Schedule 2C to the Insurance Companies Act 1982, a scheme for the demutualization of the Society and the transfer of its business to the Company (and to the Subsidiary Co) ('the Scheme').

(14) At all material times prior to the implementation of the Scheme, the Society carried on mutual insurance business, consisting mainly of mutual life assurance business.

(15) At all material times prior to the implementation of the Scheme, the value of the Society's assets was substantially in excess of its liabilities (see paragraphs (37) and (38) below) and, had there been a dissolution of the Society, a substantial surplus would have been distributable among its members. At 31 December 1999, the excess of the Society's admissible assets over its liabilities shown in its FSA return was £5,804 million (see lines 13 and 51 of Form 14 of the Society's return for year ended 31 December 1999).

(16) The Scheme came into effect on 3 March 2000.

(17) The terms of the Scheme provided for the transfer of the Society's business to the Company (with the exception of certain without-profits pension business to be transferred to the Subsidiary Co).

(18) The Scheme provided for the membership rights of the Society's members to cease and for the Company to become the Society's sole member (paragraph 38); and, in consequence, for the Society's members to receive compensation from the Lloyds TSB group (paragraph 12 of the Scheme).

(19) It was provided that UK members would receive, as membership compensation, redeemable shares issued by the Parent Co and that overseas members would receive cash. The redeemable shares would then be exchanged for cash; alternatively, there was an option for UK members to receive compensation in the form of loan notes which would be subsequently repaid (this option is described in the Policyholder Circular at pp.3, 17-18 and 60-61).

(20) Application for clearance for the Scheme was made under sections 211, 138 and 139 of the Taxation of Chargeable Gains Act 1992 and section 444A of the Income and Corporation Taxes Act 1988 and such clearance was given on the basis that H.M. Revenue and Customs were satisfied that the transactions would be 'effected for bona fide commercial reasons and [did] not form part of a scheme or arrangement[s] of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax or corporation tax'.

(21) The Scheme also provided, among other things, for the establishment of a 'Long Term Fund' of the Company (the fund maintained for its long-term insurance business for the purposes of section 28 of the Insurance Companies Act 1982) and provided for the Company to establish and maintain, for management and accounting purposes, two separate sub-funds of the Long Term Fund: a 'With Profits Fund' and a 'Non Participating Fund'.

(22) The liability to provide benefits under policies transferred to the Company was allocated between those two sub-funds, principally by reference to whether or not the benefits were with-profits (paragraph 14 of the Scheme).

(23) The Company's assets and other liabilities were also allocated between the two sub-funds, with provision for the allocation of goodwill, intellectual property rights and shares in subsidiaries to a separate 'Shareholders' Fund', outside the long-term fund (paragraphs 15 and 16 of the Scheme).

(24) The With Profits Fund was, amongst other assets, allocated a contingent asset representing the future cashflows on business in-force at the time of demutualization ('the Right to Future Surplus'). As a result of the contingent nature of that asset, its value was not admissible for satisfying the regulatory solvency requirements; it was provided that the Non Participating Fund would make a non-interest-bearing loan to the With Profits Fund of admissible assets with repayment contingent on surplus emerging (paragraph 22A of the Scheme); the loan is repayable as the future profits on the relevant in-force business arise (paragraphs 21 and 22A of the Scheme).

(25) The With Profits Fund is a so-called '90/10' fund and the surplus must be applied for the benefit of the with-profits policyholders, save for one ninth of any surplus allocated to conventional with-profits policies (subject to certain restrictions) to which the Non Participating Fund or the Shareholders' Fund is entitled (paragraph 18 of the Scheme).

(26) In contrast, the Non Participating Fund is a '0/100' fund: amounts from it may be transferred to the Shareholders' Fund, subject to requirements to retain minimum amounts of capital to support the with-profits and without-profits business.

(27) The effect of the Scheme was to procure the transfer of the business to the Company in consideration of the Lloyds TSB group procuring the payment of the compensation to the members. The mechanics of the Scheme, to achieve that objective, can be summarized as follows.

o      Lloyds TSB Group plc and the Society entered into the transfer agreement referred to in paragraph (8) above.

o      That agreement provided that the Society's business would be transferred to two subsidiaries of the Lloyds TSB group.

o      The agreement further provided that Lloyds TSB Group plc would pay or procure the payment of the membership compensation (the amount of the same was subsequently calculated as being £5,846 million: see paragraph (37) below).

o      Consequently, Lloyds TSB Group plc had the right to procure that two of its subsidiaries would acquire the Society's business, without consideration payable by those subsidiaries other than the assumption of liabilities; but Lloyds TSB Group plc had the obligation to pay or procure payment of consideration for any such transfer of business (£5,846 million).

o      Lloyds TSB Group plc procured the issue of redeemable shares (and payment of cash) by the Parent Co. The benefit received by the Parent Co for the issue was the increase in value of its subsidiary (the Company).

o      The Lloyds TSB Group provided the funds for the redemption of the redeemable shares and loan notes and the cash required for the purchase (£5,846 million) by a contribution of capital in exchange for the issue of ordinary shares in the Parent Co.

o      The amount of the funds required for the payment of the membership compensation of £5,846 million by the Parent Co to the Society's members is included in the entry for 'Investments in Group undertakings' in the balance sheet of the Parent Co's statutory accounts.

o      The provision of the membership compensation (of £5,846 million) enabled the Company and the Subsidiary Co to acquire the Society's business.

The Capital Reserve and the Membership Compensation

(28) Paragraph 22 of the Scheme provided for the establishment of a memorandum account within the Company's 'Long Term Fund' called 'the Capital Reserve' which, it stated, would, on 3 March 2000, 'represent the amount of the shareholders' capital held within the Long Term Fund'. The Capital Reserve could only be reduced in accordance with the terms of the Scheme by bringing an amount thereof into account in the revenue account of the regulatory return (see paragraphs (45) to (54) below) of either the With Profits Fund or the Non Participating Fund (paragraph 22.3 of the Scheme). No amounts could be credited to the Capital Reserve subsequent to 3 March 2000.

(29) The initial amount of the Capital Reserve was determined by the formula in paragraph 22.2 of the Scheme and was the excess of the market value at 3 March 2000 of the assets, over that of the liabilities, which were transferred from the Society to the Company's Long Term Fund; i.e. surplus assets which built up in the Society while it was a mutual company and, if the Society had been dissolved, would have been distributable to its members (see paragraphs (5) and (15) above). Under the Scheme, the members gave up their rights to participate in this excess, were compensated by the Lloyds TSB Group for so doing, and those assets were then transferred to a new entity, viz. the Company, owned by the Lloyds TSB Group. Thus, the initial amount of the Capital Reserve is equal to the value of the excess transferred to the Company's Long Term Fund to the ultimate benefit of the Lloyds TSB group.

(30) Upon the Scheme coming into effect, this initial amount was determined to be equal to £4,455 million.

(31) The initial value of the Capital Reserve and the value of the membership compensation both ultimately derived from the market value of the Society's assets which, as at 3 March 2000, was £24,923 million.

(32) The total amount of surplus capital of the business acquired by the Lloyds TSB Group from the Society was £4,769 million (see Table A in the Appendix hereto). Of that figure £314 million was allocated to the Company's Shareholders' Fund and the Subsidiary Co, and the remaining £4,455 million (the initial value of the Capital Reserve in the Company) was allocated to the Company's Long Term Fund (see Table B in the Appendix hereto). The Capital Reserve is a memorandum account which is not shown in either the statutory accounts or in the main body of the FSA returns (it is, however, referred to in the notes to the latter).

(33) Paragraph 22.3 of the Scheme provides that no additional amounts can be credited to the Capital Reserve; that the Capital Reserve shall be reduced in the event that an amount of the Capital Reserve is brought into account in the Company's revenue account; and that the Capital Reserve may not be reduced to an amount below zero.

(34) By paragraph 22.4 and 22.5 of the Scheme, part of the Capital Reserve was allocated to the With Profits Fund and part to the Non Participating Fund.

(35) The part of it allocated to the Non Participating Fund, £2,560 million, was that part of the Society's total capital allocated to the Company (£4,455 million) that remained in the Non-Participating Fund, after the contingent loan had been made to the With Profits Fund.

(36) The part of the Capital Reserve allocated to the With Profits Fund was the balance (£1,895 million).

(37) Pursuant to the Scheme, the members' compensation was subsequently determined as £5,846 million, based on valuations as at 3 March 2000.

(38) The amount of the membership compensation may be arrived at by aggregating: the total amount of surplus capital at £4,769 million (adjusted upwards by £47 million as a result of different assumptions about future mortality); goodwill of £1,826 million; the net present value of future cashflows on the in-force business equal to £1,299 million; less £1,895 million, which was the amount of capital held in the With Profits Fund immediately after all the opening transactions, and a deduction of £200 million for loss of capital liquidity. See Table C in the Appendix hereto.

(39) The total membership compensation of £5,846 million was paid, initially, by way of cash and redeemable shares. The latter were then exchanged, within a few days, for cash or loan notes in accordance with any elections made by the relevant members.

(40) Compensation payable to UK members in respect of permanent health insurance policies was chargeable to tax as income within section 209 of the Income and Corporation Taxes Act 1988.

(41) The other compensation payable to UK members constituted chargeable gains for the purposes of capital gains tax. But for section 490(2) of the Income and Corporation Taxes Act 1988, the provisions of the Tax Acts relating to distributions would have applied to the payments of this other compensation to UK members.

Post-demutualization events

(42) In each of the relevant accounting periods, the market value of the Company's assets from the inception of the Long Term Fund had decreased. For the accounting periods ending in 2000, 2001, and 2002 the market value of admissible assets less liabilities in the Company's Long Term Fund decreased by £(1,659) million, £(1,260) million, and £(386) million, respectively (as derived from comparison of the start and end year sum of lines 13 and 51 of the Company's Form 14 and equivalent records). These decreases arose principally because of falls in the value of the stock market. In relation to the Non Participating Fund, the respective amounts were £(304) million, £(158) million and £(297) million.

(43) The Company's retained profits or losses in its statutory accounts were £(226) million, £(101) million and £15 million, for the accounting periods ending 2000, 2001 and 2002, respectively.

(44) The Company has calculated that the components of those statutory results which related to the post-demutualization events of the Non Participating Fund were respectively: £(231) million, £(211) million and £(253) million. The Company has calculated these as its commercial losses on the Non Participating Fund for these periods. None of these figures is shown in the Company's statutory accounts or FSA annual returns; however, these figures are derived, directly or indirectly, from other figures shown in each of these documents.

FSA annual returns

(45) Insurance companies are under an obligation to submit annual returns to the FSA, which regulates them. These returns demonstrate that the insurer meets the regulatory standard of solvency and show the results of a required actuarial investigation which calculates the value of the insurer's liabilities and identifies the amount of surplus in excess of those liabilities (demonstrating that there was a surplus and a sufficient surplus to cover any declared bonus).

(46) At the time of the demutualization, for the Company's accounting period ending on 31 December 2000, the main regulations were found in the Insurance Companies Act 1982, the Insurance Companies Regulations 1994 and the Insurance Companies (Accounts and Statements) Regulations 1996.

(47) For the accounting periods ending on 31 December 2001 and 2002, they were replaced with rules and guidance 'the interim Prudential Sourcebook for Insurers' made by the FSA under powers granted by the Financial Services and Markets Act 2000.

(48) Relevantly, at all times material to this reference, the Company's annual return included a series of numbered forms. In particular:

o      Form 13 sets out the admissible, market value of all of a company's assets; the aggregate figures are reconciled to the figures used in the statutory accounts.

o      Form 14 gives the amount by which the value of the admissible assets in the fund exceed the liabilities (either shown in the 'excess of the value of net admissible assets' (line 51) - which is often known as the 'investment reserve' - or within the 'balance of surplus' (Line 13)).

o      Form 40 'Revenue Account' shows revenue flows and records the fund amount which is carried forward to Form 58. For the Company, the form is completed for each of the total Long Term Fund, With Profits Fund and Non Participating Fund. The form is the revenue account for each fund in question, and consists of premiums, claims, investment return, expenses, tax, etc. To the extent that those items also appear in the statutory accounts, the Form 40 is reconcilable to those accounts.

o      Form 58 'Valuation result and distribution of surplus' determines the actuarial surplus by comparing the value of the insurer's liabilities from the policies it has issued with the fund shown on Form 40.

(49) The FSA annual returns and the Company's statutory accounts are produced from the same underlying accounting data. In drawing up the Company's annual returns the liabilities were valued and the value of the fund reported in the returns was set having regard to the regulatory admissible value of the Long Term Fund's assets, in accordance with the relevant regulations.

(50) What the company has calculated as its commercial losses of its Non Participating Fund (see paragraph (44) above) is derived from the decreases in the market value of admissible assets less liabilities in the Company's Non Participating Fund which were referred to in paragraph (42) above.

Inclusion of amounts from the Capital Reserve in line 15 of Form 40

(51) In 2000, an amount of £33,410,000 shown in the notes as 'Transfer from Capital Reserve' was included within line 15 of the Company's (With Profits Fund) Form 40 for the purpose of funding the shareholders' one ninth entitlement to the bonuses allocated to conventional with-profits policies.

(52) In 2001, an amount of £30,724,000 shown in the notes as 'Transfer from Capital Reserve' was included within line 15 of the Company's (With Profits Fund) Form 40 for the purpose of funding the shareholders' one ninth entitlement to the bonuses allocated to conventional with-profits policies; and an amount of £442,000,000 was included within line 15 of the Company's (Non Participating Fund) Form 40 and is described as 'Transfer from Capital Reserve' in the notes.

(53) In 2002, an amount of £17,000,000 shown in the notes as 'Transfer from Capital Reserve' was included within line 15 of the Company's (With Profits Fund) Form 40 for the purpose of funding the shareholders' one ninth entitlement to the bonuses allocated to conventional with-profits policies; an amount of £353,000,000 was included within line 15 of the Company's (Non Participating Fund) Form 40 and is described as 'Transfer from Capital Reserve' in the notes.

(54) The above amounts are the amounts referred to in the agreed question which is subject of this referral and their being brought into account in line 15 of the relevant Form 40 reduced the overall mount of the Capital Reserve by equivalent amounts. i.e. for the relevant accounting periods the amounts in aggregate are:

£33,410,000 for the period ending 31 December 2000;

£472,724,000 for the period ending 31 December 2001;

£370,000,000 for the period ending 31 December 2002.

(55) In each of the relevant accounting periods, by way of partial repayment of contingent loan, part of the Capital Reserve allocated to the With Profits Fund was reallocated to the Non Participating Fund: £127.6 million in the period ending 31 December 2000; £123.8 million in the period ending 31 December 2001; and £64.0 million in the period ending 31 December 2002.

Taxation of the Company

(56) At all material times during which it has carried on life assurance business, the Company has been taxed on the I minus E basis of assessment.

(57) Notwithstanding the above, the Company is a proprietary company and so the profits and loss arising from its insurance trade still need to be calculated on a Case I basis.

(58) In its tax returns and current computations for the periods ending in 2000, 2001 and 2002, the Company has included Case I tax losses equal to £(28,689,437), £(612,583,866) and £(431,261,757), respectively. For the purposes of this referral it is agreed that, if the agreed question for determination is answered in the negative (as is contended for by the Company, but which is contrary to the contention of H M Revenue and Customs), the Company would have Case I losses of these amounts.

The Appendix hereto forms part of this Agreed Statement of Facts

­Appendix

RECONCILIATION OF OPENING CAPITAL AND MEMBERSHIP COMPENSATION

Table A: Derivation of total opening capital of the Company and the Subsidiary Co	notes	£m
Total market value of assets held in the Society	A1	24,923
Actuarial liabilities allocated to the With Profits Fund of the Company	A2	(16,488)
Provisions for other liabilities of the With Profits Fund	A3	(901)
Actuarial liabilities allocated to the Subsidiary Co and the Non Participating Fund of the Company	A4	(2,765)
Total opening capital		4,769

Table B: Derivation of opening capital allocated to the Long Term Fund of the Company	notes	£m
Total opening capital	B1	4,769
Opening capital allocated to Shareholders' Fund of the Company and the Subsidiary Co	B2	(314)
Opening Capital allocated to the Long Term Fund of the Company = Opening Capital Reserve	B3	4,455

Table C: Reconciliation of opening capital to membership compensation	notes	£m
Total opening capital	C1	4,769
Difference in reserving for annuities	C2	47
Goodwill	C3	1,826
Value of in-force business	C4	1,299
Capital allocated to the With Profits Fund	C5	(1,895)
Discount for 'lock in'	C6	(200)
Total membership compensation		5,846

Explanatory Notes:

A1 The total market value of assets held in the Society was based on the final statutory accounts for that entity as at 3 March 2000.

A2 The amount needed to pay benefits on with-profits policies and on non-profit policies allocated to the With Profits Fund. This amount is the sum of times (i) to (iii) of 2(c) of the Membership Compensation statement.

A3 The amount to provide for other liabilities of the With Profits Fund must also be deducted (items (vii) and (viii) of 2(c) of the Membership Compensation Statement).

A4 The amount needed to cover liabilities for non-profit policies allocated to the Non Participating Fund or the Subsidiary Co.

B1 See the last entry in Table A, above.

B2 Assets allocated to the Company's Shareholders' Fund or to the Subsidiary Co.

B3 Represents the amount of excess assets over liabilities allocated to the Long Term Fund of the Company. This equates to the total amount of the opening Capital Reserve.

C1 See that last entry in Table A, above.

C2 The Scheme allowed for a difference in reserving for annuities between that required for determining membership compensation and that required for calculation of the opening Capital Reserve.

C3 Goodwill reflects amounts payable for other intangible assets acquired, primarily the Scottish Widows brand.

C4 The value of in-force business represents the net present value of the future cashflows expected to emerge to the benefit of the shareholder from the book of business acquired.

C5 See paragraphs (35) and (36) above.

C6 A deduction was made to reflect the fact that the capital held in the Non Participating Fund would be exposed to some risks not reflected in the calculation of the value of in-force business and would not be available for immediate distribution (paragraph 12.7 of the Scheme)."

The Finance Act 1989 (as amended)

[4] The issues between the parties turn upon the interpretation and application to the facts of section 83 (as amended) of the Finance Act 1989. That section, so far as material for the purposes of computing the profits of the Company for the accounting periods ending on 31 December in each of 2000, 2001 and 2002, was in the following terms:

"(1) The following provisions of this section have effect where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D.

(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -

(a) the company's investment income from the assets of its long term business fund, and

(b) any increase in value (whether realised or not) of those assets.

If for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period.

(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business in a case where an amount is added to the company's long term business fund as part of or in connection with -

(a) a transfer of business to the company, or

(b) a demutualisation of the company not involving a transfer of business,

that amount shall (subject to subsection (4) below) be taken into account, for the period for which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above.

(4) Subsection (3) above does not apply where, or to the extent that, the amount concerned -

(a) would fall to be taken into account as a receipt apart from this section,

(b) is taken into account under subsection (2) above otherwise than by virtue of subsection (3) above, or

(c) is specifically exempted from tax.

...

(8) In this section -

'add', in relation to an amount of a company's long term business fund, includes transfer (whether from other assets of the company or otherwise);

'demutualisation' means the conversion, under the law of any territory, of a company which has been carrying on insurance business without having a share capital into a company with a share capital, without any change of legal personality;"

Section 83A of that statute (as amended) provided:

"(1) In sections 83 to 83AB 'brought into account' means brought into account in an account which is recognised for the purposes of those sections.

(2) Subject to the following provisions of this section and to any regulations made by the Treasury, the accounts recognised for the purposes of those sections are -

(a) the revenue account prepared for the purposes of the Insurance Companies Act 1982 in respect of the whole of the Company's long term business;

(b) any separate revenue account required to be prepared under that Act in respect of a part of that business.

...".

The Financial Services and Markets Act 2000 (Consequential Amendments) (Taxes) Order 2001 made certain amendments in relation to periods of account ending on or after 1 December 2001. These included the substitution of the words "long-term insurance" for "long-term business" where that expression occurs in section 83. Section 83A(2) was also amended to read:

"Subject to the following provisions of this Act and to any regulation made by the Treasury, the accounts recognised for the purposes of those sections are -

(a) a revenue account prepared for the purposes of Chapter 9 of the Prudential Sourcebook (Insurers) in respect of the whole of the Company's long-term business;

(b) any separate revenue account required to be prepared under that Chapter in respect of a part of that business."

In paragraph (a) 'the Prudential Sourcebook (Insurers)' means the Interim Prudential Sourcebook for Insurers made by the Financial Services Authority under the Financial Services and Markets Act 2000."

The legislative history

[5] Section 83 of the Finance Act 1989 (and its immediately preceding section) have a relevant statutory history. Section 16 of the Finance Act 1923 provided:

"(1) Where the profits of an assurance company in respect of its life assurance business are for the purposes of the Income Tax Acts computed in accordance with the rules applicable to Case I of Schedule D, such part of those profits as belongs or is allocated to, or is reserved for, or expended on behalf of, policy-holders or annuitants shall be excluded in making the computation, but if any profits so excluded as being reserved for policy-holders or annuitants ceases at any time to be so reserved and are not allocated to or expended on behalf of policy-holders or annuitants, those profits shall be treated as profits of the company for the year in which they cease to be so reserved."

That section (with amendments made by section 69(5) of the Finance Act 1965) ultimately became section 433 of the Income and Corporation Taxes Act 1988.

[6] Section 83 of the Finance Act 1989 (as originally enacted and in so far as material) provided:

"(1) Where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D, then, so far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), namely -

(a) the company's investment income from the assets of its long-term business fund, and

(b) any increase in the value (whether realised or not) of those assets, shall be taken into account as receipts of the period;

and if for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period.

(2) Except in so far as regulations made by the Treasury otherwise provide, in subsection (1) above 'brought into account' means brought into account in the revenue account prepared for the purposes of the Insurance Companies Act 1982."

[7] That section was first amended by the Finance Act 1995 which, by section 51 and paragraph 16 of Schedule 8, provided that there should be substituted for section 83 the following:

"83(1) The following provisions of this section have effect where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D.

(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -

(a) the company's investment income from the assets of its long-term business fund, and

(b) any increase in value (whether realised or not) of those assets.

If for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period.

(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business any amount transferred into the company's long-term business fund from other assets of the company, or otherwise added to that fund, shall be taken into account, in the period in which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above.

This subsection does not apply where, or to the extent that, the amount concerned -

(a) would fall to be taken into account as a receipt apart from this section,

(b) is otherwise taken into account under subsection (2) above, or

(c) is specifically exempted from tax.

83A(1) In section 83 'brought into account' means brought into account in an account which is recognised for the purposes of that section.

(2) Subject to the following provisions of this section and to any regulations made by the Treasury, the accounts recognised for the purposes of that section are -

(a) a revenue account prepared for the purposes of the Insurance Companies Act 1982 in respect of the whole of the company's long-term business;

(b) any separate revenue account required to be prepared under that Act in respect of a part of that business.

...".

Section 83(3) of the 1989 Act was in turn further amended by section 163 and paragraph 4 of Schedule 31 to the Finance Act 1996. Sections 83 and 83A of the Finance Act 1989 (as amended and further amended) are in the terms earlier noted. These are the applicable provisions for the purposes of the taxation of the profits of the Company in respect of accounting periods with which the referral is concerned.

The bases of taxation of insurance companies

[8] In respect of an insurance company the Crown has an option as to the basis upon which it charges the company's profits to tax. It may do so either, on the basis of Case I of Schedule D on the company's profits or, on the basis of some other Case of that Schedule, on the difference between the company's interest on its investment and its expenditure (the "I minus E basis") (Revell v Edinburgh Life Insurance Company (1906) 5 TC 221; Finance Act 1998, section 117(1) and Schedule 18, paragraph 84(3)). The Crown ordinarily opts for the latter basis - which will usually bring in a larger sum to tax. Where, however, the company claims that it has sustained a loss or losses (included losses which may be available to group companies) its claim falls to be computed under Case I of Schedule D. The Company advances such a claim.

Regulation of insurance companies

[9] Insurance companies, including the Company, are subject to regulation under the Insurance Companies Act 1982. Section 17 requires every insurance company to which Part II of that Act applies (as it did to the Company) to prepare with respect to each financial year of the company various financial documents, including a revenue account for the year and a balance sheet at the end of the year. The contents of such documents are to be as prescribed (section 17(2)). Section 18 requires every such company which carries on long term business (as the Company did) to cause, once in every twelve months, an investigation to be made into its financial condition in respect of that business by its actuary.

[10] Section 28 of the 1982 Act provides:

"(1) Where an insurance company to which this part of this Act applies carries on ordinary long-term insurance business ... -

(a) the company shall maintain an account in respect of that business ...; and

(b) the receipts of that business ... shall be entered in the account maintained for that business and shall be carried to and form a separate insurance fund with an appropriate name.

(2) An insurance company to which this Part of this Act applies which carries on ordinary long-term insurance business ... shall maintain such accounting and other records as are necessary for identifying -

(a) the assets representing the fund ... maintained by the company under subsection (1)(b) above (but without necessarily distinguishing between the funds if more than one); and

(b) the liabilities attributable to that business ...".

[11] The accounting records of insurance companies are subject to regulation. In respect of the accounting period ended 31 December 2000 the relative regulations applicable to the Company were the Insurance Companies (Accounts and Statements) Regulations 1996 (as amended). For the two succeeding periods the relative rules and guidance were those under Chapter 9 of the Interim Prudential Guidance for Insurers (IPRU), part of the Financial Services Authority Handbook of Rules and Guidance. For present purposes these provisions can be taken to be to the same effect.

[12] Regulation 8 of the 1996 Regulations provides, with Schedule 3, for the preparation of a revenue account in tabulated form (Form 40). Separate lines are provided for the insertion of figures for different types of income (with a line for total income) and for different types of expenditure (with a line for total expenditure). The third last line ("increase (decrease) in fund in financial year (19-29)") is for the insertion of the difference between the total income and the total expenditure for the year. The penultimate line is for the insertion of the fund (if any) brought forward from the previous accounting period and the final line for the insertion of the fund carried forward, being the aggregate of (1) the difference between the total income and the total expenditure and (2) the fund brought forward, if any.

[13] A line (line 15) within the income group of lines is styled "Other income". The second instruction for completion of Form 40 directs that any item of income which cannot properly be allocated to lines 11, 12, 13 or 14 (specific types of income) shall be entered in line 15.

[14] The Regulations also provided for the preparation of what is in effect a balance sheet comprising Form 13 (assets) and Form 14 (liabilities and margins). These require to be respectively at market value and actual amounts and are the basis for monitoring the solvency of the company. However, for actuarial purposes a different (lower) value may in the company's option be attributed to the assets. The effect of using the latter is to suppress surplus reported for each year, but with the balance of the asset value being retained in what is generally referred to as an "investment reserve". The legislative authority for this option is Regulation 45(6) of the Insurance Companies Regulations 1994 which provides:

"... an insurance company may, for the purposes of an investigation to which section 18 of the [Insurance Companies] Act applies or an investigation made in pursuance of a requirement of section 42 of the Act, elect to assign to any of its assets the value given to the asset in question in the books or other records of the company."

[15] The Society in years prior to the implementation of the Scheme aftermentioned exercised that option, as a result of which as at that implementation the value of its assets was substantially in excess of its liabilities.

The Scheme

[16] The Scheme (which was approved by the Court of Session) came into effect on 3 March 2000. Paragraph 22 of the Scheme provided for the establishment of a memorandum account within the Company's long-term fund. That paragraph provided:

"22.1 On and after the Effective Date, [the Company] shall maintain a memorandum account within the Long Term Fund designated as the Capital Reserve (the Capital Reserve). At the effective date the Capital Reserve shall represent the amount of the shareholders' capital held within the Long Term Fund.

22.2 As at the Effective Date, the Capital Reserve shall be credited with an amount equal to the Total Market Value calculated as described in Schedule 6 less the aggregate of [certain values and amounts].

22.3 After the Effective Date no amounts shall be credited to the Capital Reserve and the amount of the Capital Reserve shall be reduced only in the event that an amount of the Capital Reserve is brought into account in the revenue account of:

(a) the With Profits Fund (in which case the WP Part shall be reduced by an amount equal to the amount brought into account up to [a certain maximum]; or

(b) the Non Participating Fund (in which case the NP Part shall be reduced by an amount equal to the amount brought into account)

provided that no reduction shall be made in the amount of the Capital Reserve which would cause the Capital Reserve, the WP Part or the NP Part to be less than zero."

It is accepted that "revenue account" in clause 22.3, although undefined in the Scheme, means the revenue account for regulatory purposes (viz. Form 40). Upon the Scheme coming into effect (after payment of compensation to the former members of the Society), the amount of the Capital Reserve was £4,455 million.

Events subsequent to the Scheme

[17] Following the transfer of the Society's business to the Company the environment for life assurance companies deteriorated, with significant falls on world stock markets from a peak in early 2000 to lows in early 2003. Equity asset values fell significantly. That business environment materially affected the Company. In its accounts for 2000, 2001 and 2002 significant sums were recorded as transferred from the Capital Reserve. In the With Profits accounts for 2000 that amount was £33,410,000 and in the accounts for 2001 it was £30,724,000. These sums form elements in the aggregate figures (of £16,198,532 and £163,440,000) appearing as "Other income" in line 15 of Form 40 (for that Fund) for these years. In 2001 a sum of £442,000,000 was also transferred from the Capital Reserve in the Non Participating Fund and forms an element in the aggregate figure of £572,871,000 in line 15 of Form 40 for that Fund for that year. In 2002 a transfer of £17,000,000 was made from the Capital Reserve to the With Profits Fund and £353,000,000 from the Capital Reserve to the Non Participating Fund, again being elements in the relative "Other income" aggregates (£141,024,000 and £481,862,000) in lines 15 of the relative Form 40. These last mentioned transfers from the Capital Reserve were made in the expectation of adverse tax legislation.

The issue

[18] The treatment for tax purposes of the foregoing amounts so transferred from the Capital Reserve (£33,410,000 in 2000, £472,724,000 (in aggregate) in 2001 and £370,000,000 (in aggregate) in 2002 - and reflected in the relative Forms 40) is the issue in the Referral. That issue falls to be divided into two subsidiary issues namely, (1) whether these amounts fall to be taken into account as receipts by virtue of section 83(2) of the Finance Act 1989 (as amended) and (2), if they do not, whether they fall to be taken into account as receipts by virtue of section 83(3) of that statute. The Special Commissioners answered the first of these subsidiary issues in the Company's favour but the second against it.

[19] The court was favoured with detailed submissions, both in writing and orally from the parties. What follows in this Opinion is only an outline of those submissions but hopefully the material arguments are dealt with in the discussion which follows.

Submissions for the Company

[20] Mr Johnston for the Company submitted that section 83 of the Finance Act 1989 was to be construed in the context of the general scheme of corporation tax. That tax was a charge on the profits of companies (Taxes Act 1988 section 6(1) and (4)) and was a tax on its profits (section 8(1) and section 337(1)) - compare section 343), not on the profits of the Society, which had duly paid all tax exigible from it. Income tax principles were applicable (section 9(1) and (3)). Reference was also made to section 18 (Schedule D). That tax was a unitary tax on income, the Schedules being the modes by which it fell to be measured (London County Council v Attorney General [1901] AC 26, per Lord Macnaghten at pages 34-6 and per Lord Davy at page 45). Reference was also made to Gresham Life Assurance Society v Styles [1892] AC 309. The standard under Schedule D was the same for corporation tax as for income tax and was concerned with the commercial concept of profit. In the case of a life insurance business profits and gains might be ascertainable by actuarial calculations (Scottish Union and National Insurance Co v Inland Revenue (1889) 16 R 461) but the objective was the same - to ascertain the Company's true profits and gains. Insurance business did not live in a world of its own (Southern Railway of Peru Limited v Owen [1957] AC 334, per Lord Radcliffe at page 356). Reference was also made to Sun Insurance Office v Clark [1912] AC 443, Odeon Associated Theatres v Jones [1971] 1 WLR 442 and Gallagher v Jones [1994] Ch. 107, per Sir Thomas Bingham M.R. at pages 132-3, citing with approval the observations of Pennycuik V-C in Odeon Associated Theatres v Jones at pages 453-4. The ordinary principles of commercial accountancy were applicable. The I minus E basis was that ordinarily used by the Crown to tax a life insurer's profits. Where the insurer was a mutual (as the Society had been), it was well established that Case I profits could not arise since the Society could not trade with its members (Fletcher v Income Tax Commissioners [1972] AC 414).

[21] Prior to the enactment of section 83 of the 1989 Act the gains of life insurers were only brought into charge to tax when they were realised, although in the regulatory returns both realised and unrealised gains could be brought into account to cover actuarial liabilities. An increase in actuarial liabilities might thus give rise to a taxable loss, albeit there might be an (unrealised and so disregarded) gain. This had been altered by the enactment of section 83. The ruling provision was subsection (1) which applied the section where the profits of an insurance company were computed in accordance with Case I. "Brought into account" (as defined) applied to both the lettered items. The 1989 provisions had first been amended by the Finance Act 1995 and then again by the Finance Act 1996. There had been a Revenue Press Release in relation to the 1995 changes but reliance was not placed on this; it was appropriate simply to construe the language used. It was noteworthy that section 83(3) was a provision which applied only to the ascertainment of losses.

[22] As to the construction of section 83(2), the reference to "items" pointed to the real existence of such things, not simply to a book keeping exercise. Item (a) (investment income) was something capable of real existence; in the same way item (b) should be regarded as something with a real existence. The specified items were to be taken into account as receipts "as brought into account for a period of accounting (and not otherwise)". This did not define what was to be taken into account as a receipt but the timing or manner of the bringing into account (namely, in a particular Form 40). The circumstance that amounts were included in Form 40 did not of itself mean these accounts were brought into charge to tax; the amounts must fall within (a) or (b). To fall into (b) there must be an actual increase in value. What one was looking for was an increase in the value of the assets of the Company's long term business fund, not of the fund itself. It was agreed on all hands that a capital contribution (from shareholders) would not constitute an increase in value of the assets. Accordingly, examination of Form 40 did not conclusively identify whether there was a taxable receipt or not. If that were sufficient, there would be no content in the expression "(and not otherwise)". The Revenue's approach failed to address the ascertainment of the true profits or losses of the Company. It was moreover inconsistent with principle that what was in effect a capital contribution (from the Capital Reserve) should be brought into charge for the taxation of profits under Case I.

[23] As to the construction of section 83(3), that subsection had to be read in the context of the section as a whole. Its purpose was to exclude artificial losses, not real losses. The reference in that subsection to the long term business fund was to that fund as brought out in Form 40. It was by reference to it that it was possible to generate artificial losses. The Revenue appeared to maintain that it was a reference to the whole of the assets of the fund. Where section 83(4)(a) applied, as it did here, section 83(3) had no application. The Special Commissioners' treatment of this aspect was misconceived. It was important to notice that the subsection applied only to the ascertainment of losses (not of profits). Its purpose was to restrict or exclude losses where there was a close connection between claimed losses and the addition of sums in association with the transfer of a business. It was concerned with amounts added, not with assets. It was an anti-avoidance provision concerned with the artificial generation of losses. In the construction of tax legislation the proper approach was to look at "the real world" (Barclays Finance Ltd v Mawson [2005] 1 AC 684, especially per Lord Nicholls of Birkenhead at paras 26-32). The main target, it was suggested, of section 83(3) was a situation where an acquirer of a former mutual insurance company caused the latter to pay a special compensatory bonus to its members and funded this by additions of an amount to the relative Form 40; that amount would otherwise be non-taxable (section 82) and the whole cost of the acquisition could be surrendered as a loss. Here there was no such artificial loss. The compensation paid to the Society's members was "real" money paid out by the Lloyds Group; the transfer of the business did not result in a loss; this was not a tax avoidance scheme; the diminution in assets did not result from the transfer but from subsequent investment losses; at the time of the transfer it was not envisaged that the Company would sustain losses in its early years. The subsection applied only where an amount was added to the long term fund - not where assets were added to it. The fund and the assets representing it were distinguishable (Insurance Companies Act 1982, sections 28(2) and 31(7); Insurance Companies (Accounts and Statements) (Amendment) Regulations 1997, Schedule, para 6 of Instructions for Completion of Form 14). Reference was also made to Regulation 6(5) and (8) of the Insurance Companies (Accounts and Statements) Regulations 1996. The Revenue approach, which did not distinguish between a fund and the assets representing it, involved re-writing section 83(3). That subsection, which was very specific, was an anti-avoidance regulation designed to deal with a situation where an amount was brought into Form 40 which was not matched by liabilities. The present tense was used; it was not dealing with historic losses. Section 83(3) was excluded by the operation of section 83(4)(a). The only amount which was added was one which matched the opening liability. Further the amounts added in 2000, 2001 and 2002 were not added as part of or in connection with a transfer of business to the Company. They were clearly not added as part of the transfer of the business. The expression "in connection with" was protean (Coventry Waste Ltd v Russell [1999] 1 WLR 2093, per Lord Hope of Craighead at page 2103); it was necessary to construe it in context. Here the "connection" was much too tenuous. It should not apply to real trading losses occurring subsequently. The larger amounts brought in in 2000 and 2001 reflected real losses; smaller amounts in each of the three years were concerned with the payment of bonuses; the larger sum brought in in 2002 was in connection with a proposed change in tax legislation, not contemplated in March 2000. Objectively none of these exercises were "in connection with" the transfer of the Society's business to the Company. These sums would have been brought in irrespective of whether or not a Capital Reserve had been created. In any event, no amount was "added" - a concept which involved there being something existing to which the addition could be made. An addition was to be distinguished from a creation (In re VGM Holdings Ltd [1942] 1 Ch. 235, per Lord Greene M.R. at page 241). As at March 2000 a fund was created. The Company adhered to its written submission on the inadmissibility of certain evidence - though that issue was peripheral. It also founded on its written submission for its criticism of the Special Commissioners in their approach to and conclusion on section 83(3). The Company's appeal should be allowed.

Submissions for HMRC

[24] Mr Tyre for HMRC submitted that the Company's appeal should be refused. The Special Commissioners had erred in their conclusion on section 83(2) and should be reversed on that point; only if that was wrong did a question arise on section 83(3).

[25] It was necessary to have an appreciation of the process of ascertainment of the actuarial liabilities of an insurance company; and in particular of how an increase in value of the assets of the Company's long term business fund was brought into account for a particular period of account. There were two exercises - (1) demonstrating the overall solvency of the business and (2) managing the emergence of an actuarial surplus. The first was addressed by comparing the actual liabilities with the total admissible assets. The second left room for the exercise of a discretion - for example, to allow the setting of a desired level of bonuses on With Profits policies. The exercise of this discretion was not required by any regulations but had been recognised and authorised by Regulation 45(6) of the 1994 Regulations. It also allowed for the carrying forward of an actuarial surplus with a result that the "book value" of the assets was less than their actual value; thus an "investment reserve" was created. This had been a traditional practice in the life insurance industry for more than a century and had been followed both by the Society and the Company. This was reflected in Form 40 where the increase (or decrease) in the actuarial value of the fund was brought into account as an element of "income". That increase or decrease in value did not depend on the existence of actual gains in asset value, whether realised or unrealised. Thus, for example, in the accounting period ended 31 December 2000, while the Company claimed to have sustained £231 million in investment losses, the figure in Form 40 had shown an increase in the value of the fund.

[26] The "long term business fund", which might as in the present case be subdivided into a With Profits Fund and a Non Participating Fund, consisted of a single collection of assets, albeit these assets were given different values for different purposes. There is no difference between the fund and the assets of which it was made up. There was no such thing as a "Form 40 fund". The investment reserve could be used as and when required for a range of purposes - for example, to fund distribution of a surplus, to pay bonuses, to cover losses etc. In that way increases in value of a company's assets (realised or unrealised) were brought into the revenue account. It was critical to an understanding of the relevant taxation provisions to understand the long-established practice in the insurance industry.

[27] A proprietary insurance company paid tax on its profits, as did any other corporation, but the specialties of insurance companies should not be ignored. The rules for ascertaining profit, which had a common law origin (Scottish Union and National Insurance Company v Inland Revenue), were plainly different from those applicable to other styles of business. Likewise, the I minus E method was peculiar to the insurance business. The Taxes Act and associated fiscal legislation made special provision for the taxation of insurance companies. It was unsafe to think in terms of ordinary principles of commercial accountancy; here there were specialties. The concept of an investment reserve had been recognised by section 16 of the Finance Act 1923 (later section 433 of the Taxes Act 1988) whereby profits represented by such a reserve were not brought into charge to tax until the time they ceased to be reserved; only at that point were they, except in so far as allocated to or expended on behalf of policyholders or annuitants, treated as taxable profits. The amendment made by section 83 of the Finance Act 1989 (as originally enacted) had been designed to meet the incongruity resulting from the disregard of unrealised gains (or losses). What were now to be taxed were (1) investment income and (2) the increase in value (whether realised or not) of the assets of the long term business fund, all as brought into account in the relative Form 40. That provision had to be read and understood against the background of the traditional practice of the industry earlier described. The bringing into account actuarially of any increase in value - whether or not there was any actual increase - was the measure of tax liability.

[28] There was no satisfactory way of ascertaining "real" increases in value. There was no evidence of anyone ever having attempted such an exercise. The working assumption was that what was brought into account represented actual gains made in earlier years - though that assumption might not always be valid. The Company's motivation in bringing increased value into account was irrelevant to the operation of section 83(2). As to the Capital Reserve, there had been no actual transfer of monies, only a book entry by which the Capital Reserve had been reduced to some extent. That reserve did not represent an injection of capital by the purchaser of the Society's business (Lloyds Group plc). Lloyds had ingested capital but this was not it. The Company had acquired an existing business with an excess of assets over liabilities. It was attempting to extract that excess without paying tax upon it. Although it might be described as "capital", this was not determinative of its proper treatment for tax purposes. It was irrelevant that in the corresponding accounting periods there had been trading losses. The purpose of the creation of the Capital Reserve was not to provide against losses; the intention was to provide a means of bringing that reserve out to shareholders without it being treated as a Case I receipt. In any event, the Company's purpose was not in all cases to deal with losses: £100,000 million transferred in 2002 had been in anticipation of a change in legislation. It was also irrelevant that the Capital Reserve had been a transfer from the Society. It was acknowledged that tax fell to be charged on its (i.e. the Company's) profits but it had been the Company which had brought the increase in value into account.

[29] There was no artificiality about HMRC's approach to section 83(2): it merely provided for the charge to tax on the emergence in the regulatory return of a surplus. The Company's error was to treat "increase in value" as if it was the equivalent of gains. Its reliance on paragraph 1A(3)(a) of Schedule 8A to the Finance Act 1989 (treatment of overseas life insurance companies) was misconceived. Special treatment was needed for such companies and the language reflected that. It did not assist the construction of section 83(2). The Special Commissioners' conclusion on section 83(2) was vitiated by a number of errors - some based on the calculations they had endeavoured to make, some being errors of law. The latter had prejudged the issue by describing the transferred fund as "[in] tax terms it seems to us the equivalent to a capital payment"; in truth, it was merely a memorandum account representing the amount of the excess transferred.

[30] As to section 83(3), this only arose if HMRC was wrong on section 83(2); if it was right, section 83(3) was disapplied by section 83(4)(b). Section 83(3) was satisfied: an amount was added to the long term business fund on 3 March 2000 and that amount had been added in connection with the transfer of the Society's business to the Company. In so far as that amount was brought into account in Form 40 it was to be taken into account as a receipt for the relative accounting period. The "long term business fund" had the same meaning in section 83(3) as in 83(2). The initial amendment to section 83 made by the Finance Act 1995 had produced a wide-ranging disallowance for the purpose of ascertaining losses. This had led to an outcry and the scope of the provision had been restricted by the Finance Act 1996. HMRC did not dispute that a target of the legislation was the situation where a business had been acquired and then a distribution made; but that was not the full extent of the target area. The question for the court was whether the circumstances realistically fell within the subsection; they clearly did. "Amount" was a broad concept - it could include cash or other assets. "Add" included "transfer" (section 83(7)). The transfer which resulted in the Capital Reserve was clearly made in connection with the transfer of the business. A broad meaning was to be given to the expression "in connection with" (Bank of Scotland v Dunedin Property Investment Co Limited 1998 SC 657, per Lord President Rodger at pages 662-3). "Long term business fund" was not defined in the Taxes Act 1998 nor in the Finance Act 1989. What was now (since the Finance Act 1990) statutorily defined as its meaning, namely "the fund maintained by an insurance company in respect of its long term business" could be understood as having been in the mind of the draftsman in 1988 and 1989. If the addition to the long term business fund was not on the establishment of the Capital Reserve in March 2000, then there were relevant additions when the amounts were subsequently recorded in the respective Forms 40. On that hypothesis the additions were likewise made in connection with the transfer of the business. On either view it was immaterial that there was no pre-existing fund. The Scheme sanctioned by the court envisaged all the material steps being taken on the Effective Date. As to the Special Commissioners' reasoning on section 83(3), the Revenue broadly accepted their analysis in paragraph 83 of their decision, with the exception of the penultimate sentence of that paragraph.

[31] As to the admissibility of the challenged evidence of Mr Thomas and Mr Peel, HMRC maintained that their evidence was admissible - but nothing in particular turned on this issue.

Response by the Company

[32] In his response Mr Johnston identified three questions to be resolved in relation to section 83(2): (1) what fell within it, (2) what profits the Company had made and (3) how were its taxable profits to be computed. The object of the section (the computation of profits for the purposes of Case I) was spelt out by subsection (1). Subsection (2) specified two items: (a) investment income from the assets of the Company's long term business fund and (b) any increase in the value of these assets. Both were concerned with assets. That meant actual income and actual increase in value since only then would there be contribution to the computation of profits in the real world. The expression "realised or not" presupposed a real existence. It was necessary to scrutinise the entries for income in Form 40 to ascertain whether they constituted (a) or (b). It was not every item of income which was taxable, for example, a repayment of overpaid tax. The provisions in respect of overseas insurance companies were relevant; they were seeking to achieve the same result for these companies as for UK companies. There there were clear references to actual increases in value. The purpose of the references to the regulatory returns was to determine when the actual increases were to be brought into account. They did not have a definitional function. The mere fact that something was brought into account for regulatory purposes did not make it a taxable receipt as it could only be such if it was an item within the meaning of (a) or (b) in section 83(2). Mr Tyre's submission did not square with HMRC's acknowledgement that a capital contribution, albeit brought into account, did not qualify as a receipt for the purposes of section 83(2). On HMRC's construction the phrase "(and not otherwise)" was redundant; if bringing into account was definitional of taxable profits, the phrase had no content. Items (a) and (b) were clearly independent of the regulatory returns. On HMRC's approach the words "realised or unrealised" were equally redundant. There was no evidence to suggest that the figures entered in line 13 of Form 40 involved any revaluation; rather it was a balancing exercise derived from the actuarial process. If the "increase in value" was simply a notional increase, the legislation would have made that clear. Taxes were imposed by Parliament and liability should be clearly defined (Vestey v Inland Revenue Commissioners [1980] AC 1148, per Lord Wilberforce at page 1172D). If HMRC's construction was correct, it meant that there had been a radical departure in 1989 from the prior regime, involving for the first time the use of notional values; there was nothing to support the view that Parliament had intended to take such a step. Inland Revenue Commissioners v Falkirk Ice Rink Limited (1975) 51 TC 42 (referred to in HMRC's written submission) did not assist. On the other hand the Special Commissioners' findings that the Capital Reserve was capital in nature was a finding of fact which should not lightly be disturbed. On any view it was an inference from primary facts. Reference was made to Furniss v Dawson [1984] 1 AC 474, per Lord Brightman at pages 527-8. One would not expect a company to be taxed under this provision on its initial capital, either when it was put in or when it was later used. Neither the initial transfer nor the subsequent transfers were within section 83(2); they did not increase the value of the fund but were the using up of capital put into the business.

[33] In the absence of a statutory provision to the contrary, the Company could not be taxed on the income or gains of another person, whether the Society or anyone else. There was no basis in fact for any contention that there were any untaxed gains of the Society. The figure for the initial Capital Reserve might be simply the excess of premiums over payments. What was brought into account in Form 40 was not an increase in the value of the Company's assets.

[34] The objective of all tax computations was to identify the profits of the taxpayer. Actuarial surpluses were not a measure of profit. The Form 40 entries might include a figure for "income" which was not profit, as when a capital contribution was made; likewise the bringing into account of a figure from the Capital Reserve. Adjustments were commonly made in computations in order to bring out the true figure for profit. The way Form 40 was drawn and how it was completed might well owe much to longstanding practice; but that did not mean that a charge to tax arose. Whether there had or had not been an actual increase in value of the assets depended on the facts. On the evidence here (the onus being on the taxpayer) it had been demonstrated that in each of the periods in question there had been no increase in value - rather a diminution. There was no practical problem about identifying whether there had been an increase in value of the assets in any period. The Company was a sophisticated taxpayer with computerised records of its transactions. This included records of its capital gains. There had been no evidence before the Commissioners to suggest that the Company's approach gave rise to formidable practical difficulties. What was brought into account were gains which had been realised and unrealised gains on assets still held. The examples put up in Appendix I to HMRC's written argument were unhelpful.

[35] As to section 83(3), both subsection (2) and subsection (3) referred to the long term business fund but in (2) one was concerned with income and any increase in value of the assets while in (3) one was concerned with an amount. It was not the Company's position that there were two funds. On the construction of subsection (3) HMRC's argument failed to explain why the subsection was concerned only with losses (and not with profits); the restriction pointed to a statutory intention to disallow artificial losses. The purpose of the subsection cannot have been to treat the successor of the business as if it was the predecessor (cf. Taxes Act, section 444A). "Ascertaining" was directed at the situation where there had been an actual loss. There was no question here of an artificial loss being created. The amount added on 3 March 2000 matched the liabilities; there was no profit or loss. There was no proper connection between the transfer of the business and the inclusion in Form 40 of figures from the Capital Reserve. There was no existing fund at 3 March 2000 to which any amount could be added.

Further response by HMRC

[36] Mr Tyre in his further response submitted that, while non-taxable receipts might enter Form 40, it did not follow that a sum which was entered under "income" was not taxable. There was no question of taxation by subordinate legislation or by forms; the taxing provision was section 83(2). The whole transfer of value was added to the long term business fund on 3 March 2000, albeit part of that value was balanced by liabilities. It was the Company which had brought the value into account; it was its receipt and so chargeable to tax in its hands. There remained a real problem on the Company's argument of tracking the gains which were to be taxed. The Company's approach would cause consternation in the industry.

[37] As to section 83(3), the explanation for it applying only to losses was that profits of life insurers were, at least usually, computed on the I minus E basis. The Company put an excessive weight on "ascertaining". While 83(3) had an anti-avoidance element, it did not follow that it was directed only at "artificial" losses.

Submissions at the resumed hearing

[38] After the court had made avizandum certain further materials came to its attention. It sought parties' observations on these matters which were as follows:

"(1) The consultation paper "The Taxation of Life Assurance" (1988) as part of the background to the relevant provisions of the Finance Act 1989;

(2) As regards section 83(3) of the Finance Act 1989 (as amended), the Ministerial statement made by the Financial Secretary to the Treasury (Mr Michael Jack) at the Report stage of the Finance Bill 1996 (HC 274 col.1080-1);

(3) The press release of 1995 (referred to by Mr Johnston in argument but not relied on by him);

(4) The proper legal approach to items (2) and (3);

(5) The significance (if any) of the provisions in para 22.1 of the Scheme approved by the court that the appellants were to maintain the memorandum account "within the Long Term Fund" and that "[At] the Effective Date the Capital Reserve shall represent the amount of the shareholders' capital held within the Long Term Fund."; and of the provision in para 22.2 that the Capital Reserve was to be credited "with an amount equal to ...".

The case was put out for further argument in the course of which the following submissions were made.

[39] Mr Johnston observed that the 1988 consultation paper had examined a number of approaches for reform of the taxation of life assurance business. The more radical reforms there discussed had not in the event been adopted, the less radical had. Paragraph 43 (in the chapter concerned with the objective of a tax regime for life assurance) had identified as an objective parity of treatment between life offices and other financial institutions. In paragraph 10.31 (in discussing the approach to capital gains) what was envisaged was the taxation of real gains in value, rather than notional gains. The glossary to the consultation paper had also made clear that in the life assurance business "fund" could have one of two meanings, namely, "an accounting concept expressing the balance of a life company's 'liabilities' ..." or "(sometimes) the assets representing the fund". However, a prior departmental consultation paper, while relevant for the purposes of construction of legislation, would rarely point conclusively to a particular interpretation (Craies on Legislation (9^th ed.) para 27.1.11).

[40] As to the use of the other materials referred to by the court (and certain further material produced by parties), the following propositions were vouched by authority: (1) to identify the "mischief" at which a statutory provision was directed it was legitimate to have regard to, among other materials, Law Commission reports, White Papers, official press releases by Government or a department of it, (2) for the same purpose regard could be had to explanatory notes, headings and side notes, (3) official statements made by a government department in the context of the administration of an Act might be persuasive as to its meaning (R v Montila [2004] 1 WLR 3141; Grays Timber Products Ltd v HMRC [2010] UKSC 4; Bennion on Statutory Interpretation (5^th ed.) page 702), (4) where legislation was obscure or ambiguous or its literal meaning lead to an absurdity it was legitimate to have regard to Ministerial statements (Pepper v Hart [1993] AC 593), (5) a clear Ministerial statement was as much relevant background as a White Paper etc. (Wilson v First County Trust [2004] 1 AC 816) and (6) the purpose of using Hansard as an aid to construction was to identify the mischief, not to treat the expressed intentions of Ministers as reflecting the will of Parliament (Lord Steyn, extra-judicially, in "Pepper v Hart: a re-examination" (2001) 21 OJLS 59). In addition to the above authorities reference was made to R v Environment Secretary, Ex p Spath Holme Ltd [2001] 2 AC 349 and McDonnell v Christian Brothers Trustees [2004] 1 AC 1101.

[41] The Company adhered to its contention that the purpose of section 83(3) could be identified without the need to look at Hansard; but if the court was not satisfied that that was so, it would be legitimate to consider parliamentary material on the basis that the statutory provision was obscure. The threshold identified in Pepper v Hart for referring to parliamentary material did not apply to extra-parliamentary material. Reference was made to an unpublished draft press release of February 1995 (recovered under Freedom of Information procedures) and an unpublished memo by an official of HMRC commenting on that draft, together with the (amended and) published press release published in March 1995 - all with reference to the Finance Bill 1995. The draft press release had referred to "artificial losses". The published version did not include that expression but its terms suggested that it was designed to deal with a situation where there was a "mismatch"; (the relevant terms of this press release are narrated at para [66] below). Reference was also made to a press release issued in March 1996 with reference to the Finance Bill 1996; (again the relevant terms are narrated below at para [67]). Additionally, Mr Johnston referred to an observation made by the Financial Secretary to the Treasury about the 1995 Act when the Standing Committee was considering the 1996 Bill (see para [69]). Finally, reference was made to a board of Inland Revenue speaking note (again recovered under Freedom of Information procedures) prepared for the use of the relevant Minister. In that (at paragraph 46) an illustration had been given of the kind of mismatching which, Mr Johnston contended, was the target of the legislation. The present circumstances were very different. (So far as appears, this speaking note was not used in the parliamentary debates.) When all this material was looked at a clear picture emerged as to the mischief to which section 83(3) of the 1989 Act (as ultimately amended) was directed: the target was not genuine losses which arose in the ordinary course of business but artificial losses where there was a mismatch. Created, not commercial, losses were to be disallowed. As to paragraph 22 of the Scheme approved by the court, the use of the expression "within the Long Term Fund" was used to distinguish that destination from destinations of amounts directed to shareholders and to the subsidiary company. Reference was made to paragraph 33-4 of the Agreed Facts (as read with Appendix Table A). The Capital Reserve was a memorandum account, an accounting figure only. It was not the same as the Form 40 fund, which did not necessarily reflect the totality of a company's long term fund. It had no particular significance for the purposes of the application of section 83(3).

[42] Mr Tyre agreed that the Capital Reserve was simply a number. The purpose of paragraph 22 was to identify the amount of the excess value as at the date of demutualization, so that the future application of that amount could be tracked. The amount destined for the Company's long term fund had been so destined because it had come from the Society's long term fund. The ultimate objective of the framers of the Scheme was that the Capital Reserve could be channelled to the shareholders via the Form 40 revenue account without a charge to tax. He did not, for the purposes of the application of section 83(3), attach much importance to the expression "within the Long Term Fund" or the word "amount" in paragraph 22.

[43] As to the 1988 consultation paper, there was little of assistance in it in interpreting the statutory provisions in issue. It was clear that the more radical solutions discussed in the paper had not been adopted. What had been done in the 1989 Act was designed to remove anomalies and to align the tax calculation more closely with accounting and regulatory practices (Inland Revenue press release, 14 March 1989). Paragraph 10.32 of the consultation paper had flagged up the practical difficulties upon which HMRC relied for its interpretation of section 83(2).

[44] As to the approach to statutory interpretation, Mr Tyre took no issue with Mr Johnston's propositions (1) - (5). He placed particular emphasis on what Lord Nicholls of Birkenhead had said in Spath Holme. There was, however, no "freestanding" way in which Hansard material could be used to identify a mischief. Hansard could only be used if the preconditions identified in Pepper v Hart were satisfied. These preconditions were not satisfied here; accordingly Pepper v Hart was not engaged. If it was, the parliamentary material tended to support HMRC's construction. No weight could be attached to the unpublished materials. It was clear that the statutory provisions were not restricted to "artificial" losses or to "mismatching". The 1996 relaxation had focused on the transfer of businesses. The press release of that year had made no reference to artificial losses. It did not assist Mr Johnston's argument; nor did the parliamentary material. Section 83(3) should be read according to its terms. If the court was against him on the construction of section 83(2), then the present situation was in effect a "mismatching" and was caught by section 83(3).

Discussion - the approach to construction

[45] In Tennant v Smith (Inland Revenue) (1892) 19 R (HL) 1 Lord Halsbury LC said at page 3:

"... in a taxing Act it is impossible, I believe, to assume any intention, any governing purpose in the Act, to do more than take such tax as the statute imposes. In various cases the principle of construction of a taxing Act has been referred to in various forms, but I believe they may be all reduced to this, that in as much as you have no right to assume that there is any governing object which a taxing Act is intending to attain other than that which it has expressed by making such and such objects the intended subject of taxation, you must see whether a tax is expressly imposed.

Cases, therefore, under the Taxing Acts always resolve themselves into a question whether or not the words of the Act have reached the alleged subject of taxation. Lord Wensleydale said, in In re Micklethwait [1855, 11 Exch. (Hurlston and Gordon) 452 at page 456], 'it is a well-established rule that the subject is not to be taxed without clear words for that purpose, and also that every Act of Parliament must be read according to the natural construction of its words'."

[46] These observations have now to be read subject to the modern doctrine that taxing statutes have to be construed purposively. In Ramsay (WT) Ltd v Inland Revenue [1982] AC 300 Lord Wilberforce at page 323 identified five familiar principles. The first of these was:

"A subject is only to be taxed upon clear words, not upon 'intendment' or upon the 'equity' of an Act. Any taxing Act of Parliament is to be construed in accordance with this principle. What are 'clear words' is to be ascertained upon normal principles; these do not confine the courts to literal interpretation. There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded ...".

In IRC v McGuckian [1997] 1 WLR 991 at 999 Lord Steyn said:

"During the last 30 years there has been a shift away from literalist to purposive methods of construction. Where there is no obvious meaning of a statutory provision the modern emphasis is on a contextual approach designed to identify the purpose of a statute and to give effect to it. But under the influence of the narrow Duke of Westminster doctrine [1936] AC 1, 19 tax law remained remarkably resistant to the new non-formalist methods of interpretation. It was said that the taxpayer was entitled to stand on a literal construction of the words used regardless of the purpose of the statute ... Tax law was by and large left behind as some island of literal interpretation. ...

... the intellectual breakthrough came in 1981 in the Ramsay case, and notably in Lord Wilberforce's seminal speech which carried the agreement of Lord Russell of Killowen, Lord Roskill and Lord Bridge of Harwich. Lord Wilberforce restated the principle of statutory construction that a subject is only to be taxed upon clear words ... To the question 'What are clear words?' he gave the answer that the court is not confined to a literal interpretation. He added 'There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded'. This sentence was critical. It marked the rejection by the House of pure literalism in the interpretation of tax statutes."

[47] Most recently these observations were approved and followed by Lord Nicholls of Birkenhead, giving the opinion of the Appellate Committee in Barclays Mercantile v Mawson [2005] STC 1 at page 11.

[48] If a purposive approach is to be adopted, it is necessary to identify the relative purpose. That will ordinarily be done by analysis of the statutory context - the statute as a whole or the particular part of it within which the provision in question is to be found. The legislative ancestry of the provision may assist. In some circumstances it may be legitimate to consider extrastatutory material.

[49] In the present case the provision in question is section 83 of the Finance Act 1989 (as ultimately amended by the Finance Act 1996). It will also be necessary to consider that section as first enacted and as later amended by the Finance Act 1995. At the resumed hearing certain extrastatutory material was placed before us. None of it, bar possibly the 1989 consultation document, had any bearing on section 83(2). While that document is of interest in setting out the issues for discussion in the context of reform of the law of taxation of life assurance companies, it has not assisted me in construing the relevant provisions as enacted. I shall discuss the other material in addressing the construction of section 83(3).

Section 83(2)

[50] As earlier explained, the profits of a proprietary life assurance company may be computed on one of two bases - under Case I of Schedule D or on I minus E. Where it is maintained that in any period of account the company has sustained a loss - which it may wish to set against future profits or to make available to a group company - the computation requires to be made under Case I. For many years special provision was made in relation to such a computation. Section 16 of the Finance Act 1923 provided that "such part of [its computable] profits as belonged to or is allocated to, or is reserved for, or expended on behalf of, policy holders or annuitants shall be excluded in making the computation". That provision was in substance carried through to section 433 of the Income and Corporation Taxes Act 1988. An effect of that provision was that unrealised increases in value of assets held in a long term business fund of an insurance company were often not brought into account as they arose.

[51] It seems plain that a purpose of section 83 of the Finance Act 1989 (as originally enacted) was to reverse that position. Subsection (1) provided that there shall be taken into account as a receipt of the period "any increase in value (whether realised or not)" of the assets of the long term business fund. Any reduction in value of those assets was to be taken into account as an expense of the period. Section 433 of the 1988 Act was repealed (Finance Act 1989, Schedule 17, Part IV).

[52] The subsection also provided the mode by which any such increase or decrease (as well as the company's investment account from these assets) was to be taken into account. The relevant item was to be taken into account "as brought into account" for a period of account (but not otherwise), the expression "as brought into account" being defined by subsection (2) as, subject to Treasury regulation, "brought into account in the revenue account prepared for the purposes of the Insurance Companies Act 1982".

[53] Mr Tyre emphasised that the proper approach to be taken to section 83 required regard to be had to the long-established practices of the insurance industry. These included the practice of using investment reserves which had been built up over previous years for various purposes - for example, to fund distribution of a surplus, to pay bonuses, to cover losses etc. To do this, reserves were brought into the revenue account as "Other income" and distributed through it. That account showed the increase (or decrease) in the long-term business fund in the financial year (the balance of total income as against total expenditure) together with the fund, if any, brought forward and the fund carried forward. Any amount from reserves so brought into account in the revenue account (and thus enhancing the fund in the relative financial year) was to be taken into account as a receipt of the period.

[54] I am prepared to accept that the long-established practice of life insurance companies, including the nature of the regulatory accounting arrangements to which they are subject (none of which was disputed before us), is a relevant context in which to construe the statute. But I am unable to accept that the contents of the revenue account have, for the purposes of the section, the definitional character which Mr Tyre's submission imports. The section requires that "the following items" be taken into account as receipts of the period. These are (1) the company's investment income from the assets of its long term business fund and (2) any increase in value (whether realised or not) of the assets of that fund. The first of these items is inevitably an actual receipt. That suggests that the second should also be an actual, as distinct from an accounting, element. That tends to be confirmed by the parenthesis "(whether realised or not)" which would be unnecessary if the increase in value were to be defined by what was entered in the revenue account. Rather, I prefer on this aspect Mr Johnston's submission that the phrase "as brought into account for a period of account" is a timing provision, identifying when the items (which on this view have an independent character) fall to be taken into account as receipts. The timing provision also applies where there has been a reduction in the value of the assets. The phrase "(and not otherwise)" again points to when the items fall to be brought into account. This construction may also be more consistent with the opening words of section 83(1) (as originally enacted), namely, "Where the profits of an insurance company ... are ... computed" which suggests that actual profits (income or capital) are intended.

[55] This construction appears to me to be consistent with what I perceive to be the purpose of the enactment, namely, to reverse the rule encapsulated in section 433 of the 1988 Act by making unrealised as well as realised increases in capital value taxable. The use of the revenue account was, as I see it, a useful mechanism for identifying when the tax would be exigible. This limited purpose is, in my view, far more likely than the more radical change advocated by Mr Tyre.

[56] I am mindful of the principle (re-stated by Lord Wilberforce in Ramsay Ltd (WT) v IRC at page 623) that "a subject is only to be taxed on clear words". Section 83(1) (as originally enacted) does not, in my view, clearly provide that a company is to be taxed under that provision on all sums brought into account in the revenue account whether or not these sums represent actual increases in value.

[57] Paragraph 16 of Schedule 8 to the Finance Act 1995 substituted new provisions for section 83(1) and (2) of the 1989 Act. The substituted sections 83(1) and (2) (as read with the definition of "brought into account") are in substance in the same terms. The same interpretation is, in my view, to be given to them. The provisions in respect of overseas companies (first introduced by paragraph 49 of Schedule 8 to the Finance Act 1995) - where the assets to be brought into account are "real" assets - tends, if anything, to confirm this interpretation.

[58] Mr Tyre suggested that there was no satisfactory way of ascertaining "real" increases in value and thus in operating the provisions if Mr Johnston's submission was to be accepted. It would "cause consternation in the industry", he said. No such practical difficulties were explored before the Special Commissioners and accordingly they made no findings in relation to them. In the absence of relative findings I am not prepared to assume that the interpretation which I prefer would be unworkable. Where for regulatory purposes the assets of a long term business fund require to be valued annually on an admissible value (that is, on a market value, subject to certain restrictions, basis) I see no difficulty in principle in determining whether there has as at the end of any period of account been an increase, or a decrease, in the value of these assets - at least when taken as a composite whole. Paragraph 10.32 of the 1989 consultation document appears to me to be concerned with a quite different practical difficulty.

[59] For the foregoing reasons I am satisfied that the Special Commissioners were correct in rejecting HMRC's contention as regards section 83(2) (which in 1996 remained unchanged from the version substituted by the 1995 Act) and that its cross-appeal accordingly falls to be refused.

Section 83(3)

[60] Section 83(3) is more troublesome, not least because it is more difficult to identify its purpose with confidence. What is clear is that it is designed to exclude or reduce the availability of losses which would otherwise be available to the taxpayer's advantage. It does so by prescribing that, where "an amount is added" to the company's long term business fund in certain circumstances, that amount is to be taken into account (for the period for which it is brought into account) as an increase in value of the assets of that fund under subsection (2)(b). This prescription applies only in "ascertaining" whether or to what extent a company has incurred a loss; it does not apply to reduce a profit. Beyond that, the purpose is not self-evident from the terms of the subsection or of its statutory context. In these circumstances it is legitimate to enquire as to what assistance, if any, can be derived from other sources.

[61] It has long been legitimate to make use of certain types of extrastatutory material as an aid to the construction of enactments. At one stage that was to identify the mischief which the legislation was designed to cure. But, in a world where a purposive approach to the interpretation of legislation is the norm, external aids may have a wider function. In R v Environmental Secretary, Ex p Spath Holme Ltd Lord Nicholls said at pages 397-8:

"Nowadays the courts look at external aids for more than merely identifying the mischief the statute is intended to cure. In adopting a purposive approach to the interpretation of statutory language, courts seek to identify and give effect to the purpose of the legislation. To the extent that extraneous material assists in identifying the purpose of the legislation, it is a useful tool.

This is subject to an important caveat. External aids differ significantly from internal aids. Unlike internal aids, external aids are not found within the statute in which Parliament had expressed its intention in the words in question. This difference is of constitutional importance. Citizens, with the assistance of their advisers, are intended to be able to understand parliamentary enactments, so that they can regulate their conduct accordingly. They should be able to rely upon what they read in an Act of Parliament. This gives rise to a tension between the need for legal certainty, which is one of the fundamental elements of the rule of law, and the need to give effect to the intention of Parliament, from whatever source that (objectively assessed) intention can be gleaned. Lord Diplock drew attention to the importance of this aspect of the rule of law in Fothergill v Monarch Airlines Ltd [1981] AC 251, 279-280:

'The source to which Parliament must have intended the citizen to refer is the language of the Act itself. These are the words which Parliament has itself approved as accurately expressing its intentions. If the meaning of those words is clear and unambiguous and does not lead to a result that is manifestly absurd or unreasonable, it would be a confidence trick by Parliament and destructive of all legal certainty if the private citizen could not rely upon that meaning but was required to search through all that happened before and in the course of the legislative process in order to see whether there was anything to be found from which it could be inferred that Parliament's real intention had not been accurately expressed by the actual words that Parliament had adopted to communicate it to those affected by the legislation.'

This constitutional consideration does not mean that when deciding whether statutory language is clear and unambiguous and not productive of absurdity, the courts are confined to looking solely at the language in question in its context within the statute. That would impose on the courts much too restrictive an approach. No legislation is enacted in a vacuum. Regard may also be had to extraneous material, such as the setting in which the legislation was enacted. This is a matter of everyday occurrence.

That said, courts should nevertheless approach the use of external aids with circumspection. Judges frequently turn to external aids for confirmation of views reached without their assistance. That is unobjectionable. But the constitutional implications point to a need for courts to be slow to permit external aids to displace meanings, which are otherwise clear and unambiguous, and not productive of absurdity. Sometimes external aids may properly operate in this way. In other cases, the requirements of legal certainty might be undermined to an unacceptable extent if the court were to adopt, as the intention to be imputed to Parliament in using the words in question, the meaning suggested by an external aid. Thus, when interpreting statutory language courts have to strike a balance between conflicting considerations."

[62] Earlier at page 397 Lord Nicholls had distinguished between internal and external aids, the latter including "reports of Royal Commissions and advisory committees, reports of the Law Commission (with or without a draft Bill attached), and a statute's legislative antecedents."

[63] The illustrated extraneous material comprises in each case a public document which provides a background setting. It would, in my view, be contrary to principle to take into account unpublished documents such as the draft press release and the Departmental comment on it. This is not only because the press release subsequently published was in different terms but because these documents are not a source from which the intention of Parliament (objectively assessed) can be gleaned. Their use moreover offends against the constitutional principle that the citizen, with the assistance of his advisers, should be able to understand parliamentary enactments. For the same constitutional reason a speaking note prepared by civil servants for the use by a Minister in Parliament but not in the event so used cannot, in my view, be a legitimate aid to the construction of legislation.

[64] A statute's legislative antecedents are a legitimate aid - though, if the interpretation of the antecedent is itself problematic, the assistance given may be limited.

[65] A version of section 83(3) first appeared in section 83 as substituted by paragraph 16 of Schedule 8 to the Finance Act 1995. The critical words were "... any amount transferred into the company's long term business fund from other assets of the company, or otherwise added to that fund, shall be taken into account ...". That was clearly a wide-ranging provision. It referred to "any amount" (a broad expression capable of encompassing "capital" as readily as "income") transferred into the fund "from other assets of the company or otherwise added to the fund" (that is, in effect from any source). If this version of section 83(3) had been in operation as regards the Company's periods of account ending on 31 December in each of the years 2000, 2001 and 2002, it is difficult to see how it could successfully have resisted the amounts in question being brought into account as receipts. Mr Johnston accepted in argument that, if regard was had only to the words used, that must be so. There was, we were informed, an outcry in the industry when this provision was enacted and it was altered in the following Finance Act.

[66] Mr Johnston submitted, however, that there were legitimate aids to the construction of the 1995 Act and, if these were used, the provision was to a different effect. The first aid was the press release published in March 1995. Paragraph 4 of that release was in the following terms:

"There will be a new rule to prevent tax relief being given for a loss when additional assets are introduced into an insurance company's long term business fund to match an increase in the company's liabilities to its policyholders. At present, no account is taken of these funds introduced but the increase in the liabilities to policy holders is relievable for tax. In future additions of capital to the long term business fund will be treated as receipts to be brought into account in determining a loss from the life assurance business ...".

He founded on the expression "to match an increase in the company's liabilities to its policyholders" and submitted that this pointed to a provision designed to counter a "mismatch" (an "artificial loss"). But I am unable to read the words in the release in that way. These words read as a whole, in my view, point to the aim of disallowing losses where capital is introduced, as it was here, to balance liabilities to policyholders in circumstances where the increase in the liabilities to policyholders was relievable for tax. If the effect of the 1995 legislation was to disallow only "artificial" losses, it is difficult to see why there was such an outcry in the industry.

[67] Two other items were founded on in relation to the interpretation of the 1995 Act. Both were retrospective. The first was a press release issued on 26 March 1996 in the context of the amendments proposed to the 1996 Bill. It is headed "Life assurance business losses" and, in so far as material, reads:

"The Chancellor of the Exchequer, the Right Hon Kenneth Clark, Q.C., M.P., has tabled a new clause and Schedule for inclusion in the Finance Bill ... They make a number of changes to the treatment of losses incurred by life insurance companies, modifying and extending measures introduced in the 1995 Finance Act.

The changes will prevent an anti-avoidance rule from operating in a way which might inhibit new companies from starting up life insurance operations, but will strengthen the rule in the situations where it is intended to operate. ... They come into effect generally for a period of account beginning on or after 1 January 1996.

DETAILS

1. FA 1995 contained a rule that reduced or extinguished a loss incurred by a life insurance company where there was in the same period an injection of cash or other assets into the long term business fund of the company. There had been a number of cases prompting this change where wholly artificial losses had been created, which were funded by such cash injections, usually as part of or in consequence of a transfer of business.

2. It has become clear that this rule has had the effect of inhibiting to some extent the creation and development of new life insurance operations. These often show losses for genuine reasons in the first years of operation. These may be funded by capital injections from a parent company. ...

3. The Government has accepted that the 1995 Rule should be limited to cases where the transfer of funds arises in consequence of or as part of a transfer of business, including a transfer by way of re-insurance, or a demutualization ...".

[68] There are conceptual difficulties about praying in aid post enactment history - although Bennion (page 702) gives some limited support to this in the context of contemporanea expositio, which hardly applies here. I do not doubt that what had prompted the 1995 change was a number of cases where wholly artificial losses had been created and that what was then enacted was an "anti-avoidance rule". But that gives little assistance towards, and is certainly not determinative of, the interpretation of the words actually used in the enactment. This item is perhaps more helpful in pointing to the modesty of the change to be made by the 1996 legislation - in effect restricting a wide-ranging rule to exclude from its operation new life insurance operations.

[69] The remaining aid which was relied on by Mr Johnston in this connection was the Minister's observations in Parliament during the passage of the succeeding Finance Bill. The context was that another member had tabled an amendment but had withdrawn it on an assurance that the Government would bring forward its own amendment. Referring to the Government's proposed amendment the Minister said:

"This schedule amends a rule introduced in last year's Finance Act - a very necessary rule, designed to stop the creation of wholly artificial losses in a life insurance company. My hon Friend and the life insurance industry think that we went too far last year. In particular, it is said that the 1995 Rule bore too harshly on companies just starting up, and discouraged new entrants to the life insurance market. We have found a way of allowing start-up life insurance companies to use their losses within a group, as any other company would.

The new clause and the schedule identify circumstances in which the 1995 Rule will continue to apply - where there is a takeover, including one following a demutualization ... It will no longer apply to the start-up company where losses arise through normal patterns of business." (HC 274 col.1081).

[70] This excerpt, it might be said, was apt for two purposes: to point to the Government's understanding (in 1996) of the design of the 1995 Finance Act and to point to the objective of the 1996 amendment. But, as this is material from Hansard, it can legitimately be deployed only where the three conditions specified by Lord Browne-Wilkinson in Pepper v Hart at page 640 are met. These are where "(a) legislation is ambiguous or obscure, or leads to an absurdity; (b) the material relied on consists of one or more statements by a Minister or other promoter of the Bill together if necessary with such other parliamentary material as is necessary to understand such statements and their effect; (c) the statements relied on are clear." Condition (b), as expressed, appears to be directed to a statement or statements made in promoting the legislation in question - not to a comment made about previous legislation. It seems doubtful, accordingly, whether in relation to the 1995 Act the observation meets that condition. In any event, I am satisfied that neither condition (a) nor condition (c) is in that regard met. There is, in my view, no ambiguity or obscurity about section 83(3) as introduced by the 1995 Act nor does it lead to an absurdity. While the language may arguably be open to more than one interpretation, that does not, in my view, meet condition (a). Nor is the Ministerial statement clear. The clarity required is such as "would almost certainly settle the matter immediately one way or the other" (R v Warner [1969] 2 AC 256, per Lord Reid at page 279, cited by Lord Bingham of Cornhill in Spath Holme at page 391). While no doubt an aim of the 1995 Act was to counter the creation of "wholly artificial losses", I am not persuaded that the statement means or was intended to mean that that was exhaustive of its purpose.

[71] I am accordingly left, as regards the 1995 Act, with the words of the provision itself. Construing it as best I can, I am of opinion that it was of wide import and had the effect that, where any amount, whether "artificially" or "commercially", was transferred into the long term business fund from other assets of the company, that amount was, for the purposes of ascertaining any loss, to be taken into account, in the period in which it was brought into account, as an increase in the value of the assets within the meaning of section 83(2)(b).

[72] I should add that I do not regard the opening phrase of the subsection - "In ascertaining whether or to what extent a company has incurred a loss in respect of that business" - as creating an ambiguity or obscurity or as leading to an absurdity. It is perhaps not altogether clear why section 83(3) was restricted to the disallowing of losses rather than extending also to amounts brought into account to reduce profits. It may be, as Mr Tyre suggested, that the restriction was to losses only because profits were, at least usually, computed on a different basis, the I minus E basis. Section 83 was, of course, concerned only with assessment on the basis of Case I of Schedule D - see subsection (1). It may be that it was in policy terms thought sufficient to restrict the provision to losses. The restriction in the opening phrase does not, in my view, affect the meaning of the words used in the substantive provision.

[73] The provision which ultimately falls to be construed is section 83(3) as finally amended by the 1996 Act. It is important to notice that the alteration made was a modification, not a radical re-writing of the 1995 provision. The broad expression "amount" was retained - albeit "an" was substituted for "any" (not, in my view, in the circumstances a significant change); the source of the addition or transfer was effectively retained - "includes transfer (whether from other assets of the company or otherwise)" (see section 83(8)); but the context was restricted to being "as part of or in connection with" a transfer of business to the company or a demutualisation not involving a transfer of the business. That contextual restriction was clearly important but it did not take away from the stipulation that an amount which was added or transferred was, subject to that restriction, to be taken into account as a receipt.

[74] If it is necessary to identify a purpose for section 83(3) in its 1996 version, it may be this: to bring into account for taxation purposes amounts representing accumulated surpluses of the transferor company which have been transferred to the transferee, but in a way that has an actual effect on taxation only where the transferee (1) chooses to bring such amounts into its revenue account and (2) at the same time seeks to claim trading losses. This does not involve the transferee being taxed on the transferor's profits - only a limitation on the availability to it of trading losses. It is a relatively modest objective and it is intelligible. I can discover from the statutory language no more limited purpose. I am conscious that the subject is not to be taxed without clear words; but the words of section 83(3) are, in my view, clear.

[75] Accordingly, as I see it, the issue in the present case - there being no question of demutualisation not involving a transfer of the business - reduces to whether in the circumstances the sums in question were "added" (or "transferred") "as part of or in connection with" a transfer of business to the Company. It was not submitted before us that any transfer or addition was "as part of" such a transfer, though I am not persuaded that HMRC's implicit concession in that regard was well-founded - see para [80] below.

[76] Mr Johnston submitted, under reference to the distinction drawn by Lord Greene MR in In re VGM Holdings Ltd between the creation and the transfer of a chose in action, that no addition was made on the coming into effect of the Scheme since prior to that time the long term business fund had not existed. The context in which Lord Greene made these observations (the distinction between a purchase and an allotment of shares) was very different. In the context of section 83(3) an amount can, in my view, be "added" to zero, particularly where "add" includes "transfer" (section 83(8)). The phraseology in the 1995 version ("transferred ... or otherwise added"), while inverted, is to the same effect. "Transferred" may be more apt when the transferee has no pre-existing long-term business fund, "added" where it has. I accordingly reject that submission.

[77] It has been observed, adopting counsel's turn of phrase, that the expression "in connection with" is a protean one which tends to draw its meaning from the words which surround it. In some contexts, though not always, the problem may be solved by substitution of the words "having to do with" (Coventry Waste Ltd v Russell, per Lord Hope at page 2103). In Bank of Scotland v Dunedin Property Investments Co Ltd Lord President Rodger at page 663, in the context of the interpretation of a commercial contract, favoured the concept of "something having a substantial relationship, in a practical business sense, to something else". Lord Kirkwood observed at page 671:

"For my part I am prepared to accept that the words 'in connection with' are capable of a wide construction and in a case of this nature I would be prepared to accept that it would be sufficient if it was demonstrated that there was a substantial relationship in a practical business sense."

Lord Caplan at pages 679-80 observed that the cases cited were rather dependent on their own facts and that the most useful general rule might be that in Gomba Holdings UK Ltd v Minories Finance Ltd (No.4) [1994] 2 BCLC 435 to the effect that the words "fees and expenses incurred in connection with" should be restricted in application to "within parameters which the court may come to the view were reasonably within the contemplation of the parties at the time the particular document was entered into".

[78] I doubt whether any very useful guidance can be drawn from the construction of "in connection with" in these very different contexts. Here it is associated with the phrase "part of" (a transfer of a business). The latter phrase would import that the addition (or transfer) of the amount was an integral element of the transfer of the business. "In connection with" imports a less immediate but not a tenuous relationship with a transfer of the business. Perhaps "in association with" would here be the closest equivalent.

[79] Mr Tyre submitted that the transfer which resulted in the establishment of the Capital Reserve in March 2000 was an addition to the Company's long term business fund in connection with the transfer of the Society's business to it, the particular amounts thereafter being taken into account as increases in value for the respective periods in which they were brought into account. In the alternative, he submitted, the particular amounts were added in connection with that transfer in the periods in which they were respectively brought into account.

[80] The Scheme provided (para 22.1) that on and after the Effective Date (3 March 2000) the Society should maintain a memorandum account "within the Long Term Fund" designated as the Capital Reserve. The Capital Reserve was to represent the amount of the shareholders' capital held "within the Long Term Fund". In Schedule 1 "Long-Term Fund" was defined as meaning the long term fund to be maintained by the Company pursuant to section 28 of the Insurance Companies Act 1982. It is difficult to see that the Company's "long term business fund" (in section 83(3) of the 1989 Act) is any different from the long term fund maintained by it pursuant to section 28 of the 1982 Act. If that be so, the whole of the "amount" (see Scheme para 22.2) representing the Capital Reserve would appear in terms to have been added or transferred ("credited") to the Company's long term business fund as at 3 March 2000 as an integral element of the Scheme sanctioned by the Court. This destination was part of a deliberate design (see Ms Ross' Witness Statement para 27). "The initial amount of the Capital Reserve ... was the excess of the market value at 3 March 2000 of the assets, over that of the liabilities, which were transferred from the Society to the Company's Long Term Fund ..." (Statement of Agreed Facts (29)). On the same date the "Transferred Non-Pension Business" (that is, the Society's whole business other than that related to pension policies) was transferred to and vested in the Company (Scheme, para 3.1). As a result of the transfer the long term fund to be maintained by the Company was established (Scheme, para 13). The "transfer of business" in section 83(3) means a transfer of the whole or part of the long term business of the insurance company in accordance with a scheme sanctioned by the Court (section 83(6)). All this suggests that the relevant addition or transfer was "as part of" the transfer of the business on 3 March 2000, albeit only limited amounts were brought into the revenue account later. This appears to have been the primary conclusion of the Special Commissioners (see para 83, third and fourth sentences, of their decision). That conclusion is, in my view, a conclusion of fact (or possibly of mixed fact and law) and not one on a point of law, on which alone an appeal lies to this court (Taxes Management Act, 1970, section 56A). In any event, I would be inclined to agree with it. If, however, it was not part of that transfer, it certainly seems to me to have been in connection with it. The transfer of the business and the transfer to the Company's long term business fund were both integral parts of the Scheme. They were intimately connected (associated). If, however, that is wrong, I would hold that the relevant additions or transfers took place at the end of each of the accounting periods (that is 31 December 2000, 31 December 2001 and 31 December 2002) in connection with the transfer of the business. The Capital Reserve was established subject to strict regulation. It could not be reduced to any extent other than by an amount being brought into account in the revenue account. No amounts could after the Effective Date be credited to the Capital Reserve. The amounts here in issue were transferred to the revenue account in each of the three periods of account immediately following the transfer of the business. These considerations are more than sufficient, in my view, to make these transfers "in connection with" the transfer of the business. The circumstance that it was not at the outset envisaged that there would be such early calls on the Capital Reserve, or indeed calls at all to meet commercial losses, is, in my view, immaterial. While I recognise that in the Insurance Companies legislation a distinction can in some contexts be seen between the long term business fund and the assets representing that fund, that distinction does not appear to me to be of significance for the purposes of interpretation of section 83(3). That lack of significance can perhaps more clearly be seen in the 1995 version of the subsection which refers to "... any amount transferred into the company's long term business fund from other assets of the company, or otherwise added to that fund ...": the fund itself is treated as an "asset". The phrase "for the period for which it is brought into account clearly, in my view, envisages that that bringing into account (in Form 40) may be, though it need not be, in a different period from that in which an amount is added to the long term business fund - that is, a possible two-stage exercise is envisaged. That, in my view, is what in effect happened here. The Capital Reserve, being the surplus beyond what was immediately required to meet the liabilities to policyholders, was reflected in the balance sheet(s) of the long term business fund (Forms 13 and 14) kept under section 17 of the Insurance Companies Act 1982, amounts from that fund being drawn down in each accounting period and reflected in the revenue account (Form 40) kept under the same statutory provision. That Form 13 is an account of "assets" does not prevent the valuation of these assets being a valuation of the fund which these assets represent. "A separate Form 13 is completed for the Long Term Fund and for each sub-fund" Mr Eastwood's Witness Statement para 80(2)). I am for these reasons of opinion that the amounts in question are brought into account as receipts by virtue of the operation in the circumstances of section 83(3).

The evidential objection

[81] There remains for consideration the treatment of an objection taken by the Company before the Special Commissioners to evidence of certain witnesses (a Mr Thomas and a Mr Peel) adduced by HMRC. Before the Special Commissioners Mr Tyre conceded that certain passages in the witness statements of these witnesses were inadmissible as evidence, as being statements of law. The Commissioners held that certain further passages in Mr Thomas's evidence were inadmissible for the same reason. They also held that each of Mr Peel and Mr Thomas was a skilled person and that certain (limited) passages of their witness statements (touching on matters of industry practice) were admissible.

[82] In paragraph 14 of its grounds of appeal the Company contends that the Commissioners misdirected themselves in law "in determining that the interests of Mr Richard Thomas and Mr Robert Peel in these proceedings were not relevant factors to be taken into account in deciding whether to admit their evidence as expert evidence". This contention was elaborated in the written submission for the Company (Part III, paras 168-172). Mr Johnston made no oral submissions on the matter. He acknowledged that the issue there raised was peripheral to the main issues in the appeal but adhered to the written submission. Mr Tyre also acknowledged that this issue was "not very important". He, however, referred to HMRC's written response on this aspect (Part V, paras 71-4).

[83] The essence of the Company's objection (as formulated in the ground of appeal and in the written submission) to any evidence being adduced from these witnesses appears to have been that, in so far as they gave "expert" evidence of industry practice, they did not have the independence to be expected of such an expert. That objection, it seems, was grounded on Mr Thomas being an Assistant Director of HMRC and Mr Peel being a former Assistant Director. (It is far from clear that any objection taken before the Commissioners was founded on that basis - see their decision para 30). It is acknowledged that the fact that someone was an employee of one of the parties does not in itself prevent him or her from giving opinion evidence. It is said, however, that Mr Thomas and Mr Peel were intimately involved in the proceedings, Mr Thomas having been the individual who decided to litigate the matter and Mr Peel having conducted the enquiry and argued HMRC's case in correspondence. It is further suggested (in the written submissions but not in the grounds of appeal) that Mr Thomas and Mr Peel were not suitably qualified "to give evidence as to actuarial or accounting practice".

[84] In my view, these issues need not be decided for the purposes of this appeal. There is real uncertainty as to what was (or is) the basis of the objection taken. The Special Commissioners appear to have understood it as an objection that what was contained in the written statements was contentions in law rather than statements of fact - rather than as a personal disqualification of either of the witnesses. But nothing of importance now turns on the basis or validity of the objection. The evidence, in so far as it went, was concerned with what was claimed to be the practice in the life insurance industry. In so far as it was germane to the legal issues which fall to be decided, it relates to the issue under section 83(2). Even taking that evidence at its highest, I am not persuaded that HMRC's contention with regard to that subsection is well-founded.

Disposal

[85] For the foregoing reasons the Special Commissioners, in my view, reached the correct conclusions both on section 83(2) and section 83(3), although their reasoning does not in all respects concur with mine. I would accordingly refuse both the appeal and the cross-appeal. The answer to the agreed question should accordingly be in the affirmative.

FIRST DIVISION, INNER HOUSE, COURT OF SESSION
Lord President Lord Reed Lord Emslie	[2010] CSIH 47 XA31/08 OPINION OF LORD REED in the Appeal by SCOTTISH WIDOWS plc Appellants: against THE COMMISSIONERS FOR Her Majesty's Revenue and Customs Respondents: under section 56A of the Taxes Management Act 1970 _______

Act: Johnston, Q.C.; Maclay Murray & Spens LLP

Alt: Tyre, Q.C., K Campbell; Solicitor (Scotland), HM Revenue & Customs

28 May 2010

Introduction

[86] The present appeal turns on the effect of section 83 of the Finance Act 1989, as substituted by paragraph 16 of Schedule 8 to the Finance Act 1995 and amended by paragraph 4 of Schedule 31 to the Finance Act 1996. That provision forms part of a complex body of legislation governing the taxation of life assurance companies, which is closely related to the legislation governing their regulation by the Financial Services Authority. In order to understand section 83, it is necessary to understand how the law governing the taxation and regulation of life assurance companies has developed, and in particular the state of the law when section 83 was enacted in 1989, and when it was amended in 1995 and 1996.

[87] Before considering how the law has developed, however, it may be helpful to note at the outset some fundamental features of the life assurance business. Life assurance has developed considerably since its origins in the eighteenth century. In general terms, however, it involves a contractual relationship under which the life office assumes a contingent liability in return for the payment of a premium by the policy holder. There are various contingencies on which benefits may be paid: for example, under term assurance, payment is made only in the event of death within an agreed term; under whole of life assurance, payment is made on death at any age; and under endowment assurance, payment is made on survival for a term of years or on earlier death. The policy holder may be required to pay regular premiums, or only a single premium at the outset. The way in which policy benefits are determined is also variable. Without-profits (or "non-participating") policies guarantee a fixed sum assured. With-profits (or "participating") policies guarantee a minimum sum assured with the right to share in the profits of the office by way of additions of "bonus". These and other ingredients can be combined and modified in order to suit market requirements.

[88] The establishment of the life assurance industry depended upon the development of the actuarial profession, whose members were able to use statistical information about mortality rates to predict the level of claims which could be expected in any given year if risks were pooled between a large number of lives assured. Premiums could then be set on a basis which made adequate provision for future claims and which differentiated between policy holders on the basis of their life expectancy when the policy was written. The premiums could also be set on a level basis over the term of the policy, despite the fact that the likelihood of a claim increased with the advancing age of the policy holder.

[89] Because of the long term nature of most life policies, reserves must be set aside and invested until such time as they are needed to meet future liabilities. Investment by the life office is thus inherent in the conduct of life assurance business. It is primarily that investment element, generating income and capital gains, which brings life assurance within the scope of the Taxes Acts. The likely return on investments affects the amount of the reserves required in order to meet future liabilities, and hence the premiums needed in order to provide a given benefit. The solvency of a life office, and the "surplus" available for distribution to shareholders or, as bonus, to policy holders, thus depend upon judgments about the likely level of income and outgoings into the distant future, and about the reserves which need to be set aside out of assets currently in hand in order to cover future liabilities. The taxation of life assurance companies has evolved so as to base the computation of taxable profits upon the judgments made by life offices in assessing their actuarial surplus (that is to say, the amount by which their reserves exceed the amount required in order to meet future liabilities), as expressed in their statutory returns to regulatory bodies. That process of evolution began in the nineteenth and early twentieth centuries, when the basic principles of the taxation of life offices, in the absence of any special statutory provisions, were established by the courts. Those principles then underwent successive modifications by statute during the twentieth century, as Parliament attempted to address the peculiar difficulty of computing a life office's profits, and to adapt the tax regime to changes in the investment activities of life offices.

[90] Finally, by way of introduction, it is relevant to note that there are different forms of life office. Two are of particular importance: proprietary companies owned by shareholders, and mutual offices, all of whose surpluses go to benefit their members. The tax treatment of these two types of office is different. The present case is principally concerned with the taxation of a proprietary company.

The early development of the law

[91] The regulation of life assurance companies began with the Life Assurance Companies Act 1870, which was one of a number of statutes enacted in the aftermath of the collapse of the Albert Life Assurance Company in 1869. The Act reflected a concern about the instability of life offices which was by no means new: 25 years earlier, Charles Dickens had drawn attention to the problem in Martin Chuzzlewit. The Act contained a number of provisions intended for the protection of policy holders, and is the ancestor of the present system of regulation by the FSA.

[92] Sections 3 and 4, in particular, established the statutory concept of a life assurance fund. In terms of section 3, every life assurance company established after the passing of the Act was required to deposit a sum of money with the Accountant General of the Court of Chancery, the deposit to be returned to the company "so soon as its life assurance fund accumulated out of the premiums shall have amounted to forty thousand pounds". Section 4 required every such company carrying on other business besides that of life assurance to keep a separate account of all receipts in respect of life assurance and annuity contracts. Those receipts were to be carried to and form a fund to be called the life assurance fund:

"... and such fund shall be as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life assurance, and shall not be liable for any contracts of the company for which it would not have been liable had the business of the company been only that of life assurance".

In relation to existing companies, section 4 provided that

"... the exemption of the life assurance fund from liability for other obligations than to its life policy holders shall have reference only to the contracts entered into after the passing of this Act".

[93] Section 5 required every life assurance company to prepare an annual revenue account and balance sheet in the forms contained in the First and Second Schedules to the Act. The forms have features which have been carried forward to the forms in use at the present day. The revenue account set out in the First Schedule is an account recording the cumulative amount of premiums and other receipts less claims and expenses paid. The opening and closing figures are called the "amount of funds". In the balance sheet set out in the Second Schedule, the total funds brought out by the revenue account are broken down into their constituent parts: paid up shareholders' capital, life assurance fund, annuity fund (if any), and other funds (if any)). The funds are described as liabilities. The total of the liabilities is balanced against the total of the assets, which are broken down into various types of investment (consisting at that time largely of gilts and other fixed interest securities). Since the assets are not appropriated to specific funds, it would appear that the life assurance fund, in particular, is a way of categorising an amount of money for accounting purposes: the receipts and outgoings recorded in the revenue account are credited and debited to the fund as a matter of accounting. As Lord Greene MR observed in Allchin v Coulthard [1942] 2 KB 228 (affirmed, [1943] AC 607) at page 234:

"The word 'fund' may mean actual cash resources of a particular kind (e.g. money in a drawer or a bank), or it may be a mere accountancy expression used to describe a particular category which a person uses in making up his accounts."

The word appears to have been used in the second of those senses in the 1870 Act. Since the amount of the fund had to be met out of the assets, it appeared in the balance sheet as a liability to be set against the assets.

[94] The most important provision of the Act was section 7, which required every life office to have its financial condition investigated by an actuary once every five years, and to produce an abstract of the actuary's report in the form prescribed in the Fifth Schedule. That schedule required an actuarial valuation of the company's future obligations to policy holders, consisting essentially of the difference between the present value of anticipated benefits to policy holders and the present value of future premiums (a figure which, in current practice, is described as a mathematical reserve). A valuation balance sheet was to be published, showing on the debit side the company's net liability under the policies as valued by the actuary (that is, the mathematical reserve), and on the credit side the life assurance fund (and any annuity fund) as per the balance sheet, thus bringing out a surplus or a deficiency. Although it may appear confusing that the fund appeared on the credit side of the valuation balance sheet, having been treated as a liability in the ordinary balance sheet, this reflected the fact that the purpose of the valuation balance sheet was to establish that the fund was adequate to cover the mathematical reserve, and to determine the extent of any surplus or deficiency.

[95] The use of the surplus brought out by the actuarial investigation in the computation of taxable profits was considered in two cases in the later nineteenth century. The first was Last v London Assurance Corporation (1884) 12 QBD 389, where the company appealed against an assessment which had been made in respect of its marine and fire businesses only, the life business being disregarded. It was argued on behalf of the Revenue that it was entitled to treat the life business separately, and that such business did not fall within the scope of the Income Tax Acts except in relation to the interest earned on investments (the tax on which was normally deducted at source). The company on the other hand argued that it should be taxed on the profits of its entire trade. On that hypothesis, there was a further issue as to how the profits of the life business should be computed. The Revenue maintained that the annual profits should be calculated as the excess of premium receipts over claims and expenses, following the approach established for fire insurance companies in Imperial Fire Insurance Co v Wilson (1876) 1 TC 71 (an approach which was subsequently modified by the House of Lords in Sun Insurance Office v Clark [1912] AC 443). The company on the other hand based its computation of profit upon the quinquennial calculation of the surplus available for distribution to shareholders and policy holders. It conceded that the amount available for distribution to shareholders should be treated as profit, but argued that the amount appropriated for distribution to policy holders as bonus or premium reductions did not form part of its profits.

[96] The court held that the company should be taxed on the profits of its entire trade. It rejected the Revenue's contention that the annual profits of the life business could be calculated as the excess of premium receipts over claims and expenses, and also its contention that the company's life assurance fund was taxable as accumulated profit. Day J observed (at pages 400-401) that there was a radical distinction between fire insurance and life insurance. Fire insurance was taken out on an annual basis, and the profit was therefore the excess of annual premiums over annual losses; but in life insurance each year's premium related to the whole duration of the life or risk, and every year's premium had to be set aside and capitalised for payment of the future debt: in no sense could the life fund as such be deemed to represent profit. Those conclusions were not challenged in the subsequent appeals to the Court of Appeal ((1884) 14 QBD 239) and the House of Lords ((1885) 10 App Cas 438). The remaining issue - the treatment of the part of the surplus appropriated to policy holders - divided judicial opinion. By a bare majority, the House of Lords reversed the decisions of the lower courts, and held that that amount should be included in the computation of the company's profits.

[97] The relevance of the actuarial surplus to the calculation of profits was considered again in Scottish Union and National Insurance Co v Inland Revenue (1889) 16 R 461, 2 TC 551. One question which again arose in that case was whether, when a company carried on both life assurance and other types of insurance business, it could be separately assessed in respect of the investment income of the life assurance business and the profits of the other business. The court held that it could not: the company carried on only one trade, so that the profits and gains of the two branches of the business must be taken together. The second question was how the profits and gains of the life assurance business should be computed. The Commissioners had held that the profits should be calculated as the company's receipts from premiums, interest and gains on investments, less payments under policies, expenses and losses on investments: the approach which had been rejected by the Queen's Bench Division in the case of Last. The company contended that its profits should be taken to be the surplus brought out by the actuarial investigation under the 1870 Act. Its annual profits would then be a proportionate part of the surplus calculated for the five year period. Lord President Inglis, delivering the opinion of the court, stated (at page 475) that, in the case of a life assurance company:

"The profits and gains can be ascertained only by actuarial calculation. And this actuarial calculation may be obtained by taking the result of the quinquennial investigation prescribed by statute, or of the periodical investigation in use in companies established before the statute, or by an investigation covering the three years prescribed by schedule D of the Income-Tax Acts."

The court also held that realised gains on the investments of a non-life fund should be included in the computation of profits and gains, it being conceded that realised gains on the investments of the life fund were taken into account in the calculation of the surplus.

[98] Although the Scottish Union case confirmed the competency of taxing a life assurance company on its profits, and decided that the actuarial surplus was a suitable starting-point for a Case I computation, it remained the usual practice of the Revenue to tax companies carrying on life assurance business (and no other business) on the interest which they received on their investments. As Lord President Dunedin observed in Revell v Edinburgh Life Insurance Co (1906) 5 TC 221 at page 227, it nearly always paid the Crown better to take the interest on the investments and not to trouble with the profits. The Lord President also noted in that case that the Crown must elect between charging tax upon the investment income and charging tax upon the profits: it could not do both.

[99] Under the law established by these early cases, life assurance companies were therefore liable to bear tax either on their profits, under Case I of Schedule D, or on the interest arising from their investments, whichever was the greater. That alternative basis of liability was not peculiar to life assurance companies: it was common to all trading concerns, but was of greater practical significance to life assurance companies than to most, if not all, other forms of business. The calculation of the profits of such companies had given rise to difficulty; but the courts had given their approval to an approach based on the surplus established by the actuarial investigation carried out in accordance with regulatory requirements.

[100] One further point which requires to be noted is that mutual life assurance societies were treated differently from companies owned by shareholders, following the decision of the House of Lords in New York Life Insurance Co v Styles (1889) 14 App Cas 381. Since mutual insurance was not conducted with a view to profit, it did not give rise to any profits assessable under Case I. No part of the surplus of a mutual society was therefore assessable to tax under Case I, whereas (following Last) the entire surplus of a proprietary life assurance company was ordinarily regarded as profit. The investment income of a mutual society was however liable to tax in the same way as that of a proprietary company.

[101] These early cases established how life assurance companies should be taxed in the absence of any specific tax legislation relating only to life assurance. That approach continues to underpin the present system, to the extent that life assurance companies continue to be taxed under general laws modified to address the special features of the business. The modifications effected by Parliament are however extensive, and have resulted in a complex body of legislation.

Statutory developments prior to the Finance Act 1989
[102] The first legislation specifically to address the tax liabilities of life offices appears to have been the Finance Act 1915, which made a number of alterations to the existing law. First, it treated life assurance as a separate business, effectively reversing that aspect of the Last and Scottish Union decisions. This enabled the charge under cases other than Case I to apply to life assurance, while Case I could be applied to other classes of insurance business carried on by the same company. Secondly, the Act contained a separate treatment of annuity funds, which from then onwards required separate tax treatment from life assurance funds. Thirdly, the Act altered the system of taxation of investment income so as to allow relief for management expenses, thus establishing what became known as the "I minus E" basis of assessment: that is to say, life offices could be assessed on their investment income, less their expenses of management (both the day to day costs of running the business and managing the investments, and the commission and other costs involved in acquiring new business). Section 14, in particular, made provision for companies which had been taxed on their investment income to receive a repayment in respect of their management expenses, provided the relief given did not have the effect of reducing the amount of tax paid below the amount which would have been paid if the assessment had been made upon profits under Case I. The result of the provision was that a proprietary life assurance company was liable to be assessed on a sum which might exceed, but could never be less than, the annual profits as ascertained on the basis of the actuarial investigation. That remained broadly the position during the periods with which the present case is concerned, in accordance with sections 75 and 76 of the Income and Corporation Taxes Act 1988.

[103] The tax treatment of life assurance companies was considered in detail in the Report of the Royal Commission on the Income Tax, presented to Parliament in 1920 (Cmd 615). The Royal Commission was critical of the method of ascertaining profits which followed from the decision of the House of Lords in the case of Last, and recommended (at paragraph 521):

"that the alternative method of charging on profits should remain, but that the chargeable profit should be deemed to be not as at present the total surplus revealed by actuarial valuation, but only that portion of the surplus which belongs to the proprietors or shareholders of the company".

That recommendation was implemented by section 16(1) of the Finance Act 1923, the terms of which were re-enacted in almost identical terms in section 427(1) of the Income Tax Act 1952, section 309 of the Income and Corporation Taxes Act 1970 and section 433 of the 1988 Act. As set out in section 433 of the 1988 Act, the provision stated:

"Where the profits of an insurance company in respect of its life assurance business are, for the purposes of this Act, computed in accordance with the provisions of this Act applicable to Case I of Schedule D, such part of those profits as belongs or is allocated to, or is reserved for, or expended on behalf of, policy holders or annuitants shall be excluded in making the computation, but if any profits so excluded as being reserved for policy holders or annuitants cease at any time to be so reserved and are not allocated to or expended on behalf of policy holders or annuitants, those profits shall be treated as profits of the company for the accounting period in which they ceased to be so reserved."

This provision had the effect of reversing the decision of the House of Lords in the case of Last, so that any assessment under Case I would be confined to the part of the actuarial surplus which was available for distribution to shareholders. In relation to profits allocated to participating policy holders and annuitants, in particular, the provision had the effect of placing proprietary assurance companies on a similar footing to mutual societies. The effect of the exclusion of profits "reserved" for policy holders was however less clear.

[104] It is unnecessary for present purposes to consider other developments in taxation prior to the 1989 Act, besides noting the introduction of corporation tax and capital gains tax in the Finance Act 1965.

[105] In order to explain the background to the 1989 Act, it is also necessary to consider some features of the evolution of the regulation of life offices from the 1870 Act to its lineal descendant, the Insurance Companies Act 1982. The intervening statutes included, in particular, the Assurance Companies Act 1909, which largely re-enacted the provisions of the 1870 Act but added expressly, in section 3, that the investments of an assurance fund need not be kept separate from the investments of any other fund. That position was altered by the Insurance Companies Amendment Act 1973. Section 7 of that Act required an insurance company carrying on long term business to make arrangements for identifying the assets attributable to its long term business as at the end of the financial year during which the necessary regulations were made, and thereafter to maintain such accounts and records as were necessary for identifying the assets representing the fund maintained by the company in respect of its long term business. As a consequence, companies had to allocate assets (or a proportion of assets) to their long term business fund, and to provide a certificate to that effect, in accordance with the Insurance Companies (Identification of Long Term Assets and Liabilities) Regulations 1973 (SI 1973 No. 2064). Section 8 of the 1973 Act provided that the assets representing the fund maintained by an insurance company in respect of its long term business were to be applicable only for the purposes of that business, except to the extent that the actuarial investigation disclosed that the value of the assets exceeded the liabilities of the long term business: that is to say, to the extent that there was a surplus. Section 30 of the 1973 Act provided that, in the winding up of a company carrying on long term business, the assets representing the fund maintained by the company in respect of its long term business were to be available only for meeting the liabilities of the company attributable to that business. As I shall explain, these provisions were replicated in the 1982 Act.

[106] One consequence of the 1973 Act which requires to be noted is that proprietary companies, as well as having a long term business fund, would also have a fund of assets held outside the long term business fund. That fund, sometimes described as the shareholders' fund, would represent in general terms the share capital and any retained profits and liabilities held outside the long term business fund.

[107] Section 17 of the 1982 Act corresponded to section 5 of the 1870 Act, and required every insurance company to prepare each year a revenue account for the year and a balance sheet as at the end of the year, in forms prescribed by regulations made under the Act. Section 18 of the 1982 Act provided:

"18.-(1) Every insurance company to which this Part of this Act applies which carries on long term business -

(a) shall, once in every period of twelve months, cause an investigation to be made into its financial condition in respect of that business by the person who for the time being is its actuary ...; and

(b) when such an investigation has been made, ... shall cause an abstract of the actuary's report of the investigation to be made.

(2) An investigation to which subsection (1)(b) above relates shall include -

(a) a valuation of the liabilities of the company attributable to its long term business; and

(b) a determination of any excess over those liabilities of the assets representing the fund or funds maintained by the company in respect of that business ...

...

(4) For the purposes of any investigation to which this section applies the value of any assets and the amount of any liabilities shall be determined in accordance with any applicable valuation regulations.

(5) The form and contents of any abstract or statement under this section shall be such as may be prescribed."

The expression "long term business" was defined, by sections 1 and 96 and Schedule 1, as including life assurance.

[108] Section 28 of the 1982 Act provided:

"28.-(1) Where an insurance company to which this Part of this Act applies carries on ordinary long-term insurance business ... -

(a) the company shall maintain an account in respect of that business ...; and

(b) the receipts of that business ... shall be entered in the account maintained for that business and shall be carried to and form a separate insurance fund with an appropriate name.

(2) An insurance company to which this Part of this Act applies which carries on ordinary long-term insurance business ... shall maintain such accounting and other records as are necessary for identifying -

(a) the assets representing the fund or funds maintained by the company under subsection (1)(b) above ...; and

(b) the liabilities attributable to that business ...".

[109] Section 29 of the 1982 Act corresponded to section 8 of the 1973 Act. So far as material, it provided:

"29.-(1) Subject to subsections (2) and (4) and section 55(3) below, the assets representing the fund or funds maintained by an insurance company in respect of its long term business -

(a) shall be applicable only for the purposes of that business ...

(2) Where the value of the assets mentioned in subsection (1) above is shown, by an investigation to which section 18 above applies or which is made in pursuance of a requirement imposed under section 42 below, to exceed the amount of the liabilities attributable to the company's long term business the restriction imposed by that subsection shall not apply to so much of those assets as represents the excess.

...

(4) Nothing in subsection (1) above shall preclude an insurance company from exchanging, at fair market value, assets representing a fund maintained by the company in respect of its long term business for other assets of the company.

...

(6) Money from a fund maintained by a company in respect of its long term business may not be used for the purposes of any other business of the company ..."

In relation to section 29(4), it is relevant to note that section 440 of the 1988 Act addressed the tax consequences of an exchange of assets representing the long term business fund for other assets of the company, by relieving the company from any consequential charge to tax unless (in broad terms) it elected to treat the exchange as a deemed disposal of the asset at market value. That provision was predicated upon the identification of specific assets as representing the long term business fund.

[110] Section 30 of the 1982 Act made further provision in respect of any "established surplus", defined by subsection (4) as

"... an excess of assets representing the whole or a particular part of the fund or funds maintained by the company in respect of its long term business over the liabilities, or a particular part of the liabilities, of the company attributable to that business as shown by an investigation to which section 18 above applies ...".

[111] Finally, in relation to the 1982 Act, section 55 re-enacted the provisions introduced in section 30 of the 1973 Act.

[112] The character of the fund, as that concept is employed in the 1982 Act, is not altogether easy to determine. Some of the provisions of the 1982 Act, such as section 28(1), can be traced back to the 1870 Act, and are consistent with an understanding of the fund as an accounting category: a basis on which an amount of money is treated in the accounts as set aside for a particular purpose, with incomings and outgoings related to that purpose being credited and debited to the fund. Other provisions, such as sections 28(2) and 29(1), imply however that the fund is not merely an accounting category: specific assets are appropriated to the fund. The provisions concerned with the actuarial surplus, such as sections 18(2), 29(2) and 30(4), also depart from the approach adopted in the 1870 Act by requiring the actuary to investigate the adequacy of the assets (rather than the fund) to cover the mathematical reserve, and to determine the extent of any surplus or deficiency on that basis. In those circumstances, when the statute speaks of "the assets representing the fund", it appears to mean that the assets in question are, in a relevant sense, equivalent to the fund.

[113] The relevant regulations under sections 17 and 18 of the 1982 Act, as at the time when the 1989 Act was enacted, were the Insurance Companies (Accounts and Statements) Regulations 1983 (SI 1983 No. 1811), as amended. These required any company carrying on long term business to prepare the statutory returns in accordance with standard forms and instructions set out in the schedules to the Regulations. In particular, the balance sheet required by section 17 was to comprise a number of forms, including Form 13 ("analysis of admissible assets") and Form 14 ("long term business liabilities and margins"), the revenue account required by section 17 was to be in Form 40 ("long term business: revenue account"), and the result of the actuarial investigation required by section 18 was to be in Form 58 ("valuation result and distribution of surplus"). It is necessary to consider these forms in some detail, as section 83 of the 1989 Act refers to Form 40, and that form is inter-connected with the other forms. As explained below, the forms in use during the periods with which the present appeal is concerned were similar in all material respects to those prescribed by the 1983 Regulations.

[114] Form 13 is an analysis of the total value of the admissible assets representing the fund. In effect, it sets out one side of the balance sheet. In relation to long term business, regulation 6(5) of the 1983 Regulations required Form 13 to be completed by the company in respect of the total assets representing the fund or funds maintained in accordance with section 28 of the 1982 Act, and the assets appropriated in respect of each separate fund for which separate assets had been appropriated. Subsequent regulations imposed a similar requirement. The form requires values to be entered as at the end of the financial year in respect of different categories of asset: land, fixed interest securities, equities and so forth. The total of those amounts is then calculated. As explained below, the valuation is based on rules governing the "admissibility" of assets, but in broad terms is at market value. The shareholders' fund is not included: it appears in a separate return.

[115] Form 14 is primarily an analysis of the liabilities of the long term business, providing the other side of the balance sheet. It shows an amount entered as "long term business fund carried forward", and explains how that amount can be broken down as between the mathematical reserves, unpaid bonuses and unappropriated surplus. The figure entered as the amount of the fund is taken from Form 40. In Form 14, it is treated as a liability. Any other liabilities attributable to the long term business are also shown: these are liabilities which are not included in the mathematical reserves, such as unpaid tax. In the 1983 Regulations, and in the subsequent Insurance Companies (Accounts and Statements) Regulations 1996 (SI 1996 No. 943), the difference between the value of the assets, as brought out by Form 13, and the total liabilities (i.e. the Form 40 amount of the fund plus the other liabilities) was entered in line 51 of Form 14 as "excess of the value of admissible assets representing the long term business funds over the amounts of those funds". An approach which differed slightly in form, but not in substance, was adopted by the Insurance Companies (Accounts and Statements) (Amendment) Regulations 1997 (S.I. 1997 No. 2911), which were in force when the first of the returns in issue in the present case was completed. In the 1997 Regulations, the difference between the value of the assets representing the fund and the total liabilities (i.e. the Form 40 amount of the fund plus the liabilities not included in the mathematical reserve) was entered in line 51 as "excess of the value of net admissible funds". That figure is commonly referred to as the line 51 amount, or as the investment reserve.

[116] Form 40 is the long term business revenue account. It records certain amounts added to and deducted from the company's long term business fund during the year. On the "income" side (as it is described, although it may include additions to the fund of a capital nature) appear premiums, investment income, "increase (decrease) in the value of non-linked assets brought into account", "increase (decrease) in the value of linked assets", and "other income (particulars to be specified)". On the "expenditure" side (as it is described, although it may include deductions from the fund of a capital nature) appear claims payable, expenses payable, interest payable, taxation, "other expenditure (particulars to be specified)", and "transfer to (from) statement of other income and expenditure". The distinction between linked and non-linked assets is explained by regulation 3(1) of the 1983 Regulations: put shortly, investment-linked assurance is a type of long term business where the return to the policy holder is linked to the performance of specified investments. The appreciation on those investments must therefore be brought into account. Unrealised increases in the value of other assets of the fund will be reflected in the Form 13 figure but need not be entered in Form 40. It appears that assets may also be added to the fund without being entered in Form 40, as the facts of the present appeal demonstrate: they may simply be included in Form 13, and reflected in the excess disclosed in line 51 of Form 14. The instructions relating to Form 40 explain that where the company decides to allocate to the long term business investment income or capital gains arising from assets which are not attributable to its long term business, the amount allocated should be entered in the line reading "transfer to (from) statement of other income and expenditure". Transfers out of the long term business fund (such as transfers to shareholders) are also to be entered in that line, as well as appearing in Form 58 as a distribution of surplus. Transfers to the long term business fund from other funds are to be entered in Form 40 as "other income" (or as "other expenditure", as the case may be). The total income and expenditure of the long term business are then calculated. The difference between them is entered in a line reading "increase (decrease) in fund in financial year". That figure, added to the figure entered as "fund brought forward", brings out a figure for "fund carried forward". The figure stated in Form 40 as the fund carried forward also appears in Form 14. That figure need not be the same (and, in practice, is not normally the same) as the value of the assets representing the fund, as shown in Form 13. As explained below, the Form 40 figure is normally arrived at by calculating the mathematical reserves and adding the amount of the actuarial surplus which the company wishes to recognise.

[117] Form 58 deals with the calculation, composition and distribution of the actuarial surplus. In this context, the term "distribution" does not necessarily refer to amounts which have been or are imminently to be paid out. Rather, it refers to the allocation of surplus between policy holders and shareholders. As previously explained, holders of with-profits policies are entitled to a share of the surplus, usually by way of a reversionary bonus: that is to say, an addition is made at the year end to the sum assured. The company may also add terminal bonuses, at its discretion, to policies maturing or terminating during the year. Surplus which is appropriated in that manner is said to have been allocated to policy holders. A share of surplus may also be appropriated as profit for the benefit of shareholders. As Form 58 is set out, it begins with the amount of the fund carried forward from Form 40. It then adjusts that figure by adding back the amount of any bonus payments made to policy holders during the year in anticipation of a surplus, and any amount transferred out of the fund during the year. There is then deducted from the adjusted figure for the fund the company's liabilities to policy holders, as actuarially valued (that is to say, the mathematical reserves). The resultant balance is the surplus (or deficiency, as the case may be). The form then breaks down the surplus as between the unappropriated surplus brought forward from the last valuation, any transfer into the fund, and the surplus arising since the last valuation. The form then shows how the surplus is distributed as between bonus payments made to policy holders in anticipation of a surplus, amounts allocated to policy holders by way of cash bonuses, reversionary bonuses, other bonuses and premium reductions, and transfers out of the fund. Any unappropriated surplus will remain included in the fund. Although that is how the form is set out, it is in reality completed in a different order, as explained below.

[118] One notable feature of Form 58 is that it contains no reference to the assets. At first sight, this might be thought to be surprising, since section 18(2) of the 1982 Act requires the actuarial investigation to determine the excess of the value of the assets representing the fund over the liabilities of the long term business. Similarly, sections 29(2) and 30 regulate distributions out of the surplus on the basis of the same calculation. Form 58 however bears to determine the difference between the amount of the fund and the liabilities, following the format adopted since the 1870 Act. The subordinate legislation appears therefore to proceed on the footing that a calculation based on the amount of the fund meets the statutory requirement for a calculation based on the value of the assets representing the fund. It is also relevant to note that, as I shall explain shortly, the valuation regulations permit the company to assign a book value to its assets for the purposes of the actuarial investigation. The regulations governing the completion of Form 58 make provision for the situation where that is done, described as a situation where "the fund has been brought into Form 58 at book value" (emphasis added): 1983 Regulations, Schedule 4, paragraph 5(2); 1996 Regulations, Schedule 4, paragraph 6(2).

[119] Finally, in relation to the statutory returns, it is important to understand the basis upon which the assets and liabilities are valued. As at the time when the 1989 Act was enacted, regulation 4 of the 1983 Regulations required the values to be determined in accordance with valuation regulations. The relevant regulations at that time were the Insurance Companies Regulations 1981 (SI 1981 No. 1654), as amended. Similar provisions were in force during the periods with which the present appeal is concerned, as explained below. Certain aspects of the valuation regulations require to be noted. First, they define the expression "long term business assets", for the purposes of the valuation, as meaning "assets ... which are, for the time being, identified as representing the long term fund". That definition, which appeared in regulation 37(1) of the 1981 Regulations and was repeated in the later regulations, reflects the requirement that the assets representing the long term business fund should be specifically identified. Secondly, the regulations generally adopt an approach to valuation based on market value, subject to reductions where the assets are of a particular type (such as shares in a subsidiary company) or are held in a particular concentration. The resultant value is termed the "admissible" value. Thirdly, the regulations permit an insurance company, for the purposes of the actuarial investigation under section 18 of the 1982 Act, "to assign to any of its assets the value given to the asset in question in the books or other records of the company". That provision, in regulation 38(5) of the 1983 Regulations, reflected long standing practice and has been repeated in the subsequent regulations. The provision reflects the fact that it would generally be imprudent for a life office to declare a surplus representing the difference between the admissible value of its assets and the actuarial value of its liabilities. The value of the liabilities - the mathematical reserve - is an estimated figure, based on assumptions about future developments during the remaining term of the policies in force at the year end. If the company were to declare as surplus the difference between the admissible value of the assets and the year end mathematical reserve, it might subsequently emerge that the surplus had been overstated. By exercising caution in the declaration of surplus, the company can provide itself with a margin of safety against adverse developments, such as a fall in investment returns, and can smooth the emergence of surplus over a period of years, so providing policy holders with more predictable returns. To some extent, caution can be exercised in the actuarial valuation of liabilities. The principal means by which caution is exercised, however, is by assigning a book value to the assets representing the fund, for the purpose of calculating the surplus, which is below their admissible value. That is what is permitted by the valuation regulations. "Book" value, in this context, is not a historic cost, but a value assigned to the assets for this particular purpose.

[120] In with-profits funds, the starting point in determining the extent to which surplus is recognised is therefore, ordinarily at least, a judgment as to the amount of bonus to be declared. It is then possible to calculate the extent to which surplus must be recognised in order to meet the bonus requirement and any entitlement of the shareholders to participate in surplus (often, as in the present case, fixed as a fraction of the amount allocated to policy holders). Once the amount of the surplus has been decided, and the mathematical reserves have been calculated, the figure to be adopted for the purposes of the actuarial investigation as the value of the assets representing the fund is a matter of arithmetic: since the surplus is the excess of the value of the assets over the liabilities (in accordance with section 18 of the 1982 Act), the value attributed to the assets for the purposes of the actuarial investigation will be equal to the mathematical reserves plus the surplus (subject to adjustment in respect of bonus payments made in anticipation of a surplus, and transfers out of the fund, as explained earlier). That figure, entered in Form 58 as the value of the fund, is also entered in the final line of Form 40. The other entries in Form 40 then have to bring out that closing amount. Most of those entries reflect real receipts and outgoings: premium income, investment income, increases in the value of linked assets, claims, expenses and so forth. To the extent that there is a shortfall, it can be made up by bringing into account part of the value of the assets representing the fund which was previously held in reserve in line 51 of Form 14. The investment reserve disclosed by Form 14 in one year can thus be brought into account in Form 40 in another, as and when the company needs to do so. In practice, that is usually reflected in an entry in the line in Form 40 in which an increase in the value of non-linked assets brought into account is recorded, although it may be entered elsewhere (e.g. as "other income") if appropriate. To the extent that the investment reserve is brought into account in Form 40, the inevitable corollary is a corresponding reduction in the line 51 amount recorded in Form 14. The practice in relation to non-participating funds is different in that there is no bonus, but the amount of the surplus can be regulated in a similar manner so as to enable transfers to be made to other funds (such as with-profits funds) or to shareholders.

[121] Thus, in accordance with section 17 of the 1982 Act, Form 13 shows the true (admissible) value of the assets representing the fund, Form 40 shows the fund at a figure which covers the company's mathematical reserves and enables the desired level of surplus to be recognised, and Form 14 shows the excess of the value of the assets over the liabilities: that is, the investment reserve or unrecognised surplus. Regulation 38(5) of the 1983 Regulations, and its successors, form the link between that exercise and the actuarial investigation carried out under section 18 and reported in Form 58, by enabling the value of the assets to be taken, for the purpose of recognising a surplus, to be a lesser figure, which will also be the figure at which the fund is stated in Form 40. That exercise is reflected in the excess disclosed by Form 14, since the origin of that excess is the difference between the book value of the assets used in Form 58 and the admissible value recorded in Form 13.

[122] Under the valuation regulations, the assets representing the fund thus have an admissible value which is used for certain purposes, and also a notional value which is used for the purposes of the actuarial investigation. The notional value of any individual asset may be arbitrary, since all that matters for the purposes of the actuarial investigation is the notional value assigned to the assets as a whole. The practice of the appellants, for example, appears from the evidence to have been to assign some of the assets their admissible value, until the desired total had been reached, and to assign the remainder of the assets a value of nil. Which assets were valued for the purposes of the actuarial investigation at their admissible value, and which were valued at nil, would vary from one year to the next. For the purposes of Form 13, on the other hand, the appellants required to value all of the assets every year at their admissible value.

The background to the Finance Act 1989

[123] On 8 July 1987, during the course of proceedings on the Finance (No.2) Bill 1987, the Chief Secretary to the Treasury stated that Treasury Ministers had considered the question of the tax treatment of capital gains earned by life assurance companies, and had concluded that a general review should be undertaken of the tax arrangements for life assurance (H C Deb., Vol 119, col 362). That review resulted initially in the publication by the Revenue in 1988 of a consultation document, The Taxation of Life Assurance. That document contains information about the life assurance industry at that time, and its taxation, which is of some assistance in understanding the context in which section 83 of the 1989 Act was enacted. It concluded that the current tax regime did not produce a tax yield commensurate with the profits earned by life offices and the income and gains earned for, and paid out to, policy holders. Even within the industry, the tax burden fell very unevenly between individual offices (para 13.2).

[124] The document identified a number of factors which had led to this situation. One important factor was the role of unrealised capital gains in the operation of a life assurance business. There had been a major shift in the composition of investment returns brought into account (in Form 40) by life offices, away from investment income towards investment appreciation. This reflected a shift in portfolio composition from fixed-interest securities towards equity and property holdings (para 6.2). The change in the composition of investment returns in itself affected the tax paid by the industry, since investment income was taxable as soon as it arose, whereas investment appreciation was not taxed until the assets were realised. In practice, realisations were often deferred. Significant amounts of gain thus stayed out of charge in the short and medium term (paras 6.3 and 7.5).

[125] The recognition (that is to say, taking into account in the revenue account as distinct from the investment reserve) of unrealised gains had in addition given rise to significant distortions of the tax base. One distortion arose from the fact that realisations of capital gain could be deferred beyond the point where the relevant appreciation was paid out as benefit to policy holders. In other words, unrealised gains could be used to support the declaration of bonuses, by bringing such gains into account in Form 40 as transfers from the investment reserve, as and when necessary to enable the desired level of surplus to be distributed. In that way, gain flowed out in cash to policy holders without incurring a charge to tax, unlike the position in other investment contexts, such as unit trusts, where capital gains tax was charged at the level of the individual investor (paras 6.12 - 6.13). A second distortion arose from the fact that unrealised gains were excluded from the computation of taxable profits, whereas liabilities to policy holders were deductible. Those liabilities however reflected increases in the value of investments, whether realised or not, which had been brought to account in Form 40: directly, in the case of investment-linked assurance, and indirectly in other types of business (paras 6.25 and 6.34). In other words, liabilities which had to be supported by unrealised gains were treated as a deductible component in the tax computation, but the unrealised gains which were brought into account in Form 40 in order to support them were not treated as a positive component.

[126] A separate problem arose from a difference of opinion between the Revenue and some life offices over the interpretation of section 433 of the 1988 Act (particularly as applied to pension business by section 436), in so far as it allowed a deduction for amounts both "allocated to" and "reserved for" policy holders. As previously explained, any surplus allocated to policy holders was deductible (as a liability), and any surplus allocated to shareholders was taxable (as a distribution of profits). One interpretation of section 433 would allow both a deduction for amounts allocated to policy holders and also a further deduction for amounts shown as surplus in the accounts but "reserved" by directors' resolution. The unappropriated surplus might thus be left out of account, instead of being taxed as undistributed profit (paras 6.26 and 6.34).

The Finance Act 1989

[127] Against that background, the 1989 Act introduced a number of new provisions concerning the taxation of life assurance companies, in sections 82 to 90 and Schedules 8 and 9. In particular, section 433 of the 1988 Act was repealed and replaced by section 82 of the 1989 Act. Section 82(1) provided:

"Where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D, then, in calculating the profits for any period of account, -

(a) there shall be taken into account as an expense (so far as not so taken into account apart from this section) any amounts which, in respect of the period, are allocated to or expended on behalf of policy holders or annuitants; and

(b) if, at the end of the period, the company has an unappropriated surplus on valuation, as shown in its return for the purposes of the Insurance Companies Act 1982, then, subject to subsection (3) below, the closing liabilities of the period may include such amount, forming part of that surplus, as is required to meet the reasonable expectations of policy holders or annuitants with regard to bonuses or other additions to benefit of a discretionary nature."

Section 82(2) defined the "allocation" of an amount to policy holders or annuitants as meaning the making of bonus payments, the declaration of reversionary bonuses or a reduction in the amount of premiums.

[128] The effect of subsection (1)(a) was that any amounts allocated to or expended on behalf of policy holders or annuitants were to be treated as an expense when computing profits under Case I. Although differently expressed, the practical effect, so far as such amounts were concerned, appears to have been the same as under section 433 of the 1988 Act. Subsection (1)(a) did not however apply to the other amounts formerly governed by section 433, namely amounts reserved for policy holders or annuitants. The treatment of such amounts was addressed by subsection (1)(b): any part of an unappropriated surplus which was required to meet the reasonable expectations of policy holders or annuitants with regard to bonuses or other discretionary benefits could be taken into account as a liability in calculating the profits.

[129] It appears from its terms, considered against the background of the difference of opinion described in the 1988 consultation document, that section 82 was designed to preserve the general effect of section 433 of the 1988 Act, but to resolve the difficulty of interpretation which had arisen in relation to amounts "reserved" for policy holders. Subsection (1)(b) relaxed the strictness of the approach adopted in subsection (1)(a) in so far as it opened up the possibility of relief in respect of unappropriated surplus, but the tying of that relief to a requirement to meet reasonable expectations limited the extent of the relaxation. The availability of this relief ensured, in particular, that companies which did not maintain an investment reserve in the form of a line 51 amount, but took all investment appreciation into account immediately in Form 40 and then reserved part of the resulting surplus, were not placed at a disadvantage by being taxed on the whole of the surplus: the Case I profit could be reduced by such part of the surplus as was reasonably retained in order to pay future bonuses.

[130] Section 83(1) and (2) provided:

"(1) Where the profits of an insurance company in respect of its life assurance businesses are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D, then, so far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), namely, -

(a) the company's investment income from the assets of its long-term business fund, and

(b) any increase in the value (whether realised or not) of those assets,

shall be taken into account as receipts of the period; and if for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period.

(2) Except in so far as regulations made by the Treasury otherwise provide, in subsection (1) above 'brought into account' means brought into account in the revenue account prepared for the purposes of the Insurance Companies Act 1982."

The remaining provisions of section 83 were of a transitional character.

[131] Particularly when viewed against the background of the circumstances described in the 1988 consultation document, the purpose of section 83(1) and (2) appears to me to be reasonably clear. Subsection (1)(a) broadly reflected the previous law, although the references to the long-term business fund and to the revenue account (that is, Form 40) were new. Subsection (1)(b) addressed the problems arising from the leaving out of account of unrealised gains in the computation of taxable profit, when they had been taken into account by the company in ascertaining its surplus. The effect of subsection (1)(b), taken together with subsection (2), was to treat as a chargeable receipt any increase in the value of the assets of the long term business fund, whether realised or not, which was brought into account in Form 40. In other words, the basis of charge in respect of life office investment gains became their recognition in the revenue account, rather than their realisation, as was the ordinary basis of charge under tax law. The words "and not otherwise", in subsection (1), made it clear that the investment income and gains were only to be taken into account as receipts of a period under that provision, and therefore only as brought into account in Form 40.

[132] Following the 1989 Act, the starting point in the calculation of a Case I profit was the office's actuarial surplus for the year (that is, the entry in Form 58 for "surplus arising since the last valuation"), less the surplus allocated to policy holders, plus any other sources of profit not included in the surplus. The tax charge was based on the taxable elements from which the surplus was composed: that is to say, the premiums, investment income and investment gains brought into account in Form 40, less claims, surrenders and expenses (also shown in Form 40) and increases in mathematical reserves.

[133] The 1989 Act did not define the expression "long-term business fund". That omission was rectified by Schedule 6 to the Finance Act 1990. Paragraph 1(2)(b) amended section 431 of the 1988 Act so as to insert the following definitions:

"'long term business' has the meaning given by section 1(1) of the Insurance Companies Act 1982;

'long term business fund' means the fund maintained by an insurance company in respect of its long term business".

The Finance Act 1995

[134] During 1993 the Revenue began a further review of the taxation of the life assurance industry. A number of measures which were then identified as necessary were introduced in the Finance Bill of 1995. In March 1995 the Government issued a press release giving notice of further provisions which it intended to introduce by way of amendment of the Bill and which would apply with retrospective effect. In due course, the amendments in question were approved without discussion.

[135] The provision of the Finance Act 1995 which is of particular relevance to the present case is paragraph 16 of Schedule 8, to which effect was given by section 51. Paragraph 16 substituted for section 83 of the 1989 Act a new section 83 and, in addition, section 83A.

[136] The new version of section 83(1) and (2) provided:

"(1) The following provisions of this section have effect where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D.

(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -

(a) the company's investment income from the assets of its long term business fund, and

(b) any increase in value (whether realised or not) of those assets.

If for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period."

Subsections (1) and (2) are similar to the 1989 version of subsection (1). The only difference which might be of significance is that the new subsection (2)(a) refers to "any increase in value (whether realised or not) of those assets", whereas the 1989 version referred to "any increase in the value (whether realised or not) of those assets" (emphasis added). The omission of the definite article does not appear to make any difference to the sense. In each version, the subsection is concerned with an increase in value (or the value) of "those assets", that is, the assets of the long term business fund. The meaning of the 1995 version of section 83(1) and (2) therefore appears to be the same as that of the 1989 version of section 83(1). That conclusion, derived from the language of the statute, is fortified by the absence of any other indication of an intention to alter the effect of that part of section 83.

[137] The 1995 version of section 83 also introduced a new subsection (3):

"(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business any amount transferred into the company's long term business fund from other assets of the company, or otherwise added to that fund, shall be taken into account, in the period in which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above.

This subsection does not apply where, or to the extent that, the amount concerned -

(a) would fall to be taken into account as a receipt apart from this section,

(b) is otherwise taken into account under subsection (2) above, or

(c) is specifically exempted from tax."

[138] As I have mentioned, the 1995 Act also introduced a new section 83A, which provided a definition of the expression "brought into account" for the purposes of section 83, replacing the provision previously contained in the 1989 version of section 83(2). The expression was again defined so as to refer to the revenue account, that is to say Form 40.

[139] Returning to section 83(3), the first notable feature of this provision is that it applies only "in ascertaining whether or to what extent a company has incurred a loss". As I have explained, the Case I computation is also relevant to the ascertainment of taxable profits: even if the profits are assessed on the I minus E basis, the relevant figure cannot be less than the annual profits as ascertained under Case I. Why, then, does section 83(3) apply only to the ascertainment of losses? The explanation cannot be, as was suggested in argument, that the ascertainment of the Case I profits of a life assurance business is in practice of little relevance: if that were so, section 82 would scarcely be necessary; nor would it explain why section 83(3) (and that subsection alone) is confined to the ascertainment of losses. The reasonable inference is that section 83(3), in its 1995 form, was intended to address a problem which had been identified specifically in relation to losses.

[140] Secondly, the provision applies to "any amount transferred into the company's long term business fund from other assets of the company, or otherwise added to that fund". That amount, unless otherwise taxable or exempt from tax, "shall be taken into account, in the period in which it is brought into account", as a taxable receipt. The meaning of the latter phrase is explained by section 83A: the amount is brought into account in a given period when it is entered in the revenue account (Form 40) for that period. The meaning of the earlier phrase, "any amount transferred into the ... fund from other assets of the company, or otherwise added to that fund", is less clear. One possible interpretation is that the addition of an amount to the fund is simply another way of describing the bringing of that amount into account in Form 40. On that construction, the 1995 version of section 83(3) means that when an amount is brought into account in Form 40, it shall be taken into account as a taxable receipt for the accounting period in question, to the extent necessary to avoid or reduce a tax loss. The other possible interpretation is that any amount which the company adds to the assets of the fund is an amount added to the fund, whether or not it is at that time brought into account in Form 40. On that construction, the 1995 version of section 83(3) means that an amount which the company has added to the assets of the fund is to be taken into account as a taxable receipt for the accounting period in which it is brought into account in Form 40, to the extent necessary to avoid or reduce a tax loss. The difference between these interpretations is of importance because, in practice, amounts added to the assets of the fund may not be entered at that time in Form 40, but may be reflected in the difference between the value of the assets and the liabilities, as entered in line 51 of Form 14. As will appear, the choice between these alternative interpretations, in the context of the similar wording of the 1996 version of section 83(3), is of critical importance to the outcome of this appeal.

[141] In support of the first alternative - that the words in question refer to the bringing of an amount into account in Form 40 - it can be argued that the 1982 Act draws a distinction between the fund and the assets representing the fund. As I have explained, however, the assets representing the fund are treated in the 1982 Act and in the subordinate legislation as being, for some purposes at least, equivalent to the fund: in effect, as its concrete embodiment. It can also be argued, with perhaps greater force, that the first alternative is consistent with the terminology employed in Form 40, where the closing figure is described as the "fund carried forward"; and section 83(3) refers both to the fund and to Form 40. As has been explained, however, the Form 40 figure is both a figure at which the fund is stated and also a book value of the assets of the fund, the purpose of the figure being to recognise in the accounts part, but not the whole, of the actual surplus of the fund. There are on the other hand a number of indications in section 83(3) itself which, particularly when considered cumulatively, appear to me to suggest that it is the second alternative which is the correct interpretation of the words in question: that is to say, that an amount is added to the fund, within the meaning of section 83(3), when an amount is added to the assets of the fund.

[142] First, section 83(3) contrasts "the company's long term business fund" with "other assets of the company". The contrast appears to imply, in the first place, that the fund, as the term is used in section 83(3), is an asset, or a set of assets, of the company. A further point, related to the first, is that section 83(3) presumes that it is possible to identify the "other assets". That is indeed possible if the "fund" comprises the assets of the fund: all other assets of the company (such as the assets of the shareholders' fund, or of other funds) are then "other assets". If on the other hand the "fund" is simply an amount of money entered in the revenue account, how does one identify "other assets"?

[143] Secondly, it seems unnecessarily convoluted for Parliament to have referred twice in section 83(3), in different language ("added to that fund" and "brought into account"), to one and the same event. If these two expressions have the same meaning, section 83(3) could have been more economically drafted.

[144] Thirdly, on the first of the possible interpretations, the 1995 version of section 83(3) would mean that when an amount was brought into account in Form 40, it must be taken into account as a taxable receipt for the accounting period in question, to the extent necessary to avoid or reduce a tax loss, unless the amount were specifically exempted from tax. So construed, section 83(3) would effectively prevent a solvent life office from incurring a tax loss, regardless of circumstances: the office would have to show in Form 58 that its assets were adequate to cover its liabilities to policy holders (unless it were willing to incur the serious consequences of reporting a deficit); and, in order to do so, it would have to bring sufficient amounts into account in Form 40 to produce a large enough closing figure, which would then be carried to Form 58. Unless the amounts brought into account were specifically exempted from tax, they would be treated as taxable receipts regardless of their nature. It appears unlikely that a provision which went through Parliament without discussion was intended to have such draconian consequences. It also appears unlikely that Parliament would have decided on such an elaborate means of preventing solvent life offices from claiming tax losses, if that was the intended result.

[145] If, on the other hand, section 83(3) were interpreted as being concerned with amounts added to the assets of the fund from other assets of the company, or from other sources, then its effect would be somewhat less draconian. On that approach, it would apply where an amount was brought into account in Form 40 which was added to the assets of the fund from an external source, to the extent necessary to avoid or reduce a tax loss. The subsection would not however apply to other amounts. For example, a line 51 amount which arose as a consequence of a reduction in the mathematical reserves (if, for example, there was a change in mortality rates or in predicted inflation rates) would not be taxable, when brought into account in Form 40, on this interpretation of section 83(3); nor would an amount obtained by realising assets of the fund, net of any capital gain. So interpreted, the provision might, on the other hand, apply where a company acquired the business of another insurance company and introduced additional assets into its fund in order to match the additional liabilities; and, for reasons I shall explain in the context of the 1996 Act, there are reasons why such a provision should apply in that situation. The 1995 version of section 83(3) was not however confined to transfers of business or directly analogous situations. It is not altogether surprising if, as we were informed, the width of section 83(3) in its 1995 form caused concern in the industry.

The Finance Act 1996

[146] In the event, new provisions governing life assurance business losses were enacted in Schedule 31 to the Finance Act 1996, to which effect was given by section 163. In particular, paragraph 4 of Schedule 31 substituted an amended version of section 83(3). In its 1996 version, section 83 provided:

"(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business in a case where an amount is added to the company's long term business fund as part of or in connection with -

(a) a transfer of business to the company, or

(b) a demutualisation of the company not involving a transfer of business,

that amount shall (subject to subsection (4) below) be taken into account, for the period for which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above.

(4) Subsection (3) above does not apply where, or to the extent that, the amount concerned -

(a) would fall to be taken into account as a receipt apart from this section,

(b) is taken into account under subsection (2) above otherwise than by virtue of subsection (3) above, or

(c) is specifically exempted from tax."

[147] Certain expressions used in the amended section 83(3) were defined in other provisions. In particular, section 83(6) provided:

"(6) In subsection (3) above 'transfer of business' means -

(a) a transfer of the whole or part of the long term business of an insurance company in accordance with a scheme sanctioned by a court under Part I of Schedule 2C to the Insurance Companies Act 1982 ..."

Section 83(8) provided:

"In this section -

'add', in relation to an amount and a company's long term business fund, includes transfer (whether from other assets of the company or otherwise) ..."

[148] Provisions designed to prevent the avoidance of section 83(3) by "pre-funding" (i.e. bringing into account an addition to the fund which exceeds any loss for that year but will cover subsequent losses) were also introduced by paragraph 5 of Schedule 31, in the form of sections 83AA and 83AB of the 1989 Act. These provisions are complex, but in broad terms allowed the amount brought into account to be carried back to the final accounting period of the transferor, or forward to successive accounting periods of the transferee, reducing losses until it was exhausted.

[149] The 1996 version of section 83(3) has much in common with the 1995 version. Like its predecessor, it applies only "in ascertaining whether or to what extent a company has incurred a loss", and is therefore presumably intended to address a problem which had been identified specifically in relation to losses. Like its predecessor, it applies to an "amount ... added to the company's long term business fund"; and although the 1996 version of section 83(3) does not itself refer to an amount "transferred", or require that the amount be added "from other assets of the company, or otherwise", the same effect is achieved by defining "add", in section 83(8), so as to include "transfer (whether from other assets of the company) or otherwise". The 1996 version also follows its predecessor in providing that the amount in question "shall ... be taken into account, for the period for which it is brought into account", as a taxable receipt. As in the 1995 Act, therefore, the 1996 version refers first to the addition of an amount to the fund, and secondly to the bringing of the amount into account in Form 40. The only difference between the 1995 and 1996 versions is that, in the latter, the scope of section 83(3) is confined to amounts added to the fund "as part or in connection with" a transfer of business to the company or a demutualisation of the company.

[150] The alternative interpretations of section 83(3) which were discussed in the context of the 1995 version - whether, that is to say, the addition of an amount to the fund is another way of describing the bringing of an amount into account in Form 40, or is a distinct event (namely, the addition of an amount to the assets of the fund) - take on particular importance in relation to the restriction imposed in 1996. On the former interpretation, section 83(3) only applies to an amount which is brought into account in Form 40 as part of, or in connection with, a transfer of business or demutualisation, whereas on the latter interpretation it applies to any amount which was added to the assets of the fund as part of or in connection with a transfer of business or demutualisation, when that amount is brought into account in Form 40 (as it must be, sooner or later, if it is to benefit policy holders or shareholders), whether or not it is brought into account as part of or in connection with the transfer or demutualisation. The difference is of practical importance because amounts may be added to the assets of the fund, in the context of a transfer of business, without being brought into account in Form 40: if, for example, the transferor company has surplus assets which are not required to match the liabilities acquired on the transfer (that is to say, an investment reserve), the surplus assets may simply be added to the investment reserve of the transferee company. As will appear, that is essentially what happened in the present case. If there is then a lapse of time between the transfer of business and the bringing of the surplus into account in Form 40, it may be possible to argue on the first interpretation, but not on the second, that the addition of the amount to the fund is not "part of, or in connection with" the transfer, and that the amount brought into account in Form 40 is therefore not chargeable. Put shortly, that is the argument for the appellants in the present appeal.

[151] I have explained, in relation to the 1995 Act, why I consider that the addition of an amount to the fund is different from the bringing of an amount into account in Form 40. It appears to me that the 1996 version of section 83(3) should be interpreted in the same way, for the following reasons.

[152] First, if Parliament used a form of words in the 1995 version of section 83(3) with a particular meaning - specifically, if the words "amount ... added to [the] fund" were used in the 1995 version to refer to the addition of an amount to the assets of the fund, whether or not brought into account at that time in Form 40 - and the same words are used in the amended version of 1996, it is reasonable to presume that the same meaning was intended, in the absence of any clear indication to the contrary.

[153] Secondly, and in any event, most of the reasons for preferring that construction of the 1995 version of section 83(3) apply equally to the 1996 version. The argument based on the contrast drawn in section 83(3), read with section 83(8), between the fund and "other assets", remains valid. So also does the argument based on the unlikelihood of Parliament's having used two different expressions in a single subsection in order to refer to the same event.

[154] Thirdly, this interpretation is supported by the terms of certain of the anti-avoidance provisions in section 83AA. It is relevant to note in particular section 83AA(3), which refers to

"... a period of account ... for which there are brought into account one or more relevant amounts which were added to the company's long term business fund as part of, or in connection with, a particular transfer of business" (emphasis added).

The expression "relevant amount" is defined by section 83AA(2) as meaning "any amount which is added to the long term business fund of a company as mentioned in subsection (3) of section 83", subject to the exclusion of amounts falling within section 83(4). The apparent implication of the use of the different tenses in section 83AA(3) is that the addition of an amount to the fund can precede the bringing of the amount into account: they can be distinct events.

[155] As against these considerations, it was argued that that interpretation of section 83(3) could not reflect Parliament's intention, as it would not confine the scope of the provision to artificial losses. This argument however assumes in the first place that section 83(3) is intended to apply only to "artificial" losses, and it begs the question of how the artificiality of a loss is to be assessed. In this context, it is necessary to consider why transfers of business and demutualisations receive special treatment.

[156] In order to understand why legislation concerned with the ascertainment of losses should focus particularly upon transfers of business and demutualisations it is necessary to consider again how the Case I computation is carried out. As I have explained, the starting point is the actuarial surplus arising since the last valuation. That figure then requires to be adjusted so as to arrive at the taxable profit. That is because certain of the receipts and outgoings which have been entered in Form 40, and which have therefore contributed to the surplus, may not be chargeable or deductible, as the case may be. A different way of describing the same computation, which may make the point somewhat clearer, is that the taxable profit depends essentially upon a calculation of the change in the mathematical reserves, on the one hand, and the chargeable or deductible amounts brought into account in Form 40, on the other hand.

[157] In the absence of section 83(3), transfers of business and demutualisations present an opportunity for the cost of acquiring new business to be offset by tax losses. In the most simple situation, the transferee company will incur a cost which reflects the value of the assets acquired from the transferor, less the liabilities. The liabilities will be deductible for tax purposes, as an increase in the mathematical reserves. Unless the assets are treated as chargeable receipts, as and when they are brought into account in Form 40, the Case I computation may be distorted as a result of the transfer, so as to create apparent losses. Any loss which results can then be used to offset profits (in another accounting period, or in another member of the same group of companies), so ensuring in effect that the acquisition of the new business is partly funded by the taxpayer.

[158] The point may be made clearer by a numerical example. If company A has assets of £22 billion and liabilities of £17 billion, it has an investment reserve of £5 billion. Company B may pay £6 billion to acquire its business. Company B then adds £22 billion to the assets representing its fund, and brings £17 billion into account in Form 40 during that year in order to match the amount by which its mathematical reserves have increased. Plainly, the £17 billion brought into account should be treated as a taxable receipt: otherwise, the transfer would result in a colossal tax loss, and the acquisition would be paid for by the taxpayer. Over the following years, the company brings into account the remaining £5 billion of assets which it acquired on the transfer, in order to match its liabilities. Unless the £5 billion is treated as a taxable receipt, the company will have tax losses, arising from its liabilities, which can be set against group profits. The £6 billion which it cost to acquire the business will be reduced by the tax saved, and the taxpayer will part-finance the acquisition.

[159] A demutualisation can give rise to a similar type of problem. If a mutual office were to demutualise, and an outside concern became the shareholder, that shareholder would have to compensate the departing members for the loss of their rights. It would ordinarily do so by declaring a special bonus, the amount of which would reflect the excess of the mutual society's assets over its liabilities. The bonus would be deductible, but the amount brought into account in order to fund it would not necessarily be chargeable, in the absence of section 83(3). The shareholder would thus create a tax loss which it could use to offset its own profits. The consequence would be that the new owner would be given a tax deduction for the cost of acquiring the business. As in relation to transfers, it should be emphasised that this is a simplified example. It is possible to envisage more elaborate arrangements, in relation to both transfers and demutualisations, such as occurred in the present case.

[160] A special feature of transfers and demutualisations is thus that they present an opportunity for the creation of tax losses which can be used to offset the cost of the acquisition of business, effectively passing on part of the cost to the taxpayer. In each case, the loss can arise because the acquisition involves an increase in the company's liabilities which is deductible in the Case I computation, and also an addition to the fund which, in the absence of section 83(3), may not be chargeable when it is brought into account to match deductible liabilities (whether those are the liabilities acquired on the transfer, or other liabilities). Since section 83(3) is concerned specifically with the ascertainment of losses in a Case I computation, and with otherwise non-chargeable additions to a company's long term business fund as part of, or in connection with, a transfer of business or demutualisation, it can be inferred that it was intended to address this problem.

[161] The purpose of section 83(3), put shortly, is therefore to prevent the transferee company from using a tax loss to offset the cost of acquiring the new business, by treating (so far as necessary to prevent a tax loss from arising) the amounts added as part of, or in connection with, the transfer as chargeable receipts as and when they are brought into account in Form 40. That would be the practical effect of section 83(3) if (and only if) it were interpreted in the manner which I have suggested. On the interpretation advanced by the appellants, section 83(3) would not apply to amounts taken directly to investment reserve (i.e. additions to the fund which are reflected in Form 13 and in line 51 of Form 14, but are not entered in Form 40), as part of or in connection with a transfer, unless the subsequent bringing of those amounts into account in Form 40 was itself "part of or in connection with" the transfer of business (since it would only be the subsequent bringing of the amounts into account in Form 40 which, on that interpretation, would constitute the addition of an amount to the fund). If on the other hand the 1996 version of section 83(3) were interpreted in the same way as the 1995 version, for the reasons which I have explained, then amounts taken directly to investment reserve, as part of or in connection with a transfer, would always (unless exempt from tax) be treated as chargeable receipts if they were subsequently brought into account in Form 40 and a loss would otherwise occur. The practical effect is that the transferee company could not make a tax loss so long as it was bringing into account part of the value which it had acquired as part of, or in connection with, the acquisition: in other words, it could not have the acquisition partly funded by the taxpayer. This interpretation is consistent with the purpose of section 83(3), as I understand it.

[162] So construed, section 83(3) can be described as countering artificial losses, if one wishes to use that language. The losses are not, however, necessarily artificial in the sense that the liabilities taken into account in the period in question arise otherwise than through normal patterns of business. The "artificiality", or objectionability, of the loss arises from the fact that the company can use it to offset the cost of acquiring business, in a situation where the liabilities which it acquired are tax-deductible, but the assets which it acquired - and which it is bringing into account in order to cover the loss - are (apart from section 83(3)) not a chargeable receipt.

[163] I have not yet referred to the Parliamentary and other materials produced by the appellants. Counsel for the appellants was permitted to refer to these de bene esse, in support of his submissions. They have been set out fully by your Lordship in the chair. I do not wish to take up time, in an already long opinion, in discussing their admissibility as an aid to interpretation, or in a consideration of their contents. In general, even assuming their admissibility, they appear to me to be of no material assistance, and in some cases potentially misleading. They are no substitute for a close analysis of the text of section 83(3) itself, in its 1995 and 1996 versions, and of the related provisions.

Other developments

[164] It is necessary, in relation to the legislation, to note certain other developments. First, in relation to the regulatory returns, the 1983 Regulations were revoked and replaced by the 1996 Regulations. So far as material to the present case, these were similar to the 1983 Regulations, subject to a small number of changes. In particular, the instructions for the completion of Form 40 required that "value re-adjustments on investments and gains on the realisation of investments" - that is to say, realised or unrealised increases (or reductions) in the value of assets of the long term business fund which were brought into account - should be shown in lines 13 ("Increase (decrease) in the value of non-linked assets brought into account") or 14 ("Increase (decrease) in the value of linked assets") as appropriate. The instruction was predicated on the ability of life offices to identify whether amounts added to the fund were attributable to realised or unrealised gains on their assets.

[165] Secondly, in relation to the valuation rules governing the completion of the regulatory returns, the 1981 Regulations were revoked and replaced by the Insurance Companies Regulations 1994 (SI 1994 No. 1516), which were, so far as material, in similar terms. In particular, Regulation 45(6) permitted an insurance company to assign a book value to assets for the purposes of the actuarial investigation.

[166] Thirdly, the regulatory framework as a whole was altered by the Financial Services and Markets Act 2000, which came into force on 1 December 2001. The Insurance Companies Act 1982 was then repealed. The 2000 Act established the FSA as the regulator of all financial services. Rules made by the FSA under the Act, including those contained in the Interim Prudential Sourcebook (Insurers) Instrument 2001, otherwise known as IPRU (INS), replaced the previous legislation governing the statutory returns and the valuation of assets, including the relevant provisions of the 1982 Act, the 1994 Regulations and the 1996 Regulations. These changes generally took effect for periods ending on or after 1 December 2001. The present case is concerned with the appellants' accounting periods ending on 31 December 2000, 2001 and 2002. The new rules therefore applied to the latter two periods. The rules governing the FSA returns for 2001 and 2002 were however little changed from those governing the return under the 1982 Act for the year 2000. In particular, IPRU (INS) retained (in Rule 9.10(c)) the previous rule permitting insurers to assign a book value to assets for the purposes of the actuarial investigation. Appendix 9.1 set out Forms 13 and 14 with the relevant instructions. Forms 40 and 58 were set out in Appendices 9.3 and 9.4 respectively. The forms and their instructions appear, so far as material, to be the same as in the 1996 Regulations, apart from some minor changes in terminology. Consequential changes were also made to the tax legislation, so as to amend references to the regulatory legislation. In particular, section 82 was amended so as to refer to the return deposited with the FSA, and section 83A was amended so as to refer to the revenue account prepared for the purposes of IPRU (INS). Minor amendments were also made to section 83, so as to refer to "long-term insurance" rather than "long term business". These amendments, made by the Financial Services and Markets Act 2000 (Consequential Amendments) (Taxes) Order 2001 (SI 2001 No. 3629), had effect in relation to the appellants' accounting periods ending on 31 December 2001 and 2002. It was common ground at the hearing of the appeal that none of these alterations of the law was of significance to the present case.

[167] Accordingly, subject to the minor amendments just mentioned, the form in which section 83(2) and (3) stood at the time of the returns with which the present case is concerned was as follows:

"(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -

(a) the company's investment income from the assets of its long term business fund, and

(b) any increase in value (whether realised or not) of those assets.

If for any period of account there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period.

(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business in a case where an amount is added to the company's long term business fund as part of or in connection with -

(a) a transfer of business to the company, or

(b) a demutualisation of the company not involving a transfer of business,

that amount shall (subject to subsection (4) below) be taken into account, for the period for which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above."

As I have explained, subsection (2) was in the form substituted by the 1995 Act, and was virtually unchanged from the 1989 version (the only difference being the omission of the definite article before "value" in paragraph (b)). Subsection (3) was in the form substituted by the 1996 Act.

[168] Finally, in relation to the legislative history, it is relevant to note that sections 82 and 83 of the 1989 Act underwent further amendment in the Finance Act 2003, subsequent to the period with which the present case is concerned. In particular, a new section 83(2) was substituted by paragraph 2(2) of Schedule 33:

"(2) There shall be taken into account as receipts of a period of account amounts (so far as referable to that business) brought into account for the period of account as -

(a) investment income receivable before deduction of tax,

(b) an increase in the value of non-linked assets,

(c) an increase in the value of linked assets, or

(d) other income;

and if amounts (so far as so referable) are brought into account for a period of account as a decrease in the value of non-linked assets or a decrease in the value of linked assets they shall be taken into account as an expense of the period of account."

Paragraphs (a) to (d) corresponded precisely to lines 12 to 15 of Form 40. The consequence was to require that amounts brought into account in lines 12 to 15 must be treated as chargeable receipts. The difference between the pre-2003 version and the 2003 version is that the former required "any increase in value" of the assets of the long-term insurance fund, "as brought into account", to be treated as a taxable receipt, whereas the latter required "amounts ... brought into account ... as" inter alia "other income" to be so treated. The earlier version, in other words, required there to be an increase in value which was brought into account, whereas the latter version merely required that an amount be brought into account under a specified description in the account: the tax treatment of an amount was tied to its treatment in the regulatory return, rather than depending on an assessment of its inherent character. Section 83(3) of the 1989 Act was also amended, by paragraph 2(3) of Schedule 33 to the 2003 Act, so as to refer to "a case where assets are added to the company's long term business fund" (rather than "a case where an amount is added ..."): an amendment which appears to me to have been intended to clarify, rather than to alter, the meaning of the provision.

The facts of the present case
The transfer of business
[169] The Scottish Widows' Fund and Life Assurance Society ("the Society") carried on business as a mutual office from 1814. It maintained a single long term business fund. In 1999 it entered into an agreement with Lloyds TSB Group plc, the ultimate parent company of the Lloyds TSB group of companies, for the transfer of its business to two subsidiaries of the group, in accordance with a scheme of transfer to be sanctioned by the court. Three companies incorporated in 1999 were acquired off the shelf by the Lloyds TSB group for the purposes of the transfer: the appellants, their parent company Scottish Widows Financial Services Ltd ("the Parent Company"), and their subsidiary company Scottish Widows Annuities Ltd ("the Subsidiary Company"). The scheme of transfer required the sanction of the court in accordance with section 49 of, and Part I of Schedule 2C to, the Insurance Companies Act 1982. That sanction was granted on 28 February 2000, and the scheme came into effect on 3 March 2000. The assets and liabilities of the Society were transferred to the appellants on that date, with the exception of certain without-profits pension business which was transferred to the Subsidiary Company.

[170] Certain features of the scheme require to be noted. The membership rights of the Society's existing members were to cease on the Effective Date (3 March 2000), and the appellants were then to become the sole member of the Society (paragraph 38). Lloyds TSB Group plc was to pay or procure the payment of compensation to the Society's members for the loss of their membership rights (paragraph 12). The amount of the compensation was based primarily on the Society's surplus capital (that is, the extent by which the market value of the assets representing the long term business fund exceeded the mathematical reserves: in effect, the investment reserve), plus an amount in respect of goodwill, subject to certain adjustments. Had there been a dissolution of the Society, its surplus assets would have been distributed among its members. In the event, the compensation was calculated as £5,849 million. That amount was paid to the members by the Parent Company. The funds were provided to the Parent Company by the Lloyds TSB group by a contribution of capital in exchange for the issue of shares in the Parent Company. The payment of that compensation enabled the appellants and the Subsidiary Company to acquire the Society's business.

[171] The scheme also provided for the establishment of a Long Term Fund of the appellants (i.e. a long term business fund), with two sub-funds, a With Profits Fund and a Non Participating Fund (paragraph 13). The appellants' liabilities under existing policies which were transferred to them were allocated between those two sub-funds, principally by reference to whether the benefits were with-profits (paragraph 14). The appellants' assets and other liabilities were also divided between the two sub-funds, with the exception of goodwill, intellectual property rights and shares in subsidiaries, which were allocated to a Shareholders' Fund outside the Long Term Fund (paragraphs 15 and 16). The surplus arising on the With Profits Fund was to be applied for the benefit of the with-profits policy holders, apart from one-ninth of the surplus, which was to be allocated to the Shareholders' Fund or the Non Participating Fund, as the directors might determine (paragraph 18).

[172] The scheme also required the appellants to maintain a memorandum account designated as the Capital Reserve. The scheme stated that the Capital Reserve would, on 3 March 2000, "represent the amount of the shareholders' capital held within the Long Term Fund" (paragraph 22.1). The amount of the Capital Reserve as at 3 March 2000 was the amount by which the market value of the assets transferred from the Society to the Long Term Fund exceeded the liabilities transferred. That amount was determined to be £4,455 million. The Capital Reserve could not be increased after 3 March 2000, and could be decreased only by bringing amounts into account in the revenue account relating to either the With Profits Fund or the Non Participating Fund (paragraph 22.3). Part of the Capital Reserve was allocated to the With Profits Fund, and the remainder to the Non Participating Fund (paragraphs 22.4 and 22.5).

[173] The purpose of the memorandum account described as the Capital Reserve, as the Special Commissioners found, was to track the net value which had been acquired by the appellants, at the date of the transfer, in consideration of the compensation paid to the Society's members by the Parent Company. It appears to have been envisaged that that value might be returned to the appellants' shareholders by bringing it into account in Form 40 and distributing it as part of the actuarial surplus brought out by Form 58. The memorandum account thus takes as an opening figure the excess of the assets representing the Long Term Fund over liabilities as at 3 March 2000 (i.e. the investment reserve at that date), and records the extent to which that excess has been brought into account in Form 40.

[174] Applications for clearance of the scheme were granted by the Revenue under sections 138, 139 and 211 of the Taxation of Chargeable Gains Act 1992 and section 444A of the 1988 Act. It was not suggested by either party to the appeal that these clearances had any effect upon the application of section 83 of the 1989 Act. In particular, it was not suggested that they bore upon the value as at which the appellants were to be treated as having acquired the assets of the Society for the purposes of section 83.

[175] It is a matter of agreement between the parties that there was a decrease in the market value of the assets of the Long Term Fund established on the date of the transfer during each of the accounting periods with which this case is concerned. It is also agreed that there were decreases in each period in the amount by which the market value of the assets exceeded liabilities (i.e. the investment reserve). It is agreed that these decreases arose principally as a result of falls in the value of the stock market. It is agreed, for the purposes of this case, that the appellants have suffered Case I losses during these periods of about £29 million, £613 million and £431 million, unless the amounts which are in dispute, as explained below, are treated by virtue of section 83(2) or (3) as taxable receipts.

The FSA returns
(i) The 2000 returns
[176] In the Form 40 relating to the With Profits fund for the period to 31 December 2000, there was of course no entry in line 49 for "fund brought forward", as the fund had only come into existence on 3 March 2000. There therefore appeared in line 15 ("other income") a figure which included £15.9 billion described, in the accompanying notes, as "transfer in of assets to cover opening long term insurance liabilities". The corresponding figure for the Non-Participating Fund was £899 million. The total amount brought into account to cover opening liabilities was therefore £16.8 billion. There was also included in the line 15 figure for the With Profits Fund, again as explained in the notes, a figure of £33.410 million described as "Transfer from Capital Reserve". It was brought into account for the purpose of funding the shareholders' entitlement to one-ninth of the bonuses allocated to with-profits policy holders. The question which arises is whether that £33.410 million is a chargeable receipt by virtue of either section 83(2) or section 83(3).

(ii) The 2001 returns

[177] In the Form 40 return for the With Profit Fund for 2001, there was again included in line 15 ("other income") an amount which was described in the notes as "Transfer from Capital Reserve": this time, an amount of £30.724 million. As in 2000, it was brought into account for the purpose of funding the shareholders' entitlement to a share of the surplus. In the Form 40 return for the Non Participating Fund, there was included in line 15 an amount of £442 million, described as "Transfer from Capital Reserve". The question which arises is whether the £30.724 million and £442 million are chargeable receipts by virtue of either section 83(2) or section 83(3).

(iii) The 2002 returns

[178] In the Form 40 return for the With Profit Fund for 2002, line 15 included a "Transfer from Capital Reserves" of £17 million, again corresponding to the shareholders' share of surplus. In the Form 40 return for the Non Participating Fund, line 15 included a "Transfer from Capital Reserve" of £353 million. It appears from the evidence that that figure included £100 million which was transferred in order to anticipate the amendment of section 83 of the 1989 Act which was effected by the Finance Act 2003, as previously explained. The question again arises whether these amounts are chargeable receipts by virtue of section 83(2) or section 83(3).

The application of section 83(2)

[179] As I have explained, the effect of section 83(2) is to require any increase in value of the assets of the fund which is brought into account in Form 40 to be treated as a chargeable receipt. In the present case, the assets of the fund did not increase in value following the establishment of the fund on 3 March 2000: on the contrary, as has been explained, the assets fell in value during each of the accounting periods in question. The amounts which were brought into account in Form 40 under the description of "transfers from Capital Reserve" did not have their origin in, or reflect, any increase in the value of the assets of the fund. Their origin was the investment reserve which was created on 3 March 2000 by allocating to the fund assets whose total admissible value exceeded the liabilities of the long term business.

[180] The principal argument advanced on behalf of the Revenue, however, was that section 83(2) is not concerned with market value, and is therefore not concerned with actual losses and gains. Where there is a difference between the total value of the admissible assets as shown in Form 13, and the amount at which the long term business fund is entered in Form 40, this necessarily implies that the assets of the fund, taken as a whole, have been brought into account in Form 40 at a book value lower than their admissible value, as permitted by Regulation 45(6) of the 1994 Regulations. Section 83(2) is concerned with increases in the book value assigned to the assets of the fund. An increase in value of the assets of the fund within the meaning of section 83(2) can thus be brought into account in Form 40 without there being any gain, either realised or unrealised: indeed, the market value of the assets may have fallen. An increase in book value is nevertheless deemed by section 83(2) to be a taxable receipt; and such an increase is the inevitable consequence of a transfer from the investment reserve, since the transfer must be reflected in a revaluation of the assets.

[181] Put shortly, therefore, the Revenue's argument is that when section 83(2) refers to an "increase in value ... of those assets" (viz. "the assets of [the company's] long term business fund"), "as brought into account for a period of account", it is referring to an increase in the figure at which the fund is entered in Form 40. The implicit assumption, since Form 40 bears to show the amount of the fund rather than the value of the assets, is (as counsel for the Revenue submitted) that there is no relevant difference, in the context of Form 40, between the fund and the assets of the fund. Counsel for the appellants argued against that approach on the basis that the fund, and the assets representing the fund, are distinct statutory concepts. As I have explained, however, the 1982 Act, and the subordinate legislation concerned with the regulatory returns, treat the assets representing the fund as being effectively equivalent to the fund; and, in the context of the 1989 Act (as amended), the apparent implication of section 83(8) is that the fund comprises assets. Nevertheless, it appears to me that even if one accepts the initial step in the Revenue's argument - that the closing figure in Form 40 is a book value of the assets of the fund - there are compelling reasons for rejecting the Revenue's conclusions:

(1) The words "an increase of value ... of ... assets" are most naturally understood as referring to capital gains. Just as subsection (2)(a) is concerned with the investment income derived from the assets of the long term business fund, so subsection (2)(b) appears to be concerned with investment gains, realised or unrealised, arising in respect of those assets, so far as brought into account in Form 40. If section 83(2) had been intended to have the effect contended for, one would expect it to be differently expressed, for example by referring to an increase in the value assigned to the assets for the purposes of the actuarial investigation.

(2) The words "whether realised or not" in section 83(2)(b) imply that the increase in value is capable of realisation: that is to say, it will crystallise on a sale or other disposal of the asset in question. An increase in market (strictly, admissible) value is capable of realisation; an increase in book value is not. Those words are therefore a strong indication that section 83(2) is concerned with real gains rather than a change in notional values.

(3) On the Revenue's interpretation it is difficult to see what sense can be given to the words "or otherwise" in section 83(2), so far as they apply to increases in the value of assets. Since a revisal of a book value would not, in itself, otherwise be a taxable receipt, the Revenue's construction would appear to render those words otiose so far as paragraph (b) is concerned. Counsel for the Revenue was unable to suggest any meaning which might be given to them. If section 83(2) is concerned with investment gains, on the other hand, the words have an obvious meaning: they make it clear that the only basis on which such gains are taxable as receipts, for the purposes of Case I, is recognition in Form 40 (rather than, for example, realisation). Those words are therefore a further indication that section 83(2) is concerned with real gains.

(4) Section 83(2) refers to an increase in value which is "brought into account"; and those words are defined by section 83A as meaning "brought into account in ... a revenue account". The revenue account records various items of income and expenditure: those items can naturally be described as being "brought into account" in the account. Those words appear to me to be less apt to describe the overall effect of those entries, that is to say the change in the figure for the fund over the course of the year. That change is the overall result of the incomings and outgoings which have been brought into account, but is not itself something which would naturally be described as having been brought into account.

(5) The object of a Case I assessment, in the case of a life office as in the case of any other business, is to ascertain the true profit (cf. Southern Railway of Peru Ltd v Owen [1957] AC 334 at page 356 per Lord Radcliffe). It is consistent with that general aim that section 83(2)(b) should be construed as being concerned with real profits which have accrued by means of real increases in value, just as section 83(2)(a) is concerned with real profits which have accrued by means of real income. On the Revenue's construction, on the other hand, section 83(2) creates a statutory fiction, deeming there to be trading receipts where there are otherwise none.

(6) It appears from the background to the enactment of section 83(2), as previously explained, that it was intended to bring into account for tax purposes capital gains on investments, whether realised or unrealised, in so far as they were brought into account in Form 40.

[182] Counsel for the Revenue however submitted that any other construction of section 83(2) could not be correct, since it would have the consequence that the historical appreciation in the value of assets in the hands of the Society would escape taxation. This argument was disputed on behalf of the appellants on a number of bases. It was contended that, even if it were established that the Society's surplus was derived from an appreciation in the value of its investments, the surplus was net of the tax which had been assessed on the Society on the I minus E basis. The appreciation would not in any event have been taxable under section 83(2) in the hands of a mutual society, since such a society was not liable to assessment under Case I. The compensation paid to the members of the Society for the loss of their right to share in the surplus available on a dissolution of the Society, represented by the excess of the assets over the liabilities, had fallen within the scope of capital gains tax. Counsel for the Revenue contended however that in practice little tax had been recovered, since most payments of compensation had been covered by the annual exemption for capital gains.

[183] These arguments appear to me to be essentially beside the point: if the Revenue's construction of section 83(2) is inconsistent with the language of the provision, the present argument cannot affect that conclusion. In any event, the Revenue's argument disregards the fact that the Capital Reserve did not represent any past investment income or gains of the appellants. One taxpayer cannot be assessed to tax under Case I on the receipts of another taxpayer, in the absence of some provision entitling the Revenue to make such an assessment. Section 83(2) does not make any provision for such an assessment. It refers to "any increase in value ... of those assets", that is to say, "the assets of its [viz. the company's] long term business fund". The only increase in value of a given asset which is relevant is therefore an increase which accrued during a period when the asset formed part of the company's long term business fund. Increases in the value of an asset which accrued before the asset was acquired by the company do not fall within the scope of the provision. It is also relevant to note that section 444A of the 1988 Act provides for a number of matters relevant to taxation to be carried over to the transferee on a transfer of insurance business, including expenses of management and Case VI losses, but that it makes no provision for the tax treatment of the line 51 amount to be carried over.

[184] Counsel for the Revenue also argued that section 83(2) could not be concerned with actual gains, since it would be unduly onerous to require insurance companies to determine the actual gains brought into account. That argument was however not fully developed. The source of the difficulty, as I understand the argument, is that the extent to which the admissible value of the assets of the fund exceeds the amount of the fund as stated in Form 40 - the investment reserve - is the result of an accounting exercise, rather than a division of the assets themselves. One cannot say that a specific asset (or a specific proportion of its value) forms part of the investment reserve, whereas other assets (or a specific proportion of their value) are included in the amount of the fund: the assets as a whole represent the fund, but the excess of their value over the amount stated in Form 40 can be described as constituting a reserve. Since a "transfer" from that reserve is not a transfer of identifiable assets, one cannot determine the extent to which the amount transferred includes capital gains. That, as I understand it, is the argument. It seems to me to be correct up until the final step.

[185] As has been explained, life offices have to identify the specific assets representing the long term business fund, and the admissible value of those assets has to be determined each year for the purposes of Form 13. It would therefore seem to be possible in principle for records to be kept which would enable the company to determine the unrealised gains comprised in the admissible value of the assets, and to ascribe amounts added to the Form 40 amount of the fund to that source. In that regard, it is relevant to recall that the instructions accompanying Form 40 in the 1996 Regulations required unrealised increases in the value of investments to be shown in particular lines of the form, implicitly assuming that it was possible to determine the extent to which such increases in value had been brought into account. In the case of linked assets, such increases must in any case be brought into account.

[186] In the present case, the assets of the fund were acquired on 3 March 2000, when the appellants commenced trading. The excess value was not derived from any capital gains of the appellants, but arose from the fact that the assets which they acquired were greater in value than their liabilities. Since it is agreed that the assets declined in value thereafter, there is no suggestion that the transfers from the investment reserve could be regarded to any extent as being derived from capital gains of the appellants.

[187] In these circumstances, it is not apparent that an insurmountable difficulty arises, either in the present case or more generally, from the construction of section 83(2) which I favour. The contention that a difficulty would have arisen in practice was disputed by counsel for the appellants, and was unsupported by any evidence. In the circumstances, the contention cannot be accepted. I note that, even if a difficulty might have arisen from the correct construction of section 83(2), it was in any event resolved by the amendment effected by the 2003 Act.

The application of section 83(3)
[188] Section 83(3) applies "in a case where an amount is added to the company's long term business fund as part of or in connection with" a transfer of business to the company (or a demutualisation of the company, but that is an alternative which does not arise in the present case, since it was not the appellants that underwent demutualisation). In such a case, "in ascertaining whether or to what extent a company has incurred a loss ... that amount shall ... be taken into account, for the period in which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) ...".

[189] The argument submitted on behalf of the Revenue was that since the entire assets of the Society were transferred to the appellants on 3 March 2000 as part of the transfer (with the exception of the assets which were transferred to the Subsidiary Company), it followed that that entire amount (apart from the assets allocated to the Shareholders' Fund) had been added to the appellants' long term business fund on that date as part of the transfer. As and when any part of that amount was brought into account in Form 40, it therefore fell to be taken into account, in accordance with section 83(3), as a receipt falling within section 83(2). Each of the "transfers from Capital Reserve", as they were described, constituted the bringing of part of that amount into account in Form 40.

[190] On behalf of the appellants, on the other hand, it was submitted that the amount of the fund was the figure brought out by Form 40. The Revenue had failed to observe the distinction between the fund and the assets representing the fund. There was no distinction between the addition of an amount to the fund and the bringing of that amount into account in Form 40. It followed that the amounts in question had only been added to the fund when they were brought into account in Form 40. That had been done, not as part of or in connection with the transfer of business, but for reasons unrelated to the transfer of business. The addition of the amounts in question therefore fell outside the scope of section 83(3). That was consistent with the purpose of section 83(3), which was to prevent the creation of artificial losses: the appellant's losses had however arisen through normal patterns of business. In any event, section 83(3) could not apply to a transfer of assets to a newly established company such as the appellants, since there was no fund in existence prior to the transfer of business, and therefore nothing in being to which amounts could be "added" on the date of the transfer.

[191] I have come to the conclusion that the submissions on behalf of the Revenue are to be preferred, on the following grounds:

(1) For the reasons which I have explained in my discussion of the 1995 and 1996 Acts, it appears to me that the addition of an amount to the fund, within the meaning of section 83(3), is conceptually distinct from the bringing of that amount into account in Form 40: they can be distinct events, and can occur in different periods of account. It appears to me that that is the correct interpretation of the relevant words in the 1995 version of section 83(3), and it is to be presumed that the same meaning was intended when the same words were employed in the 1996 Act. That interpretation is also supported by a consideration of the terms of the 1996 version of section 83(3), and is consistent with section 83AA(3).

(2) The contention that section 83(3) is designed to prevent "artificial" losses does not advance matters unless one has a criterion of artificiality: it is plain that, since section 83(3) is designed to disallow tax losses which would otherwise arise, it must be concerned with losses which Parliament has decided ought not to be recognised. The appellants' contention, in reality, appears to be that section 83(3) is not intended to apply where liabilities resulting from normal patterns of trading are offset by amounts brought into account which were acquired on a transfer of business and are not otherwise chargeable. That contention is not in my opinion well-founded. As I have explained, the text of section 83(3) itself suggests that its purpose is to address a problem relating to the recognition of losses which arises specifically in the context of transfers of business and demutualisations. In the case of transfers, that problem, in broad terms, is that the liabilities acquired by the transferee are tax-deductible, whereas the amounts added to the fund as part of the transfer may not be chargeable when they are brought into account. In consequence, the cost of the acquisition may be offset by tax losses, and so met in part by the taxpayer. That problem can arise even if liabilities arise through normal patterns of business, if (as in the present case) the company then matches the liabilites by bringing into account amounts which it acquired on the transfer but which were not entered at that time in Form 40. Although the loss may reflect business difficulties, there are nevertheless understandable reasons why Parliament might consider that it should be disallowed.

(3) The argument that an amount cannot be added to the company's long term business fund if there is no fund already in being appears to me to be unconvincing. Parliament cannot have intended section 83(3) to be so narrowly construed, since on that view the operation of the provision could readily be avoided, even by existing life offices, through the use of new companies. The matter is put beyond doubt by section 83(8), which defines "add" as including "transfer."

[192] In the present case, the amounts in question formed part of the value of the assets which were transferred to the appellants as part of the transfer. In my opinion, they were added to the appellants' long term business fund, within the meaning of section 83(3), on the date of the transfer. When they were subsequently brought into account, they were therefore properly treated as chargeable receipts for the purpose of ascertaining whether or to what extent the appellants had incurred a loss in each of the periods in question.

Conclusion

[193] The question which the parties have referred for determination is:

"Whether in computing the Case I profit or loss of [the appellants] for the accounting periods ending in 2000, 2001 and 2002 amounts described the company as 'transfer from Capital Reserve' and included as part of the entries at line 15 of form 40 for each period fall to be taken into account in computing the profit or loss as the case may be".

For the reasons explained, I consider that that question should be answered in the affirmative, and that the appellants' appeal against the decision of the Special Commissioners should therefore be refused. The Revenue's cross-appeal, which was concerned with section 83(2), should also be refused.

FIRST DIVISION, INNER HOUSE, COURT OF SESSION
Lord President Lord Reed Lord Emslie	[2010] CSIH 47 XA31/08 OPINION OF LORD EMSLIE in the Appeal by SCOTTISH WIDOWS plc Appellants: against The Commissioners for Her Majesty's Revenue and Customs Respondents: under section 56A of the Taxes Management Act 1970 _______

Act: Johnston, Q.C.; Maclay Murray & Spens LLP

Alt: Tyre, Q.C., K Campbell; Solicitor (Scotland), HM Revenue & Customs

28 May 2010

Introduction

[194] I am greatly indebted to your Lordships for setting out in detail the legal and factual background to this appeal. For essentially the same reasons as have found favour with both of your Lordships, I am of opinion that the respondents' cross-appeal on the application of section 83(2) of the Finance Act 1989 (as amended) is ill-founded and must be refused. As regards section 83(3), however, I regret that I cannot share the conclusion which your Lordships have reached. In my judgment the appellants' contentions here are again to be preferred, and the decision of the Special Commissioners should therefore be reversed.

[195] Notwithstanding the detailed and complex background which your Lordships have summarised at some length, the issue for determination is first and foremost one of statutory construction. The parties are in dispute as to whether, in each of three consecutive years, part of the entry in line 15 of the appellants' Form 40 ("the revenue account") must be taken as falling within the proper scope of either sub-section (2) or (3) of section 83 of the Finance Act 1989 as amended. If so, the sum concerned would fall to be treated as a chargeable receipt for Schedule D Case I computation purposes, and thus as cutting down the amount of the transferable loss which would otherwise arise in the appellants' hands. It is true that, like other life insurance companies, the appellants are in practice assessed to tax on what is known as the "I ­‑ E basis" rather than under Case I of Schedule D. Nevertheless, a Case I computation is required in every case, either to enable any transferable loss to be identified in the appellants' favour notwithstanding the outcome of the I - E exercise, or alternatively to enable the respondents to elect to assess the appellants to tax under Case I instead. This long-established option was discussed by Lord President Inglis in Revell v The Edinburgh Life Insurance Company (1906) 5 TC 221, and now finds statutory expression in paragraph 84 of schedule 18 to the Finance Act 1998.

[196] The appellants maintain that, properly construed, neither of the disputed sub-sections applies to the challenged "transfers from Capital Reserve" which were included in line 15 of Form 40 for the years 2000, 2001 and 2002. Before the Special Commissioners their arguments succeeded under sub-section (2) but failed under sub-section (3), but since the respondents now cross-appeal on the former issue the whole matter is opened up before us for determination. Complications arise from the fact that substantial parts of the Special Commissioners' decision, especially those involving tabular examples and computations, are agreed by the parties to be erroneous. Further complications arise from the extent of disagreement as to (i) the validity of what may appear to be findings of fact at various points of the Special Commissioners' decision and (ii) the accuracy of some of the evidence which was led at the hearing before the Commissioners in December 2007. In the result I am content to follow the parties' approach in treating the disputed issues as if they arose before us for determination de novo.

[197] Since this appeal concerns the construction of tax legislation, certain fundamental rules, principles and presumptions may be thought to apply. First, as Lord Wilberforce explained in Vestey v IRC 1980 AC 1148 at page 1172D/E:

"Taxes are imposed upon subjects by Parliament. A citizen cannot be taxed unless he is designated in clear terms by a taxing Act as a taxpayer and the amount of his liability is clearly defined."

Second, in the absence of specific charging provisions, capital and capital receipts do not fall to be taxed as revenue and vice versa. Third, corporation tax being an annual tax on the profits of a company, it is prima facie reasonable and appropriate to construe statutory charging provisions as directed towards real receipts and gains "... in a sense which no commercial man would misunderstand": Gresham Life Assurance Society v Styles 1892 AC 309, per Lord Halsbury LC at page 315. And fourth, as reflected in countless provisions of the taxing statutes, a subject is in general assessable to tax on his own profits and gains, and not on those of any third party. With regard to the third of these principles, it is true that section 42(5) of the Finance Act 1998 now bears to disapply "true and fair view" accounting principles in ascertaining the profits of life insurance businesses, but the point here is simply that in the absence of any clear contrary indication, express or implied, Parliament should not lightly be taken to have intended to tax a subject (or conversely to deny recognition to genuine business losses) by reference to notional receipts and gains having no existence in real life.

[198] With such general considerations in mind, I believe that the issues in this appeal can be determined on fairly broad grounds by reference to the parties' competing submissions before us. The essential facts and circumstances may, as it seems to me, be briefly summarised as follows:

(i) When the life insurance business of the Scottish Widows Fund and Life Assurance Society was, in early 2000, acquired by the Lloyds TSB Group of companies, the Society's members had to be compensated for the loss of the distribution rights which they would otherwise have enjoyed relative to its contributed business fund.

(ii) As part of the relevant scheme, such compensation totalling more than £5 billion was paid by the appellants' parent company. This permitted the appellants (as a newly-acquired subsidiary within the Lloyds TSB Group) to acquire the Society's whole assets and liabilities without further consideration. The precise amounts are not material, but the liabilities amounted to some £17 billion, and the surplus of assets over that figure was just over £4.5 billion. At the time of the transfer, the Society had (with limited exceptions) paid all tax due, and it was a matter of agreement that the transfer itself gave rise to no further tax liability on its part. The Society would not in any event have been assessed to tax under Case I of Schedule D.

(iii) Under the terms of the scheme, the transfer of assets and liabilities was to result in the creation of the appellants' long term business fund, divided between "with profits" and "non-participating" policy business, and in relation to a substantial proportion of the surplus assets (amounting to more than £4.4 billion) there was to be set up a memorandum account to be known as the "Capital Reserve".

(iv) In reality, this Capital Reserve had no separate physical existence from the surplus or "investment reserve" forming part of the assets representing the fund, and was designed merely to keep "shareholders' capital" distinct from the appellants' subsequent commercial activities and from any potential tax liabilities arising in that connection. For this reason the Capital Reserve could never be increased, and in terms of the scheme no reduction could take place other than by bringing sums into account in the appellants' revenue account (Form 40).

(v) The Capital Reserve was thus earmarked for the ultimate benefit of the appellants' shareholding parent company, and (as agreed between the parties) no-one intended or envisaged that it would ever have to be deployed to cover future trading losses.

(vi) In the event, however, the appellants suffered a substantial fall in the value of their invested assets in each of the next three years. In order to facilitate the required demonstration of solvency for various regulatory purposes, they introduced a "transfer from Capital Reserve" into line 15 of the Form 40 revenue account for each of the years in question. For the year to 31 December 2000, the amount concerned was £33,410,000, and for the two succeeding years the sums totalled £470,724,000 and £370,000,000 respectively. The latter sums were split between the "with profits" and "non-participating" sub-funds.

(vii) Line 15 of the Form 40 revenue account for 2000 also contained, as a normal accounting entry, the sum of approximately £16.8 billion which directly matched the actuarial value of the initial liabilities acquired from the Society. This was not expressed as coming from the Capital Reserve, and parties were agreed that the figure of £16.8 billion fell to be treated as a chargeable receipt for Case I computation purposes. According to the appellants, this resulted from the application of ".... orthodox general principles of commercial accounting" whereby opening liabilities had to be matched by an equivalent amount of opening capital. The respondents, on the other hand, maintained that it was section 83(2) alone which rendered that sum a receipt. Neither party sought to rely on section 83(3) in that connection.

(viii) Broadly similar contentions were advanced with reference to certain entries in line 13 of the relevant Form 40 revenue accounts which were designed to match the appellants' fluctuating actuarial liabilities over the years in question.

(ix) Under the FSA regime in force at the relevant time, a company carrying on long term life insurance business had to complete and submit detailed regulatory returns in addition to its normal statutory accounts. These returns comprised a series of standard forms having numbered lines for different entries under abbreviated descriptions or headings. Under complex rules, key entries in certain forms had to match particular entries in others, and the overall purpose was (a) to demonstrate continuing solvency over actuarially-valued future liabilities, and also (b) to demonstrate that any intended bonus or dividend distribution was covered by an adequate surplus.

(x) Form 13 (assets) and Form 14 (liabilities) together served as a balance sheet, with assets identified in different categories being entered at "admissible value" which, for present purposes, broadly corresponded to their ascertained year-end market value. Liabilities, again subdivided into categories, were actuarially valued as shown in Form 58, and the total (with any intended bonus) then appeared in lines 11-14 of Form 14. Line 51 of Form 14 brought out the "investment reserve" or surplus of assets over liabilities and bonuses together.

(xi) If any transfer or "recognition" of amounts from the company's retained assets (effectively from the "investment reserve" brought out in line 51 of Form 14) was required in order to cover or match liabilities, losses or distributions referable to a given year, that would generally be entered in line 13 of Form 40 (designated: "Increase (decrease) in the value of non-linked assets brought into account"). Less commonly, however, for example where a noted explanation might be required, the alternative of using line 15 (designated: "Other income") might be considered.

(xii) Importantly, such entries might merely be "balancing items" whereby a company would "recognise" and bring into account just sufficient of its surplus to cover or match the liabilities, losses or distributions concerned. For this purpose no identified assets would be allocated, and any relevant entry was by convention deemed to comprise the whole available surplus at a notional "book value" whereby the value attributable to any individual asset would lie somewhere between admissible value and nil. The point was simply to make a sufficient balancing entry for solvency or distribution purposes.

(xiii) Here the disputed line 15 "transfers from Capital Reserve", totalling nearly £900 million, were intended principally to meet trading losses but also, in part, to fund bonus distributions and to provide against an impending change in the law.

[199] Part of the difficulty in this appeal arises from the inconsistent and interchangeable use of certain key terms in the FSA regulatory forms. For instance actuarially-valued policy liabilities are sometimes referred to as "mathematical reserves", and the term "fund" may be used to mean the same thing despite, in its normal sense, denoting the amount recognised and reported by a company in order to match such liabilities. Similarly, lines 13-15 of Form 40 are generally designated "income", despite the fact that these are lines in which any balancing item derived from the investment reserve must necessarily appear. And the phrase "increase (decrease) in the value of non-linked assets ..." is the caption to line 13 although the "value" concerned may, as already discussed, be merely notional and may be thought to reflect an "increase (decrease)" only by comparison with the blank line prior to any entry being made. Such balancing items may in other words be introduced where, in real terms, the value of aggregated or individual assets representing the company's long term business fund has gone up or down or remained the same.

Section 83(2)

[200] Against that background, the parties sought to advance two very different constructions of section 83(2) of the 1989 Act, which is in the following terms:

"(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -

(a) the company's investment income from the assets of its long term business
fund, and

(b) any increase in value (whether realised or not) of those assets.

If, for any period of account, there is a reduction in the value referred to in paragraph (b) above (as brought into account for the period), that reduction shall be taken into account as an expense of that period."

Put simply, the appellants contended for a two-stage approach whereby it was necessary to ask, first whether any relevant investment income, or any real gain in value of the assets representing the long term business fund, had arisen, and second whether, and to what extent, any such income or gain had been brought into account in Form 40. The reference to Form 40 (consistent with the definition in section 83A) was said to be a timing provision comparable to that which had applied to the taxation of life insurance business between 1923 and 1988. In a succession of provisions culminating in section 433 of the Income and Corporation Taxes Act 1988 the regime was that, so long as a life insurance company continued to hold income and gains in a reserve maintained against future liabilities, these would not be brought into charge for Case I purposes. It was only when amounts (other than those destined for the benefit of policyholders) were released from reserve that they might be assessed as "receipts".

[201] Under current arrangements, however, a key conceptual distinction fell to be drawn between, on the one hand, the appellants' long term business fund and, on the other, the assets representing that fund. Such a distinction had found statutory expression in relevant nineteenth- and twentieth-century legislation, commencing with the Life Assurance Companies Act 1870. It was, in particular, evident in many provisions of the Insurance Companies Act 1982 which remained in force when section 83 of the 1989 Act was subsequently enacted and amended. It also appeared in relevant accounting and valuation regulations and in many of the prescribed regulatory forms. As confirmed by section 28 of the 1982 Act, a company's fund was an accounting concept involving the (sometimes notional) entries required to balance liabilities and outgoings as ultimately brought out in its revenue account (Form 40), whereas the assets identified in sections 29 and 30 had a real existence and (as reflected in line 51 of Form 14) might have a value quite different from the amount of the fund. Most importantly, for present purposes, the same distinction was evident in the markedly different wording of the two adjacent sub-sections of the 1989 Act which were here in dispute. While section 83(2) concerned inter alia any increase in the value of the assets representing the appellants' long term fund, the primary focus of sub-section (3) was on the amount of the fund itself and not on the value of assets at all.

[202] Where, as here, the value of the appellants' assets had actually decreased in each of the three disputed years, to the tune of more than £3 billion in aggregate, the need for an actual increase in value under sub-section (2)(b) was plainly not satisfied and the balancing transfers from the Capital Reserve could not therefore qualify as chargeable receipts under that sub-section. Moreover, since the Capital Reserve was, as its name suggested, capital in nature, it would be strange if partial transfers from that source were at a stroke to be transformed into receipts for Case I profit purposes. It would be even stranger if such receipts were to arise in years during which the company had demonstrably suffered investment losses.

[203] In stark contrast, the respondents' position was that sub-section (2) was not at all concerned with real gains and receipts. The sub-section, it was said, envisaged a one-stage inquiry focused on Form 40 entries and on nothing else. Notwithstanding the sub-section's apparent focus on assets, the only question was whether the value of the appellants' "... fund as brought into account" in Form 40 had increased, and clearly that would be the case where any entry in lines 13-15 involved a transfer from the company's investment reserve. No relevant distinction arose between a company's long term business fund and the assets representing it. The value of assets as such was irrelevant: what mattered was recognition of the overall fund at whatever value might be brought into account. The fact that balancing items in lines 13-15 might be entered at a purely notional "book value" did not in any way preclude the value so brought into account from being deemed "receipts" for Case I computation purposes along with any investment income brought into account in line 12. According to counsel, there was nothing odd about this where, in general, a company's investment reserve would comprise gains and receipts built up over the years, and where, in particular, the appellants' investment reserve was derived by transfer from the Society whose assets had not all been taxed by the time that transfer occurred. There was also, it was said, nothing odd about a construction which would, from year 1 of the appellants' existence, credit them with "receipts" when, in reality, they had suffered trading losses of considerable significance.

[204] In my judgment there is every reason to prefer the appellants' approach to the construction of sub-section (2), and to mirror the Special Commissioners' conclusion on that aspect of the case. The wording of the sub-section naturally lends itself to a two-stage inquiry in which the first question, external to any consideration relative to Form 40, is whether (a) any investment income or (b) any gain in asset values, has arisen. There is, I think, no obvious difficulty about treating the former as denoting real income actually received, and by the same token it seems to me that (consistent with the long-established statutory distinction between "assets" and "fund" to which fuller reference appears elsewhere in this opinion) the latter should also be taken as reflecting commercial reality in the form of actual increases in the value of assets. To my mind the focus on increases in asset value "whether realised or not" lends further support in this connection, as does the description of income and gains as "items" to be identified, and the phrase "(and not otherwise)" strongly implies that there may be relevant income or gains which are not brought into account in a given year. None of these features appears to me to sit easily with the respondents' one-stage "Form 40" approach, and the sub-section's explicit focus on the value of "assets" also strikes me as inconsistent with their claim that it was intended to cover any notional recognition of the investment reserve which might, in any circumstances, appear as an entry in Form 40. It is, after all, the same assets to which sub-paragraphs (a) and (b) direct attention, namely assets having the capacity both to generate investment income and to increase in value.

[205] Another factor in favour of the appellants' construction is that in my view it accords well with the general principles (i) that the ascertainment of receipts or gains for tax purposes should prima facie reflect commercial reality; (2) that income or gains to be taxed should prima facie be the taxpayer's and not those of a third party; and (3) that the ordinary "recognition" of shareholders' capital to cover actual trading losses should not prima facie be deemed a chargeable receipt.

[206] In reaching these conclusions I am not much impressed with the respondents' contention that they would produce significant unworkability in practice, allegedly through the absence of any obvious mechanism for identifying when, and to what extent, particular gains or losses were relevantly experienced. No evidence along such lines was led at the hearing before the Special Commissioners, and in any event it is in my view the respondents, and not the appellant taxpayers, who must suffer if a taxing provision fails clearly to identify a workable basis of charge. The appellants' position was that they would have no difficulty, under current accounting and recording practices, in identifying relevant income and gains as they arose, and in the absence of evidence to support contrary findings in fact I am not persuaded that a strained construction of sub-section (2) should be adopted on alleged unworkability grounds. On any view, I would find it difficult to support a construction of sub-section (2)(b) which contrived to identify Case I receipts where the taxpayer had in reality suffered nothing but losses.

[207] Along similar lines, I am not much impressed with the various tables and examples by which the respondents sought to show that the appellants' construction of sub-section (2) would give rise to unacceptable tax consequences. Even if, contrary to the appellants' robust response, these tables and examples were thought to bring out apparent anomalies in some areas, that would still fall short of persuading me that the respondents' strained construction of sub-section (2) should be preferred.

[208] On all of these grounds, I am satisfied that the parties' dispute as to the proper construction of sub-section (2) must be resolved in the appellants' favour. Like your Lordships, therefore, I would endorse the Special Commissioners' conclusion on this aspect of the case and refuse the respondents' cross-appeal.

Section 83(3)

[209] Turning now to the construction and possible application of sub-section (3), I would regard the issue between the parties as being a little less clear-cut. This time it was the respondents who advocated a two-stage approach, commencing with real-life additions (as defined) to reserves which they sought to characterise as the appellants' long term business fund, and thereafter looking to Form 40 to see whether, and if so when, the amount of any such addition was brought into account. Provided that an initial addition to reserves was made "as part of or in connection with" a business transfer, the plain and straightforward meaning of the sub-section was that all or part of the amount concerned became a Case I receipt as soon as it was brought into account in Form 40. The first stage was, in other words, a relevant addition to reserves outwith the confines of Form 40; the second was a subsequent bringing into account in that Form; and, as in the case of sub-section (2), no relevant distinction fell to be drawn between the assets of a company's long term business fund and the fund itself. It might be difficult to understand why, on this approach, Parliament should have limited the operation of the sub-section to the ascertainment of losses, but according to counsel this was not fatal to his argument. In the knowledge that life insurance businesses generally suffer taxation on the I-E basis, Parliament might reasonably have taken the view that only transferable losses under the parallel Case I computation were a possible source of concern.

[210] All that mattered was that the disputed line 15 entries in the present case plainly fell within the terms of sub-section (3) as properly understood. This was a new provision introduced by the Finance Acts of 1995 and 1996; the disallowance of losses was self-evidently a purpose separate and distinct from that of sub-section (2); and the terminology used in the two adjacent sub-sections was not the same. The original version of sub-section (3), as it appeared in the 1995 Act, was of rather wider scope and would certainly have caught the disputed line 15 entries. At that time it read as follows:

"(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business, any amount transferred into the company's long term business fund from other assets of the company, or otherwise added to that fund, shall be taken into account, in the period in which it is brought into account, as an increase in the value of the assets of that fund within sub-section (2)(b) above.

....."

There was then no restriction to the situation of a business transfer or demutualisation, and the deeming provision was merely concerned to prevent Case I losses arising where additions to the long term business fund, from whatever source, were brought into account in Form 40.

[211] The appellants, for their part, declined to accept that sub-section (3) should be construed as a two-stage exercise. Unlike sub-section (2), it was said, and in markedly different terms, sub-section (3) called for a one-stage inquiry restricted to entries made in Form 40. On a purposive construction and as vouched by certain extra-statutory materials, the sub-section was designed to preclude artificially-created losses in one particular context. It could not sensibly be read as precluding recognition of real losses sustained in other circumstances, and the focus had to be on Form 40, not just because that was where the appellants' long term business fund was reported, but also because it was only there that any potential for the creation of artificial losses might arise. Specifically, the operative focus of sub-section (3) was not on assets representing the company's long term business fund, but only on the amount of the fund itself as constituted under section 28 of the Act of 1982. Apart from the "opening amount" of £16.8 billion, which had had to be entered as the necessary counterpart of the liabilities acquired from the Society, no addition to the appellants' fund had been made as part of, or in connection with, the business transfer in March 2000, and in any event no "addition" could sensibly be thought to have occurred at a time when no long term business fund previously existed. Once again the respondents (and also the Special Commissioners at paragraphs 65 and 81 of their decision) appeared to regard sub-section (3) as in some way carrying over receipts or gains of the transferor Society to the appellants for taxation purposes. This was entirely misconceived and contrary to principle. Had Parliament had any such intention, it was impossible to understand why sub-section (3) did not apply equally to the ascertainment of profits.

[212] The proper approach was to construe the sub-section purposively, and thereby to restrict its scope to situations in which objectionable losses might be created. No such situation arose here, it being agreed between the parties that the business transfer of March 2000 was effected for genuine commercial reasons and without any tax avoidance motive. Moreover, the genuine investment losses which supervened over the following three years were not anticipated, and in practical terms the disputed transfers from the Capital Reserve performed exactly the same function as would any external injection of capital from another source. The appellants had simply recognised some of their shareholders' capital so as to cover losses and distributions arising in consecutive years following acquisition of the Society's business, and Parliament could not have intended sub-section (3), any more than sub-section (2), to translate that orthodox use of capital into a Case I receipt.

[213] In my judgment the appellants' contentions here are again to be preferred, and it will be convenient to begin by recalling the important distinction to be drawn between, on the one hand, a company's long term business fund (essentially an accounting concept) and, on the other, the assets representing that fund (essentially a matter of valuation). As the appellants submitted, this distinction can be seen to have had a long statutory history dating back as far as the Life Assurance Companies Act 1870. In the twentieth-century, it found statutory expression in various provisions of the Assurance Companies Act 1909, the Insurance Companies Amendment Act 1973, and the Insurance Companies Act 1982. In the latter statute, specifically, sections 18(2)(b), 28(2)(a), 29(1), (2), (4) and (7), 30(4) and 55(3)(a) all referred to "assets representing" the fund or funds maintained by a company in respect of its long term business, whereas section 28(1) contained provisions relative to the formation and maintenance of the fund itself. Section 31(7) further provided as follows:

"In this section ...

'long term assets' and 'long term funds', in relation to an insurance company, mean respectively assets representing the fund or funds maintained by the company in respect of its long term business and that fund or those funds".

Significantly, all of these provisions of the 1982 Act were in force when section 83(3) of the 1989 Act was brought in by amendment in 1995 and 1996.

[214] From at least 1983 the distinction between a company's long term fund and the assets representing it was also a conspicuous feature of (i) relevant secondary legislation under which the regulatory scheme was maintained, and (ii) the prescribed regulatory forms themselves. For instance, as Lord Reed records between paras [114] and [119] of his opinion, regulation 6(5) of the Insurance Companies (Accounts and Statements) Regulations 1983 required Form 13 to be completed in respect of the total assets representing the fund or funds maintained in accordance with section 28 of the 1982 Act. Similar provisions followed in the subsequent regulations of 1996 and 1997, and at the time when the disputed sub-section (3) came into force the difference between the total value of the assets as brought out in Form 13 and the amount of a company's long term business fund had to be entered in line 51 of Form 14 as "... excess of the value of admissible assets representing the long term business funds over the amount(s) of those funds". In the field of valuation, the same distinction was reflected in regulation 37(1) of the Insurance Companies Regulations 1981 (and in later embodiments), although these regulations were essentially concerned with a company's assets and not with the reporting of any long term fund.

[215] In all of these instances, a clear distinction was recognised between a company's long term business fund (as brought out in the Form 40 revenue account) and the assets representing that fund. Although, as previously noted, usage of the term "fund" has not always been precisely consistent, the relevant primary statutes, regulations and forms have generally used this term to denote the amount recognised and reported by a company in order to match (and demonstrate ability to meet) its assessed liabilities to policyholders. In particular, the amount of a company's long term fund would be the amount so recognised and reported in its Form 40 revenue account after allowing for declared increases or decreases relative to a given year. Interestingly, for present purposes, the caption for line 51 of Form 14 at the time when section 83(3) was enacted (in both original and amended forms) bore to draw a further distinction between the "value" of assets and the "amount" of the fund or funds represented. Form 14 thus linked Forms 13 and 40 by showing how much of the value of a company's assets was required for the purposes of its long term business, and how much of that value was in excess of such requirements. In other words, it brought out the extent to which the net value of the assets representing a company's long term fund exceeded the amount of that fund.

[216] With these important background considerations in mind, I turn to examine section 83(3) of the 1989 Act as amended in 1996. It provides as follows:

"(3) In ascertaining whether or to what extent a company has incurred a loss in respect of that business in a case where an amount is added to the company's long term business fund as part of or in connection with -

(a) a transfer of business to the company, or

(b) a demutualisation of the company not involving a transfer of business,

that amount shall ... be taken into account, for the period for which it is brought into account, as an increase in value of the assets of that fund within subsection (2)(b) above."

In my view an immediately apparent feature is that, in referring to "an increase in value of the assets of that fund within subsection (2)(b) above", the final deeming provision bears to reflect the long-established statutory distinction between a fund and the assets representing it. Equally apparent, however, is the fact that the critical opening lines of the sub-section, defining its operative scope, refer only to "... the company's long term business fund"  a phrase which, under normal usage, might be expected to denote the fund as brought out in the Form 40 revenue account. Echoing line 51 of Form 14, perhaps, the term "amount" is also used in this context, but to my mind the most striking feature for present purposes is that this critical part of the sub-section (like its 1995 predecessor) contains no reference to assets at all. Thus, even though the original scheme erroneously described the Capital Reserve as being "within" the appellants' long term fund, the primary opening lines of the sub-section simply do not bear to be directed towards incoming additions to assets or reserves held outwith the confines of Form 40. At the supplementary hearing of this appeal, counsel for the respondents very fairly conceded that the Capital Reserve was truly concerned with the value of (some of the) assets representing the appellants' long term fund, rather than with the amount of the fund itself, but in any event (with the utmost respect for the views expressed by your Lordship in the chair at para [80]) I would have had difficulty in accepting that the proper construction of sub-section (3) in this regard could be affected by the terms of any individual scheme, agreement, assertion or concession.

[217] On this ground alone, and before even addressing the effect of the restriction introduced by amendment in 1996, it seems to me that the initial acquisition of the Society's assets and liabilities, and the creation of the Capital Reserve under the scheme, did not relevantly engage sub-section (3) as properly understood. What matters here is not whether the appellants' reserves were augmented by that acquisition, but whether (and if so in what circumstances and at what date) any addition to the amount of their Form 40 fund was made.

[218] In the same context it is also worth remembering that when sub-section (3) was first enacted in 1995 and then amended in 1996, sub-section (2) had already been in force for a number of years. That pre-existing provision was explicitly directed towards "... the assets of (a company's) long term business fund", and the obvious question which springs to mind is: Why should a legislature intending, in the opening lines of a new sub-section (3), to refer to exactly the same thing have chosen entirely different wording for that purpose? Why should "fund" have been used at that point if "assets" were meant? A convenient style relative to assets was already there in sub-section (2); such terminology was well understood and its repetition would have given rise to no uncertainty or confusion; the final deeming provision of sub-section (3) itself referred to "the assets of that fund"; and no reason was suggested before us as to why any earlier mention of "assets" might have had to be avoided. Conversely, introducing the term "fund" on its own would inevitably call to mind the important conceptual distinction which had received statutory recognition since the nineteenth century, suggesting that a distinction along similar lines was intended to be drawn relative to these adjacent parts of section 83, and on any view such a course would be calculated to produce uncertainty and ambiguity if "fund" was not actually supposed to mean "fund" but rather "assets" instead.

[219] Had the opening lines of sub-section (3) contained any mention of "assets", there might well have been greater force in the respondents' argument which has found favour with your Lordships, but in my judgment the fact that they did not do so is a powerful reason for regarding the respondents' argument as unsound. If, as I understand your Lordships to agree, the reference to "the assets of (a company's) long term business fund" in sub-section (2)  and consequently in the final deeming provision of sub-section (3)  cannot properly be read as denoting a company's Form 40 fund, then by the same token it does not seem to me that a specific reference to that fund alone in the opening lines of sub-section (3) should now be taken as denoting assets.

[220] So far as I am aware, there is no practical reason why this most obvious and direct approach to the construction of sub-section (3) should fall to be rejected. Apparent losses would still be avoided on relevant sums being brought into account in Form 40 in a given year, as the sub-section provides, and in all the circumstances I am not inclined to strive for a strained construction whereby "assets" might be substituted for the reference to "fund" which actually appears.

[221] It would not of course be surprising if a meticulous examination of subsidiary and remoter materials were to throw up features potentially capable of lending weight to the arguments advanced by one party or the other. For example, as pointed out by Lord Reed in his opinion at para [154], the subsidiary anti-avoidance provision in section 83AA (on which I do not believe either party relied in submissions) contains a tense which might arguably be consistent with the respondents' two-stage approach. Certain annotations to FSA forms may equally fail to match relevant charging provisions. On the other hand, section 83(8)  replicating wording in the original 1995 version of sub-section (3)  lists "other assets of the company" as a potential source from which a relevant addition or transfer may be made, and appears to contemplate inter alia a diversion out of such reserves and into the long term business fund. This may arguably weaken any notion of Parliament having intended the assets of a company's long term business fund (already featured in the deeming provision at the end of sub-section (3) itself) to be a relevant destination. But, whichever way such subsidiary indicators may be thought to point, I am unable to regard any of them as being of comparable significance to an analysis of the primary charging provisions themselves.

[222] Turning now to consider the effect, for present purposes, of the restrictive amendment which was introduced in 1996, I would regard only the 2000 "opening amount" of £16.8 billion as capable of falling within the sub-section's intended scope. That was to my mind the only amount arguably added to the appellants' Form 40 fund "... as part of or in connection with" the transfer of the Society's business. The phrase "in connection with" generally merits a wide interpretation; the term "addition" is widely defined in the 1989 Act and may reasonably be held to cover amounts being "added" or "transferred" to a fund which, as yet, had no content; the scheme envisaged the immediate creation of the appellants' long term fund (defined in the schedule, significantly, by reference to section 28 of the 1982 Act); the matching liabilities plainly arose out of the same business transfer; and in my view there are plausible grounds for acknowledging the necessary degree of connection in this one limited respect. The fact that the "opening amount" did not stand alone, but entered Form 40 as a direct counterpart of liabilities which the appellants acquired from the Society unico contextu, strikes me as being of particular importance here.

[223] By contrast, the disputed line 15 amounts for 2000, 2001 and 2002 appear to me to reflect additions to the fund of a different character altogether. In particular these entries were all made long after the fund came into existence in terms of the scheme; the making of such entries was not even envisaged at that initial stage; and that is no doubt because the later business and financial developments which brought them about had nothing to do with the previous acquisition of the Society's assets and liabilities. Neither the disputed entries nor the relative losses were, in other words, "part of" the 2000 scheme, nor in my judgment were they relevantly connected with it. To hold otherwise would in my view lead to an unacceptable end result, namely that the whole of the Capital Reserve would, over time, necessarily be caught by sub-section (3) irrespective of the date or circumstances in which particular sums came to be recognised in the appellants' Form 40. That would essentially have been the effect of the sub-section as originally enacted in 1995, and to my mind it would be wrong to construe the 1996 amended version along the same lines as if the unamended 1995 provision had still been in force. The change introduced in 1996 involved a severe limitation of the context in which the ascertainment of losses might be affected, and if the relevant losses here did not arise in a context to which sub-section (3) was directed it is in my view hard to see why the disputed entries should be thought to do so either.

[224] As regards the extra-statutory materials which were advanced as possible aids to construction, I doubt whether any of them provides much assistance here. Along well-settled lines such materials might, at most, form part of the background against which statutory wording would fall to be considered, and could never be determinative on issues of construction. That said, however, it seems to me that certain of these materials do afford some evidence of the mischief to which the developing anti-avoidance provisions of 1995 and 1996 were ostensibly directed, and on that basis it might be thought inappropriate to leave them out of account altogether.

[225] Specifically, I consider that the published press releases of 1995 and 1996, taken together, reveal that the new provisions were broadly intended to counteract the creation of artificial tax losses in the context of business acquisitions in particular. In some instances, apparently, acquired liabilities had been represented as a loss for tax purposes where the matching assets did not, under existing legislation, qualify as chargeable receipts. It may be that the contemporaneous extract from Hansard, on which the appellants also founded, points in the same general direction, but for the reasons given by your Lordship in the chair at para [70] I am not persuaded that the conditions for admissibility set out in Pepper v Hart and elsewhere are met in the circumstances of this case.

[226] Whatever the press releases may show, however, I am in agreement with your Lordships that the 1995 "solution" went far further in making any addition to the amount of a company's Form 40 fund, from whatever source and in whatever context, a chargeable receipt for the purposes of ascertaining any loss under Case I of Schedule D. The statutory wording at that time (in paragraph 16 of schedule 8 to the Finance Act 1995) was entirely general and unrestricted, and like your Lordships  although with a different construction in mind  I can see no basis on which any material limitation could properly have been implied for the purposes of a dispute such as the present. This may well explain the outcry with which the 1995 "solution" appears to have been greeted within the life insurance industry and elsewhere at the time: even a solvent company might thereby be disabled, regardless of circumstances, from recording a genuine tax loss.

[227] As previously indicated, the further development which took place in 1996 (by virtue of section 163 and paragraph 4 of schedule 31 to the Finance Act of that year) strikes me as having been of real significance. The new wording made it explicitly clear that the intended target of anti-avoidance measures was apparent losses arising in one narrow context, namely that of a business transfer or demutualisation relevantly engendering the addition of an amount to a company's long term business fund. That much is, I think, evident from a straightforward construction of the 1996 wording without the need for assistance from any extra-statutory source, but quantum valeat I am inclined to think that from 1996 onwards the provision intelligibly bore to address the apparent mischief to which I have already referred. The key question for determination is thus whether any addition is made to the amount of a company's Form 40 fund "... as part of or in connection with" one of the specified transactions, with the sub-section then (in terms similar to those of the equivalent timing provision in sub-section (2)) going on to identify the period in respect of which a chargeable receipt would in that event be held to arise.

[228] Taking all of these considerations into account, I find myself unable to accept the respondents' contention that the effect of sub-section (3) was to create Case I receipts in the circumstances of this case. Not only, in my opinion, was the primary focus of that contention mistakenly directed away from the appellants' Form 40 fund, but it also sought to "catch" transfers into that fund which were made in a non-chargeable context. On any view I find it hard to impute to Parliament, even in the years following a business transfer, the intention of inflicting Case I consequences on the ordinary deployment of shareholders' capital or other reserves to cover genuine investment losses or intended distributions. On what ground could it have been thought necessary or appropriate to bar the recognition of genuine losses having nothing to do with any business acquisition, or a fortiori to penalise accounting measures which did not relate to such an acquisition either? And where, as in this case, an acquired surplus was paid for in full, what reason could there be for making the acquiring company pay again through the arbitrary cancellation of genuine trading losses, or for treating the acquired surplus differently from pre-existing reserves which might otherwise have been deployed? In leaving such questions unanswered, the respondents' argument here does seem to me to involve an illegitimate attempt to tax the Society's accumulated surplus in the appellants' hands.

[229] To my mind the end result for which the respondents contended is also incompatible with the general principles identified earlier in this opinion. Capital should not generally be taxed as income; for tax purposes the receipts and gains of third parties should, as a rule, be irrelevant; Case I receipts should not prima facie arise in consequence of genuine losses; and on any view the statutory wording is just not clear enough to warrant the stance taken by the respondents in this appeal.

Conclusion

[230] On all of these grounds I conclude that, although the Special Commissioners correctly construed sub-section (2), they fell into error in upholding the respondents' contentions and thus in materially misconstruing sub-section (3). Their decision should therefore in my view be set aside, and the appeal sustained by answering the agreed question for determination in the negative.