© 2025 by Michael Firth KC, Gray's Inn Tax Chambers
Contact: michael.firth@taxbar.com
Substance over form
The principle
"[60] Lest it be thought that this produces an unfair result because the question whether a payment is taxable or not depends on the structure of the settlement agreement and the label put on the payment, I would emphasise that the question whether a payment is taxable is a matter of substance, not form. If in substance the agreement involves an obligation on the part of the employer to make payment or reimbursement of costs or expenses which are unconnected with the payee's services as an employee, that element will not be taxable as "earnings". But in this case the parties chose to enter into an agreement by which only part of the settlement sum fell into that category, and the rest represented payments which, had they been made when it was alleged they fell due, would have been taxable as part of the employees' income.
[61] Those payments did not cease to be taxable in full because the recipients had to use some of the money to pay the balance of what they owed their own lawyers and the premium due to the insurers. I do not regard this as giving rise to any unfairness. Moreover, there was evidence that the amount of the settlement was increased by £200,000 in recognition of the fact that the Principal Settlement Sum would be taxable. Whilst that does not affect the legal analysis, and played no part in my conclusion, it does provide a degree of comfort that the end result has not disadvantaged Mr Murphy." (HMRC v. Murphy [2022] EWCA Civ 1112, Andrews, Lewison, Newey LJJJ)
"[126] I consider that as a matter of law I must take a realistic view of the payments made, by reference to their substance and not their form. The existence of the Image Rights Agreement is not conclusive evidence that payments said to be made pursuant to that agreement are consideration for the acquisition of Geovanni’s overseas image rights. The burden is on the appellant to show that viewed realistically, in substance the payments were made to acquire Geovanni’s image rights and not earnings of Geovanni.
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[129] These are all facts which, viewed realistically, tend to suggest that the sums payable by the Club to Joniere were actually paid to secure Geovanni’s services as a footballer and not to obtain the right to commercially exploit his overseas image.
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[132] I am not making a finding that the Image Rights Agreement was a sham. The Image Rights Agreement did as a matter of contract grant rights to the Club to exploit Geovanni’s overseas image rights. I do not accept that those rights had any commercial value. I am satisfied that the Club viewed the sums payable under the Playing Contract and the Image Rights Agreement as an overall package which Geovanni required and the Club was willing to pay for him to sign for the Club. In reality payments to Joniere were a reward for Geovanni’s services as a footballer and formed part of his earnings." (Hull City AFC (Tigers) Limited v. HMRC [2019] UKFTT 227 (TC), Judge Cannan)
- Analyse the substance of a composite transaction
"The principle enunciated in the Ramsay case was therefore based on an orthodox form of statutory interpretation. And in asserting the power to examine the substance of a composite transaction the House of Lords was simply rejecting formalism in fiscal matters and choosing a more realistic legal analysis. Given the reasoning underlying the new approach it is wrong to regard the decisions of the House of Lords since the Ramsay case as necessarily marking the limit of the law on tax avoidance schemes." (IRC v. McGuckian [1997] STC 908 (HoL) at 915 - 916)
- Whether expenditure incurred under a contract is a question of substance not form
"[98] The next point is that the question whether the expenditure is incurred "under" a contract entered into by the tenth anniversary is also a question of substance rather than form. For the reasons already given, including the HMRC concession about the admissibility of unilateral rights to select and to change, the question is whether by the tenth anniversary the commitment to the relevant expenditure has reached a stage which does not require any further bargaining before it becomes, or can unilaterally be made, unconditional within the contemplation of section 5. Two points flow from this. The first, perhaps obvious, point is that the expenditure does not cease to be incurred under the contract(s) made by the tenth anniversary merely because the precise specification is later altered by the exercise of rights to select and to change contained in the original contract(s) in place by that date. Thus the expenditure committed to by the tenth anniversary may include payment for wooden windows but have been replaced under a right to change, existing as at the tenth anniversary and exercised after it, by a specification for pvc windows.
[99] The second point may be less obvious, but it is equally important. The parties to a pre-tenth anniversary contractual relationship may after that date make alterations to the project by further agreement (ie by contractual variation) rather than by the exercise of a unilateral right to change, without it necessarily meaning that there was not the requisite commitment to the relevant expenditure as at the tenth anniversary. For example the parties may have chosen to make by a contractual variation an alteration which could have been made by the exercise of a unilateral right to change, perhaps to avoid any possible argument about the scope of that right. On its proper construction, section 298(1)(b) looks to the substance of the contractual commitments in place at the first 10 year anniversary and compares that to what was done within the second 10 year period. The relevant question is not the form or mechanism which the parties later chose to use, but whether the change detracted in substance from the existence of the requisite commitment to the relevant expenditure as at the tenth anniversary. (We leave aside the more difficult question whether expenditure under a replacement contract agreed in substitution for the original contract and in substance replicating the commitments in that original contract would be sufficiently related to the original contract as to qualify as expenditure "under" that original contract)." (R (oao Cobalt Data Centre 2 LLP) v. HMRC [2024] UKSC 40)
- Relevant to consider alternative arrangements in determining substance
"[113] While we accept that the correct tax treatment must depend on the arrangements actually entered into rather than alternative arrangements that might have been entered into, it is relevant in undertaking a realistic appraisal to recognise that the substantive effect of the mechanism was really no different to the LLP retaining the Capital Amount, using it to support its borrowing by placing it on deposit in an account with the Co-op and agreeing that in certain circumstances it would pay deferred consideration to OVL. The LLP's case amounts to saying that it makes all the difference that the deposit was in the name of OVL rather than the LLP, and that that is so despite the fact that, at least for the first three years, it was the LLP (or its lender) and not OVL that could benefit from the funds." (London Luton Hotel BPRA Property Fund LLP v. HMRC [2023] EWCA Civ 362, Whipple, Falk, Lewison LJJJ)
- Husband consenting to wife's purchase of share in NewCo was in substance a gift by husband
"[27] Does this apply equally to the transfer to Mrs Jones of her share in Arctic Systems Ltd, from which her dividend income arose? The Revenue say no for three reasons. First, they say there was no gift of the share by Mr Jones to Mrs Jones. He never owned the share which she took. It belonged to the formation agents and Mrs Jones bought it from them for £1.
[28] In my opinion this narrow analysis of the transaction would be inconsistent with the reasoning by which I think that the transfer comes within section 660A in the first place. It was Mr Jones's consent to the transfer of a share with expectations of dividend to Mrs Jones for £1 which gave the transfer the "element of bounty" for the purposes of section 660A. By the same token, I think it made the transfer a "gift" for the purposes of subsection (6). And there is no dispute that, if it was a gift, it was outright." (Jones v. Garnett [2007] UKHL 35)
- Not bound by parties' labels/characterisation of transaction
[25] In construing the EPS Agreements, we apply the approach stated by Dillon LJ 25 in Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 at 160 that: “… in determining the legal categorisation of an agreement and its legal consequence the court looks at the substance of the transactions and not at the labels which the parties have chosen to put on it.”
[26] Dillon LJ went on to describe this as trite law and, at 161-163, to conclude in that case, where the question was whether the parties had created a sale of goods or a loan subject to a charge on those goods, that it was necessary to look at the provisions of the agreement as a whole to ascertain the substance of the parties’ agreement from the language used..." (Aspect Capital Limited v. HMRC [2014] UKUT 81 (TCC), Warren J and Judge Sinfield)
"I have been reminded of Duke of Westminster v Commissioners of Inland Revenue , but here the description "interest" is, I think, merely a label which inaccurately describes the transaction as it appears upon the terms of the instrument read in the light of surrounding circumstances. The distinction is neatly drawn by Viscount Simon in Commissioners of Inland Revenue v Wesleyan & General Assurance Society (1948) 30 TC 11, at page 25, where he says:
"It may be well to repeat two propositions which are well established in the application of the law relating to Income Tax. First, the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan if it is really an annuity does not assist the taxpayer, any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is what is the real character of the payment, not what the parties call it."" (Ridge Securities Ltd v. CIR 44 TC 373 at 394, Pennycuick J)
"[128] In reaching the above conclusion, we are reminded of the words of Arden LJ in Bankway Properties Limited v Pensfold-Dunsford [2001] 1 WLR 1369 (“Bankway”) in a different context, which were set out in Audley at paragraph [63], to the effect that the question in each case is “what was the substance and reality of the transaction entered into by the parties? The court is not bound by the language which the parties have used. It may for instance conclude, when it examines the substance of the transaction, that what the parties have in their agreement called a sale and repurchase of book debts is in truth a registerable charge over them” (see Bankway at paragraph [43], quoting Lord Ackner in Antoniades v Villiers [1990] 1 AC 417 at 466). In this case, the Appellant and the companies may have said in the document effecting the subscription that the entire £750,000 was being paid in respect of the issue of the Loan Notes but, viewed realistically in the light of the relevant legislation construed purposively, £694,684 of that amount was capital contributions to the companies and only £55,316 was attributable to the issue of the Loan Notes.
[129] In Tower, in the High Court (Tower MCashback LLP 1 and another v The Commissioners for Her Majesty’s Revenue and Customs [2008] STC 3366 (“Tower HC”)), Henderson J (as he then was) stated that “[in] order to say that the wrong label has been attached to a transaction, it is first necessary to identify with clarity the transaction which is said to have been misdescribed” (see Tower at paragraph [82] and Audley at paragraph [88]). In this case, as in Audley, we consider that to be straightforward – in reality, the transaction involved aggregate capital contributions to the companies of £694,684 and the payment of £55,316 in respect of the issue of the Loan Notes..." (Pitt v. HMRC [2022] UKFTT 222 (TC), Judge Beare)
- But the words used may be useful in distinguishing different types of similar transaction
"[26]...That was, however, in the context of transactions that were very similar so that Dillon LJ observed at 162:
“… the similarity between a loan and a sale … would make it virtually impossible to decide which the transaction was if it was not permissible to have regard to the words the parties had used in their agreement in describing that transaction on which they had agreed.”
It follows that the terms used by the parties to describe their legal relationship may be useful in determining the legal nature of a relationship or agreement in cases where the agreements are capable of different interpretations but the terms used by the parties cannot affect the legal categorisation of what they have agreed in cases where there is no doubt or ambiguity (see Street v Mountford [1985] A.C. 809 at 826H - 827B)." (Aspect Capital Limited v. HMRC [2014] UKUT 81 (TCC), Warren J and Judge Sinfield)
Limits
- Not to fix taxpayer with contract to which they did not agree
"[78] There are limits to the application of the Ramsay doctrine. As Patten LJ stated in Brain Disorders Research Limited Partnership v. HMRC [2018] STC 2382 at [32]: “Although the Ramsay approach to construction has undoubtedly involved the courts in looking at the commercial realities of the transaction and ignoring financial components of a scheme which are circular or have no purpose other than to produce a tax loss in order to identify whether and, if so, which parts of the transaction engage the relevant tax provisions, it does not enable the courts to fix the taxpayer with a contract which under the scheme it does not have. The actual transactions remain the same.”
[79] We consider that to bring the PIP within the profit-sharing arrangements of the Partnership would go beyond those limits in the present case. It would be necessary to fix the taxpayer, in this case the Partnership, with a contract to which its members did not agree. In our view, the correct contractual analysis is that the individual partner has no right to share in the profits of the Partnership at the time when allocations were made to the Corporate Partner and that the terms of the Partnership Deed which allocated those profits to the Corporate Partner must be respected. It is also our view that the contractual effect of the PIP and the way in which it was operated in practice do not change that position. When profits were allocated between the partners under the Partnership Deed, each individual partner had a legitimate expectation that his or her provisional PIP Award would be made final unless they failed to meet the eligibility conditions. Individual partners only had a right or entitlement to receive their PIP Awards once they were entitled to withdraw the Special Capital. Even adopting a purposive construction of section 850 of ITTOIA 2005, the PIP did not form part of the profit-sharing arrangements of the Partnership. We therefore dismiss Ground 1 of the PIP Appeals." (HMRC v. Bluecrest Capital Management LLP [2022] UKUT 200 (TCC), Leech J and Judge Herrington)
- Tax code generally applies on the basis of legal rather than economic reality
"The idea that an "artificial creation of the legislature", namely a company, has a separate legal personality from its shareholders has been protected and reaffirmed from Salomon v A Salomon & Co Ltd [1897] AC 22 onwards. It was essential, Lord Halsbury LC said in that landmark case, that "once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself". Generally speaking, the tax code is drafted and applied on the basis of legal rather than economic reality. Separate corporate entities within the same corporate group are taxed individually; a company's income and assets are not treated as "really" being those of its shareholder whether that shareholder is another corporate entity or an individual taxpayer. The tax code is drafted on the basis that a subsidiary of a corporate group may be and often is tax resident in a different jurisdiction from its shareholder. That is why the concept of the permanent establishment was created." (HMRC v. Royal Bank of Canada [2025] UKSC 2, Lady Rose)
- Court refusing to ignore the separate personality of parent and subsidiary even where parent provides all funding and receives all the result of subsidiary activity
"[84] Mr Prosser's second argument stresses that it is Sulpetro rather than Sulpetro (UK) which provides all the money and equipment, the budget and work programmes to explore and develop the Buchan Field. The Illustrative Agreement places all the burden of carrying out the exploration and development work on Sulpetro rather than on Sulpetro (UK) and it is Sulpetro rather than Sulpetro (UK) that bears all the risk of losing that investment if no oil is found. In those circumstances, the economic effect of the relationship is that it is Sulpetro rather than - or as well as - Sulpetro (UK) which is exercising the right to work the Buchan Field under the licence. The Illustrative Agreement only makes commercial sense because Sulpetro (UK) is a subsidiary of Sulpetro. No arm's length arrangement would strip out any chance of profit accruing to Sulpetro (UK) and give the right to all future revenues and profit to Sulpetro.
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[86] As Falk LJ recognised in para 113, this argument requires the court to ignore the separate legal personality of the subsidiary company and treat it as one person with its parent Sulpetro. One must not, of course, treat Sulpetro (UK) as being the same legal person as its parent for all purposes under the Illustrative Agreement because the licence could only have been granted to a UK resident corporate entity. Complying with that requirement precluded treating Sulpetro and Sulpetro (UK) as the same entity - the mechanism devised by the UK to achieve its goals depended on the two companies remaining distinct.
[87] I agree with Falk LJ that it is not possible to ignore the legal structure for the purpose of applying the provisions of the UK/Canada Convention either.
[88] The idea that an "artificial creation of the legislature", namely a company, has a separate legal personality from its shareholders has been protected and reaffirmed from Salomon v A Salomon & Co Ltd [1897] AC 22 onwards. It was essential, Lord Halsbury LC said in that landmark case, that "once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself". Generally speaking, the tax code is drafted and applied on the basis of legal rather than economic reality. Separate corporate entities within the same corporate group are taxed individually; a company's income and assets are not treated as "really" being those of its shareholder whether that shareholder is another corporate entity or an individual taxpayer. The tax code is drafted on the basis that a subsidiary of a corporate group may be and often is tax resident in a different jurisdiction from its shareholder. That is why the concept of the permanent establishment was created.
[89] There are some statutory inroads to this general principle that the separate existence of different legal entities which can be tax resident in different jurisdictions is recognised and accommodated by the tax code. For example, the CTA 2010 provides for group relief whereby losses can be transferred between companies within the same group to offset profits made by a different company. But the companies are still treated as separate legal entities, and the surrendering company must consent to the claimant company using its losses. Where an exception is made to the principle that every person, legal or natural, is a separate taxable entity with its own tax residence, the circumstances are carefully defined by the legislation without a general appeal to economic interests or to reality or to what is "actually going on".
[90] Beyond that, it is true that there has been a greater tendency of the courts to neutralise the effect of tax avoidance schemes by looking at the reality of a transaction to see whether it is a transaction that was intended to be caught by a particular taxing provision. The court looks at the transaction as a whole, ignoring the fact that it was effected by a series of pre-ordained separate steps which, if analysed individually, may arguably have fallen outside the charge. The Ramsay principle, recently discussed by this court in Rossendale Borough Council v Hurstwood Properties (A) Ltd [2021] UKSC 16, [2022] AC 690, explains when a court can to that extent focus on the reality of what is happening combined with a purposive interpretation of the taxing provision. No one here has suggested that the Ramsay principle has any application to the present facts and nothing in this judgment casts doubt on the efficacy of those principles where they apply. If the conclusion of the Illustrative Agreement between Sulpetro and Sulpetro (UK) was pre-ordained once the licence had been granted to Sulpetro (UK), that was because the UK Government ordained it and not because it necessarily suited the Sulpetro group."(HMRC v. Royal Bank of Canada [2025] UKSC 2)
Taxing similar situations in the same way
- Wrong to assume that economically equivalent transactions taxed in the same way
"There is no doctrine of UK tax law that economically equivalent structures should be taxed the same. The appellant was a stand-alone company in the contested period, which is in a different position to a company that has a dormant subsidiary as it is considered for tax purposes to be a group of companies. There may be tax advantages and disadvantages to both structures. Groups of companies are often treated differently for tax purposes to stand-alone companies (e.g., in the treatment of transfers/disposals within groups)." (M Group Holdings Limited v. HMRC [2023] UKUT 213 (TCC), Green J and Judge Ramshaw)
"[35] However, in our judgment, the discussion of these scenarios does not establish any “special statutory context”. At most they establish that economically similar transactions might be taxed differently if the phrase “by him or on his behalf” is held to be limited to situations involving agency. However, that is not a particularly startling outcome. Economically similar transactions are not infrequently taxed in different ways. More generally, scenarios (i) to (iii) are products of the ingenuity of lawyers litigating a particular issue arising out of s38(1)(b). They do not address the more “mainstream” situation where a person owning an asset incurs expenditure either directly, or through an agent, on the improving of that asset and so are less capable of establishing a “special statutory context” that displaces the ordinary and natural meaning of the words." (Lowe v. HMRC [2022] UKUT 84 (TCC), Marcus Smith J and Judge Jonathan Richards)
"[32] The process of statutory construction will thus reveal, among other things, the relevance or otherwise of the economic effect of transactions. It is wrong, however, to assume that economically equivalent transactions should be taxed in the same way. As Lord Greene MR said in Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11, 16: 9
"In dealing with income tax questions it frequently happens that there are two methods at least of achieving a particular financial result. If one of those methods is adopted, tax will be payable. If the other method is adopted, tax will not be payable.”
[33] [The taxpayer] sought to depict Wesleyan as out of date, pointing to Viscount Simon’s endorsement in the House of Lords of Lord Greene MR’s statement by reference to Duke of Westminster v IRC 19 TC 490 and suggesting things had moved on since that case. However, as [HMRC] pointed out, Wesleyan was expressly approved by Lord Wilberforce in Ramsey and we consider that it clearly remains good law." (Khan v. HMRC [2020] UKUT 168 (TCC), Judge Raghavan and Judge Andrew Scott)
"[20] Two important points emerge from the Overdrive case. First, it is necessary to give effect to the legal result of a particular transaction however artificial that may seem. Secondly, the discharge by an employer of a debt incurred by an employee represents earnings paid on behalf of that employee for the purposes of the national insurance regime. The court is clearly focusing on the employee and identifying what, depending on the nature of the transaction, he gets, whether directly, namely the petrol or indirectly, namely the discharge of a debt owed by him. In the latter case, he gets the equivalent of a payment in cash." (Tullett and Tokyo Forex International Ltd v. Secretary of State for Social Security [2000] EWHC Admin 350, Collins J)
- Transfer from A to B to C not taxed the same as transfer from A to C in performance of back to back contracts
"[53] Rackham Ltd did not acquire the Property by becoming the beneficial owner of it, and Mr Underwood did not dispose of it. Rackham Ltd did not pay £400,000 for a beneficial interest in the Property. Rackham Ltd agreed that its obligation to pay £400,000 could be set off against Mr Underwood's obligation to pay £420,000 thereby extinguishing Rackham Ltd's interest in the Property, which was the right to require transfer of the beneficial interest, but subject to the Option.
[54] I do not consider that Mr Underwood is assisted by reliance on other types of transaction which are said to be similar. In "bed and breakfast" transactions the owner of the asset disposes of it and then re-acquires it: MacNiven v Westmoreland Investments (1998) 73 TC 1, 48, affd [2003] 1 AC 311. So also in the case of a sub-sale where a transfer is made direct to the sub-purchaser at the request of the purchaser, the transaction can be characterised as two transactions in which the purchaser pays the seller for an interest and the sub-purchaser pays the purchaser for the same interest. There are two disposals, one by the seller to the purchaser and one by the purchaser to the sub-purchaser." (Underwood v. HMRC [2008] EWCA Civ 1423, Collins, Neuberger, Goldring LJJ)
- The boundary of a concept will inevitably lead to cases either side of the line that appear similar in economic terms
"[100] The application of Article 6(2) is very fact specific. It is not appropriate in these circumstances to attempt to identify the precise boundary between those arrangements which will in future be treated as falling within Article 6(2) and those which will not. Any definition which extends the meaning of a term such as "immovable property" beyond what would normally be included in it creates its own penumbra of uncertainty in a different place from the penumbra that exists around the ordinary meaning of the term. There must be a dividing line somewhere between what is caught and what is not caught and that has the inevitable consequence that some cases will fall on one side of the line and others on the other side even though they appear similar in economic terms." (HMRC v. Royal Bank of Canada [2025] UKSC 2, Lady Rose)
- Or principle that taxpayers in objectively similar situations should receive similar tax treatment
"[75] We test that conclusion by asking ourselves what the outcome would be if the opposite view were taken and a broad meaning were adopted. Two problems come into view. First, that would open the door to an obvious risk of abuse and avoidance of tax because BPRA could be claimed on expenditure of all sorts, even where the connection with the conversion (or renovation or repair) works was tenuous. Secondly, that could lead to unfairness between taxpayers, because the position could differ fundamentally between cases where the property comes into use for the purposes of the taxpayer's own trade (or, as in this case, that of a related party) and where it is let or available for letting to a third party tenant; it could also differ between cases where a structured arrangement is put in place as it was in this case and other cases where works are funded more conventionally. The desirability of construing tax legislation in a way that leads to fairness as between taxpayers was emphasised by Lord Wilberforce in Ben-Odeco v Powlson. He referred at p. 1098 B-C to "the principle of the laws of taxation … that, in the absence of clear contrary direction, taxpayers in, objectively, similar situations should receive similar tax treatment". Lord Hailsham made a similar point at p. 1100 G. We do not consider that Parliament can be taken to have intended this legislation to be construed in a way which leads to the sort of perverse outcomes we have identified." (London Luton Hotel BPRA Property Fund LLP v. HMRC [2023] EWCA Civ 362, Whipple, Falk, Lewison LJJJ)
- "Incredible" if possibility of a loan treated more harshly than an actual loan
"To a limited extent, particularised in the Section, any such capital sum would be treated for all the purposes of the Income Tax Acts as the income of the recipient for that year. It seems to be incredible that the mere possibility of a loan being made should bring upon the settlor the severe consequences set out in Section 38 (4) if the actual making of a loan only brings about the less severe consequences set out in Section 40." (Vestey v. IRC 31 TC 1 at 115)