Ingram and another (executors of the estate of Lady Ingram (deceased)) v Inland Revenue Commissioners
[1997] 4 All ER 395(Judgment by: Millett LJ)
Ingram and another (executors of the estate of Lady Ingram (deceased))
v Inland Revenue Commissioners
Judges:
Nourse LJ
Evans LJ
Millett LJ
Judgment date: 28 July 1977
UK
Judgment by:
Millett LJ
28 July 1977. The following judgments were delivered.
In the course of his submissions Mr Nugee QC for the Crown cited a passage from Potter and Monroe Tax Planning (1st edn, 1954) p vii (Preface) in which the authors warned, in words which remain as true today as when they were first written:
'A man cannot eat his cake and have it. Moreover, it is not the function of his lawyer to devise a scheme whereby this fact of life is falsified. If a man disposes of his property for another's benefit, certain tax results may follow; but the results cannot be achieved unless the disposition is in the first place effected not as a fiction but as a fact.'
A man may, however, genuinely dispose of his property by way of gift while retaining an interest in the property given or obtaining some other benefit from the donee in return. Such a transaction has traditionally been described as 'a gift subject to a reservation' and it is still so described in the legislation which is in force today. From the inception of estate duty in 1894, Parliament denied to such gifts the tax advantages which it was willing to accord to gifts made without reservation. It did so by making it a condition of relief (a) that possession and enjoyment of the property should be immediately assumed by the donee, and (b) that thenceforward the property should be 'enjoyed to the entire exclusion ... of the donor and of any benefit to him by contract or otherwise'.
The grammatical structure of these provisions indicated that the property in question was the property given; and accordingly, adopting a somewhat literal construction of the statute to the possible detriment of its evident legislative purpose, the courts laid down a settled rule that it was only the possession and enjoyment of the actual property given from which the donor must be excluded. It was, therefore, necessary in every case to identify with precision the interest which formed the subject matter of the gift. If the donor was not excluded from possession and enjoyment of the very interest which he had given, then relief from estate duty was denied. But relief from estate duty was not denied merely because the donor continued in possession and enjoyment of some other interest in the same property which he had not given. As Lord Radcliffe expressed it in St Aubyn (L M) v A-G (No 2) [1951] 2 All ER 473 at 496, [1952] AC 15 at 49:
'... if [the interest given] is, as it may be, a limited equitable interest or an equitable interest distinct from another such interest which is not given or an interest in property subject to an interest that is retained, it is of no consequence for this purpose that the retained interest remains in the beneficial enjoyment of the person who provides the gift.'
The distinction between a gift of the whole property with a gift back of a limited interest in the property on the one hand and a gift of a limited interest only in the property, the donor retaining what he has not given on the other, is not always easy to draw. The distinction is an artificial one which depends on form rather than substance. It was trenchantly criticised by Lord Radcliffe in St Aubyn's case [1951] 2 All ER 473 at 493, [1952] AC 15 at 44-45, where he deplored the fact that, when Parliament had found the time in 1940 to repeal and re-enact the legislation concerning gifts with reservation of benefit, it had not taken the opportunity to make it intelligible.
The replacement of estate duty by capital transfer tax made it unnecessary to retain the provisions which dealt with gifts with reservation of benefit, and they were duly repealed. The replacement of capital transfer tax in turn by inheritance tax in 1986, however, made it necessary once more to deal with the problems caused by such gifts. Parliament did so by s 102 of the Finance Act 1986. Despite the criticisms which had been levelled at the earlier legislation, it re-enacted it almost verbatim. It thereby revived the artificial distinction between a gift where the donor remains in possession and enjoyment of the subject matter of the gift and a gift where he remains in possession and enjoyment of some other interest in the same property which is excluded from the gift. Given that in either case the donor's purpose is to obtain a tax advantage, and that in either case he may be with equal justification be said to want to eat his cake and have it, Parliament must be taken to have considered the one course of action but not the other to be what Lord Scarman described as the safe channel of acceptable tax avoidance (see Furniss (Inspector of Taxes) v Dawson [1984] 1 All ER 530 at 532, [1984] AC 474 at 513). The difference between acceptable and unacceptable tax avoidance is pre-eminently a matter for the legislature. If Parliament has drawn the line in a particular place, however incongruously, it is not for the courts to draw it elsewhere.
Lady Ingram's scheme
Lady Ingram wished to take appropriate steps to achieve an eventual saving of inheritance tax if she lived long enough. To this end she decided to make a potentially exempt transfer of her country estate to her children. She did not, however, wish to give up the right to continue to live there rent-free during the rest of her life. She could not achieve her object by retaining a life interest in the property, for this would constitute an interest in possession in settled property, and on the death of a person entitled to such an interest inheritance tax is charged on the capital value of the property in which the interest subsists (see Sch 5 to the Finance Act 1975 (see s 43 and ss 49 to 52 of the Inheritance Tax Act 1984)). Nor could she take a lease for life or for a period determinable by reference to her death, since such a lease is treated as an interest in possession in settled property. Accordingly, Lady Ingram was advised to retain for her own benefit a leasehold interest for a fixed period which was likely to be of sufficient duration to exceed the remainder of her lifetime and to make a gift of the freehold reversion to her children.
To this end (disregarding immaterial features) Lady Ingram took the following steps or procured them to be taken. (1) Lady Ingram conveyed the freehold interest in the property to her solicitor, Mr Macfadyen, for no consideration. This transaction, of course, did not pass any beneficial interest to Mr Macfadyen. (2) Immediately afterwards Mr Macfadyen executed a deed by which he declared that he held the property as nominee for Lady Ingram and agreed to transfer it back to her or otherwise deal with it as she might direct. This merely gave formal recognition to the effect of the conveyance to Mr Macfadyen. (3) On the following day, and at Lady Ingram's direction, Mr Macfadyen granted a lease of the property to Lady Ingram for a term of 20 years free of rent. The lease contained an absolute covenant against assignment, underletting or parting with possession, and appropriate but fairly minimal covenants on the part of each party. (4) On the following day, again at Lady Ingram's direction, Mr Macfadyen conveyed the freehold interest in the property subject to and with the benefit of the lease to named trustees. (5) Immediately afterwards the trustees executed a declaration of trust by which they declared that they held the property which had been conveyed to them (that is to say the freehold interest in the property subject to and with the benefit of the lease) in trust for Lady Ingram's intended beneficiaries.
The rival contentions
Lady Ingram set out to create and retain for her own benefit a 20-year lease of the property and to give only the freehold reversion subject to and with the benefit of the lease to her children. The Revenue acknowledge that, if that is what she did, then she succeeded in making a potentially exempt transfer of the freehold reversion in the property and not a gift of the property subject to a reservation. But the Revenue contend that that is not what she did, and (implicitly) that it is not possible to do it.
The judge held that it is not possible for a nominee to grant a lease to his principal, with the result that the purported lease was a nullity. (Although Mr Macfadyen is described in the documents as Lady Ingram's nominee, the judge of course fully recognised that the relationship between them was not that of principal and agent but that of bare trustee and beneficiary.) Accordingly, he held that Lady Ingram's leasehold interest did not come into existence until the trustees executed the declaration of trust, which was when Lady Ingram for the first time ceased to be beneficially entitled to the freehold. The lease then vested in Lady Ingram and the freehold reversion vested in her intended beneficiaries simultaneously. On this analysis Lady Ingram's leasehold interest must have taken effect in equity only, although she undoubtedly intended to take a legal term of years.
On the judge's analysis, Lady Ingram and the beneficiaries acquired their respective beneficial interests in the property at one and the same moment, and it followed that there was no prior point of time at which the trustees or beneficiaries had a more extensive interest out of which Lady Ingram's interest was carved. It was clear that Lady Ingram never intended to give the property to the beneficiaries unencumbered by her leasehold interest. The judge held that the beneficial interests should be treated as vesting in such manner as would give effect to her intention, with the result that the subject matter of the gift which Lady Ingram made was the freehold shorn of the leasehold interest.
The Revenue appeal against the judge's conclusion that the subject matter of the gift was the freehold reversion shorn of the leasehold interest, and submit that, even if the two interests did vest simultaneously, they came into existence at the same time and were indissolubly bound together. The Revenue contend that in the circumstances Lady Ingram's leasehold interest was necessarily carved out of the subject matter of the gift. Lady Ingram's executors cross-appeal against the judge's ruling that the grant by Mr Macfadyen was ineffective to create and vest a legal term of years in Lady Ingram. If all else fails, the Revenue invoke the principles established by the House of Lords in W T Ramsay Ltd v IRC, Eilbeck (Inspector of Taxes) v Rawling [1981] 1 All ER 865 , [1982] AC 300 and Furniss (Inspector of Taxes) v Dawson [1984] 1 All ER 530 , [1984] AC 474 to defeat Lady Ingram's scheme.
The first question is whether the judge was correct in ruling that the lease to Lady Ingram was ineffective to vest a legal term of years in her.
Can a nominee grant an effective lease to his principal?
There is no direct English or, so far as I know, Commonwealth authority on this question, which therefore falls to be decided as a matter of principle.
In Rye v Rye [1962] 1 All ER 146 , [1962] AC 496 the House of Lords held that it is not possible for a man to grant a lease to himself. The reasons are succinctly stated in the speech of Lord Denning ( [1962] 1 All ER 146 at 155, [1962] AC 496 at 513):
'This makes it necessary to determine the point of law: Is it possible for a person to grant a tenancy to himself? or for two persons to grant a tenancy to themselves? At common law it was clearly impossible. Nemo potest esse tenens et dominus. A person cannot be, at the same time, both landlord and tenant of the same premises: for as soon as the tenancy and the reversion are in the same hands, the tenancy is merged, that is, sunk or drowned, in the reversion; see 2 BLACKSTONE'S COMMENTARIES 177. Neither could a person at common law covenant with himself, nor could two persons with themselves. Neither could one person covenant with himself and others jointly. Such a covenant, said POLLOCK, C.B., is "senseless", see Faulkner v. Lowe ((1848) 2 Exch 595 at 597, 154 ER 628 at 630)).' (Lord Denning's emphasis.)
These two reasons correspond to the dual character of a lease in English law as both contract and conveyance. A man cannot convey to himself; and he cannot contract with himself. But he can convey to a nominee for himself, and if he can contract with a nominee for himself there is no reason why he should not be able to grant a lease to a nominee for himself. Lord Radcliffe was of opinion that he could. In Rye v Rye [1962] 1 All ER 146 at 153, [1962] AC 496 at 511 he said:
'He could, of course, put land in trust for himself by conveying it to a nominee, and, I suppose, if there was any conceivable point in the operation, he could similarly demise land to a nominee.'
Lord Radcliffe's remark was obiter and expressed in tentative terms; but he clearly considered that such a transaction gave rise to no obvious conceptual difficulty. Since he agreed that a man cannot grant a lease to himself, he also recognised that the two transactions were distinguishable in this respect.
The judge relied on an observation of Lord Macnaghten in Henderson v Astwood, Astwood v Cobbold [1894] AC 150 which at first sight appears to support the contrary view. The case concerned a purported sale by a mortgagee to a nominee for himself. Giving the opinion of the Privy Council, Lord Macnaghten said (at 158):
'The so-called sale was of course inoperative. A man cannot contract with himself. A man cannot sell to himself, either in his own person or in the person of another.'
I shall have to return to this passage later.
The judge principally relied, however, on the Scottish case of Kildrummy (Jersey) Ltd v IRC [1990] STC 657, in which the Inner House of the Court of Session held that it was not possible in Scottish law for a man to grant a lease to a nominee for himself. The Lord President (Hope) said (at 662):
'I have, as I have said, no difficulty in the concept by which the title to property and beneficial interest are separated, the title being held by a nominee. There is no reason to doubt the efficacy of this arrangement where the property in question has some independent existence of its own ... But I know of no case, and none was cited to us, where it has been held that a nominee may contract with his principal so as to create new rights and obligations involving no third party whatever which are to be held only on his principal's behalf. That seems to me to conflict with the principle that a man cannot contract with himself.'
After quoting the observation of Lord Macmillan in Henderson v Astwood, to which I have referred, Lord Hope continued (at 662-663):
'The whole basis of a contractual obligation is the agreement of two or more parties as to the act or thing to be done. This is as true of a lease as it is of any other kind of contract. It is impossible to conceive of a lease by a man in his own favour. The essence of a lease lies in the tenant's right to exclusive possession of the subject let, and the landlord's obligation to put and maintain him in that possession ... I do not see how a man can contract with his own nominee to the effect that his own nominee is to be entitled to that exclusive possession against himself, this to be held for his own behoof. The truth of the matter is that the separate interests of landlord and tenant are incapable of creation by such an arrangement.'
The Lord President (Hope) then cited Grey v Ellison (1856) 1 Giff 438, 65 ER 990 in addition to Scottish authorities before continuing ([1990] STC 657 at 663):
'The position would have been different if [the nominee] had been contracting with [the principals] for its own benefit, but since it was acting from the outset as their trustee or agent and as their nominee [the principals] were in effect seeking to enter into a contract with themselves for their own benefit.
Lord Sutherland said (at 669):
'A contract of lease ... involves the creation of mutual rights and obligations which can only be given any meaning if the contract is between two independent parties. [The nominee] had no interest of [its] own to enter into such a contract, any rights and obligations accruing thereunder being exercisable only as [nominee] for [the principals]. Under a normal lease the landlords cede occupation of the property to the tenants in return for certain obligations, but if the tenants are in fact mere nominees of the landlords the whole lease becomes a pure fiction. Accordingly, in the special circumstances of this case I am of the opinion that the purported lease is not a contract to which the law can give effect and must be treated as a nullity.'
Lord Clyde, the third member of the court, said (at 670):
'But where the same person is both debtor and creditor in the same matter there can be no obligation created. It is in my view ineffective to enter into a contract with continuing mutual rights and obligations with oneself and it is whimsical to grant a lease of one's own property to oneself (see Grey v Ellison (1856) 1 Giff 438, 65 ER 990). To attempt to grant a lease to a nominee for oneself seems to me to be a similarly barren exercise.'
I have some difficulty in accepting this reasoning as accurately representing the position in English law. It appears to my mind to treat a lease as exclusively contractual in nature and the relationship between a bare trustee and his beneficiary as analogous to that between an agent and his principal. This may be so in Scottish law or in a civilian system, but it would be an unsafe foundation upon which to base a proposition of English law which is not supported by clear English authority. As will appear later, I am of opinion that neither the passage in Lord Macnaghten's speech in Henderson v Astwood nor the decision of the House of Lords in Grey v Ellison provide such support.
I propose to examine the Revenue's contention that a man cannot grant a lease to a nominee for himself (for it is common ground that the proposition and its converse must yield the same answer) as a matter of principle. In doing so I shall take the lease first as property and secondly as contract.
There is no doubt that a lease is property. It is a legal estate in land. It may be created by grant or attornment as well as by contract and need not contain any covenants at all. The mortgage term and the portions term are examples of leases which contain no covenants and which consist of nothing more than the vesting of a term of years. It was formerly the practice for a mortgagor to attorn tenant to his mortgagee. The tenancy contained no covenants and was merely a device to give the mortgagee a right to obtain summary judgment for possession under the Small Tenements Recovery Act 1838 (which was repealed in 1972). But it was effective to create the relationship of landlord and tenant (see Regent Oil Co Ltd v J A Gregory (Hatch End) Ltd [1965] 3 All ER 673 , [1966] Ch 402).
The Revenue argue that, while a lease need not contain any covenants, it is consensual and must be capable of existing as a contract. While this is usually the case, I doubt that there is any absolute rule to this effect. The relationship of landlord and tenant has its source in medieval law, and was originally exclusively contractual. But it has long since outgrown its origins, and the term of years to which the relationship gives rise one of the two interests in land which can exist as a legal estate. It normally arises by agreement, but it can be created by statute, and the obligations to which it gives rise are enforceable by privity of estate alone.
It is easy to make too much of the contractual nature of the relationship. The feature of a tenancy which distinguishes it from a licence or merely contractual right of occupation is the lessee's right to exclusive possession. But this right is a consequence of the ownership of the legal estate; it is not merely a contractual right, or it could not be the feature which distinguishes a lease from a licence. It would not, therefore, in my opinion be an accurate description of the position in English law to say that the landlord was under a contractual obligation to put and maintain his tenant in exclusive possession; still less to imply that the right to exclusive possession depended on the existence of any such contract. That would equate a lease with a mere licence.
In so far as a lease is a conveyance, that is to say in so far as it lies in grant, there is no difficulty in the proposition that a man can vest a term of years in a nominee for himself. There is no question of the same person being at the same time both landlord and tenant at law, for the two legal estates are vested in different persons; while the rule that a man cannot be both landlord and tenant does not apply in equity, which allows the question of merger to be governed by intention.
In this connection Belaney v Belaney (1867) LR 2 Ch App 138 is instructive. The testator purchased the residue of a 99-year lease and took an assignment of the term. In the following year he bought the freehold reversion and, by a deed which recited that he was desirous that the term should not merge in the freehold, the reversion was conveyed to a trustee for him. He afterwards made a will bequeathing his personal estate. Lord Chelmsford LC held that the reversion did not pass, but that the term did. He said (at 142):
'It is most important to observe, that in the conveyance of the reversion, taken by the testator within a year after the assignment of the term to him, it is stated that the conveyance is taken to a trustee for the express purpose of preventing merger. The term, therefore, remained in the testator as personal estate.' (My emphasis.)
This result could not have been achieved if the freehold had been conveyed to the testator himself, for before the Judicature Act merger took effect without regard to the intention of the parties. But the device of taking the freehold in the name of a nominee was sufficient to prevent merger and to keep the term of years alive as a separate interest even though it was in the same beneficial ownership as the reversion. If the result is legally possible, Lady Ingram's deliberate attempt to achieve it cannot be dismissed as a nullity or a barren exercise.
The Revenue argue that the grant of the lease to Lady Ingram by her nominee was devoid of any legal effect. But that is not correct. Had Mr Macfadyen fraudulently and in breach of trust conveyed the fee simple in the land free from encumbrances to a bone fide purchaser for value without notice before granting any lease to Lady Ingram, the purchaser would have taken free from her equitable interest. Had Mr Macfadyen done so after granting her the lease the purchaser would have taken subject to her lease (though not her equitable interest in the reversion) even if he had no notice of it because it was a legal estate. Of course on the facts of this case the example is somewhat fanciful, since Lady Ingram's occupation of the land would have given the purchaser notice of her interest. But the Revenue's argument must be tested generally; the validity of a lease by a nominee to his principal cannot be made to depend on whether the lessee is in possession. In my judgment the grant of such a lease is not without legal effect. The Revenue object that this reasoning is circular, since it presupposes that Lady Ingram's lease is valid. But I think that it is the Revenue's argument which is circular, since it contends that the lease is a nullity because it is incapable of having legal effect, when it is incapable of having legal effect only if it is a nullity.
I turn next to consider the lease as contract. The proposition that a man cannot contract with a nominee for himself requires close examination. Several different objections may be made to such a transaction, and it is necessary to distinguish between them. One, with which alone we are concerned, is that there cannot be a contract unless there are at least two parties to it. This is the objection made in Kildrummy (Jersey) Ltd v IRC. It is directed to the intrinsic validity of the contract, and applies whether the principal is a beneficial owner or a trustee. It is based on what may conveniently be called the two-party rule. A quite different objection is that the equitable interests of beneficiaries under a trust are not capable of being overreached by a transaction between the trustee and his nominee. For this purpose there must be not merely two parties to the transaction but two independent parties who are capable of dealing with each other at arm's length. In my opinion this is the context in which Lord Macnaghten's words in Henderson v Astwood must be understood. The doctrine applies only where the principal is himself a trustee and is part of the rule against self-dealing. We are not concerned with it.
An agent can of course contract with his principal, provided that he is contracting on his own behalf, that is to say as principal. The agency contract itself is just such a contract. What an agent cannot do is contract with his principal as agent for and on behalf of his principal so as to make his principal and not himself liable to sue and be sued on the contract. Such a contract is obviously impossible, since the agent drops out leaving only the principal liable to himself. It infringes the two-party rule. For the same reason two agents of the same principal cannot contract with each other. This is the ratio of Grey v Ellison. That case was concerned with a policy of insurance which one department of an insurance company purported to effect with another department of the same company. Although different individuals were parties to the contract, they all contracted as agents for the company with the intention that it alone should be able to sue and be sued on the policy. The policy was held to be a nullity. It infringed the two-party rule. But a trustee who contracts with his beneficiary contracts as principal, even when he enters into the contract for the benefit of the trust estate and not on his own behalf. He contracts so as to make himself personally liable to sue and be sued on the contract, though he will usually have a right of indemnity out of the trust fund. The fact that he may hold the benefit of the contract and any damages which he recovers in trust for the covenantor does not make the contract nonsensical, still less void. To put the same point another way, it is conceptually impossible for an agent to contract with his principal as agent for and on behalf of his principal so as to make the principal the only person liable to sue and be sued on the contract. But it is not conceptually impossible for a trustee to contract with his beneficiary and hold the benefit of the contract in trust for the beneficiary. It is no doubt an economic absurdity, unless it is intended to be a step in some other transaction having an economic effect. But it is not a legal absurdity. It does not infringe the two-party rule.
It is important not to understate Mr Macfadyen's position. He was not independent of Lady Ingram, but neither was he a mere cypher. His duty was 'to deal with the land as Lady Ingram might direct'. He was bound to convey the land to her or to whom she might direct. But he was not bound to comply with other directions which she might give (see Re Brockbank (decd), Ward v Bates [1948] 1 All ER 287 , [1948] Ch 206 and Re Whichelow (decd), Bradshaw v Orpen [1953] 2 All ER 1558 at 1560-1561, [1954] 1 WLR 5 at 8). He could not have been compelled to grant the lease, though if he had refused to do so Lady Ingram could simply have found someone willing to do her bidding and require Mr Macfadyen to convey the land to him. It is not, in my opinion, correct to identify Mr Macfadyen's mind with Lady Ingram's for the purposes of the two-party rule.
I reject the idea that no rational system of law could sensibly allow a party to assume an obligation to a party whose only function was to hold the benefit of the obligation for the benefit of the person subject to it. This might be so in a unified system like Scottish law, but in a divided system like ours it is possible for the parties to create obligations which are enforceable at law while being subject to equitable defences. Such obligations will not be enforced, but they are not nullities. Where the only objection is one of circuity of action they are capable of ripening into enforceable obligations when third parties become interested.
A covenant by a trustee with his beneficiary the benefit of which the trustee holds in trust for the beneficiary cannot in my judgment be dismissed as a mere whimsy. The covenant is good at law, but subject to equitable defences. Before 1873 it would have been enforced by the common law courts. It would not be enforced today, but only because enforcement would involve circuity of action (see Hirachand Punamchand v Temple [1911] 2 KB 330). This is a procedural bar, not a substantive one. Once the circuity disappears, so does all objection to enforcement. If the covenant were a nullity from the start, it could not be resuscitated.
The other objection is based on the rule which precludes a trustee from purchasing the trust property. The rule is discussed in Snell's Equity (29th edn, 1990) p 249. The purchase is not a nullity, though it is voidable at the instance of any beneficiary however honest and fair the transaction may be and even if it is at a price higher than that which could be obtained on the open market. It does not matter whether the trustee is a sole trustee who purchases from himself or only one of several trustees who purchases from his co-trustees. The vice of the transaction is not that it is unfair or that it is not the product of negotiations between independent parties dealing with each other at arm's length, but that it infringes the principle that a man may not put himself in a situation where his interest conflicts with his duty. It is obvious that a trustee cannot circumvent the self-dealing rule by using a nominee to buy the trust property on his behalf.
The rule has been thought in modern times to operate harshly where one of several trustees purchases the trust property at a fair price properly negotiated with his co-trustees. Where the trustee is a sole trustee, however, and purports to exercise his power of sale by selling the trust property to a nominee for himself masquerading as an independent third party, the transaction is objectionable on more than one ground. Both purchase and sale are bad. The purchase is bad because it contravenes the self-dealing rule; it is a purchase of trust property by a trustee. The sale is bad because it purports to be that which it is not, viz an arm's length sale of the trust property to an independent third party. A trustee's power of sale does not authorise the trustee to sell the trust property except to someone with whom he can deal at arm's length. A sale to his nominee, being unauthorised, is incapable of overreaching the interests of the beneficiaries.
The leading cases are Lewis v Hillman (1852) 3 HL Cas 607, 10 ER 239, Ingle v Richards (1860) 28 Beav 361, 54 ER 405, Farrar v Farrars Ltd (1888) 40 Ch D 395, Henderson v Astwood and Williams v Scott [1900] AC 499 . In Lewis v Hillman a sale by a sole trustee to his nominee posing as a bona fide purchaser was held to be incapable of overreaching the interests of the beneficiaries. It was, as Lord St Leonards expressed it, powerless for that purpose. Similarly, in Farrar v Farrars Ltd Lindley LJ observed that a power of sale does not authorise the donee of the power to take the property at a price fixed by himself. If the sale is unauthorised, it cannot affect the beneficial interests.
The reasons for this conclusion are variously stated in the cases. They are: (i) that a general power of sale given to a trustee does not authorise a sale in contravention of the self-dealing rule; (ii) that the very word sale connotes a transaction between independent parties dealing with each other at arm's length, so that whatever else a transaction between a principal and his nominee may be it is not a sale; and (iii) that the beneficial interests under a trust are not affected by any transaction by the trustees which is not entered into between independent parties dealing with each other at arm's length. None of these reasons are of any relevance in the present case: the first and third because Lady Ingram was an absolute owner; and the second because the word lease is not like the word sale and does not import any connotation of bargain. It is analogous to words like 'conveyance', 'transfer' or payment which denote merely the passing of property from one person to another whether preceded by a bargain between them or not.
In this connection Farrar v Farrars Ltd is instructive. A sale by a mortgagee to a company of which he was a director and shareholder was held to be effective to extinguish the equity of redemption, but only because the sale was negotiated between the mortgagee and the other directors at arm's length. It is clear from Lindley LJ's judgment that a sale by a mortgagee to a company of which he was sole director and only shareholder would be ineffective. Yet an absolute owner can grant an effective lease of his land to his own company, just as he can effectively sell and transfer his business to his own company. The truth is that the effectiveness of a contract to extinguish beneficial interests depends on there being two independent minds to conduct negotiations; but the intrinsic validity of a contract merely depends on there being two parties, not two independent minds. In many of the cases reference is made to the two-party rule, usually by way of preface to a statement of the self-dealing rule and its consequences. But contravention of the two-party rule is not in my opinion the ground upon which any of the cases proceeded; nor could it be, seeing that in all of them the arrangements between the trustee and his nominee had been completed by conveyance.
Henderson v Astwood was merely one of these cases. It was concerned with a sale by a mortgagee, ostensibly to a third party but in reality to his nominee. The land was conveyed by the mortgagee to his nominee, who executed a declaration that he held the land in trust for the mortgagee, and who subsequently sold and conveyed the land to a bona fide purchaser for value without notice of the defect in the title. This last-mentioned sale was held to be valid, but the transaction between the mortgagee and his nominee was held to be ineffective to extinguish the equity of redemption. The result was that on the taking of the mortgage account the mortgagor was entitled to the benefit of the sale to the ultimate purchaser.
The observation of Lord Macnaghten to which I have already referred must be understood in this context. His statement that a man cannot contract with himself, while true, did not in my judgment form part of the reasoning which led to his conclusion. This did not depend on the intrinsic validity as a contract of the arrangements which the mortgagee had entered into with his nominee, for these had been carried out, but on whether they constituted an effective exercise of the mortgagee's power of sale. Moreover Lord Macnaghten did not say that a man cannot contract with his nominee and he should not be understood as having said so. In my opinion his words provide no support for the conclusion of the judge in the present case or that of the Court of Session in Kildrummy (Jersey) Ltd v IRC.
In my judgment a nominee may grant an effective lease to his principal, and accordingly the lease which Mr Macfadyen granted to Lady Ingram was effective to vest a legal term of years in her. The transaction did not contravene the two-party rule, for there were two parties to the contract. It is true that they were not independent parties dealing with each other at arm's length, and had Lady Ingram been a trustee the lease would not have bound the interests of her beneficiaries; but this does not render the lease a nullity whether as property or contract. In my judgment, once the lease was granted, Lady Ingram was in the same situation as the testator in Belaney v Belaney. Pending the execution of the declaration of trust, and while Lady Ingram remained solely and beneficially entitled to the freehold and leasehold interests, the covenants in the lease were in abeyance because of the circuity of action which would be involved in any attempt by either party to enforce them. But she had succeeded in separating the two legal estates, which were in different ownership, and was in a position to deal separately with her beneficial interest in the freehold reversion and her legal estate in the term of years. Had she bequeathed one to one legatee and the other to another, the two interests would have devolved separately on her death. How, then, can it have been impossible for her during her life unilaterally to give one away and retain the other?
I reach this conclusion with satisfaction for two reasons. In the first place, a lease by a nominee to his principal is unobjectionable on any but the most technical grounds and should be upheld if not conceptually impossible. In the second place, a decision to the contrary effect would create new opportunities for fraud. Such a lease would normally contain nothing on its face to indicate any defect--the lease which Mr Macfadyen granted to Lady Ingram did not--and could be used as security to raise money or to enable the lessee to grant an underlease. This was not fully explored in argument, no doubt because the lease to Lady Ingram contained an absolute prohibition against assignment or subletting. But the Revenue's argument must be tested generally; the validity of a lease by a nominee to his principal cannot be made to depend on the presence or absence of such a covenant. If the Revenue are right and the lease is a nullity then the position of a mortgagee or underlessee must be considered. It seems that he can obtain no title; but there is no very obvious reason of legal policy why he should lose the estate. Moreover, it is contrary to principle that a purchaser should have to investigate the beneficial interests in order to satisfy himself as to the legal title.
Summary
I can summarise my reasons for upholding the transaction as follows. (1) A man can convey one of the two legal estates in land, ie the fee simple absolute in possession, to a nominee for himself. There is no rational basis for denying him the ability to vest the other, ie a term of years absolute, in a nominee for himself. (2) The right to exclusive possession is what distinguishes a lease from a contractual right of occupation. The right is a proprietary right, not a contractual right. (3) A trustee does not contract as agent for his beneficiary but as principal. A contract by a trustee with his beneficiary does not contravene the two-party rule, and is good at law. (4) Before 1873 such a contract would have been enforced by the common law courts, though the action might have been restrained by the Court of Chancery. Today proceedings to enforce such a contract would be stayed for circuity of action. But the contract would not be a nullity, and enforcement would be permitted once the circuity was eliminated by, for example, an assignment. (5) A lease can be validly created even though it achieves nothing beyond the vesting of the legal estate. It is difficult to see why it should be possible to grant a lease which contains no covenants at all but not a lease containing covenants which are temporarily unenforceable on procedural grounds. (6) The law permits a man who acquires the freehold and leasehold interests by different transactions to keep the interests separate by vesting one in himself and the other in a nominee for himself. Such a transaction is very common. Yet it produces the very result which Lady Ingram set out to achieve, and which is stigmatised as nonsensical or whimsical. (7) The lease in question is good on its face. If void, it is a potent instrument of fraud. It should not be necessary for a purchaser to investigate the equitable interests in order to satisfy himself as to the legal title. (8) The principle for which the Revenue contend rests on bare assertion. Neither principle nor authority compels its acceptance. The English authorities relied on in the Kildrummy case, when properly analysed, provide no support.
Was the property given enjoyed to the entire exclusion of Lady Ingram?
This is the first limb of s 102(1)(b) of the 1986 Act, which stipulates that the property must be enjoyed by the donee to the entire exclusion (i) of the donor, and (ii) of any benefit to him by contract or otherwise. On the view which I have formed of the validity of the lease, no contravention can have occurred. Lady Ingram created two separate interests in the land and made a gift of only one of them. The property which formed the subject matter of the gift was not the unencumbered freehold but the freehold reversion subject to and with the benefit of the lease. But I proceed to consider the case on the footing that the lease was invalid.
In analysing the transaction on this footing it is necessary to begin by observing that inheritance tax is charged on the value transferred by a chargeable transfer, and like its predecessor estate duty is charged by reference to the beneficial interests in property and not the bare legal estate. Neither the conveyance by Lady Ingram to Mr Macfadyen nor the conveyance by him to the trustees was a transfer of value. Neither Mr Macfadyen nor the trustees took any beneficial interest in the land. Lady Ingram made no gift to them. The only gift which she made was to her intended beneficiaries. They are therefore the donees for the purposes of s 102. The gift to them took effect under and by virtue of the declaration of trust. Whether the conveyance by Mr Macfadyen to the trustees preceded the declaration of trust or not it did not affect the beneficial interests, but operated in effect as an appointment of new trustees in place of Mr Macfadyen. Its only effect was that the trusts fell to be declared by them and not by Mr Macfadyen.
The trustees were not, of course, intended to take any beneficial interest for themselves, and they knew from the form of the conveyance to them, which was expressed to be subject to and with the benefit of the lease to Lady Ingram, that the beneficiaries were intended to take only the freehold reversion to her lease. In those circumstances they took the conveyance subject to an equitable obligation to give effect to her intentions. They were bound in equity to recognise Lady Ingram's right to the lease and to hold the reversion, but only the reversion, in trust for the beneficiaries. The respective rights of Lady Ingram and the beneficiaries arose at the same time and under the same instrument, that is to say the declaration of trust, and they were enforceable against the same persons, that is to say the trustees. In my judgment the same result would have been achieved and in much the same manner if Lady Ingram had simply conveyed the land to the trustees upon trust to grant the lease to her and to stand possessed of the freehold reversion in trust for the beneficiaries.
With this preamble I turn to the question whether the subject matter of the gift to the beneficiaries under the declaration of trust was enjoyed to the entire exclusion of Lady Ingram. This depends on identifying the subject matter of the gift. In my opinion it consisted on the freehold reversion expectant on the lease and not the unencumbered freehold, with the result that Lady Ingram was entirely excluded therefrom. My reasons are as follows.
Where the gift does not exhaust the whole of the donor's beneficial interest in the property, as where he gives a life interest but not the ultimate interest in the capital, the distinction between an interest which is reserved out of the property given and an interest which is not given is easy to draw. It is less easy where the donor retains a present interest in the property which did not exist as a separate interest before the gift.
In Earl Grey v A-G [1900] AC 124 , [1900-3] All ER Rep 268 the donor conveyed land to his son by way of gift but reserved an annual rentcharge during his life which was charged on the land conveyed and which his son covenanted to pay (together with the other liabilities of the donor), and retained the right to occupy the mansion house which stood on the land conveyed together with other benefits. He also reserved a power of revocation. It is difficult to see how it could have been supposed for a moment that the gift was effective to save estate duty. The gift was revocable; the donor had reserved an interest for life; he had retained the right to occupy part of the land which formed the subject matter of the gift; and he had clearly reserved a benefit by contract or otherwise in the shape of the son's covenant to pay the rentcharge. This was a benefit which the donor did not possess before the gift. It was a security for the rentcharge which guaranteed payment even if the land produced insufficient income to support it. Not surprisingly the executors received short shrift from the Earl of Halsbury LC in the House of Lords (in a speech which Lord Russell of Killowen was later to describe as 'unreserved in more senses than one' (see Comr of Stamp Duties of New South Wales v Perpetual Trustee Co Ltd [1943] 1 All ER 525 at 533, [1943] AC 425 at 444)). For present purposes, however, what is important is the way in which the rentcharge was regarded by the Court of Appeal and has been regarded in other judgments of high authority since.
In the Court of Appeal A L Smith LJ relied exclusively on the son's covenant to pay the rentcharge and to bear the other liabilities of the donor. Rigby LJ thought that the reservation of the rentcharge and the son's covenant to pay it were 'so plain as to require no further notice' (see [1898] 2 QB 534 at 542). Vaughan Williams LJ agreed that the son's covenant to pay the donor's debts was a sufficient reservation of a benefit. But, he said, such a benefit was--
'totally different from the prior estate created by the use in respect of the rent-charge, and I mention this because I am inclined to agree with the appellant that the rent-charge must be treated as something entirely outside the gift.' (See [1898] 2 QB 534 at 546.)
In the House of Lords the Earl of Halsbury LC lumped the rentcharge with the other benefits and the case was dismissed as too plain for argument.
In Re Cochrane [1905] 2 IR 626 Palles CB distinguished Earl Grey v A-G on the specific ground that the rentcharge in that case was secured by the son's personal covenant. He said (at 638):
'The limitation of this annuity, although prior to the gift, was, as well as being charged on the land, secured by the personal covenant of the grantee, and this covenant, according to The Attorney-General v. Worrall ([1895] 1 QB 99, [1891-4] All ER Rep 861), made its subject-matter a reservation out of the gift within the meaning of [the statute]; and, therefore, even if Lord Halsbury's words, "The settlement itself has reserved £4000 a year," mean, as they probably do, "reserved out of the gift," they are in no sense contrary to our present decision. The law made it a reservation out of the gift by reason of the existence of the personal covenant.' (Palles CB's emphasis.)
This is a neat explanation of the Earl of Halsbury LC's reasoning, even if it is one which is unlikely to have occurred to the Earl of Halsbury LC himself. Palles CB clearly shared the opinion of Vaughan Williams LJ, that without a covenant to pay it the reservation of a rentcharge is not in itself a benefit reserved out of the property given but is merely property not given.
The decision in Re Cochrane was affirmed by the Irish Court of Appeal ([1906] 2 IR 200), where Fitzgibbon LJ commented that if ever there was a case to which the statute applied it was Earl Grey v A-G. He referred to the various benefits which the donor had retained in that case, including the son's covenant to pay the rentcharge, but he did not mention the reservation of the rentcharge itself. Too much perhaps should not be made of this; but the same cannot be said of the speeches of Lord Russell in Comr of Stamp Duties of New South Wales v Perpetual Trustee Co Ltd and Lord Radcliffe in St Aubyn v A-G (No 2). In the last-mentioned case Lord Radcliffe made it clear that in his opinion it was not the creation of the rentcharge but the existence of the son's covenants which caused liability for estate duty to attach in Earl Grey v A-G; that this was the explanation of that case given by the Court of Appeal in Re Cochrane; that Lord Russell's speech in the Perpetual Trustee case was directed to the same point; and that he (Lord Radcliffe) agreed with those views.
Any statement of law which has the concurrence of Vaughan Williams LJ, Palles CB, and Lord Radcliffe and which has been attributed to Lord Russell is deserving of the most profound respect. It is persuasive authority of the most compelling kind. I respectfully adopt it. It follows that it is in my opinion possible for a donor to create and retain for his own benefit a present interest in property, such as a rentcharge, which did not exist as a separate interest before the gift and to make a gift of property subject thereto without thereby reserving it out of the subject matter of the gift. Neither the fact that the interest retained by the donor is a present interest which did not exist before the gift nor the fact that the interests given and retained are brought into existence simultaneously compels the conclusion that the interest which the donor retains is reserved out of the subject matter of the gift. The question is whether this principle permits a donor to create and retain for his own benefit a legal term of years and to make a gift of the freehold reversion. This question was considered by this court in Nichols v IRC [1975] 2 All ER 120 , [1975] 1 WLR 534. In that case a father conveyed land by way of gift to his son and took a lease back. Walton J held that the donee was under no more than a filial duty to grant the lease back, and that accordingly he had received by way of gift the whole unencumbered freehold interest from which the donor was not excluded thereafter. The Court of Appeal held that on the evidence the donee had been subject to an obligation binding in equity to grant the lease back. Superficially, therefore, the lease back was similar to the rentcharge which was reserved in Earl Grey v A-G. Giving the judgment of the court, Goff J said ( [1975] 2 All ER 120 at 126-127, [1975] 1 WLR 534 at 543):
'Having thus reviewed the authorities, we return to the question what was given, and we think that a grant of the fee simple, subject to and with the benefit of a lease back, where such grant is made by a person who owns the whole freehold free from any lease, is a grant of the whole fee simple with something reserved out of it, and not a gift of a partial interest leaving something in the hands of the grantor which he has not given. It is not like a reversion or remainder expectant on a prior interest. It gives an immediate right to the rent, together with a right to distrain for it, and, if there be a proviso for re-entry, a right to forfeit the lease. Of course, where, as in the Munro case, the lease, or, as it then may have been, a licence coupled with an interest, arises under a prior independent transaction, no question can arise because the donor then gives all that he has, but where it is a condition of the gift that a lease back shall be created, we think that must, on a true analysis, be a reservation of a benefit out of the gift and not something not given at all.'
The passage is obiter, since the court found it unnecessary to reach a final conclusion on the point. It is not strictly binding upon us; but it represents the considered view of the court and is of high persuasive authority. It is, however, worthy of remark that although St Aubyn v A-G (No 2) was cited it is not mentioned in the judgment; nor is any reference made to the view of Vaughan Williams LJ in Earl Grey v A-G, the explanation of that case given in Re Cochrane, or the approval of that explanation by Lord Radcliffe in the Perpetual Trustee case. While, therefore, I accept the conclusion stated in the passage in Nichols v IRC, I am unable fully to accept the reasons by which the court reached it.
In my judgment, the reason why a lease takes effect by way of regrant is not that it is a present interest which gives an immediate right to the rent, for this would apply equally to a rentcharge. The true reason is that a lease is not, like a rentcharge, merely an encumbrance charged upon the freehold which can be created by way of reservation without any regrant, and it is not, like a life interest, merely part of the freehold which can be retained without being disposed of. It is a derivative interest carved out of the freehold and must be granted by the freeholder. A man cannot grant a lease to himself, and he cannot reserve a lease to himself. Accordingly, the lease must take effect by way of regrant by the grantee of the freehold, and the grantee cannot grant it until the interest out of which it is to be carved has been vested in him. The point is made by Isaacs J in Lang v Webb (1912) 13 CLR 503 at 515:
'... you look at the instrument by which the property passes from the donor to the donee, and, disregarding mere form, ascertain its real effect. What does it give, not how does it give it? In this case the gift is made by the indenture executed by Henrietta Lang, and by that the whole of her estate in the lands was given without any exception or reservation whatever. That was the transaction of gift--complete in itself and unqualified. No other construction is possible. It had to be complete before the donee could execute to her the lease of the property. A lease is a conveyance; and it is more than form, it is substance, when the donor's interest has to be vested in the donee before the donee can convey a smaller interest.' (My emphasis.)
Accordingly, it is not possible for a donor to create and retain for his own benefit a lease on his own land and to give away only the reversion expectant on the lease by conveying the land to the donee and taking a lease back from the donee. Nor can the desired result be achieved by expressing the conveyance to the donee to be subject to the leasehold interest retained by the donor. Section 65 of the Law of Property Act 1925 provides:
'(1) A reservation of a legal estate shall operate at law without any execution of the conveyance by the grantee of the legal estate out of which the reservation is made, or any regrant by him, so as to create the legal estate reserved, and so as to vest the same in possession in the person (whether being the grantor or not) for whose benefit the reservation is made.
(2) A conveyance of a legal estate expressed to be made subject to another legal estate not in existence immediately before the date of the conveyance, shall operate as a reservation, unless a contrary intention appears ...'
At first sight these provisions might appear to dispense with any requirement for an actual regrant. But in St Edmundsbury and Ipswich Diocesan Board of Finance v Clark (No 2) [1975] 1 All ER 772 , [1975] 1 WLR 468 this court held that the words 'without ... any regrant' mean only 'without any words of regrant'. The lease back to the grantor is still created out of the absolute interest by way of regrant by the grantee.
It is for the same reason not possible to achieve the desired result by conveying the land to the donee subject to an equitable obligation to grant a lease back to the donor (as in Nichols' case) or (which comes to the same thing) subject to an equitable obligation to give effect to a lease which the donor has purported to reserve to himself. In either case the donee's conscience is not affected until he receives the freehold, and then his obligation is to grant (or give effect to) the lease out of the interest which he has received. The fact that the donee was never intended to have the freehold interest free from and unencumbered by the lease is in my opinion beside the point. What is determinative is that the donor can only obtain the lease from the donee and out of the interest which the donor has previously vested in him.
But these are conveyancing problems, not inheritance tax problems. It does not follow that it is impossible for a donor to create and retain for his own benefit a leasehold interest and give away the freehold reversion if appropriate conveyancing machinery is employed. In my opinion it is possible to do this, provided that the donor does not receive the lease by way of regrant from the donee. There are at least two methods by which the participation of the donee may be avoided: (i) by the use of a nominee (by which I mean a bare trustee) to grant or take the lease before making a gift of the reversion; or (ii) by conveying the land to a trustee upon trust to grant the lease to the settlor and subject thereto to hold the reversion in trust for the donee. In the present case Lady Ingram chose the first of these methods, and I have already concluded that she was successful. But even if the lease which Mr Macfadyen granted to Lady Ingram was a nullity, I am of opinion that Lady Ingram took her leasehold interest from the trustees without any participation by the donees, and accordingly was successful in excluding the leasehold interest from the subject matter of the gift.
If the lease actually granted to Lady Ingram was a nullity, then she never acquired a legal estate. But as I have already explained she did acquire a right to compel the trustees to grant the lease to her. Her right arose under and by virtue of the conveyance to the trustees. It was their conscience which was affected by knowledge of Lady Ingram's intention to retain a leasehold interest, so that they could not take the legal estate under the conveyance to them and deny Lady Ingram her right to remain in exclusive possession. The consciences of the beneficiaries were not affected; the only property settled upon them was the freehold reversion subject to and with the benefit of the lease which the trustees were duty bound to grant to Lady Ingram; and they could take only that which was left after the trustees had discharged their equitable obligation to her. The difference between the present case and Nichols' case is that in Nichols the donee of the freehold reversion and the grantor of the lease were one and the same, whereas in the present case they were not.
In reaching this conclusion I have not overlooked the submission of counsel for the taxpayer in Re Cochrane [1905] 2 IR 626 at 631 which was approved by this court in Nichols v IRC [1975] 2 All ER 120 at 126, [1975] 1 WLR 534 at 542 that the interposition of trustees was not relevant. This could easily be misunderstood. It comes to no more than this, that it makes no difference whether the donor makes a gift direct to the donee or vests the property in trustees and directs them to make the gift. On either footing the gift is made by the donor not by the trustees, and the subject matter of the gift is the property which the donor directs the trustees to hold in trust for the donee. So in the present case the donor was Lady Ingram, not the trustees, and the subject matter of the gift was the property which the beneficiaries took beneficially under the declaration of trust, not the legal estate which the trustees took under the conveyance. The acts of the nominee are attributed to his principal.
But it does not follow that the interposition of trustees can be disregarded, or that the court is absolved from the necessity of analysing the transaction properly in order to identify the property taken by the donee. In the present case the interposition of the trustees did not affect the substance of the transaction, which was a gift by Lady Ingram (and not by the trustees) to the beneficiaries (and not to the trustees). But it enabled Lady Ingram to overcome the conveyancing problem to which her desire to create a leasehold interest and exclude it from the gift gave rise. That is precisely the kind of problem which has traditionally been solved by resort to a use or trust, as in Belaney v Belaney.
If donor and donee agree that the donor will convey freehold land to the donee and the donee will grant a lease back to the donor, then the lease takes effect by way of regrant and is an interest reserved out of the property given. It makes no difference that the donee takes the conveyance of the freehold in the name of a nominee and directs the nominee to grant the lease back to the donor. The regrant by the donee's nominee is a regrant by the donee, for it is made at his direction.
But that is not this case. The freehold interest in the land was taken by the trustees as Lady Ingram's nominees. It was their notice of her intentions which obliged them to grant or give effect to the lease in her favour; and which disentitled them from taking the freehold estate free from the lease either for their own benefit or as trustees for the beneficiaries. It was by her direction that they held the leasehold interest in trust for her and declared trusts of the freehold reversion for the beneficiaries. The beneficiaries were passive recipients of Lady Ingram's bounty, which never extended beyond the reversion expectant on her lease.
Since writing the above I have had the advantage of reading the draft judgment of Nourse LJ. I accept, of course, that the beneficiaries could not have directed the trustees not to grant the lease, and that this is because the trustees could not have refused to grant it even if they had wanted to. Where I differ from him is that I regard the trustees and the beneficiaries as suffering from different disabilities. The trustees were entitled to the freehold estate, but their interest was subject to Lady Ingram's right to call for a lease. They could not decline to grant the lease without being in breach of an obligation which was binding on them. The beneficiaries were not subject to any such obligation. But they were given only what was left after the trustees had fulfilled their obligation to grant the lease. They could not prevent this because it did not affect the property in which their beneficial interests subsisted. Had Lady Ingram conveyed land to the trustees and directed them to stand possessed of an undivided one half-share for herself and the other half-share for the beneficiaries, the beneficiaries could not have prevented the trustees from giving effect to her interest. Their interest would not be subject to hers; it simply would not extend to hers. That, in my opinion, is the position in the present case.
Was the property given enjoyed to the entire exclusion of any benefit to Lady Ingram by contract or otherwise?
This is the second limb of s 102(1)(b) of the 1986 Act. This question can be easily disposed of. It is clearly established that to bring a case within this limb it is not necessary that the benefit to the donor should be by way of reservation out of the subject matter of the gift (see A-G v Worrall [1895] 1 QB 99, [1891-4] All ER Rep 861).
In Earl Grey v A-G the donor's right to continue to occupy the mansion house which stood on the land given to the son was a benefit reserved out of the property given and contravened the first limb of para (b), while the son's covenant to pay the rentcharge and to bear the donor's other expenses constituted a benefit to him by contract or otherwise which contravened the second limb. In Oakes v Comr of Stamp Duties of New South Wales [1953] 2 All ER 1563 , [1954] AC 57 a father made a gift of land in favour of himself and his four children in equal shares but retained wide powers of management for which he reserved the right to charge remuneration. It was held that the donor was entirely excluded from the subject matter of the gift, which was the four-fifths interest given to the children, and that his retention of powers of management did not affect the matter. This was because the donor is entirely excluded if he only holds the property in a fiduciary capacity and deals with it in accordance with his fiduciary duty. But the right to charge remuneration was a different matter. This amounted to a benefit to the donor by contract or otherwise. Lord Reid said that if the right to take remuneration could be regarded as a beneficial interest in the property reserved by the donor when making the gift, then his remuneration would not be a benefit within the scope of this limb of para (b) (see [1953] 2 All ER 1563 at 1569, [1954] AC 57 at 76). (I interpose to say that it would be, like a rentcharge, an interest in the property not given.)
In Nichols' case the lease contained a full repairing covenant by the donee. The right to have his property repaired at the donee's expense was held to be a benefit which the donor did not enjoy before.
From these cases I conclude that to come within the scope of the second limb of s 102(1)(b) the benefit must consist of some advantage which the donor did not enjoy before he made the gift, and that it is not sufficient if it consists merely of the property which he owned before the gift and which was not included in it.
No such benefit has been identified in the present case. The lease itself was merely property not comprised in the gift. It contained no covenants which would have the effect of transferring to the trustees a liability which would otherwise be borne by Lady Ingram.
The Revenue relied on the landlord's covenant for quiet enjoyment, but in my judgment there is nothing in this point. Such a covenant was present in both Nicholls' case and Munro v Comr of Stamp Duties [1934] AC 61 , [1933] All ER Rep 185. The court did not rely on the covenant in Nicholls' case and the decision in Munro's case would have gone the other way if the covenant were material. In my judgment it is not a benefit within the meaning of the second limb of para (b) because it cannot be separated from the lessee's right of exclusive possession under the lease. It reinforces that right by preventing the landlord and those claiming under him from interfering with the lessees right of exclusive possession. Thus it merely prevents the donee and his successors from interfering with the donor's continued enjoyment of property which was not included in the gift.
In my judgment Lady Ingram did not reserve a benefit by contract or otherwise within the meaning of the section.
The Ramsay doctrine
The Ramsay principle allows the court to disregard the artificial division of a single transaction into several steps or the insertion of steps which have no purpose except the avoidance of tax which would otherwise be chargeable. There is no room for the invocation of the Ramsay principle in the present case unless (i) (as I would hold) the lease was valid and (ii) (contrary to my opinion) the effectiveness of the gift as a potentially exempt transfer depended on the validity of the lease. If the lease was a nullity, it is not necessary to invoke the Ramsay principle in order to disregard it. If on the other hand the conveyance and declaration of trust would still constitute a potentially exempt transfer even if the lease were invalid, then disregarding the unnecessary creation of the lease would not affect the outcome. Since none of us was minded to reach a conclusion which could make the Ramsay principle relevant, we did not hear argument on it. Nevertheless, I shall express my own views on the subject, since it has some bearing on what might be regarded as the broader merits of the Revenue's case.
It is conceded by the executors that the several steps in the scheme were intended to be carried through as a whole and that they may properly be regarded as a preordained series of transactions or as a single composite transaction within the principle enunciated by the House of Lords in W T Ramsay Ltd v IRC and Furniss v Dawson. This is not, however, enough by itself to enable the Revenue to defeat the scheme.
Once it is found or admitted that the several steps were planned and carried through as a whole, thus forming a single composite transaction, the next question is whether the transaction as a whole or any steps artificially inserted into it have any purpose other than the avoidance of tax. These are then disregarded, not in the sense of being treated as if they did not take place, but in the sense that they cannot affect the application of the statute. As Learned Hand J put it in the seminal case of Helvering (Comr of Internal Revenue) v Gregory (1934) 69 F 2d 809 at 811:
'... we cannot treat as inoperative the transfer of the Monitor shares by the United Mortgage Corporation, the Avril Corporation of its own shares to the taxpayer, and her acquisition of the Monitor shares by winding up that company. The Avril Corporation had a juristic personality ... All these steps were real, and their only defect was that they were not what the statute means ...'
The final question is whether the transaction so identified comes within a particular taxing or relieving statutory provision. As Lord Brightman said in Furniss (Inspector of Taxes) v Dawson [1984] 1 All ER 530 at 543, [1984] AC 474 at 527:
'The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied.'
This is a matter of statutory construction. In IRC v McGuckian [1997] 3 All ER 817 at 823, [1997] 1 WLR 991 at 998 Lord Browne-Wilkinson said:
'The approach pioneered in the Ramsay case and subsequently developed in later decisions is an approach to construction, viz that in construing tax legislation, the statutory provisions are to be applied to the substance of the transaction, disregarding artificial steps in the composite transaction or series of transactions inserted only for the purpose of seeking to obtain a tax advantage. The question is not what was the effect of the insertion of the artificial steps but what was its purpose. Having identified the artificial steps inserted with that purpose and disregarded them, then what is left is to apply the statutory language of the taxing Act to the transaction carried through, stripped of its artificial steps.'
In my judgment the Revenue's attempt to invoke the Ramsay doctrine fails at each of the last two steps. It is, of course, beyond dispute that Lady Ingram was tax-motivated. If inheritance tax had not existed she would not have attempted to make a potentially exempt transfer of her property. But this is not sufficient to disregard the transaction or any steps in it, or it would not be possible to make a potentially exempt transfer at all. What is required to enable the court to disregard a transaction or step in a transaction is not the presence of a tax avoidance motive, but the absence of any other purpose. This is often described as the absence of any business purpose; but in this context business purpose does not mean commercial purpose but simply non-fiscal purpose. The circular and self-cancelling scheme in Ramsay and the artificial splitting of the disposal into two in Furniss v Dawson had no purpose at all except the avoidance of tax (see [1981] 1 All ER 865 at 873, [1982] AC 300 at 326 per Lord Wilberforce describing 'transactions designed only to avoid tax and lacking otherwise in economic or commercial reality' and citing Knetsch v United States (1960) 364 US 361 at 366 and Gilbert v Internal Revenue Comr (1957) 248 F 2d 399 at 411).
In the present case Lady Ingram set out to make a genuine gift of a reversionary interest in her property to her children. Although motivated by a desire to save tax, this was a non-fiscal purpose. The transaction was not a mere paper transaction and cannot simply be disregarded for tax purposes like the scheme in Ramsay. Nor were any of the steps artificially inserted into the transaction for an exclusively fiscal purpose. The structure of the transaction, which is what makes the scheme appear artificial, was not, as in Furniss v Dawson, tax-motivated. The several steps by which the transaction was effected were an integral part of the proper and appropriate conveyancing method to achieve the gift of the freehold reversion which Lady Ingram intended to make. They were necessitated by the conveyancing problem inherent in the need to separate the two interests in land so that Lady Ingram could deal with only one of them. Had she been entitled to a fund of money, a single step would have been sufficient. In my judgment, there is no justification for disregarding any of the steps in the transaction.
The final step is to apply s 102, not to the individual steps in the transaction, but to the substance of the transaction or its end result. In my judgment that does not help the Revenue in the present case. As Lord Steyn put it in IRC v McGuckian [1997] 3 All ER 817 at 825, [1997] 1 WLR 991 at 1000, the Ramsay doctrine is based on a broad purposive construction of the statute and a rejection of formalism in fiscal matters. If Lady Ingram's scheme is analysed broadly and without formalism, its end result was a gift of the freehold reversion. A gift of the freehold reversion and a gift of the unencumbered freehold with a lease back to the donor are two quite different legal transactions, though with very similar economic effects. One might have expected Parliament to treat them in the same way for the purpose of inheritance tax, but by adopting the earlier legislation verbatim it has evinced a clear intention to treat them differently. It is not possible, in my opinion, to adopt a broad purposive approach to the interpretation of s 102 which disregards its legislative history and attributes to Parliament a purpose which it evidently did not have.
Conclusion
I return to the point which I made at the very beginning of this elaborate and, I fear, overlong judgment. Lady Ingram made no attempt to avoid tax by pretending to make a gift while retaining the subject matter of the gift. She attempted to retain a present interest in land and to make a gift of only that which she did not retain.
The distinction is highly artificial; but it is inherent in the legislation, as construed by the highest court over many generations, that liability or exemption from tax depends on this distinction. If this creates what is popularly described as a loophole, it is one which Parliament must be taken to have intended to revive when it re-enacted the earlier legislation verbatim in 1986.
It is beyond dispute that Lady Ingram could have made a potentially exempt transfer of her land while reserving a rentcharge equal to its current annual value. But she wished to retain exclusive possession of the land itself and not merely its income. There is nothing in the nature of inheritance tax or in the detailed legislation by which it is enacted which makes this distinction material; and this is not surprising, for the two transactions have similar economic effect. The only obstacle which faced Lady Ingram was a conveyancing problem; and the only question which we have to decide is whether the conveyancing machinery which she employed to overcome it was successful. I think it was. I would dismiss the appeal.
Appeal allowed. Leave to appeal to the House of Lords granted.