Commissioner of Taxpayer Audit and Assessment v Cigarette Company of Jamaica Limited (in Voluntary Liquidation)
Key issues and words: income tax, taxpayer assessment, applicability of section 16 of the Income Tax Act, the meaning of the word ‘artificial’ in that section, artificial transactions, whether a loan by a subsidiary to a parent company was a distribution which would be subject to income tax, or a loan, which was not.
Decision: payments of $6.4bn made by CCJ to its parent company Carreras were real loans, not artificial transactions, and section 16 of the Income Tax Act was not applicable. The income tax assessment of $1.17 bn would not, therefore, have been applicable.
Privy Council Appeal No 0028 of 2011
 UKPC 9
Before: Lord Walker, Lord Mance, Lord Wilson, Lord Sumption, Sir Patrick Coghlin
JUDGMENT delivered by LORD WALKER on 13 March 2012
Anderson J had dismissed an appeal from Cigarette Company of Jamaica Ltd (in voluntary liquidation) (CCJ) against assessments of about $1.17bn in income tax for the years 1997 to 2002. This related to about $6.4bn paid by CCJ to Carreras Group Ltd (“Carreras”) in that period. CCJ was a subsidiary of Carreras, but not wholly-owned. These payments were consistently shown as loans in both companies’ audited financial statements. But the Commissioner maintained that those payments should be treated as distributions subject to income tax deductible at source under section 38 of the Income Tax Act.
The Court of Appeal allowed CCJ’s appeal. The Commissioner appealed to the Privy Council. The Privy Council dismissed the appeal from the Commissioner, holding that section 16 of the Income Tax Act, which allows the Commissioner to disregard any transaction which he believes to be artificial or fictitious and which reduces or would reduce the amount of tax payable by any person, was not applicable.
An agreement dated 1 September 1977 (“the 1977 agreement”) contained a clause stating, inter alia, that Carreras was allowed at its sole discretion (but with the approval of CCJ) to borrow from CCJ such amounts as it might from time to time require free of interest. The clause provided however, that Carreras would guarantee to CCJ the repayment of such borrowing.
Apart from CCJ, Carreras had other wholly-owned subsidiaries operating different businesses eg agriculture (especially tobacco-growing), printing, and tourism.
Lord Walker stated that fFrom 1997 until the end of the 1980s the financial statements of Carreras and CCJ indicated that Carreras was:
“… actively carrying out treasury functions, so that it was sometimes a creditor, and sometimes a debtor, of its subsidiaries. There were also loans between subsidiaries themselves.”
In 2003 the group was reorganized, and most of the non-tobacco businesses were disposed of or closed. Carreras was to become the operating company of the tobacco business and CCJ was to be put into liquidation. The dispute arose in the course of an application for various tax clearances.
The Income Tax Act
Section 16(1) of the Income Tax Act states that:
“Where the Commissioner is of opinion that any transaction which reduces or would reduce the amount of tax payable by any person is artificial or fictitious, or that full effect has not in fact been given to any disposition, the Commissioner may disregard any such transaction or disposition, and the persons concerned shall be assessable accordingly.”
Section 34 provides that a loan which falls within Section 35 shall not be treated as a distribution.
Section 35 states that a body corporate subject to income tax shall be treated as making a distribution where it grants a loan, (otherwise than in the course of a bona fide business of lending money) to a principal member of the body corporate or of any other body corporate connected with it. The provision does not apply, however, if the principal member is a body corporate resident in the Island; or if the principal member is a body corporate resident out of the Island and the Minister has approved the loan as being beneficial to the economy of Jamaica.
When is a transaction artificial?
The Privy Council examined the meaning of the word “artificial” in section 16 (1) and referred to a statement by Lord Diplock in Seramco Ltd Superannuation Fund Trustees v Income Tax Commissioner AC 287, 298:
“ ‘Artificial’ is an adjective which is in general use in the English language. It is not a term of legal art; it is capable of bearing a variety of meanings according to the context in which it is used…their Lordships reject the trustees’ first contention that its use by the draftsmen of the subsection is pleonastic, that is, a mere synonym for ‘fictitious’. A fictitious transaction is one which those who are ostensibly the parties to it never intended should be carried out. ‘Artificial’ as descriptive of transaction is, in their Lordships’ view a word of wider import. Where in a provision of a statute an ordinary English word is used, it is neither necessary nor wise for a court of construction to attempt to lay down in substitution for it, some paraphrase which would be of general application to all cases arising under the provision to be construed.”
The Privy Council added that:
“…in this context a transaction is “artificial” if it has, as compared with normal transactions of an ostensibly similar type, features that are abnormal and appear to be part of a plan. They are the sort of features of which a well-informed bystander might say, “This simply would not happen in the real world.” Recognising a transaction as artificial in this sense is an evaluative exercise calling for legal experience and judgment. It is certainly not an ordinary question of primary fact… A transaction is not artificial merely because it is not commercial, or not fully commercial. Income tax affects transactions by way of bounty as well as commercial transactions. But if a transaction effected in a commercial context is attacked as uncommercial that may be a reason for looking at it closely. To repeat what Lord Diplock said in the passage quoted above, it is necessary to examine the particular transaction and the circumstances in which it was made and carried out.”
Lord Walker stated, however, that the Board did not agree with Morrison JA’s view, in the Court of Appeal, that an artificial transaction would invariably or usually involve dishonesty. Lord Walker stated that:
“In general it would do so only if it involved active deception, or non-disclosure which was in the circumstances tantamount to active deception.”
The Law Lords stated that the judge at first instance was influenced by the absence of documentary evidence of management policy, decisions, and implementation of decisions but Lord Walker stated that:
“ …board minutes often reflect immediate preoccupations rather than long-term policy, and are sometimes uninformative… the financial statements and other documentary evidence in the Record contain a good deal of information, some of which is summarised above. But it seems that counsel did not take the judge to much of it in the course of the hearing.”
Lord Walker said that the loans were real loans, the existence of which were acknowledged regularly by directors of Carreras signing the balance sheet, and the only possible justification for those loans was the group structure.
According to the Privy Council:
“The group structure was not…a reason for treating the loans as artificial. It was, on the contrary, the commercial context in which there was nothing abnormal or artificial in the loans being unsecured, interest-free, and documented only by normal accounting and auditing processes.”