In R v Quillan and others  EWCA Crim 538, a complex fraud case, the Court of Appeal, in ruling that there was no case to answer, provided some helpful comments on the requirements of "sham".
The underlying case involved a criminal prosecution of Mr Quillan and five other defendants ("the Defendants"). The Crown alleged that the Defendants had set up two schemes with the dishonest intention of obtaining income tax relief at source from HMRC by repeatedly paying the same sum of money into pension schemes. The offences ranged from conspiracy to defraud, common law cheat, and false accounting.
In very broad terms, the first scheme worked as follows. In order to set up a self-invested personal pension ("SIPP"), an investor borrowed money from an off-shore loan company. That money was then paid into the SIPP and income tax relief was claimed from HMRC, which was also paid into the SIPP. The funds in the SIPP were then invested in unquoted UK companies which used the funds to lend to the off-shore loan company and so the cycle went on.
The Defendants were involved in the promotion of the scheme with the associated loan and unquoted companies being controlled by their associates. The administrators of the SIPP, though originally subject to prosecution, had the case against them dropped on the basis that there was no evidence to suggest they had knowingly participated in any criminal activity.
Clearly, the purpose of a SIPP is to provide the investor with a pension on retirement. In this case, however, the contributions were funded by debt which contained a rate of interest higher than the rate obtained by the unquoted companies when they provided finance at the other end of the chain. The answer, to this apparent paradox, so the Defendants maintained, was that the tax relief would generate sufficient return through other investments to repay the loans and interest over time and make up any shortfall.
Superficially, investors in the scheme appeared to be running some risk: the loans were unsecured at each end of the transaction and it appeared that many members were investing their entire annual incomes for two or three consecutive years. The apparent risk was, however, mitigated somewhat by an unusual feature: the members were not required to pay any money to join and would not be required to pay anything in the future. In fact, in many instances, prospective members were offered and paid between a few hundred and a few thousand pounds to join.
Subsequently, one of the Defendants set up his own scheme, using the same model as outlined above, save that in his case, the share sale proceeds were only used for the purposes of re-lending (rather than other investments). In all cases the members of the schemes indicated (and the Crown accepted) that they believed the schemes were legitimate.
Following an investigation by the Financial Services Authority, the Defendants were all arrested and their offices and homes raided. The Crown's case was that the Defendants knew that the schemes would not generate sufficient funds to pay off the loans and interest and generate an income for retirement. Rather, the purpose of the schemes was to generate large amounts of tax relief by recycling the same capital. Much of the relief was, it was alleged, syphoned off to pay administrative fees and expenses.
The Crown argued that the client contributions were in fact a sham and accordingly there was no entitlement to tax relief. Further, the Crown argued that in order to qualify for relief the member had to be an “active member” of a pension scheme (section 151, Finance Act 2004). If there was no pension scheme, by virtue of the initial contributions being a sham, or otherwise not compliant with the relevant legislation (section188, Finance Act 2004), then no relief was due.
The judge at first instance found that nothing in the Finance Act 2004 precluded the use of borrowed funds with which to make a “contribution”. In the judge's view, the word “contribution”, in this context, merely meant “payment” and could include money or money’s worth. The judge was of the opinion that a person would be an "active member" if there was an agreement in place between the SIPP holder and the scheme for the accrual of benefits. He concluded that there were such agreements in place.
Judgment of the Court of Appeal
The Court of Appeal agreed with the judge’s analysis. At all parts of the statutory analysis the scheme satisfied the relevant test and the tax relief became properly due and payable. As to the allegation of sham by the Crown, the Court found that the Crown’s arguments had been put at “a very high level of generality, without any attempt being made to analyse the precise respects in which it was alleged that the arrangements were sham”.
Citing the well-known case of Snook v London and West Riding Investments Ltd  2 QB 786 and Hitch v Stone  EWCA Civ 63,  STC 214, the Court found that if the Crown was to establish sham it would be necessary for it to show that "the contributions lacked any true legal substance”. The Court found that it would have been impossible to make out such an argument unless the Crown could show that the members were themselves conscious participations in the sham, since the authorities all require that for there to be sham there must be a common intention of the parties to a particular transaction. Since the Crown accepted the members considered the schemes to be legitimate, the Court of Appeal was of the view that its arguments on sham were “hopeless”.
The concept of “sham” is often hinted at by HMRC in tax disputes, in particular, in relation to disputes relating to tax planning, but rarely, when pressed, does HMRC seek to formally plead and argue it before the tax tribunals and courts. It is, as Diplock LJ said in Snook “a popular and pejorative word”, however, within the law it is a term with specific meaning. Although many may view the particular structure at issue in this case objectionable; at a time when the use and conflation of terminology for the purposes of political expediency and popular opinion are common-place, it is gratifying to see the courts attaching the proper meaning to words of importance and requiring those who seek to allege sham to do so properly, in accordance with established law, in order to make good their contentions.