Understanding the Ramsay Principle: A Comprehensive Guide for Accountants

In UK tax law, the Ramsay Principle states that if a transaction has pre-arranged artificial steps, the only purpose of which is to avoid paying tax, the effect of the transaction as a whole should be taxed.

It plays an important purpose in UK tax law – not just in terms of Capital Gains Tax (CGT) but in all types of direct taxation – as a means of preventing creative tax planning to avoid tax payments.

For the Ramsay Principle to apply, a case must feature a series of transactions that are pre-ordained, and that include steps that have been included for no other reason than tax avoidance.

The Ramsay Principle was defined as a result of two key cases in the 1980s: Ramsay vs. IRC and IRC vs. Burmah Oil Co. Ltd. Here’s what you need to know.

Historical Development and Key Cases

In UK tax law, the Ramsay Principle refers to the outcome of WT Ramsay [1981] STC 174. The company had made substantial capital gains through a sale-leaseback transaction and wanted to avoid Capital Gains Tax (CGT).

In order to do so, the company made two loans to a subsidiary company it had recently acquired. Both loans carried interest – but the company reduced the interest on the first loan to zero and doubled the interest on the second, which it sold to another company for profit.

When the first loan was repaid, it resulted in a capital loss: a loss for which the company sought capital relief. However, the company also claimed that the capital profit was debt on a security, and so tax-exempt. The House of Lords, in its judgement, disagreed, giving rise to the Ramsay Principle.

As a result of the Ramsay case, IRC vs. Burmah Oil Co. Ltd received similar scrutiny. The company sold an investment, resulting in a genuine loss – but this loss was not one that could be classed as tax-deductible. The company, however, sought to crystallise that loss into a form that was. It made a series of inter-group transactions that, on the liquidation of one of the group’s subsidiaries, became a deductible capital loss. Had it not been for the earlier Ramsay case, Burmah Oil Co. Ltd may well have got away with it.

Up until this point, the Ramsay Principle had only been applied to cases that were self-cancelling or circular. This all changed with Furniss v Dawson ([1984] STC 153).

This was the first of the “linear” tax planning strategies defined as avoidance under the Ramsay Principle. The taxpayers were looking to sell company shares to an independent buyer. To defer their CGT liability, they exchanged their shares in that business for shares in Greenjacket, a new investment company incorporated in the Isle of Man. Greenjacket sold the company shares on the same day to the independent buyer at the price that had already been negotiated.

The Lords decided that this was tax avoidance, and amended the Ramsay principle to include:

1. A preordained series of transactions – or a single composite transaction – which includes
2. Steps inserted which have no commercial purpose apart from tax avoidance or deferral.

Over the years, the Ramsay Principle has been amended and extended as further cases have been scrutinised. It seems that there are still grey areas when it comes to where the principle is applied – which is why it is vital that accountants take Ramsay into account when adopting tax planning strategies.

Application of the Ramsay Principle in Tax Planning

Based on the number of cases that have been heard since Ramsay was defined, there still appears to be a great deal of uncertainty around when and whether the principle applies.

For this reason, accountants need to ensure that client tax planning is completed as early as possible – and in a way that demonstrates that actions are not being taken purely for tax avoidance purposes. It could be that future transactions are planned and documented at a time when they could still be subject to outside influences, or that the sale of assets is planned before a potential purchaser is found.

Remember that the Ramsay Principle can be applied to all forms of direct taxation – not just CGT. Stamp Duty Land Tax, dividend payments, the sale of shares and even PAYE can be scrutinised should HMRC believe that tax planning strategies have been chosen and implemented purely for tax avoidance purposes. For accountants, it’s vital to have a solid understanding of Ramsay and scrutinise client accounts and proposed transactions to ensure that the principle can’t be applied.

Common Misconceptions about the Ramsay Principle

Accountants must remember that Ramsay may not involve just one transaction: it can, in fact, cover multiple transactions (such as in Furniss v Dawson) that contribute to one arrangement. As such, tax planning strategies designed purely for avoidance can sometimes be tricky to spot.

For Ramsay to apply, the taxpayer need not use their own funds. As in the original Ramsay hearing, the transactions could be based on loaned funds.

As previously described, the first few cases where Ramsay was applied involved circular transactions. However, this is not always the case, with Furniss v Dawson demonstrating that linear transactions could also be deemed to be tax-avoidant.

All of these misconceptions demonstrate that accountants need a detailed overview of their client’s accounts – as well as the reasons behind transactions or steps that may appear to have no business purpose. If an accountant is found to be aiding tax avoidance (as opposed to the legal reduction of tax liability), this could result in serious reputational damage.

Why Join ICPA for Expertise on the Ramsay Principle?

UK tax law is vastly detailed – and gaining an understanding of the Ramsay Principle is challenging in itself. Much of it comes down to interpretation and the analysis of sometimes complex chains of transactions – and over time, the definition of the Ramsay Principle has expanded and changed as a result of specific cases.

ICPA members have access to resources and expertise developed and curated by accountants for accountants. Join us today, and you’ll enjoy full access to Tolley’s Tax Library, as well as the use of our telephone helplines, staffed by seasoned sector experts, to answer all of your tax queries.

What’s more, our training and seminars can enhance your understanding of various aspects of accounting – including the Ramsay Principle and other legislation and regulations. See our full list of member benefits here – and get in touch to find out more.

FAQs on the Ramsay Principle

What types of tax schemes does the Ramsay principle target?

The Ramsay Principle targets various forms of direct taxation as a means of preventing creative tax planning to avoid tax payments.

How does the Ramsay principle interpret “artificial transactions”?

Artificial transactions are those that have been created for no commercial purpose other than to reduce or remove the need for taxation.

How can taxpayers ensure compliance with the Ramsay principle?

Taxpayers must ensure that they can prove that all transactions are made for commercial purposes – and not solely for tax avoidance. They should also ensure that any tax planning is done as early as possible – and in a way that demonstrates that actions are not being taken purely for tax avoidance purposes.