Sham or artifice – or what does a “real sham” look like?
April 30, 2021
By Bill Hanbury
That was the question Fordham J recently asked in Isle Investments v Leeds City Council  EWHC 345 (Admin), in which I appeared for the successful local authority.
As I explained in my recent webinar on this topic (delivered on 15 April 2021), the law on shams crosses borders from residential and commercial leases and other agreements, trusts and avoidance of creditors by use of offshore structures. It most notably arises in relation to taxation and business rates “mitigation” as it is called.
The context in the Isle case was business rates. The off the shelf rates avoidance scheme “purchased” by the ratepayer, trespassed into, what the judge below had called, a land of “practical impossibility”. This is partly because the rates avoidance organisation who sold the scheme to the ratepayer, called Crusader, went to such extraordinary lengths to avoid rates that, arguably, it brought about the end of its own scheme. In an apparent attempt to make the scheme “belt and braces” and exploit the agricultural exemption available for that type of hereditament, it took artifice to a new level by inserting a user provision in to five of the leases. Those user provisions required those units to be used solely for heliculture or heliciculture – the farming of snails!
The district judge below and Fordham J on appeal by way of case stated, found all the leases to be shams. Perhaps more importantly Fordham J and the court below looked at evidence after those instruments had been executed to ascertain their true nature. In finding that the leases were shams the court was entitled to have regard to the substance of what was agreed despite the fact that both parties had, apparently, intended the leases to have the appearance of creating “genuine” legal instruments.
The case is likely to be widely referred to as it is a rare incidence of a local authority defeating a sham argument in the business rates context, at least at appellate level. A discussion of the case , however, helps to indicate a number of problems with this area of the law relevant to other practitioners.
In Isle, the ratepayer was billed for rates in respect of unoccupied hereditaments in office units close to Leeds city centre. Isle I argued initially that at all material times the premises concerned had been let out on commercial leases for no rent. They produced leases for the relevant billing period showing that the premises had been let out. As indicated above, five of the leases contained a restrictive user provision is but the others allowed general office use. There was no evidence of actual use save an attempt at showing snail farming in relation to the snail farming leases. However, during the course of the case the ratepayer submitted evidence to the effect that the scheme had been purchased in return for 20% of the rates saved by Isle.
What is a sham?
The classic statement of Diplock LJ’s remains the clearest and most often quoted:
“… Acts done or documents executed by the parties to the “sham” which are intended by them to give third parties or the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create”.
It will immediately be seen that this is quite a high test to surmount for the person arguing a sham, since it is a species of fraud in the sense that both parties must have the dishonest joint intent. This flies into the face of the “presumption of regularity” in most cases. This is the presumption that if parties enter an apparently valid legal instrument such as a lease it will generally be assumed to be valid. As Neuberger J explained in National Westminster Bank v Jones  1 BCLC 98:
“… I should not lose sight of the fact that there is obviously a strong presumption, even in the case of an artificial transaction, that the parties to what appear to be perfectly proper agreements on their face, intended to honour and enjoy their respective obligations and rights”
Are there differences in the way shams are looked at in different areas of the law?
This tolerance of artifice was not shared by the House of Lords in the residential landlord and tenant cases which came before it between 1985 and 1990. Their approach is typified by Antoniades v Villiers  1 AC 417, where Lord Templeman equated artifice with sham. He said that a series of earlier decisions of the Court of Appeal, where landlords had successfully dressed-up leases as licences by creating an obligation on the part of the tenant to share accommodation with their landlord, were obviously shams. He said:
“… the court should be astute to detect and frustrate sham devices and artificial transactions whose only object is to disguise the grant of a tenancy and avoid the Rent Acts.”
However well drafted and however superficially convincing they were, the House of Lords said the agreements created leases not licences.
It is clear from numerous judicial statements, however, that transactions solely entered for the avoidance of tax or business rates do not thereby become shams. The fact that an instrument appears “dodgy” does not alter the court’s construction of it as an instrument. In fact this is one area where the tolerance by the judiciary of steps taken by various business people to avoid liability for tax or business rates may strike the layperson as surprising. It may be seen as being beyond merely tolerating such measure but as encouraging the avoidance of tax and business rates.
Typical of the judicial approach was the decision of Norris J in Secretary of State for Business Innovation and Skills v PAG Management Services Ltd (at paragraph 62) where he said:
“… I am not persuaded that companies and partnerships that offer tax mitigation schemes (I say nothing of tax evasion schemes) are in general carrying on a business which is inherently objectionable even if the products offered are highly artificial. There are many such companies and partnerships, some of which are of the highest repute.”.
This is a surprising comment, given that the companies in that case were created solely for the purpose of sending them into members voluntary liquidation to exploit exemptions from business rates. Many non-lawyers would find what Lord Templeman said a more likely summary of the law than what Norris J said.
Is the law in this area clear and, if not, are we going to have to just put up with it?
A means of unravelling a transaction that is “sham” would be by looking at the Ramsay principle. This involves construing the underlying purpose of the transaction and considering whether that purpose is solely to defeat the liability that would otherwise exist to pay tax. The Ramsay principle is to be considered in detail by the Supreme Court in Rossendale v Hurstwood  EWCA Civ 364. That case was heard by the Supreme Court last October and a decision is awaited. It will also consider the lifting of the corporate veil of companies created solely for the purposes of avoiding business rates. Those special purpose vehicle companies (SPV’s) were immediately voluntarily wound-up to take advantage of an exception to the rating of unoccupied business hereditaments created by regulation 4(k) of the Non-Domestic Property Rating (unoccupied Property) Regulations 2008. That paragraph exempts the property of a company that is being wound up from liability for business rates which would otherwise be created by regulation 3.
It is unfortunate that the judge at first instance in that case, HHJ Hodge QC, did not give permission to the unsuccessful authorities to appeal to the Court of Appeal on his decision to find the leases entered not to be shams. Had he done so the Supreme Court would have had the first opportunity to look at this area for many years.