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Smith v Secretary of State for Work and Pensions & Another [2006] UKHL 35

HOUSE OF LORDS SESSION 2005-06

[2006] UKHL 35

on appeal from [2004] EWCA Civ 1318

OPINIONS

OF THE LORDS OF APPEAL

FOR JUDGMENT IN THE CAUSE

Smith (FC) (Appellant)

v.

Secretary of State for Work and Pensions and another (Respondents)

Appellate Committee

Lord Nicholls of Birkenhead

Lord Rodger of Earlsferry

Lord Walker of Gestingthorpe

Baroness Hale of Richmond

Lord Carswell

Counsel

Appellants:

Nicholas Mostyn QC

Giles Goodfellow QC

Rachel Spicer

(Instructed by Family Law in Partnership)

Respondents:

For Secretary of State for Work and Pensions

Nathalie Lieven

Rupert Baldry

(Instructed by Office of the Solicitor - Department for Work and Pensions)

For Robert Smith

David Burrows

James Henderson

(Instructed by David Burrows & Co)

Hearing dates:

16 - 17 May 2006

ON

WEDNESDAY 12 JULY 2006

HOUSE OF LORDS

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

Smith (FC) (Appellant) v. Secretary of State for Work and Pensions and another (Respondents)

[2006] UKHL 35

LORD NICHOLLS OF BIRKENHEAD

My Lords,

1. On this appeal your Lordships' House is concerned with the interpretation of a singularly unhappy piece of drafting. Your Lordships are called upon to interpret the phrase 'total taxable profits ... as submitted to the Inland Revenue' in paragraph 2A of Part 1, Chapter 2 of Schedule 1 to the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 (SI 1992/1815) as amended by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977). This phrase is used for determining the earnings of a self-employed non-resident parent for the purpose of calculating the amount of child support maintenance payable by him. The legislation and facts are set out fully in the speech of my noble and learned friend Lord Walker of Gestingthorpe.

2. For the reasons given by my noble and learned friend Lord Rodger of Earlsferry I am satisfied this phrase was intended to refer to the amount inserted by a taxpayer in his tax return in the box captioned 'Total taxable profits from this business'. The newly-introduced paragraph 2A was intended to simplify the maintenance calculation process and this was the somewhat unusual means chosen for that purpose. But that is not the end of the matter. I am also satisfied that the consequence of using this amount for the purpose of a maintenance calculation was not fully appreciated. Had the consequence been appreciated, this amending regulation would not have been presented to Parliament and the world in the way it was.

3. In short, the unappreciated consequence was that using this figure from a non-resident parent's tax return can yield a significantly different result from a calculation made in accordance with the existing paragraph 3 of the 1992 regulations. Using the 'total taxable profits' figure from the tax return means using an amount of profits arrived at after deducting capital allowances and losses brought forward. By way of contrast, under the existing paragraph 3 expenses deductible from gross receipts did not include capital allowances or losses carried forward. The present case is an extreme example of the difference there can be between these two calculations.

4. The first of these two methods of calculation can produce a most unfair result to the parent with care and the children in question. Hence, it is said with force, the newly-introduced paragraph 2A cannot have been intended to have this effect. Paragraph 2A should not be so construed.

5. So what is to be done? It goes without saying that the House will seek to interpret statutory language so as to give effect to its intended meaning. The intended meaning of language is to be derived from its context. Here the context suggests that the end result produced by the 'total taxable profits' formula in paragraph 2A was not intended to bring about a radical departure from the end result produced by the existing paragraph 3.

6. But there are difficulties in interpreting the new paragraph 2A in a way which would produce much the same result as the existing paragraph 3. There are two particular difficulties. First, paragraph 2A clearly was intended to refer to figures readily derivable from the non-resident parent's tax return. If the amount appearing in the box captioned 'Total taxable profits from this business' is discarded it is far from obvious what amount is to be substituted. To achieve the same result as paragraph 3 it would be necessary to use an amount which does not, as such, appear anywhere on the tax return. It would be necessary to take the amount of net profits shown on the tax return, add back the disallowable expenses, but ignore the deductions made on the form in respect of matters such as capital allowances and losses carried forward. It is far from clear that paragraph 2A can reasonably be read as requiring any such calculation. It is, to say the least, highly questionable whether the phrase would be so understood by anyone in the context of a form which on its face applies that very phrase ('total taxable profits') to a different amount.

7. The difficulty in reading paragraph 2A in this way is compounded by the terms of paragraph 2B. In two circumstances the earnings of a self-employed earner are calculated by reference to paragraph 2B, not paragraph 2A. One circumstance is where a self-employed earner is unable to provide a total taxable profits figure for the relevant period as submitted to the Inland Revenue but he can provide a copy of his tax calculation notice. The other circumstance is where the total taxable profits figure submitted by the self-employed earner has been revised by the Inland Revenue. Paragraph 2B provides that in either of these events the earner's earnings shall be calculated by reference to his income from employment as a self-employed earner 'as set out in the tax calculation notice issued in relation to his case'.

8. Herein lies the further difficulty. The amount shown in the tax calculation notice as 'income from employment as a self-employed earner' is a net amount after deduction of capital allowances and allowable losses. Thus this alternative method of identifying a self-employed earner's earnings assumes that capital allowances and allowable losses are deductible under the paragraph 2A mode of calculation. Paragraph 2B assumes this because paragraphs 2A and 2B cannot have been intended to operate differently. Thus paragraph 2A cannot be read as identifying an amount arrived at before deducting capital allowances and allowable losses without producing an unacceptable and inescapable discord between paragraphs 2A and 2B. With reluctance and regret I would dismiss this appeal.

LORD RODGER OF EARLSFERRY

My Lords,

9. The issue in this appeal concerns the interpretation of paragraph 2A(2) of Schedule 1 to the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 which deals with the calculation of the earnings of a self-employed person for the purpose of assessing his liability to pay child support. In the speech which he is to deliver, my noble and learned friend, Lord Walker of Gestingthorpe, sets out the terms of this paragraph and of all the other relevant provisions I need not repeat them.

10. When the regulations were originally made in 1992, for the purpose of child support the earnings of a self-employed person were to be calculated in accordance with para 3. That paragraph provided that certain expenses were to be deducted from the self-employed person's gross receipts, while other expenses were not to be deducted. In terms of para 3(4)(b)(ii) among the expenses which were not to be deducted was any capital expenditure. In other words, for calculating the non-resident parent's earnings, no deduction was to be made for capital expenditure. Similarly, for example, in terms of para 3(4)(b)(v) and (vii) no loss incurred before the beginning of the current earnings period and no loss incurred in any other self-employment was to be deducted.

11. In practice the calculation of earnings in terms of para 3 proved to be far from straightforward and the complications were one of the causes of the delays for which the whole child support scheme became notorious. So in 1999 the Secretary of State for Social Security amended the Schedule and introduced a number of changes which were designed to simplify the system. One simplification was to allow more use to be made of the figures in non-resident parents' tax returns. Para 2A was designed to introduce that change.

12. Para 2A gives a new definition of "earnings", which applies subject to the provisions of paras 2B, 2C and 5A of the Schedule. In terms of para 2A(2) "earnings" means "the total taxable profits from self-employment of that earner as submitted to the Inland Revenue" less certain amounts which the sub-paragraph goes on to specify.

13. It is common ground that the expression in para 2A(2) which has to be interpreted is not just "the total taxable profits" but "the total taxable profits from self-employment of that earner as submitted to the Inland Revenue". The form of the expression ("as submitted to the Inland Revenue") points to the total taxable profits which, as a matter of historic fact, the non-resident parent submitted to the Inland Revenue. Given the purpose of para 2A, it is therefore no surprise to find that in the tax return which is submitted by self-employed earners, such as Mr Smith, there is a box (3.92) in which a figure is to be inserted and opposite which are the words "Total taxable profits from this business". The phrase is not a technical term in the tax statutes. It is found only at this one point in the form of tax return for self-employed persons drafted by the Inland Revenue. Which makes it all the more striking that it should have been adopted by the official who drafted para 2A(2). This must have been done deliberately. I am therefore satisfied that, in terms of regulation 2A, the starting point for calculating the non-resident parent's earnings is the figure for total taxable profits which he submitted to the Inland Revenue in box 3.92 of his tax return. QED, as Ward LJ so rightly said.

14. This straightforward approach assumes that anyone drafting regulations which were designed to simplify the system by allowing the non-resident parent to use a figure in his tax return might actually have looked at a sample tax return for self-employed people. It also assumes that he or she might actually have thought that the simplest thing was to copy the words used on that form to identify the desired figure. Lord Walker is not prepared to make the assumption that the draftsman working in-house in the Department of Social Security would have had a tax form before him. Joined-up government may sometimes appear to be in short supply, but it does not seem unduly extravagant to imagine that an official in another department, drafting a regulation which was intended to refer to the non-resident parent's tax return, might actually have had the initiative to obtain a copy of such a return from the Inland Revenue, to read it and to adopt its language. The alternative is to suppose that, by the most bizarre of coincidences, without ever looking at a tax return, the Social Security official quite independently alighted upon a form of words which was exactly the same as the non-technical description used by the Inland Revenue opposite box 3.92 on their form. By a sad mischance, however, the official used the words with the intention of identifying a completely different figure - to be found, presumably, somewhere else on the tax return but described by a different form of words. I forbear to express my respectful incredulity.

15. My Lords, I venture to think that the interpretation of para 2A(2) would never have been in doubt, were it not for a major inconsistency in the regulations. For the purpose of calculating the profits on which tax is to be charged, taxpayers are not allowed to deduct capital expenditure as such. But, for very many years, they have been allowed to deduct any capital allowances to which they are entitled and which they choose to claim. Therefore the figure for total taxable profits which the non-resident parent submits in box 3.92 is reached after deducting the figure (boxes 3.22 and 3.70) for any capital allowances. It follows that, if the non-resident parent's earnings are based on the figure in box 3.92 in his tax return, they are based on a figure from which any capital allowances have been deducted. For various reasons the capital allowances to which a taxpayer is entitled may be considerably higher than the depreciation figure. Where that happens, as in this case, the resulting figure for the taxable profits of a business will be appropriate for tax purposes, but may appear inappropriate if it is used for other purposes - such as calculating earnings for the purposes of child support. Nevertheless, that is the figure mentioned in para 2A(2). By contrast, before the regulations were changed in 1999, the non-resident parent's income was always calculated according to regulation 3 - which does not permit the deduction of capital expenditure and certain other items. Regulation 3 has not been revoked. It still applies, but only in certain limited circumstances. So, as a result of the amendments in 1999, the profit figure which is the starting-point for calculating the non-resident parent's earnings is different, depending on whether para 2A or para 3 applies.

16. In case it is thought that this inconsistency between paras 2A and 3 casts doubt on the interpretation of 2A(2), it is useful to consider para 2B. This paragraph applies in two situations. The first is where the self-employed earner cannot provide the total taxable profit figure as submitted to the Inland Revenue, but can provide a copy of his tax calculation notice issued by the Inland Revenue. The other is where the Secretary of State becomes aware that the total taxable figure which the self-employed earner submitted to the Inland Revenue was revised by them. In these cases the self-employed person's earnings are to be calculated "by reference to the income from employment as a self-employed earner as set out in the tax calculation notice issued in relation to his case, and if a revision of the figures included in that notice has occurred, by reference to the revised notice." It is indisputable that the income figure in the tax calculation notice or revised notice sent out by the Inland Revenue is a figure for the earner's income after deduction of capital allowances. The notice would not serve its intended purpose otherwise, since it would not explain how the Inland Revenue had calculated the taxpayer's income tax on his taxable income. It follows that what the Secretary of State uses, if the taxpayer cannot provide "the total taxable profits figure" as envisaged in para 2A, is a figure for the taxpayer's income after deduction of capital allowances. This confirms that "the total taxable profits figure" which the taxpayer is to use under para 2A must also be the figure after deduction of capital allowances - in other words, the figure in box 3.92.

17. In my view, therefore, the inconsistency between para 2A (not to mention 2B) and para 3 does not call into question the proper interpretation of the relevant words in para 2A(2). What it does indicate, however, is that when the regulations were amended in 1999 the Secretary of State and the departmental officials did not appreciate that there was an inconsistency between the two paragraphs. The approach of the majority presupposes that, if their attention had been drawn to it in 1999, the Secretary of State for Social Security and his officials would have chosen to assimilate paras 2A and 2B to para 3. That is far from obvious. After all, para 3 was one of the sources of the delays which they were trying to cure by adopting the new approach in para 2A, based on the non-resident parent's tax return. Therefore para 2A contains what they intended should be the usual approach for the future. Of course, there may be objections to basing child support assessments on figures used for tax purposes. But, wise or not, that was the policy which the Secretary of State adopted, and was entitled to adopt, in the hope of making the system more workable and so getting money more quickly to more people. This reform did indeed involve a change of substance, but there is nothing in the short speech of the Minister of State, Baroness Hollis of Heigham, in the House of Lords to suggest that the regulations were not intended to go that far. Therefore, if the Secretary of State and his officials had been asked to choose between paras 2A and 3, it is quite conceivable that they would have amended sub-paras (4)(a) and (b) so as to bring para 3 into line with para 2A. At the very least, a court cannot say that the Secretary of State and Parliament must have intended the policy in para 3 to prevail over the policy in paras 2A and 2B.

18. It follows that I see no basis upon which the House could properly select some other figure in the non-resident parent's tax return as being "the total taxable profits" as submitted to the Inland Revenue. The problem in the present case involves the deduction of capital allowances, but similar problems could arise with other deductions, eg for losses brought forward from a previous year or for losses from another self-employed business. So, if one departed from the obvious interpretation of para 2A(2), it would be necessary to find a figure on the tax form from which none of these sums had been deducted. Suffice it to say that no uninstructed reader of a self-employed person's tax return would easily pinpoint the figure which, it would have to be supposed, the draftsman of the regulations had in mind when he so unhappily chose to write the description which so uncannily pointed to box 3.92.

19. There is no doubt that, as this case shows, the approach in para 2A can produce unsatisfactory results. The fact that Mr Smith voluntarily paid a much larger sum does not alter that fact. Counsel for the Secretary of State tried to argue that, where the figure produced by using para 2A was inappropriately low, the matter could be put right by a departure direction in terms of regulations 25 and 40(5). But such a direction can be made only when the Secretary of State is satisfied that the current assessment is based on a level of income which is substantially lower than the level of income required to support the overall lifestyle of the non-resident parent. Therefore, if the non-resident parent chooses to live modestly, regulation 25 is not engaged. The regulation is directed at an entirely different problem and is not designed to deal with the difficulties thrown up by the application of regulation 2A in a case like the present where the non-resident parent quite properly deducts large capital allowances in submitting his figure for total taxable profits in his tax form. So, if the interpretation of para 2A(2) were doubtful, the departure direction regulations would not be a factor in favour of the construction which I prefer.

20. Counsel for the appellant contended that, as interpreted by the Secretary of State, para 2A was incompatible with article 8 of the Human Rights Convention. Purely for the purposes of the present case, counsel for the Secretary of State was prepared to concede that article 8 was engaged. Even so, I am satisfied that there is no breach of the article. Para 2A does not involve any positive encroachment on the appellant's family. But her counsel argued that it failed to respect the family life of the appellant and her children because it did not support it by ensuring that they received regular support at an appropriate level. The failure of the system, at one stage, to provide that the respondent should pay an appropriate figure by way of support to his children is indeed all too clear. None the less, when that happened, the appellant was entitled to income support. So there is nothing to show that the relationships and contacts between the appellant and her children were actually adversely affected by lack of adequate support from the respondent. In these circumstances the appellant has not established that the operation of para 2A resulted in a violation of her article 8 rights.

21. For these reasons, as well as for those given by my noble and learned friend, Lord Nicholls of Birkenhead, I would dismiss the appeal. It would give me no particular satisfaction to do so, since the state of the regulations is obviously far from satisfactory. His counsel assured the committee that the Secretary of State was well aware of the problem. It is therefore to be hoped that, in the course of the current review of the child support system, appropriate changes will be made as a matter of urgency.

LORD WALKER OF GESTINGTHORPE

My Lords,

Introduction

22. The Child Support Act 1991 ("CSA 1991") has been the subject of public concern and political controversy since its inception. One reason (although by no means the only reason) for this is the complexity both of CSA 1991 itself and of the secondary legislation by which it is given effect. The statutory instruments of particular relevance to this appeal are the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 (SI 1992/1815) ("MASC") and the Child Support Departure Direction and Consequential Amendments Regulations 1996 (SI 1996/2907) ("DDCA"). CSA 1991, MASC and DDCA have all been substantially amended. There have also been substantial changes, since the enactment of CSA 1991, in income tax law, and in particular in income tax law as it applies to individuals carrying on business as sole traders.

23. This appeal is concerned with the liability of a sole trader, Mr Robert Smith, to pay child support for the benefit of his three children. He is (in the old terminology) their absent parent ("AP") or (in the new terminology) their non-resident parent. A special feature of his trade was that it generated substantial capital allowances for income tax purposes. The determination of Mr Smith's liability under CSA 1991, in changing personal circumstances and under changing legislative conditions, has been a protracted and deeply unsatisfactory saga. But for the purposes of this appeal your Lordships are principally concerned with the facts as they stood, and the law as it stood, in September 2001. That is because (although other aspects of the decision are very much in issue) no one has challenged the finding by the Child Support Appeal Tribunal:

"The relevant week is 17-24 September 2001, and accordingly the accounts for the year ended 31 March 2001 together with the tax return for the tax year ending 5 April 2001 are the relevant documents for the purposes of calculating the respondent's income."

24. Because of the complexities it may be helpful to note at the outset, in chronological sequence, some salient points as to the development of child support law and tax law between 1990 and 2001. Many of the points noted here will have to be revisited and examined more closely.

(1) The system of capital allowances for income tax and corporation tax purposes (first introduced in a recognisably modern form for income tax in 1945, and frequently changed, especially in the 1980s) was consolidated in the Capital Allowances Act 1990 ("CAA 1990").

(2) CSA 1991 was foreshadowed in the White Paper, Children Come First, vol 1 (Cm 1264) published in 1990. The White Paper set out its aim (para 2.1) as a system of child maintenance which would (among other things):

" - produce consistent and predictable results so that people in similar financial circumstances will pay similar amounts of maintenance, and so that people will know in advance what their maintenance obligations are going to be;

- enable maintenance to be decided in a fair and reasonable way which reduces the scope for its becoming a contest between the parents to the detriment of the interests of the children.

- produce maintenance payments which are realistically related to the costs of caring for a child."

(3) The general scheme and structure of CSA 1991 have recently been considered by this House in R (Kehoe) v Secretary of State for Work and Pensions [2006] 1 AC 42 (see especially the speech of Lord Bingham of Cornhill at p 55, para 4). For present purposes the most important provisions of the statute in its original form were section 11(2) and Schedule 1. Section 11(2) provides:

"The amount of child support maintenance to be fixed by any maintenance assessment shall be determined in accordance with the provisions of Part I of Schedule 1."

Schedule 1 cannot be summarised concisely and I shall come back to it.

(4) The mid-1990s saw major changes in the taxation of business profits made by an individual (a company's business profits were taxed on the current year basis from the inception of corporation tax in 1965). The changes have been summarised by Professor Tiley, Revenue Law, 4th ed (2000), p 343,

"For many years, and for most of the years over which the case-law relevant to Schedule D, Cases I and II has been developed, the profits of a trade or profession were taxed on a 'preceding year' basis . . . After a transitional year in 1996-97 the new 'current year' basis was applied to all such profits as from 1997-98; the new rules were already in force for trades and professions begun on or after 6 April 1994. The same years also saw the start of the new self-assessment regime. Introducing both changes at the same time attracted much criticism."

Self-assessment for income tax was introduced by the Finance Act 1994 with effect from 1996-1997. In theory it applies to all individual taxpayers, whether traders or not, but in practice self-assessment forms are sent only to the self-employed and other individuals whose tax affairs are regarded as complex.

(5) CSA 1991 was significantly amended (in line with the White Paper, Improving Child Support (Cm 2745), published in January 1995) by the Child Support Act 1995 ("CSA 1995"). In particular, new sections 28A to 28I and Schedules 4A and 4B introduced powers enabling a "departure direction" to be made, on the application of either the parent with care ("PWC") or the AP to vary the amount of a maintenance assessment. Section 28F (1) provided:

"The Secretary of State may give a departure direction if—

(a) he is satisfied that the case is one which falls within one or more of the cases set out in Part I of Schedule 4B or in regulations made under that Part; and

(b) it is his opinion that, in all the circumstances of the case, it would be just and equitable to give a departure direction."

This introduced an element of official discretion (which it had been the government's avowed purpose to eliminate by CSA 1991). The weight to be attached to the existence of departure directions (as a means of overcoming apparent inequity in the operation of the statutory formulae) is an important subsidiary issue in this appeal.

(6) The Social Security Act 1998 made important changes to the appeal system (sections 40 to 44 being concerned with child support). It is unnecessary to go into the detail of the changes.

(7) In 1999 changes were made, by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977) to Schedule 1, Part I of MASC, which provides for the calculation of N ("the amount of [the AP's] net income, calculated or estimated in accordance with regulations"—CSA 1991, Schedule 1, para 5(1))—and of M ("the amount of [the PWC's] net income, calculated or estimated in accordance with regulations"—para 5(2)). The effect of these changes is the central issue in this appeal.

(8) Another change made in 1999, by the Welfare Reform and Pensions Act 1999, was the amendment of Schedule 2 to CSA 1991 so as to widen the powers of the Child Support Agency ("the CSA") to obtain information from the Inland Revenue. Previously it could inquire only about an AP's address or employer. Under the new para 1A it could seek information as to the earnings or other income of a self-employed AP.

25. That is, in barest outline, the background to the issues which your Lordships have to determine. Since the time relevant to this appeal (September 2001) there have been further important changes in the child support system, and counsel for the Secretary of State informed your Lordships that a further review is now in progress. The most important changes so far have been made by the Child Support, Pensions and Social Security Act 2000 ("CSPSA 2000"). It took effect from 3 March 2003 for cases occurring after that date, but has not been brought into force (and may never be brought into force) for cases pending at that date. It would add further unnecessary complication to describe the extensive changes made by CSPSA 2000. The law as to capital allowances has again been consolidated by the Capital Allowances Act 2001.

The facts

26. The facts of this case do, as I have said, amount to a most unsatisfactory saga. They are, understandably, set out in all their unhappy detail in the appellant's printed case. But for the determination of this appeal it is sufficient to give a short summary, taken largely from the agreed statement of facts and issues.

27. Mrs Helen Smith, the appellant, and Mr Smith, the first respondent, separated in December 1997 (and have since been divorced). They had three children, aged 17, 15 and 14 at the time when the statement of facts and issues was agreed. At all times since December 1997 Mrs Smith has been the PWC and Mr Smith the AP.

28. At the material time Mr Smith carried on business as an individual sole trader in the car-hire business. He specialised in adapting cars for use by driving schools and renting them to driving schools for lengthy periods (the appeal tribunal put it as "months rather than weeks"). He had a successful and expanding business. The profits of his trade were taxed under Schedule D, Case I and he was able to claim (and did claim) substantial allowances under CAA 1990. In the period from 1 April 2000 to 31 March 2001 (covered by his self-assessment tax return for 2000-2001 which he signed on 17 December 2001) he made a taxable profit (before capital allowances) of £169,520, reduced by capital allowances of £148, 628 to the sum of £20,892 on which he was charged to tax under Schedule D, Case I.

29. Mrs Smith applied promptly for a maintenance assessment (as she was obliged to do, under section 6 of CSA 1991, since after her husband's departure she had to apply for, and was receiving, income support). On 27 September 2001 the CSA made a maintenance assessment of £11.28 per week (for all three children). This was based on Mr Smith's tax return for 1999-2000, in which he also had a claim for substantial capital allowances. Mrs Smith appealed to an appeal tribunal and by the time her appeal was heard Mr Smith's tax return for 2000-2001 was available. On 8 April 2002 the tribunal made a new determination based on a figure of £20,892 for Mr Smith's taxable income (although with an upwards adjustment which, as is now common ground, was erroneous).

30. Mrs Smith had also applied for a departure direction under section 28A of CSA 1991 (as amended) and regulations 24 and 25 of DDCA. The Secretary of State referred this application to the tribunal. It declined to make a departure direction.

31. Mrs Smith appealed to the Child Support Commissioner and her appeal was heard by Mr Commissioner Howell QC. In his written decision dated 6 October 2003 he defined the issue of law which he had to determine (para 8):

"In calculating a self-employed trader's earnings for child support purposes, is he or is he not entitled to any deduction for capital depreciation or capital allowances?"

He resolved this issue in favour of Mrs Smith and allowed her appeal. He did not therefore consider the departure direction issue except to note (para 30) one "plain misdirection" on the part of the appeal tribunal.

32. The Commissioner refused leave to appeal, as did Wall LJ on paper. But permission to appeal was granted on a renewed application to the Court of Appeal. On 19 October 2004 the Court of Appeal (Ward and Wall LJJ and Sir Martin Nourse) unanimously allowed Mr Smith's appeal (which was supported by the Secretary of State for Work and Pensions, the second respondent to the appeal). The decision is reported at [2005] 1 FLR 606.

33. The Court of Appeal refused leave to appeal to this House. Your Lordships granted leave on 25 January 2005 and expressed the hope that Mrs Smith would be granted legal aid. She now has legal aid (previously she was represented pro bono by the counsel and solicitors now acting for her). The Court of Appeal remitted the matter to the appeal tribunal to determine the amount of the maintenance assessment in accordance with its judgment, and to adjudicate on Mrs Smith's application for a departure direction in accordance with the Commissioner's ruling. The Court of Appeal directed that there should be expedition. Lamentably, however, the appeal tribunal decided on 1 February 2005 to stay the proceedings before it, because of the pending appeal to your Lordships' House. That decision was maintained at a further hearing on 19 April 2005, although both Mr Smith and the Secretary of State were willing for the stay to be lifted. Before your Lordships counsel for the Secretary of State (while disclaiming her client's responsibility for the delay) did not seek to defend the state of affairs during which Mrs Smith has been, for years rather than months, without any valid maintenance assessment in force. Your Lordships were told by Mr Smith's solicitor advocate, on instructions, that Mr Smith has since 2005 been paying £750 a month (as I understand what he said, with reasonable but not total regularity) towards his children's maintenance.

CSA 1991 Schedule 1

34. CSA 1991 Schedule 1, in its original form, contained a large number of algebraic formulae. The evident purpose of the formulae was to produce certainty, even at the cost of considerable complexity, in the calculation of the amount of a maintenance assessment. I have already referred to the appearance in Schedule 1, paragraph 5 of the symbols N and M, representing the net incomes of AP and PWC respectively, to be calculated or established in accordance with regulations (that is, MASC—in this case, as amended in 1999).

35. No useful purpose would be served by a detailed survey of all the (now obsolescent) formulae in the original Schedule 1. They can be understood only by reference to MASC as from time to time amended. The general scheme is to quantify the basic maintenance requirement (MR) for the child or children in question (Schedule 1, paragraph 1 and MASC regulations 3 and 4). The AP's basic liability is then quantified by reference to his and the PWC's respective assessable incomes (A and C) (Schedule 1, paragraph 2 and MASC regulation 5). The basic liability may be adjusted upwards where the AP is relatively well off (Schedule 1, paragraphs 3 and 4 and MASC regulation 6). However the AP is accorded a measure of protection in that his assessable income (A) is arrived at by the formula A=N - E, N being net income and E being exempt income (Schedule 1, paragraph 5 and MASC regulation 9). Moreover the AP may also have "protected income" (Schedule 1, paragraph 6 and MASC regulations 11 and 12) since (as it was put in the 1990 White Paper, para 3.23):

"There is no point in alleviating one family's possible dependence on income support at the expense of creating such dependence for another family. The protected level of income will prevent that circumstance arising."

It is unnecessary, for present purposes, to go further into the complexities of exempt income and protected income. But it is necessary to look closely at the quantification of the AP's net income (N). That is of central importance to this appeal.

The quantification of N: Schedule 1 to MASC in its original form

36. In this part of my opinion references to Schedule 1 are not to Schedule 1 to CSA 1991, but to the original Schedule 1 to MASC, headed "Calculation of N and M." Schedule 1, paras 1 and 2 define "earnings" in relation to an employed earner. Para 1 describes (in minute detail) the type of earnings to be taken into account, and para 2 prescribes how they are to be quantified as a weekly figure. Paras 3 and 5 perform the same respective functions in relation to the earnings of a self-employed earner.

37. It is noteworthy that para 3 refers to income tax only as a permissible deduction in arriving at the appropriate earnings figure (para 3(3) (c) and (5)). The draftsman has not followed the technique of referential incorporation of provisions of the Income and Corporation Taxes Act 1988 ("ICTA 1988") in defining the concept (familiar for tax purposes) of trading profit. Instead the draftsman has provided his own set of rules, which reproduce more or less faithfully some (but not all) of the familiar tax rules. Thus the permissible deductions under para 3(3)(a) reproduce (but with the introduction of the word "reasonable") section 74(1)(a) of ICTA 1988 and (as extended by para 3(4)(a)) the provision about repairs in section 74 (1)(d) and the exception for interest in section 74(1)(f). The impermissible deductions under para 3(4)(b)(i) to (iii) (that is (i) repayment of capital on most loans (ii) capital expenditure and (iii) depreciation of capital assets) reproduce (in different words) section 74(1)(f) and (g); para 3(4)(b)(iv) (setting up or expansion of business) reproduces other parts of section 74(1)(d) and (f); and para 3(4)(b)(vi) (business entertainment) reproduces section 577 of ICTA 1988. The rules about losses in para 3(4)(b)(v) and (vii) are quite different from those of loss relief under ICTA 1988 Part X, Chapter I (Loss Relief: Income Tax).

38. Schedule 1, para 3 says nothing at all about capital allowances as such. But the respondents accept that in view of para 3(4)(b)(i) to (iii) they could not possibly qualify as a deduction under para 3, since they are essentially adjustments made to taxable profits on account of capital expenditure on assets which, over a period, lose their value through wear and tear or obsolescence. Under Schedule 1 in its original form the draftsman in effect wrote out his own Schedule D income tax code, but with two major variations: no capital allowances and no loss relief. Both variations are readily explicable in the context of a system of child support which aims to make an AP's obligations to his children the first charge on his spendable income.

39. Schedule 1, para 5 contains provisions for quantifying a person's self-employed earnings (typically recorded in annual trading accounts, or occasionally accounts for a period of more or less than a year) as a weekly amount. In particular para 5(3) permitted a child support officer to use a different period if otherwise the calculations would "not accurately reflect the normal amount of the earnings of the person in question."

The amendment of Schedule 1 to MASC

40. In 1994 the House of Commons Select Committee on Social Security made a report The Operation of the Child Support Act: Proposals for Change (Session 1993-94, 5th Report) which was critical of many aspects of the work of the CSA under CSA 1991. The Government responded in January 1995, first with a brief reply (Cm 2743) and then the White Paper Improving Child Support (Cm 2745). Both the reply and the White Paper acknowledged the defects in the system. Numerous changes were proposed, including the introduction of departure directions and a 30% cap on the amount of maintenance which an AP could be required to pay out of his normal net income. In para 24 of the reply it was stated:

"The Government accepts that the assessment of the self-employed can be administratively complex and agrees to consider ways in which the process could be simplified. It is considering further the best way to deal with these cases."

41. In Chapter 6 of the White Paper (Administrative Changes) this was expanded:

"6.21 The Agency has experienced considerable difficulties in completing assessments where the absent parent is self-employed. These difficulties have often been due to the unavailability of accounts. The Government intends to introduce a further interim maintenance assessment to enable self-employed cases to be assessed quickly . . .

6.22 In addition, changes will also be made so that accounts over a longer period can be used for estimating earnings, and consideration given to making better use of accounts and information which may already have been prepared for tax and national insurance purposes."

42. The introduction of departure directions and other changes in the primary legislation proposed by the White Paper were effected by CSA 1995. The changes in the computation of self-employed earnings, referred to in paragraph 6.22 of the White Paper as under consideration, were effected by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977). In introducing the regulations the Government spokeswoman, Baroness Hollis of Heigham, said (Hansard (HL Debates) vol 598, 23 March 1999, col 1269):

"This package of regulations marks a step along the way of improving the CSA. We all know the difficulty that the CSA has is particularly marked in obtaining maintenance from self-employed non-resident parents. Regulation 6 introduces provisions which self-employed parents should find helpful, enabling them to provide the figures which they use for self-assessment of their earnings for tax purposes, for use in calculating maintenance. Only where they are unable to provide them, for example, if the business is a new one, will the agency have to continue to use the old cumbersome arrangements."

In short, the change was presented as an administrative improvement, not as a change of substance.

43. Regulation 6 amended Schedule 1 to MASC by introducing a new para 2A (backed up by para 2B and para 2C) and a new para 5A. The new para 2A was intended to be the primary means of determining self-employed earnings for the future, but under para 2C the original para 3 remained the default provision applicable when neither para 2A nor para 2B provides the answer.

44. The crucial provision of the new para 2A is sub-paragraph (2):

"'Earnings' means the total taxable profits from self-employment of that earner as submitted to the Inland Revenue, less the following amounts—

(a) [income tax on the taxable profits]

(b) [national insurance contributions]

(c) [half of any retirement annuity premiums]"

The new paragraphs 2B and 2C provide as follows:

"2B (1) Where—

(a) a self-employed earner cannot provide the child support officer with the total taxable profit figure from self-employment for the period concerned as submitted to the Inland Revenue, but can provide a copy of his tax calculation notice; or

(b) the child support officer becomes aware that the total taxable profit figure from the self-employment submitted by the self-employed earner has been revised by the Inland Revenue,

the earnings of that earner shall be calculated by reference to the income from employment as a self-employed earner as set out in the tax calculation notice issued in relation to his case, and if a revision of the figures included in that notice has occurred, by reference to the revised notice.

(2) In this paragraph and elsewhere in this Schedule—

'submitted to' means submitted to the Inland Revenue in accordance with their requirements by or on behalf of the self-employed earner; and

a 'tax calculation notice' means a document issued by the Inland Revenue containing information as to the income of a self-employed earner;

a 'revision of the figures' means the revision of the figures relating to the total taxable profit of a self-employed earner following an enquiry under section 9A of the Taxes Management Act 1970 or otherwise by the Inland Revenue.

2C Where the child support officer accepts that it is not reasonably practicable for the self-employed earner to provide information relating to his total taxable profits from self-employment in the form submitted to, or (where paragraph 2B applies) as issued or revised by, the Inland Revenue, 'earnings' in relation to that earner shall have the meaning given by paragraph 3 of this Schedule."

There is also a new para 5A dealing with accounting periods for the purposes of the new para 2A, and also (para 5A(3)) conferring a residual power to compute earnings under para 3 where the information available "does not accurately reflect the normal weekly earnings of the self-employed earner."

45. It is curious that these changes (which rely heavily on documents and information actually available to the AP) were introduced at about the same time as the CSA was (by the Welfare Reform and Pensions Act 1999) granted much wider statutory powers to seek information direct from the Inland Revenue. But none of the parties made anything of that in their submissions to your Lordships.

Self-assessment in practice

46. I have already referred briefly to the introduction of self-assessment for income tax with effect from 1996-97. In order to understand the new para 2A and 2B it is necessary to go into more detail as to the administrative arrangements for self-assessment. The starting point is section 8 of the Taxes Management Act 1970 ("TMA 1970") (as substituted by section 90 of the Finance Act 1990 and largely re-substituted by section 178 of the Finance Act 1994) which imposes on a taxpayer a statutory obligation to make a return if required to do so. Section 113 of TMA 1970 empowers the Board of Inland Revenue to prescribe the form of the return. Sections 9A, 9C and 28A of TMA 1970 as amended (and apart from later amendments not material to this appeal) enabled the Inland Revenue to institute an inquiry into a completed return and the amount of its self-assessment if necessary to make good a loss of tax. Section 28C of TMA 1990 enables the Inland Revenue to determine the tax payable in a case where no return was delivered at all, despite a notice under section 8.

47. The form of return prescribed by the Inland Revenue is described as follows in Tolley's Income Tax 2005-6 para 72.1 (and the summary appears to be apt for the position during 2000-01 as well):

"Returns. The return for individuals consists of a basic eight pages to which will be attached any supplementary pages relevant to the individual concerned, forming a 'customised' tax return. The supplementary pages are colour-coded and cover employment, share schemes, self-employment, partnership income, land and property, foreign income, trust income, capital gains and non-residence etc. Each individual will also receive a tax return guide containing explanatory notes relevant to his circumstances. It is the individual's responsibility to obtain any supplementary pages he needs but has not received, which he may do by telephoning an HMRC Orderline, by which means he may also obtain the relevant explanatory notes and/or 'helpsheets' on specific topics. Each return sent out will be accompanied by a tax calculation guide designed to assist the individual in calculating his tax liability if he chooses to do so."

The same publication states at para 67.2 (and again, this seems to hold good for 2000-01):

"Accounts. Business accounts are not required with the return except in the case of partnerships with an annual turnover exceeding £15m. Instead, the return includes a section in which standard accounts information (SAI) must be completed as well as space for additional information … Accounts should otherwise be retained in case of enquiry.

(Revenue Press Release 31 May 1996, Tax Bulletins June 1996 pp 313-315, June 1997 p 436 and HMRC Income Tax Self-Assessment: The Legal Framework Manual SALF 203, paras 2.18, 2.19)."

48. Your Lordships have seen copies of Mr Smith's self-assessment return for the tax year 2000-01, including the pages relating to his income from self-employment (which was in fact his only source of income). Because of the way in which the argument has proceeded, it is necessary to describe the self-employment pages in considerable detail. There are four pages divided into various sections. For present purposes the relevant sections are those headed "Capital allowances - summary"; "Income and expenses - annual turnover £15,000 or more"; "Tax adjustments to net profit or loss"; and "Adjustments to arrive at taxable profit or loss." Each section contains several numbered boxes.

49. In the section headed "Capital allowances - summary" Mr Smith filled in three boxes:

Cars [box 3.14] £146,946

Other business plant and machinery [3.16] £1,682

Total capital allowances [3.22] £148, 628

50. The section headed "Income and expenses - annual turnover £15,000 or more" contains the SAI (summary of account information). The boxes include two parallel columns of boxes, the left-hand column headed "Disallowable expenses included in [the right-hand column]" and the right-hand column headed "Total expenses." In each of the adjoining boxes 3.44 and 3.62 (depreciation and loss/(profit) on sale) Mr Smith inserted £107,301. The total of the expenses in the right-hand column [3.64] was £221,012, deductible from his turnover (less direct costs) [3.49] of £282,317 so as to arrive at "net profit/(loss) [3.65] of £61,305.

51. The procedure described in the last paragraph calls for some explanation. The SAI assumes, as its name suggests, that self-employed traders (or professionals taxable under Schedule D Case II) will have accounts, usually prepared by professional accountants, which will include all the items normally shown in a profit and loss account, including depreciation. But depreciation (together with some other expenses such as the cost of business entertainment, where incurred), although always included in properly prepared accounts, is expressly prohibited as a deduction for tax purposes (ICTA 1988 sections 74(1)(f) and 577; the rule about depreciation is very long-established, going back at least to the decision of this House in Coltness Iron Co v Black (1881) 6 App Cas 315). So a self-employed taxpayer transcribing figures from his accounts (which he will not send to the Inland Revenue) to the SAI will find a figure for depreciation which he will enter in both columns, disallowable expenses and total expenses. The figure in box 3.65 (in Mr Smith's case, £61,305), although the "bottom line" figure in that section of the form, will be an intermediate figure which must be increased by adding back the disallowable expenses in box 3.66 of the next section (in Mr Smith's case, £108,215) to arrive at the true profit figure chargeable to tax. But that figure may then be reduced (and in Mr Smith's case, was very substantially reduced) by a claim for capital allowances. It might also have been reduced (but in Mr Smith's case was not reduced) by a claim for loss relief. Those matters are dealt with in the next two sections of the self-employed pages, to which I now return.

52. In the section headed "Tax adjustments to net profit or loss" Mr Smith filled in five boxes as follows:

Disallowable expenses [3.66] £108,215

Total additions to net profit [3.69] £108,215

Capital allowances from box 3.22 [3.70] £148,628

Deductions from net profit [3.72] £148,628

Net business profit for tax purposes

[boxes 3.65 plus 3.69 minus 3.72] £20,892

It is noteworthy that the deduction for capital allowances was nearly 40% larger than the depreciation figure which (together with some other trivial disallowable expenses) had to be added back. This is a reminder that capital allowances often do not reflect an accountant's view of economic reality.

53. The next section, headed "Adjustments to arrive at taxable profit or loss" permitted adjustments to be made for various types of loss relief under Part X, Chapter I of ICTA 1988. Mr Smith did not have any claim for loss relief, so that the only figure entered in three boxes (3.76, 3.90 and 3.92) was the sum of £20,892 already mentioned. The respondents understandably place a great deal of weight on the caption to box 3.92, another "bottom line" box, "Total taxable profits from this business"—the words "total taxable profits" being identical with the words used in para 2A(2) of the amended Schedule 1 to MASC. So at last we come to the central point in the appeal. The question which the Child Support Commissioner posed to himself was, as already noted:

"In calculating a self-employed trader's earnings for child support purposes, is he or is he not entitled to any deduction for capital depreciation or capital allowances?"

If he was entitled to a deduction for capital allowances, his earnings for the 2000-01 tax year, for child support purposes, were £20,892. If he was not entitled to the deduction, his earnings were £169,520 (the total of the intermediate "bottom line" figure of £61,305 [3.65] and the disallowable expenses of £108,215 [3.66]).

The proceedings below

54. In his decision the Child Support Commissioner noted (para 3) that he had to choose between two rival interpretations of the amended version of MASC, each of which could be seen as unfair. After summarising the relevant primary and secondary legislation he set out the problem (para 12):

"In cases where paragraph 2A does now apply however, what is in my view a quite unnecessary ambiguity has been introduced, by the Secretary of State's use of the undefined expression 'total taxable profits' (which is not a defined term of art in the income tax legislation either) without making it clear whether he means by this:

(A) the annual trading profit net of allowable revenue expenses, which is the profit chargeable to income tax under Schedule D; or

(B) that amount less the capital allowances the trader can claim against it for the tax year in question, which is the net figure carried to his taxable income in working out how much tax he actually has to pay.

Either figure can be easily got from any tax return or Inland Revenue calculation, so the choice between them is neutral so far as the stated aim of paragraph 2A to save administrative work is concerned."

He also noted (para 14):

"Both sides agreed that the choice has to be a straight 'either/or' one between (A) and (B). Either the whole of the Inland Revenue capital allowances are deductible, or nothing at all. There is no 'third way' of being able to use some intermediate figure, such as the actual profit of the business shown in the profit and loss account after the deduction of capital depreciation in accordance with normal accountancy principles, even though that may be closer than anything else to showing a true and fair picture of the real profitability of the business over the relevant period—that being of course the whole point of the accountancy standards and principles reflected in the way properly drawn accounts are presented."

55. The Child Support Commissioner preferred the submissions made by Mr Mostyn QC (appearing pro bono on behalf of Mrs Smith) as to the inconsistency between the treatment of capital allowances under para 2A (if interpreted in accordance with the Secretary of State's views) and under para 3, which remains in force as a default provision. He also relied on the parliamentary statement made by Baroness Hollis, which gave no support to the notion that the amendment was intended to make substantive changes. He also noted (para 29) that capital allowances are regularly used by the Chancellor of the Exchequer as a tool of economic management:

"These fluctuations in the amounts that may be claimed by a self-employed business for capital allowances are no doubt for good policy reasons in the general management of the economy, but there can I think be no rational basis for their being taken as intended to affect the amount of child support maintenance required to be provided for children, or what a parent responsible for such maintenance should fairly be made liable to pay."

It is apparent from his decision (paras 16 and 17) that the Commissioner had before him Mr Smith's tax returns for 1999-2000 and 2000-2001, but he did not identify the various box numbers; it is not clear whether he was urged to attach particular importance to the caption to the "bottom line" box 3.92.

56. This summary fails to do justice to the Commissioner's conspicuously clear decision, which combines thoroughness with conciseness. However it will serve to give a general idea of his reasoning.

57. In the Court of Appeal, by contrast, great importance was attached to the detail of the return form, and in particular to the figure entered in box 3.92. Ward LJ treated it as more or less decisive (para 40):

"Rather than construing the phrase in isolation, it is preferable to look at the words in the whole of their legislative context. Thus reading paragraphs 2A(2) and 2B(2) together, meaning must be given to the words: 'total taxable profits from self-employment of that earner as submitted to the Inland Revenue in accordance with their requirements.' The only identified requirement of the Inland Revenue is that contained in section 8 of the Taxes Management Act 1970 to make and deliver a return containing such information as may reasonably be required by the notice given to the taxpayer. One must, therefore, look to the tax return to see if that assists in ascertaining 'total taxable profits.' It does assist. We find the answer in box 3.92: 'Total taxable profits from this business.' There it is. QED."

58. Ward LJ rejected the contrary arguments for five reasons (paras 48-52). They can be briefly summarised as follows.

(1) Parliament could easily have excluded capital allowances expressly had it wished to do so.

(2) Para 3 of Schedule 1 to MASC was not dominant; para 2A was the rule and para 3 the exception.

(3) When para 3 did apply its application was likely to be temporary.

(4) "Capital expenditure is, and always has been, properly excluded from an assessment of taxable income, but the system of capital allowances, rough and ready, artificial and variable, as it is, is at least some recognition of an economic reality. The burden of that economic reality should be for the family to share."

(5) Mrs Smith could seek a departure direction to alleviate any hardship; Mr Smith had no possible ground for seeking a departure direction.

59. Wall LJ felt driven, with obvious reluctance, to the same result. He was finally persuaded (para 67) that the possibility of Mrs Smith obtaining a departure direction was the decisive factor. Sir Martin Nourse agreed without giving a separate judgment. Again, this brief summary is inadequate but it indicates the main lines of reasoning in the Court of Appeal.

Conclusions

60. In my opinion the Child Support Commissioner was correct in his starting point, that either interpretation is possible as a matter of language. The phrase "total taxable profits" is an ambiguous expression, and (as the Commissioner observed) either figure can easily be extracted from a self-employed person's tax return. (I shall come back to whether the caption to box 3.92 gives the figure in that box any special potency). If a trader who is not an accountant or a lawyer, but who takes an intelligent interest in his own affairs, were asked the amount of his total taxable profits for Schedule D purposes, he would be likely to respond by asking whether the questioner meant before or after capital allowances. If his only capital allowances were for (say) a single modest personal computer, he might not bother to ask; but if his trade had any resemblance to Mr Smith's, he would be very likely to do so.

61. An accountant or lawyer would also have been likely to respond to the question with a question of his own. The professional would be aware that capital allowances have to be claimed, and that sometimes there are good tax reasons for not claiming them. Section 140(2) of CAA 1990 provides that for income tax purposes capital allowances "shall be given effect by treating the amount of any allowance as a trading expense of the trade in that period" (emphasis supplied) but that is a deeming process, and the fact that it is a deeming process may be significant: see Elliss v BP Oil Northern Ireland Refinery Ltd [1987] STC 52, 55-56.

62. It is common ground that before the introduction of para 2A there would have been no question of deducting capital allowances. The changes to Schedule 1 to MASC made in 1999 were described as making administrative improvements, not changes of substance. The interpretation contended for by the respondents would be a significant change of substance, and the effect of the change from para 3 to para 2A would be startling, in a case like this, even if para 3 had been repealed and entirely replaced. As it is para 3 remains in force as a default provision. The inconsistency is to my mind very striking, and potentially very unfair to a PWC in the position of Mrs Smith. I do not think that the unfairness is removed by observing that para 3 is not a dominant provision, or that it is unlikely to apply for long.

63. I do not attach to box 3.92 anything like as much weight as Ward LJ did. I am prepared to assume in favour of the respondents that a form very like that used for Mr Smith's 1999-2000 and 2000-2001 tax returns would have been in use when the amending regulations were drafted in 1999. But I am not prepared to assume that the draftsman (presumably working in-house in the Department for Work and Pensions) had such a form before him, and deliberately copied the words "Total taxable profits" from box 3.92. If that was his deliberate intention, he was not only making a change of substance in relation to capital allowances but also introducing further possible inconsistency with para 3 in the treatment of losses from other accounting periods, or from other trades. I regard it as over-literal, and not in line with the modern approach to statutory construction, to attach so much weight to the coincidence of the use of three words—"total taxable profits"—which amount to a composite expression of uncertain meaning, without regard to the context and consequences of that reading. Ward LJ considered himself to be looking at the words in the whole of their legislative context, but in my respectful view he was not doing so.

64. Nor can I attach any weight to Ward LJ's fourth and fifth reasons for rejecting the submissions made on behalf of Mrs Smith. The economic reality is that capital allowances have enabled Mr Smith to build up a profitable and expanding business while paying very little income tax. He has had the benefit of this, and his children (and Mrs Smith in her struggles to maintain the children) have had the burden of it. I can see no fairness in that. The possibility of the position being alleviated by a departure direction (a consideration which was decisive with Wall LJ) is too speculative to be given any weight as an argument on construction. There is no necessary relation between "life-style" (the expression used in regulation 25 of DDCA 1996 (SI 1996/2907)) and entitlement to capital allowances. Even if Mr Smith were to choose a monastic, miserly life-style he would still, on the view taken by the Court of Appeal, be entitled to the full benefit of the capital allowances.

65. Mr Mostyn QC, in his carefully crafted and forthrightly delivered submissions on behalf of Mrs Smith, placed some reliance on article 8 of the European Convention on Human Rights (respect for family life) and on section 3 of the Human Rights Act 1998. He argued that the state has a positive obligation to provide an effective system of child support, under which substantial and reasonable maintenance, proportionate to an AP's means, is paid regularly to the PWC. He was inclined to be critical, so far as courtesy and precedent permitted, of the recent decision of your Lordships' House in M v Secretary of State for Work and Pensions [2006] 2 WLR 637. To my mind that decision has very little to do with Mr Mostyn's submissions in this case. It was concerned with alleged discrimination under article 14, primarily in conjunction with the private life element of article 8, although also in conjunction with the family life element of article 8 and with article 1 of the First Protocol. I do see considerable force in Mr Mostyn's submission that a state which prevents a PWC claiming child support from an AP through the ordinary court system, as CSA 1991 does, must be under a positive obligation to provide an effective alternative system of child support. But I do not think that your Lordships need decide that point in order to dispose of this appeal, and for my part I think it is better not to do so. This appeal can be disposed of, in my opinion, on conventional principles of statutory construction.

66. For these reasons I would allow this appeal and restore the decision of the Child Support Commissioner.

BARONESS HALE OF RICHMOND

My Lords,

67. Our task is to interpret the phrase "total taxable profits from self-employment . . . as submitted to the Inland Revenue". That (after deduction of income tax, national insurance contributions and half of any retirement annuity premium) is what is meant by the "earnings" of a self-employed earner in the cases covered by paragraph 2A of Schedule 1 to the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 (SI 1992/1815), as amended by the Child Support (Miscellaneous Amendments) Regulations 1999 (SI 1999/977) with effect from 4 October 1999.

68. "Total taxable profits from self-employment" is not defined in the regulations, nor is it a term of art in tax law. As the Child Support Commissioner explained in paragraph 12 of his decision, it could mean either:

(A) the annual trading profit net of allowable revenue expenses, which is the profit chargeable to income tax under Schedule D; or

(B) that amount less the capital allowances the trader can claim against it for the tax year in question, which is the net figure carried to his taxable income in working out how much tax he actually has to pay.

69. There are several very good reasons to think that when Parliament amended the regulations it must have intended meaning (A). First, paragraph 3 of the same Schedule makes it entirely clear that capital allowances are not to be deducted in arriving at the figure of earnings for the purposes of calculating child support in the cases to which paragraph 3 applies. Paragraph 3 represented the law before the regulations were amended. It still represents the law in the cases to which it applies. These are, in essence, where it is not reasonably practicable for the self-employed earner to provide information in the form submitted to the Inland Revenue (paragraph 2C), where that information is too old (paragraph 5A(1)), or where it does not accurately reflect the normal weekly earnings of the self-employed earner (paragraph 5A(3)). There is no rational reason why capital allowances should not be deductible in those cases but should be deductible in the cases covered by paragraph 2A. It is an anomaly and completely inexplicable. Parliament should be presumed not to intend to produce inexplicable anomalies.

70. Secondly, as already explained, interpretation (A) leaves the basic principles of the calculation unchanged, whereas interpretation (B) would make a substantial change. There is no indication at all that Parliament intended to change the principles by which self-employed earnings were calculated. Neither Baroness Hollis in the House of Lords nor Angela Eagle MP in the House of Commons gave any indication that this was the Government's intention. The intention was to make it much easier for the child support officer to discover what those earnings were, and indeed for the parent whose earnings were being assessed to provide the information required: the tax return would be sufficient for both purposes. If the taxpayer did not supply it, the officer could now obtain it from the Inland Revenue direct.

71. Thirdly, some light may be thrown on the meaning of a legislative definition by the term which is being defined. Here the term being defined is the person's "earnings" from self-employment. The ordinary and natural meaning of earnings is the money one has made from the work one has done. This too would lead to the trading profit, the money made, less the allowable costs of making it. Capital allowances play no part in the meaning of earnings in this sense. The tax system provides for them to be deducted from earnings in certain circumstances before the actual tax payable is calculated. But it is common ground that they bear no necessary relationship to economic reality. Furthermore, the taxpayer can choose whether or not to claim them and may have good reasons to claim in one year rather than another.

72. Fourthly, child support liability is calculated by reference to income not capital. A parent may have substantial capital assets which it would be entirely reasonable to expect him to realise in order to keep his children, but he is under no obligation to do so. The scheme is only concerned with his income. (Indeed the new scheme which superseded the original one also largely ignores income derived from capital). As capital resources cannot be included in the calculation, it would be very strange if capital expenditure could have the effect of drastically reducing the proportion of his income on which the calculation of his child support liability was based. This would be even stranger when the allowances can be claimed against income which has undoubtedly been earned at a different time from when the capital expenditure has been made. That is, indeed, the nature of a capital allowance. Although it reflects expenditure which has actually been made, it does not usually reflect it at the time when it has been made. It is spread over a different period.

73. Fifthly, the child support scheme is supposed to produce a sum which reflects what the child needs and the parent can afford to pay. Capital allowances are obviously not connected with the child's needs but nor are they connected with the parent's ability to pay. Quite apart from the fact that they reflect past rather than present expenditure, they are used as an instrument of fiscal policy to provide various kinds of economic incentive. They may be more or less generous accordingly. They have nothing to do with the amount of money in the parent's pocket before he has to pay his taxes. Indeed, their effect is to increase the amount of money in his pocket at the end of the day by reducing the amount of tax which he has to pay. The facts of this case are a dramatic illustration of this.

74. Thus it is easy to understand why Parliament chose to ignore capital allowances in the original scheme. It is easy to see why Parliament would continue to ignore them when amending that original scheme. The 1999 amendments were not a wholesale rethink of the child support calculation such as took place in 2000. The declared intention was to make minor adjustments which would improve its administration.

75. The contrary interpretation depends upon reading the regulations alongside the Inland Revenue forms. Those forms are prescribed by the Inland Revenue under statutory powers but they are not prescribed by law. They could be redesigned tomorrow. At present, the tax return contains a box labelled "total taxable profits from this business" (not, incidentally, "total taxable profits from self-employment" which is the phrase we have to construe). But it could be labelled something else. Or something else could be labelled "total taxable profits". There would be nothing irrational in tax law terms if the form contained a box so labelled which produced the figure defined in (A) above. The present form is designed to be filled in directly from the trading profit and loss account, which will of course contain both allowable and disallowable expenses, to produce a net profit or loss figure. It then adds back in the disallowable expenses, but it happens not to include a box for the resulting figure. Then it takes off the sum, claimed in a completely different part of the form, for capital allowances. It would make complete sense to have an intervening box which represented the gross turnover less direct costs and allowable expenses only, making the net profit chargeable to tax. It might even be labelled 'taxable profits'. Indeed, the form would be a great deal easier to follow if it did. But there is nothing at all difficult about calculating the sum which that box would contain. A child support officer could be given a simple instruction about how to do it.

76. As a general proposition, one would not expect to interpret the regulations which Parliament has made by reference to a form produced by a Government Department. One would expect a Government Department to produce a form which reflected what Parliament required or expected. The same applies to the alternative argument based upon paragraph 2B and the contents of a tax calculation notice.

77. For these reasons, which are simply a postscript to the reasons given by my noble and learned friend, Lord Walker of Gestingthorpe, with which I agree, I too would allow the appeal and restore the decision of the Child Support Commissioner. I would add one further postscript. In common with Lord Walker, I see considerable force in the argument that a state which prevents a parent with care from claiming child support through the ordinary court system has a positive obligation to provide an effective alternative system. The state has a positive obligation under article 8 of the European Convention to take steps which permit the child's integration in his own family: see Marckx v Belgium (1979) 2 EHRR 330. The child can scarcely benefit from family life if there is not enough to live on. But I accept that it is a considerable feat of interpretation to spell the "right to receive regular, reasonable maintenance" (for which Mr Mostyn QC so persuasively contends) out of the right to respect for family life in article 8. The European Court of Human Rights, however, also looks to other international human rights instruments when interpreting its own Convention. The United Nations Convention on the Rights of the Child is quite specific on this topic. Article 27.2 provides for the basic parental responsibility:

"The parent(s) or others responsible for the child have the primary responsibility to secure, within their abilities and financial capacities, the conditions of living necessary for the child's development."

Article 27.4 requires States Parties to back this up:

"States Parties shall take all appropriate measures to secure the recovery of maintenance for the child from the parents or other persons having financial responsibility for the child . . ."

78. This father's turnover in the year 2000-2001 was £284,570. His net profit, taking into account allowable and non-allowable expenses such as depreciation, was £61,305. But after capital allowances were deducted the sum on which income tax was calculated came down to £20,892. This bore no relationship to his actual earnings that year. It bore no relationship to actual profitability of his business as reflected in his accounts. Taking it as the basis for a child support calculation meant that he had to pay a sum in child support which no-one could consider appropriate to secure the proper development of the children of a man in his station in life. Even if an international treaty has not been incorporated into domestic law, our domestic legislation has to be construed so far as possible so as to comply with the international obligations which we have undertaken. When two interpretations of these regulations are possible, the interpretation chosen should be that which better complies with the commitment to the welfare of children which this country has made by ratifying the United Nations Convention on the Rights of the Child.

LORD CARSWELL

My Lords,

79. Statutory construction constitutes quite a sizeable proportion of the work of appellate judges. The instances and topics on which they have to engage in this exercise are multifarious, but its object is always the same, to ascertain the intention of Parliament as expressed in the instrument which has to be construed. In a judicial utopia every statute or statutory instrument would be expressed with such clarity and would cover every contingency so effectively that interpretation would be straightforward and the only task of the courts would be to apply their terms. Utopia has not yet arrived, however, and judges facing the interpretation of ambiguous or obscure provisions must use the well-worn tools of statutory construction to arrive at a result.

80. The problem facing the House and the issue which has to be resolved have been set out by my noble and learned friend Lord Walker of Gestingthorpe and I adopt his exposition with even more than the conventional gratitude. Reduced to its barest bones, even barer than the Child Support Commissioner's admirably clear and succinct summary set out in paragraph 54 of Lord Walker's opinion, it is whether for the purpose of calculation of a self-employed earner's liability to pay child support maintenance the phrase "total taxable profits … as submitted to the Inland Revenue" is intended to be interpreted in such a way that any capital allowances which he can claim in the tax year can be deducted or whether such allowances should be left out of account.

81. The phrase "total taxable profits" is not a term of art bearing a defined and ascertainable meaning in tax law or child support law. It is on its face ambiguous and its meaning cannot be determined by applying the plain meaning test of statutory interpretation. One must therefore have resort to such aids as the mischief which the legislation was intended to meet, the legislative history and the consequences which would ensue from either construction.

82. The clearly apparent objective of the enactment of paragraph 2A of the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 SI 1992/1815 ("MASC"), as added by the 1999 amending regulations, was the simplification of administrative arrangements, in the hope of speeding up the assessment of parents' liability for child support. If support for this view is needed, it may be found in the introduction of the provision in Parliament by Baroness Hollis of Heigham, set out in paragraph 42 of Lord Walker's opinion, in which she described the old arrangements as cumbersome (one of the less pejorative descriptions which have been applied to them). As Lord Walker says, the change was presented as an administrative improvement, not as a change of substance. One may conclude with some confidence that Parliament did not start with the intention of effecting a potentially enormous reduction in liability for child support of a number of self-employed earners.

83. It is also apparent from examination of the history of child support legislation and tax legislation that depreciation of capital assets was not historically an allowable set-off against profits (see Lord Walker's opinion at paragraph 51). The rule against deducting an allowance for depreciation is one of very long standing. It is based upon the distinction for tax purposes between property and earnings or profits. That distinction appears to be predicated upon the thesis that capital assets (such as the mine in Coltness Iron Co v Black (1881) 6 App Cas 315) are enduring and will remain available into the future for the benefit of their owner. On this reasoning an allowance fell to be made in Coltness Iron Co v Black for the cost of working the mine, but not for the cost of making it (per Lord Penzance at p 326). The owner would, however, be entitled to deduct interest payments on any loan taken out for acquisition of the asset. This might be regarded in economic terms as over-simplistic, for it cannot be doubted that some capital assets are wasting and their value will decline and even in some cases disappear with the passage of time. It has long been appreciated, however, that if depreciation could be claimed as an allowance it would be open to a taxpayer to manipulate the amount of his profits to suit his own fiscal interests.

84. Instead of an allowance for depreciation, the taxpayer can claim the benefit of the capital allowances provided for in legislation. As the Child Support Commissioner clearly appreciated (see paras 22-4 of his decision), these allowances, which are governed by formidably complicated provisions, are extremely variable between taxpayers, types of expenditure and regions. They are, as he pointed out in para 29, part of the macro-economic management of the economy carried out by governments, leading to considerable fluctuations in their amount.

85. Since the inception of the child support legislation no allowance has been made for any capital expenditure or the depreciation of any capital asset: see paragraph 3(4)(b) of Schedule 1 to MASC as originally enacted. By paragraph 2C that provision becomes applicable where it is not reasonably practicable for the earner to provide information relating to his total taxable profits in the Inland Revenue form. Therein lies the anomaly resulting from the decision of the Court of Appeal whose unfairness is at the heart of the appellant's case. The effect of that decision is that if paragraph 2A applies, the parent paying child support can deduct capital allowances in order to arrive at the figure of total taxable profits; whereas if circumstances are such that paragraph 3 applies, no such deduction can be made. The difference between the figures produced by the two methods may be relatively huge, as the present case demonstrates, and the lower figure may result, as in the present case, in very serious under-provision by way of child support. I find it impossible to suppose that Parliament intended to enact a provision that would bring about such anomalous and potentially unjust results. That anomaly and injustice will not in my view be sufficiently remedied by resort to a departure direction, which influenced the Court of Appeal, in particular Wall LJ (at para 67 of his judgment). The sad history of the present case, as related in Part II of the appellant's printed case, does not engender any feeling of confidence that departure directions will be a panacea. Nor does the somewhat defensive reaction of the Secretary of State to criticisms of the legislation lead one confidently to expect the enactment of early amending legislation removing the anomaly.

86. The reasoning which I have set out so far leads one ineluctably towards the conclusion that Parliament did not intend that capital allowances should be deductible in assessing a self-employed earner's total taxable profits for the purpose of child support payments. But the Court of Appeal reached the opposite conclusion, by reason of the fact that the exact phrase "total taxable profits" is found in the standard form of self-assessment tax return submitted by self-employed persons to the Inland Revenue. It is clear from the form, as Lord Walker has demonstrated in detail, that in arriving at the sum which is to be inserted in box 3.92 under the heading "Total taxable profits from this business" capital allowances will have been deducted. Ward LJ expressed his conclusion from this in paragraph 40 of his judgment in the laconic syllogism:

"One must, therefore, look to the tax return to see if that assists in ascertaining 'total taxable profits'. It does assist. We find the answer in box 3.92: 'Total taxable profits from this business'. There it is. QED."

87. My noble and learned friend Lord Rodger of Earlsferry has in paragraphs 13 and 14 of his opinion given trenchantly argued reasons why he is impelled to the view that it is most likely that the draftsman of the new paragraph 2A had a copy of the self-assessment tax return before him when preparing the amendment. He draws the conclusion that he intended, and Parliament must be taken to have intended from the expressed words of the provision enacted, that the phrase "total taxable profits" in paragraph 2A should bear the same meaning as in box 3.92 in the form.

88. I share his difficulty in supposing that the use of the same phrase was a mere coincidence. But I am not satisfied that that is the end of the search. The conclusion reached by Lord Rodger and the Court of Appeal was that the draftsman must have meant to point to the place in the self-assessment tax return form current at the time of drafting, viz box 3.92, and incorporated by reference the figure appearing in that place in each such return as the figure which was to determine conclusively the self-employed earner's liability for child support.

89. It is a commonplace of statutory construction to inquire into the archaeology of a phrase appearing in a statutory provision. If one's quest results in the discovery of the identical phrase in earlier legislation, one can usually assume that Parliament intended to use it in the same sense in the later enactment. This reasoning is predicated upon the assumption that Parliament would have known of the earlier use of the phrase and intended for the sake of consistency to give it the same meaning in the later provision. I can for my part accept that the draftsman in choosing the phrase "total taxable profits … as submitted to the Inland Revenue", and Parliament in enacting it in the amendments to MASC, were looking towards the appropriate figure as set out in the tax return, and that the intention of Parliament was to direct the process of assessment of child support in a simple and expeditious manner to that figure. But in order to accept the respondents' contention in the present case one has to suppose that the legislature wished to make the process so simple and straightforward that an official of the Child Support Agency merely has metaphorically to tick a box and enter in a mechanistic fashion the figure contained in a certain entry in a tax return. That supposition takes little account of the possibility that tax forms may change in layout and content, bearing in mind that the phrase "total taxable profits" is not a term of art in tax law or practice. I cannot accept that Parliament wished to have matters of such consequence determined by the layout of an Inland Revenue form. To link liability for child support with the content of box 3.92 is so contrary to all other indications of what Parliament intended in enacting paragraph 2A that I cannot suppose that Parliament intended to achieve a result whereby capital allowances could be deducted, with the grossly skewed consequences apparent in the present case. This would allow the assessment of liability for child support to be determined by the way in which the compiler of the form required the components of the taxpayer's profits to be set out. I am mindful of the principle that one must have regard to the expressed intention of Parliament as contained in the words which it has used. I consider, however, that the proper conclusion to be drawn from its use of the phrase "total taxable profits … as submitted to the Inland Revenue" is that it wished to simplify and speed matters by adopting the figures in the tax return to reach the proper earnings figure. Its object was to obviate the necessity for parents liable for payment of child support maintenance to furnish accounts, the source of much previous delay, but still to assess the correct and proper amounts which they were liable to pay.

90. In my opinion one is entitled to place less emphasis on the coincidence in wording and return to the exercise of attempting by the use of the several recognised methods of statutory interpretation to ascertain the true intention of Parliament. It might well be that in an ideal world it might be thought no less than fair to make some allowance for depreciation of capital assets in assessing profits for present purposes. Especially in a case such as the present, they may represent wasting assets which decline in value, perhaps markedly in a fairly short time. But no such provision was made in the legislation for child support prior to the enactment of paragraph 2A, and when an assessment is carried out in accordance with paragraph 3 no deduction may be made for either depreciation or capital allowances. In taxation law no deduction for depreciation is allowable and the taxpayer is left to the shifting imperatives of the capital allowance system. As between the stark alternatives, deducting the whole of the capital allowances payable to Mr Smith or leaving them out of account, I consider that the correct conclusion is that it was not intended that capital allowances should be deductible.