SPC00465
Corporation tax – Group of companies – Loan relationship – Novation of liabilities to group company – Whether Appellant as result of related transaction – Replaced as party to loan relationship – Finance Act 1996, Sch 9 para 12

THE SPECIAL COMMISSIONERS

	GREENE KING No.1 LIMITED	Appellant

	- and -

           STEPHEN ADIE
	(HM INSPECTOR OF TAXES)     	Respondents

				Special Commissioners:     THEODORE WALLACE
							         MALCOLM J F PALMER	

Sitting in London on 13 and 14 January 2005

Kevin Prosser QC and Richard Vallat, instructed by Ernst & Young, chartered accountants, for the Appellant

Philip Jones, instructed by the Solicitor of Inland Revenue, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

1.	This appeal concerns the applicability of paragraph 12 of Schedule 9 to the Finance Act 1996 to a loss accruing to the Appellant on novations in 1999 of its liabilities under loans secured by debenture trust deeds in 1991 and 1997, under which novations Greene King plc, the parent company of the Appellant, was substituted as debtor and the Appellant was released from its liabilities.

2.	It was common ground that the Appellant had “loan relationships” within section 81(1) prior to the novations, that the disposals of rights under the novations were “related transactions” within section 84(5) and that, subject to paragraph 12, on the novations losses arose to the Appellant from its loan relationships and related transactions within section 84(1)(a).

3.	There was no dispute as to the amount of the loss, which was duly recognised in the Appellant’s accounts, namely £11,335,533.  This loss arose because interest rates were substantially lower at the time of the novation than at the time of the loans to the Appellant and the Appellant became indebted to Greene King plc for a sum representing the excess interest over the balance of the periods of the loans in addition to the principal sums due on the loans.

4.	The dispute arose because the substitutions were effected by novations.  The Revenue contended that the transactions by which the replacement of the Appellant took effect fell to be disregarded under Schedule 9, paragraph 12.  The Appellant contended that paragraph 12 did not apply because a novation of liabilities results in a new money debt and Greene King plc did not replace the Appellant as a party to the loan relationship previously subsisting.

The facts

5.	There was an agreed statement of facts.  No witnesses were called.  There was an agreed bundle of documents including the debenture trust deeds and the deeds effecting the novations.

6.	The Appellant, then called Morland plc, was party to two debentures, the PUBCO Plc 11.25 per cent Debenture Stock 2006 (“the PUBCO Debenture”) and the Morland plc 7.75 per cent Debenture Stock 2027 (“the Morland Debenture”).

7.	The PUBCO Debenture was created by a resolution of the board of directors of PUBCO plc on 26 July 1991 and was constituted and secured by a Trust Deed dated 29 July 1991 (“the PUBCO Trust Deed”) between (1) PUBCO plc, (2) the Borrowers (i.e. Daniel Thwaites plc, Greene King plc, the Appellant and Shepherd Neame Ltd), (3) the Original Charging Subsidiaries (subsidiaries of the Borrowers) and (4) the Law Debenture Trust Corporation plc as trustee.  Under the PUBCO Debenture, the Appellant initially borrowed £10 million at 11.25 per cent repayable on 30 September 2006.

8.	The Appellant was one of a number of borrowers.  The original charging subsidiary of the Appellant was Morland Brewery Estates Ltd (“MBEL”).

9.	Under clause 12(A) PUBCO plc agreed to release the Appellant and MBEL if 

“one or more of the existing Borrowers … shall have assumed additional liabilities and obligations under or in respect of the respective loans and of those present, equivalent to the liabilities and obligations of the [Appellant] and [MBEL] to be released by executing a deed supplemental hereto …”.

10.	The Morland Debenture was created by a resolution of the board of directors of the Appellant on 16 May 1997 and is constituted and secured by a Trust Deed dated 27 May 1997 (“the Morland Trust Deed”) made between (1) the Appellant, (2) MBEL and (3) the Law Debenture Trust Corporation plc, as trustee.  Under the Morland Debenture, the Appellant initially borrowed £25 million at 7.75 per cent repayable on 30 September 2027.

11.	Greene King plc acquired all the shares in the Appellant on 5 August 1999.  Following the acquisition, most of the assets and liabilities of the Appellant were integrated into the Greene King plc group and the decision was made to substitute Greene King plc as debtor under the debentures in the place of the Appellant.

12.	The PUBCO Trust Deed of 29 July 1991 was amended by the Tenth Supplemental Deed executed 21 December 1999 entered into between the (1) PUBCO plc, (2) Greene King plc, (3) Thos Peatling Limited, (4) Greene King Insurance (Services) Limited, (5) Green King Brewing and Retailing Limited, (6) the Appellant, (7) MBEL and (8) the Law Debenture Trust Corporation plc as trustee for the Stockholders.  Under clause 2 of the Supplemental Deed and pursuant to clause 12(A) of the Trust Deed of 29 July 1991 Greene King plc assumed all liabilities and obligations under and in respect of the loan and under the Trust Deed equivalent to the liabilities and obligations of the Appellant and MBEL.  By clause 3 Greene King plc as a party to the Trust Deed of 29 July 1991 declared that the floating charge created under that agreement extended by way of security to its obligation in relation to the further loan to Greene King plc assumed under the Tenth Supplemental Deed.

13.	By clause 5 the Appellant and MBEL became additional charging subsidiaries and by clause 10 PUBCO plc released the Appellant from all its liabilities under the PUBCO Trust Deed.

14.	The Morland Trust Deed was amended by a Supplemental Deed dated 21 December 1999 entered into between the (1) Greene King plc, (2) Greene King Brewing and Retailing Limited, (3) MBEL (each as charging subsidiaries), (4) the Appellant and (5) the Law Debenture Trust Corporation plc as trustee for the stockholders.

15.	By clause 2 of the Supplemental Deed the 1997 Morland Trust Deed was amended by the additional clause 31 providing for substitution pursuant to which Greene King plc was substituted by clause 6 as principal debtor in place of Morland in respect of all amounts payable under the 1997 Trust Deed.  By clause 3 Greene King plc gave the trustee a floating charge and by clauses 4 and 5 Greene King Brewing and Retailing Ltd, the Appellant and MBEL, as new charging subsidiaries, gave guarantees and floating charges.  By clause 7 the Appellant and MBEL were released from their obligations under the 1997 Trust Deed.

16.	The debentures were fixed rate securities which at the date of transfer were paying interest above current market rates.  The book value of the PUBCO Debenture was £17,500,000 and the book value of the Morland Debenture was £24,501,000.  The market values were calculated to be £21,866,249 and £31,476,641 (after allowing for deferred costs) respectively as at 21 December 1999.

17.	It was accepted by the Revenue in the agreed statement of facts that in consideration of Greene King plc assuming the liabilities and obligations under the debentures the Appellant became indebted to Greene King plc in the sum of £53,342,890 and that in accordance with generally accepted accountancy principles, the Appellant debited an amount of £11,335,533 as a loss in its profit and loss account.  Note 14 to the audited financial statements of the Appellant for the eight months ended 29 April 2000 states that the assumption by Greene King plc of the relevant obligations of the Appellant led to losses totalling £11,335,000.

18.	When calculating its profits for tax purposes under Schedule D Case 1, the Appellant added the sum of £11,335,533 back and then claimed a loan relationship non-trading deficit under Finance Act 1996 s.83(2)(a) for the loss of £11,335,533 in its corporation tax return for the period 1 September 1999 to 30 April 2000.

19.	The Appellant appealed against an amendment to the return disallowing the loss of £11,335,533.

The legislative provisions

20.	The loan relationship legislation was introduced by Chapter II of Part IV of the Finance Act 1996 as a simplification measure.  Although minor amendments were made in 1998 they are not material to this appeal.  Further amendments in 2002 were subsequent to the transactions under consideration.

21.	Section 80 which contains the basic provisions provides as follows:

“(1)	For the purposes of corporation tax all profits and gains arising to a company from its loan relationships shall be chargeable as income in accordance with this Chapter.
…
(4)	This Chapter shall have effect … for determining how any deficit on a company’s loan relationships is to be brought into account …
…”

22.	Section 81 contains definitions of “loan relationship” and “money debt”.

“(1)	Subject to the following provisions of this section, a company has a loan relationship …wherever –

(a)	the company stands (whether by reference to a security or otherwise) in the position of a creditor or debtor as respects any money debt; and
(b)	that debt is one arising from a transaction for the lending of money;

and references to a loan relationship and to a company’s being a party to a loan relationship shall be construed accordingly.

(2)	For the purposes of this Chapter a money debt is a debt which falls to be settled –

(a)	by the payment of money; or
(b)	by the transfer of a right to settlement under a debt which is itself a money debt.

…

(5)	For the purposes of this Chapter –

(a)	references to payments or interest under a loan relationship are references to payments or interest made or payable in pursuance of any of the rights or liabilities under that relationship; and
(b)	references to rights or liabilities under a loan relationship are references to any of the rights or liabilities under the agreement or arrangements by virtue of which that relationship subsists;

and those rights or liabilities shall be taken to include the rights or liabilities attached to any security which, being a security issued in relation to the money debt in question, is a security representing that relationship.

…”

23.	Section 84 is headed “Debits and Credits brought into account”.

“(1)	The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question –

(a)	all profits, gains and losses of the company, including those of a capital nature, which … arise to the company from its loan relationships and related transactions; and
(b)	all interest under the company’s loan relationships and all charges and expenses incurred by the company under or for the purposes of its loan relationships and related transactions.

…

(5)	In this section ‘related transaction’, in relation to a loan relationship, means any disposal or acquisition (in whole or in part) of rights or liabilities under that relationship.

(6)	The cases where there shall be taken for the purposes of this section to be a disposal and acquisition of rights or liabilities under a loan relationship shall include those where such rights or liabilities are transferred or extinguished by any sale, gift, exchange, surrender, redemption or release.

(7)	This section has effect subject to Schedule 9 …”

24.	By section 85(1)(a) an accruals basis of accounting, which was used by the Appellant in this case, is an authorised method.

25.	Paragraph 12 of Schedule 9 which is headed “Continuity of treatment : groups etc” includes the following:

“(1)	… this paragraph applies where, as a result of –

(a)	a related transaction between two members of the same group of companies,
(b)	…
(c)	…
(d)	…

one of those companies (‘the transferee company’) directly or indirectly replaces the other (‘the transferor company’) as a party to a loan relationship.

(2)	The credits and debits to be brought into account for the purposes of this Chapter in the case of the two companies shall be determined as follows –

(a)	the transactions, or series of transactions, by virtue of which the replacement takes place shall be disregarded …

…

(6)	References in this paragraph to one company replacing another as a party to a loan relationship shall include a references to a company becoming a party to any loan relationship under which its rights are equivalent to those of the other company under a loan relationship of which that other company has previously ceased to be a party.

(7)	For the purposes of sub-paragraph (6) above a person’s rights under a loan relationship are equivalent to rights under another such relationship if they entitle the holder of an asset representing the relationship –

(a)	to the same rights against the same persons as to capital, interest and dividends; and
(b)	to the same remedies for the enforcement of those rights,

notwithstanding any difference in the total amounts of the assets, in the form in which they are held or in the manner in which they can be transferred.

…”

By paragraph 12(8) and paragraph 11(4) “related transaction” has the same meaning in paragraph 12 as in section 84.

Appellant’s submissions

26.	Mr Prosser said Greene King plc did not replace the Appellant as a party to a loan relationship within paragraph 12 either directly or indirectly. The novations released the liability of the Appellant, extinguishing its debts. The debts owed by Greene King plc were new money debts which did not arise from transactions for the lending of money but from the novation agreements and did not give rise to loan relationships within section 81.

27.	He said that the proposition that Greene King plc owed new money debts is highly technical but is the law.  In Re United Railways of the Havana and Regla Warehouses Ltd [1960] Ch 52 [1959] 1 All ER 214, Jenkins LJ said at page 85 that novation of a debt comprises two elements, the annulment of one debt and the creation of a substituted debt in its place; the discharge of the original debtor is distinct from the acceptance by the creditor of a substituted debtor.  In Collins v Addies (1992) 65 TC 190 Millett J said that the novation constituted a release of the old debt and its replacement by an entirely new debt.

28.	Mr Prosser said that the money debt must arise directly from the lending of money for there to be a loan relationship under section 81(1).  Section 81(3) extended the concept of loan relationship but is not relevant here because no new instruments were issued in 1999.

29.	He said that “related transaction” within section 84(5) involves a pre-existing loan relationship.  The annulment of the Appellant’s debts were related transactions in relation to its loan relationships with its creditors.  However the creation of a new debt by novation is not a related transaction within section 84(5); there was not an acquisition by Greene King plc of liabilities “under” the existing loan relationship.

30.	Mr Prosser said that the application of Schedule 9, paragraph 12 depends on Greene King plc having replaced the Appellant as a party to the Appellant’s loan relationships as a result of related transactions between the two companies.  This was not what happened.

31.	He said that paragraph 12 only covers a transfer of rights, since a transfer of liabilities involves novation which in turn results in a new contract and a new debt.  Paragraph 12(6) covers a novation of rights where there is no replacement within paragraph 12(1); it is solely concerned with rights.  Paragraph 12(1)(a) does not cover a change in debtor as happened here.

32.	Mr Prosser said that the word “replaces” in paragraph 12(1) is not a technical term but bears its ordinary English meaning.

Submissions for the Revenue

33.	Mr Jones submitted that under the novation agreements Greene King plc replaced the Appellant as a party to the loan relationships constituted by the PUBCO Debenture and the Morland Debenture with the result that paragraph 12(1) applied.

34.	He said that section 84(5) which refers to “any disposal or acquisition … of rights or liabilities under that relationship” pre-suppose that a liability under a loan relationship can be acquired.  Section 84(6) includes under “disposal or acquisition of rights or liabilities under a loan relationship” the transfer or extinguishment of liabilities. A novation with simultaneous release and assumption of liabilities is within section 84(5) and (6).

35.	He said that the Revenue did not accept the submission that the debts assumed by Greene King plc did not give rise to a loan relationship within section 81 because they did not arise from borrowing by Greene King plc.

36.	Mr Jones said that an assignment of a debt differs from a novation in that the former is bipartite and the latter is tripartite. On the Appellant’s case the transferee under a novation of liabilities does not have a loan relationship within the 1996 Act.  This would be a surprising provision for Parliament to have enacted and would allow companies to opt in or out of the legislation at will.  The Revenue’s approach that the loan relationship was the same after the novation as before avoids that problem.  Clause 12(A) of the PUBCO debenture provided for a bilateral substitution of liability.  Presumably the Appellant’s case was that even on such substitution there was the discharge of one debt and the creation of another.

37.	He said that where there is a novation there is a related transaction of which the release is only a part and which involves a transfer of liabilities.

38.	Mr Jones said that if paragraph 12(1) was intended to be limited to the transfer of rights the words “loan relationship” would read “creditor relationship”.  Section 103 defines “creditor relationship” and in section 87(1), 88(2)(5), 92(1)(2) and a number of paragraphs of Schedule 9, the draftsman referred to “creditor relationship” specifically.  

39.	He said that paragraphs 12(1)(c) and (d) clearly cover the transfer of liabilities.  There was no logical basis for Parliament to have decided not to disregard transfers of liabilities within a group.  The provisions of section 171 of the Taxation of Chargeable Gains Tax Act 1992 apply only to disposals of assets.  The purpose of paragraph 12 is to allow rights and liabilities to be transferred within a group without tax obstacles; it also has an anti-avoidance purpose to prevent the acceleration of losses.

40.	Mr Jones said that the Appellant had submitted that paragraph 12(6) was drafted to cover a novation of rights: however paragraph 12(6) as drafted clearly covered a case where a borrower repaid a lender which transfers the money to another group company which then lent to the original borrower on the same terms.  He accepted that paragraph 12(6) should have referred to obligations and was therefore amended in 2003.

41.	He agreed that the issue is whether Greene King plc “replaces [the Appellant] as a party to a loan relationship” within paragraph 12(1) and agreed that paragraph 12(6) did not apply in the present case.  The Revenue case is that the loan relationship to which Greene King plc became a party was the same loan relationship.

42.	Mr Jones said that the Revenue did not necessarily accept Mr Prosser’s observations that from a fiscal viewpoint over the life of the debt the effect on Greene King plc would be broadly neutral in that the capital sum received from the Appellant would cancel out the sums payable by Greene King plc allowing for the time value of the money.

Appellant’s Reply

43.	Mr Prosser said that the dispute was simply whether Greene King plc became a party to the same loan relationship arising from the same debt.  He said that a loan relationship depends on a particular debt; if the debt went, the loan relationship ended with it.  It is a basic concept of law that the release of a debt extinguishes it and that novation involves the annulment of a debt.  He asked why the 1996 Act should be assumed to disregard that basic principle without doing so either expressly or by implication. Nothing in the Act implies that a debt continues after novation.  The reference to “a series of loan relationships” in section 87(5) is only  applicable to that section.  Paragraph 12(1) does not refer to “creditor relationships” because ( c) and (d) potentially cover debtor relationships also.  Section 81(1) covers both creditor and debtor relationships.  The reason why paragraph 12(1)(a) covers the transfer of rights but not liabilities is that it is directed to transactions within a group which do not require the concurrence of a third party : that is also the policy for section 171 of the Capital Gains Tax Act 1992.

Conclusions

44.	This appeal has given us considerable difficulty because of the obscure drafting of Schedule 9, paragraph 12.  The appeal turns on the interpretation of the words “as a result of – (a) a related transaction between two members of the same group of companies … one of those companies … directly or indirectly replaces the other … as a party to a loan relationship” in circumstances where there is a novation of  liabilities.

45.	There is no doubt that the result of the novations was that the liabilities of the Appellant under the debenture trust deeds were extinguished and were replaced by the liabilities of Greene King plc under the deeds of 21 December 1999 and the debenture trust deeds.

46.	The issue is whether “as a result of a related transaction” Greene King plc replaced the Appellant “as a party to a loan relationship.”  Mr Jones accepted that the loan relationship referred to must be the same loan relationship as that to which the Appellant was a party prior to the novations.  This is clearly correct.  Although the indefinite article is used before “loan relationship” that is clearly because this is the first mention of the term “loan relationship” in paragraph 12(1).  It was not therefore possible for the draftsman to refer to “such” loan relationship or “the loan relationship”..

47.	As a matter of the law of contract there is no doubt that the novations resulted in new contracts and new debts.  In Collins v Addies (1991) 65 TC 190 Millett J said this at page 201,

“A novation discharges the legal obligation of the original obligee and replaces it by a new obligation of a new obligee.  It does not merely substitute a new debtor for the old in respect of the same debt or liability …”

48.	The question to be determined, therefore, is whether, given that in contract law the deeds of 21 December 1999 discharged the obligations of the Appellant and replaced those obligations by new obligations of Green King plc, Greene King plc directly or indirectly replaced the Appellant as a party to the loan  relationship under the debenture trust deeds and whether this was as a result of a related transaction.

49.	We do not accept the submission by Mr Prosser that Greene King plc did not by reason of the novations become a party to a loan relationship because the debt did not arise from the lending of money. Although the debts assumed by Greene King plc arose immediately from the deeds of 21 December 1999 they also arose from the loans to the Appellant under the original deeds.   Without the original lending of money there would have been no liabilities to novate.  We do not consider that the wording of section 81(1)(b) requires that the debt there referred to must arise immediately or directly from the transaction for the lending of money.

50.	That conclusion does not however answer the question whether Greene King plc replaced the Appellant as a party to the Appellant’s loan relationships.  

51.	It does not seem to us that the words “directly or indirectly” in paragraph 12(1) are apt to cover the circumstances where not only the party but also the loan relationship is replaced. It is to be noted that paragraph 12(6) would cover rights under loan relationships which are only equivalent and paragraph 12(7) refers to “rights under another such relationship”. Paragraphs 12(6) and (7) of course apply only to transfers of rights and do not cover novation of liabilities, however they show that the draftsman where necessary did provide for a different loan relationship albeit with equivalent rights by extending the concept of replacing another as a party to a loan relationship. We hold that since novation results in a new and distinct legal relationship there was here no replacement of the Appellant by Greene King plc as a party to the prior loan relationships.

52.	We recognise the force of the submission by Mr Jones that it would be surprising if the legislation allowed companies to opt in or out at will.  However we have already concluded that Greene King plc did become a party to a loan relationship. It follows that Greene King plc is obliged to bring the payment of £11,335,533 by the Appellant into account under section 84 under an authorised accounting method. It may be surprising that paragraph 12 does not apply to a novation of liabilities, although the loan relationship provisions in section 80 onwards do cover the acquisition of liabilities. It is however only in paragraph 12(1) that there is a reference to the replacement of one party to a loan relationship by another. The concept of replacement as a party is not apt to cover the novation of liabilities.

53.	Accordingly, the appeal is allowed.

THEODORE WALLACE

MALCOLM J F PALMER

SPECIAL COMMISSIONERS

Release Date: 3 March 2005

SC 3050/04