England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL (TAX AND CHANCERY CHAMBER)
Mr Justice Norris and Judge Roger Berner
Appeal No: FTC/01/2013

		Royal Courts of Justice Strand, London, WC2A 2LL
		20/06/2014

Lord Justice Rimer :

1. This appeal is by Nicholas Pike. Mr Pike appealed to the First-tier Tribunal (Tax Chamber) (Judge Mosedale and Mr R. Thomas, 'the FTT') against a closure notice and amendment by the Revenue to his self-assessment tax return for the year ended 5 April 2000. The amendment denied his claim for relief in respect of a loss of £3,463,563 arising for income tax purposes upon the occasion of a transfer by Mr Pike of what he claimed was a 'relevant discounted security' within the meaning of Schedule 13 to the Finance Act 1996. By a decision released on 4 May 2011, amended on 12 May, the FTT dismissed Mr Pike's appeal.
2. Mr Pike's appeal against that decision to the Upper Tribunal (Tax and Chancery Chamber) (Norris J and Judge Roger Berner, 'the UT') was dismissed by a decision released on 10 May 2013. The appeal to this court is Mr Pike's appeal against that decision of the UT. It is a second appeal. Mr Pike was represented by Mr Scott Redpath, who also appeared for him in the UT, but not the FTT. The respondents, the Commissioners for Her Majesty's Revenue and Customs ('HMRC'), were represented by Mr Michael Gibbon QC, as in both tribunals below.

The facts

3. These are not in dispute. Mr Pike was employed by Dell Computer Corporation in various senior posts until he resigned in January 2000. On 28 March 2000, he acquired 'off the shelf' a company he renamed Aim Internet Investments Limited ('the company'). The business of the company was intended to be investment in the internet and technology sectors. Mr Pike held 999 of its 1,000 issued shares, and his wife the other share. He became the sole director.
4. On 31 March 2000, Mr Pike caused the company to issue £6 million nominal of Loan Stock 2013, all of which he took at par. The stock certificate certified that the stock was constituted by an instrument entered into by the company on the same date and that it was issued with the benefit of, and subject to the provisions contained in, that instrument and the conditions endorsed on the certificate.
5. The certificate recorded that the company 'shall, subject to the terms of this Loan Stock, pay to the Stockholder on 15 July 2013 ("Repayment Date") the Redemption Proceeds as defined in Condition 2'. The endorsed conditions followed the terms of the conditions provided for by the loan stock instrument, to which no separate reference is required. Condition 2, 'Redemption', is of central importance and its material provisions were as follows:

'2.1 In these Conditions "the Redemption Proceeds" means, in respect of any repayment or redemption of the Principal Amount in full or in part pursuant to the Certificate, a sum being the aggregate of: (i) the Principal Amount to be repaid or redeemed; and (ii) an amount equal to 7.25% per annum of the Principal Amount to be repaid or redeemed, accruing on a daily basis from and including the date of the Certificate up to and including the date of repayment or redemption.

2.2 The Company may on any anniversary … by one month's notice in writing to the Stockholder repay in whole or in part in multiples of £1,000 or any integral amounts of £1,000 or the Principal Amount if less than £1,000 the Redemption Proceeds.

2.3 Where part only of the Redemption Proceeds are repaid by the Company pursuant to Condition 2.2 above the respective amounts of Redemption Proceeds set out in the Schedule to these Conditions shall be correspondingly reduced … and the Company shall issue to the Stockholder a new Loan Stock Certificate for the balance of the Redemption Proceeds not repaid setting out in the schedule thereto the reduced amounts of Redemption Proceeds thereupon so payable thereupon.

2.4 The Redemption Proceeds shall immediately become payable without any demand being made on the happening of any of the following events:

2.4.1 if an order is made or an effective resolution passed for winding up the Company except for the purposes of a reconstruction or amalgamation the terms of which have been previously approved in writing by the Stockholder; or

2.4.2 if the Company ceases to carry on its business or substantially the whole of its business or threatens to cease to carry on the same. …'

6. On 5 April 2000, five days after the issue of the loan stock, Mr Pike declared the trusts of 'The Nicholas Pike Settlement 2000' in relation to the £6 million loan stock, which he had transferred into the settlement and which constituted its trust fund. The company commenced its business in April 2000.
7. In his self-assessment tax return for the tax year ended 5 April 2000, Mr Pike claimed in Box 15.11 relief for a loss of £3,463,563 sustained on the disposal of the loan stock to the settlement. His return included the following explanation of that claim:

'[The company] was set up to manage my investments into internet and other high technology businesses. The company has a relatively low level of share capital and is principally financed by the issue of loan stock which is redeemable at a premium. I decided that it would be appropriate to create a trust for the long term security of my family. The loan stock became the trust's original property.

The loan stock is a relevant discounted security and so the relevant rules are contained in Schedule 13 to the Finance Act 1996. As [the company] is "connected" to me, the gain or loss on the transfer of the loan stock is calculated by reference to its market value at the time of the transfer to the trust.

I have therefore calculated the market value of the loan stock at the date of transfer. It is redeemable on 15 July 2013 in an amount of £6,000,000 plus a premium of 7.25% for each year that the loan stock is outstanding. This gives redemption proceeds of £11,780,984. The current value of this covenant to pay the loan stockholder this amount on the repayment date is determined by the interest rate that would be required by an unconnected person. If the return were virtually risk free, a return of 7.25% or so would be reasonable. However, the investment in [the company] loan stock is very risky. The underlying assets may be invested in risky investments with no fixed rate of return. The operating policy of the company could be changed to the detriment of the loan stockholder without even consulting them. A 5% per annum risk premium has been added to the base rate giving 12.25%. Valuing the ultimate proceeds at the rate of 12.25% gives a current market value of £2,536,437. The loan stock cost me £6,000,000 and so I have entered a loss of £3,463,563 in Box 15.11 [of my self-assessment return].'

8. The reference in that explanation to the 'premium' at which the loan stock was redeemable was to the provision in clause 2.1(ii) of the loan stock conditions. The theory underlying the incurring of the claimed loss is clear. Its claimed legal basis was, as the explanation asserted, that it was a loss sustained 'from the discount of a relevant discounted security'. If it was, in principle the claimed relief was justified. The central question, however, is whether or not the loan stock was a 'relevant discounted security'. That requires a reference to the legislation.

The legislation

9. The applicable provisions are in Schedule 13 to the Finance Act 1996, headed 'Discounted Securities: Income Tax Provisions'. At the time relevant for the purposes of Mr Pike's claim for relief, Schedule 13 provided materially as follows:

'1.(1) Where a person realises the profit from the discount on a relevant discounted security, he shall be charged to income tax on that profit under Case III of Schedule D or, where the profit arises from a security out of the United Kingdom, under Case IV of that Schedule.

(2) For the purposes of this Schedule a person realises the profit from the discount on a relevant discounted security where –

(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and

(b) the amount payable on the transfer or redemption exceeds the amount paid by that person in respect of the acquisition of the security. …

2.(1) Subject to the following provisions of this Schedule, where –

(a) a person sustains a loss in any year of assessment from the discount on a relevant discounted security, and

(b) makes a claim for the purposes of this paragraph before the end of twelve months from the 31^st January next following that year of assessment,

that person shall be entitled to relief from income tax on an amount of the claimant's income for that year equal to the amount of the loss.

(2) For the purposes of this Schedule a person sustains a loss from the discount on a relevant discounted security where –

(a) he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and

(b) the amount paid by that person in respect of his acquisition of the security exceeds the amount payable on the transfer or redemption. …

3.(1) Subject to the following provisions of this paragraph and paragraph 14(1) below, in this Schedule "relevant discounted security" means any security which (whenever issued) is such that, taking the security as at the time of its issue, the amount payable on redemption –

(a) on maturity, or

(b) in the case of a security of which there may be a redemption before maturity, on at least one of the occasions on which it may be redeemed,

is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain. …

(3) For the purposes of this Schedule the amount payable on redemption of a security involves a deep gain if –

(a) the issue price is less than the amount so payable; and

(b) the amount by which it is less represents more than the relevant percentage of the amount so payable. …

(6) For the purposes of this paragraph the amount payable on redemption shall not be taken to include any amount payable on that occasion by way of interest.'

10. Relating those provisions to the facts, the key question is whether the £6 million loan stock is a 'relevant discounted security' within the meaning of paragraph 3. It will only be such if, taking the security as at the time of its issue, the amount payable on maturity, or on any redemption before maturity, would or might be an amount 'involving a deep gain'. Such amount will involve a deep gain if the issue price is relevantly less than the amount so payable. In identifying the amount so payable, however, paragraph 3(6) requires to be left out of account 'any amount payable on that occasion by way of interest'.
11. In this case HMRC asserts, and both tribunals below accepted, that what Mr Pike asserts to be a premium payable on redemption (that is, the amount provided for by clause 2.1(ii) of the conditions) is nothing other than interest on the £6 million at an annual rate of 7.25%. If so, it is common ground that it falls to be left out of account in calculating the amount payable on redemption; and, if it is, there can and would be no deep gain on the occasion of a redemption, because the amount then payable is the same as the issue price with the consequence that Schedule 13's paragraph 3(3) conditions are not satisfied. Mr Pike's contrary argument is that the amount payable under clause 2(ii) is not interest but a premium and that the paragraph 3(3) conditions are satisfied. If he is correct, it is common ground that the conditions are satisfied and that he is entitled to the relief against income tax claimed in his tax return. It is perhaps worth noting that, as a result of an amendment made to paragraph 13 (by the inclusion into it of a new paragraph 9A) by the Finance Act 2002, Mr Pike would not, even if otherwise right in his arguments, have been entitled to claim the loss he did had his transfer to the settlement been effected on or after 26 March 2002, since the amendment excluded a claim in respect of any such loss upon a transfer to a connected party. But that amendment has no impact on his case under appeal.

The appeal

12. Mr Redpath said that, for the purposes of Schedule 13, there is a key distinction between premiums, discounts and interest. He submitted that the condition 2.1(ii) payment is a premium on redemption, which he said is conceptually different from interest, although not necessarily from a discount. He emphasised that, in determining whether a particular security is or is not a 'relevant discounted security', paragraph 3(1) shows that the security had to be considered 'as at the time of its issue'. His submission was that, under Schedule 13, the key distinction was between interest on the one hand and, on the other, a return representing the time value for money paid as a single sum on the date of maturity, being a sum that can be called either a deep gain or a discount.
13. The key words that fall to be interpreted are, said Mr Redpath, those in condition 2.1. They provide for the payment of a single sum, which includes the additional amount referred to in 2.1(ii), being an amount which is not correctly categorised as interest. Whilst paragraph (ii) includes the words 'accruing on a daily basis', they are directed at doing no more than providing how the time value is arrived at: the result of the calculation is still that what is payable is a premium. Mr Redpath accepted that if, for example, the company gave notice requiring, say, the repayment of £1 million at the beginning of year two, the repayment would include an additional amount on such £1 million calculated in the like manner provided for by condition 2.1(ii). In either case, however, the additional amount is still to be regarded as something other than interest, since were it to be categorised as interest, the exceptional provision in paragraph 3(6) would be likely to swallow up the rule.
14. Mr Redpath said the legislation plainly recognises the existence of a difference between time value payments which are interest and time value payments which are not; and that for such a payment to be characterised as interest required more specific words than are to be found in condition 2.1. It is not enough that, as is in this case, the payment is described as 'accruing' over the relevant period. The payment said to have so accrued was not to be regarded as having in fact done so; it was rather to be regarded simply as a lump sum payable on redemption calculated in accordance with the condition 2.1(ii) formula. The reason that in this case the payment was not interest is because it was not payable until the end of the term. Mr Redpath made this submission notwithstanding his acceptance that even a payment truly categorised as interest may not be payable until the end of the term. He also disclaimed any argument that, for a payment to be interest, it had to be payable on a regular basis during the term.
15. Mr Redpath referred us to the decision of the House of Lords in Willingale (Inspector of Taxes) v. International Commercial Bank Ltd [1978] AC 834, in particular to the passage in the speech of Lord Salmon, in the majority, who, at 842D to E, recognised a clear distinction between a discount and interest, saying that:

'Although there may be some superficial similarity between (a) lending £10,000 for 5 years at a rate of interest of X per cent per annum on the terms that none of the interest amounting in all to £5,000 shall be payable until the principal becomes repayable and (b) buying a foreign bill of exchange with a face value equivalent to £15,000 for a price equivalent to £10,000, the two transactions are, in my view, essentially different from each other in character.'

And Lord Fraser of Tullybelton, also in the majority, said, at 845A:

'Stamp LJ reached his conclusion in favour of the Crown by accepting the submission [1977] Ch 77, 87a, "that there is no distinction in principle between earning interest and earning discount." With respect, I cannot agree with that view. In my opinion there is an essential difference between interest and discount, so much so that to speak of "earning" discount seems to me wrong. Interest accrues from day to day, or at other fixed intervals, but discount does not.'

Both passages might be said to support the conclusion that the additional amount payable under condition 2.1(ii), described as 'accruing on a daily basis', is interest.

16. Mr Redpath nevertheless persisted in his submission that whilst the payment was the economic equivalent of interest, it was not in fact interest because it was a single composite sum payable on the defined redemption date and which therefore involved a deep gain, and he focused in particular on the words 'amount equal to' in condition 2.1(ii). The position was no different from that which would have applied if condition 2.1(ii) had simply inserted the sum that would be arrived at if the calculation used in condition 2.1(ii) were carried out, but without condition 2.1 also explaining the calculation. In such a case, he said, that additional sum would clearly not be interest. He accepted, however, that if condition 2.1 had been drafted in this way, it might then have been necessary for conditions 2.2 to 2.4 to be drafted differently: otherwise, for example, on the occurrence of a condition 2.4 event in, say, year two, the stockholder would, on the face of it, be entitled to claim or prove for the full payment that he would otherwise only receive on the much later maturity date.

Discussion

17. I gave permission for this second appeal after being persuaded by Mr Redpath at an oral hearing that there was here a point of principle that merited such an appeal. I admit now to a lack of clarity as to why I was so persuaded, because having listened to Mr Redpath's extended submissions, it became apparent to me that there is no point of principle in this appeal at all. The only question is one as to the interpretation of condition 2.1. Mr Gibbon, in his succinct submissions in response, submitted that the UT was correct, for the reasons it gave, to dismiss Mr Pike's appeal against the decision of the FTT. I agree.
18. The UT, whilst noting that paragraph 13 did not define 'interest', said that 'interest' for paragraph 13 purposes did not bear any special meaning. It was possible to identify certain characteristics of an amount payable by way of interest. First, it is calculated by reference to an underlying debt. Second, it is a payment made according to time, by way of compensation for the use of money. Third, the sum payable accrues from day to day or at other periodic intervals. Fourth, whilst the payment so accrues, it does not, in order for it to be interest, have to be paid at any intervals: it is possible for interest not to become payable until the principal becomes payable (see Willingale). Fifth, what the payment is called is not determinative; the question must always be one as to its true nature. Sixth, the fact that an interest payment may be aggregated with a payment of a different nature does not 'denature' the interest payment (Chevron Petroleum UK Ltd v. BP Petroleum Ltd [1981] STC 689, at 694, per Megarry V-C).
19. In this case, the UT concluded that in the circumstances of this case the FTT had been entitled to conclude that the additional payment provided for by condition 2.1 was one in the nature of 'interest' and that the FTT committed no error of law in so concluding. I entirely agree. Mr Redpath accepted that the payment was the economic equivalent of interest. I did not, however, follow the basis for his submission that nevertheless it was not in fact interest but was rather to be characterised as a premium. The submission was ultimately advanced as a matter of assertion rather than a reasoned proposition. The difficulty with Mr Redpath's argument is that, as it appears to me, short of expressly describing the condition 2.1(ii) payment as interest, the authors of the conditions could have done little more by way of demonstrating that the true nature of the payment was that it was interest; and at no point in his submissions did Mr Redpath come close to persuading me that it was other than one of interest. That condition 2.1 expressly described the additional payment as 'accruing on a daily basis' at a defined annual percentage rate points in my view to the conclusion that its true nature was interest. I agree with the UT that the FTT was entitled to find that it was interest and made no error of law in doing so.
20. I would dismiss the appeal.

Lord Justice Underhill :

21. I agree.

Lord Justice Tomlinson :

22. I also agree.