DECISION
Introduction
1.
This is an appeal against two notices of amendment, issued by HMRC on 6
January 2010, relating to the corporation tax returns of the appellants, Greene
King plc (“PLC”) and Greene King Acquisitions Ltd (“GKA”), a wholly-owned
subsidiary of PLC, for the periods ending 30 April 2003 and 30 April 2004.
2.
The appeal finds its origins in two transactions, which took place on 31
January 2003 and 5 September 2003 respectively, whereby PLC provided financing
to GKA by exchanging the right to receive the interest due to PLC, on loan
stock issued by another of its wholly-owned subsidiaries, for preference shares
issued by GKA. The dispute between the parties centres on the correct
accounting treatment of the transactions and the application to them of the
loan relationship provisions in Part IV, Chapter II, of the Finance Act 1996 (“the
1996 Act”); these provisions have since been re-written to the Corporation Tax
Act 2009, but as they were still in force at the relevant time, we shall refer
in this decision to the original provisions. HMRC’s case is, in essence, that the
accounting treatment of the transactions adopted by PLC and GKA was incorrect
and led to an under-declaration of profit in their accounts. The disputed
amendments were designed to bring into tax the profits which, HMRC say, that
accounting treatment was intended to, but does not, remove from tax.
3.
Before us, PLC and GKA were represented by Mr Jonathan Peacock QC and Mr
Michael Ripley, counsel, and HMRC by Mr David Milne QC. The parties had agreed
the essential facts but we heard the oral evidence of two witnesses of fact, Mr
Bryndon Webb who is the Greene King group’s tax controller, and Mr Les
Clifford, a partner in the firm of chartered accountants, Ernst & Young,
responsible for the Greene King group’s audit, who provided more detail about
the circumstances in which the group entered into the transactions, and about
their accounting treatment. We also had the expert evidence of Mr David Parish
ACA, employed by RSM Tenon as a director of its audit, tax and advisory
division, for the appellants, and of Mr Mark Chandler FCA, who is employed by
HMRC as an advisory accountant.
4.
In the customary way, the experts had agreed a joint statement of those
matters on which they were agreed and of those on which they had been unable to
agree. We shall come to those matters later. At this stage we think it
appropriate to record that we heard some cross-examination and submissions
about their respective qualifications and standing which we did not find
greatly helpful. We merely observe that we are satisfied that both gave opinion
evidence which it was within their competence to give and, for the avoidance of
any doubt there might be, that Mr Chandler’s employment by HMRC does not
compromise the independence of his views.
The agreed facts
5.
The parties’ agreed statement of facts, with some amendment, paraphrasing
and expansion, is as follows:
(1) The Greene King group is based in Bury St Edmunds,
Suffolk and its principal activities are operating managed, tenanted and leased
public houses, brewing beer, and wholesaling beers, wines, spirits and soft
drinks.
(2) The relevant transactions took place between three
companies of the group:
• PLC,
which is the UK parent company of the group;
• Greene
King Brewing and Retailing Limited (“GKBR”), a wholly owned subsidiary of PLC;
and
• GKA,
a wholly owned subsidiary of Beards of Sussex Group Limited, itself a wholly
owned subsidiary of PLC. GKA was originally called Beards of Sussex Limited but
changed to its current name on 10 February 2003. We shall refer to it as GKA in
respect of events both before and after its change of name.
(3) The first transaction giving rise to the present
dispute between the parties in this appeal (in reality a sequence of
transactions, but for simplicity referred to throughout this decision as “the
first transaction”) was as follows:
(a) On
20 October 2000, PLC lent £300 million to GKBR. On the same day GKBR created
unsecured loan stock with a nominal value of £300 million, all of which was
issued to PLC as security for the loan.
(b) At
all times material to this decision PLC was the sole holder of all the loan
stock.
(c) At
the time of issue, the terms of the loan stock were that it was to be redeemed on
4 May 2004, and in the meantime that it bore interest at a floating rate which
equated to LIBOR plus 1%, payable six monthly in arrears on 4 May and 4
November until redemption. There was an option to repay the loan and redeem the
stock early.
(d) On
31 January 2003, the terms of the loan were amended by agreement of PLC and
GKBR. The interest rate was altered to a fixed rate of 4.75%, but the interest remained
payable on the same dates. The option to redeem the stock early was removed.
(e) On
the same day, PLC assigned to GKA its right to receive the interest on the loan
stock (including interest accrued but not then due for payment), in
consideration for which GKA issued to PLC 1.5 million £1 preference shares in itself.
The right to receive repayment of the loan principal remained with PLC.
(f) The
preference shares carried the right to a special dividend, defined as an
initial dividend of 65 pence per share to be declared on 14 February 2003, and
thereafter the right to a 5% annual dividend.
(g) PLC
immediately gave notice to GKBR of the assignment and directed GKBR to make future
interest payments to GKA.
(h) On
14 February 2003, the special dividend of 65 pence per share, amounting in all
to £975,000, was declared by GKA. The dividend was to be paid on 2 May 2003,
and it was duly paid on that date.
(i) On
4 May 2003 GKBR paid interest of £7,066,438 on the loan to GKA.
(j) Three
future payments of interest on the loan were due following the assignment and
before redemption:
4 May 2003 – £7,066,438
4 November 2003 – £7,183,561;
and
4 May 2004 – £7,066,438;
Total: £21,316,437.
(k) The
net present value (or NPV) of the three future interest payments, as at 31
January 2003, was calculated to be £20,548,372, using a discount rate of 5%.
That value is not a matter of dispute.
(4) The second transaction (again, a sequence but referred
to throughout this decision as “the second transaction”) was as follows:
(a) Between
1997 and 2003 PLC lent a total of £290 million to GKBR. In return, GKBR issued
£125 million discounted unsecured loan stock on 2 May 1997, and entered into
two inter-company loan agreements: for £105 million on 10 December 2001 (reduced
to £30 million on 7 January 2003) and for £60 million on 28 February 2003.
(b) At
all times material to this decision PLC was the sole holder of the loan stock,
and remained the creditor under the loan agreements.
(c) The
terms of the loan stock, as they had been amended by deed of variation of 30
April 1999, provided that it was repayable on 4 May 2004 (with an option to
redeem early) and that it bore interest at a floating rate of six months LIBOR
plus a margin of 1%. The interest was payable six monthly in arrears on 4 May
and 4 November until redemption. The same interest rates were prescribed by the
loan agreements. The inter-company loans were repayable on demand.
(d) On
5 September 2003, the interest rates were amended to a fixed rate of 4.25% but the
interest remained payable on the same dates. The option for the borrower to pay
off the loans early was removed.
(e) On
the same day, PLC assigned to GKA the rights to the future interest payments on
the loan stock and the agreements, in consideration for which GKA issued to PLC
one million £1 A preference shares in itself. The right to receive repayment of
the principal of the three loans remained with PLC.
(f) The
A preference shares carried the right to a special dividend of 65 pence per
share, such dividend to be declared on 12 September 2003, and the right to
receive an annual preferential dividend of 5%.
(g) PLC
immediately gave notice to GKBR of the assignment and directed GKBR to make future
interest payments to GKA.
(h) On
12 September 2003, the special dividend of 65 pence per share, amounting in all
to £650,000, was declared by GKA. The dividend was to be paid on 4 November
2003, and it was duly paid on that date.
(i) Two
future payments of interest on the loans were due following the assignment and
before redemption:
4
November 2003 - £4,818,120.55; and
4 May 2004 - £4,531,198.63;
Total: £9,349,319.18.
(j) The
net present value of the two future payments, as at 5 September 2003, was
£9,184,786.88, using a discount rate of 4.5%.
(5) PLC made up its accounts to 4 May 2003 and 2 May
2004. Following the first assignment of the right to receive interest (which
took place on 31 January 2003 and therefore in the accounting period ended 4
May 2003), PLC continued to recognise the loan principal of £300 million in its
accounts.
(6) GKA also made its accounts up to 4 May 2003 and 2
May 2004. After the first assignment (of 31 January 2003) to it of the interest
strip (ie the right to receive the interest on the loan from PLC to GKBR)
and its issuing of preference shares to PLC, GKA:
• recorded
the right as a receivable from GKBR in its balance sheet at its net present
value;
• credited
the nominal value of the preference shares as a non-equity capital instrument;
and
• credited
to share premium account the difference between the net present value of the interest
strip and the nominal value of the preference shares issued.
Payments received following the assignment were credited
against the balance sheet receivable, with the excess of the amounts actually
received over the original net present value taken to the profit and loss
account.
(7) GKBR also made up its accounts to 4 May 2003 and 2
May 2004. The assignment of interest did not give rise to any changes in the
accounting adopted by GKBR in respect of the recognition of the loan principal
as a liability or the payments of interest on the loan, which were debited to
its profit and loss account.
(8) Sub-paragraphs (5) to (7) above also apply, with
necessary modifications, to the accounting treatment adopted in consequence of
the second transaction.
6.
As we have indicated, the dispute between the parties centres on the
correct accounting treatment of those arrangements; there is rather less
disagreement about the tax consequences which follow once the correct treatment
has been established. It is common ground that the accounting treatment to be
adopted in any case is dictated in part by legislation, in part by recognised
accounting standards, and in part by professional judgment. The recognised
accounting standards are known as Financial Reporting Standards, or FRS, which
are issued by the Accounting Standards Board. They provide guidance on the
accounting treatment of particular types of transactions, on the presentation
in accounts of assets and liabilities, and on similar matters, and are
universally recognised as the standards to be followed within the United Kingdom. There are several such standards, usually identified as FRS 1, FRS 2 and so
on, and they are often collectively referred to as Generally Accepted
Accounting Practice or GAAP, or (in order to distinguish them from standards in
use elsewhere) UK GAAP. We shall examine the relevant legislation and standards
later; before doing so it is necessary to say a little more about the
background to the dispute, and to identify the issues which arise.
Mr Webb’s evidence
7.
Mr Webb gave us some further information about the group, and the
circumstances in which it entered into the transactions. He is currently
employed by the Greene King group as its tax controller, but his position at
the relevant time was its tax and treasury manager, in which role he was
required, for example, to ensure that there was a match between the group’s
debt profile and its income, and that external finance was obtained as cheaply
as possible. Neither of these is a consideration in this case.
8.
His evidence was, rather, directed to the group’s need of funding for
expansion, which was achieved by acquisition rather than by organic growth.
Historically, acquisitions had been made of smaller but nevertheless
substantial companies carrying on the same kind of business; their businesses
then became an integral part of GKBR’s business. In the course of a
reconstruction in 1997, GKBR had become the group’s main operating company,
while PLC owned the properties from which trade was carried on, charging rent
to GKBR. The first loan of £125 million, referred to at para 5(4)(a) above,
came into existence in the course of the reconstruction. In 2000, however, the
board decided that the 1997 arrangement was too cumbersome: the properties were
transferred to GKBR and PLC became merely a holding company. It was the
transfer of the properties which led to the £300 million loan referred to at
para 5(3)(a) above. We should add that HMRC accept that the loan was made for
ordinary commercial reasons.
9.
The loans of £105 million and £60 million, also mentioned at para
5(4)(a) above, were made to enable GKBR to acquire the assets of two companies.
HMRC do not dispute that the money was put to that purpose, nor do they contend
that these loans too were anything other than ordinary intra-group
arrangements.
10.
By about 2002, Mr Webb said, the group was beginning to find that the
opportunities for growth by the acquisition of fairly large companies were
reducing, and in order to continue expanding it was forced to acquire much
smaller companies, some with only one public house. The decision was made in
January 2003 that GKA, rather than GKBR, would become the acquisition vehicle,
and that it would also operate the acquired businesses for a short period after
acquisition—hitherto acquired businesses had been immediately integrated into
GKBR. GKA had itself been acquired, with its immediate parent company, in 1998.
It had been effectively dormant since May 2002 although it retained some
reserves.
11.
At about the same time Ernst & Young, who were the group’s principal
accounting advisers and auditors, identified to the board an intra-group
financing arrangement, essentially that adopted for the first and second
transactions. Mr Webb’s evidence was that the arrangement was thought to be a
suitable means by which PLC could make funds available to GKA, in order that it
could continue to implement the group’s expansion plans. The arrangement was
attractive to PLC, which adopted it in respect of the first transaction on 31
January 2003 (see para 5(3)(d) above). Mr Webb’s evidence was that finance
provided by PLC to GKA, by means of the assignment to it of the interest stream
receivable from GKBR, had indeed been used for the acquisition of several pubs,
and there is no dispute that GKA received net funds which were available for
acquisitions.
12.
We need at this point to embark on a short digression. Mr Milne
suggested to Mr Webb, by reference to various contemporaneous emails, that each
of the transactions, far from being an efficient means by which PLC could
continue to do what it had been doing for many years (that is, provide acquisition
finance to its subsidiaries) was in truth no more than a tax saving device, one
moreover in which Ernst & Young was to share, by taking a percentage of the
tax saved by its adoption. It was, he said, “a scheme for making what would
otherwise be taxable income vanish into thin air”. We have no real doubt that
the perceived tax saving was the predominant purpose of the transactions: the
appellants acknowledged that they used a marketed scheme, one feature of which,
as Ernst & Young’s presentation to prospective clients showed, was that “it
provides a borrowing company within the Group an interest deduction on its
finance without the lender being taxed on this interest”.
13.
Mr Webb did not claim that the steps in the transactions undertaken in
2003 represented a more effective means by which PLC could provide funds for
its subsidiary than a simple loan, and he accepted, even if rather reluctantly,
both that the special dividends had no commercial purpose and that GKA became
the vehicle for future acquisitions as an integral part of the scheme, and not
for separate commercially-driven reasons. In addition Mr Clifford, in the
opinion to which we shall later come, made the point that
“The … transaction looked at in isolation is not on arm’s
length terms. No company would rationally sell a valuable future interest
stream for a consideration of such little comparative value, unless it already
had control of the transferee such that it could benefit indirectly from the
value of the income stream.”
14.
However, HMRC have not hitherto advanced arguments that the transactions
fail in their purpose for these reasons. At para 5 of the statement of case
they say:
“The object of the scheme was to achieve the position
whereby a debit is generated in GKBR in respect of the payment of the interest
flow to GKA, whereas no corresponding credits would be imputed to GKA (as
recipient) or PLC (as assignee).”
15.
This paragraph encapsulates the thrust of HMRC’s case
about the intended result of the arrangements, namely that one group company
receives tax relief on payments it makes to another group company, while the
recipient is not charged to tax on the receipt. As we have indicated, that is
precisely what Ernst & Young offered when presenting the scheme to
prospective clients. Mr Milne put it in this way in his skeleton argument:
“[The] transactions were structured in the curious way they
were (considering that GKA could have been funded to make its acquisitions by
simple interest-free loan) in order to attempt to take advantage of a perceived
loophole in the loan relationships legislation so as to achieve a tax mismatch
within the Greene King group. If the scheme were to succeed, GKBR would be
entitled to a deduction (for corporation tax purposes) of over £21m for
interest paid on an intergroup loan, without any company in the group being
chargeable on the corresponding receipt.”
16.
The statement of case goes on to argue, however, that the arrangement
does not succeed in that purpose, not because it is an abuse, or falls foul of
anti-avoidance provisions, but because it does not, as a matter of law and
accounting practice, have the intended result. The same approach was adopted in
the correspondence which led to the disputed notices of amendment (even though
the transactions were described by HMRC in that correspondence as “artificial”)
and, despite the extract we have set out, in Mr Milne’s skeleton argument. In
those circumstances we do not think it necessary or appropriate to dwell
further on the appellants’ motives, nor to consider whether or not the
transactions were abusive. Nevertheless, the admitted purpose of the
transactions is not a factor which can be ignored entirely. It was of
particular importance in relation to Mr Clifford’s role, to which we shall come
later.
The issues
17.
The issues between the parties which arise from the
agreed facts were identified by Mr Peacock in his skeleton argument. As
formulated in respect of the first transaction, and with some re-phrasing, they
are:
Issue 1: Whether
PLC should have accounted in its individual (or “solus”) accounts for an
additional £1.5 million (representing the nominal value of the preference
shares received as consideration for the interest strip) as taxable profit in
the year ending 4 May 2003.
Issue 2: Whether
PLC is taxable under s 84(2) of the 1996 Act (see para 39 below) on £20,453,476
(the aggregate of the sums referred to in the closure notices) as a loan
relationship credit. We are not required to decide whether the taxable amount,
assuming it is taxable, has been correctly calculated.
Issue 3: Whether
GKA has a loan relationship with GKBR as result of the first transaction.
Issue 4: Whether
s 84(2)(a) applies to the credits in GKA’s accounts arising from the receipt of
interest.
18.
The issues arising from the second transaction are identical, save for
differences in the amounts and, since there is no other difference between the
two transactions which is material to the outcome of the appeal, the parties
concentrated on an analysis of the first transaction; we shall do likewise.
19.
HMRC’s position in relation to issue 1, almost to the start of the
hearing, was that PLC should have brought the £1.5 million into taxable profit,
but Mr Chandler took the contrary view and it was agreed between the parties
before the hearing began that the answer to that issue was “no”. We thus do not
need to address it, nor do we need to investigate the differing reasons for the
agreed answer in order to determine the remainder of the appeal, though we will
shall make some brief comments below (see para 50). Issue 2 became the main
focus of argument. Some matters of dispute relevant to issues 3 and 4 were also
resolved between the parties, leaving only some residual though nonetheless
significant matters for determination.
20.
The critical question it is necessary to answer in order to decide issue
2 is whether, as HMRC contend, PLC should have partially de-recognised the
principal outstanding (in the case of the first transaction, £300 million) by
discounting it by the NPV of the interest strip (£20,548,372, the figure
mentioned at para 5(3)(a) above), and should then have accreted that value
progressively, by the same aggregate amount, over the period remaining before
redemption, bringing the accretions into profit and, correspondingly, tax. We
interpose, parenthetically, that the NPV of the interest strip and the amount
by which the principal should be de-recognised (if HMRC are correct in
principle) are not necessarily identical, but we are not required to deal with
that point. The appellants say that partial de-recognition was not merely not
required but not permissible, and that HMRC’s position is fundamentally flawed
because, had the interest strip been exchanged for cash, HMRC’s proposed
accounting method would bring the same sum into tax twice.
21.
Before coming to the rules which dictate their accounting treatment it
is, we think, appropriate to say rather more about the genesis of the
transactions, and the process by which the accounting treatment actually
adopted was determined.
The Ernst & Young presentation
22.
As we have said, the transactions were entered
into as a marketed scheme, known as “Project Sussex”, devised by Ernst &
Young. Among the documents produced to us were copies of a presentation by
Ernst & Young to prospective purchasers of the scheme. It included the
following passages:
“Accounting
·
We shall assume that
prior to stripping the coupons [PLC] has accrued interest on the loan to the
value of £1.2m, and the market value of the coupon stripped is £22.6m.
·
[GKBR]
-
[GKBR] will show the
loan as a liability in its balance sheet and will credit its Profit & Loss
Account with the interest accrued during the accounting period.
·
[PLC]
-
[PLC] will accrue
interest on the Loan prior to the date of the assignment. The interest will be
credited to the Profit & Loss account.
-
The value of the Loan
should be impaired in [PLC’s] accounts after it has assigned to [GKA] the right
to receive 1.5 years of interest payments. However it is not uncommon practice
in the UK for companies not to perform an impairment review in respect of
inter-company loans.
-
If the Loan is
impaired, it will accrete the value of the Loan to £300m over the 1.5 year
period, with corresponding credits being taken to the Profit & Loss
Account.
-
The preference share
that [PLC] receives as consideration for assigning the interest will not be
accounted for except as a revaluation as it has already effectively been
recognised in the carrying value of the loan or reflected in the accretion up
to £300m. [PLC’s] assets do not exceed £300m.
·
[GKA]
-
[GKA] will show the
payments that it will be entitled to receive from [GKBR] over the next 1.5
years as an asset in its balance sheet at its fair value (£22.6m).
-
[GKA] will show an
increase in shareholders’ funds equal to the fair value of the consideration
received (£22.6m). As a matter of company law, [GKA] will be required to show
the preference share on the basis of its nominal value of (£1.2m) and the
balance of the consideration (£21.4m) will be taken to the share premium
account.
-
The aggregate value of
the interest payments will be £23.81m. The difference between this figure and
the fair value of £22.6 m (£1.21m) will be treated as interest by the investor,
which it will credit to its Profit and Loss Account at a constant rate over the
1.5 year period.
-
On each occasion
[GKBR] makes a payment to [GKA] the payment will be split between interest and
a repayment of capital. The value of the asset shown in [GKA’s] accounts will
fall over the 1.5 year period to zero.
Taxation
·
[GKBR]
-
[GKBR] will be able to
claim relief on an accruals basis for the payment of interest in respect of the
Loan. This deduction should be unaffected by the assignment of that interest
from [PLC] to [GKA].
·
[PLC]
-
[PLC] has a Loan
Relationship with [GKBR] before and after the assignment of the interest.
-
The provisions of para
12 Sch 9 FA 1996 do not apply because [GKA] does not replace [PLC] as a party
to the loan relationship.
-
[PLC] is taxed on an
amount equal to the accounting value given to the Preference Share at the time
of the assignment as a profit on a related transaction (£1.2m).
·
[GKA]
-
[GKA] is a party to a
loan relationship in its own right, represented by the rights to interest.
[GKA] should bring into account its profit as a profit from a loan relationship
rather than as interest; there is no interest under this loan relationship.
-
[GKA] should bring
into account a profit of £1.21m in respect of its loan relationship, on which
it should be taxed on an accruals basis over the term of the loan as it
accretes the value of the asset from £22.6m up to £23.81 m.
-
[GKA] should not have
to bring, into account for tax purposes the £21.4m that is mandatorily taken to
its share premium account.”
23.
The figures given above differ slightly from those identified in the
agreed facts, but the differences are not material. The remarks made in
relation to GKBR are uncontroversial. Those made under “accounting”, in
particular the second and third indents, in relation to PLC go to the core of
issue 2, while those relating to GKA are relevant to issue 4. Some of the
remarks under “taxation” are uncontroversial, but others are relevant to issue
3 and are not agreed. We shall return to the areas of controversy in due
course.
Mr Clifford’s evidence
24.
At the time of the transactions, Mr Clifford was Ernst & Young’s
audit engagement partner for PLC and its subsidiaries and, therefore,
ultimately responsible for the truth and accuracy of the auditors’ opinion
which appeared in the group companies’ published accounts, and which he signed
on behalf of Ernst & Young. In addition, and because of PLC’s recognition
of the true underlying purpose of the transactions (that is, as a means, if it
succeeded, of generating relief for the payments of interest made without a
corresponding liability to tax on the receipts), he was asked to prepare an
opinion (see para 27 below) about their correct accounting treatment before PLC
and GKA entered into them. He gave evidence as a witness of fact, and we
accordingly treat what he told us as evidence of what was done, and why it was
done, rather than as evidence of the correctness of the manner in which the
transactions were treated within the relevant companies’ accounts.
25.
Before coming to the substance of his evidence we need to deal with a
preliminary matter. Mr Clifford rejected Mr Milne’s suggestion that his views
were coloured by his being a partner in the same firm which had devised, and
was marketing, a tax avoidance scheme. There was at that time, he said, no
legal or ethical impediment to a single firm both advising and auditing a group
such as Greene King. Mr Clifford made the points that he had taken no part
whatever in the planning of the scheme, that he was obliged, as an auditor, to
take an independent view, that any failure on his part to do so could lead to
disciplinary proceedings, and that both a technical reviewer and another
partner, neither of whom had any relationship of his own with the Greene King
group, had reviewed his work before it was released.
26.
Although it would be remarkable if Mr Clifford had been able to put out
of his mind altogether the fact that his own firm was the architect of the
scheme, we are satisfied from his evidence that he did examine the accounting
requirements which flowed from it objectively, and that the opinions given in
advance of its implementation by PLC, GKA and GKBR, and in the group’s audited
accounts, were not coloured as Mr Milne suggested. That is not to say, however,
that he was right.
27.
In January 2003, Mr Clifford and a team of other Ernst & Young
personnel prepared an opinion, for the Greene King board,
advising on the proper accounting treatment of what was then still a proposed
assignment and share issue. He told us that his main task was to consider the
various possible ways in which the companies could properly account for the
transactions. In the consolidated group accounts they would, as he put it, “eliminate”,
meaning effectively cancel each other out; what was required was a method by
which the individual companies could treat them in their own, solus, accounts.
He took into consideration, in particular, the requirements of FRS 4 (relating
to capital instruments), FRS 5 (entitled Reporting the Substance of
Transactions), and Sch 4 to the Companies Act 1985, and decided upon what he
described in his witness statement as “a method that recognises no impairment
in the underlying value of the loan receivable on day one”, rejecting the other
possible methods which he thought might have been appropriate, namely partial
de-recognition and capital contribution.
28.
As we have indicated, HMRC argue, among other things, that Mr Clifford’s
choice between these methods was wrong, and that partial de-recognition was the
only appropriate method. It is in consequence necessary to consider Mr Clifford’s
reasons for favouring one possible method over the others as one of the factors
to be taken into account: although we do not treat Mr Clifford as an expert, it
is nevertheless essentially his judgment (or, to be precise, the judgment of
the team he led in producing the opinion which preceded the transactions) which
is in issue. In his witness statement he put the
reason for favouring what he had described as a non-impairment method in this
way:
“It was considered that there would be no overall change in
the carrying value of PLC’s assets because a reduction in the value of the loan
would be offset by an enhancement in the value of investment in its
subsidiaries, ie the value of the loan to GKBR would be reduced on ‘disposing’
of the interest rights but this would be economically balanced by the increase
in the value of the equity in [GKA] as PLC would be able to control the
benefits arising from the income stream.
Maintaining consistency with the accounting practice adopted
by PLC for other intra-group loans at this time; as such non-interest bearing
loans of an intra-group nature were not routinely written down within the
Greene King group unless there was an indication of a permanent impairment in
the recoverable amount. It was considered that the £300 million receivable
under this transaction would be fully recoverable at the end of the loan term.
As set out in paragraph 1 of FRS 18 ‘the objective of the FRS is to ensure that
for all material items an entity adopts the accounting policies most
appropriate for the purpose of giving a true and fair view’. The standard
further addresses the need for ‘comparability’ in paragraph 30 which supports
the need for consistency with group practice.
Based on the above it was considered that there would be no
economic disposal by PLC as there would be no significant change in PLC’s
rights to the benefits or exposure to risks (FRS 5, paragraph 70) taking into
account the commercial effect of the transaction in practice (FRS 5, paragraph
75).”
29.
Later in his witness statement he expanded upon his reasons for
rejecting partial de-recognition:
“The partial de-recognition method does not, in my view,
adequately take into account the intra-group context of the transaction. In
particular, I do not consider that FRS 5 requires partial de-recognition in
circumstances where the commercial effect for PLC in substance is not
significant and where PLC’s rights to benefits and exposure to risks are
substantively unchanged. I have noted that HMRC itself says [in the
correspondence between the parties] that from an accounting perspective, PLC
had not suffered any loss, merely a change in the nature of the assets that it
holds, thus acknowledging the practical effect of the transaction.”
30.
Thus Mr Clifford concluded that there was
no justification for impairing the loan in PLC’s accounts because, in summary,
while the character of the group companies’ respective rights and obligations
changed, PLC’s overall position was, in net terms, unaffected, and there was no
reason to think that the loan would not be repaid in full and on time. His
distinction of this case from an arm’s length transaction in which, as he
accepted, partial de-recognition would be the technically correct accounting
treatment, by virtue of the fact that this was an intra-group transaction with
no significant risk attached to it, broadly reflects what is said in the second
indent under “accounting”, in relation to PLC, in the extract from Ernst &
Young’s presentation reproduced at para 22 above. The validity or otherwise of
this distinction is of great importance in the determination of issue 2, and we
shall return to it.
31.
It will be observed that the declaration and payment of a special
dividend (of £975,000 in the context of the first transaction) do not feature
in Ernst & Young’s presentation, and we did not learn what was the purpose
of the dividend, save that it was regarded as part of the consideration (the
remainder being the preference shares) for the interest strip. The received
dividend was treated in PLC’s accounts as a realised profit, and there is no
disagreement between the parties on that treatment. Mr Clifford took the view
that the allotment of the preference shares had no immediate impact on PLC as
it was reflected, or included, in the unimpaired carrying value of the £300
million loan; adding the value of the preference shares to that unimpaired
value would result in an over-statement of realised profits.
32.
The treatment in GKA’s accounts of the share premium arising from the
issue of the preference shares was, Mr Clifford believed, dictated by FRS 4 and
s 130 of the Companies Act 1985, which required the net proceeds to be
allocated to shareholders’ funds: he said that his understanding at the time
was that s 132 of that Act (with which we deal at para 41 below) did not apply
to the transaction. The definition of “net proceeds” he followed was that in
FRS 4, namely the “fair value of the consideration received on the issue of a
capital instrument after deduction of issue costs”, the issue costs in this
case being negligible. The accounting treatment Mr Clifford proposed was to
recognise an asset at the net present value of the income stream (see para
5(3)(a) above) and to treat as the premium the excess of that sum over the
nominal value of the shares. The asset was amortised to nil over the period of
the loan as the payments of interest were received. This treatment, too,
reflects the approach proposed in Ernst & Young’s presentation. Whether or
not this treatment was correct depends upon our answer to issue 4.
The relevant legislation
33.
The appropriate starting point is s 226 of the Companies Act 1985 (as
substituted by the Companies Act 1989, and also since repealed and replaced),
which imposed on the directors of a company the duty to prepare accounts,
including a balance sheet and a profit and loss account (together referred to
in the Act as the company’s “individual accounts”), for each of the company’s
accounting periods (usually a year). The form and content of the accounts were
prescribed by Sch 4 of the Act, which imposed a large number of individual
detailed requirements. The overriding obligation, however, was to prepare
accounts which gave a “true and fair view”; and s 226(4) and (5) amplified that
requirement:
“(4) Where compliance with the provisions of [Sch 4], and
the other provisions of this Act as to the matters to be included in a company’s
individual accounts or in the notes to those accounts, would not be sufficient
to give a true and fair view, the necessary additional information shall be
given in the accounts or in a note to them.
(5) If in special circumstances compliance with any of
those provisions is inconsistent with the requirement to give a true and fair
view, the directors shall depart from that provision to the extent necessary to
give a true and fair view.
Particulars of any such departure, the reasons for it and
its effect shall be given in a note to the accounts.”
34.
Despite the detail of the rules set out in Sch 4, they amounted to no
more than a framework, whose interpretation and application were left to
accounting practice, itself governed by the recognised standards of UK GAAP. In
essence, Sch 4 prescribed what must be recorded, but with limited exceptions
did not prescribe how the amounts to be recorded were to be determined; and in
some respects alternative approaches were permitted. The FRS provided guidance,
often amounting to prescription, about those matters. There were, however,
other legislative provisions of relevance here.
35.
It is common ground that the loan relationship provisions to which we
have referred above apply to the transactions. The principal charging provision
was s 80 of the 1996 Act which, so far as material to this decision, provided
that:
“(1) For the purposes of corporation tax all profits and
gains arising to a company from its loan relationships shall be chargeable to
tax as income in accordance with this Chapter.
(2) To the extent that a company is a party to a loan
relationship for the purposes of a trade carried on by the company, profits and
gains arising from the relationship shall be brought into account in computing
the profits of the trade.
(3) Profits and gains arising from a loan relationship of a
company that are not brought into account under subsection (2) above shall be
brought into account as profits and gains chargeable to tax under Case III of
Schedule D.…
(5) Subject to any express provision to the contrary,
the amounts which in the case of any company are brought into account in
accordance with this Chapter as respects any matter shall be the only amounts
brought into account for the purposes of corporation tax as respects that
matter.”
36.
Thus subsections (2) and (3) together brought into charge all profits
and gains arising from a loan relationship, and merely provided for
differential treatment of those derived respectively from trading and
non-trading activities. Later provisions of Chapter II, to which we shall come,
supplied rules about the determination of the profits and gains which were
chargeable in accordance with s 80. Mr Peacock placed some emphasis on sub-s
(5), making the point that, with limited exceptions not material here, the loan
relationship provisions amounted to an exclusive code.
37.
What is meant by a loan relationship was spelt out by s 81:
“(1) Subject to the following provisions of this section,
a company has a loan relationship for the purposes of the Corporation Tax Acts
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.…
(3) … where an instrument is issued by any person for
the purpose of representing security for, or the rights of a creditor in
respect of, any money debt, then (whatever the circumstances of the issue of
the instrument) that debt shall be taken for the purposes of this Chapter to be
a debt arising from a transaction for the lending of money.…
(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.”
38.
There is no dispute that PLC and GKBR were in a loan relationship within
the meaning of that section. As we shall indicate, it is not so clear, and is
before us as issue 3, whether one consequence of the transactions was the
creation of a loan relationship between GKBR and GKA.
39.
Sections 82 and 83 of the 1996 Act are of no relevance in this case, but
s 84(1) and (2) are of some importance. They provided that:
“(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 (disregarding interest and any charges or expenses) 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.
(2) The reference in subsection (1) above to the
profits, gains and losses arising to a company—
(a) does
not include a reference to any amounts required to be transferred to the
company’s share premium account; but
(b) does
include a reference to any profits, gains or losses which, in accordance with
generally accepted accounting practice, are carried to or sustained by any
other reserve maintained by the company.”
40.
A central feature of the appellants’ argument is that
s 84(2)(a) was engaged, while sub-s (2)(b) was not, since no other reserve came
into play. The significance of this point is that, if the appellants are right,
amounts required to be transferred to GKA’s share premium account (in this case
by reason of s 130 of the Companies Act 1985, to which we come next) did not
fall within the s 80 charge. HMRC agree that s 84(2)(b) was not engaged, but say
that sub-s (2)(a) was irrelevant, because of the combined effect of ss 130 and
132 of the 1985 Act. The essence of the dispute on this issue is that while the
parties agree that, at first sight, s 130 applied to the creation and issue of
the preference shares (see paras 5(3)(e) and 5(4)(e) above), the respondents
argue that its application was immediately excluded by s 132. The appellants
say that s 132 cannot apply. Those provisions too have since been repealed and
replaced, but were in force at the relevant time. Section 130 of the 1985 Act,
so far as material, provided that:
“(1) If a company issues shares at a premium, whether for
cash or otherwise, a sum equal to the aggregate amount or value of the premiums
on those shares shall be transferred to an account called ‘the share premium
account’.…
(4) Sections 131 and 132 below give relief from the
requirements of this section, and in those sections references to the issuing
company are to the company issuing shares as above mentioned.”
41.
Section 131 is of no present relevance. Section 132
(which was entitled “Relief in respect of group reconstructions”) read:
“(1) This section applies where the issuing company—
(a) is
a wholly-owned subsidiary of another company (‘the holding company’), and
(b) allots
shares to the holding company or to another wholly-owned subsidiary of the
holding company in consideration for the transfer to the issuing company of
assets other than cash, being assets of any company (‘the transferor company’)
which is a member of the group of companies which comprises the holding company
and all its wholly owned subsidiaries.
(2) Where the shares in the issuing company allotted in
consideration for the transfer are issued at a premium, the issuing company is
not required by section 130 to transfer any amount in excess of the minimum
premium value to the share premium account.”
42.
The following subsections provided a mechanism for determining the “minimum
premium value”, but we do not think it necessary to explore them as we are
required only to reach a decision in principle on this point. Although, as we
shall explain, the parties did not agree on the point, for present purposes we can
assume that Mr Clifford’s approach (of taking the difference between the net
present value of the interest strip and the nominal value of the shares, therefore
approximately £19 million) was correct. If the appellants are right, that £19
million was required to be transferred to the share premium account and, by
virtue of s 84(2)(a), escaped taxation. HMRC contend that s 132 nullified the
obligation which there would otherwise have been to make that transfer, and the
£19 million correspondingly formed part of GKA’s taxable profit. We deal with
this issue at para 85 below.
43.
Section 85 of the 1996 Act was entitled “Authorised accounting methods”.
Only sub-ss (1) and (2) are relevant to this appeal. They provided, in respect
of the accounts drawn up to 4 May 2003—there were, for present purposes
inconsequential, changes for the following year—that:
“(1) Subject to the following provisions of this Chapter,
the alternative accounting methods that are authorised for the purposes of this
Chapter are—
(a) an accruals
basis of accounting; and
(b)
a mark to market basis of accounting under which any loan relationship
to which that basis is applied is brought into account in each accounting
period at a fair value.
(2) An accounting method applied in any case shall be
treated as authorised for the purposes of this Chapter only if—
(a) subject
to paragraphs (b) to (c) below, it is in conformity with generally accepted
accounting practice to use that method in that case;
(b) it
contains proper provision for allocating payments under a loan relationship, or
arising as a result of a related transaction, to accounting periods;
(bb) it
contains proper provision for determining exchange gains and losses from loan
relationships for accounting periods; and
(c) where
it is an accruals basis of accounting, it does not contain any provision (other
than provision in respect of exchange losses or provision comprised in
authorised arrangements for bad debt) that gives debits by reference to the
valuation at different times of any asset representing a loan relationship.”
44.
Section 87(2) makes it clear that the only permitted basis of accounting
where (as here) the parties have a connection is an accruals basis, and a mark to
market basis would in any event be impractical. Subsection (2) did not
otherwise, we think, in reality restrict the choice of accounting method
unduly, since the requirements it imposed are similar to those imposed by UK
GAAP. For completeness however we should mention that s 86(3) added a further
qualification:
“(3) If a basis of accounting which is or equates with an
authorised accounting method is used as respects any loan relationship of a
company in a company’s statutory accounts, then the method which is to be used
for the purposes of this Chapter as respects that relationship for the
accounting period, or part of a period, for which that basis is used in those
accounts shall be—
(a) where
the basis used in those accounts is an authorised accounting method, that
method; and
(b) where
it is not, the authorised accounting method with which it equates ….”
The accounting standards
45.
The most important of the FRS in this case is FRS 5, entitled “Reporting
the substance of transactions”. Mr Peacock drew our attention to the comment
which appears in its introductory paragraphs that
“The FRS … will mainly affect those more complex
transactions whose substance may not be readily apparent. The true commercial
effect of such transactions may not be adequately expressed by their legal form
and, where this is the case, it will not be sufficient to account for them
merely by recording that form.
Transactions requiring particularly careful analysis will
often include features such as—
… a transaction is linked with others in such a way that the
commercial effect can be understood only by considering the series as a whole.…”
46.
Two of the substantive paragraphs of FRS 5 are of particular importance
in this case. Paragraph 23 provides that
“Paragraphs 21 and 22 deal with most transactions affecting
items previously recognised as assets. In other cases where there is a
significant change in the entity’s rights to benefits and exposure to risks but
the provisions of paragraph 22 are not met, the description or monetary amount
relating to an asset should, where necessary, be changed and a liability
recognised for any obligations to transfer benefits that are assumed. These
cases arise where the transaction takes one or more of the following forms:
(a) a transfer of only part of the
item in question;
(b) a transfer of only part of the
item in question;
(c) a transfer of all of the item
for all of its life but where the entity retains some significant right to
benefits or exposure to risk.”
47.
Paragraphs 21 and 22 do not have any relevance in this case. The second
passage of importance is para 71:
“Transfer of part of an item that generates benefits may
occur in one of two ways. The most straightforward is where a proportionate
share of the item is transferred. For example, a loan transfer might transfer a
proportionate share of a loan (including rights to receive both interest and
principal), such that all future cash flows, profits and losses arising on the
loan are shared by the transferee and transferor in fixed proportions. A
second, less straightforward way of transferring a part of an item arises where
the item comprises rights to two or more separate benefit streams, each with
its own risks. A part of the item will be transferred where all significant
rights to one or more of those benefit streams and associated exposure to risks
are transferred whilst all significant rights to the other(s) are retained. An
example would be a ‘strip’ of an interest-bearing loan into rights to two or
more different cash flow streams that are payable on different dates (for
instance ‘interest’ and ‘principal’), with the entity retaining rights to only
one of those streams (for instance ‘principal’). In both these cases, the
entity would cease to recognise the part of the original asset that has been
transferred by the transaction, but would continue to recognise the remainder. A
change in the description of the asset might also be required.”
48.
There was also reference to the requirements of FRS 18, whose purpose is
identified succinctly in its introduction:
“The objective of this FRS is to ensure that for all
material items:
(a) an entity adopts the accounting policies most
appropriate to its particular circumstances for the purpose of giving a true
and fair view;
(b) the accounting policies adopted are reviewed
regularly to ensure that they remain appropriate, and are changed when a new
policy becomes more appropriate to the entity’s particular circumstances; and
(c) sufficient information is disclosed in the financial
statements to enable users to understand the accounting policies adopted and
how they have been implemented.”
49.
Although some references were made to other parts of UK GAAP, and to
various explanatory notes and guidance published by the “Big Four” accountancy
practices, we do not think it necessary to set them out, save to the limited
extent we do so below. We repeat, for ease of understanding, that the critical
point, in relation to issue 2, is whether the combined effect of paras 23 and
71 of FRS 5 is to require PLC to de-recognise the capital value of the loan
principal in part, as HMRC contend; or, as the appellants maintain, their
effect is to require PLC to produce accounts which do not contain any element
of de-recognition.
Issue 1
50.
As we have already said, the parties agreed
shortly before the hearing began that the £1.5 million nominal value of the
preference shares issued by GKA to PLC did not represent a realised profit in
PLC’s hands. Mr Parish and Mr Chandler arrived at that answer by quite
different routes, and each doubted the other’s reasoning. In particular, Mr
Chandler did not accept that the accounting treatment actually adopted (of treating
the £1.5 million as an increase in the value of PLC’s investment in GKA, while
taking no account of what Mr Chandler viewed as the transfer of value to GKA at
PLC’s expense) was correct. It is not, however, necessary for us to deal with
their differences on this point, save to observe that they were marked, which lends
some support to Mr Peacock’s argument that there is room for divergent views
about the correct accounting treatment of some transactions.
Issue 2
The expert evidence
51.
The experts’ joint statement is lengthy, and much of what it contains is
set out elsewhere in this decision. We can, therefore, summarise much of it.
The experts identified four discrete issues, in a slightly different form from
that we have set out at para 17 above; how the preference share income should
be recognised; whether or not PLC should have partially de-recognised the loan;
whether or not PLC should have accreted the loan (in what follows, as
elsewhere, we deal only with the first transaction) from about £280 million to
£300 million between 31 January 2003 (when the interest strip took place) and 4
May 2004 (the due date for redemption of the loan), on a constant rate of
return basis, while crediting the interest receivable to its profit and loss
account over the same period; and the manner in which the share premium should
be recognised in GKA.
52.
The main battleground was, as it is in the appeal itself, whether or not
the loan should have been partially de-recognised. It was common ground between
the experts that, had the transfer of the interest strip been between
unconnected parties, it would ordinarily have been appropriate for its value to
be de-recognised in accordance with FRS 5, paras 23 and 71, in order that the
financial statements gave a true and fair view.
53.
Mr Parish argued that this was not so in the case of an intra-group
transaction such as this. It is, he said, necessary to consider the commercial
substance of a transaction and, in the case of intra-group transactions, this
may require a different accounting treatment to be adopted from that which
would be used if the parties were at arm’s length. PLC’s historic accounting
policy had been for fixed asset investments in subsidiary companies to be
valued at cost, less any provision for permanent impairment in value. He
considered that de-recognition of the value of the interest strip was not
required under UK GAAP as there was no disposal of an asset that was required
to be accounted for separately, nor any permanent impairment. Therefore, in his
opinion, the relevant question was whether there had been any impairment in the
overall value of PLC’s investment in GKBR following the transfer of the right
to interest. From the perspective of PLC, the loan stock was non-interest
bearing after assignment of the interest strip, and it was appropriate for that
loan to be accounted for in the same manner as any other intra-group loans upon
which PLC did not receive a direct economic return, that is at redemption value.
Thus the application of FRS 5, paras 23 and 71, should be modified, he
said, so as to reflect the fact that, overall, there was no change in PLC’s
position. There was no risk which it was necessary to reflect in its accounts
that PLC would not receive payment in full of the outstanding principal, and
thus no warrant for impairing its value. He relied too on application note E15
to FRS 5 which, so far as material, reads:
“Whilst the commercial effect of any particular transaction
should be assessed taking into account all its aspects and implications, the
presence of all of the following indicates that the lender has not retained
significant benefits and risks, and de-recognition is appropriate:
(a) the
transaction takes place at an arm’s length price for an outright sale;
(b) the transaction is for a fixed amount of
consideration and there is no recourse whatsoever, either implicit or explicit,
to the lender for losses from whatever cause …
(c) the lender will not benefit or suffer in any
way if the loans perform better or worse than expected …
Where any of these three features is not present, this
indicates that the lender has retained benefits and risks relating to the loan
and, unless these are insignificant, either a separate presentation or a linked
presentation should be adopted.”
54.
The effect of this note, Mr Parish said, was that de-recognition, though
apparently a requirement of paras 23 and 71, was excluded because not all of
the features identified were present. His position was that partial
de-recognition was incorrect because it would not reflect the fact that PLC had
the right to payment of the principal, and it would therefore not provide a
true and fair view. In his opinion, GAAP required PLC to reflect the full value
of the principal in its solus accounts since they would otherwise give the
misleading impression that PLC was not entitled, as overall it was, to the full
beneficial interest in that principal. PLC had thus produced GAAP-compliant
accounts, and Ernst & Young had correctly given those accounts an
unqualified auditor’s opinion.
55.
Mr Chandler took the contrary position. He pointed out that FRS 5 does
not discriminate in any way, in paras 23 and 71, between intra-group and arm’s
length transactions. Thus unless there was compelling reason to the
contrary—and there was none here— the partial de-recognition demanded by para
71 was mandatory. He accepted Mr Peacock’s point that it was customary, and
GAAP-compliant, for a parent company to record a non-interest bearing loan (as,
from PLC’s perspective, the loan was once the interest had been stripped) at
its face value but, he said, that treatment reflected the fact that such loans
were almost invariably repayable on demand, even if there was an understanding
that immediate payment would not be required in practice. That was not the case
here; the loan was not repayable for (at the time of the strip) about 15 months
and it was necessary to reflect that fact by partial de-recognition. It was not
a case of impairment—he accepted that the risk of non-payment was so small that
it could be ignored—but one in which it was necessary to reflect the present
value of a future payment, and to accrete that value, over time, as the date
for payment approached. The accretions had to be taken to PLC’s profit and loss
account.
56.
He pointed out that three of the “Big Four” accountancy firms had
published guidance to the same effect (the fourth having apparently published
no guidance on the point). It is entirely in accordance with the substance of
the transaction to de-recognise the interest strip in PLC, since as a matter of
fact, the interest strip was transferred. The cash flows in respect of the
interest strip were transferred to GKA, and GKA received them. The loan was not
interest free, albeit principal and interest were due to different companies,
and it was inappropriate to treat it as if it were. Indeed, GKBR and GKA both
recognised that the loan was interest-bearing, and accounted for it
accordingly. It is true that the requirements of an accounting standard can be
overridden (that is, in this case, that FRS para 71 might be ignored), but this
course is permissible only when the “true and fair” requirement of the
Companies Act made it necessary. No such necessity was identifiable in this
case.
The appellants’ submissions
57.
Mr Peacock’s starting point was that if PLC’s statutory accounts were
drawn up in accordance with GAAP, there is no legitimate basis on which the
respondents can substitute their own preferred accounting method for what PLC
actually did: in other words, an acceptable accounting method cannot be
rejected and replaced simply because it results in a lower tax yield than the
respondents think is appropriate. We record this argument for completeness
since Mr Milne did not demur, acknowledging that if we were persuaded that the accounting
method adopted was GAAP-compliant, we must determine the appeal in favour of
the appellants.
58.
Mr Peacock also made the point that if HMRC were to succeed on issue 2,
we would need to be satisfied that Mr Clifford and his team, as well as Mr
Parish, were all wrong in thinking that the method used was GAAP-compliant. The
fact that they thought it was compliant was, in itself, good reason for concluding
that there was at least scope for alternative acceptable methods, and the
appellants’ choice between those acceptable methods could not be challenged. However,
he went rather further by contending that the method adopted was not merely one
of several acceptable methods, but the one most appropriate.
59.
His argument depended on a number of propositions, all supported by paragraphs
of FRS 5. We need not deal with many of the points in detail, since they are
uncontroversial. It is, indeed, axiomatic that an entity must report the
substance of its transactions; that regard must be had to the true commercial
effect of a transaction; that a linked series of transactions should be looked
at as a whole; that regard should be had to increases or decreases in existing
assets or liabilities; and that the test for de-recognition is whether there
has been a significant change in the entity’s rights to benefits and exposure
to risks. It is also undisputed that if there is no significant change in
rights or risks there should be no de-recognition, whereas if there is a
transfer of all rights and risks there should be full de-recognition of the
asset. It follows that where there is a significant change in rights and risks
but no full transfer, consideration needs to be given to partial
de-recognition: this is the effect of FRS 5 para 23, set out above. What is “significant”
should be judged by reference to likely benefits and risks.
60.
Three other propositions were, however, the subject of some debate. Mr
Peacock, supported by some comments made by Mr Parish as he gave his evidence,
argued that regard must be had to “moral risk”, which will be present where the
transferor feels obliged to fund losses arising on the loans concerned (here
the interest payments). De-recognition of a loan is only appropriate if the
transferor retains no significant benefits and no significant risks; in other
words only when it has divested itself entirely of the loan. This will be so if
there is a transaction at an arm’s length price for an outright sale, the
consideration is for a fixed amount without recourse to the transferor and the
transferor will not benefit or suffer in any way from the performance of the
loans: see application note E15, set out above. Where any of these three
features is not present, a method other than partial de-recognition must be
adopted.
61.
Mr Chandler had accepted that, in order to determine whether partial
de-recognition is appropriate, it is necessary to look at all the features of a
transaction. Those in issue here were not arm’s length transactions, and made
commercial sense only if viewed in their intra-group context. Both risks and
rewards must be transferred in practice; if they are retained by, or in any way
could revert to, the transferor then, Mr Peacock argued, partial de-recognition
is inappropriate. FRS 5, para 23, merely provides for the standard practice, which
ordinarily applies where part of an asset is transferred for all of its life;
it does not lay down an inflexible rule which must be followed irrespective of
the surrounding circumstances. The experts agree that FRS 5, para 23, is
engaged when there has been a significant change in the transferor’s rights to
benefits and exposure to risks, and that whether a change is “significant” for
these purposes is to be judged by commercial and practical, rather than legal
or formalistic, criteria. Here, PLC retained all the practical and commercial
benefits and risks in respect of the interest by virtue of its being, even if
indirectly, the holder of the entire shareholding in GKA. It is common ground
that the transactions had the effect of increasing the value of GKA, while
there was no economic change in PLC. The reality therefore is that PLC’s
position was unchanged; thus there was no justification for de-recognising the
loan principal in its accounts.
62.
Mr Chandler’s opinion that PLC has confused consolidated group accounts
with solus company accounts is incorrect (and immaterial), said Mr Peacock,
since both experts agree that the consolidated accounting position is not
relevant. It is necessary, rather, to examine the value of the investments in
PLC’s solus accounts, and to determine the commercial effect of the
transaction, which was to increase the value of those investments. Mr Chandler’s
approach, Mr Peacock argued, is based on his perception that the transactions
in reality effected no change, because they were intra-group loans between
companies all controlled by PLC. Crucially, he said that when examining those
rights which have a commercial impact for the purposes of FRS 5, a transfer
between parent and wholly-owned subsidiary is not significant. But that approach,
Mr Peacock emphasised, was inconsistent with his acceptance of the proposition
that the intra-group transfer of an asset has a real economic consequence.
There was further inconsistency between his acceptance of the proposition that
the intra-group nature of the transactions is relevant to their accounting
treatment, while ignoring it when applying FRS 5. By contrast, Mr Parish did
not argue for a departure from FRS 5, but for consideration of the question
whether its terms apply to the present case.
63.
The essential question is a simple one: whether the accounting treatment
actually adopted (and, moreover, audited by Ernst & Young) was
GAAP-compliant. Mr Parish concluded that it was. Even if Mr Chandler were able
to produce an alternative GAAP-compliant method, it did not follow that the
method actually used was wrong. However, Mr Chandler had not produced an appropriate
alternative method, since his approach did not work. He had ignored the
indicators in application note E15, which he had treated as no more than
typical features rather than, as they were, determining factors, and had
disregarded the fact that none was present here. Instead, the test he had
applied was whether PLC controlled the interest strip; yet the FRS 5 test for
partial de-recognition has nothing to do with control. He also relied on the
fact that it would make no sense for both GKA and PLC to recognise the same
asset. But that analysis is fundamentally flawed, since PLC and GKA did not recognise
the same asset: PLC held a loan which had not been partially de-recognised and
GKA held certain rights to interest.
64.
It follows that in the present case de-recognition of part of the
original loan (ie the right to interest) was not appropriate because
there has been no significant change in PLC’s rights and risks in relation to that
right to interest. If one were to look at the substance and true commercial
effect of the transaction as a whole, while bearing in mind that PLC and GKA were
associated companies and the former was funding the latter
in order that it could make acquisitions on behalf of the group, it would be
seen that:
(1) PLC
retained the right to control GKBR (both as a shareholder and under the terms
of the loan stock);
(2) PLC
retained the right, through its voting power as stockholder, to change the
terms of the loan stock so as to capitalise interest and require it to be
repaid as principal on redemption;
(3) PLC
retained the “moral” risk in relation to GKA since the latter was its
wholly-owned subsidiary, and was the group’s acquisition vehicle;
(4) PLC’s
transfer of the right to interest to GKA was matched by an increase in the
value of its existing asset in the form of the ordinary shares in the
intermediate company which owned the ordinary shares in GKA;
(5) There
was no transaction at an arm’s length price for an outright sale;
(6) There
was no consideration for a fixed amount without recourse to the transferor,
since all that PLC received was preference shares in a company in which it
already owned the ordinary shares; and
(7) PLC
continued, through its ordinary shares, to benefit and suffer from the
performance of the loans.
65.
The consequences if the loan were to be de-recognised were problematic.
This was apparent from Mr Chandler’s agreement that the accounting treatment
which HMRC had suggested before he was instructed was not GAAP-compliant, a
further illustration of the appellants’ case that there was room for differing
opinions about the correct GAAP-compliant treatment of the transactions.
De-recognition would result in a credit in PLC’s accounts of £20.5m. The corresponding
debit would be partly to the assets received in consideration for the strip,
but there would be a substantial debit remaining. In the circumstances of an
arm’s length transaction it would have been appropriate to use the remaining
debit to recognise a loss. But the experts agree that this would not be
appropriate in this case. Mr Chandler thought that it should be treated as a
capital contribution in PLC’s accounts, relying on guidance published by the “Big
Four” accountants, while Mr Parish pointed out that the only reference to
capital contributions in the accounting standards is in FRS 4, and that
standard relates only to the recipient’s accounts. In fact, the guidance relied
on by Mr Chandler—published, ironically, by Ernst & Young—states that it is
possible for the transferor to record a loss. All these factors pointed to the
conclusion that it could not properly be said that PLC’s chosen method was
inappropriate.
HMRC’s submissions
66.
The core of the respondents’ case (on issues 2, 3 and 4) is set out at para
16 of the statement of case (which Mr Milne drafted), and he adopted it as part
of his argument:
“The Respondent argues that PLC is taxable under section
84(2) of the Finance Act 1996 on [£20,453,476] as a loan relationship credit in
accordance with the accruals basis of accounting, as follows:
•
The loan from PLC to GKBR was recognised in the accounts with a book
value of £300m.
•
Economically, the loan represents the right to receive future interest
payments and the right to receive the £300m on redemption (4 May 2004).
•
As of the date of assignment of the rights to future interest payments
(31 January 2003):
-
The right to the future interest had a fair value of say (for
illustrative purposes) £20m.
-
The right to the repayment of £300m on redemption therefore had a fair
value of say £280m.
Normally no distinction is made
between these two parts and a single ‘loan’ is recognised in the books.
•
FRS 5 requires the substance of transactions to be recognised in
financial statements, and para 71 of FRS 5 (at the material time) considers how
to account for a transfer of part of an item (eg an asset). It discusses
the accounting with the example of a transfer of rights to interest on a loan
without transferring the rights to the principal (a so-called ‘interest strip’),
and requires that the reporting entity should cease to recognise the part of
the original asset that has been transferred by the transaction, but continue
to recognise the remainder.
•
So, instead of the £300m loan on its balance sheet, the company should
continue to recognise only the right to the principal on its balance sheet,
with a book value and historic cost of £280m. The company should no longer
recognise the right to future interest receipts with a book value and historic
cost of £20m. This right has been assigned to the indirect subsidiary, GKA and
so is no longer recognised by PLC.
•
The right to principal is economically identical to a zero coupon bond
issued for £280m and redeemed for £300m and the standard accounting is to
accrete the £280m to £300m over the period to redemption so as to recognise ‘interest’
at a constant rate of return.
•
The accretion from £280m to £300m will be recognised in the accounts of
PLC over the course of the period between assignment of the interest rights to GKA
(31 January 2003) of the loan and repayment of the principal to PLC (4 May
2004). This gives rise to loan relationship credits for the purposes of section
84(2) of the Finance Act 1996 in the amount of [£20,453,476].”
67.
The transaction amounted to a disposal by PLC of part of its loan
receivable from GKBR to GKA. The recoverability of the loan was in no way
affected and, Mr Milne added, it is therefore incorrect to argue, as the
appellants appear to do, that the loan may have been impaired; the notion of “impairment”,
meaning a reduction in the recoverable amount of an
asset below its “carrying amount”, is irrelevant. By the same token, it
is incorrect to argue that the loan may have been devalued or is required
subsequently to be revalued; the notion of “revaluation” is likewise
irrelevant. There is a clear distinction between a loan that may (in part or in
full) not be recovered, and one of which part has been disposed of; the
appropriate accounting treatment of each is different.
68.
The loan receivable comprised rights to two separate benefit streams: the
right to repayment of the principal (£300m); and the right to interest as it became
payable, worth about £21m. The aggregate rights, to receive £321m, were stated
at their historic cost of £300m (coincidentally roughly equal to their net
present value, or NPV), as a loan receivable in PLC’s balance sheet. However,
this loan, like any other interest-bearing loan, comprised those two distinct
elements. Both experts agreed that this was correct in principle.
69.
Immediately prior to the assignment of the interest, the cost of the
loan related to those two parts, one representing the principal element and the
other the interest element. The most straightforward way to allocate the cost
between the two parts is to look at the relative values of the components: approximately
£280m and £20m, while bearing in mind that this approach constitutes an
allocation of cost and does not amount to a valuation of the two parts.
Immediately after the interest strip, therefore, the loan receivable should
have been carried at that discounted amount, £280m, being the cost, or carrying
value, of the part retained.
70.
The process of subsequent interest accretion accrues the £20m difference
between the cost of the part retained and the cash receivable on repayment over
the remaining term of the loan. While that value is the same as the NPV of the
interest strip, it is nonetheless a different thing. The £20m recognised over
the remainder of the loan is the difference between the cost of the part
retained and the amount ultimately received on repayment. Over the period
between assignment of the right to interest and redemption of the principal (at
£300m), the accretion from £280m to £300m should be recognised in the accounts
of PLC, which on the actual facts of the case gives rise to loan relationship
credits of £20,453,476. Mr Milne added that if no assignment had taken place,
PLC would have received a total of £321m, consisting of £300m principal and
£21m interest. That interest would necessarily have been brought into account in
accordance with s 84(1)(b).
Discussion
71.
It seems to us that the flaw in Mr Clifford’s reasoning, as it is set
out in the extract from his witness statement reproduced at para 28 above, and
as we have further described it in para 30, is that it fails to deal separately
with the capital value of the loan and the value of PLC’s investment in GKA,
but instead simply sets one off against the other in order to reach the
conclusion that no adjustment is required. It is perfectly true that, as Mr
Clifford put it, “there would be no overall change in the carrying value of PLC’s
assets”—plainly there would not, for the reasons he gave—but that truth does
not affect the value of the loan, considered as a single asset. It is in our
view axiomatic that a present right to receive a sum at a future date must have
a value less than the amount which is to be received, and that that value is to
be determined by conventional discounting principles. Indeed, Mr Clifford’s own
observation that “the value of the loan to GKBR would be reduced on ‘disposing’
of the interest rights” shows that he was of the same view himself. It is
nothing to the point that PLC had near certainty that the £300 million, in the
case of the first transaction, would be paid in full; had it been otherwise the
present value of the payment would be less still, but for the quite different
reason that payment was not certain.
72.
In short, both Mr Clifford and Mr Parish have, in our judgment, failed properly
to distinguish between impairment on grounds of doubtful recoverability and
discounting because of time lapse before payment, and they have failed to
recognise that, although PLC’s overall position is unchanged, the value of the
loan has been diminished in exchange for an augmentation elsewhere. The
passages we have set out from Ernst & Young’s presentation (see para 22
above), and in particular the second and third indents relating to PLC under “accounting”,
too, show a confusion between impairment and de-recognition.
73.
We are accordingly satisfied that full recognition of the loan does not
accurately reflect PLC’s own position, disregarding that of its subsidiaries.
One has only to ask whether PLC could hope, on the date of the assignment of
the interest strip, to secure an arm’s length sale of the benefit of the loan
remaining in its hands (that is, without interest over the remaining period
before redemption) for £300 million to see that the answer is obviously not. A
true and fair value of the asset on that date is therefore, as HMRC say, a
discounted value which accretes to the full £300 million as redemption
approaches.
74.
We agree too with Mr Chandler and Mr Milne that there is no ground on which
a departure from the terms of paras 23 and 71 of FRS 5 is warranted; on the
contrary, we consider they are directly in point. From the moment of the
assignment, PLC no longer had the right to receive the interest; it had instead
a more valuable subsidiary. It is irrelevant that this was not an arm’s length
transaction or that PLC could have undone the assignment at any time; accounts
must reflect the position as it is, and not as it might be. For these reasons
we perceive no need, as the appellants contend, to reflect the fact that PLC’s
overall position is unchanged by declining to de-recognise part of the loan.
The reality of the transaction is properly reflected by partial de-recognition
of the loan, and an addition to the value of PLC’s investment in its
subsidiaries. That being so, a departure from FRS 5 is not justified, and it
follows that the accounting treatment of the transactions adopted by PLC is not
GAAP-compliant. Thus HMRC are right to argue that partial de-recognition was
required by UK GAAP, that PLC was obliged to bring the accretion from the NPV
of the capital sum on the date of the assignment of the interest strip until
redemption into taxable profit, and that issue 2 must accordingly be determined
in HMRC’s favour.
Issue 3
75.
It became apparent to us as the hearing progressed that there is no need
to answer issue 3 as it is put, and for its own sake. The real question is a
little more complicated, and is whether the interest received by GKA following
the strip arises from a loan relationship of GKA. We do, however, need to
address the nature of a loan relationship in order to provide an answer. It is
convenient to deal with HMRC’s submissions in relation to this point first.
HMRC’s submissions
76.
HMRC’s central point is that the loan relationship in respect of the
£300 million loan stock issued by GKBR to PLC remained between GKBR and PLC at
all relevant times, and it remained PLC’s creditor relationship despite the
assignment from PLC to GKA of the right to receive interest on that loan.
Consequently, the “interest” which, as a result of that assignment, was paid by
GKBR to GKA is not within s 84(l)(b): it is not interest under a loan
relationship of GKA, but interest under a loan relationship between GKBR (as debtor)
and PLC (as creditor). Mr Milne relied on the observation of Lawrence Collins
LJ in Revenue and Customs Commissioners v Bank of Ireland Britain Holdings
Ltd [2008] STC 398 at [47] that
“Receipt, of itself, is not a determinant of any possible
tax liability. An assignee of the right to receive interest (without assignment
of the loan relationship) would not be taxable on the amount of that interest
under the loan relationship provisions because he has no relevant loan
relationship.”
77.
Thus the interest is not a profit or gain arising to GKA from its loan
relationship and is not “interest under the company’s loan relationships”
within the meaning of s 84(1)(b). It follows that Chapter 13 of Part IV has no
application to it, and that it is taxable in the hands of GKA as income under
general principles. The result is the same whether or not it is correct that,
once interest was accruing under the loan stock but was not yet payable, that
accrued interest represented a new “debt” owing from GKBR to GKA, and thus
created a new loan relationship between GKBR and GKA. Any credit of that
interest in GKA’s accounts did not represent a profit arising to GKA from its
loan relationships—it is the principal of the loan relationship itself or, as
Ernst & Young themselves said in material produced in connection with the
promotion of the scheme, “the rights of the interest form the corpus of [GKA’s]
loan relationship and do not arise under its loan relationship”. The
respondents say that, equally, the interest is not a profit arising from GKA’s
loan relationship, and so does not fall within section 84. But for the
assignment, the interest would obviously have been a profit arising to PLC from
the loan stock; it still arises from the loan stock (which remains an element
of PLC’s loan relationship with GKBR) even after the assignment, but now comes
into profit in GKA’s hands.
The appellants’ submissions
78.
Mr Peacock’s essential argument was that the answer is obvious: all the
requirements of s 81(1) of the 1996 Act are met and there is consequently no
room for doubt that GKA had a loan relationship with GKBR as a result of the
transactions. GKA stood as creditor in respect of a money debt, that is the
obligation imposed on GKBR to pay the interest as it fell due to GKA; and that obligation
arose from a transaction for the lending of money. Nothing more was required.
In particular, there is no requirement that the creditor should be the original
lender, or the debtor the original borrower.
79.
HMRC’s contrary case, based on the argument that GKA had not purchased debt, but rights to a future interest stream, and that GKA
did not become a creditor, or GKBR a debtor, in respect of any interest until
the interest payment date is, he said, misconceived. It disregards the
fact that under the loan relationship between GKBR and PLC there were a number
of anticipated payments: six-monthly interest payments and repayment of the
principal. From the creditor’s perspective a debt is essentially the right to
receive payment at a future date, and GKA reflected that right in its balance
sheet. The interest payments (which in the hands of GKA represented the
consideration for the share issue) in themselves represented a part of the
original debt between GKBR and PLC. GKA was a creditor of GKBR in respect of
amounts outstanding before their respective payment dates, and those amounts
were reflected as assets in its balance sheet.
80.
HMRC’s argument, Mr Peacock added, appears to confuse two concepts: the
existence of an outstanding debt, and the debt falling due. For example, the
lending of money gives rise to a creditor-debtor relationship, irrespective of
when the debt is due. Taxing the receipt of an interest strip within the
provisions for loan relationships accords with the purpose of the legislation,
that is to provide a single code for corporate debt, replacing the variety of
other rules and ensuring that all amounts previously taxed as interest fall
within this code. The respondents’ approach was not merely wrong but
unprincipled since, if it was right, it would expose PLC to tax on the
accretion to the de-recognised principal and at the same time expose GKA to tax
on the interest, essentially the same sum.
81.
The Bank of Ireland judgment was not in point, since it was given
in the context of a case concerning the treatment of deemed interest on a
deemed loan under the repo legislation, which differed from that in issue here,
and was not directed to the present situation. The observation had no wider
significance and could not be applied by analogy to this case.
Discussion
82.
We agree with Mr Peacock that the observation of Lawrence Collins LJ in
the Bank of Ireland case is not directly relevant. Perusal of the
judgment shows that the legislative provisions in issue, though related in
their purpose to those we must consider, differ in material respects. We do
not, therefore, consider that an observation (as it was) about the
interpretation of s 730A(6) of the Income and Corporation Taxes Act 1988 binds
us in the construction of s 81, which was not mentioned at all in the judgment.
It does not, however, follow that HMRC are wrong; and in our view the remainder
of Mr Milne’s argument is sound.
83.
There are two elements identified in paras (a) and (b) of s 81(1): there
must be a relationship of creditor and debtor, and the debt must arise from a
transaction for the lending of money. In the ordinary case, where the creditor
was the lender and the debtor was the borrower, those requirements pose no
difficulty of interpretation. It seems to us, too, that there is no great
difficulty when the entire benefit, or burden, of the relationship is assigned:
the assignee stands within the shoes of the assignor. Here, however, GKA did
not stand in PLC’s shoes. It had not lent money, and it had no right to the
payment of the capital sum. The creditor remained PLC, which chose to require
GKBR to pay the interest due to it, instead, to GKA. Plainly the loan
relationship between PLC and GKBR subsisted, and we agree with Mr Milne that the
interest arose from that loan relationship. Thus even if there was a
loan relationship between GKA and GKBR (and it is unnecessary for us to decide
the point), the interest did not arise under it. Mr Milne is consequently right
to argue that the sums received by GKA did not fall within s 84(1)(b); the requirement
that the interest should arise under GKA’s loan relationships is not
met.
84.
We are unimpressed with Mr Peacock’s argument that our conclusions on
issues 2 and 3 might lead to double taxation. As we have said, the transactions
were a device for ensuring that relief for payment was not matched by taxation
of the receipt; and the appellants have no evident difficulty with that
outcome. It does not seem to us that they can legitimately complain if the
scheme fails in its purpose and instead results in their paying tax twice.
Issue 4
85.
It follows from our conclusion in respect of issue 3 that issue 4 is, as HMRC contend, irrelevant. Nevertheless, in case we
should be found elsewhere to be wrong, it is appropriate to offer an answer.
The appellants’ submissions
86.
As we indicated above (see para 40), the appellant’s case is that s
84(2)(a) of the 1996 Act is engaged. Mr Peacock’s argument is that the
requirement imposed by s 130 of the 1985 Act of the transfer to share premium
account of the minimum premium value is crucial to the company law concept of
capital maintenance for the benefit of creditors. Although a company such as
GKA may enjoy the advantage of the relief provided by s 84(2)(a), a key
consequence of exchanging rights under a loan relationship for preference
shares, he says, is that any premium arising must be credited to a
non-distributable reserve. Mr Milne’s argument (that GKA was not required to
transfer any amounts to the share premium account by virtue of the relieving
provisions in s 132) is wrong, he says, because s 132 is not in point in a case
such as this.
87.
First, the title of that section, “Relief in respect of group
reconstructions”, is to be regarded as an aid to construction: see DPP v
Schildkamp [1971] AC 1. It is plain from its title that the section was not
intended to apply to transactions which are not undertaken in the course of a
reconstruction. It is plain that the draftsman never intended that company
reconstruction relief would apply to transactions such as those in issue here,
which did not involve any sort of reconstruction. Second, it is apparent from
the use within the section of “assets” in the plural that it applies only to
those reconstructions which entail the transfer of a number of assets within a
group, and not the assignment of a single asset, as here. Moreover, there are
considerable obstacles in the way of applying the statutory calculation of the
minimum premium value in such situations. In particular, whereas the appellants
contend that the “cost” of such an asset can be readily identified in the
present case, in other cases, an undertaking to pay cash (whether in the form
of interest from a third party or otherwise) may not have an identifiable cost
other than cash from the transferor company in consideration for the share
issue. Section 738(2) of the Companies Act 1985 makes it perfectly clear that
shares are deemed to be paid up or allotted for cash where the consideration is
an undertaking to pay cash at a future date. This is precisely the
consideration received by GKA.
HMRC’s submissions
88.
Mr Milne’s argument was that s 130 was designed to apply to swaps of
debt for equity, in which a company which is struggling to pay its debts enters
into an arrangement with its creditors by which, to settle its liabilities
(that is, escape from its loan relationships), it issues shares which are worth
less than the amount owed. It thus makes a nominal “profit” which, absent
legislative provision to the contrary, falls within section 84(1)(a). But, by
virtue of s 130, that “profit” is required to be transferred to the company’s
share premium account: the company has issued its shares at a premium equal to
the difference between the amount of the debt and the nominal value of the
shares. The purpose of section 84(2)(a) is to take that “profit” out of the charge
to tax. Mr Peacock, we should add, agreed with that description.
89.
GKA, however, did not have an existing loan relationship: it issued
preference shares in order to acquire the right to receive future payments,
rather than to settle a liability. The “profit” did not arise from the disposal
of a loan relationship as it would in the paradigm case within s 130. The
profit arose because GKA acquired an asset (the right to the interest stream)
that was worth more than the shares given in exchange. The Commissioners nevertheless
accept that it follows that the shares were issued at a premium, and that,
leaving s 132 to one side, s 130 required GKA to transfer a sum equal to the
amount of that premium to its share premium account.
90.
What is in issue here, however, is not the treatment of the credit
arising on the issue of the preference shares, but the treatment of the subsequent
receipt of the payments made by GKBR. There is nothing in s 130 (or elsewhere),
Mr Milne said, which requires that interest to be transferred, on receipt, to
GKA’s share premium account; and that is an unsurprising result, since it is
not the purpose of s 84(2)(a) to relieve such receipts. Moreover, GKA did not
transfer the receipts to its share premium account; instead it created an asset
account, consisting of the value of the future interest receipts, and as they
were received it set them against the asset account. That treatment, said Mr
Milne, was consistent with the Commissioners’ case that s 132 (despite Mr
Peacock’s observations about its purpose) was relevant: shares were allotted to
the issuer’s 100% parent company in consideration for the transfer to the
issuer of assets other than cash, in this case the right to future payments. Thus
if s 130 applied at all, the effect of s 132 was that only the minimum premium
value had to be transferred.
91.
We should add, for completeness, that Mr Milne also argued that the
application of subsections of s 132 we have not set out above dealing with the
determination of the minimum premium value to the facts of this case lead to
the conclusion that, even if he was wrong on his other points, the amount which
GKA was required to transfer to its share premium account was nil. Mr Peacock
did not agree, but as this is essentially an arithmetical argument we do not
think it necessary to deal with the point in the light of our remaining
conclusions.
Discussion
92.
In our judgment Mr Milne’s first argument is correct and for the reasons
he advanced: s 130 can have no application to the receipts from GKBR. But even
if that is wrong, we also agree with him that s 132 limits the obligation to
effect a transfer to GKA’s share premium account.
93.
We can see the force of Mr Peacock’s point that s 132 was designed to
deal with reconstructions, and that these transactions did not amount to
reconstructions in the ordinary sense of that word, but if its provisions
nevertheless clearly cover such arrangements, we see no basis on which we can
disregard them. Despite the title of the section, it seems to us that it does cover
the present arrangements exactly. We do not accept Mr Peacock’s argument that
we should treat the use of the word “assets” as an indication that only
multiple assets were in contemplation. That might well be the usual position;
but ordinary canons of statutory construction require the plural to be treated
as including the singular, and we see no warrant for excluding those rules
here. Our conclusion on this issue, therefore, is that s 84(2)(a) does not apply
to the receipts either in full or, if we are wrong in our first conclusion on
this issue, applies only to an amount equal to the minimum premium value.
Conclusions
94.
We determine the issues identified at para 17 above, in respect of the
first transaction, as follows:
Issue 1: PLC
should not account for the value of the preference shares received as
consideration for the interest strip as taxable profit in the year ending 4 May
2003 (this was the parties’ agreed position).
Issue 2: PLC
was required by UK GAAP to de-recognise the loan principal, to the extent necessary
to reflect its current value at the date of the assignment, and to bring a sum
equivalent to the difference between the amount so determined and its face
value into profit over the remaining period before redemption. We do not
determine whether the amount by which the principal should have been
de-recognised and the NPV of the interest strip at the date of the assignment
are identical, but leave the parties to agree on that point, or to return for
further argument should that be necessary.
Issue 3: We
do not determine this issue in quite the manner in which it is set out above.
Whether or not GKA had a loan relationship with GKBR, which we do not need to decide,
the payments received by GKA did not arise from that relationship and did not
fall within s 84(1)(b).
Issue 4: Section
130 of the Companies Act 1985 did not require GKA to transfer the premium
received on the issue of the preference shares to its share premium account. Moreover,
s 84(2)(a) does not apply to the payments received by GKA. Alternatively, it
applies only an amount equivalent to the minimum premium value.
95.
The appeal is accordingly dismissed.
96.
This document contains full reasons for the decision. Any party
dissatisfied with this decision has a right to apply for permission to appeal
against it pursuant to Rule 39 of the Tribunal Procedure (First-tier 45
Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal
not later than 56 days after this decision is sent to that party. The parties
are referred to “Guidance to accompany a Decision from the First-tier Tribunal
(Tax Chamber)” which accompanies and forms part of this decision notice.
Colin Bishopp
Tribunal Judge
Alison McKenna
Tribunal Judge
Release Date: 14 June 2012
