DECISION
Introduction – the Paragraph 19A Issue and the
Paragraph 13 Issue
1. The
Appellant, Fidex Limited (“Fidex”) appeals against an amendment to its
corporation tax return for the year ended 31 December 2005 (“the 2005 Year”).
That amendment was made by the Respondents (“HMRC”) by a closure notice dated 2
August 2010.
2. The
amendment was to disallow a loan relationship debit of €83,849,399 claimed by
Fidex.
3. The
background to the dispute can be explained in general terms as follows, taking
facts from a Statement of Agreed Facts supplied by the parties.
4. Fidex
prepared its accounts for the year ended 31 December 2004 (“the 2004 Year”)
applying UK GAAP (UK Generally Accepted Accounting Practice). In those
accounts Fidex showed, within shareholders’ funds on its balance sheet, certain
redeemable preference shares (“the Preference Shares”) issued on 22 December
2004 to Swiss Re Financial Products Corporation (“Swiss Re”) at a value
corresponding to the net proceeds
of their issue. The Preference Shares were divided into four classes (A to D)
and each class was referenced to a particular bond owned by Fidex
(collectively, “the Relevant Assets”). The Relevant Assets were loan
relationships and were recognised at their full value as assets in Fidex’s
balance sheet as at 31 December 2004.
5. At a
meeting of the board of Fidex on 22 December 2004, the board resolved to adopt
the use of International Financial Reporting Standards (“IFRS”) in place of UK
GAAP with effect from 1 January 2005.
6. Following
the adoption of IFRS as from 1 January 2005, the Preference Shares were
classified as liabilities of Fidex and derecognised. The Relevant Assets were,
as to 95% of their value, also derecognised in Fidex’s balance sheet (5% of
their value continued to be recognised as the value to Fidex of the Relevant
Assets adopting IFRS). These derecognitions reflected differences between the
closing balances on the balance sheet as at 31 December 2004 and the opening
balances as at 1 January 2005.
7. Fidex
claims that in these circumstances the effect of paragraph 19A of Schedule 9 to
the Finance Act 1996 (hereinafter “Paragraph 19A”) is to allow a debit in the
2005 Year to reflect the difference between the carrying value of the Relevant
Assets in the balance sheet as at 31 December 2004 (the end of the 2004 Year)
and the carrying value of the Relevant Assets recognised as at 1 January 2005.
8. Paragraph
19A relevantly provides as follows:
‘(1)
This paragraph applies where –
(a)
There is a change of accounting
policy in drawing up a company’s accounts from one period of account (“the
earlier period”) to the next (“the later period”), and
(b)
The approach in each of those
periods accorded with the law and practice applicable in relation to the
period.
(2) This paragraph applies, in particular, where –
(a)
The company prepares accounts for
the earlier period in accordance with UK generally accepted accounting practice
and the for the later period in accordance with international accounting
standards ...
(3)
If there is a difference between –
(a)
the accounting value of an asset or liability representing a loan relationship
of the company at the end of the earlier period, and
(b)
the accounting value of that asset or liability at the beginning of the later
period,
a
corresponding debit or credit (as the case may be) shall be brought into
account for the purposes of this Chapter [viz: Chapter 2, Finance Act
1996] in the later period.
(4)
In sub-paragraph (3) “accounting value” means ... the carrying value of the
asset or liability recognised for accounting purposes.’
9. Fidex
claims to bring into account in the 2005 Year a debit of €83,849,399 pursuant
to sub-paragraph (3) of Paragraph 19A.
10. HMRC resist the claim on two
grounds. First, they submit that UK GAAP did not allow for the Preference
Shares and the Relevant Assets (except as to 5% of their value) to be
recognised in the accounts for the 2004 Year and that Fidex’s accounts for that
year did not give a true and fair view of its position or accord with the
requirements of sub-paragraph (1)(b) of Paragraph 19A. We refer to this issue
for the Tribunal’s determination as “the Paragraph 19A Issue”.
11. Secondly, HMRC submit that,
even if we decide the Paragraph 19A Issue in favour of Fidex, the debit of
€83,849,399 must not be brought into account for the purposes of Chapter 2,
Finance Act 1996, that is, for corporation tax purposes, because the debit is
in respect of loan relationships (the Relevant Assets) which are ‘attributable
to [an] unallowable purpose’ within paragraph 13, Schedule 9, Finance Act 1996
(hereinafter “Paragraph 13”). We refer to this issue for the Tribunal’s
determination as “the Paragraph 13 Issue”.
12. Paragraph 13 provides relevantly
as follows:
‘13
(1) Where in any accounting period a loan relationship of a company has an
unallowable purpose –
(a)
the debits, and
(b) the credits in respect of exchange gains,
which,
for that period fall, in the case of that company, to be brought into account
for the purposes of this Chapter shall not include so much of the debits or
credits (as the case may be) as respects that relationship as, on a just and
reasonable apportionment, is attributable to the unallowable purpose.
...
(2) For the purposes of this paragraph a loan relationship
of a company shall be taken to have an unallowable purpose in an accounting
period where the purposes for which, at times during that period, the company –
(a) is a party to the relationship, or
(b) enters into transactions which are related
transactions by reference to that relationship,
include
a purpose (“the unallowable purpose”) which is not amongst the business or
other commercial purposes of the company.
(3) For the purposes of this paragraph the business and
other commercial purposes of a company do not include the purposes of any part
of its activities in respect of which it is not within the charge to
corporation tax.
(4) For the purposes of this paragraph, where one of the
purposes for which a company –
(a) is a party to as loan relationship at any time, or
(b) enters into a transaction which is a related
transaction by reference to any loan relationship of the company,
is
a tax avoidance purpose, that purpose shall be taken to be a business or other
commercial purpose of the company only where it is not the main purpose, or one
of the main purposes, for which the company is a party to the relationship at
that time or, as the case may be, for which the company enters into that
transaction.
(5) The reference in sub-paragraph (4) above to a tax
avoidance purpose is a reference to any purpose that consists in securing a tax
advantage (whether for the company or any other person).
(6) In this paragraph –
“tax
advantage” has the same meaning as in Chapter 1 of Part XVII of the Taxes Act
1988 (tax avoidance).’
13. The term “related
transaction” used in sub-paragraphs (2) and (4) of Paragraph 13 is defined in
section 84(5) of the Finance Act 1996 as follows:
‘In
this Chapter “related transaction”, in relation to a loan relationship, means
any disposal or acquisition (in whole or in part) of rights or liabilities
under that relationship.’
14. The relevant definition of
“tax advantage” was, at the relevant time, in section 709(1) Income and
Corporation Taxes Act 1988 (“ICTA”) – referred to in sub-paragraph (6) of
Paragraph 13 as “the Taxes Act”. It provided as follows:
‘...
“tax advantage” means a relief or increased relief from, or repayment or
increased repayment of, tax, or the avoidance or reduction of a charge to tax
or an assessment to tax or the avoidance of a possible assessment thereto,
whether the avoidance or reduction is effected by receipts accruing in such a
way that the recipient does not pay or bear tax on them, or by a deduction in
computing profits or gains.’
The
Facts
15. We received a witness
statement from Colin Gardner (proffered by HMRC). He was a director of Fidex
from 17 December 2004 to 15 April 2005 and, as his main role, Treasury Manager
of BNP Paribas SA (“BNPP”) London Branch. He was not called to give oral
evidence or be cross-examined by Fidex. We also received witness statements
from the following expert witnesses: Anthony Clifford MA FCA, a partner in
Ernst & Young LLP, Chartered Accountants, since 1991 and currently partner
in charge of the Financial Reporting Group of Ernst & Young in the UK and a
member of the firm’s global IFRS policy committee and co-chair of its global
network of IFRS financial instruments accounting experts; Colin Martin, B Eng
(Hons), Chartered Accountant, a partner and the head of Financial Services Assurance
Services, KPMG LLP, Chartered Accountants; David Chopping, a senior partner in
Moore Stephens LLP, Chartered Accountants, and responsible for his firm’s
Technical Services Department; and Richard Simon Lawrence, FCA, Advisory
Accountant in the Strategic Risk Unit of the LBS Directorate of HMRC and
formerly an audit director at Ernst & Young. Each of these witnesses
provided both an expert report and a supplemental report and each of them gave
oral evidence and was cross-examined. Mr Clifford and Mr Martin were
instructed by Fidex. Mr Chopping and Mr Lawrence were instructed by HMRC.
16. We also had before us two
bundles of documents and two bundles of accounting standards and related
materials. Besides this, as indicated above, the parties had prepared a
Statement of Agreed Facts.
17. From that Statement and the
evidence we find the following facts.
18. The Fidex group of companies
(composed of Fidex and its holding company Fidex Holdings Limited (“FHL”)) was
established in or about 1998 as an off-balance sheet group sponsored by BNPP
with the aim of Fidex issuing commercial paper into the debt capital markets,
collateralised by a diversified portfolio of highly rated bonds.
19. Following changes to BNPP’s
accounting policy in 2001, the portfolio of bonds held by Fidex was required to
be consolidated in BNPP’s 2001 Financial Statements and consequently Fidex’s
commercial paper issuance programme was terminated in 2002. Immediately prior
to the Acquisition and Refinancing (a series of transactions which took place
in December 2004 and to which we make further reference below), Fidex continued
to hold 22 bonds (the “Bond Portfolio”). These bonds had various maturities to
2012 and Fidex was entirely debt financed by BNPP. The Bond Portfolio had been
acquired in the period from 1999 to 2000. By the Acquisition and Refinancing,
the Fidex group of companies was brought into the BNPP group structure.
20. Before the Acquisition and
Refinancing, FHL’s holding in Fidex had been 49,998 shares of £1 paid up as to
25p and one share of £1 fully paid up. SPV Management Limited (“SPVM”) also
held one share of £1 fully paid up in its capacity as trustee of the Fidex
Charitable Trust (“FCT”). Further, FHL’s issued share capital was held by
SPVM as trustee of the FCT.
21. The Acquisition and
Refinancing comprised the following transactions:
(a)
An Agreement made on 17 December 2004 between SPVM (in its capacity as
trustee of the FCT) and BNPP, whereby SPVM sold to BNPP its one share of £1
fully paid up in Fidex and the benefit of a loan of £12,500 made by it to FHL;
(b)
A Subscription Agreement made on 22 December 2004, whereby BNPP
subscribed for 300 million ordinary shares of €1 in FHL at €1.00 per share;
(c)
An Agreement made on 22 December 2004, whereby FHL subscribed for 3
million ordinary shares of €1 in Fidex at €1.00 per share;
(d)
An Agreement made on 22 December 2004 whereby BNPP in effect released
approximately US$24 million of the indebtedness owed by Fidex to BNPP.
22. The Preference Shares issue
by Fidex was implemented by the following steps:
(a)
On 20 December 2004, Fidex was re-registered from a public company to a
private company (in order to make a Court-approved capital reduction easier).
(b)
By a Preference Shares Subscription Agreement (“PSSA”) made on 22
December 2004, Swiss Re subscribed for the following redeemable Preference
Shares in Fidex of €0.01 each:
19,953,967
Class A,
24,855,483
Class B,
19,881,760
Class C, and
19,801,987
Class D,
the total
consideration being €84,493,197 in immediately available funds.
(c)
On 22 December 2004, Fidex adopted new Articles of Association.
(d)
By a Conditional Subscription Agreement made on 22 December 2004, FHL
agreed to subscribe up to a maximum consideration of €85 million for €1.00
redeemable ordinary shares in Fidex, if Fidex served notice on FHL whilst the
Preference Shares issued to Swiss Re under the PSSA were in issue, provided
that Fidex required the subscription for the purpose of financing a redemption
of such Preference Shares in accordance with company law requirements and the
Articles of Association.
(e)
By a further Conditional Subscription Agreement made on 22 December
2004, BNPP agreed to subscribe up to a maximum consideration of €85 million for
€1.00 redeemable ordinary shares in FHL, if FHL served notice on BNPP at a time
when FHL was under the obligation to subscribe for shares in Fidex, pursuant to
the Agreement referred to in (d) above.
(f)
BNPP undertook to Swiss Re, by an Agreement made on 22 December 2004,
that Fidex would comply with the terms of the PSSA.
(g)
BNPP agreed to pay to Swiss Re certain fees in certain circumstances
relating to accounting and tax matters. This agreement was contained in four
letters dated 22 December 2004 from BNPP to Swiss Re.
(h)
On 22 December 2004, as indicated at [5] above, the Board of Fidex
resolved to adopt the use of IFRS in place of UK GAAP for the period commencing
1 January 2005.
23. Classes A, B, C and D of
redeemable Preference Shares issued to Swiss Re by Fidex pursuant to the PSSA
were respectively referenced to four bonds, the Relevant Assets, owned by
Fidex. That is to say, the rights attaching to each Class of Preference Shares
were related to the corresponding receipts received by Fidex in relation to the
referenced bond. The rights of the holders of the respective Preference Shares
were restricted to 95% of the amounts received by Fidex from the respective
Relevant Assets.
24. The Relevant Assets were:
Class A Assets – a bond for €20 million issued by
Textron Inc., maturing on 14 March 2005;
Class B Assets – a bond for €25 million issued by
IBM Corporation, maturing on 31 March 2005;
Class C Assets – a bond for €20 million issued by
TCNZ Finance Limited, maturing on 19 April 2005; and
Class D Assets – a bond for €20 million issued by
Coca Cola Erfrischungsgetraenke AG, maturing on 4 July 2005
25. Fidex had acquired the Class
A Assets on 29 February and 24 March 2000, the Class B Assets on 29 March 2000,
the Class C Assets on 6 April 2000 and the Class D Assets on 4 July 2000.
26. Fidex had undertaken to
Swiss Re, under clause 4.1 of the PSSA that, whilst Swiss Re held the Preference
Shares, Fidex would not:
(a)
sell, pledge, transfer or otherwise dispose of or grant security over
any of the Relevant Assets;
(b)
take any action which might impair its rights to receive or recover
payments in relation to the Relevant Assets; or
(c)
save for the nominal “Preferred Sterling Ordinary Share Dividend” (as
defined in article 18 of Fidex’s Articles of Association), make any payment in
respect of its ordinary share capital.
27. Upon Fidex’s petition, the
High Court confirmed on 23 February 2005 the reduction of the amount standing
to the credit of Fidex’s share premium account by €85 million which had been
resolved on and effected by a Fidex’s resolution in writing passed on 1
February 2005.
28. All amounts due and payable
under the Class A Assets were received by Fidex on 14 March 2005 (the maturity
date). On that day Fidex paid a dividend on and redeemed the Class A
Preference Shares.
29. All amounts due and payable
under the Class B Assets were received by Fidex on 31 March 2005 (the maturity
date). On that day Fidex paid a dividend on and redeemed the Class B
Preference Shares.
30. All amounts due and payable
under the Class C Assets were received by Fidex on 19 April 2005 (the maturity
date). On that day Fidex paid a dividend on and redeemed the Class C Preference
Shares.
31. All amounts due and payable
under the Class D Assets were received by Fidex on 4 July 2005 (the maturity
date). On that day Fidex paid a dividend on and redeemed the Class D
Preference Shares.
32. As indicated above (at [4]),
Fidex prepared its accounts for the 2004 Year under UK GAAP and for the 2005
Year under IFRS.
33. Without prejudging the issue
of whether such treatment was a proper application of UK GAAP, we find that in
Fidex’s accounts for the 2004 Year, the Preference Shares issued by Fidex to
Swiss Re under the PSSA were shown, at the net proceeds of their issue, within
shareholders’ funds on Fidex’s Balance Sheet as at 31 December 2004. The
Relevant Assets were also recognised in full on that Balance Sheet.
34. Again, without prejudging the
issue of whether such treatment was a proper application of IFRS, as from 1
January 2005 the Preference Shares were classified as liabilities of Fidex and
derecognised, and the Relevant Assets were, as to 95%, derecognised in Fidex’s
Balance Sheet, between the closing balances at 31 December 2004 (stated under
UK GAAP) and the opening balances at 1 January 2005 (stated under IFRS).
Fidex’s accounts for the 2005 Year contained no prior period restatements.
35. Fidex’s accounts for the
2004 Year and the 2005 Year received unqualified reports from its then
auditors, PricewaterhouseCoopers (“PwC”).
36. Fidex’s accounts for the
year ended 31 December 2006 (stated under IFRS) received an unqualified report
from its auditors, Deloitte & Touche, who had replaced PwC as auditors in
accordance with the BNPP group’s auditor rotation policy. These accounts
disclosed comparative information for the prior year, the 2005 Year.
37. The 18 bonds which formed
part of the Bond Portfolio but were not Relevant Assets were disposed of or
matured as follows:
(a)
3 bonds were disposed of: one bond with a scheduled maturity date of
June 2006 was disposed of in 2005, one bond with a scheduled maturity date of
December 2007 was disposed of in 2006, and one bond with a scheduled maturity
date of September 2012 was disposed of (as to part) in 2005, and (as to the
remainder) in 2006.
(b)
15 bonds were held to maturity. These bonds matured in the period from
September 2005 to October 2010.
38. At all relevant times, Fidex
was a company resident in the UK for UK tax purposes.
The
evidence of the expert witnesses
39. The above facts, which are
taken from the Statement of Agreed Facts, were understood to be the facts of
the case by all the expert witnesses, Mr Clifford, Mr Martin, Mr Chopping and
Mr Lawrence.
40. It was explained to Mr
Clifford by Clifford Chance LLP (Fidex’s solicitors) in their instructions to
him that he was being asked to give expert evidence on the accounting aspects
of the implementation of ‘a preference share fund raising transaction known as
Project Zephyr that took place in December 2004 (the “Project Zephyr
Transaction”)’.
41. The Project Zephyr
Transaction was described in Mr Clifford’s instructions as involving the issue
by Fidex of preference shares to Swiss Re (a third party). He was told that
the return on each class of preference shares was linked to the return of a
specified bond held by Fidex, and that the aim was to transfer to Swiss Re the
risk of approximately 95% of the repayment of principal and final coupons on
the bonds.
42. Mr Clifford disclosed in his
report that his firm, Ernst & Young, had advised Swiss Re in relation to
the Project Zephyr Transaction, which had constituted ‘notifiable arrangements’
within the meaning of Part 7 of the Finance Act 2004, in respect of which Ernst
& Young were the ‘promoter’. Ernst & Young stood to earn a fee related
to the tax saving resulting from the implementation of the Project Zephyr
Transaction, should the ultimate result of this litigation be in favour of
Fidex. Mr Clifford accepted that this posed a conflict of interest for him,
but said under cross-examination that the views he had come to in giving his
expert evidence were exactly the same as the views he would have come to had he
not been aware of the conflict.
43. Mr Clifford’s instructions were
to give his opinion on whether the approach adopted by Fidex’s directors when
accounting for the Project Zephyr Transaction was in accordance with UK GAAP
for the 2004 Year, and generally accepted accounting practice under IFRSs as
adopted by the EU for the 2005 Year.
44. Mr Clifford was asked to
focus specifically
·
in relation to Fidex’s accounts for the 2004 Year on whether the
non-derecognition of the Relevant Assets and the recognition of the linked
Preference Shares which had been issued was in accordance with UK GAAP extant
at that time;
·
in relation to Fidex’s accounts for the 2005 Year on whether the
derecognition of the Relevant Assets and the non-recognition of the linked
Preference Shares was in accordance with IFRS as adopted by the EU extant that
that time; and
·
on the extent to which the Project Zephyr Transaction represented
a ‘GAAP difference’ between the 2004 UK GAAP and 2005 IFRS in so far as
accounting derecognition of assets is concerned.
45. On the first of these
issues, Mr Clifford’s evidence was that the accounting provisions of the
Companies Acts relevant to the accounts for the 2004 Year included Schedule 4,
Companies Act 1985. This Schedule set out formats for the presentation of the
balance sheet which included the requirement that all called up share capital
should be included in ‘capital and reserves’.
46. Further, he said that for
accounting periods beginning before 1 January 2005, FRS 4 (Capital Instruments)
was the relevant accounting standard for the treatment of capital instruments, i.e.
‘all instruments that are issued by reporting entities as a means of raising
finance, including shares …’ – see: the definition of ‘capital instruments’ in
FRS 4. Therefore FRS 4 was the relevant standard for the presentation of the
Preference Shares in the accounts of Fidex for the 2004 Year.
47. Mr Clifford stated that, in
Appendix III to FRS 4, the UK Accounting Standards Board (“ASB”) had explained
that, in developing FRS 4, it was unable to apply a single criterion for
classifying all capital instruments, since it was constrained by the UK
Companies Act 1985. As a result, FRS 4 was a mixed model: on the one hand, FRS
4 [24] set out a general principle that capital instruments should be
classified as liabilities by the issuer if they contained an obligation to
transfer economic benefits; on the other hand, the same paragraph (FRS 4 [24])
specifically excluded shares from this principle. Instead, FRS 4 [37] stated
simply that ‘[s]hares and warrants should be reported as part of shareholders’
funds’. He acknowledged that the application of FRS 4 to preference shares
generally would frequently not have reflected economic reality.
48. He said that FRS 4 [83]
explained that certain types of shares have features that make them
economically similar to debt but that ‘nonetheless, the requirement to classify
capital instruments as debt if they contain an obligation to transfer economic
benefits does not apply to shares’. This distinction was grounded on the legal
status of shares, the conditions which have to be satisfied if any payment is
made in respect of them, and the requirement in the balance sheet formats
prescribed by companies legislation to state called up share capital separately
from liabilities.
49. Mr Clifford explained that
the ASB had resolved this dilemma to the extent they could by distinguishing
what they termed ‘equity shares’ and ‘non-equity shares’ and that FRS 4 [40]
required that shareholders’ funds should be analysed between the amount
attributable to equity interests and the amount attributable to non-equity
interests, so as to demonstrate clearly the distinction between the two types
of shares.
50. Equity shares were defined
as any shares that were not non-equity shares, and non-equity shares were
defined as:
‘Shares
possessing any of the following characteristics:
(a)
any of the rights of the shares to
receive payments (whether in respect of dividends, in respect of redemption or
otherwise) are for a limited amount that is not calculated by reference to the
company’s assets or profits or the dividends on any class of share;
(b)
any of their rights to participate
in a surplus in a winding up are limited to a specific amount that is not
calculated by reference to the company’s assets or profits and such limitation
had a commercial effect in practice at the time the shares were issued, or if
later, at the time the limitation was introduced;
(c)
the shares are redeemable either
according to their terms, or because the holder, or any party other than the
issuer, can require their redemption.’
51. Mr Clifford’s conclusion
was that, as a consequence of the Companies Act 1985 and FRS 4, the directors
of Fidex were required to report the Preference Shares in the accounts for the
2004 Year in shareholders’ funds, analysed as attributable to non-equity
shares.
52. Turning to the treatment of
the Relevant Assets in the accounts for the 2004 Year under UK GAAP, Mr
Clifford’s evidence was that the relevant standard was FRS 5 (Reporting the
substance of transactions), which applied to all transactions unless
specifically dealt with by another standard. The principle of FRS 5 was that
an entity’s financial statements should reflect the substance of the
transactions into which it had entered (FRS 5 [14]).
53. He referred to FRS 5 [22],
which is in the following terms:
‘Where
a transaction involving a previously recognised asset transfers to others –
(a)
all significant rights or other
access to benefits relating to that asset, and
(b)
all significant exposure to risks
inherent in those benefits,
the
entire asset should cease to be recognised.’
54. Mr Clifford commented that
it was clear from the Statement of Agreed Facts that, as a result of the
Project Zephyr Transaction, all significant rights or other access to benefits
and significant exposures to risks relating to 95% of the Relevant Assets were transferred
by Fidex to Swiss Re. Therefore, application of FRS 5 alone should have led
the directors of Fidex to derecognise 95% of the Relevant Assets, i.e. to
remove 95% of the Relevant Assets from the balance sheet and show no liability
in respect of the amounts received for the transfer from the transferee.
55. He made the point that FRS
5 – see ibid [11] – does not apply to individual assets or liabilities,
but to ‘transactions’, and thus would dictate the accounting treatment of both
the Relevant Assets and the issue of the Preference Shares, by which the risks
and rewards of ownership of the Relevant Assets were transferred by Fidex to
Swiss Re.
56. Therefore, Mr Clifford said,
the requirements of FRS 4 and the Companies Act (on the one hand) and FRS 5 (on
the other hand) were in conflict. If the directors of Fidex had derecognised
95% of the Relevant Assets in the balance sheet for the 2004 Year, in order for
that balance sheet to balance either the Preference Shares would have had to be
derecognised also, or an offsetting entry of an equivalent amount would have
had to be inserted, either to create a new asset or to reduce shareholders’
funds. This would not have been possible. A new asset would not have met the
definition in FRS 5 of ‘assets’ (‘Rights or other access to future economic
benefits controlled by an entity as a result of past transactions or events’).
The alternative of not recognising the Preference Shares or reducing
shareholders’ funds in any other way would have meant that shareholders’ funds
as stated in the balance sheet would not have represented the amounts
attributable to equity and non-equity interests as required by FRS 4.
57. He noted that the ASB had
recognised the potential for conflict and had provided in FRS 5 [13]:
‘Where
the substance of a transaction or the treatment of any resulting asset or
liability falls not only within the scope of this FRS but also directly within
the scope of another FRS, a [SSAP], or a specific statutory requirement
governing the recognition of assets or liabilities, the standard or statute
that contains the more specific provision(s) should be applied.’
58. Mr Clifford concluded on
the first issue that since the Companies Act 1985 and FRS 4 had established
specific requirements for accounting for preference shares, it was clear that
the treatment required by FRS 4 should prevail over that suggested by FRS 5
alone. Therefore, he said, the directors of Fidex would have had no choice but
to record the Preference Shares and to continue to recognise the 95% of the
Relevant Assets in the accounts for the 2004 Year, representing the Preference
Shares as shareholders’ funds attributable to non-equity interests in order to
account consistently and properly for the Project Zephyr Transaction. Mr
Clifford stated (having considered the reports of Mr Chopping and Mr Lawrence)
that he would not expect a reasonable accountant to arrive at any other
conclusion.
59. Under cross-examination, Mr
Clifford was invited to consider a number of extreme hypothetical situations,
such as the insolvency of an issuer of one of the Relevant Assets days before
31 December 2004. He accepted that in such a situation the Relevant Assets and
the Preference Shares would have been written down and the write-down of the
Relevant Assets would have been taken to profit and loss account which would
(without having regard to any explanatory note) have accounted for a loss
accruing in reality to Swiss Re as if it had been a loss accruing to Fidex.
The write-back of the reduced obligation inherent in the Preference Shares
would be credited either to distributable reserves (equity shareholders’ funds)
or to profit and loss account and thence to equity shareholders’ funds. (Mr
Martin’s opinion was that the necessary adjustment in this hypothetical scenario
would be through reserves.) It was put to Mr Clifford that such accounting
treatment could not have been included in accounts that showed a true and fair
view, but Mr Clifford responded that redeemable preference shares were not
accounted for under FRS 4 according to their substance and asked rhetorically:
how may extra features do you add before you decide that somehow this is no
longer tenable and you have to override FRS 4? He answered his own question by
saying he would not know where to draw the line and that he did not think
anybody in practice would have drawn that line. This was also the substance of
his answer when it was put to him by Mr Tallon QC, with reference to a 2008
Opinion of Martin Moore QC instructed by the Financial Reporting Council, that
the ‘true and fair view or fair presentation concept’ is of an overarching
nature and could justify departure from accounting standards in exceptional or
extremely rare cases in which such departure is permitted.
60. Turning to the second issue
on which he had been asked to focus (see: paragraph 44 above – the presentation
in Fidex’s accounts for the 2005 Year), Mr Clifford noted changes to the
Companies Act to allow private companies incorporated in England and Wales to
use IFRS for accounting periods beginning on or after 1 January 2005 (for
details of which, see [139] below). He said that a consequence of a private
company choosing to report in accordance with IFRS was that it was no longer
required to report in accordance with the Companies Act formats. He noted that
the directors of Fidex had made this election for the accounts for the 2005
Year.
61. He commented that, in
implementing IFRS, the directors of Fidex would have had to determine the
accounting treatment for the Project Zephyr Transaction and, in particular, the
accounting treatment of the Preference Shares and of the Relevant Assets, on
transition to IFRS. The relevant IFRS standards were: IFRS 1 (First-time
adoption of IFRS); IAS 32 (Financial Instruments: Disclosure and Presentation);
and IAS 39 (Financial Instruments: Recognition and Measurement). He said that
the accounting treatment would be based on the circumstances at year end (by
which he meant the end of the 2004 Year and the beginning of the 2005 Year) and
that this would not have been affected if, for example, there had been an
unexpected sale of the Relevant Assets in January or February 2005.
62. IFRS 1 [36A] allowed
entities not to restate their comparative balance sheet or income statement to
comply with IAS 32 and IAS 39 but instead, Mr Clifford said, they were required
to provide disclosures in the notes to the accounts showing the necessary
adjustments between the balance sheet at the comparative date as previously
reported under the previous GAAP and a balance sheet as at the start of the
first IFRS reporting period prepared under IFRS. For Fidex, he commented, this
note would have had to show the adjustments between the UK GAAP balance sheet
as at 31 December 2004 and a balance sheet prepared under IFRS as at the same
date.
63. Mr Clifford said that one of
the major differences between UK GAAP in 2004 (as set out in FRS 4) and IFRS
(as set out in IAS 32) was that, under IAS 32, the assessment of whether a
financial instrument should be treated as debt or equity by its issuer is intended
to reflect the substance of the contractual arrangement, rather than its legal
form. The overarching requirement is set out in IAS 32 at [15]:
“The
issuer of a financial instrument shall classify the instrument, or its
component parts, on initial recognition as a financial liability, a financial
asset or an equity instrument, in accordance with the substance of the
contractual arrangement and the definitions of a financial liability, a
financial asset and an equity instrument.’
64. He said that a financial
liability was defined to include any ‘contractual obligation to deliver cash or
another financial asset to another entity’, whereas an equity instrument was
any ‘contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities’. Hence, Mr Clifford observed, a
preference share that requires payments to be made to the holder is treated as
a liability. If a preference share was to be classified as equity, the issuing
entity would have to retain discretion over whether to redeem it or pay
dividends. As a consequence, he noted, under IFRS there is no such category as
‘non-equity shares’.
65. Mr Clifford commented that
classification of a preference share as a liability under IFRS is not affected
by whether the payments on the preference share are conditional on the receipt
of payments on an asset, or whether there must be available distributable
profits in order for it to be redeemed. He cited IAS 32 [25] which requires a
financial instrument to be treated as a liability if it:
‘may
require the [issuing] entity to deliver cash … in the event of the occurrence
or non-occurrence of uncertain future events [such as the issuer’s future
revenues or net income] … that are beyond the control of both the issuer and
the holder of the instrument …’
66. He said that this was
illustrated by paragraph [AG25] of the Application Guidance (“AG”) to IAS 32,
which addresses the application of IAS 32 to preference shares. Paragraph
[AG25] states:
‘Preference
shares may be issued with various rights. In determining whether a preference
share is a financial liability or an equity instrument, an issuer assesses the
particular rights attaching to the share to determine whether it exhibits the
fundamental characteristics of a financial liability. For example, a
preference share that provides for redemption on a specific date or at the
option of the holder contains a financial liability because the issuer has an
obligation to transfer financial assets to the holder of the share. The
potential inability of an issuer to satisfy an obligation to redeem a
preference share when contractually required to do so, whether because of a
lack of funds, a statutory restriction or insufficient profits or reserves,
does not negate the obligation.’
67. Turning to IAS 39 (Financial
Instruments: Recognition and Measurement), Mr Clifford observed that the
derecognition rules contained in IAS 39 are much more detailed than those in
FRS 5. Three steps are required to determine if a financial asset should be
derecognised. They are:
(a)
whether to apply the derecognition rules to an entire asset or part of
the asset;
(b)
whether the contractual rights to receive the cash flows of the
financial asset have been transferred; and
(c)
whether the transferor has transferred substantially all the risks and
rewards of ownership of the financial asset.
68. Dealing with the first step
(a), Mr Clifford said that as only 95% of the cash flows of each Bond comprised
in the Relevant Assets were to be paid to holders of the Preference Shares, it
was necessary to determine whether to apply the derecognition requirements to
95% of each Bond or to each Bond in its entirety. He observed that IAS 39
[16(a)] sets out three conditions, in order to apply the requirements to only
part of a financial asset. One of these conditions must be met by the part
being considered for derecognition. He pointed to the second of these
conditions (IAS 39 [16(a)(ii)]) which is that ‘the part comprises only a fully
proportionate (pro rata) share of the cash flows from a financial asset ..’ and
observed that, as the Articles of Association of Fidex require that 95% of the
cash flows on each Bond had to be paid to the holders of the Preference Shares,
this condition was met and the derecognition rules should have been applied to
95% of the cash flows on each Bond.
69. Dealing with the second step
(b), he pointed out that, as Fidex did not transfer the contractual rights to
receive the cash flows from the Bonds to Swiss Re, it was necessary to
determine whether, by issuing the Preference Shares, Fidex was deemed to have
transferred 95% of the cash flows on each Bond, applying what is known as the
“pass through test”. Fidex would be deemed to have done this if the Project
Zephyr Transaction satisfied the three conditions set out in IAS 39 [19], which
are:
(a) that the entity [Fidex]
has no obligation to pay amounts to the eventual recipients [Swiss Re] unless
it collects equivalent amounts from the original asset [a Bond comprised in the
Relevant Assets] …
(b) that the entity [Fidex]
is prohibited by the terms of the transfer contract from selling or pledging
the original asset …; [and]
(c) that the entity [Fidex]
has an obligation to remit any cash flows it collects on behalf of the eventual
recipients without material delay …
70. Mr Clifford said that in his
opinion the first of these conditions (a) was satisfied as articles 13 to 16 of
Fidex’s Articles of Association stated that the dividends and redemption
amounts on the Preference Shares were to be 95% of the interest and principal actually
received on the maturity of the respective Relevant Assets. The second
condition (b) was satisfied by Fidex’s undertakings to Swiss Re, set out in
paragraph 4 of the PSSA.
71. His evidence was, however,
that there were a number of difficulties with the third condition (c), mainly
concerning the meanings of the words ‘obligation’ and, more significantly,
‘without material delay’ in context, for neither of which a definition is
provided in IAS 39.
72. Mr Clifford commented that,
on the one hand, there is a requirement, set out in Fidex’s Articles of
Association, to pay dividends and redeem the Preference Shares within one
business day of receipt of interest and principal on the maturity of the
respective Relevant Assets. But, on the other hand, the main feature of the
Preference Shares which distinguished them from ordinary liabilities, is that
they could only be redeemed out of distributable reserves, or the proceeds of a
new issue of shares.
73. Taking account of this
feature of the Preference Shares, Mr Clifford observed that as at 31 December
2004 Fidex had only €16.1 million of distributable profits, which was not
enough to effect the redemption. Without further action, Fidex would not have
been in a position to redeem the Preference Shares without material delay and
Swiss Re would not have been entitled to take action against Fidex for a
failure to redeem. He added that IAS 39 [19(c)] requires that the entity has
an obligation to remit any cash flows it collects, without material delay,
which, in his view, implied that the assessment of whether the condition was
satisfied must be based as at the date of such assessment.
74. For this reason, Mr Clifford
said that he did not believe that it would have been wrong if Fidex’s directors
had concluded that, as at 31 December 2004, Fidex did not satisfy the third of
the ‘pass through’ conditions set out in IAS 39 [19(c)] in relation to the
Project Zephyr Transaction and, as a consequence, they had decided to continue
to recognise the Relevant Assets under IFRS.
75. But, as against that, he
pointed out that the term ‘obligation’ is used not only in IAS 39 as part of
the derecognition test, but also in IAS 32 for determining the classification
of preference shares. Based on the passage from paragraph [AG25] of the
Application Guidance (“AG”) to IAS 32 (cited above at paragraph [66]) he had
formed the view that the same interpretation of the word ‘obligation’ should be
used in applying both IAS 32 and IAS 39, which would mean that the directors of
Fidex were entitled to consider that Fidex did have a relevant obligation as at
31 December 2004. Mr Clifford’s reasoning was that he thought it inappropriate
to ascribe different meanings to the word ‘obligation’ when determining the
correct accounting treatment of a single transaction, especially having regard
to the fact that the two standards were revised together and were issued in
their revised form as a package.
76. He added, in support of this
conclusion, that the directors of Fidex would have been confident as at 31
December 2004 that, by the date of redemption of the Preference Shares, Fidex
would not only have an obligation to redeem them but also would be able to meet
that obligation without material delay. This was for two reasons: First, BNPP
had undertaken on 22 December 2004 to subscribe for new shares in FHL, which in
turn had agreed to subscribe for new shares in Fidex, if that was required in
order to enable the Preference Shares to be redeemed. Secondly, the directors
of Fidex would be able to apply to the Court to reduce the share premium
account in order to create sufficient distributable reserves to effect the
redemption. Such an application, while not quite a formality, in Mr Clifford’s
opinion, would – he had been advised by Fidex’s legal advisors – have been straightforward
and very likely to be successful, given that Fidex had few creditors.
77. Mr Clifford commented that
while it was possible that Fidex could have generated losses before the
redemption date(s) of the Preference Shares, it had sufficient in the share
premium account (a) to absorb losses that could have arisen under any
conceivable future scenario, given its activities, and (b) to leave sufficient
to enable the Preference Shares to be redeemed. He added that his confidence
on this point had been confirmed by what subsequently took place: by the time
the accounts for the 2005 Year were prepared and the directors of Fidex made
their assessment, the Court had long since approved the reduction of the share
premium account and the Preference Shares had been redeemed on their due dates.
78. In the result, Mr Clifford
believed that it was appropriate for the directors of Fidex to conclude that
95% of the Relevant Assets had been transferred as described in IAS 39 [19].
79. Dealing with the third step
(c), set out in paragraph [67] above, Mr Clifford pointed out that IAS 39
[20(a)] required an assessment of whether Fidex had transferred substantially
all the risks and rewards of ownership of the Relevant Assets. He said that
since 95% of all the cash flows received on the Relevant Assets were to be paid
to Swiss Re, this requirement was met. All interest rate- credit- and
liquidity-risk was, in effect, transferred to Swiss Re. His view was that, as
a result, according to IAS 39 [20(a)], 95% of each Bond was required to be
derecognised and the remaining 5% to continue to be recognised as a separate
asset.
80. Mr Clifford added that
derecognising 95% of the Relevant Assets required that the Preference Shares
should not be recognised as liabilities.
81. He noted that IAS 39 [26]
requires that on derecognition of a financial asset, the difference between the
carrying amount and the consideration received (plus any cumulative fair gain
or loss recognised in equity) must be recognised in profit or loss. The cash
received by Fidex on the issue of the Preference Shares was treated as the
consideration for the deemed transfer of 95% of the Relevant Assets. In
accounting terms, the liabilities arising from the Preference Shares had, in
effect and substance, been immediately discharged by the deemed transfer of 95%
of the Relevant Assets.
82. Turning to consider Fidex’s
balance sheet as at 31 December 2004, Mr Clifford commented that the directors
of Fidex had chosen to apply the exemption in IFRS 1 and so not to restate that
balance sheet for the effects of IAS 32 and IAS 39. As a result, they had just
showed the effect of the transition from UK GAAP to IFRS in notes 22 and 23 to
the accounts. In note 23, 95% of the Relevant Assets, to the value of
€83,849,399 were derecognised, together with €62,358 of accrued interest
payable on the Preference Shares, while in note 22, Preference Shares to the
value of €84,493,197 were deducted from non-equity shareholders’ funds.
83. On the third of the issues
on which Mr Clifford was asked to focus – the extent to which the Project
Zephyr Transaction represented a ‘GAAP difference’ between 2004 UK GAAP and
2005 IFRS in so far as accounting derecognition of assets was concerned – he
acknowledged that there was a very significant difference. The different requirements
of 2004 UK GAAP and 2005 IFRS regarding the recording of Preference Shares had
such a significant effect as to warrant the conclusion that there was a
difference in the required accounting treatment of the Project Zephyr
Transaction under UK GAAP in 2004 and under IFRS in 2005.
84. Mr Clifford commented that
had the directors of Fidex not decided to adopt IFRS for the accounts for the
2005 Year, the treatment of the Preference Shares would have changed in that
year even if the accounts had continued to be prepared under UK GAAP. This was
because a new paragraph (5A) in Part 1 of Schedule 4 to the Companies Act 1985
(see further at [141] below) had required the directors to have regard to ‘the
substance of the reported transaction or arrangement in accordance with
generally accepted accounting principles or practice’ in determining how
amounts were to be presented in the accounts.
85. This change in the Companies
Act permitted the ASB to replace those parts of FRS 4 that addressed the
classification of financial instruments by the issuer as debt or equity. FRS
25 (Financial instruments: presentation and disclosure), which imported the
equivalent provisions of IAS 32, was issued in December 2004 with effect for
periods beginning on or after 1 January 2005. In the Notes on the application
of FRS 25, the ASB explained that ‘as a result, preference shares that contain
obligations to transfer economic benefits will be classified as liabilities
rather than shareholders’ funds’.
86. Mr Clifford stated that
although FRS 25 [97] required retrospective application, FRS 25 [97B] allowed
an entity not to restate its comparative figures in the first year of
application (as in the similar provision in IFRS 1), but instead to show the
change in presentation as at the beginning of the year in a note to the
accounts. Thus, the Preference Shares would have been treated as a liability
if 2005 UK GAAP had applied but the directors of company had a choice whether
or not to restate the 2004 balance sheet.
87. The superseding of FRS 4 by
FRS 25 in 2005 would, together with FRS 5, have required the derecognition of
95% of the Relevant Assets in the accounts of Fidex for the 2005 Year if those
accounts had been prepared under 2005 UK GAAP. If the directors of Fidex had
applied 2005 UK GAAP to the accounts of Fidex for the 2005 Year and had decided
to restate the balance sheet for the 2004 Year to reflect the introduction of
FRS 25, they would also have had to derecognise 95% of the Relevant Assets,
together with the Preference Shares. However, if they had opted not to restate
the comparative balance sheet, they would have shown the effect of moving to
FRS 25 and the derecognition of 95% of the Relevant Assets and the Preference
Shares, as at 1 January 2005 in a note to the accounts. In this way the
accounting treatment under 2005 UK GAAP would have been consistent with that
actually applied by the directors of Fidex under IFRS.
88. Mr Martin’s instructions
were to give his opinion on the same issues as those addressed by Mr Clifford –
see above, paragraph [44].
89. He made the usual expert’s
declaration in his report as to his objectivity in giving his evidence and that
he was aware of no conflict of interest of any kind, other than that he was
aware that his firm, KPMG, had provided ad hoc verbal advice in 2004 to
BNPP in relation to the Project Zephyr Transaction. He stated that he was not
involved in the provision of that advice.
90. In relation to his analysis
of the Project Zephyr Transaction under UK GAAP applicable to the 2004 Year, Mr
Martin stated that the accounting standards of particular relevance would have
been FRS 4, FRS 5 and UITF Abstract 33 (Obligations in capital instruments).
91. Mr Martin’s opinion was the
same as Mr Clifford’s as regards the requirement on Fidex to report the Preference
Shares in the accounts for the 2004 Year in shareholders’ funds, analysed as
attributable to non-equity shares, under UK GAAP, pursuant to FRS 4. He
reinforced this opinion by reference to UITF Abstract 33. He said that he was
not aware of any instances of a reporting entity applying a “true and fair
override” or concluding that FRS 5 should override the provisions of FRS 4 so
as to account for preference shares as liabilities in the reporting entity’s
individual accounts and his view was that it would have been inappropriate to
do so, given the specific consideration of the ASB on this point. He made the
point that Fidex’s accounts had already accounted for the cash received (the
net proceeds) on the issue of the Preference Shares as required by FRS 4. It
would therefore, in his view, have been inappropriate to account for those
proceeds a second time as the proceeds of a bond sale. The general provisions
of FRS 5 would not in his view have applied to the Project Zephyr Transaction
having regard to paragraph [13] of FRS 5 – the view expressed by Mr Clifford.
92. Mr Martin also agreed with
Mr Clifford that the recognition (or non-derecognition) of the Relevant Assets
in Fidex’s accounts for the 2004 Year was correct. He reiterated the point
that the accounts had already accounted for the cash received as consideration
for a share issue and that it would have been inappropriate for the cash to be
accounted for a second time as proceeds of a bond sale, which would have been
the consequence of de-recognising the Relevant Assets.
93. In relation to his analysis
of the Project Zephyr Transaction under IFRS in Fidex’s accounts for the 2005
Year, Mr Martin referred (as had Mr Clifford) to IFRS 1, IAS 32 and IAS 39.
His opinion was in agreement with Mr Clifford’s in all material respects. He
said that, having regard to the facts and circumstances of the particular case
(i.e. the Project Zephyr Transaction), he would have accepted the accounting
treatment used by Fidex and therefore would not have recommended the qualification
of the auditor’s opinion with respect to that matter. This conclusion was
subject to adequate disclosure being made in the accounts to alert the reader
that off balance sheet assets exist to satisfy creditors with a prior claim
upon them and his view was that the disclosures made by Fidex in the accounts
for the 2005 Year were adequate.
94. Mr Martin also agreed with
Mr Clifford’s conclusion that there was a significant ‘GAAP difference’ – that
is, that the primary reason for the difference in treatment of the Project
Zephyr Transaction between the accounts for the 2004 Year and the accounts for
the 2005 Year was the use of different accounting frameworks in 2004 and 2005.
95. Mr Chopping, the first
expert instructed by HMRC, considered the relevant accounting requirements of
UK GAAP, in particular the interaction between FRS 4 and FRS 5. He accepted
that ‘in 2004 the treatment of preference shares was normally covered by FRS 4’
and that ‘as a general rule, preference shares were treated as non-equity shares
and initially stated at the amount of the net proceeds’. He stated in
cross-examination that this case was the only exception to the proper
application of FRS 4 to the treatment of preference shares which he had ever
encountered. His view was that a ‘normal’ redeemable preference share, although
in substance a liability, but ‘without any unusual elements’, was also in
substance a preference share that needed to be recorded, and would properly
have been accounted for in non-equity shareholders’ funds under FRS 4. He also
accepted that FRS 4 was an exception to the substance over form principle.
96. With regard to the
Preference Shares in this case, his view was not that they should have been
treated as debt in the accounts for the 2004 Year prepared under UK GAAP, but
that they should have been derecognised (or not recognised). This was because
the Preference Shares were issued as part of a much larger arrangement and FRS
5 required that recognition be given to the substance of the larger arrangement
when deciding how to account for the Preference Shares. FRS 4 did not apply
because the Preference Shares had to be derecognised: the threshold for
consideration of the application of FRS 4 was that there were preference shares
which had to be recognised. But the larger arrangement had included ‘steps that
meant the substance was [that] the normal limitations on shares [i.e. that they
were subject to more restrictions on redemption than debentures or other debt]
should not be relevant in [the] accounting treatment [adopted]’.
97. However he made reference to
FRS 5 [13] (which Mr Clifford had noted – see above [57]) and to FRS 5 [43],
part of the explanation given of the scope of FRS 5 and specifically its
relationship to other standards, which states as follows:
‘The
FRS [FRS 5] sets out general principles relevant to reporting the substance of
all transactions. Other accounting standards, the Application Notes of the FRS
and companies legislation apply general principles to particular transactions
or events. It follows that where a transaction falls within the scope of both
the FRS and another accounting standard, whichever contains the more specific
provisions should be applied. Nevertheless, the specific provisions of any
standard or statute should be applied to the substance of the transaction and
not merely to its legal form and, for this purpose, the general principles set
out in FRS 5 will be relevant.’
98. With reference to the last
sentence of FRS 5 [43], Mr Chopping stated:
‘I
can only interpret this paragraph, and in particular the final sentence, to
mean that where a transaction has been structured in such a way that it appears
to fall within the scope of another standard, but that this does not reflect
the substance of the transaction, then the general principles of FRS 5 are
applied first. The specific standard is then applied, if it remains relevant,
only once that substance has been determined and reflected.’
99. He made reference to FRS 5
[45], which addresses the interaction between FRS 5 and SSAP 21 (Accounting for
leases and hire purchase contracts), which notes that SSAP 21 governs
accounting for leases that fall wholly within its parameters, but that FRS 5 is
relevant in determining the nature of a lease, and therefore which parts of
SSAP 21 will then be applied.
100. He also made
reference to Application Note E to FRS 5, which deals with loan transfers and
commented that the arrangement entered into by Fidex, on the face of it, falls
within the scope of that Application Note. He accepted, however, that the
legal nature of shares and debt (debentures) was different and this needed to
be recognised when both UK GAAP and IFRS were being applied.
101. His opinion was
that FRS 5 takes precedence in cases where an arrangement has elements which
appear to fall within the scope of both it (or an Application Note to it) and
another standard, and that the other standard is then applied only once the
substance of the transaction has been determined.
102. He also noted
FRS 5 [47] which sets out the features of more complex transactions which
require ‘particularly careful analysis’ and commented that the paragraph
appeared directly relevant to the treatment of the Relevant Assets and the
Preference Shares.
103. Mr Chopping’s
conclusion was that the Relevant Assets and the Preference Shares should have
been derecognised in the balance sheet of Fidex, prepared under UK GAAP as at
31 December 2004 (or, in the case of the Preference Shares, never recognised).
His opinion was that the accounts of Fidex for the 2004 Year did not give a true
and fair view.
104. When asked where
he ‘would draw the line’ between accounting for preference shares under FRS 4
and derecognising them by reference to FRS 5, he said the ‘the hurdle there is
extremely high’ and ‘the situation would have to be quite extreme’ and he did
not describe (or apparently conceive of) a case other than the present case
which he thought would have been over the line. In cross-examination he
accepted that he could not be certain what he would have decided in relation to
the present case at the time when the question of how the accounts of Fidex for
the 2004 Year should be drawn up fell to be considered. In a publication for
which he had been responsible at the time (2004-05) he had made the point that
FRS 4 takes a form over substance approach and he accepted under
cross-examination that at that time he had not considered any circumstances
where shares would not (under FRS 4) be accounted for as shares.
105. In relation to
IFRS, Mr Chopping considered (as did Mr Clifford and Mr Martin) that IAS 32 and
IAS 39 were the relevant accounting standards for consideration.
106. Mr Chopping
stated that he agreed with the analysis of the relevant paragraphs of the
‘Project Zephyr Accounting Opinion’ provided by PwC on 17 December 2004, as to
how the relevant paragraphs of IAS 39 ([17] to [23]) should be applied to the
Relevant Assets and associated Preference Shares. He also agreed with PwC’s
conclusion, expressed in that Opinion, that (95% of) the Relevant Assets and
the Preference Shares should be derecognised under IFRS.
107. We note that
this was the conclusion of Mr Clifford (see [79] and [80] above) with which Mr
Martin agreed. Mr Chopping expressly accepted that he was in agreement with Mr
Martin that it was acceptable to derecognise the Relevant Assets (or 95%
thereof) and the Preference Shares under IFRS.
108. Mr Lawrence
agreed with Mr Chopping that FRS 5 [43] ‘makes it clear that the substance of a
transaction, recognition and derecognition override the classification
requirements of FRS 4’. His view was that, for accounting purposes and having
regard to FRS 5 [14], ‘Fidex never actually had any obligations under the
[P]reference [S]hares and, in substance, their non-recognition [for the
purposes of the application of UK GAAP to the accounts for the 2004 Year] is
appropriate’. He also considered that those accounts did not give a true and
fair view. In saying that, he meant that the treatment adopted in Fidex’s
accounts, which were audited by PwC without relevant qualification, (which
treatment was supported by the evidence of Mr Clifford and Mr Martin) was based
on an unreasonable interpretation of the relevant accounting standards (FRS 4
and FRS 5). He accepted that if he had considered that the treatment adopted
in Fidex’s accounts had been based on a reasonable interpretation of those
standards, even though he himself did not agree that the interpretation was
correct, or was the better view, he would still have regarded the accounts as
having given a true and fair view.
109. In
cross-examination Mr Lawrence said that until he met this case he had never
seen a case where a company would issue preference shares and not recognise
them.
110. His view on the
relevance of the balance sheet formats laid down by the Companies Act was that
they apply to the presentation of shares ‘if they [such shares] are
recognised’. He went on: ‘if a balance sheet item is not recognised it is
irrelevant that company law dictates where it would be recognised. CA85 does
not override accounting standards’. But under cross-examination he accepted
that it was implicit in the fact that an item was presented in the balance
sheet that it was recognised and that he could not point to anyone ever having
considered it possible that issued preference shares might not be recognised.
111. He agreed with
the other experts that IAS 39 was properly applied as at 1 January 2005 in
providing for derecognition of 95% of the Relevant Assets and derecognition of
the Preference Shares (subject to his view that a proper application of UK GAAP
in the 2004 Year would already have provided for such derecognition).
112. Mr Clifford and
Mr Martin disagreed with Mr Chopping (and Mr Lawrence) in their interpretation
of FRS 5 [43]. They made the point that if the argument were valid, it would
apply equally to most preference shares, the substance of which is that they
are liabilities, even if they are not ‘structured’ so as to be linked to
specific assets.
113. Mr Clifford and
Mr Martin also disagreed with Mr Lawrence’s view that accounting standards are
not overridden by Companies Acts, explaining that the ASB had expressly
developed FRS 4 so as to be consistent with the Companies Act 1985. Mr
Clifford agreed that FRS 4 (which he thought was the applicable accounting
standard) would have prevailed if it had conflicted with the Companies Act, but
said that there was no conflict, because FRS 4 was designed to be consistent
with the Companies Act. He said that in his view FRS 4 gave no choice to a
reporting entity but to report preference shares as part of shareholders’
funds, while acknowledging that if there had been a choice of applicable
accounting standards, an entity ought to select the most appropriate standard
for its particular circumstances with the object of giving a true and fair
view.
114. Mr Clifford and
Mr Martin disagreed with Mr Lawrence’s view that FRS 4 only deals with
classification once a capital instrument is recognised, but not with the issue
of whether it should be recognised. Mr Clifford said that FRS 4 nowhere
cross-refers to FRS 5 to assist determination of whether a capital instrument
should be recognised in the first place, but assumes that shares are always
classified as part of shareholders’ funds, then dealing with their
sub-classification into equity interests and non-equity interests.
115. Mr Clifford and
Mr Martin disagreed with Mr Lawrence’s view that the changes in company law and
accounting standards between 2004 and 2005 were not directly relevant to this
case and merely provided ‘recognition in statute of the extant situation’.
They pointed out that FRS 25 substantially amended FRS 4 to remove the concept
of non-equity shares with the result that capital instruments had to be
classified either as equity (shareholders’ funds) or liabilities.
Submissions
on the Paragraph 19A Issue and our comments thereon
116. At the
Tribunal’s request counsel for both parties (after the hearing) produced
written submissions on the evidence of the expert witnesses. We summarise
those submissions and the oral submissions on the Paragraph 19A Issue as
follows.
117. Fidex places
some emphasis on the ‘fire power’ of their expert evidence – two senior
practitioners from Big 4 firms who had taken the trouble to consult widely. And
they reminded us that Mr Chopping had admitted that it was difficult to be sure
what he would have thought about the issue at the time.
118. Mr Tallon
challenged Mr Clifford’s objectivity by reference, first, to the fact that his
firm, Ernst & Young, were registered as the promoters of the scheme
manifested in the Project Zephyr Transaction under the disclosure of tax
avoidance scheme rules, and, secondly, by reference to his observation that he
would not expect a reasonable accountant to disagree with his view on the
central issue of the application of FRS 4 to the accounts of Fidex for the 2004
Year.
119. We reject these challenges.
Mr Clifford referred to the fact that his firm was the promoter of the scheme
at an early stage. We were entirely satisfied that his evidence was quite
unaffected by this connection, which, in terms personal to him, was of very
minor significance. We bear the connection in mind when considering the weight
of his evidence, but we do not think it appropriate to discount the validity of
his opinion by any significant amount. Mr Clifford impressed us as a
conscientious and professional expert witness. As to his saying that he would
not expect a reasonable accountant to disagree with him, we regarded that as an
expression appropriately used to underline the confidence he felt in his
opinion. We disagree with Mr Tallon’s description of it as ‘intemperate’ and
‘unbecoming’.
120. Mr Flesch QC and
Mr Boulton QC challenged Mr Lawrence’s objectivity because he was employed by
HMRC. They also submitted that Mr Lawrence did not have the experience to
assist us, having never been an audit partner and never having had authority to
sign the audit reports for listed companies. We consider that there is some
force in these criticisms, but on the whole we found Mr Lawrence to have been a
straightforward expert witness who was as helpful as he could be.
121. Turning from the
quality of the expert witnesses, HMRC asked that we should make certain
specific findings of fact, which we do. The facts referred to are as follows:
(1)
The purpose of the forgiveness by BNPP of the release by BNPP of
approximately US$24 million of indebtedness owed to it by Fidex, on 20 December
2004 – see [22(d)] above – was to create distributable reserves in Fidex, in
order that Fidex could pay a dividend on the Preference Shares. This is
evident from a confidential internal BNPP memorandum dated 15 December 2004,
with our papers.
(2)
Fidex paid BNPP an unspecified amount for giving the undertaking to
Swiss Re to guarantee Fidex’s obligations under the Preference Shares. This is
evident from two BNPP internal documents commenting on the deductibility of the
fee.
(3)
None of the 4 expert witnesses had experience before 1 January 2005 of
an issue of redeemable preference shares whose terms could be described as
similar to those of the Preference Shares.
(4)
All of the 4 expert witnesses agreed that it was unlikely that the
framers of FRS 4 (or indeed the authors of contemporaneous books on UK GAAP)
would have had in mind an issue of preference shares on terms similar to those
of the Preference Shares.
(5)
Both Mr Clifford and Mr Martin accepted that, while there was not as a
matter of fact any reason for there to be an impairment issue arising in
respect of any of the Relevant Assets (i.e. some material effect on the bond
issuer’s ability to pay in full) any impairment loss arising in the 2004 Year
would have had to have been reflected in the profit and loss account (or
reserves) of Fidex.
(6)
The economic effect of the issue of the Preference Shares on 22 December
2004 was that Fidex sold 95% of the Relevant Assets to Swiss Re.
(7)
Both Mr Clifford and Mr Martin agreed that accounts of companies audited
by the ‘Big 4’ firms of chartered accountants had in the past been required to
be restated by the Financial Reporting Review Panel.
122. HMRC submits
that there was no relevant ‘practice’ of accountants to which we should have
regard in determining whether Fidex’s accounts for the 2004 Year were stated in
accordance with UK GAAP. This was on the basis that the terms of the Project
Zephyr Transaction, and the terms of the Preference Shares which were integral
to Project Zephyr Transaction, were to all intents and purposes unheard of
before 17 December 2004 (the date of the PWC ‘Project “Zephyr” accounting
opinion’).
123. While we accept
that the terms of the Project Zephyr Transaction and the terms of the
Preference Shares were to all intents and purposes unheard of before 17
December 2004, it does not follow in our view that there was no relevant
‘practice’ of accountants to which we should have regard. That depends on
whether the terms of the transaction and of the Preference Shares are of such
significance in interpreting and applying the relevant accounting standards
that they effectively eclipse the fact that the issue is how preference shares
ought to have been accounted for and the consequences of the answer to that
question in relation to the accepted way of accounting for the Relevant
Assets. These are the main issues for our decision in relation to the
application of UK GAAP to Fidex’s accounts for the 2004 Year and we do not
prejudge them. We note, however, that Mr Chopping admitted in
cross-examination that it was difficult for him to be sure what he would have
thought at the time was the correct accounting treatment. He recognised that in
giving his opinion on the Project Zephyr Transaction – that shares had been
issued which did not fall to be recognised – he was in a position that he had
never been in before in his professional career, in that he was giving an
opinion and interpretation of accounting standards which was unsupported by any
accounting authority apart from Mr Lawrence’s opinion. We consider this is an
important point for us to bear in mind in considering in terms of Paragraph 19A
whether Fidex’s accounts for the 2004 Year were prepared in accordance with ‘UK generally accepted accounting practice’. It tells against Mr Chopping’s opinion that
they were not.
124. The evidence of
Mr Chopping and Mr Lawrence was that the application of UK GAAP (specifically
FRS 5 [13] and [43]) as at 31 December 2004 required consideration of whether
the Preference Shares fell to be recorded on Fidex’s balance sheet (that is,
whether they ought to have been recognised at all), and, if so, whether they
took the form of shares. If both questions were answered in the affirmative
(which they would be in the case of a ‘normal’ redeemable preference share),
then FRS 4 was the correct standard to apply. Their opinion was that the
Preference Shares did not fall to be recognised at all, because the requirement
to apply an accounting treatment, which reflected the substance of the entire
Project Zephyr Transaction, would result in the transaction being treated as
the sale of 95% of the Relevant Assets. The consequence in accounting terms
was that no credit entry would fall to be recorded in respect of the Preference
Shares because there was, in substance, no issue of a ‘capital instrument’ as
defined by FRS 4 – that is, no ‘means of raising finance’ – because the Project
Zephyr Transaction had not in substance been a transaction aimed at raising
finance.
125. HMRC submitted
on this basis that FRS 4 [37], which required that shares should be reported as
part of shareholders’ funds, was not a “recognition principle” but instead a
direction of how anything called a ‘share’ had to be presented if it had been
recognised as such.
126. On the point
raised by Fidex’s experts that if this was the correct approach it would be
difficult to know where to draw the line between recognising and not
recognising shares, HMRC’s submission was that it was a matter of professional
accounting judgment to distinguish between cases where shares had been issued
which should be accounted for under FRS 4 as shares, and cases where shares had
been issued where the substance of those shares was such that they should not
be recognised as shares at all. HMRC went on in their written submissions to
assert that this was not a borderline case, since applying FRS 4 resulted in an
overstatement of Fidex’s assets by some 25%.
127. Mr Flesch and Mr
Boulton, for Fidex, took us back to the text of FRS 5 [13] and [43], reminding
us that both paragraphs made reference to the need (in the case of conflict
between FRS 5 and another FRS or SSAP, or a specific statutory requirement) to
apply the standard or statute which contains the more specific provision(s).
They make the point that FRS 4 contains the more specific provisions when it
comes to accounting for preference shares. FRS 4 (in particular Appendix III
thereto) specifically excludes shares from recognition as liabilities
because ‘shares have a distinct legal status reflected (inter alia) in
the limitations imposed by companies legislation on the circumstances in which
payments may be made in respect of them’. The point is also made that it is
impossible to classify shares as liabilities within the constraints of the
(pre-2005) statutory formats for the balance sheet. FRS 4 (as we have noted)
deals with this problem by proposing the distinction of accounting for equity
and non-equity shares.
128. The authors of
FRS 4 therefore gave explicit consideration to the potential conflict between
FRS 4 and the substance of transactions involving shares. Accounting for the
substance of transactions (later dealt with in FRS 5) had been the subject of
the predecessor to FRS 5, FRED 4. FRED 4 had been in issue when FRS 4 was
being prepared and Appendix III to FRS 4 deals with potential inconsistencies
between FRS 4 and FRED 4. However while, as stated above, there is an
exposition of why a share cannot be accounted for as a liability, there is no
explicit (or even implicit) suggestion that in some cases a share, instead of
being accounted for as a share, should not be recognised at all.
129. HMRC submitted
that the explanation for this was that (as Mr Chopping had said) it was
fruitless to look for a “non-recognition” principle in FRS 4 (or to draw any
inferences from its absence) because FRS 4, like any other accounting standard
dealing with a specific category of asset or liability, implicitly assumed that
something had fallen to be recognised in the first place. This was also the
explanation given for the fact that the authors of the chapters on FRS 4 in UK
GAAP textbooks had failed to mention the point.
130. We are not
convinced by this argument. It seems to us that FRS 4 and FRS 5 (and its
predecessor FRED 4) were carefully considered documents and were intended to
set down comprehensive standards. That is how they were approached by Mr
Clifford and Mr Martin – both very experienced accountants in this field – and
that is how, in our view, they should have been approached. The purpose of the
publication of accounting standards is, it seems to us, that they should be
regarded as comprehensive according to their terms. It is not a satisfactory
way of construing FRS 4 to say that it does not apply to certain specific
shares which are not in their substance shares at all, when FRS 4 (and FRS 5)
are entirely silent on the point.
131. We also do not
regard HMRC’s argument that it is acceptable to make an exception from
accounting on the basis of substance for ‘normal’ redeemable preference shares,
which are in substance liabilities, but are nonetheless to be accounted for as
part of shareholders’ funds, but not to make a similar exception for the
Preference Shares whose net proceeds, we accept, were in substance the proceeds
of sale of 95% of the Relevant Assets. In terms of the logic which we discern
to have been adopted in the promulgation of FRS 4 and FRS 5, we do not see any
reason for assuming any accounting treatment on the basis of substance for any
shares, once it is recognised that normal redeemable preference shares are to
be accounted for on the basis of their form, not their substance.
132. We accept that
there is no logical basis for ‘drawing a line’ between redeemable preference
shares which are to be recognised as such (although in substance they are not
shareholders’ funds – because they are liabilities) and redeemable preference
shares (such as the Preference Shares in issue in this case) which are not to
be recognised as such (although, again, they are in substance not shareholders’
funds – but for another reason). If there is no logical basis for drawing such
a line, it cannot be a question of judgment where it is to be drawn. On the
contrary, drawing such a line would be an arbitrary exercise.
133. With respect to
Mr Chopping and Mr Lawrence, we have concluded that their opinions have been
developed to deal with the specific case of the Preference Shares, not giving
sufficient emphasis to the fact that accounting standards are intended to be of
general application and not directed to specific cases.
134. We have
concluded for these reasons that we prefer the evidence of Mr Clifford and Mr
Martin as to the correct accounting treatment of the Preference Shares. In so
doing, we believe we have, as we have been urged to do by Mr Tallon, put much
more weight on the reasons given in the expert opinions and the oral evidence,
than on the experience and status of the witnesses. We have nevertheless been
fortified by the fact that the opinions we prefer on the accounting issues are
those offered by the witnesses with the more appropriate high level practical
experience. We also accept the evidence of Mr Clifford and Mr Martin, which was
not seriously disputed, that if the Preference Shares were accounted for in
Fidex’s accounts for the 2004 Year as part of shareholders’ funds, then it
followed that the 95% of the Relevant Assets (the subject of the Project Zephyr
Transaction) had also to be included in the balance sheet as a balancing item.
We find that Fidex’s accounts for the 2004 Year showed a true and fair view.
135. All the experts
were agreed that Fidex had accounted correctly in the 2005 Year under IFRS, and
we so find.
136. We asked Mr
Boulton for a document which conveniently, concisely and completely described
the changes in accounting standards and in company law that were brought into
effect from 1 January 2005. Such a document was provided, as an Appendix to
the written closing submissions of Mr Flesch and Mr Boulton, and we are
grateful for it. In the following paragraphs we set out the main points.
137. Following the
adoption of Regulation 1606/2002/EC (the IAS Regulation) by the European
Parliament and the Council of the European Union on 19 July 2002, publicly
traded companies were required to prepare their consolidated accounts under
EU-indorsed IFRS, while Member States were given power to permit or require
publicly traded companies to prepare their annual accounts and other companies
to prepare their consolidated and/or annual accounts in accordance with
EU-indorsed IFRS.
138. The UK
Government announced on 17 July 2003 that it would permit (but not require)
non-publicly traded companies to use IAS in their consolidated and individual
accounts (and publicly traded companies to use IAS in their individual
accounts). This would allow Fidex to report under IFRS in its accounts.
139. In order to
implement the Government’s policy, however, it was necessary to amend the
Companies Act 1985. This was done by the Companies Act 1985 (International
Accounting Standards and Other Accounting Amendments) Regulations 2004 (“the
Regulations”), which amended section 226 of the Companies Act 1985. The
amendment was effective for financial years beginning on or after 1 January
2005. Early adoption of IFRS was not permitted, so Fidex would not have been
able to report under IFRS for any financial period before that commencing on 1
January 2005. Fidex applied IFRS in its financial statements for the 2005 Year
and used UK GAAP as applied in the 2004 Year to give the comparative
information to financial instruments within the scope of IAS 32 and IAS 39 (as
allowed by IFRS 1 [36A]).
140. A company
preparing IAS accounts was not required to comply with the requirements of
Schedule 4 to the Companies Act 1985. Therefore, any restrictions in company
law regarding the presentation of preference shares did not apply to Fidex’s
accounts for the 2005 Year.
141. However the
Regulations also introduced a new paragraph 5A into Schedule 4 to the Companies
Act 1985 (with effect for financial years beginning on or after 1 January
2005), which required directors to have regard to the substance of a reported
transaction or arrangement in accordance with generally accepted accounting
principles, in determining how amounts are presented in the accounts. FRS 25
was issued in December 2004 and applied to accounting periods beginning on or
after 1 January 2005.
142. Following the
adoption of IFRS in Fidex’s accounts for the 2005 Year, in the opening balances
as at 1 January 2005, 95% of the Relevant Assets were derecognised and the
linked Preference Shares ceased to be recognised. The consequence was a ‘GAAP
difference’ of €83,849,399 between 2004 UK GAAP and 2005 IFRS in so far as
accounting derecognition of assets is concerned.
Decision
on the Paragraph 19A Issue
143. We hold
accordingly that the conditions in Paragraph 19A apply and that the identified
‘GAAP difference’ requires to be brought into account for the purposes of
Chapter 2, Finance Act 1996 in the 2005 Year in accordance with Paragraph
19A(3). This is subject to our decision on the Paragraph 13 Issue to which we
now turn.
The
Paragraph 13 Issue - Introduction
144. As indicated
above, the essence of the Paragraph 13 Issue is whether or not in the 2005 Year
the Relevant Assets (being loan relationships of Fidex) had an ‘unallowable
purpose’. This focuses the attention (in broad terms) on whether the purposes
for which ‘at times during’ the 2005 Year, Fidex was a party to such loan
relationships or entered into related transactions by reference to them (which
would include disposals – in whole or in part – of rights under them) was a tax
avoidance purpose, which was the main purpose, or one of the main purposes, for
which Fidex was a party to the loan relationships at a time during the 2005
Year when it held them, or for which it entered into related transactions by
reference to them.
145. It is common
ground that Fidex acquired the Relevant Assets in 2000 as collateral for its
business of issuing commercial paper – that is, for a commercial business
purpose. Fidex ceased to issue any commercial paper in 2002, but after that
time the Relevant Assets continued to be held for commercial purposes. There
is no suggestion that any tax avoidance purpose existed before December 2004.
146. An ‘Approval
Document’ prepared by BNPP Structured Finance and dated 10 December 2004 was
entitled ‘Project Zephyr – Acquisition of the Fidex group and structured risk
transfer of selected bond assets held by Fidex Plc’ was with our papers. The
Executive Summary in this document is in the following terms:
‘2.1
This transaction results in [BNPP] purchasing the legal ownership of a
presently orphaned, BNPP sponsored, failed collateralised commercial paper
issuance vehicle (Fidex Plc) and the corresponding risk transfer of circa.
€84 million of the US$488 million book value of collateral (being a diversified
portfolio of highly rated bonds) remaining within that vehicle. The risk
transfer of €84 million of bonds is structured such that it results in the BNPP
UK group being able to claim a UK tax deduction for €84 million under current UK tax law as a result of the application of the transitional rules for UK taxpayers moving
accounting basis from UK GAAP to IFRS on 1 January 2005.
2.2
Organisation Finance have been working with Swiss Re Capital Markets (who are
advised by Ernst & Young) in structuring this transaction.
2.3
The commercial purpose and net effect of the transaction is for the BNPP group
to transfer the economic risks and reward of ownership of a €84 million
portfolio of bonds in a tax efficient way to the Swiss Re group.
Counterparty risk Mitigant: The BNPP
group is not taking any additional counterparty risk as a result of this
transaction and removes €84 million of counterparty exposure and 100% risk
weighted assets as a consequence.
Market risk Mitigant: No
additional risk of any consequence.
Reputational risk Mitigant: The
transaction was presented to leading tax counsel … who, while conceding that
the proposal might be regarded as aggressive, did confirm that the anticipated
tax results were in accordance with UK tax law (as currently drafted).
Legal risk Mitigant: The
documentation is relatively simple and is being prepared by Clifford Chance on
BNPP’s behalf.
Tax risk Mitigant: A
change in tax law by the UK authorities prior to 31 December 2005 could render
this transaction without the anticipated tax result. As the fee paid to Swiss
Re is refundable in these circumstances, economic losses are confined to fixed
costs of implementation (estimated at €500,000 at the date of this paper, the
majority of which have already been incurred), additional hedging costs and
opportunity costs associated with liquidating the whole bond portfolio of Fidex
as [sic] current market levels.
Operational risk Mitigant: None in
addition to those already present in the management of Fidex and its
portfolio.’
147. As indicated
above, the Project Zephyr Transaction took place over the period between 17
December 2004 and 22 December 2004 and answered to the description in the
document dated 10 December 2004 which has just been cited. The PwC ‘Project
“Zephyr” accounting opinion’ was also dated 17 December 2004 and, as one would
expect, outline the proposed transaction in more detail.
148. We have no
hesitation in finding that the main purpose, or one of the main purposes, of
Fidex in entering into:
(1)
the acceptance of the release of approximately US$24 million of
indebtedness owed to it (Fidex) by BNPP on 22 December 2004 to create
distributable reserves in Fidex, in order that Fidex could pay a dividend on
the Preference Shares (see: [121] above),
(2)
the PSSA on 22 December 2004,
(3)
the adoption of new Articles of Association on 22 December 2004,
(4)
the Conditional Subscription Agreement with FHL on 22 December 2004, and
(5)
the adoption, on 22 December 2004, of the use of IFRS in place of UK
GAAP for the period commencing 1 January 2005,
was a tax avoidance purpose, as that expression is to be
construed for the purposes of Paragraph 13. It was the main purpose, or one of
the main purposes of these actions for Fidex to secure a tax advantage, being a
relief from tax represented by the loan relationship debit of €83,849,399 in
issue in this appeal.
149. However,
Paragraph 13 does not direct attention to the purposes for which these actions
were carried out – it directs attention to the purposes for which Fidex was a
party in the 2005 Year to the loan relationships represented by the Relevant
Assets or for which in the 2005 Year it entered into a related transaction by
reference to any of those loan relationships.
150. If those purposes
included a tax avoidance purpose as defined (a species of ‘unallowable
purpose’), then the further question arises (pursuant to sub-paragraph (1) of
Paragraph 13) as to how much of the debits falling for the 2005 Year to be
brought into account for the purposes of Chapter 2, Finance Act 1996 is, on a
just and reasonable apportionment, attributable to the tax avoidance purpose.
The
parties’ submissions on the Paragraph 13 Issue
151. Mr Flesch (for
Fidex) submits that consideration of whether Paragraph 13 applies in this case
requires one to consider precisely how and when the debit under subparagraph
(3) of Paragraph 19A crystallised.
152. The debit, he
submits (rightly), results from the fact that there was a difference between
the accounting values of the Relevant Assets as shown in the closing balance
sheet for the 2004 Year and the opening balance sheet for the 2005 Year, ‘the
beginning of’ the 2005 Year in the language of sub-paragraph (3)(b) of
Paragraph 19A. He also makes the point that those accounting values had to be
determined by reference to the same facts, namely the facts existing at the end
of the 2004 Year.
153. The time at
which the 2004 Year ended was chronologically immediately before the time at
which the 2005 Year commenced. Mr Flesch’s point is that nothing happened in
the 2005 Year (i.e. in the calendar year 2005) which did affect, or could have
affected, the accounting value of the Relevant Assets in the closing balance
sheet for the 2004 Year or the opening balance sheet for the 2005 Year. Therefore,
nothing happened in 2005 which did affect, or could have affected, the
Paragraph 19A ‘difference’.
154. Mr Flesch goes
on to submit that Fidex’s purpose in being party to the 4 loan relationships
represented by the Relevant Assets at any time after midnight on 31 December
2004 cannot have affected the facts and matters giving rise to the Paragraph
19A ‘difference’. In particular, the debit to be brought into account pursuant
to sub-paragraph (3) of Paragraph 19A cannot be said to be attributable to any
unallowable purpose of Fidex in the 2005 Year.
155. Mr Flesch
submits that the crystallisation of the debit at the end of the 2004 Year is
further demonstrated by Note 11 to Fidex’s financial statements for the 2005
Year, which showed the derecognition of the Relevant Assets (a credit of
€83,849,399) as an adjustment made at 31 December 2004.
156. He further
submits that this conclusion is reinforced by the wording of sub-paragraph (2)
of Paragraph 13 which describes purposes which may include an unallowable purpose
as purposes for which ‘at times during [the accounting period in issue] the
company (a) is a party to the [loan] relationship, or (b) enters into [related
transactions] by reference to that relationship’. He focuses on the
draftsman’s use of the plural ‘at times during’ the accounting period,
rather than the expression ‘at any time in’ the accounting period. He submits
that the reference to ‘at times during’ the accounting period indicates that
the draftsman had in mind a continuing and ongoing unallowable purpose for
being party to a loan relationship in an accounting period. Mr Flesch submits
that since the Paragraph 19A debit crystallised at midnight on 31 December
2004, there cannot have been even a single time during the 2005 Year at which
Fidex had an unallowable purpose for being party to the 4 loan relationships
constituted by the Relevant Assets – but on any view there cannot have been
‘times’ during the 2005 Year when Fidex had an unallowable purpose.
157. Mr Flesch
submitted that at the start of the 2005 Year, any alleged unallowable purpose
had been achieved, because by then the debit had already crystallised. He made
reference to and relied on Mr Clifford’s evidence that it was correct for the
accounting treatment for the 2005 Year opening balances to be based on the
circumstances as the 2004 Year end (see [61] above). An unexpected sale of the
Relevant Assets in, say, January or February 2005 would not have made any
difference to the accounting treatment of them in the opening balance sheet for
the 2005 Year.
158. Mr Flesch
contended that this demonstrated that Paragraph 13 is not apt to apply to this
type of case, where a taxpayer’s creditor loan relationship is derecognised as
a result of a change of accounting policy. He submitted that Parliament had
appreciated that such was the case when, by paragraph 5, Schedule 4, Finance
Act 2011, it had enacted a new section 455A, to be inserted into Part 5 of the
Corporation Tax Act 2009 (which re-enacted the loan relationships provisions of
Chapter 2, Finance Act 1996) as follows:
‘(1) This
section applies where –
(a) A company is at any time a party to tax avoidance
arrangements,
(b) As a result of those arrangements, a creditor
relationship to which the company is party, or any part of such a relationship,
is (in accordance with generally accepted accounting practice) derecognised by
the company, and
(c) The company continues to be a party to the creditor
relationship immediately after the transaction or other event giving rise to
the derecognition.
(2) No debit that would apart from this section be brought
into account by the company for the purposes of this Part as a result of the
derecognition is to be brought into account
…
(5) For the purposes of
this section, arrangements are “tax avoidance arrangements” if the main
purpose, or one of the main purposes, of any party to the arrangements, on
entering into them, is to obtain a tax advantage.
(6) In subsection (5)
“arrangements” includes any arrangements, scheme or understanding of any kind,
whether or not legally enforceable, involving a single transaction or two or
more transactions.’
159. Mr Flesch’s
main submission was that it was not necessary to consider Fidex’s purpose in
being a party in 2005 to the 4 loan relationships constituted by the Relevant
Assets, because any tax avoidance purpose, which Fidex may have had, had been
achieved by the start of the 2005 Year.
160. However, as a
first alternative submission, should the Tribunal not accept his main
submission, he contended that in the 2005 Year, until the Relevant Assets’
several maturity dates, Fidex remained the full legal and beneficial owner of
the Relevant Assets, as it would have done if the Project Zephyr Transaction
with Swiss Re had never taken place, and for as long as it would have done if
the Project Zephyr Transaction with Swiss Re had never taken place. The issue
of the Preference Shares did not change this – all it did was bring Swiss Re in
as a shareholder of Fidex (albeit one whose rights to dividends and redemption
proceeds were, subject to company law, linked to the Relevant Assets). Mr
Flesch made this submission on the basis that, given the agreed fact that Fidex
held 15 of the other 18 bonds (i.e. the bonds which were not Relevant Assets)
to maturity, it is more likely than not that the Relevant Assets would also
have been held to maturity if the Project Zephyr Transaction had not occurred.
Also, the Relevant Assets were bonds very close to maturity, which made them
suitable for the purposes of a short term transaction with Swiss Re but, had that
transaction not been entered into, Mr Flesch submitted that it was highly
improbable that Fidex would have chosen to sell the Relevant Assets ahead of
other bonds with longer periods to maturity.
161. For these
reasons, Mr Flesch submitted that the Tribunal could reasonably infer that,
irrespective of the transaction with Swiss Re, Fidex would have continued to be
a party to the Relevant Assets until their respective maturity dates. Thus,
during the 2005 Year, Fidex was not a party to the Relevant Assets, nor did it
dispose of them, for any tax avoidance purpose, but as part of the ‘running
off’ of its portfolio of bonds acquired and held for commercial purposes
unconnected with tax avoidance.
162. Mr Flesch
submitted that there was no evidence to suggest that Fidex was seeking to sell
the Relevant Assets prior to the approach from Swiss Re in November 2004, and
no evidence that a ‘straightforward’ sale of the Relevant Assets to Swiss Re
was ever contemplated. Mr Colin Gardner’s evidence was that his memory of the transaction
was extremely vague but that he believed that the reasons behind the
transaction was that it was a tax efficient way to dispose of certain assets
held by Fidex, which was an objective of the treasury management in BNPP
Paris.
163. If his first alternative
submission is not accepted, Mr Flesch makes a further alternative submission on
the basis that that Tribunal finds that Fidex’s reasons (purposes) for holding
the Relevant Assets did change as a result of the transaction with Swiss Re.
164. The transactions
entered into on 22 December 2004 passed the risks and rewards of ownership of
95% of the Relevant Assets from Fidex to Swiss Re. Furthermore, under the
terms of the PSSA of that date, Fidex was obliged to pay over to Swiss Re – in
broad terms – 95% of the amounts it received in respect of the Relevant Assets
when they matured. A sale of the Relevant Assets before their respective
maturity dates would accordingly have been inadvisable and unlikely because
Fidex would then not have been the person to receive the redemption proceeds on
maturity. Additionally, under the terms of the PSSA, Fidex expressly undertook
to Swiss Re that it would not sell, or otherwise dispose of, the Relevant
Assets while the Preference Shares remained in issue. This was an undertaking
given for wholly commercial (and not tax avoidance) reasons (purposes) and it
would have been uncommercial for Fidex to have acted in breach of the
undertaking. In summary, Fidex’s continuing in the 2005 Year to be a party to
the loan relationships constituted by the Relevant Assets, and its disposal of
them on their respective maturity dates, was motivated by the commercial
purpose of complying with its obligations assumed when the transactions with
Swiss Re were entered into on 22 December 2004, and not by a tax avoidance
purpose.
165. Mr Tallon (for
HMRC) submitted that, by December 2004 at the latest, BNPP had decided to
dispose of the Relevant Assets and the other corporate bonds held by Fidex.
Referring to the Approval Document dated 10 December 2004 (see [146] above), Mr
Tallon drew our attention to clause 3.5 which stated that ‘Project Zephyr
represents a precursor to the disposal of bond assets’ and referring to the
proposed issue of Preference Shares as ‘the transfer of the risk and rewards of
the selected bond assets (and therefore their synthetic disposal) to the Swiss
Re group’. Clause 3.3 of the same document indicated that the Treasury and
Group Finance function within BNPP favoured ‘an orderly disposal of Fidex’s
remaining assets’ and would make such a proposal (‘market conditions
permitting’) to the board of Fidex.
166. He submitted
that the fact that the bonds were ‘as a result (presumably) of some subsequent
change of mind, ultimately held to maturity does not negative the intention to
dispose of them evident at the material time’ – which we take to be December
2004.
167. Mr Tallon
disputed Mr Flesch’s submission that, following the Project Zephyr Transaction,
Fidex remained (as to 95% of the Relevant Assets) their beneficial owner.
Fidex was not free to transfer them and Swiss Re was entitled to 95% of all
payments made under them. He cited Wood Preservation Ltd v Prior 45 TC
112 at 133 and J Sainsbury Plc v O’Connor [1991] STC 318 at 329e-g.
168. He submitted
that throughout the 2005Year until the respective maturity dates of the
Relevant Assets, Fidex continued to be a party to the loan relationships
constituted by them after they had outlived any commercial purpose, and had
both formed an intention to dispose of them and had parted with the economic
benefits of ownership of them – and had indeed effected a ‘synthetic disposal’
of them, as belatedly recognised in its financial statements for the 2005 Year.
The reason for this, Mr Tallon submitted, was that it was necessary to be able
to derecognise the Relevant Assets in the accounts for the 2005 Year and obtain
the claimed debit under Paragraph 19A.
169. Mr Tallon
submitted that the retention of the Relevant Assets in the 2005 Year was
necessitated by the obligations Fidex undertook to Swiss Re to ensure that the
‘pass through’ requirements of IAS 39 [19] were satisfied. Fidex had, he
submitted, to remain in a position so that it could pay on the cash flows
arising from the Relevant Assets to Swiss Re without material delay – and this
meant that Fidex (in order to ensure that it could derecognise the Preference
Shares under IAS 39) had in practice to remain a party to the loan
relationships constituted by the Relevant Assets in the 2005 Year. Thus the
retention of the Relevant Assets in the 2005 Year was for the purpose of
obtaining a tax advantage and not for Fidex’s other business and commercial
purposes.
170. Additionally, as
evidenced by the BNPP confidential memorandum dated 15 December 2004, referred
to above at [121(1)], retention by Fidex of the full ownership of 5% of the
Relevant Assets into the 2005 Year was:
‘due
to the fact that when computing the tax debit, Fidex [would] need to compare
two carrying values (the carrying value of the bonds as of 31/12/2004 UK GAAP
version and the carrying value as of 1/1/2005 IAS version), If 100% of the
rights under the bonds were transferred, the bonds would totally disappear from
IAS 2005 opening balance, and there would be a technical argument from a tax
perspective that there would not be anything anymore to compare with the
carrying value as of 31/12/2004.’
171. In response to
Mr Flesch’s argument that any tax avoidance purpose on Fidex’s part had been
achieved before the 2005 Year began, Mr Tallon submitted that Paragraph 13
focuses attention on Fidex’s purposes in holding the Relevant Assets in the
2005 Year. The scheme would not have worked – that is, the debit on change of
accounting practice would not have been achieved – if the legal title to the
Relevant Assets had been disposed of before 1 January 2005. It followed that
Fidex’s purpose in retaining legal title to the Relevant Assets in the 2005
Year was a tax avoidance purpose.
172. Mr Tallon
submitted that Mr Flesch’s argument based on there not being ‘times’ in
the 2005 Year in which Fidex had an unallowable purpose was completely
unsustainable. He referred to section 6(c) of the Interpretation Act 1978
providing that words in the plural are to be taken to include words in the
singular unless the contrary intention appears. He submitted that Parliament’s
use of the plural ‘times’ was not ‘intended as an invitation to engage in the
abstruse philosophical exercises now urged on the Tribunal by Fidex’, adding
that, even if it was, it is impossible to say as a matter of fact that the
unallowable purpose only existed for a single moment in time.
173. While accepting
that Fidex’s retention of the Relevant Assets in the 2005 Year enabled it to
perform the commercial obligation undertaken to Swiss Re, Mr Tallon pointed out
that those obligations had been incurred purely for the purpose of being in a
position to comply with the requirements of its Articles of Association in
respect of the Preference Shares and to ensure that the tax avoidance scheme
based on IAS 39 was properly implemented.
174. Mr Tallon
submitted that Paragraph 13 on its face applied to both creditor and debtor
loan relationships. Reference to the new section 455A of the Corporation Tax
Act 2009 is impermissible as an aid to the construction of Paragraph 13, absent
strict ambiguity. He cited Kirkness v John Hudson & Co Ltd [1955]
AC 696 at 735-739 and Cadbury Schweppes plc v Williams [2006] EWCA Civ 657; [2007] STC 106 at [64] in support of this proposition. He also cited Walker v Centaur Clothes Group Ltd [2000] UKHL 23; [2000] STC 324 at 331 in
support of the proposition that an argument from redundancy seldom has
persuasive effect.
Discussion
and Decision on the Paragraph 13 Issue
175. We approach this
issue as one in respect of which we must apply orthodox methods of statutory
construction to a realistic view of the facts. By this we mean that we must
discern and apply to the facts of this case, viewed realistically,
Parliament’s purpose in enacting Paragraph 13. We note that such was the
approach adopted by Ribeiro PJ in the 2003 Hong Kong case of Collector of
Stamp Revenues v Arrowtown Assets Limited [2003] HKFCA 46 and approved by
the House of Lords in Barclays Mercantile Business Finance Limited v Mawson
[2005] STC 1 at [36], in relation to the application of the Ramsay principle
and, although the Ramsay principle has not been invoked in this appeal,
in our view the general guidance given in those cases is relevant and binding
on us.
176. As regards the
construction of Paragraph 13, we note, first of all, that the examination of
any unallowable purpose is confined to a consideration of the purposes for
which a company is a party to a loan relationship or enters into a related
transaction during the accounting period for which debits and credits in
respect of exchange gains fall to be brought into account. The only relevant
purposes are those ‘had’ by the company during that accounting period. So we
are confined to looking at Fidex’s purposes during the 2005 Year. So much is
common ground.
177. The next point
to notice is that sub-paragraph (1) of Paragraph 13 expressly envisages an
exclusion, from debits or credits brought into account, of so much of them, as
respects the loan relationship in question, as, on a just and reasonable
apportionment, is attributable to the unallowable purpose.
178. This is an
indication that, in Paragraph 13, Parliament is addressing loan relationships
held for mixed purposes during an accounting period, one or more of such
purposes being unallowable and one or more of them not unallowable.
179. Mr Tallon gave
an example – a manufacturing concern based in Yorkshire, which exports to South
America, borrows money to buy a property in London in which to house visiting
buyers from South America and to hold meetings with them. The debits arising
in an accounting period as respects the loan relationship – most obviously in
respect of interest – are allowable (that is, not unallowable). When the
property is used from time to time by the managing director’s son, who is going
to university in London, the debits arising in the accounting period concerned include
amounts which, by virtue of Paragraph 13 cannot be brought into account, and a
just and reasonable attribution of the debits arising in the accounting period
has to be made.
180. It is in this
context that the structure of sub-paragraphs (2) and (4) of Paragraph 13 – the
sub-paragraphs most relevant to the Paragraph 13 Issue – is to be understood.
181. Sub-paragraph
(2) sets out when a loan relationship is to be treated as having an
unallowable purpose, and sub-paragraph (4) sets out, so far as is relevant to
this appeal, what an unallowable purpose is.
182. It is noteworthy
that sub-paragraph (2), dealing with when ‘in any accounting period’ –
cf sub-paragraph (1) – a loan relationship has an unallowable purpose, uses the
expression ‘at times’ during the accounting period when the company’s
purposes include an unallowable purpose.
183. In contrast,
sub-paragraph (4) – dealing specifically with what an unallowable
purpose, in relation to tax avoidance, is – speaks of one of the purposes for
which the company is a party to a loan relationship at any time (or
enters into a related transaction) being a tax avoidance purpose, if it is the
main purpose, or one of the main purposes for which the company is a party to
the relationship at that time or for which it enters into the related
transaction.
184. We consider that
the difference in language between the use of the expression ‘at times’ in
sub-paragraph (2) and the use of the expressions ‘at any time’ and ‘at that
time’ in sub-paragraph (4) cannot be ignored in the purposive construction of
Paragraph 13 and, in particular, the context militates against reading ‘at
times’ in sub-paragraph (2) as including ‘at any time’, in accordance with the
Interpretation Act.
185. The significance
of sub-paragraph (2) – the identification of when in an accounting
period a loan relationship is to be treated as having an unallowable purpose –
is that the period of time during which the loan relationship has an
unallowable purpose is highly relevant in carrying out the just and reasonable
apportionment required by sub-paragraph (1).
186. On the other
hand, whether a loan relationship has an unallowable tax avoidance purpose,
prompting an answer to the question of what such an unallowable purpose
is, is a matter which (obviously) can be, and is required to be, tested as of a
single moment in time. This is why, in our view, sub-paragraph (4) speaks of
‘at any time’ and ‘at that time’.
187. We therefore
consider that Paragraph 13 requires us to examine the loan relationships which
Fidex had in the 2005 Year and decide whether at any time the main purpose or
one of the main purposes for which it was a party to those loan relationships
was a tax avoidance purpose.
188. If we conclude
that the main purpose or one of the main purposes for which Fidex was a party
to those loan relationships (or any of them) at any time during the 2005 Year
was a tax avoidance purpose, we must then examine at what times during the 2005
Year Fidex’s purpose for being party to those loan relationships included such
a tax avoidance purpose.
189. If we find that
there were times during the 2005 Year that Fidex’s purpose for being a party to
those loan relationships included such a tax avoidance purpose, then we need to
make the apportionment of the debits falling to be brought into account for the
2005 Year required by sub-paragraph (1) of Paragraph 13.
190. The relevant
loan relationships which Fidex had in the 2005 Year were, of course, the
Relevant Assets. In considering whether, at any time at all, the main purpose
or one of the main purposes for which Fidex was a party to the Relevant Assets
was a tax avoidance purpose, we find, on the basis of the findings of fact made
at [148] above, that one of the main purposes for which Fidex was a party to
the Relevant Assets from 22 December 2004 (the date of the PSSA pursuant to
which Swiss Re subscribed for the Preference Shares in Fidex) until such time
as the tax avoidance purpose inherent in the Project Zephyr Transaction was
achieved, was a tax avoidance purpose within the meaning of Paragraph 13. We
do not find that the tax avoidance purpose was Fidex’s main purpose in
being party to the Relevant Assets at any time, because the main purpose, or
one of the main purposes, of Fidex being party to the Relevant Assets at all
times when it was a party to them was the commercial purpose of being entitled
to the cash flows inherent in the Relevant Assets – even if (at any time) it
was contemplated that those cash flows would be accounted for to the holders of
the Preference Shares.
191. When, then, was
the tax avoidance purpose inherent in the Project Zephyr Transaction achieved?
In a sense it can only be regarded as having been achieved if Fidex is
successful in this appeal and/or on any final appeal from our decision.
However, that sense is not the sense in which we mean to be understood when we
refer to the tax avoidance purpose being achieved. We refer to the
establishment of such facts as would be necessary to support Fidex’s claim to
the tax advantage which it seeks to secure. This takes us back to sub-paragraph
(3) of Paragraph 19A and the establishing of the accounting value of the
Relevant Assets (in accordance with IFRS) ‘at the beginning of the later
period’, that is, at the beginning of the 2005 Year.
192. On this point we
accept Mr Flesch’s main submission that the debit under sub-paragraph (3) of
Paragraph 19A crystallised at the end of the 2004 Year. This is because the
Relevant Assets were held by Fidex at the end of the 2004 Year and, on 22
December 2004, Fidex had adopted the use of IFRS in place of UK GAAP for the
period commencing 1 January 2005. The accounting value of the Relevant Assets
had to be determined by reference to the facts existing at the end of the 2004
Year.
193. Mr Tallon made
the point that the retention of the Relevant Assets in the 2005 Year was necessitated
by the obligations Fidex undertook to Swiss Re to ensure that the ‘pass
through’ requirements of IAS 39 [19] were satisfied, and thus that the fact
that the accounting value of the Relevant Assets at the beginning of the 2005
Year could properly be stated as they were, in accordance with IFRS, and giving
rise to the claimed difference under sub-paragraph (3) of Paragraph 19A,
depended on the retention of the Relevant Assets in the 2005 Year. This point
was, we consider, answered by the unchallenged evidence of Mr Clifford that the
accounting was based on the circumstances at the year-end (i.e. the end of the
2004 Year) and would have been unaffected by an unexpected sale of the Relevant
Assets in January or February 2005. Mr Clifford said that he did not think
that such an event would normally be viewed as an event calling for a post
balance sheet adjustment.
194. The same answer,
we consider, can be made to Mr Tallon’s point (see [170] above) that full
ownership of 5% of the Relevant Assets was retained into the 2005 Year in order
to avoid the total disappearance of the Relevant Assets from the opening
balance of the 2005 Year as stated under IFRS. Although that may well have
been so, it does not affect the point that the opening balances were fixed by
the circumstances prevailing at the end of the 2004 Year and that,
consequently, the tax avoidance purpose was achieved at that time.
195. We accept Mr
Tallon’s submission that the scheme would not have worked if the legal title to
the Relevant Assets had been disposed of before 1 January 2005, but it does not
in our view follow that Fidex’s purpose in retaining legal title to the
Relevant Assets in the 2005 Year was a tax avoidance purpose. The tax avoidance
purpose was achieved, for the reasons we have given, by Fidex’s retention of
the legal title to the Relevant Assets to the end of the 2004 Year.
196. We turn to
examine Fidex’s purposes in being party to the Relevant Assets in the 2005 Year
in order to form a realistic view of the relevant facts. There is not much
direct evidence before the Tribunal on this issue. There is evidence from a
contemporaneous email (one dated 1 December 2004 from Sarah Roussel to Nick
Williams, which we take to be an internal BNPP email) that (one, or some, or
all of) the bonds which are not ‘synthetically sold through the issuance of the
prefs’ (i.e. Fidex’s portfolio of bonds other than the Relevant Assets) should
be retained by Fidex until at least 1 January 2006. It appears that the
thinking behind this was that Fidex’s losses in the 2005 Year (which would
include the debit in respect of the difference on the change of accounting
basis) should be available for group relief in the 2005 Year.
197. The Approval
Document dated 10 December 2004 (see [146] above, and referred to by Mr Tallon,
see [165] above) was a document by which Nick Williams and Oke Uwakwe sought
internal BNPP approval for the Project Zephyr Transaction. It evidences the
fact that BNPP had decided by that date, in general terms ‘market conditions
permitting, to propose to the board of Fidex an orderly disposal of Fidex’s
remaining assets’ and that the Project Zephyr Transaction ‘[represented] a
precursor to the disposal of bond assets’, being ‘the transfer of the risk and
rewards of the selected bond assets [the Relevant Assets] (and therefore their
synthetic disposal to the Swiss Re group’. The commercial purpose and net
effect of the Project Zephyr Transaction was described in that Document as the
transfer by the BNPP group of ‘the economic risks and reward of ownership of a
€84 million portfolio of bonds in a tax efficient way to the Swiss Re group’
(see [146] above). Colin Gardner’s evidence is that he believed ‘it was a tax
efficient way to dispose of certain assets held by [Fidex], which was an
objective of [BNPP Paris]’.
198. We find on the
basis of this evidence that Fidex embarked on a programme of disposal of its
portfolio of bonds, including the Relevant Assets. It is an agreed fact that of
the 18 bonds (apart from the Relevant Assets), 3 bonds were disposed of (by
sale, we assume) in 2005 and 2006, while the remaining 15 bonds were held to
maturity, maturing between September 2005 and October 2010.
199. We find that it
was one of Fidex’s purposes in entering into and carrying out the Project Zephyr
Transaction that Fidex would thereby dispose of the Relevant Assets as part of
a general policy of conducting an orderly disposal of its remaining assets.
Once the tax avoidance purpose inherent in the Project Zephyr Transaction had
been achieved – that is, after the end of the 2004 Year – that was the only
‘main purpose’ of Fidex’s retention of the legal title to the Relevant Assets.
At no time during the 2005 Year (except perhaps, in an abstract sense, the scintilla
temporis at which the 2005 Year began (cf. sub-paragraph (3)(b) of
Paragraph 19A)) did Fidex have a tax avoidance purpose as a purpose for being
party to the loan relationships constituted by the Relevant Assets (or the
other bonds in its portfolio).
200. In particular,
we find that Fidex’s purpose in being party to the following actions did not
include a tax avoidance purpose, viz:
(1)
the resolution on 1 February 2005 to petition the High Court for the
reduction of the amount standing to the credit of its share premium account by
€85 million,
(2)
the payment of a dividend and redemption of the Class A Preference
Shares on 14 March 2005,
(3)
the payment of a dividend and redemption of the Class B Preference
Shares on 31 March 2005,
(4)
the payment of a dividend and redemption of the Class C Preference
Shares on 19 April 2005, and
(5)
The payment of a dividend and redemption of the Class D Preference
Shares on 4 July 2005.
201. In relation to
the scintilla temporis at which the 2005 Year began, if (which we doubt)
it is right to take any account of it at all, because the statutory language of
‘times’ is not applicable to it, we go on de bene esse to consider
whether it constituted ‘a time’ during the 2005 Year that Fidex’s purposes for
being a party to the Relevant Assets included a tax avoidance purpose which was
the main purpose or one of the main purposes for which Fidex was a party to the
Relevant Assets at that time. Although rejecting the proposition that a tax
avoidance purpose was Fidex’s main purpose for being a party to the
Relevant Assets at the time of the scintilla temporis (there was no
evidence of any intention to make anything but a ‘synthetic disposal’ of the
Relevant Assets to Swiss Re in 2004), we accept that a tax avoidance purpose
was one of Fidex’s main purposes for being a party to the Relevant
Assets at that time.
202. The next step
would be to seek to make the apportionment of the debits falling to be brought
into account for the 2005 Year required by sub-paragraph (1) of Paragraph 13.
203. Although it
might be said that the whole of the debit claimed by Fidex under Paragraph 19A
should on any just and reasonable apportionment be attributed to the tax
avoidance purpose under sub-paragraph (1) of Paragraph 13, this would ignore
the effect of sub-paragraph (2), which must be taken into account in any
purposive construction of Paragraph 13 as a whole.
204. As we have
stated above (at [185]), the ‘times’ during the 2005 Year when Fidex’s purposes
for being a party to the Relevant Assets included a tax avoidance purpose (as
the main or one of the main purposes for being a party to the Relevant Assets)
– and, by the same token, the ‘times’ during the 2005 Year when Fidex’s said
purposes did not include such a tax avoidance purpose – must be considered and
are highly relevant in carrying out the just and reasonable apportionment
required by sub-paragraph (1).
205. Carrying out
this exercise we conclude that, at all ‘times’ during the 2005 Year, Fidex’s
purposes for being a party to the Relevant Assets did not include a tax
avoidance purpose as the main or one of the main purposes for its being a party
to the Relevant Assets, except at the scintilla temporis at which the
2005 Year began. On this basis we consider that, even if (which we doubt) we
can interpret ‘times’ and meaning ‘any time’, on any just and reasonable
apportionment no part of the Paragraph 19A debit would be attributed to that scintilla
temporis (on account of its having no realistic length at all) and that
therefore no part of the Paragraph 19A debit falls to be excluded from the
debits falling to be brought into account by Fidex under Chapter 2, Finance Act
1996 for the 2005 Year.
206. For the reasons
given above, our decision on the Paragraph 13 Issue is in favour of Fidex and
we allow the appeal.
207. By way of a
postscript, we would add that, as we have indicated above, there was no
evidence of any intention on the part of Fidex to make anything but a
‘synthetic disposal’ of the Relevant Assets to Swiss Re in 2004. The evidence
is that the Project Zephyr Transaction represented a precursor to the disposal
by Fidex of its portfolio of bond assets, which, in fact, was carried out in
the years 2005 to 2010. We do not therefore attribute a main tax avoidance
purpose to Fidex’s holding the Relevant Assets in the 2005
Year by reference to the argument that, but for the Project Zephyr Transaction,
Fidex would have disposed of the Relevant Assets in 2004, and that therefore
its holding of the legal title in them in 2005 demonstrated a main tax
avoidance purpose.
Right
to apply for permission to appeal
208. This document
contains full findings of fact and 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 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.
JOHN WALTERS QC
TRIBUNAL JUDGE
RELEASE DATE: 2 April 2013
