DECISION
Introduction
1.
In outline, the commercial background to these two lead appeals is ascheme for the recapitalisation of two companies (Stagecoach Holdings Ltd [
Holdings],the second appellant and Stagecoach Services Ltd [
Services] by itsultimate parent, Stagecoach Group plc [
Group], the first appellant, bymeans of forward subscription agreements [FSAs], between
Group and
Holdingsand
Group and
Services. The FSAs provided that
Group’sfunding would be calculated largely by reference to sums to be paid inrepayment by another subsidiary, Stagecoach Transport Holdings plc (
Transport),of a pre-existing loan to it from
Group, with the funding for the sharesubscription capped at £20m.
2.
In exchange for the funding by
Group,
Holdings and
Servicesagreed to issue ordinary shares to their immediate parent companies, TheIntegrated Transport Company Ltd (ITCO), and Stagecoach Bus Holdings Limited (
Bus)respectively. The fiscal consequences of the accounting treatment of thesearrangements were the subject of these appeals. The accounting treatment wasnot in dispute although it featured prominently in the evidence and insubmissions.
3.
These appeals raise two broad issues. The first relates to thestatutory loan relationship regime in Part 5 of the Corporation Taxes Act (CTA)2009
and itsapplication to the scheme. The question arises whether the sum of about£39,471,087, derecognised (removed from part of the parent’s [
Group] balancesheet), debited to investments in
Group’s balance sheet and subsequentlypaid to
Holdings and
Services as part of the recapitalisationtransactions, falls to be treated as a deduction in computing the ultimateparent company’s (
Group’s) profits for corporation tax purposes. Thederecognition reduced the sum recorded in
Group’s balance sheetattributable to the pre-existing loan (a financial asset) granted by it toanother subsidiary (
Transport). The debit increased the sum recorded inthe
Group’s Balance Sheet attributable to investments (which included
Group’sinvestment in its various subsidiaries including
Holdings and
Services)
. This first issue affects the first appellant,
Group.
4.
The second broad issue is whether, if the loan relationship regime isotherwise applicable and the sum deductible, the deduction is nevertheless, ineffect, negated by the arbitrage rules contained in Part 6 of the Taxation(International and Other Provisions) Act 2010 (TIOPA). Part 6 contains a numberof provisions intended to prevent the exploitation of tax differences in thetreatment of deductions and receipts. In considering this issue, it is assumedthat the deduction from
Group’s taxable profits is justified.
5.
The question is whether those rules require each of the tworecapitalised companies to increase their taxable income by the sum paid toeach of them by
Group under the FSAs (£19,735,543.50 - being one half of£39,471,087), thus in effect taxing the sum deducted by
Group. Thisissue affects
Holdings, the second appellant; it is one of theserecapitalised companies. The other is
Services.
6.
A Hearing took place at George House, Edinburgh on 13, 14, 15 and16 July 2015. The appellants were represented by Nicola Shaw QC, andMichael Firth, barrister of the English Bar on the instructions of KPMG LLP(UK) [KPMG]. Ms Shaw led the evidence of John Hamilton CA, Taxation Directorof
Group; he spoke to his signed witness statement
. HMRC wererepresented by Julian Ghosh QC, of the English and Scottish Bars, and RuthJordan and Barbara Belgrano, barristers of the English Bar, on the instructionsof Eric Brown of the Office of the Advocate General on behalf of HMRC. MrGhosh led the expert evidence of Peter Drummond, CA, who spoke to his Reportdated 28 January 2015.
7.
Various bundles of documents, authorities, skeleton arguments and aStatement of Agreed Facts were also produced. The appellants arranged for theproceedings to be recorded, and (instantaneously) transcribed by stenographers. A transcript of the whole proceedings is available.
8.
Although mentioned separately from time to time in the documents,evidence and submissions, there is no significant distinction to be drawnbetween the recapitalisations of
Holdings and
Services.
Procedural History
9.
Group and
Holdings submitted their corporation taxself-assessments for the period ending 30 April 2011 on 27 April 2012. Enquiries were opened into the returns
[2]on 31 July 2012. A Receipt (arbitrage) Notice was issued to
Holdings undersection 249 TIOPA but it did not amend its return.
10.
On 27 September 2013, HMRC issued to
Group a notice of completionof enquiry (Closure Notice
[3])and two letters explaining the basis on which the Closure Notice proceeded. Essentially, HMRC said there should be no deduction from taxable profits of
Groupin respect of the derecognition of the loan asset because a debit that meetsthe conditions set out in s320 can be brought into account only if theconditions of s307(3) are satisfied. These conditions, it was said, cannot bemet because the debit is not one which fairly represents a loss arising from
Group’sloan relationships. They further explained that
if there was
nosuch allowable deduction, the arbitration notices and the alleged consequenttax liability of
Holdings and
Services
would
not bepursued. But
if HMRC are wrong and there should be such a deduction,the arbitration notices and consequent tax liability of
Holdings and
Services
would be pursued.
11.
The effect of the Closure Notice was to disallow the deduction claimedof £39,471,087.
12.
A similar Closure Notice, based on the tax arbitrage provisions, wassent to
Holdings on the same date. The explanation given by HMRC inletters dated 27 September 2013 in relation to
Holdings was that(i) the total subscription amount of £20,000,000 payable by
Group to thesubsidiary in terms of the FSA was a qualifying payment under s250 TIOPA, (ii)the criteria in ss249-254 TIOPA were met, (iii) the transactions that arisefrom the FSA being entered into and the subsequent shares issued give rise to amismatch which is subject to adjustment under s256 TIOPA, (iv) the sum of£19,735,543.50 specified in an arbitrage notice (dated 21 September 2012)is the element of the qualifying payment of £20,000,000, and should thereforebe included in
Holdings’ corporation tax return as taxable income.
13.
The effect of the Closure Notice was to amend
Holdings’corporation tax return for the same period by increasing its taxable profits by£19,735,543.50. The difference between that figure and £20,000,000 is notentirely clear but it does not appear to be material to the outcome of theappeals.
14.
Group and
Holdings appealed to HMRC on 25 October 2013. They waived their right of statutory review and lodged notices of appeal withthis Tribunal on 29 October 2013.
15.
By Directions dated 8 October 2014 in the appeals of
Group and
Holdings,the Tribunal directed that
Group’s appeal be designated a Lead Caseunder Rule 18(2)(a) of the Tribunal’s Rules and that the similar appeal by MitieFacilities Services Ltd (TC/2014/01173) be designated a Related Case and sistedin accordance with Rule 18 (2)(b). These Directions also providedthat
Holdings’ appeal be designated a Lead Case and that
Services’ similarappeal (TC/2013/07422) be designated a Related Case, and similarly sisted.
16.
The parties subsequently identified that the present appeals raise factsand issues which are common or related to those facts and issues which arise inother appeals before the First-tier Tribunal (Tax Chamber) at the instance of InmarsatInvestments Ltd (TC/201501907) and Inmarsat Global Xpress Ltd (TC/2015/01908) forwhom KPMG also act. They agreed that these two appeals should be designatedrelated cases to the present appeals and that the Directions dated 8 October2014, as subsequently amended, should apply to these related appeals. This wasgiven effect to by Directions in the two related appeals dated 17 June 2015.
17.
At the outset of the hearing, HMRC moved an application (dated 6 July2015) in the instant appeals and in the appeals of several other appellants
to amend theDirections dated 8 October 2014 by adding the following issue:-
Whetherthe debit claimed by the Appellant (
Group) is in respect of a company’sloan relationship within section 320 Corporation Taxes Act 2009 (“CTA 2009”) (
“Issueaa”)
The application was granted unopposed.
18.
At the outset of the Hearing, HMRC’s combined Statement of Case in thetwo lead appeals was also allowed, without objection, to be amended
by including thesame further issue for our determination.
Ms Shaw submitted a Supplementary Skeleton Argument responding to the amendmentand the additional issue, again without objection.
19.
After the Hearing was concluded, the parties applied to amend theDirections dated 17 June 2015 to introduce the same additional issue mentionedabove, namely (aa). Although there may be some unnecessary overlap, theintention appears to be to bring the lead and related cases into line. Thisparagraph should be treated as giving effect to that intention and granting thejoint application of the parties dated 23 July 2015 to these relatedappeals.
20.
Following the Hearing in July, we received several documents from theparties, namely (i) HMRC’s Requested Findings of Fact, (ii) a topic listextending to 22 pages containing extracts from the evidence, (iii) Appellant’sResponse to HMRC’s Requested Findings of Fact, (iv) Appellants’ Submissions on
AbbeyNational Treasury Service plc v HMRC,
and (iv) HMRC’s Further Submissions on
Abbey.
Statutory Framework
Loan Relationships
21.
In relation to the first broad issue, the principal statutory provisionsfalling under the spotlight are sections 307 and 320 of CTA 2009. We quotethem below. In order to place these provisions in context, we summarise theloan relationship code, its operation, purpose and effect insofar as relevantto
Group’s appeal.
22.
Part 5 of CTA 2009
[8]sets out how profits and deficits arising to a company from its loanrelationships, and related transactions,
are brought into account for corporation tax purposes.
A company has aloan relationship if it stands in the position of a creditor or debtor asrespects a loan of money.
[11] Here,
Group had a loan relationship with
Transport. They hadentered into a contract of loan.
Group stood in the position ofcreditor, and
Transport stood in the position of debtor as respects amoney debt.
[12]
23.
A transaction which disposes or acquires, in whole or in part, rights orliabilities under a loan relationship is a related transaction.
In Part 5,profits or losses from loan relationships include profits or losses from suchrelated transactions. It is a matter of agreement that neither of the FSAsreferred to
[14]is a related transaction.
24.
The general rule is that all profits arising to a company from its loanrelationships are chargeable to corporation tax as income in accordance withPart 5
[15]and are to be calculated using the credits and debits given by that Part.
This chargeapplies to non-trading profits
[17]as well as trading profits.
[18] The non-trading credits and non-trading debits given by Part 5 are used todetermine whether a company has non-trading profits or a non-trading deficitfrom its loan relationships.
[19] Here, we are concerned with
Group’s non-trading profits with respect toits loan relationship with
Transport.
A company’s non-trading profits for an accounting period from its loanrelationships are equal to its non-trading credits less any non-trading debits.
25.
Chapter 3 of Part 5
[22]contains rules of general application about the credits and debits to bebrought into account for the purposes of this Part of CTA 2009;
they set out howprofits and deficits from a company’s loan relationships are to be brought intoaccount for corporation tax purposes.
[24] In particular, it sets out general principles
to be applied in determining the amounts to be brought into account as creditsand debits, including the application of generally accepted accountingpractice.
[26] Chapter 3 also sets out some general rules that differ from generally acceptedaccounting practice.
[27]
26.
Section 307 (headed
General Principles about the bringing intoaccount of credits and debits) begins by noting that Part 5 operates byreference to company accounts and amounts recognised for accounting purposes,
the general rulebeing that the credits and debits to be brought into account for corporationtax purposes are those that are recognised, in accordance with generallyaccepted accounting practice,
[29]in the company profit and loss account and other similar statements of itemstaken into account in calculating the company’s profits and losses for theperiod in question.
[30]
27.
S307, so far as material, provides as follows:-
(1)This part operates by reference to the accounts of companies and amountsrecognised for accounting purposes.
(2)The general rule is that the amounts to be brought into account by a company ascredits and debits for any period for the purposes of this Part are those thatare recognised in determining the company’s profit or loss for the period inaccordance with generally accepted accounting practice.
(3) Thecredits and debits to be brought into account in respect of a company’s loanrelationships are the amounts that, when taken together, fairly represent forthe accounting period in question:
(a) allprofits and losses of the company that arise to it from its loan relationshipsand related transactions (excluding interest or expenses),
(b) inentering into or giving effect to any of the related transactions,
(c) inmaking payments under any of those relationships or as a result of any of thosetransactions, or
(d) intaking steps to ensure the receipt of payments under any of those relationshipsor in accordance with any of those transactions.
…
(6) Subsection(2) is subject to the provisions of this Part and, in particular, subsection(3).
28.
It can be seen, therefore, that the credits and debits to be broughtinto account
in respect of a company’s loan relationships must beamounts that, when taken together
fairly represent for the accountingperiod in question
inter alia all profits and losses that
ariseto the company
from its loan relationships.
29.
Ss311 and 312 deal with the situation where, for various reasons,amounts have not been fully recognised for accounting purposes. Ss313 and 314deal with the application of various bases of accounting (amortised cost basis,fair value etc) and their regulation. Ss 316-319 deal with changes in a company’saccounting policy from time to time. None of these provisions was the subjectof detailed submissions by the parties, and we do not consider their detailfurther.
30.
S320 provides as follows:-
320 Credits and debits treated as relating to capital expenditure
(1) This section applies if generally acceptedaccounting practice allows a credit or debit for an accounting period inrespect of a company’s loan relationship to be treated in the company’saccounts as an amount brought into account in determining the value of a fixedcapital asset or project.
(2) Despite that treatment, the credit ordebit is to be brought into account for the purposes of this Part, for theaccounting period in which it is given, in the same way as a credit or debitwhich is brought into account in determining the company’s profit or loss forthat period in accordance with generally accepted accounting practice.
(3) Butsubsection (2) does not apply to a debit which is taken into account inarriving at the amount of expenditure in relation to which a debit may be givenby Part 8 (intangible fixed assets).
(4) Subsections (5) and (6) apply if a debit isbrought into account as mentioned in subsection (2).
(5) No debit may be brought into account inrespect of the writing down of so much of the value of the asset or project asis attributable to that debit.
(6) Nodebit may be brought into account in respect of so much of any amortisation ordepreciation as represents a writing off of the interest component of theasset.
31.
No further provisions of the loan relationship code were referred to indetail or relied upon by either of the parties, although there was somereference to ss354, 455A, and 465 by the appellants in their Skeleton Argumentsand submissions. Various other sections are also quoted but were not discussedin detail.
Tax Arbitrage Rules
32.
If HMRC’s primary case is not well founded, their fall-back case is thatthe tax arbitrage provisions set forth in TIOPA and, in particular, ss 249-254apply with the result that the bulk of the subscription proceeds under the FSA is chargeableto corporation tax in the hands of
Holdings.
33.
In broad terms, tax arbitrage rules (sometimes referred to asanti-arbitrage legislation) seek to negate the profiting from differencesbetween the way transactions are treated for different purposes. There may bea mismatch between the characterisation of transactions in differentjurisdictions, or where a taxable deduction is not matched by a taxablereceipt, sometimes referred to as tax symmetry.
34.
Part 6 provides
inter alia for the giving of a receipt notice toa UK resident company in relation to a scheme, where an officer of HMRCconsiders on reasonable grounds that each of four receipt scheme conditions ismet.
[31] The result of the service of the notice, if well founded, is that the companymust calculate or recalculate its income or chargeable gains or liability tocorporation tax (less advantageously), treating the relevant part of thepayment in question (known as a
qualifying payment) as a chargeablereceipt.
[32]
Holdings argues that not all the receipt scheme conditions have beenmet.
35.
These conditions are set out in s250 of TIOPA as follows:-
.png)
.png)
…………………
36.
Scheme is defined in s258(1) as any scheme, arrangements orunderstanding of any kind whatever, whether or not legally enforceable,involving one or more transactions. It was not disputed that the receiptnotice related to a scheme.
37.
S254 provides as follows:-
.png)
Miscellaneous statutory provisions
38.
Holdings has a fall-back argument that even if the receiptconditions are met, any charge to tax is exempted by the language of s979 CTA2009. That section provides as follows:-
.png)
39.
Finally, there was mention in the course of the hearing of the
DOTAS“rules”. The relevant provisions applicable at the time are to be found inPart 7 of the Finance Act 2004. We need only refer to s306 which provides
interalia as follows:-
306Meaning of “notifiable arrangements” and “notifiable proposal”
(1)In this Part “notifiable arrangements” means any arrangements which—
……………..
(b)enable, or might be expected to enable, any person to obtain an advantage inrelation to any tax that is so prescribed in relation to arrangements of thatdescription, and
(c)are such that the main benefit, or one of the main benefits, that might beexpected to arise from the arrangements is the obtaining of that advantage.
40.
It was submitted by Ms Shaw that the test for disclosure of a schemepursuant to DOTAS was the expectation of benefit; it had nothing to do withpurpose. Be that as it may, it does not affect our conclusions on Part 5 ofCTA 2009 or the arbitrage provisions under TIOPA.
41.
Parties agreed that these rules were applicable to the arrangements towhich these appeals relate and that the arrangements were notified to HMRC.
Grounds of Appeal
42.
In summary,
Group contends that it is entitled to deduct fromtaxable profits the sum of £39,471,087 as a non-trading loan relationship debitin its corporation tax return for the year ended 30 April 2011 by virtue ofs320 CTA 2009. It argues that s320 is not subject to the provisions of 307(3),but even if it is, the conditions therein specified are met. Accordingly,
Groupcontends that it has non-trading relationship deficits of £39,471,087 in theperiod to 30 April 2011, which are available for surrender as group relief.
43.
There were further grounds of appeal relating to the taxation ofinterest of about £125,000. However,
Group accepted, at some pointbefore the hearing, that the interest income should have been brought intoaccount. These further grounds have been withdrawn.
44.
Holdings contends that there is no amount to be brought intoaccount under ss249-254 TIOPA. The relevant conditions applicable to theReceipt Notice, in particular, receipt scheme conditions C and D, have not beenmet. The
qualifying payment was not an amount to which s254 applied. There was no expectation that a benefit would arise. There was no deductibleamount in relation to the qualifying payment. There could be no charge to taxunder Case VI of Schedule D as the relevant provisions were repealed foraccounting periods ended on or after 1 April 2009.
45.
Finally, it can be noted that an argument by
Holdings based onthe timing of the Receipt Notice was withdrawn.
Issues for Decision
46.
The parties, at an early stage, presented the Tribunal with a list ofissues they wished to be determined. After various revisions by the parties,the list was incorporated into Directions dated 8 October 2014. Aftersubsequent amendment,
[33]the issues for determination are
Whetherthe debit claimed by the Appellant (
Group) is in respect of a company’sloan relationship within section 320 Corporation Taxes Act 2009 (“CTA 2009”) (
“Issueaa”)
1)
whether the deductibility o
f
rdebits under section 320 Corporation Tax Act 2009 (“CTA 2009”) is subjectto the provisions of section 307(3) CTA 2009 (“
Issue a”);
2)
if so, whether section 307(3) CTA2009 requires the debits and credits to be tested to establish their nature (“
Issueb”);
3)
if so, the issue of whether thedebits claimed by the Appellants fairly represent losses arising from theirrespective loan relationships under section 307 CTA 2009 (“
Issue c”);
4)
whether there is an amount to bebrought into account under the relevant provisions of the Taxation(International and Other Provisions) Act 2010 (“TIOPA 2010”), and in particularwhether the receipt scheme conditions in section 250 TIOPA 2010 were satisfied(“
Issue d”);
5)
whether, under section 254 (1)(b)TIOPA 2010, each of the receipt scheme conditions has to be met in relation tothe company at the time the notice is given, so that notices given after the‘schemes’ have been completed are invalid (“
Issue e”);
6)
whether there could be a charge totax under Case VI of Schedule D in the relevant periods, as stated in HMRC’sclosure notices (“
Issue f”).
47.
The appellants intimated in their Skeleton Argument that they no longercontend that the receipt scheme conditions referred to must be satisfied at thetime of the notice.
[34]Issue (e) has therefore fallen away.
48.
Counsel tended to focus their submissions along the broad issuesoutlined above. We shall do the same but will provide our conclusions on eachof the remaining specific issues.
Facts
49.
A Statement of Agreed Facts is reproduced below. Although we have beenable to deal with what came to be HMRC’s primary argument without making anyfurther findings of fact both parties led evidence and invited us to makefurther factual findings. We discuss the more important aspects of thatadditional evidence below. In order to make sense of the evidence and theadditional facts found we have inserted further factual findings in
italics withinthe body of the Statement. Hopefully, this will preserve the logic andchronology of the existing Statement and amplify the relevant background andevents in an understandable way. We have changed parties’ abbreviations to thosewe have adopted at the outset of this Decision.
50.
Statement of Agreed Facts
.png)
1)
TheAppellants are Stagecoach Group plc (“
Group”), a company registered inScotland (SC100764) with its registered office at 10 Dunkeld Road, Perth, PH15TW and quoted on the London Stock Exchange, and one of its subsidiariesStagecoach Holdings Limited (“
Holdings”).
Group has a number ofsubsidiaries in which it holds, directly or indirectly, 100% of their sharecapital, including the following:
(i)
Stagecoach Transport Holdings plc (“
Transport”),a subsidiary of
Group;
(ii) The IntegratedTransport Company Ltd (“ITCO”), a subsidiary of
Transport; and
(iii)
Holdings, a subsidiary of ITCO.
2)
TheStagecoach group (“the group”) is a leading international transportation groupthat is listed on the London Stock Exchange. The group employs around 30,000people, and operates bus, coach, rail and tram services. The group has threemain divisions: UK Bus, UK Rail and North America.
Group, the parentcompany of the group, is a public limited company and is incorporated inScotland and tax resident in the UK. A diagram illustrating the relevant groupstructure is attached at
Tab 54
of the Bundle ofDocuments, Volume C.
The transactions to which these appeals relate concerna wholly but indirectly owned subsidiary of
Group:
Holdings, awholly owned subsidiary of ITCO which is itself a wholly owned subsidiary of
Transport.
3)
Holdings
is one of the group’stwo main management and shared services companies, and provides centralisedmanagement, accounting, payroll and IT services to the operating companieswithin the Group. SHL
Holdings employs approximately 150 employees andprovides director and executive management services. SHL
Holdings alsoemploys all of the UK-based senior group executives and UK Bus managingdirectors.
Group
had entered into a loanfacility with
Transport on 18 December 2009 (the “Loan Asset”). Underthe terms of the loan £88,105,104 was repayable by
Transport to
Groupon 31 March 2010. On 31 March 2010 the repayable date for the Loan Asset waschanged to 31 December 2010. On 30 June, the parties agreed a furtheramendment in respect of the calculation of interest on the sums lent.
Theloan was made for good commercial purposes, general investment purposes tofinance ongoing working capital requirements. The maturity date of the loanwas changed in March 2010 in order to align the terms of the loan with othergroup loans.
By early 2010, the balance sheet of
Holdingsdisclosed a cumulative profit and loss account deficit of £14.864m. Theseresults in turn led to
Holdings having net liabilities of £10.818m.
Holdingswas therefore technically insolvent and steps were taken to recapitalise
Holdings.
The initial commercial drivers for re-capitalisation were the poor state ofthe subsidiary’s balance sheet, making it difficult to obtain acceptable termsfrom third party suppliers; and increasing costs in relation to the PensionProtection Fund (PPF).
3A The PensionProtection fund was established under the Pensions Act 2004 as a statutory bodywith a duty to provide compensation to members of defined benefit schemes wherethe relevant employer becomes insolvent.
4)
InJuly 2010, Mr Hamilton,
Group’s Taxation Director and Director ofPensions and Employee Benefits, considered the Pension Protection Fund (“PPF”)levy scores and levy costs of
Holdings. On 26 July 2010 he soughtadvice from KPMG LLP. In relation the proposal to recapitalise
Holdingsusing a Forward Subscription Agreement (“FSA”), he budgeted £125,000 as thecost of implementation tax and accounting input and £50,000 as the cost ofreviewing the accounts and tax computations post-implementation after 30 April2011.
5)
MrHamilton,
who was also a director of Holdings
estimated the annual PPF levy savings which could be achieved by
Holdingsand Stagecoach Services Limited (“
Services”) (in respect of whom thesame recapitalization scheme was being considered) as in the range £175,000 and£238,000.
6)
KPMGprovided initial advice in early August 2010 and on 20 August 2010 issued aletter of engagement to
Group, accepted on its behalf by Mr Hamiltonthat day. The fixed fees agreed were the same as those budgeted for by MrHamilton in July, plus a “success” fee.
6A By this stage,the possible tax savings had become a significant feature of the wholeexercise. Much time and expense was incurred on obtaining tax advice. TheFSAs were structured with a view to obtaining a tax advantage or benefit. Group decided to proceed on that basis. While they may well have proceeded, inany event, with some form of recapitalisation, the possible fiscal benefitsidentified were a significant feature.
Even although Groupexpected there to be a reduction in the PPF levy the amount of the reductionwas small in comparison with the fees charged by KPMG which was principally fortax advice).
6B By letter toGroup dated 20 August 2010, KPMG set out confirmation of their engagement “todeliver tax advisory services …in connection with the recapitalisation of(Group’s) subsidiaries”. The letter records that it is proposed torecapitalise Holdings and Services and is “assessing doing this by subscriptionfor further share capital under Forward Share Subscription Agreements, and in atax efficient manner.” The scope of the services set out in the letter wasprimarily tax related; however, the services included an accounting opinion onthe recapitalisation of the subsidiaries, “including an accounting opinion onthe derecognition of the intercompany receivable and the resulting accountingentries in the effected (sic) companies.” The letter proposed fees of in total£175,000 plus VAT of which £50,000 related to commenting on the statutoryaccounts of the subsidiaries and assistance with the disclosure of thetransactions in the corporation tax computations and returns for the year to 30June 2011. An additional sum of £30,000 plus VAT was an outlay for obtainingTax Counsel’s opinion.
6C KPMG reported(on behalf of Group) the recapitalisation to HMRC under the DOTAS provisions. They described the transactions as “Tax-efficient recapitalisation of sub-groupby dercorgintion ( sc derecognition).” The Scheme reference number wasnotified to Group by HMRC on or about 28 October 2010. Such schemes areintended to produce a tax advantage. One of the main benefits that Group musthave expected to arise from the arrangements, namely the recapitalisation wasthe obtaining of a tax advantage
6D There werevarious means by which Holdings and Services could have been recapitalised. Group received tax and accountancy advice from KPMG. While Group was concernedabout PPF levy it did not ask KPMG to advise on that topic. The bulk of theadvice and most of the expense was tax related rather than the accountingtreatment. They were not asked to advise on the PPF Levy. The thrust of theadvice was that if the recapitalisation proceeded by way of a forwardsubscription agreement, the contingent subscription amount would not be taxablein the hands of Holdings or Services and would be given tax relief as a“derecognition debit”. The mechanism of the FSAs was suggested for thatreason. Group relied on that advice and proceeded to enter the FSAs on thatbasis. Holdings and Services were also aware of that advice, and proceeded inreliance upon it. They all proceeded with the FSAs in the expectation that theconsideration for the shares, would be relievable in the hands of Group and nottaxable on receipt in the hands of Holdings or Services, and thus provide abenefit to all three companies. One of the main purposes of the structure ofthe FSAs was to obtain a tax benefit or advantage, ie a relievable debit inGroup’s accounts and non-taxation of the receipts in the hands of Holdings. Thus, one of the main purposes of Group, Holdings and Services in entering theFSAs, was to obtain a tax advantage. These companies expected that in doing soan overall tax advantage would be obtained which was beneficial to each ofthem.
7)
On4 October 2010, quorate meetings of the directors of the
Group,
Holdings,ITCO and SBH
were held. At themeeting of the
Group’s directors, a briefing paper outlining theproposed recapitalisation of
Holdings (and
Services) was taken asread and FSAs were outlined and discussed.
Group resolved to pay £20,000(“Prepayment Amount”) to
Holdings and, following the repayment of theloan by
Transport, to pay “an amount of 22.4% of the amount receivedfrom
Transport to
Holdings as further consideration for theallotment of shares to its parent company by
Holdings. At its directors’meeting,
Holdings resolved to approve the FSA and to issue and allot toITCO 20,000 ordinary £1 shares for £20,000 plus 22.4% of the amount to berepaid by
Transport on 31 December 2010. An appropriate resolution wasmade at the meeting of the Directors of ITCO to enable the scheme to progress.
8)
On6 October 2010,
Group and
Holdings entered into the FSA pursuantto which
Holdings agreed to issue 20,000 ordinary shares of £1 each to ITCOon 31 December 2010 and
Group agreed to pay the nominal subscriptionamount of £20,000 plus a contingent subscription in a sum equal to 22.4% of theprincipal and interest repaid to
Group under the
Transport loanup to a maximum of £20m.
8A Clause 2.1 of the FSA provides:-
The Contributor (sc Group) agrees to paythe sum of (i) the Prepayment Amount and (ii) the Contingent SubscriptionAmount (up to a combined maximum amount of £20,000,000) as a contribution tothe capital of the Issuer (sc Holdings), and the Issuer agrees to allot andissue the Shares to (ITCO) subject to the terms of this Agreement
Clause 2(2) provides inter alia asfollows:-
The Consideration for the allotment andissue of the Shares shall be the Contribution Amount
which shall be satisfied as follows;
(a) theContributor shall pay the Prepayment Amount to the Issuer on the date hereof,such amount to be held as prepayment for the allotment and issue of the Shares;and
(b) the balance ofthe Contingent Subscription Amount payable subject to and conditional upon theprovisions of Clause 3.1 and 4.2 being;
(i) 22.4% ofamounts received in respect of the repayment of the Loan Agreement on or about31 December 2010.
..
Clause 3.1 provides inter alia asfollows:-
If, before the Issue Date, the Contributorshall receive…..any amount under the Loan Agreement…..from… the Borrower…, thenwithin one business day after…..the Contributor shall pay to the Issuer anamount equivalent to 22.4% of the amount of the Payment.
Clause 3.2 provides inter alia as follows-
……..nothing in this Agreement shallconstitute the transfer of the Loan Agreement or an assignment to the Issuer ofany of the Contributor’s rights and obligations under the Loan Agreement.
9)
Onentering into the FSA on 6 October 2010,
Group derecognised an amountequal to £19,735,543.50
[43]
representing a proportionate share of its loan relationship asset that wouldnow be passed to
Holdings on the event of settlement. The correspondingdebit was to investments.
10)
Onthe same day, 6 October 2010, KPMG LLP disclosed a scheme to HMRC in terms ofthe Disclosure of Tax Avoidance Regulations (DOTAS) as “Tax-efficientrecapitalisation of sub-group by recapitalisation”.
11)
Inconsideration for receiving the Contribution Amount from
Group under theFSA,
Holdings agreed to issue 20,000 £1 ordinary shares to its immediateparent company, ITCO. The terms of the FSA stated that on 31 December 2010
Holdingswould issue shares to its parent company regardless of whether any amounts(other than the Prepayment Amount) had been received from
Group. Underthe FSA the Prepayment Amount was payable on the date of the FSA and equalledthe nominal value of the shares to be issued to ITCO.
12)
Thenominal subscription amount of £20,000 was paid to
Holdings on7 October 2010.
13)
Onthe same day, 7 October 2010, HMRC advised KPMG LLP that the Scheme wasallocated the reference number 11460710 under DOTAS.
14)
On26 October 2010, the
Group’s Group Taxation Director prepared a journalfor the recapitalisation of SHL. On the same day, KPMG LLP told
Group thatthe Scheme was allocated the reference number 11460710 under DOTAS.
15)
On2 November 2010 KPMG LLP wrote to SG
Group to set out the proposedaccounting for the recapitalisation of
Holdings, in accordance with thesecond bullet point in para 1 of the letter of engagement of 20 August 2010.
16)
Asthe number of shares to be issued under the FSA was fixed, irrespective ofwhether
Group received any repayments of principal or interest under theLoan,
Holdings assumed a proportion of the economic risk of any delaysor defaults by
Transport in repaying the Loan to
Group.
17)
Onthe maturity of the Loan on 31 December 2010,
Transport repaid the fullamount of outstanding principal and accrued interest, totalling £90,111,876.80.
18)
Inthe event, 22.4 per cent of the amount received from
Transport exceededthe £20m cap in the FSA. Accordingly, a payment of £19,980,000 was made to SHL
Holdingson 31 December 2010
[45]
.
19)
Alsoon 31 December 2010,
Holdings issued 20,000 shares of £1 each to ITCO.
ACCOUNTING TREATMENT UPON ENTERING INTO THE FORWARD SUBSCRIPTION AGREEMENT
20)
Asat 5 October 2010,
Group’s balance sheet showed a cost of investment insubsidiaries of £978.5m (representing an asset in respect of
Group’sholding of shares in
Transport) and a loan debtor of £88.1m(representing an asset in respect of the
Transport Loan)
.
21)
On6 October 2010, as a result of entering into the FSA,
Group was, underUK GAAP (FRS 26), required to derecognise 22.4% of the principal amount of itsloan to
Transport, crediting (ie decreasing) the loan receivable duefrom STH
Transport and debiting (ie increasing) the cost of itsinvestment in
Holdings
. Both entrieswere in SG’s
Group’s balance sheet and both in the amount of£19,735,543.50
[48]
.
22)
Afurther debit to SG’s
Group’s cost of investment in
Holdings
was posted in respect of the nominal subscription amount of £20,000. It is notclaimed that any immediate tax consequences flow from this, and so no furtherreference has been made to this amount.
22A The parties areagreed that the accounting entries in this paragraph and in paragraph 21were made in accordance with generally accepted accounting practice.
23)
From
Holdings’ perspective, on 6 October 2010, as a result of entering intothe FSA, it recognised in its balance sheet an asset equal to the sum of thenominal subscription amount and the present value of the contingentsubscription amount expected to be received on 31 December 2010, therebyimmediately increasing its net assets by that amount.
23A If Transport haddefaulted and not repaid the loan to Group, subsequent accounting entries toreflect that would not have invalidated the derecognition entry or the debit toinvestments in the books of Group. Subsequently entries would reflect thechanged position but would not retrospectively remove the derecognition entry.
24)
Between6 October and 31 December 2010, income accrued to
Holdings as thecontingent subscription amount accreted (that is to say increased) from itspresent value at 6 October 2010. Those amounts were recognised in
Holdingsprofit and loss account as they accreted.
On 31 December 2010, when the contingent subscriptionamount was paid and shares were issued by
Holdings, a number ofaccounting entries resulted in the books of
Holdings. The full amount ofcash received at 31 December 2010 plus the nominal subscription amount (a totalof £20m) was credited to share capital/share premium account with matchingdebits to equity (shares to be issued - equal to amounts previously credited tothis account) and to the profit and loss reserve (equal to the accretion ofincome previously recognised in the profit and loss account over the period).
Holdings’net assets were unaffected by these entries.
24A All the relevant accountingentries in Group’s books and accounts were triggered by the recapitalisation ofHoldings and Services.
24B
Generally, where a loanis obtained by a company to pay for the construction of an asset, generallyaccepted accounting practice permits, but does not require, interest payable onthe loan to be capitalised rather than debited in the profit and loss accountof the company, that is to say it is charged to capital in the company’saccounts as part of the carrying value of the asset. Thus, if the interest iscapitalised, then fixed assets in the balance sheet are debited with theinterest, instead of the interest being debited to the profit and loss account,where interest payable under a loan would otherwise normally be recognised.
TAX TREATMENT ADOPTED BY
GROUP INITS CORPORATION TAX RETURN
25)
Group
brought into account anon-trading deficit of £37,721,456 in respect of its loan relationships for theaccounting period ended 30 April 2011.
26)
Amongthe elements making up this deficit is a loan relationship debit claimed unders320 CTA 2009 pursuant to
Group’s entry into the forward subscriptionagreement with
Holdings.
27)
Inits tax computation for the period ended 30 April 2011
Holdings has notrecognised as taxable any amounts receivable from
Group under the termsof the FSA.
28)
Group
submitted itscorporation tax self-assessments, for the period ending 30 April 2011,on 27 April 2012 and disclosed the Scheme’s reference number in the returns.
Group,ITCO,
Bus,
Holdings,
Services and
Transport allprepare their accounts in accordance with UK GAAP. In addition,
Grouphas adopted FRS 26.
29)
Enquirieswere opened into the returns pursuant to paragraph 24 of Schedule 18 to theFinance Act 1998 (“Schedule 18”) on 31 July 2012. Arbitrage notices undersection 249 TIOPA 2010 were issued by HMRC to
Holdings and
Services on21 September 2012.
Holdings and
Services did not amendtheir corporation tax return for the period to include the amounts of£19,735,543.50 in their taxable incomes for the period in accordance withsection 254 TIOPA 2010.
30)
On27 September 2013 HMRC completed its enquiries into
Group’s returns byissuing closure notices pursuant to Paragraph 32 of Schedule 18. The conclusionof the notice sent to
Group was that
Group was not entitled toclaim a deduction of £39,471,087 for the derecognised amount representing aproportionate share of the Loan Asset to be passed to
Holdings and
Services.
31)
Group
appealed against thoseclosure notices on 29 October 2013.
Submissions
Group
51.
In summary,
Group submits that s320 can be contrasted with s307. S320, differing from GAAP, identifies amounts that capture the credits ordebits in respect of a company’s loan relationship which are brought intoaccount in determining the value of a fixed capital asset. An example is capitalisedinterest where interest on a loan to construct a fixed asset is added to thecost of the fixed asset. The undisputed accounting treatment upon enteringinto the FSA was to derecognise part of the loan. The consequential accountingentries were
in respect of the loan. Those entries were to debit thecost of investment (the fixed asset) and to credit loans. The debit recognisesthe increased cost of the asset. S320 has been drafted widely and is notlimited to interest and expenses where relief would otherwise be denied becauseof their accounting treatment. Reference was made by comparison to CTA 2009s604 which introduced identical provisions for derivatives which do not carryinterest.
52.
It was simply wrong to say that the debit to fixed assets was not
inrespect of a loan relationship. The partial derecognition of
Group’s loanrequired a debit to fixed assets and a credit to loans. Both were in respectof the same thing, namely the derecognition of the loan. This accords with thesystem of double entry bookkeeping which recognises two corresponding butopposite entries to different accounts
in respect of each single eventor transaction. A debit to fixed assets on the partial derecognition of a loan(following an FSA) is
in respect of a loan relationship, notwithstandingit also reflects the additional cost of investment. Reference was also made toCTA 2009 ss455A and 354.
53.
Further, it was submitted that s320 debits are not subject to s307(3). This argument is said to be supported by the structure of the legislation, thewording and purpose of ss320, and 307, by previous legislation, and by acomparison with the derivatives contracts regime under CTA 2009 Part 7. Thedebit in question represents a loss arising to Group from its loanrelationship; it represents the economic outflow from Group’s loan relationshipinto the enhancement of its investment in
Holdings. The concept ofprofits and losses includes amounts recognised in other account statementswhich relate to movements in a company’s net asset position. Any gain in valueof Group’s investment in
Holdings is irrelevant. The substance of thetransaction is that
Group has lost its economic interest in the part ofthe cash flows committed to
Holdings; the loss arises from the fall inthe economic value of the loan and therefore arises
from the loanrelationship. Even if the s307(3) test is applicable the debit
,in question passes that test.
Holdings
54.
Ms Shaw acknowledged that the tax arbitrage issues only arose if HMRCwere wrong about the proper application of the loan relationship code. Inrelation to the receipt scheme notices and the tax arbitrage rules,
Holdingssubmits that receipt scheme conditions B, C and D are not satisfied. Inrelation to receipt condition B, reference was made to a statement in an HMRCManual that
A contribution to the capital of a company is any payment that
directlyincreases the company’s capital value as represented by its value toshareholders.
[54]
It is said that the increase in
Holdings’ capital value occurred atthe time the FSA was entered into when Holdings recognised the transaction foraccounting purposes, and not when the contingent premium was paid. Theagreement to pay the contingent premium in the future was not of itself apayment. Reference was made to
First Nationwide v HMRC.
Thepayment of the contingent premium itself was not a contribution to the capitalof
Holdings. It did not directly increase its capital. Rather, itsatisfied an existing obligation.
55.
Condition C was not satisfied because neither
Group nor
Holdingsexpected a benefit to arise because of the non-taxation of the receipt.Subscriptions for share capital are not taxable. Moreover, non-taxation of areceipt is not a benefit. The parties did not regard the non-taxation of thepayment as a benefit. The payment can only be a
qualifying payment,per condition B, if it is non-taxable. Condition C would always be satisfied. Here, the expected benefit arose because of the loan relationship debit in thebooks of
Group and not because of the non-taxation of the receipt by
Holdings. There was no causative link between the payment to
Holdings and thederecognition debit. The statutory focus is on the receipt of payment.
Biffa(Jersey) Ltd v HMRC
[56]
was wrongly decided, but is in any event distinguishable.
56.
Condition D is not satisfied because it is not the payment of the contingentsum that is deductible, it is the amount of the derecognised loan brought intoaccount in determining the value of
Group’s investment in
Holdings thatis deductible. There was no direct link between the deduction in respect ofthe derecognised loan and the qualifying payment.
57.
Finally, it was submitted that even if
Holdings were required torecalculate its income so as to bring the sum of £19,735,543.50 into accountthere is no mechanism for charging that amount to tax. S254 TIOPA was not acharging provision or a charging Act. The charge to corporation tax has effectin accordance with the provisions of the CTA 2009 that deal with itsapplication. Reference was made to ss2(1)(4), 35 (the charge applies to tradeprofits), 299 (non-trading profits in respect of loan relationships), incomenot otherwise within the application of the charge under the Corporation TaxActs (s979). The amount brought into charge was deemed to be Schedule D, CaseVI under Finance (No 2) Act 2005 s27. However, Schedule D Case VI was repealedby CTA 2009 for accounting periods on or after 1 April 2009.
The replacementlegislation, s979 CTA, does not impose a charge as deemed income is expresslyexempted by s979(2)(c). The surprising result is therefore said to be thateven if all the receipt conditions are satisfied the charge to corporation taxcannot be applied and so
Holdings is not liable for any additional tax.
HMRC
58.
In summary, HMRC submit that (i) the use of the proceeds (here, part ofthe sums repaid by the debtor) of a loan relationship to fund a shareacquisition is not a debit attributable to or
in respect of the loanrelationship; and is accordingly outwith the scope of s320 CTA 2009; (ii) ifthe use of the proceeds is within the scope of s320, it is subject to thegeneral principles of the loan relationship code, and in particular s307; (iii)it does not, moreover, represent a loss to
Group arising out of the loanrelationship or at all; and in the alternative, and (iv) the derecognised sumof £39,471.087,
[58]even if otherwise a tax deductible debit, gives rise to a mismatch which issubject to adjustment under the tax arbitrage rules of Part 6 of TIOPA andtherefore taxable thereunder or as miscellaneous income brought into charge byvirtue of s979 of the Corporation Taxes Act 2010.
The Evidence and Additional Findings of Fact
Peter Drummond
59.
Mr Drummond gave evidence as an expert accountant on behalf of HMRC. Hewas well qualified and experienced to do so. Before joining HMRC, he held asenior position in one of the
Big 4 accountancy firms for about 18years. Although now employed by HMRC, his independence and impartiality werenot in doubt and were not challenged. He has been an advisory accountant inHMRC’s
Large Business service since 2004. He advises tax colleagues onaccountancy matters relating to the largest businesses in the UK. He isfamiliar with UK GAAP and other accounting standards. We found him to becareful, thoughtful and straightforward in giving evidence. He was generallyreliable and credible.
60.
His task in preparing a report was to provide a detailed explanation ofhow and why the debit to investments of £39,471,087 arose in
Group’s accounts. He proceeded on the assumption that there was no dispute about that accountingtreatment. He therefore considered what the accounting treatment meant, whatit represented, and whether it complied with accounting standards. He was alsoasked to assume that
Group prepared its 2011 accounts in accordance withUK GAAP.
61.
In his report, he emphasised identifying the substance of thetransactions, ascertained by identifying whether there have been changes to thereporting entity’s existing assets and liabilities. He identified the relevantpart of the definition of financial assets as defined in FRS 25 as
acontractual right… to receive cash or another financial asset from anotherentity. He described the transaction as involving the provision ofadditional capital to
Holdings and
Services. He concluded that,in substance, the effect of the FSAs was to transfer part of the economicinterest in the loan (a financial asset) to
Holdings and
Services.
62.
He considered FRS 26 which addresses the detail of derecognition offinancial assets. The main focus was on the risks and rewards of ownership ofthe financial asset and control. His conclusion was that partial derecognitionof the loan was an acceptable accounting treatment. He had a doubt in relationto the assertion that the cap of £20m contained in the FSAs meant that what wasbeing recognised was a
fully proportionate share of the cash flows fromthe financial asset (ie the loan) (a requirement of FRS 26 paragraph 16(a)). He did, however, note that there was, in reality, no retained risk for
Groupbecause it was a parent company of
Transport.
63.
In summary, Mr Drummond concluded that partial derecognition of the loanreflected the economic effect of the transaction. He was satisfied that theamount derecognised in
Group’s balance sheet correctly reflected theproportion of the carrying value of loan transferred to
Holdings and
Services.
64.
In relation to what he described as the corresponding debit entry, heconsidered that the substance of the transaction was that the value of
Group’ssubsidiaries (
Holdings and
Services) had been enhanced, thenet assets of these companies increasing as a result of the transaction. Thedebit in
Group’s books recognised the control
Group has over itssubsidiaries which gives it rights to future economic benefits such as theproceeds of sale of the enriched subsidiaries or dividends from theirprofitable trading. He rejected the notion of the debit entry being treated asa distribution or a loss. The transfer of assets was to
Group’s subsidiariesand not to its shareholders. Moreover, it would be wrong to treat the debit asa loss because the substance of the transaction was that the value of
Group’ssubsidiaries,
Holdings and
Services, would be enhanced; theirnet assets, as shown in their balance sheets, would be increased as a result ofthe transactions ie their recapitalisation by way of the FSAs.
65.
He noted that the debit in
Group’s balance sheet was not intendedto represent the market or fair value of the additional investment, but torecord the cost of the assets, transferred to
Holdings and
Services. This accorded with the historical costs accounting rules.
66.
He summarised his views by observing that the recapitalisation of thesubsidiaries by way of FSAs was shown in
Group’s accounts as a partialderecognition of the loan with the corresponding debit entry taken toinvestments, the credit entry representing
Group’s decreased interest inthe loan to
Transport and the debit entry representing
Group’s increasedinvestment in its subsidiaries. The debit to investments reflected therecapitalisation of and
Group’s increased investment in thesubsidiaries.
67.
While, as already noted, he had some doubt as to whether all the rulesof derecognition contained in FRS 26 had been met, Mr Drummond considered,after careful analysis, that either they had been or that it did not matter. It is of some interest to note that he considered that, given
Group’s positionas ultimate parent, there was no real risk that the loan would not be repaid infull. This had a bearing on one condition of FRS26 which the part of the loanbeing derecognised had to meet. That condition was that that part comprisedonly a fully proportionate (
pro rata) share of the cash flows from theloan. The terms of Clause 2.1 of the FSAs
were such that, on one view, the part of the loan to be recognised was strictlyspeaking not fully proportionate, as, in theory,
Group retained some ofthe risk of the part of the loan being transferred in respect that if therewere some shortfall in repayment the risk of that shortfall would be borneentirely by
Group. Nevertheless, he viewed the lack of fullproportionality in Clause 2.1 as, in effect, immaterial as he accepted that thecondition was met or fell to be treated as met.
68.
Mr Drummond examined the other conditions of FRS 26 which required to bemet
[62]and concluded that they had been met. He again pointed out that
Group hadoverall control of the recapitalisation transaction. There was no real riskthat the transfer would not be carried into effect.
69.
Overall, HMRC were content to accept that the FSAs gave rise toaccounting double entries of
credit loans, debit investments. However,there was some dispute between the parties as to the effect of these entries.
70.
Mr Drummond amplified his report in evidence. He said that if thecontingent subscription amount had been for cash rather than by reference to aproportion of the loan, the debit entry would still have been to
investmentsbut the credit entry would have been to
cash and there would havebeen no derecognition.
[64]
71.
He acknowledged the soundness of the accounting example given inparagraphs 23-25 of HMRC’s Statement of Case, namely where a loan is obtainedto fund the purchase of a fixed asset at a cost of £100, the proper accountingtreatment is
Debit Cash £100, Credit Loan £100, followed by
DebitFixed Assets £100, Credit Cash £100. Where there are borrowing costs ofsay £25, these may be capitalised in the balance sheet under
Fixed Assets. The £100 is in respect of the purchase price. The £25 is in respect of theloan relationship and it attracts the relief under s320(1) that would have beenavailable had the accounting treatment been to record the interest as anexpense in the profit and loss account instead of capitalising it. Mr Drummondalso observed that capitalising the interest was a matter of accounting policychoice.
[65] That choice may, he said, be exercised where a lengthy period elapses beforethe asset is brought into use. The expense is entered in the balance sheet aspart of the cost of bringing the asset into use. That cost, (including theinterest) reflected as an asset in the balance sheet, is depreciated over timethrough the profit and loss account.
72.
Mr Drummond was also asked to consider the accounting entries arising ontotal default in repayment of the loan. He stated that in
Group’s booksthese would have been -
debit profit and loss account with the balanceof the loan, and
credit loans with the same balance thus eliminating theloan from the balance sheet. There would be no entries made in
Transport’s accountsas its liability as debtor under the loan remained. In the books of
Holdingsand
Services they would write off the asset previously recognised intheir balance sheets by debiting their profit and loss accounts with the amountof the balance (the contingent subscription amount) and crediting
theasset on their balance sheets, thereby eliminating it.
73.
Mr Drummond also expressed the view that where there is a transfer of anasset (as here ) to a group company, the debit is an asset, whereas if thetransfer had been to an unrelated third party, the debit would be a cost andnot an asset.
[67] While the debit reflected the cost of the asset, it was nevertheless an assetand reflected and represented future economic benefit and therefore there wasvalue inherent in it.
[68] The substance of the transaction was the capitalisation of the subsidiarieseffected through the FSAs; there was an investment in the subsidiaries whichshould be reflected in the accounting.
74.
More generally, he considered that the derecognition rules dealt withthe effect of the transaction in question on the assets already in the balancesheet.
[70] He thought credits and debits occurred simultaneously and corresponded with andequalled each other.
[71]
75.
In cross examination, he acknowledged that the carrying value of theloan asset had been diminished.
[72] Overall, he did not depart from the points mentioned above. We accept hisviews (which we have summarised) as sound.
John Hamilton
76.
We found Mr Hamilton to be generally reliable and credible. He provideda comprehensive witness statement. He was
Group’s director of Pensionsand Benefits and its taxation director. He was also a director of
Holdings. He was well able to appreciate the need for recapitalisation of
Group’ssubsidiaries,
Holdings and
Services, and the technicaldetails involved. We do not review all his evidence here. Much of it wasunchallenged and formed the basis of the Statement of Agreed Facts.
77.
Overall, viewing his written and oral evidence along with the otherdocuments before us it seems to us reasonably clear that by 6 October 2010,when the FSAs were entered into, the purpose in proceeding with therecapitalisation in that way, or at least one of the main purposes, was togenerate a relievable debit with no corresponding tax charge on thesubsidiaries on the contingent subscription amounts. These considerations werenot incidental to the transaction; they were to a material extent, therationale for it. The other, or at least another, main purpose was to enablethe balance sheets of the subsidiaries to be repaired (with appropriateaccounting entries) as soon as the FSAs were entered into. Group’s expectation,by 6 October 2010, was that the debit to investments would be relievable andthat the contingent subscription amounts would not be taxable in the hands of thesubsidiaries. This was a positive expectation rather than a negativeexpectation, that for example it would not expect the recapitalisation exerciseto be subject to VAT. One of the purposes of using an FSA as a vehicle tocarry into effect the recapitalisation of each subsidiary was to obtain a taxadvantage (a relievable debit with no corresponding tax charge on thesubsidiary). That was a benefit that
Group, Holdings and
Services expectedto be obtained as a consequence of recapitalising
Holdings and
Servicesby means of the FSAs.
78.
Group therefore
hoped that the tax effect of the FSA wouldbe to create a relievable debit. That was the reason the recapitalisation wasstructured in that way. Other means could have been used to effect immediaterepair of the balance sheets of the subsidiaries although these may have beenadministratively more complex. For example, a subscription through ITCO couldhave achieved the same result as Mr Hamilton accepted.
If there was anyother reason than achieving a tax advantage for specifying the considerationfor the shares by reference to a calculation of a proportion of the loanproceeds it was not the subject of evidence or submissions.
79.
Mr Hamilton said in his written statement
that the taxbenefit contemplated was incidental and that the recapitalisation was going tohappen in any event. However, in our view, the evidence of Mr Hamilton readfairly as a whole leads us to conclude that the anticipated tax benefit was notmerely incidental. It was a significant feature of the decision makingprocess.
[75]
Group spent significant sums on obtaining tax advice. It received suchadvice.
[76] It relied on it as did
Holdings and
Services.
Itcarried it into effect by entering into the transactions with
Holdings and
Services.
[78]
These transactions were the recapitalisation of these two companies bymeans of FSAs.
[79]
80.
Mr Hamilton did not suggest any non-fiscal reason for expressing thecontingent subscription amount as a percentage of the loan. Under pressure ofcross-examination, he accepted that
Group, Holdings and
Servicesrelied on the tax advice received from KPMG and counsel and expected to obtaina tax benefit from recapitalisation through the FSAs.
81.
It seems to us plain that on entering into the recapitalisation schemein the manner in which they did, both
Group,
on the one hand, and
Holdings and
Services on the other hand expected that taxbenefits or advantages would arise. The benefit or advantage was expected tobe that the consideration under the FSAs would create a tax relievable debit ofan equivalent amount, thus benefitting
Group, without any consequentfiscal liability falling on
Holdings or
Services by virtue of thereceipt of the capital sums identified in and calculated by reference to theFSAs.
82.
It is correct that
Group, Holdings and
Services alsoexpected that there would be a reduction of the PPF levy and we have madefindings of fact about that. However, that does not eliminate or dilute theimportance of their fiscal expectations. This is relevant to the considerationof the tax arbitrage provisions in TIOPA, which we discuss below.
Discussion and Decision
Issue (aa); In respect of a company’s loanrelationship (s320(1))
83.
HMRC submit that the debit relied upon was not
in respect of Group’sloan relationship at all. Rather, it was in respect of the FSA. If thatis correct, all
Group’s arguments must be rejected and the appealdismissed.
84.
This raises a question of statutory construction applied to the basicfacts of the transaction. Many of the facts in the Statement of Agreed Factshave no bearing on this question. The same can be said for much of the oralevidence. If it is correct, as Ms Shaw submitted, that the purpose of thetransaction was not relevant to the issue, the purpose of the statutory provisions
is, nevertheless, relevant to the determination of the question ofstatutory construction. In short, do the basic facts, realistically assessed,fall within the scope of the statutory provision, purposively construed?
85.
The phrase
in respect of has a causative flavour but it is not a
butfor test. The phrase
in respect of is more pointed than
relatingto or
in relation to. One might ask how did the debit arise; whatwas the reason for it? Will any tenuous connection suffice or must oneascertain the root cause of the debit before one can conclude what it is
inrespect of?
Such an approach might correlate to a wider or anarrower statutory construction. We endeavour to give the relevant statutoryprovisions a purposive construction bearing in mind that it has been acceptedat all hands that the accounting treatment was in accordance with generallyaccepted accounting practice.
86.
The purpose of Part 5, CTA 2009 is to set out how profits and deficitsarising to a company from its loan relationships are brought into account forcorporation tax purposes.
[81] Profits and deficits arising to a company from its loan relationships are to becalculated using the credits and debits given by Part 5.
Profits andlosses from loan relationships may include profits or losses of a capitalnature.
[83] Debits are equiparated with deficits. Profits and losses from loanrelationships include reference to profits or losses from related transactions.
A relatedtransaction means a disposal or acquisition of rights or liabilities under theloan relationship.
[85] That would include assignation and a variation. A related transactiontherefore has to affect the rights and obligations of the parties under theloan relationship. A transaction which is related in some way to a loanrelationship which does not affect rights or liabilities under the loanrelationship is not a related transaction. The parties are in agreement thatwe are not concerned with a related transaction.
87.
Whatever causative or other type of test is applied to determine whetherthe debit was in respect of
Group’s loan relationships, it is not met. The loan by
Group to
Transport already existed on 6 October 2010when the FSAs were entered into and the debit brought into account indetermining the value of fixed capital assets in
Group’s accounts,namely its investment as ultimate parent in two of its subsidiaries, over whichit had complete control. The
but for test of causation is not met. Itwould however, be correct to say that but for each FSA there would be nodebit. This at least illustrates the causative potency of the FSAs. It isincorrect to say that but for the loan relationship the debit would not havebeen brought into account. Mechanisms other than the medium of the loan to
Transportcould have been deployed.
Group could have injected cash into
Holdingsin exchange for the allotment and issue of shares. That would have led tothe same debit but would not attract relief.
Group could have obtaineda loan for the express purpose of funding the project. The finance cost ofdoing so (interest and expenses) could have been a debit to investments inaccordance with generally accepted accounting practice. That would be a debitin respect of the company’s loan relationship. Thus, capitalised interest isbrought into account by virtue of s320 as if it were not being capitalised. These finance costs, despite their treatment in the company’s accounts, arethus brought into account in the same way as a debit (ie an expense) which isnormally brought into account in determining the company’s profits or loss inaccordance with generally accepted accounting practice.
88.
Group sought support from the underlying rationale of theaccounting treatment, even although the accounting treatment itself was not indispute. To that end, technical accounting matters were examined in evidencein some detail with Mr Drummond. However, such an examination does not assist
Groupto elide the fundamental point that the debit in question was in respect ofthe re-capitalisation of the subsidiary; that was the transaction, rather thanthe transaction being the loan or its repayment. The reference to the LoanAgreement in the FSA clause 2.2(b)(i) is made as a means of calculating thebalance of the consideration (the Contingent Subscription Amount). This is madeclear by clause 3.2 which provides that the FSA is not to constitute anassignation of any rights under the Loan Agreement. This dilutes rather thanstrengthens any connection between the FSA and the Loan Agreement. Theinclusion of the loan to
Transport was a deliberate but incidentalmechanism designed as a means of identifying the price payable for the sharesand to secure a tax advantage.
Transport was not a party to the FSA and
Holdings was not a party to the Loan. The source of the amount whichconstitutes the debit (which in turn anticipates receipt) is the general fundsof
Group, calculated by reference to the repayment of the Loan
. TheFSA does not ring fence any part of the proceeds of the Loan or impress anysuch part with some sort of constructive trust.
89.
We repeat that the transaction was the re-capitalisation of eachsubsidiary through the medium of an FSA. The pre-existing loan relationshipwas incidental; it was essentially the mechanism by which the contingentsubscription amount was calculated; that sum was not in respect of the loanrelationship; it was in respect of the FSA which determined its amount andspecified the obligations to be implemented in respect of it.
90.
Ms Shaw relied heavily on the evidence of Mr Drummond to support theconclusion that the debit
is in respect of the loan relationship. Weconsider that Ms Shaw was wrong to do so. In the first place, while hisevidence may be relevant, it is not determinative. We know what the loanrelationship was. That is a question of fact which is not in dispute. Theloan relationship is essentially the contract of loan between
Group and
Transport. That was a transaction for the lending of money.
Group stoodin the position of creditor and
Transport stood in the position ofdebtor.
[87] There was no debit attributable to the partial derecognition of the loan. Thederecognition of the loan was recorded in
Group’s books in accordancewith generally accepted accounting practice as a credit.
91.
Moreover, in the second place, our assessment of Mr Drummond’s evidenceis that he did not say that the debit was in respect of the loan relationship. We have examined his Report and reviewed the transcript of his evidence. We donot consider that his evidence, fairly read, is that the debit is in respect ofthe loan relationship or the derecognition. He said that, for eachtransaction, the debits must always equal the credits; they correspond to eachother.
[88] He described the transaction as the capitalisation or re-capitalisation of thesubsidiary.
[89]
92.
Both the debit and the credit were thus in respect of therecapitalisation. All the accounting entries were triggered byrecapitalisation.
Group, Holdings and
Services expected that thetax effect of the FSAs would be to create a relievable debit and no taxliability on the recipients. That was the reason the recapitalisation wasstructured in that way. As we have already noted, other means could have beenused.
[90]
93.
Group submits that the source of the debit is the loan and theaccounting characterisation of it is determined by the recipient. While it maybe correct that the recipient determines the accounting characterisation of thedebit, that does not identify the source of the debit. Here, we do not acceptthat the source is the loan. The debit is in respect of the rights andobligations created by the FSA. Entering into the FSA triggered the debit. The FSA creates the obligation and right to acquire
shares, theobligation to pay and the right to receive payment for them. The sums to bepaid and received are determined by the terms of the FSA. The
debit
toinvestments anticipates the receipt of the balance of the purchase pricefor the shares. In that sense, the debit is dealing with and thus in respectof the consideration for the shares. The amount to be paid and the date ofpayment are specified by reference to the terms of the Loan and the amountrepaid by the debtor (
Transport) under it. The entry in the balancesheet, in accordance with historical cost accounting rules,
reflects thepurchase price of the shares to be issued. That price could have beencalculated in a variety of ways without reference to the Loan between
Group and
Transport.
94.
The debit is not a loss from a loan relationship. It does not representa loss at all. The loan principal and interest were repaid in full. That loanrelationship led to a profit for
Group or at least did not give rise toany loss.
The debit represents increased investment and future economicbenefit. That is its justification. The balance sheet of the subsidiary isrepaired. The repair is reflected in the increased carrying value of
Group’sinvestment in the subsidiary (future expected economic value rather thanactual market value), and in the balance sheet of
Holdings. AsMr Drummond pointed out,
[93]the assets
Group could recognise in its balance sheet were greater as aresult of the transaction; this was so, as assets represent future economicbenefits; so, in that sense,
Group obtained something in return for theinvestment. In these circumstances, the
debit to investments isdifferent in substance from a
debit that is brought into account in theprofit and loss account.
95.
It is of some interest to note that even the appellants in theirSkeleton Argument, albeit in relation to the arbitrage/receipts notice case,state that
The debit in SG (ie
Group)
arose because of theFSA.
[94]
We agree. It is difficult to see how the appellants can sensibly arguethat the debit was
in respect of the loan relationship with
Holdingswhen it is accepted in effect that it is attributable to, arises from and wasthus caused by the FSA.
96.
It makes no sense to give s320 a wider meaning and permit such adeduction in determining a company’s profits and losses. S320 must be construedin the context of the overall purpose of Part 5 of CTA 2009, namely todetermine how profits and deficits arising to a company from its loanrelationship are brought into account for corporation tax purposes. The debitin question is not or at least does not create a deficit in respect of a loanrelationship.
97.
It makes good sense to permit a deduction from profits which is alegitimate business expense and thus a deficit, or which at least may cause adeficit, which, because of generally accepted accounting practice, may featurein the balance sheet (for example, as capitalised interest) rather than as adebit in the profit and loss account. It also respects the overarching purposeof Part 5 of CTA 2009 which is concerned with how profits and deficits arisingfrom a company’s loan relationships are to be brought into account forcorporation tax purposes. Interest on a loan is an expense; it is a deficitthat would often be found in the debit side of a profit and loss account. Capitalising it and entering it in the balance sheet instead of entering it inthe profit and loss account does not deprive it of its inherent nature as adebit causing or contributing to a deficit. S320 allows it to be brought intoaccount in determining the company’s profit or loss even although generallyaccepted accounting practice may bring it into account, not in the profit andloss account, but in the balance sheet in determining the value of a company’sfixed capital asset.
98.
Properly analysed, the debit to investments enhances the assets of thesubsidiaries (
Holdings and
Services)
. One of the purposesof the transactions was to repair the balance sheets of these companies. Repairing the balance sheet, of its very nature, improves the financialstanding of the subsidiary companies in the eyes of third parties, includingcreditors, and makes trading with the subsidiaries a more attractiveproposition. In like manner, the value of
Group’s increased investmentin the subsidiaries is reflected in its balance sheet (under historical costaccounting rules) by reference to the cost paid by
Group in terms of theFSAs. As Mr Drummond put it,
Group obtains as an asset, a further andincreased investment in its subsidiary, which, in accounting terms, was of agreater amount than it had been before.
99.
If, however, the transactions are considered by reference to the groupof companies together, the consolidated accounts, as Mr Drummond pointed out,would contain no entries for the transactions.
The group is simply moving funds from one corporate pocket to another, overwhich
Group has, ultimately, complete control. Nothing is gained andnothing is lost. It would be wrong in principle to recognise such re-arrangementsas creating a tax allowable loss or debit without any corresponding charge totax. This has been described as an unusual
intra group transaction
and there is noobvious reason to conclude that Parliament intended that the general principleof tax symmetry should be violated which would be the result if the appeal wereto be allowed.
[98] While we are not concerned directly with entries or the absence of entries inconsolidated accounts, as Ms Shaw has pointed out, viewing matters from a groupperspective underlines the surprising consequence which flows from
Group’s principalargument, that an entry which is unconnected with the calculation of acompany’s profits and losses, and which represents a capital payment, shouldnevertheless create a tax relievable sum.
100.
While itmay not be relevant to the question whether the debit in question was
inrespect of Group’s loan relationship with
Transport, it seems to usthat the key to the application and operation of s320 (which was much discussedthroughout the hearing) is where generally accepted accounting practice
allows(but does not require) a debit to be treated in a company’s accounts as anamount brought into account in determining the value of a fixed capital asset. Accounting practice may permit such treatment but the debit could instead betreated as a debit in the company’s profit and loss account. Capitalisation ofinterest and other costs of financing a loan, such as an arrangement fee, areexamples of a debit that could have been treated as an expense in the profitand loss account and deducted as a debit in determining a company’s profits andlosses. Instead, because generally accepted accounting practice permits it,the debit, if capitalised, appears in the balance sheet and not in the profitand loss account. Nevertheless, the debit is brought into account in the sameway as an item of expense in the profit and loss account for tax purposes. That is so because the debit is an item of expense that would, but for theaccounting treatment, have been brought into account in determining thecompany’s profit or loss.
101.
Thus, althoughthe debit is capitalised as allowed by generally accepted accounting practice,s320 restores any relief to the debit that would otherwise have been given bys307 but for the accounting treatment. It is brought into account
in thesame way as a debit which is brought into account in determining thecompany’s profit or loss.
102.
Puttingmatters more broadly, Part 5 of CTA 2009 sets out how profits and deficitsarising to a company from its loan relationships are brought into account forcorporation tax purposes. Normally, they are brought into account inaccordance with generally accepted accounting practice. Profits and losses aregenerally concerned with income and expenses. If an expense arising from aloan relationship would be denied relief only because of its accountingtreatment, s320 gives relief. If accounting treatment of an item allocates itto the balance sheet, such as the cost of purchase of shares, because it wouldnever appear in the profit and loss account as an item of relievable expense,s320 cannot magically transform it into a relievable expense. Such an itemcould never be characterised as or creating a deficit or a loss or expensearising from a company’s loan relationship. S320 gives relief for an expensein respect of a company’s loan relationship (such as the payment to a creditorof interest on a loan), where, because, and only because, of the accountingtreatment, that relief would otherwise be denied. The general rule in s307applies even where generally accepted accounting practice places the item inthe balance sheet, provided the item when taken with the other items in theprofit and loss account fairly represent the company’s profits and losses. Thisseems to us to reflect and give effect to the purpose of s320 having regard toits context and the scheme of Part 5.
103.
For whatit may be worth, the foregoing analysis is consistent with paragraph 1081of the Explanatory Notes
[99]to s320 of CTA 2009.
104.
Here, thesum paid by
Group for the allotment and issue of shares in a subsidiarywould only be treated in its accounts as a debit brought into account indetermining its profits or loss if s320 applied to it. No one has suggestedany other basis on which it could be so treated. It would never feature in
Group’sprofit and loss account and no one has suggested that it would.
105.
Ms Shawsought support from the accounting treatment that would have arisen if the loanhad been waived. We did not find this helpful. Waiver affects the formalrights and obligations of debtor and creditor in a loan relationship. Theformal position and economic substance are the same between the two contractingparties, debtor and creditor. The true focus here is the FSA with the loanrelationship being a subsidiary relationship between one contracting party (
Group)and a different (third) party, used as a mechanism to calculate the pricepayable under the FSA.
106.
It wasalso argued that HMRC’s principal contention was inconsistent with s354 ands455A CTA 2009. S354 is concerned with the exclusion of debits for impaired orreleased connected company debts. However, that section does not appear to behelpful or relevant to the proper construction of s320 or the correctapplication of the facts as we have found them to be. Neither excludes HMRC’sprincipal argument that the debit is simply not in respect of
Group’sloan relationship with
Transport.
107.
We do notconsider s455A to be relevant. S455A(2) could not apply because the debit, aswe have found, would
not be brought into account under s320. Accordingly, there is no debit that would, apart from s455A, be brought intoaccount for the purposes of Part 5 of CTA 2009. S455A does not therefore dealwith the circumstances (as we have found them to be) of
Group’s appeal.
108.
If we arewrong, and the debit
prima facie falls to be brought into account unders320, it does not affect our decision on this or any other issues in theappeals, that the debit might also have been caught by s455A (had it been inforce, as Mr Ghosh may have been prepared to accept
). This isbecause of our findings in relation to the FSA to the effect that one of themain purposes of
Group and
Holdings in entering it, was to obtaina tax advantage. Our findings of fact would fall within the definition of
taxadvantage in s1139 of the Corporation Tax Act 2010 subsequently applied to s455ACTA 2009 by s476(1) of CTA 2009.
Tax advantage includes relief from orthe avoidance or reduction of a charge to tax, whether by accrual of receiptsin such a way that the recipient does not bear tax on them or by a deduction incalculating profits.
109.
We do notneed to decide whether the debit would have been caught by s455A. S455A wasintroduced by the Finance Act 2011, Schedule 4, paragraph 5, and applies toaccounting periods beginning on or after 6 December 2010. It has no relevancehere and we decline to construe s320 in the light of the subsequent legislativeenactment of s455A. It is perhaps worth noting that a tax avoidance provisioncan be applied even if there are other provisions which could be invoked toprevent the avoidance of tax. It is said to be an unremarkable consequencethat HMRC should have overlapping taxation powers; such a construction cannotcause any unfairness to the taxpayer since he cannot be taxed twice in respectof the same income.
[101]
110.
Nor did wederive assistance from reference to earlier incarnations of the relevantlegislation or what were said to be mirror provisions in the derivatives’code. We were referred to FA 1996 s84 and Schedule 9, and FA 2002 schedule 26,as well as to ss595 and 604 CTA 2009 and relative Explanatory Notes.
The languageand context are not identical
[103]and the analogy advanced, unsupported by authority, was not in our view,persuasive, notwithstanding Ms Shaw’s able and powerful presentation. While weaccept that it is permissible, where there is ambiguity in rewrittenlegislation, to refer to a previous legislative iteration,
we do notconsider it appropriate to do so here. The relevant statutory provisions inthe present appeals have been the subject of competing interpretations andsubmissions, but that does not mean they are ambiguous. Neither party appearsto assert that there is statutory ambiguity. Had there been binding authorityon an earlier version or iteration of a critical statutory provision, then itmight well have assisted us. However, our attention has not been drawn to anysuch authority.
111.
Further,in our view, the principles of double entry book-keeping do not lead to theconclusion that the debit to investments is in respect of a loan relationship. Ms Shaw submitted that double entry bookkeeping is a method of accountingby which a single event is recorded twice in the accounts, once to the creditof one account and once to the debit of another account. We acknowledge thatto be correct in principle. The event was said to be the partial derecognitionof the loan. The question is to identify the event.
112.
We do notagree that the event is the partial derecognition of the loan. That is thecredit entry or rather what the credit entry does. The event is thetransaction for the recapitalisation of each subsidiary, which is essentiallyan agreement to subscribe for the issue of shares for a sum, calculated byreference to the loan agreement between
Group and
Transport, witha cap on the price of £20m. This is consistent with Mr Drummond’s analysis ofthe nature of the transaction; he referred to
the derecognition through theFSA.
[105] The fact that credit and debit entries arise simultaneously, as Mr Drummondpointed out,
[106]seems to us, at the end of the day to be neither here nor there. That is theessence of double entry bookkeeping.
113.
Moreprecisely, the event is the entering into the FSAs on 6 October 2010. On thatdate, rights and obligations were created between
Group and eachsubsidiary. The substance of those rights and obligations was reflected in thebookkeeping entries. The debit entry relating to each subsidiary representedthe bulk of the anticipated purchase price for or cost of the subsidiaries’shares which were to be issued to ITCO and
Bus, namely £19,735,543.50. What was booked was an asset not an item of expenditure. The figure insertedreflected the cost of the asset but that, in turn, measures its value underhistorical cost accounting rules. The credit entry was the partialderecognition of the loan to
Transport. The event was the entering intothe FSA. The, or at least, a consequence was the debit entry reflecting theanticipated price, and the credit entry reflecting in substance the diminishedeconomic interest of
Group in the loan to its subsidiary even althoughthere had been no actual change in the loan relationship between
Group and
Transport. The loan was subsequently repaid in full with interest; thathad the effect of capping the calculation of the sum payable in terms of theFSA at £20m. Accordingly, £19,980,000 (£20m less £20,000 - the nominalsubscription amount already paid on 7 October 2010) was paid by
Group toeach of the subsidiaries on or about 31 December 2010.
114.
Finally,we note a further argument for
Group that it was enough for the debit tobe in respect of both the loan relationship and the recapitalisation. That istantamount to saying that the debit was in respect of the contractualrelationship between
Group and
Holdings (theFSA/recapitalisation)
and between
Group and
Transport (thecontract of loan).
115.
Weconsider that
in respect of will not bear such duality. While it may betrue that the debit has some connection with the derecognition, that is onlybecause the FSA refers to the loan between
Group and
Transport asthe mechanism for identifying whether the conditional element of the FSA ispurified and the amount payable thereunder. The amount payable under the FSAis not a money debt arising from a transaction for the lending of money. The debitreflected by the anticipated price payable for the shares to be issued underthe FSA, cannot in any sense be properly described as being in respect of thepre-existing loan relationship. The debit was the purchase price for theshares being created and issued. As such, it did not affect the loanrelationship between
Group and
Transport;
it could not, inany sense, be
in respect of that loan relationship.
116.
Overall,even if Ms Shaw’s analysis on cost accounting and the effects of repairing thebalance sheet are sound, it does not destroy or even prejudice the simpleargument that the debit is
not in respect of a loan relationship. Theexistence of the debit is entirely attributable to the FSA and its preciseamount attributable to the method of calculating the consideration for theshares by reference to the loan agreement. The making of the debit and theconsequent payment of it had no effect on the loan relationship between
Groupand
Transport. The loan was not varied and it was paid in full in accordancewith its terms.
117.
We answer
issue(aa) by holding that the debit claimed by
Group is
not inrespect of a company’s loan relationship within s320 CTA 2009.
118.
On thisbasis
Group’s appeal must fail. On this basis, too, the receipt noticesdirected at
Holdings and
Services are no longer required. Theywill fall away and the appeal against
Holdings must be allowed. Anyview we express on the remaining arguments in these appeals will be
obiter. However, as this decision may be appealed, we give our views on theremaining issues identified in paragraph 46 above.
Issue (a):- whether the deductibility of debits unders320 CTA 2009 is subject to the provisions of section 307(3)
Issue (b):- whether s307(3) requires the debits andcredits to be tested to establish their nature?
Issue (c):- if so, whether the debits (sic) claimed byGroup fairly represent losses arising from their respective loan relationshipsunder s307
119.
Issues(a), (b) and (c) do not now arise. Issues (a) and (b) are the second issuediscussed by Ms Shaw in her closing submissions and Issue (c) is her thirdissue. They are all academic because we have held that the debit in questionis not deductible under s320 CTA 2009. It was not in respect of a loanrelationship within s320 CTA 2009. It is not therefore necessary for usexpressly to consider s307(3). However, as the parties wish us to determinethese issues, we do so on the basis that their determination is not requiredfor the decision on issue (aa) which we have reached.
120.
We havealready considered the structure or architecture of part 5 of the 2009 Act. Chapter 3 of Part 5, as s306 itself records, contains rules of generalapplication about the debits and credits to be brought into account for thepurposes of Part 5. Both ss307 and 320 lie within Chapter 3. The general ruleis that for
credits and debits (arising from a company’s loanrelationships) to be brought into account for corporation tax purposes, theymust be recognised in determining the company’s profit or loss in accordancewith generally accepted accounting practice. That is a general rule. Ouroverall view is that the debit in question does not
arise from the loanrelationship with
Transport. Even if it did, it does not represent aloss. It cannot therefore
fairly represent a loss.
121.
Thatgeneral rule
[107]is subject to s307(3).
[108] It expands the general rule by stating that the credits and debits brought intoaccount in respect of a company’s loan relationships are the amounts that, whentaken together, fairly represent profits and losses arising from its loanrelationships. The fact that it is set out in the third of six subsections
is not relevant.
122.
S307(3)applies generally to
credits and debits arising to a company from itsloan relationships brought into account for corporation tax purposes
. Thatmust include a
debit allowed by s320. A s320 debit is not expresslyexcluded from the scope of s307(3). By s320(2), a credit or debit is broughtinto account
in the same way as such a credit or debit. To enable it tobe brought into account, a s320 debit must therefore comply with s307(3)notwithstanding its accounting treatment (in the balance sheet) in thecompany’s accounts. Any other view makes no sense, because s307(6) requiresthat any credit or debit, brought into account by generally accepted accountingpractice under s307(2), must also meet the requirements of s307(3). If therequirements of s307(3) are not met, then the credit or debit cannot be broughtinto account, whatever the accounting treatment may have been.
123.
What arethe ingredients of s307(3)? The credits and debits must be
in respect of Group’sloan relationships. They are not, for the reasons already given. However,assuming that they are, they must, when taken together, fairly represent (i)all profits and losses that arise to it from its loan relationships, (ii) allinterest under that relationship, and (iii) all expenses incurred under or forthe purposes of that relationship and transaction. We are not concerned with(ii) or (iii). The credit or debit must
arise from the loanrelationship. This raises the question of causal connection. Thus, the way orroute for a credit or debit to achieve recognition is there set out. A s320debit is to be recognised
in the same way. Thus, the generalrequirement of fair representation and causation apply to a s320 debit if it isto be brought into account. Neither of these requirements is met.
124.
The phrase
in the same way provides the connection between ss320 and 307(3). Otherwise, it seems to have no function.
Group appears to read s320(2)as if the words
in the same way as a credit or debit which is brought intoaccount were omitted. That does not seem to us to be the correctapproach. In the
same way seems to us to refer to the generalcircumstances in which the credit or debit may be brought into account andthese are set forth in s307(3). The Parliamentary draftsman has used adifferent form of cross reference in s332, perhaps for emphasis because thatsection is dealing with specific types of financial arrangements (repo or stocklending arrangements).
125.
S320 doesnot say that the credit is to be brought into account
as if it were a creditor debit which has been brought into account in determining the company’sprofit or loss. It is therefore necessary to consider the way in which acredit or debit is brought into account in respect of its loan relationships indetermining the company’s profit or loss. It is only brought into account ifit fairly represents a profit or loss arising to it from its loan relationships(s307(3)(a)). That is or at least may be a test over and above the test ofgenerally accepted accounting practice. Normally, if the debit or credit isrecognised in accordance with generally accepted accounting practice it willfairly represent a profit or loss.
126.
Group submitsthat s307(3) should be read as a composite whole and not as a broadanti-avoidance rule applying a generalised notion of fairness; rather, itshould not be read in isolation at all but as an element in the process ofidentifying the relevant accounting debits and credits. Reference was made to
D
CCHoldings
[110]
and to the fact that a company’s statutory accounts must give a
true andfair view.
[111]
The suggestion seemed to be that the phrase added nothing and was notintended to be a freestanding enquiry into the worthiness of an accountingcredit or debit.
127.
As we haveconcluded that there is no loss (see below), the proper construction of
fairlyrepresent in s307(3) does not arise. However, we do not, in any event,consider that it can be ignored which seems to be the effect of
Group’s submissions. It may be a question of emphasis or some form of cross-check, but if it is,that fits with our analysis of the relationship and connection between ss320and 307.
128.
In
DC
CHoldings, the main question was whether certain loan transactions (fivefixed price repo transactions) gave rise to taxable interest. There was apatchwork of anti-avoidance legislation to consider and a number of difficultissues to resolve. The loan relationship code (and predecessor legislation)was discussed in detail under particular reference to repo transactions. Thecourts had to determine whether the relevant statutory provisions could beconstrued so as to avoid what was described as an absurd asymmetrical result,namely DCC’s deemed income receipts being different from its deemed interestpayments as a borrower which was party to a loan relationship.
The need for asymmetrical solution lay at the heart of the appeal and came from the statutorypurpose of the relevant statutory provisions.
The decision inthe Supreme Court, affirmed the decision of the Court of Appeal but fordifferent reasons. The result expressly satisfied the equivalent statutoryrequirement of fair representation.
[114]
Group’s reference to
composite whole is presumably taken fromparagraph 35 of the Supreme Court’s Judgment, where the parties’ view of thesubsection was adopted without analysis. The views expressed on this point inthe Court of Appeal by Moses LJ were doubted, but without explanation. In theCourt of Appeal,
[115]Moses LJ, clearly thought that s84(1) contained two distinct criteriaapplicable to the sums to be brought into account, the first being theaccounting method and the second being that the sums should when taken togetherfairly represent all the interest under DCC’s loan relationships.
This, he said,gave rise to the possibility of some adjustment. Rix LJ said the statutoryphrase
taken together fairly represent were important words and had tobe given their full effect; this was a matter for the court rather than expertevidence.
[117]
129.
Whateverview one takes of the statutory phrase, it does not affect our overall decisionon any of the issues discussed.
130.
Thequestions therefore come to be
Was there a loss? If so
Did the lossarise to Group from its loan relationship with Holdings? In our view, theanswer to both questions is No. The debit does not represent a loss at all. It represents the future economic benefit of an investment by a parent companyinto one of its subsidiaries over which it has complete control, whetherdirectly or indirectly. It undertook contractual obligations to make capitalcontributions to its subsidiaries, calculated by reference to its loanpreviously granted to another subsidiary (
Transport). No loss was madeby
Group which arose from its loan relationship.
131.
The sumpaid by
Group to
Holdings on or about 31 December 2010(£19,980,000) implemented the final part of
Group’s obligations underthe FSA.
It had already paid £20,000 on 7 October 2010. The sums paidto
Holdings came from
Group’s general funds rather than anassignation of the right to the actual receipts of the loan relationship. Theloan was not assigned in whole or in part.
132.
Accordingly,the debit in question does not represent a loss of
Group that arises toit from its loan relationships. It represents the cost of a capitalinvestment. Such a cost, however expressed, has no place in a company’s profitand loss account, unless s320 magically converts, by some unintended process offiscal alchemy, the transfer of
Group’s funds from one corporate pocketto another corporate pocket, both under its ultimate control, into a taxrelievable debit. In our view, it does not do so.
133.
The debitthus does not arise from a loan relationship at all, but from the contractualobligations in the FSAs. In terms of the Loan,
Transport borrowed moneyfrom
Group long before the FSAs were entered into
. Transport repaidthe whole loan plus the contractual interest. That transaction made a profit(not a loss) for
Group, namely the receipt of interest at thecontractual rate and repayment of the loan in full.
134.
It was,however, submitted by
Group (on the assumption that the debit toinvestments fell within s320) that it fairly represented a
loss arisingfrom its loan relationship. This is a reference to the loan relationship with
Transport. Reliance was placed on a dictionary definition of
loss as meaningbeing
deprived of or
ceasing to have. That led to the argumentthat the debit represented the partial deprivation of
Group’s loanrelationship. This argument does not stand up to close scrutiny. We do not regardthe debit as a loss at all. It arises from and because of the FSA which was acontract to subscribe for shares at a price calculated by reference to
Group’sloan relationship with
Transport. There is no loss to
Group inany real sense. The definition of
loss may also connote disadvantage ordetriment. There is none here. The deprivation of part of the loan isbalanced by the additional carrying value attributable to its fixed assets,namely its further investment in its subsidiaries, measured by the cost ofdoing so, ie the price specified in the FSA. If there is a loss, it
arisesnot from the loan relationship, but from the FSA.
135.
In supportof the argument on the meaning of
loss, we were also referred to
ExplainawayLtd v HMRC
[118]
which concerned the effectiveness of tax planning designed to avoidcorporation tax which would otherwise have arisen on the disposal of certainshares by means of derivative transactions. The scheme ultimately failedentirely, on appeal to the Upper Tribunal. Both the First-tier and the UpperTribunals applied the
Ramsay approach or principle to statutoryreferences to
profits or gains and
loss. This meant real profitsor losses as opposed to arithmetical differences. The Upper Tribunal, contraryto the view of the First-tier Tribunal, found that there was no loss as thetransaction in question was self-cancelling, noting that the relevant statutoryprovisions were concerned with gains and losses having a commercial reality.
The emphasis onlosses having a commercial reality does not assist
Group even althoughthe statutory context is different
. It is difficult to see how the
intergroup transactions created a commercial loss, or any form of disadvantageor detriment, so far as
Group was concerned. They purchased shareswhich were directed to be issued to another subsidiary under their completecontrol. The expenditure was made in consideration for the issue of shares. The book entries reflect neither a gain nor a loss. There is no other evidencesuggesting that there was a real loss at any stage. Such entries are intendedto reflect the substance of transactions which has a clear resonance with thenotion of commercial reality. Here, the reality is that the
loanreceivables were not lost, as Ms Shaw put it.
They werein-gathered in full with interest, and a sum from
Group’s general fundswas expended in implement of
Group’s obligations under the FSAs.
Grouprecorded an asset in its books which pound for pound represented futureeconomic benefit and matched the so-called loss of the loan receivables. Theassumption in the accounting treatment is that future economic benefit will beobtained from the investment.
[121] That is simply not a loss at all.
136.
In thecourse of the hearing, our attention was drawn to
Abbey National TreasuryServices Plc v HMRC.
[122]
There, the First-tier Tribunal considered
inter alia whether asubstantial sum was deductible as a debit arising from certain derivativecontracts. That tribunal concluded that there was no loss arising from thederivative contracts and dismissed the appeal. In doing so, the tribunalexpressly considered and gave content to (under reference to
DCC Holdings)the statutory phrase
fairly represents
asa restraint on accounting treatment that is divorced from commercial reality.
It also considered whether the debit in question arose from a derivativecontract. The tribunal’s approach was to identify what triggered the debit,and to consider whether there was a direct nexus between the debit and thederivative contract, rather than a more remote causal link or connection.
Adopting thatapproach, the tribunal concluded that the loss in question did not arise from aderivative contract.
[125]
137.
Thetribunal’s approach in
Abbey in relation to similar statutory languageis consistent with our approach to ss320 and 307 CTA.
138.
Overall,it seems to us that there is a serious tension between
Group’s argumentthat partial derecognition of the loan constituted a loss of loan receivablesbut that it was not cancelled out by the additional cost of
Group’s investmentin
Holdings. That cost is entered in the balance sheet and is used tomeasure the additional investment adding to the carrying value of
Group’s fixedassets. The FSA itself repaired the balance sheet of each subsidiary with itsanticipated injection of up to £20m cash. Repairing a balance sheet improvesthe overall financial picture of a company. It gives it more substance, andbecomes more attractive to traders. We find it difficult to see how the debitto investments fairly represents a
loss to
Group in anymeaningful sense.
139.
Here,generally accepted accounting practice does not classify the cost of theinvestment (the debit to investments) as a loss or a deficit but as an additionto the balance sheet. It is impossible to see how such an amount can fairlyrepresent a loss which is what is claimed here, particularly as there was noloss to
Group arising out of its loan relationship with
Transport. Itis difficult to accept that a loan relationship on which a creditor receivesfull payment including interest and thus made a profit, somehow yields arelievable loan relationship loss. It is counter-intuitive to say the least.
140.
Referencewas also made on behalf of
Group to s465 of CTA 2009 (which concernsamounts which fall to be treated as distributions) as being an example of anexclusionary rule, to be contrasted with s307(3) which was said to be an
inclusionaryrule. Again, we did not find this helpful. S307(3) can be described asexclusionary or inclusionary. S307(2) states the general proposition underreference to generally accepted accounting practice. S307(3) is morespecific. Thus, a debit when taken with other credits and debits, must fairlyrepresent a profit or loss, interest or expenses, arising from, under or forthe purposes of loan relationships or related transactions. That is the waythat these credits and debits are to be brought into account. Any other debitor credit is excluded. Thus, as we have explained, capitalised interest fallswithin ss320 and 307(3).
141.
Accordingly,even if, contrary to our view, the debit to investments, as a contribution tothe capital of a subsidiary, is somehow a debit in respect of a loanrelationship and falls within s320, it does not fall within the debitsspecified in s307(3) and cannot be brought into account in determining
Group’sprofit and losses for corporation tax purposes.
142.
For theforegoing reasons we answer
issue (a) by holding that the deductibilityof debits under s320
is subject to the provisions of s307(3). We answer
issue (b) by holding that s307(3)
requires the debits and creditsto be tested to establish their nature. We answer
issue (c) by holdingthat the debit claimed by
Group
does not fairly represent lossesarising from its loan relationships under s307.
Issue (d):-
whether there is an amount to be brought into account under the relevantprovisions of the TIOPA 2010, and in particular, whether the receipt schemeconditions in s250 TIOPA 2010 were satisfied.
143.
This partof the appeal proceeds upon the basis that, contrary to the view of HMRC andcontrary to our decision in relation to issue (aa), and our views on Issues(a), (b) and (c), the sum of £39,471,087
is deductible in terms of ss320and 307, or 320 (without the need to meet the terms of s307 CTA 2009), and isthus properly brought into account as a relievable expense for the purpose ofcalculating
Group’s liability for corporation tax. It is not thereforenecessary for us expressly to consider TIOPA. However, as the parties wish usto determine these issues, we do so on the basis that their determination isnot required for the decision on issue (aa) which we have reached.
144.
Taxarbitrage is the exploitation of asymmetries between different tax regimes toachieve a reduction in the overall tax liability of entities such as companies,often in a group. Usually, there is a mismatch between two tax regimes orcodes; one example is where there is a tax deduction by one company which is notmatched by a taxable receipt in the hands of another company. Similar oridentical transactions may be characterised or classified in different ways bydifferent tax codes giving rise to the opportunity to seek a reduction in taxliability or some other tax advantage. Such mismatches and other contrivedarrangements to avoid liability to tax have been the subject of anti-arbitragerules such as those now contained in Part 6 of TIOPA 2010.
145.
Part 6provides for the service on companies of two kinds of notice, deduction noticesand receipt notices as a result of which the company must calculate orre-calculate
inter alia its liability to corporation tax lessadvantageously. We are concerned with a receipt notice, dealt with inss249-254 TIOPA 2010. In broad terms, HMRC may give a UK resident company areceipt notice if it considers, on reasonable grounds, that the receipt schemeconditions are or may be met in relation to that company.
There are fourreceipt scheme conditions (A, B, C and D). Essentially, the receipt noticetriggers liability, if the company has received a payment in a transactionwhich is a contribution to its capital, and which payment is deductible forcorporation tax purposes by the payer but is not chargeable as part of thecompany’s income arising from the transaction and is not otherwise taxable. Itis also a condition that, on entering the scheme, the company and the payingparty must have expected a benefit to arise because the payment or part of itwas not taxable.
[128]
146.
Satisfactionof the scheme essentially identifies a mismatch. There is to be assumed,contrary to our view, a deductible sum in the hands of
Group (by reasonof s320 CTA) but no corresponding charge of the same sum to corporation tax inthe hands of
Holdings. This, so the argument runs, creates a mismatchdefeating the underlying purpose of much fiscal legislation, namely to producefiscal symmetry by giving a right of deduction in respect of any payment whichgave rise to a liability to tax in the hands of the recipient. If the receiptscheme notice is well-founded and the conditions thus met, the payment, alreadydeductible in the hands of the payer (
Group) becomes a chargeablepayment taxable in the hands of the recipient (
Holdings) thus correctingthe mismatch and restoring fiscal symmetry.
147.
If thereceipt scheme conditions are satisfied, a further issue is whether thecontingent subscription amount is, nevertheless, not actually chargeable to taxin the hands of
Holdings under any relevant legislation.
148.
Wetherefore begin by considering each of the receipt scheme conditions in turn.
Receiptscheme condition A is that
ascheme makes or imposes provision as between the company and another person(“the paying party”) by means of a transaction or series of transactions.
149.
Here,
Groupis the paying party.
Holdings is the company. The transaction is theFSA. We consider the nature of the transaction in more detail below.
150.
Group acceptsthat receipt scheme condition A has been met. We therefore say no more aboutreceipt scheme condition A.
151.
Receiptscheme condition B is that
thatprovision includes [
Group]
making, by means of a transaction orseries of transactions, a payment-
(a)
which is a qualifying payment inrelation to [
Holdings], and
(b)
at least part of which is not anamount to which section 251 (amounts within corporation tax) applies.
152.
S250(4)provides that a receipt is a qualifying payment in relation to [
Holdings]for the purposes of this section and sections 251 to 254 if
it constitutes a contribution to the capital of [
Holdings]
153.
HMRC saythat the undertaking given in Clause 3.1 of the FSA together with the actualpayment in December 2010 constitutes the
contribution to the capital of
Holdings.HMRC accept that the
payment has to be a payment in cash otherwisethere could be no contribution to the capital of
Holdings. The naturalmeaning of
contribution was when the money came in.
154.
Group saythat the FSA itself when entered into was a valuable asset which
Group recordedin its books. The rights under the FSA could have been assigned for cash. TheFSA was the capital contribution. A capital contribution need not be made incash. The recognition of the event on entering into the FSA in October 2010was a capital contribution. The obligation to pay created by the FSA could notbe regarded as
payment within the ordinary meaning of that word
.The actual payment in December 2010 did not contribute or further contribute tothe capital of
Holdings. It satisfied an existing obligation but wasnot a contribution to capital.
Under reference to an HMRC Manual,
Group arguesthat the payment has to
directly increase the company’s capital.
Accordingly,
Group submit that receipt scheme condition B has not been met.
155.
There wasno dispute about paragraph (b) (s251 etc). It has been met. The payment was
notan amount within the charge to corporation tax.
156.
In ourview, receipt scheme condition B has been met. The provisions require that apayment be made and that it is a contribution to the capital of
Holdings. Theargument that the injection of about £19.8m into
Holdings was somehownot a contribution to its capital cannot be accepted.
157.
It was putto Mr Drummond in cross-examination that, as at 6 October 2010, an asset of£20m would be recognised in the subsidiary (
Holdings).
He acceptedthat proposition. That sum must represent the value of the right to obtainpayment of the contingent subscription sum on or about 31 December 2010. Theremust, as a matter of common sense, be a material difference in the eyes of acreditor or third party between the right to payment and the receipt of suchpayment. While the difference may be more theoretical than real in the contextof inter-group dealings, that cannot be said to be correct where a third partyis involved.
158.
Whatevereffect the accounting treatment had in October 2010, the fact is that
Holdingshad about £19.8m more liquid funds on 31 December 2010 than it did on29 December 2010 or earlier. From the stand point of a trader or creditorof
Holdings that must be viewed as a significant contribution to itscapital thereby increasing it for all practical purposes, and making it a moreattractive (or less unattractive) business with which to do business or againstwhich to enforce its rights.
159.
Thepurpose of part 6 of TIOPA 2010 is to redress the imbalance created bystatutory mismatches which have been deployed to create a tax advantage. Weendeavour to take a practical and realistic view of the facts. Adopting thatapproach, the payment of some £19.98m cannot simply be ignored because of atechnically correct accounting entry.
160.
If it isassumed that the purpose or main purpose of the transaction was to repair thebalance sheet of
Holdings,
then the accounting entries in thebooks of
Holdings must have led to an improvement in its balance sheetreflecting the rights conferred by the FSA. However, it is difficult to seehow those rights could have been enforced by a creditor on insolvency. In anyevent, once the FSA is implemented by issue of shares in ITCO and payment of£19.98m
[131]or thereby by
Group to
Holdings, the position of any creditor of
Holdingsmust be improved. Their rights are enforceable against the increased fundsof
Holdings; they will or at least may be paid Xp more in the £ onliquidation than they would have been paid had the FSA not been implemented. In that sense, the transaction (the FSA) involves two parts both of which makea contribution to the capital of the company. Thus, the actual payment inDecember 2010 constitutes a contribution to the capital of
Holdings. Itmakes no sense to hold that such an injection of funds makes no contribution atall to the capital of
Holdings. The statutory provision expresslycontemplates the making of a payment by means of a series of transactions.
161.
Wetherefore see no difficulty in considering the FSA as a transaction withseveral components both of which form part of the payment process. Theprovisions of the FSA thus
include the making of a payment thatconstitutes a contribution to the capital of
Holdings. The actualamount of the payment is part of the overall transaction, and it is thatpayment with which ss250 and 254 are concerned.
It is a direct paymentwhich plainly contributes to the capital of
Holdings. It directlyincreases the core value of
Holdings as represented by its value toshareholders as noted in the HMRC Manual founded on by
Group.
Receiptscheme condition B is therefore met. To hold otherwise would be to take toonarrow a view of the facts and the statutory purpose of Part 6 and, inparticular, receipt scheme condition B.
162.
Put moresimply, the ordinary meaning of
contribution to the capital of a companyis or at least includes, as Mr Ghosh put it, when the money comes in.
It is difficultto avoid the conclusion that a contribution to the capital of the subsidiarywas made when actual payment occurred as part of the overall transaction.
163.
Dicta reliedon by
Group as to the scope of complex but carefully articulatedprovisions in a different statutory context, such as
First Nationwide,do not negate the conclusion we have reached. The Court of Appeal was theredrawing the distinction between the creation of shares (acquisition bysubscription), and the purchase of existing shares by transfer in relation to arepo transaction.
[134] It was not considering the scope of the word
payment. While werecognise the juridical difference between an obligation to pay, and theimplementation of that obligation, that does not affect our conclusion that, inthe circumstances as we have found them to be, receipt scheme B is met.
164.
Receiptscheme condition C is that
onentering into the scheme [
Holdings] and [
Group] expected that abenefit would arise because at least part of the qualifying payment was not anamount to which section 251 applies.
165.
Forpresent purposes, it is sufficient to say that s251 applies to amounts whichare income or chargeable gains for the purposes of Corporation tax. An amountto which s251 does not apply is essentially non-taxable.
166.
HMRC saythat the mismatch of the tax treatment between
Group and
Holdings wasthe benefit they both expected. Tax relief for the debit and no tax charge forthe receipt of the subscription amount in the hands of the subsidiary,
Holdings,is a benefit. That was the advice
Group and
Holdings receivedfrom their tax accountants and lawyers.
167.
Holdingssay that the condition does not apply because (i) the UK tax code does notimpose tax on receipts of subscriptions for share capital; no liability to taxis being avoided (ii) the fact of non-taxation is not a benefit within themeaning of receipt scheme condition C because a payment is only a
qualifyingpayment if it is non-taxable; this would make receipt scheme condition Credundant, as, if receipt scheme condition B were satisfied, receipt schemecondition C would automatically be satisfied; the whole focus of the provisionsis on receipt. Reference was made to the HMRC Manual,
to theExplanatory Notes to the Finance Bill 2005 and to
Biffa (Jersey) Ltd v HMRC
.
168.
Thisraises questions of fact as to what evidence there is about the expectations of
Group and
Holdings. The corporate structure of the companies inthe group, the evidence about it and the appellants’ evidence generally requireus to consider them together. Either the appellants both had such expectationsor neither had any. In our view, it is clear from the facts as we have foundthem to be, that
Group and
Holdings, expected that a benefit(within the meaning of receipt scheme condition C) would arise. Thatexpectation arose from the advice given to them prior to entering into theFSA. They chose the structure of the FSA and entered into it to achieve abenefit. The benefit which
Group, and
Holdings expected to ariseon entering into the FSA was that the cost of investment (the £20m or thereby)would be a relievable expense (reducing
Group’s taxable profits) andthat there would be no taxable charge on
Holdings as recipient of thatsum.
169.
The twoaspects of the benefit plainly go together. Both are needed to make the schemework. Otherwise, the tax liability is moved around the group but is noteliminated or reduced. It either remains with
Group who are taxed on£20m or thereby which is not relieved from liability, or it is transferred, asa tax relievable expense, to
Holdings who are taxed on the £20m inaccordance with well-known principles of tax symmetry. On the facts as we havefound them to be,
Group and
Holdings (Mr Hamilton being a directorof both) expected both aspects of the perceived benefit to arise and liabilityto tax on that sum of £20m avoided within any part of the group.
170.
HMRC inits Manual explains that a benefit arises as a result of the receipt escapingtaxation in the absence of the arbitrage legislation.
Elsewhere inits Manual, and referred to by
Holdings, it states that one of theconditions to be satisfied is that the arbitrage (a mismatch in tax treatment)is a reasonable expectation of the parties to the scheme.
The ExplanatoryNotes to clause 106 of the Finance Bill 2005 to which we were referred by
Group,explain that arbitrage is the exploitation of differences between or withinnational tax systems. This, it says, can result in a deduction being given fora payment when tax on the corresponding receipt has been avoided.
171.
Leavingaside the weight which may be attached to such materials, we accept that it isdifficult to say that tax on receipt of the contingent premium would have beenavoided or that the result would have been that the receipt would escapetaxation. Such a receipt, as a contribution to the capital of a company, would(but for effective arbitrage legislation) never have been subject to tax underUK law.
172.
However,the language of the Manuals and the Explanatory notes are not the language ofthe statutory conditions. In any event, for what it is worth, the HMRC Manual(in a passage founded on in
Group and
Holdings’ Skeleton Argument
), states that amismatch itself is a reasonable expectation of the parties to the scheme.
173.
The focusof receipt scheme condition C is the
benefit that would arise. Forreceipt scheme condition C to bite, receipt scheme condition B (payment notsubject to corporation tax) will already have been met. Receipt schemecondition C, using language
[141]almost identical to receipt condition B,
links the satisfaction of receipt condition B with the condition required byreceipt scheme condition C, namely the expectation that a
benefit wouldarise. We do not see that as duplication, or as a flaw in our analysis. The legislation does not require that the expected
benefit arises to thecompany (
Holdings) rather than the paying party (
Group) or viceversa. Here, when the FSA was entered into,
Group and
Holdings hadan expectation, based on advice received, that both aspects of the benefitdiscussed above, would arise.
174.
In
Biffa,similar arguments to those advanced by
Holdings were rejected by thetribunal.
[143] There, as a result of a number of transactions, one company in a group (BHL)became entitled to deduct about £14m as an expense as deemed interest on adeemed loan from another company in the same group (BJL). The issue waswhether BJL was liable to tax on the deemed interest. BJL said thetransactions were genuine commercial transactions designed to recapitalise themain company in the group.
[144] HMRC said it was a tax avoidance scheme designed to achieve a corporate taxdeduction for BHL without any corresponding taxable receipt for BJL.
HMRC’s primaryargument, based on its analysis of FA 2003 s195, was upheld by the First-tierTribunal and led to the dismissal of the appeal.
175.
As analternative, HMRC invoked the tax arbitrage provisions then in force.
The equivalentof receipt scheme condition C was Condition E quoted in paragraph 45 of thetribunal’s decision. The tribunal held that Condition E was satisfied. Inparticular, the tribunal did
not accept that, in considering whetherCondition E was satisfied, it could only have regard to the tax treatment ofthe qualifying payment as a contribution to capital. It considered that itshould also take into account the (assumed) fact that the sum of £14m wasdeductible;
[148]thus, the two companies intended that the arrangements would produce a benefit(a corporation tax deduction for BHL without any corresponding taxable receiptfor BJL.
[149]
176.
It wassubmitted that
Biffa was wrongly decided, but in any eventdistinguishable on the basis that here, the debit (not the payment) wasallowable under s320. That seems to us to be a distinction without adifference. The tribunal’s views on Condition E in
Biffa were
obiter. However, we detect no flaw in its approach, which accords with our own viewand with the general principle of tax symmetry.
177.
To say,for the reasons advanced by
Holdings, that receipt scheme condition C isnot met is to take too narrow a meaning of
a benefit. If
Holdings’ argumentis correct, then receipt scheme condition C can never be satisfied because acontribution to the capital of a company is never of itself income or gain tothat company. Receipt scheme condition C contains a simple causative testlinking
benefit with non-taxability. While non-taxability may rarely bein issue, the question of
benefit will often be in issue.
178.
Wetherefore do not agree that we can only have regard to the tax treatment of thequalifying payment as a contribution to capital. We can and should takeaccount of the treatment of the debit under s320 on the assumption, contrary toour views, that it is allowable and the subscription price is brought intoaccount. Here, as we have explained, tax relief on the debit and no tax chargeon the receipt constitute a benefit for
Group and/or
Holdings. Thatconstitutes
benefit within any reasonable construction of that phrase asit appears in receipt scheme condition C. The statutory focus is on thebenefit expected to arise
on entering into the scheme. In short, bythat stage, the benefit expected was a tax relievable debit without anyliability to tax in the hands of the recipient subsidiary.
179.
Ultimately,the question is whether there was an expectation that a benefit would arise. The statutory language does not identify who the recipient of the benefit isexpected to be. Whoever it is must include
Holdings or Group or both. It might even extend to any company within the group as that would indirectly,at least benefit the ultimate holding company,
Group. Here, it is clearthat
Group benefits as it would secure a tax relievable debit, andconsequent reduction in its profits for corporation tax purposes, and itssubsidiary,
Holdings, is not taxed on the receipt. That creates anobvious mismatch, and an infringement of the principle of tax symmetry; themismatch is remedied by this and the other conditions of the arbitrage rules.
180.
Receiptscheme condition D is that
thereis an amount in relation to the qualifying payment that-
(a)
is a deductible amount, and
(b)
is not set against any schemeincome arising to [
Group] for income tax purposes or corporation taxpurposes.
181.
Adeductible amount is one available as a deduction for the purposes of the TaxActs.
[150] Here, the deductible amount is the (assumed) allowable debit under s320.
Schemeincome means income arising from the transaction or transactions formingpart of the scheme.
[151] There is none here.
182.
HMRC saythat the debit claimed by
Group is the tax deductible amount whicharises because of the FSA, which contains the contractual obligation on thepart of
Group to make a contribution to the capital of
Holdings. Absentthe FSA, there would be no debit to seek. Accordingly, the deductible amountrelates to the qualifying payment. It is
in relation to it.
183.
Holdingssay that it is not the payment of the contingent premium that isdeductible, but the amount of the derecognised loan that is brought intoaccount in determining the value of
Group’s investments in
Holdings thatis deductible. There is no direct link between the payment and the deduction. If
Transport had defaulted on the loan there would have been no contingentpremium paid and thus no qualifying payment made but the debit would haveremained intact.
Holdings also point out that the timing, amount andnature of the payment are each different from that of the deductible amount.
184.
In ourview, this condition is met. The facts, as we have found them to be, make itplain that there is a relationship between the deductible amount and thequalifying payment for the simple reasons advanced by HMRC. The link seems tous to be inextricable. Whether it is described as
direct does notmatter as that is not the language of the condition. The phrase
in relationto is a broad phrase unlike
in respect of which is generally morepointed having a direct causative flavour to it. There is a relationshipbetween the deductible amount and the qualifying payment, that is neitherremote nor fanciful. That is enough.
185.
It doesnot accord with our understanding of the accounting evidence and generallyaccepted accounting practice that if
Transport had defaulted on theloan, the debit would have remained intact. While the debit entry would haveremained, it would not have remained intact. It would be affected by otherentries in
Group’s books recording and reflecting the default. Theprofit and loss account would have been debited with the balance of the unpaidloan. The
Loans account would have been credited with the same amount. This eliminates the loan balance as an asset in the balance sheet. If thecarrying value of the investment needed to be repaired (reducing its value inthe balance sheet) then
Investments would be credited and the Profit andLoss account would be debited.
186.
Therewould be no entries on default in
Transport’s books. In
Holdings’ booksthe profit and loss account would be debited and the asset would be credited inthe balance sheet (thereby eliminating or writing it off); it having previouslybeen recognised as an asset when the FSA was entered into.
187.
Finally,we consider that any differences in the timing, amount and nature of thepayment and the deductible amount are not material as they do not destroy therelationship between the deductible amount and the qualifying payment which wehave identified. That relationship exists and that is sufficient to meet therequirement of the condition. No specific issue on quantum has been raised.
188.
Thereceipt scheme conditions have been met. The consequence is that, if we arewrong in our conclusion that there is no allowable s320 debit, then
Holdingsare under obligation to recalculate its liability to corporation tax forthe period specified in the Notice to
Holdings dated 27 September 2013. On that basis, the Notice and the amendments to
Holdings’ corporationtax return for the period ending 30 April 2011 stand good, and
Holdings’ profitsfor that period remain increased by the sum of £19,735,543.50.
189.
We answer
issue(d) by holding that there
is an amount to be brought into accountunder the relevant provisions of TIOPA. We hold that the receipt conditions insection 250 thereof
were satisfied.
Issue (f):- whether there could be a charge to taxunder Case VI of Schedule D in the relevant periods, as stated in HMRC’sclosure notices
190.
Our viewon this issue is also
obiter. The surprising argument for
Holdings isthat even if it is required to recalculate its income so as to bring£19,735,543.50 into account, there is no mechanism for charging that amount totax.
Holdings say that s254 TIOPA is not a charging or applicationprovision; nor is TIOPA a charging Act.
191.
It isargued that the charge to corporation tax in s2(1) CTA 2009 only has effectwhen it is applied by another provision of the legislation such as s35 (profitsof a trade), s299 (non-trading profits in respect of loan relationships), ands979 (see below). Such charging provisions are distinct from calculationprovisions such as s46 (calculation of trading profits) and s301 (calculationof trading profits from loan relationships).
192.
Holdingspoint out that the statutory predecessor of s254 TIOPA
deemed therelevant part of the qualifying payment to be income chargeable under Case VIof Schedule D. However, Schedule D Case VI was repealed for accounting periodsending on or after 1 April 2009. S979 CTA 2009 replaced the repealedprovisions by creating a charge to corporation tax on income not otherwisecharged.
Holdings submit that that provision contained an exemption for
deemed income.
[154]
Accordingly, s979 cannot apply and, as there is no other statutory chargeon s254 amounts, they fall outwith the scope of the charge to corporation tax. This view is said to be supported by paragraphs 2501 and 2496 of the ExplanatoryNotes to CTA 2009.
193.
Theconsequence, says
Holdings, is that there is no charge to corporationtax that can be applied to the s254 amount; accordingly,
Holdings’ appealmust be allowed.
194.
HMRC nowsay that s254, in terms, contains a charging provision. No question of deemingarises. Accordingly, s979 is not needed. If it is, then the charge is formiscellaneous income under s979(1).
195.
In ourview, if
Holdings’ argument were sound it would lead to an absurdresult. The tax arbitrage provisions would be sterilised. There would be nomeans of enforcement and
Holdings would escape the consequences of theirliability. Parliament, in enacting legislation, will not normally, if ever atall, be taken to have intended such absurd consequences. The courts (andtribunals) will not usually, if ever, construe legislation in a manner whichleads to such absurd results.
196.
Thehistory of the legislation and the current statutory provisions show that suchabsurd consequences were neither intended nor created. The predecessor ofs252(2) of TIOPA is s27 FA (No 2) 2005. That sub-section provided that thecompany in question had to recompute its income or its liability to corporationtax
asif the relevant part of the qualifying payment were an amount of incomechargeable under Case VI of Schedule D.
197.
Thatprovision was amended by CTA 2009
[155]for accounting periods ending on or after 1 April 2009. The equivalentprovision became
asif the relevant part of the qualifying payment were a receipt of the companywhich is chargeable for that period under the charge to corporation tax onincome.
198.
Theamended s27 was rewritten and replaced by s254(2) TIOPA for accounting periodsbeginning on or after 1 April 2010.
[156] The equivalent provision became
asif so much of the qualifying payment as falls within subsection (3) were areceipt of the company that is chargeable for that period under the charge tocorporation tax on income.
199.
Thischange was not intended to change the law. In general, the continuity of thelaw is preserved in a tax rewrite as is made clear by TIOPA s377 and schedule 1paragraph 1.
200.
The changefounded on occurred when CTA 2009 was enacted. The purpose of that Act was torestate the existing law relating to corporation tax along with variouschanges. A re-labelling exercise was carried out which removed Case VI ofSchedule D from tax legislation.
It was replaced in a variety of ways,
including by the use of the phrase
the charge to corporation tax on income.
Theseare essentially administrative changes as paragraph 36 of Explanatory Notes toCTA 2009 records.
201.
Thecharging provisions were accordingly not removed. Ss2 and 5 CTA 2009 impose acharge on profits that is to say income and chargeable gains.
Holdings requireto recalculate their income on the basis that the qualifying payment
ischargeable to corporation tax.
202.
S979 CTAprovides that the charge to corporation tax on income applies to income that isnot otherwise within the application of that charge under the Corporation TaxActs. However, that sweeping up provision does not apply to
deemed income (s979(2)(c)),or to annual payments or income otherwise exempted. Subsection (2) isessentially concerned with exemptions.
203.
TheExplanatory Notes to this section provide
inter alia that subsection (2)disapplies the charge to “deemed income”. This term refers to amounts that aretreated as income by a provision of the Corporation Taxes Acts, so that thecharge to corporation tax on income applies to that amount. The disapplicationapplies in the event that such deemed income would not fall within any otherapplication of the charge to corporation tax on income.
204.
In otherwords, if deemed income is caught elsewhere in the Corporation Taxes Act itremains caught and subsection (2) does not extinguish liability. If there isno other charging provision for deemed income, then the sweeping up provisiondoes not catch it either as it is disapplied to such deemed income bysubsection (2)(c).
205.
S254 TIOPAexplains how tax on a qualifying payment is to be charged. It does so byreference to the sum specified in the receipt notice. It is charged on so muchof the payment as meets receipt scheme condition D, and it must not be anamount to which s251 applies ie an amount chargeable to corporation tax.
206.
Thecompany must calculate or re-calculate its income for the relevant period as ifthe qualifying payment (insofar as receipt scheme condition D is met inrelation to it) were a receipt chargeable to corporation tax. Ss255-257 makeprovision for amendment of returns, closure notices and discovery assessmentsconsequent upon the service of receipt notices. It is plain from these andother provisions that a charge to corporation tax is imposed on the receipt orthe relevant part of it. It becomes part of
Holdings’ income asre-calculated. S979 therefore has no application because the re-calculatedincome
is otherwise charged under the Corporation Tax Acts.
207.
It seemsplain that the combined effect of these provisions is to impose a charge to corporationtax on the relevant part of the amount that has been the subject of a receiptnotice. That amount is to be treated as if it were a receipt that ischargeable under the charge to corporation tax on income.
208.
Thatamount is a sum that
is within the application of the charge tocorporation tax on income under the Corporation Taxes Acts. S979(1) has norelevance because it applies to income that is
not otherwise within theapplication of that charge under the Corporation Taxes Acts.
209.
The exclusionof deemed income is not relevant because, as the Explanatory Notes make clear,that exclusion relates to deemed income that does not fall within any otherapplication of the charge to corporation tax on income. Here, there-calculated income plainly does fall within the charge to corporation tax onincome by virtue of s254 TIOPA.
210.
Thus, s979creates no difficulty. Resort need not be made to it because the qualifyingpayment is or becomes part of the income of
Holdings that is
otherwisechargeable to corporation tax by virtue of s254 and ss2 and 5 CTA 2009.
211.
Putting itanother way, s979(2)(c) does not apply because s979(1) itself does not apply.
212.
Overall,we consider that the fiscal legislation is amply sufficient to impose a chargeto corporation tax on the qualifying payment. The qualifying payment istreated as a receipt that is chargeable under the charge to corporation tax onincome. Every company must submit a tax return containing an assessment of theamount of tax payable by it in the relevant period.
Holdings submitteda return with calculations showing its assessed liability to corporation tax. S254 TIOPA provides for its recalculation in circumstances which arise as aresult of our decision. The qualifying payment must be added to the company’sincome.
[161] Corporation tax is charged on profits and profits include income and chargeablegains.
[162] It is difficult to see what more is needed to impose a charge to corporationtax on the qualifying payment or the relevant part of it. The conclusion thatParliament has somehow removed the charge to tax otherwise established isunsound and would wholly frustrate the obvious intention of Parliament.
213.
In these circumstances,we answer
issue (f) by holding that although there could not be a chargeto tax under Case VI of Schedule D in the relevant period, as stated in HMRC’s ClosureNotices, there is a charge to tax by virtue of s254 TIOPA and ss2 and 5 CTA2009.
214.
We shouldadd that the argument we have rejected proceeded on the basis that, on a properconstruction of the legislation, there was no enforceable fiscal liability, andnot on the basis that the infelicitous reference to Case VI of Schedule D in theClosure Notice issued to
Holdings invalidated the Notice. This was anattack on the substance of the legislative charging provisions rather than theform of the Closure Notice. No point was taken on the basis that the Noticewrongly referred to Case VI Schedule D rather than mirroring the equivalentwords of s254(2) TIOPA.
Summary
215.
Insummary:-
(1)
We answer
Issue (aa) by holding that the debit claimed by
Groupis
not in respect of a company’s loan relationship within s320 CTA 2009.
(2)
Insofar as necessary, we answer
Issue (a) by holding that thedeductibility of debits under s320
is subject to the provisions ofs307(3). We answer
Issue (b) by holding that s307(3)
requiresthe debits and credits to be tested to establish their nature. We answer
Issue(c) by holding that the debit claimed by
Group
does not fairlyrepresent losses arising from its loan relationships under s307.
(3)
Insofar as necessary, we answer
Issue (d) by holding that there
isan amount to be brought into account under the relevant provisions ofTIOPA. We hold that the receipt scheme conditions in s250 thereof
were satisfied.
(4)
Insofar as necessary, we answer
Issue (f)
by holding thatalthough there could not be a charge to tax under Case VI of Schedule D in therelevant period, as stated in HMRC’s Closure Notices, there is a charge to taxby virtue of s254 TIOPA and ss2 and 5 CTA 2009.
Disposal
216.
Group’sappeal is dismissed. As a consequence,
Holdings’ appeal is allowed.
217.
If
Groupobtains permission to appeal and does appeal, we would expect HMRC toappeal against our decision to allow
Holdings’ appeal. In that way, allthe outstanding issues can be heard together again and their consequencesdetermined without undue complexity.
218.
Theappeals before us are lead appeals. We draw the attention of parties (and tothose interested in the related appeals referred to above, all of whom are alsorepresented by KPMG and HMRC) to Rule 18(4) and (5) of the Tribunal’s rules. We dispense with the need to send a copy of this decision to each of theparties in the related cases (appeals) as KPMG LLP
are believed to represent all
or most of them.
Insofar as KPMG donot, HMRC are directed to send a copy of the Decision to those parties in therelated appeals not represented byKPMG.
219.
We inviteproposals, by written application within 28 days of the date of the release ofthis decision, for any further procedure (including expenses, if appropriate;but not in relation to appeal, as to which see below) the parties and thoseinterested in the related appeals, or any of them, consider competent and expedient. If any person wishes to extend the period for seeking permission to appeal, anapplication to do so will no doubt be made.
220.
Thisdocument contains full findings of fact and reasons for the decision. Any partydissatisfied with this decision has a right to apply for permission to appealagainst it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal)(Tax Chamber) Rules 2009. The application must be received by this Tribunalnot later than 56 days after this decision is sent to that party. The partiesare referred to “Guidance to accompany a Decision from the First-tier Tribunal(Tax Chamber)” which accompanies and forms part of this decision notice.
JGORDON REID QC FCIArb
TRIBUNALJUDGE
RELEASEDATE: 24 FEBRUARY 2016
APPENDIX
.png)
<
2
