United Kingdom Special Commissioners of Income Tax Decisions

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Cite as: [2003] UKSC SPC380, [2003] UKSC SPC00380

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Conlon Construction Ltd v HM Inspector of Taxes [2003] UKSC SPC00380 (19 August 2003)

LOAN RELATIONSHIPS – whether for the purpose of determining whether a company controls another, and accordingly the companies have a connection, its rights as a loan creditor are ignored – no

THE SPECIAL COMMISSIONERS

CONLON CONSTRUCTION LIMITED Appellant

- and -

IAN R JARMAN

(HM INSPECTOR OF TAXES) Respondent

Special Commissioner: DR JOHN F AVERY JONES CBE

Sitting in public in London on 15 August 2003

Paul Eaves, chartered accountant, for the Appellant

Ian Jarman, HM Inspector of Taxes, in person

© CROWN COPYRIGHT 2003

DECISION

Conlon Construction Limited appeals against assessments for the accounting periods ended 30 April 1998 and 1999. The Appellant was represented by Mr Paul Eaves and Mr Ian Jarman, the Inspector, appeared in person.

The issue concerns the construction of a provision dealing with loan relations of the Finance Act 1996. In essence it is whether a person who is both a shareholder and a loan creditor in a company must count both interests when determining whether he has control of the company.

There was an agreed statement of facts, as follows:

(1) The Appellant caries on the business of civil engineering contractors and property developers operating throughout the North West of England.

(2) Ibex Equine Limited (IEL) carries on the business of the design and manufacture of plastic horseshoes

(3) IEL was incorporated on 15 March 1996 and commenced to carry on business on 1 May 1996.

(4) The Appellant owns 40 ordinary shares in IEL out of a total issued share capital of 100 ordinary shares. Each ordinary share carries one vote.

(5) The Appellant has advanced funds to IEL via loans which bring the two companies within the Finance Act 1996 loan relationship rules.

(6) The Appellant made loans to IEL and the balance of amounts owing by IEL to the Appellant are shown below according to the balance sheet of IEL.

30 April 1997 £39,500

30 April 1998 £99,836

30 April 1999 £174,024

(7) In its accounts for the year ended 30 April 1998 the Appellant made the provision of £66,557 in respect of the debt owed by IEL as being bad or doubtful. In the year ended 30 April 1999 the Appellant made a further provision in respect of the IEL debt amounting to £107,467.

(8) The Appellant's claim for relief in respect of the provision for bad debts detailed at (7) above, is under the loan relationship provisions of section 83 of the Finance Act 1996 et seq on the basis that there is a non-trading deficit on the company's loan relationship with IEL.

(9) Both the Appellant and IEL operate an authorised accounting method of accruals basis accounting in respect of the loan relationship as required by section 87(2) of the Finance Act 1996. It is accepted between the parties that the debits made in respect of the bad debt provisions are correctly made in accordance with the authorised method of accounting.

(10) IEL has lost money through trading losses from a trade which proved unsuccessful. It is agreed that the Appellant suffered the commercial loss of money and that the financial statements of the Appellant reflect proper commercial accounting practice.

(11) As the Appellant operates an authorised accounting method and the bad debt provisions represent proper accounting under that method, then tax relief would be available under the loan relationship rules unless the two companies were deemed to be under common control for the purposes of the loan relationship legislation in the Finance Act 1996. In the circumstances of the two companies being under common control, relief for the debit in the accounts of the Appellant would be denied by paragraph 6 of Schedule 9 to the Finance Act 1996.

(12) The loan relationship is not part of the Appellant's trade. Hence no relief is due under section 74(j) of the Taxes Act 1988 except tot eh very limited extent of trade credit given amounting to £15,207 at 30 April 1999.

(13) As the Appellant does not control IEL via a share holding, it could only be treated as having control of IEL if its participation as a "loan creditor" was added on.

(14) It is agreed that the Appellant would be deemed to control IEL within the meaning of section 416(2)(c) of the Taxes Act 1988 by virtue of the loan credit relationship with IEL.

(15) However the definition of control in section 416 f the Taxes Act 1988 is modified for the purposes of the loan relationship rules by the narrower definition of "participator" in section 87(8) of the Finance Act 1996, in respect of participator s who are loan creditors. The point in dispute between the parties is how the modified definition of a participator should be interpreted.

(16) The family owning the majority shares in IEL are not related to any of the shareholders in the Appellant. There is no connection via "associates" and therefore sections 87(3)(b) and (c) of the Finance Act 1996 do not apply.

The agreed statement of facts explains the background fully. It is agreed that if the Appellant has control of IEL there is a connection between the companies for the purposes of section 87 of the Finance Act 1996, with the result that the provisions for the debts are disallowed. I can therefore go straight to the statutory definition of control for the purposes of section 87 then in force (these provisions were repealed by the Finance Act 2000):

Section 87 of the Finance Act 1996

"…(6) Subsections (2) to (6) of section 416 of the Taxes Act 1988 (meaning of 'control') shall apply for the purposes of this section as they apply for the purposes of Part XI of that Act.

(7) Subject to subsection (8) below, in this section 'participator' and 'associate' have the meanings given for the purposes of Part XI of the Taxes act 1988 by section 417 of that Act.

(8) A person shall not for the purposes of this section be regarded as a participator in relation to a company by reason only that he is a loan creditor of the company."

Section 416 of the Taxes Act 1988

(2) For the purposes of this Part, a person shall be taken to have control of a company if he exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs, and in particular, but without prejudice to the generality of the foregoing words, if he possesses or is entitled to acquire—

…

(c) such rights as would, in the event of the winding-up of the company or in any other circumstances, entitle him to receive the greater part of the assets of the company which would then be available for distribution among the participators….

Section 417 of the Taxes Act 1988

(1) For the purposes of this Part, a 'participator' is, in relation to any company, a person having a share or interest in the capital or income of the company, and, without prejudice to the generality of the preceding words, includes—

(a) any person who possesses, or is entitled to acquire, share capital or voting rights in the company;

(b) any loan creditor of the company;…

(7) Subject to subsection (9) below, for the purposes of this Part 'loan creditor,' in relation to a company, means a creditor in respect of any debt incurred by the company—

(a) for any money borrowed or capital assets acquired by the company;…

…

(9) A person carrying on a business of banking shall not be deemed to be a loan creditor in respect of any loan capital or debt issued or incurred by the company for money lent by him to the company in the ordinary course of that business."

For the Appellant, Mr Eaves contends that the effect of section 87(8) of the Finance Act 1996 is to modify section 416 of the Taxes Act 1988 for the purposes of section 87 with the result that any rights as loan creditor must be ignored for the purposes of section 87. He contends that the "only" in section 87(8) means that a person who is a participator by virtue of being a shareholder and a loan creditor is still a participator, while someone who is a participator by reason only that he is a loan creditor is not a participator for the purpose of section 87. He gives the following example of the absurdity that the Inspector's interpretation creates. Company X has assets of £100,100 represented by:

Shares Loans Total

Company A £99 £0 £99

Company B £1 £1,000 £1,001

Company C £0 £99,000 £99,000

Total £100 £100,000 £100,100

On the Inspector's interpretation, Company B controls Company X because Company C is ignored as being only a loan creditor, and Company B's interest as shareholder and loan creditor is counted, resulting in its having control although it does not control Company X in any real sense.

Mr Eaves also referred to ministerial statements from Hansard to the effect that the loan relationship legislation follows the accounting treatment. On a purposive approach one would expect the result to follow the accounting treatment.

Mr Jarman, the Inspector, concentrates on the word "only" in section 87(8) of the Finance Act 1996. He contends that the Appellant is already a participator in IEL by virtue of its shareholding, and so section 87(8) has no application because the Appellant is not a participator by reason only that it is a loan creditor.

Mr Jarman contends that the effect of section 87(8) is that rights as a loan creditor are ignored only where there is no other form of participation. Where, as in this case, the Appellant is a participator because of its shareholding its rights as a loan creditor are taken into account for determining whether there is control within section 416 of the Taxes Act 1988 and a connection within section 87. The Appellant therefore controls IEL and is thus connected with IEL for the purpose of section 87.

Reasons for my decision

I set out again the words of section 87(8):

"(8) A person shall not for the purposes of this section be regarded as a participator in relation to a company by reason only that he is a loan creditor of the company."

I therefore ask myself what is the reason why the Appellant is a participator in relation to IEL. The answer is that it is a participator by reason (a) that it holds 40 per cent of the shares, and (b) that it is a loan creditor of IEL. Is it a participator by reason only of (b)? Clearly no. Therefore section 87(8) has no application. I agree with Mr Jarman's interpretation.

Mr Eaves reads section 87(8) as if it provided that a company's rights as a loan credit are always ignored. This is not what it says. If Parliament had intended that result it would have excluded any reference to loan creditor when incorporating the definition of participator. The section provides that where the only reason a company is a participator is that it is a loan creditor, it is not treated as a participator for the purposes of section 87.

I do not find Mr Eaves's example particularly anomalous. If Company C were a bank that is precisely the result that occurs under section 416, in view of section 417(9), and there is nothing surprising that the same result applies to section 87. Even if I thought that the example showed an anomaly, I would still be bound to apply what I regard as the clear words of section 87(8).

Since I do not find any ambiguity in section 87(8) it is not permissible to refer to Hansard. In any event the passage relied on by Mr Eaves did not address the meaning of section 87(8) but merely stated, which is not in dispute, that in general the accounting treatment is followed for tax purposes.

The result is unfortunate for the Appellant which has made a genuine loss on the loans to IEL, and I understand that under the law now in force it would have been able to claim the loss. However, I must apply the law as it was at the time.

Accordingly, I declare that the provisions of £66,557 in the year to 30 April 1998 and £107,467 in the year to 30 April 1999 are disallowed, I dismiss the appeal and determine the profit chargeable to corporation tax in the agreed figures of £300,132 for the year to 30 April 1998 and £68,705 for the year to 30April 1999.

J F AVERY JONES

SPECIAL COMMISSIONER

SC 3033/03