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United Kingdom Special Commissioners of Income Tax Decisions

You are here: BAILII >> Databases >> United Kingdom Special Commissioners of Income Tax Decisions >> Finance Ltd v H M Inspector of Taxes [2005] UKSPC SPC00466 (25 January 2005)
URL: http://www.bailii.org/uk/cases/UKSPC/2005/SPC00466.html
Cite as: [2005] UKSPC SPC00466, [2005] UKSPC SPC466
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Finance Ltd v H M Inspector of Taxes [2005] UKSPC SPC00466 (25 January 2005)
    SPC00466
    CORPORATION TAX – Appellant issued funding bonds to foreign subsidiary companies – whether the effect of section 582 of the Income and Corporation Taxes Act 1988 was to treat the funding bonds as interest and therefore as income with the result that the foreign exchange legislation in the Finance Act 1993 did not apply to tax the exchange gains made on the funding bonds – no - appeal dismissed – ICTA 1988 section 582; FA 1993 Ss 125 to 170

    THE SPECIAL COMMISSIONERS

    FINANCE LIMITED Appellant

    - and -

    HM INSPECTOR OF TAXES

    Respondent

    Special Commissioners: Dr A N Brice

    Dr D Williams

    Sitting in London on 1 December 2004

    Jonathan Levy of Messrs Levywatters for the Appellant

    Philip Jones of Counsel, instructed by the Solicitor of Inland Revenue, for the Respondent

    © CROWN COPYRIGHT 2005

     
    ANONYMIZED FINAL DECISION
    The appeal
  1. Finance Limited (the Appellant) appealed against an assessment to corporation tax dated 14 January 2000 in respect of the accounting period ending on 31 December 1996.

  2. Initially we were asked to give a preliminary decision in principle on one issue in the appeal, namely whether eight loans entered into by the Appellant were fixed debts for the purposes of the transitional provisions relating to the taxation of exchange gains and losses. We decided that the loans were fixed debts and so the appeal on that issue was dismissed. Our preliminary decision was released on 30 June 2003 and published as Finance Limited v HMIT [2003] STC (SCD) 344 (SpC 370).

    The second issue
  3. On 22 October 2003 a second issue emerged as a point of dispute between the parties and we were asked to give another decision. This second issue is whether the foreign exchange legislation in sections 125 to 170 of the Finance Act 1993 (the 1993 Act) applied to certain funding bonds issued by the Appellant. (A funding bond is a bond issued by a debtor in respect of, and in discharge of, his liability to pay interest to the lender.) The Appellant was of the view that the effect of section 582 of the Income and Corporation Taxes Act 1988 (the 1988 Act) was to treat the issue of the funding bonds for all the purposes of the Tax Acts as interest and therefore as income and not capital with the result that the foreign exchange legislation in the 1993 Act did not apply and so no exchange gains fell to be taken into account for the accounting period ending in 31 December 1996. The Inland Revenue, on the other hand, argued that both section 582 and the 1993 Act applied to the funding bonds and that a taxable gain arose on these bonds in that accounting period.

  4. This is the final issue for determination in the appeal. The final figures were agreed to be £94,249,784, less group relief of £52,446,256, if the appeal were allowed and £96,650,769, less group relief of £52,446,256, if the appeal were dismissed.

    The facts
  5. A bundle of documents was produced in evidence and there was a statement of agreed facts. The facts were not in dispute.

    The Appellant
  6. The Appellant is a wholly owned subsidiary of Group Plc. The Appellant provides finance and treasury services to members of the group and, in particular, makes loans to, and borrows from, other group companies.

    1991 – 1994 - The loan agreements
  7. Between 1991 and 1994 the Appellant entered into eight loan agreements to borrow money from other subsidiary companies in the same group. Two of the subsidiary companies were resident in the United States; two in Belgium; and the remaining four in the Netherlands. (These were not the same eight loans which were the subject of our preliminary Decision.) Each loan agreement provided that the lending subsidiary company would lend to the Appellant an amount stated in foreign currency for a stated period and that the Appellant would pay interest in the foreign currency quarterly in arrears on any outstanding balance of the loan in March, June, September and December of each year. The agreements provided that they were to be governed by, and construed in accordance with, the law of England and Wales.

  8. By September 1995 the Appellant had a substantial liability for accrued interest on the loan agreements. The Appellant also realised that legislative changes were on the way which could affect the way in which relief was given for interest. Relief was then given when interest was paid but the Appellant thought that the Finance Bill 1996 would provide that relief would be given when interest accrued and that the new regime would apply to the Appellant from 1 January 1996.. The Appellant therefore was concerned to ensure that the interest which had accrued under the eight loan agreements should be paid before the end of 1995.

  9. However, the Appellant was reluctant to make payments of interest in cash. Under section 349(2)(c) of the 1988 Act, where interest was paid to a person whose usual place of abode was outside the United Kingdom, the person making the payment had to deduct out of it a sum representing income tax for the year in which the payment was made. Under section 350 of the 1988 Act the payer of the interest had to deliver an account of the payment to the Inland Revenue and was assessable to tax on the basic rate on the payment. The Appellant thought that clearance would be given under the double tax treaty provisions for the payments to be made gross and so was reluctant to pay the interest in cash to the foreign subsidiaries because it would have to deduct and account for the tax in that year.

  10. The solution lay in the issue of funding bonds which were governed by section 582 of the 1988 Act. Section 582(2) provided that, where an issue of bonds was treated by virtue of the section as if it were the payment of an amount of interest, and any person by or through whom the bonds were issued would be required to deduct income tax from that amount of interest, then such a person should retain bonds the value of which at the time of their issue was equal to income tax on that amount of interest. That person could then tender the retained bonds in satisfaction for the tax.

    1995 - The funding bonds
  11. Accordingly, on 21 December 1995 the Appellant resolved to issue funding bonds under section 582 of the 1988 Act to the subsidiary group companies in respect of the interest obligations arising under the eight loan agreements. The funding bonds were all expressed in the same way and contained the same terms.

  12. The essential features of the funding bonds were that, in respect of each loan agreement, the Appellant issued on 21 December 1995 a series of four loan notes each of the four loan notes being for the same amount. Three of the four loan notes in each series were issued to the lender, the remaining loan note being issued to the Inland Revenue. The total amount of each series of four loan notes was the amount of interest accrued at 30 September 1995 under the relevant loan agreement together with a further amount equal to two years' interest on the amount of such accrued interest calculated at current market rates. The loan notes were to be redeemed by the Appellant on 22 December 1997 at par in the foreign currency.

  13. The dates of the eight original loan agreements and the amounts of the loan notes issued in respect of each were:

    Date Total amount of loan notes
    1 May 1991 US $11,555,137.60
    24 May 1993 BF 54,207,198.92
    24 May 1993 BF 32,613,872.24
    25 June 1993 DFL.8,120,389.48
    25 June 1993 DFL 3,931,802.00
    3 November 1993 DFL.4,022,797.52
    14 December 1993 US $3,484,553.64
    18 February 1994 DFL 2,570,191.36
  14. Thus, taking as an example the loan agreement of 14 December 1993, the funding bond took the form of the issue of four loan notes each in the amount of $871,138.41 making a total of $3,484,553.64. The loan notes were expressed to be in respect of the Appellant's liability to pay interest under the original loan agreement of 14 December 1993. Three of the four loan notes were issued to the lender and the fourth was issued to the Inland Revenue

  15. At the time that the funding bonds were issued (on 21 December 1995) the appropriate clearance under the double tax treaty provisions had not been obtained from the Inland Revenue to permit payments which were treated as interest arising to the non-resident lenders to be paid gross. However, this clearance was subsequently obtained and on 18 February 1997 the Inland Revenue returned to the Appellant the loan notes which had been issued to it.

  16. The funding bonds were not redeemed before 31 December 1996.

    The legislation
  17. We begin our consideration of the issue in the appeal by considering the provisions of the relevant legislation, namely section 582 of the 1988 Act which governs the issue of funding bonds (first enacted in 1938) and then the provisions of the 1993 Act which contain the foreign exchange legislation.

    1938 – the predecessor of section 582
  18. The question whether the issue of funding bonds amounted to the payment of interest was decided by the judgment of the Court of Appeal in Cross v London and Provincial Trust Ltd (1938) 21 TC 705; [1937] KB 705. There a company held some Brazilian bonds. In 1932 the Brazilian government suspended payment of interest on the bonds for three years and issued new interest-bearing twenty-year bonds in exchange for the interest coupons on the suspended bonds. There was a market for the twenty-year bonds and the taxpayer company, who had received some of the twenty-year bonds, sold some of them from time to time. The company was assessed under Case IV of Schedule D on the sums it received from such sales on the basis that the company had been paid income which arose from securities outside the United Kingdom (the securities being the original bonds and not the funding bonds). The issue in that appeal was whether the money realised from the sale of the twenty-year bonds amounted to the payment of income in the form of interest on the original bonds. The Court of Appeal held that it did not and that there had been no payment of the interest due on the original bonds; all that the debtor had done was to give a promise to pay at a future date even though what he had handed over in lieu of payment was a document possessing the character of a marketable security.

  19. The Inland Revenue did not appeal from the judgment of the Court of Appeal but the effect of the judgment was reversed by section 25 of the Finance Act 1938. The provisions of section 25 were consolidated in section 582 of the 1988 Act which now provides:

    "582(1) Where any funding bonds are issued to a creditor in respect of any liability to pay interest on any debt to which this section applies-
    (a) the issue of the bonds shall be treated for all the purposes of the Tax Acts as if it were the payment of an amount of that interest equal to the value of the bonds at the time of their issue, and
    (b) the redemption of the bonds shall not be treated for those purposes as the payment of any amount of that interest.
    (2) Where an issue of bonds is treated by virtue of subsection (1) above as if it were the payment of an amount of interest, and any person by or through whom the bonds were issued would be required by virtue of any provision of the Tax Acts to deduct income tax from that amount of interest if it had been actually paid by or through him, the following provisions shall have effect-
    (a) subject to paragraph (b) below, any such person –
    (i) shall retain bonds the value of which at the time of their issue is equal to income tax on that amount of interest at the applicable rate for the year of assessment in which the bonds are issued and
    (ii) shall be acquitted in respect of any such interest in the same way as if he had deducted tax from that interest and
    (iii) shall be chargeable with that tax accordingly, but may tender the bonds retained in satisfaction thereof. … ."
  20. Funding bonds are defined in section 582(4) as including "any bonds, stocks, shares, securities or certificates of indebtedness".

  21. The effect of section 582 is that the issue of a funding bond is treated as a payment of interest at the time of the issue of the funding bonds.. The borrower obtains relief for the deemed payment of interest and the lender is taxed on the receipt of the payment from the borrower.

  22. Both parties agreed that section 582 applied to the funding bonds issued by the Appellant. However, the Appellant argued that the effect of section 582 was that, for all tax purposes, a funding bond was income and not capital and so it followed that the foreign exchange legislation did not apply. The Inland Revenue argued that the foreign exchange legislation did apply. We therefore now turn to consider the foreign exchange legislation.

    1993 - The foreign exchange legislation
  23. The foreign exchange legislation was introduced in 1993 to deal with foreign exchange gains and losses of companies. It is found in Chapter II of Part II (sections 125 to 170) of the 1993 Act. The legislation replaced the rather piecemeal system which had developed under general case law. (The old system continues to apply to individuals and partnerships.) The effect of the foreign exchange legislation is to bring the taxation of corporate exchange gains and losses broadly into line with accounting practice and to ensure that companies recognise exchange differences on monetary assets and liabilities on the translation (accrual) basis. The 1993 legislation applies to a company's first accounting period commencing on or after 23 March 1995 and so applies to the Appellant's accounting period commencing on 1 January 1996.

  24. Section 125(1) provides that subsection (2) applies where a qualifying company holds a qualifying asset and there is a difference between the local currency equivalent (at the translation time with which an accrual period as regards the asset begins) of the basic valuation of the asset and the local currency equivalent at the translation time with which an accrual period ends. (Section 149 provides that, for the purposes of section 125, the local currency is sterling.) There is an exchange difference if there is an increase or decrease over the period. The effect of these provisions is that if sterling strengthens against the foreign currency during any period there would be an increase in the local currency equivalent and therefore an exchange gain but if sterling weakens against the foreign currency there would be a decrease in the local currency equivalent and therefore an exchange loss.

  25. Thus qualifying companies are subject to a charge to tax on exchange gains or losses on qualifying assets or liabilities (such as loans). The exchange gain or loss is found by calculating the difference between the local currency equivalent of the basic valuation of the asset or liability at the beginning and end of an accrual period. The local currency equivalent is the currency in which a company is required to prepare and express its profits subject to corporation tax (in this appeal that is sterling). The basic valuation is the value which a company, under normal accounting practice, puts on the liability when it becomes entitled or subject to it. This is normally the open book value expressed in the nominal currency of liability.

  26. The foreign exchange legislation also contains other provisions. Section 128 applies to trading gains and losses where the asset or liability is held or owed for the purposes of a trade carried on by the company. It was agreed that in this appeal the Appellant was not a finance trader. Section 129, on the other hand, contains provisions about non-trading gains and losses and that applies to the Appellant.

  27. Sections 152 to 157 contain some interpretative provisions Section 152 provides that most companies are qualifying companies and it was agreed that the Appellant was a qualifying company. Section 153 defines qualifying assets and liabilities. Section 153(1)(c) defines a qualifying asset as including a share held in qualifying circumstances and section 153(11) provides that qualifying circumstances are circumstances where the qualifying company carries on a trade and the transfer of the asset would fall to be taken into account in computing the profits or losses of the trade for the purposes of corporation tax. These provisions did not apply to the Appellant. Section 153(2)(a) provides:

    "(2) As regards a qualifying company, each of the following is a qualifying liability –
    (a) a duty to settle under a qualifying debt…
  28. Section 153(10) provides that a debt falling to be settled by a payment of money is a qualifying debt. Section 158 contains the provisions defining translation times and accrual periods. An accrual period is the interval between the start and finish of an accounting period. Section 160 defines the nominal currency of an asset or liability as the settlement currency of the debt and section 163 defines the settlement currency of a debt as the currency in which the ultimate settlement of the debt falls to be made. In this appeal the nominal currency is sterling.

  29. Section 165 contains commencement provisions and the commencement date for the Appellant was 1 January 1996.

  30. The parties agreed that the original loan agreements made between 1991 and 1994 fell within the foreign exchange legislation. The issue in the appeal was whether the 1993 Act applied to the funding bonds issued in 1995, the Appellant arguing that it did not and the Inland Revenue arguing that it did.

    The arguments
  31. The Appellant accepted that, without the provisions of section 582, the funding bonds would be governed by the provisions of the 1993 Act. Specifically, the Appellant accepted that the funding bonds were a duty to settle under a qualifying debt within the meaning of section 153(10) and section 153(2)(a) of the 1993 Act. However, the Appellant argued that the effect of section 582 was to prevent the funding bonds from being capital assets and turned them instead into a payment of interest or income for all the purposes of the Tax Acts. In this way section 582 removed the funding bonds from the ambit of the foreign exchange legislation. By the enactment of section 25 of the Finance Act 1938 (now section 582 of the 1988 Act) Parliament had clearly indicated that a funding bond, which was a capital instrument, should not be treated as a capital security but as a payment of interest for all tax purposes. The Appellant relied upon certain dicta in the High Court in Cross to support its view that without section 582 the funding bonds would be capital from which it followed that the effect of section 582 was to treat the funding bonds as income. The Appellant relied upon page 724 where Finlay J said that a person receiving the funding bonds does not receive interest or income but received, instead of interest, a capital asset. The capital asset was substituted for income.

  32. The Inland Revenue argued that the issue in the Court of Appeal in Cross was whether the issue of the funding bonds was money's worth at the time of issue. It was accepted that the payment of money's worth was a payment of interest but the issue was whether a promise to pay at a future date was a payment of interest at the time of the issue of the bond and the Court of Appeal held that it was not. The word capital was not used by the Court of Appeal. Section 582 dealt only with the question of timing and provided that payment of the interest on the original bond was deemed to take place at the time of the issue of the funding bond and so the issue of the funding bond was treated as if it were a payment of money's worth at that time. But section 582 did not say that the issue of funding bonds was a payment in cash or a money payment of the interest and the funding bond did not lose its legal character and become another asset

    The plain meaning of section 582
  33. In considering the arguments of the parties we begin with the plain words of section 582 as set out above. What the section says is that if funding bonds are issued to a creditor in respect of a liability to pay interest on a debt, the issue of the funding bonds is to be treated for all the purposes of the Tax Acts as if that was the payment of an amount of interest equal to the value of the bonds at the time of their issue.

  34. In our view section 582 only deals with what happens on the issue of the funding bonds on two dates, namely issue and redemption. It provides that the issue of the funding bonds is to be treated as a payment, on the date of issue, of an amount of the interest due on the original bonds. It also contains a corresponding provision that the redemption of the funding bonds is not to be treated as a payment of interest. What section 582 does not do is to deal with any events other than issue and redemption. In particular, it does not deal with the tax treatment of any gains or losses which might arise in respect of the funding bonds between issue and redemption, either as chargeable gains or losses or exchange gains or losses. Of course, at the time that section 582 was first enacted in 1938 there was no legislation which taxed capital gains or exchange gains and so it is not surprising that the section did not deal with such matters specifically. But the important factor in this appeal is that it confined itself to the two events of issue and redemption. That means that when legislation was enacted to tax capital or chargeable gains and exchange gains there was no conflict between the separate legislative provisions. Section 582 dealt with the treatment of funding bonds at issue and redemption, while the chargeable gains and foreign exchange legislation dealt with gains or losses made between those two dates. Thus, in our view, the plain words of section 582 lead to the conclusion that the section does not apply to any event other than the issue and redemption of the funding bonds and, in particular, does not govern the taxation of any gains or losses made during the lifetime of the funding bonds.

  35. It is also relevant that section 582 deals with funding bonds only in their capacity as a substitute for interest on the original bonds. What it does not do is to regulate the tax position of the funding bonds in their capacity as securities in their own right.

  36. Before concluding our consideration of the plain words of section 582 we consider the context of the section. In the Finance Act 1938 the section stood alone. In the consolidating Act of 1988 section 582 is found in Part XIII (miscellaneous special provisions) and in Chapter VI (other provisions miscellaneous). Thus the context of the section does not provide any assistance with its interpretation. However, what is clear is that in 1938, when the section was first enacted, it was not intended to affect the taxation of exchange gains and losses where the legislation was enacted in 1993. In 1993 the foreign exchange legislation did not need to deal with section 582 because section 582 only dealt with the issue and redemption of the funding bonds in their capacity as a substitute for interest on the original bonds whereas the 1993 legislation was dealing with the taxation of exchange gains and losses on an accruals basis during the time between issue and redemption. That further supports our conclusion that section 582 does not prevent the application of the 1993 legislation.

  37. Having considered the plain words of section 582 and its legislative context, we conclude that the foreign exchange legislation in the 1993 Act does apply to the funding bonds issued by the Appellant and we would dismiss the appeal on this ground alone. However, as other arguments were put to us we consider them briefly.

    The mischief at which section 582 was aimed
  38. Next we note that section 582 was enacted in order to reverse the judgment of the Court of Appeal in Cross and so we look to the judgment in Cross in order to identify the mischief at which the section was directed. The mischief was that what was in effect a payment of interest on the original bonds by the issue of funding bonds was not taxed as interest at the date of issue.

  39. In our view section 582 is limited to the mischief with which it was intended to deal. It provides that the issue of funding bonds is treated as the payment of an amount of interest equal to the value of the bonds at the time of their issue but it goes no further than that. In particular it does not alter any other characteristics of the bonds. So, if the funding bonds consisted of shares the issue of the bonds would be treated as a payment of an amount of interest equal to their value at the date of issue but would not affect the tax treatment of any gains or losses subsequently made in respect of those shares. We accept that in Cross in the High Court Finlay J did mention that a person receiving funding bonds did not receive interest or income but instead received a capital asset. However, in upholding his judgment, the Court of Appeal did not mention that concept and it is not mentioned in section 582 either. Further, in Cross the taxpaying company did not argue that the funding bonds were capital and not income; its argument was that the funding bonds were interest paid under the original bonds not at the date of the issue of the funding bonds but at the date of their redemption. Thus we conclude that, in enacting section 582, Parliament was not saying that funding bonds were for all the purposes of the Tax Acts income and not capital. Parliament was, however, saying that the issue of funding bonds was to be treated as the payment of interest on the original bond at the date of issue.

    Does section 582 mean that there is no remaining qualifying debt?
  40. The Appellant also argued that section 582 was expressed to apply "for all the purposes of the Tax Acts" and for all such purposes the issue of the funding bonds was deemed to be a payment of interest. If, therefore, interest had been deemed to have been paid there could be no remaining debt falling to be settled by the payment of money within the meaning of 153(2)(a) and section 153(10) of the 1993 Act. That meant that there was no qualifying liability and so the foreign exchange legislation could not apply. The debt was deemed to be paid and settled and all tax paid. However, the Appellant accepted that the debt was not extinguished as a matter of general law because the deeming provision in section 582 only applied for the purposes of the Tax Acts. Thus the debt represented by the funding bonds continued to subsist for all other non-tax purposes until it was redeemed. That meant that the lender could sue the issuer of the funding bond for non-payment.

  41. In considering this argument we remind ourselves that we have already concluded that the plain words of section 582 lead to the conclusion that the section does not apply to any event other than the issue and redemption of the funding bonds. In particular, section 582 deals with the funding bonds only in their capacity as a substitute for interest on the original bonds. What it does not do is to regulate the tax position of the funding bonds in their capacity as securities in their own right.

  42. From this it follows that, although the effect of section 582 is to treat the issue of the funding bonds as the payment of interest on the original bonds as at the date of issue of the funding bonds, the section does not provide that the debt created by the funding bonds at the date of their redemption is extinguished; if any debt is extinguished it is the obligation to pay interest on the original bonds. Thus we conclude that, for the purposes of the foreign exchange legislation, the funding bonds do constitute a qualifying liability within the meaning of section 153(2)(a) of the 1993 Act and that the obligation in the funding bonds to make the payments on redemption of the funding bonds was a debt falling to be settled by a payment of money and so was a qualifying debt. In this appeal the obligation to redeem the funding bonds on 22 December 1997 remained a duty to settle under a qualifying debt within the meaning of section 153(2)(a) of the 1993 Act.

  43. The Inland Revenue had an alternative reply to the Appellant's suggestion that section 582 meant that there was no qualifying debt for the purposes of the 1993 legislation and this was that section 582 did not deem the issue of the funding bonds to be a transfer of cash. The argument was that in Cross (at 796) Sir Wilfred Greene said that a payment of income for the purposes of Case IV of Schedule D could be in the form of money's worth as well as in the form of money. So, for example, if a person were contractually entitled to receive money as income the provision of goods or shares instead would equally be income. In Cross the argument of the taxpayer company was that the issue of the twenty-year bonds was not the same as money's worth because they were merely a promise to pay money in the future and so there was no payment of income at the time the twenty-year bonds were issued. The Court of Appeal agreed and held that the interest due on the original bonds had not been paid and that no income arose by a debtor promising that he would pay his debt later on.

  44. The Inland Revenue went on to argue that, when the amending legislation was introduced in 1938, it had the effect of putting the twenty-year bonds on the same footing as if the company had received money's worth (for example, shares) at the date of the issue of the twenty-year bonds. That meant that the issue of the twenty- year bonds was treated as a payment of the amount of interest equal to their value at the time of issue. What the predecessor of section 582 did not do was to treat the funding bonds as the payment of money (as opposed to money's worth). As Lord Evershed said in White v Elmdene Estates [1960] QB 1 at 16:

    "… the word "payment" in itself is one which … may cover many ways of discharging obligations. It may even… include a discharge, not by money payment at all, but by what is called "payment in kind".
  45. The Inland Revenue accepted that if section 582 had stated that the issue of funding bonds was to be treated for all tax purposes as a payment in cash then there would be no taxation of subsequent gains but the section did not say that. All it said was that the issue of the funding bonds was to be treated as payment in money's worth of the interest due on the original bonds. Thus, the Inland Revenue's argument continued, if the funding bonds consisted of shares they would be payment in money's worth at the date of issue. If the shares were subsequently sold, any increase in the value of the shares after the date of issue would be a capital gain (or trading income if sold as part of the trade). Section 582 did not treat the transfer of the shares as a transfer of cash but merely deemed there to have been a payment of interest at the date the funding bonds were issued. The shares would remain shares with all the incidents of shares. Thus the effect of section 582 was not to transmute the funding bonds into cash at the date of issue but to deem the issue of the funding bonds to be money's worth.

  46. If we are wrong in our analysis in paragraphs 40 and 41 then we adopt these arguments of the Inland Revenue.

    A possible anomaly
  47. The Appellant referred to section 582(4) which included stocks and shares within the definition of funding bonds. He argued that these equity instruments could not fall within the foreign exchange legislation. From that it followed that, if the foreign exchange legislation were to be applied to funding bonds, but not to funding shares, an anomaly would result and this confirmed the Appellant's view that the foreign exchange legislation did not apply to funding bonds.

  48. In considering this argument we first note that the 1993 legislation does not exclude all holdings of shares as it applies to shares held in qualifying circumstances, namely where the qualifying company carries on a trade and the transfer of the shares would fall to be taken into account in computing the profits or losses of the trade for the purposes of corporation tax (section 153(1)(c) and (11)). However, the provisions of the 1993 legislation do not apply to all holdings of shares but do apply to qualifying debts as provided by section 153(10) of the 1993 Act. We accept the argument of the Inland Revenue that this reflects normal accounting practice. SSAP 20 provides that monetary assets and liabilities such as foreign currency debts are to be re-translated at each balance sheet date but non-monetary assets like foreign equity investments are not (paragraph 5 of SSAP 20). If an interest payment is satisfied by the issue of a funding bond which provides for the payment of money in a different currency to that in which the recipient company is required to express and compute its profits it is subject to the foreign exchange legislation in respect of any exchange gain or loss in respect of that bond. But if an interest payment is satisfied by the issue or transfer of shares those shares are not subject to the foreign exchange legislation and so the possible anomaly identified by the Appellant is deliberate.

    Decision
  49. Our decision on the second issue in the appeal is that the foreign exchange legislation in the Finance Act 1993 (the 1993 Act) applies to the funding bonds issued by the Appellant and that a taxable gain arose on these bonds in the relevant accounting period.

  50. We therefore determine the appeal in the sum of £96,650,769 less group relief of £52,446,256.

    DR NUALA BRICE
    DR DAVID WILLIAMS
    SPECIAL COMMISSIONERS
    Release Date: 25 January 2005

    SC 3063/2002

  51. 02.05

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