Enter to open, tab to navigate, enter to select
Upper Tribunal overturns taxpayer victory in loan relationship avoidance scheme
Practical Law UK Legal Update Case Report 2-589-1486 (Approx. 6 pages)
Upper Tribunal overturns taxpayer victory in loan relationship avoidance scheme
| Published on 21 Nov 2014 • United Kingdom |
The Upper Tribunal, overturning a decision of the First-tier Tribunal , has held that a taxpayer who held an unallowable (tax avoidance) purpose for a loan relationship, held that purpose until it was achieved, which occurred when a loan relationship debit crystallised at the start of a subsequent accounting period. As a result, the debit could not be deducted for corporation tax purposes. (Fidex Ltd v HMRC [2014] UKUT 0454 (TCC).)
Speedread
The Upper Tribunal (tribunal), overturning a decision of the First-tier Tribunal (FTT), has held that a taxpayer having a tax avoidance motive for being party to a loan relationship in an accounting period had an unallowable purpose until that motive was achieved, which occurred when a loan relationship debit crystallised at the start of the next period due to a change in accounting policy. This was so despite the taxpayer's purpose ceasing to be unallowable at that moment.
The tribunal also held that, in attributing (part of) the debit to the unallowable purpose, time-based apportionment was not required. Instead, the debit was attributable to its main (unallowable) purpose even though the taxpayer only had that purpose for a very short period of time in the relevant accounting period.
The tribunal’s commentary on the unallowable purpose rule is helpful, albeit that section 455A of the Corporation Tax Act 2009 now counteracts this particular scheme. The tribunal appears, perhaps because the FTT had found no assistance in the Ramsay principle, to have focussed on a close analysis of the statutory provisions. That analysis would seem to make a successful appeal unlikely. (Fidex Ltd v HMRC [2014] UKUT 0454 (TCC) (Barling J and Mr Charles Hellier).)
Background
Change of accounting policy
Paragraph 19A of Schedule 9 to the Finance Act 1996 (paragraph 19A) provided that, if there was a difference in the accounting value of an asset or liability representing a loan relationship in one accounting period compared to another accounting period as a result of a change of accounting policy, a debit or credit should be brought into account when calculating corporation tax. Paragraph 19A applied where a company changed from preparing its accounts in accordance with UK generally accepted accounting practice (UK GAAP) to preparing accounts in accordance with international financial reporting standards (IFRS).
Paragraph 19A has been rewritten as sections 315 to 319 of the Corporation Tax Act 2009.
Loan relationships: unallowable purpose
Paragraph 13(1) of Schedule 9 to the Finance Act 1996 (paragraph 13) provided that where, in an accounting period, a loan relationship had an unallowable purpose, the debits attributable to that purpose (on a just and reasonable basis) would not be deductible for the purposes of corporation tax. This would apply, under paragraph 13(2), if the purposes for which the company was a party to the loan relationship included, "at times" during an accounting period, a purpose not within the commercial or business purposes of the company. It was recognised that a commercial transaction could give rise to a tax advantage and that reducing tax costs could be considered a business purpose. However, paragraph 13(4) provided that:
"For the purposes of this paragraph, where one of the purposes for which a company (a) is a party to a loan relationship at any time, or (b) enters into a transaction which is a related transaction by reference to any loan relationship of the company, is a tax avoidance purpose, that purpose shall be taken to be a business or other commercial purpose of the company only where it is not the main purpose, or one of the main purposes, for which the company is a party to the relationship at that time or, as the case may be, for which the company enters into that transaction."
Paragraph 13 has been rewritten as sections 441 to 446 of the Corporation Tax Act 2009.
For more information on loan relationships, see Practice note, Loan relationships. For more information on the unallowable purpose rule, see Practice note, Loan relationships: Special computational provisions: Unallowable purpose.
Facts
The taxpayer was established to issue commercial paper into the debt capital markets, collateralised by a portfolio of bonds. Following a change in accounting policy, this practice ceased in 2002 and, in 2004, the taxpayer entered into a tax avoidance scheme proposed by Swiss Re Financial Products Corporation (Swiss Re), using the bonds to create a tax loss that could be surrendered by way of group relief. Under the scheme, the taxpayer entered into a Preference Shares Subscription Agreement (PSSA), under which Swiss Re subscribed for four classes of preference shares in the taxpayer. Each class of preference share had rights matching those of a different set of bonds held by the taxpayer, with the result that Swiss Re was economically entitled to 95% of the amounts received by the taxpayer from those bonds. During the course of 2005, the bonds matured, and the taxpayer paid a dividend to Swiss Re and redeemed the preference shares.
In its balance sheet for the year ended 31 December 2004, the taxpayer, in accordance with UK GAAP, included the preference shares as shareholder funds and recognised the full value of the bonds. The taxpayer elected to change its accounting policy so that its accounts for 2005 onwards would be prepared in accordance with IFRS. As a result, the taxpayer derecognised the preference shares in its balance sheet for the year ended 31 December 2005 on the basis that the preference shares were liabilities. It also derecognised 95% of the value of the bonds.
This change in accounting policy resulted in a difference in the accounting value of the preference shares and bonds in the 2005 accounts when compared to the 2004 accounts, thereby resulting in a loan relationship debit in relation to the bonds, which the taxpayer sought to deduct when calculating its corporation tax liability under paragraph 19A (see Change of accounting policy). HMRC amended the taxpayer's corporation tax return on the basis that the taxpayer should not have reflected the preference shares or the bonds in its 2004 accounts. As a result, there would have been no difference in accounting value when the taxpayer started preparing its accounts in accordance with IFRS. HMRC further argued that, even if a debit had arisen, it would have been disallowed as the bonds (as loan relationships) had an unallowable purpose. The taxpayer appealed to the First-tier Tribunal (FTT).
FTT's decision
The FTT allowed the taxpayer's appeal, finding that:
- The preference shares and bonds should have been recognised under UK GAAP in the 2004 balance sheet and should have been subsequently derecognised under IFRS. A debit, therefore, arose in 2005 as a result of the change of accounting policy. Under paragraph 19A, this debit was deductible in calculating the taxpayer's corporation tax liability.
- The bonds did not have an unallowable purpose when the debit arose in 2005; although the crystallization of a loan relationship debit was clearly a tax avoidance purpose, this purpose had been achieved at the end of 2004 because the taxpayer had passed a resolution to adopt IFRS for future accounting periods at that time. The debit was, therefore, deductible in calculating the taxpayer's corporation tax liability.
Although the FTT noted that it was bound by the Ramsay principle and was required to apply a purposive approach to the legislation, that approach did not lead the tribunal to alter its conclusions on the effect of the provisions in question (as in HMRC v Mayes [2011] EWCA Civ 407 (see Legal update, Court of Appeal dismisses HMRC appeal on "SHIPS 2" second-hand life policy scheme)). (For details of the Ramsay principle, see Practice note, Anti-avoidance case law and tax: Direct taxes and stamp duties.)
For further details of the FTT's decision, see Legal update, Loan relationship debit allowed because it arose in accounting period after tax avoidance motive had been achieved (First-tier Tribunal).
The taxpayer appealed to the Upper Tribunal (tribunal).
Upper Tribunal's decision
The tribunal overturned the decision of the FTT, finding that:
- The unallowable purpose that existed in 2004 continued into 2005.
- In attributing (part of) the debit to the unallowable purpose on a just and reasonable basis, a time apportionment was not appropriate because, as a question of fact, the whole of the debit related to that unallowable purpose.
Taxpayer's application to strike out part of HMRC's argument dismissed
The FTT had decided that HMRC was permitted to raise arguments before it (in particular, the unallowable purpose argument) that had not been included in the closure notice issued to the taxpayer requiring the amendment of its corporation tax return. The tribunal agreed with the FTT that it was the subject matter of an enquiry and the conclusions stated in a closure notice issued by HMRC in relation to that enquiry, rather than the grounds for those conclusions, that mattered in determining the scope of an appeal. Therefore, following the decision of the Supreme Court in HMRC v Tower McCashback LLP [2011] UKSC 19 (see Legal Update, Tower MCashback: HMRC wins in Supreme Court (detailed update)), to which the tribunal considered the taxpayer’s position to be “precisely parallel”, it held that the FTT had jurisdiction to hear new issues of fact or law that constituted an alternative or additional ground of appeal. Therefore, the tribunal dismissed the taxpayer's cross-appeal on this issue.
Time at which unallowable purpose existed
The tribunal held that the tax avoidance scheme entered into by the taxpayer depended on the continued existence of the loan relationship in 2005. Paragraph 19A, on which the scheme hinged, required a consideration of the accounting values of an asset in one accounting period as compared with another; therefore, the debit was dependent on the taxpayer continuing to be a party to the loan relationship at the beginning of 2005 and not, as the FTT had held, until the end of 2004. The taxpayer's unallowable purpose (crystallising a debit under the loan relationship rules) must, therefore, also have existed until the beginning of 2005. The tribunal held, on this basis, that the FTT had erred in finding that there was no unallowable purpose in 2005.
The tribunal held, further, that it was irrelevant that the unallowable purpose only existed for a very short period of time in 2005, and dismissed the taxpayer’s argument that the requirement of paragraph 13(2) for an unallowable purpose to exist "at times" during an accounting period meant more than the mere scintilla of time that passed before the debit crystallised on 1 January 2005. It agreed with HMRC that the phrase "at times" simply acknowledged the fact that a company's purpose could change over the course of an accounting period; further, even a significant period of days or months could be described as a singular period of "time" and, were the unallowable purpose rule to exclude any length of time that could be described in this way, the provision would be unworkable.
Attribution of debit to unallowable purpose
Finally, in considering the attribution of that part of the debit that related to the unallowable purpose in 2005, the tribunal held that a just and reasonable apportionment did not require a time basis to be applied. While the tribunal noted that this was one possible method of achieving a just and reasonable apportionment, it was not the only method that could be used. As a question of fact, until the debit crystallised, the taxpayer's main purpose in holding the bonds was the unallowable purpose of crystallising the debit. Although other main purposes in holding the bonds may have existed subsequently in 2005, the debit had already crystallised and could not, therefore, be said to have been attributable to those purposes.
Comment
The tribunal’s commentary on Schedule 9 to the Finance Act 1996 (since rewritten to the rewritten in the Corporation Tax Act 2009) is helpful, albeit that section 455A of the Corporation Tax Act 2009 now counteracts the particular scheme employed by the taxpayer. The tribunal seems, perhaps on the basis that the FTT had found no assistance in deploying the Ramsay principle, to have focussed, instead, on a close analysis of the statutory provisions in question. That analysis, on which the tribunal's decision is based, would seem to make the chances of a successful appeal unlikely.
HMRC will no doubt be relieved, in view of the current climate and of public scrutiny of its own efforts to tackle tax avoidance, to have secured another victory against a clearly contrived tax planning scheme. The tribunal's decision leaves that of the Court of Appeal in Mayes, in which another such scheme succeeded, a somewhat isolated taxpayer victory in the context of contrived tax planning.
The tribunal’s decision in relation to the closure notice is unsurprising, given the proximity to the facts in Tower McCashback, although its summary of the case law and the principles to be applied provide a useful summary of the scope of an appeal following closure of an enquiry by HMRC.
If you don’t yet subscribe to Practical Law, you can request a free trial by completing this form or contacting the Practical Law Helpline.