Greene King Plc & Anor v Revenue And Customs

This appeal concerns the assessment of liability to corporation tax under the code for taxing “loan relationships” of companies in Chapter II of Part IV of the Finance Act 1996 (“the FA 1996”). The appeal concerns the tax consequences of two transactions carried out by the Greene King group of companies (“the GK group”). The transactions were structured in accordance with a scheme entitled “Project Sussex” devised and marketed by Ernst & Young (“EY”).

The appeal is by Greene King plc (“PLC”), the UK parent company for the GK group, and Greene King Acquisitions Ltd (“GKA”), a wholly-owned subsidiary of Beards of Sussex Group Limited, itself a wholly owned subsidiary of PLC, from a decision of the Upper Tribunal (“the UT”) (Mr Justice Mann) released on 22 April 2014 dismissing the appellants’ appeal from the decision of the First Tier Tribunal (“the FTT”) (Judge Colin Bishopp and Judge Alison McKenna) released on 14 June 2012. By its decision the FTT had itself dismissed the appeals of the appellants against two notices of amendment, issued by the respondents (“HMRC”) on 6 January 2010, relating to their corporation tax returns for the periods ending 30 April 2003 and 30 April 2004.

This is a lead case for a number of other corporate groups who have undertaken similar transactions pursuant to EY’s marketed scheme.

The principal activities of the GK group are operating managed, tenanted and leased public houses, brewing beer and wholesaling beers, wines, spirits and soft drinks.

The transactions which are the focus of this appeal were undertaken, on 31 January 2003 and 5 September 2003 respectively, by the appellants and Greene King Brewing and Retailing Ltd (“GKBR”), another wholly owned subsidiary of PLC. GKBR is not a party to these proceedings. PLC’s evidence was that it used the transactions as a way of providing finance to GKA enabling it to acquire and operate individual pubs and small pub portfolios.

The parties agreed a statement of facts, which is set out in full in the FTT’s decision. The issues of principle arising from the second transaction are identical to those in the first transaction and so the FTT and the UT concentrated on an analysis of the first transaction. The submissions before us did the same. Accordingly, I shall not address the second transaction, the details of which can be obtained from the decision of the FTT.

For the purposes of this appeal, it is sufficient to set out the following facts relating to the first transaction. Fuller details can be obtained from the decision of the FTT.

On 20 October 2000 PLC lent £300 million to GKBR. On the same day GKBR created unsecured loan stock with a nominal value of £300 million, which was issued to PLC as security for the loan.

At all material times PLC was the sole holder of all the loan stock.

The terms of the loan stock were that it was to be redeemed on 4 May 2004, and in the meantime it bore interest at a floating rate which equated to LIBOR plus 1%, payable six monthly in arrears on 4 May and 4 November until redemption. There was an option to repay the loan and redeem the stock early.

On 31 January 2003 the terms of the loan were amended by agreement of PLC and GKBR. The interest rate was altered to a fixed rate of 4.75%, but the interest remained payable on the same dates. The option to redeem the stock early was removed.

On the same day PLC assigned to GKA its right to receive the interest on the loan stock (including interest accrued but not then due for payment), in consideration for which GKA issued to PLC 1.5 million £1 preference shares. The right to receive repayment of the loan principal remained with PLC.

The preference shares carried the right to a special dividend, defined as an initial dividend of 65 pence per share to be declared on 14 February 2003, and thereafter the right to a 5% annual dividend.

PLC immediately gave notice to GKBR of the assignment and directed GKBR to make future interest payments to GKA.

On 14 February 2003 the special dividend of 65 pence per share, amounting in total to £975,000, was declared by GKA. The dividend was to be paid on 2 May 2003, and it was duly paid on that date.

Three future payments of interest on the loan were due following the assignment and before redemption: £7,066,438 on 4 May 2003, £7,183,561 on 4 November 2003 and £7,066,438 on 4 May 2004. The total of these was £21,316,437 but for the sake of simplicity I shall treat the total in the rest of this judgment as £21.3 million.

The net present value (“NPV”) of the three future interest payments, as at 31 January 2003, was calculated to be £20,548,372, using a discount rate of 5%. Again, for the sake of simplicity, I shall treat the NPV in the rest of this judgment as £20.5 million.

PLC made up its accounts to 4 May 2003. Following the assignment of the right to receive interest (“the interest strip”) PLC continued to recognise the loan principal of £300 million in its accounts.

GKA also made up its accounts to 4 May 2003. After the assignment of the interest strip and the issue of the preference shares to PLC, GKA (1) recorded the right to receive the interest as a receivable from GKBR in its balance sheet at its NPV, (2) credited the nominal value of the preference shares as a non-equity capital instrument, and (3) credited to its share premium account the difference between the NPV of the interest strip and the nominal value of the preference shares.

Payments received following the assignment were credited against the balance sheet receivable, with the excess of the amounts actually received over the original NPV taken to GKA’s profit and loss account.

GKBR also made up its accounts to 4 May 2003. The assignment of the interest strip did not give rise to any changes in GKBR’s accounting treatment of the loan principal as a liability or the payments of interest on the loan, which were debited to its profit and loss account.

After the appellants filed their tax returns, they received notices of amendment from HMRC. The amendments sought to increase the tax charge because HMRC considered that, while EY’s scheme attempted to remove the money received by GKA pursuant to PLC’s assignment of interest from the calculation of corporation tax, it did not succeed in doing so.

There are set out in the Appendix to this judgment the principal provisions of the loan relationships code in FA 1996 which related to the tax treatments of the two transactions at the relevant time and are relevant to this appeal. Those provisions, like the rest of the code, were superseded by Part 5 of the Corporation Taxes Act 2009 (“CTA 2009”), which has itself been the subject of further amendments since then.

The hearing before the FTT lasted four days. Oral evidence was given by two witnesses of fact, Mr Bryndon Webb, who was the GK group's tax controller, and Mr Les Clifford, an EY partner responsible for the GK group's audit. Expert evidence was given, on behalf of the appellants, by Mr David Parish ACA, who was employed by RSM Tenon as a director of its audit, tax and advisory division, and, on behalf of HMRC, by Mr Mark Chandler FCA, who was employed by HMRC as an advisory accountant.

The FTT identified the following issues as arising:

Issue 1 was not supported by Mr Chandler and so it was agreed that the answer to Issue 1 was negative.

The FTT said that the critical question in relation to Issue 2 was whether, as HMRC contended, PLC should have partially de-recognised the outstanding £300 million loan principal by discounting it by the £20.5 million NPV of the interest strip and should then have accreted that value progressively over the period remaining before redemption, bringing the accretions into profit and, accordingly, tax. The FTT found in favour of HMRC on this issue, holding (at paragraphs 71 to 74) that the reality of the transaction ought properly to be reflected by partial de-recognition of the loan and an addition to the value of PLC’s investment in GKA, with the accretion from the NPV of the capital sum on the date of the assignment of the interest strip until redemption being brought into taxable profit.

The FTT considered that it was not necessary to answer Issue 3 as put but that the more important question was whether, for the purposes of FA 1996 s. 81(1), the interest received by GKA following the assignment of the interest strip arose from a loan relationship of GKA. The FTT decided that issue in the negative and in favour of HMRC (at paragraphs 82 to 84). The FTT’s reasoning was that the interest on the loan arose under the loan relationship between PLC and GKBR, which subsisted after the assignment to GKA, and that, even if there was a loan relationship between GKA and GKBR (which the FTT did not decide), the interest did not arise under that relationship.

Issue 4 did not, therefore, arise. The FTT nevertheless went on to consider the point if its other conclusions were held to be wrong on appeal. The FTT decided, again in favour of HMRC, that section 130 of the Companies Act 1985 (“CA 1985”) did not require GKA to transfer the premium received on the issue of the preference shares to its share premium account. They decided, moreover, that FA 1996 s. 84(2) did not apply to the payments received by GKA; alternatively, it applied only to an amount equivalent to the minimum premium value.

For those reasons the FTT dismissed the appeal.

The FTT was unimpressed with the appellants’ argument that their conclusions might lead to double taxation. The FTT said (at paragraph 84) that the appellants could not legitimately complain if their scheme, intended to ensure that relief for payment was not matched by taxation of the receipt, failed in its purpose and instead resulted in their paying tax twice.

The appellants appealed with the permission of the FTT. In the UT Mann J identified a number of issues that had not been answered by the FTT.

On Issue 2, Mann J held that it was open to the FTT to prefer the expert evidence of Mr Chandler to that of Mr Parish on partial de-recognition of the £300 million loan and to conclude that de-recognition was required in the circumstances of the case.

He said that the FTT had not dealt adequately with the accounting and tax consequences of de-recognition. Rather than send the matter back for further reconsideration, he decided (with the encouragement of the appellants and in the absence of any strong objection by HMRC) to deal with those aspects himself. Having observed that both experts agreed that, if there was de-recognition, then it would be appropriate to accrete the lower sum back up to the amount of the principal of the loan over the remainder of its lifetime, he proceeded to find in favour of HMRC that the increase was to be taken to PLC’s profit and loss account as realised profit within FA 1996 s.84(1)(a) and (contrary to the submissions of the appellants) that was not precluded by any other legislative or accounting provisions, including FA 1996 s.85(2)(c), s.85(3)(c) and FA 1996 schedule 9 paragraphs 5 and 14.

Mann J said that the FTT had not adequately addressed Issue 3, even as re- formulated by the FTT. He did not accept fully the submissions of either counsel on the issue but, nevertheless, he ultimately concluded, in favour of HMRC, that there was no loan relationship between GKA and GKBR.

In the light of those conclusions, Mann J observed that Issue 4 did not arise. He said, however, that, having received submissions on it, he would make some remarks on it. He concluded that, if section 84(2)(a) had applied, GKA was correct to take the £19.5 million to its share premium account as the minimum premium value specified in CA 1985 s.132.

The UT dismissed the appeal from the FTT. It gave permission to appeal to this court.

The grounds of appeal are as follows:

I agree with the appellants that the FTT and the UT should have held that GKA had a loan relationship with GKBR within the meaning of FA 1996 s.81.

The appellants’ case is that the facts fit the literal wording of section 81(1): from the moment of the assignment to GKA of the interest strip GKA and GKBR stood in a position of creditor and debtor as respects the money debt represented by the future instalments of interest for the purposes of section 81(1)(a), and that arose from the £300 million loan transaction for the purposes of section 81(1)(b).

Mr David Milne QC, for HMRC, advanced the following reasons to the contrary. He submitted, firstly, as he had before the FTT (and as recorded in paragraphs 76 and 77 of the FTT’s decision), that the loan relationship in respect of the £300 million loan stock issued by GKBR to PLC remained between GKBR and PLC at all relevant times, and it remained PLC’s loan relationship despite the assignment from PLC to GKA of the right to receive interest on that loan. Consequently, he said, the interest which, as a result of that assignment, was paid by GKBR to GKA was not interest under a loan relationship of GKA, but interest under a loan relationship between GKBR (as debtor) and PLC (as creditor).

He submitted, secondly, that the right to receive the interest stream in respect of the £300 million loan stock, at the time it was assigned to GKA, was not a debt but a chose in action.

He submitted, thirdly, that the words “that debt” in section 81(1)(b) were, on the facts of a case like the present one, a reference to the debt subsisting as between the original lender and borrower and not to a new and different debt arising as between the original borrower and an assignee of the interest strip.

He submitted, fourthly, that, for the reasons given by Mann J at paragraphs 140 and 141 of the UT’s decision, section 81(1)(b) should be given a purposive interpretation so as to limit a loan relationship to one where the creditor and the debtor were respectively creditor and debtor in relation both to the loan and the interest payable on it and does not extend to a situation where the debtor in relation to the interest was not also the debtor in relation to the loan.

I do not accept those submissions for reasons which can be stated very briefly. The first submission, as is apparent from paragraphs 76 and 77 of the FTT’s decision, is really directed at, and relevant to, the meaning and application of FA 1996 s.84(1)(b) rather than the meaning of section 81.

As to the second submission, the assignment transferred to GKA the right to receive the three quantified instalments of interest on fixed dates and so brought about a relationship of creditor and debtor as between GKA and GKBR, albeit the debt was payable in the future. As appears from paragraphs 135 and 140 of the UT’s decision, that was the view of Mann J. That interpretation is consistent with the plain intention that the making of a loan by one company to another within the same group would give rise to a creditor-debtor relationship even if the loan was not repayable on demand but on one or more future dates. It is consistent with the intention apparent from section 81(3) that the loan relationship code embraced a wide category of corporate debt, which would not in ordinary legal or trade terms be categorised as a loan. It is also consistent with the accruals basis of accounting specified in section 85(1)(a) (the mark to market basis of accounting specified in section 85(1)(b) being inapplicable to the loan transaction and the assignment). Under the accruals basis of accounting both the obligation to pay and the right to receive payment of a debt on a future date is treated as accruing over time rather than at the moment of receipt: FA 1996 s. 85(3).

Mr Milne’s third submission is incorrect because the reference to “that debt” in section 81(1)(b) is plainly a reference to the debt specified in section 81(1)(a). For the reasons which I have given in relation to Mr Milne’s second submission, the assignment to GKA of the interest strip created a relationship of creditor and debtor as between GKA and GKBR in respect of the debt represented by the future instalments of interest. Accordingly, it is that debt to which the words “that debt” in section 81(b) refer.

I do not accept Mr Milne’s fourth submission, and I respectfully disagree with the approach of Mann J in paragraphs 140 and 141 of the UT’s decision. The effect of Mann J’s approach is that a loan relationship would exist not only between the original creditor and debtor but also between any persons who become in the future creditor and debtor in relation to both loan principal and interest, but such a relationship would not exist as between the debtor liable to pay interest and repay the principal and a person to whom the right to interest is transferred but not the right to the loan principal. Not only is there nothing in the wording of section 81 to support that distinction but neither Mann J nor Mr Milne identified any legislative purpose or policy which would justify such a deviation from the literal meaning of section 81(1)(b). Mann J’s only explanation appears from paragraph 140 of his decision to be his instinctive view of the type of relationship which it would be “fair to characterise as involving a transaction for the lending of money for the purposes of the subsection”.

Mann J referred to the following statement of Lawrence Collins LJ in Revenue and Customs Commissioners v Bank of Ireland [2008] EWCA 58, on which HMRC also rely :

“47.

Receipt, of itself, is not a determinant of any possible tax liability. An assignee of the right to receive interest (without assignment of the loan relationship) would not be taxable on the amount of that interest under the loan relationship provisions because he has no relevant loan relationship."

That case, however, was one concerning the very different situation of a scheme involving a “repo” transaction, that is to say the sale and repurchase of securities. There is particular tax legislation relating to such transactions, and the issue in the case was a point of statutory interpretation of that legislation as to the person to whom deemed interest was to be treated as paid. It would not be right to read the quoted words of Lawrence Collins LJ, which were strictly obiter, as carrying weight outside that factual situation.

PLC’s case, as articulated by Mr Gardiner, is that, even if there was a loan relationship between GKA and GKBR within FA 1996 s.81, the assignment of the interest strip to GKA did not give rise to any profit or gain subject to tax other than the £800,000 which represented the difference between the NPV of the assignment (£20.5 million) and the actual receipt of the interest instalments (£21.3 million). In particular, PLC contends that the £19 million taken by GKA to the share premium account, as consideration for the issue of the preference shares, did not fall within FA 1996 section 84(1).

The following reasons were advanced by Mr Gardiner for that contention. He submitted, firstly, that the value of the assignment was not a profit or gain within section 84(1)(a) because the assignment was itself the source of the loan relationship and not a profit or gain arising out of the relationship. Putting it in more general terms, his argument was that the mere receipt of a capital sum or value, as a consequence of which the recipient becomes a creditor, indicates nothing about making a profit or loss. He emphasised in this context that tax under the loan relationships provisions is not on a receipts basis. Mr Gardiner supported those propositions about the nature of profit and gain by references to Re Spanish Prospecting Company Limited [1911] 1 Ch 92, 98 and 99, Port of London Authority v IRC [1920] 2 KB 612, 618-619, Graham v Green [1925] 2 KB 37, 39, and Lowry v Consolidated African Selection Trust Limited [1940] AC 648, 660-661.

Mr Gardiner then submitted that, even if the £19 million was a profit or gain, it did not fall within section 84(1) because it did not arise to GKA from its loan relationships or related transactions as specified in section 84(1)(a).

Mr Gardiner finally submitted, on this issue, that even if PLC was wrong on the first two arguments the £19 million - which was transferred to the share premium account pursuant to (at that time) CA 1985 ss.130 and 132 as the “minimum premium value” specified in section 132 - was excluded from section 84(1) by section 84(2)(a).

If the value of the assignment of the interest strip is divorced from the issue of the preference shares by GKA, I might agree with Mr Gardiner that it would not of itself be a profit or gain within section 84(1)(a) for the reason given by him. It cannot, however, be divorced from the profit made by GKA on the issue of the preference shares, part of the consideration for which was the assignment.

The £19 million transferred to GKA’s share premium account was the difference between the net present value of the interest strip (£20.5 million) and the nominal value of the preference shares (£1.5 million). It was a profit or gain: Vocalspruce Ltd v HMRC [2014] EWCA Civ 1302 [2015] STC 861 at [54] and [59]. As stated by Lewison LJ in that case at [59], it is inherent in section 84(2)(a) that, but for that sub-section’s operation, in appropriate circumstances the amount transferred to the company’s share premium account would be a profit or gain arising either from a loan relationship or from a related transaction.

Mr Gardiner submitted and Mr Milne agreed that, even if it was profit or gain, the £19 million taken to GKA’s share premium account fell outside section 84(1)(a) on the facts of the present case because it did not arise to GKA “from its loan relationships and related transactions” within that sub-section, that is to say (having regard to my decision on Ground 1) from the loan relationship between GKA and GKBR. Although it is unusual for the Court to take a position different from that advanced by both parties, I do not agree. Each side has its own forensic reason for advancing that proposition. PLC wishes the £19 million to drop out of section 84(1) because the interest that was previously taxable as and when received by PLC will, PLC contends, fall outside any relevant taxing provision after the assignment to GKA. HMRC wish the £19 million profit to be excluded from section 84(1)(a) as not arising to GKA from its loan relationship with GKBR because that profit would otherwise be excluded from corporation tax by virtue of section 84(2)(a) whereas HMRC wish to claim that GKA is liable to tax on the full £21.3 million interest as it accrues due (less cost).

I consider that the whole of the £20.5 million representing the then current value of the right to receive interest on the £300 million loan does arise from the loan relationship between GKA and GKBR. Quite simply, it is an accounting entry representing or reflecting the future payments of interest payable by GKBR pursuant to its loan relationship with GKA which arose on the assignment. Following the assignment, payments received by GKA from GKBR in respect of the interest strip were credited against the balance sheet receivable (that is to say, the net current value of the interest strip), with the excess taken to the profit and loss account. Those payments, as and when received, undoubtedly arose from the loan relationship between GKA and GKBR. For the purposes of section 84(1)(a), the net present value of those future payments, which was recorded in GKA’s balance sheet and which gave rise to the profit transferred to GKA’s share premium account, can be of no different character.

The £19 million taken by GKA to its share premium account is nevertheless excluded from section 84(1)(a) by section 84(2)(a).

For the reasons given above Ground 3 does not arise.

Turning to the tax position of PLC, it is convenient first to address Grounds 5 and 7. They challenge the conclusion of the FTT that PLC was required to reduce the value of the loan to £279.5 million and to accrete it back up to £300 million. PLC’s case is that PLC was entitled to produce accounts which did not contain any element of de-recognition.

PLC contends that, insofar as the FTT provided any reasoning it was inadequate and inconsistent with the evidence of both sides’ experts, and the UT was wrong to conclude that the accretions were taxable as realised profit.

It was common ground between the experts that whether or not part of the £300 million loan should be de-recognised depended on Financial Reporting Standard 5 (“FRS 5”) issued by the Accounting Standards Board in April 1994. The relevant parts of the relevant paragraphs of FRS 5 are as follows:

“23.

… [W]here there is a significant change in the entity’s rights to benefits and exposure to risks … the description or monetary amount relating to an asset should, where necessary, be changed and a liability recognised for any obligations to transfer benefits that are assumed. These cases arise where the transaction takes one or more of the following forms:

(a)

a transfer of only part of the item in question; …”

“25.

In applying paragraphs 21-23 above … ‘significant’ should be judged in relation to those benefits and risks that are likely to occur in practice, and not in relation to the total possible benefits and risks.”

“71.

Transfer of part of an item that generates benefits may occur in one of two ways. The most straightforward is where a proportionate share of the item is transferred. For example, a loan transfer might transfer a proportionate share of a loan (including rights to receive both interest and principal), such that all future cash flows, profits and losses arising on the loan are shared by the transferee and transferor in fixed proportions. A second, less straightforward way of transferring a part of an item arises where the item comprises rights to two or more separate benefit streams, each with its own risks. A part of the item will be transferred where all significant rights to one or more of those benefit streams and associated exposure to risks are transferred whilst all significant rights to the other(s) are retained. An example would be a ‘strip’ of an interest-bearing loan into rights to two or more different cash flow streams that are payable on different dates (for instance ‘interest’ and ‘principal’), with the entity retaining rights to only one of those streams (for instance ‘principal’). In both these cases, the entity would cease to recognise the part of the original asset that has been transferred by the transaction, but would continue to recognise the remainder. A change in the description of the asset might also be required.”

The FTT discussed this issue at paragraphs 71 to 74 of their decision, which are as follows:

“71.

It seems to us that the flaw in Mr Clifford’s reasoning, as it is set out in the extract from his witness statement reproduced at para 28 above, and as we have further described it in para 30, is that it fails to deal separately with the capital value of the loan and the value of PLC’s investment in GKA, but instead simply sets one off against the other in order to reach the conclusion that no adjustment is required. It is perfectly true that, as Mr Clifford put it, “there would be no overall change in the carrying value of PLC’s assets”—plainly there would not, for the reasons he gave—but that truth does not affect the value of the loan, considered as a single asset. It is in our view axiomatic that a present right to receive a sum at a future date must have a value less than the amount which is to be received, and that that value is to be determined by conventional discounting principles. Indeed, Mr Clifford’s own observation that “the value of the loan to GKBR would be reduced on ‘disposing’ of the interest rights” shows that he was of the same view himself. It is nothing to the point that PLC had near certainty that the £300 million, in the case of the first transaction, would be paid in full; had it been otherwise the present value of the payment would be less still, but for the quite different reason that payment was not certain.

72.

In short, both Mr Clifford and Mr Parish have, in our judgment, failed properly to distinguish between impairment on grounds of doubtful recoverability and discounting because of time lapse before payment, and they have failed to recognise that, although PLC’s overall position is unchanged, the value of the loan has been diminished in exchange for an augmentation elsewhere. The passages we have set out from Ernst & Young’s presentation (see para 22 above), and in particular the second and third indents relating to PLC under “accounting”, too, show a confusion between impairment and de-recognition.

73.

We are accordingly satisfied that full recognition of the loan does not accurately reflect PLC’s own position, disregarding that of its subsidiaries. One has only to ask whether PLC could hope, on the date of the assignment of the interest strip, to secure an arm’s length sale of the benefit of the loan remaining in its hands (that is, without interest over the remaining period before redemption) for £300 million to see that the answer is obviously not. A true and fair value of the asset on that date is therefore, as HMRC say, a discounted value which 30 accretes to the full £300 million as redemption approaches.

74.

We agree too with Mr Chandler and Mr Milne that there is no ground on which a departure from the terms of paras 23 and 71 of FRS 5 is warranted; on the contrary, we consider they are directly in point. From the moment of the assignment, PLC no longer had the right to receive the interest; it had instead a more valuable subsidiary. It is irrelevant that this was not an arm’s length transaction or that PLC could have undone the assignment at any time; accounts must reflect the position as it is, and not as it might be. For these reasons we perceive no need, as the appellants contend, to reflect the fact that PLC’s overall position is unchanged by declining to de-recognise part of the loan. The reality of the transaction is properly reflected by partial de-recognition of the loan, and an addition to the value of PLC’s investment in its subsidiaries. That being so, a departure from FRS 5 is not justified, and it follows that the accounting treatment of the transactions adopted by PLC is not GAAP-compliant. Thus HMRC are right to argue that partial de-recognition was required by UK GAAP, that PLC was obliged to bring the accretion from the NPV of the capital sum on the date of the assignment of the interest strip until redemption into taxable profit, and that issue 2 must accordingly be determined in HMRC’s favour. “

The joint expert report of Mr Parish and Mr Chandler recorded Mr Chandler’s opinion on these matters as follows:

“3.9

Mr Chandler’s opinion is that it is clear that the correct application of FRS 5 is that the interest strip should be derecognised. This treatment is explicitly stated in FRS 5(71). Three of Big Four accountancy firm’s published guidance in this area are also of the same view (the fourth not having any published guidance in this area, to his knowledge).”

“3.11

Mr Chandler’s opinion is that it is entirely in accordance with the substance of the transaction to derecognise the interest strip in Plc, since as a matter of fact, the interest strip was transferred. The cash flows in respect of the interest strip were transferred to GKA and GKA received all of the cash in respect of the interest strip.”

“3.33

Mr Parish states that de-recognition of the interest strip is “not required under GAAP as there has not been the disposal of an asset that is required to be accounted for separately”. This, in Mr Chandler’s opinion, directly contradicts the requirements of FRS 5(23) and each of the published Big Four GAAP extracts referred to in Mr Chandler’s expert report …. It is the transfer of the interest strip that leads to its requirement to be derecognised. Prior to any such transfer there would be no separate accounting for loans and interest, they would be shown at one amount. Mr Chandler is in agreement with Mr Parish on this point. However, upon a transfer, FRS 5 and the published GAAP guidance are quite clear as to the fact that derecognition is required.

3.34

Mr Chandler disagrees with Mr Parish that the treatment in Plc reflects the substance of the transactions. Prior to the transaction, Plc had a loan balance representing two distinct elements - the right to receive cash flows in relation to interest and to the principal amount. In Mr Parish’s own report he acknowledged this (paragraphs 5.4 and 7.17 of Mr Parish’s expert report). Following the transaction, Plc only had the right to receive the principal amount. It had transferred the right to the interest cash flows. FRS 5(73) requires those transferred amounts to be accounted for as having been transferred. Mr Chandler’s view is that the application of FRS 5(73) reflects both the facts and the substance of the transaction.

3.35

As a direct consequence of the transfer of the cash flows, the investment in the principal amount would have a carrying amount in Plc’s books under FRS 5(71) of c£280m. The amount of cash to be received in respect of the principal amount in due course will be £300m. Mr Chandler disagrees with Mr Parish that this is equivalent to an interest free loan. There was an amount of £280m that ought to have been reflected in Plc’s books for which £300m was to be received in cash. The difference (c£20m) should be recorded as finance income in the profit and loss account of Plc and the loan principal will accrue up to £300m. When the £300m cash is received the £300m loan balance would then be derecognised by Plc.

3.36

The capital contribution that should, in Mr Chandler’s opinion, have been recognised by Plc would remain. Its value is supported by reference to the interest cash flows received in GKA (c£23m of cash flows). There is therefore no impairment issue to consider in this case. There is no impairment in Plc’s accounts, nor do Mr Parish or Mr Chandler claim there to be any impairments required.

3.37

Mr Chandler does not agree with Mr Parish that because the Plc accounts were approved by E&Y and contradicted the E&Y published guidance in this area, that this means the Plc accounts were validly prepared in accordance with GAAP. Mr Chandler believes the opposite to be the case, particularly given the clear guidance in FRS 5 and all of the (available) Big Four guidance taking a consistent view - that the de-recognition of an interest strip is required.

3.38

Mr Chandler does not agree with Mr Parish’s opinion that derecognition of the interest strip is not-required because Plc has continuing exposure (indirectly) to the interest asset. Mr Chandler’s comments are noted in paragraphs 4.11 to 4.16 and paragraphs 4.25 to 427 of his Expert report. If Mr Parish’s logic were true here, no-intragroup transfers would be required to be recognised at all — because there would be no significant transfer of risk or reward when assets and liabilities were transferred between group companies.

Mr Chandler notes that FRS 5(25) states that ‘significant’ is in the context not just of the ‘special cases’ in paragraph 25 of FRS 5, but in respect of all recognised assets. Hence, to interpret ‘significant’ in a way that looks through a company’s shareholding to its underlying investments in subsidiary companies would have large ramifications for all intergroup asset transfers in all groups, and so Mr Chandler believes that it cannot be intended to be interpreted in this way.”

“3.41

Mr Chandler notes that Mr Parish stated a ‘considerable concern’ about showing a gain in Plc. This ought not to be a concern as the capital contribution asset in Plc is supported in terms of cash flows by the increased cash flows arising in GKA (the interest strip); and the increase in the loan principal amount in Plc from c£280m to c300m is supported by cash flows received by Plc of £300m. Each of the assets and income in Plc are therefore supported by reference to actual cash flows arising. I cannot therefore understand Mr Parish’s ‘significant concerns’ in this area.”

The transcript of Mr Chandler’s cross-examination on 18 October 2011 (pp 130-132) records that he gave the following evidence:

“Q. … [W]hat do you think is the change here, the change in the nature of the assets that are held by PLC?

A. I think what has effectively happened – if we can just disregard the preference shares for a moment, I’m not seeking to disregard them from my view, you’ve got a transfer of an asset by a parent to its subsidiary, so legally the interest strip and all the cash flows relating to it go to GKA, not PLC. So PLC does not have control over the benefits of the interest strip because it’s GKA’s asset in GKA’s accounts. So in order to have an asset in your accounts you need to have control over economic benefits and I think where factually GKA has the interest strip asset in its accounts. So that means GKA has control over the economic benefits in relation to interest strip. So I don’t believe that two parties can have control over the interest strip. I believe that PLC has control over its subsidiary, BOSG, which then controls GKA but then I believe the control in respect of the benefits and risks of the interest strip lie with GKA and that is why the interest strip asset is in the GKA accounts. …

A. It has disposed of the interest strip effectively. I’m not being pedantic over the terminology but when you look at loans you can describe something as interest-free or interest-bearing but from an accounting perspective it’s the relative cashflows the matter. So if you had for instance a 280 loan principal, and you were to received 300 at the end of the loan term, that might be described as an interest-free loan to some or loan issued at a discount but from an accounting perspective the difference between those two amounts would be interest income. Whereas you are happy to call it an interest-free loan I just see it as the loan principal, the interest had been transferred to somebody else.

Q. Let me rephrase the question. Let me put it this way: Beforehand you see PLC as holding the right to the interest cashflow.

A. That’s right.

Q. After the transaction it no longer holds that right?

A. That’s right.

Q. And you see that as the change?

A. That’s right.

Q. And you’re also going to go on and say I assume that you see that as the significant change?

A.

That’s right.”

The FTT expressly accepted that evidence of Mr Chandler. It is impossible in the circumstances for PLC successfully to contend that the FTT did not provide adequate reasoning in support of their conclusion on de-recognition of part of the £300 million loan, let alone that the FTT did not have evidence on which it could properly base that conclusion.

Mr Gardiner sought to invoke FA 1996 s. 85(3)(c) in support of PLC’s argument that there should be no de-recognition. That provision, however, was entirely irrelevant. It required the accounting to be conducted on the basis that amounts payable under the loan relationship would be paid in full as they became due. Possible non-payment of the £300 million played no part, however, in Mr Chandler’s analysis. His evidence was simply that assignment of the interest strip transferred to GKA the benefits and risks of the interest strip and so the carrying value or cost of £300 million in the books of PLC for both the loan and the interest was required by FRS 5 to be apportioned, reducing the book value of the loan by the value of the assigned interest strip and treating the value of the interest strip as a capital contribution to PLC’s investment in GKA.

PLC contends that, in any event, the accretion-back of £20.5 million did not fall to be taken to PLC’s profit and loss account because it was not “realised profit”. The FTT did not address this point. It was, however, argued before the UT where Mann J decided, in favour of HMRC, that it was realised profit. I consider that the UT was correct on this point.

Paragraph 12 of schedule 4 to CA 1985 provided that only profits realised at the balance sheet date should be included in the profit and loss account. It was common ground between the experts that ICAEW Technical Release 7/03 applied and, according to that document, receipt of cash is one of the circumstances in which a profit can be said to be “realised”. The UT correctly held, in paragraph 81 of Mann J’s decision, that cash was received in respect of the accretion-back of

PLC submits that the accretion back of £20.5 million fell to be excluded from section 84(1)(a) in any event because it did not “fairly represent” profit as required by the wording of that sub-section. Mr Gardiner referred to and relied upon the following statement in the judgment of Moses LJ in DCC Holdings (UK) Ltd v HMRC [2009] EWCA Civ 1165, [2010] STC 8:

“[63] Section 84(1) is the machinery by which all interest under DCC’s loan relationships is brought into account. The section poses a second statutory question, namely whether any particular sum when taken together with the other sums which fall to be brought into account fairly represents all the interest including that which is the mere product of a statutory fiction. That question is different and additional to the first question, whether the sums are in accordance with an accruals basis of accounting. The introduction of that distinct additional question suggests the possibility but, I accept, not the necessity of some process of adjustment. It suggests that there may be some room or adjustment of the sums which would otherwise be given by the application of an authorised accounting method, or, at the very least suggests that in some cases the identification process in s.84(1) will not merely be resolved by an authorised accounting method.”

Mr Gardiner described the “fairly represent” requirement as a “sanity check” for the accounting to be overridden where there is no real or commercial profit from a loan relationship.

Mr Gardiner submitted that there was no real profit but merely an accounting profit which was deemed to have been achieved only because the value of the loan, following the assignment, was not shown, as it should have been, at its reduced value. He said that accounting loss had been cancelled out by the notional profit when the loss was made good by repayment of the loan. He submitted that all that happened in reality was the repayment of the loan.

Mr Gardiner submitted that the notional loss had to be accounted for somewhere, and it could not be accounted for as a debit under section 84(1)(a) because Mr Chandler had treated it as an increased capital contribution to GKA but that did not arise from PLC’s loan relationship with GKBR.

He submitted that the result is that Mr Chandler’s analysis did not make any proper accounting provision for the loss represented by the reduction in the book value of the £300 million but, had he done so, it would have cancelled out the notional profit on repayment of the loan.

I do not accept that analysis of Mr Gardiner. In the first place, it is to be noted that in DCC Holdings (UK) Ltd v HMRC in the Supreme Court ([2010] UKSC 58, [2011] STC 326) Lord Walker JSC, with whom the other Justices agreed, said at [35] that he doubted Moses LJ’s analysis of section 84(1) as containing two criteria, one of which was required to yield to the other. Lord Walker considered that the words in section 84(1) had to be construed as a composite whole.

Secondly, no evidence was given by Mr Parish or Mr Clifford to support Mr Gardiner’s analysis. Their evidence was that it was incorrect to de-recognise part of the loan for accounting purposes, and they did not go on to give evidence of the consequences, as suggested by Mr. Gardiner, if they were wrong on that point. In effect, Mr Gardiner had to advance his analysis as a matter of law. I do not consider that PLC can do so. What is in issue is the fair representation of credits and debits in accordance with “an authorised accounting method” for the purposes of section 84(1). There is no scope for some other method set by the court itself.

Furthermore, as Mr Milne pointed out, Mr Gardiner’s analysis is incorrect in treating the reduction of the loan as a loss. The FTT and the UT accepted Mr Chandler’s evidence, and his evidence was that de-recognition of the loan was simply a re-allocation of the carrying cost of the loan. Part was re-allocated as a capital increase in an investment in GKA.

Finally, PLC relies on FA 1996 s.84(7) and paragraph 14 of schedule 9. Its argument is that a capital contribution to the investment by a parent company in its subsidiary is a fixed capital asset within paragraph 14(1) and so by virtue of paragraph 14(2) it is to be brought into account for the purposes of corporation tax in the same way as it would in determining the parent’s profit or loss for that period in an arm’s length transaction. It is said that the accounting credit to the loan to reflect the assignment (reducing its value) would be matched by a debit in the profit and loss account to reflect the loss.

There are two short answers to this argument. The first is that the capital investment in GKA was not “in respect of” the loan relationship between PLC and GKBR. It was common ground that the typical situation to which paragraph 14 was directed was where interest on a loan was capitalised rather than appearing as a debit in the profit and loss account: the purpose of paragraph 14 was to enable the taxpayer company, if it wished, to treat the interest as a debit in the profit and loss account for the purposes of corporation tax.

That was not the situation in the present case. The treatment of the assignment of the interest strip as a capital contribution to GKA was not in respect of the loan relationship between PLC and GKBR. It was in respect of the relationship between PLC and GKA but that was not a relevant loan relationship. The UT correctly decided that point.

Secondly, the accounting treatment of the assignment of the interest strip as a capital contribution to GKA was not “allowed” by an authorised accounting method. It was required by virtue of FRS5. There was, therefore, no authorised accounting method which permitted the suggested debit for the purposes of section 84(1).

That approach on both points is consistent with the helpful analysis of the FTT in Stagecoach Group plc v HMRC [2016] UKFTT 0120. The factual situation under consideration in that case was different to the one under consideration in the present case and the relevant legislation was contained in Part 5 of TA 2009, which has itself been amended in part by schedule 7 to the Finance (No. 2) Act 2015. Those provisions are an amended version of the loan relationship code in FA 1996. Section 320(1) of CTA 2009 was the equivalent of paragraph 14(1) of schedule 9 to FA 1996 and, although in different terms, contained the materially similar expressions “in respect of a company’s loan relationship” and “allows”. It is not necessary to extend this judgment even further by setting out here the facts, the law and the decision of the FTT in the Stagecoach case. It is sufficient to say that the analysis of the FTT at [83] to [142] on the meaning and application of those expressions is compelling and mirrors what I have held above.

For the reasons I have given, I would allow the appeal on Grounds 1 and 2 because there was a loan relationship between GKA and GKBR and, although the

I agree

I agree that the outcome of the appeal should be as proposed by the Chancellor for the reasons given by him. I add a short judgment of my own in relation to one point in respect of Ground 2, because I was less impressed than the Chancellor by Mr Gardiner’s submissions summarised at paras. [52]-[53] above.

Although, as Mr Gardiner pointed out, the assignment of the interest strip to GKA was what created a loan relationship between GKA and GKBR, it is nonetheless the case that the interest which by that transaction became receivable by GKA (rather than PLC) represented profits or gains of GKA from that loan relationship, within section 84(1)(a), since GKA had paid less than market value in order to receive that income stream from the loan relationship. The relevant entries in GKA’s accounts were made, first, to reflect the income stream to be received by GKA from the loan relationship in the period after the assignment (i.e. as a receivable) and then to reflect the sums actually received by GKA from that loan relationship. That income is properly described as profit or gain in GKA’s hands from the loan relationship to the extent that it exceeded the value given by GKA to obtain the interest strip.

The entries in GKA’s books in respect of the interest strip as described at paragraph 5(6) of the FTT’s decision reflected the nature of the income from it as profit or gain in GKA’s hands (after allowing for the issue of preference shares by GKA to acquire that stream of income), including by booking £19 million to GKA’s share premium account in respect of the receivable acquired by GKA in the form of the interest strip. As noted by Lewison LJ in Vocalspruce Ltd v HMRC [2014] EWCA Civ 1302; [2015] STC 861 at [54], “A share premium is a price that exceeds the nominal value of the share. It is received wisdom that an amount paid to a company by way of share premium is a profit in the hands of the company …”. Section 84(2)(a) contemplates that within the scheme of the tax regime in Chapter II of Part IV of FA 1996 sums transferred to a company’s share premium account are capable of being profits or gains of a company arising from its loan relationships and related transactions (hence the need for provision in section 84(2)(a) to deem that they should not be so treated): see Vocalspruce Ltd v HMRC at [59] per Lewison LJ.

In its accounts, GKA recorded the asset strip as a receivable from GKBR in its balance sheet at its net present value (£20.5 million); credited the nominal value of the preference shares issued in return (£1.5 million) as a non-capital equity instrument; and credited the difference (£19 million) to its share premium account. The profit element of the transaction arising from the future income stream from the receivable was thus reflected at this stage by the entry in the share premium account. Thereafter, payments received from GKBR in respect of the interest strip were first credited against the balance sheet receivable, then when that amount had been fully received (i.e. was no longer a receivable) the excess of the amounts actually received over the original NPV of the receivable were taken to the profit and loss account as profit. In my view these excess sums clearly constitute profits or gains of GKA from its loan relationship with GKBR. In that regard, reflecting as they do income received in respect of the interest strip receivable, they are no different from the sums representing income received in respect of the interest strip receivable which were credited against the receivable in the balance sheet, the profit or gain from which had been booked to the share premium account at the outset of the relevant period and which was realised as those sums were received.

Finance Act 1996 Taxation of loan relationships

For the purposes of corporation tax all profits and gains arising to a company from its loan relationships shall be chargeable to tax as income in accordance with this Chapter.

To the extent that a company is a party to a loan relationship for the purposes of a trade carried on by the company, profits and gains arising from the relationship shall be brought into account in computing the [profits]1 of the trade.

Profits and gains arising from a loan relationship of a company that are not brought into account under subsection (2) above shall be brought into account as profits and gains chargeable to tax under Case III of Schedule D.

Subject to any express provision to the contrary, the amounts which in the case of any company are brought into account in accordance with this Chapter as respects any matter shall be the only amounts brought into account for the purposes of corporation tax as respects that matter.

Meaning of “loan relationship” etc

Subject to the following provisions of this section, a company has a loan relationship for the purposes of the Corporation Tax Acts wherever—

the company stands (whether by reference to a security or otherwise) in the position of a creditor or debtor as respects any money debt; and

that debt is one arising from a transaction for the lending of money;

For the purposes of this Chapter a money debt is a debt which is, or has at any time been, one that falls, or that may at the option of the debtor or of the creditor fall, to be settled—

by the payment of money; or

by the transfer of a right to settlement under a debt which is itself a money debt disregarding any other option exercisable by either party.

Subject to subsection (4) below, where an instrument is issued by any person for the purpose of representing security for, or the rights of a creditor in respect of, any money debt, then (whatever the circumstances of the issue of the instrument) that debt shall be taken for the purposes of this Chapter to be a debt arising from a transaction for the lending of money.

For the purposes of this Chapter a debt shall not be taken to arise from a transaction for the lending of money to the extent that it is a debt arising from rights conferred by shares in a company.

For the purposes of this Chapter—

references to payments or interest under a loan relationship are references to payments or interest made or payable in pursuance of any of the rights or liabilities under that relationship; and

references to rights or liabilities under a loan relationship are references to any of the rights or liabilities under the agreement or arrangements by virtue of which that relationship subsists;

In this Chapter “money” includes money expressed in a currency other than sterling.

Method of bringing amounts into account

For the purposes of corporation tax—

the profits and gains arising from the loan relationships of a company, and

any deficit on a company's loan relationships,

To the extent that, in any accounting period, a loan relationship of a company is one to which it is a party for the purposes of a trade carried on by it, the credits and debits given in respect of that relationship for that period shall be treated (according to whether they are credits or debits) either—

as receipts of that trade falling to be brought into account in computing the [profits]1 of that trade for that period; or

as expenses of that trade which are deductible in computing those [profits]1.

Where for any accounting period there are, in respect of the loan relationships of a company, both—

credits that are not brought into account under subsection (2) above (“non- trading credits”), and

debits that are not so brought into account (“non-trading debits”),

Debits and credits brought into account

The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method when taken together, fairly represent, for the accounting period in question—

all profits, gains and losses of the company, including those of a capital nature, which (disregarding interest and any charges or expenses) arise to the company from its loan relationships and related transactions; and

all interest under the company's loan relationships and all charges and expenses incurred by the company under or for the purposes of its loan relationships and related transactions.

The reference in subsection (1) above to the profits, gains and losses arising to a company—

does not include a reference to any amounts required to be transferred to the company's share premium account; but

does include a reference to any profits, gains or losses which, in accordance with generally accepted accounting practice, are carried to or sustained by any other reserve maintained by the company.

This section has effect subject to Schedule 9 to this Act (which contains provision disallowing certain debits and credits for the purposes of this Chapter and making assumptions about how an authorised accounting method is to be applied in certain cases).

Authorised accounting methods

Subject to the following provisions of this Chapter, the alternative accounting methods that are authorised for the purposes of this Chapter are—

an accruals basis of accounting; and

a mark to market basis of accounting under which any loan relationship to which that basis is applied is brought into account in each accounting period at a fair value.

An accounting method applied in any case shall be treated as authorised for the purposes of this Chapter only if—

subject to paragraphs (b) to (c) below, it is in conformity with generally accepted accounting practice to use that method in that case;

it contains proper provision for allocating payments under a loan relationship, or arising as a result of a related transaction, to accounting periods;

where it is an accruals basis of accounting, it does not contain any provision (other than provision in respect of exchange losses or provision comprised in authorised arrangements for bad debt) that gives debits by reference to the valuation at different times of any asset representing a loan relationship.

In the case of an accruals basis of accounting, proper provision for allocating payments under a loan relationship to accounting periods is provision which—

allocates payments to the period to which they relate, without regard to the periods in which they are made or received or in which they become due and payable;

includes provision which, where payments relate to two or more periods, apportions them on a just and reasonable basis between the different periods;

assumes, subject to authorised arrangements for bad debt, that, so far as any company in the position of a creditor is concerned, every amount payable under the relationship will be paid in full as it becomes due;

secures the making of the adjustments required in the case of the relationship by authorised arrangements for bad debt; and

provides, subject to authorised arrangements for bad debt and for writing off government investments, that, where there is a release of any liability under the relationship, the appropriate amount in respect of the release is credited to the debtor in the accounting period in which the release takes place.

In this section

the references to authorised arrangements for bad debt are references to accounting arrangements under which debits and credits are brought into account in conformity with the provisions of paragraph 5 of Schedule 9 to this Act; and

the reference to authorised arrangements for writing off government investments is a reference to accounting arrangements that give effect to paragraph 7 of that Schedule.

Application of accounting methods

This section has effect, subject to the following provisions of this Chapter, for the determination of which of the alternative authorised accounting methods that are available by virtue of section 85 above is to be used as respects the loan relationships of a company.

Different methods may be used as respects different relationships or, as respects the same relationship, for different accounting periods or for different parts of the same accounting period.

If a basis of accounting which is or equates with an authorised accounting method is used as respects any loan relationship of a company in a company's statutory accounts, then the method which is to be used for the purposes of this Chapter as respects that relationship for the accounting period, or part of a period, for which that basis is used in those accounts shall

where the basis used in those accounts is an authorised accounting method, that method; and

where it is not, the authorised accounting method with which it equates but this subsection is subject to subsections (3A) and (3D) below.

For any period or part of a period for which the authorised accounting method to be used as respects a loan relationship of a company is not— [(a) a method determined under subsection (3) above,

an authorised mark to market method in accordance with an election under subsection (3A) above, or

an authorised mark to market method in accordance with subsection (3D) above,

For the purposes of this section (but subject to subsection (6) below)—

a basis of accounting equates with an authorised accruals basis of accounting if it purports to allocate payments under a loan relationship to accounting periods according to when they are taken to accrue; and

a basis of accounting equates with an authorised mark to market basis of accounting if (without equating with an authorised accruals basis of accounting) it purports in respect of a loan relationship

to produce credits or debits computed by reference to the determination, as at different times in an accounting period, of a fair value; and

to produce credits or debits relating to payments under that relationship according to when they become due and payable.

Accounting method where parties have a connection.

This section applies in the case of a loan relationship of a company where for any accounting period there is a connection between the company and—

The only accounting method authorised for the purposes of this Chapter for use by the company as respects the loan relationship shall be an authorised accruals basis of accounting.

For the purposes of this section there is a connection between a company and another person for an accounting period if (subject to subsection (4) and section 88 below)—

The references in subsection (1) above to a person who stands in the position of a creditor or debtor as respects a loan relationship include references to a person who indirectly stands in that position by reference to a series of loan relationships or money debts which would be loan relationships if a company directly stood in the position of creditor or debtor.