Lloyds Asset Leasing Limited v The Commissioners for HMRC

On behalf of HMRC:

Joint expert reports:

Joint expert report of Mr Paul Sleurink and Mr Arco Bobeldijk dated 1 February 2023 Dutch Law Experts

Questions of direct tax are matters of retained competence. Articles 2-4 of the TFEU set out areas of exclusive EU competence and shared competence. It is therefore for each Member State to design their own system of taxation as they see fit. As the CJEU observed in paragraph 47 of its judgment in Case C-446/04 Test Claimants in the FII Group Litigation v Inland Revenue Commissioners [2012] 2 AC 436 (“FII (No.1)”): “it is for each member state to organise, in compliance with Community law, its system for taxing distributed profits and, in particular, to define the tax base and the tax rate which apply to the company making the distribution and/or the shareholder receiving them, in so far as they are liable to tax in that member state”. Who is liable to direct forms of taxation, on what basis and in what amounts are therefore matters of retained Member State competence.

The CJEU has confirmed that “direct taxation does not as such fall within the purview of the Community”, but further noted that “the powers retained by the Member States must nevertheless be exercised consistently with Community law”: see case C-279/93 Finanzamt Köln-Altstadt v Schumacker [1996] QB 28 (“Schumacker”). The CJEU has moreover confirmed that Member States “are not obliged to adapt their own tax systems to the different systems of tax of the other Member States” in order to eliminate difficulties for claimants arising from “the exercise in parallel by those Member States of their fiscal sovereignty”: C-67/08 Block v Finanzamt Kaufbeuren [2009] ECR I-883. Thus the existence of tax law is a matter for Member State competence. However, how the Member State decides to exercise that competence remains subject to EU law and in particular the principle of equal treatment.

The right of establishment was set out in Article 43 of the Treaty establishing the European Community (“EC”) (now Article 49 of the TFEU). Article 49 TFEU provides:

“Within the framework of the provisions set out below, restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited. Such prohibition shall also apply to restrictions on the setting-up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State.

Freedom of establishment shall include the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, in particular companies or firms within the meaning of the second paragraph of Article 54, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the Chapter relating to capital.”

Article 48 TEC (now Article 54 TFEU) confirmed that the right applies to companies.

Derogations from Article 49 TFEU are permitted under Article 52(1) TFEU which provides:

“The provisions of this Chapter and measures taken in pursuance thereof shall not prejudice the applicability of provisions laid down by law, regulation or administrative action providing for special treatment for foreign nationals on grounds of public policy, public security or public health.”

Article 54(1) TFEU further provides:

“Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of Member States.”

C-446/03 Marks & Spencer v Halsey [2006] STC 237 (“M&S”) concerned the case of a British company that had subsidiaries in a number of Member States. In 2001, it ceased trading in continental Europe owing to losses it had incurred there in the 1990s. It then claimed group relief in the UK from HMRC for the losses incurred, specifically by its Belgian, German and French subsidiaries. However, under English law applicable at the time, the resident companies in a group (i.e. UK-based subsidiaries) could set off their profits and losses among themselves but were not allowed to do so where the losses were incurred by subsidiaries which had no establishment in the UK and did not trade there.

The CJEU held that the UK rules on group relief breached Article 49 TFEU because they discouraged undertakings from setting up subsidiaries in other Member States and so constituted a restriction on freedom of establishment. However, having found a prima facie breach, the court did, however, recognise the necessary asymmetry between the treatment of profits and losses at the justification stage. The UK offered, and the Court accepted, three justifications:

However, the CJEU said that measures denying group relief in respect of loss from a non-resident subsidiary would be disproportionate only where:

“the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring those losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods, and there is no possibility for the foreign subsidiary’s losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.”

(“para 55”)

Para 55 embodies the “no possibilities” test that is referred to in subsequent case law. If the para 55 conditions are not both met by the taxpayer, then refusal of group relief will be permissible and proportionate where one of the three objective justifications set out in paragraph 15 above are available.

The treatment of Group relief claimed where the surrendering company is not resident in the UK was first introduced, to give effect to the M&S decision, by s27 of and Schedule 1 to the Finance Act 2006. The Explanatory Note to the Bill said as follows in relation to what was clause 27 and Schedule 1:

“123 On 13 December 2005 the Court of Justice of the European Communities handed down its decision in the case of Marks & Spencer plc v Halsey. This case concerned the UK’s group loss relief rules for companies.

124 In summary, the Court ruled that the UK’s group loss relief rules are in principle compatible with European Law but go too far in denying loss relief to a parent company for the losses of a foreign subsidiary where the parent company has demonstrated that the non-resident subsidiary has exhausted all possibilities of relief in its state of residence.

125 Clause 27 and Schedule 1 provide for the extension to the group loss relief rules. The new relief applies only where a UK parent company has a foreign subsidiary (including an indirectly held subsidiary) which has incurred a foreign tax loss that is unrelievable in the home state (or elsewhere) and where that subsidiary is either resident in the EEA or has incurred the relevant losses in a permanent establishment in the EEA.

126 The foreign losses are ‘relievable in the UK’ only where all possibilities of relief have been exhausted and future relief is unavailable in the Country where incurred or in any other country. Where there is a foreign company in the ownership chain between the surrendering company and a UK parent, precedence rules apply to determine whether relief is available in the UK.”

Group relief came to be governed by Part 5 of the CTA.

It is common ground that LAL’s claim to CBGR is governed by Chapter 3 of Part 5. The Explanatory Notes to Chapter 3 of Part 5 of the CTA state, at paras 406-407, as follows:

“406.

This Chapter makes the United Kingdom group relief rules compatible with European Community law following the judgment in Marks and Spencer plc v Halsey, C446/03. That case decided that in some circumstances it is contrary to the provisions of the EC Treaty on freedom of establishment to deny group relief to a UK resident parent for the losses of a non-UK resident subsidiary.

407.

So this Chapter allows relief for foreign losses. But there are two main restrictions:

the surrendering company must be resident in (or otherwise “related” to) an EEA territory; and

the losses must not qualify for relief in the EEA territory.”

Chapter 3 of Part 5 of the CTA begins at s.111 which provides an overview of the Chapter as follows:

“(1)

This Chapter allows a non-UK resident company that is resident or carrying on a trade in the European Economic Area to surrender losses and other amounts it has for a period.

(2)

Section 113 sets out the basic provisions about the surrendering of losses and other amounts.

(3)

Sections 114 to 121 set out conditions that must be met if losses and other amounts are to be surrendered (see Step 2 in section 113(2)).

(4)

Sections 122 to 128 set out other rules, assumptions and exclusions (see Steps 3 and 5 in section 113(2)).

The parties do not agree on how the UK legislation enacted to implement the M&S decision must be construed. The divergent positions are set out below in the parties’ submissions.

All references are to the CTA.

Section 119 provides as follows:

“119 The qualifying loss condition: relief for future periods

(1)

This section applies to an EEA amount so far as subsections (2) and (3) apply to it.

(2)

This subsection applies to the EEA amount so far as, for the purposes of any relevant non-UK tax, the EEA amount cannot be taken into account in calculating any profits, income or gains that—

(a)

might arise in any period after the EEA accounting period to the surrendering company or any other person, and

(b)

(if there were any) would be chargeable to that tax for any period after the EEA accounting period.

(3)

This subsection applies to the EEA amount so far as, for the purposes of any relevant non-UK tax, the EEA amount cannot be relieved in any period after the EEA accounting period—

(a)

by the payment of a credit,

(b)

by the elimination or reduction of a tax liability, or

(c)

in any other way.

(4)

The determination as to the extent to which the EEA amount—

(a)

cannot be taken into account as mentioned in subsection (2), or

(b)

cannot be relieved as mentioned in subsection (3),

is to be made as at the time immediately after the end of the EEA accounting period.”

Section 121 provides as follows:

“ The precedence condition

(1)

An EEA amount meets the precedence condition so far as no relief can be given for it in any territory which—

(a)

is outside the United Kingdom,

(b)

is not the relevant EEA territory (as defined by section 117(2)), and

(c)

is within subsection (2).

(2)

A territory is within this subsection if—

(a)

a company resident in the territory owns (directly or indirectly) ordinary share capital in the surrendering company,

(b)

a UK resident company owns (directly or indirectly) ordinary share capital in the company resident in the territory,

(c)

the surrendering company is a 75% subsidiary of the UK resident company, and

(d)

the surrendering company is not such a subsidiary as a result of its being a 75% subsidiary of another UK resident company.

(3)

In subsection (1) the reference to relief being given in any territory is a reference to relief being given—

(a)

by taking the EEA amount (or a part of it) into account in calculating any profits, income or gains of any person chargeable to non-UK tax under the law of the territory,

(b)

by the payment of a credit to any person under that law,

(c)

by the elimination or reduction of a tax liability of any person under that law, or

(d)

in any other way.

(4)

Chapter 5 explains how to determine if a company is a 75% subsidiary of another company.”

Section 127 provides as follows:

“Amounts excluded because of certain arrangements

(1)

An amount (or part of an amount) resulting from Step 4 in section 113 is excluded

if—

(a)

it is not attributable for corporation tax purposes to any permanent establishment through which the surrendering company carries on a trade in the United Kingdom, and

(b)

the following condition is met.

(2)

The condition is that the amount (or part)—

(a)

would not have resulted from Step 4 but for any arrangements within subsection (3), or

(b)

would not have arisen to the surrendering company but for any such arrangements.

(3)

Arrangements are within this subsection if their main purpose, or one of their main purposes, is to secure that the amount (or part) may be surrendered for the purposes of group relief.

(4)

“Arrangements” includes any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable).”

Applicable Irish Law

The facts are taken from the documentary evidence that was in evidence before the Tribunal. The veracity of the documents was not challenged. What was disputed was the interpretation of and the meaning to be attributed to the documents. The Tribunal is at a loss to understand why a statement of agreed facts or a chronology of key facts could not be agreed. It has therefore been necessary to set out at length, in chronological order, the key facts to provide the factual context for the further findings of fact set out below at paragraph 466.

The Appellant is registered in England under companies’ number GB02065463. It is a wholly owned subsidiary of Lloyd’s Bank Leasing Limited which in turn is a subsidiary of LBG. During the 2008 financial crisis Lloyds TSB (as then known)(“LTSB”) agreed terms to purchase Halifax Bank of Scotland plc (“HBOS’’) with formal completion in early 2009. Following the acquisition of HBOS the banking group changed its name to LBG. At all material times, LBG, Bank of Scotland (“BOS”) and HBOS were resident in the UK for UK tax purposes

BOSI was incorporated in Ireland under companies’ number IE288297. BOSI was a 100% subsidiary of HBOS and after the merger became a subsidiary of LBG. BOSI was a full service bank, providing commercial and retail banking services throughout the Republic of Ireland and commercial, corporate and asset finance in Northern Ireland. Services included corporate banking, business lending, property lending, commercial deposits, asset finance and treasury services. Retail banking, which was launched in 2006, provided a full range of personal banking products under the Halifax brand in the Republic of Ireland.

BOSI, as an Irish credit institution, was subject to regulation by the Irish Financial Regulator and it was required to maintain a prescribed level of regulatory capital and liquidity as a condition to maintaining its Irish banking licence. At the same time, the LBG group, as a UK based financial business, was subject to regulation by the UK financial regulator, which at the time was the Financial Services Authority (“FSA”).

The global financial crisis that began in 2007 caused great turmoil in the global financial markets. Numerous financial institutions collapsed or were nationalised. Royal Bank of Scotland plc had to be bailed out by the UK Government. Several Irish banks and building societies that collapsed had to be nationalised by the Irish Government. In an attempt to restore confidence in the banking system the UK Government instituted measures that sought to maintain stability in the financial markets, including the provision of £200 billion in liquidity assistance via the special liquidity scheme and a recapitalisation scheme that allowed it to inject £50 billion of capital into eight eligible institutions including HBOS and LTSB.

HBOS was one of the institutions worst affected by the liquidity crisis caused by the global financial crisis. As part of a bank recapitalisation scheme, in October 2008, HM Treasury (“HMT”) required HBOS to raise £11.5 billion in additional capital (separately, LTSB had to raise £5.5 billion).

In 2009, the BOSI property loan portfolio in Ireland was valued at approximately €32.6 billion, €20 billion of which related to corporate borrowing, impaired by €4 billion. Approximately 40% of BOSI’s loan assets comprised loans made by it to the corporate real estate (“CRE”) sector in Ireland. Of its remaining loan assets, approximately 30% comprised non-CRE commercial loans and the rest were retail mortgages and loans. BOSI’s loans to the CRE sector had grown significantly and this growth had been facilitated by the provision of a guarantee from BOS (the “Guarantee”). By the Guarantee, BOS guaranteed certain amounts owed to BOSI by its customers in the real estate sector. The Guarantee allowed BOSI to treat loans covered by it as not being real estate sector loans for regulatory purposes, thereby permitting BOSI to exceed the strict sectoral limits imposed by the Irish Financial Regulator (“FR”) on lending to that sector and allowing BOSI to increase its lending to that sector without further regulatory capital. Historically, the Guarantee was not needed to meet minimum regulatory capital requirements (only sectoral limits), but due to the erosion of BOSI’s regulatory capital base (due to the heavy losses it suffered), the Guarantee had to be relied upon from 2008 onwards to meet BOSI’s Irish regulatory capital requirements. Due to the impairments in BOSI, in 2009, the limit in the Guarantee had to be increased from €5bn to €20bn. The CRE sector was a principal cause of the problems affecting the Irish economy. BOSI’s impairment charge for 2009 was £2.949bn.

The individuals referred to in the documents, their allocated abbreviation, and title/role are set out below.

LTSB’s internal Major Country Ratings downgraded Ireland’s credit rating from 1 (AAA) to 1 (AAA) negative.

On 16 January 2009, the formal merger between LTSB and HBOS took place, the new group became LBG. BOSI joined W&I, other assets in W&I included Australia, corporate Europe and Latin America. BOSI was a small part of LBG, as at 30 June 2010 it had about £27bn in loans outstanding, by comparison, LBG had in total £612bn in loans.

In early 2009, LBG reviewed HBOS’s books in detail. At the same time, LBG’s risk function unit advised that the economic position was far worse than LBG had predicted in 2008. As a result, LBG increased its forecasts of HBOS’s impairments for 2008 and 2009, the total impairment figures for 2008 and 2009 were estimated at that time to be £23.9bn.

In 2009, the GEC of LBG sought to address the problem loans that were on the books of each of the groups.

LBG’s Annual Report and Accounts 2008 confirmed LBG’s view that by 2010 there would be a gradual restoration of growth.

LBG announced it intended to participate in the UK Government Asset Protection Scheme (“GAPS”) to reduce its risks weighted assets and strengthen LBG’s capital position.

“Options for the retail business” paper prepared for the BOSI Board Meeting on 3 April 2009 at which JH recommended Option 5 – “Exit Retail - Close all branches, close to new business and dispose of the back book as quickly as possible to effect a complete exit.”

Draft paper “Tax Losses in BOSI and HBOSA Overview of Strategic Options” provided by Deloitte. The paper outlined strategic options to preserve the value of tax losses in Ireland and Australia. The paper did not provide a comprehensive tax analysis of each option but directional guidance on four options:

The strategic decision was taken that the LBG would, going forward, have a UK focussed business and that it would identify and manage down or dispose of £200bn of non-core assets over the next five years. A public announcement regarding this strategy was made in LBG’s 2009 Interim Results for the half-year ended 30 June 2009.

Paper titled “Future of the retail business” was prepared by JH for the BOSI Board Meeting to be held on 26 June 2009. The paper sought approval to close the retail operation in Ireland and explore disposal options.

A draft LBG Forward Plan was prepared for submission to the EU Commission. The Strategy for W&I confirmed that non-core International Banking businesses would be managed-for-value (“MFV”) in the near-term with a view to managing down when markets improve.

LBG Board Meeting. AP presented a paper on LBG’s corporate strategy progress identifying key priorities and challenges faced following the acquisition of HBOS: deteriorating economy and rising impairment profile; funding constraints; recapitalisation and preference share conversion; potential state aid restructuring and behavioural remedies and participation in GAPS.

W&I Integration Update confirmed that the retail business in Ireland was fundamentally unprofitable, there was now a need to accelerate the approach and announcement of the exit from Ireland.

GEC meeting minutes record that the position in relation to Ireland was considered carefully and would be kept under review.

LBG News Release of 2009 Interim Results announced that going forward, LBG, would have a UK focussed business and would identify, manage down or dispose of £200bn of non-core assets over the next five years. The intention was to manage these assets for value and, given the current economic climate, the primary focus would be on running these assets down over time. The PowerPoint presentation by ED confirmed that impairments were concentrated in CRE and that 80% of W&I impairments were from the HBOS book.

In the following months, various options as regards BOSI were considered by LBG. Consideration was given to the possibility of BOSI joining NAMA. NAMA was the Irish Government’s scheme to purchase distressed assets from Irish banks. On 6 August 2009, SH e-mailed ED, TTO and confirmed that current thinking was that LBG did not want to join NAMA.

LBG established Project Memphis with Project Chicago running in parallel to retain optionality for LBG as it could be pursued pre or post Project Memphis. Project Memphis was the decision to withdraw from Retail Banking in Ireland with an announcement scheduled for early February 2010 with implementation by the end of May 2010. Project Chicago involved BOSI becoming part of a consolidated entity to form a “third force” in Irish banking. In the meantime, LBG continued with its medium term plan of Manage for Value (“MFV”) with a view to managing down the BOSI portfolios in the future.

A Business Support Unit (“BSU”) based on the LBG operating model, was implemented in Ireland. RF, from LBG, was appointed as head of the Irish BSU.

E-mail from JD to ED confirmed the approach was MFV whilst exploring options to reduce exposure. Confirmed that NAMA unlikely to be attractive to LBG.

E-mail from JD to ED confirming the approach for JH to take at the meeting with Irish Finance Minister: “looking at all options for our Irish Business”. ED approved the approach.

Project Chicago paper for GEC sought approval for possible transfer of BOSI business to new Irish bank for minority shareholding. Following discussion with the FR it was considered that the option is “potentially attractive ... both W&I and GCD believe that this is an option that should be investigated. The approval of GEC to proceed is requested”.

Project Chicago GEC paper circulated which sought permission “to initiate [emphasis provided] discussions with Irish Govt/Finance Ministry to seek to get a large part of our Irish business included in a sector consolidation proposal. … to create a “3rd force” in Irish Banking”. It stated that the need for such a response is being driven by the EU State Aid discussions the Irish Government is having with the EU. Confirmed that Plan A [to close down retail and manage down book and CRE book] was looking increasingly unlikely and unviable and identified a Plan C which would “hard close” the residual business and put in place a team (with UK support) who would be “incentivised solely on managing out the asset book at an acceptable price over the next 5 years (say).”

GEC Paper on Project Chicago presented by JD summarised the MFV strategy

GEC approval sought to increase projected BOSI impairment provisions.

The BOSI CFO, TF, prepared a memorandum for JD and TTO noting that BOSI’s compliance with Irish regulatory capital requirements had historically been achieved through the use of the Guarantee provided by BOS however that position had been severely impacted by the downturn in the Irish economy and the increased impairment charges which had eroded BOSI’s capital base. TF concluded that BOSI which require further capital in Q1 2010 to meet minimum Irish regulatory capital requirements and that the position would further deteriorate over the course of 2010 as BOSI continued to recognise further impairments. TF recommended an injection of up to €2bn of capital into BOSI in December 2009 to ensure ongoing compliance by BOSI with its Irish regulatory obligations up until the end of Q1 2010. BOSI would continue to work with W&I/GF to explore all options to mitigate BOSI’s capital needs and to agree a medium term capital strategy following the completion of the BOSI strategic review by the end of Q1 2010. From a statutory perspective this would include consideration of transferring assets to a non-bank subsidiary or an LBG branch.

Internal controls report rated BOSI control framework as Red. The report noted that a new executive team was in place which recognised the need to address managing risk effectively.

BOSI Board Meeting. The minutes identified the BSU as pivotal to maximising income on distressed cases. An increase of €0.7bn in the projected impairment charge for 2009 to €3.2bn and an increase of €0.2bn in 2010 to €2.3bn was approved. The Remuneration Committee recommended two short term and medium term incentive schemes be introduced in 2010 and that a higher level of bonuses be paid to BSU staff compared to other BOSI staff.

LBG Audit Committee paper considered BOSI’s poor risk management and increased impairment provisions and noted “Substantial progress has been made on the establishment of the Business Support Unit … the business is tracking towards an amber risk rating in early 2010.”

BOSI Business Review Briefing Pack for ED and TTO for the BOSI Board meeting on 6 January 2010. The Executive Summary stated: “New management team working to improve risk profile of the business, ensure control over tail risk on impairments and improve future options”. The Key Achievements identified were: a new senior management team had been appointed who were focused on risk control and BSU established. The Future of the Business section re-stated MFV strategy and noted there was a team in place to deliver MFV or Project Chicago. The Briefing Pack confirmed: the Irish recovery would lag behind Europe in the short term; modest recovery from 2010 with CRE expected to see modest recovery in 2011-12, with strong growth in 2013; confirmed that Project Chicago preferable option but unlikely without Government support and was focused on asset reduction to reduce LBG funding.

E-mail from TE to TTO with subject “Background reading for you [sic] visit to Dublin” attaching copy of Audit Committee paper on BOSI impairments and remediation of control issues. The e-mail stated: “The level of impairments have now been agreed between Group Credit Risk, Divisional Risk and Ireland, and the attached Appendix reflects the latest numbers … the level of coverage for the 2009-2014 plan period at 39% equates to that which is being used by NAMA and so holds up against local competitors.”

W&I Divisional Financial Control Committee Meeting confirmed BSU had been set-up and making progress and expected to be fully operational by end of Q1 2010. BOSI to remain at “Amber” until BSU fully operational.

Regulatory Contact Report – Meeting between BOSI (MA and CR) and FR. The summary recorded “The tone of the meeting was constructive and cooperative”.

Workshop held with key stakeholders summarised in briefing paper for TTO dated 26 January 2010:

“Representation from BOSI, W&I, Group Finance and Group Tax

Designed to consider all issues and agree structuring priorities

Compare existing subsidiary structure vs. branch alternative

Trade off between tax, capital and funding considerations

Agreed conclusion to look to immediately extract value from tax losses through claim under BOS plc guarantee and then agree revised legal entity structure at a later stage as regulatory position becomes clearer”

18 January 2010

LBG’s Audit Committee minutes record that Mr Ryan (a NED on the LBG Board) requested a paper considering alternative strategies for the BOSI portfolio. TTO agreed to raise the issue with ED for future consideration by the LBG Board.

E-mail exchanges between SC and AK with the subject “Irish Entity Structuring”. AK suggests agenda items for meeting, SC replies “Ok let's go with this plus the Irish capital and tax loss piece … can you send them the agenda plus tell them Neil and Padraig are coming”. AK confirmed: “The meeting with [TTO] is Tuesday of next week”. The distribution list at the end of the e-mail chain was GR, TF, MS, PB cc’d to MH and SM.

E-mail from GR to MH and SC cc’d to TF, PB, AK and SM with the subject “Irish Entity Structuring” stating: “Working draft of doc from Tom and Padraig which highlights where the Group Tax, capital and group view; neeeds [sic] to dovetail.”

LBG Board Meeting attended by ED, TTO, TT and CS. The minutes record ED commenting:

“after the turmoil of 2009, the management team was fully focused on delivering the goal of being the “Best Bank in the UK”. The Board would discuss the strategy to achieve this – and the key drivers of the Group’s performance – at the Strategy Session in April. The Board would also consider as part of its strategic debate how best to allocate scarce resources (including capital, funding and liquidity) and make difficult choices about strategic priorities. The Group was already heavily focused on funding and liquidity issues, which were clearly key. It was critical for the Group to begin to demonstrate in 2010 what could be achieved and delivered, although the economic, legal and regulatory environment was extremely challenging.”

The minutes record that on or around, January 2010, ED met with John Fingleton (OFT) and Clive Adamson (FSA) to help build relationships and gain greater understanding of regulatory policy objectives and that:

“[ED] and [TTO] had conducted a thorough review of the Irish business. There was a strong and motivated management team, but the Irish economy was clearly performing very badly. The historic strategy pursued by that business (particularly with respect to the Retail expansion) had done badly in the economic downturn.”

26 January 2010

On 26 January 2010, a paper titled “Irish Entity Structuring” setting out structuring options for BOSI was prepared for TTO. The paper proposed that a claim be made under the sectoral €20bn Guarantee, the proposal was not pursued.

JD prepared an Ireland specific paper titled "Group Executive Committee [BOSI] Proposed Strategy”. The Executive Summary proposed that the MFV strategy be continued.

Project Memphis paper for GEC set out the proposed MFV strategy in Ireland. The paper confirmed the planning for the exit from Ireland would be announced on 10 February 2010.

For reasons unknown, JD left BOSI in late January/early February. TT took on responsibility for W&I on an interim basis until a permanent replacement was recruited.

GEC paper prepared by JD that had been previously circulated was noted by the GEC. ED commented that:

“this was a move that would have material repercussions for the Irish business, and would be a serious development for the Irish economy. Nonetheless, this was the right course of action for the Group to take. Other possibilities had now been ruled out, or had fallen away. The programme was well planned, but execution would require close attention to detail by the W&I, and BOS management teams.”

8 February 2010

Report to the W&I Divisional Financial Control Committee – y/e 31 December 2009. The Executive summary confirmed the most significant area of focus continued to be around impairments, focussed in particular on provisions in Australia and Ireland. An unsatisfactory control environment was identified in Ireland but progress was being made with a number of initiatives likely to improve the control environment including a focus on risk and control and establishment of a BSU.

BOSI Press Release titled “[BOSI] completes strategic review” which confirmed retail business in Ireland to close. Corporate and Commercial banking to be main focus in the future with a strong presence with BSU role to be unaffected.

W&I 2009 Full Year Divisional Results Paper which stated that impairments were forecast to have peaked in Half 2, 2009 in Ireland compared with Half 1, 2009 in Wholesale division. Data supplied by LBG’s Group Chief Economists Office (“GCEO”) predicted a growth in commercial property prices in Ireland from 2011.

Irish Sunday Tribune article by Jon Ihle titled “After two false dawns, night falls on Halifax” which stated “Amid all the confusion, it emerged that a large US private equity firm, believed to be Blackstone, baulked at a deal to buy the bank's assets at a significant discount. The $93bn private equity giant, which had reportedly been on the hunt for distressed debt in Ireland last year, had completed six weeks of due diligence on Bank of Scotland Ireland's €35bn loan book before pulling out at the last minute. The collapse left Higgins strategically abandoned by Lloyds and with no concrete plan for dealing with BOSI's troubled retail franchise.”

TT e-mailed GA stating:

“would like to visit Ireland once the current noise [Project Memphis announcement] subsides … craft a “fresh” view. … The “fresh” view might be particularly important as I am “smelling” that the Wholesale first half impairment numbers might be uncomfortably good….and “optics” might motivate “senior” management to do something that might not make sense. If Wholesales numbers were to be low…..it might provide some cover for us to be toughly realistic in Ireland, and get the impairments to an even more comfortable level than they are today (again, please forgive me if I don’t express this well and it is misunderstood as either criticism of current impairments or processes. My point is that we might be “permitted” to be more conservative and give us more flexibility in what is an uncertain economy in Ireland!).

GA replied:

“this is a great idea … Ireland is our one big risk. Given everything that has happened it would also be great for you to tell the troops how valued they are.”

19 February 2010

E-mail from MO to ED and CS cc’d to TTO, SRS, SH, KC and OM with subject “Impairment guidance” which discussed a planned news release which indicated that the 2010 impairment charge will be significantly lower than 2009, with further substantial reductions in 2011 and beyond. It noted that the second half of 2009 impairment charge was lower than the first half charge.

E-mail from CS to OM cc’d to TTO, SRS, SH and KC with subject “Impairment guidance”. CS agreed was appropriate to reduce the range of market expectations even though it was early days, both Retail and Wholesale were looking good, the only concern was Ireland but “we need to this in perspective , both because of its overall size in the scheme of things and also it is very well flagged as an issue.”

W&I Credit Risk and Reporting Paper December 2009 Year End. Under Key Risks and Issues (1) it was stated:

“current forecasts suggest that impairments levels have peaked in 2009”;

“The CRE portfolio has generated two thirds of the 2009 impairment charge in BOSI.”

“[GCEO] predict a further fall of 8.4% in 2010 (14% in the downside scenario) before signs of growth emerge from 2011 onwards.”

In respect of Ireland it stated:

“Impairments in Ireland moved in line with the weak economy and deterioration in the Irish property market. The BOSI portfolio is characterised by a high level of concentration in [CRE] … which have been severely impacted by the weak economic conditions and falls in asset values. The CRE portfolio has generated two thirds of the 2009 impairment charge in BOSI.”

Under “Actions taken to mitigate risk (4)” the headline was the establishment of BSU in W&I during 2009 and to be implemented in 2010. It confirmed that:

“Wave 3 BSU recruitment completed at the end of January 2010 with 98 out of the projected headcount of 110 appointed and operating from early February.”

24 February 2010

Meeting of LBG Audit Committee attended by TTO, SH, TE, MS and CS. The Committee noted that alternative strategies for the BOSI portfolio would be considered by the new Director of W&I following appointment and this item would be considered at the LBG Board strategy session in April, although “the Group's options were considered to be limited.”

Memo “re Board Away Days” from ED to ET, AP and GEC setting out key points to cover including:

“On the question of the participation choices that are available to us within Wholesale, we have made a lot of headway as part of last year's non-core approach. I would like us to have another look at this in time for the Board, specifically to assess whether we can be more rigorous in applying the non-core criteria, as well as to examine the potential benefits of accelerating the previously agreed actions on non-core assets and activities.

…

Internationally, I want us to think through how we can right size the balance sheet and reprice portfolios more quickly, as well as consider the full range of exit options that are available to us.”

26 February 2010

LBG 2009 Results News Release. TTO stated “We continue to have ongoing concerns with regard to the outlook for the Irish economy although we expect 2009 to have been the peak for the International impairment charge.” In the W&I section the MFV strategy was confirmed and it was stated:

“We have spent a significant amount of time analysing and addressing the issues in the legacy HBOS portfolios, with the greatest attention paid to the over concentration in real estate related lending and those portfolios that fall outside the Lloyds TSB risk appetite.”

LBG Preliminary Results 2009. ED’s Key Messages headline was “A strong earnings outlook”. The transcript of ED’s address confirmed:

“Impairments are the most significant number on the slide. At £24 billion, they are up 61% on 2008 and were the primary driver behind the management pre-tax loss. But as expected, they fell back in the second half of the year.

In Wealth & International, we continue to have ongoing concerns with regard to the outlook for the Irish economy although we expect and believe that 2009 has been the peak for the International impairment charge.

And so, in concluding, … We have an improved outlook for margins going forward, we are targeting substantial cost synergies and we expect impairments to reduce significantly.

Question 15: Michael Helsby, Bank of America Merrill Lynch

Firstly, I know you mentioned that Ireland clearly we all know Ireland is going through a difficult spot. But I think most people would have been surprised by the extent that bad debt jumped in the fourth quarter. So I was just wondering if you could give us some more colour.

Answer: Eric Daniels

In terms of Ireland, yes very clearly we gave you in August a cautionary note in terms of our guidance. We were concerned about the Irish portfolios, we remain concerned about them. Basically they are very, very heavily concentrated in real estate, both commercial and residential. Basically there are therefore going to be a very high beta portfolio. The economy in Ireland is clearly not out of the woods yet. We have a rather bearish view of where the Irish economy is going, around a 2% drop in GDP and in our guidance we have said that we expect that in fact our impairments take that into effect. So we expect we will have peeked [sic] on the Irish impairments, but we are very cautious about them. There is less of a sense of confidence I think than we have in our other portfolios. Very fortunately they make up a pretty small part of our balance sheet. So I think that we feel very confident in the overall guidance that we have given.”

Engagement Report W&I BOSI - Retail & Intermediary Collections and Recoveries issued by Kate Grant, Audit Manager to Bernard Kingston, Head of Retail and Intermediary, BOSI and copied to GA, JH, MW, MA and TT:

“RED Unsatisfactory - requires urgent attention”

March 2010

BOSI W&I DRO & GCRA Review of BOSI’s 2010 Impairment Forecasts.

“The key conclusions are as follows:

•

The 2010 revised forecast range is €2.5bn - €3.0bn and only slightly changed from Q1F.

•

The Realistic Case has increased to €2.8bn, driven by deteriorating cure rates in all portfolios and a more cautious outlook for some of the largest cases.

•

Although we have not forecast by half years, we believe the revised forecast range remains consistent with a declining trend in the Impairment Charge - with H1 2010 being lower than H2 2009 and H2 2010 being lower than H1 2010.

•

In the last two weeks, 30% of the wholesale book by value has been reviewed by W&I Credit, GCRA and Group Risk with the findings factored into our assumptions.

The forecast decline in the MTP for 2011 is now looking a very large step down from 2010. Although we believe there will be a significant reduction, we intend to review the 2011 forecast as soon as possible.”

2 March 2010

LBG Group Credit Portfolio Review – March 2010. The Executive Summary confirmed that LBG’s impairments remain dominated by HBOS legacy Real Estate though the pace of deterioration has reduced.

E-mail from RF to Karen James (Corporate Markets), subject “RE: DUBLIN TRIP” stating that he would “like to establish buddying relationships with colleagues in BSU in the UK.”

E-mail from AK to TF cc’d to PB, JW, MS, GS, EG and MH with subject “RE: Meeting today”. The complete e-mail chain is not in the hearing bundle and does not include the e-mail timed at 13.27. The e-mail states:

“The purpose of the call this afternoon is to consider other options we sho [cut off] losses and to consider what work is required and when [cut off]

Moira has kindly prepared the attached and we can use this as the basis [cut off]”

24 March 2010

LBG presentation script at Morgan Stanley European Financials Conference which variously states:

“Impairments are trending better than our guidance and, based on our current economic and regulatory expectations, we expect substantial further reductions for the rest of this year and into next year.

We believe, given our current economic outlook, that the impairment charge in 2010 will be significantly lower than 2009.

In Wealth & International, we continue to have ongoing concerns with regard to the outlook for the Irish economy although we believe that 2009 was the peak for the International impairment charge.”

29 March 2010

Group Audit Engagement Report, Dublin Treasury BOSI sent to JH, TF, PB, MA, TT, MW, GA and SC. The report stated:

“RED Unsatisfactory – requires urgent attention

…

This audit is rated Red because of a number of key control weaknesses identified in the governance structure, business processes and monitoring by the Risk and Compliance functions”

April 2010

W&I update provided to LBG Board by TT. The update variously stated:

“Impairments

•

Sensitivity to economic environment, particularly in Ireland - impairments due to reduce by £1.3b in 2010, though Irish CRE/HPI values to be monitored*

•

Increasing impairments by £200m during our Q1 F exercise in recognition of continued downside in the Irish Economy.

*Risks remain if CRE values continue to decline through assumed peak-trough level of -58%: a further c. 6% decrease in CRE prices along with some decline in HP/ values would adversely impact our impairments by £1.3bn, negating the decrease we have forecasted

In 'International', outlook is on strengthening controls and actions to improve profitability .... and to create options for LBG

Ireland

Control

•

Embed robust risk management model

•

Strengthen BSU capabilities to manage impairments

•

Reduce overall balance sheet and RWAs

Profit

•

Deliver asset re-pricing

•

Right-size the cost base and exit unprofitable retail business

•

Reposition the portfolio to reduce sectoral concentrations in property

Optionality

•

Controlled run down of CRE book

•

Explore targeted asset disposals when liquidity returns.

•

Light focus on SME relationship business

Key External Risks

•

Continued lack of liquidity in Irish commercial real estate markets.”

Memo from TT to LBG Board Members with heading “[LBG W&I] STRATEGY -15 APRIL 2010” variously stating:

“In our "International" business however, continued economic problems in Ireland … are resulting in a slower recovery. Whilst we forecast impairments to decline by £1.3bn in 2010, we continue to watch Irish CRE and HPI values with caution as even a 5% variance in these values would negate this favourable impairments decline.

With impairment challenges over the short-term (which we believe have peaked in 2009), our focus will be on embedding a robust risk and control framework to manage impaired assets in both Ireland and Australia. … We are actively assessing radical options to re-size and re-shape our balance sheet. These include the recent closure of our Retail and Intermediary businesses in Ireland”

BOSI Briefing Material for Meetings with staff April 2010. Briefing confirmed:

“Colleague Messaging Messages delivered on A-Day

[key message] The Bank, and [LBG], are both committed to continuing a strong presence in the corporate and commercial banking sectors in Ireland. Corporate and commercial banking will be the focus of the Bank in the future.”

BOSI Briefing Pack for TT’s April 2010 visit to Ireland containing agenda and the following briefing:

“Executive Summary

New management team working to improve risk profile of the business, ensure control over tail risk on impairments and improve future options

Key Achievements

•

New senior management team appointed and business refocussed on risk control rather than sales activity

•

BSU formed to improve management of impairment cases – now fully operational.

Future of the Business

•

MTP assumes closure of Retail activities (announced Feb 2010) with controlled rundown of CRE Book with further strategic review of residual business (sell; retain; close) in 2 years.

•

Significant challenge to re-engage colleagues and customers in the continuing business

•

Team in place with capability and commitment to deliver.

…

Despite this, international markets believe in Ireland’s capacity to recover over the medium/long term, as confirmed by a number of successful/oversubscribed bond auctions undertaken throughout 2009 and early 2010

Economic Forecasts

Economic outlook as agreed with LBG economics – MTP Outlook: modest recovery from mid-2010

•

In the medium term (2011-14) the Irish economy expected to outperform OECD

•

Commercial property market expected to see modest recovery in 2011–12, with a strong growth in 2013.

…

Control/Profit/Optionality

Immediate focus is on improving the control environment and actions to improve current/future profitability … creating optionality for LBG.

Strategic Priorities were identified as creating optionality to dispose of some or all businesses and to determine the optimum legal structure, funding and capital model.

Initiatives underway included the asset shrinkage of 15.5bn euro over life of plan baked into MTP and a review of Subsidiary versus Branch model also underway.

Control over Key Risks confirmed that quick wins achieved; remaining actions underway and on track. The key risk on impairments analysed through full segmentation of book and now managed through the formation of BSU.

Key Risks and Mitigants

Very poor Q1 staff engagement results identified in survey, actions were underway to improve colleague engagement underway.

Regulatory

Confirmed strong relations with Financial Regulator and proactive approach to queries/requests for information and, from a Regulatory perspective, BOSI was in line with the Banking industry.

The BSU update confirmed that as at March/April all BSU staff were in place

Latest MTP would deliver lower costs and greater asset reduction over next two years at which point future strategy for business would be re-assessed. Commentary confirmed that MTP included property/mortgage portfolios adopting a run-off strategy with support functions right-sized accordingly and the strategy would be revisited as part of 2012 – 2017 planning phase.”

6 April 2010

BOSI Capital Requirement paper for GEC presented by Harry Baines. The Executive summary requested the GEC note the proposed injection of a further €1bn of capital into BOSI to “facilitate the finalisation of a medium term capital structure for [BOSI]”. It was confirmed that in “Q1LV the [BOSI] impairment forecast for 2010 was in line with the MTP reflecting broadly unchanged economic assumptions, although the forecast is currently being reviewed in conjunction with Divisional and Group Risk in the light of further emerging experience data. Any increase in the impairment forecast would have a proportional adverse impact on BoS Ireland's capital position.”

GEC Meeting chaired by ED, attended by CS with apologies from TT and TTO. GEC approved the injection of €1bn into BOSI to secure its regulatory capital obligations until end Q3, 2010, pending the finalisation of its medium term capital structure.

Memo from ED to LBG Board Members re Board Away Days, 15-16 April 2010 Briefing Materials. The memo enclosed a short briefing note for each of the sessions on the agenda. The W&I Strategy briefing note presented by TT confirmed that W&I were reshaping their International businesses stating “With impairment challenges over the short-term (which we believe have peaked in 2009), our focus will be on embedding a robust risk and control framework to manage impaired assets in both Ireland and Australia … We are actively assessing radical options to re-size and re-shape our balance sheet. These include the recent closure of our Retail and Intermediary businesses in Ireland, managing down our corporate real estate book in Australia and Ireland, as well as exploring exit options in Ecuador and Uruguay.”

E-mail from JB to MF [the presence of an external e-mail address and KPMG footer at the bottom of the e-mail chain indicates she is from KPMG] with subject “Merger and EU Directive – Irish Legislation”. E-mail states:

“We discussed this briefly yesterday.

The question has come through from Group Tax ie are there any advantages that could be gained through merging BoSI with LBG particularly in terms of getting value from the BoSI losses forward. I know we have looked at this before but could you send me a quick note on it.

My understanding is that the Irish BoSI Case 1 losses forward will only be allowable against future taxable profits”

E-mail from JB to MF states:

“In regard to the below, I understand from my colleagues in the UK that UK merger tax law seem to allow the transfer of assets at amortised value rather than impaired cost. If this was the case in Ireland, it could create a position where more of the impairments would be available against UK taxable profits.”

The reply/replies from MF to JB are not in the hearing bundle. The e-mail text at the top of the e-mail chain suggests by reference to “she” and its position that JB summarised MF’s reply/replies as follows:

“it will be treated as a separate trade and profits taxable at 28%.

•

The NI trade should simply be absorbed into BOS's trade - if there are any losses they should transfer to BOS although how to treat the losses will need to be agreed with HMRC. Capital assets would go on a tax neutral basis as the NI branch is in a group with BOS.

•

Finally there are discussions going on in the UK about an exemption for branch profits. These are only at a preliminary stage but worth mentioning.

•

She doesn't think that the Irish losses could be c/f into the UK- there may be EU arguments but it would be a battle.”

E-mail from Jeanette Craft (Secretary to CS) to GA and JH cc’d to SRS and Ras Krishneratne with subject “Visit by Matthew Elderfield, Head of Financial Supervision, Central Bank and Financial Services Authority of Ireland - 7 May 2010 at 10:30 - 11:30”. E-mail confirms that CS “knows Matthew Elderfield very well from working with him at the FSA and he is also a good friend. Mr. Daniels knows him quite well also.”

Presentation by ED at April Board Away Days titled “Delivering LBG’s strategic vision”. The Agenda identified three phases:

“Phase I: 2009 Managing through the crisis

Phase II: 2010-2013 Driving outperformance (reference made to run down non-core assets)

Phase III: Beyond 2013 Targeting growth opportunities”

It was confirmed that LBG had exited a number of higher risk activities. The 2009 results were ahead of expectations having outperformed internal and external forecasts demonstrating that the core business is in good shape with the momentum continuing to build in 2010. The 2014 objectives for International were: value protection, explore restructuring and exit options. New regulation was identified as an execution challenge: “Significant increase in RWA especially for trading activities; higher capital requirements; overall size limit on banking activities; restrictions on funding sources and quality of liquidity buffers”.

At a meeting of the BOS Board Meeting attended by ED, TT and TTO, the proposed injection of a further €1bn of capital into BOSI was approved.

E-mail from SC to DC with subject “Emailing: Group Credit – W&I impairments 11-2-1- final” with attached W&I impairments note following PwC’s audit findings reported to DFCC 11 Feb’10 which stated:

“Group credits in Feb 2010 – “Group Credit’s view of view of BOSI impairments is unchanged and is in line with PwC. We continue to believe that the BOSI impairments are, assuming we are in the LBG base case, mid-range for 2009; aggressive by €300mn for 2010; slightly optimistic for 2011; and mid-range for 2012-14, although we have undertaken only limited work on the back years & there is inherently greater uncertainty.”

Date prior to 20 April 2010

Agenda for TT visit to Ireland on 22-23 April. Objectives that TT should get from the visit were: “Understanding of the current issues faced by the business, in particular … impact of NAMA on the CRE market and the potential to dispose of assets in the future.”

Email from SM to Nick Beckwith cc’d MW and JH with subject “Briefing Materials in advance of GTT visit”. The attachments included the agenda, background briefing pack, background information ahead of meetings and meeting papers for the Board and Board Audit Committee.

E-mail from MS to AK cc’d to GR and GS with subject “Ireland - branch option”. The e-mail dated 28 April confirmed that AK had embedded his comments in the text of MS’s e-mail. The e-mail stated:

“While you were away, I progressed the various points we discussed. … From what I have managed to gather from BOSI Legal and brief discussions with the tax guys, here's where we are at:

Legally, there are 3 ways transferring the BOSI business to a branch:

• transfer of assets using the Central Bank Act procedure (similar to our Part VII transfers here)

• using an EU Directive to Implement a cross-border merger (there is precedent for a financial Institution in Ireland using this)

• a scheme of arrangement (essentially and application for a Irish High Court ruling of your choice).

For tax purposes, I see four ways of forming a branch - migration, EU cross-border merger, transfer of assets or commence trade of UK Co (whilst running down BOSI).

I've done some deeper digging on the tax front In respect of the options on the table:

1.

M&S Claim

…

The initial comments that I have been given on the Irish tax analysis are unhelpful when it comes to the M&S analysis. In the scenario of all assets being transferred to a UK company, the Irish tax losses will travel across with the trade. This will mean that we can't argue that there is 'no possibility' of the losses being used in Ireland in the full transfer scenario.

I have also looked into the detail of the M&S case to see whether there is anything of use re circumstances in which we can make an M&S claim for BOSI … The facts of the case are not particularly helpful - at the time of the ECJ hearing, the subsidiaries were no longer trading (but not yet in liquidation). However, the ECJ Just rules on points of law and not on the facts. The case was sent back to the UK courts to apply the legal analysis to the facts of the case. …

Despite the decision being in respect of companies in the course of liquidation, there are some comments made by the judges that give us some guidance. The main points to draw from the case are:

• There being 'no real likelihood' of using the losses in the future is not enough - there has to be 'no possibility', broadly equivalent to there being no legal possibility.

• For there to be 'no possibility', the indication is that a suggestion that the losses can be used must be 'fanciful'.

…

[AK Commented] This makes it much more difficult - almost back to the liquidation of BOSI situation. Just testing how far we would have to go, If we liquidated BOSI and as part of the liquidation transferred all the assets back to BOS plc to be managed out of the UK, retained some of the people on the Ground to manage collections would that work in terms of avoiding the branch in Ireland. No Irish Branch of BOS plc, no opportunity to use losses ever and a M&S claim would become possible?

2.

EU merger provisions

In respect of the EU merger directive (which states that essentially amortised cost can be used as tax basis in the UK), there are further provisions overwriting these where parties are not at arm's length. In such circumstances, the value of the loan relationship is the transfer value that would have been entered into between knowledgeable and willing parties at arm's length. This is a pity as it brings us back to the valuation issue that we have on the transfer to a branch.

[AK Commented] Pity - looks like this closes this one down

3.

Group relief of PE/branch losses to wider UK group

As discussed, if the branch generates losses, it will only be able to surrender these losses to the wider UK group if none of the losses can be used elsewhere in Ireland. I have had discussions with KPMG re the Irish grouping rules for group relief, I’ve not received anything in writing, but I've been told that the group has to have all of the following 76% connections to being the same group:

• Ordinary share capital

• Entitlement to profits available for distribution

• Entitlement to assets on a winding up

The grouping rules only Include EU companies though, so a group can. be broken by a non-EU group company (e.g. Channel Islands) holding 26% ords of the Irish entities.

Given that I suspect the notion of holding some shares/rights through, say the Channel Islands, is likely to be unpalatable, I have not investigated further anti-avoidance provisions/problems it may cause with the UK grouping. This method of breaking the Irish tax group is the only one that KPMG Ireland had.

[AK Commented] Sounds like we need to get away from having an Irish branch. I think that HAIL (the Irish life assurance company) will always have some profits so will preclude us from surrendering the losses anyway

4.

Tax projections for a branch scenario

I attach some projections of the branch scenario using the MTP and stressed MTP. As you can see, there is a considerable tax downside to a branch if the UK tax rules continue as present.

…

5.

Migration

The migration of BOSI to the UK would result in a UK resident company with an Irish PE. In order to do this, BOSl's place of 'central management and control' must be moved to the UK. Where a company is dual resident, Its ultimate residence is determined by the provisions of the UK-Ireland tax treaty. … Please note that this area has been increasingly subject to scrutiny and challenge by HMRC In recent years and must be implemented carefully.

[AK Commented] Even if we got the migration right would we still need to satisfy the point at 3 above i.e. no ability to surrender losses of Irish branch to another Irish company? That would snooker us anyway?

…

7.

Next steps

I suggest the following:

• M&S claim - please can you consider whether there is any future possible actions re BOSI, short of liquidation, that may be taken to satisfy the no possibilities test (e.g. would there be any representations made to the regulator in a branch scenario that would make any decision on the future of BOSI Irreversible?)

• Irish tax advice - I need the guys to review my attached calculations and I'm not comfortable until I have something in writing from them/KPMG. I'll pick up with them.

• Market values - If we want to weigh up the various Implications of conversion to a branch, we probably need a discussion on the MVs at some point.

• Discussion with Deloitte - I'll have a quick chat with Greig re the proposal to have a discussion with Nigel”

22 April 2010

TT arrived in Ireland for a two day visit accompanied by Hugh McKay (HR Director, W&I) and GA.

BOSI Board Meeting attended by JH, H McKay, MW, RF and TT as a guest. The minutes record that a working group had been set up comprising W&I and Group Finance to determine the optimum medium term capital strategy for BOSI and the appropriate structure to deliver this. RF provided a progress update on the BSU: Dublin was up and running with 121 colleagues, c. 1,000 Customers, €9.6bn of exposure and badged Green. There were also six regional BSUs. Concerns, primarily about the availability of resources, meant four of the regional units were currently badged Red and the remainder badged Amber. TT advised that the BSU in the UK was also on a continuous learning curve and that BOSI was only 6 months behind from an experience point of view. RF outlined the current focus of the BSU and he was confident that a strong team had been put in place. However, some lacked experience and the continuous development of colleagues was vital to the success of the BSU.

TT provided a verbal update on LBG Strategy. LBG had recently released some good news in its 2010 Quarter 1 update to the City. While impairments did continue at a high level, it was noted that the Q1 Impairments were at a lower level than the last quarter of 2009. TT outlined that as part of this strategy, BOSI needed to show discipline, de-risk and realise available synergies over the next 18 months. Overall, TT had been comforted to see the excellent progress made in Ireland in reshaping its business. The progress being made had left him with the distinct impression that there was plenty to be positive about in Ireland and reinforced how success could often be defined by spectacular execution.

E-mail from MO to ED, TTO, TT, SC and CS with subject “BOS Ireland – Moody’s rating – CONFIDENTIAL”. MO confirmed that BOSI would remain as BAA1 and “taken off review for downgrade, albeit they kept the negative outlook on the rating which largely reflected their concerns about Ireland as a whole.”

E-mail from MS to NMC with subject “Deloitte” which stated:

“I believe that my W&I Finance Colleague [AK] spoke to you a while back about Ireland. We have been doing some work on what the future structure/funding of Ireland will look like, the main driver being sorting out the capital position. [AK’s] keen to do this in a tax efficient way and we also currently have several £bn in trapped losses in BOSI that we have no hope using. We’d like to have a discussion about the tax position and whether there is any planning that would be of benefit/any ideas that Deloitte can bring to the table.

I can send you a brief note beforehand to give you an idea of the issues that we have discussed so far so that we're not starting from scratch.”

In response to NMC confirming he would be out of the country, MS confirmed to AK that she was happy stating: “It will be a couple of weeks, but given that we are exploring the TRS option in the meantime, that may be no bad thing”.

E-mail from AK to MS with his thoughts embedded in the e-mail body (at para 113 above).

E-mail from MS to NMC cc’d to GS with subject “LBG – [BOSI]”:

“In preparation for the meeting on Ireland:-

The real driver for sorting out Ireland is the capital position. We injected €1.7bn In last year, €1.5bn to date this year and expect to need to inject more in Sept. The current status quo is unacceptable and we can't just carry on injecting capital into BOSI.

Options currently on the table:

• branch (email below will bring you up to speed with our branch thoughts, plus I have confirmation from the 5 year plan of the Shannon subs that group relief from an Irish PE will always be possible to other LBG co.s In Ireland)

• branch (bad book) plus sub (good book)

• new guarantee from BOS plc

• total return swap idea from the STG guys

Are you familiar with the current guarantee? We have decided not to make a claim under it and are in the process of agreeing the TP on the old guarantee. I am attaching a briefing note Grant sent to KPMG, which will give you some background info. If we carried on using a guarantee, it would be replaced with a new one.”

May 2010

W&I Business Review by TT dated May 2010. The review variously confirmed:

“International market and competitor outlook

Ireland’s negative outlook impacts performance through impairments

Ireland

•

Irish economic situation remains challenging with a 2% GDP contraction expected in 2010 and modest recovery in the MTP

•

Commercial property has fallen, recording capital values down 50% from their peak and a further decline of 8.4% is expected in 2010 followed by an upturn of 13% growth in 2011 [footnote confirms source “Group Economic Assumptions Apr 2010]

International summary

IB is delivering on optimising returns whilst preserving medium term strategic options and reducing draw on LBG capital and funding resources

Ireland

•

BSU team now fully operational

•

Asset reduction ahead of plan on a local currency basis

Ireland update

BoSI is focussed on reducing exposure, and right-sizing the cost base, in an uncertain market

•

Given the risks and uncertainty associated with the Irish market, it is desirable to reduce exposure

•

In the medium term, a disposal would require significant write-downs and discount to book value

•

Therefore, the BoSI strategy is to reduce exposure through active run-off in the property sector

•

This retains the optionality of disposing the business more favourably at a later date, outsourcing management of these books

•

Project Memphis is the current focus, and is progressing well, but attention is also given to the residual book

Residual book update

•

Impairments: In line with plan, however ~£13bn exposure is currently within BSU”

4 May 2010

Email from AK to EG cc’d to SC, GS MS with subject “FD papers to send out””. The e-mail stated:

“Two paper for circulation. Grieg can you have a look at the tax one and make sure you are happy?”

The Ireland Update Paper produced by W&I/Group Tax was based upon MS’s e-mail to AK dated 21 April 2010 and set out the possible routes to access tax relief for the losses. The paper concluded stating:

“Future Structural considerations

All of the analysis we have undertaken highlights the importance of ensuring that we have written business in the most appropriate jurisdiction for the underling [sic] risks. While a low tax rate is superficially very attractive for low risk business with a low chance of loss, it is not so attractive in a business, lending money to small corporates and SMEs, where the risks of loss are high. Given the nature of the business we will have in Ireland going forward, it does lead us to the conclusion that we should fully review the structural option and consider whether a subsidiary is the most appropriate vehicle in the future.

Given the need to need [sic] for an additional capital injection into Ireland by September and the need to find a permanent solution to the intra group guarantee, now does feel like the right time to look at the other options for operating our business in Ireland. A move away from our traditional banking subsidiary approach may be appropriate in the circumstances.”

The note of TT’s two hour interview with FSA records as follows: TT was responsible for W&I on interim basis; it was not his aim to redefine strategy or redefine what is being done. His role was primarily to support the teams and make sure that things are well run. In response it being pointed out that he now had two full-time jobs he confirmed that he tried to double up Wholesale and W&I as much as possible and that he was working harder but he appreciated it was not sustainable in the long run. He confirmed that if W&I was his only job he would spend more time visiting and would have visited all the key geographies in his first month but had so far only visited Ireland and Switzerland. This made him more dependent on his executives. He confirmed that the objective in Ireland was to “shrink well” and that with regard to ownership of strategy for W&I he was acting as custodian and guardian and that he had “a strong management team reporting into me.”

E-mail from TT to Angela Teke confirming TT’s view of the meeting with the FSA:

“My own feeling is that it was good.”

May 2010

BOSI Briefing note for the meeting with the FR dated May 2010. The briefing note variously stated:

“Note there are now two FR supervisory staff dedicated to BoSI (previously not the case).

…

The capital requirements of the foreign banks remain unchanged for now although the FR has flagged that it plans to place particular focus in the upcoming ICAAP review on:

• stress test outcomes (including robustness of approach used and conservatism of assumptions); and

• reliance on Group support (FR likely to look at Group's ability to provide capital possibly via discussions with FSA. They may also focus attention on the guarantee and any other support from Group).

…

BoSI Engagement with the FR

Regular, constructive engagement with the Regulator - a no-surprises policy

• The key focus of recent interaction with the FR has been around Project Memphis (closure of Retail and Intermediary businesses).

…

In particular, in Dec 09 the FR queried why BoSI had not made a claim under the BoS plc guarantee (which guarantees €20bn of assets, to be chosen by BoSI on a monthly basis). BoSI has the right to claim under the guarantee in respect of a particular asset once the customer defaults on his obligations. No claim has yet been made under the guarantee as BoS plc has preferred to make capital injections into BoSI instead. If BoSI were to claim, it would trigger fair value accounting treatment of the guarantee in the accounts of both BoSI and BoS plc, which would introduce a degree of volatility for each which would raise some issues regarding the management of their respective solo capital positions. BoSI has committed to the FR that the ongoing use of the guarantee will be reviewed in 2010.

…

Other areas of recent/ongoing engagement include:

CEBS Guidelines on Liquidity Buffers - the Bank is required to confirm compliance with the guidelines to the FR by end June. Discussions ongoing with the FR regarding the methodology for maintaining a liquidity buffer under stress.

Dynamic Liquidity Line - our relationship officers in the FR were initially unhappy with the DLL proposed as it did not meet the liquidity requirements methodology. A revised DLL has been submitted and we await formal confirmation from the relevant FR officers that it is acceptable before implementation (note: we do not believe that this issue, or the issue above, has been escalated to Matthew Elderfield's office at this time).

…

Points that could be raised with the FR … LBG's ongoing commitment to support BoSI (from both a capital and funding perspective).”

6 May 2010

Papers for 7 May 2010 W&I FD meeting e-mailed by EG to TTO, SH, SC, AK and others. Attachments included Ireland Update Paper.

Note for Record of meeting on 7 May 2010 between FR, Matthew Elderfield (“ME”) and ED and CS. The note records:

“The conversation was very cordial and constructive building on the very good relationship we had with ME when he was at FSA and the contacts since. Most of the conversation was about general economic and regulatory issues. ME reported a very good relationship with Joe Higgins and the team in Ireland.

…

ME was clearly in favour of a slower introduction of the proposed liquidity and capital requirements, but said the international governance was now rather complex.

…

ME said the relationship with Joe Higgins and his team was very good and they had been impressed with the way the retail bank was wound down.”

17 May 2010

Email from PB to MS with subject “RE: Meeting today” [E-mail chain not complete] stating:

“I am trying to pull together a list of the various options that have been considered from an Irish structuring perspective.

I came across the attached paper which lists some of the tax options. Is it fair to say that most if not all of these have been discounted at this stage for a variety of different reasons or are some of them still under consideration (and if so could you tell me which ones)?

Clearly the TRS is a new option that was not on this original list.”

E-mail from AK to SRS cc’d to GS, MS and SC with subject “Ireland excl LTP – 17.05.10.xls” and attachment of same name stated:

“I wonder if you could help me with a query from [TTO] and [SH].

As you are well aware we are taking some significant Impairments in Ireland. One of the issues we are facing into is that we currently cannot get any tax relief for those losses so they are currently worthless to us.

There may be a way in which we can get UK relief for losses but that will probably require us to liquidate the BOS Ireland legal entity. Therefore a proposed route might be to put BOSI into members voluntary liquidation and them pass all the assets and liabilities up to BOS plc as part of the distributions in liquidation. The assets and impairments would then be managed out of the UK. I would envisage retaining BSUs in Ireland to manage the day to day customer relations but that all decision would be made in the UK.

Given this change in the operating model I have been told that there would be an impact on the absolute level and possible timing of impairments and I am trying to get a feel for what size the additional cost would be so I can measure the cost of additional impairments against the benefit of tax relief on losses (which are very significant).

Absolutely recognise there are a host of other issues with this proposal not least of which is managing the Irish regulator but we need to get a high level view of the cost/benefit trade off so we can decide whether to look at the idea any further. Is there someone at Group credit risk who could help me get a view on this. I have not discussed this point with the guys in Ireland given the potential impact on them so I would be grateful if you could keep this to yourselves while we investigate whether it could fly or not.”

E-mail from MS to PB with subject “Meeting today” stating:

“The gtee claim has been dropped. Of the others, from reading through my emails, there has been no 'official' dropping of the others. Though the structured transaction being considered was something that has to be parked until we know what the future structure looks like, so is not currently being pursued.”

E-mail from SRS to AK cc’d to GS, MS, SC, SC, DC, AH and NA with subject “ Ireland excl LTP - 17.05.10.xls” stating:

“Very interesting idea. I agree the BSU needs to be maintained locally, but we are writing no new corporate business (retail, of course, is shut) except to build out existing, almost complete developments, if it make [sic] economic sense.

Therefore I'm not convinced a priori that impairments would increase or would even be accelerated. Borrowers might sense weakness/that we would cut them a deal, but we could soon put them straight - and even tighten the screws further by enforcing personal guarantees/bankrupting a few of them - that would send out a pretty clear message.

Steven Clark can lead this. He works in Group Wholesale Credit in Edinburgh, reporting to David Chalk (who works for me). Steven's team has been leading our BOSI impairments work in Group Credit. We will maintain strict secrecy.

I have copied in Alison Hewitt and Neeta Atkar from a reg & compliance and op risk perspectives to get their initial views.”

18 May 2010

E-mail reply from AK to MS, GM, MH cc’d GS stating:

“I would appreciate your thoughts on how much capacity there is to utilise losses from BOSI over the MTP. Assume the losses are equivalent to what you are see in our Q2F forecast above I assume no capacity in 2009 but after that can we assume full relief and what would be the timing of when that relief would crystallise at Group Level?

Michael if we increase our forecast losses forward in 2010 and later years by the losses would we be able to recognise a deferred tax asset and improved capital position at end 2010?”

Incomplete e-mail reply from MH to AK, MS, GM cc’d GS which states “Alan” and nothing further.

E-mail reply from SC to AK cc’d to DC stating:

“Following our conversation this afternoon, just wanted to capture the key elements with a focus on the credit side. Please let me know if anything obvious missing/inaccurate, or require more info on a particular point ahead of your next session with Tim & Sue.

The proposal is in the very early stages

• BOS Ireland would be liquidated and the assets transferred to BOS plc

• The transfer would be at book value, i.e. no requirement to mtm

…

• All credit decisions to be made in the UK, although can retain (and would want to retain), the local BSUs

• The BSU teams/RMs would remain as currently, albeit perhaps some rationalisation possible in the top tier of management. In practice, I think we would want to keep most/all of the senior people given scale of the task and shortage of experienced work-out specialists. Issue would be holding onto people given focus on winding up business in Ireland as I am sure we would not aim to take out headcount deliberately under the circumstances - just need to be wary of impact on attrition

…

• In theory, there should therefore be no material impact on the timing or quantum of impairments - the decision making and process through W&I (numbers per Q2F) would be taken over by Wholesale, i.e the same Group impairment policies (incorporating IFRS) & procedures apply.

• In liquidating BOSI, the risk of losing colleagues would increase as the 'demise' of the business becomes more apparent, real or otherwise. This is mitigated in the short-medium term given the lack of alterative employment in Ireland but incentives may be required to help retain key staff.

• As discussed, the Wholesale BSU OD is expected to start to reduce later this year albeit likely to be 2011 before anything material. This freeing up of Wholesale BSU capacity could be available to backfill BOSI leavers, but equally Wholesale may have existing plans for 'repatriating' to other parts of the business with resource issues. An exco level decision.”

E-mail reply from AK to SC cc’d to DC, SC, GS and MS stating:

“Just a couple of thoughts below.

Thanks for the help”

It is unclear from the e-mail at para 135 what comments were inserted by AK into the e-mail text.

E-mail reply from AK to MH, MS, GM cc’d GS stating:

“I hope I am not talking rubbish!

In 2010 we will make losses in Ireland (£2.5bn) which we could surrender to BOS plc if we manage to make group relief claim under EU law. This will increase the losses forward over and above what you have already baked into your capital plans by the quantum of the losses in Ireland (£2.5bn) and should benefit our deferred tax asset and therefore capital plans by 28% of that amount (£700m). The point is that we would be in a position to get relief for those losses and therefore recognise a DT asset on them whereas if we leave things as they are, we could not recognise a deferred tax asset in Ireland. Then as each additional year of losses is incurred we should see a capital benefit equal to the losses incurred (c£1.5bn in total of losses to 2014 and c£430m) over and above that baked into your capital plan currently.

I hope this makes sense but no doubt you will tell me if it does not!”

E-mail from MH to AK, MS, GM and GS subject “FW: Ireland excl LTP”:

“If we can achieve a tax credit for the Irish losses then that would be an improvement over the current plan which assumes that we can not do this. Does Group Relief achieve this? i.e. what is the doubt entry that shows our reserves increasing? If it is debit DTA, Credit P&L then that’s OK. If its anything else I’d need to understand what it is. This all assumes that our tax colleagues agree that they have enough support (5 year plan) to justify recovery. Subsequent years would be recognised as incurred assuming that we recognise the tax for accounting purposes.”

E-mail from GM to AK, MS etc. – subject “RE: Ireland excl LTP – 17.05.10.xls”

“Putting aside the technical arguments about if we can group relieve etc and when PWC would allow us to book the credit, it would seem that (based on the latest loss utilisation projections I have) only £2 billion of losses could be group relieved in 2010. In later years, the plans indicate sufficient UK tax capacity to absorb to future BoSI losses noted in the spreadsheet.”

E-mail from AK to GM, MS, GS etc. - subject “RE: Ireland excl LTP – 17.05.10.xls”

“Grant, If you have doubts on whether we can get ourselves in a position where we can group relieve the losses it would be useful to know because this will grow wings if I put it in front of Tim. Greig assume that if it did look like it could fly you would tell the Revenue we’re going to do it”

19 May 2010

E-mail from GS to AK, GM MS etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

E-mail from AK to GS, GM, MS, etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

“However provided we can show this is a commercial decision to liquidate you should be able to convince them”

E-mail from GS to AK, GS, MS etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

“We have to get across our commercial object to HMRC – i.e. that we are doing this for reasons which are about managing things from the UK, that we are not seeking to import existing/forecast losses into to UK and that tax is not driving this.

It’s possibly therefore a bit misleading if we emphasise the potential bad UK debt deductions, DTA etc too much if the loans perform and the position improves we would be bringing in additional profit to the UK which will be an important part of the story.”

E-mail from AK to GS, GM , MS, etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

“There are a hundred and one commercial reasons why we might want to liquidate BoSI.

Reduce costs by folding into the UK wholesale infrastructure Capital requirements driving us to having all capital in UK for optimum capital efficiency in the new world.

Enhance risk control and monitoring

Leverage the experience and resources in wholesale UK particularly as we might have spare resources in the UK going forward.

Issue is that there will be a big cost as well. I therefore need some upside to make it fly which is where the tax comes in? I need a realistic view from you guys on whether you believe we will access the Group relief under an M&S type claim and what that would require in terms of what we could leave in Ireland. I also need to make sure that when Sue asks you whether you support it you can say yes! Need a reply on these two points by the end of the week.

Just to be clear I do not think there is a cats chance in hell of BoSI making any profits for the foreseeable future and any business they do write will not be the kind we would want in a low tax jurisdiction as it is too high risk.”

E-mail from MS to AK, GS, GM etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

“Here’s my initial thoughts, in addition to Greig’s/Grant’s comments:

A successful group relief claim would increase the amount of current year (UK) losses to be carried forward in the group (and hence potentially impact the amount of DTA recognised at y/e).

Certainty of loss – we’ve had discussions previously on the differences between the case law and the legislation enacted/HMRC practice in the UK

Anti-Avoidance rules need to considered i.e. a claim would not be successful if the main purpose, or one of the main purposes, of ‘arrangements’ were to secure group relief. There are 2 legs we can fail on here – that one of the main purposes of a liquidation is not to obtain group relief in the UK, or that a liquidations falls outside the statutory definition of ‘arrangements’.

One point to note re negotiations with HMRC will be the possibility of a branch exemption being enacted next year. It depends on how this enacted re financial institutions whether they have an interest in taxation of future profits.

Are you thinking of putting BoSI into liquidation by the end of this year? Or should we base any analysis on the assumption that liquidation would commence in 2011?

Greig – we should discuss tomorrow.”

21 May 2010

Email from AK to GS, Grant Martin, MS, etc - subject “RE: Ireland excl LTP – 17.05.10.xls”

E-mail from GS to MS and GM - subject “FW: Ireland excl LTP – 17.05.10.xls”

“Moira – can you let me have a summary on Ireland for the update note today for Sue.”

By 24 May 2010

BOSI Alternative Strategy Note prepared by AK

“Introduction

This is an update to the recent papers and discussions around the significant losses, which have been, and are being incurred in Ireland without obtaining any tax relief either in the UK or Ireland. By way of a reminder, the latest view of the losses being incurred in Ireland is predicted to be c.£2.2bn for 2010 on top of losses of £2.7bn incurred in 2009. Losses in subsequent years are predicted to be c.£700m at a minimum. Clearly this excludes a stressed position where the losses involved could be materially higher and the loss of value even greater. The amount of losses on which we are obtaining tax relief is minimal

Given the size and nature of the losses and the consequent erosion of value, we have undertaken an extensive review of the possible routes which we could utilise to improve the value proposition for shareholders by:

▪ Accessing tax relief for the losses

▪ Providing downside protection in the position where losses incurred in Ireland are worse than those indicated by the MTP driven by a worsening of the Irish Economy

Details of the outcome of this review are contained in Appendix 1 to this paper. It was clear from the review that the only alternative strategy which allows us to materially improve value for shareholders is to put BOSI into member's voluntary liquidation to allow access to the losses incurred to date … Under this model, future business in Ireland, to the extent that it meets our risk criteria, would be written onto the UK balance sheet through an Irish branch of the UK bank

Advantages of revised approach

This more radical value driven strategy with respect to Ireland has some key advantages over the current strategy:

▪ Provided we are careful in our approach, access to UK Group Relief for 2010 onwards … This is equivalent to tax relief of c£800m. Even discounting this to reflect the fact that the losses cannot be utilised immediately, the benefit remains very significant”

• Immediate incremental capital upside to MTP … this would be in the order of c£800m over the period of the MTP

Disadvantages of revised strategy

• Higher potential impairments but considered to be modest risk because will be keeping a BSU in Ireland for the foreseeable future

▪ Execution risk of winding up full service Bank is high given the complexity of BOSI

▪ Regulatory considerations [would require regulatory approval from both regulators]

▪ Further colleague attrition on the appointment of the liquidator … While this is a very real risk the current state of the Irish economy means that this should be less of a risk than it otherwise would normally be due to lack of alternative roles for colleagues.

If you think that this proposal has merit, the next step in the process would be to do a full feasibility study of what would be required. This would involve setting up a project and bringing in subject matter experts from Group Finance, Group Tax, Group Risk and Group Legal. It would also involve bringing some of our senior colleagues in Ireland into 'the inside' so we could evaluate the risks and benefits more effectively.”

24 May 2010

Email from AK’s PA to MH, GS MS, SC subject “BOS Ireland – alternative strategy note”

“Another update paper for Tim. Can you let me have any further thoughts tomorrow please?”

25 May 2010

E-mail from MS to Sian Hill, KPMG – Subject “M&S Group Relief” stating that the “latest plan that W&I are considering is a transfer of most of the BoSI operations to the UK and liquidating BoSI. There would be a branch of BOS plc, but it would look nothing like the current operations”. Telephone call requested to discuss KPMG’s experience of large M&S claims and likely HMRC response. MS confirmed that “although there are commercial drivers for reorganising the operations in this way, because of the size of the losses I am concerned that there is a danger that the tax benefits could influence the decision making process and HMRC might try to argue that tax is one of the main purposes of reorganising BoSI in this way.”

E-mail from MH to AK, GS, MS and SC – subject “RE: BOS-Ireland – alternative strategy note”

“… next more detailed stage of process…will complete under the new code name of Hermes”

I see that you have relegated the TRS to the detail at the end – I presume that this is on the basis that the proposal you set out is preferable as it gives us access to the 2010 losses. Not sure on what the lead time for the TRS is but I would guess if we could get that in fairly soon it would move the losses from Ireland to BOS from the date written? Would still caveat that we need to work through numbers etc. … All numbers will be caveated until we have done the more detailed piece of work!”

E-mail RMG to SCK and DC – subject “Project Hermes”

“I have prepared an early draft. It may need to go out as a formal memo but we can address that later. … (not sure what is driving the timeline) …”

Steve – SRS asked me to set up a meeting with Graham Allatt and Richard Dakin tomorrow to discuss UK BSU management of BOSI assets.”

Draft Memo to CS, TT and TTO: Feasibility Review – Closure of BoSI (Project Joyce)

“Proposal

In view of the difficult trading conditions encountered, and an inability to offset trading losses against Group profits, the proposal is to withdraw entirely from the Ireland market. The Irish legal entity would be dissolved and the assets transferred to the BOS/Lloyds TSB Balance Sheet, subject to advice. This action would enable the Group to benefit from past losses to the extent of £xbn (Group Finance to quantify).

A core BSU presence (c100 FTE) would be retained in Dublin. The Good Book and elements of the stressed book would be managed from the UK

Potential issues to be considered:

Accounting treatment/Tax and Legal - proposed course of action to be investigated and confirmed.

Regulatory Compliance - the proposal and the underlying TCF considerations would need to be discussed and approved by the Irish Regulator.

…

Impairments - the transfer of assets should not have a material impact upon the quantum or phasing of forecast Impairment charges.”

26 May 2010

E-mail from GS to AK, MH, MS and SC – subject “BOS Ireland – alternative strategy note”

“Alan, I only managed to look at this late last night. I have comments and would like to discuss these with you. I think Moira left you a voicemail last night.”

E-mail reply from AK to GS saying MS has left AK a voicemail about comments on the alternative strategy note:

“I got the gist of it from Moira’s message last night. If you or Moira want to tone it down that would be fine by me. I guess you guys are even more sensitive to tax related papers than Tax were in my day!”

E-mail from SCK to RMG – subject “Project Hermes”

“draft attached – made a few changes. Ready for your to fwd to Stephen & Davis with covering note”

E-mail from RMGG to SRS – subject “Project Hermes”

“As discussed, I have attached a first draft of the proposal … we are attempting to arrange a meeting for tomorrow.”

27 May 2010

E-mail from GS to MS – subject “Ireland – How are we going?”

“Did you manage to speak to Alan today?”

E-mail reply from MS to GS – subject “Ireland – How are we going?”

“Yes. I sent a txt to you (maybe should give up on that form of comms hey!). He seems to understand things and will be doing another note. I made it clear that tax cannot be a main driver and I believe that he’s got the message.

He’s not in a hurry anymore and he’ll send a new note for us to put a tax note in next week”

30 May 2010

E-mail DC to GS – subject “Project Hermes” without text forwarding the updated memo now headed “Feasibility Review – Closure of Bank of Scotland Ireland (Project Joyce)”

TT’s handwritten undated note headed “Finance” in which Project Hermes was discussed. The note records

“b)

Ireland – Biggest issue incurring losses – tax relief loss.

Project Hermes [illegible word].

Voluntary liquidation – to release this £1B

Execute Memphis, then…

Maybe an external solution - ? Alex P said

Bring Joe Higgins in.”

June 2010

June 2010 – BoSI Executive Summary for W&I Division Risk Committee

“The implementation of the BSU is the key driver to improving asset quality.

…

Legal and Regulatory – Movement to “Green” will be facilitated by the following … fact that our business going forward is “lighter” relative to regulations, given exiting of Retail and Intermediary Business.”

There are no significant pipeline regulations impacting on BoSI. The exiting of the Retail and Intermediary business reduces the impact of new regulations on the Bank.”

3 June 2010

Email from Deloitte to AK – subject “LBG Ireland (Draft v1 2 June 2010) attaching an updated Deloitte paper

“Alan, here is a draft of the tax position. In summary, based on current position of M&S, you should be able to get group relief following MVL. Couple of caveats, latest judgement in M&S due soon ( though unlikely to affect analysis on the 'no possibilities' test) and secondly we would need to make sure that the losses didn't transfer to an Irish branch of BOS PLC. To a large extent this depends on what you intend to do in Ireland following the MVL. I have assumed it’s a manageable risk, ie we could structure whats [sic] left to be an admin function only etc”

Deloitte – Draft Paper for Discussion Purposes – “BoSI Losses/Closure” dated 3 June 2010:

“Background and scope:

Further to [18 May 2009 Deloitte Note] …

Update on potential for the surrender of BoSI tax losses to UK tax resident companies in LBG; and

Possible Irish permanent establishment risk following the closure of BoSI;

…

Executive Summary

Assuming that BoSI will be liquidated in 2010 it should be possible for LBG to submit a claim for group relief of the losses incurred by BoSI in 2010 to be surrendered to other (UK resident) entities in the group.

…

It is possible that LBG will have a PE following the closure of BoSI assuming that it has staff located in Ireland who are actively engaging with customers

…

If an Irish PE exists following the restructure, it will be necessary to review the Irish tax position for the historic BoSI losses. If these losses can be transferred to the new PE and utilised against the future profits of that PE then it may be difficult to make a group relief claim for these losses. … were BoSI to be put into liquidation by the end of 2010 then LBG should be able to claim group relief suffered by BoSI during 2010

…

Irish Permanent Establishment Risk

… where the nature of the activities carried out in Ireland by the Bank go beyond marketing and the provision of information to existing/potential customers it is likely that a PE would exist … If an Irish PE exists then it will be necessary to review the Irish tax treatment of the BoSI losses on the transfer of the BoSI assets/business to the Irish PE of the UK Group. If under Irish tax principles part or all of the BoSI losses can be transferred to the Irish PE and utilised against future profits of that PE then the “no possibilities test” may not be satisfied and it may not be possible for BoSI to surrender those same losses to the UK group.

That said, it may be possible to structure the re-organisation of the BoSI business to either avoid the creation of a PE or have a PE that carried on a different business to that of BoSI such that the BoSI losses do not transfer to the new Irish PE”

Email from SC to SRS copied to MW and TTO – subject “Hermes”

“Mike and I discussed Hermes with Tim today and agreed we need to broaden the work out to be more strategic in nature.”

At the moment we have started with Alan’s great idea about how to capture Euro 1bn of value for the tax losses which are currently unrecognised… It seems to us though that we need to explore a number of different strategic options for the business simultaneously.”

In view of this Tim agreed to widen the scope and include Joe Higgins in the project team.”

We would suggest a steering group consisting of me, Mike and Joe with Alan (and any others?) in attendance as appropriate. We would like to have made material progress this month not least as we have our audit committee deep dive on July 1 and Q2F challenge just ahead of that.”

4 June 2010

E-mail from TTO to ED copied to TT and MW – Subject: “Australia and Ireland”

“I met yesterday on Aus and Ireland with Alex and Mike Wooderson etc.

We agreed that full exit strategies should be prepared for both territories with the focus being on deliverables within one month.”

June 2010

BOSI Business Review paper by Mike Wooderson dated June 2010

“We need to revisit strategy for Ireland: Whilst we intended to revisit the strategy in 2011/12, other external and internal factors will force us to revisit the issue sooner. … The intention was to revisit the options in 2012 but MTP plans shows we retain business in Ireland for longer term.

…

Recent concerns re PIIGS countries, means there will be ongoing pressures to re-assess the position; (2) Market pressure to clarify core and non-core business in line with approach RBS have adopted; (3) The scale of the impairments on the Irish book…mean that there will be pressure to make clear what is happening in Ireland…and when; (4) Sustained pressure for deposits in Irish market means local pricing is above Group appetite which has led to steady reduction in BoSI funding and increase in LBG funding

[Four options set out with advantages and disadvantages]

Announce plans to Exit – disadvantage is that “unable to utilise tax losses” because 2010 announcement not exit. Advantage is “Allows LBG to make intentions clear to market”.

Full Sale/Exit – Not feasible given requirement for initial discount on sale. Very unlikely there are interested buyers.

Tax benefit enhances benefit but reduces timescale for an exit – The work on accessing the Irish tax losses has a very tight timescale for delivery with September announcement and December implementation.

Key questions that we need to get clarity on asap. (1) How important is it that we secure the tax benefit in 2010? (If important then we must implement this year. If less important, we could take risk on legislation and complete transaction in 2011). (2) If this is really important, can we agree that all work on BoSI sales/books disposals will be deferred until 2011? (3) Can we retain BoSI staff in an LBG subsidiary (option 2) without losing or reducing the tax benefit? (4) If this is possible, then what is our preferred option for servicing the book?

The tax work to date has identified that a MVL before year end is the clear preference. … The intention is to use the next 2 – 3 weeks to do the detailed planning work”

8 June 2010

E-mail from NMC to AK subject “Re: Meeting next week”

“Alan, I expect one of the drivers on timing will be tax capacity in UK for 2010. Do you have this? Greig will I’m sure. Would be useful to see it, at meeting on thurs or even before better”

E-mail from MS to AK and NMC confirmed £2bn capacity in 2010 with MS confirming:

“It will displace the losses that BOS is group-relieving to the rest of group, so will increase BOS losses c/f. Alan’s aware of this impact and knows he needs to do a NPV calculation”

E-mail from AK to JH Subject “FW: MEJRG00l - LBG Ireland (Draft Vl 2 June 2010)” forwarding Deloitte paper:

“This is the summary of the tax position. To be confident of claiming losses for 31/12/10 we need it to be in liquidation by end of the year”

There is a bit of a debate whether UK rules allow claim if put into liquidation after that … We can certainly ask the question of Deloittes [sic] but for safety they will want us to plan for 31 December 2010.”

9 June 2010

E-mail from JH to AK copied to NMC subject “LBG Ireland..”

“LBG will need to use the services of some business with a material presence in Ireland (i.e. not just marketing) to service and collect these loans. The current plans show a much bigger operation managing the Corporate and Commercial customers than managing the retail customers.

[Identifies options for structure: fully owned LBG subsidiary (BOSI or other); an Irish branch of LBG; a Irish company in which LBG has a majority but less than 75%); or an outsource company in which LBG has a small (10 – 15%) to no shareholding. It notes that the first two options create a problem as a PE in Ireland to which the BOSI losses could be transferred. Queries if the third option breaks the tax grouping and considers fourth option should be possible in timescale]”

NMC’s reply confirms options 1 and 2 do potentially present problems and would require “much further consideration”.

E-mail from JH to NMC asking to confirm that options 3 and 4 would be acceptable from a tax perspective and would “either be a “better” or safer option?”

E-mail from NMC to JH and AK – subject “LBG Ireland…”

“Joe, one of my concerns, which i haven't bottomed out fully, is losing the ability to group relieve losses in the UK because you have actually structured the position Ireland to ensure that losses don't carry over. for this reason i'm a bit nervous about option 3, as its optics aren't great, ie it looks like you are trying to be clever and avoid a 75% group . therefore i think 4 looks better, however its clearly a commercial decision and the tax tail shouldn't wag the commercial dog.”

10 June 2010

Meeting between AK, MS and JH and Deloitte re BOSI and tax planning at which Deloitte presented their “BoSI: Tax Analysis and closure options” slide presentation. In advance of the meeting Deloitte sought information about LBG’s tax capacity.

Deloitte presentation – BoSI: Tax Analysis and closure options

“This document has been prepared in order to facilitate a discussion with LBG on the potential for surrendering tax losses from BoSI to other LBG entities which are tax resident in the UK. The document also highlights issues to consider associated with managing and controlling the proposed close down of BoSI.”

The presentation notes that when the Retail closure was announced: “A commitment to a continued presence in corporate and commercial business was indicated”:

“In May 2010 Deloitte Tax were asked to consider the tax position of BoSI and, in particular, the potential for the surrender of Irish tax losses to the UK resident members of the LBG group and the possibility of a PE tax risk following the closure of BoSI by the end of 2010.

We understand in addition to the tax considerations there may be commercial and strategic issues which will impact a closure by the end of 2010. In this respect timing and trading issues, such as the transfer of loan portfolios and management of the legacy business will need to be considered.

…

Tax objectives

Tax issues

A managed exit from Ireland involving the announced closure of the BoSI retail business and the run-off of commercial lending from BoSI could result in substantial Irish tax losses being lost [i.e. the previous/current strategy]

The following slides outline a strawman exit strategy which may be capable of generating value from current year BoSI losses through utilisation against LBG’s UK taxable profits in 2010.

…

Cross border utilisation of tax losses is very limited under current UK law (see Deloitte draft tax paper of 3 June 2010) and will likely require an expedited members voluntary (solvent) liquidation of BoSI to have commenced before the 2010 year end in order to demonstrate “no possibility” of utilising the losses in Ireland in any period.”

Consideration is then given to issues to be considered and potentially implemented by the end of December 2010 in order to be able to surrender Irish losses to the UK group and identified two options: a Solvent Liquidation or a CBM. It noted that the CBM process is new and relatively untested. The Summary confirmed:

“Based on our high level understanding, a challenging though potentially achievable solution but one requiring substantial further analysis in key areas.

Key driver: (1) Exit Ireland by 31 December 2010; (2) Optimise LBG tax position; (3) Managed Irish exit to minimise value leakage.

Timing – Transfer of portfolios to LBG potentially achievable pre 31 December 2010 with external portfolio sales thereafter, or a managed run-off with a clean investor story.

…

Legacy business – Legal structure which avoids a permanent business; Management and control of run-off business (within or outside LBG)

Implementation: Solvent liquidation/EU merger option”

Next steps – Detailed option and tax feasibility analysis given time constraints and Legal input”

E-mail from SC to TTO – subject “Hermes – Quick Update”

“We’ve taken some advice from Deloittes [sic] on capturing the value of the tax losses through liquidation and are now reasonably confident it works. It’s worth up to £1bn to us.”

The issue will be implementation … as we have to implement by 31 Dec to capture the value from this year’s losses. Implementation is of course very complex as we need to be able to run off the portfolio safely and without destroying capital.

We will have to push through governance at pace to deliver and plan to come with a GEC proposal note in 3 – 4 weeks time. We’ll look to get you, Carol and I would think Mark onside to the proposals ahead of that but your support to help us push at pace would be appreciated.

We’ll need to engage Deloittes [sic] and lawyers for the next 3 – 4 weeks to ensure we have all our facts straight. Given the huge time pressure I’ve ok’d that subject to a sensible price.”

We have our Q2F review meeting on Monday and Alan and I can update you a bit more then.”

E-mail from RMG to AK – subject “Hermes”

“I have attached the draft memo that I prepared a few weeks ago. As you will see, it essentially takes your concept to the next level, by proposing the complete closure of the Irish operation.”

E-mail from NMC to MS and JB – no subject

“we should have a chat on Monday about this 2-3 week feasibility stage. It would be worth discussing what we would like to achieve and who does what.”

I was only half-joking when I said “not if you’re in tax’ to Gerry’s comment that it was good there was a 31/12 tax deadline!”

E-mail reply from AK to NMC subject “LBG Ireland (Draft V1 2 June 2010)”

“All joking aside I would put your people on standby for Monday if you can. I think I will get the nod tomorrow morning to do the three weeks intensive work!”

E-mail reply from NMC to AK

“Will do alan. Good to see you today. Really good meeting”

AK prepared an updated version of the ‘BOS Ireland – Alternative Strategy Note’. This version has a potential tax relief of “c£1bn”, previously it was £800m. References to retaining a BSU in Ireland replaced with reference to an “outsourcing arrangement with the third party” and the need “to avoid creating a new permanent establishment which would limit our ability to access the losses”. The reference to the risks of colleague attrition in BOSI was changed from “less of a risk… due to lack of alternative roles for colleagues” to “perhaps the biggest risk we face”. Added were “the time line is very demanding” and “There would be no scope to miss this deadline if we are to hit the end December end date” – both statements are in bold and underlined.

E-mail from SC to TT - subject: “Hermes – Quick Update”

“Very quick update…wanted to keep you right in the loop as I have steered the team towards a “get on with it and stop if GEC tell us to” approach as the timescales are so so challenging.

We’ve taken some advice from Deloittes [sic] on capturing the value of the tax losses through liquidation and are now reasonably confident it works. It’s worth up to £1bn to us which goes straight to tier 1 (at least until Basel 3).

The issue will be implementation…as we have to implement by 31 Dec to capture the value from this year’s losses which is about 2/3rds of the total. Implementation [the e-mail in the hearing bundle is incomplete]”

E-mail from MS to GS – subject “Ireland MVL” stating:

“Ireland is moving on at pace. It is clear that there is a move to change the current set-up for commercial reasons.

The latest long term solution being developed is to essentially run off all of the books. Marketing, origination and sales, will move to the UK, along with the assets/deposits. BoSI would then be liquidated (timescale = by 31/12/10), but we expect to have to make an announcement on this in August.

Outsourcing to third party would be preferred solution (over setting up new Co containing remaining operations) but has the danger of a forced deal, given the time pressure.

31/12/10 is obviously an extremely challenging timetable for all, but the team thought that it would probably be possible … If we do a MVL by then, this will obviously have the added benefit of falling within the HMRC guidance on group relief claims.”

E-mail from TT to SC – subject: “Hermes – Quick Update”

“Wow. Really appreciate the heads-up and, yes……you are taking the right course (with pace) and informing the right folks. If you keep Tim, Carol and me uptodate, the GEC, is, basically, “there”!.

I will discuss shortly with Tim, but thank you for your leadership on this and let’s keep current.”

Project Hermes Conference Call notes. On the call: SC, SRS, AK and JH. [emphasis provided]:

“It was agreed that we should assume that the decision was to complete the MVL by 31 December as, even in the absence of the tax benefit, LBG would prefer to be able to announce that it was exiting the Irish market and this was the best (or most realistic) way to do it.

The tax advice is clear that to be certain of accessing the benefit of the 2010 losses in Ireland we need to have a MVL appointed by 31st December 2010. There is the possibility that a current tax case will extend the application rules but to avoid tax risk and to ensure inclusion in the 2010 results, the 31^st December 2010 date is sacrosanct.

It was agreed that we would push Deloitte to give a firm tax opinion confirming that we "will" be able to utilise the tax losses rather than a "should" opinion.

…

Rather than wait for formal approval before commencing the detailed planning work, it was agreed that we would assume that the project was proceeding and engage with Deloitte and the Bank’s legal adviser’s immediately. (… spoke with Deloitte and also Arthur Cox … start-up meeting … agreed … Monday 14^th June)

…

The straw man proposal was discussed and it was agreed that for the basis of the initial assessment we would use the indicative timeframe in the papers for the meeting (GEC initial approval early July, Announcement September, Implementation December).

…

The factors to be considered in assessing the options were minimising the execution risk (to ensure we secure the tax benefit).”

Consideration was given to four options on the possible approach to servicing and it was decided not to recommend servicing the portfolio entirely with UK because it would be extremely difficult to complete in the time available and would introduce additional risk on the collect out strategies. Servicing by BOSI staff working for a UK LGB subsidiary was rejected as the tax advice was that the losses would be linked to any PE in Ireland post MVL. Servicing by BOSI colleagues working for a new OpCo was the preferred option as:

“it avoided the PE tax risk and created the most positive story in the circumstances to maximise retention and minimise the collection risk. A suitable 5 – 7 year outsourcing agreement could be agreed with the new OpCo with flexibility to allow for subsequent asset disposals.

…

Given that timescales for completion were already tight, it was agreed that we should press ahead and abort if necessary rather than delay and potentially lose the option.

Assuming that there are no deal-breakers, and using the outputs from this work, we would then work over the following week to prepare a full project plan including financial assessment and risk assessment including mitigants. This could be socialised and incorporated into a GEC paper for circulation w/c 28th June consistent with the indicative timeline.”

E-mail from AK to MS – Subject: “Draft Note for Tim” with attachment “Ireland Alternative strategy (copy for MW GA and GR) (revised).doc. The document is a further revised version of the update and reference is made to it being “a more radical strategy that is not without its risks” and that there were a number of “disadvantages of revised structure” including higher impairments, execution risk, reputation damage and further colleague attrition”

E-mail from AK to NMC and MS subject “LBG Ireland (Draft VI 2 June 2010)”

“I was speaking to Moira on Friday [11 June] and we may only have 2bn of capacity in 2010. This is the bare minimum we would need as I assume when we transfer assets out of BoSI to bos pre liquidation at market value we will crystalise more losses than we are currently showing.

If we do is there a possibility of making a terminal loss relief claim in ireland. In the current circumstances how will we come to a view of market value? What about post cessation costs”

14 June 2010

E-mail from MS to NMC – subject “LBG Ireland (Draft V1 2 June 2010)

“Another thing for the call agenda will be the anti-avoidance clauses. In particular, at what point does a tax figure that appears in a business case turn into a main purpose in the eyes of HMRC?”

E-mail from NMC to MS – subject “LBG Ireland (Draft V1 2 June 2010)

“It is critical that this is a commercial decision as to the most effective way to extricate LBG from Ireland and that the tax analysis follows. This is true both of the liquidation and, critically, what is left behind. Speak at 1.30.”

E-mail from MS to GS – subject “note for Sue re Ireland”

“Draft note as discussed …

Sue

We have recently had a discussion with Deloitte in respect of the potential liquidation of BoSI. We are concerned about the anti-avoidance rules and how they may impact any claim for group relief in respect of the BoSI losses. It is important that we can show that the commercial decision to withdraw from Ireland completely was made before the decision to explore the current liquidation option. In order to claim group relief, we need to be comfortable that the ability to claim group relief is not one of the main purposes of the liquidation. To help substantiate this claim, access to the strategic documents relating to Ireland would be very useful. Please can you let me know whether you have been privy to any such documents, either exploring or recommending the option of a complete withdrawal from Ireland.”

16 June 2010

Memo from Arthur Cox to Project Hermes Working Group – Subject IRLCO/UKCO

“We refer to our recent discussions, in relation to the proposal to transfer the assets and liabilities IRLCO to UKCO; the revocation of the banking licence of IRLCO; and the establishment of a NewCO to service the relevant assets on behalf of UKCO (“OPCO”).”

The paper set out observations in respect of both a s33 transfer and a CBM by reference to the advantages and disadvantages of each method, the timings of each method, including that a s33 transfer is likely to take at least 4 months or more. Appendix 4 set out “Issues to be considered in determining whether an entity is providing the services through a permanent establishment in Ireland”.

E-mail from SM to MW, SC, AK, SRS, JH, MA (Deloitte) and others– subject “Hermes Steering Group Papers” for meeting on 18 June 2010. The draft GEC BOSI Project Hermes Draft paper dated 18 June 2010 is summarised as follows:

“The purpose of the paper was to seek approval in principle to close BOSI and cease trading as a regulated banking entity in Ireland and to enter into an agreement with an independently-owned servicing entity to work out the remaining loan book and “to plan and execute to an accelerated timetable to achieve closure by year end”

The paper set out in detail the commercial problems faced in the group’s Irish operations. It noted that “Withdrawal options fall into two broad categories – change of ownership and wind-down. While options in the former category (sale of the BoSI business, sale of the assets, joint venture with a third party) would potentially deliver significant benefits, we do not believe that there are buyers/partners in the market who would engage at acceptable valuations.” The footnote after “acceptable valuations” states there have been discussions with “a number of parties who expressed interest in buying asset portfolios but they were seeking significant discount”.

The paper considered that “wind-down” was the best option and suggested that the only way forward, under the “wind-down” option, was to exit the Irish banking market, which might be achieved in one of five ways, which were listed as being:

Option 1: Wind down the business in the current structure. This was considered to have the lowest transaction risk but it was stated would need incentives to retain staff and was assessed as not sending a clear message to the market about exiting Ireland. It was also noted that under this option “Tax efficiencies unlikely to be realised.”

Option 2: Transfer the business to LBG and manage the wind-down from the UK. This was dependent on UK resources and it was considered that remote management of the Irish loan book posed a risk to the value of the assets. “Delivery of this option in the current year is unlikely”

Option 3: Transfer the business to LBG by means of a cross-border merger (CBM) and manage wind-down via a LBG-owned Irish servicing entity staffed by current BOSI staff. This was considered to give rise to increased risks to tax efficiency as compared with Option 4. Concern was expressed that the Irish service entity, owned and controlled by LBG, might be treated as carrying on the same trade and its income deemed available to enable existing losses to be set against that further income.

Option 4: Transfer the business to LBG as in option 3, but manage the wind-down via an independent entity staffed with ex-BOSI staff. This was considered to improve the probability of achieving tax efficiencies, would send the correct message to the market and meant that the entity could seek business elsewhere improving staff retention and motivation. This was the option that was chosen with a significant advantage identified as “Potential tax efficiency benefit of [£1.2bn].”

Option 5: Transfer the business to LBG and manage the wind-down via a third-party provider. This was not considered desirable as it would require using several different providers and could not be achieved by the end of the year.

The paper noted the two legal mechanisms by which Option 4 might be executed were (i) a s33 Transfer under Irish law (the 1971 Act) and (ii) a CBM by which the Irish entity could be absorbed into an existing LBG regulated entity in the UK. The paper recommended use of the CBM. Appendix 2 to the Paper recorded as a “Con” that even if a s33 Transfer were possible by the end of 2010 “it increases the risk around the delivery of tax efficiencies”.

Under the heading “Tax Efficiencies” it was stated: “If the transfer of the business and the closure of BOSI can be achieved before 31 December 2010 it may be possible to obtain group relief benefit of up to £1 billion for LBG from the estimated 2010 and the forecast future tax losses associated with the BoSI business.”

18 June 2010

E-mail from MA (Deloitte) to SM, MW, SC, AK and SRS – subject “Hermes Steering Group papers” setting out Deloitte’s initial observations “based on an assumption that LBG do in principle want to exit Ireland rapidly”:

“This week the team has discounted the use of a Section 33 transfer followed by an MVL as this raises a significant number of legal and operational issues which we believe would make it very unlikely that the balance sheet would be clean enough by 31/12/10 to be able to claim that the business is no longer trading. Focus has therefore moved to the Cross Border option. This appears to be a more effective mechanism to provide for a closure/cessation of trade at BoSI by 31/12/10 … The provisional timeline prepared with Arthur Cox (Irish legal advisers) indicates that it is just possible to achieve a Cross Border Merger by the end of the year… Arthur Cox are progressing this with some urgency.

Any timetable to deliver an exit from BoSI by the 31st December 2010 is extremely tight; however the benefits (although not fully validated) are potentially very significant.

…

Further work would include an assessment of 3rd parties able to provide services to the business in part or whole, and or the most effective ownership and staff incentivisation structure to meet the Group's overarching objectives (including effective management of the BoSI assets and tax efficiency).”

Call at 13.30 between Project Hermes Steering Committee team attended by Deloitte. No record or note of the call is in the hearing bundle.

E-mail from AK to NMC copied to MS – subject “Re Ireland”

“I take it you have seen the paper prepared by Joe …We need to think about how much of a tax risk 3 is in comparison with 4. A great deal of nerves about outsourcing to an mbo in terms of how it would be perceived hence the work!”

20 June 2010

E-mail from NMC to AK cc’d to MS – subject “Re Ireland”

“I saw a draft of Joe’s paper. Asked for a couple of references to tax to be deleted. Will track down final version. Moria when are you around to discuss.”

21 June 2010

Meeting between BOSI and the FR. Issues discussed included the Control Framework, impairments, Project Memphis, funding and liquidity and “the future direction of the Bank”. In response to the FR’s question about LBG’s view of Ireland and “whether the commitment was there from Lloyds”, JH “reiterated the capital was forthcoming and we were reviewing the structure of this”. The meeting notes record:

“ME queried whether BoSI was actually in wind down given limited appetite for new business. JH noted that the business strategy was always under review as part of the regular planning process, there had been no change in the strategy announced in February. This stated that we would focus on Commercial and Corporate business, close our retail and intermediary business and runoff our CRE book.”

22 June 2010

E-mail from SM to the PHSC and Deloitte subject “Hermes – Updated Paper 1” attaching “Memo to Steering Group 22 June 2010” and “Hermes Draft GEC paper 22 June v2”. The Hermes draft v2 dated 29 June 2010 contained the following changes:

E-mail from MS to JH copied to AK & JB – subject “Hermes”

“many thanks for the paper that you have sent …we have discussed the content, along with a brief update from Deloitte … We would prefer that the third bullet point in Section 5 [Tax Efficiencies] is removed, as it could be seen as giving more emphasis to the tax benefit than is the case”

Further GEC BOSI Project Hermes paper dated 29 June 2010. The key changes from the 22 June version are:

Further Updated GEC paper on BOSI – Project Hermes with the main change from previous version is TT is now the sponsor and SC the presenter.

E-mail from AK to MS and JH copied to JB cc’d to Jon Breaks – subject “Hermes”

“Can you provide guidance for us on what would and would not constitute a pe. What the key indicators and pointers would be? We are working with a blank sheet of canvas so to a certain extent we can make it what it needs to be?

I hear the point re market value … can we argue for a value that suits us and is tailored to the tax capacity that we can use?”

E-mail from JH to AK and MS (cc’d to JB) – subject “Hermes”

“A lot of work ongoing with this with Coxs … believe we can recommend an approach that giv[e-mail cut off] change of solution”

24 June 2010

E-mail from AK to JB copied to MS, NM and SC – subject “FW: GEC paper 29th June – Project Hermes”

“Jon. This seems to be the final paper. A few questions to ask. The way it is drafted does it give us a problem with the “one of the main reason” test [sic]. It is really difficult not to mention tax in the paper at all given the nature of decision we are looking at here but the size of the risk will depend on the way the courts interpret the legislation on the point? The key point to note is that we would withdraw from Ireland whether we got the benefit or not which I would have thought would be a [sic] strong evidence in our case with the Revenue. Would it be helpful to have this documented at the GEC meeting? Are you involved in getting further clarity on this PE point. There must be a way around this?”

E-mail from Hilary Scott (Group Tax) to MS – Subject “Losses”

“Just got your message. Our transaction may generate up to £1bn of losses in bos legal entity … Therefore by crystallising the losses in bos in the current year we should not be adding to the deferred tax asset … Our transaction is being deferred to the second half of the year and is not certain to proceed”

E-mail from MS to JB – “FW: Losses” forwarding the email from Hilary Scott

“FYI below. I’ve asked her to confirm my understanding (see attached)”

“Group relief – confirmed that BoSI can only surrender as much as UK group can claim…. There is something else that we may need to be careful of when we are looking at tax capacity – we may need to make sure that the trade ceases on 31/12/10 and not before if we are to be able to surrender against the full year UK profits…. for the purposes of the memo, we could just say that we assume trade to cease on 31/12/10.”

25 June 2010

E-mail from MS to JB copied to GS – subject “Hermes update for Sue” with suggested wording for an update to send to SH about Hermes:

“Suggest the following … given things are likely to move further today, it may be best to delay a little before finalising:

A GEC paper to present the various options for the future of BOS Ireland is currently being finalised…. Substantial work has been undertaken on non-tax aspects of the proposals and Group Tax has commented on the paper…. Potential tax efficiencies from the group relief of Irish losses can only be confirmed once the future operational model has been finalised. Group relief will be denied if one of the main purposes of arrangements is a group relief claim. ... Hence we have to ensure that the tax analysis is not a main driver in the decision making process. For this reason, Group Tax are currently holding off getting detailed Irish tax advice on the impact of the continuing activities. This should ensure that proposals are not deliberately structured in a way that guarantees a successful group relief claim.”

E-mail from JB to AK and JH copied to MS & GS – subject “Hermes – GEC paper” (flagged high importance)

“ … My feeling is that we need to tone down the quantification of tax benefit in section 4 for the paper that is presented. Up to £1bn is optimistic and there are a number of transactions in place that may or may not proceed that could well impact on capacity in H2 2010. A verbal briefing during GEC would work … I’ve spoken with Deloitte also who feel it is too bullish and not enough consideration of downside. Can we have a call this pm to discuss please…”

E-mail from JB to MS copied to GS) – subject “Hermes update for Sue”

“Looks good – subject to my nervousness around the quantification used in the paper. I suspect we’ll move on this this afternoon. But I’d prefer to have a verbal discussion …”

E-mail from JH to JB and AK copied MS & GS – subject “Hermes – GEC paper”

“The paper has issued [sic] at this stage. I can flag to Mike and Steve who are presenting the paper that, depending on our transactions, there may be an impact on 2010 capacity (although we should still be able to use the benefit over the longer term and would be able to recognize the deferred tax asset in the current year?)”

Draft Memo from Arthur Cox to Project Hermes Working Group – Subject “SERVCO/UKCO” [emphasis provided] stated:

“Based on the structure discussed to date, we have considered below the risk from a regulatory perspective that UKCO will be deemed to be operating in Ireland through a permanent establishment and therefore be required to operate as a branch under the re-cast Banking Consolidation Directive.

In order for UKCO to provide services in Ireland, it will be required to passport its banking license into Ireland… However, there is a risk that the operations of SERVCO in Ireland will result in UKCO being deemed to have a permanent presence in Ireland… The ultimate determination of whether UKCO has a permanent establishment in Ireland will be made by the Financial Regulator and the FSA.

We have set out below possible steps to be taken to minimise the risk of SERCO constituting a permanent establishment of UKCO. None of these steps provide a guarantee of success but are designed to try to address issues which are likely to be raised…”

SERVCO must not have a permanent mandate from UKCO

SERVCO cannot be subject to the management and control of UKCO

To make the best possible case on this, the following steps would need to be taken [lists items like having its own management structure and not being subject to control from the UK]

SERVCO cannot commit UKCO

Conclusion

For the reasons outlined in sections 3 and 4 above both regulators are likely to have concerns on the issue and there are no guarantees that the case made for them will be successful… We have flagged in section 3 above some of the areas which could be addressed to enable the best case to be made …”

26 June 2010

E-mail from SH to SC subject “Hermes”

“Having enquired I understand that the Tax team did not sign off the paper on Hermes that went to GEC. They had seen an earlier version but the final version did not reflect their comments in total in the round.

The essence is that any decision re Hermes is strictly a commercial/strategic decision. Following the decision the tax consequence will flow subject to analysis. In respect to these and assuming the decision is in line with the commercial recommendation there will need to be a discussion with the UK and Irish tax authorities and its not clear that the potential benefits outlined in the paper will be realised. The Group tax team need to have sole 'jurisdiction' to opine on the tax analysis both from a corporate perspective and to ensure strong, transparent relationships with HMRC. We are contemplating whether to send Tim a mail [sic] drawing out the tax matters more distictly [sic] pre GEC and I wanted to give you the heads up. Given the strategic rational as I’d read the paper to take the action in line with the recommendation it seems a sensible route forward. If so tax analysis will follow.”

27 June 2010

E-mail from SC to SH – subject “Hermes”

“Useful thanks – let’s chat as I was under the impression they had signed off. Clearly must make sure we don’t mess up.”

28 June 2010

E-mail from GS to TTO copied to SC and SH subject “CONFIDENTIAL – PROJECT HERMES” attaching GEC paper – Project Hermes – 23 June.doc

“The attached Project Hermes paper is being presented to GEC tomorrow. We have been working with Steve’s team on the proposal and I want to make sure that we are absolutely clear on the rationale for this and avoid any ambiguity over the significance of the tax consequences which will follow a GEC decision to support the action proposed. There is a pressing need to take corrective action over Ireland which is intensifying as we progress through 2010. GEC is being asked to take the strategic decision to close the Irish business by liquidating BOSI. If that decision is taken and we are able to meet a challenging timetable for closure during the remainder of 2010 there would be a number of commercial advantages and there may also be an opportunity to optimise the tax position. However, the key point here is that it is only when the GEC decision is taken to withdraw from Ireland that the question of the timing of this and the possible tax impact of an accelerated timetable will be relevant.

We have carried out the preliminary tax evaluation possible within the time available and we have discussed this with Steve's team. However, this should not be confused with Group Tax having signed off on the figures quoted in paper. There are a number of factors which will need to be considered in greater detail before we are in a position to determine the tax outcome. We will engage on a transparent basis with the UK and Irish tax authorities on Hermes on a real time basis, in line with our current open relationship with both and I know that Susie has asked you to mention the Irish business situation in your update with Dave and Melanie this week.

We have flagged the following points to the Hermes project team and highlight these for your information also:

1.

The figure quoted in the paper for the potential group benefit for the ability to utilise future losses on the Irish loan book is in our view very optimistic. It is not certain that we would have sufficient tax capacity in the UK to absorb additional losses and be able to recognise a deferred tax asset. We would therefore recommend caution in viewing the figure quoted.

2.

There will be a significant tax valuation exercise required on the Irish assets and liabilities transferred to the UK. This will be an arm's length valuation and by its very nature will involve negotiation with the UK & Irish tax authorities. Valuations will be within a range and inevitably this will take a long period to agree so it is very difficult to predict where we will come out.

3.

Any future upside upon a recovery in the Irish assets transferred to the UK will be subject to UK tax. This is not in our view adequately covered in the GEC paper.

4.

The historic tax position relating the BOS guarantee arrangement in favour of BOSI is still to be agreed with HMRC. We have had an indication of HMRC's willingness to come to a reasonable agreement (Nil adjustment) in respect of the historic position on the condition that there is no attempt by LBG to gain an unreasonable tax outcome in terms of the long term solution put in place for Ireland.”

E-mail reply from TTO to GS copied to SC and SH

“… I have seen the gec paper. What happens to the existing tax losses in Ireland – are they lost?... How does the tax benefit (whatever its size) arise at all? Please describe it…”

E-mail reply from GS to TTO copied to SC an SH

“… In answer to your first question, yes we could end up getting no relief for the losses in Ireland (if we discontinue the business there) and following the transfer of the Irish assets to the UK and a turn around the upside being taxed in the UK. We may also be able to get some relief in the UK for the existing Irish losses (these relate to 2009) under the principles established in the EU courts by Marks & Spencer… However, the problems we have with a claim is the lack of certainty and the time it will take to pursue this… On your second question the potential benefit is being highlighted in the paper is in respect of the potential ability to offset 2010 tax losses on the Irish assets against UK taxable profits in 2010 and future years.”

E-mail reply from SC to GS and TTO copied to SH and SW

“Though just to be clear the prospect of us getting value for the losses in Ireland is effectively zero too. And the likelihood of an upturn very unlikely – key is getting the assets transferred at sensible value”

E-mail reply from TTO to GS and SC copied to SH and SW

“Sounds important to get assets tfrd at high value!”

E-mail from SW to TTO, SC & GS copied to SH

“HMRC will be looking for low value, so we need to ensure that our valuation is robust …”

Email from TTO to SW, GS and SC copied to SH

“Obviously the main issue is that there is no third party buyer so if hmrc push for silly low valuations then Hermes may be unviable”

29 June 2010

LBG GEC attended by ED, TT, TTO, SC, MW & SH. [SC, MW & SH attended to present the GEC paper on Project Hermes]. The minutes record:

“Project Hermes

Steve Colsell presented a paper setting out a proposal that the Group should close down [BOSI], and should cease trading as a regulated banking entity in Ireland. The decision for BOSI to exit the retail and intermediary business in Ireland had been announced in February 2010. At that stage the intention had been that BOSI should continue in business, focussed on corporate and commercial banking. A number of factors now made it appropriate to revisit strategy for BOSI. In brief, withdrawal from Ireland was now considered the optimal option for the Group, which could bring significant organisational and financial benefits if completed in 2010.

Mike Wooderson commented on the background to the proposal, with respect to:

▪ the core strategic question of whether or not the Group was committed to BOSI. The non core nature of this business; the fact that it was projected to be loss making for the next several years; the fact that it would be a net consumer of funding from the rest of the Group; and the likelihood that this business would fail to meet return on capital and return on liquidity metrics, all supported the recommendation that the Group should seek to exit this business;

▪ timing where, given the strategic imperatives, an exit sooner rather than later was believed to be the best course of action. Closure by the end of the year could offer several advantages.

▪ The fine details of the approach, which did not need to be agreed at this stage, …

The proposed timetable was challenging. A detailed plan would be brought to the Committee on 28 July, covering cost-benefit analysis; legal and regulatory issues; customer and colleague implications; and a project risk assessment. There were significant legal and regulatory hurdles that would need to be overcome, as well as not insignificant potential execution and reputational risks.

Whilst a sale of the business was a hypothetical possibility, it was not believed that there were any buyers likely to be interested in acquiring this business at a sensible valuation.

Following a review of various options, it was therefore now proposed that the best option was to transfer the existing BOSI books of business to a UK LBG subsidiary, and to enter into an arrangement with an arm's length independent service company who would be engaged to manage the run down of the portfolio. Involvement of current BOSI colleagues in the run off process would be critical. The possibility of appointing an arm's length service company owned by the BOSI management team was an option that was being considered. That approach could potentially improve motivation and retention of the management team, and optimise the eventual outturn.

The Committee agreed in principle to support the recommendations to:

▪ Close [BOSI] …

▪ Transfer BOSI’s assets and liabilities to a Group UK subsidiary;

▪ Examine the best approach to the run down of the BOSI books of business; and

▪Seek to achieve closure by the year end.

…

A further report would come back to the Committee on 28 July.”

Deloitte Memo – “Project Hermes – Summary Tax Analysis – Draft 29.6.10” to Group Tax is summarised as follows:

“Introduction - The proposed closure of BOSI via a cross border merger as outlined in the GEC paper of 23rd June is a complex transaction which will give rise to a myriad of UK and Irish tax considerations. This paper discusses the major tax considerations arising in order to assist management in understanding the tax profile of the transaction in terms of the potential risks, costs and value for tax attributes achievable. However, in a transaction of this scale and complexity there will be many points of detail in relation to the tax analysis that are bound to emerge in the course of implementation which could impact the overall tax benefits and costs arising.

Background - … The commercial and strategic background is discussed in the Group Executive Committee paper of 23rd June … As explained in the GEC paper, the legal mechanism currently favoured is a Cross Border Merger under which BOSI would be absorbed into an existing LBG banking entity in the UK …

Scope - … BOSI is 100% owned by Scotland International Finance BV ("SIF"), a Dutch holding company, which is 100% owned by BOS Plc. We consider the UK and Irish tax implications of a cross border merger of BOSI into BOS Plc. As a simplifying assumption it has been assumed that BOSI is moved under BOS plc prior to the merger. Legal and regulatory implications are outside the scope of this memo but the regulatory analysis in particular is likely to impact the tax analysis, as discussed further below. Our working assumption here is that post the merger LBG will have no regulated banking presence in Ireland to which the existing business transfers. The existence of a continuing regulated branch would make a group relief claim impossible. A service company (OpCo) will be engaged to carry out certain administrative and operational activities in relation to the legacy portfolio…

Executive Summary – Cross Border Merger” – “The CBM mechanism for achieving the closure of BOSI by 2010 year end carries a level of tax uncertainty which will need to be addressed with UK and Irish tax authorities in advance. In particular, the CBM tax rules are premised on a taxable presence remaining in Ireland post merger … a merger and closure of the Irish business effectively happen at the same time…. The group would therefore be taking the position that the CBM is not tax neutral and that Irish tax losses do not survive. The tax authorities may be sceptical of this outcome…

The ability to group relieve Irish losses therefore depends upon whether the business and operational plan for the run-off is consistent with the following: (I) There should be no banking taxable presence in Ireland post merger…

(II) The CBM mechanism should not have a main purpose of securing a group relief benefit. This is a question of fact and LBG management will need to be comfortable that the sole main purpose of the CBM arrangements is to effect the closure as rapidly and as cost effectively as possible whilst optimising the value of BOSI assets.

If there is an ongoing regulated presence… then the opportunity to take the BOSI losses in the UK will not be available as there will be a transfer and ongoing use of the losses in Ireland.

Option 4 (independent service company) provides a better starting point for a discussion of the PE issue.

Transfer Pricing of Loan Portfolio

The transfer of the loan portfolio to BOS plc under the CBM should be at fair value for tax purposes, which we understand is likely to be [c€2bn] below current book value. This will result in greater tax losses in Ireland which it will not be possible to group relieve or obtain economic value for [reference to technical group relief provisions in footnote]. On the UK side, the loans will be treated as acquired at fair value (which depending on the accounting for the merger may be below the value recognised by BOS plc in its balance sheet). Recoveries on the portfolio above fair value will be fully taxable in the UK even where no income is recognised for GAAP.”

BOSI – Project Hermes draft paper for GEC Sponsor/Presenter – SC and MW. The note states:

“This note represents an update on Project Hermes, together with a request for certain approvals which will enable us to make announcements alongside the Group’s half year results on the 4th August …”

“At this stage we are seeking GEC and subsequently Board approval to proceed to 1. Close [BOSI] … 2. Effect the closure by … the Cross Border Merger (CBM) legislation, with a view to complete by 31st December 2010”.

“We believe that there are a number of key strategic and financial reasons which point to a withdrawal from Ireland as the optimum option for the Group. Our overall aim would be to exit the Irish market as rapidly as possible in a cost effective way, whilst optimising the value of the existing BoSI assets and Group Tier 1 capital and minimising any reputational impact for the Group. The attached paper is drafted for onward submission to the LBG Board. [The attached paper largely repeated the previous GEC paper but included a timetable for current year closure.]

30 June 2010

BOSI formally closed its Halifax Retail and Intermediary business.

Undated and unaccredited documents titled “Draft and For Discussion – Hermes – TAX”. The location of the document in the hearing bundle would indicate it was prepared in June/July 2010. The draft variously stated:

“I’ve spoken with Deloitte (UK and Ireland) to join up the threads. There is a fundamental business decision it seems over whether this is do’able in 2010 vs deferring to 2011.

Clearly, there are commercial factors around pushing to complete sooner, such as liquidity, staff attrition, retention of key personnel etc which should drive this. FSA also seem keen for a swift resolution.

Reference was also made in this morning's call to a desire to announce to the market and analysts a course of action. If this is the commercial position, then the tax position should become secondary.

The risk of pushing through in 2010 if all other areas push back and say unachievable are two fold from a tax perspective: - execution risk, p.e. structure is less than ideal … tax becomes the main purpose and anti-avoidance kick in - HMRC opener would be why the rush to get through in 2010 and could probably scratch through a few of the higher level commercial arguments to cut to the fact that it was done at pace for tax and deny any relief.

3 vs 4 vs 5 – In our call this morning Susie and I discussed the relevant percentages of risk of avoiding the p.e. Option 3… we put this around 25%... Option 4… moves this risk of avoiding to around 75%... Option 5… we positioned this around 90%.

Other risks around realising tax benefit - … availability of capacity … challenge to MTP from Group Finance … Benefit in 201 1… Difference in valuation … separate trade argument”

1 July 2010

Email from Arthur Cox to “John and Lysanne” [The e-mail header is cut off] attaching Hermes.doc:

“… I attach the initial paper we prepared on the structuring of the transaction … Because of certain shortcomings in the Irish statutory transfer scheme … the decision was taken not to proceed by way of a scheme, but rather a Cross Border Merger … We have asked Counsel to consider the feasibility of having the share transfer occur immediately prior to the merger becoming effective, but this may not be possible under the relevant regulations. We have been working on the draft merger terms …”

6 July 2010

Project Hermes briefing for meeting between LBG and the FSA:

“Objectives of Meeting – “Brief the FSA and the FR on the intention to wind-down BOSI’s business in Ireland and the mechanism identified to achieve that intention”

“Why we have taken the decision to withdraw from Ireland – and why now” External Factors listed are: “market pressure to clarify the core/non core split”; “sustained pressure for deposits”; “heightened concerns regarding the PIGGS countries”; and “NAMA impact”. Internal factors listed are: “Scale of impairments”; “forecast to make a significant cumulative loss”; and reliance on “Group funding and capital” and “significant colleague concerns”.

“A summary of the proposed transaction was provided.”

Note of Meeting between LBG and FR and the Irish Regulator (ME). Talked through slides that were confirmed to be same slides that had been “walked through” with FSA that morning.

Meeting between BOSI and the Financial Regulator recorded in Business Overview Report dated 27 July 2010:

“On the 9th July, the FR held a number of onsite update meetings with senior management from Risk, Finance and the BSU. These meetings were constructive and focussed on the processes within the BSU including our current credit processes.”

13 July 2010

E-mail from Nick Beckwith to TTO, CS, AP, RL copied to others subject “W&I QBR – 15 July” with attached PowerPoint deck:

“2010 Profit & Loss Trading profitability has improved from QF1, however our Irish portfolio is showing further signs of deterioration”

“Impairments – Stress-testing of Ireland portfolio has resulted in £(283)m increase in forecasted impairment charges signalling the need for continued de-risking.”

“Project Hermes – Project Update

▪ Deloittes [sic] and A&O engaged as advisers.

▪ Initial briefings with FSA and Irish FR took place 7 July [Correct date as per above is 6 July];

▪ Detailed planning work underway to assess – relative benefits and risk associated with alternative Service Co options; structure of Service Co and UK Operating Co; financial impacts; implementation and communication plan;

▪ Go/no go decision at GEC 28 July”

15 July 2010

E-mail from AK to Craig Meldrum and others cc’d to JH, JB, SC and MW – subject “RE: OpCo Strawman”

“… clearly as the result of the strategic decision we have made some activity will cease in Ireland… The second piece of work we need of what resources and therefore costs will be required in the UK to do the work that is transferred from Ireland…”

Deloitte Paper - LBG: Project Hermes – Tax Considerations for GEC:

“Executive Summary – Cross Border group relief of BOSI losses should be achievable provided there is no [PE] in Ireland to which the losses transfer as part of the [CBM]. An independent ServCo (Option 4 or 5) will provide the best opportunity of avoiding a P.E … with the right set of regulatory and commercial circumstances it may be possible to get the decision across the line. Based on current forecasts, the value obtained for Irish losses via group relief is higher if closure and CBM is achieved by the end of 2010. Losses potentially available are [€2.1bn/£1.7bn] in 2010 vs [€0.4bn/£0.3bn] in 2011 achieved by the end of 2010 … tax capacity available in 2010 is estimated to be c£2.1bn before priority off sets ... Significant tax uncertainty exists in relation to the CBM … discussion with HMRC should be instigated at an early stage following the GEC meeting at which the commercial arrangements are settled.”

“Objectives/Scope – Our analysis of the tax implications is based on the paper presented to the GEC on 29 June 2010 and financial information prepared by LBG.…we have been asked to review the potential to surrender tax losses so the UK and the implications of various closure options set out in the GEC paper. We also highlight the tax risks and costs of these options…”

“Summary of Key Tax Considerations

Cross Border Group Relief – Benefits/Risks - Incremental value from BOSI losses of up to [£1.4bn] from closure in 2010 subject to UK capacity” - Comment – HMRC resistance to group relief claim – timing of CBM in 2010 should be consistent with the optimal commercial strategy for closure”

“Serveco ownership/P.E Analysis – Benefits/Risks - Independent Servco will provide the best opportunity of there being no P/E to which BOSI losses transfer.”

“Cross Border Merger (CBM) – Benefits/Risks – Across border merger under which the merged business is closed so that there is no on going P.E. is unprecedented and tax implications are uncertain – Comment … tax rules are premised on a P.E remaining in Ireland which is not the case here…”

“Group Relief: Value Considerations – Assuming the onerous conditions for cross-border group relief can be satisfied… a claim to surrender closure period losses of BOSI should be possible … approximately €2.1bn of Irish losses would potentially be available for surrender in 2010. As a comparison, the most recent forecast for BOSI shows €0.4bn of losses for 2011 … The Irish losses which potentially falls away if BOSI is not closed in 2010 are therefore in the order of [€1.7bn] (£1.4bn). However value through group relief depends on whether UK tax capacity is available… based on current forecast numbers at Q2, there are UK taxable profits of £2.1bn against which eligible tax losses from LBG group entities can be offset during 2010.”

“Loan Portfolio – Transfer at Fair Value

For UK tax purposes, the acquisition price of loan assets acquired through the CBM is likely to be arm's length fair value. The implication is that ultimate realisation of the loan portfolio at levels above the fair value determined for tax purposes (at the time of the CBM) will erode any group relief benefit. Conversely future losses deductible in the UK will increase the overall value obtained for Irish losses.”

Group Relief Analysis – [“main purpose” test] – “This is a factual test which looks to the subjective intention of group management as evidenced by internal and external documentation and as such it is not possible to form a firm technical conclusion on whether the anti-avoidance rules will bite…”.

“A strategic decision to exit the Irish market and cease trading as a regulated banking entity in Ireland has been taken. The strategic and financial rationale are set out in the GEC paper of 29 June 2010 - substantial on going losses, further capital required to be injected into BOSI and uncertain economic environment - all conspire to make BOSI's business non-core for the group. However group relief benefits will be a factor in the timing and manner of closure and thus there is a risk that HMRC will argue that additional losses available in 2010 vs 2011 are potentially unallowable because a CBM and closure by the end of 2010 is designed to achieve additional group relief benefits (with concomitant p&l and tier 1 capital benefits from the value of additional deferred tax asset recognition). The counter, if supported by the facts, is that as a matter of commercial reality, the overriding driver must be to maximise recoveries and minimise costs on a loan portfolio which - if not properly managed - could incur incremental losses many times any potential tax benefit. Any closure strategy therefore must first and foremost be consistent with this objective and whilst a group relief benefit is a "nice to have" it can only reasonably be viewed as subsidiary to the main commercial objective and is not itself a main purpose. The GEC paper also refers to a number of benefits of closing in 2010 - minimising employee uncertainty, contribution to group integration, clarity of strategy to the market, and the current trade union agreement.”

Closure Options Comparison – [set out options] –

Option 1 will most likely give rise to an ongoing use of losses in Ireland. Option 2 is unlikely to be delivered in current year. Option 3 presents greater risk of a PE and a greater challenge to demonstrate that it can be avoided. As such “option 5 should present the strongest position”, followed by Option 4”. Option 5 is strongest because “ServCo would appear to be entirely independent”.

“The determination of whether there is or is not a P.E is likely to be marginal in any consideration by the Irish Revenue of the issue, with Revenue initially likely saying that there is a possibility of a PE. Nonetheless, with the right set of commercial circumstances it may be possible to get the decision across the line.”

Strawman CBM structure

“… CBM will be completed via the absorption of a wholly owned subsidiary … Prior to the merger, shares in BOSI will be transferred from [SIF] to BOS plc Scotland … the CBM mechanism for achieving the closure of BOSI carries a level of tax uncertainty that will need to be addressed with the UK and Irish tax authorities in advance. Timing is already very tight and the impact of this will need to be understood in terms of the legal and regulatory timetable … tax uncertainty here is enhanced by the fact that a cross border merger and closure of the Irish business are effectively happening at the same time…”

20 July 2010

E-mail from JB to SC, AK, MW, GS, MS and SW- subject “Hermes VAT”

“A wider challenge from the Deloitte tax team this morning. Is there an increasing risk that from an execution perspective, the risk of rushing through by 31.12.10 and getting an adverse tax position on p.e. arises? … Per Jacki White’s numbers, the loss in 2011 is c£2.5bn in 2010. By we are constrained by capacity in 2010 (currently c£2.1bn) and priority loss claims in 2010 could reduce this further. We’ll likely have a capacity constraint in 2011 also and the further out we go, the less certain we can be on veracity of numbers. Deloitte’s view is that this potentially narrows the gap on benefit in doing in 2010 vs 2011. Their updated deck this pm will reflect this – what’s your view on the realistic delivery of this in 2010? Will we need to cut corners to deliver with an associated impact on risk?”

Deloitte Paper – LBG: Project Hermes – Tax Considerations for GEC – Draft II. The paper set out in more detail the tax considerations of the proposed merger.

E-mail from AK to JB, SC & MW copied to MS and GS – subject “Re: Hermes VAT”

“my thoughts would be. From a colleague point of view we must do it this year… From a regulatory point of view it feels like the regulator wants this sorted asap. Particularly the guarantee which is still out there and unresolved! From a tax point of view if we did it next year and completed early in the year our capacity in 2011 would be very limited due to the short accounting period so it does not get us out of the issue. Also there is a doomsday scenario where we miss this year end so missing the losses for this year and then find that the losses next year are not as large… My vote is for this year…”

23 July 2010

E-mail from David Taylor at Deloitte to SC, JB, AK – re “Draft GEC paper 32- Project Hermes – v5” requesting comments.

E-mail reply from JB to Deloitte copied to SC, AK

“Re the tax section, can we go with: Efficiencies… If the strategic decision is taken to withdraw from the Irish market, we will look to plan the implementation of this strategy in the most tax efficient manner possible … According to the latest version of the MTP, this benefit could be to a maximum of £0.6bn … Finally, if the Tier 1 benefit is effectively just the tax can we change all references to “Tier 1 benefit” to “Potential Tier 1 benefit”.

E-mail reply from SC:

“thanks Jon. What about the relief on the 2011 losses… I thought that’s where the original up to £1bn came from?”

E-mail reply from AK

“… I think I would agree with Jon and tone down the tax benefit to “up to £0.6bn with the potential to be higher”… I would prefer if it was headed up tax consequences rather [than] efficiencies as well…”

E-mail reply from JB

“I’d prefer to not have “with the potential to be higher but lets have that discussion on the phone”

26 July 2010

E-mail from GS to TT copied to SW – re “FW: CONFIDENTIAL PROJECT HERMES”

“As you know the Hermes follow up paper is being presented by W&I to GEC this week. The W&I team have over the past few weeks provided an additional comfort on the fundamental commercial factors (regulatory, customer and employee considerations) which underpin the Hermes proposal and they understand that we will be required to demonstrate this to HMRC. Group Tax has been involved in drafting the paper … However, there are some remaining points… The W&I view on the possible tax benefit which might arise if we are able to utilise future losses on the Irish loan book remains optimistic. There are many moving parts including UK tax capacity, valuation of the book and transfer pricing adjustments, the ability to benefit from cross border merger legislation to enable a 2010 offset and the historic transfer pricing position. It is by no means certain that LBG would have sufficient UK tax capacity to utilise the potential Irish loan book losses in 2010 and in future years. We therefore continue to recommend caution in viewing these figures. … I understand that you will be seeing [SC] and [AK] at the W&I FD’s meeting tomorrow morning … Overall our view is that the proposal should stand on its commercial merits excluding tax which Steve & his team understand.”

E-mail from SC with meeting invite for “Hermes meeting: Steve/Mark Adams/Alan K/Jonathan L /Jon B” at 9.00am on 27 July 2010:

“Further to Mark’s email today [The e-mail was not in the hearing bundle], please note there will be a meeting at 9am tomorrow morning, 27 Jul, to prepare one-pager costs benefit analysis for Hermes”.

[The “one-pager” costs benefit analysis document was not in the hearing bundle.]

Email from MA (Deloitte) to SC, AK, JB – subject “Hermes meeting: Steve/Mark Adams/Alan K/Jonathan L /Jon B”

“Please find attached a pro forma analysis, table, and graph which could be used … to illustrate the tax efficiencies v costs of Options 3, 4 & 5 in Hermes paper…For discussion on 9am call”

[The documents referred to are not in the bundle]

E-mail reply from AK

“The tax guys best estimate of capacity is £2.1bn. This is unlikely to change. I would therefore use this as the base case …”

27 July 2010

Project Hermes meeting between LBG and Deloitte to discuss one-pager costs benefits analysis for Project Hermes. [No note of the meeting is in the bundle]

E-mail from GS to AK, Mark Adams, JB, MS & SW – subject “Hermes meeting: Steve/Mark Adams/Alan K/Jonathan L /Jon B”

“I’ve been unable to speak to Susie this morning but when I did catch up with her briefly yesterday … she indicated to me that she had made it clear last week that the Group Tax view remains that £2m [sic] of capacity is very optimistic. The tax capacity remains fluid…”

E-mail reply from SW

“…yes – the 2.1 is highly optimistic and you’ll recall that I said on the call that at most I’d say there’s 1bn. The 2.1 is before capital allowance claims…”

E-mail reply from AK

“Not sure I understand. We could do a call on this attended by all parties … as we are getting confused on the position at the moment. We are trying to create a decision tree on this but it is really difficult with only half the information”

E-mail reply from SW

“The figure of £2bn assumes no capital allowance claims for 2010 … As I said on the call, I’d assume £1bn of tax capacity in 2010 given the level of judgment in putting the number together…”

BOSI – Business Overview Paper – for International Banking Ex Co Presenter JH:

“Principal Issues & Key Messages – including “Project Memphis – this project continues on-track following successful implementation of T-Day on the 18th of June … “Media coverage was limited with no significant adverse reporting…”

BSU – “c50 colleagues have now been selected to staff the 3 Regional BSUs being established. Cases are expected to migrate through July and August to these new teams”

Operational & Regulatory “The control environment continues to show improvement…”

28 July 2010

E-mail from SC to SH re “Project Hermes - pensions”

“Just a couple of thoughts on tax - they are swinging around a lot on the capacity point and really need to come off the fence; after our meeting yesterday we did a quick calc – if we got the maximum benefit in 2010 and transferred the assets at 3bn below book… the future taxable gains wipe it out; however, if it looked to be ongoing that way wouldn’t we either argue “we’ll drop the 2010 claim if you drop the market argument” or in extremis pull the cross-border merger?”

E-mail from AK to SW, MA Deloitte, JB, MS & others – subject “Hermes meeting: Steve/Mark Adams/Alan K/Jonathan L /Jon B”

“… As discussed this is a no regrets move because we have already made the decision to exit Ireland. Just confirmed it with Steve again!”

BOSI – Project Hermes Paper for GEC dated 28 July 2010:

GEC Meeting attended by ED, TT, TTO, SC, CS, HW and MW Item 2010/311 “Project Hermes – Update “

“[SC] and [MW] explained the background to the key recommendation, namely that the Group should seek to exit from the Irish market, in a cost effective way, as rapidly as possible.

[SC] commented that the Irish market was already substantially in “run off”, with very limited new lending taking place. In the longer term, full exit from the Irish market was believed to be the right strategic move. Formally recognising this - alongside a structured approach to managing the run off - could assist with satisfactory resolution of the Group's exposure, as well as staff retention and motivation (particularly with a "colleague owned" ServCo). Discussions were taking place both with the management team and independent third parties with respect to the appointment of the most appropriate ServCo … Achieving this by the end of the year would require the appropriate Court process to be commenced by no later than the end of August.”

The Committee agreed to recommend to the Board that LBG close BOSI and effect the closure through the CBM “with a view to completion by 31st December 2010”.

July 2010

LBG hired EY to programme manage the BOSI Irish exit. A Full Business Case document was completed with the “Programme/Project Description - To plan and execute the exit from the Irish market as rapidly as possible…” and lists “must do” items completed by 31/12/2010 to include disposing of property, IT solution for ServCo; Operating model development and implementation; and Service Contract between OpCo and ServCo.

Undated document [Located at the beginning of the August section of the bundle] detailing the primary and secondary messages for the rationale for BOSI exiting Ireland for use with colleagues and customers.

“Rationale – [LBG] is planning to withdraw from Ireland due to significant continuing loans losses and the poor economic environment … the Group could not see a return on investment in the foreseeable future … The Group believes that Ireland does not present scalable growth opportunities …”

“Colleagues – … It is planned that 90% of colleague will transfer, via TUPE, from BoSI to the new managed services company… most colleagues will continue in their existing roles…We plan to put in place a pay and reward structure that will incentivise colleagues to remain with the business in the years to come”

2 August 2010

LBG Group Impairment Adequacy Review – H1 2010 presented by SRS variously stated:

“Current expectations, based on our latest base case economic forecasts, are that the Group impairment charges have peaked in H1 2009 and that they will be significantly lower in 2010 compared to 2009. However, further economic deterioration remains a downside risk to the Group and could lead to material increases in our impairment charges.”

It noted that the economic conditions remained challenging, particularly in Ireland and BOSI Impairment charge “has reduced by 21% from its H2 2009 peak (£2bn) to £1.6bn as at June 2010” and “Wholesale is reporting that there are some early warning signals that in parts of the portfolio performance is deteriorating, however, this has not yet impacted impairment levels.”

“The positive trend in Group impairment charges since the peak of H1 2009 is reflective of the Group’s accelerated review of high risk portfolios and early failure of poorly structured heritage HBOS corporate transactions, rather than more recent economic recovery. The H1 2010 position confirms our previous forecast that the impairment charges would reduce, however, we expect that the level of impaired assets will continue to increase across certain portfolios.”

“Current impairment allowances are considered adequate, but downside risks remain particularly for BoS Ireland mortgages portfolio, given the on-going economic uncertainty.”

The Impairment Allowance Overview (2) stated: “Having risen significantly during 2009 across virtually all material books, impairment allowance growth has slowed during H1 2010, with increases in Real Estate BSU and Ireland offset by decreases in Retail.”

“ Impaired Assets - £62.9bn (c. 10%) of the Group’s assets are impaired as at June 2010 (Dec 2009: 9.1%). The increase in H1 2010 (up £3.0bn, 5.0%) is driven by Ireland, Real Estate BSU and Wholesale Markets books.”

“W&I impairment charge for H1 2010 is £2.2bn, representing a decrease of 16% from the H2 2009 charge of £2.7bn. … BOSI charge has reduced by 21% from its H2 2009 peak (£2bn) to £1.6bn as at June 2010, accounting for 70% of the divisional H1 2010 charge. … BOSI Commercial Real Estate portfolios remain the primary source of impairment losses (56% of H1 2010).”

“Despite strong Q1 growth, the outlook for Ireland remains challenging … Ireland - After eight consecutive quarters of contraction, the Irish economy made a surprisingly strong start to 2010, with GDP expanding by 2.7% quarter-on-quarter during Q1. The increase was attributable to a robust export performance, mainly supported by a softer euro. However, annual growth remains negative, as does the outlook, with ongoing Eurozone concerns leading to weak Euro-Area growth prospects, and prospects for growth in the UK and US (Ireland’s main trading partners) also looking fragile. Indeed, domestic demand remains weak, with private consumption, government spending and fixed investment all continuing to contract in Q1.”

3 August 2010

BOSI – Project Hermes Paper for LBG Board Meeting on 3 August 2010 with attached draft “External Announcement”, draft CBM terms and draft “Colleague Message”:

BOSI – Project Hermes Tax Considerations – by Group Tax dated 3 August 2010

“Executive Summary This note sets out the Group Tax initial conclusions following review of the closure proposals under Project Hermes … The decision by LBG to exit the remaining Irish business is driven by strong commercial imperatives set out in the paper submitted to the GEC on 28 July by [SC] and [MW], including the Group’s desire to cease having a locally regulated presence in Ireland … Further detailed consideration is required on the UK and Irish position as there remains uncertainty with regard to the final structure itself, the accounting treatment of the CBM and also the application of the Irish and UK tax rules to this. … A substantial valuation exercise will also be required to facilitate agreement with the tax authorities regarding the tax basis of the assets transferred to the BOS.”

“Tax Consequences of the Claim – … we are working through these with Deloitte, Allen & Overy and leading tax counsel in the UK and with Arthur Cox in Ireland … BOSI is currently a subsidiary of SIF … and Dutch advice will also be required, although we do not anticipate any significant Dutch tax issues.”

“Group Relief Claim – We do not expect to have a continuing regulatory (or taxable) presence in Ireland beyond 31/12/2010 … Subject to satisfying a number of conditions it should be possible under EU cross border group relief provisions for BOSI to surrender its Irish losses against LBG UK profits … There is a specific anti-avoidance provision … We are satisfied based on the information provided by the W&I business and the Hermes project team that the proposal to close [BOSI] permanently is driven by strong commercial imperatives (regulatory, market, investor, customer and colleague) and understand that the desire to eliminate a locally regulated presence in Ireland is the key consideration here. We are advised that it is intended to proceed with the exit in the way contemplated (closure of the business and CBM by 31/12/2010 with a third party Irish service company administering the loans locally) regardless of the position regarding the availability of any group relief. … [CBGR] is also subject to the availability of 2010 UK taxable profits (“tax capacity”) … there is possible capacity of around £1bn in 2010 … Indicative losses for Ireland for 2020 are in the order of £2.1bn.”

“Additional High Level Tax Comments … EU Group Relief Claim - … we expect HMRC to strongly resist a claim made in respect of BOSI losses, given the quantum …” and on the main purpose test “As there is more tax capacity in 2010 than in 2011, HMRC may argue that, whilst the CBM is executed for purely commercial reasons, accelerating it into 2010 to obtain more group relief, causes a claim to be denied.”

LBG Board Meeting attended by ED, TT and TTO. The minutes record:

“Project Hermes

Mr Tate introduced the paper. It was proposed that the Group should exit totally from its Irish businesses, which were likely to suffer additional impairments and require further capital and liquidity from “Group” … Strategically this was believed to be the correct decision, and there were strong reasons to favour an exit sooner than later. The potential tax implications of this were complex and required further work. … The sensitivity of not being seen to reward members of the management team who were part of creating "the problem" was well understood. Mr Tate would confirm to the Board in due course that appropriate safeguards were in place in this regard.

The Board: supported the decision to exit from Ireland in principle; agreed that an ad hoc Committee of the Board comprising of Mr Tookey and Mr Tate should continue the analysis of the implications of this proposal and should have the authority on behalf of the Board to proceed with the proposed transaction, with timing to be agreed by the Committee …”

TT’s handwritten speaking notes for the meeting state “Our recommendation is to truly exit Ireland, leverage our London credit and risk expertise and do both in a way and at a time which is tax and capital efficient … and doing it before year end. The timing is a tax issue and I’ll turn over to Tim to walk you though the tax implications. Importantly for the Board this is first and foremost a good thing, the right thing to do for commercial reasons but there are meaningful tax implications which drive timing.”

2010 Interim Results – News Release. The interim results confirmed “… a significant reduction in impairment… Group has returned to profitability… Impairment levels significantly lower than originally envisaged… all divisions (and importantly within the Wealth and International division, our Irish business) are showing improving trends in 2010.”

2010 Interim Results presentation by ED and TT:

“W&I Impairments up 52% … continued to reduce the size of our balance sheet … [W&I] reported a loss of £1.6 billion, reflecting the increased impairment charges in the International units. Impairments rose by 52 per cent in comparison to the same period in prior year, but were down by 15 per cent on the second half of 2009. … There will be more stringent regulatory requirements, particularly affecting both capital and liquidity … [W&I] delivered a better performance for the first half overall, and pleasingly a reduction in Irish losses compared to the second half of last year. … In W&I, impairment charges were down 15 per cent on the charge in the second half of last year and the level of losses continues to be dominated by the economic environment in Ireland. We continue to believe that the impairment charge for the Division peaked in the second half of last year, although economic conditions continue to be monitored closely.

In response to a question from a Goldman Sachs analyst – “shouldn’t we expect a relatively dramatic fall of in impairments in Ireland. You seem very cautious in your guidance.” , ED answered: “We have been cautious about Ireland ever since we started to report on the acquisition. The country continues to have a difficult economy. There is no activity as such in terms of buying and selling and we have basically seen the latest tranches going into NAMA coming in at very considerable discounts. So all of that needs to continue with caution. But we believe we have taken a very prudent stance and we will see how it develops over the next several periods.”

Email from SC to TT – subject “Hermes etc”:

“We are still planning to get you the Hermes tax note for in-flight entertainment it’s with Sue at the moment. As far as I can see only one tricky issue around the Irish withholding tax which wouldn’t prevent us implementing the operational solution but might make us pull the cross border merger if we couldn’t fix it. …”

12 August 2010

E-mail from SC to SH (cc’d to AK) – subject “Hermes Approval”:

“… I understand that the discussions on tax, accounting and capital have taken place … I understand there is nothing that should stop us proceeding… we are planning for an announcement next Thursday (the 19th). That would suggest a board sub-committee meeting of the two TTs at the start of next week … When I spoke to Tim before he left he was happy to give that remote approval once Group Finance had been through the tax and capital points.”

E-mail from SH to SC (cc’d to AK) – subject “Re: Hermes Approval”:

“The tax position is per my email to you and others of last week” [the e-mail is not in the bundle] … I haven’t seen the accounting and reg view yet … There is growing concern that CBM is indifferent with the total return swap and structuring that STG have designed. And I hear Tom is going to see/talk to Truett about that option. As the 2 seem not dissimilar in financial terms and given Risk’s concerns re CBM soln I’ve asked Greig to find out if we can withdraw from CBM if we find in a few weeks when the full analysis has been completed that for risk, accounting or tax reasons that STG’s soln is preferable.”

E-mail from SC to SH (cc’d to AK) – subject “Re: Hermes Approval”:

“Thanks Sue – there have been discussions between Alan and Tom’s team about the swap which I thought highlighted the disadvantages with it vs the CBM … The legal advice is that we can withdraw the CBM application at any point up to 31 December. Wasn’t aware of any concern from Risk re the CBM”.

E-mail from AK to SC and SH– subject “Re: Hermes Approval”:

“… I know from my limited involvement to date that the TRS had immediately run into issues because we need to do a detailed valuation on the book before implementation and that it only works for prospective losses so does not gain access to the bigger historic losses position including those in the current year (2.1 bn euros). The other disadvantage… is the need to keep BOSI for the foreseeable future as the regulated bank in Ireland. I thought we had decided that for capital and regulatory purposes we did not want this going forward. I know the MH [Head of Group Capital & Regulatory Reporting] liked the CBM idea because it solves a headache with regard to the up coming large exposures rules re Ireland. … we are unfortunately running out of time.”

E-mail from SH to SC (cc’d to AK) – subject “Re: Hermes Approval”:

“As I said in my email last week its important to look at options side by side [MH]’s e-mail to me last week was not the same as you suggest below. The end to end analysis for the project needs pulling together urgently – do you have an end to end paper please?”

E-mail from AK to SC – subject “Re: Hermes Approval” :

“Can you have a word with Sue. She needs one of her team to pull together an end to end paper. That is a Group Finance role is it not? We lay out the commercial transaction and they lay out the tax, accounting and regulatory treatment of what is proposed? Sorry to ask you but she does not listen to me!”

E-mail from AK to Jonathan Winstanley (Treasury) – subject “Enhanced TRS proposal”

“I understand from [SH]’s office that you now have a fully worked up enhanced TRS proposal complete with accounting, tax and regulatory analysis. Steve has asked if you were available to take him through it on Monday at 1pm … we are up against it in terms of time because we are aiming to announce Hermes next Thursday!"

The reply agrees to set up a meeting on Monday.

E-mail from SC to MA (Deloitte) – subject “Re: Hermes Approval” forwarding the email chain of his discussion with AK about an end-to-end paper analysing the project:

“ … could you guys give Alan some support to put together this definitive note on tax, capital, accounting and pensions in the next day if poss.”

E-mail from MA (Deloitte) to SC (cc’d to AK) – subject “Re: Hermes Approval”

“I had a call with Alan this morning. It appears to me that the Hermes GEC and Board papers, and background analysis have sought to address a number of strategic and commercial issues. I believe that the Hermes/CBM solution was driven by two key strategic/commercial factors: - the discontinuance of all new lending in Ireland, in a way that is public and sends a strong message to LBG investors…a solution to a potential need to replace the LBG guarantee, with direct capital injection into BOSI … In addition the Hermes paper/analysis prepared by W&I/LBG considered a number of further matters, including regulatory position, the customer proposition, the colleague proposition, the tier 1/regulatory capital position, the potential tax consequences, the accounting treatment, and the cost benefit analysis of implementing the solution. … in order to be provide a reasonable side by side comparison, it would be necessary to see a paper which at some level demonstrates how the TRS proposition clearly addresses [the above points] … As noted by [AK], neither he nor we, are close to the TRS proposition … As a preliminary comment, (and not having seen any paper on the TRS proposition!), it is not yet clear to me how the TRS solution meets the strategic/commercial objective of demonstrating to all that LBG has exited Ireland.”

E-mail from MA (Deloitte) to AK – subject “Re: Hermes Approval”

“We have tried to pull together a document which compares the CBM solution to the TRS solution in a matrix, which reflects the LBG key drivers as we understand them. We clearly have been provided with very little information on the TRS solution, and its structure and impact on many of these key drivers. Consequently, the attached requires considerable input from those that have analysed the TRS solution (i.e. STG).”

[No document is shown as attached to the e-mail and the document was not in the bundle.]

E-mail timed at 18.59 from SH to SC “Hermes and other solutions”. No other information is shown as the e-mail continues over the page and a complete version is not in the bundle.

E-mail from SC to SH – subject “Hermes and other solutions” replying to truncated 18.59 e-mail.

“ … clearly we are moving at a much faster pace on this than is ideal… It is probably worth reiterating for everyone exactly what the Board approved as it was deliberately separated into two parts … 1. To withdraw from the Irish market (ceasing all business) … 2. To execute a [CBM] so that we no longer had a banking entity in Ireland and could potentially access value from a tax point of view but also avoid future capital injections and importantly unwind the sectoral guarantee provided by BOS ...... [sic] and also reinforce the external message that we were out of Ireland. … The key outstanding questions related to (2) – in particular were there any financial showstoppers or indeed better alternatives. And critically was there anything which could make us rethink (1). I think from where we are it’s clear we can proceed with (1) even if (2) gets executed in a different form. It’s also clear we can stop the CBM at any time albeit with egg on our faces … we have that clear legal advice. So I’m firmly in the camp of the first option at the end of your email as that’s what we asked the Board to approve and I don’t believe we’ve found anything at all which questions (1). My understanding gleaned from holiday is that: - Tom M's team have an interesting alternative to the CBM which we should definitely discuss though it's not at all clear to me it meets the wider strategic imperatives that the CBM does around capital and regulatory concerns. … Tax, Capital, Accounting no show stopping issues… Risk - I agree with SRS's concerns about Op Risk as we are looking to implement the operational solution (1 above) at breakneck speed ..... [sic] for me we simply delay the implementation if we are not ready we cannot put a tax opportunity ahead of running a material op risk given the size of this book.”

16 August 2010

E-mail from SC to SH, AK & MW – subject “RE: Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“Here is a draft of the email I would propose sending to [TTO] and [TT] tonight to enable us to proceed to the next stage. I will update the section on the [TM] ideas when [AK] and I have met them … I’m sceptical that the new ideas solve the wider strategic issues (including capital and regulatory) as well as the CBM but let’s see … regardless we need to file the CBM papers very quickly to stand any chance of that working so I don’t think we can let that opportunity slip between our fingers.”

E-mail from SH to SC, AK & MW – subject “RE: Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“… My immediate reaction … why do we have to commit to a servco that could source external business … Risk have tabled serious concerns with the current proposal … tax while there is lots of analysis to do there are no showstoppers that suggest an adverse situations however its equally not clear this is the optimal solution. Further we should assume that whatever route we choose that HMRC will be very interested in the details. The decision should be made assuming no tax benefit … Capital … This if [sic] the first time that further capital injections have been raised with me .. Do they unwind if the CBM is successful”.

SC responds to SH’s questions by typing answers (in capitals) into SH’s email. His answers include:

“In answer to why they need to commit to a ServCo that could source external business – This was the clear preference at GEC and Board (including Carol) in terms of best value overall. As I understand Stephen’s concerns they do not relate to the principle but to executing effectively particularly given the timing. Our agreed fallback position was a group owned ServCo if we couldn’t get there in time.”

In answer to the point that the decision should be made without regard to the tax benefit – “Agree – and actually that was the reason for splitting it into (1) and (2)”.

In answer to the point about capital - “Yes they do … The other issue is the sectoral guarantee is not liked by FSA or [FR] and we will have to unwind at some stage – this would require another 1.6bn. The CBM removes the need for this but I don’t beleive [sic] the other options do”

E-mail from MA (Deloitte) to AK – subject “Re: Hermes Approval” following up on the matrix he sent re CBM and TRS

E-mail from AK to MA (Deloitte) – subject “Re: Hermes Approval”

“I think where we have got to is that there is a recognition that the enhanced TRS does not deliver a holistic solution and neither does the CBM. So we are going to lodge the CBM papers on Thursday and work up the enhanced TRS solution over the next few months and if it is significantly better then we might pull the CBM before implementation. This means better from a tax and regulatory perspective.”

E-mail from SC to TT and TTO (cc SH & MW) – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”:

“The purpose of this email is to give a brief update on Hermes, and in particular the financial items where more work was needed at the time of the Board meeting (Tax, capital, Pensions, Accounting) to ensure there were no material downsides to proceeding. If you are happy with the status we would then propose the Board committee convenes on Wednesday to approve and we announce and file the papers for the [CBM] on Thursday.

If you recall the proposal to the Board was split into two elements: 1. To exit through splitting into an OpCo and ServCo … 2. To optimise tax and capital, and strengthen the market message on exit, by executing a CBM prior to the end of this year… The further work completed since the Board meeting has consisted of advancing the commercial discussions around (1) and testing for any potential show-stoppers or alternatives around (2), particularly if they compromised the structure in (1 ). We have consulted with colleagues across Group and reflected their feedback - and Sue is happy with the position from a Group Finance point of view.

Commercial discussions – Continuing at a pace…we still have work to do to make sure any agreement is absolutely watertight… Summary position – no showstoppers and we can announce the intention to exit and establish the new model.

Tax – We have a comprehensive paper from the Group Tax team … As previously discussed we can withdraw the CBM at any time up to 31 December and we have included a specific clause in the papers relating to unfavourable tax outcomes ... Summary position - lots of work to do but no showstoppers identified… and a “get out” option by withdrawing the CBM in adverse circumstances. However, the CBM may not be the optimum tax solution – see “Other Option” – below”.

Other Options – Tom Murphy’s team have come up with an alternative to the CBM involving a Total Return Swap and a series of structured transactions which transfer income from the UK to Ireland. Though not viewed as more or less likely to be successful from a tax point of view it could gain access to 2009 losses (which the CBM would not). However, we would require an ongoing banking presence in Ireland, which is less attractive from a strategic and messaging point of view and potentially compromises the OpCo/ServCo model … The view of myself and Tom is that we should proceed with the CBM. … as otherwise we will miss the opportunity to achieve end 2010 implementation …

There is a chance that one of Tom’s options is more attractive than the CBM, or our conversations with the tax authorities are unfavourable, in which case we can withdraw from the CBM. We recognise the embarrassment factor here and this was flagged at GEC and Board … I therefore recommend we convene the Board sub-committee on Wednesday to approve an announcement of both (1) and (2) …”

E-mail from MW to SC – subject “RE: Hermes – Update and Request for Board Sub-Committee Meeting to Approve”:

“As you probably gathered on the call with Steve I have real concerns around the risks of puling the CBM down the line to accommodate the TRS … To pull the CBM at a later date and go down the TRS route would be a complete reversal of our position both internationally and externally and brings added and significant operational risk, reputational and commercial risks. I think we need to discuss this further with Truett… I am around if you want a chat.”

E-mail from SC to MW – subject “RE: Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“I agree … I think the TRS is, overall, suboptimal and we have no choice but to crack on with the CBM. I think it’s worth catching Truett if we can.”

E-mail from TT to SC and TTO (cc SH & MW) – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“Will take a closer look … but … on the surface I would support the planned meeting on Wednesday; not certain if we can arrange to have Tim piped in, but let's try to arrange around what he can do!

Also, thanks for running it past Tom and his deal! Always with good alternatives… tho [sic] the first thing that I mentioned to him is that the commercial considerations have to come first!

Let’s keep running everything down but… could be good that we have the optimal.”

E-mail from AK to SC and Deloitte and others – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“I had a conversation with greig tonight. I asked him why he was not so worried about the relative aggressiveness of the stg process. Answer was that most of the structuring was in Ireland and they are not as worried about upsetting the Irish revenue. We agreed that we should put a time limit on tom and his team in terms of coming back to us with concrete proposals … by end of September … We should also ask Susie for capacity projection at the same date so we can make a final decision.”

17 August 2010

E-mail from SC to AK and Deloitte and others – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”:

“I think that’s fine … but if showstoppers emerge in the meantime we should not wait. The bit I can’t get my head around is the UK revenue being less concerned about shipping 500m a year out of the UK tax net.”

E-mail from AK to SC and Deloitte and others – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“I do not get that as well … I do not understand why we are comparing the CBM saving tax at the UK rate of 28% now [with] a 12.5% rate [in Ireland] over say 10 years. If I discount that cash flow back the CBM must be the better approach. We did think originally about more income into Ireland to utilise the losses… but we dismissed it… The deciding factor was that it did not fit in with our commercial aims for Ireland. The commercial rationale for doing this has been lost in this discussion which I find really worrying!”

E-mail from SC to TTO and TT (cc’d to others) – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“We have reviewed the papers to make them as non-committal as possible.. So they won’t prevent other options, but it would be a very public change of direction.”

E-mail from TTO to SC and TT (cc SH, MW, Tom Murphy & others) – subject “Hermes – Update and Request for Board Sub-Committee Meeting to Approve”

“I have had a brief review with Sue this morning. On the basis of that, I delegate my position on the LBG Board Committee to [SH]. … I believe there is more work to be done to confirm that we have the optimal route but that work is sufficiently advanced for Hermes to proceed to the stage of filing court papers … [they] should not be filed in a way that narrows other options that we may wish to pursue. Sue will represent my views at the Committee and has my full delagted [sic] authority on Hermes until Monday 23 August.”

E-mail from AK to GS and JB (cc’d to SC) – subject “Tax capacity”

“As discussed we would like Group tax to give us their best view of tax capacity in 2010 by end September so we can make an informed decision between the enhanced TRS and CBM at that point in time.”

18 August 2010

E-mail from AK to JB (cc’d to GS & SC) – subject “STG ideas”

“The more I look at these the more I really do not understand them. In the first of the two ideas. Are we not getting relief for our losses at the Irish tax rate? ... In the second one… why is the benefit not at 12.5%. Even if you say 500m … a year it takes 10 years to recover the losses from 2009 and 2010. If I discount this back it will be a worse outcome than the CBM? ... We look at this and dismissed it as being unacceptable from a capital perspective and most importantly it was not in line of what we wanted to do commercially? I must be missing something.”

BOS Sub-Committee Board Meeting attended by TT, SH, SC, Hugh Pugsley (General Counsel at HBOS) and others (company secretaries)

“Cross Border Merger” – the committee discussed the proposed merger of the company with BOSI by way of a CRM and reviewed draft merger terms – “The Committee Members discussed the strategic, commercial and economic grounds for the Merger. The Chairman emphasised that the transfer of BOSI’s business … would allow the Company to take advantage of its operational and management capability in the UK in relation to the Irish portfolio …

It was resolved to ratify and approve the proposed actions.”

19 August 2010

Press Release - “LBG Banking Group announces results of a Strategic Review of its Irish Business”:

“[LBG] has announced the results of a strategic review of [BOSI]. The review concluded that there was little opportunity for scalable growth in the future and it is therefore now intended that the business currently carried on by BoSI will transfer, pursuant to [a CBM] to [BOS]

The transfer of the BoSI business , including all of the strategic management and decision making activities relating to BoSI, will allow Bank of Scotland plc to utilise its extensive operational and management capability (including general and credit management, oversight and control) within the UK in relation to the Irish portfolio. This will aid the efficient rundown of the existing lending portfolio.

… it is proposed that [BOS] would enter into an agreement with an independent service company which would perform various administrative functions relating to the BOSI banking business.”

23 August 2010

E-mail from Joanne Smith to TT, CS, JH and PWC – Subject “FW: Final Group Audit on BOSI CRM”. The audit report rated BOSI as “Red – unsatisfactory - requires urgent attention”. A separate email from Gary Henshaw (W&I Audit Director) to TT states in respect of the report: “they are making progress and subject to implementing agreed plans, should move to Amber with the right leadership and direction in a reasonably short timeframe. Clearly recent changes may impact progress.”

Post Announcement Day FSA Meeting. LBG provided the FSA with an update on IB Businesses, including Project Hermes.

E-mail from TTO to TT & SC – subject “Capita – Ireland – Hermes interest” advising that following a conversation at Lords cricket ground, Capita are “clearly interested in Hermes” as they were looking to grow their loans servicing agreement with NAMA. TTO suggest that they contact TT initially.

BOSI – Project Hermes Paper – by Group Corporate Treasury/STG - September 2010. The paper set out the alternative option of a TRS in detail described as an “alternative structure … which could be used to implement the Group’s strategic objectives for BOSI”. It stated that the alternative structure “was developed by GCT and STG in conjunction with Group Tax Group Finance and W&I” and sets out the cost rationale for this structure and the summary financial analysis including “Irish Losses Utilised under Alternative Proposal”. Under “Comparative Analysis: Advantages” tax is listed as one of the key advantages to this transaction and compares the TRS and CBM: “TRS - Potential to fully utilise BOSI 2009 and 2010 losses (GBP4.5bn); timing of capital recognition subject to capacity constraints. CBM - claim group relief for BOSI 2010 losses (GBP2bn)…BOSI prior year losses of GBP2.5bn will be lost…”

Hermes Outsourcing ServCo Commercial Briefing Paper. The Executive Summary confirmed that a “Management led ServCo is recommended as the best option, and the deal “agreed” on 26/27 August is recommended for approval”.

BOSI – Capital Requirement Paper. Sponsors are TT & TTO . The paper states that a further capital injection is required pending completion of the merger with BOS which is consistent with “the Q2 capital plan and the Hermes paper recently presented to GEC.”

E-mail from He Shen [Group Corporate Treasury/Structured Transactions] to AK, SC, TM, GC and others subject “BOSI Alternative Proposal.ppt”:

“Following our call with you in mid-August, we have been further developing our alternative proposal for Project Hermes together with our internal and external advisors. Please find attached a presentation that summarises the initial feedback from our advisers.”

16 September 2010

E-mail from AK to He Shen & SC (cc’d to others) – subject “RE: BOSI Alternative Proposal”

“could you send me your supporting opinions … [and] the supporting spreadsheets which lay out how you get to the numbers in the presentation …”

E-mail from He Shen to AK (cc’d to others) – subject “RE: BOSI Alternative Proposal”

“… we look forward to working with you to provide the appropriate comparative analysis for Tim and Truett over the next few days …

As requested please find attached –

Note from Arthur Cox on availability of trading losses for Irish tax purposes;

Note from Arthur Cox on the tax analysis of the alternative proposal;

Note from Linklaters on the UK tax analysis of the alternative proposal

…

We will circulate the revised UK and Irish regulatory analysis from KMPG when we receive it later today.”

17 September 2010

SIF removed as intermediate parent between BOS and BOSI.

E-mail from AK to SH, SC, GS and others – subject “Alternative proposal” attaching documents in advance of the meeting the next day.

CBM/TRS Options paper comparing the two options. Under the heading “Strategic Drivers” it was noted in respect of the CBM: “BOSI ceases to exist. Banking licence ceases to exist in Ireland. Regulation by FR cease. All assets and liabilities clearly transferred to the UK. Sends a clear message to the market that BoS has exited the Irish market.” TRS – “BoSI would retain a banking presence and its banking licence in Ireland, assets and liabilities remain on BoSI balance sheet although credit risk transferred to BoS PLC. Less clear message to the market that BoS has exited the Irish market”. Under the heading “Mitigate any requirement to convert guarantee into capital objection into BoSI” in respect of the CBM it notes that no capital injection would be required, the TRS section states “[To be set out]”. The “Core Requirement” for both the CBM and TRS is stated to be “minimise or eliminate asset value leakage as a result of the transaction”. The TRS is said to be “Potentially less operational restructuring required, with less associated risk”.

E-mail from CS to SC subject “FW Alternative Proposal”

“I am aware that a plan B for Ireland is under discussion. I am emailing to bring to your attention an additional regulatory factor. The FSA was greatly relieved (an understatement) to hear that the BOS guarantee which they regulate would fall away. They would give us a much, much tougher time on Ireland were that not to be the case.”

22 September 2010

E-mail from SH to TTO – Subject “Re: Hermes”

“I think Tom’s scheme [the TRS option] has a lot of offer and economically it seems the best. It doesn’t tick the we are leaving Ireland box however in practical terms I think the effect is the same. We didn’t agree a common preference yesterday … More substantively it was suggested that Risk don’t think we can control/minimise losses without the opco/servco. We have asked that this be tested with them in the context of the TSR…

Reputational – much concern about a volt face… This is so complex that SHs should be persuadable re best economic outcome and press may not fully get the detail. Steve’s concern is that the I mangt team [Irish management team] will leak and brief against us (Why they would want to do that – because financially this is not as good a financial outcome for them seemed to be the answer).

Reg risk - it does require FSA and FR clearance and they may not be forth coming. Again mixed views on the· level of risk here. We may need to get a view from Carol.

…

So in summary – pending further views re above – TSR [sic] is the best economic outcome on balance assuming this is not completely outweighed by higher losses than otherwise would be incurred… It we could square these off I would do the TSR and am prepared to work to get it ie the prize is worth it.”

27 September 2010

E-mail from GA to TT, TTO and CS cc’d to SC, MW AC, SH and TM with no subject. Embedded in the e-mail is the Word document titled “Hermes pros and cons.doc”

“Carol asked me to prepare a note of pros and cons for tomorrows meeting. You will note the tax advantages of the swap are now a multiple of those under plan A (£1.3bn vs £320m) whereas in earlier discussions the numbers were the other way round and £400m vs £1bn. The latest numbers are from Tom Murphy's team and I am advised they have been confirmed by Group Tax.

I believe the four issues we need to discuss are:

1.

The differential tax benefits

2.

The project implementation risks, noting that the current project has red status. Plan B is more complex but does not have such tight deadlines

3.

The impact on our ability to staff the various entities

4.

The attitude of the regulator, noting that letters to all customers describing plan A have already gone out”

Hermes Plan B- Pros and Cons Document:

“Pros and mitigants

Additional tax savings worth £1.3bn (per Tom Murphy – previously £1bn)

No longer a deadline for implementation of new structure of 31 December 2010

Risks

Additional complexity and regulatory risk endangers plan A savings worth £320m.

…

TRS is a greater financial prize but a greater reputational, tax, credit and regulatory risk. We won’t know until its too late to go back to Plan A whether the regulators will approve

TRS suffers adverse risk of legislative change as benefit comes over a number of years. CBM presents legislative opportunity as there is a chance 2009 losses become available

Risk that the regulator will not accept the TRS as an adequate and better alternative to the sector guarantee Also the Irish FR has directed resources to Plan A and put BAU issues to one side to focus on the CBM. We are also in the midst of the court process for the CBM. All of that brings potential reputational risk under Plan B.

TRS gives greater risk of reputational risk as more aggressive from tax point of view with no business story to back up

Uncertainty over published strategy. We have said we are coming out of Ireland now if we implement Plan B we are not. There is no clear message to put forward in terms of shareholders/regulators/customers or colleagues. What is the reason for the about turn and how might that impact us at all these levels going forward? Creates uncertainty around the tax structure for example.”

28 September 2010

Meeting of the Project Hermes Steering committee. A vote was held on the two options, Plan A versus Plan B. The votes were as recorded in an e-mail from TTO to CS, GA, TT, SC and Simon Hill (cc’d MW and others) – subject “RE: Hermes plan B”:

“Tom B perhaps unsurprisingly

Sue B driven by financial and scale of upside if it can be achieved

Steve A (I think) marginally

Graham B marginally

Truett A reputational issues with regulators and shareholders and strategic goal of exit achieved

Me A reputational issues with regulators and shareholders and strategic goal of exit achieved

… I have a 1-1 with Eric this afternoon at 2.45 and you could see if part of that time could be hijacked to get us together F2F or by phone.

…

So no decision”

E-mail from TT to Tom Murphy cc’d to TTO and Andrew Géczy Subject “Hermes”

“I wanted to drop you a quick note, even if only from my bberry.

You have been terrific in the work that you have done on Hermes and I wanted to let you know the outcome of today's meetings.

As you might have projected based on Tim's round-the-horn "count", the die was finally cast in favor of Plan A and the team is proceeding with speed.

Importantly, we invited Eric to hear the summary thoughts (Sue was a very articulate spokes-person in favor of B) and the final decision was unanimous between/amongst all the GEC members present.

While I won't do the debate justice pounding it all out with thumbs, let me summarize the critical drivers behind the vote and then open myself (or you can go to Tim; or each of us!) for a richer, personal debrief:

A)

We assumed that Plan A generates no tax benefits whatsoever. All operating complexities associated with "preserving/proving status" fall away. All financial comparisons are against a "zero" from Plan A.

B)

We are concerned that we will lose or diminish the "we-have-gotten-out-of-Ireland" confidence that we have worked so hard to achieve ... and that we feel at least partially supports the price.

C)

We are concerned about the "front page story" factor: 40% tax-payer owned Bank parks loans in Ireland to reduce taxes paid to UK.

D)

The very scale of the savings works against us. The assets required to be moved would be large ... broken out in sector announcements/analysis ..... and would have to be justified against a backdrop of "we are exiting Ireland"!?!?

E)

We worry about reputation risk with the regulators.

F)

We are worried about further delays and the impact on staff, the threatened industrial action, etc.”

October 2010

Certus created. Directors listed on Form B1 include three former BOSI employees MA, TF and JH. The shareholders were listed as Certus and Aspira both with the same Isle of Man registered address.

Unsigned and undated Project Hermes – Services Agreement between LGB and current BOSI management who will run ServiceCo.

Document headed “FINAL – Certus Contract Compliance dos and don’ts” setting out the key rules which must be followed by all Certus staff.

E-mail from SC to TT subject “Hermes – Signing of HoT/Announcement” attaching Heads of Term that had been reviewed and are now ready to be signed subject to TT’s “ok”.

E-mail from SC to AC, GA, BT and DW subject “Hermes HoT”

“ … Truett has given the all clear to sign Heads of Terms and I will be putting pen to paper this afternoon. There will be a short internal announcement in Ireland tomorrow and a local press statement which Group Comms have approved.”

15 October 2010

E-mail from Stephen Carter (Group Credit Risk) to MW, JH and MA cc’d to TT, SRS, DC, SC, GA subject “Confidential GCRA Impairment review – BOSI wholesale” stating:

“You will be aware that the GCRA view is that the 2010 Impairment charge (for the wholesale BOSI book) should be in the range of €3.4 bn. to €4.0 bn.”

18 October 2010

Document titled Hermes - FSA Briefing 18 October 2010 providing an explanation of the scheme, the planned stages and regulatory requirements. The meeting objectives were stated to be: Provide FSA with Update on Project Hermes; Explain strategy and progress on Customer Propositions; Explain impact on BOSI Colleagues; Understand Future requirements of FSA (including meeting frequency and content. The respective roles of BoS and ServCo were confirmed:

“All decision-making in respect of the transferred business conducted by BoS, with ServCo’s role being the provision of administration support to BoS. ServCo will not be able to take decisions on behalf of BoS, commit BoS or execute documents on behalf of BoS.”

It was agreed that, going forwards, there would be “daily phone calls and weekly formal meetings with FR on a range of specific questions/issues, primarily customer proposition matters” and “Awaiting FR Feedback/Confirmation of PE matter”

E-mail from GA to SC cc’d to TT, AH, MW subject “Hermes”

“I hardly dare say this, but I think we had a very good meeting with the FSA.  Their questioning was relaxed and focussed around technical areas such as passporting and subsidiary companies.  They don’t want to see us again till early Dec, which has to be good news.” 

25 October 2010

E-mail from Anne Lanc (Head of Balance Sheet Management W&I) to many people including AK and PB cc’d to SC subject “Re Hermes – Treasury Workstream (Treasury Steering Committee)- URGENT ADDITIONAL PAPER FOR TOMORROW …”

“Unfortunately we have not succeeded in securing plans from all product owners for the migration of Treasury products from the BOSI balance sheet.

As you are aware the migration of Treasury products from BOS Ireland to BOS by 31st December 2010 is a key deliverable to ensure that no permanent establishment remains in Ireland for BOS post year end. Without this Hermes will fail.

…

Could you please bring plans for these to the Steering Committee tomorrow morning as a matter of extreme urgency as I wish to resolve this as a matter of extreme urgency?”

5 November 2010

E-mail from Richard Monaghan (Group Procurement) to TT Subject “Project Hermes: Briefing Papers on advance of contract signing” confirming that in advance of the meeting at 11.30am on Tuesday to sign the outsourcing contract briefing papers were enclosed to provide background to the contracts.

Emails between Anne Lanc (Head of Balance Sheet Management W&I) and JB (Group Tax) – subject “RE BOSIF” seeking confirmation that none of the other products in the treasury product workstreams caused him any concerns from a PE perspective.

Document headed “Project Hermes – Accounting Treatment of Cross Border Merger”. Background confirmed that post merger BOS will manage the BOSI assets and liabilities with the support of Certus, Certus will be owned and manged by a number of the existing BOSI management team. All credit sanctioning activity and decisions on workout strategies will transfer to BOS and to the extent that LBG has any appetite to write new business in the Ireland it will be written in BOS by the new executive team.

Note of telephone conference between LBG (SW, GS, MS & JB, all from Group Tax) and HMRC

“[GS] explained that at the half year stage some £2bn of losses had been identified in relation to [BOSI]. External analysts and commentators had been looking for LBG to “do something” about the group’s Irish exposure. At that stage LBG had recognised the need to consider termination of the operations in Ireland and manage the wind-down of the assets ... from the UK. Since then matters had deteriorated significantly and at the end of Quarter 3 it had been recognised that BOSI had incurred further losses … LBG had therefore decided to merge the business of BOSI with LBG’s business in the UK.

The purpose of the meeting was to provide additional background to this in real time but [GS] emphasised that LBG were not seeking any tax clearances in relation to the reorganisation. He considered that statutory claims would follow in relation to group relief and he believed these to be justified. Consequently they were not seeking clarification on the operation of the law but would be very happy to engage with HMRC in relation to all matters arising on a pre-filing basis.

…

HMRC asked if LBG could have set up a non regulated subsidiary in Ireland to carry out the same function as Certus. [GS] acknowledged that this was possible but it was not the decision which had been taken.

…

[HMRC] asked who the decision-makers had been and [GS] explained that there would have been decisions at various levels involving the Boards of LBG, HBOS, BOSI and Wealth & International. [GS] confirmed that there would be various supporting papers that had been prepared to help inform Boards’ decisions and he confirmed that these would be forwarded to HMRC.”

9 December 2010

LBG Audit Committee Accounting Matters Paper.

“Executive Summary

The cross border merger between [BOSI] and [BOS], which will complete on 31 December 2010, is expected to enable the Group to claim a current tax credit of approximately £1 billion from the utilisation of BOSI 2010 trading losses against taxable profits in the UK. While this claim is supported by EU case law, it remains uncertain as to whether HMRC will accept its validity. We will await the outcome of ongoing discussions with HMRC before reaching a conclusion as to the recognition of any current year tax credit.”

10 December 2010

Court of Session Court Order approving the CBM.

Group Relief Surrender consented to by BOSI under Chapter 3 Part 5 of the CTA.

LBG announces update on Irish Portfolio.

“Since the release of its Interim Management Statement on 2 November 2010, the Group has seen a further significant deterioration in market conditions in the Republic of Ireland, with concerns over the country's fiscal position leading ultimately to the approval of its application for EU-IMF financial support on 21 November. Market sentiment has continued to be negatively affected by uncertainty about the political situation and about the economic impact of the austerity measures introduced in the Irish Budget of 7 December.

…

Therefore, the Board anticipates that, compared to 30 June 2010, approximately a further 10 per cent of the £26.7 billion Irish portfolio will become impaired by the 2010 year end. Furthermore, the Board believes that it is prudent to increase the level of provisions against the portfolio, and currently anticipates an increase in the impairment charge relating to Irish exposures for the full year 2010 to approximately £4.3 billion on a combined businesses basis. This would result in an increase in provisions as a percentage of impaired Irish loans to approximately 54 per cent at the 201 0 year end.”

19 December 2010

E-mail from SH to SW cc’d to TTO and DJ subject: “Relief for Irish losses as a consequence of the CBM”

“There was push back at the audit committee re the above, as PWC said that while they supported the technical analysis they were concerned that we would not be able to ensure no PE in Ireland over time and hence there was significant operational risk in respect of recognising the Irish losses for tax purposes. That led some to say that maybe we shouldn’t include them … I feel that if we are not prepared to show confidence that we undermine our position with HMRC.

Firstly we in any case need to have concluded the CBM to support recognition. Please can you confirm that this is on course and given the retirement of the seaview securities the value of the losses that will be sheltered and not sheltered and hence the value of the tax relief that will flow through capital.

In respect of the PE ‘risk’ can you confirm what we will need to demonstrate to HMRC and how that will happen. … I'm seeking to ensure that all interested parties know what has to happen so that there cannot be any mishaps through lack of understanding regarding how the Irish operations must be handled to be consistent with the CBM tax analysis. …

I'd appreciate your thoughts so that we can be confident pre-Xmas in respect to the treatment of the losses as we start the January YE close and reporting processes.

For the 26th January AC I would like a precis of the advice received from counsel, discussions with PWC etc, an update in respect to the valuation process, the advice we have provided to Wholesale/W&I as above and a tax risk assessment in respect to the PE point and the financials as above and in respect to capital.”

21 December 2010

E-mail from SW to SH cc’d to TTO, DJ, JB, GS, MS and others subject “Re: relief for Irish losses as a consequence of the CBM”:

“The CBM is on course. The court process has been completed and the legal process will now complete on 31/12/2010 …

… the Irish Group relief claim could amount to £3.2bn … comprises £3bn UK tax capacity [and other amounts] … Accordingly it is prudent to assume that available UK tax capacity will be £3.2 bn” … Recognising the benefit of £3.2 bn losses would result in a capital benefit of £3bn x 28% = £0.9bn.

…

Both Jon Breaks and Moira Sced from Group Tax have worked over the course of the past weeks with the project team and we have reviewed and ensured that our requirements are incorporated into the following agreements and operational manuals

…

We have held a number of discussions with Derek Woodhead (Director Ireland BSU) and his direct reports as they have been appointed, to educate and explain the principles involved. A tax workshop was held on 9 December for all senior members of IBSU to allow the training of all IBSU staff and to ensure the structure is understood.

…

We have in addition reviewed in detail the IBSU and Certus training materials and staff handbooks, proposing amendments where wording or principles were ambiguous. … It is envisaged that Craig's risk team will perform a monthly control review on activity in Ireland and Group Tax will review the output of these reviews, to ensure we comply with having no activity in Ireland that can be regarded as a permanent establishment. … We have also developed a "Rules of the Road" document for IBSU staff to show in detailed areas what must occur in the UK, and similarly, what cannot happen in Ireland.”

E-mail from TTO to SW and SH cc’d to DJ, GS, JB, MS and others subject “Re: Relief for Irish losses as a consequence of the CBM”:

“So Susie what is the group tax view of the confidence level that the various affected persons know what each entity can and cannot do – and thus should we recognise the tax benefit at 0% or 100%?”

E-mail from SW to TTO and SH cc’d to GS, MS & others subject: “Relief for Irish losses as a consequence of the CBM”

“From a technical perspective we are comfortable that everything will be in order … Recognition of 100pc of the losses is, I feel, supportable.”

E-mail from SH to TTO and SW (cc’d to GS, MS & others) – re “Relief for Irish losses as a consequence of the CM”. States this issue will need to go into a paper for the Audit Committee and will need to include “a few lines of detail with the measures in place to ensure we don’t cross the PE line… and how we have sought to ensure we continue to operate in a way consistent with the tax treatment and how the op risk is being mitigated… can we add this to the monthly tax risk dashboard so we all have visibility given the value concerned”.

E-mail from TTO to SW and SH cc’d to GS, MS & others subject “Re: relief for Irish losses as a consequence of the CM”

“for the money/capital at stake, I think we should recognise the benefit and manage activity tightly to avoid a PE. Maybe we should demand that the Servco exco has somebody like [GS] on it.”

E-mail from Wilson Downs (W&I) to GA cc’d to MW, SC and Derek Woodhead from IBSU – subject “Hermes Programme Update 20/12/10” (high importance). Refers to “worry beads” to include “IBSU Day 1 readiness. Insufficient time onboarding training and proofing. I’m now expecting a more difficult Go live start for IBSU – action plans being worked through.”

E-mail from Derek Woodhead to Wilson Downs and GA cc’d to SC and MW subject “Hermes Programme Update 20/12/10”

“I think it is important we all understand just how challenging this is … with effectively only 2 working days to go this is extremely tight.. There are also some critical processes which have only just been identified… this is going to be a very bumpy landing”

E-mail from GA to Derek Woodhead from IBSU to Wilson Downs cc’d to SC and MW subject “Hermes Programme Update 20/12/10” in which GA states that he has “previously warned” TT, TTO and CS “that not all processes will have been tested”.

CBM under European Directive 2005/56/EC, pursuant to which BOSI’s assets and liabilities were transferred to BOS by way of a merger of absorption and BOSI ceased to exist (without being liquidated). This was the completion of Project Hermes.

Note of meeting between HMRC and LBG records:

“IS read from his notes of the 18 Jan 2010 meeting “Group Tax was currently heavily involved in BOSI related matters, particularly in ensuring processes to ensure that there is no continuing presence of BOSI in Ireland”. IS requested clarification of what GS had meant. GS explained that LBG have a business model for the run off of the Irish loan book with no Irish presence. They are currently reviewing all areas to satisfy LBG, the auditors & HMRC that there is no presence in Ireland, that no-one is ignoring the guidelines and that operations in Ireland don’t affect how the Irish loan book is dealt with now that responsibility has passed to the UK.”

25 February 2011

LBG 2010 Results News Release which confirmed:

“Bank of Scotland (Ireland) Limited

In February 2010, we announced that we would close our retail and intermediary business in the Republic of Ireland, and in August 2010 we announced that we would transfer, subject to the necessary approvals, the [BOSI] business to [BOS]. The business was transferred to [BOS] on 31 December 2010, including all of the strategic management and decision making activities, at which point BOSI ceased to exist. As a result [LBG] no longer has any regulated banking business in the Republic of Ireland. [BOS] will utilise its extensive operational and management capability, including general and credit management, oversight and control, within the UK in relation to the Irish portfolio, aiding the efficient run-down of the existing lending portfolio.”

LBG 2010 Results Presentation by ED and TTO. Slides confirm that BOSI now dissolved, assets fully managed from UK and rundown driven by experienced BSU team. The transcript of the presentation stated:

“[TTO] Subsequent to our Interim Management Statement on 2 November of last year, we all saw a further significant deterioration in market conditions in Ireland, including concerns over the country’s fiscal position which ultimately led to the approval of its application for EU and IMF financial support.

As you know, our Irish operations are now closed to new business, and our focus is now on the efficient run-down of the portfolio. Having closed the regulated banking business in Ireland, we are managing the run-down using our UK based expertise.

[ED in response to a question] What we feel is that the 54% in Ireland is entirely adequate. Our actual impaired loans did not go up by much in the fourth quarter. What we thought was, that as Tim suggested in his prepared comments, that in fact the economy was going to be weaker and we would have the loans on our books for longer.”

ED’s witness evidence was as follows:

TT’s witness statement repeated information that is set out in the factual chronology above and in ED’s evidence. In the interest of avoiding repetition that information is not repeated, his witness statement relevantly stated as follows:

TTO’s witness statement repeated information set out in the chronology and facts above, in ED’s witness statement and in TT’s witness statement. In the interest of avoiding repetition that information is not repeated, his witness statement relevantly stated as follows:

We set out at the outset that we have concerns regarding the manner in which the experts were instructed. It is clear from the instructions to the experts that they were provided with very little or no background information or documentation. In certain instances, the experts were not provided with all the information relevant to the very issues that they were instructed to advise upon. The instructions were framed in such a narrow way which, together with the minimal information and documentation provided to the experts, resulted in expert reports which did not greatly assist the Tribunal nor discharge the experts’ duty to assist the Tribunal rather than the instructing party. For the reasons set out at paragraphs 515 to 544 below, we concluded that the expert evidence was largely irrelevant to the issues in dispute before us. For the sake of completeness and, in the event that the appeal proceeds further, we have summarised the expert evidence.

Mr Ciarán Rogers is a partner in A&L Goodbody LLP (“ALG”) and former head of the Banking and Finance Department of ALG. He qualified as a solicitor in England and Wales at Linklaters LLP and has advised the financial services industry in Ireland on Irish legal and regulatory law and regulation. He has extensive experience advising on Section 33 and CBMs involving Irish credit institutions. He was instructed by the Appellant to provide an expert report on the legal mechanisms available in 2010 to facilitate the transfer of a banking business from an Irish credit institution to an entity incorporated outside of Ireland, principally focusing on:

Schedule 1 to his report confirmed that he had been provided with and considered the following six documents when preparing his report:

The report set out the following:

In summary, he concluded that taking account of (i) the background to the BOSI Transaction, (ii) the legal mechanisms available in 2010 to transfer the assets and liabilities of an Irish credit institution; (iii) the principal advantages and disadvantages of the use of a s33 transfer and CBM given the particular circumstances of the BOSI transaction, in his opinion it was reasonable and credible from a legal perspective for the BOSI Transaction to be structured using a CBM rather than a s33 transfer.

He confirmed that ALG was not directly involved in the BOSI Transaction but ALG did act for the then existing BOSI management team to set up Certus in Ireland to provide outsourced loan administration services back to BOS immediately following the transfer of the loans to BOS pursuant to the CBM. He was not personally involved in advising on the Certus matter. ALG also acted for a number of acquirers of loan portfolios originated by BOSI (and included in the CBM) which were subsequently sold by BOS. Again, he was not personally involved in advising the acquirers on these loan portfolio sales and he did not regard this work as creating a conflict of duty that would interfere with his duty to the Tribunal nor his ability to provide impartial advice.

He understood and was advised that:

He considered that in order to transfer the assets and liabilities of a credit institution in 2010 three options were available under Irish law: a contractual transfer, a s33 transfer and a CBM.

He did not consider that a contractual transfer would have been a practical solution for the BOSI Transaction given its commercial objectives. Any contract under which BOSI had an obligation or a liability (i.e. a bank deposit arrangement) could have only been transferred by way of a novation and with the consent of the contractual counterparty (i.e. each depositor or customer). This would have been too problematic from an operational and execution perspective. The only practical solution was the use of a s33 transfer or CBM.

A s33 transfer was the mechanism largely used by an Irish credit institution to transfer all or part of its banking business to another Irish credit institution, it was amended to permit the transfer by an Irish credit institution of all or part of its banking business to the Irish branch of another EU credit institution. It is domestically focussed. It does not envisage or facilitate the transfer of an Irish banking business to an entity incorporated or domiciled outside of Ireland which does not have a branch in Ireland. This domestic focus is also reflected by the recognised limitations of Section 33 to effect a transfer of assets or liabilities governed under the laws of a country/jurisdiction which is not Ireland.

CBMs were introduced under the CBM Directive (and transposed into Irish law under the Irish CBM Regulations) as part of an EU initiative relating to the functioning of the single market and to facilitate cross-border mergers between various types of limited liability company governed by the laws of different Member States. It facilitated cross border mergers between limited liability companies operating in Ireland and another EU member state without the need to establish a branch in Ireland and also facilitated the transfer of contractual arrangements and liabilities which were governed by the laws of another EU member state and not just contracts governed by Irish law.

He set out the principal advantages and disadvantages of a s33 transfer.

His opinion was that taking account of (i) the background to the BOSI Transaction, (ii) the legal mechanisms available in 2010 to transfer the assets and liabilities of an Irish credit institution; (iii) the principal advantages and disadvantages of the use of s33 and CBM given the particular circumstances of the BOSI Transaction, it was reasonable and credible from a legal perspective for the BOSI Transaction to be structured using a CBM rather than s33.

In cross-examination, Mr Rogers accepted that he had not been made aware of the MTP strategy to manage for value nor the decision that a branch option was effectively ruled out in June 2010 [6/8/11-22 and 6/11/15-12/6]. He confirmed that “the background to the BOSI Transaction” referred to at paragraph 1.3 of this report was based upon the six documents provided to him, [6/25/2-26/7] and that he had just followed the information in his instructions, [6/78/4-11]. He accepted that there was nothing in s33, which he accepted gave MF a very broad discretion [6/84/17-23], that indicated that a s33 transfer would not be possible where the transferee branch was to be closed shortly after transfer. The MF’s power/discretion would have to be interpreted and exercised in accordance with EU law and there was nothing in Regulation 23 of the EC (Licensing and Supervision of Credit Institutions) Regulations 1992 that confers an entitlement on the host Member State regulator/authority to withhold conferring a banking licence on a branch of an undertaking exercising its EU law passporting rights, [6/87/9-17]. He accepted that the requirements for the exercise of the passporting right are essentially procedural and the only question is whether the FSA would have processed LBG’s application, [6/60/21-23].

Mr Paul Sharma has over 20 years of experience as a senior UK, EU and global regulator of banks and insurance companies including as Director of Prudential Policy at FSA, UK’s alternative member of the Board of Supervisors of the European Banking Authority (“EBA”) and a member of the Basel Committee on Banking Supervision (“BCBS”). In 2013, he was an Executive Director of the Bank of England and the Deputy Head of the Prudential Regulation Authority (“PRA”) before taking up his current position as the managing director of Alvarez & Marsal (“A&M”).

He was instructed to address the following areas in relation to LBG’s decision to undertake the CBM, focusing specifically on the period between 1 January 2008 and 31 December 2010 (“Relevant Period”):

He confirmed that the above paragraph was the extent of his instructions and that he had been assisted in the preparation of his report by staff at A&M but the opinions stated were his own. Paragraph 1.4.3 of his report stated that “A full list of the information that I have relied upon is set out at the start of this Report, which includes documents that I have obtained from LBG and from publicly available sources.”

It suffices for these purposes to set out the executive summary which is summarised as follows:

In cross-examination, Mr Sharma confirmed that he had made a request to his instructing solicitors for further information, the additional documents that he had been provided were not listed in his report but were only referred to in his report and exhibited if they had been relied upon, [7/4/5-5/2 and 7/6/4-22]. He confirmed that only one document exhibited to his report, AM49, detailed LBG’s interaction with either of the regulators, [7/6/25-7/14/7], and that his report in some instances provided opinions on alternatives that were not put to the regulators but hypothesised as to what would have been the regulatory considerations if they had been put to the regulator, [7/7/15-7/9/6].

Mr Tom Godfrey (“TG”) is the Chairman and Chief Executive of IBI Corporate Finance Limited (“IBI”), a Corporate Finance adviser in the Irish market, advising on Mergers and Acquisitions (“M&A”), debt and equity capital raising and providing strategic advice to Irish public and private companies, Irish State and semi-state agencies. He had advised on banking transactions mainly for BoI but also for BNP Paribas, Irish Permanent, Irish Life & Permanent and the Irish Government in relation to TSB Bank and ACC Bank. He is a fellow of the Securities and Investment Institute.

He was instructed by LBG to provide an expert report on the possibility of a sale by LBG of BOSI or its portfolio of loans in the period 1 January 2009 to 31 December 2011 (“the Relevant Period”). He was not provided with any of the appeal documents [8/3/21-4/17] and the reference to Project Hermes paper at page 26 of his report was based upon the information provided by his instructing solicitors, he had not seen the document [8/2/24-3/20] He confirmed that he did not need to see any of BOSI’s own documents in order to provide his expert report [8/4/5-12].

The Executive Summary of his Report stated that in his opinion it would not have been possible to sell BOSI or its loan portfolio in the Relevant Period. His opinion was based on:

His advice, during the Relevant Period, would have been for LBG to recapitalise, work out the loans as rigorously as possible, wait for the bottom of the market and position for sale of loan portfolios when the market showed signs of recovery and there was an established buyer group. His opinion was that the best way to maximise value from BOSI in LBG’s exit from the Irish market would have been to sell the individual constituent parts over time when the markets improved to buyers who had an appetite for each asset class e.g., non-performing loans (“NPLs”), commercial, performing residential etc. This had been the method adopted by all the foreign banks that had exited the Irish market after the Relevant Period: Rabobank, Danske Bank, KBC Bank and Ulster Bank (NatWest). Save for the mergers of two nationalised banks with other nationalised banks as directed by the Irish State and the purchase of impaired property loans by the NAMA, he was not aware of any Irish bank or portfolio sales in the Relevant Period. It was a matter of public record that Anglo Irish Bank (“Anglo”), Irish Nationwide Building Society (“INBS”), and the Educational Building Society (“EBS”) all sought purchasers in the Relevant Period, and none were successful. He was also aware of another Irish bank that was proposed for sale without success. It was his view that there was no market for Irish Banks and he was not aware of any disposal of Irish loan portfolios in the Relevant Period. He considered BOSI to be a very poor asset, a view shared by the market. There would have been no market for BOSI in the Relevant Period.

His view, based on the Project Hermes paper prepared for the LBG Board on 3 August 2010, was that the internal forecasts at that time would have given rise to grave concern by any potential buyer about the magnitude of future capital/funding commitments.

In his experience any Private Equity buyers/Sovereign wealth funds etc. looking to acquire banks or bank assets in Ireland in the Relevant Period would have:

On the introduction of the Guarantee in September 2008 the fate of the Irish State became intertwined with the banks which in time also brought down the Irish State. This link between the Irish banks and the Irish State was described as a “doom loop” in which State and domestic bank risks fed each other, the Irish banking system became the most supported banking system in Europe in 2008.

As the Irish economy deteriorated, so too did the fiscal position of the banks and NPLs started to increase at a rapid rate. Early attempts to bolster banks’ capital turned out to be woefully inadequate and several rounds of stress tests gave rise to larger and larger capital requirements.

The Irish economy, suffering from a domestic property crash and the global financial crisis, was unattractive for investors in the Relevant Period. The economy had grown significantly on the back of property development. Banks held significant amounts of security in the form of property assets. Post the crash in 2008, the face value of the loans significantly exceeded the underlying security value. Given falling property prices, a floor could not be established for the value of the underlying security. He considered it clear from this backdrop that, during the Relevant Period, the Irish economy was in a major crisis with even speculation about the future of the Eurozone. It was his view that a market for M&A in the Irish banking sector simply did not exist in the Relevant Period.

He was aware that a number of such potential buyers considered potential transactions but none proceeded. He referred to a media report (Sunday Tribune - “After two false dawns, night falls on Halifax”, 14 February 2010) in the Relevant Period which stated that LBG hired a UK corporate finance adviser, Hawkpoint, to examine the potential sale of BOSI without local management's knowledge. It was reported that a US private equity firm, believed to be Blackstone, baulked at a deal to buy BOSI's assets at a significant discount having completed six weeks of due diligence. It was further reported that BOSI continued to seek purchasers for elements of the business from both local and international banks without success. He concluded by stating that he could make no comment on the veracity of these reports.

He did not consider that the sale of BOSI for a nominal amount would have been a realistic proposition as a purchaser would have been exposed to the risk of potential claims and would need to arrange funding of €19.3bn to replace existing/LBG funding and inject regulatory capital of around €1.6bn. In his opinion, there was no possibility of BOSI’s tax losses being taken into account in the pricing of any transaction by a purchaser as it was unclear whether there would have been any opportunity to use the losses.

In cross-examination he was asked why he did not ask his own client to furnish documents relating to the Hawkpoint instruction and the details of the proposed sale to Blackstone, and in particular the price being offered and the reason why the sale fell through. His response was that he had asked his instructing solicitors for the documents but that nothing was provided other than “a response to proceed with my document as I saw fit.” [8/61/13-63/7]. He was not re-examined on that point. He confirmed that he was not aware of the MTP strategy [8/20/3-9]. He stated that he knew better than the senior staff at BOSI or LBG as to what was worth saving or not in 2009, [8/31/21-32/11].

Following Mr Godfrey’s oral evidence that he had asked his instructing solicitors for documents in respect of the proposed sale to Blackstone, the Tribunal received a letter from STB the following day which stated:

“Upon receipt of Mr Godfrey’s report, we raised this matter with our client. LBG confirmed to us that having checked their internal records, LBG did not, in fact, engage Hawkpoint and LBG did not have any discussions with Blackstone. Further, LBG confirmed that they were not aware of any due diligence having been conducted by Blackstone with regard to BOSI. Accordingly, there were no documents to be shared with Mr Godfrey.”

As HMRC submitted, the reference to Mr Godfrey’s report in the letter was presumably on receipt of Mr Godfrey’s draft report before it was finalised and served. STB’s letter does not address whether Mr Godfrey did request the documents or, if he did, that he was told to proceed as he saw fit. In our judgment, the letter from STB is, as HMRC, submitted, an impermissible attempt by STB to give evidence after the event. Accordingly, we have attached no weight to the letter and accept Mr Godfrey’s evidence in respect of Hawkpoint and the prospective deal with Blackstone.

The Dutch law expert reports were agreed by the parties and the experts did not attend to give evidence. The experts agreed on the relevant Dutch law and the availability of tax relief in the Netherlands. The experts were agreed that, as a matter of Dutch tax law, there was no possibility to transfer or utilise losses sustained by BOSI and SIF could not have taken into account a liquidation loss.

The principal reason that SIF could not claim such liquidation loss as a form of relief for the losses of BOSI, is that SIF transferred its shareholding in BOSI by way of a sale to its parent company BOS (which company was not subject to tax in the Netherlands or in any case not with respect to the acquired shares in BOSI). Only an actual liquidation of a subsidiary company could lead to recognition of a liquidation loss.

A fiscal unity was in place comprising the Dutch Permanent Establishment (PE) of BOS together with Quion BV (a 100% subsidiary of BOS) (BOS fiscal unity). The BOS fiscal unity was headed by the PE of BOS. SIF joined the fiscal unity from 1 January 2009.

The 2010 corporate income tax (CIT) return in the name of BOS shows that SIF had a stand-alone taxable profit of €128,675 which was off-set by a carried-forward pre-fiscal unity (2008) loss of €128,675. The loss of €5,318,193,445 in respect of the holding of shares in BOSI, included in the 2010 CIT return, was not deductible in the Netherlands as it was subject to the participation exemption. The Dutch tax authorities confirmed the existence of the BOS fiscal unity and its enlargement in 2009 and there were no queries in respect of it for 2010.

As a result of SIF joining the BOS fiscal unity from 1 January 2009, for CIT purposes, its balance sheet and profit and loss account (P&L) were absorbed in the balance sheet and P&L of the Dutch PE of BOS, the ‘parent’ of the BOS fiscal unity. This resulted in a full consolidation of its balance sheet and P&L for Dutch CIT purposes. For CIT purposes, profits were no longer calculated individually at the level of SIF or other members of the BOS fiscal unity, rather, there was one single taxable profit calculation for the entire BOS fiscal unity, which was considered the consolidated result of the Dutch PE of BOS.

Annually, the Dutch PE of BOS filed one single CIT return on behalf of the BOS fiscal unity and CIT was levied as if the consolidated taxable profits had been generated by the Dutch PE of BOS. For purposes of collecting the CIT though, any member of the BOS fiscal unity, including SIF, remained jointly and severally liable.

The 2010 stand-alone taxable profit of SIF, calculated in accordance with the profit split rules prescribed by the Dutch Corporate Income Tax Act (Wet op de vennootschapsbelasting) 1969 (CITA), was only relevant in the context of the BOS fiscal unity’s use of the pre-fiscal unity losses of SIF in 2010.

The application of loss carry-over by the BOS fiscal unity, and in particular pertaining to the SIF pre-fiscal unity losses, took place in accordance with Dutch CIT rules. Such loss compensation, as far as financial year 2010 is concerned, was exhaustive.

The BOS fiscal unity (including SIF) could not utilise the BOSI 2010 losses under Dutch law. Furthermore, it could not utilise such losses under EU law, as interpreted by the Dutch tax courts and the CJEU. In accordance with Dutch tax law, it is not possible to transfer or utilise losses sustained by foreign subsidiary companies. As a matter of Dutch tax law, there was no possibility to transfer or utilise losses sustained by BOSI and SIF could not have taken into account a liquidation loss. The principal reason that SIF could not claim such liquidation loss as a form of relief for the losses of BOSI, is that SIF transferred its shareholding in BOSI by way of a sale to its parent company BOS (which company was not subject to tax in the Netherlands or in any case not with respect to the acquired shares in BOSI). Only an actual liquidation of a subsidiary company could lead to recognition of a liquidation loss. Therefore, given the way in which the restructuring involving BOSI was in fact implemented, there was no possibility for relief in the Netherlands in respect of the losses sustained by BOSI, nor for an investment loss sustained by SCI on the shares held in BOSI.

Both experts stated that the Dutch State Secretary of Finance was of the view that the Dutch liquidation loss regime is an adequate regime for importing foreign final losses and should be considered in line with M&S.

Articles 15-15al and 15a CITA form the legal basis of the Dutch fiscal unity. A Dutch tax resident parent company and its Dutch tax resident subsidiaries may, under certain conditions set out in article 15 CITA, most importantly a 95% or more shareholding and having the same fiscal year, jointly request the establishment of a fiscal unity. The request is filed with the Dutch Revenue Service and may have a retroactive effect of up to three months. Once established, the fiscal unity files a CIT return as one single entity. Pursuant to article 15(1) CITA, the effect of the fiscal unity is that the balance sheet and P&L of the subsidiaries that are members of the fiscal unity are consolidated with the balance sheet and P&L of the parent of the fiscal unity and CIT is imposed on the members of the fiscal unity as if they were absorbed by the parent. A loss, incurred by a fiscal unity will be vertically carried back or forward against the taxable profits of the fiscal unity in previous and future years, as per the normal rules set out in CITA and subject to the relevant timing limitations.

SH was instructed by the Appellant and MA by HMRC. Mr Hogan’s report was dated 9 December 2022 and Mr Ashe’s report dated 19 January 2023. SH is an Irish qualified solicitor, chartered accountant and chartered tax adviser and a partner and head of tax at Matheson LLP, Dublin. MA is a barrister and has practised at the Irish Bar since 1978 and was appointed a Senior Counsel in 2000. He has also practised at the bar in England and Wales since 1978 and is a KC. The experts were not instructed to provide their opinion on the same questions of Irish tax law. The joint expert report set out areas of agreement and disagreement, we have incorporated their respective responses into the summary of their reports below.

Mr Hogan’s report addressed seven issues as follows:

In cross-examination SH accepted that the four-page briefing paper appended to his report was the totality of his instructions and information provided, he had not been provided with any case documents. SH confirmed that he was not made aware that BOSI’s decision not to write any new loan business in retail or wholesale had been taken and effected in 2009 contrary to what was stated in paragraph 2.5 of his report – “In early 2010, the decision was taken … and to cease all loan origination” stating “It was news to me.” [9/9/3]. His evidence was that he did not consider that the new information would change anything in his report. He further confirmed that he was not made aware of the extent of the impairments in 2010.

LBG’s submissions are summarised as follows.

In 2009 and 2010, LBG grappled with the consequences of the acquisition of HBOS. In early 2009, LBG was able to review HBOS’s books in detail for the first time. At the same time, LBG’s risk function advised that the economic outlook was far worse than LBG (and most of the market) had predicted in 2008; LBG increased its forecasts of HBOS’s impairments such that the total impairment figures for 2008 and 2009 were estimated at that time to be £23.9bn.

During 2008, as markets worsened, bank capital ratios became a key measure of financial strength and a point of focus for regulators and investors. The FSA nearly doubled the amount of capital that it expected banks to hold. Around the same time that LBG was coming to terms with HBOS’s books, the FSA conducted stress tests on LBG to ensure that its capital was sufficient to withstand future adverse events. The stress tests used more severe economic reference points than had previously been applied, as a result LBG had to raise an additional £24-£29bn of Core Tier 1 Capital in 2009. Some of the capital had to be raised by the issue of shares to the UK Government.

LBG spent much of 2009 exploring ways to raise additional capital. Because of its 2008 impairments (and other reasons), in 2008, HBOS made a loss of approximately £11bn. In 2009, BOS made a loss of approximately £16bn and Lloyds Bank plc (the main banking entity within the legacy LTSB) made a loss of approximately £4.38bn. Although the LBG accounts showed a consolidated pre-tax accounting profit of approximately £281m in 2010, in that year the group suffered a significant increase in loss before tax in the W&I division, which was driven by a higher impairment charge, predominantly due to the material deterioration of the economic environment in Ireland.

When LTSB acquired HBOS, BOSI was a full service wholesale and retail bank in the Republic of Ireland and Northern Ireland. BOSI, as an Irish credit institution, was subject to regulation by the FR and was required to maintain a prescribed level of regulatory capital and liquidity as a condition to maintaining its Irish banking licence. At the same time, the LBG group, as a UK based financial business, was subject to regulation by the UK financial regulator, which at the time was the FSA. This dual regulation (in Ireland and the UK) created challenges as bank regulators imposed more stringent regulatory requirements on banks.

In the years leading up to 2009, BOSI had grown substantially to hold approximately €33bn of assets. Approximately 40% of BOSI’s loan assets comprised loans made by it to the CRE sector in Ireland. Of its remaining loan assets, approximately 30% comprised non-CRE commercial loans and the rest were retail mortgages and loans. BOSI’s loans to the CRE sector had grown significantly and this growth had been facilitated by the provision of the Guarantee from BOS.

Against a backdrop of the worsening economic environment in Ireland, BOSI’s performance deteriorated rapidly. In 2008, BOSI suffered an impairment charge of £526m. However, in 2009 this grew significantly and BOSI’s impairment charge for 2009 was £2.949bn. During 2010, the position deteriorated even further than had been anticipated. The full year position in 2010 was that BOSI suffered an impairment charge of £4.26bn. As at the end of 2010, BOSI’s cumulative impairments on its loans and advances to customers stood at £7.8bn. As a public listed company, LBG had to periodically update the market on the group’s impairment charges and it had to increase its forecast for the Irish impairments several times throughout 2010. LBG struggled to ensure adequate control and stem the increasing impairment losses in Ireland.

This led to regulatory pressure on LBG from different directions. BOSI needed additional capital to ensure it met minimum Irish regulatory requirements. At the same time, LBG was required to maintain an appropriate capital position in the UK. Management of these dual regulatory requirements was a significant consideration for LBG because raising additional regulatory capital in 2009 and 2010 was difficult. LBG also came under pressure from both the FSA and the Irish financial regulator regarding the Guarantee. The Irish financial regulator became concerned that BOS may default on the Guarantee and therefore wanted it replaced with share capital. At the same time, the FSA wanted LBG to limit the UK group’s exposure to the Guarantee because it wanted the assets of BOS to support the risks in the UK business rather than in the Irish business.

Due to BOSI’s poor financial state, BOSI was unable to raise its own liquidity and funding. It became almost entirely dependent on the LBG group. At the same time, LBG was facing its own liquidity and funding challenges. By the end of 2009, LBG was reliant on £157bn of funding and liquidity support from the UK Government and Bank of England. Part of this had to be used to fund BOSI. By the Spring of 2010, LBG had provided €20bn of loan funding to BOSI to prop up its business and BOSI was totally reliant on LBG for survival.

To deal with the regulatory and funding challenges LBG was facing, as well as the challenge from the EU in respect of the state aid that LBG had received from the UK Government, in 2009, LBG’s directors decided that the LBG group should have a UK focus. In the Summer of 2009, LBG publicly announced that it would reduce the size of its non-core assets by approximately £200bn over the next 5 years. Having made this announcement, LBG was expected to both measure and report progress on its non-core asset reductions to the market. LBG determined, at the outset of its non-core asset reduction strategy that BOSI was non-core. There was also significant market and shareholder pressure on LBG to clarify its strategy in Ireland, particularly given the development of the PIIGS (Portugal, Italy, Ireland, Greece and Spain) Eurozone crisis and the continually increasing impairments in BOSI.

Following the required recapitalisations, UKFI held approximately 43% of LBG’s shares, and two representatives of UKFI sat on the Board of LBG as non-executive directors (NEDs). These NEDs were in favour of LBG’s strategies of mainly focussing on the financial service markets in the UK and reducing LBG’s non-core business, which included the Irish business.

In addition, there were significant challenges to colleague morale and engagement in Ireland. It was against the backdrop of all of these issues that the GEC took the decision in early Summer 2010 to recommend a full exit from Ireland to the LBG Board. The appropriate mechanism for exiting Ireland needed to be determined but it had to meet the desired commercial objectives which included:

The CBM was favoured because there were significant disadvantages associated with a s33 transfer, as it required the approval of the MF. In addition, the s33 transfer did not cover the transfer of non-Irish law governed contracts (BOSI had a substantial Northern Ireland branch with non-Irish law assets and was party to derivatives which were not governed by Irish law) and would have required significant legal due diligence to determine which assets were not covered. Assets not covered would have to be transferred individually which would have required obtaining the consent of each and every counterparty. This was not feasible. A s33 transfer also had to be a transfer to an Irish regulated company or an Irish branch of an EU credit institution which would have required prior regulatory approvals and would have been subject to ongoing regulatory supervision by the FR. The existence of an Irish branch would have meant continued Irish regulation and would not have enabled a clear message to be given to the market that LBG had exited the Irish market (unlike the CBM, which allowed the immediate surrender of BOSI’s Irish banking licence). In addition, LBG believed that a liquidation of BOSI following a s33 transfer would be optically less attractive to external stakeholders, including the FR.

LBG wished to move control of the Irish loan book to the UK in order to manage and maximise asset recoveries by the London BSU. At the same time, LBG wanted to maintain contacts and relationships with the customers who BOSI had lent to. That was why LBG engaged the services of Certus, an independent loan serving entity staffed by former BOSI employees. Certus provided local services to BOS in relation to the Irish loan book but control and decision making regarding the loan book resided with the London BSU. Certus assisted with the processing of collections from customers and provided administrative services in relation to the Irish loans. Certus was chosen for this role as it was run and staffed by those familiar with the Irish loan book and, compared with other third party providers, was cheaper and only required one contract. A final decision to use Certus was not taken until after the LBG Board meeting on 3 August 2010.

On 17 September 2010, the Dutch intermediary holding company, SIF, transferred its holding of the entire share capital of BOSI to BOS. This transfer was effected in order to enable the merger of BOSI into BOS to be by way of a merger by absorption. Under the CBM by way of absorption, BOS acquired all the assets and liabilities of BOSI without the need to issue any shares in BOS. If SIF had remained the intermediary holding company of BOSI, it would not have been possible to effect a CBM because a CBM in this case would have required the issue of shares by BOS to the shareholder of BOSI (i.e. SIF). That would have resulted in SIF becoming a member of BOS, which it could not do as a matter of company law. Accordingly, BOSI needed to become a direct subsidiary of BOS which is why BOSI was transferred from SIF to BOS.

The main issue is whether the qualifying loss condition in s119 was met. The UK domestic legislation imposes its own test of finality of losses, namely the qualifying loss condition in s119. To the extent that the test in s119 is met, losses will be “final” in accordance with the UK’s domestic law, irrespective of whether or not the para 55 conditions were met. The qualifying loss condition in s119 is met if the losses which are the subject of the CBGR claim could not be taken into account in calculating the taxable profits or gains of BOSI or any other person for Irish tax purposes, or otherwise be relieved (e.g., by credit or reduction of tax liability) for Irish tax purposes, in any future period (the “no possibilities test”).

Under s119(4), the determination of the no possibilities test is to be made “at the time immediately after the end of the EEA accounting period”. BOSI’s EEA accounting period terminated immediately upon the CBM taking effect. Accordingly, immediately after the end of the EEA accounting period (i.e., the time at which the no possibilities test is required to be determined pursuant to UK domestic law) BOSI had no assets or source of income and had ceased to exist. The qualifying loss condition in s119 was therefore met in respect of the CBGR claimed by LBG. LBG does not accept, per HMRC’s Statement of Case, that “options” were available as none of those were factually or legally possible as BOSI had ceased to exist at the time at which the no possibilities test is to be determined. As all permissible claims under Irish law for all available loss relief and/or loss surrenders by or to BOSI were made, the residual losses of BOSI to which the claim by LBG for CBGR relates are final losses in respect of which the no possibilities test and the qualifying loss condition in s119 were met.

Section 121 provides that an amount of losses will meet the precedence condition “so far as no relief can be given for it” in any territory which is outside the UK, is not the same territory as that in which the surrendering company is resident (which is Ireland in the present case) but is a territory in which a company is resident that owns, directly or indirectly, ordinary share capital in the surrendering company (BOSI). Here, the precedence condition is met because there was no territory in which relief could have been given for the losses of BOSI. There was no company resident in a territory outside the UK that owned ordinary share capital in BOSI at the time that the precedence condition is to be applied.

Section 127 disallows a loss if it would not have been eligible for group relief but for any arrangements the main purpose, or one of the main purposes, of which is to secure that the loss or part of it may be surrendered as group relief.

The purpose of the arrangements was the exit from the Irish market in a manner that met LBG’s commercial requirements: to send a clear signal to shareholders, investors, analysts and ratings agencies that LBG had exited the Irish market permanently; to have the Irish loan book managed by the experts in the London BSU so that recoveries from that loan portfolio could be maximised; to eliminate the challenges presented by being regulated by two sets of regulators; and to ensure that LBG would not be required to commit further resources such as regulatory capital, liquidity and funding to Ireland. An exit by way of a CBM achieved these objectives. Other ways of exiting Ireland had legal and/or commercial disadvantages that made them unattractive compared with a CBM. Project Hermes was a wholly commercial transaction and the decision was not driven by any tax analysis.

The main purposes of the relevant arrangements are to be tested by reference to the purposes of the ultimate “decision makers” unless those persons have ceded control to other persons, Oxford Instruments. In this case, control had not been ceded and the “decision makers” were the members of the LBG Board and the Sub-Committee appointed by that Board. Considering whether CBGR is available in particular circumstances does not mean that securing such relief was a purpose, let alone a main purpose, of the arrangements. There is no requirement to effect transactions in the most tax inefficient manner possible. The manner in which HMRC is seeking to apply s127 is not consistent with EU law which only precludes group relief surrenders involving “wholly artificial arrangements” which was not the case here. The possibility of obtaining CBGR was a potential benefit flowing from the transaction but it was not a main purpose (Euromoney Institutional Investor plc v HMRC [2021] S.F.T.D. 891 (“Euromoney”) at [95])

In the further and final alternative, even if it could be demonstrated that the arrangements in question did fall within the ambit of s127 CTA, the manner in which HMRC has sought to apply s127 to deny CBGR contravenes Article 49 (in conjunction with Article 54) TFEU. Section 127 must be construed in a way so as not to undermine the objectives of EU law or frustrate applicable EU jurisprudence as regards the rights conferred on nationals of EU Member States. Despite the UK having left the EU at the end of 31 December 2020, UK domestic law enacted before that date, such as the CBGR rules, must be interpreted in accordance with EU law as applicable at that date.

Section 127 must therefore be interpreted in accordance with the decision of the CJEU in Cadbury Schweppes (C-196/04) (“Cadbury Schweppes”). This means that any purpose test should only apply to “wholly artificial arrangements”. To the extent that the provision is applied in a manner that goes further than necessary to achieve the legitimate purpose of excluding “wholly artificial arrangements”, s127 would represent an infringement of EU law.

HMRC’s submissions are summarised as follows.

LBG has sought to re-characterise the nature of the primary evidence. The contemporaneous documentary evidence makes clear that seeking CBGR was either the main driver or one of the main drivers when LBG considered the options available in 2009/2010 before executing the CBM. It is significant that LBG has not adduced witness evidence from those individuals who, it is clear from the contemporaneous documentation, were closely involved in the design and implementation of the arrangements which are the subject of this appeal.

Questions of direct tax are matters of retained competence. It is therefore for each Member State to design their own system of taxation as they see fit. As confirmed by the CJEU in FII at [47], who is liable to direct forms of taxation, on what basis and in what amounts are therefore matters of retained Member State competence.

M&S is a foundational authority on the question of when a Parent company in Member State A might be entitled to seek to use losses incurred in a trade carried on by its subsidiary established in Member State B by setting them off against its own profits chargeable to tax in Member State A, thereby reducing its liability to corporation tax in Member State A. The CJEU accepted that the differential treatment of resident and non-resident group subsidiaries could be objectively justified on three bases:

The CJEU agreed that those three justifications together were legitimate objectives which were compatible with Article 49 TFEU. The CJEU said that measures denying group relief in respect of a loss from a non-resident subsidiary would be disproportionate only where the para 55 conditions were met.

In Re A Oy the CJEU confirmed that the burden of proving the no possibilities test was on the taxpayer, [at 49]. It was for the national court to determine whether the taxpayer discharges that burden on the facts, [at 54].

LBG suggests that the UK legislation that seeks to implement the principles in M&S must be read separately to that case and the CJEU case law that followed it. Parliament’s clear intention was to enact legislation that would comply with the principles in M&S. Parliament was seeking only to amend its legislation to ensure that CBGR was available to meet the Para 55 conditions and no more. Plainly what became Chapter 3 of Part 5 was not seeking to “gold-plate” the CJEU’s ruling, by making CBGR available in a wider set of circumstances than the Para 55 conditions required.

Case C-172/13 Commission v UK (“EC v UK”) involved a challenge to the way the UK responded to the judgment in M&S in its reform of the group loss regime by way of the CTA . Specifically, the Commission contended that the CTA did not in fact comply with the CJEU’s decision in M&S, because “the possibility of obtaining cross-border group relief is virtually impossible under United Kingdom law”, a challenge that was comprehensively rejected by the CJEU and which cannot now be revisited by LBG. The Court held that: “Sections 118 and 119(1) to (3) of the CTA 2010 allow losses sustained by a non-resident subsidiary to be taken into account by the resident parent company in the situations contemplated in paragraph 55 of the judgment in Marks & Spencer…”.

The Court further rejected the Commission’s contention that s119(4) made it virtually impossible to be able to claim CBG relief in respect of a non-resident’s losses. LBG seeks to rely on s119(4) insofar as it provides that the time at which the “no possibilities” test is to be taken into account is “at the time immediately after the end of the EEA accounting period”. LBG seeks to contend that because the CBM took place immediately before the end of the EEA accounting period (31 December 2010) there was no possibility of BOSI’s losses being used in Ireland because it had ceased to exist and had no assets or source of income and accuse HMRC of ignoring the clear words of s119 by seeking to apply the “no possibilities” test immediately prior to the dissolution of BOSI. It is simply not the case that EU law gives a parent the power to dissolve a non-resident subsidiary and, through that choice, generate definitive losses. BOSI had a range of possibilities prior to the end of the 2010 accounting period. Several of those possibilities would have enabled BOSI’s losses to be used such as to preclude the possibility of there being definitive losses. On LBG’s construction, a parent has a power to elect to create definitive losses: that is plainly inconsistent with the case law that s119 was enacted to give effect to and in light of which it must be interpreted.

Decisions post M&S have narrowed the para 55 test. Whether a loss might be a final or definitive loss was considered in case C-322/11 K. In K , the CJEU made clear that a Member State is not required to take into account losses from a non-resident activity if taking the losses into account at the place where the activity took place is precluded by law (‘the legal bar exclusion of final or definitive losses’), at [76]-[81].

In case C-123/11 A Oy, the CJEU concluded that the liquidation of a subsidiary which had essentially ceased trading was not sufficient in itself to support the assumption that there was no longer any possibility of relief for it in its State of residence such as to give rise to final or definitive losses.

Whether a loss might be a final or definitive loss was considered again in Memira and Holmen. The AG in Memira applied the principle in C-123/11 A Oy in concluding that where a non-resident subsidiary was liquidated following a merger with the resident parent, the existing losses in the subsidiary’s State of residence could not be automatically regarded as final or definitive losses (AGO, paras 49 – 50).

The unilateral choice of LBG to pursue a CBM (over other available options) is a further reason why those losses cannot be final or definitive as such losses are not within the gift of the taxpayer: a point reinforced by the fact that choice was exercised in order to crystalise the losses to support a claim for CBGR. Thus, BOSI’s 2010 losses cannot become final losses by, immediately before the end of the 2010 accounting period, pursuing a CBM by which BOSI ceased to exist whereupon, by operation of law, it can no longer exist such that, for example, it is no longer able to sell its business or assets, or to sell its shares to a third party such that BOSI might continue to trade, or to undergo a group restructure to permit another group company to continue the trade, even in run-off. Thus, a distinction must be drawn between losses that cannot be used in law (which losses cannot be final losses, those losses arising as a result of a legal bar, and where other Member States cannot be expected to adapt their tax legislation to provide for the consequences of those legal bars) and losses that cannot be used in fact (which can be final losses), AGO at [66] Memira.

LBG seeks to play down the significance of Memira and Holmen and also ignores the fact that the CJEU has, in effect, sought to further narrow the application of the para 55 conditions. The Court has, in A Oy and Memira, clearly held that exercising an option to merge, whether or not that involves a liquidation of the subsidiary, precludes the existence of final losses, where such a choice means that there can be, as the legal consequence of the CBM, no possibility for the surrendering company to use those losses (being an effective legal bar – a company is precluded from using losses to the extent that the legal consequence is that ‘it’ no longer has losses to use, and/or because ‘it’, legally no longer exists such as to be capable of using those losses).

M&S has undoubtedly been confined in scope over the course of the case law since. LBG’s reliance on the Para 55 conditions as interpreted by the UK courts has been superseded by the later case law of the CJEU which transparently narrows the Para 55 conditions further.

Section 121, the precedence condition, deals with the possibility that relief is available in more than one territory. More particularly, it deals with the possibility that an intermediate non-UK resident parent or parents (but not resident in the relevant EEA territory) which itself is owned by a UK resident company may be able to claim relief in which case that intermediate parent has precedence over the relief of the EEA amount. If relief is available to the company in another territory in question it is again excluded from the EEA amount. LBG is wrong to suggest that losses can only be surrendered to an intermediate to the extent of the intermediate’s available profits: there is no basis for that in s121.

Arrangements will be excluded from CBGR relief if they fall within s127(3) which provides: “Arrangements are within this subsection if their main purpose, or one of their main purposes, is to secure that the amount (or part) may be surrendered for the purposes of group relief.” The purpose of s127 is to prevent groups creating a cross border loss or creating the conditions where a cross border loss could be claimed. Moreover, because s127 (in contrast to the unallowable purpose legislation) focusses on the object of the arrangements, the FTT is not restricted to considering what was in the mind of the directors who made the decision to exit Ireland. It is legitimate and necessary to consider what was in the minds of senior individuals and advisors who were involved in the formulation and implementation of the arrangements by which the exit was effected. It will in any event be necessary to consider the views and papers from the senior managers and advisers insofar as they were communicated to the directors and / or otherwise informed the directors’ decision-making.

LBG contends that if s127 is operative, the manner in which HMRC applied it in the present case contravenes Art 49 TFEU. This is incorrect. There is nothing in s127 itself that contravenes EU law – and having infracted the UK in relation to the CTA leading to EC v UK, the Commission notably took no point on s127. Moreover, the operation of a purpose test is inherently fact sensitive and not something the CJEU interferes with – that is a matter for the domestic court.

The burden of proof in this appeal is on LBG to establish on the balance of probabilities that the closure notice and the consequent amendments made by HMRC to its tax return are incorrect. HMRC’s reliance in its Statement of Case on the precedence condition in s121 is accepted by LBG. Therefore, in this appeal, LBG bears the burden of establishing on the balance of probabilities that the qualifying loss condition in s119 was satisfied; the precedence condition in s121 had been met; and s127 does not apply to exclude group relief.

HMRC submitted that the Tribunal should draw an adverse inference from the fact that relevant witnesses have not been called to give evidence about a relevant matter (Hannah and Hodgson v HMRC [2021] UKUT 0022 (“Hannah”) at [171]-[172] and that documentary evidence that might have undermined a party’s case has not been adduced (Wetton v Ahmed [2011] EWCA Civ 610 at [14]).

In respect of the first point, at [171] in Hannah the UT stated:

“[171] It is clearly established that a court or tribunal can take into account the fact that a relevant witness has not been called to give evidence on a relevant matter and can draw an inference that, if the witness had been called, the witness’s evidence would not support the case being advanced. Before a court or tribunal can draw such an inference, there must be a case to answer in relation to the finding which the court or tribunal is asked to make. There must be some admissible evidence, even comparatively weak evidence, which points in the direction of the suggested finding. If there is such evidence, then the court or tribunal is able to draw the inference, but is not obliged to do so. The court or tribunal can take into account any explanation given as to why a potential witness has not given evidence. Whether the court or tribunal does draw the inference, and the weight which it gives to the failure to give evidence, is a matter for the court or tribunal charged with the task of finding the relevant facts.”

It is immediately apparent from the extensive correspondence and documents referring to tax/tax planning and the options available to LBG (set out in detail above) that the same senior individuals repeatedly appear or are referred to: GS, MW, MS, SC, AK and SH. In our judgment, the witness evidence of those individuals would be clearly relevant to the determination of the role that tax/tax planning played in the timing and manner in which LBG exited Ireland. The witnesses would be able to confirm to the Tribunal their role, remit and the instructions they had received. We therefore do not accept LBG’s submission that the only relevant witness evidence is that of the three decision makers: ED, TT and TTO. We understand that some of the individuals referred to in the opening sentence to this paragraph were present at the hearing and therefore available to give evidence if required. We have therefore drawn an inference that, if the individuals had been called to give evidence, their witness evidence would not have supported LBG’s case.

In respect of the second point, HMRC submitted that LBG has failed to disclose relevant documents that might have undermined its case. Mr Milne referred us to correspondence dated 5 September 2018 from HMRC to LBG which referred to previous discussions regarding the deletion of a data site holding a large number of documents and, as requested by LBG, provided confirmation that: “1. HMRC confirms its consent to the deletion of the documents contained in the data site; 2. HMRC confirms that it will not be seeking any further disclosure of documents as part of the enquiry and proceedings before the First Tier Tribunal. 3. We are unsure as to what you mean by your "disclosure obligations" but can confirm that in our view LBG have made every effort to uncover and disclose to HMRC all relevant documents to the enquiry that may have been held on the data site.” HMRC’s position in respect of disclosure of documents could not have been made any more clearly and, in our judgment, it is unconscionable for HMRC to now submit that the Appellant has failed to disclose relevant documents and we decline to draw an adverse inference. It is clear that some of the documents in the hearing bundle are incomplete but would note that the burden of proof in this appeal, which is not disputed, lies with LBG.

The witness statements of ED, TTO and TT made minimal reference to the contemporaneous documents and great reliance was placed upon their recollection of the events between 2009 and 2012. We found elements of their witness evidence troubling. During their oral evidence, the witnesses were frequently argumentative, discursive in their answers and keen to advance LBG’s legal case. Some of the assertions contained in the witness statements were clearly contradicted by the documentary evidence. Despite that evident contradiction, the witnesses, when taken to the documents were unwilling to accept that their recollection was incorrect, reluctant to accept what the document clearly stated/recorded: ED “I think the presentation is happy talk” [1/144/17-23]; the document did not accurately record what happened [1/176/11-18]); the document was for “show/public consumption” and did not record the real discussion/thinking [1/178/4-12, 2/82/2-15, 2/84/9-14, 2/28/7-11 and 2/97/5-11]); “That was our strategy of record. That doesn’t mean it was set in stone”; TTO “That still doesn’t change my view, my opinion, which I stand by my witness statement … The board minutes are not a verbatim discussion of what took place. I don’t know whether I raised that point in the board or not. I don’t recall” [3/16/6- 13]; no documents recording his frustration with the BOSI management team [3/25/9-26/2], he could not agree that a PowerPoint deck with TT’s name on it would necessarily represent TT’s view [3/111/1-112/13], he did not accept that he had asked AK to make enquiries but suggested that AK might have been using his name to elicit responses/co-operation [3/134/13-23]; and suggested that SH (who he had accepted was his deputy/number two) did not have a good understanding of his priorities despite appointing her as his delegated representative for the LBG Board sub-committees meeting deciding the final exit mechanism [4/106/4-8]; TT denied that W&I Business Review report prepared for ED bearing TT’s name and setting out his views reflected his views at the time [5/33/13-11]; his oral evidence was that the 31 December 2010 deadline was just a “coincident factor” [5/128/2-3] when his handwritten notes for the LBG Board meeting state that “the timing is a tax issue”. In addition, the witnesses asserted that there were documents that they could clearly recollect which supported their assertions but, for reasons unexplained, were not in the hearing bundle, interpreted the documents in a way that was at variance with what was plainly stated and sought to apply a strained meaning to the plain language used. We have concluded that the witnesses were seeking to advance LBG’s legal case, this was reflected in their evidence and recollection of the events of 2009 to 2012 and their role in LBG’s decision to exit Ireland.

We consider that what was said in Gestmin SGPS SA v Credit Suisse (UK) Ltd & Anor [2013] EWHC 3560 (Comm) (“Gestmin”) is apposite to the witness evidence in this appeal. In Gestmin, Leggatt J (as he then was) observed:

We note that in Kogan v Martin & Ors [2019] EWCA Civ 1645 Floyd LJ, giving the judgment of the Court of Appeal, said:

Mindful of the above comments in Gestmin and Kogan, we have assessed the witness evidence by reference to the contemporaneous documentary evidence and the scrutiny afforded by cross-examination. Where the witness evidence of ED, TTO and TT is not supported by the available contemporaneous documents or, in instances, contradicted by the contemporaneous documents we have attached greater weight to the documentary evidence.

LBG submitted as follows. What secured CBGR was BOSI’s exit from Ireland. Lord Pearce in IRC v Brebner [1967] 2 AC 18 at [27 B-G] provided helpful guidance on the meaning of arrangements in this context. The decision to leave Ireland was not driven by any tax analysis. Once the key decision makers had made the decision to exit the Irish loan market, the question arose as to how that exit could be achieved. That was purely an implementation question – how best to implement the commercial decision consistently with the commercial objectives.

The witness evidence and documents confirm that the overriding purpose of the arrangements that were implemented were to achieve an exit from Ireland. The possibility of obtaining CBGR was a potential benefit flowing from the transaction but it was not a main purpose. Those taking the decision would have made the same decision absent a tax benefit. As Lord Upjohn said in Brebner at [30 E-G]:

“… when the question of carrying out a genuine commercial transaction, as this was, is reviewed, the fact that there are two ways of carrying it out—one by paying the maximum amount of tax, the other by paying no, or much less, tax—it would be quite wrong, as a necessary consequence, to draw the inference that, in adopting the latter course, one of the main objects is, for the purposes of this section, avoidance of tax. No commercial man in his senses is going to carry out a commercial transaction except upon the footing of paying the smallest amount of tax that he can.”

As noted by the FTT (at [95]) in Euromoney:

“the purpose or purposes of arrangements is not necessarily to be equated to the known and inevitable consequences of carrying them out (see Versteegh v HMRC [2013] UKFTT 642) and that the purpose or purposes of arrangements is not necessarily to be equated to the chosen means of carrying them out (see Inland Revenue Commissioners v Brebner [1967] 2 AC 18 per Lord Upjohn at [p30E-G])”

The decision in Euromoney was upheld by the UT. Similar conclusions were reached by the Tribunal in Allam v HMRC (upheld by the UT) and Burlington Loan Management DAC v HMRC [2023] S.F.T.D. 68.

Even if obtaining CBGR were to be regarded as a purpose of the transaction, it was not a main purpose. Although the size of the potential tax benefit was significant in absolute terms, it was modest by comparison to BOSI’s portfolio and the prospect of an improved recovery from the portfolio. The same conclusion, therefore, should be reached as in Euromoney where the FTT found that Euromoney had a tax purpose but that it was not a main purpose: “The prospective tax advantage in this appeal was not “of such significance in the context that gaining it must have become a main purpose” (at [104]) and “Euromoney’s subjective intention was focused on the commercial purpose, which was a main purpose, and the company considered the tax advantage to be no more than a bonus”([107]). Claiming a relief prescribed by law for a genuine economic loss (and having the purpose of doing so), cannot be a basis for denying relief and would undermine the objectives of the legislation and the Marks & Spencer line of cases. There is no purpose test in the context of domestic UK group relief.

Contrary to HMRC’s contentions, the withdrawal from Ireland on 31 December 2010 was not planned to maximise the tax advantage to be obtained from the CBGR and did not constitute a main purpose. The purposes of the key decision makers, ED, TTO and TT, are the purposes that need to be considered and not the purposes of the other business units in LBG notably tax, finance team and Group Tax. The key decision makers did not cede control to anyone else given the commercial significance of the decision they were taking. Once the key decision had been taken to exit Ireland, there was no requirement to implement the decision in a way that was most unfavourable to the taxpayer from a tax perspective. It was permissible to see whether LBG could implement that decision in a way that would enable it to obtain any benefit from the genuine economic losses that had arisen in BOSI. As with the Brebner case, in Project Hermes there were many commercial objectives and possibly different ways of potentially achieving them and, following Brebner, nothing required the most tax inefficient structure to be chosen.

Whilst establishing and retaining an Irish permanent establishment would potentially in certain circumstances have negated any benefit of the losses (at least in the UK) there is no requirement to structure a transaction to be tax inefficient. Maintaining an Irish permanent establishment conflicted with LBG’s desire to exit from Ireland. An Irish permanent establishment would also have raised regulatory issues, likely requiring regulatory approval, so it was not a clear “default” structure to be used.

In the alternative, the manner in which HMRC has sought to apply s127 CTA to deny CBGR in the present case contravenes Article 49 (in conjunction with Article 54) TFEU.

HMRC submitted as follows. The purpose of s127 is to prevent groups creating a cross border loss or creating the conditions where a cross border loss could be claimed. The provision focusses on the concept of blocking choice in choosing the regime in which the loss is relieved. Section 127 (in contrast to the unallowable purpose legislation) focusses on the object of the arrangements, the FTT is not restricted to considering what was in the mind of the directors who made the decision to exit Ireland. It is legitimate and necessary to consider what was in the minds of senior individuals and advisors who were involved in the formulation and implementation of the arrangements by which the exit was effected.

In Travel Document Service and Anor v HMRC [2018] STC 723 the Court of Appeal held that the Finance Act 1996, schedule 9, para 13 (which had disallowed debits claimed under section 91B where they resulted from loan relationships that had an unallowable purpose) applied to deemed loan relationships as well as actual loan relationships. At para 25, the Court cited, with approval, the following passage from the UT’s decision:

“The First-Tier Tribunal found as a fact that one of TDS’s main purposes in holding the shares in LGI during the period of the Swap was to secure a tax advantage. The First-Tier Tribunal was fully entitled to make that finding on the evidence before it. The fact that TDS had a valid commercial purpose in owning the shares before, during and after the Swap did not preclude the First-Tier Tribunal from finding that, during the period of the Swap, TDS had an additional purpose in owning them. The use to which an asset is put is perfectly capable, in appropriate circumstances, of shedding light on the owner’s purpose in owning that asset. This is such a case. TDS entered into the Swap in order to make the shares it owned in LGI non-qualifying shares, and it entered into the Novations in order to depreciate the shares. Thus TDS’s purposes in owning the shares during that period included the purpose of making them non-qualifying and then depreciating them, so as to secure a tax advantage. Mr Turner did not deny this. On the contrary, he was frank that one of TDS’s main purposes in entering into the Swap and the Novations was to obtain the tax advantage.”

At para 41(iii) the Court of Appeal further observed (citing Brebner) that: “It was company’s subjective purposes that mattered … The question whether one of the main objects is to obtain a tax advantage is subjective, that is, a matter of the intention of the parties.” At para 41(iv), it further confirmed that: “When determining what the company’s purposes were, it can be relevant to look at what use was made of the shares … The benefits you hope to derive as a result of holding an asset may also evidence your purpose in holding it.”

At para 46, the Court of Appeal further considered that had the tax advantage in issue been small, there might have been scope for the argument as to whether an intention to use the shares to achieve it implied that obtaining the advantage was not a main purpose of holding the shares. In fact, however, the hoped-for gain in that case was large. That being so the inescapable inference was that securing the advantage had become a main purpose of holding the shares. The prospective advantage was of such significance that gaining it must have become a main purpose of holding the shares as well as of the Swap and Novations. The same applies here a fortiori where LBG were seeking to secure a tax windfall of in excess of £575 million. In this regard, Newey LJ held:

“As I see it, there is no necessary inconsistency between these points and securing a tax advantage having in fact become, while the Deloitte scheme was being implemented, a “main purpose” of holding the LGI shares within the meaning of paragraph 13 of schedule 9 to FA 1996.”

Therefore, in that case, the FTT, the UT and the Court of Appeal all found that securing a tax advantage was a main purpose of the Appellant, notwithstanding evidence to the contrary from directors with respect to their stated intention. At [48], the Court of Appeal held that a “main purpose” will always be a ‘more than trivial’ one, but the converse is not the case. A purpose can be ‘more than trivial’ without being a ‘main’ purpose. ‘Main’ has a connotation of importance.

In Blackrock Holdco 5, LLC v HMRC [2022] UKUT 199, the UT upheld the FTT’s finding that both a commercial and tax advantage existed as the taxpayer’s main purposes notwithstanding its director’s evidence that tax advantage was not the main purpose. The UT upheld the FTT’s approach of not just focussing on the Board meeting at which the decision was made but also the planning (in particular tax planning) that pre-dated and informed the Board meeting. The UT held that whilst it is the company’s subjective purpose that matters, that subjective purpose is not simply a question of the director’s stated subjective intentions but also a matter of inference and therefore the FTT was entitled to look beyond the stated motives of the directors when determining the subjective purposes of the company in entering into the arrangements (see UT at [162] and [165-166]. Significantly, at [165] the UT held: “The effectiveness of anti-avoidance legislation cannot be undermined by tax advisers telling parties to ignore the tax advantage purposes of a transaction which has been planned by them or others for precisely that purpose.” Relevantly for present purposes, given the heavy involvement of Deloitte in the tax planning prior to the CBM in December 2010, the UT in Blackrock held that the FTT had been entitled to examine all the circumstances when deciding the company’s purposes in entering into the transactions including the planning and preparation by the Tax group and Ernst & Young which the UT stated was “critical context”: see UT170 and 171.

In JTI Acquisition Company (2011) Ltd v HMRC [2022] UKFTT 166 (TC) the Tribunal had to determine whether the main purpose, or one of the main purposes, for which the appellant became party to the loan relationship was to obtain a UK tax advantage for the purposes of s.441 and S.442. The FTT stated in respect of the Appellant’s only witness:

“ … helpful in understanding the operation and business of the group, I find that the material aspects of Mr Olsen’s testimony as respects the adoption of the acquisition and financing structure involving the Appellant represent an account of events given with the legal issues in mind. Consequently, I have accorded more weight to contemporaneous records, and the email exchanges at the material times amongst the key personnel. I consider the value of Mr Olsen’s oral evidence lies chiefly in the opportunity which cross-examination afforded, by subjecting the documentary evidence to critical scrutiny, and for the Tribunal to ascertain the intentions of the relevant decision makers that represented the corporate body (para 6).”

The FTT held at para 174 that the prospective advantage was of such significance in the context that gaining it must have become a main purpose.

In Kwik-Fit Group Limited v HMRC [2021] UKFTT 283 the FTT held that it was necessary to distinguish between debits relating to pre-existing loans with a genuine commercial purpose and those which had been entered into purely to obtain a tax advantage, which was an "unallowable purpose" under the Corporation Tax Act 2009 s.441. The FTT at [56] summarised the applicable principles:

At para 96, the FTT held that it was the Director’s intention not that of the Group Tax Manager that was relevant but on the facts found, it was clear from the contemporaneous documents that the directors had read and understood the information provided by the Group Tax Manager etc. and this was taken into account in the decision-making of the directors of the Appellants. At para 110, the FTT found that securing a tax advantage was a purpose and that purpose was an important purpose and so a main purpose. Importantly, in reaching this conclusion the FTT again relied significantly on papers/correspondence from the Tax Manager and tax advisor and how that informed the group’s purpose. At para 116, the FTT held that the prospective commercial and tax advantages were both main purposes of the taxpayer.

In closing submissions, the Tribunal was referred to the UT decision in Seven Individuals v HMRC [2017] UKUT 0132 (TCC) at [99] and [104] and to Simon Padfield & Ors v HMRC [2020] UKFTT 513 (TC), where the FTT provided a helpful summary of the relevant authorities on the main purpose test, including the dicta in Seven Individuals, at [275].

Section 127 CTA is an anti-avoidance rule that is designed to deny group relief where arrangements have been made creating a cross border loss or creating the conditions where a cross border loss could be claimed. Arrangements are widely defined in s127(4) – “includes any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable)”. It was common ground that the relevant arrangements that fall to be considered are those put in place by LBG to exit Ireland. There was no disagreement on the purpose behind s127, where the parties disagreed was whose purposes were relevant when determining whether the purpose was a main purpose or one of the main purposes.

We do not accept LBG’s submission that the purposes of the relevant arrangements put in place by LBG to exit Ireland are to be tested solely by reference to the stated purposes of the ultimate decision makers (the LBG Board and the sub-committee appointed by the Board comprised of TTO and TT) and only the documents submitted to the LBG Board and sub-committee. We note that there is an inherent contradiction in LBG’s submission which, on the one hand relies upon the Tribunal decision in Oxford Instruments (concerning unallowable purpose and the loan relationship rules) in respect of who are the relevant decision makers but, on the other hand, wholly dismisses HMRC’s reliance on the principles in respect of main purpose derived from decisions of the Tribunal concerning unallowable purpose and the loan relationship rules. We do not accept LBG’s submission, in our judgment the principles in respect of main purpose derived from decisions considering unallowable purpose and loan relationship rules are relevant and of assistance. We agree with HMRC that s127, in contrast to the unallowable purpose legislation, focusses on the object of the arrangements and we are not restricted to only consider what was in the mind of the directors who made the decision to exit Ireland. In our view, it is legitimate and necessary to not just focus on the purposes of the ultimate decision makers but, given their heavy involvement, to also consider the views and advice of senior individuals in BOSI, Group Finance and Tax (as advised by external professional advisers) which informed and shaped the formulation and implementation of the arrangements by which the exit was effected by the LBG decision makers, per Blackrock at [162] and [165-166].

We have considered the cases relied upon by both parties and consider that the relevant legal principles to be applied are as follows.

In Simon Padfield & Ors v HMRC [2020] UKFTT 513 (TC), the Tribunal (Judge Tony Beare) at [275] provided a helpful summary of the relevant authorities on the main purpose test based on the proposition that the case law relating to “main objects” is equally applicable to the phrase “main purposes”:

“275.

… The relevant legal principles are as follows:

(1)

the mere fact that arrangements may have a commercial purpose as one of their main purposes does not mean that the arrangements cannot also have the securing of a tax advantage as one of their main purposes – see Lightman J in Sema at paragraph [48] and Rimer LJ in Lloyds at paragraph [65];

(2)

in determining whether the securing of a tax advantage is one of the main purposes of the arrangements, it is merely necessary to consider the importance or significance of that purpose. There is no authority for the proposition that there can be more than one main purpose to arrangements only in a case where there are two or more purposes to those arrangements which are of equal significance. Instead:

(a)

it is simply a case of identifying which purposes are important enough to be described as “main purposes”; and

(b)

a purpose can be a “main purpose” even if it is of less importance than another “main purpose”.

As noted by Rimer LJ in Lloyds at paragraph [52], “in any particular case there may be a hierarchy of objectives motivating the transaction…and … the inquiry must then be as to which of them are ‘main’ and which are not”;

(3)

in determining whether the securing of a tax advantage is a main purpose of the arrangements, “it is necessary to consider with care the significance to the taxpayer of the tax advantage”. Only if the tax advantage is mere “icing on the cake” will it not be a main purpose (see Lightman J in Sema at paragraph [53]);

(4)

the purposes of arrangements are to be determined by reference to the subjective intentions of the taxpayer in entering into the arrangements, coupled with certain objective elements as determined from the evidence. That evidence includes the features of the arrangements, the way the arrangements were marketed and the views of those who were involved in creating, promoting and advising on the arrangements – see Nugee J at paragraphs [97] to [104] in Seven Individuals v The Commissioners for Her Majesty’s Revenue and Customs [2017] STC 874 …”

Having considered all of the evidence in accordance with our approach to the evidence at paragraphs 439 to 442 above and applying our approach the legal principles set out at paragraph 465 above, we find the following facts for the purpose test:

We do not accept the evidence of ED, TTO and TT supports LBG’s submission that Ireland was not an immediate priority as LBG was dealing with more pressing “life and death” issues, [ED’s witness statement para 20]. That evidence is not supported by the contemporaneous documents and witness evidence:

LBG’s strategy for BOSI was MFV and that strategy only changed when Project Hermes was approved in principle by the GEC on 29 June 2010:

Extensive tax advice was taken by LBG on how to maximise the use of the BOSI tax losses. We accept that obtaining tax advice from external advisers is a prudent and entirely normal course of action for a commercial organisation such as LBG; however, the advice was obtained not on the basis of how to implement a commercial decision to exit Ireland in the most tax efficient way but in the converse way: the decision to exit was based upon the potential tax benefits and then commercial reasons sought to justify the decision to exit:

HMRC accepted that LBG had valid commercial reasons for exiting Ireland. Paragraph 77 of their Statement of Case stated: “HMRC accepts that BOSI was a serious drain on LBG’s resources and that the group had other commercial reasons to seek to put a stop to those losses and to exit the Irish loan market.” Their skeleton argument at paragraph 151 stated: “In particular, although there were commercial reasons for exiting Ireland, a main purpose of the arrangements by which (and when) the decision to exit was implemented was the accessing of group relief and the arrangements were structured and implemented to achieve that group relief purpose.” We accept that LBG had valid commercial reasons for LBG exiting Ireland but it was the identified potential tax benefits that crystallised LBG’s decision to exit Ireland and the choice of mechanism for exiting Ireland. LBG’s decision to choose Option 4 was based on the potential tax benefits. The 31 December 2010 deadline to exit Ireland was determined by the potential tax benefits.

The witness statements of ED, TTO and TT stated that the potential tax benefits were insignificant and irrelevant to LBG. We did not accept that evidence for the following reasons:

We accept that ED, TT and TTO had not delegated their decision making for the following reasons:

We found that it was more likely than not that discussions on structuring the exit from Ireland and tax discussions took place between ED, TTO and TT which were informed by information about the potential tax benefits by the PHSC for the following reasons:

We do not accept that the contemporaneous evidence supports LBG’s assertion that one of the commercial reasons for LBG leaving Ireland was due to concerns about being subject to dual regulation in the UK and Ireland for the following reasons:

There is no evidence in the contemporaneous documents of any concerns expressed in May/June 2010 regarding a further or sudden deterioration of the Irish economy such that LBG’s stated strategy had to be urgently revisited.

There were no contemporaneous documents that record any concerns expressed about the Irish BSU managing the loan book following TT’s visit to Ireland nor that it was the reason for LBG’s decision to exit Ireland:

We found that references to tax planning and/or tax benefits were removed from final versions of documents and face to face or telephone discussions held to avoid reference to tax in e-mails and meeting notes for the following reasons:

The GEC meeting held on 28 July 2010 was attended by ED, TT, TTO, SC and MW. SC and MW provided a Project Hermes update. It was accepted in cross-examination that there was likely to have been a discussion at this meeting [3/101/7-12, 5/130/12-16 and 4/75/7-17] about the tax benefits of the proposal, the importance of not having a PE in Ireland and the importance of completing by 31 December 2010 [4/101/7-21 and 5/130/12-16] despite the minutes not recording nor mentioning any such discussion(s). The GEC agreed to recommend a CBM “with a view to completion by 31st December 2010”. TTO agreed that he understood at least one of the benefits of completing by that date was the tax benefit [4/76/4-20].

TT’s handwritten note for the LBG Board Meeting on 3 August 2010 stated that “timing is a tax issue and Tim will walk you through that”. The minutes accurately record the contents of TT’s handwritten up to that point but do not mention or record TTO “walking” the LBG Board through the tax and timing issues.

We do not accept that the 31 December 2010 deadline was just a “coincident factor” [TT 5/128/2-3] for the following reasons:

ED accepted in cross-examination that, LBG had “a number of options for the Irish business” and “a number of options on the table”, only one of which was a CBM [2/50/17-20 and 2/51/5-8]. The other options open to LBG for the future Irish structure included: (i) a branch; (ii) a s33 Transfer; and (iii) the TRS. We have found that the decision to reject the three options in favour of the CBM was primarily determined by tax for the following reasons.

We have found that the manner in which Certus was structured was for tax purposes for the following reasons:

SIF was removed as BOSI’s immediate parent company on 17 September 2010. Prior to that date there is nothing in the contemporaneous documents to suggest any prior intention to remove SIF nor any commercial reasons given for its removal other than to enable LBG to execute the CBM:

We have concluded in our findings of fact that the main purpose or one of the main purposes of the arrangements put in place by LBG to exit Ireland via the CBM on 31 December 2010 was to claim CBGR for BOSI’s accumulated losses in the period 31 December 2010. It therefore follows that s127 applies to the arrangements put in place by LBG to exit Ireland via the CBM.

LBG submitted that s127 must be construed in a way so as not to undermine the objectives of EU law or frustrate applicable EU jurisprudence as regards the rights conferred on nationals of EU Member States.

Section 127 CTA must therefore be interpreted in accordance with the decision of the CJEU in Cadbury Schweppes. This means that any purpose test should only apply to “wholly artificial arrangements”. This was re-iterated by the CJEU in M&S at [57]:

“… Member States are free to adopt or to maintain in force rules having the specific purpose of precluding from a tax benefit wholly artificial arrangements whose purpose is to circumvent or escape national tax law”.

To the extent that the provision is applied in a manner that goes further than necessary to achieve the legitimate purpose of excluding “wholly artificial arrangements”, s127 would represent an infringement of EU law. As there was a commercial purpose for the existence of BOSI and the arrangements, none of the arrangements can be viewed as wholly artificial such that s127 CTA 2010 does not prevent CBGR from being available.

HMRC submitted that there is nothing in s127 itself that contravenes EU law and, having infracted the UK in relation to the CTA 2010 leading to EC v UK, the Commission notably took no point on s127. Moreover, the operation of a purpose test is inherently fact sensitive and not something the CJEU interferes with – that is a matter for the domestic court. It is wrong to suggest that s127 must be read to apply only to wholly artificial arrangements. Nothing in Article 49 TFEU and the right to freedom of establishment precludes Member States from enacting anti-avoidance provisions. In Cadbury Schweppes, the Court was not concerned with an anti-avoidance provision but rather a deemed taxation provision. It is therefore of no assistance. Nor does the application of an anti-avoidance provision that extends beyond wholly artificial arrangements undermine Article 49 TFEU insofar as the CJEU has made clear that the balanced allocation of taxation, the avoidance of the double use of losses and the prevention of tax avoidance are all objective justifications for refusing CBGR relief. Nothing in the Court’s case law suggest that the tax avoidance rationale has to be strictly and narrowly construed to capture only wholly artificial arrangements. On the contrary, given the very substantial detriment CBGR entails for the Member State of the parent company, it is perfectly proper for a Member State to adopt a more general anti-avoidance provision.

We noted at the outset that there is an inherent contradiction in LBG’s pleaded case in respect of s127 and s119: decisions of the CJEU should be ignored post M&S in respect of s119 but “domestic law must be interpreted, as far as possible, in accordance with EU law” when considering s127.

We agree with HMRC’s submission that if there was anything in s127 which contravened EU law it is highly unlikely that the issue would not have been raised by the Commission following their investigation into the CBGR provisions in CTA 2010 that culminated in EC v UK. Logically, that investigation would have considered all of the CBGR provisions including s127. There is no suggestion that s127 (nor indeed reference to s127) contravened EU law or went beyond what is necessary to achieve that objective. The Commissions’ Application stated:

“for a declaration that by imposing conditions on cross-border group relief that make it virtually impossible in practice to obtain such relief and by restricting such relief to periods after I April 2006, the United Kingdom has failed to comply with its obligations under Article 49 of the Treaty on the Functioning of the European Union and Article 31 of the Agreement on the European Economic Area.”

The Commission’s letter to the UK referred to the possible incompatibility of UK law with EU law but s127 was not one of the provisions mentioned:

“The Commission would like to draw your Government's attention to the possible incompatibility with European Community law and the EEA Agreement of certain provisions of the United Kingdom's tax legislation concerning cross-border loss compensation.”

We agree with HMRC’s submission that there is nothing in Article 49 TFEU which states that the right to freedom of establishment precludes Member States from enacting anti-avoidance provisions. Whilst we do not accept HMRC’s submission that the CJEU in Cadbury Schweppes was not construing an anti-avoidance provision (Part XVII of ICTA 1988 is headed “Tax Avoidance”) we do not accept that Cadbury Schweppes is authority for the proposition that LBG advances that any purpose test should only apply to “wholly artificial arrangements”. The CJEU stated in its judgment that the application of UK CFC legislation was too general and therefore contrary to EU law when applied to actual establishments that had genuine economic activity in the host state. It further stated that CFC legislation is only acceptable if it is targeted specifically at wholly artificial arrangements. Notably, the CJEU said at [72] that it was a matter for the national court to determine whether the fact sensitive motive test could be interpreted as compatible with EU principle of freedom of establishment.

In our judgment, the operation of a purpose test is inherently fact sensitive and not something the CJEU interferes with, it is a matter for the domestic court, Cadbury Schweppes at [72]. We have been unable to find anything in CJEU case law relied upon by LBG that supports its submission that the tax avoidance rationale has to be strictly and narrowly construed to capture only wholly artificial arrangements. The CJEU has repeatedly made clear that the balanced allocation of taxation, the avoidance of the double use of losses and the prevention of tax avoidance are all objective justifications for refusing CBGR with the caveat that the measure does not go beyond what is necessary to achieve the objective. In A Oy the CJEU stated at [26], [28] and [31]-[38] that it was for the national court to assess whether a difference in treatment was appropriate and did not go beyond what was necessary to achieve that objective. Those principles were similarly stated in in EC v UK at [23]-[25] and Oy AA at [51]-[56] and [62]- [65]. At [62]-[63] in Oy AA the CJEU stated:

In light of the above, we do not accept that s127 or the manner in which HMRC has applied section s127 to deny LBG CBGR is not compliant with Article 49 (in conjunction with Article 54) TFEU and goes beyond what is necessary to attain the objectives pursued.

We have considered the five particular issues at paragraph 4(1) above to determine whether the qualifying loss condition is met in relation to the Appellant’s claim for CBGR for its accounting period ended 31 December 2010.

LBG submitted that the claim for CBGR is a claim pursuant to UK domestic law as set out in Chapter 3 of Part 5 CTA 2010 (as that Chapter applied prior to its repeal by section 24 of the Finance Act 2022 with effect from 27 October 2021). It is not a claim on the basis of the UK’s pre-2006 legislative provisions or on the basis of EU principle. LBG acknowledges that UK domestic law must be interpreted in a manner that is compatible with EU law and in light of EU case law. Specifically this means that if Chapter 3 of Part 5 CTA 2010 infringes the freedom of establishment by Article 49 (and Article 54) of the TFEU it must be interpreted so as to permit a claim for CBGR where the para 55 M&S conditions are met. This does not mean that HMRC can rely on Article 49 and EU case law to preclude a claim for CBGR where UK domestic law clearly allows such a claim. Even if EU law were to impose a stricter test for the determination of final losses or for the availability of CBGR than that prescribed by UK domestic law, that does not mean that UK domestic law is to be accorded a stricter construction. The UK domestic legislation imposes its own test of finality of losses, namely the qualifying loss conditions in s119. To the extent that the test in s119 is met, losses will be “final” in accordance with the UK’s domestic law, irrespective of whether or not the para 55 conditions were met.

HMRC submitted that it was Parliament’s clear intention to enact legislation that would comply with the para 55 M&S conditions and no more and that legislation cannot be divorced from the CJEU ruling that caused it to be enacted. There is nothing to suggest that Parliament had enacted a more generous scheme of CBGR required by the para 55 conditions (“gold plated”) and, furthermore, subsequent EU case law has confined the scope of the para 55 conditions. The CJEU’s decisions are declaratory of EU law as it always has been, elucidating, from time to time, what EU law means and requires. Parliament was legislating to implement, not a directive or some other legislative measure, but an individual case of the CJEU; Parliament can be taken to know that case law does not stand still and can be taken to know that what certain principles mean or require will be further elaborated by the CJEU over time. Chapter 3 of Part V is ‘retained EU law’ for the purposes of the European Union (Withdrawal) Act 2018 (“EUWA”). The EUWA converted the body of existing EU law, as it applied to and within the UK prior to the end of the transition period, into domestic law and preserved the laws that implemented the UK’s obligations whilst an EU Member State. Chapter 3 of Part V, being retained EU law, must be interpreted in accordance with the CJEU’s case law that elucidates the very law which Chapter 3 of Part V sought to implement. It is therefore legally wrong for LBG to seek to contend that the words of s119 must be interpreted in isolation and without regard to the retained EU case law that in fact explains the scope of the very entitlement that Chapter 3 of Part V sought to implement. Decisions of the CJEU post M&S have narrowed the para 55 conditions.

We did not understand there to be any dispute regarding the provisions relating to retained EU law, rather the dispute was on the applicability (or not) of retained EU law. Section 6(7) of the EUW defines ‘retained case law’ as “(a) retained domestic case law, and (b) retained EU case law” where "retained EU case law" means “any principles laid down by, and any decisions of, the European Court, as they have effect in EU law immediately before IP completion day and so far as they—(a) relate to anything to which section 2, 3 or 4 applies, and (b) are not excluded by section 5 or Schedule 1, (as those principles and decisions are modified by or under this Act or by other domestic law from time to time).” Section 6(3) of EUW further provides that:

“Any question as to the validity, meaning or effect of any retained EU law is to be decided, so far as that law is unmodified on or after IP completion day and so far as they are relevant to it—

(a)

in accordance with any retained case law and any retained general principles of EU law, and

(b)

having regard (among other things) to the limits, immediately before IP completion day, of EU competences.”

Section 119 is headed “The qualifying loss condition: relief for future periods” and gives effect to the second part of para 55 M&S. HMRC submitted that LBG appears to contend that s119 has effectively “gold-plated” M&S by “imposing its own test of finality of losses” thereby making it easier to claim CBGR as a matter of domestic law than EU law. The implicit contention appears to be that whereas domestic law “must be interpreted in a manner that is compatible with EU law”, s119 should be interpreted without regard to the CJEU case law since M&S, notwithstanding that that case law has in the course of elucidating the meaning of the Para 55 conditions in Marks & Spencer clarified the meaning and scope of the principles in that case, including the meaning and application of the para 55 conditions. We agree with HMRC. We cannot see that there is any basis or support for LBG’s submission that the words of s119 must be interpreted in isolation and without regard to the retained EU case law that in fact explains the scope of the very entitlement that Chapter 3 of Part V sought to implement. We consider that conclusion is clear from the consideration of case law by the Tribunals and Courts post the M&S decision.

In our judgment, it is clear from the Explanatory Notes below that it was Parliament’s intention to enact legislation that would comply with the principles set out in M&S and not create its own test of finality of losses. We accept that there is no suggestion in the Explanatory Notes that Parliament intended to go beyond what was required to comply with and give effect to the M&S decision and “gold plate” the provision. Mr Milne referred us to Akinsanya v SSHD [2022] EWCA Civ 37 (“Akinsanya”)to rebut HMRC’s submission that there is a presumption against “gold plating”:

As Akinsanya stated at [64], whether the legislator intended to go beyond the minimum required in order to achieve compliance with EU law is no more than a consideration forming part of the overall exercise of statutory construction.

The Explanatory Note to the Bill in respect of clause 27 and Schedule 1 to the Finance Act 2006 relevantly stated:

“124 In summary, the Court ruled that the UK’s group loss relief rules are in principle compatible with European Law but go too far in denying loss relief to a parent company for the losses of a foreign subsidiary where the parent company has demonstrated that the non-resident subsidiary has exhausted all possibilities of relief in its state of residence.”

The Explanatory Notes to Chapter 3 of Part 5 of CTA 2010 relevantly stated:

“406.

This Chapter makes the United Kingdom group relief rules compatible with European Community law following the judgment in Marks and Spencer plc v Halsey, C446/03. That case decided that in some circumstances it is contrary to the provisions of the EC Treaty on freedom of establishment to deny group relief to a UK resident parent for the losses of a non-UK resident subsidiary.”

In our judgment, it is clear from the Explanatory Notes that Parliament was seeking to only amend the UK legislation to comply with the para 55 conditions and not to provide CBGR that was broader than required nor impose its own test of finality of losses. In other words, the UK Government was doing no more than the “bare minimum” to ensure that UK group relief rules were compatible with EU law. We are reassured in that conclusion by the infraction proceedings taken by the EC v UK on the basis that UK legislation had given effect to para 55 too restrictively. It would not, as a matter of logic, have commenced infraction proceedings if the UK legislation had “gold-plated” the para 55 conditions.

It can be seen from UK case law that the Courts and Tribunals have been interpreting the principles in M&S by reference to the CJEU’s case law post M&S. We cannot see that it was submitted, as in this appeal, in either of the following cases that EU case law on CBGR and final losses should not be considered by the Courts and Tribunals when considering CBGR and final losses post M&S.

In Esso Exploration and Production UK Ltd & Ors v HMRC [2020] UKFTT 0139 (TCC) (“Esso”) the Tribunal (Judge Anne Scott) considered the claim to the right to relief for trading losses, CBGR, incurred and surrendered by a company called ExxonMobil Denmark Holdings international ApS. The decision relevantly stated:

“[13] In HMRC’s Skeleton Argument there had been a reference to a draft Amended Statement of Case and an intention to seek leave to amend at the outset of the Hearing which did not materialise. On 16 April 2019, HMRC lodged a Submission seeking leave to amend the Statement of Case by the introduction of a further paragraph directed at all of the years in issue and headed ‘No possibilities test not satisfied in any event’.

[14] On 30 April 2019, the appellants confirmed that they offered no objection to the amendment although they took issue with one of the arguments advanced in the Submission by HMRC. That argument was predicated on Advocate General Kokott’s opinions in Skatteverket v Memira Holding (‘Memira’) and Skatteverket v Holmen (‘Holmen’).

…

[82] In both cases the judgments are in line with the Advocate General’s Opinions issued in January 2019. In the introductions to both Opinions, in line with her previously oft expressed reservations about Marks & Spencer, she points out the problems with ‘final losses’, the lack of clarity giving rise to the repeated references to the CJEU and states that if the CJEU wishes to adhere to the ‘final losses’ exception then it had the opportunity to ‘refine this category’ ie the Marks & Spencer exception.

[83] She makes it explicit in her Opinion in Holmen that the first question concerns the interpretation of the judgment in Marks & Spencer and the judgment also makes that explicit.

[84] Similarly, in her Opinion in Memira she points out that, although the referring court focuses primarily on A Oy, that case applied the findings in Marks and Spencer. Beyond reciting the referred question the judgment makes no reference to A Oy but refers to Marks & Spencer.

[85] In both cases the formal Rulings refer explicitly to para 55 of Marks & Spencer.

[86] It is clear that both cases do indeed further refine and develop CJEU case law on CBGR and final losses.

…

DECISION IN RELATION TO THE APPLICATION OF HOLMEN

[110] During the course of the Hearing both Mr Aaronson and Mr Yates, very appropriately, referred to the evolution of the jurisprudence of the CJEU. Holmen and Memira are precisely that. It is clear to me that the Court adopted the Advocate General’s invitation to ‘refine’ the category of ‘final losses’ as described in Marks & Spencer.

[111] I do not perceive any conflict between these cases and Marks & Spencer. Firstly, the fact that these were decided by the First Chamber is not a relevant factor.

…

[113] Secondly, it is very evident that in every stage of their deliberations, as evidenced by the references in Memira to Marks & Spencer rather than to A Oy, (see para [85] above) the CJEU were focussed on elucidating Marks & Spencer. In my view, much needed clarity has been shed on the nature and extent of the Marks & Spencer exception. I find that it is indeed acte clair and there is no need for a further reference.

LBG submitted that Esso, on the one hand, contained a helpful summary confirming that the M&S decision was “alive and well” as subsequent cases have clarified but not changed it but, on the other hand, it was not relevant as it was concerned with different legislation and the freedom of establishment was not engaged. It is clear from the decision in Esso that the Tribunal was considering legislation pre-2006 but considered it relevant to hear fully argued submissions on subsequent CJEU decisions considering M&S. Again, it is clear that the Tribunal determined that the EU right of freedom of establishment was not engaged but only after consideration of EU law post M&S. We do not accept the Appellant’s submission and consider that Esso supports the approach taken by this Tribunal: interpreting the principles in M&S by reference to the CJEU’s case law post M&S which have “elucidated and clarified” M&S.

The Court of Appeal in Volkerrail v HMRC [2023] EWCA Civ 210 (“Volkerrail”) considered the case law of the CJEU following M&S at [44]-[60] to determine whether Income and Corporation Taxes Act 1988 Pt X s.403D(1)(c), which prevented losses being surrendered by way of group relief where they were incurred by a UK permanent establishment of a non-resident company and were deductible from non-UK profits, had infringed the EU law principle of freedom of establishment. No equivalent provision restricted the surrender of losses made in the UK by a UK tax-resident company where those losses were deductible elsewhere. In HMRC v Philips Electronics UK Ltd C-18/11 (“Philips”) the CJEU held that s.403D(1)(c) imposed a restriction on freedom of establishment which could not be justified. In Volkerrail, HMRC submitted that s.403D(1)(c) was compatible with freedom of establishment on the basis that the CJEU had departed from Philips in NN A/S v Skatteministeriet (C-28/17) EU:C:2018:526, [2018] 7 WLUK 34. The Court of Appeal agreed, allowing HMRC’s appeal. The Court of Appeal (Falk LJ) stated:

Whilst Mr Milne submitted that Volkerrail was concerned with an entirely different subject matter (branches not subsidiaries) we consider that the principles derived from Volkerrail are equally applicable here: this Tribunal should consider and take into account post-M&S CJEU decisions. That, of course, was the approach taken by the Supreme Court in M&S 2013. That is the approach we have followed.

HMRC submitted that LBG only seeks to rely upon s119(4) as it provides that the time at which the no possibilities test is to be taken into account is “at the time immediately after the end of the EEA accounting period” and because the CBM took place immediately before the end of the EEA accounting period there was no possibility of BOSI’s losses being used in Ireland as it had ceased to exist and had no assets or source of income. This, it submitted, was a bad argument as BOSI only ceased to exist and had no assets because of the LBG’s unilateral choice to dissolve BOSI and on LBG’s construction, LBG had the power to elect when losses are definitive. LBG submitted that the wording of s119(4) clearly requires the test to be applied immediately after the end of the accounting period and that was held to be consistent with EU law by the CJEU in EC v UK. With respect to HMRC, its submissions do not address the timing point. However, this point can be dealt with in short order. It is clear from the wording of s119(4) and following the decision of the CJEU in EC v UK that the relevant time for determination of the no possibilities test is to be made as set out in the clear words of s119(4): “at the time immediately after the end of the EEA accounting period”:

“31 In that regard, it should be noted that Section 119(4) of the CTA 2010 sets the date by reference to which it must be decided whether losses sustained by a non-resident subsidiary are definitive, as described in paragraph 55 of the judgment in Marks & Spencer (EU:C:2005:763). Under that provision, that assessment is to be made ‘as at the time immediately after the end’ of the accounting period in which the losses were sustained.

…

35 Under Section 119(4) of the CTA 2010, in fact, the assessment as to whether the losses sustained by a non-resident subsidiary may be characterised as definitive, as described in paragraph 55 of the judgment in Marks & Spencer (EU:C:2005:763), must be made by reference to the situation obtaining ‘immediately after the end’ of the accounting period in which the losses were sustained. It is thus clear from the wording of that provision that it does not, on any view, impose any requirement for the subsidiary concerned to be wound up before the end of the accounting period in which the losses are sustained.”

The consequences of the relevant time for determination of the no possibilities test being “at the time immediately after the end of the accounting period” are considered next.

Mr Milne submitted that what the Tribunal must do is interpret s119(4) in the way in which the UK interpreted it to the CJEU in EC v UK in its Defence, Rejoinder and anonymised example annexed to the Defence in EC v UK. The anonymised example confirmed that evidence of an intention to wind-up a loss making subsidiary and commencing the liquidation process soon after the end of the accounting period were relevant factors that HMRC would take into account and the HMRC had accepted in those circumstances that there was no possibility of trading. The Rejoinder confirmed that the “no possibilities” is an entirely objective test. Therefore “no possibilities” test is straightforward and effective means of ensuring, by reference to objectively identifiable factors that a member state is only obliged to grant cross border loss relief where there is no possible threat to the balanced application of taxing rights. LBG did exactly what the UK had said to the Commission was permitted under s119(4), therefore there is no need for an objective enquiry why BOSI went into liquidation. For the Tribunal to find otherwise would be to find that the UK got it wrong in its Defence and Rejoinder as did the Supreme Court in M&S. HMRC’s own guidance, CTM81620, supports LBG’s interpretation.

In the alternative, LBG submitted that HMRC’s reliance upon the Opinions of AG Kokott issued in January 2019 in Memira and Holmen rather than the judgments of the CJEU is misplaced as, although the opinions of the AG are influential they are not binding on the CJEU nor on the UK courts. Furthermore, the views of the AG in Memira and Holmen were not endorsed by the CJEU in those cases in some important aspects. Furthermore, Memira and Holmen both concerned an advance clearance and are only of application to cases where advance clearance has been sought. Therefore, at the time of the judgments in Holmen and Memira all options were still available and so it was possible that they could carry forward losses and set them against income in the future. It was clear that M&S has been endorsed in subsequent CJEU decisions relying upon the “careful analysis of those cases”, in Esso particularly at [248] it was confirmed that Holmen and Memira did no more than endorse and clarify M&S:

“Undoubtedly not all the CJEU decisions referencing the Marks & Spencer exception are totally aligned. However, notwithstanding the many years of controversy and Advocate General Kokott’s dislike of it [see paragraph 82] quite apart from Philips, Felixstowe and A Oy, since 2018, Bevola, NN A/S Skatteministeriet, Holmen and Memira have all not only endorsed but also clarified it.”

HMRC submitted that EC v UK came several years after M&S and at a time when other decisions of the CJEU had begun to narrow the scope of the entitlement to CBGR in cases such as K and A Oy. Nothing in either the Commission’s challenge or the CJEU’s judgment suggested that formally putting a company into liquidation was sufficient for losses to be deemed final or definitive. It has never been the law that a taxpayer can opt to enter liquidation or a CBM with the consequence that CBGR can be claimed. The point, repeatedly made in CJEU case law post M&S, is that if it were otherwise taxpayers have a choice over the jurisdiction in which it could use its losses, something that the CJEU has repeatedly ruled out. The establishment of the legal bar principle in K is an important step in which the principles in M&S and the circumstances in which a definitive loss will arise, have been developed since M&S. The legal bar principle is not a refinement of the para 55 conditions but is the logical articulation of the prior objective of ensuring a balanced allocation of taxation between Member States, at [45]-[46] M&S. The CJEU considered the question of whether a loss might be final or definitive in Memira and Holmen. In Holmen, the CJEU endorsed at [38] paragraphs [57-[63] of the AG’s Opinion and in Memira, the CJEU at [26] endorsed paras [65] to [70] of the AG’s Opinion. The respective parts of AG Kokott’s Opinion refer to the legal order permitting a transfer of losses to other persons. Where there is such a legal possibility, a sale of a business or its assets to a third party means that there will always be a possibility to use the losses. Memira at [70] (AGO) and Holmen at [62] (AGO) states:

“The definitive nature of the losses in that case is thus also based either on the legal order of the Member State (preclusion of any possibility of transferring losses) or on the decision by the taxable person not to sell the company, but to place it in liquidation [by way of a merger - Memira] [place it in liquidation – Holmen]. In both cases, however, it is not obvious why non-use of losses in another Member State should be disproportionate. It is also not without reason the Court requires that all possibilities of having the losses taken into account have been exhausted. This includes the losses being transferred to a third party by way of a sale.”

The principles derived from Memira and Holmen are applicable to this appeal to determine whether the loss is definitive. LBG’s reliance on CTM81620 is misconceived: the guidance posits, for the purposes of the hypothetical it is considering, that there is no other possibility of loss relief in the subsidiary’s state; it is not at all saying that because a company is wound up on the last day of the EEA period that, for that reason, there can be no possibility of using the losses.

Mr Milne submitted that what LBG did is on all fours with what the UK submitted to the CJEU in its Defence and Rejoinder in EC v UK, submissions that the CJEU accepted in its decision. We have therefore set out the relevant parts of the UK’s Defence and Rejoinder below and then considered the basis upon which the CJEU rejected the Commission’s complaint.

The Commission claimed that s119(4), which requires the assessment of the usability of losses for future years “at the time immediately after the end” of the accounting period when the losses were sustained, would make it “virtually impossible for a resident parent company to obtain cross-border group relief”. The Commission submitted that under UK legislation CBGR may be granted in only two situations: (1) where no provision is made under the legislation of the Member State of residence of the non-resident subsidiary for losses to be carried forward and (2) where the non-resident subsidiary enters liquidation before the end of the tax year in which the losses are sustained. Therefore, “[CBGR] is thus precluded in the normal commercial situation” (outside of a liquidation). The Commission submitted that compliance with the M&S principle would require that the possibility of obtaining tax relief in the Member State of residence must be assessed at the time when the claim for group relief is made in the UK and on the basis of the actual facts of the case, and not on the basis of some theoretical possibility (of subsequently taking into account losses sustained by the non-resident subsidiary) which exists only because the foreign subsidiary has not yet been placed in liquidation.

The UK responded to the Commission’s arguments by stating that it had applied the CJEU’s guidance in M&S and that it considered that the M&S para 55 exception required the assessment of the possibility of losses being carried forward to be made immediately after the end of the accounting period in which the losses arose. It accepted the UK’s legislative conditions for CBGR are restrictive but argued that the restriction resulted from the limited scope of the CJEU’s decision in M&S. In rebutting the Commission’s arguments, it submitted that the requirements in s119(4) could be met in cases beyond the two situations mentioned by the Commission as UK law did not require the subsidiary to be liquidated before the end of the accounting period in which the losses are sustained in order for its resident parent company to be able to obtain cross-border group relief. Instead, many factors could be taken into account immediately after the end of the accounting period in which the losses were sustained such as the intention of the parent company to wind up the loss-making subsidiary or the commencement of the liquidation process. In our judgment, it is clear from the UK’s submission that by referring to cases beyond the two situations mentioned it accepted that liquidating a company before the end of the accounting period did satisfy the requirements of s119(4).

AG Kokott in her Opinion at [38] stated her understanding that both parties accepted that the M&S exception was satisfied when the subsidiary’s State of residence does not permit loss carry-forward or if the subsidiary enters into liquidation in the tax year in which the loss is suffered:

“ … The Commission claims that the United Kingdom rules are too restrictive because they permit cross-border relief only if either the State of residence of the subsidiary does not permit loss carry-forward or if the subsidiary enters into liquidation in the tax year in which the loss is suffered. Both parties to the present case appear to agree that in these two cases at least the Marks & Spencer exception is satisfied. However, according to the Court’s most recent case-law, that is not so.”

The UK’s Defence relevantly stated (emphasis added):

“THE 'NO-POSSIBILITIES' TEST

13.

In the United Kingdom's submission, it is clear from the judgment of the Court of Justice in Marks & Spencer that the 'no-possibilities' test is to be applied as at the end of the accounting period in which the loss arises. Alternatively, even if this was not clear from Marks & Spencer, it has been put beyond doubt by the terms of the Court's subsequent jurisprudence.

…

17.

The 'no-possibilities' test articulated by the Court in the second indent of paragraph 55 of its Judgment clearly contemplates a simple question to be answered prospectively as at the end of the accounting period in which the loss arose, namely whether there is there any possibility that the loss of the non-resident subsidiary could be taken into account in its state of residence in future periods. Given that the reference to 'future periods' is clearly intended to mean accounting periods chronologically following the accounting period concerned, such a test could only be applied at the end of the accounting period concerned, looking forward.

…

35.

The 'no-possibilities' test is designed to ensure that a Member State is only obliged to grant cross border loss relief where there is no possible threat to the balanced allocation of taxing rights. Where there is no possibility of the losses being used in the Member State of residence of the surrendering company, the group is not able to exercise any choice as to where the losses are utilised (whether for commercial or fiscal reasons). If the 'no-possibilities' test is applied as at the date of claim then the group has further time to arrange its affairs in order to fulfil the UK cross-border loss relief conditions and therefore could exercise such a choice. This would tend to undermine the balanced allocation of taxing rights.

…

Availability of loss relief

45.

At paragraph 24 of the Application, the Commission asserts that loss relief will only be available if the law of the State of residence makes no provision at all for loss carry-forward, or if the subsidiary enters liquidation before the end of the tax year in which the loss is suffered so that it can be said that there is no theoretical possibility of future relief.

46.

… There are other circumstances where the test for cross-border loss relief under the UK legislation may be satisfied. It is not the case, for example, that a loss-making subsidiary must be put into liquidation before the end of the tax year in which the loss is suffered. The relevant provisions do not mention being put into liquidation as a requirement and nor is it, in practice, a requirement that must be met. Evidence of an intention to wind up a loss-making subsidiary and commencing the liquidation process soon after the end of the accounting period would be factors to be taken into account. Further, whether the company in question has, for instance, income-producing assets, premises and employees will also be taken into account in determining whether losses may be used in the future.

…

Consistency with EU law

49.

In any event, however, the circumstances in which the UK legislation permits claims for cross-border loss relief are wholly consistent with the requirements of EU law. The legislative provisions mirror precisely the terms of the 'no-possibilities' test set out by the Court in Marks & Spencer, and for the reasons elaborated upon above, it is appropriate that this test should be applied at the end of the accounting period. Since they adopt the test of proportionality expounded by the Court itself, the legislative provisions in issue clearly themselves satisfy the requirement of proportionality.”

The UK’s Rejoinder stated (emphasis added):

“4.

It is quite correct that the United Kingdom contends that the 'no-possibilities' test should be applied "extremely restrictively" as was explained by Advocate General Geelhoed at paragraph 65 of his Opinion in Case C-374/04 Test Claimants in Class IV of the ACT Group Litigation [2006) ECR 1-11673. However, this does not mean that the Court's judgment in Marks & Spencer is to be interpreted narrowly. Rather, a restrictive application of the "no-possibilities" test is, in the United Kingdom's view, precisely what was intended by the Court in Marks & Spencer.

…

8.

It must also be emphasised that, as is evident from the case law, it is neither necessary nor desirable to make a detailed factual enquiry as to the purpose of the taxpayer or whether its inability to use losses in its Member State of establishment resulted from a free decision on its part. It is notable that AG Kokott in her Opinion in Case C-123/11 A at paragraphs 57-58 sought to engage in an enquiry as to whether the inability to use losses resulted from the free decision of the company concerned to merge its loss-making subsidiary, but the Court did not adopt that approach. Rather, it simply applied the "no-possibilities" test. The "no-possibilities" test is an entirely objective test. Where it is satisfied, the group is not able to take any steps which have the consequence of determining where its losses are utilised, whether for commercial or fiscal reasons, or otherwise. The "no-possibilities" test is therefore a straightforward and effective means of ensuring, by reference to objectively identifiable factors, that a Member State is only obliged to grant cross border loss relief where there is no possible threat to the balanced allocation of taxing rights.

14.

Moreover, the "no-possibilities" test asks whether there "is" no possibility for the foreign subsidiary's losses to be taken into account in future periods, whereas as is evident from paragraph 6, the Commission's approach entails asking whether it "was" possible. These departures from the clear wording of the "no-possibilities" test in paragraph 55 of Marks & Spencer are a quite clear indication that something is wrong in the Commission's formulation.

…

27.

Paragraph 15 appears to contemplate that an anti-abuse rule would preclude relief for losses where a parent company has "deliberately" arranged their affairs in such a manner as to eliminate the possibility of having the losses taken into account in the State of residence of the subsidiary. However, as has been explained above, conduct which had a valid economic rationale (and where the availability of UK group relief is not a factor) is nevertheless capable of undermining the balanced allocation of the power to tax between Member States. Moreover, this would entail an enquiry as to the purpose of the taxpayer which is not contemplated by the wholly objective terms of the "no-possibilities" test as articulated by the Court in Marks & Spencer.

28.

At paragraph 16 the Commission queries whether the United Kingdom seeks to insinuate that Marks & Spencer contrived to bring about a situation in which it was able to satisfy the "no-possibilities" test. The United Kingdom makes no such allegation. As has been explained above, the "no-possibilities" test does not envisage any enquiry into the purpose of the taxpayer. …

29.

The Commission contends at paragraph 19 that an alleged readiness to take into account an intention to wind up a foreign subsidiary is in itself inconsistent with the rule that account should be taken of the circumstances pertaining at the end of the period in which the loss is suffered. This is incorrect. There is no such inconsistency; the intention to liquidate is a circumstance pertaining at the end of the period in which the loss is suffered. The intention to liquidate will be taken into account along with all other relevant facts as at the end of the accounting period to determine whether the "no-possibilities" test is satisfied. This might also include, for example, that the company ceased to trade, and that it had no income producing assets, no premises or employees.

31.

Secondly, the Commission points out that claims for relief were rejected on the ground that since the subsidiary was still operating at the end of each of the tax periods concerned by the claim, there was a possibility that losses could be carried forward. This is a straightforward application of the "no-possibilities" test. The Commission complains that no account was taken of subsequent facts, by which it presumably means, the fact that, looking back, there was no actual use of losses. However, a retrospective assessment of whether losses have in fact been used is not the test set down by the Court. The "no-possibilities" test is very clearly intended to be a prospective assessment. Moreover, as has been pointed out above, an actual use of losses test would mean the subsidiary could simply choose not to use losses and then seek relief in respect of them.”

The Grand Chamber dismissed the Commission’s challenge but for different grounds to those suggested by the AG and restated and clarified M&S. The Court noted at [32] that, in respect of the Commission’s first claim that the loss deduction is “virtually impossible” that it was not claiming that the UK legislation made it impossible to claim loss deduction:

“32 According to the Commission, that requirement makes it virtually impossible for group relief to be obtained for losses sustained by a non-resident subsidiary, since in practice it allows the resident parent company to take such losses into account in only two situations: (i) where the legislation of the Member State of residence of the subsidiary concerned makes no provision for losses to be carried forward and (ii) where the subsidiary is put into liquidation before the end of the accounting period in which the loss was sustained.”

At [33], the CJEU rejected as irrelevant the Commission’s argument that where the legislation of the Member State made no provision losses to be carried forward on the basis that it was “settled law that losses sustained by a non-resident subsidiary cannot be characterised as definitive” as described in para 55 M&S and K paras 75 to 79:

“33 It should be noted, however, that the first of those situations referred to by the Commission is irrelevant for the purposes of assessing the proportionality of Section 119(4) of the CTA 2010. It is settled law that losses sustained by a non-resident subsidiary cannot be characterised as definitive, as described in paragraph 55 of the judgment in Marks & Spencer (EU:C:2005:763), by dint of the fact that the Member State in which the subsidiary is resident precludes all possibility of losses being carried forward (see judgment in K, EU:C:2013:716, paragraphs 75 to 79 and the case-law cited). In such a situation, the Member State in which the parent company is resident may not allow cross-border group relief without thereby infringing Article 49 TFEU.”

At [34] it rejected the second argument on the basis that the Commission had not established that s119(4) required the non-resident subsidiary to be put into liquidation before the end of the accounting period to obtain CBGR stating at [35] that it was clear that the provision did not impose any requirement for the subsidiary to be wound up before the end of the accounting period in which the losses are sustained:

At [36] it stated that the non-resident subsidiary’s losses may only be characterised as definitive only if it no longer has any income in its Member State of residence even if that income received is minimal.

“36 Secondly, it should be borne in mind that losses sustained by a non-resident subsidiary may be characterised as definitive, as described in paragraph 55 of the judgment in Marks & Spencer (EU:C:2005:763), only if that subsidiary no longer has any income in its Member State of residence. So long as that subsidiary continues to be in receipt of even minimal income, there is a possibility that the losses sustained may yet be offset by future profits made in the Member State in which it is resident (see judgment in A, EU:C:2013:84, paragraphs 53 and 54). [AB1996 A Oy C-123/11]”