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You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> The Union Castle Mail Steamship Company Ltd v HM Revenue and Customs & Ors [2020] EWCA Civ 547 (22 April 2020) URL: https://www.bailii.org/ew/cases/EWCA/Civ/2020/547.html Cite as: [2020] WLR 3772, [2020] EWCA Civ 547, [2020] WLR(D) 237, [2020] STC 974, [2020] STI 1094, [2020] 1 WLR 3772, [2020] BTC 10, [2020] 4 All ER 895 |
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 2020] EWCA Civ 547 | ||
CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
TAX AND CHANCERY CHAMBER
Mr Justice Fancourt and Judge Roger Berner
UT/2016/0198 and 0242
Strand, London, WC2A 2LL |
||
| 2020 |
B e f o r e :
LORD JUSTICE DAVID RICHARDS
and
LORD JUSTICE FLAUX
____________________
| THE UNION CASTLE MAIL STEAMSHIP COMPANY LIMITED |
Appellant |
|
| - and - |
||
| THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS And between LADBROKES GROUP FINANCE PLC and THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS |
Respondents Appellant Respondents |
____________________
Julian Ghosh QC and Ruth Jordan (instructed by the General Counsel and Solicitor to HM Revenue and Customs) for the Respondents
Hearing dates: 11 and 12 February 2020
____________________
VERSION OF JUDGMENT
Crown Copyright ©
Covid-19 Protocol:
This judgment was handed down remotely by circulation to the parties' representatives by email, release to BAILII and publication on the Courts and Tribunal Judiciary website (press.enquiries@judiciary.uk). The date and time for hand-down is deemed to be 10:30am on Wednesday 22 April 2020.
Lord Justice David Richards:
Introduction
companies of 95% in one case, and 100% in the other, of the value of derivative contracts held by them respectively gave rise to an allowable loss for the purposes of corporation tax. This issue turns on the proper construction and application of schedule 26 to the Finance Act 2002, which contains an exhaustive code for the taxation of profits arising from derivative contracts.
Union Castle Mail Steamship Company Limited (Union Castle) and Ladbrokes Group Finance plc (Ladbrokes).
Union Castle is a wholly owned subsidiary of Caledonia Investments plc (Caledonia), a publicly quoted company with investment trust status. HMRC disallowed a deduction of £39,149,128 made by Union Castle in its corporation tax return for the year to 31 March 2009, claimed as a result of a derecognition of 95% of derivative contracts held by it. Its appeal against the closure notice issued by HMRC was dismissed by the First-tier Tribunal (the FTT) in a Decision dated 27 July 2016. Its appeal to the Upper Tribunal (the UT) was dismissed, albeit on different grounds. It appeals to this court with permission granted by the UT.
Union Castle's appeal to the FTT was designated as a lead case for two other appeals, one being the appeal by Ladbrokes. HMRC had issued closure notices disallowing deductions in its 2008 and 2009 tax computations for losses resulting from the derecognition of derivative contracts. There were common issues and, in addition, an issue that applied only to Ladbrokes (the Gateway issue). On the Gateway issue, the FTT held in favour of Ladbrokes, with the result that its appeal was allowed. The UT reversed that decision. Ladbrokes appeals, with permission granted by the UT. I deal with Ladbrokes' appeal at the end of this judgment.
The facts
Union Castle were not in dispute before the FTT or the UT and were set out in an agreed statement. They were helpfully summarised by the UT in their Decision at [10] which I gratefully adopt:
"(1) Prior to 21 November 2008
(2) From about May 2007, the board of Caledonia wished to implement a hedging strategy, using put options against a FTSE index. The board was concerned about a possible substantial fall in UK equity markets.
(3) The board was concerned that purchase of such put options might prejudice Caledonia's investment trust status. Accordingly it was envisaged that
(4) Between 20 June and 31 December 2007, five FTSE put options at an aggregate cost of £10 million were acquired by
(5) In July 2008, accounting guidance for investment trusts and
(6) During the financial year ending 31 March 2009, some of the put options were exercised and further put options were purchased. As at 31 October 2008
(7) On 19 November 2008, Caledonia's audit committee considered novating the Contracts from
(8) On November 2008,
(9) The A Shares carried a right to receive a dividend equal to 95% of the cash flows arising on the close-out of the Contracts, such dividend to be paid within five business days following receipt by
(10) As a consequence of issuing the A Shares,
(11) Between January and August 2009
(12) On the issue of the A Shares, the following debits and credits were recognised by
Cr Financial asset £39,149,12825
Dr income statement £39,149,128
Cr share capital £5,020
Dr share premium £5,020
(13) The A Shares were added to Caledonia's investment ledger as a new security, with no cost attributed, but they were ascribed at fair
(14)
Union Castle's expert that the former was the more appropriate treatment, although the latter could not be said to be wrong. By reason of the relevant provisions of schedule 26, this makes no difference to the outcome of the appeal and it is unnecessary to consider it further.
Company under" and there were then identified each of the relevant derivative contracts. The rights further provided that "unless the Company has insufficient profits available for distribution and the Company is thereby prohibited from paying dividends by the [Companies Act 2006], the dividends payable on the A Shares…shall be paid without undue delay and in any event within five business days following receipt of each of the option cash settlement amounts". The dividends were payable without the need for any resolution of either the directors or the company in general meeting.
Companies Act 2006 (CA 2006). Part 23 requires, among other things, that a company's accounts must show distributable profits at least equal to a proposed dividend.
Union Castle would have distributable profits available to pay the dividends on the A Shares, Caledonia provided a letter dated 21 November 2008 to Union Castle. The letter referred to the proposed issue of the A Shares, and in particular to the dividend rights, "which will be of direct benefit to us". It requested Union Castle to proceed with the issue "to which as the Company's sole shareholder we hereby consent". It recorded that on receipt of a demand in writing Caledonia "shall make a capital contribution in cash to you in an amount equal to the option cash settlement amount receivable in respect of the relevant index option transaction less the amount of your distributable reserves (assuming receipt of that option cash settlement amount)". As the capital contribution would be made for no consideration, its entire amount would be credited to distributable reserves.
Generally accepted accounting practice (GAAP)
Union Castle, as a company incorporated under the Companies Act 1985, was required to prepare and file annual accounts. The directors had to be satisfied that such accounts "give a true and fair view of the assets, liabilities, financial position and profit or loss" of Union Castle: section 393(1) CA 2006. A company, with some exceptions, may elect to prepare its accounts either in accordance with section 396 CA 2006 or in accordance with international accounting standards: section 395(1) CA 2006. If accounts are prepared in accordance with section 396, they must be prepared in accordance with requirements laid down in regulations and, in order to comply with section 393(1), it is generally taken that they will give a true and fair view if they are prepared in accordance with the Financial Reporting Standards issued by the Financial Reporting Council (or until July 2012 the Accounting Standards Board), unless exceptionally the directors consider that departure from those standards is necessary in order for the accounts to show a true and fair view: see the discussion in GDF Suez Teeside Ltd v HMRC [2017] UKUT 68 (TCC) (GDF Suez) at [62]-[69]. In their totality, these requirements constitute UK GAAP.
company and the application of the various IAS is presumed to achieve a fair presentation. Where compliance with a particular IAS would be so misleading as to conflict with the purpose of financial statements, the directors must depart from it, with appropriate disclosure of the nature, reasons and impact of the departure.
company, Caledonia was required to prepare its group accounts in accordance with IAS, and as a subsidiary Union Castle also prepared its individual accounts in accordance with IAS.
companies' profits and gains in section 50 of the Finance Act 2004:
"(1) In the Corporation Tax Acts "generally accepted accounting practice" means
(a) in relation to the affairs of a
(b) in any other case, UK generally accepted accounting practice.
(2) In the Corporation Tax Acts "international accounting standards" has the same meaning as in regulation (EC) no 1606/2002 of the European Parliament and the Council of 19 July 2002 on the application of international standards."
The relevant legislation
"For the purposes of corporation tax all profits arising to a
Union Castle and Ladbrokes were derivative contracts, as defined, to which IAS 39 applied.
"(1) For the purposes of corporation tax the profits and losses arising from the derivative contracts of a
company is a party to a derivative contract for the purposes of a trade carried on by it.
"(1) The credits and debits to be bought into account in the case of any
(a) all profits and losses of the
(b) all charges and expenses incurred by the
....
(7) In this Schedule "related transaction", in relation to a derivative contract, means any disposal or acquisition (in whole or in part) of rights or liabilities under the derivative contract.
(8) The cases where there shall be taken for the purposes of sub-paragraph (7) to be a disposal or acquisition of rights or liabilities under a derivative contract shall include –
(a) those where such rights or liabilities are transferred or extinguished by any sale, gift, surrender or release, and
(b) those where the contract is discharged by performance in accordance with its terms.
(9) This paragraph has effect subject to the following provisions of this Schedule."
"Subject to the provisions of this Schedule (including in particular, paragraph 15(1)), the amounts to be brought into account by a
"Any reference in this Schedule to an amount being recognised in determining a
(a) in the
(b) in the
(c) in any other statement of items brought into account in computing the
"Where in accordance with generally accepted accounting practice a debit or credit for a period in respect of a derivative contract of a
(a) is recognised in equity or shareholders' funds, and
(b) is not recognised in any of the statements mentioned in paragraph 17B(1),
the debit or credit shall be brought into account for that period for the purposes of this Chapter in the same way as a debit or credit that, in accordance with generally accepted accounting practice, is brought into account in determining the
The issues
a) Did the accounting loss resulting from the derecognition constitute a "loss" for the purposes of paragraph 15(1) of schedule 26 (the "loss" issue)?
b) If there was a "loss", did it "arise from" the derivative contracts for the purposes of paragraph 15 of schedule 26 (the "arise from" issue)?
c) If there was a "loss", did the relevant debit "fairly represent" a loss arising from derivative contracts for the purposes of paragraph 15 (the "fairly represent" issue)?
d) Are the debits recognised under paragraph 25A subject to the requirements of paragraph 15 (the Gateway issue)? This issue applies only to Ladbrokes.
Union Castle on the "loss" and "fairly represent" issues, it held in favour of HMRC on the "arise from" and dismissed Union Castle's appeal.
HMRC ran an alternative case against Union Castle before the FTT and the UT that, if HMRC failed under schedule 26, the issue of the bonus shares by Union Castle fell within the scope of the transfer pricing rules in schedule 28AA to the Income and Corporation Taxes Act 1988, thereby reducing to nil the amount deductible for the debit. In view of the decisions of both Tribunals in favour of HMRC under schedule 26, this issue was not determinative of the appeals. Nonetheless, both Tribunals quite properly decided this issue, in case it should be material on an appeal. Disagreeing with the FTT, the UT held that the issue of the shares was a "provision" within schedule 28AA which was therefore capable of applying in Union Castle's case. In view of the conclusion to which I (and, as I understand it, the other members of the court) have come on the issues under schedule 26, it is not necessary to decide HMRC's alternative case under schedule 28AA and we did not hear argument on it.
company are to be computed "using the credits and debits given for the accounting period in question by the following provisions of this Schedule". Leaving to one side the Gateway issue, these words lead to paragraph 15 and, in particular for present purposes, to paragraph 15(1).
company's derivative contracts are "the sums which, when taken together, fairly represent, for the accounting period in question (a) all profits and losses of the company which (disregarding any charges or expenses) arise to the company from its derivative contracts and related transactions".
company for any period for the purposes of this Schedule", paragraph 17A(1) provides that, subject to the provisions of the schedule (including, in particular, paragraph 15(1)), the amounts shall be "those that, in accordance with generally accepted accounting practice, are recognised in determining the company's profit and loss for that period". The effect of these words is determined by paragraph 17B(1) which provides that any reference in the schedule to "an amount being recognised in determining a company's profit or loss for a period is to an amount being recognised for accounting purposes" in the company's profit and loss account or in any of the other accounts or statements listed in paragraph 17B(1).
company's GAAP-compliant accounts. Importantly, however, this is qualified by the opening words of paragraph 17A: "[s]ubject to the provisions of this Schedule (including, in particular, paragraph 15(1))". For the reasons which I will develop later, this qualification subjects the credits and debits as shown in GAAP-compliant accounts to the "fairly represent" requirement in paragraph 15(1).
The "loss" issue
HMRC submit that, even leaving aside the "fairly represent" requirement, there was no "loss" for the purposes of paragraph 15(1) arising from the derecognition. The mere fact that an accounting debit was created upon the issue of the A Shares did not necessarily mean that the debit represented a "loss" or "expense" within the meaning of paragraph 15(1). For that purpose, it was necessary to analyse the true nature of the transaction leading to the derecognition in order to determine whether, as a matter of law, it produced a loss.
HMRC's submission that there was no loss, as Union Castle was entitled to exactly the same amount on close-out of the options after the issue of the A Shares as it was before their issue. It received the full cash benefit under the closed-out options and distributed 95% of it by way of dividend on the A Shares. The issue of the A Shares and the consequent derecognition involved no real loss for Union Castle.
HMRC may be right that the issue of the A Shares did not involve a loss in relation to the relevant options, at least in common parlance, but said at [31] that the issue was the meaning of "losses" in paragraph 15(1) where the credits and debits to be brought into account in computing profits and losses are, by virtue of paragraph 17A, those recognised in GAAP-compliant accounts.
company's profits and losses are under these paragraphs determined by the entries in the company's GAAP-compliant accounts. That is the purpose of paragraphs 17A and 17B. It is not the use of the words "profits" and "losses" in paragraph 15 which requires a further assessment of their character but the "fairly represent" requirement. It is legitimate to ask why the "fairly represent" requirement should be included at all if such further assessment was in any event required.
The "fairly represent" issue
Ltd v HMRC [2010] UKSC 58, [2011] 1 WLR 44 and the decision of a differently constituted UT in GDF Suez. The UT went on to express the view that, on the other hand, "it cannot be regarded as providing a freestanding criterion of fairness by which means the accounting treatment of profits and losses can be reopened".
HMRC to prevent a mismatch in accounting treatment between the accounts of a parent company and the accounts of a subsidiary in relation to the same transaction. While it was arguable that such mismatches may not be confined to cases of parent and subsidiary, there was no authority that "fairly represent" encompassed any other category of case. Accordingly, the UT considered that the question on the authorities was whether there was any kind of accounting mismatch in the case of Union Castle and it concluded there was none.
EWCA Civ 2075, [2019] 1 All ER 528. In his judgment, with which Lord Kitchin and Asplin LJ agreed, Henderson LJ traced the genesis and development of the relevant provisions of the loan relationship code, which are precisely mirrored in the equivalent provisions of schedule 26. Section 84 of the Finance Act 1996 mirrors paragraph 15 of schedule 26. Both were amended by the Finance Act 2004 to remove the words "in accordance with an authorised accounting method", and the provisions dealing with authorised accounting methods were also deleted. Also deleted were section 84(2) and paragraph 15(3) which provided that the reference to profits and losses arising to a company included any profits and losses which in accordance with generally accepted accounting practice were carried to or sustained by any reserve maintained by the company. These deletions removed a direct express link between GAAP and section 84 and paragraph 15, but they were replaced by the indirect link introduced by section 85A and paragraph 17A respectively.
"I would be inclined to infer that Parliament's purpose must have been to make it clear that the "fairly represent" requirement in s.84 (1) is a separate and potentially overriding condition which has to be satisfied, once the initial computation in accordance with UK GAAP has been performed."
"the requirement to "fairly represent" the profits, gains and losses arising to the
company in respect of its loan relationships". At [91], Henderson LJ said there was little point in expressly making section 85A(1) [paragraph 17A(1)] subject to section 84(1) [paragraph 15(1)] if Parliament had intended that the fair representation requirement should always be assessed by reference to the same accounting criteria as those mandated by sections 85A and 85B [paragraphs 17A and 17B].
"The objection that Parliament would have formulated specific guidance on the application of the fair representation test, if it was intended to be an overriding requirement of a substantive nature, is at first sight more compelling, particularly when it is remembered that the test was until 2004 explicitly linked to "an authorised accounting method". Nevertheless, I do not think that the objection is well-founded, although it was persuasively advanced by Mr Ghosh. The concept of fairness is central both to the development and application of accounting standards, and to any process of judicial appraisal by a court or tribunal. In itself, the concept needs no elucidation, but rather provides a touchstone which is well suited to application by accountants, lawyers and judges, bringing their professional experience and expertise to bear in widely differing factual contexts."
view of the UT in GDF Suez that they could not be regarded as a freestanding criterion, which was not bound by the accounting treatment of profits and losses and could indeed override such treatment. The same applies in the present case. It is not enough to enquire whether there is any accounting mismatch between the accounts of a parent and its subsidiary that requires an adjustment to be made to the debits and credits in Union Castle's accounts.
v Jones (Inspector of Taxes) [1994] Ch 107 (CA) and HMRC v William Grant & Sons Distillers Ltd [2007] UKHL 15, [2007] 1 WLR 1448. But, as Sir Thomas Bingham MR acknowledged in Gallagher v Jones at p.134, this general principle must give way to any express or implied statutory rule. The "fairly represent" requirement is such a rule.
HMRC v Smith & Nephew Overseas Ltd [2020] EWCA Civ 299, further consideration was given to the "fairly represent" requirement in the loan relationship code. The case concerned exchange losses and was decided on the basis of the special provisions introduced to deal with such losses, which are not applicable to the present case. Submissions were made as to whether, if applicable to exchange losses, the losses in issue in that case satisfied the fairly represent test. Giving the leading judgment, Rose LJ carefully considered Henderson LJ's judgment in GDF Suez and in a passage at [42], with which Coulson LJ specifically agreed, said:
"I agree with
view there expressed as to the role of the "fairly represent" requirement or "override". Neither asymmetry of tax treatment nor a tax avoidance purpose is necessary for its operation. Indeed, it is neutral in its application for and against the taxpayer. It is therefore strictly irrelevant that both Union Castle and Ladbrokes sought to take advantage of the same tax avoidance scheme marketed by Deloitte. Nonetheless, such schemes are more likely to explore the scope for arbitrage between the strict application of technical standards and what may fairly represent a profit or a loss for the purposes of schedule 26.
Union Castle nor Ladbrokes, in preparing their accounts, departed from specific accounting standards in order to show a true and fair view or a fair presentation. However, no such tension exists, nor to be fair did Mr Peacock submit that it did. The true and fair or fair presentation "override" forms part of GAAP. It involves a departure from a particular accounting standard but not a departure from GAAP. By contrast, where applicable, the statutory "fairly represent" requirement in paragraph 15(1) does mandate a departure from GAAP.
companies, in their assessment of the financial position and performance of a company, may not always match the purpose of determining profits and losses for tax purposes. For this reason, the "fairly represent" requirement appears in paragraph 15(1) and in the equivalent provisions dealing with loan relationships.
Union Castle submitted that the correct focus of the paragraph 15 analysis was the derecognition, not the subsequent payment of the dividend on the A Shares. HMRC was wrongly conflating the two. The derecognition related to the fair value of the derivative contracts on 21 November 2008. Through the issue of the A Shares, Union Castle lost access to 95% of the cash flows from the contracts and hence lost 95% of the fair value of the contracts, which was reflected in the derecognition. This gave rise to an actual diminution of Union Castle's resources and in its net asset value. Economically, Union Castle no longer held the risk and reward in relation to the contracts, which had been passed to Caledonia. At that time no profits had been received, and therefore there could not be any application of profits at that time. When subsequently Union Castle received the close-out proceeds, it did not at that point choose to pay out 95% of the proceeds, because it had already committed to doing so by the issue of the A Shares.
Union Castle's submissions as regards the "fairly represent" requirement, particularly as informed by Henderson LJ's judgment in GDF Suez. Mr Peacock accepted that the existence of an accounting loss did not determine whether it "fairly represented" a loss, but it did mean that there needed to be a good and particular reason to justify overriding a "loss" as shown in GAAP-compliant accounts, on grounds of fair representation. No such reason existed in the present case.
Union Castle was the beneficial owner of the derivative contracts. At the time of the issue of the A Shares, their market value (approx. £41.2 million) was very substantially in excess of their cost (approx. £16.6 million). While the A Shares imposed an obligation on Union Castle to pay a dividend equal to 95% of the sums received on close-out of the contracts, that did not affect its beneficial ownership of the contracts or of their close-out proceeds. They remained assets available to Union Castle to meet any and all of its obligations, not confined to its obligation to pay the dividend on the A Shares. This is simply tested by considering the position if Union Castle became insolvent. The cash flows would have been available to meet its liabilities, and the dividend on the A Shares would be subordinated to other provable debts in a liquidation or distributing administration.
Union Castle is not an absolute obligation to pay 95% of the close-out proceeds but is an obligation to pay a dividend on the A Shares equal to that sum. This obligation not only presupposes that Union Castle remains beneficially entitled to the derivative contracts and their close-out proceeds, but also requires for its lawful performance that Union Castle has distributable profits at least equal to 95% of the close-out proceeds when payment of the dividend is due. Given the cost of the derivative contracts, their close-out would be highly unlikely to result in distributable profits equal to 95% of the close-out proceeds. Other profits would be required for the dividend to be paid. The purpose of the Caledonia agreement was to ensure, so far as possible, that this requirement would be fulfilled. In fact, Caledonia was the holder of the A Shares, so the purpose of its undertaking to make the capital contributions was to ensure that it received the dividends on those shares.
Union Castle's ordinary shares.
Union Castle's accounts by the derecognition did not, as a matter of legal analysis or economic reality, fairly represent a loss to Union Castle for the purposes of paragraph 15(1). Union Castle lost no asset nor incurred any liability other than a liability to pay a dividend on shares, such shares being issued for no consideration to its holding company. The payment of a dividend is not a loss. It is the very reverse of a loss: it is the distribution of profits. The difference between a loss and a distribution of profits is expressly recognised by section 830(2) of the Companies Act 2006, which defines a company's distributable profits as its accumulated, realised profits, so far as not previously utilised in a distribution, less its accumulated realised losses. If the payment of a dividend is not a loss, I am unable to accept that an obligation to pay a dividend, in this case out of future profits, can be a loss.
Union Castle can apply in the context of the "fairly represent" issue. Addressing the "loss" issue, the UT said at [31] that a loss arose on derecognition "because the economic value to the company of the Contracts no longer exists (as to 95% of the value in Union Castle's case) and the company's worth has gone down". That is unobjectionable if restricted to an analysis of the effect of the derecognition on the entries in Union Castle's accounts. But viewed more broadly, it would be wrong to say that Union Castle's value had gone down or that the economic value to Union Castle of the derivative contracts no longer existed. It may be thought that the only diminution in value that resulted from the issue of the A Shares was in the value of the ordinary shares, which lost the right to receive those dividends to which the A Shareholders became entitled. In reality, that was of no consequence because Caledonia held all shares of both classes, a fact candidly recognised by Caledonia in its letter of undertaking dated 21 November 2008 where it stated that the issue of the A Shares would be "of direct benefit to us".
HMRC was right in his submission that the issue of the A Shares was in substance an election by Union Castle that it would in the future distribute by way of dividend to its parent company 95% of the close-out proceeds of the derivative contracts, as and when they were received. I am unable to see that Union Castle thereby incurred anything that could fairly be described as a loss for the purposes of paragraph 15(1) of schedule 26.
Union Castle in fact ensured that it had the distributable reserves necessary to pay the dividends on the A Shares as and when the derivative contracts were closed out. In January 2009, two options were closed out for net cash settlements totalling £13,734,511, giving rise to an obligation to pay a dividend of £13,047,785 on the A Shares.
Union Castle had to comply with the requirements of Part 23 of the Companies Act 2006. Section 836 required that its "relevant accounts" should show that it had distributable profits at least equal to the proposed dividend. Section 836(1) requires that whether a distribution may be made is to be determined by reference to, among other items, "profits, losses, assets and liabilities" as stated in the relevant accounts. Those accounts are the company's last annual accounts, except that where the distribution would contravene Part 23 it may be justified by reference to interim accounts: section 836(2). Section 838(1) requires, in the case of a private company like Union Castle, interim accounts to be such accounts as enable a reasonable judgment to be made as to the amounts of the items mentioned in section 836(1).
Union Castle were for the year ended 31 March 2008, which showed distributable reserves of just under £5 million, which was inadequate for the proposed dividend. Accordingly, interim accounts were prepared. The accompanying notes stated that they had been prepared in accordance with IFRS. The income statement included the debit of £39,149,128 resulting from the derecognition of the derivative contracts. Together with other items, this produced a loss for the period since 1 April 2008 of just under £3.4 million, resulting in reserves of approximately £1.57 million after crediting the reserves as at 31 March 2008.
very debit said to be a loss. This appears to be a remarkable piece of "now you see it, now you don't" accounting.
company's profits available for distribution, I am unable to understand how the debit can nonetheless fairly represent a loss for the purposes of paragraph 15(1). In truth, it was not a loss but only, as the accounts described it, an "accounting debit".
The "arises from" issue
company from its derivative contracts and related transactions", so that the debit was not brought into account under paragraph 15(1). Union Castle appeals against that decision.
company from", it refers to credits and debits "in respect of" its derivative contracts and to charges and expenses incurred "under or for the purposes of" its derivative contracts. As a matter of language, "arises from" bears "a narrower meaning and implies a direct causal connection between losses (or profits) and derivative contracts" than, in particular "in respect of": paragraph [39].
company from its derivative contracts and related transactions". Paragraph 15(7) defines "related transaction" as "any disposal or acquisition (in whole or in part) of rights or liabilities under the derivative contract". It followed that profits and losses that arise from related transactions (as defined) do not arise from the derivative contracts themselves. The UT said at [40]:
"Since related transactions are defined as disposals in whole or in part of rights or liabilities under the derivative contracts, it would be
value of the derivatives themselves: paragraph [42].
Union Castle challenged the UT's reasoning on a number of different grounds.
value of those contracts be derecognised and that loss arose from the contracts. This was an adjustment to the value of the contracts, because in economic terms their value to Union Castle had declined as a result of the issue of the A Shares.
very different contexts does not assist the construction of "arise from' in the context of schedule 26, nor is it assisted by instancing wholly different transactions without a full examination of their terms and of the corporation tax provisions, wherever they appear, applicable to them.
value of a derivative contract causes a loss which is properly described as arising from the contract itself. Its value has declined. Union Castle argues that, likewise, a derecognition mandated by IAS 39 reflects a decline in the value of the derivative contract to the company and also arises from the contract. This submission depends on showing that the relevant debit did not arise from the issue of A Shares, but arose from the derecognition. The difficulty for Union Castle is that the derecognition and the issue of the A Shares are inseparable. The issue of the A Shares had the effect, by reason of the derecognition mandated by IAS 39, of reducing the carrying value of the derivative contracts by 95%. In my judgment, it is not tenable to say that the derecognition arises from the derivative contract, as opposed to the issue of the A Shares.
Union Castle's appeal on this ground.
The Gateway issue
Union Castle. In November 2008, it made a bonus issue of A Shares to its parent company. The A Shares carried the right to a dividend equal to amounts payable on certain swap contracts. In consequence, Ladbrokes derecognised £102,973,780 in respect of the swap contracts and claimed a deduction of that amount in its tax computation for 2008. Its accounts were prepared in accordance with UK GAAP and derecognition was required by the applicable FRS. Similar bonus issues were made in January and April 2009, involving derecognitions totalling £244,814,834, for which Ladbrokes claimed deductions in its tax computations for 2009. Following enquiries into the 2008 and 2009 returns, HMRC disallowed these deductions.
Union Castle because, when it derecognised the swap contracts, it did not recognise the debit in its profit and loss account or any of the other statements listed in paragraph 17B. Instead, the debit was recognised in equity. Accordingly, paragraph 25A of schedule 26 applies, which provides:
"Where in accordance with generally accepted accounting practice a debit or credit for a period in respect of a derivative contract of a
(a) is recognised in equity or shareholders' funds, and
(b) is not recognised in any of the statements mentioned in paragraph 17B(1),
the debit or credit shall be brought into account for that period for the purposes of this Chapter in the same way as a debit or credit that, in accordance with generally accepted accounting practice, is brought into account in determining the
HMRC's appeal against this decision: see the UT's Decision at [73]-[83]. It held that paragraph 25A equates the position of credits and debits recognised in equity or shareholders' funds with those credits and debits recognised in the profit and loss and other statements to which paragraph 17B applies. This was the effect of the words "in the same way" in paragraph 25A. Paragraph 15 sets the requirements for all credits and debits to be brought into account, namely that they should fairly represent for the accounting period in question profits and losses which arise from the company's derivative contracts and related transactions. It sets out the credits and debits to be brought into account, while paragraph 14 is concerned with the computation of profits and losses using those credits and debits. The UT did not agree with the FTT's acceptance that paragraph 15 had the limited roles for which Union Castle contended. Although the UT reached their conclusion as a matter of the natural and ordinary meaning of the relevant provisions, they considered that there could be no purpose in a more favourable and less stringent treatment for credits and debits that were recognised in equity or shareholders' funds than those recognised in the statements to which paragraph 17B applies.
company's profit or loss for that period". Debits and credits brought into account in accordance with GAAP in determining the company's profit or loss are the subject of paragraphs 17A and 17B. Those debits and credits are brought into account if they satisfy the requirements of paragraph 15. The debits and credits subject to paragraph 25A must be brought into account "in the same way". They too must satisfy the requirements of paragraph 15.
company in respect of its derivative contracts", which are echoed in paragraph 25A as well as in paragraph 17A.
company".
Conclusion
Union Castle's appeal, I agree with the UT's conclusions on the "loss" and "arise from" issues, but I have come to a different conclusion on the "fairly represent" issue and I would dismiss the appeal on that ground as well as on the "arise from" issue.
Union Castle seeking an order for the matter to be remitted to the FTT "for determination of the relevant figures [of its corporation tax liability for the period ended 31 March 2009] in accordance with the judgment" of this court. It was submitted that because the debit in respect of the derecognition in Union Castle's accounts for the period ended 31 March 2009 had been disallowed, it followed that the total net reduction in the fair value of its derivative contracts between 22 November 2008 and 31 March 2009 should be recognised, with a corresponding reduction of some £4.6 million in its corporation tax liability for that period. It was submitted that one consequence of our decision is that losses not recognised in GAAP-compliant accounts should be brought into account for corporation tax purposes. HMRC opposed this course, pointing out that this alternative case could and should have been raised at a much earlier stage.
Union Castle should now be permitted to seek to amend its tax computation in this way and (ii) if so, whether it has a good case for such an amendment. Having not heard argument on either issue, I express no views on them, nor do I express any view on Union Castle's submissions as to the consequences of our decision.
Lord Justice Flaux:
Lord Justice Lewison: