Ball UK Holdings Ltd
| Jurisdiction | UK Non-devolved |
| Judgment Date | 02 June 2017 |
| Neutral Citation | [2017] UKFTT 457 (TC) |
| Date | 02 June 2017 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Barbara Mosedale, Mr David Williams
Ms N Shaw, QC, instructed by Hogan Lovells International LLP, appeared for the appellant
Mr J Henderson, Counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Corporation tax – Whether accounts in accordance with generally accepted accounting practice – Financial Reporting Standard 23 the applicable standard – No – Appeal dismissed.
The First-tier Tribunal held that the adoption of a dollar functional currency for accounting purposes was not in accordance with the provisions of FRS 23 therefore the exchange loss arising on transition from the company's former functional currency of sterling was not allowable under the loan relationship rules.
The taxpayer company changed its accounts functional currency from sterling to dollars as a result of which a large foreign exchange loss was recognised for accounting purposes. The taxpayer claimed corporation tax relief for the exchange loss under Finance Act 1996, s. 85A which provided that the amounts to be brought into account under the loan relationships rules were those that, in accordance with generally accepted accounting practice, were recognised in determining the company's profit or loss for the period. The question for the First-tier Tribunal (FTT) was whether the taxpayer had properly applied FRS 23 (The Effects of Changes in Foreign Exchange Rates) in determining that its functional currency was dollars.
The relevant definitions and tests for determining functional currency under FRS 23 were contained in paras. 8 to 13, the results of which are summarised as follows:
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• Para. 8 contained the principal definition of functional currency i.e. the currency of the primary economic environment in which the entity operates. HMRC thought that primacy should be given to the para. 8 definition, a view with which the FTT agreed.
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• With the exception of the first sentence (which reiterated the primary economic environment test in para. 8), para. 9 was not generally applicable because the taxpayer was a passive investment holding company not an operational company. It was agreed that if para. 9 indicated an obvious functional currency, then paras. 10 and 11 need not be considered but that was not so in the present case.
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• Of the two tests in para. 10, only the para. 10(a) test was relevant. This indicated a sterling functional currency because that was the currency in which the taxpayer's financing activities (issuing debt and equity instruments) were denominated. The para. 10(b) test was not relevant because the taxpayer's receipts were mostly in the form of sterling dividends (which it used to fund interest payments on debt obligations) and not from operating activities.
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• Of the four tests in para. 11, para. 11(a) was the principal source of disagreement whilst the other three tests, being cash flow and transactions based, all indicated a sterling functional currency.
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• Para. 12 provided guidance in the event that the other tests gave mixed results. In the event that it proved relevant, the FTT held that it looked at the economic effects of the underlying transactions, events and conditions and, for the taxpayer, that was sterling.
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• Para. 13 may not have been directly relevant to the determination of the taxpayer's functional currency, nevertheless the FTT held that it was one more indicator that FRS 23, as a whole, was looking at economic factors, particularly underlying transactions, events and conditions.
The crux of the case rested on the meaning attributed to the para. 11(a) test i.e. whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy.
The taxpayer considered that autonomy, in this context, referred to control of the taxpayers activities. As it was accepted that the taxpayer took its directions from its ultimate parent, its activities were not therefore carried out with a significant degree of autonomy. On the contrary, HMRC considered that autonomy should take its meaning from the context in which it was used in para. 11 of FRS 23. As it was clearly intended to be the opposite of an extension of the parent, autonomy had a wider meaning, more akin to economic or functional independence from the company's parent rather than merely freedom from control. The Tribunal agreed with HMRC's approach finding that para. 11(a) indicated a sterling functional currency because the taxpayer's activities were carried on with a significant degree of autonomy in the sense of economic independence. It also rejected the taxpayer's argument that the para. 11(a) test over-rode (or trumped) the other tests. This meant that all relevant tests indicated a sterling functional currency.
The taxpayer's interpretation of FRS 23 was neither correct nor reasonable. It took one word (autonomy), and gave that word an elevated meaning out of the context in which it was used, ignoring the possibility that a wider meaning was appropriate; it ignored the examples given by the standard; it ignored the overall context of FRS 23; and ignored all the other functional currency tests by inventing the concept of trumping, a concept for which there was no basis in the standard. It failed to engage with the fact that, if correct, it was a major change to the previous version of the standard and yet was not listed in the notes as a major change. It did all this without being able to give a coherent explanation of why its interpretation led to a true and fair view being presented by the accounts. Lastly, and contrary to the taxpayer's arguments, its interpretation of FRS 23 was not the view taken by the Big 4 in their guidance manuals.
In a robust and emphatic rejection of the taxpayer's expert accounting evidence, the First-tier Tribunal held that the taxpayer's determination of a dollar functional currency was a misapplication of FRS 23. In particular, the word autonomy in para. 11(a) had to take its meaning from the context in which it was used which, from the examples in the standard, indicated that a company with autonomy was one which accumulates cash and other monetary items, incurs expenses, generates income and arranges borrowings, all substantially in its local currency. While autonomy of decision making might be relevant in a borderline case, this was no such a case. The taxpayer clearly had autonomy in the meaning intended para. 11(a). In any event, all the other relevant factors also pointed to sterling as functional currency. It was irrelevant that the decisions which caused those answers to point to sterling were taken by the taxpayer's ultimate parent, as FRS 23 was not about who made the decisions.
For commentary on the taxation of foreign exchange gains and losses, see the CCH Tax Reporter at 719-000.
[1] The parties were agreed that the issue for determination in this hearing was whether the accounts of the appellant company (“BUKH”) for the year ended 31 December 2006 were prepared in accordance with UK generally accepted accounting practice (“UK GAAP”). HMRC's case is that they were not because they showed BUKH's functional currency as US dollars (“dollars”) whereas, in HMRC's opinion, it was pounds sterling (“sterling”).
[2] S 85A Finance Act 1996 provided at the time in question:
(1) … the amounts to be brought into account by a company for any period for the purposes of this Chapter are those that, in accordance with generally accepted accounting practice, are recognised in determining the company's profit or loss for the period
[3] It was agreed that if the Y/E 2006 accounts were in accordance with UK GAAP, then BUKH was properly treated in its accounts and corporation tax return as having suffered a foreign exchange loss when its functional currency was changed to US dollars, its previous years' accounts having being shown in sterling. On the other hand, if the Y/E 2006 accounts were not in accordance with UK GAAP because they treated the functional currency as being dollars, then BUKH had improperly shown a foreign exchange loss in its accounts, and HMRC's amendment of its corporation tax return to remove the tax advantage which resulted from this reported foreign exchange loss (of about £24.6 million) was correct.
[4] So the dispute was whether or not BUKH's accounts for Y/E 2006 were in accordance with UK GAAP in treating its functional currency as dollars rather than sterling.
[5] The question for the Tribunal was whether BUKH's 2006 accounts were:
in accordance with generally accepted accounting practice
So what is “generally accepted accounting practice”? We consider that it is generally accepted accounting practice to adopt an accounting standard permitted by the UK Accounting Standards Board (“UK ASB”). BUKH applied (or purported to apply) FRS 23 when adopting dollars as its functional currency, and FRS23 was an accounting standard permitted by the UK ASB at the time in issue.
[6] So the question is whether BUKH actually applied FRS23 and that is a matter of fact, on which we had expert opinion evidence. Before dealing with that expert evidence, we deal with the appellant's case on whether it has to prove that it correctly applied FRS23 or whether it only has to prove that it applied a reasonable interpretation of FRS23. This submission was made by Ms Shaw in reliance on Versteegh Ltd.
[7] We were referred to this case as one question in that appeal was whether the taxpayer's accounts were in conformity with GAAP as required by s 85(2) FA 1996. The FTT said:
… the question is whether the accounting treatment adopted by [the taxpayer] … is authorised. For this purpose it will be authorised only if it is in conformity with GAAP: see 85(2) FA 1996.
[13] If [the taxpayer's] accounting...
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