Fenlo Ltd v HM Revenue and Customs
| Jurisdiction | England & Wales |
| Judgment Date | 06 November 2008 |
| Date | 06 November 2008 |
| Court | Special Commissioners |
special commissioners decision
Nicholas Aleksander
Oliver Conolly of counsel for the Appellant
Mark Harrison, HM Revenue & Customs Appeals Unit for the Respondents
Loan relationship - release - Finance Act 1996, Finance Act 1996 schedule 9 subsec-or-para 5Sch. 9, para. 5(3) - effect of covenants in loan agreement - does lender control borrower for purposes of Finance Act 1996, Finance Act 1996 section 87As. 87A - no - amount released brought into charge
A special commissioner decided that the release of part of a loan made to the taxpayer company fell within the loan relationships legislation in FA 1996, and had to be brought into account in computing the taxpayer's profits, since the taxpayer had failed to show that the amount came within the exception in Finance Act 1996 schedule 9 subsec-or-para 5FA 1996, Sch. 9, para. 5(3) as the release took place in an accounting period in which the taxpayer was controlled by its lender pursuant to Finance Act 1996 section 87AFA 1996, s. 87A.
In 1981 T bought a large semi-detached house he converted into a small hotel/guesthouse. It was also his family's home. In 1986 the opportunity arose to purchase the adjoining property with the aid of a loan from Y, a long-standing business associate. Y was not prepared to lend the money to either T or any company which he controlled. Therefore the taxpayer company was incorporated with T's wife and daughter as the only shareholders and directors. T was the company secretary. The taxpayer's articles of association incorporated Table A with some modifications. Article 70 of Table A was incorporated without amendment, which provided that the business of the company should be managed by the directors, who might exercise all the powers of the company.
The taxpayer purchased the property at a price of £500,000, using a loan of £500,000 from Y. The taxpayer also purchased the first property from T for £200,000, which was paid to T in instalments over a number of years. Building work was undertaken to join the two properties and convert them into a hotel; a link building was subsequently added at the rear. Approximately £100,000 was spent on joining the buildings and converting them into a hotel, and approximately £450,000-£500,000 was spent on the link building. All these works were financed by loans from Y. It was only in 1992 that the loans were formally documented in the form of a facility letter dated 19 October 1992 from a company, B, incorporated in the Bahamas, to the taxpayer and a debenture of the same date charging the undertaking and assets of the taxpayer by way of security for the loan. B was under the ultimate control of Y.
In October 1992, the taxpayer drew down £1,200,000 under the facility letter and used the funds to repay the loans owing to Y. On the basis that the hotel was worth approximately £1,200,000, the loan-to-value ratio then was approximately 100 per cent. In March 2002, the taxpayer defaulted and B demanded immediate repayment of the loan. Attempts were made by the taxpayer to sell the hotel in order to raise money to repay the loan. However, it proved impossible as the planning consent required the properties to be converted back into two private residences if they ceased to be owned by the taxpayer. By an undated deed, in July 2003, B accepted payment of £650,000 in full and final settlement of all amounts owing by the taxpayer under the October 1992 facility letter. The taxpayer's financial statements for the year ended 31 March 2004 showed an exceptional item of profit of £1,072,333 being the balance of the loan that had been released by B.
An issue arose concerning the treatment of the release of part of the loan made to the taxpayer. It was common ground that the loan fell within the loan relationships legislation in FA 1996, and that the amount released was to be brought into account in computing the taxpayer's profits, unless one of the exceptions in the legislation applied.
The issue was whether, as the taxpayer contended, it was connected with the lender, and the release was therefore not to be brought into account by virtue of Finance Act 1996 schedule 9 subsec-or-para 5FA 1996, Sch. 9, para. 5(3).
The special commissioner (Nicholas Aleksander) (dismissing the appeal) said that it was common ground that corporation tax was chargeable on the profit recognised in the taxpayer's accounts in respect of that part of the B loan that was released, unless a relevant exception applied. The exception on which the taxpayer sought to rely was contained in Finance Act 1996 schedule 9 subsec-or-para 5FA 1996, Sch. 9, para. 5(3) and applied if the release took place in an accounting period in which B controlled the taxpayer for the purposes of Finance Act 1996 section 87AFA 1996, s. 87A.
In practice, some of the covenants were breached. The taxpayer did not always produce management accounts on a monthly basis and the taxpayer's bookkeeping was undertaken for a fee by a company in which T had an interest. However, Y was aware of those breaches, and never raised any concern about them. Y was a regular guest at the hotel and continued to be a close business associate of T.
In all the circumstances, the commissioner had no hesitation in deciding that at no time was the taxpayer under the control of B for the purposes of s. 87A. The covenants in the facility letter were restricted in their scope and negative in their nature. They were typical of those found in agreements governing highly geared secured loans, such as this. Their purpose was to protect the financial interests of the lender: to ensure that the lender's security package was protected, that value was not leached out of the borrower and that the lender was provided with reliable financial information so that it could monitor the loan.
The facility letter did not have the flavour of, nor was it akin to, articles of association of a company. Even if it was, the covenants contained therein were not sufficient to give B control over the taxpayer. The cases indicated that control should be read as the ability to order the affairs of a company according to the controller's wishes on a continuing basis. The taxpayer had contended that as B's wishes were restricted to the covenants set out in the facility letter, the company was managed in accordance with those wishes. However, no evidence was submitted as to B's wishes or desires, and it could not therefore be accepted that that was the case. Even if at the date of the facility letter B's wishes were minimal, B would not have the ability to secure changes to the taxpayer's business in the event that its wishes changed (e.g. in the light of changes to the circumstances of the taxpayer's business). Finally, accepting the taxpayer's argument would lead to the absurd result that banks and other lenders would be treated as controlling their borrowers in very many cases, as the covenants in the facility letter were typical of those found in many secured commercial loan agreements.
Accordingly, the amount of the B debt that was released in July 2003 was liable to be brought into account for the purposes of computing the taxpayer's taxable profits.
1. The point at issue in this matter is the treatment of the release of part of a loan which had been made to the Appellant, Fenlo Limited ("Fenlo"). It is common ground that the loan falls within the loan relationships legislation in Finance Act 1996, and that the amount released is to be brought into account in computing Fenlo's profits, unless one of the exceptions in the legislation applies. Fenlo contends that it was connected with the lender, and the release is therefore not to be brought into account by virtue of Finance Act 1996 schedule 9 subsec-or-para 5Schedule 9, paragraph 5(3), Finance Act 1996. The Revenue contend that Fenlo and the lender were not connected and that no other exemption applies.
2. I heard evidence from Mr Sidney Taylor, company secretary of Fenlo. In addition a statement of facts not in dispute and a bundle of documents were submitted at the hearing by the Revenue.
3. In 1981 Mr Taylor bought 198 Hagley Road, Birmingham. This was a large semi-detached house, which Mr Taylor converted into a small hotel/guesthouse. It was also his family's home. In 1986 the opportunity arose to purchase the adjoining property, 200 Hagley Road, which was done with the aid of a loan from Mr Teddy Yip, a long standing business associate of Mr Taylor. For reasons which are not wholly clear, Mr...
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