GDF Suez Teesside Ltd v The Commissioners for HM Revenue and Customs
|England & Wales
|Lord Justice Henderson,Asplin LJ
|05 October 2018
| EWCA Civ 2075
|Court of Appeal (Civil Division)
|Case No: A3/2017/1070
|05 October 2018
 EWCA Civ 2075
Lord Justice Henderson
Lady Justice Asplin
Case No: A3/2017/1070
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
(TAX AND CHANCERY CHAMBER)
Royal Courts of Justice
Strand, London, WC2A 2LL
Mr Julian Ghosh QC, Mr Richard BoultonQC andMr Charles Bradley (instructed by Slaughter and May) for the Appellant
Mr David Milne QC, Ms Elizabeth WilsonandMr Ben Elliott (instructed by the General Counsel and Solicitor to HMRC) for the Respondents
Hearing dates: 30 April and 1 and 2 May 2018
This case concerns a tax avoidance scheme by which the appellant taxpayer, then called Teesside Power Limited (“TPL”) and subsequently renamed GDF Suez Teesside Limited, sought to reduce its potential liability to United Kingdom corporation tax (“CT”) in respect of contingent and unrealised, but nevertheless very valuable, claims which it had against certain companies in the insolvent Enron Group. When the relevant transactions were entered into, between December 2006 and March 2007, the open market value of the unrealised claims is agreed to have been approximately £200 million, but in accordance with UK generally accepted accounting practice (or “GAAP”) the claims still had a carrying value of nil in TPL's accounts. Accordingly, if nothing were done, TPL would in principle become liable to CT on profits equivalent to the full amount of the sums received as and when the claims were realised.
On advice from Ernst & Young LLP (“EY”), who devised the scheme and were also TPL's auditors, TPL hoped to escape this potential liability by the simple expedient of transferring the relevant claims to a newly-incorporated and wholly-owned Jersey subsidiary, called Teesside Recoveries and Investments Limited (“TRAIL”), in consideration for the issue by TRAIL to TPL of equivalent numbers of fully paid ordinary shares in TRAIL representing the fair value of the claims. There were three transfers in all, two of which took place on 5 December 2006 and the third on 2 March 2007. Thus TPL exchanged its beneficial ownership of the claims for beneficial ownership of the corresponding shares in TRAIL, and TPL now had indirect (shareholder) control, through its ownership of TRAIL, instead of direct (managerial) control in its own right, over the future realisation or utilisation of the claims.
Throughout these proceedings, it has been common ground that the claims gave rise to “loan relationships” within the meaning of the taxation regime governing corporate loan relationships which was first enacted in Chapter II of Part IV of the Finance Act 1996 (“ FA 1996”). The loan relationship legislation has been substantially amended on a number of occasions since its introduction, and we are concerned with the code as it stood in the tax year 2006/07, including (as I shall explain) important amendments made by the Finance Act 2004 (“ FA 2004”) and (with effect from 19 July 2006) by the Finance Act 2006 (“ FA 2006”).
The scheme was designed on the basis that the transfer of the claims by TPL to TRAIL would not give rise to any “credits” which, in accordance with UK GAAP, would have to be taken into account in computing the profits and gains arising to TPL in its two relevant accounting periods (the first of which ended on 5 December 2006, and the second of which ran from 6 December 2006 to 30 September 2007). In other words, the intention was that the transfers would not generate any taxable credits in the hands of TPL, and that the shares in TRAIL would have a carrying value of nil in TPL's accounts in the same way as the claims for which they had been exchanged.
On the other hand, it is agreed that the position of TRAIL was different from that of TPL, in that TRAIL acquired assets which did not represent anything it had previously owned, and provided full consideration for those assets by the issue of corresponding numbers of its own shares at par. Thus the base value of the claims in the hands of TRAIL was their market value of approximately £200 million, and TRAIL would in principle subsequently realise a profit from the claims only if and to the extent that realisations exceeded that base value. As a company registered and resident for tax purposes in Jersey, TRAIL was not itself liable to CT; but it was a “controlled foreign company” (or “CFC”) within the meaning of the UK tax legislation dealing with CFCs, and as such its future profits (if any) were liable to be attributed to TPL and taxed in the UK accordingly. The critical difference from the status quo, however, was that only profits arising from realisations in excess of the £200 million base value could be “brought home” in this way and taxed in the hands of TPL. So the overall effect of the scheme, if it worked, was that the £200 million would fall permanently outside the net of CT, because (a) the transfers of the claims to TRAIL gave rise to no loan relationship credits in the hands of TPL, and (b) any subsequent profits realised by TRAIL from the claims would be taxable under the CFC legislation only to the extent that they exceeded the £200 million base value.
Similarly, if TRAIL were subsequently to pay up distributable profits by way of dividend to TPL, it could only do so to the extent that it had accounting profits in excess of the base value which were available for distribution under Jersey company law (which the parties were content to assume was the same for all material purposes as English company law), and TPL would again be taxable on only that amount.
In the event, TRAIL subsequently received sums totalling approximately £243 million in respect of the claims, between April 2007 and May 2008. TRAIL never held any assets other than the claims, and the proceeds from their realisation were for the most part lent back to TPL on an unsecured and interest free basis. We were informed by leading counsel for HMRC, Mr David Milne QC, that no charge under the CFC legislation was made on TPL in respect of the profit element of £43 million realised by TRAIL, because the equivalent sum was in fact paid up by TRAIL to TPL by way of dividend and was taxable in the hands of TPL on that basis. On 3 July 2008, the directors and shareholders of TRAIL passed a special resolution to wind up the company. The sole purpose for which it had been brought into existence had been accomplished.
At this point, it may be helpful to quote the description of the scheme provided by EY when they notified it to HMRC on 8 December 2006 under the “Disclosure of Tax Avoidance Schemes” (or “DOTAS”) rules introduced by section 308 of FA 2004, as follows:
“These arrangements enable a UK company (“UKCo”) to indirectly realise the value of an existing asset which has no carrying value under UK GAAP (such as potential proceeds under a claim under litigation or an insolvency process) without triggering an immediate tax charge, by transferring it to a foreign subsidiary (“FSub”) in exchange for an issue of new shares. FSub may subsequently realise value from the asset. Any profit so arising may give rise to a liability to corporation tax through the operation of the UK controlled foreign company (“CFC”) rules, but in calculating the gain, the effective base cost of the asset will have been stepped up to market value at the time of transfer.
Under UK GAAP, the nature of the asset is such that it is not recognised as an asset in the books of UKCo. Further, no realised profit would arise on transfer of the assets to FSub solely in return for the issue of newly-issued shares. The prior history and documentation surrounding the asset is such that it is considered to be a loan relationship. Accordingly, as under UK GAAP no credits to the profit and loss account arise from the transfer, no credits should be brought into account under the loan relationships provisions.
On acquisition of the asset, FSub would record the asset in its books at its fair value at the date of transfer, to be matched by share capital. Where FSub is a CFC, the profits potentially subject to an apportionment on a future realisation of the asset under the operation of the loan relationships regime should be restricted to the excess of the net proceeds over that amount.
UKCo should obtain a capital gains base cost in the new shares in FSub equal to the open market value of the asset on the transfer date.”
The DOTAS disclosure went on to explain how the expected tax advantage would arise:
“This planning is specific to certain assets with somewhat unusual characteristics and should result in reduced taxation on the realisation of the assets as compared to simply awaiting realisation. The key characteristics of such an asset are as follows.
• It has a value, albeit one that cannot be readily or reliably ascertained.
• It falls to be treated as a loan relationship because of the existence of a money debt and documentation issued to represent the rights of the creditor.
• It is not recognised as an asset under UK GAAP, for instance as a result of uncertainty regarding the amounts that might ultimately be collected and their timing.
The transfer of such an asset by UKCo to the newly formed FSub in exchange for the issue of new shares by FSub is a “related transaction”. No credit is recognised in the accounts, in accordance with UK GAAP, because no profit is realised in the form of cash or other assets the ultimate realisation of which cannot be assessed with reasonable certainty (paragraph 28 FRS 18). Accordingly, no amount is taken into account under the loan relationships provisions as a profit on a related transaction.
In due course, after TPL had submitted its tax returns and...
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