Smith and Nephew Overseas Ltd and Others
| Jurisdiction | UK Non-devolved |
| Judgment Date | 08 February 2017 |
| Neutral Citation | [2017] UKFTT 151 (TC) |
| Date | 08 February 2017 |
| Court | First Tier Tribunal (Tax Chamber) |
[2017] UKFTT 0151 (TC)
Judge John Brooks, John Agboola
Julian Ghosh QC and Jonathan Bremner, instructed by Johnson Allen Tax Solicitors, appeared for the appellant
James Rivett and Emma Pearce, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Corporation tax – Change in local currency – Whether accounts comply with UK generally accepted accounting practice – Yes – Whether exchange differences are exchange losses – Yes – Whether exchange differences fairly represent a loss – Yes – Appeal allowed.
Foreign exchange differences arising on a change of functional currency were held by the First-tier Tribunal to be tax deductible.
Foreign exchange debits arose on intra-group creditor loan relationships in three Smith and Nephew PLC group subsidiary companies. The differences arose on a change in the functional currency of each subsidiary from sterling to dollars. An equivalent foreign exchange credit did not arise in the debtor company because there was no change in the functional currency of that company. The issues to be considered by the First-tier Tribunal were:
- whether the appellant's accounts complied with UK GAAP;
- whether the exchange differences were exchange losses within Finance Act 1996 (FA 1996), s. 103; and
- whether the exchange differences fairly represented a loss arising to the appellants as defined in FA 1996, s. 84(1).
So far as this case is concerned, the accounting treatment of foreign exchange losses at all relevant times was governed by Statement of Standard Accounting Practice 20 (SSAP 20) and, although the accounting standard was silent on the precise manner in which a change of functional currency was to be accounted for, best accounting practice recognised two distinct methods, the Foreign Operation method and the Single Rate method. The Foreign Operations method treats the results and financial position prior to the date of change of functional currency as if that were an attempt to account for a foreign branch in respect of which the profits and losses are translated at an exchange rate that ruled on the days when the transactions occurred, although in practice an average rate for the period was generally used. It also required that the balance sheet was translated at each relevant balance sheet date. The resulting exchange differences are recorded in the statement of total recognised gains and losses (STRGL). Those exchange differences would essentially relate to two things: retranslating the opening balances at the start of the accounting period to the end of year rate, reflecting the movement in the translated value of those balances over the course of the year, and the difference between the results for the year translated at average rates and again the translation of year end balances. The Single Rate method, by contrast, takes all of the items, all of the balances and all of the results prior to the date of change and translates them all as a single exchange rate, being the rate in force on the date when the functional currency changed. A consequence of using the Single Rate method is that, because all of the results prior to that date are translated as a single rate, no exchange differences arise.
HMRC contended that the Single Rate method was applicable and consequently that no exchange difference arose for tax purposes. The appellants contended that the Foreign Operations method was applicable and that the consequential exchange differences gave rise to a tax deductible loss. The FTT held that by adopting the Foreign Operations method, the accounts of the appellants did comply with UK GAAP. This was supported by the evidence of the expert witness for the appellants; the accounting manuals of Deloitte, PwC and KPMG; and the audit opinions to the effect that the accounts of the appellants gave a true and fair view.
The FTT also held that, as there was a fall in the value of the intercompany receivables at 31 December 2008 when compared with their value as at 31 December 2007 as stated using the Foreign Operation method in what were found to be UK GAAP compliant accounts, it followed that the exchange differences were exchange losses within FA 1996, s. 103.
Finally, with regard to HMRC's contention that the inclusion of fairly represent in FA 1996, s. 84(1) means that a company is required to evaluate the amounts brought into account by FA 1996, s. 85A and s. 85B in its GAAP compliant accounts to ascertain whether those amounts fairly represent the profits, gains losses etc. and therefore imposes an additional obligation on a company (and is not a restatement of the true and fair requirement), the FTT held that this was not correct. The FTT found support for this view in the judgment of Greene King plc v R & C Commrs [2016] BTC 35.
HMRC will clearly be disappointed by the FTT's judgment that the exchange differences arising as a consequence of the change in the functional currency of the appellants are tax deductible. Given the magnitude of the sums involved, an appeal to the Upper Tribunal would not be entirely unexpected.
[1] Following a change in their functional currency, from sterling to US dollars, as the result of a company reorganisation Smith and Nephew Overseas Limited (“SN Overseas”), T P Limited (“TP”) and Smith and Nephew Finance Holdings Limited (“SN Finance”) claimed foreign exchange losses in their tax returns for their accounting periods ended 31 December 2008 of $877,458,000 (£445,868,096), $271,925,000 (£138,188,096) and $178,408,000 (£90,652,234) respectively. They say that these exchange losses, which were included within the statement of total recognised gains and losses (“STRGL”) by each of the companies in their respective accounts where they were described as a “Revaluation (loss)/gain on change in functional currency”, arose as a result of the fall in value of the pound against the US dollar.
[2] On 16 April 2014 HM Revenue and Customs (“HMRC”), which does not accept that the exchange differences shown in the companies' accounts represent losses or that the correct accounting treatment had been applied by the companies, issued closure notices, under paragraph 34(2) of Schedule 18 to the Finance Act 1998 which disallowed the losses claimed by each of the companies and required certain amendments to each of their tax returns consequential on that disallowance.
[3] SN Overseas, TP and SN Finance appealed to the Tribunal against the conclusion in those closure notices on 16 May 2014. In accordance with directions issued on 16 June 2014 their appeals have been joined to be heard together.
[4] Mr Julian Ghosh QC and Mr Jonathan Bremner appeared for SN Overseas, TP and SN Finance. HMRC were represented by Mr James Rivett and Emma Pearce. We are grateful for the assistance given by their clear and succinct submissions, both written and oral.
[5] The parties produced the following Statement of Agreed Facts:
(1) The Smith & Nephew Group is a multinational group engaged in the development, manufacture and marketing of medical devices. The headquarters of the Smith & Nephew Group is in the UK. The ultimate parent of the Smith & Nephew Group is Smith & Nephew PLC.
(2) Smith & Nephew PLC has two main trading groups:
- a trading group which comprises the international operations of the Smith & Nephew Group the entities within which trading group have at all material times prepared their accounts using US dollars as the functional currency and
- a trading group the UK sub-group that comprised the UK trading operations of the Smith & Nephew Group which for periods prior to 23 December 2008 prepared their accounts using sterling as the functional currency including all 3 Appellants in this case.11At the material time in drawing their accounts the Smith & Nephew Group companies that are relevant to these proceedings applied accounting standard SSAP 20Foreign Currency Translation which refers to the local currency of a particular entity rather than its functional currency which is the term used in more recent accounting standards (FRS 23the effects of changes in foreign exchange rates). The term local currency has a similar meaning as the term functional currency. For the purposes of the Statement of Agreed Facts the term functional currency is used.
(3) The First Appellant SN Overseas is a UK incorporated company which has at all material times been resident in the UK for the purposes of the UK corporation tax code.
(4) The Second Appellant TP is a UK incorporated company which has at all material times been resident in the UK for the purposes of the UK corporation tax code.
(5) The Third Appellant SN Finance is a company incorporated under the laws of the Cayman Islands, but has at all material times been resident in the UK for the purposes of the UK corporation tax code.
(6) The abbreviation S&N is used where Smith and Nephew representatives are acting on behalf of the Smith and Nephew group as a whole or conducting negotiations in relation to a number of the Appellants and not just one individual company.
(7) Smith & Nephew Investment Holdings Limited (“SNIH”) is a UK incorporated company that acts as an investment holding company for the dormant subsidiary undertakings of the Smith & Nephew Group in the United Kingdom.
(8) At all material times prior to 23 December 2008 the Smith & Nephew Group structure was such that each of the Appellants were subsidiaries of Smith & Nephew Investment Holdings, a UK incorporated subsidiary of Smith & Nephew UK Limited, which was in turn a UK incorporated subsidiary of Smith & Nephew PLC.
(9) As at 23 December 2008 the intercompany receivables were as follows (“the Intercompany Receivables”);
- SN Overseas was entitled to an inter-company receivable of c. £1.63bn from Smith & Nephew Investment Holdings Ltd;
- TP was entitled to an...
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