The Commissioners for HM Revenue and Customs v Smith & Nephew Overseas Ltd
| Jurisdiction | England & Wales |
| Judge | Lady Justice Rose,Lord Justice Coulson,Sir Geoffrey Vos |
| Judgment Date | 03 March 2020 |
| Neutral Citation | [2020] EWCA Civ 299 |
| Court | Court of Appeal (Civil Division) |
| Docket Number | Case No: A3/2019/0521 |
| Date | 03 March 2020 |
[2020] EWCA Civ 299
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL (TAX AND CHANCERY CHAMBER)
(Fancourt J and Judge Thomas Scott)
Royal Courts of Justice
Strand, London, WC2A 2LL
Sir Geoffrey Vos, CHANCELLOR OF THE HIGH COURT
Lord Justice Coulson
and
Lady Justice Rose DBE
Case No: A3/2019/0521
Michael Gibbon QC and James Rivett QC (instructed by General Counsel and Solicitor to HM Revenue and Customs) for the Appellants
Julian Ghosh QC, Jonathan Bremner QC and Charles Bradley (instructed by Johnson & Allen Tax) for the Respondents
Hearing dates: 23 October 2019 and 15 January 2020
Approved Judgment
Introduction
This appeal from the Upper Tribunal (Tax and Chancery Chamber) contains all the classic ingredients that make up the daily fare of the successful tax law specialist. First, it requires the untangling of interrelated statutory provisions, amended several times over the years and supplemented by statutory instruments, also amended. Secondly, the answer may ultimately lie, at least according to one of the parties, in what is meant by one or two perfectly ordinary English words found in one of those statutory provisions. Thirdly, an eye-wateringly large amount of tax is either due or not due depending on which of the two contending constructions is correct. In this appeal the Respondents' entitlement to losses of about £675 million turns on the result and there is more at stake because of other cases which we are told are waiting in the wings for our decision in this case.
The appeal is against the decision of the Upper Tribunal (TCC) (Fancourt J and Judge Thomas Scott) of 29 November 2018 reported at [2018] UKUT 0393 (TCC), [2019] STC 116. They dismissed an appeal against the decision of the FTT (Judge John Brooks and John Agboola) at [2017] UKFTT 151 (TC), [2017] SFTD 678. Patten LJ granted permission to appeal to this court by order dated 24 May 2019. Before us the Appellants, HMRC, were represented by Mr Gibbon QC leading Mr Rivett QC and the Respondents were represented by Mr Ghosh QC leading Mr Bremner QC and Mr Bradley.
Summary of the legislation
The dispute concerns each of the Respondents' entitlement to set off foreign exchange losses against their liability to corporation tax. The exchanges loss arose as a result of the Respondent companies changing their functional accounting currencies from sterling to US dollars on 23 December 2008 at a time when the only asset on their balance sheets was a very substantial inter-company debt owed to them by their parent company. The debts were denominated in sterling but then had to be converted into dollars when the companies' accounts were restated in dollars. The next day, the debts were disposed of as part of a group restructuring. The exchange losses arose from the Respondents' ‘loan relationships’ as that term is used in Chapter 2 of Part IV of the Finance Act 1996 (‘Chapter 2’). All section numbers in this judgment refer to sections in that Act unless otherwise stated. I will need to examine the relevant provisions in more detail later but it is useful here to summarise the scheme set out in the Act as it applies to the exchange losses for which the Respondents claim relief from corporation tax in this case.
Section 80 provides that all profits and gains arising to a company from its loan relationships should be chargeable to tax as income in accordance with Chapter 2. It provides also that the Chapter has effect for the purpose of determining how any deficit on a company's loan relationships is to be brought into account. Section 81 defines ‘loan relationship’ for the purposes of the Corporation Tax Acts. A loan relationship exists whenever a company stands in the position of a creditor or debtor as respects any money debt and that debt is one arising from a transaction for lending money. Section 82 sets out the method for bringing into account any gains or deficits arising from the company's loan relationships and provides that those gains and deficits shall be computed in accordance with section 82, using the credits and debits given for the accounting period in question by the provisions of Chapter 2.
Section 84 then provides for what debits and credits are to be brought into account in respect of the company's loan relationships. It provides that the credits and debits to be brought into account shall be the sums which when taken together ‘fairly represent’ all profits, gains and losses of the company arising from its loan relationships. As originally enacted, section 84 did not cover gains and losses arising from fluctuations in currency exchange rates as they affected a company's loan relationships. The Finance Act 2002 introduced section 84A to deal with exchange gains and losses arising from loan relationships. Section 84A provides, broadly, that exchange gains and losses are included in the references in section 84 to profits, gains and losses arising from its loan relationships. The term ‘exchange gains and losses’ is defined by section 103(1A), which was also introduced by the Finance Act 2002.
Section 84A(3), however, excepted certain exchange gains and losses so that they were not included in the credits and debits covered by section 84. The category of exchange gains or losses to which section 84A does not apply because of section 84A(3) include those which fall within either section 84A(3)(a) or (b) and which are recognised in the company's statement of total recognised gains and losses (‘STRGL’), rather than in its profit and loss account. Section 84A conferred on HM Treasury a regulation-making power to bring into account in prescribed circumstances amounts which are taken out of the regime by section 84A(3). HM Treasury exercised that power in 2002 making regulations which covered, amongst other things, the disposal of loan relationships in respect of which exchange gains and losses have been recognised in the company's STRGL.
The restructuring of the Smith & Nephew group
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 and the ultimate parent is Smith & Nephew plc. Prior to the restructuring, Smith & Nephew plc had two main trading groups:
i) a trading group which comprised the international operations of the Smith & Nephew group, the entities within which prepared their accounts using US dollars as the functional currency; and
ii) a trading group that comprised the UK trading operations of the Smith & Nephew group. For periods before 23 December 2008 the companies in this trading group prepared their accounts using sterling as the functional currency.
All three Respondents were part of the UK trading group and have at all material times been resident in the United Kingdom for the purposes of UK corporation tax. Each of them was a subsidiary of Smith & Nephew Investment Holdings Ltd (‘S&N Holdings’) which is another UK company. As at 23 December 2008, each of the Respondents was entitled to an inter-company receivable (‘ICR’) owed to them by their parent, S&N Holdings. Smith & Nephew Overseas Ltd (‘Overseas’) was owed an inter-company receivable of about £1.63 billion; TP Ltd (‘TP’) was owed an inter-company receivable of about £524 million; and Smith & Nephew Finance Holdings Limited (‘S&N Finance’) was owed about £340 million. Although the ICRs were non-interest-bearing, their existence meant that the Respondents, which were otherwise dormant, had to prepare annual tax returns reporting notional interest income arising on the ICRs.
In December 2008 the UK trading group was restructured. The way in which the restructuring was carried out is relevant to the question of whether there was some ‘real world effect’ of the exchange rate losses on the finances of the group. Dealing first with the treatment of TP, there was a share purchase agreement entered into on 23 December 2008 under which Smith & Nephew plc agreed to buy from S&N Holdings all the share capital of Overseas and TP. The price that Smith & Nephew plc would pay S&N Holdings was £1.69 billion for Overseas and £500,000 million for TP. This consideration was expressed to be payable on completion in cash. However, TP did not stay for long as a subsidiary of Smith & Nephew plc because by an agreement dated 24 December 2008, Smith & Nephew plc agreed to sell its new subsidiary TP to Overseas (by then also a subsidiary of Smith & Nephew plc). Overseas agreed to pay Smith & Nephew plc $3.5 billion for the shares in TP. That $3.5 billion was payable by Overseas to Smith & Nephew plc partly in cash (as to about $2.4 billion) and partly by the issue and allotment by Overseas to Smith & Nephew plc of one ordinary share in Overseas at a premium equal to the balance of the consideration (that is about $1.05 billion). The effect of the restructuring on TP was that TP became a wholly-owned subsidiary of Overseas; the amount of the premium allocated to the share in Overseas was transferred to the share premium account of Overseas (or more accurately the group reconstruction account since this was an intra-group transaction) and the net inter-company receivable held by Overseas was reduced to $200,000.
TP also made an acquisition as part of the restructuring. Smith & Nephew plc owned a different subsidiary called Smith & Nephew USD Limited (‘USD’). By a further agreement dated 24 December 2008, TP agreed to buy the entire share capital of USD from Smith & Nephew plc for $3.5 billion. This was required to be satisfied partly in cash (in the amount of about $772 million) and partly by...
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...rule. The “fairly represent” requirement is such a rule. 49 In the recent decision of this court in 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 losse......