The Union Castle Mail Steamship Company Ltd v The Commissioners for HM Revenue and Customs
| Jurisdiction | England & Wales |
| Judge | Lord Justice David Richards,Lord Justice Flaux,Lord Justice Lewison |
| Judgment Date | 22 April 2020 |
| Neutral Citation | [2020] EWCA Civ 547 |
| Docket Number | Case No: A3/2018/3003 and 3004 |
| Court | Court of Appeal (Civil Division) |
| Date | 22 April 2020 |
[2020] EWCA Civ 547
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
TAX AND CHANCERY CHAMBER
Mr Justice Fancourt and Judge Roger Berner
UT/2016/0198 and 0242
Royal Courts of Justice
Strand, London, WC2A 2LL
Lord Justice Lewison
Lord Justice David Richards
and
Lord Justice Flaux
Case No: A3/2018/3003 and 3004
Jonathan Peacock QC and Sarah Black (instructed by Deloitte LLP) for the Appellants
Julian Ghosh QC and Ruth Jordan (instructed by the General Counsel and Solicitor to HM Revenue and Customs) for the Respondents
Hearing dates: 11 and 12 February 2020
Approved Judgment
Introduction
These appeals are concerned with corporation tax and derivative contracts. Although this is a combination likely to appear daunting, the issues of statutory construction that arise are not complex but they are important. The most important is whether, as counsel for the appellant taxpayers graphically submitted, Parliament has “surrendered to accountants” the determination of the taxable profits and allowable losses resulting from derivative contracts.
The issue is whether the “derecognition” in the accounts of the appellant companies of 95% in one case, and 100% in the other, of the value of derivative contracts held by them respectively gave rise to an allowable loss for the purposes of corporation tax. This issue turns on the proper construction and application of schedule 26 to the Finance Act 2002, which contains an exhaustive code for the taxation of profits arising from derivative contracts.
The appellants are The Union Castle Mail Steamship Company Limited (Union Castle) and Ladbrokes Group Finance plc (Ladbrokes).
Union Castle is a wholly owned subsidiary of Caledonia Investments plc (Caledonia), a publicly quoted company with investment trust status. HMRC disallowed a deduction of £39,149,128 made by Union Castle in its corporation tax return for the year to 31 March 2009, claimed as a result of a derecognition of 95% of derivative contracts held by it. Its appeal against the closure notice issued by HMRC was dismissed by the First-tier Tribunal (the FTT) in a Decision dated 27 July 2016. Its appeal to the Upper Tribunal (the UT) was dismissed, albeit on different grounds. It appeals to this court with permission granted by the UT.
Union Castle's appeal to the FTT was designated as a lead case for two other appeals, one being the appeal by Ladbrokes. HMRC had issued closure notices disallowing deductions in its 2008 and 2009 tax computations for losses resulting from the derecognition of derivative contracts. There were common issues and, in addition, an issue that applied only to Ladbrokes (the Gateway issue). On the Gateway issue, the FTT held in favour of Ladbrokes, with the result that its appeal was allowed. The UT reversed that decision. Ladbrokes appeals, with permission granted by the UT. I deal with Ladbrokes' appeal at the end of this judgment.
The facts
The facts as they relate to Union Castle were not in dispute before the FTT or the UT and were set out in an agreed statement. They were helpfully summarised by the UT in their Decision at [10] which I gratefully adopt:
“(1) Prior to 21 November 2008 Union Castle had issued share capital consisting of 502 shares of £1 each, fully paid, held by Caledonia.
(2) From about May 2007, the board of Caledonia wished to implement a hedging strategy, using put options against a FTSE index. The board was concerned about a possible substantial fall in UK equity markets.
(3) The board was concerned that purchase of such put options might prejudice Caledonia's investment trust status. Accordingly it was envisaged that Union Castle might purchase the put options instead.
(4) Between 20 June and 31 December 2007, five FTSE put options at an aggregate cost of £10 million were acquired by Union Castle, and a further put option was acquired in January 2008 at a cost of £2 million.
(5) In July 2008, accounting guidance for investment trusts and venture capital trusts clarified their right to invest in derivatives, such that it appeared that Caledonia could safely hold such investments in its own name.
(6) During the financial year ending 31 March 2009, some of the put options were exercised and further put options were purchased. As at 31 October 2008 Union Castle held three put options and three put spreads (“the Contracts”).
(7) On 19 November 2008, Caledonia's audit committee considered novating the Contracts from Union Castle to Caledonia but realised that this would crystallise a tax charge in Union Castle owing to the current value of the Contracts. The committee therefore considered the possible issue by Union Castle of a new kind of share capital to Caledonia with dividend rights, whereby the economic benefit of the Contracts would effectively be transferred to Caledonia. They noted that this would oblige Union Castle to write off the value of the Contracts, thereby crystallising a tax loss.
(8) On November 2008, Union Castle made a bonus issue to Caledonia of 5020 “A Shares”, ten for every one existing ordinary share held by Caledonia.
(9) The A Shares carried a right to receive a dividend equal to 95% of the cash flows arising on the close-out of the Contracts, such dividend to be paid within five business days following receipt by Union Castle of the cash flows.
(10) As a consequence of issuing the A Shares, Union Castle was required to “derecognise” 95% of the value of the Contracts for accounting purposes, amounting to £39,149,128.
(11) Between January and August 2009 Union Castle closed out the Contracts for aggregate proceeds of £25,042,545 and paid dividends to Caledonia in a sum equal to 95% of those cash flows.
(12) On the issue of the A Shares, the following debits and credits were recognised by Union Castle:
Cr Financial asset £39,149,12825
Dr income statement £39,149,128
Cr share capital £5,020
Dr share premium £5,020
(13) The A Shares were added to Caledonia's investment ledger as a new security, with no cost attributed, but they were ascribed at fair value, reflecting the “pass-through” right to 95% of the future cash flows from the derivatives. Caledonia did not include an entry in its income statement, but reallocated a part of the fair value from the Ordinary Shares in Union Castle to the A Shares.
(14) Union Castle agreed for the purpose of the proceedings that its accounting treatment in accordance with GAAP should more appropriately have debited the value of the cash flows to the statement of changes in equity rather than to income.”
Despite the agreement recorded in sub-paragraph (14), expert evidence was adduced by both sides before the FTT which addressed, among other issues, whether the debit was more appropriately taken to profit and loss account, rather than to the statement of changes in equity. The FTT accepted the evidence of Union Castle's expert that the former was the more appropriate treatment, although the latter could not be said to be wrong. By reason of the relevant provisions of schedule 26, this makes no difference to the outcome of the appeal and it is unnecessary to consider it further.
The rights attached to the A Shares as regards income were expressed as follows: “out of the profits available for distribution the holders of the A Shares shall be entitled to be paid a dividend equal to 95% of each of the option cash settlements (if any) received by the Company under” and there were then identified each of the relevant derivative contracts. The rights further provided that “unless the Company has insufficient profits available for distribution and the Company is thereby prohibited from paying dividends by the [Companies Act 2006], the dividends payable on the A Shares…shall be paid without undue delay and in any event within five business days following receipt of each of the option cash settlement amounts”. The dividends were payable without the need for any resolution of either the directors or the company in general meeting.
These rights acknowledged that dividends are not lawfully payable except in accordance with Part 23 of the Companies Act 2006 (CA 2006). Part 23 requires, among other things, that a company's accounts must show distributable profits at least equal to a proposed dividend.
In order to ensure so far as possible that Union Castle would have distributable profits available to pay the dividends on the A Shares, Caledonia provided a letter dated 21 November 2008 to Union Castle. The letter referred to the proposed issue of the A Shares, and in particular to the dividend rights, “which will be of direct benefit to us”. It requested Union Castle to proceed with the issue “to which as the Company's sole shareholder we hereby consent”. It recorded that on receipt of a demand in writing Caledonia “shall make a capital contribution in cash to you in an amount equal to the option cash settlement amount receivable in respect of the relevant index option transaction less the amount of your distributable reserves (assuming receipt of that option cash settlement amount)”. As the capital contribution would be made for no consideration, its entire amount would be credited to distributable reserves.
Generally accepted accounting practice (GAAP)
Union Castle, as a company...
To continue reading
Request your trial