Union Castle Mail Steamship Company Ltd
| Jurisdiction | UK Non-devolved |
| Judgment Date | 27 July 2016 |
| Neutral Citation | [2016] UKFTT 526 (TC) |
| Date | 27 July 2016 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge John Brooks, Michael Sharp FCA
Jonathan Peacock QC and Philip Walford, instructed by Deloitte LLP, appeared for the appellant
Julian Ghosh QC and Ruth Jordan instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Corporation tax – Derivative contracts – Derecognition of financial asset – Whether accounting debit fairly represents a loss from derivative contracts – Whether necessary to meet requirements of Finance Act 2002 (FA 2002), Sch. 26, para. 15 if debit within Sch. 26, para. 25A – Whether transfer pricing provisions of Income and Corporations Taxes Act 1988 (ICTA 1988), Sch. 28AA applicable – Appeal dismissed.
In the lead case of Union Castle Mail Steamship Company Ltd v R & C Commrs [2016] UKFTT 0526 (TC), the First-tier Tribunal (FTT) dismissed the Appellant company's appeal on the basis that an accounting debit of £39,149,128 did not fairly represent a loss arising to the company from its derivatives contracts for the purposes of Finance Act 2002 (FA 2002), Sch. 26, para. 15.
This appeal was designated as a lead case for two other appellants (Ladbrookes Group Finance plc and IG Finance Five Ltd) and concerned the ability of The Union Castle Mail Steamship Company Ltd (the Company) to bring into account in determining its profit or loss a debit resulting from the issue by the Company to its parent company of bonus shares in respect of a derivative instrument held by the Company.
The FTT was asked to decide upon four issues:
1) Whether the accounting debit of £39,149,128 fairly represents a loss arising to the Company from its derivatives contracts for the purposes of FA 2002, Sch. 26, para. 15 (the Loss Issue);
2) In the case of a debit falling within of FA 2002, Sch. 26, para. 25A whether it is still necessary to meet the requirements of para. 15 of that Schedule before it can be brought into account for tax purposes (the Gateway Issue);
3) Whether, if the Company would otherwise be entitled to a deduction in respect of the accounting debit, such a deduction should nevertheless be eliminated or reduced by a transfer pricing adjustment (the Transfer Pricing Issue);
4) The correct accounting treatment of the derecognition, by the Company, of 95% of the financial asset (the Accounting Issue).
The Company was incorporated on 21 November 1989. It is a wholly owned subsidiary of Caledonia Investments plc (Caledonia). In turn, Caledonia is an approved Investment Trust Company and as a consequence of this designation capital transactions entered into by Caledonia are not charged to tax.
In May 2007, the Board of Directors of Caledonia had a discussion about using put options against a Financial Times Stock Exchange (FTSE) index as a hedging strategy. The Directors were concerned that if such put options were purchased by Caledonia it may jeopardise its Investment Trust Company status and it was therefore agreed that the put options should be purchased by the Company instead.
Between 20 June and 31 December 2007, five FTSE put options were acquired for £10m by the Company. A further option for £2m was acquired in January 2008.
The five put options acquired in 2007 were exercised during the financial year to 31 March 2009 by the Company. With the proceeds, a FTSE 250 put option was purchased for £2.1m, four FTSE 250 put spreads for £10.3m, and a FTSE 100 put option for £4.3m in order to repay group borrowings and make payments on account of UK tax to HMRC. On 21 October 2008 one of the FTSE 250 put spreads was sold for £2.5m. This left the Company with three put options and three put spreads (together referred as the Options).
In November 2008 the Company entered into arrangements registered under the Disclosure of Tax Avoidance Regulations (DOTAS) on the advice of Deloitte. The arrangements involved the Company issuing a new class of share capital to Caledonia with dividend rights that would transfer the economic benefit of the derivatives contracts. As a result, the Company would be obliged to apply pass-through accounting and write-off the value of the options purporting to crystallise an equivalent tax loss.
The Company made a bonus issue to Caledonia of 5,020 shares (10 shares for every one existing ordinary share) (A Shares).
The A Shares carried a right to receive a dividend equal to 95% of the cash flows arising on the close-out of the Options. Consequently, the Company was required to derecognise 95% (£39,149,128) of the value of the Options for accounting purposes.
According to adopted international accounting standards, after the issue of the A Shares, the Company retained its rights and obligations under the derivatives contracts but was bound to pay dividends equal to 95% of the future cash flows to Caledonia. The Company was required to derecognise that financial asset (the 95% dividends).
On the issue of the A Shares, the Company recognised the following:
Cr financial asset |
£39,149,128 |
Dr income statement |
£39,149,128 |
Cr Share capital |
£5,020 |
Dr Share premium |
£5,020 |
HMRC contended that the carrying value of the proportion of the derecognised derivatives contracts should be regarded as a transaction with owners and that it may only be recognised in the statement of changes in equity of the Company.
The parties however agreed that as a result of the derecognition of 95% of the fair value of the derivatives contracts, the Company was not allowed to subsequently bring into account in its income statement any debits or credits for movements in the fair value, save in relation to the 5% that had not been derecognised.
The expert for HMRC argued that although the test for derecognition under International Accounting Standard 39 (IAS 39) is met in relation to 95% of the Options and therefore the credit from the transaction (because the Company retained the benefit of the cash flows under the derivative contracts by issuing the bonus A Shares and because of its contractual obligation to pay dividends equal to 95% of the future cash flows), they did not agree that IAS 39 should also be applied to the debit side of the transaction. HMRC preferred to apply a mix and match approach using IAS 1 instead arguing that IAS 39 did not deal with shareholder transactions whereas IAS 1 did.
The expert for the Company used a technical approach applying IAS 39 to both the debit and credit sides of the transaction.
After considering the expert evidence and the joint expert report submitted by the parties, the FTT decided that the application of accounting standards, given their nature, called for a technical and consistent approach and that if a particular IAS applied, it should be applied in its entirety.
The FTT preferred the Company's approach that the debit should be recorded in the income statement but noted that an entry in the statement of changes in equity would also be valid.
The FTT began with a close analysis of the derivatives code in FA 2002, Sch. 26 (all paragraph references are to this Schedule and Act) and held that it was clear from para. 17B that a debit is recognised under para. 17A in determining the Company's profit or loss for the relevant period. Further and in accordance with para. 15, the credits and debits to be brought into account shall be the sums which, when taken together, fairly represent, for the accounting period in dispute all profits and losses of the company which arise from its derivative contracts.
The FTT identified three sub-issues to be decided:
1) whether there is loss for these purposes;
2) if so, does it arise from a derivative contract; and
3) does it meet the fairly represent requirement.
Before coming to its conclusions on the above sub-issues, the FTT discussed and rejected the reasoning in the case in Abbey National Treasury Services plc TAX[2015] TC 04525 (ANTS) noting that the legislation did not refer to a direct relationship between a debit and derivative contract. The legislation refers to a loss arising from not directly from its derivative contracts. The FTT disagreed with ANTS further by explaining that a conclusion that the credit has a direct nexus with the derivative but the debit does not, was inconsistent with the principles of double entry bookkeeping and not in accordance with the expert accounting evidence that it had heard.
The FTT found that there is was no loss as defined as the Company received a cash benefit under the derivative contracts which it gave away. Accordingly, the debit could not be a loss for the Company because after the issue of the A Shares it was entitled to the exact same amount as it had prior to the issued of those shares. There was no diminution in the resources of the Company and therefore no real loss. In the circumstances, the Company's appeal could not succeed.
In the event the FTT was wrong about the Loss Issue, it went onto consider the other issues.
HMRC relied on the reasoning in ANTS to argue that the source of the loss (if any) was the issue of the A Shares which, on the Company's accounting evidence, gave rise to the financial liability. In light of its observations about the decision in ANTS, the FTT was not persuaded by this argument and held that if there had been a loss it would have been, albeit indirectly, from its derivatives.
In a similar vein, the FTT considered that the phrase fairly represents in para. 15 must have a timing (identifying that which is appropriate in a particular accounting period) and/ or allocation role (a means of identifying from entries in the accounts those things which have to do with derivatives) and that if the loss, there had been one, would have satisfied this requirement.
Although this issue affected Ladbrookes Group Finance plc's appeal only, the FTT...
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