CORPORATION TAX - exchange gains and losses - transitional provisions - delayed application of 1993 legislation to certain fluctuating debts - agreed that in this appeal the amounts of the debts were fixed - whether the terms of the debts were fixed - yes - whether it was provided that any part of the principal once repaid could not be withdrawn - yes - appeal dismissed - FA 1993 Ss 165(4); Exchange Gains and Losses (Transitional Provisions) Regulations 1994 SI 1994 No. 3226 Reg 3(1)(d) and 3(6)(b)(ii)

THE SPECIAL COMMISSIONERS

FINANCE LIMITED

Appellant

- and -

(HM INSPECTOR OF TAXES)

Respondent

SPECIAL COMMISSIONERS : DR A N BRICE (Chairman)

DR D W WILLIAMS

Sitting in London on 28 April 2003

Jonathan Peacock QC, instructed by Messrs Ernst & Young Chartered Accountants, for the Appellant

Philip Jones of Counsel, instructed by the Solicitor of Inland Revenue, for the Respondent

© CROWN COPYRIGHT 2003

1

ANONYMISED DECISION

The appeal

1.Finance Limited (the Appellant) appeals against an assessment to corporation tax dated 14 January 2000 in respect of the accounting period ending on 31 December 1996. We were asked to give a written decision in principle on one issue in the appeal, namely whether eight loans entered into by the Appellant were fixed debts for the purposes of the transitional provisions relating to the taxation of exchange gains and losses. If the loans were fixed debts then we were informed that exchange gains in the region of £29M would be included in the Appellant's taxable profits for its accounting period ending on 31 December 1996.

The legislation

2.Part II (sections 51 to 184) of the Finance Act 1993 (the 1993 Act) introduced amendments to the legislation relating to income tax, corporation tax and capital gains tax. Chapter II of Part II (sections 125 to 170) contained provisions about exchange gains and losses. Section 165 contained the commencement and transitional provisions the effect of which was that each company had its own commencement day which was the first day of its first accounting period to begin after 23 March 1995. Section 165(1) and (2) provided:

"(1)This Chapter applies where-

(a)a qualifying asset is one to which the company becomes entitled on or after the company's commencement day;

(b)a qualifying liability is one to which the company becomes subject on or after that day;

(c)the rights and duties under a currency contract are ones to which the company becomes entitled and subject on or after that day.

(2)Where a qualifying asset or liability is held or owed by a qualifying company both immediately before and at the beginning of its commencement day, for the purposes of this Chapter the company shall be treated as becoming entitled or subject to the asset or liability at the beginning of its commencement day. … "

3.Thus the effect of section 165(2) was to apply the new provisions in Chapter II to loans in existence on the company's commencement day. However, section 165(4) provided that in certain circumstances the application of Chapter II could be delayed. Section 165(4) read:

"(4)Regulations may provide that where-

(a)a qualifying asset or liability is held or owed by a qualifying company both immediately before and at the beginning of its commencement day, and

(b)the asset or liability is of a prescribed description

subsection (2) above shall not apply and for the purposes of this Chapter the company shall be treated as becoming entitled or subject to the asset or liability at such time (falling after its commencement day) as is found in accordance with the prescribed rules."

4.The Regulations referred to in section 165(4) were the Exchange Gains and Losses (Transitional Provisions) Regulations 1994 SI 1994 No. 3226 (the 1994 Regulations). Regulation 3 contained provisions about the delayed application of Chapter II in relation to certain fluctuating debts and the relevant parts of Regulation 3 provided:

"3(1)Subject to paragraph (5) below, paragraph (2) below applies in relation to an asset or liability which is held or owed by a company and falls within section 165(4)(a) where- …

(c)the asset or liability is the right to settlement of a debt or the duty to settle a debt, and

(d)the amount of the debt or the term of the debt (or both) are not fixed."

5.Paragraph 3(2) provided for the delayed application of Chapter II until the amount of the debt was increased or until the sixth anniversary of the company's commencement day. Paragraph 3(5) provided that paragraph 3(2) did not apply if a company elected that section 165(2) should apply. The relevant part of paragraph 3(6) provided:

"(6)For the purposes of this regulation the term of a debt is fixed if (and only if) -

(a) … or

(b)it is provided that-

(ii )any part of the principal once repaid cannot be withdrawn; and … "

6.Thus the scheme of the legislation was to delay the application of Chapter II in respect of certain fluctuating debts, that is debts where the amount or the term (or both) were not fixed. It was agreed that in this appeal the amounts of the debts were fixed. Regulation 3(6)(b) provided that the term of a debt was fixed only if "it is provided that any part of the principal once repaid cannot be withdrawn".

The issue

7.It was agreed that, if the loans were fixed loans, then tax was due on the exchange gains in 1996 but that, if the loans were not fixed loans, then tax was delayed under the 1994 Regulations. It was also agreed that there was no express term in the loans at issue in the appeal that any part of the principal once repaid could not be withdrawn.

8.The Appellant argued that the delayed application of Chapter II applied to the loans at issue in the appeal which were fluctuating debts because the loan agreements did not specifically provide that any part of the principal once repaid could not be withdrawn. The Inland Revenue argued that the delayed application of Chapter II did not apply because the loans were fixed debts and that a provision that any part of the principal once repaid could not be withdrawn could be implied because the loan agreements had originally provided that any part of the principal once repaid could be withdrawn and had been specifically amended to remove that provision.

9.Thus the issue for determination in the appeal was whether the application of Chapter II to the loans at issue in the appeal was delayed. Specifically, the question arising out of that issue was whether the loans were fixed debts and, in particular, whether it was provided that any part of the principal once repaid could not be withdrawn within the meaning of Regulation 3(6)(b)(ii) of the 1994 Regulations.

The evidence

10The parties produced a statement of agreed facts and an agreed bundle of documents.

The facts

The Appellant and its borrowings

11The Appellant is a wholly owned subsidiary of Group Plc. The Appellant provides finance and treasury service to members of the group and, in particular, makes loans to, and borrows from, other group companies.

The eight loans

12.Between 30 July 1991 and 18 February 1994 the Appellant entered into eight loans to borrow money from other companies in the group. One loan was of Swiss francs, one was of Belgian francs and six were of Dutch guilders. Originally, each loan provided for a facility to be available to the Appellant that could be drawn down, repaid and drawn down again as required.

13.We saw all eight loan agreements but describe only the first in detail. It was dated 30 July 1991 and was made between a Swiss company in the Appellant's group as lender and the Appellant as borrower. The relevant parts of Articles 1 and 4 provided:

"Article 1 - Amount of Loan

The Lender agrees to lend to the Borrower who agrees to borrow an amount of up to SWF 20,000,000 (twenty million Swiss Francs) … for a period from 1 January 1989 to 31 December 1995. The loan shall be drawn down to the extent required by the Borrower during the period 1 January 1989 to 31 December 1995. …".

Article 4 - Repayment

The loan shall be repaid to the Lender no later than 31 December 1995. … The Borrower may make early repayment of the loan … The Borrower's right to draw down funds according to the provisions of Article 1 will remain unaffected by any early repayments made by the Borrower".

The framework of the 1993 legislation

14.Before the enactment of the relevant provisions in the 1993 Act some gains and losses arising from currency fluctuations were treated as trading profits or losses under Schedule D Case I and some as capital gains or losses under the legislation relating to the taxation of capital gains. Some gains and losses were taxed when they accrued (the translation basis) whereas others were taxed when they were realised (the realisation basis). Exchange differences arising on non-trade assets and liabilities, and on capital assets and liabilities outside the capital gains tax regime, were not subject to tax at all. These were commonly referred to as "nothings" as they gave rise neither to a gain nor a loss. However accounting practice under SSAP 20 made no such distinction between types of exchange gains and losses.

15.The aim of the 1993 legislation was to bring the taxation of exchange gains and losses broadly into line with accounting practice and to ensure that companies recognised exchange differences on monetary assets and liabilities on the translation basis, namely on the balance sheet date if this was earlier than realisation. This was achieved by the changes in Chapter II Part II of the 1993 Act. Briefly, the aim of the new regime was to tax all exchange gains, and to relieve all exchange losses, and thus to bring "nothings" within the tax regime. However, it was appreciated that some transitional provisions would be required for fluctuating debts which varied from time to time as, in respect of such debts, there might be some difficulty in determining what amount should be brought in at the start of the new regime and, further, there would be a new tax charge where there had previously been none. There was also the difficulty of applying the new regime (based on accrual of exchange differences) to fluctuating debts where the amount outstanding could change from day to day. The effect of the 1994 Regulations, therefore, was to delay the commencement of the new regime in respect of loans which were fluctuating debts, namely those that were "nothings" under the old regime. The delay was until the debt increased or, if later, the sixth anniversary of the company's commencement day.

16.Under section 165 of the 1993 Act the Appellant's commencement day was 1 January 1996. If the Appellant had done nothing before its commencement day it would have been exposed to tax under the new regime in respect of all its fixed debts as from 1 January 1996 and in respect of its fluctuating debts (in the absence of an election) from the date of the first roll-over of each after 1 January 1996. The Appellant did consider whether to defer the application of the new regime as long as possible but decided against such an approach. It determined to enter into the new regime in full in respect of its eight non-sterling loans, by converting them into fixed loans, but to protect itself against the tax consequences by entering into tax equalisation swaps with a Bank.

December 1995 - the supplemental agreements and the swap contract

17.Accordingly in December 1995 the Appellant decided to amend the terms of the loans with a view to making them fixed loans and to enter into hedging transactions with the Bank to hedge the tax position of the group. It was then expected that sterling would depreciate against the other currencies.

18.At a meeting on 13 December 1995, attended by representatives of the Appellant and its advisers, it was agreed in relation to the eight loans that "the sentence regarding the redrawing of funds repaid should be removed". In a letter dated 20 December 1995 the advisers wrote to say that they understood that supplemental agreements had been drafted "with the intention of converting fluctuating nothings to fixed nothings".

19.The loans were amended by supplemental agreements. Six loans were amended on 15 December 1995, one on 29 December 1995 and the remaining loan was most probably amended in December 1995. The supplemental agreement for the first loan recited the loan agreement of 30 July 1991 and the fact that during the period of the loan the borrower was permitted to draw down, repay or redraw amounts up to the facility amount and that the lender and the borrower had agreed to amend the terms of the loan agreement with effect from 29 December 1995. The relevant provisions of the supplemental agreement were:

"1This Supplemental Agreement is supplemental to the Loan Agreement.

2.Article 1 - Amount of Loan is hereby deleted and replaced with the following:-

"Article 1 - Amount of Loan

The Lender agrees to lend to the Borrower who agrees to borrow an amount of SWF 7,500,000 (seven million five hundred thousand Swiss Francs) for a period from 29 December 1995 to 31 December 2001."

3Article 4 - Repayment is hereby deleted and replaced with the following:-

"Article 4 - Repayment

The loan shall be repaid in full to the Lender on 31 December 2001. Repayment shall be made in the currency of the loan. The Borrower may make early repayment of the loan … ."

5.All other terms and conditions of the Loan agreement shall remain in full force and effect."

20.The other supplemental agreements were in similar terms although some did not contain any provision for early repayment of the loan.

21.On 21 December 1995 swap contracts were entered into with the Bank. The agreement was that, if there were a tax charge, the Bank would compensate the Appellant and if there were a loss then the Appellant would pay the Bank. The advantages of these hedging transactions were that the Appellant was protected from future tax charges on exchange gains although it gave up the benefit of future tax relief on exchange losses. A premium of £6.5M was paid to the Appellant by the Bank.

22.After 1 January 1996 sterling appreciated against the currencies of the loans in 1996 and exchange gains were made on the loans in that year amounting to something in the region of £29M.

The arguments of the parties

23.The case for the Appellant was that the loans were not fixed within the terms of the 1994 Regulations because there was no express provision in the loans that any part of the principal once repaid could not be withdrawn. Mr Peacock argued that the phrase "it is provided that" required an express and not an implied provision. Generally, he argued that regard had to be had to the exact words of the legislation, the context in which the words were used, and the purpose of the relevant provisions. The exact words were clear and unambiguous and one should look only at what was clearly said relying upon Inland Revenue Commissioners v Quigley [1995] STC 931 at 938-9. It had manifestly been the intention of Parliament that fluctuating nothings should have a different treatment from other assets or liabilities and that intention could only be limited or curtailed by an express statutory provision or by an implied provision which was both necessary and unambiguously required, relying upon Carr v Armpledge [2000] STC 410 at 416. Mr Peacock referred to a number of other statutory provisions both in regulation 3 of the 1994 Regulations and elsewhere to support his argument that an express provision was required and that it could not be implied. Finally, Mr Peacock argued that the fact that, in respect of the third loan, part of the principal once repaid was subsequently withdrawn was inconsistent with an implied term barring a right to re-draw.

24.The case for the Respondent was that there was an implied term in each supplemental agreement that any part of the principal once repaid could not be withdrawn. The original loans had contained an express provision that the right to draw down funds up to the limit of the loan facility remained unaffected by early repayments. That provision had been specifically removed by the supplemental agreements and so the borrower had no right to re-draw funds once repaid. The fact was that on a true construction of the loan agreements, read with the supplemental agreements, no part of the principal once repaid could be withdrawn. The loans were therefore fixed.

Reasons for decision

25.In considering the arguments of the parties we first consider the authorities cited to us to see what principles we should apply. We then consider the actual words of Regulation 3(6)(b)(ii) and form a view on the words of the legislation. Finally, we consider each of the other statutory references put before us by way of comparison.

26.Beginning then with the authorities, Mr Peacock relied for general principles upon Quigley and Armpledge. Quigley (1995) at 938j to 939a is authority for the principle that we must look simply at what is said in the legislation and that the answer depends upon an examination of the words used. Armpledge (2000) at 416 is authority for the principle that a taxpayer is entitled to take advantage of a relief, subject only to an express or implied statutory prohibition, and implication may only be made where it is necessary and where the statute unambiguously so requires.