Summary

In the circumstances five repurchase or "repo" transactions in gilts under which the taxpayer received more than it had paid did not give rise to an entitlement to relief in respect of a non-trading deficit. On the correct interpretation of the Finance Act 1996 s.84 the deemed interest expense the taxpayer incurred would represent and thereby cancel out the interest to be credited in respect of the gilts.

Facts

The appellant commissioners appealed against a decision ((2008) EWHC 2429 (Ch), (2009) STC 77) that the result of certain repurchase or "repo" transactions was that the respondent (D) was entitled to relief in respect of a non-trading deficit of some £24.1 million. D had entered into five "fixed price repo" transactions under which it bought gilts from a bank (X) and X agreed to repurchase the same or identical gilts at specified future dates for a fixed amount. The substance of the transactions was a secured loan by D to X whilst the benefits and risks relating to the security were retained by X. D owned the gilts for periods which varied between 11 and 42 days. In the five transactions D bought gilts for £812m from X, and resold them to X for £785m, in the meantime receiving total coupon payments of £28.8m. Overall, therefore, D received £1.8m more than it had paid and that amount was recognised as a profit in its profit and loss account. It was agreed that under the Income and Corporation Taxes Act 1988 s.730A(2)(a) D had a deemed loan relationship under which it received a notional payment of £1.8m interest that had to be brought into account under the Finance Act 1996 s.84(1) as a credit. In its tax return for the relevant accounting period D claimed a non-trading deficit of just over £27 million on the basis that under the relevant statutory provisions it had made a loan relationship loss of £28.8 million less £1.8 million. The Special Commissioner dismissed D's appeal against amendment of its return. The judge allowed D's appeal. D contended that on an accruals basis of accounting the only interest on the gilts which should be brought into account under s.84 of the 1996 Act was the interest of £2.9 million accruing in the period in which D held the gilts, whereas the deemed manufactured interest debit required to be brought into account under s.84(1) in respect of the deemed loan relationship arising by virtue of s.97 of the 1996 Act and s.737A of the 1988 Act was £28.8m. The commissioners contended that since the deemed manufactured payments represented the coupons payable to D, the sums given by s.84 in respect of the coupons should cancel out the payments it was deemed to have made.

Held

(Rimer LJ dissenting) (1) On an accruals basis the sum to be brought into account under s.84 of the 1996 Act in respect of the coupons was £2.9m, as the interest accruing in the period in which D held the gilts. It was, however, premature to reach any conclusion as to the amount to be brought into account in respect of the coupons, until the second criterion imposed by s.84(1), of fair representation, was applied. That second criterion required the issue of the sum produced by s.97 of the 1996 Act in respect of D's deemed manufactured payments to be resolved first. (2) Section 97(4) of the 1996 Act required D's deemed manufactured payments to be treated as if D had made payments representative of the periodical payments of interest or coupons which became payable in respect of the gilts. The amount of deemed manufactured payments which D was deemed to have made to X had to be £28.8m. No other payment could be regarded as a representative payment, to use the language of s.97(4), or representative of the real interest. Accordingly, the amount of the deemed manufactured payment brought, by s.97(2), within the scope of s.84(1) was £28.8m. (3) Section 84(1) was the machinery by which all interest under D's loan relationships was brought into account. The section posed a second statutory question, namely, whether any particular sum when taken together with the other sums which fell to be brought into account fairly represented all the interest including that which was the mere product of a statutory fiction. The application of that additional distinct criterion, requiring the sums, taken together, fairly to represent all interest, permitted the amount given in respect of the coupons by an accruals basis of accounting to be displaced by the amount which the deemed interest expense was supposed to represent. The effect of the application of an accruals basis to the coupons, giving rise to a sum of only £2.9 million, was to deprive the deemed manufactured interest of its essential statutory function of cancelling out the credit payable to D; it produced a sum, which, when taken together with the other sums, did not cancel out the credit but exceeded it by a substantial margin. The correct construction of the relevant statutory provisions permitted the conclusion that the sum to be brought into account in respect of the coupons was not £2.9m but £28.8m. It was that sum which fairly represented all D's interest under its loan relationships. At the computation stage, the deemed interest expense D incurred would, thus, represent and thereby cancel out the interest to be credited in respect of the gilts. (4) (Per Rimer LJ dissenting) As the judge held, the statutory provisions required the credit interest under the gilts loan relationship to be brought into account under s.84 at the figure of £2.9 million calculated in accordance with the accruals method of accounting.

Appeal allowed