The Court of Appeal (by a majority) dismissed an appeal against a judgment of the High Court ([2005] BTC 436) upholding a decision of the special commissioners ((2004) Sp C 441) that certain loan notes did not carry interest at the same fixed rate throughout the period from issue to redemption within the meaning of ICTA 1988, s. 717(2)(a).

Facts

The taxpayers, which were associated companies, appealed the Revenue's determination that the receipts from the transfers of certain securities should be taxed as income and not partly as capital.

The securities were loan notes with a 15-month maturity date. They were expressed to bear interest at 7.43375 per cent per annum. However the notes provided that interest was payable in three different amounts after nine, 12 and 15 months. The scheme was that the notes would be sold before the date of the first interest payment which would be in an amount far less than the interest which had accrued, thereby realising a capital gain which could be sheltered using capital losses within the group.

The Revenue contended that the notes were not within s. 717(2)(a) because, although the loan notes provided for a notional fixed rate of interest, that was not the rate at which interest was to be paid and received and so the loan notes did not carry interest at a fixed rate which was the same throughout the period from issue to redemption.

The taxpayers’ appeal was dismissed by the special commissioners ((2004) Sp C 441) and High Court ([2005] BTC 436). The taxpayers appealed to the Court of Appeal.

Issue

Whether the loan notes were securities which carried interest at a fixed rate which was the same throughout the period from issue to redemption within the meaning of s. 717(2)(a).

Decision

Sir Andrew Morritt V-C (Tuckey LJ concurring and Sir Peter Gibson dissenting) (dismissing the appeal) said that usually liability to tax on interest arose when it was received. The object of the relevant legislation was to prevent the avoidance of tax on interest when received by selling the right to receive it before it was payable. Two regimes were introduced for that purpose: the first was provided by s. 713 in respect of fixed interest securities; the second was prescribed by s. 717 in respect of variable interest rate securities. The existence of the two regimes and the different way in which they dealt with how to apportion the consideration for the transfer of an accrued right to payment of interest in the future provided the context in which to consider the proper construction of s. 717(2) because that subsection and s. 717(4) determined to which regime any given security, as defined by s. 710(2) was subject.

The court was entitled and bound to consider which of the two regimes was the more appropriate for ascertaining the accrued amount on which to assess the transferor to tax. By that standard, the variable interest rate regime was the more appropriate in the case of these loan notes. Under that regime, the inspector could, and in this case did, assess the accrued amount on the footing that the notes carried interest at the rate of 7.43375 per cent for the period from issue to redemption. By contrast, the fixed interest security regime would require the calculation of the accrued amount by reference to the interest payable on the relevant interest payment date. Because different rates in fact applied to the three relevant interest periods, the accrued amount for any given period would vary considerably according to the interest period in which the transfer was effected. But the fact that the variable interest rate security regime was more appropriate to the notes was irrelevant if the legislative provisions did not warrant the construction of s. 717(2)(a) in a way which achieved it.

First it was necessary to identify from the terms of issue the rate of interest ‘carried’ by the securities in question ‘throughout the period from issue to redemption’. Then one had to consider whether the rate at which interest was ‘carried’ was the same throughout that period. In this case, the terms of issue themselves segmented or subdivided the period from issue to redemption into three constituent periods and it was appropriate to consider whether the provisions relating to each of those periods indicated that the rate of interest carried by the securities in each of those periods was the same or different. In all the circumstances, the text of the legislation warranted the conclusion that the special commissioners and the High Court had reached. As a matter of construction, the loan notes did not fall within s. 717(2)(a). Sir Peter Gibson (dissenting) said that the court should be careful to give the statutory language a fair construction and not be drawn into giving s. 717 an unnaturally wide meaning merely because of the evident intention on the part of the taxpayers in this case to obtain a tax advantage. If the inspector's construction were correct, and if s. 717(2)(a) required consideration of the dates and amounts of interest payable within the period from issue to redemption to see if the rate of interest was the same fixed rate on every day in the period from issue to redemption, or if interest periods within the relevant period had to be taken into account and the rate for each period had to be the same as that for any other interest period, many securities, which provided for them to carry a fixed interest rate as well as for interest payments to be made at intervals, would fall foul of s. 717.

Court of Appeal (Civil Division). Judgment delivered 24 May 2006.