The special commissioners decided that a UK resident taxpayer who was party to a tripartite ‘repo’ transaction was not deemed to have received an interest payment under the Income and Corporation Taxes Act 1988, s. 730A since, under that provision, the interest was to be treated as arising to the interim holder, which was the taxpayer's non-resident parent company.

Facts

The taxpayer was a wholly-owned subsidiary of the Bank of Ireland. It was a private limited company incorporated and registered in England and Wales; it was resident in the UK. The Bank of Ireland was incorporated and resident in the Republic of Ireland; it entered into the relevant transactions through its head office in Dublin. BCo was a Cayman Islands incorporated and resident company. On 8 November 2000, the entire ordinary share capital of PSub, another Cayman Islands incorporated and resident company, was issued to BCo. BCo continued to own that ordinary share capital at all material times after that date.

A dispute arose concerning what was commercially known as a ‘repo’ transaction involving the Bank of Ireland, the taxpayer, BCo and PSub. Under such transactions, an owner of securities agreed to sell those securities and subsequently to repurchase them from the other party by a specified future date, the repurchase price being agreed (or fixed by formula) at the outset. Under the terms of the agreement, the original owner was entitled or required to repurchase those securities.

The object of the repo was to provide funding to the original owner pending the repurchase, and to give the buyer the benefit of the securities for the same period. The transaction amounted to a form of secured lending, under which the buyer utilised surplus funds. Until the repurchase the buyer was the beneficial owner of the securities, but his rights as owner were fettered by the obligation to allow the repurchase to proceed. The original owner had the use of the sale price, but in the knowledge that when the repurchase took place, he would have to pay the amount of the repurchase price.

Repo transactions might involve more than two parties where the buyer, by agreement with the original owner, passed the securities to a third party, who was fettered with the obligation to retransfer the securities eventually to the original owner. The result would then be that the resale obligation fell to be fulfilled by the third party rather than by the buyer. This appeal concerned a repo transaction of the tripartite kind. The taxpayer delivered a corporation tax return for the year ended 31 March 2001 to its tax inspector which included a self-assessment calculated on the basis that the taxpayer was entitled to a deduction of £3,975,473 arising by virtue of ICTA 198, s. 737A.

The Revenue subsequently amended the return, in effect excluding the deduction of £3,975,473. The taxpayer appealed against that amendment on the ground that it was entitled to the deduction.

Both parties accepted that ICTA 1988, s. 730A and 737A applied to the repo and that by s. 737A(5) the taxpayer was deemed to have paid a manufactured overseas dividend of £3,975,473. It was also agreed that by virtue of s. 737C(11)(c), the repurchase price for the purposes of s. 730A was deemed to be the aggregate of £225m (the actual repurchase price) and £3,975,473, and that the sale price was £225m. Both parties therefore accepted that by s. 730(2)(a) £3,975,473 was deemed to be treated as a payment of interest made by the repurchaser on a deemed loan from the interim holder of an amount equal to the sale price.

It was agreed that the sum of £3,975,473 was to be treated as an amount of interest paid by the third party company on a deemed loan from the taxpayer's parent company which was registered in the Republic of Ireland. The dispute was as to whose income it was. The taxpayer contended that it was the income of the parent (the maker of the deemed loan), whereas the Revenue argued that it was the income of the taxpayer (which received the repurchase price).

Issues

Whether the taxpayer was deemed to have received a payment of interest under s. 730A of the Income and Corporation Taxes Act 1988 (‘ICTA 1988’); and whether the payment deemed to have been made by the taxpayer under ICTA 1988, s. 737A was to be treated as a charge on income for the purposes of corporation tax by virtue of ICTA 1988, s. 338(7) and 125.

Decision

The special commissioners (John Clark and Michael Johnson) (allowing the appeal) said that the primary question was the construction of s. 730A(2)(a). The purpose of the deemed loan was to tax as interest the commercial result of the transaction, namely the difference between the sale price and the deemed repurchase price, the latter taking into account the benefit of the dividends in respect of the securities. While that worked satisfactorily in the context of a two-party repo, it created various difficulties in relation to a tripartite repo: first, s. 730A(2)(a) simply compared the original sale price and the ultimate repurchase price, without looking at any intermediate transactions; secondly, on the taxpayer's construction the interest was treated as received by the interim holder, i.e. the Bank of Ireland. If the Bank of Ireland had been UK resident, that would have resulted in it being taxable on the deemed interest as well as the actual dividends which it received in respect of the securities; thirdly, s. 730A(2)(a) gave no indication as to how the parties to the deemed loan relationship were to be identified where a tripartite repo was involved. Those difficulties indicated that the draftsman did not have in mind the concept of anything other than a two-party repo and the legislation had to be applied to circumstances for which it did not seem to have been intended. Although the taxpayer received the repurchase price, the question was whether the legislation deemed it to have received the interest. The words of s. 730A(2)(a) clearly required the interest to be treated as arising to the interim holder, the maker of the deemed loan, here the Bank of Ireland. Although the result was bizarre, there was no justification for seeking to construe s. 730A(2)(a) in any other way. It followed that the taxpayer was correct in submitting that the £3,975,473 was not income of the taxpayer but of the Bank of Ireland, which was the interim holder. The question remained as to the deductibility of the deemed manufactured overseas dividend which depended on the application of s. 338(5)(b) and s. 338(7), bringing in s. 125(1). Section 737A(5) applied Sch. 23A and dividend manufacturing regulations ‘as if the position were as set out in s. 737A(5)(a)–(c). Under Sch. 23A, para. 4(2), the gross amount of the manufactured overseas dividend was to be treated for all the purposes of the Tax Acts as an annual payment within s. 349. To deduct that annual payment as a charge on income, the taxpayer had to satisfy the relevant conditions in s. 338.

Under s. 338(5)(b), the annual payment had to be ‘made under a liability incurred for a valuable and sufficient consideration’. There were three possible ways of applying the test in the present case: (1) on the basis of the actual transactions entered into; (2) on the basis of a statutory assumption that the conditions were met in respect of the payment deemed to be made; or (3) on the basis that the conditions must be fulfilled in respect of the relevant transactions as they were deemed to have occurred.

For a two-party repo, any of those tests appeared to work entirely satisfactorily. The difficulty in relation to a tripartite repo arose because the deemed manufactured overseas dividend was not matched by a corresponding deemed receipt. Thus it was inappropriate to look at what, if any, commercial consideration was to be regarded as given in return for the liability to pay the manufactured overseas dividend. That meant that tests (1) and (3) could not be applied.

In all the circumstances, test (2) applied; on the basis that the requirement in s. 338(5)(b) could never be met in relation to any form of repo (whether two-party or multi-party), as the relevant liability was imposed by s. 737A(5)(a) rather than for any form of commercial consideration, the only way of applying the legislation was on the assumption that what was deemed under Sch. 23A, para. 4(2) to be an annual payment would automatically be deemed to meet the condition in s. 338(5)(b).

In relation to s. 125, it followed that the deemed annual payment was not made under a liability incurred for consideration in money or money's worth, so that it did not fall within s. 125(2)(b). Accordingly, it was not prohibited by s. 125(1) (nor by s. 338(7)) from being a charge on income.

(2006) Sp C 544. Decision released 6 June 2006.