The High Court confirmed a decision of the special commissioners that a UK resident taxpayer who was party to a tripartite ‘repo’ transaction was not deemed to have received an interest payment under ICTA 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 company was Bank of Ireland Britain Holdings Ltd (‘BH’), a private limited company incorporated and registered in England and Wales and resident for tax purposes in the UK. BH was a wholly-owned subsidiary of the Bank of Ireland, which is incorporated and resident in the Republic of Ireland and entered into the relevant transactions through its head office in Dublin. The relevant events took place between November 2000 and March 2001. The scheme involved a transaction for the sale and repurchase of securities, known as a ‘repo’. The repo involved three parties, and dividends were paid on the securities during the period of some four months for which it operated. The amount of the loss, if the scheme worked, was equivalent to the dividends actually paid to Bank of Ireland during its period of ownership of the relevant securities, a sum of approximately £3.6m. That sum also comprised most of a so-called ‘manufactured overseas dividend’ which was deemed to have been paid by BH, and which is prima facie deductible by BH as a charge on income in computing its taxable profits. The scheme sought to take advantage of a perceived mismatch between two related, but independent, groups of sections in ICTA 1988, Pt. XVII (Tax Avoidance). The purpose of each group of sections, in the broadest terms, was to replace transactions which would otherwise be taxable, if at all, under the capital gains tax regime (or its equivalent for companies) with deemed flows of taxable income.

The Revenue submitted that the legislation should not be construed so as to give BH a commercially unreal tax loss, because the deduction for the deemed manufactured overseas dividend would be matched by a deemed receipt of taxable interest, thereby producing a situation of basic fiscal neutrality for BH and leaving it taxable only on the comparatively small amount of dividends (some £338,000) which it actually received during its period of ownership of the securities.

Both sides 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; and 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 also 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). The special commissioners ruled in favour of the taxpayer ((2006) Sp C 544). The Revenue appealed to the High Court.

The Revenue also had an alternative argument, which raised the question whether BH was in fact entitled to a deduction in computing its taxable profits for the manufactured overseas dividend which it was deemed to have paid. This argument involves consideration of the conditions for allowance of charges on income in s. 338 of ICTA 1988, and turns mainly on the question whether the deemed payment should be regarded as ‘not made under a liability incurred for a valuable and sufficient consideration’ within the meaning of s. 338(5)(b).

Issues

Whether the taxpayer was deemed to have received a payment of interest pursuant to ICTA 1988, s. 730A; and whether the payment of the manufactured overseas dividend deemed to have been made by the taxpayer under s. 737A was deductible as a charge on income.

Decision

Henderson J (dismissing the appeal) said that it was not possible to construe the legislation so as to make the interest taxable in the hands of the reseller, as the Revenue argued, instead of in the hands of the interim holder, who did not receive the repurchase price. The wording of s. 730A(2)(a) was clear and unambiguous. The deemed loan was still from the interim holder, notwithstanding the tripartite nature of the arrangements, and that deemed loan was the only source from which taxable interest could arise. The interest must therefore be taxable in the hands of the interim holder, whether or not he also received the repurchase price. The legislative scheme was to treat the interim holder as the deemed lender of the original sale price for the life of the repo, and it was therefore in the hands of the interim holder that the deemed interest was taxable.

The function of s. 730A was, first, to deem potentially chargeable income to exist, in the form of the deemed interest, and secondly, to deem a source of that income to exist, in the form of a deemed loan from the interim holder. It was that deemed loan which provided the necessary link between the notional interest and the relevant charging provisions which were to be found elsewhere in the tax legislation. The deemed loan was therefore of fundamental importance in bringing the notional interest into the charge to tax. Where the notional interest was deemed to be paid by a company, the interest was deemed to be interest under a loan relationship, providing the necessary machinery to bring the notional interest into charge to tax. However, s. 730A(6) did not itself deem anybody to be a party to the deemed loan relationship. As s. 730A(6)(a) made clear, it was necessary to go back to subs. (2) in order to find out who was deemed to pay the notional interest, and who was deemed to receive it. Accordingly, it was inescapable that s. 730A(2) identified the deemed payer of the interest as the repurchaser and the deemed recipient of the interest as the interim holder (here the Bank of Ireland). It followed that the deemed interest was not income of the taxpayer but of the interim holder.

As regards the deductibility of the deemed manufactured overseas dividend paid by the taxpayer as the ‘relevant person’ under s. 737A, it was not disputed that the deemed manufactured overseas dividend was an annual payment within ICTA 1988, s. 349 by virtue of Sch. 23A, para. 4(2), as applied by s. 737A(5). It was also not disputed that it was a charge on income paid by the taxpayer within s. 338, and therefore allowable as a deduction, unless it was prevented from being a charge on income either by s. 338(5)(b) or by s. 338(7) read with s. 125(1) and (2)(b).

Section 338(5)(b) was a general provision relating to charges on income, and its language only made sense in relation to transactions in the real world. Since it was conceded that the taxpayer received full and valuable consideration for the transactions which it entered into in reality, that was the end of the matter. Parliament could not sensibly have contemplated an investigation of the value and sufficiency of the consideration for a transaction which was only deemed to have occurred.

The arrangements for the transfer of the securities referred to in s. 737A(5)(a) were clearly the real world arrangements, and what the subsection did was to deem the existence of an obligation on the part of the taxpayer to pay a manufactured dividend to the transferor as part and parcel of those real world arrangements. Thus it was reasonably clear that Parliament must have intended the question of the value and sufficiency of the consideration for that deemed obligation to be tested by reference to the value and sufficiency of the consideration for the actual obligations undertaken by the relevant person under the arrangements.

It followed that s. 125(2)(b) was not engaged because all the consideration in money or money's worth for which the taxpayer's actual obligations were undertaken had been brought into account in computing the taxpayer's income.

Chancery Division.
Judgment delivered 30 April 2007.