The High Court upheld the decision of a special commissioner ((2007) Sp C 608) that the test for determining whether certain loan notes were qualifying corporate bonds within TCGA 1992, s. 117(1)(b) had to be conducted by reference to the formal terms of the security rather than by reference to those that were effective or operative at the time of disposal. The lapse of a foreign currency redemption option did not cause the loan notes to cease to be securities in respect of which a provision was made for redemption in a foreign currency for the purposes of s. 117. Therefore, in the present case, the loan notes were not qualifying corporate bonds and the gain on their disposal was chargeable to capital gains tax (CGT).

Facts

In January 1995 the taxpayer, a company director, exchanged shares in a UK company for loan notes issued by a German company. The loan notes included an option for redemption in a currency other than sterling, if the holder elected to exercise the option within ten days. It was accepted that the effect of that condition was that the loan notes were not qualifying corporate bonds, within TCGA 1992, s. 117, when they were issued. The taxpayer did not make such an election, and in July 1995 he redeemed the loan notes for sterling. The Revenue issued a CGT assessment in respect of the gain. The taxpayer appealed, contending that the loan notes should be treated as qualifying corporate bonds (QCBs) when he disposed of them, so that the gain was not taxable. He argued that that change had occurred because a right in the terms of the loan notes to opt to redeem them in a foreign currency had lapsed. If he was right then a gain which was rolled over into the loan notes when he acquired them escaped taxation.

The special commissioner decided that, considering the language and purpose of s. 117(1), the proper construction was that the test in s. 117(1)(b) had to be conducted by reference to the formal terms of the security rather than by reference to those that were effective or operative at the time of disposal. As a result, the taxpayer's loan notes were not QCBs whether the test in s. 117(1) was to be performed on disposal or otherwise. As a result the lapse of the foreign exchange condition did not cause the loan notes to cease to be securities in respect of which a provision was made for redemption in a foreign currency for the purposes of s. 117. It did not seem to be relevant whether that lapse took effect by lapse of time or by virtue of the express terms of the condition. Even though the test might fall to be conducted at different times for the purposes of different provisions, the nature of the test meant that on disposal the taxpayer's loan notes were not QCBs and accordingly a gain arose ((2007) Sp C 608). The taxpayer appealed.

Issue

Whether a security in which a currency conversion option had lapsed became, at the moment of lapse, a security in respect of which no provision was made for conversion into, or redemption in, a currency other than sterling, within s. 117 and related provisions, in the form then in force.

Decision

Briggs J (dismissing the appeal) said that a cardinal feature of the task of construction in the present case was the anomaly that arose from the taxpayer's construction which, by permitting a security to change after acquisition from a non-QCB to a QCB before disposal but without any transaction, thereby enabled substantial accrued gains to fall altogether out of tax.

It was one which was not created by any other provision in s. 117 since all the other potential changes of status were triggered by transactions. The most egregious example of the anomaly was where the non-QCB had, because of its status as such, rolled- over into it a substantial chargeable gain already accrued on the shares for which it was exchanged. In that context it fell foul of Neuberger J's analysis in Jenks v Dickinson [1997] BTC 286, and gave rise to an apparently irresistible temptation for tax avoidance.

The holder of shares replete with chargeable gains might, rather than by selling them and paying the tax, exchange them for a security which was only not a QCB because of a currency conversion option, and then by declining to exercise it convert the security into a QCB which was redeemable tax-free. The anomaly was not however confined to cases where there was a rolled-over gain. The object of the statutory distinction between the QCBs and non-QCBs was that only the former should escape tax on their gains. The logical corollary, if a non-QCB was inherently capable of changing into a QCB without a transaction, was that one would expect tax to be payable in respect of gains made during the period when the security did not qualify as a QCB. But the taxpayer's construction avoided even that consequence. Provided that, however shortly before its disposal, the security was converted, non-transactionally, into a QCB, all earlier gains, whether rolled-over or accrued during the life of the security, fell out of tax.

The mischief which caused the anomaly was simply the propensity of a security which was a non-QCB only because it fell foul of the (b) condition to acquire that desirable status when any relevant currency conversion option lapsed. However, a legitimate alternative construction of the (b) condition, by which an otherwise relevant currency conversion option did not fall out of view merely because it had lapsed by the date of disposal, was both available and the construction which ought to be preferred. First, it plainly avoided the glaring anomaly, and no counter- mischief had been suggested. Secondly it did so by bringing the (b) condition into conformity with the rest of s. 117, by preventing the lapse of a relevant currency conversion option from causing a for transactional change of status. Thirdly it was impossible to believe that the draftsman who framed the (b) condition, or Parliament when it passed it, consciously intended to introduce a propensity for transactional change of status, simply by using the phrases ‘is expressed’ and ‘in respect of which no provision is made’, and by leaving out the phrase ‘at all times’. No conceivable purpose could have existed for introducing by a sidewind a propensity for construction transactional changes of status, merely by requiring the chose in action to be examined on every relevant occasion to see what were its terms.

At the moment of redemption, the loan notes in the present case contained a lapsed currency conversion provision. The language of the (b) condition contained no deliberate pointer to the relevance or otherwise of its lapse, and might reasonably be construed as applying as much to a lapsed provision as to a currently exercisable provision or to a provision which had yet to become exercisable at the relevant date. The answer to the question which of those three different types of provision fell foul of the (b) condition was to be arrived at by consideration of the underlying consequences. The only answer which was free of anomaly was that all three types, including for present purposes a provision that had lapsed, did so.

Since November 1996, the propensity for a into transactional change of status between non-QCB and QCB had been expressly recognised by the amendments, and in particular by the amendment to TCGA 1992, s. 132(3)(a)(ia), although it was only when read together with the contemporaneous press release that it was apparent that the relevant risk was perceived as arising from the (b) condition itself.

Nonetheless, the indirect curing of a perceived risk as to a serious anomaly after the relevant date was not a sufficiently persuasive indication as to the intention of Parliament to displace the conclusion to be arrived at by a process of construction directed to avoiding glaring anomalies in the first place. That part of the 1997 amendment was, upon a long and considered appreciation of the true construction of s. 117(1)(b), unnecessary.

Consequently, the loan notes in the present case were not, either when issued or when redeemed, securities ‘in respect of which no provision is made for conversion into, or redemption in, a currency other than sterling’ within the meaning of s. 117(1)(b).

Chancery Division.

Judgment delivered 30 January 2008.