The special commissioners decided that, to the extent that they created or increased a loss, sums described as ‘transfers from capital reserve’ included in line 15 of Form 40 fell to be taken into account as receipts in computing the loss of the taxpayer company.

Facts

This was a joint referral by Scottish Widows plc and Revenue and Customs under FA 1998, Sch. 18, para. 31A of a question which arose in connection with an enquiry into the company's tax returns for the accounting periods ending 31 December 2000, 2001 and 2002. The agreed question for determination is whether in computing the Case I profit or loss of the taxpayer company for the accounting periods ending in 2000, 2001 and 2002, amounts described by the taxpayer as ‘transfers from Capital Reserve’ and included as part of the entries at line 15 of Form 40 for each period fell to be taken into account as receipts in computing the profit or loss as the case might be. If that question was answered in the negative as the taxpayer contended then some £1,072,535,060 would fall to be treated as Case I losses which the taxpayer would be able to surrender to another group company for the purposes of group relief.

In broad terms, the issues on the referral arose following the demutualisation of the Scottish Widows’ Fund and Life Assurance Society in 2000 and the acquisition of its business by the Lloyds TSB group of companies. In summary the business, assets and liabilities of the society were transferred to the taxpayer company and a subsidiary.

The scheme for the demutualisation and transfer of business to the taxpayer provided, among other things, for the establishment of a long term fund (the fund maintained for its long-term insurance business for the purposes of s. 28 of the Insurance Companies Act 1982) and provided for the taxpayer to establish and maintain, for management and accounting purposes, two separate sub-funds of the long-term fund: a with profits fund and a non-participating fund.

In each of the relevant accounting periods after the demutualisation the market value of the taxpayer's assets from the inception of the long-term fund had decreased. For the accounting periods ending in 2000, 2001, and 2002 the market value of admissible assets less liabilities in the long-term fund decreased by £1,659m, £1,260m, and £386m respectively. Those decreases arose principally because of falls in the value of the stock market.

At all times material to the reference, the taxpayer's annual return included a series of numbered forms, including Form 40 (revenue account) which showed revenue flows and recorded the fund amount. For the taxpayer, the form was completed for each of the total long-term fund, with profits fund and non-participating fund. The form was the revenue account for each fund in question, and consisted of premiums, claims, investment return, expenses, tax, etc. To the extent that those items also appeared in the statutory accounts, the Form 40 was reconcilable to those accounts.

In each of the relevant years an amount shown in the notes as ‘transfer from capital reserve’ was included within line 15 of the taxpayer's (with profits fund) Form 40, thereby reducing the overall amount of the capital reserve by equivalent amounts.

At all material times the taxpayer was taxed on the I minus E basis of assessment. The taxpayer was a proprietary company and so the profits and loss arising from its insurance trade still needed to be calculated on a Case I basis. In its tax returns and computations for the periods ending in 2000, 2001 and 2002, the taxpayer included Case I tax losses equal to £28,689,437, £612,583,866 and £431,261,757 respectively. For the purposes of the referral it was agreed that, if the agreed question for determination was answered in the negative (as was contended for by the taxpayer, but which was contrary to the contention of Revenue and Customs), the taxpayer would have Case I losses of those amounts. The resolution of the issue specified in the referral fell to be determined by the proper interpretation of FA 1989, s. 83(2), (3) correctly applied to the facts.

Issue

Whether, in computing the Case I profit or loss of the taxpayer company for the accounting periods ending in 2000, 2001 and 2002, amounts described as ‘transfers from Capital Reserve’ and included as part of the entries at line 15 of Form 40 for each period fell to be taken into account as receipts in computing the profit or loss.

Decision

The special commissioners (J Gordon Reid QC and Dr John Avery Jones) (ruling in favour of the Revenue) said that it was necessary to look at s. 83(1) as a whole. Section 83(1) started by providing that the provisions of the section applied where the profits of an insurance company in respect of its life assurance business were computed in accordance with Case I. Subsection (2) on its natural reading was a timing provision, stating that (a) investment income from, and (b) increases in value of, the assets of the fund were taken into account as income (and reductions in (b) were treated as expenses) for Case I for the period of account in which they were brought into account through Form 40. Both items (a) and (b) would, but for s. 83(2), be taken into account on an accruals basis. Section 83(2) had to be construed in the light of the fact that the section referred (via s. 83A) to Form 40 and the practice of life insurance companies. The relevant parts of Form 40 were line 13 ‘increase (or decrease) in the value of non-linked assets brought into account’ and line 15 ‘other income’.

Section 83(2)

The difference between the parties on s. 83(2) was as to which of the two values of the fund the legislation was referring in s. 83(2)(b) in the expression ‘any increase in value (whether realised or not) of those assets’, i.e. the assets of its fund. The Revenue contended that it was the market value (or admissible value), and the taxpayer that it was the Form 40 value. An amount brought into account in line 13 would generally be a Case I receipt. Subsection (2) normally operated as a relieving provision so that normally a company would not bring in all its investment income and actual increases in value of the fund in the year into account and so there would be a deduction in line 13, thus building up a line 51 amount in Form 14, the majority of which was from investment causes. There was no difficulty in ascertaining the actual increase in value figure since the fund was valued at market value (particularly as the increases in value specifically included unrealised increases) at the end of each year on Form 13. When the reverse happened (for example, when there were no actual increases in value of the assets of the fund in the year), it would reverse the process and bring a positive figure into line 13 of Form 40, which would be likely to represent past income or actual increases in value by reducing the line 51 amount. There was in practice no need to analyse what those represented since it would be clear that what was deducted in the former case would be out of the current year's income or actual increases in value of the fund; and in the latter case it would come out of past income or actual increases in value of the fund.

The Revenue's argument amounted to saying that all increases (or decreases) in the Form 40 value of the fund are Case I receipts (or expenditure) unless they were capital receipts or were included in the form under some other heading, so that whatever was put through line 13 (or 15) was a taxable receipt or allowable expenditure unless it reversed an item under another heading. If Parliament had meant to say that it would have used other words to indicate it.

The reference in s. 83(2) to an increase in value of assets was restricted to an increase in value (either an actual increase in value or an increase in the Form 40 value, depending on the interpretation of s. 83(2)) in the hands of the transferee. But the effect of s. 83(3) applying was similar to saying that the transferor's line 51 amount was carried over because the effect was that the whole of that amount was treated as an increase in value of assets within s. 83(2). Accordingly the increase in value referred to in s. 83(2) meant an actual increase in value, and the receipt from the capital reserve (and also the line 51 amount) shown in line 15 was not in fact a Case I receipt. There were no actual increases in value of the fund, and so what was brought into account in line 15 represented a capital receipt.

Section 83(3)

Section 83(3) related to the situation arising in this reference where there had been a transfer of business. It provided, on its natural meaning, that solely for determining a loss the amount added to the fund as part of (or in connection with) the transfer of business was to be taken into account in computing the loss for the period for which it was brought into account as an increase in value of the assets of the fund in s. 83(2) (except, by s. 83(4), where the amount added was a receipt anyway, or a receipt within s. 83(2), or was exempt).

Section 83(3) applied only where there was both the transfer of business and the result was a loss. It was presumed that Parliament limited the effect of s. 83(3) to losses because the transferee company could choose to bring in a capital addition to balance an existing deficiency of the Form 40 value of the fund over the mathematical reserves, thus using capital to make up an income loss. Also if there was a profit it was unlikely that the company would be taxed under Case I on the profit because the I minus E basis would be likely to give rise to a greater amount of tax. It was the Form 40 value that was relevant to the Case I computation.

Applying that interpretation of subs. (3) to the facts of this reference, the taxpayer brought into account in Form 40 from the line 51 amount (using 2001 for illustration) £1,108m in line 13 and £442m and £31m in line 15. If it had not been for those amounts there would have been a loss shown on Form 40 in the year caused by a fall in the value of the fund, which was an income item. It treated the line 15 items as capital and deducted them in the Case I computation, thus increasing the loss. All those amounts (and the corresponding amounts in the other years) should be treated as an amount brought into account in Form 40 and accordingly as a Case I receipt by virtue of subs. (3). The fact of deducting the line 15 amounts from the capital account made no difference. The line 51 amount and the capital reserve were closely related at the start, being essentially the same figure except for a difference in valuation method that gave a higher figure for the former reflecting that the difference was policyholders’ rather than shareholders’ capital. But both were capital. The fact that the taxpayer chose to reduce the capital reserve as well as the line 51 amount for the line 15 figures indicated that it considered that the shareholders had lost that amount permanently, rather than that there was any tax difference. Both the line 13 and line 15 figures should be treated as Case I receipts by virtue of subs. (3). The answer to the question in the reference was therefore that, to the extent that they created or increased a loss, the transfers from capital reserve included in line 15 of Form 40 in the relevant periods did fall to be taken into account as receipts in computing the loss. To that extent the agreed question in the reference was answered in the affirmative in favour of the Revenue.

(2008) Sp C 664.

Decision released 24 January 2008.