The Court of Appeal upheld a decision of the High Court ([2007] BTC 389) that a UK resident taxpayer which was party to a tripartite ‘repo’ transaction in securities 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 not to the taxpayer as reseller of the securities but 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 was 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 was 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 £358,000) 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 High Court dismissed the Revenue's appeal against that decision concluding that 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 ([2007 EWHC 941 (Ch); [2007] BTC 389). The Revenue appealed.

Issues

Whether, when s. 730A(2)(a) treated the difference between the sale price and the repurchase price 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’, the payment of interest was to be treated as paid to BH, the reseller, or to Bank of Ireland, as interim holder.

Decision

Lawrence Collins LJ (Maurice Kay LJ and Sir William Aldous agreeing) said that there was no basis for the Revenue's challenge to the judge's decision. The ordinary meaning of the words in s. 730A(2)(a) plainly pointed to the payment of interest being treated as paid to the interim holder. What was treated as a payment of interest was the difference between the sale price and the repurchase price ‘on a deemed loan from the interim holder’. The ‘interim holder’ was the person to whom the ‘original owner’ had transferred the securities (s. 730A(1)(a)). The section did not contemplate, or deal with, the case where there had been an assignment.

The tripartite scheme had been devised to take advantage of a mismatch between the two sets of sections. The mismatch was that s. 730A referred to the interim holder as such, i.e. the person to whom the securities were originally transferred, and s. 737A referred to the relevant person, namely the person from whom the transferor was required, or had the right, to buy back the securities. But there was no legitimate process of interpretation which would solve the Revenue's problem.

There was no legitimate basis for reading the words to the reseller’ or ‘to the relevant person’ (as defined in s. 737A(6)(a)) as inserted in s. 730A(2)(a) so that it would read that the difference was to be treated as a payment of interest to the reseller (or relevant person), as submitted by the Revenue. That would amount to an unprincipled process of legislative gloss. Receipt, of itself, was not a determinant of any possible tax liability. An assignee of the right to receive interest (without assignment of the loan relationship) would not be taxable on the amount of that interest under the loan relationship provisions because he had no relevant loan relationship.

The charge to tax in the present case was under Sch. D, Case III. Interest was chargeable by virtue of FA 1996, s. 80. Section 80(1)) provided: ‘For the purposes of corporation tax all profits and gains arising to a company from its loan relationships shall be chargeable to tax as income in accordance with this Chapter’. Where the loan relationship was not for the purposes of a trade: ‘Profits and gains arising from a loan relationship of a company … shall be brought into account as profits and gains chargeable to tax under Case III of Schedule D’ (s. 80(3)).

On the introduction of the loan relationships rules by the Finance Act 1996, s. 730A(6) was added, and provided that for the purposes of Chapter II of Pt. IV of the Finance Act 1996 (loan relationships), interest deemed by virtue of s. 730A(2) to be paid or received by any company should be deemed to be interest under a loan relationship.

Although s. 730A(6) was not determinative of the issue of construction, it was highly relevant that the interest which it deemed to be interest under a loan relationship was the ‘interest deemed by virtue of subsection (2) above to be paid or received by any company ’ and the only loan relationship expressly referred to in s. 730A(2)(a) was the ‘deemed loan from the interim holder’.

Court of Appeal (Civil Division).

Judgment delivered 8 February 2008.