The High Court upheld a decision of the special commissioners ((2007) Sp C 636) that payments made at the inception of two swap transactions were not qualifying payments eligible as deductions in calculating the taxpayer company's corporation tax liability since they were not reflected in the taxpayer's profit and loss account, not being payments allocated to a particular period.

Facts

The taxpayer company appealed against the amendment to its corporation tax return for its accounting period ending 31 December 2002. The taxpayer claimed a non-trading loan relationship debit in its tax return for that accounting period in respect of £105m, being the sum of two payments made at the inception of two swap transactions which had taken place in that period (‘the front-end payments’). The taxpayer entered into the first swap (‘the RBS short- term swap’) with the Royal Bank of Scotland plc. The second swap (‘the GSI swap’) was entered into with Goldman Sachs International.

In September 2006, following an enquiry into the taxpayer's return for the 2002 period, the Revenue issued a closure notice stating their conclusion that the amount of the front-end payments was not allowable as a deduction and consequently amended the taxpayer's return for the accounting period. The Revenue rejected the taxpayer's claim on three grounds: (1) neither sum came within the definition of a qualifying payment contained in FA 1994, s. 153 in so far as it incorporated the provisions of s. 151(1)(b) or at all; (2) neither sum had been allocated to a period in the manner required by s. 155(5); and (3) neither sum was eligible for inclusion in amount B as it was referable to a tax avoidance purpose and so excluded from the computation by s. 168A.

The taxpayer appealed to the special commissioners on all three grounds. The commissioners upheld each of the objections raised by the Revenue and dismissed the appeal ((2007) Sp C 636). The taxpayer appealed to the High Court.

Issue

Whether, in relation to the RBS short-term swap, the sum of £65m and/or, in relation to the GSI swap, the sum of £40m were qualifying payments under s. 153(1)(d) because they fell within s. 151(1)(b); and if so whether either of such sums was allocated to the accounting period ended 31 December 2002 as required by s. 155(5); and if so whether any part of either of those sums should be excluded from the computation of amount B because it was referable to a tax avoidance purpose as required by s. 168A.

Decision

Sir Andrew Morritt C (dismissing the appeal) said that the essential question was whether the provision in each confirmation for an ‘additional payment’ was a provision under which the taxpayer became subject to a duty to make the additional payment in consideration of RBS or GSI's entering into the contract. In each case the confirmation said that it was, but parties were not entitled to dictate the tax consequence of their transactions by attributing particular characteristics or descriptions to particular terms if, on an objective view of the contract as a whole, that term could not be properly so characterised or described. Thus the questions for consideration were: (1) what was meant by the phrase ‘in consideration of another person's entering into the contract’ when used in s. 151(1)(b); and (2) whether the front-end payments came within that description.

In one sense all provisions in a contract for payment by one party to the other were payments in consideration of the other party entering into the contract because it was the consideration moving from the promisor which the promisee sought to obtain by entering into the contract. Section 151(1)(b) did not use the words ‘in consideration of another person's entering into the contract’ in the sense for which the taxpayer contended. In all currency contracts there would be, by definition, the exchanges at maturity required by s. 150(2). In addition there might be such payments at the initial stages as were allowed by s. 150(4). But none of those payments were qualifying payments within s. 153. Thus to interpret s. 151(1)(b) in the manner for which the taxpayer contended would be inconsistent with other parts of the relevant legislation for it would translate into a qualifying payment part of the consideration for the exchange at maturity. If payment of the principal in exchange was not a qualifying payment then there was no reason why payment of part of it or of an additional sum in advance of exchange should be. Accordingly it could not have been the intention of Parliament that any consideration under a currency contract should be within s. 151(1) and so a qualifying payment under s. 153.

The provision in question would be included in the contract under consideration for that was what the opening words of s. 151 provided. Further, that currency contract imposed a duty on the qualifying company to make a payment to the counterparty for that was what the first part of subs. (1)(b) required.

But that payment had to be ‘in consideration of’ or ‘for’ another party's entering into the contract. If the word 'consideration' was used in the general contractual sense for which the taxpayer contended then there was no need for the addition of the later requirement limiting the purpose of the payment.

The same conclusion was suggested by a temporal approach to s. 151(1). The subsection envisaged a currency contract which included the provision imposing the duty on the qualifying company to make the payment having a notional existence before the counterparty entered into that or another currency contract. It could only do so if it was some sort of inducement; contractual performance of the contract after it had been entered into was treated differently. It was not a statutory requirement that there should be a separate contract or separate negotiation but it was likely as a matter of fact that there would be. Accordingly the subsection applied to payments which had the function of securing the making of the contract but not to payments made in fulfilment of the contract once made. The failure of the Revenue indisputably to identify payments which, on that construction, would fall within s. 151(1)(b) was not a sufficient reason to reach a different conclusion. Nor was the fact and form of the amendment made in FA 2003 of assistance in the interpretation of the words as originally enacted in s. 151(1)(b). If that was the correct interpretation of s. 151(1)(b), then it was clear that the front-end payments in the case of both the RBS short-term swap and the GSI swap did not answer the contractual description if construed consistently with the equivalent expression in s. 151(1)(b). In neither case was there any evidence of any need for a payment to induce RBS or GSI to enter into the currency contracts. The amounts of the front-end payments were not calculated by reference to any requisite inducement.

It was plain from the circumstances surrounding each relevant swap, in particular the appropriate sterling spot rate, that the front-end payments were, in the case of the RBS short-term swap, a prepayment of part of the purchase price and, in the case of the GSI swap, a deposit at interest repayable at the maturity of the currency swap. So to conclude was not to reject the contractual terms set out in the confirmations, to treat them as shams or to seek to impose tax in accordance with the economic substance of the transaction as opposed to its legal form and effect. Rather it was to recognise that the expression used in the confirmations as part of the descriptions of the 'additional payment', namely 'in consideration of [RBS or GSI] entering into this transaction', was used in a different sense to the same words in s. 151(1)(b). There was nothing surprising in such a conclusion. Such words might well bear different meanings in different contexts. Accordingly, in neither case did the front-end payment come within the terms of s. 151(1)(b). It followed that neither could be a qualifying payment or included in the calculation of the respective amounts for the purpose of computing the profits of the taxpayer for corporation tax purposes.

In those circumstances, the allocation issue and the unallowable purpose issue did not arise as the relevant provisions only applied to qualifying payments. Furthermore, the RBS short-term swap and the GSI swap were not currency contracts for the purposes of s. 150(1) since the front-end payments did not come within any of the permitted provisions for transfers of money specified in s. 150(1)(b) and could not be disregarded under s. 152.

Chancery Division.
Judgment delivered 31 July 2008.