The Union Castle Mail Streamship Company Ltd v Revenue and Customs (INCOME TAX/CORPORATION TAX : Losses) [2016] UKFTT 526 (TC)

“A UK subsidiary (Finance Co) of parent (Parent Co) holds a derivative contract with a positive fair value. The Parent Co could be tax resident in the UK or another jurisdiction. Finance Co has reserves which it passes up to Parent Co by means of a bonus share issue of shares/securities, with the coupon linked to some or all of the cashflows, to the extent they are received, under the derivatives contract. Following the bonus share issue, the derivative is remeasured in Finance Co at its new fair value under generally accepted accounting practice (GAAP) on the basis that the amounts to be passed through to Parent Co are no longer recognised in Finance Co.” (35) On 1 June 2010, pursuant to paragraph 24 of Schedule 18 to the Finance Act 1998 (“FA 1998”), the Respondents opened an enquiry into Union Castle’s corporation tax return for the year ended 31 March 2009. (36) On 11 May 2012, prior to concluding the enquiry, the Respondents also sanctioned the inclusion of a transfer pricing determination within a future closure notice to be issued to the Appellant under Section 110 of FA 1998. (37) On 23 November 2012, pursuant to paragraph 32 of Schedule 18 to FA 1998, the Respondents issued the Closure Notice and disallowed the deduction of £39,149,128 claimed by Union Castle. (38) On 6 December 2012, Union Castle appealed to the Respondents on the basis that the Respondents’ conclusions were wrong as a matter of fact and law. This appeal was acknowledged by the Respondents on 19 December 2012 (39) On 18 January 2013, the Respondents set out their reasons for not accepting the appeal and offered Union Castle a review. This offer was accepted on 14 February 2013. (40) On 28 March 2013, by way of the review decision, the Respondents upheld the Closure Notice. (41) On 26 April 2013, Union Castle submitted a Notice of Appeal to the Tribunal challenging the Respondents’ amendment to its corporation tax return. “Following Appellants” and key issues to be determined (42) The appeal has been designated as a lead case for two other Appellants under Rule 18 of the Tribunal Procedure (First-tier Tribunal) Tax Chamber Rules 2009 (SI 2009/273) (“Rule 18”). The “following Appellants” are: (a) Ladbrokes Group Finance plc – TC/2012/01365 (“Ladbrokes”); (b) IG Finance Five Ltd – TC/2013/00231(“IG”). (43) The key issues to be determined are as follows: (a) whether a debit that satisfies the requirements of paragraph 25A of Schedule 26 to the Finance Act 2002/s 605 Corporation Taxes Act 2009 is to be brought into account without regard to the requirement that it fairly represents a loss arising to it from its derivative contracts or whether the requirement contained in paragraph 25A of Schedule 26 to the Finance Act 2002/s 605 of the Corporation Taxes Act 2009 that it be brought into account "in the same way as a debit which is brought into account in determining the company's profit or loss for the period in accordance with generally accepting accounting practice" incorporates the requirement of paragraph 15 of Schedule 26 to the Finance Act 2002/s 595 Corporation Taxes Act 2009 that the debit must still fairly represent a loss arising to it from its derivative contracts; (b) whether the debit consequent upon the issue by a subsidiary company to its parent company of bonus shares, the bonus shares carrying an entitlement to a dividend in an amount equal to all or a part of the cash flows receivable by the subsidiary company in respect of a derivative instrument held by the subsidiary fairly represents a loss arising to it from its derivative contracts in accordance with paragraph 15 of Schedule 26 to the Finance Act 2002/s.595 Corporation Taxes 2009; and (c) whether the issue of the bonus shares by the subsidiary company to its parent company is a provision that falls within the scope of the transfer pricing rules in s.147 Taxation (International and Other Provisions) Act 2010 or Schedule 28AA to the Income and Corporation Taxes Act 1988, and if so, whether (a) the arm's length price for a bonus issue would be different to the actual consideration received in respect of the bonus issue, (b) if yes, the effect, if any, under s.147 of the Taxation (International and Other Provisions) Act 2010 or Schedule 28AA to the Income and Corporation Taxes Act 1988 of increased proceeds for the issue of shares, and (c) the effect, if any, under s.693 Corporation Taxes Act 2009 in relation to the company's derivative contracts and the debits thereon. (44) Issue (a) applies only to the Ladbrokes appeal however, as per the Rule 18 Direction, submissions on this matter will be made to the Tribunal, with the Tribunal requested to make findings on this point also. (45) Issue (c) applies only to the appeals of Union Castle and IG. (46) The issue of the appropriate accounting treatment for the transaction arises only in relation to the appeal of Union Castle, with the concession detailed above having been made in the context of the lead case proceedings in order to progress the matter. 4. Additionally, although not referred to in the Statement of Agreed Facts it is not disputed that by a letter dated 21 November 2008, the date Union Castle made the bonus issue of the A Shares (see paragraph 3(16), above), Caledonia undertook to Union Castle that, on the day before the cash settlement date for each of the option transactions to which the A Shares relate, it would: “…forthwith upon receipt of your demand in writing specifying the relevant amount shall make a capital contribution in cash to you in an amount equal to the option cash settlement amount receivable in respect of the relevant index option transaction less the amount of your distributable reserves (assuming respect of the relevant option cash settlement amount).”

“Whether the debit that arises upon the issue by a subsidiary company to its parent company of bonus shares, the bonus shares carrying an entitlement to a dividend in an amount equal to all or a part of the cash flows receivable by the subsidiary company in respect of a number of derivative instruments held by the subsidiary, is a debit that satisfies the requirements of paragraph 25A of Schedule 26 to the Finance Act 2002 (or its successor s 605 Corporation Tax Act 2009). The application also sought permission to amend the Statement of Case accordingly. 9. The In Respect of Issue was considered by the Tribunal in Stagecoach Group Plc v HMRC [2016] UKFTT 120 (TC) (“ Stagecoach ”) where it had been included following an unopposed application at the commencement of the hearing. Unlike this case, where the issue arises in relation to a related case, the In Respect of Issue related to the appellant in Stagecoach , which, albeit having similar issues to the present case, concerned loan relationships, not derivatives, and different legislation. 10. However, Mr Ghosh, for HMRC, said that this does not matter as the In Respect of Issue, ie whether a debit is “in respect of a derivative” is a pure question of law. He contended that if, as accepted, it is right that the Tribunal can decide whether that debit gives rise to a loss and whether that loss is “from” a derivative, it makes sense for the Tribunal to also consider whether the debit is “in respect of” a derivative for the purposes of paragraph 25A of Schedule 26 to the Finance Act 2002, especially, he said, as the facts and accounting evidence is exactly the same and no further evidence is needed as Ladbrokes, like Union Castle, is bound by the Statement of Agreed Facts. 11. Mr Peacock accepted that the meaning of “in respect of” in this context is a question of law but contended that its application in a given case is a question of fact. He said that as the In Respect of Issue related to the Ladbrokes appeal it is necessary for it to be determined by reference to Ladbrokes facts which are different from the facts of Union Castle, eg Unions Castle is concerned with IAS and Ladbrokes UK GAAP. He also said that had HMRC raised this issue in July 2015, at the time it was raised in Stagecoach , it is possible the Union Castle may not have been selected as the lead appellant in this appeal. 12. We dismissed HMRC’s application and did not permit either the addition of the In Respect of Issue or the Statement of Case to be amended. Although we gave brief reasons for our decision at the hearing we indicated that we would expand on these in our decision and now do so. 13. In essence we refused the application because the In Respect of Issue was solely in relation to the Ladbrokes appeal which, as Mr Peacock explained, did not have identical facts to Union Castle’s appeal. It was therefore not possible to apply what was, undoubtedly a question of law, to facts that were not before us. Notwithstanding Mr Ghosh’s submission that the Statement of Agreed Facts was binding on Ladbrokes it was prepared for Unions Castle’s case and although binding on related appeals, such as Ladbrokes, is only binding insofar as it relates to common facts. 14. We also did not accept that we could simply apply the expert accountancy evidence to Ladbrokes appeal when neither expert had been instructed to consider the In Respect of Issue or Ladbrokes accounting. We also were concerned about the propriety of relying on an expert witness to give evidence on behalf of an appellant who had not been instructed by that appellant which had not taken any part in the decision to appoint her. 15. Additionally, the application could have been made in July 2015 at the time Stagecoach was being heard or in February 2016 when it was released. However, Mr Ghosh offered no explanation for the delay in making the application which was simply too late in the day, the experts had written their individual and joint reports without reference to the issue and the Statement of Agreed Facts finalised. 16. We now turn to each of the issues. Accounting Issue 17. We were provided with Reports from each of the experts, Mr Drummond’s dated 9 November 2015 and Ms Wallace’s of 12 January 2016. 18. Mr Drummond is an advisory accountant employed by HMRC in their Large Business Unit where he advises HMRC’s solicitors and policy specialists. Prior to his employment with HMRC he was employed by PricewaterhouseCoopers (“PwC”). Mr Drummond’s impartiality as an expert witness was not questioned in cross-examination. Ms Wallace, a former partner of PwC, was the head of their financial instruments team. She was a member of the International Accounting Standards Board’s IAS 39 Implementation Guidance Committee and has advised the Board in relation to proposed changes to IAS 32. 19. In addition to their individual Reports, Mr Drummond and Ms Wallace produced a Joint Report dated 8 March 2016 setting out what had been agreed and explaining the areas of disagreement. Both Ms Wallace and Mr Drummond Wallace gave oral evidence in which they further explained their respective views. 20. As we have previously noted it is common ground between the experts that it was right for Union Castle to derecognise 95% of the value of the Options. It is also accepted that the transfer of the economic benefits and risks and rewards associated with the Options as effected by the issue of the A Shares was reflected in the credit entry which was to financial assets and that the commitment by Caledonia to make a capital contribution to Union Castle (see paragraph 4, above) was not necessary in order for the criteria for derecognition to be met. 21. Where the experts differ is in relation to the corresponding debit entry, while they agree that it arises simultaneously with the credit out of the same transaction, Ms Wallace says the debit should be posted to profit and loss and Mr Drummond says that it a transaction with equity holders in their capacity as such (which he summarised as a shareholder transaction) and, as a distribution, should be posted to equity. 22. Mr Drummond summarised the “fundamental difference” between himself and Ms Wallace, saying: “I look at the substance of the transaction and I see a shareholder transaction … not something that would be done with an unconnected third party. That drives my view of the accounting. Ms Wallace does not see it like that. Instead Ms Wallace focuses on the notion that there is a financial liability that arises and because the accounting standards tell you that if payments are made in respect of financial liabilities then those are taken to profit and loss account. So I think in a nutshell that is the difference and as I have set out I don’t agree that there is a financial liability, and I think that is clear from accounting standards.” 23. It is therefore necessary to consider the relevant accounting standards. 24. The material part of IAS 1, Presentation of Financial Statements , provides: Fair presentation and compliance with IFRSs 13. Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework . The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. 14. An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. Financial statements shall not be described as complying with IFRSs unless they comply with all the requirements of IFRSs. 15. In virtually all circumstances, an entity achieves a fair presentation by compliance with applicable IFRSs. A fair presentation also requires an entity: (a) to select and apply accounting policies in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors . IAS 8 sets out a hierarchy of authoritative guidance that management considers in the absence of an IFRS that specifically applies to an item. (b) to present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information. (c) to provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance … 17. In the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework , the entity shall depart from that requirement in the manner set out in paragraph 18 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. 18. When an entity departs from a requirement of an IFRS in accordance with paragraph 17, it shall disclose: (a) that management has concluded that the financial statements present fairly the entity’s financial position, financial performance and cash flows; (b) that it has complied with applicable IFRSs, except that it has departed from a particular requirement to achieve a fair presentation; (c) the title of the IFRS from which the entity has departed, the nature of the departure, including the treatment that the IFRS would require, the reason why that treatment would be so misleading in the circumstances that it would conflict with the objective of financial statements set out in the Framework , and the treatment adopted; and (d) for each period presented, the financial effect of the departure on each item in the financial statements that would have been reported in complying with the requirement. 25. Insofar as applicable IAS 39, Financial Instruments: Recognition and Measurement , provides: … 17. An entity shall derecognise a financial asset when, and only when: (a) … (b) it transfers the financial asset as set out in paragraphs 18 and 19 and the transfer qualifies for derecognition in accordance with paragraph 20. (See paragraph 38 for regular way sales of financial assets.) 18. An entity transfers a financial asset if, and only if, it either: (a) … (b) retains the contractual rights to receive the cash flows of the financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients in an arrangement that meets the conditions in paragraph 19. 19. When an entity retains the contractual rights to receive the cash flows of a financial asset (the ‘original asset’), but assumes a contractual obligation to pay those cash flows to one or more entities (the ‘eventual recipients’), the entity treats the transaction as a transfer of a financial asset if, and only if, all of the following three conditions are met. (a) The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset. Short-term advances by the entity with the right of full recovery of the amount lent plus accrued interest at market rates do not violate this condition. (b) The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows. (c) The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows, except for investments in cash or cash equivalents (as defined in IAS 7 Statement of cash flows ) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, and interest earned on such investments is passed to the eventual recipients. … 27. If the transferred asset is part of a larger financial asset (eg when an entity transfers interest cash flows that are part of a debt instrument, see paragraph 16(a)) and the part transferred qualifies for derecognition in its entirety, the previous carrying amount of the larger financial asset shall be allocated between the part that continues to be recognised and the part that is derecognised, based on the relative fair values of those parts on the date of the transfer. For this purpose, a retained servicing asset shall be treated as a part that continues to be recognised. The difference between: (a) the carrying amount allocated to the part derecognised and (b) the sum of (i) the consideration received for the part derecognised (including any new asset obtained less any new liability assumed) and (ii) any cumulative gain or loss allocated to it that had been recognised in other comprehensive income (see paragraph 55(b)) shall be recognised in profit or loss. A cumulative gain or loss that had been recognised in other comprehensive income is allocated between the part that continues to be recognised and the part that is derecognised, based on the relative fair values of those parts. 26. Mr Drummond accepts that the test for derecognition under IAS 39 are met in relation to 95% of the Options and therefore the credit from the transaction. This is because although Union Castle, as a matter of law, retained the benefit of the cash flows under the derivative contract by issuing the bonus A Shares it has assumed a contractual obligation to pay an amount equal to 95% of those cash flows by means of dividends on those A Shares if they are received. However, he did not agree with Ms Wallace that IAS 39 should also be applied to debit side of the transaction preferring instead to apply IAS 1. Although he was clear that he did not consider that IAS 1 overrides IAS 39 but that IAS 39 did not apply to the debit side of the transaction as it did not deal with shareholder transactions whereas IAS 1 did. 27. Mr Ghosh submits that we should prefer Mr Drummond’s approach, which took account of the nature of the transaction, to that of Ms Wallace. He described Ms Wallace’s approach as “narrow and technical” leading to her offering a “purely mechanistic” reason for her view that the derecognition of the derivative contracts should for accounting purposes be treated as a loss. However, it seems to us that the application of accounting standards, given their nature, must call for a technical and consistent approach. Also that if a particular standard applies it must be applied in its entirety. Ms Wallace has done so in respect of IAS 39 whereas Mr Drummond has not. 28. Therefore, on balance, while we prefer the approach of Ms Wallace that the debit should be recorded in the income statement we also accept, as Ms Wallace herself recognised, recording the debit in the statement of changes in equity would also be valid. The Loss Issue 29. All subsequent references to paragraphs, in relation to this and the Gateway Issue below are, unless stated otherwise, to paragraphs contained in schedule 26 to Finance Act 2002 which sets out the “derivatives code”. 30. Paragraph 1(2) provides: Except where otherwise indicated, the amounts to be brought into account in accordance with this Schedule in respect of any matter are the only amounts to be brought into account for the purposes of corporation tax in respect of that matter. 31. Derivative contracts are defined by paragraph 2. It is common ground that the Options are derivatives contracts for the purposes of the code. 32. Paragraph 14(1) provides: For the purposes of corporation tax the profits and losses arising from the derivative contracts of a company shall be computed in accordance with this paragraph using the credits and debits given for the accounting period in question by the following provisions of this Schedule.” 33. Paragraph 15, insofar as it applies to the present case, provides: (1) The credits and debits to be brought into account in the case of any company in respect of its derivative contracts shall be the sums which, when taken together, fairly represent, for the accounting period in question— (a) all profits and losses of the company which (disregarding any charges or expenses) arise to the company from its derivative contracts and related transactions; and (b) all charges and expenses incurred by the company under or for the purposes of its derivative contracts and related transactions. … (7) In this Schedule ‘related transaction’, in relation to a derivative contract, means any disposal or acquisition (in whole or in part) of rights or liabilities under the derivative contract. (8) The cases where there shall be taken for the purposes of sub-paragraph (7) to be a disposal or acquisition of rights or liabilities under a derivative contract shall include— (a) those where such rights or liabilities are transferred or extinguished by any sale, gift, surrender or release, and (b) those where the contract is discharged by performance in accordance with its terms. (9) This paragraph has effect subject to the following provisions of this Schedule. 34. Paragraph 17A(1) provides: (1) Subject to the provisions of this Schedule (including, in particular, paragraph 15(1)), the amounts to be brought into account by a company for any period for the purposes of this Schedule are those that, in accordance with generally accepted accounting practice, are recognised in determining the company’s profit or loss for the period. 35. Paragraph 17A(2)–(4) deals with the position if a company does not draw up correct accounts and specify that the Schedule is to apply as if accounts in accordance with generally accepted accounting practice had been drawn up. 36. The amounts to be recognised are given by paragraph 17B which provides: (1) Any reference in this Schedule to an amount being recognised in determining a company’s profit or loss for a period is to an amount being recognised for accounting purposes— (a) in the company’s profit and loss account or income statement, (b) in the company’s statement of recognised gains and losses or statement of changes in equity, or (c) in any other statement of items brought into account in computing the company’s profits and losses for that period. (2) An amount that in accordance with generally accepted accounting practice is shown as a prior period adjustment in any such statement as is mentioned in sub-paragraph (1) shall be brought into account for the purposes of this Schedule in computing the company's profits and losses for the period to which the statement relates. This does not apply to an amount recognised for accounting purposes by way of correction of a fundamental error.” 37. It is common ground that Union Castle required was to derecognise the Options as to 95% and did so be crediting the financial asset, the recognition of the obligation under the A Shares to pay up 95% of the cash received from the Options. The issue is in relation to the corresponding debit of £39,149,128 which is not necessarily the same amount as that received and paid up by Union Castle to Caledonia. It is also not disputed that the same transaction gives rise to the debit and credit, ie they must, as a result of the effect of the principles of double entry bookkeeping, both have the same source. 38. Although we have preferred the approach of Ms Wallace over that of Mr Drummond to the accounting treatment of the debit, it is clear from paragraph 17B that whichever approach had been adopted the debit is “recognised” under paragraph 17A “in determining”

“83. Both parties argued, despite the architecture of Schedule 26 and the ostensible intention of the legislation to align accounting and tax profits, that the meaning of loss for the purposes of paragraph 15 of that Schedule was not an accounting, or at least not purely an accounting concept. Both referred to it as a legal concept, but with a different ambit; Mr Prosser [counsel for ANTS] said that a loss had to be recognised for paragraph 15 purposes because the result of the issue of the Tracker Shares was to diminish the value of ANTS' assets (its interest in the Swap cash flows) and this should pertain despite the fact that the accounting treatment of the transaction was to derecognise the asset and reflect the loss in statements of equity. Mr Ghosh [counsel for HMRC] said that the term loss in paragraph 15 bore a broad legal meaning but on no basis could the loss in value of assets arising from an agreement to pay on realised profits be treated as a loss for Schedule 26 purposes. 84. The issue is answered in part by paragraph 17B of Schedule 26 which does on its face enable the derivatives legislation to take account of debits which are taken to equity. Specifically amounts taken to equity are treated as recognised for accounting purposes and therefore fall within the scope of paragraph 17A as amounts which can be brought into account as deductible debits. However, on this question of statutory interpretation we agree with Mr Ghosh that paragraph 17B and A are specific provisions which can be overridden by the general principles of paragraph 15 to which paragraph 17A is made explicitly subject. It is not all debits which are recognised in equity which can be treated as deductible debits, but only those which fulfil the other conditions of paragraph 15 in particular that they fairly represent all profits and losses of the company for the accounting period in question 85. Our starting point is that the derecognition debit which both parties accepted was the correct accounting treatment under IAS 39 cannot be accepted on its face as producing a fair representation of the company's losses arising from its derivative contracts without further analysis. 86. We agree with the approach of both parties that the reference to a loss in Schedule 26 should not be limited to a purely accounting concept and that the reference in paragraph 15 to reflecting only such losses and profits which fairly represent the company's position for that year is a means of ensuring that accounting treatment which is, for whatever reason, too far divorced from commercial reality should not be allowed to apply for tax purposes. (This is supported by the comments in the DCC Holdings Ltd decisions culminating in the Supreme Court decision ( DCC Holdings (UK) Ltd v Revenue and Customs Commissioners [2010] UKSC 58 ) and reflected in later iterations of the legislation.) In this particular situation, as made clear by Mr Drummond, the accounting treatment is reflecting the economic substance of the transaction, that ANTS is obliged to pass on the payments which it receives under the Swaps which is out of line with ANTS’ legal position, that it remains the counterparty to the Swaps and the recipient of the positive Swap Cash Flows. 87. Mr Prosser attempted to persuade us that there was a real loss because ANTS had passed on the cash flows under the Swaps and this had an impact on the value of the assets (the Swap cash flows) held by ANTS; Mr Ghosh took a different view of what had actually happened, that ANTS had merely entered into an agreement to pay on profits which it had received in the form of a dividend. On this point we agree with Mr Ghosh, for legal purposes ANTS was in exactly the same position as it always had been as far as the Swaps were concerned, it simply had an equal and opposite obligation to pay on receipts from those Swaps. 88. Mr Prosser argued that it was anomalous that two economically equivalent transactions (the assignment of the Swap Cash Flows and an agreement to pay them on on a back to back basis) should give rise to different tax results. We do not agree that this is an anomalous result in a tax code which does not operate on the basis of economic equivalence; the UK tax legislation does not generally elevate economic substance over legal form in circumstances where back to back arrangements are in place, which is what we consider Mr Prosser’s argument is suggesting that we do. 89. Mr Drummond told us that if the Swap Cash Flows had been transferred to a non-shareholding third party, that element of the Swaps would still have been derecognised under IAS 39, but the derecognition debit would have been taken to profit and loss account. In these circumstances it might have been more straightforward to accept that this represented a fair view of the company’s profits as Mr Prosser suggested, arguing that the fact that the derecognition debit was taken to equity should make no difference to our analysis. We do not agree with this approach. IAS1 overrides IAS39 here for a reason; that there is no real loss in these circumstances, as Mr Drummond said “speaking as an accountant, I would say that in one scenario, there is no loss, whereas in the other it would be represented as an expense”. 90. We come to this conclusion accepting that in some circumstances paragraph 17B of Schedule 26 provides for the possibility of recognising amounts taken to a company’s statement of changes in equity as a deductible debit. We do not consider that these are circumstances in which paragraph 17B applies because neither the legal nor the accounting analysis suggests that a loss has been generated; for legal purposes ANTS has not disposed of any rights and for accounting purposes the disposal is treated as giving rise to a dividend. 91. We think that in substance and in form that should properly be treated as a distribution of profits, or a dividend, (as in fact was the result that IAS came to) and that this cannot be treated, on a fair view, as a loss giving rise to a debit under paragraph 15 of Schedule 26.”

“92. In order to succeed ANTS needs to demonstrate not just that there is a debit which can be recognised under paragraph 15 but also that this arises from a derivative contract; the only derivative contracts which were identified to us were the Swaps. As stated above, from ANTS’ perspective (and also the Swap counterparties’) nothing had changed as far as the terms of the Swaps were concerned; ANTS had just entered into a back to back agreement to make equivalent payments on to its parent entity. 93. For accounting purposes it was agreed that the derecognition deduction arose at the time when ANTS entered into the Tracker Share agreement, not at the time when payments were actually made on the Tracker Shares in 2009. ANTS claimed a deduction in 2008 not 2009 for the £160 million debit. 94. It is clear, at least for accounting purposes then, that what triggered the debit was not any actual payment made by ANTS in respect of the Swap Cash Flows, which were not made until 2009, but the issuing of the Tracker Shares. This is an agreement which is legally separate from the Swap contracts, although it derives its economic value from those Swap contracts. It is also worth nothing that according to Mr Drummond not only were the Swap Cash Flows transferred under the Tracker Shares, but as a result they changed from being a number of assets (the 26 Swaps) to a single asset, underlining their separation from the Swaps themselves. 95. While we accept that the Tracker Shares are connected to the Swaps, we do not think that this means that the source of the debit is the Swaps; the source of the debit, the thing which gave rise to a diminution in the value of ANTS' assets is the issue of the Tracker Shares and it was not suggested that this was a derivative contract. If it had not been for the Tracker Share terms, there would have been no impact on the value of the Swaps. (If for example ANTS simply happened to have, as many financial institutions would, matching swaps on its book and paid equal and opposite amounts out to a third party, while a debit would have been available for those third party payments, no debit would be treated as having arisen from the swaps which generated the positive cash flows). 96. The issue here is not that there is no loss, but that Schedule 26 is only intended to apply to losses derived directly from derivative contracts, which this is not. Schedule 26 applies to a defined set of transactions including “related transactions” (paragraph 15(7)) which extends to the assignment of rights under derivative contracts and a defined set of expenses, being expenses directly arising from derivative contracts (paragraph 15(4)). In our view this suggests that in order to be a debit arising from a derivative contract there has to be a direct nexus between the debit and the derivative contract, rather than the more remote causal link via the Tracker Share terms which exists here. 97. In this case, no income was assigned from the Swaps, no rights under the Swaps were transferred. The debit arose, as made clear by Mr Drummond, because of the contractual obligation to pay on the Swap Cash Flows under the Tracker Shares, which had no legal impact on the Swaps at all. This debit might be economically connected to, or related to, the derivative contracts, but it does not arise from those contracts as required by paragraph 15. 98. Our conclusion is that ANTS does not have a debit which can properly be recognised under Schedule 26; the “loss” generated by the derecognition debit is not a loss to which Schedule 26 applies and even if it were to such a loss, it does not arise from a derivative contract.” 44. Although we were invited Mr Ghosh, who appeared for HMRC in ANTS , to adopt the reasoning of the Tribunal Mr Peacock contends that there are significant differences between that case and this and that the Tribunal reached the wrong conclusion in ANTS . As in that case it is common ground in the present case that the accountancy evidence is not determinative in resolving the issue of what is a matter law. As such, we do not accept that just because the appellant did not lead expert evidence to challenge that adduced by HMRC in ANTS we should disregard what the Tribunal had to say about the derivatives code in that case. 45. However, as Mr Peacock pointed out, the Tribunal in ANTS having recognised, at [84], that a debit to equity can be a loss appears to have subsequently concluded that there was not a loss relying on acceptance of Mr Drummond’s evidence, a conflation of the legal and accounting effect of the transaction and have failed to recognise the logical consequence of their conclusion that a debit to equity can amount to a loss. With regard to arising “from a derivative contract” the Tribunal, while it accepted, at [95], that the Tracker Shares were connected to the Swaps it did not think that the Swaps were the source of the debit but that the issue of the Tacker Shares, which was not a derivative contract, was. It continued, at [96], saying that “schedule 26 is only intended to apply to losses derived directly from derivative contracts” and that there has to be a “direct nexus” between the debit and the derivative contract. 46. However, the legislation does not refer to a direct relationship between a debit and derivative contract. It refers to a loss arising “from” not “directly from” its derivative contracts. The Tribunal also appears to have concluded that the debit has a different source to the credit finding that the source of the credit to be the derecognition of the derivatives and the source of the debit the issue of the Tracker Shares. Such a conclusion, that the credit has a direct nexus with the derivative but the debit does not, is inconsistent with the principles of double entry bookkeeping and clearly not in accordance with the accountancy evidence led in the present case. 47. Therefore, for these reasons we are unable to adopt the reasoning in ANTS and consider afresh whether there is a loss, if so, whether it arises “from” a derivative contract; and whether it satisfies the “fairly represent” requirement. Loss 48. Mr Peacock says that there is a loss. Before the derecognition of the derivative contracts Union Castle had 100% of their economic benefit but only 5% after 95% was passed to Caledonia. There was, he says, a loss of 95% of an asset. 49. However, we prefer the argument of Mr Ghosh who says that there is no loss as Union Castle received the cash benefit under the derivative contracts and gave it away. As such the debit cannot be a loss for Union Castle which after the issue of the A Shares was entitled to exactly the same amount as it was before the issue of those shares. There has not been a diminution in the resources of Union Castle and therefore no real loss. 50. Having come to such a conclusion Union Castle’s appeal (and those of the related appellants) cannot succeed. However, as all matters were fully argued before us and in case of any further appeal we consider that if there had been a loss, whether it was “from” the derivatives and if the “fairly represent” requirement is met before considering the Gateway and Transfer Pricing Issues. From derivatives 51. If we are wrong and there is a loss Mr Peacock contends that it arises “from” the derivative contracts. He says that the debit matches and corresponds to the credit with both arising from the same transaction, the issue of the A Shares which gave rise to the derecognition of the economic benefit of the derivatives the asset formerly on the balance sheet. However, Mr Ghosh disagrees, relying on the reasoning of the Tribunal in ANTS he contends that the source of the loss (if there is one) is the issue of the A Shares which, on Ms Wallace’s evidence, gave rise to the financial liability. 52. However, for the reasons above (in paragraphs 46 and 47) we have declined to apply the reasoning in ANTS and, given Mr Ghosh’s reliance on it, we consider that if there had been a loss it would have been, albeit indirectly, “from” the derivatives. Fairly represents 53. On the assumption that we had found that there was a loss arising from derivatives Mr Peacock submits that “fairly represents” is first, a means of identifying from entries in the accounts those things which have to do with derivatives ie an allocation or, as Mr Ghosh says, an attribution role and secondly, a timing role identifying that which is appropriate in a particular accounting period. 54. Mr Ghosh submits that “fairly represents”, in addition to an attribution and timing role, may allow HMRC to adjust credits or relevant debits and might constitute some form of override and allow HMRC to rewrite Debits and Credits because it would be fair to do so and referred such an approach being taken by the Tribunal (Judge Short and Mr Collard) in GDF Suez Teesside Limited (Formerly Teesside Power Limited) v HMRC [2015] UKFTT 413 (TC) (“ Suez ”). 55. However, Suez was concerned with the loan relationships code. The Tribunal in Stagecoach , which also concerned loan relationships, recorded at [110] that it did not: "… derive assistance from … what were said to be mirror provisions in the derivatives’ code. We were referred to … FA 2002 schedule 26… The language and context are not identical and the analogy advanced, unsupported by authority, was not in our view, persuasive, notwithstanding Ms Shaw’s [counsel for Stagecoach] able and powerful presentation.”

“The phrase in the same way provides the connection between ss 320 and 307(3). Otherwise, it seems to have no function. Group appears to read s320(2) as if the words in the same way as a credit or debit which is brought into account were omitted. That does not seem to us to be the correct approach. In the same way seems to us to refer to the general circumstances in which the credit or debit may be brought into account and these are set forth in s307(3). The Parliamentary draftsman has used a different form of cross reference in s332, perhaps for emphasis because that section is dealing with specific types of financial arrangements (repo or stock lending arrangements).” 66. Mr Ghosh explained that the Tribunal was saying that s 320 was “plugging you back” into s 307 in the same way that paragraph 35A was referring back to paragraphs 17A and 17B and on to paragraph 15. However, not only is it clear that the observations of the Tribunal at [124] were obiter but that the legislation considered, although similar, was not the equivalent of paragraph 25A and, as we have already noted (see paragraph 55, above) Stagecoach concerned the loan relationships code rather than the derivatives code and is therefore of little, if any, assistance. 67. We agree with Mr Peacock that paragraph 25A fulfils the role, in the absence of paragraph 17B statements, played by of paragraph 15 where such paragraph 17B statements are present. We therefore consider it to be unnecessary in the case of a debit falling within paragraph 25A for the requirements of paragraph 15 have to be met before it can be brought into account. The Transfer Pricing Issue 68. As a result of our decision that there is not a loss, the provisions relating to transfer pricing are not applicable. However, to consider whether any deduction to which Union Castle would have been entitled had we concluded otherwise should be eliminated or reduced by a transfer pricing adjustment it is necessary to proceed on the assumption that (contrary to our conclusion) the debit did result in a loss for Union Castle. 69. Paragraph 31A of schedule 26 to the Finance Act 2002 provides: (1) This paragraph applies where, in pursuance of Schedule 28AA to the Taxes Act 1988 (provision not at arm’s length), an amount falls to be treated as any of the following— (a) an amount of profits or losses (disregarding any charges or expenses) arising to a company from any of its derivative contracts or related transactions; (b) charges or expenses incurred by a company under or for the purposes of any of its derivative contracts or related transactions. (2) That Schedule shall have effect so as to require credits or debits relating to the amount so treated to be brought into account for the purposes of this Chapter to the same extent as they would be in the case of an actual amount of— (a) profits or losses (disregarding any charges or expenses) arising to the company from the derivative contract or related transaction, or (b)charges or expenses incurred under or for the purposes of the derivative contract or related transaction, as the case may be.” 70. The general transfer-pricing provisions are contained in schedule 28AA to the Income and Corporation Taxes Act 1988 (“ICTA”) the relevant paragraphs of which provide as follows: Basic Rule on Transfer Pricing etc 1 — (1) This Schedule applies where— (a) provision (‘the actual provision’) has been made or imposed as between any two persons (‘the affected persons’) by means of a transaction or series of transactions, and (b) at the time of the making or imposition of the actual provision— (i) one of the affected persons was directly or indirectly participating in the management, control or capital of the other; or (ii) the same person or persons was or were directly or indirectly participating in the management, control or capital of each of the affected persons. (2) Subject to paragraphs 5A, 5B, 8, 10 and 13 below, if the actual provision— (a) differs from the provision (‘the arm’s length provision’) which would have been made as between independent enterprises, and (b) confers a potential advantage in relation to United Kingdom taxation on one of the affected persons, or (whether or not the same advantage) on each of them, the profits and losses of the potentially advantaged person or, as the case may be, of each of the potentially advantaged persons shall be computed for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision. (3) For the purposes of this Schedule the cases in which provision made or imposed as between any two persons is to be taken to differ from the provision that would have been made as between independent enterprises shall include the case in which provision is made or imposed as between any two persons but no provision would have been made as between independent enterprises; and references in this Schedule to the arm’s length provision shall be construed accordingly. … Principles for constructing rules in accordance with OECD principles 2 — (1) This Schedule shall be construed (subject to paragraphs 8 to 11 below) in such manner as best secures consistency between— (a) the effect given to paragraph 1 above; and (b) the effect which, in accordance with the transfer pricing guidelines, is to be given, in cases where double taxation arrangements incorporate the whole or any part of the OECD model, to so much of the arrangements as does so. (2) In this paragraph ‘the OECD model’ means— (a) the rules which, at the passing of this Act, were contained in Article 9 of the Model Tax Convention on Income and on Capital published by the Organisation for Economic Co­operation and Development; or (b) any rules in the same or equivalent terms. (3) In this paragraph ‘the transfer pricing guidelines’ means— (a) all the documents published by the Organisation for Economic Co-operation and Development, at any time before 1st May 1998, as part of their Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations; and (b) such documents published by that Organisation on or after that date as may for the purposes of this Schedule be designated, by an order made by the Treasury, as comprised in the transfer pricing guidelines.”

“101. … there is nothing in Schedule 28AA itself or indeed Article 9 of the OECD model convention and its Guidance Notes which specifically takes the issue of shares outside the transfer pricing rules. We do not agree with Mr Prosser’s rather narrow interpretation of “commercial and financial relations” in this context which we think is wide enough to include a share issue which could, in circumstances other than those under consideration here, influence the relationship between a holder and issuer of shares. 102. We consider that Mr Prosser’s approach to be an overly restrictive and incorrect application of the Schedule 28AA rules. We think that the reason that share issuances have not been the subject of Schedule 28AA in the UK is because there is a plethora of other legislation on the UK statute book which controls the manner in which equity capital can be used to manipulate profits between related companies. Our conclusion is that the issue of the Tracker Shares can be treated as a provision to which Schedule 28AA applies and that the UK transfer pricing rules are in point.” 79. The Tribunal continued: “104. Mr Prosser attempted to suggest that shares with terms similar to the Tracker Shares could have been issued between independent enterprises, citing a proportionate issue of bonus shares of a particular class as similar to the Tracker Shares. We do not think that this is an apt analogy for the issue of shares such as the Tracker Shares whose market value was £161 million but which were issued at £1,000. Bonus shares of the type described by Mr Prosser would not be paid for at all and would not comprise a defined and valued set of cash flows as the Tracker Shares did. It is very difficult to imagine a comparable commercial situation in which a company would be willing to give away £160 million of value in exchange for £1,000 to a third party. To use the terms of the OECD Guidelines, it does not represent “commercially rational” behaviour. 105. Mr Prosser stressed that the OECD Guidelines placed clear restrictions on tax authorities either disregarding or substituting another transaction for the actual transaction carried out between the parties other than in the specific circumstances set out at paragraph 1.37. Our view is that the Tracker Shares do fall within one of those exceptions, namely that “the arrangements in relation to the transactions viewed in their totality, differ from those that would have been adopted by independent enterprises acting in a commercially rational manner and the structure impedes the tax administration from determining the appropriate transfer price”