The Court of Appeal (CoA) has published a judgement in respect of a case related to the taxation of loan relationships by entities subject to corporation tax.  Individuals and entities subject to income tax are not affected by the loan relationship rules that generally mean a company is taxable on its interest income and expense in a manner that is in accordance with generally accepted accounting practices (GAAP), such as, what is in the accounts of the company is the amount that is taxed.

A company that owned a power station in Teeside previously traded with companies within the Enron Group that ultimately fell into insolvency.  This UK company was owed considerable sums from the Enron Group and had proven its claims to the group’s administrator and liquidators.  As the Enron Group was insolvent any debts due the UK company would have been written off and the trading profits of the UK company subject to corporation tax reduced.  The claims that the UK company held in relation to the liquidation represented a money debt that was to be taxed under the loan relationship rules but under accounting rules could only be held at a nil as they were contingent assets as the timing and amount of funds to be received were uncertain.

Using a scheme that required disclosure, the UK company assigned the rights of the claims to an overseas subsidiary in exchange for shares issued by that company. This company would then have to recognise the asset acquired at fair value.  As a secondary market existed for claims against the Enron Group it was possible to obtain a fair value.  This overseas company then recognised the asset and waited for the payments by the liquidators with the effect that only the difference between fair value of the asset acquired and the actual receipts would be subject to tax.

Therefore, according to GAAP the only profits of the overseas subsidiary would be subject to tax.

The CoA sided with both lower tribunals that recent amendments to the loan relationship legislation were relevant.  The legislation had been amended a short time before the assignment transactions to ensure that taxable credits or debits that ‘fairly represent’ the transaction overrides the result of GAAP.  In this case, the assignment of the claim at fair value to its overseas subsidiary was taxable credit in the hands of the UK company despite the fact that it wasn’t required to show a profit or gain in its GAAP accounts.

The decision can be found at: GDF Suez Teesside Led v Revenue And Customs [2018] EWCA Civ 2075 (05 October 2018) (bailii.org)

This case highlights the difficulty with successful corporation tax planning.  The scheme to enable a tax-free step-up failed in the main as the legislation had been changed just before the transactions took place to defeat certain tax avoidance schemes.  This scheme wasn’t one that was intended to be stopped as the taxpayer only disclosed the scheme after the enactment of the adjusting legislation but this legislation had been drafted well enough to capture this new scheme.

Please do contact us if you are considering using any company tax avoidance scheme or have received notices from HMRC about enquiries, closures notices or the like.  These are our areas of expertise.