The First-tier Tribunal ('FTT') has held in Fidex Ltd v HMRC,1 that a loan relationship debit should not be disallowed under paragraph 13, Schedule 9, Finance Act 1996 ('Paragraph 13'),2 even though one of the main purposes of entering into the arrangement was tax avoidance.
In preparing its accounts for the period ending 31 December 2004, Fidex Ltd ('Fidex') applied UK Generally Accepted Accounting Practice ('UK GAAP').
On 22 December 2004, Fidex entered into an agreement by which Swiss Re Financial Products Corporation ('Swiss Re') subscribed to four classes of preference shares (the 'Preference Shares') in Fidex. Each class was referenced to a different bond held by the taxpayer (the 'Relevant Assets') with the effect that Swiss Re was entitled to 95% of the income the taxpayer received from the Relevant Assets.
On the same day, Fidex's board resolved to adopt the International Financial Reporting Standards ('IFRS') from 1 January 2005.
In its year-end balance sheet for 2004, and in accordance with UK GAAP, Fidex included the Preference Shares as shareholder funds and recognised the full value of the Relevant Assets. Due to the change to IFRS, the opening balance sheet for the 2005 year saw the Preference Shares derecognised (on the basis that they were liabilities). Fidex also derecognised 95% of the value of the Relevant Assets.
Fidex sought to rely on paragraph 19A, Schedule 9, Finance Act 1996 ('Paragraph 19A'),3 which provided (at subparagraph (3)) that where there is a difference between the accounting value of an asset or liability representing a loan relationship of the company at the end of an earlier period and the accounting value in the subsequent period, a corresponding debit (or credit) shall be brought into account. Fidex sought to deduct a debit of €83,849,399 when calculating its corporation tax liability. HMRC amended the relevant return disallowing the debit.
HMRC disallowed the debit on the basis that UK GAAP did not allow for the Preference Shares and the Relevant Assets to be recognised in Fidex's accounts for the period ending 31 December 2004 and its accounts for that year did not give a 'true and fair view' of its position or satisfy the requirements of Paragraph 19A(3) as there was not a 'difference'.
HMRC also argued that even if Paragraph 19A did apply, the Relevant Assets would be attributable to an unallowable purpose within the meaning of Paragraph 13.
The FTT's decision
The FTT first considered whether Fidex's 2004 accounts had been properly prepared in accordance with UK GAAP. HMRC argued that UK GAAP did not allow for the Preference Shares and Relevant Assets to be recognised in that year. If this argument was correct, there would have been no difference between the two years and so no debit.
The FTT heard extensive expert evidence on the proper accounting treatment of the Preference Shares and Relevant Assets. Having heard such evidence, the FTT concluded (see paragraph 143 of the decision) that UK GAAP had been applied correctly. Further, all of the experts were agreed that Fidex had accounted correctly in the 2005 year under IFRS. The debit was therefore correctly brought into account under Paragraph 19A.
The second issue for the FTT to determine was whether in the 2005 accounting period the Relevant Assets had an 'unallowable purpose'. The FTT explained this, broadly, as focusing attention on whether during the 2005 accounting period Fidex was a party to loan relationships or related transactions where a tax avoidance purpose was the main purpose, or one of the main purposes, in that accounting period.
The FTT found that there was a tax avoidance purpose inherent in the transactions which had been entered into, but this raised the question of when the tax avoidance purpose had been achieved. The FTT observed that the scheme would not have worked if title to the Relevant Assets had been disposed of before 1 January 2005, but it did not follow that the purpose in retaining title to the Relevant Assets was a tax avoidance purpose. This purpose was achieved at the end of 2004. The main purpose, once the tax avoidance purpose had been achieved, was the orderly disposal of Fidex's remaining assets.
The FTT considered whether there was a scintilla temporis (an abstract fraction of time) at the start of the 2005 year in which Fidex had the necessary purpose in retaining title. The FTT concluded that even if there was such a time no part of the debit would be attributed to the scintilla temporis as it had 'no realistic length at all' and so no part of the debit fell to be excluded under Paragraph 13.
The FTT has held that the purpose of a taxpayer being a party to a loan relationship in an accounting period in which a debit arises from a change of accounting policy is not tax avoidance. The loan relationship did not therefore have an unallowable purpose and the debit was deductible in calculating the taxpayer's tax liability.
Although Fidex had a tax avoidance purpose when it entered into the transactions which resulted in the debit as the debit crystallised in one accounting period, the tax avoidance purpose was achieved in that period. Accordingly, when the debit arose in the following period, Fidex no longer had a tax avoidance purpose.4
Although one suspects that HMRC are very unhappy with the FTT's decision, given the Court of Appeal's judgment in HMRC v Mayes,5 in which a pre-determined tax avoidance scheme succeeded, the decision of the FTT in this case is not at all surprising. HMRC should accept that not all legislation lends itself to purposive interpretation. The legislation under consideration in this case clearly required the tax avoidance motive to arise in the year in which the debit arose. Yet again, this decision demonstrates that the Ramsay principle has limits and cannot always be successfully invoked by HMRC whenever they do not approve of tax avoidance arrangements.