Lender does not 'acquire an asset' when a loan is repaid, tax tribunal says

This means that the debtor cannot offset any capital gain crystallised by the loan note redemption against the capital losses of another company in the same group for tax purposes by reallocating the gain under section 171A of the Taxation of Chargeable Gains Act 1992 (TCGA) .

In its decision, the First-Tier Tribunal said that the asset disposed of had to have been acquired by a third party before rules allowing the notional transfer of assets within a group for the purposes of chargeable gains tax (CGT) could be triggered.

Usually when a UK-based company makes a gain on the disposal of an asset that gain will be subject to corporation tax. The gain can be offset against losses made by the company in the same tax year to reduce that company's tax liability.

Corporate groups cannot offset the capital gains and losses made by different companies within the group automatically. Traditionally, in order to do so assets had to be transferred from one company within the group to another so that the gain and loss took place within the same company. Section 171A of the TCGA, which came into force in 2000, allows an election to be made for that transfer to happen 'notionally', as long as the asset that gave rise to the gain is transferred to a company outside of the corporate group. Section 171A TCGA was amended in 2009.

The case concerned a company called DMWSHNZ Ltd, which until October 2003 was a member of the Bank of Scotland group of companies. In September 1998, DMWSHNZ sold its wholly-owned New Zealand subsidiary to NBNZ Holdings Ltd for NZ$850m. This sum was paid in loan notes issued by NBNZ Holdings.

In 2003, Bank of Scotland and Lloyds TSB appointed joint administrative receivers to an investment trust, GI, which owed each of the banks £42m. GI had capital losses, amounting to approximately £180m. A re-structuring then took place with a view to setting Bank of Scotland's share of the GI losses against some of the gains made by DMWSHNZ when the loan notes were repaid. The re-structuring involved the making of section 171A TCGA elections.

HMRC said  that DMWSHNZ and the wholly-owned Bank of Scotland subsidiary of GI formed after the restructuring took place could not make the section 171A elections due to the strict wording of section 171A TCGA before it was amended in 2009.

HMRC argued that the natural meaning of the words "disposes of an asset to a person who is not a member of the group" was that there had to be an acquirer of the asset for an election to be valid. Physically surrendering the loan note certificates to NBNZ on repayment did not count as an acquisition, HMRC said. It argued that DMWSHNZ owed approximately £29m in CGT on a gain of over £88m.

The First-tier Tribunal took a literal approach of the TCGA. The words used were "clear" and "plainly required" the disposal of an asset to a company outside of the group, it said. Although changes were introduced to the legislation in 2009 to bring a number of situations in which there is a disposal not involving a company outside the group within the scope of the law, this was not one of the changes which were made.

"Prior to [2000], [TGCA] operated without any relief in the absence of an actual transfer between members of the same group," the judge said. "It cannot be said that there was anything irrational about the scheme ... prior to the introduction of section 171A. When that section was introduced, it was a matter for Parliament to define the limits of the liberalisation which it was introducing ... There is nothing rational or irrational in Parliament drawing the line where it did."

"In our view section 171A defines the transactions which are to qualify for the relief granted by the section. It does so in terms not just of the disposal of the asset but also in terms of the immediate consequences which must follow if relief is to be available. Namely that the asset must be transferred to and thus acquired by a third party. That is the natural and ordinary meaning of the words used and the context does not require any different meaning," said the ruling.

John Christian, a tax expert at Pinsent Masons, the law firm behind Out-law commented that the facts of the case are unusual as corporates would not generally realise a capital gain on disposal of loan notes. "Where a tax treatment relies on an acquisition or transfer of an asset or similar concepts, a close legal analysis of the transaction will be needed to minimise the risk that arguments similar to those followed in the case are used to deny the intended treatment.” he said.

"The Tribunal said that it had adopted a purposive, rather than a literal reading of the provisions, and the decision emphasises the difficulty in defining the purpose of tax legislation even in a context where tax avoidance is not alleged." Christian said.