Judgment summary
This is an appeal by UK Care No. 1 Limited (UKC1) against a decision of the First-tier Tribunal (FTT) released on 13 June 2024 concerning the amount of a loan relationship debit UKC1 could bring into account for corporation tax purposes (1).
UKC1, a Guernsey company, had issued loan notes secured on UK care homes belonging to the BUPA Group. In 2016 UKC1 was acquired by the BUPA Group, became UK tax resident, and then redeemed the loan notes early, generating an accounting loss of £150,749,046 (2)-(3).
HMRC's closure notice originally disallowed the whole debit, but by the FTT hearing HMRC accepted that only £93,903,841 should be disallowed, with the balance and accrued interest allowed (4). The FTT confirmed HMRC's position, and that disallowed sum was the subject of this appeal (4).
The Upper Tribunal considered three grounds of appeal concerning section 327 CTA 2009 (disallowance of imported losses) and section 306A CTA 2009 (matters to be brought into account in respect of loan relationships). The tribunal held that the term 'loss' in section 327 includes expenses within the meaning of section 306A(1)(c) (75), rejecting Ground 3.
On Grounds 1 and 2, concerning referability of the loss to the pre-migration period, the tribunal held that the FTT had applied the correct legal test, but had erred in relation to the unamortised issue costs and unamortised discount, which the Upper Tribunal found were, as a matter of commercial reality, referable to the post-migration period (132), (137). However, the tribunal agreed with the FTT that the compensatory element of the redemption premium was referable to the pre-migration period (149), (177).
Background
UKC1 was incorporated in 1999 and was originally a Guernsey resident company, with voting shares held by Guernsey trustees for the benefit of two charities and Guernsey resident directors (11). In February 2000, UKC1 issued two tranches of loan notes with a total face value of £235m, secured on BUPA care homes, carrying fixed interest rates of 6.3% and 7.5% (12). The loan notes contained a 'Spens' or 'make whole' clause, requiring UKC1 to pay the higher of the outstanding principal or the present value of future cashflows discounted using a rate linked to a reference gilt on early redemption (13).
In 2016, BUPA wished to sell some of the care homes forming part of the security package, and decided the best approach was to redeem the loan notes early (22). This required UKC1 to become part of the BUPA Group. The BUPA Group acquired the shares in UKC1 on 15 February 2016, new directors were appointed on 18 February 2016, and on 19 February 2016 (the Migration Date) it was agreed UKC1 would be managed and controlled from the UK, making it UK tax resident from that date (22).
The board resolved to redeem the loan notes on 24 February 2016, a redemption notice was given on 29 February 2016, and redemption occurred on 1 April 2016 (22). The redemption amount under the Spens clause was £381,618,848 (principal of £235m plus a premium of £146,618,848), while the market value of the loan notes immediately before the Migration Date was £324,805,450 (23).
UKC1 accounted for the loan notes on an amortised cost basis. The carrying value immediately before redemption was £230,869,802, giving rise to a loss of £150,749,046 on redemption, comprising unamortised discount and issue costs of £4,130,198, a compensatory element of £89,773,643, and a penalty element of £56,845,205 (28)-(30).
Core dispute
The dispute concerned whether section 327 CTA 2009, which disallows 'imported losses' referable to a time when a loan relationship was not subject to UK taxation, operated to restrict the loan relationship debit claimed by UKC1 on redemption of the loan notes (6)-(8).
UKC1 argued, first (Ground 3), that the loss was made up entirely of expenses within section 306A(1)(c) CTA 2009, and that section 327 applies only to losses and not to expenses, so no part of the debit could be disallowed under that section (47)-(48).
Second (Grounds 1 and 2), UKC1 argued that even if section 327 could apply, no part of the loss was referable to the pre-migration period as a matter of commercial reality: the unamortised issue costs, unamortised discount and compensatory element of the premium were all referable to the remaining contractual term of the loan notes, which fell after migration, and the FTT had wrongly applied a test of causation, or misapplied a 'but for' test, in reaching a contrary conclusion (45), (106)-(107), (174).
HMRC contended that a 'loss' for the purposes of section 327 is a compound concept capable of including expenses, and that the relevant elements of the loss were referable to the pre-migration period because they reflected pre-migration changes in market conditions or expenses already incurred before migration (73), (83).
Court findings
The Upper Tribunal held that the compensatory element of the redemption payment was properly characterised as an expense for the purposes of section 306A(1)(c), as was the treatment of the unamortised issue costs and unamortised discount (57), (60).
On Ground 3, the tribunal held that a 'loss' for the purposes of section 327 includes expenses falling within section 306A(1)(c). It found that sections 306A and 327 use different language and are concerned with different concepts: section 306A identifies matters in respect of which amounts are brought into account, while section 327 concerns whether the amount actually brought into account should be restricted (63)-(69), (75). The wide wording 'in connection with' in section 327 was found to support a broad construction covering expenses, consistent with the legislative purpose of preventing companies from importing pre-migration losses, whether comprising expenses or not (83)-(88).
On Grounds 1 and 2, the tribunal confirmed that referability under section 327 requires an objective assessment, with the benefit of hindsight, of whether the loss existed or had arisen as a matter of commercial reality in the pre-migration period, and that causation, including 'but for' causation, is a relevant but not determinative consideration (108)-(115), (147).
Applying this test, the tribunal found the FTT had erred in relation to the unamortised issue costs and unamortised discount. It held that, as a matter of commercial reality, these elements were referable to the post-migration period because they were written off at the time of redemption, reflecting an accounting treatment (amortisation over the life of the loan notes) that itself reflected commercial reality (126), (132), (134), (137).
However, the tribunal agreed with the FTT that the compensatory element of the premium was referable to the pre-migration period, as it arose from changes in market conditions (interest rates and credit spreads) occurring before migration, and was not simply a function of the decision to redeem early (145), (149), (169).
Outcome
The Upper Tribunal allowed the appeal in part. It set aside the FTT's decision in relation to the unamortised issue costs and the unamortised discount, remaking the decision so that UKC1's appeal against the closure notice was allowed to that extent (176).
The tribunal dismissed the appeal in relation to the compensatory element of the premium, upholding the FTT's finding that this element, amounting to £93,903,841 less the unamortised issue costs and discount, was referable to the pre-migration period and therefore disallowed under section 327 CTA 2009 (177).
Major issues / areas of contention
- Whether the term 'loss' in section 327 CTA 2009 includes expenses falling within section 306A(1)(c), such that section 327 can restrict relief for expense-based debits.
- Whether the compensatory element, unamortised issue costs and unamortised discount comprising the redemption loss amounted to 'expenses' for the purposes of section 306A CTA 2009.
- Whether the FTT applied the correct legal test of 'referability' to a pre-migration period under section 327(1)(b) and (3) CTA 2009, and in particular whether it wrongly applied a test of causation.
- Whether, as a matter of commercial reality, the unamortised issue costs and unamortised discount were referable to the pre-migration or post-migration period.
- Whether the compensatory element of the premium paid on early redemption was referable to the pre-migration period, given that it was calculated by reference to pre-migration changes in market conditions (interest rates and credit spreads).
- The relevance of fair value accounting under section 327(7) CTA 2009 to the assessment of referability.
- The relevance of legislative history, including the Finance Bill 1996 and Finance Act 1996 predecessor provisions, to the interpretation of sections 306A and 327 CTA 2009.