The Chancellor:
Introduction
- In 2002 the appellant, the Prudential, was exposed to two foreign exchange liabilities which it wished to 'hedge'. The first was a liability for €500m the Prudential was liable to repay, at the earliest, in 2011 to the holders of an issue of Euro-debt it had made in December 2001. The second was a foreign exchange exposure arising from a loan of $250m made by Prudential Finance (UK) Ltd, a subsidiary of the Prudential, with funds provided by the Prudential, to a subsidiary of BP plc. The first was hedged with Royal Bank of Scotland plc ("RBS"), the second with Goldman Sachs International ("GSI"). I shall describe these transactions in much greater detail later. At this stage it is sufficient to refer to the elements of those transactions which have given rise to this appeal.
- At the material time, March 2002, the sterling spot rate for €500m was £309m. The liability of the Prudential in 2011 was hedged by two swaps, a short term swap effected on 8th March and a long term swap agreed on that date but effected on 19th June 2002. I am only concerned with the short term swap. By the agreement made between the Prudential and RBS on 7th March 2002 the Prudential agreed to pay to RBS £65m on 12th March and £244m on 19th June 2002 in exchange for €500m delivered by RBS to the Prudential on 19th June 2002. Thus the spot rate for €500m was paid in two instalments, one of £65m on 12th March, the other of £244m on 19th June. The Prudential had no use for €500m on 19th June 2002. That sum was used as the first leg in the long term swap of €500m for £309m made on 19th June 2002 and repayable on 19th December 2011.
- At the time material for the GSI swap, August 2002, the sterling spot rate for $250m was £163m. The effective date of the swap was 23rd August 2002. On the same day the Prudential paid GSI £40m. The swap, as then agreed, was to be effected on 25th November 2002 when the Prudential would pay GSI $250m and GSI would pay the Prudential £203m. The swap was duly completed on 25th November 2002.
- Thus in each case there was a lack of symmetry between the amounts or times of the sterling payments made by or to the Prudential. In the case of the RBS short term swap £65m was paid by the Prudential in advance of delivery of the €500m by RBS to the Prudential. In the case of the GSI swap the Prudential paid £40m to GSI at the time the swap was agreed and that sum was added to the amount payable by GSI to the Prudential at the time the swap was completed on 25th November 2002.
- The regime for the taxation of profits on currency contracts was that which was introduced by Chapter II Part IV of Finance Act 1994 as amended at the relevant time. Before its introduction such profits were taxed under Schedule D or as capital gains. Indeed those provisions continue to apply for the relevant year of assessment to the extent to which the particular regime is inapplicable. The legislation, to which I shall refer in greater detail later, provides for a statutory formula by which to ascertain profits or losses. The formula is set out in s.155 and depends on the ascertainment of two amounts 'A' and 'B'. In the circumstances of this case they are
'so much of the qualifying payments received or receivable as are allocated to a particular accounting period [(amount A) less] so much thereof as are paid or payable [(amount B)]'.
There are extensive definitions in s.153 of what are qualifying payments and detailed provisions in ss.155 and 156 in relation to allocation and computation. In addition s.168A excludes from the computation of amount B any sums referable to a tax avoidance purpose.
- In its corporation tax self assessment return for the accounting period ended 31st December 2002 the Prudential sought to deduct from its profits as amounts B the sum of £105m, being the aggregate of the sums of £65m and £40m paid by the Prudential in connection with the RBS short term swap and the GSI swap. By a letter dated 26th September 2006 the respondent, HMRC, rejected the claim of the Prudential on three grounds, namely (1) neither sum came within the definition of a qualifying payment contained in s.153 insofar as it incorporates the provisions of s.151(1)(b) or at all, (2) neither sum had been allocated to a period in the manner required by s.155(5), and (3) neither sum was eligible for inclusion in amount B as it was referable to a tax avoidance purpose and so excluded from the computation by s.168A.
- The Prudential appealed to the Special Commissioners (Sir Stephen Oliver QC and Mr Theodore Wallace) on all three grounds. By their decision released on 11th September 2007 the Special Commissioners upheld each of the objections raised by HMRC and dismissed the appeal. The Prudential now appeals to the High Court on all three grounds. Thus the issues for my determination are:
(1) whether (a) in relation to the RBS short term swap the sum of £65m, and/or (b) in relation to the GSI swap the sum of £40m were qualifying payments under s.153(1)(d) because they fell within s.151(1)(b); and if so
(2) whether either of such sums was allocated to the accounting period ended 31st December 2002 as required by s.155(5); and if so
(3) whether any part of either of those sums should be excluded from the computation of amount B because it is referable to a tax avoidance purpose as required by s.168A.
I will consider those issues after I have referred in much greater detail to the relevant legislation and the facts of each of the relevant swaps as found by the Special Commissioners.
The relevant legislation
- The relevant legislation was contained in Chapter II of Part IV Finance Act 1994 as amended by Finance Act 1996. It was repealed and replaced by Finance Act 2002 in relation to accounting periods beginning after 30th September 2002. It applied to interest rate, currency and debt contracts and options. Ss.147 to 148 defined the term "Qualifying Contracts". S.147(1) provided in relation to interest rate or currency contracts that they were qualifying contracts
"...as regards a qualifying company if the company becomes entitled to rights or subject to duties under the contract or option..."
S.154 defined a qualifying company in terms which included the Prudential. Thus it is common ground that the Prudential was a qualifying company and, subject to my decision on the qualifying payments issue, that the RBS short term swap and the GSI swap were qualifying contracts.
- Ss.149 to 152 fell under the heading of "Interest Rate and Currency Contracts and Options". These provisions defined such contracts and options by reference to the terms they must, or in some cases might, contain. Thus s.150, headed "Currency contracts and options" provided in subsections (1) and (2):
"(1) A contract is a currency contract for the purposes of this Chapter if –
(a) the condition mentioned below is fulfilled, and
(b) the only transfers of money or money's worth for which the contract provides are payments falling within subsection (2), (3), (4) or (9) or section 151 below.
(2) The condition is that under the contract a qualifying company –
(a) becomes entitled to a right and subject to a duty to receive payment at a specified time of a specified amount of one currency (the first currency), and
(b) becomes entitled to a right and subject to a duty to pay in exchange and at the same time a specified amount of another currency (the second currency).
- It is common ground that both the RBS short term swap and the GSI swap complied with the condition set out in sub-section (2). The transfers of money or money's worth permitted by subsections (2) to (4) and (9) are not directly relevant to this appeal, but it is necessary to appreciate what they permitted. Subsection (2) related to payments at the maturity of a currency swap. Thus subsection (2) permitted the payments on 19th June 2002 in the case of the RBS short term swap and those made on 25th November 2002 in the case of the GSI swap. Subsection (3) permitted periodical interest payments. Subsection (4) was a mirror image of subsection (2). It permitted initial payments made at the outset of a swap. Subsection (9) permitted a gross or net settlement. S.150(6) dealt with currency options but in that case the only payments for which it might provide were those falling within s.151.
- Thus s.151 provided for payments which might, in addition to those covered by s.150(2)-(4) and (9), be permitted in the case of a currency contract and for the only permissible payments in relation to a currency option. S.151(1) provided:
"(1) An interest rate contract or option, a currency contract or option or a debt contract or option may include provision under which the qualifying company –
(a) becomes entitled to a right to receive a payment in consideration of its entering into the contract or option, or
(b) becomes subject to a duty to make a payment in consideration of another person's entering into the contract or option."
The first issue turns on the application of subsection (b) in relation to the payment of £65m in the case of the RBS short term swap and the payment of £40m in the case of the GSI swap. Subsection (2) also permitted provisions for the payment of reasonable fees and costs, payments to secure the variation or termination of the relevant contract and a provision of payment of compensation for a breach.
- S.153 falls under the heading of "Other basic definitions". It defined the term "qualifying payment". So far as relevant it provided:
"(1) Subject to subsections (2) to (5) below, in this Chapter "qualifying payment" means –
(a) [relates to interest rate contracts];
(b) in relation to a qualifying contract which is a currency contract a payment falling within subsection (3) or (9) of section 150 above;
(c) in relation to a qualifying contract which is a currency option, a payment falling within subsection (9) of that section;
(ca) [relates to a debt contract];
(d) in relation to any qualifying contract, a payment falling within section 151 above.
(2) In this Chapter "qualifying payment" includes, in relation to a qualifying contract –
(a) a payment which, if it were a payment under the contract, would be a payment falling within section 151 above; and
(b) a payment for securing the acquisition or disposal of the contract."
It is important to note that the definition of qualifying payments included the payments referred to in s.150(3) and (9) and all those referred to in s.151 but not those referred to in s.150(2) and (4). Thus the final or initial payments under a swap, for which provision might be made by s.150(2) and (4), were not included in the definition of qualifying payments, unless, as the Prudential, in effect, contends on this appeal they can be brought in under s.151(1)(b). I add by way of explanation that the exclusion of the initial and final amounts permitted by s.150(2) and (4) from the definition of qualifying payments contained in s.153, and hence from the calculation of amounts A and B, does not mean that any economic differences escape tax. At the relevant time exchange gains and losses were assessed to or relieved from tax in accordance with the provisions contained in Finance Act 1993 Chapter II of Part II.
- Ss.155 to 158 fell under the heading "Accrual of Profits and Losses". S.155 provided, so far as relevant:
"(1) Where, as regards a qualifying contract held by a qualifying company and an accounting period, amount A exceeds amount B, a profit on the contract of an amount equal to the excess accrues to the company for the period.
(2) Where, as regards a qualifying contract held by a qualifying company and an accounting period, amount B exceeds amount A, a loss on the contract of an amount equal to the excess accrues to the company for the period.
[(4)...]
(5) Where as regards a qualifying contract a qualifying company's profit or loss for an accounting period falls to be computed on a particular accruals basis -
(a) amount A is so much of the qualifying payment or payments received or falling to be received by the company as is allocated to the period on that basis, and
(b) amount B is so much of the qualifying payment or payments made or falling to be made by the company as is so allocated."
- S.156 contained provisions relating to the basis of accounting. So far as relevant it provided:
"(1) Where, for the purposes of a qualifying company's accounts, profits and losses for an accounting period on a qualifying contract held by the company are computed on -
[(a) a mark to market basis...]
(b) an accruals basis of accounting which satisfies [the requirements of Section 156],
profits and losses for the period on the contract shall be computed on that basis for the purposes of this Chapter.
[(2)
(3)]
(4) An accruals basis of accounting satisfies the requirements of this section as regards a qualifying contract if –
(a) computing the profits and losses on the contract on that basis is in accordance with generally accepted accounting practice;
(b) all relevant payments under the contract are allocated to the accounting periods to which they relate, without regard to the accounting periods in which they are made or received, or become due and payable; and
(c) where such payments relate to two or more such periods, they are apportioned between those periods on a just and reasonable basis.
(5) In determining whether, as regards a qualifying contract, a relevant payment is dealt with as mentioned in subsection (4) above -
(a) regard shall be had to the accounting period or periods to which any reciprocal payment or payments are allocated, and to the basis on which any such payment or payments are apportioned between two or more such periods, but
(b) no regard shall be had to the accounting period or periods to which any other payment or payments are allocated, or to the basis on which any such payment or payments are so apportioned.
(6) References in this section to a qualifying company's accounts shall be construed as follows -
(a) in the case of a company formed and registered under the Companies Act 1985 as references to its accounts drawn up in accordance with the requirements of that Act;
[(b)
(c)]
(7) In this section -
....
"reciprocal payment" in relation to a relevant payment, means another such payment which is the consideration or part of the consideration for that payment,
"relevant payment" means a qualifying payment made or received, or falling to be made or received, by the company.
(8) In the above definition of "reciprocal payment", the second reference to a relevant payment includes a reference to any payment which -
(a) is subject to a condition precedent, and
(b) would be a relevant payment if the condition were fulfilled."
Ss. 155(5) and 156(1) are the provisions relevant to the allocation issue.
- The third issue depends on the proper interpretation and application of s.168A. This section was inserted by s.69 Finance Act 2002 with effect for accounting periods ending after 25th July 2001. So far as relevant it provides:
"(1) When in any accounting period a qualifying contract to which a company is a party has an unallowable purpose, any amounts which for that period fall, in the case of the company, to be brought into account for the purposes of section 155 above as part of amount B shall...not include so much of the amounts given by the accounting method used as respects the contract as, on a just and reasonable apportionment, is referable to the unallowable purpose.
[(2) and (3) deal with the maximum amount which may be so disallowed]
(5) For the purposes of this section a qualifying contract to which a company is party shall be taken to have an unallowable purpose in an accounting period where the purposes for which, at times during that period, the company is party to the contract include a purpose ("the unallowable purpose") which is not amongst the business or other commercial purposes of the company.
[(6)..]
(7) For the purposes of this section, where one of the purposes for which a company is party to a qualifying contract at any time is a tax avoidance purpose, that purpose shall be taken to be a business or other commercial purpose of the company only where it is not the main purpose, or one of the main purposes, for which the company is party to the contract at that time.
(8) The reference in subsection (7) above to a tax avoidance purpose is a reference to any purpose that consists in securing a tax advantage (whether for the company or any other person).
(9) In this section "tax advantage" has the same meaning as in Chapter 1 of Part 17 of the Taxes Act 1988 (tax avoidance)."
The facts as found by the Special Commissioners
The RBS Swaps
- After setting the scene in paragraphs 1 to 11 of their decision the Special Commissioners turned to the RBS swaps. In paragraphs 12 to 17 they described how the euro liability of the Prudential arose, the decision of the relevant committee of the Prudential made on 18th January 2002 that it should be hedged by swapping the euro liability for sterling and the presentation made on 18th February 2002 to a person present at that meeting by Ernst & Young of details of a tax efficient method of hedging exchange rate risks. On 25th February 2002 Ernst & Young was engaged by the Prudential to implement the decision to hedge the euro liability by that method on terms which entitled them to a fee of £200,000 on completion of the hedge by that method and a further fee of £300,000 if the method was successful in reducing the Prudential's liability to corporation tax.
- In paragraphs 18 to 22 and 24 the Special Commissioners found the facts in relation to the RBS swaps in the following terms:
"RBS contracts: the short-term and the full-term swap contracts of 8 March 2002
18. On 8 March 2002 Prudential entered into two separate swap contracts with RBS. Both had 7 March 2002 as their "trade date". Particulars of each contract were set out in the Confirmation document relating to that contract. One of the contracts ("the short-term swap contract") had 19 December 2001 as its "effective date" and 19 June 2002 as its "termination date"; the other (the "long-term swap contract") had 19 June 2002 as its "effective date" and 19 December 2011 as its "termination date". Both agreements were said to supplement and form part of the ISDA Master Agreement.
19. The parties to the present appeal have agreed the following summaries of both contracts.
20. The short-term swap contract has the following effect:
(i) Its trade date was 7 March 2002 and it matured on 19 June 2002;
(ii) The periodics payable were made effective from 19 December 2001 to allow the cashflows under the RBS Swap to match those on the ? Debt;
(iii) Prudential agreed to pay £244,406,000 (the "final exchange amount") to RBS in exchange for RBS paying ?500 million to Prudential on 19 June 2002;
(iv) Prudential agreed to pay an amount based on a fixed rate of 5.08813 per cent (calculated by reference to six month LIBOR plus 103 basis points) in relation to £244,406,000 and RBS paid Prudential an amount based on a fixed rate of 4.2925 per cent (six month EURIBOR plus 102.25 basis points) in relation to ?500 million;
(v) The contract required each counter party to make gross payments of all periodics and the final exchange [of] principals;
(vi) The "Terms and Conditions" stated:
"Prudential Plc shall pay GBP £65,000,000 to The Royal Bank of Scotland Plc on 12 March 2002 in consideration of The Royal Bank of Scotland Plc entering into this Transaction"; and
(vii) Payment of that sum (the "RBS Premium") was made by Prudential.
21. The long-term swap contract has the following effect:
(i) Its trade date was 7 March 2002, its effective date 19 June 2002 and it matured on 19 December 2011;
(ii) PFUK agreed to pay on 19 June 2002 ?500,000,000 to RBS and RBS agreed to pay on the same day £309,406,000 to PFUK;
(iii) PFUK and RBS agreed that on 19 June and 19 December each year, PFUK would pay to RBS an amount based on LIBOR plus 103 basis points on £309,406,000 to RBS and RBS would pay to PFUK an amount based on six month EURIBOR plus 102.25 basis points;
(iv) PFUK and RBS agreed that on 19 December 2011 PFUK would pay to RBS £309,406,000 and RBS would pay to PFUK ?500,000,000; and,
(v) The sterling figure of £309,406,000 was calculated by reference to the spot rate prevailing on 7 March 2002.
The RBS contracts: the Internal Swap
22. PFUK and Prudential had entered into an exchange rate swap on 7 March 2002. This ("the Internal Swap") provided that on 19 June 2002 PFUK was to pay to Prudential £309,406,000 and receive ?500,000,000; Prudential was to pay ?500,000,000 to PFUK and receive £309,406,000.
The RBS contracts: Prudential's accounting entries in 2002 accounts
24. Prudential's balance sheet entries show that:
(i) On 7 March 2002 ?500,000,000 was due from RBS and £309,406,000 was due to RBS;
(ii) On 12 March 2002 a cash payment of £65,000,000 was made to RBS;
(iii) On 19 June 2002 ?500,000,000 was received from RBS and a cash payment of £244,406,000 was made to RBS."
- In paragraphs 25 to 33 the Special Commissioners considered the evidence of Mr Foley, the Managing Director of PFUK and Group Treasurer of the Prudential, in relation to the RBS swaps. He accepted that the sum of £65m reflected the amount of spare cash the Prudential had at that time. He stated that between December 2001, when the euro liability was undertaken, and December 2011 when its redemption was possible the Prudential did not anticipate any need for euros. He had been looking for a rate of return on the £65m no worse than that offered by the cash desk in a bank but that in assessing the return on the £65m he had not taken account of the fees payable to Ernst & Young, of which he was unaware. Whilst he was happy to tie up the £65m until June 2002 he would not have agreed to do so for ten years. He saw the two swaps "as a holistic transaction" and agreed that the £65m could be regarded as a prepayment of the principal of £309m due to RBS under the short term swap contract. The Special Commissioners recorded Mr Foley's unchallenged evidence that had Prudential
"been ready to implement a swap, in the form in which we in fact entered into it, and there had been an announcement that altered the tax treatment in relation to the premium, I would still have gone ahead with the swap in this form".
The GSI swap
- In paragraphs 34 and 35 the Special Commissioners explained how on 23rd August 2002 the Prudential had exchanged £163m for $250m and lent $250m to PFUK so that PFUK might, as it did, lend $250m to the Trinidad and Tobago subsidiary of BP repayable on 21st August 2003.
- In paragraph 38 the Special Commissioners recorded the evidence of Mr Foley as to how that dollar liability came to be hedged with GSI. Mr Foley took the decision to hedge the foreign exchange currency risk. The idea for the structure of the swap which was effected came from an associate director. The Special Commissioners found (although before me the Prudential challenged) that RBS were invited to participate "on the basis that the upfront cashflow is entirely tax driven" but declined because of a perceived 'reputational' risk. Thus it was that the transaction was undertaken with GSI.
- The terms of the GSI swap were found by the Special Commissioners in paragraph 36 of their decision in the following terms:
"Prudential approached GSI to execute a hedge of the foreign exchange exposure on the $250,000,000 Loan. Prudential agreed the terms of this in advance of entering into the Agreement with GSI. Its "trade date" was 21 August 2002. The Confirmation had 23 August as the effective date and 25 November 2002 as the maturity date. The agreed terms of the hedging arrangements are contained in the "Revised Confirmation" from GSI to Prudential dated 24 September 2002. We now reproduce the parties' agreed summary of those terms:
(i) Prudential entered into the GSI swap on 21 August 2002. It had an effective date of 23 August 2002 and matured on 25 November 2002;
(ii) Prudential and GSI agreed that on 25 November 2002, Prudential would pay to GSI the sum of $250,000,000 and GSI would pay to Prudential the sum of £203,420,055;
(iii) Prudential and GSI further agreed that on 25 November 2002, Prudential would pay to GSI an amount based on a fixed rate of 1.71 per cent in relation to $250,000,000 and GSI would pay to Prudential Plc an amount based on a fixed rate 3.845 per cent in relation to £203,420,055;
(iv) the contract required each counterparty to make gross payments of all periodics and final exchange of principals;
(v) the "Revised Confirmation" stated:
"Counterparty shall pay GBP £40,000,000 to GSI on the Effective Date in consideration of GSI entering into this Transaction";
and
(vi) payment of that sum (the "GSI Premium") was made by Prudential.
A cash payment of £40,000,000 was, according to an extract from Prudential's accounting entries, made by Prudential to GSI on 23 August 2002."
- In paragraph 41 the Special Commissioners recorded the evidence of Mr Foley as to the payment by the Prudential of £40m to GSI on 23rd August. The idea for such a payment came from his team, rather than from Ernst & Young, and was determined by the amount of spare cash then available to the Prudential. He saw the deployment of the £40m as commercially neutral when compared with placing it on deposit. The termination date of 25th November 2002 was fixed because Mr Foley envisaged then making an issue of commercial paper to cover the Prudential's $250m exposure.
The Front End Payments
- In the evidence given before the Special Commissioners by witnesses for the Prudential the sums of £65m and £40m were referred to as premiums but that description was not used in any of the contractual documents. The Special Commissioners were not satisfied by Mr Foley's explanation and indicated that they would use, as they did, the expression 'front end payments' to describe the sums of £65m and £40m.
The Qualifying Payments Issue
- In paragraphs 45 to 58 the Special Commissioners dealt with the qualifying payments issue. They set out the relevant statutory provisions. The crucial provision for the purposes of this issue is s.151(1)(b). As they said in paragraph 50 the specific issue is
"whether the front end payments were payments under provisions in the RBS short-term swap contract and in the GSI contract imposing on Prudential a duty to make each of them in consideration of RBS and GSI entering into the contract in question".
- If that question is answered in the affirmative then the front end payments were qualifying payments as defined in s.153(1)(d). In that event they are to be included in the computation of the amounts B required by s.155(5)(b). Such a result would enable the Prudential to obtain relief from its liability for corporation tax in the form of a deduction of £105m from its taxable profits. By contrast, if the question is answered in the negative, neither front end payment could be either a qualifying payment within the definition contained in s.153 or a payment permitted by ss.150 to 152 to be included in a currency contract as defined. I will leave for further argument if it arises the taxation consequences of such a conclusion.
- In paragraph 51 the Special Commissioners set out again the relevant provisions in the RBS short term swap and the GSI swap contained in the relevant confirmations, as follows:
"The RBS short-term swap contract (dated 8 March 2002) defined Additional Payment as:
"Prudential Plc shall pay GBP 65,000,000 to the Royal Bank of Scotland Plc on 12 March 2002 in consideration of The Royal Bank of Scotland Plc entering into this Transaction."
The GSI contract (whose trade date was 21 August 2002 and whose effective date was 23 August) provided, in relation to Additional Payment that:
"Counterparty shall pay GBP 40,000,000 to GSI on the effective date in consideration of GSI entering into this Transaction"."
- The Special Commissioners set out the arguments of counsel in paragraphs 52 and 53 and their own conclusions in paragraphs 54 to 58. In paragraph 54 the Special Commissioners drew a distinction between "payments which have the function of securing the making of the contract" and "payments made in fulfilment of the contract itself". They considered that only the former fell within the terms of s.151(1)(b).
- In paragraph 55 the Special Commissioners rehearsed the facts relevant to the RBS short term swap. They again quoted the relevant provision in the RBS short term swap, set out in paragraph 26 above, and expressed the view that that description had been used to suit the Ernst & Young model. They added:
"But as a statement of what really happened it was a misnomer, a deliberate mislabelling. It was part of the consideration under the contract. It cannot have been the intention of Parliament that any consideration under a currency contract was within section 151(1)."
- They dealt with the GSI swap in paragraph 56. They considered that the payment of £40m was "even less consideration "for entering into the contract"". They thought that the idea behind it was to reproduce the tax savings sought by the RBS short term swap and that the upfront payment made no sense save in the context of a tax scheme. They pointed out that the amount was dictated by the amount of cash then available to the Prudential and that there was no evidence that GSI required any inducement to enter into a swap which had been structured on arm's length terms and by reference to the prevailing rates of exchange.
- The conclusion of the Special Commissioners in relation to both front end payments was, paragraph 57, that:
"Properly understood both front end payments were, we think, payments on account or part pre-payments made by Prudential relating to its principal liabilities under the two contracts. Despite the wording of the Confirmation documentation, they were not, in the circumstances and on the plain wording of section 151(1)(b), payments "in consideration of another person's," i.e. RBS's and GSI's as the case might be, "entering into the contract"."
Arguments and conclusion on the Qualifying Payments issue
- Counsel for the Prudential submits that both the reasoning and the conclusion of the Special Commissioners are wrong. The basis of his submission is that it is common ground that the Prudential is a qualifying company and, at least before the Special Commissioners, that the two swap agreements were "currency contracts" as defined. He submitted that the requirement for the front end payment in each contract was a "provision" of that contract. He argued that such provision cast a contractual duty on the Prudential to make it. On this footing the question boils down to ascertaining from the contract what was the consideration for that front end payment. He relies on the well known dictum of Lord Dunedin in Dunlop Pneumatic Tyre Company v Selfridge [1915] AC 847, 855 that consideration is "the price for which the promise of the other is bought". In those circumstances, he submits, it is clear that the front end payment is the price paid by the Prudential for the agreement enshrined in the confirmation slips for the exchange at maturity of, respectively, euros and dollars for sterling.
- Counsel criticised the decision of the Special Commissioners on a number of grounds. He submitted that the distinction drawn by them in paragraph 54, set out in paragraph 27 above, is inconsistent with the terms of s.151(1)(b) because the provision for the payment must be under the contract and not outside it. Accordingly performance of the duty to make the payment is necessarily part of the same contract. Further, he submitted, the payment must have been consideration for the counterparty entering into the contract because, given the spot rate of exchange, RBS would not have agreed to exchange €500m for £244m on 19th June and GSI would not have agreed to exchange £203m for $250m on 25th November had they not earlier received the respective sums of £65m and £40m.
- In his oral argument counsel for the Prudential emphasised that the argument for HMRC was inconsistent with their concession that both relevant swaps were "currency contracts" within the statutory definitions because if the front end payments are not within s.151(1)(b) then the provisions for them to be made do not come within ss.150-152. He stressed that in relation to both front end payments the Prudential received interest from the time of payment to the maturity of the swap and was subjected to a credit risk for the like period. He pointed out that HMRC did not allege that either confirmation was a sham, nor was there any argument on the Ramsay lines. Nor did the application of s.151(1)(b) depend on the appropriateness of any particular label; it did not refer to 'premiums', 'inducements' or 'additional' payments. He submitted that Parliament must have had particular transactions in mind when inserting s.151(1)(b) into Chapter II of Part IV Finance Act 1994 but that HMRC had been unable to suggest what they might be if they did not include the front end payments in this case. He also relied on the terms of amending legislation in Finance Act 2003 which, he submitted, assumed that the front end payments did fall within s.151(1)(b).
- These beguiling submissions were challenged by counsel for HMRC. He submitted that the legislation draws a clear distinction between the principal payments paid, whether by instalments or not, by a company buying or selling foreign exchange, which are not qualifying payments, and other payments such as those specified in s.151(2) which are. Thus, he submits, the relevant distinction is between payments of principal for the currency and payments made to a counterparty to induce it to enter into a contract for the sale or exchange of the currency. The latter, he suggests, would be paid in addition to the price for the currency, would be priced differently and would normally be the subject of separate negotiation.
- Counsel for HMRC submits that the front end payment of £65m. in the case of the RBS short term swap was plainly just a part pre-payment of principal for which RBS delivered €500m. In the case of the GSI swap the front end payment of £40m. was simply a deposit at interest until the maturity of the swap. In neither case was there any separate negotiation or evidence of the need for any inducement to the counter-party to enter into the swap, rather the amount of the front end payment was dictated by the amount of the spare cash available to the Prudential and the purpose of paying it was to obtain the tax advantage to which Ernst & Young had drawn the attention of the Prudential. He submits that in the case of each swap the surrounding circumstances demonstrate what the front end payment was 'for' and it was not to induce the counter-party to enter into the transaction.
- The essential question is whether the provision in each Confirmation for an "additional payment" is a 'provision under which [the Prudential] [became] subject to a duty to make [the additional] payment in consideration of [RBS or GSI]'s entering into the contract'. In each case the Confirmation said that it was (see paragraph 26 above). But parties are not entitled to dictate the tax consequence of their transactions by attributing particular characteristics or descriptions to particular terms if, on an objective view of the contract as a whole, that term cannot be properly so characterised or described. Thus in my judgment there are two questions: (1) what is meant by the phrase "in consideration of another person's entering into the contract" when used in s.151(1)(b)? And (2) do the front end payments come within that description?
- In one sense all provisions in a contract for payment by one party to the other are payments in consideration of the other party entering into the contract because it is the consideration moving from the promisor which the promisee seeks to obtain by entering into the contract. If I agree to buy B's house for £200,000 I become subject to a contractual duty to make that payment. B would not have agreed to sell his house to me if I had not undertaken that obligation. That is the sense on which the argument for the Prudential summarised in paragraph 32 above, is based. But my payment of £200,000 is consideration for the transfer of title to the house by B to me; it is not consideration for B entering into the contract to sell it to me. In my view s.151(1)(b) does not use the words "in consideration of another person's entering into the contract" in the sense for which counsel for the Prudential contends.
- In all currency contracts there will be, by definition, the exchanges at maturity required by s.150(2). In addition there may be such payments at the initial stages as are allowed by s.150(4). But none of those payments are qualifying payments within s.153. Thus to interpret s.151(1)(b) in the manner for which the Prudential contends would be inconsistent with other parts of the relevant legislation for it would translate into a qualifying payment part of the consideration for the exchange at maturity. If payment of the principal in exchange is not a qualifying payment then there is no reason why payment of part of it or of an additional sum in advance of exchange should be. Accordingly I agree with the conclusion of the Special Commissioners quoted in paragraph 28 above that it cannot have been the intention of Parliament that any consideration under a currency contract should be within section 151(1) and so a qualifying payment under s.153.
- I accept that the provision in question will be included in the contract under consideration for that is what the opening words of s.151 provide. I also accept that that currency contract must impose a duty on the qualifying company to make a payment to the counterparty for that is what the first part of subsection (1)(b) requires. But that payment must be "in consideration of" or 'for' another party's entering into the contract. If the word 'consideration' is used in the general contractual sense for which counsel for the Prudential contends then there was no need for the addition of the later requirement limiting the purpose of the payment.
- The same conclusion is suggested by a temporal approach to s.151(1). The sub-section envisages a currency contract which includes the provision imposing the duty on the qualifying company to make the payment having a notional existence before the counterparty enters into that or another currency contract. It can only do so if it is some sort of inducement; contractual performance of the contract after it has been entered into is treated differently. It is not a statutory requirement that there should be a separate contract or separate negotiation but, as counsel for HMRC submitted, it is likely as a matter of fact that there will be. Accordingly I agree with the conclusion of the Special Commissioners that the subsection applies to payments which have the function of securing the making of the contract but not to payments made in fulfilment of the contract once made. Like the Special Commissioners I do not find that the failure of HMRC indisputably to identify payments which , on this construction, would fall within s.151(1)(b) a sufficient reason to reach a different conclusion. Nor do I consider that the fact and form of the amendment made in Finance Act 2003 is of assistance in the interpretation of the words as originally enacted in s.151(1)(b).
- If that is the correct interpretation of s.151(1)(b) then it is clear that the front end payments in the case of both the RBS short term swap and the GSI swap did not answer the contractual description if construed consistently with the equivalent expression in s.151(1)(b). In neither case was there any evidence of any need for a payment to induce RBS or GSI to enter into the currency contracts. The amounts of the front end payments were not calculated by reference to any requisite inducement. It is plain from the circumstances surrounding each relevant swap, in particular the appropriate sterling spot rate, that the front end payments were, in the case of the RBS short term swap, a prepayment of part of the purchase price and, in the case of the GSI swap, a deposit at interest repayable at the maturity of the currency swap.
- So to conclude is not to reject the contractual terms set out in the Confirmations, to treat them as shams or to seek to impose tax in accordance with the economic substance of the transaction as opposed to its legal form and effect. Rather it is to recognise that the expression used in the Confirmations as part of the descriptions of the "Additional Payment", namely "in consideration of [RBS or GSI] entering into this Transaction", is used in a different sense to the same words in s.151(1)(b). There is nothing surprising in such a conclusion. Such words may well bear different meanings in different contexts.
- For all these reasons I agree with the Special Commissioners that in neither case did the front end payment come within the terms of s.151(1)(b). It follows that neither could be a qualifying payment or included in the calculation of the respective amounts B for the purpose of computing the profits of the Prudential for corporation tax purposes. For these reasons I dismiss this appeal.
Consequence of conclusion on Qualifying Payment issue
- The first consequence of this conclusion is that the allocation issue and the unallowable purpose issue do not arise as the relevant provisions only apply to qualifying payments. In relation to those issues the facts (but subject to challenges made by the Prudential) are those found by the Special Commissioners. It is unnecessary and undesirable for me to express any obiter views on either of them.
- The second consequence is, as turned out in the course of the hearing to be common ground, that the RBS short term swap and the GSI swap were not currency contracts for the purposes of s.150(1). This conclusion arises from the fact that the front end payments do not come within any of the permitted provisions for transfers of money specified in s.150(1)(b) and cannot be disregarded under s.152. Counsel for HMRC contended that this would not make any difference to the liability of the Prudential to Corporation Tax. As he pointed out the assessment is in a monetary sum unconnected with any particular statutory authority for the assessment. In addition he contended that the upshot of this appeal in terms of tax payable would be the same whether the assessment was made under Chapter II of Part IV of Finance Act 1994 or the statutory provisions relating to Schedule D case VI or to capital gains tax. Counsel for the Prudential did not agree that the tax payable by his clients would be the same under whichever of the alternative grounds of assessment proved to be the right one. He tentatively suggested that the existing assessments should be discharged altogether. But as they were self-assessments that may not be as straightforward as may first appear.
- In these circumstances I dismiss this appeal. I invite the parties to agree the tax consequences of my conclusion on the Qualifying Payments issue. If, as seems likely, they cannot agree on that then I invite them to agree on the procedure by which their differences may be resolved. In either event I invite further submissions when I come to hand down this judgment.
