[2010] UKFTT 510 (TC)

TC00765                   

    Appeal number: TC/2010/00426

Section 343 ICTA 1988 – Corporation Tax – Losses.

FIRST-TIER TRIBUNAL

TAX 

	HOUSTON COX INTERIORS LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS 	Respondents

TRIBUNAL: 	Mr. Geraint Jones Q.C. (Judge)
                        Mrs J. Shillaker (Member)

Sitting in public in Reading on 15th September 2010.

Mr. Leslie Beckett representing the Appellant. 

Mr. Shea representing HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.	The appellant, Houston Cox Interiors Limited, has appealed against an amendment made to its self assessment corporation tax return, made by HMRC. The matter arose in this way.

2.	The appellant company and a company named Elvethan Interiors Limited (“Elvethan”) were in common ownership from the 1st April 2006.  On the 31st July 2006 the appellant acquired the business and assets (if any), of Elvethan. A statement of agreed facts which appears in our bundle at pages 91-92 records that this was for a “nil” consideration.  As at the 31st July 2006 Elvethan had accrued trading losses of £762,160. When the appellant submitted its self assessment return and corporation tax computation for its year ended 31st March 2007 to HMRC, it claimed to set off against its otherwise taxable profit, the sum of £396,637. It is common ground that that figure was arrived at on the basis that the appellant could only deduct that part of Elvethan’s loss as arose from the same or similar trading activities as were carried on by it.

3.	HMRC thereafter contended that the appellant was not entitled to deduct the full amount of £396,637 because although section 343(3) ICTA 1988 gave a right to deduct previous trading losses, the effect of section 343(4) was to cut down that right in circumstances where Elvethan’s “relevant liabilities” exceeded the value of its “relevant assets”.  That, in turn, involves considering the definitions of “relevant assets” and “relevant liabilities” set out in section 344 ICTA 1988. 

4.	By reference to the statutory definition of relevant liabilities, HMRC has argued that no relevant liabilities exceeding £894 can be set against the appellant's profit.  The reasoning put forward by HMRC is that the appellant did not assume legal responsibility for Elvethan’s liabilities, nor did it, as a matter of reality, give or pay money to Elvethan to allow it to discharge its liabilities.

5.	When, in 2006, it was discovered that Elvethan’s trading and financial position was unhealthy, the directors of that company, (some of) whom were also directors of other companies within the Houston Cox Group, decided, instead of allowing the company to go into insolvency, that they would procure the payment of Elvethan’s creditors.  One of the substantial creditors was HMRC which, at that time, was owned about £240,000.  

6.	The directors took their decision for pragmatic commercial reasons.  They did not want the suppliers and customers of group companies to see one company within the group going to the wall. It was their commercial judgment that there would be an adverse commercial impact upon other group companies if that happened.  It was agreed that Elvethan’s liabilities would be paid by the appellant not directly, but by the appellant providing money to Elvethan to allow it to make payment directly to its creditors.

7.	We should make clear that the facts we are setting out are not in issue.  Many of them are taken from the “Statement of Agreed Facts” at pages 91-92 of the bundle.  We heard evidence from Mr. Andrew Beckett and Mr. Shorthouse, to some of which we will refer below. Neither witness was cross examined.  The veracity of neither witness was called into question. They each struck us as honest and reliable witnesses.

8.	Mr. Andrew Beckett gave evidence about the activities of each company and explained that as group companies they had many common clients and common suppliers. It was explained that the directors took the view that if one group company went down, it would affect the confidence on the clients and suppliers dealing with other group companies.  He said the group was concerned to maintain its reputation.  That was clearly a commercial judgment which the group directors were entitled to make and were probably wise to make.  Mr. Beckett went on to say that the appellant had transferred funds to Elvethan so as to allow it to pay its various creditors thus providing for confidence in the other group companies to be maintained.  In reality, the group wanted to avoid its creditors and customers becoming aware of Elvethan's insolvent situation.  We point out that Mr Beckett did not specify the mechanism by which those funds were made available by the appellant, to Elvethan.
9.	Mr Shorthouse, the company's accountant, then gave evidence in which he confirmed that commercial presentation had been an important factor for the group. Together with Mr Cox he visited the Collector of Taxes in June 2006 and explained what was being done and sought agreement to a payment schedule for the £240,000 or thereabouts owed to HMRC by Elvethan. HMRC was subsequently paid in full.  If, instead of ensuring that Elvethan’s debts were paid in full, the directors had allowed Elvethan to go into insolvent liquidation, it is improbable HMRC would have seen much, if any, of the £240,000 owed to it. Thus HMRC has been a substantial beneficiary of the directors’ decision to act honourably and to cause the appellant to discharge Elvethan’s debts.

10.	We commented during the hearing that this is an appeal in which the appellant undoubtedly holds the moral high ground and thus the ultimate decision to which we feel we must come, as a matter of law, is one at which we arrive with no enthusiasm.

11.	The argument advanced by the appellant is that we should look at the substance of what took place rather than the form.  That is an argument often deployed by HMRC and Mr Shea had no quarrel with that approach. We agree that such an approach is appropriate.

12.	Mr Shea argued said although, in substance, Elvethan may have provided the funds with which Elvethan could pay its creditors, it was important to note that Elvethan’s business had been transferred to the appellant for a nil consideration. That is an agreed fact. It was pointed out during the argument that although the appellant puts its case on the basis that there was no consideration for the transfer of Elvethan’s business. that may have come about simply as a result of somebody not undertaking a proper legal analysis of what, as a matter of law, was happening.  For example, if the appellant had assumed legal liability for Elvethan’s debts, particularly by a mechanism that allowed its creditors to look directly to the appellant for payment, it would be unjustifiable to regard the transfer of the business or its assets as having been for a nil consideration.

13.	We have considerable sympathy for the argument that if the matter had rested there, the letter describing the transfer as being for a nil consideration should be seen as wrong, both factually and as a matter of law.

14.	But it does not rest there. The mechanism by which the appellant chose to procure the discharge of Elvethan’s liabilities was, according to the accounts and balance sheet of each company, by the appellant making a loan to Elvethan. In our judgment that is of substantial significance. A loan gives rise to a legal relationship of creditor and debtor. Any person perusing the appellant’s accounts would see that it has debtors, with the amounts due from them being counted amongst its assets. We heard evidence that the appellant’s directors knew and realised that the appellant’s loan to Elvethan could and would not be repaid, but nonetheless chose to record the monies provided by the appellant to Elvethan as a loan and thus as an asset within the appellant’s balance sheet. It is questionable whether that was consistent with the directors’ fiduciary duties to the appellant.

15.	Thus, to succeed in this appeal, the appellant has to invite us not only to say that the substance of the transaction was that the appellant gave good consideration for Elvethan’s business assets but, in addition, was not truly making a loan to Elvethan but, instead, was providing consideration for the business assets acquired by it from Elvethan. The only other possibility was that it was making a gift of money, which, again, would not assist the appellant.

16.	We have had to consider whether putting substance over form allows us to conclude that the appellant was not making a loan to Elvethan but was, in effect and reality, providing consideration which should be taken into account when undertaking calculations for the purpose of section 343(4) ICTA 1988. It is our judgment that that is a bridge too far. Such a finding would fly in the face of each company's accounts and balance sheet.

17.	There can be no doubt that had this transaction been quite lawfully constructed appropriately, upon sound professional advice, the appropriate and desired outcome could have been achieved for the appellant.  It is particularly galling for the appellant that the beneficiary of it failing to be able to take advantage of Elvethan’s accrued losses, is HMRC which, but for the directors’ entirely proper and honourable conduct in procuring the payment of Elvethan’s liabilities, probably would not have seen much, if any, of the £240,000 owed by Elvethan to HMRC in 2006. However, this Tribunal cannot take into account broad concepts of equity or fairness. It can only apply the applicable statutory provisions. 

18.	Unfortunately we cannot properly conclude that the appellant gave consideration for Elvethan’s business by assuming any of Elvethan’s liabilities and/or by discharging them or any of them. As a matter of legal analysis the appellant lent money to Elvethan with which that company could then discharge liabilities which remained with it. So far as the appellant is concerned that is an unintended result. It is an unattractive result, but one which could have been easily avoided had proper care been taken in and about organising the transfer of Elvethan’s business to the appellant, given the appellant’s known resolve to discharge Elvethan’s liabilities. 

19.	This appeal is dismissed.  We make no order as to costs.

20.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

GERAINT JONES Q.C.
TRIBUNAL JUDGE
Release Date: 21 October 2010