HMRC wins £79m tax avoidance case

The Court of Appeal has found in favour of HMRC in a long running £79m tax avoidance case involving Teesside Power Ltd (TPL) which sought to use a scheme devised by EY to avoid corporation tax liabilities

The tax liabilities in question involved £200m of contingent and unrealised claims which TPL had against certain companies in the insolvent Enron group. TPL, which was subsequently renamed GDF Suez Teesside Ltd, was acquired by the private equity division of US agricultural giant Cargill and Goldman Sachs following Enron’s collapse in 2001, which means they face paying the liability. 

Under the scheme proposed at the time by EY, which was TPL’s auditor, the company aimed to escape this potential liability by transferring the relevant claims to a newly-incorporated and wholly-owned Jersey subsidiary, called Teesside Recoveries and Investments Ltd (TRAIL), in consideration for the issue by TRAIL to TPL of equivalent numbers of fully paid ordinary shares in TRAIL representing the fair value of the claims.

There were three transfers in all, two of which took place on 5 December 2006 and the third on 2 March 2007. Thus TPL exchanged its beneficial ownership of the claims for beneficial ownership of the corresponding shares in TRAIL, and TPL now had indirect (shareholder) control, through its ownership of TRAIL, instead of direct (managerial) control in its own right, over the future realisation or utilisation of the claims.

The scheme was designed on the basis that the transfer of the claims by TPL to TRAIL would not give rise to any ‘credits’ which, in accordance with UK GAAP, would have to be taken into account in computing the profits and gains arising to TPL in its two relevant accounting periods (the first of which ended on 5 December 2006, and the second of which ran from 6 December 2006 to 30 September 2007).

In other words, the intention was that the transfers would not generate any taxable credits in the hands of TPL, and that the shares in TRAIL would have a carrying value of nil in TPL's accounts in the same way as the claims for which they had been exchanged.

On the other hand, it is agreed that the position of TRAIL was different from that of TPL, in that TRAIL acquired assets which did not represent anything it had previously owned, and provided full consideration for those assets by the issue of corresponding numbers of its own shares at par.

Therefore the base value of the claims in the hands of TRAIL was their market value of approximately £200m, and TRAIL would in principle subsequently realise a profit from the claims only if and to the extent that realisations exceeded that base value.

As a company registered and resident for tax purposes in Jersey, TRAIL was not itself liable to corporation tax, but it was a controlled foreign company (CFC) and as such its future profits (if any) were liable to be attributed to TPL and taxed in the UK accordingly.

The critical difference from the status quo, however, was that only profits arising from realisations in excess of the £200m base value could be ‘brought home’ in this way and taxed in the hands of TPL. So the overall effect of the scheme, if it worked, was that the £200m would fall permanently outside the net of corporation tax , because (a) the transfers of the claims to TRAIL gave rise to no loan relationship credits in the hands of TPL, and (b) any subsequent profits realised by TRAIL from the claims would be taxable under the CFC legislation only to the extent that they exceeded the £200m base value.

In the event, TRAIL subsequently received sums totalling approximately £243m in respect of the claims, between April 2007 and May 2008. TRAIL never held any assets other than the claims, and the proceeds from their realisation were for the most part lent back to TPL on an unsecured and interest free basis.

In due course, after TPL had submitted its tax returns and computations for the two accounting periods, HMRC opened enquiries into the returns which resulted in the issue of closure notices on the footing that loan relationship credits should be brought into account on the dates when the claims were transferred to TRAIL, in the sum of £194,899,838 for the first period and £5,154,631 for the second period.

TPL challenged HMRC at both a First Tier Tribunal and an Upper Tribunal, which considered a number of accounting issues including the question of whether the loan relationship had been treated correctly under UK GAAP.

Now the Court of Appeal has found in favour of HMRC, which stands to collect £79m in tax. The judge said: ‘Looking in the round at each claim and the assignment of it by TPL to TRAIL in return for shares in TRAIL of equivalent value, I see no difficulty in concluding that a profit or gain of a capital nature thereby arose to TPL from the disposal of the claim, and that such profit or gain can only be fairly represented by a loan relationship credit in the hands of TPL equal to the value of the claim at the date of the disposal.

‘In this way, the profit or gain is brought into charge to tax at the same value as is recognised for accounting purposes in the hands of TRAIL, and a symmetrical outcome is assured.

‘The alternative treatment, based solely on the GAAP-compliant treatment of the transactions in the books of TPL, would not "fairly represent" the profit or gain arising to TPL because it would lead to the value received by TPL in return for the claims falling out of any charge to tax at all in the hands of either TPL or (by virtue of its non-UK tax resident status) TRAIL.

‘Parliament could not rationally have intended such an outcome, and application of the fair representation test is in my opinion the appropriate means by which it is prevented.’

Penny Ciniewicz, director of customer compliance at HMRC said: ‘Anybody who tries to exploit the tax rules to gain an unfair advantage will come unstuck.

‘We have dedicated teams in place to tackle abuse wherever we find it.

‘HMRC wants to make sure everybody pays their fair share of tax that contributes towards the vital public services we all use’.

In a joint statement, Cargill and Goldman Sachs said: ‘The decision regarding the interpretation of tax law is disappointing but the parties fully respect the court process. In the meantime, all UK taxes, including those disputed have been paid.’

GDF Suez Teesside Ltd v Revenue and Customs [2018] EWCA Civ 2075 is here

Report by Pat Sweet 

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