HMRC win £79million in Court of Appeal
The collapse of Enron in 2001 left one of the largest and most complex bankruptcy proceedings the world has ever seen, with debts of $67 billion across some 20,000 creditors.
One of those creditors was Teesside Power Limited (TPL), the owner/operator of a power station at Redcar and Cleveland, who had been selling excess wholesale electricity to Enron via Enron’s UK based subsidiaries. When Enron filed for bankruptcy, TPL were owed just over $900 million in the US and £461 million in the UK. Over the years, these bankruptcy claims became pseudo-assets as a secondary market in Enron claims developed, and in 2006 they were valued at $199 million and £93 million respectively. TPL could expect roughly a quarter of what they were owed.
TPL sought to maximise the return on these claims by entering into a sophisticated scheme devised by Ernst & Young, whereby the claims were sold to a wholly-owned subsidiary company resident in Jersey, in exchange for shares. Because it was unclear exactly how much would be received under the claims, they were treated as loans, not assets, for tax purposes. As the corporation tax rate in Jersey is 0%, any payments due under the claims would effectively not be subject to CT, although anything received over the transfer value of circa £200 million would still be taxable in the UK under the Controlled Foreign Companies (CFC) rules. The tax-free £200 million could then be loaned back to TPL or distributed as dividends. The scheme was fully disclosed to HMRC by E&Y under the Disclosure of Tax Avoidance Schemes (DOTAS) regime.
HMRC challenged the tax returns for the relevant periods, arguing that loan relationship credits should have been brought into account on the date of the transfer of the claims to the offshore subsidiary, creating a tax charge to TPL. TPL appealed to the First Tier Tribunal in 2015 and Upper Tribunal in 2016, both times losing their case to HMRC. The case was subsequently escalated to the Court of Appeal, who recently decided again in favour of HMRC.
TPL’s argument was that the treatment of the transfer of the claims was in accordance with Generally Accepted Accounting Principles (GAAP), as per the loan relationship legislation, resulting in a nil value. However, amendments to these rules in the Finance Act 2004 removed the requirement that loan profits, gains and losses be calculated in accordance with GAAP, leaving only the test that the accounting treatment “fairly represent” profits, gains and losses. Finance Act 2006 then reinserted the GAAP condition alongside the “fairly represent” test. This was ultimately the issue, the court’s interpretation of the legislation being that Parliament had intended the “fairly represent” mechanism to essentially override GAAP in order to prevent avoidance using contrived transactions.
Henderson LJ ruled “I consider that the FTT and the Upper Tribunal were correct to conclude that the credits which had to be brought into account by TPL in respect of the Claims in the two relevant accounting periods were the sums shown as the value of the consideration shares in the assignments, and not a nil amount. Although my reasoning is not entirely the same as that of the two Tribunals, I consider that in substance they came to the right conclusion on this issue, and (if the other members of the court agree) that TPL’s appeal must therefore be dismissed”. HMRC stand to collect £79 million in tax.
Perhaps the most striking aspect of this case is that the tax in question relates to services rendered over 17 years ago. The repercussions of the sixth largest corporate bankruptcy in US history are still, to an extent, being felt.
25th October 2018.