The Upper Tribunal (UT) have dismissed the taxpayer’s appeal in GDF Suez Teeside Limited (Formerly Teeside Power Limited) v The Commissioners for her Majesty’s Revenue and Customs. In summary, the taxpayer transferred loan relationship assets (arising from claims for non-fulfilment of energy supply contracts) to a wholly owned Jersey resident subsidiary in exchange for issues of shares. The intended result was that the profit inherent in the transferred loan relationships would never be taxed. The taxpayer did not recognise these claims in its accounts prior to the transfer, as they represented contingent assets, and no profit was recognised on the transfers of the claims. In addition, whilst the taxpayer would be chargeable under the UK controlled foreign company rules on the profit recognised in the Jersey resident subsidiary, the tax basis had been stepped up to the value of the loan relationship assets at the date of the transfer.
The First-tier Tribunal (FTT) found that this accounting treatment was in accordance with generally accepted accounting practice (GAAP) and found for the taxpayer relating to the accounting treatment. However, it also found that the UK transferor company was required to recognise a taxable profit equal to the fair value of the transferred assets, because this ‘fairly represents’ a profit from the transfers. It was on this point that the taxpayer appealed, along with a new point that the purported closure notice issued by HMRC for the period ended 5 December 2006 had no standing as there was no valid enquiry into the corporation tax return for that period. HMRC also argued that the UT should reconsider the accounting issues as part of the appeal. As a consequence, the UT decision considers all of these issues.
HMRC argued that the FTT erred in a variety of respects in relation to the accounts. The UT rejected these arguments, finding that the FTT was entitled to conclude, as it did, that the taxpayer’s financial statements complied with GAAP, rejecting an argument that the taxpayer’s financial statements were not GAAP-compliant because they did not accord with the Companies Act 2005 requirements relating to company accounts.
Inclusion of an amount which fairly represents the profit
The taxpayer argued that if, as the FTT found, there was only one GAAP-compliant method of accounting for the transfer, then the loan relationship rules would only require them to be taxed on debits and credits derived from the accounts, and that the FTT had ‘invented’ a non-existent credit to arrive at what it considered to be a ‘fair’ result. HMRC argued that the loan relationship rules contained an overarching requirement which could (and was designed to) override GAAP-compliant accounts if necessary to ensure that amounts which ‘fairly represent’ the profits and gains which ought to be taxed did not escape the net.
The UT concluded that, while the legislation did not allow adjustments solely in the name of ‘fairness’, it allowed adjustments to reflect – as closely as possible – the economic reality of the situation, and that the FTT was entitled to allow such adjustments in this situation. In essence, the ‘fairly represents’ test required that the taxpayer bring into account a gain to counteract the asymmetrical accounting whereby the Jersey subsidiary had a positive balance sheet reflecting the fair value of the transferred loans but the taxpayer’s shareholding in that company had no value in its financial statements.
The fairly represents wording has ceased to apply for periods beginning on or after 1 January 2016, in part, because HMRC are comfortable that the targeted anti avoidance rule for loan relationships is sufficient to counter the type of arrangement covered by this case. So, this part of the decision has limited relevance going forward.
Was there a valid closure notice?
The taxpayer had argued that there was no valid closure notice for the enquiry, as the original enquiry letter had contained the wrong year end. After the initial error, subsequent correspondence from both HMRC and the taxpayer’s advisers had used the correct year end, and the UT concluded that there was no arguable ambiguity about what was meant.
The taxpayer’s appeal was therefore dismissed.
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