UK vs Smith & Nephew, March 2020, Court of Appeal, Case No A3/2019/0521

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In the case of HMRC v Smith & Nephew Overseas Ltd, consideration was given to the “fairly represent” requirement in the loan relationship code.

The dispute concerns each of the Smith & Nephew’s entitlement to set off foreign exchange losses against their liability to corporation tax. The exchanges loss arose as a result of Smith & Nephews changing their functional accounting currencies from sterling to US dollars on 23 December 2008 at a time when the only asset on their balance sheets was a very substantial inter-company debt owed to them by their parent company. The debts were denominated in sterling but then had to be converted into dollars when the companies’ accounts were restated in dollars. The next day, the debts were disposed of as part of a group restructuring. The exchange losses arose from Smith & Nephew’s ‘loan relationships’ as that term is used in Chapter 2 of Part IV of the Finance Act 1996 (‘Chapter 2’).

  • Section 80 provides that all profits and gains arising to a company from its loan relationships should be chargeable to tax as income in accordance with Chapter 2. It provides also that the Chapter has effect for the purpose of determining how any deficit on a company’s loan relationships is to be brought into account.
  • Section 81 defines ‘loan relationship’ for the purposes of the Corporation Tax Acts. A loan relationship exists whenever a company stands in the position of a creditor or debtor as respects any money debt and that debt is one arising from a transaction for lending money.
  • Section 82 sets out the method for bringing into account any gains or deficits arising from the company’s loan relationships and provides that those gains and deficits shall be computed in accordance with section 82, using the credits and debits given for the accounting period in question by the provisions of Chapter 2.
  • Section 84 then provides for what debits and credits are to be brought into account in respect of the company’s loan relationships. It provides that the credits and debits to be brought into account shall be the sums which when taken together ‘fairly represent’ all profits, gains and losses of the company arising from its loan relationships. As originally enacted, section 84 did not cover gains and losses arising from fluctuations in currency exchange rates as they affected a company’s loan relationships.
  • The Finance Act 2002 introduced section 84A to deal with exchange gains and losses arising from loan relationships. Section 84A provides, broadly, that exchange gains and losses are included in the references in section 84 to profits, gains and losses arising from its loan relationships. The term ‘exchange gains and losses’ is defined by section 103(1A), which was also introduced by the Finance Act 2002.
  • Section 84A(3), however, excepted certain exchange gains and losses so that they were not included in the credits and debits covered by section 84. The category of exchange gains or losses to which section 84A does not apply because of section 84A(3) include those which fall within either section 84A(3)(a) or (b) and which are recognised in the company’s statement of total recognised gains and losses (‘STRGL’), rather than in its profit and loss account. Section 84A conferred on HM Treasury a regulation-making power to bring into account in prescribed circumstances amounts which are taken out of the regime by section 84A(3). HM Treasury exercised that power in 2002 making regulations which covered, amongst other things, the disposal of loan relationships in respect of which exchange gains and losses have been recognised in the company’s STRGL.

The question was whether, if applicable to exchange losses, the losses satisfied the ‘fairly represent-test’

On that issue the court refered to the GDF Suez judgement where the following reasoning was provided:

I agree with HMRC’s submission that the presence or absence of a tax avoidance purpose should not be determinative. Although the Court in GDF Suez explained how the amendments to the loan relationships regime in 2004 and 2006 were prompted by the desire to close loopholes and prevent tax avoidance, the wording of the statute does not refer to tax avoidance as a yardstick. It is not correct to give the ‘fairly represent’ test a limited meaning by regarding tax avoidance as the paradigm situation where the test would not be met. The test may well be failed in a case where there is an avoidance motive but where the more specific provisions directed at preventing avoidance do not, for whatever reason, apply. However, the override is not limited to that situation since it is intended to operate in favour of the taxpayer as well as in favour of HMRC. It may lead, for example, to profits being left out of account for tax purposes even though they are included in the company’s accounts in accordance with GAAP. I also agree that the presence or absence of an ‘asymmetry’ of the tax treatment of a transaction when looked at from the perspective of the counterparties is not a factor that need be present in every case where the override is triggered. It so happens that asymmetry was a factor both in GDF Suez and in the earlier case of DCC Holdings (UK) Ltd v Revenue and Customs Commissioners [2010] UKSC 58, [2011] 1 WLR 44. That does not mean, in my view, that the absence of an asymmetry in any subsequent case militates against the override being triggered. Finally, I agree with Mr Gibbon [counsel for HMRC] that the hurdle of ‘manifest absurdity’ which the Upper Tribunal appears to have applied before triggering the ‘fairly represent’ override is too stringent test. The true analysis is that section 84(1) is engaged wherever fair representation would not otherwise be achieved.

HMRC’s  appeal was dismissed by the Court.



UK vs SMITH & NEPHEW cout of appeal 030320

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