UK: DCC And Statutory Fictions

Last Updated: 16 March 2011
Article by Sara Luder

This article appeared in the February 2011 issue of the 'Financial Instruments Tax and Accounting Review'

The saga that is the case of DCC Holdings (UK) Limited v HMRC Commissioners has finally reached its conclusion in the form of a single judgment delivered on 15 December by Lord Walker on behalf of all of the Supreme Court Judges. Given that the Supreme Court is likely to hear far fewer appeals of this nature than the House of Lords, the decision is interesting not just in its implications for the loan relationship regime but also as an indication of how the Supreme Court believes "statutory fictions" should be interpreted.

THE FACTS

In 2001 DCC, a UK resident company, entered into a number of net paying repos with a non-UK resident bank ("the Bank").

On day one, DCC bought gilts from the Bank for £812.2m. Eighteen days later, DCC sold the gilts back to the Bank for £785.2m. In the interim, DCC received a coupon of £28.8m on the gilts, which (because it was a net paying repo) DCC retained. £2.9m of this coupon represented the interest on the gilt that accrued in DCC's eighteen day period of ownership.

DCC was not exposed to any risk of movement in the market value of the gilts because the repurchase price was fixed on day one. The transaction was, therefore, in economic terms a loan, because DCC knew that it would receive an economic profit (equivalent to interest) of £1.8m (£785.2m plus £28.8m minus £812.2m).

The accounting treatment adopted by DCC reflected this economic reality. DCC did not show the gilts on its balance sheet but instead showed a loan receivable of £812.2m. Over the term of the repo, DCC accrued "interest" of £1.8m which was the only item reflected in DCC's profit and loss account.

THE TAX PROVISIONS

The tax treatment was undoubtedly intended to produce a similar result to the accounting treatment, although, rather than simply following the accounting treatment, it did this by creating three actual or notional loan transactions. These were:

  1. the gilts – the parties could not agree how much of the coupon paid on the gilts should be taxed in DCC's hands;
  2. a notional loan between DCC as lender and the Bank as borrower deemed to exist by section 730A ICTA 1988 – the parties agreed that this loan produced taxable interest of £1.8m for DCC; and
  3. a notional loan between the Bank as lender and DCC as borrower deemed under section 97A Finance Act 1996 – DCC was deemed by section 737A ICTA 1988 to pay interest of £28.8m under this loan, which DCC argued created a debit of £28.8m.

There were two problems with this regime. First, it was too complicated! Secondly, these provisions came into force before the introduction of the loan relationship regime, which fundamentally changed the tax treatment of interest for UK companies by, in most cases, taxing interest on an accruals basis rather than a cash basis. It was the interaction of section 730A and 737A with the loan relationship rules that had to be considered in this case – and each Court came to a different conclusion!

LOWER COURT DECISIONS

DCC's proposed treatment did not reflect the economic reality of the transaction, as it created a net tax deduction even though DCC made an economic profit, and therefore each of the Courts struggled to see whether it could find an interpretation to support a symmetrical tax treatment that reflected the economic position.

The Special Commissioner did this by concluding that, as neither the coupon on the gilts nor the payment deemed by section 737A were reflected in its accounts, neither should exist for tax purposes. The Special Commissioner did not seem to be troubled by the fact that, if actual accounting entries are always required, a statutory fiction could never create credits or debits for tax purposes.

This latter point, however, troubled Norris J in the High Court, who concluded that, if section 737A deemed DCC to make an interest payment of £28.8m, DCC should be entitled to a deduction of £28.8m in relation to this payment, and therefore be in a "net debit" rather than a "symmetrical" position.

The majority of the Court of Appeal disagreed with Norris J, although they struggled to find a technical basis for this. Having reviewed, and on the face of it agreed with, Norris J's interpretation of various legislative provisions, Moses LJ turned to the general charging provision in section 84 Finance Act 1996, which stated that the credits and debits to be brought into account under the loan relationship rules had to be such sums as "fairly represent" the profits etc. from the loan relationship. Moses LJ used this provision to conclude that, notwithstanding the fact that the loan relationship regime adopts an accruals basis, in this situation it was not right that DCC should only be taxed on the interest on the gilts that accrued during DCC's period of ownership. Instead, in order for the overall result to fairly represent DCC's position, the entire coupon received by DCC on the gilts should be taxable (so cancelling out section 737A debit).

The Court of Appeal decision caused great consternation, because it seemed to cut across the detailed loan relationship provisions and instead suggest that all that is required by these rules is simply to ask what is the fair amount to bring into charge to tax.

Therefore, so far we have:

  1. credit nil, debit nil (Special Commissioner);
  2. credit £28.8m, debit £28.8m (two of the three Court of Appeal Judges); and
  3. credit £2.9m, debit £28.8m (High Court and one of the Court of Appeal Judges).

Was there a fourth way? Indeed there was.

THE SUPREME COURT DECISION

The Supreme Court thought that a need for a symmetrical solution was at the heart of the appeal, in order to avoid the absurd result of DCC generating a net debit from the transaction.

The Supreme Court thought that Moses LJ in the Court of Appeal had been too quick to accept that DCC was entitled to a debit of £28.8m. The Supreme Court thought it was wrong to accept that the statutory fiction created by section 97 went so far as to treat the hypothetical interest payment under the hypothetical loan relationship as accruing in its entirety over the eighteen day period. Instead, the Supreme Court thought that an accruals basis should apply in this notional world, so limiting the debit to £2.9m, which conveniently matched the credit to give a symmetrical tax treatment.

Accordingly, the Supreme Court did indeed find a different symmetrical solution to that applied by the majority of the Court of Appeal.

It was clearly, however, a close run thing. The judgment makes its clear that, if the Supreme Court had not been able to reduce DCC's debit to £2.9m, it would probably have agreed with the majority of the Court of Appeal. In other words, the desire to achieve a symmetrical tax treatment meant that the Supreme Court was going to find in favour of HMRC one way or another.

STATUTORY FICTIONS

The Supreme Court considered the question as to how far a statutory hypothesis should be taken. The authorities suggested that, if a construction of a statutory fiction would led to injustice or absurdity, the application of that fiction should be limited to the extent needed to avoid such injustice or absurdity, unless that was clearly the purpose of the fiction. Due to the nature of deeming provisions, and the artificial assumptions underlying them, whilst normal principles of construction should generally apply, it might be necessary to apply certain limits to those assumptions to ensure that the hypothesis was not taken further that was warranted.

In the context of DCC, the statutory fictions deemed DCC to make a payment of interest under a loan relationship. The Supreme Court thought, however, that it was going too far to suggest that the statutory fiction was that the entire amount of this interest payment accrued during the eighteen day repo period.

The Supreme Court was not troubled that this meant that of the £28.8m hypothetical interest payment, only £2.9m was reflected for tax purposes, with the remaining £25.9m "vanishing into the ether". First, the £28.8m payment was only ever a hypothetical payment. Secondly, in the real world, there was a credit of £25.9m (or would have been had the Bank been a UK taxpayer) because this reflected the proportion of the actual coupon on the gilts that the Bank would have been taxed on. Quite why this latter point is of any relevance to where £25.9m of the debit has gone is not entirely clear!

CONCLUSIONS

The decision will be a disappointment to DCC and to other taxpayers who have entered into similar transactions. From a broader perspective, however, it is good news.

The decision in the Court of Appeal, had it not been appealed, would have created a great deal of uncertainty as to the extent to which one applied the prescriptive provisions of the loan relationship rules, or whether the correct approach was simply to ensure that the credits and debits brought into account were those that "fairly represented" the underlying transaction. As it appears that the Supreme Court was determined to find a symmetrical tax treatment for this transaction, they have at least done it in a way that does as little harm as possible to the loan relationship regime and, at the same time, provides some useful insights into the extent to which statutory fictions should be applied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.