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.


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 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!


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 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.


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!


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.

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