Taxable Loan Relationships Profit arises despite no Accounting Profit

Taxable Loan Relationships Profit arises despite no Accounting Profit

Mon 07 Sep 2015

The FTT case of GDF Suez Teeside v HMRC considered whether any taxable profits should arise when a UK company assigned a number of contingent debt claims to a wholly owned subsidiary resident in Jersey.


GDF Suez Teeside (sic) Limited, formerly Teeside Power Limited (‘TPL’), operated Teesside power station, and as part of that business sold electricity on a wholesale basis.  TPL had entered into long-term purchase agreements with the Enron group, requiring the group to acquire fixed volumes of energy from TPL.  Following the collapse of Enron, TPL was left with very significant debts owed by Enron, for failure to continue to perform under those contracts.  TPL lodged claims against Enron for payment of those debts, and various amounts were received by and taxed in TPL: this treatment is not in question.  However, TPL then entered into arrangements disclosed under DOTAS in which it set up a wholly owned subsidiary resident in Jersey (‘TRAIL’) and assigned to it contingent rights in relation to its other claims against Enron in return for the issue of shares by TRAIL.  TRAIL was a CFC for UK tax purposes. The fair value of the claims transferred to TRAIL (£200 million) was equivalent to the fair value of the shares received in TRAIL, so no profit arose.  The purpose of this transfer was described in the DOTAS notifications as being ‘to enable a UK company to indirectly realise the value of the existing asset…which had no carrying value under UK GAAP without triggering an immediate tax charge by transferring it to a foreign subsidiary in exchange for the issue of shares’.  No profit was recognised in TPL’s accounts in either the P&L or the STRGL at the time of the assignment.  Subsequently, TRAIL received significant amounts which it then lent back to TPL as an interest free loan.  TPL thus had the use of the monies arising when the contingent claims were settled, but had avoided being taxed on them within the UK. 

As a result, HMRC raised assessments representing the profits they contended arose when TPL assigned the claims to TRAIL.

Were the accounts UK GAAP compliant?

The FTT concluded that TPL’s accounts were compliant with UK GAAP, adding that it would be ‘slow to upset accounts which have been given audit sign off as GAAP compliant accounts’.  For example, the FTT accepted that under FRS 12, contingent assets have a nil value at inception and should not be revalued until they are realised in cash.  FRS 5 operates to ensure that profits cannot be over-stated by ignoring the substance of a transaction, which in this case meant that as, in substance, TPL still held the claims (as it owned TRAIL), no profit should be realised.  Neither did the FTT believe that HMRC had made a convincing case that an alternative set of GAAP compliant accounts could have been drawn up.  Thus TPL’s accounts were accepted by the FTT as they stood.  This is important because the taxation of loan relationships generally follows the accounting treatment.  Thus, the FTT could not upset the accounting basis even though they resulted in a significant amount ‘disappearing’ from the UK under an avoidance scheme.

Did TPL’s accounts represent a fair view of profits?

However, that was not the end of the story.  The FTT’s view was that the appeal was less about the application of technical accounting principles and more about how far accounting principles can be taken as the basis of a taxing statute, and in particular if they can be taken so far as to result in potential profits being taken out of the UK altogether.  

S84(1) FA 1996 (now s307(3) CTA 2009) requires that the debits and credits to be brought into account for tax purposes should be the sums which fairly represent all profits, gains and losses for the accounting period.  This is a different test to the accounting principles underpinning FRS 12 and FRS 5 (that shareholders should not have an inflated view of the company’s profits).  Although it was suggested by the appellant that s84(1) FA 1996 only works to ensure that profits actually booked in the accounts are fairly represented in the correct accounting period, it was decided that it actually operates as an over-ride of the accounting profits if they do not fairly represent loan relationships profits.  The FTT likened the assignment of the claims to the transfer of assets pregnant with gain from a UK to a non-UK group member.  The FTT’s view was that, on a realistic commercial approach, the claims were monetised when they were exchanged for the shares in TRAIL, and that this assignment amounted to a disposal.  As the contingent clams were valued at £200 million at the time of their assignment, the FTT concluded that amount should therefore be taxed in TPL. This was despite the fact that this resulted in tax being due whilst the claims were still contingent and also led in the tax liability arising earlier than would have been the case had the claims not been transferred.

The FTT was clearly at pains to defeat a tax avoidance scheme, stating ‘in the normal case, the accounting measure of profits will give a fair view of a company’s taxable profits.  This is not the normal case; this is a structured transaction in which accounting rules have been used in order to both defer and potentially remove profits from the UK tax net’ and ‘in essence we have used s84(1) as an anti-avoidance rule to stop accounting principles being used as a way of taking profits out of the tax net’.


The tax provision at the heart of the appeal is s84(1) FA 1996, requiring the loan relationships debits and credits to be a fair representation of the underlying profits and gains.  This provision is being removed when the Summer Finance Bill is enacted.  However, instead there will be a regime wide TAAR at s455B, which acts somewhat like a mini GAAR for loan relationships.

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