Whether a euro conversion clause turns a qualifying corporate bond into a CGT asset

Mon 22 Jan 2018

The Court of Appeal has overturned the Upper Tribunal decision in the case of Trigg and held that the euro conversion clauses applicable to the bonds in question did not prejudice the bonds ‘qualifying corporate bond’ (QCB) status for tax purposes.

HMRC’s contention that it was significant that TCGA 1992 s.117(2)(b) did not contain of the word ‘conversion’, was not supported by the Court of Appeal. Rather the Court considered how that provision clarified the interpretation of TCGA 1992 s.117(1) and whether the two conversion clauses in the bonds provided for conversion at a rate that would generate no forex or other gains (or losses).

Implications

The use of currency redemption and conversion clauses in bonds held as investments can be used to turn a CGT exempt sterling bond into a bond subject to CGT. If the bond is regarded as chargeable rather than exempt, it may be possible to apply the CGT reorganisation provisions such that there is no disposal for CGT purposes, instead of creating a gain on a conversion into a QCB that is then crystallised when the QCB is sold or redeemed.

Since the UT’s 2016 decision it may have been assumed that the inclusion of these euro conversion clauses in the terms of a sterling bond caused them to be chargeable assets rather than exempt. These assumptions, the precise operation of the relevant clauses, and the potential impact on taxpayers (corporate or non-corporate), will need to be reconsidered as a result of the Court of Appeal’s decision.

For further advice on the tax issues in this area, please get in touch with a member of the Mazars corporate tax or personal tax teams.

Background

Mr Trigg’s case was the lead case among nine joint references by HMRC and various partners in Tonnant LLP (an investment partnership). The LLP had purchased sterling denominated bonds on the secondary market at what was perceived to be an undervalue, with a view to their retention until maturity or eventual disposal at a profit. The bonds in question were all disposed of and the gains were treated in the tax returns of their respective holders (LLP partners) as exempt from CGT on the ground that they were QCBs within the meaning of s.117 TCGA 1992.

A bond is a QCB if it meets the following requirements:

• It is a security the debt on which has at all times represented a normal commercial loan;
• TCGA 1992 s.117(1)(b) – It is expressed in sterling and has no provision for conversion into, or redemption in, a currency other than sterling.

The second of these two conditions is further clarified so that:

1. A security is not regarded as expressed in sterling if the amount of sterling falls to be determined by reference to the value at any time of any other currency or asset; and
2. A provision for redemption in a currency other than sterling but at a rate prevailing at redemption shall be disregarded.

There are a number of other provisions defining a qualifying corporate bond, but the issue in this case concerned euro conversion clauses on the terms of the bonds. There were two clauses that provided for the possibility that the UK might replace sterling with the euro prior to the redemption date of the bonds in this case:

1. If the lawful currency of the UK changed from sterling to another currency, the obligations arising under the bonds would be due in the new currency converted at the rate of exchange determined by the Bank of England.  The conditions of the notes would in that event be changed so far as practicable, to place the Issuer, the Note Trustee and the Noteholders in the same position each would have been in had no change in currency occurred.
2. Once the UK became a Participating EU Member State the issuer of the bond may on giving at least 30 days’ prior notice to the noteholders “designate a Note Payment Date as the Redenomination Date”.  In this case the notes would be denominated into Euros at the rate for conversion of Sterling into euro established by the Council of the European Union under the Treaty.

The UK currently has a derogation from the adoption of the euro which it would have to give up in order for monetary union to take place.

Court of Appeal’s decision

The Court of Appeal agreed with the UT that TCGA 1992 s.117 could not be interpreted such that “sterling” could be read as including another currency should the UK replace sterling. However they disagreed with the UT that the EU regulations’ transitional provisions meant the adoption of the euro would not lead to immediate redenomination of the bonds due to the UK’s derogation from those provisions. Instead the Court of Appeal considered that if the UK chose to adopt the euro it would necessarily have had to waive its derogation.  The Court of Appeal therefore considered the bonds were QCBs notwithstanding the inclusion of the two clauses mentioned above.