Weston v HM Inspector of Taxes

For the purposes of the Taxation of Chargeable Gains Act 1992, the qualifying corporate bond test concerns the underlying debt, not merely the form of the security. A loan is not a normal commercial loan where it carries any right to conversion into shares, even if the right operates through successive loan notes and cannot be exercised immediately. It is immaterial that an intermediate note must first be issued, that the original note is cancelled, or that the right may never be exercised. The fact that the intermediate notes would themselves qualify as corporate bonds does not cure the defect in the original loan notes.

The taxpayer appealed under section 56A of the Taxes Management Act 1970 from a decision of the Special Commissioners concerning loan notes issued by Carraldo in a tax avoidance scheme. The High Court dismissed the appeal, holding that the rights carried by the first loan notes included an indirect right to convert into Carraldo shares: [2004] EWHC 1607 (Ch). The issue before the Court of Appeal was whether the first notes were qualifying corporate bonds under sections 115 and 117 of the Taxation of Chargeable Gains Act 1992, despite conversion into shares being possible only through second loan notes.

The appeal was dismissed unanimously. Chadwick LJ gave the leading judgment; Buxton LJ adopted his analysis and agreed with the result, and Pill LJ agreed.

1. Statutory focus. Section 115(1)(a) of the Taxation of Chargeable Gains Act 1992 exempts gains on qualifying corporate bonds. Under section 117(1), however, the relevant condition is that the underlying debt represents, and has always represented, a normal commercial loan. Section 132(3)(b) distinguishes the security from the debt which it secures: the loan note is the security, while the underlying loan must satisfy the statutory condition.
2. Nature of the loan. The documentation was consistent with one underlying loan authorised by the company’s resolution of 30 May 1997. The first loan notes could be exchanged for second loan notes of the same par value. The second loan notes could then be converted into Carraldo shares. That sequence gave the lender a present contractual right to require conversion of the loan into shares, although its exercise was deferred and involved machinery controlled by the lender.
3. Effect of the intermediate notes. The second loan notes would have been relevant discounted securities under Schedule 13 to the Finance Act 1996 and therefore corporate bonds under section 117(2AA). That did not make the first loan a normal commercial loan. The statutory reference to any right to conversion is not confined to a direct right. The cancellation of the first note and the later issue and conversion of the second note were immaterial.
4. Result. The loan carried a right to conversion into Carraldo shares and therefore fell outside the definition of a normal commercial loan. The first notes were not corporate bonds or qualifying corporate bonds, so the capital gains exemption was unavailable. The High Court and Special Commissioners had reached the correct conclusion.

Buxton LJ additionally observed that the statutory scheme was directed towards genuine participation in the bond market and against avoidance, but the plain statutory language was sufficient to decide the appeal.

• Court of Appeal (Civil Division): dismissed the appeal unanimously.
• High Court, Chancery Division: dismissed the taxpayer’s appeal from the Special Commissioners, holding that the first loan notes carried an indirect right to conversion into shares: [2004] EWHC 1607 (Ch), [2005] STC 617.
• Special Commissioners: dismissed the taxpayer’s appeal against the inspector’s amendment of the self-assessment and held that the loan notes were not qualifying corporate bonds: [2003] STC (SCD) 403.