Prudential Plc v HM Revenue & Customs

For a payment under a currency contract to qualify under section 151(1)(b) of the Finance Act 1994, it must be made to induce or secure the counterparty’s entry into the contract. It is not enough that the payment forms part of the contractual consideration for the currency exchange. The statutory scheme distinguishes qualifying payments from principal payments made under the exchange provisions in section 150. Contractual labels do not determine the tax treatment where the objective construction of the contract shows that the payment was a prepayment of principal or a deposit at interest. Payments that do not fall within section 151(1)(b) cannot be included in amount B under section 155.

The appellant sought corporation tax deductions for front-end payments of £65 million and £40 million made under two currency swaps with the Royal Bank of Scotland plc and Goldman Sachs International. The payments were described in the confirmations as being made in consideration of the counterparties entering into the transactions.

The Special Commissioners held that the payments were prepayments or part-payments of principal, rather than qualifying payments under section 151(1)(b) of the Finance Act 1994, and dismissed the appeal. The appellant appealed to the High Court on the qualifying-payment issue, the allocation issue and the unallowable-purpose issue.

1. The appeal was dismissed. The allocation and unallowable-purpose issues did not arise because the front-end payments were not qualifying payments.

2. Section 151(1)(b) applies where a currency contract imposes a duty to make a payment for the purpose of inducing or securing another person’s entry into the contract. It does not encompass every payment which is contractual consideration in the general contractual sense.

3. The statutory construction was required by the structure of the legislation. Payments at maturity under section 150(2), and permitted initial payments under section 150(4), were excluded from the definition of qualifying payment in section 153. Treating any part of the principal consideration as a qualifying payment would undermine that distinction.

4. The provision may be contained in the currency contract and need not arise from a separate contract or separate negotiation. The relevant question is the function of the payment. A payment made in fulfilment of the contract after it has been entered into is materially different from a payment which secures the making of the contract.

5. On the facts, the £65 million payment was a prepayment of part of the purchase price under the RBS swap. The £40 million payment under the GSI swap was a deposit at interest repayable at maturity. There was no evidence that either payment was needed to induce RBS or GSI to enter into the relevant swap, and the amounts were dictated by the appellant’s available cash.

6. The contractual descriptions could not determine the statutory consequence. This conclusion did not treat the transactions as shams or substitute economic substance for legal form; it construed the words used in the confirmations in their statutory context.

7. Neither payment fell within section 151(1)(b), so neither was a qualifying payment or could be included in amount B. The swaps also did not constitute currency contracts for the purposes of section 150(1), because the front-end payments did not fall within a permitted provision and could not be disregarded under section 152.

• High Court (Chancery Division): the appeal from the Special Commissioners was dismissed. The Special Commissioners’ decision of 11 September 2007 had upheld HMRC’s objections on all three grounds.