The Union Castle Mail Steamship Company Ltd v HM Revenue and Customs & Ors

Under Schedule 26 to the Finance Act 2002, GAAP accounts provide the starting point for taxing derivative-contract profits and losses, but the requirement that debits and credits fairly represent those profits and losses is a separate overriding condition. It is not confined to accounting mismatches, tax-avoidance schemes or asymmetrical tax treatment.

The court must examine the totality of the transaction in its factual context. An accounting derecognition does not fairly represent a loss where the company remains beneficially entitled to the derivative contracts and their proceeds, and has merely undertaken to distribute part of those proceeds as dividends. Debits recognised in equity under paragraph 25A must satisfy the same paragraph 15 requirements as debits recognised in profit or loss.

These were conjoined appeals by Union Castle and Ladbrokes against decisions of the Upper Tribunal Tax and Chancery Chamber on corporation-tax deductions claimed for accounting derecognition of derivative contracts. The Upper Tribunal had held that the relevant debits were losses, but that Union Castle’s loss did not arise from its derivative contracts. It also held that Ladbrokes’ equity debit was subject to paragraph 15 of Schedule 26.

The appeals concerned the meaning and application of the loss, arise from, fairly represent and Gateway issues under Schedule 26 to the Finance Act 2002. The central questions were whether the derecognition debits represented losses arising from derivative contracts and whether paragraph 25A provided a route around paragraph 15.

1. Both appeals dismissed. The court agreed with the Upper Tribunal on the loss and arise-from issues, but dismissed Union Castle’s appeal also on the fairly-represent issue. Union Castle’s alternative transfer-pricing issue under Schedule 28AA to the Income and Corporation Taxes Act 1988 was not decided.
2. Paragraphs 17A and 17B of Schedule 26 take GAAP-compliant accounts as the starting point. However, the opening words of paragraph 17A make that starting point subject to paragraph 15(1). The fairly-represent requirement is a separate statutory override. Following GDF Suez [2018] EWCA Civ 2075, it is not confined to parent-subsidiary accounting mismatches. Tax avoidance, asymmetrical tax treatment and manifest absurdity are not necessary conditions for its operation.
3. The court had to examine the totality of the transaction in its factual context. Union Castle remained beneficially entitled to the derivative contracts and their close-out proceeds. The A Shares imposed an obligation to pay dividends, subject to the statutory requirements for lawful distributions, but did not transfer the contracts or impose an absolute liability to pay 95% of the proceeds. The issue of the shares therefore involved a future distribution of profits, not a loss fairly represented by the accounting debit.
4. The application of Part 23 of the Companies Act 2006 confirmed that conclusion. Union Castle had to create distributable reserves by reversing the very debit relied upon as a loss before paying the dividends. An amount disregarded for distributable earnings could not fairly represent a loss for paragraph 15(1).
5. The derecognition also did not arise from the derivative contracts. It was inseparable from, and caused by, the issue of the A Shares. The definition of related transaction in paragraph 15(7) and (8), covering disposals or acquisitions of rights or liabilities under derivative contracts, supported the restricted statutory scope.
6. For Ladbrokes, paragraph 25A required equity debits to be brought into account in the same way as debits recognised in the statements covered by paragraph 17B. Since those debits must satisfy paragraph 15, the Gateway issue was resolved against Ladbrokes.
7. The Union Castle matter was remitted to the First-tier Tribunal to decide whether Union Castle should be allowed to amend its tax computation and, if so, whether the amendment had merit. The Court of Appeal expressed no view on those questions.

• Court of Appeal (Civil Division) — [2020] EWCA Civ 547: both appeals dismissed. The Union Castle matter was remitted to the First-tier Tribunal on the proposed amendment issue.
• Upper Tribunal Tax and Chancery Chamber — case numbers UT/2016/0198 and 0242: Union Castle’s appeal was dismissed on the arise-from issue after the Upper Tribunal held in its favour on the loss and fairly-represent issues. Ladbrokes’ appeal was allowed against the First-tier Tribunal on the Gateway issue.
• First-tier Tribunal — Union Castle’s decision dated 27 July 2016: Union Castle’s appeal was dismissed. The First-tier Tribunal allowed Ladbrokes’ appeal on the Gateway issue.