The Union Castle Mail Steamship Co Ltd v HMRC

This appeal concerned whether accounting "derecognition" of derivative contracts produced an allowable corporation tax loss under Schedule 26 to the Finance Act 2002. The court considered the statutory code for taxation of derivatives, in particular paragraph 15(1) (the requirement that credits and debits "fairly represent" profits and losses arising from derivative contracts), and paragraphs 17A, 17B and 25A.

The court held that (i) entries in GAAP-compliant accounts are the starting point for the computation of profits and losses under paragraphs 17A and 17B, and that paragraph 15(1)'s "fairly represent" requirement can operate as an overriding criterion, not limited to tax-avoidance or parent/subsidiary mismatches; (ii) in Union Castle the accounting debit arising on derecognition did not fairly represent a loss because the economic effect of the transaction was to commit to a dividend distribution (not to create a loss or transfer of benefit) and Union Castle remained the beneficial owner of the derivatives and their proceeds; and (iii) on the separate "arise from" question the court agreed with the Upper Tribunal that the derecognition was inseparable from the issue of the bonus A shares and the resulting debit did not "arise to" the company from the derivative contracts themselves. The court also held that paragraph 25A requires debits recognised in equity to meet the paragraph 15(1) requirements, and dismissed Ladbrokes' appeal on that ground.

This case arose from deductions claimed by two group subsidiaries (Union Castle and Ladbrokes) after accounting "derecognition" of substantial portions of derivative positions following the issue of bonus shares to their respective parents. The taxpayers claimed corporation tax deductions for accounting debits recognised on derecognition; HM Revenue and Customs disallowed those deductions. The First-tier Tribunal (FTT) and the Upper Tribunal (UT) took differing views on some issues. The present appeals brought the matter to the Court of Appeal.

• Nature of the claim: the appellants sought corporation tax deductions for losses resulting from derecognition of derivative contracts in their GAAP-compliant accounts (IAS 39 or UK GAAP/FRS treatment), computed under Schedule 26 to the Finance Act 2002.
• Procedural posture: disputes proceeded from the FTT (lead case decision including a favourable Gateway finding for Ladbrokes), to the UT (UT/2016/0198 and UT/2016/0242) which reached differing conclusions on the "loss", "arise from" and "fairly represent" issues, and then to the Court of Appeal ([2020] EWCA Civ 547).
• Issues framed by the court: (i) whether the accounting debit from derecognition was a "loss" for paragraph 15(1) purposes; (ii) if a loss, whether it "arose from" the derivative contracts; (iii) whether the accounting debit "fairly represented" a loss within paragraph 15(1); and (iv) for Ladbrokes only, whether paragraph 25A (debts/credits recognised in equity) requires compliance with paragraph 15(1) (the Gateway issue).

Court’s reasoning and conclusions: The Court of Appeal accepted that GAAP entries are the starting point for tax computation under paragraphs 17A and 17B but affirmed that paragraph 15(1)'s "fairly represent" requirement is a substantive override able to displace GAAP where fair representation is not achieved. The court rejected any narrow construction limiting the override to tax-avoidance cases or parent/subsidiary accounting mismatches. Applying that test to Union Castle, the court concluded that the accounting debit did not fairly represent a loss: the effect of the transaction was an obligation to pay dividends (a distribution of profits), not the incurrence of a loss or the transfer of beneficial title, and Union Castle remained beneficial owner of the derivatives and their proceeds. On the "arise from" point the court agreed with the UT that the derecognition was inseparable from the bonus share issue and did not directly arise from the derivatives themselves. On the Gateway issue the court held that paragraph 25A requires debits recognised in equity to satisfy paragraph 15(1), so Ladbrokes' proposed favourable treatment under paragraph 25A failed. The appeals were dismissed and the Court remitted a discrete administration point about possible amendment of Union Castle's tax computation to the FTT for determination.

This was an appeal from the Upper Tribunal. Both appeals were dismissed. The court held that: (a) GAAP-compliant accounting entries are the starting point under paragraphs 17A/17B, but paragraph 15(1)'s requirement that debits and credits "fairly represent" profits and losses is a substantive, potentially overriding test; (b) on Union Castle the derecognition debit did not fairly represent a loss because the economic reality was an obligation to distribute profits by dividend while Union Castle remained beneficial owner of the derivatives and proceeds; (c) on the "arise from" issue the derecognition was inseparable from the bonus share issue and did not "arise to" the company from the derivative contracts themselves; and (d) paragraph 25A requires amounts recognised in equity to meet paragraph 15(1), so Ladbrokes' Gateway argument failed. The appeals were therefore dismissed and a narrow remittal was ordered to the FTT for an application procedure point raised by Union Castle.

Appeal from the Upper Tribunal, Tax and Chancery Chamber (UT/2016/0198 and UT/2016/0242). The FTT issued decisions (lead case hearings with Union Castle and Ladbrokes; FTT decision dated 27 July 2016). The UT heard appeals (UT references as above) and dismissed Union Castle's appeal on the substantive Schedule 26 issues while deciding the Gateway issue against Ladbrokes. Permission was granted by the UT for appeal to the Court of Appeal, which delivered judgment in [2020] EWCA Civ 547 dismissing both appeals (Court of Appeal, 22 April 2020).