This article originally appeared in the April issue of Tax Journal.
Speed read: Reversing the FTT, the UT has decided that particular provisions for loan notes to be converted into euros in the event that the UK adopts the euro do prevent them from being qualifying corporate bonds (QCB). Accordingly, these loan notes are not exempt from capital gains tax. In the context of entrepreneurs' relief, and given how unlikely it is that the UK will adopt the euro in the near future, this is of limited significance. However, the case includes some interesting comments on the application of the Ramsay principle, particularly its application to closely articulated or prescriptive legislation.
With the 'Brexit' debate in full swing, the Upper Tribunal (UT) decision in HMRC v Trigg  UKUT 0165 (TCC) takes us back to a very different time. In the late 1990s, the burning issue was not whether the UK should leave the EU, but whether it should adopt the euro. Closer union, rather than exit, was considered a realistic possibility.
Just as now, politicians and business leaders debated the issues and lawyers sharpened their pencils to draft for the possible consequences of a historic event. One point of debate was whether to include provisions in loan notes setting out what would happen in the event of the UK adopting the euro before the note was redeemed: when should interest begin to be paid in euros and what rate of conversion to use? Although legislation would cater for this eventuality, it might not do so satisfactorily.
The significance of a currency conversion provision: a QCB or not a QCB?
Whether to specifically cater for this in the drafting was an important issue, because the inclusion of 'foreign' currency conversion provisions in a loan note prevents that note from being a qualifying corporate bond (QCB) for individuals who hold it. Indeed, including a limited provision for conversion into another currency (often, US dollars) was, and remains, a common means of preventing it from being a QCB. There are benefits to a loan note not being a QCB, namely the ability to 'roll over' capital gains on the exchange of shares for a non-QCB; for example, on a takeover of a private company. In the pre-entrepreneurs' relief era, this had the benefit of extending the ownership period for taper relief from capital gains tax.
At the time, practitioners debated whether providing for what would happen if sterling were to be replaced by the euro was a conversion right within TCGA 1992 s 117(1)(b); and, if so, whether it fell within the s 117(2)(b) exclusion for redemptions at the rate of exchange prevailing at redemption. The Inland Revenue made its view clear, that such provisions were conversion rights which precluded QCB treatment.
As draftsmen who intended to create non-QCBs were able to do so by the tried and tested technique of a dollar conversion provision, within a cap and collar, the consequences were only for those who intended to create a QCB. To be sure of such treatment, it was clear that they should not include a euro conversion pro-vision.
Mr Trigg's loan notes
This was the issue which arose in Mr Trigg's case. He was a member of a partnership which purchased six loan notes on the secondary market, thereby acquiring them, rather than being the original subscriber. Each of the loan notes contained one of two types of euro conversion clause: one applied to any change in the currency of the UK; and the other only dealt with the UK adopting the euro. The former operated automatically, whereas the latter gave the issuer the right to issue a notice of redenomination.
Mr Trigg argued that these provisions did not prevent the loan notes from being QCBs, and accordingly that his share of the gain on realisation of these notes was exempt from capital gains tax. The First-tier Tribunal (FTT) agreed, but not on the main ground advanced on behalf of Mr Trigg. By the time the case reached the UT, there were three live issues. A taxpayer win on any of them was sufficient to defeat HMRC:
- In s 117(1)(b), does 'sterling' mean the lawful currency of the UK from time to time, so that the conversion provisions did not provide for conversion, etc into a currency 'other than sterling'?
- Does that reference to sterling necessarily import a requirement that sterling continues to exist as a separate currency to that to which the notes are to be converted?
- Were the conversion provisions within s 117(2)(b) safe harbour (for redemptions at the rate of exchange prevailing at redemption)?
The distinction between the first and second issues is a fairly fine one, but in finding for the taxpayer on the second issue the FTT decision catered for a possibility which had been raised by then Chancellor John Major, namely of the UK adopting the single European currency as a parallel currency to sterling. A provision which allowed conversion in such circumstances would not meet the FTT's test to allow such a loan note to retain QCB status.
The UT agrees with HMRC on all three points
Like the FTT, the UT rejected the taxpayer's principal submission. It decided that 'sterling' in s 117 means the pound sterling, and that no amount of purposive construction can result in it being given a different meaning in this context.
The FTT's decision that the expression 'currency other than sterling' imported a requirement that sterling continued to exist was dismissed in a few lines, with the UT stating that there is no warrant for such a construction, purposive or otherwise, in the plain words of s 117(1)(b). In its judgment, the conclusion that 'a currency other than sterling is any currency which is not the pound sterling' necessarily follows from the decision (which the FTT had also reached) that the reference to 'sterling' in s 117(1)(b) is to the pound sterling.
Nor was the UT willing to construe the reference to 'redemption in a currency other than sterling but at the rate of exchange prevailing at redemption' in s 117(2)(b) as applying to conversion, as well as redemption. The UT did, however, concede that if 'in substance' a provision was nothing more than a provision for redemption at the exchange rate on redemption, this would be within the s 117(2)(b) safe harbour, even if that provision was 'labelled' as a conversion.
Much of the decision addresses the scope for purposive construction of statutes generally, and s 117 in particular. The UT had the benefit of the Supreme Court's recent decision in UBS  UKSC 13 and reviewed the line of cases from Weston v Garnett  STC 1134 to Blumenthal v HMRC  SFTD 1264 specifically on s 117. Many of these involved schemes which used loan notes to convert taxable capital gains into tax-free redemption proceeds. Although all were defeated, this was not by adopting an interpretation of s 117 which differed from its literal construction. Although purposive construction did defeat the Blumenthal scheme (to create an allowable loss), the UT noted that this was an interpretation of different provisions - ss 116(10) and 272.
This was the basis for concluding that in s 117 'sterling' means the pound sterling, rather than the lawful currency of the UK from time to time; and for rejecting the FTT's conclusion that s 117(2)(b) could be purposively constructed to apply to conversions when that provision only referred to redemption.
The Court of Appeal's decision in Mayes  EWCA Civ 407 has been taken as an indication that legislation which is closely articulated, or prescriptive in nature, is less susceptible to purposive construction. Although the UT rejected such a blanket principle, it did agree that there might be 'less room' for purposive construction to give a different answer from a literal interpretation. This issue does have the feel of a debate about the number of angels which can dance on the head of a pin, but there is an important point here about the need to focus on the language used in the specific statutory provision in a prescriptive code (for example, as in UBS, whether a share is a 'restricted security') rather than arguing that the code can be ignored entirely because the transaction is, when viewed realistically, outside the scope of the particular code, which was rejected in UBS.
The UT emphasised two other points which are also worth noting. First, that a purposive interpretation of a statutory provision will often (in the UT's view, in the vast majority of cases) be the same as the literal meaning of the words used. This is at the heart of this UT decision; namely, that even purposively construed the references in s 117 to 'sterling', a 'currency other than sterling' and 'redemption' have their literal meaning. Second, that the purpose of a statutory provision is not the same as the policy behind the introduction of that provision; as the UT noted, the statutory language used by Parliament might display a narrower, or more focussed, purpose than the more general underlying policy which Parliament is legislating for. Again, this seems to be the UT's response to the debate about the relevance of the original legislative purpose - promoting the British bond market - to the interpretation of 'sterling' etc in s 117.
What about viewing facts realistically?
An interesting aspect of the decision is that only two pages address the issue of whether the particular provisions in the loan notes were provisions for 'conversion'; and, if so, whether they were for conversion into a currency 'other than sterling'.
This might be surprising, given that purposive construction requires both an interpretation of the statutory provision and then its application to the facts viewed realistically. In this case, the facts were the provisions of the loan notes.
In determining that both sets of provision were provisions for 'conversion', the UT concluded that conversion (per the decision in Klincke  STC 2032) includes any change in the character, nature, form or function of the security. Although the UT accepted that the provisions in question would not be provisions for conversion if 'no change of substance' would occur as a result of them, it concluded that this was not a possible conclusion in this case. The UT pointed out that there is no certainty that, if the UK were to adopt the euro, the relevant EU provisions would be those which are currently in force; and that, even under those rules, it is possible that there could be a transitional period before redenomination under those rules. Certainly, there were features of both provisions which were unhelpful to the taxpayer's case - for example, the first set applied if the Bank of England recognises a different currency 'or more than one currency' as the lawful currency of the UK. Accordingly, there was the possibility of a substantive change to the character, etc. of the notes. Whether a differently drafted provision (for example, one which applied automatically and only at the end of any transitional period) might not have had this effect is open to debate, particularly if - viewed realistically - the prospects of a material change to the relevant EU rules are slim.
A similar objection might be made to the UT's conclusion that the euro would not be the same currency as sterling. The relevant EU legislation stated that the euro and the national currency are to be 'units of the same currency'. It is debatable whether, viewed realistically, there really is no certainty that, if the UK were to adopt the euro as its currency, it would adopt it as the same currency.