Case No: C3/2004/1477
Neutral Citation Number: [2005] EWCA Civ 742
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
(MR JUSTICE MOSES)
CH/2003/APP/690 
Royal Courts of Justice
Strand, London, WC2A 2LL

Thursday, 16 June 2005
Before :

LORD JUSTICE PILL
LORD JUSTICE CHADWICK 
and
LORD JUSTICE BUXTON 
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Between :

	MICHAEL CHARLES WESTON	Appellant	
	- and -		
	MICHAEL GARNETT (HMIT) 	Respondent	

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(Transcript of the Handed Down Judgment of
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Mr Michael Sherry (instructed by DMH Stallard of 40 High Street, Crawley, West Sussex RH10 1BW) for the Appellant
Mr Launcelot Henderson QC and Mr David Ewart (instructed by The Solicitor for the Inland Revenue, Somerset House, London WC2R 1LB) for the  Respondent

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Judgment
Lord Justice Chadwick: 
1.	This is an appeal from an order made on 25 June 2004 by Mr Justice Moses dismissing an appeal by the taxpayer, Mr Michael Weston, under section 56A of the Taxes Management Act 1970 from the decision of the Special Commissioners (Dr John Avery Jones CBE, sitting alone) dated 29 July 2003. The issue before the special commissioner – and on this appeal – is whether certain loan notes issued in the context of a tax avoidance scheme were qualifying corporate bonds for the purposes of section 117 of the Taxation of Chargeable Gains Tax Act 1992 (“TCGA 1992”). The special commissioner held that they were not. The judge upheld his decision. The taxpayer appeals to this Court with permission granted on 26 November 2004 by Lord Justice Ward and Lord Justice Carnwath.
The underlying facts
2.	Until June 1997 the taxpayer owned 241,376 (being 51%) of the ordinary shares of 5p each in Woodgate Farms Dairy Limited (“Woodgate”). The remaining 231,910 (49%) ordinary shares in Woodgate were held, as to 81,910 shares, by five other individuals and, as to 150,000 shares by the trustees of the Mrs E M Sale Discretionary Settlement. On 15 June 1997 the taxpayer and the other shareholders in Woodgate transferred their ordinary shares in Woodgate to Carraldo Limited (“Carraldo”) by way of gift. Carraldo was a company owned, in part, by the trustees of a settlement (the Woodgate Shareholders Settlement) of which the taxpayer and the other five individual shareholders were the settlors and, in part, by the trustees of the Sale Discretionary Settlement. 
3.	The trustees of the Woodgate Shareholders Settlement had subscribed for two ordinary shares of £1 in Carraldo at the time of its incorporation on 2 April 1997. At the end of May 1997, they subscribed for a further 10,248 ordinary shares. At the same time the trustees of the Sale Discretionary Settlement subscribed for 4,750 ordinary shares of £1 each in Carraldo. The trustees of each settlement subscribed for loan notes issued by Carraldo. Loan notes to a face value of £194,670 were issued to the trustees of the Woodgate Shareholders Settlement and loan notes to a face value of £90,330 were issued to the trustees of the Sale Discretionary Settlement. 
4.	On 23 February 1998 the shares and loan notes issued by Carraldo were purchased from the trustees of the two settlements by Dale Farm Dairy Group Limited. At the same time the purchaser acquired the preference shares and deferred shares in Woodgate not owned by Carraldo. The total purchase consideration was in excess of £17 million. Of that sum £466,800 (net of costs) was received by the trustees of the Woodgate Shareholders Settlement in respect of the Carraldo shares and £8,865,565 (net of costs) was received by them in respect of the loan notes. That represented a price of £47.473 for each £1 ordinary share and a price of £474.733 for each £10 loan note. 
5.	Gains accrued to the trustees of the Woodgate Shareholders Settlement on the disposal to Dale Farm Dairy Group Limited of the Carraldo shares and the loan notes. But the individuals who were formerly the holders of ordinary shares in Woodgate, and who were the settlors in respect of the Woodgate Shareholders Settlement, had interests in possession under the trusts of that settlement. Accordingly, they – and not the trustees – were treated as the persons to whom chargeable gains had accrued – section 77(1) TCGA 1992. In particular, the proportion of the chargeable gains which fell to be treated as having accrued to the taxpayer was equal to his proportionate interest in the trust fund under clause 5 of the settlement (74.664%). That was the proportion which his holding of ordinary shares in Woodgate (241,376) bore to the total of the holdings of the individual shareholders (323,286).   
6.	The taxpayer was entitled to (and did) claim hold-over relief under section 165 TCGA 1992 in respect of the disposal of the ordinary shares in Woodgate to Carraldo under the gift of 15 June 1997. The effect of the scheme by which Woodgate was sold to the outside purchaser, Dale Farm Dairy Group Limited, was to transfer the gains that would otherwise have accrued to the taxpayer and the other individual shareholders on their disposal of the holdings of ordinary shares in Woodgate to the gain which was treated as having accrued to them (under section 77 TCGA 1992) on the disposal by the trustees of the Woodgate Shareholders Settlement of the ordinary shares and loan notes in Carraldo. In particular, the effect was to transfer some 95% of those gains to the gain on the loan notes. As the special commissioner observed, at paragraph 6 of his decision dated 29 July 2003: “The result that the [taxpayer] hoped to achieve by these transactions was freedom from capital gains on what was previously the gain on the shares in Woodgate to the extent to which this was then represented by the value of the loan notes, on the basis that they were qualifying corporate bonds the gain on which was not liable to capital gains tax”. Whether that result was achieved depends, of course, on whether the loan notes were qualifying corporate bonds for the purposes of section 115 TCGA 1992.
The statutory provisions
7.	Section 1(1) TCGA 1992 imposes a tax in respect of chargeable gains accruing to a person on the disposal of assets. Section 2(1) TCGA 1992 provides that, subject to any exceptions provided by the Act, a person shall be chargeable to capital gains tax in respect of chargeable gains accruing to him in a year of assessment during any part of which he is resident in the United Kingdom, or during which he is ordinarily resident in the United Kingdom. 
8.	Section 115(1) TCGA 1992 provides an exemption for gilt-edged securities and qualifying corporate bonds. It is in these terms:
“A gain which accrues on the disposal by any person of –
(a)	gilt-edged securities or qualifying corporate bonds, or
(b)	any option or contract to acquire or dispose of gilt-edged securities or qualifying corporate bonds,
shall not be a chargeable gain.”
9.	In that context “qualifying corporate bond” has the meaning given by section 117 TCGA 1992. The section (in the form in which it was in force in the relevant year of assessment) is in these terms (so far as material to persons chargeable to capital gains tax, rather than corporation tax):
“ (1)	For the purposes of this section, a ‘corporate bond’ is a security, as defined in section 132(3)(b) –
(a)	the debt on which represents and has at all times represented a normal commercial loan; and
(b)	which is expressed in sterling and in respect of which no provision is made for conversion into, or redemption in, a currency other than sterling,
and in paragraph (a) above ‘normal commercial loan’ has the meaning which would be given by sub-paragraph (5) of paragraph 1 of Schedule 18 to the [Income and Corporation Taxes Act 1988] if for paragraph (a)(i) to (iii) of that sub-paragraph there were substituted the words ‘corporate bonds (within the meaning of section 117 of the 1992 Act)’. 
. . .
(2AA)	For the purposes of this section ‘corporate bond’ also includes any asset which is not included in the definition in subsection (1) above and which is a relevant discounted security for the purposes of Schedule 13 to the Finance Act 1996.
. . . 
(7)	Subject to subsections (9) and (10) below, for the purposes of this Act a corporate bond –
(a)	is a ‘qualifying corporate bond’ if it is issued after 13 March 1984; . . .
. . . 
(8A)	A corporate bond falling within subsection (2AA) above is a qualifying corporate bond whatever its date of issue.
. . . ”
10.	Schedule 18 to the Income and Corporation Taxes Act 1988 (“ICTA 1988”) contains provisions for the interpretation of Chapter IV, Part X ICTA 1988 (“Group Relief”): section 413(10) ICTA 1988. In particular, paragraph 1, schedule 18 contains provisions which determine whether one (corporate) person is an equity holder of another for the purposes of section 413(7) to (9). In that context “an equity holder of a company is any person who (a) holds ordinary shares in the company, or (b) is a loan creditor of the company in respect of a loan which is not a normal commercial loan”: paragraph 1(1). Sub-paragraph (5) of paragraph 1 defines “normal commercial loan” for that purpose. It is in these terms (so far as material):
“In sub-paragraph (1)(b) above ‘normal commercial loan’ means a loan of or including new consideration and –
(a)	which does not carry any right either to conversion into shares or securities of any other description except –
(i)	shares to which sub-paragraph (5A) below applies,
(ii)	securities to which sub-paragraph (5B) below applies, or
(iii)	shares or securities in the company’s quoted parent company
or to the acquisition of any additional shares or securities;
(b)	. . . 
(c)	. . . ”
I need not set out the text of sub-paragraphs (b) and (c). It is common ground that the requirements in those sub-paragraphs are met in the present case. 
11.	It is common ground, also, that the effect of reading section 117(1) TCGA 1992 with paragraph 1(5) of schedule 18 ICTA 1988, as the section requires, is that, in order to qualify as a corporate bond under section 117(1) TCGA 1992, the ‘security’ must be one the debt on which represents and has at all times represented “a loan of or including new consideration and which does not carry any right either to conversion into shares or securities of any other description except corporate bonds within the meaning of section 117 TCGA 1992 or to the acquisition of any additional shares or securities”.
12.	An asset which does not qualify as a corporate bond under subsection (1) of section 117 TCGA 1992 may, nevertheless, be a corporate bond for the purposes of that section if it falls within subsection (2AA) – that is to say, it is an asset “which is not included in the definition in subsection (1) above and which is a relevant discounted security for the purposes of Schedule 13 to the Finance Act 1996”.  Paragraph 3(1) of schedule 13 to the Finance Act 1996 (“FA 1996”) defines “relevant discounted security” for the purposes of that schedule as “any security which (whenever issued) is such that, taking the security as at the time of its issue, the amount payable on redemption (a) on maturity, or (b) in the case of a security of which there may be a redemption before maturity, on at least one of the occasions on which it may be redeemed, is or would be an amount involving a deep gain, or might be an amount which would involve a deep gain”. In that context, “the amount payable on redemption of a security involves a deep gain if (a) the issue price is less than the amount so payable; and (b) the amount by which it is less represents more than the relevant percentage of the amount so payable” – paragraph 3(3) of schedule 13 FA 1996. The relevant percentage is defined by paragraph 3(4) of schedule 13: for present purposes it is enough to note that, where the period between the date of issue and the date of redemption is less than thirty years, the relevant percentage is the figure equal to one half of the number of years between those dates. 
13.	The short question on this appeal is whether the loan notes, the disposal of which by the trustees of the Woodgate Shareholders Settlement has given rise to a gain, are securities which satisfy the requirement under section 117(1) TCGA 1992. It is not suggested that those loan notes would, themselves, fall within section 117(2AA). If they are within section 117(1), the scheme succeeds and the appeal must be allowed. If not, the appeal fails. In addressing that question it is immaterial that the arrangements were carried through in implementation of a scheme devised to avoid a charge to capital gains tax.
The loan notes
14.	The loan notes were created by an instrument dated 30 May 1997 under the seal of Carraldo pursuant to a resolution of its board of directors passed that day. The principal amount of the notes was limited to £285,000. The notes were to be issued in denominations of £10 and were to rank as unsecured obligations of the company. They were to carry interest at the rate of 10% per annum, payable monthly in arrears. Unless previously redeemed or converted they were to be redeemed by the company at par on the fifth anniversary of the date of issue.
15.	The right to convert the loan notes is conferred by clause 5 (Conversion):
“A Noteholder may:
5.1	(i)	during the Option Period; or
(ii)	. . . 
Convert from time to time any unredeemed and previously unconverted Loan Note irrevocably into a new loan note of the same par value issued in accordance with and subject to the terms and conditions of the draft instrument set out in the Second Schedule hereto
5.2	. . . the Noteholder shall exercise the option to convert by giving . . . written notice to the Company . . . 
. . .
5.4	Upon receiving the written notice the Company shall forthwith execute a new loan instrument in the terms set out in the Second Schedule hereto 
5.5	On the Conversion Date the Noteholder shall surrender the Certificate to the Company whereupon the Loan Note shall be cancelled and the Company shall issue a certificate in respect of the said new loan note in the terms set out in the schedule to the draft instrument in the Second Schedule hereto.”
In that context “the Option Period” means the period of four years commencing six months from the date of issue of a Loan Note – clause 1.1.
16.	It can be seen that the right to convert conferred by clause 5 (in its amended form) is a right to convert an existing unredeemed and previously unconverted Loan Note (“the first loan note”) into a new loan note of the same par value (“the second loan note”) issued in accordance with and subject to the terms and conditions of the instrument set out (in draft) in the second schedule. The execution of the second loan note instrument is authorised by clause 5.4 of the first loan note instrument (as substituted by the deed of 10 June 1997). That is reflected in clause 2.3 of the draft of the second loan note instrument:
“The Loan Notes shall only be issued at such times and on such terms as are provided for in the instrument relating to loan notes made by the Company on the 30th day of May 1997 [the first loan note instrument] subject always to the terms of this Instrument [the second loan note instrument].”
17.	Having in mind the requirement that, in order to qualify as a corporate bond for the purposes of section 115(1)(a) TCGA 1992, the first loan note must be one which does not carry any right to conversion into shares or securities of any other description except corporate bonds within the meaning of section 117 TCGA 1992, it is necessary to ask what rights the second loan note would confer and, in particular, whether the second loan note would itself be a corporate bond within section 117(2). For that purpose it is necessary to consider the terms of the instrument by which the second loan notes (if issued) would be constituted.
18.	 The principal amount of the second loan notes, also, was to be limited to £285,000. And, as in the case of the first loan notes, the second loan notes were to be issued in denominations of £10 and were to rank as unsecured obligations of the company. But they were to carry no interest and, unless previously redeemed or converted they were to be redeemed by the company on the ninth anniversary of the date of issue at a price equal to £2 per £1 par value.
19.	The second loan notes, also, were to carry a right to convert. And, again, that right was to be conferred by clause 5 of the instrument by which the notes were to be constituted. The clause, as it appears in the draft which is set out in the second schedule to the instrument dated 30 May 1997 (by which the first loan notes are constituted) is in these terms, so far as material:
“5.1	During the Option Period . . . a Noteholder may convert from time to time any unredeemed and previously unconverted Loan Note irrevocably into X £1 ordinary shares in the capital of the Company such shares to be issued as fully paid ranking pari passu with the existing ordinary shares of £1 each in the capital of the Company where X equals the aggregate of the par value of such Loan Note and the Accrued Discount thereon.
. . . 
5.4	On the Conversion Date the Noteholder shall surrender the Certificate to the Company whereupon the Loan Note shall be cancelled and the Company shall issue the appropriate number of £1 ordinary shares pursuant to clause 5.1.”
The Option Period, in relation to the second loan notes, was the period of six months from the date of issue. “Accrued Discount” means “that proportion of the difference between the Redemption Price [£2 per £1 par value] and the par value of a Loan Note as is equal to the proportion that the period from the date of issue of such Loan Note to the Conversion Date bears to the period from the date of issue to the Redemption Date [nine years].” 
20.	It is plain that the second loan notes would not fall within section 117(1) TCGA 1992 – for the reason that they do carry the right to conversion into shares in Carraldo and so cannot meet the requirement in paragraph 1(5) of schedule 18 ICTA 1988. But it is common ground that a second loan note would be a relevant discounted security within the meaning of paragraph 3(1) of schedule 13 FA 1996. That is because, taking the note at the time of its issue, the amount payable on maturity would be an amount involving a deep gain – as defined in paragraphs 3(3) and (4) of schedule 13. It follows that the second loan notes would fall within section 117(2AA) TCGA 1992, and would, for that reason, be corporate bonds for the purposes of section 117 TCGA 1992.
21.	On the basis that the second loan notes would be corporate bonds for the purposes of section 117 TCGA 1992 – which, as I have said, is common ground – the submission on behalf of the taxpayer is put simply and (if I may say so) has some superficial attraction. It may be summarised as follows: (i) The debt on the first loan notes would represent a normal commercial loan (for the purposes of section 117(1) TCGA 1992) if it were not for the fact that the first loan notes carry a right to conversion; but (ii) the only right to conversion is a right to convert the first loan notes into the second loan notes and (iii) the second loan notes are themselves corporate bonds within the meaning of section 117; so (iv) notwithstanding the right of conversion, the debt on the first loan notes remains a normal commercial loan and (v) the first loan notes satisfy the requirement in section 117(1) TCGA 1992 and are corporate bonds for the purposes of section 117 and qualifying corporate bonds for the purposes of section 115(1)(a) TCGA 1992.
22.	The submission on behalf of the revenue – which found favour with the special commissioner and the judge – is that the right to convert the first loan notes into the second loan notes carries with it the right (conferred in terms in the second loan notes) to convert the underlying loan into shares; and that that prevents the                                                                                                                                                                                                                                                                                                         debt on the first loan notes from representing a normal commercial loan for the purposes of section 117(1) TCGA 1992. It is immaterial that the second loan notes would, themselves, be corporate bonds within section 117(2AA) TCGA 1992.    
The special commissioner’s decision
23.	The special commissioner set out the facts as they appeared from a statement agreed between the parties. I have already summarised the facts which gave rise to the gain on the disposal of the first loan notes by the trustees of the Woodgate Shareholders Settlement; and I need not rehearse them here. It is enough, I think, to set out the following paragraphs of the agreed statement:
“(10)	The Appellant sold his 270,000 £1 preference shares for consideration (net of fees) of £300,111 and 12,861 5 p deferred shares in Woodgate for net consideration of £384,813.
. . . 
 (12)	The Appellant included in his 1997/98 tax return chargeable gains on the disposal of his personal holding of £1 cumulative preference shares and 5p deferred convertible shares in Woodgate, and his share of the gain arising to the Woodgate Shareholders Settlement on the sale of the ordinary shares in Carraldo.
(13)  No gain was included in respect of the sale of the Carraldo loan notes by the Woodgate Shareholders Settlement. The Appellant disclosed on his 1997/98 tax return that the loan notes had been disposed of and provided detailed paperwork and an analysis, which concluded that the loan notes were qualifying corporate bonds and hence, by virtue of section 115 of the Taxation of Chargeable Gains Act 1992, any gain accruing on their disposal was not chargeable.
(14)	The Respondent Inspector of Taxes opened an enquiry into the taxpayer’s return for 1997/98, and contended that the Carraldo loan notes were not qualifying corporate bonds, that a chargeable gain arose on the disposal of those loan notes by the Woodgate Shareholders Settlement, and that 241,376/323,286 of that gain was chargeable on the Appellant by virtue of section 77 of the Taxation of Chargeable Gains Act 1992.
(15)	As the parties were unable to agree, on 21 October 2002 the inspector wrote to the Appellant to notify him that he was amending the Appellant’s self-assessment for 1997/98 to increase the tax due by £2,647,729.20.
(16) On 31 October 2002 an appeal against the inspector’s amendment of the self assessment was lodged on behalf of the Appellant”
24.	As I have already indicated, the special commissioner dismissed the taxpayer’s appeal from the inspector’s amendment of the self assessment. After setting out the statutory provisions and the contentions of the parties he gave his reasons at paragraph 15 of his decision ([2003] STC (SCD) 403):
“I start by setting out again paragraph 1(5) of Schedule 18 in its modified form:
‘…normal commercial loan means a loan of or including new consideration and –
(a)	which does not carry any right either to conversion into shares or securities of any other description except corporate bonds (within the meaning of section 117 of the 1992 Act)
or to the acquisition of any additional shares or securities.’
The question is whether the first loan note carries ‘any right’ to conversion into something other than corporate bonds, namely whether it carries any right to convert into Carraldo ordinary shares. It seems to me that on the ordinary meaning of language it plainly does. That right is an indirect right, in that in order to obtain Carraldo ordinary shares the noteholder must (a) wait six months, (b) complete a conversion notice, (c) receive the second loan note on cancellation of the first loan note, (d) wait another six months, and (e) complete another conversion notice. Other than effluxion of time and completing the conversion notices the holder of the first notes has an absolute right from the start to convert into the ordinary shares, which is a right granted by the terms of the first loan notes. It is of course the case that the first loan note ceases to exist before the right to convert the second loan note becomes exercisable, but that is not relevant to the question whether the first loan note carries the right to convert. That interpretation corresponds also to the commercial reality that on sale the loan notes had virtually the same value as the ordinary shares into which they were indirectly convertible attributed to them on the sale to the outside purchaser.”
The appeal to the High Court
25.	The taxpayer appealed to the High Court. The appeal came before Mr Justice Moses, sitting as a Judge of the Chancery Division. I am conscious that it does less than justice to his careful judgment ([2004] EWHC 1607 (Ch), [2005] STC 617) merely to say that he dismissed the appeal for substantially the same reason as that which had led the special commissioner to uphold the inspector’s decision – that the rights conferred by the first loan notes included the right to convert (albeit indirectly by the exercise of rights conferred by the second loan notes) into ordinary shares in Carraldo. But that is how the judge himself put it in the concluding paragraph of his judgment:
“I rest my decision on the wording of section 117(1). The rights carried by the first loan notes included the rights to convert into the shares of Carraldo, and the process by which those rights could be exercised was mere machinery. Those rights fell within section 117 and preclude the characterisation of those loan notes as normal commercial loans within the meaning of that section. For those reasons, which do no more than echo the reasoning of [the special commissioner] at paragraph 15 of his decision, this appeal is dismissed.”
This appeal
26.	As I have said, the short question on this appeal is whether the first loan notes, the disposal of which has given rise to a gain, are qualifying corporate bonds for the purposes of section 115(1)(a) TCGA 1992. The appellant accepts that the answer to that question turns on whether the right to convert the second loan notes into Carraldo shares - which would have been carried by the second loan notes, had they been issued – is properly to be regarded as a right to conversion carried by the first loan notes. If it is, the debt underlying the first loan notes was not a normal commercial loan; the first loan notes are not corporate bonds for the purposes of section 117 TCGA 1992 and, accordingly, are not qualifying corporate bonds.
27.	The appellant submits, first, that – on a proper analysis - there is no right to convert the first loan notes into shares; and, second, that (if there were) that right would not be a right carried by the first loan notes. He points out the distinctions between the first loan notes and the second loan notes; and emphasises that “the right to conversion into shares” is a right which cannot be exercised until six months after the date on which the first loan note has ceased to exist. So, it is said, whatever it is that is “converted” into shares, it cannot be the first loan note. The only security of any description into which the first loan note can be converted is the second loan note. There is no right to convert the first loan note into shares for the simple reason that the first loan note is not capable of being converted into shares.  
28.	That analysis, as it seems to me, fails to give proper effect to the statutory language. It is important to keep in mind the words that Parliament has used in section 117(1) TCGA 1992: “For the purposes of this section, a ‘corporate bond’ is a security, as defined in section 132(3)(b) . . . the debt on which represents and has at all times represented a normal commercial loan”. The statutory language makes a distinction between the ‘security’ and ‘the debt on [the security]’. ‘Security’ is defined by section 132(3)(b) TCGA 1992: it includes “any loan stock or similar security . . . of any company, and whether secured or unsecured”. In the present context it is the loan note which is the security; but it is the underlying loan, which the loan note secures, which is the debt; and it is the underlying loan which must satisfy the condition that it “represents and has at all times represented a normal commercial loan”.
29.	The point is made by the terms of the resolution by which Carraldo authorised the execution of the instruments under which the loan notes were issued or to be issued. The minutes of a meeting of directors held on 30 May 1997 record:
“LOAN TO COMPANY		
There was produced to the meeting a draft copy of a loan note instrument proposed to be executed by the company by virtue of which the company may obtain medium term loan funding of up to £285,000 for a period of five years.”
That is the resolution to which both the recital in the instrument dated 30 May 1997 (the first loan note instrument) and the recital in the draft instrument set out in the second schedule thereto (the draft second loan note instrument) refer. It is also the resolution which authorises the issue of the second loan notes. That is made clear in clause 5.4 of the first loan note instrument (as substituted by the deed of 10 June 1997) and by clause 2.3 of the draft second loan note instrument. It is the resolution referred to both in the first loan note certificates which were issued and in the draft of the second loan certificates, which appears as a schedule to the draft second loan note certificate. The documentation is consistent – and only consistent – with a single underlying loan: the loan authorised by the resolution of 30 May 1997.
30.	The issue, therefore, is whether that loan, or the debt to which it gave rise, “represents and has at all times represented a normal commercial loan”. It is in relation to that loan that it is necessary to ask the question posed by paragraph 1(5) of schedule 18 ICTA 1988 (read with section 117(1) TCGA 1992): does that loan “carry any right either to conversion into shares or securities of any other description except corporate bonds within the meaning of section 117 TCGA 1992 or to the acquisition of any additional shares or securities”?
31.	I hope that it will not be thought lacking in courtesy to the elaborate and skilful arguments deployed by counsel for the taxpayer – both at the hearing when permission to bring this (a second) appeal was granted and at the hearing of that appeal before us - if I say that, to my mind, there can only be one answer to that question. The loan is not, and never has been a normal commercial loan. The loan was made on terms that the debt could be converted into shares in the company. The right to convert the loan into shares – albeit by a series of steps (all of which lay within the control of the lender) – was an essential term of the bargain between lender and borrower. At the risk of stating the obvious: if the loan had not carried the right to conversion into Carraldo shares, no loan would have been made. The whole object of the loan, in the context of the tax avoidance scheme in which lender and borrower were engaged, was to ensure that the value of the existing Carraldo shares was diluted by the prospect that further shares would, or could, be issued at or near to par (after taking account of the Accrued Discount formula) in the future.  That object could only be achieved by conferring on the holders of the first loan notes a present right – that is to say, a right which was in existence at the time when the existing Carraldo shares were to be transferred – to require conversion of the loan into shares. It is immaterial that the present right could not be exercised until some time in the future, or that it might never be exercised.   
32.	Counsel for the taxpayer sought to persuade us that there was a distinction, in the context of paragraph 1(5) of schedule 18 ICTA, between a ‘direct’ right to conversion into shares and an ‘indirect’ right; that this distinction could be seen in the provisions of paragraphs 1(5A) and (5B) – which, it is said, are concerned with indirect, or secondary, rights to conversion; and that the rights to conversion with which paragraph 1(5) was concerned are limited to direct rights. 
33.	For my part I doubt whether the supposed distinction has any relevance in the circumstances of the present case. Once it is realised that the relevant question is whether the underlying loan carries any right to conversion into shares; and that loan remains the same loan notwithstanding that the first loan notes are replaced by the second loan notes, the basis for an argument based on a distinction between direct and indirect rights falls away. But the argument was developed before us and I will address it.
34.	The judge had set out the appellant’s submissions on the point at some length (at paragraphs 27 to 42 of his judgment), but had not found it necessary to decide the point – although his observations at paragraphs 46 and 47 give the point no support. He did not decide the point because, as he observed at paragraph 43 of his judgment:
“The short answer to these submissions seems to me that an analysis of the meaning of the words “any right to conversion into shares” in schedule 18 are of no assistance in the construction of section 117. Section 117 is not in any way concerned with group relief or the identification of an equity holder for that purpose. Section 117 is merely concerned with the meaning of a QCB for the purposes of capital gains tax”.
	And, after remarking on “the vices of legislation by reference”, he went on to say that there was “no basis for seeking the correct construction of the words used to define a normal commercial loan within section 117 by reference to the meaning of those words in the wholly different context of schedule 18 merely because they have been borrowed from that source. . . . The wording in section 117, which is better understood when set out in full, provides its own discrete meaning of a normal commercial loan without the need for any reference back to the original unmodified source of that definition”.
35.  Counsel submits, in this Court, that the judge’s approach gives insufficient weight to the direction, in section 117(1) TCGA 1992, that “in paragraph (a) above ‘normal commercial loan’ has the meaning which would be given by [paragraph 1(5) of Schedule 18 ICTA 1988]” if the relevant substitution were made. He submits that the court must first construe paragraph 1(5) of schedule 18 in the context of that schedule (and in an unmodified form) in order to decide what meaning is to be given (in that context) to the phrase “which does not carry any right . . . to conversion”. Having held (as he would invite the court to do) that that phrase (in that context) is to have the meaning “which does not carry any direct right . . . to conversion”, the court must then give the phrase the same meaning when construing paragraph 1(5) in its modified form (after making the substitution) in the context of section 117(1) TCGA 1992.
36.	For my part I can see some force in the submission that a direction that, in section 117(1)(a) TCGA 1992, ‘normal commercial loan’ has the meaning which would be given by paragraph 1(5) of schedule 18 ICTA 1988 if the relevant substitution were made, requires the court to decide what meaning ‘normal commercial loan’ would have in the context of that schedule if paragraph 1(5) were construed (in that context) in the modified form; and then to give the phrase the same meaning in section 117(1)(a) TCGA 1992. It may, perhaps, be seen as a curious form of legislative draftsmanship (even in a tax statute) to provide that a phrase shall have the meaning in one statutory provision that it would have had in another (unconnected) statutory provision if it had appeared in the latter provision in a modified form. But that is not an impossible way of defining the meaning which a phrase is intended to have in the former provision. And it can be said that that is what the draftsman has done in this case.
37.	But if that were what the direction in section 117(1) TCGA 1992 required, it would be of no assistance to the appellant. The reason is that, if paragraph 1(5) is construed in the context of schedule 18 ICTA 1988 in the modified form (that is to say, after making the substitution for which section 117(1) TCGA provides), the link between paragraph 1(5) and paragraphs 1(5A) and (5B) on which the appellant relies will no longer exist. Sub-paragraphs (a)(i), (ii), and (iii) of paragraph 1(5) will not be there; and there will be no foundation upon which to base an argument that the provisions seek to distinguish between direct and indirect rights to conversion. 
38.	 It is, perhaps, for that reason that the appellant does not seek to rely on a submission in   the form to which I have just referred. As I have said he invites the court to construe paragraph 1(5) of schedule 18 in the context of that schedule in an unmodified form in order to decide what meaning is to be given (in that context) to the phrase “which does not carry any right . . . to conversion”; and then, having held that that phrase is to have the meaning “which does not carry any direct right . . . to conversion”, to give the phrase the same meaning when construing paragraph 1(5) in its modified form (after making the substitution) in the context of section 117(1) TCGA 1992. On any view, that is not what the direction in section 117(1) requires. 
Conclusion
39.	For the reasons which I have set out, I would dismiss this appeal.
Lord Justice Buxton: 

40.	I gratefully adopt the account of the legislation and the analysis of the issues that is to be found in the judgment of Chadwick LJ.  I agree with him that this appeal should be dismissed.
41.	The notes to the Current Law Statutes edition of the Finance Act 1984, the predecessor legislation to sections 115 and following of the (consolidating) 1992 Act, report that the exemption from capital gains tax of “corporate bonds” was introduced in order to stimulate the British bond market.  That accounts for the requirement in section 117(1) of the 1992 Act, otherwise difficult to explain (or justify), that to gain exemption bonds must be denominated in sterling and not be convertible into any other currency.

42.	Care was accordingly taken to ensure that the exemption only extended to bonds that were genuinely traded in that market; and more generally to ensure that the exemption could not be used as a vehicle for avoidance. That is achieved in section 117(1) by limiting qualifying bonds to those that support normal commercial loans.  The adopted sub-paragraphs of 1(5) of schedule 18 to the 1988 Act, themselves intended to prevent the misuse of group relief, are principally directed at excluding any loan that gives the loan creditor an actual or potential interest in the debtor company or its performance.   That is to ensure that the creditor’s participation in the bond market is as an ordinary investor in that market, and not for any other or wider motive.

43.	This background in itself makes it very unlikely indeed that Parliament could have countenanced the possibility of a holder of bonds whose derivatives could be converted into shares being exempt from capital gains tax on the disposal of those bonds.  The purchase of such bonds would not be an orthodox participation in the bond market, nor would such bonds be generally available to ordinary investors in the market.   However, even leaving those general considerations aside, as my Lord has set out that claim is excluded in any event by the plain and detailed words of the legislation.

44.	The argument before us was confused by being focussed on whether it was right to say that the original bonds carried a right to conversion into shares.  It is of course those bonds that are claimed to be exempt from capital gains tax on disposal.  But the statutory test for whether that end has been achieved does not turn on the nature of the bond, but on the nature of the debt or loan relationship that the bond represents.  That is entirely clear from the simple wording of sections 117 (A1) and (1) of the 1992 Act.  Accordingly, and as my Lord emphasises in his paragraph 30, the question posed by paragraph 1(5) of Schedule 18 to the 1988 Act is whether the loan in return for which the bond was issued carries any right to conversion into shares.   I agree with him that there is only one possible answer to that question.  The notion of a loan being convertible into shares is a perfectly intelligible, indeed common, arrangement.  It arises when the creditor has a right, as such creditor and by no other title, to call for the issue to him of shares in the company.   The loan notes in this case by their very terms conferred that right on the subscribers to them, albeit by the operation of a slightly unorthodox machinery.  That was enough to take the loans in respect of which they were issued squarely outside the statutory definition of a normal commercial loan.

Lord Justice Pill:

45.	For the reasons given by Lord Justice Chadwick I agree that the appeal should be dismissed.