THE HIGH COURT
REVENUE
			1999 No. 351R
BETWEEN
PATRICK J O'CONNELL, INSPECTOR OF TAXES
			APPELLANT
AND
THOMAS KELEGHAN
			RESPONDENT
JUDGMENT of Mr Justice McCracken delivered the 11th day of February, 2000.
	This is a Case Stated by the Appeal Commissioners pursuant to Section 428 of the Income Tax Act, 1967 for the decision of the High Court.
	There are in fact, two separate assessments which basically arise out of the same series of transactions, one being an Income Tax assessment and the other being a Capital Gains Tax assessment.  

The Facts
	In the Case Stated the Appeal Commissioners found the following facts proved or admitted:-
	"(a)	The Respondent acquired 2,151 IR£1 Ordinary shares in Gladebrook Limited in December, 1988.  Gladebrook Limited held 49% of the share capital of Sugar Distributors (Holdings) Limited, which in turn held 100% of the share capital of Sugar Distributors Limited.
	(b)	By way of a share purchase agreement dated 8th February, 1990, the Respondent and others sold their shares in Gladebrook Limited to Siucre Eireann CPT for a total consideration of IR£8.6 million to be satisfied by the issue of loan notes by Siucre Eireann CPT.  
	(c)	The nominal amount of the loan note received by the Respondent was IR£1,867,068.00.
	(d)	A chargeable gain did not accrue to the Respondent on the sale of his shares in Gladebrook Limited to Siucre Eireann CPT as it was accepted that the provisions of paragraph 4 of schedule 2 to the Capital Gains Tax Act, 1975 applied to that transaction.
	(e)	On 8th February, 1990 the Respondent signed a service agreement (exhibit 3) with Siucre Eireann CPT.
	(f)	On 8th February, 1990 the Respondent also signed a "side letter" (exhibit 2) addressed to Siucre Eireann CPT
	(g)	Prior to the signing of the service agreement, the Respondent was Sales Director of Sugar Distributors Limited.  He never became an employee of Siucre Eireann CPT but remained as Sales Director of Sugar Distributors Limited until his retirement in June, 1991, when he was 65 years of age.
	(h)	The Respondent's loan note was redeemed for cash in February, 1993."

	The basic transaction was the purchase by Siucre Eireann CPT (hereinafter called the "purchaser") of the entire issued share capital of Gladebrook Limited, which transaction is governed by an agreement dated 8th February, 1990 between the purchaser and the five shareholders of Gladebrook Limited, one of whom is the Respondent.  This agreement provided that the total consideration payable by the purchaser would be the sum of IR£8,680,000.00, and further provided that:-
	"The purchase consideration shall be satisfied by the issue by the purchaser 	on completion of the loan notes to the vendors."

	The form of loan note was set out in a schedule to the agreement.  The loan notes themselves provided that they could be redeemed in whole or part on 30 days notice, the earliest date for redemption being 1st November, 1991 and the latest date for redemption being 31st October, 1997.  Interest was to be payable from 31st October, 1991 on the amount outstanding.  There were detailed provisions in the loan notes as to registration and the issue of certificates and it was expressly provided in the conditions of issue of the loan notes that:-
	"Except in the case of the death of a note holder no loan note or any part thereof shall be transferable or assignable by any note holder."

	Furthermore, on the face of the loan note itself it was stated:-

	"No loan note or any part thereof is transferable or assignable by any note holder."

	The share purchase agreement also contained certain provisions whereby the holder of a loan note could convert the note into shares in the purchaser in the event of a public flotation or in the event of a placing, but if such a flotation or placing took place prior to 1st October, 1991 the loan note would be converted at a discount calculated on a sliding scale.
	In addition to the share purchase agreement, the Respondent also signed a side letter with the purchaser on 8th February, 1990, the relevant portion of which reads as follows:-
	"In relation to the sale of my shares in Gladebook Limited to Siucre Eireann CPT I confirm that notwithstanding the terms of the share purchase agreement dated the 8th day of February, 1990 between amongst others, myself, Siucre Eireann CPT, Gladebrook Limited and Talmino Limited that IR£250,000 of the purchase consideration stated therein was paid as an inducement for me to enter into the service contract (as defined in the said share purchase agreement) and accordingly, in the event of my not complying with the terms of the said service contract that portion of the IR£250,000 purchase consideration attributable to the sale of my shares in Gladebrook Limited will become payable by me to Siucre Eireann CPT."
	
	On the same day the Respondent entered into a service agreement with the purchaser which provided, inter alia:-
	"1.	The company shall employ the executive and the executive shall serve the company as Sales Director responsible for selling sugar and such other sales as Group General Manager of the flour division for the time being of the company (the General Manager) shall decide.  Subject to the provisions for determination of this agreement hereinafter contained such employment shall be for a period of 18 months commencing on the 1st day of January, 1990 and expiring on the 30th day of June, 1991 and shall continue thereafter unless and until terminated by either party by the service of three months written notice on the other party.  
	2.	As an executive of the company the executive shall:-
		(a)	undertake such duties and exercise such powers in relation to the company and its business as the General Manager shall from to time assign to or vest in him."
	
	The service agreement also contained a detailed non-competition clause and other provisions which it is not necessary to set out in detail by reason of the finding of fact by the Appeal Commissioners that the Respondent never became an employee of the purchaser.  
	
Assessment for Income Tax
	The Appellant claims that the £250,000 referred to in the side letter is liable to income tax under schedule E.  The charging section in respect of schedule E tax is set out Section 110 of the Income Tax Act, 1967 as amended.  Subsection 1(1) reads as follows:-
	"Tax under Schedule E shall be annually charged on every person having or exercising an office or employment of profit mentioned in that schedule, or to whom any annuity, pension or stipend, chargeable under that schedule, is payable, in respect of all salaries, fees, wages, perquisites or profits whatsoever therefrom and shall be computed on the amount of all such salaries, fees, wages, perquisites or profits whatsoever therefrom for the year of assessment."
	
	This being a Case Stated, I am bound by the facts as found by the Appeal Commissioners, and in particular I must accept that the Respondent was never employed by the purchaser.  The section imposes the charge on persons having or exercising an office for employment of profit in respect of income of various kinds received by him "therefrom", that is from the office or employment of profit.  If he had no such office or employment, he could have received no income therefrom, and therefore could have no liability under Schedule E.

Capital Gains Tax Assessment.
	The issue in this case is whether the redemption of the loan notes for cash in February, 1993 gave rise to a chargeable gain upon which Capital Gains Tax is payable.  Capital Gains Tax is payable in respect of chargeable gains on the disposal of assets, and the scheme of the Act as set out in Section 11(2) is that all such gains are chargeable unless there is a provision to the contrary in the Act.  There are in fact a number of provisions to the contrary in the Act, two of which fall to be dealt with in the present case.  The first point which arises is the nature of the asset which was disposed of in February, 1993, and the second point is whether, if such disposal was the disposal of a debt, it gave rise to a chargeable gain.  

Nature of the Disposal.
	The original transaction in this case was one whereby the Respondent sold his shares in Gladebrook Limited and received in return for those shares a loan note issued by the purchaser.  This undoubtedly gave rise to a capital gain, but that gain was not a chargeable gain by virtue of the provision of paragraph 2 of the second schedule to the Capital Gains Tax Act.  That paragraph dealt with the reorganisation or reduction of share capital of a company, and subparagraph 2 thereof reads as follows:-
	
	"Subject to the following subparagraphs, a reorganisation or a reduction of a company's share capital shall not be treated as involving any disposal of the original shares or any acquisition of the new holding or any part of it but the original shares (taken as a single asset) and the new holding (taken as a single asset) shall be treated as the same asset acquired as the original shares were acquired."
	
	It is common case that the sale of the shares and the acquisition of the loan note is governed by this subparagraph, and that no tax was payable on that transaction.  However, there is considerable dispute over the effect of this provision, and in particular over the meaning of the phrase "the original shares (taken as a single asset) and the new holding (taken as a single asset) shall be treated as the same asset acquired as the original shares were acquired."  
	The primary intention of this provision is quite clear.  It is to ensure that, while no tax shall be payable on the substitution of one asset for another on the reorganisation of a company, nevertheless where there is an ultimate realisation of the secondly acquired asset, the amount of the gain should be assessed by reference back to the cost of the original asset.  It is contended by the Appellant that the effect of this paragraph is that one must treat the secondly acquired asset for all purposes as if it were still the original asset, and therefore that what is being redeemed in February, 1993 must in effect be treated as if it were the original shares.  If this contention is correct, there is no doubt that Capital Gains Tax is payable on that disposition.
	The equivalent sections in the United Kingdom legislation have been considered in several cases there.  In Floor v. Davis (Inspector of Taxes) [1978] STC 436 at p. 447 Buckley L.J. commented on these provisions and said:-

	".... as I read them, provided that a disposal of assets to which they apply shall not for the purposes of the charge to tax be treated as a disposal.  This does not mean that such a disposal is not a disposal within the meaning of that term in the Act, but that, notwithstanding that it is a disposal, it shall not be taxed as such."

	Similar views were expressed in the Court of Appeal by Sir Denys Buckley in Westcott v. Woolcombers Limited, [1987] STC 600 at p. 609 where he said:-
	"The function of Schedule 6, 7 and 8 of the Act is to regulate the computation of the amount of any chargeable gains or allowable losses arising in any particular circumstances (Finance Act, 1965, SS 22(9) and 23(1)).  Paragraph 4(2) of Schedule 7 does not provide that any disposal or acquisition of an asset which shall have actually occurred shall, for all purposes, be deemed not to have occurred.  It is one of a collection of miscellaneous rules regulating how the amounts of gains and losses are to be computed.  It must be construed in that light."
	
	This case refers to "the two fictions", the first being the "no disposal fiction", and the second being the "composite single asset fiction".  These cases make it clear that these fictions are what I might call selective fictions, in that they do not have general application, but only apply when considering the computation of tax. 
	This seems to me to be the correct approach, as I think becomes clear if one looks at this problem in stages.  There could be no question that the provisions of a schedule of a Capital Gains Tax Act could change the nature of the loan notes in this case so that they in fact remain shares in the company, with the same rights attached to them as were attached to the original shares.  Were it otherwise, the holder of the notes would be entitled to notice of and to attend general meetings of the company and to participate in dividends of the company.  This is of course, absurd.  Therefore, there must be some limit to the fictions.  The next step is to consider whether the fictions apply to all the provisions of the Capital Gains Tax legislation.  This again cannot be so, as the fictions could not be intended to apply, for example, to the calculation of shareholdings for the purposes of Section 26 of the Act.  One is, therefore, driven to the inevitable conclusion that the fictions only apply to the limited objects of the schedule, namely to the calculation of the amount of tax payable.  This is confirmed by the wording of Section 11(1) which provides that the amount of the gains accruing on the disposal of assets shall be computed subject to the provisions of, inter alia, schedule 2.  This is the whole purpose of the schedule, and there is no logical reason why the provisions of that schedule should apply to matters other than the computation of the gain.  Accordingly, when considering whether there has been a chargeable gain on the disposal of the loan notes, they must be treated as loan notes and not as the original shares in the company other than for the purpose of computing the actual amount of tax payable.  
	
Nature of the Loan Note.
	Section 46(1) of the Capital Gains Tax Act reads as follows:-
	
	"Where a person incurs a debt to another (that is the original creditor), whether in Irish currency or in some other currency, no chargeable gain shall accrue to that creditor or his personal representative or legatee on a disposal of the debt:
	Provided that this subsection shall not apply in the case of the debt on a security as defined in paragraph 3 of Schedule 2 (Conversion of Sureties)."
		
	While the word "security" is defined in paragraph 3 of Schedule 2, unfortunately the definition does not in itself resolve the difficulties.  Security is therein defined as:-

	"Includes any loans, stock or similar security whether of any government or of any public or local authority or of any company and whether secured or unsecured but excluding securities falling within Section 19."

	Section 19 refers to a number of government and similar securities which are not to be treated as chargeable assets, and some reliance is placed by the Appellant on the fact that this includes savings certificates issued under the authority of the Minister for Finance.  It is argued that these are very similar to a loan note, in that they are simply an acknowledgement of a debt by the Minister for Finance to the holder, and that the implication of the definition of "security" is that were it not for the fact they fell within Section 19, savings certificates would be considered to be a security, and therefore they would constitute a debt on a security.  I do not think this argument is of great assistance to the Appellant as certainly on one view all acknowledgements of monies due by the State could be considered to be securities, in that they are in effect secured by the assets of the State.
	Unfortunately, the Act gives no further assistance in defining the words "a debt on a security".  It is quite clear, however, that a debt on a security is treated differently from an ordinary debt.  It must have some distinctive feature.  This feature has been defined in several United Kingdom cases as being that of marketability or the fact that it can be dealt in.  In W T Ramsey v. Commissioners of Inland Revenue 54 TC 101, Lord Frasier Tullybelton said at p. 194:-

	"Further consideration has satisfied me that the existence of a document or a certificate cannot be the distinguishing feature between the two classes of debt.  If Parliament had intended it be so, that could easily have been stated in plain terms and there would have been no purpose in using the strange phrase "the debt on a security" in paragraph 11(1) of Schedule 7, or in referring to the "definition" of security in paragraph 5.  The distinction in paragraph 11(1) is, I think between a simple unsecured debt and a debt of the nature of an investment, which can be dealt in and purchased with a view to being held as an investment.  The reason for the provision that no chargeable gain should accrue on disposal of a simple debt by the original creditor must have been to restrict allowable losses (computed in the same way as gains - Finance Act, 1965 S. 23, which was the relevant statute in 1973) because a disposal of a simple debt by the original creditor or his legatee will very seldom result in a gain.  No doubt it is possible to think of cases where a gain may result, but they are exceptional.  On the other hand it is all too common for debts to be disposed by the original creditor at a loss, and if such losses were allowed for Capital Gains Tax it would be easy to avoid tax by writing off bad debts - for example those owed by impecunious relatives.  But debts on a security, being of the nature of investments, are just as likely to be disposed of by the original creditor at a gain as they are at a loss, and they are subject to the ordinary rules."

	Similar definitions have been applied in several United Kingdom cases, and in particular Cleveleys Investment Trust Company v. Commissioners of Inland Revenue [1971] 47 TC 300, and Aberdeen Construction Group v. IRC [1978] A.C 885.  These cases all emphasise that a debt on a security ought to be a marketable asset worth more than its face value.  
	The phrase has also been considered by Morris J. (as he then was) in McSweeney v. Mooney [1997] 3 I.R. 424 where, after considering the English authorities, he expressed the view at p. 429 that:-
	"The essence of a loan on a security must be whether the additional "bundle of rights" acquired with the granting of the loan, to use Wilberforce L.J.'s phrase, enhances the loan so as to make it marketable and potentially more valuable than the value of the repaid loan upon repayment.  This potential increase in value must not be illusory or theoretical.  It must be realistic at the time when the loan and the rights are acquired by the lender."

	In the present case the loan notes quite clearly are not marketable.  Both on the face of the note itself and in the conditions of issue it is provided that neither the note or any part thereof shall be transferable or assignable and accordingly if marketability is an essential element of a debt on a security, then this loan note cannot come within the definition, and it is a simple promise to repay a debt, which cannot constitute a chargeable gain by virtue of the provisions of Section 46.  
	I also think that the loan note in the present does not come within the second test suggested in the passage quoted above, namely that it has, or even has the capability of having, an enhanced value.  This loan note was issued in February, 1990 and initially carried no interest at all.  If it was not redeemed on or after 31st October, 1991 it would carry interest at the Dublin Inter Bank offered rate for six month funds, but this is of course, a very low interest rate, and the loan note would be redeemed at its face value by October, 1997 at the latest.  In my view payment of interest at this rate would not enhance the value of the loan note as an investment.  The only other advantage attached to the loan note is that it could be converted into ordinary shares in the company in the event of a public flotation or placing.  However, if either of these events take place prior to 30th September, 1991, this conversion will take place at a discount, an in any event the price at which the shares are to be subscribed for is their full issue price, and therefore it seems to me that these conversion rights do not in fact add anything to the value of the loan note, because at the time of conversion the loan note will still be worth only its face value.
	Based on these facts, I do not think that the loan note could be considered to be a debt on a security within the meaning of Section 46(1), and therefore no chargeable gain accrues.
	Accordingly, in my view the Appeal Commissioners were correct in their decisions both in relation to the Income Tax issue and the Capital Gains Tax issue.

tcjmcpoc