[2011] UKFTT 289 (TC)

TC01151

Appeal number:  TC/2009/13717

Income tax – whether a security was a relevant discounted security – security paying on redemption a sum calculated as 7.25% per annum accruing daily - whether “interest” includes sums not paid periodically – yes – appeal dismissed

FIRST-TIER TRIBUNAL

TAX 

	NICHOLAS PIKE	Appellant

-	and –
-	
	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

				TRIBUNAL: Mrs B Mosedale (Tribunal Judge)
						Mr R Thomas (Tribunal Member)

Sitting in public at 45 Bedford Square, London WC1 on 13 December 2010 with further submissions from HMRC on 20 December 2010 and from the Appellant on 18 January 2011

Mr J Brooks, counsel, instructed by Sefton Potter Advisers Ltd, for the Appellant

Mr M Gibbon, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2011

DECISION

1.	This was an appeal by Mr Pike against a closure notice and amendment to his self assessment tax return for the period ending 5 April 2000 which denied the claim for relief on a loss of £3,463,563 for income tax purposes arising from the discount on a relevant discounted security (“RDS”) as defined in Schedule 13 Finance Act 1996.
The facts
2.	The evidence was contained in an agreed statement of facts and a witness statement by Mr Pike.  Mr Pike did not attend the hearing and this it seems was due to a misunderstanding between the parties.  Mr Brooks thought that there were no objections to the witness statement whereas on the contrary Mr Gibbon wished to cross examine Mr Pike.  In these circumstances it was agreed by the parties, and we directed, that the witness statement was admitted in evidence but HMRC were free to make submissions as to what weight if any the Tribunal should place on it.  In the hearing, Mr Gibbon made no such submissions and did not challenge the witness statement and we make the following findings of facts.
3.	Mr Pike was employed by Dell Computer Corporation until 2000 in which he had held various senior posts.  Having left Dell he decided to incorporate his own company whose business it would be to invest in internet technology.  On 28 March 2000 he purchased an off the shelf company and changed its name to Aim Internet Investments Ltd (“AIM”).  The company had 1,000 issued shares, 999 of which were owned by Mr Pike and one by his wife.
4.	Three days later on 31 March 2000 the company created loan stock.  The loan stock was allotted to Mr Pike who paid £6 million for it.  Clause 2.1 of the loan stock instrument (“the Instrument”) provides:
“In these conditions “the Redemption Proceeds” means, in respect of any repayment or redemption of the Principal Amount in full or in part pursuant to the Certificate, a sum being the aggregate of: (i) the Principal Amount to be repaid or redeemed; and (ii) an amount equal to 7.25% per annum of the Principal Amount to be repaid or redeemed, accruing on a daily basis from and including the date of the Certificate up to and including the date of repayment or redemption.”
5.	The loan stock was repayable after 13 years.  Assuming it was not redeemed early, Mr Pike would be repaid £11,780,974 which was calculated as £6 million plus 7.25% of £6 million per annum for the 13 years outstanding.
6.	Nothing would be payable to Mr Pike until the principal amount was redeemed.  
7.	A few days later on 5 April 2000, Mr Pike established the Nicholas Pike Settlement 2000 (“the Trust”) of which he and his wife were the trustees.  Under the terms of the Trust, Mr Pike was entitled to the income although there was a power of appointment which could be exercised in favour of a class of beneficiaries including Mr Pike and his family.  Mr Pike transferred into the Trust the loan stock issued to him a few days previously.  At the time of this transfer the loan stock had an open market value of £2,536,437.  In his tax return Mr Pike stated this was calculated on the basis that although the 7.25% return would be commercially acceptable if the return was virtually risk free, the investment in AIM was far from being risk free as the company would be investing in risky investments with no fixed rate of return.  This reduced the value at issue of the loan stock to the above figure, being less than half of what was actually paid for it, since the implicit discount rate used to value the loan stock was 12.25%, substantially higher than a risk free rate.
8.	In April 2000 the Company commenced its operations which were to make investments in high risk start up businesses concerned with internet technology. 
9.	It was HMRC’s allegation in their Statement of Case that the transactions were part of a tax avoidance scheme.  Mr Pike did not give oral evidence and his witness statement makes no comment on this allegation.  Indeed, his Counsel said that Mr Pike was entitled to the loss relief “irrespective” of whether his main purpose was to obtain tax relief as part of a scheme as alleged by HMRC.  In other words, HMRC alleged this was part of a tax avoidance scheme and the Appellant knew this and has chosen not to deny it.  We also note that Sefton Potter’s fees were stated in a letter to Mr Pike dated 24 February 2000 to be a fixed fee payable up front and the 10% of tax saved as a result of their advice payable when HMRC accepted the return.  The letter dated 24 February 2000 had a non-disclosure clause specifically related to “tax and financial planning techniques”.  Mr Pike signed and returned the letter.  
10.	We therefore find that the transactions at issue in this appeal were part of a scheme of tax avoidance:  the extent to which we think this is actually relevant is discussed later in this Decision Notice.
The loss relief claim
11.	Mr Pike considers that the loan stock is a relevant discounted security and that therefore the provisions of Schedule 13 to the Finance Act 1996 (“Schedule 13”) apply.  He made a claim for loss relief in his return for the year ended 5 April 2000.  
12.	Schedule 13 provides as follows:
 “Paragraph 2
(1)	Subject to the following provisions of this Schedule, where –
(a)	a person sustains a loss in any year of assessment from the discount on a relevant discounted security, and
(b)	makes a claim for the purposes of this paragraph before the end of twelve months from 31st January next following that year of assessment
that person shall be entitled to relief from income tax on an amount of the claimant’s income for that year equal to the amount of the loss.
(2)	For the purposes of this Schedule a person sustains a loss from the discount on a relevant discounted security where - 
(a)	he transfers such a security or becomes entitled, as the person holding the security, to any payment on its redemption; and
(b)	the amount paid by that person in respect of his acquisition of the security exceeds the amount payable on the transfer or redemption.
(3)	For the purposes of this schedule the loss shall be taken - 
(a) 	to be equal to the amount of the excess increased by the amount of any relevant costs; and
(b)	to be sustained for the purposes of this Schedule in the year of assessment in which the transfer or redemption takes place.
(4) Sub-paragraph (4) of paragraph 1 above applies for the purposes of this paragraph as it applies for the purposes of that paragraph.

13.	To take the benefit of this provision for loss relief, the taxpayer must hold a relevant discounted security and sustain a loss from the discount on it.  Paragraph 2(2) provides that there is a loss from the discount where a person transfers the security and the amount paid by him on the acquisition exceeds the amount payable to him on the transfer.
14.	Mr Pike transferred the loan stock into the family trust and was, of course, paid nothing for it.  His claim was based on paragraph 8 of Schedule 13 which deems transfers between connected persons to be at open market value:
“(1)	This paragraph applies where a relevant discounted security is transferred from one person to another and they are connected with each other.
(2)	For the purposes of this Schedule-
(a)  the person making the transfer shall be treated as obtaining in respect of it an amount equal to the market value of the security at the time of the transfer; and
(b)  the person to whom the transfer is made shall be treated as paying in respect of his acquisition of the security an amount equal to that market value.
(3)	Section 839 of the Taxes Act 1988 (connected persons) shall apply for the purposes of this paragraph.
15.	He would consider himself to be connected to the trust, and even if he was not, the transfer would still be deemed to be at market value because the transfer to the trust was made otherwise than by a bargain at arm’s length.  This is because paragraph 9 provides:
(1)	This paragraph applies where a relevant discounted security is transferred from one person to another in a case in which - 
(a)	the transfer is made for a consideration which consists of or includes consideration not in money or money’s worth; or
(b)	the transfer is made otherwise than by way of a bargain made at arm’s length.
(2)	For the purposes of this Schedule – 
(a)	the person making the transfer shall be treated as obtaining in respect of it an amount equal to the market value of the security at the time of the transfer, and
(b)	the person to whom the transfer is made shall be treated as paying in respect of his acquisition of the security an amount equal to that market value.
16.	We will return to the issue of what Mr Pike paid for his loan stock at the end of this decision notice.  In the hearing in front of us both parties proceeded on the basis that he had paid £6million.
Definition of a relevant discounted security
17.	The dispute between the parties is whether the loan stock amounted to a relevant discounted security.  If it was not an RDS, then the above loss relief provisions on a deemed open market transfer into the trust would not apply and HMRC were correct to deny Mr Pike the claim he made in his 2000 tax return.
18.	So what is a relevant discounted security?  Paragraph 3 of Schedule 13 contains the definition of an RDS.  It provides:
“3(1)  Subject to the following provisions of this paragraph and paragraph 14(1) below, in this Schedule ‘relevant discounted security’ means 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.
……..
(3)  For the purposes of this Schedule 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.
(4)  In this paragraph ‘the relevant percentage’, in relation to the amount payable on redemption of a security, means – 
(a) 	the percentage figure equal, in a case where the period between the date of issue and the date of redemption is less than thirty years, to one half of the number of years between those dates; and
(b)	in any other case, 15 per cent.;
and for the purposes of this paragraph the fraction of a year to be used for the purposes of paragraph (a) in a case where the period mention in that paragraph is not a number of complete years shall be calculated by treating each complete month, and any remaining part of a month, in that period as one twelfth of a year.
……
(6) For the purposes of this paragraph the amount payable on redemption shall not be taken to include any amount payable on that occasion by way of interest.
19.	So the principal point at issue in this appeal is whether the loan stock granted to Mr Pike by the company would (or might) on redemption realise a “deep gain”.  And to decide that point, the question was whether the amount payable under the loan stock under clause 2.1 “7.25% per annum of the Principal Amount” was a payment of interest.  Because if it was, under paragraph 3(6) it fell to be disregarded in determining what the amount payable on redemption was for the purposes of paragraph 3(3).  In this case if it was disregarded, that would mean the only amount repayable was the principal sum of £6million:  and that would be equal to and not more than the issue price so no question of a deep gain could arise under the definition in paragraph 3(3) above.
20.	 “Interest” was, in the year of assessment under consideration, defined for the purposes of the Tax Acts, including Schedule 13, in s832(1) of the Income and Corporation Taxes Act 1988 (“ICTA”).  This provided that interest “means both annual or yearly interest and interest other than annual or yearly interest”.  In other words, under this provision interest means interest and s832(1) is concerned with the natural and ordinary meaning of interest.
The submissions of the parties
21.	In summary, Mr. Brooks’ propositions were that firstly, where the only reward to a lender is a single payment of an amount in excess of the face value of a security made on redemption, such a payment is not interest within its ordinary meaning.  And secondly, even if such a payment is interest for general tax purposes, it is not to be regarded as interest for the particular purposes of the relevant discounted securities (RDS) legislation in Schedule 13 so as to remove the Appellant’s security from the RDS regime in that Schedule, as that would be contrary to the purpose of the regime.
22.	Consequently, in Mr Brooks’ submission, the security in question is a RDS and there is no challenge to the calculation of the loss relief which accordingly should be granted to Mr Pike.
23.	Mr Gibbon for HMRC submitted that interest is interest by whatever name called and that in this case the additional payment was clearly a payment of interest.  As a result, in his submission, there was no possibility of a deep gain and the security was not an RDS.  So no relief was available under Schedule 13.
Meaning of “interest”
Is it interest in the ordinary meaning of the word?
24.	Mr Gibbon suggested that case law showed that interest had a “wide and flexible meaning” per Megarry J in Re Euro Hotel (Belgravia) Ltd (1975) 51 TC 293 at 300I  and that its key features are:
•	it must be calculated by reference to an underlying debt (eg Chevron Petroleum (UK) Ltd v BP Petroleum Development Ltd & others 57 TC 137);
•	it must be payment by time for the use of money borrowed (eg Schulze v Bensted (1916) 7 TC 30 and Bennett v Ogston (1930) 15 TC 374 (where Rowlatt J said interest “is payment by time for the use of money” in a case where the issue was whether the money was trading profit (Case I) or interest of money (Case III));
•	it should accrue from day to day (Willingale v International Commercial Bank Ltd) [1978] AC 834 at 845A-C.)
25.	Mr Brooks agreed that interest must show these characteristics but suggested other things could also possess these characteristics (such as a premium on redemption) and that to be interest in addition it had to be paid periodically.
26.	There was of course no periodicity in the sum to be paid to Mr Pike on redemption of the principal amount.  Nothing would be paid for 13 years and then the whole amount would be payable in one lump sum together with repayment of the principal sum.
27.	Mr Brooks argued that there was a distinct line between ‘interest’ and ‘premium on redemption’.  Interest would be, and a premium could be, calculated by reference to an underlying debt and represent consideration for use of money over time.  The difference was that interest would be paid periodically whereas a premium would be paid at redemption and would be an indistinguishable part of the single payment made when the loan was extinguished.
28.	In this case, of course, were we to accept his analysis, the amount payable on redemption of the loan stock would fall on the “premium on redemption” side of the line and would not be interest.
29.	In support of the proposition that to be interest it had to be paid periodically,  Mr Brooks cited the judgment of Pennycuick LJ in Willingale v International Commercial Bank Ltd [1977] STC 183 at page 195 where he said:
“Plainly, interest has many features in common with discount, but it differs from discount in this critical respect that interest accrues from day to day and is usually payable at periodical intervals in each year, whereas nothing accrues or falls due for payment under a discount transaction before maturity.” 
30.	He also referred to the speech of Lord Fraser in the unsuccessful appeal to the House of Lords from the Court of Appeal’s decision in this case reported at [1978] AC 834 at page 845.  Here Lord Fraser says there is an essential difference between interest and discount:
“Firstly, when periodical interest is received …the profit or gain on the loan is realised from time to time.  But when a bill is discounted nothing is realised until the bill matures or is sold….”
31.	Mr Gibbon however draws our attention to Lord Salmon’s comments in the Lords’ decision which upheld the Court of Appeal’s decision at [1978] AC 834 at page 842 where he said:
“Although there may be some superficial similarity between (a) lending £10,000 for 5 years at a rate of interest of X per cent per annum on the terms that none of the interest amounting in all to £5,000 shall be payable until the principal becomes repayable and (b) buying a foreign bill of exchange with a face value equivalent to £15,000 for a price equivalent to £10,000 the two transactions are in my view essentially different from each other in character.”
32.	Even though Lord Salmon went on to say that a loan on such terms would be a “bizarre conception” nevertheless he contemplated that the extra amount payable would be interest even though there was no periodicity.  And indeed we find that Pennycuick LJ had only said interest would usually be payable periodically, not that it must be. Nor did Lord Fraser say that interest had to be paid periodically. 
33.	Mr Gibbon also made the point that the Willingale case was about the distinction between interest and a discount and, unlike this case, not about the distinction between interest and premium on redemption. We find there is nothing in Willingale that requires interest to be paid periodically.
34.	Mr Brooks also referred to the definition of ‘interest’ in ICTA already set out above.  It contemplates interest calculated per annum or otherwise:
“ “interest” means both annual or yearly interest and interest other than annual or yearly interest”
35.	We are unable to agree with Mr Brooks that this definition imports that interest will necessarily be paid periodically.  We do not see it as a definition at all.  We think it merely makes the point that were a provision of the Tax Acts dealing with interest does not specify whether it refers only to annual interest or only to interest which is not annual interest, it applies to both.  In other words, interest means interest of whatever kind.  So, as we have said, we are concerned with the natural and ordinary meaning of interest and for help with that we look at the decided cases.
36.	Mr Brooks also pointed out that in Bennett v Ogston, on which Mr Gibbon relied, the interest was payable at “monthly or more frequent” intervals.  However, this does not advance us.  It is not in doubt that interest is usually paid periodically, as it was in that case.  The question is whether it must be paid periodically in order to be interest, and that was not the issue in Bennett v Ogston.
37.	Mr Gibbon submitted there is no requirement in statute, authority or natural usage to say that there must be periodicity in a payment of interest.  He referred to a number of cases where a sum had been found to be interest even though it was not payable periodically.  He cited Schulze v Bensted mentioned above which was a decision of the First Division of the Court of Session.  In earlier proceedings a trustee had been found liable to pay a sum of capital and interest on it at the rate of 3.5% per annum over a period of about 10 years.  The Judges concluded that this sum calculated at 3.5% was interest liable to tax under Schedule D even though it was payable and paid in a single lump sum:  “It was none the less interest to the person to whom they were decerned to pay it.”  This case is not strictly binding on us but Scottish law appears to be identical to English law on this point and it ought to be followed by the Tribunal. 
38.	It was Mr Gibbon’s submission that if there was a premium payable on redemption but no interest is expressed to be payable then by definition the premium was interest and the authority for this is Lomax v Peter Dixon & Son Ltd 25 TC 353.  Lomax was a decision of the Court of Appeal with the leading judgment given by Lord Greene MR.  He was dealing with the tax consequences of loan notes issued at a discount, paying interest and with a premium on redemption.  His conclusion was that both the premium and the discount were capital sums and so not liable to income tax.  However, as he said, his analysis of the position depended upon a “reasonable commercial rate of interest” being payable.  On the facts of the particular case before him, where a reasonable rate of interest was paid, he concluded that the discount on issue and the premium on redemption were in the nature of capital being payable as a reflection of the risk taken by the lender and not in the nature of income as payment for the time use of the money.
39.	Lord Greene MR distinguished a hypothetical case of loan stock issued at a discount or redeemable at a premium but with no interest charged and said on page 367:
“In this summary I have purposely confined myself to a case such as the present where a reasonable commercial rate of interest is charged.  Where no interest is payable as such, different considerations will, of course, apply.  In such a case, a ‘discount’ will normally, if not always, be a discount chargeable under paragraph (b) of Rule 1 to Case III.  Similarly, a premium will normally, if not always, be interest….”
40.	We understand Mr Gibbon’s point to be that if Mr Brooks is right and the additional sum payable on redemption of Mr Pike’s loan stock is not interest, then it is a loan stock issued without any interest payable as such.  This is not a commercially reasonable rate and under the analysis of Lord Greene in Lomax the additional sum payable on redemption would be treated as interest in any event because it is a payment for the time use of money that meets all the necessary criteria set out in Re Euro Hotel.
41.	Lomax is also support for Mr Gibbon’s proposition that interest need not be paid periodically because Lord Greene’s analysis that a premium is interest where there was no interest expressly charged presupposes, of course, that such interest is not payable periodically as it is expressed as a premium on redemption.
42.	Mr Brooks’ attention was drawn to the case of Davies v Premier Investments Ltd 27 TC 27 by Mr Thomas.  In this case the High Court followed the dicta in Lomax and decided that a 30% premium on redemption of 6 year notes issued at par without interest was itself interest and chargeable to income tax.  Although the premium itself was not expressly calculated as interest, if the notes were redeemed before the redemption date there was a calculation for a reduced ‘premium’ calculated at 2.5% per half year.
43.	Mr Brooks referred us to the case of Ditchfield v Sharp [1983] STC 590 in support of his client’s case.  The Court of Appeal had to consider a promissory note issued at a discount and without interest and expressly approved and followed its decision in Lomax that the discount on notes issued at a discount and without interest were almost always of an income nature.  Therefore, in that case the Court concluded the discount was income chargeable under Case III and not as either capital nor as interest.  Mr Brooks’ point is that the Court of Appeal considered that interest and discount were mutually exclusive and therefore by implication interest and premium had to be mutually exclusive.  We find it follows from Lomax that something called premium might nevertheless be of an income nature.
44.	Our attention was also drawn to the case of Investor v HM Inspector of Taxes [1998] STC (SCD) 244.  In that case securities were issued at a considerable premium and with a low rate of interest.  The taxpayer failed in its case that it was a qualifying indexed security (“QIS”) (and therefore not taxable as a deep gain security) and one of the grounds for this was that the interest did not satisfy the condition that it was determined by the same index as the premium payable on redemption.  Mr Brooks argued that the low rate of interest was also one of the points which had caused the Special Commissioners to decide that the securities were not QIS, and he had drawn from this the implication that the premium was not treated as interest.
45.	This case was decided by the Special Commissioners and so is not binding on us.  But in any event the Special Commissioners did not make any finding about the condition as to the rate of interest (see paragraph 16(6)(iii) of their decision) and in any event having failed the QIS test on other grounds the point was irrelevant as it would make no difference to how the bond was taxed.  Lomax was not considered by the Special Commissioners and they did not decide that something described as a premium could never be interest:  the point was not considered.  In short, we get little assistance from this case.
46.	Mr Gibbon also suggested that interest is not denatured by aggregation with some other amount, and cited a passage from pages 142 and 143 of Chevron (above), a High Court case where Sir Robert Megarry VC said:
“[Counsel] submitted that the agreement provided for the calculation of a single indivisible sum which could not be dissected into a part which was principal and a part which was ‘interest of money’….I have no hesitation in rejecting this submission.  If in its nature a sum is ‘interest of money’, I think it retains that nature even if the parties to a contract provide for it to be wrapped up with some other sum and the whole paid in the form of a single indivisible sum.  The wrapping may conceal the nature of the contents but they do not alter them.  Were the law otherwise, strong contractual wrappings might become remarkably popular….I do say that if the true nature of a sum of money is that it is ‘interest of money’, that sum will not be denatured, or transmuted into something different, simply by being incorporated into some larger sum before being made payable under the terms of a contract.”
47.	We did not understand Mr Brooks to disagree with this:  in any event this case is binding on us and the conclusion reached by the Vice-Chancellor would be the conclusion we would reach in any event.  The fact that a return is wrapped up with repayment of capital does not alter its nature, whatever that may be.  Mr Brooks’ point, as we have said, is that the return was not interest as it was not paid periodically.
Conclusions on ordinary meaning of interest
48.	We agree with Mr Gibbon that the authorities do not require interest to be paid periodically:  there is nothing in even Pennycuick LJ’s remarks in Willingale which required interest to be paid periodically. On the contrary, Lomax, Schulze v Bensted  and Lord Salmon in Willingale anticipate that interest can be interest even if it is paid in a single lump sum at the end of the loan. And in Davies v Premier Investments Ltd the High Court decided that in relation to a loan on terms similar to those in this case (albeit for a shorter period) that the ‘premium’ was indeed interest although paid only on redemption. In these cases the judges were of course giving ‘interest’ its ordinary meaning and we would also comment that in our view, irrespective of these authorities, we also consider that the ordinary meaning of interest does not require periodicity in payment.  Term loans where interest is paid in one lump sum on the date of redemption are a normal type of financial instrument.
49.	We do not think whether something is interest or not can depend on the label that a person chooses to give to it.  Sir Robert Megarry VC said this in the extract quoted above from Chevron and, as he says, English law would be very different if it gave effect to the description litigants used rather than the underlying nature of the transaction they entered into.  
50.	For the reasons given above in this decision notice, we find that the natural and ordinary meaning of interest is that it is a sum of money calculated by reference to an underlying debt which is payment by time for the use of the money borrowed and which accrues from day to day, whether or not it is paid periodically.  
Purposive interpretation
51.	Mr Brooks’ further point was, however, that we should not apply the ordinary meaning of interest to paragraph 3(6) of Schedule 13.  He considered the cases referred to above pre-dated the RDS legislation and an increase in sophistication in financial instruments.  His particular point was that we should seek to interpret Schedule 13 purposively.  To treat the premium on Mr Pike’s loan stock as interest would, in his view, be an absurd interpretation of Schedule 13 in the context of the legislation as a whole.
52.	Statutes are to be given their ordinary meaning and to be interpreted in accordance with the intention of Parliament but where such ordinary meaning leads to injustice or absurdity, then in so far as the language used permits it, it should be given an interpretation which avoids injustice or absurdity  (see Lord Blackburn in River Wear Commissioners v Adamson (1877) 2 AC 743 at 764).
53.	Mr Gibbon referred us to the Supreme Court’s decision in DCC Holdings (UK) Limited [2010] UKSC 58 where the Court considered the proper method of interpreting deeming provisions in statutes.  Lord Walker, giving the unanimous decision of the Court, approved a passage by Gibson J in an earlier case that deeming provisions were to be given their ordinary and natural meaning consistent in so far as possible with the policy of the Act unless it would lead to injustice or absurdity in which case the deeming provision should be limited only in so far as necessary to avoid such injustice or absurdity (unless with the purposes of the fiction).
54.	Mr Brooks looked at the statutory regimes for deep discount securities (DDS), deep gain securities (DGS), qualifying convertible securities (QCS) and RDS.  He identified the purpose of all four regimes as one of bringing amounts that reflect the time value of money into charge to tax as income. He referred to a number of extracts from Parliamentary Debates on Finance Bills to show that the purpose of the four schemes was to devise “arrangements under which income converted into guaranteed or near guaranteed premiums would be charged to income tax...”  We consider that the general principle of all four regimes is that they would charge to income tax amounts which reflected the time value of money, but only those which were not otherwise charged to income tax as interest.
(a)	Redundant legislation?
55.	Mr Brooks’ first point is, we understand, that the RDS legislation would be largely unnecessary if interest in paragraph 3(6) of Schedule 13 carried as wide a meaning as we find its natural and ordinary meaning to be.  There would be no need to have legislation taxing premiums to income tax if the premiums were to be seen as “interest” in any event. There would be nothing for the RDS legislation to bite on.  In relation to the purpose of the DDS and DGS legislation, HMRC accept that a purpose was to catch “disguised” interest earned by way of premium or discount, but Mr Gibbon considered that this was irrelevant because the amount payable on redemption under the loan is “an amount by way of interest”, not disguised interest.
56.	However, we do not agree that giving interest in paragraph 3(6) its ordinary meaning as we have determined it to be deprives the RDS legislation of effect.  It will apply to bonds issued with the prospect of a deep gain which also bear a reasonable commercial rate of interest.  It will apply to all bonds issued at a discount.  The legislation will not be redundant even though, on our interpretation, it would apply to fewer securities than it would do on Mr Brooks’ interpretation.
(b)	Income falls out of tax regime?
57.	Mr Brooks goes on to say that the Revenue’s argument leads to an absurdity in that a sale of the security at issue in this case before redemption would not be taxable (assuming it could be sold at a profit). The object of the RDS legislation was to tax to income tax that profit as it reflects the interest that has been rolled up into premium.  But if the RDS legislation does not apply, because the premium is as a matter of law interest, then the hypothetical profit on the hypothetical sale of the loan stock could not be taxed to income tax, contrary to the intention of Parliament.
58.	His point is that if, at least for the purposes of Schedule 13, interest had to involve periodical payments then this absurdity would disappear.  Any payment for the time use of money that was rolled up and paid as a premium at the end of the term (assuming it was a deep gain) would be taxed to income tax.  Any transfer before redemption would also lead to the rolled up time value of the money being charged to income tax.  Only if the time value of money amount was paid periodically would it escape the RDS net but would of course be taxable to income tax as interest under normal rules.  This is a persuasive argument.
59.	He pointed out that in Investor v Inspector already referred to above, HMRC did not suggest (nor the Special Commissioners find) that that the premium should be re-characterised as interest.  The treatment of the security in Investor v Inspector was, he argued, consistent with the purpose of not only the DGS legislation in force from 1989 to 1996 but also the DDS legislation in force from 1984 to 1996, and, more relevantly, the RDS legislation which replaced the DDS and DGS legislation from 1996 and covered the period in question in this appeal.  His view is that it follows that in relation to this security, which was similar to that in Investor, the same treatment as in that case should be applied.  That would be consistent with the purpose of all four regimes covering securities where the amount repayable exceeds the amount subscribed.
60.	But as we have already stated, the character of the premium as capital or as interest in that case was not discussed and for this reason the decision cannot be persuasive on this point.  
(c)	Consistency with accrued income scheme
61.	Mr Brooks went on to point out that the irrationality of leaving out of the RDS regime a bond like Mr Pike’s would not be cured by the accrued income scheme (“AIS”).  Since 1985 this legislation ensures that any sale “cum-dividend” of a security carrying interest before an interest payment date results in an amount equivalent to the accrued interest being charged to income tax.  At the same time the DDS, DGS and QCS legislation (up to 1996) and the RDS legislation thereafter ensures that on a sale or other transfer of a security the time value of money gain up to the point of sale is also charged to income tax.  Each of these four regimes specifically excludes the AIS from applying to a transfer to which they apply, so are mutually exclusive with the AIS and avoid double taxation.  If HMRC were right and the amount payable on redemption here were in fact interest, then on the face of it, appropriate taxation of a transfer would be achieved by subjecting that transfer to the AIS.  
62.	But Mr Brooks’ interpretation of the definition of interest for the AIS in section 711(9) ICTA 1988 does not encompass the return on the security at issue in this appeal.  This is because it says:
“‘Interest’ includes dividends and any other return (however described) except a return consisting of an amount by which the amount payable on a security’s redemption exceeds its issue price”
63.	Mr Brooks’ submission is that the return in this case does consist of an amount by which the amount payable on the note’s redemption exceeds its issue price and that therefore it is not “any other return”, is not included in the AIS definition of interest, and so cannot be charged to income tax under that scheme.  The absurdity that, had there been a profit instead of a loss on the transfer of this security, it would not have been taxable under either the RDS or AIS, would be avoided, says Mr Brooks, if “interest” for the RDS legislation was given the same meaning that by s711(9) it is given for the AIS.
64.	Mr Gibbon’s submission is that this is not a correct reading of s711(9).  This section says “ ‘interest’ includes…”.  In other words, the “dividends” and “any other return” mentioned in s711(9) are not the only elements of interest for the AIS.  As no complete definition of interest is given in this section, it should be given its normal meaning, although for the purposes of AIS its meaning is extended to include “dividends” and “any other return”.
65.	The drafting of s711(9) is not particularly clear.  The issue between counsel is that Mr Brooks suggested the word “except” qualifies the word “interest” and Mr Gibbon suggested that it qualifies the phrase “any other return”.  Whether the “except” was intended to qualify the definition of interest as a whole (as Mr Brooks contends) or just “any other return” (as Mr Gibbon contends) is critical:  if Mr Brooks is right a return of an amount above issue price is not interest whereas if Mr Gibbon is right, the definition of “interest” is not extended to include such a return but it is included if it is within the ordinary meaning of interest. So such a return would be “interest” within the AIS if it was interest under the ordinary meaning of interest.  
66.	We think the definition is ambiguous:  it does not make it clear whether the “except” qualifies “interest” or “any other return”.
67.	To resolve the ambiguity, it is proper to look at the legislation as a whole and in particular the AIS as a whole.  Mr Gibbon referred us to s710(3)(e) which defines which securities are within the AIS, and excludes 
 “any security which fulfils the following conditions, namely, it is redeemable, the amount payable on its redemption exceeds its issue price, and no return other than the amount of that excess is payable on it.”
Mr Gibbon’s submission is that this exclusion does not apply to any return that is within the ordinary meaning of interest.  It is interest and not a return.
68.	We are unable to agree that this is its natural reading.  A normal construction of a return on an investment is that it would include an income return as well as a capital return.  Indeed, s711(9) refers to “dividends” or “any other return”.  Dividends are an income return.  So interest is within the meaning of a “return”.
69.	We think s710(3)(e) should be interpreted to be consistent with the definition of interest in s711(9).  Relying on s711(9) to show that in the context of AIS “return” includes income returns, a literal reading of s710(3)(e) is that an excess over issue price payable on redemption is a “return” even if it is actually an income return of interest.  Therefore, s710(3)(e) does not apply to loans which repay nothing but issue price and rolled up interest, so the “except” in s711 qualifies “interest”, as Mr Brooks said, and not “any other return”.  In summary, a literal reading of these sections of the AIS is that the AIS does not apply to securities where the excess over issue price payable on redemption is either a capital premium or rolled up interest.
70.	There is therefore as Mr Brooks identifies a mismatch in the legislation.  On a literal reading the RDS legislation excludes bonds which repay rolled up interest (as well as interest paid periodically), but the AIS does not apply either.  Mr Brooks’ solution is to give “interest” a restricted reading for the RDS and confine it to interest paid periodically.  This would keep such bonds in the taxation scheme of RDS.
71.	The reason why we are considering the AIS legislation is the Appellant’s case is that giving “interest” its ordinary meaning results in no income tax liability on a hypothetical profit on a transfer of loan stock similar to the security in this case.  The interest would be chargeable to income tax when it is paid at the time the security matures, but (if Mr Brooks is right and the AIS does not bite) the hypothetical profit on the transfer to the trust would be treated as a capital gain (potentially liable to capital gains tax unless it is a qualifying corporate bond) but would fall outside the income tax net.
72.	This is of course a hypothetical scenario.  Mr Pike did not realise a profit.  He intended to realise a loss for income tax purposes.  The Appellant led no evidence to suggest that the type of bond at issue in this appeal (a very long-term bond with the capital repayable together with an additional sum calculated by reference to the time value of money but rolled up and payable on redemption), was a common type of instrument or indeed the type of instrument that might ever be issued other than for the purpose of tax avoidance as in this case.  Nevertheless, even a hypothetical absurdity is unlikely to have been intended by Parliament.
73.	But we consider we are faced with competing absurdities.  Mr Brooks says it is absurd to give interest what we have found to be its natural and ordinary meaning as this would lead to (hypothetically) non-taxation in a situation where Parliament intended tax to arise.  But if we were to give interest in Schedule 13 the meaning Mr Brooks asserts for it (that it must be paid periodically) we consider that, by giving a right to a relief for a loss engineered by a tax avoidance scheme such as in this case, this would actually, and not hypothetically, lead to non-taxation (of the income against which the loss is set) in a situation where Parliament intended tax to arise.  
74.	Firstly, it seems the courts consider that where a literal and a purposive reading would both give rise to absurdities, then we should favour the literal meaning (see Lord Dilhorne in Pearson v IRC [1980] STC 318 at the end of his speech in a case where the court was faced with competing anomalies depending which construction of the words “interest in possession” was adopted and in that case opted for the ordinary natural meaning of the words.)
75.	Secondly to avoid absurdity some of the language used by the drafters must be given a purposive rather than a literal reading.  Profits referable to the value of the rolled up interest on securities which carry a premium on redemption instead of interest paid periodically were intended by Parliament to be taxed to income tax on a transfer of that security.  This could be achieved by the RDS or the AIS.  Straining the meaning of the AIS rather than the RDS to capture such securities seems best as it avoids all absurdity and one possible way of doing this might be to read s710(3)(e) as impliedly limited to excesses payable on redemption which are capital rather than income which makes sense as it is the accrued income scheme.
(d)	loophole later closed
76.	Mr Brooks went on to point out that in 2002 Parliament closed the loophole that Mr Pike sought to exploit. With effect from 25 March 2002 Schedule 13 now includes paragraph 9A which provides as follows:
“(1) Where a relevant discounted security is transferred by a person (“the relevant person”) to a person connected with him and—
 (a) the occasion of the relevant person's acquisition of the security was its issue to him,
(b) the relevant person was, at the time of issue, connected with the issuer or the conditions in sub-paragraph (2) below are satisfied, and
(c) the amount paid by the relevant person in respect of his acquisition of the security exceeds the market value of the security at the time of issue,
the relevant person shall be taken for the purposes of this Schedule not to sustain a loss from the discount on the relevant discounted security.
(2) The conditions mentioned in sub-paragraph (1)(b) above are that— 
(a) the security is a security issued by a close company;
(b) at the time of issue, the relevant person was not connected with the company;
(c) securities of the same kind as that issued to him were also issued to other persons; and
(d) he and some or all of those other persons, taken together, controlled the company.
(3) In sub-paragraph (2)(d) above, “control” shall be construed in accordance with section 416 of the Taxes Act 1988.
(4) For the purposes of this section, section 414 of the Taxes Act 1988 (meaning of “close company” in the Tax Acts) shall have effect with the omission of subsection (1)(a) (exclusion of companies not resident in the United Kingdom).
(5) Section 839 of the Taxes Act 1988 (connected persons) shall apply for the purposes of this paragraph.”
77.	The effect of paragraph 9A is that no loss relief could be claimed in a situation like Mr Pike’s where the issue of the loan stock was at a price in excess of the market value and the issuer and creditor were connected parties.  Mr Brooks refers to the Treasury’s Explanatory Notes on the clause of the 2002 Finance Bill about the changes which explain that it is intended to prevent losses being claimed where loan stock is issued at an overvalue and without any interest payments.
78.	However we agree with Mr Gibbon that this is not relevant in interpreting the earlier provisions in Schedule 13.  That some years after the original legislation was enacted, the Government perceived there to be a loophole and acted to close it does not tell us that there necessarily was a loophole in the legislation properly construed.  See in this regard the decision of the Upper Tribunal (Arnold J) in Greenbank Holidays Ltd v HMRC [2011] UKUT B11 (TCC) (11 April 2011) at paragraphs 29 and 30.  In any event, there clearly was a mismatch in the rules which paragraph 9A corrected irrespective of what is the correct definition of an RDS.  It was asymmetrical for the legislation to have an open market rule on transfers between connected parties without having the same open market value for grants and issues between connected parties.
(e)	HMRC’s interpretation
79.	Mr Brooks also referred us to various extracts from HMRC Manuals from which it is clear (at least in the limited context in which the statements were made) that HMRC do not regard premiums on redemption to be interest.  However, this tells us nothing other than it is HMRC’s view of the law.  It does not tell us what the law is.  
80.	Mr Brooks did not suggest that Mr Pike wished to make a claim that he had, on the basis of HMRC’s Manuals, a legitimate expectation that the bond would be taxed as an RDS, and in the circumstances, we think it would be very difficult to show a legitimate expectation particularly as none of the extracts deal with RDSs.  However, HMRC Manuals could only be relevant to such a claim:  they are not relevant to the question of what the law actually is.  
Conclusion
81.	For the reasons given above we find that the natural and ordinary meaning of interest is that it is a sum of money calculated by reference to an underlying debt which is payment by time for the use of the money borrowed and accrues from day to day whether or not it is paid periodically.  This meaning is consistent with case law.  
82.	We decline to give it a different meaning for the purposes of the RDS legislation and in particular to require that to be interest it must be paid periodically because we do not think this is permitted by the rules of statutory interpretation.  We do not consider it relevant to a question of statutory interpretation that HMRC’s published view of the law differs; we do not consider it relevant that Parliament later perceived there to be a loophole and acted to close it and note that in any event the perceived loophole was the lack of an open market value rule on issues between connected parties and nothing to do with the definition of interest; we do not consider that our interpretation does make the RDS legislation redundant and so does not lead to an absurdity in this sense; while we consider that there is a potential absurdity in not limiting interest to interest paid periodically, that might be cured by a reasonable reading of the AIS legislation and in any event the absurdity in this case was hypothetical and we had no evidence it would occur in the real world, so we do not think we should depart from its ordinary meaning especially when so doing would lead to another absurdity.
Was it interest as a matter of fact?
83.	We have decided that interest is not limited as a matter of law to a time-based return on money lent paid periodically but we need also to consider whether as a matter of fact the additional payment to Mr Pike under the terms of the security in this case was interest.
84.	Lord Greene MR in Lomax says “…there can be no general rule that any sum which a lender receives over and above the amount which he lends ought to be treated as income.  Each case must, in my opinion, depend on its own facts….”
85.	As we have already said the label is not particularly relevant:  it was not described as interest but that does not prevent it from being interest.  It was clearly a charge for the use of money over time as it was calculated by reference to an interest rate per annum accruing daily.  Although as Lord Greene MR said in Lomax there are reasons why a premium on redemption would be payable that might not be payment for use of money by time, such as a payment to reflect the capital risk in making the loan, we do not find that there was any such reason in this case.  In particular, the evidence of valuation put forward by the Appellant was that the interest rate was too low to reflect the capital risk of the loan (which was why Mr Pike paid too much for it when buying it at face value and why on its transfer 5 days later he made a deemed loss on its acquisition price).  We also bear in mind that Lord Greene MR’s view was, in paraphrase, that a premium on a loan without periodical interest payments was normally, perhaps always, disguised interest (see the citation in paragraph 39 above).  In this case the loan paid no periodical interest and so if we were to decide it was not interest, it would mean that there would be no charge to income tax for the value obtained for use of money by time.  That there should be a charge on such a value is a long-standing principle of income tax.
86.	 We note that the bond was for 13 years and that it is likely to be unusual for interest to be rolled up and paid in one lump sum at the end of such a long period.  Nevertheless, we do not think that the length of the loan alters the principle: on the contrary we think the longer money is loaned the more likely it is the creditor will want to paid for the use of money over time.  We note that this was at least the preliminary view of Fox LJ in Ditchfield v Sharp expressed in the penultimate paragraph of his decision. 
87.	Taking all factors into consideration, our conclusion is that the additional sum payable to Mr Pike on redemption of the loan stock was interest even though it was not payable periodically.  The loan stock was therefore not a relevant discounted security and the appeal is dismissed.
Tax Avoidance
88.	Mr Gibbon submitted, and we have found, that the security was an instrument in a tax avoidance scheme.  Having said that, Mr Gibbon asked the Tribunal not to consider applying a Ramsay approach to this case.  Indeed, although the Statement of Case alleged the transactions were part of a tax avoidance scheme, the Statement of Case does not rely on Ramsay and we think it would have been too late to raise this issue at the hearing in any event.  
89.	We have found that the transactions were all part and parcel of a single avoidance scheme, so we infer Mr Pike must have known and therefore did know that when he purchased the security on 30 March 2000 that he would transfer it at a loss 5 days later and that therefore he must have known on 30 March 2000 that its issue price of £6million was considerably in excess of its market value.  
90.	Reverting back to the question of statutory interpretation raised by Mr Brooks in relation to the definition of interest, had we been persuaded by Mr Brooks that the security in this case was an RDS, does it necessarily follow that this Tribunal must conclude that there was in 2000 a lacuna in the law and that Mr Pike paid £6million for his security?  The rule about the valuation of a security on acquisition is contained in paragraph 2(2) of Schedule 13 which refers to “the amount paid by that person in respect of his acquisition of the security”.
91.	Mr Pike gave £6million to the company and in return he got a security with a face value of £6million.  But he did so knowing that in return he would get an asset worth approximately £2.5million.  This was not a case of making a bad bargain:  Mr Pike did not pay £6million hoping it was worth £6million or more.  It was an integral part of the tax avoidance scheme that the security was in fact worth considerably less than this and the scheme could not have worked if Mr Pike had paid what the security was actually worth.
92.	Further, the excess of the amount paid over the value of the security was in no real sense given away by Mr Pike.  It was given to the Company of which he was the shareholder of 999 of its 1000 issued shares.  He owned the Company to which he paid a very substantial overvalue for a security
93.	We have not had the benefit of submissions on this point and it is not necessary for our decision, but we express the preliminary view that it may be that Mr Pike paid what the security was worth (approximately £2.5million) for the purposes of paragraph 2(2).  The rest of the £6million was to capitalise his wholly owned company and was not actually paid for the security.  We note in passing that the point was not raised by HMRC in the case of Campbell [2004] STC (SCD) 396 at paragraph 43 but was the basis of the decision (on rather different facts) in the recent decision of the First-tier Tribunal in Robert Audley [2011] UKFTT 219 (TC).
94.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

Barbara Mosedale

TRIBUNAL JUDGE
RELEASE DATE: 4 May 2011

Amended pursuant to Rule 37 of the Tribunal Procedure (First-tier Tribunal)(Tax Chamber) Rules 2009 on 12 May 2011