United Kingdom House of Lords Decisions

OPINIONS

OF THE LORDS OF APPEAL

FOR JUDGMENT IN THE CAUSE

Taylor (Her Majesty's Inspector of Taxes) (Respondent)

v.

MEPC Holdings Limited (Appellants)

ON

THURSDAY 18 DECEMBER 2003

The Appellate Committee comprised:

Lord Nicholls of Birkenhead

Lord Slynn of Hadley

Lord Hoffmann

Lord Millett

Lord Walker of Gestingthorpe

LORD NICHOLLS OF BIRKENHEAD

1. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. For the reasons he gives, with which I agree, I would allow this appeal.

LORD SLYNN OF HADLEY

My Lords,

2. I have had the advantage of reading in draft the opinion of my noble and learned friend Lord Hoffmann. For the reasons he gives I too will allow the appeal and restore the order of the Special Commissioners.

LORD HOFFMANN

My Lords,

3. MEPC Holdings Ltd ("MEPC") belongs to a group of property development and investment companies. In its accounting period ended 30 September 1994 it made profits of £300,000 and paid charges on income of £48,644,400. It wishes to surrender the surplus charges on income to other companies in the group for deduction from their profits for the purposes of corporation tax.
4. Eligibility for group relief is claimed pursuant to sections 402(1) and 403(7) of the Income and Corporation Taxes Act 1988:

"402(1) Subject to and in accordance with this Chapter…relief for trading losses and other amounts eligible for relief from corporation tax may…be surrendered by a company ('the surrendering company') and, on the making of a claim by another company ('the claimant company') may be allowed to the claimant company by way of a relief from corporation tax called 'group relief'.

403(7) Subject to the provisions of this Chapter…if in any accounting period the surrendering company has paid any amount by way of charges on income, so much of that amount as exceeds its profits of the period may be set off for the purposes of corporation tax against the total profits of the claimant company for its corresponding accounting period."

5. There is no dispute that MEPC is entitled to surrender its relief for charges on income. The question is how one calculates the surplus over the "profits of the period" which is available for surrender. This is governed by section 403(8):

"(8) The surrendering company's profits of the period shall be determined for the purposes of subsection (7) above without regard to any deduction falling to be made in respect of losses or allowances of any other period, or to expenses of management deductible only by virtue of section 75(3)."

6. "Profits" for the purposes of corporation tax means "income and chargeable gains": section 6(4). MEPC's £300,000 of profits consisted entirely of income. During the accounting period it had made disposals of property which, if taken in isolation, realised chargeable gains of £6,040,284. But it had £60,583,017 of allowable losses available from earlier accounting periods. Section 8(1) of the Taxation of Chargeable Gains Act 1992 provides that-

"…the amount to be included in respect of chargeable gains in a company's total profits for any accounting period shall be the total amount of chargeable gains accruing to the company in the accounting period after deducting -

(a)  any allowable losses accruing to the company in the period and

(b)  so far as they have not been allowed as a deduction from chargeable gains accruing in any previous accounting period, any allowable losses previously accruing to the company while it has been within the charge to corporation tax."

7. The result was that after deduction of allowable losses under section 8(1)(b), there was nothing in respect of chargeable gains to be included in MEPC's total profits.
8. The revenue say nevertheless that for the purposes of calculating the charges on income relief available for surrender, MEPC's profits must be deemed to have included the £6,040,284 of chargeable gains which accrued in the relevant accounting period. The deduction of past allowable losses is a "deduction falling to be made in respect of losses…of any other period" within the meaning of section 403(8) and must be disregarded. This argument was rejected by the Special Commissioners but accepted by Rattee J [2002] STC 430 and the Court of Appeal (Pill, Chadwick and Clarke LJJ) [2002] EWCA Civ 883; [2002] STC 997.
9. Group relief was introduced by the Finance Act 1967 (section 20 and Schedule 10), very soon after the introduction of corporation tax by the Finance Act 1965. As stated in section 402(1) of the 1988 Act (which substantially reproduces section 20 of the 1967 Act) it provided a new relief by enabling "relief for trading losses and other amounts eligible for relief from corporation tax" to be surrendered by one group company and claimed by another. The amounts which can be surrendered are all within the description of "amounts eligible for relief".
10. The word "relief" is not a term of art but has been used in tax legislation since the earliest statutes to refer to a provision which reduces the tax which would otherwise be payable. To explain how reliefs against corporation tax work, it is necessary first to describe the structure of the tax. Before 1965, companies had paid income tax on their income in the same way as individuals. The Finance Act 1965 not only introduced corporation tax but also for the first time imposed a new tax on chargeable gains called capital gains tax. But this tax is payable only by individuals. In the case of a company, its chargeable gains are added to the income which would previously have been liable to income tax to arrive at "profits" for the purpose of corporation tax. The two component parts of "profits" are separately computed before being added together. "Income" is computed and assessed according to income tax principles (section 9(3) of the 1988 Act) and "chargeable gains" are computed and assessed according to capital gains tax principles (section 8(3) of the 1992 Act).
11. The reliefs which may be surrendered under section 403 of the 1988 Act by way of group relief are all reliefs against corporation tax on the income element of profits. They are reliefs for trading losses (subsection (1)), capital allowances (subsection (3)) management expenses (subsection (4)) and charges on income (subsection (7)). The need for these reliefs arises from two features of the income tax. First, it is in theory an annual tax, imposed on the income arising within a single year. The charge to tax is contained in the annual Finance Act and expires with the relevant year of assessment. Secondly, the tax is imposed on income arising from the sources specified in the well known Schedules and computed according to the rules applicable to each source.
12. The fact that the tax is computed annually means that a special provision is needed by way of relief to enable a trading loss in one year to be set off against profits in a subsequent year: see section 393 of the 1988 Act. Capital allowances are deductions allowed in order to encourage investment. A relief for management expenses is needed because the charge to tax on income arising from investments under Schedules A and F (rents and dividends) does not in itself provide for any deductions for the cost of managing the investments. But such a deduction by way of relief is allowed to investment companies (see section 75 of the 1988 Act). Finally, the computation of profits does not allow for the cost of the capital invested in a business but a relief is given for "charges on income" by way of interest and certain covenanted payments: section 338 of the 1988 Act.
13. The mechanism by which a relief is given is not always the same. It may be simply a deduction from the overall tax which would otherwise be payable. Or it may be a deduction from the total profits. Or (as in the case of trading loss relief) it may be a deduction from the profits from a particular source, namely, the same trade in a subsequent year. Or it may be fed into the calculation of income from the source in question. This is what is done with certain capital allowances, which by section 144(2) of the Capital Allowances Act 1990 are given effect by being treated as trading expenses. This treatment may create a loss which can form the subject of group relief but the allowances are not in themselves capable of being surrendered. On the other hand, some capital allowances are given "by discharge or repayment of tax" and these can be the subject of group relief under section 403(3). The relief for management expenses disbursed by an investment company is given by deducting them in computing its total profits for the purposes of corporation tax (section 75(1) and (3) of the 1988 Act), but they can nevertheless be surrendered by way of group relief.
14. Whatever the mechanism by which a relief is given effect, it is to be distinguished from deductions which fall to be made in computing the primary liability under the Schedules. For example, the trading profits which are charged as income under Schedule D, Case I are the revenue less the expenses. Section 74 of the 1988 Act restricts the amounts which may be deducted as expenses but the computation is otherwise made according to ordinary accounting principles. No one would describe the deduction of expenses as a relief. It is not a deduction from what would otherwise be taxable under the Schedule but part of the computation of the taxable amount.
15. In the case of the chargeable gains of companies, the corporation tax is imposed on the total amount of chargeable gains accruing in the accounting period after deducting the allowable losses of that and earlier periods: section 8(1) of the 1992 Act. The tax on chargeable gains is not, like income tax, an annual tax. The charge is imposed not for a single year but indefinitely. It is assessed annually but there is nothing in the structure of the tax which requires the charge to be computed by reference to gains and losses within the year, subject to reliefs for losses in earlier years. The charge is imposed upon the balance of a running account which starts when the company first comes within the charge to corporation tax. So, as in the case of the deduction of expenses in the ascertainment of trading profits, the deduction of allowable losses is in my opinion part of the primary calculation of the amount brought into charge. Although, as I have said, a "relief" is not a term of art, I think it would be surprising to find the deduction of allowable losses described as a relief. The 1992 Act contains various reliefs expressly so called, such as section 222 (relief on disposal of private residence). But the deduction of allowable losses is not one of them.
16. Section 403(8) of the 1988 Act requires, in summary, that for the purposes of calculating for any accounting period the excess of profits over charges on income which can be surrendered, the profits must be calculated without regard to (a) deductions for losses or (b) deductions for allowances or (c) expenses of management, of other periods. These three categories appear, with one qualification, to correspond to the other three categories of reliefs which can be surrendered under section 403. The policy of the subsection appears to be to prevent the excess of profits over charges on income from being inflated by other reliefs carried forward from earlier years. It confines the surrenderable relief to the excess over profits in the accounting period.
17. So, for example, if a company has in a given accounting period a total profit of £1m and charges on income of £2m, it may surrender the excess of £1m. It may have had a £1m trading loss in an earlier accounting period which actually reduces the taxable profits to zero, but that does not enable it to surrender more than £1m by way of excess charges on income. And the same goes for earlier reliefs in respect of management expenses and capital allowances.
18. The qualification upon the proposition that the three categories in section 403(8) correspond with the three other forms of relief which can be surrendered is that the term "loss" may include losses other than the trading losses in respect of which a relief is allowed. An example is a loss in a transaction which falls within Case VI of Schedule D, which can also be carried forward by way of relief against Case VI profits in a subsequent period (section 396 of the 1988 Act), but cannot be surrendered under section 403(1). So the class of reliefs from earlier periods which cannot be used to inflate the excess of chargeable gains over profits does not correspond precisely with those which could have been surrendered. But that does not affect the conclusion that the policy of section 403(8) is to exclude reliefs granted in respect of earlier periods.
19. In my opinion this policy suggests that allowable losses are not included in the term "losses" in section 403(8). An allowable loss is not a relief. This construction is also in my opinion supported by the language of the subsection. The most natural reading of the words "profits…shall be determined…without regard to any deduction falling to be made etc." is that the deductions to be disregarded are those which the legislation requires to be made from what would otherwise be the profits - that is to say, reliefs. "Allowable losses", on the other hand, are not deducted from profits. They are deducted as part of the computation of chargeable gains which forms one element of profits.
20. Furthermore, the subsection carefully distinguishes between a "deduction …in respect of losses or allowances" and "expenses of management deductible only by virtue of section 75(3)." Why is the concept of deduction used twice, instead of a single reference to deductions in respect of losses, allowances and management expenses? The answer in my opinion is that losses and allowances are reliefs which operate by way of deduction from profits whereas, by virtue of section 75(1) and (3), the relief from management expenses operates by deduction in the computation of profits. This use of language reinforces the impression that "losses" means losses allowed by way of relief against profits and not losses, such as allowable losses, deducted in the computation of profits.
21. Finally, group relief is concerned entirely with the income element in profits. All the reliefs which can be surrendered by way of group relief are deductible from or in computing the income element. The computation of chargeable gains is completely separate and I think it would be strange if a provision which limited the availability of group relief operated by reference to a deduction made in the computation of chargeable gains.
22. For these reasons, with respect to the contrary views of Rattee J and the Court of Appeal (before whom the arguments appear not to have been quite the same as those advanced to your Lordships) I think that the taxpayer's construction of section 403(8) is correct. I would allow the appeal and restore the decision of the Special Commissioners.

LORD MILLETT

My Lords,

23. I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Hoffmann. I agree with it, and for the reasons he gives I too would allow the appeal.

LORD WALKER OF GESTINGTHORPE

My Lords,

24. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. For the reasons which he gives I too would allow this appeal.