The Greene King Group hold a broad investment portfolio ranging from property leasing to brewing. This case concerns the accounting treatment of the group's loan arrangements. In particular, where the rights to 'future interest payments' of a loan were sold to a third party. The companies involved were:
Greene King Plc - (PLC)
Greene King Acquisitions Limited - (GKA)
Greene King Brewing Retailing Limited (GKBR)
The arrangement
The loan arrangement in question was in the form of a loan stock offer, which is ultimately just an ordinary loan with interest payable. The arrangement was as follows:
(1) In 2000 PLC lent GKBR £300m. Interest was payable at (around) 5% p.a. and payable bi-annually. The loan would expire in mid 2004.
(2) In 2003 PLC assigned the last three interest payments, worth £20.5m, to GKA in return for GKA shares with a nominal value of £1.5m. The £19.5m surplus was sent to GKBRs 'share premium' account.
The tax treatment
Had the interest been paid to PLC as per the original loan agreement, the interest income would have certainly been taxable in the hands of PLC.
According to council for the Greene King Group. By PLC selling its rights to interest income to GKA in return for shares, it no longer received the income, and the income in GKAs hands was treated on the share capital account and thus was not taxable according to ordinary concepts.
The HMRC considered this to be an incorrect accounting treatment for various reasons set out below.
The legislation
Extensive rules on loan related income and deductions are found in Part 5 of the Corporations Act 2009. However, at the time of these transactions the relevant provisions were found in the Finance Act 1996.
Section 84(2)(b) of the Finance Act provided that profits from loan arrangements must be accounted for:
"in accordance with generally accepted accounting practice".
Both parties agree that the relevant accounting standard in this case was Financial Reporting Standard 5 (FRS 5), which provided that where the rights to interest are segregated from a loan arrangement and sold:
"the entity would cease to recognise the part of the original asset that has been transferred by the transaction, but would continue to recognise the remainder".
A debate arose about the precise meaning of this sentence. The HMRCs contention was that it meant that when the right to future interest in a loan is sold, a de-recognition must occur, in this case reducing PLCs £300m loan balance by £20.5m (being the value of future interest) to £279.5m. The HMRCs view is that upon receiving the £300m principle at the end of the loan, a 'profit' of £20.5m will be reflected in PLCs accounts and thus will become a profit for tax purposes. This view was in line with the Big 4s public guidance on the matter.
PLCs contention was that FRS 5 implies no such thing. At all times the balance sheet accurately reflected PLCs assets and liabilities, and that its loan arrangements were consistent with accounting principles and the law.
The Decision
The Court of Appeal ruled in favour of the HMRC on this point, for the same reasons as the Upper Tribunal which it quoted:
"It is perfectly true that, as Mr Clifford put it, "there would be no overall change in the carrying value of PLC's assets"—plainly there would not, for the reasons he gave—but that truth does not affect the value of the loan, considered as a single asset. It is in our view axiomatic that a present right to receive a sum at a future date must have a value less than the amount which is to be received, and that that value is to be determined by conventional discounting principles. Indeed, Mr Clifford's own observation that "the value of the loan to GKBR would be reduced on 'disposing' of the interest rights" shows that he was of the same view himself."1
"For these reasons we perceive no need, as the appellants contend, to reflect the fact that PLC's overall position is unchanged... The reality of the transaction is properly reflected by partial de-recognition of the loan, and an addition to the value of PLC's investment in its subsidiaries. That being so, a departure from FRS 5 is not justified, and it follows that the accounting treatment of the transactions adopted by PLC is not GAAP-compliant. Thus HMRC are right to argue that partial de-recognition was required by UK GAAP, that PLC was obliged to bring the accretion from the NPV of the capital sum on the date of the assignment of the interest strip until redemption into taxable profit, and that issue 2 must accordingly be determined in HMRC's favour."2
The Tax Treatment
In summary, the Court of Appeal ruled that the correct accounting treatment is to reduce the loan's value in PLCs balance sheet by £20.5m - to £279.5m. Meaning there would be a capital gain upon repayment of the full £300m which would be taxable in the hands of PLC.
Current Law
The loan arrangement provisions of the Finance Act 1996 were transferred into the Corporations Act 2009. Section 309 of the CAA 2009 specifically references the Generally Accepted Accounting Principles (GAAP) which are to be used in calculating an entity's net profit from loan arrangements.
Notes
Case EWCA [2016] Civ 782 : http://www.bailii.org/ew/cases/EWCA/Civ/2016/782.html
1. p64
2. p64
Legislation
Finance Act 1996 (original)
Corporations Act 2009
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