Neutral Citation Number: [2009] EWCA Civ 1165
Case No: A3/2008/2759
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT (CHANCERY DIVISION)
Mr Justice Norris
[2008] EWHC 2429 (Ch)
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 10 November 2009
Before :

LORD JUSTICE RIX
LORD JUSTICE MOSES
and
LORD JUSTICE RIMER
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Between:

	The Commissioners for Her Majesty’s Revenue and Customs 	Appellant	
	- and -		
	DCC Holdings (UK) Limited	Respondent	
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(Transcript of the Handed Down Judgment of
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Mr Michael Furness QC and Mr Michael Gibbon  (instructed by HMRC, Solicitor’s Office) for the Appellant
Mr John Gardiner QC and Mr Philip Walford (instructed by Messrs Reynolds Porter Chamberlain LLP) for the Respondent

Hearing dates : 22nd-23rd July, 2009
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Judgment
Lord Justice Moses : 
1.	In 2001, in five “fixed price repo” transactions, the respondent, DCC Holdings (UK) Limited (“DCC”), bought gilts from X Bank; X Bank simultaneously agreed to repurchase the same or identical gilts at specified future dates for a fixed amount of cash.  The substance of these transactions was a secured loan, whereby DCC lent cash to X Bank whilst  the benefits and risks relating to the security were retained by X Bank.  DCC’s profit from those five transactions, recognised in its profit and loss account, was £1.8m.   But in its return for its accounting period ending 31 March 2002, it claimed a non-trading  deficit of just over £27m. 
2.	If that is the effect of the material provisions of ICTA 1988, and of the Finance Act 1996, then the legislation which purports to bring into charge the profits, gains, losses and interest arising from those transactions has not merely misfired, it has caused the charge to explode in the muzzle.  The Special Commissioner, Mr Charles Hellier, dismissed DCC’s appeal against the Inspector’s refusal to allow the claimed deficit ([2007] STC (SCD) 592).  He concluded that the net credit to be brought into account was £1.8m.  On appeal Norris J allowed DCC’s appeal and computed DCC’s deficit at £24.1m ([2008] EWHC 2429(Ch), [2009] STC 77).
3.	All five repurchase transactions, “repos”, took the same form.  DCC owned the gilts, 10% Treasury Stock 2003, for periods which varied between 11 and 42 days. The repurchase price for the gilts was fixed not by reference to their market value but by reference to the cost of the money provided by DCC representing the sale price during the repo term.  During the term of each of the repos, DCC received payments of the semi-annual coupons on the gilts.  If DCC had been required to remit those payments of interest to X Bank, the repo would have been termed a “gross paying repo”.  However, it was agreed that, in respect of each repo, DCC would not be required to do so.   Instead, since DCC was to retain the coupon it was agreed that the repurchase price would be reduced to reflect the income DCC had received, but allowing for a notional rate of interest.  The coupon, which in each of these repos was of a value which exceeded DCC’s agreed economic reward, was used both as a payment on account of the interest and as part repayment of the loan.  Such a repo is called a “net paying repo”.
4.	The full details are contained in an agreed Statement of Facts.  It suffices to illustrate the nature of the five net paying repo transactions by reference only to one.  On 30 August 2001 X Bank (an overseas company) sold to DCC (a UK resident company) in DCC’s accounting year ending 31 March 2002, *£149m nominal of 10% Treasury Stock 2003 for £170m, and on 10 September 2001 X Bank repurchased an identical parcel for £163m.  The repurchase price represented the original sale price plus interest thereon for 11 days at 4.65% less coupons received by DCC on the repo securities of £7.45m. 
5.	In the five transactions DCC bought gilts for £812m from X Bank, and resold them to X Bank for £785m, in the meantime receiving total coupon payments of £28.8m. Overall, DCC received £1.8m more than it had paid (£785m (repurchase price) + £28.8m (coupons) -£812m (acquisition price) = £1.8m).  
6.	Neither the taxpayer nor the Revenue sought in any way to criticise Norris J’s clear and accurate summary of the relevant legislation [9]-[20].  But in order to identify the issues, and explain their resolution, I too must follow the course of the legislative labyrinth, grateful for the red thread which Norris J, in Ariadne mode, has left for this court to unwind and wind in seeking to reach the statutory core of the maze.  That core is to ascertain the credits and debits, to be brought into account under s.84 of the FA 1996 in respect of DCC’s loan relationships (whether defined in s.81 of the Finance Act 1996 or deemed to exist in other statutory provisions).  Once those credits and debits have been identified, s.82(1) requires them to be used to compute, for the purposes of corporation tax, either profits and gains or any deficit arising from the company’s loan relationships in an accounting period, by subtracting the aggregate of non-trading debits from the aggregate of non-trading credits.  The result will show whether DCC made a non-trading profit, chargeable to tax under Case III of Schedule D, or was entitled to relief, for which s.83 makes provision, in respect of a non-trading deficit (s.82(4)-(6) FA 1996). 
7.	 As the journey starts, it is as well to bear in mind the underlying technique which the draftsman has chosen to adopt.  For the purposes of corporation tax, Chapter II of Part IV of the FA 1996 introduced a discrete and exclusive code for the taxation of all the profits and gains of a company arising from its loan relationships.  All such profits and gains are to be chargeable and only chargeable as income (s.80(1) and (5)).  Following the traditional form by which income is taxed under UK fiscal legislation, Chapter II identifies the source of the income it brings into charge as a loan relationship.
8.	Loan relationships are defined as relationships in which a company stands in the position of creditor or debtor as respects any money debt and the debt arises from a transaction for the lending of money (s.81).  It is important to have in mind that this method for bringing income into charge under Chapter II is deployed not just in relation to income arising from the legal relationship of debtor and creditor as defined by s.81, but also in relation to that which the statute deems to be income arising from a relationship deemed by the statute to be a loan relationship.  The Chapter applies, in short, to fictional income arising from agreements which do not, in accordance with the definition in s.81, create a loan relationship.
9.	This appeal demonstrates three examples of this statutory scheme, two examples of fictional interest from fictional loan relationships, and one example of real interest under a loan relationship, as defined by s.81 FA 1996.
10.	The first example of fictional interest arises under the fixed price repos themselves: X Bank and DCC disposed of and re-acquired capital.  The differential between purchase and repurchase price was not income but a capital profit gained by DCC.  But the statutory scheme creates fictional income, flowing from a fictional source, called a loan relationship. That income is called interest, but it is a fictional characterisation.
11.	The second example of fictional interest arises in relation to the manner in which the repo agreements dealt with the coupons DCC received.  Had DCC been obliged to remit to X Bank sums representing the amounts of the coupons it received, pursuant to a gross repaying repo, it would not have been paying interest.  But the statutory scheme characterises such a payment as manufactured interest (Schedule 23A Para 3 TA 1988).   Pursuant to the terms of the net paying repos, DCC was not required to remit to X Bank the amounts representing coupons DCC had received from the Treasury, and X Bank never received such sums.  But under the legislative scheme, DCC is deemed to have paid and X to have received a fictional amount of interest, called deemed manufactured interest.
12.	The third example shows that the only loan relationship within the s.81 definition in this appeal was the relationship between DCC and the Government and the only payment of real interest was by the Treasury to DCC when the five coupons fell due for payment. 
13.	Once the fictional interest and real interest is identified, it is brought into account either as an interest credit or as an interest debit by s. 84(1).  S.84(1) applies two distinct criteria to the sums to be brought into account, the first requiring the application, in this appeal, of an accruals basis of accounting, the second that the sums should, when taken together, fairly represent all the interest under DCC’s loan relationships. 
14.	I start with the only uncontroversial application of this statutory scheme, that is, its treatment of the difference between the price paid by DCC for the gilts and the price paid by X Bank on repurchase.  The effect of the relevant statutory provisions was not in dispute.  S.730A TA 1988 applies to fixed price repos.  It applies where the original owner, X Bank, transfers any securities to another person, the interim holder, DCC, under an agreement to sell them, and under that agreement X Bank is required to buy them back, and the sale and purchase price are different (s.730A (1)(a-c)).  Where the repurchase price is more than the sale price then the difference is to be treated as a payment of interest made by the repurchaser, X Bank, on a deemed loan from the interim holder, DCC, of an amount equal to the sale price (s.730A(2)(a)).
15.	In fact the repurchase price of the gilts was less than the sale price.  In aggregate, DCC agreed to buy the gilts for £812m and X Bank to repurchase them for £785m.  However, the repurchase price is deemed to be increased by the amount DCC is deemed to pay to X Bank in respect of the coupons receivable by DCC during the repo terms, called, as I have mentioned, deemed manufactured interest.
16.	This increase is achieved by s.730A(9)(a) TA 1988, which, if s.737A applies, construes the repurchase price as the repurchase price increased by the gross   amount of the deemed manufactured interest (737C(9)).  S.737A applies because:-
i)	X Bank, the transferor, agreed to sell the gilts and under the same agreement was required to buy them back (s.737A(1)(a)); 
ii)	as a result of the transaction periodical payments of interest (the coupon) 	in respect of the gilts were receivable otherwise than by X Bank (s.737A(2)(a), interpreted by 737B(1)(a) and (2));
iii)	there was no requirement under the agreement for DCC to pay to X Bank an amount representing the coupon (737A(2)(c)); and
iv)	it is reasonable to assume that in arriving at the repurchase price account was taken of the fact that the coupon was receivable other than by X Bank (s.737A(2)(d)).
17.	Since s.730A(9)(a) is satisfied, the reference to the repurchase price is a reference to the repurchase price applicable by virtue of s.737A(9), namely £785m increased by the gross amount of the deemed manufactured interest, £28.8m.  The process by which DCC’s deemed manufactured payments are turned into deemed manufactured interest (by virtue of s.737A(5) and s.737C(7) and (8)) need not detain me.
18.	The difference thus procured between sale and repurchase price is then brought within the scope of the loan relationship regime, in Chapter II of the FA 1996, by creating a fictional loan relationship between X Bank and DCC, as a fictional source for the deemed interest (s.730A(6)(a)).  S.730A(6)(b) specifies the method of accounting, an authorised accruals basis, as defined in s.85(1) and s.85(3) FA 1996.
19.	Thus far, no controversy arises.  Moreover, the statutory regime reflects that which is recognised in the accounts.  As the only expert to give evidence by way of written report  and oral evidence before the Special Commissioner, Mr Peter Holgate, explained, the relevant accounting standard (Application Note B of FRS 5) recognises that X Bank retains all the benefits and risks of the underlying securities, the gilts, and that the substance of the repo tranasaction was  that of a secured loan, whereby DCC lent cash to X Bank.  Accordingly, on an authorised accruals basis of accounting, DCC’s accounts recorded the fixed price repos as loan receivables with related interest income and did not recognise the underlying gilts as assets (report 4.18).  A profit of £1.8m was recorded in the profit and loss account in the period of the five transactions (report 5.7).
20.	Had the statutory regime stopped there the profit gained by DCC would have been charged to tax in a way in which any sensible tax regime might be expected to bring such a profit into charge.  But the dispute arises because the regime did not stop there.  Two further features are brought within the scope of the regime, leading to a result which, even if  inevitable,  no-one has sought to describe as sensible. Firstly, the coupons on the gilts and, secondly, the deemed manufactured payments which s. 737A deems DCC  to have made to X Bank, and which are brought within the scope of S.84 FA 1996 by s.97, are brought into account under s.84 FA 1996.   The deficit, which Norris J accepted, arises out of DCC’s contention that on an accruals basis of accounting only £2.9m should be brought into account in respect of the coupons it received whereas the amount of the deemed manufactured payments from DCC to X Bank should be £28.8m.  The Revenue contend that since the deemed manufactured payments represent the coupons payable to DCC, the sums given by s.84 in respect of the coupons should cancel out the payments it is deemed to have made.
21.	Thus two issues arise for resolution.  What amount should DCC bring into account in respect of the coupons; what amount should it be deemed to have paid to X Bank by way of deemed manufactured payments?
22.	I shall deal first with the amounts which should be brought into account by the application of an accruals basis of accounting, the first criterion imposed by s.84, and later consider the application of the second criterion, fair representation. 
23.	The only section which brings the amount of the coupons into account is s.84(1):-
“The credits and debits to be brought into account in the case of any company (DCC) in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question –
	…	
	(b) all interest under the company’s loan relationships” (my emphasis).
24.	The dispute on this issue arises out of controversy as to the sums which in accordance with the relevant authorised accounting method, namely the accruals basis, represent the coupons.  There was no dispute but that the accruals basis was the appropriate method (para 13 Agreed Statement of Facts, s.86(4)).  Moreover, it was an authorised accounting method (s.85(2)).  It is worth noting that s. 86(3) does not apply to the loan relationship between DCC and the Government since, for reasons, to which I shall shortly turn, the income from the gilts, the coupons, is not recognised in DCC’s profit and loss account.  Thus the default method in s.86(4) is applied.
25.	The essence of the accrual basis of accounting is reflected in s.85(3)(a) FA 1996.  It allocates payments to the period to which they relate, without regard to the period in which they are made or received or in which they become due and payable.  Strictly, that subsection does not define an accruals basis, rather it explains what is meant by an accounting method which contains “proper provision for allocating payments under a loan relationship to accounting periods”, for the purpose of treating an accounting method as authorised for the purposes of s.85(2).  For a definition of the accruals basis, it is necessary to turn to FRS 18, para 27 which requires :-
“the non-cash effects of transactions and other events to be reflected, as far as possible, in the financial statements for the accounting period in which they occur, and, not, for example, in the period in which any cash involved is received or paid.”
26.	S.84 is expressed to be subject to Schedule 9 of FA 1996 (s.84)(7)).  Paragraph 15(1) of Schedule 9 requires an assumption that the disposal or acquisition of the gilts is not a related transaction for the purposes of bringing into account all profits or gains arising to DCC from its loan relationships.   Paragraph 15 is expressed to be without prejudice to the provisions under s.730A(2) and (6) which bring into charge, under s.84, the difference between sale and repurchase price (para 15(6)).  Thus the first question which s.84(1) asks is what sums in accordance with an accruals basis of accounting represent the coupons on the gilts which constitute DCC’s loan relationship with the Government?
27.	The reason why DCC’s accounts do not acknowledge the income from the gilts was explained by Mr Holgate in his report.  (I touched on this at [19]).  From an accounting perspective, as he put it, although DCC legally owned the gilts during the period in which it received the coupons, it did not beneficially own them.  Thus, the accounts do not recognise the gilts as DCC’s assets and do not, accordingly, recognise any income derived from those assets (report 7.16).  This was Mr. Holgate’s preferred conclusion: that the sum which fairly represented the interest from the gilts on an accruals basis should be nil (report 8.5).
28.	Norris J rejected that view, but endorsed Mr. Holgate’s alternative conclusion [43].  On an accruals basis, the only interest on the gilts which should be brought into account is the interest accruing in the period in which DCC held the gilts.  The full amount of the semi-annual coupon only accrued over the full period of six months.  DCC did not hold the coupons for six months, but only for periods ranging between 11 and 42 days.  Had it held the gilts for six months, the full amount of the coupon received would have been recognised on an accruals basis, since the full amount of the coupon would have accrued during that period.  Since it only held the gilts for, say, 11 days, the correct amount, on an accruals basis, to bring into account was the proportion of the coupon which accrued during that period of 11 days, i.e. 11/182½ (report 7.16-19 and 8.5-6). 
29.	The underlying rationale for such an approach was central to the debate on this issue.  Interest only accrues during the period DCC held the gilts because any vendor would expect to be compensated by receiving on sale cum div the proportion of the coupon relating to its period of ownership of the gilts (report 7.18).  As DCC put it, outside DCC’s periods of ownership, others, including X Bank, will have been parties to loan relationships with the Government, represented by the gilts, and will have been accruing interest in respect of the periods they owned the gilts; they will have to bring into account credits under s.84, if they are within the charge to corporation tax.  
30.	The Revenue contended that this approach is not applicable in circumstances in which Paragraph 15 of Schedule 9 TA 1988 requires the price at which the gilts are sold and repurchased to be left out of account.  This has the effect of treating DCC’s acquisition cost and resale price as the same.  The Revenue sought, in a written question, Mr Holgate’s opinion of the correct accounting treatment of a transaction in which a gilt is purchased for the same price as it is resold and held for seven days during which the full amount of the coupon is received (p.2 response to questions of 15 January 2007).  Mr Holgate commented that such an arrangement was not a commercial arrangement since the price would not reflect the receipt of the full amount of the coupon.  But he did appear to accept that:-
“if such a transaction were to take place, then for financial reporting purposes (but not necessarily tax purposes), it would be accounted for…in accordance with the substance of the transaction.  That is (the company) would treat the transaction as a seven day secured deposit of £X (the acquisition and resale price) generating (non-arm’s length) interest of £28m.”
31.	Naturally, this answer was the subject matter of cross-examination by Mr Furness QC for the Revenue, and re-examination by Mr Gardiner QC for DCC.  It is trite to observe that this is an appeal confined to points of law.  The Tribunal responsible for finding the facts, the Special Commissioner, accepted Mr Holgate’s evidence as to the effect of the transactions in issue [11] but, as far as I can see, made no reference to the written answer on which Mr Furness now relies.  On the contrary, the Special Commissioner concluded that the correct amount to be brought into account in respect of the coupons was £0 [94].  
32.	In those circumstances, it does not seem to me to be permissible to pick out one answer from all the written and oral evidence of the only expert called and base a conclusion upon it, not least because the Court of Appeal cannot re-create the full force and effect of the expert’s evidence, considered as a whole.    If the only true and reasonable conclusion was that £28.8m must, on an accruals basis, be brought into account then the Court must acknowledge it. But counsel’s forensic swap of choice extracts from the evidence demonstrates the impossibility of such a conclusion.  Mr Furness’ further arguments revealed that not even the Revenue, who, it should be remembered, called no accountancy evidence, was wedded to that one conclusion.
33.	There are, however, problems exposed by the application of an accruals basis to the coupon, as explained by Mr Holgate and endorsed by Norris J.  If the amount to be taken into account as a credit in respect of the coupon is the amount which has accrued during the period during which the gilts are held, and if the coupon date does not fall within that period, the interim holder, such as DCC, will have to give credit for the amount which has accrued but which has not been paid, but cannot offset that credit by any debit under s.97.  Mr Gardiner accepted this effect of the application of an accruals basis to coupons which did not fall due during the period of the repo.  The reason why s.97 would not apply is because it has no application to a net paying repo unless the conditions in s.737A apply.  In a case where a coupon is not payable within the period the gilts are held, the condition under 737A(2)(a) would not be satisfied  and thus s.737A(5) would not apply.
34.	 I accept that, on an accruals basis, the sum to be brought into account is £2.9m.  It is, however, premature to reach any conclusion as to the amount to be brought into account in respect of the coupons, until the second criterion imposed by s.84(1), of fair representation, is applied.  That second criterion requires the issue of the sum produced by S.97 in respect of DCC’s deemed manufactured payments to be resolved first.
35.	S.97 applies where s.737A(5) has effect (s.97(4)).  As I have already indicated [16], the conditions for the application of s.737A TA 1988 are satisfied because, although DCC was not required to pay to X Bank an amount representative of a periodical payment of interest (s.737A(2)(c) applying the lexicon of s.737B(1)(a)), periodical payments of interest, which became payable in respect of the gilts, were receivable by DCC (s.737A(2)(a)) and it is reasonable to assume that the repurchase price took account of that fact (s.737A(2)(d)).
36.	S.737A(5) applies Schedule 23A as if the net paying repo was a gross paying repo.  It applies that Schedule as if :-
a)  DCC was required under the terms of the repos to pay to X Bank an 	amount representative of the periodical payments;
b)   DCC made a payment in discharge of that requirement; and
c)  that payment was made when the repurchase price of the gilts became due.
37.	In order to understand the means by which deemed manufactured interest is brought into account it is necessary to appreciate how the provisions of Schedule 23A apply to manufactured interest.  Schedule 23A has effect where under a contract for the transfer of shares or other securities a person is required to pay another an amount representative of a dividend or payment of interest on securities (s736A). The meaning of manufactured interest is given by Paragraph 3(1) of Schedule 23A and echoes the words I have italicised in s.736A.  Manufactured interest on gilt-edged securities is excluded from withholding tax (paragraph 3A).  But it is important to recognise that if the securities were not securities excluded from the obligation to withhold tax, the manufactured interest would be treated as if it were an annual payment to the recipient for the purposes of the Tax Acts and thus the interest manufacturer would be required to deduct by way of tax an amount from the gross amount of the manufactured interest.  In short, in the case of certain securities, the manufactured interest is subject to withholding tax.   
38.	These provisions are of significance, even though the manufactured interest deemed to have been paid by DCC is excluded from the operation of these paragraphs and brought within the scope of s.97 by virtue of Paragraph 3(12).  If payments  representing periodical payments of interest had been made by an interest manufacturer on securities liable to withholding tax, the obligation to deduct would inevitably have been calculated on the full amount of the payments (see the references to the gross amount of the interest in e.g. paragraph 3(2)(b)).  The calculation of the amount of manufactured interest excluded from the application of paragraph 3 cannot differ from the amount which falls within the application of that paragraph.
39.	But since the application of paragraph 3 is excluded, it is to s.97 that it is necessary to look to determine how DCC’s manufactured payments are to be brought into account.  S.97(4) mirrors the hypothesis in s.737A(5).  It requires DCC’s deemed manufactured payments to be treated as if DCC had made payments representative of the periodical payments of interest (the coupons) which became payable in respect of the gilts.
40.	It is important to recognise that s.97 applies both to the transferor and to the transferee of the underlying securities.  It too creates a fictional stream of income from a fictional source, a fictional loan relationship.   If DCC had been obliged to make a payment representative of the coupons, s.97 would have applied because:-
i)	any amount (“manufactured interest”) was payable by DCC to X Bank under a contract relating to the transfer of assets representing a loan relationship (i.e. the transfer of gilts which represent a loan relationship with the Government) (s.97(1)(a)) and
ii)	that amount falls to be treated as representative of interest under that relationship, that is, the loan relationship with the Government (by virtue of Para 3(1) Schedule 23A). The interest which that payment represents is called “real interest”, as indeed it is.  The coupon the Government paid to DCC is the only real interest in the case.
41.	S.97(2) then brings the manufactured interest, and thus (by s.97(4)) the deemed manufactured payments within the scope of the  provisions of s.84 (1).  It does so by requiring the manufactured interest to be treated as if it were interest under a loan relationship to which both the company by whom the manufactured interest is payable and the company to whom the manufactured interest is payable are parties.  The opening words of S.97(2) refer to that company and thus refer back to any company by whom or to whom manufactured interest is payable under s.97(1)(a).  It is important to recognise that the company to which s.97(2)(a) refers is both X Bank and DCC.  
“In relation to that company (a reference back to any company by whom or to whom the manufactured interest is payable) the manufactured interest shall be treated for purposes of this Chapter (Chapter II) −
“as if it were interest under a loan relationship to which the company is a party” (my  parentheses and emphasis).
42.	Contrast s.97(2)(b) which requires the recipient company to be treated as if under the fictional loan relationship to which it is deemed to be a party, it was entitled to the coupons, that is, the real interest payable which the manufactured interest represents.
43.	Since s.97 creates a loan relationship to which DCC is a party, the deemed manufactured payments to X Bank must be brought into account under s.84(1) since they must be treated as  interest under one of DCC’s loan relationships for the purposes of that section (s.97(2)(a)).  The  first statutory question posed by s.84(1) is what sum, in accordance with an authorised accounting method,  represents that deemed payment of interest.
44.	The only authorised accounting method which could apply to the deemed interest would be an accruals basis of accounting (s.86(4)).  The section appears to assume that such a basis could be applied.  But, as Mr Gardiner emphasised, DCC’s accounts would not recognise income created by a statutory fiction flowing from a fictional source.  Mr Holgate acknowledged that, from an accounting perspective, it is not possible to determine the debits and credits to be brought into account in respect of any deemed cash payments by DCC without more information about the transaction (report 7.22, 7.23 and 8.9).   In reaching his conclusion that the full amount of the deemed interest was payable by DCC in respect of the period during which DCC was a party to the loan relationship created by s.97(2)(a), he accepts he is doing no more than expressing his own understanding of the assumptions which the legislation makes.  
45.	I agree with Mr Holgate’s approach.  The amount to be brought into account in respect of the deemed payment of interest by DCC must depend on the true construction of s.84(1) and of s.97.  It is not a matter of evidence for an expert because it is not a figure which can be determined by the application of any accounting principle; it is to be determined by construction of the relevant statutory provisions.
46.	Normal accountancy principles would deny the deemed manufactured payment the status of interest under a loan relationship.  As DCC put it, the deemed payment of interest is purely notional (written argument §57 and Judgment [48]).  The amount of  the deemed manufactured payment by DCC under s.97 must be the same as  the amount under s. 737(A)(5) and Schedule 23A Paragraph 3.  Under s.737A(5) it is an amount representative of the periodical payment of interest payable in respect of the gilts (see s.737A(2)(a) as construed by s.737B(1)(a)).  The amount in Schedule 23A is again an amount representative of a periodical payment of interest on the gilts (s.736A and paragraph 3(1)).  The connection between the amounts under those provisions and under s.97 is completed by s.97(4).  Thus the amount of deemed manufactured payments which DCC is deemed to have made to X Bank must be £28.8m.  No other payment could be regarded as a representative payment (to use the language of s.97(4)) or representative of interest, that is the“real interest” (to use the language of s.97(1)(b)).  It is the sum of £28.8m which represents the periodical payments of interest payable (and paid) by the Government to DCC.
47.	Accordingly the amount of the deemed manufactured payment brought, by s.97(2), within the scope of s.84(1) is £28.8m. 
48.	Once that conclusion is reached, the problem emerges in greater focus.  The interest on the gilts, which the deemed payments are designed to represent, is brought into account by S.84(1).  Bringing that interest into account on an accruals basis of accounting gives, as I have agreed, an interest credit of £2.9m; it does not give a credit which matches the  interest expense of £28.8m which DCC is deemed to have incurred.  
49.	If the coupons are treated on an accruals basis, only a proportion of the coupons payable and received is brought in as a credit under s.84(1), whereas the deemed manufactured payments to be brought into account as an expense are in an amount representative of  the coupons which have become payable.  To adopt Mr Gardiner’s submission, an accruals method is not concerned with that which is payable, it is concerned only with that which has accrued.
50.	Mr. Furness sought to gain advantage from the application of an accruals basis of accounting to the interest expense DCC is deemed to have incurred.  He attempted to achieve the Revenue’s goal of matching the sum representing the deemed manufactured payments to the sum representing the coupons on the gilts by applying an accruals basis not just to the amount brought into account in respect of the coupons but by applying that accounting method to the amount in respect of the deemed manufactured payments.  If, on an accruals basis, only that proportion of the coupon which accrued during the period of the repo is to be brought into account, then, Mr Furness contends, only that proportion of the deemed manufactured payments deemed to have accrued as an expense during that period should be brought into account.  After all, since the deemed payments are representative of the coupons (s.97(1)(b)) and since s.97 is silent as to the period to which the deemed manufactured payments relate, there is every reason, so he claimed, why an equal proportion of the deemed manufactured payments  should be deemed to have accrued over the same period as the proportion of the coupons accrued.
51.	The answer to that submission lies in the underlying rationale of the accruals basis of accounting.    In relation to the interest on the gilts, other persons will have been accruing interest in respect of periods outside DCC’s ownership of the gilts, whilst they themselves were parties to the loan relationships represented by the gilts.  Conversely, the deemed expense incurred as a result of the deemed manufactured payments could only be incurred by DCC and thus only accrued to DCC.  The deemed manufactured interest is not, as the judge put it, notionally payable in respect of any period other than the period of the repo, the period when DCC was in a deemed loan relationship with X Bank [57].
52.	That, according to DCC and Norris J, is the end of the matter. Three sources of three separate streams of income are identified.  All are brought into account as either debits or credits under s.84(1).  The interest accrued to DCC from two distinct sources.  Firstly, the sum of £1.8m fairly represents, on an accruals basis, the deemed interest from the deemed loan relationship under s.730A TA 1988 (Judgment [47]).  Secondly, the sum of £2.9m fairly represents, on an accruals basis, the interest accruing to DCC from the loan relationship with the Government represented by the gilts which it owned, and brought into account by s.84(1) FA 1996 (Judgment [43]).  But the sum of £28.8m is the amount of the deemed manufactured payments by DCC to X Bank which s.97 deems to be interest to be brought into account under s.84(1) (Judgment [50]).  The aggregate of the debits is greater than the aggregate of the credits to be used in the computation under s.82 (s.82(4)) and thus give rise to a non-trading deficit on DCC’s loan relationships.
53.	Neither Mr Gardiner nor Norris J found any statutory justification for wafting a magician’s wand, scattering the stardust of fairness over the sums brought into account by s.84(1) [Judgment 55].  Lord Hoffmann would have described such an approach as “spooky jurisprudence” (Norglen Ltd v Reed Rains Prudential [1999] 2 AC 1,14).  Parliament has chosen not to tax DCC on the basis of the economic profit shown in its statutory accounts and it is not for the courts to rectify the detailed legislation in order to achieve that result (see, e.g. Lord Hoffmann ‘Tax Avoidance’ [2005] BTR 2 197,205).
54.	In a detailed and closely argued Determination, the Special Commissioner sought to construe s.84 as authorising the selection of sums which fairly represented the income under the loan relationships by the application of:-
“judgment and common sense and an eye to the recognition of profit or loss by those (the statutory) accounts” [72].
55.	 In striving for such a result, the Special Commissioner took the view that:-
“Neither paragraph 15, section 730A, nor section 97 requires reality to be adjusted.  No payments are deemed to be made which are not made, and no transaction is deemed to take place which does not take place and no transaction is deemed not to take place which does take place.” [200(1)].
56.	I agree with both Mr Gardiner and with Norris J, [41], that the provisions of s.730A, s.737A, Schedule 23A and s.97 do not admit of such a view.  S.730A deems X Bank to have made a payment of interest to DCC of £1.8m; no such payment was made.  S.737A, Schedule 23A and s.97 deem DCC to have paid interest to X Bank; no such payments were made.  There is no basis for starting with an assumption that Chapter II is seeking to tax the economic profit shown in DCC’s statutory accounts.  On the contrary, the statutory regime deliberately and persistently creates fictional streams of income which could never appear in such accounts.
57.	Nor does it seem to me possible to invoke a canon of construction which seeks to avoid what the Revenue describes as absurdity.  The Revenue trotted round the paddock those hobby-horses which provide authority for the proposition  that effect is to be given to the presumption that Parliament did not intend to legislate to produce an absurdity (IRC v McGuckian [1997] 1 WLR 991, Billingham v Cooper [2001] STC 1177 [35], and in the context of statutory hypotheses, Marshall v Kerr 67 TC 56, 79A).  The answer to such submissions is, I suggest, to be found in the comments of Henderson J in relation to other provisions of relevance to transactions in repos in Ch II Pt XVII of TA 1988.  He declined to identify any absurdity when a taxpayer was able to exploit an unintended gap left by the interaction of two different statutory provisions, relating to the accrued income scheme and to manufactured interest, enacted at different times for different purposes (HMRC v D’Arcy  [2007] EWHC 163 (Ch) [47] [2008] STC 1329).  
58.	Since the provisions in question were different from those in issue in this appeal, it is unnecessary to analyse them further.  Similarly, it is not necessary to do more than observe that the wording of s.730A(2) itself led to what the Revenue described as a bizarre result in the case of a tripartite repo.  Lawrence Collins LJ declined to read words into that section to avoid that result; to do so “would amount to an unprincipled process of legislative gloss” (R & C Comrs v Bank of Ireland [2008] EWCA Civ 58 [45] [2008] STC 398).  These cases do not afford any basis for confidence that the provisions relating to repos will lead to what the Revenue would describe as  a sensible result. 
59.	Nor is it surprising if the relevant statutory provisions gave rise to what the Revenue describe as a mismatch between the real interest accruing to DCC in respect of its loan relationship with the Government, represented by the gilts, and the fictional interest payments which DCC is deemed to make under a fictional loan relationship with X Bank.  S.737A was introduced by FA 1994; s.730A by FA 1995, the material computational and charging provisions by FA 1996, and paragraphs 3 and 3A of Schedule 23 by FA 1997.  New repo provisions were introduced in 2007, and there is a proposal to introduce retrospective legislation to cure the apparent defect exposed by Norris J, which will not affect this appeal. 
60.	Accordingly, I agree with Mr Gardiner that the only legitimate approach is  to construe the relevant statutory provisions, and apply the result which they give, without any assumptions.  The essential complaint of the Revenue is that the amount of the debit which results from the application of the provisions relating to deemed manufactured payments does not match and thereby cancel out the amount of the credit which results from the application of the accruals basis to the coupons on the gilts.  DCC’s riposte, in short, is that there is no statutory provision by which the amount of the coupon credited to DCC on an accruals basis can be cancelled out  by the deemed interest payments DCC is deemed to have made.  
61.	Mr Gardiner’s submissions challenge the Revenue to identify some “mechanism in the legislation to ‘net off’ the coupon against the deemed interest payment”( DCC written argument §74).  It is, therefore, necessary to return to the nature of the manufactured interest in s.97 and of the deemed manufactured payments to which that section applies as if they were manufactured interest.  Both manufactured interest and deemed manufactured payments are amounts, within the statutory regime, representative of interest payable in respect of the securities.  In Paragraph 3(1) of Schedule 23A, the amount is described as representative of a periodical payment on the securities.  It is by virtue of that paragraph in the Schedule that the amount may be described as one which is, or (when paid) falls to be treated as, representative of interest under s.97(1)(b).
62.	Deemed manufactured payments are described within s.97(4) as representative payments.  As I have emphasised, such payments are amounts representative of the periodical payments which became payable to DCC (s.737A(2)(a), s.737B(1)(a)).  It is, primarily for that reason, that the amount of the deemed payments DCC is deemed to have made equals the amount of the coupons payable by the Government.  Thus the essential nature of these fictional amounts which the statute deems DCC to have paid is that they represent and are equal to the amounts payable to DCC.
63.	S.84(1) is the machinery by which all interest under DCC’s loan relationships is brought into account.  The section poses a second statutory question, namely, whether any particular sum when taken together with the other sums which fall to be brought into account fairly represents all the interest including that which is the mere product of a statutory fiction.  That question is different and additional to the first question, whether the sums are in accordance with an accruals basis of accounting.  The introduction of that distinct additional question suggests the possibility but, I accept, not the necessity of some process of adjustment.  It suggests that there may be some room for adjustment of the sums which would otherwise be given by the application of an authorised accounting method, or, at the very least suggests that in some cases the identification process in s.84(1) will not merely be resolved by an authorised accounting method.
64.	Mr Gardiner submits, and the judge observed, that the section is not intended to admit sums which would not otherwise be brought into account in accordance with an authorised accounting method or to disallow sums which would be brought into account in accordance with such a method (Judgment [43]). More positively, the judge said that s.84 and the accruals method “was concerned with the allocation of income to differing periods of account” [43].
65.	It should not be thought that DCC’s case deprives the distinct additional statutory question posed by s.84(1) of meaning and effect.  Mr Gardiner has provided adequate examples to give the requirement of fair representation content.  Provisions within Chapter II, such as s.89(1) (inconsistent application of accounting methods in successive accounting periods) or s.94 (changes in the retail prices index in relation to indexed gilts) may call for an adjustment to the sums in s.84(1), although there are provisions for adjustment within the sections themselves.  A single set of expenses incurred in respect of trading and non-trading loans may require apportionment so as to distinguish between trading and non-trading deductions.  In any event, Mr Furness never argued that DCC’s submissions deprived the criterion in question of all effect.
66.	S.84(1) does, however, require identification of sums which, when taken together, fairly represent all interest under DCC’s loan relationships.  Thus that which must fairly be represented embraces not only what might be described as real interest, such as  interest on the gilts, the source of which is a loan relationship as defined by s.81(1) (in the case of gilts between DCC and the Government), but also the fictional statutory constructs such as the deemed interest deemed to have been paid by X Bank to DCC and the deemed manufactured interest deemed to have been paid by DCC to X Bank. The sources of such interest are not loan relationships as defined by s.81(1) but merely fictional loan relationships created by s.730A TA 1988 and s.97 FA 1996.  Deemed interest income and deemed interest expense come within the application of s.84 by virtue of those statutory provisions, and not because interest derives from loan relationships falling within the definition under s.81(1).  
67.	The nature and function of those statutory fictions are wholly dependant upon the terms of the statutory provisions which created them.  Section 84(1) cannot, in my view, be read as altering, in any way, the nature and function of those fictions.
68.	Thus, the nature and function of the deemed interest expense incurred by DCC  created by s.97 cannot be altered by s.84(1).  That notional expense exists only to cancel out the interest payable to DCC under the loan relationship with the Government represented by the gilts.  Under the terms of the net paying repos, the coupons received by DCC are deployed to defray the repurchase price and to allow for DCC’s profit on the transactions.  S.730A recognises that deployment of the coupons by adding to the repurchase price an amount equivalent to the coupons DCC received.  S.97 requires the deemed manufactured interest payable by DCC to be treated for the purposes of s.84(1) as if it were payable to X Bank under a loan relationship with the Government, represented by the gilts. 
69.	So far as DCC is concerned, the source of the deemed manufactured interest expense is different from the deemed manufactured interest income received by X Bank; it is not the loan relationship represented by the gilts, but a distinct loan relationship created by s.97(2)(a).  But the deemed interest expense does not lose its quality as representative of interest (s.97(1)(b) or a representative payment (s.97(4)).  It cannot lose its essential characteristic of matching the interest receipt it represents; it cannot lose its essential function, which is to  cancel out, but not to exceed, the amount which it represents.
70.	The resolution of the dispute thus comes down to whether the application of the additional distinct criterion which requires the sums, taken together, fairly to represent all interest, permits the amount given in respect of the coupons by an accruals basis of accounting to be displaced by the amount which the deemed interest expense is supposed to represent.
71.	I acknowledge that to do so requires, in effect, the first criterion to yield to the second.  I must also recognise that S.84(1) does not assume any conflict between the application of an authorised accounting method and the requirement of fair representation.  But in my view if the sum to be brought into account as a credit is only £2.9m, the effect is to alter the essential nature and function of the deemed interest expense.  That fictional interest expense only exists by virtue of the statutory fictions created by a combination of s.737A, Schedule 23A and s.97.  It only exists as a sum which is equal to and which cancels out the interest payable to DCC.  A sum of £2.9m for the coupons given as a credit by the accruals basis deprives the interest which DCC is deemed to have paid of its essential nature and function.  The effect of the application of an accruals basis to the coupons is to deprive the deemed manufactured interest of its essential statutory function of cancelling out the credit payable to DCC; it produces a sum, which, when taken together with the other sums, does not cancel out the credit but exceeds it by a substantial margin.
72.	To use the words of the section, if the sum given by the application of an accruals basis as a credit deprives the deemed interest expense of  its statutory function, that sum cannot be said, when taken together with all the credits and debits, fairly to represent all the interest under the loan relationships.
73.	Norris J rejected the submission he described as a presupposition that debits must match credits [57].  If that was the way the submission was put, I agree with him.  Perhaps the red thread was unwound in a different way.  Certainly, the draftsman’s apparent wish to fill the vials of Norris J’s wrath was successful [22].  I have adopted his description of the legislation as a maze.  Mazes were, traditionally, devices for immuring in and for exclusion (Rykwert The Idea of a Town MIT Press 1988, p.151).  Why the draftsman should wish to conceal the process of computation is unclear.  But in my view, there is no need for any presupposition.  There is no need or room for an assumption of fairness.  The construction of the relevant statutory provisions I have proposed does permit the conclusion that the sum to be brought into account in respect of the coupons is not £2.9m but is £28.8m.  It is that sum which fairly represents all DCC’s interest under its loan relationships.  At the computation stage, the deemed interest expense DCC incurred will, thus, fulfil the function for which its statutory progenitor provides: it will represent and thereby cancel out the interest to be credited in respect of the gilts. 
74.	I would allow the appeal and substitute for the order of Norris J an order that DCC’s appeal against the Revenue’s amendment of its return  be dismissed.
Lord Justice Rimer:
75.	I have had the advantage of reading Moses LJ’s judgment in draft and gratefully adopt his lucid explanation of the facts and of the legislation upon which this appeal depends. I have also had the advantage of reading Rix LJ’s judgment in draft. I have found this to be a difficult case. 
76.	The outcome, from an economic and accounting viewpoint, of the repo transactions is that DCC earned a profit of £1.8m, a figure which would be reflected in its statutory accounts. That was the interest that the Special Commissioner held that DCC had to bring into account in accordance with section 84(1) of the Finance Act 1996. The route by which he arrived at that conclusion did not accord with either side’s contentions. 
77.	Norris J disagreed with the Special Commissioner’s approach. He applied himself to a careful analysis of the extraordinary legislation upon which this appeal depends and followed a logical path of reasoning that led him to the conclusion that the bringing into account under section 84(1) of the interest credits and debits arising under the actual and fictional loan relationships recognised by the legislation produced the result that, for the purposes of its corporation tax return, DCC incurred a loss of £24.1m. 
78.	If that is the effect of the legislation, it must be respected. My instinct, however, is that such a result amounts to an apparent commercial absurdity. If that instinct is justified, I also find it hard to accept that such absurdity can have been intended by the legislation; and if the legislation is susceptible of an interpretation that can avoid it, that interpretation may be one that the court can properly adopt (Mangin v. Inland Revenue Commissioners [1971] AC 739, at 746E, per Lord Donovan). Both Moses and Rix L.JJ have identified paths (not, I think, identical ones) leading them to the conclusion that the legislation does not result in any such absurdity.
79.	Section 84 (headed ‘Debits and credits brought into account’) provides, so far as material: 
“(1) The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question –
(a) … ; and
(b) all interest under the company’s loan relationships and all charges and expenses incurred by the company under or for the purposes of its loan relationships and related transactions.”
80.	There is no dispute that, under section 730A(2)(a) of ICTA 1988, DCC has a deemed loan relationship under which it receives a notional payment of £1.8m interest that must be brought into account under section 84(1) as a credit. I also agree with Norris J and Moses LJ that the deemed manufactured interest debit required to be brought into account under section 84(1) in respect of the deemed loan relationship arising by virtue of section 97 of the Finance Act 1996 (and section 737A of ICTA 1988) is £28.8m. 
81.	As regards the interest credit to be brought into account under section 84(1) in respect of DCC’s gilts loan relationship, I also agree with Norris J and Moses LJ that this required recourse to an accruals basis of accounting, that being an authorised accounting method for the purposes of section 84(1) (I do not understand this to have been in dispute). The only accounting evidence before the Special Commissioner was that of Mr Holgate. The Special Commissioner accepted his evidence, an acceptance that I regard as including Mr Holgate’s opinion as to the amount of the credit interest to be accounted for under the gilts loan relationship. In paragraphs 7.15 and 7.16, Mr Holgate explained that the conventional accounting treatment of DCC’s repo transactions would reflect their substance rather than their legal form, with the result that its statutory accounts would not recognise its holding of the gilts as an asset, nor would they recognise any income from the gilts. But he then went on to explain (in paragraphs 7.17 to 7.19; and see also paragraph 8.6) that if it was necessary to account for DCC’s ‘loan relationship’ by virtue of its legal ownership of the gilts, and upon the statutory assumption that it is necessary to ignore the debits and credits arising on the acquisition and disposal of the gilts, then:
“… it is appropriate to bring into account the interest accruing on the gilts only in respect of the period those gilts are held by DCC, ie the proportion of the interest received by DCC. This is because any other party holding the gilts before and after the term of the repo transaction would expect to be compensated by receiving the proportion of the coupon relating to their period of ownership of the gilts.”
82.	There is no dispute that, on the arithmetic, that accounting basis resulted in £2.9m interest having to be brought into account by DCC. DCC accepts that section 84(1) required it to account in that sum for its interest under its gilts loan relationship. Norris J accepted that the effect of Mr Holgate’s evidence was that £2.9m interest had to be brought into account (paragraphs [43] and [55] of his judgment). Moses LJ also accepts that the accruals basis of accounting under section 84(1) requires a credit of £2.9m interest to be brought into account, at any rate at the first stage of the section 84(1) exercise. He also explains his reasons, with which I agree, why it is not safely open to this court to latch on to one of Mr Holgate’s written answers to the Revenue’s written questions, and explored in the oral evidence, to the effect that on a particular hypothesis (not reflecting the applicable statutory hypothesis) the company would account for the transaction as a seven day secured deposit generating interest at the full amount of the coupon. Mr Furness QC sought to deploy this with a view to supporting an argument that the amount of the credit interest under the gilts loan relationship that must be brought into account is £28.8m, but I consider that it is £2.9m.
83.	It is the arrival at those two figures, a debit of £28.8m and a credit of £2.9m, that creates the problem. If section 84(1) requires them both to be brought into account at face value in the computation of DCC’s corporation tax return, the result favoured by Norris J must be correct. Apart, however, from the commercial oddity of the result, it is only necessary to change the facts slightly to reveal another apparent oddity that the legislation can generate. As Mr Furness pointed out, in a repo transaction taking place over a period during which no coupon is paid, the interim holder of the gilts will (like DCC) have to bring into account under section 84(1) an element of interest representing his accrued share of the coupon later paid, yet will apparently not be able to bring into account a debit in respect of deemed manufactured interest under section 97. In such a case the interim holder would not, like DCC, show a fictional loss in its corporation tax return, it would show a fictional taxable profit exceeding its true profit arrived at in accordance with conventional accounting principles. 
84.	These considerations satisfy me that the court must look carefully at the legislation to see whether, on the present facts, it compels the interpretation that Norris J favoured. Moses and Rix L.JJ have both concluded that it does not. Moses LJ agrees that the exercise required by the ‘authorised accounting method’ prescribed by section 84(1) requires the credit of £2.9m to be brought into account at the first stage of the exercise, but has concluded that the same sub-section either requires or permits the figure then to be substituted by one of £28.8m. He has given his explanation as to why the justification for that lies in the parts of section 84(1) which I here emphasise, namely its provision that the ‘credits and debits to be brought into account … shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question …. all interest under the company’s loan relationships….’.
85.	For reasons I hope I have sufficiently explained, I would like to be able to agree with Moses LJ’s reasoning, since it enables a result that accords with the conventional accounting treatment of the repo transactions and clothes the relevant legislation with a garb of commercial sanity that Norris J was unable to identify. I regret, however, that I am unable to do so. Moses LJ’s reasoning appears to me, with respect, to load on to the emphasised words a function that they cannot naturally bear and whose effect is promptly to deprive the opening provisions of the sub-section of virtually all sense. I am not persuaded that the emphasised words are capable of doing the service he derives from them. As Moses LJ has indicated, even on DCC’s case they serve an important function. But the extent of their reach cannot, in my judgment, be such as wholly to negative the subsection’s requirement that (inter alia) the credit interest under the gilts loan relationship must be calculated in accordance with an authorised accounting method and brought into account accordingly. If this had been the intention of the legislation, it would not and could not have been written in the way it is. Its manner of writing may, if Norris J was correct, have created an apparent absurdity, but I can identify no interpretative route by which that can be avoided. In particular, whatever the emphasised words may permit or require with regard to the sums arrived at in accordance with the mandatory ‘authorised accounting method’, they cannot in my view permit a substitution for any of such sums of other sums arrived at by a different, unauthorised method.
86.	Mr Gardiner QC, in the course of his cogent submissions, conceded, indeed asserted, that this much amended legislation is a mess (he may have expressed it more elegantly). He was, I consider, right to do so; and it comes as no surprise to me that legislation as complicated as this (which, following Norris J’s decision, is the subject of proposed further amendments) has led to the result that I find it has. Norris J said of it in paragraph [22] of his judgment:
“It is something of a disgrace that in order to work out the tax consequences of an entirely ordinary commercial transaction one must refer to about 20 closely articulated and specific statutory provisions replete with cross references: and it is a matter of no great credit that the eventual method of charging tax is to postulate a notional sum paid under a hypothetical obligation, which notional payment is then itself treated “as if” it was something else so that it can be deemed to affect the repurchase price and create a fictional income flow. Having entered into such a maze of hypothesis, notion, fiction and deeming it would be no surprise to discover that the draftsman did not find himself quite where he intended or facing the direction he thought.”
87.	I consider that Norris J was correct in his decision. I would dismiss the appeal.
Lord Justice Rix:
88.	The repo transactions in this case are of a nature which must have been reproduced countless times in the past. They are in form sales and repurchases of securities, but in substance they are secured loans. They are loans provided by the buyer to the seller (who is also of course the re-purchaser) for a fee which reflects the applicable market interest rate on the amount lent (the original purchase price) over the period of the loan. Although nominally the legal title to the securities passes and repasses, the beneficial interest in the securities remains with the seller. Since the beneficial interest remains with the seller, he is entitled to any coupon payments generated by the securities, and he also bears the market risk of any loss on the securities (and remains entitled to any market gain). The price of the transaction (the interest on the loan) is inherent in the fixed prices for both original purchase and repurchase which are set at the outset. If during the period of the loan the buyer receives a coupon payable on the securities, he does so on behalf of their beneficial owner, the seller. The repo transaction will therefore make clear whether such a coupon payment is taken into account as part payment by the seller of the repurchase price (a net paying repo), in which case the repurchase price will be that much lower, or whether it is to be remitted to the seller (a gross paying repo), in which latter case the repurchase price will of course simply be the purchase price plus the applicable cost of the loan. 
89.	It is not in dispute that the proper accounting treatment of such transactions is to treat them as the functional loans which they are, rather than by reference to their legal form. Thus in this case, the repo transactions have generated an interest charge and profit to the buyer, DCC, of £1.8 million. It is this profit which is reflected in DCC’s accounts. The relevant accounting standard is FRS 5 (“Reporting the substance of transactions”) which provides:
“In determining the substance of a transaction, all its aspects and implications should be identified and greater weight given to those more likely to have a commercial effect in practice. A group or series of transactions that achieves or is designed to achieve an overall commercial effect should be viewed as a whole.” 
90.	In the present case, the coupon payment of £28.8 million which the buyer, DCC, received became part of the repayment generated by the repurchase (a net paying repo). Presumably the interest charged by DCC on the functional loan reflected the time at which that £28.8 million was received by it. 
91.	However, a question has arisen in this case, apparently for the first time, as to the proper tax treatment of such repos. It is submitted on behalf of DCC that the complex statutory tax provisions which govern repos require that the effect here is not a profit to DCC of £1.8 million, but a loss of £24.1 million.  This is because, while DCC may have to be have to be treated as having incurred a debit of  £28.8 million (the amount of the coupon it received during the period in which it held the securities), the judge has held that it has limited credits to set against that debit: namely, first a credit of only £2.9 million being a calculation of that portion of the coupon payment of £28.8 million as could be attributed to the period during which DCC held the securities, and secondly the £1.8 million earned by the buyer/lender as the price of the transaction.  Thus whereas the £28.8 million is to be debited to DCC, since the coupon it received does not belong to it but to the seller/borrower, and the statute has provided that such an amount should be debited under section 97(2) of the Finance Act 1996 qua deemed manufactured interest, it has been held that the corresponding credit is not the same £28.8 million but a smaller amount representing what DCC would have earned as the holder of the securities for only a limited time. 
92.	Statutory changes have now been proposed to eradicate any possibility of this argument. The question remains whether the effect of the unamended legislation is to permit or require that result. If it is so, that legislation must be given its effect. It would be, however, a most unfortunate, uncommercial, and no doubt unintended result. 
93.	Although the statutory provisions are complex, they have been identified and worked through by Lord Justice Moses in his judgment, for which I am most grateful. In truth, the parties were for the most part in agreement as to their effect. Thus they were agreed that on one alternative view the correct debit was £28.8 million (see paras 46/47 above in the judgment of Moses LJ: but the Revenue also put forward an alternative submission that, were the correct debit to be £2.9 million, then the correct credit should be the same).  They were at issue however in particular as to the correct credit to be regarded as generated by DCC’s receipt of the £28.8 million coupon. DCC said that the judge was right.  The Revenue’s primary case was that the right figure was the £28.8 million itself.
94.	These statutory provisions, although complex, are to my mind always seeking one goal, which is to reflect the substance of a functional secured loan transaction even though that transaction appears in legal form to consist of a sale and repurchase. That is why the debit of £28.8 million is dealt with under the statute as deemed manufactured interest. It is an attempt to reproduce the commercial effect of a repo qua secured loan even though it is in form a sale and repurchase transaction. Under an ordinary sale of securities, the buyer would receive any coupon payable on the securities during the period of their ownership, and the value of this payment would have been reflected in the price paid by the buyer when he buys cum the coupon (or dividend) payment. (Of course if he buys ex the coupon or dividend payment, then he pays a lesser price, and the coupon or dividend belongs to the seller). Under a repo, however, because it is treated as a secured loan under which the beneficial interest in the securities is retained by the seller, the coupon payment belongs to the seller/repurchaser, not to the buyer.  
95.	At the end of the day, the critical statutory provision upon whose effect the parties have differed is section 84(1) of the Finance Act 1996, which for the sake of convenience I will set out again:

“The credits and debits to be brought into account in the case of any company in respect of its loan relationships shall be the sums which, in accordance with an authorised accounting method and when taken together, fairly represent, for the accounting period in question –
all profits, gains and losses of the company…
all interest under the company’s loan relationships…”
96.	There are detailed provisions in sections 85 and 86 about what “an authorised accounting method” is, but it appears to be accepted that for relevant purposes the method needs to be “an accruals basis of accounting” (see section 85(1)(a) of the 1996 Act and section 730A(6)(b) of ICTA 1988). It is not clear to me that the accounting treatment which the repos in question have in fact received in DCC’s statutory accounts is not an authorised accounting method and one on an accruals basis, but I leave that matter aside. 
97.	The statutory phrase “taken together, fairly represent” at first blush does not seem to be conducive to DCC’s submission, which produces a result which is anomalous and uncommercial, and may be said simply to fail fairly to represent the transaction, and instead to create an uncovenanted windfall. The Revenue would wish to rely strongly on this statutory provision, whereas DCC would wish to say that it is essentially met by the authorised accounting method. In my judgment, however, these are important words and have to be given their full effect, otherwise a result will be produced which the statute says is to be avoided. Moreover, I agree with Moses LJ that ultimately the assessment to be made by reference to these words has to be made by the court, and not by a witness, however expert. 
98.	Even so, in these circumstances the sole expert accountancy evidence before the court, that of Mr Peter Holgate, assumes considerable importance. But what is it that he says?
99.	His evidence, mainly in the form of his report but supplemented by his answers to questions from the Revenue, seems to me for relevant purposes to say four separate things, each of which has to be evaluated. 
100.	First, in chapter 4 of his report, he records his views about “Fixed price repos and their accountancy treatment”. As already explained, such treatment follows their substance, not their form. Thus the seller is recognised as the recipient of any income paid on the securities during the period of the loan, even though the cash is received via the buyer. Counter-entries therefore recognise both the receipt of the income and its payment to the seller. Ultimately, the profit on the transaction is recognised as the interest charged on the loan, in this case, the £1.8 million. He summarises:
“4.18 In summary, the seller accounts for a fixed price repo as a fixed rate borrowing with a related interest cost and continues to recognise the underlying security as an asset in its balance sheet. The buyer accounts for a fixed price repo as a loan receivable with related interest income and does not recognise the underlying security as an asset.”
101.	Secondly, in chapter 7, Mr Holgate deals with the section 84 exercise. He cautions (at para 7.10) that his understanding of that exercise is at odds with “accounting perspective” by which 
“Rather we look to the arrangement as a whole and ensure that the accrued interest (or finance cost/income) recognised in the profit and loss account takes into account the cash flows associated with the transaction. In essence, for a simple fixed interest term loan, the amount of the expected net cash flow is accrued in the profit and loss account over the term of the arrangement.”
He also cautions as follows:
“7.11 Furthermore, in order to prepare financial statements that show a ‘true and fair view’ of the transactions undertaken by an entity, full knowledge of the transactions and arrangements undertaken by the entity must first be understood, both from a legal and an economic perspective. Accordingly, accounting standards and GAAP are based on real, economic transactions and therefore determining the most appropriate accounting treatment without the full facts or based on transactions which do not make economic sense is difficult, if not impossible.”  
102.	Against the background of those warnings, he gives his opinion as follows:
“7.16 As described in sections 4 and 5 of my report, the accounting treatment follows the substance of the repo arrangement, rather than its legal form. Therefore, from an accounting perspective, even though DCC legally owns the gilts, as in substance it does not have beneficial ownership of the gilts DCC does not recognise the gilts as its asset and does not recognise any income in respect of those gilts. On this basis, DCC would not recognise any profits, gains, losses or interest in the accounting period in respect of its legal ownership of the gilts.”
103.	On this basis, the credit to DCC in respect of its legal ownership of the gilts is nil. That of course reflects the real accounting position. The judge rejected that answer, and it is not pursued by DCC.
104.	Thirdly, Mr Holgate gave an alternative answer to the one just given, upon a different hypothesis:
“7.17 Alternatively, if one assumes that we ignore the debits and credits arising on the acquisition and disposal of the gilts with X Bank, but that it is still necessary to account for the legal ownership of the gilts, being the ‘loan relationship’, then the position is as follows.
7.18…it is appropriate to bring into account the interest accruing on the gilts only in respect of the period those gilts are held by DCC, ie the proportion of the interest received by DCC. This is because any other party holding the gilts before and after the term of the repo transaction would expect to be compensated by receiving the proportion of the coupon relating to their period of ownership of the gilts.”
On that basis, therefore, the credit in question is the £2.9 million. This is the credit which the judge accepted. It will be observed that in this passage Mr Holgate deals with the receipt of the £28.8 million coupon in entire isolation from all other aspects of the transaction.  For the reasons given in para [94] above, I am puzzled by Mr Holgate’s rationalisation for his figure of £2.9 million, but I put that aside.
105.	Fourthly, Mr Holgate was asked the following question and gave the following answer to it:

“[Q] What is the correct accounting for the following transaction? Company A purchased a gilt for £X, held it for seven days receiving a coupon of £28m, and then resold it for £X?

[A] I am assuming that other than the resale price of the gilts being the same as the purchase price, the remainder of the terms of the repo agreement in the above question are similar to those transacted by DCC in 2002 summarised in paragraph 3.2 of my report. In such circumstances, Company A would not be able to participate in any movements in the price of the gilt, since the resale price of the gilt is fixed at the date of purchase, and the coupon receipt would not relate to Company A’s holding of the gilt for the seven day period of the arrangement. Rather, Company A has deposited £X for the period of the repo arrangement which has generated a return (ie interest income) of £28m, being the coupon received on the gilts which Company A keeps under the terms of the arrangement. Clearly such an arrangement is not on arm’s length, commercial terms, as £X, being the market price of the gilt on the day of purchase, could not generate a current market return equivalent to 6 months coupon on the gilt over a period of seven days.

However, if such a transaction were to take place, then for financial reporting purposes (but not necessarily tax purposes), it would be accounted for by Company A in accordance with the substance of the transaction. That is, Company A would treat the transaction as a seven-day secured deposit of £X generating (non-arm’s length) interest income of £28m, for the same reasons as set out in chapter 4 of my report. Company A would not recognise an investment in the gilt as an asset in its balance sheet, as it does not bear any of the risks or rewards of holding the gilt.”
106.	What is the court to make of this equivocal evidence? Mr Holgate’s first answer (chapter 4) gives the true and proper accounting treatment: the balancing profit item is £1.8 million, and the £28.8 million coupon goes through DCC’s hands but ends up with the seller, who uses it to repay (in part) the loan. If therefore that movement of funds has to be recorded and accrued separately, the receipt by DCC of £28.8 million is matched by a corresponding debit in the same amount as the money passes to the seller.  The second answer (para 7.16) reflects the same reality: the value of the coupon received by DCC is nil, because the funds in question do not belong to it. On that scenario, the concentration is all on the status of the £28.8 million when it is received by DCC as a coupon payable on the securities, but the answer is given by reference to the transaction as a whole, because that is what proper accounting requires. The third answer (paras 7.17/7.18), however, is given on the assumption that the complete context of the transaction is eradicated and ignored and all that is looked at in isolation is the receipt of the coupon by DCC at a time when it was the securities’ owner. In giving this answer, Mr Holgate is expressly not undertaking any exercise which even purports to be dealing with matters on the basis of asking what sums “taken together fairly represent” all profits, gains and losses and all interest under loan relationships (see section 84(1)). Although he speaks of his answer as being one that “fairly represents the interest arising on the gilts held by DCC”, that is not the statutory exercise which has to be performed, which has in any event been left, in my opinion, to the judge, for Mr Holgate is looking at a single item in isolation. (I have stated above my concern even on that basis at this answer, but for present purposes I accept it for what it is intended, namely a snapshot of a single item.) The fourth answer goes back to consider a particular item but in the overall context of a repo transaction, albeit a somewhat unrealistic one: that lack of realism, however, is adopted to emphasise the need to concentrate on the particular item in question. The answer appears to be that the coupon payment has to be regarded for accounting purposes as a credit to DCC of £28.8 million. 
107.	I would add that the very reason given by Mr Holgate for his third answer seems to my mind to indicate that it cannot be an attempt to give an answer to the statutory question: for its rationale is that “any other party holding the gilts before and after the term of the repo transaction would expect to be compensated by receiving the proportion of the coupon relating to their period of ownership of the gilts”. Again, I have doubts about this. But accepting its logic, I observe that on that basis the £2.9 million credit simply cannot live together with the £28.8 million debit, since the seller/repurchaser is itself the holder of the securities before and after the period of DCC’s ownership. 
108.	In my judgment, the court’s response to this evidence, in the context of the statutory enquiry, cannot simply be to accept the third answer, which does not even purport to address the statutory criterion of “when taken together, fairly represent”. Rather, the answer to the question, what is the credit to be accrued to DCC arising out of the receipt of the £28.8 million coupon, in the context of the repo transactions as a whole, and thus taking into account the datum debit of £28.8 million, can only be – £28.8 million. Only that answer reflects the totality of the statutory material, which seeks to recreate in its complex provisions the functional secured loan which the repo constitutes; only that answer reflects the real evidence which I understand Mr Holgate repeatedly to be giving concerning the proper accounting treatment of these matters; and only that answer gives a sensible, realistic and just result. Only that answer can be said to provide “the sums which, in accordance with an authorised accounting method and when taken together, fairly represent” all profits and interest which have to be taken into account.
109.	For these reasons, as well as those of Moses LJ, I would, with all respect to the judge, allow this appeal.