[2009] UKFTT 261 (TC)

TC00208
Reference No:  SC/3054/2008
Corporation Tax  -  Joint referral of four disputed issues in relation to treatment of derivatives and to capital gains treatment of the sale of a company  -  scheme for the avoidance of income recognition on a re-couponing of an "in the money" fixed/floating swap  -  paras 15 and 28 of Schedule 26 to FA 2002  -  capital gains value shifting -  Section 30 TCGAct 1992-  one issue determined in favour of the taxpayer company and three issues determined in favour of HMRC
FIRST-TIER TRIBUNAL
TAX
HBOS TREASURY SERVICES PLC
(now HBOS TREASURY SERVICES LIMITED)
The First Referrer
(Corporation Tax)
-and-
THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS
The Second Referrer
(Corporation Tax)

TRIBUNAL JUDGE:  HOWARD M. NOWLAN
Sitting in public in London on 28 – 30 April and 22 July 2009   

Malcolm Gammie Q.C. on behalf of the taxpayer
Kevin Prosser Q.C. and James Rivett, counsel, on behalf of HMRC
©CROWN COPYRIGHT 2009 
DETERMINATIONS
Introduction
1.     This case was not strictly an appeal but a joint reference, made under paragraph 31A of Schedule 18 to FA 1998, by HBOS Treasury Services Limited ("Treasury Services") and HMRC for me to determine four disputed questions that had arisen in relation to the consideration of Treasury Services' return for its accounting period ended 31st December 2003.    
2.     All four issues arose in connection with a scheme implemented by Treasury Services, designed to monetise and re-coupon some highly valuable fixed/floating interest rate swap contracts with Banque AIG ("AIG"), and to achieve that basic aim in a manner designed to avoid the normal incidence of tax on such a transaction. 
3.     These Determinations are ordered in the following way.  In paragraphs 4 to 10, I will summarise the basic facts that have occasioned the dispute between the parties. In paragraphs 11 to 15, I will indicate the four issues in dispute, and my determinations.  In paragraphs 16 to 42 I will then record the facts in more detail.   I will then take each issue in turn, adding information relevant only to that particular issue, the contentions of the respective parties, my decision on that issue and the reasons for it.   Thus paragraphs 43 to 87 contain those subjects in relation to the first, and the most important, issue.    Paragraphs 88 to 120, 121 to 138, and 139 and 140 deal similarly with the second, third and fourth issues.
The facts and the points in dispute in outline
4.     By the time of the transactions that occasioned the dispute in this case, Treasury Services held various swaps with AIG that had a positive value of approximately £180 million.  These were swaps under which Treasury Services was entitled to receive payments equivalent to fixed-interest payments at the rates of 11% and 9.375% on total notional principal amounts of £400 million until 2014 and 2021, whereas it was only liable to make floating-rate payments, involving in 2003 payments of roughly 5%.  The more detailed facts will make it clear that the fixed receipts were hedging a large proportion of the fixed-rate exposure of other group companies in relation to bonds that had been issued when the higher interest rates had prevailed, such that the HBOS plc group as a whole effectively had a floating rate exposure for accounts and tax purposes in relation to that proportion of the bonds, the high fixed interest cost of which had been swapped into a floating rate exposure by the swaps. 
5.     The valuable swaps held by Treasury Services were unusual in that they did not require the party that currently had the greater liability (i.e. AIG) to provide cash collateral to secure its obligation to pay the excess payments.  Since the HBOS plc group also had substantial other credit exposure to AIG, Treasury Services wished to reduce its credit exposure to AIG under these swaps.  The conventional way of achieving this, whilst still preserving the benefit of the swaps, was to monetise and re-coupon the swaps.  This would generally involve AIG in paying the present discounted value of the excess payments that it currently owed (approximately £180 million) for the termination of the present swaps, followed by the agreement of two replacement swaps.  Under these, a new fixed/floating swap would be entered into by reference to a fixed interest rate of 5% (the then current market rate of interest) on the full principal amount, and a second amortising swap would be entered into in respect of the reducing balance of the £180 million.  Under this amortising swap, Treasury Services would be receiving 5% fixed payments in return for floating rate payments on the reducing balance of the £180 million, the assumption being that the group’s ultimate fixed interest exposure would be met out of the fixed receipts under the first replacement swap, by progressive applications of the £180 million cash received, and by the reducing fixed interest receipts under the amortising swap. 
6.     One further important detail in relation to any re-couponing transaction is that the counter-party (i.e. AIG) would never make an outright payment exactly equal to the then discounted value of its future excess payments.  Having regard to the liquidity cost of actually having to make a payment for which it otherwise had only a deferred liability, it would conventionally negotiate to pay only a lesser sum, say of £177.8 million, if the discounted value of its excess payment liability was £180 million.  Whilst this reduction in payment would usually be dealt with simply by negotiating to make the slightly reduced payment of  £177.8 million, an alternative was possible, and this alternative was actually adopted in this case.  Thus Treasury Services agreed to make a payment of £2.2 million in return for AIG agreeing to monetise the swaps at mid-market rates (i.e. for £180 million if the swaps had been re-couponed immediately).
7.     For tax purposes it was common ground that, had the swap been re-couponed in the manner suggested above, the £180 million received would have ranked as income, but that since it was hedging a long-term liability to pay 9.375% and 11% fixed interest on internal swaps held by Treasury Services with the group company that had issued the high interest bearing bonds, the income in respect of the £180 million would only be brought into account on an accruals basis as the fixed-interest payments themselves were being deducted.  Equally if the payment received was the lower £177.8 million, such that in overall terms the transaction with AIG (when matched with the high interest liability on the internal swaps) occasioned a loss of £2.2 million, that loss would also only be recognised over the period of the remaining life of the bonds.  Under the alternative arrangement, if a fee of £2.2 million was paid to monetise at mid-market rates, such that the loss was represented by the fee, rather than the lesser amount received, the fee would occasion the loss.  The loss would similarly only be recognised over the life of the hedged liabilities, and would almost certainly have been a tax-deductible loss, if the fee had been paid for a direct re-couponing transaction effected by Treasury Services itself. 
8.     HBOS's dominant motive in wishing to effect any sort of re-couponing transaction was the desire to reduce its credit exposure to AIG.  It was however reluctant to recognise a £2.2 million loss, and so was very attracted by a proposal put to it by Lehman Brothers, and later by Swiss Re, which it was suggested would enable it to re-coupon the swap without recognising a loss at all, since the proposal would eliminate the liability to Corporation Tax on the large payment received on the re-couponing transaction. 
9.      Ignoring the detail, the scheme that I will describe from now on as the Swiss Re scheme was simple.   Treasury Services formed a new subsidiary called Dorus Investments Limited (“Dorus”), subscribed various shares in Dorus for £181 million cash, and novated the swaps into Dorus for £180 million in the expectation that that “group” transaction would pass all the latent tax liabilities in relation to the swaps down into Dorus, with its own £180 million receipt being tax free.  It then sold Dorus to a Swiss Re company for approximately £150 million.  The expectation was that within the Swiss Re group, it would be possible to monetise the swaps without the then holder  being taxed on the receipt of the £180 million because otherwise, Dorus would only have been worth approximately £126 million, i.e. £180 million, minus the Corporation Tax liability of 30% of £180 million.
10.     Ignoring, for present purposes, the way in which Treasury Services entered into the replacement swaps to achieve the basic purpose mentioned in paragraph 5 above, the above transactions were all that directly concerned Treasury Services, and indeed Treasury Services almost certainly did not know how it was that the Swiss Re group would manage to eliminate the potential Corporation Tax liability on the net £180 million excess payments within Dorus.  It was perfectly plain that Swiss Re did expect to achieve this result however, because it would not otherwise have paid £150 million for a company with an assumed value of approximately £126 million, and it was equally obvious that the avoidance was somehow associated with a further assignment within the Swiss Re group, since various modifications to the swaps made in anticipation of the novation to Dorus and the other steps in the scheme, contemplated a further proposed novation of the swaps from Dorus to a Swiss Re company called Ampersand Investments (UK) Limited (“Ampersand”).   Nothing in this case hinges on the following point, but I was told by Mr. Prosser for HMRC towards the end of the hearing that the explanation for the evaporation of Dorus’s potential liability to Corporation Tax on the £180 million was that, in the final novation, Dorus would be covered by the requirement to disregard the transaction because it was between group companies within the charge to Corporation Tax, whereas Ampersand would not be so treated because it would not, at the point of the novation, be covered by the new derivative rules. 
The four points in dispute
11.      The first point in dispute is whether Treasury Services was right in its expectation that the novation of its swaps in favour of Dorus was covered by paragraph 28 of Schedule 26 to FA 2002, such that by virtue of the novation being between group companies, both of which were within the charge to Corporation Tax, the novation would be disregarded, Treasury Services would avoid tax on its £180 million receipt and Dorus would potentially inherit Treasury Services’ Corporation Tax liabilities in relation to the swaps, and in particular the net liability in respect of the excess fixed receipts over the much lower floating amounts payable.  This issue depended on whether the novation was covered by the wording of paragraph 28(1), either on its own or coupled with paragraph 28(4). 
12.     HMRC contended that the novation was not covered by paragraph 28(1) because that paragraph required the successor to “replace” the original party to the derivative, as the “party to the derivative contract”, and HMRC contended that this wording applied only to assignments, and not to novations.   Paragraph 28(4) extended the application of paragraph 28(1) to apply to novations, but HMRC contended that the combined application of paragraph 28(1) and (4) did not cover the novation in this case because the rights and liabilities of the novatee after the novation had to be “equivalent to” the rights and liabilities of the predecessor immediately before the novation, and HMRC contended that certain technical features meant that the “equivalence” requirement was not satisfied in this case. My determination on these points is that paragraph 28 did not apply in this case, though I have the found the point to be very difficult, and finely balanced. 
13.     The second point in dispute was also difficult.   It was the question of whether under paragraph 15 of Schedule 26, Treasury Services was entitled to a deduction for the fee that it paid of £2.2 million, or rather the lesser fee that was eventually paid because the provisions for variation of the fee resulted in the fee ultimately being paid in a lesser sum.  HMRC’s initial contentions in relation to this issue were directed to establishing that a tax deduction should be denied if Treasury Services had succeeded on the first question and avoided tax on the £180 million, though the contentions changed during the course of the hearing.   During the hearing it was contended that the fee should not be deductible because it was never the purpose of Treasury Services that it itself should monetise the swaps.  My determination on this point is that the fee was deductible.  This might seem natural in the light of my determination on the first issue, namely that Treasury Services was indeed chargeable to tax on the £180 million received from Dorus, but the basis of my decision on the second issue would in fact have been the same, had I determined that Treasury Services avoided the tax, as it expected to do, on the novation to Dorus, and my decision is not based on my conclusion that Treasury Services was indeed taxable on its receipt of £180 million.      
14.     The third and fourth questions were very inter-linked, and as they were argued before me they effectively pre-supposed that the determination on the first issue had been in favour of Treasury Services, such that it would have avoided tax on the £180 million received on the novation of the swaps.   Having subscribed the shares in Dorus for £180 or £181 million, and having sold them for approximately £150 million, Treasury Services claimed that it was entitled to a capital loss of £30 million.  HMRC contended that the capital gains “value shifting” provisions of section 30 TCGAct 1992 would apply if the determination on the first issue had been in favour of Treasury Services, since Treasury Services would then have received a “tax-free benefit” within the meaning of that section, and the value of the shares in Dorus would have been materially reduced in value. The third question was whether HMRC’s “value-shifting” contention was fundamentally correct, and, if it was, the fourth question was by how much the consideration for the disposal of the Dorus shares should be adjusted to conform with the provision of section 30 that required the consideration to be adjusted by “such amount as is just and reasonable having regard to the scheme or arrangements and the tax-free benefit in question.”   HMRC’s contentions were that the section was in point, and that the claimed loss should simply be eliminated.   Both of these questions drop away in view of my determination on the first issue, since Treasury Services has not received the “tax-free benefit” that it assumed that it would receive.  Indeed the shares of Dorus had not been reduced in value either since the feature that I consider that Treasury Services was taxable on its receipt of £180 million means that Dorus was correspondingly entitled to a deduction for that payment, such that it had no material inherited tax liability, and was thus worth something close to £180 million rather than either £150 million or £126 million.    
15.     Since my determination on the first issue may be reversed on appeal, I will now decide the third and fourth questions on the alternative basis that Treasury Services’ £180 million receipt on the novation was tax free.    On that basis, my determinations on these two points are that the section would have been in point, and that the loss should be entirely disallowed.    Indeed there are only two reasons why an element of a chargeable gain ought not to be substituted for the claimed loss, one of which is that HMRC merely asserted that the loss should be disallowed.   That would accordingly have been my determination on the third and fourth issues, had they not been rendered irrelevant by my determination on the first issue.  
The facts in more detail and the evidence
16.     The facts and the evidence given to me took three forms.  I was given an agreed Statement of Facts; evidence was given on behalf of Treasury Services by Mr. Martin Cooper who had been head of trading in the Treasury Division of the HBOS banking Group, and who had been the lead negotiator in relation to all of the negotiations with AIG, Lehman Brothers and Swiss Re, and, finally, written expert evidence was given to me in relation to accounting treatment by Guy Bainbridge, ACA, a partner in KPMG LLP.
17.      I will summarise the further facts that were given to me in the Agreed Statement of Facts, though some are not particularly relevant to the determination of the tax issues.  I will then record the important points emerging from Martin Cooper’s evidence, though I will defer mentioning some points until dealing with the specific issues, where points are only relevant to one issue.   I will finally make little reference to the accounting evidence, other than to describe the basic points that it was asserted that the accounting evidence established, and to explain why I consider that the accounting evidence was not particularly relevant.
18.     I will however first make a general point about the evidence given by Martin Cooper.    The substantive steps in the scheme that I described very shortly in paragraph 9 above had been preceded by a number of agreements.   Under these, all of the parties including Treasury Services, Dorus, AIG and a company in the Swiss Re group had agreed to implement the scheme in its various stages, Treasury Services had paid its variable fee of £2.2 million to AIG, and various changes had been made to the terms of the swaps, which changes are highly significant to the first question for determination.   In the course of cross-examining Martin Cooper, Mr. Prosser suggested that Martin Cooper had very much over-emphasised the degree to which he had thought that even after the payment of the fee to AIG and the various changes to the swaps, there was still a possibility that the sale to Swiss Re might collapse at the last moment, so that either Treasury Services or Dorus as a continuing HBOS subsidiary would have to monetise the swaps themselves.  I agree with Mr. Prosser that the risk of the Swiss Re deal collapsing at the last minute seems to me to have been virtually non-existent, but I still think it right to record that even though on these points Martin Cooper had chosen to “put the best gloss” on a couple of points does not detract from the fact that in general terms Martin Cooper was a clear, helpful and honest witness.   
The further facts, revealed in the Agreed Statement of Facts
19.     The relevant swaps in this case had all been taken out initially by Halifax Building Society, to convert the 11% and 9.375% interest cost into a floating cost on £400 million out of the total bonds that it had issued (in 1988, 1996 and 1997), with an aggregate principal amount of £650 million.  The bonds were repayable in 2014 and 2021, and the duration of the swaps matched those dates. 
20.     The swaps were originally between Halifax Building Society and a different AIG company than Banque AIG. Nothing material hinges on the fact that, through the demutualisation of Halifax Building Society, and the merger of Halifax Plc and Bank of Scotland, and by virtue of the swaps being novated on the AIG side of the equation as well, by 2003 the relevant parties to the swaps were Treasury Services and the particular AIG company that I have defined as “AIG”.  When the HBOS group party to the swaps was Treasury Services, there were in fact back to back, or “internal”, swaps between Treasury Services and Halifax Plc.
21.     I have no hesitation in accepting that the transactions in this case were initiated on account of the genuine desire of Treasury Services, and doubtless the HBOS group as a whole, to reduce its credit exposure to the AIG group.  It is of course the case that other parties with no concern about credit exposure, and indeed parties to swaps that required full cash collateral to be posted to secure the position of the party currently entitled to the greater swap payments, might have entered into Swiss Re type transactions solely to achieve the tax benefits sought by those transactions.  However with a total HBOS group exposure to the AIG group of £518.8 million in February 2003, I accept that a dominant purpose of the re-couponing transaction was to reduce that credit exposure.  Reference was also made to the fact that the credit exposure to AIG also posed a problem in relation to Treasury Services’ clustering ratio, but I will not expand on this point since I have already indicated that I accept that there were good commercial reasons for the monetisation and re-couponing transaction, and it is not material to expand on what those reasons were. 
22.     It was on 2 May 2003 that Treasury Services, Dorus, AIG and the intended Swiss Re purchaser signed Heads of Terms relating to the proposed re-couponing. The asserted purpose of the re-couponing was “to facilitate further trading within existing credit approvals”.  This implicitly meant that at the level of the current credit exposure, Treasury Services would not be able to use AIG as a swap counter-party unless the credit exposure was first reduced, and the indication that Treasury Services wanted the flexibility to do new business with AIG was probably designed to indicate a further benefit to AIG of entering into the transactions.  The Heads of Terms, coupled with a letter signed on the same date, set out all of the proposed steps in the scheme, and Treasury Services agreed to pay AIG £2.2 million, subject to variation, for AIG’s “participation in the transaction”.   
23.     As regards the terms of the swaps, the Heads of Terms contemplated that:
•	the terms of the swaps would be modified, with AIG consenting to the novation  of the swaps first to Dorus, and then to the Swiss Re subsidiary, Ampersand .  The consent to these novations was accompanied by some further terms which are of great significance to the first issue for determination, which I will describe below. 
•	AIG also agreed to the insertion of a Termination Event into the swaps, enabling Treasury Services or its novatees to terminate the swaps at mid-market value (i.e. roughly the £180 million if the Termination Event had been triggered immediately) with no deduction for the liquidty cost mentioned in paragraph 6 above.   It was also agreed that if the Termination Event was triggered, Treasury Services and AIG would enter into the type of replacement swap transactions mentioned in the second half of paragraph 5 above; and
•	Treasury Services would pay AIG a variable fee, specifying the basis on which the fee would be varied.
24.     On 2 May 2003, a letter agreement was signed between Treasury Services under which Treasury Services undertook to pay AIG £2.2 million, subject to variation, on 13 May, in consideration for AIG agreeing to participate in the transactions outlined in the Heads of Terms. 
25.      On 2 May 2003 Treasury Services formed Dorus as a UK resident company, Dorus being incorporated in the Cayman Isles to avoid UK stamp duty. Treasury Services subscribed £1 million for the 1 million Ordinary Shares of Dorus, which Dorus invested in gilts, and it was accepted that Dorus was within the charge to Corporation Tax.
26.     On 13 May 2003, Treasury Services and AIG entered into the Swap Amendment Agreement, the terms of which are particularly significant to the first issue in dispute, and that I will summarise in paragraphs 55 and 56 below.  Treasury Services also paid the £2.2 million fee. 
27.     On 16 May 2003 Treasury Services and AIG made a further amendment to the swaps, removing the requirement for Treasury Services and its novatees to maintain rated debt securities to avoid triggering a termination event.
28.    On 16 May 2003, Treasury Services subscribed £180 million for 180 million £1 Preference Shares in Dorus.
29.     On 19 May 2003, the swaps were novated under a standard form ISDA Novation Agreement from Treasury Services to Dorus for approximately £180 million. For tax purposes it was expected that, because this novation was in favour of a group company, it would be disregarded, such that Treasury Services would not bring the £180 million into account as income under the derivatives legislation, and Dorus would inherit Treasury Services’ former expected Corporation Tax liability on the net excess payments, without qualifying for any deduction in respect of the £180 million paid.  Dorus then entered into a swap with Swiss Re Financial Products Corporation (“SRFPC”), under which Dorus paid fixed interest at current rates and received floating-rate interest, such that movements in floating rates would have an equal and opposite effect as between the novated swaps and the new SRFPC swaps, so that Dorus locked in the then value of the novated swaps.
30.    On 19 May 2003, Treasury Services also entered into two new swaps with SRFPC, under which it received the flows under a bullet and an amortising swap already referred to in the second half of paragraph 5 above.   
31.    The effect of the transactions mentioned at paragraphs 29 and 30 above, was that Treasury Services directly held the replacement swaps that it would wish to retain to hedge the fixed-interest liability on the Halifax bonds, once it had effected the further step of selling Dorus, as mentioned in paragraph 32 below.  Dorus by contrast held the valuable original Swaps with AIG, and had matching but “current rate” swaps with equal and opposite flows under its transaction with SRFPC, such that it was directly “hedged”, having locked in the value acquired on the novation of the original swaps. 
32.     Ignoring irrelevant detail, Treasury Services sold the entire share capital of Dorus to an investment company in the Swiss Re group for £150.8 million, some shares being sold on 20 May and the remainder on 21 May (the split sales achieving some accounting point).      Dorus at this point held swaps that had a locked-in value of approximately £180 million, plus £1m in gilts.  On the assumption of the parties that the novation between Treasury Services and Dorus, referred to in the first sentence of paragraph 29 above, would be disregarded for tax purposes and governed by paragraph 28 of Schedule 26 to FA 2002, Dorus would have inherited the potential liability to Corporation Tax on all the excess flows that it would potentially receive (i.e. those sustaining the valuation of the original swaps at £180 million) and would not be entitled to any deduction for the £180 million paid on the novation. In other words it had inherited a potential liability to Corporation Tax of £54 million.   In this context, the sale of Dorus at a price of £150.8 involved a sale of the company at a considerable premium above its net asset value, if at least the assumed tax liability was taken into account at face value. 
33.     On the sale of Dorus, Treasury Services held the required two new swaps referred to in paragraphs 5 and 30 above: it had broadly “circled” the £180 million subscribed for Preference Shares in Dorus and received back on the novation; and it held the cash proceeds of £150.8 million, received on the sale of Dorus.  On the assumption that it would not be taxed on the receipt of the £180 million, and that it no longer had the potential Corporation Tax liability of its previous tenure of the highly valuable AIG fixed/floating swaps, it recognised a deferred tax asset of £54 million.  The net effect of all these transactions, taking into account the fee of £2.2 million paid, was that instead of realising a pre-tax loss of £2.2 million (as it would have done had it monetised and re-couponed the swaps in the conventional way summarised in paragraphs 5, 6 and 7 above), it made a profit of £9 million. 
34.     On 8 September 2003, Treasury Services terminated the swaps taken out with SRFPC (mentioned at paragraph 30 above) and entered into new swaps with AIG, as a result maintaining the same hedge against its exposure under the internal swaps, and indirectly against Halifax Plc’s fixed interest cost under its bond issues.  The AIG fee was then adjusted by reference to the value of the swaps as at 8 September 2003, in accordance with the variation terms.
35.     Whilst the following points will be made out of context until I have summarised the terms of paragraph 28 of Schedule 26 to FA 2002 (“paragraph 28”), it is convenient to confirm at this point that both parties were agreed on the following facts, namely that:
•	the novated swaps were “derivative contracts” of Treasury Services within Schedule 26 FA 2002;
•	the novation of those swaps between Treasury Services and Dorus was a “related transaction” for the purposes of paragraph 28;
•	at the time of the novation, Treasury Services and Dorus were members of the same group for the purposes of paragraph 28, and were both subject to Corporation Tax; and that
•	Treasury Services used an accruals basis of accounting as respect the swaps in accordance with UK GAAP.
Martin Cooper’s evidence
36.     I will now list various specific points that emerged from the evidence given by Martin Cooper.  Where appropriate, I will add my own observations on each point.   The important points were as follows.
•	Whilst it does not need summarising, a great deal of Martin Cooper’s evidence was dedicated to explaining the transactions, the credit concerns of the HBOS group and Treasury Services in relation to AIG, and the reason why any counter-party being requested to monetise and re-coupon a swap would charge (either in the form of a fee, or by way of a reduction in the amount that otherwise reflected the discounted value of the excess payments owed by it), to cover its credit or liquidity cost.  Martin Cooper also explained, as I was well aware, that it was relatively unusual for swaps not to require the posting of collateral to secure the credit exposure to the party with the greater liabilities.  In all these respects Martin Cooper’s evidence was clear, helpful and very well-informed. 
•	Martin Cooper appreciated, as presumably do all bankers specialising in derivatives, that, as a legal matter, contracts conferring both rights and liabilities on a party cannot be transferred or assigned to a transferee without the concurrence of the counter-party.   They can only be passed over by a novation in which the counter-party releases the initial party and agrees with the new party (the novatee) that the novatee should have the same rights and obligations as against the continuing party as the released party previously had.  The distinction between the usual ability of one party to assign the benefit of a contract that purely confers rights on that party, and the contrasting position with a contract that imposes liabilities or confers and imposes both rights and liabilities, is one of the basic points that any lawyer, and presumably also virtually every banker, will be familiar with.   Consistently Martin Cooper said that swaps were almost invariably novated and never assigned.   I also accept (though this is more a point advanced in argument on behalf of Treasury Services) that whilst some rare derivative instruments may confer only rights, such that they might be capable of assignment, the vast majority confer both rights and obligations.
•	Martin Cooper said that participants in swap transactions were generally cooperative if their counter-party wished to novate their position in a swap to some other entity.   They would certainly be keen to see that they did not thereby assume any greater credit risk, so that they might well call for a guarantee if the credit-standing of the proposed novatee was inferior to that of the original counter-party.  It was unusual however for parties to seek a fee simply for agreeing to facilitate, and enter into, a novation.    This seemed entirely credible.
•	In the present case, even if the “fee”, initially put at £2.2 million, was expressed to have been given in return for AIG participating in the variation and the novation of the swaps, the fee was in reality paid to compensate AIG for the liquidity cost of actually monetising the existing swaps.  The terms for the variation of the fee made this clear.   Certainly as a matter of calculation, this was indisputable. 
•	When asked whether he saw any reason why Dorus should not have paid £180 million for the novated swaps, Martin Cooper said that the swaps were plainly worth that amount and he saw no reason why Dorus should not pay that amount for the novation of the swaps.  I entirely accept that the value of the swaps was the amount stated, and I accept that as Dorus’s purchase price was entirely paid out of share capital, the feature that no reduction in price was demanded to reflect the deferred tax liability that it was clearly assumed and intended that Dorus would inherit means that there was no remote fraud on creditors.  The payment of the full £180 million would however result in the value of the share capital immediately being reduced if the novation resulted in Dorus inheriting the potential liability to Corporation Tax of £54 million, as the parties expected.  Mr. Cooper said in evidence that he expected that if there were to be any Corporation Tax liability accruing to Dorus it would be picked up by group relief although this would not be relevant if it was sold. 
•	Martin Cooper said that he had no knowledge of why, in his words, Swiss Re was prepared “to pay a premium for Dorus”.  It had to be implicit that Swiss Re expected to be able to avoid the tax liability, and it was fairly evident that this revolved around the disclosed further novation to Ampersand, but I accept that Martin Cooper, and Treasury Services as a whole, were ignorant as to what was intended.
•	 Martin Cooper explained the accounting and business reasons why Dorus needed to take out the equal and opposite swaps with SRFPC that I mentioned in the third sentence of paragraph 29 above.  Those swaps seemed to make perfectly good sense to me, not only in terms of sustaining an accruals basis of accounting (as it was said that they did), but they also occasioned a correct matched position for the HBOS group prior to the sale of Dorus, and a similar result for the Swiss Re group after the purchase of Dorus. 
I will defer dealing with the evidence that Martin Cooper gave where it related very specifically to just one of the disputed items, until dealing with that item. 
The accounting evidence
37.    A considerable amount of accounting evidence was given, in the form of written evidence, on behalf of Treasury Services by Guy Bainbridge ACA, a partner in KPMG LLP.   HMRC accepted Mr. Bainbridge’s written evidence on the accounting aspects of the transaction and he was not called to give evidence in person.   I will summarise very shortly what I understood was sought to be established by this evidence, and why I consider that the accounting evidence is of very little relevance.
38.     As I understood it, based on Mr. Bainbridge’s evidence, it was asserted that:-
•	it was appropriate for Treasury Services to accrual account its original swaps with AIG, since they were hedging internal swaps, and ultimately hedging exposure of another group company to pay the high fixed interest on bonds issued by that company;
•	had the swaps been directly monetised and re-couponed by Treasury Services, then although the £180 million received would have been income for accounts and tax purposes, for both purposes it would still have been appropriate to bring the income into account only over the matching life of the internal swaps that the swaps were hedging;
•	had the swaps been monetised and re-couponed in that way, the fee paid, or the diminished proceeds of £177.8 million as against £180 million received, would have occasioned a tax deductible loss, which would almost certainly also have been spread over the life of the internal swaps; 
•	it was important, both in terms of the ability of Dorus to “accrual account”, and from a related point for the group as a whole, for Dorus to take out the equal and opposite swaps that it entered into with SRFPC on acquiring, by novation, the rights and obligations under the original swaps;
•	it was undesirable (more as a contention and from a general commercial point of view, than from an accounting point of view) for the group and for Treasury Services to have to record a loss, as the “downside” of effecting a re-couponing inherently designed to reduce any credit risk;
•	whilst the following point was also advanced more as a contention in argument than something specifically based on Mr. Bainbridge’s evidence, it was suggested that there was no reason, when Dorus acquired the swaps by novation, for Dorus to provide for the deferred tax liability inherited, because “there was no tax liability”.   It was somehow asserted that, because the swaps only hedged liabilities of other companies, and that in overall terms there was no net profit (but a net deduction simply for the effective floating cost of interest on the bonds) it was entirely proper for Dorus to ignore the latent or deferred Corporation Tax liability inherited by Dorus (assuming paragraph 28 to operate as the parties hoped and expected) on paying £180 million for swaps with that gross value.
39.     I do not doubt for an instant the contentions and the expert evidence about the critical need for the swaps to be accrual accounted.    It seems to me however that the basic point that the accounting evidence was said to support was the proposition that the whole scheme was done for commercial purposes, and that it was not any sort of tax avoidance scheme; and it was certainly contended by Mr. Gammie that it was quite proper for Dorus to pay £180 million on acquiring the swaps, notwithstanding that it was everyone’s intention and expectation that Dorus would acquire assets worth £180 million, and liabilities with a cost of £54 million.     Without addressing any of the four disputed issues that have been put to me at this stage, it may be clearest if I state at this point my own conclusions on these various accounting, and tax avoidance/commercial points that have been put forward as contentions, and that are allegedly somewhat supported by the accounting evidence. 
40.     There was unquestionably a scheme in the present case.  It was given various Greek names by the parties.   It had been marketed initially by Lehman Brothers and then by Swiss Re.  The scheme was designed to enable a tax liability to be rolled into Dorus, in the expectation that it would not be triggered on the sale of Dorus, and that the buyer of Dorus would somehow manage (in the way that Mr. Prosser described to me) to make the liability evaporate.  Treasury Services would then share the tax benefits with Swiss Re, in that for Treasury Services it would be better to receive £150 million on the sale of Dorus than £180 million in taxable form, if it thereby avoided the tax of £54 million.  And if Swiss Re bought a company with gross assets worth £180 million, for £150 million and could make the £54 million liability disappear, it also made a large profit.
41.     My answers to the four points that have been put to me will not be coloured or influenced in any way by those observations.   On HMRC’s contentions, the second issue (the deductibility of the fee) is certainly influenced by the need to identify the purpose for which the fee was paid, but in looking at each of the four points, I consider that no element of general prejudice to the company derives from whether there was a tax avoidance scheme or not.  Thus I attach very little significance to the accounting evidence that appears to be bound up with the general contention that everything was done for commercial and accounting purposes, and that not only was there no tax avoidance purpose, but on some group basis, no tax was avoided.  Whilst I attach no importance myself to the following conclusion, I nevertheless find it absolutely untenable for it to be suggested that the eventual profit that it was hoped and expected would be made in this case was to be made in any way other than by avoiding the tax that would have been chargeable on a direct re-couponing of the swaps with a third party.
42.     I will defer dealing with questions relating to the net value of Dorus, following its payment of £180 million for the swaps, which disregarded the £54 million tax liability that it was assumed that Dorus would inherit.  It may, however, be fairly evident that I will conclude that had the parties’ tax expectations on the first issue been achieved, then the novation would have been a depreciatory transaction that would have reduced the value of Dorus to £150 million, if not to £126 million.  
The first matter in contention
43.     The first disputed matter was whether Dorus, a wholly-owned subsidiary of Treasury Services, directly or indirectly replaced Treasury Services as a party to one or more derivative contracts, within the meaning of paragraph 28, when on 19 May 2003 it entered into a novation agreement with Treasury Services in respect of certain swaps originally entered into between Treasury Services and Banque AIG, London Branch. 
44.     The statutory provisions material to this question at the relevant time were as follows:
Transactions within groups
28   (1)  This paragraph applies where, as a result of any transaction or series of transactions falling within sub-paragraph (2), one of the companies there referred to (“the transferee company”) directly or indirectly replaces the other (“the transferor company”) as a party to a derivative contract.
(2)	The transactions or series of transactions referred to in sub-paragraph (1) are-
(a) a related transaction between two companies that are –
(i)	members of the same group, and
(ii)	within the charge to corporation tax in respect of that transaction;
(b) a series of transactions having the same effect as a related transaction between two companies each of which-
(i)	has been a member of the same group at any time in the course of that series of transactions, and
(ii)	is within the charge to corporation tax in respect of the related transaction;
(c)	a transfer between two companies of business consisting of the effecting or carrying out of contracts of long-term insurance which has effect under an insurance business transfer scheme; and
(d)	any transfer between two companies which is a qualifying overseas transfer within the meaning of paragraph 4A of Schedule 19AC to the Taxes Act 1988 (transfer of business of overseas life insurance company).
(3)   The credits and debits to be brought into account for the purposes of this Schedule in the case of the two companies shall be determined as follows-
(a)  the transaction, or series of transactions, by virtue of which the replacement takes place shall be disregarded except-
(i)	for the purpose of determining the credits and debits to be brought into account in respect of exchange gains or losses and identifying the company which is to bring them into account, or
(ii)	for the purpose of identifying the company in whose case any credit or debit not relating to that transaction, or those transactions, is to be brought  into account; and
(b) the transferor company and the transferee company shall be deemed (except for those purposes) to be the same company.
(4)     References in this paragraph to one company replacing another as party to a derivative contract shall include references to a company becoming party to any derivative contract which - 
(a) confers rights or imposes liabilities, or 
(b) both confers rights and imposes liabilities,
where those rights or liabilities, or rights and liabilities, are equivalent to those of the other company under a derivative contract to which that other company has previously ceased to be party.”
The definition of “related transaction” was contained in paragraph 15(7) of Schedule 26, and slightly amplified by paragraph 15(8), which two sub-paragraphs read as follows:
“(7)   In this Schedule “related transaction”, in relation to a derivative contract, means any disposal or acquisition (in whole or in part) of rights or liabilities under the derivative contract.
(8)   The cases where there shall be taken for the purposes of sub-paragraph (7) to be a disposal or acquisition of rights or liabilities under a derivative contract shall include-
(a) those where such rights or liabilities are transferred or extinguished by any sale, gift, surrender or release, and
(b) those where the contract is discharged by performance in accordance with its terms.”
The contentions on behalf of Treasury Services in relation to the first issue
45.     As stated in paragraph 35 above, it was agreed between the parties that the novated swaps were “derivative contracts” of Treasury Services within Schedule 26 FA 2002; that their novation was “a related transaction” for the purposes of paragraph 28; that Treasury Services and Dorus were members of the same group for the purposes of paragraph 28; that both were within the charge to Corporation Tax, and that Treasury Services used an accruals basis of accounting as respects the swaps in accordance with UK GAAP.  The only points in contention thus on the first disputed point were that Treasury Services needed to establish either that:
•	paragraph 28(1) could apply to novations; or that
•	if not, paragraph 28(1), amplified by paragraph 28(4), applied to the actual novations. 
The basic case advanced by HMRC, that Treasury Services thus had to undermine, was that:
•	Paragraph 28(1) did not apply to the novations because the final words of paragraph 28(1) that required “the transferee [to replace] the transferor as a party to a derivative contract” could only be satisfied with an assignment, and never with a novation.   The words in bold implicitly required the transferee to become a party to the very original contract, and could not be satisfied with a novation. 
•	As regards the combined application of paragraph 28(1) and (4), the case that Treasury Services had to undermine was the HMRC contention that the swaps acquired by Dorus were not, in the required sense, “equivalent” to those formerly held by Treasury Services, so that no reliance could be placed on the provisions of sub-paragraph (4) that both parties obviously accepted were designed to apply to novations. 
46.     Mr. Gammie’s first argument for Treasury Services was that on any ordinary reading of paragraph 28(1) the novation did result in Dorus replacing Treasury Services as a party to the novated swaps.  The word “replace” was not a word with any particular legal meaning, but one that had its ordinary meaning.  When in a commercial and business sense, the result of the novation was that the novatee had the rights and liabilities that the original party had had, it was a perfectly proper construction of the statutory phrase to conclude that the novatee replaced the original party “as a party to the derivative contract”, or the swaps.   
47.     Mr. Gammie next pointed out that, in contrast to the position in relation to the “loan relationships” legislation, it was generally the case with derivatives that each party would have both rights and liabilities under the pre-existing contract.  It would thus seem extremely unlikely that the core provision of paragraph 28(1) should be construed to refer only to the rarest of derivative contracts such as options, and then of course only to the party having rights capable of assignment.  Since furthermore the definition of “related transaction” (one of the transactions specifically contemplated by paragraph 28) referred to “any acquisition of rights or liabilities under the derivative contract”, it seemed implicit that a novatee (the only person who could effectively acquire liabilities under an existing derivative contract) was to be treated as acquiring liabilities “under the derivative contract”, so that this interpretation seemed to be confirmed.   If one adopts the strict legal notion, it cannot be right that a party can “acquire liabilities under the derivative contract”, if that is taken to mean “to acquire those liabilities, by some form of succession, actually under the original contract”.        It thus appeared that Parliament intended a commercial and realistic approach, rather than a strict legal approach, to be adopted in defining the way in which a transaction could result in a person acquiring liabilities under a derivative contract.   In short, he said that “In reality and effect Dorus replaced Treasury Services as a party to a derivative contract as a result of a related transaction”.   Thus the wording of paragraph 28(1) was satisfied. 
48.     Mr. Gammie’s next argument was that there was something rather abstract and non-personal about the definitions of “derivative contracts”.  Thus, because the thrust of the definition was that interest rate swaps were derivative contracts, it was easier to say, in the case of novations, that a party succeeded to the rights and obligations of another under a derivative contract, viz. under a “swap”, because the personal emphasis on the two parties to the contract was absent.  By contrast, loan relationships were defined as more personal relationships between debtor and creditor. 
49.     Mr. Gammie then dealt with the decision in Greene King No 1 Ltd v. Adie [2005] STC (SCD) 398.   In that case, the original debtor claimed an £11 million loss on paying another group company to assume its obligations under a debenture that had become highly onerous through falls in interest rates since the rate set in the debenture had been fixed. The transaction had naturally been a novation.  HMRC had argued that the loss was not realised because paragraph 12 of Schedule 9 to FA 1996 (which applied to transactions between group companies and was in strikingly similar terms to paragraph 28 of the derivatives code) required the transaction to be disregarded if “one of those companies directly or indirectly [replaced] the other as a party to a loan relationship”.  The Special Commissioners accepted the arguments advanced by Mr. Prosser on behalf of the Appellant that, with a novation, the novatee did not replace the original debtor “as a party to a loan relationship”, since it was by the new contract in the novation that the novatee assumed identical obligations to those of the original debtor.     It did not actually become a party to the original loan relationship. 
50.     Mr. Gammie made two points in relation to this case.   First he said that, had there been an appeal against the Special Commissioners’ decision, he would have been prepared to argue that the decision was wrong.   Secondly, he said that the context in which paragraph 28 had to operate, in contrast to that in which paragraph 12 had to operate, was different, and this might justify a different conclusion in interpreting paragraph 28.   For in the case of the corporate debt code, one party would often have all the rights, and the other the obligations.    Thus if, extraordinarily oddly, Parliament had intended paragraph 12 to apply only to intra-group transactions involving transfers of the rights and not the obligations, then it might make sense to construe paragraph 12 as applying only to assignments, and not to novations.    In contrast, in paragraph 28, the feature that each party would be likely to have both rights and obligations would mean that the restrictive interpretation of paragraph 28(1) would result in the “disregard” notion of paragraph 28 being applicable only in the rarest of cases when regard was paid to paragraph 28(1) in isolation, which made no sense. 
51.     Mr. Gammie then argued that if he was wrong and that paragraph 28(1) could not, on its own, apply to a novation, then paragraph 28(1) should certainly apply to the novation in this case, when read in conjunction with sub-paragraph (4).  Since this point will succeed unless Mr. Prosser’s arguments on behalf of HMRC, to the effect that sub-paragraph (4) does not apply in this case because the rights and liabilities of Dorus, immediately after the novation, were not equivalent to the rights and liabilities of Treasury Services prior to the novation, I will not expand on the various arguments as to whether or not the rights and liabilities were equivalent until I have summarised the contentions on behalf of HMRC.
The contentions on behalf of HMRC in relation to the first issue
52.     It was first contended on behalf of HMRC that, leaving aside sub-paragraph (4), a transaction falls within sub-paragraph (1) of paragraph 28 “if and only if the transferee company becomes party to the same derivative contract as the contract to which the transferor company was previously party; which is not the case with a novation whereby the rights and liabilities under the original derivative contract are discharged and new rights and liabilities are conferred and imposed under a new derivative contract”. Various authorities, including Greene King, were quoted in support of that proposition.   I might just observe at this point that I do not consider that any authority needs to be quoted to support the proposition that a person can only effectively succeed to the obligations of another by entering into a novation, and that novation of course operates exactly as just stated in the quoted passage.    The question in this case is the slightly different one of whether paragraph 28(1) should be construed in a strict legal sense or whether I should infer that the plain intention of Parliament was that paragraph 28(1) should be applied, rather as Mr. Gammie has contended, in a realistic and business-like sense.   And in approaching that issue, I am obviously going to have to pay considerable regard to the fact that paragraph 28 did include sub-paragraph (4), just as in the Greene King case the Special Commissioners were perhaps influenced by the fact that paragraph 12, that was relevant in that case, included a significant sub-paragraph (6).
53.     The second contention on behalf of HMRC was that whilst it was accepted that paragraph 28(1) and (4) together applied to novations of swaps, they only did so when the rights and obligations conferred and imposed on the novatee were equivalent to those previously conferred and imposed on the transferor company.  In the present case, it was said that the relevant rights and liabilities of Dorus were not equivalent to those of Treasury Services immediately prior to the novation “in two commercially important respects”.   Thus the transaction in this case was not covered by paragraph 28.
54.     In order to explain the second contention made on behalf of HMRC, I need to give some more facts, or rather to quote various passages from some of the documents that varied the swaps, and that effected the novation.
55.      Following the Heads of Terms that were signed on 2 May 2003, Treasury Services and AIG entered into an agreement on 13 May to amend the swaps.   The pertinent changes made to the swaps inserted some additional Termination Events; and secondly they modified the previous terms that had banned transfers, and sanctioned two forms of novation. 
56.     The most important Termination Event was one that enabled “Party A” (defined to mean Treasury Services or any novatee of its position under the swaps) to terminate the swaps at their mid-market value at any time before 17 May 2004.   This was not contentious.    The other inserted Termination Event was however contentious.   This provided that:-
“it shall constitute a Termination Event with respect to the Swap Transaction if (i) the rights, liabilities, duties and obligations of Party A under this Swap Transaction are novated to Dorus, (ii) Dorus ceases to be a wholly-owned subsidiary of Treasury Services (“Change in Status”) and (iii) within 2 Business Days of such Change in Status, the liabilities, duties and obligations of Party A under this Swap Transaction are not directly or indirectly guaranteed (in a form customarily granted by the entity providing the guarantee) by (x) Swiss Reinsurance Corporation (“SRC”) (where Dorus becomes a subsidiary of SRC in consequence of the transaction causing the Change in Status), or (y) any other entity the long- term indebtedness of which is rated by Standard & Poor’s Corporation AA or above (where Dorus does not become a subsidiary of SRC in consequence of the transaction causing the Change in Status).”
The material changes made to the swaps as regards novation provided that the ban in the original terms on transfers should not apply in respect of any novation pursuant to either of the following paragraphs (a) and (b) which were as follows:-
“(a)   Party A may novate any or all of its rights, liabilities, duties and obligations under this Swap Transaction to Dorus (and for the avoidance of doubt paragraph (b) below shall not apply to any novation under this paragraph (a)).
(b)   Party A may novate any or all of its rights, liabilities, duties and obligations under this Swap Transaction to (i) Ampersand Investments (UK) Limited (“Ampersand”) provided that Ampersand is at the time of novation a subsidiary of SRC, or (ii) any other person with the written consent of AIG, such consent not to be unreasonably withheld, PROVIDED THAT the obligations of Party A under this Swap Transaction have prior to the novation been directly or indirectly guaranteed by (x) SRC (where the rights, liabilities, duties and obligations of Party A under this Swap Transaction are proposed to be novated to a subsidiary of SRC), or (y) any other entity the long term indebtedness of which is rated by Standard & Poor’s Corporation AA or above (where the rights, liabilities, duties and obligations of Party A under this Swap Transaction are proposed to be novated to any entity which is not a subsidiary of SRC) and the guarantee is, in the case of each of (x) and (y) in a form customarily granted by the entity providing the guarantee”
57.     There was nothing particularly contentious in the terms of the novation from Treasury Services to Dorus, though I will quote the main operative terms of the Novation Agreement entered into on 19 May 2003 between those parties and AIG. This provided that in consideration of various representations and warranties, and the payment of approximately £180 million by Dorus to Treasury Services:-
“(a)  the Remaining Party (AIG) and Treasury Services are each released and discharged from further obligations to each other with respect to each Old Transaction and their rights against each other thereunder are cancelled;
(b)  in respect of each New Transaction, the Remaining Party and Dorus each undertake liabilities and obligations towards the other and acquire rights against each other on terms identical to the corresponding Old Transaction (and, for the avoidance of doubt, as if Dorus were Treasury Services and with the remaining party remaining the Remaining Party); and
(c)   each New Transaction shall be governed by and form part of the New Agreement (which shall be deemed to include the provisions inserted in the Old Agreement by the Amendment Agreements) and the relevant Old Confirmation (as amended by the Amendment Agreements) shall be deemed to be a Confirmation between the Remaining Party and Dorus and the offices of the Remaining Party and Dorus for the purposes of each New Transaction shall be London.”
58.     The various arguments advanced on behalf of HMRC in support of the basic contention that Treasury Services and Dorus did not have equivalent rights and obligations before and after the novation were as follows.
•	One first had to address the effect of the terms of the swaps and not just the wording.   Thus if unchanged wording in the swaps operated differently after the novation, (for instance by having provided all along that if there were a novation, the duration of the swaps would be extended), then the fact that the words were identical would not make the two sets of effective provisions “equivalent”.
•	“The rights and liabilities conferred and imposed on Dorus under the Dorus Swaps were not then equivalent to those previously conferred and imposed on Treasury Services under the Treasury Services swaps in two commercially important respects”. 
•	When the swaps were held by Treasury Services, Treasury Services had the right (see the first of the inserted novation events, at paragraph (a) quoted in paragraph 56 above) to novate its rights and liabilities to a wholly-owned subsidiary, namely Dorus.  Therefore Treasury Services’ liabilities to make the periodical floating rate interest payments to AIG were not absolute or unconditional:  Treasury Services could procure the release and discharge of those liabilities by novating the swaps to Dorus.  By contrast under the swaps, when held by Dorus, Dorus had no equivalent right.   Its liability to make the floating rate payments to AIG was absolute and unconditional simply because under novation event (b) (also quoted in paragraph 56 above) the proviso introduced by the words in capital letters applied both to novations in favour of Ampersand, and the possible “other party”, and in both cases the liberty to novate was dependent first on the procurement of the required guarantees.  Such procurement was not in Dorus’s control, so that its liberty to novate, and to bring to an end its liability to make the floating rate-payments, was not absolute and unconditional. 
•	The other respect in which the rights and obligations, before and after the novation, were not “equivalent” was that “the rights and liabilities of Dorus to receive and make the periodical payments under the Dorus swaps could be terminated if Dorus’s liabilities were not guaranteed within 2 days of [Dorus ceasing to be a wholly owned subsidiary of Treasury Services], in which event, Dorus would instead have a right to receive (or make) termination payments. By contrast, the rights and liabilities of Treasury Services under the swaps could not be terminated due to the absence of a guarantee.”
•	Finally, it made no sense for the tax-free transfer permitted by sub-paragraphs 28(1) and (4), read together, to require “equivalence” before and after the transaction, and for such equivalence not to be required where reliance was placed on sub-paragraph (1) in isolation. The opening wording of sub-paragraph (4) implied that that sub-paragraph was adding something to the provision of sub-paragraph (1) and it made no sense to conclude that sub-paragraph (1), when apparently satisfied in isolation, might in fact not require equivalence and might in that sense be wider in scope than the sub-paragraph that purported to widen the scope of sub-paragraph (1).
My determination in relation to the first issue
The paragraph 28(1) interpretation issue
59.      I would have had no hesitation in saying that paragraph 28(1) should be interpreted broadly in a sensible commercial sense, and not narrowly in accordance with what I accept is the correct strict legal fashion, if I was required to consider this issue on the assumption that there was no sub-paragraph (4) in paragraph 28 at all.   I am also inclined to think that, had I been required to answer the question that arose in the Greene King case on the similar assumption that paragraph 12(1) had stood alone, and not been modified by sub-paragraph (6), I would have similarly decided that a more general commercial construction should be put on paragraph 12(1) that would have encompassed both assignments and novations.  The reasons for these two observations are that the derivatives code and the corporate debt code both charge tax in relation to all material debits and credits on both the asset and liability side of the relevant relationships.   Accordingly it would appear to make no sense, in the context of the presumed intention of Parliament, to operate the “disregard” notion of paragraph 12(1), as if it applied only to transfers of the asset side of a loan relationship, and not to transactions that secured the release from the liabilities side of the transaction.  That approach would have been greatly strengthened in the case of the loan relationship Schedule by the feature that “related transactions” were defined to include “any acquisition of rights or liabilities under that relationship” which is either meaningless (statutory assumptions of liabilities apart), or else it supports the wider interpretation of sub-paragraph (1).  Even more clearly in the case of derivative contracts, I accept Mr. Gammie’s argument that the vast majority of derivative contracts will confer on each party both rights and liabilities, so that it would seem to be almost more perverse to apply paragraph 28(1) (the “core” provision of paragraph 28) just to assignments of rights, whereupon it would be operative in only a tiny minority of cases involving successions to derivative contracts.  
60.     I am not persuaded by Mr. Gammie’s argument that derivative contracts are more abstract and less personal than loan relationships and that they subsist, so to speak, almost aside from the parties to the contracts.   Whilst there may be less attention in the drafting to this point, it does seem to me that there are always parties to the contracts involved, and so I cannot draw a distinction between the loan relationship code and the derivatives code on this ground. 
61.     If I had had to decide the Greene King case on the then wording of paragraph 12, including the sub-paragraphs that I would have found easier to ignore, I confess that I would have agreed with everyone that the paragraph was very badly drafted, and would have found the decision difficult.  Since the relevant amplification sub-paragraph (sub-paragraph (6)), plainly applied only to the asset or creditor’s side of the loan relationship, I might well have decided the case as it was decided.   After all, the feature that sub-paragraph (6) extended the meaning of sub-paragraph (1), but nevertheless quite clearly applied only to the asset side of the equation, tallied with the legal argument that sub-paragraph (1) only applied to assignments of rights, and so supported the narrow construction of sub-paragraph (1).
62.     In this case, the inference to be drawn from the presence and the content of sub-paragraph (4) to paragraph 28 is different, but equally supportive of the notion that my initial approach to the broad interpretation to be given to the opening sub-paragraph is undermined.     The feature that sub-paragraph (4) does clearly apply to novations suggests that there is no longer anything absurd, and anything obviously contrary to the intentions of Parliament, in reading sub-paragraph (1) strictly.  For it is obviously widened in its scope to apply to novations by sub-paragraph (4).   There is I accept another possible construction of the two sub-paragraphs. Sub-paragraph (1) might be intended to deal with assignments and novations, and sub-paragraph (4) might be intended only to cover rather more obscure and indirect ways of substituting one party for another. This seems to me to be far-fetched however, particularly because sub-paragraph (1) anyway refers to “a transaction or series of transactions falling within sub-paragraph (2)”, and it also refers to the replacement of one party for another as a party to a derivative contract being “direct or indirect”.   I am left therefore deciding that it is the very presence of sub-paragraph (4) in paragraph 28 that leads me to decide that HMRC is right in their first contention, namely that the novation in this case was not covered by sub-paragraph (1) in isolation, because that requires the successor to become a party to the original contract, and that is not what occurs in the case of novations. 

The paragraph 28(1) and (4) questions concerning “equivalence”
63.    I turn now to the question of whether I decide that the novation to Dorus conferred “equivalent” rights and obligations to those formerly held by Treasury Services, such that it is nevertheless covered by paragraph 28.
64.     Turning first to the terms of the Novation Agreement itself, it appears that Dorus inherited and assumed all the rights and obligations formerly held by, and owed by, Treasury Services.  Nothing in the wording of the Novation Agreement leads to any issue of non-equivalence, and the Novation Agreement itself suggests that the rights and liabilities will be equivalent. 
The first basis on which HMRC contended that there was “non-equivalence”
65.     Turning now to HMRC’s arguments, I deal first with the point mentioned in the third bullet point in paragraph 58 above, namely that Treasury Services did not have absolute and unconditional rights to make the periodical floating rate payments to AIG because it could procure the release of those liabilities by novating to Dorus.  Whereas, following the novation, Dorus could only novate if it first procured Swiss Re or other AA guarantees.
66.     I fail to see that there is a material difference in this regard.  Dorus could in fact procure the same release if it managed to procure the required guarantees.   Treasury Services similarly had to procure the agreement of Dorus to novate the swaps.   It might be said that it would be easier for Treasury Services to procure the concurrence of its subsidiary to a novation, than it would be for Dorus to procure guarantees from SRC prior to a novation to Ampersand under paragraph (b) quoted in paragraph 56 above, but there is still the indisputable fact that some sort of co-operation was required by a third party and it was not in the absolute control of either Treasury Services or Dorus to procure that co-operation.     Indeed Mr. Prosser and I were in total agreement in both considering that the Board of Dorus acted in a questionable manner in paying the gross value of the swaps under the Dorus novation, making no deduction whatsoever for the assumed deferred tax liability of £54 million, so that I certainly consider that the point might have been made to Treasury Services that the terms on which it hoped and expected that Dorus would agree to the novation were highly questionable terms, to which the Board of Dorus might very properly have objected.    I also note that whilst in the Heads of Terms the Swiss Re party had undertaken to procure Swiss Re guarantees of Dorus’ swap liabilities, once Dorus had joined the Swiss Re group, and there was no equivalent undertaking to procure similar guarantees to facilitate the later novation to Ampersand,  it seems reasonable to suppose that Dorus (then a Swiss Re subsidiary) would have found it as simple to procure the required guarantees prior to the novation to Ampersand as Treasury Services would have found it possible to effect the novation to Dorus on terms that were highly questionable.  I accordingly see no material difference between the terms on which each of Treasury Services and Dorus could expect to novate their position under the swaps. 

The second basis on which HMRC claimed that there was “non-equivalence”
67.    I must now address the second claimed distinction between the rights and liabilities of Treasury Services and Dorus before and after the novation, namely the point made in the fourth bullet point in paragraph 58 above.   This was the contention that Dorus was subject to the feature that a Termination Event had been inserted into the swaps, of relevance to Dorus but of no relevance to Treasury Services.   The Termination Event applied if, following the novation to Dorus, Dorus were to leave the HBOS group and within two days of that event, no guarantee of its liabilities had been given either by Swiss Re (where Dorus became a subsidiary of Swiss Re) or by some other AA-rated company where Dorus was transferred to some purchaser other than Swiss Re. 
The further facts
68.     Since in my view the application of paragraph 28(4), and the resolution of by far the most important of the four points in dispute, hinged around this second question concerning the inserted Termination Event, I concluded, after the hearing, that there were some further facts that I needed to ascertain.   These included the questions of whether:-
•	the Swiss Re guarantee was in fact given, as contemplated, so that the Termination Event had then dropped away or whether indeed the Swiss Re guarantee might have been given at the point of the novation to Dorus;
•	whether any failure to give the guarantee could have been remedied within the 20-day notice-period in the event of AIG having given a Termination Notice such that the right on the part of AIG to terminate would again drop away if the guarantee was then given;  and
•	quite what difference there would be, were the swaps to be terminated by AIG under the Termination Event triggered by the failure to give the guarantee, as against the position, were Dorus (or any other “Party A”) to give the Termination Notice referred to in the first sentence of paragraph 56 above. 
69.    The answers sent to me drew my attention to a drafting error in the inserted Termination Event, in that neither party was expressed to be “the Affected Party”, so that at least literally there was no valid Termination Event geared to this whole point about the required guarantee following the sale of Dorus.  It was accepted that a court might construe the clause sensibly and commercially, and since there was plainly meant to be a Termination Event, and one in which it would be AIG that could call for termination, with Dorus being the “Affected Party”, I will proceed on the basis that that is the only realistic construction.   
70.     Were it to be the case that the guarantee had not been given, and that AIG was held to have a valid Termination right (as just assumed), I was told that the right to terminate could not be blocked by Swiss Re giving the guarantee within the 20 day period following the giving of the Termination Notice.   Once the Notice was given, the Termination Event would inevitably apply. 
71.    Finally I was told that if the Termination Event in question was triggered, the termination payment under this Termination Event would have been about £400 thousand less than the approximate £180 million payable under the more relevant Termination Event mentioned in the first sentence of paragraph 56 above.   It was however suggested that there were two reasons why it was realistic to assume that AIG would not have sought to terminate the swaps under this Termination Event, even if they had been able to do so due to the absence of the critical guarantee.   First it was argued that although the sum payable to Dorus might have been approximately £400 thousand less than the sum payable under the more relevant Termination Event mentioned in the first sentence of paragraph 56, AIG might have incurred other costs that would have eliminated or minimised this financial advantage.  Secondly, such conduct would have been sharp practice, and it was reasonable to assume that AIG would not have acted in this manner. 
72.     I was also given the facts in relation to the giving of the Swiss Re guarantee.    Treasury Services intimated that it did not know, or indeed need to know, whether the guarantee had been given or not, but HMRC indicated that it was aware that the required guarantee was given on 20 May 2003. 
My decision and the basis for it
73.     The further questions that I posed for the parties were initially answered in the form of a further Witness Statement given by Martin Cooper.   HMRC requested that the hearing be re-convened, as it was on 22 July, and following that both parties advanced additional written contentions, the second of which was submitted, as directed, at the end of August.  Rather than recite the various contentions, I will give my decision, and the contentions of the parties will be apparent from the reasons that I will give for that decision. 
74.     The question for me is whether the “rights and liabilities of the novatee” after the novation were “equivalent” to the rights and liabilities of the predecessor prior to the novation.
75.    This immediately poses the question of precisely what “equivalent” means.  It is obvious that the rights and liabilities did not have to be “the same” or “identical”, because it was implicit in the structure of paragraph 28 (1) and (4) that the rights and liabilities might be equivalent even though one or more additional parties might have been inserted into the transactions, such that the rights and liabilities might not subsist simply between AIG and Dorus, but might be indirect, flowing through intermediate parties.  In endeavouring to interpret the meaning of “equivalent”, it was also pertinent to note that even HMRC’s contentions had made the point that in their view, the rights and liabilities of Dorus were not equivalent to those of Treasury Services prior to the novation “in two commercially important respects”.    Since this seemed to concede that trivial changes would not undermine equivalence, yet there was no guidance for distinguishing between “commercially important” differences and trivial ones, it was arguable, when the basic terms of the swaps (as regards interest rates etc) remained the same that I should ignore a contingent termination right that would very likely become academic within two days of the sale of Dorus.   
76.     The right interpretation of “equivalent rights and liabilities” in my view is that there should be no change in the effect of the legal rights and liabilities as regards any matter of potential financial consequence.   I do not think it right to treat the notion of the rights and liabilities having to be equivalent to mean simply that they had to be “broadly” or “roughly” equivalent.   It seems to me that the use of the word equivalent was designed to reflect the point alluded to in the previous paragraph, namely that through different parties and different transactions the successor might have rights and liabilities the legal effect of which were the same as those held by and owed by the predecessor, even though because of the interposed parties, the rights and liabilities might differ.   I accordingly think that any legal change as regards the effect of the swaps that might have some meaningful financial consequence will undermine equivalence.    
77.      In this case, the insertion of an additional Termination Event that might have enabled AIG to terminate the swaps and pay £400 thousand less than it would have to pay if (as expected) the swaps were in fact terminated under the more relevant Termination Event given to Treasury Services and its novatees, did confer on the novatee, Dorus, a contingent liability of financial consequence.   In this context I consider that it is appropriate to pay regard to the consequences to Dorus of the different amounts that would be received on the two different Termination Events, and that it is not relevant to speculate as to whether AIG would have had reasons (such as other costs, or market disrepute) that might have induced it not to terminate for absence of the Swiss Re guarantee.  Beyond the fact that such matters are mere speculation, from the standpoint of Dorus, the equation was simple in that it would have been disadvantageous for AIG to have terminated the swaps for lack of the guarantee, and doubtless that is why the guarantee was indeed given, prior to the expiry of the two day window period. 
78.     I also accept that the guarantee was completely academic in that as the swaps had a positive value of £180 million to Dorus and any novatee, the prospect of there being changes in interest rates that would make Dorus or the novatee the net debtor to AIG was virtually inconceivable.  This is irrelevant however because once AIG insisted on the seemingly pointless guarantee, the absence of the guarantee beyond the two day window period would make the Termiation right immediately enforceable and nothing would turn on the fact that there had been no real need for the guarantee. 
79.      I do not accept that the “equivalence” requirement was met because the varied terms of the swaps (as distinct from their effect and potential effect) were identical before and after the novation.  In this context it was contended on behalf of Treasury Services that the contentious Termination right was contingent, when the swaps were held by Treasury Services, on three events, whilst contingent still (immediately after the novation to Dorus) on two events.  Those remaining two were that Dorus should leave the HBOS group, and secondly that no Swiss Re guarantee be given within two days of Dorus leaving the HBOS group.   And in the case of Treasury Services, prior to the novation, the additional and third contingency to the Termination right was the novation to Dorus.    In this regard I accept the contentions on behalf of HMRC.  When Treasury Services held the swaps, there was no situation whatsoever under which it might have suffered termination owing to any lack of guarantees.   Although the terms had been inserted into the swaps they were of no application or potential application to Treasury Services itself.   In the hands of Dorus, I accept that there were still two contingencies that had to be satisfied before the contentious termination right became immediately operative, but the contingent liability still applied to Dorus itself.  I even accept that there is an argument that Dorus might have had a contractual right, in the Heads of Terms, against Swiss Re that the guarantee be provided, but even this appears to me to have no bearing on the fact that once the swaps were novated to Dorus, then vis a vis AIG Dorus would be at risk of the contentious Termination right being called if Dorus left the HBOS group and the Swiss Re guarantee was not provided within the two day window period. 
80.     I must now address Treasury Services’ more compelling contention, namely that in considering the “rights and liabilities” of the parties to the swaps, I should pay regard only to the uncontingent  rights and liabilities.   In other words I should conclude that because AIG’s contentious termination right was not operative immediately after the novation to Dorus, and that it would only be operative if the guarantee was not given within two days of Dorus leaving the HBOS group, I should disregard it.   HMRC contended that I should pay regard to liabilities even if they were still contingent. 
81.      My determination is that I cannot disregard a contingent liability.   I am struck by the fact that if a counter-party to a swap consented to a novation but only on the basis that numerous contingent termination events were inserted, geared to various credit type events, it would seem impossible in that situation to disregard those very material changes, albeit that it would obviously be the case that at the time of the novation none of the contingent termination rights would have become immediately enforceable rights.  I thus conclude here that I cannot disregard the insertion of a Termination event because it was contingent at the point of the novation. 
82.     Whilst it seemed to be common ground between the parties that it was appropriate to consider the equivalence question immediately before, and immediately after the novation to Dorus, I confirm that I agree that that must be the approach.  It cannot for instance be right that one can consider the position over a period of a week, and then reach the conclusion that because the Termination right had lapsed, on the grant of the guarantee, that I can disregard its existence at the point immediately after the novation.  It is indeed noteworthy in this context that it is the point after the novation that is material, and not after the sale of Dorus to the Swiss Re purchaser, so that at that point it remained at least theoretically possible that Dorus would be sold to some other entity, and the guarantee be provided by some other AA-rated entity, so that at least theoretically speaking the feature that Dorus could call upon Swiss Re to procure the relevant guarantee was even less relevant because Dorus at the critical time might have been sold to a different buyer. 
83.      I have also given thought to the feature that the trap into which HMRC contends that Treasury Services has fallen is one that might have been avoided by structuring the transactions in a different manner.  This might not have been entirely simple because the Swiss Re guarantee needed to be given not at the point of AIG consenting or not consenting to the novation to Dorus, but at the later point when Dorus was to leave the HBOS group.    Nevertheless I accept the point made on behalf of HMRC that nothing hinges on whether the same commercial result could have been achieved in a way whereunder the equivalence requirement would have been satisfied.   What I have to consider is the transaction actually undertaken and the rights and liabilities that actually arose, and not others that might have been adopted. 
84.      It follows from the above that I determine that the rights and liabilities of Dorus, immediately after the novation, were not “equivalent” to those of Treasury Services, immediately before the novation, and that paragraph 28(1), amplified by sub-paragraph (4) did not apply to the novation from Treasury Services to Dorus.   I entirely accept that this is surprising and that it is a conclusion that I reach, notwithstanding that:
•	the guarantee called for was completely pointless;
•	the inserted Termination right was the only right that undermined the equivalence requirement, and that in every other respect the rights and liabilities were identical;
•	the termination right lapsed, on the grant of the guarantee, before the point at which it might have become uncontingent;
•	it may have been unlikely that AIG would have exercised the right even if the right had ceased to be merely contingent; and
•	there might have been other ways in which the desired end result could have been achieved without  breaching the equivalence requirement.
85     I have also considered whether I should look broadly at all the factors that I have addressed above, and conclude that because so many factors render my decision a finely balanced one, I should say that the sum total of all the factors on which Treasury Services rely is that in order to reach a commercial and sensible decision I should ignore the technical detail, and determine the question in favour of Treasury Services.   My conclusion is that the test is a technical one, and that this approach would be wrong. 
86.      I should expressly state that whilst I have determined the first critical issue in favour of HMRC, I have not done this to any degree because the scheme was a tax avoidance scheme.  The issue is a pure technical one.   I can well believe that if the precise facts had arisen in an innocent, and entirely commercial context, HMRC might have chosen to turn a blind eye to technicalities on which they have seized in this case.   Once however those technical points have been raised I cannot ignore them and it is because the argument on this Termination right point advanced by HMRC seems to me to be technically correct that I have determined this point in HMRC’s favour. 
87.     Without detracting from the point just made, I might however note that the trap into which Treasury Services has fallen in this case does somewhat result from the scheme aspects of the transactions.   Once the fee had been paid, Treasury Services had to be certain that all steps would be implemented, as intended.   Thus AIG had to have acquiesced in the novation to Dorus.  The fact that AIG then wanted for some inexplicable reason to demand a guarantee when Dorus left the HBOS group, and that it achieved this by inserting a Termination right, as “a stick”, to secure the giving of the guarantee, when no such provision applied to Treasury Services itself, is what has occasioned the trouble for Treasury Services in this case.     In this respect, my determination on the first issue may not be quite so perverse as it might otherwise seem to be. 
The second matter in contention
88.     The second matter in contention was actually worded in a slightly curious manner.   The question that was actually posed for me was worded as follows.    I was asked to decide, whether “if Dorus did replace Treasury Services as a party to one or more derivative contracts within the meaning of paragraph 28 as a result of the novation to it of the AIG Swaps, paragraph 28(3) applied so as to cause to be disregarded for the purposes of Schedule 26 to FA 2002 debits in respect of the fee paid by Treasury Services to AIG in connection with the amendment on 13 and 16 May 2003 of the terms of the AIG Swaps.”    
89.    As that question was actually worded, it presupposed that the question only arose if the first question had been answered in favour of the interpretation contended for by Treasury Services.    The question also presupposed that the deductibility of the fee was entirely geared to whether or not paragraph 28(3) applied so as to require the payment of the fee also to be disregarded, tallying with the first assumption that the basic transaction had indeed been disregarded by paragraph 28.  In fact, as the second issue was argued before me, the contentions on behalf of HMRC were contentions that, if successful, result in the conclusion that the fee is not deductible at all for reasons that have nothing to do with paragraph 28, and indeed they were reasons that would have been equally applicable whichever party prevailed in relation to the first point.  Since the point was substantially argued on this basis, I will proceed on the basis that the second question asked me the broader question of simply whether or not the fee was deductible by Treasury Services. 
Additional facts relevant only to the second issue
90.     I have already explained that AIG could be compensated in one of two ways for the credit or liquidity cost of actually having to pay approximately £180 million in 2003 rather than to have the deferred liability to pay the excess swap payments over long periods.   Either the £180 million could be adjusted downwards by the appropriate amount (to £177.8 million) or Treasury Services could pay a fee (possibly expressed to be a fee for agreeing to the novations and for committing to monetise at mid-Market rates) whereupon the fee would be £2.2 million and the monetisation payment would revert to £180 million. 
91.     By looking at the e-mails between the parties, it seems fairly clear that people realised that if the scheme succeeded, and AIG’s £2.2 million was charged as a deduction from the £180 million payment, no tax relief would be available for that cost since it would merely be diminishing the figure that would be tax-free if Treasury Services managed to avoid the tax on the £180 million.  If on the other hand, the fee was paid by Treasury Services, and Treasury Services could claim a deduction for the £2.2 million, that would reduce the cost of the fee to 70% of £2.2 million, and the fact that the lump sum would revert to being £180 million would be irrelevant if no-one was going to pay tax on it. 
92.     In this context an e-mail from Swiss Re to Martin Cooper seems significant.   The e-mail dated 27 April contained the following points:-
“If their fee is coming out of the breakage payment, there is approx. £630k of benefit lost (30% of £2.1 m).
The more efficient way to structure their fee is for AIG to pay the full breakage (i.e. payment calculated based on mid market instead of mid market + 17.5), and for Treasury Services to pay/receive a fee adjustment on breakage.  Treasury Services would pay £2.1m as a fee to AIG on novation as currently proposed, but this fee would be retrospectively adjusted depending on the actual termination amount (calculated by the difference between the termination amount at mid market on breakage date vs termination amount at mid market + 17.5 on breakage date)”.
93.     The other factual matters that I must mention in relation to the second issue are that Mr. Prosser invited me to make various findings of facts that are relevant to this issue.    Those relevant findings of fact, that I now make, are that:-
•	regardless of any personal pessimism on the part of Martin Cooper, the great likelihood on 13 May 2003, when the fee was paid, was that the transaction would proceed as planned.    In other words, there was virtually no chance that the swaps would be monetised and re-couponed in the hands of Treasury Services.  The likelihood was that the swaps would be amended, novated to Dorus, Dorus would be sold, and the expectation then was that the swaps would be novated again to Ampersand, and only then monetised and re-couponed by AIG;
•	whilst I have not yet greatly emphasised this aspect, the e-mails that have been shown to me, along with the Lehman Brothers and Swiss Re proposals, and the various Greek names given to the scheme, all confirm that this project was the acceptance by Treasury Services of a marketed tax avoidance scheme, and a scheme that Treasury Services meant to implement;     
•	the fee of £2.2 million was expressed to be payable to AIG for participating in the novations, as well as the re-couponing, albeit that the calculation of the fee shows that it was in reality all paid for the re-couponing; and 
•	finally, and the finding of by far the most significance, the clear purpose of Treasury Services, when it paid the fee, was that the transaction should proceed as planned, and that the re-couponing should not actually be done until after Dorus had passed out of its control.  It was remotely possible that Treasury Services would not have achieved its clear purpose of effecting the transactions as planned, and it might have ended up directly re-couponing the swaps with AIG, but when the fee was paid, it was certainly not Treasury Services’ purpose that this should be the outcome. 
The relevant  provisions
94.      I have already quoted sub-paragraphs (7) and (8) of paragraph 15, and the whole of paragraph 28.    The only other provisions that I need to quote for the purpose of considering the second issue are those of paragraph 15 (1), (4) and (5), which are as follows:-
Credits and debits brought into account
“15  (1)  The credits and debits to be brought into account in the case of any company in respect of its derivative contracts 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)  all profits and losses of the company which (disregarding any charges or expenses) arise to the company from its derivative contracts and related transactions; and
(b)  all charges and expenses incurred by the company under or for the purposes  of its derivative contracts and related transactions.
(4)  The reference in sub-paragraph (1)(b) to charges and expenses incurred for the purposes of a company’s derivative contracts and related transactions does not include a reference to any charges or expenses other than those incurred directly:-
(a)     in bringing any of those contracts into existence;
(b)    in entering into or giving effect to any of those transactions;
 (c)     in making payments under any of those contracts or in pursuance of any of those transactions; or
(d)	in taking steps for ensuring the receipt of payments under any of those contracts or in accordance with any of those transactions.
(5)    Where:
(a)  any charges or expenses are incurred by a company for purposes connected:-
(i)  with entering into a derivative contract or related transaction, or
(ii)  with giving effect to any obligation that might arise under a derivative contract or related transaction,
(b)  at the time when the charges or expenses are incurred, the contract or transaction is one into which the company may enter but has not entered, and 
(c)  if that contract or transaction had been entered into by that company, the charges or expenses would be charges or expenses incurred as mentioned in sub-paragraph (4),
those charges or expenses shall be treated for the purposes of this Schedule as charges or expenses in relation to which debits may be brought into account in accordance with sub-paragraph (1)(b) to the same extent as if the contract or transaction had been entered into.”
The respective contentions of the parties in relation to the second issue
95.    Much of the dispute between the parties centred around identifying under which provision of paragraph 15(1) the fee paid should be claimed.   
96.     Mr. Gammie’s contention on behalf of Treasury Services was that the fee should be deductible under paragraph 15(1)(a) as occasioning a loss from Treasury Services’ derivative contracts.   He argued that “a payment to vary the terms of a derivative contract is a loss arising from that derivative contract as a result of its particular terms, which are agreed to be varied.    It is not a charge or expense incurred under or for the purposes of the derivative contract.”  
97.    As a fall-back, he accepted that the £2.2 million variable fee might instead be deductible under sub-paragraph (1)(b), as being “a charge or expense incurred by the company under or for the purposes of its derivative contracts and related transactions”.     Were this so, the charge or expense would not fall to be disregarded by paragraph 28 because the only transaction that fell to be disregarded under paragraph 28 was the novation transaction between the group companies, Treasury Services and Dorus.   The AIG fee was not a debit relating to the novation as such and so should be taken into account by Treasury Services in the ordinary way.  
98.     Mr. Gammie then argued, as a further fall-back, that, if the AIG fee was paid for AIG’s agreement to amend the swaps and to allow their termination and re-couponing, the fee would have been deductible, had Treasury Services itself monetised and re-couponed the swaps.  In view of this, paragraph 15(5) provided that the fee should nevertheless be deductible even where Treasury Services had not entered into the re-couponing transaction, because it would have been deductible if it had entered into that transaction. 
99.     Finally Mr. Gammie argued that if no amount was to be brought into account because the fee related to a transaction that was to be disregarded by virtue of paragraph 28(3) and if paragraph 15(5) did not apply to the fee, then Treasury Services could claim an ordinary Case I deduction for the fee.  The fee was still incurred in the ordinary course of Treasury Services’ trade and was incurred wholly for the purposes of that trade.  The only basis on which it might be disallowed was by virtue of paragraph 1 of Schedule 26, which provided that:-
“  (1)   For the purposes of corporation tax all profits arising to a company from its derivative contracts shall be chargeable to tax as income in accordance with this Schedule.
(2)   Except where otherwise indicated, the amounts to be brought into account in accordance with this Schedule in respect of any matter are the only amounts to be brought into account for the purposes of corporation tax in respect of that matter”.
If thus, contrary to the principal arguments, the fee fell to be disregarded by virtue of paragraph 28(3), so that no amount fell to be brought into account in respect of the relevant matter (i.e. the agreement with AIG to vary the AIG swap terms) then ordinary Case I principles were not displaced, because “nothing would have been brought into account under the Schedule in respect of the fee”. 
100.    Mr. Prosser’s case on behalf of HMRC was phrased rather differently during the hearing, as against the argument advanced in his written Skeleton Argument, so that I shall deal with each in turn. 
101.     Mr. Prosser’s basic argument in his written Skeleton Argument rather accorded with the way in which the “second question” was put to me.    In other words, it pre-supposed that HMRC had failed to establish its case on the first issue, such that the novation between Treasury Services and Dorus had been disregarded under paragraph 28(3).    The argument in relation to the payment of the £2.2 million was thus that “paragraph 28(3) applies to require the £2.2 million fee paid by Treasury Services to AIG to be disregarded for Schedule 26 purposes”.    
102.     The support for the proposition just advanced was that “in order for the £2.2 million fee to be brought into account, it must be shown to be an expense incurred by Treasury Services under or for the purposes of a related transaction which is not required by paragraph 28(3) to be disregarded.”    It was then said that the fee was payable “in return for AIG agreeing to participate in Project Asclepius and in particular in the novation of the Treasury Services swaps to Dorus”.   On the reasoning that the fee was paid for participating in the novation, i.e. the transaction that was to be disregarded, then the fee too should be disregarded.    Alternatively, HMRC submitted “that Dorus replaced Treasury Services by virtue not only of the novation itself but also of the agreements facilitating that novation.”
103.     It was specifically stated in the Skeleton Argument that in HMRC’s view “that agreement [i.e. the Amendment Agreement to the swaps] was not itself a related transaction.”     Little attention was paid during the hearing to this contention, though I might indicate at this point that the question as to whether this argument was right or not seems to me to be of very considerable significance.     
104.     In response to the Case I argument advanced on behalf of Treasury Services, it was suggested that this argument overlooked “Schedule 26 paragraph 1(2) which provides that the amounts to be brought into account in accordance with Schedule 26 in respect of any matter are the only amounts to be brought into account for the purposes of corporation tax in respect of that matter”.  The correct interpretation of paragraph 1(2) was that it simply prevents anything taken into account in computing profits and losses under paragraph 14 Schedule 26, in computing the tax treatment of derivative contracts (whatever the debits and credits, if any, attributable to various items) from being brought into account otherwise than under Schedule 26.   Thus it precludes any Case I deduction for the fee, just as (rather more significantly, but on the same reasoning) it precludes a Case I charge on the receipt of the £180 million.
105.    The very different argument that was advanced on behalf of HMRC during the hearing was prompted perhaps by the feature (that of itself I found to be of no significance) that Mr. Gammie had occasionally referred to the £2.2 million fee as “an expense”.  It was thus argued from this that anything that was a charge or an expense was expressly said not to fall within paragraph 15(1)(a), but to fall instead within paragraph 15(1)(b).   This led to the contention that the fee was non-deductible.  This was because charges or expenses under paragraph 15(1)(b) could only be deducted if they were incurred for the purposes of the company’s derivative contracts and related transactions, and then only if the charges or expenses were incurred directly for one of the purposes set out in sub-paragraph (4).  Whilst there was considerable debate as to which of the four cases set out in sub-paragraph 15(4) might apply to the fee in question, the more material point was that, once one had to look at “purpose”, the fatal feature in Treasury Services’ case was that it was never its purpose that it would directly re-coupon the swap with AIG.    It was said manifestly to be the purpose of Treasury Services that the actual re-couponing transaction with AIG, for which the amended terms of the swaps provided, would only be effected once Ampersand became the novatee of the swaps.  The derivatives code always paid regard to the derivate transactions of each individual company, and since thus it was not Treasury Services’ purpose that it, itself, would receive the termination payment from AIG on re-couponing the swaps (or, in other words, participate in that related transaction at all), the “charges or expenses [could not be said for the purposes of paragraph 15(1)(b) to have been] incurred by [Treasury Services] under or for the purposes of its derivative contracts and related transactions”.
My determination in relation to the second issue
106.     I give my determination in relation to this second issue with some diffidence because it is largely based on a point that was not directly raised in argument.  In case therefore, HMRC should wish to appeal against my determination on this point, I ought to start by making various points regarding findings of fact and the significance of those findings of fact, quite clear. 
107.    I entirely accept that HMRC were right to suggest that the purpose of Treasury Services, in paying its fee and entering into the Heads of Terms and the later Swap Amendment Agreement, was that the Swiss Re scheme should be implemented.   Just as the very terms of the Amendment Agreement suggested therefore, it was the purpose of Treasury Services that it, itself, would not terminate the swaps with AIG at the mid-market price that had been agreed, once the fee had been paid.  It was its purpose that it would achieve its effective re-couponing by novating the swaps to Dorus and by selling Dorus and entering into the two replacement swaps with the Swiss Re company mentioned at paragraph 30 above.    
108.     I will now deal with the features that nevertheless lead me to determine the second issue in favour of Treasury Services.
109.     It was, I think, common ground that the £2.2 million variable fee paid under the letter agreement of 2 May was paid in consideration for AIG agreeing to participate in the transaction outlined in the Heads of Terms.  In their turn, the Heads of Terms provided for some amendments to the terms of the swaps, which paved the way both for the novations and the re-couponing.  Whilst Treasury Services thus achieved various purposes by paying the fee and agreeing the Heads of Terms, I think that it is not contentious to say that the commitment that AIG gave that prompted AIG to demand a fee, was all geared to the re-couponing.  The method of calculating the fee, and the terms for its variation, support this.  I also accept the evidence given by Martin Cooper that parties to swaps generally cooperate in consenting to novations without demanding any payment.  They may call for a guarantee, and AIG did so.    It was regularly pointed out during the hearing that the percentage chance of a guarantee actually being material to AIG in the case of the existing swap that involved AIG in having liabilities exceeding its rights by approximately £180 million was infinitesimally small.    Nevertheless AIG called for a guarantee.   There is still no ground for the supposition that any part of the £2.2 million was paid for AIG paving the way for the novations.   AIG might have been expected to extract some benefit from the feature that, absent its agreement, Treasury Services would not be able to effect its attractive tax-saving scheme with Swiss Re.   It would have been possible for AIG to calculate its fee by calculating the fair credit cost of the re-couponing, and by then adding to that some element for facilitating a tax scheme that was obviously highly beneficial to Treasury Services.   There was however no evidence that AIG sought any such extra payment, over and above the fee calculated entirely by reference to its credit cost. 
110.     I conclude from the observations in the previous paragraph that, whilst the fee was worded generally to be paid for AIG agreeing to a number of different amendments to the swaps, what was actually paid for, in common sense terms, was the commitment to re-coupon, achieved by amending the swap terms.   AIG demanded a superfluous guarantee in connection with the sanctioned novations, but there is no evidence, and no reality to any suggestion, that it was paid for consenting to participate in those novations. 
111.     Turning to the wording of paragraph 15(1)(a), and disregarding the issue of whether any deduction might be denied by virtue of the fee being a “charge or expense”, I find it difficult to say with Mr. Gammie that the fee was a “profit or loss… ….[that arose] from the company’s derivative contracts”.   The fee arose precisely because the pre-existing derivative contract did not provide for cash collateral to be posted, and because it contained no provision requiring the party with the greater liability to participate in a monetisation and re-couponing transaction.   It might be said however to have arisen from a related transaction if the agreement to amend, and the Amendment Agreement, ranked as related transactions.    Without elaboration, Mr. Prosser contended (see paragraph 103 above) that the Amendment Agreement was not a related transaction, and I will now address that point. 
112.     The most financially significant consequence of the Amendment Agreement was that, as required by the Heads of Terms, AIG committed to re-coupon the swaps at mid-market value.  This commitment became one of the revised terms of the swaps, and was not a distinct contractual right only exercisable by Treasury Services.  Under this amendment, Treasury Services, and effectively any novatees, acquired additional rights against AIG, that became one of the terms of the varied swaps.   From the perspective of Swiss Re, it was absolutely vital that any novatee of the swaps would be able to call for their termination at mid-market value.   The expression “related transaction” is defined to mean “any acquisition (in whole or in part) of rights or liabilities under the derivative contract”.   In the context of paragraph 15(1) (a) it seems to me that the acquisition of additional rights under the existing derivative transaction does rank as a “related transaction”.    The only contrary argument would be that the acquisition of rights that can rank as related transactions must be an acquisition of existing rights under the derivative contract, but that can make no sense in the context of computing “the profits and losses of the company … which arise to the company from its derivative contracts and related transactions”.   The company can hardly be acquiring rights under its related transactions if those rights have to be rights that it already holds under its existing derivative contracts.  I thus consider that the Amendment Agreement, and the Heads of Terms that required the Amendment Agreement to be entered into, do rank as a related transaction to Treasury Services’ derivative contract, i.e. the pre-existing swaps. 
113.    On the reasoning then that the £2.2 million fee was a charge made by AIG for entering into the Heads of Terms, and (following the conclusion given in paragraph 110 above) that it was in reality paid entirely in return for AIG’s commitment to re-coupon, and realistically then treating the commitment in the Heads to modify the swap terms to provide for this re-couponing and the Amendment Agreement that effected this as one composite agreement, it seems to me that the payment was made “under Treasury Services’ related transaction”.  I must now address the point that all charges and expenses are to be disregarded under paragraph 15(1)(a) and must instead be considered under paragraph 15(1)(b). 
114.     There is then a rather curious point in the drafting of sub-paragraph (1)(b), which refers to “all charges and expenses incurred by the company under or for the purposes of its derivative contracts and related transactions”. The seemingly odd point is that this provision appears to contemplate two types of “charges and expenses”, those incurred “under the company’s derivative contracts and related transactions”, and others “incurred for the purposes of such contracts and transactions”. Paragraph 15(4) reflects precisely this distinction in that no attention has to be given under sub-paragraph (4) to the purpose of charges or expenses incurred under the derivative contracts and related transactions.    Attention only has to be given to “purpose” where the charges or expenses are incurred for the purposes of the company’s derivative contracts and related transactions, as distinct from being incurred under the related transactions.  
115.     It may seem rather curious to relegate the fate of charges and expenses to sub-paragraph (1)(b), if the charges and expenses are automatically to be taken into account if they are incurred under the derivative contracts, and to subject only the expenses incurred for the purposes of the derivative contracts and related transactions to the requirements of sub-paragraph (4).   On the other hand, if the charges and expenses arise actually under the contracts or the related transactions, perhaps it makes entire sense that their proximity to the contracts or transactions makes it superfluous to subject them to the sub-paragraph (4) tests.     Whatever the reasoning, it appears clearly to be the case that the only charges or expenses that have to satisfy the condition of being for the purpose of the company’s contracts and related transactions are those that are incurred otherwise than actually under the contracts and related transactions.    Those incurred, actually under the contracts and transactions appear to be deductible without attention to purpose. 
116.     My conclusion at this point therefore is that the Heads of Terms and the Amendment Agreement were related transactions to Treasury Services’ derivative contract, in that Treasury Services acquired additional swap rights under the modified derivative contract as a result of this composite contract.  The fee was paid in return for AIG entering into this Agreement, and so was paid “under the related transaction”. 
117.     Whilst I have already accepted that Treasury Services would have failed the purpose test of paragraph 15(1)(b), had that test been relevant, I conclude that the test is irrelevant.       I thus conclude that the credits and debits that should be brought into account in accordance with the company’s authorised accounting method will include those in respect of the charges under the related transaction to the swaps, subject only now to the test of whether paragraph 28(3) would require the charges and expenses to be disregarded.  This question does not even arise if my determination on the issue is correct because in that case paragraph 28(3) will not have applied and none of the transactions will have been disregarded.  I will however now deal with this question on the assumption that my first determination is wrong, and that paragraph 28(3) has applied.  
118.     The answer to this paragraph 28(3) question on the assumption just mentioned is that the charges would only have to be disregarded if they were, in any realistic sense, the fee for acquiescing in the novation to Dorus.  That novation is the transaction that is disregarded and if the fee was paid for acquiescing in that novation it would have to be disregarded, even perhaps if it was paid to AIG, and not to one of the group companies whose transaction was to be disregarded.   I consider however that the conclusion that I reached in paragraph 110 above makes it unrealistic to say that the fee had anything to do with the novations.  I accept Martin Cooper’s evidence that fees are not generally charged for acquiescing in novations, though guarantees, including seemingly superfluous guarantees, are sometimes called for.    In any event all the evidence and the variation terms indicate that the calculation of the fee simply paid regard to a cost to be suffered by AIG once, by changing the swap terms, it was committed to monetise and re-coupon the swaps.  The fee really had nothing whatever to do with acquiescing in the novations.  That aspect of the amendments commanded no charge, and the charge was all related to the changed terms of the swap that entitled Party A to call for the re-couponing. 
119.     Somewhat odd as I find this conclusion, thus, my determination is that the accounting debits properly attributable to this charge, incurred by Treasury Services, and actually incurred under the amendment to the swaps that ranked as one of its related transactions, should be granted, and this conclusion would not be changed even if my first detemination was wrong, and paragraph 28(3) had thus applied.  Paragraph 28(3) would still not have required the critical amendment to the swaps, for which the fee was paid, to be disregarded.    It seems to me that the validity of this conclusion is supported by the fact that the insertion of the critical Termination Event, referred to in the first sentence of paragraph 56 above, was a change that modified the terms of the swaps, regardless of which party happened to be Party A at the time of exercising the relevant Termination right.  The modification increased the value of the swaps to the relevant party A, and if the novation to Dorus or any other company had not taken place, and Treasury Services had itself exercised the relevant Termination right, it would have got, vis-à-vis AIG, precisely what it had paid for.    
120.     I should add that if my above determination on this second issue is wrong, and that I should pay regard to whether it was Treasury Services’ purpose that it, itself, would participate in the re-couponing transaction with AIG, I would agree with Mr. Prosser and say that that was not its purpose.  I would also reject any argument on behalf of Treasury Services that as it achieved an effective re-couponing by selling Dorus and entering into the replacement swaps mentioned at paragraph 30 above, it should be treated as having borne the fee for the purpose of entering into a related transaction under paragraph 15(4)(b). The relevant related transaction must be the actual termination of the swap with AIG, and not a different transaction that conferred equivalent benefits on Treasury Services.  I also agree with Mr. Prosser that once purpose is material, then it follows that paragraph 15(5) is of no assistance to Treasury Services because, having failed to satisfy the purpose test, the fee would have been non-deductible even if Treasury Services’ purpose had been frustrated, and it had itself re-couponed the swaps directly with AIG.  I also agree with Mr. Prosser that, particularly if the fee has been disallowed on the “purpose” ground, it has thereby been taken into account under Schedule 26, such that the fall-back claim for an ordinary Schedule D Case I deduction would also fail. 
The third question
121.     The third question was:  “If paragraph 28 applied to the novation of the AIG swaps to Dorus, did section 30 of the TCG Act 1992 have effect on the subsequent sale by Treasury Services of its shares in Dorus to SwissRe Specialised Investments Holdings (UK) Ltd so that the consideration for that disposal should be increased by such amount as is just and reasonable having regard to the matters referred to in section 30(5)?”
122.     As I have already noted, once I have reached the conclusion that HMRC succeed in relation to the first question, this point altogether drops away.  This is because no company will have received a tax free benefit within the meaning of section 30, and indeed the value of Dorus will not have been materially reduced by an inherited Corporation Tax liability.  In reality Treasury Services will mistakenly have sold Dorus at a loss because of the wrong apprehension by all the parties that Dorus will have inherited a liability that I have concluded it did not inherit.   It may of course be the case that my determination on the first issue will be over-turned on appeal, and in the light of that, I will now consider the third question on the basis that my determination on the first issue turns out to be wrong, and that Dorus did inherit the potential Corporation Tax liabilities formerly faced by Treasury Services. 
Additional facts relevant to the third question
123.     I mentioned in the introductory paragraphs that the scheme in this case was first brought to Treasury Services by Lehman Brothers, and only later re-introduced by Swiss Re.    The principal reason for this switch of promoter was apparently that the team that were familiar with the scheme moved from Lehman Brothers to Swiss Re, and it took Lehman Brothers a little time to re-approach Treasury Services, by which time it seems that Martin Cooper and his colleagues had decided to pursue the scheme with Swiss Re. 
124.     The marginal significance of this point is that, when the scheme was first proposed by Lehman Brothers, the suggested steps were slightly different from those eventually promoted by Swiss Re, and adopted by Treasury Services.   Using, as the Lehman Brothers proposal did, the example number that the gross value of the swaps was £100, the Lehman Brothers proposal suggested that only £70 be contributed as capital into the company that was eventually named Dorus, with thus £70 being paid for the novation of the swaps, whereupon it was suggested that Lehman Brothers would buy the company at a premium, namely for £75.     Expressing this example in tax terms, the novation would be priced to reflect the full value of the assumed tax liability of £30 in respect of the £100, and because Treasury Services and Lehman Brothers would share the benefit of the tax saving, the shares of Dorus would be sold for £75, giving Treasury Services a small proportion of the tax saving, and conferring most of the benefit on Lehman Brothers.  Treasury Services would accordingly realise a chargeable gain for capital gains purposes, equal to the premium at which it would sell the Dorus shares, that premium being equal to its share of the tax saving. 
125.    The figures had been changed by the time the same team of individuals made their presentation from Swiss Re.  It was then suggested that Dorus should be capitalised at £100, and that that amount should be paid on the novation, and the view was then expressed that this “may enable Treasury Services to claim a capital loss on the sale of the shares of Dorus”. 
126.     In cross-examining Martin Cooper, Mr. Prosser suggested that one of the reasons why Treasury Services chose to use the Swiss Re scheme was that they preferred this capital gains feature of the scheme.  Martin Cooper said that he gave no attention to this capital gains point, and that the Swiss Re scheme was simply preferred because “the pricing was better”.    Virtually nothing hinges on this point, but I might say that:
•	I can well understand that an individual, whose expertise is entirely in banking, financial instruments and derivatives, would be quite likely to give little attention to what I might describe as a “capital gains value shifting point, geared to the share sale”;
•	I would certainly have expected tax experts in, and working for, Treasury Services to note the capital gains implications of the difference between the two schemes;
•	I would expect those experts to have noted instantly that the amount subscribed for the shares of Dorus, and the price paid for the novation, would have little bearing on the purchaser, save for its bearing on whether Dorus might be at liberty to pay dividends, so that the price paid on the novation could have been set at £180 million, regardless of which promoter bought the Dorus shares;
•	Finally I cannot imagine that the Lehman Brothers proposal would have conferred only the £5 in the example above of the overall benefit on Treasury Services, but that is the area of pricing that may have distinguished the two schemes, and I can well accept Martin Cooper’s evidence that he preferred the Swiss Re scheme because its pricing was better. 
127.     The only point that seems to me to be material in relation to the points just canvassed is that the distinction between the two schemes put the spot-light on the feature, that was anyway obvious, namely that the price that Dorus would pay for the novation, and the degree to which it would or would not reduce that price to reflect an assumed deferred tax liability that would only be “half-recognised” at the point when the shares of Dorus were sold, was inherently geared to the amount that would be subscribed for the shares of Dorus, that would in turn govern  whether a gain or loss would be made on selling those shares .
128.     The relevant provisions of the TCGAct 1992 in relation to this issue are as follows:-
“30.    (1)  This section has effect as respects the disposal of an asset if a scheme has been effected or arrangements have been made (whether before or after the disposal) whereby:
(a)  the value of the asset or a relevant asset has been materially reduced, and
(b)  a tax-free benefit has been or will be conferred:-
(i)	on the person making the disposal or a person with whom he is connected, or
(ii)	subject to sub-section (4) below, on any other person.”
Sub-section (3) of section 30 provides that “a benefit is conferred on a person if he becomes entitled to any money …, and a benefit is tax-free unless it is required, on the occasion on which it is conferred on the person in question, to be brought into account in computing his income, profits or gains for the purposes of income tax, capital gains tax or corporation tax”.
The contentions on the part of HMRC
129.     The contentions of HMRC were that:
•	when the shares of Dorus were subscribed in cash, the value of the shares was £181 million;
•	when £180 million was paid for swaps with a gross value of £180 million in the expectation that Dorus would inherit a Corporation Tax liability with a similarly discounted present value of £54 million, the effect of the over-payment for the swaps was that the value of the shares was reduced from £181 million to a figure well below the £150 million that was the approximate price received on the sale of Dorus to the Swiss Re purchaser;
•	the contrast between the basis on which the Lehman Brothers scheme would initially have been implemented, and the change made when the Swiss Re scheme was adopted made it clear that the pricing adopted was deliberately chosen, if not to generate an artificial capital loss, certainly to diminish the gain that would have arisen had the swaps been purchased for their net post tax value, and the shares later sold at the envisaged premium;
•	this feature was all part of a tax avoidance scheme, and this element of it resulted in the “material reduction of the value of an asset”, namely the shares in Dorus; 
•	Treasury Services received a tax-free benefit, in that on the sale of the swaps it became entitled to £180 million, and that entitlement to money was a “tax-free benefit” because Treasury Services did not bring the receipt into account in computing its income, profits or gains for the purposes of Corporation Tax.   By virtue of the fact that the receipt was disregarded by paragraph 28 of Schedule 26 to FA 2002, it could not be said to have been brought into account in computing Treasury Services’ profits for the purposes of Corporation Tax.
The contentions on behalf of Treasury Services
130.     The contentions on behalf of Treasury Services were that:-
•	when the swaps were purchased, the feature that they continued to be matched with Treasury Services’  internal swaps with Halifax Plc, meant that from a group perspective they would generate neither an accounting or tax profit or loss;
•	Dorus was able to pay the full gross value of the swaps “because on a group basis it could expect to be in the same position” (i.e. the “same position” as Treasury Services prior to the novation) meaning that it too would not expect to pay any tax on the swaps;
•	it was the sale of Dorus that would bring about the “de-grouping” so that at that point it was necessary to recognise the deferred tax liability, and it was at that point that the value of  the shares fell; 
•	Treasury Services’ commercial choice to sell Dorus was not a scheme or arrangement “whereby” the value of the Dorus shares was materially reduced within the meaning of section 30;
•	Treasury Services did bring the £180 million receipt into account in its accounts in accordance with its authorised accounting method for the purposes of  Corporation Tax, even though the credits attributable to the £180 million were required by paragraph 28 to be disregarded; and 
•	Paragraph 1(2) to Schedule 26 provides that “the amounts to be brought into account in accordance with [the] Schedule in respect of any matter are the only amounts to be brought into account for the purposes of corporation tax in respect of that matter”.   “Accordingly, [according to Mr. Gammie’s contentions] the amount as determined under Schedule 26 is the only amount to be brought into account for the purposes of corporation tax in respect of the novation.    This does not alter because the amount that paragraph 28 determines shall be brought into account under Schedule 26 is nil.    There is nothing in section 30 TCGAct 1992 to displace paragraph 1(2) and permit the £180 million to be brought into account for the purposes of that section”.
My determination on the third issue
131.     I consider that this issue, and indeed the fourth issue that I will come to shortly, is relatively easy, and I rather endorse the remark by Mr. Prosser that the third and fourth issues were only added to the “joint reference” to enable me to be more even-handed, like Shylock, and decide two issues in favour of each contestant.   In that regard, Mr. Prosser was unduly pessimistic in relation to the first point. 
132.     The contrast between the suggested terms of share subscription, and price to be paid for the novation of the swaps, as between the Lehman Brothers scheme and the Swiss Re scheme, leads me to conclude that the pricing of the share subscription and novation was chosen deliberately to avoid the capital gain that would otherwise arise on the sale of the shares, and to occasion some chance of generating a loss.   This feature was certainly part of the overall scheme. 
133.     When Dorus entered into the novation, whatever the group accounting position, the Directors of Dorus assumed that Dorus would inherit a Corporation Tax liability of £54 million; they knew that Dorus had no legal entitlement to receive group relief surrenders, let alone group relief surrenders for nil payment; they knew that from the very day of its formation, Dorus had been a party to the Heads of Terms that made it clear that the whole plan was for Dorus to be sold, such that “group relief” was anyway manifestly irrelevant; and so on a stand-alone basis they knew that they were significantly “over-paying” when they paid £180 million for the novation, altogether disregarding the assumed deferred liability of £54 million. 
134.     The Board Minutes of the meeting when Dorus decided to pay £180 million for the novation made no reference to any reasoning as to why no attention was given to the assumption of the deferred tax liability in calculating the price to be paid for the swaps.     This, it seems to me, was because it would have been impossible to have written anything remotely cogent to explain why the assumed deferred tax liability was completely ignored.    Although he was not a Director, Martin Cooper was present at the Board Meeting in question.    Throughout the hearing he repeatedly referred to the sale of the shares of Dorus as being made “at a premium” reflecting the fact that, as he was well aware, the realistic value of Dorus, “special purchasers” apart, was £126 million, i.e. its net after tax value. 
135.     I therefore conclude that there was a scheme to occasion a material reduction in the value of the shares of Dorus, and that that reduction occurred when the £180 million was paid in the novation.  The sale of Dorus in fact commanded a premium price as against the realistic value of Dorus prior to that sale, and I totally reject the suggestion that it was only the sale of the shares that reduced the value of the shares. 
136.     I cannot regard a direction in paragraph 28 that the novation should be disregarded to be remotely consistent with the proposition that the £180 million has “been brought into account in computing Treasury Services’ income, profits or gains for income tax, capital gains or corporation tax purposes”.   When something has been required to be left out of account, it is difficult to conclude that it has been brought into account actually in computing income.    
137.     I also reject the third thread of Treasury Services’ contentions.  The effect of paragraph 1(2) is that the “amounts brought into account in accordance with Schedule 26 [I might add, “if any”] in respect of any matter are the only amounts to be brought into account for the purposes  of corporation tax in respect of that matter”.   “That matter” is plainly the taxation of the company’s derivative transaction, namely the novation.  One is not bringing any derivative contract into charge under other legislation, when the capital gains calculation on the disposal of the shares is adjusted on account of the feature that the capital gain has been distorted, and a realistic gain turned into an unrealistic loss, by the deliberate choice to “over-pay” for the novation. 
138.     My determination is accordingly that section 30 TCGAct would have been in point, on the assumption on which I have approached this question, namely that my determination on the first point is overturned on appeal.  On the basis that my first determination stands, then the section 30 point altogether drops away, for the reasons given in paragraph 122 above.
The fourth issue
139.     The fourth issue is to determine by how much it would be just to reduce the apparent loss made by Treasury Services on the sale of the shares, in the case where section 30 was in point (i.e. where my first determination was wrong and Treasury Services had avoided the tax on its receipt under the novation to Dorus).    It seems to me that on this assumption Treasury Services would still in one respect have “won” the section 30 issue in that on any realistic basis, just as the Lehman Brothers proposal revealed, and just as Martin Cooper effectively conceded when he said that the shares were sold “at a premium”, the realistic result would have been for a gain to be realised on the sale of the shares, because they were sold to the only purchaser that demanded only a half reduction in respect of the deferred tax liability.     All other purchasers would have pitched their pricing, other special circumstances aside, at a figure of around the true net value of Dorus, which was closer to £126 million than £150 million.  Thus the feature that HMRC are only contending that the loss should be entirely eliminated would have been “a partial result” for Treasury Services, on the assumption that section 30 had been in point.  As I indicated in the opening paragraphs, there are only two reasons that I can think of that justify the mere elimination of the loss, as distinct from the conversion of the loss into a capital gain. One is that there was known to be a special purchaser in the wings, ready to pay approximately £150 million.  The other is simply that HMRC are only suggesting that the loss should be entirely eliminated. 
140.      My determination is accordingly that the disposal of the shares of Dorus would have been treated as occasioning neither a gain nor a loss for capital gains purposes, on the assumption that section 30 was in point.  On the basis that my first determination stands, then section 30 will not be in point and Treasury Services will have realised the capital loss on the sale of the shares of Dorus.

HOWARD M. NOWLAN 
TRIBUNAL JUDGE
Released: 12 October 2009