QCBs and the Limits of Purposive Interpretation

The Court of Appeal has unanimously held that terms which convert the currency of bonds from sterling to the Euro (and which also allowed the bonds to be repaid in Euros) following an adoption by the UK of the Euro did not preclude the bonds from constituting “qualifying corporate bonds” (“QCBs”).  While at first glance the relevance of the facts in this case is somewhat limited, the decision will be of interest to taxpayers relying on a similar Euro-based clause for their own tax planning purposes.  More generally, the approach taken by the court in relation to purposive interpretation in the absence of a tax avoidance scheme may well be of interest.

For capital gains tax purposes, a QCB is a security: (i) the debt on which represents (and at all times has represented) a normal commercial loan; (ii) that is expressed in sterling; and (iii) for which no provision is made for conversion into, or redemption in, any currency other than sterling (other than a redemption provision at the exchange rate prevailing at redemption). (my emphasis)

A QCB is an exempt asset the disposal of which does not give rise to capital gains tax arises on its disposal.  The exemption does not apply to the disposals of bonds which are not QCBs (“non-QCBs”).  Special rules apply where non-QCBs are converted into QCBs – click here for further details in this regard.

Along with other members of an investment partnership, the taxpayer acquired sterling-denominated bonds at what was perceived to be an undervalue.  The bonds were sold at a profit, and no capital gains tax was paid on the gains on the basis that the bonds were QCBs.  HMRC disagreed with the analysis because the terms of the bonds included currency provisions to deal with the risks of monetary union: very broadly, if, following the issue of the bonds, the UK were to change its currency to the Euro, the currency of the bonds would also be converted at (and/or the notes would be redenominated according to) the official exchange rate.

HMRC’s position was that these provisions meant that the bonds could not constitute QCBs and therefore the taxpayer should have paid capital gains tax on disposal.  As described above, although provision for a redemption into another currency at the prevailing exchange rate does not preclude QCB status, that is not true in the case of a conversion.

The Court of Appeal held that the terms did not prevent the bonds from being QCBs. Their reasoning seems to follow the taxpayer’s main argument that the terms only become effective once the necessary legislative changes had occurred such that the Euro had become the UK’s lawful currency.  Rather than provide a conversion mechanism, therefore, the terms simply dealt with the administrative consequences of the changes in law.

Interestingly, the Court agreed with HMRC that a purposive construction of the legislation (as used in cases involving a “tax avoidance scheme”, such as UBS AG v HMRC [2016] UKSC 13) was not applicable here.  According to Lord Justice Patten:

The general presumption or approach is that the legislation is intended to deal with real (in the sense of ordinary) commercial transactions and not those put together solely for the purpose of obtaining the relevant fiscal advantage.  Using that as a yardstick, it is much easier to construe the legislation in general terms as being inapplicable to scheme-based transactions.

Ref: Nicholas Trigg (A partner in Tonnant LLP) v The Commissioners for Her Majesty’s Revenue and Customs [2018] EWCA 17 Civ