HMRC says another £5.9m is at stake in a follower case, while the other five users of a similar approach to accounting for novations contracts conceded before the legal action began, paying £215m in tax.

The Court of Appeal hearing looked at two separate issues arising from earlier tax litigation in the First Tier Tribunal (FTT) and Upper Tribunal (UT). [The Commissioners for Her Majesty’s Revenue and Customs and Bristol & West plc, [2016] EWCA Civ 397].

These concerned Bristol & West’s  treatment of the corporation tax due on the novation of a portfolio of ‘in the money’ interest-rate swaps to another company in the same group, Bank of Ireland Business Finance Ltd (BIBF) for a premium of £91m on 29 August 2003.

One issue was whether or not there should be a disregard relating to the transaction, while the second issue was a procedural one relating to a closure notice served by HMRC.

The Court of Appeal heard that the date of the novation fell within the accounting period of Bristol &West commencing on 1 April 2003 and in the accounting period of BIBF commencing on 1 September 2002.

Section 83(3) of the Finance Act 2002, schedule 26 to the Act, containing a comprehensive code as regards corporation tax on derivative contracts, took effect in relation to accounting periods beginning on or after 1 October 2002.

The schedule therefore applied to Bristol & West, but not to BIBF, as regards their respective accounting periods in which the novation took place.

Bristol & West sought to argue that this meant the premium of £91m paid to it on the novation would not be entered as a credit in its accounts and would not therefore be subject to charge to corporation tax.

However, BIBF was entitled to enter the novated contracts in its accounts at the cost to it of the premium of £91m, so that it is only any subsequent gain made by it on those contracts which would be chargeable to corporation tax in its hands.

As the Court of Appeal noted: ‘In effect, the premium of £91m would not be brought into account for corporation tax purposes by either company, with a resulting loss of taxation and a corresponding benefit to the companies and the group of which they formed part.

‘While the underlying derivative contracts had been entered into for entirely commercial reasons and there had been no change in the accounting periods of the two companies for the purposes of the novation, Bristol & West accepts that the novation was effected for the purpose of securing a tax advantage.’

HMRC’s case, which was accepted by both the FTT and UT, is that paragraph 28 applies only where paragraph 28(3) can be applied to the accounts of both the transferor and the transferee companies.

This is not the case as regards BIBF because the novation occurred in its accounting period commencing on 1 September 2002 and is not therefore an accounting period to which Schedule 26 applies.

The Court of Appeal has now found in HMRC’s favour on this, and has rejected Bristol and West’s appeal. The court also allowed HMRC’s appeal in relation to the question of the closure notice.

Jim Harra, HMRC’s director general of business tax, said: ‘This was a cynical attempt to exploit a non-existent loophole to avoid paying tax. It has failed.

‘We will continue to investigate and pursue those who try to avoid paying their fair share on behalf of the majority who play by the rules, and pay the tax they owe.’

The Court of Appeal ruling The Commissioners for Her Majesty’s Revenue and Customs and Bristol & West plc, [2016] EWCA Civ 397 is here