SPC00563

CAPITAL GAINS – pre-entry losses – meaning of para 1(6) Sch 7A TCGA 1992 – appeal dismissed

THE SPECIAL COMMISSIONERS

	(1) FIVE OAKS PROPERTIES LIMITED, (2) SPECIALITY SHOPS DEVELOPMENT LIMITED, (3) FIVE OAKS UK LIMITED, (4) FC5 LIMITED, (5) DELANCEY 16000 LIMITED AND (6) MANCHESTER SQUARE ESTATES (LONDON) LIMITED 	Appellants

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S 
	REVENUE AND CUSTOMS	Respondents

			Special Commissioner:	DR JOHN F AVERY JONES CBE

Sitting in public in London on 27 September 2006

Graham Aaronson QC, counsel, instructed by Olswang, for the Appellant

Malcolm Gammie QC and David Ewart QC, counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2006

DECISION

1.	These are appeals by (1) Five Oaks Properties Limited, (2) Speciality Shops Development Limited, (3) Five Oaks UK Limited, (4) FC5 Limited, (5) Delancey 16000 Limited and (6) Manchester Square Estates (London) Limited against notices of amendment issued on 30 January 2006 to their company tax returns for the accounting period ended 31 March 2002.  The Appellant companies were represented by Mr Graham Aaronson QC, and the Revenue was represented by Mr Malcolm Gammie QC and Mr David Ewart QC.
2.	The appeal concerns the interpretation of the pre-entry loss provisions which were enacted to prevent the buying-in of loss companies by companies about to realise a gain.
3.	There was an agreed statement of facts as follows:
The appeals
(1)	These appeals are before the Special Commissioners to determine the correct construction of certain provisions in Schedule 7A to the Taxation of Chargeable Gains Act 1992.
(2)	The case has arisen because the parties have failed to agree as a matter of principle whether capital losses which were incurred by the Appellant companies before they became members of the Tribeca group can be set off against chargeable gains made by another company on disposals made when it and the Appellant companies were members of the Tribeca group, in circumstances where all of the relevant companies had been members of the former Delancey group.
(3)	The Appellant companies filed tax returns for the accounting period 1 April 2001 to 31 March 2002.  Upon receipt, the Inland Revenue (as it then was) instigated an enquiry into those tax returns.  In subsequent correspondence with the Appellant companies’ accountants, the Inland Revenue indicated that the losses could not be used to offset the chargeable gains.
(4)	Following further correspondence, it was accepted by both parties in late 2005 that it would be necessary to litigate the matter.  The matter was initially listed before the General Commissioners, before being transferred to the Special Commissioners in early 2006.
(5)	Amendment Notices in respect of all of the Appellant companies were issued on 30 January 2006.  The appeals against these Amendment Notices, which form the subject of this hearing, were accepted by the Clerk to the Special Commissioners on 17 March 2006.
(6)	The various transfers and acquisitions of companies were carried out for wholly commercial reasons, and it is accepted by the Respondent that the transactions were not pre-planned as part of a tax avoidance scheme.
(7)	The parties have agreed that the Appeals be dealt with at this stage as a point of principle.
History of the group companies
(8)	Conrad Ritblat Group plc acquired Speciality Shops plc to form the Milner Group on 10 November 1997.
(9)	Manchester Square Estates (London) Limited (now known as Manchester Square Estates (London) UK Limited) was a member of the Conrad Ritblat Group plc at the time of that acquisition.  From then until 31 March 2002, it was successively a company within the Milner Group, the Delancey Estates group and then the Tribeca group.
(10)	Speciality Shops Development Limited, Delancey 16000 Limited and FC5 Limited were members of the Speciality Shops plc group when that company was acquired by Conrad Ritblat Group Plc.  From then until 31 March 2002, they were successively companies within the Milner Group, the Delancey Estates group and then the Tribeca group.
(11)	The Milner Group acquired Five Oaks Investments plc on 13 March 1998.
(12)	Five Oaks Properties Limited and Five Oaks UK Limited were subsidiaries of Five Oaks Investments Plc when that company was acquired by the Milner Group.  From then until 31 March 2002, they were successively companies within the Delancey Estates group and then the Tribeca group.
(13)	There were various intra-group movements within the Milner Group involving the Speciality Shops and Five Oaks sub-groups that are not relevant for the purposes of the point of principle that has to be decided.
(14)	Delancey Estates plc acquired the Milner Group on 18 October 1999.
(15)	There were various intra-group movements within the Delancey Estates group involving the Speciality Shops and Five Oaks sub-groups that are not relevant for the purposes of the point of principle that has to be decided.
(16)	Tribeca UK plc acquired the Delancey Estates group on 29 May 2001. The ultimate shareholders in Tribeca UK plc were not the same as the ultimate shareholders in the former Delancey Estates group.
(17)	In the period between 29 May 2001 and 31 March 2002, Aridgrove Ltd realised chargeable gains on the disposal of assets which it had acquired on 31 March 1994.  Aridgrove Ltd was a member of the Conrad Ritblat Group when Conrad Ritblat plc acquired Speciality Shops plc (see para 3(8) above) and from then until 31 March 2002 Aridgrove Ltd was successively a company within the Milner Group, the Delancey Estates group and the Tribeca group.
(18)	Elections were made, under TCGA 1992 section 171A, that the assets in question should be deemed to have been transferred to the Appellant companies prior to being disposed of at a gain.
Relevant losses and chargeable gains
(19)	For the purposes of this hearing, the Appellant companies have prepared a schedule of the relevant losses and chargeable gains.  This schedule is appended for illustrative purposes and the facts within the schedule have not been agreed between the parties.
Schedule of Losses and Chargeable Gains	
								
	CAPITAL LOSSES		GAINS TRANSFERRED
FROM ARIDGROVE LIMITED*	
	Pre Milner Acquisition of Speciality Shops and Five Oaks	Pre Delancey
Acquisition of Milner	Post Delancey
Acquisition of Milner	Total		Total (and Inland Revenue reference)	
Manchester Square Estates (London) Limited	£24,847	£0	£24,649	£49,496		£49,496	(623/48753/30840)	
Delancey 16000 Limited	£0	£0	£20,076	£20,076		£20,076	(623/66410/44395)	
FC5 Ltd	£38,133	£0	£0	£38,133		£38,133	(623/46410/44561)	
Speciality Shops Developments Limited	£296,123	£0	£0	£296,123		£1,728,095	(623/16410/46662)	
Five Oaks Properties Limited	£997,044	£136,503	£0	£1,133,547		£1,258,361	(623/68340/04896)	
Five Oaks UK Ltd	£863,415	£0	£0	£863,415		£1,004,576	(623/10071/61278)	
	__________	__________	__________	__________		__________		
	£2,219,562	£136,503	£44,725	£2,400,790		£4,098,737		
* Gains in excess of the listed pre-entry losses were set off against other allowable losses
4.	Mr Aaronson, for the Appellants, contends:
(1)	The pre-entry loss legislation fails to deal with the present factual situation, which it is common ground, results from commercial transactions not intended to avoid the effect of the legislation.
(2)	By s 170(10) Taxation of Chargeable Gains Act:
“…if at any time the principal company of a group becomes a member of another group, the first group and the other group shall be regarded as the same…”
Accordingly when when Milner Estates plc was acquired by Delancey Estates plc the Appellant companies became members of the Delancey group; and when Delancey was acquired by Tribeca UK plc, the Appellant companies became members of the Tribeca group.
(3)	Paragraph 7 of Schedule 7A provides:
“7—(1) A pre-entry loss that accrued to a company before it became a member of the relevant group shall be deductible from a chargeable gain accruing to that company if the gain is one accruing—
(a) on a disposal made by that company before the date on which it became a member of the relevant group (“the entry date”);
(b) on the disposal of an asset which was held by that company immediately before the entry date; …”
Pre-entry loss is defined by paragraph 1(2):
“(2) In this Schedule “pre-entry loss”, in relation to any company, means—
(a) any allowable loss that accrued to that company at a time before it became a member of the relevant group;…” 
Relevant group is explained in paragraph 1(1):
“1—(1) This Schedule shall have effect, in the case of a company which is or has been a member of a group of companies (“the relevant group”), in relation to any pre-entry losses of that company.”
(4)	It is the interpretation of para 1(6) that is in issue.  This provides:
“(6) Subject to so much of sub-paragraph (6) of paragraph 9 below as requires groups of companies to be treated as separate groups for the purposes of that paragraph, if—
(a) the principal company of a group of companies (“the first group”) has at any time become a member of another group (“the second group”) so that the two groups are treated as the same by virtue of subsection (10) of section 170, and
(b) the second group, together in pursuance of that subsection with the first group, is the relevant group,
then, except where sub-paragraph (7) below applies, the members of the first group shall be treated for the purposes of this Schedule as having become members of the relevant group at that time, and not by virtue of that subsection at the times when they became members of the first group.”
(5)	It is common ground that paragraphs 9(6) and 1(7) do not apply.  The Appellant companies are deemed to have become members of the relevant group on the date when Tribeca acquired Delancey (29 May 2001).  The pre-entry losses of the Appellant companies are therefore the losses incurred before 29 May 2001, which covers all the losses.  By paragraph 7(1)(b) the losses incurred by the Appellant companies are deductible from the gain accruing on assets held by them immediately before that date.  This is extended to assets held by other group companies that became part of the group at the same time by para 7(3):
“(3) Where two or more companies become members of the relevant group at the same time and those companies were all members of the same group of companies immediately before they became members of the relevant group, then, without prejudice to paragraph 9 below—
(a) an asset shall be treated for the purposes of sub-paragraph (1)(b) above as held, immediately before it became a member of the relevant group, by the company to which the pre-entry loss in question accrued if that company is one of those companies and the asset was in fact so held by another of those companies;…”
Accordingly assets held by Aridgrove are treated as held by the Appellant Companies.
(6)	Since (a) the Appellant companies and Aridgrove became members of the Tribeca group at the same time (deemed to be when Tribeca acquired Delancey), and (b) the Appellant companies together with Aridgrove had all been members of the Delancey group of companies immediately before they became members of the Tribeca group, and (c) assets held by Aridgrove are treated as held by the Appellant companies, the result is that the losses incurred by the Appellant companies are deductible against the gains accruing to them on the disposal of the assets to the third party during the period in which they are members of the Tribeca group.
5.	Mr Gammie and Mr Ewart, for the Revenue, contend:
(1)	Whether a loss is a pre-entry loss has to be answered in relation to each loss incurred by a company.
(2)	Paragraph 1(1) identifies the pre-entry loss to which Schedule 7A has effect, rather than identifying the group by reference to which the Schedule applies once it has effect in relation to pre-entry losses: 
“1—(1) This Schedule shall have effect, in the case of a company which is or has been a member of a group of companies (“the relevant group”), in relation to any pre-entry losses of that company.”
(3)	By s 170(10) there is only one group of which the Appellant Companies are or have been members, the Tribeca group.
(4)	Where a first group is acquired by a second group, since there is only one group by virtue of s 170(10), the acquisition of the first group by the second will not affect the date of entry of companies in the first group.  In principle therefore a company joins the Tribeca group when it actually joined the first constituent group to which it belonged.  This is changed where paragraph 1(6) applies, as is confirmed by the final words “and not by virtue of that subsection [s.170(10)] at the times when they became members of the first group.”  
(5)	If companies A and B are members of a group of which the principal company is Z, and Z transfers A and B to X on 1 June 2002, A and B become members of the X group on that date, having previously been members of the Z group.  Their realised losses would become pre-entry losses of the X group on that date whether or not they were pre-entry losses of the Z group.  On the other hand, if A were the principal company of the group consisting of A and B when it is acquired by X, the A/X group is the relevant group for determining whether a loss is a pre-entry loss.  
(6)	Leaving aside paragraph 1(6), if A and B had become members of a group by virtue of A acquiring B on 12 March 2000, A and B would join the relevant (A/X) group on 1 March 2000 and not on 1 June 2002 (when X acquired A).  If paragraph 1(6) applies, it treats A and B as joining the group on 1 June 2002 when X acquires A.  The first condition for para 1(6) to apply is “if (a) the principal company of a group of companies (‘the first group’) has at any time become a member of another group (‘the second group’) so that the two groups are treated as the same by virtue of subsection (10) of section 170.”  This begins by regarding the two groups separately and paragraph (a) is satisfied where s 170(10) treats them as the same group because the principal company of the first group has become a member of the second group (this will not always be the case, see the first example in sub-para (5) above).  The second condition for para 1(6) to apply is “if (b) the second group, together in pursuance of that subsection [s 170(10)] with the first group, is the relevant group.”  If losses are pre-entry losses of the A group [the first group] s 170(10) means that they are pre-entry losses of the X group [the second group] and so paragraph (b) adds nothing.  But where in respect of a particular loss the A group [the first group] is not the relevant group the X group [the second group] will be the relevant group because the merged group is not the relevant group.  Where the A/X group is not the relevant group para (b) does not apply and the date of joining the group is the date of joining the constituent group.
(7)	By way of examples: 
(a) Assume that on 1 February 1999 A (a sole company) sells an asset realising a capital loss.  X acquires A on 1 June 2002.  Section 170(10) does not apply and A will join the X group on 1 June 2002.  The relevant group is the X group.
(b) If A had acquired a subsidiary B on 1 March 2000 which owns assets with unrealised gains, the relevant group is the A group.  A’s losses are pre-entry losses in relation to the A group because A became a member of the A group on 1 March 2000.  When on 1 June 2002 X acquires A the A/X group is the relevant group because the A group is already the relevant group in relation to that loss.  Paragraph 1(6)(b) is not satisfied because the X group is not the relevant group in relation to A’s loss, but there is no need for it to disapply the general rule that A became a member of the A/X group when it acquired B, because A’s loss is already a pre-entry loss in relation to the A/X group. 
(c) Assume instead that A and B have always been grouped.  A’s loss realised on 1 February 1999 is not a pre-entry loss in relation to the A group.  When the X group [the second group] acquires the A group [the first group], s 170(10) treats them as the same group (the A/X group).  If paragraph 1(6) were not there, the loss would not be a pre-entry loss of the A/X group because the A/X group is the same group as the A group and A’s loss did not accrue to it before it became a member of the A group, with the result that the use of the loss within the A/X group would be unrestricted.  Para 1(6) applies to prevent this result.  The X group [the second group] (together with the A group) is the relevant group in relation to A’s loss because A’s loss is a pre-entry loss in relation to the X group [the second group] even though it was not in relation to the A/X group.  The condition in para 1(6)(b) is met: A and B are deemed to join the X group in relation to those losses on 1 June 2002.  By para 7(3) A’s loss can be used against B’s gains because they became members of the relevant group (the A/X group) at the same time and A and B were members of the same group of companies immediately before they became members of the relevant group.  But the X group companies cannot use A’s loss because the X group companies will have become members of the A/X group companies at different times and were not grouped with A prior to 1 June 2002.
(8)	The function of para 1(6) is to determine whether there is a pre-entry loss by reference to a relevant group.  It updates the time of entry of the first group companies to the relevant group to the extent that losses are not pre-entry losses of the first group but are pre-entry losses of the second group.  Without para 1(6), s 170(10) would mean that such losses would not become pre-entry losses on the merger with the result that the Schedule would not have effect in relation to them.  The deeming goes no further than that; it does not affect the operation of s 170(10) to regard the A and X groups as the same group.
Reasons for the decision
6.	I heard this case on a Wednesday having previously read the lengthy skeletons (Mr Gammie’s and Mr Ewart’s runs to 25 pages) in advance and I thought at the end of the hearing that while the draftsman was supposed to have said the interpretation for which Mr Gammie and Mr Ewart contended, what he actually said was the interpretation for which Mr Aaronson contended.  I then wrote a draft decision in Mr Aaronson’s favour.  But having thought about it for a further three days, by the end of Saturday it finally dawned on me what the draftsman was trying to say.  I believe that the answer to the problem can be deduced by putting oneself in the shoes of the draftsman.  The fundamental definition on which the whole Schedule is based is that “‘pre-entry loss’ in relation to any company means—(a) any allowable loss that accrued to that company at a time before it became a member of the relevant group…”.  A unwelcome constraint that had already been imposed by the legislation before he started was s 170(10):
“For the purposes of this section and sections 171 to 181…if at any time the principal company of a group becomes a member of another group, the first group and the other group shall be regarded as the same, and the question whether or not a company has ceased to be a member of a group shall de determined accordingly.”
7.	The draftsman clearly had to make a distinction between: 
situation 1: a company realises a loss; joins the first group; the first group joins second group, and
situation 2: a company joins the first group; realises a loss; the first group joins second group.
Situation 1 presents no problem.  In the deemed world of s 170(10) it is a case of a loss accruing before the company becomes a member of the deemed group, for which the definition of pre-entry loss fits perfectly.  Situation 2 is not merely a problem; it is impossible to draft because becoming a member of the second group is not an event recognised as existing in the deemed world of s 170(10), and so one cannot attribute a time to its happening in order to determine whether a loss accrued before it.  The draftsman might have been tempted to cancel the effect of s 170(10) but obviously one cannot dispense with part of the definition of what is a group when the question is when a company joined a group.  The draftsman therefore had to deal with situation 2 while working within the constraints of the deemed world of s 170(10).
8.	He might have written something like this:
Condition (a): if the principal company of a group of companies (“the first group”) has at any time become a member of another group (“the second group”) so that the two groups are treated as the same (“the deemed group”) by virtue of subsection (10) of section 170
Condition (b): if a loss accrues to a company which is a member of the first group before it becomes a member of the second group 
Legal action: the members of the first group shall be treated for the purposes of this Schedule as having become members of the deemed group at that time, and not in consequence of the deeming at the times when they became members of the first group.
He then had to redraft condition 2 in terms of his definition of pre-entry loss, and so he might have written:
Condition (b): if the second group is the relevant group
But that does not work because the second group does not exist as a group in the deemed world of s 170(10) so as to be capable of being a relevant group, so he had to write something like:
Condition (b): if the second group, which together with the first group comprises the deemed group, is the relevant group
9.	He then might have polished up the drafting and his final version was what we see in the legislation:
 “…if—
(a) the principal company of a group of companies (“the first group”) has at any time become a member of another group (“the second group”) so that the two groups are treated as the same by virtue of subsection (10) of section 170, and
(b) the second group, together in pursuance of that subsection with the first group, is the relevant group,
then the members of the first group shall be treated for the purposes of this Schedule as having become members of the relevant group at that time, and not by virtue of that subsection at the times when they became members of the first group.”
10.	I consider that reading sub-para (b) in this way explains why the obscure wording was adopted by the draftsman.  It is the best that can be done given the constraints of s 170(10) to express that the loss accrued before the company became a member of the second group.  Therefore in my view Mr Gammie’s and Mr Ewart’s interpretation is to be preferred.  Unfortunately if one spends less than three days thinking about it and does not put oneself in the position of the draftsman, Mr Aaronson’s contention seems entirely reasonable, that it looks as if the draftsman has said the opposite, on the lines of:
(b) the deemed group comprising the second and first groups, is the relevant group,
But this makes no sense.  If a loss accrues before becoming a member of the deemed group (ie what I have called situation 1) there is no need to treat the company as having joined the deemed group at the time of the merger of the constituent groups because the legislation works perfectly well on the basis that the loss accrued before the company joined the deemed group.  The purpose of the provision deeming the company to have become a member of the relevant group at the time of the merger of the groups must be in order to deal with a loss accruing before that time.
11.	I therefore decide in favour of Mr Gammie’s and Mr Ewart’s interpretation, and I agree that the consequence is as set out in paragraph 5(7)(c) above in relation to each of the mergers of the groups that has taken place, so that the losses are not available against the gain made by Aridgrove.   Accordingly I dismiss the appeal in principle.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 9 October 2006

SC 3053/2006