Unfortunate Consequence

A loan did not come within the exception in section 419, Taxes Act 1988, ruled the Court of Appeal in Brennan v Deanby Investment Co Ltd.

A close company made eight loans at a commercial rate of interest to an associate of a participator in the company. The company claimed that the loans were made in the course of its investment business, i.e. lending money, and were exempt from liability to corporation tax under section 419(1), Taxes Act 1988. The Revenue disagreed, saying that the loans were to the chairman of the company, and were not made in the course of the company's business activities. The Court of Appeal (Northern Ireland) held that the loans were not within the exclusion for loans in the course of an investment business.

Background

Deanby Investment Co Ltd was an investment company. Between 1983 and September 1997, the company made eight loans at a commercial rate of interest to John McCaughey, an associate of a participator in the company. The final loan was made in September 1997, and amounted to £30,000. The accounting period including September 1997, showed two other loans to two related close companies and a £5,000 loan to an unrelated company of which Mr McCaughey was chairman.

The Inspector issued an assessment on Deanby Investment Co under section 419, Taxes Act 1988, on the basis that the September loan had been made to an associate of a participator. The company appealed, saying that the loan had been made in the ordinary course of its investment business which included the lending of money, and therefore came within the exception in section 419(1).

The Special Commissioner allowed the appeal, so the Revenue appealed.

(Ronald Weatherup QC and Paul Maguire for the Revenue; the taxpayer was not represented; Nicolas Hanna QC as amicus curiae.)

Judgment in the Court of Appeal (Northern Ireland)

Lord Chief Justice Carswell began his judgment by saying that the struggle against tax avoidance often gave rise to 'unintended consequences'. Parliament would enact a provision aimed at a particular type of tax avoidance which, although successful, would also catch other persons who had no intention of avoiding tax. He said that the instant case was an example of this: the company clearly was not intending to gain a tax advantage through its actions, but if the legislation had to be construed as the Inland Revenue argued, then the company would inevitably be caught.

Earlier tax cases concerning similar situations could not be relied upon as a guide, the judge said, because of different wording and different policy objectives. It was therefore necessary to focus on the wording of section 419. He said that the idea behind Chapter II of Part XI of the Taxes Act 1988 was to prevent tax avoidance whereby companies made loans to participators which, if not repaid, would constitute distributions. The exception in section 419(1) aimed to exempt loans made to participators by companies all or part of whose business consisted of moneylending.

However, the judge said that the Special Commissioner had given this section too broad a meaning. The phrase in section 419(1) 'a business carried on by it which includes the lending of money' meant as a regular practice. The making of eight loans over 14 years to one associate of a participator, did not amount to regular business practice. If it did, a company would be able to make a series of loans to its participators and their associates, and say that the lending of money was the business carried on by the company. The judge did not believe that this was the intention of the legislature.

The Special Commissioner was entitled to rule that the loans to Mr McCaughey were made as investments, but he had erred in law in finding that this led to the business of the company being moneylending. What the Commissioner should have considered was what more was required to bring the transactions within section 419(1), and whether the making of loans was sufficient.

The judge said that it was not a reasonable conclusion for the Special Commissioner to have reached that the case was excepted. While the legislation was not intended to catch such cases as this, in order to make the law effective, it had to be widely expressed, and so would inevitably catch some innocent transactions.

The transactions carried out by Deanby Investments Co were not within section 419(1), even though Mr McCaughey had not sought or obtained a tax advantage.

The appeal was allowed.

Decision for the Revenue

(Reported at [2001] STC 536.)

Issue: 3834 / Categories: