SPC00608
Capital Gains Tax - qualifying corporate bonds (QCBs) - shares exchanged for loan notes with foreign currency redemption option - section 135 TCGA applying to exchange - loan notes not QCBs on exchange - forex option lapsing - whether lapse was conversion within s132 TCGA or transaction within s116 TCGA - held no - loan note later redeemed - whether loan notes were QCBs on redemption within s117 TCGA - held no.

THE SPECIAL COMMISSIONERS

	NICHOLAS JOHN HARDING	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioner: 	CHARLES HELLIER

Sitting in public in London on 5 and 6 December 2006

David Southern of Counsel instructed by Deloitte & Touche LLP for the Appellant

Michael Gibbon of Counsel instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Introduction
1.	This appeal concerns the proper construction and application of the definition of qualifying corporate bond (QCB) in section 117 TCGA.
2.	The Appellant contends that his loan notes were not QCBs when they were issued to him but were QCBs when he disposed of them. He says that this change occurred because a right in the terms of the loan notes to opt to redeem them in a foreign currency lapsed. If he is right then a gain which was rolled over into the loan notes when he acquired them escapes taxation.
Facts
3.	There was no dispute about the relevant facts. I had before me a bundle of copy documents and heard oral evidence from Mr Harding. One of the crucial documents was made under German law. I had written evidence from Dr Sybille Steiner, a German lawyer, to which I shall refer later. 
4.	On the basis of this evidence I find the following facts:
(1)	Between 1983 and 1994 Mr Harding participated in the development of a successful software business. That business was by 1990 carried on through a holding company Quartet PLC and its wholly owned operating company, Frontline Distribution Ltd (among other entities).
(2)	In 1990 computer 2000 AG, a German company with similar business interests entered into an agreement (the Subscription Agreement) with Quartet, Frontline, Mr Harding, John Weatherhead and Terrance Watson under which it subscribed for new shares in Frontline, acquired some of Quartet’s shares in Frontline, and entered into put and call options in relation to the other shares in Frontline held by Quartet. The agreement was amended in 1990 and in 1992.
(3)	John Weatherhead and Terrance Watson were colleagues of Mr Harding who had been involved in the development of the business and were shareholders in Quartet.
(4)	On 22 July 1992 Mr Harding, Mr Weatherhead and Mark Mulford (the ‘three directors’) acquired the shares in Frontline then held by Quartet. Under a deed of adherence the three of them effectively took the place of Quartet under the provisions of the amended Subscription Agreement.
(5)	As a result of the Subscription Agreement, its 1990 amendment and the Deed of Adherence, the three directors became subject to the right of Corporation 2000 AG to call for, and took the benefit of a right to require, the sale to it of their shares in Frontline. The consideration for the transfer of shares under the option was ordinary shares in Computer 2000 AG, or at its election, loan notes of face value equal to an agreed amount or 50% loan notes, 50% shares. The loan notes were to be in the “agreed forms” i.e. in a form agreed between the parties and signed for the purpose of identification (Clause 1.1 and 1.10 of the Subscription Agreement). No agreed form document dating from the time of the Subscription Agreement was available in the documents before me. But I was told by Mr Harding and accept that a draft loan note was annexed but that it did not provide for a currency conversion option (and was intended to be applicable in relation to other provisions of the agreement which provided for the issue of loan notes in other circumstances).
(6)	In late 1994 there were discussions with Computer 2000 AG’s lawyers about the form of the loan notes which would be issued on an exercise of the options. Frere Cholmeley Bischoff wrote to those lawyers on 28 November 1994 enclosing a draft loan note which included a new clause 4.7 which contained a right for the holder of the note to opt for redemption in Canadian dollars, US dollars or German deutschmarks.
(7)	In December 1994 Mr Harding disposed of some of his shares to related parties, and was left with 33,120 shares in Frontline.
(8)	On 7 December 1994 Arthur Anderson wrote to the Revenue on behalf of Frontline and the shareholders in Frontline for clearance under section 138 TCGA that the provisions of section 137 TCGA should not apply in relation to the exchange of the Frontline shares for loan notes pursuant to the exercise by the shareholders of their options. This letter indicated that the loan notes would be denominated in Sterling but have options for redemption in other currencies at a holder’s election. It expressed the view that the loan notes did not constitute QCBs.
(9)	Mr Harding and the others exercised their options under the Subscription Agreement to require Computer 2000 AG to acquire the Frontline shares on 13 January 1995, and Computer 2000 AG issued loan notes in payment.
(10)	At this time Mr Weatherhead was living and working in Canada, and Mr Mulford was living in Holland. After the issue of the loan notes Mr Weatherhead elected pursuant to the terms of the loan notes for redemption in Canadian Dollars and Mr Mulford for redemption in deutschmarks. Mr Harding made no elections.
(11)	The three directors gave notice to redeem their loan notes on the earliest date permitted under their terms. The redemption date was 1 July 1995. On that date Mr Harding received £1,925,718 from Computer 2000 AG as the redemption proceeds. Mr Weatherhead and Mr Mulford received Canadian dollars and deutschmarks respectively.
(12)	The Appellant was assessed to capital gains tax for the year ended 5 April 1996 in respect of a gain computed on the basis that the loan notes were not QCBs on redemption.
5.	The loan notes issued to Mr Harding on 13 January 1995 provided for redemption on the fifth anniversary of their issue or if earlier, and if a redemption notice was given between 1 and 21 January in any year, on the 1 July following the giving of the notice. As noted above, redemption notices were given shortly after issue and the notes therefore became redeemable on 1 July 1995 just under 6 months after their issue.
6.	The notes bore interest payable quarterly in arrears at a rate which for present purposes I can call LIBOR. The notes were assignable to a limited class of assignees without consent of the issuer and otherwise with such consent (condition 8). There was a provision preventing repayment if the holder had not repaid a loan from Frontline or been released from repayment (condition 5.10).
7.	Condition 13 of the conditions of notes provided that “This Note shall be governed by, and construed in accordance with the laws of Germany”.
8.	Condition 4.7 of the conditions of the notes provided the option referred to in paragraph 4(7) above under which the holder could elect, within 10 days after giving a redemption notice, for the note to be redeemed in US dollars, Canadian dollars or German Deutschmarks.  Later on in this decision I refer to this clause as the “forex option”. I should set it out in full:
“4.7 The holder may be notice in writing to the company given no more than 10 days after a Redemption Notice given in accordance with Condition 4.1 elect that the Note should be redeemed on the Redemption Date in US dollars, Canadian dollars or German deutschmarks at the Holders option (“the Relevant Currency”) in which event the Company shall, in substitution for the payment referred to in Condition 4.6, pay into the account specified in the written notice an amount in the Relevant Currency (“the Relevant Currency Redemption Amount”) obtained by converting the Principal Amount of the Note into Relevant Currency at the closing mid point for £ sterling against the Relevant Currency as derived from the WM/Reuter Closing Spot Rate (“Spot Rate”) on the 30th day prior to the Redemption date (or, if that day is not a Business Day, on the next following Business Day) PROVIDED ALWAYS THAT:
(a) 	if the Relevant Currency Redemption Amount exceeds an amount in Relevant Currency obtained by converting 100% of the Principal Amount or the Note into Relevant Currency at the Spot Rate on the business day immediately prior to the Redemption Date, that lesser amount shall be substituted therefore; and
(b)	if the Relevant Currency Redemption Amount is less than the amount in Relevant Currency obtained by converting 98% of the Principal Amount of the Note into Relevant Currency at the Spot Rate on the business day immediately prior to the Redemption Date, that greater amount shall be substituted therefore.
In the event that the Holders fail to notify the Company in accordance with the provisions of this Condition 4.7, that payment should be made in a currency other than Sterling, this Condition 4.7 shall lapse and cease to have any effect.”
9.	The effect of the election was thus  that if it was exercised, the noteholder received a non-sterling amount whose value in sterling on the redemption date lay between 98% and 100% of the sterling amount which would have been payable had the option not been exercised. (see paragraph 21 below).
10.	By agreement between the parties and pursuant to a direction made at the hearing I received, after the hearing, expert evidence from Dr Sybille Steiner as to the effect under German law of the terms of the notes. From that evidence I find as follows:
(1)	the notes were enforceable against the issuer in accordance with their terms;
(2)	after 23 January 1995 Mr Harding could not, under the terms of the obligations created by the notes, have compelled the issuer to pay redemption proceeds in any currency other sterling;
(3)	after 23 January 1995 condition 4.7 would have had no continued effect on the enforceable rights or obligations of any party under the notes; and
(4)	if the last sentence of condition 4.7 - the express provision for the lapse of the condition - were omitted from condition 4.7, that condition would, after 23 January 1995 have had no continued effect on the enforceable rights or obligations of any party under the notes.
The Legislation
11.	I shall set out the relevant provisions later, but at this stage I want to explain their effect generally and in the circumstances of this appeal.
12.	Where there is a reorganisation of a company’s share capital, and as a result the shares previously held by a taxpayer become reorganised into other shares and possibly debentures, the result could be that the shareholder would be treated as disposing of his original shares, and a taxable capital gain or allowable loss could arise. Section 127 TCGA avoids this result by deeming there to be no disposal and treating the new shares or debentures as acquired as and when the original shares were acquired. Thus in computing the gain or loss on the later disposal of those new shares or debentures the calculation is performed by reference to the original cost of the original shares and any gain or loss latent but unrealised at the time of the reorganisation is effectively rolled forward into the computation of the later gain or loss.
13.	Section 132 TCGA applies the section 127 treatment to a conversion of securities. So, for example, on the conversion of convertible bonds into the shares of the issuing company, there is deemed to be no disposal of the bonds and the shares acquired on conversion will be treated as having the acquisition cost of the convertible bonds for the purpose of calculating any gain or loss on the later disposal of those shares.
14.	Section 135 TCGA extends this section 127 treatment to shares and debentures acquired in takeovers and like transactions: where company A issues shares or debentures to the shareholders of company B in return for their shares or debentures in company B and the exchange is (very broadly)part of a takeover, the shares and debentures in company B will be treated as having the same acquisition cost as the shares and debentures originally held in company A. (This treatment however is subject to an anti-avoidance condition in section 137 to which I shall refer later.)
15.	All this works very well when the only instruments relinquished and received are shares. But when debentures are involved complexities arise. That is because some debentures may be QCBs, and gains and losses on QCBs are by section 115 TCGA outside the CGT regime. As a result, without further statutory provision, if a share was exchanged for a QCB in circumstances where the section 127 treatment applied, then, although the QCB would be treated as acquired as the share was acquired, the latent gain or loss in the share at the time of the reorganisation or exchange would not be brought into the CGT regime because it would be exempted by section 115.
16.	Section 116 contains provisions to address this problem (and also the converse circumstance where a QCB is exchanged for a share). Where a share is reorganised into, converted into, or exchanged for a QCB it provides that:
(i)	you calculate the gain or loss which would have arisen had the share been sold at that time for market value;
(ii)	you freeze that gain or loss; and
(iii)	when the QCB is disposed of then, although any gain  or loss from fluctuations in value of the QCB itself remains exempt, the frozen gain or loss comes into charge to CGT.
17.	Now, had Mr Harding sold his shares on 13 January1995 for market value a substantial gain would have arisen. Therefore if Mr Harding’s loan notes were to be treated as QCBs for the purpose of section 116, then a frozen gain would have become taxable on their redemption. But if they are not to be treated as QCBs for the purposes of section 116 then at the time of exchange no gain became frozen but the section 127 treatment would have applied so that any subsequent gain or loss would be calculated by reference to the (relatively modest) acquisition cost of the shares; but if, at some time following the exchange and before their redemption the loan notes became QCBs so that they are treated as QCBs in relation to their disposal, then the latent gain escapes taxation. This is the result which in essence Mr Southern submits is the inevitable consequence of the legislation.
18.	Put more specifically, Mr Southern says:
(i)	at the time of the exchange of the shares for the loan notes, the loan notes were not QCBs and, since section 116 has effect only by reference to their status at that time, no frozen gain falls to be computed or brought into charge on their disposal;
(ii)	at the time of their disposal the loan notes were QCBs: the determination as to whether or not they were QCBs for the purposes of section 115 falls to be made at the time of disposal and at that time the forex option had lapsed and as a result the loan notes were QCBs within section 117; and
(iii)	there was no event between the acquisition of the loan notes and their redemption which gave rise to a disposal on which the latent gain would have become chargeable; in particular there was no conversion of the loan notes into QCBs which gave rise to a frozen gain taxable on their redemption.
As a result no chargeable gain arises on the redemption of the loan notes.
19.	Crucial to the first two of these propositions are: (a) that the question as to whether a security is or is not a QCB falls to be determined separately at the time of the exchange to which section 116 applies and again at the time of disposal; and (b) that the loan notes so changed their nature between those times that they were not QCBs  at exchange but were at disposal. Crucial to the third proposition is that that change in nature was not a conversion within section 132.
20.	In the remainder of this decision I shall deal these issues in reverse order: first with the conversion issue (because of the arguments in relation to the other issues which arose from later statutory amendments to this provision), then point (a) (When should the test be conducted?) and finally with point (b) above (Were the loan notes QCBs on disposal?).
21.	It was common ground before me that the loan notes were not QCBs at the time of their issue; in other words both sides accepted that the limited effect of the forex options (see paragraph 9 above) was sufficient at that time (taking that to be the relevant time) to constitute a provision for the redemption of the bond in a currency other than sterling (see also paragraph 63 below).
The Conversion Issue
22.	Section 132 TCGA as it applied prior to 1997 provided that:
“(1) Sections 127 to 131 shall apply with any necessary adaptations in relation to the conversion of securities as they apply in relation to a reorganisation (that is to say, a reorganisation or reduction of a company's share capital).
  (2) This section has effect subject to sections 133 and 134.

  (3) For the purposes of this section and section 133— 

 "(a) conversion of securities" includes— 
 (i) a conversion of securities of a company into shares in the company, and

 (ii) a conversion at the option of the holder of the securities converted as an alternative to the redemption of those securities for cash, and

 (iii) any exchange of securities effected in pursuance of any enactment (including an enactment passed after this Act) which provides for the compulsory acquisition of any shares or securities and the issue of securities or other securities instead,

(b) "security" includes any loan stock or similar security whether of the Government of the United Kingdom or of any other government, or of any public or local authority in the United Kingdom or elsewhere, or of any company, and whether secured or unsecured.”

23.	Section 116 provides for what I have called the frozen gain treatment. Subsection (1) and (2) as they applied prior to 1997 set out the circumstances in which section 116 applied:
“(1) This section shall have effect in any case where a transaction occurs of such a description that, apart from the provisions of this section— 
 (a) sections 127 to 130 would apply by virtue of any provision of Chapter II of this Part; and
 (b) either the original shares would consist of or include a qualifying corporate bond and the new holding would not, or the original shares would not and the new holding would consist of or include such a bond;
and in paragraph (b) above "the original shares" and "the new holding" have the same meaning as they have for the purposes of sections 127 to 130.

(2) In this section "relevant transaction" means a reorganisation, conversion of securities or other transaction such as is mentioned in subsection (1) above, and, in addition to its application where the transaction takes place after the coming into force of this section, subsection (10) below applies where the relevant transaction took place before the coming into force of this section so far as may be necessary to enable any gain or loss deferred under paragraph 10 of Schedule 13 to the Finance Act 1984 to be taken into account on a subsequent disposal.
24.	Subsection (4) defines, in the context of this appeal, the shares exchanged for the loan notes to be the “old asset” and the loan note to be the “new asset”. The remaining relevant provisions of the section are these:
“(5) So far as the relevant transaction relates to the old asset and the new asset, sections 127 to 130 shall not apply in relation to it.
(6) In accordance with subsection (5) above, the new asset shall not be treated as having been acquired on any date other than the date of the relevant transaction or, subject to subsections (7) and (8) below, for any consideration other than the market value of the old asset as determined immediately before that transaction…
(9) In any case where the old asset consists of a qualifying corporate bond, then, so far as it relates to the old asset and the new asset, the relevant transaction shall be treated for the purposes of this Act as a disposal of the old asset and an acquisition of the new asset.
(10) Except in a case falling within subsection (9) above, so far as it relates to the old asset and the new asset, the relevant transaction shall be treated for the purposes of this Act as not involving any disposal of the old asset but— 
 (a) there shall be calculated the chargeable gain or allowable loss that would have accrued if, at the time of the relevant transaction, the old asset had been disposed of for a consideration equal to its market value immediately before that transaction; and
 (b) subject to subsections (12) to (14) below [which have no relevance in the context of this appeal], the whole or a corresponding part of the chargeable gain or allowable loss mentioned in paragraph (a) above shall be deemed to accrue on a subsequent disposal of the whole or part of the new asset (in addition to any gain or loss that actually accrues on that disposal); and
 (c) on that subsequent disposal, section 115 shall have effect only in relation to any gain or loss that actually accrues and not in relation to any gain or loss which is deemed to accrue by virtue of paragraph (b) above.”
25.	It will be seen that if the change in status of the loan notes caused by the lapse of the forex option was a “transaction” which was such that sections 127 to 130 would “apply” then section 116 would have applied to it. If the transaction was a “relevant transaction” then section 116(5) and (iv) would apply. That would have had the effect that, if the loan notes changed from non-QCBs to QCBs, a frozen gain would be computed at that time and would have been taxable on their redemption.
26.	The Respondents put up little fight on these provisions. Whilst Mr Gibbon said that they contended that it was arguable that the lapse of the forex option constituted a conversion he did not assert that it was a transaction or that, if it was, section 132 could be said to apply. It seems to me that this is right: a “transaction” is something done between two or more parties, and whilst the exercise of the forex option might be said to be a transaction, its lapse could not. Nor does it seem to me that the use of “transaction” in section 116 is such that it must necessarily be taken to include anything which is a conversion within section 132.
27.	In the 1998 Finance Act amendments to sections 132 and 116 were introduced. The amendment to section 132 added words to subsection (3) so that it read (with the added words emboldened):
“(3) For the purposes of this section:
(a) conversion of securities includes any of the following whether effected by a transaction or occurring in consequence of the operation of the terms of any security or of any debenture which is not a security, that is to say -:
(i)  a conversion of securities of a company into shares in the company, and
(ia) a conversion of a security which is not a qualifying corporate bond into a security at the same company which is such a bond, and
(ib) a conversion of a qualifying corporate bond into a security of the same company which is not such a bond, and
(ii)…”
28.	And section 116(2) was amended by inserting the words:
“references to a transaction include references to any conversion of securities (whether or not effected by a transaction) within the meaning of section 132….”
29.	The effect of those amendments was thus that if, for example, the lapse of a forex option in a loan note caused it to change from being a non-QCB to a QCB, then that change was a conversion to which section 132  was expressly stated to apply, that that conversion was a “transaction” and therefore a “relevant transaction” on which section 116 could bite, and that as a result of section 116(10) the change would not be a disposal, and a frozen gain (or loss) would be calculated which could fall into tax on the disposal of the notes (such a disposal would include their redemption).
30.	Furthermore, whereas with the unamended sections there may have been some concern that section 132 could only be said to “apply” if it had substantive effect to prevent a disposal which would otherwise give rise to a gain or loss from being recognised - and the lapse of a forex right would probably not have been such a disposal - it seems to me that, given the express incorporation into section 132 of a change from non-QCB into QCB, the proper construction of the provisions after amendment is to treat such a change as being a transaction for the purposes of section 116.
31.	As a result I suspect that, had the forex option lapsed after these amendments had come into force, this appeal would not have arisen because the gain would have fallen into tax either under the frozen gain provisions or under the argument advanced by the Respondents in this appeal. But there are a couple of points to make in relation to the amendments.
32.	First, Mr Southern says that it is implicit in these amendments that a security can change its fiscal status during its term and in particular can change from a QCB into a non-QCB and vice versa. 
33.	Second, he says that the accrual of a frozen gain could not happen by a side-wind: it had to be specifically provided for by new legislation. Before the entry into force of this new legislation (on 25 November 1996) there was no statutory mechanism: there was no charging provision apt to achieve the result for which HMRC contend.
34.	Mr Gibbon says that the new legislation is not relevant. He says that the questions before me relate to the legislation before these changes. Effectively he says that the issue before me is whether these changes were strictly necessary (echoing Lord Walker in Trennery v West [2005] STC 214 at [243]).
35.	I shall return to these issues below.
When should the test be conducted?
36.	Mr Southern referred me to HSBC Life (UK) v Stubbs [2002] STC (SCB) 9 where at paragraph 54 the Special Commissioners apply the definition of loan relationship in section 81 FA 96 in such a way that it is apparent that they regarded the particular obligation at issue in that case as becoming a loan relationship or ceasing to be one depending upon the exercise of certain options during the life of the obligation. The fiscal nature of the obligations was recognised as being changeable.
37.	He gives the example of conversion rights being injected into a bond which previously was a normal commercial loan. After the injection it could not be said that the bond was a QCB. It would have changed its fiscal nature. It would not be appropriate to treat it as a QCB on a later disposal: the test had to be conducted at the time of disposal. On a disposal before the injection it would be a QCB; on a disposal afterwards it would not be.
38.	In their skeleton argument the Respondents say that there is a discernable scheme in s116 and the related sections that on an exchange of shares for debentures the loan notes should qualify for only one or the other (QCB or non-QCB) of the possible treatments in section 116. They say that that intention is only effective they if the status of the loan notes under section 117(1) is fixed at the time of exchange and is retained until there is a disposal of the loan notes. Moreover they say that this provides certainty for the taxpayer and, the Revenue and where the loan notes are QCBs allow calculation at the time of exchange of the taxable gain or allowable loss which will in due course accrue. It would be both uncertain and unsatisfactory to the taxpayer and Revenue alike if it was not clear at the date of exchange whether or not the new holding consisted of QCBs.
39.	Mr Gibbon says that a test which applies at issue only serves the purpose of the exemption by giving those purchasing bonds alongside gilts in the market certainty that they will (if they are QCBs) be treated the same way as gilts for tax purposes.
40.	So far as the examples given by Mr Southern went, Mr Gibbon did not dispute that an obligation could become a loan relationship (as in Stubbs), or that by virtue of section 117(7) a debenture which was not thitherto a QCB could become one.
Discussion
41.	There are a number of possibilities. The test in section 117 could be applied (i) only at the time of issue of the security, (ii) only at the time of redemption of the security, (iii) in relation to a taxpayer holding the security only on acquisition, (iv) in relation to a taxpayer only on his disposal; or (v) at any time when an event occurs by reference to which a tax charge may arise or be computed.
42.	An investor in a security will want to know when he acquires it whether any gain or loss on its eventual disposal will be exempt. Such certainty would be afforded if the test were conducted only on acquisition. But it seems to me that the cases where there is a possible change in the nature of security such that it would, if the test were performed at the time of disposal give a different result from that which results from performing it at the time of acquisition, are so few and so rare that such certainty for the investor should not weigh heavily against the possibility that the test should be performed at the time of disposal or at any other relevant time if that is the natural reading of the statutory provisions.
43.	The examples of: (i) securities, which by acquiring (by gift of the issuer or otherwise) conversion rights attaching to the debt become instruments on which equity style gains and losses can arise and so which should not be QCBs, (ii) securities which become QCBs by operation of section 117(7), and (iii) (although not strictly relevant in this context) securities which are not QCBs in the hands of an original individual owner but are required in the hands of a corporation tax paying investor to be treated as QCBs by what is now section 117(1A) because they are loan relationships of a company, also all suggest that a test which is to be applied only on issue is not the one intended by the legislature.
44.	Reading together the words of section 115 and section 117(1) it seems to me that the question is whether, looking at the security at the time of the disposal, it satisfies the condition in sub-paragraphs (a) and (b) of section 117(1). The exemption in section 115 is for a gain “on the disposal of… QCBs”, and by section 117(1) a QCB “is a security” satisfying the condition in (a) and (b). In my judgment this points plainly to asking whether on disposal the conditions are satisfied. For the reasons above, it does not seem to me that there are any more general considerations which displace that conclusion.
45.	Turning to section 116, this too seems to me to require the question as to whether the security is a QCB or not to be addressed at the time of the relevant transaction. Sub-section (9) is written in the present tense: “In any case where the old asset consists of a QCB; and sub-section (1): “where a transaction occurs… such that… the original shares would consist of…”. I see nothing which suggests that this section should be treated as requiring the test to be performed at any time other than at the time of the transaction.
46.	Thus, if on disposal Mr Harding’s loan notes were QCBs, they would not necessarily fall to be treated as QCBs at the time of the exchange. And if, at that time they were QCBs no frozen gain would come into charge to tax on their redemption. Given that it was common ground that applying the test in section 117(1) on issue the bonds were not QCBs, no gain would fall to be assessed on their redemption.
Were the Loan Notes QCBs on disposal?
47.	In this section I start with some general comments on the legislation before turning to the arguments of each party.
General Comments
48.	First I note that the question of whether or not a security is a QCB is not relevant only in the context of section 116. Very many securities will be acquired and disposed of in circumstances in which there is no reorganisation, conversion or exchange. In my judgment it is to those “normal” transactions one should look first in determining whether a security is a QCB, and one should be wary  of allowing the affects of section 116 to intrude on the consideration - particularly if to do so would create anomalies or injustices in simpler transactions. For this reason, and also because it seems to me that later legislation is relevant to the construction of earlier legislation only where there is a clear ambiguity (in the sense that the earlier legislation is fairly open to divers meanings) - which in my view there is not here - I consider that the amendments to section 116 discussed at paragraph 27 to 35 above are irrelevant to the question now addressed.
49.	Section 115 TCGA provides that a gain (which includes a loss) on the disposal of:
(i)	a gilt-edged security (as defined in Schedule 9 TCGA); or
(ii)	a QCB;
is not a chargeable gain (or allowable loss).
50.	Gains and losses on gilt-edged securities arise from changes in prevailing interest rates. Although governments do default in their debt, I think it is generally accepted that fluctuations in the credit rating of Her Majesty’s Treasury do not in practice affect the price of gilts. Gilts are also simple instruments: they pay interest at fixed rates (unless they are simply strips) and are repayable at a fixed amount (or an index linked fixed amount) on or before specified dates (or in some cases after a given date). And they are in Sterling.
51.	By contrast debt instruments issued by companies come in many shapes and flavours. They may have interest rates which are fixed, or which vary either by reference to factors such as bank rate, or by reference to a Schedule, or by reference to the available cash or profits of the issuer or even of another entity. The amount payable on redemption may also vary by reference to a formula, the price of a commodity or share, interest rates or other factors. They may be convertible into shares of the issuer or other debt, or exchangeable for shares or debt or commodities. They may be subscribed in one currency and repayable in another. And all these matters may be at the option of the Issuer or at the option of the holder.
52.	There are thus many more factors which affect the price at which a bond trades, or the market value of a bond, than simply prevailing interest rates and the period to redemption. These factors will include:
(i)	the creditworthiness of the issuer at any time;
(ii)	the bells and whistles added to its terms which differentiate it from a bond with plain vanilla terms equivalent to those of a gilt edged security; and
(iii)	the currency in which the bond is, or may be, repayable or in which interest is payable.
53.	Section 117 defines a qualifying corporate bond as a corporate bond satisfying the conditions in subsection (7). I shall revert to those conditions later but they are irrelevant for present purposes. A corporate bond is defined in subsection (1) as:
“a security, as defined in section 132(3)(b):
(a)  	the debt on which represents and has at all times represented a normal commercial loan; and
(b)	which is expressed in Sterling and in respect of which no provision is made for conversion into, or redemption in, a currency other than Sterling.”
(I note that it is the second part of (b) which is at issue in this case because the notes were expressed in sterling).
54.	These two conditions it seems to me reflect the factors (ii) and (iii) in the preceding paragraph. As I shall explain below a normal commercial loan is a loan without bells and whistles: a plain vanilla loan; and the correspondence between (iii) and (b) is clear.
55.	Thus in broad terms the purpose of the definitions seems to me to be to leave within the charge to CGT gains and losses on bonds where those gains or losses may derive from bells and whistles and forex effects (and at the same time leave within the charge gains and losses derived from interest rate movements and creditworthiness effects on such bonds), but to remove from the charge bonds gains and losses on which derive only from interest rate movements (like gilts) and from creditworthiness changes (unlike gilts in practice if not in theory).
56.	Part (a) of the definition requires the “debt” to represent a normal commercial loan. That expression is defined by the tailpiece of subsection (1):
“and in paragraph (a) above “normal commercial loan” has the meaning which would be given by sub-paragraph (5) of paragraph 1 of Schedule 18 to the Taxes Act if for paragraph (a) (i) to (iii) of that sub-paragraph there were substituted the words “corporate bonds (within the meaning of section 117 of the 1992 Act).”
57.	And paragraph 1(5) Schedule 18 TA 88 as so amended (in bold) reads:
“ ….a loan of or including new consideration and-
(a) which does not carry any right either to conversion into shares or securities of any other description except corporate bonds (within the meaning of section 117 of the 1992 Act); or to the acquisition of any additional shares or securities;
(b) which does not entitle that creditor to any amount by way of interest which depends to any extent on the results of the company’s business or any part of it or on the value of any of the company’s assets or which exceeds a reasonable commercial return on the new consideration lent;
and
(c)  in respect of which the loan creditor is entitled, on repayment, to an amount which either does not exceed the new consideration lent or is reasonably comparable with the amount generally repayable (in respect of an equal amount of new consideration) under the terms of issue of securities listed in the Official List of the Stock Exchange.”
58.	I must make two points about this provision:
(i)	first, it provides for a snapshot to be taken at any particular time. The question to be asked at such time is “does the loan carry” or “does the loan entitle”. There is no reference to the past;
(ii)	second, although it gets close to a requirement that the loans have similar terms to a gilt edged security, it does not go all the way; but the essence of the definition is that a normal commercial loan is one on which the only return to which the holder is entitled is an ordinary commercial interest-like return: there are very few bells or whistles which could be added to a loan otherwise with terms equivalent to a gilt which would add non ordinary interest-like features which would not take the loans outside the definition. (In this paragraph I use “interest” to include returns economically equivalent to interest such as discounts and premium).
59.	Buxton LJ summarised the introduction of the exemption for QCBs thus in Weston v Garnett [2005] STC 1134 at paragraphs 41 and 42:
“41. The notes to the Current Law Statutes… report that the exemption from capital gain tax of “corporate bonds” was introduced in order to stimulate the British Bond market. That accounts for the requirement in section 117(1) of the 1992 Act otherwise difficult to explain (or justify) that to gain exemptions bonds must be denominated in Sterling and not be convertible into any other currency.
“42. Care was accordingly taken to ensure that the exemption only extended to bonds that were genuinely traded in that market; and more generally to ensure that the exemption could not be used as a vehicle for avoidance. That is achieved in section 117(1) by limiting qualifying bonds to those that support normal commercial loans. The adopted sub-paragraphs of 1(5) of Schedule 18 of the 1988 Act, themselves intended to prevent the misuse of group relief, are principally directed at excluding any loan that gives the creditor an actual or potential interest in the debtor company or its performance. That is to ensure that the creditor’s participation in the bond market is an ordinary investor in that market, and not for any other or wider motive.”
60.	I was also told that a part of the reason for the introduction of the QCB provisions was to remove the difference between the tax treatment of gilts and sterling corporate debt which difference gave rise to distortions in the market.
61.	I mentioned section 117(7). Section 117(1) defines a “corporate bond”, section 117(7) provides that, subject to exceptions, a corporate bond is a QCB if issued after 13 March 1984 (as were Mr Harding’s loan notes) or if issued before that date it is acquired by a person after that date.
62.	I should also note section 117(2) which tightens the meaning of the requirement that a QCB should be expressed in sterling:
“ (a) a security shall not be regarded as expressed in sterling if the amount of sterling falls to be determined by reference to the value at any time of any other currency or asset; and
(b) a provision for redemption in a currency other than sterling but at the rate of exchange prevailing at redemption shall be disregarded”
63.	I note in relation to this subsection, first the acceptance by both parties (implicit as the common ground that the loan notes were not QCBs on issue) that this subsection did not cause the loan notes to be treated as sterling investments from issue; and second, that it makes plain that economically the condition in 117(1)(b) is that the note should be a sterling asset.
64.	Lastly, I record that the effect of section 117(6A) was to treat Mr Harding’s loan notes as securities if they were otherwise not to be so regarded. It was not in dispute that the loan notes were to be regarded as securities and were therefore capable of being QCBs within section 117.
The Parties’ arguments
65.	First Mr Southern says that the legal and fiscal status of a financial instrument can change over its term.
66.	He says that this is inherent in the 1997 amendments in relation to conversions discussed at paragraphs 26ff above.
67.	He notes that a loan which was not a normal loan because it carried rights to convert can cease to be such a loan if those rights lapse. Its fiscal status will change.
68.	He says that if the issuer of a plain vanilla QCB granted by deed poll conversion rights to the holders of the debt, the debt would thereupon cease to be a normal commercial loan and the security cease to be a QCB.
69.	Mr Gibbon did not dispute that a security could change so as to become or not to become a QCB.
70.	I agree with Mr Southern. There are examples in section 116 itself of securities being treated by the section as becoming QCBs on the happening of various events.
71.	Next Mr Southern points to the difference in the language between the two conditions in section 117(1). The condition in paragraph (a) is not only that the debt presently represents a normal commercial loan but that “at all times” it has represented such a loan: it looks therefore to the present and the past. In paragraph (b) by contrast the question is whether the security is expressed in Sterling: it is concerned with the present and not the past. The absence of the words “at all times” in (b) was clearly deliberate and must not be ignored.
72.	Mr Southern submits that this distinction between a condition which looks to past and present, and a condition which looks to the present and future is explicable in terms of the policy of the legislation. Sub-paragraph (a) excludes from QCB treatment securities which have an equity like return or an equity like component in their return. Those returns should fall within CGT. The possibility that equity like gains have been pumped into the security should take you outside the exemption because it will already have affected the value of the instrument. By contrast, when there exists no possibility of future forex gains or losses there is no reason why the QCB exemption should be prevented from applying: if the instrument has become a Sterling debt (also the comment in paragraph 63 above) then (assuming (a) is also satisfied) it should benefit from the exemption.
73.	Mr Gibbon says that the nature of the test in (b) is such that it applies to present and future without the need for the additional words “at all times”. The test looks to the way an instrument “is expressed” and what provision “is made”; it is not concerned with whether a particular provision is operative but whether it is in the terms of the instrument. It would be unnatural for the legislature to specify that a negative requirement be met “at all times”. He points to the context of Schedule 18 which, in setting a test applicable at any time, needs words which, when translated into section 117, require a time description specifying when the test is to be applied. By contrast the restriction in paragraph (b) is not by reference to such a test but to what is provided for in the terms of the bonds and does not need such words.
74.	Mr Southern says that if the legislature intends a negative restriction to relate to present and past it does so. He points to section 117(2)(a) set out above: “the value at any time of any other currency or asset”; and to section 164I(8)(a) TCGA:
“the letting is for a period not exceeding 12 months and no provision is made at any time (whether in the charterparty or otherwise) for extending it beyond that period…”,
and, I note to a similar effect is section 164I(8)(b):
“during the period of the letting there is no provision in force (whether by virtue of being contained in the charterparty or otherwise) for the grant of a letting to end…”
75.	Mr Gibbon notes that the Appellant’s argument is that from the date of the lapse of the forex option the loan notes were QCBs. He says this suggestion - that the fiscal nature of an instrument can change merely because of the failure of a person to exercise an option - is problematic. He asks whether, for example, the failure of the postal service to deliver a notice of election in time, or a delay in an overseas flight which prevents the proper exercise of an option can properly change the fiscal nature of a security.
76.	The problem it seems to me with these examples, however, is that the failures have real economic effects (as would also be the case with the exercise of an option) and there is nothing inherently illogical in an economic change affecting a fiscal classification.
77.	Mr Gibbon makes a related point. He says that an issuer will want to know before the date fixed for redemption whether he has to pay out Sterling, dollars, Euro or whatever. Thus any note in which there is a forex option will, if carefully drafted, set a date before redemption before which notice of a decision to take one currency or another must be given. If the election is exercised (or not exercised as the case may be) so that Sterling is to be taken, it cannot be that the legislature intended that note to be a QCB merely because of the practical necessity of making a choice some days before redemption. If it were intended that that would be the result the condition in (b) would merely have been that the security was not redeemed in sterling, not that there be “no provision” for redemption in a foreign currency.
78.	Mr Southern answers this by saying that whilst administrative necessities may require an election to be exercised prior to redemption, and that potentially the short period between such date and redemption should be ignored as de minimis, where there is a tract of time in which it can be said that the bond is truly a sterling instrument only, then its position is different, and in the Appellant’s case there was a period of over five months in which his loan notes were sterling instruments.
79.	Mr Southern says that what the security delivers today is the key consideration. If it is sterling only, then the bond is a sterling instrument and should be treated as satisfying (b). He says that the FA 1997 amendments recognised this: they were necessary and the fact that they were thought necessary is relevant to the paper construction of section 117. Mr Gibbon says that these changes were made to avoid future argument and are not evidence that Mr Southern is right about section 117.
Discussion
80.	I start by noting the distinction made by Chadwick LJ at paragraph 28 of Weston that the language of section 117 makes a distinction between the “security” and the “debt”, and that it is the debt which must satisfy the normal commercial loan definition in paragraph (a).  However it seems to me that the same is not true of the condition in paragraph (b): whilst it is the debt on the security which must meet the normal commercial loan condition, it is the “security” which must meet the forex condition in (b).  This follows to my mind from the layout and structure of s117: the word “which” at the beginning of (b) plainly refers back to “security” in the opening words and not to the “debt” in (a). 
81.	Although the cases on the meaning of debt on a security look principally to the conditions which need to be met before an ordinary debt can be said to be a marketable debt on a security, there is I consider something in the word “security” when contrasted with debt which looks to the formal terms of an instrument rather than the rights attaching to the debt.
82.	Next I accept that the seemingly deliberate omission of the words “at any time” or their equivalent is at first sight a powerful argument, but I accept Mr Gibbon’s point that the words “at any time” fulfil an essential function in paragraph (a) which may not be needed in paragraph (b).  They perform a function or are effective because the schedule 18 test contains no time constraint.  It seems to me, therefore, that the significance of their omission in (b) needs to be judged by reference to the test they would qualify, and it is not a necessary conclusion that their absence from paragraph (b) means that the test in that paragraph is only to be conducted by reference to the provisions in effect at a particular time.
83.	The use of the words “at any time” in the context of section 164I(8)(a) are used to qualify “no provision is made” so there is by comparison a noticeable omission of “at any time” in section 117(1).  But in the context of section 164I(7)(d) and (8)(a) I am not sure that the words add much of anything to the meaning of the provision: merely making absolutely clear what in that context was tolerably clear anyway.  I therefore derive little from the comparison.
84.	By contrast the words “during the period of the letting” in section 164(8)(b) could be said to limit what would otherwise be a much wider ambit of “there is no provision in force”. Thereby suggesting that it is not a snapshot phrase.
85.	In section 117(1), the condition in (b), leaving aside the question of the currency that security is expressed in, can be rewritten: “no provision is made in respect of the security for conversion…”  Having in mind the concept of a security as something which has a structure of permanence (see Taylor Clark International Ltd v Lewis [1997] STC 499) this suggests to me an enquiry as to the formal terms of the security rather than an enquiry into which of these terms are effective at a given time.
86.	Thus a consideration of the words of section 117(1) leads me to the tentative conclusion that the absence of “at any time” in (b) does not conclusively point towards looking at the effective terms only on a particular date, and that at the very least the words permit an interpretation which focuses on the formal terms of the security rather than those which are effective at any particular time. The use of the words “expressed in sterling” in the first part of the condition in paragraph (b) of section 117(1) however suggest to me that the provision is concerned with the formal terms of the security.
87.	Indeed if the enquiry were solely in relation to terms which were effective at a particular time I can see difficulties arising in relation to sleeping provisions which at a particular time have no effect but which could be switched on by later events. If the test required one to look only at operative or currently effective provisions such provisions would be ignored. That approach seems to me not to fit the language and purpose of section 117(1).
88.	Taking all this together, and although the arguments on the words are finely balanced, I conclude that the proper construction is that the test in (b) must be conducted by reference to the formal terms of the security rather than by reference to those that are effective or operative at the time of disposal. I am confirmed in this conclusion by a further consideration. It is this: the effect of the inclusion in the terms of a security of equity rights or bells and whistles or forex provisions will affect the value of the security not only while those provisions are extant or operative but also after they lapse.
89.	For example a bond with rights to convert into shares in a company will generally carry a lower interest rate than a plain vanilla security: the holder being compensated for his loan by the mixture of the conversion right and the interest. The interest rate may remain the same after the conversion right has lapsed and the security may therefore trade at value lower than one with a normal interest rate which was never convertible. The loss made by the holder of the security if he then disposes of the security at market value reflects not a fluctuation in credit rating or market interest rates but the fact that his equity right acquired in the bond at the outset has proved to be a bad investment. It seems to me that it is not the purpose of section 117 to exempt that loss, and neither, because of clear words of paragraph (a) is it its effect.
90.	Now suppose instead a bond redeemable at the option of the issuer in either US$ or £. Such a bond might carry a higher interest rate because the holder is taking the risk of a lower redemption amount. Once the issuer has exercised his election that higher interest rate may continue for some time and affect the value of the bond in the market. That value represents part of the consideration given to him by the issuer for assuming the currency risk. The increased value does not flow from market interest rate fluctuations or creditworthiness but from the forex provision. Likewise consider a 5 year bond subscribed for $100 which was repayable in £ sterling or $ at the option of the issuer to be made at the end of year 3. If the issuer elected for sterling at that time it would result on redemption (or other disposal after year 3) in a real loss or gain for the holder by comparison to the sterling value of his acquisition price. It seems to me that the purpose of the legislature was not to exempt that gain or loss.
91.	Clearly not every bell and whistle, or forex provision, will leave an after-taste, a shadow on the later value of the security. But the realisation (i) that such a provision may affect a gain or loss arising after the provision has ceased to have legal effect, and (ii) that such a gain or loss may therefore derive, at least in part, from factors other than market interest rate fluctuations and creditworthiness, suggest that the provisions should be construed to leave that gain or loss within the charge to CGT. Further, I can see no reason for (and no indication in the statute of) a different regime for gains and losses which arise from forex provisions from that for other bells and whistles in the context of a provision which appears to be directed to plain vanilla sterling bonds. This is for me strong confirmation that paragraph (b) should be read as I have indicated above.
92.	For the reasons set out in paragraph 48 above I am not dissuaded from this conclusion by the amendments made by FA 97.
93.	I accept that this conclusion means that if Mr Harding had sold his loan notes to a third party after the forex option had lapsed, the loan notes in the hands of that third party would not be QCBs even though that third party’s gains and losses would be limited to those arising through interest rate and creditworthiness fluctuation. But the same is true even on Mr Southern’s view in relation to lapsed equity or other bells and whistles, and I can see no clear legislation policy in the Act for distinguishing the result in the case of forex options.
94.	As a result I conclude that Mr Harding’s loan notes were not QCBs whether the test in section 117(1) is to be performed on disposal or otherwise. As a result the lapse of the forex condition did  not cause the loan notes to cease to be securities in respect of which a provision was made for redemption in a foreign currency for the purposes of section 117. It does not seem to me to be relevant whether that lapse took effect by lapse of time or by virtue of the express terms of the final sentence of condition 4.7: Dr Steiner’s evidence supported that conclusion. 
95.	Even though the test may fall to be conducted at different times for the purposes of different provisions, the nature of the test in my judgment means that on disposal Mr Harding’s loan notes were not QCBs and accordingly a gain arose.
 A Further Point
96.	At paragraph 7 above I referred to section 137 TCGA. This section denies rollover relief to a person holding 5% or more of the shares in a company (or any class of the shares) if the exchange is not for bona fide purposes or is part of a scheme or arrangement of which the main purpose or one of the main purposes was the avoidance of a liability to CGT or corporation tax.
97.	If section 135 did not apply to the exchange of Mr Harding’s shares for loan notes then section 127 would not have applied and section 116 would not have been relevant. Instead the shares would have been treated as disposal for the value of the loan notes received. (Mr Harding held more than 5% of the relevant class of shares for the purposes of section 137).
98.	Section 138 TCGA provides a clearance procedure under which a taxpayer may seek a binding clearance from the Revenue that section 137 will not apply.
99.	I referred in paragraph 3 above to the section 138 TCGA clearance letter sent by Arthur Andersen to the Revenue in December 1994. This letter explained that the notes could be redeemed in other currencies at the holder’s option, but made no reference to the lapse of that option. The letter expressed the view that the loan note did not constitute a QCB, but made no reference to any argument that it might constitute one at redemption. And yet Mr Harding told me that he was advised by Arthur Andersen that, because of the way the currency option was drafted, their view was that he would not have to pay CGT on their redemption.
100.	It seems to me that if Arthur Andersen appreciated the intended effect of the loan note terms, their letter to the Revenue was, to be charitable, wholly inadequate for its purpose.
101.	Section 138(5) provides that if any particulars furnished under section 138 do not fully disclose any material facts or considerations any clearance given is void. It is clear to me that the  possibility that a gain might be avoided and the existence of the lapse provisions were material circumstances in relation to the consideration of whether or not the contemplated exchange was, or was not, part of any scheme or arrangement for the avoidance of tax.
102.	In my view the clearance obtained was void.
103.	I asked Mr Gibbon if HMRC would take any point on the clearance application. He said that given the lapse of time the Respondents had not proposed to run any argument to that effect. I have taken this as a statement that the Respondents did not wish to contend before me that section 137 denied rollover treatment under section 135.
104.	Of course, had section 137 had that effect, then a taxable gain would have arisen at the time of exchange and no gain would have arisen on the loan notes. In other words in relation to the matter under appeal the Appellant would win. But to do so he would have to have argued that the exchange was part of a scheme of which a main purpose was the avoidance of liability to CGT which was hidden from the Revenue in the letter from Arthur Andersen. It seems to me that Mr Southern was wise not to pursue that course. Since the appeal was argued on both sides on the basis that section 135 did apply to the exchange I have considered it on that basis.
Conclusion
105.	For the reasons given at the end of the penultimate section of this decision I dismiss the appeal in principle. I was not asked to consider any argument relating to the amount assessable. If that is not agreed the matter can be brought back before this tribunal.
CHARLES HELLIER

SPECIAL COMMISSIONER
RELEASE DATE: 15  March  2007

SC/3315/2005

Authorities referred to in skeletons and not referred to in the decision:

Memec plc v IRC [1996] STC 754.
Jenks v Dickinson [1997] STC 853.
Collector of Stamp Revenue v Arrowtown Assets Ltd [FACV No. 4 of 2003].
HP Balmer Ltd v J Bullinger SA [1974] 1 All ER 1226.
Billingham v Cooper [2001] STC 1177.
Barclays Mercantile Finance Ltd v Mawson [2005] STC 1.
Dilworth v Stamp Commissioner [1899] AC 99.