UT (Tax & Chancery) UT/2023/000096 - [2024] UKUT 00203 (TCC)

We have drawn the following conclusions… :

Montpelier presented the Pendulum CFD and surrounding arrangements to its customers as a tax avoidance scheme that, provided it went into Phase Two, would deliver trading losses. Montpelier told users of the scheme that they would first need to “establish a financial trade” before they purchased the Pendulum CFD which was the instrument by which the tax loss would be delivered.

The tax avoidance result could be achieved only if a Pendulum CFD entered Phase Two (or subsequent Phases). In that case, it was important that a user of the tax avoidance arrangements should appear to pay a high Designated Issue Value for rights under the Pendulum CFD but that, shortly after entering Phase Two, a Pendulum CFD could be said to have a low value for accounting purposes. So, for example, in Mr Worsfold’s case, the Designated Issue Value of the Pendulum CFD was £300,000 but just 5 or 6 days after it moved into Phase Two, the Pendulum CFD was said to have a value of just £4,653 for accounting purposes. The difference between the high Designated Issue Value and the low accounting value would be the tax loss that would be generated. That was the “GAAP anomaly” to which Mr Gittins referred in his evidence… Indeed it is precisely the basis on which all appellants are claiming the loss that is in dispute.

To achieve the result set out at [(2)], the Index Target Levels applicable to Phases Two to Five (and the lengths of Phases Two to Five) in the Pendulum CFD needed to be set at values that meant that, when Pendulum came to make its repurchase offer described at [44] above, it could justifiably offer a low price. Pendulum was not purporting to “value” the Pendulum CFD. However, it was hoped that a low repurchase value offered by a counterparty who was, at least ostensibly, transacting at arm’s length, would justify a low value for accounting purposes. Without such pricing of the Pendulum CFD, the “GAAP anomaly” that Mr Gittins identified could not be achieved, and the desired tax loss could not be generated.

If the appellants had had to pay the full Designated Issue Value of the Pendulum CFDs out of their own pockets the steps set out above would have achieved little. For example, Mr Worsfold would have paid £300,000 for a CFD that, a few days later, was, at least according to Pendulum, worth only £4,653. He would have made an economic loss of £295,347 and even if he obtained a tax loss as a result, that would only compensate him for part of his economic loss.

For the arrangements to function as a tax avoidance scheme, the arrangements had to produce a tax loss without an economic loss. That was achieved by the Bayridge Loan which meant that the appellants were not themselves funding the entire Designated Issue Value of the Pendulum CFDs out of their own resources. Under the Bayridge Loan, Bayridge funded 95% of the Issue Value of the Pendulum CFD on highly advantageous terms. The Bayridge Loan therefore operated to “ramp up” the amount that the appellants could claim they invested in the Pendulum CFD even though they had not in any economically real sense invested the full Designated Issue Value.

Phase One of the Pendulum CFD had two functions. Its first was to act as a smokescreen by enabling the appellants to argue that the Pendulum CFD was not inevitably going to produce a loss. That is why the presentation … speaks in slightly apologetic terms about the possibility that there might be a profit at Phase One. It also explains why Mr Gittins attached significance … to the effect that the Pendulum CFD might not produce a tax loss. Since counterparties had to fund the Initial Margin at Phase One out of their own resources, the second function of Phase One was to ensure that Pendulum would receive the Initial Margin from counterparties which was in the nature of a “fee” payable to Pendulum for the tax avoidance scheme that was offered.”

Claims to set-off their losses against current year income were made under s380 (the conditions for which are set out in s384). The combined effect of these provisions is that where a taxpayer incurs a loss in a trade in a particular year, that loss can be set off against other taxable income arising in the same year, or the immediately preceding year, but only where the requirements of s384 are met. Those requirements are that the trade was being carried on a commercial basis and with a view to the realisation of profits (which is deemed to be the case if the trade is carried on so as to afford a reasonable expectation of profit).

Claims for loss relief in earlier years were made under s381, which provides that relief is available for losses incurred in the first four tax years of a trade which, if the loss exceeds the income of that year, is applied to the preceding three years starting with the earliest. The loss relief under s381 is only available if the trade was carried on throughout the relevant year on a commercial basis and in such a way that profits could reasonably be expected to be realised in the period in which the loss occurred or shortly thereafter.