UK stock lending and tax planning – a cautionary tale
One aspect of securities lending that we have not covered is the legal and tax ramifications that many practitioners leave in the hands of their specialist teams. To this end we have enlisted the insight of Adam Blakemore of Cadwalader, Wickersham & Taft who draws upon a recent tax case in the UK Supreme Court which has a number of important implications for UK stock lending.
The Supreme Court decided in HMRC v DCC Holdings (UK) Ltd [2010] UK SC58 that the legislation could not be interpreted to entitle DCC Holdings to a tax loss resulting from a transaction in which it made a commercial profit. Lord Walker analysed the relevant legislation relating to manufactured payments, and ruled that the purpose of the legislation was to apply a tax treatment of the transactions that corresponded to their economic substance. He talked at length about the "overwhelming need for a symmetrical solution" when applying the legislation, and said that to allow the taxpayer company to claim a large tax loss despite their having made a profit from the transaction, would amount to a "commercial nonsense".
Although the UK legislation which was considered by the Supreme Court was applicable to repo transactions, the UK taxation legislation dealing with stock lending is similar. In this context, it may be said that the Supreme Court’s decision in DCC Holdings signals a practical approach to addressing complex legislation and that the approach is one in which the Court may disallow interpretations which produce arbitrary or absurd tax results.
The legal construction of taxing provisions is only one consideration in looking at how stock lending is taxed in the UK. The legislation on stock lending also, for example, imports certain accounting concepts. A number of components, including legal interpretations, therefore need to be balanced against an overall substantive view of a transaction and its economic merits. Reaching a balanced view of the taxation of any stock lending trade involving UK parties or UK stock and securities can therefore be challenging, particularly if some element of tax mitigation is present.
Added to this is an overlay of the general approaches of Courts and tax authorities to structured finance and financial engineering which includes any element of tax planning or mitigation. These approaches have not always been consistent over the years, and discerning the current position and attitude to such transactions requires careful analysis of each element of a transaction.
Any institution, fund or company looking to include tax mitigation attributes in a transaction needs to be aware of this point, and transactions involving stock lending are no different. In particular, any transaction which HM Revenue perceives as being motivated by “tax avoidance” and which is entered into by an institution operating in the UK may well face particular scrutiny at the present time for a number of reasons connected with the drive of the UK Government to discourage tax avoidance in the financial institution and banking sectors.
As is well known, revenue bodies across the world are concerned with the risk to national tax systems posed by the extent that banks and financial institutions use, as well as facilitate, aggressive tax planning schemes. In this environment, the practical approach of the Supreme Court in DCC Holdings demonstrates the care and caution which is needed in contemplating transactions where the taxation attributes may be viewed as overshadowing the commercial features of those transactions.
Adam Blakemore
Cadwalader, Wickersham & Taft LLP
Adam.Blakemore@cwt.com
