Chester Lettings Limited v The Commissioners for HMRC

This appeal concerns the correct tax treatment of a sum paid to the Appellant (‘Chester Lettings Limited’) by way of compensation for the mis-selling of a financial derivative known as an Interest Rate Hedging Product (“IRHP”).

The Appellant entered into four loan agreements (“the Loans”) with Clydesdale Bank plc (“Clydesdale”) (part of the National Australia Group Europe), which were terminated in 2009 and replaced by a fifth loan. In 2012, the remaining loan was transferred to the National Australia Bank Ltd (“NAB”). The Appellant later raised complaints with Clydesdale, in respect of the terms of the Loans. The settlement of these complaints was embodied in an agreement, dated 17 May 2019 (“the Settlement Agreement”), between the Appellant, Clydesdale and NAB. Under this agreement, Clydesdale agreed to pay £650,000 to NAB to reduce the outstanding debt, and to pay £100,000 to the Appellant. The Appellant’s accounts for Accounting Period Ending (“APE”) 31 March 2020 recorded this payment as ‘income’. The payment was then removed from the tax calculations on the grounds that it was a ‘capital’ receipt (Income Adjustment B2 in the Tax Calculation for that period).

HMRC’s position is that the payment received by the Appellant under the Settlement Agreement is a ‘redress payment’, which is taxable as a Non-Trading Loan Relationship (“NTLR”). In further amplification of this position, Mr Chacko submits that the redress payment is a “money debt”, and “interest” arises on that debt and is, therefore, treated as a taxable loan relationship credit. He further submits that the ‘interest’ element arises from a deemed “loan relationship” within the Corporation Tax Act 2009 (“CTA 2009”).

The Appellant’s position, on the contrary, is that the payment received under the Settlement Agreement did not arise from a loan relationship. In further amplification of this position, Mr Bowe submits that where someone has been overcharged under a finance arrangement, and is compensated for the difference between the amount they actually paid and the amount they would have paid had they been sold a more appropriate financial product, this is not ‘income’ but is compensation for a “lost opportunity”, which is a ‘capital’ sum. 

The Appellant appeals against a closure notice (“the Closure Notice”) issued by HMRC on 15 December 2023, pursuant to para. 32(1A) of Schedule 18 to the Finance Act 1998 (“Schedule 18”), in the sum of £140,104.29. The Closure Notice brings the payment received by the Appellant into charge as an NTLR receipt.

Having carefully considered the evidence and the submissions made by both parties, I decided to dismiss this appeal. In this Decision, the legislation and case law are cited so far as is relevant to the issue(s) in dispute.

There is, in truth, one issue for consideration in this appeal. That is: what is the correct tax treatment of a payment in respect of the mis-selling of an IRHP? This, in turn, requires consideration of:

The burden of proof is on HMRC to show that the Closure Notice was validly issued. The burden of proof then shifts to the Appellant to show that the Closure Notice is incorrect, or excessive.

The standard of proof is the ordinary civil standard; that of a balance of probabilities.

As explained by Moses LJ in Tower MCashback LLP 1 v HMRC [2010] STC 809 (‘Tower MCashback’), at [17] to [18] (in the context of a discovery assessment), the taxpayer’s self-assessment constitutes the final determination of their liability, subject to three circumstances; namely (i) an amendment to the return; (ii) an enquiry by HMRC; or (iii) a discovery assessment.

The authorities to which I was referred included:

The documents to which I was referred included: (i) the Hearing Bundle consisting of 379 pages (within which were the Notice of Appeal and the Statement of Case); (ii) the Authorities Bundle consisting of 308 pages: (iii) HMRC’s Skeleton Argument dated 16 February 2026; and (iv) the Appellant’s Skeleton Argument (undated).

On 7 July 1999, the Appellant was incorporated. The Appellant is a UK registered company carrying on a property business (purchasing and renovating property). Its director is Mr Graham Haywood.

On 4 July 2007 and 3 April 2008, the Appellant entered into the following loan agreements (i.e., the Loans) with Clydesdale:

On 6 August 2009, the Loans were consolidated into anew Fixed-Rate Loan Facility (“the 2009 restructure”). The Appellant thereby agreed to:

The 2009 restructure caused Loans 2 to 4 to be broken and incurred breaks cost of:

The break costs were blended into ‘Loan 5’ by increasing the fixed-rate.

On 17 December 2014, Clydesdaleoffered redress to replace ‘Loan 3’with a variable-rate loan to be redressed for the difference in the payments that would have been made if the loan had been variable from the outset. When ‘Loan 3’ was broken during the 2009 restructure, a break gain of £172.97 was realised and blended into the subsequent fixed-rate of ‘Loan 5’.

‘Loan 4’ also qualified to be reviewed under Clydesdale’s voluntary review. Clydesdale determined that ‘Loan 4’ should be replaced with a ten-year cap, set at 5.9%. Clydesdale then offered to redress the difference between payments under a capped-rate loan, and those actually paid under ‘Loan 4’. The 2009 restructure caused ‘Loan 4’ to be broken and incur a break cost, which Clydesdale offered to refund. The redress calculation also included a break gain of £10,709.55, which would have become due in relation to the replacement cap product, on the assumption that the replacement capped loan would have also been broken when the 2009 restructure took place.

On 26 January 2016, Clydesdale confirmed that it would revise the offer of redress in relation to ‘Loan 4’. This resulted in the break gain being removed from the offer, but still included break costs of £60,682.97. The offer included the ‘premium’, which would have been payable for a capped product of £10,928.91. The offer was, thus, reduced.

On 13 April 2016, Mr Haywood signed a “Settlement Form”, in full andfinal settlement of the complaint about ‘Loan 4’, which stated that:

Redress of £98,058.11 was paid (including the break costs).

By a letter dated 17 April 2015, Clydesdale’s complaints team determined that the Appellant would have still taken a fixed-rate loan for ‘Loan 2’, but for a shorter term offive years for greater flexibility. No redress was considered to be due because the interest-rate for the alternative product was higher, although Clydesdale would not recover the difference. The letter, which also offered redress for ‘Loan 5’, made clear that:

On 31 May 2017, Mr Haywood signed a form to accept the decision in respect of ‘Loan 2’, with no redress actually being due as the replacement five-year fixed-rate loan had a higher rate than the 22-year loan.

On 17 May 2019, the “Settlement Agreement” was signed between Mr Haywood, Clydesdale and NAB. In return, the Appellant agreed to surrender all rights of action to sue for damage alleged to have been caused by the mis-selling, with no admission of liability by Clydesdale and NAB.

On 31 March 2022, the Appellant submitted its corporation tax return for the APE 31 March 2020. This included a deduction from the profit of £737,391, described as an income adjustment “written-off in settlement of rights of action against Bank.” The compensation payment was, therefore, treated as a ‘capital’ receipt by the Appellant. The return claimed “Extra-Statutory Concession (“ESC”) D33” relief for the full amount.

On 9 March 2023, Officer Griffiths issued a notice of enquiry under para. 24(1) of Schedule 18, informing the Appellant that a check would be made into the corporation tax return for APE 31 March 2020.

By an email dated 17 May 2023, the Appellant accepted that the compensation received from the out of court settlement is “on all fours” with compensation that is received under the Financial Conduct Authority’s (“FCA”) ‘Redress Scheme’ for Small and Medium Enterprises (“SMEs”).

By a letter dated 31 October 2023, Officer Bescoby expressed the view that compensation relating to an IRHP is taxable as ‘income’, rather than ‘capital’, and provided a link to HMRC Guidance that was first published in 2014 and a link to additional Guidance that was updated in 2017.

On 15 December 2023, Officer Bescoby issued the Closure Notice and amended the Appellant’s corporation tax return to increase the self-assessment.

The Appellant later made an appeal to the First-tier Tribunal (‘FtT’).

In order to put the parties’ respective contentions into context, I start with the relevant statutory provisions.

The relevant law, so far as is material to the issues in this appeal, is as follows:

Section 295 provides for the general rule in respect of “profits arising from loan relationships”, as follows:

Section 299 provides for the “charge to tax”, as follows:

Section 302 provides the definition of a “loan relationship”:

Section 307 provides for the bringing into account of credits and debits, as follows:

Paragraph 24 of Schedule 18 deals with a “notice of enquiry” as follows:

Paragraph 32 of Schedule 18 deals with the “completion” of an enquiry, as follows:

Paragraph 34 of Schedule 18 deals with the “amendment” of return after an enquiry, as follows:

Pursuant to sub-para (3), an “appeal” may be brought against an amendment of a company's return under sub-paragraph (2) or (2A).

The documents for the hearing, set out at [12] above comprised pleadings, correspondence relating to HMRC’s enquiry and appeal correspondence.

Mr Bowe’s submissions (as set out in his Skeleton Argument) can be summarised as follows:

Mr Chacko’s submissions can be summarised as follows:

At the conclusion of the hearing, I reserved my decision, which I now give with reasons.

The “Background Facts” are not in issue between the parties, save that the parties differ in view as to the conclusions that I should reach as a result. I, therefore, adopt the ‘Background Facts’, at [13] to [30],above as the “Findings of Fact”, and do not repeat these here.

The Appellant appeals against a Closure Notice issued pursuant to s 32(1A) of Schedule 18, for the APE 31 March 2020. The Appellant entered into various Loans with Clydesdale. After the Loans were terminated and replaced with a Loan that was transferred to NAB, the Appellant raised various complaints with Clydesdale in respect of the terms of the Loans that it entered into. The settlement of the complaints resulted in the Settlement Agreement. Under the Settlement Agreement, Clydesdale agreed to pay £650,000 to NAB to reduce the outstanding debt, and pay £100,000 to the Appellant. The Appellant included this sum as ‘income’ in its accounts to 31 March 2020, but removed them in the tax computation for that year on the basis that these were ‘capital’ sums not taxable under ESC D33. HMRC considers that these sums were taxable as ‘income’ arising from a NTLR, resulting in the Closure Notice.

Mr Bowe submits that the appeal does not raise any substantive question as to whether the Appellant is subject to corporation tax in relation to the settlement sum it received. He further submits that HMRC’s findings are internally inconsistent, and that HMRC have not articulated a coherent position capable of being accepted, rejected, or disputed on its merits. I am satisfied that Mr Bowe’s submissions are highly misconceived, and are based on false premises. Whilst Mr Bowe submits that the appeal raises procedural issues, it is clear that the Appellant has appealed against the amendment of its corporation tax return following an enquiry which resulted in the Closure Notice.

In light of the submissions made by Mr Bowe above, I start by considering the workings of a closure notice, and the jurisdiction of the FtT.

As confirmed by the Upper Tribunal (‘UT’) in Shinelock Ltd v HMRC [2023] UKUT 107 (TCC) (‘Shinelock’), the matter in issue in relation to an appeal against a closure notice is the conclusion notified in the closure notice - albeit not limited to a stated reason for that conclusion - and the associated amendment arising from such conclusion. In Daarasp LLP & Anor v HMRC [2021] UKUT 87 (TCC) (“Daarasp”), at [24], the UT made clear that although there is a nexus between the conclusions in a closure notice and the consequential amendments implementing the conclusions, the two are distinct.

The jurisdiction of the FtT is fixed, and defined, by the terms of the Closure Notice, as confirmed by the UT in Daarasp, at [25(7)]. Consistent with the decision of the UT in Shinelock,I adopt the summary of the essential workings of the enquiry and closure notice process set out in Daarasp:

I further adopt what the UT in Daarasp said at [36(4)(c )]:

In Fidex Ltd v HMRC [2016] STC 1920 (‘Fidex’), the Court of Appeal set out the following principles, at [45] (per Kitchin LJ):

The Closure Notice issued to the Appellant amended the Appellant’s corporation tax return to bring into charge amounts received in respect of mis-sold IRHPs. The Appellant had a right to appeal against the conclusion stated by the Closure Notice, in accordance with statute. That is precisely what the Appellant in this appeal did.

In Tower MCashback LLP 1 & Anor v HMRC [2011] UKSC 19 (‘Tower MCashback SC’), at [15], Lord Walker quoted, with approval, the words of Henderson J in the High Court:

In this respect, it is for the Appellant to prove that the Closure Notice is excessive, and not for HMRC to prove that the tax is owed. There is no suggestion in this appeal that the enquiry was not valid, or that the enquiry was not closed with the issuing of a Closure Notice.

Whilst there may be many reasons advanced as to why HMRC’s conclusions are asserted to be wrong by a taxpayer, an argument that the conclusion is invalid and/or the decision is void does not, in my view, cause the task of the FtT (a creature of statute) to differ from that set out in statute. Contrary to the matters urged upon me by Mr Bowe, I am required to decide whether the Appellant has been overcharged by the Closure Notice. This necessitates an analysis of whether the reasons for the amendments were correct by analysing of the facts, statutory provisions and authorities.

As the Closure Notice in this appeal relates to mis-sold IRHPs, it is helpful to set out a brief history to the litigation that has arisen as a result of the mis-selling of IHRPs as this will shed light on the FCA’s Redress Scheme (and the status of redress payments).

IRHPs were used by banks to enable customers to manage - or hedge - their exposure to fluctuating interest rates on the money they borrowed from banks. There is a history to the litigation that arose as a result of the mis-selling of IRHPs, which gives context to the situation that has arisen in this appeal.

IRHPs are a form of derivative. A “derivative” is a financial instrument with all three of the following characteristics:

IRHPs include financial instruments such as options, warrants, futures contracts, forward contracts and swaps.

By March 2010, the then Financial Services Authority (“FSA”) became aware of concerns regarding the alleged mis-selling of IRHPs. For instance, one of the most significant developments in interest rate swap mis-selling litigation was the court’s treatment of London Interbank Offered Rate (“LIBOR”) manipulation, as a separate and independent cause of action. LIBOR was the floating reference rate used in virtually every interest-rate swap sold by the banks.

In 2013, the FSA entered into agreements with nine banks, which resulted in over £2,200.000 in compensation being paid by those banks to thousands of customers who had been mis-sold IRHPs, over the period from 2001 to 2011. This voluntary customer “Redress Scheme” - which was overseen by skilled persons approved by the FSA/FCA - was implemented from 2013, and was largely completed by 2016.

Section 150 (and later s 138D) of the Financial Services and Markets Act 2000 (“FSMA”) provided certain individuals with a possible route to pursuing a ‘damages’ claim in the civil courts where the mis-sale of IRHPs constituted a breach of particular FSA/FCA rules, and caused loss to the individual. In addition, customers had the option of bringing various statutory, or common law, claims against the banks by virtue of their advisory relationship. In general, however, customers who claimed to have been mis-sold IRHPs were often unsuccessful in the civil courts. 

In Titan Steel Wheels v Royal Bank of Scotland plc [2010] EWHC 211 (Comm) (‘Titan’), the court rejected a claim under s 150 FSMA for a breach of the FSA's Conduct of Business Sourcebook (“COBS”) rules brought by a company which had entered into an IRHP in connection with a loan to buy its business premises, on the basis of the reasoning in Bailey & Mtr Bailey Trading Limited v Barclays Bank Plc [2014] EWHC 2882 (QB), at [37] to [51]

The banks were, in general, able to argue successfully that:

Where a mis-selling claim succeeds, whether through litigation, negotiation or the FCA Redress Scheme, the primary remedy is ‘rescission’ and ‘damages’ assessed to place the claimant in the position they would have occupied had the mis-selling never occurred. In practical terms, this typically means:

The FCA Guidance explained that, in respect of the opportunity cost of customers being deprived of money, customers can choose between either:

The underlying principle was that the bank should put the customer back in the position they would have been in had the mis-selling not occurred:

The FCA review looked, in some detail, at how the banks were to determine the redress due. The FCA’s review further set out who was entitled to redress, what redress might be available and how some elements of that redress were to be calculated. The FCA considered that:

Therefore:

The review then set out the different elements that might be comprised in the redress. The FCA published its review into IRHPs on its website. The standard basis for compensation under the FCA process is set out as follows:

There are, therefore, three standard elements for compensation under the FCA process:

Turning to the appeal before me:

The Appellant made a complaint against Clydesdale, but did not pursue litigation and instead signed a Settlement Agreement. A settlement sum was paid to the Appellant by Clydesdale. In return, the Appellant agreed to surrender all rights of action to sue Clydesdale and NAB for the damage alleged to have been caused by the mis-selling. The Settlement Agreement included no admission of liability by Clydesdale. The parties, thereby, agreed to compromise the Appellant’s claim and settle the Dispute. The Appellant subsequently appealed to this Tribunal upon the issuing of a Closure Notice by HMRC bringing the amount received into the charge to tax.

The Grounds of Appeal upon which the appeal was launched assert that:

In support of the Appellant’s appeal, Mr Bowe submits that:

Materially, however, by an email dated 17 May 2023, the Appellant’s agent said this:

Having considered the evidence before me, I am satisfied that contrary to Mr Bowe’s submissions, the Appellant appears to accept that the payment it received was compensation for mis-selling IRHPs, and was agreed on a similar basis to that under the FCA Redress Scheme. Mr Bowe submits that where someone has been overcharged under a finance arrangement, and is compensated for the difference between the amount they actually paid and the amount they would have paid had they been sold a more appropriate financial product, this is not ‘income’ but is compensation for a “lost opportunity”, which is a ‘capital’ sum. Having reviewed the authorities, I am satisfied that Mr Bowe’s submissions are misconceived, and completely miss the mark.

I therefore turn to consider the correct tax treatment of the payment received by the Appellant.

The relevant principles to be applied to the tax treatment of compensation, such as that which arises in this appeal, has been the subject of some adjudication and consideration. The principles were set out in Attwooll, Spencer and Deeny, which I now go on to consider individually. The principles to be derived from those cases apply with equal force to the circumstances in this appeal.

The principle that compensation received in respect of a failure to receive sums which would have been taxable trading receipts in the hands of the relevant taxpayer should be subject to tax as trading income is founded on the judgment of Diplock LJ in Attwooll, and in the decision of the Court of Appeal in Spencer; which demonstrates that the same principle applies to compensation received in respect of expenses which have been treated as deductible trading expenses, and which would not have been incurred but for the action which gave rise to the claim to compensation. The case of Attwooll relates to a sum of money paid to replace income which would otherwise have been received. The same principle applies to the payment of a sum of money to make up for a liability to pay an excessive revenue expense.

In Attwooll, Diplock LJ set out a rule for determining the income or capital nature of monies received by a trader by way of compensation. The taxpayer in that appeal owned a jetty, which was damaged by the negligent handling of a tanker owned by a company (‘H Limited’). H Limited paid a sum (by way of damages) to the taxpayer, partly in respect of the cost incurred by the taxpayer in repairing the jetty and partly in respect of the consequential loss which the taxpayer had suffered because the jetty was out of use for an extended period while the repairs were carried out. The taxpayer also received a sum from its insurers in respect of the damage to the jetty, and legal expenses which it had incurred. The taxpayer was assessed to income tax on such part of the aggregate sums in question as exceeded the cost of repairing the physical damage to the jetty. This was on the basis that such amount represented a payment to the taxpayer for loss of profits and should, therefore, have been included in the taxpayer’s trading receipts.

The taxpayer appealed on the grounds that the jetty was a ‘capital’ asset and, therefore, that the amount in question had a capital nature as it was in respect of the damage to, and consequent sterilisation of, that capital asset. In finding against the taxpayer, the Court of Appeal held that a distinction should be drawn between:

The latter fell to be treated as ‘income’ and not ‘capital’ and, as such, amounted to a taxable revenue receipt. Willmer LJ said this, at p 803F-G; 804A:

Willmer LJ continued, at p 804E-F:

At p 806G; 806A-B, Willmer LJ said this:

Diplock LJ agreed, and said this at p 815D-816A-D:

As eloquently stated by Diplock LJ, there is, therefore, a “two-stage process”:

Diplock LJ concluded that compensation received in respect of a failure to receive sums which would have been taxable trading receipts in the hands of the relevant taxpayer should be subject to tax as trading income. As noted by Diplock LJ, the mere fact that a compensation payment was calculated by reference to something did not mean that that was the source of the compensation. In other words, the method by which compensation was calculated did not identify what the compensation was paid for. The method of calculation was no more than a factor which might assist in identifying the answer to that question. In this respect, Diplock LJ explained that where a trader receives compensation for the failure to receive money which, had it been received, would have formed part of the profits of the trade, that compensation forms part of the profits of the trade. The question is what was the compensation received for (i.e., what is it that the recipient had lost?). The legal right on which the compensation is based is not determinative, just as the method by which the compensation is calculated is not determinative.

In Spencer, the Court of Appeal dismissed an appeal about the nature of the compensation, agreeing with the decisions before it that it was ‘revenue’ in character, not ‘capital’. In that appeal, a counter-notice had not been served, due to negligence, meaning that Spencer incurred increased rental payments beyond what they should have been had the negligence not occurred. The taxpayer had a 15-year lease of business premises which were subject to a five-year rent review. The landlord served a notice of increase, suggesting a rent which was well in excess of the then current market rent for the property, and the taxpayer instructed an estate agent to serve a counter-notice objecting to that figure. As a result of the estate agent’s negligence, that counter-notice was not served and, consequently, the taxpayer incurred significantly more rent than it would otherwise have done.

The Court of Appeal held that the compensation which was paid by the estate agent to the taxpayer - in respect of that negligence - was subject to corporation tax as a ‘receipt’ of the taxpayer’s trade because it was paid for the loss suffered by the taxpayer, in the form of increased rental payments (which were deductible expenses of the trade) and not for the diminution in value of the lease to the taxpayer. The event which gave rise to the compensation payment to the taxpayer in Spencer was the negligent failure by the estate agent to serve the counter-notice. The consequence of that failure was that the rent payable under the lease became greater than the market rent which the taxpayer was entitled to pay under the terms of the lease. It was possible to describe the loss incurred by the taxpayer in that instance as the increased rent which the taxpayer became liable to pay as a result of the estate agent’s negligence or, alternatively, as the decline in the value to the taxpayer of the taxpayer’s lease caused by that additional rent. Both of those descriptions would have been accurate.

However, the Court of Appeal held that the correct approach was to identify the ‘reason’ for the compensation which was paid to the taxpayer. Kerr LJ, giving the substantive judgment, said this at p 261:

The decision of the Court of Appeal in Spencer demonstrates that the same principle applies to compensation received in respect of expenses which have been treated as deductible trading expenses, and which would not have been incurred but for the action which gave rise to the claim to compensation (i.e., the loss being compensated was the obligation to make additional payments, rather than the failure to receive further income). This was endorsed by Lord Hoffman in Deeny.

The correlation between compensation for foregone trading income, and compensation for additional trading expenses, was noted by Lord Hoffman in his decision in Deeny.

In Deeny, the relevant taxpayers were Lloyd’s names who were awarded damages against their managing agents and member’s agents for negligence in carrying out underwriting on their behalf. The principal source of the taxpayers’ loss was that the agents had failed to secure protection for the losses which the taxpayers then incurred in the course of their trade. Accordingly, the damages awarded to the names were such amounts as would have put the taxpayers in the same position as if the agents had arranged reinsurance in respect of those losses. The House of Lords held that the damages in question were taxable revenue receipts of the taxpayers’ trades because the taxpayers had entered into their contracts with the agents in the course of carrying on their underwriting trade. Lord Hoffmann went further than the other Law Lords in his judgement in saying that another reason why the compensation was subject to tax as trading income in the hands of the taxpayers was that it had been received as compensation for a liability to pay sums of money which were deductible trading expenses.

Lord Hoffman gave the opinion of the House of Lords. In a passage that was agreed to by the rest of the Judicial Committee, Lord Hoffman said this at p 308E:

Lord Hoffman also said this, at p 308J, when he was considering part of what Diplock LJ had said in Attwooll:

The correlation between compensation for foregone trading income and compensation for additional trading expenses was, therefore, noted by Lord Hoffman.

Having reviewed the authorities, I find that Mr Bowe’s submissions on the correct tax treatment of the settlement sum received by the Appellant completely miss the mark and cause the narrow and, I venture to add, simple issue in this appeal to be unnecessarily complex. The Appellant’s appeal follows two recent appeals before the FtT where each taxpayer - also represented by Mr Bowe - ran similar arguments to those being relied on in support of the appeal before me. Those appeals are Wilkinson and Hackett FTT. In both of those appeals, the FtT rejected Mr Bowe’s arguments. In Hackett FTT, Mr Bowe appears to have refined his argument to ‘opportunity cost’, whilst adding a separate ground relating to ‘capital’. In Wilkinson, the two appeared to be part and parcel of the same argument. Judge Beare said this, concerning a similar argument run by Mr Bowe:

Whist the following decisions are decisions of the FtT, I find them to be highly persuasive insofar as they sit well with the authorities referred to above, in the context of the situation which has arisen in this appeal.

The nature of compensation was an issue common to all of the appeals in Gadhavi. At the time that the appeal in Gadhavi was listed to be heard, Wilkinson (which I will return to shortly) had been designated as an informal lead case under Rule 5 of the Tribunal Procedure (First Tier Tribunal) (Tax Chamber) Rules 2009 (“the Procedure Rules”). Mr Roe (of Rational Tax) wished to be able to present arguments about the taxable nature of the compensation payments in the context of the Gadhavi appeals, and to submit expert evidence from aprofessor of economics and others in support of their approach.

In summary, Rational Tax’s position was that the compensation represents the customers’ “opportunity cost”, which is a non-taxable ‘capital’ item, rather than a reimbursement of excessive expenditure (which is a taxable revenue item (HMRC’s view)). Mr Roe was content for the application to be determined by the FtT by consolidating all the appeals, or by making Mr Wilkinson and the others “interested parties”, and allowing them to present their arguments as part of the Gadhavi hearing. Alternatively, he suggested that the hearing could proceed, but with the Tribunal reserving its decision until it had heard Rational Tax’s arguments. The FtT refused the application. In determining the correct tax treatment of compensation payments,Judge McKeever said this, at [63] to [65]:

The same view that was expressed by Judge McKeever in Gadhavi was expressed by Judge Beare in Wilkinson. Unfortunately, it has not been possible to cut down the relevant paragraphs in the decision as that would result in a lack of clarity as to the focus in an appeal of the nature of the appeal before me. Judge Beare said this, at [45] to [48]:

Similarly, in Hackett FTT, Judge Rudolf KC said this:

Judge Rudolf KC had earlier said this, at [170]:

The FtT’s decision in Hackett FTT was upheld by the UT in Hackett UT (Judges Ramshaw and Brannan). The UT said this in relation to the FtT’s conclusion concerning Mr Bowe’s submissions (referred to by the FtT at [182]):

I completely agree with those propositions. Having reviewed the authorities, it is clear that the legal source of the compensation is relevant, but does not resolve the issue of the nature of the payment; namely, the principle applied by the FCA to put the Appellant back into the position it would have been in had the mis-selling not occurred.

Mr Chacko acknowledges that there are two differences between Wilkinson and Hackett FTT, and the appeal before me. Those differences are that:

I have already determined that the Appellant accepts that the payment it received was compensation for the mis-selling of IRHPs, and was agreed on a similar basis to that under the FCA’s Redress Scheme. Under the terms which the FCA agreed with the banks, SMEs who were mis-sold IRHPs were entitled to “fair and reasonable” redress. As with any other tortious act, the legal principle involved was to put the relevant SME in the position in which it would have been had the mis-selling not occurred.

Having regard to the authorities, I proceed to, firstly, identify the reason why Clydesdale offered to pay and, ultimately, did pay the basic redress element to the Appellant. In other words, to adopt the language used by Diplock LJ in Attwooll (i.e., the first question/problem), I need to identify the source of that element of the compensation; and, secondly decide whether, if that sum of money has been received by the Appellant, it would have been credited to the amount of ‘profits’ (if any) arising in any year from the trade carried on’ (i.e., the second question/problem). This applies equally to compensation for a liability to pay a sum of money which was a deductible revenue expense: Deeney.

While one can certainly say that the compensation was paid “for” the mis-selling, in Diplock LJ’s two-stage test, this simply establishes the “source of the legal right” which entitles the Appellant to compensation. It does not resolve the issue of the nature of the payment. Consequently, the solution to the “first problem” identified by Diplock LJ, and further explained by Lord Hoffman, is that the compensation was paid for the Appellant’s liability to pay a sum of money which it had to pay because the instruments had been mis-sold to it. The “second problem” is whether the liability in respect of which the compensation is paid was a liability to pay money which was a revenue expense. The answer can only be that it was. The payments were properly deductible from the profits of the business. They were revenue expenses. It follows that the compensation paid by reference to those expenses must be a revenue receipt, and must constitute taxable income in the hands of the Appellant.

Despite the matters urged upon me by Mr Bowe, I am satisfied that while a taxpayer who has paid excessive amounts under a hedging product because they have been sold the wrong hedging product has lost the opportunity of acquiring a more suitable product, the compensation for the excessive payments is in the nature of revenue - for tax purposes - because the payments, when made, were expenses for tax purposes. Put plainly, the payment was not made to compensate for a “missed opportunity”. As the UT in Hackett UT said, at [96]:

Basic redress is taxable as income. It is compensation for having made excessive payments which were deductible business expenses. The basic redress cannot be compensation for the lost opportunity of choosing to not enter into the product, otherwise there would need to be evidence that the loss was caused by the mis-selling, and an evaluation of the financial loss occasioned by reference to that lost opportunity, when determining quantum. The basic redress scheme makes no reference to any such lost opportunity. The compensation is for the customer’s liability to make payments under the terms of the mis-sold product that they would not, but for the mis- sale, have made. The quantum of the redress is to refund the IRHP payments made (as calculated on a net basis so as to put the customer back in the position they would have been in). The method of calculating the quantum of the compensation does not identify what it was paid for. It is no more than a factor which may assist in the solution of the problem of identification: see Attwooll. The nature of what the compensation was paid for does not alter simply because the banks could take into account whether or not an alternative product would have been entered into. The burden lay with the bank, if they were asserting that the customer would have entered into an alternative product. Furthermore, the excessive payments, made under the Loans which were compensated under the Settlement Agreement, would have been deductible expenses of the Appellant.

I am satisfied that the costs involved in a mis-sold loan relationship unequivocally arise from that loan relationship, and amount to compensation to remedy those costs arising from it. The question whether a sum arises from a loan relationship or derivative contract was considered by the Court of Appeal in Union Castle, at [67] to [77], where, endorsing the UT, the Court of Appeal held that there needed to be a direct causal relationship between (in that case) the derivative contract and the loss on that contract (in that appeal a derecognition triggered by the taxpayer’s decision to issue shares, while it involved the contract losing value, did not arise from the contract). This was applied in the IRHP compensation context in Hexagon, where compensation was held to arise from the mis-selling by the bank, and not from the loan relationship itself. In this appeal, however, the hedging product was embedded within the Loans themselves. As considered earlier, a loan relationship is:

Therefore, even if the compensation was not income on ordinary principles, it is taxed as income because it is a profit on a NTLR.

For the reasons set out above, I have decided that the whole of the redress payment received by the Appellant as compensation for the mis-selling of the IRHPs is a revenue receipt of its business.

“Interest” follows on from the outcome in respect of basic redress. The three cases whose principles inform the analysis of what amounts to ‘interest’ for tax purposes are Westminster, Euro Hotels and Chevron.

In Westminster, interest was awarded in addition to damages as compensation and the House of Lords held that the interest element was taxable. In that appeal, a person who received damages for a failure to receive a sum of money which would have been due to him had the defendant not acted fraudulently received, as part of those damages, an amount equal to interest on the sum to which he would have been entitled if he had not been defrauded. That sum was calculated by applying an interest-rate to the sum which the relevant person should have received from the defendant from the date when the sum should have been received, down to the date of the judgement. The House of Lords held that the part of the overall ‘damages’ payment - which was the amount equal to interest - was ‘interest’ for the purposes of the schedule of the tax legislation under which interest was subject to tax. Viscount Simon said the following, at pp 396-397:

Lord Wright added this:

The House, therefore, rejected the argument for the taxpayer that the relevant sum could not be interest for that purpose because it was damages.

In Euro Hotels, established principles on the definition of ‘interest’ in financial transactions. In that appeal, a lease agreement between a landlord and its tenant - in relation to a site that was being developed - provided that once the aggregate payments made by the landlord for the purpose of carrying out the development exceeded a certain figure then, until the lease was granted, the landlord would pay interest on that aggregate amount. Sir Robert Megarry VC said this, at p 690F to 691:

Sir Robert Megarry held that that interest amount was not ‘interest’, properly so called, because in order for a payment to be interest, two requirements had to be satisfied:

The second of those requirements was not met because the sum of money by reference to which the payment was calculated was just a unit of calculation. It could not be said that that sum was in any way due from the tenant to the landlord

In Chevron, two groups of companies each held a production licence over adjacent areas of the North Sea. The two groups agreed that the two adjacent areas should be developed and operated as a single unit. As part of that overall agreement, it was agreed that all expenditure in relation to that single unit was to be shared in proportion to the total estimated oil attributable to each area but that, as and when the actual oil attributable to each area was known, an adjusting payment would be made between the parties to reflect that re-determination. The adjusting payment was expressed to include an amount of interest on the payment that was being made to reflect the re-determination. Sir Robert Megarry re-emphasised what he had said in Euro Hotels (p 697C):

Sir Robert Megarry held that the interest component was ‘interest’ properly so called because, although the sum of money which was due from one group to the other was not known at the outset, there was an obligation at the outset to make the adjustment payment once the oil attributable to each area was known. The interest component was, therefore, properly to be characterised as payment by time for the use of money.

The basic redress and the refund of bank charges (which I am satisfied are revenue expenses) represent the damages, and the banks agreed to add simple interest of 8% a year to these amounts. This is a time-based payment. It was paid only for the period during which a claimant was deprived of the money which was the subject of the claim. It was not part of the package of compensation claimed. The interest payment was intended to avoid the need for many to make consequential loss claims. The payment did not preclude a consequential loss claim where the claimant could demonstrate specific losses.

In relation to the appeal before me, the interest element of the compensation is an additional amount, which has been added to the award of the basic redress and refund of charges because the Appellant had been deprived of that money for a period. It is interest and is taxable. The financial loss arises because there was a liability to make payments under the mis-sold IRHP. There is nothing in the basic redress scheme that indicates that the loss is quantified by taking into account, in the calculation of quantum, the loan and the interest payments made. As Judge Rudolph KC said in Hackett FTT:

I am satisfied that the compensation in this appeal, while not segregated, was in the nature of ‘basic redress’ and/or ‘interest’ (i.e., to cover the additional amounts the Appellant paid under the Loans by virtue of the mis-sold IRHP elements, as opposed to other kinds of loss (for example, lost business opportunities or more usual consequential losses). The fact that the Appellant is within the charge to corporation tax, rather than income tax, has two material consequences:

The Appellant seeks to rely on ESC D33, which would typically be applied to exempt the first £500,000 of any gain. However, that is a concessionary provision and cannot be applied by the FtT when considering the Closure notice. If I were to find that the receipts were ‘capital’, then HMRC would need to consider the application of the concession. The FtT does not have the jurisdiction to determine the case on the basis of any such concession.

Having considered all of the evidence, and the authorities, I dismiss the appeal and uphold the Closure Notice. There is no suggestion that the quantum in the Closure Notice is in issue.

In conclusion, therefore, I hold that:

Accordingly, therefore, the appeal is dismissed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.