Wednesday Law Report: Computation of profits for corporation tax

13 January 1999

Commercial Union Assurance Co plc v Shaw (HMIT)

Court of Appeal (Lord Woolf, Master of the Rolls, Lord Justice Peter Gibson and Lord Justice Brooke) 21 December 1998

A TAXPAYER company which had made payments of interest constituting charges on income and received foreign income subject to foreign tax qualifying for double taxation relief was not entitled to compute its profits in such a way as to produce an excess of charges on income capable of being carried forward to a subsequent accounting period.

The Court of Appeal dismissed Commercial Union's appeal against a decision of Harman J, dismissing its appeal against corporation tax assessments for the eight accounting periods in the years 1984 to 1991 and against the Revenue's refusal to allow its claim to carry forward losses in the form of excess charges on income in respect of the last three of those periods.

Commercial Union had profits including dividends in respect of which tax was payable under the laws of territories outside the UK. In each of the relevant periods Commercial Union had made payments of interest constituting charges on income and received foreign income subject to foreign tax qualifying for double taxation relief ("DTR"). It had purported to allocate to its foreign income only so much of the charges on income as would leave the corporation tax otherwise payable on that foreign income equal to and offset by DTR.

The primary issue on the appeal was whether Commercial Union was entitled to compute its profits in that way, producing an excess of charges on income capable of being carried forward to a subsequent accounting period.

Graham Aaronson QC and Malcolm Gammie (Linklaters & Paines) for Commercial Union; Ian Glick QC and Jonathan Peacock (Solicitor of Inland Revenue) for the Crown.

Lord Justice Peter Gibson said that Commercial Union submitted that DTR came within the words "other relief from tax" in section 338(1) of the Income and Corporation Taxes Act 1988, so that the total profits had to be treated as reduced by DTR. However, section 338(1) did not assist Commercial Union because DTR was not a relief from tax which reduced profits, but was a credit to be allowed against UK tax.

The scheme of the corporation tax legislation required first the ascertainment of income from a particular source and chargeable gains, as reduced by any relief applicable to income from that source or to those gains, then the ascertainment of the total profits by aggregating the income from the various sources and the gains, as reduced by any relief applicable to those total profits.

Once the amount of the net total profits had been ascertained the corporation tax prima facie chargeable on the total profits could be determined. That corporation tax might in turn be reduced or extinguished by other reliefs which were expressed to apply to that tax: only then was the amount of corporation tax payable ascertained.

Commercial Union further relied on the fact that it was entitled to use its power of allocation under section 797(3) to allocate charges on income in such amounts and to such of its profits as it chose. However, the right to allocate under section 797(3)(a) of the Act existed only for the purposes of the section, which was to set foreign tax against UK tax on the same profits, and Commercial Union had aimed beyond that limited purpose.

Moreover, the exercise of the right to allocate could not affect the calculation of whether in a given accounting period the charges on income paid by Commercial Union exceeded the amount of the profits against which they were deductible. Section 393(9) did not permit the carry forward of charges on income which were less than the amount of Commercial Union's profits against which they were deductible. Consistently with that, section 797(3) did not permit a company to allocate to profits a deduction greater than the amount necessary to reduce those profits to nothing.