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Pru Loses GBP105m Claim Appeal

by Carla Johnson, Investors, London

26 September 2007

A special commission appeal by well-known life insurer Prudential has failed to claim GBP105m worth of foreign exchange tax relief.

The claim, which was requesting relief from tax generated via tax-efficient off-market swaps (TOMS), was first rejected by HM Revenue and Customs, with the official verdict confirmed earlier this month by special commissioners Sir Stephen Oliver and Theodore Wallace.

According to the AccountancyAge website, several other major corporations are likely to face a similar predicament after buying into these TOMS schemes, which largely exploit a significant loophole in the legislation which allows certain companies to claim back the premium paid on foreign exchange against tax.

TOMS schemes have reportedly cost the Exchequer as much as GBP1m .

Delivering their conclusions on the RBS short-term swap agreement under examination, the Special Commissioners observed that:

"We are satisfied that at least one of the purposes for which Prudential was party to the short-term swap agreement was a tax advantage purpose. Was that the main purpose or one of the main purposes? Hedging was not a main purpose of the short-term swap agreement. We have already observed that the Prudential Group had no need of GBP500,000,000 on 19 June 2002; and a full-term swap agreement of the same date as the short-term swap agreement could, we infer, have been given the same effective date as the short-term swap agreement. The remaining candidate as a “main purpose” was the investment opportunity presented by the front end payment. Mr Foley had GBP65,000,000 of what he called “idle” cash which, again to use his words, could be invested “on commercially acceptable arm’s length terms”."

"Did the Prudential’s decision to deploy the GBP65,000,000 of idle cash as the front end payment under the admittedly tax driven Ernst &Young Opportunity rank as a main purpose for which it entered into the RBS short-term swap contract? Prudential argue that it did. We find the evidence in support to be unconvincing. There is no evidence that Mr Foley or his team actually evaluated the return likely to be achieved from investing the GBP65,000,000 as a front end payment. Nor is there any evidence that Mr Foley compared the possible return on the £65,000,000 as a front end payment (which had the effect of pro tanto abating Prudential’s initial liability of 5.088 per cent over a short-term swap contract calculation) with other possible returns over a 3½ month period. Moreover, any real comparison would surely have taken into account the fact that Prudential was bound, regardless of the success of the Ernst & Young Opportunity, to have to pay GBP200,000 plus largely irrecoverable VAT on the Ernst & Young fees."

"For those reasons we are not satisfied that finding a better use for the GBP65,000,000 of idle currency was the main purpose for which Prudential was party to the RBS short-term swap contract. Prudential was implementing the scheme in the manner prescribed by Ernst & Young ...and using as much cash as was available for the purpose. It follows, we think, that the tax advantage of securing that GBP65,000,000 was brought into account as part of amount B was, to use the expression of Lightman J in SEMA (see above), more than “mere icing on the cake”. It was the main purpose."

With regard to the GSI swap contract also being studied, they announced that:

"The GSI arrangement differed from the RBS short-terms swap contract in two respects. First the GSI agreement provided cover from April until November 2002. From November onwards Mr Foley envisaged that an issue of “commercial paper” was to be made. Second, the front end payment of GBP40,000,000 paid by Prudential to RBS on 23 August 2002 was to come back to Prudential on 25 November 2002. The 23 August exchange had been expressed as Prudential making a front end payment of £40,000,000 as consideration for GSI agreeing to buy $250,000,000 for GBP203,420,055 in circumstances where the arm’s length exchange rate for $250,000,000 was GBP163,420,055."

"We accept that a swap was needed to protect the sterling value of the BPT&T loan denominated in dollars. We accept also that Prudential had cash reserves of at least GBP40,000,000 available at the time for short-term investment. There was no evidence that the benefit of investing in that manner had been evaluated. Nor was there any evidence that using the GBP40,000,000 to make a returnable front end payment was as good or better than any other investment."

"We are not persuaded that the main purpose or indeed one of the main purposes of the GSI swap arrangements was to provide Prudential with the opportunity of investing the £40,000,000 of idle money. The purposes for structuring the GSI agreement such that a GBP40,000,000 front end payment was to be made and for Prudential’s entering into it were, we think, together a tax avoidance purpose which was a main purpose if not the main purpose."

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