STICS, Strips and Discounting – first round to HMRC

In Savva and others v HMRC, the Tribunal held that the return was taxable, and in so doing considered the meaning of 'discount' and 'security' for relevant tax purposes.

03 October 2013

In Savva and others v HMRC [2013] UKFTT 211 (TC) the First-tier Tribunal had to consider the tax treatment of a marketed investment product.  Essentially the question was whether an interest-like return arising to investors was subject to income tax or not.  Consistently with another similar recent case (Malcolm Healey v HMRC [2013] UKFTT 176 (TC)), the Tribunal held that the return was taxable, and in so doing considered the meaning of 'discount' and 'security' for relevant tax purposes.

Facts

Various individuals had invested in a product marketed by UBS Wealth Management. The product was called a STICS (Sterling Investment in Capital Security) and was intended to give the investor rights against UBS in respect of the principal element of fixed rate notes issued by another bank.

By way of example, one of the investors, Mr Savva, paid approximately £1.92 million for STICS with a face value of just over £2 million on 28 September 2004. Then on 5 October 2004, the fixed rate notes were issued by the other bank to UBS at par and subsequently 'stripped', so that the interest payments were separated from the principal element. The principal element was held under the name of UBS. In its records, UBS then allocated interests in the stripped fixed rate note to Mr Savva and other investors.

The fixed rate notes redeemed at par on 27 January 2006. Mr Savva received payment under his STICS on the same day.

Decision

The First-tier Tribunal had to decide two questions. First, was the investor's profit from the investment to be treated as a 'discount', and so treated as interest for income tax purposes? Alternatively, was the profit in any case to be taxed as income on the basis that it arose from the disposal of a 'deeply discounted security'?

The taxpayer argued the investment was in an interest bearing instrument which was issued and redeemed at par and that the return was essentially of a capital nature which did not fall to be taxed as income. There was no discount element and nor were the fixed rate notes 'deeply discounted securities' as they had not been issued at a discount (the taxpayer's return was also not subject to capital gains tax on the basis of the nature of the fixed rate notes).

The First-tier Tribunal, after considering relevant case law, took a broad approach to the meaning of 'discount', not limiting the concept to particular types of instrument or requiring there to be a security as such. The investor had simply paid the net present value of a right to a future payment, or in other words an amount discounted to what was payable at maturity. The investor received no interest or other return, which pointed towards the investor's return having an income nature. Therefore, according to the Tribunal, the return was to be treated as a discount and taxed as income.

On the second point, the investor could only be taxed under the 'deeply discounted security' rules if the investment was itself a 'security' which had been 'issued' at a discount. For the taxpayer, it was argued that the investment was in the underlying fixed rate notes themselves. As these had been issued at par, they could not be deeply discounted securities. HMRC argued that the investor had purchased an interest in the STICS which was to be treated as a separate security from the underlying fixed rate notes and that the STICS had been issued by UBS. The First-tier Tribunal agreed with HMRC, finding that the STICS had certain features of securities (in particular, that they were capable of being assigned and there was a structure of permanence) and that because they were capable of being represented by a distinct entry in a clearance system, they were sufficiently different from the underlying notes.

Had the product been acquired on or after 2 December 2004 it would probably have been caught by the corporate stripping rules (sections 452A to 452G ITTOIA 2005) which deem such products to be deeply discounted securities whether or not they would otherwise be so. The tribunal agreed with HMRC that this did not shed any light on the application of the previous legislation (even though the fact new legislation had been enacted does suggest that there was some room for doubt as to the previous tax treatment).

Comment

The case provides some degree of commentary on the meaning of 'discounts' and 'securities' (and when securities are 'issued') for relevant tax purposes. The technical analysis is, however, not as detailed as it might be and could well be susceptible to challenge on appeal. Certainly, there may be scope for questioning whether the Tribunal was correct in applying such a broad meaning of 'discount' or in its categorisation of the STICS as securities which had been issued.

Separately, it is interesting to note that HMRC has recently highlighted this particular case on its 'spotlights' page. HMRC is seeking to encourage investors in such products to settle (whereas, the focus of the spotlights page is generally on products which are still being marketed).

If you have any queries please contact Ian Carnochan.

Key contact

Ian Carnochan

Ian Carnochan Partner

  • Tax
  • Corporate Tax
  • Real Estate Tax

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