Commissioners of Inland Revenue v John Lewis Properties Ltd
| Jurisdiction | England & Wales |
| Judge | Lady Justice Arden,Lord Justice Dyson,Lord Justice Schiemann |
| Judgment Date | 20 December 2002 |
| Neutral Citation | [2002] EWCA Civ 1869 |
| Docket Number | Case No: A3/2001/1543 |
| Court | Court of Appeal (Civil Division) |
| Date | 20 December 2002 |
[2002] EWCA Civ 1869
Lord Justice Schiemann
Lady Justice Arden and
Lord Justice Dyson
Case No: A3/2001/1543
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF
JUSTICE, CHANCERY DIVISION
(The Hon Mr Justice Lightman)
Royal Courts of Justice
Strand,
London, WC2A 2LL
Launcelot Henderson QC and Michael Furness QC (instructed by The Solicitors of Inland Revenue) for the Appellant
David Goldberg QC and Wayne Clark (instructed by Messrs Lovells) for the Respondent
The Inland Revenue appeals against the order dated 13 June 2001 of Lightman J dismissing an appeal by it against the decision of a Special Commissioner (T.H.K Everett) dated 5 September 2000 on the grounds that the sum of £25,556,762.55 (which I will call "the proceeds") received by the respondent, John Lewis Properties plc ("JLP"), as consideration for an assignment of rents constituted a capital, and not an income, receipt. The judge's judgment is now reported at [2002] 1 WLR 35 [2001] STC 1118. Receipts are chargeable to corporation tax whether they are income or capital, but only if they are capital does the taxpayer have the ability to claim certain reliefs including the ability to roll over any gain into the costs of improving the properties.
There is no dispute about the facts. In essence, JLP owns the freehold or a long leasehold interest in five substantial properties ("the properties") which are let to John Lewis plc ("JL") on yearly tenancies. JL is the ultimate group holding company. In 1995 JLP entered into arrangements for factoring some of the rents receivable from the properties. By a deed of assignment dated 20 November 1995 ("the deed of assignment") made between JLP and a Dutch bank, Rabobank, JLP assigned to Rabobank the right to receive rents payable in respect of the five years and one day between 23 January 1996 up to and including 23 January 2001 in return for the proceeds. The proceeds were calculated as the value of the rents due to be received in that period, using a discount rate of about 7.6%. (There is no suggestion that that rate was not negotiated at arm's length). JLP gave notice of the assignment to JL. Rabobank and JLP also entered into a swap arrangement pursuant to which JLP would pay to or receive from Rabobank the amount by which a notional commercial floating rate of interest on an amount equal to the consideration for the assignment exceeded, or was less than, the discount rate of 7.6%. By a further agreement of the same date ("the guarantee and indemnity"), made between JLP, JL and Rabobank, JL gave certain warranties and undertakings to Rabobank in relation to its and JLP's financial position and (among other matters) agreed to indemnify Rabobank against non-payment of the assigned rents. Moreover, under clause 16 of the guarantee and indemnity Rabobank could require the transaction to be unwound if JL failed to pay any of the assigned rents.
Following the rental assignment, the bulk of the proceeds were used by the JL group to open new stores and to improve its existing stores. JLP now claims rollover relief in respect of this expenditure. In accordance with Financial Reporting Standard 5 ("FRS5"), Reporting the Substance of Transactions,JLP has prepared its statutory accounts (which are required to show a true and fair view) by accounting for the proceeds as an advance in its accounts and the assigned rents for the period under review as receivables, because the risk of non-payment remains with JLP. However, little argument has been addressed to FRS5 on this appeal. It is not clear to me why that course was taken since the question whether a receipt is capital or income has to be decided from a commercial point of view and in principle the accountancy treatment is, therefore, a relevant consideration.
There was no evidence from any officer or employee of JLP as to why the assignment was executed. There was expert evidence from a chartered accountant, Mr Philip Haberman, who analysed the theoretical distinctions between the position of JLP under the transaction and the position of JLP on the basis that no transaction had been carried out. These distinctions included a reduction in the value of the underlying properties, certainty of receipt, certainty as to timing, removal of economic risk, removal of regulatory risk, creation of opportunity and removal of administrative obligations, but it is not suggested that these distinctions were the actual reasons why JLP carried out the transactions. Mr Haberman also produced what he described as practical differences in economic terms. These included a table showing "the opportunity value" to the John Lewis Partnership group of the assignment on a pre-tax basis. He carried out the same exercise on a post-tax basis. Using the group's actual return on capital, he was able to show that the group's return on capital is greater if it received a sum of £25m. in year 1 than if it received the rents due each year. In cross-examination Mr Haberman agreed that the assignment was a financing operation and could be viewed as either a loan or purchase. The Special Commissioner accepted Mr Haberman's evidence ( [2001] STC 1118 at 1124). JLP called a further expert witness, Mr Richard Asher, a Chartered Surveyor. The opinion of Mr Asher was that:—
"The value of JLP's reversionary interests in the Properties would be reduced immediately following the Rental Assignment as any purchaser of those interests would have to take subject to the Rental Assignment and would only acquire the right to receive rentals after the five year Rental Assignment period had expired. The value of the Properties should gradually increase again as the period of the Rental Assignment outstanding reduces over time."
The Special Commissioner also accepted the evidence of Mr Asher ( [2001] STC 1118 at 1124). However, the amount of the reduction in value which in Mr Asher's opinion would occur was not quantified by him as at any point in time.
On this appeal it is common ground that the deed of assignment effected both an assignment of the contractual rights of JLP to receive the rents and the transfer of an interest in land. The judge was required to spend considerable time on that issue although it is of limited significance in relation to the capital/income issue for the reasons given below.
The only questions decided by the judge which arise on this appeal are the questions whether the proceeds constituted a capital or income receipt, and if the latter under which head of charge they were chargeable. The judge analysed the capital/income issue in these terms. He held that "the authorities offer as a guide the principle that a receipt for the recurrent produce of an asset, and compensation for the loss of such produce, or to make good a hole in the receipts from such produce, constitute income, whilst a receipt for the asset or part of the asset or for the permanent impairment or the sterilisation of an asset constitutes capital" (judgment, paragraph 18). In so doing the judge drew the hallowed distinction between the fruit of a tree and the tree itself. He further concluded from his survey of the authorities that it was clear that the receipt of a lump sum in consideration of the sale of an income stream, together with the underlying asset producing such income stream, was a capital receipt as was the receipt of a lump sum in consideration of an income stream when there was no underlying asset (for example, an annuity). In his judgment, the question raised by the present case was whether the position was the same where a lump sum was paid in consideration for an income stream but the underlying asset was retained by the vendor.
On this, the judge referred to Paget v IRC [1938] 2 KB 25 in which Lord Romer (sitting in the Court of Appeal) held that the proceeds of the sale for a lump sum of an annuity were capital and that this was so even where the subject of the sale was not the annuity for its whole duration but the right to be paid the annuity for a number of years or even for one year (pages 44/45). On this appeal (as before the judge), the Revenue challenges the correctness of Lord Romer's conclusions in this respect.
The judge then examined certain Australian cases which in the event he did not find persuasive as they conflicted with what Lord Romer had said in Paget. The judge also examined two recent decisions of the House of Lords, namely IRC v McGuckian [1997] STC 908 also [1997] 1 WLR 1991 and MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] STC 237. In the latter case the House of Lords restated the principles established in W T Ramsay Ltd v IRC [1982] AC 300. I shall have to examine these cases below but critically Lord Hoffmann indicated that a transaction without commercial reality which purported to exchange income for capital failed "to perform the alchemy of transforming the receipt of a dividend from the company into a receipt of a capital sum from someone else." (paragraph 58).
Having analysed the speech of Lord Hoffmann (with which the remainder of the House agreed), the judge expressed his conclusions thus:—
"37. The guidance afforded by Lord Hoffmann in my view supports the approach of Lord Romer in Paget and reinforces the view that the price received by JLP was capital and not income: (1) JLP was perfectly entitled for the avoidance of tax to structure its commercial transaction with the bank so that in place of an income receipt of rent it received a capital sum. There is no broad 'economic equivalence test'...
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