First Nationwide v HM Revenue and Customs
| Jurisdiction | England & Wales |
| Judge | Lord Justice Moses,Mr Justice Briggs,Lord Justice Rix |
| Judgment Date | 13 March 2012 |
| Neutral Citation | [2012] EWCA Civ 278 |
| Docket Number | Case No: A3/2011/1713 |
| Court | Court of Appeal (Civil Division) |
| Date | 13 March 2012 |
[2012] EWCA Civ 278
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
TAX AND CHANCERY CHAMBER
Mr Justice Warren, President and Judge Edward Sadler
Royal Courts of Justice
Strand, London, WC2A 2LL
Lord Justice Rix
Lord Justice Moses
and
Mr Justice Briggs
Case No: A3/2011/1713
Mr Malcolm Gammie QC (instructed by HMRC Solicitor) for the Appellant
Mr John Gardiner QC and Mr Philip Walford (instructed by Slaughter and May) for the Respondent
Hearing dates: 17 th-19 th January 2012
First Nationwide, a UK resident unlimited company, is a wholly-owned investment company subsidiary of the Nationwide Building Society. It sought, in the second half of 2003, to raise funds from Anglo Irish Bank for the use of the Nationwide Building Society. The structured finance transaction by which it sought to raise those funds was a combination of a stock loan agreement and what HMRC (the Revenue) contended to be a sale of the loaned securities by First Nationwide to Anglo Irish Bank and a re-purchase of similar securities by way of subscription (a repo).
Blueborder Cayman Ltd (Blueborder) raised £51.1m by issuing two classes of shares, Ordinary and First Issued Preference Shares, to be used for the purposes of the financing transaction. Blauwzoom (Netherlands Antilles), Blueborder's parent, subscribed for, and Blueborder issued, 1,050 Ordinary Shares with a nominal value of £1 each at a premium of £999 per Ordinary Share and 50,050 non-voting redeemable First Issued Preference Shares with a nominal value of £1 each at a premium of £999 per Preference Share. Thus Blueborder raised £51,048,900 on share premium account. The First Issued Preference Shares were then, for the purposes of the financing transaction, lent under a stock loan agreement to ABN AMRO (London branch) and, under a further stock loan agreement, ABN AMRO (London branch) subsequently lent them to First Nationwide. Those 50,050 First Issued Preference Shares were, it is agreed, overseas securities within the meaning of paragraph 1(1) Schedule 23A, Income and Corporation Taxes Act 1988 (" ICTA"). First Nationwide then sold the 50,050 First Issued Preference Shares to Anglo Irish Bank for the sum of £50,314,975. Anglo Irish Bank was to obtain reimbursement through the payment of two dividends by virtue of dividend rights attaching to the First Issued Preference Shares under Blueborder's Articles of Association. The First Issued Preference Shares carried a right to a dividend on 29 December 2003 of £25,500,000, but, it is important to record, this was a right to payment of dividends exclusively out of share premium. The Second Preference Dividend was payable, similarly, exclusively out of share premium in the sum of £25,500,000 in total on 29 March 2004. By that means, Anglo Irish Bank obtained a repayment to which was added the right to redeem the First Issued Preference Shares, exercisable by both Anglo Irish Bank and Blueborder for the sum of £1m.
First Nationwide then had to satisfy its obligation in relation to the First Issued Preference Shares, the subject of the stock loan agreement with ABN AMRO. It satisfied that obligation by subscribing, pursuant to an agreement between First Nationwide and Blueborder, for 50,050 Second Issued Preference Shares.
Pursuant to the stock loan agreement First Nationwide was obliged to pay to ABN AMRO, in respect of each dividend paid on the First Issued and Second Issued Preference Shares, a manufactured dividend equal to the amount of the First Preference Dividend and the Second Preference Dividend. In its self-assessment to corporation tax for the accounting period ending 31 March 2004, First Nationwide deducted the £51m, paid as manufactured dividends to ABN AMRO pursuant to the stock lending agreement, as expenses of management. Such a deduction was only permissible if the dividends were payments of an income nature, charged to tax under Case V of Schedule D, being "income arising from possessions out of the United Kingdom". If those manufactured dividends were of an income nature they were deductible by virtue of Regulation 4(1)(c) of the Income Tax (Manufactured Overseas Dividends) Regulations 1993. The definition of a manufactured overseas dividend is contained within paragraph 4(1) Schedule 23A ICTA 1988: an overseas dividend is defined as "any interest dividend or other annual payment payable in respect of any overseas securities" (paragraph 1 of Schedule 23A). Regulation 2(1) of the 1993 Regulations adopts the definitions within Schedule 23A.
The efficiency of the structured finance transaction into which First Nationwide entered depends upon the deductibility of those dividends: such a deduction produces an income rather than a capital loss. It is in that context that the first issue in this appeal arises: were the payments of an income nature? The Revenue contends that since the dividends were paid out of the share premium account of Blueborder they constituted capital payments and were, accordingly, not deductible.
The second issue relates to the subscription by First Nationwide of the Second Issued Preference Shares for £1m. The Revenue contends that the subscription constitutes the buying of similar securities for the purposes of the repo legislation (s.737A and 730A ICTA). If the Revenue is correct then the effect of those statutory provisions is to deem an income payment (a deemed manufactured dividend representative of the preference dividends of £51m) to First Nationwide. That deemed manufactured payment would be taxable income of First Nationwide, offsetting the claimed deduction of the manufactured dividends paid by First Nationwide to ABN AMRO. Judge Berner, as he then was, in the First-Tier Tribunal (Tax) [2010] SFTD 408, upheld First Nationwide's appeal against the Revenue's amendment of its self-assessment on both issues. The Upper Tribunal [2011] STC 1540 dismissed the Revenue's appeals. The Revenue, by way of appeal, now seeks to overturn the conclusions of both Tribunals. Both the Tribunals set out the facts in detail. Most of the facts were agreed save for a dispute between experts on Cayman Islands law. The facts have now been set out twice in both decisions and I incorporate them into this judgment by way of Annex I.
Dividends: Capital or Income?
The essential question, in relation to the first issue, is whether the Preference Dividends, payable as they were exclusively out of share premium, were income payments or were, as the Revenue contended, payments of capital. There was no dispute between the experts that, for the purposes of Cayman Islands company law, the Preference Dividends constituted dividends (First-Tier Tribunal [8]). But that is not determinative of the answer, as a matter of United Kingdom tax law, (see Upjohn LJ in Rae v Lazard Investment Co Ltd [1963] 41 TC 1, 20). The taxpayer contended that the distinction between capital and income turned on the legal machinery employed to make the two distributions of £25,500,000. The Revenue argued that Blueborder's Articles of Association engrafted the share premium onto the corpus of the shares and that corpus was diminished on payment of the First and Second Preference Dividends. The distributions, in short, amounted to return of the share premium as capital forming the body of the foreign possession.
The starting point must be the legal mechanism by which the First and Second Issues Preference Dividends were paid. They were dividends paid out of the share premium account. That, contends First Nationwide, is not merely the starting point; it is the finishing point. The mechanism by which the payments of £51m were made, namely the payment of dividends, determines the character of the payments. They were, as dividends, necessarily income payments.
This simple and clear proposition rests on two foundations: the treatment of share premium in United Kingdom jurisprudence and its treatment under Cayman Islands' Companies Law.
The jurisprudence is well-established. Payments made by a company in respect of shares are either income payments, or, if the company is not in liquidation, by way of an authorised reduction of capital. The courts have recognised no more than that dichotomy. The distinction has depended upon the mechanics of distribution. If the payments are made by deploying the mechanisms appropriate for reduction of capital, then they are payments of capital. Such mechanisms can be readily identified as designed to protect the capital of a company. If the payments are not made by such mechanisms but are made by way of dividend, they are income payments. In R.A. Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720, trustees sought a ruling whether a payment of a dividend out of the proceeds of the sale of breeding stock was income belonging to those beneficially entitled to the income of the trust estate. The Board's opinion, expressed by Lord Russell, is authority for the proposition that the form which the distribution takes determines whether it is a capital or income distribution:—
" …moneys paid in respect of shares in a limited company may be income or corpus of a settled share according to the procedure adopted, i.e. according as the moneys are paid by way of dividend before liquidation or are paid by way of surplus assets in a winding-up". (page 729)…
"(2) A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorized reduction of...
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