Halifax Plc v Davidson (HM Inspector of Taxes)
| Jurisdiction | England & Wales |
| Judgment Date | 31 May 2000 |
| Date | 31 May 2000 |
| Court | Special Commissioners |
special commissioners decision
STEPHEN OLIVER QC and DR A N BRICE (SPECIAL COMMISSIONERS)
1. On 1 June 1997 Halifax plc succeeded to all the "properties, rights and liabilities" (to use the words of the Transfer Agreement) of Halifax Building Society. These covered the core business of mortgage lending in the UK and holding personal deposits and included shares in various operating subsidiaries. Halifax plc had been an existing member of the Halifax Building Society group. Shares in Halifax plc (listed on the London Stock Exchange) were issued to voting members of Halifax Building Society (comprising essentially its mortgage borrowers and its depositors) and staff. Members who were not entitled to shares received "statutory cash bonuses". Until then the core business of making mortgage loans and accepting deposits had been carried on by the Halifax Building Society under the regulatory regime imposed by the Building Societies Acts (BSA) and implemented by the Building Societies Commission. From then on that core business was conducted by Halifax Plc as a bank regulated by the Bank of England.
2. In this decision we use the terms Halifax Building Society (or "the building society" for short), and Halifax plc (or "the plc" for short) where we refer specifically to the activities, rights, liabilities etc of those two entities. Otherwise we use this term "the Halifax" which refers to Halifax Building Society until 1 June 1997 and to Halifax plc thereafter.
3. The costs of conversion, which included statutory cash bonuses of some £14.9 million, amounted in aggregate to some £184.8 million. Deductions have been made for this expenditure in computing the Halifax's profits for tax purposes for the periods in which it was incurred. The Inland Revenue have disallowed the full amount as a deduction on the grounds, firstly, that it was capital expenditure and, secondly, it was not incurred wholly and exclusively for the purposes of the Halifax's trade.
The Halifax has appealed. We have been asked to resolve the issues as matters of principle leaving amounts to be agreed. This appeal is the first of four appeals heard successively. These are
Woolwich plc v Davidson (SpC 240)
Northern Rock plc v Thorpe (SpC 241)
Alliance & Leicester plc v Hamer (SpC 242)
4. Documentary evidence included -
Accounts of Halifax Building Society and Halifax Plc for the periods to which this dispute relates.
Transfer Document issued to all members in pursuance of requirements of BSA Transfer Agreement of 20 December 1996
Stock Exchange Listing Particulars
Business Plan dated 26 July 1996 provided for Bank of England and update dated 10 March 1997
Building Societies Commission Guidance Note entitled "Conversion Procedures"
Board minutes, Conversion Committee Minutes and related reports and letters: these will be referred to where relevant
Press releases
Letters of engagement and invoices relating to services provided by lawyers, accountants, merchant banks, public relations advisers and stock brokers
Internal conversion documents
Communications with members and customers etc
Correspondence with Inland Revenue
Sample invoices etc.
5. The following witnesses provided witness statements, attended and gave evidence in person for the Halifax -
(i) H J Foulds, the chairman of the Halifax during the period in which it converted from a building society to a bank. Where Mr Foulds' oral evidence is referred to, it is identified by reference to the day and the page of the transcript (e.g. 5/20).
(ii) Ronald McNeill Paterson FCA gave evidence on the accounting treatment of the costs to which this appeal relates. His qualifications are summarized in paragraph 100 below.
6. Witness statements of witnesses for the Halifax were provided by -
Terence Mathews, a full-time member of the Building Societies Commission until his retirement in 1995.
Christopher Knight, managing director of Deutsche Bank. Deutsche Bank's advisory activities were conducted under the name Deutsche Morgan Grenfell. In March 1996 Deutche Morgan Grenfell was appointed to act as merchant bank to the Halifax in connection with its proposed conversion.
David Walkden, assistant General Manager of the Halifax, Commercial Lending, since 1993. He held the role as Programme Manager co-ordinating the conversion process until November 1997.
7. T C Carne FCA, Advisory Accountant to the Board of Inland Revenue, whose other qualifications are set out in paragraph 101 below, provided a witness statement and gave evidence in person on the accounting treatment of the costs to which this appeal relates.
8. The first issue is whether the expenditure is excluded from deduction by Income and Corporation Taxes Act 1988 section 74(1)(a)(the Taxes Act) on the grounds that it was not laid out wholly and exclusively for the purposes of the relevant trade. It was not in dispute that Halifax plc succeeded to Halifax Building Society's "trade". The Inland Revenue accept that the trade carried on before conversion was the same as that carried on after conversion. They do not therefore contend that the expenditure is to be excluded from deduction as expenditure of Halifax Building Society on the grounds that it was incurred for the purpose of a different trade, i.e. that of Halifax plc. They accept that the expenditure was incurred for the purposes of the Halifax's trade. Their case is that the expenditure was not incurred exclusively for the purpose of the Halifax's trade because it was incurred for other purposes which were non-trade purposes so far as concerned the Halifax. These other purposes included benefiting the trades of the Halifax's subsidiaries, benefiting its non-trading "holding company" function, securing a merger with the Leeds Permanent Building Society ("the Leeds"), resolving a perceived conflict between the interests of customers who were members and customers who were not and releasing value to members.
9. The case for the Halifax, put shortly, is that the sole purpose of the expenditure was to rid it of the regulatory impediments to the efficient and competitive carrying on of its trade, these impediments being imposed by the Building Societies Commission in pursuance of the BSA. The Halifax could only achieve that by becoming a bank regulated by the Bank of England and this meant converting. Conversion could only be effected if a sufficient number of the members could be persuaded to vote and a sufficient number of them could be persuaded to vote in favour of conversion. The subsidiaries were separately regulated and it was not part of the purpose to benefit either individual subsidiaries or the Halifax's holding company operation. The first issue is dealt with in paragraphs 45 to 97 below.
10. The second issue is whether the expenditure is to be excluded from deduction by reason of its capital nature, as the Inland Revenue contend. This is dealt with in paragraphs 98 to 207 below.
11. The costs which are the subject matter of the present dispute were incurred in the period from 1 January 1996 to 31 December 1998. They related to the steps required to implement the conversion process. The event that triggered the conversion process was the decision in principle of the board of directors of Halifax Building Society on 19 October 1994 to convert at a time in the future to a public limited company regulated as a bank; this was followed on 25 November 1994 by a Press Release of the Halifax and the Leeds Permanent Building Society ("the Leeds") announcing that they intended to merge and subsequently to convert to a Plc. The conversion was achieved under section 97 of BSA 1986.
12. The costs were incurred in six main areas:
(i) Corporate finance: This involved preparation of business plans to meet Bank of England requirements for Banking Act 1987 authorization and the preparation of the application for authorization. "Due diligence" work was carried out by KPMG. Share rights of members had to be calculated. A suitable capital structure following flotation had to be prepared and other associated tasks had to be completed.
(ii) Legal and regulatory: This involved satisfaction of legal and regulatory requirements of the Building Societies Commission, the Bank of England and the London Stock Exchange, the preparation of the Transfer Document and of the Listing Particulars. "Due diligence" work including the verification of corporate and subsidiary companies structure was carried out and the Memorandum and Articles of Association were prepared.
(iii) Register: This involved the production of a validated register of members for the purposes of the voting process and for share and cash bonus distributions. Much of the work was involved in "de-duplicating" membership records.
(iv) Logistics: This involved mailing and all customer contact, provision of programme support, timetable management and accounting and budgetary control, preparation and implementation of the special general meeting at which the vote was taken.
(v) Communications: Effective communication was required between the Halifax and its members, customers, employees/pensioners, the media, institution investors and analysts, overseas markets, regulators and politicians by means of mailings, press releases and the telephone "helpline".
(vi) Treasury: Work was carried out to achieve Bank of England approval involving the satisfaction of Bank of England reporting requirements, due diligence work, provision of investor relation services and a new listings for security.
Of the total expenditure of £184.8 million, the following are the principal ingredients:
Staff and staff-related costs £20.2 million
Literature/stationery/printing £20.1 million
Postage and mailing £22.8 million
Communications and advertising £25.5...
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