Dividends - Deduction of tax - Taxpayer company self-assessing corporation tax for relevant accounting period

First Nationwide v Revenue and Customs Commissioners: Court of Appeal, Civil Division (Lords Justice Rix, Moses and Mr Justice Briggs): 13 March 2012

The respondent taxpayer was an unlimited company based in England and Wales. It was the wholly owned subsidiary of the Nationwide Building Society (Nationwide). The taxpayer sought to raise funds from the Anglo Irish Bank (Anglo) for the use of Nationwide. Under a structured finance transaction, B, a company registered in the Cayman Islands, raised £51.1m by issuing two classes of shares: ordinary and first issued preference shares (preference shares).

B's parent company was BZ, a company registered in the Netherlands Antilles. BZ subscribed for, and B issued, 1,050 ordinary shares and 50,050 non-voting redeemable preference shares. Consequently, B raised £51,048,900 on share premium account. The preference shares were then lent under a stock loan agreement to ABN AMRO (ABN) and, pursuant to a further stock loan agreement, lent to the taxpayer. Those preference shares were overseas securities within the meaning of paragraph 1(1) of schedule 23A to the Income and Corporation Taxes Act 1988 (ICTA). The taxpayer then sold the preference shares to Anglo for £50.3m. The preference shares carried a right to a dividend of £25.5m, but, that was a right to payment of dividends exclusively out of share premium. A second preference dividend was payable three months later, also in the sum of £25.5m and also payable out of share premium.

The taxpayer subscribed, pursuant to an agreement between it and B, for 50,050 second issued preference shares (preference2 shares) in return for £1m. The taxpayer was obliged to pay ABN, in respect of each dividend paid on the preference and preference2 shares, a manufactured dividend equal to the amount of the first and the second preference dividend, namely £51m. In its self-assessment tax return, the taxpayer deducted the £51m as expenses of management. The Revenue and Customs Commissioners (Revenue) contended that there had been a sale of the loaned securities by the taxpayer to the lender and a re-purchase of similar securities by way of subscription.

It considered that, first, since the dividends had been paid out of the share premium account of B, they had constituted capital payments and so had not been deductible, and, second, that the subscription for the preference2 shares constituted the buying of similar securities for the purposes of sections 737A and 730A of ICTA, the effect of which had been to deem an income payment to the taxpayer which would have been taxable income of the taxpayer and would have offset the claimed deduction of the manufactured dividend paid to ABN. The Revenue, therefore, amended the taxpayer's self-assessment return. The taxpayer successfully appealed to the First-tier Tribunal (Tax Chamber). The Revenue was unsuccessful in its appeal to the Upper Tribunal (Tax and Chancery Chamber). The Revenue appealed.

The issues for determination were: (i) whether the preference dividends, which had been payable exclusively out of share premium, had been income payments or payments of capital; and (ii) whether the taxpayer's subscription for, and B's issue of, the preference2 shares had constituted a buying back of similar securities within the meaning of sections 737A and 730A of ICTA. Consideration was given to sections 737B and 730B of ICTA. The appeal would be dismissed.

(1) Applying established authority to the instant case, the character of the payment in the hands of the taxpayer was a matter for domestic legislation, with the law of the Cayman Islands being relevant but not determinative. Domestic law recognised only capital or income payments. Further, it was the form by which the payments were made which determined their character. Since the disputed payments had been made having adopted the mechanism of distribution by way of dividend, that mechanism dictated the conclusion that the payments had been income and not capital (see [25], [34], [35] of the judgment). Hill v Permanent Trustee Co of New South Wales Ltd [1930] All ER Rep 87 considered; Drown v Gaumont-British Picture Corpn Ltd [1937] 2 All ER 609 considered; Duff's Settlement, Re, National Provincial Bank Ltd v Gregson [1951] 2 All ER 534 considered; IRC v Reid's Trustees [1949] 1 All ER 354 applied; Rae (Inspector of Taxes) v Lazard Investment Co Ltd (1963) 41 TC 1 applied; Courtaulds Investments Ltd v Fleming (Inspector of Taxes) [1969] 3 All ER 1281 considered.

(2) Sections 737A, 737B, 730A and 730B of ICTA did not admit of a construction which elided the buying of similar securities with the subscription and issue of those shares. Those provisions related to the purchase of shares, the transfer of a chose in action, and not to the creation of a chose in action which was not in issue at the time of subscription and which only came into existence following subscription on the issue of the shares. Had parliament intended to include within the scope of the provisions a subscription for shares, then it would have said so (see [30] of the judgment).

On the facts, the taxpayer had not bought similar securities for the purpose of section 737A and 730A of ICTA (see [33]-[35] of the judgment). VGM Holdings Ltd, Re [1942] 1 All ER 224 considered.

Decision of the Upper Tribunal (Tax and Chancery Chamber) [2011] STC 1540 affirmed; John Gardiner QC and Philip Walford (instructed by Slaughter and May) for the taxpayer; Malcolm Gammie QC (instructed by the Revenue and Customs Commissioner solicitor) for the Revenue.