Factual and Procedural Background
This opinion concerns an appeal by the Commissioners for Her Majesty's Revenue and Customs ("Appellants") against a decision of the First-tier Tribunal Tax Chamber involving First Nationwide ("Respondent"), a wholly owned investment company subsidiary of Nationwide Building Society ("the Society"). The dispute relates to tax treatment of deductions for management expenses in respect of manufactured dividends paid under a stock lending agreement involving shares in a Cayman Islands company ("Blueborder Cayman Ltd").
Blueborder issued preference shares at a premium, which were lent under stock lending agreements and subsequently sold to Anglo Irish Bank. Dividends paid by Blueborder out of its share premium account ("Preference Dividends") were paid to Anglo Irish Bank, and First Nationwide paid corresponding manufactured dividends to ABN AMRO Bank under its stock lending obligations. First Nationwide claimed a £51 million deduction for expenses of management in its corporation tax self-assessment for the period ending 31 March 2004. HMRC disallowed this deduction, leading to the appeal.
The First-tier Tribunal Judge held that the Preference Dividends were "dividends" and "overseas dividends" within the relevant UK tax legislation and that the sale and subscription transactions did not constitute a sale and repurchase of securities for the purposes of sections 737A and 730A ICTA. HMRC appealed with permission.
Legal Issues Presented
- Whether the two distributions made by the Cayman Islands company to Anglo Irish Bank were "dividends" and "overseas dividends" for the purposes of the manufactured payments provisions found in Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993.
- Whether a sale of preference shares followed by a subscription for preference shares constitutes a sale and repurchase of securities under sections 737A and 730A ICTA, as extended by subsections 737B(5) and 730B(2)(a).
Arguments of the Parties
Appellants' Arguments
- The Preference Dividends paid out of the share premium account are not "dividends" or "overseas dividends" within the meaning of the UK tax legislation because they represent a return of capital rather than income.
- The meaning of "dividend" in the manufactured payments legislation should reflect current English company law, which prohibits dividends paid out of share premium account.
- The statutory language in sections 737A and 730A ICTA regarding "buying similar securities" includes subscription for new shares, so the subscription for Second Issued Preference Shares should be treated as a purchase under the repo provisions.
- The economic substance of the transactions supports treating the subscription as a repurchase, ensuring tax symmetry in repo transactions.
Respondent's Arguments
- The Preference Dividends are lawful dividends under Cayman law and fall within the ordinary meaning of "dividend" for the purposes of the manufactured payments provisions.
- The share premium account under Cayman law is distributable profit, not capital, and dividends paid out of it should be treated as income in the hands of the recipient for UK tax purposes.
- The statutory language in sections 737A and 730A ICTA, including related definitions and context, excludes subscription for new shares from the meaning of "buying" or "purchase" of securities.
- The sale and subscription transactions do not amount to a sale and repurchase of securities under the relevant statutory provisions.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| IRC v Reid's Trustees [1949] AC 361 |
Determination of whether a receipt is capital or income depends on the legal machinery employed and the law of the relevant jurisdiction. |
Used to analyse whether Preference Dividends were capital or income; the court emphasized looking at the legal mechanism under Cayman law. |
| Rae v Lazard [1963] 1 WLR 555 |
Foreign law governs the characterisation of distributions; English law respects foreign legal machinery unless it is unreasonable. |
Applied to conclude that Cayman dividends paid out of share premium account are income for UK tax purposes given the similarity of legal machinery to English law. |
| Re Duff's Settlement Trusts [1951] Ch 721 |
Prior to Companies Act 1948, dividends could be paid out of share premium account and were income in the hands of recipients. |
Supported the proposition that dividends paid out of share premium account are dividends in the ordinary sense and income in the recipient’s hands. |
| Drown v Gaumont-British Picture Corporation Ltd [1937] 2 All ER 609 |
Share premium is distinct from share capital and may be treated as distributable profit available for dividend. |
Supported the conclusion that Cayman share premium account is distributable profit and dividends paid out of it are income. |
| Quayle Munro Ltd [1992] SC 24 |
Cancellation of share premium releases funds distributable as profits by way of dividend. |
Referenced to support the view that share premium can revert to distributable profit under Cayman law. |
| Verner v General and Commercial Investment Trust [1894] 2 Ch 239 |
Dividends presuppose profits and cannot be paid out of capital. |
Used to emphasize the distinction between capital and profit in dividend distributions. |
| Esso Petroleum Co Ltd v Ministry of Defence [1990] Ch 163 |
Ordinary meaning of "dividend" as a payment out of profits in respect of a share. |
Considered but found not directly helpful to the specific statutory context. |
| Memec Plc v The Commissioners of Inland Revenue [1998] STC 754 |
Reiterated the ordinary meaning of "dividend" as payment of part of profits for a period. |
Considered but not determinative in the special statutory context. |
| Marshall (Inspector of Taxes) v Kerr 67 TC 56 |
Principles governing interpretation of statutory deeming provisions. |
Guided careful interpretation of the repo provisions to avoid absurdity. |
| Jenks v Dickinson [1997] STC 853 |
Interpretation of statutory deeming provisions. |
Applied in interpreting sections 737A and 730A ICTA. |
| DCC Holdings (UK) Ltd v HMRC [2011] 1 WLR 44 |
Clarification of the scope and limits of statutory deeming provisions in tax law. |
Informed the approach to the interpretation of the "sale and repurchase" provisions. |
| Re VGM Holdings Ltd [1942] 1 Ch 235 |
Distinction between subscription for shares and purchase of existing shares; subscription is not a purchase. |
Relied upon to conclude that subscription for shares does not constitute "buying" under the repo legislation. |
| Abbey National Building Society v The Building Societies Commission (1989) 5 BCC 259 |
Confirmed the distinction between subscription and purchase in company law context. |
Supported the argument that subscription is not a purchase in the statutory context. |
| Mersey Docks & Harbour Board v IRC [1897] 2 QB 316 |
Broad meaning of purchase in stamp duty context including acquisition of annuities. |
Referenced in discussion on the ordinary meaning of "buy". |
| Wimpey v IRC [1975] 1 WLR 995 |
Sale and purchase of options for stamp duty purposes. |
Referenced in relation to the scope of purchase. |
| Parksha v Singh [1968] P 233 |
Appellate court’s role in reviewing findings of foreign law. |
Discussed in relation to appellate review of foreign law findings. |
| Dalmia Dairy Industries Ltd v National Bank of Pakistan [1978] 2 Lloyd's Rep 233 |
Appellate court’s duty to assess foreign law evidence independently but cautiously. |
Referenced in appellate review context. |
| MCC Proceeds Inc v Bishopsgate Investment Trust plc (No 4) [1999] CLC 417 |
Appellate court’s approach to foreign law findings involving legal concepts familiar to English law. |
Applied to the assessment of Cayman law evidence. |
| Inchyra (Baron) v Jennings [1966] Ch 37 |
Classification of receipt as capital or income for English law depends on rights and machinery of distribution, not foreign classification. |
Supported treating Cayman dividends as income despite possible foreign capital character. |
| Hill v Permanent Trustee Company of New South Wales Ltd [1930] AC 720 |
Limited companies can only return capital by authorised reduction; other payments are distributions of profits. |
Used to emphasize the binary classification of distributions as capital or profit. |
| Re Hoare & Co Ltd and Reduced [1904] 2 Ch 208 |
English case on company law principles relevant to share premium and dividends. |
Considered in assessing Cayman law position. |
| Re Bates [1928] Ch 682 |
Distinction between capital and income for company law and tax purposes. |
Referenced regarding classification of share premium. |
Court's Reasoning and Analysis
The court undertook a detailed purposive construction of the relevant UK tax legislation, including Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993. It started by examining the ordinary meaning of "dividend" under English law, distinguishing it from Cayman law but recognizing the similarities in company law principles between the two jurisdictions.
The court accepted that under Cayman law, dividends paid out of share premium account are lawful dividends and that the share premium account is distributable profit rather than capital, following the repeal of restrictions analogous to the English Companies Act 1948 by Cayman Islands legislation in 1989.
It rejected the Appellants’ argument that the manufactured payments provisions should adopt the English law position excluding dividends from share premium account, emphasizing that the relevant company's governing law should determine the nature of the payment. The court held that the Preference Dividends constituted dividends and overseas dividends for the purposes of the legislation.
Regarding the characterization of the Preference Dividends as income or capital in the hands of the recipient, the court applied established principles from English case law. It concluded that the dividends were income, notwithstanding that Cayman law might treat them differently, because the legal machinery employed was analogous to English law and the distributions were made out of profit.
On the secondary issue, the court examined sections 737A and 730A ICTA concerning sale and repurchase of securities. It held that the statutory language requires the reacquisition of existing securities and does not extend to subscription for new shares. The court relied heavily on the ordinary meaning of "buy" in the context of securities transactions, supported by authority distinguishing subscription from purchase.
The court noted HMRC’s own consultation documents suggesting that the legislation might need amendment to include subscriptions but emphasized that the existing statutory language does not cover subscriptions. The court was cautious about extending the legislation beyond its clear wording, especially given the potential broad market consequences.
Finally, the court dismissed the appeal, affirming the First-tier Tribunal’s decision on all issues, including the treatment of the Preference Dividends as dividends and overseas dividends and the exclusion of the subscription from the definition of sale and repurchase of securities.
Holding and Implications
The appeal by HMRC is dismissed.
The court held that:
- The First and Second Preference Dividends paid by the Cayman Islands company were "dividends" and "overseas dividends" under Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993.
- The corresponding manufactured dividends paid by First Nationwide to ABN AMRO Bank are deductible as management expenses.
- The sale of the First Issued Preference Shares and the subscription for the Second Issued Preference Shares do not constitute a sale and repurchase of securities under sections 737A and 730A ICTA.
The direct effect is that First Nationwide’s deduction for management expenses stands, and the tax treatment aligns with the First-tier Tribunal’s decision. No new precedent altering the interpretation of dividends paid out of share premium accounts or the scope of the repo provisions was established beyond the application to the facts of this case.
Costs were awarded against HMRC, to be paid to First Nationwide on the standard basis.