England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM CHANCERY DIVISION
MR JUSTICE ETHERTON

		Royal Courts of Justice Strand, London, WC2A 2LL
		22nd October 2003

Lord Justice Carnwath:

Introduction

1. This appeal raises a short but difficult issue under Corporation Tax law. It concerns the treatment for tax purposes of part of the consideration received by Strand Futures and Options Ltd ("SFOL") on a transaction in 1995.
2. The relevant facts were stated shortly by the judge:

"On 31 October 1986 SFOL acquired by allotment 29.9% of the issued share capital of City of London Options Limited ("CLO"). By 1995 SFOL held 179,400 shares in CLO, still comprising 29.9% of the issued share capital.

In 1995 SFOL proposed to sell half of its shareholding in CLO to Financielle Participaties Amsterdam GV ("FPA") for £871,630 and, the other half to CLO for a similar amount.

The proposal was duly carried out. On 29 September 1995 CLO purchased 89,700 of its own shares from SFOL for £871,630. FPA purchased SFOL's remaining 89,700 shares in CLO for £871,630."

3. It is now common ground that the sales of the shares to FPA and to CLO were both disposals for the purposes of capital gains tax. It is also common ground that the whole of the consideration paid by FPA had to be brought into account in calculating the chargeable gain on the disposal. The issue is whether the same applies to the consideration paid by CLO. SFOL's case is that the bulk of the consideration fell to be treated as a distribution for tax purposes (the "distribution element"); and is in effect exempt from any charge to corporation tax, by virtue of Income and Corporation Taxes 1988 s 208.
4. SFOL was assessed to corporation tax for the accounting period ending 31 December 1995 on the basis that the distribution element should be brought in to account in computing its chargeable gains. That view was supported by the Revenue's published practice (SP 4/89). SFOL's appeal was dismissed by the Special Commissioners (Dr John Avery Jones and Malcolm Palmer), but upheld by Etherton J. This is the Revenue's appeal.

Relevant tax law

5. The relevant provisions relating to corporation tax are contained in the Income and Corporation Taxes Act 1988 ("ICTA") and the Taxation of Chargeable Gains Act 1992 ("TCGA"). Under section 6 of ICTA, the charge is on "profits", defined as "income and chargeable gains". Income is to be computed "in accordance with income tax principles" (s 9(1)), under the appropriate Schedules and Cases (s 9(3)). Similarly, chargeable gains are to be computed "in accordance with the principles applying for capital gains tax" (TCGA s 8(3)). Income and chargeable gains are aggregated to arrive at "total profits" (ICTA s 9(3)), and the assessment and charge to corporation tax is on the "full amount of profits" in the relevant period (ICTA s 12(1)).
6. The disposal of CLO shares by SFOL was a chargeable disposal for the purposes of capital gains tax. Applying ordinary capital gains tax principles, the chargeable gain would consist of the consideration received, less acquisition costs, allowable expenditure and the costs of disposal (TCGA s 38). That consideration, apart from any special provision, would include the whole of the payment made by CLO.
7. The provision which is relied on by SFOL as displacing the ordinary rule is section 208 of ICTA. This is in a chapter headed "Taxation of Company Distributions". It provides:

"208 Except as otherwise provided by the Corporation Tax Acts, corporation tax shall not be chargeable on dividends and other distributions of a company resident in the United Kingdom, nor shall any such dividends or distributions be taken into account in computing income for corporation tax."

"Distribution", for the purpose of corporation tax, is defined by section 209. It includes:

"…any other distribution out of assets of the company (whether in cash or otherwise) in respect of shares in the company, except so much of the distribution, if any, as represents repayment of capital on the shares…"

It is common ground that the payment made by CLO was a "distribution" as so defined, except for the (very small) part which represented the return of capital.

Advance Corporation Tax and Schedule F

8. In considering the application of those provisions to the present case, it is necessary to set them in the context of the law applying to taxation of company distributions in 1995.
9. When a UK resident company made a "qualifying" distribution it was required to pay an amount of corporation tax, called advance corporation tax ("ACT") (ICTA s.14). The company could in due course set the ACT against its liability to "mainstream" corporation tax (s 239). The distribution element in this case was such a qualifying distribution. The recipient (whether an individual or a company) was entitled to a "tax credit", calculated as a proportion of the distribution corresponding to the current rate of ACT (s.231(1)). A company recipient was treated as receiving income equal to the aggregate of the distribution and the tax credit, defined as "franked investment income" (s 238(1)).
10. In the recipient's hands, the tax treatment of the distribution differed depending on whether the recipient was an individual or a company.

Individual recipient

11. An individual recipient of such a distribution was liable to income tax under Schedule F (ICTA s 20). Under Schedule F, income tax was (and is) chargeable:

"…in respect of all dividends and other distributions… of a company resident in the United Kingdom which are not specially excluded from income tax, and for the purposes of income tax all such distributions shall be regarded as income however they fall to be dealt with in the hands of the recipient."

Under the ACT system, where the distribution was one in respect of which a person was entitled to a tax credit, it was treated for income tax purposes as representing income equal to the aggregate of the amounts of the distribution and the tax credit. The judge correctly summarised the position:

"In effect, the amount of the distribution was 'grossed up' at the ACT rate. Income tax was then chargeable on the gross amount, with credit being given for an amount equal to the ACT." (para 28)

12. Where, as in this case, the distribution also formed part of the consideration for a disposal, there would be no capital gains tax liability in respect of that amount. Double taxation was avoided by TCGA section 37(1), which provided that, in computing a gain for CGT purposes, there was to be excluded any amount "charged to income tax, or taken into account as a receipt in computing income…" Again I adopt the judge's summary:

"Accordingly, in summary, if SFOL had been a UK resident individual, it would have been liable to income tax under Schedule F on so much of the purchase price of £871,630 as did not constitute repayment of share capital, income tax being chargeable on such amount "grossed up" at the ACT rate, with credit being given for the ACT. There would have been no liability to capital gains tax in respect of the purchase price." (para 31)

Company recipient

13. Turning to the position of a company recipient, it is common ground that one effect of ICTA s 208 was to exclude such a distribution from the corporation tax equivalent of a charge to income tax under Schedule F. As the judge said, the purpose was to achieve "corporation tax neutrality for distributions between companies". A company which had sufficient franked investment income could use it in a number of beneficial ways, including:

i) for exempt companies, to secure repayment of the amount of the tax credit (s.231(2));

ii) to "frank" its own distributions (s.241(1) to (3));

iii) to set against losses, charges on income, and capital allowances (s.242(1)).

14. The difference between the parties is as to the consequence in relation to corporation tax on chargeable gains. It can be shortly stated:

i) SFOL, through Mr Matthews, submits the first part of section 208 is clear. It provides in unqualified terms that corporation tax "shall not be chargeable on… distributions". This exemption applies equally, whether the distribution is treated as income or as part of a chargeable gain.

ii) The Revenue, through Mr Henderson, submits that these words are apt only to exclude tax otherwise chargeable "on" the distribution itself (such as would arise under Schedule F). By contrast, corporation CGT is chargeable, not on the dividend as such, but on a "chargeable gain". The distribution is not itself subject to the charge, but is simply one element in the computation of the gain.

15. As a matter of pure construction of the current statutory provisions, in my view, the Revenue's contention is preferable. Three factors point to this conclusion:

i) I agree with Mr Henderson that the words "chargeable on … distributions" suggest a tax which is directly charged on the dividends as such, rather than indirectly as part of the computation of a taxable amount. The words are thus apt to describe the charge, such as that under Schedule F, which is expressed to be "in respect of all dividends or other distributions". It is true that the corporation tax analogy is not exact. Although corporation tax is assessed on income tax principles (including the Schedules), the amounts assessed under different schedules, as well as any chargeable gains, are aggregated to arrive at "total profits" (ICTA s 9(3)). Strictly speaking, the tax is "on" the profits so defined (s 6(1)), rather than on the individual elements. However, the analogy with the income tax position is sufficiently close to make the language appropriate and understandable where the intention is to provide immunity from a corporation tax equivalent of Schedule F.

ii) This view is reinforced by the contrast with the second part of section 208, which refers specifically to dividends or distributions being "taken into account in computing income". In the capital gains context, the distribution is not directly the subject of tax, but is one element taken into account in computing the chargeable gain. If it had been intended to exclude it from the CGT computation, it would have been more natural to do so by including a specific reference to chargeable gains in the second part of section 208.

iii) As is common ground, the identical payment for the shares sold to FPA would have been included in the consideration for CGT purposes. It is hard to see any reason why the payment received for the shares sold to CLO should be treated differently, given that, in SFOL's hands, it was not subject to tax under any other provision. The fact that CLO has had to pay ACT on the distribution did not affect the matter from SFOL's point of view (other than beneficially, in that it was entitled to a tax credit). This position can be contrasted with the case of an equivalent buy-back from an individual (see above), when the distribution element of the receipt was taxable as income under Schedule F, but TCGA s 37 applied so as to exclude it from the CGT computation.

16. Mr Matthews submits that this approach is contrary to the decision of the House of Lords in Hughes v Bank of New Zealand [1938] AC 366 (HL). The issue in that case was whether the Bank, which was non-resident, was liable to tax under Case I of Schedule D on the interest on certain holdings of War Loan, India Government Stock and securities of colonial companies. The Bank relied on specific statutory exemptions: for the interest on War Loan, the Finance (No 2) Act 1915 ("neither the capital nor the interest thereof shall be liable to any taxation") and the Income Tax Act 1918 ("the interest thereon shall not be liable to tax or super-tax"); and for the other holdings of non-residents, Rule 2(d) of the Schedule C General Rules ("No tax shall be chargeable in respect of …the interest…" ). The Crown argued that the exemptions applied to "the interest, qua interest", but did not operate to exclude it from the computation of trading receipts under Case I.
17. The argument in relation to interest on War Loan was rejected in the Court of Appeal. Lord Wright MR (at [1937] 1KB 429, 430) said:

"Section 46 is in my opinion a perfectly general exemption: the language is unqualified… If, notwithstanding what I regard as the clear language of this Section, it was construed as merely relating to interest as interest, which is the expression used in argument by Mr Hills as defining its meaning, with the consequence that the owner of the securities – in this case the bank – can only escape taxation if the tax is sought to be imposed upon him under Case III of Sch. D and that he is liable to be taxed under the provisions of Case I of Sch. D, then it seems to me that a result is being reached which is quite contrary to the apparent meaning of the particular legislation and which, to my mind, involves the very serious frustration of what I imagine the parties taking the securities from time to time might be assumed to have contemplated."

In the House of Lords this argument was abandoned by the Crown in relation to the War Loan, but maintained (along with other arguments) in respect of the other holdings. It was rejected by the House. Lord Thankerton said:

"This appears to have been the only argument submitted by the Crown as to the War Loan, but, despite their abandonment of it as regards the War Loan, they still maintained it as regards the remaining items before your Lordships.

My Lords, I have no difficulty in rejecting this contention; I agree with the Courts below that whether as interest or as a component part of the profits of a trade, the exemptions must equally apply." (p 374)

18. Mr Matthews submits that the same reasoning should apply here. Section 208 evinces an intention to exempt distributions from any tax, no less clearly than the provisions considered in Hughes. They should therefore be treated as exempt from any form of tax, whether as "distributions qua distributions", or as component parts of some other form of taxable profit or gain.
19. Like the judge, I do not find this a helpful authority in the present context. As he said:

"… the Court's interpretation of completely different tax statutes, relating to different subject matter and dating from a completely different era, can only be, at best, of marginal assistance in the interpretation of TA 1988 s.208. " (para 69)

It is not difficult to see why, in the statutes there in issue, the specific exemptions were given a wide effect. For the reasons I have explained, the same considerations do not apply in the context of section 208, particularly having regard to the contrast between the two parts of the section.

The judgments below

20. The Special Commissioners arrived at the same conclusion as I have done, but by a slightly different route. They noted that the Revenue's current view, as stated in SP 4/89, reflected "a change from the Revenue's initial position" and was "disputed by textbook writers". That difference of view led them to consider the provision sufficiently "ambiguous or obscure" to justify looking at the "pre-consolidation legislation", within the principles stated in R –v- Secretary of State for the Environment, Transport and the Regions, ex p. Spath Holme Ltd [2001] 2 AC 349, 388. In their view, section 47 of the Finance Act 1965 (the predecessor of section 208) clearly supported the Revenue's interpretation.
21. We have not been referred by either party to any previous conflicting statement by the Revenue, nor to any relevant textbooks. Although Mr Henderson before us has supported the Commissioners' reasoning, the arguments before the judge and before us have taken a somewhat different direction. Accordingly, without disrespect to the Commissioners, I will not comment in detail on their decision.
22. The judge also considered it appropriate to look at section 47 of the 1965 Act, but for different reasons and with a different result. He was impressed by an anomaly resulting from the Revenue's construction, that ICTA section 13 (relating to "small companies' relief") had apparently been drafted on the wrong basis. This is a somewhat technical point, but, since the existence of the anomaly is not disputed, I can adopt the judge's summary:

"… It is… common ground that the assumption of the legislative draftsman of s.13 was that franked investment income would not form part of a company's profits on which corporation tax falls finally to be borne. Taking s.13 at face value, the Revenue's interpretation of s.208 would mean that, in determining whether the profits of a company are such as to attract the small companies' rate, a distribution forming part of a calculation leading to a capital gain would be included twice: first, as an ingredient of the company's basic profits, and, secondly, by the addition, under s.13(7), of franked investment income to the basic profits…." (para 73)

The judge considered the anomaly "a significant one" which could not be eliminated by a purposive interpretation of the section. (He also noted a similar assumption by the draftsman in section 74 of the Finance Act 1965.)

23. The existence of this admitted anomaly led the judge to consider it appropriate to refer to the predecessor enactment of section 208. This involved the need to consider section 47 against the background of the different company tax regime applying at the time:

"…under the regime imposed by FA 1965, income tax under Schedule F was deducted at the standard rate on all distributions, whether made to individuals or to companies. If s.47(1) of FA 1965 bore the meaning for which the Revenue contends, company recipients of distributions which were of a capital nature, but nevertheless also included amounts within the extensive definition of "distribution" for Schedule F, would have been potentially liable to bear both a charge to income tax on the distribution under the deduction of tax at source provisions, and also corporation tax on the distribution as giving rise to a capital gain. That seems to me a highly anomalous and unlikely consequence." (para 78)

24. The judge rightly saw paragraph 2 of schedule 6 of the 1965 Act (the predecessor of ICTA s 37 – see above), as reflecting

"…a policy that the consideration for a disposal of assets should not give rise to a liability both to income tax and to tax on a chargeable gain." (para 85)

He took the view that the same provision (which had not been cited in argument) would not have the same effect in relation to corporation tax. Accordingly, he commented::

"Interpreting FA 1965 s. 47(1) as conferring a blanket exemption from corporation tax, and so avoiding the potential double charge to tax to which I have referred, would give effect to the plain policy consideration reflected in paragraph 2 of Schedule 6 to FA 1965." (para 86)

25. His final conclusion was stated thus:

"Drawing together the various threads, I conclude that TA 1988 s.208, on its proper interpretation, and save where otherwise expressly provided by the Tax Acts, exempts from corporation tax all distributions of a company, whether as income or as giving rise to a capital gain. The broad language used in the first limb of s.208, the anomalous position under TA 1988 s.13 on the Revenue's interpretation of s.208, the identical language in the first limb of FA 1965 s.47(1), the deduction of standard rate tax at source under FA 1965 s.47, the policy principle embodied in paragraph 2 of Schedule 6 to FA 1965, and the apparent assumption of the draftsman of FA 1965 s.74(1) that there was a general exemption from corporation tax on distributions, whether as income or as giving rise to a capital gain, provide a compelling case for that interpretation. The significance of those factors outweigh the contrary indications relied upon by the Revenue.

This interpretation gives TA 1988 s.208 a sensible meaning and effect. It achieves corporation tax neutrality for distributions between companies. The Revenue accepts that such tax neutrality was an objective behind TA 1988 s.208, but merely disputes the intended extent of such tax neutrality." (para 89-90)

26. With respect to the judge's careful analysis, I think that he gave too much weight to the anomaly in section 13. Argument by anomaly is rarely of assistance in tax cases (see Pearson v IRC [1981] AC 753, 775), particularly if the court is unable to form a clear view of the practical significance of the alleged anomaly. The present case is not concerned with small companies' relief under section 13. We have no evidence that the problems with which the present case is concerned have arisen, or are likely to arise in that context. In those circumstances any discussion can only be academic. It may also be relevant to bear in mind that, in the 30 years since the provision was introduced (in the Finance Act 1972 s 95) company law has also changed. It is only when the company is buying its own shares that the consideration takes on the dual character of both income and consideration for the disposal. In 1972 there was a general prohibition on companies buying their own shares, which was not removed until 1981 (Companies Act 1981 s 46, now Companies Act 1985, s 162). It would be unsurprising therefore if this theoretical problem was not at the forefront of the draftsman's mind.
27. More importantly, as is now common ground, and contrary to the judge's understanding, the Finance Act 1965 did contain a specific provision to prevent liability to both corporation tax on income and corporation tax on chargeable gain. Paragraph 2 of Schedule 6, to which the judge referred, should have been read subject to section 55(3) of the 1965 Act (TCGA s 8(4)), which adapted the same provision to avoid such an overlap. It was therefore unnecessary to look to a wide interpretation of section 47 to achieve that purpose.
28. Finally, I should mention Mr Henderson's submission that, if one is comparing anomalies, there is an even greater anomaly on SFOL's construction, because it would distort the provisions as applied to allowable losses. For example, one may assume a case where SFOL, before disposing of the shares to CLO, had acquired them at the same price from a third party. If the distribution element is excluded from the consideration for the sale by SFOL, almost the whole of the price paid by it can be treated as an allowable loss, even though it has lost nothing in reality. Mr Matthews counters that, by submitting that section 208, on his construction, is concerned only with the charge to tax; it has nothing to do with losses. Alternatively, even if he is wrong on that, he submits that the supposed anomaly is one which, on the Revenue's view, already arises in relation to the buy-back of shares from an individual. I do not find it necessary to rule on this dispute.

Conclusion

29. In my view, the question of construction can, and therefore should, be answered within the confines of the legislation current at the relevant time. For the reasons I have given, I would allow the appeal and restore the assessment, in accordance with the decision of the Special Commissioners.

Lord Justice Rix

30. I agree.

Lord Justice Potter

31. I also agree
ORDER: Appeal allowed. Determination of Special Commissioners to be restored. Respondent to pay the appellant's costs in the High Court and the Court of Appeal summarily assessed and agreed in the sum of £30,000. Leave to appeal to the House of Lords to be dealt with in writing. (Order does not form part of the approved judgment)