Supreme Court of Ireland Decisions

1. A company called Gladebrook Limited held 49% of the share capital of Sugar Distributors (Holdings) Limited (“Holdings”) which in turn held 100% of the share capital of Sugar Distributors Limited (“Distributors”).

2. In 1990 the issued share capital in Gladebrook was £10,000 divided into 10,000 shares of £1 each which were held and registered in the name of five persons (hereinafter called the Vendors) of whom the above named Thomas Keleghan (Mr Keleghan) was one. Mr Keleghan was the registered owner of 2,151 of those shares. By an agreement in writing dated the 8th day of February, 1990, the Vendors agreed with Suicre Eireann (therein and hereinafter sometimes called “the Purchaser” ) for the sale to the Purchaser of the issued share capital in Gladebrook for the sum of £8,680,000 to be paid to the Vendors in the proportions set out in the third column of Schedule I to that agreement and on the express terms that:-

3. The proportion of the purchase consideration to be paid to Mr Keleghan amounted to £1,867,068. The “loan notes” were defined as being the loan notes set out in Schedule VIII to the agreement.

4. The loan notes took the form of a certificate to which an identifying number was ascribed and a particular amount inserted. The Certificate stated that the documentation was:-

5. It then provides space for the name and address of the holder of the note followed by a statement in the following terms:-

6. There is then provision for the certificate to be sealed by Suicre Eireann and dated. That is followed by the significant annotation:-

7. The financial provisions contained in the conditions on which the notes were issued are simple. First, there is provision for the payment of interest on notes not redeemed on or after the 31st of October, 1991, secondly, for interest at a rate equal to the Dublin Inter Bank Offered Rate for six months funds (DIBOR) and, thirdly, there is provision that the note holders may elect at any time to have loan notes redeemed in whole or in part by Suicre Eireann on 30 days notice: the earliest date for redemption being the 1st day of November, 1991 and the latest date for redemption the 31st October, 1997. All notes outstanding on the 31st October, 1997, must then be redeemed in full. The conditions provide in considerable detail for the issue - and where necessary the replacement - of certificates to the holders of the loan notes. There is also provision for the maintenance of a register of holders of the loan notes and the details to be kept in that register. There is provision for transmission of the loan notes on the death or bankruptcy of a note holder but the conditions repeat in clause 8 the express prohibition on transfer in the following terms:-

8. Neither the certificate nor the conditions make any reference to conversion rights attaching to the loan notes. The share purchase agreement, however, expressly provides that in the event of a public floatation or a private placing of shares in the Purchaser the loan notes may be converted into ordinary shares of the Purchaser on the basis of £100 of note for every £100 of shares provided that the floatation or placing takes place after the 1st October, 1991, but on the basis that a discounted value will be attributed to the loan notes in the event of the floatation or placing occurring between the date of the share purchase agreement and the 1st October, 1991.

9. Superficially the loan notes and the conditions on which they were issued bear considerable similarity to debenture stock. The fact that the indebtedness secured by the loan notes is not charged on property of the Purchaser might be unusual in practice but unexceptional in principle. What is more surprising is the inclusion of the standard conditions dealing with the issue of certificates and the registration of owners, which are procedures ordinarily designed to facilitate marketability, coupled with an express prohibition on assignment and transfer. This apparent contradiction is not due to any error or oversight. I will return to this aspect of the matter later.

10. On the same date as the share purchase agreement, the 8th February 1990, Mr Keleghan executed a service agreement with the Purchaser as required by the provisions of the share purchase agreement. Under the service agreement Mr Keleghan was bound to serve the Purchaser for a term of 18 months expiring on the 30th day of June, 1991, and thereafter until termination by either party giving three months notice to the other of them. Whilst the agreement provided that Mr Keleghan “shall serve the company as sales director” at clause 2 (E) it was stated that:-

11. The service agreement does contain covenants in restraint of competition to which some importance was attached but those covenants do not differ significantly from those to which Mr Keleghan was committed under the share purchase agreement.

12. The final document to which reference must be made is the “side letter” also dated the 8th day of February, 1990, signed by Mr Keleghan. By that letter he expressly recognised that of the purchase price payable to him in respect of his share holding in Gladebrook £250,000 “was paid as an inducement for me to enter into the service contract (as defined in the share purchase agreement) and accordingly in the event of my not complying with the terms of the said service contract that portion of the £250,000 purchase consideration attributable to the sale of my shares in Gladebrook Limited will become repayable by me to Suicre Eireann Cpt.”

13. Apparently the transfer of the shares in Gladebrook to the Purchaser was completed in February, 1990, and the loan notes issued to the Vendors on the same date. Mr Keleghan’s loan note was ultimately redeemed for cash by the Purchaser in February, 1993. The Appeal Commissioners expressly found that Mr Keleghan never became an employee of the Purchaser. Before signing the service agreement he had been sales director of Distributors and he remained in that capacity until his retirement in June, 1991, when he attained the age of 65 years. Distributors were of course a wholly owned subsidiary of Holdings which in turn had become a wholly owned subsidiary of the Purchaser.

14. If Mr Keleghan had sold his shares in Gladebrook in 1990 for £1.8 in cash (whether payable immediately or at a later date) or, indeed, if he had exchanged his share holding for other assets, prima facie this would have constituted a disposal for the purposes of the Capital Gains Tax Act, 1975, and rendered Mr Keleghan liable to tax on the difference between the sale price of his share holding and the cost of acquiring it. It is common case - agreed by both Mr Keleghan and the Revenue Authorities - that the exchange of the shares with the Purchaser was exempt from Capital Gains Tax on the grounds that the transaction fell within paragraph 4 of the Second Schedule to Act of 1975. That paragraph - so far as material - provides as follows:-

15. Those parts of paragraph 2 which would appear to be relevant to the present proceedings are as follows:-

16. It was conceded by the Revenue Authorities that the Loan Notes in the Purchaser constituted “debentures” for the purposes of paragraph 4 aforesaid with the result that the exchange of the shares in Gladebrook (the original shares) for the Loan Notes (the new Holding) did not fall to be treated as involving any disposal of the original shares or the acquisition of the new Holding. The issue was whether the ultimate redemption of the new holding in 1993 was a disposal or whether it too was exempt this time by virtue of s.46 of the Act of 1975 which so far as material provides as follows:-

17. Notwithstanding the complex cross-references contained therein it seems reasonably clear that s.46 deems no chargeable gain to accrue on the disposition or satisfaction of debts generally but that exemption does not extend to the disposition or satisfaction of a “debt on a security”. Unhappily the latter phrase is not defined in the Act although the word “security” is defined in paragraph 3 of Schedule 2 as including:-

18. In those circumstances two questions arose in relation to Capital Gains Tax, namely,

19. The other issue which arose on the case stated was whether the sum of £250,000 which, as appears from the side letter, was paid to Mr Keleghan by the Purchaser as an inducement to influence him to join the employment of the Purchaser was taxable on him under s.110 of the Income Tax Act, 1967.

20. Both questions were answered by McCracken J in favour of Mr Keleghan. From that decision the Inspector of Taxes has appealed to this Court.

21. Like the learned trial Judge I will deal first with the income tax issue.

22. It is common case that if the sum of £250,000 were to be liable to tax that such a liability would arise under s.110 of the Income Tax Act, 1967, (as amended) or not at all. Subsection 1(1) of that Section reads as follows:-

23. McCracken J dealt shortly and clearly with the application of Section to the facts of the present case in the following terms:-

24. It may be helpful to consider that conclusion in the context of the analysis made by the House of Lords in Shilton .v. Wilmshurst [1991] STC 88 of somewhat analogous problems of fact and law.

25. Mr Shilton was a well-known football player under contract to Nottingham Forest Football Club in 1982. With a view to raising money, Nottingham agreed to transfer Mr Shilton, subject to his consent, to Southampton Football Club. The manager of Nottingham informed Mr Shilton that they would pay him a sum of £75,000 if he consented to the transfer. The Inspector of Taxes assessed that sum of £75,000 under schedule E pursuant to s.181 (1) of the UK Income and Corporation Taxes Act, 1970 (which is similar to s.110 of the Irish Act of 1976). The General Commissioners upheld the assessment. In the High Court Morritt J allowed the tax payer’s appeal and the Court of Appeal upheld the decision of Morritt J. The House of Lords allowed the appeal from the Court of Appeal and reinstated the decision of the General Commissioners. The issues in the Shilton case were not as complex as that legal history might suggest. In the High Court Morritt J having analysed the facts and the material authorities concluded (at page 877) that:-

26. Whilst the Court of Appeal recognised that payments made by third parties to persons who were in the employment of another - such as tips to waiters or taxi drivers - were emoluments of the recipient taxable under Schedule E they endorsed the reasoning and conclusion of Morritt J.

27. The unanimous decision of the House of Lords was delivered in the speech of Lord Templeman who noted that the Court of Appeal had accepted that payments made to an employee by a person other than his employer might be liable to tax under Schedule E but subject to the qualification that such liability could only arise “where the payer has an interest direct or indirect in the performance of the contract of employment ”. The House of Lord rejected that qualification pointing out that there was nothing in s.181 of the UK legislation to justify that inference. I believe that the law so stated in the judgment of Lord Templeman in this respect is a correct statement of the law in this jurisdiction.

28. No doubt that there are many cases in which it would be important to ascertain why money is paid to an employee by a person who is not his employer. A question might arise as to whether the payment was a non taxable gift or a payment relating to some entirely different action or activity which might give rise to no liability to tax or alternatively to taxation on a different basis or with the benefit of particular allowances. However, the fact that it was a matter of indifference to Nottingham whether in playing for Southampton Peter Shilton never scored a goal or, more correctly, never saved one, did not affect the nature and purpose of the payment of the sum of £75,000. That sum was paid by Nottingham to induce Mr Shilton to play for Southampton and thus achieve the ulterior motive of Nottingham, if it may be so described, of obtaining a substantial transfer fee. The payment by Nottingham was nonetheless as much a payment to induce him to join Southampton as the signing-on fee paid by that club to Mr Shilton.

29. Of course Peter Shilton did play for Southampton whereas Mr Keleghan never took up employment with Suicre Eireann. The Appeal Commissioners have found that as a fact and indeed there is no reason to believe that it was ever disputed that Mr Keleghan had been prior to the share exchange and until his ultimate retirement in June, 1991, an employee of Distributors and never an employee of Suicre Eireann. Nevertheless, regard must be had to the fact that he expressly and in writing agreed to enter into a service contract with Suicre Eireann and for that was paid a sum of £250,000. There was also the provision for the repayment of that sum if the transaction was not consummated. Whilst there is no specific finding in relation to it, I understand that it is agreed that the payment of that sum was never sought or made. If it had been repaid the question of taxation would not arise. Whilst tax legislation frequently proceeds on the basis of legal fictions, as has already been noted, and legitimate tax avoidance arrangements may well demand the implementation of transactions which would not be justified on purely commercial considerations, I think that the Court must infer that Suicre Eireann were satisfied to accept the continued service of Mr Keleghan with Distributors as compliance with the terms of his service agreement and in particular clause 2(e) thereof. The alternative interpretation would be to treat the payment as one made for a consideration which wholly failed or else as a gift the validity of which might be open to question. These alternatives are neither attractive nor compelling. In my view the payment of £250,000 by Suicre Eireann or the treatment of that sum as having been so paid in accordance with the provisions of the side letter resulted in a taxable emolument in the hands of Mr Keleghan which is prima facie liable to tax under Schedule E. Accordingly I would allow the appeal in that regard. However, an issue as to whether the assessment was raised in relation to the correct year is recorded in the Case Stated. As that issue was not resolved in the judgment of the learned trial Judge it must now be remitted to the High Court for further consideration.

30. The issues in relation to Capital Gains Tax are even more complex. It is common case that the initial transaction by which the Gladebrook shares were exchanged for the Loan Notes did not give rise to a liability for CGT. By an exception or statutory fiction provided for in paragraph 2 of the second schedule to the Act of 1974 that exchange was deemed not to be a disposal for the purposes of the Act of 1974. The first issue between the parties in this connection was whether that statutory fiction extended to the transaction which occurred in February, 1983. When Mr Keleghan was paid the redemption sum in February 1993 was he to be treated as disposing of shares in Gladebrook or Loan Notes in Suicre Eireann? Mr Keleghan correctly points out that there is nothing in Schedule 2 expressly extending the statutory fiction to the ultimate disposition of the asset received in exchange for the original share holding whereas the Appellant argues it must be accepted that the statutory “fiction” extends to or revives on the realisation of the asset received in exchange. It is agreed that if the realisation gave rise to a chargeable gain the amount thereof would have to be calculated by reference to the cost of acquisition of the Gladebrook shares. The issue was whether the statutory fiction requires the Loan Notes to be treated as retaining the character, and indeed the identity of the Gladebrook shares, as well as having been acquired at the same cost as those shares.

31. The Appellants drew attention to Lord Asquith’s admonition in Eastend Dwellings Company Ltd .v. Finsbury Borough Council [1952] AC 109 in the following terms:-

32. Having quoted that passage Nourse J in CIR .v. Metrolands 54 TC 679 went on to explain as follows:-

33. That legislation may and does from time to time deem acts or events to be what they are not is common particularly in legislation imposing taxation or seeking to prevent its avoidance. There is no reason why the Courts would not enforce such legislative fictions as fully and faithfully as any other legislation or “boggle when it comes to the inevitable corollaries” of the fiction. The Courts are not unaccustomed to dealing with notional or hypothetical situations or (in the words of Danckwert J in Holt 1953 1 WLR 1488 at 1492) entering “ into a dim world peopled by the indeterminate spirits of fictitious or unborn sales”. If the second schedule to the Act of 1975 requires that the Loan Notes should be deemed to be or treated as if they were shares in Gladebrook Limited so be it. The difficulty from the Appellant’s point of view is that the legislation does not so provide and the only justification for accepting that fiction would be the alleged purpose of the particular legislation. It was contended that the purpose of the fiction was to permit the first transaction to escape tax on the footing that tax would be payable on a subsequent disposition as if no change had taken place in the share holdings of the parties to the original transaction.

34. In my view the requirement to treat the disposal of the Loan Notes in February, 1993, as a disposal in substance of shares in Gladebrook Limited is in no sense a consequence or a corollary of the original fiction which deemed the exchange not to be a disposition or of the further “selective” fiction requiring the cost price of the Gladebrook shares to be that of the Loan Notes. There was no necessary requirement in law or in logic for the extension of the fiction. The Legislature might well have been content to impose tax by reference to the price which might be expected to be obtained for the asset received in exchange for the original share holding. In my view the learned trial Judge was correct in concluding that the asset realised by way of redemption in February, 1993, was in law, as it was in fact, a disposition of the Loan Notes which had been issued to Mr Keleghan for his shares in Gladebrook Limited.

35. The remaining question is whether the Suicre Eireann Loan Notes constituted a “debt on a security” within the meaning of s.46(1) of the 1975 Act.

36. The learned trial Judge understandably lamented the absence of any statutory definition of that crucial phrase. He did recognise, correctly, in my view that as a debt on a security is treated differently from an ordinary debt is must have some distinctive feature or features. What constitutes a “debt on a security” for the purposes of the Act of 1975 was considered by Morris J (as he then was) in McSweeney .v. Mooney [1997] 3 IR 424 and the same expression as used in virtually identical legislation was considered in a series of English cases of the highest persuasive authority including Cleveleys Investment Trust Company .v. CIR 47 TC 300; Aberdeen Construction Group Ltd .v. CIR 52 TC 281; WT Ramsey Ltd .v. CIR 54 TC 101 and Taylor Clark International Ltd .v. Lewis [1998] STC 1259. All of these cases demonstrate that the term does not admit of any fully satisfactory definition or explanation. Furthermore, there is the difficulty that it is not possible to pray in aid the principle that taxation should not be imposed in the absence of clear wording because the existence of a debt due on a security (as opposed to an ordinary debt) will in some cases impose a liability to tax and in others create a deductible allowance.

37. The decision of the Court of Appeal in Taylor Clark International Ltd .v. Lewis (above), contained in the judgment delivered in November 1998 by Peter Gibson LJ has the advantage that it reviews and seeks to reconcile the earlier English and Scottish authorities which had grappled with this problem. The learned Lord Justice analysed the variety of features which it had been contended were material in determining whether a debt would properly be described for the purposes of the Capital Gains Tax legislation as a “debt on a security”.

38. Much of the judgment in Taylor Clark was devoted to a consideration of whether the existence of a charge on property or a guarantee (which were described as a proprietorial securities) was an essential ingredient of the statutory “debt” on a security. Considerable debate had taken place in the earlier authorities as to whether the presence or absence of a proprietorial security was of decisive importance. Peter Gibson, LJ, concluded on both precedent and principle that such a security had little or no significance in determining whether a particular transaction constituted a debt on a security. The relevance (or irrelevance) of a proprietorial security was dealt with by Peter Gibson, LJ, in the concluding part of his judgment on that aspect of the matter (at page 1271) in the following terms:-

39. In the Court of Appeal it was noted that the Judge of first instance had identified certain features of a debt on a security which Peter Gibson, LJ, summarised (at page 1271) as follows:-

40. The learned Judge then turned to consider the terms of the particular loan made by Taylor Clark in the light of those characteristics which he clearly accepted as helpful if not necessarily decisive.

41. The loan made by Taylor Clark was, as counsel on their behalf emphasised, secured; it was evidenced in writing in the form of promissory note; it was assignable. The monies advanced were to be used for property development purposes. On the other hand counsel on behalf of the Revenue Authorities pointed out that the creditor or the debtor could bring the transaction to an end at any time.

42. As in earlier cases some doubt was cast upon the relevance of provisions dealing with the assignment of the debt in whole or in part. It was noted that equity would recognise an assignment of part of the benefit of the loan even though the express provisions for assignment did not extend to such an arrangement.

43. The features of the loan in the Taylor Clark case which might have pointed to the degree of marketability which would have qualified it as a debt on a security were, in the judgment of the Court of Appeal, wholly outweighed by the impermanence of the transaction which appears to have been the most important but not the only factor influencing the decision of the Court to reject the claim by the taxpayer.

44. Though the judgment of the Court of Appeal in Taylor Clark is helpful it does seem to me that the decision in McSweeney .v. Mooney [1997] 3 IR 424 provides clearer guidance as to what constitutes a debt on a security for the purposes of the Capital Gains Tax Act, 1975. Having analysed the UK cases and in particular the decision of the High Court in the Taylor Clark case Morris J (as he then was) he went on to say (at page 429):-

45. The legal and logical justification for that approach had been dealt with in the previous page of the report in the following terms:-

46. Whilst the right to assign a debt in whole or in part and the arrangements made to facilitate such an assignment may be material in determining whether a particular debt has the requisite characteristic of marketability the clear analysis provided by the President shows the decisive importance of the underlying commercial potential of the debt to appreciate in value if it is to qualify as a “debt on a security” for Capital Gains Tax purposes.

47. In the present case the terms of the Loan Notes are in a sense contradictory. They adopt a number of clauses which would suggest that the company by which they were issued intended them to be marketable. These clauses are effectively negatived by the unequivocal prohibition on assignment. However, more significant are the commercial terms of the loan. The period of the loan is nearly six years and to that extent the transaction is distinguishable from the Taylor Clark case. The loan does carry interest but it is limited to DIBOR (now the Euribor) rate from time to time. Apart from the modest rate of such interest, the fact that it would fluctuate with public financial conditions suggests that there could be no capital appreciation on the debt over the period of the loan. Certainly no expert evidence was adduced at the hearing before the Appeal Commissioners which would suggest that there was any prospect of an increased value attaching to the Loan Notes though presumably there would have been confidence that the Vendor was of such substance that a reduction in value was unlikely. The extent to which the Loan Notes might have been converted into shares was extremely limited indeed. First of all the right did not attach by virtue of the Loan Notes but by virtue of the agreement to which Mr Keleghan and the other vendors were parties. No enforceable right arose on the public floatation and such a right as might have arisen in the case of a private placing seems to have been of questionable value. Certainly the share purchase agreement excluded the possibility of the Vendors enjoying any special discount in applying for such shares. In my view the conversion rights, such as they are, added nothing to the value or marketability of the debt.

48. The entire transaction was consciously and carefully designed so as to create a document or transaction which would qualify as a debenture for the purpose of the exchange which took place in February, 1990, but yet fall short of a debt on a security when the repayment was made in 1993. No doubt this was a deliberate tax avoidance scheme. Many will resent the transaction on which the Vendors embarked. Others will envy it. The only function of this Court at this stage is to determine whether the Loan Notes possessed sufficient characteristics to elevate it above the status of a mere unsecured debt to one which would properly be described as “a debt on a security” within the meaning of the Capital Gains Tax Act, 1975. In my view it did not achieve that status. Whether it even escaped the character of a mere unsecured debt is not for me to decide. I would dismiss the appeal in this regard.