[2010] UKFTT 24 (TC)

                                                                                    TC00339

                                    Appeal number SC/3213/2008

Stocklending agreement – deduction for management expenses in respect of manufactured dividends – para 1(1), Sch 23A ICTA – Income Tax (Manufactured Overseas Dividends) Regulations 1993 – whether dividends paid by a Cayman Islands company out of share premium account are “dividends” and “overseas dividends” – ss 737A and 730A ICTA – whether a sale of preference shares and a subscription for preference shares is a sale and repurchase of securities

FIRST-TIER TRIBUNAL

TAX

                                            FIRST NATIONWIDE                           Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                   REVENUE AND CUSTOMS (Corporation tax) Respondents

                                                TRIBUNAL: JUDGE ROGER BERNER

                                                           

Sitting in public in London on 2 – 5 November 2009

John Gardiner QC and Philip Walford, instructed by Slaughter and May, for the Appellant

Malcolm Gammie QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1. First Nationwide (“the Appellant”), a UK resident unlimited company that is a wholly-owned investment company subsidiary of Nationwide Building Society (“the Society”), appeals against an amendment dated 23 April 2008 made by HMRC to the Appellant’s corporation tax self-assessment for the accounting period ended on 31 March 2004 excluding a deduction of £51,000,000 for expenses of management.  The Appellant claims the deduction in respect of certain manufactured dividends paid by the Appellant under a stock loan agreement with ABN AMRO bank.

2. John Gardiner QC and Philip Walford appeared for the Appellant.  HMRC were represented by Malcolm Gammie QC.

The facts

3. The parties produced an Agreed Statement of Facts and Issues which I set out below (references to volume and tab are to the documents bundles produced):

Introduction

1. This statement of agreed facts and issues relates to the appeal against the Respondent’s amendment dated 23 April 2008 [Volume B2, tab 50] in respect of a Corporation Tax Self-Assessment of the Appellant for its accounting period ending 31 March 2004 [Volume B2, tab 49].[1]

The Appellant and other relevant parties

2. At all material times:

(A) First Nationwide, a private unlimited company, was a UK resident and incorporated wholly-owned investment company subsidiary of Nationwide Building Society;

(B) Nationwide Building Society was UK resident and incorporated under the Building Societies Act 1986 and was the parent of the Nationwide group of companies;

(C) First Nationwide and Nationwide Building Society formed part of the same group for the purposes of section 170 of the Taxation of Chargeable Gains Act 1992 (“TCGA”);

(D) First Nationwide was an investment company within the meaning of section 130 of the Income and Corporation Taxes Act 1988 (“ICTA”) and was not an approved United Kingdom intermediary (an “AUKI”) within the meaning of regulation 2(1) of the Income Tax (Manufactured Overseas Dividends) Regulations 1993 (the “1993 Regulations”);

(E) ABN AMRO Bank N.V., a Dutch resident and incorporated company that carries on a banking business, acting through its London branch in the United Kingdom (“ABN AMRO”), was an AUKI;

(F) Blauwzoom N.V. (“Blauwzoom”), was a Netherlands Antilles resident and incorporated company and a wholly-owned subsidiary of ABN AMRO Bank N.V.; and

(G) Blauwzoom held all the issued ordinary shares in Blueborder Cayman Ltd (“Blueborder”), a Cayman Island resident and incorporated company.

Blueborder’s Share Capital

3. On 19 September 2003 Blauwzoom acquired one Ordinary Share in Blueborder, which, at that time, was the only issued share.  Consequently, at that time, Blueborder became a wholly-owned subsidiary of ABN AMRO Bank N.V.  On 24 September 2003, the authorised share capital of Blueborder was increased from £50,000 to £110,101 and was divided into 10,001 Ordinary Shares with a nominal value of £1.00 each, and 100,100 non-voting, redeemable Preference Shares with a nominal value of £1.00 each [Volume B1, tab 21].

4. Under Blueborder’s articles of association [Volume B1, tab 21]:

(A) Holders of the Preference Shares were entitled, in respect of each Preference Share held, to a fixed cumulative preferential dividend of £509.49051 payable on 29 December 2003 and a further such dividend payable on 29 March 2004 (such dates being the “Quarterly Dividend Dates”); thereafter each such share carried a right to an annual dividend accruing on a daily basis at a fixed rate equal to 1 per cent of the paid-up nominal amount.  The articles of association also made provision for the early payment of dividends on the Preference Shares; they also provided that all dividends on Preference Shares were to be paid out of share premium only. (Article 5.2(a))

(B) The directors could declare and authorise payment of dividends on other classes of share in issue. (Article 128)

The First Issued Preference Shares

5. Further, on 24 September 2003, Blauwzoom subscribed for, and Blueborder issued:

(A) 50,050 non-voting, redeemable Preference Shares with a nominal value of £1.00 each in Blueborder (the “First Issued Preference Shares”) at a premium of £999 per Preference Share.

(B) 1,050 Ordinary Shares with a nominal value of £1.00 each in Blueborder at a premium of £999 per Ordinary Share [Volume B1, tab 21],

and pursuant to a stock lending arrangement, Blauwzoom transferred the First Issued Preference Shares to ABN AMRO, which acquired legal and beneficial ownership of them on that day.

6. The First Issued Preference Shares were overseas securities, as defined by paragraph 1(1) of Schedule 23A ICTA. 

The Stock Loan Agreement

7. On 25 September 2003, ABN AMRO entered into an “Overseas Securities Lender’s Agreement” with First Nationwide [Volume B1, tab 23], as further amended and supplemented by a “Borrowing Request” made thereunder by First Nationwide [Volume B2, tab 28]] (together the “Stock Loan Agreement”; and reference will be made hereinafter to the consequent “stock loan”).

In particular, under the Stock Loan Agreement:

(A) It was agreed that ABN AMRO would transfer the First Issued Preference Shares to First Nationwide such that First Nationwide would become the legal and beneficial owner of them.  (See clauses 1.3 and 4.1.[2])

(B) First Nationwide agreed to redeliver to ABN AMRO shares of an identical type, nominal value, description and amount to the First Issued Preference Shares on 29 March 2004 (or earlier in certain defined circumstances).  (See paragraph 1 and clauses 1 and 7.1.)

(C) In relation to each dividend paid on the First Issued Preference Shares during the currency of the stock loan, and following the receipt of a copy of a dividend voucher, First Nationwide was required to pay a “Manufactured Dividend” (as defined in paragraph 3.3 and clause 4.2.2 (as substituted by paragraph 3.3(b)) of the Stock Loan Agreement) to ABN AMRO.  The Manufactured Dividend was payable whether or not the dividend itself was received by First Nationwide.  The Manufactured Dividend was equal to the amount of the dividend together with an amount equivalent to any deduction, withholding or payment for or on account of tax made by or on behalf of Blueborder (or, if First Nationwide was the then holder of the First Issued Preference Shares, the amount of the dividend together with the amount of any associated tax credit).  (See clause 4.2 as amended by paragraphs 3.3 and 4.1.)

(D) First Nationwide agreed to pay to ABN AMRO a fee of £325,000 on 25 September 2003.  (See paragraph 1.)

8. Pursuant to the Stock Loan Agreement, on 25 September 2003 the First Issued Preference Shares were transferred from ABN AMRO to First Nationwide and First Nationwide became the legal and beneficial owner of, and was entered on the share register of Blueborder as the holder of, them.  On that day, First Nationwide also paid ABN AMRO the fee of £325,000.

9. The Stock Loan Agreement is a contract for the transfer of overseas securities for the purposes of paragraph 4(1) of Schedule 23A ICTA.

The Subscription Agreement; the Second Issued Preference Shares

10. Further, on 25 September 2003, Blueborder entered into an agreement (the “Subscription Agreement”) with First Nationwide [Volume B2, tab 32].

In particular, under the Subscription Agreement:

(A) First Nationwide agreed to subscribe and pay for, and Blueborder agreed to issue to First Nationwide, 50,050 non-voting, redeemable Preference Shares with a nominal value of £1.00 each in Blueborder (the “Second Issued Preference Shares”).  The Second Issued Preference Shares were of an identical type, nominal value, description and amount to the First Issued Preference Shares.

(B) The subscription and issue would take place on 29 March 2004, or, if First Nationwide so chose, at any time prior to that date (provided that at such a time First Nationwide was under an obligation pursuant to the Stock Loan Agreement to redeliver equivalent Preference Shares and would not be otherwise entitled to shares which would enable it to meet such a requirement).

(C) The aggregate amount payable by First Nationwide (the “Subscription Amount”) depended on the date of the subscription (“the Payment Date”) and on what dividends Blueborder had paid on the First Issued Preference Shares.  The formula for the Subscription Amount is set out in Schedule 1 of the Subscription Agreement.  However, leaving aside the provisions for possible adjustments, upwards or downwards, in the event of dividends being unpaid or being paid early, the Subscription Amount was equal to:

                       

where

“NA” means the amount set out in the second column of the table below next to (i) the Payment Date if such date is a Reference Date and (ii) in any other case, the Reference Date immediately preceding the Payment Date;

“n” means (i) zero, if the Payment Date is a Reference Date and (ii) in any other case, the actual number of days from (and including) the Reference Date immediately preceding the Payment Date to (but excluding) the Payment Date; and

 “r” means the rate per annum set out in the third column of the table below next to (i) the Payment Date if such date is a Reference Date and (ii) in any other case, the Reference Date immediately preceding the Payment Date.

Reference Date	NA	r
24 September 2003	£51,193,437.00	4.0310%
29 December 2003	£26,236,191.00	4.0310%
29 March 2004	£1,000,000.00	1.0000%

Thus, on each of the two Quarterly Dividend Dates, the amount of the Subscription Amount would decrease so as to reflect the fact that the subscriber for the Second Issued Preference Shares would no longer be entitled to receive the relevant dividend.

(D) On 25 September 2003, ABN AMRO entered into the Deed of Covenant with First Nationwide [Volume B2, tab 29], under which ABN AMRO undertook to First Nationwide to procure, inter alia, that any payment of a “Quarterly Dividend” or an “Annual Dividend” by Blueborder would be made in accordance with and pursuant to its articles of association (see clause 2.1 of [Volume B2, tab 29]) and that on any Quarterly Dividend Date or Accelerated Dividend Date, Blueborder would have sufficient share premium to pay the relevant Quarterly Dividend in full (clause 2.5, ibid)..

The Onward Sale

11. On 29 September 2003, pursuant to a share sale agreement, First Nationwide sold the First Issued Preference Shares to Anglo Irish Bank Corporation plc (“Anglo Irish Bank”), an Irish incorporated, and Irish resident, company, in consideration of the receipt of an aggregate sum of £50,314,975 [Volume B2, tab 33].  As a result, Anglo Irish Bank became the legal and beneficial owner of, and was entered on the share register of Blueborder as the holder of, the First Issued Preference Shares.

The Dividends and Manufactured Dividends

December 2003

12. On 29 December 2003, Blueborder, in accordance with its articles of association:

(A) paid to Blauwzoom a dividend in the aggregate sum of £498,938.50 in respect of the issued Ordinary Shares; and that dividend was paid out of amounts available for distribution other than share premium;

(B) paid to Anglo Irish Bank a dividend in the aggregate sum of £25,500,000 in respect of the First Issued Preference Shares (the “First Preference Dividend”); and that dividend was paid out of share premium account; and

(C) executed and issued a dividend voucher in respect of those two dividends [Volume B2, tab 40].

13. No Cayman Islands income, withholding or capital gains taxes were payable in relation to the dividends; and there was no associated tax credit.

14. Further, on 29 December 2003, in accordance with the terms of the Stock Loan Agreement, First Nationwide paid a Manufactured Dividend in the aggregate sum of £25,500,000 to ABN AMRO, equal to and representative of the amount of the First Preference Dividend that was paid to Anglo Irish Bank.

March 2004

15 On 29 March 2004, Blueborder, in accordance with its articles of association:

(A) paid to Blauwzoom a dividend in the aggregate sum of £257,263 in respect of the issued Ordinary Shares; and that dividend was paid out of amounts available for distribution other than share premium;

(B) paid to Anglo Irish Bank a dividend in the aggregate sum of £25,500,000 in respect of the First Issued Preference Shares (the “Second Preference Dividend”); and that dividend was paid out of share premium account; and

(C) executed and issued a dividend voucher in respect of those two dividends [Volume B2, tab 46].

16. No Cayman Islands income, withholding or capital gains taxes were payable in relation to the dividends; and there was no associated tax credit.

17 Further, on 29 March 2004, in accordance with the terms of the Stock Loan Agreement, First Nationwide paid a second Manufactured Dividend in the aggregate sum of £25,500,000 to ABN AMRO, equal to and representative of the amount of the Second Preference Dividend that was paid to Anglo Irish Bank (together with the Manufactured Dividend of 29 December 2003, the “Manufactured Dividends”).

Subscription for the Second Issued Preference Shares; the Ending of the Stock Loan

18. Pursuant to the Subscription Agreement, First Nationwide subscribed on 29 March 2004 for 50,050 Second Issued Preference Shares in Blueborder at a price of £1,000,000 in aggregate.

19. On 29 March 2004, First Nationwide transferred the Second Issued Preference Shares to ABN AMRO, thereby closing out the stock loan.

The Appellant’s Return

20. In making its self-assessment to corporation tax for the year to 31 March 2004 First Nationwide treated:

(A) the Manufactured Dividends as expenses of management and thus deducted the sum of £51,000,000 from its total profits for the relevant accounting period following which it had excess management expenses of £48,670,942 in that accounting period which it surrendered to Nationwide Building Society by way of group relief; and

(B) the sale of the First Issued Preference Shares by First Nationwide to Anglo Irish Bank as giving rise to a chargeable gain of £49,314,975, being the difference between the proceeds of the sale (i.e. £50,314,975) and the base cost, which, by virtue of section 263B(3) of the TCGA, was equal to the subscription price for the Second Issued Preference Shares (i.e. £1,000,000).  First Nationwide made an election under section 171A TCGA pursuant to which this chargeable gain accrued to Nationwide Building Society.

The Issues

21. The issues for determination are as follows:

(A) whether or not each of the First Preference Dividend and the Second Preference Dividend constitutes a “dividend” for the purposes of paragraph 1(1) Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(B) if so, whether or not each of the First Preference Dividend and the Second Preference Dividend constitutes an “overseas dividend” for the purposes of paragraph 1(1) Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(C) if so, whether or not the sale of the First Issued Preference Shares by the Appellant to Anglo Irish Bank and the subscription by the Appellant for the Second Issued Preference Shares was a sale and repurchase of securities for the purposes of sections 737A and 730A ICTA (as extended by subsections 737B(5) and 730B(2)(a), respectively, to include the case where a person sells securities and buys similar securities).

Witness evidence

4. I heard oral evidence from five witnesses.  The first was Alison Gayton, Assistant Treasurer in the Treasury Department of the Society, who provided evidence as to the Society’s funding requirements.  The other four were all expert witnesses as to Cayman Islands law.  There were two experts instructed by each party.  The Appellant instructed Sandra Corbett, a partner of Walkers, attorneys at law, and William Bagnall, a partner of Ogier, attorneys at law.  HMRC instructed Christopher Humphries, a director of Stuarts Walker Hersant, attorneys at law and Paul Scrivener, a partner in Solomon Harris, attorneys at law.

Miss Gayton

5. Miss Gayton gave evidence, which I accepted, in relation to the background, in funding terms, to the transactions with which this appeal is concerned.  Miss Gayton explained the funding requirements of the Society in the second half of 2003 and the causes of those requirements, and confirmed that the funds raised from the transactions contributed to meeting those funding requirements.  I find that the purpose of the sale of the First Issued Preference Shares to Anglo Irish Bank was to provide funds for the Society’s group to use, and that this was with a view to assisting, in the medium term, with the ongoing funding requirements faced by the group from the growth in the Society’s mortgage assets at that time.

The Cayman Islands experts

6. Whilst differing in a number of material respects, which I consider later in this decision, the Cayman Islands’ experts were able to agree on certain matters, and helpfully prepared a Joint Memorandum of Agreed Matters of Cayman Islands law, which I set out below:

Introduction

A          The Cayman Experts met at the offices of Solomon Harris in Grand Cayman, Cayman Islands on 22 September 2009. Each of the Cayman Experts was present in person except for Sandra Corbett who was in attendance from overseas by conference call.

B.         The Cayman Experts noted that the Rules between the Parties for Expert Meetings had not been finalised between the Appellant and the Respondent prior to the start of the Meeting. Nevertheless, the Cayman Experts agreed that the Meeting would be held on a 'without prejudice' basis and that any written note of the Meeting and any subsequent correspondence or communications between two or more of them relating to the issues relevant to the dispute would be considered 'without prejudice'.

C.         The Cayman Experts agreed that this Memorandum would be prepared as a record of all matters in their expert reports on which they all agreed. All other matters in those expert reports were not agreed between them except for the paragraphs and matters stated in paragraph E below which the Cayman Experts acknowledge were neither agreed nor disagreed. This Memorandum is not, therefore, a stand alone document but supplements the expert reports of the Cayman Experts by identifying those matters of Cayman Islands law on which they all agreed, subject to any qualifications expressly set out in this Memorandum.

D.        Each Cayman Expert confirmed that they had prepared their expert report by reference to the facts set out in the Statement of Agreed Facts and Issues (Bundle Index, volume A, tab 4).

E.         Mr Scrivener and Mr Humphries stated that they would not address those paragraphs in the expert reports of Ms Corbett and Mr Bagnall which, they asserted, analysed and debated principles of English law as they considered that these were matters of English law for the Tribunal to determine and beyond the role of the Cayman Experts. Ms Corbett and Mr Bagnall did not accept these assertions, and contended that the application (or otherwise) of these principles of English law (including the interpretation of applicable English case law) by a Cayman Islands court was a matter of Cayman Islands law. No agreement having been reached by the Cayman Experts on this issue, it was acknowledged by Ms Corbett and Mr Bagnall that Mr Scrivener and Mr Humphries would not address such paragraphs and therefore they should be treated as having been neither agreed nor disagreed by the Cayman Experts for the purposes of this Memorandum.

F.         The Cayman Experts also noted that the questions posed to Ms Corbett and Mr Bagnall for their expert reports differed from those posed to Mr Humphries and Mr Scrivener.

G.        The Appendix to this Memorandum[3] attaches extracts of the following statutory provisions referred to in this Memorandum and the Cayman. Experts agree that such extracts correctly state such statutory provisions:-

Cayman Islands

Section 32 of the Companies Law, 1961 (the "1961 Law'')

Section 11 of the Companies (Amendment) Law 1989

Section 8 of the Companies Law (2003) Revision (the "Companies Law")

Sections 13 to 19 (inclusive) of the Companies Law

Section 34 of the Companies Law

Section 37 of the Companies Law

Section 183 of the Companies Law

United Kingdom

Section 56 of the Companies Act, 1948 (the "1948 Act")

Matters Agreed

1.         Share premium is not share capital of a company. The payment of a dividend out of share premium account is therefore not a return of share capital.

2.         The legal system in the Cayman Islands is founded on the English system. Specific sources of Cayman Islands law are Cayman Islands legislation (for example the Companies Law (Cap 22), English legislative provisions extended to the Cayman Islands by United Kingdom Orders in Council, Cayman Islands case law, and case law from England and other common law jurisdictions.

3.         The doctrine of judicial precedent applies in the Cayman Islands as it applies in England. The ultimate court of appeal is the Judicial Committee of the Privy Council in London, whose decisions are binding on the Cayman Islands Court of Appeal and the Cayman Islands Grand Court. Decisions of the Cayman Islands Court of Appeal are similarly binding on the Grand Court.

4.         There is a comparatively small body of case law in the Cayman Islands, contained in the Cayman Islands Law Reports (“ClLR"), but where there is no applicable Cayman Islands case law, the Cayman Islands will look to English authorities which are of persuasive but not binding authority in the Cayman Islands. Decisions of courts in other Commonwealth jurisdictions are similarly of persuasive but not binding authority.

5.         At the material time, Cayman Islands company law comprised the Companies Law and case law applicable in the Cayman Islands as it relates to companies.

6.         In the case of a company limited by shares, section 8 of the Companies Law requires the amount of capital with which the company proposes to be registered to be stated in its memorandum of association. Unless the company is registered pursuant to section 183 of the Companies Law as an exempted company, the capital must be divided into shares of a fixed amount, commonly known as the nominal or par value of the share. Exempted companies may also divide their capital into shares without nominal or par value but cannot divide their share capital into both shares of a fixed amount and shares without nominal or par value.

7.         Section 13 of the Companies Law permits, inter alia, a company to alter the conditions of its memorandum to increase its share capital, if so authorised by its articles, Subject to the provisions of section 37 of the Companies Law, a company can reduce its share capital in accordance with the provisions of sections 14 to 19 of the Companies Law. However, any reduction of share capital must be sanctioned by both a special resolution of the company and an Order of the Court confirming the reduction, such Order being made on such terms and conditions as the Court thinks fit. Absent an Order of the Court confirming the reduction, the reduction will not be effective, even if the resolution is filed with the Registrar of Companies.

8.         Under Cayman Islands law, prior to a winding up, a Cayman Islands company is only permitted to return share capital to its members in two specific circumstances, namely, by a court approved reduction of share capital and by a lawful repurchase or redemption of shares by the Company[4]. A Cayman Islands company is not permitted to pay a dividend to its members out of share capital.

9.         In the Cayman Islands, the term "profit" has not been defined by the Companies Law even though the term "profit" is used in a number of places in the Companies Law. The question of payment of dividends was considered by the Grand Court in the Cayman Islands' cases of In re the Matter of Omni Securities Limited (No 5)[5] and in Prospect Properties Limited (in liquidation) v. McNeill and J.M Bodden II[6].

10.       Where a company issues shares for a sum in excess of their nominal or par value, the excess is known as share premium and section 34 of the Companies Law requires that the excess be transferred to a separate account known as the share premium account. The share premium account is a statutory fund created pursuant to section 34(1) of the Companies Law that separates out the share capital component of the consideration paid for the company's shares from the share premium component.

11.       What is now the first sentence of section 34(1) of the Companies Law has been part of Cayman Islands law since the 1961 Law was enacted (then sectioned as Section 32(1)). Section 32(1) of the 1961 Law relating to share premium appears to have been modelled on section 56 of the 1948 Act and there are no appreciable differences between section 32(1) of the 1961 Law and section 56 of the 1948 Act. Those sections provided that the provisions of the 1961 Law and the 1948 Act respectively relating to the reduction of share capital, applied (save as provided in the relevant section) as if the share premium account were paid up share capital of the company.

12.       In 1989, under section 11 of the Companies (Amendment) Law, 1989, section 32 of the 1961 Law was amended. Section 32(2) was amended and became what was (and remains) section 34(2) in the Companies Law and the following words in subsection 32(1) of the 1961 Law were deleted: "the provisions of this Law relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the share premium account were paid up share capital of the company". The new section 32(2) (section 34(2) in the Companies Law) permits share premium to be applied by a company, subject to any provisions of its memorandum or articles of association, in such manner as the company may from time to time determine, including, among other things, paying dividends to the company's members, subject to the solvency test in the proviso to section 34(2).

13.       The effect of section 32(1) of the 1961 Law was that from the date of that Law until the coming into force of the Companies (Amendment) Law, 1989, the provisions of the Companies Law relating to the reduction of share capital applied (save as provided in section 32 of the 1961 Law) as if the share premium account were paid up share capital of the company.

14.       The relevant record of Government Business recording the first reading of the Companies (Amendment) Bill, 1989 records that clause 11 of the Bill sought to amend section 32[7] by substituting two new sections, 1 and 2, " ... to extend the purposes for which share premium account may be applied .... ". This extension included the payment of dividends.

15.       The Financial Secretary, when introducing the Bill to the Legislative Assembly on September 4, 1989 did not explain in further detail the reasoning behind the individual amendments, but referred to their overall purpose. He referred to an article in that day's Caymanian Compass newspaper which contained statements by the chairman of the Company Law Revision Committee which proposed the changes with the support of the financial community, that "they will make Cayman more saleable in the face of competition from other jurisdictions". Commenting on particular new provisions, the chairman referred to the introduction of "more flexible accounting procedures for companies", which could only refer to the new subsection 34(2).[8]

16.       There is no income tax or capital gains tax in the Cayman Islands so there is no Cayman Islands statutory definition which assists in determining whether any particular payment received is received by way of income or capital.

17.       Except where it is necessary to determine the rights or entitlement of beneficiaries under the terms of a Cayman Islands trust with regard to a dividend in the hands of a trustee of such trust, the Cayman Experts have not been able to identify any obvious reason under Cayman Islands law that would make it necessary to characterise  the payment of a dividend out of the share premium account as either a receipt of capital or income in the hands of the recipient shareholder.

18.       There is no Cayman Islands authority on whether dividends constitute income or capital in the hands of the recipient[9]. English authorities and authorities of other common law jurisdictions would therefore be of persuasive authority in accordance with the principles referred to in paragraph 4 above.

7. It is apparent from the Introduction to the Joint Memorandum that the questions posed to the experts instructed by the Appellant (Ms Corbett and Mr Bagnall) and those put to the experts instructed by HMRC (Mr Humphries and Mr Scrivener) were not the same.  The issues considered by the Appellant’s experts were:

(1) Whether the First Preference Dividend and the Second Preference dividend both constituted dividends for the purposes of Cayman Islands law, and in particular notwithstanding the fact that the dividends were paid out of the share premium account of Blueborder;

(2) Whether the share premium account of Blueborder constituted part of the share capital of Blueborder, or instead constituted part of the funds of Blueborder available for distribution as profits or in a manner similar to profits;

(3) Whether the First Preference Dividend and the Second Preference Dividend would be considered as a payment of an income or capital nature under Cayman Islands law.

The questions addressed by HMRC’s experts were:

(1) Can the share premium account be seen as distributable profits, and is a dividend out of share premium account a distribution of profit?

(2) Does a payment of dividends out of share premium account constitute a distribution of capital?

(3) If a dividend out of share premium account is neither a distribution of profit nor a distribution of capital, then what is the nature of such a dividend under Cayman Islands law?

8. It will be seen from this that the question whether the First Preference Dividend and the Second Preference Dividend (together “the Preference Dividends”) constituted dividends for the purposes of Cayman Islands law was specifically addressed only by the Appellant’s experts, but it is implicit in the questions asked of HMRC’s experts, and in the responses of those experts to those questions, that in each case such a dividend was indeed paid.  HMRC accepted that the legal mechanism of the payments took the form of a dividend declared and paid out of share premium account, and, as appears from the agreed statement of facts and issues, did not deny that the Preference Dividends constituted dividends for the purposes of Cayman Islands company law, but argued that this did not determine the Dividend Issues.  However, as a matter of Cayman Islands law, there was no dispute among the experts that the Preference Dividends were dividends.

9. Each of the experts did, however, consider the nature of the share premium account under Cayman Islands law, and here there was a distinct difference, both in approach and in the conclusions reached.  The Appellant’s experts took the view that the share premium constituted a category of divisible or distributable profit.  The experts instructed by HMRC, by contrast, concluded that share premium was in the nature of capital.  I must consider the questions of Cayman Islands law in the context of the issues for determination in this appeal.  Accordingly I now turn to those issues and the arguments of the parties.

The Dividend Issues

10. I consider first the Dividend Issues.  It is in relation to these issues that I will need to make findings in relation to Cayman Islands law.  The Repo Issues concern the application and construction of UK statute law alone, and I shall consider those arguments separately.

11. Mr Gardiner was disposed to treat the Dividend Issues essentially as one issue.  However, as the issues have been agreed by the parties and have been expressed separately as to whether the Preference Dividends constitute “dividends” and “overseas dividends”, and I consider it appropriate to address them separately.

The law

12. The relevant legislation is contained in Part XVIII of the Income and Corporation Taxes Act 1988 (“ICTA”) and in the Income Tax (Manufactured Overseas Dividends) Regulations 1993 (“the 1993 Regulations”).  Part XVIII is entitled “Tax Avoidance”, but it is no part of HMRC’s case that the appeal must fail on the basis that it is, wholly or in part, a scheme to avoid tax.  As Mr Gammie noted in his skeleton argument, although the legislation is found in the Part of the Act that is set aside for provisions that are designed to counter what Parliament regards as tax avoidance, the legislation in question incorporates no relevant tax avoidance or commercial purposes test.  The Appellant’s reasons for entering into the transaction, the purpose of which I have found was to assist the Nationwide group’s funding requirements, are accepted as being of no concern in construing the legislation.

13. Section 736A makes provision for manufactured dividends and interest by giving effect to Schedule 23A as follows:

“Schedule 23A to this Act shall have effect in relation to certain cases where under a contract or other arrangements for the transfer of shares or other securities a person is required to pay to the other party an amount representative of a dividend or payment of interest on the securities.”

14. Schedule 23A makes provision for manufactured payments relating to a number of different types of securities.  Paragraph 1 is an interpretation provision for the Schedule and relevantly provides as follows:

“In this Schedule—

...

“overseas dividend” means any interest, dividend or other annual payment payable in respect of any overseas securities;

“overseas dividend manufacturer” has the meaning given by paragraph 4(1) below;

“overseas securities” means—

(a) shares, stock or other securities issued by a government or public or local authority of a territory outside the United Kingdom or by any other body of persons not resident in the United Kingdom; ...

“transfer” includes any sale or other disposal;”

15. Paragraph 4 is the principal part of Schedule 23A relating to overseas securities.  Paragraph 4(1) provides that:

“This paragraph applies in any case where, under a contract or other arrangements for the transfer of overseas securities, one of the parties (the “overseas dividend manufacturer”) is required to pay to the other (“the recipient”) an amount representative of an overseas dividend on the overseas securities; and in this Schedule the “manufactured overseas dividend” means any payment which the overseas dividend manufacturer makes in discharge of that requirement.”

16. Paragraph 8 authorises the making of dividend manufacturing regulations to make different provision from that contained within, amongst others, paragraph 4 of Schedule 23A.  The 1993 Regulations were made by the Treasury using that power.

17. Regulation 2(1) provides the following relevant definitions:

“In these Regulations unless the context otherwise requires—

...

  “manufactured overseas dividend” shall be construed in accordance with paragraph 4(1) of Schedule 23A;

“overseas dividend”, “overseas dividend manufacturer”, … have the meanings given by paragraph 1(1) of Schedule 23A”

18. Regulations 4(1) and (2) relevantly provide:

“(1) For the purposes of the provisions of the Tax Acts relating to the charge to tax under Schedule D other than paragraph 4(3) of Schedule 23A, a manufactured overseas dividend paid in the circumstances prescribed in paragraph (2)—

(a) shall not be treated as an annual payment pursuant to paragraph 4(2) of Schedule 23A;

(b) shall be paid without deduction of an amount on account of income tax;

(c) where the maker of the payment is an investment company within the meaning of section 130 of the Taxes Act, shall be treated as if it was an expense of management in relation to that company.

(2) The circumstances prescribed by this paragraph are where—

(a) a manufactured overseas dividend is paid to an approved United Kingdom intermediary or an approved United Kingdom collecting agent by an overseas dividend manufacturer who—

          (i) is resident in the United Kingdom … and

         (ii) is not an approved United Kingdom intermediary; and

(b) the manufactured overseas dividend is not representative of the overseas dividend received by the overseas dividend manufacturer.”

19. The Appellant accepts that, as a result of the transactions that are the subject of this appeal, it made a chargeable gain of £49,314,975 and it completed its corporation tax self assessment on that basis.  The Appellant contends that the transactions also give rise to a deduction for expenses of management of £51 million (being the amount of the manufactured dividends it was required to pay to ABN AMRO).

20. Although HMRC dispute the entitlement to that deduction, the operation of much of the legislation was not in dispute in this appeal.  The dispute concerns whether or not the Preference Dividends were “overseas dividends”.  If they were, then regulation 4(1)(c) of the 1993 Regulations would apply so as to treat the manufactured dividends as expenses of management of the Appellant and consequently they would be deductible under section 75 ICTA.

21. In this respect, the agreed Dividend Issues reflect two points raised by HMRC.  First, are the Preference Dividends “dividends” within the meaning of para 1(1) of Sch 23A and the 1993 Regulations?  Secondly, if so, are they “overseas dividends” within the meaning of para 1(1) of Sch 23A and the 1993 Regulations?

Are the Preference Dividends “dividends”?

22. In construing these statutory provisions there was no dispute as to the approach I should adopt.  As Mr Gammie pointed out, taxing statutes have to be construed purposively according to the reality of the arrangements in question (Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1 at [32]).  This does not, as Mr Gammie accepted, give rise to some overriding power to strike down transactions that have no commercial purpose.  The correct approach is, first, to decide on a proper construction exactly what transaction will answer to the statutory description, and secondly to decide whether the transaction in question does so (Barclays Mercantile at [36]).  The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction viewed realistically (Collector of Stamp Revenue v Arrowtown Assets Ltd (2004) ITLR 454 per Ribeiro PJ at [35]).

23. Mr Gardiner submitted that both of the Dividend Issues came down to the simple question whether there is a special and exceptional meaning to the word “dividend” in the legislation.  He argued that “dividend” should be accorded its straightforward and ordinary meaning as it has everywhere else in the tax legislation.  “Dividend” has the meaning that it has as a matter of English company law, so that, in the case of overseas securities under the law of a foreign jurisdiction that is close to English law, a dividend under that law will be a dividend for the purposes of the UK statutory provisions.

24. Whilst accepting that the legal mechanism for the payments under Cayman Islands law took the form of a dividend declared and paid out of share premium account, Mr Gammie argued that this was not finally determinative of whether the payments were dividends within the meaning of that term in the definition of “overseas dividend” in para 1(1), Sch 23A in the overall context of the relevant provisions.  He said that the mere labelling of payments as dividends under local company law does not conclusively determine the character of the payment for UK tax purposes and in particular for the purpose of the definition in para 1(1).

25. Mr Gammie’s reference here to labelling essentially emanated from the judgment of Upjohn J in the Court of Appeal in Rae v Lazard Investment Co Ltd 41 TC 1 (at p 20), a case I will consider in more detail later, where the learned judge drew a distinction between the legal machinery a company employs in making a distribution and any mere label that might be attached to that distribution.  But it is clear to me that this present case is very far from one of mere labelling.  It was agreed amongst the Cayman Islands experts that the Preference Dividends were dividends as a matter of Cayman Islands law, and it is equally clear that under that law those amounts were capable of being paid out of share premium account as dividends, and were declared and paid as such.  These were as a matter of legal machinery plainly dividends, and there is no question of this case falling into the mere labelling category.  Mr Gammie argued nevertheless that it is still necessary to look behind the legal machinery and at the substantive quality of the payment.  He referred again to Rae v Lazard, this time to the speech of Lord Pearce (at p 31), where he said:

“… foreign law might create colourable labels or machinery whereby it could fix upon a distribution a specious appearance of capital when in truth it should be income, and that thus tax could be unfairly avoided. If such a situation arises, it may well be that the English Courts would feel entitled to look behind the labels or even, perhaps, behind the machinery itself to find the true substance of the matter.”

26. Mr Gammie referred to two cases as illustrating the ordinary meaning of “dividend”.  In Esso Petroleum Ltd v Ministry of Defence [1990] Ch 163 Harman J sated (at pp 165 to 166):

“In ordinary language today among people having some understanding of business a "dividend" refers to a payment-out of a part of the profits for a period in respect of a share in a company.”

This formulation was accepted by Peter Gibson LJ in Memec plc v Commissioners of Inland Revenue 71 TC 77, who said (at p117):

“The ordinary meaning of ‘dividend’ is that it is a payment of part of the profits for a period in respect of a share in a company.”

27. Mr Gardiner argued that the dicta referred to in these two cases cannot be elevated to the status of a statutory definition.  Indeed, Mr Gammie accepted that.  Mr Gardiner said that neither case purported to lay down a statutory test or to place some gloss on the meaning of the word “dividend”.  They were not, and Mr Gammie also accepted this, concerned with the issue in the present case.  Memec was concerned with a share of profits under a silent partnership agreement entered into under German law.  The Court considered that a share in the profits of such a silent partnership was not a dividend since the partnership was not a company and since the share of the profit was not related to the shares in any of the companies involved.  The focus of the Court in Memec was on whether there was payment of a part of the profits for a period in respect of a share in a company.  Likewise Esso Petroleum was concerned with a quite different situation to that of this appeal, namely determining the meaning of the term “public revenue dividends”.

28. Mr Gardiner’s primary argument in this respect was that attempting to construe “dividend” in the manner of the meanings suggested in Memec and Esso Petroleum was the wrong approach.  The statutory language, and accordingly the word to be construed for present purposes is “dividend”.  It is clear that the Preference Dividends, having been properly declared as dividends, and lawfully paid as dividends in accordance with Blueborder’s articles of association and Cayman Islands law, fall within that term as used in the statute.  They were dividends under Cayman Islands law, the concept of which is the same as under English law.  In consequence the Preference Dividends constituted “dividends” within the meaning of Schedule 23A.

29. In this respect I agree with Mr Gardiner.  The legislation must be construed purposively, but I can see no basis for ascribing any meaning to “dividend” in this context that is different from the ordinary understanding of that term as a matter of legal machinery.  Here it is accepted that the Preference Dividends were lawful dividends as a matter of Cayman Islands law, and that the concepts of that law are analogous to the same concepts under English law.  In this respect, therefore, it does not seem to me that the enquiry need go any further.  This was not mere labelling; the payments were in substance dividends under Cayman Islands law, the machinery of which is recognisable in the context of English law.  Nor is there any question in my view of the machinery of the making of the Preference Dividend payments being in any way colourable in the sense referred to by Lord Pearce in Rae v Lazard.  Lord Pearce was there referring to machinery which might fix upon a distribution a specious appearance, in that case of capital.  That goes to the question, not of the nature of the means of payment itself, but of its UK tax treatment, which is the next issue to be considered.  And in Rae v Lazard Lord Pearce said that the transaction there was admittedly genuine and that he could see nothing in the concept of partial liquidation (in that case under the law of the US state of Maryland) that was wholly out of accord with the notions of English law.  That equally applies here.  The payments of the Preference Dividends out of the share premium account were genuine, and the machinery accorded with notions of English law.

30. That would dispose of the first of the Dividend Issues, but in case I am wrong, and that in order for a dividend to be a “dividend” for the purposes of para 1(1) of Schedule 23 and the 1993 Regulations it must be a payment of part of the profits, and because this issue involves a finding of fact as to the expected position under Cayman Islands law, I must now turn to the conflicting evidence of the Cayman Islands experts in this regard.

31. The starting point in this inquiry is the Joint Memorandum.  From this it can be concluded, as a matter of Cayman Islands law, that:

(1) As share premium is not share capital of a company, the payment of a dividend out of share premium is not a return of share capital.

(2) Sources of Cayman Islands law include case law from England and other common law jurisdictions, and decisions of English and Commonwealth courts are of persuasive, but not binding, authority.

(3) There is no definition of “profit” in the Cayman Islands Companies Law, even though that term appears in a number of places in the legislation.

(4) The question of payment of dividends was considered by the Grand Court of the Cayman Islands in the cases of In re the Matter of Omni Securities Limited (No 5) (2000) CILR 187 and Prospect Properties Limited (in liquidation) v McNeill and JM Bodden II (1990-91) CILR 171.

(5) Section 32(1) of the Cayman Islands Companies Law 1961 appears to have been modelled on s 56 of the English Companies Act 1948.  The effect of section 32 was that the provisions relating to the reduction of share capital applied as if the share premium account were paid up share capital of the company.

(6) Section 32(2) of the 1961 Law was amended in 1989 and became what is now s 34(2) of the Companies Law (2003 Revision).  The application of the provisions relating to the reduction of share capital as if share premium account were paid up share capital was removed.

(7) Section 34(2) permits share premium of a Cayman Islands company to be applied by the company, subject to any provisions in its memorandum or articles of association, in such manner as the company may from time to time determine, including paying dividends to its members, subject to the solvency test in s 34(2).

32. Mr Humphries and Mr Scrivener take the view that the share premium account cannot be seen as comprising distributable profits and that a dividend out of share premium account is not a distribution of profit.  In summary their reasons for this conclusion are as follows:

(1) A Cayman Islands court would be likely to give the term “profits” its ordinary commercial meaning such as the earnings from the company’s operations and/or assets after deducting the expenses of earning them.

(2) Share premium is a statutory fund that separates out the share capital component of the consideration paid for the company’s share capital from the premium. The share premium account represents funds paid as a component of that consideration

(3) Section 34(2) does not transform share premium into profits.  Share premium account remains an accumulation of capital contributed by members of the company over and above the nominal capital.

(4) Other elements of the Cayman Islands Companies Law make a distinction between share premium and profits.  For example, s 13(7) requires, in connection with any rounding up of euro denominated share capital following conversion to euro from any other currency, a transfer to be made “from the share premium account or from profit and loss account (as the directors shall, in their discretion, determine)”, and s 37(3)(e) of the Companies Law requires that any premium payable on the redemption or repurchase of shares must be provided for “out of the profits of the company or out of the company’s share premium account ... or in the manner provided for in subsection (5).”

(5) The statutory scheme for the establishment and use of share premium account under s 34 is not the same, nor is it intended to be the same, as the English common law position relating to the treatment of the share premium prior to the coming into force of s 56 of the English Companies Act 1948 (or s 72 of the Companies Act 1947). 

33. Neither Mr Humphries nor Mr Scrivener placed reliance upon case law of the Cayman Islands or any English or Commonwealth authorities in support of their views.

34. Ms Corbett and Mr Bagnall took a different approach, and reached a different conclusion.  Their views can be summarised as follows:

(1) Under Cayman Islands law share premium is something additional to the capital subscribed upon the issue of shares and is thus profit in the real sense such that the capital of the company is not increased by share premium nor is it decreased if dividends are paid out of share premium account.  There is English authority for this proposition in Re Duff’s Settlement Trusts [1951] Ch 721, which considered the impact of the introduction of s 56 of the English Companies Act 1948.  Mr Justice Harman said (at p 724):

“It is well known that before the Act of 1948 these sums [sums received by companies as premiums on the allotment of their shares] ranked as profits available for payment of a dividend …”

and at p 727 he continued:

“It is true also that the share premium account itself represents a profit in the sense that the company got more for its shares than their nominal value.”  

(2) In the Cayman Islands case of In re the Matter of Omni Securities Limited (No 5) (2000) CILR 187 Chief Justice Smellie states (at p 191):

 “As a matter of basic principle, it appears to be settled law that before any dividend is declared, there must be profits in an amount necessary to sustain the dividend in existence in the company itself … This principle is based on long-standing authority, best expressed and understood in terms of the prohibitive statement that dividends may not be paid out of capital.”

Although Smellie CJ was not asked to consider the question whether a payment out of share premium account would be a payment out of profit or capital, this strongly suggested that he would have concluded that such a payment could not be regarded as out of capital but was a payment out of some kind of profit.

(3) To the extent that the applicable principles have not been altered by any Cayman Islands legislation or authority, the position will be that of the English common law prior to the enactment of section 56 of the English Companies Act 1948.

(4) The English authorities, in particular Re Hoare & Co Ltd and Reduced [1904] 2 Ch 208, Drown v Gaumont – British Picture Corporation Ltd [1937] 2 All ER 609, Re Duff’s Settlement Trusts and Quayle Munro Ltd 1992 SC 24 show that reserves formed by setting aside a premium should not be treated differently from reserves of “normal profits”, that share premium itself represents a profit and is in the category of divisible profit, subject to the effect of s 56 of the Companies Act 1948, and that sums released from share premium account are available to be distributed a profits distributable by way of dividend.  The same analysis would be applied to the share premium account under Cayman Islands law.

35. In view of the competing evidence of the Cayman Islands expert witnesses I must decide which view I consider to be correct.  The task of the experts was to predict the likely decision of a Cayman Islands court (see MCC Proceeds Inc v Bishopsgate Investment Trust PLC and others [1999] CLC 417), and in consequence of the fact that they have differed in their conclusions, it is for me to make a finding as to what the ruling of the Cayman Islands court would likely be if the issue were to arise for decision there.

36. Before turning to the difference of substance in the categorisation of share premium account, I should first deal with a particular point of disagreement between the two sets of experts as to the nature of the solvency test in s 34(2) of the Cayman Islands Company Law (2003 Revision).  The ability of a company to apply share premium account in paying distributions or dividends to members is constrained by the solvency test which provides that no distribution or dividend may be so paid unless, immediately following the date on which the distribution or dividend is proposed to be paid, the company shall be able to pay its debts as they fall due in the ordinary course of business.  There are penalties for breach of this requirement.  The Cayman Islands experts differed as to the nature and effect of this requirement.  Ms Corbett and Mr Bagnall took the view that this amounted to no more than a re-statement of the common law position regarding the payment of a dividend out of “normal profits”.  Mr Scrivener and Mr Humphries took a different view, namely that in the case of a dividend otherwise than out of share premium account a cash flow solvency test was merely one of the factors to be taken into account by the directors in exercising their fiduciary duties.

37. The respective positions are best summarised by considering the evidence of Mr Bagnall and Mr Scrivener.  Mr Bagnall referred to Professor Gower’s “Summary of legal rules regarding dividends” in Modern Principles of Company Law, the first of which was that “Dividends cannot be paid if this would result in the company’s being unable to pay its debts as they fall due.  To this overriding condition of solvency all the following rules are subject.”  This principle was illustrated by the Irish case of Peter Buchanan Ltd v McVey [1955] AC 516 at pp 521 to 522.  Mr Scrivener, under cross-examination, argued that Buchanan did not support the rule stated by Gower and that a Cayman Islands court would be persuaded that there is no rule in the terms described by Gower that applies in the Cayman Islands.  Mr Scrivener argued that the context of Buchanan was the capital maintenance rule, and said that he was not aware of any authority that states the common law rule in the terms of section 34(2).  I do not accept Mr Scrivener’s argument on this point.  It seems to me that Buchanan does support the rule described by Professor Gower.  That case concerned monies paid out of a Scottish-incorporated company to a shareholder despite the existence of a contingent debt in the form of excess profits tax.  One of the questions was whether such a payment was a proper lawful distribution of profits or an unauthorised repayment of capital.  In the High Court of Justice of Eire (in a judgment upheld on all counts by the Supreme Court), Kingsmill Moore J said (at p 522):

“I do not overlook the fact that the assessment of the company did not take place till March, 1945, after the distribution had been made, and that an assessed tax does not involve any immediate liability till after the assessment has been made: In re Winget Ld.  But where such an assessment is pending, and the basis of the assessment has been fixed by statute so that it is known within very narrow limits, it is impossible to contend that in computing what are the net profits legitimately available for distribution to shareholders such contingent liability can be ignored.  To do so is clearly to defraud the creditors of the company, who will find all its available assets and capital swallowed up by a priority revenue claim.  Accordingly, it would appear that the agreement come to between the corporators was an agreement to distribute property otherwise than out of profits and so was to do an act ultra vires the company and was inoperative for that reason.”

In my judgment this supports the rule described by Gower, and also describes the same test as the solvency test set out in section 34(2).  I am therefore of the view that a Cayman Islands court would be disposed to find that the s 34(2) restriction does no more than re-state the common law position on a payment of dividends out of “normal profits”.

38.  On the question of the analysis of the character of share premium account under Cayman Islands law I turn first to the Cayman Islands authorities relied upon by Ms Corbett and Mr Bagnall, but not by Mr Humphries and Mr Scrivener.  In my view those authorities would be regarded by a Cayman Islands court as relevant to that question.  In my view a Cayman Islands court is most likely, in considering the question at issue here, to have regard to what is profit in the legal, and not in the commercial or economic, sense.  This is clear from the Cayman Islands case of Prospect Properties, where Harre J said (at p 195):

“Profit, simpliciter, has indeed been referred to judicially as the amount of gain made by a business in a year.  See In re Spanish Prospecting Co Ltd per Fletcher Moulton LJ ([1911] 1 Ch. at 98).  However, the terms “profits in the legal sense” or “divisible profits” means the profits which the law allows a company to distribute to the shareholders as dividend.”

39. The case of Omni Securities is also a Cayman Islands authority.  In that case a dividend was paid out of capital and was unlawful.  In the passage of his judgment quoted above, what Chief Justice Smellie was saying, essentially, is that subject to the prohibition on payment of dividends out of capital (or, it might be added, anything assimilated to capital by statute), dividends can be paid out of any other reserve available to the company, subject of course to its memorandum and articles of association.  It seems to me that this is a much more productive enquiry when one is ascertaining the nature of a particular fund out of which dividends are paid, than to attempt an exhaustive definition of profits available for distribution.  On that basis, since it is common ground that dividends were not paid out of capital (again, in the legal sense of share capital, there being no longer under Cayman Islands law any assimilation of share premium to share capital), in my view it is likely that a Cayman Islands court would consider the Cayman Islands authorities themselves to indicate that the dividends in this case were paid out of profits available for distribution.  In this respect I agree with the opinions expressed by Ms Corbett and Mr Bagnall.  I do not consider that the court would be dissuaded from this view by the fact that the draftsman of the Cayman Islands law refers separately in the legislation in various parts to “share premium” and “profits”.  This does no more, in my view, than to recognise the fact that share premium must be set aside in a separate account.  It does not provide any indication as to the legal nature of share premium.  The references in s 13(7) of the Companies Law to “share premium account” and “profit and loss account”, for example, to my mind do no more than confirm the different balance sheet categories of those accounts, and not their legal characteristics.

40. I now turn to the English and Commonwealth authorities and consider whether, and to what extent, those authorities would be applied by a Cayman Islands court considering the question at hand.  I was referred by Mr Gardiner to Re Hoare in the Court of Appeal.  In that case, which concerned the position well before the English Companies Acts of 1947 and 1948, under its articles of association a company was empowered to create a reserve fund out of profits.  The company did so partly out of premiums received for leases, partly out of premiums received on the issue of preference shares and partly out of ordinary business profits.  The Court was asked to sanction a scheme for the reduction of capital, consequent upon a loss which it attributed to a greater extent to the reserve than to its share capital.  It had been held by Buckley J in the High Court, in refusing to sanction the scheme for capital reduction, that the premiums on the issue of the preference shares were not “profits” in the strict sense of the word.  In the Court of Appeal, however, the reduction was sanctioned.  Lord Justice Romer said (at p 214):

“Now what does such a fund as that represent? To my mind it in no wise represents the capital account properly so called. Test it in this way. In this case the company might, if they thought fit, have taken assets, and set them apart to represent the reserve fund, and might have kept those assets wholly apart from all the other accounts of the company. They might have kept the assets representing the reserve fund strictly to answer that reserve fund, and not have dealt with them in any way as part of the general assets of the company. So long as they did that, it is clear to my mind that the reserve fund could not be properly called in itself a capital asset.”

It is also clear from this judgment and that of Vaughan Williams LJ that the reserve fund could itself have been distributed by way of dividend, even if it was considered for the time being prudent not to do so.

41. The next case is Re Bates [1928] Ch 682.  There capital profits were made by a company owning and operating steam trawlers from selling some of the vessels.  The proceeds were carried to a suspense account and afterwards distributed as cash bonuses stated to be capital payments.  The case concerned the characteristics of the payments as between income and capital beneficiaries of a trust.  Mr Justice Eve referred to the origination of the fund, saying that although in one sense the realisation of assets, as distinct from the ordinary income of the company’s business, was capital, this could not properly be regarded as capital for all purposes.  He continued (at p 687):

“In this state of affairs it was a fund which the company could treat as available for dividend and could distribute as profits, or having regard to its power to increase capital could apply to that purpose by, for example, increasing the capital, declaring a bonus and at the same time allotting to each shareholder shares in the capital of the company paid up to an amount equivalent to his proportion of the bonus so declared. Unless and until the fund was in fact capitalized it retained its characteristics of a distributable profit, and on the authority of the passages which have been read from Lord Herschell's speech in Bouch v. Sproule , the only method by which a company with power to increase its capital can capitalize such a fund is to increase its capital by an amount equivalent to the sum sought to be capitalized. No such procedure was adopted here, and in my opinion no change in the character of the fund was brought about by the company's expressed intention to distribute it as capital. It remained an uncapitalized surplus available for distribution, either as dividend or bonus on the shares, or as a special division of an ascertained profit derived, not from the trading of the company, but from a fortunate appreciation in value of some or other of its capital assets, and in the hands of those who received it it retained the same characteristics.”

Although Re Bates was concerned with capital profits and not with share premium, it is helpful, I consider, in drawing a distinction between what might, in ordinary terms, be considered capital in nature, and what is capital for the purpose of company law.

42. Re Bates was approved by the Privy Council in Hill v Permanent Trustee Company of New South Wales Limited [1930] AC 720.  The headnote, which reflects the judgment delivered by Lord Russell, reads as follows:

“A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorized reduction of capital. Any other distribution of money, whether called dividend or bonus or any other name, can only be made by way of dividing profits. Moneys so paid to a shareholder who is a trustee consequently will belong prima facie to the person beneficially entitled to the income of the trust estate. If the moneys or any part of them are to be treated as corpus there must be some provision of the trust deed which brings about that result; no statement by the company or its officers can affect the rights of the beneficiaries in the matter.”

This is a clear statement that there are two categories of payment to shareholders.  One is a reduction of capital.  The other is a dividend, or other such description, which involves a division of profits.  Mr Gammie referred me to the earlier case of Re Spanish Prospecting Company [1911] 1 Ch 92, where Lord Justice Fletcher Moulton referred (at p 98) to the “well-developed legal meaning” of the word “profits” as an increase in the total assets of the business between two comparative dates (due allowance being made for any capital introduced or taken out).  I have already referred to Spanish Prospecting Company in the quotation from the judgment of Harre J in the Cayman Islands case of Prospect Properties, where a distinction was drawn between the ordinary meaning of “profits” and the legal meaning of profits available for distribution.  Although Fletcher Moulton LJ also stated (at p 101) that his remarks on the definition of “profits” had no bearing on the “vexed question of the fund out of which dividends may legally be paid in limited companies” and that such a fund might be larger than what could rightly be regarded as profits, there is to my mind nothing in the legal meaning of “profits” as described by Fletcher Moulton LJ that would preclude share premium (absent statutory assimilation to capital) being regarded as profits, and I consider the distinction he himself drew between profits and capital introduced or taken out to reflect what was later said in Hill v Permanent Trustee.  And as also noted above and considered further below, this was the view taken in relation to share premium by Harman J in Re Duff’s Settlement [1951] Ch 721.

43. As noted above, the availability for distribution by way of dividend of a reserve fund, including premiums paid on the issue of shares, was confirmed in Re Hoare.  That judgment was applied in Drown v Gaumont – British Picture Corporation Ltd [1937] 2 All ER 609.  That case, which also considered the position before the 1948 Companies Act, concerned an application or an injunction to restrain the payment of dividends out of a fund that included profits that were admittedly available for dividend and, in part, premiums on the issue of shares.  It was held that the part of the reserve fund consisting of monies paid by way of premium on shares, unless set aside in some particular fund which has been wholly spent, is available for dividend purposes.  In a judgment that I consider a Cayman Islands court would be likely to find most apt to the question of the nature of the share premium at issue in this case, Clauson J held that the plaintiff could have cause for complaint only if the proposed dividend could only be paid by trenching upon that part of the assets which extended to and represented in full the subscribed capital.  In relation to the specific position of the share premium the learned judge said this (at pp 616 – 617):

“As I have stated, the reserve fund was built up to a great extent out of premiums on shares, and it was suggested that there is some special feature about the money which has been obtained by way of premium upon the issue of shares, and there is some principle which prevents that money from being dealt with as available to pay a dividend. I am not aware of any such principle, nor can I see any ground upon which such principle could be established. Of course, I can well appreciate that there may be circumstances in which moneys which have been obtained on the issue of shares at a premium such as this are set aside in some particular fund, and that, that particular fund having disappeared in some way, it may afterwards be said that premium has disappeared and is no longer available. I can understand that, but, when the premium has once become a part of the general assets of the company, I do not see what justification the court would have for treating those particular assets as being on a footing different from that of any other assets, or as treating a reserve formed by setting aside such premiums as on any footing different from that of any reserve set aside out of what one may call normal profits. This is undoubtedly true, that, subject always to the question of whether there may be something in the articles of association that interferes with it, there is nothing legally wrong in a company dividing among its shareholders a premium obtained on the issue of shares, so long as the sum it pays out does not form part of the capital subscribed upon the shares, but the premium, of course, is something additional to the capital subscribed upon the shares.”

This is as clear a statement as there could be that share premium is different to share capital, and that the rules as to maintenance of share capital do not apply to share premium where it is not, by statute, assimilated to capital.  The premium may be divided among shareholders in the same way as “normal profits”.  For legal purposes, if a distinction has to be drawn, it is between “capital” in the legal sense of that word, and “profits”, meaning in this context everything that is distributable in principle because it is not capital.  Mr Gardiner argued that the principle set out so clearly in Drown, that if a premium is set aside by a company into a separate fund, it is nevertheless distributable profit and may be paid out by way of dividend, applies to this case.  The only difference between the situation in Drown and here, he said, is that s 34 of  the Cayman Islands Companies Law provides a statutory rule that a share premium be set aside as a separate fund, rather than that being the result of a voluntary act of the company.  Essentially the effect is the same.  I agree that this is highly relevant to the question at issue here, and that a Cayman Islands court is likely to find it so.

44. The cases I have so far referred to concerned the position prior to the enactment of s 56 of the English Companies Act 1948, which, as a matter of English law, essentially assimilated share premium to share capital.  There are two cases I should consider in relation to the post-1948 position.  The first is Re Duff’s Settlement [1951] Ch 721, a case to which I referred briefly above, in which Harman J held that the effect of section 56 is that money paid out of a share premium account is to be treated as capital and not as income.  This conclusion was confirmed by the Court of Appeal [1951] Ch 923.  In the High Court, at page 724, referring to Drown v Gaumont – British Picture Corporation Limited, Harman J said:

“It is argued for those interested in income that s. 56 of the Companies Act, 1948, made no alteration in the nature of the sums received by companies as premiums on the allotment of their shares. It is well known that before the Act of 1948 these sums ranked as profits available for payment of a dividend …”

And at pages 727 to 728, dealing with the post 1948 position, the learned judge concluded:

“A share in a company, as was pointed out for those interested in capital, has been described as "a bundle of rights", and one of those rights since the passing of the Act of 1948 has been to maintain the share premium account inviolable except to the extent to which it may be distributed by virtue of s. 56. It follows in my judgment that, when the share premium account is reduced in accordance with the section, there has been a reduction in the value of every share and it is therefore right to say that there has been a reduction of capital, though it is not share capital. The section has in fact produced a novel type of capital distributable only by the same process as any share capital and having, in my judgment, both in the hands of the company and in the hands of those who receive it as a result of a reduction petition, the quality of capital.”

From this, and the cases I have earlier referred to, it can be concluded that, as a matter of English law, which would be of persuasive authority in a Cayman Islands court, the effect of s 56 of the Companies Act 1948 was to convert what would otherwise have been profits into capital, in the legal sense, but a type of capital that was not share capital.  This was the effect of the statutory provision alone; anything else, such as the creation of a separate reserve fund of the premium or voluntary restrictions on the ability to distribute out of premium, does not have this effect.  In all other cases the premium retains the legal quality of distributable profit.  Indeed, Harman J also confirms (at p 727) that, even after the 1948 Act, share premium “represents a profit in the sense that the company got more for its shares than their nominal value” albeit not, after section 56, a distributable profit.  On this basis his judgment can be analysed as saying that share premium is a profit that, solely by virtue of section 56, has the quality of capital.

45. Re Duff’s Settlement considered the effect of s 56 of the Companies Act 1948 on amounts transferred to share premium account in accordance with that provision.  Quayle Munro, Petitioners 1992 SC 24 concerned the effect of the cancellation of share premium.  The Lord President (Hope), delivering the opinion of the Court of Session, considered whether it was appropriate to look at the common law position as regards the treatment of premium on the issue of shares having regard in particular to the detailed rules concerning redemptions of shares out of capital, and decided that it was.  He said (at p 27):

“The statutory restrictions which apply to the share premium account prevent sums held at credit of that account from being distributed as distributable profits of the company.  But once they have been released from the share premium account following upon its cancellation, they are available to be distributed, in accordance with the principles described in Drown v Gaumont British Picture Corporation [1937] Ch 402, as profits distributable by way of dividend.”

This confirms that, as a matter of domestic law, once the restrictions contained in what became s 130 of the Companies Act 1985 (formerly s 56, Companies Act 1948) cease to apply, those amounts, although they represent premiums on the issues of shares, are profits available to be distributed by way of dividend.  This is, in my view, apt to describe not only the process of cancellation of share premium account, but also the case were the relevant statutory provision in the nature of section 56 to be repealed or amended so that share premium was no longer assimilated to capital.

46. In determining for these purposes the likely outcome of proceedings in a Cayman Islands court I start from the position agreed by all the Cayman Islands experts that English and Commonwealth authorities are persuasive in that jurisdiction.  Mr Scrivener and Mr Humphries agreed that this was so, but their view was that the pre-1948 position under English law would not be determinative of the position under the law of the Cayman Islands after the enactment of the Cayman Islands Company Law 1989.  Mr Scrivener, noting that s 34 of the Companies Law (2003 Revision) appeared in a part of the Law that included reference to distributions of capital, regarded the English authorities as being not particularly helpful in interpreting section 34.  He referred to the enactment of s 32 of the 1961 Law as the starting point for Cayman Islands company law in identifying share premium.  His view was that the English cases do not have a bearing on that matter because the Cayman Islands regime was different from the English regime at that point.  By contrast, Ms Corbett and Mr Bagnall took the view that the English authorities were not only relevant, but that those authorities would be followed by a Cayman Islands court.

47. I heard from Mr Scrivener that prior to 1961 there was no distinct law of the Cayman Islands, and that the position was governed by the Jamaican law, as regards which I heard no evidence.  Were it necessary for me to do so, I would therefore need to resolve any question regarding the position in the Cayman Islands before that date by reference to English law.  But in this case I do not believe that is necessary.  It is clear from the Cayman Islands cases to which I have referred that the Cayman Islands courts will consider carefully the position under English law prior to 1961, and that they will be prepared to give effect to those principles as a matter of Cayman Islands law.  Section 32 of the 1961 Law was modelled closely on s 56 of the English Companies Act 1948, and must be regarded as having the same statutory effect.  The removal of the assimilation to capital in 1989 must, in my view, be regarded as having a similar outcome to the removal of share premium from those corresponding restrictions under the English law provisions as in Quayle Munro, namely to render share premium once more as profit distributable by way of dividend.

48. I am not persuaded, and I do not believe a Cayman Islands court would be, that Cayman Islands company law is a wholly discrete regime, and that in consequence the English and Commonwealth authorities to which I have referred would be regarded by a Cayman Islands court as having no application.  I do not consider that the fact that section 34 of the Companies Law (2003 Revision) requires an amount to be transferred to share premium account as affecting, or altering, the legal nature of that share premium.  In my view this amounts to no more than a transfer of profit from one account to another in the same way as in Drown premiums were transferred to a reserve fund, or in Quayle Munro the amount released from the share premium account was transferred to a special reserve subject to restrictions on distribution.  By the same token I do not consider that the solvency test in section 34(2) alters in any way the nature of the share premium account, namely as representing profit.  I have stated my view that a Cayman Islands court would be likely to find that the s 34(2) restriction does no more than re-state the position that obtains on a payment of dividends out of “normal profits”.  Even if I had accepted that a Cayman Islands court might consider that the solvency test in section 34 is not identical to the test that a company or its directors might be required to apply on a distribution of “normal profits”, the inclusion of the solvency test in section 34(2) is, in my view, no indication that the law intended the character of share premium to be transmuted from its normal character of profit into that of capital, or some special intermediate category of distributable share premium distinct from profit.  Such a legal transformation, in my view, could be achieved only by express provision such as the assimilation of share premium account to share capital under s 56 of the English Companies Act 1948 or s 32 of the Cayman Islands Company Law 1961.  Once section 32 had been superseded by the 1989 Law, and the statutory assimilation had disappeared, it seems to me that Ms Corbett and Mr Bagnall’s view is the correct one, and that a Cayman Islands court would determine that the share premium reverted to distributable profit.

Are the Preference Dividends “overseas dividends”

49. Having therefore decided that the dividends that were paid on the First and Second Issued Preference Shares out of share premium were indeed “dividends” within the meaning of Sch 23A and the 1993 Regulations, I turn now to consider whether those Preference Dividends were “overseas dividends” within the meaning of para 1(1) of Sch 23A and those same Regulations.

50. In this connection it was common ground that overseas dividends for this purpose must be income dividends chargeable under Case V of Schedule D.  Mr Gardiner argued that a dividend is fundamentally income.  Mr Gammie submitted that the Preference Dividends were not income dividends but were dividends of a capital nature, and that the receipt was therefore one of capital.

51. The question whether a distribution is received as capital or income is determined not by the source from which the relevant assets are distributed, but by the machinery employed in their distribution (see Rae v Lazard [1963] 1 WLR 555 per Lord Pearce at p 572).  Although that question is one to be determined according to English law (Camille v Henry Dreyfus Foundation Inc v IRC 8 TC 167; Inchyra v Jennings [1966] 1 Ch 37), the factual situation, including that of the applicable foreign law, has to be examined in order to apply the English law (Rae v Lazard, p 573).  This involves determining the true nature of the foreign possession in respect of which the relevant distribution or payment is made, in this case the First and Second Issued Preference Shares in Blueborder, and the effect, if any, the Preference Dividends had upon the corpus of that foreign possession (Courtaulds Investments Ltd v Fleming 46 TC 111 per Buckley J at p 124).

52. I have found that, on the basis of my view of Cayman Islands law having regard to the evidence of the Cayman Islands experts, the share premium account out of which the Preference Dividends were paid was in law profit available for distribution and not capital.  Mr Scrivener and Mr Humphries took the view, as I have described above, that share premium account under Cayman Islands law is distinct from profits, and that it is in the nature of capital, or at least more in the nature of capital.  Mr Scrivener’s arguments in particular focussed upon the economic effect of a shareholder subscribing for shares in a company.  He referred to the distinction between share capital and share premium as being artificial and rooted in the need under English law (and under Cayman Islands law prior to it being made permissible for shares to be issued without a nominal value) for the shares in a company to have a nominal value.  On the facts of this case, of course, the First and Second Issued Preference Shares did have a nominal value, and accordingly one must have regard, under English law, to the distinction to which Mr Scrivener referred.  Mr Scrivener also made reference to the Cohen Committee, whose work in this connection led to the enactment of s 56 of the Companies Act 1948 and who reached the following conclusion in section 108 of its report (Report of Committee on Company Law Amendment, Cmd 6659, June 1945, chaired by Cohen J):

“Share premiums are in essence capital though the assets acquired therewith do not represent the capital account strictly so called, and there is no legal objection, apart from any provision in the articles, to prevent the distribution thereof by way of dividend.  In our view this is undesirable.”

53. The view espoused by the Cohen Committee that share premium is in essence capital also seems to me to proceed from an economic standpoint.  But what the Cohen Committee clearly understood was that, notwithstanding that it might be said that share premiums had an essential characteristic of capital, the legal analysis was that they were nevertheless distributable profit.  This conflict could only be eliminated as a matter of law by a change in the law to assimilate share premium to share capital, as was achieved by s 56 of the English Companies Act 1948 and, in the Cayman Islands, by s 32 of the Companies Law 1961.  But what it also confirms is that an argument on the essential, or as I see it economic, classification of share premium as “capital” cannot affect its treatment as a matter of law.  Prior to 1947 it was in law distributable profit even though throughout that time it was also “in essence” capital.

54. Nor am I persuaded that those provisions in the Cayman Islands company law that group together share premium account with capital redemption reserve and fully paid share capital, or that refer separately to share premium and profits, can be determinative of the position.  On the facts of this case, in my view, the only capital as a matter of Cayman Islands law is the nominal share capital of the First and Second Issued Preference Shares, and not the share premium.

55. The key question in determining the nature of the Preference Dividends for this purpose is the consequence of those dividends on the corpus of the First and Second Issued Preference Shares.  In IRC v Reid’s Trustees [1949] AC 361, a South African company, in addition to a dividend from trading profits, declared a dividend “payable from capital profits realised on the sale of properties”.  It was held that the sum received was assessable under Schedule D, Case V, and that the shares on which he dividend was paid remained intact.  Lord Morton said (at pp 379 to 340):

“This sum must be either income arising from that possession or part of the capital of that possession. Despite the ingenious argument of counsel for the respondents, I am clearly of opinion that it cannot be part of the capital of that possession. No part of that possession has been sold; no part of the capital paid up on that possession has been returned. Before the payment was made, the respondents held 3,433 shares of 10l . each, fully paid, in the company: after the payment was made their holding was exactly the same. All that happened was that certain cash belonging to the company, and representing part of the profit realized by the sale of a capital asset belonging to the company, was paid away as a dividend. Your Lordships are not concerned to consider whether the company could or could not have given its shareholders the benefit of this profit in a form which would have been capital in the hands of the respondents. The directors, having this sum in their hands representing a profit which they were at liberty to distribute, very naturally decided to utilize it in paying a dividend.

For the reasons which I have briefly stated, I must reject the contention that this dividend came to the respondents as part of the capital of the "possession." It follows, I think, inevitably that the dividend is income arising from the "possession." Prima facie a dividend paid on shares is income. It has been held that even if a distribution by way of dividend has been made out of profits arising from some dealing with the company's capital assets, the distribution is income, as between the persons beneficially interested in capital and income respectively. See In re Bates; Hill v. Permanent Trustee Company of New South Wales; In re Doughty . None of these cases is binding on your Lordships' House, but I see no reason to differ from any of them.”

And in a passage which I regard as particularly apposite to the facts of this case, Lord Reid said (at p 385):

“The crucial question in this case must therefore be decided with little direct assistance from authority. The contention for the Inland Revenue has the merit of extreme simplicity, if that be a merit in questions of income tax. It is that the dividend cannot be capital because the respondents' foreign possessions, the shares, remain intact, and therefore the dividend must be income. It is admitted that if the money had been paid by way of reduction of the share capital that would not have been income: the shares would not have remained the same. It is also admitted that if the surplus profits had been used to create bonus shares, or even it may be bonus debentures, there would have been no receipt of income: new capital assets would have been created. But it is said that so long as the capital asset abroad remains the same anything received by the shareholder in this country must be income subject to assessment under case V. of sch. D. This may seem a technical argument which neglects the real fact that the capital value of the respondents' foreign asset has been reduced by the making of the payment. But a company can, and often does, reduce considerably the market value of its shares by paying a dividend out of accumulated trading profits, and there can be no doubt that such a dividend would fall within case V. if it came from a foreign company. There are many ways in which a company can deal with its profits. If it adopts certain methods the result is the creation of new capital assets. If it adopts other methods the result is the receipt of income by its shareholders. In either case it is immaterial whether the profits were trading profits or capital profits. It is true that, owing to the special provisions of the Income Tax Acts which distribute liability for income tax (including surtax) between a British company and its shareholders, a dividend paid by a British company out of its capital profits is not taxable. But there are no provisions applicable to a foreign company which bring about this result. I can find no satisfactory alternative to the view that, if a foreign company chooses to distribute its surplus profits as dividend, the nature and origin of those profits does not and cannot be made to affect the quality of the receipt by the shareholder for the purpose of income tax.”

The same theme was reflected in the speech of Lord MacDermott who said (at p 383):

“No doubt the shares abated in market value after the payment of the dividend, but they nevertheless remained intact. The ripe tree loses weight and worth when it sheds its fruit, but the fruit remains fruit and no more unless in its fall it has taken part of the tree with it.”

56. This test was accepted by the House of Lords in Rae v Lazard.  There a part of a company’s business was hived-off by means of a procedure under local law of the US state of Maryland known as a distribution in partial liquidation.  It was held as a matter of fact that the hive-off could not have been achieved by way of declaration of dividend, and that under Maryland law the original interest in the company did not remain intact and that the courts of Maryland would look to the substance of the transaction, namely that the interest was in the entirety of the company’s capital assets and that under Maryland law there was a receipt of capital.  It was held that the receipt was a capital receipt for UK tax purposes.  Lord Reid said (at p 567):

“In deciding whether a shareholder receives a distribution as capital or income our law goes by the form in which the distribution is made rather than by the substance of the transaction. Capital in the hands of the company becomes income in the hands of the shareholders if distributed as a dividend, while accumulated income in the hands of the company becomes capital in the hands of the shareholders if distributed in a liquidation. In the present case the form of the distribution was one unknown to our law — distribution in a partial liquidation. By the law of Maryland which governs the company and which authorised this distribution the shares distributed were capital in the hands of the shareholders. Why, then, should we regard them as income? It is said that if this had been an English company and it had done what Certain-teed did these shares would have been income in the hands of the shareholders. But an English company could not do what Certain-teed did for it could not distribute in a partial liquidation. No doubt an English company could have reached the same result by using a different method — declaring a dividend. But it is found as a fact that it would not have been possible in Maryland to effect this transaction by way of a declaration of dividend. So why are we to hold something to be a dividend which by the law of Maryland was not and could not be a dividend? There is no question here of the foreign law producing a result which is unreasonable or contrary to our idea of justice.”

He then referred to the Crown’s argument that the payment should be treated a income, based largely on Reid’s Trustees, and on Lord MacDermott’s reference in that case to the tree and its fruit, and concluded:

“Accepting that test, as I do without reservation, the question is whether “the corpus of the asset” or “the shares of the company” or “the capital of the possession” did or did not remain intact after the Bestwall shares were distributed: or whether the Bestwall shares were merely fruit or had in their fall taken part of the tree with them.

It is not disputed that the nature of a taxpayer's right to his foreign possession must be determined by the foreign law: Archer-Shee v. Garland. So we must go to the law of Maryland to find whether the taxpayer's capital asset remained the same, and it is found as a fact

‘(6) As a result of the distribution by Certain-teed in partial liquidation under Maryland law Lico's original interest in Certain-teed did not remain intact’

and then the reason is given followed by the statement that the shareholder received capital. The plain meaning of that appears to me to be that after the partial liquidation the corpus of the respondents' capital asset did not remain intact. And I do not find it surprising that the law of Maryland should so hold: I would expect that after a partial liquidation the corpus would be different. To adopt Lord MacDermott's metaphor, trees in Maryland are unlike trees in England, they can be split and both halves can live: after partial liquidation Certain-teed was only half the original tree, the other half becoming Bestwall. The appellant says that both before and after the distribution the respondents held 2,000 shares of Certain-teed so their foreign possession or capital asset must be the same. But that is going by our law; which looks to form. We are told that the law of Maryland looks to substance, and in substance the foreign possession did not remain intact. The shares after partial liquidation were not the same in substance as they had been before. So on the findings of fact as to the law of Maryland I have no difficulty in holding that this appeal should be dismissed.”

57. Rae v Lazard was applied, and Reid’s Trustees distinguished, in Courtaulds Investments Ltd v Fleming 46 TC 111.  In that case a payment was received out of the share premium reserve of a company incorporated under Italian law.  The appellant company was assessed to income tax under Schedule D, Case V on the basis that the payment was income from a foreign possession.  Under Italian law premiums paid on shares were normally carried to a share premium reserve, which was distributable provided that a legal reserve (made up of allocations of profit and which was not distributable except in a winding-up) was not below 20% of the company’s capital.  Under Italian law a withdrawal from share premium constituted a return of capital.  If the share premium reserve were distributed the holder of a share would be entitled to the same rights as before the distribution, though the value of the share would be diminished.  It was held that the share premium reserve must be regarded as standing under Italian law in the same position as the legal reserve so that the foreign possession constituted by each of the appellant’s shares represented both paid-up capital and an accretion of a proportion of legal and share premium reserves and was not left intact by a distribution out of share premium reserve.  In his judgment, Buckley J considered the competing claims of the Crown and the appellant: for the Crown that the distribution out of share premium left the foreign possession intact, and so was income; for the appellant that under Italian law the distribution was of capital.  He said (at pp 126 to 127):

“The fact that before and after the distribution the Appellant Company held a particular number of shares in the Italian company of a nominal value of 1,200 lire each does not, in my judgment, provide an answer to the problem. It did not do so in In re Duff's Settlements , nor in Rae v Lazard Investment Co. Ltd. If nothing had ever happened to affect the size of the fund of non-distributable capital of the company it might do so; but has anything, and if so what, occurred to affect the size of that fund? I have already indicated that in my judgment the legal reserve is an accretion to that fund. On the true view of the facts I think that the share premium reserve stands in the same position. Italian law demands that this fund be set aside and that it be not distributed at all so long as the legal reserve is less than 20 per cent. of the share capital, and that when the legal reserve has achieved that level the share premium reserve may be distributed, but only apparently on the footing that the distribution is treated as a return of capital. It seems that no legal formalities need be fulfilled to justify a distribution from, a share premium reserve at any time when the legal reserve is complete, such as are required under the Companies Act 1948 to justify distribution of a sun, standing to the credit of a share premium account of an English company, but the capital character of the distribution appears, upon the finding of the Commissioners, to be no less clear under Italian law than under our own law.

In my judgment, on the findings in this case, Italian law must be regarded as treating premiums paid on shares as being, ab initio and always, notional paid-up capital of the company. In other words, the share premium reserve is as much a graft upon the tree - that is, the capital strictly paid up on its shares - as the legal reserve is, and must be treated as having become an accretion to the tree and part of it. If this is right, the foreign possession of the Appellant Company was not merely a given number of fully-paid shares of the Italian company of 1,200 lire each, but that number of shares each representing 1,200 lire paid-up capital together with the accretion thereto of a proper proportion of the Italian company's legal reserve and of its share premium reserve. The effect of the distribution of 130 lire per share out of the latter reserve was to lop from the tree part of the engrafted member consisting of a proportionate part of the share premium reserve. So the distribution did not, in my judgment, leave the foreign possession intact.

The Crown has contended that so long as the legal reserve was complete the share premium reserve was as freely distributable as was a sum standing to the credit of an English company's share premium account before 1948. Under our law at that time such a sum was in the nature of a capital profit and was distributable as such: Drown v Gaumont-British Picture Corporation Ltd. [1937] Ch. 402. But the finding is that under Italian law this distribution from the share premium reserve was a return of capital; it was not distributable as profit. The assimilation is consequently, in my view, unsound.”

58. Mr Gammie argued that the Preference Dividends manifestly did not leave the First and Second Issued Preference Shares “intact and precisely as they were before [it]”, in the words of Lord Normand in Reid’s Trustees (p 440 [TC]).  He drew my attention to the share rights under Blueborder’s articles of association.  The following summary is taken from Mr Gammie’s skeleton argument:

No voting rights

(1) The Preference Shares carried no voting rights at all.  This remained the case at all times, and was not affected by the payment of the Preference Dividends.

Rights to dividends

(2) Each Preference Share carried the right to a fixed cumulative preference dividend (“Quarterly Dividend”), out of share premium account only and in priority to the transfer of any sum to reserves and to any payment of dividend to any holder of any other class of share, of £509, or more precisely, £509.45051 (which, across all 50,050 Preference Shares in issue, amounted to £25,500,000) on 29 December 2003 (“the first “Quarterly Dividend Date”).

(3) In addition, each Preference Share carried the right to a second fixed cumulative preference dividend (the final “Quarterly Dividend”), out of share premium account only and on the same terms as above, also of £509.45051 (again, totalling £25,500,000 across all of the Preference Shares in issue), on 29 March 2004 (the “Final Quarterly Dividend Date”).

(4) If on either Quarterly Dividend Date the company had insufficient share premium available for distribution to enable it to pay the Quarterly Dividend due on that date, the relevant Quarterly Dividend would become payable as soon as and to the extent that the company had sufficient share premium available for distribution.

(5) After the two Quarterly Dividends had been paid, each Preference Share carried an “Annual Dividend”, from 31 March 2005 onwards (if not redeemed by that date) (the first “Annual Dividend Date”), of 1% of the paid up nominal amount on that share.  The paid up capital was £1.  The Annual Dividend was therefore 1 penny per share (totalling £505 across all 50,000 Preference Shares in issue).

(6) In short, once the Quarterly Dividends had been paid, the remaining dividends rights were negligible.

Rights to return of capital on a winding-up or otherwise

(7) The effect of the formula in the definition of “Preference Share Return Amount” can be summarised as follows:

(a) Where (as actually occurred) the Quarterly Dividends were both duly paid on the two Quarterly Dividend Dates (and not earlier or later), each Preference Share carried the right, in priority to any other shares, to repayment of the following amounts:

(i) Where (on winding up, redemption etc) payment of the Preference Share Return Amount was due on or after 24 September 2003 (the date of incorporation of the company) but before 29 December 2003 (the first “Quarterly Dividend Date”), the amount payable was £1022.8459 per Preference Share (i.e. £51,200,000 in aggregate), plus an interest-based amount at 4.031% per annum per number of days elapsed between 24 September 2003 and the date when the Amount was due.

(ii) Where (on winding-up, redemption etc) payment of the Preference Share Return Amount was due on or after 29 December 2003 but before 29 March 2004 (the “Final Quarterly Dividend Date”), the amount payable was £524.1996 per Preference Share (i.e. £26,200,000 in aggregate), plus an interest-based amount at 4.031% per annum per number of days elapsed between 29 December 2003 and the date when the Amount was due.

(iii) Where (on winding-up, redemption etc) payment of the Preference Share Return Amount was due on or after 29 March 2004 (the “Final Quarterly Dividend Date”), the amount payable was £19.98 per Preference Share (i.e. £999,999 in total), plus 1% per annum per number of days elapsed between 29 March 2004 and the date when the Amount was due.

(b) Where a Quarterly Dividend was unpaid on a Quarterly Dividend Date and had still not been paid at the time when the Preference Share Return Amount became payable (e.g. on winding-up or redemption), the Preference Share Return Amount fell to be increased by the amount of the unpaid dividend.

(c) Where a Quarterly Dividend had been paid early (on an “Accelerated Quarterly Dividend Date”), and the date when the Preference Share Return Amount became due (e.g. on winding-up or redemption) preceded the Quarterly Dividend Date when the relevant Quarterly Dividend would have been due, the Preference Share Return Amount was decreased by the amount of the dividend already paid plus an early interest-based amount.

59. On this basis Mr Gammie argued that:

(1) The effect of the Blueborder share rights as described was that:

(a) On winding-up, redemption etc, where payment of the Preference Share Return Amount fell due before the first Quarterly Dividend had been paid, the priority capital repayment amount due was £1,023 per Preference Share, i.e. £51.2 million in aggregate (plus an interest-based amount at 4% per annum thereon);

(b) On winding-up, redemption etc, where payment of the Preference Share Return Amount fell due after the first Quarterly Dividend had been paid but before the second, Final Quarterly Dividend had been paid, the priority capital repayment amount due was £524 per Preference Share, i.e. £26.2 million in aggregate (plus an interest-based amount at 4% per annum thereon);

(c) On winding-up, redemption etc, where payment of the Preference Share Return Amount fell due after the second, Final Quarterly Dividend had been paid, the priority capital repayment amount due was £19.98 per Preference Share, i.e. £999,999 in aggregate (plus an interest-based amount at 1% per annum thereon).

(2) Further, this was not simply the consequence of the effluxion of time.  If the relevant Quarterly Dividend had been paid early or was late and unpaid at the time when the Preference Share Return Amount fell due, then adjustment fell to be made according to the formula.  The actual (early or late) payment of the relevant quarterly dividend thus reduced the amount payable on a subsequent return of capital.

(3) In other words, as soon as the First Preference Dividend (the first Quarterly Dividend) had been paid, and as a result of its payment, the rights to return of capital on a subsequent redemption or winding-up reduced from £1023 per share (£52.2 million in total) to £524 per share (£26.2 million in total).  That is a reduction of 49.9% of the rights to “capital” as set out in the heading to the relevant article in the company’s articles of association.

(4) As soon as the Second Preference Dividend (the Final Quarterly Dividend) had been paid, the rights to return of capital on a subsequent redemption or winding-up reduced further from £524 per share (£26.2 million in total) to £19.98 per share (£999,999 in total).  That is a further reduction of 96% of the rights to “capital”.

(5) In summary, when the Second Preference Dividend was paid, the remaining capital rights, like the remaining dividend rights, became negligible – approximately 2% of the initial “capital” rights attaching to the shares on issue.

(6) The payment of the First Preference Dividend thus reduced the rights attaching to each Preference share, in accordance with the articles, by almost 50%.  It took away almost 50% of the share rights.  The payment of the Second Preference Dividend left the Preference Shares (and the company, Blueborder) an empty husk.  It took away a remaining 48% of the initial share rights.  The two Preference Dividends in turn took away 98% of the share rights.  The shares were not left intact.

(7) In Courtaulds Investments v Fleming, Buckley J held that the effect of the distribution out of the Italian share premium reserve was to “lop from the tree part of the engrafted member consisting of the share premium reserve” and that the dividends did not leave the shares “intact in that case (46 TC 111 at pp 126 to 127).  If the metaphor of fruit and tree is similarly adopted in the present case, then the First and Second Preference Dividends took away virtually the whole of the tree (about 98%), leaving almost nothing behind.

He concluded by submitting that the Preference Dividends were capital in nature.

60. I do not agree with Mr Gammie.  In my view the proper analysis of the Cayman Islands law is that the corpus of the assets in question is the nominal share capital only of the First and Second Issued Preference Shares.  Unlike the position in Courtaulds Investments, there is no legal reserve in Cayman Islands law with which to equate share premium reserve, nor in my view is the distribution under Cayman Islands law a distribution of capital.  Whereas in Courtaulds Investments it was not correct to assimilate the position of the Italian company to that under English law prior to 1948, this was on the basis that it had been found that under Italian law the distribution from share premium reserve was a distribution of capital.  There is no such finding here.  Indeed, I have found the opposite to be the case; share premium account under Cayman Islands law is not in my view capital, but is distributable profit.  It follows that I consider that a dividend out of Blueborder’s share premium account ought properly to be assimilated to such a dividend under English law pre-1948.  Such a dividend would not be a return of capital, but would be a distribution of profits.

61. Mr Gammie’s argument rested on the corpus of the foreign possession being not only the nominal value of the First and Second Issued Preference Shares but the amounts specified in the articles of association as the “priority capital repayment amounts”.  He relied upon this to demonstrate that the effect of the payment of the Preference Dividends was to reduce the rights to “capital” under the articles, and not simply the value of the shares, by 98%.  He compared this to the lopping from the tree of part of the engrafted share premium reserve as in Courtaulds Investments.  I do not consider this is right.  The first point is that, unlike in Courtaulds Investments, there is no engrafting of the share premium account onto the First and Second Issued Preference Shares.  Share premium account under Cayman Islands law was not, at the material time, assimilated to share capital, but was, as I have found, part of the distributable profit.  Secondly, in my view the dividend rights in this case were part of the fruit and not part of the tree.  Dividend rights that are satisfied otherwise than out of share capital, or a reserve that is assimilated to share capital, are part of the fruit even though they may be exhausted by the payment of a dividend.  Such a dividend is the fruit even though it might be harvested in a single crop.

62. Mr Gammie also took me to Sinclair v Lee and another [1993] Ch 497.  This case concerned a proposed demerger by ICI Plc under which shareholders would, in addition to their existing shares, be issued with a corresponding number of shares in a new company (Zeneca Plc), to be allotted in satisfaction of a dividend to be declared by ICI.  The plaintiff was one of the trustees of a will trust in which there were both income and capital beneficiaries.  The issue was whether the shares in Zeneca Plc that the trustees would receive in the demerger should be held on income or capital account in the trust.  It was held by Sir Donald Nicholls V-C in the High Court that the purpose of the declaration of the dividend was to bring about a reconstruction whereby one existing capital asset in the trustees’ hands would be replaced by two separate capital assets of equivalent value and that to regard the transaction as a distribution of profits would be to exalt company law over commercial substance and defeat the presumed intention of the testatrix.  Accordingly the shares in Zeneca Plc would be held by the trustees as capital for the benefit of the remaindermen.

63. In Sinclair v Lee the Vice-Chancellor referred to Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720.  In that case there was a sale by the company of substantially the whole of its assets, and a cessation of its business.  The proceeds of sale were distributed by way of dividend.  The Privy Council held that the dividend was income as between life tenant and remainderman.  Sir Donald Nicholls referred in particular to two of the propositions stated by Lord Russell in that case (at p731):

"(2) A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorised reduction of capital. Any other payment made by it by means of which it parts with moneys to its shareholders must and can only be made by way of dividing profits . . . (3) Moneys so paid to a shareholder will (if he be a trustee) prima facie belong to the person beneficially entitled to the income of the trust estate. If such moneys or any part thereof are to be treated as part of the corpus of the trust estate there must be some provision in the trust deed which brings about that result."

Sir Donald held that, as the decision in Hill v Permanent Trustee had been approved by the Court of Appeal in Re Doughty [1947] Ch 263, it was binding on him as to the income character for trust purposes of all cash distributions (otherwise than by way of reduction of capital or in the course of a winding-up) whatever their scale or description or source.  The same principle would apply to dividends in specie.  However, he decided that in the case before him he should not regard the ICI transaction as a distribution of profits, akin to a dividend in specie, and that the transaction was instead to be characterised as a company reconstruction, with two capital assets (shares in ICI Plc and Zeneca Plc) in the trustees’ hands replacing one capital asset (shares in ICI).

64. In my view Sinclair v Lee cannot assist Mr Gammie.  In this case there is in respect of each of the Preference Dividends a cash dividend declared and paid in accordance with Cayman Islands law out of share premium account.  I have found that the dividends were paid out of share premium account which was in law distributable profit.  The dividends were not in the nature of a dividend in specie, and in my view there is no question of the transaction being characterised as a company reconstruction in the nature of a demerger as in Sinclair v Lee.  I am of course bound by Hill v Permanent Trustee.  The Preference Dividends were cash distributions that were not in the course of a winding-up nor, in my view, based on the authorities, reductions of capital.  Accordingly, in my judgement, the Preference Dividends were of an income character.

65. My conclusion, therefore, is that the Preference Dividends did constitute income chargeable under Case V of Schedule D.  Consequently I find that the Preference Dividends were “overseas dividends” within the meaning of para 1(1) of Schedule 23A and the 1993 Regulations.

Sections 737A and 730A

66. Mr Gammie argued that, even if, as I have found, the Preference Dividends are “overseas dividends”, the subscription by the Appellant for the Second Issued Preference Shares constituted “buying similar securities” within the meaning of s737A and s 730A TA, so bringing the transaction within the sale and repurchase of securities (repo) rules.  If this is right, then the effect is that the “relevant person” as defined under s 737A(6) (which would in these circumstances be Blueborder) is deemed by virtue of s 737A(5) to have paid to the Appellant an amount representative of the relevant dividend, which then falls to be treated under Schedule 23A as the receipt of a manufactured overseas dividend on which the Appellant would be liable to tax under para 4(4) of Schedule 23A.

67. I set out below the relevant statutory provisions.  The first is s 737A:

“737A Sale and repurchase of securities: deemed manufactured payments

(1) This section applies where on or after the appointed day a person (the transferor) agrees to sell any securities, and the transferor or a person connected with him—

(a) is required to buy them back in pursuance of an obligation imposed by, or in consequence of the exercise of an option acquired under, that agreement or any related agreement, or

(b) acquires an option to buy them back under that agreement or any related agreement which he subsequently exercises;

but this section does not apply unless either the conditions set out in subsection (2) below or the conditions set out in subsection (2A) below are fulfilled.

(2) The first set of conditions referred to in subsection (1) above are that—

(a) as a result of the transaction, a dividend which becomes payable in respect of the securities is receivable otherwise than by the transferor,

(b) ...

(c) there is no requirement under any agreement mentioned in subsection (1) above for a person to pay to the transferor on or before the relevant date an amount representative of the dividend, and

(d) it is reasonable to assume that, in arriving at the repurchase price of the securities, account was taken of the fact that the dividend is receivable otherwise than by the transferor.

(2A) The second set of conditions referred to in subsection (1) above are that—

(a) a dividend which becomes payable in respect of the securities is receivable otherwise than by the transferor,

(b) the transferor or a person connected with him is required under any agreement mentioned in subsection (1) above to make a payment representative of the dividend,

(c) there is no requirement under any such agreement for a person to pay to the transferor on or before the relevant date an amount representative of the dividend, and

(d) it is reasonable to assume that, in arriving at the repurchase price of the securities, account is taken of the circumstances referred to in paragraphs (a) to (c).

(3) For the purposes of subsections (2) and (2A) above the relevant date is the date when the repurchase price of the securities becomes due.

(4) Where it is a person connected with the transferor who is required to buy back the securities, or who acquires the option to buy them back, references in the following provisions of this section to the transferor shall be construed as references to the connected person.

(5) Where this section applies, ... Schedule 23A and dividend manufacturing regulations shall apply as if—

(a) the relevant person were required, under the arrangements for the transfer of the securities, to pay to the transferor an amount representative of the dividend mentioned in subsection (2)(a) or (2A)(a) above,

(b) a payment were made by that person to the transferor in discharge of that requirement, and

(c) the payment were made on the date when the repurchase price of the securities becomes due.

(6) In subsection (5) above “the relevant person” means—

(a) where subsection (1)(a) above applies, the person from whom the transferor is required to buy back the securities;

(b) where subsection (1)(b) above applies, the person from whom the transferor has the right to buy back the securities;

and in that subsection “dividend manufacturing regulations” means regulations under Schedule 23A (whenever made).”

68. Section 737B provides interpretation for section 737A.  It provides:

“737B Interpretation of section 737A

(1) In section 737A and this section “securities” means United Kingdom equities, United Kingdom securities or overseas securities; and—

(a) where the securities mentioned in section 737A(1) are United Kingdom securities, references in section 737A to a dividend shall be construed as references to a periodical payment of interest;

(b) where the securities mentioned in section 737A(1) are overseas securities, references in section 737A to a dividend shall be construed as references to an overseas dividend.

(2) In this section “United Kingdom equities”, “United Kingdom securities”, “overseas securities” and “overseas dividend” have the meanings given by paragraph 1(1) of Schedule 23A.

(3) For the purposes of section 737A agreements are related if each is entered into in pursuance of the same arrangement (regardless of the date on which either agreement is entered into).

(4) In section 737A “the repurchase price of the securities” means—

(a) where subsection (1)(a) of that section applies, the amount which, under any agreement mentioned in section 737A(1), the transferor or connected person is required to pay for the securities bought back, or

(b) where subsection (1)(b) of that section applies, the amount which under any such agreement the transferor or connected person is required, if he exercises the option, to pay for the securities bought back.

(5) In section 737A and subsection (4) above references to buying back securities include references to buying similar securities.

(6) For the purposes of subsection (5) above securities are similar if they entitle their holders to the same rights against the same persons as to capital and interest and the same remedies for the enforcement of those rights, notwithstanding any difference in the total nominal amounts of the respective securities or in the form in which they are held or the manner in which they can be transferred; and “interest” here includes dividends.

(7) For the purposes of section 737A and subsection (4) above—

(a) a person who is connected with the transferor and is required to buy securities sold by the transferor shall be treated as being required to buy the securities back notwithstanding that it was not he who sold them, and

(b) a person who is connected with the transferor and acquires an option to buy securities sold by the transferor shall be treated as acquiring an option to buy the securities back notwithstanding that it was not he who sold them.

(8) Section 839 shall apply for the purposes of section 737A and this section.

(9) In section 737A “the appointed day” means such day as the Treasury may by order appoint, and different days may be appointed in relation to—

          (a) United Kingdom equities,

         (b) United Kingdom securities, and

          (c) overseas securities.”

69. Section 730A(1) provides:

“730A Treatment of price differential on sale and repurchase of securities

(1) Subject to subsection (8) below, this section applies where—

(a) a person (“the original owner”) has transferred any securities to another person (“the interim holder”) under an agreement to sell them;

           (b) the original owner or a person connected with him—

(i) is required to buy them back in pursuance of an obligation imposed by, or in consequence of the exercise of an option acquired under, that agreement or any related agreement, or

(ii) acquires an option to buy them back under that agreement or any related agreement which he subsequently exercises; and

          (c) the sale price and the repurchase price are different.”

70. Section 730B provides the interpretation for section 730A.  Subsections (1) and (2) read:

“730B Interpretation of section 730A

(1) For the purposes of section 730A agreements are related if they are entered into in pursuance of the same arrangement (regardless of the date on which either agreement is entered into).

(2) References in section 730A to buying back securities—

          (a) shall include references to buying similar securities; and

(b) in relation to a person connected with the original owner, shall include references to buying securities sold by the original owner or similar securities,

notwithstanding (in each case) that the securities bought have not previously been held by the purchaser; and references in that section to repurchase or to a repurchaser shall be construed accordingly.”

71. The Appellant subscribed for the Second Issued Preference Shares; it did not acquire existing shares by purchase.  The Appellant says that this is a crucial distinction.  Mr Gardiner argued that it is apparent from the wording of the sections that there must be a sale and repurchase (or a sale and a further purchase).  Each section requires there to be an agreement to sell the securities and to buy them back (or to buy similar securities).  The section also uses terminology such as “repurchase price”, “repurchaser”, “transfer” and “transferor”, and they are headed “Sale and repurchase of securities”.  Mr Gardiner submitted that these are some of the most closely articulated and detailed provisions in the tax legislation, and that in a case where the legislation creates a legal fiction, precision in the draftsman’s language must be particularly respected.

72. Mr Gardiner argued further that it is well-established that a subscription for new shares for a subscription price does not constitute a purchase or buying of shares.  He referred me to the explanation of Lord Greene MR in Re VGM Holdings Ltd [1942] 1 Ch 235 (at pp 240 to 241):

“The sole question is whether or not the word "purchase" in this section covers a case where the money which the company provides is used to assist a subscription for the company's own shares. There could, I think, be no doubt that, if that question were answered in favour of the liquidator, the 15,980l. was provided by the company by way of financial assistance, because whether a company provides the money by way of gift or by way of loan or by buying assets from the person who is purchasing the shares at a fraudulent overvalue, all those transactions, it seems to me, would fall within the phrase "financial assistance." I, therefore, feel no difficulty about that, but, with all respect to Bennett J., I am unable to agree with the view which he took that the subscription by these three directors for shares in V. G. M. was, within the meaning of the section, a purchase of those shares. In the first place, throughout the whole of the Companies Act, 1929 , the language which is used with regard to the issue of shares to subscribers is invariably confined to words like "issue," "subscription," "application," "allotment," and so forth. There is not a single passage in the Act to which we were referred, or to which my fairly complete recollection of the Act goes, in which the word "purchase" is used in relation to the transaction of subscription. That being so, it seems to me that a very clear context would be required to enable a meaning to be put on the word "purchase" in this section which would extend it so as to cover the acquisition of shares by subscription. Quite apart from those considerations of mere language of the Act, it seems to me that the word "purchase" cannot with propriety be applied to the legal transaction under which a person, by the machinery of application and allotment, becomes a shareholder in the company. He does not purchase anything when he does that. Mr. Wynn Parry endeavoured heroically to establish the proposition that a share before issue was an existing article of property, that it was an existing bundle of rights which a shareholder could properly be said to be purchasing when he acquired it by subscription in the usual way. I am unable to accept that view. A share is a chose in action. A chose in action implies the existence of some person entitled to the rights which are rights in action as distinct from rights in possession, and, until the share is issued, no such person exists. Putting it in a nutshell, the difference between the issue of a share to a subscriber and the purchase of a share from an existing shareholder is the difference between the creation and the transfer of a chose in action. The two legal transactions of the creation of a chose in action and the purchase of a chose in action are quite different in conception and in result. The result, therefore, is that I can find no context in this section which enables me to construe the word "purchase" as bearing the extended meaning suggested, and I cannot agree with the view which Bennett J. took on that part of the case.”

Mr Gardiner emphasised in particular the distinction drawn by Lord Greene between the creation and purchase of a chose in action both in conception and result.

73. Mr Gammie argued that Lord Greene’s reasoning was peculiarly confined to the meaning of “purchase” in the context of the Companies Act 1929.  He referred me to examples where “purchase” had been held to cover the transaction whereby a life insurance policy (that is, a newly created chose in action) was acquired (see Re Turcan LR 40 Ch D 5), and the grant of an annuity (see the comments of Rigby LJ in Mersey Docks & Harbour Board v IRC [1897] 2 QB 316 at p 317).  He also referred me to Wimpey v IRC [1975] 1 WLR 995, where for stamp duty purposes the grant of an option was held correctly to be said to be a sale and purchase of the option.  He argued that “purchase” and “buy” are general words and that a court or tribunal should be slow to construe the language more restrictively.

74. Mr Gardiner submitted that the passage quoted from Lord Greene’s judgment in VGM Holdings went wider than the narrow context of the 1929 Act, and that it was applicable more generally in the case of shares.  He argued that, in the context of the acquisition of shares, “purchase” does not include “subscription”, and that there would need to be  a particular context to enable “purchase” to be construed as having an extended meaning.  He referred me to comments of Young CJ in the Australian case of McMillan Properties Pty Ltd v WC Penfold [2001] NSWSC 1173, where he describes the judgment of Lord Greene as a “classic statement” that has “never been gainsaid”.  I was also directed to the judgment of Browne-Wilkinson LJ in Abbey National Building Society v The Building Societies Commission (1989) 5 BCC 259 (at p 264):

“In my judgment the word “subscriber” in [section 100(8) of the Building Societies Act 1986] is basically used in its strict company law meaning, that is to say a person who applies for the allotment by the company of new shares in return for cash payable to the company. A purchase of shares is not a subscription for shares: see Re V.G.M. Holdings Ltd. [1942] Ch. 235; Governments Stock and Other Securities Investment Co. Ltd. & Ors. v. Christopher & Ors. [1956] 1 W.L.R. 237.”

Finally, in this respect, I was referred to the recent judgment of Christopher Clarke J in the Commercial Court in Ojsc Oil Company Yugraneft v Abramovich [2008] EWHC 2613 (at [358]) where, referring to VGM Holdings in the context of the creation of participation interests in a company established under Russian law, he stated that “Creation (by issuing) and transfer of shares are two different things.”

75. I prefer the arguments of Mr Gardiner to those of Mr Gammie.  In my view the normal meaning of a “purchase” or “buying” in relation to shares or securities of a company (whether a company incorporated under English law or under foreign law) excludes a subscription, unless the context indicates otherwise.  There is no such contextual indication in sections 737A or 730A.  I agree with Mr Gardiner that if Parliament had wished to extend the ambit of those sections to transactions involving a subscription for shares special provision would have to have been made to this effect.

76. Both Mr Gardiner and Mr Gammie addressed me on the statutory history of the relevant provisions.  I do not find it necessary to consider that history, as in my view the answer is to be found by construing the provisions according to their plain words, guided by Lord Greene’s judgment in VGM Holdings.

77. For these reasons I conclude, in agreement with the submissions of the Appellant, that sections 737A and 730A do not apply to the subscription by the Appellant of the Second Preference Shares, and that accordingly the Appellant has no liability to tax under para 4(4) of Schedule 23A TA on a deemed manufactured dividend from Blueborder.

78. I should for completeness mention that I heard argument on two alternative propositions of the Appellant as to why sections 737A and 730A do not apply in this case.  These were very briefly:

(1) Section 737A does not apply since neither the condition in subsection (2)(d) nor (2A)(d) is satisfied.  This is because the subscription price payable under the Subscription Agreement only takes account of whether dividends have been paid (rather than who receives them).

(2) Section 730A would be disapplied by subsection (8)(b) since, when the First Issued Preference Shares were sold by the Appellant to Anglo Irish Bank, all of the benefits and risks arising from fluctuations in their market value fell on the latter (the interim holder for this purpose).

These alternative arguments arose only if I had found that the subscription of the Second Issued Preference Shares did constitute the buying back of the First Issued Preference Shares within the meaning of sections 737A and 730A.  As I have found that the subscription does not constitute such a buying back, these arguments do not arise, and I therefore express no view on them.

Decision

79. On the issues for determination:

(1) Each of the First Preference Dividend and the Second Preference Dividend constitutes a “dividend” for the purposes of paragraph 1(1) of Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(2) Each of the First Preference Dividend and the Second Preference Dividend constitutes an “overseas dividend” for the purposes of paragraph 1(1) of Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(3) The sale of the First Issued Preference Shares by the Appellant to Anglo Irish Bank and the subscription by the Appellant for the Second Issued Preference Shares was not a sale and repurchase of securities for the purposes of sections 737A and 730A ICTA (as extended by subsections 737B(5) and 730B(2)(a) respectively to include the case where a person sells securities and buys similar securities).

80. For all these reasons, I allow this appeal.

The Respondents have a right to apply for permission to appeal against this decision pursuant to rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of the decision notice.

ROGER BERNER

TRIBUNAL JUDGE

RELEASE DATE: 12 January 2010