Hilary
Term
[2019] UKSC 12
On appeal from: [2017] EWCA Civ 2124
JUDGMENT
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Commissioners
for Her Majesty’s Revenue and Customs (Respondent) v Joint
Administrators of Lehman Brothers International (Europe) (In Administration)
(Appellants)
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before
Lord Reed, Deputy President
Lord Carnwath
Lord Hodge
Lady Black
Lord Briggs
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JUDGMENT GIVEN ON
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13 March 2019
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Heard on 12 February 2019
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Appellants
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Respondent
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David Goldberg QC
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Malcolm Gammie CBE
QC
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Daniel Bayfield QC
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Catherine Addy QC
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(Instructed by Linklaters
LLP)
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(Instructed by HMRC
Solicitor’s Office and Legal Services)
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LORD BRIGGS: (with whom
Lord Reed, Lord Carnwath, Lord Hodge and Lady Black agree)
Introduction
1.
This appeal concerns the relationship between two statutory provisions,
one very old and the other very young. The old provision, which dates back to
the inception of Income Tax during the Napoleonic Wars, but is now to be found
in section 874 of the Income Tax Act 2007, requires a debtor in specific
circumstances to deduct income tax from payments of “yearly interest” arising
in the United Kingdom. The young provision, first made the subject of
legislation in 1986 (and replacing previous judge-made rules) but now to be
found in rule 14.23(7) of the Insolvency Rules 2016, requires a surplus
remaining after payment of debts proved in a distributing administration first
to be applied in paying interest on those debts in respect of the periods during
which they had been outstanding since the commencement of the administration.
The short question, which has generated different answers in the courts below,
is whether interest payable under rule 14.23(7) is “yearly interest” within the
meaning of section 874, so that the administrators must first deduct income tax
before paying interest to proving creditors.
2.
The question arises in connection with the administration of Lehman
Brothers International (Europe) (“LBIE”) which, although it commenced at a time
when LBIE was commercially insolvent due to the worldwide crash of the
international group of companies of which it formed an important part, has
nonetheless generated an unprecedented surplus after payment of all provable
debts, in the region of £7 billion, of which some £5 billion is estimated to be
payable by way of statutory interest (before any deduction of income tax). LBIE
went into administration on 15 September 2008. It became a distributing
administration in December 2009. A final dividend was paid to unsecured proving
creditors (bringing the total dividends to 100p in the pound) on 30 April 2014.
After the coming into effect of a scheme of arrangement, interest slightly in
excess of £4 billion was paid to creditors, after deduction of a sufficient
amount on account of tax to abide the outcome of these proceedings, on 25 July
2018. Thus the time which elapsed between the commencement of the
administration and the payment of interest to creditors was slightly under ten
years. The periods in respect of which interest was payable under rule 14.23(7)
(and its predecessor) ranged from a little over four years (which expired when
the first interim distribution to proving creditors was made in November 2012)
and little over five and a half years, when the final dividend to creditors was
made, as described above.
Statutory Interest in Administration
3.
Rule 14.23(7) of the Insolvency Rules 2016, which replaced substantially
identical provisions in rule 2.88(7) of the Insolvency Rules 1986, provides as
follows:
“(7) In an administration -
(a) any surplus remaining
after payment of the debts proved must, before being applied for any other
purpose, be applied in paying interest on those debts in respect of the periods
during which they have been outstanding since the relevant date;
(b) all interest payable
under sub-paragraph (a) ranks equally whether or not the debts on which it is
payable rank equally; and
(c) the rate of interest
payable under sub-paragraph (a) is whichever is the greater of the rates
specified under paragraph (6) and the rate applicable to the debt apart from
the administration.”
4.
Rule 14.23(6) provides that the relevant rate of interest is that
specified in section 17 of the Judgments Act 1838 (1 & 2 Vict c 110), which
was, at the material time, 8% per annum. The “relevant date” referred to in
rule 14.23(7)(a) is the date upon which the company entered administration; see
rule 14.1(3).
5.
In In re Lehman Brothers International (Europe) (in administration)
(No 6) [2015] EWHC Civ 2269 (Ch); [2016] Bus LR 17, para 149, David
Richards J said this about statutory interest payable under the predecessor of
rule 14.23(7):
“The right to interest out of a
surplus under rule 2.88 is not a right to the payment of interest accruing due
from time to time during the period between the commencement of the
administration and the payment of the dividend or dividends on the proved
debts. The dividends cannot be appropriated between the proved debts and
interest accruing due under rule 2.88, because at the date of the dividends no
interest was payable at that time pursuant to rule 2.88. The entitlement under
rule 2.88 to interest is a purely statutory entitlement, arising once there is
a surplus and payable only out of that surplus. The entitlement under rule 2.88
does not involve any remission to contractual or other rights existing apart
from the administration. It is a fundamental feature of rule 2.88, and a
primary recommendation of the Cork Committee that all creditors should be
entitled to receive interest out of surplus in respect of the periods before
payment of dividends on their proved debts, irrespective of whether, apart from
the insolvency process, those debts would carry interest.”
6.
In the present case, in the Court of Appeal [2018] Bus LR 730, after
citing that passage in full, Patten LJ continued, at para 16:
“There is no doubt at all that
statutory interest, as David Richards J explained, is not a continuing
liability which accrues from day to day on a prospective basis over the period
to which it relates. It is paid, as I have said, as statutory compensation for
the loss which the creditors have suffered by being kept out of their money for
the period of the administration.”
I agree.
7.
In In re Lehman Brothers International (Europe) (in administration)
(Nos 6 and 7) [2017] EWCA Civ 1462; [2018] Bus LR 508, para 26, giving the
judgment of the Court of Appeal, Gloster LJ said of the simple words of rule
2.88(7), when aggregated with the following two paragraphs (all in
substantially the same terms as are now to be found in rule 14.23, as set out
above):
“… this simple formula
constitutes, in our view, a complete and clear code for the award of statutory
interest on provable debts. As [counsel] put it, it contains all you
need to know.”
In the present case, at first instance, Hildyard J said at
para 16:
“In my judgment, the statutory
right to interest is sui generis and is not to be equated with a right
to interest which accrues over time.”
Again, I agree with both those dicta (and was a party to
the first of them).
Yearly Interest under the Income Tax Legislation
8.
Section 874 of the Income Tax Act 2007 provides (so far as is relevant)
as follows:
“(1) This section applies if a
payment of yearly interest arising in the United Kingdom is made -
(a) by a company,
(b) by a local authority,
(c) by or on behalf of a
partnership of which a company is a member, or
(d) by any person to
another person whose usual place of abode is outside the United Kingdom.
(2) The person by or through
whom the payment is made must, on making the payment, deduct from it a sum
representing income tax on it at the basic rate in force for the tax year in
which it is made.”
There is no definition of the phrase “yearly interest”
anywhere in the 2007 Act. Nonetheless there is this deeming provision in
section 874, added by Schedule 11 to the Finance Act 2013:
“(5A) For the purposes of
subsection (1) a payment of interest which is payable to an individual in
respect of compensation is to be treated as a payment of yearly interest
(irrespective of the period in respect of which the interest is paid).”
9.
This is unfortunately another case in which the full meaning of an
apparently innocent-looking simple statutory phrase can only be addressed by
reference to the historical deployment of that phrase, or equivalent phrases
seeking to express the same concept, in early legislation.
10.
Hildyard J set out in an Appendix to his judgment an admirable brief
summary of the history of the statutory provisions about deduction of yearly
interest, beginning with the introduction of income tax by Pitt’s Income Tax
Act 1799 (39 Geo 3 c 13). In the present case, the main reason for needing an
understanding of the statutory history is so that important decisions about the
underlying concepts behind yearly interest can be reliably interpreted, by
reference to the particular context of the use of the phrase in the statute
then in force. As would appear, the earliest of those authorities was decided
in 1854, and the latest in 1981.
11.
The concept of “yearly interest” first appeared within the income tax
legislation in section 208 of Addington’s Income Tax Act 1803 (43 Geo 3 c 122).
It appeared as part of the phrase:
“Annuities, yearly Interest of
Money, or other annual Payments … whether the same shall be received and
payable half-yearly, or at any shorter or more distant Periods.”
Section 208 both charged yearly interest to tax and
authorised the payer to deduct an amount equal to the tax chargeable on the
interest.
12.
When income tax was reintroduced by Sir Robert Peel in the Income Tax Act
1842 (5 & 6 Vict c 35), section 102 charged to tax:
“Annuities, yearly Interest of
Money, or other annual Payments.”
And, as in 1803, provided for deduction at source by the
payer, where paid out of taxed profits or gains.
13.
Deduction of yearly interest at source was continued in Gladstone’s
Income Tax Act 1853 (16 & 17 Vict c 34), by section 40, while Schedule D
brought into charge:
“All Interest of Money, Annuities,
and other annual Profits and Gains.”
14.
From 1888 until 1965, a succession of provisions to substantially the
same effect made it compulsory to deduct tax at source and to account for it to
the Revenue where interest of any kind was not wholly paid out of taxed income,
but permitted the deduction of tax at source and its retention in respect of yearly
interest which was wholly paid out of taxed income. In relation to yearly
interest, this enabled the interest payer to be compensated for the fact that
yearly interest paid out was not deductible in computing his own taxable
profits or gains. This dichotomy was, between 1918 and 1952, achieved by rules
21 and 19 respectively of the General Rules Applicable to all Schedules of the
Income Tax Act 1918 (“the 1918 Rules”). In short, rule 21 was about all types
of interest, whereas rule 19 was concerned only with yearly interest. From 1952
until 1965 this dichotomy was preserved by sections 169 (concerning yearly
interest) and 170 (concerning interest of any kind) of the Income Tax Act 1952.
15.
This dichotomy between the treatment of interest of any kind which is
not paid out of profits or gains and yearly interest which is so made was
progressively unwound, first for corporate taxpayers by the Finance Act 1965
and then generally by the Finance Act 1969. The regime for deduction of tax on
interest at source which has continued, without substantial change, from 1969
is that set out in section 54 of the Income and Corporation Taxes Act 1970,
then section 349(2) and (3) Income and Corporation Taxes Act 1988 and,
latterly, section 874 of the Income Tax Act 2007. In summary, it provides only
for the mandatory deduction at source of tax on yearly interest paid by
companies as well as certain other categories of payers, or paid by any person
to someone whose usual place of abode is outside the UK.
The issues
16.
In order to make sense of what follows, it is convenient at this stage
to provide a bare outline of what is and is not in issue, under the general
question whether or not statutory interest payable by administrators out of a
surplus is yearly interest. It has been common ground throughout this
litigation that the payments are properly to be regarded as interest, not
merely because they are so described in rule 14.23(7), but also within the
meaning of the word as used in section 874(1). As will appear (and as the Court
of Appeal concluded) that apparent concession by the administrators serves more
to mask than to define the real issues.
17.
The main thrust of the administrators’ submissions (by Mr David Goldberg
QC and Mr Daniel Bayfield QC in this court although Mr Goldberg did not appear
below) has been to contrast the characteristics which the authorities show are
required for the classification of interest as yearly interest with those of
interest payable from a surplus in administration. The required characteristics
are that the interest should derive from a source with the requisite degree of
permanence and durability over time, and that the interest should accrue due
over a period intended, or at least likely to last for a year or more. By
contrast, it is submitted, statutory interest payable from a surplus in
administration has, as its source, first the emergence of a surplus and second
the decision of the administrators that it is time to pay it. It does not
accrue due over any significant or likely period of time. Rather it is simply
payable out of that surplus once it has been ascertained and turned into money,
usually (and as here) by a single payment of a lump sum to each qualifying
creditor.
18.
For HMRC it is submitted (by Mr Malcolm Gammie QC and Ms Catherine Addy
QC) first, that it is unnecessary to identify a source for a statutory interest
payment to qualify for deduction under section 874(1) and secondly, that it is
not a requirement of yearly interest that it should accrue due over a period of
time. Rather, the characteristic which satisfies the requirement that the
interest should be yearly is that, once a surplus has been identified, the
statutory interest is payable in respect of the period, commencing with the
beginning of the administration, and ending with payment of the proving
creditors’ debts in full, during which the creditors have been kept out of
their money. If that period is, on the facts about a particular administration,
in excess of a year, then the requirement for duration over time encapsulated in
the word “yearly” is satisfied. Further, to the extent that the authorities
made it a requirement that the source of the interest should be something in
the nature of an investment, this was satisfied in relation to all LBIE’s
creditors, and regardless of the basis of their claims admitted to proof,
because they were involuntary long-term investors in LBIE by reason of the
moratorium placed upon their claims by its administration.
19.
At first instance, Hildyard J was persuaded that the absence of any
accrual over time (prior to the identification of a surplus and its
quantification after payment of all proved debts in full) was fatal to the
categorisation of statutory interest as yearly interest. By contrast, the Court
of Appeal could discern no requirement from the authorities that yearly
interest should accrue due over time. Since it was compensation for the proving
creditors being kept out of their money for a substantial time, the interest
had the requisite long-term quality sufficient for it to be categorised as
yearly.
The Authorities
20.
The relevant authorities may broadly be divided into two groups. First,
there are those which address the question whether interest which does accrue
due over time is properly to be categorised as yearly interest or, in bankers’
jargon, “short interest”. Secondly, there are those authorities which address
the question whether an entitlement to money described as interest, but which
does not accrue due over time, can properly be regarded as yearly interest, or
indeed interest at all, within the meaning of the income tax legislation. This
second group is mainly concerned with interest payable as a result of a
judicial decision, either when granting an equitable remedy or when exercising
a discretion to award interest under statute. As will appear, it is this second
group of authorities which, in my view, provides the answer to the questions
raised by this appeal, albeit only by analogy because, as the judge himself
observed, statutory interest payable from a surplus realised in a distributing
administration is sui generis. Nevertheless it is convenient to take the
first (generally earlier) group of authorities first.
21.
The earliest is Bebb v Bunny (1854) 1 K & J 216. The question
was whether interest contractually payable upon the late completion of a
contract for the purchase of land was yearly interest of money within the
meaning of section 40 of the Income Tax Act 1853, so that it was payable
subject to deduction of tax, either by the purchaser or by the court, even if
paid into court gross as the condition for a decree of specific performance
against the vendor. In deciding that it was yearly interest, Sir William Page
Wood V-C said, at pp 219-220:
“The whole difficulty is in the
expression ‘yearly’ interest of money; but I think it susceptible of this view,
that it is interest reserved, at a given rate per cent per annum; or, at least,
in the construction of this Act, I must hold that any interest which may be or
become payable de anno in annum, though accruing de die in diem,
is within the 40th section. I cannot make any solid distinction between
interest on mortgage money and interest on purchase-money. … I consider the Act
very singularly worded, yearly interest being used apparently in the same sense
as annual payments; but I am clearly of opinion that it means at least all
interest at a yearly rate, and which may have to be paid de anno in annum;
such as interest on purchase-money, as well as mortgage interest; and that,
therefore, the purchaser is entitled to deduct the tax in this case.”
22.
The reference to mortgage money, by way of analogy, becomes intelligible
when it is understood that the drafting practice of the time was typically to
make mortgage loans repayable, with interest, on a fixed date, usually less
than a year after the making of the advance, even if the parties’ expectation
was that the mortgage would endure for much longer, before redemption, with
interest being payable periodically in the meantime. As the Vice Chancellor put
it, at p 218:
“Most mortgage deeds contain only
a covenant to pay the principal, with interest at a certain rate per annum, on
a day certain. After that it accrues de die in diem, and the interest,
without any particular reservation, ordinarily is received half-yearly, from
year to year. It is difficult to see the distinction between interest so
reserved and paid, and that which by special agreement accrues on
purchase-money, which also goes on from day to day, and may run on for a year
or stop at any time on payment of the purchase money, and which, in some shape
or other, forms a lien on the property.”
Thus it was the propensity, rather than the intention or
inevitability, for interest payable during a period of delayed completion to
run on for more than a year which made it yearly interest, even though in many
cases the delay in the completion of the purchase might well be much shorter.
23.
The potentially very wide interpretation of yearly interest in Bebb v
Bunny was, in a series of later cases, significantly curtailed, albeit that
in none of them was the decision held to have been wrong. On the contrary, it
has remained the leading case. Goslings & Sharpe v Blake (1889) 23 QBD 324 was about a three months’ bankers loan, repayable with interest on a fixed
date, interest being calculated by reference to a rate per annum,
an example of what Lindley LJ called, at p 330: “short loans by bankers”. It
establishes two principles relevant to the question whether interest is yearly
interest (then within the meaning of section 40 of the Income Tax Act 1853).
The first is that interest is not yearly interest merely because it is
calculated by reference to a rate per annum: see per Lord Esher MR, at p 328.
Secondly it establishes that the question whether the interest is “yearly” or
“short” depends upon a business-like rather than dry legal assessment of its
likely duration. At p 330, speaking of the mortgage example used in Bebb v
Bunny, Lindley LJ said:
“The difficulty is not lessened by
the circumstance that most mortgages are loans for six months. The ordinary
form of mortgage contains a covenant to repay the loan in six months, and if
not then paid a covenant to pay interest until the loan is repaid. Those are
short loans; but in fact, as men of business, we know perfectly well that,
except in exceptional cases, money lent on mortgages is very seldom repaid at
the end of six months, the mortgagee usually being content with his security
and receiving his interest half-yearly. … In point of business, therefore, a
mortgage is not a short loan; but a banker’s loan at three months is a totally
different thing. That is a short loan, it is intended and understood to be a
short loan, and the difference in practice between the two is perfectly well
known to every business man.”
24.
The first relevant case about whether statutory (rather than
contractual) interest can be yearly interest is In re Cooper [1911] 2 KB 550, in which objection was taken to the supposed failure of a judgment creditor
to deduct tax from statutory interest due on the judgment relied on in a
bankruptcy notice served on the judgment debtor. That depended upon whether the
interest was yearly interest. In deciding that interest payable on a judgment
debt under the Judgment Act was not yearly interest Cozens-Hardy MR said this,
at p 553:
“The words ‘yearly interest’ are
satisfied although the interest be not payable yearly but be payable quarterly
or half-yearly, and further, as in the case of a mortgage, although the money
is covenanted to be paid six months after date in the ordinary course of a
mortgage, the court treats that as being a transaction to the knowledge and the
reasonable intendment of all parties, upon which yearly interest was payable in
the understanding and contemplation of all parties, it being really in the
nature of an investment.”(my emphasis)
25.
He continued:
“Now in the present case I ask
myself is it possible to suppose that this was a transaction in which anybody
contemplated or intended anything permanent? It is quite impossible so to
regard it.”
26.
At first blush, this decision of the Court of Appeal might appear to
suggest that statutory interest could never be yearly interest because it arose
otherwise than pursuant to any agreement, transaction or common intention of
the parties. Subsequent cases have shown that this is not so but the concept of
addressing the yearly interest question by reference to a perception whether
the source of the interest can properly be regarded as a form of investment has
survived. A negative answer to that question in relation to statutory interest
from a surplus in administration formed a major plank in the administrators’
submissions.
27.
A question deliberately left open in the Goslings case was
whether interest on a short loan could nonetheless become yearly interest if
the loan was left outstanding for more than a year. In Gateshead Corpn v
Lumsden [1914] 2 KB 883 the plaintiff local authority had become entitled
against the owners (including the defendant) of premises fronting a street
which it had paved and made up, to a proportion of its costs, plus interest at
5% per annum. Although the Corporation had no settled practice of allowing
these statutory debts to remain outstanding for periods of more than a year, it
did so in relation to the defendant, who made payments on account of interest
and capital from time to time. The Court of Appeal rejected a submission that
the Corporation’s forbearance converted interest into yearly interest within
the meaning of section 40 of the 1853 Act. Applying the principle which he
extracted from In re Cooper, Lord Sumner said, at pp 889-890:
“… applying the principle
underlying that decision, I am unable to see how the words ‘yearly interest’
can apply to this transaction. There is no agreement for a short loan or a long
loan. The debt is due and repayment is not enforced; only in that sense is
there a loan. Truly speaking there is simply a forbearance to put in suit the
remedy for a debt. The repayment might have been enforced at any moment. The
debt might have been paid by the debtor at any moment.”
Lord Sumner was careful to put on one side any case in
which it might be established that the local authority had a settled practice
of leaving statutory debts for street improvements outstanding for substantial
periods of time. But the decision is good authority for the proposition that
mere forbearance by a creditor who is entitled to statutory interest on a debt
which is immediately due and payable does not bring that statutory interest
within the confines of yearly interest. It serves as a caution against treating
the words of Sir William Page Wood V-C in Bebb v Bunny (quoted above) as
meaning that the mere possibility that a stream of interest may endure for more
than a year is sufficient in all cases to make it yearly interest.
28.
The investment test first enunciated in In re Cooper gains force
from the analysis of Rowlatt J in Garston Overseers v Carlisle [1915] 3
KB 381. Persons claiming to be charitable trustees enjoyed a long-standing
arrangement with their bankers whereby credits on current accounts generated
interest. The question was whether that was yearly interest within section 105
of the Income Tax Act 1842, qualifying for deduction at source. By concession,
that phrase in section 105 was treated as having the same meaning as in section
40 of the Income Tax Act 1853. Referring to the case law on section 40, Rowlatt
J said this, at p 386:
“The broad result of the decisions
in those cases is, I think, that yearly interest means, substantially, interest
irrespective of the precise time in which it is collected, interest on sums
which are outstanding by way of investment as opposed to short loans or as
opposed to moneys presently payable and held over or anything of that kind.”
29.
He continued, at p 387:
“They (the overseers) are
to levy rates as far as they can for their current expenditure. However, they
must necessarily keep a small balance in hand, and they get interest upon it
under the arrangements which the bank were willing to make. It is no doubt
contemplated that the balance will continue for a long time; but what is the
daily balance? It is not even a short loan; it is merely money at call, money
payable on demand.”
Since those temporary balances could not be described as
investments, the interest payable was not yearly interest.
30.
An attempt to reduce this jurisprudence to a concrete set of useful
propositions was made by Lord Anderson, sitting in the Inner House (Second
Division) of the Court of Session in Inland Revenue Comrs v Hay (1924)
VIII TC 636 at 646. The case was about yearly interest within the meaning of
section 27(1)(b) of the Income Tax Act 1918, but it was, again, common ground
that the phrase had the same meaning as was under consideration in all the
earlier cases, beginning with Bebb v Bunny. Lord Anderson said this:
“Now the authorities referred to
by Crown Counsel seem to me to establish these propositions, five in number: -
(First), that interest payable in respect of a short loan is not yearly
interest (Goslings …). … (Second) that in order that interest payable
may be held to be yearly interest in the sense of the Income Tax Acts, the loan
in respect of which interest is paid must have a measure of permanence.
(Third), that the loan must be of the nature - and this is pretty well
expressing the second proposition in another form - that the loan must be of
the nature of an investment (Garston Overseers). (Fourth), That the loan
must not be one repayable on demand (Gateshead Corpn …). And (fifth)
that the loan must have a ‘tract of future time’ (per Lord Johnston in Scottish
North American Trust Ltd, 1910 Session Cases 966, 973). These propositions
are perhaps one proposition expressed in different forms, but they are the
result of the authorities.”
I will refer these tests as “the Hay tests”.
31.
Some further support for the pre-eminence of the investment test is to
be found in the judgment of Lord Denning MR in Corinthian Securities Ltd v Cato
[1970] 1 QB 377, at 382-383. After referring to Inland Revenue Comrs v Hay,
he continued:
“The words ‘short loan’ are not
used in the statute: it is a mistake to place too much emphasis on them. The
real question is whether the interest payable is ‘yearly interest of money’.
Interest is ‘yearly interest of money’ whenever it is paid on a loan which is
in the nature of an investment no matter whether it is repayable on demand or
not.”
After reviewing the Goslings case he continued:
“Looking at the agreement in this
case, it is plain to me that this loan was made as an investment. Although
payable on demand, it was unlikely that any demand would be made so long as the
interest payments were kept up. It was a loan on the security of property,
indistinguishable in principle from an ordinary loan or mortgage. The interest
was ‘yearly interest of money’.”
32.
Some cold water was cast upon the investment test by Sir John Donaldson
MR in Cairns v MacDiarmid [1983] STC 178, at 181, as follows:
“It is well settled that the
difference between what is annual and what is short interest depends on the
intention of the parties. Thus interest payable on a mortgage providing for
repayment of the money after six months, or indeed a shorter period, will still
be annual interest if calculated at a yearly rate and if the intention of the parties
is that it may have to be paid from year to year (Bebb v Bunny … Corinthian
Securities Ltd v Cato …). I would personally wish to avoid the use of the
term ‘investment’ as providing any sort of test in the context of whether
interest is annual interest, notwithstanding its use in the latter case,
because it is possible to have a short term and indeed a very short term
investment, eg overnight deposits, and such an investment does not involve any
annual interest, regardless of whether the interest is calculated at an annual
rate.”
33.
That was a case in which it had been found that the loan was never
intended to last for more than a few days, although there was an entitlement to
postpone repayment for two years. It had, as intended, been discharged within a
week, by novation. In my view the difference in approach to the use of
investment as a test between that case and those which preceded it has more to
do with changes in what the financial world regards as an investment than with
any change in the underlying tax law. I consider that the Hay tests
remain the best convenient summary of the jurisprudence about the meaning of
yearly interest, in the context of interest which accrues due over time,
whether purely contractual or statutory in origin.
34.
I turn now to the second group of cases, all of which were concerned
with interest payable after the event (and usually in one lump sum) as
compensation for the payee being kept out of money or property during some
earlier period. The common characteristic of these cases, shared with this
case, is that the interest does not accrue due during the period in question.
Rather, it is awarded after the period has ended, as compensation relating to
that earlier period. Taking them chronologically, the first is Barlow v
Inland Revenue Comrs (1937) 21 TC 354. In 1923 the appellant, who was a
trustee of settlements in favour of his children, realised the trust
investments and reinvested the proceeds in his own name in unauthorised
securities which subsequently fell in value. Recognising that he acted in
breach of trust, by a deed made in March 1930 he covenanted to pay his fellow
trustees an amount equivalent to the proceeds of the realisation in 1923,
together with compound interest at 5% per annum from the date of realisation
until 1 January 1930. Finlay J, on appeal from the Special Commissioners, held
that the interest element in the lump sum agreed to be paid by the deed was
yearly interest. Following Vyse v Foster (1872) LR 8 Ch App 309 and Inland
Revenue Comrs v Barnato [1936] 2 All ER 1176, he held that where a trustee
agrees to pay principal and interest in respect of his breach of trust in
relation to a period in the past, the interest element is properly to be
regarded as interest (rather than damages) because the beneficiary has a right to
elect between interest and an account of profits in respect of the period
during which the trust property was mis-applied. He held that it was yearly
interest on the basis that it fell clearly within the definition as explained
in Bebb v Bunny. Although he did not say so in terms, this must have
been because of the lengthy period of over six years prior to the March 1930
deed in respect of which the trustee had been accountable.
35.
In the famous litigation known as Regal Hastings v Gulliver the
House of Lords had, in an order made in February 1942 [1967] 2 AC 134; [1942] 1 All ER 378, found that the defendant directors were liable to account to their
company for a profit made by them in 1935 from the use of information which
they held as fiduciaries. Interest at 4% per annum was ordered to be paid from
the dates in October and December 1935 when the defendants had made the
relevant profits. In March 1942 the defendants paid what they regarded as owing
to the company including interest, but they deducted income tax on the interest
element. Cassels J held (1944) 24 ATC 297, that this was yearly interest,
deductible either under rule 19 or under rule 21 of the 1918 Rules. Although
rule 21 related to interest of all kinds, rule 19 related only to yearly
interest. The outcome was therefore much the same as it had been in the Barlow
case save that, whereas the trustee in that case had volunteered an account
including interest to the beneficiary, the liability of the defendant trustees
in Regal Hastings v Gulliver had only been ascertained, after lengthy
litigation, in the House of Lords. It was sufficient for Cassels J’s decision
that the interest was yearly interest that it had been paid in respect of a
period of accountability of some six and a half years, so that cases such as
the Gosling case were plainly distinguishable.
36.
The next, and most important case, is Riches v Westminster Bank Ltd
[1947] AC 390. Section 3(1) of the Law Reform (Miscellaneous Provisions) Act
1934 provides that:
“In any proceedings tried in any
court of record for the recovery of any debt or damages, the court may, if it
thinks fit, order that there shall be included in the sum for which judgment is
given interest at such rate as it thinks fit on the whole or any part of the
debt or damages for the whole or any part of the period between the date when
the cause of action arose and the date of the judgment.”
37.
This discretion applies, as Viscount Simon said at p 397, regardless
whether there is or is not a contractual right to interest which underlies the
cause of action. He said that:
“The added amount may be regarded
as given to meet the injury suffered through not getting payment of the lump
sum promptly, but that does not alter the fact that what is added is interest.”
38.
At p 398 he addressed a submission to the effect that an order for
interest under section 3 could not be interest within the meaning of the Income
Tax Acts because the added sum only came into existence when the judgment was
given and from that moment had no accretions under the order awarding it.
Viscount Simon said:
“But I see no reason why, when the
judge orders payment of interest from a past date on the amount of the main sum
awarded (or on a part of it) this supplemental payment, the size of which grows
from day to day by taking a fraction of so much per cent per annum of the
amount on which interest is ordered, and by the payment of which further growth
is stopped, should not be treated as interest attracting income tax. It is not
capital. It is rather the accumulated fruit of a tree which the tree produces
regularly until payment.”
39.
Addressing the submission that the payment under section 3 was, however
described, in truth damages, Lord Wright said, at pp 399-400:
“The appellant’s contention is in
any case artificial and is in my opinion erroneous because the essence of
interest is that it is a payment which becomes due because the creditor has not
had his money at the due date. It may be regarded either as representing the
profit he might have made if he had had the use of the money, or conversely the
loss he suffered because he had not that use. The general idea is that he is
entitled to compensation for the deprivation.”
40.
Later, at p 403, he said:
“It was said that the sum in
question could not be interest at all because interest implies a recurrence of
periodical accretions, whereas this sum came to existence uno flatu by
the judgment of the court and was fixed once for all. But in truth it
represented the total of the periodical accretions of interest during the whole
time in which payment of the debt was withheld. The sum awarded was the
summation of the total of all the recurring interest items.”
41.
Lord Simonds addressed the same submission at p 410 as follows:
“It was further urged on behalf of
the appellant that the interest ordered to be paid to him was not ‘interest of
money’ for the purpose of tax because it had no existence until it was awarded
and did not have the quality of being recurrent or being capable of recurrence.
This argument was founded on certain observations of Lord Maugham in Moss
Empires Ltd v Inland Revenue Comrs [1937] AC 785, 795, in regard to
the meaning of the word ‘annual’. It would be sufficient to say that we are
here dealing with words in the Income Tax Act which do not include either ‘annual’
or ‘yearly’, but in any case I do not understand why a sum which is calculated
upon the footing that it accrues de die in diem has not the essential quality
of recurrence in sufficient measure to bring it within the scope of income tax.
It is surely irrelevant that the calculation begins on one day and ends on
another. It is more important to bear in mind that it is income.”
42.
In 1947 the income tax treatment of interest was still subject to the
dichotomy described in paras 14-15 above. Tax on interest of any kind had to be
deducted at source if not wholly paid out of taxed income, pursuant to rule 21
of the 1918 Rules. By contrast, rule 19 permitted the deduction (and retention)
of tax at source where yearly interest was paid wholly out of taxed income. The
Riches case was about rule 21 rather than rule 19 but the interest
awarded under section 3 of the 1934 Act represented interest from June 1936
until May 1943, being the period since the arising of the cause of action
during which the plaintiff had been kept out of his money. As Patten LJ
observed in the present case (at para 54, referring back to para 25), the
passage in Lord Simonds’ speech quoted above suggests that he would have
regarded the statutory interest awarded in that case as both interest and
yearly interest for the purposes of the Income Tax Acts. This is because he
regarded the payment of a single lump sum by way of interest after the event,
referable to an earlier period for which the claimant needed compensation for
being kept out of his money, as having the requisite quality of recurrence.
Recurrence over seven years is plainly sufficient for that purpose.
43.
Jefford v Gee [1970] 2 QB 130 was another case about an award of
interest under section 3 of the 1934 Act. The award was made in June 1969 by way
of addition to damages for personal injuries incurred by the plaintiff in a
motor accident in November 1966. It therefore compensated the claimant for
having been kept out of his money for some two and a half years. At p 146,
addressing the principles applicable to an award of interest in personal injury
cases under section 3 of the 1934 Act, Lord Denning MR said:
“Interest should not be awarded as
compensation for the damage done. It should only be awarded to a plaintiff for
being kept out of money which ought to have been paid to him.”
44.
Later, under the heading Tax, at p 149, he continued:
“When the court awards interest on
debt or damages for two, three or four years, the interest is subject to tax
because it is ‘yearly interest of money’: see Riches v Westminster Bank
[1947] AC 390.”
45.
It has been suggested (for example by Hildyard J at para 71(2) of his
judgment) that Lord Denning MR may have failed to appreciate that the Riches
case was about “interest” rather than “yearly interest”. In my view this
ignores Lord Denning MR’s reference to the period of “two, three or four years”
in respect of which interest is awarded. He was entitled to conclude that, even
if the Riches case only established that the relevant payments were
interest for tax purposes, they were nonetheless yearly interest because of the
historical period of several years in respect of which the lump sum award of
interest was made.
46.
Chevron Petroleum (UK) Ltd v BP Petroleum Development Ltd [1981]
STC 689 is about the interest element in rolled-up payments by way of
contribution to expenses in a joint venture agreement for the exploitation of
the Ninian oilfield in the North Sea. The participants made payments against the
expenditure in accordance with their expected share of the production.
Provision was made for each participating group’s share to be adjusted in the
light of later experience of actual production. After an accounting which added
interest to the amounts expended, the participants were credited or debited
with the differences between their contributions on account and their adjusted
contribution liability. Thus the liability to make payments against debits was
contingent upon share adjustments pending final calculations, and the interest
element in them related to periods of time which had passed before any payment
liability fell due. Nonetheless Sir Robert Megarry V-C held that the interest
element was yearly interest, and therefore subject to deduction at source. He
said, at p 696:
“I cannot see why the contingency
should deprive the so-called ‘interest’ of the quality of being true interest.
If X lends £100 to Y, the loan to carry interest at 10% per annum, why
should a provision for repayment and interest to be waived in certain events,
or for repayment with interest to be made only in certain events, prevent the
interest from being true interest if in the event it becomes payable?”
Later, at pp 696-697, commenting upon the Riches
case and interest awarded under section 3 of the 1934 Act, he continued:
“Although the obligation to pay
interest was created by the judgment, the award was made on the basis that the
defendant ought to have paid the money sued for at an earlier date and had not
done so. The interest awarded was interest in respect of the plaintiff having
been wrongfully kept out of the money: ... That was not so in the present case,
where the operating parties had duly paid all that was due from them under the
contract at the time when it was due.
I do not think that this point,
or, indeed, any other point, suffices to distinguish the Riches case. If
a contract (eg with a builder) provides for specified payments to be made on
account of the final liability, and for interest at a specified rate to be paid
on any balance when the final accounts have been agreed, the fact that all the
specified payments on account were punctually made does not, it seems to me,
prevent the interest payable on the balance from being truly ‘interest’.”
Analysis
47.
The statutory interest in the present case shares many of the relevant
features with the contractual provision for interest in the Chevron case.
In both cases it cannot be known during the period in respect of which interest
is calculated whether it will in fact be payable at all. In the Chevron case
liability depended upon an adjustment of participants’ shares made in the light
of actual production, after the relevant expenditure was incurred, which
increased rather than reduced the relevant participant’s share of the liability
to fund expenses. In this case it depends upon the realisation of a surplus
after payment of proving creditors’ claims in full, necessarily after the
commencement of the administration and indeed after the end of the period in
respect of which interest is calculated, which ends upon payment of the
creditors’ debts. In both cases there is no liability to pay interest during
the period in respect of which it is calculated. In both cases the interest is
not itself payable over a period of time. It is rolled up and payable in a
single lump sum. In short the interest is not an income stream, payable over a
period of a year or more, but it is nonetheless income rather than capital, as
the Vice Chancellor was at pains to emphasise, at p 696.
48.
More generally the relevant features of the interest in this case have
much more in common with the second group of cases about statutory interest
under section 3 of the 1934 Act, and about interest ordered or agreed to be paid
by a trustee or fiduciary in respect of a past loss or misapplication of trust
property than they have with the first group of cases about interest accruing
due and payable immediately, or over time, beginning with Bebb v Bunny.
This is not because the interest is statutory rather than contractual. There
are examples of each in both groups. It is first because in none of the second
group is the interest actually due and payable during the period by reference
to which it is calculated, nor can it be said with certainty during that period
that it ever will become due. But the interest is nonetheless payable, after
the event, as a form of compensation for the recipients being in some way out
of their money during the period in respect of which it is calculated. In the
cases about interest under the 1934 Act the recipients are (usually)
compensated for that loss during the period when they have a cause of action
for debt or damages, until a judgment gives them an enforceable right to
payment. In the trust cases the beneficiary is compensated by payment of
interest for the loss (if any) represented or caused by the trust fund being
out of the monetary value of the trust property lost or misappropriated by the
trustee, until the trustee accounts and pays that sum back into the trust fund.
In the Chevron case the payment of interest by the participants who
later incurred an increased contribution share compensated those participants
who, in the light of production experience, turned out to have paid more than
their fair share of the cost of generating it.
49.
In the present case, as Mr Goldberg was at pains to emphasise, it cannot
generally be said from the commencement of an administration whether there will
ever be generated a surplus out of which statutory interest will become
payable. Such surpluses are in fact very rare indeed. It may be that, during
that period, the process of asset recovery by the administrators will make a
surplus more likely, but even then its amount and the timing of any interest
payment will all depend upon countless contingencies, including (in this case)
long drawn out litigation about the amount of creditors’ claims. Statutory
interest is never due until after all proving creditors have been paid in full.
There is always a risk that an administration will be followed by a winding up,
with unfortunate (and probably unforeseen) consequences upon the availability
of interest under rule 14.23, even if there is a surplus: see In re Lehman
Brothers International (Europe) (in administration) (No 4) [2018] AC 465
per Lord Neuberger of Abbotsbury, at paras 117 to 121. Nonetheless, as rule
14.23 makes clear in the plainest terms, the interest once paid compensates
proving creditors for being kept out of their proved debts from the
commencement of the administration (which prevents them seeking any other form
of recovery), until they are actually paid.
50.
Mr Goldberg sought to distinguish the trust cases on the basis that,
pursuant to Vyse v Foster, a beneficiary had an enforceable right to
interest from the moment when the trust property was lost or misapplied. For
the reasons given by Patten LJ in the Court of Appeal, at paras 45 to 50, based
upon Target Holdings Ltd v Redferns [1996] AC 421, this is not
the correct analysis of the basis upon which the court awards interest in
equity. It is discretionary, like interest under the 1934 Act, even though the
discretion may be exercisable in accordance with well-settled principles.
51.
It is true, as the administrators submitted, that some of the second
group of cases were primarily concerned with the question whether payments
described as interest were truly interest at all for income tax purposes,
rather than whether they were yearly interest. In the Riches case this
was because the question arose under a provision in the 1918 Rules relating to
all types of interest. In Jefford v Gee it may be that Lord Denning MR
was not overly concerned with whether the interest was yearly or not, although
he certainly took notice of the fact that the plaintiff had been out of his
money for several years. In the Chevron case the contrary argument was
that the element in the rolled-up payment described as interest was not
interest at all. There may have been no dispute that, if it was, it was yearly
interest. By contrast in the present case it has been common ground throughout
that statutory interest under rule 14.23 is interest for the purposes of income
tax.
52.
But those cases nonetheless provide the answer to the conundrum: what
period of durability is to be identified for interest payable in a single lump
sum as compensation for the payee being out of the money in the past, for the
purpose of deciding whether it is to be treated as yearly interest, under the Hay
principles? The simple answer, supplied by all the second group of cases,
is that it is the period in respect of which the interest is calculated,
because that is the period during which the loss of the use of money or
property has been incurred, for which the interest is to be compensation.
53.
This appears also to have been the assumption made by the drafter of
what is now section 874(5A), quoted above. It deems payment of interest to an
individual in respect of compensation to be yearly interest “irrespective of
the period in respect of which the interest is paid”. This suggests that, but for
the deeming provision (introduced, so the court was told, to deal with
compensation for mis-selling of Payment Protection Insurance), the question
whether the interest would or would not have been yearly interest would have
depended upon the duration of the period in respect of which the compensatory
interest was calculated.
54.
It may of course be said that this approach has nothing to do with the
intentions of the payer and the payee, and that, for most of the relevant
period it will not be known when it will end, or whether interest as
compensation for that loss will ever be paid. This is true of all the second
group of cases, just as in the present case. But this gives rise to no relevant
uncertainty. The payer will always know what that period is by the time that
the interest becomes due and will be able to deduct tax or pay gross
accordingly. In the case of interest under the 1934 Act the judge is required
to identify the period. In the trust cases the order for payment of interest
will also be by reference to a defined period. In the present case the period
is fixed by the date of commencement of the administration and the date (or
dates) upon which the proving creditors are paid their debts.
55.
I must finally address the group of submissions deployed by the
administrators under the heading “source”. These were not deployed with any
prominence in, or at least addressed by, the Court of Appeal, but they were
advanced at the forefront of Mr Goldberg’s submissions in this court. The
argument goes like this. Income Tax is, and always has been, levied by
reference to the source of the relevant income. The only source from which
interest under rule 14.23 can be said to derive, apart from the statutory
provision itself, is the combination of a realised surplus and a decision by
the administrators that it is time to pay it. Those elements cannot, either
singly or together, be said to have the quality of durability over time
sufficient to make the interest yearly interest for income tax purposes,
applying the Hay tests. They are unpredictable, liable to evaporate in
the event of a winding up, will generally not have existed for a year before
payment, and cannot be regarded as being in the nature of an investment. The
period of time in respect of which the statutory interest is calculated cannot
itself be regarded as a source of the interest. If there has to be a search for
any source of the statutory interest other than the surplus and the decision to
pay, it can only be the contractual debts owed by LBIE to its creditors at the
moment when it went into administration, but those debts were mainly short term
in nature, lacking the requisite capacity to generate yearly interest.
Furthermore for income to be taxable at all the source has to be in existence
at the time when the income becomes due and payable. Neither those contractual
debts, nor the provable debts which replaced them from the commencement of the
administration, remained in existence when the statutory interest became
payable. They had all by then been discharged by payment in full.
56.
The short answer to this submission is that, if it were correct, all the
second group of cases would have been wrongly decided. In none of them did the
interest under review have a source in the sense of some kind of durable
investment. In the equity cases the beneficiaries received interest by way of
compensation for part of their trust fund being lost or misappropriated. In the
cases under the 1934 Act the plaintiffs were being compensated for the delayed
payment of damages, in one case for the pain and suffering occasioned by a
broken leg which had no doubt healed long before the interest became due. In
the Chevron case one group of joint venturers were in substance being
compensated, long after the event, for having contributed more than their fair
share of the expenses.
57.
But the flaws in the submission are more fundamental than that. First,
the obligation to deduct tax from interest under section 874 does not depend at
all upon the question whether the interest is taxable in the hands of the
recipient. If the payment is yearly interest, and the payers (or the
circumstances) qualify, for example because the payer is a company, or the
usual place of abode of the recipient is offshore, then tax must be deducted.
There is no requirement to identify a source at all, in the case of statutory
or other UK interest. At the most it may be said that the first group of cases
can loosely be characterised as involving an examination of the source of the
interest as part of the inquiry about whether the income in question was
“yearly interest of money”.
58.
Secondly, it is artificial to regard the source of statutory interest as
having anything to do with the realisation of the surplus, still less the
decision of the administrators to pay it, even though the combination of those
two factors may be said to have been the immediate cause of the interest
becoming payable. Of course the interest may be said to derive from the
surplus, in the sense of constituting the fund from which it came, but the
concept of source in that literal sense had nothing whatever to do with the
characterisation of the payments as yearly interest in any of the second group
of cases or, for that matter, even in the first group. As for the decision of
the administrators to pay, this broadly equates with the exercise of a judicial
discretion, both in the equity cases and those under the 1934 Act. To the
limited extent that it may be said to render the right to payment contingent,
it is a much less formidable contingency than the exercise of judicial
discretion. In truth the administrators have no real discretion at all.
59.
Thirdly, to the extent that it is instructive to look for a source of
the statutory interest under rule 14.23, the obvious candidate is the status of
the recipient as a proving creditor during the period between the commencement
of the administration until payment of the principal amount by dividend. That
is a statutory status created by the insolvency code laid down by the
Insolvency Act and Rules, which (as we now know) replaces the creditor’s former
contractual rights at the commencement of the administration. It precisely
coincides with the period in respect of which the statutory interest is
calculated and, for the reasons given above, amply fulfils the necessary quality
of durability over time.
60.
Finally, if it were necessary to do so, I would regard the status of a
proving creditor in a distributing administration as having the requisite
character of being an investor, albeit an unwilling and involuntary one. It is
no mere irony that LBIE’s unsecured debt has, during that last ten years,
turned out to be a very satisfactory long-term investment, generating interest,
payable in full, at a handsome 8%.
61.
For all those reasons, which do not differ in their essentials from those
given by Patten LJ in the Court of Appeal, I would dismiss this appeal.
