UK and International Tax news
Court Of Appeal – First Nationwide
Tuesday 10th April 2012
The CA has recently given its decision in the appeal from the Upper Tier Tribunal [UTT] in the case of HMRC v First Nationwide [2012-278], and has upheld the decision of the UTT, and of the FTT, that a dividend received from a Cayman company paid out of a share premium account was an overseas dividend for UK tax purposes, and a subscription for shares was not a purchase within the sale and repurchase rules.
First Nationwide [FN] had entered into a stock loan with the UK branch of ABN Amro under which it acquired certain preference shares in a Cayman company. The preference shares carried rights to two large quarterly dividends, thereafter, the dividend rights reduced significantly.
FN sold the preference shares to a third party, who received the two quarterly dividends. Under the terms of the stock loan, however, the taxpayer was required to pay manufactured dividends in respect of these dividends to the bank. FN claimed a deduction for these manufactured dividends as a management expense under Sch 23A TA88.
In order for FN to return the preference shares to the bank under the stock loan, it subscribed for replacement shares with the Cayman company at market value, and after the two large dividends had been paid.
For the taxpayer, the overall result of these transactions for tax purposes was the creation of an income deduction and a capital gain so as to be able to utilise capital losses thereby effectively converting capital losses into trading losses.
HMRC argued that the two dividends were not ‘overseas dividends’ for the purposes of Sch 23A because even if they were lawful ‘dividends’ for the purposes of Cayman company law, they were not dividends as that word should be construed for the purposes of Sch 23A. Alternatively, even if they were dividends, they were dividends that had a capital nature in the hands of the recipient. HMRC argued that this was because the dividends were paid out of the company’s share premium account, rather than out of distributable profits.
HMRC went on to argue various points under English company law, in particular, that although before s.56 CA48 was enacted, a UK company could pay a dividend out of its share premium account, the share premium ranked as profits available for payment of a dividend and that such dividends were treated as income in the hands of the recipient. Since CA48 however, the understanding as to what amounted to a dividend had changed, and that the definition of dividend now would not include payments out of share premium account, even if (as in this case) such a dividend was permitted under the relevant company law of the company paying the dividend.
The UTT had rejected HMRC’s argument, and could see no reason why an English company could not pay a dividend out of its share premium account and that in other jurisdictions the payment of such a dividend would be permissible and would still amount to a dividend. The UTT went on to consider whether there was any aspect of Cayman company law that meant that the payments were not dividends as that expression was ordinarily understood, or whether a purposive interpretation of Sch 23A required a special meaning of dividend to be considered. In the view of the UTT, the payments were dividends for the purposes of Sch 23A.
HMRC’s other argument was that the sale of the preference shares to the third party, when combined with the taxpayer’s rights under the subscription agreement, amounted to a repurchase, and therefore the taxpayer was deemed by s.737A TA88 to receive an amount equivalent to the two dividends. This argument turned on whether ‘buy’ included a subscription, or whether it was necessary for the shares to be in existence before they could be ‘bought’.
The UTT had commented that HMRC’s Technical Note was evidence that HMRC did not consider it obvious that subscriptions should be included. In addition, to extend the rules in the way suggested by HMRC would not give an economically symmetrical result as the taxpayer also made a chargeable gain on the disposal of the preference shares. In the context of the repurchase rules, the UTT held that ‘buy’ did not include a subscription and therefore they did not apply.
It had been hoped that HMRC would not appeal the UTT decision and prolong the uncertainty arising as to the tax treatment of dividends, given in particular the new exemption from tax on foreign dividends and recently issued HMRC guidance thereon.
The CA held that ‘the reality was the distribution of share premium as dividends, that mechanism establishes that the payments were income and the correct identification of the dividends as income, notwithstanding that they were paid out of share premium account’.
With regard to the repo issue, the CA distinguished between the purchase of shares in order for the manufactured dividends provisions to apply and the acquisition of shares by way of subscription which had occurred in this case.
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