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England and Wales Court of Appeal (Civil Division) Decisions
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Cite as:  STC 398,  EWCA Civ 58
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COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM HIGH COURT OF JUSTICE
MR JUSTICE HENDERSON
CH/2006/APP/0555 & 0593
Strand, London, WC2A 2LL
B e f o r e :
LORD JUSTICE LAWRENCE COLLINS
SIR WILLIAM ALDOUS
| THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS
|- and -
|BANK OF IRELAND BRITAIN HOLDINGS LIMITED
WordWave International Limited
A Merrill Communications Company
190 Fleet Street, London EC4A 2AG
Tel No: 020 7404 1400, Fax No: 020 7831 8838
Official Shorthand Writers to the Court)
Mr John Gardiner QC and Mr Philip Walford (instructed by Slaughter and May) for the Respondent
Hearing date : January 15, 2008
Crown Copyright ©
Lord Justice Lawrence Collins :
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 is required to buy them back either
(i) in pursuance of an obligation to do so imposed by that agreement or by any related agreement, or
(ii) in consequence of the exercise of an option acquired under that agreement or any related agreement; and
(c) the sale price and the repurchase price are different.
(2) The difference between the sale price and the repurchase price shall be treated for the purposes of the Tax Acts
(a) where the repurchase price is more than the sale price, as a payment of interest made by the repurchaser on a deemed loan from the interim holder of an amount equal to the sale price; and
(b) where the sale price is more than the repurchase price, as a payment of interest made by the interim holder on a deemed loan from the repurchaser of an amount equal to the repurchase price.
(3) Where any amount is deemed under subsection (2) above to be a payment of interest, that payment shall be deemed for the purposes of the Tax Acts to be one that becomes due at the time when the repurchase price becomes due and, accordingly, is treated as paid when that price is paid.
(4) Where any amount is deemed under subsection (2) above to be a payment of interest, the repurchase price shall be treated for the purposes of the Tax Acts (other than this section and sections 737A and 737C) and for the purposes of [the Taxation of Chargeable Gains Act 1992]
(a) in a case falling within paragraph (a) of that subsection, as reduced by the amount of the deemed payment; .
(5) For the purposes of section 209(2)(d) and (da) any amount which is deemed under subsection (2)(a) above to be a payment of interest shall be deemed to be interest in respect of securities issued by the repurchaser and held by the interim holder.
(6) For the purposes of Chapter II of Part IV of the Finance Act 1996 (loan relationships)
(a) interest deemed by virtue of subsection (2) above to be paid or received by any company shall be deemed to be interest under a loan relationship; and
(b) the debits and credits falling to be brought into account for the purposes of that Chapter so far as they relate to the deemed interest shall be those given by the use in relation to the deemed interest of an authorised accruals basis of accounting.
(9) In this section references to the repurchase price are to be construed
(a) in cases where section 737A applies as references to the repurchase price which is applicable by virtue of section 737C (11)(c).
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).
(3) In section 730A and this section "securities" has the same meaning as in section 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 under the same or any related agreement the transferor or another person connected with him
(a) is required to buy back the securities, or
(b) acquires an option, which he subsequently exercises, to buy back the securities;
but this section does not apply unless the conditions set out in subsection (2) below are fulfilled.
(2) The conditions 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,
(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.
(3) For the purposes of subsection (2) above the relevant date is the date when the repurchase price of the securities becomes due.
(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) above,
(b) a payment were made by that person to the transferor in discharge of that requirement, and
(c) the payment was 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).
737B Interpretation of Section 737A
(1) In section 737A and this section "securities" means United Kingdom equities, United Kingdom securities or overseas securities; and
(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.
737C Deemed manufactured payments: further provisions
(1) This section applies where section 737A applies.
(10)Subsection (11) below applies where
(a) the dividend mentioned in section 737A(2)(a) is an overseas dividend, and
(b) by virtue of section 737A(5), paragraph 4 of Schedule 23A applies in relation to the payment which is treated under section 737A(5) as having been made;
and in subsection (11) below "the deemed manufactured overseas dividend" means that payment.
(11)Where the subsection applies
(a) the gross amount of the deemed manufactured overseas dividend shall be taken to be the amount found under paragraph 4(5)(b) and (c) of Schedule 23A;
(b) any deduction which, by virtue of paragraph 4 of Schedule 23A, is required to be made out of the gross amount of the deemed manufactured overseas dividend shall be deemed to have been made;
(c) the repurchase price of the securities shall be treated, for the purposes of section 730A, as increased by the gross amount of the deemed manufactured overseas dividend.
(1) 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.
(2) ...where this paragraph applies the gross amount of the manufactured overseas dividend shall be treated for all purposes of the Tax Acts as an annual payment, within section 349, but
(b) the amount which is to be deducted from that gross amount on account of income tax shall be an amount equal to the relevant withholding tax on that gross amount; and
(c) in the application of sections 338(4)(a) and 350 (4) in relation to manufactured overseas dividends the references to Schedule 16 shall be taken as references to dividend manufacturing regulations
By virtue of paragraph 4(2), the payment can qualify as a charge on income paid by the overseas dividend manufacturer under section 338. Paragraph 4(4) provides that, in relation to the recipient, the manufactured overseas dividend is treated as if it were an overseas dividend of an amount equal to the gross amount of the manufactured overseas dividend.
III The facts
(1) A share sale agreement ("the Share Sale Agreement") whereby Birkdale agreed to sell the Securities to Bank of Ireland on November 14, 2000 for a price of £225 million payable on that date;
(2) An option agreement ("the First Option Agreement") whereby Bank of Ireland granted BH a call option and BH granted Bank of Ireland a put option on the Securities, the options being exercisable until March 23, 2001 at a purchase price of £225 million plus any unpaid accrued dividend on the Securities; and
(3) An option agreement ("the Second Option Agreement") whereby BH granted Birkdale a call option and Birkdale granted BH a put option on the Securities, the options being exercisable until March 23, 2001 with a completion date no later than March 30, 2001. The purchase price, if either option was exercised, was fixed by a formula: the aggregate of £225 million, plus an amount accruing on that sum at a rate of 8.3% per annum from November 14, 2000 to the completion date, less any dividends paid on the Securities divided by 0.7, together with any finance breakage costs if completion took place before March 30, 2001.
(i) November 14, 2000: Bank of Ireland paid Birkdale £225 million for the Securities.
(ii) November 25, 2000 to January 25, 2001: Bank of Ireland received approximately £3.6 million in dividends on the Securities.
(iii) February 23, 2001: BH paid Bank of Ireland £225 million for the Securities.
(iv) February 25, 2001 to March 5, 2001: BH received approximately £350,000 in dividends.
(v) March 5, 2001: BH sold the Securities back to Birkdale for £225 million. An additional sum of about £3.95 million fell to be added to that price under the Second Option Agreement (under the formula for interest) but that additional amount fell to be reduced by the amount of the dividends actually received (i.e. £3.95 million).
IV The parties' positions and the judgment
(1) Whether BH was to be deemed to have received a matching payment of interest of about £3.95 million pursuant to section 730A of ICTA 1988; and
(2) Whether the payment of the manufactured overseas dividend deemed to have been made by BH under section 737A was deductible as a charge on income.
(1) Section 730A reflected a perception that repos were widely used as a means of providing finance without the usual income tax consequences of making a loan. Consistently with that approach, and in order to avoid double taxation, the repurchase price was treated for CGT purposes as reduced by the amount of the deemed interest: section 730A(4)(a).
(2) Because the deemed interest represented the return on a notional loan, section 730A(2)(a) provided that it would be taxable in the hands of the deemed lender, namely the interim holder, who was defined in subsection 730A(1)(a) as the person to whom the original owner had transferred the securities under an agreement to sell them.
(3) When a third party was introduced into the arrangements (BH), and the notional lender, i.e. the interim holder (Bank of Ireland), was no longer the person who receives the repurchase price, it was not possible to construe the legislation in a way which made the interest taxable in the hands of the reseller who received the repurchase price, as the Revenue submitted, instead of in the hands of the interim holder, who did not receive the repurchase price.
(4) The wording of subsection 730A(2)(a) was clear and unambiguous. The deemed loan was still from the interim holder, notwithstanding the tripartite nature of the arrangements, and that deemed loan was the only source (albeit a deemed source) from which taxable interest could arise. The interest must therefore be taxable in the hands of the owner of that source (the interim holder), whether or not the interim holder also received the repurchase price.
(5) Since the only relevant source was the deemed loan by the interim holder, the deemed payment of interest was taxable in the hands of the interim holder and nobody else.
(6) The source doctrine was fundamental to the UK law of income tax (Brown v National Provident Institution  2 AC 222), as was the need to identify a charging provision before any charge to tax could be imposed. Section 730A was not in itself a charging provision. The function of section 730A was, first, to deem potentially chargeable income to exist, in the form of the deemed interest, and secondly, to deem a source of that income to exist, in the form of a deemed loan from the interim holder. It was that deemed loan which provided the necessary link between the notional interest and the relevant charging provisions which were to be found elsewhere in the tax legislation. The deemed loan was therefore of fundamental importance in bringing the notional interest into the charge to tax.
(7) The main charging provision in the loan relationship regime was in section 80 of the Finance Act 1996, which provided by section 80(1) that for the purposes of corporation tax all profits and gains arising to a company from its loan relationships shall be chargeable to tax as income in accordance with Chapter II of Part IV of the Act, and by section 80(3) that profits and gains arising from a loan relationship of a company that were not brought into account under section 80 (2) (which applied where the company was a party to a loan relationship for the purposes of a trade carried on by it) were to be brought into account as profits and gains chargeable to tax under Case III of Schedule D. BH was not a trading company, and it was Case III of Schedule D (in the modified form in which it applied to corporate loan relationships) which imposed the relevant charge to tax by virtue of section 80(3).
(8) Where the notional interest was deemed to be paid by a company, the interest was deemed to be interest under a loan relationship for the purposes of Chapter II of Part IV of the Finance Act 1996: section 730A(6), as substituted by the Finance Act 1996 with effect for accounting periods ending after March 31, 1996. Section 730A(6) did not itself deem anybody to be a party to the deemed loan relationship. Section 730A(2) identified the deemed payer of the interest as the repurchaser (Birkdale) and the deemed recipient of the interest as the interim holder (Bank of Ireland).
(9) This conclusion could lead to strange results where dividends had been paid during the life of the repo and received by the interim holder. Those dividends might give rise to deemed manufactured dividends under section 737A, which would in turn lead to a deemed increase in the repurchase price of the securities, which would then trigger a deemed payment of interest under section 730A, so that the interim holder might end up potentially liable to tax not only on the dividends which it had actually received, but also on the interest which it was deemed to have received. But the language of section 730A(2)(a) was clear and unambiguous.
(10) From the Revenue's point of view, the real vice in the present case was not that section 730A failed in its object of replacing what would otherwise be a capital gain with a flow of taxable income, but rather that the arrangements had been framed in such a way that the income accrues to a non-resident company outside the charge to corporation tax.
V The appeal
Sir William Aldous:
Lord Justice Maurice Kay: