Rae v Lazard Investment Co Ltd

A receipt from a foreign company is classified as capital or income under English tax law, but the rights created and the legal character of the company’s acts must first be determined under the law governing that company. The court cannot assess a foreign statutory distribution by assuming that the company was incorporated under English law.

The source of the distributed assets is not decisive. The machinery by which they are distributed determines their character. A genuine partial liquidation under the applicable foreign law may therefore produce a capital receipt even though English company law provides no equivalent procedure.

An English investment company held shares in a Maryland corporation which operated two businesses. The corporation transferred one business and its assets to a newly formed company. It then distributed shares in that company to its shareholders through a partial liquidation authorised by Maryland law.

The respondent was assessed under Case V of Schedule D on the footing that the distributed shares were income arising from a foreign possession. The Special Commissioners discharged the assessment. Plowman J reversed their decision, but the Court of Appeal restored it.

The Crown appealed to the House of Lords. The central issue was whether English tax law treated the shares received through the Maryland partial liquidation as income or capital.

1. The appeal was dismissed unanimously and the Court of Appeal’s order was affirmed. Lord Reid delivered the principal speech. Lord Cohen concurred. Lord Jenkins, Lord Guest and Lord Pearce also concluded that the distributed shares were capital rather than taxable income.

2. Per Lord Reid, the established inquiry was whether the corpus of the shareholder’s foreign asset remained intact after the distribution. The nature of the shareholder’s rights in a foreign possession had to be determined under the applicable foreign law. The unchallenged findings about Maryland law established that the respondent’s original interest did not remain intact: the two post-distribution shareholdings represented the same underlying assets which had previously been held through one company.

3. Per Lord Reid, English law generally classifies a corporate distribution by its form rather than the source or substance of the assets distributed. The transaction nevertheless could not be treated as though an English company had undertaken it. English law did not provide for partial liquidation, while Maryland law authorised that machinery and did not permit this transaction to be effected as a dividend. The foreign-law findings characterised it as a division of capital assets.

4. Lord Jenkins agreed with the Court of Appeal and emphasised that every Case V dispute must turn on its own facts, including the applicable foreign law. On the Maryland-law evidence, the transaction returned part of the company’s assets without winding it up and contained no element of dividend or income.

5. Lord Guest reasoned that the character of the payment depended on the legal machinery employed by the company under the law of its incorporation. Asking how an English company would have effected the transaction was fruitless because English law contained no comparable machinery.

6. Lord Pearce held that English tax law supplied the ultimate classification, but it had to be applied to a factual situation which included the foreign law. The source of the assets was not decisive. A foreign statutory procedure could enlarge the recognised methods by which assets were distributed as capital. He left open, as obiter, whether an English court could look behind colourable foreign labels or machinery devised to give income a specious appearance of capital. The present transaction was genuine and accorded with its commercial substance.

1. House of Lords: Dismissed the Inspector’s appeal, affirmed the Court of Appeal’s order and ordered the appellant to pay the respondent’s costs.
2. Court of Appeal: Restored the Special Commissioners’ decision and held in favour of the taxpayer.
3. High Court: Plowman J reversed the Special Commissioners’ decision.
4. Special Commissioners: Discharged the assessment under Case V of Schedule D.