Inland Revenue v Kahn & Anor

Corporation tax charged on a company’s post-liquidation profits, including income which the taxing legislation requires it to bring into account although not received, is a necessary disbursement and an expense of the winding up. It must be paid from the company’s assets in priority to debts proved in the liquidation under the Insolvency Act 1986.

The court’s general discretion over liquidation outgoings cannot be used to refuse payment of a statutory tax liability. Under the Insolvency Rules 1986, corporation tax on chargeable gains is given a different, lower priority, but other post-liquidation corporation tax remains within the necessary-disbursements category. In re Kentish Homes Ltd was wrongly decided.

The joint liquidators of Toshoku Finance UK Plc applied under section 112(1) of the Insolvency Act 1986 for directions concerning corporation tax on interest accruing after the company entered creditors’ voluntary liquidation. The interest had not been received and would not be received, but the parties proceeded on the basis that the company was liable to tax on it under the relevant taxing provisions.

Mr Justice Evans-Lombe held that the tax was not payable from the company’s assets as an expense of the winding up: [1999] 2 BCLC 777. The Commissioners appealed. The central issue was whether post-liquidation corporation tax had to be paid as a liquidation expense in priority to creditors proving in the winding up.

Chadwick LJ delivered the leading judgment. Buxton LJ and the Vice-Chancellor agreed. The appeal was therefore allowed unanimously.

1. Under the Income and Corporation Taxes Act 1988 and the Finance Act 1996, the company’s connected loan relationship with TEE had to be accounted for on an authorised accruals basis. Interest contractually payable during the relevant accounting period had to be brought into account as if paid in full. The connected-company rules prevented a bad-debt adjustment under Schedule 9 of the Finance Act 1996.
2. Tax on profits arising in the accounting period beginning with the winding up was a post-liquidation debt and was not provable under the Insolvency Rules 1986. If payable from the company’s assets, it had to be treated as an expense of the winding up.
3. The replacement of rule 195(1) of the former winding-up rules by rule 4.218(1) did not remove post-liquidation corporation tax from the necessary-disbursements category. Paragraph (m) excluded only corporation tax falling within paragraph (p), namely tax on chargeable gains accruing on realisation of an asset. That element was reintroduced at a lower priority, below specified liquidator remuneration. The rules did not exclude other post-liquidation corporation tax altogether.
4. The liquidation-expenses principle recognised a general judicial discretion concerning outgoings, but that discretion had to be exercised consistently with settled law. Following In re Mesco Properties Ltd, tax which the liquidator was bound to pay was a necessary disbursement and an expense incurred in the winding up. The result did not depend on a corresponding benefit to unsecured creditors.
5. The court could not refuse payment merely because the tax was imposed on notional or unreceived income and appeared unfair to pre-liquidation creditors. That consequence flowed from Parliament’s statutory scheme. In re Kentish Homes Ltd, insofar as it treated payment of such a statutory liability as discretionary, was incorrect.

The tax was payable from the company’s assets as an expense of the winding up and in priority to debts proved in the liquidation under section 115 of the Insolvency Act 1986. Permission to appeal to the House of Lords was refused.

1. Court of Appeal (Civil Division): appeal allowed. The court held that post-liquidation corporation tax, including tax on unreceived interest required to be brought into account, was a necessary disbursement payable as an expense of the winding up.
2. Chancery Division: Mr Justice Evans-Lombe held that the liquidators were not required to pay the tax from the company’s assets as a winding-up expense: [1999] 2 BCLC 777.