Kahn and Another v Commissioners of Inland Revenue

The House of Lords held that corporation tax chargeable on profits arising in a winding up is a post-liquidation liability which, if falling within the language of rule 4.218(1) of the Insolvency Rules 1986 (in particular paragraph (m)), is an "expense properly incurred in the winding up" within section 115 of the Insolvency Act 1986 and therefore payable in priority out of the company's assets. The court rejected the liquidators' submission that the rule should be given an implied equitable gloss derived from the "liquidation expenses" principle (as discussed in In re Atlantic Computer Systems Plc and applied in In re Kentish Homes Ltd) so that only liabilities incurred for the benefit of the estate would qualify. The decision relies on statutory construction of rule 4.218(1), the long line of authorities since the 1890 rules and the earlier decision in In re Mesco Properties Ltd concerning corporation tax on chargeable gains.

Background and facts:

The appellants were joint liquidators of Toshoku Finance (UK) Plc which went into creditors' voluntary liquidation on 26 January 1998. The company's principal asset was a loan claim against a related group company, Toshoku Europa Establishment (TEE). On the liquidation date TEE owed principal and accrued contractual interest. TEE was insolvent and, by agreement, the company accepted a compromise sum in full and final settlement of its claim; no post-liquidation interest was paid.

Nature of the application:

• The liquidators sought the court's directions whether, assuming a corporation tax liability arose on the accounting period deemed to commence on the liquidation date (pursuant to the taxation provisions cited in the judgment), such liability was an "expense properly incurred in the winding up" within section 115 of the Insolvency Act 1986 and therefore payable in priority out of the company's assets.

Procedural posture:

Evans-Lombe J held that the liability would not be an expense of the winding up ([1999] STC 922). The Court of Appeal reversed that decision ([2000] 1 WLR 2478). The liquidators appealed to the House of Lords.

Issues framed by the court:

• Whether a corporation tax liability on profits/gains arising in winding up falls within the heads of liquidation expenses listed in rule 4.218(1) of the Insolvency Rules 1986;
• Whether rule 4.218(1) is a definitive code of liquidation expenses or whether an additional equitable "liquidation expenses" principle is required, limiting post-liquidation expenses to those incurred for the benefit of the insolvent estate;
• The relevance of earlier authorities (notably In re Mesco Properties Ltd, In re Atlantic Computer Systems Plc and In re Kentish Homes Ltd) to the construction of the rule.

Reasoning and conclusion:

The Lords concluded that rule 4.218(1) was intended as a definitive statement of what counts as an expense of the liquidation (subject only to the limited power to reorder priorities under section 156 of the Insolvency Act 1986 and to matters expressly reserved in the Rules). The court followed Brightman J's reasoning in In re Mesco Properties Ltd that corporation tax on gains arising in the winding up is a necessary disbursement of the liquidator. It rejected the liquidators' submission that post-liquidation liabilities must satisfy the equitable "liquidation expenses" principle. That principle has its origins in allowing pre-liquidation creditors special priority where the liquidator retains property for the benefit of the estate (Lundy Granite Co and related cases), but it is not a general gloss to construe the statutory heads of expense. Applying this construction, tax on profits arising in winding up between connected companies falls within rule 4.218(1)(m) and is therefore payable in priority. The appeal was dismissed.

Appeal dismissed. The House of Lords held that corporation tax chargeable on profits arising in the winding up is a post-liquidation liability which falls within the heads of liquidation expenses in rule 4.218(1) (in particular paragraph (m)) and therefore, if payable, is an "expense properly incurred in the winding up" under section 115 of the Insolvency Act 1986. The court rejected a requirement that such liabilities must additionally satisfy an equitable "liquidation expenses" principle.

Evans-Lombe J: liability not an expense ([1999] STC 922); Court of Appeal: reversed, held liability was an expense ([2000] 1 WLR 2478); House of Lords: appeal dismissed ([2002] UKHL 6).