Revenue & Customs v First Nationwide

The Court of Appeal held that the payments characterised and made as dividends out of Blueborder's share premium account were payments of income for United Kingdom tax purposes because the legal machinery adopted for the distributions was that of a dividend. The court applied the well-established rule that the form or mechanism of a distribution determines whether it is income or capital and relied on prior authority emphasising that only two categories exist under UK law: income or capital.

The court rejected the Revenue's submission that share premium in Blueborder amounted to a protected capital corpus or a distinct 'third' category; Cayman Islands law (s.34) permitted distribution of share premium as dividends and the articles provided for payment by dividend rather than by authorised reduction of capital, so the payments were income. The Court of Appeal also held that the subscription by First Nationwide for newly issued Second Issued Preference Shares was not a "buying back" or purchase of similar securities for the purposes of the repo provisions (ss.737A and 730A ICTA 1988): subscription creates a chose in action rather than transferring an existing chose in action, and the statutory wording and legislative history indicate that Parliament intended the provisions to apply to purchases/repurchases rather than subscriptions. The appeal was therefore dismissed on both grounds.

Background and parties. First Nationwide, a UK-resident unlimited company and wholly-owned subsidiary of the Nationwide Building Society, entered a structured financing arrangement involving Blueborder Cayman Ltd (issuer of ordinary and preference shares), stock loans through ABN AMRO and a sale of the First Issued Preference Shares to Anglo Irish Bank. Blueborder's preference dividends of £25,500,000 on two dates (total £51m) were declared payable exclusively out of share premium. First Nationwide, obliged under a stock lending agreement to pay manufactured dividends to ABN AMRO equal to those preference dividends, deducted those payments as expenses in its corporation tax self-assessment for the period to 31 March 2004.

Procedural posture and relief sought. HM Revenue & Customs amended First Nationwide's assessment. First Nationwide succeeded in the First-tier Tribunal (Judge Berner) [2010] SFTD 408 and in the Upper Tribunal ([2011] UKUT 174 (TCC) / [2011] STC 1540). HMRC appealed to the Court of Appeal seeking (i) a determination that the preference dividends paid out of share premium were capital rather than income, and (ii) a finding that First Nationwide's subscription for Second Issued Preference Shares amounted to a "buying back" or acquisition of similar securities under sections 737A and 730A ICTA 1988 so as to trigger deemed manufactured payments.

Issues framed.

• Whether the preference dividends paid out of share premium were payments of income (deductible under the manufactured overseas dividends regime) or payments of capital.
• Whether First Nationwide's subscription for the second issued preference shares constituted a "buying back" or acquisition of similar securities for the purposes of ss.737A and 730A ICTA 1988, thereby producing deemed manufactured payments and altering the tax consequences.

Reasoning and conclusions. The court applied the long-standing principle that classification of a distribution as income or capital depends on the legal machinery used to effect it. It surveyed authorities (including R.A. Hill v Permanent Trustee, Drown v Gaumont-British, Re Duff's Settlement, Reid's Trustee, Rae v Lazard and Courtaulds) and concluded that where share premium is distributed by dividend the receipts are income in the shareholders' hands. Cayman Islands law (s.34 of the Cayman Islands Companies Law 2003) permitted the share premium account to be applied in paying dividends provided a solvency condition was met; Blueborder's articles similarly prescribed payment by dividend and attached capital rights only in the event the premium was not distributed. The court rejected the Revenue's argument that these features created a protected capital corpus or a novel third category; because the chosen mechanism was dividend distribution the payments were income.

On the repo issue the court held that the repo provisions (ss.737A and 730A) require a sale and a subsequent buy-back or acquisition of similar securities and are directed at transfers of existing choses in action. A subscription (issue) creates a new chose in action rather than effects a purchase of an existing security. Legislative history and precedent (including Re VGM Holdings) distinguish subscriptions from purchases and the drafting of earlier and related provisions demonstrates Parliament knew how to address subscriptions if it had intended to do so. Accordingly the subscription did not fall within the statutory concept of buying back; the repo provisions did not apply.

Outcome in context. The Court of Appeal affirmed both tribunals' decisions and dismissed HMRC's appeal, noting the narrowness and legal character of the questions and the reliance on established company law principles and the statutory wording of the repurchase provisions.

Appeal dismissed. The court held that the payments made by Blueborder out of its share premium account were income in the hands of the recipient because the distributions were effected by the mechanism of dividend, and that the subscription by First Nationwide for newly issued shares was not a "buying back" or acquisition of similar securities within the meaning of ss.737A and 730A ICTA 1988; accordingly the repo provisions did not create deemed manufactured payments. The court affirmed the First-tier and Upper Tribunals' conclusions on both issues.

Appeal from the Upper Tribunal (Tax and Chancery Chamber) (Warren P and Judge Edward Sadler) [2011] UKUT 174 (TCC) (reported [2011] STC 1540), following the First-tier Tribunal decision ([2010] SFTD 408). HMRC appealed to the Court of Appeal which heard argument on 17-19 January 2012 and delivered judgment on 13 March 2012 ([2012] EWCA Civ 278).