Revenue & Customs v First Nationwide

For United Kingdom tax purposes, the legal machinery used for a distribution determines whether a shareholder receives capital or income. A distribution lawfully made as a dividend is income, even where it is paid from a share-premium account and reduces the capital rights otherwise attaching to the shares. A dividend may be analysed differently where the facts show that its declaration was merely part of a reconstruction or other capital transaction, but not where it was a genuine dividend distribution.

Repo provisions applying to the sale and repurchase of securities do not treat a subscription for newly issued shares as the purchase of similar securities. A subscription creates a new chose in action; it does not transfer an existing one.

First Nationwide entered a structured financing transaction involving stock lending, the sale of Cayman Islands preference shares and a later subscription for newly issued preference shares. It paid manufactured dividends of £51m under the stock-loan agreement and claimed a corporation-tax deduction.

HMRC contended that the underlying dividends were capital distributions because they were paid from share premium. It also contended that the subscription was a repurchase of similar securities under the repo provisions of the Income and Corporation Taxes Act 1988, giving rise to deemed taxable payments.

The First-tier Tribunal allowed First Nationwide’s appeal against HMRC’s amendment: [2010] SFTD 408. The Upper Tribunal dismissed HMRC’s appeals: [2011] UKUT 174 (TCC). HMRC appealed on both issues.

1. Appeal dismissed unanimously. Moses LJ, with whom Briggs J and Rix LJ agreed, upheld both Tribunals.

2. United Kingdom law recognised the relevant payments as either capital or income. Their character depended on the legal form of the distribution, rather than on the economic origin or capital character of the funds in the company’s hands. A non-liquidating company makes an income distribution by dividend, unless it employs the authorised machinery for a return or reduction of capital.

3. The Cayman Islands law permitted payment of a dividend from share premium, subject to a solvency condition. Blueborder used that mechanism. The articles also provided capital rights if the premium remained undistributed, but the diminution of those rights after payment did not change the character of the dividends received. The payments were therefore income, not capital, and the manufactured-dividend deduction remained effective.

4. The court accepted that a declared dividend can, on a true analysis, form part of a reconstruction or other capital transaction. That was not this case. The distributions were genuine dividends from share premium, rather than colourable labels for a capital return.

5. Sections 737A and 730A of the Income and Corporation Taxes Act 1988 required a buying back of the securities, including similar securities. They did not extend to a subscription for shares. Applying the distinction in Re VGM Holdings, a subscription and allotment creates a chose in action, whereas a purchase transfers an existing chose in action. First Nationwide’s subscription for the second preference shares was consequently not a buying back, so the deemed-payment provisions did not apply.

• Court of Appeal (Civil Division) HMRC’s appeal was dismissed unanimously: [2012] EWCA Civ 278.
• Upper Tribunal (Tax and Chancery Chamber) Dismissed HMRC’s appeals from the First-tier Tribunal: [2011] UKUT 174 (TCC); [2011] STC 1540.
• First-tier Tribunal (Tax) Allowed First Nationwide’s appeal against HMRC’s amendment to its self-assessment: [2010] SFTD 408.