Commissioners for Her Majesty’s Revenue and Customs v Joint Administrators of Lehman Brothers International (Europe)

Interest paid from a surplus in a distributing administration under rule 14.23(7) of the Insolvency Rules 2016 is yearly interest for section 874 of the Income Tax Act 2007 where it compensates creditors for periods exceeding a year.

For compensatory interest awarded retrospectively as a lump sum, the relevant measure of durability is the period in respect of which the interest is calculated. It need not have accrued or been payable during that period. Nor does the duty to deduct tax require identification of a durable investment as the interest’s source.

The administrators of Lehman Brothers International (Europe) realised an exceptional surplus after paying all proved debts in full. Rule 14.23(7) of the Insolvency Rules 2016 required part of that surplus to be used to pay statutory interest for the periods during which the proved debts had remained outstanding.

Hildyard J held that the absence of accrual over time prevented the interest from being yearly interest. The Court of Appeal reversed that conclusion in [2017] EWCA Civ 2124; [2018] Bus LR 730, holding that the interest possessed the necessary long-term quality because it compensated creditors for being kept out of their money for substantial periods.

The administrators appealed. The issue was whether interest payable under rule 14.23(7) was yearly interest within section 874 of the Income Tax Act 2007, requiring deduction of basic-rate income tax before payment.

1. Appeal dismissed unanimously. Lord Briggs gave the judgment, with which Lord Reed, Lord Carnwath, Lord Hodge and Lady Black agreed. Statutory interest payable under rule 14.23(7) of the Insolvency Rules 2016 was yearly interest within section 874 of the Income Tax Act 2007. The administrators were therefore required to deduct income tax before paying it to proving creditors.

2. Interest under rule 14.23(7) is a sui generis statutory entitlement. It does not accrue from day to day during the administration. It arises only if a surplus remains after proved debts have been paid in full and is then payable from that surplus. Its function is nevertheless to compensate proving creditors for being kept out of their money between commencement of the administration and payment of their debts.

3. For interest which accrues over time, the principles conveniently summarised in Inland Revenue Comrs v Hay remain applicable. The inquiry is practical and concerns whether the underlying financial relationship has sufficient permanence and durability. Calculation at an annual rate alone is insufficient. The language of an investment may assist, although modern short-term investments show that it is not an inflexible test.

4. A different analysis applies where compensatory interest is calculated retrospectively and paid as a lump sum. The relevant period for determining durability is the period in respect of which the interest is calculated. It is immaterial that liability was contingent, that the interest did not accrue or become payable during that period, or that the payer could not then know whether it would ultimately become due. The retrospective interest authorities, particularly Riches v Westminster Bank Ltd and Chevron Petroleum (UK) Ltd v BP Petroleum Development Ltd, supported that conclusion.

5. The administrators’ source argument was rejected. Section 874 does not make deduction dependent upon whether the payment is taxable in the recipient’s hands and imposes no separate requirement to identify an investment-like source. If a source were relevant, the creditor’s statutory status as a proving creditor throughout the compensatory period supplied the necessary durability. That status could also be regarded as an involuntary investment.

6. The interest related to periods of more than four years. It therefore had the required yearly character. The Court of Appeal’s order was upheld.

1. United Kingdom Supreme Court: The appeal was dismissed unanimously. The court affirmed the Court of Appeal’s conclusion that the statutory interest was yearly interest under section 874 of the Income Tax Act 2007.
2. Court of Appeal: In [2017] EWCA Civ 2124; [2018] Bus LR 730, the court held that accrual over time was unnecessary and that the substantial compensatory period gave the interest the required long-term quality.
3. High Court: Hildyard J held that the absence of accrual before identification and quantification of a surplus prevented the statutory interest from being yearly interest. The judgment’s citation is not stated.