Appeal Number SC/3213/2008

[2010] UKFTT 24 (TC)

TC00339

Appeal number SC/3213/2008

Stocklending agreement – deduction for management expenses in respect of manufactured dividends – para 1(1), Sch 23A ICTA – Income Tax (Manufactured Overseas Dividends) Regulations 1993 – whether dividends paid by a Cayman Islands company out of share premium account are “dividends” and “overseas dividends” – ss 737A and 730A ICTA – whether a sale of preference shares and a subscription for preference shares is a sale and repurchase of securities

FIRST-TIER TRIBUNAL

TAX

FIRST NATIONWIDEAppellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS (Corporation tax) Respondents

TRIBUNAL: JUDGE ROGER BERNER

Sitting in public in London on 2 – 5 November 2009

John Gardiner QC and Philip Walford, instructed by Slaughter and May, for the Appellant

Malcolm Gammie QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

1

DECISION

1. First Nationwide (“the Appellant”), a UK resident unlimited company that is a wholly-owned investment company subsidiary of Nationwide Building Society (“the Society”), appeals against an amendment dated 23 April 2008 made by HMRC to the Appellant’s corporation tax self-assessment for the accounting period ended on 31 March 2004 excluding a deduction of £51,000,000 for expenses of management. The Appellant claims the deduction in respect of certain manufactured dividends paid by the Appellant under a stock loan agreement with ABN AMRO bank.
2. John GardinerQC and Philip Walford appeared for the Appellant. HMRC were represented by Malcolm Gammie QC.

The facts

1. The parties produced an Agreed Statement of Facts and Issues which I set out below (references to volume and tab are to the documents bundles produced):

Introduction

1. This statement of agreed facts and issues relates to the appeal against the Respondent’s amendment dated 23 April 2008 [Volume B2, tab 50] in respect of a Corporation Tax Self-Assessment of the Appellant for its accounting period ending 31 March 2004 [Volume B2, tab 49].[1]

The Appellant and other relevant parties

2. At all material times:

(A) First Nationwide, a private unlimited company, was a UK resident and incorporated wholly-owned investment company subsidiary of Nationwide Building Society;

(B) Nationwide Building Society was UK resident and incorporated under the Building Societies Act 1986 and was the parent of the Nationwide group of companies;

(C) First Nationwide and Nationwide Building Society formed part of the same group for the purposes of section 170 of the Taxation of Chargeable Gains Act 1992 (“TCGA”);

(D) First Nationwide was an investment company within the meaning of section 130 of the Income and Corporation Taxes Act 1988 (“ICTA”) and was not an approved United Kingdom intermediary (an “AUKI”) within the meaning of regulation 2(1) of the Income Tax (Manufactured Overseas Dividends) Regulations 1993 (the “1993 Regulations”);

(E) ABN AMRO Bank N.V., a Dutch resident and incorporated company that carries on a banking business, acting through its London branch in the United Kingdom (“ABN AMRO”), was an AUKI;

(F) Blauwzoom N.V. (“Blauwzoom”), was a Netherlands Antilles resident and incorporated company and a wholly-owned subsidiary of ABN AMRO Bank N.V.; and

(G) Blauwzoom held all the issued ordinary shares in Blueborder Cayman Ltd (“Blueborder”), a CaymanIsland resident and incorporated company.

Blueborder’s Share Capital

3. On 19 September 2003 Blauwzoom acquired one Ordinary Share in Blueborder, which, at that time, was the only issued share. Consequently, at that time, Blueborder became a wholly-owned subsidiary of ABN AMRO Bank N.V. On 24 September 2003, the authorised share capital of Blueborder was increased from £50,000 to £110,101 and was divided into 10,001 Ordinary Shares with a nominal value of £1.00 each, and 100,100 non-voting, redeemable Preference Shares with a nominal value of £1.00 each [Volume B1, tab 21].

4. Under Blueborder’s articles of association [Volume B1, tab 21]:

(A) Holders of the Preference Shares were entitled, in respect of each Preference Share held, to a fixed cumulative preferential dividend of £509.49051 payable on 29 December 2003 and a further such dividend payable on 29 March 2004 (such dates being the “Quarterly Dividend Dates”); thereafter each such share carried a right to an annual dividend accruing on a daily basis at a fixed rate equal to 1 per cent of the paid-up nominal amount. The articles of association also made provision for the early payment of dividends on the Preference Shares; they also provided that all dividends on Preference Shares were to be paid out of share premium only. (Article 5.2(a))

(B) The directors could declare and authorise payment of dividends on other classes of share in issue. (Article 128)

The First Issued Preference Shares

5. Further, on 24 September 2003, Blauwzoom subscribed for, and Blueborder issued:

(A) 50,050 non-voting, redeemable Preference Shares with a nominal value of £1.00 each in Blueborder (the “First Issued Preference Shares”) at a premium of £999 per Preference Share.

(B) 1,050 Ordinary Shares with a nominal value of £1.00 each in Blueborder at a premium of £999 per Ordinary Share [Volume B1, tab 21],

and pursuant to a stock lending arrangement, Blauwzoom transferred the First Issued Preference Shares to ABN AMRO, which acquired legal and beneficial ownership of them on that day.

6. The First Issued Preference Shares were overseas securities, as defined by paragraph 1(1) of Schedule 23A ICTA.

The Stock Loan Agreement

7. On 25 September 2003, ABN AMRO entered into an “Overseas Securities Lender’s Agreement” with First Nationwide [Volume B1, tab 23], as further amended and supplemented by a “Borrowing Request” made thereunder by First Nationwide [Volume B2, tab 28]] (together the “Stock Loan Agreement”; and reference will be made hereinafter to the consequent “stock loan”).

In particular, under the Stock Loan Agreement:

(A) It was agreed that ABN AMRO would transfer the First Issued Preference Shares to First Nationwide such that First Nationwide would become the legal and beneficial owner of them. (See clauses 1.3 and 4.1.[2])

(B) First Nationwide agreed to redeliver to ABN AMRO shares of an identical type, nominal value, description and amount to the First Issued Preference Shares on 29 March 2004 (or earlier in certain defined circumstances). (See paragraph 1 and clauses 1 and 7.1.)

(C) In relation to each dividend paid on the First Issued Preference Shares during the currency of the stock loan, and following the receipt of a copy of a dividend voucher, First Nationwide was required to pay a “Manufactured Dividend” (as defined in paragraph 3.3 and clause 4.2.2 (as substituted by paragraph 3.3(b)) of the Stock Loan Agreement) to ABN AMRO. The Manufactured Dividend was payable whether or not the dividend itself was received by First Nationwide. The Manufactured Dividend was equal to the amount of the dividend together with an amount equivalent to any deduction, withholding or payment for or on account of tax made by or on behalf of Blueborder (or, if First Nationwide was the then holder of the First Issued Preference Shares, the amount of the dividend together with the amount of any associated tax credit). (See clause 4.2 as amended by paragraphs 3.3 and 4.1.)

(D) First Nationwide agreed to pay to ABN AMRO a fee of £325,000 on 25 September 2003. (See paragraph 1.)

8. Pursuant to the Stock Loan Agreement, on 25 September 2003 the First Issued Preference Shares were transferred from ABN AMRO to First Nationwide and First Nationwide became the legal and beneficial owner of, and was entered on the share register of Blueborder as the holder of, them. On that day, First Nationwide also paid ABN AMRO the fee of £325,000.

9. The Stock Loan Agreement is a contract for the transfer of overseas securities for the purposes of paragraph 4(1) of Schedule 23A ICTA.

The Subscription Agreement; the Second Issued Preference Shares

10. Further, on 25 September 2003, Blueborder entered into an agreement (the “Subscription Agreement”) with First Nationwide [Volume B2, tab 32].

In particular, under the Subscription Agreement:

(A) First Nationwide agreed to subscribe and pay for, and Blueborder agreed to issue to First Nationwide, 50,050 non-voting, redeemable Preference Shares with a nominal value of £1.00 each in Blueborder (the “Second Issued Preference Shares”). The Second Issued Preference Shares were of an identical type, nominal value, description and amount to the First Issued Preference Shares.

(B) The subscription and issue would take place on 29 March 2004, or, if First Nationwide so chose, at any time prior to that date (provided that at such a time First Nationwide was under an obligation pursuant to the Stock Loan Agreement to redeliver equivalent Preference Shares and would not be otherwise entitled to shares which would enable it to meet such a requirement).

(C) The aggregate amount payable by First Nationwide (the “Subscription Amount”) depended on the date of the subscription (“the Payment Date”) and on what dividends Blueborder had paid on the First Issued Preference Shares. The formula for the Subscription Amount is set out in Schedule 1 of the Subscription Agreement. However, leaving aside the provisions for possible adjustments, upwards or downwards, in the event of dividends being unpaid or being paid early, the Subscription Amount was equal to:

where

“NA” means the amount set out in the second column of the table below next to (i) the Payment Date if such date is a Reference Date and (ii) in any other case, the Reference Date immediately preceding the Payment Date;

“n” means (i) zero, if the Payment Date is a Reference Date and (ii) in any other case, the actual number of days from (and including) the Reference Date immediately preceding the Payment Date to (but excluding) the Payment Date; and

“r” means the rate per annum set out in the third column of the table below next to (i) the Payment Date if such date is a Reference Date and (ii) in any other case, the Reference Date immediately preceding thePayment Date.

Reference Date / NA / r
24 September 2003 / £51,193,437.00 / 4.0310%
29 December 2003 / £26,236,191.00 / 4.0310%
29 March 2004 / £1,000,000.00 / 1.0000%

Thus, on each of the two Quarterly Dividend Dates, the amount of the Subscription Amount would decrease so as to reflect the fact that the subscriber for the Second Issued Preference Shares would no longer be entitled to receive the relevant dividend.

(D) On 25 September 2003, ABN AMRO entered into the Deed of Covenant with First Nationwide [Volume B2, tab 29], under which ABN AMRO undertook to First Nationwide to procure, inter alia, that any payment of a “Quarterly Dividend” or an “Annual Dividend” by Blueborder would be made in accordance with and pursuant to its articles of association (see clause 2.1 of [Volume B2, tab 29]) and that on any Quarterly Dividend Date or Accelerated Dividend Date, Blueborder would have sufficient share premium to pay the relevant Quarterly Dividend in full (clause 2.5, ibid)..

The Onward Sale

11. On 29 September 2003, pursuant to a share sale agreement, First Nationwide sold the First Issued Preference Shares to Anglo Irish Bank Corporation plc (“Anglo Irish Bank”), an Irish incorporated, and Irish resident, company, in consideration of the receipt of an aggregate sum of £50,314,975 [Volume B2, tab 33]. As a result, Anglo Irish Bank became the legal and beneficial owner of, and was entered on the share register of Blueborder as the holder of, the First Issued Preference Shares.

The Dividends and Manufactured Dividends

December 2003

12. On 29 December 2003, Blueborder, in accordance with its articles of association:

(A) paid to Blauwzoom a dividend in the aggregate sum of £498,938.50 in respect of the issued Ordinary Shares; and that dividend was paid out of amounts available for distribution other than share premium;

(B) paid to Anglo Irish Bank a dividend in the aggregate sum of £25,500,000 in respect of the First Issued Preference Shares (the “First Preference Dividend”); and that dividend was paid out of share premium account; and

(C) executed and issued a dividend voucher in respect of those two dividends[Volume B2, tab 40].

13. No Cayman Islands income, withholding or capital gains taxes were payable in relation to the dividends; and there was no associated tax credit.

14. Further, on 29 December 2003, in accordance with the terms of the Stock Loan Agreement, First Nationwide paid a Manufactured Dividendin the aggregate sum of £25,500,000 to ABN AMRO, equal to and representative of the amount of the First Preference Dividend that was paid to Anglo Irish Bank.

March 2004

15 On 29 March 2004, Blueborder, in accordance with its articles of association:

(A) paid to Blauwzoom a dividend in the aggregate sum of £257,263 in respect of the issued Ordinary Shares; and that dividend was paid out of amounts available for distribution other than share premium;

(B) paid to Anglo Irish Bank a dividend in the aggregate sum of £25,500,000 in respect of the First Issued Preference Shares (the “Second Preference Dividend”); and that dividend was paid out of share premium account; and

(C) executed and issued a dividend voucher in respect of those two dividends [Volume B2, tab 46].

16. No Cayman Islands income, withholding or capital gains taxes were payable in relation to the dividends; and there was no associated tax credit.

17 Further, on 29 March 2004, in accordance with the terms of the Stock Loan Agreement, First Nationwide paid a second Manufactured Dividend in the aggregate sum of £25,500,000 to ABN AMRO, equal to and representative of the amount of the Second Preference Dividend that was paid to Anglo Irish Bank (together with the Manufactured Dividend of 29 December 2003, the “Manufactured Dividends”).

Subscription for the Second Issued Preference Shares; the Ending of the Stock Loan

18. Pursuant to the Subscription Agreement, First Nationwide subscribed on 29 March 2004 for 50,050 Second Issued Preference Shares in Blueborder at a price of £1,000,000 in aggregate.

19. On 29 March 2004, First Nationwide transferred the Second Issued Preference Shares to ABN AMRO, thereby closing out the stock loan.

The Appellant’s Return

20. In making its self-assessment to corporation tax for the year to 31 March 2004 First Nationwide treated:

(A) the Manufactured Dividends as expenses of management and thus deducted the sum of £51,000,000 from its total profits for the relevant accounting period following which it had excess management expenses of £48,670,942 in that accounting period which it surrendered to Nationwide Building Society by way of group relief; and

(B) the sale of the First Issued Preference Shares by First Nationwide to Anglo Irish Bank as giving rise to a chargeable gain of £49,314,975, being the difference between the proceeds of the sale (i.e. £50,314,975) and the base cost, which, by virtue of section 263B(3) of the TCGA, was equal to the subscription price for the Second Issued Preference Shares (i.e. £1,000,000). First Nationwide made an election under section 171A TCGA pursuant to which this chargeable gain accrued to Nationwide Building Society.

The Issues

21. The issues for determination are as follows:

(A) whether or not each of the First Preference Dividend and the Second Preference Dividend constitutes a “dividend” for the purposes of paragraph 1(1) Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(B) if so, whether or not each of the First Preference Dividend and the Second Preference Dividend constitutes an “overseas dividend” for the purposes of paragraph 1(1) Schedule 23A ICTA and the Income Tax (Manufactured Overseas Dividends) Regulations 1993;

(C) if so, whether or not the sale of the First Issued Preference Shares by the Appellant to Anglo Irish Bank and the subscription by the Appellant for the Second Issued Preference Shares was a sale and repurchase of securities for the purposes of sections 737A and 730A ICTA (as extended by subsections 737B(5) and 730B(2)(a), respectively, to include the case where a person sells securities and buys similar securities).

Witness evidence

1. I heard oral evidence from five witnesses. The first was Alison Gayton, Assistant Treasurer in the Treasury Department of the Society, who provided evidence as to the Society’s funding requirements. The other four were all expert witnesses as to Cayman Islands law. There were two experts instructed by each party. The Appellant instructed Sandra Corbett, a partner of Walkers, attorneys at law, and William Bagnall, a partner of Ogier, attorneys at law. HMRC instructed Christopher Humphries, a director of Stuarts Walker Hersant, attorneys at law and Paul Scrivener, a partner in Solomon Harris, attorneys at law.

Miss Gayton

1. Miss Gayton gave evidence, which I accepted, in relation to the background, in funding terms, to the transactions with which this appeal is concerned. Miss Gayton explained the funding requirements of the Society in the second half of 2003 and the causes of those requirements, and confirmed that the funds raised from the transactions contributed to meeting those funding requirements. I find that the purpose of the sale of the First Issued Preference Shares to Anglo Irish Bank was to provide funds for the Society’s group to use, and that this was with a view to assisting, in the medium term, with the ongoing funding requirements faced by the group from the growth in the Society’s mortgage assets at that time.

The Cayman Islands experts

1. Whilst differing in a number of material respects, which I consider later in this decision, the Cayman Islands’ experts were able to agree on certain matters, and helpfully prepared a Joint Memorandum of Agreed Matters of Cayman Islands law, which I set out below:

Introduction

A The Cayman Experts met at the offices of Solomon Harris in Grand Cayman, Cayman Islands on 22 September 2009. Each of the Cayman Experts was present in person except for Sandra Corbett who was in attendance from overseas by conference call.

B.The Cayman Experts noted that the Rules between the Parties for Expert Meetings had not been finalised between the Appellant and the Respondent prior to the start of the Meeting. Nevertheless, the Cayman Experts agreed that the Meeting would be held on a 'without prejudice' basis and that any written note of the Meeting and any subsequent correspondence or communications between two or more of them relating to the issues relevant to the dispute would be considered 'without prejudice'.

C.The Cayman Experts agreed that this Memorandum would be prepared as a record of all matters in their expert reports on which they all agreed. All other matters in those expert reports were not agreed between them except for the paragraphs and matters stated in paragraph E below which the Cayman Experts acknowledge were neither agreed nor disagreed. This Memorandum is not, therefore, a stand alone document but supplements the expert reports of the Cayman Experts by identifying those matters of Cayman Islands law on which they all agreed, subject to any qualifications expressly set out in this Memorandum.