CORPORATION TAX Deductions Charges on Income Qualifying Donations Distributions - Articles

SPC00521

CORPORATION TAX – deductions – charges on income – qualifying donations – distributions - articles of association of company provided that the holders of the A shares could by ordinary resolution require the company to make gifts to any charity – the A shares were transferred to a charitable foundation which resolved that the company should make gifts to the charitable foundation – whether the payments were distributions “in respect of shares” within the meaning of section 209(2)(b) – yes – whether section 209(4) applied to the gifts – yes – appeal allowed – ICTA 1988 Ss 209, 254, 338 and 339

THE SPECIAL COMMISSIONERS

NOVED INVESTMENT COMPANY

Appellant

- and -

THE COMMISSIONERS OF HER MAJESTY’S

REVENUE AND CUSTOMS

Respondents

Special Commissioners : DR A N BRICE

CHARLES HELLIER

Sitting in public in London on 5 September 2005 and 7 November 2005

Richard Bramwell QC, instructed by Messrs Withers Solicitors, for the Appellant

David Ewart of Counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

DECISION

The appeal

1.Noved Investment Company (the Appellant) appeals against adjustments to its corporation tax returns for the accounting periods ending on 31 December 2000 and 31 December 2001. In computing its total profits the Appellant had sought to deduct payments made by it as gifts to the Foyle Foundation (the Foundation) which is a charity. The Respondents dis-allowed the deductions and made the appropriate adjustments to the Appellant’s returns.

2.We were asked to give a decision in principle in respect of the accounting period ending on 31 December 2001 because of a concurrent appeal to the Lands Tribunal.

The legislation

3.Part VIII of the Income and Corporation Taxes Act 1988 (the 1988 Act) (sections 337 to 347) contains the provisions about the taxation of income and chargeable gains of companies. Section 338(1) provides that, subject to certain exceptions, in computing the corporation tax chargeable for any accounting period of a company, any charges on income paid by the company shall be allowed as deductions from the total profits for the period. Section 338(2)(b) provides that the phrase “charges on income” means payments which are qualifying donations within the meaning of section 339. Section 339 provides that a qualifying donation is a payment of a sum of money by a company to a charity other than a payment which, by reason of any provision of the Taxes Acts (except section 209(4)), is to be regarded as a distribution.

4.Part VI of the 1998 Act (sections 207A to 255) contains the provisions about company distributions. Section 209 defines the meaning of “distribution”. The relevant parts of section 209(2) provide;

“(2) In the Corporation Tax Acts “distribution” in relation to any company means -

(a) any dividend paid by the company, including a capital dividend;

(b) subject to subsections (5) and (6) below, any other distribution out of the assets of the company (whether in cash or otherwise) in respect of shares in the company, except so much of the distribution, if any, as represents repayment of capital on the shares or is, when it is made, equal in amount or value to any new consideration received by the company for the distribution.”

Thus, the opening words of section 209(2) indicate that anything which falls within the following paragraphs will be a distribution for the purposes of the Corporation Tax Acts. Section 209(2)(b) also uses the word distribution. Thus the term of art - the term distribution for the purposes of the Corporation Tax Acts - is defined in at least one of its limbs by reference to the same word whose meaning is not specifically defined. We attempt in this decision to distinguish the two by using “distribution for the purposes of the Corporation Tax Acts” as the term defined by section 209.

5.Section 254 is the interpretation section for Part VI and section 254(1), (9) and (12) provide:

“(1)… “share” includes stock, and any other interest of a member in a company.

(9)A distribution shall be treated under this Part as made … out of assets of a company if the cost falls on the company.

(12)For the purposes of this Part a thing is to be regarded as done in respect of a share if it is done to a person as being the holder of the share, or as having at a particular time been the holder, or is done in pursuance of a right granted or offer made in respect of a share … .” .

6.As mentioned above, section 339 provides that a qualifying donation is a payment of a sum of money by a company to a charity other than a payment which is to be regarded as a distribution unless the payment is to be regarded as a distribution by reason of section 209(4). Section 209(4) and (5) provide:

“(4)Where on a transfer of assets or liabilities by a company to its members or to a company by its members, the amount or value of the benefit received by the member (taken according to its market value) exceeds the amount or value (so taken) of any new consideration given by him, the company shall, subject to subsections (5) and (6) below be treated as making a distribution to him of an amount equal to the difference.

(5)Subsection (4) above shall not apply where the company and the member receiving the benefit are both resident in the United Kingdom and either the former is a subsidiary of the latter or both are subsidiaries of a third company also so resident; and any amount which would apart from this subsection be a distribution shall not constitute a distribution by virtue of subsection (2)(b) above”.

The issues

7.The Respondents dis-allowed the deductions because they were of the view that the payments made by the Appellant as gifts to the Foundation were distributions in respect of shares within the meaning of section 209(2)(b). The Appellant argued that the gifts were not distributions in respect of shares and so should be deductible. Alternatively the Appellant argued that, even if the gifts were distributions in respect of shares within section 209(2)(b), they were also distributions within section 209(4) from which it followed that the exemption in section 209(5) applied (because both the Appellant company and the member (the Foundation) were resident in the United Kingdom and the Appellant company was a subsidiary of the Foundation).

8.Thus the issues for determination in the appeal were:

(1)whether the gifts to the Foundation were distributions in respect of shares within the meaning of section 209(2(b) and, if they were:

(2)whether they were also distributions within the meaning of section 209(4).

The evidence

9.A bundle of documents was produced by the Appellant. There was no dispute about the facts.

The facts

10.From the evidence before us we find the following facts.

The Appellant and its shares

11.The Appellant was incorporated with limited liability in 1919 by two members of the Foyle family and carried on the business of selling books. The Appellant was then re-registered as an unlimited company with a share capital and in 1969 the business of selling books was transferred to another company. The Appellant is now an investment company.

12.The shares in the Appellant devolved upon members of the Foyle family including Mrs Christina Batty, formerly Miss Christina Foyle (Miss Foyle). Miss Foyle died on 8 June 1999 on which date she held 7,213 of the £1 issued shares of the Appellant; there were altogether 12,007 issued shares and so, at the date of her death, Miss Foyle held about 60% of the total number of shares. As at 8 June 1999 the assets of the Appellant comprised portfolios of commercial and residential property, cash, investments and the Foyle Library (the Library). The Library was a collection of manuscripts, first editions, some paintings and some furniture. The net assets of the Appellant were then worth in the region of £60m.

13.By her Will Miss Foyle left her residuary estate (including her shares in the Appellant) on general charitable trusts. Her executors gave effect to her bequest by establishing the Foundation as a charitable foundation. It was proposed that the shares in the Appellant which were owned by the executors of Miss Foyle should be given to the Foundation and that the Appellant should then be partitioned so that the shares given to the Foundation became A shares and the remainder of the shares, which belonged to other members of the Foyle family, became B shares. The A shares were to be interested in defined assets (the A assets) representing 60 per cent of the total assets of the Appellant and the B shares were to be interested in the remainder of the assets of the Appellant (the B assets). The Foundation, as the A shareholder, was to be entitled to pass resolutions to require the making of gifts by the Appellant to any charity

14.In July 2000 the bulk of the Library was sold by the Appellant and the proceeds of sale exceeded £11M. On 28 July 2000 the Foundation was registered as a charity.

December 2000 – the shareholders’ agreement

15.On 14 December 2000 the executors of Miss Foyle, the other shareholders in the Appellant, the Foundation and the Appellant entered into an agreement for the partition of the shares and assets of the Appellant. Under the agreement the parties agreed to the immediate transfer of the shares belonging to Miss Foyle by her executors to the Foundation and to partition the Appellant by passing certain specified resolutions. The shareholders agreement provided: for the change in the Memorandum of the company to permit gifts to charity; that no gifts should be made by the company other than those provided for in the Agreement (cl 5.1.6); that the Foundation should be the company’s attorney for the purpose of effecting any gift to the Foundation (cl 10); that the resolution requiring the company to make the specified gifts to the Foundation should be passed; and for amendment to the company’s Articles to be made which permitted the A Shareholder to require the company to make gifts of A assets to any charity.

16.On the same day (14 December 2000) the shares held by the executors of Miss Foyle were transferred to the Foundation and the Appellant passed two resolutions. The first resolution (the partition resolution) was a special resolution passed by all the shareholders with a right to vote at general meetings. This resolution converted the 7,213 shares then registered in the name of the Foundation into A shares and converted all the remaining shares into B shares, each class of shares was to have the rights set out in the articles of association as amended by the same resolution. Amended article 6.4 provided that the A shares should have attached to them certain stated rights and privileges. One such right concerned the A assets. The Foundation assets (defined as properties, shares and such amount of cash as to amount in aggregate to 60% of the company’s net assets) were to be deemed to be attributable to the A shares. Another such right concerned the A reserves. At the end of each financial period the auditors were to determine the profit or loss attributable to the A assets and such profit or loss was to be credited or debited against reserves known as the A reserves which should be deemed to be attributable only to the A shares to the exclusion of any other class of shares. A third such right was set out in amended article 6(vi) which was headed “donations to charity” and the relevant parts of which provided:

“For the avoidance of doubt the holders for the time being of the A shares may by ordinary resolution of the Company require the Company to make gifts of cash or other property out of the A assets to any body registered as a charity in England and Wales … and the resolution may provide for the manner in which the said gifts are to be constituted.”

17.The second resolution passed by the Appellant on 14 December 2000 was a resolution to make gifts. This resolution was passed by the A shareholder (the Foundation). It resolved that the holder of the A shares required the company to make gifts out of the A assets to the Foundation such gifts being all the freehold and leasehold properties comprised in the A assets; all the shares and securities comprised in the A assets; and the cash sum of £9M.

The Appellant’s tax position for 2000

18.In the Appellant’s corporation tax return for the period ending on 31 December 2000 profits of £7,220,762 were reduced by charges on income of the same amount. These charges on income included £1,870,445 in respect of certain qualifying investments transferred to the Foundation under the resolution for gifts dated 14 December 2000. These charges on income have been allowed (they fell within a separate relieving provision: section 587B). However, the Respondents dis-allowed the balance of the charges on income of £5,350,317 represented by the cash payment of £9M.

The Appellant’s tax position for 2001

19.In the accounting period ending on 31 December 2000 the auditors established the A reserves as £7,084,740. Of this, £4.2M was represented by a loan to the Foundation and the balance of £2,884,740 was paid by the Appellant to the Foundation on 1 May 2001 pursuant to a decision of the directors of the Appellant recorded in a minute dated 27 April 2001.

20.In the Appellant’s corporation tax return for the period ending on 31 December 2001 profits of £1,874,884 were reduced by charges on income of the same amount. These charges on income were represented by the cash payment of £2,884,740 paid on 1 May 2001. However, the Respondents dis-allowed the deduction of this charge on income.

21.We consider now separately each of the issues for determination in the appeal.

Reasons for decision - issue (1)

22.The first issue in the appeal is whether the gifts to the Foundation were distributions in respect of shares within the meaning of section 209(2)(b). We remind ourselves that section 209(2)(b) provides that the word distribution for Corporation Tax Act purposes means;

“… any other distribution out of the assets of the company (whether in cash or otherwise) in respect of shares in the company, except so much of the distribution, if any, as represents repayment of capital on the shares or is, when it is made, equal in amount or value to any new consideration received by the company for the distribution.”

23.We also remind ourselves that section 254 is the interpretation section for Part VI and section 254(1), (9) and (12) provide:

“(1) In this part, except where the context otherwise requires -…

“share” includes stock and any other interest of a member in a company;

(9)A distribution shall be treated under this Part as made … out of assets of a company if the cost falls on the company.

24.In considering the arguments of the parties we first consider the meaning of the word “distribution” and then the meaning of the phrase “in respect of shares”. We then apply those words, with the meanings which we have identified, to the facts of the present appeal looking first at the first gift (of 14 December 2002) and then at the second gift (of 27 April 2001) We then reach our conclusions on the first issue.

The meaning of the word “distribution”

25.The arguments of the parties on the meaning of the word “distribution” centred round the question as to whether the meaning in the 1988 Act was the same as that in company law. For the Appellant Mr Bramwell argued that the word distribution was not used in section 209(2)(b) in its company law meaning. In company law, distributions were made out of profits but section 209(2)(b) referred to distributions out of assets. Many of the other transactions mentioned in section 209(2) were not distributions under company law.

26.Mr Ewart for the Respondents argued that the word had its company law meaning. What was now section 209(2)(b) was first enacted in paragraph 1 of Schedule 11 of the Finance Act 1965 when the new tax legislation dealing with companies was introduced. The word was used in the Companies Act 1985 and it was natural that it should have the same meaning in tax legislation. Mr Ewart referred to Palmer’s Company Law Volume 2 at paragraph 9.705 which stated the principle that no dividend must be paid otherwise than out of profits legally available for distribution to the shareholders. The same paragraph went on to say that a distribution was the transfer of funds or assets without consideration. In support of the latter statement Palmer referred to Clydebank Football Club Limited v Steedman [2000] ScotCS 250 (29 September 2000). Mr Ewart relied upon the same authority for the principle that a distribution was limited to a wholly gratuitous transfer or a sale at a gross undervalue. From this he argued that section 209(2)(b) applied if there was either a wholly gratuitous transfer or a transfer for a consideration which was manifestly an undervalue. He accepted that the principle established in 2000 in Clydebank could not have been known in 1965 when the tax legislation was enacted but he argued that in 1965 there would have been an awareness of the uncertainties which are resolved by the decision in Clydebank..

27.In Clydebank one issue was whether the disposals of two properties constituted a distribution for company law purposes within the meaning of section 263 of the Companies Act 1985. At [53] Lord Hamilton referred to section 263 which provides that a company shall not make a distribution except out of profits available for the purpose and defines the meaning of distribution for this purpose. At [56] he stated

“It is accepted by the defenders that an unlawful distribution may be constituted not only by a wholly gratuitous transfer but also by [a] sale which was known and intended to be at an undervalue at least in circumstances where the undervalue was gross.”

28.At [75] he found that the object of the statutory provisions was to prohibit the gratuitous return to shareholders of subscribed capital and assets representing capital. However, a transfer involving the passing of some consideration might also, in certain circumstances, give rise to a distribution if it was, in substance, a gift of capital to the transferee. At [77] he found that the value of the properties transferred was £765,000 and that the value given was £620,000 and concluded that that was not a sale at a “gross undervalue” and so was not a distribution within the meaning of section 263.

29.We first note that the company law meaning of the word distribution relates to a transfer out of profits whereas section 209(2)(b) refers to a distribution out of assets. This indicates that the company law meaning of the word distribution may not be appropriate in section 209(2). Further in section 209(2)(b) the additional words “out of the assets of the company” which are defined in section 254(9) as “if the cost falls on the company” indicate that the meaning of the word distribution for tax purposes is wider than the meaning for the purposes of company law because they restrict what would otherwise be a Corporation Tax distribution in a way which would not be necessary if the meaning of distribution were already restricted, as it appears to be in company law, to gratuitous transfers or transfers at a manifest undervalue.