Withholding tax on yearly interest - companies in administration
This case concerns interest withholding tax, in particular, whether interest imposed by law or by a court is 'yearly interest' or 'short interest' - the former is subject to withholding tax. While a UK company can offset withholding tax against it's tax bill for the year, non UK-resident recipients of a liquidation may not have any UK income tax to offset the withholding tax against - and they would have no other recourse (the money would thus remain with HMRC).¹
The law
Section 874 of the Income Tax Act 2007 provides:
"(1) This section applies if a payment of yearly interest arising in the United Kingdom is made—
(a) by a company...
(2) The person by or through whom the payment is made must, on making the payment, deduct from it a sum representing income tax on it at the [basic rate] in force for the tax year in which it is made."
Note: The basic rate is currently 20%.
The issue
In the UK 'short interest', i.e. that interest which is not 'yearly interest' is not covered by Section 874 and therefore not subject to withholding tax. The basic indicators of yearly interest are set out in the case of Bebb vs Bunny [1854]. They are that the interest accrues:
At a given rate per cent, per annum;
Payable de anno in annum (year on year);
Accruing de die in diem (day by day).
The case of Goslings and Sharpe v Blake [1889] clarifies that loans which were not intended to last longer than one year (and therefore without interest payable 'year on year') are not covered by the indicators set out in the Bunny case, and thus constitute short interest loans.
As a matter of principle, interest imposed by insolvency law or by a court order for damages would be applied retrospectively. In this case, statutory interest is payable under Rule 14.23 of the Insolvency (England and Wales) Rules 2016 at 8% per year - commencing at the date the administration of Lehman Brothers ("LB") began in late 2008. Rule 14.23 only applies where there is a surplus in the administration, it exists to compensate the creditors for the 'time value of money'. Because Rule 14.23 only applies once there is a proven surplus in the administration, it gets calculated retrospectively starting on the first day of administration.
The argument
LB argued that the interest was not yearly interest, in particular because:
It applied retrospectively;
It therefore did not accrue year on year (as the obligation doesn't exist until the end of administration)
It consists of one single payment and therefore isn't payable year on year;
The interest couldn't have accrued over time in any sense because the invoking of Rule 14.23 is contingent on a surplus remaining at the end of liquidation.
This is the first case on statutory interest under the insolvency acts (on this withholding tax issue). The only comparable cases heard previously on retrospective interest were in relation to court-awarded damages. HMRC claimed there is no difference between the two situations, and that the precedents should be followed (which would result in an HMRC victory).
However LB argued that there are distinctions to be made. They argued statutory insolvency interest cannot be treated as accruing over a period of time in the same sense as damages interest, as statutory insolvency interest is contingent on there being a surplus in the first place, whereas in the case of damages a wrongful act has been committed (i.e. the misuse of company funds) and the interest could be said to accrue over that period of time.
The High Court had accepted that there is a distinction - and criticised HMRC for its conflicting online guidance on this topic. However, in this appeal to the Court of Appeal, the Court of Appeal disagreed with the lower Court on this point. In discussing the previous cases on retrospective interest (in the case of a court order for damages) the Judge noted:
"[HMRC] relies upon these decisions as indicating that interest calculated retrospectively and payable as part of a compensatory award can amount not only to interest as held in cases like Barnato and Riches but also yearly interest. If [the High Court] is right and interest can only be yearly interest for the purposes of s.874 if it accrues prospectively from year to year then these cases must, [HMRC] submits, have been wrongly decided.
The [High Court] sought to avoid that conclusion by treating the payments of interest as having accrued over the period to which they related rather than becoming payable retrospectively as from the date of the judgment and [LB] in [its] own submissions said that they represented an obligation to pay interest which accrued on the principal amount in real time. But in my view this analysis is untenable." ²
The ruling
The Judges of the Court of Appeal found that conclusion untenable, because they ruled that court-awarded damages do not accrue prospectively over time, but are in fact enforced retrospectively from the date of judgement:
"As a statement of general principle this is incontrovertible. But the obligation of the defaulting trustee to make good the loss he has caused with interest is not to be treated as an ongoing obligation to pay in the same sense as a contractual obligation. It is an obligation to make good the loss (just as a tortfeasor is liable in damages) but the quantum and the amount of any interest are matters to be calculated on the taking of the account and are converted into an enforceable liability by the judgment which follows."³
Therefore their decision implies there can be no distinction drawn between insolvency interest and court-awarded damages interest. The precedents must be followed.
"Lord Simonds considered that an award of interest under s.3 of the 1934 Act [in court-ordered damages] did have that quality of recurrence for the reasons which he and the other members of the Appellate Committee give.
The [High Court's] approach to what can constitute yearly interest seems to me inconsistent with this line of reasoning. If statutory interest cannot be yearly interest because it does not accrue prospectively in real time then, on one view, it is difficult to see how it can be interest at all. But the need for it to accrue de die in diem has been held in Riches to be satisfied even where there is no real time accrual. The same test applies equally to the type of statutory interest which we are concerned with on this appeal.
[LB's] principal submission is that statutory interest under the Act, even if interest, is not yearly interest because it does not accrue from year to year. The mere fact that it covers a period of several years is not, he says, in itself conclusive. The answer to this question does not, I accept, depend exclusively on the length of the period to which the interest relates. It is necessary to focus on the purpose of the relevant provisions of the Insolvency Rules and on whether the administrators' obligation to pay interest in the event of a surplus should be treated as essentially a short-term liability (as in the case of short-term loans) regardless of how long the administration in fact lasts.
In my view it would be wrong to treat such statutory interest under the Insolvency Rules as a short-term liability of this kind. Unlike, for example, the indebtedness under the local Act in Gateshead Corporation v Lumsden which could have been called in at any time, the obligation of the administrators to pay interest on the proved debts was unlimited in point of time under rule 2.88(7) (and now rule 14.23(7)), was calculated (where the Judgment Act rate applies) by reference to a per annum rate of interest, contemplated a period of administration which could in many cases last over a prolonged period of time and did in fact endure for a number of years. It did therefore satisfy the definition in Bebb v Bunny in that it was payable from year to year whilst accruing from day to day. Unless the fact that it did not accrue prospectively in real time is fatal to the contention that it is yearly interest which, in the light of the authorities, it is not, I can see nothing in the Insolvency Rules or the other relevant surrounding circumstances which prevents it from being treated as the long-term liability which it in fact was."⁴
That last sentence is crucial. The Court of Appeal reached its decision by following precedents in the House of Lords and declaring there to be no reason (or available 'distinction') to part from them. However, the Judges end their judgement noting that if the precedents were overturned, the decision may be different. If an appeal is made - it will be up to the Supreme Court to review the precedents and determine if they are correct. If no appeal is made, the question may be left to a later case (although that may take a long time).
Notes
[1] See para 4 of the High Court judgement regarding the non-resident aspect of the case.
[2] Paras 43 and 44.
[3] Para 48
[4] End of para 54 to 57.
[4] All bolding in the quotes is emphasis added
Court of Appeal (this judgement): http://www.bailii.org/ew/cases/EWCA/Civ/2017/2124.html
High Court (prior judgement): http://www.bailii.org/ew/cases/EWHC/Ch/2016/2492.html
No comments:
Post a Comment