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STEPHEN BRANDON QC, BA, LLM, FTII considers a controversial issue: capital gains and purchase of own shares from a company.
STEPHEN BRANDON QC, BA, LLM, FTII considers a controversial issue: capital gains and purchase of own shares from a company.
A QUESTION WHICH has kept many of us awake at nights is whether the Inland Revenue's Statement of Practice SP4/89 is right. An answer is to be found in the recent decision of the Special Commissioners in Strand Futures & Options Limited v Vojak (SpC 328), but is it the right answer?
For those who do not have this Statement of Practice at the forefront of their minds, let me remind you of the point. Section 209(2), Taxes Act 1988 defines 'distribution' widely, so that it will include, in particular, dividends and purchases of its own shares by a company. Where the shareholder is a company subject to corporation tax, relief is found in section 208:
'Except as otherwise provided by the Corporation Tax Acts, corporation tax shall not be chargeable on dividends and other distributions of a company resident in the United Kingdom, nor shall any such dividends or distributions be taken into account in computing income for corporation tax.'
Section 208 thus has two 'limbs'.
Originally, the Revenue thought that section 208 meant what it said, i.e., that, under the 'first limb', corporation tax was not chargeable on distributions, whether the part of the computation involving the receipt related to income or chargeable gains. It then changed its mind and issued Statement of Practice SP4/89 on 19 April 1989:
'Company purchase of own shares: capital gains treatment of distribution received by corporate shareholder
'If the purchase of its own shares by a company resident in the United Kingdom gives rise to a distribution, and a shareholder receiving such a distribution is itself a company, the distribution is included in the consideration for the disposal of the shares for the purposes of the charge to corporation tax on chargeable gains. In the Revenue's view, the effect on sections 208 and 345(3), Taxes Act 1988 [now section 8(4), Taxation of Chargeable Gains Act 1992] is that the distribution does not suffer a tax charge as income within the terms of section 37(1), Taxation of Chargeable Gains Act 1992. The Revenue will apply this Statement of Practice where a company purchases its own shares after 19 April 1989.'
What about dividends?
The obvious point arose: if section 208 does not prevent corporation tax being levied in respect of a chargeable gain on an outright disposal (on the redemption/purchase of a share), then it must follow that even a straightforward dividend must likewise give rise to a chargeable gain, as a capital distribution within section 122, Taxation of Chargeable Gains Act 1992. This point is made cogently by Richard Bramwell QC and his co-authors in Taxation of Companies and Company Reconstructions (Sweet and Maxwell) at paragraph B4.2.8. Mr Bramwell went on to ask the Revenue to explain the dichotomy and, helpfully, it tried, explaining (briefly) that where there was a dividend, section 122(5)(b), Taxation of Chargeable Gains Act 1992 prevented it being treated as a capital distribution, whilst with a redemption of share capital section 37(1) of that Act only could apply, and it did not. This is, of course, nonsense (as Mr Bramwell, in far more polite language, shows). Each of both sections 37(1) (consideration chargeable to tax as income) and 122(5)(b) (meaning of 'capital distribution') effectively exclude from capital gains tax a sum charged to tax as income. In both cases, the ultimate question is whether the sum is charged to corporation tax (section 122(5)(b) read with section 6, Taxes Act 1988, or section 37(1) read with section 8(4), Taxation of Chargeable Gains Act 1992), and, in each case, it is not. (In my view, neither section 122 nor section 37 will help.) Mr Bramwell makes a brave attempt at arguing why the Revenue is wrong but, in my view, the correct approach here is to take the bull by the horns and argue, quite simply, that section 208 exempts all distributions from corporation tax (i.e., it does what it says on the tin!).
At the Special Commissioners
In Strand Futures, however, the Special Commissioners followed the Revenue's Statement of Practice SP4/89. I mention that they included the very distinguished Dr John Avery Jones, whose decisions merit particular respect, but, on this occasion, in my view, they got it wrong.
As to facts, we only need to note that in Strand, on 29September 1995, the company sold shares back to the company which issued them. The taxpayers' main point was that section 208 applies to exempt the distribution from corporation tax completely. Corporation tax, it was argued, is chargeable on a global computation of profits and gains and therefore the 'first limb' in section 208 applied to exclude the charge to tax on that computation (profits and gains). Counsel for the taxpayer pointed out that where there is a clear exemption from tax, a charge should not be levied indirectly: see Hughes v Bank of New Zealand 21 TC 472.
The Special Commissioners' decision on this point, in paragraph 12 of the decision, is as follows (I have placed key passages in italics):
'12. If section 208 is intended to give a complete exemption why is it stated to apply 'except as otherwise provided by the Corporation Tax Acts', and why is the first limb worded to exclude tax on distributions and the second limb to refer only to income? [Counsel for the Revenue] referred us to the origin of section 208 in section 47 of the Finance Act 1965. Although the question whether we were entitled to look at pre-consolidation legislation was not argued, we consider that we are entitled to look on the ground that, while it is not permissible as a matter of course to refer to the earlier legislation, it is permissible to do so if the consolidated legislation is ambiguous or obscure, see R v Secretary of State for the Environment, Transport and the Regions, ex parte Spath Holme Ltd [2001] 2 WLR 15 (see also the application of those principles in relation to tax legislation in Padmore v Commissioners of Inland Revenue (No 2) [2001] STC 280). Lord Cook in the Spath Holme case at page 40 regarded a provision as ambiguous if reasonably open on orthodox rules of construction to more than one meaning. We consider this to be the case particularly as SP4/89 reflects a change in the Revenue view and the Revenue's interpretation is disputed by textbook writers. The original legislation makes it clear that a new charge was being imposed under Schedule F on distributions that were not exempt or chargeable under another Schedule; this was subject to corporation tax not being charged on distributions under Schedule F nor their being taken into account in computing income. It is perfectly accurate to say that corporation tax is not charged under Schedule F on distributions, meaning that distributions are left out of account, even though the ultimate charge to corporation tax is on total profits. The context has nothing to do with taxing capital gains. Accordingly, we prefer [Counsel for the Revenue's] approach that section 208 cannot prevent inclusion of the distribution in the computation of capital gains.'
The decision seems to me to depend on the answers to four questions:
(1) why section 208(1) commences 'Except as otherwise provided …';
(2) why the 'second limb' only refers to 'income';
(3) whether it is appropriate to refer to pre-consolidation legislation; and
(4) whether section 47, Finance Act 1965 clearly shows that chargeable gains were not covered.
Wrong analysis?
In my opinion the reasoning in paragraph 12 is wrong for the following reasons:
Why it commences 'Except as otherwise provided ...'
It seems to me to be clear what the words 'Except as otherwise provided …' refer to. Certain provisions in the Taxes Act 1988 specifically exclude the benefit of section 208, such as section 95 (taxation of dealers in shares) and section 434(1) (taxation of insurance companies). There is, therefore, no reason to assume that the words 'Except as otherwise provided …' refer to chargeable gains.
Why the 'second limb' only refers to 'income'
There is a number of provisions in the Taxes Acts excluding receipts from being taken into account in computing income. The purpose here, as counsel for the taxpayer said, is to exclude a distribution from being taken into account in a computation, which may be relevant even though there is no charge on the distribution. This might be relevant, for the avoidance of doubt, in relation to section 13, Taxes Act 1988 (small companies relief). The draftsman may not have seen any point, however, in excluding a distribution from a computation of chargeable gains. (I can find no use in the Taxes Acts of the phrases 'taken into account in computing gains' or 'taken into account in computing chargeable gains'. (The reference to 'profits or gains', now repealed, in section 776(6), Taxes Act 1988 was to income, not chargeable gains.))
Whether it is appropriate to refer to pre-consolidation legislation
Turning to the reference to looking at pre-consolidation legislation, there is a number of House of Lords authorities on when it is permissible to examine such material, not all entirely consistent. The leading case is currently R v Secretary of State ex parte Spath Holme [2001] 1 AER 195. Here, in a case concerned with the Rent Acts, Lord Bingham said, at page 208:
'… it is plain that courts should not routinely investigate the statutory predecessors of provisions in a consolidating statute, particularly where (as in … Farrell v Alexander) the issue concerns a construction of a single word or expression. Such practice would reduce the benefit to be derived from the process of consolidation … but the overriding aim of the Court must always be to give effect to the intention of Parliament as expressed in the words used. If, even in the absence of overt ambiguity, the Court finds itself unable, in construing the later provision in isolation, to place itself in the draftsman's chair and interpretive provision in the social and factual context which originally led to its enactment … it seems to me legitimate for the Court … to the consider the earlier, consolidated, provision in its social and factual context for such help as it may give …'
Each of the other Lords agreed with Lord Bingham but gave their own views on the process of statutory construction. Thus, at page 217, Lord Nichols said that the constitutional implications point to a need for courts to be slow to permit external aids (including pre-consolidation legislation) to displace meanings which are otherwise 'clear and ambiguous and not productive of absurdity'. Lord Hutton, at page 229, specifically adopted the words in Farrell v Alexander, to the effect that self-contained statutes should be interpreted, if reasonably possible, without recourse to antecedents, and the recourse should only be had where there is '… a real and substantial difficulty or ambiguity which classical methods of construction cannot resolve'.
It seems to me here that, somehow, the boot has been put on the wrong foot. The words in the 'first limb' of section 208 seem to me to be crystal clear in their meaning: they say that corporation tax shall not be charged on the distribution. It is the Revenue, which is trying to point to some 'ambiguity' behind the clear words used. The fact that the Revenue has changed its view, and that its view is disputed by others (the reasons the Special Commissioners give for looking at pre-consolidation Acts), is not an ambiguity in the legislation.
Nor can I see that there is any need to refer to the 'social and economic conditions' at the time of the drafting of the Finance Act 1965. The 'social and economic conditions' prayed in aid in Spath Holme were the Government's fight against inflation. I can see no analogy here.
Further, the clear words used in section 208 do not, in my view, produce an 'absurdity': indeed, they produce a clear and simple system of charge since all distributions, including dividends, are prevented from being subject to corporation tax whether in the income or gains part of the computation. In fact the 'absurdity' is the other way since, in my opinion, the Revenue's reason why the repurchase of shares, but not the payment of a dividend, is subject to corporation tax on chargeable gains (as cited by Mr Bramwell) is unsupportable. (In Strand, section 122 was held to be inapplicable and therefore was not considered by the Special Commissioners. They did not mention this 'dichotomy'.) I find the argument unconvincing.
Whether section 47, Finance Act 1965 clearly shows that chargeable gains were not covered
Even if one looks at the original legislation in section 47(1) of that Act, that commences by stating the rule which is now reflected in section 208(1) and then goes on to provide the treatment of distributions presently contained in section 20(1), Taxes Act 1988. I cannot see that simply because these two provisions are found together, when both corporation tax and the imputation system were being introduced, leads one necessarily to the conclusion that 'the context has nothing to do with chargeable gains'.
Appeal
Accordingly, with great respect, I believe that this decision on section 208 is wrong. It is shortly to come before the High Court and we can expect a judgment soon. Fingers crossed.
Stephen Brandon QC is a member of tax chambers at 24 Old Buildings, Lincoln's Inn; telephone 020 7242 2744.
