Lomas – Court confirms statutory interest payable on insolvency is not 'yearly interest' and criticises HMRC's change of position
In Lomas and others v HMRC [2016] EWHC 2492 (Ch), the High Court has confirmed that statutory interest payable on insolvency is not 'yearly interest' for UK tax purposes. The administrators therefore had no obligation to account for income tax on the interest payments made. The Court was also critical of HMRC's contradictory guidance on this issue.
Background
Lehman Brothers International (Europe) (Lehman) had been in administration for eight years. There was substantial surplus in the administration after payment of debts of somewhere between £6-7bn. The surplus was to be used, amongst other things, to pay statutory interest to creditors under the provisions of paragraph (7) of Rule 2.88 of the Insolvency Rules 1986 (Rule 2.88(7)).
The potential tax sums involved were significant given the considerable surplus and were estimated to be in the region of £1.2bn.
HMRC's guidance indicated that statutory interest was not subject to UK withholding tax and the applicants sought confirmation of this treatment from HMRC. After initial confirmation, HMRC changed its position and claimed that withholding tax was due on the statutory interest.
Lehman's joint administrators applied to the High Court for directions regarding the correct tax treatment of interest arising on the surplus funds.
The question for the Court was whether such interest, when paid, would rank as 'yearly interest' for the purposes of section 874, Income Tax Act 2007 (ITA 2007). If section 874 applied, the joint administrators would be required, subject to specific statutory exceptions, to deduct basic rate income tax from the payments made to creditors and account for the same to HMRC. If the interest was not 'yearly interest', no such obligation would exist and payments to creditors could be made gross.
The joint administrators argued that the interest was not 'yearly interest' on the basis that 'yearly interest' must have a quality of recurrence, or at least be capable of recurrence which is not a feature of interest under Rule 2.88(7).
Decision
The Court directed that the statutory interest was not 'yearly interest' for the purposes of section 874 and accordingly there was no obligation on the joint administrators to deduct tax at source.
The Court reached this conclusion on the basis that the right to statutory interest under Rule 2.88(7) is in the nature of an arrangement statutorily imposed for the equitable distribution of surplus and is not a right to interest that recurs over time. There is no accrual of a right to interest unless (and until) a surplus is established. Further, for statutory interest to be 'yearly interest', it is insufficient merely for money to remain outstanding for over a year, as contended by HMRC.
Comment
Until late 2015, HMRC's publicly available guidance had indicated that interest in these circumstances was not 'yearly interest'. However, presumably on reviewing the fiscal impact, HMRC altered its position and contended that statutory interest is in fact 'yearly interest' and, as such, a distribution of statutory interest should be subject to deduction of income tax at source. The Court was, understandably, critical of HMRC's change of position.
The sums involved in this case are considerable and it is an important issue for HMRC given that many of the creditors entitled to interest are non-resident and therefore cannot be charged to tax in relation to UK source interest beyond any amount deducted at source pursuant to sections 811 and 815, ITA 2007.
Although the circumstances of this case are novel, this judgment will be of assistance to administrators and liquidators more generally in relation to their tax withholding obligations and the meaning of 'yearly interest'.
Mr Justice Hildyard has given permission to HMRC to appeal to the Court of Appeal and given the significant sums at stake, it is anticipated that HMRC will proceed with its appeal.
A copy of the judgment can be found here.