United Kingdom House of Lords Decisions

OPINIONS

OF THE LORDS OF APPEAL

FOR JUDGMENT IN THE CAUSE

Her Majesty's Commissioners of Inland Revenue (Respondents) v. Laird Group plc (Appellants)

ON

THURSDAY 16 OCTOBER 2003

The Appellate Committee comprised:

Lord Nicholls of Birkenhead

Lord Hoffmann

Lord Millett

Lord Rodger of Earlsferry

Lord Walker of Gestingthorpe

HOUSE OF LORDS

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

1. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Millett. For the reasons he gives, with which I agree, I would allow this appeal and make the order he proposes.
LORD HOFFMANN My Lords,
2. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Millett. For the reasons he has given, I too would allow this appeal.

LORD MILLETT

My Lords,

3. The question for decision in this appeal is whether the payment of a dividend in respect of shares is "a transaction in securities" or "a transaction relating to securities" within the meaning of section 703 of the Income and Corporation Taxes Act 1988 ("the 1988 Act"). The Tribunal established under section 706 of the 1988 Act ("the Tribunal") and Lightman J held that it is not. The Special Commissioners and the Court of Appeal held that it is.

The facts.

4. The facts are remarkably simple for a case concerned with tax avoidance. In June 1990 the taxpayer The Laird Group plc ("Laird") acquired the entire share capital of Stanton Rubber and Plastics Ltd ("Stanton"). Six months later Laird declared and paid a dividend of £3,848,000 to its shareholders ("the Laird dividend"). Shortly afterwards Stanton paid an interim dividend of £3,000,000 to Laird ("the Stanton dividend").

The tax consequences.

5. Companies pay mainstream corporation tax on their profits. In turn their shareholders are generally liable to income tax under Schedule F on dividends and other distributions which they receive in respect of their shares. At all material times the United Kingdom operated a partial imputation system under which shareholders could use part of the corporation tax for which the company was liable to offset their own liability to income tax on dividends and other distributions which they received from the company. In order to ensure that the credit taken by the shareholders represented tax which the company had actually paid, a company resident in the United Kingdom and paying a dividend to its shareholders was required to pay advance corporation tax in respect of the dividend. The company could set off the amount of advance corporation tax which it paid against its liability to mainstream corporation tax on its profits in the current year or past years. It could also carry any unused balance of advance corporation tax forward and set it off against its liability to mainstream corporation tax in future years.
6. This system penalised companies such as Laird which paid substantial dividends to their shareholders but which earned most of their profits overseas through subsidiaries resident and taxable abroad. They had to pay advance corporation tax in respect of the dividends but were liable to relatively little mainstream corporation tax on their overseas profits because these would already have borne tax abroad. This gave rise to unusable advance corporation tax which fell to be written off against profits.
7. Stanton had accumulated substantial profits on which mainstream corporation had been paid. On its acquisition by Laird, Laird and Stanton became members of the same group of companies. Stanton could have elected to pay dividends to Laird under a group election. Had it done so, it would not have been required to account to the Revenue for advance corporation tax in respect of the Stanton dividend. Laird, on the other hand, would have had to pay advance corporation tax on the Laird dividend, but would have insufficient mainstream corporation tax against which the payment could be set off.
8. Stanton therefore did not make a group election. Instead it paid advance corporation tax of £1m on the Stanton dividend and set this sum off against mainstream corporation tax on its profits for the current and past years. Payment of the Stanton dividend thus gave rise to a reduction or repayment of £1m of Stanton's mainstream corporation tax. Laird, for its part, received the Stanton dividend as franked investment income, that is to say a dividend on which advance corporation tax had been paid, and this could be set against Laird's liability to pay advance corporation tax on the Laird dividend. As a result Laird paid £1m less by way of advance corporation tax in respect of the Laird dividend than it would have done if it had not received the Stanton dividend.

The proceedings.

9. In 1993 the Board of Inland Revenue issued a notice under section 703(3) of the 1988 Act to counteract the tax advantage which Laird had obtained by arranging to receive payment of the Stanton dividend. Section 703 enables the Board to take action to counteract a tax advantage which has been obtained in prescribed circumstances in consequence of a transaction in securities or of the combined effect of two or more such transactions. The taxpayer can repel the Board's attack by showing that the transaction or transactions in question were carried out for bona fide commercial reasons or in the ordinary course of making or managing investments and that none of them had as their main object or one of their main objects the obtaining of a tax advantage.
10. The Board alleged that the payments of the Stanton and Laird dividends were transactions in securities which were not carried out for bona fide commercial reasons or in the course of making or managing investments and had as one of their main objects the obtaining of a tax advantage within the meaning of section 703(1) of the 1988 Act. Following service of the section 703 notice Laird was assessed to advance corporation tax in a sum of £1m.
11. The Special Commissioners dismissed Laird's appeal against the section 703 notice and upheld the assessment. They held that each of the dividends was a transaction in securities. Laird asked for the case to be reheard by the Tribunal, which held that the declaration and payment of a dividend do not constitute transactions in securities within the meaning of section 703 of the 1988 Act and discharged the assessment. The Revenue appealed by way of case stated to the High Court, where Lightman J upheld the Tribunal's decision and dismissed the Revenue's appeal. The Court of Appeal allowed the Revenue's further appeal and reinstated the assessment. Laird now appeals to your Lordships' House.

The legislation.

12. The narrow issue arising on the appeal is whether the Stanton dividend (which was the dividend which gave rise to the tax advantage which Laird obtained) was "a transaction in securities" within the meaning of section 703 of the 1988 Act. This section forms part of a group of sections (sections 703 to 710) which were first enacted by section 28 of the Finance Act 1960. These provisions have been amended from time to time in a number of respects which, with one exception, are not material, and were consolidated by the Income and Corporation Taxes Act 1970 and again by the 1988 Act. The critical definition of "transaction in securities" which is now to be found in section 709(2) of the 1988 Act, however, has not changed over the years. For ease of exposition, I shall refer to the predecessor sections by reference to their counterparts in the 1988 Act.
13. It is not necessary to set out the lengthy and complicated statutory provisions at length. They can be found in the reports of the decisions below. Shortly stated, they enable the Revenue to counteract a tax advantage where
(i)  there is a transaction in securities (or two or more such transactions);

(ii)  the transaction or transactions have occurred in one or more of the five sets of circumstances mentioned in section 704; and

(iii)  in consequence of the transaction or the combined effect of two or more such transactions the taxpayer has obtained or is in a position to obtain a tax advantage.

14. These are three separate and independent requirements. The Revenue do not suggest that it is sufficient that the taxpayer has obtained a tax advantage in one of the circumstances described in section 704; he must also be shown to have obtained the tax advantage in question in consequence of one or more transactions in securities. This appears plainly from the structure of the section, from the fact that it is a defence for the taxpayer to show that the transaction or transactions were entered into for bona fide commercial reasons even if the circumstances described in section 704 are present, and from the way in which the courts have stated the issues: see, for example, Inland Revenue Commissioners v Joiner [1975] 1 WLR 1701, 1705E per Lord Wilberforce.
15. It is common ground that conditions (ii) and (iii) above are satisfied. The circumstances described in paragraph A of section 704 occurred because "in connection with the distribution of profits of a company" (Stanton) "the person in question" (Laird) received an abnormal amount by way of dividend and the amount so received was taken into account for the purpose of the application of franked investment income in calculating Laird's liability to pay advanced corporation tax.
16. It is also common ground (i) that the Stanton dividend was of an abnormal amount; (ii) that Laird gained a tax advantage in consequence of the receipt of the Stanton dividend in that the receipt reduced or discharged its liability to pay advance corporation tax; and (iii) that the payment of the Stanton dividend had as one of its main objects the obtaining of a tax advantage. The remaining requirement, on which issue is joined, is whether the payment of the Stanton dividend constituted a transaction in securities. Laird concedes that the acquisition of the share capital of Stanton was such a transaction. But the Tribunal found that it was carried out for bona fide commercial reasons and did not have as its main object, or one of its main objects, the obtaining of a tax advantage; and this finding has not been challenged by the Revenue.
17. The expression "transaction in securities" is defined in section 709(2) of the 1988 Act as follows:
"(2) … 'transaction in securities' includes transactions, of whatever description, relating to securities, and in particular -

(i) the purchase, sale or exchange of securities;

(ii) the issuing or securing the issue of, or applying or subscribing for, new securities;

(iii) the altering, or securing the alteration of, the rights attached to securities. . . ."

The question is whether the payment of a dividend is "a transaction relating to" the shares in respect of which it is paid.

18. I need set out only one further provision which has a bearing on the present issue, viz section 703(2) of the 1988 Act. This was first introduced by the Finance Act 1962 and is in the following terms:
"(2)  For the purposes of this Chapter a tax advantage obtained or obtainable by a person shall be deemed to be obtained or obtainable by him in consequence of a transaction in securities or of the combined effect of two or more such transactions, if it is obtained or obtainable in consequence of the combined effect of the transaction or transactions and the liquidation of a company."

This assumes that, whatever else "a transaction in securities" may mean, it does not include the liquidation of a company, for if it did the subsection would be pointless: see Joiner at p 1708H per Viscount Dilhorne and at p 1712B-F per Lord Diplock. Section 703(2) is directed at the perceived lacuna which would otherwise arise where the tax advantage was obtained, not in consequence of two or more transactions in securities, but in consequence of a transaction in securities and a liquidation and would not have been obtained but for the liquidation.

The authorities.

19. The relevant statutory provisions have been considered by your Lordships' House on three occasions: in Inland Revenue Commissioners v Parker [1966] AC 141; Greenberg v Inland Revenue Commissioners [1972] AC 109; and Joiner (supra). In none of them did the present question fall for decision.
20. In Parker a company capitalised a sum standing to the credit of its profit and loss account and applied it in issuing redeemable debentures to its members in proportion to the amounts paid up on their shares. The company subsequently redeemed the debentures at par. The difficulty arose because the debentures were issued in 1953, long before the enactment of the Finance Act 1960, while notice of redemption was not given until 1961. The Finance Act was not retrospective. The question was whether the redemption and cancellation of the debentures by themselves constituted transactions in securities. The House unanimously held that they did.
21. In Greenberg a company created a new class of preferred shares which it issued credited as fully paid to its two shareholders. They sold the shares to a purchaser on terms that the price was to be paid by instalments. Under arrangements made between the parties the company paid dividends on the shares which were paid into the purchaser's bank account. Corresponding sums were then paid out of the bank account to the shareholders in payment of the purchase price for the shares. By this means the shareholders converted dividends, which would have been taxable in their hands, into instalments of the purchase price for their shares, which were not. The problem was again one of timing. The arrangements were made before the enactment of the Finance Act 1960, but the payments were made after it. The Revenue did not contend that the declaration and payment of a dividend by itself was a transaction in securities. Its contentions were more modest. It did not focus its attention on the dividends. It claimed that the payment of the instalments of the purchase price, or the completion of the sale by such payment, was such a transaction. All members of the Committee accepted the Revenue's contention that the contract of sale, which was clearly a transaction in securities, was not carried out until the instalments of the purchase price were paid. Four members of the Committee (Lord Reid, Lord Morris, Lord Guest and Lord Simon) also agreed that the payments of the instalments of the purchase price were themselves transactions in securities in consequence of which a tax advantage had been obtained. Lord Simon thought that the payments of the dividends were the transactions in securities in consequence of which the tax advantage was obtained. Lord Reid agreed with him but did not rest his conclusion on this ground. Lord Guest was equivocal on this point; while Lord Wilberforce expressly reserved his position.
22. In Joiner the taxpayers entered into a shareholders' agreement which varied the rights attached to their shares in important respects before putting the company into liquidation. The variations were all necessary steps in order to achieve the taxpayers' objective, which was to receive the undistributed profits of the company as surplus assets in the liquidation (and therefore free of surtax) while keeping the business itself in existence. The Court of Appeal held that the liquidation by itself was a transaction in securities. Before your Lordships' House, however, the Revenue did not contend that a straightforward liquidation without any variation of the rights attached to the shares was a transaction in securities, and the House did not hold that it did. All members of the Committee rested their decision on the ground given by Goulding J at first instance, that the variation of rights constituted a transaction in securities and that accordingly the tax advantage was obtained in consequence of the combined effect of a transaction in securities and the liquidation of a company.
23. Both Parker and Greenberg contain dicta on the question whether the payment of a dividend is a transaction in securities. Opinion was divided in Greenberg on the question whether Parker compelled the conclusion that a dividend is a transaction in securities. Lord Simon thought that it did (at p 151G) while Lord Wilberforce went out of his way to say that it did not (see p 146E). Greenberg itself has often been assumed to be authority for the proposition that it is: see, for example Sheppard v Inland Revenue Commissioners (No 2) (1993) 65 TC 724, 744H. I respectfully prefer Lord Wilberforce's conclusion. As I have already observed, the point did not arise for decision in any of the cases. Moreover, the dicta in Parker and Greenberg must be treated with caution, for both cases were decided on the Finance Act 1960 as it stood before the introduction of what has become section 703(2).
24. But the three cases in your Lordships' House contain many valuable and authoritative insights which help to tease out the statutory definition of "transaction in securities" in section 709(2). Lord Reid's speech in Greenberg makes it clear that the expression may include a unilateral transaction, such as the redemption or cancellation of a debenture or payment of a dividend. In Parker at pp 164-5 Lord Hodson said of the words "transactions, of whatever description, relating to securities" that "there could hardly be a wider net connecting transactions and securities."
25. In Joiner [1975] 1WLR 1701, 1705-1706, Lord Wilberforce summarised the effect of the earlier decisions in two propositions. First:
"Upon the enactment of the original section 28 of the Finance Act 1960 it was possible to contend, and it was contended, that this section (and its associated sections) was directed against a particular type of tax avoidance known generally under such descriptions as dividend stripping, asset stripping and bond washing and that the sections and particular expressions used in them, amongst others 'transactions in securities' should be interpreted in the light of this supposed purpose. But this line of argument became unmaintainable after the decisions of this House in Inland Revenue Commissioners v Parker [1966] AC 141 and Greenberg v Inland Revenue Commissioners [1972] AC 109."

Despite this the taxpayer was at some pains to resurrect the argument before us. With all due respect, that horse has been dead for nearly 30 years.

26. Secondly:
" … we must continue to give to 'transactions in securities' and 'transactions … relating to securities' the widest meaning: we can neither confine these expressions to the instances given in [section 409(2)], nor can we deduce from that enumeration any limitation upon their scope."

"Transactions in securities".

27. My Lords, with all respect to those who have argued otherwise in the past, I do not think that there is any room for doubt that, as a matter of ordinary language, the creation, issue, sale, purchase, exchange, redemption and extinguishment of shares or debentures are all "transaction[s] in securities". In each case the securities themselves are the subject-matter of the transaction. But there is also no doubt that the connection between the transaction and the securities may be looser than this. The transaction need not be a "transaction in securities"; it may be a "transaction … relating to securities." One example of such a transaction appears in section 709(2)(iii): "the altering, or securing the alteration of, the rights attached to securities". It is not possible to use this example to deduce the nature of the necessary relationship between the transaction and the securities; but some relationship there must be.

"Transaction … relating to securities".

28. I think that there are two indications of the kind of relationship that Parliament had in mind. One is the width of the word "securities". The other is in section 703(2), which shows that Parliament did not regard the liquidation of a company in itself as a transaction relating to its shares.
29. The word "securities" includes not only stocks and shares of every description, including preference shares, but also debentures and unsecured loan notes. It would not be a normal use of language to describe the payment of a fixed dividend in respect of preference shares as a transaction relating to securities; and I would at least pause before attaching such a description to the payment of interest on a debt merely because it was secured by a debenture or unsecured loan note. Neither the debt nor the rights attached to it, which include the right to receive interest payable in respect of it, is affected by the payment in any way. The debt merely provides the measure of the amount to be received by way of interest. The same applies to fixed dividends payable in respect of preference shares.
30. Before the introduction of section 703(2), therefore, the question whether the payment of a dividend on ordinary shares was a transaction relating to securities was a question of some nicety which was never finally resolved. But that section and the assumption which it makes that the liquidation of a company is not such a transaction cast further light on the kind of relationship between the transaction and the security which Parliament had in mind.
31. It can hardly be said that the liquidation of a company does not affect its shares or the rights of the shareholders at all. Any transfer of shares made after the commencement of the winding up is void unless made to or with the sanction of the liquidator: (section 88 of the Insolvency Act 1986). The company's property is realised and applied in satisfaction of the companies' liabilities and subject thereto is distributable among the shareholders according to their rights and interests in the company: (ib. section 107). After the creditors have been paid in full and the amounts credited as paid up on the share capital have been repaid, the balance in the liquidator's hands represents the undistributed profits of the company. If there is nothing due in respect of any preference shares, these belong to the ordinary shareholders and are distributable to them in proportion to the amounts credited as paid up on their shares. The company is then dissolved.
32. It is not difficult to see why the effect of the liquidation in making the shares non-transferable should not be regarded as a transaction relating to the shares. It is because it is only the right to transfer legal title to the shares which is affected; shareholders remain free to deal with the beneficial interest in their shares. The purpose of making the legal title to the shares non-transferable is merely to freeze the company's register of members at the date of the winding-up so that the liquidator can safely deal with the shareholders whose names appear on the register at that date. Taxation is normally concerned with beneficial interests.
33. It is also tolerably clear why the dissolution of the company at the end of the process is not regarded as a transaction in securities. The shares themselves are not extinguished by payment of the amounts due to the shareholders (which may and often does take place by instalments), though since they merely represent a proportionate share of the company they necessarily cease to exist when the company itself does. But the shareholders remain contributories, and if for example further assets are discovered they may petition to have the company restored to the register so that they may share in the proceeds.
34. Accordingly the critical questions are: (i) why is the payment of the undistributed profits of the company to the shareholders in the course of a liquidation not a transaction relating to their shares? and (ii) what if any is the difference between the payment of the undistributed profits to the shareholders in the course of a liquidation and their distribution to shareholders by way of dividend while the company is a going concern? In both cases the payment to each shareholder is made in respect of his shares.
35. The juridical nature of a share is not easy to describe. It is not a share in the company's undertaking, for the company owns its property beneficially and not in trust for its members: "shareholders are not, in the eye of the law, part owners of the undertaking" (see (Short v Treasury Commissioners [1948] 1 KB 116, 122, CA). It is classified as a chose in action, but this merely tells us that it is a species of intangible personal property. It is customary to describe it as "a bundle of rights and liabilities", and this is probably the nearest that one can get to its character, provided that it is appreciated that it is more than a bundle of contractual rights. The most widely quoted definition of a share is that of Farwell J in Borland's Trustee v Steel [1901] 1 Ch 279, 288 which was approved by your Lordships' House in Inland Revenue Commissioners v Crossman [1937] AC 26. It was usefully and in my respectful opinion accurately summarised by Lord Russell of Killowen in his speech (dissenting on the facts) in that case, at p 66:
"It is the interest of a person in the company, that interest being composed of rights and obligations which are defined by the Companies Act and by the memorandum and articles of association of the company."

These rights, however, are not purely personal rights. They confer proprietary rights in the company though not in its property. The company is at one and the same time a juridical person with rights and duties of its own, and a res owned by its shareholders: see Gower's Principles of Modern Company Law 6th ed (1997) p 301.

36. The rights of the shareholders in a company are set out in its articles of association. In the case of ordinary shareholders they are normally those described by Lord Wilberforce in Joiner at p 1706-7: "rights to received dividends, if declared, rights to vote, rights in a liquidation to receive a share of surplus assets after discharge of liabilities."
37. Once realised the assets of a company in liquidation are a distributable fund in the hands of the liquidator, who no longer needs funds with which to carry on its undertaking. After the creditors have been paid and the amounts credited as paid up on the shares have been repaid, the balance is distributable to the ordinary shareholders because it belongs to them, subject only to the liquidator's discretion to retain sufficient funds in his hands to enable him to complete the winding up. The distribution of the undistributed profits of a company in liquidation to its shareholders is not a transaction relating to securities because neither the shares themselves nor the rights attached to them are affected by a payment which merely gives effect to the shareholders' rights; they receive only what is already theirs. Distributions are made to shareholders in respect of the shares, but the shares of the individual shareholder are nothing more than the measure of the proportion of the total which is due to him.
38. In my opinion the position is not materially different if part of the undistributed profits is paid to the shareholders by way of dividend while the company is a going concern. The Court of Appeal seized on the fact that until a dividend, if final, is declared or, if interim, is paid, the shareholders have no right to it: [2002] STC 722. Accordingly, the Court of Appeal concluded, the declaration and payment do not merely give effect to pre-existing rights.
39. This proposition merits further examination. If correct, it has the advantage of distinguishing the payment of ordinary dividends from the payment of interest on a debenture or loan note, and the disadvantage of leaving the payment of a preference dividend to depend upon the particular wording of the articles of association in question.
40. The right to receive a dividend does not arise until the conditions laid down in the company's articles of association are satisfied. Any requirement that a dividend must be declared by the directors before the shareholders are entitled to receive it must be found in the company's articles of association: there is nothing in the Companies Acts save an obligation not to pay dividends out of capital. Constraints on the shareholders' rights to receive dividends contained in the articles are self-imposed.
41. In the early days articles of association commonly left the declaration of dividends to the company in general meeting, that is to say to the shareholders themselves. Gradually, however, it became the general practice to require the dividend to be declared by the directors. The change was a response to the increasing separation of ownership and management. The shareholders own the company, but they entrust the management of its undertaking to the directors. To enable the directors to carry out their functions, shareholders give them a discretion to decide how much of the company's funds should be retained to pay creditors and carry on the business and how much can safely be returned to shareholders by way of dividend. By declaring a dividend, the directors effectively release funds due to the shareholders from their power to retain them in the business.
42. Whether the company is in liquidation or continuing to carry on business as a going concern, therefore, the distribution of the undistributed profits of a company to the shareholders entitled thereto merely gives effect to the rights attached to the shares. The funds are released, in the one case from the liquidator's discretion to retain them for the purpose of the winding up, and in the other from the directors' discretion to retain them for the purposes of the undertaking. Given that the former is not "a transaction relating to securities", neither in my opinion is the latter. The relationship between the payment and the shares in respect of which it is paid is the same in both cases.
43. I have reached this conclusion without reference to Hansard; but I am comforted by the fact that it is supported by the explanation given to Parliament by the Attorney-General, Sir Reginald Manningham-Buller QC (later Viscount Dilhorne), when introducing what was to become section 28 of the Finance Act 1960. This makes it unnecessary to consider whether it would have been proper to resort to Hansard had the meaning of the expression "transaction … relating to securities" been incapable of resolution without doing so.

Conclusion.

44. I would allow the appeal with costs here and below, set aside the decision of the Court of Appeal and the Board's notice under section 703, and discharge the assessment.
LORD RODGER OF EARLSFERRY My Lords,
45. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Millett. For the reasons he gives in his speech I would allow this appeal.
LORD WALKER OF GESTINGTHORPE My Lords,
46. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Millett. For the reasons he gives in his speech I would allow this appeal.