JUDGMENT
Commissioners for Her Majesty’s Revenue and
Customs (Respondent) v Joint Administrators of
Lehman Brothers International (Europe) (In
Administration) (Appellants)
before
Lord Reed, Deputy President
Lord Carnwath
Lord Hodge
Lady Black
Lord Briggs
JUDGMENT GIVEN ON
13 March 2019
Heard on 12 February 2019
Appellants Respondent
David Goldberg QC Malcolm Gammie CBE QC
Daniel Bayfield QC Catherine Addy QC
(Instructed by Linklaters
LLP
)
(Instructed by HMRC
Solicitor’s Office and Legal
Services
)
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LORD BRIGGS: (with whom Lord Reed, Lord Carnwath, Lord Hodge and
Lady Black agree)
Introduction
1. This appeal concerns the relationship between two statutory provisions, one
very old and the other very young. The old provision, which dates back to the
inception of Income Tax during the Napoleonic Wars, but is now to be found in
section 874 of the Income Tax Act 2007, requires a debtor in specific circumstances
to deduct income tax from payments of “yearly interest” arising in the United
Kingdom. The young provision, first made the subject of legislation in 1986 (and
replacing previous judge-made rules) but now to be found in rule 14.23(7) of the
Insolvency Rules 2016, requires a surplus remaining after payment of debts proved
in a distributing administration first to be applied in paying interest on those debts
in respect of the periods during which they had been outstanding since the
commencement of the administration. The short question, which has generated
different answers in the courts below, is whether interest payable under rule 14.23(7)
is “yearly interest” within the meaning of section 874, so that the administrators
must first deduct income tax before paying interest to proving creditors.
2. The question arises in connection with the administration of Lehman
Brothers International (Europe) (“LBIE”) which, although it commenced at a time
when LBIE was commercially insolvent due to the worldwide crash of the
international group of companies of which it formed an important part, has
nonetheless generated an unprecedented surplus after payment of all provable debts,
in the region of £7 billion, of which some £5 billion is estimated to be payable by
way of statutory interest (before any deduction of income tax). LBIE went into
administration on 15 September 2008. It became a distributing administration in
December 2009. A final dividend was paid to unsecured proving creditors (bringing
the total dividends to 100p in the pound) on 30 April 2014. After the coming into
effect of a scheme of arrangement, interest slightly in excess of £4 billion was paid
to creditors, after deduction of a sufficient amount on account of tax to abide the
outcome of these proceedings, on 25 July 2018. Thus the time which elapsed
between the commencement of the administration and the payment of interest to
creditors was slightly under ten years. The periods in respect of which interest was
payable under rule 14.23(7) (and its predecessor) ranged from a little over four years
(which expired when the first interim distribution to proving creditors was made in
November 2012) and little over five and a half years, when the final dividend to
creditors was made, as described above.
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Statutory Interest in Administration
3. Rule 14.23(7) of the Insolvency Rules 2016, which replaced substantially
identical provisions in rule 2.88(7) of the Insolvency Rules 1986, provides as
follows:
“(7) In an administration –
(a) any surplus remaining after payment of the debts
proved must, before being applied for any other
purpose, be applied in paying interest on those debts in
respect of the periods during which they have been
outstanding since the relevant date;
(b) all interest payable under sub-paragraph (a) ranks
equally whether or not the debts on which it is payable
rank equally; and
(c) the rate of interest payable under sub-paragraph
(a) is whichever is the greater of the rates specified
under paragraph (6) and the rate applicable to the debt
apart from the administration.”
4. Rule 14.23(6) provides that the relevant rate of interest is that specified in
section 17 of the Judgments Act 1838 (1 & 2 Vict c 110), which was, at the material
time, 8% per annum. The “relevant date” referred to in rule 14.23(7)(a) is the date
upon which the company entered administration; see rule 14.1(3).
5. In In re Lehman Brothers International (Europe) (in administration) (No 6)
[2015] EWHC Civ 2269 (Ch); [2016] Bus LR 17, para 149, David Richards J said
this about statutory interest payable under the predecessor of rule 14.23(7):
“The right to interest out of a surplus under rule 2.88 is not a
right to the payment of interest accruing due from time to time
during the period between the commencement of the
administration and the payment of the dividend or dividends on
the proved debts. The dividends cannot be appropriated
between the proved debts and interest accruing due under rule
2.88, because at the date of the dividends no interest was
payable at that time pursuant to rule 2.88. The entitlement
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under rule 2.88 to interest is a purely statutory entitlement,
arising once there is a surplus and payable only out of that
surplus. The entitlement under rule 2.88 does not involve any
remission to contractual or other rights existing apart from the
administration. It is a fundamental feature of rule 2.88, and a
primary recommendation of the Cork Committee that all
creditors should be entitled to receive interest out of surplus in
respect of the periods before payment of dividends on their
proved debts, irrespective of whether, apart from the
insolvency process, those debts would carry interest.”
6. In the present case, in the Court of Appeal [2018] Bus LR 730, after citing
that passage in full, Patten LJ continued, at para 16:
“There is no doubt at all that statutory interest, as David
Richards J explained, is not a continuing liability which accrues
from day to day on a prospective basis over the period to which
it relates. It is paid, as I have said, as statutory compensation
for the loss which the creditors have suffered by being kept out
of their money for the period of the administration.”
I agree.
7. In In re Lehman Brothers International (Europe) (in administration) (Nos 6
and 7) [2017] EWCA Civ 1462; [2018] Bus LR 508, para 26, giving the judgment
of the Court of Appeal, Gloster LJ said of the simple words of rule 2.88(7), when
aggregated with the following two paragraphs (all in substantially the same terms as
are now to be found in rule 14.23, as set out above):
“… this simple formula constitutes, in our view, a complete and
clear code for the award of statutory interest on provable debts.
As [counsel] put it, it contains all you need to know.”
In the present case, at first instance, Hildyard J said at para 16:
“In my judgment, the statutory right to interest is sui generis
and is not to be equated with a right to interest which accrues
over time.”
Again, I agree with both those dicta (and was a party to the first of them).
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Yearly Interest under the Income Tax Legislation
8. Section 874 of the Income Tax Act 2007 provides (so far as is relevant) as
follows:
“(1) This section applies if a payment of yearly interest
arising in the United Kingdom is made –
(a) by a company,
(b) by a local authority,
(c) by or on behalf of a partnership of which a
company is a member, or
(d) by any person to another person whose usual
place of abode is outside the United Kingdom.
(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.”
There is no definition of the phrase “yearly interest” anywhere in the 2007 Act.
Nonetheless there is this deeming provision in section 874, added by Schedule 11 to
the Finance Act 2013:
“(5A) For the purposes of subsection (1) a payment of interest
which is payable to an individual in respect of compensation is
to be treated as a payment of yearly interest (irrespective of the
period in respect of which the interest is paid).”
9. This is unfortunately another case in which the full meaning of an apparently
innocent-looking simple statutory phrase can only be addressed by reference to the
historical deployment of that phrase, or equivalent phrases seeking to express the
same concept, in early legislation.
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10. Hildyard J set out in an Appendix to his judgment an admirable brief
summary of the history of the statutory provisions about deduction of yearly interest,
beginning with the introduction of income tax by Pitt’s Income Tax Act 1799 (39
Geo 3 c 13). In the present case, the main reason for needing an understanding of
the statutory history is so that important decisions about the underlying concepts
behind yearly interest can be reliably interpreted, by reference to the particular
context of the use of the phrase in the statute then in force. As would appear, the
earliest of those authorities was decided in 1854, and the latest in 1981.
11. The concept of “yearly interest” first appeared within the income tax
legislation in section 208 of Addington’s Income Tax Act 1803 (43 Geo 3 c 122). It
appeared as part of the phrase:
“Annuities, yearly Interest of Money, or other annual Payments
… whether the same shall be received and payable half-yearly,
or at any shorter or more distant Periods.”
Section 208 both charged yearly interest to tax and authorised the payer to deduct
an amount equal to the tax chargeable on the interest.
12. When income tax was reintroduced by Sir Robert Peel in the Income Tax Act
1842 (5 & 6 Vict c 35), section 102 charged to tax:
“Annuities, yearly Interest of Money, or other annual
Payments.”
And, as in 1803, provided for deduction at source by the payer, where paid out of
taxed profits or gains.
13. Deduction of yearly interest at source was continued in Gladstone’s Income
Tax Act 1853 (16 & 17 Vict c 34), by section 40, while Schedule D brought into
charge:
“All Interest of Money, Annuities, and other annual Profits and
Gains.”
14. From 1888 until 1965, a succession of provisions to substantially the same
effect made it compulsory to deduct tax at source and to account for it to the Revenue
where interest of any kind was not wholly paid out of taxed income, but permitted
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the deduction of tax at source and its retention in respect of yearly interest which
was wholly paid out of taxed income. In relation to yearly interest, this enabled the
interest payer to be compensated for the fact that yearly interest paid out was not
deductible in computing his own taxable profits or gains. This dichotomy was,
between 1918 and 1952, achieved by rules 21 and 19 respectively of the General
Rules Applicable to all Schedules of the Income Tax Act 1918 (“the 1918 Rules”).
In short, rule 21 was about all types of interest, whereas rule 19 was concerned only
with yearly interest. From 1952 until 1965 this dichotomy was preserved by sections
169 (concerning yearly interest) and 170 (concerning interest of any kind) of the
Income Tax Act 1952.
15. This dichotomy between the treatment of interest of any kind which is not
paid out of profits or gains and yearly interest which is so made was progressively
unwound, first for corporate taxpayers by the Finance Act 1965 and then generally
by the Finance Act 1969. The regime for deduction of tax on interest at source which
has continued, without substantial change, from 1969 is that set out in section 54 of
the Income and Corporation Taxes Act 1970, then section 349(2) and (3) Income
and Corporation Taxes Act 1988 and, latterly, section 874 of the Income Tax Act
2007. In summary, it provides only for the mandatory deduction at source of tax on
yearly interest paid by companies as well as certain other categories of payers, or
paid by any person to someone whose usual place of abode is outside the UK.
The issues
16. In order to make sense of what follows, it is convenient at this stage to provide
a bare outline of what is and is not in issue, under the general question whether or
not statutory interest payable by administrators out of a surplus is yearly interest. It
has been common ground throughout this litigation that the payments are properly
to be regarded as interest, not merely because they are so described in rule 14.23(7),
but also within the meaning of the word as used in section 874(1). As will appear
(and as the Court of Appeal concluded) that apparent concession by the
administrators serves more to mask than to define the real issues.
17. The main thrust of the administrators’ submissions (by Mr David Goldberg
QC and Mr Daniel Bayfield QC in this court although Mr Goldberg did not appear
below) has been to contrast the characteristics which the authorities show are
required for the classification of interest as yearly interest with those of interest
payable from a surplus in administration. The required characteristics are that the
interest should derive from a source with the requisite degree of permanence and
durability over time, and that the interest should accrue due over a period intended,
or at least likely to last for a year or more. By contrast, it is submitted, statutory
interest payable from a surplus in administration has, as its source, first the
emergence of a surplus and second the decision of the administrators that it is time
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to pay it. It does not accrue due over any significant or likely period of time. Rather
it is simply payable out of that surplus once it has been ascertained and turned into
money, usually (and as here) by a single payment of a lump sum to each qualifying
creditor.
18. For HMRC it is submitted (by Mr Malcolm Gammie QC and Ms Catherine
Addy QC) first, that it is unnecessary to identify a source for a statutory interest
payment to qualify for deduction under section 874(1) and secondly, that it is not a
requirement of yearly interest that it should accrue due over a period of time. Rather,
the characteristic which satisfies the requirement that the interest should be yearly
is that, once a surplus has been identified, the statutory interest is payable in respect
of the period, commencing with the beginning of the administration, and ending
with payment of the proving creditors’ debts in full, during which the creditors have
been kept out of their money. If that period is, on the facts about a particular
administration, in excess of a year, then the requirement for duration over time
encapsulated in the word “yearly” is satisfied. Further, to the extent that the
authorities made it a requirement that the source of the interest should be something
in the nature of an investment, this was satisfied in relation to all LBIE’s creditors,
and regardless of the basis of their claims admitted to proof, because they were
involuntary long-term investors in LBIE by reason of the moratorium placed upon
their claims by its administration.
19. At first instance, Hildyard J was persuaded that the absence of any accrual
over time (prior to the identification of a surplus and its quantification after payment
of all proved debts in full) was fatal to the categorisation of statutory interest as
yearly interest. By contrast, the Court of Appeal could discern no requirement from
the authorities that yearly interest should accrue due over time. Since it was
compensation for the proving creditors being kept out of their money for a
substantial time, the interest had the requisite long-term quality sufficient for it to
be categorised as yearly.
The Authorities
20. The relevant authorities may broadly be divided into two groups. First, there
are those which address the question whether interest which does accrue due over
time is properly to be categorised as yearly interest or, in bankers’ jargon, “short
interest”. Secondly, there are those authorities which address the question whether
an entitlement to money described as interest, but which does not accrue due over
time, can properly be regarded as yearly interest, or indeed interest at all, within the
meaning of the income tax legislation. This second group is mainly concerned with
interest payable as a result of a judicial decision, either when granting an equitable
remedy or when exercising a discretion to award interest under statute. As will
appear, it is this second group of authorities which, in my view, provides the answer
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to the questions raised by this appeal, albeit only by analogy because, as the judge
himself observed, statutory interest payable from a surplus realised in a distributing
administration is sui generis. Nevertheless it is convenient to take the first (generally
earlier) group of authorities first.
21. The earliest is Bebb v Bunny (1854) 1 K & J 216. The question was whether
interest contractually payable upon the late completion of a contract for the purchase
of land was yearly interest of money within the meaning of section 40 of the Income
Tax Act 1853, so that it was payable subject to deduction of tax, either by the
purchaser or by the court, even if paid into court gross as the condition for a decree
of specific performance against the vendor. In deciding that it was yearly interest,
Sir William Page Wood V-C said, at pp 219-220:
“The whole difficulty is in the expression ‘yearly’ interest of
money; but I think it susceptible of this view, that it is interest
reserved, at a given rate per cent per annum; or, at least, in the
construction of this Act, I must hold that any interest which
may be or become payable de anno in annum, though accruing
de die in diem, is within the 40th section. I cannot make any
solid distinction between interest on mortgage money and
interest on purchase-money. … I consider the Act very
singularly worded, yearly interest being used apparently in the
same sense as annual payments; but I am clearly of opinion that
it means at least all interest at a yearly rate, and which may have
to be paid de anno in annum; such as interest on purchasemoney, as well as mortgage interest; and that, therefore, the
purchaser is entitled to deduct the tax in this case.”
22. The reference to mortgage money, by way of analogy, becomes intelligible
when it is understood that the drafting practice of the time was typically to make
mortgage loans repayable, with interest, on a fixed date, usually less than a year after
the making of the advance, even if the parties’ expectation was that the mortgage
would endure for much longer, before redemption, with interest being payable
periodically in the meantime. As the Vice Chancellor put it, at p 218:
“Most mortgage deeds contain only a covenant to pay the
principal, with interest at a certain rate per annum, on a day
certain. After that it accrues de die in diem, and the interest,
without any particular reservation, ordinarily is received halfyearly, from year to year. It is difficult to see the distinction
between interest so reserved and paid, and that which by special
agreement accrues on purchase-money, which also goes on
from day to day, and may run on for a year or stop at any time
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on payment of the purchase money, and which, in some shape
or other, forms a lien on the property.”
Thus it was the propensity, rather than the intention or inevitability, for interest
payable during a period of delayed completion to run on for more than a year which
made it yearly interest, even though in many cases the delay in the completion of
the purchase might well be much shorter.
23. The potentially very wide interpretation of yearly interest in Bebb v Bunny
was, in a series of later cases, significantly curtailed, albeit that in none of them was
the decision held to have been wrong. On the contrary, it has remained the leading
case. Goslings & Sharpe v Blake (1889) 23 QBD 324 was about a three months’
bankers loan, repayable with interest on a fixed date, interest being calculated by
reference to a rate per annum, an example of what Lindley LJ called, at p 330: “short
loans by bankers”. It establishes two principles relevant to the question whether
interest is yearly interest (then within the meaning of section 40 of the Income Tax
Act 1853). The first is that interest is not yearly interest merely because it is
calculated by reference to a rate per annum: see per Lord Esher MR, at p 328.
Secondly it establishes that the question whether the interest is “yearly” or “short”
depends upon a business-like rather than dry legal assessment of its likely duration.
At p 330, speaking of the mortgage example used in Bebb v Bunny, Lindley LJ said:
“The difficulty is not lessened by the circumstance that most
mortgages are loans for six months. The ordinary form of
mortgage contains a covenant to repay the loan in six months,
and if not then paid a covenant to pay interest until the loan is
repaid. Those are short loans; but in fact, as men of business,
we know perfectly well that, except in exceptional cases,
money lent on mortgages is very seldom repaid at the end of
six months, the mortgagee usually being content with his
security and receiving his interest half-yearly. … In point of
business, therefore, a mortgage is not a short loan; but a
banker’s loan at three months is a totally different thing. That
is a short loan, it is intended and understood to be a short loan,
and the difference in practice between the two is perfectly well
known to every business man.”
24. The first relevant case about whether statutory (rather than contractual)
interest can be yearly interest is In re Cooper [1911] 2 KB 550, in which objection
was taken to the supposed failure of a judgment creditor to deduct tax from statutory
interest due on the judgment relied on in a bankruptcy notice served on the judgment
debtor. That depended upon whether the interest was yearly interest. In deciding that
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interest payable on a judgment debt under the Judgment Act was not yearly interest
Cozens-Hardy MR said this, at p 553:
“The words ‘yearly interest’ are satisfied although the interest
be not payable yearly but be payable quarterly or half-yearly,
and further, as in the case of a mortgage, although the money
is covenanted to be paid six months after date in the ordinary
course of a mortgage, the court treats that as being a transaction
to the knowledge and the reasonable intendment of all parties,
upon which yearly interest was payable in the understanding
and contemplation of all parties, it being really in the nature of
an investment.”(my emphasis)
25. He continued:
“Now in the present case I ask myself is it possible to suppose
that this was a transaction in which anybody contemplated or
intended anything permanent? It is quite impossible so to
regard it.”
26. At first blush, this decision of the Court of Appeal might appear to suggest
that statutory interest could never be yearly interest because it arose otherwise than
pursuant to any agreement, transaction or common intention of the parties.
Subsequent cases have shown that this is not so but the concept of addressing the
yearly interest question by reference to a perception whether the source of the
interest can properly be regarded as a form of investment has survived. A negative
answer to that question in relation to statutory interest from a surplus in
administration formed a major plank in the administrators’ submissions.
27. A question deliberately left open in the Goslings case was whether interest
on a short loan could nonetheless become yearly interest if the loan was left
outstanding for more than a year. In Gateshead Corpn v Lumsden [1914] 2 KB 883
the plaintiff local authority had become entitled against the owners (including the
defendant) of premises fronting a street which it had paved and made up, to a
proportion of its costs, plus interest at 5% per annum. Although the Corporation had
no settled practice of allowing these statutory debts to remain outstanding for
periods of more than a year, it did so in relation to the defendant, who made
payments on account of interest and capital from time to time. The Court of Appeal
rejected a submission that the Corporation’s forbearance converted interest into
yearly interest within the meaning of section 40 of the 1853 Act. Applying the
principle which he extracted from In re Cooper, Lord Sumner said, at pp 889-890:
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“… applying the principle underlying that decision, I am
unable to see how the words ‘yearly interest’ can apply to this
transaction. There is no agreement for a short loan or a long
loan. The debt is due and repayment is not enforced; only in
that sense is there a loan. Truly speaking there is simply a
forbearance to put in suit the remedy for a debt. The repayment
might have been enforced at any moment. The debt might have
been paid by the debtor at any moment.”
Lord Sumner was careful to put on one side any case in which it might be established
that the local authority had a settled practice of leaving statutory debts for street
improvements outstanding for substantial periods of time. But the decision is good
authority for the proposition that mere forbearance by a creditor who is entitled to
statutory interest on a debt which is immediately due and payable does not bring that
statutory interest within the confines of yearly interest. It serves as a caution against
treating the words of Sir William Page Wood V-C in Bebb v Bunny (quoted above)
as meaning that the mere possibility that a stream of interest may endure for more
than a year is sufficient in all cases to make it yearly interest.
28. The investment test first enunciated in In re Cooper gains force from the
analysis of Rowlatt J in Garston Overseers v Carlisle [1915] 3 KB 381. Persons
claiming to be charitable trustees enjoyed a long-standing arrangement with their
bankers whereby credits on current accounts generated interest. The question was
whether that was yearly interest within section 105 of the Income Tax Act 1842,
qualifying for deduction at source. By concession, that phrase in section 105 was
treated as having the same meaning as in section 40 of the Income Tax Act 1853.
Referring to the case law on section 40, Rowlatt J said this, at p 386:
“The broad result of the decisions in those cases is, I think, that
yearly interest means, substantially, interest irrespective of the
precise time in which it is collected, interest on sums which are
outstanding by way of investment as opposed to short loans or
as opposed to moneys presently payable and held over or
anything of that kind.”
29. He continued, at p 387:
“They (the overseers) are to levy rates as far as they can for
their current expenditure. However, they must necessarily keep
a small balance in hand, and they get interest upon it under the
arrangements which the bank were willing to make. It is no
doubt contemplated that the balance will continue for a long
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time; but what is the daily balance? It is not even a short loan;
it is merely money at call, money payable on demand.”
Since those temporary balances could not be described as investments, the interest
payable was not yearly interest.
30. An attempt to reduce this jurisprudence to a concrete set of useful
propositions was made by Lord Anderson, sitting in the Inner House (Second
Division) of the Court of Session in Inland Revenue Comrs v Hay (1924) VIII TC
636 at 646. The case was about yearly interest within the meaning of section 27(1)(b)
of the Income Tax Act 1918, but it was, again, common ground that the phrase had
the same meaning as was under consideration in all the earlier cases, beginning with
Bebb v Bunny. Lord Anderson said this:
“Now the authorities referred to by Crown Counsel seem to me
to establish these propositions, five in number: – (First), that
interest payable in respect of a short loan is not yearly interest
(Goslings …). … (Second) that in order that interest payable
may be held to be yearly interest in the sense of the Income Tax
Acts, the loan in respect of which interest is paid must have a
measure of permanence. (Third), that the loan must be of the
nature – and this is pretty well expressing the second
proposition in another form – that the loan must be of the nature
of an investment (Garston Overseers). (Fourth), That the loan
must not be one repayable on demand (Gateshead Corpn …).
And (fifth) that the loan must have a ‘tract of future time’ (per
Lord Johnston in Scottish North American Trust Ltd, 1910
Session Cases 966, 973). These propositions are perhaps one
proposition expressed in different forms, but they are the result
of the authorities.”
I will refer these tests as “the Hay tests”.
31. Some further support for the pre-eminence of the investment test is to be
found in the judgment of Lord Denning MR in Corinthian Securities Ltd v Cato
[1970] 1 QB 377, at 382-383. After referring to Inland Revenue Comrs v Hay, he
continued:
“The words ‘short loan’ are not used in the statute: it is a
mistake to place too much emphasis on them. The real question
is whether the interest payable is ‘yearly interest of money’.
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Interest is ‘yearly interest of money’ whenever it is paid on a
loan which is in the nature of an investment no matter whether
it is repayable on demand or not.”
After reviewing the Goslings case he continued:
“Looking at the agreement in this case, it is plain to me that this
loan was made as an investment. Although payable on demand,
it was unlikely that any demand would be made so long as the
interest payments were kept up. It was a loan on the security of
property, indistinguishable in principle from an ordinary loan
or mortgage. The interest was ‘yearly interest of money’.”
32. Some cold water was cast upon the investment test by Sir John Donaldson
MR in Cairns v MacDiarmid [1983] STC 178, at 181, as follows:
“It is well settled that the difference between what is annual
and what is short interest depends on the intention of the
parties. Thus interest payable on a mortgage providing for
repayment of the money after six months, or indeed a shorter
period, will still be annual interest if calculated at a yearly rate
and if the intention of the parties is that it may have to be paid
from year to year (Bebb v Bunny … Corinthian Securities Ltd
v Cato …). I would personally wish to avoid the use of the term
‘investment’ as providing any sort of test in the context of
whether interest is annual interest, notwithstanding its use in
the latter case, because it is possible to have a short term and
indeed a very short term investment, eg overnight deposits, and
such an investment does not involve any annual interest,
regardless of whether the interest is calculated at an annual
rate.”
33. That was a case in which it had been found that the loan was never intended
to last for more than a few days, although there was an entitlement to postpone
repayment for two years. It had, as intended, been discharged within a week, by
novation. In my view the difference in approach to the use of investment as a test
between that case and those which preceded it has more to do with changes in what
the financial world regards as an investment than with any change in the underlying
tax law. I consider that the Hay tests remain the best convenient summary of the
jurisprudence about the meaning of yearly interest, in the context of interest which
accrues due over time, whether purely contractual or statutory in origin.
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34. I turn now to the second group of cases, all of which were concerned with
interest payable after the event (and usually in one lump sum) as compensation for
the payee being kept out of money or property during some earlier period. The
common characteristic of these cases, shared with this case, is that the interest does
not accrue due during the period in question. Rather, it is awarded after the period
has ended, as compensation relating to that earlier period. Taking them
chronologically, the first is Barlow v Inland Revenue Comrs (1937) 21 TC 354. In
1923 the appellant, who was a trustee of settlements in favour of his children,
realised the trust investments and reinvested the proceeds in his own name in
unauthorised securities which subsequently fell in value. Recognising that he acted
in breach of trust, by a deed made in March 1930 he covenanted to pay his fellow
trustees an amount equivalent to the proceeds of the realisation in 1923, together
with compound interest at 5% per annum from the date of realisation until 1 January
1930. Finlay J, on appeal from the Special Commissioners, held that the interest
element in the lump sum agreed to be paid by the deed was yearly interest. Following
Vyse v Foster (1872) LR 8 Ch App 309 and Inland Revenue Comrs v Barnato [1936]
2 All ER 1176, he held that where a trustee agrees to pay principal and interest in
respect of his breach of trust in relation to a period in the past, the interest element
is properly to be regarded as interest (rather than damages) because the beneficiary
has a right to elect between interest and an account of profits in respect of the period
during which the trust property was mis-applied. He held that it was yearly interest
on the basis that it fell clearly within the definition as explained in Bebb v Bunny.
Although he did not say so in terms, this must have been because of the lengthy
period of over six years prior to the March 1930 deed in respect of which the trustee
had been accountable.
35. In the famous litigation known as Regal Hastings v Gulliver the House of
Lords had, in an order made in February 1942 [1967] 2 AC 134; [1942] 1 All ER
378, found that the defendant directors were liable to account to their company for
a profit made by them in 1935 from the use of information which they held as
fiduciaries. Interest at 4% per annum was ordered to be paid from the dates in
October and December 1935 when the defendants had made the relevant profits. In
March 1942 the defendants paid what they regarded as owing to the company
including interest, but they deducted income tax on the interest element. Cassels J
held (1944) 24 ATC 297, that this was yearly interest, deductible either under rule
19 or under rule 21 of the 1918 Rules. Although rule 21 related to interest of all
kinds, rule 19 related only to yearly interest. The outcome was therefore much the
same as it had been in the Barlow case save that, whereas the trustee in that case had
volunteered an account including interest to the beneficiary, the liability of the
defendant trustees in Regal Hastings v Gulliver had only been ascertained, after
lengthy litigation, in the House of Lords. It was sufficient for Cassels J’s decision
that the interest was yearly interest that it had been paid in respect of a period of
accountability of some six and a half years, so that cases such as the Gosling case
were plainly distinguishable.
Page 16
36. The next, and most important case, is Riches v Westminster Bank Ltd [1947]
AC 390. Section 3(1) of the Law Reform (Miscellaneous Provisions) Act 1934
provides that:
“In any proceedings tried in any court of record for the recovery
of any debt or damages, the court may, if it thinks fit, order that
there shall be included in the sum for which judgment is given
interest at such rate as it thinks fit on the whole or any part of
the debt or damages for the whole or any part of the period
between the date when the cause of action arose and the date of
the judgment.”
37. This discretion applies, as Viscount Simon said at p 397, regardless whether
there is or is not a contractual right to interest which underlies the cause of action.
He said that:
“The added amount may be regarded as given to meet the injury
suffered through not getting payment of the lump sum
promptly, but that does not alter the fact that what is added is
interest.”
38. At p 398 he addressed a submission to the effect that an order for interest
under section 3 could not be interest within the meaning of the Income Tax Acts
because the added sum only came into existence when the judgment was given and
from that moment had no accretions under the order awarding it. Viscount Simon
said:
“But I see no reason why, when the judge orders payment of
interest from a past date on the amount of the main sum
awarded (or on a part of it) this supplemental payment, the size
of which grows from day to day by taking a fraction of so much
per cent per annum of the amount on which interest is ordered,
and by the payment of which further growth is stopped, should
not be treated as interest attracting income tax. It is not capital.
It is rather the accumulated fruit of a tree which the tree
produces regularly until payment.”
39. Addressing the submission that the payment under section 3 was, however
described, in truth damages, Lord Wright said, at pp 399-400:
Page 17
“The appellant’s contention is in any case artificial and is in my
opinion erroneous because the essence of interest is that it is a
payment which becomes due because the creditor has not had
his money at the due date. It may be regarded either as
representing the profit he might have made if he had had the
use of the money, or conversely the loss he suffered because he
had not that use. The general idea is that he is entitled to
compensation for the deprivation.”
40. Later, at p 403, he said:
“It was said that the sum in question could not be interest at all
because interest implies a recurrence of periodical accretions,
whereas this sum came to existence uno flatu by the judgment
of the court and was fixed once for all. But in truth it
represented the total of the periodical accretions of interest
during the whole time in which payment of the debt was
withheld. The sum awarded was the summation of the total of
all the recurring interest items.”
41. Lord Simonds addressed the same submission at p 410 as follows:
“It was further urged on behalf of the appellant that the interest
ordered to be paid to him was not ‘interest of money’ for the
purpose of tax because it had no existence until it was awarded
and did not have the quality of being recurrent or being capable
of recurrence. This argument was founded on certain
observations of Lord Maugham in Moss Empires Ltd v Inland
Revenue Comrs [1937] AC 785, 795, in regard to the meaning
of the word ‘annual’. It would be sufficient to say that we are
here dealing with words in the Income Tax Act which do not
include either ‘annual’ or ‘yearly’, but in any case I do not
understand why a sum which is calculated upon the footing that
it accrues de die in diem has not the essential quality of
recurrence in sufficient measure to bring it within the scope of
income tax. It is surely irrelevant that the calculation begins on
one day and ends on another. It is more important to bear in
mind that it is income.”
42. In 1947 the income tax treatment of interest was still subject to the dichotomy
described in paras 14-15 above. Tax on interest of any kind had to be deducted at
source if not wholly paid out of taxed income, pursuant to rule 21 of the 1918 Rules.
Page 18
By contrast, rule 19 permitted the deduction (and retention) of tax at source where
yearly interest was paid wholly out of taxed income. The Riches case was about rule
21 rather than rule 19 but the interest awarded under section 3 of the 1934 Act
represented interest from June 1936 until May 1943, being the period since the
arising of the cause of action during which the plaintiff had been kept out of his
money. As Patten LJ observed in the present case (at para 54, referring back to para
25), the passage in Lord Simonds’ speech quoted above suggests that he would have
regarded the statutory interest awarded in that case as both interest and yearly
interest for the purposes of the Income Tax Acts. This is because he regarded the
payment of a single lump sum by way of interest after the event, referable to an
earlier period for which the claimant needed compensation for being kept out of his
money, as having the requisite quality of recurrence. Recurrence over seven years is
plainly sufficient for that purpose.
43. Jefford v Gee [1970] 2 QB 130 was another case about an award of interest
under section 3 of the 1934 Act. The award was made in June 1969 by way of
addition to damages for personal injuries incurred by the plaintiff in a motor accident
in November 1966. It therefore compensated the claimant for having been kept out
of his money for some two and a half years. At p 146, addressing the principles
applicable to an award of interest in personal injury cases under section 3 of the
1934 Act, Lord Denning MR said:
“Interest should not be awarded as compensation for the
damage done. It should only be awarded to a plaintiff for being
kept out of money which ought to have been paid to him.”
44. Later, under the heading Tax, at p 149, he continued:
“When the court awards interest on debt or damages for two,
three or four years, the interest is subject to tax because it is
‘yearly interest of money’: see Riches v Westminster Bank
[1947] AC 390.”
45. It has been suggested (for example by Hildyard J at para 71(2) of his
judgment) that Lord Denning MR may have failed to appreciate that the Riches case
was about “interest” rather than “yearly interest”. In my view this ignores Lord
Denning MR’s reference to the period of “two, three or four years” in respect of
which interest is awarded. He was entitled to conclude that, even if the Riches case
only established that the relevant payments were interest for tax purposes, they were
nonetheless yearly interest because of the historical period of several years in respect
of which the lump sum award of interest was made.
Page 19
46. Chevron Petroleum (UK) Ltd v BP Petroleum Development Ltd [1981] STC
689 is about the interest element in rolled-up payments by way of contribution to
expenses in a joint venture agreement for the exploitation of the Ninian oilfield in
the North Sea. The participants made payments against the expenditure in
accordance with their expected share of the production. Provision was made for each
participating group’s share to be adjusted in the light of later experience of actual
production. After an accounting which added interest to the amounts expended, the
participants were credited or debited with the differences between their
contributions on account and their adjusted contribution liability. Thus the liability
to make payments against debits was contingent upon share adjustments pending
final calculations, and the interest element in them related to periods of time which
had passed before any payment liability fell due. Nonetheless Sir Robert Megarry
V-C held that the interest element was yearly interest, and therefore subject to
deduction at source. He said, at p 696:
“I cannot see why the contingency should deprive the so-called
‘interest’ of the quality of being true interest. If X lends £100
to Y, the loan to carry interest at 10% per annum, why should
a provision for repayment and interest to be waived in certain
events, or for repayment with interest to be made only in certain
events, prevent the interest from being true interest if in the
event it becomes payable?”
Later, at pp 696-697, commenting upon the Riches case and interest awarded under
section 3 of the 1934 Act, he continued:
“Although the obligation to pay interest was created by the
judgment, the award was made on the basis that the defendant
ought to have paid the money sued for at an earlier date and
had not done so. The interest awarded was interest in respect of
the plaintiff having been wrongfully kept out of the money: …
That was not so in the present case, where the operating parties
had duly paid all that was due from them under the contract at
the time when it was due.
I do not think that this point, or, indeed, any other point,
suffices to distinguish the Riches case. If a contract (eg with a
builder) provides for specified payments to be made on account
of the final liability, and for interest at a specified rate to be
paid on any balance when the final accounts have been agreed,
the fact that all the specified payments on account were
punctually made does not, it seems to me, prevent the interest
payable on the balance from being truly ‘interest’.”
Page 20
Analysis
47. The statutory interest in the present case shares many of the relevant features
with the contractual provision for interest in the Chevron case. In both cases it cannot
be known during the period in respect of which interest is calculated whether it will
in fact be payable at all. In the Chevron case liability depended upon an adjustment
of participants’ shares made in the light of actual production, after the relevant
expenditure was incurred, which increased rather than reduced the relevant
participant’s share of the liability to fund expenses. In this case it depends upon the
realisation of a surplus after payment of proving creditors’ claims in full, necessarily
after the commencement of the administration and indeed after the end of the period
in respect of which interest is calculated, which ends upon payment of the creditors’
debts. In both cases there is no liability to pay interest during the period in respect
of which it is calculated. In both cases the interest is not itself payable over a period
of time. It is rolled up and payable in a single lump sum. In short the interest is not
an income stream, payable over a period of a year or more, but it is nonetheless
income rather than capital, as the Vice Chancellor was at pains to emphasise, at p
696.
48. More generally the relevant features of the interest in this case have much
more in common with the second group of cases about statutory interest under
section 3 of the 1934 Act, and about interest ordered or agreed to be paid by a trustee
or fiduciary in respect of a past loss or misapplication of trust property than they
have with the first group of cases about interest accruing due and payable
immediately, or over time, beginning with Bebb v Bunny. This is not because the
interest is statutory rather than contractual. There are examples of each in both
groups. It is first because in none of the second group is the interest actually due and
payable during the period by reference to which it is calculated, nor can it be said
with certainty during that period that it ever will become due. But the interest is
nonetheless payable, after the event, as a form of compensation for the recipients
being in some way out of their money during the period in respect of which it is
calculated. In the cases about interest under the 1934 Act the recipients are (usually)
compensated for that loss during the period when they have a cause of action for
debt or damages, until a judgment gives them an enforceable right to payment. In
the trust cases the beneficiary is compensated by payment of interest for the loss (if
any) represented or caused by the trust fund being out of the monetary value of the
trust property lost or misappropriated by the trustee, until the trustee accounts and
pays that sum back into the trust fund. In the Chevron case the payment of interest
by the participants who later incurred an increased contribution share compensated
those participants who, in the light of production experience, turned out to have paid
more than their fair share of the cost of generating it.
49. In the present case, as Mr Goldberg was at pains to emphasise, it cannot
generally be said from the commencement of an administration whether there will
Page 21
ever be generated a surplus out of which statutory interest will become payable.
Such surpluses are in fact very rare indeed. It may be that, during that period, the
process of asset recovery by the administrators will make a surplus more likely, but
even then its amount and the timing of any interest payment will all depend upon
countless contingencies, including (in this case) long drawn out litigation about the
amount of creditors’ claims. Statutory interest is never due until after all proving
creditors have been paid in full. There is always a risk that an administration will be
followed by a winding up, with unfortunate (and probably unforeseen)
consequences upon the availability of interest under rule 14.23, even if there is a
surplus: see In re Lehman Brothers International (Europe) (in administration) (No
4) [2018] AC 465 per Lord Neuberger of Abbotsbury, at paras 117 to 121.
Nonetheless, as rule 14.23 makes clear in the plainest terms, the interest once paid
compensates proving creditors for being kept out of their proved debts from the
commencement of the administration (which prevents them seeking any other form
of recovery), until they are actually paid.
50. Mr Goldberg sought to distinguish the trust cases on the basis that, pursuant
to Vyse v Foster, a beneficiary had an enforceable right to interest from the moment
when the trust property was lost or misapplied. For the reasons given by Patten LJ
in the Court of Appeal, at paras 45 to 50, based upon Target Holdings Ltd v Redferns
[1996] AC 421, this is not the correct analysis of the basis upon which the court
awards interest in equity. It is discretionary, like interest under the 1934 Act, even
though the discretion may be exercisable in accordance with well-settled principles.
51. It is true, as the administrators submitted, that some of the second group of
cases were primarily concerned with the question whether payments described as
interest were truly interest at all for income tax purposes, rather than whether they
were yearly interest. In the Riches case this was because the question arose under a
provision in the 1918 Rules relating to all types of interest. In Jefford v Gee it may
be that Lord Denning MR was not overly concerned with whether the interest was
yearly or not, although he certainly took notice of the fact that the plaintiff had been
out of his money for several years. In the Chevron case the contrary argument was
that the element in the rolled-up payment described as interest was not interest at all.
There may have been no dispute that, if it was, it was yearly interest. By contrast in
the present case it has been common ground throughout that statutory interest under
rule 14.23 is interest for the purposes of income tax.
52. But those cases nonetheless provide the answer to the conundrum: what
period of durability is to be identified for interest payable in a single lump sum as
compensation for the payee being out of the money in the past, for the purpose of
deciding whether it is to be treated as yearly interest, under the Hay principles? The
simple answer, supplied by all the second group of cases, is that it is the period in
respect of which the interest is calculated, because that is the period during which
Page 22
the loss of the use of money or property has been incurred, for which the interest is
to be compensation.
53. This appears also to have been the assumption made by the drafter of what is
now section 874(5A), quoted above. It deems payment of interest to an individual
in respect of compensation to be yearly interest “irrespective of the period in respect
of which the interest is paid”. This suggests that, but for the deeming provision
(introduced, so the court was told, to deal with compensation for mis-selling of
Payment Protection Insurance), the question whether the interest would or would
not have been yearly interest would have depended upon the duration of the period
in respect of which the compensatory interest was calculated.
54. It may of course be said that this approach has nothing to do with the
intentions of the payer and the payee, and that, for most of the relevant period it will
not be known when it will end, or whether interest as compensation for that loss will
ever be paid. This is true of all the second group of cases, just as in the present case.
But this gives rise to no relevant uncertainty. The payer will always know what that
period is by the time that the interest becomes due and will be able to deduct tax or
pay gross accordingly. In the case of interest under the 1934 Act the judge is required
to identify the period. In the trust cases the order for payment of interest will also be
by reference to a defined period. In the present case the period is fixed by the date
of commencement of the administration and the date (or dates) upon which the
proving creditors are paid their debts.
55. I must finally address the group of submissions deployed by the
administrators under the heading “source”. These were not deployed with any
prominence in, or at least addressed by, the Court of Appeal, but they were advanced
at the forefront of Mr Goldberg’s submissions in this court. The argument goes like
this. Income Tax is, and always has been, levied by reference to the source of the
relevant income. The only source from which interest under rule 14.23 can be said
to derive, apart from the statutory provision itself, is the combination of a realised
surplus and a decision by the administrators that it is time to pay it. Those elements
cannot, either singly or together, be said to have the quality of durability over time
sufficient to make the interest yearly interest for income tax purposes, applying the
Hay tests. They are unpredictable, liable to evaporate in the event of a winding up,
will generally not have existed for a year before payment, and cannot be regarded
as being in the nature of an investment. The period of time in respect of which the
statutory interest is calculated cannot itself be regarded as a source of the interest. If
there has to be a search for any source of the statutory interest other than the surplus
and the decision to pay, it can only be the contractual debts owed by LBIE to its
creditors at the moment when it went into administration, but those debts were
mainly short term in nature, lacking the requisite capacity to generate yearly interest.
Furthermore for income to be taxable at all the source has to be in existence at the
time when the income becomes due and payable. Neither those contractual debts,
Page 23
nor the provable debts which replaced them from the commencement of the
administration, remained in existence when the statutory interest became payable.
They had all by then been discharged by payment in full.
56. The short answer to this submission is that, if it were correct, all the second
group of cases would have been wrongly decided. In none of them did the interest
under review have a source in the sense of some kind of durable investment. In the
equity cases the beneficiaries received interest by way of compensation for part of
their trust fund being lost or misappropriated. In the cases under the 1934 Act the
plaintiffs were being compensated for the delayed payment of damages, in one case
for the pain and suffering occasioned by a broken leg which had no doubt healed
long before the interest became due. In the Chevron case one group of joint venturers
were in substance being compensated, long after the event, for having contributed
more than their fair share of the expenses.
57. But the flaws in the submission are more fundamental than that. First, the
obligation to deduct tax from interest under section 874 does not depend at all upon
the question whether the interest is taxable in the hands of the recipient. If the
payment is yearly interest, and the payers (or the circumstances) qualify, for
example because the payer is a company, or the usual place of abode of the recipient
is offshore, then tax must be deducted. There is no requirement to identify a source
at all, in the case of statutory or other UK interest. At the most it may be said that
the first group of cases can loosely be characterised as involving an examination of
the source of the interest as part of the inquiry about whether the income in question
was “yearly interest of money”.
58. Secondly, it is artificial to regard the source of statutory interest as having
anything to do with the realisation of the surplus, still less the decision of the
administrators to pay it, even though the combination of those two factors may be
said to have been the immediate cause of the interest becoming payable. Of course
the interest may be said to derive from the surplus, in the sense of constituting the
fund from which it came, but the concept of source in that literal sense had nothing
whatever to do with the characterisation of the payments as yearly interest in any of
the second group of cases or, for that matter, even in the first group. As for the
decision of the administrators to pay, this broadly equates with the exercise of a
judicial discretion, both in the equity cases and those under the 1934 Act. To the
limited extent that it may be said to render the right to payment contingent, it is a
much less formidable contingency than the exercise of judicial discretion. In truth
the administrators have no real discretion at all.
59. Thirdly, to the extent that it is instructive to look for a source of the statutory
interest under rule 14.23, the obvious candidate is the status of the recipient as a
proving creditor during the period between the commencement of the administration
Page 24
until payment of the principal amount by dividend. That is a statutory status created
by the insolvency code laid down by the Insolvency Act and Rules, which (as we
now know) replaces the creditor’s former contractual rights at the commencement
of the administration. It precisely coincides with the period in respect of which the
statutory interest is calculated and, for the reasons given above, amply fulfils the
necessary quality of durability over time.
60. Finally, if it were necessary to do so, I would regard the status of a proving
creditor in a distributing administration as having the requisite character of being an
investor, albeit an unwilling and involuntary one. It is no mere irony that LBIE’s
unsecured debt has, during that last ten years, turned out to be a very satisfactory
long-term investment, generating interest, payable in full, at a handsome 8%.
61. For all those reasons, which do not differ in their essentials from those given
by Patten LJ in the Court of Appeal, I would dismiss this appeal.