RAE (Inspector of Taxes)
v.
LAZARD INVESTMENT COMPANY LIMITED
10th April, 1963.
Lord Reid
My Lords,
The Respondents were assessed to income tax for the years 1956-57 in
the sum of £12,507 under Case V of Schedule D. In 1955 they had bought
for £21,397 2,000 shares in Certain-teed, a corporation incorporated in
the State of Maryland. That corporation was carrying on two separate
businesses as manufacturers of asphalt roofing products and as manufac-
turers of gypsum and paper products. It was thought to be in the interest
of the latter business that it should be ” hived off “. This was done by
a procedure authorised by the laws of that State, a distribution in partial
liquidation. A new company called Bestwall was formed and the gypsum
business was sold to it with all the assets used in that business. The
consideration was 715,145 shares of Bestwall and these shares were
distributed to the shareholders of Certain-teed, who received one for each
three Certain-teed shares. The prices on the New York Stock Exchange
for Certain-teed shares cum Bestwall and then for Certain-teed shares
ex Bestwall showed that the business sold to Bestwall was considerably
more valuable than the business which Certain-teed retained.
In this distribution the Respondents received 666⅔ Bestwall shares free
of cost, and they allocated the original purchase price so that much the
greater part was attributed to their Bestwall shares. They were assessed
on the basis that these Bestwall shares were income within the meaning
of Case V. The Special Commissioners discharged this assessment. Their
decision was reversed by Plowman, J. but restored by the Court of Appeal.
The Crown now maintain that these Bestwall shares should be held
to have been received by the Respondents as income. They rely on the
rule applicable to foreign companies in countries whose law is similar to
the law of England. Under our law there is no doubt that every distribution
of money or money’s worth by an English company must be treated as
income in the hands of the shareholders unless it is either a distribution in
a liquidation, a repayment in respect of reduction of capital (or a payment
out of a special premium account) or an issue of bonus shares (or it may
be bonus debentures). But the Respondents maintain that this case depends
on the law of Maryland. Partial liquidation is unknown to our law. but
its effect was explained in evidence by Mr. Egerton, an eminent member
of the Bar of Maryland, and in light of that evidence the Special Com-
missioners have made findings of fact as to the law of Maryland which are
not challenged.
The most important findings of fact are—
” (3) Certain-teed effected the ‘ hive-off ‘ by proceeding under the
” said Section 70. Certain-teed did not declare a dividend. Under
” Maryland law it would not have been possible to effect this ‘ hive-off ‘
” by way of a declaration of dividend. What the stock-holders received
” from Certain-teed was part of Certain-teed’s capital assets represented
” by stock in Bestwall. Put in another way, the distribution effected
” a division of capital assets formerly owned by Certain-teed and now
” owned in part by Certain-teed and in part by Bestwall.
” (4) In the case of a distribution under the said Section 70 to a
” stockholder who held Certain-teed stock as a trustee for a Maryland
” trust the question as to whether the distribution is to be regarded
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” as principal or income of the trust is answered by section 3 (2) of
” Article 75B (Exhibit ‘ J ‘). The relevant words are ‘ All receipts
” … in liquidation of the assets of a corporation ‘. Under Article 75B
” the Bestwall stock would belong to ‘ Remaindermen’ and not to
” ‘ Tenants ‘ (as defined in Section 1 of Article 75B). The said
” Article 75 B was copied by the State of Maryland from one of the
” model acts promulgated by the Commissioners on Uniform State
” Laws; most of the States of the Union have adopted a similar
” provision. The words ‘ in liquidation’ in the said Section 3 (2)
” cover a partial liquidation as well as a full liquidation.
” (5) The observation of Lord Normand in Commissioners of
” Inland Revenue v. The Trustees of Joseph Reid (deceased), 30 TC 431
” at p. 442, viz. ‘ it is incorrect, both in law and in substance, though I
” would prefer to draw no such distinction, to treat the shareholder as
” possessing the capital assets of the company’, would be a correct
” statement of the law in Maryland.
” (6) As a result of the distribution by Certain-teed in partial
” liquidation, under Maryland law Lico’s original interest in Certain-teed
” did not remain intact. Under that law the Courts of Maryland would
” look for the substance of the transaction. The substance of this
” transaction was that Lico’s original interest was in the entirety of
” Certain-teed’s capital assets ; Lico’s subsequent interest was comprised
” in its combined holdings of stock in Certain-teed and in Bestwall
” and those two holdings represented in reality the identical assets in
” which it had its original interest. Without any question under the
” law of Maryland, Lico did not receive a dividend from Certain-teed
” but received capital.”
I would first observe that Mr. Egerton’s evidence and these findings
relate not to the general effect of partial liquidation in Maryland but to the
facts of this case. If the Courts of Maryland look for the substance of each
transaction we cannot assume that the same results would follow if the facts
were substantially different. It was suggested in argument for the Appellants
that, if the findings in this case are given what seems to me to be their
natural meaning, this procedure by way of partial liquidation could be used
for tax avoidance: all that would be necessary would be to use accumulated
profits to buy shares in another company and then distribute these shares
by way of a partial liquidation when the shareholders would receive them
as capital. But that would be quite a different case from the present case,
and I am not at all prepared to assume that the Courts of Maryland,
looking for the substance of the transaction, would reach the same result. It
may well be that tax avoidance is not unknown in the United States, and that
Courts there have appropriate means for dealing with. In the present
case partial liquidation appears to me to be an apt name for what was done:
it did not involve the death of the company but it did involve the amputation
of one of its businesses.
In deciding whether a shareholder receives a distribution as capital or
income our law goes by the form in which the distribution is made rather
than by the substance of the transaction. Capital in the hands of the company
becomes income in the hands of the shareholders if distributed as a dividend,
while accumulated income in the hands of the company becomes capital in
the hands of the shareholders if distributed in a liquidation. In the present
case the form of the distribution was one unknown to our law—distribution in
a partial liquidation. By the law of Maryland which governs the company
and which authorised this distribution the shares distributed were capital in
the hands of the shareholders. Why, then, should we regard them as income?
It is said that if this had been an English company and it had done what
Certain-teed did these shares would have been income in the hands of the
shareholders. But an English company could not do what Certain-teed did,
for it could not distribute in a partial liquidation. No doubt an English
company could have reached the same result by using a different method–
deciding a dividend. But it is found as a fact that it would not have been
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possible in Maryland to effect this transaction by way of a declaration of
dividend. So why are we to hold something to be a dividend which by
the law of Maryland was not and could not be a dividend? There is no
question here of the foreign law producing a result which is unreasonable or
contrary to our idea of justice.
The argument for the Crown was based to a large extent on what was
said in this House in Inland Revenue Commissioners v. Reid’s Trustees
[1949] A.C.361. In that case a dividend in the form of cash was received
from a South African company by a taxpayer in Scotland. It is clear from
several of the speeches that this dividend was received as income. But
its source was profit from appreciation of capital assets of the company.
It was assumed, in the absence of evidence to the contrary, that the law of
South Africa was the same as the law of England: so the dividend would
be received in South Africa as income. But the taxpayer maintained that
it was not taxable income, founding on the fact that a similar dividend paid
by a British company would not be subject to income tax. This was held
to be irrelevant: the dividend was income from a foreign possession and
was therefore within Case V. The decision is, therefore, not in point, but
the Appellant relied on statements which I shall quote. Lord Simonds
said (at p. 373): ” I cannot imagine a safer or better [basis], the question is
” as to income arising from a foreign possession, than to ask whether the
” corpus of the asset remains intact in the hands of the taxpayer.” Lord
Normand said (at p. 374): “It seems to me beyond dispute that ‘ the
” ‘ possessions ‘ are the shares … In law capital cannot be returned to
” shareholders by a mere money distribution whether called a dividend or
” by some other name and there was in this instance no return of capital.
” The shares of the company remained after the distribution intact and
” precisely as they were before it.” Lord Morton of Henryton said (at p. 379) :
” This sum must be either income arising from that possession or part of the
” capital of that possession “. And Lord MacDermott said (at p. 383) :
” No doubt the shares abated in market value after the payment of the
” dividend, but they nevertheless remained intact. The ripe tree loses weight
” and worth when it sheds its fruit, but the fruit remains fruit and no more
” unless in its fall it has taken part of the tree with it.”
Accepting that test, as I do without reservation, the question is whether
” the corpus of the asset ” or ” the shares of the company ” or ” the capital
” of the possession ” did or did not remain intact after the Bestwall shares
were distributed: or whether the Bestwall shares were merely fruit or had in
their fall taken part of the tree with them.
It is not disputed that the nature of a taxpayer’s right to his foreign
possession must be determined by the foreign law—Archer-Shee v. Garland
[1931] AC 212. So we must go to the law of Maryland to find whether
the taxpayer’s capital asset remained the same, and it is found as a fact
” (6) As a result of the distribution by Certain-teed in partial liquidation,
” under Maryland law Lico’s original interest in Certain-teed did not remain
” intact “, and then the reason is given, followed by the statement that the
shareholder received capital. The plain meaning of that appears to me to
be that after the partial liquidation the corpus of the Respondents’ capital
asset did not remain intact. And I do not find it surprising that the law of
Maryland should so hold: I would expect that after a partial liquidation the
corpus would be different. To adopt Lord MacDermott’s metaphor, trees
in Maryland are unlike trees in England, they can be split and both halves
can live: after partial liquidation Certain-teed was only half the original
tree, the other half becoming Bestwall. The Appellant says that both before
and after the distribution the Respondents held 2,000 shares of Certain-teed,
so their foreign possession or capital asset must be the same. But that is
going by our law ; which looks to form. We are told that the law of Maryland
looks to substance, and in substance the foreign possession did not remain
intact. The shares after partial liquidation were not the same in substance
as they had been before. So on the findings of fact as to the law of Maryland
I have no difficulty in holding that this appeal should be dismissed.
My Lords, my noble and learned friend, Lord Cohen, is unable to be
present this morning, and he has asked me to say that he concurs.
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Lord Jenkins
My Lords,
In this case I agree with the judgments delivered by my noble and learned
friend Lord Evershed, M.R., and Upjohn and Diplock, LL.J. in the Court
of Appeal, and would serve no useful purpose by repeating them at length.
Accordingly I have very little to add.
Each, case in which it is sought to charge with income tax under Case V
of Schedule D income arising from possessions out of the United Kingdom
must turn on its own facts, including as part of those facts whatever foreign
law may be found to be properly applicable to such income or possessions.
In the present case the proper law has been found to be that of the State
of Maryland in the United States of America, and it has further been found
(on the evidence of Mr. Egerton. a well known Corporation lawyer in
Maryland) that under Maryland company law it is (within limits) possible
and permissible to effect what is known as i partial liquidating distribution,
which is a method of returning assets to members of a company in a partial
liquidation, extending to part only of such assets, without winding up.
It would seem that no comparable procedure exists under United Kingdom
company law. Be that as it may, there is, as I understand it. no doubt
that according to Maryland law a ” partial liquidation distribution ” was
validly effected in the present case and that it resulted in the receipt by the
Company, Lazard Investment Company Ltd. (incorporated and carrying
on business in England), of the 666 ⅔ rds common shares in Bestwall in respect
of which income tax is now claimed, in addition to the 2,000 common shares
of $1 each in Certain-teed originally purchased by the Company, and still
held by it.
The Inspector of Taxes claims that the 666-odd shares in Bestwall were
income arising from possessions outside the United Kingdom in the shape
of the 2.000 shares in Certain-teed acquired by Bestwall as already men-
tioned. I find it difficult to understand how any element of dividend or
income could come into this transaction. It seems to me to have been
essential to the scheme that the Company’s interest in the capital assets
made over to Bestwall should be retained as capital and not paid away as
income, which, as I understand the position, would have been both incon-
sistent with the scheme and indeed with Maryland company law.
Mr. Egerton has described very clearly the way in which a partial
liquidating distribution works with special reference to the present case.
At page 11, paragraph (3), of the Case he said : ” Put in another way, the
” distribution effected a division of capital assets formerly owned by Certain-
” teed and now owned in part by Certain-teed and in part by Bestwall “.
At page 12, paragraph (6), of the Stated Case he said: “Without any
” question under the law of Maryland, Lico ” (that is, Lazard Investment
Co. Ltd.) ” did not receive a dividend from Certain-teed but received
” capital.”
It is interesting to note that in Mr. Egerton’s view (page 11, paragraph
(4), of the Case) on a distribution of Bestwall stock to the Trustee for a
Maryland Trust such stock would belong to the ” remaindermen” and
not to ” Tenants ” (i.e. ” for life “).
As regards the much-discussed case in your Lordships’ House, Inland
Revenue Commissioners v. Reid’s Trustees [1949] A.C. 361, I need only
say that I think it should be held distinguishable from the present case on
the ground that it was decided without any evidence of the relevant foreign
law.
For these reasons I would dismiss this appeal.
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Lord Guest
My Lords,
I have had the advantage of reading the speech delivered by my noble
and learned friend on the Woolsack, and I agree that the appeal should
be dismissed for the reasons given by him. I only propose to add a very
few observations.
The question as to what is the character of the payment by Certain-teed in
the hands of recipient shareholders, the Respondents, falls to be determined
by the law of the country in which Certain-teed is incorporated (Garland
v. Archer-Shee [1929] 15 T.C.693). Certain-teed was incorporated under
Maryland corporation law. Being a creature of statute the corporation’s
activities are entirely governed by and subject to Maryland law. The
rights of shareholders in that corporation could only be exercised according
to Maryland law. The character of a payment in the hands of a share-
holder in this country is determined for all purposes by the legal machinery
employed by the company acting under the relevant statutes (see Viscount
Haldane in Commissioners of Inland Revenue v. John Blott, 8 T.C.101 at
page 125). In ascertaining the character of a payment to a shareholder
in this country resort must therefore be had to the machinery under English
law. Similarly, if the corporation is incorporated under Maryland law resort
must be made to the machinery under Maryland law. Counsel for the
Appellant argued that the enquiry was whether the Bestwall distribution
came within the words of Case V of Schedule D as ” income arising from
“possessions out of the United Kingdom” (section 123, Income Tax Act,
1952). The question depended on whether the distribution was income
according to English law. But the form in which the ” partial liquidating
” distribution ” was made under section 70 of the Maryland code is unknown
to our law. To ask what would be the effect of such a distribution if made
in England is to embark upon a fruitless inquiry because English law gives
no guiding light. Accordingly to English law a distribution of capital profits
would be income in the hands of the shareholder (Commissioners of Inland
Revenue v. Trustees of Joseph Reid (Deceased), [1947] 30 T.C.431). But
this is nihil ad rem in the present case, where the distribution has been made
under Maryland law. In the Stated Case there are findings of fact as to
the law of Maryland and they leave me in no doubt that according to the
law of Maryland there was a capital distribution. In these circumstances
my opinion is that the Special Commissioners arrived at a correct conclusion
and the decision of the Court of Appeal was right.
Lord Pearce
My Lords,
I agree with the judgments of the Court of Appeal.
Certain-teed since its incorporation in Maryland in 1917 had been
continuously engaged in the manufacture and sale of asphalt. Since 1926 it
had also been engaged in the manufacture and sale of gypsum and paper
products. For various commercial reasons in 1956 it decided to conduct the
two businesses as two distinct entities and it separated them accordingly.
If one could regard the commercial substance of the transaction without
the necessary formalities and fictions of company law, the Respondents
before 1956 owned a share in the two businesses conducted together under
one management, and after 1956 they owned a like share in the two businesses
conducted as separate entities. Their commercial position is therefore sub-
stantially unchanged. From this informal aspect it would be surprising
if the retention of their share in the gypsum and paper business were to
be regarded as income. It would also be surprising if their share in that
business were to go to the life tenant under a settlement or were to pay
income tax before going to the remainderman.
Undoubtedly, a large portion at least of the assets of Bestwall were
the undivided trading and capital profits of the two businesses previously
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conducted by Certain-teed. But that fact does not, even by English company
and income tax law, decide whether the Bestwall shares were received
by the Respondents as income or capital. The matter was put succinctly
by my noble and learned friend, Lord Reid, in the cause of Reid’s Trustees
[1949] A.C. 361 at page 386, which dealt with income from a company in
South Africa where the company law was taken to be similar to that in
England. ” There are many ways in which a company can deal with its
” profits. If it adopts certain methods the result is the creation of new capital
” assets. If it adopts other methods the result is the receipt of income by its
” shareholders. In either case it is immaterial whether the profits were trading
” profits or capital profits … I can find no satisfactory alternative to the
” view that, if a foreign company chooses to distribute its surplus profit as
” dividend, the nature and origin of those profits does not and cannot be
” made to affect the quality of the receipt by the shareholder for the purpose
” of income tax.”
In that case the taxpayer had received a dividend out of capital profits;
but there was no liquidation and no reduction of capital. The taxpayer’s
original capital was intact. It was therefore held that the dividend must
be treated as income.
In Commissioners of Inland Revenue v. Blott (1921) 8 T.C.101 at page
125, Lord Haldane said: ” The company, acting with the assent so given
” of the shareholders, can decide conclusively what is to be done with
” accumulated profits. It need not pay these over to the shareholders.
” It can convert them into capital as against the whole world, including,
” as I think the principle plainly implies, the Crown claiming for taxing
” or any other purposes.” In that case it was held that fully paid bonus
shares in the company credited to a shareholder, being distributed as capital,
were not income in the hands of the shareholder.
Thus it is not the source from which the assets are distributed but
the machinery employed in their distribution which determines the question
whether they are received as capital or income. They are received as
capital if they are distributed as a bonus issue as in Blott’s case or on an
authorised reduction of capital or in a liquidation (see Commissioners of
Inland Revenue v. Burrell, 9 T.C.27). If, however, they are distributed in
any other way they are received and taxable as income (R. A. Hill and
Others v. Permanent Trustee Company of New South Wales, Limited and
Others [1930] A.C.720). But it is possible for a new statutory method of
distribution to enlarge the categories of possible capital distribution set out
in Hill v. Permanent Trustee. See In re Duff’s Settlements. National Pro-
vincial Bank Ltd. v. Gregson and Others [1951] Ch.923, where the distribu-
tion of money paid out of a share premium account under the Companies
Act. 1948, was held to have been received as capital. If, however, assets are
distributed as shares in another company that is ” merely a distribution of
” money’s worth instead of money ” and they ” simply represent a dividend ”
(per Rowlatt, J. in Wilkinson v. Commissioners of Inland Revenue, 16
T.C.52, and in Briggs v. Commissioners of Inland Revenue, 17 T.C.11).
It is conceded that had Certain-teed been an English company controlled
by English law its method of distribution could not have constituted a
capital distribution and must therefore have been an income distribution,
since our law does not allow the process of partial liquidation. But Certain-
teed is incorporated under Maryland law which does allow a partial liquida-
tion whereby part of a company’s business or assets may be ” hived-off ”
in the method adopted by Certain-teed in the present case. The stock
so ” hived-off ” belongs to remaindermen and not to life tenants under a
trust. The law of Maryland was a question of fact for the Special Commis-
sioners to decide on the evidence before them. They accepted the expert
evidence that Certain-teed did not distribute a dividend, and that without
any question the shareholders received not a dividend but capital. The
distribution was made in accordance with powers conferred by Section 70
(which related to partial liquidation) of the law relating to Corporations in
the State of Maryland, and by that law the distribution could not have
been made as a dividend.
The question whether a receipt is ” income arising from possessions out
” of the United Kingdom ” is a question to be decided according to the ” law
” of England ” (see Camille and Henry Dreyfus Foundation Inc. v. Inland
Revenue Commissioners [1956] A.C.39 at page 44). But it cannot be
decided in vacua. The factual situation (which includes the foreign law)
has to be examined in order to apply the English law. In Garland (H.M.
Inspector of Taxes) v. Archer-Shee, 15 T.C.693 at page 711, Rowlatt, J.
said: ” The question of the American law is, what are exactly the rights
” and duties of the parties under an American trust, and when you find
” what those rights and duties are, you see what category they come in,
” and the place they fill in the scheme of the English Income Tax Acts
” which the Courts here must construe “.
A corporation, being a persona ficta, owes its existence to the law under
which it is created and cannot act except in accordance with it. It is,
therefore, impossible to assess the behaviour of a Maryland company on the
hypothesis that it has been created by and acts in accordance with
English law.
By the law of Maryland this Maryland Corporation has made a distribu-
tion of capital. In the hands of the shareholder the distribution is received
as capital and not income. It is, therefore, not liable to tax under the
English Income Tax Act.
In the present case that conclusion accords with the commercial substance
of the transaction. It has been suggested in argument that foreign law
might create colourable labels or machinery whereby it could fix upon a
distribution a specious appearance of capital when in truth it should be
income and that thus tax could be unfairly avoided. If such a situation
arises, it may well be that the English Courts would feel entitled to look
behind the labels or even, perhaps, behind the machinery itself to find
the true substance of the matter. But in the present case the transaction
was admittedly genuine, and I see nothing in the concept of partial liquida-
tion which is wholly out of accord with the notions of English law.
I would dismiss the appeal.
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