HMRC has won a longstanding legal challenge over whether or not PwC as administrators to collapsed bank Lehman Brothers International (Europe) (LBIE) should deduct income tax from some £5bn of interest payable to creditors, after the Supreme Court ruled in its favour
The administration generated an unprecedented surplus in the region of £7bn of which about £5bn is payable as statutory interest. All unsecured creditors have already been repaid the principal sums owed, in full, by 30 April 2014.
The question to be decided at the appeal was whether interest payable under rule 14.23(7) of the Insolvency Rules 2016 is ‘yearly interest’ within the meaning of section 874 of the Income Tax Act 2007. If so, the administrators must deduct income tax before paying interest to creditors.
The High Court had previously determined that statutory interest under rule 14.23(7) is not ‘yearly interest’ for the purposes of the 2007 Act because of the absence of any accrual of interest over time, before the surplus was identified and quantified.
The Court of Appeal disagreed, allowing HMRC’s appeal. It did not accept a requirement that yearly interest should accrue over time and considered that, because the statutory interest was compensation for the creditors, it had the required long-term quality.
PwC as administrators then appealed to the Supreme Court, which has now ruled that the statutory interest payable is yearly interest. Therefore, income tax is to be deducted at source pursuant to section 874 of the 2007 Act. [Commissioners for Her Majesty’s Revenue and Customs v Joint Administrators of Lehman Brothers International (Europe) (In Administration)  UKSC 12].
In coming to this conclusion, the judges said the income tax legislation adopted a dichotomy between the treatment of interest of any kind which is not paid out of profits or gains, on the one hand, and yearly interest, on the other hand.
Interest payable on a surplus in an administration is of a special type. Such interest, once paid, compensates proving creditors for being kept out of their proved debts in respect of the period from the beginning of the administration until they are actually paid. There is no liability to pay interest during the period in respect of which it is calculated, and the interest is not itself payable over a period of time. In addition, it cannot be known during the period of calculation whether interest will in fact be payable at all. The interest amounts to compensation for the recipients having been out of their money.
Arguments based on the source of the relevant income were discounted as wrong in principle as the income tax deduction obligation under section 874 of the 2007 Act does not depend on whether the interest is taxable in the hands of the recipient; it is artificial to regard the source of statutory interest as either the realisation of the surplus or the administrators’ decision to pay interest; and, if anything, the relevant status of the recipient is as a proving creditor between the start of the administration and payment of the principal debt. On these facts, the result is that the statutory interest payable is yearly interest.
An HMRC spokesman said: ‘We welcome the Supreme Court ruling that confirms our analysis and means over £5bn is in scope of withholding tax rules.’
In a statement PwC said: ‘We are pleased that the Supreme Court has handed down this important decision on a technical tax issue.
‘It provides the clarification needed in the rare circumstances where insolvency officeholders pay interest to creditors out of an estate’s surplus -having paid creditors in full- as has been achieved in the case of LBIE, and other UK Lehman companies, by PwC.’
Report by Pat Sweet