In HMRC v Coal Staff Superannuation Scheme [2019] EWCA Civ 1610 (3 October 2019), the Court of Appeal found that the imposition of withholding tax on manufactured overseas dividends (MODs) was contrary to EU law and adopted a conforming interpretation of the relevant UK provisions.
The appellant was a corporate trustee which had responsibility for managing the UK Coal Staff Superannuation Scheme. It had claimed repayment of withholding tax in connection with stock lending transactions. Typical stock lending arrangements involve institutional investors transferring legal and beneficial ownership of shares to a borrower on terms that, at the end of the stock loan, the shares or an equivalent number of shares will be transferred back to the lender. The contractual terms of a stock lending transaction involve an obligation on the borrower to provide the lender with a payment of equivalent value to any dividends paid during the term of the loan. These payments are known as manufactured dividends (MDs); and, when they relate to dividends derived from overseas shares, as MODs.
In the relevant tax years, the UK imposed no charge to UK income tax or corporation tax on MDs paid in respect of shares in UK companies; however, it imposed a withholding tax on MODs where a withholding tax would have been imposed by the country of origin had the MOD been an actual dividend (ICTA 1988 Sch 23A). Furthermore, the trustees were exempt from tax on their investment income (FA 2004 s 186), so that no double taxation relief or credit was available for this deemed overseas tax (ICTA 1988 s 796). The issue was whether EU law permitted the UK to charge withholding tax on MODs when it did not charge any tax or equivalent tax on MDs in relation to UK shares.
The court noted that although the tax deducted under the MOD regime was not necessarily the rate at which tax was withheld by the relevant overseas country on the real dividend, the MOD regime limited the returns available to investors from stock lending of overseas shares and was therefore liable to discourage investors from buying or retaining overseas shares. The MOD regime did amount to a restriction on the movement of capital.
The court added that in order to be proportionate, and therefore justified, the legislation imposing the restriction must not only be targeted at artificial arrangements but must also provide a mechanism whereby the taxpayer is able to make representations to the taxing authority to show that there was a commercial justification for the transaction concerned. The MOD regime did not have either of those characteristics.
As to the suitable remedy, agreeing with the UT, the court found that it was possible to give ICTA 1988 Sch 23A para 4 a conforming interpretation, by reading it as being subject to an exception, so that it would not apply in the case of the recipient of an MOD which had no liability to income tax (FA 2004 s 186), to the extent that the recipient was not entitled to a credit for the relevant withholding tax (ICTA 1988 s 796).
Why it matters: The court observed that similar claims had been made by other pension funds, life insurance companies, investment funds and charities. This was therefore seen as a test case. HMRC estimated that the total amount of tax and interest at stake was in the region of £905m.
Also reported this week:
H Tevfik v HMRC Capital allowances and residential accommodation
In HMRC v Coal Staff Superannuation Scheme [2019] EWCA Civ 1610 (3 October 2019), the Court of Appeal found that the imposition of withholding tax on manufactured overseas dividends (MODs) was contrary to EU law and adopted a conforming interpretation of the relevant UK provisions.
The appellant was a corporate trustee which had responsibility for managing the UK Coal Staff Superannuation Scheme. It had claimed repayment of withholding tax in connection with stock lending transactions. Typical stock lending arrangements involve institutional investors transferring legal and beneficial ownership of shares to a borrower on terms that, at the end of the stock loan, the shares or an equivalent number of shares will be transferred back to the lender. The contractual terms of a stock lending transaction involve an obligation on the borrower to provide the lender with a payment of equivalent value to any dividends paid during the term of the loan. These payments are known as manufactured dividends (MDs); and, when they relate to dividends derived from overseas shares, as MODs.
In the relevant tax years, the UK imposed no charge to UK income tax or corporation tax on MDs paid in respect of shares in UK companies; however, it imposed a withholding tax on MODs where a withholding tax would have been imposed by the country of origin had the MOD been an actual dividend (ICTA 1988 Sch 23A). Furthermore, the trustees were exempt from tax on their investment income (FA 2004 s 186), so that no double taxation relief or credit was available for this deemed overseas tax (ICTA 1988 s 796). The issue was whether EU law permitted the UK to charge withholding tax on MODs when it did not charge any tax or equivalent tax on MDs in relation to UK shares.
The court noted that although the tax deducted under the MOD regime was not necessarily the rate at which tax was withheld by the relevant overseas country on the real dividend, the MOD regime limited the returns available to investors from stock lending of overseas shares and was therefore liable to discourage investors from buying or retaining overseas shares. The MOD regime did amount to a restriction on the movement of capital.
The court added that in order to be proportionate, and therefore justified, the legislation imposing the restriction must not only be targeted at artificial arrangements but must also provide a mechanism whereby the taxpayer is able to make representations to the taxing authority to show that there was a commercial justification for the transaction concerned. The MOD regime did not have either of those characteristics.
As to the suitable remedy, agreeing with the UT, the court found that it was possible to give ICTA 1988 Sch 23A para 4 a conforming interpretation, by reading it as being subject to an exception, so that it would not apply in the case of the recipient of an MOD which had no liability to income tax (FA 2004 s 186), to the extent that the recipient was not entitled to a credit for the relevant withholding tax (ICTA 1988 s 796).
Why it matters: The court observed that similar claims had been made by other pension funds, life insurance companies, investment funds and charities. This was therefore seen as a test case. HMRC estimated that the total amount of tax and interest at stake was in the region of £905m.
Also reported this week:
H Tevfik v HMRC Capital allowances and residential accommodation
