Following the administration of Lehman Brothers International (Europe), there is a substantial surplus in the administration (presently estimated to be between £6.6 billion and £7.8 billion). Some of this surplus will be used to pay statutory interest to creditors under the insolvency rules. Statutory interest arises once creditors have received payment in full of their debts at the outset of the insolvency procedure (administration in this case) and is an additional amount payable out of any remaining surplus as interest on the creditor debts in respect of the periods during which they have been outstanding since the start of the insolvency procedure. This decision concerns whether this statutory interest, when paid, is 'yearly interest' for tax purposes. If so, the Joint Administrators will be required to deduct basic rate income tax from the payments made. If it is not ‘yearly interest’ then there is no requirement to deduct income tax from such payments.
The Joint Administrators submitted that the statutory interest is not of the nature of ‘yearly interest’, in summary, for the following reasons:
- As no interest is payable until such a surplus (after paying creditor debt in full) is ascertained it does not accrue from day to day and is not payable from year to year;
- Statutory interest is purely a statutory entitlement and there is no underlying transaction akin to a loan or investment;
- The right to statutory interest is not referable to an obligation having a ‘tract of future time’ as there is no period when the principal is outstanding and the right to interest accrues - it only accrues after the debts have been repaid; and
- There is no quality of capability of recurrence in respect of statutory interest.
HMRC contended that:
- All that needs to be asked in determining whether statutory interest is ‘yearly interest’ is whether at the time it is paid it is calculated over a period of a year or more; or
- As an alternative argument, whether at the commencement of the insolvency procedure it is likely whether the debts [on which statutory interest could be paid] would be repaid within a year.
A summary of the key observations made by the Judge, the honourable Mr Justice Hildyard, in considering the decision is as follows:
- The purely statutory entitlement [to statutory interest] under the scheme of distribution seems to be some way away from any of the cases where interest has been determined as ‘yearly interest’;
- In particular, there is no loan, no investment, no judgement, no period of accrual, no right [to statutory interest] unless and until a surplus [in the insolvency] is established; no quality or capability of recurrence; there is only a moratorium [from enforcing the debts] and a scheme of distribution mandated by statute;
- Gateshead Corporation v Lumsden demonstrates that the fact that money remains for more than a year outstanding and interest-bearing does not suffice. Something akin to a loan or investment “at interest” must also be demonstrated;
- It is also clear that the word ‘yearly’ and ‘annual’ denote the further quality of being recurrent or at least capable of recurrence;
- There was no discernible intention to make anything akin to a loan or investment, or any real element of recurrence;
- The fact that no interest is payable unless and until a surplus is available, and the fact that there is no accrual, nor any prospective expectation of it, amply demonstrate that the statutory interest has none of the characteristics of ‘yearly interest’.
In summary the judge concluded that the unique nature of statutory interest, in particular a lack of investment character or recurrence, means that is not ‘yearly interest’ for tax purposes and no obligation to deduct tax arises.
In the final paragraphs of his decision, the judge also criticised HMRC for initially confirming that the interest could be paid without deduction of interest, and then reversing this position, stating, “It is of real importance, both in terms of good governance and a fair market, that HMRC should make every effort to ensure that this sort of thing does not happen again.”
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