The Times - UK (2022-05-02)

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The regime applicable to foreign
withholding tax paid on manufac-
tured overseas dividends arising from
a stock lending agreement, as it ap-
plied to a tax-exempt lender, did not
have the effect of restricting the free
movement of capital contrary to
European Union law.
The Supreme Court so held in al-
lowing the appeal of the Revenue and
Customs Commissioners against the
dismissal by the Court of Appeal
(Lord Justice Newey, Lady Justice As-
plin and Lady Justice Rose) ([2020] 1
WLR 777) of their appeal against the
decision of the Upper Tribunal (Tax
and Chancery Chamber) (Mr Justice
Morgan and Judge Roger Berner)
([2018] STC 1095) which allowed the
appeal of the Coal Staff Superannua-
tion Scheme Trustees Ltd from the
decision of the First-tier Tribunal
(Tax Chamber) (Judge Jonathan
Cannan and Helen Myerscough)
([2016] UKFTT 450 (TC)) in favour of
the revenue.
Rupert Baldry QC and Oliver Co-
nolly for the revenue; Malcolm
Gammie QC and James Rivett QC
for the trustees.
Lord Briggs and Lord Sales, with
whom the other members of the
court agreed, said that stock lending
was a relatively recent commercial
activity by which, for an agreed fee,
an investor (lender) transferred legal
and beneficial ownership of shares in
its portfolio to a counterparty (bor-
rower), on contractual terms that the
borrower would (i) return equivalent
shares to the lender at the end of the
lending period and (ii) in the mean-
time pay to the lender amounts
equivalent to the dividend stream
which the shares would have yielded
to the lender if it had retained rather
than lent them during the period of
the loan.
That amount was called, both gen-
erally and in the relevant tax legis-

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Rules applying to withholding tax on manufactured

overseas dividends not restricting movement of capital

lation, a manufactured dividend

(MD) if the shares were held in a

company established in the United

Kingdom (UK shares). If the shares

were held in a company established

outside the UK (overseas shares) the

contractual income stream was

called a manufactured overseas divi-

dend (MOD). The phrase manufac-

tured dividend would be used to de-

scribe both types collectively, and the

abbreviations MD and MOD used to

describe each type separately.

The stock lending market had

grown up to satisfy the desire of bor-

rowers to make profits by doing

things with the underlying shares

which the lender either could not or

did not wish to do as part of its own

business or investment activities.

They included (i) short selling, that

was selling shares into what the seller

hoped would be a falling market with

a view to buying them back at a lower

price in the future and (ii) settling

short positions, that was using bor-

rowed shares to fulfil contractual ob-

ligations to deliver shares which the

borrower did not already own. One

benefit associated with stock lending

was that it increased liquidity in the

relevant markets.

Self-evidently stock lending agree-

ments did not generally require the

borrower to hold on to the borrowed

shares during the period of the loan.

Rather the borrower was free to make

any use of the borrowed shares, in-

cluding their outright disposal, leav-

ing the borrower to satisfy its obliga-

tion to deliver equivalent shares to

the lender at the end of the period of

loan either by buying shares on the

market, or by further borrowing,

from the same or a different lender.

Thus it was by no means inevitable

or even typical that the manufac-

tured dividend (MD or MOD) paya-

ble to the lender would be funded by

the receipt by the borrower of the div-

idend actually paid by the subject

company during the period of the

loan. The amount of that dividend

merely fixed the amount of the finan-

cial obligation of the borrower to pay

the manufactured dividend, from

whatever financial resources the bor-

rower might have available.

Dividend income received by a UK

taxpayer was generally subject to UK

income tax, unless the recipient was

exempt. If the company paying the

dividend was UK based, then the tax-

exempt shareholder incurred no tax

liability on the dividend. Dividend in-

come from a company outside the

UK was likewise subject to tax, de-

pending upon whether the recipient

was or was not exempt. But such a

dividend (an overseas dividend)

might also be subject to withholding

tax levied by the country in which the

company was based.

To avoid double taxation the UK

generally allowed a tax credit for part

or all of the foreign withholding tax.

But that tax credit was only available

as a way of reducing the UK share-

holder’s own liability to UK tax. If

therefore the shareholder was ex-

empt from UK tax, the credit for for-

eign withholding tax was of no use to

it.

The result of that limited use to

which the foreign withholding tax

credit could be put was that a tax-ex-

empt UK investor such as a pension

fund suffered a real disincentive from

investing in overseas shares rather

than UK shares. The extent of the dis-

incentive was measurable by refer-

ence to the rate of foreign withhold-

ing tax levied by the country in which

the subject company was based.

The reason for the disincentive

was that the UK gave tax credits

against foreign withholding tax only

as a means of relieving from double

taxation, rather than as a way of en-

suring that its exempt investors were

truly exempted from any tax at all.

Their exempt status was only from

UK tax, not foreign tax.

The liability of overseas dividend

payments to deduction of tax in the

foreign state and then to taxation in

the state where they were received

had come to be labelled “juridical

double taxation” and was regarded as

the unfortunate but currently inevi-

table consequence of the fact that the

member states of the EU each had

sovereign authority to tax income

within their own jurisdiction and had

not harmonised their national tax

systems.

The trustee was the corporate trus-

tee of a tax-exempt pension fund,

with a very large portfolio of UK and

overseas shares. It engaged in sub-

stantial stock lending of its portfolio

during the period 2002 to 2008. It re-

ceived deemed withholding tax cred-

its amounting to more than £8.8 mil-

lion in respect of the MOD withhold-

ing tax for which its borrowers were

liable to account to the revenue in re-

spect of MODs paid to the trustee.

It claimed that the MOD with-

holding tax was unlawfully charged

on its income because that liability

amounted to a restriction on the free

movement of capital contrary to

what was now article 63 of the Treaty

on the Functioning of the European

Union, and sought payment of the

full sum with interest. The present

case was a test case. The full amount

of the liability of the revenue to pay

other tax-exempt lenders if the trus-

tee’s claim was in principle well-

founded was said to amount to more

than £600 million.

The answer to whether the MOD

regime had any dissuasive effect up-

on the lending of overseas shares,

once acquired, compared with lend-

ing UK shares, depended upon a

market economic analysis of the ef-

fect of the MOD tax regime upon the

investor, best undertaken by the ap-

plication of a “but for” test.

The question was whether, had

there been no MOD tax regime (or at

least nothing materially different

from the MD regime) the investor

would have been sufficiently better

off from engagement in stock lending

than it was under the MOD regime,

so that its presence could be de-

scribed as an additional disincentive

to the acquisition of overseas shares,

as opposed to UK shares, beyond the

disincentive already constituted by

juridical double taxation.

The reason why the use of a “but

for” test was appropriate in the

present context was that it was an ef-

fective tool for splitting off the specif-

ic disadvantage (if any) of the MOD

tax regime from the continuing dis-

advantage of juridical double taxa-

tion in connection with the stock

lending of overseas shares.

Stock lending took place in a high-

ly sophisticated market, in which

both sides might be supposed broadly

to understand what were the (very

different) objectives of the counter-

parties.

Thus the provisions in the stan-

dard form overseas shares lending

agreements for the payment of

MODs were specifically crafted so as

precisely to replicate the lender’s net

dividend income (the net dividend in-

come which it would have received if

it had held the shares), not to provide

any share of the benefits derived from

the uses to which the borrower

wished to put the shares. That was

what they were intended to do.

The lender’s sharing of the addi-

tional benefits generated by the bor-

rower’s use of the lent shares was to

be found not in the MOD but in the

lending fee, which was tax-free in the

hands of an exempt investor like the

trustee, just as were fees for the lend-

ing of UK shares. The MOD tax re-

gime did not impose any structural

constraint on what the lender might

bargain for by way of fee for giving the

borrower the opportunity to make

profits from the use of the lent shares.

In those circumstances it was hard

to see why the MOD tax regime

would be likely to have had a dissua-

sive effect on the willingness (if any)

of borrowers to share with lenders the

benefits of dividend arbitrage, or any

other benefits, by way of lending fees.

Further, in general, the revenue re-

ceived no cash attributable to MOD

withholding tax because, as active

stock traders, liable to corporation

tax only on their profits, borrowers

typically had more than sufficient

withholding tax credits available to

soak up the MOD withholding tax li-

ability by way of set-off, whether they

held the shares or disposed of them,

and those tax credits were otherwise

unavailable for use by them for any

other economically beneficial pur-

pose. If that was right, and the reve-

nue’s explanation why that was so

had gone unchallenged, then it was

hard to see why the MOD tax regime

would be likely to have had a dissua-

sive effect on the willingness (if any)

of borrowers to share with lenders the

benefits by way of lending fees.

The MOD tax regime did not con-

stitute, or include, any restriction on

the free movement of capital con-

trary to article 63.

Solicitors: General Counsel and

Solicitor to HM Revenue and Cus-

toms; Pinsent Masons LLP.

Coal Staff Superannuation Scheme
Trustees Ltd v Revenue and Customs
Commissioners
Published May 2, 2022
Before Lord Reed, Lord Hodge, Lord
Briggs, Lord Sales and Lord
Hamblen
[2022] UKSC 10
Judgment April 27, 2022

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IN THE HIGH COURT OF JUSTICE

BUSINESS AND PROPERTY

COURTS OF ENGLAND AND WALES

COMPANIES COURT (ChD)

IN THE MATTER OF THE CONYGAR

INVESTMENT COMPANY PLC

AND IN THE MATTER OF THE

COMPANIES ACT 2006

NOTICE is hereby given that by a Part 8

Claim Form dated 21 April 2022 the

above named Company has made an

application to Her Majesty's High Court

of Justice for the confirmation of the

cancellation of its share premium

account.

AND NOTICE is further given that the

application is directed to be heard

before an Insolvency and Companies

Court Judge at the Royal Courts of

Justice, The Rolls Building, 7 Rolls

Building, Fetter Lane, London EC4A

1NL on 10 May 2022.

ANY creditor or shareholder of the

Company desiring to oppose the

making of an Order for the

confirmation of the cancellation of

share premium account should appear

at the time of hearing in person or by

legal representative for that purpose.

As the hearing is expected to be held

remotely (by Microsoft Teams), any

creditor or shareholder who wishes to

appear should contact

[email protected] in

advance of the hearing.

A copy of the Part 8 Claim Form will be

furnished to any person requiring the

same by the under mentioned

solicitors.

Dated: 2 May 2022

GOWLING WLG (UK) LLP

4 More London Riverside

London SE1 2AU

Tel: 0370 903 1000

Ref: 2736084/NRH/EFA01

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