The Inland Revenue has decided not to appeal against the decision of the Special Commissioners, given on 31 May, in a landmark case involving four building societies that converted from mutual status to banks. At stake was nearly half a billion pounds of costs that had been incurred by the Woolwich, Halifax, Northern Rock and Alliance and Leicester.
In all four cases, the Inland Revenue had disallowed deductions in respect of the costs of conversion, and contended, first, that the sums incurred were not incurred wholly and exclusively for the purposes of the trade and, secondly, that the expenditure was capital in nature (See section 74 (1), Income and Corporation Taxes Act 1988). The cases were heard sequentially, with Halifax plc v Davidson [2000] STC (SCD) 251 being the first. As the Halifax served as the base case for legal argument (with variances only being addressed in the other three cases), this article focuses mainly on the Halifax.
The dispute
With regard to the first issue, “wholly and exclusively”, it was argued by the Revenue that the object of the Halifax in incurring the expenditure was to benefit not only the core trade of the Halifax, but also activities that were not part of its trade.
The Revenue identified six particular “objects” of conversion, which included: benefitting the trades of its subsidiaries and (non-trading) holding company operations; and resolving the tension between the interests of members who were customers and customers who were not members. It was argued that these objects were the “real” purposes of conversion, and even if they were not purposes but consequences, they were “consequences so inevitably and inextricably involved in the expenditure that they should be taken to be purposes even if not consciously regarded as such”.
The Special Commissioners considered the Halifax’s intentions at the time of incurring
the expenditure and found that only one of the six “purposes” identified by the Revenue had actually been a purpose – resolving the member/customer dichotomy.
However, it was a wholly trade purpose. The other “purposes” identified by the Revenue were (at most) simply effects or consequences of the decision to convert. Consequently, the Special Commissioners concluded that the costs of conversion were deductible, provided that such costs were not of a capital nature.
With regard to “capital/revenue”, the Special Commissioners said: “for a payment to be capital it is not necessary to show the acquisition of an asset which appears on the balance sheet. If such an asset does appear then that would lead to the conclusion that the expenditure was of a capital nature, but the lack of an asset on the balance sheet does not necessarily mean that the expenditure is of a revenue nature.”
It was agreed by the expert accountants that there was no relevant asset on the balance sheet. Thus, in order to determine whether the expenditure was of a revenue nature, the Special Commissioners indicated that it was necessary to identify the principles that had been established by the authorities, although they said there was no single determining principle other than the application of judicial common sense.
The conclusion reached by the Special Commissioners was that the “pointers” identified in the cases were conflicting. For example, whereas the new regulatory regime was an enduring benefit for the purpose of the trade (“capital”), the payments were made to remove a recurring disadvantage (“revenue”). Similarly, while the purpose of the expenditure was to enable the Halifax to carry on the same business unfettered by a particular difficulty (“revenue”), the particular difficulty did not arise in the course of one year (“capital”).
The Special Commissioners found that what the expenditure was calculated to effect from a practical and business point of view was a change of the regulatory regime so that the Halifax could more easily carry on its trade; and concluded that the new regulatory regime is not an asset now possessed by the [Halifax] because it is available to all companies incorporated in the same way as the [Halifax], therefore the conversion costs were of a revenue nature.
The Commissioners then went on to consider whether any of the particular costs should be treated differently. One such class of costs incurred was that of “statutory cash bonuses”, which were distributions from the reserves of the building society to investing members who did not have a right to vote on the transfer.
These were held to be capital in nature for two reasons. The first was that they received a different accounting treatment from the other costs of conversion: that they were dealt with as an item deducted from the profit and loss account reserve in the balance sheet, whereas, in contrast, the other costs of conversion were treated as an ordinary expense in the profit and loss account. Secondly, the recipients of such bonuses were liable to capital gains tax, not income tax.
Consequently, it was held by the Special Commissioners that all the disputed expenditure, other than that incurred in paying the statutory cash bonuses, is allowable as a deduction in computing the Halifax’s profits for tax purposes.
In each of the other three sequential appeals, the Commissioners held that the reasoning in the Halifax case applied and, consequently, reached the same decision with regard to the similar expenditure that had been incurred.
