Mellham Ltd. v Collector of Taxes

1. LORD JUSTICE BUXTON: This appeal from a decision of Her Honour Judge Alton sitting in the Mercantile Court in Birmingham concerns a dispute between the Inland Revenue on the one hand and a company called Mellham Limited on the other. The facts are comparatively straightforward once one has put them in the context of the statutory provisions engaged, which relate to the payment of advance corporation tax in respect of distributions that have a foreign element, and the impact thereon of the obligation to make interest payments when those sums owed in respect of advance corporation tax are not in fact paid.

2. For simplicity I have rounded all the figures to a convenient number. The figures that I give are not those that are in detail the actual ones in the case. Mellham made a relevant distribution for the purposes of the Income and Corporation Taxes Act to its foreign overseas parent of £1.4m on 7th October 1997. Therefore, by section 14 of The Income and Corporation Taxes Act 1988 ("ICTA") Mellham became liable on 14th January 1998 to pay a sum equivalent to 25 per cent of that amount, that is to say, £350,000, as advance corporation tax under the provisions of paragraph 3 of Schedule 13 to ICTA. No such payment was made. No explanation has been given of why that was so.

3. Under section 87 of the Taxes Management Act 1970 interest on the £350,000 debt or obligation started to run from the date upon which the obligation accrued, namely 14th January 1998. That advance corporation tax was due on 14th January 1998 because the distribution had taken place in the last quarter of 1997. Corporation tax itself is computed not on a quarterly but on an annual basis. Taking into account double taxation relief, the corporation tax liability of Mellham for the year 1997 was £100,000, payable on 1st October 1998. Advance corporation tax is not normally repayable in cash, though it may be set against future obligations. There are, however, special provisions for repayment of advance corporation tax where the eventual bill for corporation tax itself is reduced or likely to be reduced because of double taxation relief. In appropriate circumstances, a company that pays a dividend such as the distribution in the present case can elect under section 246 of ICTA to treat that distribution as a "foreign income dividend". That foreign income dividend can then be set off against foreign profits that are eligible for double taxation relief. That process produces a computation for "notional foreign source advance corporation tax" which is then used, by a balancing exercise against the advance corporation tax actually paid, to restore the overall tax position to what it would have been if direct taxation relief had been taken into account throughout. The account that I have just given is, I trust, broadly accurate. It is accurate enough to illuminate the issues in this appeal.

4. The process for the balancing exercise is to be found in section 246N(2) of ICTA, which reads as follows:

"In a case where -

(a) the company pays an amount of advance corporation tax in respect of qualifying distributions actually made by it in the relevant period,

(b) the amount, or part of it, is available to be dealt with under this section, and

(c) there is as regards the company an amount of notional foreign source advance corporation tax for the relevant period,

an amount of the advance corporation tax paid shall be repaid to the company, or set off, or partly repaid and partly set off, in accordance with this section and section 246Q."

The distribution of the surplus or overpaid corporation tax is dealt with in two ways: firstly, as a set-off against the payer's actual corporation tax, which is provided for by section 239(1) of ICTA; and, secondly, as to any further surplus, by repayment under section 246Q(2) of ICTA, a section it is not necessary to set out. It is agreed in this case that, if it had actually been paid, the whole of the £350,000 would have been eligible for distribution under section 246N(2). The appellant contends that the £100,000, which was the actual corporation tax obligation of the company, should therefore be set off against his corporation tax bill, and the remainder of the advance corporation tax, £250,000, should be repaid to him.

5. In the events that occurred, none of the £350,000 advance corporation tax was ever paid by the appellant; nor was any payment made in respect of the outstanding sum of corporation tax of £100,000. In July 2001 the Revenue obtained judgment for that outstanding sum and Mellham met that judgment. £100,000, or something very close to it, was thereafter agreed by the Revenue to be the amount of corporation tax owing after calculation of double taxation relief, but ignoring credits that were available from adjusted ACT.

6. The Inland Revenue's position is that no such credits are available in respect of the advance corporation tax liability because no advance corporation tax has been paid. However, because the £100,000 has in fact been paid in respect of corporation tax, the Revenue has expressed itself content to regard the unpaid corporation tax as limited to £250,000, that is to say, the unpaid sum of £350,000, less the £100,000 paid on the judgment; and further to make no claim for the principal of that balance, because, if paid, it would have to be immediately repaid under section 246Q(2). The issue in this appeal is not about the figures, as I have already said, nor is it about the principal sum, but it is about the continuing interest on the unpaid advance corporation tax. The logic of the Revenue's case is that interest continues to be due on the whole of that sum, but as a concession it limits its claim to interest due before 4th December 2001, one week after the final payment of the appellant's obligation under the judgment in respect of corporation tax, and it advances its claim to interest only on the sum of £250,000. The appellant contends that, once the provisions of section 246N(2) are applied to this case, far from the appellant owing the Revenue £250,000, the Revenue owes that sum to the appellant under section 246Q(2) and is liable to pay interest on that debt under section 826(1)of the Taxes Management Act. The principal question, as formulated before us, was said to be whether and to what extent section 87 of the Taxes Management Act applies in this case at all; that is to say, can it be said that "payment" under section 246N(2) occurred at some date in October or December 1998?

7. We therefore have to address the proper construction of section 246N(2), because these provisions only come into operation, and the assistance that the Act gives to a company in the position of Mellham only applies, "in a case where the company pays an amount of advance corporation tax". No payment has been made here, but it is argued that the obligation created upon the Revenue to repay the surplus of advance corporation tax, once that payment is made, creates a set-off in favour of the taxpayer by reason of the fact that, had the money been paid once the corporation tax obligation had accrued, it would indeed have had to have been immediately paid back by the Revenue.

8. The issue therefore is one of simple statutory construction. Can the expression "payment" when used in section 87 of the Taxes Management Act 1970, or "pays" when used both in section 246N(2) of the ICTA and section 239 of the ICTA, encompass a set-off of the sort that the appellant asserts? In order to succeed, the appellant has to establish, both that those statutory references to payment or paying can potentially include a situation of set-off; and also that in this case "set-off" was in fact available to the appellant. In my judgement, the appellant fails on both of those scores.

9. Before going into that matter in more detail it is, I think, necessary to say something about the general nature of the concept of set-off. What follows is not in fact necessary for the decision of this appeal because the appeal turns, as I have indicated, on the issue of statutory construction to which I will come. However, because of the way in which set-off has been spoken about in this case, and hopefully to clear the ground, I need to say something in general terms about it.

10. There are in my estimation three aspects of the concept of set-off that are or are potentially relevant in this case. The first is what I would venture to call, though only for the purposes of identification, equitable set-off properly so-called. That is described by Morris LJ in Hanak v Green [1958] 2 QB 9, an account described as masterly by Lord Diplock in Gilbert Ash v Modern Engineering [1974] AC 717. What that account makes plain is that Morris LJ was addressing himself to the circumstances in which set-off as a defence or counterclaim can be introduced into legal proceedings after action brought. Morris LJ sets out how it was that, after the Judicature Acts, set-off in that sense was available in proceedings other than under the statutes of set-off. In other words, that is an exercise or operation that takes place in the context of cross-claims in legal proceedings. It is not our case.

11. Secondly, it has been suggested much more broadly that "equitable set-off" also extends to what has been described by at least one commentator as a "self-help" deduction of a cross-claim on payment, which will in appropriate circumstances protect the payer of the smaller amount even before he raises a cross appeal when sued. For my part, this would seem to be the only species of set-off that potentially arises in our present case.

12. To explicate that species of set-off, Miss Dunn took us, as she had taken the judge, to some observations of Lord Denning MR in Federal Commerce and Navigation Co Ltd v Molena Alpha [1978] QB 927. Lord Denning referred at page 974 to the history of the law of equitable set-off and said this at page 975:

"It is only cross-claims which go directly to impeach the plaintiff's demands, that is, so closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim."

In that case it was held that charterers were entitled to deduct from hire payments valid claims in respect of underperformance by the vessel. Cross-claims were adjusted outside the ambit of litigation, and the case therefore went further than Hanak v Green. This jurisdiction is however of uncertain basis, and certainly very strongly fact-specific, as Her Honour Judge Alton observed. Further, it is far from clear that Lord Denning's observation can be relied upon as a general principle, available in every case where it is alleged that manifest injustice would apply or be asserted. As Brooke LJ pointed out in the course of argument, that apparent approach on the part of Lord Denning did not appear to be adopted by the other members of the court. Moreover, at least some difficulty is caused for the contention that a self-help set-off can expunge a claim by an observation of Lord Wilberforce in Aries Tanker Corporation v Total Transport Ltd [1997] 1 WLR 185, 188H. Speaking of what appears, if I may respectfully say so, to be a deduction of that sort, he said:

"The deduction of $30,000, unaccepted by the respondents, conferred no legal rights, and could not alter the legal position."

It is not necessary, as I have emphasised, to reach any firm conclusions on this aspect of the law: first, because it is not necessary for a decision of this case; and, secondly, in my judgement, the dictum, as I respectfully think it to be, of Lord Denning does not apply to this case. It will have been noted that he limited the case to cross-claims which go directly to impeach the plaintiff's demands. But that is not this case, because the cross-claim made in this case, to repayment, far from impeaching the claim to advance corporation tax can only arise if that claim is satisfied by payment. I therefore do not think that this is a case that remotely approaches the categories of fact envisaged by Lord Denning, irrespective of whether or not Lord Denning's verbal formulation is too broadly put.

13. In this connection Miss Dunn also took us to an early Australian case, Ralston v South Greta Colliery Co, a decision of the District Court of Appeal of New South Wales in 1912, that, she said, demonstrated that equitable set-off could be satisfied by a conditional claim such as her client had to advance in this case: that is to say, on the basis of a right to repayment as if the original payment had actually been made. Ralston comes nowhere near to any such proposition; much less anywhere near to supporting any such proposition as a general understanding of the nature of set-off. I do not take time setting out the facts, but I summarise them by saying that there were a series of interlocking obligations which the court in New South Wales considered that equity would permit to be asserted all in the same proceedings, rather than requiring what might have happened before the Judicature Acts, when separate claims had to be fought out in separate actions in different courts. Not only is that an example of set-off in proceedings rather than by self-help; it also is clearly an example of the orthodox operation of equitable set-off in the sphere of litigation. It does not help in this case.

14. Thirdly, it is possible for parties to agree consensually to arrange their affairs in a particular way, which sometimes produces an outcome that is the same as in a set-off of the type that I have just referred to. That result depends on an agreement of a normal contractual nature. It is hardly likely to produce much of an analogy in our case where the set-off is asserted to be as of right on the part of the appellant, not depending at all on any agreement on the part of the Revenue, but indeed overriding the will of the Revenue, and also what might appear to be a contrary statutory provision.

15. Against that background, I turn to what the appellant says is the issue in the case: whether payment in section 87 indeed means payment alone or includes equally set-off. Miss Dunn argues that although there is now no argument about the principal, it is to be assumed that something equivalent to payment had taken place at the time at which the balancing exercise in respect of corporation tax would have occurred. At that stage her client had no further obligation in regard to the principal, and therefore, the equivalent of payment having been made, no interest can thereafter be charged.

16. As I have said, I cannot accept, despite Miss Dunn's submissions to the contrary, that that contention can be divorced from what I understood to be her concession that no payment was in fact made under section 146N(2). That is because, first, if the appellant does not pay an amount of corporation tax, none of the structure of repayment thereafter has anything to bite on; and, secondly, because it would be extraordinary if, in the structure of these related Acts, payment meant something difference in one section from another. I am quite satisfied that, both in section 246N(2) and in section 87, "payment" cannot extend to a set-off. First, it is the literal meaning of the statute that payment means payment, not to be departed from without good reason. Secondly, the statute itself distinguishes payment from set-off. It does so in terms in section 246N(2), and the judge drew attention to that, if I may say so rightly, at page 13F of her judgment, when she said this:

"Part of the pattern of the Act is to use words "paid" and "repaid" in circumstances which do not sit comfortably with the concept of set-off. It is interesting also to note that where it regards it as appropriate, the statute does, indeed, refer to set-off and one sees those words in section 246N(2) itself."

Third, there is a clear policy reason, in the interests of the Revenue's cash flow, why advance corporation tax must be actually paid, and not treated as a suspended book debt which the taxpayer can revert to or fall back on when his corporation tax comes to be assessed. The judge so found at page 4A of her judgment:

"It is plain that advance corporation tax is designed to define and instigate an income stream to be paid in to the Revenue in advance of the corporation tax assessment."

That, I think, is not a controversial point, but it is valuable to see it as the basis of the judge's approach to this subject. It points very strongly against any suggestion that a taxpayer can be counted as having "paid" advance corporation tax when he has paid nothing at all. Fourthly, the very outline account that I have ventured to give of the background to the law of set-off indicates that, on any view, it is something very different from, much more complicated than, and much more many-headed than the single concept of payment. It would be odd indeed if the legislature had imported the concept of set-off into a statute without making it plain what aspect of set-off it was referring to, and even more difficult to know, against the background that I have set out, exactly what it is that counts as a set-off that can be relied on as equivalent to statutory payment.

17. The appellant's argument, at paragraph 43 of counsel's skeleton, was to say that "it was well established" that payment in a statutory context normally includes set-off. The appellant had to go that far because, if all that could be said was that it was potentially possible for payment to include set- off, that would be not nearly enough to offset the considerations from the structure of the Act that I have ventured to set out. Before the judge the Federal Commerce case was relied on for this contention. I have already set out why I do not think that it can carry any general construction, much less any construction of the word "paid".

18. Further authority relied on is Spargo's case, Harmony and Montague Tin and Copper Mining Company (1873) 8 Chancery Appeals 4O7, the authority of which is no doubt only reinforced by its antiquity. That case has nothing to do with the case before us, and I think that I am right in saying that it was not referred to by Miss Dunn in her oral submissions, though it played a part in the skeleton argument.

19. The two difficulties that immediately present themselves are, firstly, that it seems to me that such set-off as occurred in that case was in fact a set-off by agreement and therefore does not touch the present case, for reasons that I have already given; and, secondly, it is difficult to say that set-off of the type that was envisaged in Spargo's case could extinguish the debt in the way that has to be contended for in our case. It is also relevant to note that in Spargo's case Mellish LJ (at page 413) said that the setting off of accounts that he envisaged in that case only applied between settled accounts: but in our case the account on the appellant's side was never settled. There is, therefore, no authority that supports the view that the concept of payment in a statutory context normally envisages set-off. Even if that were not so, and further in relation to our case, the judge was in my view right to say that the appellant's argument in this case is circular. The judge dealt with this at page 13B, adopting a submission made to her on behalf of the Revenue. In our case, the appellant's right is not to an independent payment by the Inland Revenue, but to repayment of a surplus that has not been set-off against corporation tax. It seems to me quite obviously to be the case that there can be no repayment and no right to repayment if the sum out of which the repayment is to come has not been paid in the first place. This is not an objection that the appellant's right is simply conditional, but rather the objection that the right does not arise at all until the advance corporation tax is paid. That is not so much a matter of legal analysis as one of fact. The factual position cannot in my judgement be improved by the appellant claiming as "payment" a set-off that can only arise once an actual payment is made. The judge took that view, saying at page 14E:

"Here I accept that there are, as Miss Hitching submits, in practice, and until the ACT liability is discharged, two liabilities but both of these are owed by the defendant to the Revenue. There is, accordingly, nothing to set off against anything. I conclude that one cannot establish a set-off, whether at common law or equity it matters not, against an admitted liability, a right to repayment which can only arise once the admitted liability has been discharged. The two liabilities are not concurrent. The second liability is ultimately contingent upon the discharge of the first."

I respectfully agree. That, as the judge went on to say, is another reason why Lord Denning's observations in Federal Commerce do not assist the appellant because, for the reasons that the judge had just indicated, the cross-claim in this case does not go to impeach the plaintiff's demands.

20. The appellant complained at the potential complication, indeed the unfairness, of the Revenue's position, the logic of which I have set out, that the right to interest continues until payment is made, and contends that that is a very unlikely result if it is said that that right adheres even after the obligation in respect of the principal has been cleared by the operation of section 246N(2). That argument only has force if it is accepted that in some way the taxpayer has a right not to discharge his statutory obligation to pay in the first place; and it was conspicuous that Miss Dunn entirely accepted that her client was liable for both the capital and the interest in the period between 14th January 1998 and the date upon which the corporation tax liability was settled. The equity was only claimed at the latter date. If the taxpayer wishes to protect himself he protects himself by tendering the amount of advance corporation tax. If at that stage the Revenue says, as we are told they said in this case: "We do not require you to tender it because the balance is in your favour", then it is, I am afraid, wholly artificial to suggest, as the appellant suggested, that the Revenue could thereafter in any effective way seek to enforce either principal or interest. But that is not in any event what this company did. Had it done so, had it paid its advance corporation tax as the statute required, in January, none of this trouble would have occurred and we would not have had to spend time investigating what I have to say are arcane matters of equitable law.

21. This tax system is simple and straightforward. Taxpayers may not like it but it is what Parliament has decided. If people keep the rules everybody knows where they are. The rules were not kept in this case. I would dismiss the appeal.

22. I say as a footnote that some reference was made in the skeleton argument, though not before the judge, to article 1 of the First Protocol to the European Convention on Human Rights. Miss Dunn did not pursue that point before us. She was right not to do so. It is well known that the tax system itself is only in the most extreme circumstances vulnerable to attack under the Convention. As far as any allegation of unfairness is concerned in this case, that only arose if it was the case, which it is not, that liability to payment ceased at some stage in October or December 1998. The Convention therefore adds nothing to the rest of the arguments. The appellant fails on those arguments and fails on the appeal as a whole.

23. MR JUSTICE MORLAND: I agree.

24. LORD JUSTICE BROOKE: I also agree. The appeal is dismissed.

Order: Appeal dismissed with costs assessed in the sum of £3,848.