Peninsular & Oriental Steam Navigation Company v HM Revenue and Customs

This judgment is about the tax effectiveness of a “rate-boosting” scheme (“the Scheme”), that is, a scheme to boost claims to double tax credit relief (“DTR”) in the hands of a UK parent company (“the UK ultimate parent”) on a dividend (“a Case V dividend”) received by it from any of its overseas subsidiaries and originating from another UK resident company (“the UK subsidiary”). A Case V dividend is taxable under Case V of schedule D to the Income and Corporation Taxes Act 1988 (“ICTA”). The UK ultimate parent is entitled to credit for foreign tax suffered by the paying company (“the paying subsidiary”) and its subsidiaries.

The object of the Scheme is to maximise the amount of the credit in response to changes in the law made in 2000 and 2001. The Finance Act 2000 for the first time limited the amount of the foreign tax credit to the maximum amount of UK corporation tax via “a mixer cap” (explained below) by amending the double tax code in the ICTA. In the following year the Finance Act 2001 sought to mitigate the effects on multinational companies apparently by allowing credit in a specific case, namely for tax that would have been paid by the UK subsidiary of a foreign subsidiary if it (the UK subsidiary) had not been relieved from paying UK tax at the full rate, for example by using group relief. For this purpose the UK subsidiary might be an indirect subsidiary owned by an overseas intermediate holding company, but each of the companies in the chain would have paid dividends (“intragroup dividends”) to the company up the chain. The credit derived from the UK company at the bottom of the chain (“the bottom company”) would be reduced as it became diluted by other profits when it went up the chain.

The purpose of the relevant provisions of the Finance Act 2001, it is said, was to put the UK subsidiary of a foreign subsidiary of a UK parent which does not pay UK tax at the full rate effectively into the same position as the UK subsidiary of a UK parent company which pays a dividend to its UK parent. That payment of dividend is not subject to UK corporation tax. It was considered by HMRC and others that the absence of DTR in this situation (“the Unfair Case”) was unfair.

The dispute on this appeal is based on a difference of approach to the relevant charging provisions. Principally, the appellant, which is the UK ultimate parent in this case, contends that, under the legislation as amended, in the Unfair Case the amount of the credit (allowed in this case by unilateral DTR) is fixed mathematically by reference to the difference between the amount of foreign tax credit resulting from the mixer cap and the amount of underlying tax (foreign tax), which might be nil. HMRC, on the other hand, say that this case is answered principally by two propositions: (1) that underlying tax must have been paid for DTR to be given (“the tax borne argument”) and (2) that the dividend paid by the UK subsidiary must flow through to the UK ultimate parent, i.e. be the source of profits for successive dividends up the chain to the UK ultimate parent, which to all intents and purposes did not happen in this case (“the disappearing dividend argument”).

In essence both the First-tier Tribunal (“the FTT”) (Sir Stephen Oliver QC and Helen Myerscough FCA) and the Upper Tribunal (“UT”) (Proudman J and Colin Bishopp) upheld HMRC’s rejection of the appellant’s DTR claim. I have come to the conclusion after careful consideration of the arguments that the appeal should be dismissed (save in minor part) but on the basis that the appellant is right on the tax borne argument but that HMRC is right on the disappearing dividend argument. This will sound like heresy to HMRC which urged on us that double taxation necessarily involved that the original dividend had been paid out of profits which had been taxed in its local jurisdiction. But I see no reason why Parliament should not have decided in the national interest to give a foreign tax credit where A, who is resident overseas, makes a payment of dividend out of profits distributed to it by a UK subsidiary to a UK-resident company B in circumstances where the payment carries tax in the UK but would have carried no tax if A had been in the UK, and to do so without requiring that A or its subsidiary should have suffered tax locally. Parliament might logically impose a condition (as happened here) that the payment should arrive in the UK with B, but equally it could provide for the credit to be reduced in line with the payment that was reduced if the payment only reached the UK to some extent (the extent being matched by a sliding scale of reducing fractions for the credit). That is a very simplified statement of my conclusion, and, even though the legislation with which this appeal is concerned has been repealed there are surely issues here which are relevant to the future development of double tax.

At the end of the day there are only two points of statutory interpretation that matter: the interpretation of tax “borne” and cognate expressions (which affects sections 790(1), 799(1) and 801 ICTA) and the interpretation of “higher level dividend” (sections 806B and 806J). Essentially the UT took the same view. I shall explain how the appellant’s DTR claim arises and summarise the decisions of the Tribunals. Then I shall:

summarise the double tax code on tax credits

summarise the key submissions (organised not as counsel presented them but round the two points I have identified)

set out my conclusions with reasoning.

We are not asked about the amount of any DTR credit: we are simply dealing with questions of principle. Nor are we concerned with the appellant’s claim under the UK/Australia double tax treaty for Australian tax paid (the local tax). When in this judgment I refer to a company as a UK company, I am referring to a company which is liable to UK tax. References below to “the legislation” and “the statute” are (unless it appears otherwise) to the statutory provisions on DTR which I am about to outline and which form part of what is effectively a code of statute law.

Because of the disappearing dividend argument, the sequence of events is important. One of the issues which arises is a timing issue because the intermediate holding company paid a dividend in May 2004 before the UK subsidiary paid it the dividend in November 2004 which the appellant contends gives rises to creditable foreign tax.

P & O Australia Ltd (“POAL”), a wholly-owned Australian subsidiary of the appellant (“P & O”), held 99% of the share capital of Liena Pty Ltd (“Liena”). Abbott & Goldman (“A & G”) was a UK company, which had not paid the full rate of UK corporation tax. It is common ground that POAL and Liena are members of an Australian tax group that was taxed in Australia as a single entity and accordingly, where appropriate, the term “POAL” in this judgment includes the two companies so treated.

On 26 May 2004, POAL declared an interim dividend (“the First Dividend”) of A$ 75m in favour of P & O. The dividend was payable on 27 May 2004 and was from its profits for the year ended 31 December 2004.

On 14 October 2004, Liena, a subsidiary of P & O subscribed A$193m for shares in A & G. On 15 October 2004, these shares were cancelled and A & G credited the sum of A$193m arising on that cancellation to a profit and loss account reserve.

On 19 November 2004, A & G paid a dividend of £193,766,877 to Liena. It is common ground that, as a matter of company law, this was a lawful dividend. The dividend was paid out of the profit and loss account reserve arising on the cancellation of Liena’s shares and as to the balance out of trading profits. The profits standing to the credit of the profit and loss account reserve were not chargeable to tax. The trading profits were chargeable to tax and that tax would have constituted “underlying tax” as defined in section 792(1) but for the fact because A & G used group relief, which had been surrendered to it, to discharge its liability to tax.

Liena applied nearly the whole of the dividend which it received from A & G in writing down the book value of its investment in A & G. The amount written off did not appear in Liena’s profit and loss account for the period 1 January to 23 November 2004.

On 22 November 2004 Liena declared a dividend of A$820,000 payable on 23 November 2004 to its shareholders. Of this, some A$811,800 was paid to POAL.

On 30 November 2004 POAL declared a dividend (“the Second Dividend) of A$80m out of its profits for the year ended 31 December 2004, which it paid the next day.

P & O claimed DTR of about £21m. HMRC subsequently allowed DTR for £6.7m only. Foreign tax credit is allowable as a relief in the UK by unilateral relief.

The diagram set out below shows the dividends that were actually paid by POAL/Liena and A & G (with their tax residence indicated in brackets next to their names):

I have omitted any reference to the substantial intragroup loans that were made. The parties did not refer to them on this appeal or suggest to us that the issues were affected by any sham or steps taken to avoid tax.

The FTT rejected the whole of the appellant’s claim for DTR. It held that the profits out of which A & G paid its dividend to Liena had “borne” tax for the purposes of section 799(1) even though it had not paid any tax due to group relief ([53]). It then identified the three statutory assumptions in section 801. As I explain below I agree with that approach, and that the profits out of which the A & G dividend was paid fall to be treated as having borne tax.

The next part of the FTT’s reasoning is not in all respects relevant to this appeal. The FTT sought to identify the amount of the foreign tax which would have been payable on the A & G dividend. It assumed that the item for tax of A$339,376 shown in A & G’s accounts was tax paid (it was in fact the sum paid for the surrender of group relief). Nonetheless it held that this tax was not attributable to the dividend ([56]). The FTT went on to hold that neither the dividend from Liena to POAL nor that from POAL to the appellant were higher level dividends because (in the case of Liena) Liena had actually used the monies paid by A & G to repay a loan payable by it to P & O and (in the case of POAL) POAL had other distributable profits which could be used to fund the dividend ([57]). The FTT went on to conclude on the facts that the A & G dividend was not a dividend for the purposes of sections 799(1) and 801 and that it should be characterised as a loan ([60] to [72]). The appellant’s expert witness, Mr Steve Parkinson ACA of Ernst & Young, gave evidence on the appropriate accounting treatment. This part of the decision is superseded by HMRC’s agreement that the A & G dividend was lawful as a matter of company law.

I shall now summarise some of the detailed reasoning of the UT based on provisions which I summarise in the next section of this judgment, and so this paragraph should be read with that summary. The UT upheld HMRC’s argument that section 790(6) could only include tax actually borne and not deemed tax ([72]). Moving to section 799(1), the UT then held that deemed tax could not be “borne” and could not be “attributable” to profits represented by a dividend ([74]). It further held that even if “U” in section 801(4A) could be nil, the mixer cap could not apply because section 799(1) did not apply. The effect of section 801(4B) was to treat as tax paid by POAL the tax payable by A & G, but as that tax as nil, the tax to be treated as paid by POAL similarly was nil ([76]). There was therefore nothing on which section 801(4A) to (4D) could bite. But even if that was wrong, the UT rejected the appellant’s submission that section 801(4B) applied because in their judgment it could not be shown that the mixer cap formula resulted in a figure which exceeded U ([77]). So the gateway in section 801(4A) was not open. In any event, the FTT were correct to hold that on the facts there was no higher-level dividend ([78] and [79]).

As to the decision of the UT, as appears above, I have come to the contrary view on “tax borne” and on the effect of section 801(4B). I consider that the decision of the UT was therefore in error. As will appear, I agree in part with the UT on higher level dividends.

In this case the relevant relationships were that of parent and subsidiary. The legislation with which we are concerned also applies to companies which have a looser relationship. Nothing turns on that so for simplicity I will describe the provisions as if they were limited to parent and subsidiary companies. The code which I next summarise is that applying at the time relevant for the purposes of this appeal. The focus of this judgment will as indicated above be on sections 790, 799, 801, 806B and 806J but I have taken the sections in sequence for ease of explanation.

The relevant provisions may be summarised as follows:

Section 792 defines “underlying tax” as in effect the tax imposed on the profits out of which the dividend has been paid. This is to be distinguished from withholding tax paid out of dividends.

Section 790(12): credit is given only for foreign tax which corresponds to UK corporation tax.

Section 795(2): the amount of the Case V dividend is grossed up by the underlying tax to determine the amount of the income chargeable to tax.

Section 797(1): the amount of a credit for foreign tax is capped at the current corporation tax rate. Prior to the introduction of the mixer cap, any limit on the rate of tax was avoided by the use of “mixer companies” but that was negated by the mixer cap in section 799(2).

Section 799: is the basic provision that determines the amount of underlying tax to be set against the tax chargeable on the Case V dividend.

Section 799(1)(a): where relief is provided for, the creditable foreign tax is limited to the attributable proportion of the foreign tax “borne” on the “relevant profits” by the bottom company. There is no definition of “borne”. This limit applies to each company in the chain.

Section 799(3) to (6): “relevant profits” are in general distributable profits for a specified period or, if no period was specified, the last period prior to the date of the dividend for which the company had drawn up accounts.

Section 799(1) (b) and (2) (“the mixer cap”): under arrangements for relief, the UK ultimate parent company can claim foreign tax credit for the dividend paid by the bottom company up to the maximum rate of corporation tax. This is achieved through the formula: (D+U) x M% where D is the dividend ( www.practicallaw.com/A34897) , U is the foreign tax attributable to that dividend and M is the maximum relievable UK corporation tax ( www.practicallaw.com/A34755) . The mixer cap applies to underlying tax only but to all companies in the chain.

Section 801 adapts the method in section 799 for the computation of DTR in three ways: (1) third country taxes, (2) dividends paid by companies below the company paying the Case V dividend in the corporate chain and (3) tax on dividends paid by UK subsidiaries of a foreign subsidiary. This appeal is concerned only with (3), which is achieved by sections 801(2) and 801(4) to (D).

Section 801(4A): constitutes the gateway to section 801(4B). A dividend passes through this gateway if with respect to any Case V dividend the amount produced by the mixer cap formula exceeds the actual underlying tax (“the excess”).

Section 801(4B): if a dividend goes through the gateway, then (on the appellant’s case) an “appropriate portion” of the excess is added to underlying tax which may be set against the tax payable on the Case V dividend.

Section 801(4C): the appropriate portion is ascertained in accordance with section 806B by reference to higher level dividends. These are dividends which “to any extent” represent the dividend paid by the UK subsidiary or is the Case V dividend (section 806B(10)). The appropriate portion is obtained by (a) working out for each higher level dividend a simplified fraction of the dividend divided by the dividend-paying company’s profits and (b) multiplying these fractions. The resultant fraction is then applied to the excess (see section 806B (5) and (6)).

This issue is crucial because A & G did not pay any UK tax on the profits out of which it paid the A & G dividend. A claim to DTR is given against “tax payable” (section 790(1)) and “tax borne” (section 799(1)). Section 799(1) is imported into section 801, which extends the relieving provision in section 799(1) to UK tax incurred by UK subsidiaries of overseas intermediate holding companies. The appellant must lose if the legislation imposed a requirement that A & G should actually have paid underlying tax (which in its case was UK tax). As I see it the ultimate issue is what “underlying tax payable” in section 801(2) means. The rest follows.

Jonathan Peacock QC, for the appellant, summarises his wider submission here: under section 801(4A) the only question is whether there was an excess between the amount produced by the mixer cap and the underlying tax. For this purpose U could be a nil amount. If there was an excess, then under section 801(4B), the amount of the underlying tax was increased. Mr Peacock deals in detail with the tax borne argument.

First, submits Mr Peacock, despite the reference to section 799(1) in the opening words of section 801(4A), once a claim comes within section 801(4B), there is no need to go back to section 799(1) because section 801(4B) applies where section 799(1)(a) and (b) have already been applied. Parliament would not have intended a result whereby it was necessary to go back to section 799(1) because that would lead to a “world of endless iterations.”

On Mr Peacock’s submission, the purpose of section 801 is that a dividend paid by a UK subsidiary of an overseas holding company should give rise to a foreign tax credit even if the UK subsidiary had not paid UK corporation tax in full (see the explanation of the purpose of this legislation in paragraphs 2 and 3 of this judgment). Section 801 asks whether any underlying tax is “payable”. It is only necessary to find whether there is an excess between the statutory amount and the underlying tax. If there is an excess, the effect of section 801(4B) to increase underlying tax. That then becomes underlying tax even though no tax has been paid. Unless there is no local tax, the underlying tax is payable.

So on Mr Peacock’s submission section 801(4B) must apply where tax is neither payable nor paid. The legislative scheme applies to distributable profits, which are different from taxable profits precisely because the profits may be relieved from tax, as in this case (or by capital allowances and so on). It can hardly have been intended, therefore, that underlying tax should either be paid or payable before section 801 applies. Moreover there are textual indications that this is so since (i) section 801(4B) applies directly to the Case V dividend “after applying paragraphs (a) and (b) of” section 799(1), which are paragraphs which deal with underlying tax; (ii) section 801(4B) expressly increases the foreign tax for which unilateral relief is available, and (iii) the increased foreign tax is described as underlying tax even though no such tax actually exists.

One of the diagrams produced by Mr Peacock shows the amount of corporation tax which the UK ultimate parent will have to pay (having taken into account DTR) in three situations (i) as a result of section 801(4B) construed in accordance with (a) HMRC’s approach and (b) the appellant’s approach and (ii) the amount of corporation tax which would have to be paid in relation to a dividend paid by the UK subsidiary where there is no overseas intermediate holding company. The appellant’s interpretation leads to a consistent straight-line progression according to the amount of underlying tax paid by the UK subsidiary (shown by a line on the graph) whereas using HMRC’s approach, the result is an inverted Laffer-type shape (my description) where the rate of tax paid by the UK subsidiary is half or less than the full rate of corporation tax, the rate of corporation tax rises (and DTR falls). The diagram also shows the UK company to UK company situation which the situation of a dividend paid by the UK subsidiary of an overseas intermediate holding company was intended to mirror.

Mr Peacock submits that HMRC’s approach, which means that the subsidiary must pay some underlying tax, leads to the anomaly that relief may be given even though only £1 tax has been paid. A UK subsidiary may therefore get the relief as if it had been a direct subsidiary where only £1 relief taken, but not if no tax was paid. This is incoherent. On Mr Peacock’s submission, the legislation does not require the question to be asked why no tax was paid.

Mr Peacock draws an analogy with “tax spared”: in some cases an otherwise taxable event is “spared” tax i.e. given DTR, even though there is no underlying tax paid. Provision is made for tax sparing in section 788(10A). Mr Peacock submits that in section 788(10A) Parliament does not ask why tax was not paid. Likewise section 788(5) provides that in the particular circumstances there described tax not paid shall be treated as payable. Section 801 is a mini-code to equate the position of a UK subsidiary of an overseas intermediate holding company with that of a UK company which pays a dividend direct to its parent free of tax.

Mr Peacock relies on the treatment of the excess as foreign tax in 801(4B). “Foreign tax” is defined by section 792 as tax which is chargeable and thus as payable. The fact that it is not paid is irrelevant. Moreover, he submits the charging provisions work by reference to “relevant” (i.e. distributable) profits, not taxable profits. This is a deliberate choice and is consistent with the intention that the provisions should apply to tax whether or not it has become payable or been paid.

David Goldberg QC, for HMRC, submits that as A & G paid no underlying tax, the section 801(2) gateway was not open, that section 801(4A) was not satisfied and that section 801(4B) is not applicable.

Mr Goldberg submits that the appellant ignores the express wording of the legislative scheme. He submits that sections 790(6) and 799(1) refer to actual, not deemed, tax. The section 801(4A) gateway has not been opened and so section 801(4B) does not apply.

In any event, submits Mr Goldberg, both section 801(4A) and section 801(4B) apply when the exercise is one of applying section 799, that is, for the purposes of ascertaining DTR in relation to the Case V dividend. Having regard to the provisions of section 790(3) and (6), only foreign tax which is actual tax falls to be taken into account. That is because the reference to local tax “paid” in section 790(6) is by implication the underlying tax. That means that in the field of DTR arising out of dividends paid by subsidiaries there is not just a mixer cap but also a cap in that the tax must be “borne”: section 799(1). Contrary to the appellant’s case, the legislation does not refer to deemed tax. The words “of the underlying tax” in the mixer cap formula have to be given meaning. Moreover, the statutory definitions of “foreign tax” and “underlying tax” in section 792(1) both look to actual, not deemed, tax.

Section 801(4B) provides that foreign tax is to be increased, and that must on Mr Goldberg’s submission be actual underlying tax. Mr Goldberg accepts that the inverted Laffer-type graph produced by Mr Peacock may produce odd results but the words “underlying tax” are in section 801(4B) and impose a cap.

Mr Goldberg submits that the tax must be paid or payable. Mr Goldberg submits that section 799(1) continues to be relevant because otherwise there may be no application of section 799(1)(b). On his submission it is unnecessary on this appeal to determine whether the expression “tax payable” includes tax set off against losses. It might do so, but here U is nil. As the appellant states, the sum of A$193m could never have borne tax.

Mr Goldberg also submits that tax “paid” does not include tax “payable”. Tax “paid” does not therefore include tax set against losses or reduced to nil because of losses surrendered and credit taken. On Mr Goldberg’s submission it is the same in section 801(4A) and (4B). He further submits that the expression “tax borne” in section 799(1) is contemplating the type of profits which could bear tax. He submits that in the events which happened, the profits of A & G used for the payment of dividend could never have borne tax.

In addition, the tailpiece to section 801(4B) uses the words “of underlying tax”. Therefore, submits Mr Goldberg, the “tax borne” argument is sound.

Mr Goldberg accepts that it is sufficient to get through section 801(2) that only £1 of tax is paid. On Mr Goldberg’s submission, there are two caps in section 801(4B). There is a reference to foreign tax in relation to the UK company’s dividend. That must be foreign tax. Then there is a cap in section 799(1) itself (“so much of the foreign tax borne…”). The reference here is to the amount paid by A & G, reference to foreign tax must be to actual tax. So there must be tax borne on the profits for which claim is made, or at least they have to be profits of the kind that can bear tax.

Mr Goldberg submits that there are further indications in the legislation that section 790(6) and section 799(1) must refer to actual and not deemed tax. These include section 806(1)(b)(ii) which he submits makes it clear that tax must be paid before a taxpayer must make a claim for DTR. Another indication, Mr Goldberg submits, can be found in the tax sparing provisions (sections 788(5) and 790(10A) to (C)). These provisions show that, where the legislation intends to give relief when tax is not paid, it says so expressly.

Mr Goldberg submits that before section 801(2) can apply, the overseas company must be in a position to claim DTR because DTR is only given on a claim: see sections 806, 788(5) and 788(6). For this purpose the tax must be paid: section 790 (6). Therefore “payable” in section 790(2) must mean “paid”.

Mr Goldberg further submits that the A & G dividend was the wrong kind of dividend because it must be paid out of a fund liable to tax. He submits that the whole tenor of the legislation is that there needs to be an actual tax charge before the DTR provisions can apply.

In reply Mr Peacock sums up the appellant’s case by submitting that the “tax borne” argument adds nothing:

the fact that the dividend was paid out of profits available for distribution was enough. Parliament did not provide that those profits had to be capable of being taxed in the circumstances of the Scheme.

Parliament was concerned that DTR should be given where the UK subsidiary had not paid tax without stipulating or inquiring into the circumstances in which it had not paid tax.

the correct order of priority is to apply section 799(1A) and (B) to the dividend paid by the UK company (section 790(2)). Then the taxpayer goes to section 801 (4A) and (4B). At that stage the taxpayer does not go back to section 799 to see if tax borne or capable of being borne because that would lead to a world of endless iterations. As to the words “in the application of section 799…” when the words “tax borne” are applied in this context, they must mean that it is borne as a necessary consequence of the fiction in section 801(4B).

irrespective of the “tax borne” argument, HMRC’s interpretation defeats the purpose of the provision, and depends on anomalies for which there is no rational explanation and which do not exist under the appellant’s approach.

Mr Peacock submits that the dividends paid by Liena and POAL were higher level dividends because they were the intermediate companies in the corporate chain. It is sufficient that they included profits of a UK company “to any extent”. Those words do not mean “to that extent”. Moreover a dividend for company law purposes was all that was required.

Mr Peacock rejects the argument that the DTR rules do not apply where a dividend is not needed to fund a higher level dividend or a Case V dividend. He submits (in my view correctly) that there is no statutory requirement for this.

On the timing of the First Dividend, Mr Peacock submits that Liena could pay this dividend even before it had received the relevant dividend from A & G.

Mr Peacock rejects HMRC’s approach in the Tribunals that the A & G dividend was “the wrong kind of dividend.” He submits that “dividend” is not defined and that it should bear its ordinary meaning.

Mr Goldberg submits that the A & G dividend must flow through to the appellant for this legislation to apply. He submits that:

the A & G dividend was “the wrong sort of dividend” for the purposes of this legislation in that:

it was not received in full as part of the profits of the intermediate holding company;

it disappeared as a result of the write-off by Liena;

to the extent it disappeared, the recipient did not, and could not, bear any sort of tax and

it was not paid out of profits which had borne tax, or which were capable of bearing tax.

as a matter of fact, the payment by A & G was not properly regarded as a dividend.

the “appropriate portion” is zero because there was no higher level dividend.

So, to have a higher level dividend, there must be dividends representing one another (section 806J(3)). Derivation is a question of fact which Mr Goldberg submits the FTT decided in HMRC’s favour (see FTT Decision, [57]). The appellant has the onus of establishing derivation. Mr Peter Walker, group finance director, (a factual witness called by the appellant at the FTT hearing) as much as accepted that there was no chain of dividends here. He was not able to say that the POAL dividend was derived from the A & G dividend. He gave evidence to the FTT that he could not comment on what happened in Australia. In answer to the question “Read the accounts and tell me whether the A$193m passes back to the UK” he replied: “It would appear not.”

Moreover, POAL paid the first dividend before the A & G dividend and so it cannot be a higher level dividend.

Mr Goldberg stresses that the amount of the dividend must be distributable profit in the hands of both the payer and payee. It must be wholly income in the payee’s hands. That, he submits, is not this case. Section 790(6) also shows it must be the same for the payer and the payee: it must be paid “by” one company and “to” another company. Mr Goldberg submits that it is inconceivable that the drafter thought they were not distributable profits in both companies’ hands.

Mr Goldberg submits that the court should examine the facts realistically. He also submits that the dividend was the wrong kind of dividend. While, when pressed, Mr Goldberg accepts that it is not open to him in this court to argue that the A & G dividend was actually the repayment of a loan and that it should have been characterised as a loan and not as a dividend, he asks us to take into account odd features of the accounting in determining whether it is a dividend or not. I will deal with that point here. HMRC failed to prove that the A & G dividend was not paid out of distributable profits and in my judgment the Court should not speculate about what might have happened if they had done so.

Mr Goldberg further submits that the A & G dividend was the wrong kind of dividend because it must be paid out of a fund liable to tax. He submits that the whole tenor of the legislation is that there needs to be an actual tax charge before the DTR provisions can apply.

Mr Goldberg submits that the dividends paid by POAL could not represent dividends from A & G. The UT rightly held that that was essential to the purposes of the legislation. As a result of the write down by Liena of the cost of its investment in A & G it is, he submits, impossible to track the dividend paid by A & G through to the appellant and so the appellant’s DTR claim is wrong.

I have two preliminary points to make about the approach to the issues in this appeal. First, Mr Peacock, in his carefully marshalled submissions, picked his way through the statutory thicket by focusing on individual phrases taken from the statutory scheme. He drew a parallel between Humpty Dumpty’s well-known words in Lewis Carroll’s Alice though the Looking Glass, quoted by Lord Atkin in Liversidge v Anderson [1942] 1 AC 206 at 245, and the argument put forward by HMRC. I will respond to his atomised approach with a quotation from another work by the same author, Alice in Wonderland:

The right way to interpret this statutory code, in my judgment, is to read it as best one can as a whole piece of prose and to work through it from the beginning and then stop and not to pull out phrases, potentially without their context, or to overcomplicate the matter with numerous possible and, if I may say so, in some cases (necessarily) selective, examples of the operation of the provisions. I am of course very grateful for all the visual aids that we have been given to help us decide this appeal (including flip-chart size diagrams in multi-colour) but I have endeavoured simply to follow the intended sequence of the statutory provisions in my summary of reasons in paragraphs 64 and 65 below, and then (almost) stop.

My second point is about the relevance of the purpose of the legislative amendments enacted by the Finance Act 2001 so far as relevant to this case. Mr Peacock emphasises that the purpose of these amendments was to ensure the result that no corporation tax charge was levied where a UK company paid a dividend to another UK company, even where there was an overseas intermediate holding company between the paying company and the receiving company. He relies for instance on statements in the notes on clauses presented by HM Treasury to Parliament:

In my judgment, one must be somewhat cautious before accepting any assertion of purpose of an Act of Parliament not set out in any provision of the Act itself made by a party propounding a particular statutory interpretation. Of course I make exceptions for assertion of purpose deducible by implication from the legislative scheme or clearly stated in some material which is admissible as an aid to interpretation. The reason for being cautious (without intending any disrespect to either of the distinguished advocates in this case) is that such assertions can be self-fulfilling or examples of what is sometimes called “confirmation bias”.

Fortunately I can find a statutory statement which throws light on the purpose, or one of the purposes, in section 801(2). That states near the end (and here I paraphrase) that where there is a dividend by a UK subsidiary foreign tax will be taken into account as if the dividend were paid by an overseas subsidiary and there was DTR for the underlying tax. That confirms that the object is, in substance, to ameliorate the Unfair Case and (through this and other provisions) to make the tax position analogous to that of a dividend paid by one UK subsidiary to another, as explained in more detail below. But that only takes one so far: it does not set out all the conditions spoken or unspoken on which the amelioration takes place. Moreover, Mr Peacock recognises in his skeleton argument that the purpose also involves the payment of a dividend from one UK company to another UK company, that is, the flow of that dividend from one UK company to another and a taxable receipt in the UK. That, too, is deductible from the detailed provisions for higher level dividends in sections 806B and 806J.

In the next section of this judgment, I will summarise my conclusions as to how the relevant provisions work. In fact, if my summary is right, both the appellant’s legislative purpose and HMRC’s legislative purpose are ultimately achieved. The economic effect of the exemption from corporation tax for a dividend paid by a UK company to another UK company is in certain cases achieved by prescribing an amount of creditable foreign tax with respect to the dividend. It will be achieved where the dividends flow through to the UK ultimate parent. There will then be an amount of creditable notional foreign tax for the UK ultimate parent though the amount will not necessarily be the same because that depends on the amount of the dividends paid successively up the chain. Moreover, the UK ultimate parent has no further tax to pay so far as it has a foreign tax credit which it can use.

As I see it, the legislation contains a trilogy of statutory hypotheses. The first hypothesis is in section 801(1). It treats third country and UK taxes payable by an overseas subsidiary as taxes payable under the law of the country in which that company is resident. So UK tax becomes notionally foreign tax. The second hypothesis is in section 802(2). It states that “underlying tax payable by the third company [the UK subsidiary]” is to be treated for the purpose of section 801(1) as tax paid by the overseas company [here, POAL]. The third hypothesis is in the tailpiece to section 801(2): “to the extent that it would be taken into account under this Part if the dividend had been paid by a company resident outside the [UK] to a company resident in the [UK] and arrangements had provided for underlying tax to be taken into account.” The underlying tax attributed to the UK company by the second hypothesis undergoes a further transformation because the dividend is treated as paid by an overseas company and as qualifying to be taken into account for DTR purposes.

In the process of interpretation I would give the textual points second place to the trilogy of statutory hypotheses, to which I attach greater significance. I would, therefore prefer to focus on where they lead. It seems to me that, when one follows the drafter’s process of thought as reflected in the words he or she has chosen, it is possible to see more easily the meaning of the words.

I now summarise my conclusions and then I will respond to the parties’ key submissions.

In my judgment, for the detailed reasons given below, this appeal should be dismissed. The statutory scheme contains a trilogy of statutory hypotheses (see paragraphs 63 above and the next paragraph). The appellant’s scheme fails (as to very nearly 100%) not because of the statutory trilogy but because of the way in which the scheme was implemented in this case.

The way that legislation operates in this case is, as I see it, as follows:

Where, as here, the intermediate holding company is a company to which section 801(1A) applies in relation to a dividend which it pays to its UK ultimate parent, section 801(1) creates a statutory hypothesis, for the purpose of allowing a credit against that dividend as unilateral relief, that the UK tax payable by it (the intermediate holding company) in respect of its profits is underlying tax.

Section 801(2) creates a second statutory hypothesis for the purpose of section 801(1), which is relevant in this case, that where the intermediate holding company has received a dividend from its subsidiary (in this case a UK subsidiary) the underlying tax payable by the UK subsidiary is treated as tax paid by the overseas company for the purpose of applying section 801(1).

The second statutory hypothesis is to be worked out in accordance with subsections (4A) and (4B), to which it is “subject”.

The underlying tax payable by the subsidiary is subject to a third statutory hypothesis, for the purpose of section 801(1), namely that the subsidiary was not a UK subsidiary, that it had paid a dividend to a UK subsidiary and DTR arrangements provide for underlying tax to be taken into account. On that basis, the subsidiary is deemed to be liable to pay the rate of tax that would be payable on a dividend payable by a non-resident company (30%). There is nothing in section 801(2) which requires or authorises the deduction from underlying tax of any relief to which the paying company is entitled. Moreover, the use in the tailpiece of the words “underlying tax payable,” without any definite article, confirms that the tailpiece is looking at underlying tax generically, not with reference to the specific case of any particular dividend-paying subsidiary.

Section 801(4A) applies in the application of section 799(1)(b) (the mixer cap) by virtue of section 801(2) in relation to the dividend paid by the UK resident subsidiary: see opening words of section 801(4A). So section 801(2) contemplates that the ultimate UK holding company is in the process of applying section 799(1)(b) with the benefit of subsection (2) to the dividend paid by the UK subsidiary. To apply section 801(4A)(a), the UK ultimate parent works out the “amount given” by the mixer cap formula which in the case of a dividend is (100 + 30%) x 30% because the third statutory hypothesis applies, and so the UK holding company obtains the excess. It is not necessary to ask whether the value of U is nil because the third statutory hypothesis requires the application of the relevant rate of corporation tax.

As a result the ultimate holding company has gone through the gateway and now goes to subsection (4B). It now has to apply section 799 without the second and third statutory hypotheses. The final calculation of creditable foreign tax must be increased by the appropriate portion of the excess in relation to the dividend paid by the UK company. The appropriate portion must be calculated in accordance with section 806B (with modifications which need not be further mentioned).

By virtue of section 806B(6), this is a mathematical calculation based on the higher level dividends only.

Higher level dividends must be dividends which flow through to the UK ultimate parent to some extent (which could be £1). The resultant figure is the amount of the creditable foreign tax in the hands of the UK ultimate parent as a result of the dividend by the UK subsidiary referred to in (ii) above.

However, in this case, only a part of the UK subsidiary’s dividend flowed through as the dividend paid to its parents (POAL/Liena) ceased to form part of the profits of the intermediate holding company (save for the sum of about A$820,000) because the book value of the shares was written down by the amount of the profits so applied.

Even if that was not so, the First Dividend of A$75m was paid out before the profits were received. The fact that the profits are related to a financial period which covers the date does not help because the question is whether the Case V dividend represented the dividend paid to the intermediate holding company, which it did not. There was no evidence that the anticipated dividend could be taken into account as profit before the date on which it was declared.

That leaves the sum of A$811,800. This was paid by Liena to POAL as a stand-alone dividend on 22 November 2004. It thereafter formed part of the profits out of which POAL paid a dividend of A$80m on 30 December 2004. Liena and POAL were taxed as a single entity so that section 803A applies. Subject to the effect of that section (which has not been fully argued), the sum of A$811,800 constitutes the numerator for the reducing fraction to be applied to this dividend under section 806(6) and (7). It is common ground that the denominator is equal to the relevant profits of the consolidated Australian tax group and that the multiplicand is the amount of tax which is deemed to be underlying tax.

Most of the points which I would wish to make here have already been made in my summary of my conclusions. In my judgment, the fulcrum is section 801(2) which contains two of the statutory hypotheses. As to the tax borne argument, it is very attractive to read the words “tax borne” in tax legislation as meaning “tax paid” (by deduction or however). Tax “borne” is generally tax suffered. But in section 801 we are not in the actual world but in a hypothetical world. When the hypotheses in that section are given effect, in my judgment the underlying tax payable is correctly described as deemed underlying tax payable for the purposes of section 801(1) and thus for the purposes of section 799(1). The underlying tax payable produced by the hypotheses is treated as underlying tax paid and there is no need to discount the actual underlying tax by any amount if it was not in fact payable because it was relieved by group relief or capital allowances or whatever it might have been. In other words, the hypotheses are exclusive. They prescribe the only facts which can be taken into account in the hypothetical world. If the legislation were to permit the reading in of further facts, it would lead to the anomalies that HMRC’s argument entails. The inverted Laffer-type shape curve is one of those anomalies, as Mr Goldberg fairly accepted. Moreover, as the UT remarked, the idea that DTR would be available under section 801(2) if only £1 tax was paid but not if tax was fully relieved by capital allowances is capricious. In my view it is just unreal to conclude that Parliament would have provided for foreign tax credit in a group situation in all cases except the common one where a subsidiary has for reasons of sensible group financial management taken advantage of reliefs available to it. Therefore I would resist the temptation to read section 801(2) as including a restriction to actual tax paid. The resultant interpretation is consistent with the commercial purpose which Mr Peacock has urged upon us.

I have not accepted the appellant’s argument about the endless world of iterations. I consider that sections 799 and 801 can be read together in the manner set out in my summary of conclusions. I have accepted Mr Goldberg’s argument that “in the application” of section 799(1) at the start of sections 801(4A) and (4B) require the taxpayer to perform the exercise required by the relevant part of section 799, subject of course to the modifications which follow from section 801(1) and (2), which extend the field of operation of section 799(1).

Once the hypotheses are recognised it is clear that many of the textual points extracted out of other parts of the legislation are simply irrelevant and unhelpful. Thus, for example, section 790(1) refers only to tax “chargeable” which in the context must mean tax capable of being levied, and not “paid” or “payable”. The same word is used in the definitions of “foreign tax” and “underlying tax” in section 792. Section 790(6) refers to tax “paid” but in the context of dividends paid by overseas subsidiaries not UK subsidiaries. Section 799(1) refers to “tax borne” but section 799(1) operates in the context of dividends paid by UK subsidiaries of overseas intermediate holding companies in the way set out in section 801 and so is in that context subject to contrary provision in section 801. In section 801(2), the expression “underlying tax payable” is modified by the tailpiece, which makes underlying tax payable by a dividend-paying UK subsidiary to the extent, i.e. the full extent, that DTR on underlying tax would have been available on a dividend paid by an overseas subsidiary. Put another way the expression “underlying tax payable” is in this context explicated by the tailpiece (“to the extent that” etc). The tax sparing provisions demonstrate that tax need not always actually be paid to be given DTR. Section 801(4A) applies section 799(1) but that is modified by section 801(2) and section 801(4B) is dealing with the Case V dividend so section 799(1) applies without any modification. Section 801(4B) itself does not refer to tax paid or payable.

The Scheme fails in my judgment because of the disappearing dividend argument. A & G paid a lawful dividend but the recipient used most of it to write down its investment in A & G, which is perhaps unsurprising. Only a comparatively minor balance remained which may when the calculations are done be a higher level dividend.

There were a number of other arguments which I must address. The first is about whether the dividend from POAL to the appellant was incapable of being a higher level dividend because POAL did not use profits derived from A & G. The FTT accepted this argument when it held that:

The UT accepted (as I infer from the second sentence quoted) that the FTT had made a finding in this paragraph that the POAL/appellant dividends were not higher level dividends in relation to the A & G dividend but expressed doubts as to whether it was a finding of fact, as did Mr Goldberg. In my judgment, the findings in the passage cited, so far as controversial on this appeal, were the findings of law. I therefore reject the argument which Mr Goldberg advanced about Mr Walker’s evidence. It matters not on this appeal what Mr Walker conceded in his evidence to the FTT.

The FTT proceeded on the basis that the proper approach to the question whether there was a higher level dividend was to follow the sequence in which they were paid as if it were a tracing exercise. But there is also the question whether they were paid out of distributable profits and if so whether it mattered that the monies had been used for some other purpose. In my judgment the issue was not the use of cash, but of distributable profits, and the fact that the cash was used for some purpose is not relevant.

Therefore in relation to the POAL dividend the question is whether there were distributable profits representing at least to some extent the dividend paid by A & G. I will deal first with the First Dividend. In my judgment, at the time POAL paid the First Dividend to the appellant it had not received any dividend from A & G and no part of that dividend could therefore “represent” the dividend from A & G for this purpose of paragraph (a) of the definition of higher level dividend in section 806B(10). There was no finding that POAL could include the amount of that dividend in its distributable profits at the date of the First Dividend. (Mr Peacock suggested that this problem for POAL was resolved in its favour by section 799(3) as the First Dividend was covered by the profits for the year ended after the date of payment, but that does not add to the undefined concept of representation in the definition of higher level dividend but deals only with proof of distributable profits: see generally section 790(3) to (6)). By the time of the Second Dividend all but A$820,000 had been applied in writing down the cost of the investment in A & G and so only that sum could represent profits of Liena (subject to scaling down for any other distributable profits that it had). Subject to the effect, if any, of section 803A, only the portion of that sum used to pay a dividend to the appellant (A$811,800) therefore could represent a higher level dividend in relation to the A & G dividend.

I pay tribute to the concision of reasoning in the decisions of the Tribunals. I have disagreed with the reasoning of the UT on the “tax borne” argument because as I see it they failed to give full weight to the statutory hypotheses.

For the reasons given, I would dismiss this appeal save in so far as necessary to ensure the appellant has appropriate relief in relation to the amount of the dividend of A$811,800 paid by Liena to POAL.

I agree.

I also agree.

In this Chapter, except where the context otherwise requires—