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Session 2001- 02
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| Judgments - Kahn and Another (Appellants) v Commissioners of Inland Revenue (Responents)
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HOUSE OF LORDSLord Hoffmann Lord Woolf Lord Hutton Lord Hobhouse of Wood-borough Lord Rodger of Earlsferry OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENTIN THE CAUSEKAHN AND ANOTHER (APPELLANTS) v COMMISSIONERS OF INLAND REVENUE (RESPONDENTS) ON 20 FEBRUARY 2002 [2002] UKHL 6 LORD HOFFMANN My Lords, 1. Toshoku Finance (UK) Plc ("the company") is in creditors' voluntary liquidation. It was a subsidiary of a Japanese corporation called Toshoku Ltd, which went into liquidation in December 1997. The resolution to wind up the company was passed on 26 January1998 ("the liquidation date"). Two partners in PwC ("the liquidators") were appointed joint liquidators. The only substantial asset was a debt owing by another Toshoku subsidiary called Toshoku Europa Establishment ("TEE") under a loan facility agreement. TEE's indebtedness to the company on the liquidation date (including arrears of interest at the contractual rate) was US$156.3m. But TEE was itself heavily insolvent. It had realisable assets of only about US$43m and total liabilities (mainly to other group companies) of US$381.75m. Negotiations took place for the distribution of TEE's assets among its creditors. On 25 November 1998 the company agreed to accept about US$21.5m in full and final settlement of its claim. Nothing was paid in respect of interest which had accrued after the liquidation date. 2. Despite the fact that the company received no interest from TEE after the liquidation date, it is in principle liable to pay corporation tax as if it had. Section 8(2) of the Income and Corporation Taxes Act 1988 provides that a company is "chargeable to corporation tax on profits arising in the winding up of the company". It may be assessed in respect of an accounting period deemed to commence on the liquidation date (section 12(7)) and the liquidator is the proper officer liable to pay the tax (section 108(2)). Chapter II of the Finance Act 1996 provides that, in the case of companies between which there is a "connection" as defined in section 87(3), profits from a "loan relationship" must be computed on an accruals basis: see section 87(2). In addition, the computation must be made on the assumption that "every amount payable under the relationship will be paid in full as it becomes due": see section 85(3)(c), read with section 85(5)(a) and paragraphs 5 and 6 of Schedule 9. No allowance may be made for bad debts. 3. There was at the relevant time a connection between the company and TEE because they had both been under the control of the Japanese holding company. In principle, therefore, the company was liable in respect of the accounting period after the liquidation date for corporation tax on profits computed on the assumption that it received all interest contractually payable by TEE. The liquidators do not admit liability to tax because they may wish to dispute whether TEE's obligation to pay interest continued after the liquidation date. But they applied to court for directions as to whether, assuming that there was such a liability, it was an "expense properly incurred in the winding up" which they were required by section 115 of the Insolvency Act 1986 to pay out of the company's assets in priority to other claims. The Inland Revenue was joined as a defendant to the application. Evans-Lombe J held that the liability would not be an expense incurred in the winding up ([1999] STC 922), but the Court of Appeal reversed his decision: [2000] 1 WLR 2478 The liquidators appeal to your Lordships' House. 4. The case for the Crown is extremely simple. Section 115 provides that in a voluntary winding up such as this -
5. Mr Briggs QC, who appeared for the Crown, submits that rule 4.218 of the Insolvency Rules 1986 determines both what counts as an expense in the winding up and the priorities of such expenses between themselves. The rule was made under both the general power in section 411 of the Insolvency Act 1986 (to make rules "for the purpose of giving effect to" the winding up provisions of the Act) and a specific power in paragraph 17 of Schedule 8 to make "[p]rovision as to the fees, costs, charges and other expenses that may be treated as the expenses of a winding up". 6. Rule 4.218(1), with the omission of irrelevant items of expense, provides:
7. Mr Briggs says that the only question is whether the liability to corporation tax falls within one, and if so which, of these paragraphs. He submits that it plainly falls within (m). It is a sum which by statute is payable by a company in respect of profits or gains arising during a winding up. The liquidator is obliged to pay it. It is therefore a "necessary disbursement" which the liquidator has to make in the course of his administration. That is an end of the matter. 8. This approach is supported by high authority. In In re Mesco Properties Ltd [1979] 1 WLR 558 the question was also whether corporation tax had to be paid as an expense of the liquidation in priority to other claims. In that case it had arisen not on profits but on chargeable gains, on sales of the company's properties after the commencement of the winding up. Some of the properties had been sold by an administrative receiver appointed by a mortgagee, one by the mortgagee itself and the others by the liquidator. Under section 22(7) of the Finance Act 1965 a sale by a mortgagee or receiver was treated as if it had been a sale by a nominee for the mortgagor. The company was therefore assessed to corporation tax on chargeable gains realised on all the dispositions. 9. At that time the relevant rule was rule 195(1) of the Companies (Winding-up) Rules 1949 (SI 1949/330(L4)). It provided that the assets of a company in a winding-up which remained after "payment of the fees and expenses properly incurred in preserving, realising or getting in the assets" should "be liable to the following payments" and there followed an earlier version of the list of items which are now in rule 4.218. At that time, however, the rules did not specifically refer to corporation tax. The fifth paragraph, corresponding to paragraph (m) of the current rule, simply said "the necessary disbursements of any liquidator appointed in the winding up by the court…". Brightman J said, at p 561:
10. This is a clear and uncompromising statement. When the case went to the Court of Appeal, Buckley LJ [1980] 1 WLR 96, 100, quoted it and said that he agreed. Bridge LJ, at p 101, said expressly that he agreed with the judgment of Brightman J and Templeman LJ also agreed. Mr Briggs says that it formed the basis upon which paragraphs (m) and (p) were drafted. Paragraph (m), in excepting corporation tax on chargeable gains, assumes that it would otherwise have fallen within the general description of a "necessary disbursement". It follows that corporation tax on profits remains within (m). Chadwick LJ suggested in the Court of Appeal ([2000] 1 WLR 2478, 2496) that the reason for giving tax on chargeable gains a lower priority (below the first tranche of the liquidator's remuneration) was because it was thought unfair to give the higher priority to tax on gains which did not necessarily accrue during the liquidation period but may have been latent in the company's assets at the liquidation date. This seems a plausible explanation. The consequence is that, as a matter of construction, the corporation tax chargeable in this case falls within (m). 11. Both Evans-Lombe J and the Court of Appeal accepted the Crown's submission that whether the liability counted as an expense turned upon the construction of rule 4.218. But the judge thought that corporation tax did not come within (m). It was mentioned in (p) and so in his view could not come within another paragraph as well. The Court of Appeal disagreed and Mr Phillips QC, who appeared for the liquidators, did not support the construction adopted by the judge. 12. Instead, Mr Phillips put forward a more radical argument. He said that the terms of rule 4.218(1) did not in themselves determine whether a liability counted as an expense of the liquidation.. The rule was made, as I have said, under a power to make provision as to the expenses which "may be treated as the expenses of a winding up". Mr Phillips laid stress upon the word "may". He said that the rule created only an outer envelope within which expenses were contained. If they could not be brought within one of the paragraphs of the rule, they could not count as expenses. But the reverse was not necessarily true. In order to be treated as liquidation expenses, they also had to pass a judge-made test which Nicholls LJ in In re Atlantic Computer Systems Plc [1992] Ch 505, 520 called the "liquidation expenses" principle. That principle was one of fairness. If a liability was incurred as a result of a step taken for the benefit of the insolvent estate, it was fair that the burden should be borne by the persons for whose benefit the estate was being administered. So Mr Phillips said that a liability falling within rule 4.218(1) was payable as an expense only if it arose as a result of a step taken with a view to, or for the purposes of, obtaining a benefit for the estate. If the corporation tax had been chargeable on profits arising from carrying on the business of the company in liquidation, it would have satisfied the liquidation expenses principle. In the present case, however, the liquidator had neither received interest nor taken any steps to recover it. It was therefore not fair that the creditors should have to bear the burden of corporation tax on fictitious credits. 13. My Lords, I do not think that, as a matter of statutory construction, rule 4.218(1) is capable of being given the gloss for which Mr Phillips contends. It was in my opinion intended to be (subject to certain express qualifications and a well-established rule of construction to which I shall later return) a definitive statement of what counted as an expense of the liquidation. Until 1890, this question was answered by reference to the practice of the Companies Court. But the practice was codified by the Companies (Winding-up) Rules 1890. Rule 31 was the lineal ancestor of rule 4.218(1). It provided:
14. There followed a list of items. My Lords, the language of the rule is mandatory. The assets "shall" be liable to the payments listed. There may have been room for an argument (which I shall touch upon later) over whether the list was exhaustive. But the language is inconsistent with there being any ground upon which an item expressly mentioned in the rule can be denied the status of an expense. Similar language was used in the successive Rules which were in force until 1986. Rule 4.218(1) uses slightly different language. It says "[t]he expenses of the liquidation are payable out of the assets in the following order of priority" and then sets out the list. But I do not think that any change of meaning was intended. 15. The courts have treated the rule as a complete statement of liquidation expenses, subject only to the qualifications contained in the Rules themselves. In In re M C Bacon Ltd [1991] Ch 127, 136 Millett J said "The expenses of the winding up and the order on which they are payable out of the assets are listed in rule 4.218(c)." Giving the judgment of the Court of Appeal in Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499, 510 Peter Gibson LJ said "Rule 4.218 tells us both what are the expenses to be treated as the expenses of a winding up and what priority they have inter se." In In re London Metallurgical Co [1895] 1 Ch 758, decided soon after the first rules had been made, it was noted that the list said nothing about the costs of litigation incurred by the liquidator or awarded against him. Under the pre-1890 practice, costs awarded to a successful litigant had been recoverable in priority to the general costs of the liquidation. Vaughan-Williams J said that rule 31 of the 1890 rules did not change this practice. But he did not say that this was because the rule was not intended to be a complete statement of the law. He said that the practice on costs was preserved by the words "subject to any order of the court." When the 1890 Rules were replaced by the Companies Winding-up Rules 1903, it was specifically provided in rule 170(3) that-
16. This provision is now rule 4.220(2) of the 1986 Rules. No head of liquidation expense not mentioned in the rules has been discovered since the London Metallurgical Co case [1895] 1 Ch 758. And the general provision that the rules are "subject to any order of the court" has gone. The only power reserved to the court is that conferred by section 156 of the 1986 Act, which gives it a discretion to rearrange the priorities of the listed expenses inter se. This power is expressly reserved by rule 4.220(1). 17. In my opinion, therefore, both as a matter of construction and on authority, the heads of expense listed in rule 4.218(1) are not subject to any implied qualification. And I do not think that the use of the word "may" in the power in paragraph 17 of Schedule 8 to make provision for expenses which "may be treated as the expenses of a winding up", will bear the weight which Mr Phillips wants to put upon it. I think that the word "may" does no more than indicate that the liquidator has a right to reimburse himself out of the assets in respect of his liabilities which fall within the rule. Whether they fall within the rule is a question of construction and no more. 18. Mr Phillips accepts that, with the exception of the case of In re Kentish Homes Ltd [1993] BCLC 1375, there is no case which supports a qualification of the statutory language. But that case has the authority of being a decision of Sir Donald Nicholls V-C and is based upon his own dicta when sitting as Nicholls LJ in In re Atlantic Computer Systems Plc [1992] Ch 505. For that reason, and in deference to the able argument of Mr Phillips, I must examine the true scope of what Nicholls LJ called the "liquidation expenses" principle. 19. The rule has somewhat obscure origins in In re Exhall Coal Mining Co Ltd (1864) 4 De G J & S 377, a briefly reported case in the Chancery Court of Appeal. Section 163 of the Companies Act 1862 provided "any … distress or execution put in force against the estate or effects of the company after the commencement of the winding up shall be void to all intents." After the presentation of a petition (which is deemed to be the commencement of a compulsory winding up) but before the winding up order, the lessor of land of which the company was the beneficial tenant levied a distress upon the company's goods for arrears of rent. The liquidator claimed that the distress was void under the statute. The court nevertheless said that it had a discretionary power to validate the distress. It derived this power from section 87, which provided that after a winding up order, no "suit action or other proceeding" should be proceeded with or commenced against the company without the leave of the court. The judgment of Turner LJ, at p 379, has usually been cited in later cases. It reads in (in its entirety) as follows:
20. Thus was created a discretion to allow a creditor to use a process of execution to recover in full a debt for which he would otherwise have had to prove in the liquidation. In subsequent years a body of precedent on the exercise of the discretion developed. In In re Progress Assurance Co Ex p Liverpool Exchange Co (1870) LR 9 Eq 370 the lessors of a company in liquidation levied a distress for unpaid rent upon its office furniture three months after the winding up order. Lord Romilly MR said, at pp 372-373, that a distress after the winding up order would be allowed to proceed only where the company-
21. This principle was restated in the influential case of In re Lundy Granite Co; Ex p Heavan (1871) LR 6 Ch App 462. The landlord of Lundy Island, which was let to a third party, distrained upon goods of the company which had been left upon the tenant's property. The distraint was for rent which had fallen due more than a year after the winding up order. The tenant had agreed to assign the lease to the company but had not actually done so. He had however allowed the company into possession and the company had brought its goods upon the land. After the winding up order the liquidator retained possession with a view to a sale of the company's assets on the land. 22. The Lords Justices gave two reasons for allowing the distress to proceed. The first was that the distress was not in respect of a claim for rent against the company, for which the landlord could have proved in the liquidation. The company was not his tenant. The landlord was exercising his ancient right to distrain upon any goods on the land, whether they belonged to his tenant or not. It should not make a difference that the third party to whom the goods belonged happened to be a company in liquidation. 23. The second and, for present purposes, more important reason, was that even if the rent had been owing by the company, the liquidator had retained possession of the land for the purposes of the liquidation. Following the Progress Assurance Co case, LR 9 Eq 370, Sir William James LJ said, at p.466:
24. Although these principles were evolved in relation to a statutory discretion to allow a process of execution to proceed, it was obvious to everyone that there could be no practical difference between allowing a landlord to levy a distress for rent falling due after the winding up and directing the liquidator that he should be paid in full. It is important to bear in mind that the rent was a future debt for which the landlord could have proved in the liquidation: see Hardy v Fothergill (1888) 13 App Cas 351. Under rule 12.3(1) of the 1986 Rules, all claims by creditors are provable as debts against the company "whether they are present or future, certain or contingent, ascertained or sounding only in damages". But a "debt" is defined by rule 13.12(1) as
25. Thus debts arising out of pre-liquidation contracts such as leases, whether they accrue before or after the liquidation, can and prima facie should be proved in the liquidation. In this respect they are crucially different from normal liquidation expenses, which are incurred after the liquidation date and cannot be proved for. In the Lundy Granite Co case LR 6 Ch App 462 the court was therefore exercising the discretion conferred by section 87 of the 1862 Act to decide that, contrary to the normal pari passu rule, a creditor who had a debt which was capable of proof at the date of liquidation should be paid in priority to other creditors. What was the justification for the exercise of such a discretion? 26. A reason, or at any rate a rationalisation, was put forward by Lindley LJ, giving the judgment of the Court of Appeal in In re Oak Pits Colliery Co (1882) 21 Ch D 322, 330. He said:
27. My Lords, it is important to notice Lindley LJ was not saying that the liability to pay rent had been incurred as an expense of the winding up. It plainly had not. The liability had been incurred by the company before the winding up for the whole term of the lease. Lindley LJ was saying that it would be just and equitable, in the circumstances to which he refers, to treat the rent liability as if it were an expense of the winding up and to accord it the same priority. The conditions under which a pre-liquidation creditor would be allowed to be paid in full were cautiously stated. Lindley LJ said (at p 329) that the landlord "must shew why he should have such an advantage over the other creditors". It was not sufficient that the liquidator retained possession for the benefit of the estate if it was also for the benefit of the landlord. Not offering to surrender or simply doing nothing was not regarded as retaining possession for the benefit of the estate. 28. I give two modern examples which illustrate this restrictive application of the principle. In In re ABC Coupler & Engineering Co Ltd (No. 3) [1970] 1 WLR 702, the liquidator on appointment closed down the business which had been conducted on the premises, had the company's plant and machinery valued and thought about what he should do. It was only from the time he decided to put the lease on the market that Plowman J held that he was retaining the premises for the benefit of the winding up and was liable to pay the rent in full. In Re HH Realisations Ltd (1975) 31 P & CR 249 Templeman J held that a company ceased to be liable to pay the rent in full from the time it gave notice to the landlord that it was seeking authority to disclaim the lease, even though it remained in occupation for nearly two months longer. (See also In re Downer Enterprises Ltd [1974] 1 WLR 1460). 29. The principle evolved from the Exhall Coal Mining Co Ltd 4 De G J & S 377, and Lundy Granite Co LR 6 CApp 462 cases is thus one which permits, on equitable grounds, the concept of a liability incurred as an expense of the liquidation to be expanded to include liabilities incurred before the liquidation in respect of property afterwards retained by the liquidator for the benefit of the insolvent estate. Although in was originally based upon a statutory discretion to allow a distress or execution against the company's assets, the courts quickly recognised that its effect could be to promote a creditor from merely having a claim in the liquidation to having a prior right to payment in full. As in the case of other equitable doctrines, the discretion hardened into principle. By the end of the nineteenth century, the scope of the Lundy Granite Co principle was well settled. 30. It was not, however, a general test for deciding what counted as an expense of the liquidation. Expenses incurred after the liquidation date need no further equitable reason why they should be paid. Of course it will generally be true that such expenses will have been incurred by the liquidator for the purposes of the liquidation. It is not the business of the liquidator to incur expenses for any other purpose. But this is not at all the same thing as saying that the expenses will necessarily be for the benefit of estate. They may simply be liabilities which, as liquidator, he has to pay. For example, there will be the fees payable to fund the Insolvency Service, ranking as paragraph (c) in rule 4.218(1), where the benefit to the estate may seem somewhat remote. There would be little point in a statute which specifically imposed liabilities upon a company in liquidation if they were payable only in the rare case in which it emerged with all other creditors having been paid. 31. The difference between the treatment of pre-liquidation debts under the Lundy Granite Co principle and the treatment of post-liquidation liabilities emerges clearly from the nineteenth century cases on rates. In In re Watson, Kipling & Co (1883) 23 Ch D 500, which concerned an assessment for rates made after the liquidation upon property occupied by the company, Kay J rejected the submission of counsel for the rating authority, at p 506, that-
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