Legal & General Assurance Society Ltd v Revenue and Customs  (No.2) [2005] UKSPC SPC00492 (19 July 2005)

SPC00492

INSURANCE COMPANY TAX – pension business – whether deduction available for foreign tax expended on behalf of holders of pension policies under FA 1989 s 82(1)(a) in respect of amounts for which the Appellant has secured credit – no 

THE SPECIAL COMMISSIONERS

	LEGAL & GENERAL ASSURANCE SOCIETY LIMITED (No.2)	Appellant

	- and -

	DAVID VIVIAN THOMAS
	(HM INSPECTOR OF TAXES)	Respondent

		Special Commissioners:	DR JOHN F AVERY JONES CBE
						DR NUALA BRICE

Sitting in public in London on 17, 20-22 December 2004, 30 June 2005

Malcolm Gammie CBE QC and Daniel Jowell, counsel, instructed by Elaine Herbert, for the Appellant

Launcelot Henderson QC and David Ewart, counsel, instructed originally by the Solicitor of Inland Revenue and now by the Acting Solicitor for HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2005

DECISION

1.	This is the second part of our decision in this appeal by Legal & General Assurance Society Limited.  The first part was released on 28 January 2005 (see [2005] STC (SCD) 350) and dealt with the first two issues in that appeal.  At the same time we gave a draft decision only to the parties on the third issue because it was affected by our decision on the first issue; the section we were construing was obscure; and any decision we made might have implications for other insurance companies carrying on pension business.  Accordingly we felt that we needed further input from the parties.  Subsequently the Revenue asked for a further hearing and both parties made written statements of case, following which we now issue our decision on the third issue.  This decision needs to be read with the original decision as we have not repeated any of the facts. The Appellant was represented by Mr Malcolm Gammie QC and Mr Daniel Jowell, and the Inspector was represented by Mr Launcelot Henderson QC and Mr David Ewart.
Issue 3
2.	The third issue depends on the interpretation of section 82(1)(a) of the Finance Act 1989 as modified by section 436(3)(a).  It is whether in arriving at the pension business Schedule D Case VI profit in 1992 and 1993 the Appellant is entitled to a deduction for foreign tax expended on behalf of holders of pension policies in respect of amounts for which it has secured credit.  Originally section 82 read:
“Where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D, then, in calculating the profits for any period of account,—
(a) there shall be taken into account as an expense (so far as not so taken into account apart from this section) any amounts which, in respect of the period, are allocated to or expended on behalf of policyholders or annuitants;….”
This was amended by section 43(1) the Finance Act 1990 with retrospective effect so that paragraph (a) now reads with the amendment shown in italics:
“(a) there shall be taken into account as an expense (so far as not so taken into account apart from this section) any amounts which are allocated to, and any amounts of tax or foreign tax, which are expended on behalf of, policy holders or annuitants in respect of the period;….”
The modification made to this provision by section 436(3)(a), for the computation of pension business profits, also as amended by section 43 of the Finance Act 1990, reads:
“(1) Where the profits of an insurance company in respect of its life assurance pension business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D, then, in calculating the profits for any period of account,—
 (a) there shall be taken into account as an expense (so far as not so taken into account apart from this section) any amounts which are allocated to, and any amounts of tax or foreign tax, which are expended on behalf of, policy holders of policies referable to pension business or annuitants in respect of the period;….
The amount allocated to policyholders is defined in subs (2):
(2) For the purposes of this section an amount is allocated to policy holders or annuitants if, and only if,—
(a) bonus payments are made to them; or
(b) reversionary bonuses are declared in their favour or a reduction is made in the premiums payable by them;
and the amount of the allocation is, in a case within paragraph (a) above, the amount of the payments and, in a case within paragraph (b) above, the amount of the liabilities assumed by the company in consequence of the declaration or reduction.”
Contentions of the parties
3.	We deal with Mr Henderson’s contentions on behalf of the Revenue first as that is the order in which the case was argued at the resumed hearing.  His primary contention at the original hearing was that where foreign tax was expended on behalf of policyholders and accordingly was deductible in computing the Case I profit there was no UK tax against which to credit it.  In the light of our decision on the first issue this argument is no longer open to him.  At the resumed hearing he contends, as he did as his second contention at the original hearing, that it is unlikely that Parliament provided for the double relief, by credit and deduction, for the same tax.  Foreign tax for which credit is given cannot be regarded as having been expended on behalf of policyholders.  He focuses on the position at the time of making the Case I computation because that is what s 82 deals with, rather than the more natural meaning of looking at the position at the time the tax is paid.
4.	The historical development of s 82 is that in 1885 the House of Lords decided in Last v London Assurance Corporation 2 TC 100 by a majority that bonuses paid to with-profits policyholders were not deductible expenditure in computing the company’s Case I profits as they were a distribution of the profit.  The effect of the decision was limited by s 433 (dating from 1923) which provided:
“Where the profits of an insurance company in respect of its life assurance business are, for the purposes of this Act, computed in accordance with the provisions of this Act applicable to Case I of Schedule D, such part of those profits as belongs or is allocated to, or is reserved for, or expended on behalf of, policy holders or annuitants shall be excluded in making the computation, but if any profits so excluded as being reserved for policy holders, or annuitants cease at any time to be so reserved and are not allocated to or expended on behalf of policy holders or annuitants, those profits shall be treated as profits of the company for the accounting period in which they ceased to be so reserved.”
This excluded from the profits amounts belonging to, allocated to, or reserved for, or expended on behalf of, policyholders.  This provision was interpreted in White v Confederation Life Association (1969) 46 TC 77 in which a Canadian proprietary life assurance company mutualised by buying in its own shares over a period, writing down the purchase price of the shares to their par value from the participating life fund.  The amount written off in the year was held to be reserved for, or expended on behalf of, policyholders:
“No doubt, if A pays a debt due by B he can be accurately described as making a payment on B’s behalf.  I think, he is equally accurately described as making payment on B’s behalf if he buys valuable property for B, not if he buys valuable property with the intention thereafter of giving it to B, but if he buys property in circumstances in which it will become B’s property as a direct result of the expenditure by A.”  (per Buckley J at 91F)
Mr Henderson contends that this shows that the words expended on behalf of have a wide construction and look to who benefits in economic terms.
5.	Section 433 was replaced in 1989 by s 82 which reverses Last by allowing a deduction in computing profits for amounts allocated to, or expended on behalf of, policyholders, which deduction was limited in 1990, with retrospective effect, first, to amounts allocated to policyholders (as defined in subs (2) to mean only payment of bonuses and declaration of reversionary bonuses), and secondly, tax and foreign tax expended on behalf of policyholders.  Mr Henderson contends that tax or foreign tax is expended on behalf of policyholders where, in broad terms, the company pays the tax as proxy for them.  This happens where the burden of the tax is cast, as between the company and the policyholders, on funds which would otherwise have been allocated for the benefit of policyholders.  The underlying principle is that a deduction is allowed for the gross amount of funds allocated to policyholders including any tax at source which has reduced that amount.
6.	In relation to life assurance taxed otherwise than under Case I, ss 88 and 89 of the Finance Act 1989 impose a separate rate of corporation tax equal to the basic rate of income tax on “the policyholders’ share of the relevant profit” for an accounting period (s 88).  This is what is left after deducting the profits computed in accordance with Case I principles from the total profits of the life assurance business after deducting expenses of management (s 89).  Since the Case I profits include a deduction for liabilities to policyholders they represent the return to shareholders.  Mr Henderson contends that the purpose of s 82 is first to draw a distinction between tax and foreign tax paid on behalf of shareholders, meaning referable to the shareholders’ share of the profit (non-deductible), and tax paid on behalf of policyholders, meaning the tax entering into the computation of the policyholders’ share of the profit (deductible).  Mr R A Peel, Assistant Director (Business Tax), gave us a simplified example following the original hearing showing how the split was done.  In short, the example shows that, starting with the regulatory return, one can determine the after-tax shareholders’ profits and policyholders’ profits and the tax, the total of which equals the I minus E profit (so long, as in the simplified example, as there are no gains, because I minus E includes realised gains, while Case I includes recognised gains).  Section 82 requires the deduction of the policyholders’, but not the shareholders’, tax in the Case I computation whereas the figures are after deducting the total tax.  The problem is that in order to calculate the policyholders’ tax one needs to know the Case I profit, and in order to calculate the Case I profit one needs to know the policyholders’ tax.  In the simplified example one can gross-up the shareholders’ profit at the corporation tax rate to determine the gross profit and the shareholders’ tax.  (In practice, it is more complicated because of franked investment income and the Revenue accepts the Appellant’s calculation at a rate determined by a formula which gave a rate of 31.23%.)  The balance of tax is the policyholders’ tax.  Since 1995 the Revenue perceived weaknesses in this approach and have put forward a series of as many as 15 alternative formulae from which to choose depending on the taxpayer’s circumstances.  None of these is accepted by the Appellant.  
7.	For pension business, the profit is taxed under s 82 under Case VI computed under Case I principles with the deduction of amounts allocated to, or foreign tax expended on behalf of, policyholders, so that it is the shareholders’ proportion of the profit that is taxed.  The reason for the reference to UK tax being deleted in relation to pension business is that income from investments and deposits referable to pension business is exempt from tax (s 438).
8.	Mr Henderson attached to his skeleton a further example prepared by Mr Peel:
“Assume the receipt of a foreign dividend of £1,000 that the company shares 90% to pension business policyholders and 10% to shareholders.  If this dividend bears no foreign tax, the company will allocate £900 to policyholders and £100 to shareholders.  So for the purpose of computing Case I profits from the business there will be a receipt of £1,000 and there will be a deduction of £900 under s 82(1)(a) in respect of amounts allocated to policyholders.  This will leave a profit for the company of £100.
Assume now that the £1,000 dividend suffers withholding tax at 10%, so that only £900 is actually received by the company, and that no credit is available for the foreign tax.  The company will allocate 90% of the £900, namely £810, to policyholders and £90 to shareholders.  For the purpose of computing Case I profits from the business there will be a gross receipt of £1,000 and there will be a deduction of £810 under s 82(1)(a) in respect of amounts allocated to policyholders and a further deduction of £90 under s 82(1)(a) in respect of foreign tax expended on behalf of policyholders.  This will leave a profit for the company of £100 before any deduction that it may be able to claim in respect of the foreign tax of £10 relating to the shareholders’ share of the dividend.
But suppose that credit relief is available for the foreign tax against corporation tax on the pension business profits as a whole.  In this case the total tax bill (UK corporation tax plus foreign withholding tax) is exactly the same as in the case where the dividend suffered no withholding tax.  So the amount of tax reflected in reduced policyholder benefits will be the same and the amount allocated to policyholders will be the full £900.  On the Respondent’s interpretation, that is the full amount of the deduction available under s 82(1)(a)—there is a deduction for the amount allocated to policyholders but none for foreign tax expended on behalf of policyholders.  For the purpose of computing Case I profits from the business there will be a gross receipt of £1,000 less a deduction of £900 under s 82(1)(a) to leave a profit for the company of £100.
On the Appellant’s interpretation, however, there will be a deduction under s 82(1)(a) in respect of amounts allocated to policyholders of £900 and a further deduction in respect of foreign tax expended on behalf of policyholders of £90.  When deducted from the gross receipt of £1,000, this leaves a contribution to the company’s profit of £10.  So, compared with the situation where no relief is due for the foreign tax, the company gets credit relief for the £90 and relief for an additional £90 allocated to policyholders and relief for the foreign tax of £90 itself.  So profits are reduced by £180 and the UK tax bill is additionally reduced by £90, all for the sake of withholding tax of £90 (in addition to the company’s own 10% share of the foreign tax suffered, the treatment of which is not disputed).”
9.	The example shows that one would expect the credit against the tax on the shareholders’ share of the profit to enure for the benefit of policyholders since the shareholders suffered exactly the same amount of tax as they would have suffered if there had been no foreign tax.  But even if this were not the case Parliament cold not have intended to give relief by way of both deduction and credit.
10.	In the alternative Mr Henderson contended that of the foreign tax had been expended on behalf of policyholders, the subsequent reimbursement of that expenditure by means of the tax credit should be treated as a receipt of the pension business.  He based this on the well-established principle that receipt of a sum which compensates for failure to receive a trading receipt is itself treated as a trading receipt, see London and Thames Haven Oil Wharves Ltd v Attwooll [1967] Ch 772, which Diplock LJ stated at p 815 was applicable “whatever the source of the legal right of the trader to recover the compensation.”  Here the tax credit reimburses the Appellant for the foreign tax which had been deducted at source and which, if not deducted, would have formed part of the income receipts of the Appellant’s life assurance business. 
11.	Mr Gammie, on behalf of the Appellant, contends that the effect of the provision is that the Appellant can claim both credit and a deduction for the whole of the foreign tax.  He contends that this is the effect of the plain words of the section which treats the shareholders and policyholders as separate taxpayers.  The policyholders are entitled to a deduction for the foreign tax under s 82, and the shareholders may be entitled under the double taxation relief provisions to a tax credit for the same foreign tax.
12.	He described Mr Peel’s example as not being based in the real world.  Profits were allocated between policyholders as bonuses and shareholders by transfer from the long term fund according to contractual, actuarial and regulatory considerations.  This is an allocation of profits not an identification of items of income that contributed to those profits.  
13.	We saw a letter from the Appellant answering the Revenue’s question whether the credit relief in the two years in question enured for the benefit of pension policyholders, stating:
“The simple fact is that the foreign tax credits in question are received by the Appellant company and not by the Appellant company on behalf of its policyholders.  The tax credits reduce the tax charged to the long term insurance fund of the Appellant.  This reduction increases the after-tax surplus, or profit, of the ling term insurance fund, and this after-tax surplus is divided between participating policyholders and shareholders.  Shareholders are only entitled to their share of the after-tax surplus when it has been transferred out of the long term fund to the shareholders’ fund of the Appellant, which may be in a later period to that in which the foreign tax was suffered.  It is, therefore, impossible to determine whether (or to what extent) foreign tax credits benefit policyholders or, ultimately, shareholders.”
Mr Gammie described the question as irrelevant to the point of statutory construction since the Revenue accepted that the Appellant had correctly computed the policyholders’ share of pension business foreign tax.
14.	He accepts that it is anomalous to give both a deduction and a credit for the same foreign tax.  While a life assurance company carries on business for itself and the policyholders’ share is contractual only, the shareholders and policyholders are effectively treated as different classes of taxpayer.  It is not therefore surprising or anomalous that foreign tax should be deductible in relation to the policyholders and creditable in relation to the shareholders.  Providing a deduction for the foreign tax was a logical provision in the context of s 82 replacing s 433.  It would be unfair to deny entirely any credit for foreign tax because a life company was allowed to deduct some of that tax in one part of its computation.  Parliament may have considered the most practical solution to permit a deduction for foreign tax without concerning itself with a more elaborate computation scheme to resolve the complex interaction of deduction and credit for both proprietary and mutual companies.  This is precisely what Parliament has done through the plain and unambiguous language that it has used and its silence on the interaction.
15.	Mr Gammie went on to argue that the scheme of the Act, its context and the statutory language does not support Mr Henderson’s construction of the word “expended” for the following reasons:
(1)	The ordinary meaning of the words of s 82 entitles the Appellant to deduct the policyholders’ tax.
(2)	You can only identify what you can credit after you have deducted what Parliament says what you can deduct.
(3)	Credit is available for foreign tax because it has been incurred and expended.
(4)	The possibility that this expenditure may affect the UK tax that the Appellant may eventually be called upon to pay does not alter the fact that foreign tax has been expended.
(5)	The word “expended” was used in s 433.  In the context of introducing a deduction for amounts allocated to policyholders, it is quite logical for Parliament also to provide a deduction for tax for which a deduction would otherwise be denied.
(6)	While s 82 is a part of the reformulation of the statutory provisions for measuring life business profits, thee is nothing in the language or the context to warrant giving “expended” the meaning for which Mr Henderson contends.
(7)	Had Parliament wished to deny credit for what it had allowed to be deducted or to allow a deduction only for that part of the foreign tax that could not be credited, it would have made that clear through specific statutory language as in s 795 and 811 and previously in para 7 of Sch 16 to the Income Tax Act 1952.
16.	Mr Gammie replied to Mr Henderson’s alternative argument that, since tax was not a deductible expense, it would need a statutory provision to achieve this result.  Mr Henderson replied that it was implicit in s 82 which computes a Case I profit with a deduction for the foreign tax.
 Reasons for our decision
17.	Section 82 is at first sight a strange provision.  In its application to life assurance business taxed under Case I, which is the unusual case since the I minus E basis will normally produce a higher figure, the section reverses the effect of Last by providing a deduction for amounts allocated to policyholders (ie bonuses), which will be after-tax amounts.  If nothing were said about tax, the tax referable to the amounts allocated to policyholders would be added back in the Case I computation because tax is not an allowable deduction.  The section therefore allows a deduction for such tax, which it describes as tax “expended on behalf of policyholders.”  This is a loose expression to find in legislation since legally the company expends any tax on its own behalf because the policyholders have only contractual rights.  The result is that the Case I profit reflects the shareholders’ profit.  The deduction of tax is therefore logical, although in practice calculating the difference between deductible and non-deductible tax is difficult.  
18.	As it is applied to pension business, s 82 gives a deduction only for foreign tax expended on behalf of pension policyholders, which will be foreign tax deducted at source, because income from investments and deposits is exempt from UK tax.  Mr Peel’s simple example quoted above is attractive in showing that if credit but not deduction is given for the foreign withholding tax the result is the same as if the income were received gross.  But as the letter from the Appellant points out, one cannot in practice identify particular foreign tax with shareholders or policyholders.  This makes the application of the section difficult in practice.  However, we are concerned only with a point of principle: whether in arriving at the pension business Schedule D Case VI profit in 1992 and 1993 the Appellant is entitled to a deduction for foreign tax expended on behalf of holders of pension policies in respect of amounts for which it has secured credit.  
19.	The real issue is what is meant by foreign tax expended on behalf of pension policyholders.  Essentially Mr Gammie concentrates on the immediate expenditure, so that if the foreign tax is deducted from income contributing to the profit allocated to policyholders the tax is so expended; while Mr Henderson concentrates on the ultimate burden of the foreign tax, so that if it is credited against UK tax that the company pays on behalf of its shareholders, it is not expended on behalf of policyholders.  Mr Henderson assumes that the credit for foreign tax enured for the benefit of the policyholders, as in Mr Peel’s example which makes the split between policyholders and shareholders before tax.  Where credit is taken for the foreign tax against the tax on the shareholders’ profit, the income before foreign tax is naturally allocated to the policyholders giving the same result as if there had been no foreign tax.  
20.	The letter from the Appellant shows that it is impossible to determine whether foreign tax credits benefit shareholders or policyholders, and any split between shareholders and policy holders is made after tax, which is in accordance with the approach in Last.  Mr Gammie told us that bonuses to policyholders are calculated during the year in advance of the tax computation although the actuaries may make some estimates for tax.  When the tax computation is made after the end of the year the amounts allocated to policyholders are known and so the most that can be said is that an estimate of the tax formed part of the calculation of the amount allocated to policyholders.  The amount of foreign tax referable to policyholders must also be capable of determination even though this may be difficult in practice.. We do not therefore understand why it is impossible to determine what credit is given for a known amount of foreign tax.
21.	We have identified the purpose of s 82 as being to separate the tax referable to policyholders from the tax referable to the shareholders and to give a deduction for the former.  The only relevant tax as the section is applied to pension business is foreign tax.  The expression “amounts of foreign tax which are expended on behalf of holders of policies referable to pension business or annuitants in respect of the period” requires a determination of how the foreign tax is expended, which we consider means ultimately expended, so that, as in White v Confederation Life one looks to who suffers the economic burden of the foreign tax.  Expended on behalf of policyholders means actually expended after taking any credit for the foreign tax.  Mr Peel’s example assumes that there is an allocation of profit before tax and also that the allocation calculation is done at the same time as the tax computation.  This naturally leads to the result that foreign tax for which credit can be given against tax that otherwise would be paid on behalf of the shareholders is not ultimately expended on behalf of policyholders since they do not suffer the economic burden of the tax.  In his example, when credit is given for the foreign tax, one does not allocate the net amount (£810) and the foreign tax (£90) to policyholders but instead one allocates the gross amount of their share (£900), since the shareholders are in the same position after credit as if there had been no foreign tax, and there is therefore no foreign tax expended on behalf of policyholders.  But the Appellant points out that it is not as simple in practice.  It makes two calculations at different times: first, the allocation to policyholders is made, and secondly, the tax is computed.  When the tax computation comes to be made the allocation to policyholders had already been made and the figure to be deducted for the allocation is known.  The question is then whether to make a further deduction in respect of foreign tax relating to that allocation, the amount of which is known as it is included in the Appellant’s computation.  By the time of making the tax computation the treatment of foreign tax can be determined and if it is clear that the tax can be credited against tax on the profit attributed to the shareholders that tax will not have been expended on behalf of policyholders.  But if no credit is available for the foreign tax it will have been expended on behalf of policyholders and a further deduction will be made in the tax computation.  Or the position may be somewhere in between.  
22.	We are not attracted by Mr Henderson’s alternative contention that receipt of the tax credit should be treated as a corresponding receipt of the life assurance business.  While we can see the logic that reimbursement of the foreign tax (by means of credit) treated as an expense in computing income should be treated as income in the same way as damages for loss of income are treated as income, tax is in principle non-deductible.  Section 82 reverses this by providing a deduction for foreign tax but we do not consider that we should go further and imply into the section that there are circumstances in which the reimbursement of foreign tax should be treated as taxable income.
23.	Accordingly, we consider that the credit treatment of the foreign tax must be taken into account in order to decide whether such foreign tax has been expended on behalf of policyholders.  Our decision in principle on issue 3 is that in arriving at the pension business Schedule D Case VI profit in 1992 and 1993 the Appellant is not entitled to a deduction for foreign tax expended on behalf of holders of pension policies under section 82(1) Finance Act 1989 in respect of amounts for which it has secured credit.
24.	In summary, our decision in principle on the three issues in the appeal is:
(1)	That in the circumstances of the example in paragraph 2 of our original decision the full amount of foreign tax is creditable against any corporation tax charged on the Case I profit in which the foreign income is a receipt, subject only to the limit of the maximum rate of credit in s 797.
(2)	Double taxation relief is computed separately for pension business in accordance with the Case I principles that we have decided in Issue 1.
(3)	In arriving at the pension business Schedule D Case VI profit in 1992 and 1993 the Appellant is not entitled to a deduction for foreign tax expended on behalf of holders of pension policies under section 82(1) Finance Act 1989 in respect of amounts for which it has secured credit.
25.	In accordance with section 56A(2) of the Taxes Management Act 1970 we hereby certify that our decision involves a point of law relating wholly or mainly to the construction of an enactment that has been fully argued before us and fully considered by us.  This means that if both parties consent, and if the leave of the Court of Appeal is obtained, either party may appeal from our decision directly to the Court of Appeal.

J F AVERY JONES

NUALA BRICE

SPECIAL COMMISSIONERS
                                            Release Date: 19 July 2005

SC3043/04

Authorities referred to in skeletons but not referred to in the decision
Smith’s Potato Estates Ltd v Bolland [1948] AC 508
IRC v Dowdall, O’Mahoney & Co Ltd [1952] AC 401
Luke v IRC [1963] AC 557
Chevron UK Ltd v IRC (1995) 67 TC 414
Deeny v Gooda Walker Ltd [1996] 1 WLR 426
Sportsman v IRC [1999] STC (SCD) 289