Commissioners for HMRC v Joint Administrators of Lehman Brothers [2019] UKSC 12

The collapse of Lehman Brothers back in September 2008 became, for many, the focal starting point of the global recession and its effects are still being felt, both in terms of subsequent government policy and also in current litigation; as shown by this recent Supreme Court case.

Background to the case

Lehman Brothers International (Europe) (“LBIE”) went into administration on 15 September 2008.  The entire global group had massive cashflow issues, due in part to the well documented sub-prime crisis. The Lehman Brothers parent company went into Chapter 11 proceedings which then precipitated the administration process in the UK.  Despite being technically insolvent on a cashflow basis, LBIE had substantial balance sheet assets.  Perhaps unusually for an administration, the joint administrators managed to recover approximately £40bn to pay all creditors in full, including those unsecured, and even amassed a surplus of £7bn through the administration process.  The administration is now in its final stages.

This case relates to whether interest payable under rule 14.23(7) of the Insolvency Rules 2016 (“the 2016 Rules”) is “yearly interest” within the meaning of section 874 of the Income Tax Act 2007 (“the 2007 Act”). If deemed so, the administrators must deduct income tax before paying interest to creditors.

The initial hearing at the High Court found that the statutory interest payable under the 2016 Rules did not amount to yearly interest and therefore no income tax was payable.  This finding was overturned at the Court of Appeal ([2017] EWCA Civ 2124) where it was held that no long-term accrual had to be proven for amounts to be deemed as yearly interest and furthermore, the compensatory element paid to creditors, who are unable to access such amounts set aside for them until the end of the administration also strengthened this argument.  The Court of Appeal therefore found in favour of HMRC.

The administrators then appealed to the Supreme Court, given the unusual circumstances of the case and the vast sums involved.

The Supreme Court findings

The Supreme Court dismissed the joint administrators’ appeal and upheld the Court of Appeal’s view that the amounts of statutory interest payable to creditors at the end of the administration are subject to income tax pursuant to section 874 of the 2007 Act.

The administrators had argued that the interest was only payable as a result of their decision to declare a surplus and to pay statutory interest; thus, there could not be a lengthy period of accrual as the statutory interest payable under the 2016 Rules crystallised at a snapshot in time. 

Lord Briggs used a line of reasoning from the case of Riches v Westminster Bank Ltd ([1947] AC 390) where a lump sum is received after a particular event and usually as compensation for being deprived of money or property during a past period. If that period of deprivation is longer than 12 months, then interest is held to be yearly interest for income tax purposes.

Lord Briggs argued that interest payable on a surplus in an administration is of a special type pursuant to the 2016 Rules (which is substantively identical to the previous 1986 Rules).  It effectively is in place to compensate creditors for being kept from their proven debts from the beginning of the administration (in this case 2008) until they are actually paid (most creditors were paid in full by 2014). The reasoning followed was that of the Riches case, “as there is no liability to pay interest during the period in respect of which it is calculated, and the interest is not itself payable over a period of time but it still accrues”. In fact, the administrators could not be expected to pay interest in this accrual period as there may not even be a surplus left at the end of the administration but yet the interest still accrues.  

The Supreme Court found that the statutory interest payable under the 2016 Insolvency Rules is yearly interest. Therefore, income tax is to be deducted at source pursuant to section 874 of the 2007 Act.

Impact of this ruling

This case is unusual as it is rare for an administration to declare a surplus which requires the payment of statutory interest (and now income tax as well). It is unlikely that this will become a feature of “run of the mill” administrations; however, it is helpful to have this technical tax point clarified by the highest court in the land. It is estimated that at a standard tax rate of 20%, HMRC is now due £1bn.  An HMRC spokesperson said: “This is another example of HMRC seeking robust challenges to ensure that money is available for the UK’s vital public services.”  This is clearly a welcome windfall for the Treasury.

It is not only HMRC who has received a windfall - The Guardian in a recent article notes that “the administration has been particularly profitable for hedge funds, including King Street Capital Management, Elliott Advisors and CarVal Investors. They bought debt owed by Lehman to other parties at the height of the crisis at bargain prices.”  It states that some hedge funds bought the debt at 20p in the pound and have been able to sell that debt on for 140p, and so there are some commentators who have little sympathy for the creditors now being taxed at source.  It is thought that some of these hedge funds will seek to prevent HMRC collecting in this newly confirmed income tax, relying on international tax treaties aimed at preventing the double taxation of income and so the money is by no means secure for HMRC at present.

By way of conclusion, Lord Briggs wrote in his judgment: “It is no mere irony that [Lehman Brothers’] unsecured debt has, during that last 10 years, turned out to be a very satisfactory long-term investment” - arguably even in spite of the requirement to pay income tax on the “added bonus” of the administration surplus.