Taxman loses his share of the divvy, court rules

Nationwide Building Society

The deals undertaken between banks are a mystery to most outside the
financial services sector, but it can be boiled down to its barest bones when
the situation requires it as far as the taxman is concerned.
Put simply: who owes what and are there any tax implications?

HMRC is licking its wounds and considering whether to challenge a court
ruling after losing a £51m corporation tax wrangle with Nationwide Building
Society’s investment company.

Nationwide claimed that £51m in expenses incurred on dividend payments made
to ABN AMRO could be offset against their incurred corporation tax bill. HMRC
had argued Nationwide was distributing profits which were taxable.

The case, which seems fairly niche at first glance, has far-reaching effects
advisers say, and it comes in the
of the taxman closing down a corporation tax loophole
linked to the same

Advisers suggest the case puts into question the wider issue of how banks
treat the dividends they pay out in relation to their corporate tax liabilities
– an issue which John Whiting, head of tax policy at the Chartered Institute of
Taxation, said: “There isn’t anything much more fundamental in banking.”

“This is part of the way banks do business now. The old and fast ‘cricket and
warm beer’ view of the traditional banker is no more. Life has moved on,”
Whiting said.

The nub of the case is: First Nationwide borrowed shares from ABN AMRO in
2003. The contract said Nationwide could keep the shares until 2004, but on a
certain date the bank gives back the same number of shares.

Nationwide could keep any dividend received on the shares when it held them,
but had to give a “manufactured dividend” back to ABN AMRO.

These manufactured divvies were treated as expenses of management by
Nationwide, and on that basis the £51m paid in manufactured dividends should be
excluded from its corporation tax bill.

The taxman questioned whether the dividends, paid out of share premium
account, could be treated as a distribution of profit and therefore liable to

However, First Nationwide successfully appealed HMRC’s challenge last month.

The ruling might encourage those banks not currently following this strategy to
follow suit, Whiting added.

But they must note that HMRC has not been shy to appeal cases in the past,
particularly with so much pressure on Treasury coffers. However, it has not yet
decided on the next step.

“HMRC is considering this tribunal decision carefully and will decide in due
course whether to appeal,” it said.

First Nationwide is a UK resident unlimited company that is a wholly-owned
investment company subsidiary of Nationwide Building Society. It appealed
against an amendment dated 23 April 2008 made by HMRC to the division’s
corporation tax self-assessment for the accounting period ended on 31 March
2004, which excluded a deduction of £51,000,000 for expenses of management.

HMRC’s lawyer noted in his representations, that the tax collectors were in
no way accusing First Nationwide of tax avoidance. “It is no part of HMRC’s case
that the appeal must fail on the basis that it is, wholly or in part, a scheme
to avoid tax,” Judge Berner said in his ruling.

“As Mr Gammie noted in his skeleton argument, although the legislation is
found in the Part of the Act that is set aside for provisions that are designed
to counter what Parliament regards as tax avoidance, the legislation in question
incorporates no relevant tax avoidance or commercial purposes test.

“The appellant’s reasons for entering into the transaction, the purpose of
which I have found was to assist the Nationwide group’s funding requirements,
are accepted as being of no concern in construing the legislation.”

In our view

The banking industry has been under the cosh in recent times but must rightly
pay their tax liabilities. In general HMRC fights tooth and nail to maximise the
tax take – never more so than in the current climate. This particular dispute
not only puts the scale of the lending trade between banks into perspective, but
also the associated tax minefields. This case is not the first and will by no
means be the last of its kind.

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