Revenue and Customs v Joint Administrators of Lehman Brothers International (Europe) [2019] UKSC 12

Lehman Brothers International (Europe)'s administration generated an unprecedented £7 billion surplus, with around £5 billion payable as statutory interest to creditors. The Supreme Court held that this statutory interest qualified as 'yearly interest' under section 874 of the Income Tax Act 2007, requiring administrators to deduct income tax at source.

Facts

Lehman Brothers International (Europe) (LBIE) entered administration on 15 September 2008 following the collapse of the Lehman Brothers group. Despite being commercially insolvent at that time, the administration generated an unprecedented surplus of approximately £7 billion after payment of all provable debts, of which approximately £5 billion was estimated to be payable by way of statutory interest (before any deduction of income tax).

A final dividend bringing total dividends to 100p in the pound was paid to unsecured proving creditors on 30 April 2014. Interest slightly in excess of £4 billion was paid to creditors on 25 July 2018, after deduction of a sum on account of tax pending these proceedings. The interest periods ranged from just over four years to around five and a half years.

Rule 14.23(7) of the Insolvency Rules 2016 requires any surplus remaining after payment of proved debts to be applied in paying interest on those debts in respect of the periods during which they had been outstanding since the commencement of the administration, at the greater of the Judgments Act rate (8%) or the contractual rate.

Issues

The narrow question was whether interest payable under rule 14.23(7) of the Insolvency Rules 2016 constitutes ‘yearly interest’ within the meaning of section 874 of the Income Tax Act 2007, such that the administrators were obliged to deduct income tax at source before paying interest to proving creditors.

It was common ground that the payments were ‘interest’ within the meaning of section 874(1); the dispute concerned whether they were ‘yearly’ interest.

Arguments

Administrators’ submissions

The administrators (represented by David Goldberg QC and Daniel Bayfield QC) submitted that yearly interest required: (i) a source with the requisite degree of permanence and durability over time; and (ii) that the interest should accrue due over a period intended, or at least likely, to last a year or more. Statutory interest under rule 14.23(7) had as its source merely the emergence of a surplus and the administrators’ decision to pay it. It did not accrue over time; rather it was payable as a lump sum once the surplus was ascertained. Furthermore, creditors’ underlying contractual debts were mostly short-term and had been discharged when interest became payable, leaving no qualifying source.

HMRC’s submissions

HMRC (represented by Malcolm Gammie QC and Catherine Addy QC) submitted that identifying a source was unnecessary for deduction under section 874(1), and yearly interest did not require accrual over time. The relevant period was that commencing with the administration and ending on payment in full, during which creditors were kept out of their money. Where that period exceeded a year, the ‘yearly’ requirement was satisfied. To the extent an investment-type source was required, creditors were involuntary long-term investors in LBIE due to the administration moratorium.

Judgment

Lord Briggs (with whom Lord Reed, Lord Carnwath, Lord Hodge and Lady Black agreed) dismissed the appeal, holding that statutory interest under rule 14.23(7) was yearly interest for the purposes of section 874.

Statutory interest as sui generis

The Court confirmed (citing David Richards J in In re Lehman Brothers International (Europe) (No 6) and Patten LJ in the Court of Appeal) that statutory interest is not a continuing liability accruing from day to day; rather it is statutory compensation for creditors being kept out of their money during the administration period. Hildyard J had correctly observed that the statutory right is sui generis.

The two groups of authorities

Lord Briggs divided the authorities on yearly interest into two groups. The first group (including Bebb v Bunny (1854), Goslings & Sharpe v Blake (1889), In re Cooper [1911], Gateshead Corpn v Lumsden [1914], Garston Overseers v Carlisle [1915], Inland Revenue Comrs v Hay (1924) and Corinthian Securities Ltd v Cato [1970]) concerned interest accruing over time. These established what Lord Briggs termed ‘the Hay tests’: the loan must have a measure of permanence, be in the nature of an investment, not be repayable on demand, and have a ‘tract of future time’.

The second group of authorities

Crucially, Lord Briggs held that the second group of authorities (Barlow v Inland Revenue Comrs (1937), Regal Hastings v Gulliver, Riches v Westminster Bank Ltd [1947], Jefford v Gee [1970] and Chevron Petroleum (UK) Ltd v BP Petroleum Development Ltd [1981]) provided the answer by analogy. These concerned interest payable after the event as compensation for being kept out of money, which did not accrue due during the relevant period but was awarded retrospectively.

Period of calculation as the relevant durability

Lord Briggs concluded that, where interest is payable as a lump sum compensating the payee for being out of money in the past, the relevant period for determining whether the interest is ‘yearly’ is the period in respect of which the interest is calculated. In LBIE’s case, this period (over four to five and a half years) amply satisfied the yearly requirement.

Source argument rejected

The Court rejected the administrators’ ‘source’ argument for several reasons: (i) section 874 imposes a deduction obligation independent of the recipient’s tax position; (ii) it is artificial to regard the source as the surplus or the administrators’ decision to pay; (iii) if a source is required, it is the creditor’s status as a proving creditor during the administration, which precisely coincides with the calculation period; and (iv) if necessary, that status has the character of an involuntary long-term investment. The Court also noted section 874(5A)’s deeming provision for compensation interest paid to individuals suggested that duration of the calculation period was the relevant test.

Implications

The decision clarifies that, for the purposes of deduction of tax at source under section 874 of the Income Tax Act 2007, ‘yearly interest’ includes lump sum interest payments which compensate a payee for being kept out of money over a historical period exceeding a year, even where the interest does not accrue day-to-day and is contingent on future events (such as the realisation of a surplus in administration).

The judgment is of direct practical significance to administrators in distributing administrations where a surplus arises: they must deduct basic rate income tax when paying statutory interest to proving creditors under rule 14.23(7), provided the interest period exceeds a year and the conditions of section 874(1) are otherwise met.

More broadly, the case reinforces the approach that, for lump-sum compensatory interest, the ‘yearly’ characterisation depends on the length of the period in respect of which the interest is calculated, not on the payment mechanism or contingent nature of the underlying right. The ‘Hay tests’ remain the best convenient summary of the jurisprudence for interest accruing over time, but they apply somewhat differently to compensatory lump-sum interest.

The decision’s scope is limited to the specific statutory context of rule 14.23(7) and comparable compensatory interest arrangements. It does not disturb the first line of authority dealing with interest accruing over time. Surplus administrations are noted to be very rare, so the direct practical application is narrow, but the reasoning has wider implications for how compensatory interest is characterised under the deduction at source regime.

Verdict: Appeal dismissed. Statutory interest payable by administrators out of a surplus under rule 14.23(7) of the Insolvency Rules 2016 constitutes ‘yearly interest’ within the meaning of section 874 of the Income Tax Act 2007, and the administrators are therefore obliged to deduct income tax at source before paying interest to proving creditors.

Source: Revenue and Customs v Joint Administrators of Lehman Brothers International (Europe) [2019] UKSC 12