The Supreme Court decided that interest paid to proving creditors out of the surplus in the administration of Lehman Brothers International (Europe) was “yearly interest”. Although it was paid as a lump sum only after a surplus had been found, and did not accrue from day to day, it compensated creditors for being kept out of their money for several years. The administrators therefore had to deduct income tax before paying it.
Two statutory rules
The appeal concerned the relationship between a long-standing tax rule and a modern insolvency rule. Section 874 of the Income Tax Act 2007 requires a person who pays “yearly interest” arising in the United Kingdom to deduct income tax at the basic rate where the payer is a company or falls within the other categories in that section. The Act does not define “yearly interest”. Rule 14.23(7) of the Insolvency Rules 2016 requires any surplus remaining after payment of proved debts in an administration to be applied first in paying interest on those debts for the periods they have been outstanding since the company entered administration. The rate is the greater of the rate under section 17 of the Judgments Act 1838, then 8 per cent a year, and any rate applicable to the debt apart from the administration. All such interest ranks equally.
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Both sides accepted that the payments were interest. Only their character as yearly interest remained in dispute.
How the interest arose
Lehman Brothers International (Europe) entered administration on 15 September 2008, while commercially insolvent, and became a distributing administration in December 2009. On 30 April 2014 a final dividend brought unsecured proving creditors to 100 pence in the pound. The administration nevertheless produced a surplus in the region of £7 billion, of which some £5 billion was estimated to be payable as statutory interest before tax. On 25 July 2018, after a scheme of arrangement, interest slightly in excess of £4 billion was paid, with enough withheld on account of tax to await the outcome of these proceedings.
The interest did not accrue as an enforceable liability from day to day. The statutory right to payment depended on the administration having a surplus after proved debts had been paid. But once a surplus existed the calculation looked back to the period that creditors had been kept out of their money.
The disagreement below
Hildyard J held that the absence of accrual before the surplus was identified and quantified, after all proved debts had been paid in full, was fatal. The interest was not yearly interest. The Court of Appeal disagreed. Patten LJ found no requirement in the authorities that yearly interest must accrue due over time. Because it compensated creditors for being kept out of their money for a substantial time, it had the long-term quality required.
Which period makes the interest yearly
Lord Briggs distinguished interest that accrues under a loan from a single compensatory payment calculated afterwards. For a loan, the duration and expected continuity of the underlying arrangement can matter.
In the second group, a statute or court order supplies compensation for the use of someone else’s money. The right to payment may arise late, even though the amount is calculated by reference to a much longer period.
Lord Briggs held that this second group supplies the period to be used when a single compensatory payment is tested for duration. It is the period in respect of which the interest is calculated, because that is the period of the loss, not the later moment when a surplus appears or payment is decided upon. By the time the interest becomes due, the payer knows that period and can deduct tax or pay without deduction accordingly. Section 874(5A), which treats interest payable to an individual in respect of compensation as yearly interest irrespective of the period covered, supported that reading. The Court was told that the provision was introduced to deal with compensation for mis-selling of payment protection insurance. Its wording assumes that, without the deeming provision, the length of the period in respect of which the interest is paid would decide whether it was yearly.
The Lehman interest shared the relevant features of that second group. A surplus could not generally be foreseen at the start of an administration, and such surpluses are very rare. Statutory interest is never due until proving creditors have been paid in full. There is also a risk that a later winding-up may affect the availability of interest under the rule even if there is a surplus. Once paid, however, the interest compensates proving creditors for being kept out of their proved debts from the commencement of the administration, which prevented other forms of recovery, until they were paid. Those periods exceeded a year, so the interest was yearly interest.
The argument about source
The administrators argued that income tax is levied by reference to the source of the income. They said the only source here, apart from the statute itself, was the realised surplus together with the administrators’ decision that it was time to pay. Those elements were unpredictable, might evaporate on a winding-up, would not generally have existed for a year, and were not an investment. The period of calculation was not itself a source. If any other source had to be found, it was the contractual debts owed when the company entered administration, but those debts were mainly short-term. Neither they nor the provable debts which replaced them still existed when the interest became payable, because they had been discharged in full.
Lord Briggs rejected that analysis. It confused the immediate occasion for payment with the relationship that explained why the creditor was entitled to it.
He also considered it artificial to treat the surplus, or the decision to pay it, as the source which characterises the interest. The administrators had no real discretion. If it is instructive to look for a source, it is the recipient’s status as a proving creditor from the start of the administration until payment of the principal by dividend. That status is created by the insolvency legislation, replaces the former contractual rights, coincides with the calculation period, and has the necessary durability. Lord Briggs would also regard it as an investment, albeit an unwilling and involuntary one. Over those ten years, LBIE’s unsecured debt had produced interest, payable in full, at 8 per cent.
Verdict: The Court unanimously dismissed the administrators’ appeal. The statutory interest was yearly interest, so the administrators had to deduct income tax before paying the creditors.
