The Court of Appeal (CoA) provided valuable clarity on the interpretation of "dividends of a capital nature" and reinforced the primacy of the distribution mechanism in determining its tax treatment.
Background:
Mr. Beard is a shareholder in Glencore plc, a Jersey-incorporated company that is Swiss tax-resident. Prior to 2011, Mr. Beard held interests in a Swiss Glencore entity, which were converted into Glencore shares during the restructuring.
He received interim and final cash distributions between 2011 and 2016, and a distribution of Lonmin plc shares in 2015. All these distributions were debited to Glencore's share premium account, as permitted under Jersey law. The total value received by Mr. Beard was circa. £150 million.
Mr. Beard argued that these distributions were "dividends of a capital nature" and therefore not subject to income tax but rather to capital gains tax (CGT). HMRC, however, disagreed, a stance which was supported by both the First-tier Tribunal (FTT) and the Upper Tribunal (UT). Given that Mr. Beard no longer disputes that the distributions were "dividends" under Section 402 of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005, the appeal focuses on whether they were "of a capital nature" under s.402(4)
Decision:
The CoA dismissed the appeal and upheld the decisions of the FTT and UT that distributions received from an overseas company, which were debited from the company’s share premium account, were dividends that were not capital in nature and, therefore, were chargeable to income tax under Section 402 of ITTOIA.
Lady Justice Falk summarises Robert Walker J's judgement in Memec, referencing Lord Pearce in Rae v Lazard usefully, as UK tribunals apply UK tax law to foreign transactions, arrangements, or entities. They must first consider the foreign law to determine the nature and characteristics of these transactions based on the facts, and then apply UK tax law. She ruled that a foreign legal system's label of "capital" doesn't dictate UK tax treatment.
Lady Justice Falk then addresses the interpretation of Section 402(4) ITTOIA. The Judge rejected the argument about a major structural change with ITTOIA, noting that, while UK and foreign income tax treatment wasn't fully integrated, the accompanying explanatory notes clearly explain the separate treatment of UK dividends (Chapter 3) and non-UK dividends (Chapter 4). The different structure thus reflects prior law.
While "dividend of a capital nature" seems paradoxical, she acknowledges that a dividend might not always be income, citing Sinclair v Lee as an example. The UT correctly noted the impossibility of foreseeing all dividend scenarios under diverse foreign laws. Given the unclear scope of "dividend" itself, the draftsman likely intended to clarify that capital dividends fell outside Section 402(1).
Implications:
This judgement reaffirms the long-standing principle, which was particularly evident in cases like Rae v Lazard and First Nationwide, that the legal mechanism employed by a company to make a distribution is the primary determinant of its character (in terms of income or capital) in the hands of the recipient for UK tax purposes. While the source of the funds, in this case, the share premium, often considered a capital reserve, is a factor, it is not however the decisive one. Moreover, the fact that the funds originated from share premium, or that Jersey law might treat it as "capital" for certain purposes, did not override the income nature of the distribution.
More importantly, this case seems to suggest that “dividend of a capital nature” is a fact-specific and relatively rare categorisation. This implies that taxpayers cannot simply label a distribution as "capital" based on its funding source or the distributing company's internal accounting treatment. The legal form and effect of the distribution under the relevant foreign law, as applied through the lens of UK tax principles, will be paramount.