Classification of foreign dividends

The core issue in Beard v HMRC [2025] EWCA Civ 385 ("Beard") was whether distributions made by a Jersey incorporated company, which were debited to the share premium account of the company, were "dividends of a capital nature" within the meaning of section 402(4) of the Income Tax (Trading and Other Income) Act 2005 ("ITTOIA").  The significance of this is that dividends of a capital nature paid by a non-UK resident company are not subject to income tax.

The Court of Appeal ("CA") decided that the distributions were not of a capital nature: they were income and therefore subject to income tax.

The CA's decision clarifies the test to be applied to determine the income or capital nature of dividends for the purposes of section 402 ITTOIA. It not only confirms that the pre-ITTOIA case law in this area remains relevant, but it also clarifies the relationship between the two different formulations of the test under the pre-ITTOIA case law. Specifically, it confirms there is a single test to be applied (whether the "corpus of the asset" remains intact) and that, in applying this test, the "mechanism employed" is key (though not determinative).

Facts

The appellant, Mr Beard, was a UK tax resident individual, and a shareholder of Glencore plc, a Jersey incorporated and Swiss tax resident company.

Between 2011 and 2016, Mr Beard received from Glencore a number of interim and final cash distributions, and one in specie distribution of shares in Lonmin plc (respectively, the "Cash Distributions" and the “In Specie Distribution” and, together, the “Distributions”). Importantly, all the Distributions were debited to Glencore's share premium account (as permitted under Jersey company law), and they were made using the procedure established in Part 17 of the Companies (Jersey) Law 1991 ("CJL 1991") – the same mechanism available to Jersey companies to pay dividends out of profits. There is a different mechanism, in Part 12, available to Jersey companies to reduce their "capital accounts", including their share premium account. The total value of the Distributions was in the order of £150m, of which the In Specie Distribution represented c. £4.7m.

Glencore's share premium account, out of which the Distributions were made, had been credited as a result of two main share issues. The first was made in 2011, for the purposes of reorganising the wider Glencore group (to make Glencore the holding company of the group) and raise capital from investors. The second was made in 2013, for the purposes of funding the acquisition of the 66% of Xstrata plc that Glencore did not already own. Xstrata held a minority stake in Lonmin, which Glencore chose to divest to its shareholders by way of a distribution in specie in 2015 (i.e. the In Specie Distribution).   

HMRC assessed Mr Beard to income tax on the Distributions on the basis that they were "dividends of a non-UK resident company" under section 402(1) ITTOIA.  Mr Beard appealed, first to the First-tier Tribunal ("FTT") and then to the Upper Tribunal ("UT"), on the basis that: (i) the Distributions were not "dividends"; and (ii) even if they were, they were dividends "of a capital nature" under section 402(4) ITTOIA and, therefore, not subject to income tax (but rather CGT under section 122 TCGA). The FTT and the UT rejected both grounds of appeal, holding that the Distributions were dividends, but not of a capital nature. 

Appeal to the CA

Before the CA, Mr Beard did not challenge the conclusion of the FTT and the UT that the Cash Distributions were "dividends". He appealed on two grounds:

• Ground 1: the Cash Distributions were dividends "of a capital nature".
• Ground 2: the In Specie Distribution was not a "dividend" and, even if it was, it was a dividend "of a capital nature".  (In the case, Ground 2 was subdivided into two related grounds.)

In relation to Ground 1, Mr Beard argued that the Distributions were "of a capital nature" because they were made out of Glencore's share premium account, so they represented what had been originally contributed for the shares, and they were recorded at all times as part of Glencore's capital (and, therefore, as part of Glencore's liability to its shareholders). In particular, Mr Beard relied on Article 39(4) CJL 1991, which provided that the share premium account of a company was to be treated as part of its "paid up share capital".  (Based on a similar provision in the UK Companies Act 1948, the CA had held in Re Duff's that a distribution out of the share premium account of a UK company was capital for trust law purposes.) He further argued that, if the test to be applied was whether the "corpus of the asset" remained intact (following Reid's Trustees and Rae v Lazard), then the shares in respect of which the Distributions were paid did not remain intact because the Distributions, in fact, reduced Glencore's liability to its shareholders.

In relation to Ground 2, Mr Beard argued that the In Specie Distribution was not a "dividend" because it was not a payment out of "profits" (the Lonmin shares having been inherited from the acquisition of Xstrata), and it was a "one-off" distribution. 

Decision

The CA decided that:

• The Cash Distributions were not dividends "of a capital nature"; and
• The In Specie Distribution was a "dividend", but not "of a capital nature".

The relevant legal test

The CA found that the relevant test to determine whether the Distributions were "dividends of a capital nature" derived from the pre-ITTOIA case law on the distinction between income and capital distributions, including the House of Lords' decisions in Reid's Trustees and Rae v Lazard. In both cases, the relevant test had been formulated as being whether the "corpus of the asset" had been left intact after the distribution. However, in Rae v Lazard, the Lords had emphasised that it is the "machinery employed" to make the distributions which is determinative. The CA decided that there was a single test to be applied (namely, whether the "corpus of the asset" was left intact) but that, in answering this question, the "mechanism employed" is key (albeit not determinative).  

Importantly, the CA also noted that:

• The origin of the funds out of which a distribution is made is irrelevant to whether the distribution is income or capital – in particular, it is irrelevant whether the original funds are income or capital in the hands of the company.
• Moreover, in determining whether a distribution is income or capital, it is necessary to "look behind the labels" that may be applied under foreign law.  Although the nature of the mechanism employed to make the distribution is a question of foreign law, the question of whether a distribution made through that mechanism is income or capital is a question of UK domestic law.

The relevant Jersey law

The CA identified the following key findings of facts from the FTT's decision:  

• The Distributions could have been made under two different procedures under Jersey company law: (a) the procedure in Part 17; or (b) the procedure in Part 12.  
• Both procedures allowed distributions to be made out of the share premium account of a Jersey company. In the case of Part 17, this was the result of a relaxation of the principle of capital maintenance in Jersey company law in 2008, which allowed distributions to be made out of the share premium account of a company subject the requirement of a "solvency statement". The procedure in Part 12 required either a solvency statement or court sanction. 
• As it happened, all the Distributions were made using the procedure in Part 17. 
• Part 17 was not only the same machinery available to Jersey companies to make distributions out of profits, but also "the only relevant machinery which can be used by a company like Glencore to make income distributions".
• The Royal Court of Jersey had noted (in a case considering the impact of the relaxation of the principle of capital maintenance in Jersey law) that: "the Law no longer distinguishes between a distribution out of share premium account and a distribution out of profits…[T]he principle of maintenance of capital…is now only applied in respect of the nominal capital and the capital redemption reserve". 

Application to the facts

Ground 1

The CA decided that the Cash Distributions were not dividends "of a capital nature" on the basis that they were made using the procedure in Part 17, which was the same (and only) procedure available to make distributions of profits.

In relation to Article 39(4) CJL 1991, the Court concluded that, although this provided for the share premium account of a company to be treated as part of its share capital, on a proper construction, the article had no application to distributions under Part 17. The article was expressly subject to the rest of Article 39, including Article 39(3) which allowed the share premium account of a company to be used to make Part 17 distributions.

Ground 2

The CA decided that the In Specie Distribution was a "dividend", but not "of a capital nature", on the basis that it was made using the procedure in Part 17.

The Court expressly rejected Mr Beard's argument that the In Specie Distribution was not a "dividend" because it had not been paid out of Glencore's profits. While the Court recognised that this was an element of the definition of dividends adopted by the CA in Memec ("a payment-out of a part of the profits for a period in respect of a share in a company"), the Court noted that this definition was "not necessarily apt in all circumstances" (for instance, in the case of dividends paid out of capital profits). On this basis, the Court concluded that "there is…no requirement to identify what is paid as representing something that can be characterised as profit for a period". The Court reasoned further that, even if this were a requirement, the share premium account of a company could itself be characterised as a profit arising on the issue of shares, in the sense that the company received more for the shares than their nominal value.

Comment

The CA reiterated the orthodox approach to applying UK tax provisions to factual scenarios involving foreign elements (for example, foreign entities or transactions).  That approach is as follows:

• First, identify the nature and characteristics of the foreign element (in this case, the distributive transaction undertaking by the company).  This is a question of fact.
• Second, construe the relevant UK tax legislation (a question of domestic law).  (In this case, the meaning of "dividend", and "of a capital nature", were matters of domestic law.)
• Third, apply the law to the facts.

As noted above, the CA was clear that – as a matter of UK domestic law – the relevant legal test (for determining whether a dividend is of a capital nature) is whether the corpus of the shares remains intact, and that an essential element in determining that question is identification of the mechanism or form of distribution.  However, the Court did not provide much guidance on what features of mechanism for distribution must possess to make the distribution a dividend of a capital nature.  As such, there remains room for dispute (and a possible appeal to the Supreme Court).  Viewed from this perspective, the CA's decision is perhaps a missed opportunity to formulate a more practicable and predictable test for taxpayers in this area.

In coming to its decision, the CA made a number of observations regarding the correct approach to findings of foreign law (and the role of expert evidence in relation to the same) which those litigating in this area should bear in mind.

• First (and having reiterated that matters of foreign law are questions of fact), the CA endorsed the view that there is a spectrum of systems of foreign law.  At one end, there are common law systems (which apply an approach similar to English law) where judges will be more able and willing to bring to bear their own skill and experience in making findings regarding foreign law. At the other end of the spectrum are legal systems far removed from common law where judges will need to place greater reliance on foreign law experts.
• Second, given that foreign law is a question of fact, there is no scope to challenge first instance findings about foreign law other than on Edwards v Bairstow grounds (viz, that no person acting judicially and properly instructed as to the relevant law could have come to the determination being challenged). However, it may be that, on appeal, such an error will be more readily identifiable where the relevant foreign law is closer to the "common law system" end of the spectrum (since the appellate Court will be more familiar with the legal principles that must have been weighed by the first instance judge).