The decision was the latest of a number of decisions arising out of the administration of Lehman Brothers International (Europe) (LBIE), the European business of Lehman Brothers, the financial services group which went into administration in 2008.
The Court of Appeal said it was necessary to consider the purpose of the provisions in the Insolvency Rules which applied statutory interest and to consider whether the administrators' obligation to pay interest in the event of a surplus should be treated as essentially a short-term liability like a short-term loan, regardless of how long the administration actually lasted.
Lord Justice Patten said it would be wrong to treat such statutory interest as a short-term liability because the obligation of the administrators to pay interest was unlimited in point of time, was calculated by reference to a per annum rate of interest, contemplated a period of administration which could in many cases last over a prolonged period of time and did in fact endure for a number of years. It therefore satisfied the definition in the case of Bebb v Bunny in that it was payable from year to year whilst accruing from day to day, he said.
"Unless the fact that it did not accrue prospectively in real time is fatal to the contention that it is yearly interest which, in the light of the authorities, it is not, I can see nothing in the Insolvency Rules or the other relevant surrounding circumstances which prevents it from being treated as the long-term liability which it in fact was," the judge said.
The High Court had decided in 2016 that the statutory interest was not yearly interest as it arose only if and when a surplus was established and there was no accrual of a right to interest.
For hundreds of years the UK tax system has made a distinction between 'annual' or 'yearly' interest and other interest. Current rules provide that basic rate tax only has to be deducted from payments of 'yearly' interest.
Until late 2015 the stated view of HM Revenue & Customs (HMRC) was that statutory interest paid in the course of an administration could be paid without any obligation to deduct income tax. However, when in August 2015 and in anticipation of actually making distributions, the administrators of LBIE asked HMRC to reconfirm their position, the matter was referred to an HMRC specialist team which said that there was an obligation to deduct. As the matter could not be resolved, the administrators applied to the court for a direction.
HMRC wants tax to be deducted at source from the interest payments in this case to ensure tax is collected from UK residents, but more importantly so that payments to the many non resident creditors are subject to UK tax. If the payments were not subject to deduction of tax at source, there would be no UK tax liability for non-residents. The amount payable by way of statutory interest is estimated to be in the region of £5bn so significant amounts of tax are at stake.
The obligation to pay the interest arose because upon repaying all creditors 100 pence in the pound and settling administration expenses, the administrators of LBIE were unexpectedly left with a surplus estimated at £7.39 billion. The administrators looked to the courts for direction on how to distribute the surplus. As there were a number of issues which required the court's direction, the case was split into Waterfall I, Waterfall II and Waterfall III. In November 2017 in the Waterfall II case, the Court of Appeal determined the extent of creditors' entitlements to statutory interest on their debts and the correct approach for calculating their entitlement.