Interest on borrowings to finance redemption of shares is a deductible expense

Sean MacAonghusa (plaintiff/ appellant) v Ringmahon Company (defendant/respondent).

Revenue - Statutory interpretation - Whether interest payable on capital sum borrowed to finance redemption of redeemable shares wholly and exclusively expended for purposes of company's trade - Case 1 Schedule D - Income Tax Act 1967, section 61.

The Supreme Court (Mrs Justice Denham, Mr Justice Murray and Mr Justice Geoghegan); judgment delivered 29 May 2001.

While a capital sum borrowed by a company to finance the redemption of redeemable shares is not a deductible expense in computing the company's profits, the ongoing interest arising thereon is expenditure wholly and exclusively laid out for the purposes of a company's trade in terms of section 61 of the Income Tax Act 1967 and is a deductible expense. The Supreme Court so held in dismissing the appeal brought by the Inspector of Taxes against the High Court's decision allowing the respondent a deduction of £435,764 in computing the amount of its profits under Case 1 of Schedule D.

Frank Clarke SC for the appellant; Thomas S. McCann SC for the respondent.

Mr Justice Geoghegan said that the proceedings arose from a case stated by Judge Lynch in the Circuit Court who sought the High Court's opinion as to the correctness of his holding that the respondent ("Ringmahon") was entitled to a deduction of £435,764 in computing its profits under Case 1 of Schedule D. The appellant, the Inspector of Taxes ("the inspector") appealed against the High Court decision of Mr Justice Budd wherein he held that Ringmahon was entitled to such a deduction. Mr Justice Geoghegan outlined the facts of the case and which may be summarised as follows: Ringmahon was an unlimited company, a wholly owned subsidiary of Ringmahon Holdings Ltd and its ordinary shares were held by members of the Dunne family. In 1987, Ringmahon acquired some supermarkets from which it began to trade in the retailing of food, clothing and other household goods under the brand name of Dunnes Stores. Ringmahon's purchase of the supermarkets was initially financed by way of a loan from Dunnes Stores Ireland Company ("DSIC"). This loan was replaced when Ringmahon subsequently issued 11,500,000 redeemable preference shares of £0.05 at a premium of £0.95 per share to DSIC on 4 January 1988. DSIC was ultimately controlled by the Dunne family trust, the beneficiaries of which were members of the Dunne family. In 1991, the board of Ringmahon decided to redeem 6,000,000 of the redeemable preference shares held by DSIC. Ringmahon obtained a bank loan of £6,000,000 and redeemed 6,000,000 redeemable preference shares in the period ending on 28 December 1991. The proposal to redeem the preference share capital was pursuant to the stated objective at the time that Ringmahon was set up that it would be financed independently of the Dunne family trust (including the group companies owned by the trust) and would stand alone as a separate operation. Ringmahon's articles of association gave it sole discretion regarding redemption and it was not obliged to redeem the preference share capital. At the time of redemption, Ringmahon's issued ordinary share capital comprised two ordinary and fully paid up £1.00 shares.

Mr Justice Geoghegan noted that the bank loan to finance the redemption gave rise to a continuing liability to pay interest and that such interest was normally tax deductible as "wholly and exclusively laid out or expended for the purposes of the trade, profession or vocation" of the taxpayer. Mr Justice Geoghegan noted that this was the statutory test of tax deductibility of non-capital expenditure in section 61 of the Income Tax Act 1967, which provided: "Subject to the provisions of this Act, in computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of - (a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade or profession".

Mr Justice Geoghegan noted the inspector's argument that, because the purpose of the loan was to redeem preference shares, and was therefore related to the capital structuring of the company and not ordinary trading, ongoing interest liability on the loan had to be treated as being of the same character and could not be deducted against profits for tax purposes. Mr Justice Geoghegan noted Ringmahon's contention that, although the purpose of the loan was to redeem shares and there could be no question of the capital sum spent on the redemption being deductible, the ongoing annual interest was different because it became merged in the ordinary ongoing liabilities of the company in its trading. Mr Justice Geoghegan referred to Ringmahon's written submissions which contended, inter alia, that the interest was "wholly and exclusively" laid out for the purposes of its trade because "the only way in which the trade could be carried on after the redeemable preference shares were redeemed was by the new share capital or by borrowings and the interest on those borrowings was then wholly and exclusively laid out for the purposes of the trade. If the interest was not laid out for the purposes of the trade the question arose as to what it was laid out for? - nothing in the case stated suggested that it was laid out for anything other than to enable the company to carry on the trade and while the principal was laid out to redeem the preference shares the interest in each year was laid out to retain the benefits of the borrowing so as to enable the company to carry on its trade."

Mr Justice Geoghegan further referred to Ringmahon's submission that the interest had to be examined in each year and the interest was not necessarily coloured by the fact that the principal was used for a capital purpose. Furthermore, Ringmahon contended that the interest was not so coloured because, while the principal on a loan to build a factory would not be deductible because it would be a capital expenditure, Revenue agreed that the interest on such a loan would be an allowable deduction. Ringmahon submitted that it had not acquired a new asset but had merely extinguished share capital and continued its business by substituting bank borrowings and, in respect of which, it was paying interest.

Mr Justice Geoghegan said that in interpreting the statutory provision, and without the assistance of any case law, Ringmahon's argument was the more convincing one. He noted Ringmahon's submission that, if it was not correct in its submission, there would be an anomaly in the tax regime because, if it had borrowed to finance its business, the interest payable thereon would have been deductible as a trading expense and it would be strange if the position was different just because there were no borrowings prior to 1991 when the company was financing its business by redeemable share capital.

Mr Justice Geoghegan referred to Ringmahon's submissions that there was no distinction in principle between interest payable on the bank borrowings for the purposes of redeeming share capital and interest payable on bank borrowings incurred to substitute for earlier borrowings from another bank. Mr Justice Geoghegan said that, even if this was no better than a debating point, Ringmahon successfully demonstrated that ongoing interest had to be regarded as being laid out wholly or exclusively to earn profits in the particular accounting year. Mr Justice Geoghegan took this view as a matter of principle on the arguments made and without recourse to case law. He noted that a large number of cases had been cited to the court and that the case law was exhaustively reviewed in the High Court judgment. Mr Justice Geoghegan noted that the general principles applicable had been considered in Irish, English, Scottish and Canadian cases but he did not consider any of the decisions directly relevant to the case before the court. Mr Justice Geoghegan did note, however, that his view was supported by the Canadian decision in Trans-Prairie Pipelines Ltd v Minister of National Revenue 70 DTC 6351, the facts of which were very similar to those in the present case. Mr Justice Geoghegan reviewed the facts of that case which may be summarised as follows: the appellant company's original issued capital consisted of common shares and 140,000 redeemable preferred shares having a total par value of $700,000. Two years after its incorporation, the company issued $700,000 first mortgage bonds and used $400,000 of the amount raised, together with $300,000 raised by the issue of further common shares, to redeem the preferred shares. The company deducted the interest that it paid on the bonds when calculating its taxable income in subsequent years. The Minister of National Revenue, however, only allowed the company to deduct three-sevenths of the expenses on the basis that four-sevenths of the money borrowed was used by the company to redeem the preferred shares and did not satisfy the statutory requirement that it be "used for the purpose of earning income from its business". The Tax Appeal Board upheld the minister's decision and, on further appeal, the Exchequer Court of Canada allowed the appeal. Mr Justice Geoghegan considered the decision of Mr Justice Jackett in the Exchequer Court who saw the alternative as follows: prior to the transaction, the capital used by the company to earn income was $700,000 in preferred shareholders' subscriptions and $140,006 in common shareholders' subscriptions. After those transactions, the preferred shareholders' subscriptions were withdrawn. Thereafter, the company used $440,006 in common shareholders' subscriptions and borrowings of $700,000 to earn income. It followed that the entire $700,000 borrowings was being used by the company to earn income even though, from another point of view, $400,000 of the $700,000 was in fact paid on the redemption of the preferred shares.

Mr Justice Geoghegan completely agreed with the reasoning in Trans-Prairie and he considered that the difference between the wording of the Canadian legislation and section 61 of the Income Tax Act 1967 was not relevant to the case before him. Mr Justice Geoghegan said that Mr Justice Jackett, in terms of analysing what happened to the borrowings, was clearly expressing the view that they were wholly and exclusively laid out or expended for the purposes of the business. Mr Justice Geoghegan noted that, notwithstanding Ringmahon's strong reliance on the Trans-Prairie decision, the inspector's written submissions seemed to rely on Mr Justice Budd's acknowledgement of the difference between the wording of the Irish and Canadian legislation. Mr Justice Geoghegan considered that this reliance was somewhat misleading because, having considered the Canadian legislation, Mr Justice Budd expressed the view that assistance could be gleaned from Trans-Prairie even though the Canadian legislation was narrower in scope. Mr Justice Geoghegan also noted that, while the inspector admitted that the facts of Trans-Prairie were similar to those in the present case, the inspector submitted that, "for those and other reasons", the Trans-Prairie decision was of little assistance and the inspector never really indicated the nature of the "other reasons". Mr Justice Geoghegan noted that Mr Justice Budd pointed out that, under the Canadian legislation, using the loan to buy a luxury yacht would not be for the purpose of earning income but that, if the yacht was subsequently sold and the proceeds used to earn income from the business, the interest on the loan would then become deductible. Mr Justice Geoghegan further noted that Mr Justice Budd cited, with what Mr Justice Geoghegan considered to be some implicit approval, Ringmahon's argument that, under the Canadian legislation, the interest should be deductible for the years in which the borrowed capital was used in the business and that the same principle applied to Ringmahon's situation.

Mr Justice Geoghegan cited a further portion of the Trans-Prairie judgment wherein Mr Justice Jackett opined that it must have been intended by the Canadian legislation that interest would be deductible for the years in which the borrowed capital was used in the business as opposed to being deductible for the life of the loan as long as its first use was in the business. Mr Justice Geoghegan said that it made no sense to interpret the Irish provision as meaning that, because the loan was originally raised in order to redeem preference shares, the interest thereon could never thereafter be treated as "wholly and exclusively laid out or expended for the purpose of a trade". Mr Justice Geoghegan was satisfied that the appeal ought to be dismissed and he reiterated his reluctance to delve into the decisions cited before him on the basis that same were of little assistance and had been fully reviewed in the judgment of Mr Justice Budd. Mr Justice Geoghegan did, however, append to his judgment a list of the decisions that he had read and considered. Mr Justice Geoghagan briefly referred to Archbold Thomson, Black and Company v Batty 7 TC 158 and Strong and Company of Romsey Ltd v Woodifield 5 TC 215 and he noted that each of the other decisions in the appendix involved a finding of fact as to the purpose of a payment and whether or not each such payment was deductible was reasonably clear as a matter of law. As an example, Mr Geoghegan commented that, if the purpose of the payment was to finance the business rather than to earn profits, the payment would not be deductible (citing Montreal Coke and Manufacturing Co v Minister of National Revenue [1944] 1 All ER 743). Mr Justice Geoghegan had no doubt that, in the present case, the Circuit Court judge took the view that the ongoing interest payments were necessarily part and parcel of Ringmahon's trading and were clearly deductible. Mr Justice Geoghegan was satisfied that Mr Justice Budd was correct in upholding that view and he dismissed the appeal.

Mrs Justice Denham and Mr Justice Murray agreed with Mr Justice Geoghegan.

Solicitors: Frances Cooke, Revenue Solicitor's Office (Dublin) for the appellant; Matheson Ormsby Prentice (Dublin) for the respondent.