Kahn and Another (Appellants) v Commissioners of Inland Revenue (Respondents)

United Kingdom

Kahn and Another (Appellants) v Commissioners of Inland Revenue (Respondents), otherwise known as Re Toshoku Finance, recently decided by the House of Lords, considered whether corporation tax was an expense of the liquidation or not. There is a long history to this argument. The House of Lords have ended the debate in Kahn and decided that corporation tax is a liquidation expense under section 115 Insolvency Act 1986 and rule 4.218 Insolvency Rules 1986 and overrule the Re Atlantic Computers case

Toshoku Finance went into creditors’ voluntary liquidation. Toshoku Finance’s only significant asset was a debt of $156.3m owed to it by TEE, another Toshuku group company. Toshoku Finance accepted $21.5m in full and final settlement of its claim. For the purposes of the appeal it was assumed that Toshoku Finance was liable to corporation tax, on the interest that accrued on the loan since the liquidation date (even though it never received the interest at all), because the loan relationships legislation in Finance Act 1996 taxes the receipt of interest on an accruals basis and does not give bad debt relief where the lender and borrower are connected. The liquidators sought directions regarding whether this liability was an “expense properly incurred in the winding up”, which, according to s115 of the Insolvency Act 1986 they were required to pay out of Toshoku Finance’s assets in priority to other claims.

At first instance, the liability was held not to be an expense of the liquidation. The Court of Appeal overturned this and so the liquidators appealed to the House of Lords.

The liquidators tried to argue that the equitable principle of liquidation expenses developed by Nicholls V-C in Re Kentish Homes Ltd [1993] BCC 212 and Re Atlantic Computer Systems plc [1992] Ch 505 applied in this case, whereby if a liability arose as a consequence of a step taken for the benefit of the insolvent estate, it was fair that the burden be borne by those for whose benefit the estate was administered.

Lord Hoffmann disagreed stating that the Atlantic Computer Systems case was incorrectly decided: the considerations which determine whether post-liquidation debts count as expenses are different from those which determine whether a continuing obligation arising under a pre-existing contract may be treated as an expense of the liquidation. Furthermore, whether debts should count as expenses of the liquidation was not within the court’s discretion: rule 4.218(1) of the Insolvency Rules 1986 provided a definitive account of expenses of the liquidation and were not subject to any implied qualification. As corporation tax falls within rule 4.218(1)(m), it is properly an expense of the liquidation notwithstanding that it was in respect of income never received.