Stamp Duty Refundable on In Specie Redemptions by Unit Trusts

The recent combined High Court case, M&G Securities Ltd v IRC; Schroder Unit Trusts Ltd v IRC, is the latest in a growing line of cases since Pepper v Hart [1992] STC 898 in which reference to extrinsic materials has played a vital role in construing an ambiguous statutory provision so as to give effect to the evident or presumed intention of Parliament. The case is unusual in that the statements in Parliament by the Solicitor-General on the relevant stamp duty provision were held to be of no help (indeed, it was suggested that members of the House had not the faintest idea what the Solicitor-General was talking about!). By contrast, the report of a Board of Trade committee (the Anderson Committee), some of whose recommendations led to the enactment of the stamp duty provision in question, was critical in the court's assessment of Parliament's intention.

The relevant stamp duty provision is FA 1946 s.54(4)(b), which forms part of a group of provisions dealing with stamp duty on transactions relating to units in a unit trust scheme. An understanding of the stamp duty position before the enactment of the 1946 Act (and, indeed, before the publication of the Anderson Committee report in 1936) is crucial to an understanding of the objectives which that Act sought to achieve. The relevant transactions are as follows:

(i) the issue of units by the trustee;

(ii) the sale of units by investors to the manager (acting as a principal in its market-maker role) and the re-sale of those units by the manager to new investors (the transactions which give rise to the "bid to offer" spread);

(iii) the sale of units by investors to the manager (acting as a principal in its market-maker role) and the redemption of those units for cash by the trustee at the instance of the manager;

(iv) the in specie redemption by the trustee of units held by investors (the manager acting as agent for the trustee).

In 1936, settlement duty was payable on transaction (i) (the issue of units) but only on the formation of the unit trust scheme on the initial money or investments transferred to it. There was no charge to settlement duty on the subsequent issue of units by an existing unit trust in exchange for further money or investments. By contrast, as regards investment trust companies, capital duty was chargeable at a higher rate than settlement duty not only on the initial issue of shares but also on subsequent increases in share capital. Being anxious to eliminate the competitive advantage enjoyed by units trusts over investment trusts, the Anderson Committee recommended that settlement duty should be extended to all occasions on which further money or investments were brought into the unit trust. This recommendation was enacted as FA 1946 s.53(2). Both of these heads of duty are now defunct.

In 1936, the sale of a unit by one investor to another through the manager's "box" (transaction (ii)) was not chargeable to transfer on sale duty, as the transaction took the form of a release or surrender of the units by the vendor to the manager (without the creation of an instrument of transfer) and a re-issue of the units by the manager to the purchaser. By contrast, the sale of shares by an investor in an investment trust to another investor was chargeable to transfer on sale duty in the normal way. The position was the same if the sale was effected through a "stock jobber", except that there would be double duty if the jobber did not effect the re-sale within two months (FA 1920 s.42). Again, being anxious to eliminate the competitive advantage enjoyed by units trusts over investment trusts, the Anderson Committee recommended that sales of units through the manager's box should attract transfer on sale duty, even if they took the form of a release. This recommendation was enacted as part of FA 1946 s.57, with the release by the vendor being deemed to be a transfer to the manager and attracting transfer on sale duty (s.57(3)) and the re-issue by the manager being deemed to be a transfer to the purchaser and attracting only fixed duty of 50p (ten shillings) if effected within the same two month period (s.57(4), read with s.54(3)).

However, the Committee recognised that this recommendation could lead to a competitive disadvantage for unit trusts by comparison with investment trusts. If the vendor sold the units to the manager, the manager would be liable to transfer on sale duty (s.57(3)). But the manager might not be able to find a purchaser and might, therefore, require the trustee to redeem the units for cash (transaction (iii)). Alternatively, the investor might request the manager (acting as agent) to arrange a redemption of his units directly from the trustee (transaction (iv)). Again, the manager would be liable to transfer on sale duty by virtue of s.57(3). By contrast, if an investment trust reduced its capital or bought in redeemable preference shares, no stamp duty was payable. The Committee dealt with this potential problem by recommending that the stamp duty paid by the manager should be repaid to it where it and the trustee "jointly certify that specified units ... have been cancelled and that the underlying securities have been sold within two months of the transfer of the specified certificates to the Managers". This critically important recommendation led to the enactment of FA 1946 s.54(4), the provision in issue in the M&G/Schroders case.

Facts of the cases

In both the M&G and the Schroders case, an investor exercised a right under the trust deed to take an in specie redemption of his units instead of selling them for cash (transaction (iv)). He sent a written request for the redemption of his units to the manager, the units were cancelled and the trustee transferred investments and cash to the investor out of the underlying trust property. The manager paid transfer on sale duty on the written request under FA 1946 s.57(3). Within two months after the transfer of the units to the manager, the manager and the trustee sent the joint certificate provided for in FA 1946 s.54(4) to the Inland Revenue and claimed repayment of the duty.

The decision

By virtue of s.54(4)(b), the claim for repayment could not succeed unless: "as a consequence of the transfer [ie the notice of redemption given by the investor to the manager which is deemed by s.57(3) to be a transfer of the units to the manager], a proportionate part of the trust property has been realised, and the trust property diminished accordingly". There was no dispute that, as a consequence of the notice of redemption, the trust property had diminished. The Inland Revenue, however, refused the claim for repayment of the duty on the grounds that the in specie redemption had not involved a proportionate part of the trust property being realised. That condition would only have been satisfied if it had involved the trustee selling a proportionate part of the trust fund for cash on the open market (resulting in a redemption of the units for cash rather than in specie).

The appellants contended that the reference in s.54(4)(b) to a proportionate part of the trust property being realised was a reference to the unitholder realising his units pursuant to the redemption, the realisation taking the form of the unitholder exchanging his units for specific investments and sums of cash distributed to him out of the trust fund. A unitholder under a unit trust is the owner of an equitable interest in the underlying investments and cash comprising the trust fund. Accordingly, a unit is an undivided share in the trust fund and can accurately be described as "a proportionate part of the trust property". Park J agreed with the appellants.

The Inland Revenue's argument that, if the draftsman had intended the expression "a proportionate part of the trust property" to refer to the units, he could easily have said "the units" was not conclusive. If he had intended "realised" to mean "sold", he could easily have said so.

Having regard to the Anderson Committee report, it was clear that Parliament had intended to equate the stamp duty treatment of units with that of shares. If the Inland Revenue were right, there would be a stamp duty charge on the redemption of units in specie, though there was no such charge on the reduction or redemption by an investment trust of its share capital.

It was clear from s.54(4)(b), in particular from the use of the word "accordingly", that the realisation of a part of the trust property and the diminution of the trust property are one and the same thing, or two sides of the same coin. Thus, the realisation of a part of the trust property cannot mean a sale of trust assets on the open market, as that does not diminish the trust property. It merely converts a part of it into cash.

Perhaps the overwhelming difficulty encountered by the Inland Revenue's argument was the situation where the trustee already held part of the trust fund in cash (which in practice it would in virtually every case). It is impossible to "realise" (if "realise" means "sell") a proportionate part of that part of the trust fund which comprises uninvested cash. Furthermore, in a case where the trustee had sufficient uninvested cash to meet the redemption request, it could not use it (if the Revenue were right), but had to sell a precise proportion of the trust fund (perhaps at an unfavourable time) and use the sale proceeds to effect the redemption. Park J could not believe that Parliament could have intended to bring about such an unreasonable result.

The Inland Revenue had further argued that Parliament's purpose in giving relief to the manager only if the trustee sold investments out of the trust fund was to prevent double duty. (This argument was based on the confusing statements by the Solicitor-General in Parliament.) Normally, when the trustee sells investments out of the trust fund, stamp duty was paid on the sale. There should not, therefore, be a further charge to duty on the manager. That argument could not be accepted. The Anderson Committee had not been concerned with double taxation, but with equating unit trusts with investment trusts. Furthermore, the 1946 Act did not say that payment of duty on the sales by the trustee was a condition of s.54(4) relief and there were many kinds of investment the sale of which by the trustee would not attract stamp duty.

The fact that, in making its recommendation which led to the relieving provisions of s.54(4) being enacted, the Anderson Committee report had referred to the manager and the trustee jointly certifying that specified units had been cancelled and that the underlying securities had been sold within two months of the transfer of the units to the manager was not conclusive. The Committee probably thought that in practice the redemption of units would involve a sale of investments by the trustee in order to provide cash funds for the redemption but there was no suggestion that they regarded such a sale as a legally essential pre-condition for the repayment of duty to the manager.

Finally, Park J rejected a Revenue argument based on a decision in favour of the appellants possibly leading to wholesale avoidance of stamp duty on normal sales of units.

Implications of the judgment

The most immediate implication of the judgment in the M&G/Schroders case is that those unit trust managers who have paid duty on an in specie redemption and, together with the trustee, have provided the relevant certificate within the two month period should now be entitled to s.54(4) relief (barring a successful Revenue appeal). But what of those cases where a manager has paid duty on an in specie redemption, the units have been cancelled and the trust property diminished within the two month period but no joint certificate was provided in that period? There is a line of cases (of which McKinney v Hagans Caravans (Manufacturing) Ltd [1997] STC 1023 is a recent example) suggesting that, in some cases, statutory time limits are directory rather than mandatory and can, therefore, be extended where it would be appropriate to do so. It is possible that s.54(4) may be such a case.

The M&G/Schroders case does not decide whether, in a case where an investor sells units to the manager (acting as a principal in its market-maker role) and, within two months, the trustee redeems the units by making a cash payment to the manager, the manager qualifies under s.54(4) for repayment of the duty which it will have paid by virtue of s.57(3) on the sale of the units (transaction (iii)). The Anderson Committee report would certainly suggest that the manager should qualify for a repayment in this instance, as that would ensure equality of treatment with an investment trust which reduces or redeems its capital. However, there is a technical difficulty in the manager's way. Again, it concerns s.54(4)(b). In this case, the trust property is diminished as a direct consequence, not of the deemed transfer of units by the investor to the manager, but of the redemption of the units by the trustee at the instance of the manager (a different transaction to which the investor is not a party). This results from the fact that, in this case, the manager acts as a principal in effecting two transactions, rather than as an agent effecting only one. Nevertheless, if it is sufficient for the trust property to be diminished as an indirect consequence of the deemed transfer of the units from the investor to the manager, then it seems that the manager may qualify for a repayment of duty.

What are the implications of the M&G/Schroders case for in specie redemptions of shares by OEICs? The corresponding requirement is that "as a consequence of the transfer, a proportionate part of the investments of the open-ended investment company concerned has been realised and the property of the company diminished accordingly" (Stamp Duty and Stamp Duty Reserve Tax (Open-ended Investment Companies) Regulations 1997 reg 4(4)(b)). Clearly, the reference in this provision to investments of the OEIC being realised cannot be a reference to the shareholder realising his shares. Unlike a unitholder in a unit trust, a shareholder in an OEIC does not have an equitable interest in the assets of the OEIC. It would, therefore, seem that the condition in reg 4(4)(b) can only be satisfied by the OEIC (or its ACD) realising a proportionate part of the OEIC's investments. The ACD's best argument may be that the reference to investments of the OEIC being realised is a reference to the OEIC transferring assets in specie to the shareholder pursuant to the redemption. This argument is strengthened by the fact that, having regard to the use of the word "accordingly", the realisation of a part of the OEIC's investments and the diminution of the OEIC's property must be one and the same thing, or two sides of the same coin. That is true of the transfer of assets to the shareholder but not of the sale of investments on the open market. But, according to the M&G/Schroders case, whether realisation of investments means sale of investments on the open market or transfer of them to the shareholder, it is impossible to realise a proportionate part of the OEIC's investments where it has any uninvested cash, at least if "investments" includes cash!

Since publication of this article, the Inland Revenue has announced that it will not be making an appeal.

This article appears in The Tax Journal, published by Butterworths

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.