A taxing time for windfall payments

Patrick Mears, head of the tax department at Allen & Overy

Heather Gething, a tax partner at Herbert Smith

Dominic Stuttaford, tax partner at Norton Rose

Scottish Widows is appealing to the Inland Revenue over the amount of windfall tax its members are liable to pay upon demutualisation.

Members of the organisation, which was recently the subject of a £7bn takeover by Lloyds TSB, may have to pay thousands of pounds worth of tax on their windfall payments.

The move follows the Inland Revenue's decision to treat windfall payments from this year's other major mutual takeover of AA by Centrica as dividend income for tax purposes.

The argument is centred around whether members of a demutualised organisation have to pay capital gains tax or income tax. The tax legislation is not clear as the decision depends heavily on the structure of each mutual body.

There are also concerns that unless Scottish Widows reaches a compromise with the Inland Revenue, it may face legal action from its members over the threat to their pay outs.

Patrick Mears, head of the tax department at Allen & Overy, is concerned that the Inland Revenue has no discretional powers over taxation.

He says: "Widows will have some degree of difficulty because the Inland Revenue has to apply the law strictly as it stands."

"It could go to court because it wants some sort of clarification. But I do not think it would force actions from its members because they have the option of voting and the tax is individual to each person."

But Mears believes the Revenue should clarify the situation: "One thing the Inland Revenue could do is to come out with a statement on capital gains tax. Uncertainty is one of the worst problems [for members expecting windfalls] and that is probably worse than the tax situation itself."

Heather Gething, a tax partner at Herbert Smith, which acted for AA in its takeover by Centrica, also believes the Inland Revenue must clarify the situation.

She does not think Scottish Widows' discussions with the Revenue will gain much. She says: "The Revenue have no discretion as to how the tax law applied. They could not do it for us."

But she adds: "I can understand wanting to agree the treatment when so many people are affected. It is about creating certainty on how members should fill in their tax returns and how they should treat the lump sum."

However, she is dubious that specific changes to tax legislation would help. "Each of these organisations are unique because no constitution is the same. Some will be friendly societies, some will be incorporated under their own acts of Parliament, some will be incorporated under the companies' acts. Yes, they have all got similar issues but how these issues affect the windfalls depends on the constitution."

Dominic Stuttaford, tax partner at Norton Rose, also thinks that the very unique structure of mutual organisations is the main hurdle in legislating for taxing windfall payments.

He says: "It is difficult to say if there should be any specific rules because although [demutualisations] are quite common and they do affect many people, they are all quite unique."

He adds that the eventual amount of windfall, and hence the amount of tax payable, is a business decision as much as anything else.

"The rationale depends on the structure that they want to end up with at the end of the deal. It will also depend on what [the board] wants to offer to their members and how it wants to entice its owners to sell the business," he says.

Although Stuttaford doubts that Scottish Widows will want to pursue the matter in court, he believes two options are open to the company should initial negotiations fail.

"They could continue their dispute with the Revenue or they could say to their policy holders 'we will accept the Revenue's tax treatment but it's not so good for you'."