Acornwood LLP and others v HMRC [2014] UKFTT 416 is the latest in a line of cases involving the carrying on of a trade combined with the use of secured bank borrowing to enhance tax relief for trading losses. In this case, the tax reliefs depended on fees apparently paid for the exploitation of intellectual property rights (‘IP rights’) being accepted as wholly and exclusively incurred for trading purposes. That argument failed, as most of the fees were in fact paid to acquire the tax avoidance package. HMRC was also largely successful in persuading the FTT that the tax reliefs would otherwise be denied by specific anti-avoidance provisions.
Following Icebreaker 1 LLP v HMRC [2011] STC 1078, further LLPs promoted by the Icebreaker group (‘Icebreaker’) have failed in their attempt to have substantial upfront payments of ‘fees’ accepted as expenditure incurred wholly and exclusively for the purposes of their trades of exploiting IP rights. As a result, their members have been denied sideways relief for the losses that these payments would otherwise have produced. In Acornwood, five Icebreaker LLPs acted as lead cases for some 50 Icebreaker LLPs covering five successive tax years (from 2005/06) and involving nearly 1,000 individual taxpayers and over £330m of capital contributions.
In addition, seven individual members (‘the referrers’) of Icebreaker LLPs referred specific questions to the FTT relating to aspects of sideways relief which concerned them as individuals, rather than the LLPs. The names of these members do not appear in the FTT’s decision, not to anonymise them but on the grounds that it would be unfair to put a greater spotlight on them than the other members. The names of all the members can be accessed at Companies House and, as a result, a number of well-known celebrities who invested in Icebreaker LLPs have been named and shamed.
The facts relating to each lead case LLP differed but the tax effects attributable to these differences were not material. There were also some differences in tax law over the six year period. As each lead case LLP started in a different tax year, earlier LLPs and their members were not affected by later changes in law. In a typical case:
The IP rights varied from LLP to LLP and members were able to choose which LLP to join depending on their individual interests or expertise. The rights related to musical productions (including compositions to be recorded by Sinead O’Connor), a documentary film, a screenplay, the printing and publishing of books, an internet retail scheme for fashion products and a device to help smokers give up the habit.
HMRC accepted that the LLPs were carrying on a trade to the extent of the net amount (£450,000 in the above example) actually expended in exploiting the IP rights. The case is, therefore, different from Eclipse Film Partners (No. 35) LLP v HMRC [2013] UKUT 639, in which HMRC’s so far successful argument is that no trade was carried on. It is interesting that the FTT in Acornwood held that any belief that the LLPs would make a worthwhile profit from the exploitation of the IP rights was ‘nothing more than wishful thinking’ and that no serious investor would have engaged in such a high risk venture, apart from for the hoped-for tax relief. This is not that different from the ‘contingent receipts’ in Eclipse, which were too speculative to justify a finding of trading. They were nothing more than ‘pixie dust’. There is a fine dividing line between trading but with no reasonable prospect of profit and not trading at all.
The question was, therefore, whether the fee paid by the LLPs to the IEC to have the IP rights exploited was incurred wholly and exclusively for the purposes of their trades (now ITTOIA 2005 s 34). The FTT decided that the predominant purpose of the members in investing in the LLPs was to achieve a tax saving. It followed that the purpose of the LLPs in paying fees to the IEC was, to the extent of the amounts paid into the blocked deposit, to secure a guaranteed income stream and a ‘final minimum sum’, which together would service and repay the bank loans, not to further the trade of the LLPs. To the extent, therefore, that the agreements between the LLPs and the IEC suggested that the entire payments were to secure exploitation services, the payments had been mislabelled. Accordingly, they were not deductible (to that extent) by virtue of ITTOIA 2005 s 34.
The payment by the IEC to the IP vendor of a gross amount to have the IP rights exploited was described as a ‘pretence, designed, if we may say so, rather crudely, to confer some plausibility on the claim that the borrowed money was available for use in the exploitation of intellectual property rights’. In reality, the IEC had to use the borrowed money as security for its own servicing and repayment.
This makes Acornwood very similar to Tower MCashback LLP 1 v HMRC [2011] UKSC 19, in which the Supreme Court held that borrowed money was not in reality spent, for capital allowances purposes, on the acquisition of software rights but ‘went into a loop to indulge in a tax avoidance scheme’.
For good measure, the FTT also decided that the payments were (to the extent of the blocked deposit amounts) capital on the grounds that they were for the acquisition of a capital asset, namely the guaranteed income stream. They were, therefore, not deductible by virtue of ITTOIA 2005 s 33.
HMRC argued that at least part of the fees paid by the LLPs to Icebreaker was for the provision of the capital structure of a tax avoidance scheme and not, therefore, revenue payment for advice and administration. The FTT held, with some differences between the lead case LLPs, that the fees should be divided between non-deductible payments for the Icebreaker structure or package (a capital asset), deductible advisory fees and a pre-payment for future services (deductible only in future years).
Having decided, by applying conventional legal principles, that most of the payments by the LLPs were not deductible once their true nature was ascertained (and their mislabelling rejected), there was no need for the FTT to invoke the Ramsay principle. It seems that, as Tower MCashback was largely decided on Ramsay grounds, there is a fine dividing line between ascertaining the true nature of a payment by reference to a realistic view of the facts and ascertaining it by disregarding misleading labels. The FTT agreed with HMRC that if conventional legal principles had not defeated the scheme, it would have come to the same decision on Ramsay grounds.
The decision that most of the payments by the LLPs were not deductible rendered the references by the individual referrers largely academic. However, in case it should be found to be in error as to its principal decision, the FTT decided to consider the references.
On the assumption that the LLPs’ payments were deductible, individual members would still not be entitled to sideways relief if the trades of the LLPs were not carried out on a commercial basis and with a view to profit (now ITA 2007 s 66). On this point the FTT decided, having regard in particular to the absence of any but the vaguest of revenue predictions and discounting the optimistic aspirations of the referrers, that none of the referrers can realistically have invested in the LLPs for the principal purpose of making a trading profit. The IP projects undertaken by the LLPs were highly speculative and considerably more likely to make losses than profits. As the FTT said: ‘a 14-handicap golfer may set out on the first tee with the aim and hope of going round the course in par; but he could have no reasonable expectation of doing so’.
On the assumption that the LLPs’ payments were deductible, an individual member would still not be entitled to sideways relief exceeding £25,000 if he or she was a ‘non-active partner’ (one who devotes less than an average of ten hours a week to the trade) (ITA 2007 s 103C). On this point, the FTT’s decision was that the research activities performed by the referrers (for instance, listening to music recordings) did not advance the trade of the LLPs and, accordingly, did not count as activities of the trade. The research activities were assiduously carried out and recorded to satisfy the statutory test, not to further the purposes of the trade.
Under the Partnerships (Restrictions on Contributions to a Trade) Regulations, SI 2005/2017, there would be a further restriction on the referrers’ right to sideways relief if the cost of repaying the bank loans would be borne by a third person (in particular, the LLPs). On this point, the referrers were successful. The LLPs may have made security arrangements under which the loans would be discharged but it could not be said that the ultimate burden of repaying the loans fell on the LLPs.
The final restriction on sideways relief affected only the referrer from the LLP established in 2009/10. From October 2009, sideways relief is denied if one of the main purposes of the arrangement giving rise to the loss is obtaining sideways relief. Referring to a famous statement in IRC v Trustees of the Sema Group Pension Scheme [2002] STC 276, the FTT observed that there was a great deal of icing in the Icebreaker arrangement and very little, if any, cake. The referrer’s primary motive for joining the LLP was to secure sideways relief. No other plausible conclusion was possible.
Acornwood cannot be viewed in isolation. It is one of a very large number of cases based on variants on a theme under which a trade is (or purports to be) carried on and the available trading reliefs are boosted by secured bank borrowing or other defeasance arrangements. Some of these will continue their appeals to the higher courts; others will throw in the towel. It remains to be seen what the partners in the Icebreaker cases will decide to do. It is, however, difficult to believe that the celebrities whose names have hit the headlines will have any appetite for further appeals.
The other important development in this line of cases is the bringing of claims against the promoters for misselling.
A successful claim has already been made to the Financial Ombudsman in the Crossover case on the grounds that the investment was unsuitable. However, it remains to be seen how far this development will go.
