In a surprising development HMRC has argued sham, and won, in another case involving circularity of funding to leverage available tax reliefs for individual partners. The High Court has rejected a public law challenge to the legality of the issue of an accelerated payment notice by HMRC. The FTT has considered again the ‘fairly represents’ concept, this time in the context of the derivative contracts rules.
Mark Middleditch (Allen & Overy) reviews the latest tax developments that matter affecting the City.
The First-tier Tribunal (FTT) has, unusually, held that parts of a document used to implement a leveraged tax relief scheme, amounted to a sham.
In Brain Disorders Research Limited Partnership and others v HMRC [2015] UKFTT 0325 (TC), the scheme was designed to produce relief from tax in excess of amounts actually paid. In this variant, the partners borrowed to fund a contribution to a partnership, which then made a payment to a special purpose company (Numology) so that it, or a third party, could undertake medical research. Out of the monies paid to Numology, the largest part found its way straight back to the lending banks in repayment of amounts owing by the partners. An amount was paid in fees, and the small amount remaining (six out of 100 in the example used in the judgment), was then paid by Numology to an Australian pharmaceutical company, which actually undertook the research. The aim of the planning was to provide the partners with tax relief (on 96 out of 100 in the example), both by way of research and development allowances, and for an advance payment of interest made on the loans.
The courts have now been faced with similar arrangements on a number of occasions (most recently in Samarkand Film Partnership No.3 and others v HMRC [2015] UKUT 0211 (TCC)). Usually, the courts have found that the partnership is not trading, and denied the tax relief to the individual partners on this basis. A similar argument was advanced here, and the FTT agreed that none of the payments made by the partnership had anything whatsoever to do with a trade. This was a slightly different finding from the FTT in a similar case (The Vaccine Research Limited Partnership and others v HMRC [2014] UKUT 0389 (TC)), where at least the sub-contracting activity, but nothing else, was held to be trading.
What makes this case more interesting is that HMRC argued that parts of the documents were a sham (being the agreement under which Numology would undertake the research itself, or sub-contract to a third party). As a fact, the FTT found that there was simply no way that Numology could have done the work itself, as it was nothing more than a special purpose company interposed to facilitate the tax planning. Indeed, the FTT then went further than HMRC, and also held that the schedule to the agreement, which itemised the expenditure to be incurred on the research, was an ‘elaborate nonsense’. Once these sham elements were removed from the documents, it was clear that only six out of the 96 could ever have been spent on research and development. Even this attracted no tax relief however, given the finding that the partnership was not trading.
This is something of a shot across the bows from HMRC to those engaged in the more aggressive forms of tax planning. Although this was a rather extreme case, if documents are constructed to say X, when nothing but Y was ever intended, then there must now be a real danger that HMRC will argue, and the courts will accept, a case based on sham.
In FA 2014, HMRC was given the power to issue APNs. Broadly, where an arrangement disclosed under the rules for disclosure of tax avoidance schemes (DOTAS) is challenged by HMRC, and in certain other cases, HMRC can issue an APN requiring the disputed tax to be paid up-front. An APN can be issued even if the DOTAS disclosure was made before the rules for APNs came into effect, and even if the tax at stake had been postponed under the law as it stood before FA 2014. These and other features of the APN regime had led some lawyers to speculate that APNs could be challenged under public law principles in a judicial review.
Some of these questions have now been considered by the High Court in Nigel Rowe and others v HMRC [2015] EWHC 2993 (Admin). These judicial review proceedings were brought by investors in a film financing scheme which had received APNs (or, more technically, in this case, partner payment notices).
The court held that the issue of the APNs was lawful. The APN rules did not breach natural justice as the rules only provided for where the tax should sit during a dispute. The underlying tax liability could still be challenged, and was not changed by the APN regime. Money paid in advance would also be paid back if the taxpayer was ultimately successful. Taxpayers still had the right to a judicial review if HMRC used the APN regime unfairly.
The taxpayers also had no legitimate expectation here that the tax would be postponed pending the court hearing. In any event, even a legitimate expectation will not prevent Parliament from changing the law.
The court also found that HMRC was not acting irrationally by issuing APNs to almost all participators in schemes disclosed under DOTAS. Applying a general rule in this way, save in exceptional circumstances, was a permissible approach.
Finally, the court rejected a variety of arguments based on the European Convention on Human Rights. It was clear that the right to protection of property could be overridden by a state exercising its taxing rights; here, Parliament had done less than this, and simply decided where the tax should sit while in dispute.
The scope for arguing a public law defence to an APN must now be much reduced in light of this judgment. However, in another application for judicial review yet to be heard (R v HMRC ex parte Dunne and Gray [2015] EWHC 1204 (Admin)), the court will need to consider if an APN can be issued where a DOTAS disclosure was made on a precautionary basis (the interim application for an injunction to prevent HMRC issuing the APN already having been rejected).
The FTT has held that there is no deduction under the DC rules for a swap derecognition scheme involving tracker shares.
In Abbey National Treasury Services plc (ANTS) v HMRC [2015] UKFTT 0341 (TCC), ANTS was a party to swaps, some with another member of its group. The swaps were made gross-paying, and ANTS then issued tracker shares to its parent. The rights attaching to the shares provided for dividends to be paid equal to the amounts received by ANTS under the swaps (called the swap cashflows). ANTS remained a party to the swaps, but for accounting purposes, derecognised the swap cashflows, giving rise to a debit in its statement of changes in equity. ANTS then claimed a deduction equal to the debit under the DC rules (old FA 2002 Sch 26, now CTA 2009 Part 7).
HMRC argued that there was no loss here which could give rise to a deduction under the DC rules. Instead, ANTS was simply paying away the profit realised on the swaps by paying a dividend on the tracker shares. This also meant that, even if there was a debit, it arose from the shares, and not the swaps, and so would not be relieved under the DC rules which dealt only with derivatives.
The FTT held that although a debit in equity can be recognised under the DC rules, this was subject to the other provisions of the code, including the requirement that it must ‘fairly represent’ all profits and losses of the company (see now CTA 2009 s 595(3)). This meant that accounting treatment that was too far divorced from commercial reality should not be applied for tax purposes. The FTT therefore preferred HMRC’s analysis that nothing had changed for ANTS, apart from the requirement to pay on whatever it realised in terms of the swap cashflow. There was no loss, and the payment was effectively a distribution of profit, which cannot give a deduction under the DC rules. The tracker shares were also too remote from the swaps to give any relief under rules intended to deal directly with derivatives.
Although not strictly relevant, the FTT also considered HMRC’s argument based on transfer pricing. Here, the FTT held that an issue of shares can be subject to the transfer pricing rules. The issue of the tracker shares was not arm’s length, as ANTS had received a £1,000 issue price and given up swap cashflows of some £160m. The comparator transaction was no issue of tracker shares at all. This meant that even if the DC rules had applied, the debit would have been reduced to zero through a transfer pricing adjustment.
This case follows on from another recent case (see Cater Allen International Limited and Abbey National Treasury Services plc v HMRC [2015] UKFTT 0232 (TC)), which also considered the concept of ‘fairly represents’ this time in the context of the loan relationships code. When looking at the DC rules, the concept worked largely in HMRC’s favour, although its demise is now imminent given the changes to the loan relationships and derivatives rules in the Summer Finance Bill. Other changes of law to prevent derecognition would also make the planning here now redundant. The use of transfer pricing as a basis of attack was a clever move by HMRC, and a reminder that an issue of shares can, albeit unusually, be subject to challenge under transfer pricing.
In a surprising development HMRC has argued sham, and won, in another case involving circularity of funding to leverage available tax reliefs for individual partners. The High Court has rejected a public law challenge to the legality of the issue of an accelerated payment notice by HMRC. The FTT has considered again the ‘fairly represents’ concept, this time in the context of the derivative contracts rules.
Mark Middleditch (Allen & Overy) reviews the latest tax developments that matter affecting the City.
The First-tier Tribunal (FTT) has, unusually, held that parts of a document used to implement a leveraged tax relief scheme, amounted to a sham.
In Brain Disorders Research Limited Partnership and others v HMRC [2015] UKFTT 0325 (TC), the scheme was designed to produce relief from tax in excess of amounts actually paid. In this variant, the partners borrowed to fund a contribution to a partnership, which then made a payment to a special purpose company (Numology) so that it, or a third party, could undertake medical research. Out of the monies paid to Numology, the largest part found its way straight back to the lending banks in repayment of amounts owing by the partners. An amount was paid in fees, and the small amount remaining (six out of 100 in the example used in the judgment), was then paid by Numology to an Australian pharmaceutical company, which actually undertook the research. The aim of the planning was to provide the partners with tax relief (on 96 out of 100 in the example), both by way of research and development allowances, and for an advance payment of interest made on the loans.
The courts have now been faced with similar arrangements on a number of occasions (most recently in Samarkand Film Partnership No.3 and others v HMRC [2015] UKUT 0211 (TCC)). Usually, the courts have found that the partnership is not trading, and denied the tax relief to the individual partners on this basis. A similar argument was advanced here, and the FTT agreed that none of the payments made by the partnership had anything whatsoever to do with a trade. This was a slightly different finding from the FTT in a similar case (The Vaccine Research Limited Partnership and others v HMRC [2014] UKUT 0389 (TC)), where at least the sub-contracting activity, but nothing else, was held to be trading.
What makes this case more interesting is that HMRC argued that parts of the documents were a sham (being the agreement under which Numology would undertake the research itself, or sub-contract to a third party). As a fact, the FTT found that there was simply no way that Numology could have done the work itself, as it was nothing more than a special purpose company interposed to facilitate the tax planning. Indeed, the FTT then went further than HMRC, and also held that the schedule to the agreement, which itemised the expenditure to be incurred on the research, was an ‘elaborate nonsense’. Once these sham elements were removed from the documents, it was clear that only six out of the 96 could ever have been spent on research and development. Even this attracted no tax relief however, given the finding that the partnership was not trading.
This is something of a shot across the bows from HMRC to those engaged in the more aggressive forms of tax planning. Although this was a rather extreme case, if documents are constructed to say X, when nothing but Y was ever intended, then there must now be a real danger that HMRC will argue, and the courts will accept, a case based on sham.
In FA 2014, HMRC was given the power to issue APNs. Broadly, where an arrangement disclosed under the rules for disclosure of tax avoidance schemes (DOTAS) is challenged by HMRC, and in certain other cases, HMRC can issue an APN requiring the disputed tax to be paid up-front. An APN can be issued even if the DOTAS disclosure was made before the rules for APNs came into effect, and even if the tax at stake had been postponed under the law as it stood before FA 2014. These and other features of the APN regime had led some lawyers to speculate that APNs could be challenged under public law principles in a judicial review.
Some of these questions have now been considered by the High Court in Nigel Rowe and others v HMRC [2015] EWHC 2993 (Admin). These judicial review proceedings were brought by investors in a film financing scheme which had received APNs (or, more technically, in this case, partner payment notices).
The court held that the issue of the APNs was lawful. The APN rules did not breach natural justice as the rules only provided for where the tax should sit during a dispute. The underlying tax liability could still be challenged, and was not changed by the APN regime. Money paid in advance would also be paid back if the taxpayer was ultimately successful. Taxpayers still had the right to a judicial review if HMRC used the APN regime unfairly.
The taxpayers also had no legitimate expectation here that the tax would be postponed pending the court hearing. In any event, even a legitimate expectation will not prevent Parliament from changing the law.
The court also found that HMRC was not acting irrationally by issuing APNs to almost all participators in schemes disclosed under DOTAS. Applying a general rule in this way, save in exceptional circumstances, was a permissible approach.
Finally, the court rejected a variety of arguments based on the European Convention on Human Rights. It was clear that the right to protection of property could be overridden by a state exercising its taxing rights; here, Parliament had done less than this, and simply decided where the tax should sit while in dispute.
The scope for arguing a public law defence to an APN must now be much reduced in light of this judgment. However, in another application for judicial review yet to be heard (R v HMRC ex parte Dunne and Gray [2015] EWHC 1204 (Admin)), the court will need to consider if an APN can be issued where a DOTAS disclosure was made on a precautionary basis (the interim application for an injunction to prevent HMRC issuing the APN already having been rejected).
The FTT has held that there is no deduction under the DC rules for a swap derecognition scheme involving tracker shares.
In Abbey National Treasury Services plc (ANTS) v HMRC [2015] UKFTT 0341 (TCC), ANTS was a party to swaps, some with another member of its group. The swaps were made gross-paying, and ANTS then issued tracker shares to its parent. The rights attaching to the shares provided for dividends to be paid equal to the amounts received by ANTS under the swaps (called the swap cashflows). ANTS remained a party to the swaps, but for accounting purposes, derecognised the swap cashflows, giving rise to a debit in its statement of changes in equity. ANTS then claimed a deduction equal to the debit under the DC rules (old FA 2002 Sch 26, now CTA 2009 Part 7).
HMRC argued that there was no loss here which could give rise to a deduction under the DC rules. Instead, ANTS was simply paying away the profit realised on the swaps by paying a dividend on the tracker shares. This also meant that, even if there was a debit, it arose from the shares, and not the swaps, and so would not be relieved under the DC rules which dealt only with derivatives.
The FTT held that although a debit in equity can be recognised under the DC rules, this was subject to the other provisions of the code, including the requirement that it must ‘fairly represent’ all profits and losses of the company (see now CTA 2009 s 595(3)). This meant that accounting treatment that was too far divorced from commercial reality should not be applied for tax purposes. The FTT therefore preferred HMRC’s analysis that nothing had changed for ANTS, apart from the requirement to pay on whatever it realised in terms of the swap cashflow. There was no loss, and the payment was effectively a distribution of profit, which cannot give a deduction under the DC rules. The tracker shares were also too remote from the swaps to give any relief under rules intended to deal directly with derivatives.
Although not strictly relevant, the FTT also considered HMRC’s argument based on transfer pricing. Here, the FTT held that an issue of shares can be subject to the transfer pricing rules. The issue of the tracker shares was not arm’s length, as ANTS had received a £1,000 issue price and given up swap cashflows of some £160m. The comparator transaction was no issue of tracker shares at all. This meant that even if the DC rules had applied, the debit would have been reduced to zero through a transfer pricing adjustment.
This case follows on from another recent case (see Cater Allen International Limited and Abbey National Treasury Services plc v HMRC [2015] UKFTT 0232 (TC)), which also considered the concept of ‘fairly represents’ this time in the context of the loan relationships code. When looking at the DC rules, the concept worked largely in HMRC’s favour, although its demise is now imminent given the changes to the loan relationships and derivatives rules in the Summer Finance Bill. Other changes of law to prevent derecognition would also make the planning here now redundant. The use of transfer pricing as a basis of attack was a clever move by HMRC, and a reminder that an issue of shares can, albeit unusually, be subject to challenge under transfer pricing.
