Commissioners for Her Majesty’s Revenue and Customs v Tower MCashback LLP 1 and another [2011] UKSC 19

“For the purposes of the Tax Acts, where a limited liability partnership carries on a trade, profession or other business with a view to profit – (a) all the activities of the partnership are treated as carried on in partnership by its members (and not by the partnership as such), (b) anything done by, to or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the members as partners, and (c) the property of the partnership is treated as held by the members as partnership property.” (a) all the activities of the partnership are treated as carried on in partnership by its members (and not by the partnership as such), (b) anything done by, to or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the members as partners, and (c) the property of the partnership is treated as held by the members as partnership property.”

“The repayments claimed by a number of partners are currently being withheld and in these circumstances the partnerships generally are anxious to ensure that your enquiries are settled without delay. In these circumstances I have to inform you that if we do not receive either confirmation that you can now agree the amounts claimed in the partners’ returns or a detailed explanation of your reasons for not doing so by 20 June 2006, we will apply to the Commissioners for a directive under section 28A(4) TMA 1970.”

“In helping you to managing your clients’ expectations I can tell you that I very much hope to reply fully before 31 July, although if I have to defend an application for closure notice before then that date will obviously slip back.”

“I have now concluded my enquiries into the Partnership Tax Return for the year ended 5 April 2005. As previously indicated, my conclusion is: The claim for relief under section 45 CAA 2001 is excessive. The partnership return for the year ended 5 April 2005 is amended as follows. Capital Allowances £Nil Allowable Loss £Nil”

“Given the content of my last letter to you I am satisfied that the MCashback scheme fails on the section 45(4) CAA 2001 point alone. I would prefer to have had longer to examine the full records, as they have only been completely made available to me with your letter of 24 May. This would enable me to provide your clients with a full list of additional points for their consideration. In the circumstances I have to accept that any additional points that may arise will make no difference to the bottom line that no loss relief is due because of section 45(4). Therefore as your clients are so very anxious to receive closure notices I now enclose copies of those that I have issued today.”

“There is no express requirement that the officer must set out or state the reasons which have led him to his conclusions, and in the absence of an express requirement I can see no basis for implying any obligation to give reasons in the closure notice. What matters at this stage is the conclusion which the officer has reached upon completion of his investigation of the matters in dispute, not the process of reasoning by which he has reached those conclusions.”

“There is a venerable principle of tax law to the general effect that there is a public interest in taxpayers paying the correct amount of tax, and it is one of the duties of the Commissioners in exercise of their statutory functions to have regard to that public interest. [The judge then considered changes in the tax system and continued] For present purposes, however, it is enough to say that the principle still has at least some residual vitality in the context of section 50, and if the Commissioners are to fulfil their statutory duty under that section they must in my judgment be free in principle to entertain legal arguments which played no part in reaching the conclusions set out in the closure notice. Subject always to the requirements of fairness and proper case management, such fresh arguments may be advanced by either side, or may be introduced by the Commissioners on their own initiative. That is not to say, however, that an appeal against a closure notice opens the door to a general roving inquiry into the relevant tax return. The scope and subject matter of the appeal will be defined by the conclusions stated in the closure notice and by the amendments (if any) made to the return.”

“I agree with Henderson J that the fact that the taxpayers had pressed the inspector to issue the closure notice had no relevance to the identification of the subject matter of the appeal. It was, as he remarked, open to the inspector to delay until he had considered, for example, the business plan. He chose not to do so. But the fact that the inspector had indicated that there might have been other issues which arose, was relevant to the exercise of the special commissioner’s case management powers. The taxpayer was not deprived of an opportunity fairly to marshal evidence as to the other grounds subsequently advanced by the Revenue on the appeal. There is a second basis on which I differ from Henderson J. Apart from the importance of leaving it to the fact-finding tribunal to determine the subject matter of the closure notice, in my view the closure notice itself does not allow of so restricted a view of the subject matter of the appeal. Whilst it did refer to previous correspondence which clearly focussed on section 45(4), the closure notice itself was, in plain terms, a refusal of the claim for relief under section 45 CAA 2001. That was the conclusion stated pursuant to section 28B(1). There is neither statutory warrant nor any need to look further.”

“It seems to me inherent in the appeal system that the tribunal must form its own view on the law without being restricted to what the Revenue state in their conclusion or the taxpayer states in the notice of appeal. It follows that either party can (and in practice frequently does) change their legal arguments. Clearly any such change of argument must not ambush the taxpayer and it is the job of the Commissioners hearing the appeal to prevent this by case management.”

“A trader computing his profits or losses will ordinarily make some deduction for depreciation in the value of the machinery or plant which he uses. Otherwise the computation will take no account of the need for the eventual replacement of wasting assets and the true profits will be overstated. But the computation required by Schedule D (whether for the purpose of income or corporation tax) has always excluded such a deduction. Parliament therefore makes separate provision for depreciation by means of capital allowances against what would otherwise be taxable income. In addition, generous initial or first-year allowances, exceeding actual depreciation, are sometimes provided as a positive incentive to investment in new plant.”

“The general rule is that expenditure is qualifying expenditure if (a) it is capital expenditure on the provision of plant or machinery wholly or partly for the purposes of the qualifying activity carried on by the person incurring the expenditure, and (b) the person incurring the expenditure owns the plant or machinery as a result of incurring it.”

“(1) Expenditure is first-year qualifying expenditure if (a) it is incurred on or before 31 March 2004, (b) it is incurred by a small enterprise, (c) it is expenditure on information and communications technology, and (d) it is not excluded by section 46 (general exclusions) or subsection (4) below. (2) ‘Expenditure on information and communications technology’ means expenditure on items within any of the following classes: Class A. Computers and Associated Equipment … Class B. Other Qualifying Equipment … Class C. Software This class covers the right to use or otherwise deal with software for the purposes of any equipment within Class A or B … (4) Expenditure on an item within Class C is not first-year qualifying expenditure under this section if the person incurring it does so with a view to granting to another person a right to use or otherwise deal with any of the software in question.”

“The overall effect of the single composite transaction from LLP2’s point of view is that the highly uncommercial loan reduced the cost to LLP2 of the software with the result that LLP2 did not incur expenditure of £27.5m for the purposes of CA 2001. It did incur expenditure of at least £5m, but . . . it was for LLP2 to prove how much more than this it incurred, by giving evidence as to the value of its members’ liability under the Member Loans. But LLP2 chose to give no evidence of this before the Special Commissioner. In those circumstances the correct conclusion is that LLP2 incurred expenditure of only £5m.”

“MCashback had devised a complex software package, called the M Rewards system, to enable manufacturers to promote their products to retail customers by offering them free airtime on their mobile phones. The manufacturers would pay MCashback a fixed fee, called a ‘clearing fee’, per transaction. MCashback required additional funding to ‘roll-out’ the M Rewards system. This potentially involved negotiations with manufacturers, supermarket groups and mobile phone companies around the world. MCashback approached Tower Group plc (“Tower”), which had experience of arranging finance for similar software companies. The funding arrangement proposed by Tower was for MCashback to sell part of its software (by means of SLAs) to four newly-created Tower LLPs, the members of which would include Tower personnel and individual outside investors, for a total of £143 million; the LLPs would thereby acquire a right to receive part of the clearing fees derived from the exploitation of the M Rewards system.”

“To force the courts to adopt, in relation to closely integrated situations, a step by step, dissecting, approach which the parties themselves may have negated, would be a denial rather than an affirmation of the true judicial process. In each case the facts must be established, and a legal analysis made: legislation cannot be required or even be desirable to enable the courts to arrive at a conclusion which corresponds with the parties’ own intentions.”

“An email from Tower’s lawyers on 29 March indicated however that there would be some problem in the LLPs simply purchasing percentage slices of the software, and therefore the solution was adopted that LLP1 would buy the Code Generation Software for £7.334m, carrying an entitlement to 0.66% of clearing fees and to 5.128% of the clearing fees allocable to all four LLPs; LLP2 would buy the Customer Support Software for £27.501m; LLP3 would buy the Call Centre Software for £45.835m and LLP4 would buy the fourth element of software for £62.33m. Notwithstanding the allocations of specific software to each of the LLPs, the price payable by, and the percentage entitlement to clearing fees acquired by, each LLP retained their earlier matched relationship.”

“It was always intended that each LLP would raise 75% of the finance which it needed by way of bank borrowing, and that MCashback would be obliged to deposit approximately 82% of the consideration which it received for the grant of the licence as an indirect security for that borrowing. The details had not yet been worked out on 31 March 2004, and the identity of the two participating banks was still undecided. However, the basic framework of the arrangements had been agreed, and this was reflected in the definitions in clause 1.1 of the SLA of the ‘Bank Loan’, ‘Bank One’, ‘Bank One Security,’ ‘Bank Two’ and ‘Bank Two Security’. Clause 4.2(d) provided that on completion MCashback should deliver to Bank Two the Bank Two Security, and procure that Bank Two provide to Bank One the Bank One Security.”

“In the first flush of victory after the Ramsay, Burmah and Furniss cases, there was a tendency on the part of the Inland Revenue to treat Lord Brightman’s words as if they were a broad spectrum antibiotic which killed off all tax avoidance schemes, whatever the tax and whatever the relevant statutory provisions.”

“Thereafter, when LPI required to spend or spent money in making the film, the amount involved was credited by LPI to the scheme current account (which was controlled by LPI) and returned to LPI on the same day for credit to its account at Chemical Bank. The scheme current account was thus never in credit or debit at the close of any day and [VP] was never in debt as a result of the scheme.”

“But the non-recourse nature of the borrowing ensured that LPI paid the whole cost of the film exceeding $3¼m and conversely that [VP] would not be liable for the cost of the film in excess of $3¼m. By the operation of the scheme current account in accordance with the provisions of the scheme, the money of LPI, at all times under the control of LPI, was electronically transferred from Hollywood to the City of London and back again without serving any useful purpose and leaving no trace except entries on computer prints.”

“In the present case if LPI had been a British company, the fact that LPI borrowed $10¾m from Chemical Bank to enable LPI to make the film would not have denied to LPI a first year allowance equal to the sums borrowed and expended. But [VP] neither borrowed nor spent $10¾m.”

“I accept, too, that money was indeed paid by LPI to VP on the various occasions when the relevant account was credited; although that too was deprived of any practical effect by the immediate repayment, on the same day, of exactly the same sum from that account. What I have to do, however, is to stand back from the composite transaction; to look at it as a whole; and to decide, first, what is the true nature and effect of the transaction and, second, whether, on a true construction of section 41(1) of the Finance Act 1971, VP is entitled to an allowance in respect of the whole of the cost of the film, viz $14m. When I embark upon this process, I find it impossible to characterise the money paid by LPI into the bank account to the credit of VP as, in any meaningful sense, a loan. It was not in my opinion money lent to VP to enable VP to finance the production of the film. It was money paid by LPI into the bank account opened in VP’s name to enable VP to indulge in a tax avoidance scheme, and for no other purpose.”

“Section 24 focuses on the incurring of expenditure by the trader on the provision of plant or machinery wholly and exclusively for the purposes of his trade. It therefore requires one to look only at what the taxpayer did. To the test posed in section 24 it is immaterial how the trader acquires the funds to incur the expenditure or what the vendor of the provided plant or machinery does with the consideration received.”

“However, there is nothing in the statute to suggest that ‘up-front finance’ for the lessee is an essential feature of the right to allowances. The test is based on the purpose of the lessor’s expenditure not the benefit of the finance to the lessee. Nor, as the judge recognised, should it make any difference whether the arrangements by which the tax advantage was achieved were simple or, as the Commissioners thought in this case, ‘complicated [and] convoluted’.”

“There might be more room for argument as to whether there was ‘expenditure’, given the apparent circularity of the payments. However, once one accepts the transfer of ownership, it is difficult to question the reality of the expenditure by which the purchase price was discharged.”

“If the lessee chooses to make arrangements, even as a pre-ordained part of the transaction for the sale and leaseback, which result in the bulk of the purchase price being irrevocably committed to paying the rent, that is no concern of the lessor. From his point of view, the transaction is exactly the same. No one disputes that [Barclays Finance] had acquired ownership of the pipeline or that it generated income for [Barclays Finance] in the course of its trade in the form of rent chargeable to corporation tax. In return it paid £91m. The circularity of the payments which so impressed Park J and the Special Commissioners arose because [Barclays Finance], in the ordinary course [of] its business, borrowed the money to buy the pipeline from Barclays Bank and Barclays happened to be the bank which provided the cash collateralised guarantee to [Barclays Finance] for the payment of the rent. But these were happenstances. None of these transactions, whether circular or not, were necessary elements in creating the entitlement to the capital allowances.”

“The question that I have to address, therefore, is whether it is appropriate to say that capital expenditure of the gross figures has been incurred when the seller has filtered back 75% of the price to the investor members of the LLPs via the cosmetic banking chain, when the reality is that there is a great likelihood that a substantial proportion of the wholly uncommercial loans will eventually be waived, and when, in the meantime, any partial repayments of the loans will be liable to be made on an entirely contingent basis. And when I address that question by looking at the legal reality of what has occurred, and at the money movements, rather than looking fixedly at discredited labels attached to the transactions by the parties, I conclude that the gross capital expenditure has not been incurred. On a purposive basis it seems to me that the investor members and the LLPs have so far incurred the 25% element of the total price, and that the LLPs will incur further capital expenditure if and to the extent that the LLPs discharge members’ loans on their behalf by the envisaged application of 50% of clearing fees.”

“In the light of the principles laid down in BMBF and MacNiven’s case, there cannot in my judgment be any real doubt about the answer to the Expenditure Issue. The whole of the purchase price of £27.501m was expended by LLP2 on the acquisition of the software, and it was not expended on anything else.”

“I accept that there are distinctions between the facts of the present case and those of BMBF, and I would agree that in the absence of evidence from the banks the Special Commissioner was entitled to be sceptical about the commerciality of the arrangements into which they entered. It seems to me, however, that none of this advances the Revenue’s case, because it does not impinge on the narrow question whether LLP 2 incurred the relevant expenditure on the acquisition of the software.”

“I hope I have now said enough to explain why in my judgment the Special Commissioner’s conclusion on the Expenditure Issue cannot stand, and in the absence of a finding of sham the only conclusion open to him was that the whole of the consideration for the software, when it was paid on completion of the SLA in January 2005, was expenditure incurred on the provision of plant within the meaning of section 11 of CAA 2001.”

“The terms of the borrowing, in the context of all the facts, may be relevant in order to cast light on whether LLP2 had really incurred expenditure, as Carnwath LJ foresaw ([2003] STC 66, para 58…). The source of the money was irrelevant in BMBF because the borrowing was on regular, commercial terms. Rather than regarding the terms on which LLP2 borrowed 75% of the consideration as ‘simply irrelevant’, the Court should consider them in relation to the fundamental question whether the taxpayer suffered the economic burden of paying the full amount. By doing so, it is possible to decide whether there was ‘real’ expenditure.”

“Whilst there was an expectation, on the basis of conservative predictions, that the whole of the loan agreement would not be paid off in full over the period of ten years, it cannot be shown that the terms were such that the loan was never likely to be repaid. It all depended on success in marketing the software. In Ensign, the loan never had to be repaid whatever success the film achieved.”

“LLP and its members owned free of any liability software which could generate a substantial proportion of an annual income which the projections showed to be approximately £38m. In Ensign Tankers, the partnership never acquired a right to more than 25% of the returns.”

“It is this feature which to my mind is the most important ground for distinguishing Ensign Tankers and this appeal. The ownership of the software agreement was transferred to LLP 2. The question of transfer of ownership casts a clear light on the reality of the expenditure, just as it did in Ensign Tankers. It was unacceptable to contemplate that [VP] had incurred 100% of the expenditure on the film in acquiring a mere 25% of the rights. But the fact that LLP2 acquired the right to the full economic benefit of the agreement is a powerful, and, to my mind, a determinative feature of this appeal. It is worth repeating part of Carnwath LJ’s judgment (at para 85) which I cited earlier: ‘However, once one accepts the transfer of ownership, it is difficult to question the reality of the expenditure by which the purchase price was discharged.’”

“In the absence of a finding of sham the only conclusion open to him was that the whole of the consideration for the software … was expenditure incurred on the provision of plant within the meaning of section 11 of CAA 2001.”