In HMRC v Investec Asset Finance Plc and Another  UKUT 0069 (TCC), the Upper Tribunal (UT) has held that payments made to acquire partnership interests are deductible in calculating the profits of the partners’ solo trades of dealing in those partnership interests.
Investec Asset Finance Plc and Investec Bank Plc, collectively Investec, appealed against conclusions and amendments to their corporation tax returns contained in closure notices issued by HMRC for seven transactions involving Investec’s participation in leasing partnerships.
The First-tier Tribunal (FTT) had to consider three leasing transactions undertaken by certain partnerships Investec had purchased. The transactions were complicated. In each one Investec acquired an interest in a partnership entitled to lease receivables and became a partner in that partnership, with a view to the partnership realising the receivables and making distributions to Investec.
In the FTT, six issues were decided on a preliminary basis, four of which were contested, namely:
1. Whether particular expenditure was capital or revenue in nature.
The FTT decided that it was revenue.
2. Whether the disputed expenditure should nevertheless be disallowed on the ground that it was not incurred wholly and exclusively for the purposes of Investec’s trades.
The FTT decided the expenditure was incurred wholly and exclusively for those purposes and should be allowed.
3. Whether HMRC was precluded by the closure notices from raising the point in issue 4 (below). Investec argued HMRC could rely only on the grounds and conclusions set out in the closure notices.
The FTT decided that HMRC was not so precluded.
4. Whether the partnership’s taxed profits – or the distributions of the partnerships which represented taxed profits – needed to be brought into account when computing the tax on the solo financial trades.
The FTT decided they did not.
The FTT said it was ‘unrealistic’ to say that Investec had, by buying the partnership interests, acquired the receivables. It was equally unrealistic to say that the acquisition of the partnership interests was irrelevant. On the contrary, the purchase by Investec of the partnership interests was determined as crucial to the tax planning of its counterparties.
Nevertheless, the FTT also concluded that, although in all three transactions Investec had acquired interests in partnerships that were conducting leasing trades, it had no interest in carrying on these. Rather, its aim was to effect pre-planned steps of terminating the leases so as to receive distributions or to receive the distributions from one sale and the proceeds from selling the remaining partnership interests to another partnership.
HMRC appealed against the decisions on issues 1, 2 and 4 and Investec cross-appealed against the conclusion on issue 3.
The UT concluded that the disputed expenditure was revenue in nature. Agreeing with the FTT, it determined that Investec had not merely acquired partnership interests, but had become partners in those arrangements. Therefore, looking at the character of the advantage sought by Investec in terms of duration and recurrence, the manner in which it was to be enjoyed and the means employed to obtain it, the FTT had rightly concluded that:
• the transactions were short-term recurrent transactions akin to trading transactions;
• the partnership interests were exploited, not by carrying on the trades of the partnerships for any length of time, but by quickly extracting the lease receivables in distributions and sales proceeds; and
• that had been achieved by using planned steps.
HMRC’s appeal on this issue was dismissed.
Although the FTT had found that the disputed expenditure was incurred wholly and exclusively for the purpose of Investec’s trades, in the view of the UT this conclusion was contrary to its other findings of fact.
The UT determined that expenditure incurred by a company partly for its own trading purposes and partly for those of another company was not ‘wholly and exclusively’ incurred for the purposes of the trade of the first company, even if they were members of the same group. It was therefore necessary to distinguish between the disputed expenditure paid to acquire partnership interests and shares, and sums paid by way of capital contributions. There was, therefore, no flaw in the FTT’s reasoning on the former.
Investec had acquired the partnership interests and shares for the purposes of their solo financial trades. They paid the sums as solo traders, to become partners, not as partners, and thereby obtained access to the lease receivables. The position was different for capital contributions. Applying the reasoning of the Court of Appeal in Interfish Ltd v CRC  STC 55, the UT assessed the taxpayer’s subjective intentions objectively. The UT said the FTT was entitled to find that Investec’s ultimate objective was to profit from distribution and sale proceeds, and that such profits were made in the solo financial trades. However, it was ‘inescapable’ that the capital contributions were made at least partly for the purposes of the partnership businesses, which were distinct from those carried out by Investec. HMRC’s appeal was allowed for the capital contributions.
The UT agreed with the FTT’s decision that HMRC was not precluded from raising issue 4 because, although HMRC’s case on this was not set out in the closure notices, it was set out in its covering letter. A closure notice has to set out the department’s conclusion and any amendment required, but HMRC was not precluded from setting out an alternative conclusion and amendment to that in the closure notices.
The UT confirmed that a closure notice had to be read in context (Fidex Ltd v CRC  STC 1920). A key aspect of this was the covering letter to the closure notices giving HMRC’s alternative view. The UT said the two documents could and had to be read together. They made it clear that, if HMRC was unsuccessful on the first and second issues, the partnership profits issue would be raised in the alternative.
Investec had argued that it was an important point of procedural propriety and fairness, but later accepted that there had been no procedural unfairness because it had not been taken by surprise. Rather, Investec contended that the FTT had no jurisdiction to entertain this part of HMRC’s appeal. The UT confirmed that the FTT had been right to conclude that it had jurisdiction to hear the issue. Investec’s cross-appeal was therefore dismissed.
The UT said:
‘It should be noted before proceeding further there are two very odd features to HMRC’s case on issue 4. First, HMRC only advance their case on issue 4 in the alternative to their cases on issues 1 and 2. As is common ground, however, if HMRC are right on issue 4, that would result in a larger sum being payable in tax than if HMRC are right on either issue 1 or issue 2. Normally parties advance as their primary case the contention which is most beneficial to them and advance as alternative cases contentions which are less beneficial to them, but HMRC’s stance in this matter is the other way round. Secondly, there is no analytical reason why HMRC should be constrained to advance their case on issue 4 only in the alternative to their case on issues 1 and 2. If the case is a good one, it runs anyway.’
The UT agreed with the FTT that profits taxed in the hands of the partnerships should not be taxed again in the hands of Investec and that the ‘source doctrine’ did not have the effect contended for by HMRC because it did not justify taxing the same income twice. The ‘source doctrine’ is a general principle described by Park J in Pumahaven Ltd v Williams  STC 1423: ‘Taxpayers are not taxed on income in the general sense of the term, but rather on specified kinds of income from specified sources’. As the UT noted, the most important application of this principle is that income cannot be taxed in a particular year unless there is a ‘source’ in that year.
In the present appeal, two tax computations were needed because there were two trades in each case. But it did not follow that the same income should be brought into account in both computations. The UT concluded that the basic principle was clear, but its application to the facts of Investec’s case was less so. It therefore invited the parties to restore the appeal in order to canvass further argument on this issue.
This decision highlights the difficulty in ascertaining whether expenditure is capital or revenue in nature.
First, there is no single test that can be applied in all circumstances to determine this question, and there may be facts that point in both directions. It is therefore important to consider the economic and business reality of the expenditure under consideration and the character of the advantage sought in entering into the underlying transactions.
Second, the subjective element in determining whether expenditure is incurred wholly and exclusively for the purpose of a trade can create uncertainty. The UT said such uncertainty could be avoided if an objective test were applicable, but that this would require a decision of the Supreme Court.
It is likely that the appeal will be restored and the parties will have an opportunity to address the FTT on issue 4.
On whether HMRC is entitled to raise a further issue that is not in the closure notice, the UT confirmed that the notice must set out HMRC’s conclusion and any amendment required to the return. However, it is not prevented from setting out an alternative conclusion and amendment if it is wrong as to the primary conclusion and amendment for which it contends.
Further, a closure notice must be read in context and in conjunction with accompanying correspondence from HMRC. On the facts of this case, Investec had suffered no ‘procedural unfairness’ because the issue had been clearly identified in HMRC’s covering letter and it had not been taken by surprise. However, the outcome might have been different had the issue not been identified. In such circumstances, it is likely that Investec would have been successful with its procedural unfairness argument.
A copy of the decision can be viewed here.
A copy of this article was first published in Taxation magazine on 23 May 2018.