In Hargreaves Lansdown Asset Management Ltd v HMRC  UKFTT 127 (TC) TC06383, the First-tier Tribunal (FTT) has found that loyalty bonus payments paid to investors were not "annual payments" for the purpose of section 683, ITTOIA.
Hargreaves Lansdown Asset Management Ltd (the taxpayer) was an investment company. It operated a platform through which investment products from different fund providers were made available directly to investors.
In 2014, the Financial Conduct Authority (FCA) issued new rules requiring platform service providers to charge clients a direct fee for their services, rather than retain payments from the product providers. The taxpayer charged investors a platform fee. An annual management charge (AMC) was also levied on investors, which was deducted monthly from the investor's fund. The taxpayer had negotiated lower AMCs with investment providers on behalf of its clients and the providers rebated part of the management charge to the taxpayer, who passed it on to investors in the form of a 'loyalty bonus'. This was paid by crediting cash to the investor's client account, and reinvesting the cash into shares or units once it had reached a minimum amount.
HMRC claimed that the payments were "annual payments", under section 683, Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) and therefore subject to income tax.
The taxpayer appealed against assessments issued by HMRC under section 957, Income Tax Act 2007. The assessments were issued on the basis that the taxpayer should have deducted basic rate income tax from loyalty bonuses paid to investors.
The taxpayer's appeal was allowed.
The issue before the FTT was whether the payments made by the taxpayer to investors required it to deduct and account for sums representing income tax on those payments because they were “annual payments” for the purpose of section 683, ITTOIA.
The FTT observed that section 683 does not define "annual payments". However, case law had established that an annual payment bore the following four characteristics:
(a) was payable under a legal obligation; (b) recurred or was capable of recurrence (although the obligation to pay could be contingent); (c) constituted income and not capital in the hands of the recipient; and (d) represented "pure income profit" to the recipient.
The taxpayer accepted that the loyalty bonus payments constituted income and not capital in the hands of investors, but disputed that the remaining criteria were satisfied.
Whether there was a binding legal obligation to make the payments depended on whether the taxpayer had a contractual obligation to pay the loyalty bonus to investors who satisfied the relevant criteria. Before the FCA's rule change, the taxpayer's terms and conditions expressed the loyalty bonus as a percentage of funds invested, or a reduction in the net AMC for particular funds. After the introduction of the new rules, it was shown as "an ongoing saving from [the taxpayer]" expressed as a percentage.
The FTT concluded that that language was apt to describe an offer by the taxpayer to pay a stated amount as a loyalty bonus at the end of a month, capable of acceptance by an investor who satisfied the criteria the taxpayer had set for that month.
The investor was on notice that the amount and frequency of the loyalty bonus could be changed, but not with retrospective effect. Therefore, at the end of a given month the taxpayer would be bound to pay the loyalty bonus to an investor who satisfied the criteria. After the introduction of the new FCA rules, it was even clearer that the loyalty bonus payments were made by the taxpayer under a binding legal obligation because under the FCA's Code of Business Sourcebook, it was obliged to pass on the full amount of any rebate from an investment provider.
Capable of recurrence
The taxpayer argued that if an offer could be withdrawn at any time, the necessary feature of recurrence was lacking.
The FTT disagreed with such an approach which it considered would deprive the words "capable of" of any substantive meaning and would extend the first characteristic so that it was necessary to establish a continuing binding legal obligation with the minimum period of such continuance at large. The loyalty bonus payments recurred over many months and they were not prevented from being recurrent simply because they were dependent on a contingency. Nor were they prevented from being annual because they were made monthly, provided they might continue beyond a month. Section 683(3) states that the frequency with which payments were made is to be ignored in determining whether such payments are "annual payments".
Pure income profit
The FTT said that examples of annual payments given in Campbell v Inland Revenue  AC 77 were a signpost to the primary intent and purpose of section 683, which was to identify a category of payments where the payee had satisfied his substantive obligation at the outset of the contract or agreement.
The FTT concluded that the AMC deprived the loyalty bonus of its character as pure income profit. The AMC was a compulsory charge directly borne by the investor as a term of investing through the taxpayer and that investors would (or should) have understood that the AMC would be reduced by the loyalty bonus. The FTT said:
"The assertion by HMRC that an investor does not need to pay or bear an AMC to receive a Loyalty Bonus and that there is nothing in the contract between HL and investors to impose the AMC ignores the plain terms on which HL offers and permits investment to be made.
Investment on terms that HL would meet what I have found (and HMRC assert) to be a binding legal obligation to pay the Loyalty Bonus each month, but without the recipient being charged the applicable AMC, is not an option, and would be a commercial nonsense. Yet that in substance is what HMRC say occurs when a Loyalty Bonus is received, because it is “pure income profit”."
The FTT concluded that the nature and quality of the loyalty bonus was such that it was not a "profit" to an investor, but rather a reduction of the net cost. This reflected the true factual matrix. The FTT said it was unlike an annuity payment, or interest, in respect of which a recipient need do nothing but sit back and receive the payments.
Accordingly, the FTT held that the loyalty bonus payments could not constitute annual payments as they were not pure income profit.
This decision provides a useful consideration and summary of the relevant case law relating to the meaning of "annual payments".
It is also worth noting that the FTT considered the proposition put forward by HMRC, that the taxpayer would meet a binding legal obligation to pay the loyalty bonus each month, without the recipient having to pay the relevant charges in relation to his investment, to be ‘commercial nonsense’ and simply not a true reflection of the facts. HMRC regularly argues in tax disputes that the facts must be viewed realistically, normally in a situation where the facts are unhelpful to its case. It would appear that it failed to review the facts realistically in this instance.
A copy of the decision can be viewed here.