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KEY POINTS
- The politicisation of tax avoidance.
- HMRC’s actions against unacceptable tax avoidance.
- The facts of the Tower MCashback case.
- The Appeal Court’s dismissal of HMRC’s claims.
- Will an appeal to the Supreme Court clarify or confuse the position?
One of the two authors of this article began tax practice as a member of the former Inland Revenue Solicitors’ Office some 20 years ago. The administration of tax was a very different affair in those days.
It was possible to carry a set of tax legislation without risking physical injury and tax inspectors carried out their duties diligently without being influenced by any underlying political agenda. It would seem that those days are long gone.
Avoidance and politics
The issue of tax avoidance and what is ‘acceptable’ and ‘non-acceptable’ behaviour on the part of taxpayers has become something of a political issue in recent years.
This may be due, in part at least, to the greater influence of the Treasury in the affairs of HMRC following the merger between the Inland Revenue and HM Customs and Excise in 2005.
The new organisation has tended to blur the distinction between tax avoidance, which is lawful, and tax evasion, which is not. As regards the former, the terminology has been complicated and politicised by the use of terms such as ‘acceptable’ and ‘unacceptable’, which, of course, begs the question, acceptable to whom?
In recent years there have been numerous pronouncements from HMRC in relation to acceptable and unacceptable taxpayer behaviour.
One is left to ponder why it is that a government department, primarily responsible for the collection of taxes and the payment of some forms of state support, has become so politicised.
Whether this is a good thing or bad thing can, no doubt, be debated at length on another occasion.
The current position
Bespoke structures are still being generated both for corporate and high net worth individuals who wish to structure their affairs in such a way so as to minimise their tax liability.
This is likely to remain the case until Parliament enacts that taxpayers are obliged to structure their affairs so as to maximise the amount of tax payable. There are also available, largely in relation to high net worth individuals, a number of mass-marketed structures which are intended to reduce the participants’ tax liability.
As a consequence, HMRC have introduced the disclosure rules, frequent piecemeal changes to particular statutory provisions, targeted anti-avoidance rules, and principles-based legislation.
In addition, HMRC rely upon a large and complex body of non-legislative rules which take the form of, for example, the departmental manuals and tax bulletins.
The Tower MCashback case
It is against this background that the Court of Appeal was recently asked to consider a tax mitigation structure in CRC v Tower MCashback LLP 1 & Another [2010] EWCA Civ 32.
There were two issues in this case. The first related to the scope of a tax enquiry closure notice and subsequent appeal. The Court of Appeal (by a two-to-one majority) allowed HMRC’s appeal on this issue and held that it is for the First-tier Tribunal to determine the scope of a tax enquiry closure notice.
We do not intend to comment further on this aspect of the decision, but rather to focus on the second technical issue which was whether a taxpayer who funds the acquisition of an asset with a non-recourse loan and acquires the full economic benefit of that asset has ‘incurred expenditure’ for capital allowances purposes.
On this issue the Court of Appeal unanimously dismissed HMRC’s appeal and confirmed the judgment of Henderson J in the High Court who had held that the taxpayer had incurred expenditure for capital allowances purposes.
Facts
Tower MCashback LLP 1 (LLP1) and Tower MCashback LLP 2 (LLP2) claimed first-year capital allowances under CAA 2001, s 45 in respect of the full amount of qualifying expenditure on completion of software licensing agreements (SLAs) entered into between them and MCashback Limited (MCashback) on 31 March 2004.
The claims were denied by HMRC.
Focusing on LLP 2, on 31 March 2004 it entered into an SLA with MCashback under which it acquired a right to use certain computer software in consideration of £27.5 million.
Under the agreement, LLP 2 was entitled to receive 2.5% of the gross revenues from the software.
However, only £5 million was funded by the investing members of the partnerships from their own resources. The remaining £22.5 million was funded by way of non-recourse loans made to the partners of LLP2 by Tower MCashback Finance UK Limited, a company in the Tower MCashback group.
There was no issue that investors had incurred ‘expenditure’ for the amounts of money that they had invested, i.e. £5 million. The arguments before the Court focused on whether they had incurred expenditure for the balance of the acquisition price.
On this point the taxpayer had been successful before Henderson J in the High Court.
The key authorities which the High Court and Court of Appeal had to consider were the decisions of the House of Lords in Barclays Mercantile Business Finance Limited v Mawson [2005] STC 1 and Ensign Tankers (Leasing) Ltd v Stokes [1992] STC 226.
The leading judgment
Moses LJ, who gave the leading judgment in the Court of Appeal, began by stating that the issue concerned was the correct construction of the capital allowances legislation.
Had LLP 2 ‘incurred capital expenditure’ for the purposes of CAA 2001?
In Barclays Mercantile Business Finance, the House of Lords had clearly stated that a statutory entitlement to capital allowances depended on the acts and purposes of the purchaser of the plant.
The key point in that case was that the taxpayer company had obtained ownership of the pipeline and had incurred an obligation to pay for it, an obligation discharged by the expenditure of £91 million.
The source of that £91 million and what was done with it by the recipient was not relevant.
In this case, however, HMRC had pointed to five non-commercial aspects of the transaction.
First, the loans were repayable only out of 50% of the fees received from the exploitation of the technology. This was to enable the investors to pay income tax on any revenues which the software might generate. Second, the loan was funded by the vendor, MCashback. Third, it was interest free.
Fourth, MCashback received no interest. Fifth, the loans were for ten years and, on the basis of MCashback’s own projections, insufficient revenues would be received to repay the non-recourse loans in full.
In paragraphs 77, 83, 84 and 85 of his judgment, Moses LJ dismissed these arguments. He said:
‘There is persuasive additional authority for the proposition that a non-recourse loan is a loan if repayable out of the proceeds in the hands of the taxpayer borrower. The opinion of the Board, given by Lord Millett in Peterson & Others v New Zealand Commissioner of Inland Revenue [2005] STC 448, echoes Lord Gough’s acceptance that even on non-recourse terms, where the borrower has no personal liability to repay, the borrowed funds belong to the borrower and not the lender, just as they would if the funds were given by a friend or relative… Lord Millett accepted that the capital allowance depended upon the investors suffering the economic burden of the expenditure claimed before the tax deductions taken into account…
‘The terms of the borrowing in the instant appeal, in contrast to the alleged borrowing in Ensign Tankers, did provide for repayment of the loan out of 50% of the relevant income …
‘In this case, I take the view that the borrowed funds paid by LLP 2 to purchase the software licensing agreement were paid out of its own resources notwithstanding the terms of the loan agreement… It cannot be shown that the terms (of the loan) were such that the loan was never likely to be repaid. It all depended on success in marketing the software. In Ensign Tankers, the loan never had to be repaid, whatever success the film achieved.
‘This brings me to another important feature of the facts which provide a clear contrast with those in Ensign Tankers. LLP 2 acquired the full economic benefits of the software in return for the expenditure… it is this feature which to my mind is the most important ground for distinguishing Ensign Tankers and this appeal.’
Where are we?
Following the decision of the Court of Appeal in MCashback, HMRC petitioned the Supreme Court for leave to appeal which has been granted. The case is likely to be heard in February of next year.
Unusually, and as an indication of the importance of this case, it will be heard before a full sitting of seven Supreme Court judges.
What has prompted the Supreme Court to consider this case with a full appellate sitting? The issue here goes to the heart of the jurisprudence on tax mitigation and avoidance.
The Ramsay doctrine, as developed by the courts in WT Ramsay Ltd v CIR [1981] STC 174 and Furniss v Dawson [1984] STC 153 (and subsequent decisions), arose because the courts were anxious to curtail the worst excesses of an aggressive tax avoidance industry.
Although stressing that the Ramsay principle is purely one of statutory construction, the courts were nonetheless prepared, under certain circumstances, to re-characterise transactions and excise steps inserted for no commercial or business purpose other than an avoidance of tax.
The golden thread of the Ramsay jurisprudence is purposive construction, but in no other area of law have the courts been so prepared to push this to its outer limits.
The battleground between HMRC and the taxpayer is how far the courts are prepared to go in the pursuit of such purposive construction.
The issue here is whether expenditure is ‘real’ when funded by a non-recourse loan, in circumstances where the investor is investing in high-risk assets with a view to profit which, if successful, will generate income which will be taxable.
Should the courts re-characterise what is essentially a commercial transaction, an investment, and excise a ‘non-commercial’ loan even if that loan will be repaid if the asset generates income and even though the investor will be chargeable to tax in the event of a successful investment?
Are some types of non-recourse loan more susceptible to being re-characterised than others?
How far, in fact, can purposive construction be taken? Thus far, the courts have held that such structuring is permissible. Will the Supreme Court agree with HMRC?
Where to now?
Any dispute relating to the meaning of a particular statutory provision, whether in the field of tax or any other area of the law, that ends up before the courts will do so because the legislation in question is considered so ambiguous or difficult to construe that an independent judge is required to adjudicate on the intention of Parliament.
In theory, judges do not make new law, they simply declare what the law is. Judges are often, however, required to decide what it is that our legislature actually intended when enacting the provision in question.
The Ramsay doctrine of statutory construction introduced a novel methodology of ascertaining the intention of Parliament and a decision adverse to the taxpayer in MCashback will be a further blow to the traditional canons of statutory construction.
Rather than the courts adopting a different approach when it comes to construing fiscal legislation, which creates a great deal of uncertainty for taxpayers, it must surely be preferable for Parliament, as a democratically elected body, to legislate against practices it considers unacceptable, whether in the form of a general anti-avoidance rule or specific anti-avoidance legislation.
Jonathan Levy is a partner and head of the tax disputes resolution team at Reynolds Porter Chamberlain LLP. Telephone 020 3060 6472 or email. Matt Greene is an associate solicitor in the tax disputes resolution team.
