Acornwood LLP and Others v Revenue and Customs Commissioners
| Jurisdiction | UK Non-devolved |
| Judgment Date | 04 August 2016 |
| Neutral Citation | [2016] UKUT 361 (TCC) |
| Date | 04 August 2016 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
Mr Justice Nugee
Jonathan Peacock QC and Hui Ling McCarthy (instructed by Rosenblatt Solicitors) appeared on behalf of the appellants
Jonathan Davey QC, Nicholas Macklam and Sam Chandler (instructed by HMRC Solicitor's Office) appeared on behalf of the respondents
Income tax – Loss relief – Arrangements for exploitation of intellectual property rights – Whether first-year losses incurred – Whether large part of money paid for exploitation of rights or purchase of guaranteed income stream – Whether remainder used within first accounting year and allowable loss in that year – Appeals against First-tier Tribunal dismissed.
The Upper Tribunal (UT) has dismissed the lead appeals by various ‘Icebreaker partnerships’ against the decision of the First-tier Tribunal (FTT) in Acornwood LLP TAX[2014] TC 03545 finding that the FTT were correct to conclude that borrowings by LLP investors which were purportedly applied by the LLP's wholly and exclusively for the purposes of their trades were payments for the acquisition of a guaranteed income stream, not for the exploitation of intellectual property rights, and could not be brought within the calculation of LLPs profits (and losses) by reason of the Income Tax (Trading and Other Income) Act (‘ITTOIA 2005’), s. 34(1).
This was an appeal against the decision of the FTT in Acornwood LLP TAX[2014] TC 03545, involving lead appeals by five limited liability partnerships claiming sideways loss relief for payments made for the exploitation of intellectual property rights which they claimed to be trading losses. The FTT's decision had followed the decision of the UT in Icebreaker 1 LLP v R & C Commrs TAX[2011] BTC 1,579 and the partnerships were similarly known as ‘Icebreaker partnerships’.
In essence, the individual members who participated in the partnerships contributed some money of their own and a rather larger amount of borrowed money to the LLPs, in order to provide finance for a range of creative projects. Each LLP claimed to have made a significant trading loss in its first year which the individual members sought to claim as an allowable loss against their income tax liability. This FTT decision had dealt with both the matter of whether the losses claimed to have been made by the LLPs were allowable trading losses and also whether the individual referrers could claim sideways loss relief in relation to them. This appeal, however, was to consider only the first matter, whether the expenditure claimed by the LLPs satisfied the requirement of ITTOIA 2005, s. 34 that for losses to be allowable as trading losses they must arise from expenses incurred wholly and exclusively for the purposes of the trade. The matter of whether the individuals could claim sideways loss relief is the subject of a separate appeal still to be heard.
The UT initially noted the mechanics of the scheme, which worked by (taking a £100 sum as an example) the investor paying into the LLP £20 from their own resources and borrowings of £80. The LLP then paid £5 to a management company as an advisory fee and the remaining £95 to the principal exploitation company. Approx. £90 (of the £95) was then paid by the exploitation company to a production company, responsible for producing an end product such as a book or music cd. The production company simultaneously purchased a share in the revenues from exploitation of the product for £80 (from the exploitation company) so the production company was paid only the net amount of £10 and the exploitation company retained £85 of the £95 it had received. £80 (of the £85) was then placed on deposit with interest used to pay an income stream by quarterly payments to the LLP and in turn used to finance the interest costs of the £80 borrowed by the LLP investors. The exploitation company retained the remaining £5. The £80 on deposit was then ultimately (after 4 years) returned to the LLP and used to repay the £80 initial borrowings by the LLP investors.
The FTT had disallowed the £80 (of the £95) contribution to the exploitation company on the grounds that it was not wholly and exclusively incurred for the LLP's trade and also because it was a payment of a capital rather than income nature. The FTT had allowed all or part of the £15 balance paid to the exploitation company and had also allowed parts of the £5 advisory fee paid to the management company.
The UT examined the documentation noting that:
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• the purpose of the LLPs was to acquire exploitation rights (widely defined) and to exploit these rights;
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• the LLPs then entered into arrangements with the creator of an idea (e.g. Sinead O'Connor in one case);
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• the LLPs then, not having the expertise to exploit the rights acquired, engaged an exploitation company to do so, in turn licensing the rights acquired to that company for a finite period;
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• the exploitation company then arranged for production of the material/product taking a share of any revenues generated from the product;
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• the LLPs were also entitled to a share in any revenues.
The UT then reviewed the financing agreements and noted that FTT had found that in terms of the interest earned by the exploitation company on the £80 deposit, paid in turn to the LLP and then used to finance the investors initial borrowing costs, that the money went round in a circle, merely passing from one Barclay's account to another and never leaving Barclay's control. Much the same applied to the principal borrowings by the investors, the FTT had found that this was essentially a bookkeeping exercise and that there was never any risk that the loans would not be repaid and that the investors' exposure to any risk of having to finance the borrowings from their own resources was illusory.
The UT decided first to consider whether the £80 was an expense incurred wholly and exclusively for the purposes of the LLP's trade noting the statutory provisions; that ITTOIA 2005, s. 25(1) required profits to be computed in accordance with UK GAAP, subject to any law requiring adjustments for tax purposes and that s. 26(1) applied the same rule in calculating losses. ITTOIA 2005, s. 34(1) then denied deductions for expenses not incurred wholly and exclusively for the purposes of the trade or losses not connected with or arising out of the trade.
It was not disputed that the LLPs were trading with a view to a profit and the FTT had concluded that in return for the payment by the LLPs to the exploitation company, the LLPs had acquired two things, (1) exploitation services and (2) a guaranteed income stream (but the assertion in the documentation that the consideration for the guaranteed income stream was the right to assign a share of the revenue was a pretence; the price of the guaranteed income stream was paid by part of the £95 payment to the exploitation company). Having found that part of the amount paid to the exploitation company represented the purchase of a guaranteed income stream, it followed that only the remaining part of the payment might represent an allowable deduction.
The FTT had then found that as the £80 borrowed by the investors matched the final sum repaid by the exploitation company to the LLP, in turn used to repay those borrowings, and the periodic payments by the exploitation company to the LLPs matched the interest earned on the £80 deposit that it was holding which also matched the interest payable on the initial borrowings by the LLP investors, there was no basis to value the consideration for the guaranteed payments (the income stream) as anything other than the amount of the deposit (i.e. the £80). The reality was the borrowings were only ever available for use as the price of the guaranteed minimum payments and not for the exploitation of intellectual property rights and were as a matter of fact used only for that purpose. That sum (the £80) could, therefore, not be brought within the calculation of profits by reason of ITTOIA 2005, s. 34(1).
In so finding, the FTT had followed the decision of Vos J in the UT in Icebreaker 1 LLP v R & C Commrs TAX[2011] BTC 1,579. The UT considered the approach taken by Vos J and his conclusions and then the submissions on behalf of HMRC that their analysis and approach could not be faulted.
Firstly, the FTT had considered the business of the LLPs and the UT confirmed the FTT was justified in its findings that the LLPs business did not include the acquisition of an income stream which was not derived from the exploitation of intellectual property rights.
Secondly, the FTT had considered the transaction as a whole. This broke down into consideration of five matters. The UT noted that there was no challenge to the FTTs findings of fact, only to the conclusions drawn from those findings. The UT considered each of the five matters in turn and the particular criticisms on each but concluded that none of the conclusions reached by the FTT were capable of being displaced on appeal. In summary, the FTT were justified in concluding that:
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1) the borrowings were merely an artificial inflation of the apparent size of the amount paid for the exploitation of intellectual property rights and an arrangement with no commercial purpose and only a tax avoidance purpose;
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2) the fact that the payer knew from the outset that the money borrowed would be used directly or indirectly to secure its own repayment was relevant to the assessment of what was being paid for (by the LLPs);
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3) that the borrowings were entirely artificial with no purpose other than to secure the interest payments and eventual repayment of the borrowing; that the guaranteed payments had nothing to do with the assignment or grant of rights and that the ability to meet the guaranteed payments was wholly unaffected by the deployment of the rest of the...
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