Barnetts v HM Revenue and Customs
| Jurisdiction | UK Non-devolved |
| Judgment Date | 22 June 2010 |
| Neutral Citation | [2010] UKFTT 286 (TC) |
| Date | 22 June 2010 |
| Court | First Tier Tribunal (Tax Chamber) |
[2010] UKFTT 286 (TC)
Judge Colin Bishopp (Chairman)
Nigel Hutton of Grant Thornton UK LLP, chartered accountants, for the Appellant
Susan Alexander of their appeals unit for the Respondents
Income tax - interest earned by solicitors on short-term funds in clients' account - fee agreements with clients reflecting the solicitors' right to retain the interest - whether interest to be taxed in accordance with Income Tax (Trading and Other Income) Act 2005 section 5s. 5 or Income Tax (Trading and Other Income) Act 2005 section 369s. 369 of ITTOIA - priority rules - interest properly to be regarded as trading income - appeal allowed
Interest received by a solicitors' partnership on its clients' account was to be treated, for income tax purposes, as trading income since it was money received from clients in return for professional services, even if it was indirectly received.
The taxpayer was a firm of solicitors trading in partnership. The greater part of its income was derived from volume conveyancing work. The firms' clients were lending institutions. The firm's fees were paid by the lending institution.
Significant interest was earned on a client account because typically the amount to be lent to a home owner was paid to the taxpayer on the day fixed for completion of the transaction, or the working day before. Although the amounts remained in the account for a short time, the volume of work meant that the aggregate balance in the taxpayer's client account at any one moment was a very large sum, and the interest earned on it for the relevant period was correspondingly significant.
That interest offset a loss on the fees, leaving the firm with an overall profit on its volume conveyancing business.
The short period for which the individual advances remained in the taxpayer's account meant that rarely, if ever, was the firm required by the Solicitors' Accounts Rules 1998 to account for the interest to the lending institution.
The taxpayer's case was that the retained interest was to be regarded as part of the firm's trading income, and taxed accordingly, while HMRC contended that it was to be taxed as interest. The significance of the difference between the parties lay in the restrictions on the offsetting of trading losses incurred in one year against interest gains in later years (ICTA 1988, Income and Corporation Taxes Act 1988 section 385s. 385) (in force in the relevant year but since replaced by various provisions of the Income Tax Act 2007).
Whether the interest on the firm's client account was to be treated, for income tax purposes, as interest or as trading income.
The First-tier Tribunal (Colin Bishopp) (allowing the taxpayer's appeal) said that the ITTOIA 2005, Income Tax (Trading and Other Income) Act 2005 section 5s. 5 provided that income tax was charged on the profits of a trade, profession or vocation, while Income Tax (Trading and Other Income) Act 2005 section 369 subsec-or-para 1s. 369(1) provided simply that income tax was charged on interest. There was no dispute that the taxpayer's fee income came within s. 5. Although the Act did not contain a general definition of "interest", there could be no real doubt that the interest in issue in this case, taken in isolation, had to be regarded as interest for the purposes of the section. The question was rather whether it was also to be regarded as part of the profits of a trade, profession or vocation, so as to bring it within s. 5.
Income Tax (Trading and Other Income) Act 2005 section 366 subsec-or-para 1Section 366(1) of ITTOIA 2005 provided that any income, so far as it fell within: (a) any Chapter of this Part; and (b) Ch. 2 of Pt. 2 (receipts of a trade, profession or vocation), was dealt with under Pt. 2. Sections 366 and 369 were within Pt. 4 of the Act, while s. 5 was within Ch. 2 of Pt. 2. The Act offered no guidance on the criteria by which it should be determined whether interest came within Ch. 2 of Pt. 2, or was to be taxed in accordance with Pt. 4, but there was some relevant judicial authority: Liverpool and London and Globe Insurance Co v BennettELR[1913] AC 610, Northend (HMIT) v White & Leonard & Corbin GreenerTAX(1975) 50 TC 121, Re Euro Hotel (Belgravia) LtdTAX(1975) 51 TC 293 and Nuclear Electric plc v Bradley (HMIT)TAX[1996] BTC 165.
In this case it was understood that the interest would comprise part of the solicitors' reward. Had the taxpayer not agreed to accept fees which fell short of the cost of doing the work, it would not have been instructed and in consequence would not have had the opportunity of earning the interest which made up the shortfall. The taxpayer could instead have agreed with its clients that it would charge fees which provided it with a profit, and account to the clients for the interest earned, whether or not the Solicitors' Accounts Rules required it to do so. The overall "package" would have been much the same, but the taxpayer's profit would unquestionably have fallen within Income Tax (Trading and Other Income) Act 2005 section 5s. 5. That the taxpayer agreed, at the clients' insistence, to structure the arrangement differently did not affect the outcome.
The reality was that the interest was earned in the course of the solicitors' trading, and as an integral part of the trading activities. It was not interest earned on money set aside to meet future liabilities, as in Nuclear Electric, nor interest casually earned, as in Northend. It was money received from clients in return for professional services, even if it was indirectly received. It was not a case in which carrying on the profession of a solicitor gave rise to the opportunity of earning interest, but one in which the interest was properly to be regarded as part of the solicitor's trading income, because it was understood between solicitor and client that the interest would form part of the total fee. Applying ITTOIA 2005, Income Tax (Trading and Other Income) Act 2005 section 2 subsec-or-para 3s. 2(3), the tribunal was satisfied that the interest in this case was properly to be regarded as trading income to be taxed in accordance with Income Tax (Trading and Other Income) Act 2005 section 5s. 5 of that Act.
1. The taxpayer in this appeal is a partnership, a firm of solicitors. The appeal arises from the amendment by the respondents of its partnership return for the year 2006-07. The nominated (and senior) partner is Richard Barnett, who gave the only evidence I heard. The issue is an essentially simple one: whether certain interest receivable by the partnership on its clients' account is to be treated, for income tax purposes, as interest or as trading income. The firm's liability for other years will also be affected by the outcome of this appeal, but I am asked to determine only the principle. The return in issue was originally submitted in a form which offset trading losses for the year against interest for the year, but was later re-submitted, claiming to offset trading losses incurred in earlier...
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Shirley
...accepted those changes as the price of tax simplification. This is illustrated by Judge Bishopp's decision in Barnetts (a firm)TAX[2010] TC 00575 at para. 11: The difficulty with that argument, in my judgment, is that while it may be that the Rewrite Project did not intend to make material ......
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Euroceanica (UK) Ltd
...taking account of the loan-to-value ratios applied by the lenders. Mr Goodfellow referred to the case of Barnetts (a firm)TAX[2010] TC 00575) as supporting the statements of Lord Jauncey in Nuclear Electric and the meaning of interest arising "in the course of" activities, in that instance ......