Brain Disorders Research Ltd Partnership and Another
| Jurisdiction | UK Non-devolved |
| Judgment Date | 02 July 2015 |
| Date | 02 July 2015 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Howard M. Nowlan, Helen Myerscough ACA
Jolyon Maughan QC and Alice Mayhew, counsel, instructed by Berwin Leighton Paisner, appeared on behalf of both Appellants
Kevin Prosser QC, David Yates and Zizhen Yang, counsel, instructed by the General Counsel and Solicitor to HMRC, appeared on behalf of the Respondents
Income tax Claim for capital allowances in respect of expenditure on scientific research Scheme to claim the allowances for a substantially higher amount than that actually applied in undertaking such research Whether the partnership's whole activity or any part of its activity constituted trading for tax purposes Whether if so, trading losses derived from capital allowances arose in a non-commercial venture Whether pre-payments of interest on two substantial borrowings were allowable Whether the amounts borrowed had been contributed to a partnership and applied wholly for trading purposes Whether interest had actually been paid Whether relief was denied by Income Corporation Taxes Act 1988 (ICTA 1988), s. 787 Whether certain expenses were deductible Both appeals dismissed.
The First-tier Tribunal (FTT) dismissed a taxpayer partnership and partner's appeals against HMRC's rejection of claims for capital allowances and interest deductions claimed as part of a tax avoidance scheme, finding the scheme to be a scam.
These appeals were brought by The Brain Disorders Ltd Partnership (the partnership), which comprised of high net worth individuals and was promoted to undertake scientific research and designed to claim the capital allowances granted for such expenditure, and Neil Hockin (hereinafter referred to as the partners), who was one of the partners whose appeal was a test case for the points affecting the individual partners. The appeals related to a tax avoidance scheme promoted by Matrix-Securities Ltd (Matrix), designed initially to repeat the type of scheme dealt with in the First-tier and Upper Tribunal decisions in Vaccine Research Ltd Partnership, reported as [2013] TC 02491 and [2014] BTC 525 (against which there could still be an appeal to the Court of Appeal). The transactions, effecting the scheme, were inter-dependent and were effected on the same day. In summary, the tax planning sought to (a) generate up-front reliefs by artificial steps enabling capital allowances to be claimed for vastly more than the amount that was actually to be spent on undertaking such research, and (b) to arrange for additional borrowings to be incurred, almost entirely to fund vast pre-payments of interest, designed again to generate up-front tax relief that could be set against other income.
The original proposed scheme essentially replicated the steps in the Vaccine Research scheme i.e. an area of scientific research was identified (in this case research into treatments for certain brain disorders) where the cost of undertaking a conventional research programme would be, say, 100 (indicative figures in bold italics are used throughout for simplicity), but where the technology, expertise, systems and data bank held by a particular company would enable the relevant research to be undertaken by that particular company for much lower sum, albeit that the company would retain 90% of any net royalties from the research. So the partnership would pay 100 to a special purpose vehicle (Numology Ltd (Numology), which performed the same role in the Vaccine Research scheme), which was said to be the amount that a third party would have charged to undertake the research conventionally. Numology contracted to either undertake the work itself or to sub-contract the work to BRC Operations Pty Ltd (BRC), an Australian company which had the relevant expertise, systems and data bank. Numology then paid BRC 6 to perform the research. BRC also licenced its existing intellectual property, patents and knowhow, relating to this research, to Numology, and indirectly to the partnership for 1, which was then licenced back to Numology in return for fixed royalties, over the 15 year term which BRC had to complete the research, and fluctuating royalties. It was then sub-licenced by Numerology back to BRC in return for fluctuating royalties equal to 10% of the net royalties eventually derived from the improved and enhanced intellectual property following the research. Numology would then acquire various deposits or other financial instruments with the remaining 94 (100 6) less fees, to meet its obligation to pay the fixed royalties to the partnership. The partnership would then claim capital allowances for the 100 paid to Numology, with the partners being able to set their share of the allowances against other income. And coupled with the fixed royalties the partnership would receive it meant that the investment was attractive even if no 10% royalties were ever received.
In March 2007 it was announced that partners would only be able to offset 25,000 of losses or allowances in this situation against other income. This meant that the planning had to be amended. To contribute 100 to the partnership Matrix organised that the partners borrowed 43 from each of two banks (Schroders and Bank of Scotland (BoS)) and the partners contributed the remaining 14 (100 86), either from available cash or ordinary bank borrowings. There was some confusion about fees and expenses, but based on what the appellants initial said of the 100 contributed to the partnership 96 was paid to Numology under the research agreement. Numology then paid the partnership 57 immediately as an advance payment of the fixed royalties. The 57 was distributed to the partners, although held in a bank account, 40 was then immediately paid to Schroders, fully discharging the full recourse liability to pay the entirety of the interest on the Schroders loan. The remaining 17 (57 40) was then used to pre-pay all the interest on the BoS loan. Of the remaining money held by Numology (96 57), 29 was used to acquire a deposit to pay the remainder of the fixed royalties to the partnership, 6 was paid to BRC under the research sub-contract, 3 was paid to Schroders for an assignment to Numology of Schroders' remaining rights under its loan and 1 met expenses. The aim of the revised planning was to reduce the net losses derived from the capital allowances to 39 (96 57), with relief then being claimed on the 57 used to prepay interest on the Schroders and BoS loans.
HMRC argued that:
1) elements of the documentation were a sham. In particular Numology was never going to undertake the research project itself and therefore it could not be asserted that anything more than 6 was to be paid for the scientific research (the sham issue).
2) if the sham argument was wrong, it still contended that the claim for capital allowances could not be for more than 6. The Capital Allowances Act 2001 (CAA 2001), s. 437 provided that allowances are only available if a person incurs qualifying expenditure and the partnership knew that no more than 6 would be spent on the scientific research (the quantum issue).
3) the partnership was not trading at all or the trade only extended to the marginal activity related to the sub-contracting of the research to BRC.
4) even the limited research function in relation to the 6 was an investment activity and not trading.
5) if there was a trading activity it was not being carried on on a commercial basis as required by the Income and Corporation Taxes Act 1988 (ICTA 1988), s. 384.
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6) in relation to the relief claimed for the pre-payments of interest on the bank borrowings:
i) none of the interest was allowable because the money borrowed was not used wholly for the purpose of the trade as required by ICTA 1988, s. 362;
ii) the prepayment of the Schroders interest was simply not a payment of interest at all;
iii) if the above two contentions were wrong, the interest was disallowed under the anti-avoidance rule in ICTA 1988, s. 787.
iv) there was also the issue of whether the fees and expenses were deductible.
v) there was a question over whether the receipt of the 57 by the partnership was taxable (this was flagged but not considered).
The parties placed great emphasis on the request that the FTT make numerous finds of fact. Whilst the FTT did address the questions posed by both the appellants and HMRC in some cases it found the questions to be irrelevant and considered that the appeals depended entirely on legal issues and the application of those principles to some simple and undisputed facts.
The FTT found that:
1) there was a sham. It was false for the contract to suggest that Numology might itself conduct the research. If this false claim had been deleted in accordance with reality, so that Numology's obligation to the partnership was to sub-contract the research to BRC, it could not possibly have suggested that Numology was ever to pay more than 6 in order to procure the scientific research. As this false wording was the basis of the claim for vastly excessive capital allowances, that is why the FTT decided to strike it down as being a sham. The FTT also noted that it was possible that there was some element of sham in relation to the various fees paid.
2) on the quantum issue, assuming the partnership was trading (see below), allowances would have been limited to no more than 6 (as was found by the FTT, and upheld by the UT, in the Vaccine Research case). The FTT rejected the appellants' arguments that the cases of Barclays Mercantile Business Finance Ltd v Mawson (HMIT) TAX[2004] BTC 414 and R & C Commrs v Tower MCashback LLP 1 TAX[2011] BTC 294 supported their assertions that 96 was paid for the scientific research and instead applied the statutory provisions CAA 2001, s. 437 purposively and analysed the facts realistically and found it absolutely impossible to conclude that capital expenditure ha[d] been incurred on any scientific research in any amount in excess of 6.
3) on the...
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