Daarasp LLP; Betex LLP

JurisdictionUK Non-devolved
Judgment Date13 September 2018
Neutral Citation[2018] UKFTT 548 (TC)
Date13 September 2018
CourtFirst Tier Tribunal (Tax Chamber)

[2018] UKFTT 0548 (TC)

Judge Rachel Short, Mr John Adrain (Member)

Daarasp LLP; Betex LLP

Mr Andrew Thornhill QC and Mr Ben Elliott of Pump Court Tax Chambers appeared for the appellants

Ms Aparna Nathan, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents

Capital allowances – LLPs – Expenditure on software licences – Ambit of closure notices – Trading – Incurring of expenditure – LLP as small enterprise – Long-life assets – Anti-avoidance rules – Main object of LLP.

The First-tier Tribunal rejected the appellants' appeals against the reduction of their losses to nil primarily on the basis that the LLPs were not trading and were therefore not carrying on a qualifying activity in order to claim capital allowances.

Summary

The appeals were against a closure notices amending the loss figures contained in partnership returns. For the first appellant, the loss was amended from £18,192,004 to nil for the 2003–04 tax year. For the second appellant, the loss was amended from £25,482,181 to nil for the 2005–06 tax year. The main issue for both appellants was whether they were entitled to capital allowances under CAA 2001, s. 45 for payments to acquire software licences.

Although structured slightly differently, the transactions of both appellant LLPs involved acquiring software licences. The licences were first created between the businesses that had developed the software and another company (the software company) and then the appellants acquired the licences from the software company. The appellants had many investing members who were lent sums by a bank to make the investments and there were various arrangements in place to guarantee the lending and also to provide secondary loans to repay the original bank lending. Options arrangements were in place for the original developers to reacquire the software licences. Both appellants had the same managing member and that person was also involved in various other capacities in the arrangements.

Both appellants claimed capital allowances for ICT expenditure incurred by small enterprises under CAA 2001, s. 45, resulting in tax losses for their first period.

The following points were considered by the First-tier Tribunal:

  • the issues that could properly be considered as under appeal taking account of the terms of the closure notices issued to the appellants;
  • whether either appellant carried on a trade at the time when qualifying expenditure on information and communications technology was incurred;
  • even if the appellants were trading, whether the expenditure which they claimed to have incurred on the software licences can properly be treated as incurred on those licences, taking account of the way in which the software licences were valued and the way in which the expenditure was financed;
  • whether the expenditure incurred was incurred by a small enterprise under CAA 2001, s. 45(1)(b);
  • whether the expenditure on the software licence by the first appellant was long-life asset expenditure under CAA 2001, s. 44(2);
  • whether the anti-avoidance rule at CAA 2001, s. 215 was applicable to the transactions.
The issues that could be considered as under appeal

The closure notices for both appellants did not state the reasons why the losses may not be allowable. They simply stated, “of the losses claimed, only a currently unquantifiable part may be allowable”. The appellants argued that the only issues under appeal were the value of the software licences and the functionality of the software. The appellants considered that any arguments that would result in the complete denial of capital allowances were outside the scope of the appeal given that the closure notices referred to disallowing an “unquantifiable part”, and not all, of the capital allowances claimed.

Both the appellants and HMRC relied upon Tower MCashback v R & C Commrs [2011] BTC 294; [2010] BTC 154; [2008] BTC 805 in support of their views.

The FTT accepted that the “knock-out” points were under appeal and open to the Tribunal to consider. The FTT observed that while the closure notice itself did not identify the full scope of the points in issue, relying on Tower MCashback, the Tribunal is allowed to look back further than the face of the closure notice and in its view, there was sufficient evidence in the notices of enquiry to indicate that HMRC were considering a range of reasons why the capital allowance claims may be disallowed in whole or in part.

Whether the appellants were trading

First year allowances are only available where a qualifying activity was being carried on (CAA 2001, s. 11) and the burden of proof was on the appellants to demonstrate that they carried on a trade. The view of the FTT was that the appellants had to demonstrate that they were carrying on a trade at the time when the expenditure was incurred.

For the first appellant, the question of whether they were trading included considering whether the transactions which it said it undertook in the relevant period did in fact take place. For both appellants the question included asking if a trade was carried on at the time when, or during the accounting period when, the qualifying expenditure was incurred and whether activities were carried on on a commercial basis, by reference to the profits made in the relevant and subsequent accounting periods and the way in which the business was marketed and managed.

The first appellant owned no assets and carried out no significant activities prior to its acquisition of the software licence on 26 March 2004. The various agreements that it entered into on or around the acquisition of the software licence effectively ensured that all of its core activities were outsourced. The Tribunal made a finding of fact that at the time that the software licence was acquired, the software was capable only of very restricted functionality. In its first accounting period from 17 February 2004 to 4 April 2004, the LLP generated income of £3,619 compared to expenditure on the software licence of over £18m. The FTT was shown evidence of trades that were supposedly carried out in New York using the software, but these were in May 2004 after the end of the first accounting period and there was nothing to associate these trades with the software. The only other income was warranty payments under the software licence as the software had not generated the warranted income. The FTT considered that the source of the warranty payments was the deed of agreement rather than the trading activities of the first appellant and that the warranty payments should not be taken account of when analysing the appellant's trading income. The FTT also had misgivings about accepting that this was typical of a start up as there was significant doubt that the software licence on which the appellant was relying to generate profits was a viable asset and even when considering later periods, the majority of income came from warranty payments with sales being just £9,433.

The appellant's argued that the question of whether a trade was being carried on commercially with a view to profit is not a specific test for capital allowances (it is relevant to sideways loss relief). However, the Tribunal considered that it still had an obligation to consider the commercial framework of the business. The Tribunal observed that most of those involved with the first appellant seemed to distance themselves from any decision making processes and did not question the profitability of the software licence. The Tribunal also considered whether the first appellant could be carrying on its trading activities through other parties, but concluded that it was not. The Tribunal reviewed the “badges of trade” as set out in the case of Marson v Morton [1986] BTC 377 and concluded that the first appellant was not carrying on trading activities.

As a result, the FTT decided that the first appellant was not carrying on a trade throughout its first accounting period from 17 February 2004 until 5 April 2004 and specifically not on 26 March 2004 when the expenditure was incurred on the software licence. For completeness, the FTT also concluded that it was not trading in the subsequent period from 6 April 2004 to 5 April 2005.

The analysis for the second appellant was more promising as the software it acquired under licence was operational in late 2005. Despite this, the FTT concluded that the activities of the second appellant did not amount to trading activities at the times when the expenditure was incurred (4 November 2005 and 20 March 2006) and during the accounting period from 19 February 2005 until 5 April 2006. This was for similar reasons as for the first appellant, namely that:

  • the majority of the income was generated from warranty payments;
  • the commercial framework for the operations was thin bearing in mind the value of the asset acquired;
  • the LLP could not be treated as undertaking trading activities through third parties;
  • it did not have a trading strategy; and
  • its activities did not satisfy the badges of trade.

The FTT also concluded that the second appellant could not be treated as trading in its subsequent accounting period from 6 April 2006 to 5 April 2007.

The amount of expenditure incurred on the assets for which capital allowances are claimed

This point was considered in the event that the FTT had reached the wrong conclusion about whether the appellants were carrying on a trade. The Tribunal reviewed a number of factors including the reality of the expenditure, the reality of the purpose of the expenditure, the value of the software licences, the funding structure, the initial consideration, the remaining consideration and the option agreements. It decided that the amount of the expenditure incurred would be limited to the £1.4 million and £1.641 million paid by the software companies to the original developers and not the higher amounts paid by the appellants to the software companies.

Was the expenditure...

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1 cases
  • Daarasp LLP; Betex LLP v R & C Commissioners
    • United Kingdom
    • Upper Tribunal (Tax and Chancery Chamber)
    • 13 April 2021
    ...as under appeal. Summary Daarasp LLP and Betex LLP (the appellants) appealed against the decision of the FTT (Daarasp LLP; Betex LLP [2018] TC 06718) that it had jurisdiction to consider the so-called “knock-out” points. The appellants had incurred losses relating to capital allowances in r......

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