Partners of the Vaccine Research Ltd Partnership and Anor
| Jurisdiction | UK Non-devolved |
| Judgment Date | 27 December 2012 |
| Neutral Citation | [2013] UKFTT 73 (TC) |
| Date | 27 December 2012 |
| Court | First Tier Tribunal (Tax Chamber) |
[2013] UKFTT 073 (TC)
Judge David Williams, Ms S O'Neill
Jonathan Peacock QC and Joylon Maughan of counsel, instructed by Berwin Leighton Paisner LLP appeared for the Appellants
Kevin Prosser QC, David Yates and Zizhen Yang of counsel instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the Respondents
Capital allowances - research and development allowances for expenditure on vaccine research and development - claim by partners of limited partnership - whether arrangements a sham - whether partnership trading - whether partners entitled to loan interest
The First-tier Tribunal decided that a funding scheme wherein a third-party company agreed, as a subcontractor to a partnership's contractor, to undertake scientific research into the identification and preparation of certain vaccines, was not a sham. The allegation of fraud was not made good by HMRC. Moreover, considerable effort was spent in setting up the scheme. The Tribunal also decided that the taxpayer partners were entitled to loss relief under the Income and Corporation Taxes Act 1988 ("ICTA 1988"), Income and Corporation Taxes Act 1988 section 381s. 381, but only in respect of the amount paid by the taxpayer partners to the subcontractor since it was an expenditure incurred on research and development. In respect of that amount, the taxpayers were engaged in trading activities and was carried on in such a way that profits could be expected to arise within a reasonable time. Finally, as all the taxpayers were UK residents for income tax purposes, their trading activities in relation to their investment took place at least in part in the UK.
The taxpayer partners appealed against HMRC's decision denying their claim for loss relief in respect of research and development capital allowances incurred in the 2006-07 income tax year. The total amount claimed by the taxpayers was about £193 million.
A biotechnology company ("PTL") wished to secure working capital to finance research, development and application costs in respect of proposed research into the identification and development of vaccines. The founder of PTL arranged a funding scheme that reduced the level of risk to investors.
On 15 August 2006, a partnership was established by a limited partnership agreement between the general partner ("MRD") and a class A limited partner ("NL"). The class B limited partners became parties to that agreement by adherence agreements made on the same day. They were required to pay their capital contributions on 17 August 2006. That was done as to 75 per cent by drawdown of loan facilities arranged by each class B limited partner with a bank ("BOS"). The balance was provided by the class B limited partners by other means.
On 17 August 2006, the partnership entered into a research agreement with NL. Under that agreement, NL agreed to undertake research and development, or to arrange for it to be undertaken for the partnership. NL agreed a research subcontract with PTL to undertake research and development of vaccines. Under that subcontract, NL paid the sum of £14 million to PTL. PTL assigned the benefit of four identified patent applications and inventions to NL pursuant to that agreement. NL then assigned by deed the benefit of the same identified patent applications and inventions to the partnership.
On the same day, the partnership and NL concluded a licence agreement. Under that agreement, the partnership granted licences to NL for up to 70 years to use or deal with any products incorporating or based on any of the patents or other intellectual property arising from the vaccine research. In consideration, NL agreed to pay guaranteed non-refundable licence fees to the partnership consisting of specific sums to be paid annually in respect of the following 15 years. It also agreed to pay royalties of ten per cent of any sums received by it or subcontractors from the intellectual property. NL agreed to guarantee the licence fees by delivering a letter of credit in a scheduled form to the partnership. A letter of credit in that form was provided by another bank ("RBS") and then delivered that day.
Also on the same day, an agreement and deed between the partnership, NL and PTL assigned the benefit and burden of the relevant licence agreement to PTL, save for the obligation to pay the guaranteed licence fees.
On 16 November 2009, HMRC issued a closure notice to the partnership. The notice concluded that the partnership was not carrying on a trade in the UK. Alternatively, the partnership had not incurred expenditure qualifying for relief under the Capital Allowances Act 2001, Capital Allowances Act 2001 section 437s. 437. Alternatively, the partnership had not incurred expenditure deductible in computing the profits of a trade. As a result, the loss figure in the return was reduced to £0.
HMRC accepted that there was expenditure of £14 million on relevant research and development, but did not accept that the claim could be made by the partnership. They contended that since the scheme, or essential parts of it, was a sham, the partnership was not engaged in a trade. If it was not, then it was nonetheless not a trade. If the partnership was engaged in a trade, the trade did not take place in the UK.
(2) Whether the scheme was a sham so that the taxpayers were not engaged in trading activities.
(3) Whether the taxpayers were entitled to loss relief in respect of research and development capital allowances incurred during the relevant income tax year.
(4) Whether the partnership was engaged in a trade and if so, whether the trade took place in the UK.
Held, allowing the taxpayers' appeals in part:
The Tribunal held that the scheme was not a sham. The allegation of fraud was not made good in this case. It was not established solely because, as HMRC alleged separately, the total funds were not spent on research and development, or because the scheme could be categorised as artificial. There should be fraud proven to the relevant level. Furthermore, considerable effort was spent in setting up the scheme, with trouble being taken to create and insert the relevant companies, agreements and deeds into the scheme as planned. The companies were established; the deeds and agreements were concluded; the money was passed through accounts as stated.
The Tribunal also held that the sums paid for the guaranteed licence fees were obligations agreed as part of the scheme, but separate from payment of £14 million to secure research and development of the intended kind. The only source of funds for the payment deposited with RBS to obtain the letter of credit to guarantee the licence fees was the flow of funds from the capital contributions of the class B limited partners. The only amount that could be regarded as incurred on research and development was the £14 million paid to PTL together with any allowable part of the fees and expenses.
In respect of the £14 million paid to PTL, there was a stronger argument that there were trading activities. Enquiries were made by class B limited partners and by agents employed by the partnership to monitor the activities of PTL. To that extent, the class B limited partners were engaged in trading activities.
Under ICTA 1988, Income and Corporation Taxes Act 1988 section 381 subsec-or-para 4s. 381(4), loss relief shall not be available unless the trade was carried on throughout that period on a commercial basis and in such a way that profits of the trade could reasonably be expected to be realised in that period or within a reasonable time thereafter. Here, the Tribunal held that the activities linked to the £14 million paid to PTL were incurred on a commercial basis in such a way that profits could be expected to arise within a reasonable time. The accounts of the partnership showed that the class B limited partners all incurred losses in the year in which the expenditure was incurred. Indeed, that was an inherent part of the scheme. Accordingly, it was reasonable for a profit to be expected from that investment within the scope of the test under ICTA 1988, Income and Corporation Taxes Act 1988 section 381s. 381.
Finally, the Tribunal held that it was not disputed that all the class B limited partners were UK residents for income tax purposes. That, again, was an element in establishing the scheme. The test was whether the activities were wholly outside the UK. That being so, in so far as the individual partners were engaged in trading activities in relation to their investment to the extent that they were paid to PTL, those activities took place at least in part in the UK.
1.The central issue in these appeals is whether the Appellants, the partners of the Vaccine Research Limited Partnership (The Partnership), are entitled to loss relief in respect of research and development capital allowances incurred in the 2006-2007 income tax year. The total claimed for the Appellants is about £193 million. The Respondents (HMRC) accept that there was expenditure of £14 million on relevant research and development but did not accept that the claim could be made by The Partnership. We also considered whether it might be some sum in between those contentions.
2.Formally, we had two appeals before us: one in the name of The Partnership and the other in the name of one of the limited partners (a Class B Limited Partner). It was agreed and directed that the two appeals be heard together although some of the issues raised for Mr Vaughan do not apply to The Partnership as whole. It was put to the tribunal at the hearing that he was a representative partner. No separate evidence or submissions were offered by or for the individual partner, who was represented before us by the same counsel as The Partnership, save on the issues relevant only to him. Nor was any point taken by either party about procedural aspects of these appeals...
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