Thomson and Others
| Jurisdiction | UK Non-devolved |
| Judgment Date | 16 July 2018 |
| Neutral Citation | [2018] UKFTT 396 (TC) |
| Date | 16 July 2018 |
| Court | First Tier Tribunal (Tax Chamber) |
[2018] UKFTT 0396 (TC)
Judge Jonathan Richards, Elizabeth Bridge
Alison Graham-Wells, instructed by Montpelier Tax Consultants Limited appeared for the appellants
Sadiya Choudhury, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Income tax – Loss relief – Whether appellants carrying on a trade – No – Whether any trade carried on on a commercial basis with a view to profit – No – Whether loss calculated in accordance with generally accepted accounting practice – No – Whether appellants liable to penalties – Yes – Whether penalties correctly calculated – No – Mr Mungavin's and Mr Worsfold's penalties reduced.
The First-tier Tribunal found that the conditions required to claim trade loss relief were not met, but considered that the penalties ascribed to two of the three appellants should be reduced.
All three appellants entered into a financial contract described as a contract for differences (CFD) with Pendulum Investment Corporation, a company incorporated in the Seychelles (a Pendulum CFD). The appellants had been made aware of the Pendulum CFD following discussions with companies in the Montpelier Group. The appellants contended that they entered into their Pendulum CFD in the course of a trade of dealing in derivatives and that the CFD resulted in them making a loss that could be set against their other taxable income.
All three appellants had started to buy and sell CFDs on online trading platforms a few months before they entered into their Pendulum CFD.
The Pendulum CFD had five potential phases. At the start of the Phase One, the appellant would have to pay their initial margin to Pendulum. If the CFD resulted in a profit or success at the end of Phase One, the appellant would have the potential to realise funds. None of the three appellants achieved success and therefore moved into Phase Two. HMRC were aware of 222 instances of taxpayers entering into similar Pendulum CFDs and only 23 contracts resulted in success at Phase One. In all of those 23 cases, instead of taking the proceeds, the taxpayers immediately reinvested in a further Pendulum CFD.
On moving to Phase Two, the appellants had to fund the balance of the designated issue value and all three appellants entered into loan arrangements with Bayridge Investments LLC to fund that balance. The loans were interest free and only repayable together with a fee on success at Phases Two to Five and repayable on a limited numbers of default events (not including death). If the loan had not been repaid at the end of Phase Five (which ended 25 years after the commencement of the Pendulum CFD), the loan would continue interest free for a further 25 years.
The Montpelier group of companies was headed by Montpelier Group LLC. Bayridge Investments LLC was a subsidiary of Montpelier Group LLC.
Mr Gittins was a controlling shareholder of Montpelier Group LLC. The shares in Pendulum were initially owned by a Mr Michael Darwyne. Mr Darwyne agreed with Mr Gittins that, if Pendulum was successful, he would give Mr Gittins the first chance to buy the shares in Pendulum from him. In September 2005, Mr Gittins bought the Pendulum shares. Although Pendulum was not a member of the Montpelier group, from September 2005 Mr Gittins had control of both.
Pendulum made a repurchase offer to the appellants in respect of the CFDs quoting a repurchase price at the last day of the relevant tax year (which was significantly lower than the designated issue value). The appellants claimed a tax loss relating to the difference between the designated issue value and the amount of the repurchase offer. However, the appellants had not suffered an economic loss of this amount as 95% of the designated issue value had been funded by the loan from Bayridge Investments LLC.
HMRC refused the appellants' claims for loss relief as they did not consider that the appellants were carrying on a trade on a commercial basis with a view to profit. HMRC also charged the appellants penalties for negligent completion of their tax returns for the tax years in question.
For each appellant, the Tribunal considered:
- Whether they were carrying on a trade in dealing in CFDs in the relevant tax years;
- If they were trading, whether that trade was carried on on a commercial basis;
- If they were trading on a commercial basis, whether they satisfied the profits limb of ICTA 1988, s. 384 (Mr Worsfold and Mr Mungavin) or the profits limb of ICTA 1988, s. 381 for losses in early years of trade (Mr Thomson);
- Whether the Pendulum CFD was entered into in the course of a trade;
- Whether the loss claimed on the Pendulum CFD was calculated in accordance with GAAP; and
- Whether they were liable to a penalty for negligently delivering a tax return.
For the first appellant, the Tribunal observed that they had neither the time, nor the expertise to carry on a trade of dealing in CFDs and that the transactions that he effected lacked the hallmarks of trading transactions. Rather than being motivated by profit, the appellant's motivation was the desire to obtain a tax loss from the Pendulum CFD and the attempt to establish a trade of dealing in CFDs online was a stepping stone towards that desired result. The Tribunal also concluded that the Pendulum CFD was not a one-off adventure in the nature of trade.
The Tribunal reached the same conclusion for the second appellant. Although the second appellant's CFD activities were off a greater scale, the Tribunal considered that the appellant exhibited no more rigour in entering the transactions and the appellant was engaged in pure speculation which is different to trading.
The third appellant's online CFD activities had the greatest scale and he took real risk demonstrated by some significant losses. Despite this, the Tribunal drew the same conclusions concerning the way in which the activities were conducted and the primary motivation (i.e. securing a tax loss on the Pendulum CFD).
Therefore, the Tribunal concluded that none of the appellants were carrying on a trade in dealing in CFDs.
For the first appellant, the Tribunal concluded that even if they were carrying on a trade, they did not carry it on on a commercial basis as someone “seriously interested in profit” would not engage in derivatives trading with such limited expertise in the area and as a side-line to their accounting practice. The research that the appellant carried out was not different to that of a private investor. The activities also lacked the scale necessary to be run on a commercial basis.
For the second and third appellants, the Tribunal again acknowledged that the scale of transactions were greater but considered that the transactions were not carried out in the way that a person “seriously interested in profit” would undertake them.
For the purposes of ICTA 1988, s. 384(1), “with a view to the realisation of profits” is a subjective test looking at the intentions of the taxpayer. The Tribunal did not consider this test could be met for the first appellant given that the primary motivation was the generation of a loss from the Pendulum CFD.
The Tribunal went on to consider whether the activities could offer a “reasonable expectation of profit” (ICTA 1988, s. 384(9)). It concluded that as the Pendulum CFD dwarfed the online CFD transactions and Pendulum had not hedged its risk that investors might make a profit, there was no reasonable prospect of the transactions as a whole making a profit. This conclusion also applied for the purposes of ICTA 1988, s. 381(4).
Only ICTA 1988, s. 384 was relevant to the second and third appellants.
Once again, the Tribunal noted that the second appellant was motivated by the tax loss on the Pendulum CFD rather than making a commercial profit. It also concluded that similar to the first appellant, there could have been no reasonable expectation that the CFD transactions would produce a profit over a particular period.
For the third appellant, the Tribunal added that the fact that he made such a large loss on his online CFD dealings pointed firmly against the conclusion of a reasonable prospect of making a profit. Furthermore, the third appellant did not claim to have performed an evaluation of the prospects of the Pendulum CFD making a profit.
The Tribunal recorded its view that if the first appellant had been carrying on a trade (consisting of dealing in CFDs online), the Pendulum CFD was not carried on in the course of the trade as the CFD did not have the hallmarks of trading and had a very different economic profile to the CFDs bought and sold online.
HMRC had submitted that even if the appellants had suffered a trading loss, the loss had not been calculated in accordance with UK GAAP. Conflicting evidence concerning the accounting treatment was submitted by the parties. The Tribunal did not have to make a decision on this issue to determine the appeal, but did comment that it considered that HMRC's view was more likely to be correct.
For the first appellant, the Tribunal agreed with HMRC's assessment of penalties.
The Tribunal concluded that that the penalty should be reduced for the second and third appellants based on the seriousness of the appellants' behaviour.
All appeals against HMRC's closure notices were dismissed. Penalties for the second and third appellants were ordered to be recalculated at 40% instead of 55%.
The Tribunal considered that the primary motivation of the taxpayers in this case was to secure a trading loss from the Pendulum CFD.
While all three appellants' undertook online activities in dealing in CFDs, the Tribunal concluded that these activities did not meet the requisite characteristics of being a trade.
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