Vaccine Research Ltd Partnership v Revenue and Customs Comrs
| Jurisdiction | UK Non-devolved |
| Judgment Date | 02 September 2014 |
| Neutral Citation | [2014] UKUT 389 (TCC) |
| Date | 02 September 2014 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
[2014] UKUT 0389 (TCC)
Upper Tribunal (Tax and Chancery Chamber)
Hon Mr Justice Sales and Judge Julian Ghosh QC
Jonathan Peacock QC and Jolyon Maugham (instructed by Berwin Leighton Paisner) appeared for the Appellants
Kevin Prosser QC and David Yates, and Zizhen Yang (instructed by the General Counsel and Solicitor to HM Revenue and Customs) appeared for the Respondents
Capital allowances - Expenditure on research and development - Capital Allowances Act 2001 ("CAA 2001"), Capital Allowances Act 2001 part 6Pt. 6 - Whether partnership trading - Quantum of expenditure incurred on research and development - Whether trade conducted on a commercial basis - Location of partnership's trade - Income tax relief for interest incurred on borrowings to fund partnership capital - Deductibility of fee incurred by partnership in consideration for services - Whether wholly and ordinarily incurred for the purpose of the partnership's trade.
The Upper Tribunal (UT) has dismissed a taxpayer partnership and partner's appeals and HMRC's cross-appeals against the decision of the First-tier Tribunal (FTT) in Partners of the Vaccine Research Ltd Partnership & AnorTAX[2013] TC 02491. In the UT's view all of the appeals and cross-appeals were complaints on findings of fact made by the FTT, and the UT found that each of these findings was sustainable and lawful. The outcome is that although a partnership set up for research and development purposes can claim loss relief in respect of research and development allowances, the loss relief is restricted to the expense incurred to finance the relevant research and development activities, thus reducing the allowable losses from the £193m claimed to £14m.
A biotechnology company (PepTcell) wished to secure working capital to finance research, development and patent application costs in respect of proposed research into the identification and development of vaccines. The founder of PepTcell arranged a funding scheme that reduced the level of risk to investors. The investors contributed £114m to a partnership, with £86m (75%) of the contribution from loans and £28m (25%) from other sources. The £86m contributed by the investors was paid to a company (Numology Ltd) which then reinvested the funds in the Partnership. The Partnership subcontracted its research and development to Numology Ltd, which in turn subcontracted the research and development to PepTcell for £14m. Numology Ltd agreed to pay guaranteed non-refundable licence fees to the Partnership, which enabled them to meet their loan obligations, and royalties of 10% of any sums received by it or subcontractors from the intellectual property. The £193m claimed to have been invested in the Partnership comprised: the investors' contribution of £114m, less £7m of fees (being £6.4m paid to Matrix Structured Finance LLP (Matrix), which helped develop and market the scheme and £0.6m of other fees); and the £86m reinvested by Numology Ltd.
HMRC denied the claim for loss relief on the basis that: the Partnership was not carrying on a trade in the UK; or the Partnership had not incurred expenditure qualifying for relief under CAA 2001, Capital Allowances Act 2001 section 437s. 437; or the partnership had not incurred expenditure deductible in computing the profits of a trade.
HMRC accepted that there was expenditure of £14m on relevant research and development, but did not accept that the claim could be made by the Partnership.
The Partnership and one of the individual partners (Mr Vaughan) appealed to the FTT. The FTT found that the scheme was not a sham. The FTT 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 (i.e. the £14m plus any allowable part of the fees and expenses) since it was an expenditure incurred on research and development. In respect of that amount, the taxpayers were engaged in trading activities and it was carried on in such a way that profits could be expected to arise within a reasonable time. 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 interest relief due to the individual partners under the Income and Corporation Taxes Act 1988 (ICTA 1988), Income and Corporation Taxes Act 1988 section 362s. 362(1)(b) was restricted to those borrowings attributable to the funding of the trading activity, i.e. the cost of funding and monitoring PepTcell's research and development. The fee paid to Matrix was found to relate to the whole scheme and could not be sub-divided, therefore the wholly and exclusively test in the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), Income Tax (Trading and Other Income) Act 2005 section 34 subsec-or-para 1s. 34(1)(a) was not satisfied and none of the fee was allowable.
The Partnership and Mr Vaughan appealed and HMRC cross-appealed to the UT, which dismissed all the appeals and cross-appeals. The issues addressed by the UT were:
(2) Whether the Partnership was trading at all (the trade issue);
(3) If the Partnership was trading, what was the quantum of the Partnership's "qualifying expenditure" (the quantum issue);
(4) If the Partnership was trading, was it being carried on on a commercial basis (the commercial basis issue);
(5) If the Partnership was trading, was it being carried on at least partly within the UK (the trade location issue);
(6) Whether interest payable on borrowings taken out by the partners for investment into the Partnership was eligible for income tax relief (the interest relief issue);
(7) Whether a fee paid by the Partnership, in consideration of certain services provided to the Partnership, was deductible from its trading profits.
The UT's view was that all of the appeals and cross-appeals were complaints on findings of fact made by the FTT, and could therefore only be disturbed if the findings were found to be perverse or founded on a misdirection, per Edwards (HMIT) v BairstowTAX(1955) 36 TC 207. Although the UT found that the FTT could have set out its decision more clearly and coherently the UT concluded that each of the FTTs findings of fact was sustainable and lawful.
With regard to the trade location issue the UT found the FTT's reasoning to be in error, but an immaterial error. The FTT should have focused on where the relevant activity of the Partnership which qualified as the carrying on of a trade was located, not on where the individual partners were located or where they carried on their affairs separately from the Partnership. Given that PepTcell carried out its research and development in the UK and it was the funding and monitoring of this research and development which constituted the Partnership's relevant trading activity, it must mean that this was at least partly carried on in the UK.
This is another decision that HMRC and the Government have been very keen to publicise as it is another win for HMRC in a tax avoidance scheme case. However, looking at the individual issues addressed in the case the taxpayer succeeded completely on three of the issues, partially on another issue and HMRC only succeeded completely on two of the issues. Although of course by HMRC succeeding in respect of the quantum issue, the scheme substantially failed in its aim to provide investors with considerable tax refunds to set off against other income.
[1]There are two Appellants in this case. The first Appellant is the Vaccine Research Limited Partnership ("the Partnership"). The second Appellant is Mr Lionel Patrick Vaughan. Mr Vaughan is one of the partners in the Partnership.
[2]The Partnership's appeal concerns the question whether the Partnership incurred "qualifying expenditure" within the meaning of Capital Allowances Act 2001 section 437section 437 of the Capital Allowances Act 2001 ("CAA 2001"), being expenditure "on" research and development which related to the Partnership's trade. This question raises the following issues:
(2) whether the Partnership was trading at all ("the trade issue");
(3) if the Partnership was indeed trading, what was the quantum of the Partnership's "qualifying expenditure" ("the quantum issue").
[3]So far as Mr Vaughan's appeal is concerned, a proportion (calculated by reference to the interest of the partner in the Partnership) of any "qualifying expenditure" incurred by the Partnership, to the extent that such qualifying expenditure gives rise to a trading loss for the Partnership, may be claimed as a loss against a partner's otherwise taxable income ("sideways loss relief": we discuss the relevant provisions below). To that extent, Mr Vaughan's appeal depends on the resolution of the trade issue and the expenditure issue. However, Mr Vaughan's sideways loss relief also depends on:
(2) the Partnership's trade, if any, having been carried on on a commercial basis ("the commercial basis issue") and
(3) the Partnership's trade, if any, having been carried on at least partly within the United Kingdom ("the trade location issue").
[4]This case also raises two further issues which are conceptually distinct from that of the Partnership's "qualifying expenditure" and any loss relief available to Mr Vaughan in relation to such "qualifying expenditure". The first of these further issues is whether interest payable on certain borrowings taken out by the partners, including Mr Vaughan, for investment into the Partnership was eligible for income tax relief ("the interest relief issue"). The second further issue is whether a fee paid by the Partnership, in consideration of certain services provided to the Partnership, was deductible from its trading...
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