Public authorities, distortion of competition and VAT
Owain Thomas KC
Protective assessments: a thing of the past?
Natasha Barnes
VAT a mess: Court of Appeal clears up CJEU’s decision in SKF, 14 years on Nicholas Jones
Corporation tax: when are professional advisory fees capital expenditure?
Matthew Donmall
“Unallowable purposes” in group loan relationships
Edward Waldegrave
Unicorns, ice-creams and the mis-selling of interest rate hedging products
Lance Baynham
Welcome
Sarabjit Singh KC Joint Head of Team
Welcome to the 1 Crown Office Row tax newsletter for 2024. Our tax team in Chambers has had an exceptional year, acting in a number of significant indirect and direct tax cases in a broad range of courts and tribunals. Our work has covered virtually every tax imaginable, including VAT, customs and excise duties, income tax, corporation tax, stamp duty land tax and non-domestic rates, to name but a few. Our expertise is reflected in our commentary in this newsletter on a few of the year’s most interesting tax cases, some of which our members themselves appeared in.
Our tax team currently consists of 26 members, ranging from silks down to tenants just out of pupillage, and so is able to offer expertise at every level of call. Given our varying levels of seniority, our team is able to act in cases worth billions of pounds that raise multiple issues of principle as well as in cases where the stakes are far lower but the case is just as important to the client.
Many of us now act mainly or exclusively for taxpayers but almost all of us have at least some experience acting for HMRC also We believe that it is always a good idea to have some insight into how one’s opponent may be thinking, and we find that our practical experience of seeing a case from both sides of the fence tends to lead to the best outcomes for our clients.
As well as acting in technical tax cases involving advisory work or advocacy in tax tribunals, we have continued to act in tax judicial review cases as well, bringing our public law expertise to bear in our tax cases. Our members have appeared in tax judicial review claims in the Administrative Court and beyond, which have raised classic public law matters such as legitimate expectation in a specifically tax context.
We hope you enjoy reading this newsletter, and we look forward to working with as many of you as possible in the near future.
Gideon Barth Editor
I am absolutely delighted to welcome you to this firstever edition of the 1 Crown Office Row Tax Newsletter. In this issue, we bring you a range of important insights and updates from across the tax team covering the ever-changing landscape of tax law. The newsletter covers a broad range of topics across the work we do, covering significant and interesting cases from 2024.
In the field of VAT, Owain Thomas KC covers how VAT applies to local authorities and how the concept of distortion of competition applies following the Court of Appeal decision in Northumbria, Natasha Barnes explores the validity of HMRC’s protective assessments and provides guidance on how those assessments may be challenged, and Nick Jones looks at the Court of Appeal’s decision in Hotel La Tour on the deductibility of input tax on services associated with a share sale.
On the topic of corporation tax, Matt Donmall addresses the Supreme Court’s recent decision in Centrica Overseas Holdings and Edward Waldegrave gives his take on the decision in JTI and the complexities of ‘unallowable purposes’ in group loan relationships. Finally, on income tax, Lance Baynham focuses on a recent decision on the income tax treatment of compensation payments for mis-sold financial products.
I hope this newsletter provides a useful insight into some of the most interesting developments this year, and even assists with some of the issues with which you and your team are grappling. It is also a great opportunity to get to know some of the members of our tax team who you have not yet worked with. We hope you enjoy reading through and I welcome your feedback and suggestions for future topics.
Public authorities, distortion of competition and VAT
Owain Thomas KC
Introduction
In Northumbria NHS Trust v HMRC [2024] EWCA Civ 177 the Court of Appeal clarified two important concepts in the application of VAT to public bodies. First, on what basis will public bodies not be considered as taxable persons for VAT purposes? And secondly, how should the concept of distortion of competition be applied?
The basic rule in VAT is that public authorities are not regarded as taxable persons where they perform activities “as public authorities” and so no VAT is charged on fees they earn from such activities unless this would lead to significant distortions of competition.
To make this latter concept easier to apply the legislation contains a list of activities which are always presumed to give rise to such distortions. The list of such activities comes from the PVD but is enshrined in domestic legislation by section 41A(2). Those areas are clear examples of where there are established markets in goods and services which would obviously be adversely affected by VAT free supplies being made by public bodies.
There are many scenarios outside this list where public bodies have a legal duty to do something or where they act under specific legal requirements but where the activities give rise to supplies of goods or services for consideration, such as car parking and leisure facilities.
Northumbria was a case about hospital parking. It was required by guidance issued by the Department of Health (DOH) and by its stakeholders to provide parking to visitors and patients at a reasonable price (with some free and reduced rates) and it actively managed the car parking by adjusting visiting and shift times. Most visitors to its hospitals arrived by car and the car parks were mostly unsuitable for general parking. The evidence was that most parking was for hospital purposes and that those were enough to fill the car parks. The car parking was operated at a small surplus.
The requirement for a “special legal regime”
In deciding whether a public authority is acting as such, what is determinative is the way in which the activities are carried on rather than the subject matter or purpose of the activity itself. The test is whether the public authority engages in activities under a “special legal regime”. The corollary is that public authorities do not act as such where they act under the “same legal conditions” as those which apply to private traders. All relevant national law conditions must be considered. It is therefore insufficient that the authority in question possesses public law powers if they do not have some impact on the activity in question. Some of the early parking cases concentrated on whether the activity involved the exercise of public powers but many private operators will exercise similar controls and restrictions but without a public law power/duty to do so.
In Northumbria the Court of Appeal clarified whether there was any requirement that the activity itself be closely related to the exercise of public powers. This has been held in many of the cases to be a feature of activities covered by this exception to the general rule that VAT applies to goods and services supplied in the course of economic activity. This point arose because car parking is not closely related to the provision of healthcare (although it undoubtedly supports it) and, moreover, the public responsibilities derived from DOH Guidance and policy documents are not hard legal requirements. However there were recommendations which bore on the way the Trust provided parking not only in terms of cost but also on discouraging general parking, not penalising the patient population and the priority to be given to staff.
The Court held that the activity was done under a special legal regime and, overruling the FTT and UT, the source of the special rules (i.e. being contained in Guidance) did not matter. If the effect of the public guidance (which the Trust had a public law duty to comply with) impinged on the way the activity was conducted in a way which did not apply to private operators then that was enough. The critical paragraphs are at 124 to 129 where the Court held that directions concerning access, reasonable charges and waiver of penalties would not apply to commercial operators. It is noteworthy then that the net is cast very wide in terms of identifying the applicable conditions under which a public body performs particular functions. The only limit expressly countenanced by the Court from the suite of policies and guidance documents that might apply was for
“self-authored” policies which might otherwise give rise to self-generated special legal regimes Such a scenario would give rise to potential abuse of the system.
Distortion of competition
The concept of distortion of competition appears in several places in the legislation on VAT and has caused numerous problems over the years in terms of understanding what is required to be demonstrated to show it exists (or does not) and how to go about that in the context of a given piece of litigation. Do you lead evidence? Do you need experts? Or is the whole exercise conceptual and/or built on inferences from the manner in which the public authority performs its activities.
The CJEU has provided limited guidance on the application of this concept but it is clear that the point of the caveat about distortion of competition is to ensure that private operators in fields other than the listed markets are not placed at a disadvantage by being taxed whereas public bodies are not. Potential or actual distortion is enough but the effects on the market must be more than negligible. The Courts have held that the question is to be assessed by reference to the activity as such and without reference to a particular local market and that this requires an assessment of economic circumstances which shows what the impact of nontaxation would be on private operators.
The Court overturned the FTT and UT on whether there was distortion of competition. The FTT had decided that there was. In reaching the opposite conclusion the Court held that the burden of proof was on HMRC to show that there was a significant distortion which would arise if the Trust’s car parks were VAT free. The key paragraphs are at 163-164. The critical point was that although the FTT had found that the Trust competed in a market for car parking with private operators it did not decide that prices would be lower if there were no VAT on the Trust’s supplies and there was evidence from national guidance to suggest that Trusts would be encouraged not to set prices so low that the car parks might be attractive to general users. Further the evidence showed that hospital car parks were full anyway (even with VAT on them) suggesting that price was not the driving factor for use.
This was a substantial reversal of the previous two tribunals, which, like Hotel la Tour, shows that VAT litigation is still capable of upsetting the form book.
The Court provided valuable guidance on the test to be applied to public authorities and to the assessment of distortion of competition.
Protective assessments: a thing of the past?
Natasha Barnes
One might expect the First-tier Tribunal’s decision in Go-City to be just another case in the long-running saga of multi-purpose vouchers. Or a handy reminder of the advantages of a sightseer credit package if one has friends visiting who are about to hop on an opentop bus to Big Ben. Instead, it unexpectedly raises an issue with potential wide-ranging ramifications for the way HMRC conducts VAT disputes. In short, in what circumstances can HMRC issue “protective assessments”?
The relevant legislation is set out in s. 73 Value Added Tax Act 1994 (VATA):
(1) Where a person has failed to make any returns required under this Act (or under any provision repealed by this Act) or to keep any documents and afford the facilities necessary to verify such returns or where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT due from him to the best of their judgment and notify it to him.’
(6) An assessment under subsection (1), (2) or (3) above of an amount of VAT due for any prescribed accounting period must be made within the time limits provided for in section 77 and shall not be made after the later of the following:
(a) 2 years after the end of the prescribed accounting period; or
(b) one year after evidence of facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge,
but (subject to that section) where further such evidence comes to the Commissioners knowledge after the making of an assessment under subsection (1), (2) or (3) above, another assessment may be
Go City Limited v HMRC [2024] UKFTT 00745 (TC)
Owain Thomas KC made under that subsection, in addition to any earlier assessment
In this case, there was no suggestion that the Appellant’s VAT returns were incomplete. The power to make the assessment therefore depended upon it “appear[ing] to the Commissioners that [a person’s] returns are incorrect” In the Tribunal’s view, the words “appears to the Commissioners” meant “forms the view” Accordingly, the power to assess is predicated upon the officer, responsible for issuing the assessment, first forming the view that the taxpayer’s VAT return was incorrect.
It is fair to say that the decision does not make happy reading for HMRC. The assessing officer maintained in oral evidence that she “had come to a view that tax had not been disclosed” by the time a Technical Advice Request (TAR) was sent to HMRC’s policy team. However, when the TAR was subsequently disclosed, it set out three possibilities for the proper characterisation of the relevant transaction One was the Appellant’s view, with the officer noting the case law “provides a seemingly solid basis” for that approach. An alternative “preferred approach” was also identified albeit the officer had doubts about its likelihood of success if challenged. The FTT found that the Officer’s evidence lacked credibility on this point.
HMRC’s technical lead also gave evidence, maintaining that he had decided before the first assessment was issued that the Appellant’s treatment was incorrect albeit that he had not written this down. His evidence was given equally short shrift with the Tribunal referring to Gestmin SGPS SA v Credit Suisse (UK) Ltd [2013] EWHC 3560, to the effect that “the best approach for a judge to adopt in the trial of a commercial case is, in my view, to place little if any reliance at all on witnesses’ recollections of what was said in meetings and conversations, and to base factual findings on inferences drawn from the documentary evidence and known or probable facts”
Overall, the Tribunal concluded that HMRC had not formed the view that the Appellant’s returns were wrong by the time either the first or second assessment were issued. The assessments were invalid on that basis. The Tribunal also drew a distinction between the facts of this case and a true ‘protective assessment’:
“189. When used in the case law, the term “protective assessment” refers to situations where HMRC are litigating a particular point, and to the extent that
other taxpayers are affected by the same issue, a “protective assessment” can be issued. By way of example, in Courts plc v C&E Commrs, [2004] EWCA Civ 1527 (“Courts”), assessments were raised because HMRC were litigating the same issue in the CJEU, see C & E Commrs v Primback Ltd (Case C34/99) Protective assessments were also issued during the long-running Rank litigation about betting terminals.
190. The First and Second Assessments were not “protective assessments”: they were not raised because HMRC had come to a view that the Appellant’s returns were incorrect, but the self-same issue was being litigated in another case. Instead, they were issued because the two year time limit for periods 03/19 and 06/19 was about to expire.”
We wait to see whether HMRC seeks to appeal the decision. Overall, what is clear is that we are likely to see a rise in challenges to the making of VAT assessments, along with increases in requests for associated disclosure. As things stand, any attempts by HMRC to extend time limits by issuing assessments that are not based on a clear view are likely to be doomed.
VAT a mess: Court of Appeal clears up CJEU’s decision in SKF, 14 years on
Nicholas Jones
In Hotel La Tour v HMRC [2024] EWCA Civ 564, the Court of Appeal was asked to determine whether the decision of the Court of Justice of the European Union (CJEU) in Skatteverket v AB SKF [2010] STC 419 (SKF), permitted the deduction of input tax incurred by the taxpayer in connection with the sale of shares in its managed subsidiary, Hotel La Tour Birmingham (HLTB). It decided that it did not, overturning the decisions of the First Tier Tribunal and Upper Tribunal. In doing so, Whipple LJ barely disguised her dissatisfaction with SKF, describing it as “not easy to understand”, and finding “irony” in the CJEU’s suggestion that it was providing a “helpful answer”
The facts
Hotel La Tour (HLT), a holding company, sold HLTB by way of a share sale, in order to raise funds to construct a new hotel in Milton Keynes. Whilst the sale
of shares is VAT-exempt, HLT sought to deduct the input tax it had paid on professional services, including marketing, legal and accounting fees, relating to the sale share.
The right to deduct post-BLP
This issue was decided long ago by the CJEU in BLP Group PLC v Customs and Excise Commissioners [1996] 1 WLR 174 and the cases that followed.
In BLP, it was held that input tax on services such as those incurred by HLT, which would ordinarily be deductible, could not be deducted where they were incurred in respect of an exempt transaction. The right to deduct arose where there is a “direct and immediate link” between the services on which input tax was paid, and a taxable transaction.
Subsequent cases had added further clarity to the effect that, as the Court of Appeal summarised:
“By inference based on [Midland Bank plc v Customs and Excise Commissioners [2000] 1 WLR 2080], input tax incurred on services connected with an exempt supply of shares but not having a direct and immediate link with that supply, may nonetheless have a direct and immediate link with the business as a whole and be recoverable to the extent that the overall business is taxable”; and
“Input tax incurred on services connected with a fund-raising transaction which falls outside the scope of VAT (either because it was a TOGC [transfer of a going concern] as in [Abbey National plc v Customs and Excise Commissioners [2001] 1 WLR 769] or because it was a share issue as in [Kretztechnik AG v Finanzamt Linz [2005] 1 WLR 3755]) may have a direct and immediate link with the business as a whole and be recoverable to the extent that the overall business is taxable.”
The decisions below and SKF
HLT successfully argued in the FTT and UT, however, that it could deduct the input tax it had incurred on the services, because the purpose of incurring those costs was related to fundraising in relation to its downstream activities (i.e., the construction of a new hotel). It argued that the cost of the services was not incorporated in the price of the shares sold.
Both parties were in agreement that a two-stage test applied as follows: first, ask whether the input services were used in making a specific supply to which they could be directly attributed, and second, if such attribution could not be identified, ask whether the inputs were part of the business’ general overheads attributable to downstream taxable outputs. HLT had managed to persuade the FTT and UT that even though the inputs were closely connected with the share sale, on the particular facts of this case the right to deduct arose anyway because of HLT’s relationship with HLTB: HLT argued that the share sale ought to be treated as “overheads having a direct and immediate link with the company’s general outputs”, which were therefore “deductible to the extent that the company makes taxable supplies”. HLT drew support for this argument from the SKF, in particular the section which the CJEU boldly described as “useful”:
The court has typically found a right to deduct VAT paid on input services, where those services were used for the purpose of financial transactions which were “directly attributable to the economic activities of the taxable persons”.
There was a risk that the principle of fiscal neutrality would be undermined if the right to deduct arose where the input services related to a transaction which is outside the scope of VAT on the ground that those costs constitute general costs of the taxable person, but did not arise where the services related to a disposal of shares which is “exempted because of involvement in the management of the company whose shares are sold”.
Therefore, based on the above, if input service costs “relating to disposals of shareholdings are considered to form part of the taxable person’s general costs in cases where the disposal itself is outside the scope of VAT, the same tax treatment must be allowed if the disposal is classified as an exempted transaction.” [68 in SKF].
These points, argued HLT, established that, apparently notwithstanding the two-stage test, the right to deduct arose where a share sale was undertaken to “increase the company’s capital for the benefit of the business overall”.
Corporation Tax
The Court of Appeal’s decision
Agreeing with HMRC’s appeal, the Court rejected HLT’s arguments. Ultimately, despite its apparent contradictions, the Court found that SKF did little more than reiterate the decision in BLP, albeit adding a certain gloss to the effect that “inputs could, in theory at least, be attributed to overheads if (and only if) there was no direct and immediate link established by way of direct attribution to the share sale”.
Owain Thomas KC
Corporation tax: when are professional advisory fees capital expenditure?
That was the question which the Supreme Court addressed in the recent decision in Centrica Overseas Holdings Ltd v HMRC [2024] UKSC 25.
The difficulty for HLT was that, as the Court of Appeal emphatically put it, the input services in question “were used in, were cost components of, were directly and immediately linked with, the exempt share sale”. There was therefore no need to even consider whether the inputs were part of the business’ general overheads attributable to downstream taxable outputs, which was the second element of the test. As HMRC successfully argued, the central error of the FTT and UT was that they wrongly merged the two stages, instead of considering them entirely separately.
Clarity at last?
It remains to be seen if HLT will appeal this decision further. Whilst the Court of Appeal was unanimous and clear in its decision, the ambiguities presented by SKF, in particular in respect of the role of fiscal neutrality, perhaps open the door to a final determination by the Supreme Court.
Until then, the decision brings clarity in that businesses ought to be in no doubt that the fundamental question remains that of whether a direct and immediate link is evident between input services and a taxable transaction.
Under s.1219 of the Corporation Tax Act 2009 (the CTA), expenses of management of a company’s investment business are allowed as a deduction, with the qualification under ss.1219(3) that “no deduction is allowed under this section for expenses of a capital nature” That legislative provision envisages management expenses which are not deductible as being expenses of a capital nature.
The Appellant, COHL, disposed of ‘Oxxio’ subsidiaries in March 2011. Between July 2009 and March 2011, COHL paid professional fees of some £2.5m in connection with that transaction for services ranging from considering how best to realise value from those businesses to advice on structuring and preparing the details of the final transaction (the Disputed Expenditure). HMRC did not allow the claim for relief. A preliminary question of whether the Disputed Expenditure was expenses of management was determined against HMRC. Before the Supreme Court, the residual question was whether it amounted to capital expenditure.
The test for expenditure of a capital nature is the same for investment business as for trading
Isabel McArdle represented HMRC in the Court of Appeal. She was not involved in the preparation of this article.
The Supreme Court agreed with the Court of Appeal that the test under s.1219 as regards investment business as to whether an item of expenditure is revenue or capital in nature is no different to that under s.53 of the CTA in respect of trading business. Lady Simler observed that the respective statutory formulations (“expenses of a capital nature” and “items of a capital nature”) must mean the same thing. The s.1219(3) exclusion was introduced in 2004, at a point when the concept of expenditure of a capital nature was already well-established in the tax code and Parliament can be taken to have been aware of that case law.
Nicholas Jones
Matthew Donmall
Corporation Tax
Importantly, in so finding, the Court rejected the argument of the taxpayer that at one level of abstraction all expenditure incurred by an investment business has a connection to a capital transaction because (by definition) the activity of an investment business is the making and holding of investments. Even if a holding company might attain or dispose of investments, this was not all it did. A holding company could be concerned with decisions in respect of the management of its companies, none of which were directed to buying or selling them.
The principles to be applied in determining whether expenditure is capital or revenue in nature
The applicable principles were therefore as had already been identified in “the many decided cases” as regards items of a capital nature for trading business. There is no single test or criterion and in borderline cases, differentiating between revenue and capital expenditure can be difficult. Lady Simler considered that in most cases the objective purpose for which the payment is made is likely to be an important indicator. In effect, she suggested that there was a rebuttable evidential presumption: “Where a capital asset (whether tangible or intangible) is obtained or can be identified, the starting point is to assume that money spent on the acquisition or disposal of the asset should be regarded as capital expenditure.” Conversely, where money is spent in a recurrent fashion on improving an asset, that may indicate it is expenditure on maintenance or upkeep of a revenue nature.
The principles applied to the facts of the case
The fact that the Disputed Expenditure were expenses of management did not determine the issue, as they are capable in principle of being revenue or capital. There was an identifiable asset –Oxxio – and having taken the decision to dispose of it, the Disputed Expenditure was incurred to achieve that disposal. The contracts of engagement with the professional service companies in question were relied on – for example, PwC’s letter of engagement stated its appointment in connection with “your proposed disposal of Oxxio” Further, uncertainty about whether the Oxxio business would in fact be sold did not make the expenditure revenue in nature.
n conclusion, the Supreme Court found that the law in respect of the costs of a capital nature is the same whether or not they are incurred by a trading
company or an investment company: either way, the critical question is whether the costs are incurred to assist in the disposal of an identifiable capital asset. Of course, while that question may be simply stated, its application on the facts may be anything but.
“Unallowable purposes” in group loan relationships
Edward Waldegrave
The Court of Appeal’s decision in JTI Acquisition Company (2011) Limited v. HMRC [2024] EWCA Civ. 652 is the latest word on the approach to be adopted in identifying whether a group subsidiary has an ‘unallowable purpose’ in entering into a loan relationship.
Facts
Joy Global Inc. (JGI) was the ultimate parent of a group which was headquartered in the US, and which manufactured mining machinery. In May 2011 JGI entered an agreement to acquire Le Tourneau Technologies Inc (LTT), a corporation based in Texas which also manufactured machinery. Although JGI was from this point committed to the acquisition of LTT the details of how the acquisition would be structured were not yet settled. There was no suggestion that the decision to acquire LTT was driven by anything other than wholly commercial considerations.
In June 2011 Deloitte made a proposal to JGI as to the structure which should be used for the acquisition of LTT. This proposal envisaged that a new UK company would be incorporated to acquire LTT. The UK company would be funded by a mixture of debt, equity, and ‘quasi-equity’ provided by a US subsidiary of JGI, known as JTI. The total acquisition price for LTT was to be $1.1 billion, and it was envisaged that JTI would lend the UK company $500 million of the amount required (with the remainder being funded as equity or quasi-equity).
Under Deloitte’s proposals, the UK company was expected to pay interest on the debt at a commercial rate. It was envisaged that this would result in a reduction of the Group’s UK corporation tax liability
Corporation Tax
Owain Thomas KC
of more than $6 million per annum. Other aspects of the planning (which involved entities which were disregarded for US tax purposes, and the relevant loan notes issued by the UK company ultimately being held by a Cayman Islands entity) meant that the interest paid by the UK company would not be taxable in any jurisdiction.
Pursuant to these proposals, the Appellant was incorporated as a subsidiary of JTI. Its board met on 20 June 2011. The board was provided with a letter from JTI, which asked that it consider whether to acquire LTT (and to borrow from JTI) by reference only to its own interests, and not to any broader benefits which the transaction might generate for the group. Notwithstanding this, the evidence given before the First-tier Tribunal (FTT) was to the effect that the directors (or some of them) were well aware of the tax benefits which the proposals were expected to generate for the broader group. The board agreed to proceed with the transactions. The Appellant issued loan notes to JTI and paid interest pursuant to those loan notes. It claimed debits under the loan relationship rules, and surrendered the resulting losses to other UK group companies which had profits. As identified above, the interest paid by the Appellant was not taxable in any jurisdiction.
Dispute with HMRC
HMRC took the view that the Appellant was not entitled to bring debits into account in respect of the relevant debt because it had an ‘unallowable purpose’ in terms of section 442 of the Corporation Tax Act 2009. Section 442 provides, in summary, that there is an ‘unallowable purpose’ where the purposes for which a company is a party to the relevant loan relationship include a ‘tax avoidance purpose’ as the (or a) main purpose for which the company is party to the relationship. In turn a ‘tax avoidance purpose’ is defined as “a purpose which consists of securing a tax advantage for the company or any other person”.
The Appellant appealed against HMRC’s decision. The FTT concluded that the Appellant had a main tax avoidance purpose in being party to the loan relationship. In large part this conclusion was founded on the FTT’s view that, in resolving to proceed with the relevant transactions, the Appellant’s board was simply agreeing to implement decisions which had been made elsewhere in the Group, and which clearly were driven by a desire to secure a reduction in UK tax liabilities. While the FTT accepted that there was an underlying commercial driver for the acquisition of
LTT, it concluded that the Appellant itself had no nontax advantage purpose in being party to the relevant loan relationship. The FTT therefore concluded that the entirety of the debits claimed by the Appellant were attributable to the tax avoidance purpose.
Matt Donmall
The Appellant appealed to the Upper Tribunal, which dismissed the appeal, and then to the Court of Appeal. It was argued that the FTT had wrongly asked itself why the Appellant was chosen to acquire LTT (which was accepted to be for tax reasons). Rather, it was submitted, the FTT should have focussed on the narrower question of why the Appellant borrowed the money, and the answer to that question was that it did so purely for commercial reasons. It was also submitted that, while the Appellant’s board may have known that the structuring would generate tax benefits for the Group, that did not mean that it had a purpose of securing a tax advantage.
Lord Justice Newey (with whom the rest of the Court of Appeal agreed) began his analysis by discussing what the FTT had decided. He concluded that the FTT had determined that the Appellant’s directors “went along with the scheme which, to their knowledge, the [G]roup had adopted for tax reasons” In this sense they were “seeking to fulfil the company’s role in a plan which those ‘at JGI level’ had decided on to secure a tax advantage” It followed from this that the Appellant had a main tax avoidance purpose.
Nicholas Jones
Newey LJ then went on to consider whether the Appellant also had a commercial purpose in being party to the loan relationship. On this point Newey LJ held that it had been open to the FTT to reach the conclusion it had as to the lack of a commercial purpose (although he noted that a differently constituted FTT might have formed a different view). Even if the Appellant did have a commercial purpose in being party to the loan relationship, no part of the debit would fall to be apportioned to that non-tax avoidance purpose. This was because, but for the existence of the tax avoidance scheme, there would have been no debit at all.
Comment
JTI is one of several cases which consider the application of the ‘unallowable purpose’ rules in the loan relationships legislation in circumstances in which (i) the underlying ‘deal’ is wholly commercial; but (ii) the transaction is structured in a particular way in order to try to obtain a tax advantage. The Court of Appeal’s decision makes clear that it is open to courts
Income Tax
and tribunals to conclude in such circumstances that there is a main tax avoidance purpose, and no nontax avoidance purpose. It also makes clear that, while the focus must be on the objectives of the specific entity in question, those purposes may be coloured by objectives set elsewhere in the corporate group. In particular, this will be the case where, as in JTI, it is found that the directors of the specific entity in question are seeking to fulfil their role in a plan developed in the wider group.
Unicorns, ice-creams and the mis-selling of interest rate hedging products
Lance Baynham
In Hackett v HMRC [2024] UKFTT 749 (TC), the Firsttier Tribunal (FTT) agreed with HMRC that compensation received for the mis-selling of interest rate hedging products (IRHPs) was chargeable to income tax. It also criticised – sometimes implicitly, sometimes explicitly – the approach taken by the Appellants in presenting their case.
Background
The Hacketts ran a property rental business. In 2006, they jointly purchased IRHPs from the bank. IRHPs “assist customers manage fluctuations in interest rates on loans taken”. For instance, they might allow a customer to fix the interest rate (a ‘swap’) or place a limit on any interest rate rises (a ‘cap’). The most complex products are ‘structured collars’.
The Hacketts paid over £1,000,000 for ‘structured collars’. From around 2010, it became clear that there were widespread issues with the mis-selling of IRHPs by banks. Complex products, such as ‘structured collars’, had been sold to ‘nonsophisticated customers’, such as the Hacketts. The FCA agreed a review process including compensation for the regulatory failings.
The bank decided that, but for the mis-selling of the complex ‘structured collars’, the Hacketts would have purchased ‘caps’. Thus, their redress was the difference between the payments made on the complex IRHP purchased, and those that would have been made on the simpler product.
The issue was the chargeability of the compensation payments to income tax. HMRC argued they were paid as compensation for the expenditure paid by the Hacketts after the mis-selling of the IRHP product, and so income. The Hacketts argued they were for the opportunity cost of being unable to enter into the simple caps, and so not income.
Judgment
The FTT considered the key case of London & Thames Haven Oil Wharves Ltd v Attwooll (Inspector of Taxes) [1967] Ch. 772, where damages had been recovered for a collision with the respondent’s jetty. In that case, Diplock LJ identified two key issues: first, identify what the compensation is paid for; second, decide whether the money in respect of which the sum has been paid would have been taxable as income if it had been received. The compensation received in that case represented the trading profits which the jetty owner would have made had they had use of their jetty, and so it was chargeable in the same way.
For the Hacketts, on the first issue, the FTT was “in no doubt” that the payments were “compensation for business expenditure that the Hacketts would not have otherwise incurred but for entering into the mis-sold IRHPs” The IRHPs were entered into as part of the property rental business. The compensation included a deduction to reflect the costs that would have been incurred as a result of purchasing an alternative product. The compensation was clearly not for the opportunity cost of not being able to purchase a simpler IRHP.
As to the second, the FTT held that the money, had it been received “would have been income in the Hacketts’ hands and chargeable to income tax”. This was clear from the fact that the Hacketts properly deducted the sums paid to the bank pursuant to the mis-sold IRHPs against their profits. The contrary “would result in the Hacketts receiving tax relief for the sums paid toward the mis-sold IRHPs but not being subject to any tax for sums received back to compensate them for the very same expenditures being made in the first place”. The compensation payments were treated in the same way as the products in respect of which the compensation was paid.
Income Tax
Comment
This is the third time that the question of the tax treatment of compensation payments for the misselling of IRHPs has reached the FTT, after Gadhavi v HMRC [2018] UKFTT 600 and Wilkinson v HMRC [2020] UKFTT 362, with the same answer given on each occasion. The answer appears to be settled.
Owain Thomas KC
It is also worth noting the FTT’s criticism of the approach taken by the Appellant’s representatives, who had also represented the taxpayers in Wilkinson and sought to intervene, through “a rather unusual application” in Gadhavi
First, the Appellants provided 58 pages of “full written submissions” rather than a skeleton argument. There was “nothing skeletal about them” and the FTT made clear that it “would have been quite entitled to refuse to receive the document”. Second, the FTT was unimpressed with the way the Appellants presented their case. Whilst HMRC “focussed on the tax treatment of the basic redress payments and interest by reference to statute and authority”, the Appellants sought “to apply economic, philosophical, mathematical, semantic, logic based and linguistic theory at the expense of the law”. These arguments operated to “obfuscate the facts of the case and the task of the Tribunal”
It is perhaps unsurprising that submissions made “by reference to statute and authority” are likely to be preferred to those made “at the expense of the law” Nonetheless, the case is a useful reminder that it is far more effective to provide a simple analysis of a complex issue, than to over-complicate the already complicated. The apples, pears, unicorns and icecreams, which the Appellant relied on to rally to their cause, were unable to change that equation.
Our clerks are always happy to discuss any of our barristers’ practices or to help arrange conferences and hearings.
They are available on: 020 7797 7500 Or by email on: London@1cor.com
Highlights for our tax team over the last 12 months
Chambers welcomes Laura Inglis Laura joins us from a specialist tax chambers and has a broad practice spanning all areas of UK tax and commercial law. She was shortlisted for Tax Junior of the Year at the Legal 500 Bar Awards 2024. Read more about her practice here.
Edward Waldegrave appeared in the Supreme Court in the case of R (on the application of Cobalt Data Centre 2 LLP) v. HMRC, concerning the construction of capital allowances legislation.
Paul Reynolds appeared in the Upper Tribunal in the appeal against a decision of the valuation tribunal for England between Kevin Prosser KC and Andrew Ricketts, concerning business rates.
Edward Waldegrave appeared in the First-tier Tribunal in the case of Barclays Service Corporation v. HMRC [2024] UKFTT 785 (TC), concerning VAT grouping.
Isabel McArdle appeared in the Court of Appeal in the case of HMRC v Hotel La Tour Ltd [2024] EWCA Civ 564, concerning Input Tax.
Amy Mannion appeared in the Supreme Court in Jersey Choice Ltd v His Majesty’s Treasury, a Francovich damages claim, concerning the lawfulness of the UK removing low value consignment VAT relief from goods sold by mail order from the Channel Islands.
Matthew Donmall appeared in the Upper Tribunal in Hippodrome Casino [2024] UKUT 27 (TCC) about partial exemption, and CCLA Investment Management [2024] UKFTT 636 (TC) concerning the exemption for the management of special investment funds.
Gideon Barth appeared in Nexans Norway v HMRC [2024] UKFTT 782 (TC), a customs classification case.
