Tax Journal continues its quarterly review of tax cases, with a look back at the cases that matter most, reported from April to June 2015.
In Samarkand Film Partnership No. 3, Proteus Film Partnership and three partners v HMRC [2015] UKUT 211 (29 April), the UT found that the partners were not entitled to loss relief and that they had not had a legitimate expectation that the relief would be available.
The issue was whether two partnerships, which had acquired and leased films under sale and leaseback arrangements, were entitled to loss relief in respect of losses which arose on the acquisition of the films. If so, their partners could claim sideways relief under ICTA 1988 ss 380 and 381 to set the losses against their taxable income from other sources.
The purchase of an asset which a person intends to exploit over a period of time is normally treated as capital expenditure. However, ITTOIA 2005 s 134 provides that in the case of a film, the expenditure should be regarded as revenue in nature. Furthermore, ss 138 and 140 allow loss relief to be claimed in advance of the normal rules. Relief is not available, though, if the expenses are not incurred wholly and exclusively for the purposes of a trade or if the losses are not connected with or arising out of a trade.
The UT found that the FTT had been entitled to conclude that the partnerships had not been carrying on a trade, so that no loss relief was available to the partners. This was so, even though a transaction of that type could have constituted a trade. In particular, it accepted the FTT’s factual finding that the commercial nature of the agreements was ‘the payment of a lump sum in return for a series of fixed payments over 15 years’.
No further arguments were required following the release of the Court of Appeal’s decision in Eclipse Film Partners [2015] EWCA Civ 95, which recommended a ‘realistic approach to the transaction’. The UT added that even if the partnerships had been conducting a trade, they would not have been doing so on a commercial basis, as the transactions were intended to produce a loss in net present value terms. This analysis was not affected by the fact that the individual partners were accruing ‘extra benefits’ as a result of the tax reliefs. Those reliefs were obtained by ‘deliberately causing the partnership to trade in an uncommercial manner’.
The two judges disagreed as to whether, in any event, one of the partnerships had incurred the expenditure for the acquisition of a film (as opposed to that of an income stream). The president exercised its casting vote on this issue, finding that the partnership had incurred the expenditure for the purchase of a film. This was because it had acted bona fide in the belief that it was acquiring valuable rights.
The taxpayers also claimed judicial review on the ground that HMRC’s denial of relief was at odds with its own published guidance in HMRC’s Business Income Manual (BIM). The UT pointed out that unlike IR20, which was aimed to give taxpayers guidance on residence, the BIM was intended for the use of HMRC staff – although it was made available to the public. The UT observed that the BIM stressed in several places that the relief was aimed at tax deferral only.
Furthermore, the BIM included clear statements that transactions involving tax avoidance would be closely scrutinised and that the guidance may not be applied to them. The argument that this statement suggested that HMRC reserved the right to treat similar transactions differently was robustly rejected. ‘Taxpayers may not like that statement but they could not say that they derived a legitimate expectation that was at odds with it.’ Finally, the UT found that HMRC had reasonably thought that tax avoidance was at play. Several features indicated that the aim of the transactions was not tax deferment but tax avoidance.
Why it matters: The appeal failed on both the ‘trading issue’ and the legitimate expectation issue. On the trading issue, the UT simply reiterated the points made by the FTT on the basis of its factual findings. On the legitimate expectation issue, the taxpayers could not rely on HMRC’s description of a plain vanilla transaction (claiming that their arrangements were similar) and ignore the general statement about tax avoidance. They could not ‘take out the plums they liked and ignore the duff they did not’.
Tax Journal coverage: ‘The decision in Samarkand serves as a timely reminder to taxpayers of the extent to which they can rely on HMRC’s manuals. The decision highlights that no matter how clear or unqualified a statement in HMRC’s manuals might appear to be, it will be open for HMRC to depart from that guidance if it considers that tax avoidance is or may be involved, leaving the taxpayer in question with an uphill struggle to prove that it has a substantive legitimate expectation that should be protected.’ See the article ‘Samarkand: illegitimate expectations?’ (Jeanette Zaman & Owen Williams) Tax Journal, 22 May 2015.
In Pendragon and others v HMRC [2015] UKSC 37 (10 June), the Supreme Court, reversing the decision of the Court of Appeal, found that a scheme designed by KPMG to avoid VAT on the resale of demonstrator cars was abusive.
The object of the scheme was to ensure that companies in a car distributor group were able to recover input tax incurred on the price of new cars acquired as demonstrator cars, while avoiding the payment of output tax on the sale of these cars to consumers. The issue was whether it was abusive under the Halifax principle.
The KPMG scheme involved the sale by the distributors of newly acquired cars to captive leasing companies (CLCs); the leasing of the cars by the CLCs to the distributor’s dealerships; the assignments of the leasing agreements and titles to the cars to a Jersey bank (SGJ); the sale by SGJ of its hire business as a transfer of a going concern (TOGC) to a company of the distributor group (Captive Co 5); and, finally, the sale of the cars by Captive Co 5 to customers.
The success of the scheme relied primarily on the VAT (Cars) Order, SI 1992/3122, art 8, which provides that dealers in second-hand goods are allowed to charge VAT not on the whole consideration for the sale of the goods, but on their profit margin only.
The Supreme Court thus observed that the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second hand under the margin scheme, in circumstances where VAT had not only been previously charged but fully recovered, so ‘that no net charge to VAT was ever suffered, except on the small or non-existent profits realised on the resale’. The Supreme Court concluded that a system designed to prevent double taxation on the consideration for goods had been exploited so as to prevent any taxation on the consideration at all. The first limb of the Halifax test was therefore satisfied; the scheme was contrary to the purpose of the legislation.
As for the second limb, the Supreme Court found that the transaction had the essential aim of obtaining a tax advantage. Two steps had been inserted which had had no commercial rationale other than the achievement of a tax advantage. The first one was the leasing of the cars by the CLCs to ensure that one of the gateways of art 8 applied: the assignment of rights under a hire purchase or conditional sale agreement. The second one was the acquisition of the business by Captive Co 5, so that the acquisition of the cars was brought within the gateway for assets acquired as part of a business transferred as a going concern.
As the scheme was an abuse of law, it fell to be redefined as a sale and leaseback transaction, followed by a sale to customers to which art 8 did not apply.
Why it matters: The court highlighted two difficulties of the Halifax principle. The first arose from the assumption that the principle will not apply to ‘normal commercial transactions’, as ‘the VAT Directives must be assumed to have been designed to accommodate them’. This had led the Court of Appeal to find that the arrangements were not abusive. The second difficulty resulted from concurrent purposes. The question was then whether the commercial objective was enough to explain the particular features of the arrangements.
Tax Journal comment: ‘HMRC is likely to take great comfort from Pendragon and to attack existing and future VAT planning structures. The continued efficacy of offshore structures, as in Newey [2015] UKUT 0300, must be in doubt … One may also expect a degree of mission creep in the willingness of the Upper Tribunal to take an intrusive approach to factual evaluation by the FTT.’ See the article ‘What’s new in VAT abuse?’ (Michael Conlon QC and Rebecca Murray) Tax Journal, 26 June 2015.
In Littlewoods Ltd and others v HMRC [2015] EWCA Civ 515 (21 May), the Court of Appeal found that Littlewoods was entitled to compound interest on VAT wrongly paid.
Littlewoods had paid VAT which was not due. HMRC had repaid the principal amount together with simple interest. Littlewoods claimed that it was also entitled to compound interest. There were four issues.
First, were Littlewoods’ restitution claims excluded by VATA 1994 ss 78 and 80 as a matter of English law and without reference to EU Law? The Court of Appeal found that the net effect of the provisions was that the only cause of action available to the taxpayer for the repayment of the principal sums was that afforded by s 80(1) and so restitutionary claims for repayment of VAT were barred by s 80(7). Furthermore, s 78(1) excluded common law claims for interest.
Second, did the exclusion of the claim by VATA 1994 violate the principle of effectiveness by depriving Littlewoods of an adequate indemnity for the loss occasioned through the undue payment of VAT? The Court of Appeal noted that ‘adequate indemnity’ was not a rigid ‘straitjacket’ which required compound interest in every case. However, s 78 did deprive Littlewoods of an adequate indemnity.
Third, ss 78 and 80 could not be construed so as to conform with EU law as the exclusion of common law claims for interest was a cardinal feature of the legislation. The provisions must therefore be disapplied. Furthermore, the Court of Appeal did not have the power to disapply the domestic bar to the enforcement of Littlewoods’ rights on a selective basis. The choice of remedy therefore belonged to Littlewoods who chose to make a mistake-based restitution claim as this was not time-barred whereas a Woolwich claim would have been time-barred.
Finally, on quantum, HMRC should not be treated as if it were an involuntary recipient of overpayments of tax. ‘Objective use value’ applied to the valuation of the time value of the overpayments made to HMRC and compound interest was payable. Interest should continue to run after the date of the repayment of the principal amounts of overpaid VAT on such amounts of accrued interest as remained outstanding.
Why it matters: This is the latest instalment of a judicial saga which includes two high court decisions and a preliminary ruling by the CJEU. The tax at stake is colossal: £1.2bn in compound interest.
Tax Journal comment: ‘A further appeal to the Supreme Court must be a possibility … and it would be surprising if the court did not grant permission to appeal. A further period of uncertainty is inevitable. In the meantime, businesses and their advisers should: ensure proceedings for restitution are commenced within the time limits laid down by the Limitation Act 1990; obtain expert evidence on appropriate interest rates, including evidence to rebut HMRC’s attempts to reduce the quantum of the claim by arguing for a defendant-focused rate; [and] be prepared to demonstrate why the claim displays “exceptional circumstances”, in order to support the case for compound, rather than simple, interest.’ See ‘Littlewoods Retail: compound interest claim upheld’ (Michael Conlon QC) Tax Journal, 5 June 2015.
In HMRC v Southern Cross Employment [2015] UKUT 122 (1 April 2015), the UT found that HMRC was bound by a contract with the taxpayer.
HMRC had paid £1.4m to Southern Cross for repayment of VAT and associated interest and now sought to recover it. Southern Cross contended that the repayment had been made under a binding contract.
There were three issues:
(1) Did VATA 1994 s 80 bar HMRC from entering into a binding agreement with Southern Cross?
(2) Would any compromise agreement have been ultra vires and so void?
(3) Was a compromise agreement formed on the facts?
In relation to (1), the UT found that s 80 did not bar HMRC from entering into a binding agreement to settle a claim. The UT referred inter alia to DFS [2002] EWHC 807 – which establishes that s 85 allows HMRC to enter into a binding agreement in the context of an appeal – and noted that there was no reason why such ability would not exist in the absence of an appeal.
As for (2), the UT again found in favour of Southern Cross. The fact that it was later established that the supply of dental nurses to dentists was standard rated and not exempt, as agreed by HMRC, did not make the agreement void.
Finally, in relation to (3), the UT found that the pattern of correspondence between HMRC and Southern Cross, viewed objectively, pointed towards a process of negotiation and, in the end, an intention to conclude a contractual agreement. The UT noted in particular the language used by the parties, for instance the use of expressions such as ‘offer’ and ‘accept’.
Why it matters: The case is interesting on two grounds: firstly, it confirms that HMRC can enter into agreements relating to VATA 1994 s 80 repayments; and secondly (and perhaps most importantly), it suggests that such agreements are binding even if the position agreed by HMRC is then judicially found to be wrong.
Tax Journal comment: ‘This decision exposes limitations on HMRC’s ability to make assessments under s 80(4A), (7). Perhaps most significantly, both tribunals held that the agreement entered into was not ultra vires. At the time the agreement was entered into, HMRC did not make any error of law by entering into the agreement, so it was a reasonable one. It was not ultra vires because it turned out that HMRC had not been liable to repay VAT to Southern Cross ... The case illustrates that there must be merit in closely reviewing whether a compromise agreement has been entered into where a repayment has been agreed by HMRC, if it seeks to reopen it and recover the repayment.’ See the article ‘Southern Cross: compromise agreement not ultra vires’ (Tarlochan Lall) Tax Journal, 17 April 2015.
Tax Journal continues its quarterly review of tax cases, with a look back at the cases that matter most, reported from April to June 2015.
In Samarkand Film Partnership No. 3, Proteus Film Partnership and three partners v HMRC [2015] UKUT 211 (29 April), the UT found that the partners were not entitled to loss relief and that they had not had a legitimate expectation that the relief would be available.
The issue was whether two partnerships, which had acquired and leased films under sale and leaseback arrangements, were entitled to loss relief in respect of losses which arose on the acquisition of the films. If so, their partners could claim sideways relief under ICTA 1988 ss 380 and 381 to set the losses against their taxable income from other sources.
The purchase of an asset which a person intends to exploit over a period of time is normally treated as capital expenditure. However, ITTOIA 2005 s 134 provides that in the case of a film, the expenditure should be regarded as revenue in nature. Furthermore, ss 138 and 140 allow loss relief to be claimed in advance of the normal rules. Relief is not available, though, if the expenses are not incurred wholly and exclusively for the purposes of a trade or if the losses are not connected with or arising out of a trade.
The UT found that the FTT had been entitled to conclude that the partnerships had not been carrying on a trade, so that no loss relief was available to the partners. This was so, even though a transaction of that type could have constituted a trade. In particular, it accepted the FTT’s factual finding that the commercial nature of the agreements was ‘the payment of a lump sum in return for a series of fixed payments over 15 years’.
No further arguments were required following the release of the Court of Appeal’s decision in Eclipse Film Partners [2015] EWCA Civ 95, which recommended a ‘realistic approach to the transaction’. The UT added that even if the partnerships had been conducting a trade, they would not have been doing so on a commercial basis, as the transactions were intended to produce a loss in net present value terms. This analysis was not affected by the fact that the individual partners were accruing ‘extra benefits’ as a result of the tax reliefs. Those reliefs were obtained by ‘deliberately causing the partnership to trade in an uncommercial manner’.
The two judges disagreed as to whether, in any event, one of the partnerships had incurred the expenditure for the acquisition of a film (as opposed to that of an income stream). The president exercised its casting vote on this issue, finding that the partnership had incurred the expenditure for the purchase of a film. This was because it had acted bona fide in the belief that it was acquiring valuable rights.
The taxpayers also claimed judicial review on the ground that HMRC’s denial of relief was at odds with its own published guidance in HMRC’s Business Income Manual (BIM). The UT pointed out that unlike IR20, which was aimed to give taxpayers guidance on residence, the BIM was intended for the use of HMRC staff – although it was made available to the public. The UT observed that the BIM stressed in several places that the relief was aimed at tax deferral only.
Furthermore, the BIM included clear statements that transactions involving tax avoidance would be closely scrutinised and that the guidance may not be applied to them. The argument that this statement suggested that HMRC reserved the right to treat similar transactions differently was robustly rejected. ‘Taxpayers may not like that statement but they could not say that they derived a legitimate expectation that was at odds with it.’ Finally, the UT found that HMRC had reasonably thought that tax avoidance was at play. Several features indicated that the aim of the transactions was not tax deferment but tax avoidance.
Why it matters: The appeal failed on both the ‘trading issue’ and the legitimate expectation issue. On the trading issue, the UT simply reiterated the points made by the FTT on the basis of its factual findings. On the legitimate expectation issue, the taxpayers could not rely on HMRC’s description of a plain vanilla transaction (claiming that their arrangements were similar) and ignore the general statement about tax avoidance. They could not ‘take out the plums they liked and ignore the duff they did not’.
Tax Journal coverage: ‘The decision in Samarkand serves as a timely reminder to taxpayers of the extent to which they can rely on HMRC’s manuals. The decision highlights that no matter how clear or unqualified a statement in HMRC’s manuals might appear to be, it will be open for HMRC to depart from that guidance if it considers that tax avoidance is or may be involved, leaving the taxpayer in question with an uphill struggle to prove that it has a substantive legitimate expectation that should be protected.’ See the article ‘Samarkand: illegitimate expectations?’ (Jeanette Zaman & Owen Williams) Tax Journal, 22 May 2015.
In Pendragon and others v HMRC [2015] UKSC 37 (10 June), the Supreme Court, reversing the decision of the Court of Appeal, found that a scheme designed by KPMG to avoid VAT on the resale of demonstrator cars was abusive.
The object of the scheme was to ensure that companies in a car distributor group were able to recover input tax incurred on the price of new cars acquired as demonstrator cars, while avoiding the payment of output tax on the sale of these cars to consumers. The issue was whether it was abusive under the Halifax principle.
The KPMG scheme involved the sale by the distributors of newly acquired cars to captive leasing companies (CLCs); the leasing of the cars by the CLCs to the distributor’s dealerships; the assignments of the leasing agreements and titles to the cars to a Jersey bank (SGJ); the sale by SGJ of its hire business as a transfer of a going concern (TOGC) to a company of the distributor group (Captive Co 5); and, finally, the sale of the cars by Captive Co 5 to customers.
The success of the scheme relied primarily on the VAT (Cars) Order, SI 1992/3122, art 8, which provides that dealers in second-hand goods are allowed to charge VAT not on the whole consideration for the sale of the goods, but on their profit margin only.
The Supreme Court thus observed that the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second hand under the margin scheme, in circumstances where VAT had not only been previously charged but fully recovered, so ‘that no net charge to VAT was ever suffered, except on the small or non-existent profits realised on the resale’. The Supreme Court concluded that a system designed to prevent double taxation on the consideration for goods had been exploited so as to prevent any taxation on the consideration at all. The first limb of the Halifax test was therefore satisfied; the scheme was contrary to the purpose of the legislation.
As for the second limb, the Supreme Court found that the transaction had the essential aim of obtaining a tax advantage. Two steps had been inserted which had had no commercial rationale other than the achievement of a tax advantage. The first one was the leasing of the cars by the CLCs to ensure that one of the gateways of art 8 applied: the assignment of rights under a hire purchase or conditional sale agreement. The second one was the acquisition of the business by Captive Co 5, so that the acquisition of the cars was brought within the gateway for assets acquired as part of a business transferred as a going concern.
As the scheme was an abuse of law, it fell to be redefined as a sale and leaseback transaction, followed by a sale to customers to which art 8 did not apply.
Why it matters: The court highlighted two difficulties of the Halifax principle. The first arose from the assumption that the principle will not apply to ‘normal commercial transactions’, as ‘the VAT Directives must be assumed to have been designed to accommodate them’. This had led the Court of Appeal to find that the arrangements were not abusive. The second difficulty resulted from concurrent purposes. The question was then whether the commercial objective was enough to explain the particular features of the arrangements.
Tax Journal comment: ‘HMRC is likely to take great comfort from Pendragon and to attack existing and future VAT planning structures. The continued efficacy of offshore structures, as in Newey [2015] UKUT 0300, must be in doubt … One may also expect a degree of mission creep in the willingness of the Upper Tribunal to take an intrusive approach to factual evaluation by the FTT.’ See the article ‘What’s new in VAT abuse?’ (Michael Conlon QC and Rebecca Murray) Tax Journal, 26 June 2015.
In Littlewoods Ltd and others v HMRC [2015] EWCA Civ 515 (21 May), the Court of Appeal found that Littlewoods was entitled to compound interest on VAT wrongly paid.
Littlewoods had paid VAT which was not due. HMRC had repaid the principal amount together with simple interest. Littlewoods claimed that it was also entitled to compound interest. There were four issues.
First, were Littlewoods’ restitution claims excluded by VATA 1994 ss 78 and 80 as a matter of English law and without reference to EU Law? The Court of Appeal found that the net effect of the provisions was that the only cause of action available to the taxpayer for the repayment of the principal sums was that afforded by s 80(1) and so restitutionary claims for repayment of VAT were barred by s 80(7). Furthermore, s 78(1) excluded common law claims for interest.
Second, did the exclusion of the claim by VATA 1994 violate the principle of effectiveness by depriving Littlewoods of an adequate indemnity for the loss occasioned through the undue payment of VAT? The Court of Appeal noted that ‘adequate indemnity’ was not a rigid ‘straitjacket’ which required compound interest in every case. However, s 78 did deprive Littlewoods of an adequate indemnity.
Third, ss 78 and 80 could not be construed so as to conform with EU law as the exclusion of common law claims for interest was a cardinal feature of the legislation. The provisions must therefore be disapplied. Furthermore, the Court of Appeal did not have the power to disapply the domestic bar to the enforcement of Littlewoods’ rights on a selective basis. The choice of remedy therefore belonged to Littlewoods who chose to make a mistake-based restitution claim as this was not time-barred whereas a Woolwich claim would have been time-barred.
Finally, on quantum, HMRC should not be treated as if it were an involuntary recipient of overpayments of tax. ‘Objective use value’ applied to the valuation of the time value of the overpayments made to HMRC and compound interest was payable. Interest should continue to run after the date of the repayment of the principal amounts of overpaid VAT on such amounts of accrued interest as remained outstanding.
Why it matters: This is the latest instalment of a judicial saga which includes two high court decisions and a preliminary ruling by the CJEU. The tax at stake is colossal: £1.2bn in compound interest.
Tax Journal comment: ‘A further appeal to the Supreme Court must be a possibility … and it would be surprising if the court did not grant permission to appeal. A further period of uncertainty is inevitable. In the meantime, businesses and their advisers should: ensure proceedings for restitution are commenced within the time limits laid down by the Limitation Act 1990; obtain expert evidence on appropriate interest rates, including evidence to rebut HMRC’s attempts to reduce the quantum of the claim by arguing for a defendant-focused rate; [and] be prepared to demonstrate why the claim displays “exceptional circumstances”, in order to support the case for compound, rather than simple, interest.’ See ‘Littlewoods Retail: compound interest claim upheld’ (Michael Conlon QC) Tax Journal, 5 June 2015.
In HMRC v Southern Cross Employment [2015] UKUT 122 (1 April 2015), the UT found that HMRC was bound by a contract with the taxpayer.
HMRC had paid £1.4m to Southern Cross for repayment of VAT and associated interest and now sought to recover it. Southern Cross contended that the repayment had been made under a binding contract.
There were three issues:
(1) Did VATA 1994 s 80 bar HMRC from entering into a binding agreement with Southern Cross?
(2) Would any compromise agreement have been ultra vires and so void?
(3) Was a compromise agreement formed on the facts?
In relation to (1), the UT found that s 80 did not bar HMRC from entering into a binding agreement to settle a claim. The UT referred inter alia to DFS [2002] EWHC 807 – which establishes that s 85 allows HMRC to enter into a binding agreement in the context of an appeal – and noted that there was no reason why such ability would not exist in the absence of an appeal.
As for (2), the UT again found in favour of Southern Cross. The fact that it was later established that the supply of dental nurses to dentists was standard rated and not exempt, as agreed by HMRC, did not make the agreement void.
Finally, in relation to (3), the UT found that the pattern of correspondence between HMRC and Southern Cross, viewed objectively, pointed towards a process of negotiation and, in the end, an intention to conclude a contractual agreement. The UT noted in particular the language used by the parties, for instance the use of expressions such as ‘offer’ and ‘accept’.
Why it matters: The case is interesting on two grounds: firstly, it confirms that HMRC can enter into agreements relating to VATA 1994 s 80 repayments; and secondly (and perhaps most importantly), it suggests that such agreements are binding even if the position agreed by HMRC is then judicially found to be wrong.
Tax Journal comment: ‘This decision exposes limitations on HMRC’s ability to make assessments under s 80(4A), (7). Perhaps most significantly, both tribunals held that the agreement entered into was not ultra vires. At the time the agreement was entered into, HMRC did not make any error of law by entering into the agreement, so it was a reasonable one. It was not ultra vires because it turned out that HMRC had not been liable to repay VAT to Southern Cross ... The case illustrates that there must be merit in closely reviewing whether a compromise agreement has been entered into where a repayment has been agreed by HMRC, if it seeks to reopen it and recover the repayment.’ See the article ‘Southern Cross: compromise agreement not ultra vires’ (Tarlochan Lall) Tax Journal, 17 April 2015.
