Double Taxation arguments with reference to Investec Asset Finance Plc and another v HMRC [2020] EWCA Civ 579
May 6, 2020
By Katherine Traynor
Introduction
In Investec Asset Finance Plc and another v HMRC[1], the Court of Appeal (‘CA’) considered a number of issues relating to the tax treatment of an investment structure concerning a mixture of companies and partnerships. The CA ruled on appeals and a cross-appeal arising out of the Investec litigation, in particular two Upper Tribunal (‘UT’) decisions. The CA on 30 April 2020 held, that outstanding issues on the application of the double taxation principles to companies in partnerships should not be remitted to the First-tier Tribunal (‘FTT’).
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Partnership Legislation
The Partnership Act 1890 (‘the Act’) defines a partnership as the relationship which subsists between ‘persons carrying on a business in common with a view of profit’[2] Those persons could be individuals, or legal entities such as limited liability partnerships, or trustees; however, the Act excludes from this definition a company or association otherwise incorporated under the Companies Act (or any other letters patent, royal charter or Act). A fundamental element of a partnership is that partners are jointly liable for any obligations of the firm, inclusive of debts.
Limited partnerships are governed by the Limited Partnerships Act 1907 (‘the 1907 Act’), which consists of:
- One or more ‘general partners’, who are liable for all debts and obligations of the partnership; and,
- One or more limited partners whose liability for the partnership’s debts and obligations is limited to the amount they have invested.
A Limited partnership has to have at least one ‘general partner’, however, the ‘general partner’ can be a company with limited liability.
Limited liability partnerships (‘LLPs’) are governed by the Limited Liability Partnerships Act 2000. An LLP is a body corporate for company law purposes, with a separate legal personality – with the LLP rather than its members being liable for any debts and obligations. LLP’s are typically used as a vehicle for professional services firms; inclusive of industries such as financial advisory services, accountants, lawyers and consultants. Despite this corporate structure, LLPs are generally taxed as though it were a partnership (i.e. LLPs are tax transparent).
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Tax Transparency
General partnerships, limited partnerships and most LLP’s are treated as transparent for most UK tax purposes. This means that the partnership as a whole is not itself liable to tax. Instead the legislation ‘looks through’ the partnership, meaning the activities of the partnerships are considered as carried on by the individual partnership for corporation tax purposes,[3] and income tax purposes.[4] Accordingly, the partners are taxable individually on their share of any profits, or losses of the partnerships as and when these arises, whether they are distributed or not. The same contrasting with UK corporate entities, which are considered opaque for tax purposes, and are tax separately from their shareholders.
Most LLP’s are transparent for tax purposes, meaning each member would be charged to Income Tax or Corporation Tax on their share of the LLP’s income, as if they were members of a ‘general partnership’ pursuant to the Act. In certain circumstances however, an LLP is not treated as transparent for tax purposes and will be considered a body corporate for purposes of tax. For example, if at least one partner is a company, the profits and losses of the partnership must be treated as if the partnership were a company resident in the UK, subject to specific exemptions –[5] meaning an LLP that is not transparent would be chargeable to corporation tax as if it were a company.
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Background
The matter concerned three appeals – the HMRC and two financial dealing companies (that were in partnership) appealed against a decision regarding the principle against double taxation on capital returns derived from partnerships’ taxed profits when computing profits of the separate, financial trade of the partners.
HMRC issued eight closure notices, one for each Appellant for each accounting period between April 2006 and 31 March 2010. The trades carried on by the Appellants themselves, taxable under S.42 Financial Act 1998, were referred to as the ‘solo financial trades’ to distinguish them from the trades carried on by them in their capacity as partners in the ‘Leasing Partnerships’. They had acquired interests in and had become partners in the Leasing Partnership, which were entitled to lease receivables as part of a tax mitigation scheme In that respect, the Appellants incurred both acquisition costs, and capital expenditure – which the HMRC disputed were deductible for purposes of computation tax pursuant to S.42 FA 1998. They were also considered liable for tax pursuant to the Income and Corporation Taxes Act 1988, S.114; they asserted that the income had been taxed twice.
The main substantive issue in this case was what happens when some of the income of the corporate partners own business comprises of profits of partnerships in which the companies own an interest. Accordingly, the question before the CA was whether the profits made by a partnership that had already been taxed pursuant to S.114,[6] should be left out when assessing the profits of the partners’ solo trades under S.42.[7]
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Previous Decisions
The FTT established that two trades existed – suggesting that taxpayers conducted financial trades (buying and selling partnership interests) and the trades carried on in partnership with other partners in leasing partnerships. It was also confirmed, that no double taxation principle applied to exclude profits or other distributions which had already been treated as taxable for the purposes of leasing trades from the gross income –[8] meaning, the same should not be brought into account when computing the tax on solo trades.
However, applying this principle to the facts was somewhat difficult. The UT in the second decision held that the HMRC was not precluded from arguing that the partnerships’ taxed profits should be taken into account when computing the profits of the solo financial trades and raised the possibility that a distinction should be made between trading receipts and repayment of capital contributions. It suggested that further consideration needed to be given to these issues and remitted the matter to the FTT for a further finding of fact.
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Court of Appeal Decision
The CA allowed the appeal in part and held that HMRC was not entitled to opt now to abandon its case, or reformulate the issues, so as to allow it to go back and argue further points that had not been previously raised before the FTT. It considered it to be unfair on the appellants to allow the HMRC to now change its position and approach at a late stage.
With reference to the issue of ‘double taxation’ the CA held that the HMRC was not permitted to withdraw its concession that this issue was academic in nature, especially as they had won on the issue of capital contributions (namely, that the same were not deductible expenses). Whilst it was acknowledged that the statutory provisions under S.114 ICTA[9] and s.42 FA 1998[10] had been in operation for some time, the CA suggested that the HMRC’s application of these provisions was still a “work in progress”. Accordingly, the no double taxation principle applied to exclude from the computation of income of the companies’ solo trades, profits and other distributions, which had already been treated as taxable in accordance with their S.114(2) trades. However, in computing the profit of solo financial trades, it was considered that capital contributions were not deductible against other forms of income for the purposes of S.42 – but acquisition costs were deductible for purposes of tax computations.
The CA confirmed that the UT had been right to uphold the FTT’s findings of fact – which there was no reason to disturb – that capital contributions made by the taxpayers were not wholly and exclusively incurred for the purposes of solo financial trades, and were therefore not deductible for tax computations.
However, this CA judgement highlights the difficulties in ascertaining whether expenditure is tax deductible, whilst also illustrating the uncertainties of taxation of companies with partnership interests – particularly, given the CA’s comments in respect of the UT’s distinction between repayment of capital contribution and trading profits.
Katherine Traynor is a commercial pupil at Exchange Chambers.
[1] [2020] EWCA Civ 579.
[2] Partnership Act 1890, S.1(1).
[3] S.111(1) Income and Corporation taxes Act 1988 (‘ICTA 1998’), rewritten to, Corporation Tax Act 2009, S.1258.
[4] Income Tax (Trading and Other Income) Act 2005, S.848.
[5] Section 114 ICTA, rewritten to S.1259 Corporation Tax Act 2009.
[6] Section 114 ICTA, rewritten to S.1259 Corporation Tax Act 2009.
[7] S.42 Finance Act 1998
[8] FS Securities Ltd v Commissioners of Inland Revenue (1964) 41 TC 66.
[9] S.114(2) Income and Corporation Taxes Act 1988.
[10] S.42 Finance Act 1998
