The First Tier Tribunal (FTT) has dismissed in part several partnerships’ appeals concerning arrangements entered into for the acquisition and exploitation of intellectual property rights.

In the case, Acornwood LLP & Ors [2014] TC 03545 UKFTT 416 (TC), the FTT found that although each of the partnerships was carrying on a trade of the exploitation of intellectual property rights, the scheme substantially failed in its purpose to secure sideways loss relief for the partnerships’ members and to increase the amount of the relief by unnecessary borrowing, which was purported to be available for use in the exploitation of intellectual property rights, but was in reality used to service itself.

In respect of a joint reference designed to ascertain whether, if the partnerships’ appeals had been successful, the individual members of the partnerships would have satisfied the conditions necessary for sideways relief to have been available, the FTT concluded that they would not.

This is yet another win for HMRC in its battle against what the tax authorities and the government see as aggressive tax avoidance schemes and with yet more famous names involved, including three members of Take That. It has led to more public outcry about those with money being able to avoid paying their fair share of tax.

However, what is more important, from a technical viewpoint, is why the FTT found that the scheme substantially failed, and in the main part this was because it decided that purported revenue expenses were actually capital in nature.

Summary

This case looked at the tax position of five Limited Liability Partnerships (the appellant partnerships) and their members and follows on from the Upper Tribunal decision in Icebreaker 1 LLP v R & C Commrs [2011] BTC 1,579.

The appellant partnerships’ cases and a joint reference from seven individuals (the individual referrers), who were members of the appellant partnerships, or other similar partnerships, and HMRC, were heard together as all involved essentially the same facts and arrangements, with the five appeals being lead cases. There were a further 46 partnerships and approximately 1,000 members involved in related cases (with all 51 partnerships collectively referred to as ‘Icebreaker Partnerships’).

The case considered arrangements in the tax years 2005/06 to 2009/10 during which each of the partnerships acquired, for relatively modest sums, certain intellectual property rights (often in the music or publishing industry), and for much larger payments agreed with an exploitation company that it would exploit the rights on its behalf.

The revenue from the exploitation was to be shared between the partnership and the exploitation company, which was also required, as part of the arrangements, to pay certain guaranteed sums to the partnership.

The ‘underlying, and fundamental, conclusion we have reached is that the Icebreaker scheme is a tax avoidance scheme’ and substantially failed in its purpose.

In addition, each partnership entered into agreements with the promoter of the arrangements (Icebreaker Management Limited or IML) by which, in return for substantial payments, IML provided, or was to provide, various services to the partnership.

One of the key features of the arrangements was the financing of the members’ capital injections; these were in each case derived in part from their own resources (often 20–25%) and in part from secured bank borrowings (often 75–80%). In each case the expenditure mentioned above was incurred in the partnership’s first accounting period and the members were guaranteed returns sufficient to enable them to service and repay their secured borrowings.

The appellant partnerships claimed that the expenditure incurred in the first year of trading gave rise to allowable losses which their members were entitled to set off by way of sideways loss relief against income or capital gains arising outside the trade.

Although HMRC accepted that the appellant partnerships were trading with a view to profit and that none of the arrangements were a sham, it argued that the true purpose was the creation of artificial losses.  The aim being to generate tax relief as part of tax avoidance schemes and the earning of trading profit was incidental to this. HMRC issued closure notices disallowing almost all of the supposed losses, against which the appellant partnerships appealed.

The FTT looked at five key issues:

What were the relevant payments made for?

The FTT decided that the payments to the exploitation company were, to the extent they matched the amount borrowed, paid for the purchase of a guaranteed income stream with the remainder of the payment being for exploitation services.

Was each of the payments of a revenue or capital nature?

The FTT found that the payments to the exploitation company which represented the purchase of a guaranteed income stream were of a capital nature while the remainder were of an income nature.

The advisory fees paid immediately by all but one of the appellant partnerships were all of a capital nature, whereas the fee paid by the partnership which comprised the purchase of a ready-made package of projects, advisory services rendered in the relevant year and a pre-payment for future service, had to be apportioned, with the portion that represented the purchase price of the package being of a capital nature while the remainder was of a revenue nature. The entirety of the administration services fee paid on closure of the partnership was of a revenue nature.

Did the appellant partnerships’ accounts reflect those conclusions?

The FTT found that the accounts were not GAAP-compliant. The taking to the profit and loss account of all of the amounts paid to IML and the exploitation company was not correct, since it led to the introduction into the calculation of the profit or loss what the FTT found to be capital payments and of sums properly to be treated as pre-payments. That approach did not satisfy the requirements of ITTOIA 2005, ss 25(1) and 26(1).

What were the tax consequences of the arrangements?

The FTT ruled that each partnership was entitled to treat as an allowable expense, in the relevant year only, so much of the payments it made as was of a revenue nature, and which did not represent a pre-payment.

If the arrangements succeeded in their alleged purpose, were the tax consequences to be disregarded on Ramsay grounds?

HMRC argued that there was a close parallel between Ramsay v Commissioners of Inland Revenue 54 TC 101 and this case. The arrangements were structured so that except for the IML fees and some incidental expenditure in respect of the money borrowed, the members were guaranteed at the end of the sequence to be put back in the position from which they started. This meant that their borrowings were repaid and they did not have to find the interest on the borrowings in the meantime. If any money was ever at risk it was no more than their own capital injection.

The defence argued that HMRC’s proposition misrepresented the reality as the borrowed money was in fact used for the purposes of the trade and the conditional or contingent character of the final minimum sum or its equivalent shows that, unlike in a case to which the Ramsay principle might apply, the necessary element of certainty was absent.

The tribunal judges were not convinced that the Ramsay principle applied because, on the basis that it was right in its conclusion about the ineffective argument, the tax treatment of the transactions conformed with the purpose of the legislation.

In respect of these questions the FTT found that:

None of the appellant partnerships’ trades were carried out on a commercial basis and with a view to profit

The FTT concluded that only a small proportion of projects of the kind pursued by the Icebreaker Partnerships could have been expected to make significant profits and although a single project could have made substantial profits, because each partnership typically adopted less than six projects this limited the chances that a project with true potential had been identified.

None of the individual referrers was an active partner

It was accepted by HMRC that members had spent an average of ten hours a week on partnership activities. Therefore, the FTT concentrated on whether the activities were ‘for the purposes of the trade’.

The FTT accepted that members typically spent approximately two hours a week on ‘management activities’, such as attending partnership meetings, considering reports, draft resolutions and similar documents and exchanging emails.

The FTT was satisfied that ‘the individual referrers spent the time because they had been told they must, and that they undertook activities such as they described, not in the expectation or even hope that anything useful might come of them, either for that reason alone or, because they happened to enjoy the particular activity for its own sake, as a pleasurable means of fulfilling a statutory requirement.’

The Partnerships (Restrictions on Contributions to a Trade) Regulations 2005 (SI 2005/2017) did not apply to any of the individual referrers

The aim of the Restrictions Regulations was to remove or restrict relief in those cases in which the borrower did not truly have any liability to repay the borrowing - so the provisions were aimed at arrangements in which there was the appearance but not the substance of a borrowing, or where the borrower is in some way fully indemnified without cost to himself.

Although, the FTT found the borrowings in these cases to be wholly unnecessary, and undertaken only in order to increase the amount of tax relief, the arrangements were not a sham.

The members did borrow money and used it to purchase an income stream and final minimum sum which would have enabled them to repay the loans and service them in the meantime.

Although the possibility that they would have to repay the borrowings from funds not within the scheme was illusory, the FTT accepted that these were full recourse loans, albeit fully secured.

There was no realistic prospect that the partnership would have to repay the loan, but even if there were, a partnership which pays a member’s debt from the member’s share of the partnership assets is not, as the Conditions require, bearing or assuming the liability. In a meaningful sense it is doing no more than discharge it for the member.

The ‘underlying, and fundamental, conclusion we have reached is that the Icebreaker scheme is, and was known and understood by all concerned to be, a tax avoidance scheme’ and substantially failed in its purpose.

The tribunal did allow some of the partnerships’ appeals in part, by ruling that relief should be given for what were found to be revenue expenses incurred in the relevant tax year, but not for expenses found to have been capital expenses or pre-payments.

Even if the partnerships’ appeals had been successful, the FTT decided that the individual members of the partnerships would not have satisfied the conditions necessary for sideways relief to have been available.

The decision was released on 7 May 2014. The FTT judges were Judge Colin Bishopp and Richard Law FCA.

Meg Wilson is a specialist tax writer at CCH, a Wolters Kluwer business www.cch.co.uk

This article was first published in CCH Tax News 163, 21 May 2014