Brain Disorders plus Tax Avoidance equals Ramsay Robust

Those (like me!) who appreciate the significance of the above headline will be thinking ‘Tax is Fun’ and ‘This is Fascinating’.  For the rest I challenge you to struggle on to the end.

The case (Brain Disorders Research Limited Partnership – TC4510) is interesting because the complex, highly cogent, judgement goes through the arrangements as a whole.  Then the Court decides that overall they do not make commercial sense (on the grounds that 6 ≠ 99).  As a result, the Court strikes down the whole structure as a “sham”, and hence ineffective from a tax perspective.  This is oversimplification, of course, but in this case the First Tier Tribunal have struck to the heart of a manufactured tax avoidance scheme by destroying it as having crucial aspects which meant the whole scheme effectively amounted to a sham.

Where does the case leave us?

Analysis of the detailed judgement is interesting in itself, as will be the question of whether the case is appealed to a higher court.

For the moment though, in looking at the commercial picture and looking at steps obviously inserted for tax purposes the First Tier tribunal could be said to be adopting an approach on the lines of ‘Ramsay Robust’.  Those of you familiar with the classic anti-avoidance case of CIR v Ramsay will know that it analysed tax planning schemes and then surgically excised steps inserted just for tax planning purposes and then re-analysed the result.

It seems to me the Brain Disorders judgement follows similar principles, but, in simile, perhaps by using a large axe rather than a scalpel!  It does though leave interesting (and relevant) thoughts, especially as in terms of the claim, the underlying scientific research seemed to be accepted by the Courts to be genuine and cutting edge.  The issue was whether the price had been artificially inflated.  Effectively, therefore it leaves open the question for future commercial planners of what makes the tax axe fall?  All of us need to use the tax system.  You can’t opt out!  How do we know we are not ‘abusing’ it?

In the case, the fact that (blatantly) 6 ≠ 99 was a key determinant, and understandable in may people’s eyes as an inherent misrepresentation.  Where though is the cut off?  Where 6 moves and then tends to approach 99?  Does ‘abuse’ stop at 12 or 50 or where?  Surely there cannot be a ‘fixed’ level?  As is clear from my insurance quotes, in a free market, there seems to be little that approaches a fixed price.  It depends upon the precise terms of the contract, plus the expertise and reputation of the provider.  There must therefore be a range of values which would be acceptable and thus ‘non-abusive’?  Crucially though, how is this ‘non-abusive’ range to be determined in advance by advisors?

The Court’s technical analysis and indeed the scheme details are highly complex, but essentially (to use the round numbers adopted in the case) the higher rate taxpayers investing in the scheme sought to claim 99 or 96 of interest/scientific research allowances, for true research expenditure that was actually being sub-contracted out for 6.

HMRC convinced the Court that it was never remotely considered (or even possible) for the investors to undertake the research themselves, in the Partnership Structure established.  This was believed, to be because of the bank borrowings and lack of relevant resources for the Partnership Structure meant that it would be problematic in raising the finance to undertake the research itself.  As a result, the Courts held it was thus inevitable that the research would be subcontracted to the true scientific experts at the agreed price of 6.  Thus it was ‘false wording’ in the documentation to suggest that 99 (or indeed any amount other than 6) was to be paid to procure the research.

The Court judged;

“Most of the money movements related entirely to the borrowing arrangements and had nothing to do with genuine royalties derived from scientific research”.

It went on;

“Everything in relation to the refund of capital expenditure should the research project be abandoned was uncommercial”.

The FTT held that the scheme was a sham.  It was based on the premise that the recipient of the borrowed/invested funds may undertake the relevant scientific research.

A previous case, Tower M Cashback, showed that the price paid had to represent fair value for allowances to be available.  A valuation exercise was undertaken by the designers of the Scheme to show that a number of “traditional” researchers in institutions or universities would have charged 99 or 100 for the work.  However, the Courts criticised this exercise as being effectively a self-fulfilling prophecy, undertaken in a hurry by a party associated with those involved through past work, and not actually comparing like with like.  The Courts also pointed out that a genuine commercial arrangement would have made the most of the quote of 6 from Australian leaders in the relevant brain research.  Any true commercial investors would have been unlikely to do anything other than go for that price, rather than committing to 99 or 100 created via the inflated borrowing.

The internal un-commerciality of the finance arrangements was apparent by the fact that some of the quotes compared US $ prices to AUS $ prices without ‘noticing’ the 22% currency exchange difference existing at the time.

The First Tier Tribunal was scathing:-

“We agree that there was a sham in this case [None] of the parties or indeed the investing partners were intended to be deceived into thinking that the possible aim of sub-contracting was just one of two realistic possibilities. Of course it was known that it was the only conceivable way of proceeding.  [Hence] the alternative contractual provision, suggesting that [the Partnership Structure] might itself conduct the research was false. The significance of the false claim was that, had it been deleted in accordance with reality, it could not possibly have been suggested that [the Partnership Structure] was ever to pay more than 6, let alone 99 or 96, in order to procure the scientific research. The falsely worded clause was therefore the foundation of the Partnership’s claim for vastly excessive capital allowances, and this is why we decide to strike it down as being a sham.  The [HMRC] counsel was slightly more hesitant in describing the whole pricing of the scientific research in the Schedule to the top-level contract, sub-dividing the total expenditure and allocating elements of it to each step and stage in the research, as a sham. We are not so hesitant. By sub-dividing the alleged expenditure of 99 or 96 in this way, inserting all this elaborate nonsense into the Schedule, it becomes clear that the critical drafting of [the Partnership Structure] clause is not just some mistaken reference to one irrelevant possibility. The Schedule shines the light on the fact that the whole fiction is indeed intended, and that it is indeed the foundation of the Partnership’s claim. [My emphasis].

Comments please on whether you feel my idea of ‘Ramsay Robust’ makes sense and what needs to be done to aid commercial certainty.  Obviously everyone needs to act in accordance with tax law.  Similarly commercial enterprise needs to know tax consequences of their actions.

Careful with those Capital Gains Tax deductions

Accountants and clients used to the broad brush “commercial” approach to computing trading profits can get caught out by the different and stricter rules for calculating capital gains.

Payments which may make sense, or even be thought essential from a commercial perspective are not necessarily then allowable for capital gains tax purposes.

This is demonstrated by the recent case of J. Blackwell.  In exchange for £1m, Mr Blackwell agreed to act exclusively in voting his shareholding in BP Holdings in favour of the Taylor and Francis Group who wished to purchase BP Holdings.  Later another prospective purchaser came along for BP Holdings.  In order to extricate himself from the first agreement Mr Blackwell paid Taylor and Francis Group £17.5m which he then claimed under S38 TCGA 1992 as a deduction against his subsequent sale of the BP Holdings shares to the second purchaser.

The Upper Tier Tribunal found against him on the grounds that the expenditure was not reflected in the value of the asset disposed of to the purchaser.  Admittedly, it put him in a position to make the disposal, by releasing him from the previous restrictions, but it did not enhance the value of the shares themselves.  Similarly, the Courts held the payment did not create or establish any new rights over the underlying shares themselves.

This principle can be a factor in helping clients decide whether to accept an offer, by understanding what it would be worth after tax.  It can often be in point where a client is considering an offer from a developer for (say) housing.  On this principle, if the developer is buying a cleared site, where a bulldozer has taken down perhaps years of “enhancement expenditure” on the former trade site, then it is likely HMRC will seek to deny the cost of the previous building works, perhaps increasing the gain by a material amount.

Care in understanding the facts is crucial.