Daarasp – Loss claims denied as closure notices were valid

In Daarasp LLP & Betex LLP v HMRC [2021] UKUT 0087, the Upper Tribunal (UT) upheld the First-tier Tribunal's (FTT) decision and dismissed the taxpayers' claims for losses as the conclusions in HMRC's closure notices were not inconsistent with the losses being reduced to zero in the taxpayers' returns.

Background 

Daarasp LLP and Betex LLP (the Appellants) were formed in order to participate in an arrangement which was intended to produce trading losses in respect of the acquisition of certain software licences. The aim was for the Appellants to sustain a first-year loss equivalent to the capital allowances claimed under section 45, Capital Allowances Act 2001 (CAA 2001), in respect of the expenditure on the software licences. The individual members of the Appellants would then seek to claim income tax loss relief in respect of their respective shares of the Appellants' first year losses.

HMRC opened enquiries and in due course issued closure notices to the Appellants which stated: “I conclude of the losses claimed only a currently unquantifiable part may be allowable” (the Closure Notices).

Daarasp LLP appealed against the closure notice issued to it amending the loss figure in its partnership return for the 2003/04 tax year from £18,192,004.00 to nil.  

Betex LLP appealed against the closure notice issued to it amending the loss figure in its partnership return for the 2005/06 tax year from £25,482,181.00 to nil. 

The FTT dismissed the appeals agreeing with HMRC that the capital allowance claims made by the Appellants were invalid. In the view of the FTT, the Appellants were not trading in the period in respect of which the claims for capital allowances were made. The capital allowance anti-avoidance rules in section 215, CAA 2001, applied to Daarasp LLP and neither of the Appellants was a "small enterprise", within the meaning of section 45(1), CAA 2001 (these points were referred to as the 'knock out points'). 

The Appellants were granted permission to appeal on the following two grounds:

(i)  the FTT had been wrong to conclude that the Closure Notices permitted HMRC to consider the knock out points (the Closure Notice issue); and 

(ii)   the FTT had erred in law in concluding that the only expenditure incurred on the software licences were sums equal to those paid by certain third parties to the software developer (the Expenditure issue). 

The Appellants had to succeed on both grounds in order for their appeals to be allowed. 

UT decision

The appeals were dismissed.

The Appellants argued that the wording of the Closure Notices either expressly, or impliedly, accepted that some of the losses were allowable and that the FTT was not entitled to use the prior history relating to the scope of the enquiry to widen otherwise narrowly drawn Closure Notices. As a result, the FTT had erred in law in disallowing all of the losses claimed.

The UT concluded that the FTT had erred in law in its approach to construing the Closure Notices but, on their proper construction, the FTT did have jurisdiction to consider all of the issues raised by HMRC.

In the view of the UT, the FTT should have considered exactly what conclusions the HMRC officer reached in the Closure Notices when properly construed and whether those conclusions were too narrow to support the amendments made to the Appellants' tax returns. The correct construction of the Closure Notices was to consider them as a whole. HMRC’s conclusions were not to be viewed separately from the amendments made to the tax returns. If it was correct to conclude that the wording of the Closure Notices meant some of the losses would be allowable, as contended for by the Appellants, the amendments to the tax returns would not have been so precise as to reduce the losses to nil and the Closure Notices would have set out how the unquantifiable allowable part was to be quantified. In addition, the HMRC officer would have used the word ‘will’ be allowable rather than ‘may’.

As the Appellants were unsuccessful on the Closure Notice issue, the UT did not consider the Expenditure issue.    

Comment

Although the UT has confirmed that closure notices should be construed as a whole, it considered it wrong, as a general proposition, that amendments to tax returns should be used to construe conclusions contained in closure notices more widely than their ordinary meaning would permit. Amendments to a tax return can only widen or narrow conclusions contained in a closure notice if considered as part of the whole factual matrix, and not if the  meaning of the conclusions is otherwise clear.

The decision can be viewed here.