Investec - Court of Appeal confirms partnership contributions not deductible

In Investec Asset Finance Plc and Another v HMRC [2020] EWCA Civ 579, the Court of Appeal has held that partnership contributions were non-deductible, but has upheld the 'no double taxation' principle and prevented HMRC from introducing arguments not previously relied upon.

Background

Investec Asset Finance Plc and Investec Bank Plc (the taxpayers) entered into a series of complex transactions, the precise detail of which is not relevant for the purpose of this blog, under which they became partners in a number of leasing partnerships. The taxpayers incurred costs in acquiring their interests in the partnerships and subsequently made further capital contributions to the partnerships. Shortly thereafter, the partnerships sold off their assets and received a large sum of money which generated profits in their hands, a large portion of which was then paid over to the taxpayers.

A dispute between the taxpayers and HMRC ensued in respect of their liability for corporation tax in the accounting periods between 1 April 2006 and 31 March 2010, which resulted in two Upper Tribunal (UT) decisions. At the end of the first UT decision, the UT invited further submissions on two points that it had raised for the consideration of the parties.  Following a further hearing, the UT issued a second decision dealing with those points. The second decision resolved some points but remitted one issue back to the First-tier Tribunal (FTT) for further findings of fact.  

The UT granted permission to appeal to the taxpayers and HMRC. 

The appeals raised a number of important substantive and procedural issues.  

The substantive issues concerned the relationship between the statutory provisions relating to the taxation of profits made by partnerships and the taxation of a company’s business where that business includes owning interests in partnerships.  Generally speaking, where a partnership is carried on by persons at least one of which is a company, it is not treated as a separate entity for tax purposes.  According to sections 111 and 114, Income and Corporation Taxes Act 1988 (ICTA), the profits of the partnership are first calculated for the purposes of corporation tax as if the partnership were a company but then those profits are taxed in the hands of the corporate partners according to their proportionate interests in the partnership.  Where those partners are companies rather than individuals, the companies are also liable for corporation tax on their own business profits under section 42,  Finance Act 1998.

The main substantive issue in this case was what happens when some of the income of the corporate partners’ own business comprises profits of partnerships in which the companies own an interest.  Should the profits made by the partnership that have already been taxed in the hands of the partners pursuant to section 114, ICTA, be left out of account when calculating the profits of the partners’ own businesses so as to ensure compliance with the principle that the same profits should not be taxed as income twice?

The procedural issues concerned, firstly, how far HMRC can defend a challenge brought by a taxpayer against a closure notice, by relying on arguments that the proper tax treatment of the taxpayer's affairs should be something different from the conclusions HMRC set out in its closure notice and secondly, can HMRC rely on new arguments before the Court of Appeal?   

Court of Appeal judgment

(i) Deductibility of the capital contributions  

HMRC accepted that the acquisition costs were wholly and exclusively incurred for the taxpayers' own trades but argued that the capital contributions were not deductible from income because they were not wholly and exclusively incurred for those trades, as required by section 74(1), ICTA. The Court agreed with HMRC. The acquisition costs incurred in buying the partnership interests were deductible but the capital contributions were not deductible from any other income of the taxpayers' trades.

(ii) Scope of the closure notices  

With regard to this issue, the Court held that although the FTT did not have an unlimited discretion in determining the matter to which an appeal related, for the purposes of sections 49I(1)(a) or 49G(4), Taxes Management Act 1970, it had been within its jurisdiction to decide on the subject matter of the closure notices. In its view, the FTT had been best placed to determine whether the context and the surrounding circumstances demonstrated that the subject matter was broader than the particular conclusion and adjustments addressed in the notices. It was open to HMRC to put forward arguments in any appeal even if they resulted in a larger amount of tax being due, provided that the different arguments all dealt with the matters identified in the closure notice under consideration. 

(iii) Double taxation issue 

The 'no double taxation' principle applied to exclude from the computation of the income of the companies' trades the amount of the profit that had already been taxed in their section 114(2) separate trades, which the taxpayers' were deemed to carry on as partners in the partnerships. The Court held that the principle did apply and in reaching this decision and HMRC should not be allowed to introduce new arguments at the hearing which were different from those presented in the closure notice, to the FTT, to the UT and in its written submissions before the hearing. The Court therefore dismissed HMRC's appeal on this issue.

Comment

This decision illustrates the complexity of certain aspects of the taxation of corporates with partnership interests, a fact highlighted by the Court's comment that it was not persuaded by the UT's purported distinction between repayment of capital contribution and trading profits.  Although the provisions relating to corporate partners have been in operation for many years, the Court described HMRC’s approach to the law in this area as "to put it kindly, work in progress".

The judgment can be viewed here.