Tribunal finds for the taxpayer and concludes that a trade was being carried on

In the recent case of Albermale 4 LLP v HMRC,1 the First-tier Tribunal ('FTT') was called upon to consider the difficult question of the meaning of 'trade' for the purpose of section 262 Income Tax (Trading and Other Income) Act 2005 ('ITTOIA 2005').

The FTT also opined on whether 'profits' could include losses, for the purpose of HMRC's discovery powers contained in section 30B Taxes Management Act 1970 ('TMA').

The facts

Albemarle 4 LLP ('Albemarle') was a limited liability partnership formed in December 2002 with four individual members and a corporate representative member. Albemarle acquired five retail parades in 2003 and 2004 and a store in 2005. The purchase of all of the properties was financed mostly using bank loans. The properties generated rental income and were then sold. In 2005 Albemarle acquired three further stores with secured bank lending to finance the majority of the acquisition. Albemarle then entered into a letting agreement with the vendor of the three stores, under which the vendor agreed to procure the letting of the properties on payment of remuneration.

In its tax returns for 2005/06 and 2006/07, Albemarle recorded trading losses in relation to the properties and described its trade as one of 'property investment'. Albemarle argued that these losses were trading losses because its intention when buying the properties had been to improve their value by securing tenants and then selling the properties and that this intention had not changed throughout the relevant period.

HMRC, however, disagreed that Albemarle incurred trading losses and argued that Albemarle's intention had in fact been to continue to hold the properties once tenants had been secured in order to receive rental income, and that the losses were therefore property business losses.

The substantive issue before the FTT was, therefore, whether Albemarle's activities in relation to the properties constituted trading activities. If HMRC were correct, the income arising to Albemarle would be taxed as a property business under part 3 of ITTOIA 2005. This would prevent Albemarle setting-off losses arising from its trade against its general income. If, on the other hand, a trade was being carried on then section 262 ITTOIA 2005 would apply, enabling it to do so.

The FTT's decision

Trade

The FTT analysed the facts in issue and concluded that a trade was in fact being carried on. In particular, the FTT examined the available contemporaneous documentary evidence and concluded that, viewed as a whole, it supported Albemarle's contention that its intention was to realise a profit from the properties in the short term. This meant that the activities of Albemarle were that of trading. References in the documents to 'letting' were, the FTT held, consistent with Albemarle's commercial need to find tenants with a view to selling the properties with such tenants in place, rather than finding long term tenants with a view to accruing rental income.

Of particular importance was the credibility given by the FTT to Albemarle's witnesses. The FTT said:

            "101. Both Mr Egan and Mr Wallis gave evidence which was relevant to the issue of the appellant's intent. Both witnesses came across to me as seasoned participants in commercial property and investment activities. I found both Mr Egan and Mr Wallis to be credible witnesses."

Meaning of 'profits'

HMRC had also purported to make a discovery amendment to Albemarle's partnership return for 2005/06, pursuant to section 30B TMA. Under section 30B(1) TMA, HMRC may amend a partnership return if, amongst other things, it discovers that, in relation to any period, any profits that ought to have been included in the return have been omitted from the return, or any profits included in the return are insufficient. HMRC had argued that the term 'profits' could include negative amounts, such as losses. If HMRC were correct, such a construction of the legislation would enable HMRC to make a discovery amendment on the basis that the loss claimed should in fact be a property loss rather than a trading loss. In the FTT's view, however, the word 'profits' could not conceivably include losses and HMRC could not, therefore, use the legislation to make a discovery amendment under section 30B TMA.

Comment

The decision of the FTT is a reminder of the necessity for careful case preparation where important issues of fact, such as whether a taxpayer is trading, are in point.  It also provides some welcome clarification to the meaning of the term 'profits', for the purposes of HMRC's discovery powers contained in section 30B TMA.

¹ [2013] UKFTT 83 (TC).