When you can have your cake but can’t eat it

A number of recent tax case decisions have made interesting reading, mainly for the wrong reasons. They all focus on Tax Planning in one form or another, although the arrangements or tax planning structures behind each case were very different. Let’s start with two decisions from the Court of Appeal then, one for the Taxpayer and one against.

Tower MCashback

Firstly in HMRC v Tower MCashback LLP 1 & Anor, there were two main points up for consideration in connection with a tax avoidance scheme which sought to obtain tax relief for capital allowances, where previously none had been available. The first point was an important administrative issue to do with HMRCs ability to “widen” the scope of its technical arguments against the scheme, whilst the other was the heart of the tax scheme itself and whether the Tower MCashback partnership was entitled to claim capital allowances for expenditure on the purchase of computer software, largely funded by non-recourse finance.

The first point centred on the closure notice issued by HMRC to close their original enquiry into the Tower MCashback accounts and returns. A closure notice is issued at the end of any HMRC enquiry, and generally provides that the Revenue Officer does not accept the loss or other claim for tax relief etc and states the grounds on which they have reached this conclusion. The Taxpayer may appeal against this closure notice, which in turn commences the legal process. In Tower MCashback the arguments presented to the Special Commissioners (the first stage of that legal process, now replaced by the First Tier Tribunal) at the commencement of the legal process, were different from or expanded upon the reasons stated in the closure notice. The closure notice itself had stated that HMRC were “satisfied that the MCashback scheme fails on the s45(4) CAA 2001 point alone.” Whereas the arguments presented to the Special Commissioners by HMRC were that the planning failed on wider grounds. The first question for the Court of Appeal was whether the “subject matter” of the closure notice and thus the appeal itself, could include those wider arguments or had to be confined to the specifics of the statement made in the closure notice.

In his judgement, Lord Justice Moses gave us his “walk-through” the legislation governing the enquiry and appeals procedure, under both the existing self-assessment regime and under the previous regime of HMRC assessment. There is no doubt that the jurisdiction of the First-Tier Tribunal (and previously the Special Commissioners) on an appeal, is confined to the subject matter of the conclusions and amendments stated in the Closure Notice. Moses LJ concluded however, that the general reasons for denying relief for capital allowances as stated in the closure notice, were wide enough to encompass the so-called new arguments. It is for the fact-finding tribunal (in this case the Special Commissioners) to determine the subject matter of a tax enquiry and the conclusions which closed that enquiry, he said. Lord Justice Scott Baker agreed, whilst Lady Justice Arden did not. The majority rules however, and that part of the appeal was therefore found in favour of HMRC.

With the “right” to raise the arguments determined in HMRCs favour, it was on to the capital allowances claim itself and the question of whether the partnership incurred real expenditure on the acquisition of software licences. A number of earlier relevant tax planning cases were considered, including Barclays Mercantile Business Finance Ltd v Mawson [2004], which also concerned an entitlement to claim capital allowances and circular financing transaction, Macniven v Westmoreland Investments Limited [2001] UKHL 6, Carreras Group Ltd v Stamp Commissioner (Jamaica) [2004] UKPC 16, Astall & Edwards v HMRC [2009] EWCA (discussed below) and Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655.

As in BMBF v Mawson, the circularity of the financing arrangements were not relevant. There was no requirement to consider what the vendor had done with its proceeds of sale or indeed how the purchaser had come to receive is funds in the first place. The question was simply whether the purchaser had actually incurred the expenditure. Unlike Ensign Tankers v Stokes, the partnership had acquired the full economic benefits of the software licences in return for the expenditure it paid and was free to exploit that software for its own benefit.

In a reversal of fortune from Astall and Edwards, discussed below, this time it was the Revenue who were told they could have their cake but not eat it. The Special Commissioners were right to allow the wider arguments to be introduced within the subject matter of the closure notice but it did not affect the outcome and capital allowances could be properly claimed.

Gaines-Cooper

This week has seen many column inches in the press and online, commenting on the Gaines-Cooper case. This case, more than most, seems to have polarised opinion between the tax advisors (who want certainty and many of whom consider that this judgement blurs the edges of the tax residence and domicile rules) and those who take a more emotional line and consider Mr Gaines-Cooper a “tax avoider”, who now has his just desserts. The Court of Appeal decision was delivered on 16 February 2010 following the hearing which took place back in November 2009. However, the case itself has rumbled on for what seems like an eternity and it is now more than 35 years since Gaines-Cooper left the UK, he claims to take up permanent residence and domicile in the Seychelles.

As ever, the Special Commissioner’s judgement laid out the essential facts of the case, when it was first heard way back in July 2006. We learned the irony that Robert Gaines-Cooper’s parents were both Tax Inspectors with HM Inland Revenue. We are also told that after a varied and successful career as an entrepreneur Gaines-Cooper was invited to set up a plastics factory in the Seychelles in 1975. Around this time he met Miss Jane Laye-Sion, his future wife. The daughter of a local civil servant, she was born and bred in the Seychelles but was only 16 when they first met. Gaines-Cooper was granted a residency permit in the Seychelles but retained his British passport, although he claimed Seychellois domicile from 1976 and stated so when he redrafted his will around that time.

Throughout the 1970s and 80s he had interests in a number of businesses and properties around the world, including the Seychelles, the UK, Canada and the USA, although through much of this time his Seychelles property was let to the British Embassy and was therefore not available to him. In 1979 he married for the first time, a woman who was a citizen of both the Netherlands and Indonesia. She apparently preferred to live in their home in California and visited the Seychelles infrequently. They divorced in 1986.

Then in 1993 he married Miss Jane Laye-Sion, who by then had moved to the UK for her education and whose parents had both left the Seychelles also. In 1998 the Gaines-Coopers had a son, James who has since grown up both in the UK, the Seychelles and elsewhere. At the time of his birth his father registered James to be educated at Eaton, and pre-paid the school fees. Throughout this time, Mr Gaines-Cooper also recorded his main residence for certain purposes (gun licence applications for example) as being in the UK.

All in all a very colourful and often glamorous lifestyle is set-out in great detail through the first 25 or so pages of the Special Commissioners’ judgement. What becomes clear, is that in terms of Mr Gaines-Cooper’s domicile position, whilst he may have loosened his ties with the UK, he did not make any other place his permanent home. Rather he seemed to take on an International Jet Set lifestyle around several locations, including the UK. Throughout this time, with the possible (and irrelevant) exception of the mid-70s, Gaines-Cooper’s ties were strongest with the UK, so said the Commissioners. In the end they concluded that he had retained his domicile of origin in the UK and not assumed a domicile of choice in the Seychelles.

Furthermore, they found that his travels outside the UK between 1993 and 2004 were for “occasional residence abroad”, with the result that he should continue to be assessed and charged to income tax “upon the whole amount of his profits or gains, whether they arise from his property in the United Kingdom or elsewhere”. We find this aspect more difficult to understand. Domicile is all about permanence, whilst residence being something else for the Internationally mobile, is by its nature temporary or only semi-permanent. Plenty of people take up temporary positions of employment abroad or come to the UK with every intention of returning to their homeland at some defined or undefined date in the future. It is Gaines-Cooper’s residence status that determines his tax status in the UK and for the most part, his domicile would be irrelevant until his death (unless he were resident here). Perhaps those representing him should have gone for the drop-goal rather than the try, and focused more closely on the residence position, than domicile.

In November 2007 the High Court appeared to have some sympathy with Gaines-Cooper’s argument against this judgement but Mr Justice Lewison could not find that the Commissioners had made an error in law and the appeal was thus dismissed. In 2008 Gaines-Cooper then sought permission to pursue a second appeal in order to challenge the High Court ruling, which upheld the decision of the Special Commissioners. That application was refused by the Court of Appeal, thus bringing to an end the legal process as far as the technical arguments are concerned.

Which brings us to 2010, where Mr Gaines-Cooper has now tried a different tactic, namely to ask the Court of Appeal to grant a judicial review on HMRCs application of their own guidance rules as set-out in their own IR20 pamphlet. That original guidance, which stood for many years, ceased to apply from 6 April 2009 and has now been replaced by a new pamphlet – HMRC6, which is a more onerous interpretation of our UK domicile and residency rules. In his judgement Mr Justice Lloyd Jones refused to grant a judicial review, stating that, whilst HMRC are bound by the terms of any guidance booklet they publish, Gaines-Cooper had not made a distinct break when he left the UK in 1976 and was not therefore within the IR20 guidance.

The Court of Appeal judgment confirms what we always knew, that it is not straightforward to loose either one’s UK residence or domicile status, although the latter is significantly more onerous. Retaining property and other ties to the UK can jeopardise a claim for non-residence status and will almost always ruin a domicile change. Professional advice is crucial for those coming to the UK as well as those leaving and until HMRC introduces a statutory definition of UK residence, which they have confirmed will not happen any time soon (not in the Finance Bill 2010 at least) there will always be uncertainty. Gaines-Cooper adds to that uncertainty and HMRC will inevitably challenge more ex-pats over their residence and domicile status as a result.

Astall & Edwards

Finally, we learn that Astall & Edwards have been refused leave to appeal to the Supreme Court. The Special Commissioners (UKSPC SPC00628), the High Court (2008 EWHC 1471) and the Court of Appeal (2009 EWCA 1010) had all found against the taxpayers, so perhaps it is no bad thing that they are now forced to give up their appeal.

In summary, the taxpayers entered into a KPMG tax avoidance scheme under which they loaned monies to the trustees of a settlement in which they had a beneficial interest. The loans were recorded in a debt instrument or loan note which was structured (they thought) as a relevant discounted security. These particular debt instruments had their own taxing regime and any loss arising from a sale or transfer of an RDS would be allowable against their general income (PAYE earnings and profits, investment income etc.). The loan note therefore contained features which were designed to ensure that it fell within this RDS regime.

In terms of the planning transactions, a short while after the loan was made and following various currency movements, the so-called contingent events, which were predicted to be around 85% likely to occur, the terms of the loan notes changed so that their current market value became a fraction of the amount actually lent to the trustees by the taxpayer. In other words, not only were the loan notes RDSs, they were now virtually worthless RDSs, which Astall and Edwards then sold to a bank for a price that was slightly less than their open market value. The bank redeemed (encashed) the loan notes and the trustees were left with a large capital sum, namely the profit on the loan i.e. the balance of the monies loaned to them by the taxpayer. They no longer had any requirement to “hold” those monies to satisfy a future debt repayment and were therefore free to distribute those funds to the beneficiaries of the settlement, namely the taxpayers themselves.

Messrs Astall and Edwards therefore received almost all of their original loan monies back either as sale proceeds for the RDS they sold to the bank or as a distribution of funds from the settlement. However, as far as their loan note was concerned, they had each made a significant loss, being the amount subscribed for the loan note in the first place (the amount lent to the trustees), less the amount they received for the sale of the loan note to the bank. Arithmetically a loss and one which would be allowable as a deduction against other income, provided the loan note was indeed a Relevant Discounted Security.

At the Special Commissioners hearing Dr John Avery Jones concluded that the events which would give rise to a “profit” under the loan note were so remote and unlikely that they could be ignored. On the other hand, the contingent event (the currency movement) was such a practical certainty that the loan note could be treated as though it had always contained these provisions. It was also a practical certainty that they would be sold to the bank, perhaps not the bank they actually were sold to but a bank nevertheless. All in all, it was a practical certainty that there would have be no event in which the RDS features of the loan notes would be triggered and on that basis, it was not an RDS therefore.

Thus, the taxpayers could have their “arithmetical loss” but without it being a loss on the disposal of an RDS, there was no basis on which it could be set against their other income.

The High Court and Court of Appeal agreed that the Special Commissioners had made no error in law in reaching this decision and, now the Supreme Court has denied leave to appeal, this one would appear to be dead. The decision is probably too narrow to have far reaching implications for other tax planning schemes, although the “son-of-RDS” planning in the form of Gilt Strips, which was perhaps the most widely promoted scheme of the last decade (it seems everyone had their own version), does have significant similarities and the first case in this area will be eagerly awaited.