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||Neutral Citation Number:  EWCA Civ 1578
||Case No: A3/2010/2627/CHRVF
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM the High Court of Justice,
Mr Justice Lewison
 EWHC 2582 (Ch)
Royal Courts of Justice
Fetter Lane, London, EC4A 1NL
B e f o r e :
THE CHANCELLOR OF THE HIGH COURT
LORD JUSTICE MOSES
LORD JUSTICE PATTEN
|| THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS
||- and -
||LANSDOWNE PARTNERS LIMITED PARTNERSHIP
Richard Coleman (instructed by HMRC) for the Appellant
John Gardiner QC and John Brinsmead-Stockham (instructed by Pricewaterhouse Coopers Legal LLP) for the Respondent
Hearing dates : 22 - 23 November 2011
HTML VERSION OF JUDGMENT
Crown Copyright ©
The Chancellor :
- In 1998:
(1) Lansdowne Partners International Ltd ("LPIL") was incorporated in the Cayman Islands to carry on the business of an investment fund manager.
(2) Lansdowne Partners Ltd ("LPL") was incorporated in England as a subsidiary of LPIL in order to carry on such a business in England.
(3) The respondent, Lansdowne Partners Limited Partnership ("LPLP") was constituted as a limited partnership under the Limited Partnerships Act 1907 by means of an agreement subject to English Law. Its general partner is LPL, its limited partners have changed from time to time but at the material time were individuals resident in England.
(4) Lansdowne European Equity Fund Ltd ("LEEF") was incorporated in the Cayman Islands as an open ended investment company. It was also registered with the Cayman Islands Monetary Authority under the Mutual Funds Law as a regulated mutual fund but was not and is not recognised in England as a collective investment scheme under the Financial Services and Markets Act 2000.
(5) By an agreement made between LEEF (1) and LPIL (2) ("the Management Agreement") the former appointed the latter to be its manager. The Management Agreement provided for LPIL to be paid a monthly management fee and an annual performance fee calculated, in each case, by reference to the value of the underlying investments of LEEF. LPIL was authorised to delegate responsibility for the management of the underlying investments (clause 4.1) and to waive or rebate all or any part of its fees to LEEF or to any third party (Clause 7.5).
(6) By an Agreement made between LEEF (1) LPIL (2) and LPLP (3) ("the Investment Management Agreement") LPLP was appointed by the other parties thereto to be the investment manager of LEEF to provide portfolio management services in relation to its underlying investments. LPLP was to be remunerated by LPIL by such fee as might be agreed between them from time to time (clause 16.1) and might waive or rebate any part of its fees to LEEF or to any third party (clause 16.9).
- From time to time thereafter LEEF invited investment in various funds by means of the issue of redeemable shares. In relation to each such issue the membership of LPLP might have changed and the detailed terms of both the Management and the Investment Management Agreements were varied. The issue with which this appeal is concerned was made in 2004 on the basis of a prospectus issued by LEEF on 31st August 2004. LEEF invited subscription for 99,998,000 shares divided into two equal classes, A and B, half of each such class being denominated in Euros and US$. The investment objective for each class was to provide investors with good absolute returns. Shares of each class were redeemable on prior notice, subject in some cases to payment of a redemption fee. The prospectus stated that LPIL was entitled to a monthly management fee of 1/12th of 1.5% of the net asset value of each class of share and an annual performance fee equal to 20% of the increase in value of the underlying investments for that year. The prospectus declared that:
"[LPIL] and [LPLP] may from time to time and at their sole discretion and out of their own resources decide to rebate to some or all investors (or their agents including the Directors) or to intermediaries part or all of Management Fees and/or the Performance Fees. [LPLP] may at its discretion rebate its share of the Performance Fee attributable to the Shares issued to it or to its partners, employees and related entities. [LPIL] shares both the Management Fees and the Performance Fees with [LPLP]."
- In the course of its accounting year to 31st March 2005 LPLP received from LPIL £92,232,571 in management and performance fees. It 'rebated' to third parties the sum of £4,696,133 of which a sum in excess of £2m was 'rebated' to its limited partners, their families and trusts. The latter sum was equal to the aggregate of the performance and management fees attributable to the investments in the funds under management representing the money invested by them in the shares in LEEF and in other funds. In the partnership tax return of LPLP for the year ended 5th April 2005 the taxable income or profit of LPLP was stated to be £67,123,805. That amount did not include £2m+ repaid to the limited partners and their associates.
- The partnership tax return of LPLP was sent to and received by HMRC in the third week of August 2005. There was a meeting between representatives of LPL and HMRC on 22nd February 2006 followed by correspondence between them in March 2006. No amended return was put in by LPLP under s.12ABA Taxes Management Act 1970 ("TMA") nor did an officer of HMRC give notice under s.12AC of his intention to enquire into the partnership tax return of LPLP within the time allowed by that section. That time expired on 31st January 2007. It is common ground that on 1st May 2008 HMRC first concluded that the declared profits of LPLP were insufficient because the rebates paid by LPLP to its limited partners, their families and associates had been deducted from the income of LPLP returned for tax purposes. On 27th August 2008 HMRC purported to amend the tax return of LPLP for the year ended 5th April 2005 by increasing the income or profit by £2,194,693 being HMRC's estimate at the time of the aggregate of the 'rebates' to the limited partners, their families and associates. In their covering letter of that date HMRC contended, on the authority of Mackinlay v Arthur Young McLelland Moores  2 AC 239 (Arthur Young), that the deduction of that sum had been precluded by the terms of s.74(1)(a) Income and Corporation Taxes Act 1988 as not being wholly and exclusively laid out or expended for the purposes of the trade or business of LPLP.
- LPLP appealed against the amendment so made pursuant to s.31(1)(c) TMA. They contended that the amendment should not have been made on three grounds:
(1) the sum of £2,194,693 was not part of the income or profits of LPLP liable to tax; alternatively if it was;
(2) such sum was deductible when computing the income or profits of LPLP for tax purposes; alternatively if it was not;
(3) HMRC had not been entitled to make the amendment to the partnership tax return of LPLP because it did not satisfy the condition specified in s.30B(6) TMA in that the relevant officer of HMRC could have been reasonably expected, on the basis of the information described in s.29(6) TMA, to have been aware on or before 31st January 2007 that such sum ought to have been included in the partnership statement as profits or income for the year ended 5th April 2005.
- For the reasons explained by the General Commissioners in their case stated made on 4th March 2010 they considered that the sums so 'rebated' were part of the income or profits for tax purposes of LPLP but were deductible for those purposes because they did comply with the conditions imposed by s.74(1)(a) ICTA. In addition they concluded that HMRC had not been entitled to amend the tax return of LPLP because the relevant officer did have the information from which he could have been reasonably be expected to appreciate that the profits of LPLP were understated by the amount of the 'rebates' to limited partners, their families and associates. HMRC appealed. The appeal came before Lewison J on 7th and 8th October 2010. For the reasons given by him in his judgment handed down on 18th October 2010 he agreed with the General Commissioners on the first and third point. He considered that they had asked themselves the wrong question in relation to the second point and, if necessary, would have remitted the matter to the General Commissioners for them to consider the facts in relation to the correct question. In view of his conclusion on the third point a remission to the General Commissioners on the second point was unnecessary.
- HMRC now appeal to this court on the third point with the permission of Rimer and Etherton LJJ. They agree with the General Commissioners and Lewison J on the first point and with Lewison J on the second point, save to the extent that they submit that there is no need for any remission to the General Commissioners. They invite this court to allow their appeal and declare that LPLP's taxable profits for the year ended 5th April 2005 were £69,142,423. LPLP cross appeal on the first and second points with the permission of Rimer LJ. With the agreement of the parties we heard argument first from LPLP and HMRC on grounds 1 and 2 and then from HMRC and LPLP on ground 3. I will, in due course, deal with them in that order. First, I should refer to the case stated in more detail.
The Case Stated
- The appeal was heard together with an appeal by one of the limited partners, Steven Heinz. Lewison J was not concerned with any further appeal of Mr Heinz nor are we. In paragraph 6 the General Commissioners referred to the facts I have already summarised. They had witness statements from two witnesses on behalf of LPLP, Ms Suzanna Nutton, the head of operations for the investment management business of LPLP and a limited partner, and Mr Yok Wah Tai, head of finance and chief compliance officer of LPL and a limited partner in LPLP. Each of them was cross-examined. The General Commissioners also had witness statements from Mr Desmond Ryan, the Inspector of Taxes responsible for the taxation affairs of LPL down to 14th November 2008, and Mr Steve Terry, his immediate superior and an aspect enquiry team leader. They were both cross-examined as well. In paragraph 10 of the Case Stated the General Commissioners recorded that:
"We considered the evidence and arguments put before us. We were prepared to accept the evidence given by the four witnesses as modified under cross examination with the proviso that we consider that neither Steven Terry nor Desmond Ryan were in a position to give direct evidence on what knowledge was actually held by Revenue officers at the Cardiff office during the time that they had conduct of the file for LPLP."
The General Commissioners then referred to various specific findings not relevant to this appeal.
- In his judgment Lewison J commented on the problems caused by the failure of the General Commissioners properly to find the relevant facts. He proceeded in paragraph 5 of his judgment to set out the facts relevant to the first two questions he had to decide. Neither side has criticised them. Accordingly I reproduce that paragraph as representing the facts as found by the General Commissioners. He said:
"(i) It is the strong norm in the industry for the investment manager principals or partners to make substantial investments of their personal monies in the funds to which their fund provides investment management services (Ms Nutton's witness statement § 3; Case §10.2.2);
(ii) Investment by partners is not compulsory (§ 7A.8); and there is no formal requirement about how much partners should invest (§ 7B.7);
(iii) Ms Nutton did not invest her own money immediately on becoming a partner but did so later on (§ 7A.3). Mr Tai made his first personal investment six to nine months after becoming a partner (§ 7B.2);
(iv) Investments by partners were partly for creating confidence in clients; partly for financial gain, and partly for convenience. Partner investment gives a strong message to clients and makes investment managers risk averse (§ 7A.10). There were advantages to partners in investing in the funds under management by the partnership. It avoided having to contact brokers and keep a separate check on personal investments; avoided conflicts of interest, and simplified the obtaining of consents needed for regulatory purposes (§ 7B.6);
(v) In so far as the individual limited partners manage investments, they do so as employees of the general partner under contracts of employment (§ 7B.12);
(vi) Investment manager principals who invest in the funds under management do not pay performance fees or management fees on their investments. Either they have zero fee shares, or the fees are rebated to them (§ 7A.14);
(vii) Rebates to partners are discretionary (§ 7B.8). However, it was inevitable that at the end of the year rebates would be paid, and so the partnership's accounts record this. The partnership receives management fees monthly. It makes accruals for rebates in the accounts on a monthly basis. Performance fees are only shown in the accounts when they are received in cash after the fund year, which is typically 10 days after 31 December in each year. Rebates of performance fees are typically paid within ten days. (§ 7B.4);
(viii) Rebates are also given to members of partners' families and their trusts such as pension schemes. The thinking behind this is that if a partner puts money into a pension scheme he looks on it as his own money (§ 7B.11)
(ix) Fees are rebated to outside investors, but this will always be covered by a written agreement. Rebates made under such an agreement are not discretionary (§ 7A.17), but are contractual (§ 7B.8). Some investors positively demand rebates (§ 7B.8). In the case of rebates to outside investors the level of rebate is lower, amounting to between a third and a quarter of the fees (§ 7A.17);
(x) Performance and management fees received by [LPIL] come directly from the funds that it manages (§ 7A.20). There is no contractual relationship between the funds and the partners (§ 7A.19); although there is a contractual relationship (in the shape of the prospectus) between investors (including partners who invest) and the funds (§ 6.10);
(xi) The partnership receives from [LPIL] 90 per cent of the management fee and 100 per cent of the performance fee (Mr Tai's witness statement § 35). However, the fees rebated to the partners amounts to 100 per cent of both fees (Mr Tai's witness statement § 47);
(xii) As from the beginning of 2008 partners no longer paid fees and received rebates. Instead they subscribed for zero fee shares (Ms Nutton's witness statement §§ 8, 9); and their existing holdings were converted into zero fee shares (Ms Nutton's witness statement § 20)."
In relation to the third issue, the General Commissioners and Lewison J referred to other facts not relevant to the first and second issues. I will deal with them when I come to consider the third issue.
- In the course of the submissions of counsel for LPLP the court questioned the suggestion that the investments of LEEF allocated to its A or B shares were to be regarded as belonging to the investors in those shares. The consequence, so it was submitted, is that management or performance fees paid out of those investments and debited to the funds allocated to those shares are to be regarded as paid by the relevant partner. In support of that submission we were, at the conclusion of counsel's submissions, referred to s.152 Finance Act 1995 whereunder open ended investment companies may, in accordance with regulations made by the Treasury, be treated for certain tax purposes as if they were unit trusts. No such suggestion had been made to either the General Commissioners, to Lewison J or in the written arguments of counsel on the appeals to this court. However it appears from the note of counsel we requested that the Treasury regulations do not seek to apply the provisions of s.152 Finance Act 1995 to companies, like LEEF, which were incorporated overseas.
Should the rebated fees have been included in the income or profits of LPLP for tax purposes?
- Logically, this issue comes first for if they are not so included there is no occasion to deduct them. The issue was argued and decided first by both the General Commissioners and by Lewison J. In this court counsel for LPLP argued it second on the basis that if he failed to persuade us that the rebated fees should be deducted then they should not have been included in the income or profit of LPLP in the first place. In my view these issues are most conveniently considered in their logical order. Accordingly I will consider this issue first. If I conclude that the fees are properly included in the income or profits of LPLP for tax purposes but are not deductible then I will reconsider my conclusion on the first issue in the light of my conclusion on the second and the submissions of counsel for LPLP.
- Ss.12AA and 12AB TMA oblige a partnership through such of its partners as an officer of HMRC may identify to make a return accompanied by the partnership accounts and a partnership statement showing for each accounting period the amount of income from each source taking into account any relief or allowance which has accrued to the partnership for the period in question. S.18 Income and Corporation Taxes Act 1988 ("ICTA"), in force at the relevant time, provides for the taxation under Schedule D of the annual profits or gains arising to any person resident in the UK from any trade profession or vocation wherever carried on. The computation of those profits is to be in accordance with generally accepted accounting practice but subject to any adjustment required or authorised by law, see Finance Act 1998 s.42. One of those adjustments is contained in s.74(1)(a) ICTA which prohibits a deduction of any expense "not being money wholly and exclusively laid out or expended for the purposes of the trade profession or vocation". In the case of a partnership its profits are to be computed in like manner as if the partnership were an individual resident in the UK but it is not otherwise to be treated as an entity separate and distinct from its partners, see s.111 ICTA.
- Subject to the arguments for LPLP, to which I shall refer shortly, it is clear that the fees are receivable by LPLP as consideration for its investment management services under the Investment Management Agreement. They are payable to LPLP by LPIL. No doubt the amount of the fee is ascertained by reference to the fees payable to LPIL by LEEF under the Management Agreement. In addition the fees paid by LEEF to LPIL under the Management Agreement will diminish any amount payable to an investor/member of LEEF on redemption of his shares. But the fees paid to LPLP by LPIL are not paid by LPIL as agent for LEEF or the investor/members of LEEF nor are they paid out of monies to which the investor/members of LEEF are beneficially entitled. Accordingly, subject to those arguments, the fees received by LPLP from LPIL do constitute income of the trade of LPLP which should be shown in the partnership return required by s.12AB TMA. That was the conclusion of the General Commissioners. In paragraph 8.4.1 they said:
"The overriding question is whether the fees received by LPLP were ordinary profits. Prima facie they are. They were paid by LPIL under a contractual obligation and treated as partnership income in the accounts."
It is clear that Lewison J was of the same opinion.
- The contrary argument advanced by LPLP before the General Commissioners and Lewison J was founded on what their counsel called the principle of mutuality or mutual trading. The principle has been described in a number of aphorisms such as 'a man cannot trade with himself' (Dublin Corporation v M'Adam (1887) 2 TC 387, 397), 'a man cannot make a profit by taking money out of one pocket and putting it into another' (Harris v Corporation of Burgh of Irvine (1900) 4 TC 221, 233) and 'a self-employed plumber would not be expected to charge himself for fixing his own bathroom' (HMRC v Lansdowne Partners Limited Partnership  EWHC 2582 para 7). The application of the principle is exemplified in cases such as The Carlisle and Silloth Golf Club v Smith (1913) 6 TC 198 in which the green fees paid by members of the club were not income or profits liable to tax but green fees payable by non members were; or National Association of Local Government Officers v Watkins (1934) 18 TC 499 where the charges paid by members of a trade union which owned a holiday camp were not income subject to tax but charges paid by others were. Similarly, the surplus of premiums over claims paid by a mutual insurance company was not a profit liable to tax, Jones v South-West Lancashire Coal Owners Association  AC 827.
- The principle has been formulated more precisely by Lord Wilberforce in Fletcher v Income Tax Commissioner  AC 414, 421 in these terms:
"The expression "the mutuality principle" has been devised to express the basis for exemption of these groups from taxation. It is a convenient expression, but the situations it covers are not in all respects alike. In some cases the essence of the matter is that the group of persons in question is not in any sense trading, so the starting point for an assessment for income tax in respect of trading profits does not exist. In other cases, there may be in some sense a trading activity, but the objective, or the outcome, is not profits, it is merely to cover expenditure and to return any surplus, directly or indirectly, sooner or later, to the members of the group. These two criteria often, perhaps generally, overlap; since one of the criteria of a trade is the intention to make profits, and a surplus comes to be called a profit if it derives from a trade. So the issue is better framed as one question, rather than two: is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it, on the other, a mutual arrangement which, at most, gives rise to a surplus?"
- In this case the General Commissioners considered that the relevant activity of LPLP was a trade. In paragraph 10.1 of the Case Stated they said:
"10.1 Mutual trading
10.1.1 We do not accept that rebates of management fee and performance fee payments made to [Mr Heinz] and other partners in LPLP fall under the category of mutual trading.
10.1.2 The nature of the activities of LPLP does not fit into any of the categories of the cases presented to us which succeeded in showing elements of mutual trading. In particular LPLP trades for a profit and on our reading of the cases put to us we would have had to find that it had been set up (or at least a part would have had to be set up) with the intention of providing some non profit benefit to a class of people. We were unable to so find.
10.1.3 Other factors which we believe show this was not mutual trading are that [Mr Heinz] and the other partners received rebates as partners whereas the fees were paid on their behalf as investors and LPLP rebates 100% management and performance fees but only receives 90% management fee from LPIL.
10.1.4 In terms of the question of who makes payments and who receives rebates we might have been willing to accept that it would not be fatal to LPLP's appeal before us that fees are paid by LPIL not the individual investors as we find that the fees are paid by LPIL on behalf of [Mr Heinz] and other investors, calculated individually according to their individual investments."
- Lewison J to whom the same or similar arguments were addressed agreed. In paragraph 18 of his judgment he said:
"Consequently in my judgment the Commissioners were entitled to conclude that the receipts by the partnership were to be taken into account in computing its profits. That leads on to the next question: if the receipts are to be taken into account in computing profits, are the rebates proper deductions?"
- In this court counsel for LPLP put the point somewhat differently as an alternative to the second issue of deductibility. LPLP contends that the rebated fees are not the subject matter of trade at all because, to quote their written argument, they "are never intended to give rise to profit in LPLP. Those moneys are destined simply to be returned to the persons against whom they were, prima facie, initially chargeable." In this court the contention is raised only in respect the fees LPLP actually receives from LPIL, that is all the performance fees and 90% of the management fees amounting in all to £1,968,693 which are attributable to fees paid on account of limited partners. This figure, therefore, omits the sum of £49,925 being the rebates paid by LPLP not to limited partners but to persons or entities connected with them. They rely on that part of the speech of Lord Wilberforce in Fletcher v Income Tax Commissioner  AC 414 where he refers to:
"…other cases, [where] there may be in some sense a trading activity, but the objective, or the outcome, is not profits, it is merely to cover expenditure and to return any surplus, directly or indirectly, sooner or later, to the members of the group."
They contend, in reliance on the findings of the General Commissioners summarised by Lewison J and quoted in paragraph 9 (vii) and (x) above, that the fees are paid by LEEF to LPIL and by LPIL to LPLP on behalf of the limited partners in LPLP and in the confident expectation that they will be repaid by LPLP to the limited partners.
- I do not accept these submissions. They involve disregarding the plain effect of a number of commercial documents and legal relationships which are not alleged to be shams. First, the relationship between the investor/limited partner and LEEF is that of member and limited company. The investor/limited partner pays his money to LEEF by way of subscription for redeemable A or B class shares in LEEF. In no sense does the investor/limited partner retain any beneficial interest in such money such as to be traceable into any investment made by LEEF with that money. Second, the management and performance fees payable by LEEF to LPIL are those ascertainable in accordance with the terms of the Management Agreement in relation to all investments and are paid out of money or investments beneficially owned by LEEF. The amount of those fees attributable to money subscribed in LEEF by an investor/limited partner are capable of being ascertained but they are not paid out of the investor/limited partner's money or on his behalf in any agency sense. Third, the consideration payable to LPLP is payable by LPIL, not LEEF or any investor/limited partner. Under the terms of the Investment Management Agreement the amount is to be determined by agreement between LPIL and LPLP. In the event it may have been equal to all the performance fees and 90% of the management fees paid by LEEF to LPIL but the Investment Management Agreement did not require it. Fourth, the sums paid to the investor/limited partners were not fixed and were payable at the discretion of LPLP. Whatever their expectation the investor/limited partners had no right to them. If LEEF, LPIL or LPLP had become insolvent any link between the subscription money and the amounts receivable from LPLP would have been broken. Fifth, if and when an investor/limited partner gave notice to redeem his A or B shares in LEEF the amount payable to him by LEEF would be reduced by the amount of the fees paid by LEEF to LPIL for the investment of its funds. It is only then and in that sense that the cost of the management services of LPIL and, by sub-contract, the investment services of LPLP would be borne by the investor/limited partner.
- In my view it is plain from this analysis that there is no 'mutuality' between what the investor/limited partner pays and receives; the activities of LPLP are not divisible between investing on behalf of limited partners and others; there is no surplus or common fund remaining after expenditure of contributions on the activity for which they were paid; there are none of the hallmarks which accounted for the decision in the cases on which counsel for LPLP relied. In short the fees received by LPLP from LPIL as consideration for its services under the Investment Management Agreement are income or profits arising to LPLP from its trade as an investment manager and are taxable under Schedule D. For the reasons I have explained, I will reconsider this conclusion after I have considered the second issue, namely whether the amounts paid by LPLP to investor/limited partners are deductible in computing those profits.
Were the sums paid by LPLP to its limited partners deductible for tax purposes?
- I have already quoted from s.42 Finance Act 1998 to the effect that the profits of a trade are to be computed in accordance with generally accepted accounting treatment. Counsel for LPLP points out that the accounts drawn up by Ernst & Young show the gross fees received from LPIL less all amounts repaid to investors whether they are also limited partners or not. In the case of amounts repaid to investors who are not limited partners it is accepted by HMRC that such expenditure is "money wholly and exclusively laid out or expended for the purposes of the trade" within s.74(1)(a) ICTA. Why, counsel for LPLP ask rhetorically, should it be different in the case of limited partners?
- The General Commissioners considered that they were not different. In paragraph 10.2 of the Case Stated they said:
"10.2.1 We are prepared to accept that the rebates paid to [Mr Heinz] and other partners are deductible expenses.
10.2.2 We consider that Mallalieu and Arthur Young are distinguishable as the non deductible items in those cases relate to a claim for tax allowances on personal expenses or reimbursement of personal expenses for employees. Here the fee rebates are of the same nature as those to non partners which were accepted by HMRC as deductible expenses of the business. Does it matter that there was no express contract by which the fees were rebated to partners? From the evidence put forward on behalf of LPLP, especially that of Suzanna Nutton we accept that fee rebates were the strong norm in the business and partners expected fee rebates. Furthermore we believe that if the fee rebates had not been given it would have been a significant sign that partners were not valued (especially but not merely if given to some but not others) and there was a significant danger that non rebated partners would have left. As such the rebates were part of partner care and we find that they were paid wholly and exclusively for the purposes of a trade."
- Lewison J disagreed. In paragraph 28 of his judgment he said:
"I agree with [counsel for HMRC] that the Commissioners asked themselves the wrong question. They concentrated on the reason why the rebates to partners were made; and treated that as the relevant purpose. But as Arthur Young shows the relevant purpose is the purpose of the individual partner in making the expenditure in the first place. The Commissioners appear to have distinguished Arthur Young on the ground that it concerned reimbursement of personal expenses for employees. It did not. The House of Lords was at pains to stress that the reimbursement of expenditure incurred by a partner was quite different from the reimbursement of expenditure incurred by an employee. In my judgment the distinction drawn by the Commissioners did not exist."
In paragraph 32 he concluded that the purpose of the original outlay was a question of fact. As the General Commissioners had not asked themselves that question, if it arose, the matter would have to be remitted to the General Commissioners for them to make the relevant finding.
- The order of Lewison J is challenged by HMRC and LPLP. The former contend that the judge was wrong to remit the issue of the purpose of the repayments to the General Commissioners because there could be only one answer. They submit that we should set aside that part of his order and declare that the taxable income of LPLP for the year ended 5th April 2005 was £69,142,423. LPLP contend that the judge was wrong in his analysis of Arthur Young and reversed the conclusion of the General Commissioners without sufficient cause.
- Mackinlay v Arthur Young McLelland Moores  2 AC 239 concerned the reimbursement to partners of relocation expenses incurred by them personally in moving house to another part of the country where they were required to work. Two partners were so reimbursed but the Inspector of Taxes refused to allow a claim to deduct those sums in computing the profits of the partnership on the ground that they had not been laid out wholly and exclusively in the business of the partnership. The appeal of the partnership was allowed by the Special Commissioners and the Court of Appeal but not by Vinelott J and the House of Lords. The other members of the Appellate Committee agreed with the speech of Lord Oliver of Aylmerton. After describing the circumstances in which the appeal arose, Lord Oliver cited with approval the following description of Vinelott J of the process for ascertaining the tax liability of a partnership:
"There are, in effect, three stages. First, the profits of the firm for an appropriate basis period must be ascertained. What has to be ascertained is the profits of the firm and not of the individual partners. That is not, I think, stated anywhere in the Income Tax Acts, but it follows necessarily from the fact that there is only one business and not a number of different businesses carried on by each of the partners. The income of the firm for the year is then treated as divided between the partners who were partners during the year to which the claim relates - the year of assessment in one of the many senses of that word: see the proviso to section 26 of the Income and Corporation Taxes Act 1970. That is the second stage. The tax payable is then calculated according to the circumstances of each partner - that is, after taking into account on the one hand any personal allowances, reliefs or deductions to which he is entitled and any higher rate of tax for which he is liable. The Acts do not provide for the way in which personal allowances, reliefs and deductions are to be apportioned between the partnership income and other income. I understand that in practice they are deducted from the share of the partnership income if that was the partner's main source of income. When the tax exigible in respect of each share of the partnership income has been ascertained the total tax payable is calculated. Section 152 (formerly rule 10 of the Rules applicable to Cases I and II of Schedule D) provides that the total sum so calculated is to be treated as 'one sum … separate and distinct from any other tax chargeable on those persons … and a joint assessment shall be made in the partnership name.' That is the third stage."
- Lord Oliver then posed the question in that appeal in the following terms (p.250A):
"The question in the instant case is whether, at the first stage, moneys paid out of the partnership assets to a partner in order to indemnify him against expenses incurred by him out of his own pocket otherwise than on behalf of the partnership or in the course of acting in the partnership business can be deducted at the first stage as being a payment any personal benefit from which is purely incidental or ancillary to the purposes of the firm considered as an entity separate from the recipient."
Lord Oliver then described the detailed facts of the appeal and continued (p.251H):
"In order to justify treating expenditure by an individual partner on a different footing, it was necessary, in effect, to ignore any benefit deriving from the original outlay made by him as an individual and to treat as the relevant purpose only the motive of the executive committee in making the reimbursement out of the partnership funds, from which of course the firm as such derived no benefit beyond that of securing the performance of the individual partner's services in the most convenient area. Thus the respondent's case rested before your Lordships upon the proposition that, in its relationship to individual partners, the firm can be treated as a separate legal entity in exactly the same way as if the relationship were that of employer and employee."
For reasons he described in some detail Lord Oliver rejected that proposition.
- He expressed the true principle (p.254H) in the following passage:
"A partner, on the other hand, whether he be senior or junior is in a quite different position. What he receives out of the partnership funds falls to be brought into account in ascertaining his share of the profits of the firm except in so far he can demonstrate that it represents a payment to him in reimbursement of sums expended by him on partnership purposes in the carrying on of the partnership business or practice - the example was given in the course of argument of the partner travelling to and staying in Edinburgh on the business of the firm - or a payment entirely collateral made to him otherwise than in his capacity as a partner (as in Heastie v. Veitch & Co.  1 K.B. 535). It may be that in relation to a particular receipt by a partner of partnership moneys not falling under either of the above heads, his co-partners are agreeable to his retaining it without bringing it into account so that to that extent the divisible profits at the end of the year are notionally reduced by the amount retained; but this cannot alter the fact that what is retained is part of the profits which would otherwise be divisible. What is taxable is the actual not the notional profit and what has to be demonstrated if a deduction is to be allowed for tax purposes in respect of moneys paid to a partner is that it was paid exclusively for the purposes of the partnership business."
In the result the House of Lords concluded that the expenditure on moving served the personal interests of the partners. Accordingly, it was not deductible.
- In this appeal counsel for LPLP seek to distinguish the decision of the House of Lords in Arthur Young on two grounds. They contend, first, that the payments of the fees to the investor/limited partners was in their capacity as investors, not as limited partners and, second that the initial payment by them was to the partnership, not to a third party. I will consider each of those contentions in turn.
- The first contention arises from the qualification in the speech of Lord Oliver, which I have quoted already, namely "a payment entirely collateral made to him otherwise than in his capacity as a partner". That exception recognised the decision of the Court of Appeal in Heastie v. Veitch & Co.  1 K.B. 535. In that case one partner permitted the partnership to occupy premises separately owned by him in return for what the Special Commissioners found to be a fair and proper rent. The Court of Appeal concluded that such rent was properly allowed as a deduction in computing the profits of the partnership for tax purposes because it was paid to that partner as landlord, not as partner.
- Counsel for HMRC suggests that the collateral payment principle cannot apply to payments out of partnership funds to a partner to reimburse him for expenses he incurred. In addition, he submits, it cannot apply on the facts of this case even if the initial expenditure by the partner was a payment to the partnership itself not to a third party. For my part I would accept both of those contentions.
- In relation to the first, a payment to a partner in reimbursement of expenses incurred by him in relation to the partnership business cannot, by definition, be entirely collateral to his status or capacity of partner; nor is there anything in the decision of the Court of Appeal in Heastie v. Veitch & Co. to suggest otherwise. So, in my view, the distinction is not a proper one as a matter of law. In addition the facts do not fit the suggested distinction. The repayments are made to individuals because they are (1) investors and (2) limited partners. None of the relevant repayments were or would have been made to individuals who did not satisfy both those qualifications. It follows that no such repayment can be entirely collateral to the recipient's position as a partner.
- In relation to the second, it is true that the principle was expounded by Lord Oliver in the context of a payment to a partner in reimbursement of expenses paid by him in relation to the partnership business. If it be assumed that the initial payment was made by the partner to the partnership its repayment cannot give rise to expenditure entirely collateral to his position as a partner. It may or may not satisfy the conditions specified in s.74(1)(a) ICTA but that will depend on the purpose of his initial payment. As Lord Oliver observed in the passage in his speech I have quoted already:
"What he [the partner] receives out of the partnership funds falls to be brought into account in ascertaining his share of the profits of the firm except in so far he can demonstrate that it represents a payment to him in reimbursement of sums expended by him on partnership purposes in the carrying on of the partnership business or practice…"
- But even if the suggested distinction gave rise to a different legal result it could not apply in the circumstances of this case. What the limited partner paid as an investor was paid to LEEF in subscription for A or B shares. He did not pay the performance or management fees to either LPIL or LPLP. They were paid respectively by LEEF and LPIL. What he receives is not entirely collateral to his position as a partner and is not applied wholly and exclusively for the purposes of the trade of the partnership.
- For these reasons I do not accept either ground as sufficient to distinguish the decision of the House of Lords in Arthur Young or to preclude its application to the facts of this case. It follows that the sums repaid are not deductible for tax purposes. In that context I revert to the first issue where I left it in paragraph 20 above. The submission was to the effect that if, prima facie, the performance and management fees, attributable to the investments made by LEEF with the money subscribed by a limited partner, received by LPLP, constituted part of its taxable income but was not deductible for tax purposes then that was itself a reason for concluding that it was not part of the income of LPLP in the first place. But this argument was based on the proposition that the only reason for concluding that the repayment was not deductible would be that the limited partners both paid the fees to LPLP and received the repayments from LPLP in their capacity as partners. As that is not the ground for my conclusion on deductibility I see no reason to reconsider what I have stated in paragraph 20 and preceding paragraphs.
- I turn then to consider the contentions of HMRC that it would be pointless to remit to the General Commissioners the question of the purpose of the repayments made by LPLP to the investor/limited partners. HMRC point out that the purpose of remission would be to ascertain the object of the limited partners in subscribing for shares in LEEF, see, for example, Mallalieu v Drummond  2 AC 861, 870D-871A. HMRC contend that expenditure on personal investments must, by definition, be made in the personal interests of the partners. Further, the General Commissioners had, contrary to what Lewison J thought, found the relevant facts in the Case Stated. They rely on paragraph 7A.10 where the General Commissioners said:
"7A.10 Investments by partners in LPLP were partly for creating confidence in clients, partly for personal financial gain and partly for convenience. Investment managers spend the whole day considering investments. It is convenient to have personal wealth in the fund as managed by the job. Partners could choose to have personal portfolios that mirror the fund but the arrangement avoids peer trading. Partner investment gives a strong message to investors and makes investment managers risk averse."
Although that statement was made in connection with the evidence of Ms Nutton there is no suggestion that it was undermined in cross-examination or by the evidence of others. Accordingly, it is to be regarded as accepted by the General Commissioners and to be part of their factual findings.
- I did not understand counsel for LPLP to challenge that submission. I see no reason not to accept it. Lewison J did not order any remission because of his conclusion on the third issue. Similarly in this court all now depends on our conclusion on the third point. To that point I now turn.
Was HMRC entitled to amend the return of LPLP?
- The regime of self-assessment requires the taxpayer to include in his return an assessment of the amount payable by him by way of income tax in respect of the income declared by him in his return, s.9 TMA. Such return and assessment may be amended by the taxpayer within 12 months of its filing date under s.9ZA. In addition HMRC is entitled to correct obvious errors or omissions under s.9ZB within 9 months of its delivery to them by the taxpayer. HMRC may also within a limited time enquire into a return by giving notice under s.9A. Both the taxpayer and HMRC may amend the return in the course of the enquiry in accordance with ss.9B and 9C and may refer questions to the Tribunal in the case of a doubt. An enquiry is terminated by a closure notice given under s.28A. Parallel provisions exist in relation to a partnership return and partnership statement required under s.12AA and 12AB. After the completion of all these steps or the expiration of the periods in which they may respectively be taken a taxpayer's self-assessment is, effectively, final unless a 'discovery' is made by an officer of HMRC in accordance with ss.29 and 30B TMA, see, for example, Monro v HMRC  Ch 69.
- The provisions relating to a discovery in relation to individuals are contained in s.29 and in relation to a partnership in s.30B. The relevant discovery is dealt with in s.30B(1) in these terms:
"(1) Where an officer of the Board or the Board discover, as regards a partnership statement made by any person (the representative partner) in respect of any period—
(a) that any profits which ought to have been included in the statement have not been so included, or
(b) that an amount of profits so included is or has become insufficient, or
(c) that any relief or allowance claimed by the representative partner is or has become excessive,
the officer or, as the case may be, the Board may, subject to subsections (3) and (4) below, by notice to that partner so amend the partnership return as to make good the omission or deficiency or eliminate the excess."
- As I have already recorded, it is common ground that the relevant discovery was made on 1st May 2008, some 15 months after the time limit on HMRC instituting an enquiry had passed. It was, as stated in the letter from HMRC dated 27th August 2008, that the profits shown in the return of LPLP were understated in that they should have included the amount of the rebates paid to limited partners so that the allocation of profit to each partner needed to be amended. The letter indicated that the partnership return of LPLP for the year ended 5th April 2005 was amended as shown in the document attached.
- The power to make such an amendment is dependent on satisfaction of one of two conditions, see s.30B(4). The condition relevant to this case is that set out in s.30B(6) in the following terms:
"(6) The second condition is that at the time when an officer of the Board—
(a) ceased to be entitled to give notice of his intention to enquire into the representative partner's partnership return; or
the officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the situation mentioned in subsection (1) above."
The relevant date for the purposes of subsection (6)(a) is 31st January 2007.
- The relevant information is that set out in s.29(6) which is applied referentially by s.30B(7) with the corresponding alterations there specified. S.29(6) so far as relevant provides:
"(6) For the purposes of subsection (5) above, information is made available to an officer of the Board if—
(a) it is contained in [the representative partner's partnership return] in respect of the relevant year of assessment (the return), or in any accounts, statements or documents accompanying the return;
(b) it is contained in any claim made as regards the relevant year of assessment by [the representative partner] acting in the same capacity as that in which he made the return, or in any accounts, statements or documents accompanying any such claim;
(c) it is contained in any documents, accounts or particulars which, for the purposes of any enquiries into the return or any such claim by an officer of the Board, are produced or furnished by [the representative partner] to the officer. . .; or
(d) it is information the existence of which, and the relevance of which as regards the situation mentioned in subsection (1) above—
(i) could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or
(ii) are notified in writing by [the representative partner] to an officer of the Board."
- The information on which LPLP relies for its contention that HMRC could have been reasonably expected to be aware that the profits of LPLP were understated by the amount of the rebates paid to limited partners or to persons or entities connected with them is contained in two exchanges, one in 2000 the other in 2006. The exchange in 2000 comprised a letter from Ms Holdsworth, an Inspector of Taxes, to Ernst & Young acting for LPL and the reply of the latter dated 4th July 2000. So far as relevant they were in the following terms:
(1) Ms Holdsworth wrote on 11 May 2000:
"There is provision for rebate of both the management and performance fees. In particular [LPLP] will rebate out of its own resources all the performance fees received by it and relating to shares issued to it, its partners or related entities. [LPLP] will also rebate part of the management fee attributable to shares subscribed for in the IPO as long as held by the original subscriber. These rebates may be applied in paying up additional shares to the shareholder.
Please provide an analysis of the rebates of £90,362 and £239,361 shown in the partnership accounts, indicating the name of the investor, whether and how connected with [LPL] and/or [LPLP], the amount rebated and what amount, if any, was used to pay up additional shares."
(2) Ernst & Young replied on 4 July 2000:
"We enclose a schedule detailing the performance and management fee rebates that have been paid and accrued for the period ended 31 March 1999. Of the investors listed, the only parties to be connected with Lansdowne were [names were given]."
- Nothing relevant to this issue then occurred until 2006. By then the relevant officer of HMRC had in his possession the partnership return and statement of LPLP for the year ended 5th April 2005 and the accounts for the year ended 31st March 2005 which showed:
Management fees 23,805,497
Performance fees 68,427,074
To the General Partner (20,410,341)
Bank Charges (2,292)
Operating Profit 67,123,805
There was no note or other indication that part of the sum deducted on account of rebates had been paid to any of the limited partners.
- On 22nd February 2006 there was a meeting between Mr Mike Gregory, an employer compliance office of HMRC, and Mr Tai of LPLP. Mr Gregory made a note of that meeting which recorded, amongst other things:
"Directors/Partners invest their own money in the funds which they are responsible for managing.
As with all investors they are charged a management fee which is paid to a separate entity which is a partnership formed by the directors and senior managers of [the general partner].
The directors and other partners then claim a refund from [the partnership] in respect of the portion of the overall management fee which relates to their own investments.
Mr Tai believes the individuals return this income on their own Tax Returns but was unsure whether a liability in the true sense arises and used an analogy of a plumber fixing his own bathroom and not charging himself for the labour.
[Mr Gregory] advised Mr Tai whilst this transaction is outside the review of the [general partner] he would need to consult and pass the information on to each individual's tax office for their consideration and [Mr Gregory] will ask for a full list of partners and their National Insurance numbers in follow-up."
- On 15th March 2006 Mr Gregory wrote to Mr Tai. He enclosed a copy of his note of their meeting and said:
"… if you have any observations to make with regards to these notes please would you make me aware of those observations in your reply to this letter."
Later on he added:
"My understanding from our meeting was that the rebates of fees in respect of the partners was paid back to the [partnership] and was not paid back through [the general partner]. Understanding this to be the case, I would request details of the names and addresses of each of the partners along with their National Insurance numbers so that I may notify the partners' individual tax offices of the fee rebate arrangements. It will then be up to the partners' own tax offices to make further enquiries with regards to this item should they wish to do so."
On 30th March Mr Tai acknowledged receipt of the letter of 15th March and continued:
As requested please find attached:
In paragraph 10.3 of the Case Stated the General Commissioners recounted this evidence and concluded that HMRC were out of time for amending LPLP's tax return under s.30B on the basis of a discovery. They considered (paragraph 10.3.4) that:
- name, address and N.I. No of each partner for tax years 2004-5 and 2005-6."
"…it is only necessary that information is given to HMRC which would enable a decision to be made by HMRC whether to raise an additional tax assessment."
This was based on the fact that in Ernst & Young's letter dated 4th July 2000 and again by Mr Tai's letter dated 30th March 2006 the fact that some of the rebates had been paid to partners had been disclosed to an officer of HMRC. Lewison J considered  that the exchange in 2000 was not relevant to the particular year of assessment under consideration and was, accordingly, of no assistance. I did not understand HMRC to dissent from that view, LPLP considered that it was unnecessary to rely on the correspondence from 2000. Lewison J concluded in paragraph 59 that the General Commissioners had asked themselves the right question and that their answer to it was open to them on the evidence.
HMRC now appeal. Their counsel submits, correctly, that it is important to identify the information available to the hypothetical officer of HMRC which qualifies under s.29(6). He accepts that the partnership return and statement of LPLP for the year ended 5th April 2005 and the letter from Mr Tai dated 30th March 2006 satisfy one or other sub-paragraph of s.29(6). Counsel for HMRC submits that on the basis of that information alone it was not open to the General Commissioners to conclude that LPLP paid rebates to limited partners so that the income or profit declared in the partnership return and statement for the year ended 5th April 2005 was understated. In particular he submits that
(1) there is not to be attributed to the hypothetical officer either what Mr Tai told Mr Gregory at the meeting between them on 22nd February 2006 or what Mr Gregory recorded in his note of that meeting;
(2) Mr Tai's letter dated 30th March 2006 was not a written notification that rebates were paid to limited partners.
I agree that oral information given at the meeting does not alone satisfy the conditions imposed by s.29(6)(d)(ii). The subsection is quite specific in excluding oral information no doubt for good reasons. But insofar as that information was recorded by Mr Gregory in his note of the meeting held on 22nd February it was capable of being verified by the taxpayer and provided by him to the officer. If, for example, Mr Tai had just been handed the note and then later wrote to Mr Gregory confirming the contents of the note as being a correct record of what LPLP had done then the information in the note would have been provided to the officer in writing in the form of Mr Tai's letter.
In fact Mr Gregory sent the note to Mr Tai, asked for his comments on it and recorded his understanding that rebates had been paid to limited partners. On that basis he asked Mr Tai for the names and addresses of the partners "so that I may notify the partners' individual tax offices of the fee rebate arrangements". In his reply Mr Tai made no comment on the note or Mr Gregory's understanding but sent the names and addresses of the partners "as requested". In my view that is a clear adoption of the statements made by Mr Gregory in both his note and his letter. If those statements had been set out in full in Mr Tai's reply they would clearly satisfy the condition set out in s.29(6)(d)(ii) for information made available to the officer. I can see no reason for excluding such statements because instead of rewriting them in full Mr Tai adopted them by what he did write in his letter dated 30th March 2006. Accordingly and to that extent, I would reject both submissions made by counsel for HMRC. I would have accepted that what Mr Tai said at the meeting which is not recorded in Mr Gregory's note is not information for the purposes of s.29(6)(d)(ii) because it is not in writing.
In these circumstances the question is whether on this information an officer of the Board could have been reasonably expected to be aware that the amount of the profits included in the partnership return was insufficient. Plainly it is necessary to assume an officer of reasonable knowledge and understanding. He would have been aware of the decision of the House of Lords in Arthur Young. He would see from the partnership return and statement that the income included management and performance fees and that some of them had been deducted from the income because they had been 'rebated'. He would know from the letter from Mr Tai that at least some of those rebates had been made to limited partners in LPLP. And he would know from his general knowledge of Arthur Young and s.74(1)(a) ICTA that payments to partners are not usually deductible for tax purposes. But is that enough?
Counsel for HMRC contends that it is not. He maintains that the hypothetical officer would not have been aware that the fees repaid to limited partners had been among those deducted from the income of LPLP for tax purposes or that for any reason the amount returned as taxable income or profit of LPLP was insufficient. He relies on what actually happened in this case in relation to Mr Heinz where HMRC opened an enquiry under s.9A TMA on 14th December 2006 and pursued it in extensive correspondence. The Inspector sought further information and documents in order to establish whether his tax return for 2005 was complete and correct. On 6th June 2007 the Inspector gave it as his view that the rebated fees constituted distributions of profits and required the production of further documents. Further details were supplied by Mr Heinz on 20th July 2007. On 13th September 2007 PwC on behalf of Mr Heinz sought to argue on his behalf the points raised by LPLP on this appeal. On 17th October 2007 the Inspector referred those arguments to his technical advisers for their advice. It was not until 1st May 2008 that the Inspector obtained sufficient advice to respond to the points raised by PwC. That is the date on which, it is agreed, HMRC made its discovery relevant for the purposes of s.30B(1). It was not until 30th May 2008 that the Inspector was satisfied that additional tax was due from Mr Heinz and amended his tax return.
Counsel for HMRC submits that suspicion is not enough. He relies on the terms of s.30B(1) and (6). They require that the officer could not have been reasonably expected to be aware that either profits which should have been declared "have not been…included" or that "an amount of profits so included is or has become insufficient". Neither alternative admits of doubt, neither includes the verb "may" in any of its moods.
In addition he relies on the decision of this court in Langham v Veltema  STC 544. In that case a company transferred a house it owned to its sole director for no consideration. The relevant return of the company showed the value of the house to be £100,000 and CGT was computed on that basis. The tax return of the director showed that sum to be £100,000 also. The company's return went to an inspector in Leicester, the director's to an inspector in King's Lynn. The Leicester inspector referred the valuation of the house to the District Valuer and eventually the parties agreed a value of £145,000. The King's Lynn inspector sought to amend the director's return under s.29 TMA to recover tax on the extra £45,000. The director contended that they were not entitled so to do. His objection was upheld by the General Commissioners and Park J. HMRC then appealed successfully to the Court of Appeal. Much of the decision of the Court of Appeal concerns what information the hypothetical inspector is to be treated as having had made available to him but the court also considered what that information needed to disclose in order to satisfy s.29(5) TMA. That subsection is in the same terms as s.30B(6). The former relates to individuals, the latter to partnerships.
Auld LJ described the relevant issue in paragraph 11 as being:
"whether, as the Inspector contends, only awareness or an inference by him of an actual insufficiency in the self-assessment, though not necessarily its precise extent, would have disentitled him from making a discovery assessment under section 29(5), or whether, as Mr. Veltema contends, an awareness or inference by the Inspector of circumstances suggesting a possible insufficiency and the need for some basic check did so;"
He expressed his conclusion on this issue in paragraphs 32 and 33 where he said:
"32. If, as here, the taxpayer has made an inaccurate self-assessment, but without any fraud or negligence on his part, it seems to me that it would frustrate the scheme's aims of simplicity and early finality of assessment to tax, to interpret section 29(5) so as to introduce an obligation on tax inspectors to conduct an intermediate and possibly time consuming scrutiny, whether or not in the form of an enquiry under section 9A, of self-assessment returns when they do not disclose insufficiency, but only circumstances further investigation of which might or might not show it…..
33. More particularly, it is plain from the wording of the statutory test in section 29(5) that it is concerned, not with what an Inspector could reasonably have been expected to do, but with what he could have been reasonably expected to be aware of. It speaks of an Inspector's objective awareness, from the information made available to him by the taxpayer, of "the situation" mentioned in section 29(1), namely an actual insufficiency in the assessment, not an objective awareness that he should do something to check whether there is such an insufficiency, as suggested by Park J. If he is uneasy about the sufficiency of the assessment, he can exercise his power of enquiry under section 9A and is given plenty of time in which to complete it before the discovery provisions of section 29 take effect."
The other members of the Court, Chadwick and Arden LJJ, differed as to the information which should be treated as available to the inspector. Both of them agreed with Auld LJ as to what the inspector needed to be aware of.
Counsel for LPLP did not challenge either the construction of s.30B(6) or the principle of Langham v Veltema. They disputed the effect of the documents on which they relied, namely the partnership return and statement and the letter from Mr Tai to the inspector dated 30th March 2006.
In the end, this part of the appeal boils down to a very short point. The question, to adopt the formulation used by Auld LJ, is whether the hypothetical inspector having before him those three documents and the note of the meeting held on 22nd February 2006 would have been aware of "an actual insufficiency" in the declared profit. I would answer that question in the affirmative. He could see from those documents:
(1) The income of LPLP consisted of management and performance fees.
(2) There had been deducted from that income what was described as 'rebates'.
(3) 'Rebates' had been paid to limited partners.
(4) Arthur Young had established that all payments to partners should be included in gross income and were not, generally, deductible for tax purposes.
(5) There was no indication on the face of the accounts or in Mr Tai's letter to suggest any special treatment of 'rebates' paid to limited partners either by omission from the gross income or in their deduction therefrom.
I do not suggest that the hypothetical inspector is required to resolve points of law. Nor need he forecast and discount what the response of the taxpayer may be. It is enough that the information made available to him justifies the amendment to the tax return he then seeks to make. Any disputes of fact or law can then be resolved by the usual processes. For these reasons I would dismiss the appeal of HMRC.
Summary of Conclusions
For all these reasons, I would:
(1) dismiss the cross-appeal of LPLP,
(2) declare that the taxable profits of LPLP for the year ended 5th April 2005 were £69,142,423,
(3) dismiss the appeal of HMRC.
Lord Justice Moses:
This appeal requires three questions to be answered:-
i) whether the sums, described as 'rebates', were correctly excluded from LPLP's statement of income or profits?
ii) if not, whether they were deductible from those profits ?
iii) if not, whether the Revenue was entitled to amend LPLP's partnership tax return?
I agree with the Chancellor's conclusions in relation to all three questions and only set out my views for the purpose of reflecting on the application of Section 30B(6), the condition which is relevant to the third question.
First, the rebates paid to the limited partners of LPLP were plainly a distribution out of the profits of LPLP and ought not to have been excluded from its statement of income. LPLP received fees from LPIL as remuneration for managing the investments held by the fund LEEF. The fees were paid pursuant to the investment management agreements, to which the Chancellor has referred, made between LPLP, LPIL and LEEF. LPLP's activity as investment managers was plainly a trade, producing a profit. It is impossible to regard the activity as a mutual arrangement designed at most to give rise to a surplus, merely because some of its limited partners chose to purchase shares in the fund whose investments the limited partnership managed for reward. The point is only worth underlining to demonstrate that it ought to have caused no difficulty and raises no complex or sophisticated point of law.
Nor does the second question. The issue is not to identify the purpose of LPLP's expenditure in paying rebates to the limited partners. That was no more than a repayment of the expenditure incurred by the limited partners. Its deductibility turns on the purpose of their expenditure. The statutory prohibition in Section 74(1)(a) ICTA focuses on the purpose of the expenditure of those limited partners who chose to purchase shares in the fund. As the Chancellor points out, the limited partners did not, in any event, incur expenditure on management and performance fees. It was LEEF which incurred that expenditure, calculated by reference to the shares purchased by the limited partners. But even if it could be assumed, as the Revenue appears to have assumed, that the partners incurred such expenditure, it is clear that they incurred such expenditure at least in part for the purposes of their personal investment.
There can be no warrant for treating LPLP as a legal entity separate from its partners. The repayment of a figure notionally expended by the limited partners was made to them because they were partners and investors. This case is miles away from the payment of rent by a partnership to one of the partners who was landlord of the premises used by the partnership for its chartered accountancy business (Heastie v. Veitch & Co  1 K.B.535). The solecism in equating the partners who invested to third party investors is no different from that committed by the Court of Appeal in Arthur Young in equating the partners to employees. On the facts as found by the General Commissioners the only true and reasonable conclusion is that there was no expenditure by the partners, and, even if there had been, it was not deductible. In those circumstances, there can be no point in remittal; Lewison J's diffidence was unjustified.
I have sought to underline what I regard as a plain case because it seems to me to be relevant to a particular feature of the third question. I agree with the Chancellor that Mr Tai's letter dated 30th March 2006 was information which fell within section 29(6) TMA 1970. That letter constituted an adoption by Mr Tai of the factual propositions set out in Mr Gregory's note of the meeting on 22nd February 2006. That letter, in conjunction with the reference to the deductions, in LPLP's return and statement for the year ending 5th April 2005, amounted to information that what were described as "rebates" had been deducted from the partnership income and that rebates had been paid to identified limited partners.
The statutory question posed by Section 30B(6) is whether an officer of the Board could not have been reasonably expected, on the basis of that information, to be aware that an amount of profits included in LPLP's statement was insufficient. The Revenue contended that, even if, by the expiry of the time for opening an enquiry, on 31st January 2007, the hypothetical officer would have been aware that the rebates paid to partners were not included in the computation of the profits, he would still not have been aware that the amount of profits stated in LPLP's statement was insufficient. I wish to focus on that final argument advanced by the Revenue.
The situation mentioned in Section 30B(1), to which the full-out words of Section 30B(6) refer, is, in the instant appeal, that an amount of profits is insufficient. That, as it seems to me, involves not only a question of fact but of law. The amount of profits shown in LPLP's statement is only insufficient if the rebates which gave rise to the insufficiency had been excluded or deducted in circumstances where they ought not, as a matter of law, to have been excluded or deducted.
Mr Coleman, on behalf of the Revenue, contended that the hypothetical officer needed a full explanation of the factual and legal basis on which the rebates had been excluded or deducted, before it could be said that he ought to have been aware that the profits stated were insufficient. He sought to demonstrate what could reasonably have been expected of such an officer by reference to the facts of the case.
Mr Morrow, a member of the "Complex Personal Return Team", opened an enquiry, in December 2006, into Mr Heinz's 2004/5 return on the basis that, as a limited partner of LPLP he may not have returned the rebates paid to him. He said he had an open mind and wished to establish their correct tax treatment (see evidence of Mr Terry, accepted by the General Commissioners). Once the Inspector had sought the further information identified by the Chancellor at  and received technical advice, it was not until 30th May 2008, just over seventeen months later, that the Inspector amended the return. That process demonstrates, so the Revenue contends, that mere awareness of the fact that rebates had been deducted is not the same as awareness that the amount of profits stated were insufficient.
There is a factual objection to that argument. Mr Tai's letter containing information, on the basis of which an officer ought to have been aware that the rebates had been excluded or deducted from the profits, arrived more than 10 months before the expiry of the time limited for opening an enquiry. That was more than sufficient time to obtain further information as to the taxpayers' justification for exclusion or deduction and to form a legal view as to the lawfulness of exclusion or deduction.
But even if the information had been obtained shortly before the time for enquiry expired, I would have taken the view that an officer could have reasonably been expected to be aware that the profits stated were insufficient. The legal points were not complex or difficult. As the Chancellor points out , awareness of an insufficiency does not require resolution of any potential dispute. After all, once an amendment is made, it may turn out after complex debate in a succession of appeals as to the facts or law, that the profits stated were not insufficient. I have dwelt on this point because I wish to leave open the possibility that, even where the taxpayer has disclosed enough factual information, there may be circumstances in which an officer could not reasonably be expected to be aware of an insufficiency by reason of the complexity of the relevant law.
I also wish to express polite disapproval of any judicial paraphrase of the wording of the condition at Section 30B(6) or Section 29(5). I think there is a danger in substituting wording appropriate to standards of proof for the statutory condition. The statutory condition turns on the situation of which the officer could reasonably have been expected to be aware. Awareness is a matter of perception and of understanding, not of conclusion. I wish, therefore, to express doubt as to the approach of the Special Commissioner in Corbally-Stourton v Revenue and Customs Comrs  STC (SCD) 907 and of the Outer House in R(on the application of Patullo) v Revenue and Customs Commissioners  STC 107, namely, that to be aware of a situation is the same as concluding that it is more probable than not. The statutory context of the condition is the grant of a power to raise an assessment. In that context, the question is whether the taxpayer has provided sufficient information to an officer, with such understanding as he might reasonably be expected to have, to justify the exercise of the power to raise the assessment to make good the insufficiency.
I agree with the disposal the Chancellor has proposed.
Lord Justice Patten:
I agree with both judgments.
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