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First-tier Tribunal (Tax)
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Cite as:  STI 1758,  UKFTT 109 (TC),  SFTD 653
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Appeal number SC/3190/2008
CORPORATION TAX – Intangible fixed assets – Goodwill – Chargeability of gains and losses – Commencement of new statutory code – Application of the code and goodwill created or acquired after commencement – Taxpayer company purchased business and internally-generated goodwill from associated company after commencement date of code – Taxpayer company recognised goodwill element as purchased goodwill in its accounts – Whether goodwill created by taxpayer company after commencement of code – No – Appeal dismissed – FA 2002 Sch 29 para 118(1)(a)
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TRIBUNAL: SIR STEPHEN OLIVER QC
MARK BUFFERY FCA
Sitting in public in London on 25-27 January 2010
Francis Fitzpatrick, counsel, instructed by Reynolds Porter Chamberlain LLP, solicitors for the Appellant
Christopher Tidmarsh QC and Nicola Shaw, counsel, instructed by the General Counsel for HM Revenue and Customs, for the Respondents
© CROWN COPYRIGHT 2010
1. Greenbank Holidays Ltd (“Greenbank”) appeals against an amendment by HMRC (pursuant to paragraph 34 Finance Act 1998) to its return for the period ended 30 September 2003. The amendment in effect disallowed a deduction in respect of expenditure on goodwill relating to the business acquired from Keyline Continental Ltd (“Keyline”), a company in the same group, on 30 September 2003 (“the Goodwill”).
2. The issue in this appeal is whether, in computing its taxable profits for purposes of corporation tax for the period ending 30 September 2003, Greenbank is entitled to a deduction by reference to the Goodwill recognised in its accounts that relates to the business acquired from Keyline.
3. The legislation in point is Schedule 29 Finance Act 2002. This was introduced with effect from 1 April 2002 as a new corporation tax code for intangible assets, defined so as to include, amongst other things, intellectual property and goodwill. In essence, the code contained in the Schedule brought the tax treatment of intangible assets into line with the manner in which such items were treated in a company’s accounts and treated gains in respect of intangible assets as income for corporation tax purposes. Many of the terms in Schedule 29 are expressly defined by reference to the meaning they bear for accountancy purposes (a phrase given legal meaning for purposes of the Schedule).
4. Unless otherwise stated all statutory references in this Decision are to paragraphs in Schedule 29 Finance Act 2002.
5. Greenbank elected, pursuant to paragraph 10, to write down at an annual fixed rate of 4% the cost of the Goodwill arising from its acquisition of the business from Keyline. HMRC have denied the relief on the grounds that it falls outside the scope of the code contained in Schedule 29. Specifically, HMRC say, the Goodwill was acquired after the commencement date of the Schedule 29 code, i.e. 1 April 2002, from a related party. Greenbank claims that relief is available because the Goodwill was created by Greenbank after the commencement date.
6. Greenbank was at all material times a member of a UK corporate group whose parent company was Holidaybreak Plc, a UK listed company. The group was organised into three divisions, known as “Camping”, “Hotel Breaks” and “Adventure”. Greenbank’s carried on the Camping division trade. The trade was that of a tour operator of camping holidays throughout Europe and involved the provision of self-catering holidays in mobile homes and tents pre-sited on a number of European camp sites. Some years ago, in or around 1998, in order to expand the business of the Camping division, Keyline, another tour operator, was acquired and became a member of the group.
7. Keyline as vendor and Greenbank as purchaser entered into an agreement dated 30 September 2003 for the sale and purchase of the camping and mobile home holiday business of Keyline (excluding certain specified assets) for a consideration of £46,632,000 and the assumption by Greenbank of various debts, liabilities and obligations of Keyline.
8. Following the acquisition of the Keyline business, Greenbank’s accounts recognised an amount of £37,119,927 in respect of the Goodwill relating to that acquisition. The accounts were prepared by Greenbank in accordance with UK Generally Accepted Accounting Practice. That phrase is referred in this Decision as GAAP.
9. Greenbank’s corporation tax computation and return for the accounting period ending 30 September 2003 was filed in October 2004 with a Schedule showing the Goodwill as being non-deductible in nature. In early 2005 HMRC commenced an enquiry into that return. In May 2005 HMRC were informed by the accountants to the group that the treatment of the Goodwill in the accounts had been incorrect. An election was made under paragraph 10 claiming a deduction on account of the Goodwill at a fixed rate of 4% per annum. On completion of their enquiry in October 2007, HMRC concluded that Greenbank was not entitled to any deduction for the Goodwill pursuant to paragraph 10 and, on 29 November 2007, they gave notice to Greenbank amending its return for the accounting period ending 30 September 2003 to give effect to that conclusion. Greenbank appealed in December 2007 and in January 2010 the appeal came on for hearing before the Tax Chamber of the First-tier.
The legal and accounting background
10. Much of the legislation referred to in this decision has been extensively amended by section 70 of Finance Act 2009. The amended code now appears in Part VIII of Corporation Tax Act 2009. It is not in dispute that the amendments, or some of them, were expressly designed to cater for the issue arising in this appeal.
11. Schedule 29 introduced a new code for bringing into charge corporation tax profits and losses in respect of “intangible fixed assets”.
12. For these purposes “intangible asset” is given by paragraph 2(1) “the meaning it has for accounting purposes”. It is expressly extended to “intellectual property”: paragraph 2(2).
13. Paragraph 3(1) provides that an “intangible fixed asset” means “an intangible asset acquired or created by the company for use on a continuing basis in the course of the company’s activities”: nothing in this appeal turns on the meaning of “fixed”.
14. “For accounting purposes” means for “the purposes of accounts drawn up in accordance with generally accepted accounting practice” (Taxes Act 1998 section 832(1) as amended by Finance Act 2002 section 103(1)). “Generally accepted accounting practice” (i.e. GAAP) means “generally accepted accounting practice with respect to the accounts of UK companies intended to give a true and fair view”: Taxes Act 1988 section 836A.
15. Goodwill is not regarded as an asset (intangible or otherwise) for accounting purposes but paragraph 4 provides:
“(1) Except as otherwise indicated, the provisions of this Schedule apply to Goodwill as to an intangible fixed asset.
(2) In this Schedule “Goodwill” has the meaning it has for accounting purposes”.
16. Part 14 of the Schedule sets out the commencement and transitional provisions. Paragraph 118 of the Schedule provides:
“(1) Except as otherwise expressly provided, the provisions of this Schedule apply only to intangible fixed assets of a company (“the Company”) that –
(a) are created by the company after commencement, or
(b) are acquired by the company after commencement from a person who at the time of the acquisition is not a related party in relation to the company, or
(c) are acquired by the company after commencement from a person who at the time of acquisition is a related party in relation to the company in the cases specified in subparagraph (2).
As and when assets are regarded as created or acquired, see paragraphs 120-125”.
(Keyline was a related party. It is not therefore in dispute that any other cases specified in paragraph 118(2) could apply here.)
17. Paragraph 117 prescribes 1 April 2002 as the “commencement” date.
18. Paragraph 118(1)(a) is the key provision in this appeal. Greenbank’s case, as already noted, is that the Goodwill was created by it as the result of its purchase on 30 September 2003 coupled with its recognition in Greenbank’s accounts. HMRC contend that the Goodwill was not created by Greenbank; consequently the code in the Schedule has no application in relation to the Goodwill.
19. To the extent that the present dispute involves a consideration of what meaning Goodwill has for accounting purposes, we heard expert evidence in relation to this. The expert report of Professor David H Cairns OBE was adduced by Greenbank. The expert report of Matthew J Blake FCA, an accountant employed by HMRC and whose duties included advising their Solicitors Office on accounting matters, was adduced by HMRC. The two experts produced a Joint Statement which contains the following elements as common ground:
(1) There are assets that may exist in a commercial or legal sense that are not recognised on the balance sheet as assets.
(2) On the purchase of a business, the purchaser’s accounts recognise as goodwill (described in the accountancy literature as “purchased goodwill”) the difference between the cost of the business and the fair value of the identifiable assets and liabilities that have been purchased.
(3) That what the accountancy literature describes as “internally generated goodwill” is prohibited from being recognised in accounts.
Introduction to the issues
20. HMRC’s case for refusing the Greenbank’s claim for relief is that Schedule 29 has no application to the present circumstances because the goodwill to which the claim was related fails to meet the requirements of paragraph 118. It had not been created by Greenbank on or after 1 April 2002; and if and to the extent that it had been created by Greenbank, then pursuant to paragraph 121 it was to be treated as having been created before 1 April 2002. Greenbank’s case, as already noted, is that the Goodwill in question was created after 1 April 2002. Goodwill, Greenbank contends, is not created until it appears as an asset in the balance sheet of the company in question. The Goodwill only appeared in Greenbank’s accounts as purchased goodwill as the consequence of its acquisition for consideration from Keyline on 30 September 2003, i.e. after the commencement date.
21. The issue is whether the Goodwill was created by Greenbank on or after 1 April 2002. The issue arises in the context to section 118 which provides that the provisions of Schedule 29 apply to specified “intangible fixed assets”. Intangible fixed assets, as noted above, are defined in terms of intangible assets (by paragraph 3(1)) and paragraph 2(1) gives “intangible asset” the meaning it has for accountancy purposes. The provisions of Schedule 29 apply to goodwill as they apply to intangible fixed assets (see paragraph 4(1)); and by paragraph 4(2) goodwill has the meaning it has for accountancy purposes. The Goodwill (i.e. that to which the present claim relates) will, whether acquired or created, have been a fixed asset, as having been acquired or created for use on a continuing basis in the course of Greenbank’s activities: see paragraph 3(1).
Is the term “Goodwill” in Schedule 29 confined to purchased goodwill?
22. HMRC’s reliance on paragraph 121, which provides that internally generated goodwill is to be treated as created before 1 April 2002 if the business was carried on before then by the company (Greenbank in the present situation) or a related party (i.e. Keyline), is, so Greenbank’s argument goes, misplaced. This is because the definition of Goodwill (in paragraph 4(1) and sections 832(1) and 836A of Income and Corporation Taxes Act 1988) covers purchased goodwill, i.e. goodwill acquired for valuable consideration, and not internally generated goodwill. Consequently the Goodwill was not created until it appeared as an asset in the balance sheet of Greenbank following the purchase for valuable consideration from Keyline.
24. “Intangible asset”, it will be recalled, has the meaning it has “for accounting purposes”. At the material time “for accounting purposes” was defined in section 832(1) as meaning “for the purposes of the accounts drawn up in accordance with” GAAP; and GAAP was defined in section 836A as (unless the contrary required) “generally accepted accounting practice with respect to accounts of UK companies that are intended to give a true and fair view”.
24. Greenbank points out that at the material time section 226(3) of Companies Act 1985 required Companies to prepare their accounts in accordance with Schedule 4 of that Act. Schedule 4 sets out the prescribed formats for accounts reflecting the requirements of the Fourth Council Directive (78/660/EEC). Paragraph 36A of Schedule 4 to that Act required the accounts to state whether they had been prepared in accordance with applicable accounting standards. The relevant statement of accounting practice with regard to intangible assets was Financial Reporting Standard 10 (“FRS10”). The title of FRS10 is “Goodwill and Intangible Assets” and it was issued by the Accounting Standards Board in 1997.
25. So far as is material to the present circumstances the definition in FRS10 of “intangible assets” is found in paragraph 2. We quote:
“Non-financial fixed assets that do not have physical substance that are identifiable and are controlled by the entity through custody or legal rights.
An identifiable asset is defined by company’s legislation as one that can be disposed of separately without disposing of a business of the entity. If an asset can be disposed of only as part of the revenue-earning activity to which it contributes, it is regarded as indistinguishable from the goodwill relating to that activity and is accounted for as such.
In the context of an intangible asset, control is normally secured by legal rights: a franchise or licence grants the entity access to the benefits for a fixed period; a patent or trademark restricts the access of others. In the absence of legal rights, it is more difficult to demonstrate control. However, control may be obtained through custody. This could be the case where, for example, technical or intellectual or knowledge arising from developments activity is maintained secretly.
The definition does not encompass assets, such as prepaid expenditure, that are not fixed assets.”
26. In the light of that definition, Goodwill will not be an intangible asset. This is because by its very nature it is not an identifiable asset and consequently it cannot be disposed of separately from the business of the undertaking in question. Prima facie therefore Goodwill would fall outside the scope of Schedule 29. However, as already noted, paragraph 4(1) provides that (except as otherwise indicated) “the provisions of this Schedule apply to Goodwill as to an intangible fixed asset. Paragraph 4(2) goes on to provide of “goodwill” that it “has the meaning it has for accounting purposes”. The definition of “for accounting purposes” has already been addressed. Using that definition, Goodwill has the meaning it has for purposes of accounts drawn up in accordance with GAAP with respect to UK companies that are intended to give a true and fair view.
The development of Greenbank’s argument
27. The basis for the case for Greenbank is that, for the purposes of such accounts drawn up in accordance with GAAP, goodwill must mean goodwill acquired for valuable consideration, i.e. purchased goodwill. This, say Greenbank, is based on the principles of European Community law, primary UK legislation and the relevant statements of standard accounting practice in FRS10. Moreover, say Greenbank, the evidence of the experts endorses that conclusion.
28. The EC legislation is, as noted, found in the Fourth Directive which prescribes, in Notes 3 to Articles 9C and 10C two identical lay-outs in the balance sheet. Under the heading “Fixed Assets”, the notes state –
“3. Goodwill to the extent that it was acquired for valuable consideration”.
That provision, it is said (and there is no dispute about this) shows that Goodwill that has not been acquired for valuable consideration may not appear on the balance sheet of the company in question. Hence while a business may be thought to have a value in excess of its net assets and so may be thought to have goodwill, such goodwill, i.e internally generated goodwill, is prohibited from appearing on the balance sheet. Goodwill acquired for valuable consideration, such as the purchase of a business for a sum greater than its net asset value (as is the case here) will rank as “purchased goodwill” and will therefore fall within the scope of Note 3 to Article 9C.
29. UK law has implemented the Fourth Directive provisions in the Balance Sheet Formats in Section B of Schedule 4 to the Companies Act 1985 where Note 3 states:
“Amounts representing goodwill may only be included to the extent that the goodwill was acquired for valuable consideration”.
Here again there is no dispute that under UK primary law a company’s accounts may only include goodwill to the extent that it was acquired for valuable consideration.
30. So far as goodwill is concerned FRS10 provides:
“7. Positive purchased goodwill should be capitalised and classified as an asset on the balance sheet.
8. Internally generated goodwill should not be capitalised.”
FRS10 defines “purchased goodwill” in paragraph 2 as –
“The difference between the cost of an acquired entity and the aggregate of the fair values of that entity’s identifiable assets and liabilities. Positive goodwill arises when the acquisition cost exceeds the aggregate fair values of the identifiable assets and liabilities. Negative goodwill arises when the aggregate fair values of the identifiable assets and liabilities of the entity exceed the acquisition costs.”
From those provisions it is evident (and here again there is no dispute) that the term purchased goodwill is the term used to describe the excess of the purchase price over the fair values of the acquired entity’s net identifiable assets.
31. It is relevant to mention the following passage from paragraph (b) of the Summary to FRS10 in this connection. This states:
“The accounting requirements for goodwill reflect the view that goodwill arising on an acquisition is neither an asset like other assets nor an immediate loss in value. Rather, it forms the bridge between the cost of an investment shown as an asset in the acquirer’s own financial statement and the values attributed to the acquired assets and liabilities in the consolidated financial statement. Although purchased goodwill is not in itself an asset, its inclusion amongst the assets of the reporting entity, rather than as a deduction from shareholder’s equity, recognises that goodwill is part of a larger asset, the investment for which management remains accountable.”
32. So much is more or less common ground. The controversy here revolves round the significance to be given to internally generated goodwill. Greenbank say it is no more than “the product of a measurement formula” (to use the expression in their Skeleton Argument); it means any goodwill other than purchased goodwill and represents the notional excess of a business over the value of its net identifiable assets. It is not an identifiable separate asset and, because it cannot be disposed of separately from the business, its value will depend on the price a purchaser is prepared to pay for it. By contrast, purchased goodwill will have an established value.
33. From those principles and on the evidence of the experts (on which we will draw later), say Greenbank, it follows that the existence, the nature, the character and the quantum of the goodwill of a business will be wholly dependent on whether it has been purchased and on the terms of the purchase. It must follow that internally generated goodwill is to be disregarded for all purposes of Schedule 29. Consequently no goodwill will have been created or acquired, by either Keyline or Greenbank, before the commencement date, i.e. 1 April 2002. The Goodwill in the form of purchased goodwill was therefore created as the result of Greenbank’s purchase from Keyline and this meant that it had to appear as an asset in Greenbank’s balance sheet. Until then the goodwill had no significance for the purposes of accounts (and in particular to those of Keyline) drawn up in accordance with GAAP.
Conclusion on whether goodwill in Schedule 29 is confined to purchased goodwill
34. We start by examining whether the use of the term “goodwill” in Schedule 29 confines its meaning to purchased goodwill. The argument for Greenbank is that the meaning is so confined: therefore the entry of goodwill in accounts drawn up in accordance with UK GAAP means purchased goodwill.
35. Paragraph 4(2) provides that goodwill has “the meaning it has for accounting purposes” which in turn means for the purposes of accounts drawn up in accordance with UK GAAP. The construction of those definitions advanced by HMRC is that goodwill is to have the meaning it has for accounting purposes. This is the meaning underpinning such accounts, being the meaning in accordance with such accounts are drawn up. That meaning of goodwill is not just clear; it harmonises with the other provisions throughout Schedule 29.
36. We agree with HMRC’s construction. The legislative provision governing the presentation of a company’s accounts is Note 3 in Section B of Schedule 4 to the Companies Act 1985, set out above. This directs that “Amounts representing goodwill” are to be included to the extent only “that the goodwill was acquired for valuable consideration”. The use of the expression “amounts representing goodwill” demonstrates that there is a relevant statutory concept of goodwill. It goes wider than purchased goodwill.
37. FRS10 defines purchased goodwill but contains no explicit definitions of either goodwill or internally generated goodwill. In its substantive part dealing with recognition FRS10 states:
The positive purchased goodwill should be capitalised and classified as an asset on the balance sheet.
Internally generally goodwill should not be capitalised”.
The definition of purchased goodwill in FRS10 is set out in paragraph 30 above. Those extracts show, we think, that for the purposes of FRS10 “goodwill” exists generally and is divided into purchased goodwill and internally generated goodwill.
38. We mention in this connection the requirement in FRS10 for an “impairment review” to be made at intervals, and certainly at the end of the first financial review after the acquisition of a business. This review is designed to ensure that goodwill is not carried in the balance sheet at more than the amount at which the company expects to recover from that goodwill. While the impairment review exercise does not have the effect of bringing internally generated goodwill on to the balance sheet, it does involve (and this was accepted by Professor Cairns) a calculation of the internally generated goodwill in order to determine what impairment should be ascribed to the purchased goodwill.
39. Our understanding of the company’s legislation and FRS10 is that, whereas they do not define goodwill, the strong implication is that there is a general concept of goodwill, being the excess of the value of a business over the fair net assets value; and only part of that excess, the purchased goodwill part, falls to be capitalised and included in the balance sheet. This was accepted by both experts.
40. Developing that point in the light of our findings of the evidence of the two experts, we mention that both experts agreed that, for the purposes of both the Companies Act and FRS10, Goodwill comprises both internally generated goodwill and purchase goodwill. And, as already noted, they both accepted that the nature of goodwill is the difference between the value of the business in question and the fair value of its assets. Thus where, as here, there has been a purchase of a business, then the purchase price paid (by Greenbank to Keyline as happened here) evidences or measures the overall value of the business; the consequence is that the purchased goodwill, or the part that has been purchased, is to be included in the balance sheet and comes into the reckoning for purposes of any impairment review.
41. When our understanding of the general concept is tested by reference to the other relevant provisions of Schedule 29, the implication becomes inescapable.
42. The proposition that Goodwill covers both purchased goodwill and internally generated goodwill is consistent with paragraph 3(3). This provides that Schedule 29 applies to an “intangible fixed asset whether or not it is capitalised in the company’s accounts”. Paragraph 4(1) provides that – “Except as otherwise indicated, the provisions of this Schedule apply to goodwill as to an intangible fixed asset.” Combining the effect of paragraph 3(3) with that of paragraph 4(1) it follows that the provisions of Schedule 29 apply to goodwill whether or not it is capitalised in the accounts of the company in question.
43. This conforms with the accounting rules. Intangible assets are not defined for purposes of Schedule 29. But FRS10, as noted in paragraph 25 above, defines “intangible assets” as “Non-financial assets that do not have physical substance but are identifiable and are controlled by the entity through custody or legal rights”. That definition, however, says nothing about a relevant asset having to be capitalised; to do so would be inconsistent with what FRS goes on to say. In paragraphs 7 to 14 of FRS10, in the section headed “Initial recognition of positive goodwill and intangible assets” are the rules about whether the thing in question is to be recognised or capitalised. The effect of these is that an intangible asset is only to be capitalised if it has an ascertainable market value. If an intangible asset is purchased it has one; otherwise it might not. It follows that in determining whether something is an intangible asset, then for FRS10 purposes, its meaning has nothing to do with whether it is or has to be capitalised.
44. Finally on this topic the provisions of paragraph 121 are consistent with HMRC’s contention that “goodwill” in Schedule 29 covers both internally-generated and purchased goodwill. Paragraph 118 expressly incorporates paragraph 121 as being one of the provisions determining when assets are to be regarded as created. Paragraph 121 provides:
“For the purposes of paragraph 118 … internally-generated goodwill is regarded as created before (and not after) commencement if the business in question was carried on at any time before commencement by the company or a related party.”
This shows that, for the purposes of the Schedule, goodwill encompasses internally generated goodwill and it is at odds with Greenbank’s assertion that for the purposes of the Schedule “goodwill” means “purchased goodwill” alone.
Was the Goodwill created after the commencement date?
45. This brings us to paragraph 118(1). HMRC rely on this as their ground for refusing relief under Schedule 29. This, as already noted, provides:
“(1) Except as otherwise expressly provided, the provisions of this Schedule apply only to intangible fixed assets of a company … that –
(a) are created by the company after commencement, …”.
(The later provisions of paragraph 118, which deal with acquisitions, are not in point save for paragraph 118(2)(b) which has the effect of excluding from relief assets acquired after commencement from a related party.)
46. HMRC say that the Goodwill to which Greenbank’s claim relates was created from the time when Keyline started to carry on the business to which the Goodwill related. This, HMRC say, follows from paragraph 121 which provides:
“For the purposes of paragraph 118 (application of Schedule to assets created or acquired after commencement) internally-generated goodwill is regarded as created before (and not after) commencement if the business in question was carried on at any time before commencement by the company or a related party.”
That, say HMRC in reliance on paragraph 3(3), is the position irrespective of the fact that in Keyline’s hands the goodwill was never capitalised.
47. Greenbank’s response is that, given Goodwill the meaning it has for accounting purposes (by virtue of paragraph 4(2)), it is not “created” until it appears as an asset of the company in question following a purchase at a value in excess of the value of the business assets. Keyline’s accounts never recognised any amount in respect of goodwill. Greenbank’s accounts did. Consequently there was no goodwill in the relevant sense to have been acquired by Greenbank from a related person; Greenbank’s purchase of that goodwill and its recognition in the accounts had the effect of creating it “after commencement”. Paragraph 121, says Greenbank, does not apply because there was no goodwill of Keyline in the relevant sense of that word, being its meaning in the context of Schedule 29.
48. We disagree. No goodwill was created by Greenbank. It had already been created by Keyline. From the time when Keyline carried on the business to which the Goodwill to which this appeal relates, it was creating internally generated goodwill. That was the goodwill that became the subject-matter of the sale to Greenbank on 30 September 2003. No part of the purchase price paid to Keyline was expenditure “on” the creation of the goodwill. More fundamentally, Greenbank’s case is founded on the proposition that internally generated goodwill is a “nothing” for purposes of the code in Schedule 29 until recognised in the accounts of the relevant company. We have already concluded that Goodwill, using the meaning that it has for accounting purposes, covers both purchased goodwill and internally generated goodwill. Paragraph 121 is consistent with that.
49. For the reasons given above we have concluded that the Goodwill was not created by Greenbank. Consequently the relief given by Schedule 29 does not in the present circumstances apply in relation to the Goodwill.
50. For those reasons we dismiss the appeal.
51. The Appellant has a right to apply for permission to appeal against this decision pursuant to Rule 39 of the Rules. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.