Clavis Liberty Fund 1 LP v Revenue & Customs Commissioners (2017)
Where a limited liability partnership had engaged in a scheme under the Income and Corporation Taxes Act 1988 s.730 to generate losses which could be offset against its tax affairs elsewhere, HMRC were entitled to reduce those losses to nil because the transaction was an artificial arrangement and not part of the partnership's genuine trading activities.
A taxpayer appealed against a decision of the First-tier Tribunal upholding a closure notice in which HMRC reduced to nil a claim for trading losses.
The taxpayer was a Jersey limited liability partnership which traded in gilt strips and treasury bills in addition to engaging in a scheme intended to generate a tax loss by application of the Income and Corporation Taxes Act 1988 s.730. The partners subscribed over £62 million to the partnership's capital. The aim of the scheme was to enable the partnership to deploy the loss in its tax affairs elsewhere. Under the scheme, the partnership was to buy the right to a dividend declared by an offshore company incorporated specifically for that purpose. The purchase price was £59,958,000, funded by a complex structure of loan transactions. The scheme was to generate a profit of £42,000. The dividend right was to have been purchased on 31 March but the transaction did not complete until 3 April. Neither the purchase price nor the amount of the dividend was adjusted to take account of the delay. According to the partnership, s.730 had the effect of deeming the dividend to be the income of the seller and not of the partnership, so that the partnership could bring in the purchase cost of the dividend as an expense but did not have to bring in the profit it generated as income. That was said to give rise to a loss of £60,942,061 available to the partnership. HMRC ruled that none of the expenditure relating to the transaction could be taken into account for tax purposes, thus eliminating the loss. The partnership challenged that decision before the tribunal, which held that the transaction was an artificial arrangement entered into to enable a tax loss to be claimed, illustrated by the fact that a delay in purchasing the dividend rights had had no effect on the purchase price despite reducing the period before payment.
The partnership submitted that the scheme was a trade in the nature of the other transactions it carried out and that trading transactions did not cease to be such merely because they were entered into in the hope of later recovering tax.
(1) Although the tribunal had referred to the likelihood that the partnership, in entering into the transaction, was motivated by claiming a tax loss, its reasoning was that the transaction was not a trading transaction because it was artificial, not because it was motivated by tax avoidance. By the example it had given of the artificiality of the scheme, the tribunal had demonstrated that it was looking at the overall factual picture and the nature of the transaction, not relying on the tax avoidance motive. Nor had the tribunal erroneously concluded that fiscal considerations were sufficient to mean that the transaction was not a trade, Lupton (Inspector of Taxes) v FA & AB Ltd  A.C. 634 followed (see paras 42-44 of judgment).
(2) It was apparent that the purchase of the dividend right was nothing like a normal arm's length transaction: it had taken place within a closed funding structure designed to make sure that the money moved along a pre-defined route. The profit generated had originated in funds introduced by the partnership, so that it had effectively financed its own profit. Moreover, although all the partners had lost their personal contributions to the capital of the partnership, there was no evidence of any complaint about that or to the effect that the partnership had performed badly in relation to the transaction. The scheme was the centrepiece of the partnership's purpose, notwithstanding its other trading activities, and the partners had regarded their personal contributions to the capital as payment for tax losses which they hoped would result from the arrangements. That was not indicative of a genuine trading transaction (paras 45, 48).