ON APPEAL FROM the High Court of Justice,
Mr Justice Lewison
Royal Courts of Justice
Fetter Lane, London, EC4A 1NL
B e f o r e :
LORD JUSTICE MOSES
LORD JUSTICE PATTEN
| THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS
|- and -
|LANSDOWNE PARTNERS LIMITED PARTNERSHIP
John Gardiner QC and John Brinsmead-Stockham (instructed by Pricewaterhouse Coopers Legal LLP) for the Respondent
Hearing dates : 22 - 23 November 2011
Crown Copyright ©
The Chancellor :
(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).
"[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]."
(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.
"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.
"(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.
"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 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?"
"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."
"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?"
"…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.
"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."
"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.
"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."
"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.
"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.
"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…"
"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.
"(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."
"(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.
"(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."
(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]."
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.
"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."
"… 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:
- 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.
(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.
"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.
(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.
(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:
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?
Lord Justice Patten: