England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		18/10/2010

Mr Justice Lewison:

Introduction

1. Lansdowne Partners Limited Partnership ("the partnership") is a fund manager. The funds it manages are open ended investment companies. The partners in the partnership are Lansdowne Partners Ltd, as general partner, and a number of individuals as limited partners. The funds in question had appointed Lansdowne Partners International Ltd ("International") as manager of the funds under the terms of a written agreement which entitled International to delegate its functions. It delegated those functions to the partnership. Investors in the funds subscribed for shares on the terms of a written prospectus. The prospectus described International as the Manager; and the partnership as the Investment Manager. The prospectus informed investors that the Manager was entitled to a management fee and a performance fee; and also informed them that the Manager shared those fees with the Investment Manager. The management fee and the performance fee were collected monthly. The prospectus also stated:

"Without prejudice to the above the Manager and the Investment Manager may from time to time and at their sole discretion and out of their own resources decide to rebate to some or all Shareholders … part or all of the Management Fee and/or Performance Fees in respect of the A Class Shares or the B Class Shares. Any such rebates may be applied in paying up additional Shares to be issued to the Shareholder. The Investment Manager may at its discretion rebate its share of the Performance Fee attributable to Shares issued to it or its partners, employees or related entities."

2. A number of the individual limited partners made investments in the fund on the terms of the prospectus. The fund paid the monthly fees to the Manager (International) on behalf of the investors, and International shared the fees with the partnership. As envisaged by the prospectus, the partnership rebated the management fee and the performance fee to the partners in respect of their individual investments. When the partnership submitted its partnership statement for the year 2004/05 these rebates were treated as deductible expenditure in computing its taxable profit. On 27 August 2008 HMRC notified the partnership that it had amended the partnership statement for the tax year 2004/05 by adding back an estimate of the payments made to partners when arriving at the partnership profit. The partnership appealed against the amended assessment.
3. The General Commissioners for Income Tax ("the Commissioners") decided that the rebates were deductible expenses in computing the partnership's profits. They also decided that HMRC were out of time in amending the partnership statement. HMRC now appeal against the Commissioners' decision by way of case stated. The partnership seeks to uphold the decision; and advances a further ground for challenging the assessment. The partnership says that the flow of funds attributable to management and performance fees passing between the partnership and the partners was simply mutual trading and should not have featured in its tax computation at all.

The case stated

4. The case stated leaves a lot to be desired, even if it does not warrant the excoriating criticism to be found in Leith, Hull and Hamburg Steam Packet Co v Bain (1897) 3 TC 560, 567. The primary function of a case stated is to set out the facts that the Commissioners found (either admitted or proved); to summarise the contentions of the parties; to state what legal test they applied to the facts as found and then to pose the questions of law for the court. The case stated in the present case contains a long and discursive recitation of the evidence adduced on each side and the submissions (both legal and factual) made on each side. But it does not clearly state what facts were found; nor what legal test the Commissioners applied. HMRC rightly complained to the Commissioners that the draft case was not in proper form; but the complaints fell largely on deaf ears. Neither side asked for the case to be remitted to the Commissioners for amendment or clarification, so I will have to do the best I can.
5. Ms Nutton and Mr Tai made witness statements on behalf of the partnership, which they confirmed in evidence. They were then cross-examined. The Commissioners said that they accepted the evidence of Ms Nutton and Mr Tai as modified under cross-examination (although without identifying the modifications they had in mind) (§ 10). Thus it is necessary to combine what they said in their witness statements with what the Commissioners recorded about their respective cross-examinations. On that basis I can, I think, conclude that the Commissioners found the following facts relevant to the first two questions I have to decide:

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 International 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 International 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).

Mutual trading

6. Logically the place to begin is with the partnership's argument that both the receipts and the rebates fall outside the scope of tax because they amount to what is (somewhat inaccurately) called mutual trading. The General Commissioners rejected this argument. It forms the subject of the partnership's Respondent's Notice.
7. The argument is based on the common sense proposition that you cannot trade with yourself or make a profit out of yourself. If a plumber mends his own tap he does not have to bring into account what he would have charged a client to carry out that work. Even if he were to "pay" himself for the work by transferring money from his personal account to his business account, it would make no difference.
8. In Thomas v Richard Evans & Co Ltd [1927] 1 K.B. 33 Rowlatt J said:

"It is true to say that a person cannot make a profit out of himself if what is meant is that he may provide himself with something at a less cost than that at which he could buy it, or if he does something for himself instead of employing some one to do it. He saves money in those circumstances, but he does not make a profit. But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if any other trading company, by trading with its shareholders even if it is limited to trading with them, makes a profit, that profit belongs to the shareholders in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers; it comes back to them as shareholders upon their shares. Where all that a company does is to collect money from a certain number of people - it matters not whether they are called members of the company or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then … there is no profit. If the people were to do the thing for themselves there would be no profit, and the fact that they incorporate a legal entity to do it for them makes no difference; there is still no profit. This is not because the entity of the company is to be disregarded; it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it."

9. This decision was upheld both by the Court of Appeal and the House of Lords. In the House of Lords (sub nom. Jones v South-West Lancashire Coal Owners' Association [1927] A.C. 827) Viscount Cave LC said:

"In this case … there are no shareholders interested, and the whole of the yearly surplus remains to the credit of the members, and must either be applied to meeting their future claims or be returned to them on retirement. Sooner or later, in meal or in malt, the whole of the company's receipts must go back to the policy holders as a class, though not precisely in the proportions in which they have contributed to them; and the association does not in any true sense make a profit out of their contributions."

10. As Mr McDonnell pointed out, the principle can apply even where the entity in question carries on a parallel trade. Thus in the case of a members' golf club green fees payable by members will not count as profits, whereas green fees paid by non-members will: The Carlisle and Silloth Golf Club v Smith (1913) 6 TC 195. Likewise in the case of a holiday camp owned by a trade union receipts from holidays sold to members did not count as profits, whereas holidays sold to non-members did: The National Association of Local Government Officers v Watkins (1934) 18 TC 499. Here Mr McDonnell says fees received by the partnership from non-partners count as profits, whereas fees received from partners (and rebated to them) do not.
11. On the other hand a partnership can trade with its partners, just as a company can trade with its shareholders. In such a case the relationship between the partnership and the partners will be a dual relationship. For example one partner may own the property in which the partnership carries on its business. In such a case there may be a landlord-tenant relationship between that partner and the partnership. Even if there is no formal lease, the property may have been supplied to the partnership by the property owner; not in his capacity as partner, but in his capacity as landlord (cf. Heastie v Veitch & Co [1934] 1 KB 535). As Rowlatt J pointed out in Thomas v Richard Evans & Co Ltd the capacity in which monies are paid and repaid is one of the critical factors to decide whether the mutuality principle applies.
12. I have said that "mutual trading" is a somewhat inaccurate description. I say this because the real question is whether what appear to be transactions amount to a trade at all. This was the way that Lord Wilberforce approached the question in Fletcher v Income Tax Commissioner [1972] AC 414. He said:

"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?"

13. The Commissioners' reasoning on this point was as follows:

"10.1.2 The nature of the activities of [the partnership] does not fit into any of the categories of the cases presented to us which succeeded in showing elements of mutual trading. In particular [the partnership] 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 so to find.

10.1.3 Other factors which we believe show that this was not mutual trading are that SH [one of the partners] and the other partners received rebates as partners whereas the fees were paid on their behalf as investors and [the partnership] rebates 100% management and performance fees but only receives 90% management fee from [International]."

14. The first of these reasons was the Commissioners' answer to the question posed by Lord Wilberforce. In other words, they decided that the partnership's activities were a trade. The second reason echoes the point made by Rowlatt J: namely, that the initial payments were made by the partners in their capacity as investors, whereas the rebates were made to them in their capacity as partners. They paid in one capacity but received rebates in another. The third reason, namely that the rebate was more than the partnership itself received, is another feature that, in my judgment, the Commissioners were entitled to rely on in deciding that the actual arrangements were inconsistent with a mere return of the surplus in a common fund. Mr McDonnell accepted that in so far as the rebates exceeded the fees actually received by the partnership the mutuality principle could not apply. But the case presented to the Commissioners was an all or nothing case.
15. In addition, as Mr Coleman pointed out, rebates were made not just to partners but also to their family members, pension funds and to trusts connected with them. Although the Commissioners did not rely on this fact in reaching their conclusion it is a fact which supports that conclusion. He also said that the initial payment was not made by the partners at all, but was made by the fund to International under contractual arrangements between the fund and International coincident with the terms of the prospectus which itself represented the contract between the partners (in their capacity as investors) and the fund. The Commissioners did not rely on this latter argument. Since the prospectus (which was the contract between the partners and the fund) expressly envisaged that fees could be shared between International and the partnership and also that the partnership might rebate fees to the partners, I do not think that this is a killer point.
16. However, in my judgment, on the facts found the Commissioners were entitled to conclude that this case fell outside the mutuality principle.
17. Mr McDonnell had a secondary argument on this part of the case. The Commissioners did not expressly deal with this argument; and it is not entirely clear from the case whether it was presented to them as a separate and secondary argument. Mr McDonnell said that because the partnership knew that fees paid by partners were to be rebated at the end of the year, there was a net zero contribution by the partners. Since there was a net zero contribution both the receipts from and the rebates to partners should be disregarded. Mr McDonnell drew an analogy with a purchase from a supermarket offering a "buy one get one free" offer where both items are initially rung up on the till and a final deduction is made before the customer is actually charged. However, as Mr Coleman submitted the amount received by the partnership was its contractual entitlement under the management agreement made between the partnership and International. International, rather than the individual partners, is in the position of the shopper in Mr McDonnell's analogy. International paid the full price to the partnership. It was at that point that the partnership made its profit. What it did with the profit after that is irrelevant. I agree with Mr Coleman.
18. 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?

Deductible expense

19. Section 74 (1) of the Income and Corporation Taxes Act 1988, as it stood in the year of assessment, provided:

"Subject to the provisions of the Tax Acts, in computing the amount of the profits to be charged under Case I or Case II of Schedule D, no sum shall be deducted in respect of—

(a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession or vocation"

20. Mr McDonnell says that whether a payment is money "wholly and exclusively laid out or expended for the purposes of the trade" is a question of fact. The Commissioners have answered that question in the partnership's favour; and that is an end of it. The court has no power to interfere with a finding of fact. Mr Coleman does not dispute the principle; but says that it only applies if the Commissioners have applied the correct legal test. In this case he says that it is clear that they have not.
21. The first thing to do is to identify the question. Mr McDonnell says that the question is whether the partnership, when making the fee rebates to partners, had any relevant reason for doing that other than a business reason. Mr Coleman says that in a case where the payment in question consists of the reimbursement or rebate of money paid by a partner the question is a different one. In such a case he says the question is whether the initial outlay by the partner was made wholly and exclusively for the purposes of the partnership business. The Commissioners did not ask themselves that question with the result that they applied the wrong legal test. If they had applied the correct legal test, then on the findings of fact that they made there was only one answer.
22. In Mackinlay v Arthur Young McClellend Moores & Co [1990] 2 AC 239 a partnership had reimbursed the domestic removal expenses of one of the partners who had been transferred from one office to another. The House of Lords held that that reimbursement was not deductible for tax purposes. Lord Oliver delivered the leading speech. In my judgment the case establishes the following propositions:

i) A partner, unlike an employee, is a co-owner of all the assets of the firm. Every receipt must therefore be brought into account in computing his share of the profits or assets. Equally any expenditure which he incurs out of his own pocket on behalf of the partnership in the proper performance of his duties as a partner will be brought into account against his co-partners in that computation (p. 249);

ii) For the purposes of taxation a partnership is not an entity separate from the partners (p. 253);

iii) The mechanics of payment are not relevant. The same tax consequences will apply whether the expenditure is met by the partner drawing directly on the partnership bank account or by spending his own money and then seeking reimbursement (p. 254);

iv) Consequently when considering the purpose for which money is paid it is the purpose of the original outlay by the partner, rather than the purpose of the reimbursement, that is the relevant purpose (p. 254);

v) What a partner receives out of partnership funds must be brought into account 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 (p. 255);

vi) It is only in the latter case that it will be deductible for tax purposes.

23. It was not suggested that any different principles applied to limited partnerships. The application of these principles means, in my judgment, that the relevant expenditure is not the reimbursement or rebate of management and performance fees by the partnership to the partners, but the original payment of the management and performance fees by or on behalf of the partners themselves. It is their purpose in paying those fees in the first place that counts. Accordingly I accept Mr Coleman's identification of the correct question; and reject Mr McDonnell's.
24. Was the payment of management fees by the partners wholly and exclusively laid out for the purposes of the partnership business? When a payment is made "wholly and exclusively" for a particular purpose is authoritatively laid down by the House of Lords in Mallalieu v Drummond [1983] 2 A.C. 861. Lord Brightman delivered the leading speech. In my judgment the case establishes the following propositions:

i) The question is whether the expenditure is made to serve the purposes of the trade (p. 870);

ii) The effect of the word "exclusively" is to preclude a deduction if it appears that the expenditure was not only to serve the purposes of the trade, profession or vocation of the taxpayer but also to serve some other purposes. Such other purposes, if found to exist, will usually be the private purposes of the taxpayer (p. 870);

iii) To ascertain whether the money was expended to serve the purposes of the taxpayer's business it is necessary to discover the taxpayer's "object" in making the expenditure (p. 870). The taxpayer's "object" in making expenditure is not limited to his conscious motive (p. 875);

iv) The object of the taxpayer in making the expenditure must be distinguished from the effect of the expenditure. An expenditure may be made exclusively to serve the purposes of the business, but it may have a private advantage (p. 870);

v) If it appears that the object of the taxpayer at the time of the expenditure was to serve two purposes, the purposes of his business and other purposes, the expenditure will not be deductible even if the business purposes are the predominant purposes intended to be served (p. 870).

25. Lord Brightman illustrated his distinction between the "object" and "effect" of expenditure as follows:

"For example a medical consultant has a friend in the South of France who is also his patient. He flies to the South of France for a week, staying in the home of his friend and attending professionally on him. He seeks to recover the cost of his air fare. The question of fact will be whether the journey was undertaken solely to serve the purposes of the medical practice. This will be judged in the light of the taxpayer's object in making the journey. The question will be answered by considering whether the stay in the South of France was a reason, however subordinate, for undertaking the journey, or was not a reason but only the effect. If a week's stay on the Riviera was not an object of the consultant, if the consultant's only object was to attend on his patient, his stay on the Riviera was an unavoidable effect of the expenditure on the journey and the expenditure lies outside the prohibition in s 130."

26. Lord Brightman's distinction between the "object" of expenditure and the "effect" of expenditure was taken up by the House of Lords in McKnight v Sheppard [1999] STC 669. The case concerned the legal costs incurred by the taxpayer in defending disciplinary proceedings that had been brought against him. The Special Commissioner found that the taxpayer was not unconcerned about the slur on his personal reputation, but that nevertheless the expenditure was incurred wholly and exclusively for the purposes of his trade. Upholding the Special Commissioner, Lord Hoffmann referred to Lord Brightman's example in Mallalieu and commented:

"If Lord Brightman's consultant had said that he had given no thought at all to the pleasures of sitting on the terrace with his friend and a bottle of Côtes de Provence, his evidence might well not have been credited. But that would not be inconsistent with a finding that the only object of the journey was to attend upon his patient and that personal pleasures, however welcome, were only the effects of a journey made for an exclusively professional purpose."

27. The Commissioners' conclusion in the present case was expressed as follows (§ 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 than there was no express contract by which the fees were rebated to partners? From the evidence put forward on behalf of [the partnership], especially that of Suzanne 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."

28. I agree with Mr Coleman 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. The Commissioners assumed, and Mr McDonnell submitted, that if the partners had been contractually entitled to the rebate of fees, then the rebated fees would have unquestionably have been deductible. The service being provided to the partners was the management of funds, which is the same service as that being provided to outsiders. Thus a partner whose fees are rebated must be treated in the same way as an outside investor whose fees are rebated. I do not agree. I cannot see that it would have made any difference to the outcome in Arthur Young if the partnership deed (which is the contract between the partners) had entitled partners to reimbursement of their domestic removal expenses. In all cases the question is whether the initial outlay by the partner was an outlay made wholly and exclusively for the purposes of the business. Mr McDonnell's analysis concentrates on the purpose of reimbursement by the partnership which, in my judgment, is looking at the question through the wrong end of the telescope. Mr McDonnell also submitted that the critical fact that distinguished this case from Arthur Young was that in Arthur Young the initial outlay had been payments made to third parties outside the partnership (conveyancing fees, removal expenses etc). Here by contrast the initial outlay had been made by way of payment to the partnership itself. This was not a ground on which the Commissioners found for the partnership. However, in my judgment this submission fails on the facts as found. The fees are paid by the fund to International on behalf of the investor. International then pays fees to the partnership. It is only then that the partnership rebates the fees to the partners. Thus the partner's initial outlay is money paid to International rather than to the partnership. Mr McDonnell's point also overlooks the fact that payments and rebates were made by and to partners' family members, pension funds and connected trusts.
29. If the Commissioners had applied Arthur Young correctly, they would have asked themselves: what was the purpose of the payment of fees by the partners? Only if that purpose was wholly and exclusively the furtherance of the partnership business would the expenditure be deductible under section 74 (1).
30. Mr McDonnell had a separate argument in support of the Commissioners' decision. He said that without the fee rebate, the corresponding fee income would not have been earned in the first place. The two things, the receipt of the fee income and the later rebate of the same amount of fee income, go together. Consequently if the fee income is part of the partnership's taxable receipts, it must follow that the rebates are part of its deductible expenses. The difficulty with this argument is two fold. First, if the fee rebates are not deductible under section 74 (1), there is no other provision which permits the deduction. Second, the Commissioners made no finding of fact that the fee income would not have been earned without the rebates. Their findings included a finding that in the case of outsiders the fees rebated amounted to between a third and a quarter of the full fees. They also found that it was the strong norm in the industry that partners' fees were rebated in full. It is a leap of faith, rather than a logical deduction, from those two findings to conclude that if, say, the partnership had agreed to rebate eighty or ninety per cent of partners' fees they would have refused to invest. In addition, as Mr McDonnell conceded, the evidence did not go so far as to support the Commissioners' finding that if some partners had had rebates and others had not there was a significant danger that the non-rebated partners would have left. That being so, it is impossible to say that if there had been no rebates there would have been no investment by partners.
31. Mr Coleman submitted that on the facts as found there could only be one answer to the question: what was the purpose of the initial outlay? It was at best a mixed purpose. Although part of the purpose was to advance the partnership business by building confidence in investors ("le patron mange ici"), another purpose was that of personal financial gain for the individual partners by investing in good quality funds. If there was a dual purpose, then the outlay cannot have been made wholly and exclusively for the purpose of the trade.
32. The purpose of the original outlay is a question of fact. It is a question of fact which may entail distinguishing between a purpose and an effect. Since the Commissioners did not ask themselves the right question, I do not know what factual answer they would have given to the right question. They might have concluded that the advantages to the partners were no more part of their purpose than the prospect of a shared bottle of Côtes de Provence was part of the hypothetical consultant's purpose in going to the south of France. I must be cautious about substituting my own decision for that of the fact finding tribunal even if there are strong pointers towards the ultimate conclusion. Sometimes I have not displayed the proper caution (e.g. Revenue and Customs Commissioners v Grace [2009] STC 2707; Revenue and Customs Commissioners v Kearney [2010] STC 1137). If, therefore, HMRC succeed on the "discovery assessment" point this question of fact must be remitted to the First Tier Tax Tribunal.

Discovery assessment

33. As noted, HMRC amended the partnership statement. They were out of time to raise an enquiry. Time for opening an enquiry ran out on 31 January 2007. Consequently the amendment can only be made if HMRC can rely on the provisions relating to discovery assessments. In the case of persons liable to pay income tax or capital gains tax, they are contained in section 29 of the Taxes Management Act 1970. In the case of a partnership statement they are contained in section 30B, which in turn incorporates part of section 29.
34. The partnership statement was submitted on 18 August 2005. It was accompanied by the partnership accounts. These showed a figure for fee income and deductions of rebates of £4.6 million-odd. The deduction for rebates did not differentiate between rebates to partners and rebates to others. The relevant findings by the Commissioners were as follows:

i) The partnership had not sought to hide the fact that rebates were paid to partners. This had been disclosed to an experienced officer during an enquiry in 2000 and also by letter dated 30 March 2006 giving full details of the partners and their NI numbers to an officer who had undertaken to pass on the knowledge of the relevant tax offices (§ 10.3.2);

ii) From about 14 August 2006 Mr Ryan, the officer responsible for the general partner in the partnership, knew that some partners were in receipt of rebates (§ 10.3.3);

iii) It was not necessary that a disclosure must declare an insufficiency of assessment to HMRC. All that was necessary was that information is given to HMRC which would enable a decision to be made by HMRC whether to raise an additional tax assessment (§ 10.3.4).

35. Some of these findings need further elucidation. What had been disclosed in 2000 is contained an exchange of letters between Ms Holdsworth (an inspector of taxes) and Ernst & Young. Ms Holdsworth had written on 11 May 2000:

"There is provision for rebate of both the management and performance fees. In particular [the partnership] 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. [The partnership] 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 [the general partner] and/or [the partnership], the amount rebated and what amount, if any, was used to pay up additional shares."

36. Ernst & Young replied on 4 July 2000. They said:

"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, the only parties to be connected with Lansdowne were [names were given]."

37. The letter of 30 March 2006 was written in response to a letter from Mr Mike Gregory, an employment compliance officer (who HMRC accept is "an officer of the Board"). Mr Gregory had held a meeting with Mr Tai on 22 February 2006. He prepared a note of that meeting. The note recorded:

"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."

38. On 15 March 2006 Mr Gregory wrote to Mr Tai. He enclosed a copy of his note of the 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."

39. Mr Gregory's letter also contained the following passage:

"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."

40. Mr Tai replied on 30 March 2006. He acknowledged receipt of the letter of 30 March and continued:

"Fee rebates:

As requested please find attached:

…

name, address and N.I. No of each partner for tax years 2004-5 and 2005-6."

41. Section 30B provides (so far as relevant):

"(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.

…

(4) No amendment shall be made under subsection (1) above unless one of the two conditions mentioned below is fulfilled.

…

(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

(b)     informed that partner that he had completed his enquiries into that return,

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.

(7)     Subsections (6) and (7) of section 29 of this Act apply for the purposes of subsection (6) above as they apply for the purposes of subsection (5) of that section; and those subsections as so applied shall have effect as if—

(a)     any reference to the taxpayer were a reference to the representative partner;

(b)     any reference to the taxpayer's return under section 8 or 8A were a reference to the representative partner's partnership return; and

(c)     sub-paragraph (ii) of paragraph (a) of subsection (7) were omitted."

42. The relevant sub-sections of section 29 which are incorporated by reference (with the modifications required by section 30B) provide:

"(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.

(7)     In subsection (6) above—

(a)     any reference to [the representative partner's partnership return] in respect of the relevant year of assessment includes—

(i)     a reference to any return of his under that section for either of the two immediately preceding years of assessment; and

(ii)    …; and

(b)     any reference in paragraphs (b) to (d) to [the representative partner] includes a reference to a person acting on his behalf."

43. The use of the word "discovers" in provisions of this kind has a long history. Although the conditions under which a discovery assessment can be made have been tightened in recent years following the introduction of the self-assessment regime, the meaning of the word "discovers" in this context has not changed. In R v Commissioners for the General Purposes of the Income Tax for Kensington [1913] 3 KB 870 Bray J said that it meant "comes to the conclusion from the examination he makes and from any information he may choose to receive"; and Lush J said that it was equivalent to "finds" or "satisfies himself". In Cenlon Finance Co Ltd v Ellwood [1962] A.C. 782 the House of Lords considered the meaning of the word "discovers". They rejected the argument that a discovery entailed the ascertainment of a new fact. Viscount Simonds said:

"I can see no reason for saying that a discovery of undercharge can only arise where a new fact has been discovered. The words are apt to include any case in which for any reason it newly appears that the taxpayer has been undercharged and the context supports rather than detracts from this interpretation."

44. Lord Denning said:

"Mr. Shelbourne said that "discovery" means finding out something new about the facts. It does not mean a change of mind about the law. He said that everyone is presumed to know the law, even an inspector of taxes. I am afraid I cannot agree with Mr. Shelbourne about this. It is a mistake to say that everyone is presumed to know the law. The true proposition is that no one is to be excused from doing his duty by pleading that he did not know the law. Every lawyer who, in his researches in the books, finds out that he was mistaken about the law, makes a discovery. So also does an inspector of taxes."

45. In my judgment, on the assumption that HMRC knew all the relevant facts, a change in their interpretation of the law would amount to a discovery. At one stage in the appeal I understood Mr McDonnell to be challenging that; but in the end I think that he accepted that the argument on this part of the case was all about section 29 (6) (d) (ii).
46. In Langham v Veltema [2004] STC 544 the Court of Appeal considered section 29 and discovery assessments. In my judgment that case establishes the following propositions:

i) "Awareness" is the officer's awareness of an actual insufficiency in the self-assessment in question, rather than an awareness that he should do something to check whether there is an insufficiency (§ 33);

ii) The test whether an officer could reasonably have been expected to be aware of an actual insufficiency is an objective test (§ 33);

iii) The sources of information referred to in section 29 (6) are the only sources of information to be taken into account in deciding whether an officer ought reasonably to have been aware of the actual insufficiency (§§ 36, 51);

iv) The information in question must clearly alert the officer to the insufficiency of the assessment (§ 36).

47. By way of gloss on the first of these propositions, the "situation mentioned in section 29 (1) above" is not just the existence of an insufficiency; but an insufficiency in respect of a particular period. Thus it follows, in my judgment, that information provided by or on behalf of the representative partner must clearly alert HMRC to an insufficiency in the partnership return for a particular period. By way of gloss on the third proposition, the statute requires that the representative partner notifies HMRC in writing of both the existence of the information and also its relevance to the "situation mentioned in subsection (1)". In other words the information must clearly alert HMRC to the relevance of the information to the insufficiency in the year in question. However, I do not consider that the statute requires that the existence of the information and its relevance must be contained in the same written communication. It would, I think, be sufficient if one communication notified the officer of the existence of the information and another notified the officer of its relevance.
48. In Corbally-Stourton v Revenue and Customs Commissioners [2008] STC (SCD) 907 Mr Hellier, the Special Commissioner, said that in order to make a discovery the officer need not be certain beyond all doubt that there is an insufficiency: what is required is that he comes to the conclusion on the information available to him and the law as he understands it that it is more likely than not that there is an insufficiency. This approach was adopted by Lord Bannatyne in the Scottish case of R (on the application of Pattullo) v Revenue and Customs Commissioners [2010] STC 107. Mr Coleman said that this was the wrong test. HMRC had to know with reasonable certainty of the insufficiency in question otherwise the office could not have been "aware" of it. There is, no doubt, an epistemological debate to be had about whether you can discover or be aware of something that does not in fact exist. In the present case, for example, the Commissioners decided that there was no insufficiency. Had HMRC discovered or been aware of an insufficiency before their decision that there was in fact no insufficiency? Or had they been aware of it, but then ceased to be aware of it? And now that I have disagreed with the Commissioners on one of the points, are HMRC aware of it again? Or have they been aware of it throughout? But I do not consider that I need to enter into this debate. In the present case the Commissioners asked whether HMRC had sufficient information to make a decision whether to raise an additional assessment. That seems to me to be the right test.
49. In Corbally-Stourton Mr Hellier pointed out (correctly in my judgment) that:

i) The statutory reference is to "an officer" of the Board, not to any particular officer;

ii) This entails a hypothetical officer rather than any real individual;

iii) The hypothetical officer must be endowed with knowledge of elementary arithmetic, some knowledge of tax law, and some tax law, all of which he will apply to the prescribed sources of information.

50. The formulation of the first proposition by the Court of Appeal in Veltema leads me to reject Mr McDonnell's submission that the question is whether HMRC had enough information to open an enquiry. In my judgment the threshold is higher than that. Indeed the Commissioners themselves applied a more stringent test. The submission for HMRC in Veltema (which the Court of Appeal appears to have accepted) is that the officer had to be aware of an insufficiency, although not necessarily its precise extent (see Veltema § 11).
51. On that footing the question is: whether an officer of the Board could not have been reasonably expected:

i) on 31 January 2007

ii) on the basis of the information notified to him in writing by or on behalf of the representative partner before 31 January 2007

iii) to be aware of an insufficiency in the partnership return for the year of assessment 2004/2005.

52. In support of the Commissioners' reliance on the exchange of correspondence in 2000 Mr McDonnell said that there was no temporal restriction on the information that counted under section 29 (6)(d)(ii), unlike the restrictions on information contained in tax or partnership returns to be found in section 29 (7). Thus far I agree. However, the information relied on under 29 (6)(d)(ii) must communicate not only the existence of the information but also its relevance to the situation mentioned in subsection (1) namely the insufficiency in the particular year of assessment. The exchange of correspondence in 2000 dealt only with rebates in the period to 31 March 1999. I cannot see how that could have clearly alerted HMRC to an insufficiency in 2004/05. After all, as we now know, the partners no longer pay fees and claim rebates. They subscribe for zero fee shares instead. That could have happened in any of the years of assessment after 1999. It might have been different if the letter had said "partners were given rebates in the year to 31 March 1999 and will continue to be given rebates in future years"; but it did not. In my judgment, therefore, the Commissioners were in error in attaching significance to that correspondence.
53. The events of 2006 raise different questions. Mr Coleman concentrated on what was explicitly stated in Mr Tai's letter of 30 March 2006. Since information must be notified in writing by or on behalf of the representative partner, that is clearly the starting point.
54. The relevant part of Mr Tai's letter is headed "fee rebates". So what follows is being provided in the context of fee rebates. That is its relevance. What follows is also being provided "as requested". The request is obviously the request made in the letter of 20 March, whose receipt Mr Tai has just acknowledged in the very same letter. Since this is part of an exchange of correspondence, it is legitimate in my judgment to refer to the request in order to amplify the relevance of the information that Mr Tai is providing. The relevance of the information is that HMRC had been notified that rebates of fees were made to the partners, and the information is requested so that Mr Gregory can pass it on to the individual officers dealing with each partner and notify them of the fee rebate arrangements. The hypothetical officer, receiving the information that Mr Tai provides will therefore understand its general relevance. The information that Mr Tai provided consisted of the NI numbers and names of the partners for two particular tax years. Thus the hypothetical officer will also have understood that fee rebates were made to those partners in those specific years.
55. Mr Gregory's letter also enclosed his notes of the meeting, and invited Mr Tai's observations on them. Mr Tai did not say that he disagreed with the notes in any way. Mr Coleman said that silence could not amount to notification of information; although he accepted that if Mr Tai had said in writing that he agreed with Mr Gregory's notes, that would have amounted to notification of the information contained within the notes. This information would have included Mr Tai's analogy with the plumber fixing his bathroom; which an officer with knowledge of tax law would have understood as a reference to the mutuality principle, and hence as raising the question whether the rebated fees were part of the partnership's taxable receipts. There are two competing views about silence. One is the strict contractual approach ("If I hear no more I shall consider the horse mine": Felthouse v Bindley (1862) 11 CBNS 869). The other is that of Sir Thomas More in A Man for All Seasons:

"The maxim is "Qui tacet consentire": the maxim of the law is "Silence gives consent". If therefore you wish to construe what my silence betokened, you must construe that I consented, not that I denied."

56. The modern approach to the interpretation of written communications (especially those intended to impart information) is to take into account the knowledge of the reasonable recipient. In the present case the reasonable recipient would have known of the written request which prompted Mr Tai's letter; and also the notes of the meeting that accompanied that request. In my judgment the Commissioners would have been entitled to apply a common sense approach to the status of the notes and, in company with Sir Thomas More, to have concluded that the notes of the meeting were agreed.
57. I also consider that the Commissioners were entitled to place weight on the fact that Mr Gregory had said that he would pass the information on to the officers dealing with the partners and that it would be for those officers to raise further iequiries if they wished to. It is not here a question of estoppel or legitimate expectation or anything of that kind. Rather the question is whether the hypothetical officer of the Board is to have attributed to him the knowledge of more than one real officer. This may depend on the facts to some extent. Mr McDonnell did not suggest that information contained in a letter to an officer in a local office at one end of the country, who had nothing to do with the taxpayer, could necessarily be attributed to an officer at the other end of the country in charge of that taxpayer's affairs. But where, as here, the information was given to an officer who was in some sense "on the case" and who had said he would pass it on to other officers who were also on the case, that was sufficient to justify the attribution of knowledge. I agree. The knowledge attributed to the officer would include both what Mr Tai had said (interpreted in the light of the considerations I have mentioned) and also what was in the partnership statement and its accompanying partnership accounts.
58. Mr Coleman submitted that even if the facts were known to HMRC, the legal analysis of those facts was difficult, and that in those circumstances it was not reasonable to expect HMRC to have been aware of the insufficiency. In Veltema the Court of Appeal attached some importance to the fact that the statutory question was framed in the negative ("the officer could not have been reasonably expected… to be aware of the situation mentioned"). Accordingly, if some officers could have been reasonably expected to be aware of the insufficiency but others could not, then the statutory question is answered adversely to HMRC and a discovery assessment may not be made. Mr Coleman's submission thus postulates that no officer could reasonably have been expected to have been aware of the insufficiency on 31 January 2007. This is essentially a question of fact. There is no finding of the Commissioners which, in my judgment, would support the argument.
59. The insufficiency ultimately discovered by HMRC was that fees rebated to partners had been wrongly deducted from trading profits. The Commissioners posed the question: did HMRC know enough to enable them to decide whether to raise an additional assessment? They answered that question in the affirmative. I do not consider that they asked themselves the wrong question. Their answer to it is a question of fact. Whether I would have reached the same answer is neither here nor there. In my judgment, despite their reliance on the events of 2000, their answer was one that was open to them on the facts.

Result

60. The case stated poses a number of very detailed questions. However, I do not consider that it is necessary for me to answer them. I consider that the Commissioners were entitled to reject the argument based on the mutuality principle; were wrong to have held that the rebated fees were proper deductions; and were entitled to find that the discovery assessment was out of time. Since the discovery assessment was out of time, even though the rebated fees were incorrectly treated as a deduction, this means that HMRC's appeal must be dismissed.