[2009] UKFTT 318 (TC)

 

 

 

 

 

 

TC00261

 

                                    Appeal number SC/3017/2009

 

 

Corporation tax – lump sum paid for release of annuity – deductible expense – obligation to pay annuity assumed on transfer of partnership business – whether revenue or capital

 

 

FIRST-TIER TRIBUNAL

 

TAX

 

 

 

                               PARNALLS SOLICITORS LIMITED              Appellant

 

 

                                                                      - and -

 

 

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                   REVENUE AND CUSTOMS (Corporation tax) Respondents

 

 

 

 

                                                TRIBUNAL: JUDGE ROGER BERNER

                                                                        CHARLES BAKER (Member)

                                                                       

                                                                       

 

Sitting in public in London on 27 October 2009

 

 

Brian Harvey, Tax Consultant, for the Appellant

 

Jane Hodge, HM Revenue and Customs, Local Compliance Appeals and Reviews Unit, for the Respondents

 

© CROWN COPYRIGHT 2009

DECISION

 

1.     This is the appeal of Parnalls Solicitors Limited (“the Appellant”) against an amendment to the Appellant’s return for the accounting period ended 31 December 2004.  The issue for determination is whether a provision made by the Appellant in the sum of £1.15 million in respect of a lump sum payment due to MR J H B Parnall (“Mr Parnall”), a former partner in the solicitors’ practice to which the Appellant succeeded, in commutation of the right of Mr Parnall (and his widow) to an annuity, is an allowable deduction in computing the Appellant’s profits chargeable to corporation tax.

2.     The Appellant was represented by Brian Harvey, a tax consultant.  The Respondents were represented by Jane Hodge of HMRC’s Appeals Unit.

The Facts

3.     Subject to one issue of material importance, in respect of which we make a determination later, there was no dispute on the facts.  The parties produced a statement of facts not in dispute, and we also received into evidence uncontested witness statements of Mr Parnall and his son, Mr R M B Parnall.  We were also provided with an agreed bundle of documents.

4.     From the evidence before us we find the following material facts.  We omit certain aspects of the background information with which we were provided as this does not impact directly on our decision.

(1)  The Appellant company acquired the solicitors’ practice of Parnalls on 1 January 2001.  That practice had originally been established as long ago as the late 1700s, and the Parnall family have been involved in the ownership and running of the firm (and latterly the Appellant) for three generations.

(2)  On 27 June 1974, when the partnership was called Parnall, Godwin and Chegwin, a memorandum of terms was entered into on the occasion of a new partner, Mr E J W Pitt, being admitted as a partner.  The memorandum included provision for annuities in favour of the then existing partners, including Mr Parnall, from the dates of their retirements and, after the death of a retired partner, any widow of that partner.  The annuity was calculated by reference to a basic amount set as a proportion of the profit of the year preceding the partner’s retirement (but not less that the like proportion of the average profit over the last three years as a partner), increasing or decreasing in accordance with a formula to reflect fluctuations in the retail prices index.

(3)  Over the succeeding years there were a number of partnership changes.  In 1987, there was a partnership split, as a result of which the annuity obligations under the 1974 memorandum were divided between two separate partnerships which emerged.  The responsibility for Mr Parnall’s annuity on his retirement was assumed by the partnership called Parnall Langsford carrying on business out of Launceston.  The 1974 memorandum continued to apply to that annuity.

(4)  As well as the annuity of Mr Parnall, the partnership was also responsible for an annuity in favour of another former partner, Mr H Godwin.  He retired on 31 December 1974, and was paid his annuity by the successive partnerships up to his death on 5 March 1989.  An annuity then became payable to Mr Godwin’s widow; this was paid by Parnall Langsford, which became Parnalls on 1 January 1996.

(5)  Mr Parnall retired from the partnership of Parnalls on 30 November 2000.  On that date he gifted his share of goodwill of the partnership equally to his two sons, Mr J Parnall and Mr R Parnall, and his daughter in law, Mrs K Parnall.  The gift was valued for capital gains tax purposes at a market value of £332,500.  Mr Parnall’s entitlement to his annuity arose on the date of his retirement, but he did not at that stage seek to enforce his entitlement.  As he explains in his witness statement, this was due to the then financial situation, and the fact that the partnership was obliged to pay the annuity to Mr Godwin’s widow.  He did not at that stage wish to burden his sons and daughter in law with his own annuity.

(6)  On 1 January 2001, the partnership transferred its business to the Appellant.  The former partners in Parnalls became the sole shareholders in the Appellant.  There was no written agreement or transfer document in relation to this business transfer, but the Appellant took over all of the assets and liabilities of the partnership.  However, the annuity obligation was not reflected in the company balance sheet on incorporation.  Mr Parnall held no shares in the Appellant, but was appointed as a director and worked for the Appellant in return for certain income and benefits.

(7)  We should say at this stage that not all aspects of the transaction whereby the Appellant acquired the business of the partnership were agreed.  We shall return to an important issue below, but at this stage we should record that the Respondents argued that the assets of the business were exchanged in consideration of the Appellant issuing shares and taking over partnership liabilities, whereas the Appellant said that the shares in the Appellant were allotted for cash and the assets and liabilities of the partnership were transferred at net book value, with the surplus being credited to the director’s loan accounts.  The question whether the taking over of the liability for Mr Parnall’s annuity was part of the consideration for the transfer is material, and we consider that later.  We do not consider it material to our decision whether the Appellant’s shares were issued for cash or as part of the consideration for the transfer.

(8)  The Appellant made annuity payments to Mr Godwin’s widow until her death on 27 April 2004.  Those annuities were shown in the Appellant’s accounts as “annuities to former employees”.

(9)  Following the death of Mr Godwin’s widow, and as Mr Parnall considered that the Appellant was in a position to commence payment of his own annuity, he then took the opportunity to bring negotiations as to his own annuity to a conclusion.  The calculation of the annuity was not a simple one, given that there had been numerous changes to the partnership since 1974, including dissolutions and creations of new firms, without any variation to the annuity rights agreed under the 1974 Memorandum.  The problem in essence was that there was no longer a single firm the profitability of which could be ascertained in order to calculate values within the agreed formula.  For this reason, a basis of calculation was agreed on a just and reasonable basis adopting a formula as specified in paragraph 8 of the HMRC Statement of Practice D12.  This calculation took two-thirds of Mr Parnall’s average share of the taxable profits of the partnership in the best three of the last seven years during which he was a full-time partner.

(10)   The settlement on this basis of Mr Parnall’s annuity was documented by a Deed of Covenant and Compromise Agreement entered into on 1 October 2005, between (1) Mr Parnall, (2) the former partners of Parnalls at the date of the Appellant’s acquisition of the business and (3) the Appellant.  In that deed it was recited that “[The Appellant] became liable for the annuity by virtue of the transfer of all assets and liabilities of the firm of Parnalls into [the Appellant] on the 1^st day of January 2001”.  The Appellant covenanted with Mr Parnall and the former partners that it would perform the annuity obligations contained in the deed, and the former partners guaranteed those obligations.  The annuity was calculated at the base date of 31 December 2000, and index-linked from that date.  Certain sums that had been paid by the Appellant to or for the benefit of Mr Parnall in 2002 and 2003 were taken into account.

(11)   The annuity was expressed to accrue from day to day and was payable monthly.  Payments, under deduction of tax, were made for October 2005 and November 2005.

(12)   On 23 November 2005 the Appellant obtained a professional opinion from consulting actuaries of the cost of providing Mr Parnall with an index-linked pension of the relevant amount, such pension to continue at the same level to his widow following his death.  This was established as being in the region of £1.5 million.  Following negotiations, an agreement was reached with Mr and Mrs Parnall, set out in a Deed of Release dated 16 December 2005, that they would release the Appellant and the former partners from the obligation to pay the annuity in consideration of the sum of £1.15 million.  That sum was not paid immediately, but was secured by a promissory note made on 16 December 2005 under which the Appellant and the former partners jointly and severally promised to pay Mr and Mrs Parnall the sum of £1.15 million on demand with interest (if demanded) at 1% over base.  This amount has been credited to a loan account on which Mr Parnall is free to draw on demand.

(13)   The accounts for the Appellant for the accounting period ended 31 December 2004 were prepared in accordance with generally accepted accounting standards.  The liability under the Deed of Release was provided for in full and was shown as an extraordinary item, after deduction of tax.

Was the assumption of the annuity obligation part of the consideration for the Appellant’s acquisition of the partnership business?

5.     We return now to the circumstances of the acquisition of the partnership business by the Appellant, and the terms on which this was agreed.  There was no written agreement.  We need to determine, as a matter of fact, if, as the Respondents argue, the Appellant’s assumption of the obligation to pay Mr Parnall’s annuity was part of the consideration for the acquisition.  Mr Harvey argued that it was not.  He said that all the assets and liabilities of the partnership business were transferred at net book value, but there was no valuation of the annuity obligation.  He acknowledged that as a matter of valuation an annuity for life may have a capital equivalent, but said that this would be no more than a unit of calculation, so long as it did not form part of the bargain that was struck.  In the case of Mr Parnall’s annuity, he argued, this was not capable of quantification.  As no liability in respect of the annuity would arise until payment was actually due it had not been appropriate for any provision in this respect to have been made.  The annuity obligation was not included in the opening balance sheet of the Appellant at 1 January 2001.  Such a liability would arise only if Mr Parnall or his widow were alive at the relevant date.

6.     The burden of proof in this respect is on the Appellant.  It is common ground that the obligations in respect of Mr Parnall’s annuity were assumed by the Appellant as part of the transfer of the partnership business to it.  The parties to the transfer were, we can infer, the then existing partners and the Appellant; there is no evidence that Mr Parnall was a party.  The Appellant came under a direct obligation to Mr and Mrs Parnall only in 2005 with the execution of the Deed of Covenant and Compromise Agreement.  Until then, the Appellant’s only legal or contractual obligation was to the previous partners on the terms on which the obligation to Mr Parnall was assumed.  We therefore find as a fact that the Appellant’s assumption of the obligation to pay Mr Parnall’s annuity was part of the consideration for the acquisition of the partnership business.  We do not consider that it is material that the obligation was not valued, provided for or otherwise included in the Appellant’s opening balance sheet, nor that the obligation was in the nature of an annuity which would accrue over time only if either Mr or Mrs Parnall were alive on the relevant dates.  The bargain was for the transfer of all assets and liabilities, which we consider is properly construed as a bargain for the sale of the assets for a consideration that includes the assumption of the liabilities.  Although not quantified or otherwise recognised in accounting terms, the annuity obligation was a liability assumed in this way, and so in our view must be considered as part of the consideration for the assets of the partnership business that were transferred to the Appellant.

Discussion

7.     It was common ground between the parties that the starting point, in determining whether the lump sum payment in commutation of Mr Parnall’s annuity is deductible is s 42 of the Finance Act 1998 which provides:

“For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in computing profits for those purposes.”

8.     The Appellant’s accounts show the sum of £1.15 million as an extraordinary item deducted in computing profits.  The question therefore is whether any adjustment is required by law.  The Respondents say that an adjustment must be made to exclude this amount as a deduction solely on account of the fact that, as they argue, it is an item of a capital nature and items of a capital nature must be excluded unless specifically allowed by statute.  It was not contended by the Respondents that any other adjustment was required, including any adjustment by virtue of s 74 of the Income and Corporation Taxes Act 1988 (“TA”).

9.     Mr Harvey referred us to J P Hancock v General Reversionary and Investment Co Ltd 7 TC 358 and Vodafone Cellular Ltd and Others v Shaw 69 TC 376 as authority for the proposition that where a lump sum payment is made to commute or extinguish a contractual obligation to make recurring revenue payments, then the lump sum payment is prima facie a revenue payment.  In Hancock a company whose business included the granting of annuities paid a lump sum for the purchase of an annuity for the benefit of a former employee equal to the pension that the company had awarded him.  It was held that the lump sum was an expense incurred in the business and was not in the nature of capital expenditure, and so was deductible.

10.  Vodafone is a more recent authority.  In that case it was held that a lump sum payment made for cancellation of a fee agreement under which Vodafone was to pay a percentage of its consolidated pre-tax profits to another company in return for the provision of future know-how was a revenue payment and that the fee agreement was not a capital asset.  After referring to the fact that whether a payment is a capital or a revenue payment is a question of law, and that there is no single test or infallible criterion for distinguishing between capital and revenue payments, Millett L J in the Court of Appeal said (at p 433-434):

“Two matters are of particular importance: the nature of the payment; and the nature of the advantage obtained by the payment. The fact that the payment is a lump sum payment is relevant but not determinative. In a case such as the present, where the payment is made in order to get rid of a liability, a useful starting point is to inquire into the nature of the liability which is brought to an end by the payment. Where a lump sum payment is made in order to commute or extinguish a contractual obligation to make recurring revenue payments then the payment is prima facie a revenue payment.

In J. P. Hancock v. The General Reversionary and Investment Co. Ltd. [1919] 1 KB 25; 7 TC 358, the payment of a lump sum in order to commute an annual pension was held to be an income payment because it merely anticipated payments which if not commuted would have been income payments. In such a case "the lump sum might be regarded as of the same nature as the ingredients of which it was composed" see Van den Berghs Ltd. v. Clark (supra) [1935] AC 431, at page 442 per Lord Macmillan.

In Anglo-Persian Oil Co. Ltd. v. Dale 16 TC 253; [1932] 1 KB 124 the payment of a lump sum in order to secure the cancellation of an agency agreement which was onerous to the principal and would otherwise have endured for a further ten years was held to be a revenue payment. It

"neither enlarged the area of its operations, nor improved its goodwill, nor embarked upon a new enterprise; it merely effected a change in its business methods and internal organization, leaving its fixed capital untouched"

per Lawrence L.J. [1932] 1 KB 124, at page 141; 16 TC 253, at page 270.

But the principle that a payment made in order to commute or discharge a liability to make recurring revenue payments is itself a revenue payment is subject to an important qualification. If the liability to make recurring revenue payments is reduced or brought to an end by the modification or disposal of an identifiable capital asset, then any payment made for the modification or disposal is itself a capital payment.

In Tucker v. Granada Motorway Services Ltd. (supra) Lord Wilberforce explained that the assumption that money spent on the acquisition of an asset should be regarded as capital expenditure has been extended in two ways. First, money spent on getting rid of a disadvantageous asset is normally regarded as capital, and secondly money spent on improving the asset or making it more advantageous is also normally so regarded. In Mallett v. Staveley Coal and Iron Co. Ltd. 13 TC 772; [1928] 2 KB 405 a reverse premium paid by a tenant to a landlord to accept the surrender of a mining lease was held to be a capital payment. In that case the payment was made to dispose of a capital asset. In Tucker v. Granada Motorway Services Ltd. A payment made to commute part of the rent payable under a lease was also held to be capital. The payment was not made in order to get rid of a disadvantageous asset, but it was made in order to render the asset less disadvantageous. The lease itself was non-assignable and so had no balance sheet value, but it was nevertheless a balance sheet item, that is to say a capital asset the value of which (if it had any) would have appeared in the balance sheet. It followed that a payment made to make the lease more advantageous was a capital payment even though the object in making the payment was to increase the taxpayer's profits by reducing its revenue expenditure.”

11.  On this basis, Mr Harvey argued that the payment to extinguish Mr Parnall’s annuity was a revenue payment.  He submitted that this was not prevented from being the case by the qualification described by Lord Justice Millett.  The obligation to Mr Parnall was not a capital asset.  He relied upon the following further extract from Millet L J’s judgment (at p 434):

“In the present case the payment in question was made to get rid of the liability to pay annual fees under the fee agreement. The Crown submits that the fee agreement was a capital asset. I do not accept this submission. The fee agreement was certainly not a balance sheet item, and in my opinion it was no more a capital asset than was the agency agreement in Anglo-Persian Oil Co. Ltd. v. Dale (supra).

It is obvious that not every contract under which a liability to make revenue payments arises is a capital asset for this purpose, or the general principle that payments to get rid of revenue liabilities are revenue payments would be entirely subsumed in the exception. It is only where such a contract is one the cancellation of which would effectively destroy or cripple the whole structure of the taxpayer's profit-making apparatus that it falls to be treated exceptionally as a capital asset.”

12.  Miss Hodge submitted that both Hancock and Vodafone were inapplicable to this appeal.  This appeal relates to annuity payments to a former partner, whereas in Vodafone the payment was to cancel an ordinary trading contract.  Furthermore, as regards both Hancock and Vodafone, those cases concerned revenue payments whereas it is argued on behalf of HMRC that the annuity payments in this case are capital payments.

13.  We do not agree that Vodafone in particular is not relevant.  From that case we take the law to be that as a general matter a lump sum payment to commute or extinguish a contractual obligation to make recurring revenue payments will itself be a revenue payment.  We do not accept that there is any distinction to be drawn in this regard between ordinary trading obligations and other obligations of a revenue nature.  We find also that the annuity obligation of the Appellant to Mr Parnall was not a capital asset of the Appellant.  It was not an asset at all, and certainly not something answering to the description provided by Lord Justice Millett.

14.  The question therefore is whether the annuity payments that would have fallen to be payable to Mr Parnall or his widow but for the lump sum commutation payment would themselves have been revenue payments.  In this respect Miss Hodge referred us to two cases, Royal Insurance Company v Watson 3 TC 500 and Commissioner of Inland Revenue v New Zealand Forest Research Institute Ltd 72 TC 628.

15.  In the Royal Insurance Company case, under the agreement by which the Royal Insurance Company acquired the business of another insurance company, it was provided that the manager of the latter company would be taken into the service of the Royal Insurance Company at a yearly salary, which the Royal Insurance Company was permitted to commute by a payment of a gross sum on the basis of certain annuity tables.  It was held by the House of Lords that this payment was consideration for the transfer of the business and was capital expenditure in the hands of the Royal Insurance Company.  The agreement in question was not with the manager, in which case, as Lord Shand observed (at p 506), “such a payment [of a capital sum] might properly form a deduction from gross profits”, but with the transferor company.  A payment in consideration of acquiring the business was a payment of capital, and so not a proper deduction from profits.

16.  The New Zealand Forest Research Institute Ltd case was a New Zealand case the final appeal of which was heard by the Privy Council.  Under a New Zealand statute, the Crown sold a forestry research business to NZPRI.  Under the agreement NZPRI assumed various of the vendor’s contractual obligations to its employees, including vested and contingent entitlements to paid leave.  In giving the judgment of the Privy Council, Lord Hoffman said (at p 631):

“… the position was that the Institute, pursuant to the Transfer Agreement and as part of the consideration for the purchase of the assets, accepted a liability under its employment agreements with former Crown employees not merely to remunerate them for services to the Institute but also to discharge obligations, either vested or contingent upon some future event, which were attributable to their previous service with the Crown. It seems to their Lordships plain that, viewed in this light, the payments were capital expenditure, being part of what was paid for the acquisition of the assets. There can be no doubt that the discharge of the vendor's liability to a third party, whether vested or contingent, can be part of the purchase price. It does not matter that the payment is not made at once but pursuant to an arrangement whereby the purchaser agrees to be substituted as debtor to the third party.

Nor can it matter that the payments would be income in the hands of the third party recipient. In Royal Insurance Co. v. Watson [1897] AC 1 the purchaser of a business agreed as a term of the acquisition to employ a manager previously employed by the vendor at a salary, with power to commute the salary by payment of a lump sum. The purchaser company took on the manager and shortly afterwards exercised the power of commutation and paid him £55,846. The House of Lords held that the payment was part of the capital consideration paid for the business. It will be noticed that the payment was made in that case pursuant to a new contract of employment but the employee's entitlement to the commutation payment was nevertheless held to be part of the purchase price rather than attributable to his services to the purchaser company. Whether it was attributable to one or the other was a question of fact. The Commissioner's argument in the present case is much stronger because the payments in issue were clearly attributable to services rendered to the Crown and, but for the sale, would have been obligations of the Crown.”

17.  Mr Harvey argued that Royal Insurance Company was a case that plainly turned on its own facts.  In that case there was a specified lump sum payment provided for under the agreement between the vendor and purchaser of the business.  In this case, he says, by contrast the lump sum payment was agreed between the annuitant and the company.  In the Hancock case, Royal Insurance Company was not followed, and Lush J made clear that the facts of that case were entirely different from those in Hancock.

18.  Mr Harvey likewise submitted that New Zealand Forest Research Institute Ltd was a case that turned on its own particular facts.  The contractual arrangements relating to the transfer of the business in that case required an adjustment to be made to the purchase price for the assets transferred by the Crown to NZFRI by an amount determined having regard to “accrued staff liabilities”.  Those liabilities were, Mr Harvey argued, certain.  By contrast, he said, at the time of the acquisition of the partnership business by the Appellant, the question whether, and in what amount, the obligation to pay an annuity to Mr Parnall was completely uncertain.  It was not clear at that time that there was any need to account for the annuity.

19.  It is doubtless correct to say that both Royal Insurance Company and New Zealand Forest Research Institute Ltd were decided on their own facts.  There is nevertheless a clear principle that can be derived from those cases.  It is that where an obligation, whether vested or contingent, is assumed as part of the purchase price, or consideration, for the purchase of assets on a transfer of a business, payments in discharge of that obligation are capital expenditure, and not revenue expenditure.  Whilst we agree with Mr Harvey that Royal Insurance Company concerned a lump sum payment, it is clear that, as New Zealand Forest Research Institute Ltd decided, the principle also extends to other obligations which, if paid by the vendor, would have been deductible revenue expenses.  As Lord Hoffman remarked (at pp 632 – 633):

“It is by no means remarkable that acceptance of liability to discharge another person's obligations to make payments in return for a capital or a capital asset should be a capital expense, even though the same payments if made by the original debtor would have been a revenue expense. In this case, their Lordships think there is no doubt that if the Crown had been a taxable entity and had itself paid the Accrued Staff Liabilities, they would have been deductible revenue expenses. But that does not affect the conclusion that the Institute's acceptance of liability to pay them was a capital expense.”

20.  Nor do we consider that the New Zealand Forest Research Institute Ltd case can be distinguished as Mr Harvey suggests.  Even on the facts of that case the relevant liabilities were not wholly vested, and only an estimate of them had been taken into account.  But in any event, we consider that both that case, and Royal Insurance Company, do not turn on the nature of the obligations assumed, but on the fact as found in those cases that the obligations were assumed as part of the purchase price or consideration for the acquisition of the business in each case.

21.  Mr Harvey argued that we should concern ourselves not with the circumstances of the original acquisition by the Appellant of the partnership business, but only with the circumstances at the time the lump sum payment was provided for.  He relied upon a passage from the judgment of Millett L J in Vodafone (at p 435) where he said: “… the question whether a payment is capital or income must depend on the circumstances at the time when the payment is made.”  He characterised the argument of the Respondents as being that the lump sum provided for in commutation of the annuity was a belated capital cost of acquiring the trade of the partnership.  He said that the circumstances leading to the commutation sum were settled in December 2005 and were to distinguish an onerous obligation of the Appellant.  The acquisition of the partnership business was the causa sine qua non but not the causa causans for the commutation payment.

22.  As Mr Harvey says, we are certainly bound to consider the circumstances at the time of the making of the provision for the commutation payment.  But the circumstances undoubtedly include the character of the annuity payments that were released.  To consider the commutation of these payments in isolation, ignoring the acquisition of the partnership business and the assumption of the annuity obligations as part of that acquisition, would fail to take account of all the circumstances existing at the time of the commutation payment or provision, which include the character of the annuity payments.  If something is a causa sine qua non for a payment or provision, then it would be quite wrong to ignore it in considering all the circumstances at the material time when the payment or provision is made.

23.  Applying these principles, as we have found as a fact that in this case the obligation to pay Mr Parnall’s annuity was assumed as part of the consideration for the acquisition of the partnership business, we decide that payments of that annuity would have been capital expenditure and not a revenue expense.  The treatment of the lump sum is determined by the nature of the payments it supplants.  Accordingly, we decide that the payment of the sum of £1.15 million in commutation of the annuity was not to extinguish a contractual obligation to make recurring revenue payments and is not itself a revenue payment, but extinguished an obligation to make payments of capital expenditure and is a capital payment.

Charges on income

24.  It was common ground between the parties that the correct treatment of annuity payments made by the Appellant to Mr Parnall in 2002 and 2003 was that:

(1)  the annuity payments were charges on income under s 338A TA;

(2)  the Appellant should have paid the annuity after deducting tax; and

(3)  the annuity payments should have been added back in the Appellant’s corporation tax computation in computing the income chargeable in accordance with the prohibition in s 337A(1)(b) TA (a company’s income from any source shall be computed without any deduction in respect of charges on income).

25.  Mr Harvey argued in addition that the payments would, after the changes made by s 38 of the Finance (No 2) Act 2005, be allowable in the Appellant as management expenses.  Miss Hodge submitted that this was not the case and that to be deductible in the case of the Appellant the payments would have to satisfy the normal rules for the deduction of trading expenses.

26.  Each party relied upon the agreed treatment of the annuity payments in 2002 and 2003 in support of their respective cases.  Miss Hodge argued that because a payment that was deductible in computing profits for the purposes of corporation tax could not be a charge on income (s 338A(3) TA), charge on income treatment confirmed that the annuity payments were not so deductible and it followed that the lump sum commutation payment was also non-deductible.  We do not agree.  The test in Vodafone does not depend on deductibility (though we accept that payments commuted in this way will often be deductible as trading expenses), but on the quality of the payments as revenue or capital.

27.  Mr Harvey’s argument on this was that as the annuity payments were accepted as charge on income prior to 2005, it followed that the annuity must be income, as it would not be a charge on income if it were a payment of a capital sum by instalments.  Miss Hodge argued that this was not the case: a charge on income could be capital in the hands of the payer and income in the hands of the payee.

28.  We agree with Miss Hodge on this point.  At a late stage in the hearing Mr Harvey referred us to a number of authorities which he said supported his proposition.  We refer first to Commissioners of Inland Revenue v Hogarth 23 TC 491 in the Court of Session (First Division).  In that case, on the retirement of a partner of a firm he was paid, in settlement of his share in the capital, assets and profits of the business, amongst other things a proportionate share of the net profits of the business over a three-year period.  This was paid as income under deduction of income tax.  It was held that the payments were deductible as they were not in the nature of capital but were in the nature of annual payments of income.  One of the significant factors identified by the court in that case was the fact that the parties had stipulated that the payment was to be made under deduction of tax and so could be regarded as having intended that the payment should be of an income character.  However, it is clear that the basis for this conclusion was that the payment was in satisfaction of an interest in or claim to annual profits, and that it was not the price for the acquisition of an asset under a vendor and purchaser agreement.  Here, as we have found, the annuity payments were part of the price for the acquisition of the partnership business by the Appellant, and accordingly in our judgment Hogarth is not applicable on the facts of this case.

29.  Mr Harvey also referred us to IRC v Church Commissioners for England [1976] STC 339.  In that case a company, Land Securities Investment Trust Ltd (“Land Securities”) purchased certain reversionary interests in property from a charity, the Church Commissioners.  The consideration was the payment of rentcharges.  It was held in the House of Lords that the payments received by the charity were wholly of an income nature.  However, that case related to only one side of the coin: to the position of the payee and not that of the payer.  The position of the payer (Land Securities) was decided in another case, IRC v Land Securities Investment Trust Ltd 45 TC 495, which also reached the House of Lords.  We need only to refer to the summary of the judgment in that case given by Lord Morris of Borth-y-Gest in Church Commissioners (at pp 348 – 349):

“The tax position of Land Securities arose for consideration in the case which reached this House (Inland Revenue Comrs v Land Securities Investment Trust Ltd). Land Securities were assessed to profits tax. They are a property investment company. They acquire properties for letting. Such properties are their capital assets. They make profits from the rentals they receive. Were the payments to be made by them pursuant to the agreement of 5 January 1960 payments of such a nature that they were allowable deductible expenses in computing the company's taxable profits? Were the rentcharges proper items to debit against the company's incomings of its trade when computing its profits for profits tax purposes? In holding, in effect, that the payments were the cost to Land Securities of acquiring capital assets and accordingly were not allowable deductions, the House was content to assume, without expressly deciding, that the rentcharges were income in the Church Commissioners' hands and were in their entirety liable to deduction at source under s 177.

Whether that assumption was correct is the question which now arises. The House clearly considered that capital assets could be purchased by payments which, when made, were of a capital nature so far as concerned the payer but which so far as concerned the recipient could be or might be of an income nature.”

30.  It is clear from the judgments in Church Commissioners and Land Securities that there does not need to be, as Mr Harvey argued, symmetry between the quality of the payments in the hands of payer and payee.  The same conclusion can be derived from the speech of Lord Hoffman in New Zealand Forest Research Institute to which we have already referred, and from Royal Insurance Company.  The fact that the annuity was income in the hands of Mr Parnall does not determine whether the payments by the Appellant are revenue or capital.  That must fall to be determined by the general law, and, as we have described above, we are satisfied that on the authorities the annuity payments from the perspective of the Appellant were not revenue payments, but capital.

31.  It follows from this that we do not regard the treatment of the annuity payments as charges on income, as deductible or non-deductible expenses or as management expenses as material to our decision.  However, as the point was argued before us, we ought to say a few words about Mr Harvey’s submission that, following the amendments made by s 38 of the Finance (No 2) Act 2005 to s 338A TA, the annuity payable to Mr Parnall would have been deductible as a management expense under s 75 TA.  The relevant amendments took effect in respect of payments of annuities on and after 16 March 2005.  In our view Mr Harvey’s submission in this respect is misconceived.  Section 38(12) of the 2005 Act provides that in certain circumstances a payment in respect of an annuity made on or after 16 March 2005 will be deductible as a management expense, but this only applies to payments that would have been so deductible but for being precluded because they were charges on income by reason of being annuities.  This does not operate, as Mr Harvey’s submission suggests, to convert all annuity payments into management expenses, but applies only to expenses of management of a company’s investment business which are otherwise allowable under s 75.  There was no suggestion that the Appellant was a company with investment business within s 130 TA, and the annuity payments could not therefore qualify for relief as management expenses under this provision.

Published HMRC materials

32.  Mr Harvey referred us to a number of extracts from HMRC publications and other materials in support of an argument that HMRC were guilty of inconsistency in arguing the case against the Appellant.  We do not consider that these were material to our decision, which depends on the law as we have found it and not on any interpretation which might be attributed to HMRC.  We do not therefore refer to such materials in our decision, and we make no comment on their validity or otherwise.

Decision

33.  For the reasons we have given, we dismiss this appeal.

The Appellant has a right to apply for permission to appeal against this decision pursuant to Rule 39 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

 

 

 

 

ROGER BERNER

 

TRIBUNAL JUDGE

RELEASE DATE: 10 November 2009

 

 

 

Case also cited and not referred to in this decision:

 

Scoble and Others v The Secretary of State in Council for India [1903] 1 KB 494