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Cite as: [2007] UKSPC SPC619, [2007] UKSPC SPC00619, [2008] STC (SCD) 1

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Tower Mcashback LLP1 v Revenue & Customs [2007] UKSPC SPC00619 (19 July 2007)

Spc00619

Capital expenditure on software - whether HMRC can raise additional contentions in an appeal beyond those indicated in the Closure Notice - whether expenditure was incurred pursuant to an unconditional contract - whether the expenditure paid 10 months after the date of the contract was still paid under a contract that required payment within a four month period, or whether the eventual payment was under a varied contract – whether one of the Appellants had commenced trading before the end of the tax year 2003/2004 - whether the value of the software was broadly in line with the capital expenditure ostensibly given by the LLPs in which the Appellants were members – how to analyse the transaction for capital allowance purposes if the value of the acquired asset was materially lower than the price paid initially for the asset with the support of non-recourse loans - Appeal by LLP1 dismissed and appeal by LLP2 dismissed in part

THE SPECIAL COMMISSIONERS

TOWER MCASHBACK LLP1

TOWER MCASHBACK LLP2 Appellants

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Special Commissioner: HOWARD M NOWLAN

Sitting in public in London from 16 to 25 May 2007

Giles Goodfellow, QC and Richard Vallat, instructed by Castle Tax Consultants, for the Appellant

Bruce Carr, counsel, instructed by the Acting Solicitor for HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Introduction

This has been a very interesting and relatively complex case. In this judgment I must give my decision on five different points, with those points somewhat curiously not including the point that was principally in contention at the beginning of the hearing.

The main point that remained in contention related to the quantification of capital allowances available in respect of a purchase of software, where the purchase was substantially funded by non-recourse loans indirectly made available by the vendor of the software. This point raised Ramsay type issues of first having to discern the form and then the truth and reality of the main transactions effected by the Appellants, and then the need to apply the statutory provisions in a purposive manner to those findings.

Three of the other points in contention raised technical issues in relation to the claims for capital allowances.

The fifth point related to whether the Commissioners for HM Revenue and Customs ("HMRC") could advance new contentions in an appeal beyond that or those points indicated in the Closure Notice issued by the Inspector. In this case the conclusion and the adjustments required by the Closure Notice related (or at least were initially wrongly thought to relate) solely to the original point in contention, which HMRC actually abandoned on the second day of the hearing.

I must also refer to the preliminary point that HMRC had requested an adjournment of the hearing both in Directions Hearings prior to the commencement of the main hearing and on the first morning of the hearing (both of which requests I rejected) in order to have more time in which to obtain their own expert evidence on valuation matters in relation to the main capital allowance point concerning the financing of the software purchase. I must explain why those requests had been made and must also indicate the one circumstance where, were my decision on the main substantive point in dispute to be overturned on appeal, it might remain the case that further evidence would be required in a further hearing before the Special Commissioners on the valuation aspects that led HMRC to request those adjournments.

The facts, very briefly, were that a company, MCashback Limited ("MCashback"), had devised some clever and novel software that it believed, and indeed that it still believes, will revolutionise the loyalty cards often promoted by food and drink producers and supermarkets, providing, as its reward to "customers", free air-time on mobile phones.

Whilst MCashback had already devised the software to enable the system to work satisfactorily, MCashback required additional finance to roll-out the system. This roll-out potentially involved negotiations with food and drink producers, supermarket groups and mobile phone companies in numerous parts of the world. MCashback accordingly sought the assistance of Tower Group PLC ("Tower") which had had experience of arranging finance for similar software companies.

The scheme adopted by Tower involved the creation of four LLPs, eventually known as Tower MCashback LLP 1 ("LLP1"), Tower MCashback LLP 2 ("LLP2") etc. Each of the four LLPs was to purchase software related to MCashback's system, the aggregate price for the purchase by all four LLPs being £143 million. With a view to the LLPs claiming 100% first year capital allowances for tax purposes under section 45 Capital Allowances Act 2001 ("CAA 2001") the four LLPs entered into contracts to buy discrete elements of software on 31 March 2004, on the basis that the purchases would be completed before the expiry of a four-month period. The contracts all envisaged that while the LLPs would pay the whole of the allocated slices of the £143 million total purchase price on completion, MCashback would procure that two banks would be interposed in a chain to provide the investing partners with non-recourse loans to fund 75% of their capital contributions to the LLPs, Mcashback providing the ultimate security and all of the funding to those intermediate banks.

The initial challenge to the scheme by HMRC focused on the purchases by the first two LLPs, and was geared to the claim that allowances were not available under section 45, because the software was so dealt with that a third party (the first retailer to operate the system) was to have rights to use the software such that section 45(5) denied the allowances. Section 45(5) was designed to prevent a special capital allowance provision directed to giving incentives to small- and medium-sized enterprises on purchasing software from making such allowances available in a leasing or quasi-leasing context. This claim was however dropped by HMRC on the second day of the hearing, and the main point of contention became the issue of what allowances were due if HMRC were right in their contention that the value of the software was very materially less than the price paid for it. HMRC's contention was that capital allowances were only available for 25% of the price paid because that reflected the value of the software (and the capital provided otherwise than with loan assistance), the balance of the price being paid for the provision of beneficial finance, so that whether the loans were eventually paid off out of the revenues designated to pay off the non-recourse loans or not, no further allowances would be available. During the hearing I asked both parties to deal with my alternative suggestion that the provision of the non-recourse loans meant that the only expenditure incurred at the outset was the 25% paid out of the capital provided by the partners to the LLPs ignoring the element funded by the loans, but that further expenditure would be treated as incurred if and when but only to the extent that designated revenues were applied in paying off the non-recourse loans. My decision on this, the most important point in this case, is that the value of the software was dramatically lower than the gross price paid for it, and that the right capital allowance analysis is the one that I had advanced, just described.

The different capital allowance implications of the points remaining in contention

Before summarising the claims made by the two Appellants for capital allowances and the various grounds on which HMRC had disputed the entitlement to such allowances, it will be clearest to outline first the complicated but un-contentious points in relation to the various different sections under which allowances were available, and to give some indication of when points were in contention.

Sections 45 and 52 CAA 2001 provided that expenditure incurred by small- or medium-sized enterprises on software, incurred before 31 March 2004, qualified for a 100% first-year allowance. Section 5(1) and (5) were relevant in deciding whether the expenditure was to be treated as incurred on or before 31 March 2004, these two sub-sections providing that expenditure was still to be treated as incurred on or before 31 March 2004 if it was incurred under an unconditional contract made on or before that date provided that it was also incurred under a contract that required completion within four months. Both these points were claimed to be satisfied in relation to LLP1 and LLP2 notwithstanding that completion only occurred in January 2005, and both were disputed by HMRC. If the Appellants fail on either issue, then no allowances will be available under section 45, and instead allowances will have to be claimed under section 44.

Sections 44 and 52 CAA 2001 provide that expenditure incurred by small- or medium-sized enterprises that implicitly failed to qualify for allowances under section 45 qualifies instead for a 40% first-year allowance, save that if incurred in the tax year 2004/2005, the first-year allowance will be 50% rather than 40%.

The slightly complicated point to add however is that in judging when expenditure is incurred for the purposes of ascertaining whether the expenditure qualifies for s. 45 allowances, section 50 overrides section 12 and thus deletes the normal rule that expenditure incurred by a person about to trade is treated as incurred on the first day of trading. The section 12 rule is only overridden for this limited purpose so that if the first Appellant (LLP1) succeeds in establishing the two points in contention under section 5, but is shown not to have commenced trading by 5 April 2004, then section 45 allowances would still be available, but the expenditure would be treated by section 12 as incurred on the first day of trading (in other words in the period 2004/2005 when HMRC concedes that LLP1 had commenced trading) for the separate purpose of ascertaining when the expenditure had actually been incurred so that the allowances could then be claimed.

It follows that if LLP1 is to sustain its claim for allowances in the tax year 2003/2004, it must succeed on both of the section 5 points, and must also show that it had commenced trading by 5 April 2004. For it is only by succeeding on the section 5 points that the expenditure actually laid out in January 2005 can be back-dated to 31 March 2004 for section 45 purposes, and it is only by succeeding on the trading point before 5 April 2004 that any allowances can be claimed in the period 2003/2004.

One then has to overlay on all the above points the more fundamental point that if HMRC succeed in demonstrating that the Appellants only incurred on the software, say, 25%, of the ostensible total expenditure, on account of the various points relevant to value, soft finance and non-recourse loans, then all the allowances mentioned above might be restricted to the relevant lower percentage. The later availability of allowances would vary, were some of the non-recourse loans actually to be discharged out of designated revenues, in that on the HMRC approach this would not increase the available allowances, whereas on the analysis that would treat the discharge of the loans as if they constituted further instalments of price, there would be further allowances. I refer in paragraphs 168-174 below to the issue of whether this decision, even if not overturned on appeal, will necessarily govern this last matter conclusively.

The formal appeals by LLP1 and LLP2

The appeal by LLP1 is for the tax year 2003/2004. This results from the fact that LLP1 had contracted to buy the software on 31 March 2004; it contended that it had thereby commenced trading and since the members of LLP1 had all signed up by 31 March 2004 and undertaken to contribute their capital, those members claimed that they were able to offset the allowances against their other income, and able to carry the allowances (and other "income losses") back to the previous tax year. Accordingly the allowances had been claimed for that year. This claim was made notwithstanding that completion of the 31 March contract did not occur until January 2005.

The appeal by LLP2 by contrast was not made until the following tax year, namely 2004/2005, not because the facts as regards LLP2 in terms of that LLP (with its three founder members) signing the contract to acquire the software were any different from those for LLP1, but rather because the investor members had not been signed up so that there were no investor members to take the allowances. Accordingly the capital allowances were therefore not claimed until the following tax year.

The points on which I must now give my decision

The points on which I must now give my decision are first the Closure Notice issue, and then (whether I conclude that HMRC can raise additional points or not) both parties agreed that I must also decide:

• whether LLP1 had commenced trading in the tax year 2003/2004;

• whether the 31 March contracts were conditional or unconditional;

• whether the expenditure incurred more than four months after the date of the contracts was still incurred under contracts that required completion within four months, or whether the contracts had implicitly been varied after 31 March such as no longer to be the same contracts; and

• all points material to the valuation of the software; to whether the claim for allowances should be reduced and allowed only insofar as the expenditure was rightly treated as incurred on the purchase of software and disallowed as to the balance which was to be treated as a payment to acquire the benefit of soft finance; or whether the transaction should be taxed as an instalment sale.

Even if I concluded that the Appellants were right to say that HMRC could not raise the additional points, both parties accepted that since the case had been fully argued on the other four points, I would obviously have to give my decisions on those points in case a conclusion in favour of the Appellants on the Closure Notice issue was itself overturned on appeal. I should also add the point that no reference was made during the hearing to the disallowance of the claim for income losses (largely the interest expense and the cost of Tower's fees and loan arrangement fees), and I record that HMRC confirmed that they were prepared to drop their contentions in relation to these matters provided that that confirmation was not used in argument as a ground for resisting HMRC's contentions in relation to the capital allowance points.

My decision on the Closure Notice issue.

The Closure Notice issue was unfortunately disputed for the whole of the hearing until the final moments of the eighth day of the hearing on a misunderstanding of precisely what the Closure Notice actually said. It had earlier been assumed in argument that the Closure Notice itself had concluded that the allowances were denied under section 45(5), and thus (not that this was stated) because of the claimed user rights to be granted to third parties. The Closure Notice did also conclude that all income losses should be disallowed, without giving any reason and naturally that consequence could not have arisen from any application of any capital allowance provision.

The confusion was eventually clarified when it was pointed out by counsel for HMRC at the end of the final day of the hearing that the letter in which the Inspector gave the conclusions and adjustments required in relation to the taxpayer's self-assessment return simply said that allowances were refused under section 45 (i.e. not specifically under section 45(5)) and that no capital allowances and no revenue losses were allowed. It was only a covering letter that referred to s.45(5), the subsection concerned with denying allowances when the software was effectively licensed to another party, and that letter also contained additional remarks to the effect that the Inspector was only issuing the Closure Notice at an early point because he was being pressed to do so by the Appellants' representatives, and that he would have preferred to have had more time in which to complete his enquiries, because he might then have wished to raise additional grounds for dismissing the claims.

It was contended on behalf of the Appellants that:-

• the Closure Notice was deficient at the very least in relation to the denial of relief for income losses (interest cost, Tower's fees, and loan finance arrangement fees) since these could not be denied under a capital allowance provision, and the mere statement that they were disallowed was not a "conclusion". A "conclusion" implicitly required that the reasons for the conclusion should be given;

• the letter giving the ostensible conclusions and adjustment was not the totality of the Closure Notice, since there was no particular statutory form laid down for the giving of the Notice, and thus both letters together should be taken to constitute the Notice, from which it became clear that the denial of allowances under section 45 (stated in the letter giving the conclusions) was obviously explained by the point raised under section 45(5) in the covering letter;

• the remarks by the Inspector that he would have preferred to have had more time to consider the issues because he might then have adduced other grounds as well for denying the allowances and the losses were of no standing because they did not give "a conclusion"; and

• the Inspector was under no statutory pressure to issue a Closure Notice even when pressed to do so by the Appellants and their representatives because the statute laid down a machinery whereunder the Inspector could take extra time before giving the Notice, there being further provisions enabling the taxpayer to apply to the General or Special Commissioners requesting them to order the Inspector to issue the Notice within some set time period.

My conclusions on these points are as follows:-

• Whilst there may be no required statutory form for the giving of Closure Notices, it was clear in this case that the letter that referred only to denying the allowances under s. 45 and denying the income losses was regarded as the letter that gave the conclusions and adjustments, and the statute required neither detail nor reasons to be given for this notice to be a valid notice. Accordingly the import of the notice was that it denied the allowances under the section under which they were claimed and it also denied the income losses.

• I was certainly not prepared to hold that HMRC could not adduce other grounds for challenging the capital allowances when the covering letter alone referred to section 45(5) and it also indicated that but for his being pressed to issue the notice by the Appellants' representatives, he would have preferred to have had more time in order to indicate other grounds for the conclusions and adjustments.

• Whilst it is not strictly necessary for me to consider what the position would have been had the formal letter itself referred just to s. 45(5), I confirm that I would have reached the same conclusion as John Avery-Jones reached in the recent case of D'Arcy v. HMRC [2006] STC (SCD) 543, and would not have been able to distinguish this case from the decision in the D'Arcy case in the way that the Appellants suggested that I should do. The Inspector in that case had issued a closure notice based solely on a Ramsay attack on a scheme, and he subsequently dropped that line of attack and claimed that taxable income arose under another step in the transactions. John Avery-Jones' decision was that the Inspector could advance other arguments in an appeal than those indicated in the Closure Notice, provided that they related to the same factual matter, on account of the tribunal's over-riding power and duty to reach a correct finding in relation to the matter in dispute, rather than just to accept or reject particular contentions. In the D'Arcy case, the further arguments all related to the same gilt repo scheme, and could thus be advanced. In the present case it was suggested to me that the factual confines of the matter, for the purpose of applying the test just stated, extended only to points geared to the alleged licence to third parties. I disagree with that. The factual compass of the matter, the subject of the Closure Notice in this case, was the purchase of the software and all related transactions. The denial of trading losses can hardly have been based on anything to do with licence rights to third parties. Thus, consistently with the decision in the D'Arcy case, I accept that in an appeal HMRC can raise any arguments in support of their conclusions and adjustments related to those transactions.

• It is perhaps worth observing two practical points. Unless an appellant succeeds in a contention in relation to Closure Notices that a notice is invalid if it merely gives conclusions and adjustments, without giving reasons for the conclusions, it seems likely that Inspectors will adopt the practice of giving bare conclusions without adding reasons. This would diminish the risk of their being prevented from raising additional grounds in support of their adjustments, albeit that if a wide construction is given to the notion of "the factual subject matter covered in a Closure Notice", this cautious approach might not be so tempting. Secondly it would seem desirable for further attention to be given to this aspect of the statutory framework for Closure Notices. For it might be desirable first that the Inspector should be encouraged to give reasons for his conclusions (in that the reasons given will often remain the only reasons in contention and the taxpayer will thereby be given clearer information) and desirable secondly that attention should be given to the further grounds that HMRC can raise in appeals because in litigation it is common for additional arguments to be raised at later stages. It would seem strange if HMRC were to be precluded from raising any grounds in an appeal for supporting the bare conclusions given as regards a particular subject matter in a Closure Notice, and strange also if they were to be precluded from supporting conclusions and adjustments by adducing additional reasons beyond one or more actually mentioned in a Closure Notice as regards a particular subject matter addressed in a Closure Notice, construed broadly.

The facts in more detail

The M Rewards system

I can state the facts, particularly those in relation to the M Rewards system itself, quite shortly, because a great deal of the factual detail given to me was directed to showing that the initial and abandoned ground on which HMRC first challenged the scheme was unsound. Once this point was formally dropped, the facts in relation to the system ceased to be particularly relevant, save for background colour.

As already mentioned, the M Rewards system is a highly complex computer software package for managing the provision of rewards to customers in the form of free air-time in using their mobile phones, at the cost of manufacturers of products sold in supermarkets. The system is not like the numerous types of loyalty card such as Tesco's Cashback card, Sainsbury's Nectar card, and all other equivalent cards. Those cards generally provide some form of points, available in respect of all goods sold in the relevant shops, and the customer then receives a voucher representing the total value of the points awarded, which can be used instead of cash as part-payment when next using the relevant store. Loyalty schemes of this sort are of course operated by the supermarkets, and it is the supermarkets themselves that presumably bear the cost of the discounts when vouchers are used to purchase goods.

The M Rewards system, by contrast, is targeted at manufacturers who either wish to promote particular products, new lines for instance, and also at manufacturers who are reluctant to be seen offering their goods at a discount but who nevertheless wish to provide disguised discounts and incentives to purchasers of their products. When operating the M Rewards system, the manufacturer will print a bar-code on the packet of something intended to carry M Rewards, and when the customer buys this product at the till of a supermarket operating the M Rewards system, the customer will be given a complex code that he or she can send by mobile phone to their mobile provider assuming that their provider is also operating the M Rewards system. The mobile phone provider will then text the customer informing the customer of the value of free air-time awarded.

The financial way in which the system operates is that MCashback buys the air-time from the mobile provider at a discount and sells it at face value to the manufacturer putting the bar-codes on products that the manufacturer wishes to promote. The profits that MCashback thereby makes or hopes to make are called "clearing fees".

The supermarkets operating the system are expected to be largely uninvolved with the clearing fees. They are certainly not expected to bear the cost of them, since they are simply monitoring that promotions that a particular manufacturer wishes to give have gone through their tills. It is generally supposed that supermarkets will operate the system in this way for no charge in that customers with appropriate mobile phones, or with children with such mobile phones, may be more likely to use the particular supermarket than the store of a competitor that does not operate the M Rewards system, and that will be sufficient incentive for the supermarket to operate the system. In the alternative, it is thought that some retailers will demand some hopefully small percentage of the clearing fee profits as further reward for operating the system.

Some of the alleged attractions of the M Rewards system are geared to various assumed attitudes of buyers to different forms of promotion. Since the system enables a customer at a supermarket to add the free air-time to someone else's mobile phone, some emphasis is placed on:

• the insatiable desire of children and teenagers to use their mobile phones;

• the reluctance of parents to pay mobile phone bills;

• the relative disinterest of customers in merely buying goods at a discount, and the apparent greater excitement at receiving a text message indicating that some stated amount of free air-time has been added to some particular mobile; and thus

• the attraction to a parent of providing free air-time to a child without having to give it in cash.

I should mention for completeness that there are various other applications of the M Rewards software that can generate other revenues though these are of only marginal relevance since on acquiring the software that was licensed to the LLP's, the LLP's collectively (that is all four originally envisaged LLPs) only secured a 13% interest in the clearing fees, and no share of any other revenues that the full M Rewards software might produce. Those other revenues included fees for enabling customers to top up their mobile phones with cash at supermarket tills, so called "licence fees" that might be earned from supermarkets for giving supermarkets exclusive operating rights over the system in a particular location, and fees from manufacturers for providing information about the buying habits of customers who had purchased the bar-coded products. There is some relevance to these other applications of the software in that it is emerging that some supermarkets are keener on the application geared to topping-up mobile phones than they are on the promotional free air-time aspect, though it is hoped that the use of one application will lead to the use of the full M Rewards programme and to the receipt of clearing fees in due course.

No evidence or information was given during the hearing concerning several obvious difficulties that seemed implicit in the system, though I accept that there may be a simple answer to these concerns. It did however occur to me that the difficulties encountered by the system included the features that:-

• in order to introduce it in any particular market, MCashback would require the agreement and active participation of at least one supermarket group, presumably several manufacturers, and at least one mobile provider;

• it seemed to me that manufacturers might be somewhat reluctant to provide rewards in a way that could only be accessed through one supermarket chain, and then only if the purchaser of the goods happened to use a mobile phone operated by a provider who had also signed up to the M Rewards system;

• supermarkets might find operating the system less attractive as competitors joined the system, so that there might be a tension between the preferences of manufacturers on the one hand and supermarkets on the other;

• mobile phone operators might be less ready to concede discounts to MCashback if other providers were also operating the system, though naturally the other participants in the cycle (the manufacturers and the supermarkets) would be more attracted to the system if free air-time could be purchased on all mobile phones; and

• very significant costs would obviously be involved in co-ordinating negotiations and legal and computer arrangements between MCashback and all the parties required to operate the system in every territory where it was to be introduced, and the costs and complexities of this for a relatively small organisation would present a significant challenge.

No evidence was given in relation to any of the above fairly obvious questions, though I was told that there seemed to be more appetite for the M Rewards system in less wealthy and less sophisticated markets than in say the United States and the major European countries. This was attributed to the fact that in the wealthier markets, retailers might have, say, a 10% profit margin so that they were content to give away 1% in loyalty card promotions. In less wealthy countries, the profit margin might be only 3% so that a system that put the costs selectively onto manufacturers, and confined the awards to products that they particularly wished to promote, had its attractions.

The members of the Board of Mcashback

Without listing all the members of the Board of MCashback, it is material to record that several of the members of the Board had impressive credentials in the retailing world. Bob Cooper, the CEO and Managing Director of MCashback had formerly been a main board director of Sainsbury's PLC. Paddy Doyle had been a founder director of Orange PLC and 118118. Dr. Adrian Rowe, the technology expert who essentially devised the computer software system that would operate the M Rewards project, was a director of iMeta Technologies until 2005 and then became a director of MCashback. Finally Tom Viadboncoeur was a Vice-President of one of Coca-Cola's European businesses.

The financing scheme to fund the roll-out of the M Rewards system

As mentioned above, MCashback turned to Tower to raise the finance for the roll-out of the M Rewards system.

The Tower proposal envisaged the creation of four LLPs, in each of which there would be founder members and investor members. Each of the four LLPs was intended to acquire an interest in the software owned by MCashback, with each becoming entitled to a slice of the total 13% interest to be acquired by the four LLPs in aggregate in the gross clearing fees generated by the M Rewards system. Each of the LLPs entered into their contracts to buy the interests in the software on 31 March 2004, since it was thought that by entering into the contracts on that date (it then being envisaged that all four would complete their purchases by the date designated for completion in the contracts, namely 30 April for LLP1 and 29 July 2004 for the other LLPs), the LLPs would be entitled to 100% capital allowances under section 45 CAA 2001. As at 31 March, three members of the Tower team, namely Mr. Paul Feetum, Mr. Stephen Marsden and Mr. Simon Smith were designated as founder members of each of the four LLPs, but there were only investor members committed to subscribing their capital in one of the LLPs, namely LLP1. On account of several hoped-for outside investors backing off, three of the five investor members in LLP1 were in fact the members of the Tower team who were also founder members, so that only two outside investors became members of LLP1. In LLP2 and LLP3 by contrast, the same Tower personnel became founder members, contributing only minimal amounts for their capital interests, and the members of the Tower team did not become investor members at all.

The valuation of the software to be acquired by the four LLPs together was a critical ingredient in the proposed acquisitions, and this valuation was largely derived from the projected figures of income for the first 10 years of operation in an MCashback Business Plan that was generated principally by Bob Cooper, then Chief Executive and Managing Director of MCashback. Mr. Cooper did not give evidence in the hearing, and no evidence was given at all as to the assumptions made in preparing the projected income figures. The income figures in the Business Plan were periodically varied, generally upwards, and the figures of income applicable to all four proposed LLPs, and their purchase of an interest in 13% of the income (given in the Investment Memorandum, in reliance on which outsiders were asked to invest) indicated that the income was projected to be £192 million in the ten-year period. The projected income figures (to give three examples) rose progressively from £4.8 million in year 2, to £20.7 million in year 6, to £38 million in year 10.

In the few weeks of frenzied drafting prior to 31 March 2004, the LLP proposal was refined, and the way in which the different interests in the software to be acquired by each of the four LLPs was all changed somewhat, but a common feature at all times was that the investor members would be given loans to subscribe 75% of their total capital commitments. Furthermore under the 31 March contracts MCashback was require to provide the security to procure that banks would lend to investor members the required 75% on the following terms.

The terms of the loans provided as follows.

• Capital repayments would only fall to be made out of 50% of gross clearing fees, and only to the extent that the LLPs had the available cash to enable them to repay loans on behalf of the investor LLP members. Thus the LLP agreements envisaged that assuming that there was sufficient cash, 40% of the LLP's net profits would be distributed to investor members to fund their assumed tax liabilities on the share of profits allocated to each investor member; 50% of gross revenues (i.e. clearing fees) would be applied automatically on behalf of investor members in repaying their loans; 5% of net profits would be held as a reserve, and 5% would be distributed as "a bonus" to investor members.

• Ignoring the largely irrelevant detail that for administrative reasons the loans to the investor members were filtered through Tower Project Finance LLP, ("Tower Finance"), the lending arrangement was always to be along the lines that Bank A would lend the 75% through Tower Finance to the members; another bank, Bank B, would guarantee the repayment by the investor members and Tower Finance to Bank A and would place a security deposit with Bank A, sufficient in amount to cover its total exposure under its guarantee; and in its turn MCashback would guarantee the repayment to Bank B of the security deposit that Bank B had placed with Bank A, and MCashback would place a security deposit with Bank B in an amount always sufficient to cover the full guarantee exposure of MCashback to Bank B.

• The capital contributions to the LLPs and the loans were not designed to fund just the capital expenditure to be incurred by the LLPs but were also designed to fund the other front end costs of the transactions which included fees paid to Tower, loan arrangement fees charged by Banks A and B, and the spread interest cost to which I shall refer shortly. Thus, using the total figures geared to the total purchases contemplated by the four LLPs, the total capital commitment went up from £143 million to £156 million when the front end costs were added, and it was for 75% of this total figure that the banks, and indirectly MCashback, had to provide the finance.

• The interest arrangements under the loans were somewhat curious. The loans provided that the total interest payable by the LLP members was split into a LIBOR element (matching the LIBOR interest payable to MCashback on MCashback's security deposit with Bank B), and then "spread interest", being the excess interest over LIBOR payable by the investor members, which funded the turn over LIBOR taken by Tower Finance, Bank A and Bank B. The loan agreements then provided that the liability of the members to pay the LIBOR element of their interest was to be discharged by Bank A taking the LIBOR interest that it potentially owed Bank B on the security deposit placed by Bank B with Bank A, and applying that to discharge the members' liability to pay the LIBOR element of their interest to Bank A. Correspondingly, Bank B was to take the whole of the interest (i.e. the LIBOR interest) owed to MCashback on its security deposit, and apply that in satisfaction of its entitlement to the LIBOR element of its interest under its, Bank B's, security deposit with Bank A. Thus as regards the LIBOR element of the interest, both Bank A and Bank B would be matched or "flat"; MCashback would receive no interest in cash, and the members would pay none of the LIBOR element of their interest liability in cash.

• The treatment of the spread interest was that this was all pre-paid and simply added, along with the loan arrangement fees and Tower's fee to the initial figures of total capital and total loans required.

• So far as interest liability was concerned therefore, the members never had to put their hands in their pockets to pay interest. The liability for the LIBOR element of the interest was discharged on their behalf, via the banking chain and ultimately by the feature that MCashback forfeited any cash receipt of interest on its deposits; and the spread interest was dealt with by being added to the initial capital requirement, 75% of it thus being funded by the loans, by this element of the interest then being pre-paid, with the 75% loans being liable to be repaid out of and only out of 50% of gross clearing fees.

• The terms for repayment of the loans were also somewhat curious in that the loans were 10-year loans and any balance of the loans not discharged by the repayment date was to be discharged in much the same way as the LIBOR interest was to be dealt with. During the 10-year period, to the extent that 50% of clearing fees was applied in repaying loans, these repayments would flow down the lending chain, resulting in partial releases to MCashback of its security deposit with Bank B. At the end of the 10-year period, however, assuming an unpaid balance of loans, MCashbank's residual entitlement on its deposits would be taken by Bank B in satisfaction of Bank B's rights to the repayment of the balance of its deposit with Bank A; Bank A would then retain the balance of Bank B's deposit in satisfaction of, and total discharge of Bank A's remaining rights to its security deposit with Tower Finance; and Tower Finance would retain Bank A's security deposit in satisfaction of its rights to the repayment of the balance of the loans owed by the investor members.

Without at this stage expanding on conclusions as regards the facts, it would be misleading not to mention that the substantial effect of these various provisions was that, apart from the feature that the spread interest was pre-paid and rolled up into the initial capital requirement, 75% of which was funded by the non-recourse loans, the loans were effectively interest free, with MCashback getting no interest on its deposit, and the balance of loans at the end of the 10-year period effectively being cancelled, with MCashback losing its residual entitlement in respect of its deposits at the end of that period.

I should also add at this point that 50% of the projected clearance fees attributable to all four intended LLPs in the MCashback Business Plan for the first 10 years came to a figure of only £94 million, which is £23 million short of the total expected members' loans of £117 million (viz 75% of £156 million) with the result that even on the figures of income in the Business Plan, £23 million of loans were projected to be waived at the end of the 10-year period.

Whilst the following points were not dictated by the terms of the loan arrangements, it is also worth mentioning that:-

• The contracts between the various LLPs and MCashback dated 31 March 2004 required MCashback to procure the making of the loans by Bank A, and the guarantee and security structure under which MCashback would effectively procure the various loans by placing monies on deposit with Bank B.

• It was originally envisaged that the roles of Bank A and Bank B would be performed by Lloyds TSB and HBoS, but in the event cheaper terms were apparently obtained from two Channel Island banks, namely a bank called Janus Holdings Limited, and one called R & D Investments Limited, and it was those two banks that performed the roles of Bank A and Bank B respectively.

• The Investment Memorandum, available to all investors whose investment was sought in the various LLPs, made it clear that at the end of the 10-year period of the loans, the members of the LLPs who had borrowed to inject 75% of the required capital into the LLPs would be held harmless from any liability in respect of the outstanding balance of the loans that had not been discharged by the application of the designated revenues.

• The Partnership Agreements provided that the LLPs themselves would apply 50% of clearing fees on behalf of members in reduction of the members' loans.

• Finally, whilst the members contributed gross capital into the LLPs to fund not only the capital expenditure on the software but also the various revenue items such as the fees to Tower, the loan arrangement fees, and the spread interest cost (with the members only themselves having to fund 25% of the total commitment), MCashback by contrast only had free use of 18.2% of the monies contributed by the members as capital, once it had placed the required proportion of the sale proceeds for the software on deposit with Bank B. This of course resulted from the fact that the front-end fees and spread interest cost were all retained by Tower or the intermediate parties and not passed through as sale proceeds for the software sold by MCashback.

The purchase of the software, the price paid, and the allocation of different categories of software to the different LLPs

It was intended from a date, some weeks before the 31 March contracts were entered into, that the four LLPs together would purchase an interest in the software owned by MCashback that would command an entitlement to 13% of clearing fees, and it was intended that they would together pay £143 million for the aggregate interest purchased.

The feature of acquiring an entitlement to 13% of clearing fees meant first that the LLPs were acquiring gross income and not a percentage of MCashback's net profits, and secondly it meant that if MCashback derived other income from its retained software than clearing fees, then the LLPs would receive no percentage of that. Accordingly the basic expectation was that the LLPs would bear their own administrative expenses out of their share of gross income, whilst MCashback itself would incur and be fundamentally responsible for all the costs of running out the system in order to generate gross revenues.

The expectation that an interest in the total software that would command an entitlement to 13% of gross clearing fees was to be purchased for, and was thus implicitly worth £143 million, suggested that the total software owned by MCashback (that had at this point generated no income, and that no third party had agreed to utilise) was implicitly valued at approximately £1.2 billion, even disregarding any value attributable to other possible sources of income than clearing fees.

The evidence was somewhat contradictory in relation to the following point, but it nevertheless appeared that until 29 March 2004 it was merely envisaged that the projected total purchase price for the software of £143 million would be split between the four intended LLPs, and that there would be a corresponding split in the percentage entitlement to clearing fees and software, without the various LLPs buying separate elements of software. An e-mail from Tower's lawyers on 29 March indicated however that there would be some problem in the LLPs simply purchasing percentage slices of the software, and therefore the solution was adopted that LLP1 would buy the Code Generation Software for £7.334 million, carrying an entitlement to 0.66% of clearing fees and to 5.128% of the clearing fees allocable to all four LLPs; LLP2 would buy the Customer Support Software for £27.501 million; LLP3 would buy the Call Centre Software £45.835 million and LLP4 would buy the fourth element of software for £62.33 million. Notwithstanding the allocations of specific software to each of the LLPs, the price payable by, and the percentage entitlement to clearing fees acquired by, each LLP retained their earlier matched relationship. Assuming completion of all these various purchases, which together would command an entitlement to 13% of the clearing fees, it was never clarified what categories of software would have been retained, implicitly commanding an entitlement to the remaining 87% of clearing fees, and this issue was somewhat ignored. It was also suggested in evidence that whilst Tower had no idea how to allocate values between the separate categories of software being acquired, the indication of the various different elements of software and the appropriate allocation of value to them was based on information provided by MCashback.

Another curious point to mention, in relation to the calculation of the price to be paid for the four categories of software together, related to the way in which an independent valuation was not sought for the software to be sold until about mid-June 2004, notwithstanding that the parties had settled on a figure of £143 million certainly by the date of the 31 March contracts, and indeed between 29 and 31 March the parties had managed to change the proposals in the marginal way mentioned in the previous paragraph, allocating the decided split of consideration between the various categories of software.

Whilst I will refer in detail below to the evidence given by Mr. Brewer in relation to his role in the expert valuation given by Valuation Consulting Limited ("Valuation Consulting"), there are a number of points that I should mention now about that valuation.

The most important point to mention is that Valuation Consulting were only asked to provide a fairly cursory valuation, in the time available, and they were asked and instructed to accept the estimates of income for the first 10 years of operation from 2004 to 2014 in MCashback's own Business Plan provided to them, rather than to question those figures and the assumptions made in arriving at them.

Whilst no explanation was ever given of what the following two preliminary observations meant, early e-mails from Valuation Consulting in the month devoted to the valuations suggested first that the software commanding the 13% entitlement had a negative value and secondly that it was worth about £65 million. After further refinement of the estimates of income made by MCashback in modifying the figures in the Business Plan, the eventual valuation report indicated that the valuation range was in the area of £145 to £150 million, such that the intended purchase price of £143 was treated as validated. It was never explained how the valuation jumped from the figures in the initial e-mails of a negative figure and £65 million to the eventual figure, and in his evidence Mr Brewer said that he believed that all indicative figures were based on a total valuation of the software. His working figures did however indicate that he had first present-valued the income for the ten-year period indicated in the Business Plan (discounting that for time and risk in a manner that I will explain more fully in connection with his evidence) arriving at a figure of £75 million for that income and then he had calculated the residual value by assuming a number of years' purchase of the year ten income in order to arrive at a discounted residual value in July 2004 for the assumed value of the software in 2114, setting that present-value also at £75 million. The two together thus came to the indicative figure of £145 to 150 million. It was suggested to Mr. Brewer by counsel for HMRC that it was possible that the £65 million figure represented the discounted valuation of the first element, namely the discounted valuation of the 10 years of income figures provided in the Business Plan, with the disparity between the two figures of £65 and £75 million being explained by the fact that the income figures in the Business Plan were constantly being egged up a bit, but Mr. Brewer rejected this explanation and said that it was inconceivable that he valued the software by looking just at the discounted value of the income for the first ten years, thereafter ignoring the residual value. I will refer again to these points, and to the different interests in the various LLPs of the founder members and the investor members in due course. For present purposes I need simply to mention that whilst Mr. Brewer rejected this possible explanation of why the two early figures were so dramatically lower than the eventual figure, absolutely no explanation was given of why there were these vast disparities.

Another point to record in connection with the figures of income projected in the Business Plan is that in May 2007, at the date of the hearing, the income figures were running about two to three years, and nearer three years, behind the projected levels. I was also told that the separate estimates of income produced in late 2006 for each month of 2007 for a an new investor who apparently subscribed new shares in MCashback towards the end of 2006 (the monthly income figures rising steeply in the later months of the year) were also running about three months behind projection. This was revealed in only mid-May, only four and a half months into the year. This failure again to meet projections arose notwithstanding that the new investor had requested that the figures be produced on a very conservative basis, indicating only income that was almost bound to be received.

The LLP agreements, and the founder and investor members

The LLP agreements all envisaged that the members of the four LLPs would include both founder members, namely Mr. Paul Feetum, Mr. Stephen Marsden and Mr. Simon Smith, all directors of Tower, and also investor members.

It was envisaged that the founder members would subscribe only nominal capital for their interests in the four LLPs, whilst the investor members would subscribe the capital (assisted of course by the 75% loan funding) required to fund the purchase of the software and the various front-end fees to Tower, loan arrangement fees and spread interest cost, all of which were paid at the outset. In the event, the founder members also subscribed investor interests in LLP1 on account of the inability to raise the full capital required by LLP1 from outside investors, but the founder members held only founders' interests in LLP2 and LLP3.

Although the present appeals only involve LLP1 and LLP2 it is appropriate to note that LLP3's completion of the 31 March 2004 contract was delayed even more than the completion of the contracts in January 2005 by LLP1 and LLP2, and that the subscription terms for LLP3 were varied. The variation involved the total commitment of LLP3 being split into two instalments, with 75% loan funding of course for each instalment, and with Tower or Tower personnel agreeing to take up the second instalment if outside investors could not be found. Beyond these changes to the subscription by LLP3, LLP4 never completed its contract at all.

The interests of the investor members and the founder members reflected the fact that although the LLPs themselves purchased their interests in the software for the full life of the software, and the LLPs were thus interested in the full value of the software, the investor members had a rather more limited interest in the software, with the founder members having the residual value, after the interest of the investor members.

The interest of the investor members in the early years was structured on the basis that the investor members would receive cash distributions of 40% of the LLP's net profits (assuming there to be sufficient cash to make these distributions) this 40% distribution being designed to give the investor members cash with which to pay tax at the assumed 40% rate on their income entitlement in the LLP. Again assuming sufficient cash 50% of gross clearing fees was to be applied by the LLPs on behalf of members in reducing the 75% loans made to the investor members by the banking chain procured and secured by MCashback. 5% of net profits would then be held as a reserve, and 5% distributed to investor members, as a "bonus", assuming there to be sufficient cash.

The investor members' interest was capped to the effect that they should never receive more than a return of their original investment plus a 10% return per annum on their gross capital contribution. The same entitlement and capping applied in the event of a sale of the software by the LLP. In such event, unless the sale occurred after year 10 in which event the balance of any loans not discharged out of designated revenues would have been repaid by the lenders (i.e. effectively waived), the investor members would receive an amount equal to their 25% capital contribution, plus an amount equal to the balance of their loans, to be applied immediately in repaying the balance of those loans, and again a 10% return on their capital contribution for each year in which they had held their investment, up to a maximum of 100%. Thereafter the entire income and interest in the software would inure to the founder members.

It would not be accurate to say that the investor members had an interest in and only in the income arising in the first 10 years, and that the founder members had all the residual value of the acquired software, but in a broad-brush manner this is not far from the reality. It is of course possible that income might be so high that the capping provision might prevent excess income above the capped entitlement in the first 10 years from being allocated to the investor partners, and in the reverse direction it is possible that the investor members might receive the balance of their return after the 10 year period. It is certainly the case, however, that at the end of the 10 year period the balance of any loans will be waived, and certainly realistic to say as well that the interest of the investor members is a limited interest designed to repay their borrowings and give "up to a capped return", and once that capped return has been achieved, the entire residual value of the software will inure entirely to the founder members.

In this context it is worth observing that the loans made to the members take on an additional air of artificiality. If the evidence supported the price paid for the software of £143 million, and that entire value was available to repay the loans of £117 million, the prospect of the loans realistically being repaid would appear to be a reasonable one. But when it is remembered that the outstanding balance of the loans is to be waived at the end of the 10-year period, that £23 million of those loans will be waived even if the entire income projected to arise in the Business Plan is in fact received, and when it is remembered that Mr. Brewer, albeit basically adopting the figures given in the Business Plan, only valued the 10-year income flow at £75 million (half of which is available for loan repayment), the expectation that the loans will be repaid in full, rather than a substantial slice of them be waived, drops very materially. In paragraph 75 below I produce and explain a calculation that I have made, but for present purposes it is sufficient to say that even when using Mr. Brewer's figures, based on the Business Plan, I calculate that those figures indicate that the risk adjusted gross amount of income to flow in the 10-year period (not discounted for "time") will only be £94 million, and if only half of that is available to be applied in repaying investor members' loans, £70 million of those loans (60% of £117 million) will be waived at the end of the 10-year period.

The delays in effecting the intended transactions between MCashback and the four LLPs and the difficulties in attracting the required amount of investor interest

While little direct evidence was given at the hearing in relation to the difficulties that Tower had in attracting investors to become investor members of each of the four LLPs, it was nevertheless very evident that the investor appetite for the scheme was much lower than had been hoped, with many consequences.

I will, however, just record that reference was made to a number of investors "backing off", and to three individuals within the Tower organisation having to make loans in May 2004 on account of the realisation that deadlines were slipping. It therefore seems reasonable to conclude that the LLP structure manifestly failed to deliver what was hoped and expected of it. On my calculations, since I was told that the three founder members of LLP1 contributed virtually £4.5 million between them (£374,000 each after allowing for their 75% loans) it follows that the actual cash put up by the two outside investor members in LLP1 was only £700,000, i.e. one quarter of £2.8 million.

The evidence

Evidence was give by Dr. Adrian Rowe, who was responsible for the computer software, by Mr Paul Feetum of Tower, Mr. Stephen Marsden of Tower, Mr. Amhed Zghari, Chief Operating Officer of MCashback and a director of MCashback since July 2002, and by Mr. Ian Brewer, a Director of the valuation firm, Valuation Consulting, which was instructed by Tower in June 2005 to provide independent valuations of the software to be acquired by the four LLPs.

Much of the evidence contained in the Witness Statements had been directed to dealing with the initial point of attack by HMRC, geared to the alleged user rights that were intended to be conferred on the first supermarket group to sign up to operate the system. Once this particular contention had been abandoned, much of the evidence became irrelevant and I need not summarise it.

Dr. Rowe's evidence was largely directed to explaining the software, and to dealing with the point referred to in the previous paragraph. Since it was not disputed that the software did do what was purported for it, I need simply confirm that I was satisfied that the system indeed worked, and that nothing further turns on Dr. Rowe's evidence. I might just mention that Counsel for HMRC made the fair observation that it was curious that so much of Dr. Rowe's Witness Statement was taken up with explaining the vitally important Code Generation Software when that element of the software was only transferred for 5.2 % of the price intended to be paid by the four LLPs together, and for 0.667% of the implicit total valuation of all the software (the 13% sold and the 87% retained), but I will indicate below that nothing very decisive seems to me to hinge on this fair observation.

It is unnecessary to summarise the evidence given by Mr. Feetum, Mr. Marsden and Mr. Zghari because I have based much of the description of the facts on this evidence already. The general picture given by all three witnesses was substantially similar, and thus I will just record the generality of what was said:

• All of the witnesses claimed to have great faith in the MCashback concept, and I had no reason to doubt this evidence. Mr. Zghari made the point that he considered that the roll-out of the system was "at or near the tipping point, after which retailers and manufacturers will come to us and ask to join the Rewards programme".

• Considerable reference was made to the hard negotiations that there had been between the Tower personnel and the MCashback directors and to the insistence on the part of the former that the LLPs should acquire their interest in software indefinitely and not just until the LLPs had derived some given amount of income from the software. By contrast the MCashback team had been reluctant to dispose of the interest indefinitely, and Mr. Cooper was said to have referred to his aspiration of buying the interest back at some time, and indeed ideally within three to five years before the full value of the software was appreciated by everyone. There were of course no arrangements for such a buy-back and in the light of the fact that MCashback has had to raise new equity at the end of 2006 to assist the roll-out of the system, it is obvious that the aspiration of buying back the LLPs' interests, at least in the foreseeable future, will not come to pass.

• Whilst there was reference to the negotiations being hard fought, it was always understood that the LLP transactions would involve 75% loan funding, and that MCashback would have to secure and fund the loans such that it would only have free use of 18% of the total capital contributed to the LLPs, after taking into account the 82% that would have to be placed in blocked deposit accounts.

• There was considerable reference to the feature that some hoped-for investors backed off, and that there was reference to the pressure that MCashback put on Tower to complete the intended transactions. The pressure resulted in three Tower personnel making the £500,000 loan to MCashback in May 2004, the same three becoming investor members of LLP1, and Tower having to underwrite the second instalment of the LLP3 transaction.

• Reference was made to the feature that M Rewards were no longer being issued and processed through the Indonesian supermarket Hero that was the first group to adopt the system, and it was mentioned that Hero was still using the MCashback software for the seemingly more popular service of simply topping-up mobile phones. It was not explained why the arrangements with Hero had ceased in relation to M Rewards.

• Mr. Marsden referred in his Witness Statements to the feature that he claimed to have assisted in marketing the M Rewards system (implicitly on behalf of LLP1) before 5 April 2004 by having discussions with Hollywood film producers in California, and with Mr. Gildersleeve of Tesco. I will refer to these discussions in giving my decision on the issue of whether LLP1 has established that it had commenced its trade in the period 2003/2004.

• Mr. Feetum conceded that the interposition of the banks in the lending chain was said to be "tax efficient", and he confirmed that by that he adopted the point made in the Counsel's tax opinion that had been attached to the Investment Memorandum, to the effect that distancing the transactions from the appearance of straight non-recourse loans back from the seller was important.

I should deal specifically with the evidence that was given as regards the need for interposing two banks in the lending chain, since I had suggested that I could see no reason, other than one of "window dressing", for filtering the loans back to the investor members through Banks A and B, and I asked both counsel and the witnesses to indicate to me any cogent reasons why the banks were inserted into the lending chain. In response to this the following points were made:

• Mr. Marsden made the point that "An instalment arrangement would not have had the advantage to MCashback that they were assured of the balance of the purchase price. Unless they had the money under their own control they would have had to rely on the LLP being in a position to make future payments. I am totally convinced that they would not have been prepared to rely on this".

• Mr. Zghari made a virtually identical point.

• Mr. Feetum made a similar point and said that he did not consider that "MCL would have been willing to accept a promise from the LLPs to pay the licence fee by instalments due to the credit risk, particularly since the LLPs would own the entirety of the Licensed Software and still be entitled to 13% of the income generated from the outset".

• Various other references were made to the supposition that the banks had been inserted not so as to affect or enhance the position of MCashback, but in order to assist in marketing the arrangements to investors. It was suggested that investors would derive comfort from the fact that banks were involved and it was consistently suggested that it would have been impossible to market the deal to investors without the inter-position of the banks.

Prior to giving any of my decisions, I will make two comments on the credibility of the witnesses. The first is to confirm that I found them all fundamentally honest, and I certainly believed that they retained confidence in the MCashback system. It does indeed seem to me that it is possible that substantial clearance fees will fall to be paid, and that partial loan repayments will be made of the members' loans. This factor, and the feature that I am absolutely convinced that this transaction was definitely not a scam where investors were simply induced to purchase worthless or near worthless software simply so as to secure capital allowances, are the considerations that have influenced me not to accept the "soft finance" analysis advanced on behalf of HMRC. This would have capped the allowances at 25% of the total theoretical capital expenditure, and I am convinced that the prospect of more expenditure genuinely being borne makes this approach unrealistic and unfair to the Appellants.

The other observation that I make is that I do reject all the frail reasons that were advanced in response to my request that someone should indicate to me some cogent reason, tax presentation apart, for why the banks had been inserted into the lending chain. I was absolutely unable to understand how investors might be encouraged to invest by loans being made by two not terribly well-known banks, when the loans were entirely funded by MCashback, and when the position of the borrowing investor members was entirely governed by the non-recourse loan terms, and the extraordinary terms as regards automatic repayment at year ten. Equally I was unable to understand how MCashback was placed in a better position by having received the full purchase price, with 75% being placed on deposit with Bank B. It was asserted that MCashback thereby ceased to be reliant on the members duly repaying their loans before it could withdraw monies from the blocked deposits, as would have been the case with direct loans to the members from MCashback or with an instalment sale. Since however the banks will plainly not contemplate for an instant releasing the deposits to MCashback until the members have started the loan repayments flowing down the line, it seems manifest to me that MCashback is not remotely better placed in the way suggested. It seems to me that the same effect, with less complication, fewer fees, and fewer legal costs, could have been achieved equally or more easily with straight loans back to the members by MCashback, or by an instalment sale.

I do not say that the witnesses were being deliberately dishonest in giving ostensible reasons which seemed to me to be incredible. I entirely accept that some of the witnesses will have assumed the involvement of banks from the start, as with film schemes, and will not have understood precisely why the banks were required. And when specifically asked to give reasons for their involvement, it is unfair to criticise the witnesses for volunteering reasons. I do nevertheless say that I found all such reasons wholly unconvincing.

Mr. Brewer's evidence was, however, very much more material.

Mr. Brewer indicated that when he was approached in order to give a valuation in June 2005, his likely fee was negotiated on the basis that he would dedicate enough time to the matter to provide an indicative valuation, which was what was required. He confirmed that had he been instructed by private equity investors he would have been required to conduct a much more extensive valuation.

Mr. Brewer confirmed that he had been instructed to accept the projected income figures for the first ten years of operation provided in Mr. Cooper's Business Plan, and he was not required or expected to understand the basis on which those figures had been calculated or the assumptions behind them. All that he was required to do was to apply best practice in relation to valuations in arriving at a valuation of the software, taking those figures as a given.

Mr. Brewer then explained various possible valuation techniques and then confirmed that he decided that the most appropriate valuation method in the present case would be to take the indicative figures of income for each of the 10 years and then discount each of them for time and risk. He indicated that the appropriate discount rate for time was approximately 3% per annum. He then indicated that he calculated the discount to be applied for risk (in other words the risk that the predicted income would not in fact materialise at the levels suggested) by looking at the discount rates for "similar sector" quoted companies, and by then adding on something to reflect the fact that MCashback's system was untried, and had not yet been successfully marketed. Thus a sector discount for risk of about 6.5% was increased to about 12% to reflect the extra risk of buying into untried and un-marketed software. I emphasise that this addition to the risk factor was based on a general judgment about the different risk factors for well-proven software owned by quoted companies, and untried software generally, and it was not based on examining the assumptions and reasoning underlying the projected income figures in the Business Plan.

Mr. Brewer showed us a work sheet dated 7 July, made very shortly before his formal valuation was issued on the same day. This showed that by applying a total discount factor of 15% for time and risk (roughly 3% for time and 12% for risk) Mr. Brewer discounted the figures of income in the business case that I gave in paragraph 35 above from £4.8 million to £3.5 million for year 2; from £20.7 million to £8.7 million for year 6 and from £38 million to £9.2 million for year 10. Adding together the total discounted figures for the 10 years produced a total figure of £70.6 million.

Mr. Brewer then explained the balance of the valuation which addressed what the present value of the income stream from year 10 onwards would be. I am not so concerned with the methodology of arriving at this element of the valuation, and it is sufficient to say that after adjusting the year 10 income figure of £38 million for growth, for a multiple of years for which the income could be expected to continue to flow, and then discounting the resultant figure for time and risk, he ended up with a present value of the residual value of the 13% interest in the software in 2114 of £79 million. When he then aggregated his figure for the discounted value of the income for each of the ten years of £70.6 million with the present value of the 2114 residual value of the software, he came to a combined figure of £149 million. This was then taken by MCashback and the LLPs to validate the figure of £143 million at which it had always been assumed, and indeed contracted since March 2004, that the interest in the software would be sold.

I then entered into a discussion with Mr. Brewer as to whether I might be able to extrapolate a figure of income for each of the 10 years that Mr. Brewer was assuming was more likely to be received on a cautious risk-adjusted basis, by taking his discounted value of the income for each of the years, and then adding back the element of discounting for time, but not the element of discounting for risk. My reason for pursuing this line of enquiry was that it had already been pointed out that if every single pound of predicted income for each of the 10 years, illustrated in Mr. Cooper's Business Plan, was actually to be received as predicted, then the 50% of that income to be applied in loan repayments by the LLPs on behalf of the investor members would amount to only £94 million. As I have already indicated, this would mean that £23 million of the total members' loans of £117 million (that is approximately 20% of the loans) would fail to be discharged out of predicted revenues, so that, a sale apart, the balance of the loans of £23 million would effectively be released at year 10. The point that I was trying to ascertain from Mr. Brewer was whether I could use his figures to indicate the level of eventual income in each of the 10 years (i.e. not a figure discounted for "time" to the present day valuation) that his more sober and pessimistic approach to the valuation suggested could more confidently be expected, than the full figures in the Business Plan that he had thought it appropriate to discount for risk. Mr. Brewer said that this approach was wrong and that he was not, in his discounting calculation, suggesting that less income would be received than that predicted in the business case. Counsel for HMRC himself pursued the same line of questioning as I had done with Mr. Brewer, but without any different result or more success. Whilst I consider it right to record that Mr. Brewer did not agree with the rough calculation that I was indicating that I was making, I nevertheless think that the calculation that I was making is worth recording.

Whilst admitting that these figures are extremely rough, I simply observed that if 3% was the right figure by which to discount income per annum for time, and 12% was the element of discounting for risk, it should follow that if the total 15% discounting reduced the gross income figures of £192 million (per Mr. Cooper's Business Plan) to £70.7 million (Mr. Brewer's discounted valuation), thus reducing the gross income by £122 million for time and risk, if I added back 3/15ths of the discounting, I would implicitly be predicting total income that Mr. Brewer was anticipating, in discounting for risk. The resultant figure of predicted income is £94 million, rather than the full £192 million predicted in Mr. Cooper's Business Plan. If 50% of £94 million was applied in reducing the loans of £117 million, this would leave £70 million of the loans (i.e. 60% of the loans) outstanding at year 10, such that a sale apart, 60% of the loans would effectively be released.

Whilst I repeat that this calculation is extremely rough, it seems to me that it is incontestable that 20% of the loans would not be repaid out of income on the Business Plan figures; manifestly less would be repaid if the feature of discounting for risk suggests that it was prudent in making the valuation to assume that less income would be received than that predicted in the Business Plan; and if my figures are anywhere near right then it follows that Mr. Brewer's element of discounting income for risk, not time, indicated that 60% of the loans would not be repaid out of income.

The contentions on behalf of the Respondents

I will now summarise shortly the contentions on behalf of the Respondents.

I have already accepted the Respondents' case in relation to the jurisdictional issue concerning the Closure Notice, but should add the point made in Closing Submissions that for 7 days the Appellants had been able to deal with all the arguments advanced by HMRC, and had introduced many further Witness Statements to address the additional points, and it appeared that they had not been prejudiced in any way by having to deal with points said by the Appellants to be outside the confines of the Closure Notice. Counsel then quoted the main conclusion given by John Avery-Jones in the D'Arcy case where, having looked at the appeal provisions of the Taxes Management Act, John Avery-Jones stated that:-

"These provisions seem to me to indicate that the jurisdiction of appeal commissioners is not merely to decide whether the stated conclusions on a point of law in the closure notice are right or wrong, and if wrong, to allow the appeal and reduce the assessment to nil. I agree with Mr. Furness that such a result is inconsistent with the Tribunal's duty to decide whether the appeal is over- or under-charged by the self-assessment and accordingly to determine the figure for the amendment to the self-assessment".

On the pre-5 April 2004 trading issue for LLP1, it was contended that since LLP1 was not due to acquire the software until 30 April 2004; it was not funded to acquire it; and it had not entered into arrangements with MCashback to regulate joint operation, "the idea that it was "trading" on the basis that it could, contrary to the whole of the negotiations on which the contract was based, go off on its own between 31 March and 5 April 2004 and seek to exploit the software for its own purposes, [was] fanciful".

On the "conditionality" issue under section 5(1) CAA 2001, it was contended that the 31 March agreement was conditional because MCashback had to assist with due diligence and to provide the Bank B security, prior to the due date for completion. On the section 5(5) point, it was contended that when the contract was not completed on its due date, the agreements fell to be treated as varied by the conduct of the parties, in other words by MCashback not having repudiated the contract on account of the failure by LLP1 to complete on the date given for completion.

On the fundamental question concerning the quantification of capital expenditure that had been incurred on the software, the Respondents advanced various valuation arguments, which I will not recite because they correspond to those to be summarised in my decision below. Reliance was also placed on various authorities to all but one of which I again refer in my decision. The Respondents then canvassed the two possible analyses to the granting of capital allowances being the "soft finance" argument and the "instalment" approach. They also placed considerable emphasis on the proposition that the transactions had been crafted to as to provide allowances for 100% of the gross expenditure, when it was possible that only 25% would in reality be incurred.

The contentions on behalf of the Appellants

Having already summarised the Appellants' contentions in relation to the Closure Notice issue, the Appellants' contentions in relation to the other four points were as follows.

On the issue concerning the date of commencement of trade it was argued that LLP1 had commenced trading before 5 April 2004 because it then had a clear business purpose, it had entered into an unconditional obligation to acquire the software which would be used in supplying the services it intended to make, it had obtained commitments to provide funds from the LLP members, and it had incurred legal fees and entered into marketing activities.

On the section 5 "conditionality" point, it was argued that the 31 March contract was unconditional because "no further act or event outside a contracting party's power to procure had to occur before the LLP was obliged to pay for the software".

On the section 5 "variation of contract" argument, it was contended that no evidence emerged in examination or cross-examination of the witnesses that supported the proposition that the contract had been varied after the parties failed to complete it on the date provided for completion.

On the fundamental point concerning the quantification of capital expenditure incurred on the purchase of the software, it was contended that the Respondents' "soft finance" analysis was un-sound because:

• there was no evidence attributing any part of the consideration to the provision of loan finance to members or anything other than the purchased software;

• the evidence demonstrated that the software had been valued at the price paid, and "corroborated by the independent valuation subsequently provided by Valuation Consulting";

• the valuation had been based on the figures in the Business Plan;

• "the provision of the cash collateral by MCashback in support of Bank B's guarantee did not distort the price paid for the software. The consideration reflected the parties' perception of the present value of the items being licensed. A fully funded purchaser could have reasonably paid the same price without placing any restrictions on MCashback's access to the consideration or requiring the provision of collateral";

• to the extent that the funding and security arrangements reduced the present value of the consideration received by MCashback this does not lead to an inference that any part of the consideration was paid for the financing, but "merely shows that the LLPs negotiated a good commercial deal in acquiring the software at a lower price than it might otherwise have paid" (a contention that I imagine the Appellants might prefer to re-phrase marginally!).

On the alternative "instalment" analysis that I had asked both parties to consider, the Appellants contended that this approach was unsound because:

• the instalment analysis involves disregarding the clear legal effect of the transaction actually undertaken by the LLPs and MCashback and substituting an alternative transaction which they did not and would not have entered into;

• even if the taxpayer has chosen to accomplish a transaction in a manner solely for "tax avoidance" reasons (which was not so in the present case) the Courts cannot ignore the transaction actually undertaken by the taxpayer by re-characterising it so as to produce some different tax result;

• the price for the software was paid by the LLPs and not the members, and after they had paid the price, there was thereafter no obligation on the LLPs to pay anything more;

• the only money obligation which the LLPs owed MCashback after completion was to pay a proportion of its income (imputed to the members for income tax purposes) to Tower Finance in satisfaction of the members' loans;

• it would have been commercially unacceptable to the LLPs to have entered into a direct debtor/creditor relationship with MCashback and or granted any charge over the licensed software to MCashback because MCashback wanted to re-purchase the software, and its position as a secured creditor would wrongly enable it to further its commercial agenda of reacquiring the software;

• the Court of Appeal had remarked in the Mawson case that there was a close analogy between the concept of payment for the purposes of section 338 Taxes Act as considered by the House of Lords in MacNiven and the concept of "incurring capital expenditure" for the purposes of section 11 CAA 2001;

• for section 11 purposes it is irrelevant how the taxpayer acquires funds with which it incurs capital expenditure; and

• the only relevance of any "soft finance" provided by MCashback would have been to the question of whether the amount paid for the software had been artificially inflated in consequence. The test for determining the amount of the qualifying expenditure is not the market value of the asset acquired in consequence but the amount of the consideration paid for the asset. This depends upon the terms of the bargain actually made by the parties and not whether the parties made a good or bad bargain. In any event, the price agreed was well within the range that the two parties dealing at arm's length could agree for the purchase of the software even before the collateral agreement was taken into account.

The decisions

The decision in relation to the date of the commencement of trade by LLP1

In order to sustain a valid claim for allowances for the tax year 2003/2004, LLP1 needed to establish that it had commenced trading prior to the end of that year (5 April 2004), and since nothing material occurred by 5 April 2004 after LLP1 entered into the Software Licence Agreement with MCashback on 31 March, it was largely in reliance on that that LLP1 asserted that it had commenced trading. I should add that it was also argued that Mr. Marsden had undertaken some work in trying to market the system before 31 March 2004, and that this might also establish that LLP1's trade had commenced.

The import of the contract on 31 March was that LLP1 had agreed to acquire the Code Generation software, albeit that the contract was not due to be completed until 30 April 2004. It was in fact not completed until 11 January 2005. Furthermore at the date 31 March and indeed on 5 April 2004, the Collaboration and Operating Agreements that would regulate the respective roles of MCashback and the LLPs in relation to the exploitation of the system had not been entered into, and none of the required banking arrangements, designed to provide 75% of the capital to be contributed by the investor members, had been entered into either.

The contention on behalf of the Appellants was largely based on the decision in Mansell v. R.C.C. [2006] STC (SCD) 605 by Special Commissioner Charles Hellier, to the effect that the taxpayer commenced trading in that case when he entered into the formal option agreement to buy an interest in land, the land in question being land that the taxpayer considered might well be developed and used as a motorway service station. The taxpayer in question in the Mansell case had actually needed to contend that he had commenced trading at a yet earlier date than the date of the option agreement on account of certain reductions in tax that would arise, were he successful, under the transitional provisions under the rules terminating the "preceding year basis". Accordingly he argued that he had spent considerable time and money in researching likely service station sites and suggested that he might have commenced trading by amassing knowledge and expertise that he could exploit in a trading sense without even acquiring any actual interest in land. He also argued in relation to the option agreement that the entering into of a non-binding heads of terms for the grant of the option marked the point when he commenced trading (this also being at a point prior to the critical date under the relevant transitional provisions). Charles Hellier's decision was that the taxpayer had not commenced trading by virtue of any of these activities and it was only thus when he acquired the option, being the asset that he might well be able to realise by selling it to one of the operators of service stations, that he actually commenced his trade.

The salient feature of the Mansell decision is that the option agreement was actually the stock-in-trade that the taxpayer would dispose of in order to make his trading profit. Although options to acquire land are in a sense of course "contracts to acquire land" in the way that the contract in this case on 31 March was a contract to acquire software, the two vital differences between the Mansell case and this case are that options to acquire land are regularly traded (particularly in fact in relation to the multiple competing cases for building motorway service stations in various different locations), and the option in the Mansell case resulted in the taxpayer actually acquiring his stock-in-trade that he intended to realise. By contrast in this case, LLP1 was only entering into an agreement to acquire the capital asset that it would eventually exploit in earning trading profit. Once trading stock is acquired, the owner is essentially in a position to realise that stock, and generate gross income. When the contract was merely to acquire the capital asset that LLP1 hoped to exploit, it could not commence exploitation immediately since it then had nothing to exploit, and would indeed have nothing to exploit until 11 January 2005. Moreover it had not entered into the other agreements with MCashback that would regulate the way in which LLP1 would co-operate with MCashback in promoting the system. I accordingly conclude that the fact of having entered into the 31 March 2004 contract did not mean that LLP1 had thereby commenced its trade.

I must now deal with the point that Mr. Marsden indicated in his evidence that even before 31 March 2004, and certainly after that date, as well he had personally attended meetings with a view to trying to promote the M Rewards system.

HMRC had conceded that both LLP1 and LLP2 had commenced their trade in the later period 2004/2005, largely I imagine because MCashback had by the end of that period entered into an agreement to operate the system with the Indonesian supermarket group, referred to as "Hero". On account of the fact that trading had been conceded by HMRC, very little attention was given during the hearing to the relationships between the LLPs and MCashback, and what their respective roles would be. The Collaboration and the Operating Agreements had not been entered into, and I might say that even when they were entered into, the relationship between the LLPs and MCashback struck me as being slightly confused. Whilst it was asserted in these agreements that the LLPs could, and perhaps should, look for opportunities to exploit the system in conjunction with MCashback, there seemed also to be a major question mark over how genuine this role was actually to be. In reality, the basic intention was after all that the LLP transactions were meant to be fund-raising transactions that would enable MCashback to perform what was undoubtedly its core responsibility, namely to roll-out the system, and to seek opportunities to exploit the system, negotiate them, and enter into all the required legal arrangements. The provisions of the LLP agreements also made it clear that although LLP1 for instance would bear its own administrative expenses, and receive 13% of gross clearing fees (not net profits) from MCashback, there would be little room for any material expenditures of a trading kind to be met. After all, the LLP agreement provided that 40% of net profits would be distributed to the investor members to fund their tax liabilities; then 50% of gross income would be applied in debt repayment, and then 5% of net profit would be held as a reserve, and the balance distributed to the investor members as a bonus. Whilst all of these applications of net profit and gross revenue were said to be subject to the availability of cash, it did very obviously emerge from the formula just indicated that the formula pre-supposed that there would not be a great difference between gross revenue and net profit, or else much of the formula would be irrelevant. Furthermore in the Investment Memorandum that I was shown (for some reason the Investment Memorandum for LLP3), whilst predicted gross income grew from £187,000 in the period ending September 2005, to £6,326,000 in the period ending September 2010, and £11,601,000 for the period ending September 2014, the only two lines shown for any sort of expenditure referred to "Administration and accounting fees", and "Operator's Fees". These two increased from £91,000 and £178,000 respectively in the first period to £119,000 and £233,000 in the tenth period. The Operator's Fees were always almost double the Administrative and Accounting Fees, and the Operator's Fees were predicted to rise by precisely £3000 in each year. None of this was explained at the hearing but I have to say that the projected figures sound rather curious as the figures for a trading entity.

Ignoring predicted figures, I refer now to the Profit and Loss Account figures for LLP1 for the two periods ending 5 April 2004 and 5 April 2005. The rather simple figures for the first period show naturally no income, and Administrative Expenses of £599,000. A later Schedule breaks down the expenses into a commission paid to a related entity, Tower Project Finance LLP, of £579,000 and an Audit Fee of £20,000. Significantly there is no deduction of any sort claimed for any expenses related in any way to Mr. Marsden's supposed marketing role notwithstanding that there was a reference in his Witness Statement to his being in discussion with Hollywood Producers in California in March 2004 in relation to the system.

The accounts for the 2005 period also indicate the same picture. Notwithstanding that trading was now accepted to have commenced, the profit and loss account is even simpler than in the previous period in that the income remained constant at nil, and the expenses fell to £716. These expenses were then described as "Administrative Expenses", and whilst I cannot account for the last £216, the audit fee accounted for £500 out of the £716. No other deduction is shown for any trading expenses, and so I can only conclude that LLP1's role in promoting the system was barely undertaken in either period, which seems entirely consistent with the basic reality that it was MCashback that had the prime role in promoting the system.

The two pre-5 April 2004 promotional activities that Mr. Marsden referred to in his Witness Statement were the discussions in California, and discussions with Mr. Glidersleeve of Tesco, the latter relating to how the LLPs could assist MCashback in promoting the system, to which the understandable answer was that they could provide finance that would enable MCashback to look less like a "start-up" company which would have little standing with multi-million pound retailers. In the absence of any expenses claimed in the Accounts of LLP1, I have to conclude that these activities were not such as to result in the commencement of trade by LLP1. Since Tower were also involved with film schemes, it seems possible at least that Mr. Marsden was in California principally for other purposes than to promote the MCashback system. Furthermore other reference was made to discussions with Mr. Glidersleeve being relevant principally in the context of introducing Tower to MCashback, and of convincing Tower to proceed with the LLP proposals with MCashback. Since the alleged discussions to which Mr. Marsden referred were in February/March 2004, and in the very final days of March there was still a major disagreement about price and structure such that the whole LLP proposal was in doubt, I really cannot reach the conclusions that Mr. Marsden's discussions either in California or with Mr. Glidersleeve resulted in LLP1's trade commencing.

I accordingly decide that LLP1 had not commenced any trade by 5 April 2004, with the result that its capital expenditure is deemed not to have been incurred in the tax year 2003/2004, for the purpose of actually claiming the allowances.

My decision on the fundamental question in relation to valuation, and the implications (if any) of the provision of non-recourse finance on the claim for capital allowances

The four possible approaches

It is worth first summarising the four possible approaches that might, depending on the findings of fact and the realistic analysis of the transactions undertaken by the parties, apply in this case:-

• the first approach would be that the gross capital expenditure incurred was within the range of the genuine and sustained market value of the acquired software; nothing should thus turn on the separate provision of loan finance; and the LLP's should thus be able to claim capital allowances (whether 100%, 50%, 40% or writing down allowances) by reference to the full price paid;

• the second approach would be that the market value of the acquired software might be materially lower than the price paid for it in this case, but that nevertheless the LLPs should still be entitled to claim capital allowances by reference to the full price paid because, whilst the LLPs might only have paid that price because of the non-recourse loans provided to the members to contribute their capital, the LLPs have nevertheless paid the full price for the software and nothing can adjust that analysis for tax purposes;

• the third approach would be that because there is a wide disparity between the price paid for the software by the LLPs and the genuine value of the software, the LLPs must be analysed to have purchased two things, namely software and beneficial finance, with the price being allocated between the software and the beneficial finance filtered back to the contributing members of the LLPs (the suggested split advanced by HMRC in relation to this, their principal case, being 25% and 75%); and

• the fourth approach would be to treat expenditure as incurred for capital allowance purposes as and to the extent that capital was provided by the members to pay the price for the software on an outright basis, initially thus being confined to 25% of the price paid, but subsequently including further amounts as and when and to the extent that 50% of designated revenues paid off the members' borrowings.

The first possible approach

I have no hesitation whatsoever in concluding that the market value of the software acquired by the Appellants was very materially below the price ostensibly paid for it.

The factor that most obviously supports this conclusion is that whether the form of the various transactions stands up to scrutiny (and that yet remains to be seen), the transactions were in economic substance contingent instalment sales where MCashback would only eventually receive the full price over a 10-year period, and indeed would receive it (assuming no sale and there was no arrangement for any sale) only if the figures of clearance fees assumed in the Business Plan were materially exceeded. As a consequence, at the date of sale, MCashback would only have at its disposal an amount equal to 18.2% of the gross capital contributions made to the LLPs. If the software intended to be sold to the four LLPs was in fact worth the £143 million aggregate price, why did MCashback not find the willing purchaser ready to pay this price, and why did it instead choose to proceed via a complex transaction that was only expected to deliver at the outset approximately £26 million? In fact of course it produced far less than £26 million because the lack of appetite on the part of genuine investors for the transaction resulted in no completion of the sales occurring until January 2005, the LLP3 transaction being completed on an instalment basis at a later date still, and by far the largest transaction, that involving LLP4, never being completed at all. And the "outside" funds contributed into LLP1 amounted to only £700,000.

Consistently with the fact that whatever the form of the transactions, the deal was economically a contingent instalment sale from both the perspective of the seller and the buyers, no serious attention was ever given to the valuation issue. A Business Plan was produced containing staggering rising figures of revenues over a 10-year period for a software concept that had at the point of the preparation of the figures been sold to no-one. I saw absolutely no evidence that ever addressed whether the figures in the Business Plan were carefully calculated and cautious estimates, or whether they were "away with the fairies". In reality it did not particularly matter whether the figures could be supported because the proposed transaction was only ever going to be put to investors on the basis that their ceiling exposure would be for 25% of the price paid, and the expected tax relief (that could even be carried back to the previous year) was expected and represented to be worth not 25% of the gross price paid, but 40%. I am not suggesting that the transaction was a fraudulent one where the aim was to sell capital allowances in relation to a fictitious sale of near worthless software. But I certainly say that the reality of the transactions meant that nobody had to give great attention to whether the software was worth the asserted figure, when nobody was going to give that figure, or indeed any figure that should not be more than underwritten by the tax relief expected from the exchequer.

It was suggested in argument by counsel for the Appellants that the software was worth the full price paid on the assumption of an outright purchase by a purchaser providing the entire purchase price out of his own resources. And it was then contended that if the transaction had instead been an instalment sale the price would have been much higher. I am simply unable to understand how this could be advanced as an argument. I note that this argument did at least recognise the inevitable difference in price between the price commanded in an outright sale, and that in an instalment (or I would say "a highly contingent instalment") sale. Why it is supposed however that the parties would have failed to note that notwithstanding its form, this transaction was economically identical to a contingent instalment sale I simply cannot understand.

Counsel for HMRC attached considerable importance to the suggestion that just prior to the execution of the four critical 31 March 2004 contracts, it was discovered on 29 March that the four LLPs could not simply acquire, between them, percentage slices of the total 13% interest in the total software and the clearance fees that the LLPs were to acquire. Whether this point and this realisation resulted from some tax point or a legal point relevant to dealings in intangible property I never ascertained, and I do not think that this matters. Whatever the explanation, the parties scurried around rapidly and defined the four elements of discrete software, and adjusted the deal so that LLP1 acquired the Code Generation Software for the originally envisaged price of £7.334 million, and still thereby earned itself 0.66% of clearance fees (or 5.128% of the total 13% of clearance fees intended to accrue to the four LLPs). Counsel for HMRC attached great importance to his suggestion that this last minute revision of plan involved no thought as to what the Code Generation software was actually worth and was simply an arbitrary allocation. I am inclined to agree with that and accept the point made by counsel for HMRC that there was something very extraordinary in Dr. Rowe spending the bulk of his Witness Statement in explaining the novel and key aspects of the Code Generations Software, if the value of that software was only a very small proportion of the value of all the software intended to be acquired by the four LLPs. I am also left a bit bemused as to which categories of software, beyond the four defined categories to be licensed to the four LLPs, was actually to be retained by MCashback, supporting its retained interest in 87% of the clearance fees, and all other potential revenues. Whilst this rather marginal point just adds to the artificiality of the valuations, I attach little importance to this particular point, in contrast to the importance that I attach to the unrealistic way in which the aggregate valuation question was approached.

I have already referred to Mr. Brewer's evidence and to the fact that somewhat late in the day, MCashback procured an independent valuation of the software from Valuation Consultants. Without repeating the points already made about this valuation it is just worth remembering that in the space of a month (whilst the Business Plan figures were being egged up a bit) the valuation in draft went from the inexplicable figure of a negative figure to £65 million, and then to a figure in the range of £145 to £150 million. Significant features of this valuation were that Mr. Brewer was told to work on the figures in the Business Plan, and not to explore the assumptions underlying the figures (thus making the valuation totally worthless) and when he discounted the projected cash flows for time and risk, he merely took a risk factor applicable to similar sector companies and added on something extra to reflect the untried nature of the software and the business model, and the start-up nature of the company. I am not criticising Mr. Brewer for proceeding in this way, in that he was following his instructions, but I am saying that in rightly following the instructions that he was given, Mr. Brewer naturally produced a fairly useless conclusion. Mr. Brewer himself said that a far more extensive exercise would have been required by a private equity firm investing, and that the present valuation was only good enough for Inland Revenue purposes. In my view the only thing that Mr. Brewer said that was manifestly wrong was that last remark, because it is absolutely clear to me that the valuation given, the whole projections of income in the Business Plan, and all the arguments advanced about valuation by the Appellants are not good enough for either HMRC or for me.

It is worth repeating the point made in paragraph 75 above that if I calculate a figure of income that might cautiously and prudently be anticipated by reference to Mr. Brewer's figure of 12% discounting for risk, I end up with total income in the 10 years of £94 million, 50% of which would be available to reduce the so-called loans, leaving on this basis 60% of the loans outstanding at the point when they were due to be written off. I also make the obvious point that Mr. Brewer's discounting calculation was based on accepting the projected income figures in the Business Plan and simply discounting them for time and risk, the latter being an adjusted figure based on the discount figures for quoted companies, and having nothing to do with the verification of the projected income figures themselves. In the light of the fact that every prediction has so far been shown to be wrong, it might be the case that if an experienced valuer had been requested to undertake a fuller exercise, he might have cast more doubt still on the projected income figures than was implicit in the actual discounting calculation.

Events have shown that the figures in the Business Plan were unduly optimistic for the years that have so far elapsed. I was told that the figures are running about two to three years behind schedule, nearer three in fact, which in view of the dates 2004 and 2007, is quite a troublesome slippage. In fairness I should concede that this may in substantial part be because the LLP structure failed to attract anything like the investment that had been hoped for and as the funds raised were intended to be spent on rolling-out the system, the slow start could derive from the failure of the financiers to raise the required funds rather than just from any miscalculations in the original numbers contained in the Business Plan. Nevertheless the failure to raise the finance, particularly when the expectation was that the exchequer would be more than underwriting the investors' total outlay and exposure, does rather suggest a certain lack of confidence in the whole venture that hardly supports the claimed valuation. And all such potential costs and risks in rolling-out the system and of thereby generating the gross revenues should have featured in the valuation.

I was told that in 2006, a new transaction had been effected, which sounded like a rather simpler issue of new shares for cash in MCashback itself. Estimates of clearance fee income were made for every month of 2007 for the new investor at the end of 2006, and I was told that the request was that these figures should be prepared on a very cautious basis, giving only revenues that really could be counted on. The figures for the various months of 2007 show a steeply rising curve of revenues, such that "Christmas plainly does not come" until late December. Nevertheless it was admitted that half way through May, the fifth month of the year, the new projections were running three months late.

My conclusions on the valuation issue are that:

• I do not purport to have any clear idea what the 13% interest in the software was worth in 2004, and I heard no evidence that could enable an experienced valuer, let alone me, to make that judgment;

• I consider that the actual figures bandied around, and inserted into the Business Plan, were highly optimistic, untested and unreliable aspirations. Some people might have genuinely believed them, but their approach to valuation would inevitably have been influenced by the fact that the proposed transaction meant that no-one would have to rely on the figures or pay either anything approaching the full price on an outright basis, or indeed even as much as the projected front end savings in tax;

• in my view it is ridiculous to try to support a market valuation of the software by reference to the proposition that independent people gave percentages of £143 million for it, when no-one gave anything other than 25% on a very contingent instalment basis; no-one expected to spend more than 62% of their projected tax savings on their total capital contribution to the project; several investors backed off; and the sum raised from outside investors in LLP1 at as late a date as January 2005 was only about £700,000;

• in short, the Appellants' valuation arguments fail to establish their case by a very wide margin indeed.

In the light of the conclusions just reached, I reject the first of the four possible analyses that I listed in paragraph 98 above. In my view the true value of the acquired software was nowhere near the price ostensibly paid for it, and therefore the Appellants can succeed on this aspect of the case only if they can support, or rather I can accept, the second approach that I gave in paragraph 98. Before addressing this, I should just observe that it was barely even contended by the Appellants that they might succeed on this ground. Their entire argument was along the lines that the price paid was in the right ball-park which I have now rejected.

The second possible approach

In testing the validity of the second possible analysis of this case referred to in paragraph 98 above, I first record the self-evident point that the price that a buyer would be prepared to pay outright for an asset, entirely out of his own resources (or entirely at his own risk), would often be considerably less that the price that might be paid on a contingent instalment basis. And that disparity would be bound to widen considerably when valuing an asset with a speculative value, and for instance untried software which had yet to be launched into the market. Notwithstanding that disparity in likely price I accept that it would be right to refer both to the outright price and the instalment price, as both being price payable for the asset. The market value of the asset would by contrast only be one figure, that being the figure that would be given outright in a sale between a willing buyer and willing seller.

It accordingly follows that if the present transaction had been framed as an instalment sale, in accordance with the economic reality, then capital expenditure would plainly be incurred and capital allowances would be available, as each instalment of price was paid, and there would be no possible dispute then that what was paid was price paid for the software. The transactions were of course framed, as in the case of many film schemes, as an outright purchase, with the whole price being paid up-front, financed by non-recourse loans because the LLPs and the investing members wanted to be able to claim the full capital allowances up-front, and to claim those allowances whether the loans were repaid or not. It does however follow that if the resultant price ostensibly paid was way in excess of the market value figure (in other words that single figure based on an outright, rather than a contingent instalment purchase) then the payment made cannot realistically all be said to be "price" for the asset, or "capital expenditure incurred on the acquisition of the software". This point does not arise by any means in the case of all transactions involving non-recourse loans, because non-recourse loans might well be made available on stringent terms where the lender obtains a share of profits in the event of high revenues arising, which will not make the loans manifestly valuable from the perspective of the borrower, and will not thus enable the buyer to pay a ramped-up price. In many cases non-recourse loans have been used in film schemes where whatever their role and terms, the expenditure incurred by the entities acquiring the films partly with the aid of non-recourse loans was at least paying for the production of the films on a fair-value basis.

In my judgment, the availability of non-recourse loans on the very extreme terms on which they were advanced in this case, has enabled the price for an untried asset to be ramped-up to a figure far in excess of its value, and I therefore consider that it is fictitious to say that the price given was truly all given for the acquired software. The Appellants cannot have it both ways. Framed on a contingent instalment basis, with allowances only arising when capital expenditure is truly given, all the deferred contingent price would have been price given for the acquired asset. But if the transaction is re-framed as an outright purchase, with everything attributed to the asset, the total payment cannot all be said to be the price given for the asset alone.

The third possible approach

I turn now to the third possible analysis summarised in paragraph 98 above, namely to HMRC's case that part of the price paid by the LLPs (25%) was for the software and part (75%) for the benefit of soft finance.

HMRC's case was in part based on the remarks made by the majority Lords in the Privy Council case of Peterson v. CIR [2005] STC 448. This case was principally concerned with the ambit of a New Zealand anti-tax-avoidance provision, and the ultimate outcome was largely dictated by the way in which the case had been advanced, by points that had been dropped and by the limited nature of those that remained in contention before the Privy Council. The case involved a fraudulent non-recourse loan in a film financing transaction where investors had been induced to purchase a film for x plus y, with the y being matched by a fraudulent non-recourse loan when, unbeknown to the investors, only the x had actually been spent on the film. In the majority recommendations, their Lordships suggested that had they been able to look at issues other than the only ones remaining in contention, they would have been inclined to split the expenditure and conclude that only the x had been spent on the film, with the y being paid to acquire beneficial finance, which was non-depreciable for tax purposes.

As already mentioned, HMRC's case is that the price paid by the LLPs was vastly in excess of the value of the software acquired, and that in truth, the price paid should be split between the software and the benefit of soft finance, as in the Peterson case. The split in the Peterson case was fairly self-evident because only the x element of the price had actually been spent on the film. Nevertheless, in this case the HMRC contention was that the allocation of price attributable to the software was 25%, the figure matching the outright capital contributions by the members, and the balance of 75% was attributed to the benefit of soft finance. In fairness to HMRC I should record that, had they been able to obtain expert valuation witnesses, they might have refined that allocation.

The choice between the approach advanced on behalf of HMRC and the one that I asked the parties to consider is difficult, and is influenced by both pragmatic advantages and disadvantages as well as by the more fundamental question of which is the more realistic and which better reflects the statutory purpose of the relevant provisions of CAA 2001.

A factor in favour of the HMRC approach, and possibly one of the points that induced HMRC to advance this argument rather than the fourth approach, is that this third approach is in no way reliant on any sort of re-analysis of the transactions effected, and it does not involve any effort to judge the purpose of legislation involved under the so-called purposive approach to statutory construction. I will address fully the degree (if any) to which the fourth approach involves any such re-analysis in due course, but simply make the point here that the HMRC contention at least has the virtue of steering well clear of this contentious area.

It does however have major practical disadvantages. The first is that valuing an asset at the early stage of the business cycle in which the asset is to be employed is very difficult. For all the reasons given above in paragraphs 100-109 above, I have no doubt that the valuation of the software adopted in this case is totally unreliable for the purpose of now judging what the software was worth in March 2004, albeit that I have no doubt that it was not worth the price ostensibly paid for it. However I have no idea what the software was realistically worth, and correspondingly what value should be attributed to the soft finance were I to decide that HMRC's approach was correct and were I thus to be faced with the task of making some split between the single price paid and the two things for which, on this approach, that price would be treated as given. In order to reach a sensible finding on those points I would have had to adjourn the appeal and further evidence would have been required, both from the people who put together the figures in the Business Plan, and from an expert valuation witness on behalf of the Respondents. I strongly suspect that no material progress would have been made in relation to this valuation until every assumption behind the figures in the Business Plan had been explained and subjected to criticism. In other words it would have been necessary to re-examine every potential difficulty in launching the business. This would have included the appeal to manufacturers in providing promotions for their products when the "rewards" might only be available if the products were purchased through one retailer; the difficulties of providing benefits only through one operator of mobile systems; questions of whether retailers would be less attracted to operating the system if manufacturers' promotions could in fact be accessed through numerous competitive retailers; the conflicts that retailers might assume would impact on their existing loyalty promotions; the management time and costs, legal costs, and software integration costs of making arrangements with numerous counter-parties in different parts of the world; the implications of delay in the roll-out of the business in the event that the Tower proposal was not fully subscribed; and the degree to which it was realistic to assume that the M Rewards system would remain popular and valuable in 2114 in the light of the expected rapid changes in technology, competition and buying habits over such a long period. Those might or might not be relevant questions to consider in judging the realistic value of the software at a very early point in the business cycle, and doubtless other longer lists could be complied. The salient point is that none of these issues was explored in the course of an eight-day hearing, and I thus repeat my observation that in order to reach a reliable valuation judgment as at March 2004, very substantial amounts of further evidence would have had to be produced. Indeed I consider that what I heard barely even constituted a starting point.

A related concern with HMRC's approach to splitting values is illustrated by observing that HMRC suggested that on their approach, 25% of the total price reflected the value of the software, and argued that the balance was paid to acquire the benefit of the soft finance. There is really no basis for this split. Certainly the split was not based on a balanced judgment in relation to all the points that I have just listed. More relevantly however, if the tax expectations are initially ignored, and a valuer is asked whether a purchaser would pay more than 25 outright for an asset if another deal on offer was to pay 25 down, and the balance of 75 on a contingent basis, most buyers would increase the up-front price by something if that eliminated the risk of having to pay 75 in due course. So logic suggests that the value of the asset in this case, ignoring the hoped-for tax treatment, would have exceeded the 25. Once one takes the hoped-for tax treatment into account however, the logic reverses, and it becomes perfectly possible that the asset was worth less than 25. With the tax expectation that buyers would derive immediate tax relief worth 40 in return for their 25 put genuinely at risk, the attitude of the buyers might have been that they were keen to take a punt on paying 25 to derive tax relief worth 40, and that they had no idea whether the software as such was worth anything. I repeat that I am not suggesting that the case was fraudulent and that the transactions were a device to buy capital allowances worth 40 for 25, regardless of whether the software was worth anything at all. I am simply observing that the hoped-for tax implications so confuse the valuation issue that the split adopted and suggested by HMRC seems to me to be quite arbitrary, and it might well be wrong in either direction.

Another consideration in relation to the split suggested by HMRC is that if 75% of the price is allocated to the receipt of soft finance, it seems difficult to conceive that anyone would pay the full gross amount of a loan in return for a loan of an identical amount, however favourable its terms. One might pay 75 in return for 75, but to pay 75 in return for 75 that might have to be returned, however remote the contingencies of repayment, makes no sense at all. Even this point does not however suggest that the value, and the right price, for the sale of the software was at least equal to the 25% given outright (and implicitly more), because it remains perfectly possible that the software was worth less than 25%, and that the 25% contributed outright to the LLPs by investor members was itself ramped-up by the hope and expectation of securing tax relief worth substantially more than the 25%.

There is however a more substantive objection to HMRC's approach which is that, while it might have been tenable in a case where the film in the Peterson case was only worth, and was only purchased for, x and the y element was entirely fictitious, this case is not that extreme. Whilst I hope to have thrown great down on all the estimates of income and valuations, it certainly remains possible, and indeed I hope likely, that some of the loans will be discharged because there will be the required receipt of clearing fees to discharge some, albeit probably not all, of the non-recourse loans. I find it extremely difficult to conclude that the Appellants will not have incurred further capital expenditure than the initial 25% paid outright if in the event some of the loans are repaid. On the discredited form of the documents, the full price will have been paid and, to the extent of loan repayments, it will then also be realistic to say that the contributing members have ultimately borne more (by the amount of the loan repayments) of the capital contributions than the initial 25%, and correspondingly the LLPs will have fictitiously paid all of the price and also genuinely borne an amount of the price equal to the initial 25% plus the amount of the loan repayments. To deny that in these circumstances more capital expenditure has been incurred seems to me to be unrealistic. And to leave the Appellants with potential tax liabilities on all the income, with no hope of sustaining further claims for allowances, seems an unrealistically harsh result.

The fourth possible approach

I turn now to the fourth possible approach. I will test this approach by first considering whether the pricing of the actual transaction was fictitious; whether the loans were on non-arms' length terms; and whether the interposition of the banks was principally designed to conceal the feature that the loans back were in reality made by the seller. I will then address whether on a purposive construction of the statute, the allowances should be given in accordance with this fourth approach. In order then to test this approach further I will check whether it is permissible to marry the making of the contributions (and the loans back to fund the capital contributions) with the payment of the price, and I will finally consider the relevant authorities.

The price paid for the software

There is no need to repeat the findings as regards the unrealistic nature of the price paid. I also record the conclusion in relation to the second approach, namely that it is a mis-description to say that the whole of the money paid by the LLPs could be described as "price paid for the acquired software".

The non-arms' length nature of the loans

I turn now to the question of whether the loans were on un-commercial and non-arms' length terms and conclude that they were. Non-recourse loans can be made on arms' length terms, generally providing additional reward to the lender where the contingencies, subject to which repayment is to be made, are satisfied. Such loans can also be made in a genuine fashion when made by, say, a producer of a film provided they fund the purchase or production of the film on a fair-value basis, and are again on reasonable terms. The terms of the loans that I summarised in paragraphs 37 and 38 above however are un-commercial, and the feature that it was initially projected that only 80 % of the loans would be discharged if all the revenues projected in the Business Plan were in fact received (and only 40% on the basis of the risk-adjusted figures that I have roughly calculated) demonstrates that the loans were extraordinarily un-commercial.

The interposition of the banks

I will now deal with the feature that the loans to the members were technically filtered through a Tower Finance lending vehicle, and then made by a bank, rather than directly by the seller.

The facts and findings that I need to list to support a conclusion in relation to the role of the two banks are as follows:

• it was at all times a feature of these transactions that the price payable would be substantially funded by non-recourse loans indirectly provided by M Cashback, and M Cashback was required to procure that the banks advanced those soft loans in the initial License Agreements under which the various LLPs agreed to purchase the software;

• in contrast to the situation in the case of Mawson v. BMBF [2005] STC 1 (HL), the loans were not provided in the ordinary course by the usual lender to the borrower, but were simply procured, as they were required to be, by the seller, MCashback;

• whilst evidence was given that MCashback preferred the arrangements actually put in place to my suggested alternative under which MCashback might have lent monies back directly to the members, without the interposition of the banks, or have left 75% of the purchase price outstanding on a contingent instalment basis, and whilst it was suggested that MCashback was better placed by having monies under its control when its monies were placed in a security deposit in favour of R & D, much of this evidence was also contradicted by the observation that MCashback thought that the interposition of the banks was a feature required by Tower or the LLPs and not by MCashback;

• the suggestion that MCashback had more control over the deposits placed with R & D than it would have had if monies had been lent back directly to the members is without foundation, because it is inconceivable that the banks would release MCashback's deposit without having first had their own deposits refunded indirectly out of loan repayments on behalf of the members;

• when I repeatedly asked what actual advantage (if any) was secured by M Cashback by the interposition of the banks in contrast to the position that would have obtained with a direct loan back from MCashback to the members, or a straight instalment sale, counsel for the Respondents agreed with me that he could see no advantage and I was not persuaded by counsel for the Appellants that the position of MCashback was made more attractive in any real and genuine way whatsoever;

• M Cashback's position was, by contrast, made worse in that the cost of arrangement fees and spread interest costs all added to the funds that had to be placed on deposit by M Cashback (75% of the price received by it, and 82% of the gross capital contributions of the investor members) to secure the chain of bank lenders. These figures are to be contrasted with the 75% of the capital contributions to the LLPs that were funded by the loans back. Finally the creation of the chain created complication and the need for numerous additional documents, and the cost of extra legal fees;

• were there a possibility that the intermediate links in the banking chain could have commercial implications in the event of the insolvency of one of the banks, this represents merely an unwelcome disadvantage to MCashback that would not have arisen with direct loans back to the LLPs or the members or an instalment sale;

• suggestions that the members of the LLPs derived comfort and protection from the notion that they were borrowing from banks, rather than from the vendor of the software, and that the financing structure could not have been marketed without the involvement of the banks, are without foundation, since the protection of the members was entirely dependent on the correct drafting of the non-recourse provisions of the loan agreements, quite regardless of who the loans were made by; and

• in response to my repeated questioning of whether the members of the LLPs derived any cogent advantage by the loans back having been filtered through the banks, in contrast to the position that would have obtained had MCashback lent directly to the members or the LLPs or had the transaction been a contingent instalment sale, counsel for the Respondents agreed with me that he could see no advantage secured by the more complex structure, and I was not persuaded by counsel for the Appellants that the investor members derived any real advantage whatsoever.

Proceeding from the facts and findings just summarised, I consider that it is overwhelmingly likely that the banks were interposed because it was believed that the hoped-for advantage of enabling the investor members to claim allowances in respect of 100% of the ostensible price paid, notwithstanding that only 25% of the price paid was genuinely given by the members, would be at risk if the loan back was made directly by M Cashback. It was confirmed in evidence that the interposition of the banks was thought to enhance the "tax efficiency" of the deal and it is clear from the counsel's opinion that there was concern about non-recourse loans, and a considerable premium associated with trying to distance the loans back from the analysis of a simple reversal of the payment of 75% of the price. In other words the banks were interposed to try to diminish the impression that the reality was that the loans to the LLP members were simply a reversal of 75% of the price just paid, or about to be paid. I also conclude that the "window dressing" is actually counter-productive because when I can discern no real change or implication or benefit that results from the insertion of the two banks, the fact that that interposition has increased costs, complexity, documentation and legal fees just serves to underline how vital it was thought to try to disguise the reality of what was happening.

Nothing in the previous paragraphs is dependent on disregarding any transactions that have been undertaken. My analysis is not that the actual transactions should be disregarded and that there should instead be deemed to be loan backs directly from M Cashback, or indeed that the transaction should be treated as an instalment sale. I entirely accept that what was, in substance, an instalment sale was actually implemented as an outright sale, accompanied by a loan back that was non-recourse, and ultimately to be discharged by the lenders, all filtered through two banks for no real purpose other than to try to disguise the reality of what was happening. It thus follows that I accept that, insofar as the borrowers bore the cost of interest payable to the banks, nothing detracts from the technicality that the members had borrowed from banks and indeed paid interest to those banks. [Counsel for HMRC confirmed that it was accepted that tax relief would be available for the "income losses" including the interest expense and other front-end fees.]

Were the transactions a sham?

These various conclusions in paragraphs 107, 108 and 111 raise the question of whether I consider the transactions effected to have been a sham.

The conventional definition of a sham is of a transaction where the documents purport to effect some different transaction from the one actually effected, with both parties being aware of the sham nature of the transaction. Thus, examples of shams will be the purchase and export of worthless goods in a Carousel fraud for VAT purposes, accompanied by documents suggesting that the goods purchased and exported are real and valuable goods, with the parties being aware of the resultant fraud, and secondly a gift from a parent to a child, dressed up as a purchase of a worthless asset at a high price to conceal the gift for Inheritance Tax purposes.

I find it difficult to decide whether the transaction in the present case was a sham or not. I naturally accept that software was sold, and I also accept that, in the fullness of time, the software might become very valuable and successful, generating high revenues. I also accept that the people who produced the business case figures might have done so honestly, albeit very optimistically, and there was certainly no actual evidence to suggest that there was a conspiracy to ramp up the value of the asset in order to increase the available allowances. I do however consider it clear that the parties paid no attention to verifying the real figures, because everyone knew that the non-recourse loans would make everyone indifferent to whether the figures were correct or not. It accordingly follows that in my view the figure given as price was appreciated to be a figure that no-one would have considered paying outright; it was appreciated that in economic reality no-one was paying the price outright, and it was appreciated that the higher figure would simply increase the up front allowances.

On the sham point, I do not suggest that the whole transaction can be set aside in any way. I do however say that all factors related to the price at which the asset was sold, the terms of the loans to finance the capital contributions, and the supposedly cosmetic insertion of the banks into the lending chain are fictitious features designed to dress-up a contingent instalment sale as something that these transactions manifestly were not. Whilst I do not consider that the knowledge of these factors by the parties is required to sustain these observations in the way that parties to a sham must generally be aware that the transaction is a sham before it can be set aside, it seems self-evident to me that the parties must all have known that the economic reality of the transactions was of a highly contingent instalment purchase; that the ceiling price payable on that basis had relatively little bearing on the true value of an asset and the price that might be paid outright for an asset, and that accordingly the ostensible payment of the full price outright was phoney.

The result of the conclusion in paragraph 132 above is that I consider that I cannot sensibly apply the tax provisions to the transactions by paying regard to the discredited form of the transactions, and to the discredited labels that the parties have attached to the transactions.

The provisions of section 5 CAA 2001 and the application of those provisions to certain examples and then to the facts of this case

Section 5 CAA 2001 treats capital expenditure incurred under an unconditional contract as incurred at the date of the contract. Whilst this is a general timing rule, the emphasis on the contract having to be unconditional plainly reflects the notion that capital expenditure will only realistically be "incurred" when it is incurred and borne in a realistic sense. I entirely accept of course that if the purchaser borrows money to pay some or all of the purchase price, or is given funds by some third party other than the vendor, neither of these factors derogates from the buyer incurring capital expenditure on the asset purchased in a realistic sense.

Turning to a possible example to which the correct analysis seems startlingly obvious, I question what capital expenditure would be "incurred", if a taxpayer paid 100, on terms that the seller would rebate 20 to the buyer. It seems inconceivable on that simple example that the buyer could be treated as incurring any expenditure other than 80. The same conclusion would plainly also apply if the seller paid a commission of 20 to an agent, and the agent rebated the 20 to the buyer in accordance with prior arrangements between all three, such that again the buyer would effectively pay only the net 80.

These examples might appear initially to be different from the facts in this case, but on further consideration, the difference appears rather less than one might suppose. On the basis of the figures that I summarised in paragraphs 74 and 75 above, it is implicit that even if every £ of the "predicted" and highly optimistic income figures contained in the Business Plan was received, there would still not be sufficient income in the first 10 years to pay off more than 80% of the non-recourse loans unless there was a sale by the LLPs generating substantial proceeds. I accept that it will remain theoretically possible that clearing fees will exceed all estimates, and it may be that all the loans will be paid off. It seems to me however that much the more likely scenario is that the figures in the Business Plan were "away with the fairies", such that the very great likelihood is not just that 20% of the loans will be waived, but that a far greater percentage will be waived.

It is worth remembering that on the basis of the very rough calculation that I made in paragraph 75 above of the level of clearing fees likely to be received by reference to Mr. Brewer's risk analysis of the case, and his resultant fairly rough valuation, only 40% of the loans would be repaid in the 10-year period, and absent a sale and substantial proceeds before that date, the 60% balance of the loans would be repaid by the lenders, not the borrowers, in other words would effectively be waived. Again I note that Mr. Brewer's discounting calculations only applied a standard risk discount factor to the projected income figures and did not address whether the Business Plan figures were at all reliable.

The question that I have to address, therefore, is whether it is appropriate to say that capital expenditure of the gross figures has been incurred when the seller has filtered back 75% of the price to the investor members of the LLPs via the cosmetic banking chain, when the reality is that there is a great likelihood that a substantial proportion of the wholly un-commercial loans will eventually be waived, and when, in the meantime, any partial repayments of the loans will be liable to be made on an entirely contingent basis. And when I address that question by looking at the legal reality of what has occurred, and at the money movements, rather than looking fixedly at discredited labels attached to the transactions by the parties, I conclude that the gross capital expenditure has not been incurred. On a purposive basis it seems to me that the investor members and the LLPs have so far incurred the 25% element of the total price, and that the LLPs will incur further capital expenditure if and to the extent that the LLPs discharge members' loans on their behalf by the envisaged application of 50% of clearing fees.

It may just be worth addressing two suggested virtues of the conclusion just given.

The first is the point that while the approach advocated by HMRC encountered great valuation difficulties (including in particular the point that I made in paragraph 120 above), the approach that I have adopted does have the virtue that whether the investor members would have participated in the scheme, had they realised that tax relief would only be available in the way that I have decided, nevertheless I am giving tax relief for the figure that, like it or not, the LLPs and more relevantly the investor members have given, and that they cannot have back. And the same will apply if and to the extent that loans are progressively discharged.

The other self-evident observation is that whilst the Appellants will find this outcome disappointing, they might dwell on the fact that it is potentially far less unattractive than the prospect of having their allowances indefinitely capped at some low figure, 25% on HMRC's contention, whereafter they would be fully taxed on the clearing fees with no chance of claiming further allowances. And the choice between the third and the fourth approaches becomes all the more stark if the apparent confidence of the witnesses in the M Rewards system is shown to be justified!

The relationship between the making of the capital contributions, the loans to make those contributions, and the payment of the price.

I must now consider whether the fourth possible approach that I have adopted is undermined by the factor that the loans made indirectly by the seller were technically made to the members to fund most of their capital contributions to the LLPs, and were not made strictly to the LLPs to fund part of the payment of the price for the software.

I observed, on raising the instalment analysis with the parties, that the loans had been made to the members, rather than to the LLPs themselves that paid the price, and indeed I asked the parties to consider whether they considered that this had implications on the possible application of section 118ZC (3) (d) Taxes Act 1988. This would be along the lines that some other entity had lent the members 75% of the capital to be contributed to the LLP and that in one circumstance, since the lenders would repay the loans for the borrowers, it might be appropriate to conclude that the "net capital" treated as contributed to the partnership for the purposes of the relevant section would be merely the 25% unless and until the loans were repaid out of designated revenues. I refer to that point again in paragraph 175 of this decision.

Reverting to the question posed in paragraph 142 above, I consider that the fourth approach is not undermined by the feature that the loans were made to the LLP members, rather than to the LLP.

Pursuing the notion that the loans back were made to the members, such that the genuine net capital contributed at the outset was 25% of the nominal gross capital contribution, it follows that since the LLPs themselves did not borrow or raise any other funds than the capital contributed by the partners, then once the loans back should be netted off against the capital contributed, the LLP could not have the funds to pay the gross price, ostensibly paid for the software, as opposed to just 25% of it. And correspondingly MCashback provided in full against the loans and only treated itself as having received for accounting and tax purposes the element of the cash that it had not had to place on deposit. It is also appropriate to note that if and when designated revenues are received and the loans thus fall to be reduced, the loan repayments are required to be made directly by the LLPs "on behalf of the members", short-circuiting the mechanism whereunder the profits might have been distributed, with the partners themselves then repaying the loans. Whilst this is of less significance, it is finally worth noting that following loan repayments via the chain of banks, the monies that will actually be received by MCashback will be treated in accounting terms as additions to the sale proceeds for the sale of the software, the initial proceeds having been treated for accounting purposes as being confined to the 25% received outright.

Further support for the proposition that the "instalment" analysis is not undermined by the fact that the loans back are made to the partners, and not to the LLPs that paid the price, is derived from the way in which LLPs are treated for UK tax purposes. Although the LLP is an entity distinct from its members, LLPs are treated transparently for UK tax purposes, with section 118 ZA (1) providing that:-

" …. where a limited liability partnership carries on a trade, profession or other business with a view to profit-

(a) all the activities of the partnership are treated as carried on in partnership by its members and not by the partnership as such,

(b) anything done by, to or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the members as partners, and

(c) the property of the partnership is treated as held by the members as partnership property".

Applying these deeming provisions, the contribution of capital is treated as being a contribution from the members to the members (in other words not as a payment at all but as an allocation of the property of members to be held for the purposes of the LLP), the purchase of the software is treated as being made by the members, who are treated as owning the software, and it is thus the members who are treated as having paid the price for the software, with those members having actually received the loans in their actual capacity as members.

I acknowledge that in the previous paragraph the payment of the price and the loans back to the members end up being treated for tax purposes as being "in the same hands" only because of a taxation provision that deems them to be in the same hands , when in strict legal terms the loans were made back to the members and the price was paid by the LLP. It still seems to me, however, that it is legitimate to arrive at the tax analysis of the transactions in this case by adopting a deeming notion that applies for all UK tax purposes, particularly because it is the tax treatment of the payment of the price and the loans back with which I am presently concerned

Relevant judicial authorities

I will now consider the relevant authorities, to test whether those authorities preclude me from confirming the decision on the fundamental issue in the way that I have now indicated.

There is considerable judicial authority on the circumstances where the General and Special Commissioners and the courts can look to the reality behind the form of transactions, and it is convenient now to consider the leading authority in relation to non-recourse loans and films schemes, namely Ensign Tankers v. Stokes, 64 TC 617, and judge whether that authority supports the proposition that I should look behind the form and the discredited labels placed by the parties on the relevant transactions.

In the case of Ensign Tankers v. Stokes, 64 TC 617, the House of Lords decided that it was open to the courts to re-analyse the transaction ostensibly undertaken by Victory Partnership and the production company, Lorimar Productions Inc, that was both producing the film in issue in that case and purportedly making a non-recourse loan to Victory Partnership. The form of the transactions recorded that Victory Partnership paid the whole gross price to acquire and then pay for the completion of the film, with approximately 75% of the price being funded by a non-recourse loan. The purpose of that form was to gear up the acquisition price so that the partners in Victory Partnership could claim capital allowances on approximately four times their actual outlay, albeit that it was recognised that if and when revenues flowed in, the partnership would be taxable on all of the revenues, notwithstanding that 75% of them would be applied in reducing the non-recourse loans. The decision of the House of Lords was that they could re-analyse the relationship of owner and lender into one of a partnership, whereupon Victory Partnership was treated as incurring only the expenditure that it incurred, ignoring the element funded out of the loan, with the lender being treated as incurring the balance of the expenditure. Correspondingly, the income was also split so that instead of the partnership's highly-geared allowances being put into reverse by the partnership being taxed on 100% of the revenues when 75% were applied in loan reduction, the partnership was treated as receiving only the 25% net revenues, with the lender (the quasi-partner) being treated as the direct recipient of 75% of the revenues, rather than loan repayments.

I have four observations to make in relation to the Ensign Tankers decision. First the gross expenditure incurred by the partnership was at least genuinely spent on the purchase and production of the film. Secondly, whilst the loan was artificial, it is worth noting that the revenues from the film were sufficient to give the formal partners back income nearly equal to their initial gross outlay, and the lender received (via its 75% share of the income or loan repayments, however expressed) $9 million in respect of its outlay of $10.75 million. There were accordingly losses but they were fairly marginal. There was thus no remote issue of the initial price of the film being ramped up so as to increase the claims for capital allowances, in the expectation that there would be large losses. All films are risk investments, and this one made losses, but in the event, the eventual tax treatment on the analysis adopted by the House of Lords was not all that different from the analysis that would have prevailed on the loan approach contended for by Ensign. Thirdly, the basis on which the non-recourse loan was to be repaid out of income was less generous to the taxpayers and the members of Victory Partnership than the loan repayment profile in the present case. In the Ensign case, the partnership expected to receive 100% of the income, which would all be taxed, notwithstanding that 75% would be paid away in loan repayments. Thus the initial gearing feature would be entirely reversed, and whilst this feature cast doubt on the trading status of the partnership (in that the partners actually expected to be prejudiced in after tax terms by the receipt of income), the profile of payments did at least demonstrate the commercial desire of the lender to recover its monies equally with the partners; and the profile of spending and income mirrored the way in which in any leasing situation, the tax benefits are put into reverse once income flows and the lessor must repay borrowings. By contrast in the present case, the way in which income is always to be split such that only 50% of the gross income is to be applied in loan repayments, with 40% of net profit being distributed to the members to pay the tax on their profit share, and another 5% potentially being distributed as "bonus", means that the loans in the instant case are considerably "softer". My final observation is that the treatment accorded by the House of Lords was less extreme than the suggestion now being advanced by HMRC in this case. The present contention by HMRC is that the LLPs only expended 25% of the total gross capital on software, qualifying for allowances, and no allowances are due for the 75% spent on "the benefit of soft finance". Nevertheless all of the income will still be taxed in the hands of the members of the LLP, in contrast to the position in Ensign where the re-analysis applied to reduce both the capital allowances and the taxable income allocable to Ensign and the other limited partners in Victory Partnership.

I could at this point rely on the authority of the Ensign case, and observe that on account of the first three of the points made in the previous paragraph this instant case is more extreme, so that this case must plainly fail, on the authority of Ensign. I accept however that the authority of the Ensign case has in recent years been questioned both in judgments and in commentaries, and it seems more prudent to me to proceed on the basis that the courts might now feel bound by more recent authorities not to follow the decision in Ensign. The line of reasoning, for such a departure, would be along the lines that either of the forms (i.e. that adopted in the documentation by the parties, and that substituted by the House of Lords) could both explain the money movements and the transactions in the Ensign case reasonably cogently and it was not open to the courts to adopt a different analysis from that adopted by the parties, merely because the choice of form adopted by the parties was motivated by tax motives.

The reason why I still consider that the analysis in this case must still depart from that adopted by the parties is that on the facts that I have found without hesitation, I simply cannot accept that the price ostensibly paid outright by the LLPs for the software remotely reflected the value of the software. This manifest artificial pricing was also matched by loans that really just reversed 75% of the initial payment of the price since they were made on wholly un-commercial terms. This makes it necessary to consider other analyses of the transactions, once the one underlying the original form has been found to be totally discredited.

I should also refer to two other authorities which might be thought to preclude me from departing from the form of the transactions in the present case. Those authorities are CEC v. Faith Construction Ltd [1989] STC 539 and MacNiven (Inspector of Taxes) v. Westmoreland Investments Ltd [2001] STC 237.

Faith Construction related to a VAT scheme where companies engaging builders sought to accelerate the tax point of the supplies of building services to a date before the relevant services were to cease to be zero-rated. This was achieved by paying the builders in advance of the normal date for payment which was usually geared to production of architects' certificates. In one of the cases the monies paid were put into a blocked account of the builders, on terms that monies could be withdrawn on production of architects' certificates, and in other cases the monies paid were simply lent back, with the loans to the customers falling to be repaid to the builders against provision of the same certificates. In all the cases the payments, whilst artificial and tax motivated, were held to have been valid payments and they secured the hoped-for results. The decisions were partly explained by the fact that a VAT Notice almost invited taxpayers to pay early to accelerate the supply, and by the feature that in slightly different circumstances the same advantage could have been achieved simply by the building company issuing the tax invoices early. And in the case of the monies being paid into a blocked account, the one and only payment had plainly been made and the builder ceased to be at risk to the customer's credit standing. Even however in relation to the more extreme case of the matching loans back, the judge made it perfectly clear that his decision supporting the validity of the payments "assume[d] that the transaction [was] genuine, not a sham, and that A and B [were] not taking part in a charade, [since] in all these cases the commissioners accept[ed] that the transactions [were] genuine and not a sham". Beyond this, the price paid to the builders was the correct price for the work done.

Much the same points arose in the Willoughby case where the insolvent company, which had incurred large interest liabilities to its shareholder, a pension scheme, paid the interest with the aid of loans advanced by the pension fund so as to crystallise the entitlement to tax relief for that interest, all with a view to the company being sold to third parties for the benefit of the resultant tax deductions. Whilst the payment was again artificial, and the advance of the new loans to facilitate the payment was clearly tax motivated, it was indisputable that the company had genuinely incurred the interest indebtedness; relief would already have crystallised had the loans been made by banks which had debited the customer's account with the interest; and the court concluded that the technical payment thus succeeded in conferring relief for interest plainly already incurred.

The critical difference between those cases, and the present case, and indeed between the Ensign case and the present case, making the somewhat extraordinary leap of supposing that that case would today be decided in favour of Ensign Tankers, is that it is only in this case that the validity of the Appellants' claims are based not just on formal steps of payment being matched by loans back, but critically by adopting fictitious and wrong pricing. In this case the price ostensibly paid by the LLPs greatly exceeded the value of the software; totally non-commercial loans on quite extraordinary terms really reversed much of the payment of the price; on the parties' own highly optimistic figures, some of the loans were suggested at the outset to be unlikely to be repaid, and the banks were interposed essentially in a failed attempt to disguise this reality.

The decision in favour of the taxpayer in the Mawson v. BMBF case

Some reliance was placed by the Appellants on the Mawson decision and on the fact that the full capital expenditure was still said to have been incurred by the lessor company, notwithstanding the effective funding of the transaction by the lessee.

I do not consider the Mawson case to be of any relevance to the facts of this case. The Mawson case essentially raised the question of whether the full tax characteristics of a leasing transaction should apply when the transaction was designed to transfer the asset in question to the lessor, but in circumstances where the lessee did not want the additional common characteristic of a leasing transaction, namely that the transaction should also provide funding to the lessee. The core attribute of the leasing transaction, in other words a subsidy towards the rentals derived from the accelerated tax relief available to the lessor was no different in the Mawson case than in any more straight-forward leasing transaction, merely because the lessee did not want the funding, and the costs of genuine borrowings and credit risk that would have accompanied the more ordinary transaction where tax benefits and funding were both required.

I see no relevance to the point that was thus at stake in the Mawson case, where the price paid for the pipe-line was not seriously in question, and when the loans were on commercial terms to the facts of this case and the fictitious features that I have identified.

I accordingly conclude that the judicial authorities do not preclude me from confirming the decision that I gave in paragraph 138 above.

My decision on the two technical capital allowance points under s.5 CAA 2001 and the resultant question of whether 100% allowances are potentially available under s.45 CAA 2001, to the extent that expenditure has been incurred