Upper Tribunal (Administrative Appeals Chamber)

IN THE UPPER TRIBUNAL Appeal No. CCS/3334/2013

ADMINISTRATIVE APPEALS CHAMBER

Before: Upper Tribunal Judge PA Gray

The decision of the Upper Tribunal is to allow the appeal.  The decision of the Plymouth Tribunal made on 2 April 2013 under number SC 220/12/00042 was made in error of law. I set that decision aside, and remake the decision as follows:

(i)      The Secretary of State shall calculate the child support maintenance payable by the appellant father to the second respondent mother upon the basis that losses from the new business ‘T’ shall be offset  against the profits of LM LLP which have been payable in the same tax year.  The effective date of any change of maintenance calculation is the first day of the maintenance period in which the application for supersession was made. That application was made on 13 July 2010.

(ii)    Interest on the loan to fund the father’s purchase of his share in LM LLP is not to be taken into account.

(iii)   There is liberty to apply to the Upper Tribunal as to calculations within one month of their being issued to the parties. This is as to mathematical calculations only; factual findings and legal conclusions cannot be challenged under this provision.

REASONS FOR DECISION

1. This matter concerns child support maintenance for three children, C, G and T.  At all material times the children lived with their mother the second respondent; although they spent time with the father on a shared care basis, the mother is the Parent with Care and the father the  Non-Resident Parent in the terms of the applicable legislation. I will refer to the parents as the mother and the father in this decision.  The Secretary of State for Work and Pensions is the respondent, the functions of CMEC (formerly the CSA) having been transferred to the DWP under a transfer of functions order effective from 1/8/12.  I will refer to the body that has from time to time been administering child support maintenance as the agency in this decision.
2.  Child support maintenance was based on the statutory scheme which was in force from 3/3/2003, known as the "new rules".
3. The First-Tier Tribunal (FTT) heard the substantive appeal in this matter as long ago as 18 July 2012.  The decision of the tribunal involved remission to CMEC for recalculation.  The father's application for permission to appeal was initially quite properly treated as an application that the calculation be looked at by the FTT.  That required a further hearing which took some time to arrange and there followed consideration of the application for permission to appeal which was refused by a District Tribunal Judge and was renewed before me within the time provided for in the procedural rules.
4. The father made a number of points in his application for permission to appeal, which I decided were not arguable. I gave permission to appeal, however, on a limited but important issue concerning the calculation of “gross profits” for child support purposes

Background

5. The father has at all relevant times been a partner in a Limited Liability Partnership LM LLP and was assessed for child support maintenance as a self employed earner on the basis of his share of the profits of that partnership.  The maintenance calculation had been made on 21 April 2010 to the effect that he was liable to pay £117.14 each week for the three qualifying children from an effective date of the 30 March 2010.
6. He applied for a supersession of the formula calculation on 13 July 2010 on the basis that his net income was wrongly calculated because losses from a new business should be taken into account.  The reason for this was that he now had, in addition to the partnership, a new business as a self-employed earner, a restaurant enterprise which I shall call T. He was asked to submit three months accounts for T and did so for the period 1 July 2010 to 30 September 2010, together with the 2009/2010 self-assessment tax return for the partnership. Although the partnership LM LLP showed a profit, the new business T had made a loss. The father wished to offset the loss on the new business against the profits of the partnership.  In both ventures he is a self-employed earner for the purposes of child support legislation. The Secretary of State made a decision on 6 January 2011 that the reduction claimed was for losses which were not deductible from his self employed income from LM LLP. 
7. The father appealed to the FTT, which confirmed the decision under appeal on the basis that the losses from the new business were not an allowable deduction against the profits of LM LLP.
8. I have sympathy with the judge, because the view that she took was historically correct in relation to child support calculations.  It may be that an amendment to the regulations changed that, and the point is not one upon which there has hitherto been case law. 
9. That was the matter upon which I initially invited submissions.
10.  I later reconsidered my grant of permission which had closed down a subsidiary matter, which was the treatment of the father’s loan taken out to purchase his equity share of the Partnership LM. The father made a further specific request to be able to argue that point, and on reflection I directed further submissions on the issue as to whether the interest on that loan could be deducted in the calculation of the father’s net income for child support purposes.
11. The parent’s have not been represented; the Secretary of State is represented by Mrs Tarver.
12. No party has requested an oral hearing of this case, and I consider that I am able to decide the matter fairly upon the information and submissions now available to me.

The father’s submissions

13.  These were on the main issue simply to the effect that the losses in respect of the new business were deductible against the profits of the existing partnership. The father also raised objection to the agency having assessed his income under paragraph 8 of the schedule to MCSC regulations, contending for regulation 7 being the appropriate provision.
14. His submission on the subsidiary issue was, as pointed out by Mrs Tarver, not as full as I had expected when making my supplemental direction, and which dealt with HMRC issues from a tax year which was not the relevant one, however that matter seems to me to be one of relatively straightforward resolution, as I set out below.

The mother’s submissions

15. The mother has made submissions before me on the subsidiary issue, as to the father failing to provide either the detail that I required by my directions or the relevant tax return, and making the point that it was the father’s choice to take out the loan that he did, and to allow credit against that within the child support the scheme would leave it open to non-resident parents to make such choices to the detriment of their children’s financial well-being.  

The Secretary of State’s submissions

16. Mrs Tarver on behalf of the Secretary of State argues that the decision of the FTT was erroneous in law, and she suggests that this is a case in which I can make the decision that the FTT should have made.  I agree with her; it seems to me that the financial expertise available in the FTT would not assist on these purely legal points. In addition and importantly the time that has already elapsed makes it imperative that I deal with the matter finally without further delay if I am able to do so fairly.
17. The Secretary of State supports the appeal as to two points raised on behalf of the father, the main point, the potential set off of losses from the new business, and the subsidiary point relating to the loan.
18. She reiterates the point that I made in my grant of permission to appeal, that prior to 1 August 2007 the provisions which set out the calculation of income, the Schedule to the Child Support (Maintenance Calculations Special Cases) Regulations (the MCSC regulations) at paragraph 8 (b)(vii) specified  that deductible expenses did not include “any loss incurred in any other employment in which he is engaged as a self-employed earner.”
19. She explains that this provision had most of its content removed by regulation 5 of the Child Support (Miscellaneous Regulations) 2007. She sets out the explanatory note to that legislation in relation to both regulations 4 (which related to the “old rules”) and regulation 5, applicable in the current case. 

Child support legislation and taxation provisions and policy

20. I will digress briefly from the circumstances of this case to make a point concerning the interplay between the legislative provisions which govern child support maintenance and the workings of the tax system.  The father’s argument is really predicated upon the basis that the treatment of his financial position by the revenue is determinative in relation to the calculation of his income for child support purposes.  This is not so.

21.  Case law in child support from its earliest days emphasised that there is a positive duty on the tribunal to ascertain the true level of earned income, rather than simply accept the figures in the accounts produced: CCS/12420/95.  This remains so even where the accounts have been accepted by HMRC. The inherent purpose in the departure/variation provisions (in force since 1996) which relate to diversion and lifestyle was to recognise that there may be a dichotomy between information provided to HMRC, and the actual situation.  Case law has also drawn that distinction (in particular where there is a need to construe actions) and a decision as to what was permissible in relation to income tax may not be replicated in a child support context.   For example, where questions of diversion under the Child Support (Variation) Regulations 2000 are raised it may be argued that certain actions have been done with a view to (perfectly legally) avoiding tax rather than reducing child support, but minimising child support and minimising tax liability are not two sides of the same coin. CCS 3675/04.
22. More recently, despite certain amendments which have aligned some child support provisions with those applicable in taxation legislation, the legal authorities have repeatedly emphasised and preserved the distinctions, in particular as to an expert tribunal being required to make findings and not being dependent upon the acceptance of a certain state of affairs by HMRC; Gray-v- SSWP and James [2012] EWCA Civ 1412.   KB-v-CMEC (CSM)[ 2010] UKUT 434 (AAC) and DB-v- CMEC (CSM)[ 2011] UKUT 202 (AAC) are recent authorities for the tribunal’s ability to substitute their own figures for income and expenditure for any in the tax calculation, although in doing so they must apply the provisions of part 2 of The Income Tax (Trading and Other Income) Act 2005 (ITTOIA).

The main issue

23. The main issue is as to whether the loss from one business, in this case the new business, can be deducted from the profits of another, here the established partnership which generated a substantial profit. The ITTOIA 2005 is the starting point for the calculation of the gross earnings of self-employed earner, as set out in paragraph 7 (1A) of the Schedule to the Child Support (Maintenance Calculations Special Cases) Regulations (the MCSC regulations) as amended by the Child Support (Miscellaneous Amendments) Regulations) (S.I. Number 1979 regulation 5, effective from 1 August 2007 reads

7[(1A). In this paragraph and paragraph 8 a person’s "gross earnings" are his taxable profits calculated in accordance with part 2 of the Income Tax (Trading and Other Income) Act 2005

24. The decision maker, and thereafter the tribunal, used the method of calculating for self-employed earnings set out in paragraph 8, namely gross receipts less deductions. I will deal with the father’s criticism as to the employment of that provision. 
25. The initial assessment had been made without reference to the father’s loss-making new business. The decision under appeal required the application of paragraph 8, because the alternative provisions under paragraph 7 can only apply where the business or businesses in question have accounts which cover the position over a period of more that 24 months. Paragraph 8 applies where the conditions set out in paragraph 7 (6) are not satisfied. Those conditions are that “the net weekly income of the self-employed earner may only be determined in accordance with this paragraph where the earnings concerned relate to a period which terminated not more than 24 months prior to the relevant week..”  Here, the new business T had accounts for a few months only which demanded the use of paragraph 8;
26. In the light of that I discuss details of the actual calculation which was correctly assessed under that paragraph. 
27. Paragraph 8 used to specifically provide, (at (b) (vii)) that deductible expenses did not include "any loss incurred in any other employment in which he is engaged as a self employed earner". That provision was not continued by the Child Support (Miscellaneous Amendments) Regulations) which came into force on 1 August 2007.
28. The effect of that omission and those 2 provisions is the main arguable issue in the case.

The error of law

29. The judge said in her decision at paragraph 10 that “paragraph 7 (1A) of the Schedule to the Child Support (Maintenance Calculations and Special Cases) Regulations 2000 provides that a person’s “gross earnings” are his taxable profits calculated in accordance with Part 2 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005). The ITTOIA 2005 is a very long Act with no less than 19 Chapters and 257 clauses and covers many areas but it does not cover losses. Losses are dealt with in the Income Tax Act 2007.”
30. I find that the judge fell into error in that comment.  Section 26 of Part 2 of ITTOIA 2005 provides that losses are to be calculated in the same way as profits;

(i)            the same rules apply to income tax purposes in calculating losses of the trade as applying calculating profits.

(ii)          This is subject to an express provision to the contrary.

31. In my view if one business has a profit, and another a loss, the two must be added together to show the “gross profits” for child support purposes. It should be noted that this is not “gross” for income tax purposes, as it is net of deductible expenses. 
32. I therefore accept the arguments put forward that the losses are deductible from the profits which arose in the same tax year.

The loan

33. As to the loan, the Secretary of State refers to paragraph 8 (2) which deals with deductions to be taken from the gross receipts to calculate net earnings for the purposes of that paragraph, of which subparagraph (a) is the only part of potential relevance in relation to this issue. It reads:

(a) Any expenses which are reasonably incurred and are wholly and exclusively defrayed for the purposes of the earners business in the period by reference to which his earnings are determined under paragraph 9 (2) or (3).

34. Paragraph 8 (3) (a) goes further, setting out specific items which are to be included or which cannot be deducted under paragraph 8 (2) (a).  Of potential relevance as to matters included is

(iii) any payment of interest on a loan taken out for the purposes of the business;

35. Paragraph8 (3) (b) (ii) clarifies that no capital expenditure can be deducted.
36.  It is these provisions that constitute the basis of the Secretary of State’s argument that the loan interest can be deductible, but not the capital.
37. There is case law concerning what constitutes a loan taken out for the purposes of the business in the earlier legislative provisions that applied under the ‘old rules’ that is to say the initial child support scheme: CCS 15949/1996 This is the case to which I made reference in my original ruling that this was a matter upon which I did not grant permission to appeal. As I have indicated I later took the view that the matter should be argued.
38. The Child Support (Maintenance Assessment and Special Cases) Regulations 1992, schedule 1 paragraphs 3 (3) (a) and (4) (iii) which governed the old rules that were under consideration in that case are mirror provisions to those now under consideration by me. 
39. Mr Commissioner Howell (as he then was) discussed in that case what he termed “Loan number one”

Under which the father had at 31 December 1993 a liability of £62,982: this was a liability he took on at the time he joined the partnership to finance the amount credited to him in the partnership account as his contribution to the capitals (sic).  So far as he was concerned this liability was incurred in order to provide money to buy himself into the partnership,

at paragraph 5 the learned Commissioner found that

Even if the aggregate liability on the number one account was derived from borrowings originally used by the partners’ at the time to purchase fixed assets,

(a reference to the provision under (4) (a) (i), including as a deductible expense the repayment of capital on a loan used to the replacement, in the course of business, equipment or machinery, or the repair of an existing business asset)

….the reality so far as the father was concerned was that his assumption of the liability was to buy himself into a share of the partnership capital rather than for an expense incurred by him in the course of carrying the business on.  It does not seem to me that this expenditure or the related interests satisfies the test in para 3(3)(a) of the Schedule that it was an expense reasonably incurred and wholly and exclusively defrayed for the purposes of the earner’s business in the period by reference to which his earnings are to be determined, and nor so far as he was concerned was the interest “any payment of interest on a loan taken out for the purposes of the business” so as to bring it within the special inclusion in para 3(4)(a)(iii). 

40. I reiterate that the wording that he had to consider is identical to that which now appears in paragraph 8 (2) (a) and (3) (a) (iii). The amendments which I discuss above in relation to the main issue do not affect this matter, and paragraph 7 (1A), (which I have set out above) imports part 2 of ITTOIA only, which does not deal with interest. 
41. In considering the test in paragraph 8 (2) (a) as to expenses reasonably incurred and wholly and exclusively defrayed for the purposes of the business during the relevant period, and the amplification of that subparagraph by paragraph 8 (3) (a) (iii) to include payment of interest on a loan taken out for the purposes of the business,  I must construe those provisions as they relate to the factual circumstances surrounding the father’s loan, which seems to me to be virtually identical to loan number one in CCS 15949/1996.
42. I adopt the reasoning set out in CCS 15949/1996; accordingly I disagree with the submissions of the father and those of the Secretary of State in relation to the treatment of interest on the loan taken out by the father in order to purchase his interest or equity in the partnership LM. 

What is the effective date?

43. I said in granting permission to appeal that if the submissions of the father were correct in relation to the set off issue, the effective date needed to be considered. No specific submissions have been made to me on this point, but it is straightforward.  
44. Under section 17 of the Child Support Act 1991 the effective date of a supersession will be the beginning of the maintenance period in which the application (or notification) was made.  This is the correct effective date in this case, because, although my decision is that there has been an error of law, the set off point was not under consideration by the Secretary of State prior to that supersession application; the Secretary of State became aware that the father had another business which may fall to be considered in connection with his assessment of income only upon his application for supersession which was 13 July 2011.   The usual rule under s 17 therefore applies.
45. The Secretary of State will need to revisit the maintenance calculation upon the basis that any losses from the father’s business T which accrued in the tax year for which the profits from LM LLP have been used for child support maintenance calculation purposes are deductible in coming to the figure for his gross earnings for child support purposes. 
46. I have made provision in my decision as to the appropriate route for any arithmetical challenge to that calculation.

(Signed on the original)  

Upper Tribunal Judge Gray

16 June 2014