Supreme Court decision in Tower MCashback

The Supreme Court's eagerly awaited decision in Tower MCashback has now been released (the importance of the case is reflected in the fact that it was considered by seven Supreme Court Justices).

The case concerns the tax consequences of an arrangement utilised by MCashback Limited ('MCashback') to raise finance to enable it to 'roll-out' M Rewards, a software package which it had developed and which enabled manufacturers to promote products to customers by offering free mobile phone airtime.  On the advice of Tower Group plc ('Tower'), it was decided to raise funds by selling rights to the software via software licence agreements ('SLAs'), to four Limited Liability Partnerships ('LLPs') to be set up as part of the financing arrangements.  The SLAs provided for the LLPs each to receive a proportion of the clearing fees which manufacturers would pay in respect of each transaction via the M Rewards system.  For the purposes of this litigation, Tower MCashback 2 LLP ('LLP 2') was a lead case for the other LLPs.  LLP 2 entered an SLA with MCashback, under which it was to pay £27.5m for a licence of part of the M Rewards system.  LLP 2 was entitled to 2.5% of the gross clearance fees received from exploitation of M Rewards.  LLP 2 obtained the funds required to pay the consideration under the SLA (and the associated professional fees) from investors, who became investor members of LLP 2.  They contributed 25% from their own funds and obtained the remaining 75% from bank borrowing on non-commercial terms.  Janus Holdings Limited ('Janus') lent the required sum to a special purpose vehicle set up by Tower, which made interest-free, non-recourse loans to the investor members.  MCashback was obliged to deposit approximately 82% of the consideration due to it in terms of the SLA as indirect security for the investor members' borrowing from Janus.  These sums were placed on a security deposit with R&D Investments Limited ('R&D'), which R&D in turn deposited with Janus as security for Janus' loan to the SPV.

LLP 2 claimed £27.5m first year capital allowances for the 2004/05 tax year, the amount of consideration set out in the SLA.  One of the conditions for entitlement to capital allowances is that a person 'incurs qualifying expenditure': section 11 Capital Allowances Act 2001 ('CAA 2001').  Expenditure is qualifying expenditure if, amongst other things, it is capital expenditure on the provision of plant or machinery, which includes software or rights to software. On 30 June 2005 HMRC issued a notice of enquiry into LLP 2's partnership return.  Attention initially focused on section 45(4) CAA 2001, which withholds first year allowances for expenditure on software rights in certain circumstances.  After a lengthy period of enquiry, during which correspondence was exchanged about the application of section 45(4), HMRC issued closure notices (under section 28B Taxes Management Act 1970) which stated that, 'as previously indicated … the claim for relief under section 45 CAA 2001 is excessive' and amended the partnership return so that the capital allowances claimed, and allowable loss, were 'nil'.

The LLPs appealed against the closure notices.  Before the Special Commissioner, HMRC abandoned the argument that the claims were disallowed by section 45(4) CAA and sought instead to argue that the full extent of the consideration under the SLA was not expenditure incurred on software.  The Special Commissioner decided the procedural point in favour of the HMRC, allowing them to advance this new argument, and, on the expenditure issue, disallowed 75% of LLP 2's claim. 

On appeal, the High Court allowed the LLPs' appeals on the procedural issue.  It would also have allowed the LLPs' appeals on the expenditure issue, had the point arisen for decision.  HMRC appealed to the Court of Appeal. The  Court of Appeal, by majority, reversed the High Court on the procedural issue (Arden LJ dissenting), but agreed with the High Court on the expenditure issue.  HMRC appealed against the determination of the expenditure issue and the LLPs cross-appealed against the determination of the procedural issue.

The Supreme Court considered two previous decisions of the House of Lords: Ensign Tankers (Leasing) Ltd v. Stokes [1992] 1 AC 655 and Barclays Mercantile Business Finance Ltd v. Mawson [2004] UKHL 51.  Both remain good law.  In the court's view it is not enough for HMRC, in attacking a tax structure of this sort, simply to point to money going round in a circle.  Nor, however, is it the law, as the judge had held, that unless one finds the transaction in this case to be a sham, the only possible conclusion is that the whole of the consideration in the SLA was expenditure incurred on the provision of software. In the context of a complex pre-ordained transaction, the court's task is to test the facts, realistically viewed, against the statutory test, purposively construed.  Entitlement to capital allowances requires there to have been real expenditure for the real purpose of acquiring plant or machinery for use in a trade.  Concerns about the valuation of what is being acquired and the commercial soundness of the transactions are relevant.  The fact that rights in the software had been transferred by MCashback to LLP 2 demonstrated the reality of some expenditure on acquiring those rights, but did not conclusively show that the whole of the consideration in the SLA was expenditure for that purpose.  The Special Commissioner found that the market value of the software was 'very materially below' £27.5m.  He had also found that there was little chance that the members' loan would be repaid in full within ten years – as much as 60% might be unpaid, and waived, at the end of that period.  These findings justified the conclusion that the money which the investor members borrowed was not used, in any meaningful sense, as expenditure in the acquisition of software rights.  Instead, it went in a loop back to the lender in order to enable the LLPs to indulge in a tax avoidance arrangement.

This case is significant and welcome in that it upholds the previous and important decisions of the House of Lords in Barclays Mercantile and Ensign Tankers.  However, it does place the spotlight firmly on the commercial drivers for a transaction and shows that issues of valuation and commerciality will be key to a successful defence of tax mitigation arrangements.