Corporation Tax S13a Income and Corporation Taxes Act 1988 Meaning of Purpose Appeal Dimissed
[2011] UKFTT 395 (TC)
TC01250
Appeal number: TC/10/09198
Corporation Tax – s13A Income and Corporation Taxes Act 1988 – meaning of “purpose” – Appeal dimissed.
FIRST-TIER TRIBUNAL
REDDLEMAN PROPERTIES LTDAppellants
- and -
THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMSRespondents
TRIBUNAL JUDGE:John M Barton, WS
Sitting in public at Wick Sheriff Court on 3 June 2011
Stuart Walker, Director, for the Appellants,
Mrs Pauline Carney, for the Respondents
© CROWN COPYRIGHT 2011
1
DECISION
1. The Appellants (“RPL”) appealed against a Closure Notice and Amendment to its Corporation Tax Return for the year to 31 December 2008. The effect of the Amendment had been to charge RPL’s profits at the full rate of Corporation Tax on the basis that RPL was a Close Investment Holding Company (“CICH”), thereby increasing the liability to tax from £18,852.62 to £25,889.76. Having considered the circumstances in full, the Tribunal dismisses the appeal.
2. The Notice of Appeal had been lodged on behalf of RPL on 20 September 2010. A Statement of Case was lodged by HMRC, and the Appeal was set down for Hearing at Wick on 3 June 2011.
3. HMRC lodged with the Tribunal a bundle incorporating inter alia all the documents on which each party intended to rely.
4. The documents in the bundle were as follows:-
(1) the Closure Notice dated 7 September 2010
(2) Notice of Appeal dated 20 September 2010
(3) RPL’s Tax Return for year to 31 December 2008
(4) RPL’s Accounts for years to 31 December 2003 – 2010
(5) Summary of RPL’s letting income
(6) HMRC Statement of Case
(7) Correspondence between RPL and HMRC
(8) Particulars and Statement re purchase of property in Inverness
(9) Extracts of relevant legislation
(10) Report – Cook v Medway Housing Society Ltd 69 TC 319
(11) Report – Herts Photographic Bureau Ltd v HMRC [2010] UKFTT 629 (TC)
(12) Extracts from Oxford Dictionaries and Chambers 21st Century Dictionary
(13) HMRC Guidance Manuals
5. In the course of the Hearing, Mr Walker also produced:
(A) RPL projected 2011 gross rental income
(B) RPL company assets at 1 January 2008
6. Mr Walker and Mrs Carney addressed the Tribunal. In the course of Mr Walker’s submissions, he provided certain evidence (which was not in dispute) but he was not cross-examined by Mrs Carney. Mrs Carney did not lead any evidence for HMRC.
Material Facts
7. The material facts, which were not in dispute, were as follows:-
(1) RPL was incorporated in August 2000. The Directors are Mr Walker and his wife, and between them, they own the whole share capital of the company.
(2) In December 2000, RPL purchased its first commercial property at 15 Princes Street, Thurso. This property comprised two townhouses. The ground floor of one of the townhouses and the whole of the upper floor of the property was let to the firm of Reid & Fraser, of which Mr Walker was a partner. The other partner was a Mr Grant.
(3) Two shops occupied the ground floor of the other townhouse at 15 Princes Street. One of the shops has been continuously let to a hairdressing business. The other shop was also let.
(4) In May 2002 RPL purchased a second commercial property, at 92 High Street, Wick. This property was let in its entirety to the firm of Reid & Fraser.
(5) In June 2003 the company purchased a third commercial property, in John o’Groats. This property was a tourist information centre and was let to Visit Scotland.
(6) Over the period from 2001 to 2003, RPL made an unsuccessful bid for an industrial unit at Wick Airport and two unsuccessful offers to buy holiday letting cottages in Caithness. In November 2003 RPL also made an unsuccessful attempt to purchase a house in the Black Isle which was to have been used for furnished holiday letting.
(7) In May 2004 firm of Reid & Fraser incorporated its trade into a limited company under the name of Reid & Fraser Ltd. Throughout, Reid & Fraser Ltd has been owned by Mr Walker and his wife. Mr Grant did not take any financial interest in the new company and he retired from the business shortly after its incorporation.
(8) The tenancy of the offices at 15 Princes Street, Thurso and 92 High Street, Wick passed to Reid & Fraser Ltd on the incorporation of that company.
(9) In 2005, the tenant vacated the other shop at 15 Princes Street, and from then until 2011 the shop was occupied rent free by an unconnected party, who runs a Christian bookshop on a not-for-profit basis. The notional annual income of this shop would have been about £4,500 to £5,000.
(10) There were no further property transactions in the period from 2004 to 2007. Over the period from around 2005 to 2008 the Directors of RPL used the rental income to reduce the company’s debt; and funds in the company began to accumulate from around 2008.
(11) In January 2008, RPL had a monthly equivalent rent of £1,800 from each of the two offices occupied by Reid & Fraser Ltd, £425 from the hairdresser’s shop and £517 from the tourist information centre.
(12) In February 2008, RPL sold the tourist information centre following an approach from the sub-tenant.
(13) During the years 2005 to 2010, the directors of RPL viewed several residential properties in Inverness but did not put in any offer as they considered that the market conditions were not right. In 2009 and the early part of 2010 the directors looked at 3 or 4 small commercial properties in Edinburgh but did not make any offer as the rental yield was below expectation.
(14) In June 2010 RPL bought a new-build residential apartment at 9 Castlefield Apartments in Inverness; and in March 2011 RPL purchased a commercial property at 46 Church Street, Inverness. Until this most recent purchase, the rent received from Reid & Fraser Ltd represented more than 50% of the rental income of RPL.
Legislation
8. The relevant provisions of the Income and Corporation Taxes Act 1988 (“ICTA”) are as follows –
13 Small companies' relief
(1) Where in any accounting period the profits of a company which (a)is resident in the United Kingdom, and
(b)is not a close investment-holding company (as defined in section 13A) at the end of that period,
do not exceed the lower relevant maximum amount, the company may claim that the corporation tax charged on its basic profits for that period shall be calculated as if the rate of corporation tax (instead of being the rate fixed for companies generally) were such lower rate (to be known as the "small companies' rate") as Parliament may from time to time determine.
…………………………………………
13A Close investment-holding companies
(1) A close company is for the purposes of section 13(1) a "close investment-holding company" unless it complies with subsection (2) below.
(2) A company ("the relevant company") complies with this subsection in any accounting period if throughout that period it exists wholly or mainly for any one or more of the following purposes -
(a) the purpose of carrying on a trade or trades on a commercial basis,
(b) the purpose of making investments in land or estates or interests in land in cases where the land is, or is intended to be, let to persons other than
(i) any person connected with the relevant company, or
(ii) any person who is the spouse or civil partner of an individual connected with the relevant company, or is a relative, or the spouse or civil partner of a relative, of such an individual or of the spouse or civil partner of such an individual,
(c) the purpose of holding shares in and securities of, or making loans to, one or more companies each of which is a qualifying company or a company which,
(i) is under the control of the relevant company or of a company which has control of the relevant company, and
(ii) itself exists wholly or mainly for the purpose of holding shares in or securities of, or making loans to, one or more qualifying companies,
(d) the purpose of co-ordinating the administration of two or more qualifying companies,
(e) the purpose of a trade or trades carried on on a commercial basis by one or more qualifying companies or by a company which has control of the relevant company, and
(f) the purpose of the making, by one or more qualifying companies or by a company which has control of the relevant company, of investments as mentioned in paragraph (b) above.
(3) ......
(4) …………………..
(5) In this section
"control" shall be construed in accordance with section 416, and
"relative" has the meaning given by section 839(8).
(6) Section 839 shall apply for the purposes of this section.
Submissions
9. Mr Walker submitted that RPL was not a CIHC as defined in s13A of the ICTA 1988 and in view of the level of profits for the year, was entitled to apply the small company rate of tax to its profits in the corporation tax period ended 31 December 2008. He referred specifically to ss(2)(b) of s13A which states that a company is not a close investment holding company if "in any accounting period...throughout that period...it exists wholly or mainly for the purpose of making investments in land...where the land is, or is intended to be, let to persons other than any person connected with the relevant company". Mr Walker maintained that the “purpose” of RPL for the year of enquiry was to make investments in land for letting to unconnected persons.
10. Mr Walker invited the Tribunal to give the word “purpose” its ordinary meaning, pointing out that the Oxford Dictionary's primary definition of the word is: "the reason for which something is done or created or for which something exists", and that Chambers Dictionary defines the word as: "the object or aim in doing something", "the function for which something is intended", "the intentions, aspirations, aim or goal", "determination; resolve". He added that as a company has no real existence or intelligence in its own right; it is the directors who determine why the company was created and why it continues to exist; and on this basis, he considered that he was the best person to explain what he and his wife had been trying to do with the company. In the case of RPL, Mr Walker and his wife, as the directors, had intended, aimed and aspired towards the company letting property to unconnected persons, and that this aspiration, or purpose, had been the same for every single accounting period.
11. Mr Walker referred to HMRC's internal guidance contained in CTM60720 which states:
In each case, it is a question of determining the relevant company's purpose of existence, which is not necessarily the same as its current activities. Thus a company may exists (sic) for the purpose of carrying on a trade, even though in a particular accounting period it does not receive any trading income, or, indeed, actually carry on a trade. This would be exceptional. It will be a matter of fact whether or not it exists for a particular purpose, and what a company actually does will be a significant indicator of its purpose, but it must exist for that purpose throughout the relevant accounting period.
12. Mr Walker considered that RPL had been working towards achieving the purpose of having mainly unconnected persons as tenants. He claimed that this purpose had been achieved in the first few years of the company, from 2000–2004; and that the achievement of this purpose only stopped because of the change in the tenant partnership. During the year of enquiry, RPL’s purpose continued to be to make investments in land for unconnected persons letting, and that this purpose was achieved during 2010 and 2011.
13. He explained that during the period of 2005-2007 there was an unsustainable boom in property prices suggesting that it was a very reckless time to borrow to fund property purchases. He also referred to the global banking crisis of 2008 and 2009 and the associated property slump. Interest rates were historically low and this had prevented general property prices from failing quickly. Nevertheless, RPL was able to find two investment properties without taking on any borrowing. Under different economic circumstances RPL would have achieved its purpose more quickly.
14. Mr Walker referred to the case of Herts Photographic Bureau Ltd v HMRC. In that case, the company had sold its only property and in the decision, it was observed:
After careful consideration, we accept Mr Giffen's evidence that he intended to reinvest the proceeds of sale of the Property in acquiring residential properties as a rental investment throughout the accounting period ended 31 May 2008. We accept that the impact of the financial crisis, which began to make itself manifest in the late Summer and early Autumn of 2007 and which continued throughout 2008, led him to hesitate from procuring further rental properties but that it was still his intention to do so.
15. Mr Walker submitted that in a case like the present, where the rental income in the year of enquiry is not mainly from unconnected letting it is essential to look at what the company was doing before the year of enquiry and after to see whether this supports what the directors say they were trying to do with the company. In support of this contention, Mr Walker referred to the case of Cook v Medway Housing Society Ltd and in particular at p332 where Mr Justice Lightman observed:
In determining what is the business of a company for the purposes of s130 (ICTA 1988), it is necessary to have regard to the quality, purpose and nature of the company and its activities…………It is relevant to have regard to the actual activities carried on by the taxpayer at the relevant date, but if these are viewed without regard to the taxpayer's past history or future plans they may give only a partial and incomplete picture.
16. In support of his argument about the activities of later periods, Mr Walker referred to the analysis of projected rental income for 2011 which he had prepared in advance of the Hearing – showing that RPL’s projected unconnected letting income was forecast to be 53% of total rental income, thereby supporting his claim that the purpose of RPL in the year of enquiry was to have mainly third party investments.
17. In Mr Walker’s opinion, HMRC did not give sufficient weight to the words `making investments' in s13 of the Act. He submitted that the phrase has an element of looking to the future in its definition and understanding, and that a significant part of making investments must be the identification of suitable opportunities. The process involves making decisions when and when not to invest in property; it is not simply the case that the purpose of a property investor should be to buy in any market and at any price in order to show they had that purpose.
18. Mr Walker also suggested that HMRC had taken too narrow a view when trying to measure the actual activities of RPL in that they were apparently concerned only with rental income and did not appear to have followed their own internal guidance contained in CTM60730 namely:
Where, for example, a company has substantial income from sources other than (or as well as) trading or property investment, its purpose may not be clear-cut. There will also be cases where the amount and source of income is inconclusive as a test of purpose. In such cases, a common sense approach is needed, and a review of all the facts should enable you to make a decision.
19. Mr Walker submitted that the capital asset value of RPL’s properties should have been taken into account by HMRC in recognition of the fact that assets can be held not just for the income they produce each year; but also for other reasons, for example, prospective capital gains and a hedge against inflation. In support of this contention, Mr Walker referred to an analysis which detailed the estimated net asset values of the various investment properties owned by RPL at the start of the year of enquiry. This analysis demonstrated that at the start and the end of the year, at least 50% of RPL’s total asset value was held for letting to unconnected persons.
20. Mr Walker added that a further reason for not looking at rental income on its own is that in this case of connected landlord and tenant relationship it would have been quite easy for the directors to have reduced the rental income below 50% of total income. They did not do this and have instead always charged the same rent income throughout the tenancy.
21. Mr Walker concluded with a request that RPL’s anonymity be protected in the event of the decision in this case being published. His main reason for this request was that he had given a very open and full disclosure of the history of the financial transactions of RPL and he was apprehensive that the publication of the financial information which might be contained in the decision could be prejudicial to his accountancy firm of Reid & Fraser Ltd. Indeed if there were to have been such publicity, he might have reconsidered taking this case to appeal.
22. On behalf of HMRC, Mrs Carney pointed out that s 13A(1) ICTA 1988 provides that a close company is for the purposes of s13(1) a CIHC unless it complies with the requirements of ss(2); and that s13A(2) provides that a company complies with this subsection in any accounting period if throughout that period it exists wholly or mainly for any one or more of prescribed purposes. In the present case, the critical period was the year to 31 December 2008.
23. Mrs Carney emphasised that s13A(2) applies to "any accounting period…….. throughout that period", and therefore the “purpose” test applies to each accounting period in isolation, and is applied to the whole of each such period. She also observed that the company must exist "wholly or mainly……."; that these words had to be given their normal meaning, and that this required any prescribed purpose to have more than 50% of the company's activities.