The final chapter in this long running case was delivered on 11 May 2011.  As previously reported in the case preview , the questions for the Supreme Court were: (i) is the ambit of an appeal limited to the conclusions stated in a closure notice? (“the procedural issue”) and; (ii) whether expenditure on the acquisition of a right to use software, which was funded by loans from the owner of the software, could qualify under the Capital Allowances Act 2001, s 45 for a first year allowance (“the expenditure issue”).


MCashback Limited developed a software system.  Further finance was required to “roll-out” the system and so four LLPs were set up.  The LLPs entered into licence agreements with MCashback under which each acquired rights to use an element of the software.  25% of the consideration was funded by the investor members of the LLPs, and the 75% balance was funded by non-recourse loans provided indirectly by MCashback.  The first two LLPs claimed 100% first year allowances (“FYAs”) in respect of the expenditure on the software.

HMRC formed the view that the structure failed in its object of generating 100% FYAs under s 45(4), which disqualified expenditure from being first-year qualifying expenditure if the person potentially entitled to FYAs incurred the expenditure “with a view to granting another person a right to use or otherwise deal with” any of the software in question. After various exchanges of correspondence between the LLPs (and their advisers) and HMRC, the officer issued a closure notice in which he stated that, “as previously indicated“, his conclusion was that the claim under s.45 was excessive and that the return had been amended as follows: “Capital Allowances £nil; Allowable loss £nil“. In his covering letter to the LLPs’ advisers, the officer stated: “I am satisfied that [the structure] fails on the section 45(4) CAA 2001 point alone.” A few weeks before the Special Commissioner’s hearing, HMRC raised two new points (the “expenditure issue” and the “trading issue” (whether LLP1 had begun to trade on or before 5 April 2004)). During the hearing itself, HMRC abandoned its initial contention (s 45(4)), leaving only the new points (and a further point that was raised by the Special Commissioner on the third day of the hearing) as the subject matter of the appeal. The LLPs argued that the s 45(4) argument was the only issue that could be raised in the appeal. The Special Commissioner had no jurisdiction to hear legal arguments on the wider question as to whether the other requirements of s 45 had been satisfied, because then the appeal would no longer be an appeal against the conclusion stated in the closure notice.

The Special Commissioner rejected the LLPs’ arguments. He said that each closure notice denied the allowances under the section under which they were claimed (i.e. s.45) (it was only the covering letter that had referred to a particular sub-section) and he disallowed 75% of the expenditure.

In the High Court, Henderson J accepted the LLPs’ appeal on the procedural issue and said that he would have found in favour of the LLPs on the expenditure issue if that issue had arisen. The Court of Appeal (Arden LJ dissenting on the procedural issue only) reversed the High Court’s decision and held that the Special Commissioners had jurisdiction to hear any legal argument relevant to the subject matter of the conclusions stated in a closure notice. On the expenditure issue, the Court of Appeal agreed with Henderson J that FYAs should be available (LLP1 had conceded the trading issue).

The procedural issue

The Supreme Court upheld the Court of Appeal’s decision on the procedural issue. Both the High Court and Court of Appeal had undertaken a detailed analysis of the self-assessment provisions in order to answer this question. In contrast, the Supreme Court adopted a ‘broad-brush’ approach (by way of contrast, the Court of Appeal’s decision comprises 103 paragraphs, 68 of which pertain to the closure notice issue; only 17 paragraphs of the Supreme Court’s 94 paragraph decision concern the issue). The Supreme Court held that it preferred the approach of the Court of Appeal to that of Henderson J as regards the application of the principles (on which principles there was broad agreement). Lord Hope added the comment that, although the scope and subject matter of the appeal was defined by the conclusions in the closure notice, s.50, TMA meant that the tribunal was not tied to the precise wording of the closure notice when hearing the appeal.

The expenditure issue

The Supreme Court overturned the Court of Appeal’s decision on the expenditure issue.  It denied the LLPs’ claim in relation to 75% of the first year capital allowances and held that only 25% of the price paid by the LLP to the MCashback had been properly incurred on the acquisition of software.  This 25% proportion represented the amount funded out of the individual members’ own resources; the remaining 75% having been funded out of non-recourse loans to the members.

The most significant factor for the Court, which was referred to by both Lord Walker, giving the leading judgment, and Lord Hope concurring, appears to be that 75% of the funds paid by the LLP for the licence of software rights did not go to MCashback (even temporarily) but instead were immediately passed back by way of a chain of banks to the lender.  Consequently, MCashback received no immediate benefit from that element of the purchase price (it really being used in an attempt to quadruple the individual members’ capital allowances) on the basis that such funds were not at its disposal.  Hence, such funds had not been spent by the LLP on acquiring the software rights from MCashback.

Lord Walker acknowledged that it is not enough for HMRC when attacking a scheme to simply point to money going round in a circle suggesting that, instead, closer analysis of the facts is required.  He referred to the following factors as being relevant to the decision:

  • whilst the transfer of ownership in software rights indicated that some of the LLP’s expenditure had been incurred on acquiring such rights, it did not necessarily mean that the whole of the expenditure had been used for that purpose;
  • the fact that market value of the software was “very materially below” the amount the LLPs paid was not determinative, but the question of valuation was not “totally irrelevant” when a court is testing “the facts, realistically viewed, against the statutory text, purposively construed” in accordance with the Ramsay principle;
  • concerns over the commercial soundness of the transaction were relevant despite the original transaction having been negotiated between third parties on arm’s length terms.  The Court noted that the software rights were licensed “in bits” which Lord Walker commented was only a little less unreal than a syndicate owning undivided shares in a race horse partitioning the animal just before a race so that “one member takes the head and neck, and another the off-hind leg, and so on”); and
  • the terms of the individual members’ loan financing were also relevant and, in particular, the likelihood of such loans ever being repaid, although there was no suggestion that interest free, non-recourse loans were not loans.


Lord Walker concluded his judgment on the expenditure issue by confirming that the previous House of Lords decisions in this area (namely, Ensign Tankers and Barclays Mercantile) remain good law.  The Supreme Court’s decision in this case gives further guidance on the dividing line between Ensign Tanker and Barclays Mercantile. However, all three cases are particularly fact specific, so detailed consideration of the facts will be needed in every case. After the decision of the High Court had been released, HMRC adopted a defensive position in relation to the closing of enquiries. When forced to close enquiries, often this would be undertaken either by simply amending returns without providing any reasons or expressing the closure notices in such broad terms that the questions in issue were left completely open-ended.

As the Supreme Court has confirmed that tax tribunals are not limited by the precise wording of a closure notices when hearing an appeal, it will be harder for HMRC to contend that there are reasonable grounds for keeping the enquiry open, because the officer has not pursued to the end every line of enquiry or investigation. Accordingly, it should now be easier to obtain closure notices.

However, the decision of the Supreme Court does mean that there may be an element of uncertainty as to the ambit of an appeal to the tax tribunals. As the Supreme Court hinted at, this will need to be controlled by the tax tribunals. It is to be hoped that the tribunals will take note of the Supreme Court’s comments and be more active in their use of case management duties to prevent HMRC (or taxpayers) springing new arguments or evidence, like a conjurer producing a rabbit out of a hat, at or during the hearing of an appeal.