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Tax case – whether a partnership is trading and is thus entitled to R&D allowances

Tax case – whether a partnership is trading

Court of Appeal judgment in the Brain Disorders Research Limited Partnership case – taxpayer loss.

Michael Everett - Director, Fixed Asset Tax Services

Director, Fixed Asset Tax Services

KPMG in the UK


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The Court of Appeal judgment has been handed down in the case of The Brain Disorders Research Limited Partnership and The Commissioners for HMRC which was heard on 26 July this year ([2018] EWCA Civ 2348). This judgment is very much in the spirit of recent decisions in cases such as Daarasp LLP and Betex LLP concerning software development. The decision followed principles followed in cases such as Icebreaker 1 LLP, in which the trading nature of payments by a partnership was denied because its primary reason for being was to generate tax shelters.

In Brain Disorders too, the partnership had as its partners, wealthy individuals hoping to shelter income using in this case research and development (R&D) allowances generated by the partnership.

The partnership did this by a largely circular and de-risked set of transactions, in which a small piece of actual R&D was conducted but a large sum was paid for this to an intermediary – just as in Daarasp. Specifically, the partnership paid £122 million to a Special Purpose Vehicle (SPV) under an agreement whereby the SPV was to perform medical research. The SPV paid a sub-contractor some £7 million to perform this research. The remainder of the £122 million was broadly passed back by the SPV to the partnership under a ‘fixed royalty agreement’. The partnership could also benefit from a variable royalty of a small portion of any real benefits obtained from the R&D, however the expectations from this variable royalty were limited when compared to the tax benefits. The Brain Disorders structure was re-engineered somewhat to preserve tax benefits post the FA 2007 changes to sideways loss relief, but the details of that do not have bearing on the key issues decided.

HMRC had argued that:

  • The arrangements were so odd and uncommercial as to constitute a ‘sham’;
  • Even if it was not a sham, only £7 million had really been incurred by the partnership – the Court called this the ‘quantum’ argument; and
  • In fact there was no qualifying expenditure anyway as the partnership was not trading.

By the time this case came to the Court of Appeal, the taxpayer had accepted HMRC’s ‘quantum’ argument, thus the amount at stake was reduced to allowances on some £7 million expenditure. However the taxpayer argued that findings that the arrangements were a sham had influenced the First-tier Tribunal (FTT)’s decision on the trading point. We surmise that the FTT view that the transaction was a sham, was felt by some to be a step too far.

The Court of Appeal focused on the question of whether the partnership was trading (regardless of the outcome of the sham point). It concluded that the partnership had no role or interest in the development of the research after making the initial ‘investment’ and that it was therefore not trading and could have no qualifying expenditure. On this basis no R&D allowances were available per section 439 CAA 2001.

The decision is no surprise and follows principles and trends in the last decade’s jurisprudence.

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KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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