Altus Group (UK) Limited v Baker Tilly Tax and Advisory Services LLP (and Anor)
Chancery Division (HHJ Keyser, sitting as a Judge of the High Court)
7 January 2015
[2015] EWHC 12 (Ch)
Subject: Professional Negligence—Tax advisers—Tax mitigation structures—Allocation of losses to corporate members of limited liability partnership—Changes brought about by Corporation Tax Act 2009—Failure to advise on implications—Loss of a chance to implement alternative tax mitigation structure—Principles to be applied—Approach to assessment of loss of a chance in tax advice cases—Ramsay principle
Summary: In a tax advice claim involving the loss of a chance to mitigate or avoid a corporation tax liability, the Court was required to apply the second limb of Allied Maples v Simmons & Simmons so as to determine the prospects of a successful challenge by HMRC to the tax planning in question. Tax advice cases were not in their own special category and did not require a derogation from Allied Maples on SAAMCO or public policy grounds. However, the claims failed on primary causation as the Claimant would not have undertaken the restructuring necessary to obtain the benefits it claimed to have lost.
Abstract
The claimant (“Altus”) was a corporate member of Altus UK LLP (“the Existing LLP”). The Existing LLP was incorporated on 24 September 2007 as the corporate structure by which its Canadian parent company (“AGL”) acquired the business of a firm called Edwin Hill.
The acquisition of Edwin Hill gave rise to an asset in the Existing LLP’s accounts in respect of the goodwill of that business; the total cost of the goodwill was approximately £26.5 million. In late 2007 it was decided that the goodwill would be amortised over a five-year period concluding at the end of the third quarter of 2012. This resulted in amortisation of goodwill at the rate of approximately £5 million per annum.
An LLP which carries on a trade is not itself liable to tax. Rather, its profits and loss arise to its members, who are then subject to taxation. Individual members are subject to the income tax regime. Corporate members are subject to the corporation tax regime. For the purposes of corporation tax, the amortisation of goodwill is an allowable deduction against profits. In contrast, such amortisation is not an allowable deduction for the purposes of personal income tax.
In addition, the allocation of losses to an individual (personal) member of an LLP was at all material times controlled by a mechanism in section 850 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”). Until 2009, and again in contrast, it appeared that there was no equivalent controlling mechanism in the case of corporate members of an LLP.
By an Engagement Letter dated 7 January 2008, the defendant (“Tilly”) was engaged to prepare Altus’s corporation tax returns. In February 2008 Altus and Tilly agreed that the returns would be prepared on the basis that the two corporate members of the Existing LLP would be allocated 100% of the deduction for the amortisation of goodwill. In practice, this inevitably resulted in Altus incurring a loss, which it could then carry forward to set aside its liabilities for corporation tax in future years.
The returns were prepared in this manner. However, on 1 April 2009 the Corporation Tax Act 2009 (“the Act”) came into force for accounting periods ending on or after that day. The effect of sections 1263 and 1264 of the Act was that it became impermissible for Altus to be allocated a loss from the Existing LLP for corporation tax periods from the period ending 31 December 2009 onwards.
Tilly did not provide advice to Altus about the implications of these legislative changes until November 2011. By that point, the corporation tax returns for 2009, 2010 and 2011 had been prepared on the previously agreed basis, allocating losses to Altus so as to mitigate the amount of tax payable.
In November 2011, Tilly did inform Altus of Act and its consequences for the corporation tax returns which Altus had filed for 2009, 2010 and 2011. At that time, Altus consulted Ernst & Young (“EY”). EY had undertaken the tax planning work in connection with the original acquisition of Edwin Hill. EY agreed with Tilly’s advice about the effect of the changes under the Act, and confirmed that Altus would need to de-recognise losses of £3,299,000.
At the same time, EY suggested it may have restructuring proposals which Altus could implement “to facilitate the tax efficient allocation of profit and losses arising to the corporate and individual members of Altus UK LLP“—in other words, proposals to seek to circumvent section 1263 and 1264 of the Act. This was referred to as “the New LLP Proposal”. A key hallmark of the structure was that a new UK would be created (“the New LLP”).
Altus consulted Tilly about the New LLP Proposal in January 2012. Tilly were sceptical, considering that the New LLP might look “somewhat artificial” and be vulnerable to challenge by HMRC. Altus relayed Tilly’s concerns to EY, but EY felt the issues could be overcome. EY advised that it was hard to see how HMRC could establish that the New LLP Proposal was unlawful.
Altus discussed the merits and demerits of the New LLP Proposal internally. The Director of Finance, Ms Webster, was concerned that “HMRC may see this as a tax avoidance scheme and as such will seek to unravel it”. However, EY stood firm to their advice that the structure was lawful. On 3 February 2012 the New LLP was incorporated.
However, there remained an internal divergence of views among senior Altus personnel about whether to proceed with the restructuring. The individual members of the Existing LLP then received independent legal advice, which recommended that they should seek a full indemnity from AGL, the parent company. AGL was only prepared to offer them a limited indemnity.
Amid these issues, and amid other persistent concerns that the implementation of the restructure was impractical, Altus ultimately chose not to proceed any further with the New LLP Proposal in 2012.
Altus later sued Tilly for breach of retainer and negligence. It argued that if it had been properly advised in 2009, Altus would within about four months have implemented a restructuring materially similar to the New LLP Proposal, and that there would have been a substantial chance that the restructuring would have been successful in mitigating its corporation tax liabilities from 2009 onwards. Altus claimed damages for the loss of that chance.
Tilly admitted that it was in breach of duty in failing to advise Altus about the Act in July 2009, when it was preparing Altus’s corporation tax computation for the six-month period to 30 June 2009. (Altus alleged, and proved at trial, that the relevant advice should in fact have been given sooner, namely in January 2009, prior to the coming into force of the Act).
However the key questions were of causation: Tilly argued that Altus would not have implemented the restructuring proposal as a result of timely advice; that, if it had done so, the restructuring would have taken approximately eight or nine months rather than four months to implement; that as a matter of law the restructuring would not have been effective to mitigate Altus’s tax liabilities and that therefore damages for the loss of the opportunity to mitigate those liabilities were irrecoverable in principle; and that if, in fact, damages for the lost opportunity were recoverable in principle, they were either small or illusory because of the strong likelihood that HMRC would successfully have challenged the restructuring.
These issues engaged the well-known principles set out in Allied Maples Group Ltd v Simmons & Simmons [1995] 1 W.L.R. 1602. On the conventional application of that case, the court would first need to decide on the balance of probabilities whether Altus would have implemented the New LLP Proposal (or something like it) in 2009. If Altus would have done so, the court would then need to assess the chances that the restructuring would have been successful in mitigating the amount of tax paid by Altus—in other words, to assess the chances that HMRC would not have made a successful challenge to the restructuring.
Interestingly, Tilly sought to argue for a different approach to that second limb of the enquiry.
Tilly contended that the second question should be whether the restructuring would on the balance of probabilities have had the desired tax effect as a matter of law. It was incorrect, Tilly argued, to assess the chances that HMRC might have chosen not to challenge it or that the Upper Tribunal might have rejected the legal challenges to it; rather, the court should itself rule on the legal question of the efficacy of the New LLP Proposal. If the proposal were held to be ineffective as a matter of law, no damages should be recoverable, even if there might (in practical terms) have been a significant chance of the New LLP Proposal succeeding.
Tilly deployed a number of arguments in support of this approach. It argued that if the New LLP Proposal was ineffective in law, there was no legally recognised loss for Altus to pursue. It relied on a SAAMCO scope of duty argument to the effect that no tax adviser could owe a duty to a client save a tax that was, in fact, lawfully payable. It argued that it would be contrary to public policy to award damages in respect of the chance to avoid tax that was lawfully due, and it would be unreasonable for such damages to be awarded (applying Voaden v Champion [2002] EWCA Civ 89). Tilly also relied on Harrison v Bloom Camillin [2001] PNLR 195 (per Neuberger J) for the proposition that the court should be “far more ready to determine that the claimant would have failed or succeeded on a point of law than to determine that the claimant would have failed or succeeded on a point of fact”.
The Judge rejected these arguments. He held that the benefit Altus might have gained from implementing the New LLP Proposal depended on the prospects of it being successfully challenged by HMRC. If the scheme had not been successfully challenged, Altus would as a matter of fact have paid less tax. The Judge felt that the resulting financial loss was no less real than, for example, the loss resulting from the lost opportunity to negotiate a more advantageous settlement of a dispute. The proper approach was therefore the conventional loss of a chance enquiry.
At paragraph [61], His Honour Judge Keyser stated:
“61 The fact that one of the contingencies on which the outcome was dependent was a judicial decision by the First-tier Tribunal or Upper Tribunal would not by itself preclude the “loss of a chance” approach. The usual principle is that, where the chance in question relates to the outcome of curial proceedings, it is inappropriate to try those proceedings as a trial within a trial: Dixon v Clement Jones Solicitors [2004] EWCA Civ 1005, [2005] PNLR 6 , per Rix LJ at [27]. Of course, if the law on a point is clear, it will be inappropriate to proceed on the assumption that the court or tribunal would have got it wrong. But that does not mean that the court trying the professional negligence claim is bound to resolve disputed points of tax law.”
He concluded that Tilly’s alternative approach would involve a trial within a trial, namely the litigation of an HMRC challenge that was never actually brought. HMRC would not be involved in that process and it would be conducted on a wholly hypothetical basis. The Judge considered there was an “obvious potential for difficulty more widely” if the Court were called upon to make rulings on tax law on the basis of hypothetical facts.
The SAAMCO argument was rejected: the adviser’s relevant duty to its client was to adopt any filing position that was properly arguable and was in the client’s best interests, while at the same time making full disclosure of any matter that would be necessary for HMRC to understand and appraise the filing position. There was also no offence to public policy in such a duty, and it would therefore be inconsistent to hold that no damages could be recovered for a breach of such a duty on public policy grounds.
Despite rejecting Tilly’s arguments of principle, and despite finding Tilly in breach of duty over and above its admissions, the judge dismissed Altus’s claims. The case failed at the first limb of the factual causation test. On the detailed evidence, Altus failed to prove on the balance of probabilities that it would have taken the course of action upon which it relied, namely that it would have implemented the New LLP Proposal (or a similar scheme) in or around early 2009 if it had been otherwise advised.
The judge went on to make detailed obiter findings on the second limb of the causal enquiry. The central issue was to assess the chances of the notional restructure having been effective. This meant looking at the prospects of HMRC challenging the scheme, and the bases upon which that might have been attempted. The judge therefore had to consider the parameters of the New LLP Proposal in the context of the Act and other applicable anti-avoidance case law.
He first considered challenges based upon the decision in W. T. Ramsay Ltd. v. Inland Revenue Commissioners, Eilbeck (Inspector of Taxes) v. Rawling [1982] A.C. 300 – the so called Ramsay principle. He concluded that a Ramsay challenge to s.1263 would have had no merit because the New LLP Proposal, properly understood, simply did not engage section 1263 at all. He also dismissed an argument that HMRC could have based a legitimate challenge to the New LLP Proposal on Heastie v Veitch & Co [1934] 1 KB 535, which deals with monies paid by a partnership to a partner otherwise than in his/her capacity as a partner; and he dismissed certain other subsidiary bases of challenge (including a transfer pricing objection on the basis of a deemed disposal of goodwill).
However, a Ramsay challenge based on section 54 of the Act would have been more problematic for Altus. Section 54 prohibits the deduction, from the calculation of a corporation’s profits, of expenses that are “not incurred wholly and exclusively for the purpose of the trade”, and of losses which are “not connected with or arising out of the trade.” Although expenditure does not fail the “wholly and exclusively” test simply because the corporation arranges its business so as to involve deductible expenditure, and although there is no general rule that an otherwise permissible deduction would fail the test if the corporation had traded “deliberately and for fiscal motives” in such a way as to generate the deductions, nonetheless the judge considered that HMRC would have challenged the New LLP Proposal on this ground. The restructure had, arguably, no commercial purpose for the Existing LLP and was simply a method of creating a fiscal advantage for Altus.
The judge held there was a 60% chance that HMRC would have brought such a challenge. The challenge would have enjoyed a 50% chance of success, which meant that ultimately, there was a 30% chance of the New LLP Proposal failing on the grounds of a section 54 challenge.
Finally, the judge concluded that if HMRC had brought a challenge based on section 54, there was a 40% chance that it would have included a transfer-pricing challenge, and a challenge to Altus’s original filing position. Either of these additional arguments would have had a 33% chance of success. Accordingly, there was a 7.2% chance of Altus’s tax benefits from its original filing position being set aside.
Comment
Tilly’s contention that the second limb of Allied Maples should not apply amounted to an argument that the assessment of lost chance damages should be approached differently in tax advice cases, where a potential variable was a challenge by HMRC to the tax planning in question.
The judge rejected this approach for a number of reasons. But the sense is that his fundamental concern was to avoid the court making findings about tax legislation in circumstances where HMRC was not represented, and where the findings would be predicated on hypothetical facts.
Tilly’s argument highlighted a consistent interplay between two rival pronouncements in the surrounding case law on loss of a chance. Clement Jones confirms the established injunction against the Court conducting a ‘mini-trial within a trial’. On the other hand, Bloom Camillin advocates a greater readiness to make a black and white decisions on points of law (as distinct from contested facts or matters of opinion).
The learned judge interpreted Bloom Camillin as meaning that, in a tax advice case, the correct approach “…will generally be to assess the chance of the scheme succeeding or failing upon a challenge, although there may be cases where it is appropriate to determine the legal point.” He gave no guidance on what might constitute an appropriate case.
One then considers the approach the judge actually took on the facts. Although not conducting a ‘mini trial’, he proceeded to assess in considerable detail the arguments which would have been fought out upon a variety of potential challenges by HMRC. Indeed, he also determined in absolute terms that a number of the possible challenges would simply have had no merit at all.
It therefore seems that tax advice cases do not stand apart from Allied Maples in their own special category. But once the second limb enquiry is on foot, the dividing line between what the Court will and will not definitively resolve may lie in whether the point would ever have come before the notional arbiter of the tax challenge:
- In concluding that certain of the potential challenges by HMRC would have had no merit, the judge was apparently comfortable making findings that HMRC would not have run those points, and that no deduction to damages should be made for the chance that it might have done so.
- In contrast, for those points which might properly have been argued by HMRC before a tribunal, the Court would not decide as a certain fact what that arbiter would or would not have concluded. An assessment of the percentage chances of any outcome was as far as the Court should go.
Simon Hale
4 New Square