Follower notices invalid, says Court of Appeal

"It is reassuring that the Court of Appeal has again confirmed that because of the serious consequences for the taxpayer, the power to issue follower notices must be kept within narrow bounds," said Steven Porter, a tax disputes expert at Pinsent Masons, the law form behind Out-law.com.

Alasdair Locke had joined the Eclipse 10 film partnership, making a £29 million contribution funded by bank loans. He claimed tax relief on the interest payments and HMRC opened enquiries into Locke's tax returns arguing that he was not entitled to interest relief because the loans were not 'qualifying loans'. In March 2017 HMRC issued 10 follower notices to Locke.

Follower notices are designed to discourage a taxpayer from persisting with a claim when a court has already ruled in an earlier case that a tax advantage does not arise for a taxpayer in the same circumstances. A taxpayer who continues their litigation following receipt of a follower notice has to pay a penalty of 50% of the disputed tax if they are ultimately unsuccessful. In addition, as happened in this case, an accelerated payment notice (APN) is usually issued where a follower notice is issued, requiring the disputed tax to be paid upfront.

Locke challenged the issue of the follower notices by way of judicial review as there is no right of appeal against a follower notice.

HMRC said in the follower notices that the conditions for the issue of the notices were met because in February 2015, the Court of Appeal had handed down a ruling in a case involving the Eclipse 35 film partnership, which involved a similar structure to Eclipse 10. HMRC said it considered that the Eclipse 35 case showed that Locke was not entitled to relief on the interest payments.

One of the conditions for the issue of a follower notice is that "HMRC is of the opinion that there is a judicial ruling which is relevant to the chosen arrangements". A ruling is "relevant" if it relates to tax arrangements, the principles laid down, or reasoning given, in the ruling would, if applied to the chosen arrangements, deny the asserted advantage or a part of that advantage, and it is a final ruling.

In the Eclipse 35 case, the Court of Appeal decided that the film partnership was not trading. However, Locke claimed that he was claiming interest relief on the basis that he had borrowed the money to purchase a share in a partnership, and not on the alternative basis that he had contributed money to a partnership. Where money is contributed to a partnership the legislation requires that for interest relief to be available, the money contributed has to be "used wholly for the purposes of the trade, profession or vocation carried on by the partnership".

Where the loan is to buy a share in a partnership, there is no requirement that the money be used for the purposes of a trade. He argued that the Eclipse 35 case was not relevant to his circumstances because the question of whether the partnership was trading was not relevant to the basis on which he was claiming interest relief.

In Locke's case the Court of Appeal said that HMRC could not have lawfully held the opinion that the Eclipse 35 decision, if applied to the Eclipse 10 arrangements, would deny the tax advantage that Locke was claiming. The follower notices and APNs were therefore quashed.  

The Court agreed with the decision of Lord Justice Newey earlier this year in a case involving follower notices issued to a taxpayer called Mr Haworth, where the judge said that the threshold for deciding whether an earlier decision was relevant was a high one and that HMRC "must be of the opinion that the principles or reasoning in the ruling in question would deny the advantage, not merely that they would be more likely than not to do so."

"The focus of the statutory provisions is not on whether the particular chosen arrangements from which the tax advantage is said by the taxpayer to arise are identical or similar to the arrangements considered by the court or tribunal in the earlier judicial ruling," Lady Justice Rose said, giving the judgment of the Court of Appeal in Locke's case.

"The question is rather whether the principles laid down or reasoning given in that ruling would, if applied to the chosen arrangements, deny the asserted advantage or part of it. To decide that one must identify the legal issues that arise from Locke's dispute with HMRC over his entitlement to interest relief and consider what Eclipse 35 has to say about those legal issues," the judge said.

In HMRC's opinion, Locke's payment could only be properly characterised as a contribution of capital and not as a purchase of a share.  HMRC argued that for there to be the purchase of a share in a partnership the taxpayer had to purchase a share from an existing partner.

Lady Justice Rose said that the Eclipse 35 case did not deal with this question and no tribunal or court has yet laid down any principle that HMRC's construction is the correct legal position or given any reasoning as to why Locke's payment cannot be characterised as the purchase of a share in Eclipse 10.

"There may be cases in which the alternative legal characterisation that a taxpayer puts forward to circumvent the relevance of a judicial ruling is, in HMRC's view, clearly unsustainable. That does not entitle HMRC to issue a follower notice if there is no prior judicial determination to that effect. Rule 8(3)(c) of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009 (S.I. 2009/273 (L.1)) confers on the FTT a power to strike out the whole or part of proceedings if the Tribunal considers that there is no reasonable prospect of the appellant's case or part of it succeeding. That is the route that can be pursued without invoking the powers in Part 4 of the FA 2014," Lady Justice Rose said.

"The consequence of the follower notices and APNs being quashed is that Locke can now argue that he is entitled to interest relief because he purchased a share in the partnership, rather than making a contribution to a partnership, without the threat of a 50% penalty being imposed if he turns out to be wrong and without having to pay the disputed tax now," Steven Porter said.