Neutral Citation Number: [2008] EWHC 2387 (Ch)
Case No: CH/2007/APP/0596 & 0662
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
ON APPEAL FROM THE SPECIAL COMMISSIONERS
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 13/10/2008

Before :

THE HONOURABLE MR JUSTICE HENDERSON
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Between :

	TOWER MCASHBACK LLP 1
TOWER MCASHBACK LLP 2	Appellants	
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	THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS	Respondents	

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Mr Giles Goodfellow QC and Mr Richard Vallat (instructed by Ashton Rowe (Solicitors)) for the Appellants
Mr Bruce Carr (instructed by the Solicitor for HMRC) for the Respondents

Hearing dates: 30 June and 1, 2, and 3 July 2008
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Judgment
Mr Justice Henderson: 
Introduction
1.	These appeals from a decision of a single Special Commissioner, Mr Howard Nowlan, released on 19 July 2007 (“the Decision”) raise two main questions, one of substantive law and one of procedure. The question of substantive law, briefly stated, is whether the appellants, Tower MCashback 1 LLP (“LLP 1”) and Tower MCashback 2 LLP (“LLP 2”), are entitled to first-year allowances (“FYAs”) in respect of the full amount of first-year qualifying expenditure claimed to have been incurred by them on completion of Software Licence Agreements (“SLAs”) entered into between them and a company called MCashback Ltd (“MCashback”) on 31 March 2004.  The procedural question, again briefly stated, is whether the Special Commissioner had jurisdiction to permit the respondents (“HMRC” or “the Revenue”) to raise and rely on certain additional grounds to support the closure notices which they had issued in June 2006, and (if so) whether he was correct to allow them to raise any or all of those grounds.  I will refer to these two main questions as “the Expenditure Issue” and “the Closure Notice Issue” respectively.  
2.	In addition, there are two relatively minor questions which are still in contention on the appeals.  The first of these (“the Trading Issue”) is whether LLP 1 had begun to trade on or before 5 April 2004.  The second, raised by HMRC in a Respondent’s Notice dated 18 October 2007, is whether the expenditure incurred by the LLPs was incurred pursuant to an unconditional contract requiring payment to be made within a period of four months of the date of the contract (“the Conditional Contract Issue”).
3.	A further major issue, which was the focus of much of the evidence and argument before the Special Commissioner, was whether the two LLPs should be treated as having incurred 75% of the relevant expenditure on the provision of something other than plant and machinery, and in particular on the provision of finance on favourable terms (or “soft finance”, as it is often termed) to their individual members.  The Special Commissioner decided this issue in favour of the LLPs.  HMRC raised it by way of cross-appeal in their Respondent’s Notice, but announced in their skeleton argument dated 18 April 2008 that they had abandoned it.
4.	This was in fact the second occasion on which HMRC had decided to abandon a major argument upon which they had previously relied.  The first, and even more striking, occasion was at the start of the third day of the eight day hearing before the Special Commissioner, when HMRC (represented then, as on the appeals to this court, by Mr Bruce Carr of counsel) formally abandoned the only contention on which they had expressly relied in support of the closure notices when they were originally issued on 20 June 2006, namely a contention that the relevant expenditure was disqualified from being first-year qualifying expenditure under section 45 of the Capital Allowances Act 2001 (“CAA 2001”) by subsection (4) of that section, which provides that expenditure on an item of software within Class C (which the expenditure in question admittedly was, at least as to 25%) is disqualified “if the person incurring it does so with a view to granting to another person a right to use or otherwise deal with any of the software in question”.  The abandonment of this contention brings out the importance in the present case of the Closure Notice Issue, because if the LLPs are right in their argument that the Special Commissioner had no jurisdiction to allow HMRC to rely on other grounds in support of the closure notices, the result must be that the self-assessments by the LLPs for the relevant tax years could no longer be challenged once the argument based on section 45(4) had fallen away.
5.	The Special Commissioner decided the Closure Notice Issue in favour of HMRC: see paragraphs 19 to 22 of the Decision.
6.	In relation to the Expenditure Issue, the Special Commissioner adopted an analysis for which neither side had contended and which he himself had propounded during the course of the hearing.  His analysis sought to reflect the fact that the investors in the LLPs provided only 25% of the finance for the purchase of the software from their own resources.  The remaining 75% was borrowed by the investors under arrangements which involved two offshore banks, and which required the vendor of the software, MCashback, to deposit an equivalent amount with the second of the banks as a security deposit.  The effect of the arrangements, most easily seen with the assistance of a diagram, is that 75% of the purchase price went round in a circle which started and ended with the first bank, although at each stage on its journey the money had, at least ostensibly, a separate function to perform.  The arrangements envisaged that this financing structure would be unwound over a period of approximately ten years, as and when fees for the licensed software were paid to the LLPs. The Special Commissioner regarded the arrangements as being equivalent in economic terms to a sale for a purchase price payable by instalments, and he held that on a realistic analysis of the transactions the only expenditure initially incurred by the LLPs was the 25% provided by the members.  He also held, however, that further expenditure would be incurred as, when and to the extent that the borrowings by the members were paid off out of the designated fee income.  The upshot was that the LLPs could in principle obtain FYAs for only 25% of the purchase price of the software in the tax years under appeal, because it was only to that extent that expenditure had been truly incurred by them at that stage.  
7.	On the Trading Issue, the Special Commissioner decided that LLP 1 had not begun to carry on any trade by 5 April 2004, with the consequence that none of the capital expenditure which it had incurred could qualify for FYAs in the tax year 2003/04.  Since this was the year for which LLP 1 had claimed the FYAs, it followed that LLP 1’s appeal in relation to that year had to be dismissed.  
8.	The Trading Issue did not arise in relation to LLP 2, because LLP 2 only claimed FYAs for the next tax year, 2004/05, when it was accepted by HMRC that it had started trading.  It is common ground, as I understand it, that LLP 1 also started trading in 2004/05, if the true position is that it had not started trading in the previous year. HMRC therefore accept that LLP 1 will be entitled to the benefit of FYAs in the latter year, on the same basis as LLP 2, if LLP 1’s appeal for 2003/04 is dismissed.
9.	I should explain at this point that the reason why LLP 2 did not seek to claim FYAs for 2003/04 has nothing to do with any differences in the basic arrangements and transactions which it entered into with MCashback – in all essentials they appear to have been identical – but rather reflects the fact that no investor members of LLP 2 had been signed up before 6 April 2004, so FYAs for the previous tax year, even if available, would have been of no use to them: see paragraph 17 of the Decision.  
10.	On the Conditional Contract Issue, the Special Commissioner decided in favour of the LLPs that the obligation to pay the purchase price under the SLAs was unconditional: see paragraphs 162 to 166 of the Decision. (He also decided – see paragraph 167 – that there had been no subsequent variation of the SLAs so as to provide for completion at a date more than four months after the date of the contract.  There is no cross-appeal by HMRC in relation to that conclusion).
11.	The Decision is reported at [2008] STC (SDC) 1.  It is a long one, running to 176 paragraphs and some 42 pages in the report.  I will refer to those parts of the Decision which are relevant to my discussion of the live issues, but I will not attempt to summarise it in any detail or to describe the factual background to the appeals. The present judgment therefore needs to be read in conjunction with the Decision.  
12.	The representation on both sides was the same before me as it had been below.  Mr Giles Goodfellow QC and Mr Richard Vallat appeared for the taxpayers, and (as I have already said) Mr Bruce Carr appeared for HMRC.  I am grateful to counsel on both sides for their clear and helpful submissions.  
13.	I remind myself, before going any further, that an appeal to the High Court from a decision of the Special Commissioners lies only on questions of law: see section 56A(1) and (4) of the Taxes Management Act 1970 (“TMA 1970”). It follows that I may only interfere with findings of fact made by the Special Commissioner on the limited grounds explained by the House of Lords in Edwards v Bairstow [1956] AC 14.
Legislation
14.	The legislative background to the present appeals is a little complex, but fortunately most of it is not in dispute.  Much of what follows is based on the helpful analysis in the schedule to the skeleton argument of Mr Goodfellow and Mr Vallat.
(A) Capital Allowances
15.	Section 5 of CAA 2001 contains general timing provisions which say when capital expenditure is to be treated as incurred for the purposes of the Act.  So far as material, it provides as follows:
“5. When capital expenditure is incurred
(1) For the purposes of this Act, the general rule is that an amount of capital expenditure is to be treated as incurred as soon as there is an unconditional obligation to pay it.  
(2) The general rule applies even if the whole or a part of the expenditure is not required to be paid until a later date.
(3) There are the following exceptions to the general rule. 
…
(5) If under an agreement an amount of capital expenditure is not required to be paid until a date more than 4 months after the unconditional obligation to pay has come into being, the amount is to be treated as incurred on that date.  
… ”
16.	The effect of these provisions is that expenditure is in general treated as incurred when the purchaser becomes unconditionally obliged to pay it, not when the payment is actually paid.  This is so even if the whole or part of the expenditure is not required to be paid until a later date, so long as that date is no more than four months after the unconditional obligation to pay has arisen.  If the requirement to pay is postponed for more than four months, the subsequent date on which it is payable is substituted as the date on which the expenditure is treated as incurred.  In either case, however, what matters is the date on which the sum is payable.  Provided that the obligation is unconditional, delay in making the actual payment will not alter the fact that the expenditure, once made, is treated as having been incurred when the obligation first arose (or, in a case to which subsection (5) applies, on the date originally fixed for payment).
17.	The SLAs which LLP 1 and LLP 2 entered into with MCashback on 31 March 2004 each provided for completion to take place on 29 July 2004, or earlier.  Since 29 July is less than four months after 31 March, the effect of section 5 was to deem the expenditure of the purchase price to have been incurred by the LLPs on 31 March, so long as the obligation to pay it on 29 July was indeed unconditional. It is common ground that the purchase price was not in fact paid on the due date, and that completion did not take place until January 2005.  However, this delay in payment does not matter, in the sense that once the expenditure had actually been made section 5 would still deem it to have been incurred on 31 March 2004.
18.	Part 2 of CAA 2001 (running from sections 11 to 270 inclusive) deals with plant and machinery allowances.  The basic entitlement to such allowances is conferred by section 11, which provides as follows:
“11. General conditions as to availability of plant and machinery allowances
(1) Allowances are available under this Part if a person carries on a qualifying activity and incurs qualifying expenditure. 
(2) “Qualifying activity” has the meaning given by Chapter 2.
(3) Allowances under this Part must be calculated separately for each qualifying activity which a person carries on.  
(4) The general rule is that expenditure is qualifying expenditure if –
(a) it is capital expenditure on the provision of plant or machinery wholly or partly for the purposes of the qualifying activity carried on by the person incurring the expenditure, and
(b) the person incurring the expenditure owns the plant or machinery as a result of incurring it.
(5) But the general rule is affected by other provisions of this Act, and in particular by Chapter 3.”
19.	None of the provisions in Chapter 3 is relevant in the present case.  It is also common ground that the expenditure by the LLPs was capital expenditure; that it was incurred for the purposes of a qualifying activity (namely a trade: see section 15(1)(a)); and that the LLPs were carrying on a trade at least during 2004/05.
20.	Section 12 deals with expenditure which is incurred before a qualifying activity is carried on, and provides that:
“For the purposes of this Part, expenditure incurred for the purposes of a qualifying activity by a person about to carry on the activity is to be treated as if it had been incurred by him on the first day on which he carries on the activity.”
Accordingly, if LLP 1 did not begin trading until after 5 April 2004, any qualifying expenditure incurred by LLP 1 before that date for the purposes of the intended trade will be deemed to have been incurred on the first day of actual trading.  However, by virtue of section 50 any effect that section 12 would have on the time when expenditure is treated as being incurred is disregarded for the purpose of determining whether qualifying expenditure is “first-year qualifying expenditure” under Chapter 4 of Part 2.  The relevance of this point is that certain provisions in Chapter 4, including in particular section 45 (see below), make qualification as “first-year qualifying expenditure” dependent upon the expenditure having been incurred on or before certain dates.  Section 12 does not alter the date when expenditure is treated as incurred (normally pursuant to section 5), even if the taxpayer does not commence the qualifying activity until a later date.  Accordingly, the entitlement of LLP 1 or LLP 2 to allowances under section 45 will not be affected, even if they only commenced trading after 31 March 2004.  This is explained by the Special Commissioner in paragraph 13 of the Decision.
21.	There are two main types of capital allowances, namely FYAs and writing-down allowances.  By virtue of CAA 2001 section 39, FYAs are not available unless the qualifying expenditure is first-year qualifying expenditure under certain specified provisions, including section 44 (expenditure incurred by small or medium-sized enterprises) and section 45 (ICT expenditure incurred by small enterprises).
22.	Sections 44 and 45 provide as follows:
“44. Expenditure incurred by small or medium-sized enterprises
(1) Expenditure is first-year qualifying expenditure if – 
(a) it is incurred by a small or medium-sized enterprise, and
(b) it is not excluded by subsection (2) or section 46 (general exclusions).
(2) …
45. ICT expenditure incurred by small enterprises
(1) Expenditure is first-year qualifying expenditure if –
(a) it is incurred on or before 31 March 2004,
(b) it is incurred by a small enterprise,
(c) it is expenditure on information and communications technology, and
(d) it is not excluded by section 46 (general exclusions) or subsection (4) below.
(2) “Expenditure on information and communications technology” means expenditure on items within any of the following classes.
Class A. Computers and associated equipment
…
Class B. Other qualifying equipment
…
Class C. Software
This class covers the right to use or otherwise deal with software for the purposes of any equipment within Class A or B.
(3) …
(4) Expenditure on an item within Class C is not first-year qualifying expenditure under this section if the person incurring it does so with a view to granting to another person a right to use or otherwise deal with any of the software in question.”
I have reproduced section 45 above with the amendments to it made by sections 165 and 166 of the Finance Act 2003.  It is the amended wording which is relevant in the present case.
23.	Section 71 contains further provisions relating to software and rights to software.  In short, it provides that for the purposes of Part 2 computer software is to be treated as plant, whether or not it would constitute plant apart from that section; and that if a person carrying on a qualifying activity incurs capital expenditure in acquiring a right to use or otherwise deal with computer software, Part 2 is to apply as if the right and the software to which it relates were plant provided for the purposes of the qualifying activity, and as if the person owned the plant in question for so long as he is entitled to the right.
24.	It is common ground that LLP 1 and LLP 2 were small enterprises within the meaning of sections 44 and 45; that the expenditure incurred by them was expenditure on ICT technology within Class C under section 45(2); and that none of the general exclusions in section 46 applies.
25.	By virtue of section 52(1), a person is entitled to a FYA in respect of first-year qualifying expenditure if:
“(a) the expenditure is incurred in a chargeable period to which this Act applies, and
(b) the person owns the plant or machinery at some time during that chargeable period.”
Section 52(2) says that any FYA is made for the chargeable period in which the first-year qualifying expenditure is incurred.  Subsection (3) then says that the amount of the allowance is a percentage of the first-year qualifying expenditure in respect of which the allowance is made, as shown in the Table which follows.  The amount of the allowance for expenditure qualifying under section 45 is 100%, but the amount for expenditure qualifying under section 44 is only 40%, although the effect of section 142 of the Finance Act 2004 is to substitute an allowance of 50% instead of 40% where expenditure qualifying under section 44 is incurred by a small enterprise in 2004/05.
26.	Because of the difference in the rates of allowance, it is obviously advantageous for a small enterprise which incurs expenditure on ICT technology to claim an allowance under section 45, if it is able to do so, in preference to an allowance under section 44.  In the context of the present case, the arrangements were designed to enable LLP 1 and LLP 2 to take advantage of section 45, and the only relevance of section 44 is that it will apply if for any reason they are not entitled to FYAs under section 45, and in particular if the qualifying expenditure was incurred after 31 March 2004 (having regard to the timing provisions in section 5).
27.	It will be noted that FYAs are made for the “chargeable period” in which the relevant first-year qualifying expenditure is incurred.  In the case of a person carrying on a trade, “chargeable period” means, for income tax purposes, the period of account for which his trading accounts are drawn up: see section 6(1)(a) and (2)(a).  Section 247 provides that the allowance is to be given effect in calculating the profits of the trade by treating it as an expense of the trade. The effect of these provisions, therefore, is that a small enterprise carrying on a qualifying activity is entitled to a deduction for tax purposes of 100% of the qualifying expenditure incurred by it on ICT on or before 31 March 2004, in computing the profits of its accounting period in which the expenditure is incurred.  If an allowance of 100% under section 45 is not available, the trader will still be entitled to a FYA under section 44 for the year of expenditure (at the rate of 50% if the expenditure is incurred during the tax year 2004/05, and thereafter at the rate of 40%), and subsequently to WDAs at the normal rate of 25% a year on the reducing balance of any expenditure which did not qualify for a FYA.
(B) The Income Tax and Capital Allowances treatment of LLPs
28.	The general rule is that a limited liability partnership (“LLP”) which carries on a trade is treated for tax purposes in the same way as a partnership, despite its separate legal personality.  This follows from section 118ZA of the Income and Corporation Taxes Act 1988 (“ICTA 1988”), subsection (1) of which provides as follows:
“(1) For the purposes of the Tax Acts, where a limited liability partnership carries on a trade, profession or other business with a view to profit – 
(a) all the activities of the partnership are treated as carried on in partnership by its members (and not by the partnership as such),
(b) anything done by, to or in relation to the partnership for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the members as partners, and
(c) the property of the partnership is treated as held by the members as partnership property.”
It should be noted that although subsection (1)(b) imputes anything done by, to or in relation to the partnership to the individual members, and thus looks through the separate corporate identity of the LLP, there is no deeming provision in the opposite direction which imputes the actions of the individual partners to the LLP.  I mention this point because the Special Commissioner seems at times in the Decision to have lost sight of it, and to have proceeded on the footing that the LLPs and their members could for all practical purposes be treated as interchangeable.
29.	The general rules for the treatment of partnerships are contained in section 111 of ICTA 1988.  In summary:
(a) if there are individual partners, the profits and losses of the trade carried on by the partnership are to be calculated as if the partnership were an individual resident in the United Kingdom (section 111(2));
(b) an individual partner’s share of those profits and losses is calculated according to the interests of the partners in the relevant period (section 111(3)); and
(c) the partner’s share of the profits or losses is treated as derived from a separate trade carried on by him alone (section 111(4)).
Trading losses may be relieved against the partner’s general income of the current and previous years: see sections 380 and 381 of ICTA 1988.  It is this ability to set off trading losses against general income which explains the attraction to many individual taxpayers of 100% FYAs.  However, it must not be forgotten, in the context of the present case, that the investor members of the LLPs also became liable to income tax at their full marginal rate on their share of all future income generated by the LLP.  Furthermore, this is not a case where the provision of 100% FYAs to well-off individual investors was the prime, or even the main, purpose of the arrangements.  Had that been the case, HMRC would no doubt have invoked the anti-avoidance provisions in Chapter 17 of Part 2 of CAA 2001, including in particular section 215 which (read with section 217) disallows FYAs in any case where “the sole or main benefit” which might have been expected to accrue to the investor from the relevant transactions was the obtaining of an allowance under Part 2.
The Expenditure Issue
30.	In the light of the statutory provisions and common ground to which I have referred, the critical question is to identify the amount of the expenditure which the two LLPs incurred on the purchase of the relevant software (or, more accurately, on the acquisition of licences to use the relevant software) under the SLAs which they entered into with MCashback on 31 March 2004. Once the Special Commissioner had rejected HMRC’s submission that the consideration under the SLAs was paid as to 75% for the benefit of soft finance, one might have thought that the answer to this question was obvious: the whole of the consideration paid on the delayed completion date in January 2005 must have been paid, as the SLAs themselves provided, for the acquisition of the licences, and for nothing else.  However, as I have already explained, the Special Commissioner felt able to reach a different conclusion based on an analysis for which neither side had contended.  
31.	The starting point in any consideration of this question must in my judgment be the terms of the SLAs themselves.  Before coming on to the SLAs, however, I will first say a little about the background to the conclusion of the deal on 31 March 2004.  There can in my judgment be no doubt that the terms of the SLAs were negotiated at arms’ length between wholly unconnected parties.  This is made abundantly clear by the contemporary email traffic during the period of negotiation in February and March 2004, not only on the side of the LLPs but also within MCashback itself, whose internal documents  HMRC obtained shortly before the hearing by service of a notice under section 20 of TMA 1970.  This material shows that there were serious and concentrated negotiations before terms were finally agreed at a meeting on 26 March 2004; that detailed consideration was given by each side to questions of valuation; and that MCashback did not succeed in obtaining all of the benefits that they had originally hoped for, including in particular a right to repurchase the licensed software after a specified period had elapsed.  There could be no suggestion that this was in any sense a collusive deal.  MCashback needed to raise external funding for the next stage in the development of the MRewards system.  For this purpose they sought the assistance of Tower Group Plc (“Tower”), who had experience of arranging finance for similar software companies (see paragraph 7 of the Decision). Tower set up the LLP structure, sought external investors, and conducted the negotiations with MCashback.  In so doing, Tower were not acting for or retained by MCashback, but on the contrary were responding to MCashback’s need for finance (which was originally explained to Tower at a number of presentations by the MCashback board) and were aiming to provide it in a tax-efficient way which would not only be acceptable to MCashback but would also attract the necessary outside investors.  
32.	The evolution of the deal is described in the witness statements of two of the founder members of Tower, Mr Paul Feetum and Mr Stephen Marsden, and in the witness statement of Mr Ahmed Zghari, who is the Chief Operating Officer of MCashback and has been a director and shareholder of the company since 2002.  The Special Commissioner found all of them to be “fundamentally honest” witnesses: see paragraph 65 of the Decision.
33.	In paragraph 2 of his second witness statement, Mr Feetum described the negotiations with MCashback in the following terms:
“2. The negotiations with [MCashback] were very tough and on a couple of occasions almost broke down. [MCashback] clearly thought that the MRewards System had a great future (as we did) and their reason for selling part of the IPR to the LLPs was simply to raise money they considered essential to fund their working capital so that they could roll out the project quickly in a large number of countries and trading operations over the next few years.  Consequently, they wanted to get as much cash up front as they could and to allow the LLPs as little of the future income stream as possible particularly after the LLPs had made sufficient trading profits so that the members of the LLPs had repaid their initial loans.  In addition, they did not wish to part with equity, with consequent Board representation for any investor(s).  We, on the other hand, as members of the LLPs wanted to obtain and retain as large a part of the business without taking an equity stake, such a position being achieved by taking a share of the income in perpetuity even after we had recouped our initial investments.”
34.	To similar effect, and on the other side of the deal, Mr Zghari said in paragraph 18 of his witness statement that at least two of the meetings which took place in March 2004 between representatives of MCashback and Tower “involved very intense negotiations on terms”. He went on to say in paragraph 21 that MCashback considered the financing offered to them by Tower “quite expensive compared to, say financing from a bank”.  He said that MCashback were “rather reluctant” to give away any of the rights relating to their software, and for another party to obtain fees in respect of those rights, but Tower insisted on acquiring the software.  He then said (at the end of paragraph 21):
“We only agreed to enter into this agreement if we could obtain a large payment of capital upfront.”
35.	The Special Commissioner found it unnecessary to summarise the evidence given by Mr Feetum, Mr Marsden and Mr Zghari, because he had already based much of his description of the facts on their evidence.  However, in paragraph 63 of the Decision he commented that the general picture given by all three witnesses was substantially similar, and recorded the generality of what they said in seven sub-paragraphs, the first three of which I will quote (for ease of reference I have replaced the Special Commissioner’s bullet points with numbers):
“(1) All of the witnesses claimed to have great faith in the MCashback concept, and I had no reason to doubt this evidence.  Mr Zghari made the point that he considered that the roll-out of the system was “at or near the tipping point, after which retailers and manufacturers will come to us and ask to join the Rewards programme”. 
(2) Considerable reference was made to the hard negotiations that there had been between the Tower personnel and the MCashback directors and to the insistence on the part of the former that the LLPs should acquire their interest in software indefinitely and not just until the LLPs had derived some given amount of income from the software.  By contrast the MCashback team had been reluctant to dispose of the interest indefinitely, and Mr Cooper was said to have referred to his aspiration of buying the interest back at some time, and indeed ideally within three to five years before the full value of the software was appreciated by everyone.  There were of course no arrangements for such a buy-back and in the light of the fact that MCashback has had to raise new equity at the end of 2006 to assist the roll-out of the system, it is obvious that the aspiration of buying back the LLPs’ interests, at least in the foreseeable future, will not come to pass.
(3) Whilst there was reference to the negotiations being hard fought, it was always understood that the LLP transactions would involve 75% loan funding, and that MCashback would have to secure and fund the loans such that it would only have free use of 18% of the total capital contributed to the LLPs, after taking into account the 82% that would have to be placed in locked deposit accounts.”
36.	I now turn to the terms of the SLAs.  Tower had arranged for the incorporation of four LLPs, and each of them entered into a separate SLA with MCashback on 31 March 2004.  For present purposes it is enough to concentrate on the SLA between MCashback and LLP 2 (which at that date was still called Tower Taxi Technology 34 LLP).  Both sides argued the appeal on the basis that the documentation relating to LLP 2 could be taken as representative, and the core bundle was prepared accordingly.  Although nothing turns on the point, I was told that before the Special Commissioner it was the documentation relating to LLP 1 which was taken as typical.  The main difference between the documentation for LLP 1 and LLP 2, apart of course from the different items of software licensed and the different consideration and share of fee income, was that the scheduled completion date for the agreement with LLP 1 was 30 April 2004 rather than 29 July 2004.  In fact, as I have already said, neither target was met, and both agreements were completed in January 2005. The agreement for LLP3 also had a completion date of 29 July 2004.  I was told that it too was completed late, in February 2005. The agreement for LLP 4 can for all practical purposes be ignored, because no investor members were ever found to participate in it.  I was told by Mr Goodfellow that the scheduled completion date for the agreement with LLP 4 was in fact 31 March 2005, and not 29 July 2004 as stated by the Special Commissioner in paragraph 34 of the Decision.  
37.	Clause 2 of the SLA between MCashback (referred to in the SLA as “MCash”) and LLP 2 was headed “Agreement to Grant of Licence” and provided as follows:
“2.1 MCash shall grant the LLP an exclusive worldwide royalty-free licence to use the Licensed Software for the Consideration subject to the provisions set out in this Agreement.
2.2 All the provisions of this Agreement shall have effect as at the date hereof, (except for the Licence which shall have effect as from Completion) or as otherwise stated.
2.3 Completion is not conditional upon the occurrence of any event or circumstance or upon any action being taken by any party or any other person.”
The “Licensed Software” was defined in clause 1.1 as meaning the software programs forming the Customer Support Interface as referred to on page 3 of the “Definition of the System” in schedule 2.  Schedule 2 appears to contain nothing apart from a heading “The System”, at least in the copy contained in the core bundle, but it has never been suggested so far as I am aware that there was any uncertainty about the nature or identity of the software which was licensed to LLP 2.  The “Consideration” was defined as meaning £27.501 million.
38.	Clause 3 contained further provisions dealing with the consideration.   Clause 3.1 obliged LLP 2 to provide to MCashback a “Receipt of Funds Statement” once it was in receipt of sufficient funds to pay the consideration in full.  This statement had to contain various particulars, including details of the subscriptions received by LLP 2 from subscribers (“the Partners”) and a certified statement of the funds which the LLP had available to discharge the consideration. By virtue of clause 3.5, the consideration was to be paid unconditionally by LLP 2 to MCashback on the Completion Date, which was defined as meaning 29 July 2004 or such earlier date as was determined in accordance with clause 3. This was a reference to clause 3.4, which provided for early completion at the option of MCashback following receipt of a Receipt of Funds Statement showing that LLP 2 had sufficient funds available to it to discharge the consideration.
39.	Clause 4 then dealt with completion, and clause 5 with the obligations of the parties prior to completion.  I will return to some of these provisions below. Clause 6 contained warranties by MCashback, including (pursuant to clause 6.1) a warranty to LLP 2 in the terms set out in schedule 3, both as at the date of the agreement and repeated immediately prior to completion.  By paragraph 1.1 of schedule 3, MCashback warranted that:
“All information contained in the Original Business Model, in so far as it consists of fact is true and accurate in all material respects and in so far as it consists of opinions of MCash, such opinions are honestly held and believed.”
The “Original Business Model” was defined as meaning the business model annexed to the SLA in Annex 1.  It consists of a lengthy and detailed business plan for the period of 10 years from 2004 to 2013 (“the Business Plan”).  This is an important document, running to some 90 pages including appendices, which set out in considerable detail the nature of the MRewards system, the proposals for its worldwide development, and the financial projections for its first 10 years of operation, including profit and loss account projections, annual revenue projections, and cash flow projections for each of the 10 years. The “financial commentary” on page 5 of the Business Plan explained that it had been built on conservative assumptions, and drew on “the very high level of relevant commercial expertise amongst the management team and its advisers”.  This was not mere hype, because MCashback’s management team was indeed very high powered, and included leading figures in relevant commercial and professional fields: see the brief summary in paragraph 32 of the Decision, and the fuller biographies in appendix 8 to the Business Plan. The financial commentary went on to say that the cost and revenue projections had been “rigorously analysed” for the first five years up to and including 2008, and that the projections for the following five years “should be considered as sensible projections consistent with the stated assumptions”. Particulars were then given of the conservative assumptions which had been made.
40.	Section 6 of the Business Plan set out the various potential sources of revenue for MCashback which the MRewards scheme would engender. The relevant source of revenue for present purposes is the so-called “clearing fees”, i.e. the fee per transaction which would be triggered by the sale of any product accompanied by an offer of an MReward.  For the purposes of the projections, this fee was assumed to be 5p per transaction at 2004 prices.  
41.	Clause 7 of the SLA dealt with the obligations of the parties after completion.  The two important provisions for present purposes are those contained in clauses 7.5 and 7.6:
“7.5 MCash hereby agrees and undertakes that the LLP shall be entitled to receive 2.5% of all the Clearing Fee[s] from Completion and the LLP hereby undertakes to procure by contractual obligation of any relevant person that the LLP shall receive such percentage of such income.
7.6 The LLP undertakes to apply 50% of the income it receives under clause 7.5 in the reduction of the Bank Loan on behalf of the Partners and it shall be free to apply and use the balance as it sees fit.”
Thus LLP 2 was prospectively entitled to receive a flow of income, with no time limit, consisting of 2.5% of the gross amount of all the clearing fees generated by the MRewards system after completion.
42.	It was always intended that each LLP would raise 75% of the finance which it needed by way of bank borrowing, and that MCashback would be obliged to deposit approximately 82% of the consideration which it received for the grant of the licence as an indirect security for that borrowing.  The details had not yet been worked out on 31 March 2004, and the identity of the two participating banks was still undecided.  However, the basic framework of the arrangements had been agreed, and this was reflected in the definitions in clause 1.1 of the SLA of the “Bank Loan”, “Bank One”, “Bank One Security”, “Bank Two” and “Bank Two Security”.  Clause 4.2(d) provided that on completion MCashback should deliver to Bank Two the Bank Two Security, and procure that Bank Two provide to Bank One the Bank One Security.  For its part, LLP 2 was obliged on completion by clause 4.3 to procure that the Bank Loan was drawn down by the Partners (or by a special purpose company set up by them or on their behalf), and to procure that the necessary documents required by Bank One in respect of the Bank Loan and the Bank One Security should be entered into.  Clause 4.3(c) provided that the consideration should be paid on completion to the solicitors of MCashback, on their undertaking to apply the funds first in procuring the release of the licensed software from an existing debenture and secondly in procuring the Bank Two Security.
43.	Clause 5.1 obliged LLP 2 prior to completion to endeavour to raise funds by way of subscription from new partners in order to enable the consideration to be paid, and to undertake due diligence with respect to the relevant technology and the Business Plan. Clause 5.2 obliged MCashback prior to completion to co-operate with LLP 2 in relation to the due diligence undertaken by it, and to make the necessary arrangements for provision of the Bank Two Security and the Bank One Security.  Clause 5.3 obliged both parties, acting reasonably and in good faith, to 
“co-operate and assist each other in negotiating the terms of the Bank Loan (including arrangements fees, interest margin call and deposit terms in respect thereof) and each of the Bank One Security and Bank Two Security.”
It is apparent from all these provisions that the terms of the bank borrowing, and of the two securities, were still to be resolved when the SLA was entered into on 31 March 2004.
44.	Over the course of the next nine months the necessary arrangements were put in place to enable the SLA to be completed.
45.	The first step was the execution on 6 July 2004 of a limited liability partnership agreement relating to LLP 2.  At this stage the only members of LLP 2 were the three original founder members, namely Mr Feetum, Mr Marsden and Mr Simon Smith, each of whom had made an initial capital  contribution of £1 and held a founder share.  The agreement recited that LLP2 intended to raise capital with which to finance the acquisition of ICT Software, and to carry on the trade of exploiting such software in accordance with the terms of an Operations Agreement to be entered into between the LLPs and MCashback.  It was further recited that LLP2 would seek to raise the capital by the issue to Participating Members of  Participating Shares in the LLP, and that the original founder members would incorporate a loan company, namely Tower MCashback Finance UK2 Limited, which would (in essence) act as an intermediary between the lending bank and the Participating Members.  Clause 2.2 said that LLP 2 was incorporated solely to pursue the purpose of carrying on a trade with a view to profit by acquiring and exploiting the software, and for no other purpose whatsoever.  The agreement went on to deal with the admission of members and the management of the LLP.  Clause 8 dealt with the distribution and allocation of income.  In short, and slightly simplified, clauses 8.2 and 8.3 provided that up to 40 percent of the net income and gains of the LLP should be distributed to the members in order to cover their liability to the income tax in respect of the taxable profits of the LLP; that an amount equal to 50 percent of the gross income should be paid to the loan company in reduction of the members’ loans; and that the balance of the income and gains should be held as reserves.  Clauses 8.7 and 8.8 placed a cap on the entitlement of participating members.  Again at the risk of some over-simplification, clause 8.7 said that such entitlement was not to exceed a non-cumulative distribution for each accounting period of no more than 5 percent of the member’s initial capital contribution, while clause 8.8 said that the balance for the time being standing to the credit of a member’s nominal account should not exceed one quarter of his initial capital contribution plus the outstanding amount of his member’s loan, and his capital account should not exceed a total entitlement equal to one eighth of his initial capital contribution multiplied by the number of complete years of continuous membership from 1 October 2004 up to a maximum of ten years.  The effect of this formula was that if the member’s initial capital contribution (including a member’s loan of 75 percent) had been 100, his total entitlement after ten years was not to exceed 125.  Clause 8.9 then provided that any surplus remaining was to be allocated among the founder members, who were of course representatives of Tower. 
46.	It can thus be seen that the participating members and the founder members had differing interests under LLP 2, with the interests of the former, but not the latter, being subject to a cap calculated by reference to the size of the member’s initial contribution and the length of his period of membership.  It follows that each category of member had a financial interest in ensuring that the LLP’s income was as high as possible, at any rate until the level of the cap was reached.  
47.	The next step was not directly relevant to LLP 2, but I will mention it here because there are some references to it in the Decision.  On 12 July 2004 Tower Project Finance LLP issued an Information Memorandum inviting members of the public to invest in LLP 3 (“the Information Memorandum”).  This document explained the economics of the proposed investment, and made it clear that it was addressed only to individual investors who were either “certified sophisticated investors” or “investment professionals” within the meaning of those expressions in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001.  Section 1 of the Information Memorandum, headed “Key Features”, described the investment opportunity in the following terms:
“A trading opportunity has arisen for the LLP to exploit the Software throughout the world.  It is anticipated that the majority of such exploitation shall be undertaken in a joint trading venture with the exploitation by MCashback of the MCashback System.
The Software purchased by the LLP has been independently valued … The purchase price substantially accords with the independent valuation contained in the Valuation Report.
…
The investment will take the form of Contributions by way of subscription for Participating Shares.  The Lending SPV [i.e. the relevant loan company] has been formed by the Three Founder Members to provide funding, by way of a loan to each Applicant, of up to 75% of that Applicant’s total Contribution. The funding will be secured solely on the Member’s Share in the LLP.  The Lending SPV shall be funded by way of the Bank Loan which will itself be secured by a Bank Guarantee from Bank Two (satisfactory to Bank One) which is to be secured by cash deposited by MCashback.
… 
All repayments of the SPV Loan shall be made out of distributions made by the LLP to its members and such payments shall not be due until such distributions are made.”
48.	The Investment Memorandum went on to point out that any return of the capital invested would depend entirely on the success of the new venture, and to explain how the income of the LLP would be distributed.  Under the section headed Tax Treatment, it was explained that tax relief should be available under section 45 of CAA 2001 on the entire amount of the investor’s contribution, and a simplified illustration of possible cash flows was set out. The appendices to the Information Memorandum included an Opinion by tax counsel, Mr Patrick Soares, dated 6 July 2004.  This Opinion dealt, among other matters, with the proposal that MCashback would ultimately secure the loan to be taken out by the LLP members.  Counsel said that he saw no difficulty in the commerciality of such an arrangement, provided that it was properly implemented and the purpose of the arrangement was to enable the purchaser to pay MCashback the appropriate purchase price for the software.  He identified (in paragraph 104) the critical question as being whether the Ramsay approach could be applied to the circular money movements in such a way that it could be said that, with regard to those monies, the members of the partnership would not have incurred capital expenditure on the provision of the plant and machinery within section 11(4)(a) of CAA 2001.  In paragraph 105 he said that the critical case was Barclays Mercantile Business Finance Ltd v Mawson (“BMBF”), which at that stage had been decided in favour of the taxpayers by the Court of Appeal but was due to be heard by the House of Lords in the Autumn.  He expressed the view that, as the law presently stood, the Ramsay approach would not cause problems “subject to satisfactory bona fide documentation and the loan having the necessary commercial background (duly evidenced) and commercial characteristics”. After briefly discussing various House of Lords authorities, counsel continued in paragraph 109 of his Opinion:
“The Court of Appeal in Barclays v Mawson … dealt with a situation where the buyer of a pipeline borrowed monies and these were paid over to the vendor and they effectively found their way back to the original lender.  There was undisputed evidence that this was a standard commercial finance leasing transaction … The LLP will produce appropriate evidence in this regard from the banks.”
After further discussion of the decision of the Court of Appeal in BMBF, and the decision of the House of Lords in Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655, 64 TC 617, counsel said in paragraph 113:
“It may well be now that in an Ensign v Stokes type transaction members will be successful following the [BMBF] decision but it is clear that one must seek to avoid non-recourse loans and situations where there is an immediate payment back to the same lender.  Although I cannot see any distinction in principle between a blocked funds arrangement and a loan by the vendor to the purchaser on non-recourse terms (where there is a bona fide belief that the loan will be repaid) one clearly has to avoid that structure.”
49.	Before leaving the Investment Memorandum, it is also worth noting that the term of the bank borrowing for LLP 3 was expressly envisaged as being 12 years, rather than the 10 years applicable to LLP 1 and LLP 2: see paragraph 8.3 of the assumptions set out on page 25, where this is said to be in accordance with the terms of the Partnership Agreement for LLP 3.
50.	Returning now to LLP 2, the participating member taken as typical was a Mr Paul Donaldson, who filled in an application form on 29 July 2004 applying for a subscription of £600,000.  On 30 July 2004 he entered into a loan agreement with Tower MCashback Finance UK2 Ltd, whereby that company agreed to make a loan of £450,000 to Mr Donaldson on the subscription date and it was agreed that Mr Donaldson should repay the loan in accordance with the provisions of clause 8 of the LLP Partnership Agreement, with a final repayment on 30 July 2014.  The loan was interest-free, apart from default interest chargeable in the event of failure to pay any sums due on the due date. As security for the loan, Mr Donaldson charged his interest under the LLP to the lender.  Clause 6 was headed “Recourse on default”, and provided as follows:
“6.1 In the event that the Bank Loan [i.e. the loan by Bank One] is repaid in full under the Bank Guarantee [i.e. the guarantee given by Bank Two] and all liability of the Lender to repay the same or otherwise in respect of its borrowings under the Bank Facility [i.e. the loan facility entered into with Bank One] are [sic] satisfied in full by such repayment and it has no liabilities to any other person as a result thereof, the Lender hereby agrees and undertakes that it shall have no right to enforce the terms of this Agreement with respect to the repayment of amounts of principal against the Borrower who shall be released absolutely and unconditionally from all obligations to repay the principal amount of the Loan then outstanding upon such satisfaction.
6.2 The Lender hereby agrees and undertakes that its only right of recourse against the Borrower under this Agreement shall be the enforcement of the security effected hereunder being the security set out in clause 2.1 above.”
It can therefore be seen that the borrowing by Mr Donaldson, and the other participating members, was on limited recourse terms, and that in practice the lender had no rights against the members apart from a right to enforce the security given by them over their shares in the LLP.
51.	As the Special Commissioner records in paragraph 40 of the Decision, it was originally envisaged that the roles of the two banks would be performed by Lloyds TSB and HBOS, but in the event cheaper terms were obtained from two Channel Island banks, namely Janus Holdings Ltd (“Janus”), which was based in Jersey, and R & D Investments Ltd (“R & D”), which was based in Guernsey.  The necessary arrangements involving the two banks were eventually put in place by three agreements, namely:
(a) a loan agreement dated 1 December 2004 and made between Tower MCashback Finance UK2 Ltd (1) as borrower and Janus (2) as lender (“the Loan Agreement”);
(b) a guarantee and deposit agreement dated 12 January 2005 and made between R & D (1) and Janus (2) (“the Guarantee and Deposit Agreement”); and
(c) a collateral agreement also dated 12 January 2005 and made between MCashback (1) and R & D (2) (“the Collateral Agreement”).
52.	By the Loan Agreement Janus granted Tower MCashback Finance UK2 Ltd a loan facility of £22.5 million, to be drawn down in one amount only on or before 31 March 2005.  The loan bore interest at a rate equal to the aggregate of LIBOR and an additional figure defined as the “Spread” (0.18% per annum on the first £14 million of principal outstanding from time to time, and 0.155% on the balance).  However, clause 7.2 provided that the Spread element of the interest should be discharged by payment of a lump sum of £428,750 (which included an arrangement fee of £45,000) on drawdown, such payment to be non-refundable and to be accepted by Janus in full and final settlement of the borrower’s liability to pay the Spread interest.  Furthermore, clause 7.3 provided that the borrower’s liability to pay the LIBOR portion of the interest should be set off against the interest due from Janus to R & D under clause 6.2 of the Guarantee and Deposit Agreement.  Repayment of principal could be made at any time on five days’ notice in multiples of £50,000, and all amounts due were to be repaid in full by no later than the final repayment date, which was defined as the tenth anniversary of drawdown.
53.	Clause 12 specified various events of default, but in clause 12.2 Janus undertook that on the occurrence of any such event it would not take enforcement action against the borrower without first taking enforcement action under the Guarantee and Deposit Agreement.  
54.	By the Guarantee and Deposit Agreement R & D agreed, in consideration of Janus granting the loan to the borrower under the Loan Agreement, to guarantee payment of the sums due under the Loan Agreement, and agreed to deposit £22.5 million with Janus in a deposit account as security for the guarantee.  Clause 5 provided for a corresponding release and repayment from the deposit account when Janus received payment of any principal under the Loan Agreement from the borrower.  Janus also agreed to pay R & D interest on the deposit at a rate equal to the aggregate of LIBOR and a spread equal to one half of the spread under the Loan Agreement.  The spread element of the interest was again to be discharged by payment of a lump sum (of £191,825) on drawdown. By clause 6.2 R & D directed that the LIBOR element of the interest should be applied by Janus in settlement of the LIBOR element of the interest due from the borrower under the Loan Agreement.  Clause 7 provided that the amount in the deposit should never be less than the principal amount outstanding from the borrower to Janus under the Loan Agreement, and clause 8 provided that the sum held in the deposit account would be repayable to R & D only to the extent that funds were received by Janus from the borrower.
55.	By the Collateral Agreement MCashback agreed, in consideration of R & D entering into the Guarantee and Deposit Agreement, to deposit £22.5 million with R & D in a collateral security account.  It was agreed that R & D could use this money to fund the deposit under the Guarantee and Deposit Agreement, and that R & D could reduce the balance outstanding to MCashback on the security account pro tanto as and when R & D was called on to honour the Guarantee and Deposit Agreement.  Conversely, repayments by Janus to R & D would lead to a corresponding release to MCashback from the security account.  Clause 4.2 provided that the amount in the security account would not be repayable in any other circumstances.  Clause 5 provided that the sum deposited by MCashback would bear interest at a rate equal to LIBOR (with no spread), but MCashback directed that the interest should be applied by Janus (my emphasis) in settlement of the LIBOR element of the interest due from the borrower under the Loan Agreement.
56.	The effect of these complex and interlocking provisions was no doubt intended to be that on drawdown the £22.5 million would pass in a circle, as follows:
(a)	from Janus to Tower MCashback Finance UK2 Ltd, pursuant to the Loan Agreement; 
(b)	from Tower MCashback Finance UK2 Ltd to the members of LLP 2, such as Mr Donaldson, pursuant to their individual loan agreements with that company;
(c)	from the members to LLP 2, representing 75% of their subscriptions and as an addition to the 25% which they had already subscribed from their own resources;
(d)	from LLP 2 to MCashback, as part of the purchase price for the software of £27.501 million;
(e)	from MCashback to R & D, as the deposit pursuant to the Collateral Agreement; and
(f)	from R & D  back to Janus, as the deposit pursuant to the Guarantee and Deposit Agreement.
57.	So far as concerns the LIBOR element of the interest, both banks would be “flat”, i.e. their liability would be matched by a corresponding entitlement; while the liability of Tower MCashback Finance UK2 Ltd to pay such interest to Janus would be discharged on its behalf by MCashback pursuant to the direction in clause 5.2 of the Collateral Agreement.   The borrowing by the individual members (at stage (b) in the chain) was interest-free and non-recourse, save in the event of default; and even then each member’s exposure was limited to enforcement of the charge given by him over his interest in the LLP.
58.	The spread element of the interest, as between Tower MCashback Finance UK2 Ltd, Janus and R & D, was dealt with in the way I have described, by lump sum payments up front which were non-refundable and accepted in full and final settlement of the entitlement to such interest.
59.	The term of the loan by Janus to Tower MCashback Finance UK2 Ltd was 10 years from drawdown, and it was repayable in full on that date.  However, the two security deposits would in practice ensure that repayment was made in all but exceptional circumstances, and the Loan Agreement provided that Janus was to have recourse to the security deposit placed with it by R & D before taking any enforcement action against the borrower. 
60.	I have thought it necessary to examine these documents in some detail, because the summary in paragraph 37 of the Decision is very compressed and also contains a number of inaccuracies.  For example, it is said that the loans to the investor members were filtered through Tower Project Finance LLP (“Tower Finance”), whereas the intermediary companies were in fact special purpose vehicles such as Tower MCashback Finance UK2 Ltd. Tower Finance was a company in the Tower group which acted in an advisory capacity, and entered into fee agreements with LLP 1 and LLP 2 in July 2004.
61.	Rather surprisingly, the Special Commissioner made no detailed findings of fact relating to the completion of the SLA between MCashback and LLP 2.  However, he noted in paragraph 52 that completion of the contracts with LLP 1 and LLP 2 took place in January 2005, and I was informed by counsel for the taxpayers that the date of completion was in fact 11 January.  I do not understand this to be disputed by HMRC.  Furthermore, although the Special Commissioner was evidently concerned about many features of the scheme, it seems fairly clear to me that he accepted the reality of the transactions which had ostensibly taken place, and was not prepared to hold that any of them were sham.  I will need to return to the concerns expressed by the Special Commissioner later in this judgment, but for now I draw attention to what he said in paragraphs 128 and following:
“128. Nothing in the previous paragraphs is dependent on disregarding any transactions that have been undertaken. My analysis is not that the actual transactions should be disregarded and that there should instead be deemed to be loan backs directly from MCashback, or indeed that the transaction should be treated as an instalment sale. I entirely accept that what was, in substance, an instalment sale was actually implemented as an outright sale, accompanied by a loan back that was non-recourse, and ultimately to be discharged by the lenders, all filtered through two banks for no real purpose other than to try to disguise the reality of what was happening.  It thus follows that I accept that, in so far as the borrowers bore the cost of interest payable to the banks, nothing detracts from the technicality that the members had borrowed from banks and indeed paid interest to those banks.
…
131. I find it difficult to decide whether the transaction in the present case was a sham or not.  I naturally accept that software was sold, and I also accept that, in the fullness of time, the software might become very valuable and successful, generating high revenues. I also accept that the people who produced the business case figures might have done so honestly, albeit very optimistically, and there was certainly no actual evidence to suggest that there was a conspiracy to ramp up the value of the asset in order to increase the available allowances. I do however consider it clear that the parties paid no attention to verifying the real figures, because everyone knew that the non-recourse loans would make everyone indifferent to whether the figures were correct or not. It accordingly follows that in my view the figure given as price was appreciated to be a figure that no one would have considered paying outright; it was appreciated that in economic reality no one was paying the price outright, and it was appreciated that the higher figure would simply increase the up front allowances.
132. On the sham point, I do not suggest that the whole transaction can be set aside in any way … ”
The Law
62.	The leading case in this area is now the decision of the House of Lords in BMBF, [2004] UKHL 51, [2005] 1 AC 684, delivered on 25 November 2004 after a two day hearing in October.  The House of Lords upheld the decision of the Court of Appeal (Peter Gibson, Rix and Carnwath LJJ) [2002] EWCA Civ 1853, [2003] STC 66, who had reversed the decision of Park J at first instance and the decision of the Special Commissioners.  The importance of the case for present purposes is that it dealt with a claim for capital allowances under section 24(1) of the Capital Allowances Act 1990 (“CAA 1990”), which was in substantially similar terms to section 11(1) and (4) of CAA 2001 (the long title of CAA 2001 says that it was “An Act to restate, with minor changes, certain enactments relating to Capital Allowances”).
63.	The taxpayer company, BMBF, was a member of the Barclays group and carried on the trade of finance leasing.  In 1993, in the course of that trade, it bought a gas pipeline from an Irish statutory corporation, BGE, for approximately £91 million, and immediately leased it back to BGE.  The pipeline was then sub-let by BGE to a UK subsidiary, BGE (UK), and the two companies entered into a transportation agreement and ancillary documentation with complex payment terms designed to ensure that BGE (UK) would always have sufficient funds to meet the rent payable to BGE under the sub-lease.
64.	The decision of the House of Lords was contained in a single opinion delivered by Lord Nicholls, to which the other four members of the committee (Lord Steyn, Lord Hoffmann, Lord Hope and Lord Walker) had all contributed.  In paragraph 13 Lord Nicholls said that there would have been no dispute about BMBF’s entitlement to capital allowances if there had been no more to the transaction than the outline facts which I have summarised above.  However, those facts formed part of a larger scheme devised by BZW, which was itself another company in the Barclays group.  The key features of that scheme are summarised in paragraphs 14 to 17.  Although described as “security arrangements” from the perspective of BMBF, the Revenue said that viewed as a whole they were not security arrangements, and neutralised the effect of the transaction in a way which took it outside section 24(1).  The result of the arrangements (see paragraph 17) was that the £91 million which BMBF had borrowed from Barclays Bank in order to purchase the pipeline went in a circle, from Barclays Bank to BMBF, from BMBF to BGE, and then via two further companies in Jersey and the Isle of Man back to Barclays Bank again. Lord Nicholls continued at 692B:
“The effect, as Park J said, was that BGE, having sold the pipeline, was unable to get its hands on the purchase price.  It had to remain on deposit with Deepstream [the Jersey company] and be paid out, year by year, partly (in the form of A payments) to discharge the liability for rent under the lease and partly (in the form of B and C payments) for the benefit of BGE.  And the benefit obtained by BGE was entirely attributable to BMBF being able to pass on the benefit of its capital allowances.”
65.	The Special Commissioners had found that the scheme was pre-ordained and designed as a composite whole.  There was no challenge to that finding.  However, the circularity of the payments was not an essential part of the scheme, because the security arrangements might have been provided by a bank other than Barclays.  Lord Nicholls said at 692D:
“The terms upon which BMBF bought and leased back the pipeline were commercial terms negotiated at arms’ length and, as a matter of history, the scheme originally contemplated that a company outside the Barclays group would be the purchaser and lessor. Likewise, the terms upon which Barclays Bank provided the guarantee were ordinary commercial terms.  It could have been provided by a different bank without affecting the way in which the scheme worked.  In fact, however, the payments did circulate within the Barclays group.”
66.	Against this background, the Special Commissioners took the view that even if BMBF could be said to have incurred expenditure when it paid the £91 million to BGE, it could not be said to have been expenditure on the pipeline, because it achieved no commercial purpose.  They held that the purpose of the expenditure was not to acquire the pipeline, but rather to obtain capital allowances which would result ultimately in a profit to BGE and fees payable to BMBF and BZW.  They said that the transaction “had no commercial reality”.  Park J agreed, holding that in the light of the Ramsay principle the expenditure of the £91 million was not really incurred on the provision of the pipeline, but rather 
“on the creation or provision of a complex network of agreements under which, in an almost entirely secured way, money flows would take place annually over the next 32 or so years so as to recoup to BMBF its outlay of £91 million plus a profit.”
67.	Lord Nicholls then commented in paragraph 24:
“The special commissioners and the judge therefore considered that BMBF did not incur expenditure of £91 million in the provision of a pipeline for the purposes of its finance leasing trade because the transaction lacked commercial reality.  The judge went so far as to say that the existence of the pipeline and the amount of the consideration were irrelevant.  Because of the circularity of the payments, the scheme would have worked just as well whatever price had been named in the documents and whether there had actually been a pipeline or not.”
68.	The House of Lords then proceeded to give important guidance on the Ramsay principle, which is by now so well-known that I need not cite it. I will, however, quote the final paragraphs, in which Lord Nicholls stated the  conclusions of the House as follows:
“39. The present case, like MacNiven [MacNiven v Westmoreland Investments Ltd [2001] UKHL 6, [2003] 1 AC 311], illustrates the need for a close analysis of what, on a purposive construction, the statute actually requires.  The object of granting the allowance is, as we have said, to provide a tax equivalent to the normal accounting deduction from profits for the depreciation of machinery and plant used for the purposes of a trade.  Consistently with this purpose, section 24(1) requires that a trader should have incurred capital expenditure on the provision of machinery or plant for the purposes of his trade.  When the trade is finance leasing, this means that the capital expenditure should have been incurred to acquire the machinery or plant for the purpose of leasing it in the course of the trade.  In such a case, it is the lessor as owner who suffers the depreciation in the value of the plant and is therefore entitled to an allowance against the profits of his trade.
40.  These statutory requirements, as it seems to us, are in the case of a finance lease concerned entirely with the acts and purposes of the lessor.  The Act says nothing about what the lessee should do with the purchase price, how he should find the money to pay the rent or how he should use the plant. As Carnwath LJ said in the Court of Appeal [2003] STC 66, 89, para 54: 
“There is nothing in the statute to suggest that “up-front finance” for the lessee is an essential feature of the right to allowances.  The test is based on the purpose of the lessor’s expenditure, not the benefit of the finance to the lessee.”
41. So far as the lessor is concerned, all the requirements of section 24(1) were satisfied.  Mr Boobyer, a director of BMBF, gave unchallenged evidence that from its point of view the purchase and leaseback was part of its ordinary trade of finance leasing.  Indeed, if one examines the acts and purposes of BMBF, it would be very difficult to come to any other conclusion.  The finding of the Special Commissioners that the transaction “had no commercial reality” depends entirely upon an examination of what happened to the purchase price after BMBF paid it to BGE.  But these matters do not affect the reality of the expenditure by BMBF and its acquisition of the pipeline for the purposes of its finance leasing trade.
42. If the lessee chooses to make arrangements, even as a preordained part of the transaction for the sale and lease back, which result in the bulk of the purchase price being irrevocably committed to paying the rent, that is no concern of the lessor.  From his point of view, the transaction is exactly the same.  No one disputes that BMBF had acquired ownership of the pipeline or that it generated income for BMBF in the course of its trade in the form of rent chargeable to corporation tax.  In return it paid £91m.  The circularity of payments which so impressed Park J and the special commissioners arose because BMBF, in the ordinary course of its business, borrowed the money to buy the pipeline from Barclays Bank and Barclays happened to be the bank which provided the cash collateralised guarantee to BMBF for the payment of the rent.  But these were happenstances. None of these transactions, whether circular or not, were necessary elements in creating the entitlement to the capital allowances.
43. For these reasons, which are substantially the same as those of the Court of Appeal, we would dismiss this appeal.”
69.	The judgments in the Court of Appeal of Peter Gibson and Carnwath LJJ (with the former of whom Rix LJ agreed) also repay careful study, but to avoid unduly lengthening this judgment I will confine myself to two citations.  
70.	In paragraph 37 Peter Gibson LJ pointed out that the purpose of the capital allowances legislation “would appear to be to encourage the expenditure of capital on plant and machinery”.  He then said at [2003] STC 84e:
“Section 24 focuses on the incurring of expenditure by the trader on the provision of plant or machinery wholly and exclusively for the purposes of his trade.  It therefore requires one to look only at what the taxpayer did.  To the test posed in section 24 it is immaterial how the trader acquires the funds to incur the expenditure or what the vendor of the provided plant or machinery does with the consideration received.  Provided that the expenditure is incurred on the provision of plant or machinery and is so incurred wholly and exclusively for the purposes of the trader’s trade, subject to section 75(1) [the forerunner of the anti-avoidance provisions now contained in sections 214 to 218 of CAA 2001] it is irrelevant to the operation of section 24(1) whether or not the trader’s object is or includes the obtaining of capital allowances.  The express reference in section 75(1)(c) [now section 217] to the disallowance of a first-year allowance where the sole or main benefit that might have been expected to accrue was the obtaining of an allowance suggests that save in a case to which that provision applies, the expectation of, or the intention to obtain, such benefit is not a reason for denying the capital allowances.”
71.	For his part, Carnwath LJ stressed in paragraph 55 that it is “the viewpoint of the taxpayer … to which the section directs attention”.  In paragraph 57 he criticised the view of Park J that the pipeline transaction could be disregarded as simply “the fifth wheel of the coach”, and continued:
“I find that difficult to follow, even if one looks at the BZW scheme as a whole.  One cannot ignore the reality of the pipeline, nor can one ignore the fact that ownership was transferred to BMBF, with whom it remains, and that leases were granted to BGE and BGE (UK).  On any view, those are real transactions with lasting consequences in the real world.
58. There might be more room for argument as to whether there was “expenditure” given the apparent circularity of the payments.  However, once one accepts the transfer of ownership, it is difficult to question the reality of the expenditure by which the purchase price was discharged.  Furthermore, BMBF gave evidence that it financed the purchase price in the normal way by a loan from its parent bank, in accordance with its standard drawing facility, and that it was not concerned with the security arrangements made by the bank.  There is no indication that this evidence was disbelieved.
59.  In any event, there seems to me a close analogy with the issue, which was decided by the House of Lords in MacNiven. The ratio was that, for the purposes of section 338 of [ICTA 1988], there had been “payment” of yearly interest, in the ordinary meaning of that term, and that the Ramsay principle could not alter that simple fact. This was explained succinctly by Lord Nicholls of Birkenhead … at [15]:
“In the ordinary case the source from which a debtor obtains the money he uses in paying his debt is immaterial for the purpose of section 338.  It matters not whether the debtor used cash-in-hand, sold assets to raise the money, or borrowed money for the purpose.  Does it make a difference when the payment is made with money borrowed for the purpose from the very person to whom the arrears of interest are owed? In principle, I think not.  Leaving aside sham transactions, a debt may be discharged and replaced with another even when the only persons involved are the debtor and creditor.  Once that is accepted, as I think it must be, I do not see it can matter that there was no business purpose other than gaining a tax advantage.  A genuine discharge of a genuine debt cannot cease to qualify as payment for the purpose of section 338 by reason only that it was made solely to secure a tax advantage.  There is nothing in the language or context of section 338 to suggest that the purpose for which a payment of interest is made is material.”
Similarly, under the BMBF transaction, BMBF obtained ownership of a pipeline and incurred an obligation to pay for it. That obligation was discharged by the expenditure of the £91 million. There is nothing in the section to suggest that it matters what is the source of the £91 million, or alternatively what is to be done with the £91 million by the recipient, once the obligation has been discharged.”
Discussion
72.	In the light of the principles laid down in BMBF and MacNiven, there cannot in my judgment be any real doubt about the answer to the Expenditure Issue. The whole of the purchase price of £27.501 million was expended by LLP 2 on the acquisition of the software, and it was not expended on anything else. The purchase price was negotiated at arms’ length between wholly unconnected parties, largely on the basis of the information and projections in the Business Report, which were themselves the subject of a limited warranty given by MCashback in the SLA.  Title to the licensed software rights passed to LLP 2, and (subject to the Conditional Contract Issue, which I will consider in due course) no further steps had to be taken after completion in January 2005 in order to perfect LLP 2’s ownership of those rights.  What happened to the purchase price of £27.501 million after it had been paid by LLP 2 to MCashback is immaterial, because section 11 of CAA 2001 “requires one to look only at what the taxpayer did” (BMBF in the Court of Appeal, per Peter Gibson LJ at para 37). As he went on to say, “To the test posed in section 24 [now section 11 of CAA 2001] it is immaterial how the trader acquires the funds to incur the expenditure or what the vendor of the provided plant or machinery does with the consideration received”.  See too the judgment of the House of Lords at para 40 (“The Act says nothing about what the lessee should do with the purchase price, how he should find the money to pay the rent or how he should use the plant”), and para 42 (what matters is that BMBF had acquired ownership of the pipeline, and that it generated income for BMBF in the course of its trade in the form of rent chargeable to corporation tax).  Similarly in the present case, what matters is that LLP 2 had acquired ownership of the licensed rights in return for its payment of £27.501 million, and those rights then generated income in the form of a share of clearance fees which were chargeable to income tax in the hands of the members.
73.	The circularity of the money movements in relation to the £22.5 million borrowed from Janus, and the fact that MCashback was required to deposit that amount (equivalent to nearly 82% of the purchase price) as security with R & D, on terms whereby the interest was indirectly used to fund the borrowing of the members through Tower MCashbank Finance UK2 Ltd, is in my judgment irrelevant, just as the comparable features of the composite scheme in BMBF which led Park J and the Special Commissioners to conclude as they did in that case were irrelevant, in view of the fact that the legislation on its true construction focuses only on the position of the purchaser.
74.	With every respect to the Special Commissioner, it seems to me that a combination of errors distracted him from the true question and led him to substitute an approach of his own devising which was not only unwarranted by the facts but also sought to substitute taxation on the basis of an economically equivalent transaction for taxation on the basis of what the parties actually did. 
75.	In the first place, although the Special Commissioner considered some of the relevant authorities towards the end of the Decision, he did so only after he had provisionally reached the conclusion which he favoured, and to test whether they precluded him from so deciding (see paragraph 148).  This was in my view to approach the question the wrong way round, and it may have contributed to the astonishing fact that he did not consider BMBF “to be of any relevance to the facts of this case” (paragraph 159).  I can only conclude that he must have misunderstood, or at least failed to appreciate the significance of, the principles of law which were so clearly established by BMBF.
76.	Secondly, the Special Commissioner was heavily influenced throughout by what he considered to be the “fictitious” and “wrong” pricing of the software, and the fact that (as he saw it) it was grossly over-valued. He discusses this aspect of the case at great length, and returns to it a number of times, expressing his conclusions in colourful and sometimes contradictory terms.  Two points in particular appear to have impressed him.  First, he considered the valuation evidence of Mr Brewer (who gave evidence for the LLPs) to be flawed and unreliable, and had “no hesitation whatsoever in concluding that the market value of the software acquired by [the LLPs] was very materially below the price ostensibly paid for it” (paragraph 99). At the same time, however, he “[did] not purport to have any clear idea what the 13% interest in the software was worth in 2004”, and he had “heard no evidence that could enable an experienced valuer, let alone me, to make that judgment” (paragraph 108, first bullet point). Secondly, he regarded the circular financing, the making of non-recourse loans to the members, and the indirect use of 80% of the purchase price to secure the borrowing, as artificial features which “enabled the price for an untried asset to be ramped-up to a figure far in excess of its value” (paragraph 112) and which demonstrated “that the loans were extraordinarily un-commercial” (paragraph 124).
77.	In my judgment there are several difficulties with this analysis, of which the most important is that the market value of the software is completely irrelevant to the Expenditure Issue, once the contention that the purchase price was paid for something other than the software has been eliminated.  As between unconnected parties who negotiate a price for plant at arms’ length, it is the amount paid for the acquisition of the plant which fixes the amount of the capital allowance.  That is the effect of the relevant wording in sections 4, 11 and 52 of CAA 2001, including in particular section 11(4)(a) which says that expenditure is qualifying expenditure if it is capital expenditure on the provision of plant. The legislation only introduces a restriction on the amount of the allowance by reference to the market value of the plant in cases where the anti-avoidance provisions in sections 214 to 216 apply, dealing respectively with transactions between connected persons, transactions where obtaining an allowance is the sole or main benefit in prospect, and (as in BMBF) transactions where there is a sale and leaseback.  In those cases, FYAs are excluded by section 217, and section 218 also provides that any expenditure in excess of the market value of the plant or machinery is to be left out of account. It has never been suggested in the present case that any of these anti-avoidance provisions apply.  Accordingly, as I have said, the market value of the software is irrelevant, save in so far as it may throw light on the contention that the money was in fact paid for something other than the software.  
78.	That apart, however, I am in any event satisfied that the Special Commissioner’s criticisms of Mr Brewer’s evidence are largely unfounded, and betray a fundamental confusion between the prediction of future income and the valuation of predicted income.  Mr Brewer was not asked to predict the future income stream that would be derived from the MRewards system.  That was the function of the Business Report, and he was instructed to take those figures as his starting point.  What he was asked to do was to place a present value on that predicted income stream, with a view to confirming (or otherwise) that a fair and reasonable price had been agreed for the software.  In the course of his valuation Mr Brewer applied a number of variables, including a discount for risk.  The Special Commissioner illegitimately sought to use this discount factor in order to substitute his own prediction of a “safe return” on the investment by the LLPs for the projections in the Business Report, and then to conclude from this that the figures in the Business Report were grossly inflated, unreal, fictitious, and (on one occasion) “away with the fairies” (see paragraph 136). I do not propose to deal with this question in any detail, since (as I have explained) I consider the question of valuation to be irrelevant to the Expenditure Issue.  However, I should record that I agree with the submission of counsel for the LLPs that the approach adopted by the Special Commissioner in paragraphs 74 to 76 of the Decision is fundamentally misconceived.
79.	The Special Commissioner’s failure to identify the relevant principles of law before embarking on his analysis of the facts is reflected in the fact that he started his discussion of the question by setting out “four possible approaches” in paragraph 98 of the Decision.  Those approaches were stated by him as follows (I will again substitute numbered sub-paragraphs for his bullet points):
“(1) the first approach would be that the gross capital expenditure incurred was within the range of the genuine and sustained market value of the acquired software; nothing should thus turn on the separate provision of loan finance; and the LLPs should thus be able to claim capital allowances (whether 100%, 50%, 40% or writing down allowances) by reference to the full price paid;
(2) the second approach would be that the market value of the acquired software might be materially lower than the price paid for it in this case, but that nevertheless the LLPs should still be entitled to claim capital allowances by reference to the full price paid because, whilst the LLPs might only have paid that price because of the non-recourse loans provided to the members to contribute their capital, the LLPs have nevertheless paid the full price for the software and nothing can adjust that analysis for tax purposes;
(3) the third approach would be that because there is a wide disparity between the price paid for the software by the LLPs and the genuine value of the software, the LLPs must be analysed to have purchased two things, namely software and beneficial finance, with the price being allocated between the software and the beneficial finance filtered back to the contributing members of the LLPs (the suggested split advanced by HMRC in relation to this, their principal case, being 25% and 75%); and
(4) the fourth approach would be to treat expenditure as incurred for capital allowance purposes as and to the extent that capital was provided by the members to pay the price for the software on an outright basis, initially thus being confined to 25% of the price paid, but subsequently including further amounts as and when and to the extent that 50% of designated revenues paid off the members’ borrowings.”
The Special Commissioner then proceeded to consider these four approaches in turn.  
80.	The first approach is in my judgment wrong in principle, because it treats the question of market value as determinative of whether the expenditure is allowable.  It follows that the discussion of market value in paragraphs 99 to 109 is completely irrelevant to the Expenditure Issue, quite apart from the fact that it contains a number of unjustified criticisms of Mr Brewer’s evidence.  
81.	The second approach is in my judgment the correct one as a matter of law. The Special Commissioner was, however, again led to reject it by his view that the price paid was far in excess of the value of the software: see paragraphs 111 and 112.  The logic of this approach, assuming it to have been justified on the facts, would presumably be that he should then have accepted the third approach.  However, in his discussion of the third approach he pointed out a number of difficulties which it faced, and recognised (in my view correctly) that there was (at the lowest) a real possibility that the clearing fees derived from the software would be sufficient to ensure that at least some of the 75% loan finance was repaid: see in particular paragraph 121. Accordingly it would be unrealistic to regard the 25% which was not borrowed as the only consideration paid for the software.  As he rightly said at the end of paragraph 121, “to leave the Appellants with potential tax liabilities on all the income, with no hope of sustaining further claims for allowances seems an unrealistically harsh result”; and see too paragraph 65, where the same point is made even more forcibly.
82.	Having rejected the first, second and third approaches, the Special Commissioner was left by elimination with his favoured fourth approach. He discussed it at considerable length in paragraphs 122 to 147, before turning in paragraphs 148 to 161 to considering whether the authorities precluded him from adopting it. Despite the length of this discussion, however, I have to say that I find it very difficult indeed to understand his reasoning.  He appears to have considered that the transaction had an underlying “reality” which differed from what was actually done.  Yet he was not prepared to disregard any of the actual transactions, and he accepted (rightly) that the transaction was not in fact structured as an instalment sale (see paragraph 128).  In those circumstances the nature of the supposed underlying reality of the transaction seems to me entirely elusive, and the use of colourful but imprecise metaphors to describe it obscures rather than illuminates the issue (see in particular paragraphs 128, 132 and 138). In paragraph 138 the Special Commissioner appeals to a supposed “purposive basis” to justify his conclusion, and talks of the “legal reality” as opposed to the “discredited labels attached to the transactions by the parties”. But BMBF shows that the only relevant purpose is that of the party who incurs the expenditure, here LLP 2; and in the absence of any clear and intelligible finding of sham I can discern no proper basis for concluding that LLP 2’s expenditure of £27.501 million on the software was anything other than what it purported to be.  In order to say that the wrong label has been attached to a transaction, it is first necessary to identify with clarity the transaction which is said to have been misdescribed.  In my respectful judgment the Special Commissioner nowhere succeeds in doing that.
83.	I am also unable to accept his view that the transaction was in some way equivalent in economic terms to a sale of the software for a purchase price payable by instalments.  There were some similarities with such a transaction, but there were also important differences, not least the fact that the whole of the purchase price was payable on completion, albeit financed as to 75% by limited-recourse loans.  Furthermore, even if the Special Commissioner’s view were correct, it is by now well established that a taxpayer must be taxed by reference to what he has actually done, and not by reference to some different transaction with the same or similar economic effect: see for example MacNiven at  para 60 per Lord Hoffmann.     
84.	The Special Commissioner was also influenced by his view that there was no commercial justification for the insertion of the two banks into the transaction. He was in my judgment fully entitled, having heard and considered the oral evidence, to conclude that the reasons advanced for the inclusion of the banks were of no substance (see paragraphs 66 and 67), and that they were in fact interposed for tax reasons (see paragraph 127).  It is indeed a fairly obvious inference from the tax advice given by Mr Soares (see paragraph 48 above) that this was the reason for involving the banks, because it was thought desirable to avoid a direct loan-back of part of the proceeds of sale.  It is entirely understandable that such a view should have been taken, in the period of uncertainty between the decision of the Court of Appeal in BMBF and the hearing of the Revenue’s appeal in the House of Lords. However, it does not follow from this, as the Special Commissioner seems to have assumed in paragraph 127, that the involvement of the banks should therefore be disregarded, or that the underlying reality of the transaction had thereby been disguised.  The only real transaction was the one which, in the event, the parties actually carried out, and which included the involvement of the two banks.  In some statutory contexts, the Ramsay approach may, as a matter of construction of the relevant provisions, enable artificially inserted steps to be disregarded in the process of applying the relevant legislation to the facts.  But the legislation relating to capital allowances, as expounded by the House of Lords in BMBF, is resistant to such an approach, because it focuses attention solely on the position of the purchaser, and the wider financing arrangements are irrelevant so long as the purchaser actually incurs expenditure on acquiring the plant for the purposes of his trade.  
85.	Counsel for HMRC submitted that the present case could be distinguished from BMBF, because the circular movements of money in BMBF were the product of “happenstance” and the loan arrangements were made on fully commercial terms.  He argued that the banks had been inserted into the chain in the present case for tax reasons, and pointed out that no evidence had been adduced from the banks as to the commerciality of the arrangements, even though Mr Soares had recommended this in paragraph 105 of his Opinion.  I accept that there are distinctions between the facts of the present case and those of BMBF, and I would agree that in the absence of evidence from the banks the Special Commissioner was entitled to be sceptical about the commerciality of the arrangements into which they entered.  It seems to me, however, that none of this advances the Revenue’s case, because it does not impinge on the narrow question whether LLP 2 incurred the relevant expenditure on the acquisition of the software.  An analogy may be drawn at this point with the facts of MacNiven, in the context of the closely comparable question whether the taxpayer in that case had made a payment of the interest which it owed to its parent.  The transaction by which it was put in funds to make the payment could hardly have been more uncommercial.  The taxpayer was a heavily insolvent company, and it was lent the money to make the payment by its parent, which was the creditor to whom the debt was owed. Nevertheless, these features did not detract from the fact that the interest in question was paid, and for the purposes of the relevant statutory provision (section 338 of ICTA 1988) that was all that mattered.
86.	I hope I have now said enough to explain why in my judgment the Special Commissioner’s conclusion on the Expenditure Issue cannot stand, and in the absence of a finding of sham the only conclusion open to him was that the whole of the consideration for the software, when it was paid on completion of the SLA in January 2005, was expenditure incurred on the provision of plant within the meaning of section 11 of CAA 2001.
The Trading Issue
87.	The question for determination under this heading is whether LLP 1, which was incorporated on 30 March 2004, had begun to carry on a trade before the end of the tax year 2003/04, that is to say by midnight on 5 April 2004.  For the reasons which he gave in paragraphs 88 to 97 of the Decision, the Special Commissioner concluded that LLP 1 had not commenced any trade by that date.  It was unnecessary for him to decide precisely when LLP 1 began to trade, because HMRC conceded that both LLP 1 and LLP 2 had begun to trade in the course of the following tax year, 2004/05, and the availability of capital allowances for that year does not depend on the exact date when the trade had started.  It was enough that the trade began to be carried on at some point during the year.
88.	The statutory language which has to be applied in answering this question is section 11(1) of CAA 2001, which says that allowances are available under Part 2 of the Act “if a person carries on a qualifying activity and incurs qualifying expenditure”.  Qualifying activities are defined in section 15, and include “a trade”: section 15(1)(a).  Other examples of qualifying activities are an ordinary Schedule A business, a profession or vocation, the management of an investment company, and an employment or office.  Each such activity is, however, subject to the proviso at the end of section 15(1) which reads:
“but to the extent only that the profits or gains from the activity are, or (if there were any) would be, chargeable to tax.”
89.	It is also material to note section 12, which says that for the purposes of Part 2:
“expenditure incurred for the purposes of a qualifying activity by a person about to carry on the activity is to be treated as if it had been incurred by him on the first day on which he carries on the activity.”
The legislation therefore expressly envisages that a person may incur expenditure on the provision of plant or machinery for the purposes of a trade or other qualifying activity that he intends, but has not yet begun, to carry on. In those circumstances the prospective trader does not forfeit entitlement to capital allowances, but is treated as if he had incurred the expenditure on the first day when he begins to carry on the activity.  This provision seems to me to be important for three reasons.  First, it recognises that there may be a distinction, at least in some cases, between the acquisition of plant or machinery by way of preparation for a trade or other qualifying activity which is to be carried on in the future, and the actual carrying on of the trade of activity.  Secondly, and by the same token, there is no reason to stretch the concept of “carrying on” to include activities which are merely preparatory to the commencement of the activity, because expenditure at the preparatory stage can still qualify for allowances so long as the activity is in fact subsequently carried on.  Thirdly, section 12 appears to me to reflect an underlying principle of fiscal symmetry, whereby relief should not in general be given for capital expenditure on plant or machinery until it is actually being used for the purposes of an activity which will, at least potentially, generate taxable income or gains: compare the proviso at the end of section 15(1).  In the context of a trade, it seems to me that a person cannot normally be said to be carrying it on within the meaning of section 11 if he is not yet in a position to start turning the business to account, or operating it, in a way that is designed (at least ultimately) to yield a profit.  
90.	There is no suggestion that LLP 1 has ever carried on any qualifying activity apart from a trade.  Accordingly, the question is whether LLP 1 began to carry on its trade in the course of the seven days between its incorporation on 30 March 2004 and the end of the tax year on 5 April.  The only activities that are relied upon by LLP 1 as constituting the carrying on of a trade before the end of the 2003/04 tax year are:
(a) the entry into the relevant SLA with MCashback on 31 March 2004; and
(b) some preliminary marketing or promotional activities by Mr Marsden in February and March 2004.
91.	Under the relevant SLA, LLP 1 agreed to purchase a license of the code generation software from MCashback for £7,334,000 payable on completion, which was initially scheduled to take place on 30 April 2004.  In return, LLP 1 would become entitled from the date of completion to 0.66% of the gross clearing fees generated from the exploitation of the MRewards technology. It is important to note that there was never any question of the code generation software being exploited by itself, or by LLP 1 alone.  It was always envisaged that the system as a whole would be operated by MCashback and the LLPs, pursuant to Collaboration and Operating Agreements.  Neither the software licensed to the four LLPs nor the software retained by MCashback could function independently, and the proposed business model was for the joint exploitation and development of the technology under the direction and management of a committee with members appointed both by the LLPs and by MCashback.  However, these agreements had not progressed beyond draft stage by 6 April 2004, and the Collaboration Agreement was not in fact signed until more than one year later, on 16 May 2005.  Furthermore, completion of the SLA itself was also delayed and did not take place until 12 January 2005.
92.	In the light of these facts alone, it is in my judgment plain that LLP 1 could not have begun to carry on a trade within the meaning of section 11 on or before 5 April 2004.  All it had done was to enter into a contract to acquire an asset which it intended to use in due course for the purposes of a trade of exploiting the licensed software, on terms still to be agreed with MCashback and its fellow LLPs.  The entry into the SLA was a step preparatory to the carrying on of a trade.  It was not a step taken in the course of a trade which had already begun, nor was it a step which itself marked the commencement of trading.  Until terms had been agreed, it could not in my view be said that LLP 1 was in a position to start turning the licensed software to account, or that it had in any meaningful sense started to trade.
93.	As I read paragraphs 90 to 91 of the Decision, these were essentially the considerations which led the Special Commissioner to conclude (at the end of paragraph 91) that the fact of having entered into the SLA “did not mean that LLP 1 had thereby commenced its trade”. He also referred to the decision of another Special Commissioner, Mr Charles Hellier, in Mansell v HMRC [2006] STC (SCD) 605, where it was held that the taxpayer began trading when he entered into a formal option agreement to buy an interest in land, with a view to its development and use as a motorway service station.  The Special Commissioner in the present case distinguished Mansell on two grounds: first, he said that “options to acquire land are regularly traded”; and secondly, he said that the acquisition of the option “resulted in the taxpayer actually acquiring his stock-in-trade that he intended to realise”.  
94.	Mansell was not a case concerned with capital allowances, but with the different question whether the taxpayer’s trade had been “set up and commenced” before 6 April 1994 within the meaning of transitional provisions relating to the introduction of the change from the preceding year basis to the current year basis in assessing the trading profits of individual traders: see sections 210 to 218 of the Finance Act 1994, and in particular section 218(1).  In a valuable discussion in paragraphs 88 and following of his decision, Mr Hellier referred to the fitful guidance to be obtained from earlier authorities (none of which deals directly with the question when a trade commences), and concluded that in his view a trade commences “when the taxpayer, having a specific idea in mind of his intended profit making activities, and having set up his business, begins operational activities”.  He went on to say that by operational activities he meant dealings with third parties immediately and directly related to the supplies to be made which it is hoped will give rise to the expected profits, and which involve the trader putting money at risk.  
95.	It is unnecessary for me to say whether I would have reached the same conclusion on the facts as Mr Hellier did in Mansell, but in broad terms I find his test of the beginning of operational activities a useful one.  Every case will turn on its own facts, but in general the test presupposes that the framework or structure for the trade will have to be set up or established before any operational activity can begin.  Mr Hellier gave as examples of setting up a trade such matters as the purchase of plant, and organisation of the decision making structures, the management and the financing (see paragraph 88).  In my judgment a similar approach is helpful in answering the question whether a trade is being carried on for the purposes of CAA 2001 section 11, and the present case falls clearly on the pre-trading side of the line because the SLA amounted to no more than a contract for the acquisition of plant at a time before any decision-making, financial or management structure for the intended trade had been put in place.  
96.	The promotional activities of Mr Marsden seem to me to take matters no further, for at least two reasons.  First, the activities in question (discussions with Mr Gildersleeve of Tesco about how the LLPs could assist MCashback in promoting the system, and some discussions in California at a time when Tower was also promoting some film schemes) must have taken place before LLP 1 was incorporated – at any rate, there is no evidence that any of them took place in the week after its incorporation and before the end of the tax year.  Accordingly it is impossible for that reason alone to regard them as activities in the course of a trade carried on by LLP 1.  A corporate entity cannot trade, or indeed do anything, before it has a separate legal existence.  Secondly, and in any event, the evidence about these activities in Mr Marsden’s witness statements shows that the discussions, both with Tesco and in California, were of a very preliminary character, and did not result in any contracts.  This evidence was not fleshed out in cross-examination, and whether taken alone or in conjunction with the entry into the SLA it does not in my judgment begin to provide a solid foundation for the contention that LLP 1 had started trading before 6 April 2004.  
97.	Mr Goodfellow QC elaborated his submissions on this part of the case both in writing and orally, and referred me to a number of cases, including Birmingham & District Cattle By-Products Co Ltd v IRC (1919) 12 TC 92, Kirk and Randall Ltd v Dunn (1924) 8 TC 663 and Khan v Miah [2000] 1 WLR 2123 (HL).  However, none of these decisions was concerned with the legislation which I now have to construe, and for the reasons which I have given I feel no doubt that the Special Commissioner was correct to conclude that LLP 1 had not begun trading before 6 April 2004, despite the optimistic assertion to that effect in its first set of accounts for the period to 5 April 2004.
The Conditional Contract Issue
98.	I can deal with this issue very shortly.  The question is whether LLP 1 and LLP 2 came under an unconditional obligation to pay the consideration due under their respective SLAs on the date when they were entered into, namely 31 March 2004, or whether their obligation was conditional upon the prior performance by MCashback of the obligations which it undertook to perform prior to completion. In particular, clause 5.2 of each SLA provided that prior to completion MCashback would provide the Bank Two Security, and procure that the Bank One Security would be granted by Bank Two to Bank One upon completion. In reliance on this provision, counsel for HMRC argued that the obligation of the LLPs to pay the stated purchase price on completion was not an unconditional obligation within the meaning of section 5(1) of CAA 2001.
99.	I am unable to accept this submission.  In my judgment there was nothing conditional about the obligation of the LLPs to pay the consideration on completion.  There was only one contract, and it provided for sequential obligations to be undertaken by each side; but that is not at all the same thing as saying that the obligations, or any of them, were themselves conditional.  A similar point arose in Eastham v Leigh London and Provincial  Properties Ltd [1917] Ch 871, where the taxpayer entered into a contract on 22 June 1962 with the owners of a site to put up a building within two years at a cost of not less than £270,000, and the agreement provided that, if the building was completed satisfactorily at the expiration of the two years and the taxpayer had observed all stipulations and conditions, then the taxpayer should be granted a lease of 125 years from June 1962.  The building was duly completed, and the lease was granted in May 1964.  The question was whether this contract was a conditional contract within paragraph 1 of Schedule 9 to the Finance Act 1962, in the context of the legislation relating to short-term capital gains which preceded the introduction of Capital Gains Tax in 1965.  It was held by Goff J and the Court of Appeal that the contract was not a conditional contract, and that the land was acquired at the date of the contract.  As Russell LJ said at 886E:
“The answer, to my mind, is a short and simple one: I cannot accept that it is correct to say that because the grant of the lease was dependent upon the fulfilment by the tenant of those obligations which constituted the consideration for the grant of the lease, the contract to acquire can properly be described as a conditional contract at all.  It is a contract for sale and purchase, or, rather, grant and acceptance of a lease; what is provided for in the contract is not a condition of the contract at all, it is simply a provision that the one party shall carry out certain works in consideration of a promise thereafter to grant a lease, and that the other party, in consideration of those works being carried out, shall thereafter grant the lease.  Indeed, it appears to me that once it is accepted that it is one contract of acquisition and not two contracts the matter is completely answered.  If there be one contract I cannot see, with respect, how the postponement of the carrying out of one part of one contract until the fulfilment of the consideration by the other party can in any way be properly described as a “condition” of the contract as distinct from a perfectly ordinary part of, or term of, the contract.”
See too, to similar effect, the judgment of Buckley LJ at 891B-E.  The third member of the Court, Cairns LJ, agreed with both judgments.
100.	The Special Commissioner dealt with this question in paragraphs 163 to 166 of the Decision.  He complicated the question unnecessarily, in my view, by describing the bank loans as “fictitious” and by referring to the underlying “reality” which he thought the provisions relating to the loans were intended to disguise.  As I have already explained, I am unable to accept the Special Commissioner’s analysis of the transaction in those terms.  However, he was in my judgment quite right to conclude that the contracts entered into on 31 March 2004 by LLP 1 and LLP 2 were unconditional.  On the true construction of the agreements, that was in my view the only conclusion which he could have reached.
101.	It follows that HMRC’s cross-appeal on this point must in my judgment be dismissed.
The Closure Notice Issue
(1) Facts
102.	The background to the Closure Notice Issue can be briefly stated.  HMRC opened enquiries into the partnership tax returns and self-assessments which had been submitted by LLP 1 for the tax year 2003/04 and by LLP 2 for the tax year 2004/05, and in which (among other things) claims had been made for FYAs under section 45 of CAA 2001 in respect of the whole of the consideration payable under the SLAs which the two LLPs had entered into with MCashback on 31 March 2004.  Following investigation and correspondence, HMRC formed the view that the scheme failed in its object of generating 100 percent FYAs for one reason only, namely that the expenditure had been incurred “with a view to granting to another person a right to use or otherwise deal with any of the software in question” within the meaning of section 45(4) of CAA 2001, with the result that it was disqualified from being first-year qualifying expenditure under section 45.  The detailed considerations which led HMRC to form this view do not matter for present purposes, but in broad terms they thought that the plans to test and develop the scheme on a pilot basis with a supermarket group in South East Asia called Hero would necessarily involve granting to Hero a right to use or deal with the software licensed to the LLPs.
103.	On 20 June 2006 the HMRC official who headed the enquiries, Mr Peter Frost of the Anti-Avoidance Group (Investigation) based at 22 Kingsway, London WC2, wrote to KPMG, who were acting for LLP 1 and LLP 2, in the following terms:
“Given the content of my last letter to you I am satisfied that the MCashback scheme fails on the S45(4) CAA 2001 point alone.  I would prefer to have had longer to examine the full records, as they have only been completely made available to me with your letter [of] 24 May. This would enable me to provide your clients with a full list of additional points for their consideration.
In the circumstances I have to accept that any additional points that may arise will make no difference to the bottom line that no loss relief is due because of S45(4).  Therefore as your clients are so very anxious to receive closure notices I now enclose copies of those that I have issued today.
…”
104.	On the same day, Mr Frost wrote to the designated representative members of LLP 1 and LLP 2 giving formal notice of the conclusion of his enquiries into the partnership tax returns.  His letter to Mr S Smith, the designated member for LLP 1, read as follows:
“I have now concluded my enquiries into the Partnership Tax Return for the year ended 5 April 2004.  As previously indicated, my conclusion is:
The claim for relief under S45 CAA 2001 is excessive.
The Partnership Return for the year ended 5 April 2004 is amended as follows.
Capital Allowances £nil
Allowable Loss £nil
Although there is no tax liability for the partnership for the year my amendments do result in a reduction of losses available to the individual partners for the year ended 5 April 2004. The partnership has the right to appeal against this amendment or conclusion within 30 days of the date of this notice.  Any appeal must be in writing and should state the grounds on which the appeal is made …”
Mr Frost’s letter to LLP 2 (the designated member for which was Mr Marsden) was in identical terms, save that it referred to the tax year 2004/05 instead of the tax year 2003/04.
105.	On 13 July 2006 KPMG wrote to Mr Frost appealing against the amendment of LLP 1’s partnership tax return.  The letter said:
“The grounds for the appeal are that the amendment to the return does not include the correct Capital Allowances and therefore Income Tax losses for the period of the return.”
Letters of appeal were also sent by Mr Feetum on behalf of both LLPs on 19 and 20 July 2006, in the latter of which Mr Feetum said:
“The grounds of the appeal are that we disagree with your analysis for the reasons set out in earlier correspondence.”
106.	On 30 August Mr Marsden wrote to Mr Frost on behalf of both LLPs, confirming that they wished to have the appeals listed before the Special Commissioners and enclosing proposed draft directions.  Mr Marsden identified the first matter to be determined at the appeal as follows:
“In issuing the closure notice on 20 June, the partnership was denied first year allowances in the sum of £27,501,000 to which it was entitled.”
The draft directions enclosed with the letter provided for the LLPs to set out with full particularity “all the legal and factual grounds” they currently relied upon in support of their appeals, and for HMRC to serve a statement of case in answer setting out “all the legal and factual grounds” upon which they relied in issuing the closure notices. 
107.	As I have already explained, HMRC abandoned their contention based on section 45(4) of CAA 2001 on the third day of the hearing before the Special Commissioner: see paragraph 4 above.  This was the only ground relied on by HMRC at the time when the closure notices were issued on 20 June 2006, and in his letter of that date to KPMG Mr Frost had said in terms that he was satisfied that the scheme failed on that point “alone”.  The question therefore arises whether it was open to HMRC to seek to uphold the closure notices, and the amendments to the partnership tax returns, on any other grounds, including in particular the grounds which give rise to the Expenditure Issue, the Trading Issue and the Conditional Contract Issue.
(2) Statutory Provisions
108.	Section 28B of TMA 1970 provides as follows:
“28B Completion of Enquiry into Partnership Return 
(1) An enquiry under section 12AC(1) of this act [i.e. an enquiry into a partnership return] is completed when an officer of the Board by notice (a “closure notice”) informs the taxpayer that he has completed his enquiries and states his conclusions.
In this section “the taxpayer” means the person to whom notice of enquiry was given or his successor.
(2) A closure notice must either – 
(a) state that in the officer’s opinion no amendment of the return is required, or
(b) make the amendments of the return required to give effect to his conclusions.
(3) A closure notice takes effect when it is issued.
(4) Where a partnership return is amended under subsection (2) above, the officer shall by notice to each of the partners amend- 
(a) the partner’s return under section 8 or 8A of this Act, or
(b) the partner’s company tax return,
so as to give effect to the amendments of the partnership return.
(5) The taxpayer may apply to the Commissioners for a direction requiring an officer of the Board to issue a closure notice within a specified period.
(6) Any such application shall be heard and determined in the same way as an appeal.
(7) The Commissioners hearing the application shall give the direction applied for unless they are satisfied that there are reasonable grounds for not issuing a closure notice within a specified period.”
109.	By virtue of section 31(1)(b) of TMA 1970, an appeal may be brought against any conclusion stated or amendment made by a closure notice under section 28B of the Act.  Section 31A provides, so far as material, that notice of an appeal under section 31(1)(b) must be given in writing and within 30 days after the date on which the closure notice was issued. The notice of appeal must specify the grounds of appeal, but on the hearing of the appeal the Commissioners may allow the appellant to put forward grounds not specified in the notice, and take them into consideration, if satisfied that the omission was not wilful or unreasonable. 
110.	Section 50 of TMA 1970 deals with the procedure on the hearing of an appeal, and provides relevantly as follows:
“(6) If, on an appeal, it appears to the majority of the Commissioners present at the hearing, by examination of the appellant on oath or affirmation, or by other … evidence, - 
(a) that, … the appellant is overcharged by a self-assessment;
(b) that, … any amounts contained in a partnership assessment are excessive; or
(c) that the appellant is overcharged by an assessment other than a self-assessment, 
the assessment or amounts shall be reduced accordingly, but otherwise the assessment or statement shall stand good.
(7) If, on an appeal, it appears to the Commissioners –
(a) that the appellant is undercharged to tax by a self- assessment …; 
(b) that any amounts contained in a partnership statement … are insufficient; or
(c) that the appellant is undercharged by an assessment other than a self-assessment,
the assessment or amounts shall be increased accordingly.
…
(9) Where any amounts contained in a partnership statement are reduced under subsection (6) above or increased under subsection (7) above, an officer of the Board shall by notice to each of the relevant partners amend –
(a) the partner’s return under section 8 or 8A of this Act, or
(b) the partner’s company tax return,
so as to give effect to the reductions or increases of those amounts.”
(3) Discussion
111.	No form has been prescribed for closure notices, either under section 28B of TMA 1970, which applies on completion of an enquiry into a partnership return, or under section 28A, which contains corresponding provisions upon completion of enquiries into returns made by individuals or trustees.  In practice, closure notices are usually given by letter, as happened in the present case. 
112.	By virtue of section 28B(1), the closure notice must inform the taxpayer that the officer who gives the notice has completed his enquiries, and it must also state his conclusions.  In addition, it must either state that in the officer’s opinion no amendment of the return is required, or make the necessary amendments to the return in order to give effect to his conclusions. These are the only statutory requirements, and it follows that the closure notice need not be a long or complicated document.  
113.	There is no express requirement that the officer must set out or state the reasons which have led him to his conclusions, and in the absence of an express requirement I can see no basis for implying any obligation to give reasons in the closure notice.  What matters at this stage is the conclusion which the officer has reached upon completion of his investigation of the matters in dispute, not the process of reasoning by which he has reached those conclusions.  I find confirmation for this view in the statutory provisions relating to appeals.  An appeal lies under section 31(1)(b) against “any conclusion stated or amendment made by a closure notice under section 28A or 28B”. No provision is made for an appeal against the reasons given by the officer for reaching his conclusions.  Similarly, the duty of the General or Special Commissioners hearing the appeal is not to review or adjudicate upon the officer’s reasons, but rather (in the context of a partnership return) to consider whether the amounts contained in the partnership statement included in the return (as to which see section 12AB) are excessive or insufficient, and (if it so appears to them) to reduce or increase the amounts accordingly: see TMA 1970 section 50(6) and (7).
114.	A further important principle can in my judgment be deduced from the wording of section 50(6) and (7).  Because one of the matters that the Commissioners have to consider is whether the taxpayer is undercharged to tax by an assessment or self-assessment, or whether any amounts contained in a partnership statement are insufficient, it would seem to follow that the Commissioners are not confined to an examination of the reasons advanced by HMRC in support of the conclusions set out in a closure notice, and that they are not compelled to treat an amendment to a return under section 28A or 28B as fixing the maximum amount of tax which is recoverable.  Provided that they act fairly, and on the basis of evidence that is properly before them, the Commissioners may take the initiative and apply the law to the facts in the manner that appears to them to be correct, regardless of the arguments advanced by either side.
115.	There is nothing surprising in this conclusion, because the wording of section 50(6) and (7), which applies alike to appeals relating to self-assessments and appeals against assessments made by an officer of HMRC, reflects similar wording of very long standing which goes back long before the introduction of self-assessment.  There is a venerable principle of tax law to the general effect that there is a public interest in taxpayers paying the correct amount of tax, and it is one of the duties of the Commissioners in exercise of their statutory functions to have regard to that public interest.  This principle finds expression in cases such as R v Income Tax Special Commissioners, ex parte Elmhirst [1936] 1KB 487 (CA), and in the need for special legislation (now contained in section 54 of TMA 1970) to enable tax appeals to be settled by agreement between the parties without the need for a hearing. The precise nature and scope of this principle in the 21st century is a controversial topic, having regard in particular to changes which have taken place over the years in the functions of the General and Special Commissioners, and to the introduction in 1994 of procedural rules regulating appeals to both tribunals.  Furthermore, the whole question may become academic when appeals to the Commissioners are replaced next year by appeals to the new Tax Tribunal.  For present purposes, however, it is enough to say that the principle still has at least some residual vitality in the context of section 50, and if the Commissioners are to fulfil their statutory duty under that section they must in my judgment be free in principle to entertain legal arguments which played no part in reaching the conclusions set out in the closure notice.  Subject always to the requirements of fairness and proper case management, such fresh arguments may be advanced by either side, or may be introduced by the Commissioners on their own initiative. 
116.	That is not to say, however, that an appeal against a closure notice opens the door to a general roving enquiry into the relevant tax return.  The scope and subject matter of the appeal will be defined by the conclusions stated in the closure notice and by the amendments (if any) made to the return.  The legislation does not say this in so many words, but it follows from the fact that the taxpayer’s right of appeal under section 31(1)(b) is confined to an appeal against any conclusions stated or amendments made by a closure notice.  That is the only appeal which the Commissioners have jurisdiction to entertain.
117.	Again, there is in my judgment nothing surprising about this conclusion.  The introduction of self-assessment placed new and considerable burdens on taxpayers, including in many cases the obligation to calculate the amount of tax payable. For a helpful introduction to the subject, see the judgment of Park J in Langham v Veltema [2002] EWHC 2698 (Ch), (2004) 76 TC 259 at 274-6. As Park J said, “[t]he new burdens were balanced by new protections for taxpayers who conscientiously complied with the system”.  The protections which were considered by Park J and the Court of Appeal in Langham v Veltema (and, more recently, by myself in HMRC v Household Estate Agents Ltd [2007] EWHC 1684 (Ch), (2007) 78 TC 705), were the new and tighter time limits on the power of HMRC to make further tax assessments under section 29 of  TMA 1970.  In the present case, the more relevant protections are the strict time-limits within which an enquiry may be opened into a return (normally up to 12 months from the filing date for the return), and the provisions relating to closure notices in sections 28A and 28B.  During the course of an enquiry into a return, HMRC have extensive information-gathering powers available to them, and any question arising in connection with the subject matter of the enquiry may be referred to the Special Commissioners for their determination (see section 28ZA).  Furthermore, the officer conducting the enquiry cannot be compelled to issue a closure notice until he has completed his investigations and is ready to do so, subject only to the procedure set out in section 28A(4)-(6) and 28B(5)-(7) whereby the taxpayer may apply to the Commissioners for a direction requiring a closure notice to be issued within a specified period, and the Commissioners are required to give the direction applied for “unless they are satisfied that there are reasonable grounds for not issuing a closure notice within a specified period”.
118.	Against this background, it is I think clearly implicit in the statutory scheme that an appeal under section 31(1)(b) may not stray beyond the subject matter of the conclusions and amendments (if any) stated in the closure notice.
119.	I would add that my discussion in the previous paragraphs owes much to the learned and illuminating review of the topic by another Special Commissioner, Dr John Avery-Jones CBE, in D’Arcy v Revenue and Customs Commissioners [2006] STC (SCD) 543 at 547-554.  Both sides were content to adopt his reasoning and conclusions on this question, and so am I. Briefly stated, D’Arcy was a case where the appellant had entered into a tax avoidance scheme involving transactions in gilts designed to create a tax deduction for a manufactured interest payment.  HMRC issued a closure notice, contending that the Ramsay principle applied with the result that no deduction was created.  However, they subsequently abandoned that contention, in the light of detailed evidence adduced by the taxpayer, and sought instead to argue that the relevant statutory provisions, construed without reference to the Ramsay principle, did not produce the desired result.  It was argued for the taxpayer that HMRC could not change the basis of their conclusion as stated in the closure notice.  The Special Commissioner heard submissions on this question from experienced leading counsel on each side (Mr Michael Furness QC for HMRC and Mr Kevin Prosser QC for the taxpayer), and concluded that it was open to HMRC to advance new arguments of law relating to the facts identified by the closure notice.  He then considered the new arguments, and decided the appeal in the taxpayer’s favour.  HMRC subsequently appealed (without success) to the High Court, but there was no cross-appeal by the taxpayer on the procedural question: see Revenue & Customs Commissioners v D’Arcy [2007] EWHC 163 (Ch), [2008] STC 1329, at paragraph 2 of my judgment, 1346f-g.
120.	The critical question in the present case, therefore, is to identify the subject matter of the conclusion stated by Mr Frost in his letters of 20 June 2004 to the designated members of LLP 1 and LLP 2.  The crucial words are:
“As previously indicated, my conclusion is:
The claim for relief under [section] 45 CAA 2001 is excessive.”
The words “as previously indicated” can only refer to the previous correspondence and discussions which had taken place, and which culminated in Mr Frost’s letter of the same date to KPMG when he said he was satisfied that the MCashback scheme “fails on the [section] 45(4) CAA 2001 point alone”. That statement was clear and unambiguous, and would have conveyed to any reasonable recipient that HMRC’s challenge to the effectiveness of the scheme was confined to section 45(4).  The letters must in my view be read together, because the letters to the LLPs made it clear that Mr Frost was intending to state a conclusion which he had already informally indicated.  Had he intended for the first time to rely on other grounds as part of his conclusions, he would not have said “as previously indicated”.  One would also expect him to have raised any such grounds in the course of his enquiry and discussed them with the taxpayers’ advisers before stating his conclusions.  
121.	To put the same point another way, it seems to me that read in context the conclusion stated in the letters to the LLPs was equivalent to:
“The claim for relief under [section] 45 CAA 2001 is excessive [for the sole reason that section 45(4) applies so as to disqualify the expenditure on the software from being first-year qualifying expenditure].”
122.	If this is right, it must then follow in my judgment that the scope of any appeal was confined to the question whether section 45(4) did indeed apply, and in particular to the factual issue whether the LLPs had incurred the expenditure on the software with a view to granting to another person a right to use or deal with it.  The Special Commissioner had no jurisdiction to entertain the wider question whether the other requirements of section 45 were satisfied, because the appeal would then no longer be an appeal against the conclusions stated in the closure notice.  He should therefore have refused to consider the Expenditure Issue, the Trading Issue and the Conditional Contract Issue, or at least should have done so only on the footing that he was wrong on the Closure Notice Issue.  
123.	Instead, however, the Special Commissioner decided the Closure Notice Issue in favour of HMRC.  He dealt with the question in paragraphs 19 to 22 of the Decision.  In paragraph 22 he stated his conclusions as follows (as before, I will replace his bullet points with paragraph numbers):
“(1) Whilst there may be no required statutory form for the giving of Closure Notices, it was clear in this case that the letter that referred only to denying the allowances under section 45 and denying the income losses [i.e. the letter to the LLP] was regarded as the letter that gave the conclusions and adjustments, and the statute required neither detail nor reasons to be given for this notice to be a valid notice. Accordingly the import of the notice was that it denied the allowances under the section under which they were claimed and it also denied the income losses.
(2) I was certainly not prepared to hold that HMRC could not adduce other grounds for challenging the capital allowances when the covering letter alone [i.e. the letter to KPMG] referred to section 45(5) [an error, as elsewhere in these paragraphs, for section 45(4)] and it also indicated that but for his being pressed to issue the notice by the Appellants’ representatives, he would have preferred to have had more time in order to indicate other grounds for the conclusions and adjustments.
(3) Whilst it is not strictly necessary for me to consider what the position would have been had the formal letter itself referred just to section 45(5) [sic], I confirm that I would have reached the same conclusion as John Avery-Jones reached in the recent case of [D’Arcy], and would not have been able to distinguish this case from the decision in the D’Arcy case in the way that the Appellants suggested that I should do.
…
The factual compass of the matter, the subject of the Closure Notice in this case, was the purchase of the software and all related transactions. The denial of trading losses can hardly have been based on anything to do with licence rights to third parties. Thus, consistent with the decision in the D’Arcy case, I accept that in an appeal HMRC can raise any arguments in support of their conclusions and adjustments related to those transactions.”
124.	With respect to the Special Commissioner, I am afraid that I am unable to accept his reasoning.  It seems to me that he fell into three main errors.
125.	First, he looked at the letters to the LLPs separately from what he termed the “covering letter” to KPMG, thereby wholly ignoring the force of the words “as previously indicated” and artificially construing the letters to the LLPs without any regard to the context in which they were written.
126.	Secondly, he evidently attached weight to Mr Frost’s stated wish to have had longer to examine the background to the matter. This was in my view wrong for two reasons.  In the first place, once a closure notice has been issued, there is no procedure which enables it to be amended or supplemented.  The statutory scheme requires the officer to complete his investigations before stating his conclusions, and if he requires more time, his remedy is not to issue the notice.  The LLPs and KPMG may well have been pressing him, but Mr Frost was under no obligation to yield to their pressure, and they had not applied to the Special Commissioners for a direction pursuant to section 28B(5). Secondly, and in any event, Mr Frost himself recognised in his letter to KPMG that he had to accept “that any additional points that may arise will make no difference to the bottom line that no loss relief is due because of [section] 45(4)”. He therefore made a conscious decision to pin his colours to the mast of section 45(4), and once he had done so, and framed his closure notice accordingly, it was too late for HMRC to go back on his decision and seek to widen the scope of the LLPs’ appeals.
127.	Finally, the decision in D’Arcy is in my judgment clearly distinguishable, because the factual compass of the conclusion stated in the Closure Notice embraced all the steps in the scheme, and all that HMRC wished to do was to advance fresh legal arguments arising out of those facts. In the present case, by contrast, the limitation of the stated conclusion to the provisions of section 45(4) meant that the factual compass of the appeal was confined to those facts which are relevant for the purposes of section 45(4).
128.	Counsel for HMRC argued that the scope of the closure notices was wide enough to embrace all issues of fact and law which might arise under section 45, and that to accede to the LLPs’ argument would present them with a wholly unmerited windfall. However, for the reasons which I have already given I consider that the scope of each closure notice, properly construed and read in context, was limited to matters arising under section 45(4), and did not extend to other matters arising under the section as a whole. It follows from this that HMRC were only entitled to defend the appeals from the closure notices on the basis that section 45(4) applied. Section 45(4) operates by excluding certain expenditure which would otherwise qualify for FYAs under the section, and it therefore presupposes that the conditions for relief would otherwise be satisfied.  Accordingly a challenge based on section 45(4) alone cannot put those other conditions in issue, but must treat them as satisfied.  If, for any reason, the true position is that one or more of the other conditions are not satisfied, the result of limiting the challenge in this way may, from HMRC’s point of view, be characterised as conferring a windfall benefit on the taxpayer. However, another way of looking at the matter is to say that the limitation on the scope of the appeal is part of the protection given by parliament to taxpayers under the self-assessment system. There is always a balance to be struck between the interests of individual taxpayers on the one hand, and the interests of the State and the general body of taxpayers on the other hand.  Parliament has decreed how the balance is to be struck, and in the present case the result is in my judgment that the scope of the appeals was limited to matters arising under section 45(4).  If there is a moral to be drawn, it is that HMRC should ensure that they have considered all the points on which they may wish to rely before a closure notice is issued.  Issue of the notice is an irrevocable step, and once it has been taken the battle ground on any future appeal will be defined by reference to it.
Conclusion
129.	For the reasons which I have given, I will allow the appeals of LLP 1 and LLP 2 on the Closure Notice Issue.  The result of this is that the other issues do not need to be determined, because the Special Commissioner had no jurisdiction to consider them.  If, however, I am wrong on the Closure Notice Issue, I would allow the appeals of the LLPs on the Expenditure Issue but dismiss their appeals on the Trading Issue; and I would also dismiss HMRC’s cross-appeals on the Conditional Contract Issue.