Mark Wallace v The Commissioners for HMRC

The Appellant (“Mr Wallace”) was a member of three LLPs (“the Partnerships”), which (it was agreed) carried on a trade from premises in the UK. At all relevant times he was not UK tax resident. The income of the partnerships arose solely (or very substantially) from lease rentals from overseas (non-UK) lessees.

Mr Wallace says that the effect of section 849(3) of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA 2005”) is that, to the extent the Partnerships’ profit is derived from income from non-UK lessees, his share of those profits is not subject to UK income tax. HMRC disagree. The only question in this appeal is whether Mr Wallace’s analysis is correct.

This appeal relates to four closure notices (the “Closure Notices”) issued by HMRC under section 28A(1B) and (2) of the Taxes Management Act 1970 for the tax years ending 5 April 2016, 5 April 2017, 5 April 2018 and 5 April 2022. The Closure Notices charge Mr Wallace to additional income tax in relation to profits of the Partnerships previously omitted from his self-assessment tax returns as shown in the table below:

Mr Wallace does not dispute the procedural validity of the Closure Notices or HMRC’s calculation of his share of the profits of the Partnerships. He has also abandoned an attempt to challenge the Closure Notices based on an assertion that HMRC applied his preferred analysis of the legislation to another non-UK resident partner, and he is entitled to be treated in the same way. He accepts that this tribunal does not have jurisdiction to entertain such a (purely public law) challenge.

As we will see shortly, a statement of agreed facts records the parties’ agreement that the Partnerships were trading from premises in the UK. Mr Young’s skeleton argument suggested that Mr Wallace wished to revisit the question whether the Partnerships were in fact trading. When this was challenged by HMRC, Mr Wallace’s advisers confirmed that it was common ground that the Partnerships were trading, and they would “not be making an application to resile from the narrative of the agreed statement of fact”. We will see questions around the nature of the Partnerships’ activities cropping up from time to time in this decision. Whilst I have recorded the points Mr Young made, I have (I hope) made clear the basis on which this appeal has been decided.

A statement of facts agreed between HMRC and Mr Wallace’s counsel sets out (so far as relevant) the following:

Section 5 ITTOIA 2005 provides that income tax is chargeable on “the profits of a trade, profession or vocation”. A trade is defined as “any venture in the nature of the trade”.

Section 6 ITTOIA 2005 provides the territorial scope of the charge to tax. Section 6(2) is specifically relevant to this appeal. It provides:

“(2)

Profits of a trade arising to a non-UK resident are chargeable to income tax under this Chapter if they arise –

(a)

from a trade carried on wholly in the United Kingdom, or

(b)

in the case of a trade carried on partly in the United Kingdom and partly elsewhere, from the part of the trade carried on in the United Kingdom.”

Part 9 of ITTOIA makes some special provisions for partnerships (which includes LLPs – see section 863 ITTOIA). Included in Part 9 is section 849, which provides (so far as relevant):

“(1)

If –

(a)

a firm carries on a trade, and

(b)

any partner in the firm is chargeable to income tax,

the profits or losses of the trade are calculated on the basis set out in subsection (2) or (3), as the case may require.

(2)

For any period of account in which the partner is a UK resident individual, the profits or losses of the trade are calculated as if the firm were a UK resident individual.

(3)

For any period of account in which the partner is non-UK resident, the profits or losses of the trade are calculated as if the firm were a non-UK resident individual.”

A point which made us pause in our discussions is that, although subsections (2) and (3) direct different bases for calculating “the profits of the trade”, it is not at all obvious why they would produce different answers. We took as our example a medium-sized City law firm with a single non-resident partner running a small branch office in Belgium. Why would “the profits of the trade” (which is a reference to the single, overall trade carried on by the partnership) be different if calculated on the assumption that the business was carried on by the foreign partner or by one of the UK partners? This (including any implications the answer to this question might have on the issues before us) was the point on which the parties were invited to submit written representations after the hearing.

In his written submissions, Mr Young asserted that the Partnerships were “plain vanilla” sale and leaseback partnerships of the type found not to be trading in cases such as Hoyle v HMRC, [2024] UKUT 1060 (TCC), and Samarkand Film Partnership No3 v HMRC, [2017] EWCA Civ 77.

HMRC had suggested in correspondence with Mr Wallace’s advisers that it would not make any difference whether the Partnerships were trading or not. If they were not, HMRC said, Mr Wallace’s income from the Partnerships would be chargeable to income tax as income from a “non-trade business” under section 609 ITTOIA. Section 847(2)(b) ITTOIA makes it clear that section 849 applies to partnerships which are carrying on businesses which are neither trades nor professions, and so we would be back with the same point of interpretation on section 849(3). Mr Young described the position that, whether the Partnerships are trading or not, the relevance and analysis of section 849(3) is the same as common ground.

Given the agreed facts on the basis of which this appeal is being decided, this point is not relevant to the outcome of this appeal, but (with respect) I am not sure that I am with Mr Young and Mr Ellis when they say that it makes no difference whether the Partnerships are trading or not. I agree that section 849(3) is equally applicable whether the Partnerships are trading or not, but the territorial scope of income tax is not the same in both cases.

The territorial scope of the charge to tax on trading profits is driven by the residence of the individual sought to be taxed and the place where the trade is carried on (section 6 ITTOIA). The charge to tax on miscellaneous income (which includes income chargeable under section 609 ITTOIA), on the other hand, is driven by the residence of the individual sought to be taxed and the question whether the income has a UK source (sections 574(4) and 577(2) ITTOIA). I could see how, on the basis of what Mr Young says are the facts of this case (that not very much activity goes on in the UK), it might be argued that the income from the Partnerships’ non-trade leasing business with non-UK counterparties is not UK source income. I am not, of course, saying that the outcome would be different, but I can see how it might be. That is, I am glad to say, not something I need to decide.

Mr Young says that section 6 ITTOIA provides the statutory framework to achieve Parliament’s intention of charging UK residents tax on their worldwide trading income whilst restricting charges on non-UK residents to the profits of a trade caried on wholly in the UK or, where a trade is carried on partly in the UK, that part of the trade carried on in the UK.

He says that the ordinary and natural meaning of the words in section 849(3) is clear and unambiguous. He says that, on any rational view, the purpose of section 849 is to ensure that a non-resident partner in a resident partnership should not be taxed on foreign source partnership profits. If there were any doubt, he referred us to the House of Commons Explanatory Notes. Notes 1715-1717 read as follows:

“1715 This clause [ie section 849] contains the basic rules for calculating the profits of a firm. It is based on section 111 of ICTA.

1716 If some of a firm’s partners are resident in the United Kingdom and some are not, the profits of the firm’s trade must be calculated on different bases. For the resident partners, the calculation includes profits arising outside the United Kingdom; for the non-resident partners, the calculation is restricted to profits arising in the United Kingdom.

1717 Section 111 of ICTA is not explicit that the profits may have to be calculated on more than one basis. This clause brings together the rules for resident and non-resident partners. Subsection (1) introduces the idea that more than one calculation may be needed.”

In correspondence with HMRC, Mr Wallace’s advisers had drawn attention to the Explanatory Notes. The agreed statement of facts records them as writing to HMRC and commenting that the Partnerships’ income which arises outside the UK should not be chargeable to income tax (section 849 ITTOIA), “arising” means derived, emanating or originating from and that the Explanatory Notes make it clear that income emanating or originating from outside the UK would not be taxable on a non-resident partner.

Just pausing here, I can see how someone just reading the Explanatory Notes might be left with the impression that Mr Wallace’s advisers were. However, as we saw at [12] above, section 849 applies to trades, professions and businesses which are neither trades nor professions, and so the reference to “profits arising in the UK” in Note 1716 can only mean income chargeable in the hands of a non-resident according to the territorial scope rules for that type of income. This is a point we will come back to, but I do not read the Explanatory Notes as suggesting that the government was looking to introduce a special new territorial scope rule for income derived through a partnership.

The consequence, Mr Young says, is that Mr Wallace’s profits are calculated as if the Partnerships were non-UK resident individuals. For these purposes, the law treats Mr Wallace as a non-resident sole proprietor. A non-resident partner could be taxed under section 849(3) if the partner had a branch or agency within the UK, but Mr Wallace “had no foot on the ground for the purposes of tax law.”

The Partnerships have registered offices in the UK. But these amount to little more than brass plates. No trade was or is carried out at a registered office. The only business activity, save for accounting and payment activities, is the signing of a lease. A film would be purchased and immediately leased back to the producers for a fixed period of 15 years. Mr Young says that leases were not signed at a Partnership’s registered office or even necessarily in the UK at all. Typically, a film lease is for a period of 15 years. It may be signed in the United States or some other location. Nothing happens by way of trade behind the brass plate.

If, which Mr Young says was not the case, there was any business activity capable of being attributed to a registered office, then the activity would be restricted to the initial period when the lease and leaseback arrangement was put into place. Trade in year one does not create an immutable precedent for every other year. On this point he refers us to Carvill v Inland Revenue Commissioners (No 2) [2002] STC 1167.

Mr Young says that it appeared to be common ground that Mr Wallace, as a Swiss resident, benefits from the UK/Switzerland Double Tax Treaty. If there were a conflict, then the provisions of the treaty displace the domestic law. He also says that the UK/Switzerland double tax treaty defines a permanent establishment as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Mr Wallace asserts that there is no business of an enterprise being wholly or partly carried on the UK by the Partnerships. The expression “carried on” envisages activity of a commercial nature. The only activity being carried on was the movement of funds by the lessee and the investors’ lending banks.

HMRC agree with Mr Wallace’s analysis that the effect of section 849(3) is that the Partnerships should be treated as non-UK resident individuals for the purposes of calculating the profits chargeable to income tax. However, they do not accept that this has the effect of deeming that a Partnership’s trade was carried on outside the UK and therefore the profits arising from that trade are not chargeable to income tax under section 6 ITTOIA 2005.

Under section 849(3), a partnership is treated as a non-UK resident individual when calculating its profits chargeable to income tax in the hands of a non-resident individual partner. It is clear that the effect and intention of section 849(3) is to tax a non-resident partner on the partnership’s income from the UK, just as non-resident sole traders are taxed. HMRC say that this is apparent from the Explanatory Notes and reflected in their guidance (in the Partnership Manual at PM163030).

As to the suggestion that section 849(3) should be interpreted to go further and deem the part of a Partnership’s trade which arose from lease rentals from an overseas lessee to be carried on wholly outside of the UK, so that there are no profits chargeable to tax, HMRC say that the logic for this argument must be an assertion that, as the Partnership is treated as non-UK resident and the lessees are non-UK resident, it must follow that the profits do not arise from a trade in the UK.

HMRC say that this would be taking the deeming in section 849(3) too far and it would produce effects clearly outside the purpose the legislation. It would mean that any non-UK resident could carry on a trade in a partnership in the UK which included foreign profits/activities without the UK profits of that trade being chargeable to income tax. This would result in non-UK resident partners receiving an advantageous tax treatment of their UK profits compared to non-UK resident sole traders, whose entire UK profits are chargeable to income tax.

HMRC say that this was clearly not the intention of Parliament when drafting section 849; if the intention was to exempt from tax a non-UK resident partner’s income from a UK trade, then that intention would have been clearly articulated in the legislation. They refer to Fowler v HMRC [2020] UKSC 22, at [27], as supporting their approach. They say that the outcome Mr Wallace is arguing for would produce effects clearly outside the purpose of the legislation and which would be somewhere between anomalous (at best) and absurd. On that basis, they say, Mr Wallace’s approach amounts to a flawed, over-literal reading of section 849(3), which (in the light of Fowler) should not be adopted.

On the question of how subsections (2) and (3) in section 849 can produce different answers when they instruct the same action, HMRC were very clear on the intended purpose of the two subsections, and they say this means that the profits of a single firm for a single accounting period may have to be calculated twice for income tax purposes.

Section 849 does not direct how the computation of the profits and losses is to be carried out, it merely sets out the basis of the calculation; see Muller Dairy UK Ltd v HMRC, [2024] UKUT 273 at [40], addressing the corporation tax equivalent of section 849. It mandates the first (calculation of the profits of the single actual trade of the partnership) of the three stages in the assessment of partnership profits we can see articulated in MacKinlay (HMIT) v Arthur Young McClelland Moores & Co, [1989] BTC 587, and Vaines v HMRC, [2018] EWCA Civ 45.

HMRC say that section 849 meets its purpose of providing the first step for a firm (to ascertain the profits and losses of their trade which are chargeable to income tax) by establishing the basis of the calculation. The two bases provided by section 849 ITTOIA 2005 mean that “the profits and losses of the trade” are calculated differently for UK resident and non-UK resident partners, reflecting the difference in calculating the profits chargeable to tax for a resident and non-resident.

In absence of the two bases provided by section 849 ITTOIA 2005, “the profits and losses of the trade” would be the same for UK resident and non-UK resident partners when calculating the profits of the firm’s trade which was carried on partly in the UK and partly overseas. This is because the firm is to be treated as having one collective trade, as acknowledged in Vaines at [27].

The first point to make, to the extent I have not made it clearly already, is that I am deciding this appeal on the basis of the agreed facts, which are:

Mr Young suggested that, if the Partnerships were carrying on trading activity in the UK, that would be very slight and would be restricted to the initial period/s when the lease and leaseback arrangements were put into place. That suggestion is at odds with the description of the trades carried on by the Partnerships in the statement of agreed facts. Close and Rose carried on a trade which included “managing” a portfolio of films and Cherwell’s trade was more expansively described as “developing commercial film opportunities through a combination of sale and leaseback transactions and film development projects”. There is nothing here to suggest that activity took place only for a very small period at the beginning of each Partnership’s life. Even it that were the case, it would not follow that the trades ceased at that point or that the receipts from the film rentals were post cessation receipts or anything other than trading receipts of a continuing trade properly accrued over time (which is what agreed fact (5) rather suggests – see [32] above). Mr Young did not elaborate on the consequences of (or provide evidence to support) his assertion. In my judgment, the Partnerships’ trades continued throughout the periods to which the Closure Notices relate, and the film lease rentals were receipts of trades which continued throughout those periods.

Turning to the question I raised about how the same direction (to find the profits of the trade) in subsections (2) and (3) of section 849 could produce two different results, it must be the case that Parliament intended the calculations to be effected in the light of the different territorial scope of the charge to income tax on various types of income (here trading profits) for UK and non-UK resident individuals. If not, as HMRC observed (and which was really my question), “the profits and losses of the trade” would be the same for UK resident and non-UK resident partners when calculating the profits of a partnership trade which was carried on partly in the UK and partly overseas. My question notwithstanding, I entirely accept that a reading of section 849(2)-(3) which results in the profit calculation under both those subsections being the same would be wholly irrational. Parliament must have intended the different hypotheses to produce different answers.

The instruction in these subsections should be understood as one to calculate the profits or losses of the trade “for the purposes of income tax” (which, ironically, is what section 111 of the Income and Corporation Taxes Act 1988, which section 849 replaced and was intended to be an improvement on, provided, albeit without making the need for two bases of calculation explicit). In other words, we are to calculate the profits of the trade chargeable to income tax on those different hypotheses, incorporating the relevant territorial scope rules, which is where the main difference between resident and non-resident individuals lies. If an explicit direction that we are concerned with calculating the profits chargeable to income tax were needed, subsection (1)(b) provides it.

Section 849(3) is a deeming provision. It tells us to calculate the chargeable profits of a partnership “as if” the partnership were a non-UK resident individual, which it very clearly is not.

Before the profit calculation is carried out, section 849(3) mandates two changes from the actuality. First, we are to replace the partnership with an individual. Secondly, that hypothetical individual is to be assumed to be non-UK resident, although we are not told where that hypothetical individual is resident – just that it is not in the UK.

One of the questions raised in Fowler is how far a deeming provision should be carried. The Supreme Court (at [27]) said that this “is primarily a matter of construction of the statute in which it appears”.

In this statutory context, I do not consider that we should make any further changes to the actuality beyond the two changes I have just mentioned (although, as we will see, quite a lot flows from these seemingly modest changes). The first reason for this is that section 849(3) clearly mandates these changes, but does not mandate any others.

Secondly and more importantly, as Vaines makes clear, a partnership has a single, actual trade and it is the profits of that real trade which are being calculated on these hypotheses. As Henderson LJ explained, at [17]:

“In 2007/08, Mr Vaines was resident in the UK. It therefore follows from section 849 (1) and (2) that the profits of the … partnership trade are to be calculated “as if the firm were a UK resident individual”, the “firm” for this purpose being a collective description of Mr Vaines and his fellow partners … . The trade in question is the actual trade of SSD, … . It is not a separate trade carried on by Mr Vaines alone, but the trade of SSD carried on collectively by himself and his fellow partners.”

Mr Vaines had incurred significant personal expenditure, and he sought to deduct that in calculating the profits of the separate, notional trade he was deemed (for certain limited purposes related to the old basis period rules) to carry on. He failed because the profits of the trade (his share of which were then treated as the profits of his notional trade) being calculated in section 849 were the profits of the actual trade carried on collectively by Mr Vaines and his partners.

What we are required to calculate, therefore, are the profits chargeable to income tax of the actual trade carried on collectively by Mr Wallace and his fellow partners on the assumption that each Partnership’s trade was carried on by a hypothetical non-resident individual sole trader. No other departures from the actuality are permitted; as Vaines confirms, we are to calculate the profits of a trade as it was actually carried on by the relevant Partnership, so in the same place/s, in the same way and with the same (revenue and capital) income and expenditure.

There is an element of unreality in this construct, of course, as our hypothetical individual sole trader could end up being treated as doing more than one thing at once (as they are treated as doing everything that all the partners do) and (in a multi-site partnership) being in several places at the same time. That clear disconnect from reality confirms that the assumed sole trader is not imbued with any of the characteristics of any of the real non-resident individual partners. The hypothetical individual is stateless (so not Swiss resident, which makes any provisions of the UK/Switzerland double tax treaty irrelevant at this point) and can be deemed to do things in places a real non-resident partner has never been to (so the actuality of Mr Wallace having no business footprint in the UK is neither here nor there).

I should just pause to note that, although our hypothetical sole trader does not have any of the attributes of any actual partner, that assumption is just for the purposes of the profit calculation in section 849. Mr Wallace is a Swiss resident, and this assumption does not deprive him of any of the benefits of that status (such as protections in the UK/Switzerland double tax treaty) which would otherwise be available to him. Whether there are any such benefits is not a matter for me.

Finally, I should note that I do not agree with Mr Young’s submission that I should approach the interpretation and application of section 849(3) through the lens of the UK/Switzerland double tax treaty. The UK is party to numerous double tax treaties. Whilst many are based on a common model (the OECD Model Treaty), this is not universally so, and there are differences between treaties. Double tax treaties are designed to provide exceptions, to give people entitled to particular treaty benefits a different outcome to the one they might expect by applying domestic law. And, of course, not every non-resident will be entitled to the benefits of a double tax treaty. Against that background, it seems to me to be conceptually wrong (as well as practically very difficult) to take that spectrum of different outcomes and use one of them to interpret the domestic base case.

The effect of projecting the actuality of the trade of a Partnership onto a hypothetical non-resident individual sole trader here is that the sole trader ends up being treated as carrying on a trade wholly in the UK whilst remaining non-resident. That might seem surprising (as it clearly does to Mr Wallace), but that is the inevitable effect of the deeming, and it is no stranger than the hypothetical individual being treated as doing lots of different things in different places all at the same time.

It follows that, for the purposes of calculating Mr Wallace’s income tax liabilities, the profits of each of the Partnerships are to be calculated as if trade of the Partnership in question was carried on by an individual who was not UK tax resident, but in all other respects as if it was carried on in exactly the same way as the trade was actually carried on.

As the Partnerships carried on their trades wholly in the UK, it follows that Mr Wallace is taxable on his share of the whole of the profits of the Partnerships in the years to which the Closure Notices relate.

The Closure Notices were correct and this appeal is dismissed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.