The First De Sales Ltd Partnership & Ors v Revenue and Customs (Tax - application to strike out)

Factual and Procedural Background

The Appellants consist of one limited partnership and three limited liability partnerships (LLPs) that implemented marketed tax avoidance schemes disclosed under the Disclosure of Tax Avoidance Schemes (DOTAS) legislation. Each Appellant conducted a modest business employing one or more individuals. Each entered into a Deed of Restrictive Undertakings with an employee and a third party ("the Recipient"), whereby the employee agreed to restrictive undertakings as part of their employment contract, and the Appellant made payments to the third party pursuant to the Deeds. These schemes aimed to generate losses that individual partners or members could use to reduce their UK income tax liability.

The Respondents, Her Majesty's Revenue and Customs ("HMRC"), opened enquiries into the Appellants' tax returns and issued closure notices disallowing the payments as deductible. The Appellants appealed to the First-tier Tribunal (Tax Chamber) ("FTT"). HMRC applied to strike out the appeals under rule 8(3)(c) of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009, contending no reasonable prospect of success existed. The FTT granted the strike out, concluding the appeals had no reasonable prospect of success. The Appellants appealed this decision to the Upper Tribunal ("UT").

The payments in dispute were made under Deeds of Restrictive Undertakings involving employees with modest salaries and administrative duties, with payments purportedly valued in the hundreds of millions of pounds but unrelated to the commercial value of the undertakings. The Appellants claimed deductions under section 69 of the Income Tax (Trading and Other Income) Act 2005 or the Corporation Tax Act 2009, relying on the payments being treated as earnings under section 225 of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA 2003").

Legal Issues Presented

1. Whether the appeals have a reasonable prospect of success and thus should not be struck out under rule 8(3)(c) of the FTT Rules.
2. The proper construction of section 225 ITEPA 2003, specifically the meaning of payments made "in respect of" restrictive undertakings.
3. Whether the First-tier Tribunal erred in concluding that, on the evidence, the Appellants had no reasonable prospect of establishing that the payments were deductible in whole or in part.

Arguments of the Parties

Appellants' Arguments

• The Deeds expressly state that the payments were "solely in consideration" of the restrictive undertakings, which should be determinative that the payments were made "in respect of" those undertakings under section 225 ITEPA 2003.
• The legislative background, including the reversal of the House of Lords' decision in Beak v Robson, supports a broad construction of section 225 to prevent tax avoidance.
• The payments had a commercial purpose: to restrict employees' activities during and after employment, even if the amount paid was grossly disproportionate to any commercial value.
• The First-tier Tribunal erred in requiring a "real-world" or economic equivalence connection between the payments and the undertakings, which is not mandated by the statutory language.
• There was a reasonable prospect of establishing at least a partial deduction, and the strike out was premature as the precise amount of any deductible payment should be determined at a full hearing.

Respondents' Arguments

• The First-tier Tribunal's decision contains no errors of law and correctly applied established principles of statutory construction and tax law.
• Section 225 ITEPA 2003 requires a real-world, commercial nexus between the payment and the restrictive undertaking.
• The payments in question lacked any real commercial rationale and were made solely for tax avoidance purposes.
• The Appellants' evidence failed to demonstrate any reasonable prospect of success, justifying the strike out.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by affirming the correct legal framework, focusing on section 225 ITEPA 2003, which treats payments for restrictive undertakings as earnings from employment regardless of the recipient or enforceability of the undertaking. The key interpretative question was the meaning of "in respect of" in this context, requiring a nexus between the payment and the restrictive undertaking.

The court applied the purposive approach to statutory construction, referencing Ramsay and UBS, emphasizing that tax legislation operates on real-world commercial transactions with economic effect. It rejected the Appellants' argument that the contractual language in the Deeds alone sufficed to establish that payments were made "in respect of" the undertakings.

Drawing on Vaughan-Neil and Pritchard v Arundale, the court held that the critical inquiry is factual: what is the real reason for the payment, not merely what the contract states. The court agreed with the FTT that the payments bore no real-world commercial connection to the restrictive undertakings given the employees' modest roles, limited duties, modest salaries, short duration of restrictions, and the grossly disproportionate sums paid to third parties.

The court found that the Appellants failed to provide evidence of any reasonable prospect of establishing a deductible payment, either wholly or partially. The absence of evidence quantifying any commercial value or damage prevented any realistic prospect of success. The purported commercial rationale was insufficient to overcome the conclusion that the payments were made solely for tax avoidance.

The court also endorsed the FTT's application of strike out principles, confirming that the Appellants' case was more than merely arguable but lacked the degree of conviction required to avoid dismissal. The court rejected the notion that the case should proceed on the hope of further evidence emerging.

Holding and Implications

The Upper Tribunal DISMISSED the Appellants' appeals against the First-tier Tribunal's decision to strike out the appeals.

The direct effect is that the Appellants are not entitled to deduct the payments made under the Deeds of Restrictive Undertakings for tax purposes. The decision confirms that payments must have a real-world commercial nexus with restrictive undertakings to qualify as earnings under section 225 ITEPA 2003 and thus be deductible under related provisions.

No new precedent was set beyond affirming established principles of statutory construction and the application of strike out standards in tax litigation involving avoidance schemes.