Updated: Jul 5, 2020
The recent case of DAARASP LLP and BETEX LLP considers expenditure on software licenses, closure notices, trading, incurring of expenditure, LLPs as a small enterprise, long life assets and anti-avoidance rules.
The cases concern the availability of capital allowances on around £83 million of software license costs and the 100% First Year Allowances (FYAs) available at that time. The taxpayer lost in both situations and on a number of points.
Businesses that treat software expenditure as an intangible fixed asset will normally receive tax relief in line with accounts (i.e. as it amortised) or, when it is more advantageous to do so, via the capital allowances rules (CTA 2009 Part 8, s815).
Qualifying expenditure incurred on or before 31 March 2004 by a small enterprise (which both appellants claimed to fall within) could qualify for 100% FYAs and therefore, benefit from a significant timing advantage.
Although computer software is not defined in the capital allowances legislation, HM Revenue & Customs (HMRC) guidance and practise is to treat such assets as allowable items of plant (including rights to use).
DAARSAP involved the acquisition of a 25 year software license for equity trading for £18,188,244 and BETEX the acquisition of a software license that involved certain on-line gambling functions for £64,806,700.
Qualifying trade or activity
Tribunal struggled in both cases to identify a legitimate (or potential future trade) in either of the partnerships. Both software products were in development and whilst had potential, there was no clear evidence (business framework or resources) to support significant trading activities in the periods of claim (2004) or in the future.
It’s interesting that neither party sought to argue on the application of CAA 2001 s50 which disregards the normal pre-trading rules on when expenditure is incurred. Presumably, this is because on first principle, the whole basis of a legitimate trade was in dispute. Tribunal concluded neither DARSAAP or BETEX was trading or likely to do so in the future.
Commercial reality of expenditure
Both parties submitted a Discolurse of Tax Avoidance Scheme (DOTAS) form as a matter of caution and it was clear from the documents and explanations provided that the availability of capital allowances was a major factor for all concerned.
The transactions also contained esoteric finance features with limited recourse loans and warranties to the effect that investors were exposed to limited commercial risk if the licenses failed to generate any profits. Significantly, the majority of funds also remained in bank accounts and was never actually paid over to the original sellers of the software licenses.
Quantum of software expenditure
A common thread in both scenarios was the lack of independent third-party valuations on the software licenses and their experimental nature at the time expenditure was incurred. Combined with the finance arrangements and lack of evidence to support robust commercial usage Tribunal concluded that the actual expenditure was significantly lower for DAARSAP (£1.4 million) and Betex (£1.641 million).
Tribunal considered the application of CAA 2001 s215 “transactions to obtain allowances” which would have resulted in even lower amounts but concluded it was not applicable.
A fundamental condition to claim FYAs on software expenditure within CAA 2001 s45 is that the claimants meet the criteria of a ‘small enterprise’. This was not in dispute for Betex but was for DAARSAP which had a corporate partner.
The taxpayer relied on the argument that the LLPs were ‘body corporates’ and treated as companies for tax purposes and eligible under s48(2).
HMRC rejected this argument and Tribunal agreed. Both LLPs may well be body corporates but because DAARSAP was not a partnership entirely of individuals and not in itself subject to corporation tax (as a transparent entity) it could not fall within either s48(2)(b) or (d).
Long Life Assets
Since the DAARSAP license was granted for a period of 25 years, Tribunal also considered the application of the Long Life Assets (LLAs) exclusion in CAA 2001 s46(5) from FYAs. HMRC contended that the software license was a LLA (an asset with a useful economic life of 25years or more).
Tribunal found in favour of the taxpayer with a controversial interpretation of the application of s46(5) that will no doubt trigger wider debate.
The overall decision reinforces earlier rulings on similar transactions and provides useful commentary on wider tax matters. If you would like more details, or have any questions, please do not hesitate to contact us.