SPC00455

ENTERPRISE INVESTMENT SCHEME – whether money raised by share issues was for the purpose of a qualifying business activity or partly for the activities of foreign subsidiaries – whether money employed wholly for the qualifying business activity – appeal allowed

THE SPECIAL COMMISSIONERS

	4CAST LIMITED	Appellant

	- and -

	ROBERT ARBUCKLE MITCHELL
	(HM INSPECTOR OF TAXES)	Respondent

		Special Commissioner: 	DR JOHN F. AVERY JONES CBE 

Sitting in public in London on 13 and 14 December 2004

Jolyan Maugham, counsel, instructed by Ridley & Co, for the Appellant

Jane Hodge, HM Inspector of Taxes, Southern England Regional Appeals Unit, for the Respondent

© CROWN COPYRIGHT 2005

DECISION

1.	This is an appeal by 4Cast Limited against refusal by the Inspector to allow Enterprise Investment Scheme (EIS) relief in respect of share issues made on 8 September 200 and 5 March 2002.  The Appellant was represented by Mr Jolyon Maugham, and the Inspector by Miss Jane Hodge.
2.	Mr Brian Park, managing director of the Appellant, gave evidence and a witness statement by Mr Raymond Attrill, global research director of the Appellant, was admitted unopposed.
3.	There was a statement of facts not in dispute as follows:
(1)	The Appellant Company, registration number 02711701, was incorporated on 5 May 1992 with a nominal share capital of £2,000, increased to £1,000,000 on 13th March 1995. 
(2)	It engaged in activities preparatory to its trading from 1993 and issued its first invoice in the year ended 31 December 1995. It carried on a trade, from offices at 191 Victoria Street in Victoria London SW1, of providing up-to-the-minute market analysis to those dealing in non-equity and non-commodity financial instruments. This activity is carried on wholly or mainly in the United Kingdom. It now trades from 52 Grosvenor Gardens in Victoria London SW1.
(3)	The provision of this analysis involves gathering data from various sources around the world including central banks, government agencies and news and data services such as Reuters and Bloomberg. This data is then analysed by the Appellant’s research teams and reports are prepared which are sent to its clients by a variety of electronic means. 
(4)	The Appellant’s published accounts for the years since it commenced trading show trading profits (losses) after tax as follows: 
Year		Profits (losses) 		Accumulated profits (losses) 
			        £			        £
1994	(33.819) 	(33,819) 
1995	(513,323) 	(547,142) 
1996	(941,314) 	(1,488,456) 
1997	(881,498) 	(2,369,954) 
1998	4,199  	(2,365,755) 
1999	211,593 	(2,154,162) 
2000	778,391 	(1,375,771) 
2001	(486,666) 	(1,862,437) 
2002	224,689 	(1,637,748) 
The Share Issues 
(5)	The Appellant having initially been substantially loss making, its activities were funded, inter alia, from the proceeds of the issue by it of a series of tranches of shares. The instant appeals concern two of those share issues, namely, those occurring on 8 September 2000 and 5 March 2002 (together the “Share Issues”).
(6)	The share issue on 8 September 2000 was for 787 shares, the entirety of which were subscribed for by Philip Howard. The amount subscribed for those shares was £49,211. The share issue on 5 March 2002 was for 1,150 shares, the entirety of which was subscribed for by Jivko Stantchovsky. The amount subscribed for those shares was £149,500. 
The Subsidiaries 
(7)	The Appellant has, and at all material times had, two active subsidiaries: 4Cast, Inc (“New York”) (a company incorporated in the State of New York) and Forecast Plc Ltd (“Singapore”) (a company incorporated in the Republic of Singapore) (together the “Subsidiaries”). New York was incorporated on 11 July 1997 and commenced trading in March 1998 with an issued-shared capital of US $1000. Singapore was incorporated on 11 June 1999 and commenced trading in June 1999 with an issued share capital of SGD 2. The Appellant owned and owns the entirety of the issued share capital of the Subsidiaries. 
(8)	New York’s tax returns for the years since it commenced trading show trading losses as follows: 
Year 		Losses 			Accumulated Losses 
			     US$			     US$
1998	(660,408) 	(660,408) 
1999	(718,928) 	(1,379,336) 
2000	(1,121,161) 	(2,500,497)
2001	(638,681) 	(3,139,178) 
2002	(444,245) 	(3,583,423) 
The activities of New York were and are not carried on wholly or mainly in the United Kingdom. 
(9)	Singapore’s published accounts for the years since it commenced trading show trading losses as follows: 
Year			Losses 		Accumulated losses 
				   SGD			SGD
30/07/2000 	(1,306,575)	(1,306,575) 
31/12/2000 	(393,261)	(1,699,837)
2001	(1,737,497)	(3,437,334) 
2002	(1,190,608)	(4,627,942) 
The activities of Singapore were and are not carried on wholly or mainly in the United Kingdom. 
(10)	Neither of the Subsidiaries has or has had material third party borrowings. The activities of the Subsidiaries have been funded by loans made to them by the Appellant. These loans had as their source monies raised by the Appellant through share issues including the Share Issues.
The claims
(11)	Philip Howard asked the Appellant to issue a certificate on form EIS 3 in respect of the 787 shares issued to him on 8 September 2000. On 2 May 2002, the Appellant submitted form EIS 1 (1998) to Kensington 2 TDO in respect of these shares. 
(12)	Jivko Stantchovsky asked the Appellant to issue a certificate on form EIS 3 in respect of the 1,150 shares issued to him on 5 March 2002. The Appellant submitted form EIS 1 (1998), signed on 29 January 2003, to Small Companies Enterprise Centre Dundee in respect of these shares.
The appeal 
(13)	After correspondence between the parties, by two decisions dated 11 June 2003 and 5 November 2003 (together “the Decisions”), Robert Mitchell, Inspector of Taxes, refused, pursuant to section 306(2) Income and Corporation Taxes Act 1988, the Appellant authority to issue certificates in respect of the Share Issues. The basis of that refusal was that, the monies raised in the Share Issues having been loaned to and spent by the Subsidiaries, the shares issued pursuant thereto were not “issued in order to raise money for the purpose of a qualifying business activity” in the sense in which those words are used in section 289(1) Income and Corporation Taxes Act 1988. 
(14)	By letters of 1 July 2003 and 19 November 2003 the Appellant appealed against those refusals. 
4.	I find the following further facts.
(1)	The Appellant publishes for its clients data that it has compiled and analysed to provide up-to-the minute financial information to financial institutions employing money market traders for an annual subscription.  The main focus is on the foreign exchange markets in London and Frankfurt.  To service its clients it requires information and analysis from each time zone throughout 24 hours from which some 400 reports are made every day.  The Appellant also provides daily outlook reports (in four editions per day produced in different time zones) that are sent by email to the users.  In addition, it provides email alerts structured to the user’s needs.  Originally it attempted to provide this from London by working long hours but it proved impracticable to employ analysts on this basis, and they lost clients and other clients were becoming dissatisfied by their not being able to provide local analysis in Singapore.  It therefore decided to establish a presence in New York and Singapore in order to support its existing, mainly European, client base with a comprehensive analysis of the markets across the globe, and to put it into a position to grow the client base.
(2)	It was decided in 1997 to open a New York office.  Mr Park said that it took a further six months for a subsidiary company (4Cast Inc.) to be incorporated but according to New York’s US tax return it was incorporated on 11 July 1997.  The office opened in March 1998 even though the subsidiary may have been incorporated earlier.  
(3)	Initially in Singapore the Appellant entered into an agreement for the provision of analysis in March 1998 with a Singapore company, R-squared Capital PTE Limited which was owned by a Mr David Lewis.  When Mr Lewis decided to leave Singapore in 1999 the Appellant operated a Singapore branch by sending an analyst and a sales person to work with Mr Lewis before he left.  They then continued in the same office.  The Appellant then decided to establish a Singapore subsidiary, Forecast PTY Limited, which was incorporated on 11 June 1999.
(4)	The method of operating the Subsidiaries was unusual.  They were treated as branch offices save for accounting purposes.  In particular, all the administration, accounting and invoicing was conducted from London.  Singapore had no management structure so that all the employees reported directly to London; research individuals in New York reported to the head of research there, Mr Ruskin, who reported to London, as did other New York non-research individuals.  
(5)	The Subsidiaries try to make sales of the Appellant’s services (which will include content prepared by the Appellant and both Subsidiaries) in order to help to fund the running costs of the office concerned.  If a Subsidiary makes a sale it is invoiced by the Subsidiary concerned (although the invoice is prepared by the Appellant) and payment is made to the Subsidiary.  Mr Park said, and I accept, that both Subsidiaries would have been established even if they never made local sales.
(6)	The Appellant funded the Subsidiaries by way of loans.  No payment was made for the analysis supplied to the Appellant.  The Subsidiaries made some local sales of the Appellant’s services (comprising research derived from the Appellant and both Subsidiaries).  This implies that for sales made by one Subsidiary the Appellant and the other Subsidiary were making free supplies of services to it, for onward supply to the client for a fee.
(7)	By way of example, the accounts of Singapore from 11 June 1999 to 30 June 2000 show share capital of $2 (all figures are in Singapore dollars), an accumulated loss of $1,306,575, with a loan from the Appellant of $1,365,123.  The remaining balance of $58,550 is represented by fixed assets of $39,760 and net current assets of $18,790.  The detailed profit and loss statement shows as income fees of $34,984, bank interest of $50 and exchange differences of $6,998.  Expenses were $1,348,607 (which include pre-operating expenses written off of $832,890, salaries of $228,566 and rent of $86,020), resulting in the loss of $1,306,575.  Mr Park said that the pre-operating expenses written off was the payment to Mr Lewis’s company but it seems too large for this and it may therefore include other expenses incurred before the Subsidiary was set up.
(8)	New York does not make up accounts but files a detailed tax return.  The return for the calendar year 2000 shows income of $564,635 (all figures are in US dollars) less cost of goods sold $24,000 plus interest of $411 and a capital gain of $428.  Expenses were $1,657,346 (including interest on the debt to the Appellant of $197,575.  The balance sheet at the end of the year showed share capital of £1,000, indebtedness to the Appellant of $2,564,198 and a loss of $2,500,497 represented by net assets of $64,701.
(9)	In the year 2000 (the time of the first share issue in question) the Appellant employed 65% of the staff and received 90% of group revenue.  Singapore employed 12% of the staff and received 0% of revenue (in view of the figure in the accounts I assume that this means less than 1%).  New York employed 23% of the staff and received 9% of the group revenue.  In 2002 (the time of the second share issue in question) the figures for the percentages of the staff were the Appellant 60%, Singapore 18% and New York 22%; and for revenue were the Appellant 82%, Singapore 5% and New York 13%.
(10)	At the time of the two share issues in question the Appellant required the money raised in order to meet expenses, whether incurred by the Appellant or the Subsidiaries, all of which expenses were necessary to enable the Appellant to carry on its own business activities.
5.	In order to qualify for EIS relief the Appellant needs to satisfy the following provisions of s.289 of the Taxes Act 1988. 
“(1) For the purposes of this Chapter, an individual is eligible for relief, subject to the following provisions of this Chapter, if— 
(a) eligible shares in a qualifying company for which he has subscribed [wholly in cash] are issued to him and, under section 291, he qualifies for relief in respect of those shares, 
 (b) the shares… are issued in order to raise money for the purpose of a qualifying business activity, 
[(ba) the requirements of subsection (1A) below are satisfied in relation to the company,] ... 
[(c) the money raised by the issue is employed not later than the time mentioned in subsection (3) below wholly for the purpose of the activity mentioned in paragraph (b) above. 
[(1A) The requirements of this subsection are satisfied in relation to a qualifying company if throughout the relevant period the active company— 
 (a) is a company which— 
 (i) is such a company as is mentioned in section 293(2)(a), and 
(ii) if it is a subsidiary of the qualifying company, is a 90 per cent subsidiary of that company, or] 
[(1C) In subsection (1A) above ‘the active company’ means the qualifying company or, where the qualifying business activity mentioned in subsection (1) above consists in a subsidiary of that company carrying on or preparing to carry on a qualifying trade [or research and development], that subsidiary.] 
(2) In this Chapter “qualifying business activity”, in relation to a company, means— 
(a) the company or any subsidiary— 
(i) carrying on a qualifying trade which, on the date the shares are issued, it is carrying on, or… 
but only if, at any time in the relevant period when the qualifying trade is carried on, it is carried on wholly or mainly in the United Kingdom, [or]7 
(3) The time referred to in subsection (1)(c) above is— 
 (a) the end of the period of twelve months beginning with the issue of the eligible shares, ... 
and for the purposes of this Chapter, the condition in subsection (1)(c) above does not fail to be satisfied by reason only of the fact that an amount of money which is not significant is employed for another purpose.”
It should be mentioned that in relation to shares issued after 6 March 2001, which therefore applies to the second share issue, a paragraph (d) was added to subsection (1) which contains a different timing requirement for employing the money raised, which it is common ground was satisfied, and so paragraph (d) is not included.
6.	It is common ground that the Appellant was carrying on a qualifying trade at the dates of the share issues in question; that the activities of the Appellant were carried on wholly or mainly in the UK; that the activities of the Appellant and the two Subsidiaries if aggregated were carried on wholly or mainly in the UK; but that the activities of the two Subsidiaries if taken individually were not carried on wholly or mainly in the UK; and that the moneys raised were expended within the relevant time limits.  It is not possible to trace the proceeds of the share issues into any particular use but the Appellant concedes that more than the total has been lent to the two Subsidiaries.  It is also common ground that the test of purpose is subjective and that a person’s stated purpose is not conclusive.
7.	Mr Maugham, for the Appellant contends that in relation to subs (1)(b) the shares were issued in order to raise money for the purpose of the Appellant carrying on a qualifying trade which, on the date the shares are issued, it was carrying on wholly or mainly in the UK.  He interprets “for the purpose of” (if necessary) as meaning “for the principal (or predominating or main) purpose of.”  In relation to paragraph (c) he contends that the money raised was employed within the time limits wholly for the purpose of the qualifying trade which, on the date the shares are issued, it was carrying on wholly or mainly in the UK.  He contends that by virtue of the words at the end of subs (3) (“the condition in subsection (1)(c) above does not fail to be satisfied by reason only of the fact that an amount of money which is not significant is employed for another purpose”) “employed…wholly” means that the whole of the money was employed in the purpose set out, not that the money was employed wholly for the purpose.
8.	Miss Hodge contends that the Appellant fails to satisfy subs (1)(b) because the shares were issued partly for the purpose of making loans to the Subsidiaries.  The words “for the purpose of” meant “for the sole purpose of” and here there was a mixed purpose.  Because of the investment in the Subsidiaries, which had their own activities, it was not possible for the purpose test to be satisfied.  Nor does the Appellant satisfy subs (1)(c) because the money was not employed wholly for the qualifying business activity, being employed in the Subsidiaries which do not carry on their qualifying trade wholly in the UK.
9.	The first question for me is what was the purpose of raising funds by the share issues.  Was it solely (or on his contention, at least predominantly) for the purpose of the Appellant’s trade, as Mr Maugham contends, or partly for the Subsidiaries’ activities, as Miss Hodge contends?  This involves considering the directors’ subjective purpose when the shares were issued.  I accept the evidence that the Appellant had a qualifying trade carried on wholly or mainly in the UK which required it to have access to information and analysis prepared in New York and Singapore.  If it had used the funds raised to buy the service from the Subsidiaries it is common ground that paragraph (b) would be satisfied.  Similarly if branches in those countries had provided the service it would be satisfied.  I suggested to Miss Hodge that if the Subsidiaries made no local sales but were otherwise funded in the same way the Appellant would have qualified but she contends that the separate personality of the Subsidiaries prevents them from qualifying.  I do not think one should go that far.  The Appellant requires the services provided by the Subsidiaries in order to carry on its trade.  Making loans to the Subsidiaries is the means by which it obtains those services; it would not have a separate purpose of benefiting the Subsidiaries’ activities which, on the assumption that they make no local sales, has expenses but no income.  
10.	The next question is whether the local sales by the Subsidiaries make any difference.  The proportion of the expenses of the office paid by the local sales was: for 2000, 34% New York, 2.7% Singapore (or 6.8% if one ignores the pre-operating expenses written off); and for 2002, 67.6% New York, 34.9% Singapore (taken from a table in the papers as we did not have accounts for that year).  At least if these sales do not themselves make a loss (after taking into account any additional expenses resulting from the sales), which seems unlikely that they would, particularly as part of the content is provided by the Appellant and the other Subsidiary free, their effect is merely to reduce the expenses of the Subsidiaries that the Appellant would have paid anyway.  The Subsidiaries are insolvent and completely dependent on the Appellant.  At 30 June 2000 Singapore had net assets of SGD $58,550 and owed the Appellant SGD $1,365,123; and at 31 December 2000 New York had net assets of US $64,701 and owed the Appellant US $2,564,198.  The position was getting worse because losses were continuing although the rate of increase was slowing because the amount of the losses was decreasing (see paragraph 3(8) and (9)).  In these circumstances, it cannot realistically be said that the Appellant had a separate purpose of raising money to invest in the Subsidiaries for the purpose of saving the Subsidiaries’ businesses; the Appellant is merely indirectly paying for the analysis that it needs.  Accordingly I find that the money was raised wholly for the purpose of the Appellant’s qualifying business activity, and not partly for the purpose of the Subsidiaries’ business activity, and therefore the Appellant qualifies under paragraph (b).  
11.	I should mention two subsidiary points.  No doubt the Appellant had the immediate purpose of lending the money to the Subsidiaries but that is a purpose envisaged by the section as a necessary step in determining whether the ultimate purpose is for a qualifying business activity.  Secondly, Miss Hodge pointed out that in a number of places in Mr Park’s witness statement he failed to distinguish between the Appellant and the group.  This is not surprising given the circumstances that the Appellant was paying the expenses of the Subsidiaries as a means of obtaining the information that it needed for its own business activities. Accordingly neither point alters the finding I have made.  
12.	It is not therefore necessary to decide whether “for the purpose of” means the sole, or main, purpose, but had it been necessary I would have decided that it meant main purpose.  The came issue arose in relation to s.741 where paragraph (a) refers avoiding taxation not being “the purpose or one of the purposes” for which certain transactions were effected, and paragraph (b) “…that the transfer and any associated operations were bona fide commercial transactions and were not designed for the purpose of avoiding liability to taxation.”  In Carvill v IRC [2000] STC (SCD) 143 at [89] I said:
One must ask in para (b) whether the transfer was designed for the purpose of avoiding tax or not. This seems to me to require that the main purpose was not tax avoidance because if one has to categorise a transaction as being either designed for the purpose of tax avoidance or not, when it is clearly accepted that a transaction may be designed for more than one purpose, the only way to categorise the design into one purpose is to look at the main purpose of the design. I think, therefore, that the taxpayer’s contention of sole purpose is too loose a test and the Revenue’s contention of significant purpose is too stringent a test although it will in practice be difficult to determine the difference between a significant and a main purpose. 
The contentions of the parties are the opposite here but I would apply the same reasoning.  In the alternative, if I had not found that the money was raised wholly for the purpose of the Appellant’s qualifying business activities, I would have found that, if the money was raised in part for the purpose of the Subsidiaries’ business activities, that was not the (or even a) main purpose. 
13.	In relation to paragraph (c) I consider first Mr Maugham’s interpretation that the word “wholly” means the whole of the money raised must be employed for the stated purpose, rather than that the money is employed wholly for the purpose.  The words at the end of subs.(3) are that “the condition in subsection (1)(c) above does not fail to be satisfied by reason only of the fact that an amount of money which is not significant is employed for another purpose.”  If any money raised by the issue is expended on another purpose it cannot be said that the money (meaning the whole of the money) has been employed wholly for the stated purpose, but subs (3) ignores this if the money employed for another purpose is not significant.  Accordingly, it seems to me, contrary to Mr Maugham’s submission, that the “wholly” refers to the purpose, and so the question for me is whether the whole of the money raised by the two share issues was employed wholly for the purpose of the Appellant’s qualifying trade which it was carrying on wholly or mainly in the UK?  In other words, what was in the minds of the directors of the Appellant when employing the money, and therefore their purpose: was it wholly for the purpose of the Appellant’s trade, or was it partly for the purpose of the Subsidiary’s trade (or activities)?  For the same reasons that I found that the condition in paragraph (b) was satisfied, I find that what was in the directors’ minds was that the Appellant needed for the purpose of its own business activities the information and analysis from the Subsidiaries for which they were prepared to pay the whole of the running costs of the Subsidiaries.  Because of the local sales by the Subsidiaries, the Appellant needed to pay less than the whole of the running costs but at the time of both share issues it was clear that the running costs were well in excess of the local sales income.  Indeed even today, Mr Park said, and I accept, that the neither the New York nor the Singapore offices were likely to be able to pay its own running costs for some time.  Accordingly, when lending funds to the Subsidiaries in 2000 and 2002 to enable them to pay the balance of the running costs I find that the Appellant did not have a purpose of funding the Subsidiaries for the purpose of the Subsidiaries’ business activities, but was employing the money wholly for the purpose of the Appellant’s qualifying business activities.
14.	I should stress that the facts of this case are highly unusual.  If the Subsidiaries had been carrying on business normally by selling their services to the Appellant for a consideration (whether or not the arm’s length price), any investment in the Subsidiaries by way of loan could not qualify as being wholly (or even mainly) for the purpose of the Appellant’s trade carried on in the UK.  But in that situation the Appellant would not be investing the money in Subsidiaries but would be spending its money directly in acquiring the services of the Subsidiaries.  Here it is paying nothing for the services for which the Subsidiaries were set up to provide, and making loans to the Subsidiaries is the means by which the Appellant obtains those services which it requires for the purpose of its trade (incidentally in a way that is disadvantageous to the Appellant from the UK tax point of view, because it can deduct only the expenses paid by the Appellant).
15.	Accordingly the Appellant has shown that on the facts it satisfies s.289(1)(b) and (c) in relation to the two share issues in question and I allow the appeal.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 6 January 2005

SC 3001/04

Authorities referred to in skeletons and not referred to in the decision:
Sweet v Parsley [1970] AC132
IRC v Brebner 43 TC 705
River Wear Commissioners v Adamson (1877) 2 App Cas 743
Morgan v Tate & Lyle (1954) 35 TC 367
Joseph Thompson & sons Ltd v Chamberlain (1962) 40 TC 657
Forthright (Wales) Ltd v Davies [2004] STC (SCD) 35
Strong v Woodifield [1906] AC 448