SPC00511

INCOME TAX: ALLOWABLE EXPENDITURE Sch D: interest payments on a commercial mortgage- was the purpose of the mortgage to purchase just business assets or to purchase a private  dwelling house as well – a question of fact – the purpose of the mortgage was to buy a parcel of assets with a mixed business and private use – the interest payments apportioned to reflect the mixed use – the appropriate rate of apportionment 35/65 private and business use based on the finding that the mortgage was to facilitate the purchase of the entire business assets plus the dwelling rather than the purchase of two properties – decision in principle to allow the Appeal in part but only in so far as substituting 35 per cent for the 50 per cent add back in respect of the interest – parties directed to agree computations in order to make final determination.  

THE SPECIAL COMMISSIONERS

	IAN DIXON	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	Respondents

			Special Commissioner:	MICHAEL TILDESLEY OBE	

Sitting in public in Edinburgh on 29 September 2005

James Paterson, Chartered Accountant for the Appellant

June Kennerley of the Northern England Regional Appeals Unit HM Revenue & Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2005

DECISION IN PRINCIPLE
The Appeal
1.	The Appellant was appealing against amendments to his tax returns for 2000/01 and 2001/02, and against discovery assessments for 1996/97, 1997/98, 1998/99 and 1999/2000. In their amendments and discovery assessments the Respondents reduced the amount of mortgage interest by 50 per cent which the Appellant had claimed for business expenditure. 
The Issue in Dispute
2.	The issue in dispute was whether the Appellant’s expenditure on interest payments under a mortgage with the Northern Rock was applied wholly and exclusively for the purposes of the Appellant’s trade as a newsagent.
3.	The Appellant contended that he took out the mortgage with the Northern Rock to purchase the assets of an ongoing business. The assets included the shop premises at 5A Grove Gardens, fixtures and fittings, trading stock and goodwill. The Appellant was of the view that the interest payments on the mortgage should be allowed in full when computing his taxable profits under Schedule D.
4.	The Respondents submitted that the purpose of the mortgage was to purchase a parcel of assets including a private residence at 5 Grove Gardens. Thus the Respondents contended that the interest payments should be apportioned between business use and private use. The proposed apportionment ratio was 50 per cent business use. 
5.	The underlying question raised by this Appeal is: “what was the purpose of the mortgage taken out by the Appellant with Northern Rock in 1994 and amended in 1995”.
The Law
6.	Section 74(1)(a) ICTA 1988 provides that expenditure is allowable only as business expenditure if it is: “laid out and expended wholly and exclusively for the purposes of the trade, profession or vocation”. 
7.	In Scorer v Olin Energy Systems Ltd  [1985] 58 TC 592 at 611 Walton J approved the approach taken by the Special Commissioners regarding the payment of interest for the purposes of a trade, namely:
“… we take the view that the question whether interest was paid for the purposes of a trade must depend upon whether the loan, on which the interest was paid, was incurred for the purposes of that trade. It does not necessarily follow that the purposes of the loan can be ascertained by looking at the immediate use to which the borrower applies the money. The question is one of fact to be decided on the evidence available in each case”.
8.	Evidence of what the taxpayer said he intended for the expenditure is not decisive for determining whether it was incurred wholly and exclusively for the purposes of his trade. In Mackinlay v Arthur Young McClelland Moores & Co [1989] 62 TC 704 at 757 EF Lord Oliver said:
“ Your Lordships have been referred to what may be regarded as a seminal decision of the House in Mallalieu v Drummond [1983] 2 AC 861 and much argument has been addressed to the question whether the purpose of the particular payment falls to be ascertained objectively or by reference only to the subjective intention of the payer. For my part, I think that the difficulties suggested here are more illusory than real. The question in each case is what was the object to be served by the disbursement or expenses? As was pointed out by Lord Brightman in Mallalieu’s case, this cannot be answered simply be evidence of what the payer says that he intended to achieve. Some results are so inevitably and inextricably involved in particular activities they cannot but be said to be a purpose of the activity”.
The Hearing
9.	I heard evidence from the Appellant and received separate bundles of documents and skeleton arguments from the parties.
The Findings of Fact
10.	On 24 December 1993 the Appellant retired early from his position at British Telecom where he had worked for 14 years. He received a redundancy payment in the sum of £21,000. His first wife worked part-time for a Mr Mullan in his newsagents and shop at 5a Grove Gardens. Mr Mullan had put up for sale as a package, his house, shop and business at 5/5a Grove Gardens, Tweedmouth. 
11.	On 14 January 1994 the Appellant and his first wife completed the purchase of 5/5a Grove Gardens. 5 Grove Gardens was a dwelling house in which the Appellant and his wife would live. 5a Grove Gardens was a self-contained shop premises which adjoined the dwelling house at 5 Grove Gardens. The Appellant intended to carry on Mr Mullan’s trade as a newsagent and shop from 5a Grove Gardens. As part of the transaction Mr Mullan purchased the Appellant’s home at 43 Northumberland Road, Tweedmouth.
12.	The total purchase price for the dwelling house and business at 5/5a Grove Gardens was £134,500 which comprised £47,500 for 5 Grove Gardens, £47,500 for 5a Grove Gardens, £30,000 goodwill, £5,000 fixtures and fittings and £4,500 for stock.
13.	The Appellant and his first wife funded the purchase price with the market value of their house (£58,000) which was exchanged with Mr Mullan as part of the transaction, a mortgage advance of £67,500 from the then Northern Rock Building Society with the Appellant meeting from other sources the balance of £9,000 plus professional fees incurred in connection with the purchase. The Appellant used his redundancy payment to discharge the mortgage on their former home at 43 Northumberland Road.
14.	The Appellant instructed Tyne and Tees Mortgage and Insurance Services to obtain the loan necessary for the purchase of Mr Mullan’s business and dwelling house. His instructions were to obtain the best deal possible on a loan of £75,000.
15.	Tyne and Tees Mortgage and Insurance Services put the Appellant in touch with Northern Rock Building Society which was prepared initially to lend the Appellant £75,000 on a purchase price of £130,000. On 1 December 1993 the loan advance, however, was reduced to £67,500 to reflect the property valuation of 5/5a Grove Gardens. 
16.	The Appellant and his first wife completed an application form in connection with the mortgage with Northern Rock. In the form the property subject to the mortgage was described as “residential dwelling and separate retail property (newsagency and general store)”.  The Northern Rock Building Society described the property as           “business with dwelling, 5 and 5A Grove Gardens” in its Offer of Advance for £67,500 on 1 December 1993.  The purchase price in the application form was recorded as £130,000 which was reproduced on the initial offer of advance dated 19 November 2003 but downgraded to £94,499 in the subsequent offer of 1 December 2003 presumably on the basis of the valuation of the two properties.
17.	The mortgage with the Northern Rock Building Society was a commercial loan with an initial fixed rate of 8.6 per cent until 1 September 1997 and thereafter at a rate of 1.5 per cent above the Society’s variable base mortgage rate. In a letter dated 2 December 1993 to the Appellant and his first wife, their solicitors explained that they contacted Northern Rock Building Society about the possibility of a residential mortgage but the Society was not willing to consider this, insisting upon a commercial mortgage for both properties. At the hearing, the Appellant could not recall instructing his solicitors to contact the Society. 
18.	 The solicitors in the same letter informed the Appellant and his first wife that they had apportioned the assumed purchase price of £95,000 for the buildings at 5 and 5a Grove Gardens equally between them, so that the price for each building was £47,500.  In the solicitors’ view this would enable the Appellant and his first wife to obtain MIRAS relief on that part of the mortgage allocated to the dwelling house. The solicitors added that if the Inland Revenue did not agree with MIRAS relief, the Appellant would be able to set off the interest repayments on the commercial mortgage against business expenses for tax purposes.
19.	On 19 May 1995 the Appellant took out a fresh mortgage with Northern Rock Building Society in his own name because he had separated from his wife. In all respects this mortgage replicated the one granted on 1 December 1993 with a slight variation in the actual interest rates. In the mortgage application form the property subject to the mortgage was described as: “house and shop newsagents”.
20.	On 1 September 2005 Heather Gatenby of the Commercial Finance Department for Northern Rock stated in a letter to the Appellant’s representative that
“I write to confirm that we as a building society originally made an advance of £67,500 to Mr Dixon so that he could purchase the business as 5a Grove Gardens ….
We charged Mr Dixon a commercial premium of 1.50% over the variable base rate as this was commercial borrowing and we charged his properties at 5 and 5a Grove Gardens as security of the mortgage”.
My Reasons
21.	 The Appellant sought to persuade me at the hearing that the purpose of the commercial mortgages with the Northern Rock was to purchase the shop premises and the goodwill associated with business. He stated that he had enough money from the sale of his property at 43 Northumberland Road to buy the house at 45 Grove Gardens. According to the Appellant Northern Rock would not lend him the money on the shop and goodwill alone, the Society wanted the dwelling house as security. In my view the Appellant’s explanation did not fit in with the picture painted by the facts found above about the circumstances of the purchase. In essence the facts demonstrated that the Appellant bought a package of a business with a home and that the loan was taken out to facilitate the purchase of the whole package not just individual parts of it.
22.	 Mr Mullan sold his house and business at 5/5a Grove Gardens as a package for a single price. Mr Mullen did not stipulate an individual value for each of the two properties. The Appellant’s solicitors assumed that the purchase price for the two properties was £95,000 based presumably on the valuation carried out by the Northern Rock. They took the decision to allocate equally the assumed purchase price between the two properties after the deal was struck.  
23.	My conclusion that the Appellant purchased a complete package was supported by the Appellant’s individual circumstances at the time of the transaction and the actual mechanics of the deal, namely:  
(1)	The Appellant was about to take voluntary redundancy from British Telecom and on the lookout for a new business venture. 
(2)	His first wife knew the business since she was employed part-time in Mr Mullan’s shop.
(3)	 Mr Mullan was prepared to take the Appellant’s house in part satisfaction of the purchase price. This undermined the Appellant’s assertion that he had available cash to purchase the dwelling house without the shop. The Appellant’s sale of his house was dependent upon him buying the complete package from Mr Mullen. 
(4)	 The Appellant and his first wife would live in the dwelling house at 5 Grove Gardens which adjoined the shop. 
24.	The Appellant did not have the funds to make up the shortfall between the purchase price required by Mr Mullan and the market value of his house at 43 Northumberland Road.  He instructed Tyne and Tees Mortgage and Insurance Services to obtain the best deal on a loan of £75,000, which represented the shortfall rather than the price of the business assets. Northern Rock Building Society apparently gave the best deal but only on a loan of £67,500. 
25.	The Appellant’s intentions were clearly set out in his mortgage application form. He was requiring a mortgage to meet the shortfall in the purchase price of £130,000 for a residential dwelling and separate retail property as a newsagency and general store.   The Society advanced the mortgage for the purpose of purchasing “a business with a dwelling”. 
26.	 The Appellant was, therefore, purchasing a business with a dwelling from Mr Mullan. The purpose of the mortgage with Northern Rock Building Society was to effect the purchase of Mr Mullan’s business with a dwelling by providing the necessary funds to make up the shortfall between the purchase price and the market value of the Appellant’s house. The mortgage was not taken out for the sole purpose of paying for the assets associated with Mr Mullan’s business.
27.	The Appellant   relied on his solicitors’ letter of 2 December 1993 to justify his stance that the mortgage was taken out solely to purchase business assets. I placed a different interpretation on the letter. The relevant paragraph dealing with the mortgage application talked about the solicitors making enquiries about the possibility of obtaining a residential mortgage. I considered that the solicitors would not have made those enquiries if they believed that the mortgage was taken out solely for the purchase of business assets. I also noted that the completion statement prepared by the solicitors did not breakdown the purchase price between the relevant components of the sale, nor allocate the mortgage advance to the purchase of business assets only.
28.	The one document supporting the Appellant’s stance was the letter of 1 September 2005 from Heather Gatenby of the Commercial Finance Department for Northern Rock. I have discounted this letter because it was written almost 12 years after the date when the first mortgage was taken out. Further the letter was inconsistent with the contents of the documents issued by the Northern Rock Building Society at the time of the mortgage advance.
29.	The Appellant subscribed to a new mortgage with the Northern Rock Building Society in 1995 because he had separated from his wife. The details of the mortgage application replicated those in the previous application made in 1993 except that the Appellant was making the application himself rather than as a joint applicant with his first wife. I consider that the 1995 mortgage shared the same purpose as the previous mortgage. The 1995 mortgage was simply regularising the position of the Appellant following the separation from his wife. 
30.	I am, therefore, satisfied for the reasons set out above that the purpose of the commercial mortgages taken out by the Appellant with the Northern Rock Building Society in 1994 and 1995 was to purchase a parcel of assets which were the business assets associated with the newsagent and shop at 5a Grove Gardens and the private dwelling house at 5 Grove Gardens. 
The Apportionment of the Interest
31.	It follows from my decision at paragraph 29 that I agree with the Respondents’ basic premise that the purpose of the commercial mortgages entered into by the Appellant was to purchase a parcel of assets with mixed business and private use. On that basis the Respondents have seen fit to apportion the interest paid by the Appellant on the mortgages equally between business and private use. Their rationale for the 50/50 split between the respective uses was that the value of the properties subject to the mortgage had been assessed identically at £47,500 by the Appellant’s solicitors. In their correspondence with the Appellant’s representative the Respondents considered that they had been generous by conceding a 50/50 split. They could have, for example, based the apportionment on the respective square footage of the two buildings resulting in a 72/28 split of the interest in favour of private use. Despite their reservations, the Respondents accepted that the apportionment of the mortgage interest should be based on the monetary value of the assets concerned.
32.	 My finding on the principal issue in dispute, however, differed in a material respect from the Respondents’ view that the commercial mortgages were taken out to purchase the two properties. I have decided that the Appellant took out the mortgages to meet the shortfall between the purchase price of the business and dwelling at 5/5a Grove Gardens and the market value of his house at 43 Northumberland Road. Thus the purpose of the mortgages was to facilitate the purchase of the whole package rather than two separate properties. The Respondents in my view have wrongly transposed the security for the mortgages with the purpose for which the mortgages were taken out. Therefore, my decision challenged the Respondents’ basis for their 50/50 apportionment of the mortgage interest.
33.	The Respondents accepted that I had jurisdiction to deal with the issue of apportionment of the mortgage interest.  In view of my finding that the purpose of the mortgage was to purchase the whole package, namely the business assets including the shop and the residential property, I consider that the apportionment should be based on the value of the residential property against the purchase price of the whole package. The documents produced gave conflicting prices for the whole package. The mortgage application stated a purchase price of £130,000, whilst the completion statement prepared by the Appellants’ solicitors gave £134,500. I prefer the figure given by the completion statement. Thus the apportionment for private use is £47,500 divided by £134,500 which gives 35 per cent rounded down. The apportionment for business use is 65 per cent.
My Decision
34.	I have decided in principle that
(1)	The purpose of the commercial mortgages taken out by the Appellant with the Northern Rock Building Society in 1994 and 1995 was to purchase a parcel of assets which were the business assets (goodwill, fixtures, stock and premises) associated with the newsagent and shop at 5a Grove Gardens and the private dwelling house at 5 Grove Gardens.
(2)	The interest paid on the mortgages should be apportioned accordingly to reflect the mixed private and business use of the commercial mortgages.
(3)	The rate of apportionment should be 35 per cent private use and 65 per cent business use. 
35.	The effect of my decision in principle is that I have allowed in part the Appellant’s appeals against the amendments to his tax returns for 2000/01 and 2001/02, and the assessments for 1996/97, 1997/98, 1998/99 and 1999/2000 but only in so far as substituting 35 per cent for 50 per cent of the interest added back to the amendments and assessments in question.
36.	 I am not in a position to make a final determination because I do not have the computations for a 35 per cent add back.  I, therefore, direct that the Respondents produce the necessary computations and agree them with the Appellant’s representative within two months from the date of release of this decision. The parties are to inform the Office of the Special Commissioners in writing that they have reached agreement by no later than two months from the release date, whereupon I will formally determine the Appeal on the basis of the agreement reached. If there is no agreement I will make the final determination on written representations which shall be provided by the parties by no later than two months from the release date. 
Ancillary Matters
37.	The Appellant cited BIM45745, an Extra Statutory concession, as an additional ground of Appeal. The ground was not proceeded with because I have no jurisdiction over Extra Statutory concessions granted by the Respondents.
38.	The Appellant made application for costs in relation to the Appeal hearing. I have no power to award costs unless I consider that the Respondents have acted wholly unreasonably in connection with the Appeal hearing. I do not consider that the Respondents have acted wholly unreasonably. In fact both the Appellant’s and Respondents’ representatives prepared and presented their cases in a professional and competent matter. I express my gratitude to the representatives. 

MICHAEL TILDESLEY

SPECIAL COMMISSIONER
RELEASE DATE: 24 November 2005

SC 3082/05

££Dixon v Revenue and Customs [2005] UKSPC SPC00511 (24 November 2005)