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HMRC wins £15m Hargreaves Lansdown loyalty bonus case

HMRC has successfully overturned a ruling on the tax status of ‘loyalty bonus’ rebates made by fund management platform Hargreaves Lansdown, with the result that over 150,000 investors are no longer in line for a £15m repayment windfall

Prior to April 2013, rebates of annual management charges (AMCs) to clients of the platform when discounting investments, also known as loyalty bonuses, were paid out tax-free. From that date, HMRC changed the rules so that rebates on annual charges, such as loyalty bonuses paid on funds held outside Isa or SIPPs [self invested personal pensions] had to be taxed as income and paid net of the basic rate tax.

Hargreaves Lansdown challenged HMRC on the change, taking the case to the First Tier Tax (FTT) tribunal where the company won their argument in March 2018.

The FTT held that the loyalty bonuses were payable under a legal obligation and were recurrent or capable of recurrence. However, the FTT concluded that the payments did not represent pure income profit and consequently that the payments were not annual payments.

HMRC took the case on appeal to the Upper Tribunal, which has now found in its favour. [The Commissioners for Her Majesty’s Revenue and Customs and Hargreaves Lansdown Asset Management Ltd, 2019 UKUT 246].

The Upper Tribunal found that loyalty bonuses paid to investors represented pure income profit for the investors and so were annual payments for tax purposes.

Annual payments are subject to the charge to income tax (ITTOIA 2005, s683). ITA 2007, s901 requires the payer of a ‘qualifying annual payment’ to deduct income tax from that payment. ITA 2007, s. 899 sets out the conditions which must be met for an annual payment to be a qualifying annual payment. The term ‘annual payment’ is not defined in legislation.

Case law indicates that a payment which demonstrates four characteristics is an annual payment. These are that it is payable under a legal obligation; it recurs or is capable of recurrence; it constitutes income and not capital in the hands of the recipient; and it represents pure income profit to the recipient.

It was common ground that the loyalty bonus had the third characteristic, while Hargreaves Lansdown did not challenge the FTT’s finding that the first characteristic was also present.

This meant the Upper Tribunal largely considered whether the second and fourth characteristics were present.

As regards the second characteristic, which is whether the loyalty bonus payments were capable of recurrence, Hargreaves Lansdown had argued before the FTT that the necessary feature of recurrence was not satisfied because the company could reduce the amount of a loyalty bonus to zero. In those circumstances, it was submitted that if an offer to pay the loyalty bonus could be withdrawn at any time, the necessary feature of recurrence was lacking.

However, the Upper Tribunal was in full agreement with decision of the FFT. Looking at the features of the arrangements, and the commercial background against which they were entered into, the Upper Tribunal was satisfied that the loyalty bonus payments were capable of recurrence.

This left the question of whether a payment amounts to pure income profit for the recipient ‘should be determined, in the light of the relevant facts, by establishing whether the payment is a taxable receipt in the hands of the recipient without any deduction for expenses or the like.’

The tribunal stated: ‘It is therefore clear that as far as the pure income profit issue is concerned, the key question that we need to determine is whether the investor received the loyalty bonus without having to do anything in return, or whether on the contrary the investor incurred an expense in return for receiving the loyalty bonus, namely the fact that he had to bear the AMC so that the payment of the loyalty bonus was simply a payment in reduction of an expense that the investor was obliged to bear.’

The Upper Tribunal found that the FTT had erred in law in this regard; it had looked at the ‘overall picture’ and had not based its decision on the terms of the contractual arrangements.

Based on the findings of fact made by the FFT, and its own contractual analysis, the Upper Tribunal remade the FFTs decision on this point, determining the issue in favour of HMRC: ‘the correct classification of the arrangements is that the investor receives a further income distribution in respect of his investment in the fund as result of his continuing investment in the fund. The term loyalty bonus is therefore a correct description; the payment does what it says on the tin – it rewards loyalty. We therefore conclude that the loyalty bonus is pure income profits.’

An HMRC spokesperson told Accountancy Daily: ‘We are pleased with the decision of the Upper Tribunal. This decision supports the published view of HMRC that these payments to investors are taxable.’

Chris Hill, chief executive of Hargreaves Lansdown, said: ‘We challenged this tax on behalf of clients as we always felt it was an unnecessary and unwarranted attack. Naturally we are very disappointed and following legal advice we have reluctantly accepted this ruling.’

Croner-i tax lead Stephen Relf ACA CTA said: ‘This issue goes back to March 2013 when HMRC first set out its position that trail commission is taxable in the hands of the investor (see HMRC Brief 4/13).

‘In this case, the issue turned on whether, looking in detail at the particular contractual arrangements, the payment was “pure income profit” for the investor. The Upper Tribunal agreed with HMRC that is was and therefore that the payer should have deducted income tax from the payment.’

The Commissioners for Her Majesty’s Revenue and Customs and Hargreaves Lansdown Asset Management Ltd, 2019 UKUT 246

(Source: Pay Sweet, Reporter, Accountancy Daily, published by Croner-i Ltd – 16 Aug 2019)