Case Report: Scotts Atlantic Management Ltd (in members' voluntary liquidation) & Ors [2013] TC 02704

[2013] UKFTT 299 (TC)

Judge Howard M. Nowlan, Gill Hunter

Decision released 13 May 2021

Corporation tax – deduction of expenditure – whether expenditure revenue or capital – revenue – whether scheme of works – no – whether relevant asset an entirety – yes – appeal allowed.

  The First-tier Tribunal decided that the taxpayer companies could not sustain their claims for corporation tax deductions for the cost of funding the Employee Benefit Trusts (‘EBT’). The taxpayers' intentions were plainly to secure a far from ordinary tax deduction, one that would not ordinarily be expected, and was designed to achieve the very opposite of the result intended by Parliament. The curious position, thus, became that if no attempt was made to circumvent Finance Act 2003 (‘FA 2003’), Sch. 24, para. 1, the deduction was denied. If a contrived scheme was effected to achieve the opposite result, it failed simply because that objective became the fatal purpose that created the ‘duality of purpose’ that itself undermined the deduction. Thus, the entire corporation tax deduction should be disallowed to both taxpayers in respect of all the contributions to the EBT.

Facts

  The taxpayers appealed against HMRC's decision, disallowing the taxpayers' entire corporation tax deductions for the cost of funding the EBT and imposing PAYE liabilities in respect of the benefits provided to the directors.

  In 2000, the individual taxpayer (‘Mr D’) set up various companies (‘Scotts’). By 2003 to 2004, there were several active Scotts companies, including the two taxpayer companies (‘SA’ and ‘FM’). Mr D and another individual each owned 50 per cent of the shares of a company, which owned SA and FM.

  The steps undertaken to avoid the application of the disallowance provided under FA 2003, Sch. 24, para. 1 were as follows: The employer company (SA or FM), intending to make contributions of, say, £1m into an EBT would first form a new UK company (‘Newco’). The employer company would then form two EBTs (‘EBT1’ and ‘EBT2’) with Guernsey trustees. The employer company would then subscribe a few shares, say, 100 1p shares (‘the trivial shares’) in Newco for a premium of £999,999, such that those shares would be worth £1m. Newco would then grant an option, exercisable within ten years, to EBT1 to subscribe 10,000 1p shares at par, i.e. for £100. The effect of the grant would be to procure that the value of the 100 shares in Newco held by the employer would drop to one per cent of £1m, i.e. £10,000, and the option would be worth £990,000. The employer company would then sell the 100 shares to EBT2, at their heavily diminished, but now correct, value of £10,000. EBT2 would countersign the option agreement, committing to ensure that no share issues or distributions would dilute the value of the option.

  HMRC contended that SA and FM failed to sustain their deductions for corporation tax purposes even before FA 2003, Sch. 24, para. 1 was considered. Corporation tax deductions were only available for revenue expenses incurred wholly and exclusively for the purposes of the trade. That could not be established in the present case. The real purpose of making EBT contributions was just to avoid corporation tax, or to strip the companies of their assets. None of those purposes was wholly or even remotely a legitimate revenue expense of the trade. Since the vast majority of the benefits passed to the people who were the ultimate shareholders, an improper deduction was being claimed for payments that really ought to have been dividends. There was a distribution of profit, not an expense in earning profit, and worse still, a distribution of all the assets. That left both companies quite unable to pay any remaining liabilities, including corporation tax, should it emerge that the contributions were non-deductible such that the companies were left with corporation tax liabilities.

  HMRC also contended that in respect of the PAYE liability, the point at which such liability arose was the point at which value was contributed by SA into its Newco (‘SAIL’). At that point, because Mr D and another were the directors of SAIL, the value in it was ‘unreservedly at the disposal of the directors’. Thus, PAYE tax should have been accounted for.

  The taxpayers accepted that under the scheme, SA and FM acquired shares in the Newcos and contributed very substantial capital into the companies. Those Newcos ranked as capital assets. However, the only reason why SA and FM then suffered losses was that they quite deliberately diverted value into the options granted by the Newco companies themselves. That diversion was made entirely to meet bonus expectations of the directors, such that it was a revenue expense. There was no way in which the capital assets lost value in any respect, other than by the deliberate step designed to remunerate directors.

Issues

(1)Whether SA and FM could sustain their claims for corporation tax deductions for the cost of funding the EBTs.

(2)Whether SA and FM had no PAYE liabilities in respect of the benefits provided to their directors.

Decision

  Held, dismissing the taxpayers' corporation tax appeal and allowing their PAYE appeal:

  In respect of the first issue, the Tribunal held that trading companies only secured trading deductions for expenses ‘wholly and exclusively incurred’ for the trading purposes of the company. Expenses could be split if, for instance, expenditure was incurred on a property, half of which was used for trading purposes, and half of which was not held for any trading purpose. However, there could be no split where the entire expenditure was incurred for a ‘dual purpose’, one element of which was simultaneously a trading purpose and a non-trading purpose.

  An objective, on the part of a company, of seeking to eliminate its liability for corporation tax, could not be a legitimate ground for claiming a trading deduction. In the case of ordinary payments of salary and bonus, when a company ordinarily made such payments, the feature that it expected to secure a trading deduction for the payments did not occasion any ‘duality of purpose’ concern. In the ordinary way, salary and bonuses were obviously tax deductible. They were meant to be tax deductible, and the expectation that that would be so was not an objective of making the payments.

  However, the provisions of FA 2003, Sch. 24, para. 1, undermined that ordinary expectation. The reality became that if no steps were undertaken to oust the application of FA 2003, Sch. 24, para. 1, the corporation tax deductions would obviously be denied by that provision. Here, SA and FM's intentions were plainly to secure a far from ordinary tax deduction, one that would not ordinarily be expected, and certainly one that was designed to achieve the very opposite of the result intended by Parliament. On that ground, the resultant ‘duality of purpose’ in making the contributions, via the value-draining scheme, was the very factor that occasioned the fatal duality of purpose that resulted in the denial of the entire deductions claimed by both companies. The curious position, thus, became that if no attempt was made to circumvent FA 2003, Sch. 24, para. 1, the deduction was denied. If a contrived scheme was effected to achieve the opposite result, it failed simply because that objective became the fatal purpose that created the duality of purpose that itself undermined the deduction. Thus, the entire corporation tax deduction should be disallowed to both taxpayers in respect of all the contributions.

  In respect of the second issue, the Tribunal found that once the EBTs held the shares in the various Newcos, the directors did consult the trustees when aiming to make some new loan. The trustees declined to lend money back to SA when requested to do so by Mr D. By that point, SAIL had been liquidated and the moneys were in the direct hands of the trustees. But that still suggested that the trustees were acting independently and there was no reason to suppose that they would have acted very differently had the funds still been in a company wholly owned by them. It was the trustees that had called for the repayment of loans made to Mr D that had been one of the reasons why he had been declared bankrupt. Whilst the requested repayment was of the replacement loans made by the trustees and not those originally made by the companies, the present state of affairs did make it abundantly clear that Mr D did not have control over the moneys in the trusts, and did not have those funds ‘unreservedly at his disposal’. When HMRC were apparently raising assessments in respect of loans to participators in close companies, those assessments were also inconsistent with the proposition that the moneys in the Newcos were properly subject to PAYE liability either when contributed into the Newcos or indeed at any point.


SOURCE: CCH Online