[2010] UKFTT 422 (TC)

TC00698

Appeal number: TC/2009/13703

INCOME TAX – PAYE – NIC – whether a tax saving scheme in which employees agreed to reduced wages linked to receipt of dividends was effective – scheme not put into effect – appeal dismissed.   

FIRST-TIER TRIBUNAL

TAX 

	UNIPLEX (UK) LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

TRIBUNAL: 	Richard Barlow (TRIBUNAL JUDGE)									
								
Sitting in public in Manchester on 11 and 12 August 2010

Mr Steven Fallon of Premier Accountancy, chartered accountants, for the Appellant.

Mr Duncan Tebbet for the Respondents.

© CROWN COPYRIGHT 2010

DECISION

1.	This is an appeal against determinations made under Regulation 80 of the Income Tax (Pay as You Earn) Regulations 2003 by which HMRC determined to their best judgment that sums of tax were due from the appellant as employer concerning tax which had not been paid in respect of the earnings of a number of employees for the years 2004/5, 2005/6 and 2006/7 and against decisions under section 8 of the Social Security Contributions (Transfer of Functions etc) Act 1999 which decided that national insurance contributions were payable arising out of the same circumstances as gave rise to the PAYE determinations.
2.	A similar determination and decision in respect of 2007/8 had been withdrawn before the appeal was heard.
3.	The amounts in dispute are substantial and the parties are in agreement about the calculations.  The appellant did not seek to argue that the determinations were not to best judgment.
4.	The issue in the appeal is whether sums received by the employees in question were earnings of their employment or whether they were payments of dividends to those employees as shareholders.  The appellant admits that the circumstances were that a tax avoidance scheme relating to both PAYE and National Insurance Contributions was the reason why the payments were structured as it contends they were.
5.	The two directors of the appellant, Mr Adriaan Posthuma and Mr Malcolm Manning, attended the Tribunal and confirmed the statements being made on the appellant’s behalf by Mr Fallon which largely consisted of references to the documents produced for the hearing.  Although the documents were voluminous they were largely inconclusive and generally speaking the ones that might have been most relevant either did not exist or at least were not produced as will appear below.     
6.	The scheme was sold to the appellant by a Mr Backhouse, who seems to have operated through several legal entities during the relevant period and who provided some administrative support for the operation of the scheme.  I will refer to those legal entities as “the Backhouse organisation” as it was not possible to determine precisely which entity did what from time to time in respect of the scheme.
7.	The scheme was sold to the appellant and such of the appellant’s staff as agreed to be involved in it at a presentation by Mr Backhouse.  I was told that documents explaining the scheme were given out in a scheme brochure but surprisingly the appellant is unable to produce a copy of that brochure.  Given that about ten of the staff of the appellant and its two directors joined the scheme (and others joined later) it is very surprising that the appellant is unable to produce the brochure.
8.	The only document I was shown about the sale of the scheme was a document headed “Important Notes – Terms of Agreement”.  Copies of that document signed (as the document required) by members of the staff who joined the scheme were produced at the hearing.  Some of them are dated in early 2004 and some of them are undated.  Although they all required the employer to sign as well as the employee none are in fact signed by the employer.
9.	That document reads, so far as is relevant:
“You agree that your remuneration from the date of this agreement will be the statutory minimum wage from time to time (currently £4.50 per hour).  This will be administered under PAYE.  You will remain an employee of your existing employer for this purpose.
Apart from these variations, all other employment terms remain the same.
You will be entitled to participate in the Profit Share Scheme.  Under the Profit Share Scheme you will become a potential beneficiary under a discretionary trust.
Out of the profits due to the trust under the Profit Share Agreement you will receive income from the trust from time to time.
The member is also entitled to other benefits:
Death in service benefit
Critical illness Insurance
 A Will Service
Mortgage Information service
Other Services provided by the Introducer.
…
TERMINATION
I have read the Employee Profit Share Plan with Services together with the Tax and National Insurance Contributions Product Brochure and terms and conditions and agree to join on those terms and conditions”.
10.	If the reference to the brochure in the last paragraph quoted is to the brochure presented at the sales presentation, then I have not been made aware of its terms.  If it is a different brochure then there is no evidence before me either of its terms or even that it was in fact presented to the signatory of the document.  It is clear that the employees who signed that document were, on the face of it, giving up part of their wages or salary, being such part as exceeded the statutory minimum wage, and were doing so on the basis of a promise that they would potentially benefit from a discretionary trust, the source of income for which was not stated.  The terms on which the assets, if any, of the trust would be distributed were not explained.  So far as that document is concerned, those employees might have received absolutely nothing in return for giving up part of their wages.  
11.	 The appellant admits that no discretionary trust was ever set up.  The scheme envisaged and partly evidenced by production of that document was therefore never actually implemented.
12.	The appellant’s case is that a different scheme was in fact implemented, though ultimately it also admitted that even that scheme was not correctly implemented. 
13.	The substitute scheme, as explained by the appellant, was that the employees who agreed to be involved in the scheme were paid amounts exactly equal to what their wages or salary, including bonuses, would have been under their existing terms of employment and after deductions of national insurance contributions (both employees’ and employer’s NIC) and tax.  That was calculated by running a programme on a computer which was in effect the same programme as the one that calculated the wages and salaries or bonus after deductions of tax and national insurance contributions for staff who had not joined the scheme.  A second programme was then run for the staff who had agreed to be involved in the scheme but it was based on the minimum wage only, with additions of bonuses and calculation of the tax deductions and national insurance contributions accordingly.  The appellant then paid PAYE and NIC to HMRC on the reduced basis in respect of the staff whom it regarded as being in the scheme.
14.	A company called Embenplan Limited was set up by the Backhouse organisation and it calculated the pay and deductions from pay already referred to in respect of both the employees who had agreed to be involved in the scheme and those that had not.
15.	An agreement called the Profit Share Agreement was purported to have been made on 1 April 2004 between Embenplan and the appellant.  Embenplan was not in fact incorporated until 7 April 2004 and when that was pointed out to the appellant it simply asserted that the date of the agreement was a clerical error. However that may be, the only copy of the agreement produced at the hearing was for an unspecified date in 2007 and was accompanied by a memorandum agreeing that the “profit share” between Embenplan and the appellant for the year ended 30 April 2007 was that the appellant would pay to Embenplan 90% of its profits.  The respondents were able to show that the appellant had in fact only paid approximately 59% of its profits for that year to Embenplan.
16.	As explained to me at the hearing by the appellant, the purpose of setting up Embenplan, as well as providing the service of administering the payment of wages and salary as already explained, was to provide a legal entity into which the savings in PAYE and NIC payments derived from the scheme would be paid.  Those savings were the difference between what would have been paid on the total relevant earnings of the participants and the reduced amounts when they agreed to reduce their wages or salaries to the statutory minimum rate.
17.	The rationale for the rather surprising fact that the appellant was prepared to agree to pay 90% of its profits to Embenplan appears to be that Embenplan had to be put in funds to make monthly payments in advance for the Backhouse organisation’s services which were supposed to be then calculated precisely and any balance repaid to the appellant (though the appellant and the Backhouse organisation are now in dispute about whether there is a balance due to the appellant).
18.	The 59% of the appellant’s profit that was in fact paid to Embenplan rather than the 90% purportedly agreed represented approximately the correct amount to account for the PAYE and NIC which would have been payable in respect of the wages and salary foregone by the employees who had agreed to be bound by the terms of the ‘Important Notes – Terms of Agreement’.       
19.	As mentioned in paragraph 12 above, the employees who had agreed to have their wages and salary reduced to the minimum wage rates were in fact paid exactly the same amount as they would have received had they not made that election.  The balance between the minimum wage rates and what was paid was allegedly treated as a loan to the employees.  I say allegedly because there was no document produced about any terms upon which such loans might have been made.  The employees in question might or might not have been entitled to defend a demand for immediate repayment of those loans had one been made.  It is not even clear whether the loans were supposed to have been made by the appellant or Embenplan.  On the face of it the loans may have been intended to tide the employees over until they received payments from the discretionary trust although, if so, the lack of any precise terms on which that trust would have made those payments makes it clear that the employees would have been taking an enormous risk by agreeing to the terms and indeed as the trust was never set up, as the appellant admitted, that was a risk that fully materialised.
20.	However, the appellant’s case was that, in stead of the discretionary trust being set up, what happened was that the employees were going to be paid what was due to them by way of dividends from Embenplan which would have equalled the amounts of unpaid wages or salary and bonuses less amounts equal to the PAYE and NIC that would have been deducted had they not entered the scheme.  Those dividends would then have been allocated to repayment of the loans so that no actual payment would be made to the employees at that stage.  Ultimately the employees were supposed to receive additional distributions from Embenplan which would be funded by the actual savings of PAYE and NIC (less administration costs paid to the Backhouse organisation) which would then remain in Embenplan’s funds.  The dividends initially paid to the employees were only equal to the wages or salary and bonuses after deduction of amounts equal to the PAYE and NIC payments that would otherwise have been due to HMRC so that the actual savings would remain in Embenplan’s account until distributed.  No such distribution has occurred. 
21.	The issues of shares were not correctly dealt with.  There was some evidence that what was intended was that each member of staff in the scheme would be allotted a single share and that each of those shares would be in a different class of shares with a view to declaring a dividend for each class of shares equal to the amounts owed to that employee under the scheme and that that dividend would then be used to repay the loan or loans which had already been paid to the employee from time to time to top up his wages as explained in paragraph 12 above. 
22.	The issue of the shares would have had to be made in April 2004 if the scheme in the revised form were to have any chance of being effective for the whole of the period under appeal.  A document purporting to be dated 7th April 2004 recording a resolution of Embenplan passed at an extraordinary general meeting on that date but not received at Companies House until 9 October 2004 was produced by the appellant.  That resolution provided that the one £1 share then allotted should be sub-divided into 20 five pence shares and that twelve of the five pence shares should be issued in classes A to L.  One such share was said to have been issued to the appellant and the other eleven to the individuals who had by then, so the appellant contends, agreed to be bound by the ‘Important Notes – Terms of Agreement’.  
23.	The issue of those shares might have facilitated dividends consisting of the top up payments envisaged by the scheme.  I am not satisfied that the correct procedures were adopted for the issue of those shares to the appropriate persons.  However, whether they were or were not issued correctly it is clear that they did not represent the actual operation of the scheme.  On 9th May 2005 a meeting was held called the Embenplan Compliance Meeting and the minutes of that meeting have been produced.  Mr Backhouse was in attendance as were both the directors of the appellant.  The minutes include the following:
“… JB [Mr Backhouse] stated that the most important issue was to get an Embenplan Bank Account opened.  MSM [Mr Manning] stated that the Bank required a list of the shareholding for them to open such an account.  They had applied to Companies House and found that Embenplan had lodged no shareholder notification.  After technical discussions between JB and SF [Mr Fallon], it was decided that the quickest and easiest way to deal with the shareholding issue was to let Stuart Brooks initially be the only shareholder. Later it was intended to divide this share between all the members of the scheme – so that every member became a shareholder. …
JB stated that a way (mechanism) had to be put in place to transfer the saving being made in NI into Embenplan.  He stated that there were currently 10 different methods that he was operating between the 90 companies he was engaged with.  He briefly described his conversation with his “Tax Council” (sic) and the advice he had been given.  He reaffirmed that all his schemes were lawful and complaint with Inland Revenue Rules.  In summary the 3 methods of transfer he suggested for consideration were: …”. 
24.	The document purporting to show that the single share was divided and that the new shares were then issued to the participants on 7 April 2004 is demonstrated to be false by the first paragraph quoted from the compliance meeting.  The second paragraph shows that even the basics of the scheme had not been decided on at that point.  Given that that was the case on 9 May 2005, over a year after the scheme was supposed to have been put into effect, I have no hesitation in finding that as at 9 May 2005 no scheme was in place and that consequently the payments made to the employees up to that date had to be judged in light of that fact.  
25.	Given that the appellant’s case was that there was a scheme in place from April 2004 and given that that is demonstrably not the case, only the most cogent evidence would satisfy me that a scheme came into effect after 9 May 2005.  At the very least the evidential burden lies upon the appellant to produce evidence of that and I find that it has wholly failed to produce any satisfactory evidence that the scheme was put in place at any later date.  As the scheme envisaged in the only documents which the employees signed was certainly not given effect to (because no trust was set up), an alternative scheme would have required their agreement and although the appellant asserts that the employees agreed to something orally no satisfactory evidence of that was produced, for example by evidence from the employees or some of them, and the appellant was not able to state with any certainty what it was contended the employees had actually agreed to.  
26.	Despite the arrangements that were alleged to have been put in place for each employee who signed the ‘Important Notes – Terms of Agreement’ the employee received a payment of exactly the same amount as he would have received had no such arrangements been in place and the calculation of the amount paid to him included the deduction of sums exactly equal to what would have been deducted as PAYE tax and National Insurance Contributions.  
27.	The question that arises is whether those payments made to the employees should be treated as in whole or only in part as ““taxable earnings” from the employment” (as required by section 15(2) of the Income Tax (Earnings and Pensions Act 2003) the meaning of which is partly explained by section 62 of that Act which refers to salary, wages and “anything else which constitutes an emolument of employment”.  The important word in that legislation is “from” as that word (or “therefrom”) was the basis of the House of Lord’s determination of the correct approach to the question of what should be treated as taxable earnings in  Hochstrasser –v- Mayes (1956-1960) 38 TC 673.
28.	The correct approach is set out by Viscount Simons in Hochstrasser (page 706).  He says that it is for the Crown to establish that a payment to an employee is a reward for the employees’ services.  Lord Radcliffe said (at page 707) that the meaning of the statutory words “is adequately conveyed by saying that, while it is not sufficient to render a payment assessable that an employee would not have received it unless he had been an employee, it is assessable if it has been paid to him in return for acting as or being an employee”.  
29.	Although the statutory words are now slightly different the same principle applies today.   In The Commissioners for Her Majesty’s Revenue and Customs –v PA Holdings [2010] UKUT 251 (TCC) the Upper Tribunal held (at paragraph 30) that “applying a purposive construction, we consider that [the statutory language] is intended to cover payments which, on a realistic view of the circumstances in which and the reasons why they are made would sensibly be regarded as coming “from” the recipient’s employment”.  
30.	In this case the payments made were exactly what they would have been had the appellant never considered operating a tax saving scheme and so, in the absence of a scheme which had been put into effect (properly or at all), there is no doubt at all that the full payments came “from” the employment of the employees and that the payments coming from the employment were not restricted to those within the statutory minimum wage.  The respondents have therefore shown, in principle, that the additional amounts which exceed the minimum wage were “from” the employment in the relevant sense and the evidential burden falls on the appellant to show otherwise, which they have failed to do. 
31.	 Had the scheme been put into effect, it may well have still been the case that the full amount would have been taxable because the employees had given no consideration for the payment other than their services (as to which see Hochstrasser at page 692) but as that question is not relevant to my decision I am not prepared to consider it as it is hypothetical.
32.	The PA Holdings case is authority for the proposition that payments from a party other than the employer can be from an employee’s employment.  It therefore makes no difference whether the so called loans were from the appellant or from Embenplan. 
33.	I would add that the appellant ultimately admitted that it would have been prepared to settle this appeal had the respondents been prepared to settle for a reduced amount.  That was stated by the appellants openly before me.  The appellants put forward such case as they could but having been told by Mr Backhouse that they had a good case in law (possibly endorsed by counsel) they were not prepare to withdraw the appeal in case I agreed that they did have a good case.  I have considered such arguments as were open to the appellant and I am grateful to Mr Tebbet for the helpful and fair way in which he presented the case.  However, my holding is that the appeal fails and it is dismissed for the reasons stated.   
34.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

RICHARD BARLOW

TRIBUNAL JUDGE
RELEASE DATE: 10 September 2010