Spc00629

PAYE and National Insurance Contributions –Payments made as management charges – Preliminary hearing on whether Notices issued by HMRC were valid notices – Appeal Dismissed

THE SPECIAL COMMISSIONERS

WESTEK LIMITED	Appellant

-	and –

THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

Special Commissioner:  HOWARD M NOWLAN

Sitting in public in London on 10 July 2007

David Smith of Accountax Consulting Limited on behalf of the Appellant 

Sam Grodzinski, Counsel, instructed by the Solicitor’s Office of HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

The dispute in the Preliminary Hearing in outline

1.     This was a preliminary hearing to decide whether the Notices of decisions issued by HMRC under section 8 of the Social Security Contributions (Transfer of Functions) Act 1999 ("the Transfer Act") and whether the PAYE determinations made by HMRC under Regulation 80(4)(b)(i) of the Income Tax (Pay As You Earn) Regulations 2003 ("the PAYE Regulations")  (both for all of the periods 2000/2001, 2001/2002, 2002/2003, and 2003/2004) were invalid.

2.      HMRC had contended that large payments or awards falling into two categories that had been made by the Appellant to or in respect of three directors were liable to primary and secondary National Insurance contributions, payable by the Appellant, and were also liable to PAYE deduction by the Appellant, as emoluments.   The first category of payment was of payments described as "management charges" that were paid by the Appellant to companies or in one case to  a partnership, where the companies were said to be controlled by the directors of the Appellant company and where a director of the Appellant was one of the partners of the partnership.   The second category of payment was described as awards under a "discounted option scheme".      Substantive appeals are pending in relation to the Appellant's liability for both contributions and tax in respect of both categories of payment or award.    Different advisers will be representing the Appellant at the substantive hearing.   This preliminary hearing related only to the validity of the National Insurance notice and the PAYE determination in respect of the management charge issues.

The terms of the decision under section 8 and of the determination under Regulation 80

3.    The terms in which the decision and determination were made and then notified were as follows. 

4.    The formal notices were preceded by a letter dated 18 October 2006 from the Special Civil Investigations Section of HMRC at Manchester indicating that 

"…my colleagues at Warrington will shortly be issuing determinations under Regulation 80 of the Income Tax (Pay as You Earn) Regulations 2003 and Decisions under s. 8 of the Social Services Contributions (Transfer of Functions etc) Act 1999.   These will relate to payments to Westek directors namely A Cotter, G Cooper and B Turner.
"The determinations and decisions will cover separately payments from the Discounted Option Scheme and payments described by the company as "management charges.
"I attach a schedule indicating how amounts are broken down between directors, sources of income and years".

5.     The Schedule attached to the letter did precisely what it was indicated that it would do, with the reference to "sources of income" clearly meaning the two different categories of delivering what HMRC regarded as taxable emoluments, namely the Discounted Option Scheme and the Management Charges.      There is no need to summarise the content of the Schedule though it is worth mentioning that the sums at stake were very significant, with the figures awarded under the Discounted Option Scheme amounting to £6,397,770 for the two years in which awards were made and the figures paid to the various recipient companies and the partnership as management charges amounting to £2,996,616 for the four years, 2000/2001 – 2003/2004, for which management charges were paid.

6.     On 2 November the Local Compliance Section of HMRC at Warrington wrote to Westek attaching the Notices of Decisions under Section 8 of the Transfer Act for National Insurance purposes and the Notices of Determinations made under Regulation 80 for PAYE purposes.     The covering letter referred back to the 18 October letter and broke down the amount of Class 1 NICs and Tax being demanded for each of the four years, and again segregated the claims in relation to the awards under the Discounted Option Scheme, and the payments described as management charges. 

7.     The wording of the Notices of Decision in relation to National Insurance contributions (taking the Notice for 2003/2004 as an example) was as follows:-

"My decision is as follows:-

1.    That Westek Ltd is liable to pay primary and secondary Class 1 contributions for the period 6 April 2004 in respect of the earnings of employees in receipt of management charges from the company.
2.   The amount Westek Ltd is liable to pay in respect of those earnings is £339301.17.
3.    The amount that Westek Ltd has paid in respect of those earnings is nil."

A Notice in substantially similar form was issued in respect of the National Insurance claims in relation to the awards under the Discounted Option Scheme, but this is of no present relevance since this preliminary hearing related only to the management charge payments. 

8.     The Notice of the Regulation 80 Determinations for PAYE purposes indicated in the box where the Name and National Insurance number of the employee was to be entered the phrase "employees in receipt of management charges from the company";  and thereafter simply listed the total pay, tax payable, tax already paid and the tax "now due" for each of the years in dispute.   Similar Notices related to the awards under the Discounted Option Scheme, where the wording again simply referred to "employees in receipt of awards under the discounted option scheme". 

The legal requirements in relation to the decisions and determinations to be made in relation to National Insurance and PAYE claims by HMRC and the required content of the Notices, informing the taxpayers of the terms of the decisions and determinations

9.     For National Insurance purposes section 8 of the Transfer Act provides for "an officer of the Board" to make a number of decisions as regards National Insurance matters.    Section 8(1) (a) covers decisions as to whether "a person is or was an earner and, if so, the category of earners in which he is or was to be included"; section 8(1)(b) covers decisions as to whether a person is or was employed in employed earner's employment", and section 8(1)(c) provides for the officer:-

"to decide whether a person is or was liable to pay contributions of any particular class and, if so, the amount that he is or was liable to pay".

Numerous other paragraphs then provide for the officer to make various other decisions.

10.     Regulation 3 of the Social Security Contributions (Decisions and Appeals) Regulations 1999 provides that decisions made by the officer of the Board under section 8 of the Transfer Act must be made to the best of his information and belief; must state the name of every person in respect of whom it is made and the date from which or the period for which it has effect.     Regulation 4 then requires notice of any section 8 decision to be given "to every person named in the decision".  

11     For PAYE purposes, Regulation 80 of the PAYE Regulations empowers the Inland Revenue to determine any amount of PAYE tax which appears not to have been paid, and Regulation 80(4) provides that:-

"A determination under this regulation may:-

(a)  cover the tax payable by the employer under regulation 68 for any one or more tax periods in a tax year, and
(b) extend to the whole of that tax, or to such part of it as is payable in respect of-

(i) a class or classes of employees specified in the notice of determination (without naming the individual employees), or
(ii) one or more named employees specified in the notice."

The contentions advanced on behalf of the Appellant

12.     Prior to the preliminary hearing the ground on which the Appellant contended that the Social Security decision and notice were void was that the notice did not specifically declare that anyone was "an employed earner".    This contention had been abandoned by the date of the preliminary hearing, and it was then contended as regards the Social Security decision and Notice that:-

1.	the decision and the notice were void because they failed to clarify which employees were involved, in that they only referred to "earnings of employees";
2.	the decision and notice were invalid because they failed to name "every person in respect of whom [the decision] was made", and the directors or employees were persons in respect of whom the decision was made;
3.	the directors were concerned with the decision because their National Insurance contributions would be affected by the contentions being advanced, and therefore they were persons in respect of whom the decision was made; 
4.	the decisions made by the officer were implicitly decisions under section 8(1)(a) as well as 8(1)(c) so that the individual directors should have been named because they were the people implicitly treated as "earners"; 
5.	in any event, no payments were paid to employees, but payments were made to companies, and in one case to a partnership, so that the decisions and Notices were based on an incorrect statement of the facts; 
6.	the three directors in question were directors but were not employees at all; and
7.	since the IR35 legislation had been introduced for all tax years in question, the Inland Revenue should re-frame their Notices in the form applicable to payments made through intermediaries, rather than on the basis that the payments were made to un-named employees, and the Inland Revenue should thus issue new notices.
13.     As regards the PAYE determinations, it was again alleged that the payments were made to entities distinct from the individual directors and again alleged that the three directors in question were not employees at all, and then it was contended that the determination had not been made "in respect of a class of employees", as required by the terms of Regulation 80(5).

14.      In so far as the Appellant's contentions admitted that HMRC could issue new Notices in a different and corrected form even if the Appellant's contentions were upheld, a partial explanation was given as to why some significance still attached to these preliminary contentions.     It is, however, unnecessary for me to summarise the possible consequences, though I might just mention that the significance attached to the proposition that if the Appellant's substantive appeal was dismissed, the result of it having succeeded on the preliminary points might be that HMRC would be unable to collect some of the National Insurance contributions or tax in dispute. 

The contentions advanced on behalf of HMRC

15.      The following contentions were advanced on behalf of HMRC:-

1.	For National Insurance purposes, the only decision made by the officer of the Board was one under section 8(1)(c) of the Transfer Act, and the only person in respect of whom the decision was made was Westek Limited.     The employer alone was liable to pay primary and secondary Class 1 contributions.     Although there is a distinction between primary and secondary contributions in that the latter are the liability only of the employer, whilst the former are deducted from the employee's earnings, the exclusive liability for both contributions still falls only on the employer, and therefore it was only Westek "in respect of whom the decision was made". 
2.	It was not accepted that the directors were not employees, but as no evidence had been given at the stage of the preliminary hearing on this issue, this was plainly a matter to be dealt with at the later substantive hearing.    It was however HMRC's contention that there was some evidence that one at least of the directors was an employee.
3.	It was also HMRC's contention that this case was brought on the basis that the companies were only conduits that filtered payments to the directors and that the case was not thus one more appropriately covered by the IR 35 provisions.    If in due course HMRC decided to advance their contentions or a different or an additional ground they would do so.
4.	For PAYE purposes, the description of the category of employees in the PAYE determination, geared to their being "employees in receipt of management charge payments" was a description of a class of employees for the purposes of Regulation 80(5).
5.	In the light of all the information contained in the earlier letter sent to Westek on 18 October, and in the covering letter sent with the formal notices, the Appellant cannot have been under the remotest doubt as to any of the points where the Notices themselves were said to be defective.     This point, and the further point that the original ground on which the National Insurance case was advanced, geared to the failure to describe the directors as "employed earners" (which HMRC were simply unable to understand)  indicated how the technical points raised in this case were technical and tenuous in all senses, without the slightest merit.  
6.	In the event that I decided the PAYE matter under Regulation 80 in favour of the Appellant on considering the terms of Regulation 80 alone, then section 114 Taxes Management Act 1970 would correct the minor deficiencies in the Notice.
My decision

16.       The most difficult question in this appeal is the issue of whether the National Insurance decision correctly named, as required by Regulation 3, every person in respect of whom it was made.       Listing all the arguments as to why I might conclude that the decision was deficient in this respect, I might conclude:-

1.	that linguistically the words "in respect of" suggested that the decision should be treated as made in respect of an employee if it was made "about the employee", regardless of whether the employee would be liable for some tax as a result of the decision;
2.	 that the officer's decision was made under both section 8(1)(a) and (c) so that plainly the employees had to be named under the section 8(1)(a) decision;
3.	that the decision in Netherlane Ltd v. York (Officer of the Board of Inland Revenue) [2005]STC (SCD) 305 suggested that even a decision under section 8(1)(c) should name the employee concerned and not just the employer that was liable for the tax in dispute; and
4.	that since the employees' National Insurance records of total contributions would be affected by the decision, they were concerned with the decision.
17.     My conclusion and decision is that the decision and the notice were entirely consistent with the requirements of the statute and the Regulations.        The reference in the Notice to the terms of the decision precisely tracked the wording of section 8(1)(c) in that the Notice indicated that the decision was "that Westek Limited was liable to pay primary and secondary Class 1 National Insurance contributions in respect of the earnings of employees in receipt of management charges from the company", and the terms of section 8(1)(c) were that a decision might be made as to "whether a person was liable to pay contributions of any class, and if so the amount that he is or was liable to pay".    The focus of the decision under section 8(1)(c) is thus simply on whether Westek Limited was liable to pay contributions and how much was owed in contributions, and it accordingly seems to me that the officer's decision was a decision only under section 8(1)(c) (a number of  factors implicitly being involved in that decision) and the terms of the decision were notified to the only person named in it and were precisely in accordance with the matter to be decided under section 8(1)(c). 

18.     In the Netherlane case, the decision itself mentioned the employer, the employee and the intermediary company that actually received the management charges that were alleged to be the employee's "earnings".       The Notice however was only issued to the employer and the employee, and it was suggested that the Notice was deficient in that as the intermediary company had been mentioned in the decision, the Notice ought to have been issued also to the intermediary company.     Dr. John Avery-Jones held that the Notice was not deficient in that although the intermediary company was mentioned in the decision, the intermediary person was nevertheless not a person "in respect of whom" the decision was made, and not thus a person to whom the Notice should have been issued.    Although in that case the employee was also named in the Notice and the Notice was issued to the employee, it was not decided that such references were required, and it was not decided that the employee was indeed a person "in respect of whom the decision was made".      Deciding this issue, thus, on the simple wording of section 8(1)(c), that paragraph empowers the officer of the Board to decide whether a person is liable to pay contributions of any Class, and for what amount that person is liable.   Since the only person liable to pay both the primary and secondary contributions in this case is the Appellant, and the paragraph does not even refer to why, or in respect of whose income, the employer's exclusive liability has arisen, it seems to me that the employer, namely Westek Limited, is the only person in respect of whom the decision is made, and thus the only person on whom Notice needs to be served. 

19.     I accept the argument advanced on behalf of the Respondents to the effect that the slightly curious use of the words "in respect of whom the decision is made", rather than words along the lines of "the person treated as liable to pay contributions under the decision", is explained by the undoubted fact that several other of the decisions that could be made under section 8(1) were decisions where no-one would be liable for anything, and where it might for instance just be declared that a person was "an earner".    The broad wording of "in respect of whom the decision is made" is accordingly explained by this feature.

20.     I am also satisfied that there are other ways in which employees could ascertain their cumulative total of earnings and National Insurance contributions, even if they were not given Notice under Regulation 4 referred to above.    And as a practical matter in the present case, the covering letter made it quite clear which individuals’ contribution records might be affected by the disputed decision. 

21.     I agree with counsel for HMRC that all questions concerning whether directors are always to be treated also as "employees", or whether they should appropriately be classed as "employees" in this case, are matters to be dealt with at the substantive hearing, and that even if the Appellant is right to suggest that the directors whose companies and partnership directly received management charges were not employees, this would not render the Notice invalid.    In other words, the officer can issue a valid Notice where the person in respect of whom the decision is made may succeed on appeal in showing that the decision was wrong (perhaps because someone was not an employee) but this does not make the Notice invalid.   I also accept that no relevant evidence was given to me in relation to the status of the three individual directors.

22.     The same point applies to the management charges.    Counsel for HMRC asserted that in the present case the companies and the partnership were only a mechanism for routing payments to the directors and that this case is not one where HMRC should proceed under IR35.     It may be that HMRC will revise their approach on this point, or they may persist with the approach reported at the preliminary hearing.    Whatever the eventual position I was given no evidence in relation to the payments made, and I am certainly not prepared to hold that the Notice was invalid even if the phrase "employees in receipt of management charge payments" might more accurately have been expressed along the lines of "employees to whose companies management charges were paid, in the course of routing the payments to them".

23.      My decision is accordingly that whether or not HMRC succeed in establishing their case at the substantive hearing, which may depend on the technical status of the individuals or on the routing of the payments (about which I know virtually nothing at this stage), the critical point is that the decision made by the officer only impacted on the person liable to make contributions; the decision and the Notice in respect of it were correctly worded in terms of the decision falling to be made under section 8(1)(c), and the Notice was thus served on the only person on whom it should be served. 

24.     I also dismiss the appeal in relation to the PAYE notice.   It seems to me to be self-evident that by describing the employees as those who were in receipt of management charges that the PAYE determination correctly referred to a "class of employees", which was one of the two options under the PAYE Regulations.   It is also clear that no-one was in doubt for an instant as to which employees were included in the class.  Whether it eventually emerges that a more accurate description of the facts would have suggested that some slight re-phrasing of the description of the class of employees might have been appropriate, I still consider that the Notice was clear enough, no-one was in the remotest doubt as to whose income was covered by it, and which of their two categories of challenged payments was in dispute, and I therefore decide that the notice was valid.

25.    In the light of my decision in paragraph 24 above, it is inappropriate to comment on whether section 114 Taxes Management Act 1970 could have been invoked by HMRC as regards the PAYE Notice.

Costs

26.     Counsel for HMRC requested that if I decided this case as I have done, in favour of HMRC, then I should award costs in favour of  HMRC.    This was not on the basis that in one sense this appeal was an un-meritorious one where the Appellant was seeking to avoid liability on purely technical grounds where there was no realistic doubt as to the substance of HMRC's contentions, but on the ground that by having changed their arguments in the course of the appeal, the Appellant and its representatives had increased the costs of HMRC.    In other words the National Insurance appeal was first advanced on the ground that a valid notice had to designate the employees as "employed earners", and this ground was then abandoned in favour of those considered above. 

27.     Whilst I have plainly decided the appeal in favour of the Respondents I reject their request for costs because I consider that the Appellant's conduct of the appeal itself has not been unreasonable.  The initial contention was one that I am satisfied the Appellant advanced genuinely since it was remarked that other "officers of the Board" had oddly accepted that it was a valid point.   In a sense it also reflected the suggestion that the officer's decision was implicitly made under section 8(1)(a) as well as under section 8(1)(c).     Although I have rejected that point, I can appreciate why the Appellant's argument was refined in the way that it was.   I also accept that it is common for additional points to be raised by both sides in any Appeal, and since in this regard I do not consider that the Appellant's conduct or that of their representatives was at all unreasonable, I reject the request that costs be awarded in favour of HMRC.

HOWARD M NOWLAN
SPECIAL COMMISSIONER

RELEASED: 16 August 2007

SC 3018/2007