“All happy families are alike; each unhappy family is unhappy in its own way”. So begins Tolstoy’s epic novel of family and tragedy in Imperial Russia. The idea that happy families share a fairly consistent set of attributes while the attributes which lead to an unhappy family are practically limitless has gained wide traction. It is developed by the mathematician Vladimir Arnold in his principle of fragility – a good system must meet a number of requirements simultaneously which means that good systems are inherently fragile. Sadly, there is no such restriction on bad systems and so these are more likely. Which brings us to tax planning in general and disguised remuneration schemes in particular.
The year of reckoning
2021 has been an interesting year for disguised remuneration schemes (DRs). Following the Supreme Court’s decision in what is usually known as the Rangers case [2017] UKSC45, some forecast this as the death knell of DRs. However, like history, DRs have proven themselves to be more resilient than some thought.
In September 2021 we had the First Tier Tribunal (FTT) judgement in Marlborough (Marlborough DP Limited (TC08246)) and in December 2021 we had the FTT judgement in Strategic Branding (Strategic Branding Limited (TC08348)).
All 3 cases involved a traditional DR structure where the employer contributed to a remuneration trust (RT) which, with various arrangements put in place, led to a loan being provided to an individual who was (or happened to be) an employee. To avoid the weak spots in these – potentially fragile – DR schemes they should have attributes in place which lead to a judgement that:
- The contributions by the employer to the RT are such that they are deductible in computing corporation tax; AND
- The loan in the hands of the individual employee does not constitute “earnings” under s62 ITEPA 2003; nor is it caught by what is often referred to as the disguised remuneration legislation at Part 7A ITEPA 2003.
In both Marlborough and Strategic Branding the judgements of the FTT are subject to appeal. However, as things stand:
In Rangers, the court found that: the loan in the hands of the employee was “earnings”; the employer contributions were not deductible in computing CT.
In Marlborough, the court found that the loan in the hands of the employee was not “earnings” and was not caught by the disguised remuneration legislation but was taxable as a distribution; the employer contributions were not deductible in computing CT (since they constituted a distribution) but would have been had the loan been taxed as employment income.
In Strategic Branding, the court found that the loan in the hands of the employee was not “earnings” but was caught by the disguised remuneration legislation; the employer contributions were not deductible in computing CT.
In the three cases above, the only instance of unalloyed joy will have been HMRC’s reaction to Rangers.
Strategic Branding
Hereon out, I will focus on the Strategic Branding case and explore what attributes it lacked to achieve the desired result for the taxpayer. A follow up article will compare and contrast the three cases to consider the challenges which DRs face to overcome the inherent fragility of “good systems”.
What follows is an attempt to summarise a 56 page Decision. It cannot do justice to the complexity of the respective barrister’s submissions to the court or the Judge’s detailed analysis. The intention is to provide a summary of the challenges faced in this particular DR case.
The structure
Strategic Branding Limited (SBL) was incorporated in Scotland. It advised on maximising brand value and had a single employee, director and shareholder, Mr Wilson. Mr Wilson’s advisers, Westwood Trustees, advised him to consider entering into a remuneration trust (RT) which had been designed by Baxendale Walker LLP or affiliated persons (BW). The RT was established by trust deed in February 2011. Subsequent arrangements distinguish between Founder, Trustees, Beneficiaries (& Excluded Persons), Provider and Protector. In summary:
- The original trust deed is between the Founder (WUT No 1 Ltd) and the Trustees (Bay Trust International Limited (BTIL)).
- Beneficiaries are defined by reference to Providers and a wide range of people linked to them.
- Excluded Persons are the Founder or anyone linked to the Founder.
- A Provider is a person who provides services to the Founder or finances to the Trustee.
- The RT had two Protectors Mr and Ms Chiesa of Westwood Trustees, Mr Wilson’s advisers. Protectors had absolute powers to alter or add to the original trust deed although the absolute power was somewhat restricted by the need to have the written consent of the Trustees.
Adding to the mix was the creation in May 2012 of Strategic Management Europe Limited (SMEL) with Mr Wilson as sole shareholder and director. SMEL entered into a Fiducuary Services Agreement (FSA) with another new party, UTW Holdings Limited (UTW). The court was aware that UTW had its registered office in Belize but had no documentation to explain the role of UTW. However, submissions from both sides referred to UTW having been appointed to manage the RT. In the FSA, the Principal (UTW) grants rights to the Fiduciary (SMEL).
In June 2012, the Protectors (those persons linked to Westwood Trustees) with the agreement of the Trustees (BTIL) executed a Deed of Amendment to the original trust deed which purported to have retrospective effect. The Deed defined Beneficiaries, Providers and Excluded Persons in what seems (to the writer) broadly similar lines to the original trust deed although the “Particular Trade” of the Provider is now specified to be the provision of finance.
In July 2012 a Finance Agreement is signed between Mr Wilson (as Borrower) and SMEL (as Lender). SMEL was acting in its capacity as nominee for BTIL, Trustees of the RT. The agreement provides for a loan to be made to Mr Wilson for a period of 10 years with the interest to be rolled up. The Agreement provides for further advances on the same terms to be evidenced by memoranda. Each memorandum was signed by Mr Wilson both in his capacity as Borrower and as director of SMEL, the Lender.
With the various arrangements in place, the procedure followed was: 1 SBL would resolve to make contributions to the RT in each accounting period. The resolution always linked the proposed amount to the “economic cost to the company” of earning its profits for that period. 2 Contributions would be paid to Westwood Trustees or BW. 3 SBL wrote to the Trustees (BTIL) to ask that consideration be given to a contribution of a specified amount to SMEL. The letter recognised that the Trustees must exercise their discretion. The amount transferred was usually about 90% of the contributions received from SBL. 4 The balance was paid as a fee to Westwood Trustees or BW. 5 SMEL lent the funds transferred to Mr Wilson.
In each accounting period, the contribution by SBL to the RT would be almost exactly the amount which, absent the contribution, would have been its profit. The 5 steps would usually occur over 2 days.
In addition to the 5 steps, SBL would occasionally send a letter to potential beneficiaries of the RT which referred to the company’s legal obligation to foster relationships with customers and suppliers. Applications were invited to seek a discretionary award. No evidence was presented to the court as to whether any recipient took action.
Findings of Fact
In moving to a decision, a court will first wish to establish facts from the evidence presented. Unhelpfully for SBL, the Judge did not accept all of Mr Wilson’s evidence as truthful. The Decision is carefully written, perhaps in anticipation of an appeal, but is explicit that the Judge did not accept all of Mr Wilson’s assertions as to his reasons for entering into the various transactions and that he did not anticipate that the transactions were likely to result in loans to him.
The Judge also accepted that certain documents submitted in evidence were a “sham”, that is that the intention was not that the documents actually create legal rights and obligations but merely appear to do so.
Considering whether this was a mass-marketed tax avoidance scheme involving pre-ordained steps, the court found it was. The pre-ordained steps were designed to lead to a net amount being lent to Mr Wislon.
Considering the reasons for SBL entering into the arrangements, Mr Wilson had argued that he had not considered tax and the tax consequences were not a key driver. Rather the reason for entering the arrangements was asset protection. He faced the threat of legal action (for breach of restrictive covenant) from a previous employer and wished to protect profits of the company for the benefit of business creditors as well as for the business itself by getting profits out of the company. The court accepted that there was a real threat of legal action from a previous employer but did not accept that that was the reason or driver for entering the RT and making contributions. The court’s conclusion was that it was “clear that Mr Wilson’s expectation was that there would be no tax payable if amounts were lent to him”.
A “good system”?
In the context of DR litigation, the fragility associated with a good system is seen in the requirement of meeting the legislative tests. Looking at Strategic Branding:
Test 1
Whether the contributions to the RT satisfy the requirement that expenses are wholly and exclusively for the purposes of the trade: s54(1) CTA 2009
The Appellant relied on a range of case law including the FTT Decision in Marlborough in September 2021. In Marlborough the court had accepted that there was a distinction between the purpose of the contributions to the RT (which was asset protection) and their effect (which was avoiding tax which would otherwise have been payable).
The Respondent’s references to case law often overlapped with the Appellant’s although not reaching the same conclusions. With regard to Marlborough, Mr Ghosh QC argued that the decision was contrary to the text of s54, contrary to the principle and contrary to authority. He referred to HMRC’s intention to seek permission to appeal.
The Judge, while taking no account of the HMRC intention to appeal Marlborough, respectfully decided not to adopt the reasoning in that case and found that the contributions of SBL to the RT did not meet the requirements of s54. Consequently, the contributions from the company to the RT were not an allowable deduction in computing CT profits.
Test 2A
Whether the loan in the hands of the individual employee constitutes “earnings” under s62 ITEPA 2003
This was the point considered by the Supreme Court in Rangers which found that the loans received by employees did constitute earnings. They were a reward for the relevant employee’s services. In Marlborough, where the individual who received the loans was sole director and shareholder as well as an employee, the FTT found that the loans did not constitute remuneration for services. As the link between employment and monies being received into the hands of the individual was broken, the monies could not be “earnings”. Rather they were dividends, distributions made as a return to the shareholder.
In Strategic Branding, the Judge did accept that, as a matter of fact, there was a link between the loans to Mr Wilson and his employment. However, under the Finance Agreement between Mr Wilson and SMEL there was an obligation on Mr Wilson to repay these loans. The Judge did not accept that the loans constituted emoluments within s62
Test 2B
If the loan in the hands of the individual employee does not constitute “earnings” under s62 ITEPA 2003, whether it is caught by what is often referred to as the disguised remuneration legislation at Part 7A ITEPA 2003.
To satisfy this test, the criteria are (s554A(1)):
- Are there “relevant arrangements in place”?
- Is it reasonable to suppose that, in essence, these arrangements provide a means of providing rewards or recognition or loan in connection with the employment (my emphasis)?
- Is a “relevant step” taken by a third party?
- Is it reasonable to suppose that, in essence, the “relevant step” is linked to the “relevant arrangement””?
The complexion of advisers (including this one) can pale when asked to opine on whether Part 7A applies. In Strategic Branding, Ms Brown for the Appellant: queried whether the arrangements or relevant steps satisfied the “in essence” requirement in the legislation; argued that certain actions were in breach of trust and so could not be a “relevant step”; and submitted that the argument accepted by the FTT in Marlborough applied equally here. Mr Ghosh for the Respondents rejected these arguments. On Marlborough, he argued that the FTT had applied the same test for s62 and for Part 7A while the whole point of Part 7A is that it does not apply the same test. In her analysis, Judge Zaman concluded that the legislative language of Part 7A is not concerned with whether an employee has the legal right to have a relevant step taken in relation to a sum of money or whether a scheme is legally enforceable. It looks at the practical reality of what takes place. With this in mind, she concluded the legislative tests of Part 7A had been satisfied. A relevant step taken by a relevant third person did actually take place. Also, it was reasonable to suppose that the relevant step was taken (wholly or partly) in pursuance of the relevant arrangements. The loans to Mr Wilson were pre-ordained and, considering s554Z2, the value of the relevant step counts as employment income and the value of the relevant step was the value of the loans. NIC was also in point.
Consequences
The above points to the difficulty which DR planning has in achieving its aim. A reading of the full Decision emphasizes that difficulty but also points to the number of interesting tributaries open for exploration by Appellant and Respondents in navigating the legislative flow. A number of appeals have been received by the FTT in the wake of Marlborough from taxpayers who believe their fact pattern is similar. Whether the taxpayer or HMRC will lodge an appeal following Strategic Branding is not known at the time of writing but it would come as no surprise and so many taxpayers may consider a protective appeal pending the decision of higher courts.
These cases involve companies. The writer’s understanding is that HMRC have also been enquiring into DR schemes involving contractors which are likely to go to litigation. Apart from DR cases, further film scheme cases are also likely to be litigated. The workload of the FTT, already substantial, is likely to see a substantial upturn.
While for many taxpayers their cases will be put on hold pending ultimate resolution of test cases, fine distinctions in fact pattern could influence whether some cases involving the same planning might be more robust than others, for example in the ability to separate the reward from any employment services. Consequently, assuming HMRC offer further settlement opportunities, while many taxpayers may be minded to go down the settlement route, for some the decision may be more nuanced. With this in mind, there will be a follow-up article which explores the distinctions between Rangers, Marlborough and Strategic Branding.
This article was first posted in Taxation 28 January 2022
