Employers Beware! – PAYE Penalties

Typically, PAYE has been described as an ‘approximate’ method of collecting tax due, which remained the ultimate liability of the employee.

Recent judgements, including the case of Paringdon Sports Club, suggest more of the risk may fall on the employer.

In addition the risk may be worse with the current HMRC penchant for penalties. Many advisors will be familiar with their tendency to seek around 15% extra tax for relatively minor ‘careless’ errors. This represents increased risk for business and their advisors.

There are methods related to potentially mitigating or suspending such penalties.

To avoid embarrassment and excessive cost a prudent review may seem sensible?

Whilst most businesses operate routine PAYE relatively easily with the backing of software, experience suggests that ‘unusual’ or one off events can cause problems.

These days such errors can lead to expensive penalties, so procedures should be put in place to check the correct treatment on one off matters and if necessary take advice.

On the penalty front the case of P Steady shows that it can be worth appealing against a penalty imposition. In that recent case the taxpayer managed to get a penalty suspended where, by oversight he had put down bank interest earned in incorrect years. The Tribunal said ‘The mere fact that this is an error in a tax return does not mean that a taxpayer has been careless’. They went on to say, ‘To levy a penalty on a taxpayer who hereto has had a good compliance record over many years and then refuse to consider suspension of those penalties does not reflect well on HMRC’.

As always thinking of the correct technical position makes sense.

Law, Interpretation and Common Sense

Here is a conundrum.

A long, long time ago … in a galaxy far, far away (a.k.a. York, England 1981) I was a newly created Inspector of Taxes.

I was taught that the tax rules were strict and should be followed to the letter. However, that should not mean artificial impositions and ridiculous decisions. In those days (what is now HMRC) had ‘care and management’ of the Tax System.

Hence, my training was that, if during a Tax Investigation (of which I did quite a few!) I ‘discovered’ (see S29 TMA 1970) that some profits from one year, really ought to have been taxed in a different year, I should adjust it accordingly – but on both sides. So, in adding the profit to one year (per the correct accounting) I should then deduct the profit from the year I have moved it from. I should not seek to tax it twice, because that would be blatantly unfair!

A recent case [Ignatius Fessal v HMRC] reached the same conclusion, albeit using complex legal arguments concerning the European Human Rights Act. In this case the question was one of interpretation. In analysing it the Tribunal have resorted to the Human Rights Act to get to a fair conclusion. In other (older) leading cases, Justice Rowlatt, said that there was no ‘Equity’ in tax, you just read the words stated by Parliament and interpreted them strictly. However, the fact that there was no ‘Equity’, did not mean there should be no fairness. It was simply a method of how best to analyse the statute, bearing in mind the underlying fundamental principle that no Government would wish to impose double taxation.

So the answer should be – No Double Tax.

That truly should be the end of the story.

BUT NO!

In the Fessal case (which as Andrew Hubbard rightly says is complex in the 19 May issue of the leading professional magazine, Taxation) the First Tribunal spent 36 rather closely argued and difficult pages, including analysing a key issue as to whether the ‘European Human Rights Act’ should apply?

To be fair to the Tribunal, they gave detailed legal analysis, which is impressive in scope and response. However, should it have been necessary to invoke such complexity on what surely should have been determined as a simple question of fairness? As certain Old-Fashioned English Common Law Chaps might have concluded – You cannot tax a person twice on the same profits!

To use the current jargon “End of …”

Would the Revenue in the days of their duties for ‘care and management of the tax system’ objected to this ‘as a matter of law?’ It would be hoped not.

In present times though – they did. As the Court pointed out, the way HMRC handled the matter put the taxpayer in a worse position than if they had not made a Tax Return at all! Surely, this could not be just and would (fairly quickly) lead the tax system into disrepute? This would cost HMRC far more in lost goodwill and compliance.

In addition, the Fessal case does raise rather interesting issues as to the impact of Double Tax Treaties, where maybe they do not work as well as anticipated. Could the Human Rights principle established against Double Taxation assist in cases where there is effective Double Taxation not strictly protected by a Double Tax Treaty? (See the Anson case?)

Moving on, business needs certainty. If the system is to be strictly on a ‘rules basis’ then surely that should be the same for both sides – taxpayer and HMRC. This brings us on to the latest Finance Bill proposals for penalties under GAAR. Are these well thought out and balanced?

Taxpayers who have indulged in tax avoidance have obeyed the law, by definition. Otherwise they would be guilty of tax evasion – a criminal offence.

I hold no brief for artificial tax schemes. In my experience, many of them fail either because they do not meet the underlying commercial requirements, or in truth they depend upon a sham. Some are correct under the law though. Surely they should not be punished severely because the opinion of a bureaucrat finds them objectionable? The Finance Bill proposal for a tax geared penalty of up to 60% may seem disproportionate? Could this be challenged as a breach of ‘Human Rights’?

My opinion is that to protect Government Revenue, HMRC do not need greater powers, nor heavier penalties. They need more, better trained personnel, so that cases can be dealt with and if necessary investigated properly.

I believe the issue is an administrative one – not one for even more legislation.

Opinions please?

Entrepreneurs’ relief – What is an ordinary share?

We have written in previous blogs about the need to take care over Entrepreneurs’ relief (ER) and preference shares (see Entrepreneurs’ Relief – 5% Test and Preference Shares) and a recent case heard by the First-Tier Tribunal has shed more light on how the rules are to be interpreted.

One of the conditions for ER is that the taxpayer must hold at least of 5% of the company’s ordinary share capital and voting rights. For these purposes, ordinary share capital is defined as all share capital excluding fixed rate preference shares.

However, in the recent case of M & E McQuillan v HMRC [2016] TC05074 redeemable non-voting shares which did not carry rights to dividends were found to not constitute ordinary shares for ER purposes.  It was found that shares with no rights to dividends could be considered as having a right to a fixed rate of 0% and therefore could be excluded from the calculation of ordinary share capital.

In this case, this provided the right outcome for the taxpayers as they were selling their ‘ordinary’ shares in the company, of which they had 33% each.  Another couple had made a loan of £30,000 which had been converted into the 30,000 preference shares which were redeemable non-voting share capital with no rights to dividends.

Had the 30,000 extra shares have been treated as ordinary share capital, the taxpayers would not have had the required 5% holding.

The case highlights the importance of checking through all the details before making a sale of shares in your company.  In this case, the taxpayers were successful but others will not be so fortunate.  Eaves and Co have extensive experience advising on share sales and Entrepreneurs’ relief and would be delighted to hear from you if you are considering a sale in the near future.

What happens when laws collide?

Here is a case which emphasises points about pre-planning for tax purposes.  It may also be one for legal philosophers!

In the recent case of G4S Cash Solutions (UK) Ltd v CIR, the Courts followed the old case of CIR v Alexander von Glehn and held that payments of fines should not be allowed as tax deductible.

So far, so good.  It even sounds sensible as public policy: but –isn’t there a ‘but’ in tax matters – the fine in Alexander von Glehn was for ‘collaborating with the enemy in time of war’; maybe many business owners may distinguish this from parking fines incurred by getting armoured cash delivery vans close to shops/banks to protect employees and the public from extra risk of armed robbery, but by doing so infringing parking regulations.  The statutory fines in the G4S case were for parking infringements.

The Courts accepted:-

  1. It made sense (and was accepted by the police) to minimise the time/distance that the person delivering the cash had to spend outside the van.
  1. G4S owed a duty of care to their staff, customers and the general public, so parking close by, even in crowded shopping centres made sense.  Thus, health and safety law was to a degree in conflict.
  1. Parking infringements were not on a par of severity with ‘collaborating with the enemy’.

Nevertheless, the Courts decided that it was inappropriate to grant a tax allowance for the payment of statutory fines, so G4S lost out on a substantial tax relief to what they had generally seen as an occupational hazard.  Interestingly, G4S did ‘advance deals’ with some Councils whereby in exchange for a lump sum in advance, they got an agreement that the parking wardens would not issues tickets for certain G4S parking infringements.  These were agreed to be tax deductible, showing that a different structure can lead to the same commercial end, but in a more tax efficient manner.

In the G4S case the First Tier Tribunal quoted the judge in McKnight v Shepherd as an illustration of how the tax picture may be altered by minor distinctions.  Mr Justin Lightman said, “The authorities reveal what a fine line may need to be drawn between what is within and what is outside the trader’s profit earning activities and there are to be found subtle distinctions not immediately obvious to minds of mere ordinary intelligence”.

Lessons to be drawn:

  1. This case could be a rich earner for HMRC with tax, interest and penalties falling on the multitude of delivery firms set up to provide services in these days of internet shopping.  No doubt a number of them will face similar traffic fines and treat them as an incidental cost of doing business.
  1. Forewarned is forearmed, so checking future accounts for fines etc., and then adding them back, would seem prudent.  This is unlikely to be the outcome desired by the business, but HMRC are getting stricter with imposing penalties on even ‘technical’ mistakes.
  1. Advance thought and planning can help the same commercial ends be achieved – with a better tax outcome.

HMRC Use Incorrect Procedure – A Revell v HMRC

We recently highlighted the importance of ensuring HMRC have taken the right steps in terms of the use of their powers – see Make Sure HMRC Notices are Valid! – Technicalities and Human Rights Law. This has been confirmed by a further recent case which again shows the importance of checking the facts.

In A Revell v HMRC the First-Tier Tribunal was asked to consider whether HMRC had acted correctly within the legislative framework for their powers. The taxpayer in the case had voluntarily submitted a tax return for 2008/09. HMRC had sent the request to deliver a return to the wrong address, despite having received the updated address for the taxpayer.

HMRC attempted to enquire into the return and determined that further tax should have been due. The taxpayer, however, appealed on the basis that the enquiry was invalid because he had not received a notice requesting a return under TMA 1970, s8.

The First-tier Tribunal agreed that no request to deliver a return had been made due to it being sent to the wrong address. They found that the taxpayer had not waived the requirement for the issue of a notice to file under TMA 1970, s8 by submitting a voluntary return. As such, they determined that his return should be treated as a notice of liability to income tax under s.7 and not a self-assessment return.

The appeal was therefore allowed. In addition, as the time limit to request a return had expired HMRC’s only further option would be to issue a discovery assessment. This would appear to then bring further technical considerations into play, as to whether such a discovery assessment itself would be valid based on case law (see our blog post on some of the case law in this area for further information).

This case again shows the importance of ensuring HMRC are acting within their powers as a first step. It also appears to raise some interesting questions as to the implications for making a voluntary tax return, as the Tribunal found that these should not be treated as a self-assessment return.

Make Sure HMRC Notices are Valid! – Technicalities and Human Rights Law

Recent cases have emphasised the importance of that European Human rights laws have on the UK tax system; however the cases and our own recent experiences suggest that HMRC do not take these implications seriously.

The recent Tribunal case of PML Accounting Ltd v HMRC [2015] considered a number of issues, including one relating to Human Rights.  The case involved an HMRC Notice requiring information from PML Accounting and the firm’s appeal against a penalty for failing to provide the information on time.

The Tribunal found that the information notice had not been complied with and that the taxpayer did not have a reasonable excuse for the failure.  However, they also determined that the Notice was invalid as it had been issued under the wrong piece of legislation.

The notice was issued under FA 2008 Sch 36, para 1 as part of a review of the company’s position under the Managed Service Company Legislation.

The Tribunal determined that there had been suggestion that any investigation under the MSC legislation would lead to a charge on PML.  As a result, the information notice should have been issued under paragraph 2 (third-party notices) instead of paragraph 1.

The Tribunal also concluded that the Notice breached the human rights of PML’s clients as it had been issued under the wrong paragraph.  A paragraph 2 notice relating to third-parties provides a level of protection for the taxpayers involved as they may not be issued without either the taxpayer’s prior consent or the tribunal’s approval.

There have also been a number of other cases highlighting the inadequacy of HMRC’s approach to human rights law.  For example, in Bluu Solutions Ltd v RCC [2015], the Tribunal confirmed that a tax penalty, which is meant to be punitive and to deter, is “criminal” for the purposes of Article 6 of the Convention for the Protection of Human Rights and Fundamental Freedoms.  This provides taxpayers subject to HMRC penalties with additional protection stating that taxpayers have the right to a fair trial and requires that the taxpayer is presumed innocent, with the burden of proof on HMRC.  Also proceedings have to be brought within a reasonable time, and the taxpayer must have enough resources and time to defend against the penalty.

Further protection is provided by Article 7 which requires that any penalty should have a clear basis in law and therefore where there is genuine uncertainty as to the underlying tax law, it could potentially be a breach of Article 7 to impose penalties based on non-payment.

These points all provide extra protection that advisors should bear in mind when assisting clients faced with HMRC investigations.  If you have any concerns over HMRC’s approach then please contact us and we will be delighted to assist.

Brain Disorders plus Tax Avoidance equals Ramsay Robust

Those (like me!) who appreciate the significance of the above headline will be thinking ‘Tax is Fun’ and ‘This is Fascinating’.  For the rest I challenge you to struggle on to the end.

The case (Brain Disorders Research Limited Partnership – TC4510) is interesting because the complex, highly cogent, judgement goes through the arrangements as a whole.  Then the Court decides that overall they do not make commercial sense (on the grounds that 6 ≠ 99).  As a result, the Court strikes down the whole structure as a “sham”, and hence ineffective from a tax perspective.  This is oversimplification, of course, but in this case the First Tier Tribunal have struck to the heart of a manufactured tax avoidance scheme by destroying it as having crucial aspects which meant the whole scheme effectively amounted to a sham.

Where does the case leave us?

Analysis of the detailed judgement is interesting in itself, as will be the question of whether the case is appealed to a higher court.

For the moment though, in looking at the commercial picture and looking at steps obviously inserted for tax purposes the First Tier tribunal could be said to be adopting an approach on the lines of ‘Ramsay Robust’.  Those of you familiar with the classic anti-avoidance case of CIR v Ramsay will know that it analysed tax planning schemes and then surgically excised steps inserted just for tax planning purposes and then re-analysed the result.

It seems to me the Brain Disorders judgement follows similar principles, but, in simile, perhaps by using a large axe rather than a scalpel!  It does though leave interesting (and relevant) thoughts, especially as in terms of the claim, the underlying scientific research seemed to be accepted by the Courts to be genuine and cutting edge.  The issue was whether the price had been artificially inflated.  Effectively, therefore it leaves open the question for future commercial planners of what makes the tax axe fall?  All of us need to use the tax system.  You can’t opt out!  How do we know we are not ‘abusing’ it?

In the case, the fact that (blatantly) 6 ≠ 99 was a key determinant, and understandable in may people’s eyes as an inherent misrepresentation.  Where though is the cut off?  Where 6 moves and then tends to approach 99?  Does ‘abuse’ stop at 12 or 50 or where?  Surely there cannot be a ‘fixed’ level?  As is clear from my insurance quotes, in a free market, there seems to be little that approaches a fixed price.  It depends upon the precise terms of the contract, plus the expertise and reputation of the provider.  There must therefore be a range of values which would be acceptable and thus ‘non-abusive’?  Crucially though, how is this ‘non-abusive’ range to be determined in advance by advisors?

The Court’s technical analysis and indeed the scheme details are highly complex, but essentially (to use the round numbers adopted in the case) the higher rate taxpayers investing in the scheme sought to claim 99 or 96 of interest/scientific research allowances, for true research expenditure that was actually being sub-contracted out for 6.

HMRC convinced the Court that it was never remotely considered (or even possible) for the investors to undertake the research themselves, in the Partnership Structure established.  This was believed, to be because of the bank borrowings and lack of relevant resources for the Partnership Structure meant that it would be problematic in raising the finance to undertake the research itself.  As a result, the Courts held it was thus inevitable that the research would be subcontracted to the true scientific experts at the agreed price of 6.  Thus it was ‘false wording’ in the documentation to suggest that 99 (or indeed any amount other than 6) was to be paid to procure the research.

The Court judged;

“Most of the money movements related entirely to the borrowing arrangements and had nothing to do with genuine royalties derived from scientific research”.

It went on;

“Everything in relation to the refund of capital expenditure should the research project be abandoned was uncommercial”.

The FTT held that the scheme was a sham.  It was based on the premise that the recipient of the borrowed/invested funds may undertake the relevant scientific research.

A previous case, Tower M Cashback, showed that the price paid had to represent fair value for allowances to be available.  A valuation exercise was undertaken by the designers of the Scheme to show that a number of “traditional” researchers in institutions or universities would have charged 99 or 100 for the work.  However, the Courts criticised this exercise as being effectively a self-fulfilling prophecy, undertaken in a hurry by a party associated with those involved through past work, and not actually comparing like with like.  The Courts also pointed out that a genuine commercial arrangement would have made the most of the quote of 6 from Australian leaders in the relevant brain research.  Any true commercial investors would have been unlikely to do anything other than go for that price, rather than committing to 99 or 100 created via the inflated borrowing.

The internal un-commerciality of the finance arrangements was apparent by the fact that some of the quotes compared US $ prices to AUS $ prices without ‘noticing’ the 22% currency exchange difference existing at the time.

The First Tier Tribunal was scathing:-

“We agree that there was a sham in this case [None] of the parties or indeed the investing partners were intended to be deceived into thinking that the possible aim of sub-contracting was just one of two realistic possibilities. Of course it was known that it was the only conceivable way of proceeding.  [Hence] the alternative contractual provision, suggesting that [the Partnership Structure] might itself conduct the research was false. The significance of the false claim was that, had it been deleted in accordance with reality, it could not possibly have been suggested that [the Partnership Structure] was ever to pay more than 6, let alone 99 or 96, in order to procure the scientific research. The falsely worded clause was therefore the foundation of the Partnership’s claim for vastly excessive capital allowances, and this is why we decide to strike it down as being a sham.  The [HMRC] counsel was slightly more hesitant in describing the whole pricing of the scientific research in the Schedule to the top-level contract, sub-dividing the total expenditure and allocating elements of it to each step and stage in the research, as a sham. We are not so hesitant. By sub-dividing the alleged expenditure of 99 or 96 in this way, inserting all this elaborate nonsense into the Schedule, it becomes clear that the critical drafting of [the Partnership Structure] clause is not just some mistaken reference to one irrelevant possibility. The Schedule shines the light on the fact that the whole fiction is indeed intended, and that it is indeed the foundation of the Partnership’s claim. [My emphasis].

Comments please on whether you feel my idea of ‘Ramsay Robust’ makes sense and what needs to be done to aid commercial certainty.  Obviously everyone needs to act in accordance with tax law.  Similarly commercial enterprise needs to know tax consequences of their actions.

Careful with those Capital Gains Tax deductions

Accountants and clients used to the broad brush “commercial” approach to computing trading profits can get caught out by the different and stricter rules for calculating capital gains.

Payments which may make sense, or even be thought essential from a commercial perspective are not necessarily then allowable for capital gains tax purposes.

This is demonstrated by the recent case of J. Blackwell.  In exchange for £1m, Mr Blackwell agreed to act exclusively in voting his shareholding in BP Holdings in favour of the Taylor and Francis Group who wished to purchase BP Holdings.  Later another prospective purchaser came along for BP Holdings.  In order to extricate himself from the first agreement Mr Blackwell paid Taylor and Francis Group £17.5m which he then claimed under S38 TCGA 1992 as a deduction against his subsequent sale of the BP Holdings shares to the second purchaser.

The Upper Tier Tribunal found against him on the grounds that the expenditure was not reflected in the value of the asset disposed of to the purchaser.  Admittedly, it put him in a position to make the disposal, by releasing him from the previous restrictions, but it did not enhance the value of the shares themselves.  Similarly, the Courts held the payment did not create or establish any new rights over the underlying shares themselves.

This principle can be a factor in helping clients decide whether to accept an offer, by understanding what it would be worth after tax.  It can often be in point where a client is considering an offer from a developer for (say) housing.  On this principle, if the developer is buying a cleared site, where a bulldozer has taken down perhaps years of “enhancement expenditure” on the former trade site, then it is likely HMRC will seek to deny the cost of the previous building works, perhaps increasing the gain by a material amount.

Care in understanding the facts is crucial.

No Private Residence Relief on Uncultivated, Separate Land – Fountain & Anor v HMRC

Private Residence Relief (PRR) is a very useful relief for taxpayers and prevents Capital Gains Tax from being paid on the sale of a primary residence in most cases.  There are aspects of the rules which can be complex and these continue to cause difficulties for some taxpayers.

In a recent First-tier Tribunal case, Fountain & Anor v HMRC, the Tribunal found that the taxpayers in question were not entitled to claim PRR relief in respect of their disposal of a building plot, which they had argued was part of the grounds of the house.

The taxpayers owned an area of land behind their home which had previously been used in their haulage business. The business was closed and subsequently part of the property was divided into five building plots. Most of the plots were sold or gifted in 2006 and a new home was built on one of the plots for the Fountains, who moved in in January 2007. Their previous residence was then sold in February 2007 together with a field. The last plot (named ‘Plot 2’) was sold later, in December 2009 and led to the Tribunal case.

The taxpayers argued that Plot 2 formed part of the garden or grounds of their new residence on the basis that they were on the same title deed and the plot had formed part of the garden of their original home and continued to be used for their domestic use and enjoyment.

The Tribunal agreed that Plot 2 had indeed formed part of the grounds of their original home, however they did not believe this was relevant to the disposal in question. They also found that being on the same title was irrelevant.

The Tribunal found that Plot 2 was uncultivated and was physically separated from their new house by a separate plot which had a further house built on it and had been fenced off. They did not believe that Plot 2 has ever formed part of the garden or grounds of the new house.  No private residence relief was due and the appeal was therefore dismissed.

When dealing with PRR claims, it is important to thoroughly analyse the facts of the specific case and take previous case law into account.  Such planning at the time could help to prevent a nasty surprise in the future.  Eaves and Co would be delighted to assist if you have any queries on disposing of your home and the tax implications.

Compensation Payment Found to be Taxable

A recent First-Tier Tribunal raised an interesting point with regard to the rules on Termination Payments under ITEPA 2003, s.401.  These rules apply not only to compensation payments made on termination, but also a change in the duties of a person’s employment or a change in the earnings from a person’s employment, and can mean that the first £30,000 of such qualifying payments is exempt from Income Tax.

An important point to note however, is that these rules only apply where there is not already a tax charge under another heading per s.401(3).  In the case of payments made due to a change in duties this presents difficulties, as the payment could be taxed as normal employment income if the payments are found to be emoluments.

This is how the taxpayer in A Hill v HMRC (TC04480) came unstuck.  The taxpayer had his employment transferred under the Transfer of Undertakings Regulations 2006 but was not happy with the new conditions.  A compromise agreement was made under which each company paid him £15,000 in settlement of his complaints. He was required to continue working for the new company and would have to repay them both if he left within two years.

The taxpayer argued that the payments should be exempt under ITEPA 2003, s 403, however HMRC argued that they were taxable.

The First-tier Tribunal decided the payments were consideration for agreeing to accept a change in his contract of employment, however the fact he was required to continue working, and would have to repay the sums if he did not, showed they referred to his continuing employment. As such they were taxable as emoluments and not exempt.