Scotts’ facts

The facts were complex, but the basic steps to avoid the disallowance of the deduction for 'employee benefit contributions' in FA 2003, Schedule 24, were described thus:

• employer company (C), intending to make contributions of, say, £1m into an EBT, forms Newco, and two EBTs;

• C subscribes 100 1p shares in Newco for a premium of £999,999 (shares are worth £1m);

• Newco grants an option, exercisable within 10 years, to EBT 1 to subscribe 10,000 1p shares at par (ie for £100) – which grant reduces the value of the 100 issued shares held by C to some £10,000, with the option worth £990,000;

• C sells the 100 shares in Newco to EBT2, at their heavily diminished value of £10,000; and

• EBT 2 commits to ensure no share issues or distributions (that would dilute the value of the option).

The monies raised in the Newcos, one way or another, came out to the two principal director shareholders as loans.

Issues

The taxpayer appeals essentially concerned two matters.

1. Deductibility of the amounts or value passed into the EBT structures.

2. Whether the arrangements crystallised income tax liabilities for the directors; if so whether such tax was deductible by employer under PAYE (and with a further point concerning recovery from directors under a (PAYE) regulation 72(5) notice).

HMRC arguments

HMRC's approach was:

• The claim for deductions failed on 'general principles' – neither 'revenue' nor 'wholly and exclusively for the purposes of the trade' – without going to Schedule 24 at all;

• If HMRC won that argument, they would not seek to argue that PAYE tax arose;

• If HMRC lost the deductibility argument, that income tax (and PAYE) arose as the funds were first put into Newco by the companies: notwithstanding this 'earliest possible' date had precluded raising assessments.

These look odd: why would HMRC not put all and the best arguments forward, for the maximum tax? It's not clear, although maybe winning on PAYE would make losing on deductibility more likely: seemingly undesirable, in circumstances where one of the appellants was in liquidation and another bankrupt.

HMRC do also seem to have a 'point of principle' that, in these 'offensive' EBT cases, 'earnings' invariably arise for PAYE when funds are contributed into the EBT – being the third (reluctantly made) argument above.

Deductibility

The Tribunal rejected HMRC's arguments to disallow on general principles, but found another ground to do so.

The taxpayers' intention was plainly 'to secure a far from ordinary tax deduction, the very opposite of the result intended by parliament'. This was 'the Catch-22 point' – if no attempt was made to circumvent Schedule 24, the deduction was denied; but if a contrived scheme was effected to do so, it failed because that objective became a fatal 'duality of purpose'.

The Tribunal also found a motivation to pass out assets so as to be unable to meet tax claims if the deductions were successfully challenged. Stripping the company of assets was also a 'duality of purpose', and should carry no deduction to the extent of the rate of corporation tax on relevant amounts.

Interestingly, the Tribunal expressed the view that Schedule 24 did not itself preclude the deduction. The grant of the option by Newco occasioned the loss or cost for which the deduction was claimed; that step involved no 'payment of cash or transfer of an asset', nor was it made by the employer; accordingly, there was no 'employee benefit contribution' to be disallowed under Schedule 24.

PAYE

The Tribunal decided no PAYE liabilities crystallised when monies were paid into the EBT structures (or at any other point). The directors did not at any time have control over the monies in question, or have such monies 'unreservedly at their disposal'. The fact that repayment of loans had been sought (one of the reasons why one appellant was declared bankrupt), and that assessments had been raised under the close company 'loans to participators' provisions, only went to confirm the point. The Aberdeen Asset Management and Garforth v Newsmith cases set out the relevant parameters as to when there is 'payment' for PAYE.

Ramifications

Although the objective of avoiding the disallowance machinery in Schedule 24 was core to the Tribunal's decision, the scope of that machinery itself was downplayed. Schedule 24 was to be construed 'purposively', but the Tribunal did not comment as to why the several scheme steps, 'viewed realistically', should not be taken as 'payment of cash or transfer of assets' by the employer over to the EBT.

The unhappily worded Schedule 24 no longer exists. But 'the Catch-22 point' is something of a new one, and interesting to see if HMRC pursue this in appropriate cases (not least Schedule 24's successor, now at CTA 2009, s. 1290), and whether the courts will endorse the analysis.

Meanwhile, whilst advisers catch up with possible implications of 'Catch-22', and take note of the finding on 'stripping the company of assets', they will no doubt look to draw some encouragement from the Tribunal's application of PAYE principles, per the Aberdeen case.

Mark Cawthron, Tax Writer, CCH