Dentist extracts better tax treatment using trustby
Amounts paid from a dentist’s company to a remuneration trust, which were lent back to the dentist, were distributions rather than earnings, and weren’t caught by the disguised remuneration rules.
Dr Thomas was the sole director and shareholder of Marlborough DP Limited (MDPL), which operated a dental practice in which Thomas provided his dental services. MDPL established a remuneration trust (RT) with a Belize corporate trustee for the benefit, broadly, of persons who had provided or might in the future provide services, custom or products to MDPL
The money flows through the remuneration trust operated as follows:
- MDPL made contributions to the RT on the basis that they reflected “part of the economic cost to [MDPL] of earning its profits”
- For each relevant accounting period, MDPL deducted the contributions as business expenses in computing its profits for accounting purposes and claimed a corporation tax deduction
- Acting on behalf of the trustee of the RT, a company controlled by Thomas used the funds received as contributions, in each case very shortly after a contribution was made to the RT, to make loans to Thomas of the same or very nearly the same amount as the relevant contribution.
The arrangements ran over several years. The purpose of the scheme was twofold: to extract MDPL’s profits into the hands of Thomas in a way designed to not attract any liability to tax (ie through loans) while enabling MDPL to obtain a tax deduction for the relevant sums in computing the profits of its dental trade for corporation tax purposes.
HMRC’s position was that MDPL was liable to account for income tax and class 1 NIC in respect of the contributions paid by MDPL that passed into Thomas’s hands as loans. This was on the basis the sums either constituted “earnings from an employment” within the meaning of the general rules in ITEPA 2003 and to NIC under corresponding provisions, or were taxable under the disguised remuneration provisions in chapter 2, part 7A ITEPA 2003.
HMRC also took the view that, for each relevant accounting period, MDPL was not entitled to a deduction for the contributions as they were not incurred wholly and exclusively for the purposes of its trade. Alternatively, a deduction would not be available under rules relating to employee benefit schemes.
HMRC issued a number of assessments, determinations, and decisions to impose taxes on MDPL in line with the above. MDPL appealed.
Sums not taxable as earnings
In the first tier tribunal case of Marlborough DP vs HMRC [TC08246], the judges concluded that the relevant sums did not constitute “earnings from employment” under the general rules in ITEPA 2003.
Referring to case law (such as PA Holdings and Kuehne), the FTT summarised the issue to be decided in this appeal as whether:
- The contributions made by MDPL (ultimately passing to Thomas as loans) should be regarded as remuneration or a reward for the provision of Thomas’ services as director of MDPL, on the basis that that role is the reason why MDPL made the contributions or was a sufficiently substantial case of the contributions; or
- MDPL made the contributions for a different reason such that they have a non-employment source (ie that they were made in respect of Thomas’ shareholding in MDPL).
The FTT concluded that the relevant sums were not paid to Thomas under the trust arrangements as a reward for his services as director. Rather, they constituted distributions made as a return on his shareholding in MDPL.
The FTT noted that the sums paid to Thomas comprised the totality of the overall profits of MDPL’s business, and took into account Thomas’ credible assertion that, had those profits not been routed through the trust arrangements, they would have been paid to him by way of dividend and not as salary.
There was also no contractual obligation on MDPL to pay the sums as a reward for Thomas’s services as director/dentist.
The tribunal next had to consider was whether the relevant sums were taxable as income under the disguised remuneration rules in Part 7A ITEPA 2003 (in particular s554A(1)(c) ITEPA 2003) were met.
The FTT determined that the “connection” test under s554A (1)(c) was not met, as for there to be a connection of the required kind with Thomas’s employment, the employment must have been part of the reason for the reward, recognition or loan.
This required essentially the same analysis as undertaken above to determine whether the relevant sums constituted earnings, with the FTT already having determined that they did not.
Therefore, the relevant sums were not taxable under the general rules in ITEPA 2003, nor under the disguised remuneration rules (and NIC accordingly did not fall due).
No CT deduction
As the FTT decided that the relevant sums were not taxable under ITEPA 2003, MDPL accepted that it was not entitled to a deduction for the contributions when computing its profits for the relevant accounting periods for corporation tax purposes.
However, the tribunal did explore whether MDPL would be entitled to a deduction if the relevant sums were actually taxable under ITEPA 2003. The FTT found that under this scenario, MDPL would (contrary to HMRC’s assertions) be entitled to deduct the contributions for CT purposes.
Notably, tribunal member Woodman did not agree with this final conclusion, but as chairman Judge Morgan exercised the casting vote.
The appeal was allowed.