HMRC’s heavy-handed approach in EBT case pays offby
The case against an IT contractor over whether payments into an employee benefit trust constituted taxable income, turned out to be more than just another EBT case for HMRC.
The Court of Appeal has given its judgment in the case of Stephen Hoey (CA2020 000291), a wide-ranging affair covering both judicial review and regular appeals against assessments.
This case, which was the lead case for a number of follower taxpayers, is notable for the apparent importance placed by HMRC on winning at any cost – the hearing involved the engagement of no fewer than two QCs and three junior counsel to plead HMRC’s position. Rory Mullan QC, appearing alone for Hoey, must have felt quite outnumbered!
What was it all about?
Hoey was an IT contractor employed by two offshore companies (“the Employers”) that provided his services to a number of UK-based companies (“the End Users”). A small portion of the fees earned by the Employers were paid to him as salary, but the overwhelming majority was paid into an employee benefit trust (EBT), which in turn advanced interest-free loans to Hoey (“in practice it was not expected that the loans would have to be repaid”).
The EBT arrangement was duly disclosed to HMRC under the Disclosure of Tax Avoidance Schemes arrangements, and no tax or national insurance contributions (NIC) was accounted for. Inevitably, HMRC argued that the payments into the EBT constituted employment income taxable under the Income Tax (Earnings and Pensions) Act (ITEPA) and subject to PAYE.
Even before the Supreme Court’s judgment in Rangers, Hoey would have anticipated a bumpy ride in resisting HMRC’s argument; after Rangers, he was obliged to concede on that point. However, he argued that any obligation to withhold PAYE/NIC should fall on the End User (as a deemed employer), and that he would be entitled to a credit for the PAYE that ought to have been deducted from any notional employment income paid to him.
HMRC chose instead to invoke section 684(7A) of ITEPA, which absolves any person from complying with the PAYE Regulations “in circumstances in which an officer of Revenue and Customs is satisfied that it is unnecessary or not appropriate for the payer to do so”. Since, on this construction, neither the Employer nor the End User needed to operate PAYE, Hoey would have no PAYE credit available to reduce his tax bill.
Hoey felt that this was wrong, since it deprived him retrospectively of a PAYE credit, and argued that HMRC had not exercised its discretion “correctly, legally or reasonably”.
By the time the case reached the first tier tribunal (FTT), HMRC had introduced an alternative line of attack, under the Transfer of Assets Abroad (TOAA) legislation in Chapter 2 of Part 13, ITA2007: did “the creation of the employment contracts between Mr Hoey and [the Employers] constitute the transfer of an asset by Mr Hoey, a UK resident, to… a person abroad” such that any income arising should be taxable on Hoey?
What was under appeal?
The appeals and cross-appeals escalated from the FTT to the upper tribunal (UT), whose judgment was:
- The assessments made on Hoey (charging tax of just under £80,000 in aggregate) were validly made;
- The availability of any PAYE credit (in establishing how much of that tax was owed by Hoey in person, and how much by the Employer or End User) was a matter for judicial review;
- The amount of income assessable under the TOAA legislation was nil: as a trading entity, the Employer’s income is its profit after deducting amounts paid out wholly and exclusively for the purposes of its trade, such as emoluments paid to its employees. If the amounts paid into the EBT were (as conceded) employment income, “that must be an uncontroversial proposition”.
The case then proceeded to the Court of Appeal as a blend of judicial review and statutory appeal. The court distilled matters down to a few main heads:
- Can HMRC use s684(7A) to “deprive” Hoey of a PAYE credit? If so, was that power lawfully exercised?
- Does the FTT have jurisdiction to address those matters?
- Is there a separate liability under TOAA and, if so, did the FTT err in law by concluding that the income at issue was nil?
The s684(7A) dispute
The court heard evidence that made it very clear that HMRC’s alternatives (tracking down every individual End User, issuing Regulation 80 determinations, litigating the inevitable appeals and ultimately issuing Regulation 81 notices against Hoey and the other appellants) would have been ludicrously cumbersome and costly.
Added to this, the court had no sympathy for Hoey’s argument that denying him a PAYE credit imposed on him a tax charge he was not expecting to have to pay:
- “No deduction was ever made by the End Users in this case, nor did they account for any tax; and [Hoey] cannot have thought they had done so”;
- If a deduction had been made, the notional PAYE credit would not arise at all;
- “The reason why [Hoey] did not expect to pay the tax was not because of the availability of the PAYE credit. It was because [he] believed that the avoidance scheme worked and the EBT contributions were not chargeable to income tax… regardless of the PAYE credit”.
In this the court recognised that, far from commencing by declaring employment income in his returns from the beginning and asserting his entitlement to a PAYE credit on notional payments, Hoey had begun by declaring no taxable income at all. His post-Rangers claim to a credit comes across as a retrospective attempt to shift some or all of the tax bill onto the End Users who were (as far as can be seen) unaware of his tax planning steps.
The court reminded us that it is established law that there is a three-stage process for taxation: liability, assessment and recovery. The FTT’s jurisdiction primarily extends to appeals under s31 TMA, which broadly relate to matters within the first two stages.
Some matters within the third stage do have express appeal rights given by legislation, but s684(7A) is not one of them. The prescribed route for seeking redress against an unreasonable exercise of HMRC’s discretion lies via judicial review, no matter how tempting it might be to wish for the FTT to act as a “one-stop shop”.
Ultimately both the FTT and the UT were correct not to seek to rule on this aspect. The correct venue was the Administrative Court and, by extension, the Court of Appeal, which now found in HMRC’s favour on that point.
Transfer of assets abroad
While having “some misgivings about treating the entry into a contract of employment as involving the creation by the employee of rights vested in the employer”, the court was content to proceed on the basis that, entering into a contract with the offshore Employers had in fact transferred assets abroad.
That conceded, for any tax charge to arise, “income” must become payable to the Employer – which, as the FTT and UT had already enumerated, could only be taken as being the trading profit of the Employer.
Intriguingly, at earlier stages of the case it was clear that HMRC had made little or no attempt to establish the basis on which payments to the Employers from the End Users constituted “income”. Any engagement with the concept that payments made to the EBT might not be wholly and exclusively for the purposes of the Employer’s trade came very late in the process. For most of the time, HMRC simply attempted to place a burden of proof on Hoey, rather than justify its own position that 100% of the payments constituted “income”.
As the court noted, there is an “important distinction, which HMRC’s submissions frequently seemed to elide, between trading receipts, which do not themselves constitute income, and trading profits, which do”.
As for HMRC’s belated suggestion that the payments to the EBT should be disallowed owing to duality of purpose (they formed part of a scheme whose purpose was to avoid tax for Hoey), the court was unsympathetic. While the purpose of Hoey may well have been tax avoidance, the purpose of the Employer was to remunerate its employee.
“In the case of an employee… anything paid to him by way of remuneration for acting as an employee cannot easily fail to be… exclusively for the purpose of the firm’s business. Given the existence of that principle, it seems to us that there was an evidential burden on HMRC to explain why the payments into the EBTs were not deductible… That evidential burden was neither recognised nor discharged by HMRC”.
In summary, the FTT did not err in law by ruling that the Employers’ income was nil.
The Court held that HMRC’s use of s684(7A) was entirely appropriate and, as a consequence, Hoey was not entitled to any PAYE credit. All the tax due on the notional earnings was properly payable by him through self-assessment.
There was no liability under TOAA because there was no income to assess. Even if there had been, the ITEPA assessment would take priority.
Taxpayers who wish to challenge HMRC’s exercise of its powers should not attempt to do so via the FTT. Judicial review is the only appropriate route.
Could HMRC not have found a single QC capable of arguing both the ITEPA/PAYE and the TOAA points, and did this case really require three juniors in addition to two Silks?
HMRC’s long-standing propensity to use a sledgehammer (bought and paid for by the taxpayer) to crack its nuts seems never to go away.