Tax scheme promoters scuppered by own scheme
The promoters of the Alchemy scheme were so confident that it could turn earnings into untaxable gambling winnings, that they used the scheme themselves, with predictable consequences.
The Alchemy scheme is a complex tax avoidance scheme using a combination of spread bets on financial markets to benefit directors and their companies.
The scheme has already been savaged by the first tier tribunal for the promoter’s failure to comply with the DOTAS requirements, and it has now been roundly defeated in another case (Root2 Tax Ltd TC07502).
Place your bets
Root2 Tax Ltd marketed the Alchemy scheme, and its three directors (Forsyth, Baker and Hughes) had such faith in its ability to avoid tax and NI that they used it for their own remuneration.
This is a very much simplified illustration of how the scheme worked:
A director took out a matching set of wagers with a company (Heronden):
- A bet that a specified basket of hedge funds would grow, over a three-month period, by a specified amount; and
- A call spread option (CSO) which took the position that the bet would fail.
The director was required to pay a stake to Heronden, which was based on the maximum amount lost on the bet if it failed. Heronden had to pay the director an initial premium on the grant of the CSO, and would also be obliged to pay a final premium at the end of the three months.
This is an example of one such transaction for the director:
|Maximum winnings on bet||374,400||-|
|Maximum loss on CSO||(468,000)||-|
The example shows that, regardless of whether or not the basket of funds met the specified target, the director stood to lose financially. The overall losses represented Heronden’s fees.
Spin the wheel
Happily for the director, there was a get-out. At some stage during the three-month period, he could novate the CSO to a third party – inevitably his employer.
By paying a margin (equal to the maximum loss on the CSO less the final premium) to Heronden, Root2 took on the ownership of the CSO. The final position was as follows:
|Loss on CSO||-||(468,000)|
It was never suggested that an employer novating an obligation of one of its directors did not confer an employment benefit. The value of the CSO at the date of novation was calculated by Heronden as £213, which Root2 took as its cost of providing the benefit for income tax purposes.
HMRC considered that Root2 Ltd had spent £393,333 in order to put £385,686 into the director’s pocket, and one of those two sums constituted earnings from employment.
If successful in this argument, HMRC accepted that it would need to pursue the directors as individuals for any income tax due. Root2 Ltd, however, would have to pay the Class 1A NIC on the earnings.
Judge Harriet Morgan had to disentangle the arguments, and made the following observations:
- The individuals entered into the CSOs and the bets as a pair of matched transactions with the intention from the outset of novating the CSOs to the employer. Entering into the contracts otherwise made no sense for the individuals given that if they held both to term they would inevitably have made a loss.
- The accounting advice given to Root2 Ltd by Grant Thornton was based on the fact that the Alchemy structure was intended to provide employers with a strategy for remunerating their employees. Grant Thornton advised that the employer should account for payments it made under the scheme as employees’ remuneration. Root2 Ltd did so and claimed a deduction for those amounts as employees’ earnings in computing its profits for corporation tax purposes.
- It is very difficult to see who would be willing to take on the CSOs on being required to provide a margin, other than a party who would gladly spend money to confer a benefit on the individuals, such as their employer.
- Most of the more elaborate details of the scheme were nothing more than “window dressing”.
The conclusion drawn from the law was clear: the overall package needs to be considered, not just the effect of individual isolated steps.
On that basis, the payments made by Root2 Ltd to Heronden, which in effect enabled it to pay the bet profits to the individuals, were earnings from the individuals’ employment with Root2 Ltd. They were paid as a reward for their services as employees/directors employed in its tax consultancy business, and the PAYE rules apply.
In the modern, post-Ramsay and post-Rangers world, it is hard to see how a tax scheme such as this could have been expected to succeed.