A director has won a complex tribunal case after challenging HMRC’s assertion that his company had deducted insufficient PAYE and NIC, and he had under-declared his employment income.
This complex case was sent back to the first tier tribunal (FTT) to decide afresh, without reference to any previous decision at FTT or upper tribunal.
HMRC issued Michael John Febrey (TC06897) with discovery assessments for 2005/06 and 2006/07, and amended his 2007/08 self assessment, on the basis that he had underdeclared his employment income.
HMRC also argued that insufficient PAYE or NIC had been deducted, and issued directions under Regulation 72 of the PAYE Regulations and Regulation 86 of the NIC Regulations to recover the deductions from Febrey. The tax and NIC at stake totalled £218,600.
Febrey was the sole director (but not a shareholder) of Febrey Ltd (FL), a construction company. He also provided services to a related company (FCS) of which he was a director and 50% shareholder. The shares in FL and the remaining half of those in FCS were held by Anne Rogers, his former partner and mother of his two sons.
In 2007, the two companies had around 400 subcontractors and employees, but the 2008 financial crisis brought it down and the bank appointed Grant Thornton as administrators.
Febrey’s relationship with Rogers also deteriorated, and as means to protect his position in the company he signed a £300,000 poison pill service contract.
Uncertain and missing documents
There was much confusion and uncertainty over what was paid when, and more importantly why.
HMRC assumed the service contract came into force in April 2006, but Febrey’s evidence was that – although he had signed it earlier - he only invoked it in April 2007.
Grant Thornton, who had seized and retained the company’s records, had provided HMRC with a sheet purporting to show amounts relating to “M Febrey salary”, but failed to supply HMRC with any supporting documentation. Grant Thornton did not include Febrey on the P35 it submitted to HMRC, nor had they issued a P60 to him.
In his 2007/08 tax return, Febrey made a white space disclosure that he had no access to a P60 or other records, but that his sole source of income was pay from FL which he “knew” was fully taxed at source. He included income of £300,000 (based on his maximum entitlement from the service agreement) subject to estimated PAYE of £111,414.40.
The judge outlined what needed to be established.
- Was there an insufficiency of tax for the three years because Febrey received undisclosed employment income?
- If so, do the PAYE and NIC directions apply?
HMRC had not provided evidence to conclude that Febrey’s drawings in 2005/06 and 2006/07 were employment income rather than, as all the indications suggested, on account of dividends paid by FCS to its shareholders.
For 2007/08 there clearly was employment income. Febrey continued to draw £400 a week from the company. What had changed was that he was now – by his own admission – doing so on account of the service contract.
How much employment income?
HMRC argued that the full £300,000 provided for by the service contract was assessable in that year.
The judge pointed out that “entitlement” in ITEPA 2003 s686 refers to “a present right to present payment” – as set out in UBS 2012 UKUT 320. That entitlement did not arise until April 2007, and given that the company went into administration in February 2008 a full year’s entitlement could not possibly have accrued.
Febrey’s white space disclosure on his tax return had been made on a qualified basis (since he did not have access to genuine figures), and was simply wrong.
The judge made a factual finding that the employment income for 2007/08 was £56,276.
What about the directions?
In order for directions to be made to recover underdeducted PAYE and NIC from an employee, HMRC has to show that:
- the company wilfully and deliberately failed to deduct PAYE and NIC; and
- the employee received the payments knowing that the company had wilfully failed to make the deductions.
HMRC tried to rely on the precedent of West 2018 UKUT 100, where a sole director was held to be the “controlling mind” behind a company, and so could not protest ignorance of its actions. The judge, however, decided that what might be true in a one-man company was less so for one where there was a large workforce.
Delegating to appropriately qualified staff discharges a director’s duty. Febrey could arguably have done more, for example querying why he was not receiving payslips. The evidence, however, was that he genuinely believed PAYE and NIC were being deducted from his income.
The directions to collect tax and NIC from Febrey personally were not valid.
The appeals for all three tax years were allowed, and HMRC was instructed to vacate the assessments and directions.
This case teaches us two simple lessons:
- a director who is also a shareholder is fully entitled to receive dividends, and those dividends are not employment income; and
- a director may, under law, have “ultimate responsibility” for the company’s actions, but that does not automatically translate into wilful culpability for all mistakes made by the company.