Taxpayer’s appeal took flight despite carelessnessby
Despite the careless conduct of the directors of Magic Carpets, HMRC was trampled underfoot in this tax avoidance scheme case because it was out of time to issue its PAYE determinations.
Magic Carpets, which carried on a floor and wall covering business, adopted a scheme that – broadly – intended to ensure that loans made to the company’s employees (Jeremy and Jacqueline Holt – also the company directors) would not attract a liability to PAYE income tax and national insurance contributions (NICs), while securing Magic Carpets a corporation tax deduction for the payment.
The scheme was first recommended to the Holts in a meeting with Magic Carpets’ accountants in March 2009. The company used the scheme twice, once in 2009/10 and once in 2010/11.
The company’s accountants did not explain any of the risks involved in the scheme, and the Holts understood little of the steps in the scheme – other than it involved an employee benefit trust (EBT) and loans to them – or of the tax implications of the scheme – other than that it was “tax planning” that would save them and the company tax. However, the Holts trusted the accountants implicitly and took the steps that they were told to take.
(It’s worth noting that Magic Carpets subsequently brought proceedings in the High Court against the accountants, alleging professional negligence, which was settled out of court).
Magic Carpets did not account for PAYE income tax or NICs on the amounts in 2009/10 and 2010/11, and did not include the loans in its P35 returns for those years.
In April 2016, HMRC issued a determination under Regulation 80 of the Income Tax (Pay As You Earn) Regulations 2003 for 2009/10, with a further Regulation 80 determination issued in February 2017 for 2010/11. Together, the determinations totalled over £150,000.
In December 2020, HMRC issued a notice of penalty assessment to Magic Carpets under Schedule 24 Finance Act 2007 for over £22,000, which covered the two tax years. The penalty was assessed on the grounds that there were inaccuracies in the company’s PAYE returns, which were careless.
Magic Carpets appealed both determinations, as well as the associated penalties [TC/2020/02133].
Out of time
Under section 34 TMA 1970, the ordinary time limit for HMRC to make an assessment to income tax is four years after the end of the year to which it relates. HMRC issued its PAYE determinations and penalties outside of this window, instead relying on section 36, which extends the time limit to six years where the loss of tax is brought about carelessly.
The amount of the determinations and penalty were not in dispute. Rather, the FTT had to consider whether:
- HMRC had issued its determinations in time, in other words, whether Magic Carpets and/or the accountants acting on its behalf carelessly brought about the inaccuracies in its P35 returns in 2009/10 and 2010/11, and
- Magic Carpets was liable to the penalty on the grounds that there was an inaccuracy in its PAYE return, which was brought about carelessly.
Uncertain case law
Subsequent to the events in this case, in 2017 the Supreme Court decided in RFC 2012 Plc (in liquidation) (formerly the Rangers Football Club Plc) vs Advocate General for Scotland  UKSC 45 that payments made by a company to an EBT for the purpose of providing remuneration in the form of loans to employees should be treated as earnings of the relevant employees, such that PAYE income tax and NICs became due immediately.
However, as the FTT noted, before the decision in Rangers, the courts and tribunals had reached differing views on the treatment of tax avoidance schemes involving EBTs and the provision of remuneration to employees in the form of loans, pointing to cases such as Sempra Metals Ltd vs HMRC  STC (SCD) 1062.
The FTT acknowledged that some aspects of the company’s conduct and that of its directors could be regarded as careless. The Holts made no attempt to understand the steps in the scheme; they did not understand the documents that the company entered into, nor properly sign or execute them; and they signed documents that referred to meetings that did not take place. At the very least, the FTT found the company to be careless in not making any further enquiries into the scheme.
However, the FTT accepted that the Holts were not sophisticated taxpayers. They trusted their advisers implicitly and relied on them, following their reassurances, to implement the scheme.
On balance, the FTT concluded that HMRC did not discharge its burden to show that there was any causal link between any carelessness on the part of the company (or by the accountants acting as agent of the company) and the tax loss or the inaccuracies in the P35 returns.
One factor in the FTT’s decision was the state of the case law as it stood at that time. Namely, the FTT commented that, even if the company had gone as far as seeking independent specialist advice at the time, an independent adviser was likely to have concluded that the scheme (albeit controversial) did achieve its aims, at least in relation to the lack of any obligation to account for PAYE income tax.
The appeals were allowed.
The FTT did make the point that, had this case concerned the claim for a corporation tax (CT) deduction in relation to the payments made by the company, it may well have reached a different conclusion. However, this case dealt with the Regulation 80 PAYE determinations and associated penalties; the fact that a deduction had been claimed for CT purposes on the scheme payments did not affect the treatment of the arrangements for PAYE income tax purposes.