Has the Court of Session Today Made a Decision Which Will Win HMRC the Big Tax Case?

I know that I am not known for the brevity of my blog posts, especially where I have substantial material to work from.

However I am going to change the habits of a blogging lifetime by writing a short post based on a long piece of source material. I will write at greater length but thought this worthy of comment now.

Remember the “Big Tax Case”? That was known, more formally, as Murray Group Holdings & Ors v Revenue & Customs [2012] UKFTT 692 (TC) (29 October 2012) and the decision can be read in full here.

The Murray Group (and predominantly “Rangers”) “won” the case to the extent that, by a two to one majority, the First Tier Tax Tribunal decided that, except in the cases where the appellant conceded otherwise, the payments which had been made via the Employee Benefit Trust structure by the employer and taken by the employee from the trusts and sub-trusts in the form of loans were not payments subject to Income Tax.

The appeal by HMRC is grinding its way towards a full hearing at the Upper Tier Tribunal and will get there eventually.

But today, in a decision running to 36 pages and over 16,000 words, the Inner House of the Court of Session has issued a  decision which, from an initial look, seems to make the job of HMRC in the appeal that much easier.

The full decision in Aberdeen Asset Management PLC v HMRC can be read here.

In this case, which was heard at the level in the court system above the Upper Tier Tribunal, the court, consisting of Lord President Gill, Lord Drummond Young and Lord Glennie, over-turned a decision of the Upper Tribunal on the operation by AAM of EBTs for its senior employees.

Whilst the facts are not identical to those in the Big Tax Case, the legal principles are closely related and the Inner House has, on my reading, made a decision which is far more in line with the minority opinion of Dr Poon in the Rangers case than with the majority.

As Lord President Gill commented in the AAM case:-

[1] The tax-avoidance scheme which has given rise to these appeals is summarised by Lord Drummond Young. The scheme involved a series of linked transactions based on the appellants’ offshore Employee Benefits Trust. The object of the scheme was to pay to senior employees and directors of the appellants large sums of money tax free. The money passed from the appellants to the EBT and thence to a series of companies, aptly named money box companies, which were incorporated offshore for each of the beneficiaries. The benefits received by the employees were expressly provided to them as part of their overall remuneration. At the stage when the money was passed from the money box to the employee, the assets of the company were effectively at the disposal of the employee. The directors were mere ciphers.

Does this not sound familiar to those of us with a keen interest in the Big Tax Case?

He added:-

[6] In a case of this kind, our concern is with the reality rather than with any simulation of reality that may be achieved by the interposition of a company, the issue of shares and the oversight of compliant directors. Looking at the matter in that way, I think that it is obvious that the employee had complete control of the company and had immediate access to its cash. The money box company was simply a conduit between the EBT and the employee. The directors’ purpose was that of compliance with the objective of the scheme.

[7] On the Ramsay principle (W T Ramsay Ltd v IRC [1982] AC 300), the transfer to the employee of shares in the company was a payment within the meaning of section 203(1) of the 1988 Act (cf Garforth v Newsmith Stainless Ltd (1978) 52 TC 522). The error of the Upper Tribunal in this case lies, in my opinion, in deciding the question on the basis of the formal legal rights that flowed from the interposition of the company. The Upper Tribunal should have looked at the obvious and inescapable reality.

In the Big Tax Case was the “obvious and inescapable reality” that the money was being paid as a “tax-efficient” way of rewarding employees, and not as a “genuine” system of truly discretionary loans? Did the majority opinion consider the “obvious and inescapable reality” of the arrangements?

Lord Drummond Young delivered the most detailed of the three opinions. He said:-

[14] … The employees benefited from the funds in the companies in a number of ways: these included receiving soft loans (loans at low interest rates or loans which would not require to be repaid) and obtaining the use of property from the company. In this way the employee received substantial financial benefits as a form of bonus…

Does reference to “soft loans” sound familiar?

[29] There was generally no discussion between the appellants and the employees regarding the benefits that might be provided by the offshore companies. There was no standard way in which the companies applied their respective funds: each company invested in different kinds of investment and/or made soft loans to the employee who held all or half of the issued shares. Employees obtained benefits from their individual company in a variety of ways. This included the making of loans by the company to the employee; the taking of assets of the company as a dividend; and the purchase of land by the money box company, where the company substituted itself as a party to land purchase agreements which an employee had concluded. The duration and value of loans granted by the offshore companies were agreed in a dialogue with the employee who had beneficial ownership of the shares. Loans were invariably granted. Such credit checks as were carried out were formal. With one exception, the loans were never repaid.

Loans never repaid?

No formal credit checks?

No applications for loans ever refused?

[31] In relation to the trusts, the First-tier Tribunal found that the edifice that had been constructed merely disguised the fact that none of the trustees exercised any real discretion but simply went through the motions to give the appearance of the application of thought leading to a reasoned decision; the reality was that each component of the structure played its part in giving effect to the decisions of the appellants’ Remuneration Committee. It was inconceivable that if the Remuneration Committee recommended that a particular employee receive a benefit or bonus, the trustees of the EBT, the FBT or the directors of the offshore company would do anything other than facilitate the benefit or bonus’s reaching the employee or being placed under his sole direction and control (paragraph 57). Moreover, the directors of the company did no more than go through the motions of checking the propriety of making loans to shareholder/employees (paragraph 59).

[34] In considering what amounts to payment for the purposes of the PAYE legislation, it is important in my opinion to bear in mind that money is a medium of exchange. In practical terms, therefore, the crucial question is whether funds have been placed in a position where as a practical matter they may be spent by the employee as he wishes; it is at that point that the employee can be said to obtain the benefit of those funds. If the PAYE legislation is construed purposively it is in my view obvious that it is such a benefit that is to be taxed. For this purpose it is not appropriate to deconstruct the precise legal nature of the employee’s rights, drawing fine distinctions according to the methods that he must adopt in order to use the funds for his benefit. The fact that the employee has practical control over the disposal of the funds is sufficient to constitute a payment for the purposes of the legislation.

The majority in the Murray case seemed to “draw fine distinctions” and to “deconstruct the precise legal nature of the rights”.

[37] The argument for the appellants was that the funds transferred to the companies were not placed unreservedly at the disposal of the employees. The only right that an employee had was ownership of the shares, and he had no clear legal right to the cash. The Scheme came to an end when the shares were issued to the employee, and did not involve transferring any right to the cash to him. In this connection reliance was placed in particular on the statement in DTE Financial Services Ltd v Wilson, supra, at paragraph 42, that for the purposes of the PAYE system payment “ordinarily means actual payment: i.e. a transfer of cash or its equivalent”. This involves focusing on the legal right enjoyed by the employee; what was required was a right to payment of cash. It was submitted that that followed from a proper analysis of the PAYE legislative code.

[38] In my opinion this opinion reads the word “payment” too narrowly in the context of the PAYE legislation. It amounts in effect to saying that for payment to occur an employee must have a direct legal “right”, in a very strict sense, to the funds that are paid, and it is not enough that the employee can, by exercising a power that has been conferred upon him, obtain the beneficial use of those funds. That involves a concentration on strict legal form rather than the substance of the transaction, and treats the form as critical. Perhaps more importantly, it takes one aspect of the complex transaction contained in the Scheme, namely whether an employee has a direct right to payment of the funds paid into the Scheme by the employer, and treats that as determinative of whether there is a “payment” to the employee. Under the Ramsay approach, however, the transaction under consideration must be viewed “realistically” (Ribeiro PJ in the Arrowtown Assets case, cited above at paragraph [25]). That clearly requires the transaction to be looked at as a commercial whole. In the present case the First-tier Tribunal expressly found that the Scheme was conceived as a whole, to channel money from the appellants to the favoured employees. When such a transaction is viewed realistically, as the unity that it was intended to be, it is apparent that the employee-shareholders had ample power to ensure the beneficial use of the funds that had been transferred by the appellants into the money box companies. The fact that powers conferred by company law might have to be exercised to achieve that purpose if the directors are not compliant does not matter; it is the substance of control, and in particular the ability to use the funds in the companies as a medium of exchange for the benefit of the employee, that is important. In this connection it should be noted that, even if funds are paid into the employee’s bank account, the employee will require to exercise a legal power in order to make beneficial use of them, namely the power to direct the bank how the funds due to him are to be applied, as by writing a cheque or directing a credit transfer. In my opinion there is no material difference between that power and the powers that the employee-shareholders in the present case had to determine the beneficial use of the funds provided by the appellants as employer. This accords with the test applied in Garforth, where Walton J held that payment occurred “when money is placed unreservedly at the disposal of directors by a company” (52 TC 529). Nothing is said there about any need for a “clear” or “direct” legal right to payment; Walton J rather considered that it was the practical ability to make use of the funds that was important.

And here is the nub of the case – what does “payment” mean?

Reading the AAM decision the court seems to adopt an approach which is markedly different from that of the majority in the Murray case.

There is still a long way to go before the Murray case is concluded. However the AAM case will be one which might be exercising the mind of the learned Mr Thornhill, the excellent QC for Murray International Holdings.

The Big Tax Case still lives!

Posted by Paul McConville