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  • Duker-ing it out over ‘mistake’ and the true construction of a Remuneration Trust deed

    20 August 2021

    Introduction

    Let’s face it, if nothing else, the world of tax avoidance can throw up some interesting cases.

    A certain Mr Levack was the shareholder in a number of companies including Dukeries Healthcare Limited, which (along with other related companies) made contributions to Remuneration Trusts arranged by Baxendale Walker LLP.

    This was a Part 8 claim brought by Mr Levack and his Companies in the High Court. It was not a tax case, albeit a FTT hearing had been stayed awaiting the outcome of this case.

    What is Part 8 claim?

    Part 8 is an alternative procedure to the usual manner of bringing a legal claim under Part 7. This alternative route and is aimed at disputes where the claimant seeks the court’s decision that does not involve a substantial dispute of fact. For example, as in this case, it can be used to seek a declaration from the court as to the correct interpretation of a trust deed.

    The issues

    There were primarily two points being brought by the Claimants:

    • On one hand, the Claimants sought a determination from the Court that all or part of the assets of the trust were (1) not permitted contributions and should revert back to the Claimant; or (2) Were held on some other trust (“True construction issue”)
    • That the trusts should be set aside with the contributions revested in the Claimant by virtue of the doctrine of mistake (“Mistake issue”)

    Why would the Claimant, who had entered into the scheme all those years ago, now be seeking to unwind the position? I guess they must feel that ‘giving up’ the corporation tax deduction which would result from either of the above was a sweeter pill than one which might result in PAYE and IHT liabilities.

    The key features of the trust

    The scheme had the following main features:

    It could only receive Permitted ContributionsA payment which does not constitute an Employee Benefit Contribution.   Indeed, under Clause 10.2, the Trustees had no power to permit any settlement of property unless it was a permitted contribution
    It could not pay Prohibited BenefitsThe fund could not be used to provide benefits to or in respect of present or former employees of the relevant company (“the Founder”)
    BeneficiariesThese were defined by reference to past and present Providers. The beneficiaries were the wives, husband, children etc of the Providers. However, this is further caveated by: No excluded person shall be a beneficiary; andThe Trustees do not have the power and shall not:Provide benefits to Excluded Persons; orShall not participate in an Employee Benefit Scheme
    ProviderA person who provides services or finance to the Founder or Trustees – the idea with the structure was that the shareholder would provide small loans to the Trustees making him or her a Provider
    Excluded personsThe founder, any person connected with the founder, any participator in the Founder are excluded from benefitting from the trust
    Post death construction clauseAny person who is an Excluded Person will cease to be an Excluded Person where they cease to qualify as one under the terms of the trust deed

    The main asserted tax features

    In summary, the effect of the above features was to ensure the following outcome for tax purposes:

      
    The scheme was not an employee benefit schemeThis would mean that contributions to the trust would be deductible for corporation tax purposes under basic principles – and not deferred until the employee sustained a taxable benefit
    No transfer of value (“ToV”) for IHT Purposes    Both s13 of the Inheritance Tax Act 1984 (IHTA84) prevents a contribution from being a transfer of value   Interestingly, the judgement sets out a common mistake about s13/28 that Participators cannot benefit. This is not the case. A participator may benefit as long as the benefit is subject to income tax. See s13 and s28 respectively.   In addition, on the basis that the trust was purportedly designed to achieve a corporation tax deduction on the contribution, this should prevent the contribution from being a ToV under s12 in any event.
    Post death construction clauseThe post death construction was to ensure that, following the Founder’s (Mr Levack) death, his family were no longer connected with the Participator and not Excluded persons.   Of course, the problems with this ‘post death construction’ clause are well documented in Barker v Baxendale-Walker [2018].   It is interesting that HMRC is using this case quite proactively in their interventions on so-called s86 trusts – even where there is no such clause in the trust deed at all.  

    The original scheme had been established prior to December 2010 and the introduction of Part 7A (aka disguised remuneration rules) albeit, I assume, further contributions were made to the trust after this date. It is suggested that the argument would have been that, as the trust did not permit employees past and present to benefit, the required nexus between employer and employee was not present to trigger the original Part 7A rules (ie any payments etc were in respect of some other non-employer/employee relationship)

    Further, it should be noted that the ‘Rangers’ tax case had not taken place in 2010 when the structure was being contemplated. As such, whether the provision of such benefits were subject to income and NICs were, at least, arguable.

    Scheme user siding with HMRC’s view that it does not work?!

    Perhaps surprisingly, the Claimant’s case was that the scheme was duff.

    In the paused FTT case, we are told that HMRC argued that the scheme was an employee benefit trust and therefore any tax deduction should be restricted.

    They also argued that the contributions were not made to the trust wholly and exclusively for the purposes of the trade so were not deducible under general principles.

    The Claimant racked up some further reasons why they felt that the scheme did not deliver the benefits ‘as advertised’:

    1. The planning did not prevent the contributions from being earnings in the hands of Mr Levack – presumably on the application of a Rangers type analysis that they were ‘redirected’ earnings.
    2. The Contributions were a transfer of value for IHT purposes because:
      1. They were neither deductible for corporation tax purposes; nor
      1. Excluded Participators could benefits in a way that was not consistent with the provisions referred to above

    The Court’s view

    General

    As set out above, the Court had two issues to consider, namely:

    • The True Construction Issue; and
    • The Mistake Issue

    True Construction Issue

    The argument by the Claimant was that the trustees were not able to accept the contributions to the trust. This is because, in order to be a Permitted Contribution, the trust could not be an employee benefit contribution.

    The Claimant put forward HMRC’s view that the contribution was an employee benefit contribution and, resultingly, was not permitted. As such, the funds should have been held on resulting trust for the founder.

    The Court set out clearly its role was to construe the deeds and not come to a conclusion about any tax liabilities – which was for the FTT to determine.

    The Judge’s view here was that the trusts were valid. He made clear that there were residual purposes for which the trust could receive contributions without falling foul of Clause 10.2.

    Further, the Court seemed to accept Counsel for HMRC (the Third Defendant in this case) that “there are numerous provisions that would have to be disregarded to justify the conclusion that the trusts are employee benefit trusts”. This seems an interesting position for HMRC to take.

    In conclusion, the Court found against the Claimants on this issue and that the trusts were valid.

    The Mistake Issue

    In respect of the second issue of ‘mistake’, the points for consideration were as follows:

    1. Is there evidence of a mistake of sufficient gravity
    2. If there was such a mistake – did Mr Levack run the risk of being wrong?
    3. If not, is the mistake or mistakes, such that it would be unconscionable for the Remuneration Trusts to remain in place?

    The judgement is helpful in that it sets out the views of Morgan J in Van der Merwe v Goldman [2016] EWHC 790 which provides a helpful checklist when considering the doctrine of mistake.

    As you will recall, this was a Part 8 claim. Such a claim requires a claimant to be scrupulous in ensuring that the Court has the full picture.

    However, it was clear that the Court found Mr Levack’s evidence far from compelling. It says his main statement in relation to these matters was 65 pages in length. He quoted extensively from the reports and materials provided to the firm. However, on cross examination, he did not remember reading the report and, in fact, read “hardly anything”. Why the gap in understanding? I’ll leave that to you.

    The result was that the Claimants failed on the basis of inadequate evidence showing that they had acted under ‘a mistake so serious a character to render it unjust.’ That was enough.

    However, the Judge was eager to point out that there was evidence to show that Mr Levack was willing to run the risk of being mistaken – as he accepted the schemes ‘warts and all’. His failure to properly consider the documents or seek additional advice showed a ‘cavalier attitude to risk’.

    Further, the fact that “the schemes are properly characterised as being artificial tax avoidance schemes’ also were counter to the Claimants objectives. As such, it was open to the Court to decide that Mr Levack accepted the risk that the schemes might fail.

    A word (or several) on Part 7A and the loan charge

    The application of Part 7A (aka disguised remuneration) is not covered in any detail in the judgement – or by the time I’ve highlighted and scribbled on it such analysis has been under layers of pink Staedtler ink!

    The finding that there is no Employee Benefit Contribution is interesting and the impact, if any, it has for the purposes of Part 7A.

    First of, Part 7A is not defined in terms of whether there is, or is not, an employee benefit contribution. The terminology and provisions that trigger Part 7A are separate.

    When it was first enacted, Part 7A had one gateway which latched on to an employer / employee relationship. Loosely, this required the following:

    1. A is an employee of B
    2. An arrangement exists which relates to A
    3. The arrangement is a means of providing rewards or loans in connection with A’s employment
    4. A relevant step, such as the payment of cash, is taken in the carrying out of the arrangement (or there is some other connection between the relevant step and the arrangement)

    It seems to me that the argument underpinning the Remuneration Trust in this case was that it did not permit a person to benefit in their capacity as an employee. Resultingly, the requirements would not be satisfied.

    As such, in terms of how it was originally enacted, it seems to me that the High Court’s decision probably supports the argument that Part 7A does not apply in similar cases.

    Of course, the loan charge, like any good parasite, needs a host to burrow into. In this context, there needs to be a transaction within Part 7A to grab on to. In the absence of any changes to the Part 7A gateway, then it would follow that that the loan charge would not apply to the RT either.

    However, we know that the Part 7A gateways were expanded. With effect from April 2018, a new close company gateway was introduced (there was also a new gateway for unincorporated trading profits – but that is irrelevant for this article).

    The requirements here are slightly different:

    1. A is a director or employee of B
    2. An arrangement exists which relates to A
    3. The arrangement is a means of A-linked payments or benefits or loans
    4. A relevant transaction is entered in to in order to carry out of the arrangement (or there is some other connection between the relevant step and the arrangement)

    It is clear under the original gateway that the loan or payment must be made in connection with A’s employment. It is explicit.

    Under the close company gateway, it is not so clear.

    Here, one would need to rely on the fact that the payment being made by the trustees was simply not in pursuance of the arrangement – for example, the trustees were exercising their investment powers. Of course, where one is making loans to the trustee of £100 per month in order to be able to receive larger loans or benefits from the trustees as a provider then I will leave you to decide how sympathetic a Court might be.

    The loan charge is relevant to this gateway. Despite the fact that this gateway was only introduced in 2018, it still manages to suck up loans made from structures that weren’t within Part 7A when they were made. So, a trust that was outside the original version of Part 7A, took steps that otherwise would not have been taxable under Part 7A but then later comes within the close company gateway is still within the loan charge.

    Just one of the time-bending properties of the loan charge.

    Of course, the fact that the loan charge is of little comfort to those whose schemes are under investigation. Indeed, HMRC will be pushing the point that contributions in to the trust were taxable as earnings as per the ‘Rangers’ case.

    But what about GAAR?

    Ultimately, I think all loan-based schemes (post 2013) are likely to be defeated by the GAAR Advisory Panel who, as far as I can see, have made sensible decisions here. So, whether it is an employee commuting 80% of their salary for a loan or someone making £100 loans to trustees so they can borrow £100k from the trust on commercial terms then I think success is unlikely. In many ways, this is a better result than trying to bring in measures that attack specific structures. For instance, direct loan schemes are not within Part 7A or the loan charge but, in my opinion, they are unlikely to withstand an attack under GAAR.

    Indeed, Part 7A should largely become redundant over the coming years. However, I won’t hold my breath waiting for it to be repealed!

    I’m now feeling out for the count myself…

    If you have any queries about this article, have been involved in similar tax avoidance scheme or tax matters in general then please get in touch.

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