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  • The Rangers case: The art of misdirection?

    27 November 2015

    Andy Wood


    Misdirection is a form of deception in which the attention of an audience is focused on one thing in order to distract its attention from another.

    In the latest chapter of the ‘Rangers Case’, this could apply equally on two fronts.

    Firstly, that the Scottish Court of Sessions ultimately opined that the payments made to the EBT were financial sleight of hand and were really earnings.

    Secondly, that HMRC had distracted the taxpayer by waiting until their third appeal to even advance this as an argument!


    HMRC’s third appeal was upheld in the Scottish Court of Sessions (“The Court”), which is the equivalent of the Court of Appeal in English money.

    Of course, many will consider that they wouldn’t touch an EBT with someone else’s barge-pole. However, depending on how ‘fact sensitive’ the decision proves to be, it could have much wider implications when one is considering providing any form of deferred reward or benefits.

    This is because, rather than the creation of sub-trusts or the provision of loans being seminal, it is the “mere redirection of earnings” which seems to get the goat of the Court. This therefore potentially has a wider import than just the much maligned EBT.

    In this note, I want to tease out some of the arguments and principles highlighted and then discuss some of the potential implications and questions raised. These will be solely in relation to the (successful) “redirection of earnings” argument put forward by HMRC and will exclude the other discussions. Furthermore I do not want to set out the facts of the case here.

    You will also find no (intentional) football or sporting puns!

    The traditional view

    We go back to Hochstrasser v Mayes where payments would be “assessable if [they] had been paid… in return for acting as or being an employee”. This stands to reason.

    It is also on this fundamental ‘emoluments doctrine’ that the Court of Sessions has based its decision choosing to strip away any other machinery through which any payment may have been provided.

    However, traditionally there has been another key consideration. Whether the payment has been a contractual payment or whether the payment is a discretionary one.

    Where the payment is a contractual (relating to the employment) one then the payment will be treated as being from the employer / employee relationship.

    However, where the payment is discretionary then a differing practice, where no immediate tax liability has crystallised, has applied.

    Transposing the traditional view to Trust arrangements

    Let us assume that an EBT or some other trust is used and it is to this that payments are being proposed.

    The case of Gartside v IRC [1968] dictates that a potential employee beneficiary of a discretionary EBT would have no interest in the trust property. However, following the ‘traditional view’, there is an important distinction to be drawn on how contributions might be treated in respect of the employee:

    1. A contractual right exists to the contribution (“Contractual Contribution”). For instance, the Employer uses the contribution to a trust to discharge an existing contractual right. For example, satisfying a contractual bonus or a specified percentage of contractual earnings;
    1. There is no contractual right (“Discretionary Contribution”). An employer might decide to make a contribution over which no employee has any right to be held on a long term investment fund. Certain employees might receive benefits, payments, loans or annuities on retirement subject to the Trustee’s absolute discretion.

    Contractual contributions to trust arrangements

    There are two key cases in this regard, both of which helpfully(!) provide the same answer.

    Bell v Gribble [1903] concerned a number of employees who were required to make compulsory contributions from their salaries in to a ‘thrift fund’. It was held that these were assessable as earnings

    Similarly, Smyth v Stretton [1904] – which is a pivotal case in the Court of Session’s judgement – involved schoolmaster’s salaries being part paid to a trust established for their benefit. Again, as these were contractual payments being ‘redirected’ they were found to be taxable.

    The principle is therefore easy to establish. Where there is a contractual requirement to make the payment one cannot merely ask that the earnings are paid to someone else and expect the tax position to change.

    Discretionary contributions to trust arrangements

    A discretionary payment will be one where no employee has the right to compel the Employer to make a payment. In other words, the payment is not made to satisfy an existing obligation.

    This was confirmed in Edwards v Roberts [1935] where, as well as being entitled to an annual salary, the main protagonist also had an interest in a fund from which he could benefit if he remained an employee for five years. In this case, the contributions to the trust were not taxable until such a time as benefits were taken (assuming the contingency was fulfilled).

    The Court’s approach in Rangers

    In addition to Smyth, the Court also advanced a Privy Council case of Hadlee v Commissioner of Inland Revenue [1993] to reinforce this argument. This seemed to involve a fairly crude arrangement where an accountant assigned part of his profit share to a trust for his family. This is a case from New Zealand and the resulting income would be taxable under UK anti-avoidance rules in any event. However, the result was that the assignor was subject to tax as the profit stemmed from his accounting work.

    There seems to be some helpful comment at para 56 of the judgement where it states:

     “the fundamental principle…if income is derived from an employee’s services [in their capacity as an] employee, it is an emolument or earnings… even if the employee requests or agrees to it being redirected to a third party.”

    This seems to back up the traditional view and that some sort of ‘redirection’ is required. In other words, there must be some existing obligation for the Employer to make a payment to the Employee at the outset. I agree with the Court that this represents “common sense” and also the case law.

    However, in their next breath, the Court also seems to down play the significance of the absence of contractual arrangements:

    “While the bonuses were discretionary, and there was no contractual entitlement to them, it is very obvious that they were derived from and based on the work done by the particular employee” (at para 59)

    And that:

    “It is not in our opinion necessary that there should be any prior obligation [being discharged by the Employer] provided that the payment itself can be shown to be remuneration for the employee’s services. The mere making of the payment is sufficient to give rise to an emolument or earnings.”

    The Court then summarises:

    “The critical feature of emoluments or earnings is that they represent consideration for services provided under a contract of employment, and such consideration is ultimately provided by the employer.

    Thus the critical point when it can be said that an emolument or earnings have been paid is when….[the] employer makes payment…to the employee…or in a manner that has been requested or… acquiesced in by the employee”

    So, when considering whether the earnings are being redirected, it is irrelevant that the payment is non-contractual and ultimately of a discretionary nature. It is the fact that an Employer is making a payment to, or in respect of, an employee that is relevant. In other words, an employee can potentially redirect earnings to which he has no entitlement!

    How on earth can this approach be squared off with Edwards?

    What about Edwards and other case law to the contrary?

    It is therefore important to see whether the Court has downplayed the significance of Edwards? The case is finally mentioned at para 71 in the section entitled Further Cases. The Courts states:

    “It is important to bear in mind [in Edwards] that a critical feature… was that the taxpayer was not entitled to anything until the lapse of six years and his right could be defeated if he had… left his employment during that period.”

    On that basis the Court decide the facts are distinguishable. This might be helpful generally as it suggests that a discretionary fund where no person has an interest until such time a contingency is fulfilled will not result in the contributions being taxable. Also, bearing in mind the fact that the arrangements in the Rangers case are fairly egregious, it may well be that the decision is very case specific.

    The Court then goes on to state that Sempra Metals v Revenue and Customs [2008] should not be followed. In Sempra, it was payments to a trust were not taxable as the payments were not placed “unreservedly at the disposal of the employee in question.”

    They also go on to distinguish the case from UBS AG v Revenue and Customs [2013] on the basis that it was “held by the Upper Tribunal that it could not be said that in the circumstances the employees were “entitled to payment” of the amount of the bonuses.”

    Other, to this point helpful analysis from Dextra Accessories v MacDonald [2005], is also deemed to be “not relevant” by the Court.

    There is little detailed reasoning as to why these cases are jettisoned in favour of the ‘re-directed earnings’ analysis. It may be that the decision turns on the facts. Though the judgement does not make that clear to this reader.

    Mismatch between this decision and Part 7A of ITEPA 2003

    It is interesting that if the Rangers decision applies widely then there seems little need to Part 7A which applies to payments by employers to third parties in order to provide reward to employees. Regardless of whatever machinery that the payment passes, under the ‘redirected earnings’ analysis, the contributions are taxable.

    It is also interesting that Part 7A prevents the Employer from taking a relevant step for the purposes of this legislation. As such, an employer could make a cash contribution to an EBT without having any issues with Part 7A, but the ‘redirection principle’ of the Court would nevertheless apply.

    What if there is no earmarking? For example, a global contribution is made to a collective pooled investment. Under Part 7A would not provide for earmarking. Could this payment be taxable under this redirection principle? If so, how would you calculate how much was taxable?

    Jurisdiction of the Court of Session

    It is worth noting that a judgement of the Scottish Court of Session creates no legally binding precedent for any Court in England. For instance, even the First Tier Tribunal is not bound by this decision.

    What effect going forward?

    It should be said that Rangers is a specific case and, with reference to the surrounding documentation, the fact that the payments were held on sub trusts for each employee, it is perhaps easy to see why a Court might want to seek to tax this as earnings. As such, it may well be that the Court has looked at the substance rather than the form, treating the existence of the trusts and loans as window dressing.

    However, it is difficult to see whether the principle of ‘redirected earnings’ will start and end here – or whether it could be used to apply more widely.

    For now, it seems that there are two near certainties:

    • That, assuming there is still a taxpayer standing, this will be appealed to the Supreme Court; and
    • That HMRC will use this decision as the basis to issue Accelerated Payment Notices to those who have not used the EBT Settlement Opportunity

    However, to throw in the footballing reference I promised not to, I don’t think anybody thinks this is all over…