Tax Update provides you with a round-up of the latest tax developments. Covering matters relevant to individuals, trusts, estates and businesses, it keeps you up-to-date with tax issues that may impact you or your business. If you would like to discuss any aspect in more detail, please speak to your usual Smith & Williamson contact. Alternatively, Ami Jack can introduce you to relevant specialist tax advisors within our firm.
1. PAYE and employment
1.1 Landmark SC ruling on the application of UK tax law to international treaties
The SC has overturned the CA’s decision, finding that the income of a diver was employment income for the purposes of a double taxation agreement (DTA). The UK legislation that deems the employment income of a diver to be trading income was held not to change the nature of that income for the purposes of the DTA.
The taxpayer, a South African resident, worked as a diver on the UK continental shelf. Under the UK/South African DTA, earnings from self-employment are taxed where the individual is resident, whereas employment earnings are generally taxed where the duties are performed. ‘Employment’ is not defined in the DTA; so, according to the DTA provisions, the definition in UK tax law applied in this case. The Income Tax (Earnings and Pensions) Act 2003 defines employment, but the definition is overridden to the extent that income from diving activities is treated as trading income. The issue in this case was whether or not this deeming provision should cause the taxpayer’s employment earnings to be treated as trading income for the purposes of the DTA.
The CA had ruled that this deeming provision entirely displaces the charge to IT and the earnings were trading income for all tax purposes. The earnings therefore took on the nature of trading income and should be treated as such for the purposes of the DTA.
The SC unanimously overturned this decision. It found that the ‘real’ meaning of ‘employment’ should be applied; the deeming provision served only to determine how the income should be taxed in the UK, it did not change the nature of that income. The deeming provision was also not intended to govern whether or not a diver was taxed on his income in the UK. It was only intended to determine how a diver’s income was to be taxed. The income was therefore held to be employment income subject to tax in the UK.
Fowler v HMRC  UKSC22
1.2 Diver not entitled to Seafarers Earnings Deductions
An employed diver has been prevented from claiming a relief for employees working on ships outside the UK, as the diving income of employees is taxed as trading income under a specific provision in legislation. The FTT also considered the PAYE assessment and collection regulations.
The taxpayer worked as a diver. In four tax years, he had participated in a tax avoidance scheme, which he subsequently accepted did not work. The tribunal found that the discovery by HMRC was valid. He did however challenge the discovery assessments and one closure notice on the grounds that he was entitled to Seafarers Earnings Deductions (SED).
SED reduce the tax bills of UK resident employees who work on a ship outside the UK for substantial periods. Effectively, the income from offshore duties is disregarded. HMRC argued that SED did not apply, as the taxpayer’s earnings fell within another provision, which specifically treats divers’ employment income as that of a trade. If SED were applied before this provision, the taxable income treated as a trade would be nil. If the provision were applied first, SED would not apply, as the income would be trade, not employment. On considering the wording, the FTT found that the provision took precedence, as the reference to employment income within it should be taken as applying to gross income before deductions such as SEDs. This only applied to offshore duties.
Regarding the work on the UK continental shelf, HMRC argued that SED would not apply to divers, as it specified duties performed ‘on’ a ship, and diving was work performed ‘from’ the ship but on the seabed. The FTT agreed with the taxpayer that he was within the ordinary meaning of ‘seafarer’ and his work was connected closely to the ship. HMRC had more success with its second point, that the ships were in the nature of offshore installations, not ships, as they were simply used to exploit mineral resources. The FTT found that in two of the five voyages the evidence was insufficient to show that duties were not solely exploiting resources, so no SED would be available for those voyages.
Szymusik v HMRC  UKFTT 154 (TC)
1.3 HMRC wins appeal on employment-related securities
The UT has upheld an appeal by HMRC, finding that a share option granted to an employee was granted by reason of his employment. It was granted for more than one reason, including in exchange for the cancellation of a previous option, but it was enough that one of the reasons was that of his employment.
A company in financial difficulty settled a debt to an adviser by granting him a share option rather than paying the fees. Later, as part of a rescue package, it appointed him a director, cancelled the option, and granted him a new share option commensurate with that of other investors. If this new option was employment-related, as argued by HMRC, PAYE and NIC would be due on its later exercise.
The FTT found that the grant of the second option was not issued by reason of his employment, but simply as a replacement for the non-employment related first option. Further, it decided to disregard the deeming provision that would normally treat any share option granted to an employee as employment-related, finding that it should be limited such as not to result in an absurd outcome.
The UT found that the FTT had erred in law. When the second option, ultimately sold at a gain of £636,238, was granted, the company was in such a state that the first option was worthless. The rescue package was conditional both on the adviser becoming a director, and on the first option being cancelled or amended. In fact, the second option was granted for more than one reason, and as it was conditional on the adviser becoming an employee then it was employment-related. The UT therefore allowed the appeal without considering the deeming provision.
HMRC v Vermilion Holdings Ltd  UKUT 162 (TCC)
2. Business tax
2.1 Smith & Williamson succeed on IFRS 2 corporation tax deductions case in CA
HMRC has lost the latest round in the long-running dispute over the deductibility of accounting expenses for employee share options.
The case concerned several distinct but linked issues over the corporation tax deductibility of accounting entries in the taxpayers’ accounts for the award of share options.
Since the UT case, HMRC v NCL Investments Ltd & Anor  UKUT 111 (TCC) HMRC had dropped its claim over the interpretation of the specific statutory rules for awards of qualifying shares, this law having anyway been changed in 2013.
The main head of HMRC’s claim was that to be generally deductible for corporation tax purposes an expense in the accounts had actually to be incurred for tax purposes, as opposed, it argued, to mere accounting expenditure. In the period between the UT case and this hearing, this area had been explored in the UT case of in Ingenious Games LLP v HMRC  UKUT 226 (TCC),  STC 1851 which HMRC sought to call in aid here in interpreting ‘incurred’ for this purpose. The CA reviewed the new case law but saw no reason to revise the decisions of lower courts. It similarly accepted the lower courts’ judgements on other points in the appeal over the meaning of employee benefit contributions, whether the or not expenses in question were capital and whether or not the expenses had a purpose. The UT’s judgement in favour of the taxpayers was therefore confirmed and leave to appeal was refused.
HMRC v NCL Investments Ltd & Anor  EWCA Civ 663
2.2 UT allows appeal on validity of closure notices
The UT has overturned an FTT decision, finding an enquiry into an LLP partnership return and subsequent closure notices were valid. This was despite the fact that the LLP was found not to be trading with a view to profit during the enquiry, and so should have filed a corporation tax return.
Enquiries were opened into two LLPs, followed by closure notices finding that the LLPs were not trading with a view to profit, so were not entitled to business property renovation allowance. HMRC opened the enquiries under the income tax provisions, but the FTT found that the closure notices were invalid, as the enquiries should have been opened under the corporation tax provisions. It found that LLPs are always treated as companies for the purposes of tax administration laws, regardless of whether or not the LLP is deemed to be partnership or a company for the purposes of calculating and paying tax.
HMRC appealed and argued that the enquiries were valid. HMRC had issued notices to file a partnership return and argued that it had been reasonable to assume that this was correct at the time.
The UT upheld HMRC’s appeal. It considered the various tax provisions and their interaction, and agreed that HMRC was entitled to issue the notices to file a partnership return. The returns, although ultimately incorrect, were properly submitted. The enquiry notices and subsequent closure notices were found to be appropriate and valid.
Following the FTT decision, a provision was added to the Finance Bill, currently before Parliament, to ensure such enquiries by HMRC are, in most cases, treated as always having been valid.
HMRC v Inverclyde Property Renovation LLP & Anor  UKUT 161 (TCC)
2.3 Scottish Parliament restricts COVID support for companies based in tax havens
The Bill that legislates for relief for Scottish businesses affected by the COVID crisis has been amended to prevent companies based in tax havens from obtaining grants.
The Coronavirus (Scotland) (No. 2) Bill was amended by the Scottish Parliament to include new measures that will prevent some businesses from accessing Government grants. Coronavirus-related grants will not be available to a business that:
- is based in a tax haven;
- is the subsidiary of a company based in a tax haven;
- has a subsidiary based in a tax haven; or
- is party to an arrangement under which any of its profits are subject to the tax regime of a tax haven.
For these purposes, ‘tax haven’ is taken to mean a jurisdiction on the EU’s list of non-cooperative tax jurisdictions.
2.4 FTT makes split ruling on distributions and directors’ loan accounts
The FTT has ruled that, when calculating the excess paid for goodwill, the element of consideration comprised of a credit to a directors’ loan account did not amount to a distribution. Only the excess of the cash payment over the true value of the goodwill was relevant to determining the distribution. This ruling was made by the Presiding Member; the other Tribunal Member dissented.
The taxpayers owned a potato grading and processing business, which they operated as a partnership. They incorporated the partnership, which involved transferring goodwill to a new company. The goodwill was valued at approximately £1.2m in the accounts. The company paid approximately £750,000 cash to acquire it, and left the balance on a loan account. The company later became insolvent and so the balance was never repaid.
HMRC disputed the value of the goodwill, and the FTT found that it should have been valued at approximately £270,000. The parties agreed that the excess paid for the goodwill over the true value was a distribution taxable on the taxpayers. They disagreed, however, on whether the excess should be measured using the figure of £1.2m or £750,000. The presiding member of the FTT found that the distribution was equal to the excess of £750,000 over the true value of the goodwill. He held that the amount actually transferred was what mattered; crediting a directors’ loan account did not amount to a distribution. The increase to the loan account created a liability for the company, it was not a transfer of assets.
The other Tribunal member agreed with HMRC that the correct distribution was the excess of £1.2m over the true value. The FTT allowed HMRC permission to appeal to the UT, and made clear in the judgment that HMRC is encouraged to do so.
Pickles and another v HMRC  UKFTT 195 (TC)
2.5 FTT clarifies the deductibility of management expenses for investment businesses
The FTT has dismissed an appeal for the deduction of management expenses in relation to the sale of a subsidiary by an investment company. It was found that the investment business had been carried on by the taxpayer’s parent company, not by the taxpayer.
The taxpayer was an intermediate investment holding company. It held a 100% holding in a Dutch company that itself owned four subsidiaries carrying on a diverse range of businesses. A strategic decision to dispose of the Dutch holding company was taken by the taxpayer’s parent company. A complex restructuring was undertaken that resulted in the sale of the assets of some of the subsidiaries by means of a partial de-merger. The taxpayer was denied a deduction for the expenses of this restructuring and sale on the basis that those expenses were not management expenses.
HMRC argued that the expenses could not be regarded as part of the management of the taxpayer’s own investment business because it was the taxpayer’s subsidiary that had disposed of its businesses, rather than a direct disposal by the taxpayer. The FTT held that some of those expenses were capable of being management expenses of the taxpayer. An investment business aims to maximise the value of its investments, which may involve facilitating the sale of businesses of subsidiaries. The primary issue, however, was that the management activities in relation to the restructuring and sale had been carried out by the taxpayer’s parent company, not the taxpayer. The FTT closely examined the process of the sale and found that, taking a realistic view, the parent company had made all the decisions. The taxpayer had not, therefore, managed the investment business in relation to which the expenses were incurred. On this basis, the appeal was dismissed.
The FTT went on to make further alternative rulings, including a useful discussion on how to distinguish between expenses of management and expenses of implementing a decision to sell a business.
Centrica Overseas Holdings Limited v HMRC  UKFTT 00197 (TC)
3. Tax publications and webinars
3.1 Tax publications
3.2 COVID-19 hub
4. And finally
4.1 Court Dress
We obviously can’t let the recent case of HMRC v NCL Investments (see item 2.1 above) -that’s us- pass without noting that it was a landmark.
Yes; it may just be the last case ever heard in the Court of Appeal where counsel keeps his shoes on in court. To look back to the hearing is to recall a really strange occasion. The case was heard just before Lockdown. The Court swirled with concerns about COVID-19 but didn’t quite know how to deal with it. The respective legal teams had been pared down to essentials beforehand and one of us was literally sent to the back of the courtroom for getting too close. Well, well. It may never be the same again.
Now, presumably, for a world of Zoom and Teams where attire below the waist is irrelevant and arguably pretty optional if the laptop camera is set correctly. Counsel, though, will still need briefs.
HMRC v NCL Investments Ltd & Anor  EWCA Civ 663
|ATT – Association of Tax Technicians||ICAEW - The Institute of Chartered Accountants in England and Wales||CA – Court of Appeal||ATED – Annual Tax on Enveloped Dwellings||NIC – National Insurance Contribution|
|CIOT – Chartered Institute of Taxation||ICAS - The Institute of Chartered Accountants of Scotland||CJEU - Court of Justice of the European Union||CGT – Capital Gains Tax||PAYE – Pay As You Earn|
|EU – European Union||OECD - Organisation for Economic Co-operation and Development||FTT – First-tier Tribunal||CT – Corporation Tax||R&D – Research & Development|
|EC – European Commission||OTS – Office of Tax Simplification||HC – High Court||IHT – Inheritance Tax||SDLT – Stamp Duty Land Tax|
|HMRC – HM Revenue & Customs||RS – Revenue Scotland||SC – Supreme Court||IT – Income Tax||VAT – Value Added Tax|
|HMT – HM Treasury||UT – Upper Tribunal|
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.