The Upper Tribunal (UT) was asked whether a contribution to an employee benefit trust (EBT) made by a company constitutes ‘taxable earnings’.
Background:
M R Currell Ltd. (MRCL) is a family business operating in the painting and decorating sector. When it was established in the 1980s, it was created as a sole trader. In 2002, MRCL was incorporated. Between 2002 and November 2010, MC and his wife, KC, served as the directors of the company. In November 2010, KC and MC each held about 31% of the shares of the company, while their two sons held circa. 5%.
By November 2010, the company employed contract managers who were "essential to the success of the business". The company has a history of rewarding employees with ‘sizeable’ performance-based bonuses. In 2010, an employee incentive arrangement was set up in the form of an EBT.
An £800,000 contribution was made to the trust from MRCL. MC then applied to the trust for a loan of £800,000 to buy A class shares in the company from his wife. The interest-free loan was approved and was repayable on the fifth anniversary of the date of the loan agreement. There was evidence that KC received the £800,000 from MC which she then transferred to the company where it was treated as a loan from her to the company which could be repaid to her at any time.
In 2015, HMRC opened an enquiry and issued the determination. The company appealed and the First-tier Tribunal (FTT) ruled that the contribution was taxable as earnings under Section 62 of the Income Tax (Earnings & Pensions) Act 2003 (ITEPA). The company appealed.
Decision:
The UT remade the decision of the FTT due to an error in law. The Tribunal noted that the FTT should have had regard to the character of what the director received, specifically a loan subject to an obligation to repay. The loan was also genuinely repayable within 5 years and the company never ceased to have access to the funds as working capital.
The Judge rejected HMRC's argument that the earnings were not regarding the loan but the payment to the EBT. The UT noted that treating repayable loans as earnings simply because they confer a "benefit" could not have been Parliament's intention.
The UT also distinguished this case from RFC 2012 plc (formerly The Rangers Football Club plc) v Advocate General for Scotland [2017], because the parties’ payments to the trust were not remuneration for employee’s services. As such, the loan was not made in satisfaction of any entitlement to salary or bonus.
Implications:
This decision clarifies that genuinely repayable loans do not constitute earnings and, as such, “this case provides a good guide as to the meaning of ‘earnings’”.
However, it must be kept in mind that such a set of facts would potentially fall within the disguised remuneration regime and Part 7A of the Income Tax (Earnings & Pensions) Act 2003 (ITEPA) which came into force in December 2010.