Sometimes one comes across a case decision where it is hard to discern how a judge reached it on the basis of tax law. One such case is Arvind Shah v Insafe International Ltd (, EWHC 1036 (Ch)) which appears to have been decided on the basis of a misunderstanding of tax law and procedures.
This is not a tax case; it is a trust case. But the result depends largely on tax law.
Insafe International set up an Employee Benefit Trust in 2006 into which it paid £1.25m. The trustees then created two sub-trusts, one of £982,400 for the benefit of Mr Bullock, its managing director and the other for £245,600 for the benefit of Mr Shah, its Finance Director, and their respective families. The sub-trusts lent the funds back to Insafe International at a market rate of interest.
HMRC challenged the use of the EBTs, contending that the payments were disguised remuneration. In August 2015 Insafe International entered into a contract settlement with HMRC under which it agreed to pay £643,302.31 to HMRC in consideration of HMRC not taking proceedings against Insafe for the unpaid liabilities in relation to PAYE and NICs “imposed wholly or in part because of the Employer’s failure to meet all its obligations”, and interest thereon. The unpaid liabilities were of course the PAYE and NIC claimed by HMRC in relation to the payments into the EBT sub-trusts.
The EBT was then wound up. Insafe reclaimed the PAYE and NIC from the sub-trusts so the beneficiaries received only the net amount. Mr Shah was unhappy. He believed he was entitled to the gross amount, and sued. The Deputy Judge held that the company was entitled to reclaim the £643,302.31 from the EBT.
This seems a very odd decision on the basis of tax law. It also seems a strange decision on the basis of trust law.
The appointment by the EBT into the sub-trusts did provide at clause 4(6) that, “Whenever any … conferment of any benefit provided by the Trustees or any other person, or a benefit or payment deemed as arising by a competent fiscal authority, or treated as arising under relevant legislation results in any liability whether the liability is that of the employer or employee or provided if the benefit or payment, or any income tax whereby the Trustees or an employer or provided of the benefit or payment is required to account for income or other taxes by payment of tax or deduction, the Trustees shall be obliged to pay all such taxes and contributions and make all such deductions or withholdings or payments and account to the relevant authority for the same notwithstanding that there may be no liability to do so or that any liability to do so may not be enforceable against them”.
The judge was not alone in having to try hard to work out what this means!
The Deputy Judge, Simon Monty QC, applied what he perceived to be the “clear” principles set out in the Court of Session decision in Murray Group Holdings Ltd ([2015 CSIH 77; 2016 STC 468). In particular that “the income derived from the personal exertions of the taxpayer is his income for tax purposes, even if it is paid to a third party”.
He then set out some principles of his own, which is where things start to go badly wrong. These include:
“34. It is always the employee’s liability to account to HMRC for income tax. See for example s 13 of ITEPA and ss 59A and 59B of TMA 1970
35. The position is the same in respect of NICs: see SSCBA 1992, s 6(4)(a) and Sch 1, para 3(1) …
36. The fact that the employer has an obligation to deduct PAYE and NICs does not detract from the fact that the liability to pay income tax and employee’s NIC is always that of the employee.
37. That is also true of interest …”.
He then held that although clause 4(6) of the deed creating the sub-trusts was a difficult clause to follow, the trustees have an obligation under the clause to make the PAYE and NIC payments out of the trust fund because either –
- a benefit has been conferred,
- a benefit or payment is deemed as arising by a competent fiscal authority, or
- a benefit or payment is treated as arising under any relevant legislation.
The deed prevented the exercise of a power where it causes or permits any part to the fund to become in any way payable to or applicable for the benefit of Insafe as settlor. The Deputy Judge dismissed that holding that “Under the Agreement [i.e. the contract settlement between Insafe and HMRC], there is nothing payable to Insafe. The liability to tax is that of Mr Shah. The money has been paid by Insafe to discharge his liability. It is not money applicable for the benefit of Insafe, but money which has been paid for and is applicable to the benefit of Mr Shah”.
Leaving aside the fact that it is hard to see how Insafe could have had any authority to reach a settlement with HMRC in relation to a tax liability of Mr Shah, there are two fundamental problems with the Deputy Judge’s reasoning. The first is that the PAYE and NIC was not a liability of Mr Shah; it was a liability of Insafe International. The second is that it was not tax and NIC at all, it was a contractual payment that Insafe agreed to make to HMRC in consideration of HMRC not penalising it for failing to deduct PAYE and NIC.
ITEPA 2003, s 13 does indeed make Mr Shah the person liable for tax on his employment income. However ITEPA 2003, s 683(2) makes the income “PAYE employment income” and s 684(1) requires HMRC to make regulations with respect to the assessment, charge, collection and recovery of income tax in respect of all PAYE income. The PAYE Regulations contain a complete code for the collection of tax on PAYE income.
Reg 21 states that “on making a relevant payment to an employee during a tax year, an employer must deduct or repay tax in accordance with these Regulations” (Reg 21). A relevant payment means, inter alia, payment of PAYE income (Reg 4). Reg 67G requires the employer to pay the tax over to HMRC. The Regulations allow the liability to pay the tax to be transferred from the employer to the employee in two specific circumstances only. These are set out in Reg 72(3) and (4). However in both cases HMRC have a discretion as to whether to transfer the liability. They both require a Direction by HMRC. As the making of the direction absolves the employer of all responsibility for the tax, this gives HMRC the choice of which to pursue. It would, to say the least, be odd if, as the Deputy Judge seems to believe, they can circumvent this procedure by simply assessing the employee and ignoring the PAYE system completely.
In the absence of an HMRC direction under Reg 72 the PAYE and NIC is a liability of Insafe International, not Mr Shah. Accordingly it is hard to see how, by reimbursing it to the company, the EBT is not conferring a benefit on the company in breach of clause 3 of the deed.
The second problem is that the sum payable under a contract settlement is not tax and NIC at all. It is an amount equivalent to tax, and clause 4(6) says nothing about such amounts. That it is not tax has been made clear by recent penalty rules which have had to specifically apply the penalty to amounts payable under a contract settlement as well as to tax.
Finally, there is (or ought to be) a public interest issue here. Insafe International Ltd entered into what, in HMRC’s view at least, was a tax avoidance scheme. Lord Greene in Lord Howard de Walden v HMRC (25 TC 121) pointed out that, “It scarcely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers”. That is surely as apposite today as it was in 1943. But this decision seeks to alleviate that complaint. It relieves Insafe completely of the fiscal consequences of having unsuccessfully sought to avoid tax. It transfers the consequence of what Insafe itself agreed with HMRC in the contract settlement as tax lost because of Insafe’s failure to meet its obligations, to a third party. Effectively that seems to be saying that there is no public interest in either the enforcement of an employer’s tax obligations or in seeking to deter companies from engaging in tax avoidance.
That surely cannot be right!