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Mary Ashley reports on a rare taxpayer win

Cases like Marlborough are helpful to reveal how HMRC will form its arguments when it wants a tribunal to look at the overall effect of an arrangement rather than the detail.

Marlborough DP Ltd v The Commissioners for Her Majesty’s Revenue & Customs [2021] is a First-tier Tribunal decision by Judge Harriet Morgan and Member John Woodman. It considered an appeal by Marlborough DP Ltd (MDPL) against various assessments and determinations and decisions issued by HMRC in respect of payments made under a remuneration trust for the benefit of its sole shareholder and director, Dr Mathew Thomas.

The case itself considered one of the many structures devised by and connected with Mr Paul Baxendale Walker. The result, therefore, is somewhat surprising given the reputations of those schemes as it is a taxpayer win. Although as a result of this decision, the scheme does not have the complete effect as envisaged by its creator (namely, no tax payable), it did not lead to the worst-case scenario result of the most tax payable considering the circumstances. This case should be of interest to a wide variety of individuals who participated either in one of Mr Baxendale Walker’s schemes or in a different remuneration trust structure.

Background facts

MDPL is a company registered in England and Wales whose principal activity is operating a dental surgery in which Dr Thomas provides his dental services. Dr Thomas was the sole shareholder and sole director since 27 November 2007. Dr Thomas had incorporated the business as he felt it safeguarded him personally if he fell into arrears with the bank, HMRC or suppliers.

As a means of providing sums to Dr Thomas, MDPL entered into the following arrangements (the RT arrangements) which were summarised by the tribunal at para 2:

(1) MDPL established a trust (‘the RT’) which was stated to be for the benefit, broadly, of persons who had provided or might in the future provide services, custom or products to MDPL.

(2) MDPL made ‘contributions’ to the RT (‘the contributions’) on the basis that, as stated in the relevant documents, the contributions ‘reflect part of the economic cost to [MDPL] of earning its profits’. For each relevant accounting period, MDPL (a) deducted the contributions as business expenses in computing its profits for accounting purposes, and (b) claimed a deduction for them in computing its profits for corporation tax purposes.

(3) Acting on behalf of the trustee of the RT, a company controlled by Dr Thomas used the funds received as contributions, in each case very shortly after a contribution was made to the RT, to make ‘loans’ to Dr Thomas (‘the loans’) of the same or very nearly the same amount as the relevant contribution.

The goal of the arrangements was for Dr Thomas to limit the tax payable by him on the receipt of the sums by not paying tax on the loans he received while at the same time allowing MDPL to claim corporation tax deductions for their contributions to the RT.

HMRC, however, took the view that MDPL was not entitled to a deduction for the contributions in computing its corporation tax. Further, in each of the relevant years, MDPL was liable to account for income tax and NICs on the loaned monies. HMRC assessed MDPL on that basis and MDPL appealed.


Apart from an issue regarding the validity of the determinations which I will not consider in this article, there were two key issues which the tribunal had to consider:

  • Were the monies taxable as earnings from employment either under the general rules in the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) or under Part 7A ITEPA (Employment Income Provided through Third Parties)? If the answer to that question was yes, then MDPL would have been liable to account for income tax and NICs.
  • Was MDPL entitled to deduct the sums contributed to the RT for corporation tax purposes?


Are the relevant sums taxable as earnings?

The first issue the tribunal considered was whether the sums received by Dr Thomas under the RT arrangements constituted ‘earnings from employment’ under the general rules in ITEPA. If the sums constituted earnings, then MDPL would have been required to account for income tax and NICs in respect of them. If the payments were not earnings, then they should have instead been taxable as distributions made to Dr Thomas.

The tribunal stated that it had already been established through the case law as set out by Lord Hodges in RFC 2012 plc (in liquidation) (formerly Rangers Football Club plc) v Advocate General for Scotland [2017] at para 35 that the tax on emoluments or earnings is ‘principally, but not exclusively, a tax on the payment of money by an employer to an employee as a reward for his or her work as an employee’.

Establishing the purposes of making the payment is key to assessing its character in the hands of the recipient (HMRC v PA Holdings Ltd [2011]). The difficulty arises where there is more than one purpose for making the payment and, as such, the focus of much of the case law is on whether this test is satisfied where the party providing the payments is motivated by more than one purpose for so doing.

In analysing the specific payments made in Marlborough, the question was whether the contributions made by MDPL to the RT were to be regarded as remuneration or a reward for the provision of Dr Thomas’s services as director of MDPL or whether the contributions were made for a different reason such that they had a non-employment source (namely Dr Thomas’s shareholding in MDPL).

The tribunal determined that, in these circumstances, on the basis of the limited evidence that there was, the relevant sums were not paid to Dr Thomas under the RT arrangements as a reward for his services but rather constituted distributions made as a return on his shareholding in MDPL. On a purposive construction of the legislation relating to distributions, the legislation is broad enough to capture the relevant sums even though they were loans made under the RT arrangements.

The following factors supported that this was a distribution rather than ‘earnings’:

  • There was no contractual obligation on MDPL to pay the sums as a reward for Dr Thomas’s services.
  • The sums paid were the totality of the overall profits of MDPL’s business (computed after expenses) and so were paid out sporadically.
  • Dr Thomas stated that, had he not been paid through the RT arrangements, he would have taken the monies as a dividend rather than as a salary. This was supported by the fact that it is common practice for owners/directors to organise their payment in this way. Further, since stopping his use of the RT arrangements, Dr Thomas paid himself through dividends.

The tribunal noted that there is nothing to prevent a sole owner/director from arranging to take a company’s profits as split between salary and dividends/distributions in whatever proportion they deem fit, regardless of whether it reflected the amount of work that the person did for the company. It is a generally accepted practice. In addition, the General Anti-Abuse Rule commentary states that arrangements of this type are not caught by that rule.

HMRC sought to argue to the contrary, taking a more holistic approach to what had happened as opposed to looking at the minutiae. This is always a risk when persons undertake complex planning which HMRC may not like. Cases like Marlborough are therefore helpful to reveal how HMRC will form its arguments when it wants a tribunal to look at the overall effect of an arrangement rather than the detail.

In that regard HMRC argued that because MDPL received the income generated by its dental business because of Dr Thomas’s role as director, the resulting profits represented the fruits of his labour, and as the payments of those profits as contributions to the RT were not declared as dividends, these payments were earnings.

The tribunal, however, found difficulties with HMRC’s analysis both factually and legally. In relation to the conclusions that HMRC drew from the facts, the tribunal stated the following:

  • HMRC’s analysis of the facts ignored the distinction for corporate law (and tax) purposes between MDPL as a legal person in its own right, and the individuals involved in its management and operation. MDPL carried on a dental business which made profits from the work undertaken by all of the employees of MDPL, not just Dr Thomas. Its profits, therefore, did not relate solely to the work undertaken by Dr Thomas as director.
  • The fact that the sums were paid through RT arrangements implemented only for tax avoidance purposes did not provide evidence that the sums were a reward for Dr Thomas’ services. Simply because payments are made through arrangements that HMRC does not like does not mean that it can reclassify the payments as it sees fit. If one strips away the RT arrangements, one is not further forward in establishing whether the sums were earnings or would have been paid as dividends. The tax avoidance purpose does not lead to the conclusion that the payments would have been earnings.
  • As such, HMRC could not demonstrate, based on the evidence upon which it sought to rely, that MDPL’s underlying purpose was to reward Dr Thomas for his services as director as opposed to providing him with a return on his investment.
  • As a matter of fact, Dr Thomas himself did not accept that he would have received the same amounts through the RT structure even if he had not been the sole shareholder of MDPL, and did not accept that the relevant sums were not paid in respect of his shares in MDPL.

The tribunal also had difficulties with HMRC’s legal analysis. HMRC was unable to point to any material factor clearly showing that the relevant sums were sufficiently linked with Dr Thomas’s role as director to constitute earnings or that the sums were not paid in respect of his shares. HMRC’s argument could be boiled down to the proposition that income or profits arising to a corporate owner of a business which are at least in part generated by the activities of its sole shareholder/director are linked in their entirety to the role of that person as director/employee. As such, unless a formal dividend is declared, the extraction of those profits will be earnings.

The tribunal, however, disagreed with this general proposition and more generally with the approach which HMRC took to the issue:

  • HMRC’s approach was out of kilter with the case law on this topic. In assessing if sums constitute earnings, the courts look at why the payment was made by the employer and not the reasons why it receives the funds in the first place.
  • RFC does not take the matter forward. RFC only establishes that once a payment is categorised as earnings, it is not a bar to the sums being taxed as earnings that they were routed through a trust arrangement.
  • Suggesting that a dividend payment can only be a dividend payment if formally declared is incorrect. First, it suggests that a formal dividend declaration breaks the link or connection with employment which would otherwise exist. This is unsustainable. Second, it is established through case law that sums may constitute distributions even if formal company law procedure is not followed.

As a result of the above arguments, the tribunal determined that the relevant sums did not constitute ‘earnings’ under its general definition in ITEPA.

Are the relevant sums taxable under Part 7A?

The tribunal then went on to consider whether the sums were taxable under Part 7A ITEPA. Part 7A applies to tax arrangements where a third party takes a ‘relevant step’ (for example making a payment) in pursuance of the arrangement to provide rewards or recognition for an employee’s work.

Where the conditions for Part 7A to apply are satisfied, the value of the relevant step counts as employment income. Here, if Part 7A applied, then income tax and NICs would have been chargeable on the sums.

HMRC took the view that the scheme was a means of providing Dr Thomas with loans and that the loans were provided in connection with Dr Thomas’s employment with MDPL. Given that the language used in s554A ITEPA is broadly drafted and that Part 7A is anti-avoidance legislation, it must be construed broadly. As a result, the tribunal should take a realistic view of the structure of the arrangement and what it is intended to achieve rather than looking at the minutiae of what happened. Taking a holistic view of what happened, the monies were received by MDPL due to Dr Thomas’s work for it as a dentist and the fruits of these labours were channelled to him through the scheme. These should therefore be taxed under Part 7A.

The tribunal disagreed with HMRC. Despite how broadly s554A is drawn, there must be a connection of the required kind with Dr Thomas’s employment for the arrangement to come within Part 7A. The employment must be part of the reason for the reward, recognition or loan. To establish that connection, it was necessary to undertake a similar analysis to that undertaken in relation to the question of whether or not something was ‘earnings’. For the reasons given in relation to the question of earnings, the tribunal concluded that there was not a sufficient connection between the loans made and the employment for Part 7A to apply instead of the loans being treated as distributions.

Deduction for corporation tax purposes

The tribunal, having concluded that the sums were not taxable under ITEPA, did not have to consider the question of whether or not they would have been deductible for corporation tax purposes. MDPL had accepted that if they were not taxable under ITEPA then they were not deductible for corporation tax purposes.

That being said, the tribunal had heard full arguments on the point so nonetheless went on to consider whether, if they were wrong on the first point, deductions would have been available.

HMRC argued that MDPL should not be entitled to a deduction on the basis that the contributions to the RT arrangements were not incurred wholly and exclusively for the purposes of its trade. As the contributions to the RT arrangements were made purely for tax purposes, they were not paid for the purposes of MDPL’s trade or incurred as expenses enabling MDPL to carry on and earn profits in any trade.

The tribunal disagreed. Under the assumption that the sums constitute earnings, it follows that the purpose in making the contributions would be to provide Dr Thomas with earnings. In choosing to deliver the funds to Dr Thomas through contributions and loans through the RT arrangements, its purpose must be to avoid the sums being taxed as earnings on a basis that preserved the usual consequential tax effects of an employer paying such sums – that is, a tax deduction. Following the decision of the Upper Tribunal in Scotts Atlantic Management Ltd v HMRC [2015], the obtaining of the tax deduction was the ordinary, intended or realistically expected outcome of expending sums which true intent were incurred to reward Dr Thomas for his services. Therefore even if that were a tax avoidance purpose in making the payment, it would not be enough to mean that the payment was not made wholly and exclusively as is required for it to be deductible.

Why does this matter?

This case is a great example of HMRC’s preferred approach to these complex matters – preferring a realistic/holistic approach rather than having regard to the consequences of each step. While this approach can be lauded for its simplicity, tax law (and law more generally) is not that simple. There are many intricacies of UK law which cannot be ignored in favour of a broad brush ‘reality’, especially where those facts have clear legal consequences.

This case provides taxpayers with some hope given that it is a win and it shows a tribunal taking a really detailed look at what happened.

Further, this case puts limits on the otherwise very widely drafted Part 7A. It has always been difficult to know quite how widely a tribunal would be willing to take those provisions given that the language used in them is so vague.

The downside to this case is that this is just a decision of the First-tier Tribunal. It is highly debatable whether this will hold up in front of the Upper Tribunal or beyond. Certainly, HMRC will want to fight this until it can get the result that it wants. But for now, if this is at all representative of how these questions will be approached in the future, then it is welcomed.

Cases Referenced

  • HMRC v PA Holdings Ltd [2011] EWCA Civ 1414
  • Marlborough DP Ltd v The Commissioners for Her Majesty’s Revenue & Customs [2021] UKFTT 304 (TC); [2021] WTLR 1329 FTT
  • RFC 2012 plc (in liquidation) (formerly Rangers Football Club plc) v Advocate General for Scotland [2017] UKSC 45
  • Scotts Atlantic Management Ltd & anor v Commissioners for HMRC [2015] UKUT 66 (TCC)