Courts and Tribunals: Julian Harris summarises selected recent decisions.

Delaware LLC member not entitled to double tax relief on his share of profits

A UK resident member of a Delaware limited liability company (LLC) could not set his share of the profits against his UK tax liability using double tax treaty relief because the profits did not belong to the members from the moment of their creation, and the profits in the US were not the same as those to which he was liable to tax in the UK. The appellant, who was resident but not domiciled in the UK for tax purposes, was a member of a profitable Delaware LLC. Under US federal and state law the profits of such LLCs are treated as the profits of the members unless they have elected to be treated as a corporation (no such election was made in this case). The appellant was liable to pay UK tax only on income remitted to the UK, but that included his share of the profits from the LLC for the fiscal years 1998-2004.

HMRC sought to tax the appellant on the basis that the appellant’s share of the LLC’s profits derived from his investment in the LLC, and was not the same as the profits which the LLC made.  The issue to be decided was whether the appellant was entitled to double tax relief (DTR) under the terms of the UK/US Double Tax Convention of 31 December 1975 (for all the years in issue except the last) and the UK/US Double Tax Convention of 24 July 2001 (in relation to 2003/04). The First-tier Tribunal (FTT) concluded that the profits of the LLC belonged to the members as they arose, and therefore the same profits were taxed in both the UK and the US and the appellant was entitled to DTR. The Upper Tribunal (UT) disagreed, finding that the profits belonged to the LLC, and the contractual obligation to credit and distribute them did not make the profits belong to the members for English tax purposes. On this basis the profits were not the same as those to which the appellant was liable to tax in the UK, and HMRC’s appeal was allowed.

The Court of Appeal (CA) referred to Memec plc v IRC (1998) 71 TC 77, which established that the test for determining whether a person is taxed on the same profits or income in a foreign jurisdiction and the UK is whether the source of the profits or income in each jurisdiction is the same. Where the taxpayer is entitled to the profit of an entity by virtue of being a party to some contractual arrangement, the taxpayer must show that the contract is actually the source of the profit rather than a mechanism to secure a right to a profit derived from another source. Generally this means that the taxpayer must be able to show a proprietary right to the profits.  A partner in English partnership has a proprietary interest to the extent of his profit and share in the partnership, but the position of members in a Delaware LLC is nothing like the position of an English partner. In the CA’s judgment it would be unusual for an entity with a separate legal personality to be tax transparent for English law purposes.

The key issue in the case was whether the members of the LLC in question were entitled to the profits as they arose. The fact was that the profits arose from the LLC’s trading as principal, and deductions could be made from profits before they were allocated. These were powerful indications that the profits did not belong to the members from the moment of their creation. The UT came to the correct conclusion that the profits of the LLC in this case did not belong to its members, double tax relief was not available, and the appeal was dismissed.

HMRC v Anson [2013] EWCA Civ 63

Principles to be applied on deductibility of travel expenses for NHS consultant’s private practice

Travel expenses incurred by a self-employed  consultant between his office at home and private hospitals in connection with his private practice were not tax deductible because the journeys had a mixed purpose and were not incurred ‘wholly and exclusively’ for work.

The appellant had a permanent NHS office at one hospital, and started a private practice alongside his NHS work which expanded so that he conducted outpatient sessions at two private hospitals, cared for in-patients at one of them, and occasionally visited patients at their homes and other places. He had an office at home but did not generally see patients there. HMRC and the appellant sought a decision by the First-tier Tribunal (FTT) on the principles to be applied in relation to the deductibility of travel expenses incurred by the appellant.

The issue was which of the journeys undertaken between the appellant’s home and the various places he visited for work, and between those places, constituted expenses incurred ‘wholly and exclusively for work’ under ITTOIA 2005, s 34 (and before that under ICTA 1988, s 74), and which had a mixed purpose and were therefore not deductible. The FTT considered Newsom v Robertson (1952) 33 TC 452 (CA), Horton v Young [1972] 1 Ch 157 (CA), Sargent v Barnes [1978] 1 WLR 823 (Ch), Jackman v Powell [2004] EWHC 550 (Ch) and the House of Lords decision in Mallalieu v Drummond [1983] STC 665.

In the light of Mallalieu the tribunal was required to determine the appellant’s object in making any particular journey, all of which the appellant asserted were wholly and exclusively for business purposes. Newsom provided that the object for each journey needed to be considered individually, but where journeys were logically linked to each other the factors that link them might indicate a partial or shared object for all of them (eg commuting). In each of Newsom, Horton, Sargent and Jackman the taxpayer was found to have a single business base.

The appellant relied primarily on Horton, where the taxpayer succeeded in achieving a deduction for travel expenses from his home. The FTT noted that Horton was the only case referred to in which the taxpayer succeeded in achieving a deduction for travel expenses to and from his home, and considered that it required closer examination.

The FTT observed that in Horton the court found that his home was the only place of business that he had, but the appellant’s case differed in a number of important ways. He had a pattern of regular attendances at specific locations other than his home in order to perform significant professional functions as a clinician. In the FTT’s view this constituted the two private hospitals as ‘places of business,’ and negated the suggestion that the appellant’s profession was entirely home-based as was the case with Horton. Unlike the situation in Newsom – where the taxpayer was a barrister who could do all his work in chambers – the appellant had a place of business at his home because he would not have been able to do all his professional work at the two private hospitals he visited. The FTT found that the appellant had a mixed object in his general pattern of travelling between his home and places of business at the two hospitals, and this travel could not be deductible in the light of the reasoning in Mallalieu.

An important distinction was drawn by the FTT between travelling in the course of a business and travelling to get to the place where the business is carried on. The object of the travel between the appellant’s place of NHS employment and the two private hospitals was to put him in a position where he could carry on his business away from his place of employment. As the travel was not an integral part of the business itself, it was not deductible. Where callouts to patients involved travel to either of the private hospitals, this was not deductible because the object of the travel was to put the appellant in a position to start carrying on his business at one of his regular places of business. Where the appellant visited patients in their homes or at some other care facility, travel to and from this category of callout was an integral part of this professional activities and should be deductible.

Samadian v Commissioners for Revenue and Customs [2013] UKFTT 115 (TC)

Penalty could be suspended for careless mistake over ‘one-off’ payment

HMRC’s view that a penalty could not be suspended in respect of a taxpayer’s careless inaccuracy regarding a ‘one-off’ payment was wrong, the First-Tier Tribunal (FTT) has ruled. The appellant made what he acknowledged was a careless error in his tax return, the effect of which was to underdeclare income tax of £38,866 on a redundancy payment. HMRC accepted his explanation, and imposed the minimum penalty in the circumstances of 15 per cent of the underdeclared amount (£5,829). The appellant suggested that a suspended penalty could be imposed if he undertook to retain a professional tax adviser to submit his self-assessment returns on his behalf for the next two years. HMRC’s response made it clear that the penalty could not be suspended because the termination payment was a ‘one-off.’ The appellant’s mistake would not be repeated, and therefore no conditions HMRC could set would prevent the error recurring.

The FTT decided that HMRC’s view that ‘one-off’ mistakes were not eligible for suspended penalties was flawed. The regime for suspension of penalties in FA 2007, Sch 24, para 14(3) provides that suspensive conditions can only be authorised where compliance with them would help the taxpayer avoid becoming liable to future penalties for careless inaccuracy. Where, for example, an inaccuracy arose in a taxpayer’s Construction Industry Scheme (CIS) system, and the taxpayer agreed to commission an external report on its CIS reporting process providing recommendations for improvement, a condition requiring those recommendations to be implemented could fall within para 14(3) even if the original error was a ‘one-off’ and unlikely to be repeated. HMRC’s approach to the legislation was too narrow, and as a result the appellant’s case was not considered on its merits in accordance with the legislation on the basis of whether a suspended penalty would help the appellant to avoid future careless inaccuracies in his return. There was also no evidence that any proper consideration had been given to the appellant’s suggestion. Cases including Fane v HMRC [2011] UKFTT 210 (TC) and Hearn v HMRC [2013] UKFTT 782 (TC) were submitted by HMRC in support of its argument that ‘one-off’ mistakes were not appropriate for the suspension regime, but the FTT concentrated on interpreting FA 2007, Sch 24 and described caselaw on it as ‘nascent.’ The appeal was allowed, and HMRC ordered to suspend the penalty.

Testa v Commissioners for Revenue and Customs [2013] UKFTT 151 (TC)

HMRC decision to cancel taxpayer’s CIS gross payment status was wrong

The possible future effect on a taxpayer’s business of cancelling his registration for gross payment status under the Construction Industry Scheme (CIS) was a factor that should have been taken into account by HMRC when making the decision. The appellant’s registration was cancelled when he admitted being over 28 days late with a self-assessment payment and was unable on his own admission to supply a reasonable excuse for late payment. He requested a review of the decision, contending that he was already subject to an individual voluntary arrangement (IVA) and the effect of the loss of his gross payment status would probably lead to his bankruptcy and the consequent laying off of subcontractors he employed. HMRC upheld the decision, and explained in a letter to the appellant that it could only act in accordance with legislation and ‘“possible effect on future trade is not relevant.”’

At the First-tier Tribunal (FTT) HMRC cited decisions including Grosvenor v HMRC [2009] UKFTT 283 (TC) in support of the argument that the consequences of cancellation of gross payment status are not relevant to whether a reasonable excuse exists. HMRC claimed that the comments of the judge regarding reasonable excuse in Terence Bruns t/a T K Fabrications v HMRC [2010] UKFTT 58 (TC) were obiter and the tribunal in S Morris Groundwork Ltd v HMRC [2010] UKFTT 585 (TC) was wrong to prefer TK Fabrications over Grosvenor. It was further contended by HMRC that the Upper Tribunal (UT) judgment in HMRC v Hok Ltd [2012] UKUT 363 (TCC) established that the consequences of withdrawal of gross payment status could not be taken into account in the current appeal as a reasonable excuse, under a review function, or because of any alleged lack of proportionality. The FTT rebuked HMRC for not bringing the tribunal’s attention to all relevant authorities, including those that did not assist HMRC’s case. As the UT found in Hok, it was impossible to read TMA 1970, s 100B(2) in such a way as to extend the tribunal’s jurisdiction to include a power to override a statute, supervise HMRC’s conduct, or exercise a judicial review function.

However, this should be contrasted with the jurisdiction of the FTT in the present case under FA 2004, s 67(4) to ‘review any relevant decision taken by [HMRC] in the exercise of their functions under sections 63, 64, 65 or 66’ of the Act. As the tribunal found in J P Whitter (Waterwell Engineers) Ltd v HMRC [2012] UKFTT 278 (TC), it is well established that HMRC exercises a discretion when cancelling a registration under the power contained in s 66. It must follow that the tribunal has decision under s 67(4) to review any relevant decision taken by HMRC in the exercise of that function. This is similar in nature to a judicial review function, but arises directly from the relevant legislation. The FTT was therefore able to review HMRC’s decision to cancel the appellant’s registration for gross payment status, and having established that the decision was made without taking account of the possible effect of cancellation on future trade the tribunal was satisfied that HMRC failed to take a relevant factor into account. The decision was wrong in law and susceptible to review, and the appeal was allowed.

John Kerr Roofing Contractors v Commissioners for Revenue and Customs [2013] UKFTT 135 (TC)

PILON prevented taxpayer claiming tax free sum on termination payment

A payment on termination of employment was made in lieu of notice and could not be treated as a redundancy payment for tax purposes. The appellant’s contract of employment contained a PILON (period in lieu of notice) clause which stated that once notice had been given by either side, the company could at its discretion terminate his employment by making a payment in lieu of 26 weeks’ notice. The contract stipulated that such a payment would be subject to tax and NI contributions.

When his employment was terminated, the appellant signed a compromise agreement which provided for payment in lieu of 26 weeks’ notice to be made in two equal instalments, and stated that each one was subject to tax and NI. His own solicitor had also advised him that ‘“there is a PILON so it can’t be paid tax free.”’ Nevertheless the appellant made his self-assessment return on the basis that the first £30,000 of the payments in lieu of notice was free of tax because he had been made redundant.

HMRC claimed that the payments constituted earnings within ITEPA 2003, s 62, but the appellant advanced two arguments to the First-tier Tribunal (FTT). The first was that the amounts he had received amounted to redundancy payments because his employer had not replaced him, there was no new business, senior managers had left and the head office was closed. Second, he claimed that the compromise agreement superseded his contract of employment, and since the payments made to him were effectively redundancy payments, he was entitled to claim £30,000 as a tax free sum.

The FTT disagreed, finding that the compromise agreement did not supersede the appellant’s contract of employment and should be read with it. The contract left no doubt that the payments in question must be regarded as emoluments of the appellant’s employment, and the appeal was dismissed.

Manley v Commissioners for Revenue and Customs [2013] UKFTT 99 (TC)

Taxpayer who funded his company had reasonable excuse for non-payment of income tax under self-assessment

A taxpayer who failed to pay his outstanding income tax liability under the terms of a ‘time to pay’ (TTP) agreement on time because he had committed his available funds to support his main trading company had a reasonable excuse for non-payment. The appellant owned two companies, Quattro (UK) Ltd (QUK) and Quattro Holdings Ltd, from which his basic employment income in 2009/10 and 2010/11 was £90,000 per annum. In 2009/10 his investment income exceeded £750,000, but fell to £135,000 in 2010/11. The appellant’s income tax liability for 2009/10 was £233,644, and on 2 February 2011 he entered into a time to pay (TTP) agreement with HMRC for his outstanding tax liabilities which totalled £227,720. He undertook to pay £40,000 by 11 February 2011, £60,000 by 30 March 2011, and the balance by 30 June 2011.

The appellant was unable to pay the amount due on 30 June. The TTP agreement was cancelled, and a surcharge notice issued. In a letter to HMRC the appellant claimed that he had to provide financial support for his main trading company, QUK, so that it could discharge its liabilities for PAYE, VAT and corporation tax. He claimed this provided him with a reasonable excuse for not paying his personal tax on time, but HMRC disagreed and maintained that the substantial amount of income he had received from his companies should have enabled him to plan for and meet his personal tax liabilities.

The First-tier Tribunal (FTT) established that QUK, a substantial company with 104 employees in 2010, experienced severe cash flow problems from the beginning of 2011 and had sought, but failed to secure, alternative sources of finance. The appellant would not have become liable for the surcharge at the end of February 2011 provided he complied with the terms of the TTP agreement, but the final instalment was not paid as required by 30 June 2011 because he used the money to support QUK through its cash flow difficulties, in particular with a view to ensuring that it could continue to pay its outstanding tax liabilities wholly or in part. The appellant was faced with the choice of using his available funds to comply with the TTP or funding QUK, and he chose the latter. From the authorities cited by HMRC ‘“it was clear that a ‘reasonable excuse’ does not depend upon the existence of exceptional circumstances, and that whether an excuse is reasonable or not is to be judged objectively according to the ordinary meaning of the words.”’

HMRC’s Debt Management and Banking Manual’ requires officers to ascertain whether a taxpayer falls into the category of ‘can’t pay’ or ‘won’t pay’, and the appellant fell into the former category. Attempts by HMRC to investigate how the appellant had used the money he had derived from QUK during 2009/10 in the intervening period could have been relevant to the question of reasonable excuse in establishing whether he had the resources to pay his tax at the due date. However, HMRC failed to establish or suggest that the appellant had sufficient other resources which would have enabled him in June 2011 to have both supported his company and complied in full with the TTP agreement. The appellant was able to demonstrate that he had a reasonable excuse throughout the period of default, and therefore the tribunal would exercise its power to set aside imposition of the surcharge. The appeal was allowed.

James v Commissioners for Revenue and Customs [2013] UKFTT 109 (TC)

Written by Ellie MacKenzie

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