Case Report: Hepburn [2013] TC 02837

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Judge J Gordon Reid QC, FCIArb, Dr Heidi Poon, CA, CTA, PhD.

Decision released 20 August 2013.

Income tax; provision of consultancy services; unformed company; fee for services subsequently paid to newly formed company after services performed; substance and commercial effect of arrangements; accounting treatment of fee; generally accepted accounting practice; corporation tax on fee paid by newly formed company; whether appellant contractually or by reason of principles of unjust enrichment entitled to the same consultancy fee as individual and also liable to pay income tax thereon – No. Whether appellant acting as promoter of unincorporated company under obligation to account for fee – No. Whether consultancy fee should be treated as miscellaneous income of appellant – No. Statutory penalty – Appellant relying on accounts accepted as accurate by HMRC; whether appellant"s conduct negligent conduct – No. Income Tax (Trading and Other Income) Act 2005 (‘ITTOIA 2005’), s. 5, 8, 25, 34, 687, 689; Companies Act 1985 (‘CA 1985’), s. 36C; Appeal allowed.

The First-tier Tribunal allowed a taxpayer"s appeal against HMRC"s decision that the consultancy fee in respect of services she provided through a company that had not yet been incorporated, fell to be taxed as her self-employed trading income, reports Harris & Co accountancy services. The substance and commercial effect of the consultancy arrangements were that the taxpayer would never be entitled to payment of the consultancy fee and did not receive any such payment. Thus, under generally accepted accounting practice she did not realise any profit within ITTOIA 2005, s. 8 (person receiving or entitled to profit) and no charge arose under ITTOIA 2005, s. 5 (charge to tax). Notwithstanding that this finding rendered the other issues raised in argument redundant, the Tribunal nevertheless pronounced on the various other issues finding that: the taxpayer had no personal entitlement to the fee as a matter of law either under CA 1985, s. 36C (now the Companies Act 2006 (‘CA 2006’), s. 51) or on the basis of unjust enrichment; if she were entitled to the fee, it would not be because she were acting as a promoter of the new company and there would be no obligation to account to the new company for the fee; she did not realise any ‘profit’ as a result of the fee; if she had been entitled to the fee as profit, it would have had a trading source; it would , therefore, be unnecessary to classify the income as miscellaneous income within ITTOIA 2005, s. 687 but if it were so classified, actual receipt would be required for it to be taxable as such.

The Tribunal also allowed the taxpayer"s appeal against penalties on the basis of their main findings but noted that they would have allowed the appeal in any event because they found the taxpayer"s conduct was not negligent.

Summary

The taxpayer proposed to provide consultancy services to a company through the medium of a new limited company. She performed the bulk of those services and raised an invoice in the name of the new company before it had been incorporated. The fee for the consultancy services was paid to solicitors and held for the new company until it was incorporated when it was then. paid by the solicitors into the new company"s bank account.

HMRC opened an enquiry into the corporation tax return of the company to whom the consultancy services were provided, in relation to the consultancy fee paid by them. On 4 February 2010, HMRC issued a closure notice with no amendments. They held that the consultancy fee fell to be taxed as self-employed trading income of the taxpayer. They raised protective discovery assessments for 2004–05 and 2005–06. The taxpayer appealed against the discovery assessments.

Both HMRC and the taxpayer contended that generally accepted accounting practice would determine the treatment of the consultancy fees received and this was the main issue for the Tribunal to consider. Both put forward expert witnesses who agreed that it was necessary to consider the commercial substance of the transaction and not simply its legal form, however, the witnesses then disagreed as to what that commercial substance was. For the taxpayer, it was contended that the new company gained the principal economic benefits of the transaction and that gain needed to be reflected in the company accounts. For HMRC, it was contended that the commercial effect in practice was the taxpayer performing the services on her own behalf and that the risks and rewards of the agreement governing the provision of the services were with the taxpayer.

The Tribunal held that the substance and commercial effect of the arrangements were that the taxpayer would never be entitled to payment of the consultancy fee. All that accorded with the reasonable commercial expectations of the taxpayer and the company receiving the services. Furthermore, there was never any intention that the taxpayer would have any entitlement qua individual to the fee. No right to the consultancy fee was ever created in her favour. She did not receive the fee; she did not demand it be paid to her; it was not offered to her and it was not paid to her. At no stage did she have any control as an individual over the money, which the consultancy fee represented. Thus, generally accepted accounting practice would not require her to recognise the consultancy fee as her income.

Notwithstanding that their findings on the main issue rendered the remaining issues raised in argument redundant, the Tribunal nevertheless went on to consider and find on each of the other issues raised.

The second issue considered was 1) whether the taxpayer had entitlement to the consultancy fee, either a) because CA 1985, s. 36C operated with the result of the taxpayer having contracted personally under the agreement for the provision of the consultancy services (and was both liable under and entitled to sue upon it), or b) on the basis of unjust enrichment (that if the taxpayer had no contractual right to payment for her services then the company to whom the services were provided would be ‘unjustly enriched’ at the expense of the taxpayer which in turn would make the taxpayer entitled to the whole of the consultancy fee), and 2) assuming it was found that she was entitled to the fee, whether she had any obligation to account to the new company for it either by a constructive obligation existing (requiring the creation of a balancing item of expenditure be recognised in her accounts), or because she would have earned the fee in her capacity as a promoter of an unincorporated company and would be bound by fiduciary obligation to account to the new company for the fee once incorporated. The Tribunal found that having regard to all the evidence, and viewing it objectively, it was clear that 1) neither the taxpayer, the company receiving the services or the new company (once formed) agreed (expressly or by implication) that the tax payer should have any entitlement qua individual to the consultancy fee; there could be no unjust enrichment because the company receiving the services had paid a fee for it, and 2) the very notion of a constructive trust was inconsistent with the taxpayer having a personal right to receive the income.

The third issue was whether there was any profit arising under ITTOIA 2005, s. 8Here, the Tribunal held that for the same reasons that no entitlement arose on the taxpayer, there could be no profit within ITTOIA 2005, s. 8.

The forth issue was an argument touched on briefly by the taxpayer that if she were entitled to receive the consultancy fee that there was no trading source for the receipt and for a liability to arise under ITTOIA 2005, s. 5, the relevant receipt should have a trading source. The Tribunal found that had the arrangements entitled her to payment qua individual (contrary to the actual findings) this would have been sufficient to justify liability to income tax and such services could be described as being in the nature of a trade

The fifth issue considered was an argument advanced by HMRC on the basis that assuming the taxpayer were entitled to the fee and it was not a trading receipt, it was nevertheless chargeable as miscellaneous income under ITTOIA 2005 s. 687; that entitlement was sufficient and receipt not necessary to give rise to the charge. The Tribunal found that if the taxpayer had been entitled to the fee, it would have arisen as a result of the supply of services in the nature of a trade. Accordingly, it would be unnecessary to classify the income as miscellaneous income within ITTOIA 2005, s. 687, but if it was classified as miscellaneous income, then actual receipt would be required before the taxpayer could be taxed under the miscellaneous income charge..

Finally, the Tribunal noted that the issue of the taxpayer"s appeal against penalties did not arise given that the appeal was being allowed, however, did comment that they would have discharged the penalties in any event because they did not consider the taxpayer"s conduct to have been negligent.

Comment

This case interestingly considers the position of commercial arrangements entered into where the paperwork has lagged behind and the timing fallen out of sequence. Encouragingly, the Tribunal found that the commercial effect (what happened) reflected the commercial intentions and that the late incorporation of the company (once most of the services had been provided and an invoice raised) did not present any difficulties because ultimately the company was incorporated and the whole commercial arrangements were carried into effect as planned. However, the Tribunal did note that the position might have been more problematic had the new company never been incorporated. Additionally, the taxpayer was able to provide board minutes supporting that the intentions from the outset were for the consultancy services be provided through a limited company rather than by the taxpayer personally including that she had been released from a restriction in her director"s services agreement with another company which would have prevented her from working for the new company. Accordingly, there was evidence that supported the intentions at the outset which the Tribunal found to be credible and reliable and the appeals were upheld.

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