For example:

• The ‘settlements’ provisions treat trust income as belonging to the settlor for income tax purposes (ITTOIA 2005, s624).

• Capital gains tax holdover relief is not available on a transfer of chargeable assets to the trustees if the settlor has aninterest in the settlement (TCGA 1992, s169B).

• The ‘gifts with reservation’ provisions can treat property transferred into trust as remaining within the transferor’s estate for inheritance tax purposes (e.g. if the settlor transfers a property into trust and occupies it rent-free as a beneficiary) (FA1986, s 102, Sch 20).

With regard to the first bullet point, there has been uncertainty in the past about whether a settlor can be liable to income tax under the settlements provisions on payments that he or she has made to the trustees,  such as loan interest or rents. Payments by the settlor In Rogge, Kent, Kent Settlement [2012]UKFTT 49 (TC), the tribunal considered whether payments made by a settlor can be taxed as his income, under what is now ITTOIA 2005, s 624(1) (previouslyICTA 1988, s 660A(1)). The tribunal held that previous case law (CIR v Leiner (1964) 41 TC 589 and Ang vParrish (Inspector of Taxes) [1980] STC341) supported HMRC’s argument that it is possible for a settlor to be subject to tax on a payment that he himself has made. The tribunal accepted that a literal interpretation of ICTA 1988, s 660A(1) appeared to lead to an “absurd conclusion” when a payment was made to the trust by the settlor, and sympathised with the appellants’ view that this “cannot be right”.  However, the tribunal considered that it was constrained by the words of the legislation itself.

In Mr Rogge’s case, he had paid interest to a discretionary settlement, in respect of a loan made to him by the trustees. It was argued for Mr Rogge that a person cannot be both payer and payee for income tax purposes, but HMRC contended that as settlor and a beneficiary, the effect of ICTA 1988, s 660A was that Mr Rogge was liable to income tax on income arising under the settlement. In the case of Mr Kent and the Kent Settlement, rent was paid to the trusteesof the settlement by Mr and Mrs Kent, who occupied property owned by the trustees. Mr Kent also appealed in his capacity as trustee of the settlement, on the grounds that the rental income should only be taxable on Mr Kent under s 660A. Mr Kent was the settlor and had an interest in possession in the settlement. The trustees owned the residence occupied by Mr Kent and his wife, and received rent from Mrand Mrs Kent as tenants. It was argued for the appellants that s660A treats the trust income as being that of Mr Kent only, and also that he could not be both payer and payee for income tax purposes, but the tribunal rejected both arguments and dismissed the appeals.

The tribunal held “with some reluctance” that as s 660A refers to ‘income’ as opposed to ‘profit’, it must follow that Mr Kent was liable to tax on all of the rent paid to the trustees, without deduction of trust management expenses. The settlements code in ICTA 1988 (PartXV, Ch 1A) was replaced and is now contained in ITTOIA 2005, Pt 5, Ch 5. The current code includes a specific provision to prevent trust expenses being used to reduce the settlor’s income (ITTOIA 2005,s 624(1A)). However, for the purposes of calculating the settlor’s income, the same deductions and reliefs are allowed as if the income had actually been received bythe settlor (s 623), such as property expenses for rental business purposes (although if the trustees make a loss froma property business, HMRC considers that the trustees’ loss cannot be used by the settlor; see TSEM4017).

The settlor is entitled to recover from the trustees any tax paid under s 624 (or s 629). On theother hand, a repayment arising to the settlor as a result of those provisions must be paid to the trustees (or any other person to whom the income was payable due to the settlement) (s 646).

Conclusion

The above tribunal decisions bring some guidance on what has been a long standing conundrum, albeit that the outcome will no doubt seem unsatisfactory and unfair to many settlors. The settlements rules are also particularly complex and potentially confusing from an administrative viewpoint, in terms of how settlors and trustees of settlor-interested trusts report income for self-assessment purposes. The simplification of such requirements for settlors and trustees would therefore be most welcome.

The TiS legislation for individuals is in ITA2007, Pt 13 (ss 682-713), and for companies is in CTA 2010, Pt 15 (ss 731-751). The focus below is on the TiS provisions as they apply to individuals. The legislation was amended significantly by FA 2010, to be more targeted at tax avoidance. The following five points are among those which need to be considered in respect of the TiS provisions as they now stand.

1. ‘Main purpose’ test

The TiS provisions are subject to a ‘main purpose’ test. This is that “the main purpose, or one of the main purposes, of the person in being a party to the transaction in securities…is to obtain anincome tax advantage” (ITA 2007, s684(1)). The burden of proof is on HMRC to prove that this is the case. By contrast, the previous version of the legislation included a let-out from the TiS provisions (in ITA 2007, s 685(1),previously ICTA 1988, s 703), but which required the transaction(s) to be for genuine commercial reasons (or for ordinary investment purposes). This requirement has disappeared from the TiS code, which could be helpful in certain circumstances (e.g. owner-managed or family companies where succession planning is a major consideration).

2. The 75% ‘let-out’

There is an exclusion from the TiS provisions, where there is a “fundamental change of ownership” (ITA 2007, s 686). In the context of a vendor shareholder,this broadly means that at least 75% of ordinary share capital, distributions and voting rights in the close company must be held by one or more unconnected persons (i.e. person(s) not connected at the time of the TiS or within the previous two years). These conditions must continue to be satisfied for a period of at least two years after the transaction. This 75% ‘let-out’ was intended to provide some certainty and reduce the number of clearance applications submitted toHMRC, whose previous (unpublished)practice had been to grant clearance “inmost cases” where there had been a 75% change in ownership.

3. Measuring the tax advantage

The proceeds potentially subject to’counteraction’ under the TiS provisions depends on the extent of any ‘income tax advantage’. An income tax advantage is obtained broadly where the amount of any income tax payable if the relevant consideration was a qualifying distribution exceeds the CGT payable in respect of it,or if the consideration would be liable to income tax if paid as a qualifyingdistribution and no CGT is payable. That figure is then reduced by any relevant consideration in excess of the maximumthat could ‘in any circumstances’ have been paid as a qualifying distribution (ITA2007, s 687(2)). In other words, in broad terms ‘income tax advantage’ is defined by reference toCGT, and limited by reference to distributable reserves (e.g. any excess of sale proceeds over a company’s distributable reserves).

4. Clearance applications

For taxpayers who require certainty about whether the TiS rules apply, there is a statutory clearance procedure. Many tax advisers will be familiar with clearance applications under ITA 2007, s 701. Of course, full and accurate disclosure is required so that any clearance which has been given by HMRC can be relied upon. Unfortunately, there remains no right of appeal if HMRC refuses to give clearance that transactions are not ‘caught’ by the TiS provisions and that no counteraction notice ought to be served. This may result in a change in the structure of transactions by the taxpayer, and the submission of a new clearance application. Alternatively, some taxpayers may prefer to ‘take a chance’ and proceed as planned without submitting a clearance application, in the hope that HMRC will not considerthat the TiS legislation apply (but seebelow).

5. Not self-assessed

One practical aspect of the TiS provisions that effectively remains unchanged following the FA 2010 amendments is that taxpayers are not required to self-assess income tax liabilities under the TiS rules (although taxpayers will still need to disclose and self-assess CGT on thetransaction, as appropriate). HMRC must issue a ‘counteraction notice’ under the TiS legislation (CTA 2010, ss 695-700). As mentioned, the lack of an appeal procedure against HMRC clearance refusals means that some taxpayers willprefer to self-assess a CGT liability ratherthan apply for clearance, and take their chances on whether HMRC will issue acounteraction notice. Some taxpayers may even wish to self-assess their tax liability on that basis despite clearance having been applied for and refused, albeit that the required full disclosure may result in an enquiry and the issue of acounteraction notice (see HMRC Statement of Practice 3/80).

Guidance please!

Finally, HMRC’s guidance on transactionsin securities in the Company Tax Manual(at CTM36800-CTM36885) has not been updated for the Finance Act 2010 changes at the time of writing. Draft guidance was published by HMRC in a consultation document in July 2009, but for some reason the final version has yet to be published. The final guidance (albeitnon-statutory) is therefore overdue, as its appearance is awaited with interest.

However,toolkits and checklists only offer general guidance. Practical issues and problems can arise in respect of DLAs for director shareholders of ‘close’ family or ownermanaged companies, three of which are outlined below.

1. ‘Bed and breakfasting’

One of the checklist points in the HMRC toolkit is: “Where an overdrawn loanaccount has been repaid, has the same or a similar amount been withdrawn in the subsequent period?” This refers to the practice of what HMRC refers to in its guidance (Enquiry Manual, at EM8565) as ‘bed and breakfasting’. It is broadly the practice of avoiding a company tax charge of 25% under the ‘loans to participator’ provisions (in CTA 2010, s 455), wherethe loan is repaid shortly before the charge arises (i.e. shortly before the endof the company’s accounting period, orjust within nine months after the end of theaccounting period). The director shareholder then withdraws the same or a similar amount shortly afterwards, making the loan account overdrawn again.

The guidance at EM8565 indicates thatHMRC will seek to establish the facts and evidence that repayment took place, and that the book entries reflect genuine underlying transactions. It also warns: “You should consider penalties for inaccuracies when a temporary repayment arrangement is successfully challenged. This could be because of the incorrect accounts where the bed and breakfasting occurred around the accounting date, on the grounds that the Balance Sheet was carelessly or deliberately misleading. Where the loan was on the Balance Sheet but was claimed to have been repaid within 9 months of the end of the accounting period there could be a carelessly or deliberately incorrect claim for Section 458 relief.”

2. Bonus and dividends

Many director shareholders of small or owner-managed companies regularly withdraw funds from the DLA for ‘drawings’, living expenses etc, resulting inthe DLA becoming overdrawn. A bonus or dividend will subsequently be voted to clear the overdrawn balance. If an overdrawn loan account is cleared by abonus, HMRC will often argue that the amounts withdrawn are payments on account of employment income, and seek to apply PAYE income tax and National Insurance contributions.

Penalties may also apply, such as for the late payment of those deductions. A potential solution to this problem is toclear the overdrawn loan account by dividends instead of a bonus. However, care is needed to ensure that thecompany law requirements are satisfied. For example, the dividend should be properly voted, paid and formally documented by minutes, dividend vouchers, etc. It is also important to appreciate when a dividend is treated as paid. HMRC’s Company Taxation Manual includes guidance on company law aspects of dividends (albeit that it is in some need of updating, for statutory references, etc), which states (atCTM20095): “In practice, a distinction is drawn between the final dividend and an interim dividend, (that is a dividend paid between annual general meetings). The Articles usually provide that: i) final dividends may be declared by thecompany in general meeting…and ii) interim dividends may be paid bydirectors from time to time…”HMRC states that a final dividend whichdoes not specify a future date for payment creates an immediately enforceable debt, whereas an interim dividend can only be regarded as due and payable when it is actually paid.

This analysis of interim dividends is based on case law (Potel vCIR, Ch D 1970, 46 TC 658). The meaning of ‘paid’ in this context can cause difficulties, particularly in respect of interim dividends. The HMRC guidance states: “In the case of an interim dividend (which does not create an enforceable debt and which can be varied or rescinded prior to payment), payment is only made when the money is placed unreservedly at the disposal of the directors/shareholders as part of their current accounts with the company. So, payment is not made until such a right to draw on the dividend exists (presumably) when the appropriate entries are made in the company’s books.” It adds: “If, as may happen with a small company, such entries are not made until the annual audit, and this takes place after the end of the accounting period in whichthe directors resolved that an interim dividend be paid, then the “due and payable” date is in the later rather than th eearlier accounting period.”

Care is therefore needed in the timing andpayment of dividends. If the director shareholder normally withdraws funds from the company in anticipation of dividends, consideration should be given to voting and paying the dividends in advance (say, on a monthly or quarterly basis), if possible. Where the director shareholder receives acombination of salary/bonus and dividends, it may be helpful to maintain separate loan accounts for each. If the director shareholder makes regular drawings on account, such payments could be taken from the loan account into which the dividends are paid. This should reduce the possibility of a challenge by HMRC on the basis that the amounts withdrawn are on account of employment income for PAYE and NIC purposes. It should be noted that HMRC considers separate loan accounts to be a ‘risk’ area in terms of the loans to participator charge in CTA 2010, s 455. HMRC’s toolkit on directors’ loan accounts states: “ensure each loan account balance is considered separately and s 455 tax calculated separately on each overdrawn balance”. Itadds: “separate accounts should not beaggregated or “netted off” for s 455purposes”.

3. Loan releases

Another risk area identified in HMRC’s toolkit is: “have any released or written offloans made to directors or participators been treated correctly?” Whilst the release or write-off of a loan to a participator triggers relief for the company from thecharge under CTA 2010, s 455 (see s458), it also results in taxable income for the individual on the amount written off or released, grossed up at the (nonrepayable)dividend rate of 10%. This income tax charge (under CTA 2010, s415) takes precedence over an employment income tax charge where (forexample) the participator (or associate) is also a paid director (ITTOIA 2005, s366(3)(a)).

By contrast, if the individual is a director or employee but not a participator, HMRC’s toolkit points out that the amount of loan released or written off is taxable as employment income under ITEPA 2003, s62 (i.e. the general employment income charge) or s 188 (‘loan released or written off: amount treated as earnings’). If the participator (or associate) is an employee, HMRC’s view is that “…theamount released or written off will attract aClass 1 NIC liability if it is remuneration or profit derived from an employment (Section 3(1) SSCBA 1992)” (CTM61630). If a director shareholder’s loan account isbeing released or written off in thecapacity of a shareholder, it must bemade clear (e.g. in company minutes and documentation dealing with the release or write-off) that this has been done in thatcapacity, instead of as a director/employee.  Otherwise, a Class 1NIC charge could result (see StewartFraser v RCC [2011] UKFTT (TC)).It should be noted that HMRC’s general approach to loan releases or write-offs is to treat them as ineffective unless made by deed (i.e. due to a lack of consideration for the release or write-off). In addition, a company deduction is not available under the loan relationship rules for the release or write-off of loans to participators (CTA2009, s 321A). However, consideration could be given to whether a business deduction is potentially available under general ‘wholly and exclusively’ principles.

Conclusion

There are generally more tax and NIC issues surrounding directors’ loan accounts than meet the eye, so care is needed. HMRC’s Directors’ Loan Account Toolkit, whilst general in nature, at least highlights some of those issues to consider, and provides an indication of risk areas from HMRC’s perspective.

In order to reduce the risk of companies diverting profits overseas without good commercial reason, UK companies are subject to tax on the profits of their ‘controlled foreign companies’.  A controlled foreign company (CFC) is one which is resident outside the UK, controlled by persons resident in the UK – the reform of the rules removes the requirement that the company be in a lower tax jurisdiction than the UK, although there is an exemption for CFCs in countries with effective tax rates similar to the UK.

Control

‘Control’ is determined by considering the rights of the UK residents with an interest in the company, together with any rights held by persons connected with the UK resident. Broadly, a person will have control of they have power to secure that the affairs of the company are conducted in accordance with their wishes, where that power arises through shareholdings, voting power, or by the documents governing the non-UK company (ICTA 1988, s747 – being replaced with an equivalent provision under the current reform proposals in Finance (No 4.) Bill).

When do the new CFC rules apply to IP profits? Let-out 1: the gateway

Where an entity is capable of being a CFC, the profits have to pass a gateway test in order to be capable of being caught by the rules.  For an IP holding company, the relevant part of the test is Chapter 4, covering profits attributable to UK activities. The other parts of the gateway test relate to finance profits and captive insurance businesses, and so will be less relevant to IP businesses.

Chapter 4 will apply, so that the test is met and the profits are within the scope of the CFC charge for the UK shareholder unless one of the following four conditions is met.

The first condition is that the assets and risks of the CFC must not be held under an arrangement which has as its main purposes, or one of its main purposes, the reduction or elimination of liability to tax in the UK of another person, and the CFC expects its business to be more profitable than it otherwise would be.

The second condition is that the CFC does not have any UK managed risks or assets.

The third condition is that, if it does have UK managed assets and risks, then the CFC would be commercially effective even if it did manage the assets and risks directly.

The fourth condition cannot be met by a company whose business is the exploitation of IP, so it is not considered further.

It should be possible for a non-UK company holding intellectual property to meet one of these conditions so that the profits are outside the UK tax charge.

In particular, a CFC with appropriate substance should be able to have no UK managed assets and risks. One of the points of the new CFC rules is that they should not catch companies with appropriate substance and management in their local jurisdiction, even if that company pays little local tax. The key is to ensure that profits are not artificially diverted from the UK – HMRC are finally beginning to accept that businesses are not required to operate solely from the UK and that it is open to a business to move some or all of its operations outside the UK.

Let-out 2: Taxable profits

Where the gateway test cannot be met, so that the profits of the cell could fall within the CFC charge for a UK shareholder, the profits within the UK tax charge are calculated.  Excluded from those profits are profits from ‘trading income’, which will include IP profits unless the profits come from IP that was transferred to the UK within the previous seven years or so.  There’s no bona fide commercial exclusion, so it’s questionable whether this meets EU law requirements post-National Grid but, in practice, it means that profits from non-UK connected IP will be outside the CFC tax charge.

Let-out 3: exemptions

If the CFC fails the gateway test, and can’t exclude the IP profits, there are still a number of exemptions available. The principal exemption likely to apply to an IP business in this case would be the general exemption for CFCs with low profits; in particular, the profits of a CFC with accounting profits (or assumed UK-equivalent taxable profits) of less than £500,000 and non-trading profits of less than £50,000 will be exempt from the charge (proposed TIOPA 2010, s371LB following Royal Asset for Finance Act 2012).

Other exemptions

There are other exemptions which could apply but the main ones have a requirement that the IP not be UK connected, so companies that fail the second let-out above will probably fail to qualify for these as well:

IP holding company exemption

There is a IP holding company exemption (Sch 25A, PArt 2B, ICTA 1988, inserted by Finance Act 2011): this exemption applies, however, only for profits of a CFC whose sole business is foreign-to-foreign licensing of IP with a minimal UK connection.

The IP itself must have a minimal UK connection, which is to say that it cannot have been transferred from someone (related or otherwise) in the UK in the accounting period or the previous 6 years before the accounting period started.

Where the CFC itself creates (or subcontracts someone else to create) the IP, then the IP will not have a substantial UK connection, provided that the R&D was not done in the UK by a connected person or paid for by a UK connected person. The IP must also not be maintained or enhanced in the IP by a connected person.

In addition, the CFC itself cannot have substantial income from the UK (substantial is not yet defined), hence the focus on foreign-to-foreign licensing.

Excluded territories exemption

Finally, there is an exemption for CFCs in particular named territories – but this is subject to the same test for IP income as the taxable profits exclusion: it must not be derived from IP transferred by related parties from the UK in the accounting period or the six years before that.

Summary

The revised CFC rules provide a reasonable territorial exclusion for IP income from the UK tax charge on CFCs, with the principal issues being with IP that has had some connection with the UK in the last seven years or so.  It’s questionable whether the rules properly comply with EU law but, in general, it is a substantial improvement on the old CFC rules (which rather seemed based on the view that any non-UK IP ownership was tax avoidance).

Anne Fairpo

Tax relief claims for losses against capital gains are prevalent. However, such relief generally only shelters gains at rates of up to 28%. By contrast, loss relief against income potentially provides income tax relief at rates of up to 50%, and is therefore the preferred route for many individuals.

The provisions allowing individuals to claim relief for losses on disposal of shares against general income (ITA 2007, ss 131-151) are subject to a number of conditions. For example, the shares must be ‘qualifying shares’, i.e. either shares to which enterprise investment scheme relief is attributable, or shares in a qualifying trading company which were subscribed for by the individual (ITA 2007, s 131(2)).

In Halnan and Squire v CRC [2011] UKFTT S80, HM Revenue and Customs (HMRC) disallowed the taxpayers’ claims for an allowable loss for 2004-05 (under what was then ICTA 1988 s 574), in respect of a close company of which both were directors. The taxpayers appealed.

The points at issue were whether the taxpayers were entitled to claim income tax loss relief in respect of the shares. The company ceased to trade on 31 October 2004, and a liquidator was appointed. Both taxpayers had agreed to provide £50,000 to the company at a meeting in May 2004. However, they were unable to produce share certificates, and there was no contemporaneous note of the meeting in which the share purchase was said to have been discussed, agreed and allocated to them. There was no record of the share purchase at Companies House, and the directors were unable to produce the company’s register of members.

The taxpayers argued that the affairs of a small private company are often conducted informally, and that the absence of share certificates and other evidence of shares being issued was not fatal to their arguments. The tribunal accepted that a subscription of the shares was discussed at a meeting of the company, and that the taxpayers each added £50,000 to the company. However, the burden of proof in respect of the shares was on the appellants. HMRC disputed that the appellants subscribed for shares for the purposes of ICTA 1988, s 574 (the share loss relief provisions), and stated that there was no evidence to support this.

The tribunal reviewed the available evidence. The taxpayers had acknowledged that shares would only be subscribed for the purposes of the share loss relief rules if the company had an obligation to issue the shares as a result of receiving the payments. A letter (from a consultant to the company) had been provided as evidence of what had happened at the above meeting in May 2004, but the tribunal considered that at most this only evidenced what two of the three company directors intended at the time (the third director was not present at the meeting).

The tribunal held that although they were directors of the company, there was no suggestion that they left the meeting committed to provide funds to the company, nor that the company was bound to issue further shares to them upon receiving payment, as certain other matters remained to be resolved, including the position of the third director and the raising of further funds required from third parties. The taxpayers’ appeal was dismissed.

Close companies

The taxpayers certainly had a point when arguing that small (‘close’) company matters are often dealt with on an informal basis. That has certainly been my experience of dealing with such companies over the years. Unfortunately, the lack of documentation such as board minutes or written agreements has the potential to cause difficulties, as illustrated in the above case.

HMRC cited the case National Westminster Bank PLC v CIR as providing guidance on what constitutes the ‘issue’ of shares (the inference being that shares are issued when allotted and recorded in a share register). However, that case concerned a public limited company. The tribunal in Halnan and Squire commented in the context of a small company. “We can see that a degree of informality is to be expected compared with say, the company whose shares were relevant in the Natwest case.”

The taxpayer had argued that Blackburn and anor v RCC [2009] STC 188 (an Enterprise Investment Scheme case) was helpful and relevant, as it considered the meaning of ‘issue’. The taxpayer in that case made a number of payments to a company. The Court of Appeal had to consider the status of those payments, and decide whether they were made for the allotment of shares.

The tribunal in Halnan and Squire distinguished the facts of that case on the basis that in Blackburn there had been a prior course of share dealing, and the taxpayer had taken advice from his accountant about making payment for the shares. However, in Blackburn the taxpayer’s initial payment to the company prior to the history of share dealing and before taking advice from his accountant was held not to be eligible for relief. The tribunal in Halnan and Squire considered that the payments had a similar profile to the non-eligible payment in Blackburn.

Thus if making a claim for share loss relief (or indeed any claim for relief) it is clearly important to ensure that there is sufficient evidence to substantiate the claim. Such attention to detail can easily be overlooked in the case of small, family or owner-managed companies, but could be crucial to a claim.

The legislation allowing relief for losses on the disposal of shares against general income can be difficult, depending on the circumstances. Attention to detail is important not only in terms of the company’s administration, but also in ensuring that the relief conditions are satisfied and a valid claim is made.

This article is accredited to Mark McLaughlin for the ICPA

http://www.icpa.org.uk/

Mark McLaughlin CTA (Fellow) ATT TEP

In Clarke v CRC [2011] UKFTT 619 (TC), HMRC raised assessments on the taxpayer, on the basis that he was not entitled to PPR relief in respect of two properties. Prior to purchasing those properties, he lived at the matrimonial home with his wife and two daughters. Following marital difficulties, he purchased a property (Property 1) on 17 July 2002, improved it and moved in with his eldest daughter. He considered Property 1 to be his PPR from the time of moving in (as soon as he completed on the property), and had acquired it with a view to permanently leaving the matrimonial home. He used a twelve month business loan from Nat West bank, as this was the fastest and cheapest route for him to raise the necessary funds.

The taxpayer subsequently developed land attached to Property 1. He obtained planning permission to build Property 2 on 15 November 2002. In order to raise funds to do so, Property 1 was put on the market in December 2002 and sold in March 2003. The taxpayer then stayed at his mother’s house. He started work on Property 2, and began living there in July 2003. In July 2005, his wife attempted to commit suicide, and he moved back to the marital home to protect his children. Property 2 was put on the market, and was sold in November 2005. The former matrimonial home was subsequently sold, and the taxpayer went to live in a converted house with his children.

HMRC submitted that at no time in the period of ownership was either of the two properties the taxpayer’s only or main residence. HMRC also argued that there was no intention to live permanently in either property, and no evidence had been provided to show any degree of permanence or continuity.

The tribunal considered the circumstances of the case, and found that when the taxpayer moved into Property 1 he intended to live there permanently. There had been a necessity to move out of the marital home. The twelve month business loan from Nat West had been the fastest and cheapest route for the taxpayer to raise the funds to purchase the property, and his intention was to sell the land attached to the house to pay off the bank loan. The tribunal also found it credible that after planning permission was obtained he decided to develop Property 2 himself, and accepted that he had to move back to the martial home after the suicide attempt by his wife. The tribunal held that the taxpayer was entitled to PPR relief in respect of the two properties, and allowed his appeal.

Permanence and continuity

When considering whether an individual potentially qualifies for PPR relief on the disposal of a dwelling house, HMRC appears to look at certain fundamental issues. Firstly, did the individual occupy the property as his or her only or main residence; secondly, if (s)he did reside in the property, was there a degree of permanence and continuity to indicate that the individual intended to occupy the property as his or her home.

On the ‘occupation’ issue, it should be noted that the PPR relief provisions allow certain ‘deemed’ periods of occupation, such as the last 3 years’ ownership. However, the dwelling house must have been physically occupied as the individual’s residence at some time during his period of ownership to qualify for relief. HMRC considers that an intention to occupy is not enough (CG64465).

With regard to HMRC’s ‘permanence and continuity’ requirement, HMRC appears to derive this requirement from (non-PPR relief) case law on the meaning of ‘residence’, and on the judgment in the PPR relief case Goodwin v Curtis [1998] STC 475. In that case, the taxpayer had only lived in a farmhouse for 32 days. It was held that he had not intended to occupy it as his permanent residence.

In the Clarke case, HMRC accepted in correspondence that the appellant resided at Property 1, but argued that he did not intend to live in either of the properties permanently. HMRC also argued that there was no evidence of continuity. Fortunately, the tribunal found in favour of Mr Clarke on this point.

HMRC will no doubt state that each case is based on its particular facts. However, the Clarke case suggests that PPR relief may be available after relatively short periods of ownership and occupation. Clear evidence of occupation and intention to reside at the dwelling house permanently should be gathered and retained, particularly in borderline cases.

This article is accredited to Mark McLaughlin for the ICPA

http://www.icpa.org.uk/

Mark McLaughlin CTA (Fellow) ATT TEP

HMRC issued a ‘briefing’ in October 2011, ‘Giving taxpayers time to pay’ (www.hmrc.gov.uk/about/briefings/index.htm). HMRCs basic conditions for TTP are:

• HMRC is satisfied that the taxpayer is genuinely unable to pay their tax on time;

• The taxpayer can keep up with the payments they are offering to make;

• Other tax bills are capable of being paid as they arise;

• Any outstanding tax is paid off as quickly as possible

TTP arrangements will not be agreed solely to stop a business from going bankrupt, where HMRC is the major creditor and the business is relying on not paying its tax to stay afloat. Nor will HMRC agree TTP only to project jobs or a particular activity or industry.

Is that so?

HMRC denies that it has ‘tightened up’ on TTP. Instead, HMRC blames an increase in the proportion of TTP applications not meeting the above conditions, e.g. businesses which have had a succession of TTP arrangements, or which have failed to keep up the terms of previous arrangements. Refusals in 2011 (up to the end of August) represented 14% of total applications.

Despite HMRC’s claims to the contrary, there is anecdotal evidence that HMRC is taking an increasingly tougher line. Firms have outlined to me instances where HMRC has by-passed them as agent and contacted the taxpayer directly to pursue outstanding tax liabilities. I also recently queried with my local ‘Working Together’ group in Manchester whether HMRC is denying TTP arrangements where companies have a history of dividend payments (as had previously been reported on AccountingWeb). Whilst it was agreed that this matter would be ‘escalated’ to a higher level, HMRC has yet to reply or make any official announcement of its policy on this issue at the time of writing to my knowledge.

Official guidance

HMRC devotes a whole section of its Debt Management and Baking Manual to time to pay arrangements. HMRC generally seeks to distinguish between taxpayers who ‘can’t pay’ and those who ‘won’t pay’ – TTP arrangements may be extended to the former but not the latter. TTP arrangements typically span a few months or possibly longer (e.g. for business taxes), although TTPs lasting over a year are only agreed in “exceptional cases” (DMB800040). Interest will invariably be charged whether TTP is agreed or not.

Guidance on how HMRC distinguishes between ‘can’t pay’ and ‘won’t pay’ taxpayers is included at DMBM800050. In general, it is good practice before speaking to HMRC about TTP arrangements to read their guidance on the subject, and to ensure that HMRC’s staff adheres to their own guidelines without imposing further conditions for TTP.

Late Payment penalties

The HMRC briefing on TTP states that if an arrangement is agreed, HMRC will remove any surcharges or penalties that would otherwise have arisen, where TTP is agreed before any surcharges or penalties become due.

It should be noted that this treatment is statutory, not concessionary. Under the recently introduced penalty regime for late tax payments, the law requires that HMRC must suspend late payment penalties if certain conditions are satisfied (FA 2009, Sch 56, para 10) (Note – a similar rule applies in respect of the late payment surcharges regime applicable to tax returns up to and including 2009/10, where the TTP arrangement was made on or after 24 November 2008 (FA 2009, s 108)). These conditions are broadly as follows:

• The taxpayer must approach HMRC before becoming liable for the penalty;

• HMRC must agree to the ‘time to pay’ arrangement; and

• The taxpayer must adhere to the agreement and comply with any conditions of the arrangement.

If the taxpayer breaks the agreement (i.e. by defaulting on payment of the tax, or by failing to comply with any conditions of the time to pay arrangement) HMRC may impose the suspended penalty.

Mark McLaughlin CTA (Fellow) ATT TEP

HMRC points to case law in support of ‘spreading’ in its Enquiry Manual (see EM3310). Probably the most well-known of these cases is Jonas v Bamford [1973] STC 519. In that case, Judge Walton J expressed the presumption of continuity as follows:

“…once the inspector comes to the conclusion that, on the facts which he has discovered, Mr Jonas has additional income beyond that which he has so far declared to the Inspector, then the usual presumption of continuity will apply. The situation will be presumed to go on until there is some change in the situation, the onus of proof of which is clearly on the taxpayer.”

HMRC encourages its enquiry staff to use spreading where it is considered to be appropriate (EM3309). For example:

“…if you have proven omissions for which there is no ready explanation and the business and way of life of the taxpayer have not changed you will be in a much stronger position to argue for addition to other years.”

In addition to applying the concept of spreading to assess additional income for other years, it seems that HMRC will also seek to disallow expenses on a similar basis.

In Syed v Revenue & Customs [2011] UKFTT 315 (TC), HMRC amended the taxpayer’s return for 2005/06 following an enquiry, and raised discovery assessments for the tax years 2001/02 to 2004/05 inclusive, and for 2006/07. HMRC sought to increase the taxpayer’s profits for 2005/06 as a dentist, not only in respect of unrecorded income, but also by disallowing certain expenses (e.g. repairs, legal and professional costs and interest paid). HMRC’s adjustments going back to 2001/02 and forward to 2006/07 were made on the assumption that the errors identified for 2005/06 had been repeated in the other years. The taxpayer’s appeals against the assessments were dismissed. The tribunal held that there was no evidence to suggest that the adjustments for disallowed costs were wrong (and there was also insufficient evidence that the additional income was not business income).

The decision in Syed is worrying, because it indicates that accepting (say) the disallowance of an item of business expenditure during the course of an enquiry will require careful thought, due to the potential for HMRC to apply spreading and seek adjustments in respect of other tax years.

Limitations

However, there have been indications that the presumption of continuity may be more limited in its scope than HMRC perhaps consider it to be. For example, in the Syed case the tribunal made the following comments about the application of the principle established in Jonas v Bamford: “In our view [the above quotation by Walton J] expresses no legal principle. It seems to us that it would be quite wrong as a matter of law to say that because X happened in Year A it must be assumed that it happened in the prior year.” The tribunal added:

“In practice it will generally be reasonable and sensible to conclude that if there was a pattern of behaviour this year then the same behaviour will have been followed last year. Sometimes however that will not be a proper inference: there will be occasions when the behaviour related to a one off situation, perhaps a particular disposal, or particular expenses; in those circumstances continuity is unlikely to be present.”

In addition, it should be noted that the Judgment of Walton J in Jonas v Bamford indicates that the presumption of continuity, on the basis of that case, applies to the future and not the past.

Back and forth

Backwards and forwards spreading was at point in Chapman v Revenue & Customs [2011] UKFTT 756 (TC). In that case, the taxpayer appealed against assessments for 2004/05 to 2007/08. The enquiry year was 2006/07. In the absence of adequate business records, HMRC conducted a ‘takings build-Up’ exercise. HMRC considered that the retail price index should be applied to calculate the shortfall in declared income for 2004/05 and 2005/06, and the later year of 2007/08.

However, the tribunal noted that virtually all the evidence presented related to the period covered by the year of enquiry. With regard to HMRC’s takings build-up exercise, the tribunal noted that it was only an estimate, and held that the resulting turnover figure was “wholly unrealistic.” The omitted sales figure for 2006/07 was reduced accordingly. The tribunal also noted that a takings build-up was not produced for 2004/05 or 2005/06 due to “time constraints”, and commented: “…we cannot endorse such an approach in this case where the takings build-up relies on a number of specific transactions peculiar to the enquiry year”.

The tribunal added in the context of business economics exercises generally: “Where a capital statement is prepared for one year and sought to be applied to other years, they have to be adjusted to take account of exceptional items peculiar to the particular year. That was not done here”. The tribunal concluded that the assessments therefore could not stand, and that because there was no basis on which to substitute other figures, the assessments must be reduced to nil. Similarly, the tribunal held that HMRC’s takings build-up calculation for 2007-08 seemed arbitrary, and therefore could not stand. The assessment for that year was also reduced to nil.

The presumption of continuity was also considered recently in The Red Star v Revenue & Customs [2011] UKFTT 812 (TC). In that case, following an into a partnership return for 2005/06, HMRC considered that there had been a suppression of sales and profit at the partnership’s Chinese takeaway restaurant business. HMRC adjusted the sales and profit figures for 2005/06 based on the quantities of rice used in the business. Applying the presumption of continuity, HMRC then adjusted the profits for all the other tax years from 2002/03 to 2007/08 to the same figure, subject to rounding, an inflationary adjustment and time apportionment for the final period of trading in 2007-08 of less than a year.

However, the tribunal was not satisfied that the presumption of continuity applied in the way that HMRC had sought to apply it. The tribunal considered that HMRC should have amended partnership profits for earlier years not by simply substituting an inflation adjusted figure carried back from 2005-06, but by applying the same methodology used in arriving at the 2005-06 figure, and assuming the same degree of under-declaration of both sales and purchases. With regard to later years, the tribunal commented that if proper partnership returns had been made for those years, the retirement of the senior partner during 2006 would have been sufficient to displace the presumption of continuity. However, as the partnership returns for 2006-07 and 2007-08 were estimated, the profit figures for those tax years were amended based on the revised 2005-06 figure, subject to an adjustment for inflation and time-apportionment for the cessation period.

Conclusion

Taxpayers who are subject to ‘spreading’ in HMRC assessments of additional income following an enquiry should be prepared to challenge HMRC’s calculations in appropriate circumstances, particularly where there is evidence to indicate that a presumption of continuity is not the correct approach based on the facts and particular circumstances of the case. Whilst the tribunal decision in Chapman offers taxpayers some encouragement it does not create a binding precedent, and further guidance regarding the limitations of the presumption of continuity would therefore be welcomed.

HMRC guidance points out that not all money debts arise from the lending of money, such as trade debts (CFM31010). The same applies to directors’ loan accounts consisting only of undrawn or overdrawn remuneration etc. In the context of inter-company accounts, HMRC states that balances on such accounts may arise from the lending of money where one group member has borrowed from another (CFM31040). Money debts not arising from the lending of money are brought into the loan relationship regime (as ‘relevant nonlending relationships’), by treating them as such (CTA 2009, Pt 6). The term ‘transaction for the lending of money’ seems straightforward enough on the face of it. However, in MJP Media Services Ltd v CRC [2011] UKUT 100 (TCC), the taxpayer company (MJP) was a wholly-owned subsidiary of company C. Company C in turn was a wholly-owned subsidiary of company A. A series of intercompany transactions took place between MJP and company A.

A signed agreement stated that MJP had loaned a sum of money to company A, and provided for interest to be charged. A deed of waiver was subsequently signed, in which MJP agreed to waive most of the outstanding sum. MJP claimed a deduction in its corporation tax computation in respect of the waived amount. HM Revenue and Customs (HMRC) disallowed the deduction claimed in respect of the loan relationship debit. MJP appealed.

Lending of money
The First-tier tribunal ([2010] UKPTT 298 (TC)) had to consider whether the intercompany debt arose from ‘transactions for the lending of money’ and was thus within the definition of loan relationship. The tribunal decided against the taxpayer company, which subsequently appealed. The Upper Tribunal noted that the Firsttier tribunal made the point that MJP had only disclosed four bank statements, which showed only a few of the relevant transactions. The witnesses had given “unsatisfactory explanations” for the failure to produce bank statements for the other transactions, and did not have firsthand knowledge of the transactions. Counsel for MJP defended the company’s inability to produce the necessary bank statements (notwithstanding the requirement to retain them for six years for VAT purposes), the witnesses’ lack of first-hand knowledge of the relevant transactions, the accounting documents (which the First-tier tribunal had regarded as incomplete evidence), and an inability to explain certain matters. However, the Upper Tribunal rejected those arguments. To prevail on the appeal, MJP needed to succeed in its arguments on all (four)  transactions.

The Upper Tribunal considered two of them, and agreed with the First-tier tribunal that the first transaction was not, on the balance of probabilities, a cash payment. The tribunal was not obliged to explain the transaction and why the same sum subsequently turned up in the books of company A. With regard to the second transaction, MJP had argued that company A had repaid £6.1 million to company C, that company C had repaid the same sum to MJP, and that MJP had paid company A the same sum. However, it was unable to explain why the transactions took place or how the transfers had been made, or show that cash payments had been made as opposed to transfers by book entry. It was held that the First-tier tribunal had been entitled to conclude that MJP had taken over company A’s debt to company C, in exchange for cancelling company C’s own debt, and that the transaction had been by book entry.

The Upper Tribunal also dismissed MJP’s argument that even if payments were
made by MJP to third parties on behalf of company A, that was sufficient to amount to “transactions for the lending of money”. The company’s appeal was dismissed.

The first hurdle
In practice, it is perhaps understandable to focus on how a loan relationship should be treated for tax purposes, particularly in view of the complex legislation in this area. However, the MJP case is a reminder of the importance of ensuring that a transaction falls within the statutory definition of a loan relationship to begin with. The case is perhaps unusual, in the sense that the taxpayer company could not produce banks statements for all relevant transactions, or provide other satisfactory evidence or explanations to support its arguments. However, it does emphasise
the general need to retain records and documentary evidence of transactions, not least because of a statutory requirement to do so in many cases (e.g. TMA 1970, s 12B for individuals, or FA 1998, Sch 18, para 21 for companies), and also where such evidence is important to the taxpayer’s claims or arguments.

Mark McLaughlin CTA (Fellow) ATT TEP

Living together
The principal private residence (PPR) rules for CGT purposes include a provision for married couples. It states that there can only be one sole or main residence for both spouses (or civil partners) so long as they live together (TCGA 1992, s 222(6)). In addition, any PPR election for their sole or main residence must be made by them both. The meaning of ‘living together’ appears clear and unequivocal on the face of it, but this will not always be the case. The term shares the same meaning as for income tax purposes (TCGA 1992, s 288(3)). The income tax legislation states that spouses and civil partners are treated as living together unless they are separated under a court order, or by deed of separation, or are separated in circumstances where the separation is likely to be permanent (ITA 2007, s 1011).

In Benford v CRC [2011] UKFTT 457 (TC), the tribunal had to consider whether the taxpayer had separated from his wife for PPR purposes. The taxpayer had purchased a property in his sole name, and later sold it at a gain. He claimed CGT relief on the property on the basis that it had been his principal private residence during a period of separation from his wife (it was common ground that she had never occupied the property). HMRC subsequently raised a CGT assessment under the ‘discovery’ rules in respect of the property disposal. The taxpayer appealed. The onus of proof was on the taxpayer to establish on a balance of probabilities that the property was occupied as his residence during the period he owned it, and that during this time he was separated from his wife in such circumstances that the separation was likely to be permanent. The tribunal said that whether the taxpayer occupied the property was a question of fact. Having considered the evidence, the tribunal found that he did indeed occupy the property during his period of ownership.

However, the tribunal also noted an absence of “convincing documentary evidence” to show that the taxpayer lived in the property, a lack of furniture and appliances there and a very small amount of electricity used. The tribunal held that there was not sufficient assumption of permanence or degree or expectation of continuity to turn such occupation into residence. In terms of whether Mr and Mrs Benford’s separation was likely to be permanent, the tribunal concluded that the taxpayer had not discharged the burden of proof required to demonstrate that he was separated from his wife in such circumstances that the separation was likely to be permanent. It was therefore held that he should be treated as living with his wife for CGT purposes. As mentioned above, TCGA 1992, s 222(6) provides that there can only be one residence or main residence for a husband and wife living together. As Mrs Benford had never lived at the property bought by Mr Benford, the matrimonial home was considered to be the taxpayer’s main residence. The taxpayer’s appeal was dismissed.

Conclusion

This case emphasises the need for taxpayers to provide satisfactory evidence to support claims or assertions in enquiry cases. The burden of proof in tribunal cases is on a balance of probabilities. The concept of ‘living together’ for tax purposes is not always straightforward, and can be counterintuitive. For example, if one spouse (or civil partner) is resident in the UK but the other is non-resident, they may still be treated as living together, assuming that they are not separated (Gubay v Kington [1984] 1 All ER 513, HL). Some care is therefore needed to ensure that a couple satisfies the statutory definition of living together in the relevant tax year.