Loans from Remuneration Trust are not earnings

In Marlborough DP Ltd v HMRC [2021] TC08246, the First Tier Tribunal (FTT) held that loans funded by a remuneration trust were not earnings, or disguised remuneration taxable under part 7A of ITEPA 2003. They were taxable as distributions so no Corporation Tax deductions could be claimed by the contributing company.

Marlborough DP Ltd (MDLP) was a dental practice through which the sole director and shareholder, Dr Thomas, provided services.

• In 2007 MDPL set up a Baxendale Walker offshore Remuneration Trust (RT) for “the benefit of persons who had provided or might in the future provide services, custom or products to MDPL”.
• Between 2008 and 2015 MDPL made several contributions per year to the trust for which it claimed Corporation Tax deductions.
• Shortly after each contribution, on behalf of the trustees, a Belize company controlled by Dr Thomas used the funds from the contributions to make loans of similar amounts to Dr Thomas.
• HMRC disallowed the contributions for Corporation Tax (CT) purposes and issued Discovery assessments.
• HMRC also issued assessed MDLP under PAYE for Income Tax and National Insurance Contributions (NICs) on the basis that either the loans were earnings under ITEPA 2003 or that the loans were taxable under the Part 7A ITEPA Disguised Remuneration rules.
• MDPL Appealed the PAYE assessments. It accepted that the amounts received by Mr Thomas were taxable as distributions meaning no CT deductions were available.

The FTT allowed the appeal.

• Establishing the purpose of an employer in making a payment is key to assessing its character in the hands of the recipient “looking at its substance and not its form”.
• Such relevant evidence as existed pointed to the conclusion that the loan amounts were not paid to Dr Thomas as a reward for his services as a director but instead constituted distributions made as a return on his shareholding in MDPL.
• There was no contractual obligation on MDPL to pay the sums as a reward for Dr Thomas’ services as director/dentist. The loans were therefore not general earnings within ITEPA.
• On a purposive interpretation, the distribution provisions at s.383 and 384 of ITTOIA 2005 and s.1000 CTA 2010 are broad enough to capture the amounts paid to Dr Thomas even though they were paid in the form of contributions to an RT and subsequent loans.
• The amounts were also not taxable under Part 7A ITEPA. This requires at s.554A(1)(c) that the relevant arrangement is a means of providing, or is otherwise concerned with the provision of, rewards or recognition or loans in connection with employment, former or prospective employment, with the employer company, ‘the connection test’.
  • The connection test was not met: Dr Thomas’ employment was not shown to be part of the reason for the loans he received, the analysis here being the same as that required to assess whether a general earnings charge applies. In other words, if there was no general earnings charge there also could not be a part 7A charge in this particular case.

In his evidence, which the FTT found credible on the whole, Dr Thomas agreed that a main feature of the RT arrangements was to reduce MDPL’s tax liabilities and said it was also one of the objectives to take the monies contributed to the RT out into his hands tax-free. As a result, the only driver for deciding how much was to be paid into the RT arrangements was to reduce MDPL’s profits to nil for CT purposes. Dr Thomas’ understanding was that he would not have to repay the loans unless he wanted to. He admitted that absent the RT arrangements, he would have withdrawn the MDPL profits as dividends and not salary.

Though not relevant here, the FTT considered HMRC’s argument that even if the loans were taxable as earnings, no corporation tax deductions would be due as the contributions to the RT were not Wholly and exclusively for the purposes of MDPL’s trade. The FTT judge disagreed however the member sitting alongside her concurred with HMRC’s view.

Useful guides on this topic

Disguised remuneration loan charge
What is disguised remuneration? What is the loan charge? When does the loan charge apply? Will the loan charge affect me?

Disguised remuneration 2020 settlement opportunity
What is HMRC's position on disguised remuneration loans where settlement was not reached by 30 September 2020? Can a settlement still be reached?

FAQs for Disguised Remuneration Settlements
Can I just repay my loans? Which is cheaper: the loan charge or settling? How much will it cost to settle? And many other FAQs.

How to appeal an HMRC decision
Disagree with a HMRC decision? How to appeal, what type of decision can you appeal and what are your different options when you disagree with HMRC? What are the key steps in making an appeal?

External link

Marlborough DP Ltd v HMRC [2021] TC08246