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Case Law Updates

Empowerment Enterprises Ltd (2006) CSIH 46


HMRC’s policy on the liability of private tuition is set out in VAT Notice 701/30 ‘Education and vocational training’. It advises that the VAT exemption for private tuition applies to sole proprietors and partnerships who teach a subject that is taught regularly in a number of schools or universities.

The extent of the exemption was examined in October 2006 in the case of Empowerment Enterprises. The Court of Session (upholding HMRC’s appeal against the VAT Tribunal’s decision) held that the VAT exemption for private tuition cannot apply unless the trader personally acts as the teacher.

This overruled the Tribunal’s decision that tuition supplied by a company through teachers employed by that company could qualify.

Business Briefs 16/06 and 10/07 issued following the judgement confirm that HMRC now expects any trader who has treated supplies of private tuition, through a teacher other than himself, as VAT exempt to correct his VAT Returns, using the usual Notice 700/45 procedures.


HMRC v Pal and others [2006] EWHC 2106

The High Court has confirmed that an individual does not become liable for a partnership’s VAT debt simply by signing Form VAT2 (the partnership Details’ form submitted with an application for registration). He or she is only liable if he or she is in fact a partner.

A and B were lessees of restaurant premises, and wished to sublet to C and D. However, the freeholder refused permission to sublet, so A, B, C and D jointly registered for VAT as restaurateurs, although the business was in fact conducted by C and D alone.

In the absence of VAT Returns, HMRC issued an assessment on the partnership.

It was held that only partners were liable for partnership VAT, and that an individual does not become a partner simply by signing Form VAT2.

Moreover, although an individual can (under the general law) assume the obligations of a partner by holding himself out to be one, this applies only where the claimant ‘has on the faith of such representation given credit to the firm’ (s14, Partnership Act 1890) and it could not rightly be said that HMRC ‘gives credit’ to traders, at any rate in respect of the VAT debt they accrue in the ordinary course of business.

The judge also held that the assessment, which had been made in the name of the business, could still be enforced against C and D


Mr. and Mrs. Morgan trading as ‘The Harrow Inn’ v HMRC (19671)

Some pubs with a voluntarily (now compulsory) smoking ban have seen profit rise, mainly attributable to increased food sales, which in some cases have increased by 80%.

This will however create a VAT trap for smaller licensed premises, as was illustrated by the above VAT Tribunal decision. Mr. and Mrs. Morgan ran a pub where ‘bar meals’ were served. (There was no separate restaurant room).

From 1 October 2003 they were authorised by HMCE to adopt flat rate accounting, and subsequently calculated VAT liability at the FRS percentage for ‘Pubs’ – 6% until 31 December 2003 and 5.5% thereafter.

In June 2005 a visiting VAT inspector noted that food sales accounted for just over half the traders’ total turnover and so held that the business was properly categorised as ‘Catering services, including restaurants and takeaways’, for which the flat rate percentage was 13% in January 2004.

The Tribunal upheld assessments covering the whole period form the date FRS was adopted. However, penalties for the first year were struck out, on the grounds that the traders had the ‘reasonable excuse’ of expecting bar sales to exceed food sales.

Customs guidance (Notice 733) says: ’If we approve you to join the FRS scheme, we will not change your choice of sector retrospectively as long as your chose it.’

Note that the higher rate is payable if food sales exceeds bar sales – by however small margin, and that the same flat rate must be applied to the whole of the trader’s operation: the legislation does not allow a trader to operate different flat rates for different parts of his business.

A robust record-keeping system is required, either to convince the VAT Inspector that food sales account for less than half of turnover, or to warn the trader that the 50% limit is about to be breached. Publicans registered under FRS need to be aware of Customs’ restricted view of what constitutes a ‘pub’ for VAT purposes. This may affect their decision whether to adopt or continue with flat rate accounting and their pricing policy.


Anderson v HMRC [2007] UKVAT V20255

Mr Anderson registered for VAT in October 2001 and subsequently (2006) also applied to operate FRS – but with backdated effect to the inception of the scheme i.e. April 2002.

HMRC’s refusal to admit backdating was considered by the tribunal which held that they

Had acted unreasonably and had applied the policy without regard to the individual circumstances of the application – and the appeal was allowed (13 July 2007).


Société thermale d’Eugénie-les-Bains v Ministère de l’Économie, des Finances et de l’Industrie (ECJ C-277/05)

An hotelier in France took deposits from guests who booked rooms in advance. A dispute over the VAT due on these deposits arose where retained by the hotelier because of the guests cancelling the booking; were the remuneration for the reservation service and subject to VAT, or cancellation payments to compensate for the loss of a guest’s custom and therefore not subject to VAT?

The ECJ (18 July 2007) held that Articles 2(1) and 6(1) of the Sixth Directive meant that a sum paid as a deposit was to be regarded, where the hotelier retained the amount as a result of the guest cancelling, as compensation for the loss suffered as a result of the cancellation. It had no direct connection with the supply of any service for consideration – and therefore not subject to VAT.

In principle, the decision concerns all agreements whereby parties agree upon cancellation charges in advance, which a party cancelling the agreement owed the counterparty.


Jones v Garnett (UKHL 35 [2007])

On 25 July 2007, the House of the Lords found in favour of the taxpayer in this case by a unanimous 5-0 decision.

Mr. and Mrs. Jones started their own business by buying an off-the-shelf limited company – Arctic Systems Ltd, and each subscribed for one ordinary £1 share. For the next few years they each drew small salaries and distributed the balance of income via equally shared dividends.

Mr. Jones was higher-rate taxpayer and undertook most of the company work, while Mrs. Jones was a basic-rate-taxpayer who carried out minor duties only. The dividend payments escaped Nic, and in addition any amount Mrs. Jones received was subject to a lower rate of tax than that received by her husband. HMRC used the settlements legislation (s660A ICTA 1988, now s. 619 ITTOIA 2005) to argue that the dividend Mrs. Jones received was an ineffective disposition of income by her husband and could therefore be reallocated to him and extra tax sought.

In earlier hearings of the case, HMRC succeeded before the Special Commissioners and the High Court, but lost in the Court of Appeal.

In the House of Lords HMRC argued that an arrangement existed between Mr. and Mrs. Jones, and that the set-up enabling Mts. Jones to take half of any dividend was not a transaction at arm’s length.

Points made by HMRC:

 There was no gift of a share in this case because Mrs. Jones subscribed for her own £1 share.

 The transfer of the share was not the whole of the arrangement

 The share was ‘wholly or substantially a right to income’, which under the legislation would mean that the exemption could not apply.

Within the settlements legislation is a “spouse exemption” – (was) s.660A(6) ICTA 1988 – when a spouse makes an ‘outright gift’ to the other of the property (i.e. the share in the company) from which income arises.

The judges considered that the facts did amount to an arrangement, which meant that potentially the settlements legislation could have applied, but unanimously agreed that the exemption applied, so resulting in the impossibility if the dividend received by Mrs. Jones being reallocated to her husband.

Immediately following the case, the Government issued statement that it would look to change the law, although no date was set for when this might become effective. This statement avers that the Arctic Systems case has now ‘brought to light the need for the Government to ensure that there is greater clarity in the law regarding its position on the tax treatment of “income splitting”’

Referring to the many cases which awaited the outcome of the Arctic case, HMRC subsequently stated “We will now review all these cases and will seek to settle them in line with the Jones v Garnett decision if appropriate. …not every case will be exactly the same as Jones v Garnett…..we will consider each case on the basis of its individual facts.”

Until the House of Lords decision is changed by legislation, it remains valid case law and should be followed. SA returns for 2006/2007 must be finalised by 31 January 2008 and should reflect the decision. Existing guidance on the settlements legislation on the HMRC website is out of date, and HMRC has promised revised guidance in line with the decision by this autumn.


AB (A firm) v HMRC (SpC 572)

The boundaries of the wholly and exclusively rule were recently examined in AB (A firm) v HMRC. The main issue related to an expense incurred by the firm, a partnership of solicitors. The original liability to pay this expense arose from litigation involving one of the partners (referred to in the decision as Mr. A) in a personal capacity. As Mr. A was unsuccessful in the litigation, he became liable to pay the legal costs his opponents had incurred.


The partnership claimed that the amount incurred was deductible as an expense of the firm even though they acknowledged that, had Mr. A. paid the amount personally no tax relief would have been available to him. HMRC queried the claim for the deduction, and the Special Commissioners held that the liability to pay the costs was always Mr. A’s and never the firm’s. They also held that the idea to treat the expenses as the firm’s liability was simply in order to convert a non-business expense into a tax-deductible one. A’s claim to a deduction was refused.


McQueen v HRMC (SpC 601)

In the case of McQueen v HMRC, the taxpayer was a successful rally driver and publicised his coach business by the sponsorship of his rally car, painted in its colours.

The question in this case was whether the expenditure on sponsoring the rally car was incurred wholly and exclusively for the purposes of the business or whether there was duality of purpose. HMRC argued that Mr. McQueen’s was indulging his interest and the business purpose was incidental.

However, the Special Commissioner decided that the whole of the expenditure was incurred for the purpose of benefiting the coach business by the promotion of the name and the facilities it offered. The fact that it gave him satisfaction was merely a consequential and incidental effect of the expenditure.

He concluded that:

 Mr McQueen used his skill and enthusiasm for rally driving as the best means available to him for promoting his coaching business.

 The marketing advantage was not vague and uncertain (often the case with marketing expenditure) but clear and successful, the evidence demonstrating a direct correlation between the sponsorship and the gaining of new clients.

Accordingly the expenditure was laid out wholly and exclusively for the purposes of the coach trade and fully deductible.

A non-business purpose that would lead to the expenditure being disallowed is more likely to be viewed by HMRC where the sponsored person is a relative of the controlling director. HMRC would want to see evidence of the decision making process that led to the making of sponsorship payments as a means of advertising the company. Matters are not helped if the company is sponsoring a total novice with no public reputation, or if the company simply pays over what (say) a relative of the controlling director seeks without any thought of whether the expenditure is commercial.

Other tips on securing tax relief on sponsorship costs;

 Minuted meetings to support the view that the sponsorship decision was taken solely for commercial reasons.

 A formal agreement governing advertising benefits

 The bigger and more publicly visible the organisation or event being sponsored, the stronger the argument that the expenditure was for business purposes.

 Concentration on events close to the trading premises/customers’ trading catchment’ area


Demibourne Ltd v HMRC (Spc 486)

A hotel employee, Mr Bone, retired in 1993 but afterwards continued the same work on a self-employed basis. In 2002, HMRC ruled that Mr Bone was still an employee and the hotel proprietor should operate PAYE on his earnings. This was done, until Mr Bone ceased working for the hotel in 2004.

In 2003, HMRC issued determinations under reg. 49 of the IT (Employments) Regulations 1993 on the hotel for the years 1997-98 to 2001-02, charging tax and NI on Mr Bone’s earnings.

The hotel appealed saying that:

Mr Bone had been self-employed between 1993 and 2002 and both parties hand intended this.

In the event that the determinations should stand, the tax already paid by Mr Bone as self-employed should be taken into account.

The appeal was dismissed, the Special Commissioner ruling: “Whatever the parties may have believed that they were doing in arriving at the agreement concerning Mr Bone’s engagement, the overall effect of the contractual terms, taken together with the course of conduct as between the parties, was to continue a relationship of master and servant”.

The changes after he retired in 1993 were insufficient to constitute self-employment. In effect, the only things that had changed were the way Mr Bone was paid and that he was no longer entitled to paid holidays. The beliefs of the parties involved could not determine the nature of the relationship.

With regard to taking into account tax already paid by Mr Bone, the Special Commissioner had no power to consider this.

Established HMRC practice had been to agree a settlement whereby amounts of tax already paid by individuals under SA were treated as payments on account of the PAYE due.

However, following the case, HMRC issued revised instructions requiring the employer to account for the full amount of income tax due under PAYE plus NIC. The employee will then be able to reclaim tax previously paid under SA.

The reason for this change in approach is that HMRC were concerned that if they agree a settlement with the employer, the employee could later ask for a refund of the tax that he had paid on the basis that PAYE was properly due, and not the tax paid under SA.

Previously, the employer undertook to pay the PAYE to MMRC if that were to happen, but following the decision HMRC have considered that this is not an acceptable basis for settlement.

HMRC have instead insisting that the employer can only paying the reassessed arrears if he obtains an irrevocable written undertaking from each of the employees concerned, stating that the employee will not seek a refund and agrees to the SA tax paid being offset against the PAYE liabilities.

This clearly not only impose difficulties on the employer, but will be impossible to implement in those cases where the employees cannot be traced by the employer, perhaps where they left the employment some time ago.

Recognising the practical difficulties caused by the change of policy, HMRC stated (August 2006) “The particular concern is the potential difficulty raised by the case in terms of whether or not is was possible to continue with longstanding arrangements that had often been applied whereby HMRC had allowed an offset of tax paid by an individual whilst they were treated as self-employed in arriving at the PAYE settlement due from the employer, and the method to be adopted….. although a number of points are still being considered, it is hoped that a solution will be found that will meet the needs of both employers and HMRC, both in terms of the immediate need to conclude numbers of outstanding PAYE settlement cases as well as providing a platform for introducing a longer term solution for settling such cases in the future”.


MAL Scaffolding and others v HMRC (Spc 527)

MAL, a scaffolding business, provided services to building sites throughout South East England, and recruited workers to provide the scaffolding services. MAL was subject to individual decisions by HMRC about identified individuals. Some of the workers appealed (and their appeals were joined together), as did MAL, against notices of decision that the workers were employees.

MAL and the scaffolders pointed to the absence of any written agreement and also to the absence of any obligation on MAL to offer work. There was no mutual obligation on a continuing or future basis, and the workers were free to, and did, refuse work. The evidence showed that payment was made by MAL for work previously done, not on any future or continuing basis, which was also evidence of no continuity.

With regard to control, the evidence was that of fiercely independent people over whom MAL had no competence to assess the quality of the work of the scaffolders; that could only be done by site agents of the main contractors. In addition, there was also evidence of substitution. The workers provided their own tools and protective clothing, hired helpers, and at all times they had the financial risk on themselves so that if there was no work of if poor weather prevailed then they were not paid.

HMRC argued, in considering the issue of control, it was important to consider the control available, not what actually was exercised. They submitted that control was shown, and also mutuality, in all cases. In their view, in all cases the evidence pointed firmly towards employment status as confirmed by the statements made by individual appellants during the investigation.

The Special Commissioner found that no adverse conclusion was to be drawn from the lack of documents. The relationships were simply not written down in any constitutive document.

He found that there was no clear pointer to an employer-employee relationship in the methods of payment and delivery of services undertaken. The rate of payment for work done was fixed on the basis of a daily rate. There was no formal system of parity between individual workers about the daily rate, and no regular review of the rates.

The arguments about control did not provide a clear answer by themselves. The evidence suggested a complete absence of any of the control expected between an employer and employee.

As regards other terms of the relationship, there was no holiday pay, no sick pay, no set hours the hours of a particular site, no standard rates of pay or standard arrangements for overtime, no obligation to provide or undertake work, no period of advance notice that no work would be available, no notice period for absences during a period of work, and not notice period to end the relationship on either side.

The Special  Commissioner was persuaded on all the evidence and on the balance of probabilities that the usual form of  relationship between MAL and a worker during the relevant period was that of an informal und undocumented verbal contract for services and not any form of contract of service.


Parade Park Hotel and another v HMRC (Spc 599)

A handyman (Mr May) undertook general maintenance work for a local hotel owned by Mr Merrick. The features of the agreement were as follows:

 Price quoted for each job, but subsequently amended to a daily rate

 Jobs required were listed in a maintenance book, which the two parties would check, with Mr May tackling those that he felt competent to do.

 Originally he worked five days a week, but subsequently varied to three, five or no days a week. Mr May would decide which days he would come to work at the hotel.

 The hotelier gave Mr May permission to hire an assistant if required and would have allowed a suitable substitute if needed.

 There had been some occasions when the work had not been up to standard and Mr May put this right at his own expenses.

 Mr May used his own transport and tools, although the hotel usually purchased the materials as this was cheaper and they could reclaim the VAT. He did not receive holiday or sick pay and did not have to give notice of holidays or advise when he was sick.

In addition, Mr May did not consider himself to e employed by Mrs Derrick.

In February 2004, following a meeting between HMRC, Mrs Derrick and her accountant, HMRC concluded that Mr May was an employee and raised determinations for £7188 under reg. 80 of the IT (PAYE) Regs 2003 for the years 1999-00 to 2003-04.

The Special commissioner considered whether there was an ‘irreducible minimum’ to the relationship.


Mutuality: HMRC argued that the daily payment showed that Mr May was working regular days for regular pay. The fact that he might miss days simply meant that the contract of employment had ceased; it was possible to have mutuality of obligation within one-off jobs. The Commissioner however held that ‘to amount mutuality, each part had to bind itself to something, and a relationship where a party could choose whether to commit itself could not be a contract of employment’.


Personal service: it was Mr May who was contracted to do the work.

Control: there was insufficient control to constitute a contract of service or a series of such contracts’.

As a result of the above findings, the taxpayer’s appeal against the HMRC determinations was accordingly allowed.

Conclusion: Parade Park is a helpful case which clarifies the basics of tax status. The decision follows earlier recent decisions (e.g. MAL Scaffolding) which have made it clear that unless there is mutuality of obligations, a requirement for personal service and control, the worker cannot in law be an employee.


Lam v Inland Revenue [2005] EWHC 592 (Ch)

Mr Lam asked the court to set aside a bankruptcy order made against him on the grounds that the tax liabilities for which he had been made bankrupt were incorrect. Mr Lam maintained that he had not made the profits as a self-employed individual, but a limited company of which he was an employee. The tax should be changed to the company.

The judge said that he was ‘not without a little sympathy’ for Mr Lam, but it was not possible for the court to go behind the tax assessments; the bankruptcy court could not intervene.

HMRC have subsequently stated that ‘we will look at assessments which have become final in law if at a later date compelling information comes to light showing that the tax charged may have been excessive, and that ‘to admit such a claim the inspector must be satisfied on clear evidence to show that the original assessments were excessive’.

This is “equitable liability”, the application of which may be applied to tax debts which are incorrect, but outside the time limit for adjustment in any other way (see Tax Bulletin 18).

Under the provisions of equitable liability, HMRC agrees not to pursue its legal right to recovery where it would clearly e unconscionable to do so.

The concession is reserved entirely for an individual’s tax liabilities, and there was no question of its application to a corporation tax liability.


Rowland v HMRC (SpC 548)

In the appellant made a capital gain of 15.6 million in 1999-2000. On the advice of her Accountant, to reduce the gain she became a partner in a film partnership. Her accountant advised her that her share of the estimated loss of the film partnership for 2000-01 was to be set against her income and gains for 1999-2000, so that the tax due on 31 January 2001 would be £861k instead of £5.6m. Her return, including an estimated loss relief claim, was filed in January 2001 together with payment. In April, an amended return claiming loss relief was submitted.


However, in July 2001, her accountant advised her there was an issue over the timing of the loss claim, and an amended return was submitted. In October, HMRC imposed a surcharge on underpaid tax. The appellant appealed claiming reasonable excuse, in that she had relied on her accountant to deal with her tax affairs.

The Special Commissioner considered that reliance on a third party could be a reasonable excuse in respect of direct tax. Legislation specifically excluded reliance on a third party as being a reasonable excuse in VAT, but no equivalent provision exists in direct tax. Her appeal was allowed.


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