Magic Carpets: Introduction
One Thousand and One Nights or, as commonly known, The Arabian Nights is a collection of Middle Eastern folk tales originally compiled in the Arabic language, but translated into many different languages since.
If a tax story had ever been considered for the Arabian Nights then one would have to look no further than the tale of the Employee Benefit Trust (“EBT”).
If one were to add up the time spent by Tribunals over the last two decades dealing with EBTs and Remuneration Trusts, this would comfortably exceed the allotted one thousand and one nights.
It is perhaps accepted by most that these vehicles are not quite the magic lamps that they were once marketed as (at one time by the Big Four and large law firms).
However, it is clear that the Government has long had ongoing difficulties in putting the genie back in the…err… lamp.
It has taken aggressive legislation in the form of Part 7A of ITEPA 2003 (aka disguised remuneration) and the loan charge plus seminal cases such as the Rangers case, which eventually found against the taxpayer.
But I digress.
The case – Magic Carpets (Commercial) Limited v HMRC
In a recent tribunal case, Magic Carpets (Commercial) Ltd found itself at odds with HMRC over a tax planning arrangement involving an employee benefit trust (EBT).
However, what makes this case stand out is not just the nature of the dispute but also the critical role of the four-year discovery window.
Magic Carpets had employed a tax planning scheme involving an EBT for compensating its key staff. For a change, this was not a Baxendale Walker remuneration trust, but an EBT operated by another sizeable operator, Clavis.
Here’s a simplified breakdown of what happened.
- A Jersey-based ‘human resources consultancy’, Herald, would recommend how Magic Carpets should remunerate its key personnel and outsource the execution to a UK limited liability partnership;
- Magic Carpets would then settle an amount into an offshore EBT, from which its staff could benefit. While the recommendations were made, Herald would send an invoice covering both their fees and the amount Magic Carpets should set aside for their staff;
- Magic Carpets paid the invoice, deducted the relevant fees, and the balance was deposited into the EBT;
- Subsequently, for each employee benefiting from the scheme, a sub-trust of the EBT was established, with shares of the funds allocated to individuals in the form of loans.
Of course, Magic Carpets claimed a deduction from its UK corporation tax for the amount paid under the Invoice, as it considered this to be fees.
However, it didn’t account for PAYE or National Insurance contributions for the sums loaned to its employees.
HMRC’s Determinations
HMRC made determinations under regulation 80, Income Tax (Pay As You Earn) Regulations 2003 (Regulation 80), claiming unpaid PAYE income tax for 2009/10 and 2010/11.
In addition, it raised a penalty assessment under Schedule 24 of Finance Act 2007.
The determination for 2009/10 was issued on 5 April 5 2016. The one for 2010/11 was issued on 10 February 2017.
Magic Carpets disputed these determinations and assessments, leading to the case reaching the First-tier Tribunal (“FTT”).
The Legal Framework
Regulation 80(5) outlined that determinations made under it would be subject to specific sections of the Taxes Management Act 1970 (TMA) relevant to assessments and all the relevant timings.
The usual time limit for HMRC to issue an income tax assessment is four years after the end of the relevant tax year.
However, in cases involving careless loss of tax, HMRC has up to six years to make assessments.
Importantly, this extended limit also applies when another person causes the loss of tax on behalf of the individual.
Additionally, Paragraph 1 of Schedule 24 introduces penalties when an inaccuracy in a document leads to an insufficiency of tax.
The FTT’s Verdict
The FTT found in favour of Magic Carpets.
While there was no dispute that the EBT arrangement proved ineffective, the FTT focused on whether Magic Carpets’ carelessness was the root cause of this loss.
Although Magic Carpets’ directors had displayed some carelessness, the FTT considered it reasonable for them to rely on the advice of professional advisors in completing their tax returns.
They had entrusted their accountants, who were recommended by friends and business associates.
The directors, however, had not taken sufficient steps to understand the complexities of the arrangements beyond recognising the involvement of an EBT and loans.
They failed to ensure proper document execution and were complacent regarding discrepancies in the arrangement’s implementation.
Despite knowing that Herald’s arrangements had little substance, the directors had not sought independent advice.
The FTT acknowledged Magic Carpets’ carelessness but stressed that HMRC needed to demonstrate that this carelessness directly caused the tax loss.
In this case, they failed to do so.
Given the prevailing legal context, it would have been unreasonable to conclude that the contributions to and loans from the EBT should be treated as employment income.
Magic Carpets’ carelessness hadn’t led to the tax loss, making HMRC’s determinations invalid due to the time limit constraints.
The same reasoning applied to dismiss HMRC’s argument regarding the carelessness of Magic Carpets’ accountants.
Magic Carpets: Conclusion
The absence of a direct link between their actions and the tax loss that ultimately saved them from the long arm of HMRC.
It serves as a reminder that tax cases, even one’s around aggressive tax schemes, can be highly nuanced when it comes to assessing and collecting disputed taxes.
So, in this case, there was no magic bullet for HMRC when it came to this Magic Carpet.
The full judgment can be found here.
If you have any queries about this article or tax matters in general, then please get in touch.