Too good to be true
-
June 2022
Justine Riccomini FFTA AIPA Chartered MCIPD ChFCIPP, head of taxation at the Institute of Chartered Accountants of Scotland (ICAS) discusses why employment law practitioners should ‘look through’ what seems to be a complex arrangement, to see it for what it really is – here, a way of paying cash bonuses to employees
Main points
-
in the Jones Bros Ruthin case, the question was whether or not bonuses paid under ‘contracts for differences’ (CFDs) were governed by Part 7 of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003
-
they were found not to be, but the cash received was deemed to be employment income anyway
-
the case serves as a reminder to look confidently through layers of complication to determine the true nature of an item.
Background
In Jones Bros Ruthin (Civil Engineering) Co Ltd and Britannia Hotels Ltd v Her Majesty’s Revenue and Customs (HMRC), two cases with similar fact patterns were heard under this first tier tribunal (FTT) case reference – and the decision resulted in the same outcome for both appellants.
Both businesses were running a tax avoidance scheme, with the purpose of avoiding pay as you earn (PAYE) and National Insurance contributions (NICs) on bonus payments. Instead, they wanted to apply capital gains tax (CGT) to the profits of the arrangement. The question to be determined by the tribunal was to establish whether the use of CFDs in a remuneration planning scheme was governed by the employment-related securities legislation at Part 7 of ITEPA 2003, or not.
Mutton dressed as lamb?
The complex nature of the arrangements needed to be unpicked so the tribunal could determine what was happening. Were the employees receiving a return on a commercial investment, in which case CGT applied? Or was it a good old-fashioned bonus, taxable in the standard way by virtue of Section 62 of ITEPA 2003 – a bonus which should simply be payrolled and subject to PAYE and NICs as earnings? Her Majesty’s Revenue and Customs (HMRC) produced a Spotlight paper in February 2016 on the very concept of why it considers CFDs don’t work, entitled, Spotlight 28: Employee Bonus Schemes – Growth Securities Ownership Plan and other avoidance schemes based on contracts for difference.
What were the arrangements in these two cases?
Under the arrangements, CFDs were used to facilitate:
-
a minimal upfront payment by the employee for the CFD to be implemented
-
the employee being contracted under the CFD to pay the employer if there was a specified monetary difference in the profits as reported, as opposed to those which had been forecast
-
the employee receiving a payment if the profits exceeded a specific level.
What happened after HMRC reviewed the arrangements?
HMRC concluded the payments were earnings under a bonus scheme and weren’t governed by the employment-related securities legislation, which would potentially exempt them from being subject to PAYE and NICs as employment earnings. They issued Regulation 80 PAYE assessments on the basis that the CFD didn’t represent an arm’s length commercial investment-style arrangement, and the employers appealed to the FTT.
What was the FTT’s decision?
Having considered and followed the Supreme Court decision in UBS AG v HMRC, which concerned itself with a scheme for paying bankers’ bonuses and applied the Ramsay Principle to the fact pattern to take a purposive approach to interpreting the law, the FTT concluded that the ‘only purpose’ of the CFD was… ‘to bring the arrangements within the legislation to obtain the tax benefit’. The FTT went on to quote the definition supplied by the European Securities and Markets Authority of a CFD insofar as it relates to commercial arrangements: ‘A CFD is an agreement ... to exchange the difference between the current price of an underlying asset (shares, currencies, commodities, indices, etc.) and its price when the contract is closed. CFDs are leveraged products. They offer exposure to the markets while requiring you to only put down a small margin (“deposit”) of the total value of the trade. They allow investors to take advantage of prices moving up (by taking “long positions”) or prices moving down (by taking “short positions”) on underlying assets. When the contract is closed you will receive or pay the difference between the closing value and the opening value of the CFD and/or the underlying asset(s).’
The scheme was deemed to fail to fall under the employment-related securities legislation because:
-
there was no commercial objective
-
although the scheme was designed to characterise CFD, there was virtually no chance the employees would make a loss due to the nature of the arrangements in place – so they would instead be highly likely to receive a cash bonus
-
as such, the payments represented employment earnings and should be subjected to income tax and NICs in the usual way.
Conclusion
It’s interesting to see the outcome of cases which are considered in a purposive way by the courts, to reveal what the facts are telling them about what’s really going on, to reach an equitable and well-founded conclusion. In other words, dear reader: if something looks too good to be true, it probably is.