In the First-tier Tribunal (FTT) case of Richard Hirst (TC04038 published on 9 October 2014), the issue was whether Mr Hirst (RH) had been a director or an employee during the 12 month period prior to the disposal of his shares, a key qualifying condition laid out at s.169I(6)(b) TCGA 1992, in order to qualify for entrepreneurs’ relief (ER). HMRC’s position was that since his resignation from the role as Business Development Director, some two years prior to the sale, he was not eligible for relief. However based on the nature and level of activity which RH undertook for the company post resignation and the fact payment for his services was offered, the FTT found that RH was an employee and therefore entitled to ER.
The facts of the case
RH was one of the founders of a company formed in 2005 involved with arranging corporate finance. He was joint Managing Director and took on the role of Business Development Director in 2006. During 2007, business became difficult and in order to control costs, RH resigned his position with the company in December 2007. RH continued to source new business for the company and in February 2008 RH approached ACF, a finance broker which lead to broker-to broker deals, all of which were high risk and needed to be approved by the company’s board. He retained his laptop and phone from the company who continued to pay his home internet costs. Around the same time, RH was arrested and subsequently found guilty of assault. In July 2009 he was acquitted of all charges following a retrial. During that time it was not appropriate for RH to resume as a director of the company. It was agreed however that RH would be paid commissions for new work introduced which would help his defence costs. However, due to the distractions of the case and the fact he had sufficient funds in the form of dividends, RH did not pursue for payment. In late 2008 further redundancies took place in which included RH. In 2009, an offer for the business was received with a sale completed in July 2009 whereby RH disposed of his 13.5% stake.
RH took the view that he was both an employee and a director in the 12 months leading up to the sale. RH sited three key factors which supported his employee relationship.
- He was obliged to provide work personally via his personal involvement with ACF which was critical to its success;
- Mutuality of obligation between RH and the company. He was paid commissions and provided with assets in return for continued work services;
- There was a master/servant relationship as outlined in the Ready Mixed Concrete  case. RH developed strategy, but this still required checks by the company and therefore under their control.
In relation to directorship, RH took the view that he was acting as a de facto or shadow director since his resignation in 2007 right up to sale. He had been given copies of board packs and had given instructions to the CEO. Third parties such as ACF saw RH as a decision-maker on behalf of the company, who had authority to make legally binding obligations. He had been central to the business and exercised real influence in the corporate governance of the company. These points were largely supported by Mr. Millard a fellow director of the company who gave evidence and who also added that the staff continued to view RH as a director.
On the shadow director aspect, HMRC felt that the acid test was not whether the employees continued to treat RH as a director, but whether the directors of the company treated RH as a director on a level footing with themselves acting in accordance with RH’s instructions. There was no evidence to convince them this was the case. On considering employee status, HMRC did not think that a contract of service existed on the basis of the Ready Mixed Concrete case where payment was required in return work. HMRC believed that RH was wholly unpaid after his resignation. Furthermore there was no evidence of who owned the laptop and other assets provided to RH. The evidence showed that RH had corresponded via a personal email rather through a company email address.
FTT commentary and decision
The tribunal firstly considered whether RH was an officer of the company within the meaning of s.5(3) ITEPA 2003 in particular a de facto or shadow director. They drew upon statutory definitions in the Companies Act 2006 and the leading case of HMRC v Holland  and applying the evidence to these, concluded that RH was not an officer of the company after his resignation as a director. The tribunal did not find evidence which supported RH’s influence over corporate governance beyond that of a significant shareholder. He was not held out to be a director and RH’s behaviour in the relevant period did not include directing or instructing the board how to act. When considering employee status the tribunal considered there were elements in the findings which in line with the Ready Mixed Concrete case supported an employment relationship which were:
- The work undertaken by RH following his resignation and in particular his personal involvement with ACF, was significant beyond the nature of someone acting as self-employed;
- RH had agreed to provide his skills in return for commission and non-cash benefits;
- RH was under the control of the company who made the key decisions in relation to the broker-to-broker deals;
Why this matters
In certain situations it is quite acceptable for commercial reasons that individuals resign their directorship without regard to the wider tax position and in particular the impact on ER. In this case RH had to build a case that he was still acting both as a de-facto or shadow director and employee and the case is interesting on the examination of these arguments. Certain aspects of which may be helpful from both an employment status perspective as well as eligibility of ER. On balance, RH is probably fortunate the FTT came down on his side in terms of employee status While it might not have been appropriate to appoint RH as a director while his court case was running if RH had been advised to enter into a formal employment contract for the ongoing work after his resignation as a director, it is unlikely the claim for ER would have been challenged. Although HMRC lost the case, this being the third such case involving ER shows that this valuable relief is firmly on their radar and it will be interesting to see if HMRC appeal the decision.
If you require any further information in relation to this case or advice on entrepreneurs’ relief please ring the TaxDesk on 0845 4900 509 and ask for Martin Mann.