Scotts Atlantic – Corporation Tax relief tested before the Upper Tribunal

In a judgment released on 13 February 2015, the Upper Tribunal (“UT”) has dismissed the taxpayers’ appeal in the case of Scotts Atlantic Management Limited v HMRC [2015] UKUT 0066 (TCC).  The UT has largely upheld the First-tier Tribunal’s decisions, although there are a number of key points of difference between the two judgments.

The case concerned planning to circumvent the rules in FA 2003, Schedule 24 (subsequently re-enacted in CTA 2009, Part 23, chapter 1), which deny corporation tax relief for company contributions to employee benefit trusts (“EBTs”) and other structures that allow assets to be ring-fenced for employees without distributing those assets in a way that gave rise to income tax (in the language of the Act, “employee benefit contributions”).

In this case, a ‘money-box’ company would be established by an employer with a small number of shares.  That company would then grant an option to an EBT to issue a very much larger number of shares to the EBT.  The employer would then sell their shares to a third party at a price equal to their fully diluted value (i.e. taking into account the additional shares that would be issued when the option held by the EBT was exercised).  Finally the EBT would exercise the option, leaving it effectively in possession of the money-box company and its assets.

The intention behind the planning was that the grant of an option would result in a value-shift in the employer’s holdings in the money-box company, which would give rise to a charge in the books of the employer, on which a CT deduction was then claimed.

The FTT had held that a value-shifting arrangement of this sort was not an “employee benefit contribution” and was therefore not subject to FA 2003, Schedule 24, on the basis that the grant of the option, which gave rise to the value shift, was not an action taken by the employer and that the grant of an option could not constitute a “contribution”.

However, the FTT held that there were flaws in the implementation of the plan that rendered it ineffective, and also that there was an obvious intention inherent in the plan to avoid tax in addition to the ostensive business purpose of remunerating employees.  This incidental purpose meant that the arrangements could not be “…wholly and exclusively…for the purposes of the trade…” and therefore failed the test in ICTA 1988, s 74 (now enacted as CTA 2009, s 54).

The UT has reversed the FTT decision with regard to FA 2003, Schedule 24: holding that the payment of the subscription monies by the employer to the money-box company should be considered as part of the same transaction as the grant of the option to the EBT – ultimately the employer had paid cash which was going to be held for employees.

Where the UT agreed with the FTT was on the application of ICTA 1988, s 74: the planning used by the employer had been convoluted and was clearly intended to escape the strictures of FA 2003, Schedule 24; although there was a genuine commercial purpose discernible in the transactions, the intention to avoid tax was one of the purposes behind the transactions, which meant that a deduction would not be allowed even if FA 2003, Schedule 24 had not been in point.

The UT was careful to draw a distinction between the motives for undertaking a transaction, which is the key to securing a deduction, and the motives for structuring a transaction in a particular manner, which is not relevant to deductibility.  The UT also rejected a contention put forward by counsel for HMRC, to the effect that the purpose of one step in a series of transactions can be taken in isolation from the purposes of the transactions taken as a whole.

The comments of the UT on ICTA 1988, s 74 offer a useful guide to the availability of deductions where a complex series of transactions have been entered into with a view to avoiding tax and reiterate the courts’ longstanding disinclination to view transaction steps in isolation.  Although the current political and legislative climate makes it less likely that companies will enter into arrangements of this sort, this case remains a useful guide to the likely approach of the courts to planning that companies have entered into and which is under scrutiny.

For further information on corporation tax relief please contact the TaxDesk on 0845 4900 509 and ask for Thomas Dalby.