In Maureen Hepburn v HM Revenue and Customs (“HMRC”) (2013) the First-Tier Tax Tribunal (“FTT”) ruled in favour of a taxpayer’s appeal in relation to consultancy fee paid to a company which was not incorporated at the time. The taxpayer appealed against HMRC’s tax assessment that the consultancy fee should form part of trading income, rather than corporation tax. The FTT’s decision was largely influenced by the fact that the fee was intended to be paid to the company (not to an individual) and that the time of incorporation was not itself a material factor.
Facts of the Case & Issues in Dispute
Miss Hepburn owed 80% of Envireneer Limited and was the managing director. At a board meeting on 10 December 2004, the directors decided that Envireneer could benefit from Miss Hepburn business expertise and development advice. Envireneer Limited therefore decided to appoint Miss Hepburn as a consultant to help development business strategy, on condition that Miss Hepburn would do so through a separate company which would shortly be incorporated.
A consultancy agreement was drawn up on 10 October 2005. At that time, a new company had not been incorporated and the consultancy agreement provided for a company to be incorporated “once it has been determined if there are fees chargeable”. Miss Hepburn began providing a consultancy service and an invoice for the sum of £2.385 million was raised by Torglenn Limited.
HMRC’s Tax Assessment: Trading Income
HMRC’s contention was that section 5 of the Income Tax (Trading and other Income) Act 2005 provides that income tax is charged on the ‘profits of a trade, profession or vocation’. Section 8 provides that a person is liable for such tax is the person receiving or entitled to the profits. HMRC raised two tax assessments stating that the fee should form part of Miss Hepburn’s trading income. The combined tax claimed under these two assessments was approximately £1.2 million.
Miss Hepburn appealed to the tribunal against HMRC’s assessment stating that the fee should not form part of her trading profits, but should be subject to corporation tax liabilities.
FTT’s Decision: Corporation Tax
The FTT allowed the appeal and held that despite the obvious timing deficiencies, the intentions of the relevant parties matched the reality of the arrangement. The tribunal stated:
“We cannot accept HMRC’s view that the fee should be treated as the trading income of Miss Hepburn. That seems to us to ignore the reality of the arrangements… the substance and commercial effect of the arrangements was that Miss Hepburn would never be entitled to payment of the fee. She was to incorporate a company. It was within her power to do so and she eventually did so.”
Furthermore, the FTT considered it relevant that Miss Hepburn at no point had any real commercial risk arising out of the arrangement and held that Miss Hepburn would not be required to recognise the fees as trading income.
Outcome of FTT’s Decision
The decision of the FTT demonstrates that the tribunal was heavily influenced by a) the intention of the parties when entering into a consultancy agreement b) that the arrangement was entered into for a genuine commercial purpose, not for the purposes of tax avoidance.
The tribunal was persuaded to consider the scope and intention of the consultancy agreement and decided that Miss Hepburn was never entitled to payment of the consultancy fee. The case demonstrates that HMRC assessments are capable of challenge if a well-considered legal argument is put forward by expert tax solicitors and barristers.