In Taylor Pearson (Construction) Limited v HMRC [2019] UKFTT 691 (TC), the First-tier Tribunal (FTT) has held that input tax on fees incurred in implementing a tax scheme, intended to remunerate directors in a tax efficient manner, was deductible.

Background

Taylor Pearson (Construction) Limited (the company) made supplies of construction goods and services, which were all taxable supplies for VAT purposes.

In March 2012, following a profitable trading year, the company decided to reward its three directors with bonuses of £50,000. The company engaged tax advisers to do so in a tax efficient manner. The fee was 11.5% of the total amounts paid to the directors. The scheme devised by the tax advisers included an issue of shares to the directors.

In HMRC's view, the company's case was similar to Customs and Excise Commissioners v Rosner [1994] STC 228 and Finanzamt Köln-Nord v Becker (Case C-104/12), in which input VAT incurred in defending a sole trader or individual employees personally, in criminal proceedings entirely unconnected to the business, was held not to be deductible.

HMRC issued a VAT assessment to the company pursuant to section 73, Value Added Tax Act 1994 (VATA), in relation to the company's VAT periods ending 31 December 2012 and 31 March 2014. The company appealed.

The substantive issue was whether the company was entitled to deduct input VAT in relation to services provided by the tax advisers. There were two specific issues to be considered by the FTT:

1. whether the services supplied were used for the purpose of the company’s business, within the meaning of section 24, VATA; and

2. whether the services supplied could have a direct and immediate link with taxable output supplies even though they had a direct and immediate connection with exempt supplies, being the issue of share capital in the company.

FTT decision

The appeal was allowed.

HMRC withdrew its first argument during the hearing, as the first issue of shares is not a supply for VAT purposes, and it is only the subsequent sale of shares that is exempt.

In the view of the FTT, the economic and commercial reality was that the services provided were tax advice in relation to the provision of employment rewards.

Referring to Kretzchtechnik (C-465/03), the FTT noted that the ultimate purpose of the arrangements, from the perspective of both the company and the employee, was to incentivise the employee in a tax efficient manner. It therefore had to consider whether that objective was for the purposes of the company's business.

HMRC argued that the incentivisation of employees did not have a direct and immediate link with the purposes of the business. The FTT did not agree and was highly critical of HMRC commenting:

"I do not consider this argument has any merit whatsoever and do not understand why HMRC put it forward. This concerns me … Perhaps of more concern to me is that this case is materially identical to the relatively recent case of Doran Bros ([2016] UKFTT 829), which was decided in favour of the appellant. HMRC did not appeal Doran Bros".

Applying Doran Bros, the FTT concluded that the incentivisation of employees, even when they were directors and shareholders of the company, had a direct and immediate link to the purposes of the business and it therefore allowed the appeal.

Comment

It is surprising that HMRC litigated this case, given its similarities to the FTT's decision in Doran Bros and the fact that case law in respect of Kretcztechnik is also well-established.

It is to be hoped that following this decision and the FTT's criticism, HMRC will think long and hard before adopting a position which has already been rejected by the FTT. If HMRC considered the FTT's decision in Doran Bros to be incorrect, it should have appealed the decision.

Although this can be a difficult area of tax, it is generally the case that VAT incurred on expenditure which is designed to increase staff morale and performance is a business expense.

The decision can be viewed here.