The First-tier Tribunal ('FTT') has recently ruled in favour of a taxpayer in relation to a consultancy fee purportedly paid to a company which was not at the time incorporated (Maureen Hepburn v HMRC  UKFTT 445 (TC)). The FTT held that the fee was always intended to be paid to the company; the fact that the timing of incorporation and payment of the fee was 'not synchronised and [was] to some extent out of sequence'2 was not itself determinative.
The taxpayer, Miss Hepburn, was the 80% owner and managing director of Envireneer Limited ('Envireneer'). At a board meeting held on 10 December 2004, it was resolved that Envireneer would appoint Miss Hepburn as a consultant to provide strategic business development advice. This appointment was made on the basis that Miss Hepburn would provide her consultancy services through a company shortly to be incorporated.
Miss Hepburn began providing consultancy services to Envireneer in January 2005. The company through which Miss Hepburn purported to provide these services had not, at this point, been incorporated. In about June or July 2005, Miss Hepburn began discussions with various advisors about the most suitable form of corporate vehicle to use.
On 10 October 2005, an agreement relating to the consultancy services was entered into between Envireneer and 'Newco Limited (a company which will be incorporated once it has been determined if there are fees chargeable…)' (the 'Consultancy Agreement'). An invoice was subsequently raised by Torglenn Limited ('Torglenn') in the sum of £2.385m (the 'Consultancy Fee'), pursuant to the Consultancy Agreement. This invoice was approved at an Envireneer board meeting on 23 December 2005. The minutes of that meeting recorded that 'Miss Hepburn thought that Torglenn had been or was on the point of being incorporated'.
On 30 December 2005, Envireneer paid an amount equal to the Consultancy Fee to its solicitors to be held for Torglenn. On 4 January 2006 Torglenn was incorporated. On 8 January 2007 (over a year later) the solicitors paid the money representing the Consultancy Fee to Torglenn. The Consultancy Fee was:
- recorded in Torglenn's accounts for the relevant period and corporation tax paid thereon;
- recorded in Envireneer's accounts for the relevant period as a payment to Torglenn; and
- not declared by Miss Hepburn in her self-assessment tax returns for the relevant period.
HMRC contended that the Consultancy Fee fell to be taxed as self-employed trading income of Miss Hepburn, and raised protective discovery assessments in relation to the two tax years spanned by the Consultancy Fee. The combined tax claimed under these two assessments was approximately £1.2m.
In the FTT's view, the overarching issue was whether, by the application of generally accepted accounting practice, the Consultancy Fee constituted 'profits from a trade profession or vocation'.
The principle additional issue related to whether Miss Hepburn was entitled, as a matter of law, to the Consultancy Fee. The FTT considered this potential entitlement by reference to:
- Miss Hepburn's possible liability under section 36C of the Companies Act 1985 (which treats a contract purported to be made by a company not yet incorporated as made by the person purporting to act for the company);
- Envireneer's possible unjust enrichment by Miss Hepburn providing the consultancy services (if Miss Hepburn had no contractual right to payment for her services); and/or
- Miss Hepburn's potential obligation to account to Torglenn for the Consultancy Fee had she received it.
The FTT's decision
The FTT rejected HMRC's contention that the Consultancy Fee should be treated as trading income of Miss Hepburn: the 'substance and commercial effect of the arrangements was that Miss Hepburn would never be entitled to payment of the Consultancy Fee'3. The FTT considered that despite the obvious timing deficiencies, the expectations/intentions of the relevant parties matched the reality of the arrangements. Miss Hepburn did not receive the Consultancy Fee, did not demand it be paid to her, and at no stage had any control (as an individual) over the money the Consultancy Fee represented. Further, the FTT considered it relevant that Miss Hepburn (as an individual) at no point had any real commercial risk arising out of the arrangement. For these reasons, generally accepted accounting practice would not require Miss Hepburn to recognise the Consultancy Fee as self-employed trading income.
The FTT also considered that there was never any agreement (express or implied) that Miss Hepburn should have any entitlement to the Consultancy Fee as an individual. Furthermore the FTT held that:
- the application of s.36C of the Companies Act 1985 is expressly subject to any agreement to the contrary. The FTT considered that such contrary agreement was demonstrated in this case by the Consultancy Agreement and/or the various relevant board minutes;
- it would be impossible to conclude that Envireneer would be unjustly enriched at the expense of Miss Hepburn; and
- whether Miss Hepburn had any obligation to account to Torglenn for the Consultancy Fee (had she received it) was irrelevant given the FTT's finding that she had no entitlement to receive it.
The FTT acknowledged at the outset that the arrangements in this dispute 'were not, nor were they intended to be, an elaborate or even a simple tax-avoidance scheme. They were genuine commercial arrangements which had a rational purpose.' In other words, these were sensible and honest commercial arrangements poorly executed. This fact no doubt assisted Miss Hepburn in persuading the tribunal to allow her appeal, notwithstanding the obvious timing deficiencies.
Although Miss Hepburn was successful in her appeal, taxpayers and their advisors should not interpret this decision as an invitation to be anything other than thorough when implementing similar arrangements. Attention should always be paid to the detail of such arrangements, as to do otherwise may lead to a protracted and costly dispute with HMRC.