UK: Weekly Tax Update - Monday 15 October 2012

Last Updated: 16 October 2012
Article by Richard Mannion

1. Private Clients

1.1. Employee-owners

The Chancellor of the Exchequer has announced plans for a new kind of employment contract called an owner-employee contract.

New employee-owners will exchange some of their UK employment rights for rights of ownership in the form of shares in the business they work for, any gains on which will be exempt from capital gains tax.

Companies of any size will be able to use this new kind of contract, but it is principally intended for fast growing small and medium sized companies that want to create a flexible workforce.

Under the new type of contract, employees will be given between £2,000 and £50,000 of shares that are exempt from capital gains tax. In exchange, they will give up their UK rights on unfair dismissal, redundancy, and the right to request flexible working and time off for training, and will be required to provide 16 weeks' notice of a firm date of return from maternity leave, instead of the usual 8.

Employee-owner status will be optional for existing employees, but both established companies and new start-ups can choose to offer only this new type of contract for new hires. Companies recruiting employee-owners will continue to have the option of inserting more generous employment conditions into the employment contract if they want to.

Legislation to bring in the new employee-owner contract will come later this year so that companies can use the new type of contract from April 2013. The Government will consult on some details of the contract later this month. Employee-owners receiving full capital gains tax relief on the shares awarded as part of their contract will still be eligible for existing employee share ownership schemes such as the Enterprise Management Incentive.

The Government consultation on the employee-owner contract will include the details of restrictions on forfeiture provisions to ensure that if an employee-owner leaves or is dismissed, the company is not able simply to take the shares back but is able to buy them back at a reasonable price.

2. PAYE and Employment matters

2.1. Employees resident but not ordinarily UK resident, taxed on the remittance basis, carrying out duties both in the UK and overseas under a single contract of employment

HMRC has published responses to the consultation on legislating SP1/09, together with draft legislation for its implementation. SP1/09 applies to employees who:

  • are resident but not ordinarily resident in the UK;
  • are taxed on the remittance basis; and
  • carry out duties both in the UK and overseas under a single contract of employment.

Such individuals will typically have their employment income paid into a single overseas bank account. This will by definition hold a mixture of UK and overseas earnings which will mean that it is a 'mixed fund' for the purpose of the remittance basis. Mixed funds are accounts containing more than one kind of income, capital gains or capital, or containing income, and/or capital gains and/or capital from more than one tax year. There are statutory provisions setting out how money or other property within a mixed fund is to be treated for tax purposes in section 809Q of the Income Tax Act (ITA) onwards ("the mixed fund rules"). The mixed fund rules operate on a transaction by transaction basis.

This single overseas bank account will normally be used to fund an individual's day-to-day living expenses, resulting in a very large number of transactions within a single tax year. Therefore a strict application of the mixed fund rules would be administratively complicated for individuals in this position. The purpose of SP1/09 is to provide a simpler alternative to the mixed fund rules for those who meet the relevant criteria. Under SP 1/09, such individuals can calculate their UK tax liability by reference to the total amount transferred out of their overseas account during the tax year as a whole, rather than by reference to each individual transaction.

The Government's aim in legislating SP1/09 is broadly to preserve the features and details of the existing practice, whilst recognising the need for a pragmatic approach to deliver simplification and clarity for the taxpayer. As a result of responses to the consultation, the Government proposes to extend the legislation to cover:

  • existing accounts, possibly with a requirement that they are cleared of all funds before being used as a SP 1/09 account;
  • accounts held jointly with a spouse, where the spouse makes no economic contribution to the account in line with the relaxation introduced by HM Revenue and Customs when SP1/09 was published; and
  • accounts containing funds from more than one employment which have duties both in the UK and overseas.

In relation to employment related securities, the consultation indicates special mixed fund rules will continue to apply to income and gains from employment related securities (ERS) in the same way as they do currently under SP1/09. There will still be an exception for the sale proceeds from employee share schemes where the employee is able to sell the shares but decides to retain them for a period before disposing of them.

The legislation to facilitate this is complex. There is an alternative approach - to treat all deposits of ERS income as tainting the account, and for them to be subject to the rules for deposits made in error outlined in the consultation document.

The proposed legislation has been drafted on the basis that ERS income may be deposited into the qualifying account in the following limited circumstances:

a) the securities or options were acquired pursuant to a right or opportunity available by reason of an employment of the individual;

b) the disposal is or occurs in conjunction with, or as soon as reasonably practicable after, a relevant event involving those securities or options; and

c) employment income from the employment for the tax year in which that relevant event occurs is mixed employment income (or would be if there were any).

3. Business tax

3.1. EU Financial Transaction Tax

On 9 October Anni Podimata, the MEP spearheading Parliament's position on establishing a financial transaction tax, made the following statement about the intention of 11 countries to press ahead with the FTT.

"I welcome the decision of 11 Member States to introduce a Financial Transaction Tax under enhanced cooperation on the basis of the Commission proposal of September 2011. It is a socially fair tax, an indispensible part of a complete and coherent solution to exit the crisis.

This is a reward for Parliament, which has been calling for an FTT for over two years. It will contribute to shifting the burden from the citizens to the financial industry - which has not yet contributed its fair share to the cost of the crisis. It will target the most speculative activities and at the same time provide finances equal to more than half of the EU's annual budget at a time of intense fiscal consolidation.

We will continue pushing to bring on board the greatest possible number of Member States."

Currently 11 countries have signalled their intent to press ahead with an FTT. Nine are needed for enhanced cooperation to be used. The countries are Germany, France, Belgium, Austria, Slovenia, Portugal, Greece, Italy, Spain, Estonia and Slovakia.

3.2. Corporation tax deductibility of penalties not imposed by statute

In 2007 McLaren Racing Ltd was required by the Federation Internationale de L'Automobile (the "FIA") to pay some £32 million and in addition to suffer a reduction in its gross income of some £34 million because, through its employees and agents, it had possessed and in some way used proprietary information belonging to Ferrari, and had thereby breached the rules of the FIA's International Sporting Code (the "ISC") to which McLaren was contractually bound. This penalty was not imposed by any statutory provision but under provisions to which McLaren was bound as a participant in Formula One racing. HMRC disputed the deductibility of the £32m penalty.

In calculating trading profits ICTA s74(1) (now CTA09 s54) prohibits deduction for expenses not incurred wholly and exclusively for the purposes of the trade (ICTA s74(1)(a) or CTA09 s54(1)(a)), as well as for losses not connected with or arising out of the trade (ICTA s74(1)(e) or CTA09 s54(1)(b)).

The Tribunal considered the issues according to the following principles:

1) In the case of a statutory penalty one must have regard to the policy of the statute imposing it in order to determine its nature. In so doing one seeks an answer to the question whether this penalty is like imprisonment, the cost or expense of (or punishment for) being the person who committed an act, or is it instead a cost of doing the act as it would be if it were compensatory or confiscatory.

2) The answer to that question will affect the application of both paragraph (1)(a) and paragraph (1)(e) [of ICTA s74(1)]. In relation to (1)(e) if the penalty arises from being the person who commits the act it will not arise out of the trade and will be not connected with the trade: in the same way that, if it were a gift to an employee, it would not have come "from" an employment.

3) A consideration of the policy of a penal statute, where the policy of the penal statute would be diluted by deductibility, may inform the interpretation or application of the tax statute. That may be the case where to permit deduction would be preposterous.

4) Where the purpose of the penalty is to punish so that the policy of the penalising statute would be diluted by deductibility, the expense or loss falls foul of (1)(a) and (1)(e).

5) Where a penalty arises in non-statutory circumstances the policy of the rule under which the penalty became payable will also be relevant to whether it is, like imprisonment, designed to punish the individual but considerations of policy are also relevant.

6) In the non-statutory case however the policy considerations which may affect the interpretation or application of taxing statutes are different. The proper understanding of the tax statute cannot be affected by the non-statutory policy, although more general policy considerations can have a part to play where they can be identified. But this exercise requires great caution. It is not permissible to say that a fine should not be deductible because the policy of a private body imposing it would be diluted. There must instead be such a public interest in the nature of this conduct that it would be wholly preposterous for the cost to be shared with the body of taxpayers.

7) In the non-statutory case, if the penalty arose from actions taken for the purpose of the trade, it will only be if it was imposed to punish the individual and if it would be contrary to a serious public interest to permit its deduction, that the penalty should be treated as not having been incurred for the purpose of the trade.

8) In relation to (1)(a) in the context of a non-statutory penalty, the question is whether the expense was wholly and exclusively incurred for the purposes of the trade. In addressing that question there is no test of sufficient connection to be applied. One is not required to ask whether the expense did or did not arise from the normal or ordinary course of trade, the statutory question is simply whether it was incurred wholly and exclusively for the purposes of the trade. If an expense is regular and unavoidable it may well be for the purposes of trade, but that does not mean that an unusual or avoidable expense will not be.

9) The Tribunal judge and member disagreed about the deductibility of this penalty. Mr Hellier (the Tribunal judge and chairman) considered that it was deductible, and Mr Dee (Tribunal member) that it was not.

Mr Hellier's views

Mr Hellier concluded that as McLaren's trade is "trying to make money from the design and racing of Formula One cars" the actions of its employees (which caused the penalty) might fall within it. This was in contrast to "trying to make money by participating in Formula One racing subject to any rules imposed in the Concorde agreement". On that description the employees' action could not be for the purpose of that trade.

This conclusion was reached because: (1) it was an ordinary part of McLaren's activities to seek information on its competitors' designs and strategy; (2) employing other teams' employees, and correspondingly taking steps to ensure that the damage which could result as the result of an employee defecting, were part of that activity; (3) Renault did the same; and (4) the World Motor Sport Council (WMSC) held that McLaren, by the activities of its employees, had obtained a sporting advantage - namely an advantage in the activity which gave rise to its income.

Whilst he could understand that fraud or deceit might be found not to be part of a trade which depended on probity or trust, he could see no compelling reason for finding that McLaren's trade was so limited. He noted that the penalty was set so as to deter others from the same course of action in the pursuit of their trades, but the deterrence of others does not of itself point to a policy of personal punishment for McLaren. In his view the penalty was a commercial penalty designed to affect McLaren in its commercial activity. It was not of a like nature with a statutory penalty designed to be suffered by an individual. It shared with criminal penalties the object of deterrence, but its motivating policy was not principally to punish McLaren in its person. In relation to public policy he concluded that the penalty was not levied for the protection of the public but mainly for the regulation of commercial activity. He therefore concluded neither ICTA s74(1)(a) nor (e) were in point.

Mr Dee's views

In Mr Dee's opinion it was clear that consideration of the penalty and potential exclusion from the F1 championship was an issue which affected McLaren's very existence. MacLaren did not appeal the overall penalty, though this was open to them. He found it hard to believe that the huge sum intended to punish such serious misconduct constituted an expense laid out wholly and exclusively for the purposes of the trade. It was paid to secure their continuing existence, F1 being crucial to this. No part of their trade could encompass what their employees or agents had done in view of the WMSC findings.

In McKnight v Sheppard 71 TC 419 (1999) [which concerned non-statutory fines imposed on a stockbroker by the Stock Exchange] the fine was held to be non-deductible by both the Special Commissioner and the Chancery Division. Lord Hoffmann in the House of Lords specifically approved of their view, saying "the reason [for disallowing] in my opinion is much more specific and relates to the particular character of a fine or penalty. Its purpose is to punish the taxpayer and a court may easily conclude that the legislative policy would be diluted if the taxpayer were allowed to share the burden with the rest of the community by a deduction for the purposes of tax".

In the view of Mr Dee therefore, one firstly has to look at the nature of the expense - it was a punishment.

Mr Dee therefore concluded that the penalty would be disallowed under s74(1)(a). He also concluded it was even more apparent that the penalty was caught by s74(1)(e) as it was imposed because the conduct of McLaren fell way outside any normal and acceptable way of conducting their trade, as found by the WMSC.

We will have to wait to see whether the case is appealed, but in view of the large sum and differing views, this would seem likely.

3.3. Use of personal service companies

The Public Accounts Committee (PAC) has criticised the BBC for having about 25,000 off-payroll contracts, e.g. using staff operating through personal service companies with the consequence (apart from the disguised remuneration rules) of no PAYE tax deduction obligations for the BBC. This is not really new news because there were newspaper headlines some years ago about the then Chairman John Birt being paid via his personal service company.

The first point to note here is that no details have been given about the nature of the duties of the 25,000 people in question. It may well be that some of them are genuinely self-employed artists or contractors, in which case there would be no reason to deduct tax at source. The BBC is to review these contracts and the PAC will be looking for assurance that the staff involved are paying the correct amount of tax on income received from the public purse.

There has been a wider issue recently about people in senior positions in Government and public bodies who are receiving their remuneration via a personal service company.

Personal service companies are a commonly used vehicle in many businesses. Often their use has nothing to do with tax mitigation and in many cases the "employer" insists on their use in order to circumvent the employment protection legislation. Where personal service companies are used the employer does not pay for holidays, sick leave, maternity pay and there will be no question of redundancy payments.

The Government first became concerned about the use of personal service companies in the 1990s because of concerns that the individual was subsequently taking dividends from the personal service company rather than being paid wages that would be liable to national insurance contributions. In 2000 it introduced a very complex special tax charge known as IR35 which effectively required a personal service company to operate a pseudo PAYE regime if certain conditions were met.

Consequently there will only be a loss of tax to the country if:

  • Payments are made to a personal service company that otherwise would have been taxed under PAYE.
  • The personal service company fails to operate IR35 properly.

No details have been provided to demonstrate that IR35 is not being properly applied although there are suggestions that HMRC does not currently check many cases a year, presumably because it doesn't have sufficient resources to do so.

To summarise, we have a horrendously complicated tax charge that few people really understand and this charge is in turn a by-product of the UK's over-complex tax system. The PAC noted that HMRC enquiries into the use of personal service companies have reduced from around 1,000 in 2003/04 to 23 in 2010/11. The most likely outcome of the PAC's concern will be a redoubling of effort by HMRC to police the IR35 system so personal service companies need to beware.

4. VAT

4.1. Partial exemption and the right to apply a special method

The standard method (based on turnover) of apportioning deductible and non-deductible input VAT must be used by all partly exempt taxable persons unless HMRC has agreed or directed the use of a different method, called a partial exemption special method ("PESM"). LockNStore Group plc has succeeded in overturning HMRC's refusal to consider a special method for their storage service business (they provided facilities for self storage and also sold insurance). Their proposal was to allocate input VAT according to floor space, resulting in a 99.8% deduction of input tax, compared to the recovery rate of between 94% and 96% using the standard method.

4.2. Repayment supplement

Our Communications Limited has succeed in overturning HMRC's refusal to give repayment supplement in relation to the late payment by HMRC of claims for VAT credits not made on a VAT return but accepted by HMRC exercising their discretion under regulation 29(1) of the Value Added Tax Regulations 1995 (SI 1995/2518). HMRC contended that the conditions to satisfy entitlement to repayment supplement required the VAT credits to arise from entries on returns.

The Tribunal did not accept HMRC's interpretation of VATA s79, and considered that it is neither necessary nor correct to restrict repayment supplement to VAT credits claimed in a return.

4.3. Whether energy saving materials qualified for the reduced rate

Pinevale Ltd have succeeded in overturning HMRC's refusal to accept the reduced VAT rate on two of their products. The products were Insupolycarbonate Roofing Panel, consists of polycarbonate materials comprising four or more cells used in conservatory Toofs (designed to reduce heat loss), and transparent heat reflector taking the form of a radiation reflector strip (designed to exclude summer solar heat). HMRC contended the roofing material was akin to efficient double glazing and was new roofing panelling rather than 'roof insulation' that qualified for reduced rate VAT as set out in the notes to group 2 of VATA Schedule 7A.

With respect to the reflector, HMRC contended this was more a product that would regulate conservatory temperature rather than one which would insulate the conservatory (they also contended the conservatory roof was a window rather than a roof).

The Tribunal concluded HMRC had adopted too restrictive an interpretation of insulation for a roof and that a conservatory roof was a roof rather than a window.

4.4. Rank Group and betting machines

The ECJ's decision in November 2011 (joined cases C259/10 and 260/10 on reference from the Court of Appeal and Upper Tribunal) considered the VAT treatment of betting and gaming machines. Gaming machines operating under the regulations contained in Part III of the Gaming Act 1968 ("Part III machines")) were at the relevant time subject to the VAT regime, whereas fixed odds betting terminals were exempt.

The Upper Tribunal has now considered how to give effect the guidance from that decision. The main question is whether charging VAT on Part III machines is a breach of the principle of fiscal neutrality, given that Fixed Odds Betting Terminals (FOBTs) are exempt from VAT, and that involves deciding whether the services provided by Part III machines and by FOBTs are relevantly "similar". The Upper Tribunal has directed that the case be re-heard at the First-tier Tribunal, consisting of the same members (as nearly as possible) and considering the same evidence. They will be required to take account of the differences in permitted stakes and prize limits, and to take account of the relevant or significant elements or circumstances liable to have a considerable influence on the consumer's decision to play one game or the other.∂=1&cid=71373

4.5. Zero rating of toasted sandwiches etc

The Upper Tribunal has confirmed the October 2010 decision of the First-tier Tribunal that toasted sandwiches known as 'toasted Subs' and meatball marinara did not come within the VAT zero rating definition and were therefore standard rated. The case was taken by Sub One Ltd (in liquidation) and was the lead case involving claims by over 1,200 Subway franchise outlets.

4.6. Agent and principal and the VAT implications

St Moritz Developments Limited ("SMDL") developed an hotel complex called the St Moritz Hotel which was in Trebetherick near Wadebridge in Cornwall. The rooms were later sold individually to investors to sub-let the rooms to guests wishing to stay in the hotel.

On 30 August 2007 SMDL entered into a management agreement with St Moritz Hotel and Garden Villas Limited ("GVL"). Under this agreement, in brief, GVL agreed to manage the hotel complex and in particular maintain the estate and common parts, and to maintain and let the hotel rooms as undisclosed agents for the owners of the rooms.

On 6 April 2010 SMDL granted a 999 year lease ("the Lease") of Apartment 104 of the Hotel to the appellants in this case, Mr & Mrs Roden, in return for which they paid £400,000 plus VAT of £70,000.

The terms of the Lease included terms that the Rodens would not underlet the property other than "through the landlord's letting agency". SMDL also covenanted to undertake services such as marketing the hotel, receiving the hotel guests, servicing the accommodation (such as changing the beds), and making the leisure facilities available. SMDL was entitled to deduct commission from the letting charges it collected. Even though GVL was not a party to the Lease, there was a provision that it would provide the same services to the Rodens that SMDL covenanted to provide, such as making up the rooms and receiving the guests.

The Rodens sought to recover this input VAT on their first return but were denied by HMRC on the grounds that they were using the hotel for exempt supplies of property. The case was heard before the First-tier Tribunal.

It was assumed by all parties that GVL acted as undisclosed agent to the appellants when letting their apartment to hotel guests. The Tribunal concluded that the legal position under the lease was that SMDL was liable to facilitate the letting of Apartment 104 to hotel guests and entitled to use an agent to do so, and was entitled to be paid commission for doing so. In the event SMDL used GVL to facilitate the lettings. Therefore, although the documents did not create a direct legal relationship between GVL and the Rodens, the Tribunal found that they did allow SMDL, as a disclosed agent, to create an agency relationship between GVL and the Rodens.

Item 1(d) of Group 1 to Schedule 9 provides that the following supplies are excluded from exemption: "the provision in an hotel, inn, boarding house or similar establishment of sleeping accommodation or of accommodation in rooms which are provided in conjunction with sleeping accommodation or for the purpose of a supply of catering."

VATA s47(3) provides that where services are supplied through an agent who acts in his own name the Commissioners may, if they think fit, treat the supply both as a supply to the agent and as a supply by the agent. Article 28 of the VAT directive states that where a taxable person acting in his own name but on behalf of another person takes part in a supply of services, he shall be deemed to have received and supplied those services himself. HMRC's case was that Art 28 deemed the Rodens to make a supply of the accommodation to their undisclosed agent GVL, and because GVL was not the occupier of the room, the supply could not be within Item 1(d), and was therefore exempt.

However the Tribunal considered that a very wide interpretation of the discretion given to HMRC by s 47(3) should be imputed so as to make the "agent-as-principal" treatment virtually mandatory. Referring to the ECJ decision in Henfling (C-464/10), the Tribunal concluded the following points: ï,— where Art 28 creates deemed supplies, a deemed supply principal to agent would normally but not necessarily, depending on the wording of the exemption or zero rating provision, have the same taxable status as the other deemed supply from agent to customer.

  • HMRC was wrong to treat the exclusion from exemption in Item 1(d) as limited to supplies direct to the physical user of the room for the following reasons: - there is nothing on the face of Item 1(d) that requires the supply to be to the person who actually uses the accommodation;
    • Item 1(d) should be interpreted in so far as possible to be consistent with VAT Directive Article 135(2)(a) which says nothing about limiting the exclusion of exemption to grants to the end user of the accommodation;
    • exclusions from exemption should be interpreted widely.

The Tribunal also directed HMRC and the appellant to confirm that VAT was properly chargeable on the original supply of the long lease. The Tribunal concluded that the long lease could not be zero rated as there was a limitation on the use of the property by the purchasers (the Rodens). However whether VAT was chargeable in the first place would depend on whether SMDL had opted to tax the property.

5. Tax Publications

NTBN231 - Buying High Value Residential Property in the UK

The Government has announced a number of changes that impact on the purchase of ownership of high value residential properties in UK.

NTBN235 - Partnership issues Sept 2012

Highlights 3 tax areas that will affect the tax paid by a partnership business, the proposed cap on tax reliefs, transfer pricing and HMRC task force.

NTBN234 - High income child benefit charge (short)

Overview of the key elements of the child benefit clawback charge and election not to receive child benefit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.