VAT recoverable on shareholder employee tax avoidance scheme says tribunal

"In my opinion the incentivisation of employees, even though in this case they were directors and shareholders of the company, has a direct and immediate link to the purposes of the business," said Judge Philip Gillett in the case which involved Taylor Pearson (Construction) Ltd.

The company had claimed VAT input tax recovery in respect of the fees for tax advice on granting rewards to three directors who were also shareholders of the company. HMRC said that the input tax was not recoverable on the basis that the only purpose of the transactions was to benefit the shareholders/directors of the company. The arrangements involved the issue of a new class of shares to the individuals.

The judge dismissed HMRC's argument that because the scheme involved an issue of shares, the advice was provided for the purpose of an exempt supply. He said that case law required him to consider the true purpose of the arrangements and to look through any initial transaction to ascertain objectively the overall purpose of the arrangements, considering all the circumstances. On this basis, he said that the ultimate purpose of the arrangements was to incentivise the company's employees in a tax efficient manner, from the perspective of both the company and the employee.

"This case is a particularly welcome decision for taxpayers, as HMRC has been known to challenge input tax recovery where companies have incurred significant professional fees in connection with arrangements designed to avoid PAYE and NIC on reward arrangements for directors/employees, particularly where the recipients are also shareholders." said Christine Yuill, a share incentives and tax expert at Pinsent Masons, the law firm behind Out-law.

Although each case is different, the decision in this case will be of considerable assistance to taxpayers facing challenges from HMRC on input tax recovery. The judge was very clear that input tax which is incurred for the purposes of rewarding and incentivising employees is deductible, and the fact that particular arrangements may seek to avoid PAYE and NIC is irrelevant, dismissing HMRC's argument as having 'no merit whatsoever'," she said.The judge found that the company's objective purpose in using the scheme was to avoid the payment of Class1A national insurance contributions (NICs), and to reward and incentivise its directors in a tax-free manner. The economic and commercial reality was therefore that the services provided were tax advice in relation to the provision of employment rewards, the judge said.

"The reward and incentivisation of employees is one of the more obvious overheads of the business that is treated as a cost component of the company's overall economic activities. It is in principle identical to expenditure on normal payroll services," the judge said.

He also dismissed HMRC's argument that expenditure on non-contractual bonuses, or salary paid outside the normal course of salaries was somehow different from a 'normal' payroll. "In my view, it is irrelevant whether the services are supplied in relation to contractual or non-contractual rewards and I can see no merit in this argument," he said.The judge said he was concerned that the case was "materially identical" to the 2016 FTT case of Doran Bros, where HMRC challenged input tax recovery on a fee for advice as to how to reward its sole employee with the least possible liability to tax and NICs. The taxpayer won that case, which was not appealed by HMRC. Although Judge Gillett was not bound by another FTT decision, he pointed out that convention dictated that he should treat it as highly persuasive unless he believed it to be clearly wrong.

He said he did not believe the Doran decision to be wrong and "given that the present appeal also concerns advice given to a taxable person as to how it can reduce its tax and NICs liabilities in rewarding one or more employees in the context of a 'tax avoidance scheme', the similarities are obvious. Not surprisingly therefore I come to the same conclusion".