Tax Newsletter

Welcome to the latest issue of our tax newsletter in which we consider recent tax developments.

We look at the VAT exemption for insurance-related services and the discrepancy between the UK's position and that delineated in the CJEU on the scope of that exemption; the recent decision of the Court of Session which characterises certain payments into an employee benefit trust as employment income; and the scope of jurisdiction of appellate courts.

Outsourcing in the insurance industry

The First Tier Tribunal in Riskstop Consulting Ltd -v- Revenue & Customs [2015] UKFTT 469 (Riskstop) has recently criticised how far adrift UK domestic legislation with regards to the VAT exemption for insurance-related services is from the Court of Justice of the European Union's (CJEU) interpretation.

Back in 2003, the CJEU held that, in order to obtain the benefit of the VAT exemption, an insurance broker must have freedom of choice of insurer for their client and an insurance agent must be instrumental in bringing together the two parties to an insurance contract by finding prospective clients and performing introductory services.¹ This decision meant that the UK's interpretation of the VAT exemption which applies to insurance-related services was too wide. However, despite this, HMRC issued guidance (VATINS5210) (Guidance) reassuring the public that for now, at least, the UK's wider interpretation of the exemption was still available. Consequently, according to the Guidance, the VAT exemption can still be applied to, for example, claims handling services relating to the administration of contracts of insurance provided separately from introductory services.

This approach taken by HMRC was pragmatic and widely welcomed within the insurance industry. At the time of issuing the Guidance, HMRC considered itself able to take this approach because of the ongoing negotiations to modernise the financial services VAT exemption and recast it in a new regulation and directive. The hope was that the EU law would be changed to follow the UK's approach. However, it proved impossible to agree the new financial services exemption and the European Commission has now shelved its proposal to rewrite the VAT Directive. Despite this, HMRC has not updated the Guidance even though the industry is still relying on it.

It remains to be seen whether HMRC's practice in this area (i.e. the Guidance) will change. It could be that the VAT exemption is changed by some form of infringement proceedings being initiated by the EU Commission against the UK. Alternatively, HMRC may consider that they no longer have the power to apply the law in accordance with their Guidance, particularly in light of the recent judicial criticism in Riskstop (see below). It is our view, however, that what is most likely to focus attention on the scope of this VAT exemption is another case on insurance outsourcing going through the CJEU.²

If the UK approach changes, that would be of concern to a large number of insurers which outsource administrative services and currently rely on the Guidance.

Riskstop
Riskstop provided risk management services to insurers either by assessing the insured's risk based on the contents of a questionnaire that Riskstop sent to the insured (the Questionnaire Survey) or by way of a site survey (the Site Survey). The First Tier Tribunal was asked to consider whether these services of providing Questionnaire Surveys or Site Surveys fell within the financial exemption for the provision of certain services by insurance brokers or insurance agents.

Riskstop was unable to persuade the Tribunal that it could avail itself of the exemption for its services as, while it advised the insurer on risk management issues and liaised with the insured to monitor compliance with any required improvements, it did not find prospects, introduce new customers to the insurer, or put insurers in touch with potential customers. ECJ and domestic case law – most recently, the Upper Tribunal case of Westinsure – provide that "essential aspects of the work of an insurance agent include the finding of prospects and their introduction to the insurer". As Riskstop did not carry out this type of activity, it was not, therefore, an insurance agent and its services could not be exempt.

In relation to how the scope of the UK VAT exemption for insurance-related services differs from the scope of the same delineated by the CJEU, the Tribunal stated:

"Mr Connell very properly reminded us that HMRC accept (and so state in the Manual) that the provisions of Item 4 seem to range wider than the scope delineated by the CJEU in its case law on art 135 (and its predecessor art 13B). We do consider it unsatisfactory that, a decade after the Andersen decision, the UK domestic legislation still appears to be so far adrift from the CJEU's interpretation of art 135."

Unexpected twist to employee benefit trusts?

On 4 November, the Court of Session decided in Advocate General for Scotland -v- Murray Group Holdings and Others [2015] CSIH 77 (Murray Group) that tax planning which, when implemented back in 2001, was thought to be at the more robust end of the spectrum, appears not to achieve its aims. Furthermore, the decision has people questioning the tax treatment of other common scenarios.

In Murray Group, the Court of Session (which is Scotland's equivalent of the Court of Appeal) has overturned the decision of the Upper Tribunal that loans provided to Rangers FC players and executives through an employee benefit trust (EBT) were not subject to income tax and NICs as employment income (see our September 2014 Newsletter for the Upper Tribunal decision). The Upper Tribunal decision was appealed by HMRC on two grounds, of which the Court of Session agreed with one: that the trust structure and loans amounted to a "mere redirection of earnings", rendering payments to the EBT emoluments or earnings and accordingly subject to income tax and NICs as employment income.

Murray Group – the facts
In April 2001, Murray Group Management Ltd (MGM), a company in the same group as Rangers, set up a principal discretionary "Employees' Remuneration Trust" (the Principal Trust) to be used as the basis of a scheme for the purpose of providing benefits for family members of employees of other companies within the same group as MGM. The employing company would then advance monies to the trustees of the Principal Trust and "without exception" a sub-trust was subsequently created in the name of each participating employee for the benefit of nominated family beneficiaries excluding the employee himself. 108 sub-trusts were set up in total between the tax years 2001/02 to 2008/09.

Each sub-trust was funded by the Principal Trust effectively in lieu of either a payment of a discretionary bonus in the case of non-footballers or a payment on recruitment or renegotiation of a contract, bonus, or on a transfer in the case of footballers. For footballers, this payment was embodied in a side letter negotiated at the time of the player's contract which contained provisions for a discretionary trust payment akin to a bonus payment. There was no equivalent contractual right for non-footballers. In both cases, the payments were grossed up for income tax and NICs, to reflect an apparent intention to make a tax-free payment.

It was explained to each employee that he could access a loan from the sub-trust as a tax-free sum greater than a payment of salary net of tax deducted under the PAYE system and repayable out of his estate, so reducing its value for inheritance tax purposes. While the fundamental purpose of the sub-trust was to benefit the employee's family, in virtually all cases the full amount of the funding into each sub-trust was loaned to the relevant employee. These loans were unsecured, for a term of ten years (with the understanding and expectation that the loan would be renewable on request and repayment not demanded during the employee's lifetime) and at an interest rate of LIBOR plus 1.5–2 per cent. On applying to the trustee for the loans, very little consideration appears to have been given to the purpose to which the loan would be put or the ability of the employee to repay the loan.

The employee was always appointed as protector of the sub-trust (broadly equivalent to a trustee) and the Court of Session found that he did not have the power to amend the trust purposes such that other beneficiaries could be removed and he could be appointed the sole beneficiary. The funds were not placed "unreservedly" at his disposal, i.e. he did not have practical control over the disposal of the funds.

Redirection of earnings
It may appear surprising to some that the Court of Session has held that, despite the trust arrangements and the fact that funds were not placed "unreservedly" at the employee/protector's disposal, payments into the Principal Trust are a redirection of earnings. In taking a common sense and realistic approach to the facts, looking at the true nature of the transaction, the Court essentially ignored the trust structure and loan arrangement. Instead, they focused on the fundamental question of whether payments made by the employing companies were part of the consideration for employees' services – if they were, they were emoluments or earnings and were taxable.

The Court based this approach on the following principle:

"If income is derived from an employee's services qua employee, it is an emolument or earnings, and is thus assessable to income tax, even if the employee requests or agrees that it be redirected to a third party. That accords with common sense. If the law were otherwise, an employee could readily avoid tax by redirecting income to members of his family to meet outgoings that he would normally pay. … It follows that if the principle applies, it is irrelevant that the redirection is through the medium of trust arrangements."

In respect of payments made to footballers, they held that the obligations in the side letter were part of the employee's employment package. In relation to the payments to non-footballers, the Court held that bonuses were paid on the basis of the work performance of the employee and the profitability of his employing company. Thus, the amount of the bonus was determined by reference to the employee's employment activities. It was "very obvious" that the bonuses were derived from, and based on, the work done by the particular employee. The fact that the payments were made by way of loan was considered irrelevant.

It was therefore held that the payments made by the employing company to the Principal Trust were relevant payments of emoluments or earnings and are accordingly subject to income tax, with the obligation to deduct tax under the PAYE system falling on the employer who made the payment.

This sort of advantageous tax planning with loans is no longer possible in any event as a result of the introduction of the Disguised Remuneration Rules (known to some as Part 7A ITEPA 2003) in April 2011.

What about other arrangements?
It remains to be seen if this judgment has any consequences for common forms of tax planning where an employee foregoes salary for a contribution to a pension, or in exchange for selected non-cash benefits, and would no longer attract the beneficial tax treatment of the pensions regime. Arguably, this is taking the application of the case too far, as such arrangements may still give their intended benefits if implemented properly. But the case has given rise to the question of when and how, if at all, can the link between employment and money, which may or may not be at an employee's disposal, be broken for amounts not to constitute earnings or emoluments.

What is next?
Even though only one respondent opposed HMRC's appeal, given that this judgment could potentially have ramifications beyond the EBT remit and overturns the findings of both previous appellate courts, we would expect Murray Group to appeal.

Playing with the facts – Murray Group again

Earlier this year, Lord Carnwath, sitting in the Supreme Court, discussed the jurisdiction of the Upper Tribunal when examining the findings of First Tier Tribunals (HMRC -v- Pendragon plc [2015] UK SC37 (Pendragon)). While these comments were made in obiter, they are importantly comments with which the other four judges sitting in Pendragon agreed. Numerous Upper Tier Tribunal decisions since Pendragon have broached this topic and we have now received the decision in Murray Group from the Court of Session which also addressed this topic.

What does an appellate Court have jurisdiction to comment on?
The underlying principle of Edwards -v- Bairstow [1956] AC 14 is that a finding of fact by a lower Court cannot be disturbed unless the lower Court has either erred in law or interpreted the evidence so badly that their findings were perverse.

Lord Carnwath in Pendragon reiterated that there had to be a finding of an error of "law" for the Upper Tribunal to be able to intervene with a decision of the First Tier, but was more focused on the difficult issue of the jurisdiction of the Upper Tribunal when an appeal arises which is grounded in a matter of principle rather than the black letter law itself.

Pendragon
From paragraphs 44 to 57 of the judgment in Pendragon, Lord Carnwath set out his views as to the jurisdiction of the Upper Tribunal. He stated that the Upper Tribunal is a "specialist tribunal" with an extended jurisdiction conferred upon it as compared to the jurisdiction of the High Court, and that part of its role is to ensure that the First Tier Tribunals adopt a consistent approach to the law. The meaning of "law" in this context includes issues of general principle and therefore the Upper Tribunal is also responsible for developing structured guidance on the use of expressions in order to reduce the risk of inconsistent results being made at the level of the First Tier. Because "law" in this context also includes matters of general principle, this means that when a case is appealed which is concerned with a "general principle", such as Pendragon, the appeal may not be purely confined to matters of law, and in such a case the Upper Tribunal may also be required to make such factual judgments as are necessary in remaking the decision.

Murray Group
In Murray Group, Lord Young considered the powers of an appellate court on a statutory appeal but in the context of the Murray Group appeal and thus the Court of Session being able to overturn the decision of a lower court. Lord Young, therefore, did not comment on the jurisdiction of the Upper Tier and that is perhaps why he did not reference Lord Carnwath's comments in Pendragon. What Lord Young did discuss, however, was how controversial a "point of law" can be and, as part of the discussion, he set out four different categories of case upon which an appeal may be made on the basis of a "point of law".³ Within these four categories he included appeals on the general law: the content of its rules and explained that this category included non-statutory rules and principles such as the Ramsay principle.

Broader jurisdiction for the Upper Tribunal?
It could be inferred from Lord Carnwath's comments that the Upper Tribunal has a broader jurisdiction than the higher appellate Courts. This is not something which Murray Group touched on, as it was concerned with the jurisdiction of the Court of Session. However, what did emerge from both Pendragon and Murray Group is that matters of principle can amount to matters of law and that the distinction between fact and law which the Courts face can be a difficult one.

_Notes

_{¹ Case C-472/03, Staatssecretaris van Financiën -v- Arthur Andersen & Co. Accountants c.s.
² Case C-40/15, Minister Finansów -v- BRE Ubezpieczenia Sp. Z o.o.
³ The four categories of case which fall within the remit of an appeal of a point of law are:
(a) appeals on the general law: the content of its rules;
(b) appeals on the application of law to the facts;
(c) where the Tribunal has made a finding for which there is no evidence or which is inconsistent with the evidence and contradictory of it; and
(d) where the First Tier Tribunal has made a fundamental error in its approach to the case.}