Judgment summary
Mr John Lowry appealed against three closure notices issued by HMRC on 15 December 2016, which amended his self-assessment returns for 2011/12, 2012/13 and 2013/14 to include additional tax of £316,908.40, £183,724.40 and £89,259.55 respectively (paragraph 1). The notices were issued on the basis that the appellant's participation in the K2 Scheme resulted in him receiving 'earnings' under section 62 ITEPA and/or amounts treated as employment income under Part 7A ITEPA (paragraph 1).
The tribunal considered two issues: first, whether sums paid as 'loans' constituted 'earnings' under section 62; and second, if not, whether they were taxable as employment income under Part 7A (paragraphs 5 and 9). The tribunal heard extensive evidence, including cross-examination of the appellant, and considered marketing materials, guidance notes from the appellant's tax adviser, and the contractual chain of arrangements.
The tribunal concluded that the sums provided under the 'loans' were 'earnings' within the meaning of section 62, applying a purposive construction of the statute and, if necessary, a purposive approach to construing the loan agreements themselves (paragraph 10, Part D). The tribunal also considered, in case of appeal, that Part 7A would independently apply to tax the same sums (Part D, paragraphs 144 to 159). The appeal was dismissed (paragraph 160).
Background
The appellant, an independent turnaround and restructuring specialist, provided his services through a company, Eclecsys Limited (EL), which contracted with various end-user clients (paragraphs 2 and 25). Prior to the arrangements in question, he used a similar structure known as the 'Hamilton scheme' (paragraph 2).
Under the arrangements known as the K2 Scheme, developed by EDF Tax LLP and marketed by Peak Performance Tax Ltd (PPT), the appellant became an employee of a Jersey-resident person or trust (paragraphs 2 and 4). His employer paid him a salary at approximately the national minimum wage and made interest-free 'loans' to him at its discretion (paragraph 3). Very soon after each 'loan' was made, the right to repayment was assigned to an offshore Employer Funded Retirement Benefits Scheme (EFRBS), of which the appellant was a beneficiary (paragraph 4(4)).
The sums which K2 provided to the appellant as salary and 'loans', net of tax and NICs, equated to roughly 82% of the amounts paid to EL by end-users of the appellant's services, with the remaining 18% representing fees deducted in the chain of supply (paragraph 4(3)). The arrangements ceased to operate on 31 March 2014 (paragraph 4(1)(d)). The appellant contended that the 'loans' were repaid in full in December 2018, using funds from a 'commercial loan' from Pyrrhus Capital Limited, in response to the 'loan charge' introduced by Schedule 11 of the Finance (No.2) Act 2017 (paragraph 4(6)).
Core dispute
The central dispute was whether the sums paid to the appellant under the 'loans' constituted 'earnings' within the meaning of section 62 ITEPA, or, alternatively, whether they were taxable as employment income under Part 7A ITEPA (paragraphs 5 to 9).
The appellant argued that the 'loans' contained a genuine obligation to repay, relying on the Court of Appeal decision in Currell, and that funds provided under a loan do not generally constitute 'earnings' because of the existence of a repayment obligation (paragraph 11). He contended he intended to repay the loans on retirement and that his ability to repay was never in question (paragraph 11(5), paragraph 41).
HMRC contended that, on a purposive construction and a realistic view of the facts, the parties never intended the 'loans' would be repaid, and that the 'loans' were simply a mechanism for delivering employment reward to the appellant, relying on Acornwood, Antoniades, RFC, and related authorities (paragraph 12). HMRC also raised, as an alternative basis, that Part 7A applied to tax the payments made through the contractual chain from EL to 3PCL to K2 (paragraphs 144 to 159). There was also a dispute over whether the tribunal should have regard to factual findings made in other cases involving similar or connected schemes (the 'disputed cases'), including the Hyrax decisions, in light of the rule in Hollington v Hewthorn as explained in Evans v Barclays Bank plc (paragraphs 13 to 24).
Court findings
The tribunal found the appellant's evidence that he intended, from the outset, to repay the 'loans' voluntarily on retirement was not credible (paragraph 42, paragraph 138(5)). It found it was not credible that Mr Marum gave the appellant assurance that HMRC had reviewed and approved the arrangements (paragraph 43(2)). The tribunal found the appellant's account of ceasing to use the Hamilton scheme due to governance concerns was not credible, concluding instead that the scheme simply ceased due to a change in the law (paragraph 46).
The tribunal found the appellant had no basis for his belief that the contracts between 3PCL, EL and K2 were 'bespoke' or subject to material negotiation, or that there was any commercial reason for K2 or 3PCL's involvement (paragraph 55). It did not accept that the 'loans' were repaid in 2018 through a genuinely commercial arrangement with Pyrrhus, finding that arrangement unusual, unsecured, arranged through the appellant's tax adviser, and involving the appellant taking a small shareholding in the lender (paragraphs 72 to 80, paragraph 138(6)).
The tribunal concluded it was reasonable to infer there was no realistic prospect that K2 or the EFRBS trustee would ever require repayment against the appellant's wishes, and that the arrangements were designed to give the appellant unfailing, undelayed access to the funds generated by his services, less a scheme fee (paragraph 138(7), paragraph 141). Applying a purposive construction of section 62, informed by Currell, RFC, PA Holdings and related authorities, the tribunal held the sums paid under the 'loans' had the character of a reward for the appellant's services and constituted 'earnings' under section 62, regardless of whether the 'loans' were loans in a strict legal sense (paragraphs 140 to 143).
On the disputed cases point, the tribunal held that the principle in Evans v Barclays Bank plc applies to proceedings in the tribunal, and that it would not be appropriate to make findings of fact based on findings in other decisions concerning different issues to which the appellant was not a party; it did not find it necessary to rely on the disputed cases (paragraphs 23 to 24).
On Part 7A, although not strictly necessary given the section 62 finding, the tribunal concluded that, on a purposive construction, the payments made through the contractual chain from EL to 3PCL to K2 constituted 'relevant steps' within section 554C, as the appellant had in substance chosen that payments be made to K2 as his employer, and the conditions of section 554A were met (paragraphs 157 to 159).
Outcome
The appeal was dismissed (paragraph 160). The tribunal held that the sums provided to the appellant under the 'loans' were taxable as 'earnings' under section 62 ITEPA, and, in the alternative, would also be taxable as employment income under Part 7A ITEPA (paragraph 10, paragraph 159).
Major issues / areas of contention
- Whether sums paid to the appellant under 'loans' made pursuant to the K2 Scheme constituted 'earnings' within the meaning of section 62 ITEPA (paragraph 5).
- Whether, if not earnings under section 62, the sums were taxable as employment income under Part 7A ITEPA, including whether a 'relevant step' occurred under section 554C (paragraph 9, paragraphs 144 to 159).
- Whether the written repayment terms in the loan agreements should be construed on their ordinary legal effect or whether a 'purposive approach' akin to that in Antoniades v Villiers and Autoclenz Ltd v Belcher should be applied to determine the true agreement between the parties (paragraphs 82 to 117).
- Whether the tribunal could or should have regard to factual findings made in other decisions concerning related or successor schemes (the Hyrax decisions and other 'disputed cases'), applying the rule in Hollington v Hewthorn as explained in Evans v Barclays Bank plc (paragraphs 13 to 24).
- Whether the appellant genuinely intended to repay the 'loans' and whether the 2018 repayment via a loan from Pyrrhus Capital Limited was a genuine commercial transaction (paragraphs 41 to 42, paragraphs 72 to 80).