Limitation proves to be a magic bullet for Magic Carpets

In Magic Carpets (Commercial) Ltd v HMRC [2023] TC08892, the First-tier Tribunal (FTT) held that although a taxpayer acted carelessly in implementing a tax planning arrangement involving an employee benefit trust (EBT), this carelessness did not bring about a loss of tax. HMRC's determinations were therefore out of time as they had been issued after the regular four-year limitation period had expired.

Background

Magic Carpets (Commercial) Ltd (Magic Carpets) had utilised a tax planning arrangement which involved the use of an EBT, for the remuneration of its key personnel.  

In outline, a Jersey-based human resources consultancy (Herald) would offer recommendations as to how key personnel should be remunerated and incentivised.  It would outsource this exercise to a UK limited liability partnership whose members included the directors of the UK based promoter.  The recommendation would 'invariably' be that the company using the arrangement (in this case, Magic Carpets) should settle an amount into an offshore EBT from which its key personnel could benefit.  At the same time as making its recommendation, Herald would send an invoice (the Invoice) for an amount that included its fees for implementing the recommendation and the sum it had recommended be made available to the relevant personnel.  Magic Carpets would pay the invoice, Herald and the UK promoter would deduct their fees, and the balance would be settled on the EBT in Magic Carpets' name.  For each employee who was to benefit from the arrangement, a sub-trust of the EBT was created, and a share of the amounts paid to the EBT would be allocated to the sub-trust.  The sub-trust would make loans to the relevant individual.  Magic Carpets would claim a deduction from its UK corporation tax for the amount paid under the Invoice (on the basis that it constituted fees for Herald and the UK promoter) although the amounts to be allocated to the individuals were included in its accounts as remuneration.  It would not account for PAYE or National Insurance contributions in respect of the sums which were loaned to its employees.   

HMRC made two determinations under regulation 80, Income Tax (Pay As You Earn) Regulations 2003 (Regulation 80) in respect of unpaid PAYE income tax for 2009/10 and 2010/11, and issued a related penalty assessment under Schedule 24, Finance Act 2007 (Schedule 24).  The 2009/10 determination was issued on 5 April 2016, and that for 2010/11 on 10 February 2017.  

Magic Carpets appealed the determinations and the assessment to the FTT.

Legislation

Regulation 80(5) provided, for the relevant years, that determinations made thereunder were subject to parts 4, 5, and 6 (and for 2010/11, part 5A), Taxes Management Act 1970 (TMA) as if they were assessments and the amount of tax determined was income tax charged on the employer.  

Section 34, TMA, provides that the ordinary time limit for HMRC to raise an assessment for income tax is four years after the end of the year of assessment to which it relates.  

Section 36, TMA, provides, relevantly, that 'An assessment ... in a case involving a loss of … tax brought about carelessly … may be made at any time not more than 6 years after the end of the year of assessment to which it relates' and that 'references to a loss brought about by the person who is the subject of the assessment include a loss brought about by another person acting on behalf of that person'.

Paragraph 1, Schedule 24, provides that a penalty is payable by a person who gives HMRC a document of a relevant kind (including a tax return) and that document contains an inaccuracy which amounts to or leads to an understatement of a liability to tax, a false or inflated statement of a loss or a false or inflated claim to repayment of tax, and where the inaccuracy was careless or deliberate on the part of the person submitting it.

FTT decision

The appeals were allowed.

There was no dispute that the EBT arrangement was ineffective and did not achieve the tax savings expected by Magic Carpets and that there had been a loss of tax.  There was also no dispute that HMRC's determinations had been issued outside the ordinary time limit of four years but within the six-year time limit that is available when a loss of tax is brought about carelessly.

In assessing Magic Carpets' conduct, it was agreed  that it should be assessed by reference to a hypothetical 'prudent and reasonable taxpayer' in its position (the test set out by the Upper Tribunal in HMRC v Hicks [2020] UKUT 0012 (TC)).  

The FTT took the view that in normal circumstances it would be reasonable for Magic Carpets to rely on the advice of its professional advisors in compiling its tax returns, and ought not to be treated as 'careless' if it followed that advice.  Magic Carpets had relied on its accountants, an independent firm of professional advisers recommended to its directors by friends and business associates.  However, in the view of the FTT, there were some aspects of Magic Carpets' conduct that could be regarded as careless: its directors had made 'no attempt' to understand the steps involved in the arrangements beyond the fact that they involved an EBT and loans.  They did not ensure that documents were properly executed or signed in the right order, and they signed documents that referred to meetings that had not happened.  Moreover, they knew, or should have known, that the arrangements with Herald lacked any real substance.  They knew that their accountants were using the arrangement themselves, and the FTT considered that it might be said that it should have sought independent advice.  Against this, Magic Carpets' directors were not sophisticated taxpayers and they trusted their advisers implicitly.  On balance, the FTT considered that the company was careless in not making any further enquiry (whether of its accountants or of another adviser), given the 'material inadequacies' in the implementation of the arrangements.  

However, it was not sufficient simply to show that Magic Carpets had been careless. HMRC bore the burden of showing that the carelessness had caused the tax loss and/or inadequacies in Magic Carpets' returns and it had failed to do so.  On the basis of the case law as it stood at the time, it would 'not have been unreasonable' to take the view that the EBT contributions and director loans did not attract PAYE income tax. Indeed, at the time, the 'better view' would probably have been that they did not.  Had Magic Carpets made further enquiry in relation to the arrangements, it was unlikely that independent specialist advice would have been that the contributions to and loans from the EBT should be treated as employment income.  

Accordingly, even though Magic Carpets had been careless, the carelessness had not caused the loss of tax and HMRC was therefore out of time to issue the determinations.  The same reasoning applied to render unsuccessful HMRC's alternative argument that Magic Carpets' accountants had been careless in acting on its behalf and therefore the determinations were in time due to section 36(1B), TMA.   

Comment 

This decision illustrates the importance of considering the entirety of a statutory test.   Although Magic Carpets was considered by the FTT to have acted carelessly, this was not enough to render HMRC's determinations in time since the loss of tax to which they related was not occasioned by that carelessness.  

The decision can be viewed here.

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