What it means to be an employee for the purposes of a claim to Entrepreneurs’ Relief
It is interesting how things go around and come around in the world of tax. I remember starting work with the Inland Revenue in the late 1980s when Retirement Relief was the big CGT relief for owner-managers. Every claim submitted was the subject of what HMRC would now call a ‘check’. As inspectors, we were not necessarily looking to deny the claim, just to establish its veracity. Bearing in mind that Retirement Relief could lead to no tax being payable, it seemed fair enough to check whether the relief was actually due.
We then moved into the brave new world of Taper Relief, potentially worth far more ultimately than its predecessor. However, this occurred at a time when HMRC was being reduced and restructured. Rather strangely, there were very few Tribunal cases in this area and, quite clearly, the days of a claim equalling an automatic enquiry had gone.
Then came Entrepreneurs’ Relief, a rush job due to a political faux-pas and a poorly drafted piece of legislation. What appears to be clear, though, is that HMRC are starting to raise far more enquiries into claims than was ever the case with Taper Relief.
The Entrepreneurs’ Relief rules have been with us some time and remain pretty much unchanged. There is a material disposal of business assets where an individual makes a disposal of business assets and this is a material disposal.
One particular disposal of one or more assets consisting of (or of interests in) shares in or securities of a company. In order to be a material disposal of shares, then Condition A, B, C or D need to be met.
Condition A is that, throughout the period of one year ending with the date of the disposal:
- The company is the individual’s personal company (5% of the ordinary shares and votes) and is either a trading company or the holding company of a trading group; and
- The individual is an officer or employee of the company or (if the company is a member of a trading group) of one or more companies which are members of the trading group.Condition B is that the above conditions are met throughout the year ending with the date on which the company ceases to be a trading company without continuing to be or becoming a member of a trading group or ceases to be a member of a trading group without continuing to be or becoming a trading company, and that date is within three years ending with the date of the disposal.Conditions C and D relate to EMI options/shares.
The most prevalent enquiry which I have seen, and which is also reflected through the Tribunal system, is the employee question. It would seem an easy test to meet but the informality of the family company seems to be causing problems.
HMRC are right to ask the question but their interpretation seems extreme and, possibly, incorrect. If the claimant is not visible on the payroll and is not a director, then HMRC take the approach that s169S TCGA 1992 defines ‘employment’ as having the meaning given by s4 ITEPA 2003. This section defines the term as including a contract of service. Where HMRC’s approach seems to break down is that the Entrepreneurs’ Relief legislation does not define the term employee and nowhere uses the term employment, so the cross reference from s169S to s4 above seems irrelevant.
Assuming HMRC are correct regarding the above interpretation, the HMRC party line seems to be to use the quote from Ready Mixed Concrete:
‘I must now consider what is meant by a contract of service. A contract of service exists if the the following three conditions are fulfilled:
- The servant agrees that in consideration of a wage or other remuneration he will provide his own work and skill in the performance of some service for his master.
- He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other’s control in a sufficient degree to make that other master.
- The other provisions of the contract are consistent with its being a contract of service.’
Therefore, no pay equals no Entrepreneurs’ Relief.
However, two recent cases seem to give the taxpayer some hope. In TC04038: Richard Hirst September 2014 First tier Tribunal, the taxpayer appealed against a decision to disallow an Entrepreneurs’’ Relief (ER) claim in respect of a capital gain on a disposal of shares in 2009/10.
HMRC argued that the taxpayer was not, throughout the period of the one year ending with the disposal of the shares, either an officer or an employee of the company.
During 2007 the position of the company became very difficult and, in order to control costs, the taxpayer resigned his position as managing director in December 2007. In December 2008 the taxpayer was guilty of assault and the criminal prosecution meant that it was not appropriate for him to resume a directorship.
He retained a company laptop and phone and the company continued to pay him for his home internet access.
The taxpayer argued that he was a ‘de facto director’. The statutory definitions of de facto director and shadow director appear in ss250 and 251 Companies Act 2006 respectively. Director includes any person occupying the position of director, by whatever name called. Shadow director means a person in accordance with whose directions or instructions the directors of the company are accustomed to act.
In respect of the employment issue, HMRC relied heavily on the above quote from Ready Mixed Concrete.
The Tribunal felt that relevant factors in this decision included:
- Whether the company considered him to be a director and held him out as such; and
- Whether third parties considered that he was a director.
The Tribunal stated:
‘We find that he was also not a director de facto, as that concept is explained in Smithton, at the relevant time. The test is that Mr Hirst should have acted as a director of the Company:
“The question is whether he was part of the corporate governance system of the company and whether he assumed the status and function of a director so as to make himself responsible as if he were a director.”
From the evidence we conclude that Mr Hirst’s influence was not a shadow director of the corporate governance of the Company was commensurate with but limited to that of a significant shareholder.
Further, we find that Mr Hirst was not a shadow director of the Company at the relevant time. The test here is (per Millett J in Hydrodam, quoted with approval in Holland);
“A shadow director…does not claim or purport to act as director. On the contrary, he claims not to be a director. He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to the exclusion of himself. He is not held out as director by the 40 company.”
We consider that the work undertaken by Mr Hirst between December 2007 (when he resigned his directorship) and the sale of his shares in July 2009 was significant…we consider they constitute the elements of an employment relationship between the Company and Mr Hirst. Looking at the matters identified in Ready Mixed Concrete:
- Mr Hirst agreed to provide his skills to the Company, and there was consideration in the form of (i) the agreement as to commission, and (ii) the non-cash remuneration consisting of the provision of the assets for the use of Mr Hirst.
- Mr Hirst was under the control of the Company – as evidenced by the Company’s oversight of the broker-to-broker business which was to be gained from ACF. Mr Hirst reported to the Company and the Company made appropriate decisions.
- There are no significant facts that are inconsistent with there being an employment relationship.’
The appeal was allowed.
In the second case (TC03435: Susan Corbett March 2014 First tier Tribunal), the taxpayer had been an employee of the company as clerical assistant to her husband, who was a director of the company.
She worked from home, as mainly did her husband between trips abroad. Her duties comprised answering the telephone, faxing documents, filing, and general office work. She occasionally worked for other people in the company as well as her husband and her salary was £14,000. In February 2009 she was removed from the payroll but her duties were exactly the same after February 2009 as before. Her husband had explained to her that receiving a P45 was the best way of dealing with the changes necessary for the sale of the company, as the purchaser’s policy was not to employ spouses. The taxpayer stated that the husband’s salary had been increased due to this.
HMRC rejected the claim on the grounds that she had ceased to be employed and had therefore not been an employee for the whole of the year ending with the disposal.
However, the Tribunal disagreed:
‘We accept that the motivation for removing Mrs Corbett from the payroll at the end of February was to keep her out of sight of the potential purchaser because of Kiotech’s sensitivity to the employment of spouses of senior executives. That was also the reason why she was not (apparently) disclosed on the list of employees scheduled to the share purchase agreement.
In relation to the adjustment to Mr Corbett’s salary from March 2009, we do not accept HMRC’s suggestion…that this was just a convenient explanation invented after the event to gloss over the absence of any remuneration for Mrs Corbett after February 2009. Mr Corbett’s sworn oral evidence was that his wife’s salary was directed to him from March 2009.’
The appeal was allowed.
The way ahead
The rules are not too onerous to meet, so think 12 months ahead to ensure that clients qualify. Failing that, it may be a fight but being on the payroll is not the be all and end all for a successful Entrepreneurs’ Relief claim.