UK: directors' liability for the company's debts - a tax deductible expense?

In small, private companies it is not unusual for directors to guarantee company debts.  In A Guarantor v HMRC Commissioners [2008] UKSPC 00703 a company's directors guaranteed the company debts and did so as a condition of a factoring agreement which the company had entered at a time of financial difficulty. One director (hereafter 'the taxpayer') resigned from office but nevertheless became liable under the guarantee. He argued that his liability was a tax deductible expense. HMRC disagreed and the taxpayer appealed: the appeal was heard in July by Special Commissioner Colin Bishopp. 

The general rule concerning the deductibility of employees' expenses is found in Section 336(1) of the Income Tax (Earnings and Pensions) Act (2003), which provides that a deduction is permitted if:

(a) the employee is obliged to incur and pay it as holder of the employment, and

(b) the amount is incurred wholly, exclusively and necessarily in the performance of the duties of the employment.

The taxpayer argued that conditions (a) and (b) were satisfied because he had a duty to maintain the company's solvency and, given that the company had exhausted all other possible sources of finance, his liability was incurred wholly and necessarily in the course of his employment. Special Commissioner Bishopp rejected the taxpayer's claim, agreeing with the majority of arguments advanced on behalf of HMRC including the fact that liability arose after the taxpayer's employment had ended (and was not, therefore, incurred in the performance of the employment). The Special Commissioner did, however, observe (at para. [12]): "Mr Smith's argument [on behalf of HMRC] that the payment is disqualified for relief because not every company director is obliged to give a personal guarantee for the company's debts may well overstate the position" (para. [12]). 

UK: England and Wales: an investment company?

Judgment was given earlier this week in Dawsongroup Plc v Revenue & Customs [2010] EWHC 1061 (Ch). The case concerned a company - Dawsongroup plc - the holding company for a group of companies carrying on the business of renting trucks, trailers, buses, coaches and other specialist equipment. The company undertook two activities: [1] providing services to the subsidiary companies (including banking, financial, legal and IT services) and [2] holding the shares of the subsidiary companies and arranging the affairs of the group (which included the disposal and acquisition of companies, the general control of the subsidiaries to ensure the maintenance of their value, and receiving income from the subsidiaries in the form of dividends).

Last year, in the First-tier Tribunal (Tax) (see [2009] UKFTT 137 (TC)) it was held that the company was not an investment company, defined by Section 130 of the Income and Corporation Taxes Act (1988) as "any company whose business consists wholly or mainly in the making of investments and the principal part of whose income is derived therefrom...". As such, the company was unable to deduct certain expenditure under Section 75 of the 1988 Act when calculating its profits for corporation tax purposes.

The company appealed. Mann J. heard the appeal and held that the company was an investment company although, for other reasons, the disputed expenditure was not deductible. In holding that the company was an investment company, Mann J. held that the First-tier Tribunal judge had incorrectly decided that the company's exercise of control over the subsidiaries was a trading activity. HMRC argued that the company's investment activity was ancillary to its main trading activity of providing services. Mann J rejected this argument because it failed to describe the company's raison d'être and the overall picture of its functions. He instead found that the company was "primarily a holding company ... which also happens to provide services to the rest of the group ... its main activity is being a holding company with a degree of real control over the rest of the group" (para. [39]).

Europe: freedom of establishment and the 'life and death' of companies

Yesterday, Advocate General Poiares Maduro gave his opinion in Cartesio Oktató és Szolgáltató Bt. (Case C-210/06). The case concerned a limited partnership (Cartesio) which wanted to move its headquarters from Hungary to Italy. Hungarian law prevented Cartesio transferring its headquarters to another Member State whilst retaining its status as a partnership governed by Hungarian law. The only way for Cartesio to transfer its operational headquarters was by dissolving its business in Hungary and reestablishing in Italy. Does this amount to a restriction on freedom of establishment under Articles 43 and 48 of the EC Treaty?

The Advocate General held that the Hungarian legislation, which applied to partnerships and companies, breached Articles 43 and 48 of the EC Treaty. Articles 43 and 48, in his opinion, precluded rules which make it impossible for a company or partnership formed under the national law of a Member State to transfer its operational headquarters to another Member State. In this regard, and after considering recent case law of the Court, the Advocate General observed:

... it is impossible, in my view, to argue on the basis of the current state of Community law that Member States enjoy an absolute freedom to determine the ‘life and death’ of companies constituted under their domestic law, irrespective of the consequences for the freedom of establishment. Otherwise, Member States would have carte blanche to impose a ‘death sentence’ on a company constituted under its laws just because it had decided to exercise the freedom of establishment".

The Advocate General nevertheless recognised that restrictions of the kind in the Hungarian law could be justified on grounds of general public interest including the prevention of fraudulent conduct or the protection of the interests of creditors, minority shareholders, employees or the tax authorities. The Hungarian law did not, however, contain any grounds of justification.

NB:

[1] The Advocate General's opinion is not binding on the Court but in the majority of cases such opinions are followed.

[2] In 2004 the European Commission consulted on a proposed Directive (the 14th Company Law Directive) on the right of limited companies to transfer their registered office from one Member State to another. However, in December 2007 the Internal Market Commissioner Charlie McCreevy decided that legislative action was not required (see here). In the impact assessment it was explained why:

Since the practical effect of the existing legislation on cross-border mobility (i.e. the cross-border merger directive) is not yet known and that the issue of the transfer of the registered office might be clarified by the Court of Justice in the near future, the assessment concludes that it might be more appropriate to wait until the impacts of those developments can be fully assessed and the need and scope for any EU action better defined"

Europe: Executive pay

Executive pay was discussed at this week's meeting of the European finance ministers. In a report published in International Herald Tribune it is stated:

For the first time, the finance ministers pledged to consider steps to rein in bonuses for executives that are deemed 'excessive'. Dutch Finance Minister Wouter Bos explained how his government plans to discourage such payments with a 30 percent tax for companies that shell out €500,000 (US$772,000) or more to get an executive out the door. Bos said concern was expressed by all EU finance ministers about the size of so-called 'golden parachute' payments and other executive bonuses that have been making headlines. 'There is a general commitment of us all that this is a subject that we have to take a serious look at,' Slovenian Finance Minister Andrej Bajuk, the meeting's chairman, told reporters.

The International Herald Tribune has reported on the Dutch proposals here. For further information about the European Commission's work on executive pay, see here.

NB: In 2002, the UK introduced the Directors' Remuneration Report Regulations which required quoted companies to provide shareholders with an advisory vote on the Remuneration Report (see, now, Section 439 of the Companies Act (2006)). Recent research suggests that this change has contributed to the higher sensitivity of CEO cash and total pay to negative operating performance. See: Maber, D. and Ferri, F., "Solving the Executive Compensation Problem Through Shareholder Votes? Evidence from the UK", available on SSRN here.

UK: the pre-budget report: tax, stock lending and a governance code for building societies

The chancellor delivered his pre-budget report (PBR) today and, as expected, announced the introduction of a temporary bank payroll tax of 50% on discretionary bonus payments over £ 25,000: see here for HMRC guidance and the draft legislation. The Government offered several justifications for the new tax: it was necessary until remuneration practices change as a result of corporate governance and regulatory reforms; evidence that some banks are proposing bonuses that are not consistent with a prudent approach to risk; and fairness: the tax representing a quid pro quo for taxpayer support of the banking sector. 

Of particular interest elsewhere in the report are the following announcements (at paras. 3.39 and 3.58):

The FSA has been reviewing the governance and risk management of stock lending in the market. The Government welcomes this work and will work with the FSA and market participants as necessary to help develop thinking in this area.

Following the Walker Review, and the subsequent Financial Reporting Council (FRC) consultation on the Combined Code, the Government proposes the introduction of a specific governance code for building societies and other financial mutuals. The Government will also consider the introduction of a regular independent review of building societies (and other financial mutuals) adherence to the Code".

UK: Corporation Tax Act (2010) - explanatory notes published

Explanatory notes for the Corporation Tax Act (2010) were published yesterday on the OPSI website: see here (pdf). Tables of destinations and origins have also been published: see, respectively, here (pdf) and here (pdf).

UK: Corporation Tax Act 2010 published

A copy of the Corporation Tax Act 2010 has been published on the OPSI website: see here (pdf). The Act comes into force on 1 April 2010 although some sections are already in force (see Section 1184 for further information).

UK: Parliamentary Bills update

The Corporation Tax Bill received Royal Assent earlier this week: see here. The Bill, now an Act, will soon be published on the OPSI website. It largely completes the Government's rewrite of the corporation tax code and is the sixth Act produced by the Tax Law Rewrite Project.

The Bribery Bill, which was introduced in the House of Lords, received its Second Reading in the House of Commons on Wednesday: see here. This provided MPs with their first opportunity to debate the Bill. Background information about the Bill, covering debate in the Lords, is available in a House of Commons Library research paper published on 1 March: see here (pdf).

UK: corporation tax, small companies' rate - proposed reform to the associated companies' test

HM Treasury and HMRC have published a consultation paper setting out a proposed new test for determining whether companies are associated for the purposes of the small companies' rate of corporation tax. Where a company is deemed to be associated with other companies the corporation tax thresholds are reduced. The purpose of reform (to quote from the consultation paper (at para. 3.3):

... is to provide a test that retains those aspects of the current test that work well within a new test that attributes rights held between linked persons only in circumstances where actual links between the companies make it appropriate to do so. Put broadly, the new test seeks to ensure that companies cannot be associated by an attribution of rights by mere ‘accident of circumstance’".

Ireland: Dáil Public Accounts Committee calls for company law changes

The Dáil Public Accounts Committee has published a report on the loss of fiduciary taxes arising from the abuse of limited liability: see here (pdf). The Committee has recommended that company law should require directors to have their own tax affairs in order when incorporating a new company or when being appointed to an existing company. It has also recommended that the Company Law Review Group should examine whether the current levels of capitalisation required when incorporating a limited liability company should be increased.

UK: Budget 2008: Income shifting

Many people have formed companies in order to reduce the tax that would otherwise have been paid if another business structure were used. In Jones v Garnett [2007] UKHL 35, the House of Lords considered whether the tax anti-avoidance provisions within Part XV of the Income and Corporation Taxes Act 1988 applied to the arrangements made by two taxpayers, Mr and Mrs Jones, with regard to the distribution of income from a company (Arctic Systems Ltd.) in which they were equal shareholders. The company had been formed as the vehicle through which Mr Jones' services as a computer consultant would be provided; his wife, Mrs Jones, provided administrative support. Mr and Mrs Jones received modest salaries and received the majority of their income from the company in the form of dividends. This minimised their total tax liability. The House of Lords held that these arrangements did not breach the anti-avoidance provisions.

The Government subsequently announced that legislation would be introduced to remove the tax benefits of "income shifting" (sometimes called "income splitting") and a consultation paper was published at the end of last year. It was expected that legislation would be introduced later this year in the Finance Act 2008. In this week's budget the Government has, however, announced that legislation will now be brought forward in the Finance Act 2009 (see paragraph 4.69 of the budget report).

The Government's proposals have been widely criticised. In its response to the Government's consultation, the UK's Chartered Institute of Taxation described the draft legislation as "unworkable, impractical and lacking certainty". In its response, the Institute of Chartered Accountants in England and Wales described the legislation as "too widely drafted to be workable" and stated:

"We deplore the growing practice of relatively brief legislation that then has to be supplemented by lengthy HMRC guidance because the primary legislation is not adequately drafted. This guidance will have no legal authority, but is merely an indication of HMRC’s view of particular arrangements. It can also be changed in the future without Parliamentary approval".

UK: England and Wales: the accountant, legal professional privilege and tax law

Yesterday, in Prudential Plc & Anor, R (on the application of) v Special Commissioner of Income Tax & Anor [2009] EWHC 2494 (Admin), Mr Justice Charles held that where a person obtained skilled legal advice about tax law from an accountant, that advice was not subject to legal professional privilege (LPP). Disclosure of that advice could not, therefore, be resisted where this was sought by HMRC using its powers of investigation in respect of a commercially marketed tax avoidance scheme. His Lordship observed (paras [44], [64] to [67]):

... in my view the present law as developed, applied and understood is that for LPP to apply to legal advice and assistance it has to be given by a member of the legal profession with exceptions or extensions when the right or privilege arises in litigation, or when litigation is contemplated ...

In my view Prudential have put forward a compelling, and indeed unanswerable, case that in modern conditions accountants have the expertise to advise on tax law and it is firms of accountants, rather than firms of solicitors, who do give such advice and represent clients in disputes with the Revenue on many aspects of their tax affairs. Further many firms of accountants now employ lawyers to advise on tax and what they, and qualified accountants in the same firm, do in this context is the same ...

So, in my view, Prudential have shown that accountants do what lawyers are described as doing in the cases that establish LPP. This has been the case for some time and in my view an equivalent position can be said to exist in respect of other professions.

But, for the reasons I have set out, I have concluded that the cases do not provide existing authority that clients of accountants and other professions (apart for lawyers) have a right to claim LPP on the basis of legal advice privilege. Indeed it is accepted by Prudential that if I was to hold that accountants have such privilege this would be a first.

Although I acknowledge that the courts have power to develop the common law by the application of existing principle to modern conditions I am of the view that the conclusions I have reached and set out above mean that the doctrine of precedent excludes me from so developing the law".

UK: determining the market value of shares

The Supreme Court gave its opinion last week in Grays Timber Products Ltd v Revenue and Customs (Scotland) [2010] UKSC 4 - see here (html) or here (pdf). The Supreme Court summary of the decision is available here (pdf). The opinion contains some brief discussion of shareholder rights and the extent to which the rights attaching to shares might be found in documents other than the articles of association.

A summary of the decision has been provided by the ICLR as part of its WLR Daily Service, the headnote for which reads:

In assessing whether employment-related securities had been disposed of for a consideration which exceeded their “market value”, so as to occasion a charge to income tax, it was necessary to postulate a notional sale between a hypothetical vendor and purchaser, with the personal characteristics of the actual vendor, such as his right under a subscription agreement to a disproportionately large part of the consideration paid, being ignored".

USA: "The Race for the Bottom in Corporate Law" - Frank Easterbrook

The Virginia Law Review recently held a symposium to mark the 75th anniversary of the Securities and Exchange Commission (SEC). The keynote address, titled "The Race for the Bottom in Corporate Law", was delivered by Chief Judge Frank H. Easterbrook of the United States Court of Appeals for the Seventh Circuit. Within corporate law scholarship, Judge Easterbrook is perhaps most well known for his book The Economic Structure of Corporate Law, co-authored with Daniel Fischel (considered here).  The following outline of Judge Easterbrook's speech is taken from Virginia Law Weekly (the Virginia Law School newspaper):

The primary focus of Easterbrook’s talk was the application of Judge Ralph Winter’s hypothesis regarding broad state regulation of corporations, particularly of corporate governance. Winter had argued that increased discretion in the hands of corporate managers would, in the end, enable them to design the governance measures that investors want the most. Easterbrook pointed out that economic event studies in the last 20 years or so had confirmed this: securities prices would rise and fall depending on different structures of governance, and investors could indeed move to those forms which they found most attractive.

The national government, however, has been “hampering the market of corporate control” in recent years. Easterbrook singled out the Sarbanes-Oxley Act passed in the wake of the Enron and WorldCom scandals as the major culprit, although he also targeted the recently imposed limits on short sales and changes to the tax code. Sarbanes-Oxley, Easterbrook argued, mandated corporate governance structures that often set up an “adversarial mode of corporate governance” that made little sense for the companies forced to adopt them and were, ironically, not at all what investors wanted.

Worse, Easterbrook argued, the “national government could win a race to the bottom in a way that the states cannot,” since in “moving toward a national system of corporate governance,” corporations could not simply change to another jurisdiction’s corporate law if dissatisfied with federal requirements. Easterbrook argued that in theory there are four basic models of corporate governance, and that any one could be appropriate for a corporation at a given time. “A reduction in [this] opportunity set,” the judge concluded forcefully, “makes everyone worse off, all the time—and that’s what the Sarbannes-Oxley Act has done.” As further evidence, he noted that event studies indicated that the Act actually depressed stock prices, and that Enron was, in fact, a model corporation under the governance terms of the Act.

Easterbrook had some suggestions on what might happen as a result of the “Race to the Bottom.” He noted that many firms are “opting out” of the system by becoming private and thereby removing themselves from regulation. He also argued that the international market could supply a response to Sarbanes-Oxley, the ultimate result of which may be the flow of capital to other countries with more desirable governance regulations.

UK: financial regulation - Conservative Party's reform proposals

The Conservative Party has published, at the start of its conference in Birmingham, a policy document titled "Reconstruction - our plan for a strong economy". The proposals are many and wide-ranging; they cover the tax system, consumer credit regulation, the housing market and the role of the Bank of England and Financial Services Authority. Amongst the proposals are the following (to quote directly from the report):

• Improve the system for regulating banks by asking the FSA to tackle irresponsible bonus structures. Institutions that use massive bonuses to encourage short-term reckless risk-taking will have to hold more capital to offset their higher risks. 
• Improve the quality of regulation by matching the FSA’s new responsibilities with new funding. Financial institutions will have to contribute more funds and skilled secondees to the FSA so that the regulator is more equal to the regulated.
• Introduce more transparency into the regulation of complex financial instruments and off balance sheet vehicles.
• Make DBERR the clearing house across Whitehall for all legislation which has a regulatory impact.

UK: Controlled Foreign Companies taxation regime proposals published

Yesterday HM Treasury published a discussion paper setting out its proposed framework for the Controlled Foreign Companies taxation regime: see here (pdf).

UK: European Commission requests that the UK properly implement M&S v Halsey, C-446/03, ECJ

The European Commission has requested that the UK Government properly implement the European Court of Justice's decision Marks and Spencer plc v Halsey (Case C-446/03). The Commission notes that although the UK has amended its legislation in the light of the ECJ's decision, conditions are still imposed on the availability of cross border group relief which make it impossible or virtually impossible for a UK parent company to obtain tax relief in respect of losses incurred by a subsidiary in another Member State. For further information click here.

UK: ABI remuneration guidelines - letter to remuneration committees

The Association of British Insurers has written to remuneration committee chairmen highlighting aspects of its remuneration guidelines which are of particular relevance in the current economic climate: see here (Word). The ABI states, for example, that:

Remuneration structures that seek to increase tax efficiency should not result in additional costs to the company or an increase in its own tax bill. Remuneration Committees should be aware of the potential damage to the company’s and shareholders’ reputation from implementing such schemes".