[2010] UKFTT 550 (TC)

TC00803                      

  Appeal number:  TC/2010/01244

Corporation Tax – small companies’ relief – loan creditor – associated company - Appeal dismissed.

FIRST-TIER TRIBUNAL

TAX 

	EXECUTIVE BENEFIT SERVICES (UK) LTD	Appellants

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

TRIBUNAL: 		JOHN M BARTON, WS (Judge)
W SNOWDON (Member)

Sitting in public in Glasgow on Thursday 23 September 2010

Charles Martin CA of Gerber, Landa & Gee CA, for the Appellants

Ms Ros Shields, inspector of Taxes, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.	The Tribunal dismisses the appeal by Executive Benefit Services (UK) Ltd (“EBS”) against a decision of Her Majesty’s Revenue and Customs (“HMRC”) to amend EBS’s assessment to Corporation Tax wherein Marginal Rate relief was reduced from £14,154.09 to £7,279.09.  
Material facts
2.	EBS operate as authorised independent financial advisers.   They claimed in their Corporation Tax return for accounting period ending 31 December 2006 an amount of Marginal Rate Relief of £14,154.09 on the basis that EBS was associated with only one other company, namely EBS Trustee Ltd. The legislation for this relief is at s13 Income and Corporation Taxes Act 1988 (“ICTA 1988”).
3.	Over the year to 31 December 2006, the directors of EBS were Charles McCann, his son Richard McCann, and Peter Eager, solicitor.   The shareholders were Charles McCann, 72,000 ordinary shares of £1, Richard McCann, 6,500 ordinary shares of £1, and Peter Eager, 1,000 ordinary shares of £1.
4.	On 2 December 2008, HMRC opened an enquiry into the 2006 return in accordance with. Para 24(1) Sch 18 of the Finance Act 1998 to explore the issue of associated companies. HMRC concluded that EBS had an association with another company, namely Hyndford Estates Ltd (“Hyndford”).   The business of Hyndford is that of property developers - a completely separate activity from that carried out by EBS.
5.	Chris McCann is a joiner to trade and owner of a construction business. He, along with his father Charles McCann and his father-in-law George Cowan, had formed Hyndford with a view to buying land, building houses and flats thereon and selling these to individual house-buyers, based on Chris's knowledge of the sector. It was agreed that each would have a one-third interest in the business.  
6.	At the relevant time, the shareholders of Hyndford were Charles McCann, 334 ordinary shares of £1, George Cowan, 333 ordinary shares of £1, and Chris McCann, 333 ordinary shares of £1.   The directors were Charles McCann and George Cowan.
7.	Finance for Hyndford was sought from RBS, but it became clear that personal funding and guarantees would be required in order to provide the bank with sufficient comfort in relation to their advances. This came by way of unsecured loans from both Charles McCann and George Cowan.  The loans were interest-free with no fixed repayment date and with no other entitlements, such as voting control or a share of a distribution of profits in the event of a winding-up.
8.	The unaudited accounts of Hyndford for the year to 31 October 2006 showed creditors of £615,349 which includeed bank loans and overdrafts of £294,881 and sundry creditors of £303,614. Included in the sundry creditors was an interest free loan from Charles McCann of £215,998 and a loan of £45,000 from George Cowan.   Both directors, Charles McCann and George Cowan, had provided RBS with a joint and several guarantee for £800,000 in respect of any cost overrun; and Charles McCann had also provided a personal guarantee to RBS  for the total sum of the facility.
9.	On 7 July 2009, a closure notice was issued in accordance with Para32 Sch18 of the Finance Act 1998, which reduced the amount of Marginal Rate Relief claimed under s13 ICTA 1988 from £14,154.09 to £7,279.09.    The amended Corporation Tax then due became £63,312.71, an increase of £6,875. 
10.	A formal Notice of Appeal for EBS was subsequently lodged by Gerber, Landa & Gee on 13 January 2010.   
Legislation
11.  Particular reference was made to the following sections of ICTA 1988

s13 Small companies' relief
(1)     Where in any accounting period the profits of a company which—
(a)     is resident in the United Kingdom, and
(b)     is not a close investment-holding company (as defined in section 13A) at the end of that period,
do not exceed the lower relevant maximum amount, the company may claim that the corporation tax charged on its basic profits for that period shall be calculated as if the rate of corporation tax (instead of being the rate fixed for companies generally) were such lower rate (to be known as the “small companies' rate”) as Parliament may from time to time determine.
(2)     Where in any accounting period the profits of any such company exceed the lower relevant maximum amount but do not exceed the upper relevant maximum amount, the company may claim that the corporation tax charged on its basic profits for that period shall be reduced by a sum equal to such fraction as Parliament may from time to time determine of the following amount—
(M – P) x (I /  P)
where—
M is the upper relevant maximum amount;
P is the amount of the profits; and
I is the amount of the basic profits.
(3)     The lower and upper relevant maximum amounts mentioned above shall be determined as follows—
(a)     where the company has no associated company in the accounting period, those amounts are £300,000 and £1,500,000 respectively;
(b)     where the company has one or more associated companies in the accounting period, the lower relevant maximum amount is £300,000 divided by one plus the number of those associated companies, and the upper relevant maximum amount is £1,500,000 divided by one plus the number of those associated companies.
(4)     In applying subsection (3) above to any accounting period of a company, an associated company which has not carried on any trade or business at any time in that accounting period (or, if an associated company during part only of that accounting period, at any time in that part of that accounting period) shall be disregarded and for the purposes of this section a company is to be treated as an “associated company” of another at a given time if at that time one of the two has control of the other or both are under the control of the same person or persons.
In this subsection “control” shall be construed in accordance with section 416. 

s416  Meaning of “associated company” and “control”
(1)     For the purposes of this Part, a company is to be treated as another's “associated company” at a given time if, at that time or at any other time within one year previously, one of the two has control of the other, or both are under the control of the same person or persons.
(2)     For the purposes of this Part, a person shall be taken to have control of a company if he exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs, and in particular, but without prejudice to the generality of the preceding words, if he possesses or is entitled to acquire—
(a)     the greater part of the share capital or issued share capital of the company or of the voting power in the company; or
(b)     such part of the issued share capital of the company as would, if the whole of the income of the company were in fact distributed among the participators (without regard to any rights which he or any other person has as a loan creditor), entitle him to receive the greater part of the amount so distributed; or
(c)     such rights as would, in the event of the winding-up of the company or in any other circumstances, entitle him to receive the greater part of the assets of the company which would then be available for distribution among the participators.
(3)     Where two or more persons together satisfy any of the conditions of subsection (2) above, they shall be taken to have control of the company.
(4)     For the purposes of subsection (2) above a person shall be treated as entitled to acquire anything which he is entitled to acquire at a future date, or will at a future date be entitled to acquire.
(5)     For the purposes of subsections (2) and (3) above, there shall be attributed to any person any rights or powers of a nominee for him, that is to say, any rights or powers which another person possesses on his behalf or may be required to exercise on his direction or behalf.
(6)     For the purposes of subsections (2) and (3) above, there may also be attributed to any person all the rights and powers of any company of which he has, or he and associates of his have, control or any two or more such companies, or of any associate of his or of any two or more associates of his, including those attributed to a company or associate under subsection (5) above, but not those attributed to an associate under this subsection; and such attributions shall be made under this subsection as will result in the company being treated as under the control of five or fewer participators if it can be so treated.

s417  Meaning of “participator”, “associate”, “director” and “loan creditor”
(1)     For the purposes of this Part, a “participator” is, in relation to any company, a person having a share or interest in the capital or income of the company, and, without prejudice to the generality of the preceding words, includes—
(a)     any person who possesses, or is entitled to acquire, share capital or voting rights in the company;
(b)     any loan creditor of the company;
(c)     any person who possesses, or is entitled to acquire, a right to receive or participate in distributions of the company (construing “distributions” without regard to section 418) or any amounts payable by the company (in cash or in kind) to loan creditors by way of premium on redemption; and
(d)     any person who is entitled to secure that income or assets (whether present or future) of the company will be applied directly or indirectly for his benefit.
In this subsection references to being entitled to do anything apply where a person is presently entitled to do it at a future date, or will at a future date be entitled to do it.
(2)     The provisions of subsection (1) above are without prejudice to any particular provision of this Part requiring a participator in one company to be treated as being also a participator in another company.
(3)     For the purposes of this Part “associate” means, in relation to a participator—
(a)     any relative or partner of the participator;
(b)     the . . . trustees of any settlement in relation to which the participator is, or any relative of his (living or dead) is or was, a settlor . . .; and
(c)     where the participator is interested in any shares or obligations of the company which are subject to any trust, or are part of the estate of a deceased person—
(i)     the . . . trustees of the settlement concerned or, as the case may be, the personal representatives of the deceased; and
(ii)     if the participator is a company, any other company interested in those shares or obligations;
and has a corresponding meaning in relation to a person other than a participator.
(4)     In subsection (3) above “relative” means [spouse or civil partner], parent or remoter forebear, child or remoter issue, or brother or sister.
(5)     For the purposes of this Part “director” includes any person occupying the position of director by whatever name called, any person in accordance with whose directions or instructions the directors are accustomed to act, and any person who—
(a)     is a manager of the company or otherwise concerned in the management of the company's trade or business, and
(b)     is, either on his own or with one or more associates, the beneficial owner of, or able, directly or through the medium of other companies or by any other indirect means, to control 20 per cent or over of the ordinary share capital of the company.
(6)     In subsection (5)(b) above the expression “either on his own or with one or more associates” requires a person to be treated as owning or, as the case may be, controlling what any associate owns or controls, even if he does not own or control share capital on his own.
(7)     Subject to subsection (9) below, for the purposes of this Part “loan creditor”, in relation to a company, means a creditor in respect of any debt incurred by the company—
(a)     for any money borrowed or capital assets acquired by the company; or
(b)     for any right to receive income created in favour of the company; or
(c)     for consideration the value of which to the company was (at the time when the debt was incurred) substantially less than the amount of the debt (including any premium thereon);
or in respect of any redeemable loan capital issued by the company.
(8)     Subject to subsection (9) below, a person who is not the creditor in respect of any debt or loan capital to which subsection (7) above applies but nevertheless has a beneficial interest therein shall, to the extent of that interest, be treated for the purposes of this Part as a loan creditor in respect of that debt or loan capital.
(9)     A person carrying on a business of banking shall not be deemed to be a loan creditor in respect of any loan capital or debt issued or incurred by the company for money lent by him to the company in the ordinary course of that business.

Submissions
12.	 The grounds of appeal stated by Gerber, Landa & Gee in the Notice of Appeal were as follows – 
We do not believe that it is the intention of the legislation to deem companies to be associated in the circumstances of our client and therefore we believe that a mechanical application of the legislation to the present facts leads to an inequitable result.
HM Treasury have stated that the function of the associated company rules is to act as "a deterrent against income fragmentation for the purposes of the small company rate". There is no such fragmentation in the current case. Our client simply exercised the opportunity to obtain finance on more favourable terms than those which would have been available from a third party bank. Had they been aware that this would trigger an increase in their corporation tax they could and would have structured the arrangement in a different way to achieve the same result.
As our client has not sought to take advantage of the small companies rate by the practice of income fragmentation but rather has entered in to a commercial transaction for the benefit of their business, we do not believe the legislation should apply so as to disadvantage them. This was not the intention of the legislature and produces an inequitable result.
Further based on the accounts for the year ended 31 October 2006 and our interpretation of ICTA 1988 Section 416c Charles McCann is clearly not entitled to receive the "greater part" of the company's assets.
13.	In addressing the Tribunal, Mr Martin emphasised that the activities of Hyndford were the building and selling of dwellinghouses; whereas EBS was engaged in financial services – financial planning and related matters including the sale of insurance policies.   Chris McCann was not involved in the activities of EBS.    Mr Martin explained with reference to s416(2), that his interpretation of an amount that would be available for distribution among the participators in a winding up is the amount after discharging the company’s liabilities, and that this would include the bank debt and loan creditors.   In effect, he submitted that the repayment of a loan to a participator was not a distribution.   Charles McCann was only an unsecured creditor behind RBS and that he would only receive a minority share of the reserves, basically one third.   He confirmed that there was no instrument or contractual obligation with Hyndford that gave Charles McCann a controlling stake or share in those assets.
14.	Mr Martin added, as an alternative, that the accounts of Hyndford showed the financial position of that company as a going concern and that if there was to be a winding up, then it would be necessary to look at the winding up value.
15.	In the written submission for HMRC, it was claimed that the Financial statements and Directors’ Reports of both companies, EBS and Hyndford, displayed sufficient association and control by Charles McCann to satisfy the requirements of s416 and s417.
16. Reference was made to the following extra statutory concession, ESC C9 -
The Revenue will not, by concession, treat one company as being under the control of a loan creditor of that company where there is no past or present connection between the company and the loan creditor other than the loan or loans which cause it to be a loan creditor.  Nor will the Revenue treat one company as associated with another where the first company is only associated with the second by being controlled by the same loan creditor provided there is no past or present connection between the companies other than the common loan creditor.. In all cases, this part of the concession applies only when the loan creditor:
is a company which is not a close company, or
is a bona-fide commercial loan creditor.
The financial statements and directors’ report of EBS for 2005 & 2006 displayed a past and present connection with Charles McCann in that Charles McCann was a director with both companies, that the interest free loan with no fixed repayment date was a personal loan from Charles McCann to Hyndford and that the loan was not a company loan but a personal loan with a personal guarantee.      The loan creditor was therefore not a company, and Charles McCann was not a bonafide commercial creditor.    The above concession could therefore not apply.
16.	It was HMRC's view that Charles McCann controlled Hyndford by virtue of his directorship and his being a substantial loan creditor: furthermore his personal guarantee to the RBS highlighted his "past and present connection" with Hyndford.  HMRC therefore asked the Tribunal to dismiss the appeal and uphold the closure notice issued on 7 July 2009 resulting in the amendment to the 2006 Corporation Return in the amount of £63,312.71.
17.	In addressing the Tribunal, Ms Shields added with reference to Charles McCann’s loan to Hyndford, that he was uniquely placed to withdraw the funding from the company; and taking into account his shareholding, he had effective control of the company.  She dismissed as irrelevant the suggestion contained in correspondence that Charles McCann did not exercise control, the essential fact is that he did have the right of control.  She also dismissed the argument that in the event of a winding up, the realisable value of current stock would have had little or no value – submitting that what was at issue was the accounting period of Hyndford to 31 October 2006.    There was no winding up of the company and the issue was the facts as they were in that year.
Reasons
18.	 Charles McCann undoubtedly had control over EBS.  The question before the Tribunal was, in considering EBS’s entitlement to small companies’ relief under the provisions of s13 of ICTA 1988, whether Charles McCann also had “control” over Hyndford.   Section 13(4) directs that “in this subsection ‘control’ shall be construed in accordance with section 416”. 
19.	Charles McCann only had a minority shareholding in Hyndford, namely 334 shares out of a share capital of 1000 shares.   He was indeed a director of Hyndford, along with George Cowan, but there was no indication that Charles McCann had a casting vote, such as would have given him control.
20.	However, the balance sheet of Hyndford as at 31 October 2006 shows creditors of £615,349 of which £215,998 was payable to Charles McCann and £45,000 payable to George Cowan.   The net assets were stated at £82,816. 
21.  The critical phrase is contained in s416(2)(c) of ICTA 1988, namely
such rights as would, in the event of the winding-up of the company or in any other circumstances, entitle him to receive the greater part of the assets of the company which would then be available for distribution among the participators.

22.  Section 417 defines a “participator as
a person having a share or interest in the capital or income of the company, and, without prejudice to the generality of the preceding words, includes—
(a)     any person who possesses, or is entitled to acquire, share capital or voting rights in the company;
(b)     any loan creditor of the company;
Charles McCann, George Cowan and Chris McCann all qualified as participators in view of their share capital, but significantly, Charles McCann (and also George Cowan) again qualified in their capacity as loan creditors.

23.  What is the meaning of “assets ……….available for distribution ?   Mr Martin submitted that the repayment of a loan to a participator was not a distribution; and that the amount that would be available for distribution among the participators in a winding up is the amount after discharging the company’s liabilities, and that this would include the bank debt and loan creditors.  However, this interpretation fails to take into account the express declaration in s417 that a participator includes a loan creditor.  It is also significant that the expression “distribution” is widely interpreted in ICTA 1988.  In the opinion of the Tribunal,  it would be stretching the meaning of s416 to accept that Charles McCann was a loan creditor, and then to deny any effect to that position by excluding the amount of the loan from the assets of the company available for distribution.
24. It follows that on the basis of the balance sheet values, the assets to be distributed among the participators in the event of a winding up of Hyndford, would have been the aggregate of £215,998, £45,000, and £82,816, namely £343,814, of which more than half would have been payable to Charles McCann. 
25. The Tribunal also repels Mr Martin’s alternative submission that the accounts of Hyndford showed the financial position of that company as a going concern and that if there was to be a winding up, then it would be necessary to look at the winding up value.    Section 416 is set out in the widest possible terms, and the words “or in any other circumstances” takes the interpretation beyond a possible insolvency situation.
25. With this background, the Tribunal is satisfied that for the purposes of s 416, the loan of £215,998 requires to be included as an asset to be distributed to Charles McCann, and that at the relevant time, this would have represented the greater part of the assets of Hyndford.
26.   It is appreciated that Charles McCann’s loan to Hyndford was entirely for practical purposes, and not made as part of any tax avoidance measure. Nevertheless, the initial words of s416(2) “shall be taken to have control…” are mandatory, and  Charles McCann is therefore deemed to have had control of Hyndford. As he also had control of EBS, s416(1) declares that these two companies were associated companies, and the legislation relating to small companies’ relief in s13 of ICTA 1988, has to be applied accordingly. 
27.	The Appeal is accordingly dismissed.
28.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

JOHN M BARTON, WS
TRIBUNAL JUDGE

RELEASE DATE:  4th November 2010