Case Study: LM Ferro Ltd v HMRC  UKFTT 463 (TC)
HMRC are currently on a roll with a number of recent court rulings in their favour in relation to taxpayers improperly disguising bonuses using shares.
We have previously spotlighted this as an area that HMRC are targeting successfully, notably in relation to the PA Holdings case which we commentated on in our previous blog, "When are dividends and earnings the same thing?" see here.
LM Ferro Ltd v HMRC
This case concerns the avoidance of tax and National insurance contributions on employee bonuses. This is relevant when employers are paying bonuses in the form of an award of shares. This case confirms that these tax avoidance schemes do not work and if employers are paying what is effectively a bonus, then tax and National Insurance Contributions (NICs) are due regardless of how the scheme has been set up.
Mr Ferro was the owner of a community pharmacy shop. As the company was profitable, he sought advice on how to extract value from the company in a tax-efficient manner. Advised by Powrie Appleby he used a scheme which involved the taxpayer subscribing for shares in another company, a transfer of those shares subject to a forfeiture restriction to Mr Ferro, his transfer of the shares to another company and various other steps.
Mr Ferro subscribed for shares in separate special purpose vehicle company, Stoneygate 123 Ltd (SG123) as a reward him for his services to his pharmaceutical company. A transfer of £300,000 from the pharmaceutical company to SG123 was carried out under the guise of a bonus for Mr Ferro. However, after changes were made to government legislation in May 2004 which brought in an anti-avoidance provision, Mr Ferro transferred the shares from SG123 to another special purpose vehical company, San Gabriel 108 (SG108), an unlimited liability company. This was done under the guidance of Mr Ferro's tax advisers, to avoid any chargeable events. Around three years after they were set up, both SG123 and SG108 were dissolved.
All parties acknowledged the fact that the scheme was devised to be tax-efficient, so this case centres on whether the scheme worked and whether it was actually an artificial tax avoidance scheme. The taxpayer argued for the case that the bonus should not be taxable. The argument here was that it was not a clear 'money in money out scheme' because it was never obvious that money would be paid out. However, HMRC disputed this and put forward the argument that as Mr Ferro was rewarded with money, the bonus should have been taxable as earnings.
Also, HMRC claimed that Mr Ferro should not have needed an incentive to stay at the company he already owned. Another compelling argument was that realistically, Mr Ferro had no plans to invest in the special purpose vehicle company and use it as a trading vehicle. It is more likely that he invested in the company as a way of trying to avoid paying tax.
The Relevance of Part 7 of ITEPA
The Income Tax (earnings and Pensions) Act 2003 (ITEPA) was drawn upon heavily in the case, by both the taxpayer and HMRC. The taxpayer argued that the bonus did not fall within the scope of Part 7 of the ITEPA. The argument put forward here was that the transfer of shares should have been considered as restricted employment related securities, so should not have been exposed to tax charges or National Insurance Contributions. However, HMRC contended that as the bonus amounted to a payment of money, the taxpayer should have been liable to pay tax and NICs.
Ultimately, the evidence weighted heavily against the taxpayer and HMRC provided compelling evidence that the scheme amounted to a bonus of money, rather than real shares in a company. The tribunal agreed that SG123 and SG108 were used for tax avoidance rather than investment. The taxpayer's appeal was therefore dismissed.
Whilst we only advise in relation to the use of share arrangements to provide genuine employee equity participation (through approved plans like Enterprise Management Incentive [EMI], Company Share Option Plan [CSOP] and Share Incentive Plan [SIP]; or carefully tried and tested unapproved arrangements like Unapproved Share Option Plan [USOP] and Deferred Share Purchase Plan [DSPP]) and always warn against pushing the envelope with planning that is likely to be inflammatory and, ultimately, unsuccessful, we feel it appropriate to raise these cases as evidence that all must take care in how employee equity awards are positioned.