Scotts Atlantic Management Limited (in members’ voluntary liquidation), Scotts Film Management Limited and John Dryburgh (in bankruptcy) v CRC  UKFTT 299 (TC)
Well known promoters of film schemes, Scotts Atlantic Management Ltd and Scotts Film Management Ltd (“the Appellants”), were successfully challenged by HM Revenue and Customs in a recent decision at the First Tier Tribunal. The case itself was not in relation to a film scheme, but an Employee Benefit Trust (“the Scheme”), under which the Appellants sought to shelter the proceeds of their venture. The ruling draws emphasis to the clear gulf between the technical sophistication of the Scheme and the problematic implementation, with the resulting drama during proceedings making for compelling reading.
This article will briefly touch on the structure of and arguments for the Scheme; the myriad issues in implementation; and finally, the technical points on which the planning was ultimately ruled as unsuccessful by the Tribunal.
The Scheme was a sophisticated method of contributing to an Employee Benefit Trust, intended to escape the corporation tax disallowance of paragraph 1 Schedule 24 Finance Act 2003. Using illustrative figures, the following steps were undertaken by each of the Appellants:
A New Co was formed and two EBTs established
100 shares were subscribed for in the New Co at 1p par value (i.e. £1) and a significant premium (i.e. £999,999)
New Co granted an option to EBT1 to subscribe for 10,000 shares at par value in 10 years, resulting in the value of shares held by the Appellants dropping to 1% of their original value, and 99% of the value now in the option
The shares held by the Appellants were sold for market value (now £10,000) to EBT2, simultaneous with EBT2 countersigning the option agreement (as a non-dilution covenant), thereby preserving the value of shares held by EBT1
As, under paragraph 1, deductions were denied only “in respect of employee benefit contributions” defined narrowly as “payments of money or transfers of assets” by the employer company to another person, the appellants made the argument that, as the contribution itself was the result of the granting of an option, the disallowance did not bite. The appellants further argued that a corporation tax deduction should be allowed, and the loans received were not taxable under PAYE.
In reality the planning was implemented in a way that was far from intended. A myriad of issues plagued both the implementation process and the documentation evidencing the transactions. The sequence of events was not always as intended and a number of the documents had errors, or, at times, did not seem to exist at all. This is even more surprising given the background of the Appellants in promoting and implementing tax schemes.
However, though the implementation was far from perfect, which did cast doubt on the Scheme, the Tribunal did not accept that these issues undermined the technical arguments. It would seem that the Tribunal’s confidence in this matter was not shared by the Appellants, as documents, which appeared initially not to exist, were subsequently located. The fortuitous nature of this discovery gave rise to suspicions by HMRC as regards their authenticity, suspicions which were subsequently proved to be valid. In a dramatic turn of events, one of the appellants subsequently admitted to their fabrication. As stated in the ruling “there is no doubt that Mr Dryburgh not only lied to the Tribunal in a material way, but he appeared also to have fabricated evidence, forged documents and thrown away a memory stick in order to destroy evidence.”
The Tribunal considered the Scheme to be unsuccessful in its intended aim of securing a corporation tax deduction, though PAYE was not due. The Tribunal followed the reasoning in Aberdeen Asset Management, ruling that, as the monies in the New Cos were not “unreservedly at the disposal of the various employees” the veil of incorporation could not be lifted.
Despite a number of issues in its implementation the Scheme was successful in its intended aim of escaping the corporation tax disallowance of paragraph 1 Schedule 24 Finance Act 2003. Nonetheless, the corporation tax deduction was still denied on related grounds. The Tribunal ruled that, by structuring the arrangement in a way that was clearly contrived to circumvent these provisions, there was a “duality of purpose” – the contribution was not wholly and exclusively a means to motivating and incentivising the employees, but was also a means to seek to escape an anti-avoidance provision. As articulated in the ruling: “the curious position thus becomes that if no attempt is made to circumvent paragraph 1 Schedule 24, the deduction is denied. If a contrived scheme is effected to achieve the opposite result, it fails simply because that objective becomes the fatal purpose that creates the duality of purpose that itself undermines the deduction”.
The judgement is no doubt controversial. As raised by the Appellants, the argument that a reduction of tax would constitute a duality of purpose would appear problematic when compared with, for example, the payment of bonuses which, from the perspective of the company, would have a similar effect. Whether such a controversial judgment would be upheld at a higher court will of course be a matter for much debate. However, this may well prove academic as an appeal would seem unlikely as the issues surrounding the Scheme’s implementation may provide ample opportunity for the planning to be successfully challenged on other grounds.