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KEY POINTS
- The facts of the case and the points at issue.
- Obtaining evidence relating to the associated companies issue.
- The reason behind the key man insurance policy.
- Difficulties in agreeing the points at issue with HMRC.
- The importance of thorough preparation.
- Looking back at the commissioners and into the future.
As Mark Antony might have said to his Roman friends and countrymen, ‘I come to bury the General Commissioners, not to praise them’.
According to Shakespeare, by the end of his speech Antony had persuaded the mob that Julius Caesar was the noblest of men and that Brutus and Cassius were murderers.
I won’t go quite that far, but the fundamental change coming soon to tax appeals might imply that the old system was badly broken.
There should be a moment’s pause on 1 April to remember the unnumbered and unsung volunteers who have heard appeals for over 200 years – unnamed, unreported, unpaid, often unthanked – and who have done their best to come to fair and sensible conclusions on the evidence put before them.
The story
My experience of the Commissioners is – and will always be – limited to one case. The facts are simply told.
In the early 1990s, a company entered into a key man insurance policy on the life of the managing director. Ten years later he died and the company collected just over half a million pounds.
It adjusted this receipt out of its corporation tax computation for the 2003 period, claiming that it was not taxable as income. The Inspector commenced an enquiry within the two-year time limit.
There were two issues in dispute – the number of associated companies and the status of the insurance proceeds.
The Inspector was willing to concede on the small companies rate if the company gave in over the key man policy and by the middle of 2005 the company’s auditors advised them to settle, paying £143,125 to save £23,375 (see Example 1).
Fools rush in
One of the company’s advisers had consulted me when the original accounts were being prepared.
At that time, I had recently read the decision of Dr J F Avery Jones in Greycon Ltd v Klaentschi [2003] SSCD 370 (SpC 372), in which the Special Commissioner held that the proceeds of a key man policy were capital and not chargeable to corporation tax.
The story seemed so similar to me that I said the result should very probably be the same, even if a Commissioners’ decision did not create a binding precedent.
Three years later, the company came back to me and asked me to pursue this argument as the auditors clearly did not believe in it.
I looked at the story again – now in more detail, as there were notes of a formal meeting between the Inspector, the new managing director and the auditors in December 2005 in which the facts were rehearsed – and was even more convinced that the situation was identical to Greycon.
I agreed to carry on the argument, expecting to be able to identify why the Inspector thought that the case did not apply and put him straight. ‘It will all be over by Christmas’, I thought. How wrong I was.
First setback
I discovered early on that there was a problem with the associates dispute. The company had been controlled by a foreign individual who owned 51% of the shares through a Panamanian nominee company.
There was no evidence that the nominee did not carry on any business – it had never filed accounts, so the Inspector refused to accept that it could be left out of the count of associates under Statement of Practice SP5/94.
Worse, the Inspector had discovered from an internet search that there was a group of companies in Nigeria with the same name as the individual: these were indeed owned by him and his three brothers, and it seemed clear that the circumstances in Extra-statutory Concession ESC C9 applied (no commercial interdependence – no relationship at all between the UK company and the Nigerian group); but the foreigner had sold his shares and it was not now possible to obtain hard evidence from Nigeria that would satisfy the Inspector.
As the Inspector was refusing to apply a concession, there would be no appeal to the Commissioners; although I thought it was unreasonable not to accept the evidence that we had produced (assurances from the Nigerian auditors that the shareholder did not control any of the companies in the group), I was not sure that the Inspector’s attitude was ‘wholly unreasonable’ in the sense required for a judicial review to overturn his decision.
So the company was likely to have to concede on the small companies rate.
Much has been written about the unfairness of the operation of the small companies rate rules.
This seemed a particularly harsh example: there was clearly no saving of UK tax through the operation of several Nigerian companies that had no business here, and the ‘right’ result could have been achieved by the Inspector deciding that the evidence provided was acceptable. However, he stood by the letter of the law.
I want an argument
Back to the key man insurance. The company’s contention was that the policy had been taken out in order to secure the involvement of the foreign investor in 1993 and it was therefore connected with the capital of the business, not with the trade.
Such a policy was required by the shareholders’ agreement signed by the deceased key man, the present managing director and the outside investor.
The understanding of all those involved – unfortunately, not written down anywhere – was that this was to protect the outside investor from the likely collapse of the company if the driving force behind its success were to die.
When that unfortunate event happened ten years later, the company nearly did collapse; but the investor was no longer interested in owning it, so he took the benefit of his protection – the proceeds were paid to the shareholders as a special dividend – and sold his shares.
The Inspector’s position was that the proceeds appeared as a credit in the profit and loss account and were therefore taxable as trading profits unless there was a statutory reason to adjust them out.
Furthermore, the company had deducted the premiums as trading expenses for all the years until the key man was diagnosed with cancer, when a retrospective adjustment to disallow them was requested.
He took this as confirmation that the policy was part of the trade, and the proceeds should be taxable.
Determination and appeal
I put forward my responses to these points very early in the proceedings.
The precedent cases showed that the distinction between capital and revenue is one area in which the accounting treatment is not relevant.
The circumstances which made the receipt capital in Greycon were also present here. Deducting the premiums was a mistake that ought to be corrected, not a factor that should determine the tax treatment.
For two years I tried to get HMRC to engage in an argument about these contentions.
All through 2007 I only ever received a restatement of the Inspector’s starting position; he never gave any convincing reason for distinguishing Greycon.
At the end of that year the enquiry was concluded and a determination issued, against which the company appealed; the case was referred to an appeals specialist in HMRC.
All through 2008 I tried to find out from him whether he thought the dispute was about the principles or the facts.
Did HMRC not accept that the facts were as they had been represented, or did they believe that the policy would be taxable anyway – in effect, holding that Greycon was wrongly decided?
This is a critical distinction, because it determines what needs to be argued before the Commissioners – whether the appeal will revolve around such evidence of the facts as we could gather together, or whether the facts were not controversial and the debate would be about how the precedent cases said those facts should determine the outcome.
With no clarification of this as 2008 turned into 2009, I had to prepare for both types of case.
Be prepared
The one advantage of the long delays – which appeared to be caused mainly by a lack of resources in HMRC – was that it gave me time to be very well prepared for the hearing when it came.
I had never represented a taxpayer on appeal before. It is of course essential only to take on a task if you are confident that you are competent to do so: I believed that I was the best person to present the arguments, provided that I was properly briefed on the procedure.
So I met with a Special Commissioner for some technical advice, and a General Commissioner – twice – to understand how the hearing would proceed and what would be required of me.
I also spent many happy hours reading the company’s files, digging out correspondence that might be useful. I tracked down some of the key participants in the 1993 transaction and obtained statements.
I knew the company’s story forwards and backwards, and boiled it down into a brief account. I pored over the precedent cases in which key man proceeds have been held to be taxable – CIR v Williams’ Executors [1944] 60 TLR 255 and Keir & Cawder Ltd v CIR [1958] 38 TC 23 – and identified numerous key differences between the circumstances and those of my client.
I prepared annotated copies of the precedents for the Commissioners to read.
I met three times with the HMRC appeals specialist. He seemed very fair minded, and was helpful and friendly. The fact that the case advanced at a snail’s pace, and that I could not get a clear response to my arguments, I put down to the demands on his time as a scarce resource within the department.
I took some comfort in the thought that he might have more experience than me, but he surely could not know the case as well as I did.
Hearing at last
In the end, two-and-a-half years’ work boiled down to three hours in front of the General Commissioners in January. I delivered my bundles of documents, including the company’s argument, annotated precedent cases, documents and correspondence, a week beforehand to the Clerk.
It would have been earlier, but a bout of flu and Christmas combined to delay my final meeting with the man from HMRC to agree the final statement of facts. I hoped that the Commissioners would read the papers, because I felt that the company’s case was very strong.
Superficially, HMRC’s points appeared to have some force, so I needed them to understand the story and to appreciate the contrast with the old cases and the similarity to Greycon.
At the meeting itself, the three Commissioners sat at one end of the room with copies of our bundles of papers in front of them.
The HMRC man and I sat at the other end, side by side. The Clerk, seated on one side of the room half way between us and the bench, took notes.
The atmosphere was informal, but businesslike and professional. I exercised the taxpayer’s choice and let HMRC present first (as Mark Antony deferred to Brutus).
Hopes and glory
My first indication that things would be all right followed the reading of the agreed statement of facts.
The case featured two women with the same surname, but with very different roles.
From the Inspector’s reading, it was possible to think that they were the same person, and I raised my hand to point that out.
One of the Commissioners asked, ‘So the first one would be Linda?’ Yes! He had clearly read the papers. If they had taken the time and trouble to absorb my arguments, I felt sure that they would find for us.
I was a little surprised, and almost disappointed, that HMRC’s argument was exactly what the original Inspector had given me in 2006.
I had constantly expected them to produce something better, but there was nothing else.
That original argument was opposed only to the company’s version of the facts: the Inspector did not accept that the sole reason the company entered into the policy was to secure the involvement of the outside investor.
In all the circumstances (space does not allow a full rehearsal of these), it was extraordinarily improbable that the managing director should have independently decided to protect the company’s trade from the possible effect of his death by ‘filling a hole in the profits’, but that was what the Inspector’s case was based on.
With two witnesses present to confirm their memories of the reasons for the policy in 1993, the balance of probabilities was surely with us, and so the Commissioners found.
‘We uphold the appeal’ were among the sweetest words I have ever heard.
Looking back
I was impressed (and relieved) that three strangers, who would not necessarily have any professional technical knowledge of tax or accountancy, had nevertheless absorbed the important principles, asked the pertinent questions and come to the right conclusion – not just right for my client, but correct in legal terms in that they explicitly stated that they found the facts to be the ones that established the result.
As a finding of fact for which there was evidence, and in the absence of any apparent dispute about the principles of the law itself, their ruling was appeal proof.
It was a happy ending of a sort, but it left me feeling bitter about the unfairness of the procedure for my client.
The enquiry had lasted three-and-a-half years and had absorbed a great deal of management time and energy.
The argument that convinced the Commissioners – in essence, that Greycon was right and the facts were nearly identical – was put to the Inspector at the very start and he dismissed it.
The evidence that convinced the Commissioners was made available long before the determination was issued, but the Inspector did not even confirm that the dispute was about the facts rather than the principles.
And yet the resources of HMRC – clearly scarce, but infinitely greater than those of the small company – were brought to bear in pursuing tax that could never have been collected even if they had won (it would have bankrupted the company).
I cannot help thinking that they hoped the compromise offer over the associates issue would make the company settle.
Looking ahead
This is not just a ‘war story’. Much has been written about the ‘new, improved’ tax appeals system that will operate from April 2009: I wonder how this dispute would play out under the new rules.
First, would the new statutory review force HMRC to engage in a proper discussion of the principles of the case?
They are supposed to confirm or rescind a decision, with reasons, within 45 days of the taxpayer requesting a review. I did not receive any reasons in two-and-a-half years.
Second, would it make any difference on the associates’ issue? I gave that up so long ago that I have almost forgotten to be angry about it now.
I still believe that it was obviously appropriate to apply ESC C9 in the company’s situation on the evidence available.
Third, what will the new tribunal structure do to the costs? The company used me because I was confident that I could deal with the relatively informal hearing in the General Commissioners.
When I consulted the Special Commissioner, he told me how much he – as a QC – would charge to take the case to the Specials. The company could not have paid it, although they could also not have paid the tax.
With no recovery of costs, they would have been completely stymied if they had had to engage an expensive legal team.
The one question I can answer is the personal one: would I feel able to take a case myself to the new tribunal?
Almost certainly not. It was the promise of an informal, not legalistic approach, and the availability of a General Commissioner of many years’ standing to brief me, that led me to believe that I had the necessary knowledge and ability to handle this one.
My last question is not related to the new tribunals. Does anyone want a book on the tax treatment of key man insurance policies?
I doubt if there is anyone out there who has thought about it more than I have over the last thirty months.
And I have some nicely annotated precedents to refer to.
Mike Thexton MA, FCA, CTA (Thexton Training Ltd) writes and lectures on tax issues and runs a small practice.
