Written by Andy Vessey ATT, Larsen Howie's Head of Tax

In the recent First-tier Tax Tribunal case of Petrol Services Ltd v HMRC [2018] UKFTT 773 (TC), its two directors sought to argue that they were providing consultancy services rather than carrying out duties of their office.

The company: Petrol Services Ltd

Petrol Services Ltd (PSL) run a petrol station business.

The business is comprised of two petrol stations. However, it does not engage any employees as the shops at the stations are sublet; the shop tenant collects the payments for petrol on behalf of its landlord.

In addition, each car wash on each site is let to another person providing hand car wash services.

The share capital is owned 25% each by the two directors, Mr. Odedra and Mr. Badiani, and their spouses.

Odedra and Badiani did not receive a salary from their company. They instead provided consultancy services to PSL - via a husband and wife partnership in the case of Odedra, and a company called Jadeprime Ltd in the case of Badiani.

Both entities were equally owned by their respective spouses.

Working practices

Odedra and Badiani usually work together, visiting the petrol stations two to three times a week and making decisions in unison.

During their visits to the petrol stations, one of them checks the takings whilst the other checks the site to ensure it's clean and there are no breaches of insurance conditions. They also check the volume of petrol sold and order more, check the prices of local competitors and adjust the price accordingly.

The pair usually work between 20 – 40 hours a week, even though their consultancy contracts required their services for no more than 15 hours per week.

Whilst Odedra can take any amount of holiday he wishes, he cannot take more than two weeks at a time and he agrees his leave with Badiani.

Odedra habitually provided services to other customers in the past but now he is in his sixties he does not do so much additional work.

Contractual arrangements

Virtual identical contracts were put in place between PSL and the two directors trading vehicle of choice, in June 1999.

A monthly VAT exclusive fee of £3,000 was payable, with the fee being reviewed every 12 months and increased with reference to the upturn in PSL’s turnover and profit.

Each consultant was required to advise and assist PSL and also to promote the interests of PSL.

Odedra’s contract had an initial term of 5 years terminable on 2 years notice, whereas Badiani’s was 1 year terminable on 6 months’ notice.

HMRC’s view

HMRC had previously enquired into the Corporation Tax returns of PSL in both 2000 and 2007 but found nothing wrong. During the course of a separate PAYE enquiry, however, the Revenue argued that the arrangements were motivated by the saving of tax and that the payments for consultancy services were really directors fees and should be subject to PAYE tax and NIC by PSL.

During the course of their enquiries, HMRC obtained information from third parties that suggested that both Odedra and Badiani were acting in their capacity as directors of PSL rather than as independent consultants.

The activities carried out simply amounted to the day-to-day running of the business and what might be expected of the directors of a close company.

Both contracts named the two directors individually, as well as their respective businesses, which indicated that their personal service was required.

Payments made to both were regular monthly amounts and bore no direct relationship between the amount and timing of the work done which was indicative of salary.

Tribunal agreed with Revenue

The taxpayers argued that they were non-executive directors of PSL and, therefore, the Companies Act 2006 did not require them to be remunerated:

“A director does not have to be remunerated for any services performed for the company except as provided by its constitution or approved by the company’s members.”

The Companies articles include Table A which indicates that a director is entitled to remuneration as provided by ordinary resolution of the shareholders in general meeting. As there was no such resolution, then it would have been unlawful for PSL to pay any remuneration. This was countered by the Tribunal who considered that as Odedra and Badiani are old friends and that they and their wives own all the shares in PSL, a formal resolution to approve remuneration is not required.

PSL suggested that the contracts were not of the sort provided by non-executive directors but this cut no ice with the Tribunal who pointed out that it is normal in the case of close companies for the directors to perform all tasks great or small.

The fact that Odedra’s and Badiani’s contracts had been extended and not terminated beyond their initial periods, and that their remuneration was increased over the years was indicative that PSL did not consider the quality of the services. To allow the contracts to run the directors had to be satisfied that the services were being performed satisfactorily. This would be done by the pair scrutinising the standard of each other’s work and, as such, control was exercised over their work by PSL.

With the contracts not affording a right of substitution and the individuals being named personally, the Tribunal concurred that Odedra and Badiani’s personal service was a feature of the working relationship.

Other than the two directors, no one else performed any activities of the business which were overseen by PSL and they were considered to be part and parcel of PSL.

PSL’s appeal was dismissed leaving them with a PAYE tax and NIC bill of over £187K for the six years ended 5th April 2015, although some tax had been paid by the consultancy businesses which the judge expected HMRC to take into account so as to avoid double taxation.

Why IR35 didn’t apply

Some readers may be wondering why IR35 did not come into play. After all, a partnership and a PSC (both entities which IR35 applies to) were providing services to PSL.

This was one of the arguments put forward by PSL, i.e. that if HMRC were correct then the Intermediaries legislation should be an issue and therefore the consultancy vehicles should be held liable for the tax and NIC. The Tribunal did not agree, pointing out that the obligation to deduct and collect tax and NIC from earnings from an office or employment, where the directors exclusively conduct the entire business of the employer, cannot be sidestepped by putting in place supposed contracts for services.

It was also inconceivable to the Tribunal that tax avoidance was not a motivating factor in establishing the consultancy businesses. Mr. and Mrs. Odedra were equal partners but Mrs. Odedra took no part in performing the services. Inevitably the tax collected from two partners on the fees paid, with two personal allowances and lower rate bands, would have been less than the tax would have been paid by Mr. Odedra as a director.

HMRC’s Employment Status Manual 4022 states that it is perfectly possible and legitimate for an employee or director of a company to provide their services in a separate capacity but this should be something that is quite distinct from their duties as an employee/director and on terms similar to those given to other customers.

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