Scotts Atlantic Management Ltd & Anor v Revenue & Customs

Factual and Procedural Background

The Appellants, two companies in members voluntary liquidation ("Company A" and "Company B"), engaged in arrangements between 2003 and 2004 designed to circumvent Schedule 24 of the Finance Act 2003. The arrangements aimed to secure tax deductions for rewarding directors and certain employees without those individuals becoming liable to income tax and national insurance contributions within the relevant accounting periods or nine months thereafter.

The tax authority ("The Commissioners") challenged the effectiveness of these arrangements, amending the companies' tax returns and raising an assessment on a director ("Plaintiff Director"). The First-tier Tribunal ("FTT") allowed the appeal regarding the director's assessment but dismissed the companies' appeals. The companies appealed the FTT decision concerning Schedule 24 and the application of section 74 of the Taxes Act 1988.

Legal Issues Presented

1. Whether the deduction arising under a scheme involving a transfer of value occasioned by the grant of an option was "in respect of" an employee benefit contribution within Schedule 24 FA 2003.
2. Whether expenses of contributions under the scheme were wholly and exclusively for the trade under section 74 Taxes Act 1988, or whether the FTT erroneously treated an incidental effect as a purpose.

Arguments of the Parties

Appellants' Arguments

• The deduction claimed was not in respect of an employee benefit contribution because the critical step (grant of an option) did not involve payment or transfer of an asset by the employer as defined in paragraph 1(2)(a) Schedule 24.
• The deduction should be identified with the value shift caused by the option grant, not with the subscription payment or transfer of shares, and thus Schedule 24 should not apply.
• The grant of the option was not a transfer of an asset by the employer company, as the options were granted by newly incorporated companies ("Newcos").
• Even if there was a duality of purpose, the expense was wholly and exclusively incurred for trade purposes, with any tax benefit being a merely incidental effect, not a purpose.
• Reliance on precedent that expenditure incurred with a dual purpose remains deductible if the expense would have been incurred regardless of the tax motive.

Respondents' Arguments

• The deduction was in respect of the whole scheme to reward employees, which included employee benefit contributions, and thus Schedule 24 applied.
• Alternatively, the deduction arose from the subscription payment for shares in the Newcos, which was a payment to an employee benefit scheme.
• Payment should be construed broadly to include making money available to another person who holds it for employees, thus step (3) constituted an employee benefit contribution.
• The grant of the option was a transfer of an asset within the meaning of Schedule 24.
• The options granted were unenforceable, making the transfer of trivial shares at undervalue an employee benefit contribution triggering Schedule 24.
• The FTT correctly found that the contributions were not wholly and exclusively for trade purposes because the dominant purpose was to secure a tax deduction, constituting a duality of purpose.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by considering the application of Schedule 24 FA 2003, which restricts deductions for employee benefit contributions unless the related benefits become taxable in the employee's hands within the relevant period or nine months thereafter. The Appellants' scheme aimed to avoid this by structuring transactions to move value without constituting a payment or transfer of assets by the employer, particularly by granting options rather than transferring assets directly.

The court analyzed the statutory language, particularly the phrase "in respect of" an employee benefit contribution. It rejected the Appellants' narrow interpretation that the deduction was solely in respect of the value shift caused by the option grant (step 3) rather than the underlying payment (step 2). The court held that the deduction, even if identified with the value shift, was naturally and unstrainedly "in respect of" the employee benefit contribution made by the subscription payment.

The court found that the scheme, taken as a whole, constituted an employee benefit scheme and that the payments made to the Newcos were employee benefit contributions as defined. It emphasized that the deduction sought related to the entire arrangement, not isolated steps, and thus Schedule 24 applied to deny the deduction.

Regarding the application of section 74 of the Taxes Act 1988, the court examined whether the expenses were incurred wholly and exclusively for the purposes of the trade. It reaffirmed established principles distinguishing the object of expenditure from its effects and clarified that incidental tax benefits do not negate deductibility. However, it found that the FTT correctly identified a duality of purpose: the Appellants incurred expenditure both to provide employee benefits and to secure a tax deduction not ordinarily available.

The court rejected the Appellants' argument that the expenditure would have been incurred regardless of the tax motive and thus remained deductible. It concluded that the duality of purpose here was fatal to deductibility, as the tax avoidance purpose was a dominant and not merely incidental or consequential effect.

Finally, the court noted that the FTT's reasoning was consistent with the evidence and legal principles, and that the Appellants had not demonstrated any error of law in the FTT's findings.

Holding and Implications

The court DISMISSED the Appellants' appeals against the FTT's decision.

The effect of the decision is that Schedule 24 applies to deny the Appellants deductions for expenses arising from their employee benefit contribution schemes, and that the expenses were not incurred wholly and exclusively for the purposes of their trades due to the duality of purpose including a tax avoidance motive.

No broader precedent was established beyond the application of existing principles to the facts of this scheme. The decision confirms the court's willingness to look at arrangements in their entirety and to apply Schedule 24 purposively to prevent circumvention of its provisions.