Mirror Image Contracting Ltd v Revenue & Customs

Factual and Procedural Background

This appeal concerns amendments made to Company A's corporation tax self-assessments for the years ended 31 March 2008 and 31 March 2009. Company A was represented by Attorney Mitchell, and the Respondents by Officer Linnaker. Evidence was heard from a director of Company A and a related individual.

The background facts are undisputed. An individual, formerly a sole trader in the building industry, whose business failed leading to an insolvency arrangement, was engaged as an employee by Company A, which was incorporated to resume business activities. The shareholding was split between two individuals: 49% owned by one individual and 51% by another, who were also directors. One director and shareholder managed the finances, holding sole access to the company’s debit and credit cards and internet banking.

The business was initially successful and accumulated cash balances for working capital. One director withdrew surplus cash to deposit into a personal savings account to earn higher interest, claiming the funds were held on trust for the company and would be repaid with interest. Subsequently, the directors re-mortgaged their home, creating an offset mortgage account. During a period of lost contracts, the director who managed finances resigned as director but remained the primary signatory on the company bank account and withdrew substantial sums, depositing them into the joint offset mortgage account without informing the other director.

Later, the director requested removal from the bank mandate. Company A paid off a hire purchase agreement on a vehicle and arranged a replacement vehicle, which was purchased and registered in the director’s own name. The director moved out of the shared home, withdrew a large sum from the joint offset mortgage account into a personal account, and has refused to return the funds or the car despite requests, claiming the money was held pending financial settlements.

Legal Issues Presented

1. Whether the loans made by Company A to its participators (the shareholders/directors) were deductible as trading expenses under corporation tax law.
2. The legal effect of withdrawals made by a director from the company accounts and whether such funds were held on trust or constituted shareholder loans.
3. The tax implications of a director’s misappropriation of company property (the vehicle) and whether this constituted a capital or trading transaction.
4. The applicability of a charge under section 419 of the Income and Corporation Taxes Act 1988 on loans to participators and the conditions for its refund.

Arguments of the Parties

Appellant's Arguments

• The amounts withdrawn by the director were held on trust for Company A and would be repaid with interest.
• The loans written off as bad debts should be deductible as trading expenses in the company’s profit and loss account.

Respondents' Arguments

• The withdrawals were not held on trust but were shareholder loans and thus not deductible as trading expenses.
• The misappropriation of company property was a capital transaction, not eligible for a trading deduction.
• The tax due for the year ended 31 March 2008 should have been assessed by discovery assessment rather than amendment to self-assessment.

Table of Precedents Cited

Court's Reasoning and Analysis

The court found that the funds withdrawn by the director were not held on trust for Company A because they were commingled with personal accounts and used to reduce personal liabilities, which is inconsistent with trust arrangements. The withdrawals were shareholder loans, not trading transactions. The director’s withdrawal of £100,000 from the joint offset mortgage account was a personal transaction between the director and the other shareholder, not involving the company.

The loans written off as bad debts were made outside the course of Company A’s trade and thus could not be deducted as trading expenses. The misappropriation of the company van, replaced by a vehicle registered in the director’s name, was a capital transaction. The company had correctly obtained a capital allowance for the disposal of the van at zero consideration, providing the appropriate tax deduction.

Finally, the court confirmed that loans to participators under section 419 ICTA 1988 give rise to a tax charge which is refundable upon repayment of the loan. The appeal against the 2008 assessment was allowed on procedural grounds, as the tax should have been assessed by discovery assessment rather than amendment.

Holding and Implications

The court allowed the appeal regarding the amendments to the corporation tax self-assessment for the year ended 31 March 2008, on the basis that the tax due should have been assessed through a discovery assessment rather than an amendment.

The court dismissed the appeal with respect to the amendments for the year ended 31 March 2009, upholding the Respondents’ position that the loans to participators were not deductible as trading expenses and that the misappropriation of company property was a capital transaction.

The decision directly affects the parties by confirming the tax treatment of shareholder loans and misappropriated assets in this context. No new legal precedent was established beyond the application of existing principles.