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Mark McLaughlin CTA (Fellow) ATT TEP reports on a tax case with a cautionary note for a service partnership.

Introduction

It is probably not uncommon for one business to provide services to another related business, where there are individuals who are common to both businesses.

A good example is a partnership and a related company. The partnership might provide administration services to the company, and its partners may also be directors of the trading company.

What would the position be in those circumstances, if the partnership provided cars and car fuel for business and private use to partners who are also directors and employees of the company, or perhaps family members of those directors or employees? Could it be argued that the cars and car fuel were being ‘made available’ to those individuals by reason of the directors’ employment with the company, so that a benefit in kind charge arose in respect of the car and fuel provided by the partnership, resulting in an income tax liability for the individuals and a Class 1A NIC liability for the company?

Service Partnership

In Cooper & Others v Revenue & Customs [2012] UKFTT 439 (TC), there was a partnership ('CMS'), which had four partners. Two of the partners were directors of a company called Leaside Timber and Builders Merchants Ltd ('L Ltd'). The other two partners of CMS were the wife and son of one of the directors. CMS provided personnel and administrative services to L Ltd. The service charges were the partnership’s only source of business income. CMS provided cars and car fuel to the partners, and the cars were available for private use. The partnership also paid for the running costs of the cars. The partnership recovered the cost of providing and running the cars through its service charges to L Ltd. The profit shares of the partners were calculated by adding back a private use adjustment and depreciation in respect of the cars. Capital allowances were also claimed on the cars. The net book value of cars represented the greater part of the partnership's balance sheet assets.

HMRC looked at the arrangement between the partnership and the company, and concluded that the cars and fuel provided by CMS were made available to the partners in their capacity as directors of L Ltd, or as family members of one of the directors. HMRC raised assessments on the individuals in respect of car and car fuel benefits, and on the company in respect of Class 1A NIC. The individuals and company both appealed. The tax and NIC at stake was around £215,000.
 
The partnership had a number of employees who provided services to L Ltd, but the partners of CMS themselves apparently had a minimal role in the business.

HMRC's argument was broadly that the partnership was little more than an extension of the company, and had been set up and operated to avoid or reduce income tax for the individuals and NIC for the company. For the taxpayers, it was argued that HMRC's treatment would result in the individuals effectively being taxed twice, once as partners on their profit shares after adding back depreciation, and again under the benefits in kind rules. It was also pointed out that the partners had capital accounts with undrawn profits in CMS, and it was argued that by not drawing these profits the individuals had “made good” the costs of car fuel and private use of the cars, and also contributed towards the partnership's expenditure on the cars. The effect would be reductions in the benefit in kind charges for the cars and car fuel under ITEPA 2003 s 132 (which deals with capital contributions by the employee), ITEPA 2003 s 144 (concerning payments for private use of cars) and ITEPA 2003 s 151 (for making good the cost of private fuel).

The tribunal said that the case Wicks v Firth [1983] 56 TC 318 was authority for the view that a benefit in kind such as a car can be provided by reason of employment where it is provided or made available by a separate entity to the employer of the person enjoying the benefit. However, whether this principle applies in any particular case would depend on a variety of circumstances. Hence it is necessary to look at the arrangement as a whole. The tribunal accepted that CMS was a valid partnership, and a separate legal entity from L Ltd. It also said that CMS was carrying on a commercial business. However, the tribunal pointed out that the business was wholly dependent upon L Ltd as its sole customer.

Commercial Arrangements?

The tribunal held that commercially, the terms of business between CMS and L Ltd were not the terms that might be expected between independent parties on an arm's length basis. The tribunal judge looked at the arrangements in their entirety and also the relationship between the parties, and concluded that the company was at least complicit in providing cars and car fuel to the individuals. The judge also said that the partnership's business did not require the partners to be provided with cars. There was no commercial rationale for CMS to provide cars to its partners, and there was no commercial rationale for the company to pay CMS sufficient amounts to enable the partnership to recover the capital costs of the cars and the car fuel provided to the partners.

The tribunal dismissed the taxpayers’ argument about a potential double tax charge, stating that it was not altogether clear that this was the case, and pointed out that the partnership had claimed capital allowances in respect of the cars. The tribunal judge did not seem particularly sympathetic to the implication of double taxation in any event, saying that because the parties had taken advice and chosen to arrange their affairs in a particular way, they would have to live with the consequences.

The tribunal also dismissed the taxpayers' argument about the potential reduction or elimination of benefits in kind on the grounds of making capital contributions towards the cars, and also that they had effectively made payments for private use and private fuel through their capital accounts with the partnership. The tribunal judge said that undrawn profits left in CMS could not be regarded as contributions or payments made by the individuals to either CMS or L Ltd, and it could not be said that they were “required to pay” for the use of the cars (within ITEPA 2003 s 144) or “required to make good” the cost of private fuel (within ITEPA 2003 s 151). The tribunal therefore dismissed the appeals of the individuals and the company.

Implications

As mentioned, structures involving services provided between partnerships and companies are seen fairly regularly, so what does this case mean for service partnerships in the future? Firstly, not every service partnership will make cars available to the partners, although in principle the Cooper case could have implications for other types of benefits provided through a partnership and funded by a company in which the partners are directors or employees.

Secondly, it is worth noting HMRC's comments in the Business Income Manual at BIM72070, albeit in the context of a service company rather than a service partnership. It broadly states that the service company’s charges should be at cost plus a modest uplift. The key word is “cost”, i.e., the cost of providing the actual services. In the Cooper case, the tribunal pointed out that the partnership’s three largest annual overheads were employee salaries, depreciation of cars and the provision of car fuel. The tribunal judge commented that employee salaries were the only one of these costs reflected in the services which the partnership provided to the company. It said that an independent customer of CMS would probably be unwilling to pay service charges to cover all of these costs, particularly the expenditure on cars. The cars were extraneous to the services provided, and also the value of those services. So it would seem that had the cars' being used extensively in the partnership’s business, the outcome may have been different, but unfortunately for the taxpayers this was not the case.

Decisions of the first-tier tribunal do not create a binding precedent, and it is not known whether the Cooper case has been appealed. However, the decision is likely to be persuasive in similar cases, and no doubt HMRC will be looking more closely at service partnerships in the future, particularly those where cars are provided to the partners. 

The above article is reproduced from Practice Update, a tax Newsletter produced by Mark McLaughlin Associates Limited. To download current and past copies, visit: Practice Update.