Hoey: you’d better PAYE up
The Court of Appeal’s recent judgment in Hoey raises important issues for practitioners about the operation of PAYE and the transfer of assets abroad (TOAA) regime. It explores the nature of HMRC’s potentially far-reaching discretion to ‘switch off’ the application of the PAYE regime (even retrospectively) under ITEPA 2003 s 684(7A)(b). As regards TOAA, there is a brief but potentially important discussion of the priority between the TOAA code and the charge to tax on employment income and the possibility of double taxation. The court also explores the ‘wholly and exclusively’ rule for deductibility of expenses in a tax avoidance context.
Reviewing the Court of Appeal’s recent judgment in Hoey and others v HMRC  EWCA Civ 656 (Hoey), a reader could be forgiven for wondering how
anyone manages successfully to operate PAYE in the real world. The intricate nature of the rules is, of course, a given. However, Hoey highlights an altogether more concerning aspect, namely the existence of potentially far-reaching but hitherto little-understood powers for HMRC to switch off the operation of the PAYE system and shift the payment obligation from employer to employee.
The judgment released on 13 May 2022 runs to 65 pages and contains much of interest for practitioners. Mr Hoey’s arguments were ultimately unsuccessful on the PAYE issues, but the court also rejected further arguments raised by HMRC on the potential applicability of the transfer of assets abroad (TOAA) regime. The court also explored issues around the deductibility of trading expenses under the ‘wholly and exclusively’ rule in a tax avoidance context.
Mr Hoey was an IT contractor. Like many others in the same industry, he worked for banks and other clients (‘end-users’) in the UK through an umbrella company arrangement. He was advised to enter into a contractor loan scheme during the tax years 2008/09 to 2010/11, which years were the subject of the appeal. Mr Hoey’s case was designated the lead appeal for a number of other cases relating to the same arrangements.
As part of the scheme, Mr Hoey became an employee of an offshore entity (‘the offshore employer’). The endusers made payments through UK intermediaries to the offshore employer for the services they received from
him. Although he received a small salary, the bulk of Mr Hoey’s remuneration from the offshore employer was ‘paid’ in the form of contributions to an employee benefit trust (EBT), which were then paid to him through an
The original intention behind the scheme was that the sums provided to Mr Hoey by way of contributions into the EBT and subsequent loans would not be subject to income tax and NICs. His tax position for the years 2008/09 to 2010/11 was duly challenged by HMRC through a mixture of discovery assessments and closure notices. No assessments were issued to the offshore
employer or end-users.
Shortly before the First-tier Tribunal (FTT) hearing in 2019, following the decision of the Supreme Court in RFC 2012 plc v Advocate General for Scotland  UKSC 45, Mr Hoey conceded that the amounts contributed to the EBT for onward loans to him were earnings from employment and chargeable to income tax on that basis. As a result, they should have been subject to PAYE. However, no such PAYE had been accounted for. The real issue, therefore, was who was liable (and how) by reference to the operation of the PAYE regime and the TOAA code.
The PAYE dispute
Mr Hoey’s case rested on an attractively logical reading of the PAYE regime that was consistent with how the regime was generally thought to operate. The core of his argument was that:
- The principal obligation to pay tax on employment
income that is subject to PAYE rests on the employer. In Mr Hoey’s case, this included the income arising by reference to the contributions into the EBT. Although the economic burden of the tax is always intended to
be borne by the employee, it is only possible to transfer the payment obligation to the employee directly under the specific provisions of the Income Tax (Pay As You Earn) Regulations, SI 2003/2682 (‘the PAYE regs’) that allow such redirection (regs 72, 72Fand 81) (‘the redirection regulations’).
- In cases where the employer remains under the duty and there has been no such transfer, the employment income should feature in the employee’s own selfassessment, but he would be able to claim a ‘credit’ for PAYE payable by the employer under regs 185 and 188 of the PAYE regs (even where PAYE is not actually paid).
The complication in Mr Hoey’s case was that the offshore employers had no UK presence and were therefore out of scope of PAYE. Although they had voluntarily operated PAYE on his salary, they were under no obligation to do so for the rest of his remuneration. In such cases, the liability to account for PAYE was displaced to the end-users in the UK as his ‘notional employers’ (ITEPA 2003 s 689).
It is not hard to spot the potential practical problems for the operation of PAYE with such an arrangement. The end-users had only ever dealt with Mr Hoey through UK-based intermediaries and there was no evidence that they had known about Mr Hoey’s offshore employer, let alone the payments subsequently made by it into the EBT.
HMRC originally challenged the arrangements on the basis that the EBT loans constituted taxable employment income, plus a fall-back argument under
TOAA. It appears that at no point did they seek to assess the end-users (nor indeed the offshore employers) for unpaid PAYE. Several years after issuing the assessments and closure notices, in 2017, HMRC wrote to Mr Hoey
to notify him that they intended to use their discretion under ITEPA 2003 s 684(7A)(b) (‘the 7A discretion’).
‘Nothing in PAYE regulations may be read … (b) as requiring the payer to comply with the regulations in circumstances in which the Inland Revenue is satisfied that it is unnecessary or not appropriate for the payer to do so.’
This would relieve the end-users of their PAYE obligations retrospectively. Mr Hoey would therefore be unable to claim the PAYE credit in respect of the
employment income arising by reference to the EBT contributions and so would be personally liable to pay the tax. Mr Hoey appealed against the decision and also brought a claim for judicial review.
The consequences of this case are potentially far-reaching for the whole
PAYE system and the full ramifications will no doubt take time to be fully
The TOAA Dispute
Separately, HMRC argued that Mr Hoey was liable under the TOAA regime in ITA 2007 Part 13 Chapter 2. In very brief summary, they argued that the extended definitions of ‘transfer’ and ‘assets’ in ITA 2007 ss 715–717 meant
that Mr Hoey made a ‘relevant transfer’ for TOAA purposes when he entered into his employment contract with the offshore employer. As a result, income arose to a person abroad (the offshore employer). In HMRC’s view, that income was broadly equal to the amount of the contribution to the EBT. Mr Hoey had the power to enjoy that income, meaning a charge to income tax arose to him under ITA 2007 ss 720 or 727. Mr Hoey rejected this argument on a number of grounds, although the key issue was the quantum of the income arising to the offshore employer – which he argued was nil.
The procedural history
Mr Hoey’s appeal was heard by the FTT in 2019 but was unsuccessful. Among other things, the FTT concluded that it did not have jurisdiction to consider
matters of public law and had no general jurisdiction over everything arising from the operation of PAYE. As a result, it could not determine the availability of PAYE credits nor whether HMRC’s exercise of the 7A discretion was lawful. However, it concluded that the 7A discretion ‘overlapped’ with the redirection
regulations. This did not mean that the 7A discretion could only be used in situations not covered by these regulations – the only issue was whether it had been properly exercised.
The FTT also concluded obiter that the TOAA rules were potentially applicable to Mr Hoey’s situation but that no charge arose. This was because the ‘income’ transferred abroad was the trading profit of the offshore employer – i.e. the offshore employer’s receipt of net fees paid by the intermediary in respect of Mr Hoey’s services, less the payments of salary to Mr Hoey and
the payments into the EBT, which were deductible as expenses incurred ‘wholly and exclusively’ for the purposes of its trade. There was therefore no ‘income’ on which the TOAA rules could bite.
Mr Hoey appealed to the Upper Tribunal (UT). The UT upheld the FTT’s judgment on the issue of jurisdiction over the PAYE aspects and its wider analysis of the TOAA regime. However, the UT was critical of the FTT’s obiter comments on the mechanics of the 7A discretion. The UT considered that the 7A discretion could only apply prospectively. As a result, Mr Hoey’s entitlement to the PAYE credits could not be affected retrospectively by the exercise of that discretion because the obligations had already been incurred. Again, Mr Hoey appealed and HMRC cross-appealed.
Court of Appeal
The case came before Simler LJ, Phillips LJ, and Sir Launcelot Henderson at the Court of Appeal in March and April 2022. The joint judgment sided firmly with HMRC on the PAYE issue, while upholding the FTT’s view on TOAA.
The nature of PAYE
As the starting point for its analysis, the court reiterated the view expressed by Lord Dunedin in Whitney v IRC  AC 37 that the tax system involves three discrete stages: liability, assessment and recovery. In the context
of the PAYE regime, this tripartite classification is helpful because it helps to clarify how the different parts of the tax system interact.
The correct interpretation of the 7A discretion
Mr Hoey contended that the 7A discretion could not be used to impose liability to pay or account for PAYE tax on him for three main reasons. First, this would effectively involve granting HMRC a discretion to decide who was liable to pay tax, which could not be achieved without clear wording. Second, the legislative wording and the presumption against retrospectivity meant it
only operates prospectively. Third, the 7A discretion could not operate as an alternative to the redirection regulations, especially where these incorporate
safeguards such as appeal rights.
The Court of Appeal disagreed. A fundamental point was that the 7A discretion does not impose or transfer liability to tax. Liability rests throughout on Mr Hoey. Rather, the discretion functions as part of the PAYE
regime and is therefore purely about the collection of tax. There was nothing in ITEPA 2003 suggesting that the purpose of the PAYE regs is to forgive the employee in respect of his or her own income tax liability when PAYE has not in fact been deducted or accounted for by the employer (or deemed employer).
In the court’s view, the admitted overlap between the 7A discretion and the redirection regulations was ‘not a case of specific legislation displacing a general provision’ even though the former appeared in the primary legislative provisions in ITEPA 2003 and the latter in the delegated PAYE regs. Rather, they addressed ‘different (but potentially overlapping) situations’. The vires for the redirection regulations were concerned with situations in which the payer should have made deductions while the 7A discretion catered for a situation in which it was unnecessary or not appropriate to require compliance with the PAYE regime. The former’s safeguards for the affected employee correspond closely with the basis on which the direction is made meaning no wider protection is available than for the 7A discretion. The appropriate route for the challenge of an exercise of that discretion is judicial review.
As to retrospectivity, the court found that there was no reason to read the 7A discretion as applicable on a purely prospective basis. Any PAYE credit was
contingent and not a vested or accrued right at the time the PAYE income is earned. As the court noted, similar retrospectivity was also inherent in the redirection regulations. Further, there was no unfairness because Mr Hoey had no serious expectation that the endusers had deducted tax and potential issues could be considered as a relevant factor when HMRC considered their discretion. If the power was purely prospective in nature and was only applicable where HMRC were aware of the facts in advance, its scope would be severely curtailed.
The 7A discretion did therefore have the wide effect contended for by HMRC but needed to be exercised subject to well-established public law principles.
Was the discretion lawfully exercised?
As part of his judicial review claim, Mr Hoey argued that HMRC’s application of the 7A discretion was unlawful and procedurally unfair. Again, this was rejected by the Court of Appeal.
HMRC’s internal guidance suggested that it would consider using the 7A discretion in relation to contractor loan schemes where the end-users had been unaware of the scheme and could not have discovered it with reasonable due diligence. It would decide on the facts of the case and invite representations from the taxpayer. HMRC had done this but had not received
any representations from Mr Hoey. On the available evidence, there was no reason to believe that the endusers had or reasonably could have had such knowledge.
Mr Hoey submitted that HMRC’s policy was adopted with his circumstances in mind and that the 7A discretion was used for an improper purpose, namely to correct HMRC’s failure to issue in-time PAYE determinations to the end-users. These submissions were rejected as irrelevant and/or unsupported by evidence.
Ultimately, HMRC adopted a policy and the only question was whether the exercise of the power in this particular case was lawful in light of this policy. The court noted that it could ‘intervene only if no reasonable decision maker could be satisfied, on the basis of the enquiries made, of the merits of the decisions. This test is not met.’
The court also rejected an argument that Mr Hoey had a legitimate expectation that HMRC would only seek to rely on the redirection regulations to transfer liabilities based on statements in the Compliance Operational
The court then considered whether the FTT had jurisdiction to determine the validity of the PAYE credit following exercise of the 7A discretion. It agreed that the FTT had no such jurisdiction. The FTT is a creature of statute, with no inherent jurisdiction. There is no specific statutory right of appeal against the exercise of the 7A discretion; and so it was simply a question of statutory
construction of the general right of appeal against assessments and closure notices in TMA 1970 s 31. The key point was whether the PAYE credit under regs 185 and 188 affects the amount payable at the assessment stage or whether it relates only to adjustments made at the collection stage. The court went through the relevant statutory provisions in great detail and concluded that the PAYE credit was only relevant at the collection stage and so was not within the FTT’s jurisdiction. Any challenge against the exercise of the 7A discretion therefore needs to be by way of judicial review.
After dealing with the PAYE issue, the court considered the TOAA arguments raised by HMRC. It expressed ‘misgivings’ about whether the entry into a contract of employment could constitute a transfer of assets (on the basis of IRC v Brackett  STC 521) but proceeded on the basis that it did.
The key issue centred on whether income became payable to a person abroad (the offshore employer) as a result of the transfer: did the offshore employer
have any trading profits? This turned on whether the contributions into the EBT had been incurred ‘wholly and exclusively’ for the purposes of its trade and so were deductible in computing trading profits.
The court began with the familiar test from Vodafone Cellular Ltd v Shaw  STC 734 – focusing on the limb that a payment may be made exclusively for the purposes of the trade even though it also secures a private benefit, provided that this was merely a consequential and incidental effect. However, a duality of purpose is fatal.
The court took the opportunity to criticise arguments raised by HMRC which ‘come close to suggesting that the court should recognise a general principle that the existence of a tax avoidance motive which is more than purely incidental must give rise to a duality of purpose which means that the wholly and exclusively rule cannot be satisfied’. Rather, the EBT contributions were remuneration (as per the decision in RFC 2012 Plc) and on that basis there was an evidential burden on HMRC to explain why they were not incurred ‘wholl and exclusively’, which they had not discharged. In the authors’ view, this is a welcome and sensible analysis of this issue by reference to existing case law, without allowing the avoidance context to infect everything.
On this basis, the quantum of the trading profits arising to the offshore employer (and therefore the income of the person abroad) was nil. The TOAA rules were not in point.
The court also dealt briefly with one other potentially important point. HMRC had argued before the UT that any charge under TOAA would take precedence over a charge to employment income. In the court’s view, this result would be ‘extraordinary’ given the highly complex and penal TOAA provisions, and would ‘raise the unwelcome spectre of economic double taxation, potentially giving rise to concurrent liabilities arising out of the same transactions’.
HMRC conceded that the TOAA provisions do not have priority over an employment income charge, although they are a fallback. HMRC also explicitly undertook not to seek to impose double taxation in the event that both sets of provisions applied. The precise mechanism for achieving that result was a complex question however.
This is a welcome clarification. While it seems an obvious and fair conclusion, it is not necessarily easy to reach on the words of the legislation, as HMRC appears to have conceded. It may have wider ramifications for other areas of the tax code with the possibility of double charges, such as within the TOAA regime itself.
For many practitioners, the existence of a wide-ranging power for HMRC to switch off the operation of PAYE retrospectively will come as a distinct surprise. This is particularly so given the existence of the specific redirection regulations and the fact that the exercise of the power is challengeable only through judicial review. That said, the statutory wording is certainly amenable to such an interpretation, and the court’s analysis is notably detailed and methodical.
For many practitioners, the existence of a wide-ranging power for HMRC to switch off the operation of PAYE retrospectively will come as a distinct surprise ... In practice, one would hope that the use of this discretion is limited
Nevertheless, the consequences are potentially far-reaching for the whole PAYE system and the full ramifications will no doubt take time to be fully
understood. In practice, one would hope that the use of the discretion is limited to the sorts of cases considered in the judgment and reflected in HMRC’s guidance, i.e. marketed loan schemes where the person liable for PAYE is not aware of the arrangements in question. It will be interesting to see whether HMRC seeks to develop or expand the current policy to other, more straightforward cases. Another point to consider is what standard of due diligence would now be expected of an end user, particularly given the increased focus on supply chain due diligence, for example in the context of the recent changes to the IR35 rules and the Criminal Finances Act 2017.
Beyond PAYE, the brief discussion of the interaction of the TOAA and employment income charges and the elimination of double taxation is tantalising – and potentially very significant. Further clarification on this (and potentially the impact in other areas of the tax code) would be very welcome.
Finally, at the time of writing, it is not known whether the Court of Appeal’s judgment is the definitive word on the subject or whether the case will be proceeding further. There may well be issues here to interest the Supreme Court.
This was first published in TaxJournal on 24 June 2022.