[2010] UKFTT 272 (TC)

TC00566

Appeal number:TC/2009/13343

Income tax – Appellant claimed relief against other income for losses incurred in a trade of manicure, pedicure and make up largely carried on by his wife – whether Appellant was carrying on a trade – no – whether any such trade would have been “carried on on a commercial basis” (s 384 ICTA) or “commercial” (s 66 ITA) – no – whether HMRC barred from raising a discovery assessment (s 29 TMA) in view of the information already supplied to Inland Revenue about the conduct of the trade in an earlier enquiry – in relation to 2003-04 yes, otherwise no – appeal allowed in part.

FIRST-TIER TRIBUNAL

TAX

JOHN CREE LOCKE AGNEW / Appellant

-and-

THE COMMISSIONERS FOR HER MAJESTY’S REVENUE AND CUSTOMS / Respondents
TRIBUNAL: / KEVIN POOLE (TRIBUNAL JUDGE)
WILL SILSBY CTA

Sitting in public in Birmingham on 18 May 2010

The Appellant appeared in person

Colin Williams, Higher Officer, appeared for the Respondents

© CROWN COPYRIGHT 2010

DECISION

Introduction

  1. This appeal concerns a claim for relief under s 380 Income and Corporation Taxes Act 1988 (“ICTA”) (in respect of the years ended 5 April 2004, 2005, 2006 and 2007) and s 64 Income Tax Act 2007 (“ITA”) (in respect of the years ended 5 April 2008 and 2009). The Appellant maintained that he was carrying on a trade throughout those years, in which he incurred losses which he sought to set against his income from employment.
  2. HMRC argued that either the Appellant was not carrying on a trade at all or, if he was, he was not carrying it on on a commercial basis. They also sought to disallow the wages paid by the Appellant to his wife, which they argued were not expended or incurred “wholly and exclusively for the purposes of the trade”
  3. An issue also arose as to the ability of HMRC to raise assessments in relation to some or all of the years in question due to the fact that much information had been given to the Inland Revenue in an earlier enquiry, a method of calculating allowable costs had been agreed at that time and the Appellant contended that he had simply been following that basic method in subsequent years.

The facts

  1. The Appellant has at all material times been married and his wife is an experienced manicurist, pedicurist and cosmetic make-up artist. She holds City & Guilds certificates, issued in 1992, in relation to cosmetic make-up and manicure. She worked for a while in a professional beauty salon, then took a break to have children. She returned to working part time in 1999, operating from the matrimonial home as a manicurist, pedicurist and beautician.
  2. From the time of her return in 1999, the Appellant maintains that she has been working as his employee in a self-employed trade which he started to carry on at that time, which trade has incurred losses in every year of its operation.
  3. The trade (if that is what it was) was extremely simple and only took up part of Mrs Agnew’s time (ten hours per week was historically accepted by HMRC, though from the evidence before the Tribunal, that would appear to be a very generous estimate). The activities of the trade consisted of:
  4. carrying out manicures, pedicures and facials/make-up;
  5. taking telephone bookings (and the occasional unplanned visit from established customers); and
  6. buying the necessary treatment products.
  7. Very little promotional activity was undertaken and all the operations were carried out at or from the matrimonial home, without any separate business premises or separately allocated accommodation. The Appellant himself devoted very little of his own time to the trade as his wife effectively ran it on her own.
  8. Over the four years ended 5 April 2000, 2001, 2002 and 2003, the Appellant claimed losses from this trade totalling £26,906. During 2004, the Inland Revenue opened an enquiry into the 2003 return, which culminated (following a meeting between the Appellant and a Mrs Foley of the Inland Revenue’s Compliance Unit on 4 October 2004) in an amendment to the Appellant’s self-assessment for the year ended 5 April 2003 and an agreement for the basis of calculating his self-employed expenses for the purposes of his return for the year ended 5 April 2004.
  9. The expenses claimed in the 2003 return were reduced from £9,065 to £3,884, resulting in a reduction of the trading loss from £8,357 to £3,176 and a correspondingly increased tax liability of £1,139.82 for that year. The main disallowances were the cost of two foreign trips (which were found to have a mixed private holiday/business purpose) and a reduction in his wife’s wages from approximately £4,500 to £2,880 (10 hours per week at £6 per hour with four weeks’ unpaid holiday); there were some other minor adjustments.
  10. At the 4 October 2004 meeting, Mrs Foley also apparently raised the question of whether the Appellant was trading with a view to profit. He explained that he was ill during 2003-04, so the income was reduced because his wife spent more time looking after him. Mrs Foley warned that his trade would be “reviewed for profitability” in the year ended 5 April 2005.
  11. The Appellant then carried on as before, claiming relief for trading losses as summarised in the table set out at [16] below.
  12. On 14 January 2009, a different Inspector of Taxes, Mr M G Smith, wrote to the Appellant, notifying him of HMRC’s intention to carry out a full enquiry into his returns for the years ended 5 April 2007 and 2008. On 14 May 2009, Mr Smith wrote again, notifying the Appellant of HMRC’s intention to carry out a full enquiry into his return for the year ended 5 April 2009.
  13. After obtaining more information from the Appellant about the conduct of the business and the expenses claimed, and after the Appellant had declined to attend a meeting on the basis that the business had not changed since Mrs Foley’s review in 2004, Mr Smith formed the view (expressed in a letter to the Appellant dated 27 July 2009) that the wages paid to Mrs Agnew should be disallowed as expenses of the trade, as their payment was not made “for business purposes but due to the relationship between you”, and they represented “merely a transfer of income” between the Appellant and his wife. He also expressed the view that “if the wages were paid to an independent person the business would have closed down many years ago as the income generated is insufficient to cover expenses.”
  14. HMRC then issued assessments to recover the tax underpaid as a result of disallowance of the loss relief claims in full for the years ended 5 April 2004, 2005 and 2006; they also issued closure notices setting out amendments to the Appellant’s self-assessment returns in respect of the years ended 5 April 2007, 2008 and 2009 for the same purpose. All these assessments and notices were issued on 13 August 2009. In the closure notices (in relation to the later three years), Mr Smith stated under the heading “My conclusion”:

“I am not satisfied that a business is carried on by you, if a business is carried on it is not run on a commercial basis and I also consider that the expenses claimed are not wholly and exclusively incurred for business purposes.”

  1. There was no similar wording in the letters of assessment in relation to the three earlier years, but the Tribunal is satisfied that the basis for these assessments would have been clear when read with the closure notices in relation to the later years.
  2. The information which was available in relation to the losses claimed, the wages paid to Mrs Agnew, the reported income of the business and the cost of purchases claimed is summarised in the following table (where the income minus purchases and wages do not agree with the losses claimed, it is presumably because the evidence provided to the Tribunal is incomplete):

Loss claimed / Wages to Mrs Agnew / Income reported / Purchases and other expenses (exc wages)
Year to 31.3.03[1] / £3,176 / £2,880 / £708 / £1,004[2]
Year to 31.3.04 / £3,713[3] / No evidence / No evidence / No evidence
Year to 31.3.05 / £3,997 / No evidence / £695[4] / £880.48[5]
Year to 31.2.06 / £3,352 / No evidence / £654[6] / £230.28[7]
Year to 31.3.07 / £4,145 / £3,900 / £432[8] / £377.69[9]
Year to 31.3.08 / £5,289 / £4,800 / £991.50[10] / £843.21[11]
Year to 31.3.09 / £4,797[12] / £4,800 / £648[13] / No evidence
  1. From the Appellant’s evidence that the business was carried on in much the same way from Mrs Foley’s visit in 2004 up to the present time, the Tribunal infers that Mrs Agnew’s wages in the years ended 31 March 2004, 2005 and 2006 would have been somewhere between the £2,880 agreed in 2004 to the £3,900 reported for the year ended 31 March 2007
  2. Copy notebook entries covering the period January (expenses)/February (sales) 2004 to March 2009 were produced by the Appellant (listing treatments given by date and summarising expenses). They showed that in a typical month, Mrs Agnew would provide between two and seven treatments. In two months, she provided as many as nine treatments. The highest monthly income received from customers during the period was £145.50.
  3. The Appellant produced copy insurance documentation and some customer testaments in relation to the business. The insurance provided was in the name of Mrs Agnew “Trading as Beautiful Nails”, and shows employer’s liability and public liability cover (amongst other things) for the year commencing 28 September 2009 at a premium of £231.47. There was evidence of insurance having been taken out at a similar cost in at least two earlier years. The Appellant explained that the main concern was to cover the risk of claims from customers from adverse skin reactions to cosmetics and other chemicals used. He gave evidence that the reason for the insurance being in his wife’s name rather than his own was that this would make any claims simpler. A secondary purpose, he said, was that some wholesalers would only offer discounts to businesses that could produce evidence of insurance. He emphasised (and the Tribunal accepts) that the insurance was paid by direct debit from his own bank account and not from his wife’s.
  4. There were three written customer testaments. The first one (from a Mrs Routley) says she is a longstanding client of Mrs Agnew “who runs her own business known as ‘Beautiful Nails’”. The second (from a Ms Wakeman) states “I have been a client of [Mrs Agnew] for approximately five years”. The third (from a Mrs Clement) starts: “This lady has been manicuring my nails for 10 plus years”. Whilst all three letters are very complimentary of the services supplied by Mrs Agnew and her professionalism, none of them show any evidence of knowledge that the business is actually run by the Appellant, indeed their natural assumption is that the business appears to be Mrs Agnew’s.
  5. We were also provided with a copy of a business card of Mrs Agnew’s, headed “Artistic Nail Design”, which contains no reference to the Appellant. Finally, the Appellant produced a price list, which contained no reference to him or Mrs Agnew, the only helpful wording in it being: “Let me pamper you for any occasion...” which the Appellant agreed referred to his wife.
  6. The Appellant gave evidence that he had carried out some promotional work for the business. This took the form of some leafleting and the provision of free promotional vouchers (as a raffle prize for a good cause). He maintained that it was he who contracted with customers rather than his wife, and said he believed some were aware it was his business rather than his wife’s, but he rapidly went on to say that the customers were aware a business was being run and it did not matter to them who was running it. He likened his situation to Marks & Spencer, where a customer would deal with a sales assistant without giving a second thought to the fact that she was actually contracting with the company owning the shop. The Tribunal finds that none of the customers of the business would have been aware of any intention on the part of the Appellant that they should regard themselves as dealing with him rather than with his wife.
  7. The Appellant confirmed that the business had never made a profit and indeed there was not a single month since its commencement in 1999 when the income from customers had been greater than the wages paid to his wife. As can be seen from the table in [16], he accepted that in the years ended 31 March 2007 and 2008, the amounts spent on cosmetic supplies (£377.69 and £843.21) were roughly similar to the total payments received from customers for treatments (£309.50 and £871.50).
  8. The Appellant’s evidence on how the actual payments were made to his wife was unclear. Some copy bank statements were provided and the Appellant attempted to trace a clear payment of the monthly wages to his wife in them, but without success. He eventually accepted that the various payments shown in the statements could not be directly linked to monthly payments of wages, and no other records were maintained to show how the payments disclosed in the statements linked back to the alleged monthly payment of wages. The Tribunal did not consider the documentary evidence disclosed any real degree of formality, consistency or clarity in the payment of wages and the answers given by the Appellant to questions about the frequency of and basis for salary reviews were wholly unconvincing. Mrs Agnew’s evidence was that there was no particular salary review date and her husband pays her what he does because he thinks she does the job properly. The Tribunal finds that the Appellant fixed the wages by reference initially to what had been accepted by Mrs Foley in 2004 and thereafter raised it arbitrarily for no discernible commercial reason.
  9. The Appellant confirmed he had never operated PAYE in relation to the wages he had paid to his wife, on the grounds that they never exceeded her personal allowance income tax relief.
  10. When it was put to the Appellant that there was no realistic prospect of the business making any profit as currently constituted, he disagreed. He maintained that he planned to commit himself full time to the business once he retired from his current employment and it would be possible to turn the operation into profit within a matter of months at that time. In the meantime he said he wanted to keep the business running, albeit at a loss, in order to preserve it for his retirement. He accepted that it would be possible to move the business into profit by reducing his wife’s wages, but he did not wish to do so. He said he had done some advertising and promotional activity with a view to increasing the turnover, but the details were vague and the activity in question was clearly very limited. He said he had investigated the possibility (at some unspecified time in the past) of acquiring premises to operate from, but the expense involved clearly made any such action unviable. There has been no change to the treatments offered since the business was started.
  11. The Appellant also gave evidence that the benefits of running the business were not entirely financial. He referred to one situation, when a customer sent her husband to help to mend a fence damaged in a storm, and another where a carpet was fitted free of charge by the husband or other relative of another customer. He also said there was a benefit in terms of his wife’s self-esteem, in that she earns her own income and does not need to ask him for support.

Arguments of HMRC

  1. HMRC argued three bases for dismissing the appeal:
  2. The Appellant did not carry on a trade at any material time. They submitted the evidence showed that if a trade was carried on at all, it was carried on by Mrs Agnew. In the absence of a trade, the Appellant could not have suffered losses from that trade.
  3. If the Appellant did carry on a trade:
  4. it was not carried on on a commercial basis and with a view to the realisation of profits (s 384 Income and Corporation Taxes Act 1988 (“ICTA”)) during the period up to 5 April 2007 and therefore any losses arising were not eligible for relief under s 380 ICTA; and
  5. it was not “commercial” within the meaning of s 66 Income Taxes Act 2007 (“ITA”) during the period after 5 April 2007 and therefore any losses arising were not eligible for relief under s 64 ITA.

Sub-section 384(1) ICTA applied in relation to periods up to 5 April 2007 and, so far as relevant, provided at the relevant time:

“(1) Subject to subsection (2) below, a loss shall not be available for relief under section 380 unless, for the year of assessment in which the loss is claimed to have been sustained, the trade was being carried on on a commercial basis and with a view to the realisation of profits in the trade...

(9) Where at any time a trade is carried on so as to afford a reasonable expectation of profit, it shall be treated for the purposes of subsection (1) above as being carried on at that time with a view to the realisation of profits.”

Section 66 ITA applied in relation to tax years commencing on or after 6 April 2007 and, so far as relevant, provided:

“(1) Trade loss relief against general income for a loss made in a trade in a tax year is not available unless the trade is commercial.