De-facto director and entrepreneurs’ relief

Richard Hirst v HMRC, FTT TC04038, 29 September 2014

This case is about the successful appeal by Mr Hirst against HMRC’s decision disallowing his claim for entrepreneurs’ relief (ER) made during the tax year 2009-10. HMRC argued that Mr Hirst was neither an officer nor an employee of the company throughout the period of one year ending with the disposal of his shareholding, and that the statutory qualifications for ER had not therefore been met in full. A formal internal review within HMRC had then upheld that view.

The law

In order to be entitled to entrepreneurs’ relief, one of the conditions, amongst others, is that throughout the period of 1 year ending with the date of the disposal the individual should be an officer or employee of the company or (if the company is a member of a trading group) of one or more companies which are members of the trading group (s.169I(6)(b) TCGA 1992).

Facts of the case:

Basically Mr Hirst had been the joint managing director of a company formed in 2005, and the business was about arranging corporate finance, specifically for IT and telecom equipment. Mr Hirst had then recruited a chief executive officer and a sales director in 2006 with himself taking up the role of business development director. As the business position of the company worsened and, in order to control costs, Mr Hirst resigned his position with the company in December 2007. However, post resignation he continued to be involved in sourcing new business for the company through a finance broker ACF. In 2008 Mr Hirst faced criminal charges and needed funds to defend his case. The intention was that he would receive a commission from the company in relation to the new business he was introducing. The arrangements for the sales commissions were agreed with the chief executive officer. However, since the company paid dividends to its shareholders it was sufficient for Mr Hirst, and he did not bother to pursue payment of the commissions. Mr Hirst retained the laptop and phone provided by the company, and the company continued to pay for his home internet access. As the financial condition worsened the shareholders agreed get rid of the sales director and the CEO. Further in February 2009 the shareholders were approached with an offer for the business. The sale was completed in early July 2009 and Mr Hirst's interest in the Company was around 13.5%.

So the question before the tribunal was whether Mr Hirst was an officer or employee of the company so as to be eligible for the relief. The tribunal examined in depth concepts like ‘employee’, ‘director’, and ‘shadow director’. Here are the references which the tribunal considered:

Being in employment:

Obligation to provide work personally (Express & Echo v Tanton [1999] IRLR 367): Mr Hirst’s personal involvement in the relationship with ACF (from where the company got the business) was critical to the success of that project.
Mutuality of obligation between the employer and employee (Clark v Oxfordshire Health Authority [1998] IRLR 125): the employer is under an obligation to provide work and the worker to do it when offered” (Employment Appeal Tribunal in Younis v Trans Global Projects Ltd (UKEAT/0504/05/SM). The Company had to put transactions to Mr Hirst for him to put to ACF, and ACF clearly saw the transactions between the company and ACF as being through Mr Hirst.
Remuneration: the provisions relating to ER did not require any particular hours of work or level of remuneration - that was confirmed by HMRC’s own internal manuals (CG64110). The Tribunal in Corbett v HMRC [2014] UKFTT 298 (TC) had held that ER was available to a taxpayer who received no remuneration. In Secretary of State for BIS v Knight (UKEAT/0073/13/RN) the EAT had held an individual to be an employee even though she received no remuneration for two years prior to the company’s insolvency. Here the company had an obligation to pay commission to Mr Hirst, meet certain expenses and provide certain assets (being the phone, laptop and home internet access). The provision was valuable consideration. The commission would have been paid had he demanded it. He did not request the commission because he was receiving sufficient funds through the dividends that the company was paying at that time to him and his fellow shareholders in accordance with his requests.
Control: The employee both expressly and impliedly agreed that he was subject to the employer’s control sufficient to render the employer master (Ready Mixed Concrete (South East) Ltd v Minister of Pensions [1968] 1 All ER 433). Mr Hirst’s role was as a skilled expert and thus the degree of control must be viewed in that light. He developed strategy but that still required checks by the company and thus he was a servant under the control of the company.

The tribunal found that the elements of an employer-employee relationship were indeed present in Mr Hirst’s relationship with the company and there were no significant facts that were inconsistent with there being an employment relationship.

Regarding Mr Hirst claimed to be a de-facto director.

In Gemma Ltd v Davies [2008] EWHC 546 (Ch) the High Court considered the definition of a “de facto director.

To establish that a person was a de facto director of a company, it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director (Millett J in Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180).
It is not a necessary characteristic of a de facto director that he is held out as a director; such 'holding out' may, however, be important evidence in support of the conclusion that a person acted as a director in fact (Etherton J in Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch), [2007] Bus LR 352)
Holding out is not a sufficient condition either. What matters is not what he called himself but what he did (LewisonJ in Re Mea Corp Ltd [2007] 1 BCLC 618)
It is necessary for the person alleged to be a de facto director to have participated in directing the affairs of the company on an equal footing with the other director(s) and not in a subordinate role (Etherton J in Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch), [2007] Bus LR 352 explaining dicta of Timothy Lloyd QC in Re Richborough Furniture Ltd [1996] 1BCLC 507)
The person in question must be shown to have assumed the status and functions of a company director and to have exercised 'real influence' in the corporate governance of the company (Robert Walker LJ in Re Kaytech International plc [1999] 2 BCLC 351)
If it is unclear whether the acts of the person in question are referable to an assumed directorship or to some other capacity, the person in question is entitled to the benefit of the doubt (Timothy 25 Lloyd QC in Re Richborough Furniture Ltd [1996] 1 BCLC 507 at 524), but the court must be careful not to strain the facts in deference to this observation (Robert Walker LJ in Re Kaytech International plc [1999] 2 BCLC 351)

It was clear that third parties such as ACF and the financiers saw Mr Hirst as a decision-maker on behalf of the Company, who had authority to make legally binding obligations. He had been central to the business of the company and exercised real influence in the corporate governance of the company. There was no doubt that Mr Hirst maintained a relationship with the company other than as a mere shareholder after the formal resignation. However, the question was whether the quality of that relationship was it such as to make Mr Hirst a de facto director of the company.

“De facto director”: the question who is a director of a company is important because of the substantial duties which a director has. It is usually easy to tell if a person is a director if he has been duly appointed as such by the company (and is then a de jure director or "director in law"), but much less easy if he has not been even purportedly appointed as a director but has simply acted as a director on occasions (when he might be a de facto director or director "in fact") or if he has persuaded the directors to act in a particular way (when he might be a "shadow" director). …(Smithton Ltd & Naggar v Townsley & others [2014] EWCA Civ 939)

Statutory definitions of de facto and shadow director

"Director" includes any person occupying the position of director, by whatever name called (s.250 Companies Act 2006). "Shadow director" in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act. A person is not to be regarded as a shadow director by reason only that the directors act on advice given by him in a professional capacity..."
The role of a de facto or shadow director need not extend over the whole range of a company's activities (Re Mea Corporation Ltd [2003] 1 BCLC 618; Secretary of State v Deverell [2001] Ch 340). A person may be both a shadow director and a de facto director at the same time.
“Office” (s 169S TCGA 1992) includes in particular any position which has an existence independent of the person who holds it and may be filled by successive holders (s 5(3) ITEPA 2003).

What makes a person a de facto director?

Lord Collins held that there was no one definitive test for a de facto director (HMRC v Holland [2010] 1 WLR 2793). The question was whether he was part of the corporate governance system of the company and whether he assumed the status and function of a director so as to make himself responsible as if he were a director.

On whether Mr Hirst was an officer or employee of the company in the twelve months up to 7 July 2009 the tribunal observed that whilst Mr Hirst did have influence in the corporate governance of the company which was commensurate with but limited to that of a significant shareholder. His suggestions and proposals were considered by the board and he was consulted on various issues but the decisions were made by the board, not Mr Hirst.

The tribunal, therefore, held that whilst Mr Hirst was not a de-facto director of the company but was nevertheless an employee of the company and therefore, on that basis his claim for entrepreneurs’ relief was allowed.

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