Tribunal rejects HMRC's attempt to transfer PAYE liability to employee

07 October 2016. Published by Adam Craggs, Partner

In Stephen West v HMRC [2016] UKFTT 536 (TC), the First-tier Tribunal (FTT) allowed the taxpayer's appeal and confirmed that under the PAYE system the obligation to pay income tax fell on the employer, and liability will only be transferred to the employee under the regulation of the Income Tax (Pay As You Earn) Regulations 2003, if he has received his remuneration knowing that his employer has wilfully and deliberately failed to deduct PAYE.


Stephen West (the Appellant) was the sole director and shareholder of Astral Telecom Ltd (Astral). He drew money from Astral for a number of years and the drawings were recorded in the director's loan account as loans. At the end of the year a small remuneration and large dividend were approved and credited to the loan account extinguishing the loan. Corporation tax was paid on Astral's profits and income tax was paid by the Appellant through self-assessment. The director's loans were outstanding and increased in amount for the years ending 30 April 2007–2010, inclusive.

In 2011, the Appellant became concerned about the state of Astral's business. He knew that he could be liable for Astral's debts if it traded while insolvent. The Appellant sought the advice of an insolvency practitioner and he was advised to put the company into liquidation and that he would not receive any dividends for that year as there were insufficient profits available. Instead, payment to him would have to be wholly by way of salary.

The Appellant instructed his accountant to prepare accounts for the liquidation proceedings which, after deducting PAYE and NICs, would be sufficient to offset the drawings on the loan account. This 'net' remuneration, which was equivalent to the outstanding director's loans of £129,150, would be 'grossed up' by a calculated PAYE and NICs liability to arrive at the figure for director's remuneration in the profit and loss account of £202,967. The company's loan to the Appellant would be repaid in full by the 'net' remuneration. The PAYE and NICs where shown on the balance sheet as current liabilities, but not paid to HMRC. The Appellant received no further money from the company.

At the creditor's meeting held on 13 September 2011, a resolution was passed for the voluntary winding up of Astral. The Statement of Affairs showed the PAYE and NICs amounts still owing to HMRC as well as corporation tax and VAT.

HMRC opened an enquiry into why Astral had not paid the PAYE liability. The Appellant acknowledged that he had drawn monies from Astral and that the tax and NICs due in respect of these payments had not been paid to HMRC. The Appellant informed HMRC that he was prepared to consider voluntarily paying the amounts to HMRC. The Appellant was invited to settle on the basis that the liability would be the outstanding amount of the loan account rather than the director's remuneration in the draft management accounts. The Appellant did not respond to this offer and in October 2013, in the absence of a response from the Appellant, HMRC issued separate income tax and NIC decisions[1] for the years 2010/11 and 2011/12, formally transferring the PAYE liabilities from Astral to the Appellant on the basis that he had knowingly received payments from the company on which it had 'wilfully' failed to deduct tax. 

The Appellant appealed the decisions.

FTT's decision

Before the FTT, the Appellant argued that under the general principles of PAYE the obligation fell on the employer and that this general rule was set aside in limited circumstances where:

(i)   the employer did not deduct PAYE;

(ii)  the failure was wilful and deliberate; and

(iii) the employee received the remuneration knowing that the employer had wilfully failed to deduct the tax.

HMRC had to show that all three circumstances were present in order to succeed.

HRMC confirmed that it now accepted that the monies drawn by the Appellant were loans and not payments on account of remuneration. There was therefore no failure to operate PAYE when the payments were made, as had been suggested by HMRC in earlier correspondence. However, HMRC argued that the retrospective grossing up of the director's remuneration to cancel the Appellant's indebtedness to Astral did not constitute the proper operation of PAYE. It relied on R v CIR, ex parte McVeigh [1996] STC 91, in which it was held that book-keeping entries without the concomitant payment of tax and NICs to HRMC do not constitute the operation of PAYE. HMRC also argued that this was a 'paper exercise' with the aim of clearing the Appellant's overdraft loan account and to prevent liquidators recovering the debt from him personally.

It was argued that the Appellant, as the sole shareholder of Astral, had been fully aware of the action taken by his accountant in preparing the draft management accounts and accordingly there was a rebuttable presumption that the determinations had been validly made and the Appellant had failed to rebut this presumption.  

The FTT was formed of Judge John Clark and Sandi O'Neil.

Judge Clark agreed with the Appellant that the PAYE was deducted and therefore the first precondition to the operation of regulation 72 was not fulfilled. Judge Clark was satisfied that the relevant net sum sufficient to discharge the loan account was credited to that account in the company's books. The judge said that there was a difference between deducting tax and paying it. The accounts showed deductions for tax and NICs from the payment to the Appellant. As all three preconditions needed to be satisfied in order to justify the transfer of liability to the Appellant, the judge did not need to consider the other two preconditions.

In the view of the judge, the liability could not be shifted to the Appellant and he would therefore allow the appeal.  

The other member of the panel, Sandi O'Neill, disagreed with Judge Clark's conclusion. In her view, it was clear from the accounts that the PAYE and NICs deductions were notional and had no substance in reality. Ms O'Neill considered that as the Appellant was the company's 'controlling mind' and his knowledge was its knowledge, by creating obligations which the company knew it could not meet, it had wilfully failed to discharge those obligations and had done so in the knowledge of the taxpayer. Accordingly, the Appellant had wilfully failed to discharge those obligations and she would have dismissed the appeal.

As Judge Clark had the casting vote, the Appellant's appeal was allowed.


Given the dissenting view of Ms O'Neil and the concerns that she expressed that the decision might enable owner managers of small businesses that are about to go into liquidation to make preferential payments to themselves at the expense of creditors such as HMRC, it would not be surprising if HMRC seek to appeal this decision to the Upper Tribunal.

A copy of the decision can be found here:


[1] Under regulation 72 of the Income Tax (Pay As You Earn) Regulations 2003 SI 2003/2682 and regulation 86 of the Social Security (Contributions) Regulations 2001 SI 2001/1004, respectively.

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