In the recent decision of Hoey v HMRC EWCA Civil 656 (Hoey), the Court of Appeal confirmed that HMRC has a very wide discretion not to apply the PAYE scheme to employers, so income tax amounts can instead be collected directly from an employee.
Hoey involved a UK contractor (Mr. Hoey) who provided services to various UK-based entities (the end users) but was employed by two offshore entities (the employers). In what was considered a tax avoidance scheme, the employers were paying a significant portion of Mr. Hoey’s compensation into employee benefit trusts (EBTs). Mr. Hoey regularly received interest-free loans from EBTs equal to payment for services he provided to end users. The loans were not expected to ever have to be repaid and neither the employers nor Mr. Hoey paid income tax on the loans.
Following the Supreme Court’s decision in RFC 2012 plc (in liquidation) (formerly Rangers Football Club plc) v The General Counsel of Scotland  UKSC 45, it was accepted that contributions made by employers to EBTs for a subsequent loan to Mr Hoey were subject to income tax. The remaining question was: who has the main obligation to pay income tax – the employer or the employee?
While the economic burden of tax falls on the employee (as a taxable person under section 13 of the Income Tax (Income and Pensions) Act 2003 (ITEPA)), the PAYE scheme generally operates so that the obligation to collect tax on employment earnings rests with the employer. However, HMRC has the power to remove an employer’s obligation to comply with PAYE regulations under ITEPA Section 684(7A) where it is “satisfied it’s unnecessary or inappropriate” for the regulations to apply (Discretion 7A). In this case, the obligation to pay the tax falls to the employee.
In this case, HMRC exercised its 7A discretion and issued Mr Hoey with prior EBT assessments.
Mr. Hoey disagreed. He argued that the end users were his alleged employers and were therefore liable to PAYE on the EBT contributions he had received (the employers were not obligated to operate PAYE because they were offshore entities). Mr. Hoey argued that the 7A discretion, when used to forgive an employer (or deemed employer in this case) of its obligations under the PAYE plan, could not be used to impose the obligation to pay or account for PAYE tax. He also argued that the 7A discretion could only be applied prospectively to release a person from future liability. Once the obligation to account for PAYE had become apparent to an employer (and a PAYE credit had been accrued for the employee), discretion 7A could not be used to remove it.
The Court found that HMRC had correctly exercised discretion 7A.
The Court noted that discretion 7A was drafted in general terms. In particular, the use of alternatives – “unnecessary” and “inappropriate” – has demonstrated its extent. Even where compliance was otherwise necessary, HMRC could still find it nonetheless inappropriate to expect an employer to comply with PAYE.
In granting HMRC a broad discretion, the Court also noted that the 7A discretion does not impose or transfer the liability to tax, which rests entirely with the employee, but simply “allows HMRC to collect the tax from the person who has the obligation to pay the tax due, instead of collecting it from the source of the payment (the employer)” (at age 67).
This is potentially a very broad power. It is limited only by principles of public law (which apply to ensure that public bodies reasonably administer their powers) and where the rules relate to administration (rather than the imposition of a tax liability ), the Court was prepared to apply these rules with considerable latitude. As the Court said to  “We can only intervene if no reasonable decision maker could be convinced, on the basis of the investigations carried out, of the merits of the decisions. Accordingly, while the exercise of 7A discretion can in principle be challenged by way of judicial review on the ground that any decision was irrational (known as Wednesday irrational) or was incompatible with the purpose of the legislation (violation of the so-called Padfield obligation), in practice the Court has confirmed that these are very high standards to be met.
The Court also concluded that the 7A discretion was not limited to prospective application. Such an interpretation would conflict with the broad wording of discretion 7A, which simply requires the officer to consider whether it would be appropriate to expect the employer to comply with PAYE regulations. This makes sense, as HMRC is unlikely to know all the facts before the PAYE income in question is paid.
At some level, one might wonder if this decision undermines the purpose of the PAYE scheme. However, although the Court said that HMRC had a wide discretion not to apply the PAYE scheme, it repeatedly noted that the unusual circumstances of this case meant that there were good reasons for HMRC does not use its specific powers to make a Regulation 80 determination with respect to end users. There are also guidelines from HMRC (mentioned in the ruling) which identify tax avoidance schemes involving an offshore employer as a circumstance in which HMRC would consider exercising discretion 7A.
In the normal course of events, HMRC will want to use its Regulation 80 powers to impose PAYE obligations on an employer – after all, the purpose of the PAYE scheme is to alleviate tax collection difficulties – and in circumstances where HMRC seeks to impose PAYE regulations, they can hardly argue that it is also improper to do so.
It may therefore be that discretion 7A is rarely used and mainly applies in cases where the identity of the ’employer’ is unclear or there has been a good reason why HMRC has missed its chance to impose a determination under Rule 80. In this case, the complex circumstances surrounding the EBT payments and the decision in RFC 2012 plc meant that HMRC had not correctly identified where the tax should be assessed
Nevertheless, there have been various instances of employees seeking to defend their tax position by claiming that the responsibility to collect tax rests with their employers and not them. This ruling is a timely reminder to taxpayers that if employment income tax has not been deducted at source and there is no clear path (for whatever reason) to collect this tax from an employer, then HMRC may be encouraged to exercise its wide discretionary powers. to collect the tax from the employee instead.
Read the full decision in Hoey.
There is no express limit to the circumstances in which an HMRC officer may decide it is ‘inappropriate’ for the payer to comply with obligations under the PAYE Regulations. The provision recognizes that, despite the details of the PAYE settlement, HMRC may consider…that it is not appropriate to expect an end user (or other employer) to comply with the deduction…in the PAY payment.