Mark Alan Smith v The Commissioners for HMRC

B – a distribution out of assets of the company in respect of the shares in the company except repayment of capital on the shares or where made to a new contribution of capital of equal value; and/or

G – an amount treated as a distribution (pursuant to section 1020 CTA) i.e. the transfer of assets to a member where the value of the benefit exceeds any new contribution.

The Appellants are, and at all material times were, personally registered and regulated as independent financial advisors (IFAs)by the Financial Conduct Authority (or its predecessor body) (FCA). They are licenced to provide individuals with independent financial advice concerning investments, life policies, pensions etc. In the provision of such advice each of the Appellant’s built up personal connections of trust with the individuals to which financial advice was provided.

SIFA and SWM are also entities regulated by the FCA. The firm registration and regulation is separate from the individual registrations.

Individuals requiring independent financial advice, at least from small providers, will form a relationship will a particular regulated individual agnostic to whom the IFA is employed by (if employed at all). This is so despite the contract for the provision of such advice being between the individual requiring advice and, where relevant, the IFA’s employer.

The income derived from the provision of advice will accrue to the employer and not the individual. Despite this it was and is the professional “norm” for IFAs who work in small organisations and, in any event for those who worked for Mr Corbett, SIFA and SWM, to consider that their client relationships from which such income is derived “belonged” to the IFA such that when moving between employers (or organisations) it was expected that the clients would follow the IFA. The contracting entity/employer would not consider there to be an ongoing ability to derive income from those contractually advised by the entity once the advising IFA was no longer employed; however, ultimately it would be a decision for the client whether to switch to another IFA employed by the contracting entity or whether to follow the IFA with whom there was a relationship. Where an IFA retires the relationships can be transferred to another IFA, but it is expected that there will be a full hand over carried out personally by the retiring IFA who will look to ensure that the clients are facilitated to build trusted relationships with the transferee.

The Appellants were known to one another prior to their joining forces in business. In or about 1995 Mr Smith commenced employment for Mr Corbett. At that time Mr Corbett operated as a sole trader under the trading name Simpson Independent Financial Advisors.

There is no written evidence as to the terms of Mr Smith’s employment at the time he commenced employment, but we accept the evidence of both Mr Smith and Mr Corbett that his clients “belonged” to him. Whilst employed it was expected that Mr Smith would cultivate and nurture professional relationships with the clients with whom he had historically worked and develop new relationships, usually by word of mouth from existing relationships. The propensity for (initially Mr Corbett and subsequently SIFA) to be able to derive income from those clients was founded in the relationship between the client and Mr Smith and his personal reputation with them and not as a consequence of the reputation of his employer. As such, we find that despite there being no formal written terms of employment for the period from 1995 - 1999 it was accepted and agreed between Mr Corbett and Mr Smith that should Mr Smith cease employment with Mr Corbett his clients would follow him together with the ability to obtain an income from advice provided to them. For the period from 1999, when the business operating under the trading name Simpsons Independent Financial Advisers was incorporated into SIFA, we find that there was a similar understanding/expectation between SIFA and Mr Smith.

On 24 June 2002 Mr Smith’s employment arrangements were formalised with SIFA through a written contract. The contract used was a template provided to SIFA by a local firm of solicitors. The template included restrictive covenants precluding: Mr Smith from (a) soliciting business from any person firm or company which had been a client of SIFA in the prior 12 months; (b) offering employment to anyone employed by SIFA in the prior 12 months and (c) a non-compete clause. We were told and accept that the Appellants were agreed that the template was not appropriate as it precluded Mr Smith from continuing to advise his clients if he left SIFA contrary to the agreement between them. The non-solicitation clause was struck out of the agreement and the contract then signed. We find that the parties did not adopt the template the written agreement reflected the oral arrangements which had existed before June 2022 i.e. that he was entitled to continue to provide advice to individuals to whom he had previously provided advice. The non-compete clause remained.

Mr Smith was appointed as a director on 1 January 2006. We infer (though there was no direct evidence) that the terms of Mr Smith’s employment which subsisted from 2002 continued whilst he was a director and accordingly, find that the expectation regarding the ability to port clients on a change of employer continued.

As indicated above Mr Corbett operated as a sole trader prior to the incorporation of SIFA in 1999. Mr Corbett was a director from incorporation. There was no evidence of the arrangements between SIFA and Mr Corbett i.e. no contract appointing him as a director or a contract of employment. Whilst Mr Corbett was the sole director we infer from the evidence generally that he considered his client relationships/list to be his. We do not have accounts for this period but understand, by reference to the later period accounts that we do have, that, at no point, was any value attributed to Mr Corbett’s clients in the SIFA accounts.

Mr Smith became a shareholder of SIFA on 1 October 2006. He paid £15,000 for his 33 shares (one third of the total shareholding). The price of the shares was said to have determined by reference to the net book value of fixtures and fittings of the business premises. At the time of the share purchase we find that no value for goodwill was attributed to Mr Corbett’s client relationships and the price paid for the shares represented approximately one third of the net book value of fixtures and fittings.

In the early 1990s the consideration payable for the activities of an IFA was generally an up-front commission paid by the financial product provider to the IFA personally (or the employer of the IFA where appropriate).

This mode of remuneration changed over the 1990s and what is known as “trail commission” was introduced. Trail commission provides for remuneration of the IFA/their employer as appropriate to be paid by the financial product provider over the life of the product, usually by reference to the value held under the product. Under both the up-front and trail commission model there was little inherent value in an ongoing client relationship as the IFA earned the right to receive commission income at the point at which a client was introduced to the financial services provider. Even with trail commission the right to receive the commission did not require that the client had a continuing relationship with the introducing IFA. Commission continued to be paid to the IFA/their employer provided that the client did not cancel the product/move their investment. Nevertheless, we accept that client lists and the potential for new business from existing clients switching financial product thereby generating new commission had value and could be traded. However, due to the more personal nature of the relationship the continuing value of a relationship with the IFA who had nurtured it was greatest.

From 31 December 2012 regulatory change precluded remuneration of IFAs through trail commission on any new financial products sold. Trail commissions can (and continue) to be earned for financial products sold prior to 31 December 2012. From 1 January 2013 IFAs must be remunerated directly by the client. This is usually under an annual retainer, time spent basis or as a percentage of assets in the portfolio. This change had an impact on the intrinsic value of the client to the IFA. From 1 January 2013 the relationship and in particular the propensity to continue to seek advice regarding suitability and performance of investments and financial products is the means by which future income is derived in the form of advisory fees. This enhances the value of the personal relationship from which the income might then be generated.

We were told and accept that Mr Corbett and Mr Smith understood that the market value of their relationships with individuals needing independent financial advice was 2 – 4 times the prior year income derived from such clients.

In the period in which Mr Smith was employed by initially Mr Corbett and subsequently SIFA all income derived from relationships with clients as a consequence of their individual personal relationship accrued initially to Mr Corbett/SIFA as appropriate.

In or about early 2012 the Appellants were advised by Mr Pink that conversion from a limited company to a limited liability partnership would suit the business. The reason underlying this advice was not clear to us. It was claimed that the underlying rationale was that the corporate structure did not permit fair remuneration for the shareholder/directors through dividends. Rightly, Mx Lunt cross examined all the witnesses on this rationale as remuneration for performance of key personnel need not be restricted to dividends of a single class of shares; it was put to the witnesses that they could have remained as a limited company and paid remuneration through dividends of different share classes, salary, bonuses etc. The witnesses accepted that the remuneration infrastructure could have been altered but, somewhat weakly and without any real supporting rationale, they asserted that they considered that a limited partnership was a better vehicle through which to ensure a fairer remuneration of all. We note that the timing of the restructuring was proximate with the regulatory change to remuneration of services by IFAs and we wonder whether this was a contributory factor. We also note that Mr Pink is a tax advisor and question whether beneficial tax arrangements may also have been a factor. However, no positive case was put to the witnesses as to an alternative rationale and in the end we do not consider the reason for the restructuring is relevant to the matter we have to decide so we make no finding in this regard.

Following formation of SWM, SWM and SIFA entered the BTA dated 11 June 2012.

The BTA provided for the transfer and assignment or agreement to transfer or assign with full title and guarantee the ongoing business of SIFA as a going concern and all assets used in the business including “the goodwill and the trade name ‘Simpsons Independent Financial Advisers’” and “lists of customers, suppliers, agents and others and all subsisting records lists and information”. The effective date of transfer was intended to be 1 July 2012. The consideration for the transfer was agreed to be the fair value of the business which was transferred as a credit to the capital account of SIFA in SWM. The transfer recorded in the BTA was proposed to the shareholders by resolution of the board of SIFA on 11 June 2012 and approved unanimously by the shareholders on the same date. The minutes of the partnership approved the introduction of SIFA’s “beneficial interest in the goodwill and assets of the business” as contribution of capital on behalf of SIFA by resolution dated 11 June 2012. The BTA and associated resolutions indicate that the date of transfer was expected to be 1 July 2012 and this was the position confirmed in correspondence between the parties. However, we were told in oral evidence by Mr Corbett that the transfer was delayed as it needed to await regulatory approval. Further, it is recorded in the accounts (by way of a note concerning related party transactions) of both SIFA and SWM that the transfer occurred on 1 October 2012. On the evidence it has not been possible for us to determine precisely when the transfer was made however, we infer that there were two transactions pursuant to which SIFA’s membership account with SWM was credited:

We reach our conclusion on the second transfer by reference to the following evidence:

The accounts for SIFA were prepared by Mr Killick. It was accepted by HMRC that he prepared them on the understanding and belief that he was doing so in accordance with generally accepted accounting principles (GAAP).HMRC did not put to Mr Killick that the accounts were not in fact prepared in accordance with GAAP. They considered that as he was not an expert he was in no position to give an opinion to that effect. HMRC did not call any evidence of their own that the accounts failed to comply with GAAP and it was, at least implied, that the Tribunal did not need to and should not make a finding as to GAAP compliance. However, for the reasons addressed below at paragraphs 24 - 30 we consider that it is important to consider the question of GAAP compliance. Having considered the evidence we determine whether that it is no reasonable basis for concluding that the accounts either do not give a true and fair view and/or are not GAAP compliant. We do so for the following reasons:

The Limited Liability Partnership Agreement (Partnership Agreement)for SWM was signed on 1 July 2012. It provided that each equity member (Mr & Mrs Smith, Mr & Mrs Corbett and SIFA) “shall acquire … a Member’s Share equal to the amount or value of any Contribution made by him”. Contribution is defined for the purposes of the Partnership Agreement as “money or assets paid into the account of or transferred into the ownership of the LLP by a Member …”. Members’s Share is defined as the Equity Member’s share of the interest in the Capital which itself is defined as the net capital of the LLP as should in any balance sheet prepared in accordance with the provisions of the Partnership Agreement as belonging to the Members and being the excess of assets of the LLP over its liabilities.

On 1 October 2012 each of the Appellant’s introduced as capital what is recorded in the SWM accounts as goodwill. Mr Corbett is recorded as contributing £1,179,000 and Mr Smith £1,017,000. On the evidence before us such contributions represented the market value (being 3x the prior year’s income derived for the benefit of SIFA from their respective personal relationships) of the personal relationships with individuals requiring independent financial advice. The contributions were made by the Appellant’s personally, the underlying asset so contributed not having been the property of SIFA.