Frances Delaney v The Commissioners for HMRC

The Appellant established her first nursery school in 1996. At that time it operated from premises at St James’ Norlands Church (St James’) under the terms of a personal licence granted to the Appellant.

In 2001 the Appellant opened a second school known as “Miss Delany’s Too” which operated from premises at St Clements Notting Dale Church (St Clements)also under a personal licence.

The licences at both premises were renewed periodically.

In the period to 2011 the business gained reputation and grew.

In or about 2011 the Appellant was advised by Dick Watson at Menzies (her personal advisor for many years) that she should consider transferring her business to a limited company so as to protect her from personal liability arising from the business and with a view ultimately to selling the business in due course. We have no further details as to the advice provided. Ms Delaney had little understanding of the basis on which incorporation protected her.

In 2012 the Appellant began renewal negotiations with the church diocese for both properties as the licences were due to expire in August 2014. As part of those negotiations the possibility of a transfer of the business to a limited company was discussed with the church’s representatives with a view to aligning the then potential transfer with the granting of continued occupation for the nursery business. Given occupation of the premises was under personal licence, transfer of the business into an incorporated company would have precluded continued occupation under renewed licences and required the granting of a lease.

Limited correspondence on the negotiations was provided to us though we were provided with a letter dated 19 October 2012 from Hunters (the Appellant’s solicitors). This letter stated:

We find that this letter indicates a general intention to incorporate and transfer the business but lacks any specificity so as to evidence even an intention to contract at that stage.

We were then provided with a letter dated 19 October 2013 from the Appellant to the church pursuant to which the church was informed:

We consider that this letter demonstrates the true position in October 2013. The Appellant wished to negotiate for the continued occupation of St James’ and St Clements on the basis that the occupier post the expiry of the then current personal licences on 31 August 2014 would be the limited company. However, on 19 October 2013 she was “looking to operate [the nurseries] under a corporate structure in the future”. We find that this is evidence that there was no definite intention as to whether or when a transfer might take place, we infer that the Appellant’s advisors were keeping the options open as to the vehicle through which the business was operation as the premises from which the business operated was inherently critical – unless the church was prepared to grant a lease any incorporated entity would have no place from which to operate the business.

Excerpts of a letter dated 23 October 2013 from Hunters were disclosed. We do not know its author. The letter sets out the scope of work to be undertaken by Hunters as follows:

Despite Hunters being instructed to do so no business sale agreement was ever drafted. The explanation given was that as there was no risk of disagreement between the vendor (the Appellant) and the purchaser (MDNSL) as to the terms of the transfer it was unnecessary to incur the costs associated with preparation of the agreement. 0

We can accept that saving costs may well have been a reason not to proceed with the preparation of the business sale agreement. And whilst as vendor and sole director and shareholder of the purchasing company a “disagreement” as to terms was unlikely we consider the proposition that it justified no agreement to be naïve. A limited company offers protection to the owners which is absent in an unincorporated entity with the consequence that a limited company has a far wider group of stakeholders than an unincorporated business including customers, the landlord of leased property, lenders, employees etc. It is the company (and thereby the wider stakeholders of that company) whose interests would have been protected by a business sale agreement. It was apparent that the Appellant was unaware of the true and real ramifications and responsibilities in what she referred to as incorporation of her business and her responsibilities as a director.

We were also informed and find that Hunters never ultimately: (a) incorporated the second company, (b) drafted an employment contract for the Appellant, (c) drafted standard employment terms or (d) drafted a licence agreement for use of the “Miss Delaney” name as envisaged in the letter of 23 October 2013. We were informed an accept that the trademark “Miss Delaney’s” was registered in the Appellant’s name on 7 March 2014 but was never formally licenced.

We find that the engagement letter (being between Hunters and the Appellant in her capacity as a private individual) cannot represent evidence of an intention by both the Appellant and MDNSL to contract for the sale and purchase of the goodwill and any other assets of the business. At best it was a statement of intent of what may or may not have been delivered by Hunters to the Appellant in due course.

In her witness statement the Appellant stated: “as far as I was concerned, the agreement to transfer the business to [MDNSL] was implicit in my decision to proceed to incorporate the business”. When cross examined on this statement the Appellant became very confused and upset. She was unable to answer the questions put to her as to the basis on which the statement was founded. On the evidence we find that the Appellant gave no thought at the time to the connection or otherwise between the incorporation of MDNSL (as opposed to “the business” which is never incorporated per se) and the transfer of the business whether by formal written contract or otherwise. We further find that it is not possible, on the evidence, to find that MDNSL was incorporate with the sole intention of being the recipient of a transfer of the business. We struggle to find evidence of any particular intention of Ms Delaney either in her capacity as the Appellant or director of MDNSL, she was merely doing what was suggested to her. The intention of those advising her cannot be assimilated as her intention.

In any event and whatever the reason, there is no written contract between the Appellant and MDNSL.

The Appellant stated that she “did not go through the charade of verbally making an offer on behalf of myself and verbally accepting it on behalf of [MDNSL]”. We find that there was no oral contract between the Appellant and MDNSL in 2013 or at all.

On 21 November 2013 MDNSL was incorporated. The Appellant was the sole director and shareholder.

We were told that the decision to incorporate was taken because as at that date the Appellant understood that the church was willing to grant a lease in respect of the St James’ premises and incorporation was synonymous with an intention to transfer the business which would be operated from the premises to which a lease had been granted. We have some difficulty with this evidence as the Appellant’s evidence was also that in November 2013 the church had indicated that they were not willing to grant a lease in respect of the St Clement’s premises. The granting of a lease only for St James’ would have precluded the possibility of operating both schools under the common ownership of the incorporated entity (given a presumed inability to grant a sublicence from a personal licence). We find that incorporation may have facilitated the granting of a lease for St James’s and, had the Appellant been able to also reach agreement for a similar arrangement for St Clement’s, the incorporated entity could have been the recipient of a transfer of the business but the asserted synonymity is not made out on the evidence. Incorporation was, in our view a necessary step which the Appellant was advised to take in a process leading to “incorporation of the business”.

That conclusion is supported by the actions taken by the Appellant arising from the difficult negotiating position of the church. In November 2013 she began to investigate alternative premises for the operation of a combined business. Premises were found and negotiations began for a lease of the new premises. We were informed and accept that in principal terms were agreed in December 2013, but the landlord withdrew in January 2014 (we were not provided copies of the in principal agreement).

By this time it was also apparent that the church was not willing to grant a lease for St James’s and, at most, would only consider extending the terms of the Appellant’s personal licence. In the circumstances, the Appellant, continued negotiations to renew the personal licences. Absent alternative accommodation, securing occupation of the premises at St James’ and St Clements beyond August 2014 was an imperative for the Appellant as the contractual commitment for places for the academic year commencing 1 September 2014 were entered up to 18 months in advance of that date. The Appellant agreed an extension of the personal licences to 31 August 2014 as an interim measure.

We find that this is continuing evidence that the Appellant wanted to effect a business transfer to a limited company and maintained an intention to do so when and if the circumstances provided. However, as of January 2014 the business could not have been transferred to and operated by an incorporated entity as there were no premises from which that business could be operated available to MDNSL.

In March 2014 the landlord of the alternative property sought to reopen engagement regarding occupation of the property by the nursery schools. The alternative property offered what appeared to be more suitable premises for the school, enabled the two schools to come together and operate together and also facilitated the potential for the business to be transferred. However, as the building was in residential use, use for the provision of nursery education required the Appellant/MDSNL to obtain planning permission for change of use and, when and if granted, the property then needed to be inspected and registered with OFSTEAD. We understand that negotiations regarding the property continued throughout the summer of 2014.

We were informed that on 30 June 2014 MDNSL employed a head teacher for the schools, with a deferred start date of 5 January 2015. We were told that the recitals to the contract of employment (which we were not provided with) referenced “Miss Delaney’s” the registered trademark for the operation of the proposed combined school. We were told that the recitals also indicated that MDNSL owned and operated the schools. As we did not have sight of the contract we cannot make findings as to its terms. However, we note that any use of the trademark by MDNSL is strictly contrary to its registration as there was no licence granted for its use to MDNSL and that it is admitted that as of 30 June 2014 MDNSL did not own or operate the business.

Terms of an underlease with MDNSL as tenant were agreed an on 9 September 2014; the Appellant was also a counterparty acting as guarantor for MDNSL. The lease provided that MDNSL would apply for “Planning Consent” (whilst the nomenclature used indicates that Planning Consent is a defined term it is not so defined) and that if such Planning Consent was not granted then MDNSL was entitled to give one month’s notice of termination of the lease. The consequence of this clause was that MDNSL did not become obligated under the terms of the lease save for a period of months at the start unless there was at least planning certainty that the premises could be used as a nursery school.

We find that the extended personal licences and the break clause in the lease enabled the Appellant to keep all her options open for the running of the business until she had certainty that she could transfer the business to company who would then be able to operate it. It cannot therefore be said that there was a definite intention to transfer the business from any date (or indeed at all) by virtue of the lease for the new property being signed.

Planning consent was granted on 11 December 2014. At that point we find that MDNSL could have been reasonably confident that once the necessary works had been undertaken on the property it would be in a position to acquire and operate the business. Whilst obtaining OFSTED registration was essential both form MDNSL and the property we accept that Ms Delaney did not consider there to be a realistic risk that registration would be refused. Her evidence, which we accept, was that the registrations would be likely to be successful because of her experience and personal registration.

Following receipt of the planning consent, MDNSL began to make the changes necessary in order to run a nursery school from the property. The Appellant, presumably in her capacity as director of the company, determined not to make the application for OFSTED registration as a new provider of nursery school education until completion of the building works. The Appellant stated, and we accept, that the decision to do so was for convenience and facilitated both the entity and property registrations being made and considered at the same time. MDNSL and the property were both duly registered in July 2015.

The head teacher spent the period from January to September 2015 overseeing the works to the new property and the preparation and submission of the OFSTED applications. In her statement the Appellant stated: “I did not formally second [the head] from the Company to the business but this is in effect what happened”. Unless we have misunderstood the evidence as to the role undertaken by the head we do not consider there would have been any need to second her as she was acting for MDNSL putting it in a place to receive and then run a nursery school business. If in fact the head teacher taught in the two schools at St James’ and St Clements then a secondment would have been required.

We understand that the head teacher was paid by way of the Appellant’s payroll and not by MDNSL and this is borne out by the accounts. Use of the Appellant’s payroll without formal agreement between MDNSL and the Appellant is, in our view, indicative of a fluid and close association between the Appellant and MDNSL and a failure to maintain the necessary procedural boundaries which would have been maintained between third parties – the relationship was “familial”.

However, and in any event, we consider that the employment of the head teacher by MDNSL is evidence of a general intention that the business would be transferred in due course (as indeed it was) but not evidence supporting a conclusion that there was a contract to transfer the business at that time.

We were told that none of the agreements with parents were novated by the Appellant to MDNSL. Education continued to be provided to the children and parents paid MDNSL, but the formal contracting was not remediated though, we understand, that any new contracts post 1 September 2015 are with MDNSL.

The Appellant’s business was valued on three separate occasions:

It was the latter of these valuations which was used as the valuation of the disposal when made.

Accounts were prepared for MDNSL for the period 21 November 2013 to 31 August 2014. These accounts show the company as a dormant company with assets of £60,000 cash and a loan of £59,900 from the Appellant. There was no contingent asset or liability associated with a purported right to buy and obligation to pay for the business. From this it can be inferred that there was certainly no transfer of the beneficial interest in the business and no liability (even a contingent liability) to pay for the business when transferred at some point in the future. The accounts are consistent with there being no contract for purchase when those accounts were drawn up and signed by Ms Delaney as director of the company and representing a true and fair view of the company’s financial position at those dates.

MDNSL’s accounts to 31 August 2015 state that the company commenced trading on 1 September 2015. Further loans are recorded as made by the Appellant (together with a smaller bank loan). The lease is recorded as are administrative expenses but no employment costs. We find these accounts are consistent with there being a contract for purchase of the business on 31 August 2015.

The accounts to 31 August 2016 record an operating profit of £23,815. Assets are identified valued at £994,500 (acquisition price for the business of £1,105,000 amortised at 10% per annum).

The Appellant’s tax return for the tax year ended 5 April 2014 made no mention of the agreement now said to have been reached to sell the business to MDNSL. We find this unremarkable given that the actual disposal was made on 31 August 2015 (see further paragraphs 35 to 38 below)

On 28 January 2017 the Appellant submitted her income tax return for the year ended 5 April 2016 together with the capital gains tax pages. In box 33 the Appellant declared a chargeable gain of £1,105,000 and in box 38 she stated:

Pursuant to the claim to ER the Appellant declared capital gains tax of £109,390 (i.e. 10% of the gain exceeding the annual exempt amount).

In correspondence dated 1 November 2018 Menzies stated that the disposal was incorrectly reported in the 2015/16 tax year and should have been reported for 2013/14 and that the error was Menzies. In evidence Mr Downey stated that the letter had effectively been written without authority and was wrong. Mr Downey stated that the disposal had been correctly reported as taking place in the 2015/16 tax year but that the date on which it was treated as made was 21 November 2013 such that the provisions of the gain was subject to ER. The accuracy of these statements is a matter of law which we address below (see paragraphs 35 to 38 below). However, and for present purposes, we find that the disposal was correctly reported as taking place on 1 September 2015.

In cross examination the Appellant confirmed that she was of the view that had a third party sought to buy the business prior to 31 August 2015 she would not have been prepared to sell it but that she did not understand that she would have been precluded from doing so. This evidence ran somewhat contrary to the evidence given as to the reasons for incorporation (which included the ability to sell the business on further at some point). However, taking the evidence together we find that in the period 2013 – 2015 Ms Delaney was not yet ready to retire from the business and transfer it to a third party she did not want to sell it but could have done so.