Use of image rights companies - Taxation

The taxation of image rights has and continues to be a thorny topic for sportspersons and their employers. Although much of the attention in the press has focused on the football industry, the principles are applicable to any sport in which a sportsperson’s image rights have some potential commercial value.

In the UK, HMRC have been focusing attention for a while on payments made to corporate entities which hold and exploit the image rights of a sportsperson. Although case law has suggested that this approach to remunerating a sportsperson is possible, two recent developments suggest that this mechanism may now be short-lived. The first development is HMRC’s changed attitude following RFC 2012 Plc (in liquidation) (formerly The Rangers Football Club Plc) v Advocate General for Scotland [2017] UKSC 45 (the Rangers Case), and the second is the publication on 10 April 2018 of a consultation document aimed at tackling tax avoidance involving profit fragmentation.

These two developments together mean HMRC is likely to apply increased scrutiny to the characterisation of payments paid to image rights companies, in particular where negotiated alongside employment contracts. Employers should ensure that there is sufficient commercial justification for payments made to third party companies (whether offshore or otherwise) in respect of the image rights of a sportsperson, with supporting documentation from the time of negotiating the relevant contracts evidencing the rationale behind those payments. Where necessary, employers should review their current arrangements for remunerating employees (including, in particular, record keeping procedures) and consider and/or take advice on whether these need updating, involving employees in the review process where necessary.

The typical structure considered in this article is one in which image rights are held by an image rights company which contracts with a UK club in respect of the use of those rights separately from the employment contract of the sportsperson, but image rights payments are (by various means) enjoyed by either the sportsperson or persons connected to the sportsperson:

The leading case in this area is Sports Club plc and others v Inspector of Taxes [2000] STC 443 (the Sports Club Case). The Sports Club Case (which was anonymised) concerned payments to image rights companies. The Special Commissioners found that payments to the companies by the sports club, which held the image rights of two high profile football players, were, in principle, permissible. However this approach has been put in doubt by the Rangers Case, and subsequent guidance released by HMRC in August 2017.

Development 1: the Rangers Case

The Rangers Case makes it clear that employment income paid by an employer to a third party (irrespective of the location or type of third party used) remains taxable in the UK as income. It also made it clear that the courts could adopt a “realistic” approach when determining whether payments to a third party were in fact employment payments. Consequently, UK sportspersons, or sportspersons domiciled overseas, who are remunerated by a UK tax resident employer, may be taxed in respect of the entirety of their employment income, even where all or a proportion of that income is paid to a third party in respect of image rights (or indeed any other right or in respect of any other services provided by the sportsperson). For payments to image rights companies to be considered separate from the employment of the sportsperson, they must be just that – payments with clear commercial purpose which are definitively separate from that person’s role as an employee.

The Rangers Case concerned arrangements by which players were remunerated both via normal wages, and by certain payments made to a trust which would then loan those monies back to the players (directly or indirectly) at their instruction. Although the exploitation of image rights was not directly applicable or referenced in the case, the court took, and in future cases will take, a purposive approach in interpreting the relevant tax legislation. The effect of this approach, in practice, is that where payments are made which would otherwise be employment income, but fail to be so by virtue of the inclusion of certain steps which serve no clear commercial purpose, they are likely to be caught.

HMRC have subsequently released specific guidance on the taxation of image rights, and updated the HMRC Employment Income Manual. The guidance defines image rights, in the sports context, as likely to consist of various rights allowing for the exploitation of an individual’s name, likeness, trademarks etc. as well as public appearances. Depending on what constitutes the ‘image rights’ in each case, this revised guidance is likely to have a bearing on how HMRC look at the tax treatment of any payments made for their exploitation. The guidance also expressly states that HMRC considers the Sports Club Case as informative rather than having any precedent value because it was handed down by the Special Commissioners and did not proceed to the higher courts. In considering whether payments should properly be considered employment income, HMRC are therefore likely to consider each case on its merits, and refer to the Rangers Case where relevant.

Development 2: proposed new legislation

The consultation document published on 10 April 2018 details how the Government are seeking to target profits which are split, and at present are taxable in the hands of two separate persons, but which in substance derive from a single activity. The consultation provides examples of the kinds of arrangements it expects to catch under the proposed legislation, the most relevant being as follows:

Although the consultation does not reference the sports industry (the other example provided (in addition to the structure above) relates to architectural services provided by a sole trader), or image rights payments specifically, the proposed changes may catch these kinds of arrangements. The proposed legislation contains three conditions:

1. profits arise which are attributable to the professional or trading skills of an individual resident in the UK (even if they are an employee);
2. some or all of those profits end up in an entity which results in significantly less tax (approximately 20% less than under the applicable UK rate) being paid on them than would have been had they arisen to the individual only; and
3. the individual, or a connected person, or someone acting together with the individual or the connected person, is able to enjoy economic benefits (whether directly or indirectly) from the alienated profits.

If each of these three conditions is satisfied, the legislation will only bite if a final condition is met: it must be reasonable to conclude that some or all of the profits of the entity which receives the alienated profits is excessive in relation to the profit-making functions it performs. This ‘excessive profits’ condition requires an examination of all the facts and surrounding circumstances of the arrangements. Where the UK individual does not report UK profits/losses, the profits are assessed as those of a free-standing trade.

The Government is also proposing a separate notification requirement and, where the legislation applies to the arrangements, this will result in an upfront payment of tax, removing any cash flow advantage otherwise available. The obligation to notify is set wider than the conditions of the offence itself so that HMRC can examine borderline cases. The current proposal is that the obligation to notify arises on satisfaction of conditions 1-3 above, with no requirement to meet the final condition.

It is possible that this proposed legislation could catch a situation where an employee has negotiated an amount in respect of remuneration with a club, and this is then split between direct earnings and payments to an offshore trust or corporate vehicle which (in practice) deals with amounts received at the employee’s wishes (either directly or indirectly). Whether HMRC intend to also use these proposed rules specifically in relation to image rights payments is not clear. Certainly, where such payments are in effect remuneration for the employee in respect of their services as a sportsperson, they may be caught. Where, however, it is clear that the payments are not derived from a single underlying activity, and the image rights company carries out a genuine commercial trade in its jurisdiction (as noted in the consultation itself), such arrangements should not come within the tax avoidance provision.

We understand that HMRC are currently in the process of reviewing payments made by English football clubs to players for the exploitation of their image rights. While an HMRC challenge to image rights payments on Rangers grounds will be more difficult than HMRC’s task in the Rangers Case itself, because of the underlying commercial nature of image rights, clubs and other employers more generally should examine existing arrangement to establish whether they are vulnerable to an enquiry on these grounds. The negotiation, or renegotiation, of contracts with image rights companies which take place alongside the negotiation of employment contracts should be considered carefully and, where necessary, advice sought to ensure that those contracts, and the negotiation of them, accurately reflect their nature as separate commercial arrangements. For employers, failure to consider this properly could lead to PAYE and NIC compliance failures, with accompanying interest and penalties.

In light of the new consultation, employers should review their arrangements with employees and the methods by which they are remunerated. With the new legislation proposed to form part of the Finance Bill 2018/2019, taxpayers should also be involved in the review process so that consideration can be given to the proposed notification requirement, such notification having to be submitted before that person is required to submit their tax return for the relevant period.

Lastly, employers should consider the forms of records they hold in respect of the remuneration of their employees and other third party payments. HMRC have published a non-exhaustive list as part of the revised guidance, including evidence of consideration of the commercial activities to be performed, business plans, details of individual negotiations, and what independent advice was sought. Given the likelihood of heightened scrutiny by HMRC regarding these sort of arrangements, legal advice should be sought where necessary in dealing with HMRC, and any associated PR concerns.