By Stephen Woodhouse and Debbie Masterton
As Premier League players and managers become celebrities and marketable personalities in their own right, the use of image rights contracts has become more prevalent. Leading players with international reputations can command fees for personal appearances, interviews with the media and personal endorsements.
Broadly, under an image rights contract, the club negotiates the right to use or control the personality and image of the player or manager with a third party company (the “IR Company”), which legally holds the image rights of the player or manager. The image rights contract (“IR Contract”) will take the form of a contract or licence between the club and the IR Company to exploit the image of the particular player or manager.
Many clubs are considering offering IR Contracts to their top players as it allows them to exploit the player’s image rights to generate revenue, mainly through merchandising and other promotion. In addition, as the club will hold the licence to use the image rights the club can ensure that a player devotes his time to sporting activities and, furthermore, is able to control the use of the image rights to ensure the player does not undertake any activities which may potentially have a negative impact on the club, e.g. endorsing competitor brands.
For the purposes of this Article, we have considered:
- the UK tax implications of IR Contracts;
- how best to structure the IR Contracts to achieve the intended tax treatment; and
- HM Revenue & Customs (“HMRC”) current attitude towards IR Contracts.
The Use of IR Contracts
Since the advent of the Premier League in 1992, revenues generated by Premier League clubs have increased considerably. Between 1992 and 2008, revenues for the top 20 clubs grew at a compound annual rate of 16%, compared with 5.4% for the UK economy as a whole.
The Premier League is the richest football league in the World. In the 2010 Annual Review of Football Finance by the Sports Business Group at Deloitte, it was reported that Premier League revenues for 2008/09 were €2,326m, which was €751m above the second highest revenue generating league, the Bundesliga (Germany) with revenue of €1,575m. This remarkable growth in revenue has enabled Premier League clubs to compete with clubs from the Spanish, Italian, French and German leagues to attract the best players from around the world. However, this competition has led to record high wage bills, with the total wage bill for Premier League clubs topping €1.3bn in the 2008/09 season.
In the past three years, total wages for Premier League clubs has grown by in excess of 55% (£474m). With wages growth outpacing revenue growth in 2008/09, the Premier League’s wages/revenue ratio increased to 67% – a record high.
Agents regularly seek to renegotiate player contracts, with a key focus on how much the player will actually take home after tax. In a world of increasing tax rates, the cost to a club of paying a player £1 million per annum after tax is increasing (see Salary Comparison).
Club pays a player a net salary of £1 million.
Note: Income tax at 40% in 2009/10 and 50% in 2010/11 and 2011/12. Employee and Employer NIC of 1% and 12.8% respectively in 2009/10 and 2010/11 and 2% and 13.8% respectively in 2011/12.
The following table shows the taxes incurred by clubs in the Premier League and the Football League in the 2008/09 season, showing that tax is a significant cost to Premier League clubs.
Therefore, methods of saving income tax and National Insurance Contributions (“NIC”) are of significant interest to clubs, with one such structure being the IR Contract which has become increasingly common (see Salary plus IR Contract). Several high profile players in the Premier League receive a payment to their IR Company for use of their image rights. The payments under IR Contracts can represent up to a third of a player’s total earnings, which can, in turn, offer a 33% saving on employer’s NIC for the club.
Salary plus IR Contract
Club pays a player a net salary of £1 million including £330,000 as a payment to an IR Company.
Salary plus IR Contract
Salary Payment to player
Income tax and Employee NIC
Image Rights payment
Net to Employee
Note: Income tax at 50% and Employee and Employer NIC of 1% and 12.8% respectively in 2010/11.
Structuring the IR Contract
Assuming the player has previously transferred his image rights into a separate IR Company, the IR Company will enter into a contract with the club to exploit that player’s image. The payment is therefore not connected to the employment of the player and as it is between two companies, there is no requirement to withhold income tax under Pay-As-You-Earn (“PAYE”) or NIC on the payment. Depending on the jurisdiction in which the IR Company is established, there may be no corporation tax due on the payments received by the IR Company, thus allowing the payments to remain tax free until they are drawn out of the IR Company in the form of dividends or capital distributions.
However, in order to achieve the desired tax treatment, the payment must be shown to be under a contract which has independent value and is separate from the contract of employment.
Clearly, with the ability to reduce the player’s income tax bill (and the club’s NIC liability) the arrangements have come under the close scrutiny of HMRC, who argue that the large sums paid under IR Contracts are not commensurate with the value received by the club and consequently that the payments are a smokescreen for additional remuneration, which is paid in a form not subject to income tax or NIC.
In fact, HMRC challenged the use of IR Contracts in the case Sports Club & Ors vs HM Inspector of Taxes in 2000 and were unsuccessful. The key points of the case found that the IR Contracts were:
• Genuinely commercial agreements which the parties could seek to enforce;
• Agreements which had independent value: established players are capable of earning very substantial sums each year from commercial contracts;
• Not a smokescreen for the payment of additional remuneration: the agreements were real and the parties intended activities to be performed under them in return for payments. The club took steps, including appropriate legal advice, to ensure they acquired the rights that they were paying for;
• The payments were made in return for promotional rights and were not made “in reference to” the playing of games i.e. the payments were not connected with employment.
Certain players are well established and have a strong image and therefore are capable of earning very substantial sums each year from commercial contracts. It is well known that organisations are willing to pay for the right to use the players’ images in association with their products. Therefore, if properly established, valued and exploited, the payments under IR Contracts should not attract income tax or NIC in line with current case law.
HMRC do not automatically assume that payments made under an IR Contract are earnings from employment. HMRC’s concern comes from the valuation of the image rights. In particular, where negotiations centre on a pay package, which cover both payments for playing and payments for image rights, HMRC do not consider an arbitrary carve up of an amount to be sufficient to prove that the image rights have been properly valued. HMRC also want to see a clearer link between the income generated through the players’ image rights and payments under the IR Contract.
It is essential that the commercial reality is that the club wishes to purchase or manage the player’s image and promotional activities, over and above the extent to which it is already provided for in his contract of employment.
In order to ensure the best chance of success when establishing an IR Contract, the club should consider the following issues:
- The Board of the club should consider its policy with regard to IR Contracts, the benefit to the club, the success of previous arrangements and the extent to which they may be improved;
- Club’s are likely to benefit from agreeing a pro-forma contract which can be used as a starting point for future IR Contract negotiations;
- The club should ensure the IR Company is set up in an appropriate jurisdiction and the players have legally transferred their image rights to that company. Note that if the player is UK resident at the time of the transfer, capital gains tax would be payable on the value of the image;
- The terms of each IR Contract should be negotiated with the IR Company and the contract drafted according to the facts and circumstances of the image involved;
- When signing a player, the club should consider whether that player has an independent image that the club wishes to exploit. If so, the image rights of the player should be included as a separate component of the negotiations on which the player should take independent advice;
- A business plan should be drafted setting out:
o the rights to be covered;
o the extent to which these are to be used;
o the value to the club of the contract; and
o a plan for how the rights are to be exploited.
The rights acquired must be over and above those provided for in the player’s contract of employment and the valuation should exclude any value attributable to contractual activity;
- The club will normally assess the value of the image rights contract based on previous experience. However, it would be useful if the club could also obtain independent third party expert valuations to support its negotiations;
- Once the negotiations on the value of the image rights have concluded and been documented, the agent can then negotiate salary as a separate matter. It will be clear therefore that there are two separate arrangements which the club has entered into; one with the IR Company for the players image rights and the other with the player for his services as a football player;
- The promotional activities provided under the IR Contract should be monitored and an annual report should be prepared to demonstrate the activities performed and the value to the club of those activities. The success of the IR Contracts should be reported to the Board to inform future decisions or policy changes.
HMRC’s preferred structure
As IR Contracts have become more common, agents have negotiated ever-increasing proportions of the overall player’s package to take the form of payments for image rights. As a result, HMRC have sought to challenge the arrangements on the basis that payments under the IR Contracts are excessive and are essentially a smokescreen for additional remuneration.
We understand that HMRC have suggested that their preferred structure for an IR Contract is for the contract between the club and the IR Company to provide for a low fixed annual fee (“retainer”) at an appropriate level plus a percentage of income generated from the player’s image rights (e.g. percentage of “net revenue”).
If clubs structured their IR Contracts this way, HMRC consider this structure would be robust as the value the player receives from the IR Contract would be linked directly to the value created for the club through exploitation of the player’s image rights.
However, it is not necessary to structure IR Contracts this way as, provided the amounts paid for use of the image rights is commensurate with the value of those image rights, the amount can be paid as a fixed sum per annum. Clubs may choose to increase the payment made under the IR Contract if the income from exploitation of the image rights exceeds the fixed sum, however this is a point for commercial negotiation between the club and the agents.
From a commercial perspective, a fixed sum structure is often preferable for clubs than providing for a share of incomes generated to be paid under the IR Contract, for the following reasons:
– Identifying the revenue generated through exploitation of a particular player’s image with such direct causality may be difficult from a practical perspective;
– The player’s image may provide indirect and intangible enhancement to the value of the club’s brand, which cannot be recognised simply by participation in direct income generated through exploitation of their image (e.g. revenue from sales of player named shirts);
– In granting a licence to the Club to exploit their image, a player is ceding his ability to generate income on his own behalf without any control or recourse to the Club to actually take steps to exploit that image. The player would therefore seek appropriate consideration for this;
– In addition, this structure of IR Contract does not deliver full value to the club for the benefit of being able to control the player’s image such that his time and energy are used on sporting activities and not in a manner which could potentially damage the clubs brand.
Valuing the Image Rights
In determining the value of the rights granted under the IR Contract, the club should assess the value of the IR Contract to it. This would include an assessment of a number of factors, including:
– The player’s contracted salary for playing football;
– Whether the player is already recognisable;
– How many international appearances the player has made to date;
– Whether the player is likely to appear in the first team; and
– The level of control over the activities of the player and the ability to ensure the player focuses on their sporting activities rather than commercial activities.
In addition when valuing the IR Contract, the club should consider the terms of the contract, including:
– Whether the licence to exploit the image rights is exclusive;
– Any carve-outs from exclusivity;
– The term of the licence;
– The ability to prevent the player from undertaking activities which have a detrimental impact on the value of the image rights to the club.
When determining the valuation of the IR contract the club will only take into account information available at the time the contract is entered into. The club may seek advice to determine what the value of the image rights is e.g. an indication of how much money players of a similar calibre have made from their image and promotional activities.
In making this assessment of the value of the IR Contract, the club should ideally complete a business plan, setting out the rights to be covered, the extent to which these are to be used and a plan for how the rights are to be exploited.
Notwithstanding this, it is understood that contract negotiations are often time pressured and therefore it may not always be possible to conduct a thorough valuation process prior to signing the player.
Therefore the IR Contract should be reviewed periodically to determine if the payments under the contract still represent good value to the club. The club should aim to maximise the value received from the exploitation of the player’s image. Clearly the club should intend to recoup from the exploitation of the player’s image the fees paid under the IR Contract and make a further profit, which they may wish to share with the player by allowing an additional percentage of revenues to be paid over and above the fixed annual payment under the IR Contract.
To the extent the services under the IR Contract are not being provided then the club should seek to rectify the position.
The club should prepare an annual report for each IR Contract setting out the specific activities performed under the IR Contract in the year and assessing how the activities are providing value to the club with quantification.
It is understood that in certain circumstances the basis for determining the fee under the IR Contract may be valid but ultimately lead to a mismatch between the actual value created from the exploitation of the player’s image rights. For example, from time to time the club may undertake an action which directly or indirectly impacts on the value of the player’s image, e.g. if a promising player performs poorly and is dropped from the first team, or if the player is injured, this would reduce the marketability of the player and therefore the potential to exploit the player’s image to create value. Such action should not invalidate the basis for valuing the IR Contract at the time it was entered into, nor change the nature of the payments to employment income. Information that becomes available after the IR Contract has been agreed should not be taken into account when determining the value of the IR Contract at inception.
One concern that has been expressed by HMRC is that the IR Contracts provide for a fixed fee for a number of years (usually the number of years of the employment contract) which may or may not turn out to be an appropriate valuation of the player’s image. Therefore, a periodic review and adjustment should be built into the contractual terms.
HMRC Challenges to Historic Arrangements
HMRC are investigating the use and implementation of IR Contracts at a number of clubs and it has been reported in the press that they intend to scrutinise all image rights deals of Premier League players. If HMRC found that payments under IR Contracts should be reclassified as remuneration, the clubs could be liable for a significant amount of underpaid PAYE and NIC.
As noted above, based on existing case law payments under IR Contracts should not be considered earnings from employment where the IR Contracts are properly established and operated. However, HMRC would be in a strong position where there is a lack of evidence that the image rights have been properly valued or that any steps have been taken by the club to exploit the rights it has been granted under the IR Contract.
HMRC are likely to challenge arrangements where they do not believe there is any commercial substance. However, clubs should not simply accept HMRC’s view. HMRC cannot merely ignore the existence of the commercial contract between the club and the IR Company and therefore will have to attack the arrangements on the basis of the valuation of the rights. Provided clubs can demonstrate that the value they have placed on the rights granted under the IR Contract is appropriate and that they have the intention and have tried to exploit the rights, they should have a robust starting position to defend any HMRC challenge.
The future for IR Contracts
As HMRC will be looking into IR Contracts, clubs should review their existing arrangements and be ready to provide evidence to support the value of the payments made under the existing IR Contracts.
Notwithstanding HMRC scrutiny, IR Contracts can provide significant value to clubs. Therefore, entering into IR Contracts with high profile players and looking for ways to generate value from their image rights will allow clubs to grow their commercial revenue streams through a share in the income from the players’ promotional activity.
 Deloitte, London