The phrase "sham contracts" has dominated the sports pages this week, after an independent commission found that Manchester City used them as part of what it described as a disguised funding scheme. Most business owners will never face a Premier League disciplinary panel, but the issues at the heart of the case come up in ordinary companies every day. Money moves between a business and the people or companies connected to it, and the question is always the same: do the paperwork and the accounts reflect what is really going on?

This article briefly explains what the commission found and what happens next, then turns to what matters for your business. It covers what a sham contract actually is in law, what related party transactions are, how they must be shown in your accounts, and how HMRC approaches arrangements between a company and its directors, their families and their other businesses. Worked examples show the most common situations we see in owner managed companies.

Disclaimer: This article is for general information only and reflects public reporting, legislation and HMRC practice available at the time of writing in October 2026. References to Manchester City describe the published findings of an independent commission, which the club disputes and is appealing. No conclusion should be drawn about the final outcome of that case. Always seek specific advice on your own arrangements.

The Man City Ruling in Brief

In February 2023, the Premier League charged Manchester City with more than 100 breaches of its financial rules. The case was heard by an independent commission between September and December 2024, and its decision was published in late September 2026.

The commission found the club guilty of all charges relating to breaches of the league's financial rules over the nine seasons from 2009/10 to 2017/18, and of three of the four charges relating to failing to cooperate with the investigation. Its central finding was that the club arranged sham contracts with a number of commercial partners as part of a disguised funding scheme, artificially inflating the club's revenues by £830 million. In simple terms, the commission concluded that money presented as sponsorship income from commercial partners was in substance funding from the club's owner. The commission also found that the club's accounts concealed the true state of its finances. During the hearing, the club argued that additional sponsorship funding came from the Abu Dhabi government, an explanation the commission rejected.

Manchester City denies wrongdoing. It lodged an appeal on 1 October 2026, stating that it is innocent and that the decision contains clear material errors of law, principle and fact. The appeal will be heard by a separate three person appeal board. Under rules introduced this season, appeals are meant to conclude within 12 weeks, although the club may argue that this faster timetable should not apply to a case that began years ago. Sanctions have not yet been decided.

Whatever the final outcome, the case turns on two questions every accountant asks about transactions between connected parties. First, does the contract reflect the real arrangement between the parties? Second, have the accounts presented that arrangement truthfully?

What Is a Sham Contract?

In English law, "sham" has a narrow and specific meaning. The leading definition comes from the 1967 Court of Appeal case of Snook v London and West Riding Investments, where Lord Justice Diplock described a sham as acts or documents that the parties intend to give third parties, or the court, the appearance of creating legal rights and obligations different from those they actually intend to create.

Two features are essential. The document must misrepresent the true arrangement, and the parties must share an intention to create that false appearance. A contract that is simply badly drafted, commercially unwise or generous to one side is not a sham. Equally, a perfectly genuine contract can still be challenged for other reasons, for example because the price is not commercial or the arrangement is designed mainly to avoid tax.

This distinction matters in practice. HMRC and the courts rarely need to prove a full sham in tax cases. Instead, they apply a principle of looking at the substance of a transaction rather than just its form. In tax, courts interpret legislation by reference to what actually happened, viewed realistically, a principle that dates back to the Ramsay case in 1981. In employment status cases, including IR35, the Supreme Court confirmed in Autoclenz v Belcher in 2011 that a tribunal can look past the written terms to the true agreement between the parties. Our guide to IR35 explains how this affects contractors.

The practical lesson is simple. It is not enough for paperwork to exist. It must describe what genuinely happens, and the money must move in the way the documents say it does.

What Are Related Party Transactions?

A related party transaction is any transfer of money, goods, services or obligations between a business and a person or organisation connected to it. Under FRS 102, the accounting standard most UK private companies use, related parties include the company's directors and other key management personnel, close members of their families such as spouses, partners and children, companies that those people control or significantly influence, and other companies in the same group.

In owner managed businesses, related party transactions are everywhere and are usually entirely legitimate. Common examples include a company renting premises from a director who owns the building, a director's spouse or child being employed by the company, loans between a director and the company, management charges between companies under common ownership, a director's other business supplying services to the company, and personal guarantees given by directors to the company's bank.

None of these is wrong in itself. The risk arises when the terms are not commercial, the paperwork does not match reality, or the transaction is not properly recorded and disclosed.

How Related Party Transactions Appear in Your Accounts

Related party transactions must be reflected accurately in the accounts and, in many cases, disclosed in the notes. The level of disclosure depends on the size of the company.

Companies preparing full FRS 102 accounts must disclose material related party transactions, including the nature of the relationship, the amounts involved, any outstanding balances and their terms. Small companies preparing accounts under Section 1A of FRS 102 have reduced requirements, but must still disclose related party transactions that were not concluded under normal market conditions, along with advances, credits and guarantees given to directors, and are encouraged to disclose other material transactions. Micro entities have the lightest requirements, but must still show advances, credits and guarantees given to directors.

A director's loan account is the most common related party balance of all. If you owe money to your company, or your company owes money to you, this must appear correctly on the balance sheet. An overdrawn balance can trigger the Section 455 tax charge, explained in our guide to director's loan accounts.

Directors are legally responsible for the accounts giving a true and fair view. Approving accounts that directors know do not comply with the law can be a criminal offence under the Companies Act 2006, as can failing to keep adequate accounting records. Our guide to reading your company accounts explains what the main statements show.

The Tax Risks: How HMRC Approaches Connected Arrangements

HMRC pays close attention to transactions between a company and the people connected to it, because the normal tension between buyer and seller is missing. When a director agrees a price with their own company, nobody is pushing back. HMRC's tools for challenging these arrangements include the following.

The wholly and exclusively test means a company can only deduct a cost for Corporation Tax if it was incurred wholly and exclusively for the purposes of the trade. Where a payment to a connected person exceeds what the company would pay an unconnected party, HMRC may argue that the excess was not for business purposes and disallow it.

Reclassification is another risk. A payment described as one thing, such as rent, a management fee or a consultancy charge, may in substance be remuneration or a distribution to a director or shareholder. If HMRC reclassifies it, PAYE, National Insurance or dividend tax may become due, often with interest and penalties.

Transfer pricing rules require transactions between connected businesses to be priced as if they were between independent parties, at what is called an arm's length price. Most small and medium sized enterprises are exempt from the formal UK transfer pricing rules for domestic transactions, but the exemption does not apply to transactions with connected parties in certain overseas territories, and HMRC can still challenge non commercial pricing through the wholly and exclusively test and other rules.

Penalties also apply. Where errors in tax returns result from carelessness, or from deliberate behaviour, penalties can be substantial on top of the tax itself. HMRC is investing heavily in compliance work on smaller businesses, as covered in our article on HMRC SME investigations.

Worked Examples

Worked Example 1: Owner Funding Dressed Up as Sales

This example illustrates, on a small scale, the type of arrangement at the centre of the Man City findings.

James owns two companies, Northfield Print Ltd and Northfield Property Ltd. The print business has had a difficult year and James is about to apply for a bank loan. To make its turnover look healthier, he arranges for the property company to pay the print company £40,000 plus VAT for "marketing services" that are never actually provided, supported by an invoice and a short service agreement.

On paper, the print company's turnover rises by £40,000. In reality, the property company has simply funded the print company, and the service agreement describes something that never happened. This creates several serious problems. The print company's accounts overstate its trading income and do not give a true and fair view. The property company claims a Corporation Tax deduction and recovers input VAT on services it never received, which is likely to be disallowed. A bank lending on the strength of inflated figures may treat this as misrepresentation, with potential consequences far beyond tax.

The legitimate way to achieve the same funding is straightforward. The property company, or James personally, could lend the money to the print company under a simple written loan agreement, or James could subscribe for additional shares. Either option is transparent, is shown correctly in both sets of accounts, and gives the bank an honest picture.

Worked Example 2: Rent Paid to a Director

Sarah is the director and sole shareholder of Hayes Joinery Ltd. She personally owns the workshop the company uses, and the company pays her rent of £36,000 a year. A local surveyor confirms that the market rent for a similar workshop is around £24,000 a year.

Sarah pays Income Tax on the full £36,000 as property income. However, HMRC could argue that the £12,000 above market rent was not incurred wholly and exclusively for the company's trade and disallow it for Corporation Tax. At the main rate of 25%, that would add £3,000 of Corporation Tax for each year affected, plus interest and possibly penalties. HMRC could also argue that the excess is in substance extra remuneration or a distribution.

There is a further, less obvious cost. When Sarah eventually sells the business, a claim for Business Asset Disposal Relief on the workshop as an associated disposal may be restricted because she has charged the company rent. That does not mean charging rent is wrong, but the decision should be made with the full picture in mind. Our article on Business Asset Disposal Relief explains the relief in more detail.

The fix is to put a formal lease in place at a rent supported by independent evidence of market value, review it periodically, and make sure the payments match the lease terms.

Worked Example 3: A Spouse on the Payroll

Michael runs Brookside Consulting Ltd and employs his wife, Anna, who handles bookkeeping and client scheduling for around four hours a week. The company pays her £20,000 a year. An unconnected part time administrator doing the same work would cost the company around £6,000 a year.

Employing a spouse is entirely legitimate, and paying a reasonable salary can use their Personal Allowance efficiently. The problem here is the level of pay. HMRC is likely to accept a deduction for a salary that reflects the work done, but could disallow the excess of around £14,000 as not incurred wholly and exclusively for the trade. The company would lose Corporation Tax relief on that amount.

The fix is to keep a simple job description, a record of the hours Anna works, and evidence of what the role would cost on the open market, and to set her pay at a level that can be justified. Payments must also comply with National Minimum Wage rules and be run through payroll properly.

Worked Example 4: Management Charges Between Group Companies

Alder Holdings Ltd owns two trading companies, Alder Electrical Ltd and Alder Plumbing Ltd. At each year end, the directors move £60,000 of central costs, including their own salaries, into whichever company has made the larger profit, with no written agreement and no consistent basis for the split.

Because both companies are in the UK and qualify as small or medium sized, formal transfer pricing rules are unlikely to apply, and the overall Corporation Tax effect across the group may be limited. But the arrangement still causes problems. Each company's accounts may not reflect its true performance, which matters to lenders, to any minority shareholders and to any future buyer. VAT may be due on management charges unless the companies are in a VAT group. And if one company later gets into financial difficulty, an insolvency practitioner will examine whether charges moved into it were genuine.

The fix is a written intercompany agreement setting out what services are provided and how costs are allocated, using a consistent and defensible basis such as staff time, headcount or turnover, applied every year.

A Note on the Failure to Prevent Fraud Offence

Since 1 September 2025, large organisations can be criminally liable if an employee, agent or other associated person commits fraud intending to benefit the organisation, unless the organisation can show it had reasonable procedures in place to prevent fraud. The offence applies to organisations meeting at least two of three conditions: more than 250 employees, turnover above £36 million, and total assets above £18 million, with group figures counted together.

Most owner managed businesses fall well below these thresholds. However, small businesses that supply large organisations are increasingly being asked about their financial controls as part of supplier due diligence. Being able to show that related party transactions are documented, priced fairly and properly recorded is part of demonstrating that your business is a trustworthy partner.

A Practical Checklist for Business Owners

Make a list of every person and business connected to your company, including family members and other companies you own or control, so that related party transactions can be identified.

Put written agreements in place for regular arrangements, such as leases, loans, management charges and service agreements, and make sure the money moves exactly as the agreements say.

Price connected transactions at a level you could justify to an independent third party, and keep evidence such as surveyor's reports, quotes or market salary data.

Keep your director's loan account up to date throughout the year, not just at the year end.

Tell your accountant about any transaction with a connected person or business, so it can be recorded and disclosed correctly in your accounts.

Never create paperwork to describe a transaction that has not happened, or to make a transaction look like something it is not. If you need to fund the business, there are transparent ways to do it.

Frequently Asked Questions

What does "sham contract" mean in the Man City case?

The independent commission used the term to describe commercial contracts that, in its view, did not reflect the true arrangement between the parties. It concluded that money presented as sponsorship income from commercial partners was in substance funding from the club's owner. Manchester City denies this and is appealing the decision.

What is a sham contract in UK law?

A sham is a document or arrangement that the parties intend to give the appearance of creating legal rights and obligations different from those they actually intend to create. Both the misleading appearance and a shared intention to mislead are required. A contract that is simply poorly drafted or commercially unwise is not a sham.

What counts as a related party for a small company?

Under FRS 102, related parties include the company's directors and key management personnel, their close family members, companies controlled or significantly influenced by those people, and other companies in the same group.

Do small companies have to disclose related party transactions?

Small companies using Section 1A of FRS 102 must disclose related party transactions that were not concluded under normal market conditions, along with advances, credits and guarantees given to directors, and are encouraged to disclose other material transactions. Micro entities have lighter requirements but must still show advances, credits and guarantees to directors.

Can my company pay me rent for premises I own?

Yes. This is common and can be tax efficient, provided there is a proper lease and the rent reflects the market rate. Rent above market value risks part of the cost being disallowed for Corporation Tax, and charging rent can affect Business Asset Disposal Relief on a future sale of the property, so take advice first.

Can I employ my husband, wife or partner in my company?

Yes, provided they genuinely do work for the company and their pay reflects that work. HMRC may challenge salaries that are clearly higher than the role justifies. Keep a record of their duties and hours, and pay them through payroll in the normal way.

Do transfer pricing rules apply to my small business?

Most small and medium sized enterprises are exempt from the formal UK transfer pricing rules for domestic transactions. However, the exemption does not cover transactions with connected parties in certain overseas territories, and HMRC can still challenge non commercial pricing through other rules, such as the wholly and exclusively test.

Is it illegal to inflate my company's turnover?

Deliberately overstating turnover through fictitious transactions can lead to accounts that do not give a true and fair view, which can be an offence for the directors who approve them. Depending on the circumstances, it can also amount to misrepresentation or fraud against lenders, investors or HMRC.

What is the failure to prevent fraud offence?

It is a criminal offence, in force since 1 September 2025, under which large organisations can be liable for fraud committed by associated persons for the organisation's benefit, unless they had reasonable procedures to prevent it. It applies to organisations meeting at least two of the size conditions of more than 250 employees, turnover above £36 million and total assets above £18 million.

What CoreAcc Accountants Can Help You With

CoreAcc Accountants helps owner managed businesses structure transactions with directors, families and connected companies on a sound footing. We review existing arrangements such as rent, family salaries, intercompany charges and director's loans, help put proper documentation in place, make sure related party transactions are recorded and disclosed correctly in your accounts, and advise on the tax consequences before you commit to a new arrangement, rather than after HMRC asks questions.

Get in Touch

If your company pays rent to a director, employs family members, lends or borrows from its owners, or operates alongside other businesses you control, contact CoreAcc Accountants for a review. We will check that your arrangements reflect commercial reality, are properly documented, and will stand up to scrutiny from HMRC, lenders and anyone else who relies on your accounts.

CoreAcc Accountants is an ACCA accredited firm of Chartered Certified Accountants based in Borehamwood, Hertfordshire. This article was published in October 2026. References to Manchester City describe the published findings of an independent commission, which the club disputes and is appealing. This article does not constitute professional or legal advice. Always seek specific advice tailored to your individual circumstances.

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