That would help a lot, particularly if the customer made separate payments to the FTO and the FI. But the practicalities would be a pain, as the FTO would probably want to collect the full amount from the student (how many pay in cash or by cheque nowadays?) and then pay the tuition element of the fee to the FI against an invoice.
The legal relationships between the parties would have to be carefully thought through and stuck to. So the student would need to contract with the FI for tuition and with the FTO for hire. The FTO would have to contract with the FI to act as his agent to collect the tuition fee on his behalf and so on. Since most FTOs charge more for tuition than they pay to FIs, the agreements would have to be structured to take account of this. Not having all of that in well structured legally enforceable written contracts would in practice be fatal.
And the sales literature/website etc. would also need to reflect the arrangements. Easily overlooked. And what about up front fees and students who might use more than one instructor? Can be coped with, but with care.
VAT would also rear its ugly head - the FI probably wouldn't have to register for VAT, unless he is giving a hell of a lot of lessons, so his tuition fee would in theory be VAT free. Good!
That would certainly interest HMRC - there has been litigation in the area in the recent past. Spearmint Rhino Ventures (UK) Ltd v. HMRC was a victory for the taxpayer. HMRC argued that the dancers were acting as agents of the company when they were paid in cash by customers for whatever it was they were doing, so that the company should have accounted for VAT on the payments. Company won. Different facts might give a different result.
So not simple in practice. And easy to mess up over time.
And I'm assuming that none of this would cause a problem under the regs. For example, if for any reason it was unlawful to give tuition under this kind of structure, the whole edifice would come crashing down.
How about doing it completely differently? e.g. having the FTO hire the aircraft to FI? if the FI was genuinely at some kind of economic risk - for example if he still had to pay for that hire even if the student did a no show or if he hired for periods when he might not have students, that might work. But is that practical?!
If it was structured so that he had no real risk - say because he was charged for tacho hours/time flown (so no fly, no hire charge) and he simply inflated his "fees" to the FTO to match his hire cost, so that hours on the ground cost him nothing, then the position would be far less defensible.
It might help if the hiring was not directly from the FTO, but from another company, even in the same ownership as the FTO, as the transactions are far less easily ignored because they are not so "self cancelling".
As for the regulatory issues (if any) on that scenario - ask an aviation lawyer.
This is all a balancing act of competing factors and requires carefull thought. Just signing a document saying that the FI is self employed and will look after his own tax is pretty much useless.
Fortunately for some, HMRC don't act with complete uniformity - their internal guidelines as to employment/self-employment (just look at the HMRC manuals on their website) are interpreted by human beings, not machines, who inevitably will vary in their approach. Some FTOs and FIs will get lucky. Some won't.
But for any already under investigation, all this planning is a waste of time as regards the past. Find yourself a competent account with access to further expertise if needed.
Alexa