Article by Arthur Sellwood, a former Inspector of Taxes who writes on tax subjects, published in the June 2002 issue of Tax Adviser.
- A long running battle
- Sportsmen and company directors as the main protagonists
- Popular misconceptions lead to failure in the courts
- Latest decision relies on only a fraction of the wealth of case law
Taxpayers and the Revenue have had some indecisive skirmishes in the past preparing themselves for some hard-fought actions in a battle which has continued until the present time.
The point at issue was whether certain lump sum payments constituted emoluments within the charge to tax under Sch. E (now in Income and Corporation Taxes Act (ICTA 1988), 1988 s.19). At that time these lump sums were described as compensation payments. They are now generally referred to as termination payments and, indeed, the present legislation concerning them in ICTA 1988, s.148 is headed Payments on retirement or removal from office or employment. It should, however, be borne in mind that as well as referring to payments in consideration or consequence of, or connection with, termination of an office or employment, the section also embraces payments in consideration or consequence of, or connection with, any changes in the functions or emoluments of an office or employment. The alternative to a charge under Sch. E suggested by taxpayers was that the payments should escape taxation altogether as being either voluntary gifts or in compensation for some capital right such as loss of the office. There was, of course, no capital gains tax at that time.
The early cases
The two groups of people who have, from the beginning, been concerned in court cases arising from this problem have been directors and senior managers of limited companies, and sportsmen. Examples covering each of these groups are to be found among the earliest cases.The proceeds of a county cricketers’ benefit match were held not to be liable in Reed (HMIT) v Seymour (1927)11 TC 625. In the same year a Football League player was less lucky in respect of his benefit in Davis (HMIT) v Harrison (1927)11 TC 707. In 1932 two cases with opposite results concerned directors of the same company. Directors of this company who resigned were, under the terms of their appointment, entitled to a payment based on remuneration for their last five years of service. In Henry (HMIT) v Foster (1932) 16 TC 605 two retiring directors were held to be chargeable on the payment received. But in Hunter (HMIT) v Dewhurst (1932) 16 TC 605 the director – who was chairman of the company and was due to retire on the same entitlement as the others – was persuaded to stay on at a reduced rate of remuneration and under an agreement to waive his right to the compensation which he would be entitled to on final retirement. In his case the courts held that the payment he received at this intervening time was not assessable income. A few years later in a case where a manager received agreed damages after starting an action against his company for repudiation of his service agreement, the amount received was held not to be assessable – Du Cros v Ryall (HMIT) (1935) 19 TC 444).
Some gruelling contests
Honours so far had been fairly even, but cases had been relatively infrequent. They became much more common between 1940 and the change in the law which took place in 1960. Some of the cases mentioned have, although heard after the change in the rules, related to years before that change. One point which emerged from the cases was that where the payments received were provided for in the recipient’s contract or agreement for service it was likely to be taxable. If, however, a service agreement was terminated prematurely, or there was some other breach of it by the employer so that the payment was for loss of the agreement or rights under it, the recipient would probably escape assessments.
In this period sportsmen continued to lose claims that their benefit moneys should escape liability to tax. Amongst such claims were those by a Lancashire League cricketer in Moorhouse (HMIT) v Dooland (1954) 36 TC 11 and by a Football League player in Corbett v Duff (HMIT) (1941) 23 TC 763. Cases relating to directors and senior managers were very numerous and it would be tedious to list them all. The Revenue were often successful, having impressive victories in the cases that follow: in Dale (HMIT) v de Soissons (1950) 32 TC 118, the employer had a right, which was exercised, to terminate a service agreement at the end of the first year in return for a specified payment. This payment was held to be assessable. In Prendergast (HMIT) v Cameron (1940) 23TC 122 a director wanted to retire, but was persuaded to stay on at a reduced salary and with reduced duties in return for a large lump sum which was held to be taxable. In Wilson (HMIT) v Daniels (1943) 25 TC 473) a managing director agreed to resign on the grounds of ill-health, but continued to act as an advisory director at a reduced salary and was paid a lump sum which was held to be assessable.
But taxpayers also had some considerable successes. In Hose (HMIT) v Warwick (1946) 27 TC 459 a director was partly remunerated by commission on connections which he had introduced on joining the company. He agreed to become managing director and to give up the rights he had had under his previous agreement and was paid a lump sum for doing so. This sum was held not to be assessable. In Wales (HMIT) v Tilley (1942) 25 TC 136) a managing director was paid a large lump sum for entering into a revised service agreement which gave him a reduced salary and released the company from paying him a pension. The part of the lump sum referable to his reduced salary was held to be assessable, but not the part referable to his loss of pension rights.
The 1960 legislation
The decisions in these and other cases made the authorities realise that such payments could lead to a considerable loss of tax and it was decided to close the loophole. Legislation in 1960 was designed to make lump sum payments of the kind which had been escaping assessment chargeable under Sch. E. But in order not to make the change too harsh, relief was given to exempt the first £5,000 from tax. A distinction was drawn between compensation payments (namely those made under a court order in proceedings for wrongful dismissal or breach of contract or in settlement of a claim for which such proceedings could be brought) and other types usually referred to as ex-gratia payments. The exemption for these latter payments could be increased up to the level of the ‘standard capital superannuation benefit’. Both types of payment could be further relieved by top-slicing.
This legislation which after some amendments now appears as ICTA 1988, s.148 and 188 has been, and still is, the subject of some popular misconceptions. It has, for instance, been looked on as a relieving provision, whereas it is in fact, an additional charge to tax. But, more importantly, there has been a tendency to overlook the wording which still appears in s.148 that the charge is made on payments not otherwise chargeable to tax. Cases quoted above and quite a few others have shown that many payments of this kind are already chargeable to tax under the rules of Sch. E. Payments so chargeable do not rank for relief under s.188.
The exemption of £5,000 was increased to £10,000 in 1978 and to £25,000 in 1981. In the latter year it was decided to abolish the distinction between compensation and ex-gratia payments and the extra reliefs for standard capital superannuation benefit and for top-slicing. More controversially, however, relief was given by a lower rate of tax on the excess over £25,000; and further changes in 1982 gave full relief on £25,000; 50 per cent relief on the next £25,000 and 25 per cent on the next £25,000 after that. But some excessive payments to take advantage of these reliefs led to cancellation of relief on the two upper tranches in 1988 and the stabilisation of the amount exempted at £30,000.
Cases continued to arise in which taxpayers claimed the exemption whereas the Revenue contended for tax on the full amount. In the sporting world a sum paid to Peter Shilton (the England football team’s goalkeeper) by his old club for accepting transfer to a new club, was held to be fully taxable in Shilton v Wilmshurst (HMIT)  BTC 66. So also was a payment to a managing director in Williams (HMIT) v Simmonds (1981) 55 TC 17.
In recent years cases concerned with such matters as redundancy and payments in lieu of notice have come under consideration in connection with the meaning of such terms as wages and emoluments. In Delaney v Staples  1 All ER. it was said that a payment in lieu of notice is not a payment of wages in the ordinary sense as it is not in return for work to be done under a contract of employment. In Mairs v Haughey  BTC 339) a sum paid by the Department of Economic Development as part of a total received by a manager on the transfer of Harland and Wolff plc to a new buy-out company was not an emolument or a benefit in kind. Then in EMI Group Electronics Ltd v Coldicott  BTC 294 it was held that payments in lieu of notice were clearly derived from being an employee as they were provided for in the employment contracts.
The latest claimant
In June 2001 an appeal by the Revenue against a decision of the General Commissioners in Richardson (HMIT) v Delaney  BTC 392) came before the court. Under his service agreement the taxpayer’s employment was terminable by either party on eighteen months’ notice in writing, but the employer could also terminate it immediately by paying salary in lieu of notice. On 1 December 1995 the employer wrote to the employee giving notice to terminate the employment and putting the employee on garden leave. Another letter was sent on the same date proposing termination on 28 December and suggesting a payment of £68,001. Subsequent negotiations led to the agreement of 28 December as termination date with a payment of £75,000 and retention of a company car. The Commissioners held an appeal that the employer was in breach of contract and that the payment was not, therefore, chargeable to tax under ICTA 1988, s.19.
It seems surprising that, with the wealth of available case law, only four cases which included Dale v de Soissons, Delaney v Staples and EMI Group Electronics Ltd v Coldicott were quoted in the judgment. This was evidently because the taxpayer neither appeared nor was represented. The judge held that there was no evidence to suggest that the employers had been in breach of contract and that their decision must be set aside. The payment was taxable in full under s.19. It has been suggested that more notice might have been taken of obiter dicta in Williams v Simmonds as to what might have been the result in that case if the taxpayer has constructed his departure somewhat differently. But in view of the employer’s right in Richardson v Delaney to terminate the employment immediately by making a payment in lieu of notice and the great weight of case law it is difficult to see how the judge could have come to any conclusion other than that the payment was ‘otherwise chargeable to tax’
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June 2002 by