INCOME TAX – payment received for cancellation of share options – whether exempt as termination payment under section 148 ICTA 1988 – whether assessable to income tax under s.135 ICTA 1988 - whether outcome affected by conduct of Inland Revenue in confirming that taxpayer’s affairs in order – appeal dismissed

THE SPECIAL COMMISSIONERS

	M C BLUCK	Appellant

	- and -

           MRS H A SALTON
	(HM INSPECTOR OF TAXES)    	Respondents

				Special Commissioner:   MALCOLM GAMMIE QC

Sitting in London on 23 June 2003

The Appellant appeared in person

John Hughes of the Inland Revenue’s Appeal Unit for the Respondents

© CROWN COPYRIGHT 2003

DECISION

1.	In January 1997 Mr Melvyn Bluck received a payment of £10,102.59 for the cancellation of shares options. He had been granted the options as part of his employment with Videotron Corporation Limited (“VCL”).  His employment with VCL had ceased in April 1995, due to redundancy and ill-health, but Mr Bluck had retained his options. Mr Bluck did not enter the January 1997 payment on his tax return for 1996/97.  I am satisfied that in failing to do so Mr Bluck was not seeking to conceal the payment but honestly believed that there was nothing to report.  (VCL had reported the payment to the Inland Revenue, as it was required to do.)  
2.	Mr Bluck believed that there was nothing to report because so far as he was concerned he had agreed with VCL in 1995 that he should retain his options as part of agreed termination arrangements and had been told that what he received as a result was entitled to exemption from charge to tax under section 148 Income and Corporation Taxes Act 1988 by virtue of section 188(4) of that Act.  Furthermore, in so far as the payment might have been liable to capital gains tax as a capital sum, Mr Bluck had concluded that it did not need to be reported in his return as a capital gain because it fell below the limits specified in Question 8 of the return for 1996/97.  
3.	The Inland Revenue disagreed and amended his 1996/97 return to charge the payment to income tax under section 135 Income and Corporation Taxes Act 1988.  Mr Bluck appeals against that Revenue amendment to his self-assessment return for the year 1996/97.  
The Facts
4.	Mr Bluck and his wife, Mrs Patricia Bluck, gave evidence and the facts were not seriously disputed.  Mr Bluck started work with a company called West Side Cable in January 1990.  The Videotron group acquired West Side Cable in January 1991 and on 1st December in each of the years 1992, 1993 and 1994 Mr Bluck was granted options to subscribe 100 ordinary shares of £1 each in Videotron Holdings Limited (“Videotron”) at a subscription price of £15 per share.  Mr Bluck was unable to produce any document describing the terms of the options and could not recall ever receiving any such document.  By the time the options were cancelled, the Videotron ordinary shares had apparently been subdivided, so that Mr Bluck’s options subsisted over 6,000 ordinary shares of 5p each, with an exercise price of 75p per share.
5.	On 30th April 1995 Mr Bluck was made redundant.  This followed a period of illness during which Mr Bluck had had two operations.  On 15th March 1995 Valerie Elliott, VCL director of Human Resources, visited Mr and Mrs Bluck at their home to discuss the terms on which his employment with VCL would be terminated.  Unfortunately there is no full record of what they agreed, in particular as they related to the share options.  Mr Bluck said that his options would have lapsed on his ceasing to be employed by VCL but that he agreed with Valerie Elliott that he should retain them.  It is impossible to say whether or not this is correct.  While employee options frequently lapse on leaving employment, especially if the employee gives notice or is dismissed for good reason, it may be different if the employment ends by reason of retirement, ill-health or redundancy.  
6.	Thus, it might be that the options would have lapsed and Mrs Elliott agreed on VCL’s behalf that they should not.  Alternatively, Mrs Elliott might merely have confirmed that the options would not lapse under the terms of the scheme because Mr Bluck’s employment was being terminated at VCL’s instigation.  It could also be that the options were immediately exercisable on termination through redundancy and that what Valerie Elliott agreed was that Mr Bluck need not exercise them within the time required under the scheme.  Mr Bluck said that he did not have the means to exercise the options at the time and any shares that he would have acquired as a result were not then publicly traded.  Whatever the option terms and whatever the agreement with Valerie Elliott, what is clear is that Mr Bluck did retain his share options and did remain entitled to exercise them after the termination of his employment.  Certainly in January 1997 he was included in the class of persons who held options that were capable of being exercised.  There is no evidence that the terms of his options were varied in April 1995 or that VCL granted new options in April 1995 to replace the existing options, which would otherwise have lapsed.
7.	Both Mr and Mrs Bluck also gained the impression from their meeting with Valerie Elliott that the retention and later exercise of the options would involve no income tax liability as any amount received would come within the £30,000 exemption for termination payments under section 188(4) of the Income and Corporation Taxes Act 1988.  This may or may not be what Valerie Elliott told them but it cannot affect my determination in this appeal.
8.	The next event that I must record occurred on 13th May 1995.  Mr Bluck wrote a letter to his wife on the occasion of her birthday.  The letter was as follows—
	“Happy Birthday to you, as you know under the Videotron Holdings Ltd Management Share Option Scheme I have share options for 300 ordinary shares. Under this letter I therefore give to you half of these share options that is 150 ordinary shares.”
9.	In his cross-examination of Mr and Mrs Bluck, Mr Hughes sought to call into question whether this letter truthfully reflected what had passed between them at the time.  He also questioned whether it amounted to a valid gift of half the share options and whether it was open to Mr Bluck to make the gift under the terms of the options.  Mr and Mrs Bluck’s evidence was that, having lost his job (and he has not been in employment since then) he had little money to spare and could not afford to buy his wife a birthday present.  He therefore gave her something that he hoped would prove to be of value in the future (as indeed was the case).  I see no reason for disbelieving Mr and Mrs Bluck on this point and I therefore find that the letter of 13th May 1995 accurately recorded what passed between them on the occasion of Mrs Bluck’s birthday that year. It is impossible to know whether the terms of the options entitled Mr Bluck to transfer the options to his wife.  Mr Bluck said that he had not informed VCL of his gift as he saw no need to do so as he owned the options and this was a matter solely between his wife and himself.  
10.	On 8th January 1997 Mr Bluck received a circular from Videotron and Bell Cablemedia Plc (“BCM”).  This told him that BCM and its subsidiaries now owned 81.7 per cent of the ordinary shares of Videotron and was making an offer to acquire its remaining ordinary shares.  This meant that his options had become exercisable but as part of its offer, BCM indicated that in return for the cancellation of the Videotron options, it would pay the difference between the option exercise price and the offer price for the ordinary shares of US$3.95 per share.  There were two alternatives to accepting this cash cancellation offer.  The first was to exercise the options and acquire Videotron ordinary shares.  These could be retained or sold but BCM indicated that if it acquired more than 90 per cent of the outstanding shares it would exercise its right to purchase the balance compulsorily.  The second alternative was to allow the options to lapse.  
11.	Not unexpectedly in view of these alternatives, Mr Bluck elected to accept BCM’s cash cancellation offer.  On 19th January 1997 he received a cheque for £10,102.59 and accounted for half of this amount to Mrs Bluck.  Finally, on 7th May 1997 VCL wrote to the Inland Revenue reporting the issue, sale and cash cancellation of shares under its unapproved share option scheme.  The circular advised option holders that “you will be liable to income tax at your marginal rate on the amount paid to you to cancel your option(s)”.  Mr Bluck, however, regarded this information as being directed to current Videotron employees and as not applying to him given what he had been told by Valerie Elliott in 1995.
The Law
12.	Section 148 Income and Corporation Taxes Act 1988 provides that—
	“(1) Subject to the provisions of this section and section 188, tax shall be charged under Schedule E in respect of any payment to which this section applies which is made to the holder or past holder of any office or employment, or to his executors or administrators, whether made by the person under whom he holds or held the office or employment or by any other person.
	(2) This section applies to any payment (not otherwise chargeable to tax) which is made, whether in pursuance of any legal obligation or not, either directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of the holding of the office or employment or any change in its functions or emoluments, including any payment in commutation of annual or periodical payments (whether chargeable to tax or not) which would otherwise have been so made.”
Section 188 provides that—
	“(4) Tax shall not be charged by virtue of section 148 in respect of a payment of an amount not exceeding £30,000 (“the exempt sum”) and, subject to subsection (5) below, in the case of a payment which exceeds that amount shall be charged only in respect of the excess.”
13.	As appears from these provisions, section 148 and the exemption in section 188(4) are only relevant in the case of a “payment to which [section 148] applies” and any such payment must not be “otherwise chargeable to tax”.  The payment must also be in consequence of or otherwise connected with the termination of employment.  Even if I assume that this payment was indirectly connected with the termination of Mr Bluck’s employment (on the basis that he was allowed to retain options that otherwise would have lapsed), the question that remains is whether the payment in question is otherwise chargeable to tax under section 135, as Mr Hughes for the Respondent contends.
14.	Section 135 provides that—
	“(1)  where a person realises a gain by the exercise, or by the assignment or release, of a right to acquire shares in a body corporate obtained by that person as a director or employee of that or any other body corporate, he shall be chargeable to tax under Schedule E on an amount equal to the amount of his gain, as computed in accordance with this section.
	(3) Subject to section 136(4)—
		(a) 
		(b) the gain realised by the assignment or release of any such right shall be taken to be the difference between the amount or value of the consideration  for the assignment or release and the amount or value of the consideration given for the grant of the right;
	(8) In any case where—
		(a) a person has obtained any such right to acquire shares as is mentioned in subsection (1) above (“the first right”); and
		(b) as to any of the shares to which the first right relates, he omits or undertakes to omit to exercise the right or grants or undertakes to grant to another a right to acquire the shares or any interest in them; and
		(c) in consideration for or otherwise in connection with that omission, grant or undertaking, he receives any benefit in money or money’s worth;
	he shall be treated for the purposes of this section and section 136 as realising a gain by the assignment or release of the first right, so far as it relates to the shares in question, for a consideration equal to the amount or value of the benefit referred to in paragraph (c) above.”
15.	It is therefore immaterial that Mr Bluck was employed by VCL but received options over shares in Videotron or that the payment to cancel the options was eventually made by BCM.  Mr Bluck also does not dispute that he initially acquired his options “as an employee” but was that requirement affected by the agreement he reached with Valerie Elliott in April 1995?
16.	As I have already noted, a difficulty for Mr Bluck in this regard is that he has been unable to say whether the option would have lapsed on his leaving employment or precisely what he and Valerie Elliott did agree vis-à-vis the options.  There is no evidence, however, that his options did lapse in April 1995 or that he was granted new options after he left employment.  What evidence I do have indicates that the options that he held in January 1997 were the options that he was granted between 1992 and 1994 and that they remained capable of exercise.  Section 136(5)(c) makes it clear that an “employee” for these purposes includes a person who has been an employee.  Furthermore, section 140(1) provides that a person acquires an option as an employee if it is granted to him by reason of his employment and that this applies to a right granted by reason of employment after the employment has ceased.  Accordingly, even if Mr Bluck could be more particular about the terms of the option and what was agreed in April 1995, I doubt that it would affect the application of section 135.
17.	Finally, I do not need to resolve whether Mr Bluck’s gift to his wife of half his share options was an effective gift.  The gift itself would not have given rise to any charge to tax under section 135.  Even assuming the gift to be a valid equitable assignment, it involved no gain.  Thereafter, section 135(6) provides that—
	“(6)  , a person shall, in the case of a right granted by reason of his office or employment, be chargeable to tax under this section in respect of a gain realised by another person—
(a)	 
(b)	if the other person acquired the right otherwise than by or under an assignment made by way of a bargain at arm’s length, or if the two are connected persons at the time when the gain is realised,
but in a case within paragraph (b) above the gain realised shall be treated as reduced by the amount of any gain realised by a previous holder on an assignment of the right.”
18.	Mrs Bluck acquired half the options otherwise than through an arm’s length bargain and she is in any event connected with Mr Bluck (see s.140(2) and s.839(2)). Accordingly, even though half the payment received by Mr Bluck may have belonged to Mrs Bluck, section 135(6) ensures that Mr Bluck remains liable to tax under section 135 on the whole amount.  
19.	I therefore determine that the payment of £10,102.59 for the cancellation of shares options in January 1997 is chargeable to tax under Schedule E by virtue of section 135 and that sections 148 and 188 do not apply to it.
20.	Mr Bluck argued vigorously against that conclusion on the basis that he had never been employed by Videotron or BCM, that he had left VCL’s employment in April 1995 on terms that gave him the benefit of exemption under section 188(4) and that half the options belonged to his wife.  For the reasons I have given, however, these arguments are of no avail to Mr Bluck.  
21.	Mr Bluck referred in his skeleton argument to the cases of Mairs v Haughey (1992) 66 TC 273, Wilcock v Eve (1994) 67 TC 223 and Nichols v Gibson (1996) 68 TC 611.  The last of these establishes that section 148 is a charging section independent of the general Schedule E charging provisions in section 19 of the Act.  That does not, however, serve to bring the payment in this case within section 148.  Mairs v Haughey was concerned with whether certain payments made in respect of a non-statutory redundancy scheme were taxable as emoluments under section 19.  The Inland Revenue does not contend, however, that in Mr Bluck’s case the payment is chargeable to tax under Schedule E otherwise than by virtue of section 135.  Wilcock v Eve bears a greater similarity to Mr Bluck’s case because it involved an individual who was granted share options in the employing company’s parent but following a management buy-out of the employing company the options lapsed.  Some time thereafter, the former parent company made an ex gratia payment of £10,000.  The amount paid was determined by reference to the lost options and the payment was made to maintain the company’s reputation of dealing fairly with its employees and ex-employees.  As is apparent from that brief statement of the facts in that case, however, section 135 was not in point because the options had lapsed some time before the payment was made.  In Mr Bluck’s case, the options never did lapse and the payment was made to secure their cancellation.
The Inland Revenue’s conduct of Mr Bluck’s tax affairs
22.	Mr Bluck also drew my attention to the way in which the Inland Revenue had handled his tax affairs.  This cannot affect my conclusion on the liability of the payment that Mr Bluck received but it is nevertheless appropriate that I should record Mr Bluck’s submissions as they relate to Extra-statutory Concession A19.  
23.	On 21st November 1997, Alex Henderson, Deputy District Inspector of London Provincial 24 District, wrote to Mr Bluck in respect of his tax affairs for several previous tax years.  In the course of his letter, Mr Henderson said—
	“My review clearly shows that we have not dealt with your tax affairs at all well and there are still areas which require further explanation and correction.  Again you have my sincere apologies for this.”
Towards the end of the letter he said (under a heading “The Way Forward”)—
	“I hope that, after you receive this letter, you feel able to put the past behind us (i.e. all years up to 5 April 1996 – only of course if you are satisfied with the various outcomes – and move forward to consider your present and future tax position.”
The final paragraph of the letter noted that—
	“Finally, I am arranging for your liability to tax (on pension) for the year 1996/97 to be reviewed and hope to advise you of the outcome in the near future.  This will bring your tax affairs right up to date as at 5 April 1997.”
24.	Mr Henderson wrote again on 21st January 1998 dealing with whether Mr Bluck was entitled to compensation for the Inland Revenue’s handling of his affairs.  He concluded that—
	“In truth I can advise you that if this office had dealt with your tax affairs correctly (ie well) then you would not have received the tax refunds made to you.  This was down to errors (of a technical and judgemental nature) made by this office which I decided should remain undisturbed on account of:
•	you are ultimately entitled to finality of your tax affairs up to a point in time, ie your tax affairs are now cleared up to 5 April 1997
•	that finality, should be given (or at least some indication) as quickly as possible
•	it was important to regain your trust and confidence
•	it recognised the irritation, inconvenience, etc caused by our bad handling of your tax affairs.
I would ask you therefore to consider this matter further and if you believe that you are entitled to a further sum in respect of compensation then please advise me.”
The letter closes by saying that, “My aim is still to close the past to your satisfaction as quickly as possible and to ensure that your tax affairs are deal with correctly in the future.”
25.	Apparently, Mr Bluck was not satisfied with this response because the next letter is from Karen McWilliams of Inland Revenue (Scotland) Customer Services on 30th June 1998 setting out the conclusions of her review of Mr Bluck’s claim for compensation.  She noted that LP24 District had settled matters up to and including 1996/97 and she offered a consolatory payment of £100 and reimbursement of £25 expenses.  Karen McWilliams wrote again on 25th September 1998 to the effect that, “When I wrote to you on 30 June 1998 I confirmed that your tax affairs up to and including 1996/97 were now settled and this remains the case.”  Ms McWilliams also records that she is sending back Mr Bluck’s Self-Assessment Return for 1997/98 with the reminder that he should submit it by 31st January 1999.
26.	Ms McWilliams was writing more than 16 months after VCL had notified the Inland Revenue of the payment that had been made to Mr Bluck in January 1997.  Nevertheless, that information had either not found its way to LP24 District or LP24 District had not appreciated its significance for Mr Bluck’s tax liabilities in 1996/97.  That changed when shortly after Ms McWilliams’ second letter LP24 District issued Mr Bluck with a tax return for 1996/97 and asked for its return by 24th February 1999. On 31st March 1999 the Inland Revenue wrote to Mr Bluck giving notice of its intention to enquire into his 1996/97 Return and asking for details of the share option payment.
27.	Mr Bluck submitted that he had been given three assurances that his tax affairs were settled up to 5th April 1997, in every case at a time at which the Inland Revenue had been in possession of information relating to the share option payment.  Not unnaturally, Mr Bluck believed that he should not now be facing a tax demand for 1996/97 based on what the Inland Revenue had known when they gave their assurances.  He drew my attention to Extra-statutory Concession A19.  
28.	As I explained to Mr Bluck at the hearing, it is not within my jurisdiction to require the Inland Revenue to extend the benefit of an extra-statutory concession to a particular taxpayer.  That must be determined elsewhere and it appears from the correspondence that the Inland Revenue’s conduct of this matter is likely to be reviewed by the Adjudicator following my decision.  
Conclusion
29.	The adjustment specified by the Inland Revenue shows further tax of £2,239.73 due from Mr Bluck for 1996/97.  Mr Bluck drew my attention to several statements of account issued to him by the Inland Revenue for a variety of years, including 1996/97, showing amounts that were due to be repaid to him.  Mr Bluck objected to having to pay the Inland Revenue any further tax when according to their own statements they owed him money for several years.  The amounts that are shown as due to him in relation to other years must be determined separately and are unaffected by my decision for 1996/97.  The Inland Revenue will no doubt give Mr Bluck appropriate credit for any over-payments that he has made for other years.  
30.	As regards 1996/97, the amount shown in the statement of account as due to Mr Bluck, namely £184.75, is the amount that would have been repaid to Mr Bluck if his appeal had succeeded.  That figure is accordingly no longer relevant.  Nevertheless, there was no discussion before me of the Inland Revenue’s figures for 1996/97.  These include pension and other income and the history of Mr Bluck’s tax affairs over the years is such as to suggest that I should not at this stage formally determine the tax due in respect of 1996/97 solely on the basis of the Revenue’s figures without having heard from Mr Bluck.  If the other items in the calculation are undisputed, the parties should be able to agree the figures based on my decision.  Otherwise the matter must be referred back to me with the necessary information to determine the final amount due for the year.

MALCOLM GAMMIE
SPECIAL COMMISSIONER

SC  3122/2002