SPC00542

INCOME TAX – Employment – Service agreement with partnership entitled employee to 2.5% of the proceeds on sale or dissolution of partnership during term of employment – Partnership business transferred to company – Employee issued with shares in company in satisfaction of rights under employment agreement – Whether emolument from employment – Yes – Income and Corporation Taxes Act 1988 s.19(1) 

THE SPECIAL COMMISSIONERS

	K T McLOUGHLIN	Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Special Commissioner:  STEPHEN OLIVER QC

Sitting in public in London on 11 May 2006

John Brooks, counsel, instructed by Sefton Potter, accountants, for the Appellant 

Brendan Hone, Appeals Unit, for the Respondents

© CROWN COPYRIGHT 2006

DECISION

1.	Mr K T McLoughlin appeals against the amendment to his self-assessment return for the year ended 5 April 1999.  The amount charged as a result of the amendment is £546,148.  That amount has been charged to tax under Schedule E as a result of the amendment.  It arises in the circumstances explained below.

Summary of the facts

2.	Mr McLoughlin was employed by a partnership trading under the name Pontis Consulting (“the Partnership”) in accordance with the terms of a letter agreement dated 18 August 1992 (“the 1992 Letter Agreement”).  The 1992 Letter Agreement provided that 1 September 1992 was to be the start date of the employment and that Mr McLoughlin was to be paid a salary of £40,000 a year, reviewable annually.  Mr McLoughlin’s ordinary place of work was to be his home and, because he was to be employed in a “start-up operation”, he was expected to use his own computer.

3.	Central to the present appeal is this clause in the 1992 Letter Agreement:

“Should the partnership be dissolved or sold during your term of employment then you will receive 2.5% of the proceeds after costs.”

It was not in dispute that Mr McLoughlin remained an employee of the partnership until May 1998 when the business and other assets of the partnership were transferred to Pontis Consulting Ltd (“PCL”).  Again it is not in dispute that that occasion marked the dissolution or sale of the partnership.

4.	Mr McLoughlin did not, immediately upon PCL’s taking over the partnership business, receive anything in satisfaction of his right to receive “2.5% of the proceeds”.  The only explanation of what happened then was supplied in a letter from Sefton Potter, Mr McLoughlin’s accountants, of 20 September 2001.  Apparently he was “given the chance to acquire shares in” PCL.  I infer from this statement that the ex-partners in the Partnership recognized Mr McLoughlin’s entitlement under the 1992 Letter Agreement.

5.	Although this is not strictly germane to the present issue, there was no evidence as to whether Mr McLoughlin was employed throughout the period from May 1998 until 18 March 1999.  Nonetheless I have assumed that he remained in employment by PCL.  

6.	On 18 March 1999 a Board meeting of PCL took place.  Applications for B shares of 1p each by three individuals, one of whom was Mr McLoughlin, were received.  As regards Mr McLoughlin the Board resolved that 1,118,232 B shares of 1p each be allotted to him fully paid for cash at par.  Mr McLoughlin’s application letter (of 18 March 1999) had applied for an allotment of 1,118,233 B shares of 1p each for a total subscription price of £11,182.33.

7.	The next day, 19 March 1999, all the shareholders in PCL agreed to sell their entire holdings of shares to Skillsgroup Plc. The consideration attributed to Mr McLoughlin’s holding of B shares was £557,330.  

8.	Pausing there I should mention that the amount charged to tax under Schedule E, i.e. £546,148, was determined on the basis that his employer (PCL) had issued him with the B shares at an undervalue, i.e. £557,333 (being the price that they would fetch on sale to Skillsgroup the next day) less £11,182.  The £548,148, the Revenue say, was an emolument from his employment.

The case for Mr McLoughlin

9.	The facts recorded above were all that the accountants representing Mr McLoughlin were prepared to reveal.  The argument for Mr McLoughlin, presented by Mr Brooks (as instructed by the accountants) was based on those facts.  The issue of the B shares was not derived from Mr McLoughlin’s “being an employee” of PCL but as a result of his interest in the partnership and the right to receive “2.5% of the proceeds”.  Those rights had been obtained by Mr McLoughlin in 1992.  They should properly be regarded as an inducement for him to agree to become an employee of the Partnership; as such they were taxable under Schedule E in 1992.  The B shares could not have been derived “from” Mr McLoughlin’s employment with PCL; they were derived instead from his own property in the “2.5% of the proceeds”.

The case for the Revenue

10.	The case for the Revenue is that the relevant emolument arose when PCL issued its 1,118,233 B shares of 1p each on 18 March 1999 for £11,182.  They were sold for £557,330 the next day.  There must therefore have been an issue of shares at an undervalue producing a Schedule E benefit to Mr McLoughlin of £546,148.  

Conclusions

11.	Section 19(1) of Income and Corporation Taxes Act 1988 provides:

“Tax under this Schedule shall be charged in respect of any office or employment on emoluments therefrom which fall under one or more of the following Cases …”

The question is whether the value obtained by Mr McLoughlin as a result of his subscription for the B shares in PCL followed by the acquisition of those shares from him by Skillsgroup is an emolument from Mr McLoughlin’s employment for the year 1998/99.  

12.	The argument advanced for Mr McLoughlin that the Schedule E charge arose in 1992 when the entitlement to “2.5% of the proceeds” was first conferred upon him is not, I think, sustainable.  Mr Brooks had relied upon a passage from the speech of Lord Templeman in Shilton v Wilmshurst [1991] 1 AC 684 at 689 and [1991] STC 88 at 99:

“… an emolument “from employment” means an emolument “from being or becoming an employee”.  The authorities are consistent with this analysis and are concerned to distinguish in each case between an emolument which is derived from “being or becoming an employee” on the one hand and an emolument which is attributable to something else on the other hand.”

It is correct that Mr McLoughlin’s entitlement to 2.5% of the proceeds has its origin in the words of the 1992 Letter Agreement.  But unless and until the partnership is dissolved or sold Mr McLoughlin has no immediate right to 2.5% of the proceeds.  Two conditions have to be satisfied before that right matures and achieves a value.  First, the time has come when the partnership is dissolved or sold.  Second, Mr McLoughlin must still be employed on the terms of the 1992 Letter Agreement.  An emolument is something that both arises from the employment in question and, as Lord Simonds observed in Abbott v Philbin (39 TC 82 at 118) is capable of being turned into money.  In 1992 Mr McLoughlin’s “right” to the 2.5% of the proceeds was a mere expectation.  It was as much an expectation as Mr McLoughlin’s right to salary.  In both situations he had to work for his employer and carry out the terms of his employment contract before the right could mature into money or something capable of being turned into money.  It follows that the right to 2.5% of the proceeds was not an emolument arising in the year 1992.  From this it must also follow that that right, which could only mature if Mr McLoughlin continued to work for the Partnership, did not cease to be within the scope of Schedule E after the 1992 Letter Agreement came into being.

13.	The present case is not the same as Shilton v Wilmshurst.   In that case a lump sum was paid to a professional footballer by his former club to induce transfer to another club.  The payment was held by the House of Lords to have been an emolument notwithstanding that it was an inducement paid by his ex-employer.  Here however Mr McLoughlin received neither payment nor moneys’ worth as an inducement, in 1992, for taking up his employment with the Partnership.   The right to the 2.5% of the proceeds was therefore not an emolument taxable in 1992.  

14.	To the extent that the amount assessed under Schedule E is an emolument of Mr McLoughlin, it is an emolument from his employment with the Partnership.  It matured or “vested” in May 1998 when the partnership was dissolved or sold following the transfer of the business and assets to PCL.  From that moment on Mr McLoughlin was entitled to 2.5% of the proceeds. 

15.	Because of the way Mr McLoughlin’s advisers presented his case, i.e. that the taxable benefit arose in 1992 and nothing that happened after that had any bearing on the present dispute, I learned nothing about the circumstances leading to the issue of the B shares on 18 March 1999.  For the same reason Mr Brooks had no instructions that could enlighten me on this point. The inevitable inference must be that Mr McLoughlin’s right to 2.5% of the proceeds was satisfied by the ex-partners, who were by then shareholders in PCL, procuring PCL to issue B shares to Mr McLoughlin at 1p a share. Value passed out of the A shares and into Mr McLoughlin’s shares and by that means his entitlement under the Letter Agreement was satisfied. 

16.	It follows that Mr McLoughlin’s entitlement to 2.5% of the proceeds became something capable of being turned into money in May 1998.  His entitlement was an emolument of an amount to be determined.  It was determined by 18 March 1999, that being the date on which Mr McLoughlin subscribed £11,182 for the B shares that were going to be sold the next  day for £557,330.  

17.	At one stage in the course of the hearing I suggested an alternative analysis, which was that the benefit under the “2.5% of the proceeds” clause in the 1992 Letter Agreement accrued to Mr McLoughlin by two stages.  The first stage was on the date in May 1998 when the partnership came to an end.  At that moment the Schedule E charge arose on the value, at that time, of Mr McLoughlin’s right to 2.5% of the proceeds. That right was a separate chose in action which Mr McLoughlin kept for ten months and disposed of it on 18 March 1999 when he subscribed for the B shares.  If the value of the chose in action had increased or decreased between May 1998 and 18 March 1999 a capital gain or capital loss would have accrued to Mr McLoughlin.  On reflection I do not think that that analysis is right. I think that the net overall benefit that Mr McLoughlin obtained, i.e. £546,148, is the consideration that the ex-partners in the partnership ascribed to his right to “2.5% of the proceeds”. That amount arose from Mr McLoughlin’s rights as an employee of the partnership and it was the only consideration derived from those rights. The Revenue are therefore correct in charging Mr McLoughlin to tax under Schedule E on £546,148 for the year 1998/99.

18.	For the reasons given above I dismiss the appeal.

STEPHEN OLIVER QC
SPECIAL COMMISSIONER

RELEASED:  25 May 2006

SC/ 3062/2005