SPC00610

Employment; termination; Compromise Agreement; compensation; payment in lieu of notice, Income and Corporation Taxes Act 1988 sections 19, 148, 188, Schedule 11 paragraph 2

THE SPECIAL COMMISSIONERS

MR A M BRANDER
MR H W BOCKER
	MR G W McGROTTY 	Appellants

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

		

				Special Commissioner:  J GORDON REID QC, F.C.I. Arb

Sitting in public in Edinburgh on 6 February 2007

Norrie J Roberts, a partner of Cowan & Partners, Chartered Accountants, Edinburgh, for the Appellant 

Brendan Hone, HM Inspector of Taxes, Appeals Unit Glasgow, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Introduction

1.	These are three appeals directed to be heard together.  Each of the three raises one identical issue and two of them raise another identical issue.  The appeals are concerned with the tax treatment of sums paid to the appellants on the termination of their employment with the same company.  Norrie J Roberts, a partner of Cowan & Partners, Chartered Accountants, Edinburgh, appeared on behalf of the Appellants.  Brendan Hone, HM Inspector of Taxes, Appeals Unit Glasgow appeared on behalf of the Respondents (the “Revenue”).  Neither party led evidence.  An attempt was made to agree a Statement of Facts.  Although there did not seem to be any dispute about the facts no such signed Statement was produced.  Both parties made submissions in the course of which they referred to documents and correspondence contained in a bundle prepared by the Revenue.  There was no dispute as to the authenticity of the copy documents produced.

Factual Background

2.	The company in question was developing its manufacturing capacity of safety syringes.  Further institutional investment was required.  A condition of that investment, following a change of CEO in 1999, was that a new management team should be brought in.  This led to the departure of the appellants (who were directors) from the company [Bundle E53-54] on agreed terms following a short but intense period of negotiation.  Their contracts with the company were set forth in Service Agreements.  The agreed terms were set forth in Compromise Agreements.  It is accepted that due notice was not given under the Service Agreements in relation to the termination of the Appellants’ contracts [E/17]

3.	By letter dated 4/10/04 [F/1] to the Appellant Bocker, the Revenue intimated that enquiries into his Tax Return, which had opened in November 2002 [E/1], had been completed for the year ended 5/4/01.  The conclusion was that the 

“PILON you received is chargeable to tax under section 19 ICTA 1988 not section 148 ICTA 1988; the payment for the balance of your May salary is by concession and without prejudice, chargeable to tax under section 148 ICTA 1988; and the payments for additional holiday pay and “share compensation” are also chargeable to tax under section 148 ICTA 1988.”

4.	An amendment was made to the Appellant Bocker’s Return.  The net result was that the Self Amendment was amended from £22,348.28 being due for repayment to £18,453.39 being due for repayment.

5.	Similar letters were sent to the other Appellants [F4-8] and were treated as closure notices under section 28A(1) & (2) of Income and Corporation Taxes Act (ICTA) 1988.  Appeals were intimated by letters dated 28/10/04 with the grounds of appeal stated in a letter dated 16/2/05 [G/1-5]

The Service Agreements

6.	Mr Brander’s Service Agreement with the Company, dated 1st and 2nd April 1997, provided inter alia that he was to be employed as Corporate director from 1/4/97 for one year and thereafter unless terminated on 12 months notice (Clause 3.1) [H un-numbered].  Clause 7 provided for remuneration.  Clause 10 required the Company to contribute to a personal pension scheme nominated by Mr Brander.  Provision was also made for life insurance.  Clause 11 made provision for health insurance.  Clause 13 dealt with holiday pay, clause 13.1 providing for payment in lieu of outstanding holiday entitlement on termination of employment for any reason (except circumstances justifying summary termination).

7.	Clause 18 made further provision about termination of employment.  It made provision for termination on summary notice on various grounds relating, broadly, to misconduct.  Clause 18.5 provided as follows:-

“The Company may terminate the Employment forthwith by paying salary and the value of all other contractual benefits (all discounted to reflect any benefit to the Executive (sc Mr Brander) which would result from early payment thereof) in lieu of the required period of notice and it is expressly agreed and declared that such payment in lieu of notice shall not constitute repudiation of this Agreement.  Any payment shall be made net of tax and statutory deductions.” [underlining added]

8.	It was agreed that the Service Agreements of the other two appellants were in substantially the same terms.  In particular, clause 18.5 was in identical terms.  There are no other relevant contractual provisions for present purposes and none was relied upon by either party.

9.	It is clear from the available information that the Company did not in fact terminate the employment of any of the Appellants by operating clause 18.5.  Rather, the appellants were invited to resign or possibly threatened with termination of their Service Agreements.  This led to negotiations and settlement reflected in a Compromise Agreement [JK/un-numbered] entered into by each Appellant on 10/5/00 with the Company whereby the employment of each appellant was, by mutual consent, terminated.

10.	The preamble to the Compromise Agreement signed by Mr Bocker records that his employment “has terminated with effect from 10 May 2000”.  Clause 1 provided as follows:-

“The Company shall pay to the Executive (i) the sum of £131,818.1 (subject to the deduction of income tax and national insurance) and (ii) the sum of £9,273.63(which will be paid to the Executive without deduction of income tax or national insurance by virtue of sections 148  and paragraph 7 of Schedule 11 of the Income and Corporation Taxes Act 1985 (together the “Termination Payments”)” 

11.	Clause 5 provided inter alia as follows:-

The Executive has agreed to accept the Termination Payments and all other sums and benefits paid to or received by the Executive in terms of this Agreement in full and final settlement of the Executive’s particular claims against the Company for (i) unfair dismissal and (ii) breach of contract both as a result of the termination of the Executive’s employment with the Company and, without prejudice to the foregoing in full and final settlement of all claims, whether at common law, under statute or regulation, or pursuant to European Community Law that the Executive has or may have against the Company arising directly or indirectly from the Executive’s employment with the Company or termination thereof, including without limitation any claim relating to wrongful dismissal, redundancy, equal pay, sex, race or disability discrimination or under ….. [various statutory provisions] or any other claim which might be made by the Executive to a court or tribunal, provided that nothing herein contained shall affect any claims the Executive may have in respect of accrued pension entitlement (if any) or any personal injury claim.”

12.	Clause 9 recorded that Mr Bocker received independent legal advice in relation to the terms and effect of the Compromise Agreement.  Clause 10 acknowledges that various statutory provisions concerning compromise agreements have been satisfied.

13.	Apart from the sums involved, the Compromise Agreements relating to Messrs Brander and McGrotty were in virtually identical terms [L and M].  Under the Compromise Agreements the Appellants were paid the following sums:-

Bocker		£131,818.51 	and	£9,273.63

McGrotty	£123,312.57	and	£9,273.63

Brander	£115,045.52

14.	A Schedule of Termination payments, produced by the Company, [E/21] shows the extent to which the payments made to each of the Appellants exceeded the sum to which they would otherwise have been entitled to receive under their Service Contracts.  That Schedule is in the following terms:-

NMT GROUP PLC
TERMINATION PAYMENTS

						Contractual	Actually	
						Entitlement	  Paid		Excess

	(1)  H W Booker
	      12 months salary		   	    98,659	  98,559
	      May 00 Salary (due to 10.5.00)	      2,703	    8,222		  5,519
	      Holidays				      5,001	  10,813	               5,812
	      Pension Contributions 		         -		  19,734		19,734
	      Other benefits			      2,602	    2,602		_____ 
						  108,975	140,040		31,065

	(2)  A M Brander
	      12 months salary			    86,100	  86,100	                -
	      May 00 Salary (due to 10.5.00)	      2,359	    7,175	              4,816
	      Holidays				       (826)	    5,072	              5,898
	      Pension Contributions	 	        -		  21,525		21,525
	      Other benefits			      2,349	    2,349		_____   
						    89,982	 122,221	32,239

	(3)  G W McGrotty
	      12 months salary			    93,117	   93,117	    -
 	      May 00 Salary (due to 10.5.00)	      2,551	     7,760	  5,209
	      Holidays				      3,699	     9,057	  5,357
	      Pension Contributions	                    -		   18,623	18,623
	      Other benefits			      2,515	     2,515	_____
						  101,882	  131,072	29,189

	      Holiday Entitlement
						    HWB	    AMB	  GWM
	      Accrued too 10.5.00			    10.5		    10.5		  10.5
	      b/f from 1999 			       10		       10	                 10
	      Total				    20.5		    10.5		  20.5
	      Taken				         2		       14		       6
	      Due					    18.5	 	     -3.5	               14.5

	      Reconciliation of the amounts actually paid
   	      to the sums in the compromise agreements
	      is as follows:

	     Per compromise agreement		131,878		115,046		123,312
	     May salary (paid in full)	                 8,222		    7,175		    7,760
					             140,040		122,221		131,072

In addition Messrs Bocker and McGrotty each received the sum of £9,273.63 for what was described as loss of share option rights.

15.	The Rules of the NTM Share Save Scheme were produced [N] but neither party addressed me on them.  The Company’s solicitors pointed out, in effect, that no question of exercising the options therein provided arose. [E/38]  So, there was no actual loss of rights.

16.	In a letter dated 18/12/00 to the Revenue, the Company’s solicitors, set out how certain of the various sums were arrived at.  Neither party challenged the accuracy of the contents of that letter.  In summary, the details are as follows:-

£9,273.63 [to Bocker and McGrotty]

17.	There was no contractual entitlement to this sum.  No payment was due under or arising out of the Share Save Scheme or the Service Agreement.  This sum was part of the package to buy off the risk of a claim being made to an employment tribunal.

Holiday Entitlement

18.	Sums were paid over and above the entitlement in terms of the Service Agreements.  There does not appear to by any dispute about this element of the payments.

Legislation

19.	The following provisions of the Income and Corporation Taxes Act 1988 were cited in the course of submissions:-
19	Schedule E
  (1) The Schedule referred to as Schedule E is as follows:-
SCHEDULE E
1. Tax under this Schedule shall be charged in respect of any office or employment on emoluments therefrom which fall under one or more than one of the following Cases-
Case I:	any emoluments for any year of assessment in which the person holding the office or employment is resident and ordinarily resident in the United Kingdom, subject however to section 192 if the emoluments are foreign emoluments (within the meaning of that section)	

…………….
and tax shall not be chargeable in respect of emoluments of an office or employment under any other paragraph of this Schedule.
5. The preceding provisions of this Schedule are without prejudice to any other provision of the Tax Acts directing tax to be charged under this Schedule and tax so directed to be charged shall be charged accordingly.
…..
(3) Part V contains further provisions relating to the charge to tax under Schedule E.
148.-Payments and other benefits in connection with termination of employment, etc.
(1) Payments and other benefits not otherwise chargeable to tax which are received in connection with-
(a) the termination of a person's employment, or 
(b) any change in the duties of or emoluments from a person's employment,
are chargeable to tax under this section if and to the extent that their amount exceeds £30,000. 
(2) For the purposes of this section a "benefit" includes anything which, if received for performance of the duties of the employment-
(a) would be an emolument of the employment, or 
(b) would be chargeable to tax as an emolument of the employment,
or which would be such an emolument, or so chargeable, apart from any exemption. 
(3) An amount chargeable to tax under this section is income chargeable under Schedule E for the year of assessment in which the payment or other benefit is received. 
The right to receive the payments or other benefits is not itself regarded as a benefit for this purpose. 
(4) For the purposes of this section-
(a) a cash benefit is treated as received-
(i) when payment is made of or on account of the benefit, or 
(ii) when the recipient becomes entitled to require payment of or on account of the benefit; and
(b) a non-cash benefit is treated as received when it is used or enjoyed.
(5) This section applies-
(a) whether the payment or other benefit is provided by the employer or former employer or by another person, and 
(b) whether or not the payment or other benefit is provided in pursuance of a legal obligation.
(6) This section has effect subject to Schedule 11, which contains provisions extending, restricting and otherwise supplementing the provisions of this section. 
(7) In this section and that Schedule "employment" includes an office and related expressions have a corresponding meaning.
154.-General charging provision.
(1) Subject to section 163, where in any year a person is employed in employment to which this Chapter applies and-
(a) by reason of his employment there is provided for him, or for others being members of his family or household, any benefit to which this section applies; and 
(b) the cost of providing the benefit is not (apart from this section) chargeable to tax as his income,
there is to be treated as emoluments of the employment, and accordingly chargeable to income tax under Schedule E, an amount equal to whatever is the cash equivalent of the benefit. 
……………
185.-Approved share option schemes.
(1) The provisions of this section shall apply where, in accordance with the provisions of an approved share option scheme, an individual obtains a right to acquire shares in a body corporate by reason of his office or employment as a director or employee of that or any other body corporate and he obtains that right-
(a) in the case of a savings-related share option scheme, on or after 15th November 1980; or 
(b) in the case of any other share option scheme, on or after 6th April 1984.
188.-Exemptions from section 148.
  (1) Tax shall not be charged by virtue of section 148 in respect of the following payments, that is to say-
(a) any payment made in connection with the termination of the holding of an office or employment by the death of the holder, or made on account of injury to or disability of the holder of an office or employment; 

643. - Employer's contributions and personal pension income etc.
  (1) Where contributions are paid by an employer under approved personal pension arrangements made by his employee, those contributions shall not be regarded as emoluments of the employment chargeable to tax under Schedule E. 

SCHEDULE 11 PAYMENTS AND OTHER BENEFITS IN CONNECTION WITH TERMINATION OF EMPLOYMENT, ETC.  
Introductory
1. 
The provisions of this Schedule supplement the provisions of section 148 with respect to the taxation of payments and other benefits received in connection with-
(a) the termination of a person's employment, or 
(b) any change in the duties of or emoluments from a person's employment.
Payments and other benefits to which section 148 applies
2.-
(1) Section 148 applies to all payments and other benefits received directly or indirectly in consideration or inconsequence of, or otherwise in connection with, the termination or change-
(a) by the employee or former employee, 
(b) by the spouse or any relative or dependant of the employee or former employee, or 
(c) by the personal representatives of the former employee.
Application of £30,000 threshold
7.-
(1) This paragraph specifies how the £30,000 threshold in section 148(1) applies. 
(2) Tax is charged only on the excess over £30,000, …………….
Valuation of benefits
12.-(1) For the purposes of section 148, the amount of a payment or other benefit is taken to be-
(a) in the case of a cash benefit, the amount received, and 
(b) in the case of a non-cash benefit, the cash equivalent of the benefit.
16. In this Schedule -
"the relevant date" means the date of the termination or change in question; and 
"tax year" means a year of assessment. 

Submissions

20.	Mr Cowan for the Appellants submitted that in relation to the sums identified in the analysis and still in dispute [E/21] namely the item labelled pension contributions the question was whether compensation paid under the Compromise Agreement was qualitatively different from the benefit which would have been payable under the Service Agreement and therefore chargeable as emoluments under section 19.  The answer, he submitted is that this was purely a compensation payment to put right the loss of a non-taxable payment which the Appellants were deprived of as a consequence of the abrupt termination of their employment.  He relied on Wilcock v Eve1994 BTC 490 at 500C-D.  The payment was not caught by section 148.  It is a non-taxable benefit outwith the scope of section 148.

21.	As for the loss of share option rights payments (applicable to Bocker and McGrotty) which are not identified in the analysis [E/21], the position was on all fours with Wilcock.  For the same reason section 148 was not applicable.  He went on to submit that if section 148 does apply then the Appellants are entitled to exemption up to £30,000. 

22.	Mr Cowan invited me to find, in principle, that neither the compensation paid to make good the loss of pension contributions nor the gains which could have arisen if the options had been exercised, should be regarded as taxable.

23.	Mr Hone submitted that (i) the Compromise Agreement did not abrogate the Service Agreement but merely supplemented it; it was drawn up to satisfy and finalise payments due to each Appellant by virtue of Clause 18.5 of the Service Agreement, (ii) it quantified and gave legality to the amounts payable in lieu of notice, (iii) under reference to Clause 18.5 the payments were not damages but compensation for loss of office; the negotiations did not yield anything to which the Appellants were not entitled, the pension contributions constituted a payment of what would have been paid had the employment continued; Richardson v Delaney 74 TC 167; it was a contractual payment by virtue of the employment; the appellants had a right to payment in lieu of notice; no question of damages arises  (iv) Wilcock was distinguishable because section 148 and Schedule 11 were not considered, (v) the payments of £9273.60 fell within section 148 and Schedule 11 paragraph 2, (vi) section 643 was irrelevant because the payments were not contributions to a pension scheme

Discussion

24.	In Richardson, the employer gave contractual notice of termination of employment.  Negotiations took place during the period of notice leading to termination by agreement and payment of a lump sum plus a car which the Revenue sought to tax under Schedule E.  The taxpayer argued that the £30,000 exemption should apply under section 148. The General Commissioners concluded that the employer was in breach of contract and that the payment was caught by section 148 and not by section 19.  On appeal to the Chancery Division of the High Court (the taxpayer was unrepresented), Lloyd J, after reviewing sections 19 and 188 and acknowledging the wide words of section 188, considered that the question was whether the payment was chargeable under section 19.  He held that the Commissioners were wrong to conclude that the employer had been in breach of contract.  The value of the package was very close to what would have been due under the contract of employment.  This led the judge to conclude that as there was no breach of contract the only possible conclusion was that the sum was taxable under section 19 and not 148.  The £30,000 exemption therefore had no application.

25.	Whatever the soundness of Richardson, it is distinguishable on its facts.  Here, it is abundantly plain from the precise terms of the letters dated 18/12/00 [E/26] and 29/9/03 [E/38] from the solicitors of the Appellants’ former employer that the payments of £9,273.63 were not due and payable under the Service Agreements at all.  The earlier letter discloses that the same can be said for part of the sums paid under the heading Holidays in the analysis [E/21].  It cannot therefore be an emolument within the meaning of section 19.  

26.	Section 148 is concerned with payments (or benefits) which are not otherwise chargeable to tax.  No other applicable provision has been cited.  The payments of £9273.63 are therefore not otherwise chargeable to tax.  They were received in connection with or as a consequence of the termination of the employment of Messrs Bocker and McGrotty within the meaning of section 148 as extended by paragraph 2 of Schedule 11 to the Taxes Act.  The £30,000 exemption applies to each of these payments as contended for by the Revenue.  I agree with Mr Hone that Wilcock is distinguishable.  There, the payment was ex gratia  and was found as a fact not to be linked to the taxpayer’s employment.  Moreover, section 148 or its predecessor was not discussed.  Here, the payment formed part of the consideration in exchange for which the employment was terminated by mutual agreement and various statutory rights discharged.

27.	As for the pension contributions, I cannot identify any clause in the Service Agreement which obliged the company to pay these sums to the Appellants as opposed to investing them in a pension scheme for their benefit.  Clause 10 obliged the company to make pension contributions.  Clause 18.5, which refers to contractual benefits, only applies where the employment is terminated by the company forthwith.  That is not what happened.  The employment was terminated by mutual agreement following negotiation.  Clause 18.5 does not therefore apply.  In any event, no attempt has been made to discount the benefit to reflect early payment.  

28.	In my opinion therefore, the payment under the label pension contributions falls into the same category as the payments for loss of share option rights.  It is a capital payment arising out of the negotiated termination of the employment and is caught by section 148, but subject to the £30,000 exemption.  None of the other statutory provisions to which I was referred affect this conclusion.

Result

29.	I find and determine, in principle, that section 148 of the Taxes Act applies to (i) the payments labelled pension contributions and (ii) the payments labelled loss of share option rights. 

J GORDON REID QC, F.C.I.Arb
SPECIAL COMMISSIONER

RELEASED: 23 April 2007

SC 3061/2006
SC 3062/2006
SC 3063/2006