Spc00634

INCOME OR CAPITAL – employer entering into deed making up widow’s shortfall in pension from the pension scheme – income 

THE SPECIAL COMMISSIONERS

	JEAN ANN FORD	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioner: 	DR JOHN F. AVERY JONES CBE 

Sitting in public in London on 3 September 2007

Robert McKenzie, counsel, instructed by JJ Company Secretariat, for the Appellant

Mike Faulkner, HMRC Local Compliance South Appeals Unit, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

1.	Mrs Jean Ann Ford (formerly Jackson) appeals against amendments to her self-assessment for 2000-01 and 2001-02 and against an assessment for 1999-00.  The Appellant was represented by Mr Robert McKenzie, and the Revenue by Mr Mike Faulkner.
2.	The issue in this appeal is whether payments under a deed entered into to make up a shortfall in the Appellant’s widow’s pension caused by a change in the terms of the pension scheme are taxable income or instalments of capital.
3.	I had a bundle of documents and I heard evidence from the Appellant and Mr Richard Andrew Jackson, the Appellant’s son.  I find the following facts:
(1)	Mr Anthony Walter Jackson (“Mr Jackson”) was the managing director of Jokyle Holdings Limited (“the Company”) which had been founded by Mr Jackson’s father, Mr George Jackson.  Mr Jackson was the only son of Mr George Jackson by his first marriage; Mr George Jackson married again and had two children by his second wife.  The Company was involved in processing raw materials for the pet food industry and pet trade wholesale.  The operating profit (before interest and investment income) of the Company before tax fell during Mr Jackson’s time as managing director from £950,632 in the year to 29 September 1995 to £97,772 in the year to 27 September 1998.  
(2)	85 per cent of the ordinary shares in the Company were controlled by Mr Mervyn Jones (Chairman of the Company, and a trustee of its Pension Plan), Mr Patrick Burgess (a solicitor, and a director of the Company), and Mr Roland Wreford (director) in their capacity as trustees of six family trusts.  
(3)	The minutes of a board meeting of the Company on 8 July 1998 record that Mr Jones wanted to retire as Chairman at the end of September and Mr Peter Haworth, who I was told had a reputation for turning round companies, was proposed as his successor.  Mr Jackson said that he thought that Mr Haworth was the right person to be Chairman but Mr Haworth’s requirement that everyone should report to him was effectively a demotion of Mr Jackson that amounted to constructive dismissal.  Mr Jackson said at the meeting that Mr Jones and Mr Burgess had promised him that if he left the Company his remuneration would remain the same until he was due to retire in April 2000.  Mr Jones confirmed that he had made this offer, which Mr Jackson has asked to be put in writing and the minutes record “this was agreed by the remaining members of the Board.”  Mr Jones duly stated in a letter to Mr Jackson of 8 July 1998, signed for and on behalf of the Company, that Mr Jackson was to become a consultant who would make himself available for advice but working from home.  It stated that “your remuneration, benefits and pension will be exactly as they are now (subject to upward revision, if any, at future review dates).”  Mr Burgess wrote to Mr Jackson suggesting that it would be sensible to table the correspondence at the next Board Meeting, and this was done at the meeting on 18 August 1998.
(4)	In early March 1999 Mr Jackson was diagnosed as suffering from cancer.
(5)	An actuarial valuation of the Pension Plan at 5 April 1998 made in March 1999 showed that the assets covered 84% of its liabilities representing a deficit of £3.031m (the valuation records that at 6 April 1995 the equivalent figures were 83% and £3.424m).  On 23 March 1999 the Company and the Trustees of the Pension Plan announced in a circular to members of the Pension Plan that the Company would cease to pay contributions in respect of future benefits.  The announcement also contained the following: “You will continue to be provided with the lump sum life assurance benefit (but not for the spouse’s death in service pension).”  The announcement said that the Company would concentrate its resources on eliminating the funding deficit to ensure that all benefits accrued to 5 April 1999 were covered by assets of the plan.    In June 1999 Mr Jackson was given a reserved benefit statement showing that if he died before retirement his widow’s pension would be £12,368.04 pa (compared to the estimate that he had received at 6 April 1998 of £40,821.34 pa), and if he died after retirement his widow’s pension would be £40,399.33.  Because of Mr Jackson’s health it was by then uncertain whether he would survive to his retirement date of 26 April 2000.
(6)	In June 1999 Mr Jackson wrote to Mr Jones, Mr Burgess and Mr Wreford “as trustees of the main shareholding trust” asking them if there was any way of protecting the Appellant if he died before retirement, saying that he was writing to them “and not to the trustees of the pension fund at Ascot, as I believe that the agreement between us was based on personal assurances.”  Mr Burgess replied saying that “I can assure you that Mervyn [Jones] and I have every intention of ensuring that the Company complies with its legal obligations to you.”  Mr Jones replied saying that he had spoken to Mr Burgess and Mr Wreford and “we all agree that we will ensure that the Company complies with its obligations as stated in correspondence between us and as filed with Board Minutes.”  He added that the death in service benefit would be £363,768.
(7)	Unfortunately Mr Jackson died on 31 December 1999, before the date on which he would have retired.  The Appellant received a death in service benefit from the Pension Plan of £369,360.40 and their two children £20,000 each.  The Appellant received a pension of £12,368.04 pa from the Pension Plan.
(8)	Mr Burgess asked William Mercer the Pension Plan administrators the reason for the reduction in the Appellant’s pension.  The explanation received on 23 March 2000 was:
The benefits on death in service before retirement were also extremely generous and consequently expensive and just the spouse’s death in service pension was quantified in our report of January 1999 as having a cost of £8,000 per month.  In the circumstances, it was agreed that the lump sum death benefit should be maintained and the spouse’s death in service pension should cease (although it needed to be maintained at a relatively low level because the scheme had been contracted out of the State scheme.”  
I did not see the report referred to, or any agreement that the spouse’s death in service benefit should cease, but that is the effect of the words in the announcement of 23 March 1999: “You will continue to be provided with the lump sum life assurance benefit (but not for the spouse’s death in service pension).”  Because he asked William Mercer for the reason in the Appellant’s pension, Mr Burgess must also have been unaware of the change.  The 5 April 1998 valuation of the Pension Plan made in March 1999 notes that the spouse’s death in service pension benefit ceased from 6 April 1999. 
(9)	The Appellant asked for the pension to be made up to what it would have been.  Mr Burgess wrote on 25 May 2000 saying that the Company had been advised that it was not under any legal obligation to increase the pension.
(10)	On 22 December 2000 Mr Burgess wrote to the Appellant’s solicitor saying that:
“The Board of [the Company] has therefore resolved that without any admission of liability on its part, and out of concern for the morale of its employees, the company will execute a deed providing a further payment to [the Appellant] monthly in lieu of the shortfall on her pension expectations which she would otherwise have received—but that it cannot formally commit to the extra expenditure until it knows the outcome of the OPRA appeal and can responsibly undertake further liabilities.”
(11)	The Pension Plan solvency level was 78.9% at 17 May 2000 which was required to be increased to 90% by April 2003 and to be fully funded by April 2007.  The reference to the “OPRA appeal” was that the Company had asked the Occupational Pensions Regulatory Authority for an extension to 2014 to eliminate the deficit.  
(12)	The Appellant’s solicitors obtained quotations for a lump sum to buy an annuity to make up the shortfall in the pension of £1,063,956.88 from one insurance company, £1,021,829.19 from another and £1,130,025.89 from a third. On 2 January 2001 they wrote a formal letter to Messrs Jones, Burgess and Wreford reminding them of their promise and saying that the capital value of the obligation was £1,063,956.88. 
(13)	On 4 January 2001 Mr Burgess replied confirming again that the Company would make up the pension deficit “provided the financial future of the Company is clearer after the OPRA appeal meeting: but if it is the resolution will then be implemented straight away).”  OPRA rejected the Company’s application on the ground that it was not satisfied that the Company could continue trading until the end of the period.  The minutes of a board meeting on 14 February 2001 recorded that the Company should consider putting aside funds to cover the pension shortfall but should resist any request for a substantial lump sum payment to purchase an annuity.  On 19 February 2001 Mr Burgess wrote again saying that the OPRA decision was against the Company but that the Board had resolved to make the Appellant a monthly payment of £2,600 and was prepared to enter into a deed to this effect.
(14)	On 1 May 2001 the Company and the Appellant entered into a deed (“the Deed”) under which the Company agreed to pay to the Appellant £2,600 per month from 1 May 2001, plus the arrears of £47,475 as if payment had started on 1 January 2000 by four quarterly payments and a £5,000 (plus VAT) contribution to her legal fees.  Under the Deed the Appellant agreed that while the sums were paid she would not institute any action against the Company, any of its subsidiaries, or any director or former director which involved a claim that any of them were liable to make up the pension.  It was stated for the avoidance of doubt inclusion of the reference to directors was not an admission that they were under any liability to the Appellant.
(15)	On 11 November 2005 the Company went into members’ voluntary liquidation.  The final report of the joint liquidators on 15 January 2007 sated that all creditors had been paid in full except that the final payment of interest due to the Pension Plan was being settled.  Mr Faulkner told me (and I accept) that the liquidators came to an arrangement to make a payment to the Appellant in respect of the Company’s liability under the Deed.
4.	Mr McKenzie, for the Appellant, contends in outline:
(1)	Messrs Jones, Burgess and Wreford, as trustees of trusts holding shares in the Company, gave a personal assurance in consideration of Mr Jackson’s agreeing to retire as a director, that his pension entitlement would be unaffected.  The Deed satisfied that personal liability while ostensibly the Company paid it.
(2)	The objects clauses in the Company’s Memorandum of Association were not expressed to be separate objects and so the power to pay pensions was ancillary to its main objects.  Even after s 35 of the Companies Act 1985 it remained the duty of directors to observe any limitations on their powers in the Memorandum of Association.  A gratuitous promise of payment of the shortfall in pension to the Appellant having a capitalised value of over £1m at a time when the Company was making a loss of £1.7m and had shareholders’ funds of under £1m was not a bona fife exercise of the directors’ duties and the Deed was voidable.
(3)	It is significant that there was no mention of tax liability in the Deed.
(4)	To determine whether payments under a deed were of a capital or income nature it is wrong to look at the deed in isolation and disregard the other elements in the legal relationship between the parties (IRC v Mallaby-Deely 23 TC 153, 169).  There was a claim for a capital sum of £1.063m which it was financially convenient for the Company to assume.  The Deed was a compromise agreement.
5.	Mr Faulkner, for the Revenue, contends in outline:
(1)	The payments under the Deed are a pension within the ordinary meaning of the term, being periodic (monthly), made by the Company to the widow of a former employee and director.  They represent payments that the Appellant would have received under the Pension Plan if its terms had not been altered.
(2)	The payments are not instalments of a lump sum.  No lump sum was ever agreed.  The only lump sum mentioned in the correspondence was derived from quotations from insurance companies.  The Company never agreed to pay a lump sum in damages and denied the existence of any liability to make up the shortfall before the Deed was entered into.
(3)	Alternatively, the payments are annual payments.
(4)	Any assurance given by Messrs Jones, Burgess and Wreford was given in their capacity as directors and any liability to Mr Jackson or the Appellant was a liability of the Company.
(5)	It was intra vires the Company to pay a pension to the widow of a director who died in service.  Even if it were ultra vires the Appellant was protected by s 35 of the Companies Act 1985.  Nor would it affect the tax treatment, see Esslemont v Estill 53 TC 663 at 673: “Whether they were payments of pension properly made or improperly made is, in my judgment, neither here not there; they were payments of pension, and as such the recipient cannot avoid paying tax on them.”  There is no evidence that the directors acted in bad faith.
6.	The essence of Mr McKenzie’s contention is that (1) in consideration of Mr Jackson agreeing to retire as a director, Messrs Jones, Burgess and Wreford, in their capacity as trustees of trusts controlling 85% of the shares in the Company, promised as a personal liability to meet the shortfall in the Appellant’s pension; (2) had the Appellant, in her capacity as Mr Jackson’s executor, sued them for breach of that promise, she would have obtained damages of over £1m; (3) therefore the payments under the Deed are instalments of capital.
7.	I do not agree with any of these three propositions.  As to the first, what was promised, was that Mr Jackson would effectively leave service but would be paid the same salary until his 60th birthday and meanwhile serve as a consultant giving advice when required, and as part of that arrangement the Company told him that “your remuneration, benefits and pension will be exactly as they are now (subject to upward revision, if any, at future review dates).”  That promise, which is about Mr Jackson’s terms of service, was obviously initially made by Messrs Jones, Burgess and Wreford in their capacity as directors.  The only relevance of their also being trustees of trusts controlling 85% of the shares in the Company, is that they could, in their capacity as shareholders, ensure that the directors carried out their wishes, in the last resort by removing the others as directors.  I believe it is significant that the minutes of the 8 July 1998 board meeting record that Mr Jones confirmed that he had made this offer, and “this was agreed by the remaining members [my italics] of the Board.”  The implication is that the offer had been made by three members of the board without the others being consulted and now the remaining members of the board (not the whole board, as it would have been if there had been a promise made in a different capacity) agreed to it.  It is in my view absurd to suggest that they (particularly Mr Burgess as a solicitor) were entering into a personal obligation to pay Mr Jackson’s salary and pension, particularly when all the directors knew that the Pension Plan was in deficit. 
8.	The next question is whether the obligation undertaken by the board minute of 8 July 1998 covered the diminution to the death in service pension payable to the Appellant caused by the subsequent change in terms of the Pension Plan.  It is arguable that it did not as the promise was in terms restricted to “your…pension,” which seems to accord with the advice the Company received, although it might be said to be within the spirit of the obligation.  Whether or not the obligation could have been enforced against the Company is irrelevant because the Company duly met what was at least its moral obligation by entering into the Deed.  Accordingly I consider that it is doubtful that the Appellant could have sued the Company, and I find that she could certainly not have sued Messrs Jones, Burgess and Wreford personally. 
9.	Mr McKenzie’s contentions about the Deed being ultra vires and made in bad faith by the directors were premised on the existence of a personal liability of Messrs Jones, Burgess and Wreford that was improperly taken over by the Company.  As I have found that there was no such personal liability, the point no longer arises.  However, I find that the Deed was intra vires the Company even though payment of pensions was not stated to be a separate object.  It must be intra vires a company and a proper exercise of directors’ duties to agree to pay a pension to the widow of a director who had served 30 years and died in service, and particularly so in this case where the pension is the same as the one that the Company had already secured through the Pension Plan before the change to the terms of the Pension Plan was made.  Far from being bad faith by the directors, in my view they behaved very properly by putting the Appellant back in the position that she would have been in before the change to the Pension Plan.  I think it is regrettable that the Appellant as beneficiary of the directors’ action to give effect to their moral obligation should impugn their good faith.
10.	Since the Appellant could not have sued Messrs Jones, Burgess and Wreford, I need not decide whether, if she had been awarded a capital sum that was paid by instalments, that would be capital.  The Special Commissioner’s decision in Joyce v HMRC [2005] STC (SCD) 696 was similar to this case.  There a person sued for a promise that his pension would be higher than it actually was.  There was no existing capital sum.  The Special Commissioner said: “if the Appellant had sued the Trust for the capital sum of £127,350 [the calculated capital sum measuring the loss], and if he had been awarded that sum by the court, and if that sum had then been paid by instalments, it would be likely that those instalments would be of a capital nature.”  I agree in principle, but not to the extent that, merely by suing, one can turn one obligation to make periodic payments into another identical obligation which would then be regarded as payments of capital.  The highest it can be put here is that the Appellant threatened to sue, mentioning a calculated capital sum, but no capital sum ever awarded or agreed to by the Company, which merely agreed to make payments equal to the shortfall in the pension.  For there to be instalments of capital there must be an initial capital obligation, as in Dott v Brown [1936] 1 All ER 543, in which a debt of between £9,000 and £10,000 was discharged by two payments of £1,000 and an annuity of £250 pa for the appellant’s life, which were held to be instalments of capital.  This should be compared with IRC v Church Commissioners [1976] STC 339, in which properties were sold by the Church Commissioners for a 10-year rentcharge of £96,000 pa, which were held to be income payments.  A capital value of £720,000 was calculated by the Church Commissioners who agreed in principle to sell the properties “for the equivalent of £720,000 and to take in exchange a rentcharge of £96,000 a year for 10 years.”  This was not sufficient to create an obligation to pay a capital sum.  Here the capital sum had been quantified by the Appellant but the Company had expressly resolved to resist any request for a lump sum.
11.	I therefore agree with Mr Faulkner that the Deed provides for a widow’s pension in the way one would expect the Company to do when it was complying with a moral obligation, and the payments under the Deed are a pension taxable under Schedule E.  I do not need to consider Mr Faulkner’s alternative contention that they are annual payments since the Schedule E charge takes priority (s 18(1)(b) of the Taxes Act 1988).  
12.	Accordingly I dismiss the appeal.  On the basis that the payments are taxable under Schedule E the figures are agreed as 1999-00 income £8,183, tax £1870.59; 2000-01 income £31,200, tax £13,709.22; and 2001-02 income £31,200, tax minus £3,106.29.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 6 September 2007

SC 3300/05

Authorities referred to in skeletons and not referred to in the decision:
Earl Howe v IRC  7 TC 289
Item Software (UK) Ltd v Fasshi [2005] 2 BCLC 91
Re Lee, Behrans and Co Ltd [1932] 2 Ch 46
Re W&M Roith Ltd [1967] 1 All ER 427
Re Horsley & Weight Ltd [1982] Ch 442
Rolled Steel Products (Holdings) Ltd v British Steel [1986] Ch 246
IRC v Wesleyan and General Assurance Society [1948] 1 All ER 555
Southern-Smith v Clancey [1941] KB 276
IRC v Ramsay [1935] All ER Rep 847
Laird v IRC 14 TC 395
Village Cay Marina v Acland [1998] 2 BCLC 327, [1998] BCC 417