Spc00727

Income tax – notional gains on share options – employer reimbursed by employees over 30 days after event – whether tax charge on employees under s 144A ICTA 1988 properly due – yes – appeal dismissed – whether in practice mitigation of charge possible

THE SPECIAL COMMISSIONERS

	JE CHILCOTT (1); RI GRIFFITHS (2);
                     EVOLUTION GROUP SERVICES LTD (3)	Appellants

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioner: 	JOHN CLARK 

Sitting in public in London on 22 October 2008

Paul Yerbury of Fasken Martineau Solicitors, for the Appellant

Colin Williams of HM Revenue and Customs Appeal Unit, Wales Scotland and Northern Ireland, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	This appeal concerns the application of a statutory provision in respect of events occurring in the tax year 2001-02. The provision in question is s 144A Income and Corporation Taxes Act 1998 (“ICTA 1988”), which has been replaced in similar terms for the year 2003-04 onwards by s 222 Income Tax (Earnings and Pensions Act) 2003 (“ITEPA 2003”), but with an amendment by the Finance Act 2003 for payments treated as made after 8 April 2003. (Except where stated, all statutory references in this decision are to ICTA 1988.)
The law
2.	Section 144A(1) is as follows:
“144A Payments etc received free of tax
(1) In any case where—  
	(a) an employer is treated, by virtue of any of sections 203B to 203I, 	as having made a payment of income of an employee which is 	assessable to income tax under Schedule E,
	(b) the employer is required, by virtue of section 203J(3), to account 	for an amount of income tax (“the due amount”) in respect of that 	payment, and
	(c) the employee does not, before the end of the period of thirty days 	from the date on which the employer is treated as making that 	payment, make good the due amount to the employer,
the due amount shall be treated as income of the employee which arises on the date mentioned in paragraph (c) above and is assessable to income tax under Schedule E.”
3.	Section 203J provides:
“203J s 203B to s 203I: accounting for tax
(1) Where an employer makes a notional payment of assessable income of an employee, the obligation to deduct income tax shall have effect as an obligation on the employer to deduct income tax at such time as may be prescribed by PAYE regulations from any payment or payments he actually makes of, or on account of, such income of that employee.
(2) For the purposes of this section—  
	(a) a notional payment is a payment treated as made by virtue of any 	of sections 203B, 203C and 203F to 203I, other than a payment 	whose amount is determined in accordance with section 203B(3)(a) 	or 203C(3)(a); and
	(b) any reference to an employer includes a reference to a person who 	is treated as making a payment by virtue of section 203C(2).
(3) Where, by reason of an insufficiency of payments actually made, the employer is unable to deduct the amount (or the full amount) of the income tax as required by virtue of subsection (1) above, the obligation to deduct income tax shall have effect as an obligation on the employer to account to the Board at such time as may be prescribed by PAYE regulations for an amount of income tax equal to the amount of income tax he is required, but is unable, to deduct.
(4) . . . .
(5) Any amount which an employer deducts or for which he accounts as mentioned in subsections (1) and (3) above shall be treated as an amount paid by the employee in question in respect of his liability to income tax for such year of assessment as may be specified in PAYE regulations.”
The facts
4.	The evidence consisted of an agreed Statement of Facts, together with copies of correspondence and returns. I set out the Statement of Facts (with minor editorial changes), and refer later to any other matters covered in the correspondence.
STATEMENT OF FACTS
(1)	Evolution Capital Limited (“Evolution”) was a private limited company registered in England and Wales with registration number 3930783. It was incorporated on 22 February 2000.
(2)	On 23 February Mr James E Chilcott (“JEC”) was appointed director and secretary and Mr Richard I Griffiths (“RIG”) was appointed director. Each of these directors subscribed for 5 20p shares as at that date having sub-divided the normal 2 £1 subscriber shares into 10 20p shares.
(3)	On 27 April 2000, 2,495 shares were issued to JEC, 2,495 to RIG and 2,500 to a new shareholder, Dunedin Limited.
(4)	Also on 27 April 2000 4,000 options were granted to each of JEC, RIG and a third party in the proportions respectively of 1,333 to JEC, 1,334 to RIG and 1,333 to a third party.
(5)	Also on 27 April 2000 an Unapproved Executive Share Option Scheme was entered into.
(6)	On 27 April 2000 the shareholdings and options of Evolution were as follows:

					No. of 20p shares		No of Options	
	JEC				2,500				1,333
	RIG				2,500				1,334
	Third party			    -				 1,333
	Dunedin Limited		2,500				    -
	Totals				7,500				4,000

Further capital was subscribed for by unconnected third parties in May 2000 and later.
(7)	Evolution’s business commenced in August 2000. Its business was carrying out financial research and providing corporate finance advice to corporate and individual clients. Its particular expertise was in high-tech, bio-technology and computer technology companies. It also took equity in unquoted client companies.
(8)	On 1 March 2001 the entire issued share capital and options in Evolution were exchanged for shares and options in The Evolution Group PLC (“EG”) (then called EVC Christows PLC). The options were exchanged under an Option Rollover Agreement. The new options obtained were 1,428,767 shares and 1,429,839 shares for RIG and JEC respectively at exercise prices of 1p per share.
(9)	RIG exercised his options, now over EG shares, in June 2001 and JEC exercised his options, now also over EG shares, in December 2001. EG did not deduct any PAYE, employer’s or employee’s national insurance on the issue of new shares in EG in 2001, on the grounds that they believed the options obtained by RIG and JEC were not obtained by reason of employment.
(10)	The issue of whether the options were obtained by virtue of being founder shareholders or as a consequence of employment was extensively discussed between solicitors Stringer Saul and Mr JA Clark of HMRC in 2003 and early 2003.
(11)	On 7 December 2001 JEC exercised his options to realise a gain of £1,092,439.
(12)	On 7 June 2001 RIG exercised his options to realise a gain of £976,919.44.
(13)	RIG submitted a Self Assessment Return, dated 17 January 2003, for the period ended 5 April 2002. The taxable income received from the realisation of the share options was not declared within this return.
(14)	On 17 April 2003 a Self Assessment Return for the period ended 5 April 2002 was received from JEC. The taxable income received from the realisation of the share options was declared within this return.
(15)	On 9 May 2003 a letter was forwarded to HMRC by Stellar Financial Partners Ltd, the agents who were then acting on behalf of RIG, asking for the Self Assessment Return to be amended to include the taxable income received from the realisation of the share options.
(16)	On 23 October 2003 a letter was forwarded to HM Revenue & Customs by EG confirming that the company accepted liability for the Employer’s and Employees’ Class 1 National Insurance contributions arising from RIG and JEC exercising their share options in 2001. A cheque for £246,135 in settlement of this liability which should have accompanied this letter was sent with SC’s letter of 27 October 2003.
(17)	On 22 January 2004 HMRC opened an enquiry under s 9A of the Taxes Management Act 1970 into the Self Assessment Return of JEC.
(18)	On 1 March 2004 Mr Graeme Dell, Finance Director of EG, wrote to Miss J Matthews, an Employment Compliance Officer at HMRC, stating that to avoid expensive litigation it was decided to accept there was a Schedule E liability arising on the exercise of the options and that the company did not accept that an irregularity had arisen or arisen at all, as there had been extensive correspondence with HMRC on this matter.
(19)	On 21 June 2004 Miss Matthews wrote to EG stating that there was a s 222 ITEPA 2003 liability as a benefit in kind which should have been declared on forms P11D at the year end.
(20)	On 6 July 2004 Stringer Saul wrote to Miss Matthews explaining that s 222 ITEPA 2003 was not in point (the correct statutory reference being s 144A ICTA 1988) as there was no payment free of tax or avoidance, that the employer had taken reasonable care to comply with the Regulations and that the Inland Revenue were seeking double taxation.
(21)	On 15 November 2004 Miss Matthews responded disagreeing with the arguments advanced in the Stringer Saul letter of 6 July 2004.
(22)	Various other correspondence between Stringer Saul and the Inland Revenue took place with no agreement.
(23)	On 15 May 2006 HMRC issued a closure notice to JEC amending the Return for the period ending 5 April 2002 to charge the tax arising under s 144A, resulting in additional tax due of £174,459.60.
(24)	On 14 June 2006 Stringer Saul, on behalf of JEC, appealed against the closure notice and HMRC’s amendment for the period ended 5 April 2002.
(25)	On 1 August 2006 a Regulation 80 Determination and Section 8 Decisions were issued for year 2001-02 formally charging tax and Class 1 National Insurance Contributions on the company [ie Evolution Group Services Ltd] for failing to operate PAYE on the share options exercised by RIG on 7 July 2001 and JEC on 7 December 2001.
(26)	On 8 August 2006 Stringer Saul appealed against the Regulation 80 Determination for year 2001-02 on behalf of Evolution Group Services Ltd. The grounds of appeal are:	

	The tax in question has been paid by Messrs Griffiths and Chilcott and 	agreement has been made between them and the company to set off 	their own liabilities under self assessment as a credit for the company’s 	PAYE liability that should have been paid.
	It is not possible to make a Regulation 80 Determination as this only 	applies to PAYE from 2003-04.
(27)	On 19 February 2004 a discovery assessment was issued for year 2001-02 to RIG charging tax of £156,306.80 under s 144A ICTA 1988.
(28)	On 20 March 2007 Stringer Saul, on behalf of RIG, appealed against the discovery assessment for the period ended 5 April 2002.
Additional facts
5.	Subsequently to the hearing, Mr Yerbury confirmed to the Tribunal that the company employing Mr Chilcott and Mr Griffiths was Evolution Group Services Ltd (described in this decision as “EGS”), of which Evolution Group plc was the parent company. I do not have details of the point when that employment commenced, but the parties accepted that EGS was the employer at the relevant times.
6.	On 26 January 2004 Miss Matthews wrote to Mr Dell concerning EGS and the exercise of unapproved share options. She stated that the exercise of these options should have resulted in EGS remitting the PAYE tax and secondary (but not primary) National Insurance Contributions at the time of exercise. The next point of action would have been for EGS either to have obtained repayment of the PAYE tax from the individuals within the stated time limits, or to declare the benefit under s 222 ITEPA 2003. She acknowledged that Mr Dell had indicated in the letter dated 23 October 2003 that the options had been declared by the two individuals via their self-assessment returns, but pointed out that declarations in this fashion did not negate the responsibilities of the employer.  However, by concession and without prejudice, as Mr Griffiths and Mr Chilcott were stated to have paid the tax arising in respect of the exercised options, she attached a copy of a mandate which EGS might wish to offer to them for their consideration. Under the mandate, the individual would confirm the inclusion of the exercise of the option on his self-assessment return, payment of the tax arising, acknowledgment of EGS’s responsibility and authority for repayment to be set against the employer’s liability. Miss Matthews emphasised that the PAYE liability, as well as the National Insurance contributions, remained the liability of EGS.
7.	The mandate took the following form:
“During the period starting on 6 April 2001 and ending on 5 April 202, Evolution Group Services Ltd (‘employer’) paid earnings to me as detailed below
Date of Payment	Type and Payment		Amount

I disclosed the relevant amounts as taxable income on my tax return for the year ended 5 April 2002 but without claiming any tax credits that the company was required to deduct and account for under PAYE. I received a statement for the year ended 5 April 2002 showing tax underpaid and subsequently made payment of the amount involved. My self-assessment for the year ended 5 April 2002 disclosed tax underpaid and, accordingly, I made payment of the amount involved.
I now understand that my employer was required to deduct and account for tax under PAYE and that I am entitled to a tax credit in respect of the relevant amount for the year involved. I now wish to claim repayment of tax previously paid by me.
I wish the repayment of tax due to me in respect of the tax year ending 5 April 2002 to be set off against the amounts now payable by my employer in settlement of the PAYE income tax determined under regulation 49 of the Income Tax (Employments) Regulations 1993, and I therefore irrevocably instruct the Inland Revenue to set the repayment due to me against that liability on the part of my employer.”
8.	On 11 February 2004 Mr Griffiths and Mr Chilcott each wrote to HMRC in a form corresponding (to a certain extent) to the draft letter. The second sentence of the second paragraph (“I received . . .”) was omitted, and the following sentence read: “My self assessment tax return for the year ended 5 April 2002 disclosed tax underpaid and I was assessed on the tax liability accordingly.” The second sentence of the next paragraph read: “I now wish to claim repayment of the tax which has now become overpaid.” The first sentence of the final paragraph began: “After taking into account the tax credit due, I wish for the tax overpaid in respect of the tax year . . .”, and finished: “. . . against the liability on the part of my employer.”
Arguments for the Appellants
9.	Mr Yerbury explained that there were two matters in issue. The first was whether there was a Schedule E charge under s 144A. Evolution Group Services Ltd (“EGS”) had ultimately accepted that the options over shares in Evolution Group PLC had been granted by reason of the directors’ employment. The options had been granted at the time of issue of shares in Evolution Capital Ltd. The directors and the company had considered that there was a respectable argument that the options had been granted to the directors as “promoters”, but EGS did not want to embark on expensive litigation to establish this, possibly all the way up to the House of Lords.
10.	The charge to tax on the exercise of the options was under s 135. Under s 203FB, this was treated for PAYE purposes as if the individuals were being provided with assessable income in the form of the shares, thus treating the notional gains as subject to PAYE. EGS as employer had been unable to operate PAYE, because of the absence of funds. This brought s 203FB into operation. This first required the employer to deduct tax from actual payments. He argued that if the employer was unable to deduct, this meant that the employer had to go to the employee for the balance due. It followed that under s 144A(1), the employee was required to make up the difference. There had been disclosures in the two separate self-assessment returns.
11.	The second issue was whether or not PAYE was due from the employer, as the directors had made payments under their self-assessments. The requests in 2004 for the tax paid in relation to the self-assessment to be set against the liability of EGS as employer in respect of the tax due under PAYE on the option gains had not been made within 30 days of the exercise of the options; it was for this reason that HMRC were seeking a tax charge under s 144A.
12.	Mr Yerbury argued that s 144A did not apply, because a tax avoidance motive was required. Parliament had made this clear in the headnote to the section, which referred to:  “Payments etc received free of tax”. The only way in which payments could be received free of tax was if tax avoidance was involved or in contemplation. Secondly, HMRC’s Manuals, at SE 11950, SE 11951 and SE 11853 (none dated) all referred to “PAYE Avoidance”. He argued that it would be an abuse of power for HMRC to resile from these published statements as to their interpretation of the law.
13.	He contended that income assessable to Schedule E arising from a non-payment of PAYE tax by an employer under s 144A(1) could not be deemed to be income of an employee if the employee reimbursed the employer after 30 days, as the employer could not be deemed to have properly received income if he had reimbursed such deemed income (ie the PAYE tax) to the employer. The time limit and the concept were both irrational in the absence of avoidance or inability to deduct.
14.	Section 144A was penal in nature; this was confirmed by the comments of Peter Smith J in McCarthy v McCarthy & Stone plc [2006] EWHC 1851, [2006] 4 All ER 1127 at [53], which Mr Yerbury acknowledged was not a tax case. He did not accept that the word “penalise” in Peter Smith J’s judgment had been used in a non-technical sense. In the absence of avoidance or inability to deduct it could not have been Parliament’s intention to charge a penalty of up to 40 % of the PAYE tax, dependent on the taxpayer’s personal income. It was not relevant to the penal nature of the legislation that, for example, trading losses could in principle be set off against such liability. He indicated that the circumstances of the parties did not involve inability to deduct the PAYE tax, as might be the case with (for example) a non-resident employer of a UK resident employee.
15.	He submitted that s 144A was not only penal in nature but involved double taxation. Taking a simple example of a share option gain of £100, liable to tax at 40%, if it was not reimbursed within 30 days, this resulted in a further liability of 40% of £40, ie £16. This meant that, as a result of non-compliance for a short period, the total rate of tax became 56%. The legislation imposed a short time limit in a difficult area. The absence of any credit for having made payment if this was after the 30 days seemed quite clearly to amount to a penalty. The £16 was a penalty and so was unfair to the taxpayer as falling outside the purpose of the section unless there was avoidance or evasion; he accepted that in the latter circumstances there could be some justification for the section having been enacted.
16.	He referred to a number of cases on the construction of statutes. In IRC v McGuckian [1997] STC 908 at 915, Lord Steyn had indicated that a purposive approach was required. A literal construction of s 144A, which Mr Yerbury contended had been judicially defined to be a penal section, was not appropriate where there was no avoidance and no inability to deduct tax. Its purpose was to penalise in specific cases of avoidance or when deduction was not possible. Viewed realistically on the facts of this case, namely the uncertainty of whether options granted concurrent with a subscription by founding shareholders were options granted by virtue of being a founding shareholder and were thus capital, or were to be regarded as obtained by virtue of being a director and thus fell to be treated as income, it could not be said that a literal construction of the statute, ie the plain reading of the statute, could apply.
17.	He submitted that as the PAYE tax not paid within the 30 days was treated as income assessable to Schedule E under s 144A, it must have the character of an emolument, as Schedule E was a tax on emoluments. He referred to the definition of “emoluments” in s 131(1), and argued that if the employee reimbursed the employer after the 30 day period had elapsed, he could not be said to have received an emolument. Thus in normal circumstances he could not logically be taxed under Schedule E. Parliament had not deemed the PAYE tax to be, for example, Case VI income, but had characterised it as Schedule E income because the concept of a benefit (in the everyday rather than the statutory sense) had to arise before the section could operate. He argued that if there was no “benefit” the section could not apply because to pay tax on a benefit (emolument) where there was none was patently absurd.
18.	Section 19, which set out Schedule E, referred at s 19(3) to Part V of ICTA 1988. Part V contained s 154 ICTA 1988, which charged tax on the cash equivalent of the benefit. This was defined at s 156(1) as the cost of the benefit, less so much (if any) of it as was made good by the employee. He emphasised that there was no time limitation on making good the benefit; he contrasted this with s 144A, which imposed a very short time limit. There was thus a conflict between the benefits legislation and s 144A. He questioned why Parliament should have made a special rule in s 144A different from that applicable to benefits generally. Section 144A was taxing a benefit; HMRC’s acceptance of this was confirmed by SE 11950, which indicated that the amount chargeable to tax under s 144A should be returned on the relevant form P9D or P11D. He submitted that it was necessary to look at the authorities to find the reason for the difference, in particular the purpose behind the legislation, and argued that to be consistent with s 154, s 144A should only apply in limited circumstances.
19.	He referred to Bibby (Inspector of Taxes) v Prudential Assurance Co Ltd [2000] STC 459 at [59] (Sir Richard Scott V-C):
“The answer to these questions cannot be found merely from the literal meaning of the statutory language. It is necessary to place the statutory provisions in their context, to ask what the mischief was that s 95 was intended to meet and to try to bring into focus a picture of the legislative scheme that Parliament intended to produce.”
This and a number of other cases on the construction of tax statutes showed that it was necessary to look at the purpose behind the legislation and the mischief with which it was intended to deal. He submitted that s 144A was a penal section, dealing with two situations, namely tax avoidance or evasion, and cases where there was no reasonable likelihood that PAYE could be obtained. His understanding was that it was aimed at non-residents. As the purpose was so clearly penal, s 144A should only be applied in these limited circumstances.
20.	It was clear from HMRC’s own guidance that avoidance was necessary for the section to apply. This was in addition to the indication given by the headnote to s 144A, which had remained until at least 2001 as a statutory guide to the mischief covered by the section. In order properly to construe its legal and penal nature, it was necessary to consider its purpose; it was separate from other benefit provisions. It was grossly unfair to charge double taxation for an innocent taxpayer, especially if both the employee and the employer thought that there was no PAYE issue.
21.	Mr Yerbury made a peripheral comment in respect of the Income Tax (Employments) Regulations 1993 (SI 1993/744). In regulation 42, there was an “error in good faith” provision; it was possible to invite collection from an employee, but this was not possible for notional payments. This gave an “out” for the employer, but here there was no such means of escape by way of an equivalent provision for the employee. This was unfair and could not have been contemplated by Parliament in the absence of avoidance or inability to deduct.
22.	Finally, Mr Yerbury submitted that it was not appropriate in the present case to apply s 144A; this was not a case where HMRC would have failed to receive, either from the employer or from the employees, the tax arising on the exercise of the options. The short period during which the latter tax had been outstanding should be taken into account, as well as the delay in resolving matters because of the argument that the options had been granted to the individuals as founder shareholders.
Arguments for HMRC
23.	Mr Williams contended that as Mr Chilcott and Mr Griffiths had not reimbursed to their employer the Schedule E tax payable on the notional gains within 30 days of the date when those gains had arisen, a tax charge under s 144A did apply to them in respect of the tax not reimbursed within that time.
24.	HMRC’s understanding was that the Appellants, albeit reluctantly, accepted that a notional gain arose under s 135 and that by virtue of s 203FB, the employer was required to operate PAYE on the notional gains. EGS had accepted liability for the Employers’ and Employees’ National Insurance Contributions in October 2003. Under s 203FB(2), the PAYE obligation arose at the time when the “relevant person” acquired the shares pursuant to the right falling within s 135. HMRC accepted that the Appellants had thought that they were founder shareholders, and on this basis had not considered that they were within s 135, and HMRC also acknowledged that the business did not start for about four or five months. However, the “clock had started ticking” as soon as the options had been exercised.
25.	Where an employer was required to operate PAYE in respect of a notional payment such as the notional gain arising on the exercise of a share option, it was impossible for the employer to deduct tax in the conventional manner associated with PAYE. For this reason, s 203J prescribed how an employer should deduct and account for the PAYE tax. The deduction should first be from actual payments made in respect of such income at the same time or later in the income tax period in which the notional payment occurred. If the employer was unable to deduct a sufficient amount to cover the PAYE tax due, the employer had to account for the balance.
26.	The legislation said nothing about how the employer might recover that balance from the employee. That was a matter between employer and employee. Nevertheless, s 144A did deal with the instance where the employee did not make good promptly to the employer the amount which the employer was required to account for under s 203J(3).
27.	HMRC submitted that the wording of s 144A was plain and unambiguous. It operated simply and mechanistically to impose a charge to tax where the employer had not been reimbursed the tax within 30 days.
28.	HMRC understood that the Appellants did not dispute that the conditions specified in s 144A were met; it was common ground that each of the three specified conditions in s 144A applied. This meant that on a plain reading the charge would arise, thus rendering both Mr Chilcott and Mr Griffiths assessable. This was subject to the Appellants’ “purposive” argument, which was that other requirements should be read into s 144A to give effect to what they claimed was the intention of Parliament.
29.	In the course of the correspondence, it had been argued that s 144A imposed double taxation. HMRC did not accept this argument. In McCarthy v McCarthy & Stone plc at the passage cited, Peter Smith J had been satisfied that what was involved was an extra payment which “has nothing to do with the actual income tax deduction”. Thus there was no element of double taxation.
30.	Mr Yerbury had argued that an avoidance motive was required for s 144A to operate, and had sought to derive support for this proposition from HMRC manuals. It was well established that HMRC guidance was of no assistance in construing statutory provisions. Further, the Appellants had sought to use the guidance selectively and out of context.
31.	Mr Williams acknowledged that many of the original notional payments provisions had been broadly regarded as anti-avoidance measures. However, there had been significant changes to the notional payments legislation since 1994 which had caused its effect to extend beyond its origin as an anti-avoidance measure. In particular, the introduction of s 203FB by s 67 of the Finance Act 1998 had extended the application of PAYE to cover events which gave rise to a charge to income tax in respect of equity based remuneration. He argued that the fact that the provisions of s 144A were not amended to reflect the possibility that a charge to tax might arise in circumstances where there was no avoidance motive indicated that Parliament was content that s 144A did not require tax avoidance for it to be operative.
32.	HMRC submitted that the Appellants had not established the parliamentary intention on which they sought to rely. HMRC did not dispute that it was correct to apply a purposive approach, but there were limitations to this. The starting point must be the words of the statute. More generally, the attempt to read into s 144A a condition that was simply not there was an impermissible approach to statutory construction. Mr Williams referred to Black Clawson International Ltd v Papierwerke Waldhof-Aschaffenberg AG [1975] All ER 810 at 814-815, which had been quoted in Pepper v Hart [1992] STC 898 at 916, and to Lord Browne-Wilkinson’s comments in the latter case at 918-919. Mr Yerbury had argued that judicial interpretation had developed considerably from the times of these cases, and that, especially in the construction of tax statutes, the more recent authorities which he had cited were the appropriate ones to consider. Mr Williams submitted that there was no need to prefer these later authorities, as the two which he had cited made the position quite clear.
33.	In the light of those comments, HMRC submitted that the words of s 144A simply could not bear the meaning that the Appellants sought to impute to them. If Parliament had intended to impose an anti-avoidance precondition to this legislation, the draftsman could easily have incorporated a “sole or main benefit” provision such as those seen elsewhere in the Taxes Acts. HMRC’s submission was that the plain words of s 144A could not legitimately be read so as to include a requirement for an avoidance motive to be established.
34.	The Appellants had also sought to argue that the word “penalise” used by Peter Smith J in McCarthy v McCarthy & Stone plc at [53] meant that the charge under s 144A was a “penalty” for which negligence must be established. HMRC submitted that Peter Smith J was clearly using the word in an everyday sense that could in no way counteract the plain and explicit intention of s 144A to impose a charge to tax, not a penalty. He was not saying that it was a “penalty” within the terms of the Taxes Acts. There was no warrant for saying that s 144A required negligence; if there were to be such a requirement, it would be certain to be made explicit.
35.	HMRC submitted that the meaning of s 144A was plain and unambiguous. The Appellants had not established that the intention of Parliament was what they claimed it to be. In any event, the wording of the statute simply would not bear the meaning that the Appellants sought to give them.
36.	Mr Williams responded to Mr Yerbury’s points:
(1)	The heading to s 144A referred to the conditions in the section itself. The meaning was plain and there was no need to look further for an avoidance motive.
(2)	As already indicated, HMRC’s guidance was not a help in statutory construction. Examination of SE11950 showed that it clearly stated the effect of the legislation. It was seeking to implement the legislation.
(3)	Mr Yerbury’s argument as to the inappropriateness of deeming income to have arisen under s 144A where the employee had reimbursed the employer after the 30 day period missed the essential character of s 144A as a deeming provision. Emoluments or benefits under s 154 were different. Mr Yerbury was inviting a reading to the effect that if the employee made good the tax after the 30 day period, there would be no charge. However, this would render part of s 144A(1)(c) redundant, namely the 30 day period.
(4)	The point concerning regulation 42 was not relevant. It was there to ensure that the employee incurred the economic cost. Were it not to have existed, the employer would have had to pursue the employee. Essentially s 144A was concerned with the same matter, as indicated by Peter Smith J in McCarthy v McCarthy & Stone. The case was authority that s 144A imposed an extra charge and not double taxation of the same income.
(5)	There had been an inability to deduct tax; as insufficient cash had been paid to the employees, EGS as employer had in fact been unable to make such deduction.
(6)	On the authorities cited, there was no essential difference between the Ramsay approach (WT Ramsay Ltd v IRC [1981 STC 174]) and that in Black Clawson and Pepper v Hart. It was not appropriate to look wider than s 144A; its language was clear and it had an obvious plain meaning. Even on a purposive construction, it was not capable of being construed in a different way. There was no reference to avoidance; the only words to be construed were those present in the section. The Appellants had not said what words needed to be construed.
(7)	There were two problems with Mr Yerbury’s approach. First, he was seeking to impute Parliament’s will. It was not sufficiently made out that this was as he argued. The mechanism was that the liability fell on the employer; s 144A was a tool to apply to notional payments. There was no evidence that it was restricted to avoidance.
(8)	Secondly, even if this were the case, the principles of statutory construction had to be taken into account, in particular that words could not be given a meaning that they could not bear. There was no reason to impute an “avoidance” restriction into the section, especially as this would render the 30 day period provision redundant.
37.	Mr Williams submitted that s 144A should be construed in accordance with its plain meaning, and that charges under it accordingly arose. There were two issues in the appeal. The first was whether s 144A applied. Secondly, it had been argued that no PAYE was due as the tax had been accounted for in the employees’ self-assessments. This was an erroneous approach. It had been their obligation to include this income in their self-assessments, but the obligation to deduct the tax under PAYE had been a separate matter, provided for by s 203J(1). The appeals should be dismissed.
38.	Mr Williams confirmed that the circumstances in the present case did not correspond to those considered in the Demibourne case [2005] STC (SCD) 667 and the subsequent discussions between the representative bodies and HMRC. The charge under s 144A was separate from and additional to that made in respect of the liability on the exercise of the option. In relation to the Regulation 80 determination, this was not in issue as it had been satisfied by payment; the appeal had been a protective appeal.
Discussion and conclusions
39.	The facts of this case were not disputed. It is clear that, on the basis that the option gains fell within s 135, s 203FB applied. As the gains were notional gains, s 203J came into play. Under s 203J(3), the payments being notional and thus being in themselves incapable of being subjected to deduction of tax under PAYE, the obligation to account for the PAYE tax remained on EGS as employer despite the absence of deduction.
40.	I accept Mr Williams’ argument that the legislation does not provide any specific method by which an employee might reimburse the employer for the tax on the notional gain. Nevertheless, the basis on which s 144A is framed suggests a normal expectation that there will be a prompt reimbursement within the relatively short period of 30 days.
41.	Where there has been such a reimbursement, the employer should be in a position to make its monthly PAYE payment without difficulty. In the absence of reimbursement, the employer is left with the obligation to account for the PAYE, but is left to fund in some other way the element of the PAYE tax attributable to the notional payment.
42.	In the present case, the tax referable to the exercise of the options was not reimbursed in this way. Instead, Mr Chilcott and Mr Griffiths made payments in respect of their self-assessment liabilities. HMRC’s draft letters were intended to treat these payments as repayable tax, which would be mandated towards payment in satisfaction of EGS’ liability as employer under s 203J. The versions actually written by Mr Chilcott and Mr Griffiths were accepted by HMRC as having the appropriate effect.
43.	The making of these mandated payments did not affect the obligations of EGS under s 203J. Such obligations continue whether or not there has been any reimbursement by the employee. In the same way, the credit for that tax taken into account under PAYE is available to the employee whether or not he has reimbursed the employer for the tax. This shows that the payment of the tax is assumed throughout to be the responsibility of the employer, and thus that if the employee does intend to deal with the tax liability, he should do so by reimbursing the employer rather than by seeking to make payment in his capacity as an individual taxpayer. The method which Mr Chilcott and Mr Griffiths adopted, in dealing with matters through their self-assessments, was not appropriate and confused their position as individual taxpayers with the obligation which had fallen on EGS as their employer.
44.	Although the payments were mandated to discharge the amounts due from EGS under s 203J, this did not happen until after Miss Matthews’ letter dated 26 January 2004 enclosing the draft mandate; Mr Griffiths’ mandate letter was undated, and Mr Chilcott’s was dated 11 February 2004. Mr Griffiths had exercised his options on 7 June 2001 and Mr Chilcott had done so on 7 December 2001. The payments in respect of their self-assessments had been made earlier, but considerably after the expiry of 30 days from the respective dates of exercise of the options. Thus on either test, the precondition to the operation of s 144A set out in sub-s (1)(c) was fulfilled.
45.	Mr Yerbury accepted that the circumstances of Mr Chilcott and Mr Griffiths brought them within the literal terms of s 144A. His arguments were directed towards an interpretation of the section which would place restrictions on the extent of its operation.
46.	He argued that the section should be confined to cases where there had been avoidance, or where there had been no inability to deduct tax. In relation to avoidance, I do not consider that the sidenote to s 144A (“Payments etc received free of tax”) can be construed as limited to avoidance. What is contemplated by ss 203B to 203I as referred to in s 144A(1)(a) is notional payments. The second precondition in s 144A(1)(b) is that the employer is required by s 203J(3) to account for an amount of income tax under PAYE. This requirement arises because the notional payment falling within s 203FB in respect of the share option exercise cannot be subjected to deduction of tax; there is no “actual income” to which s 203J(1) can be applied. Thus Mr Yerbury’s alternative case of “no ability to deduct tax” cannot arise in this context.
47.	Apart from the absence of any reference in the sidenote to avoidance, there is nothing in the rest of s 144A to suggest any such limitation. If the section is to be read as Mr Yerbury suggests, it is necessary to point to evidence of Parliament’s intention, and also to establish that there is nothing in the section which could be regarded as inconsistent with that apparent intention.
48.	I agree with Mr Williams that the HMRC manuals and HMRC guidance cannot be used as aids to statutory construction. They represent HMRC’s interpretation of legislation and practice, and do not have any form of quasi-legislative status. To ascertain Parliamentary intention, the principal method is to follow normal methods of statutory construction. Only in limited categories of cases will it be appropriate to look behind the legislation and review the history of its enactment.
49.	In any event I do not find, in any of the three extracts from the HMRC manuals cited by Mr Yerbury, anything that implies avoidance to be a precondition to the application of the various statutory provisions under discussion. I accept that they all carry the title “PAYE avoidance”, but if any criticism is due, it is merely that this is not an entirely accurate indication of their content.
50.	The difficulty in seeking to read s 144A in the way which Mr Yerbury suggests is that it involves seeking to read in words into the section which are not there and are not implied by any of the words actually used. To confine its effect as he suggest would require the addition at the beginning of sub-s (1)(c) words such as: “in a case involving avoidance”. Leaving aside the difficulty of defining “avoidance” for this purpose, this would introduce an inconsistency with the initial words in sub-s (1), “In any [my emphasis] case where—”. It would also be necessary to ensure that the effect of the limitation extended to the operative provision at the end of sub-s (1); arguably the limitation in sub-s (1)(c) might be enough, but the possible lack of clarity is itself an indication that seeking to rewrite the section in this way, rather than merely construing it, is an inappropriate exercise.
51.	Mr Yerbury argued that the effect of s 144A was penal. Taking into account the way in which the related statutory provisions are intended to operate, with credit given to the employee for the PAYE due from the employer under s 203J(3), whether or not this has actually been paid, and irrespective of whether the employee has actually reimbursed the employer, something additional is needed to encourage the employee to do something about reimbursement. In the absence of s 144A, the employee could keep the option gains, take credit for the PAYE, and leave the employer to bear the cost. The charge under s 144A recognises that the employee has had the benefit of the PAYE credit.
52.	I agree with Mr Williams that in McCarthy v McCarthy & Stone plc Peter Smith J was using the word “penalise” in an everyday sense, and was not describing s 144A as imposing a “penalty” as such. I do not consider it to involve any penalty; it simply imposes a charge to tax if the various preconditions which it sets out are fulfilled.
53.	In relation to Mr Yerbury’s argument that double taxation is involved, I think it necessary to consider differing circumstances. The employee will have had the credit for the employer’s PAYE liability. If the employee does not reimburse the employer for the PAYE tax, the only tax charge which the employee will have suffered will be that under s 144A. If the employee reimburses the employer within the 30 day time limit, s 144A does not of course apply. If the employee reimburses the employer after the 30 day time limit, the employee will have borne the cost of the PAYE tax, and will also have suffered a charge to tax under s 144A, thus giving an effective combined tax rate of 56%, as Mr Yerbury explained. This is substantial, especially as it applies equally whether the delay is 31 days (or under s 222 ITEPA 2003, 91 days) or a matter of years before the underlying question of the tax charge under s 135 is resolved. Effectively, the employee in these circumstances has suffered two tax charges in respect of the same income; the liability under s 144A amounts to a form of surcharge, imposed because of the employee’s late reimbursement of the employer.
54.	Mr Yerbury argued that the PAYE tax not paid within the 30 days must have the character of an “emolument”, and that if the tax was reimbursed after the 30 day period had elapsed, this would not amount to an emolument, so that it ought not to be taxed under Schedule E. However, this ignores the employee’s cash flow position; the employee has been given credit for the PAYE tax due from the employer, so that from the time when the employer would have made a deduction if it had been in a position to do so, the employee has had a form of “loan” from the employer. This “loan” subsists until the employee reimburses the employer (or indefinitely if he does not do so). The tax charge under s 144A is not related to the time for which the “loan” subsists; it is a specific charge which arises if the preconditions set out in s 144A(1) are fulfilled.
55.	In any event, I do not think it necessary for the income under s 144A to fall within the description of an “emolument”. Under s 144A(1) “the due amount shall be treated as income of the employee which arises on the date mentioned in para (c) above and is assessable to income tax under Schedule E.” This deeming process brings the income within Schedule E without the need to apply any other tests in order to determine whether it is so chargeable.
56.	The same applies to Mr Yerbury’s argument concerning benefits in kind. If the charge under s 144A can be described as a charge on some form of benefit in kind, it is entirely separate from the mechanisms set up to deal with the more general categories of benefit falling under s 154 and related sections. The existence of a mechanism under those provisions for making good the cost to the employer and so eliminating the chargeable benefit is a facet of that broader regime; it does not imply that any corresponding provision is appropriate for the specific “stand-alone” charge under s 144A. The deeming process which I have referred to imposes the charge without bringing in other aspects of the Schedule E charging provisions. As I do not accept the contention that there is a conflict between the benefits legislation and s 144A, I do not consider that there is any need to construe the latter as only applicable if there is avoidance or evasion. (I have already commented on the question of inability to deduct.)
57.	Mr Yerbury contended that it was inappropriate to apply s 144A in a case such as the present, which was not one where HMRC would have failed to receive, either from the employer or from the employees, the tax arising on the exercise of the options. I accept Mr Williams’ argument that this misses the essential character of s 144A as a deeming provision. On the face of the section, the deemed income charge applies where an employee does not make the reimbursement payment within the 30 day period. If it is not to apply in all such circumstances, what criteria could be applied to determine which cases should, and which should not, be subjected to the charge under the section? I have already dealt with the difficulty of reading any form of restriction into s 144A; I do not see any basis for limiting its application so that it does not impose a charge to tax in “inappropriate” cases, whatever test might apply to determine this.
58.	The result is that I can see no basis for the charges under s 144A not to be applied to Mr Chilcott and Mr Griffiths. It follows that their appeals must be dismissed. I comment below on certain practical implications of the s 144A charge. Before doing so, I deal with a further matter raised after the hearing.
59.	In a letter to the Tribunal dated 27 October 2008, HMRC wrote to explain that it had become apparent in discussion with Mr Yerbury after the hearing that he was unsure of HMRC’s procedures in relation to setting off overpayments of tax that may arise. In the attachment to that letter, HMRC described the history of the matter, and commented:
(1)	It had been accepted that Mr Chilcott and Mr Griffiths were entitled under regulation 185 of the Income Tax (Pay As You Earn) Regulations 2003 (SI 2003/2682) to treat as deducted any tax that EGS was liable to deduct whether or not that tax was actually deducted. The tax that should have been deducted should therefore be treated as a credit within the respective employees’ self-assessment returns.
(2)	If as a result of these credits Mr Chilcott and Mr Griffiths have overpaid tax in respect of the year 2001-02, then the overpayments of tax can be reallocated against EGS’ Regulation 80 Determination, as they had provided HMRC with the appropriate mandates authorising that this could be done.
(3)	The point at issue was whether a s 144A charge arose; if it was accepted that it did, then the overpayments of tax in respect of Mr Chilcott and Mr Griffiths would be reduced and there would therefore be less tax to be reallocated to EGS as the employer.
60.	In his letter dated 10 November 2008 to the Tribunal responding to HMRC’s letter, Mr Yerbury disputed the conclusion that the effect of charges under s 144A would be to reduce the amount available under self-assessment for set-off by Mr Chilcott and Mr Griffiths against the liability of EGS to tax under PAYE. The grounds for disputing this were that the s 144A charge was a new charge assessed on the employee and was independent of the tax already utilised to satisfy the employer’s PAYE tax. It was not possible by virtue of a new charge to reduce the amount of tax already fully utilised to reduce the PAYE tax. The mandates were simply rectifying an error made by the employer in not deducting PAYE. It was not open to HMRC to utilise this error by arguing that the set-off did not occur in full as intended.
61.	I have already explained the process whereby the credit for the PAYE for which the employer is accountable (whether or not the employer ultimately received reimbursement from the employee) is given to the employee. This means that in respect of his own self-assessment for the year in question, the employee may well be in a repayment position. Through the respective mandate letters, Mr Chilcott and Mr Griffiths gave irrevocable authority to HMRC to set the repayments due to them against the liability of EGS as employer under regulation 49 of the Income Tax (Pay As You Earn) Regulations 1993 (SI 1993/744).
62.	As my decision is that Mr Chilcott and Mr Griffiths are liable to charges to tax under s 144A, that charge is treated by the final words of s 144A(1) as having arisen on the date on which EGS was treated as having made the notional payment. Thus the liability falls into the year 2001-02. The review of the respective self-assessments for that year will therefore need to be adjusted to take account of any reduction in the available repayments resulting from the additional tax due in respect of the s 144A liabilities. I do not think that HMRC’s reference to regulation 185 of SI 2003/2682 is appropriate for 2001-02; the applicable provision appears to me to be regulation 101A of SI 1993/744. (I think it important that in correspondence HMRC should refer to the legislation relevant to the year in question, rather than to replacement legislation relevant only to later years.)
63.	Thus, subject to the substitution of the appropriate references to SI 1993/744, I accept the position as stated in HMRC’s attachment, and not as put in Mr Yerbury’s response. Subject to my remaining comments, the respective repayments for 2001-02 will have to be adjusted accordingly.
Further comment
64.	In arriving at my decision, I have confined my attention (as I am required to do) to the effects of the statutory provision in question. The consequences which follow from that process appear to me inevitable; in terms of that statutory provision, the charge to tax arises.
65.	However, certain features of the s 144A charge give me some concern. First, the liability is an additional imposition on an employee who does reimburse the employer, but only after the 30 day period has expired; as Mr Yerbury explained, the overall burden may well be as high as 56%. This seems to put employees who choose not to reimburse their employer in a better position, as they have the tax credit and yet only have to find the s 144A tax, amounting to a maximum of 40% of the non-reimbursed tax on the notional payment. Secondly, there is no account taken of the amount of time which has actually elapsed between the expiry of the 30 day period and the date on which the reimbursement occurs. If the reimbursement takes place a day after that expiry, the tax charge will be exactly the same as it would be if the delay was five years, or the somewhat lesser period which actually occurred in the present case.
66.	Although the legislation itself cannot be construed as providing otherwise, I do question whether it would be possible for HMRC on an extra-statutory basis, using their “collection and management” powers under the Commissioners for Revenue and Customs Act 2005 (as described at paragraph 115 of my decision in Parade Park Hotel v Revenue and Customs Commissioners [2007] STC (SCD) 470), to adjust the tax actually charged under s 144A. I suggest that such adjustments could be made to limit the tax payable under s 144A by reference to the amount of time elapsed between the end of the 30 day period and the date on which the reimbursement is actually made. This would mean that the longer the delay, the greater would be the proportion payable of the tax statutorily due.
67.	I accept that these are matters over which I have no jurisdiction. However, I encourage HMRC to consider following this course of action, leaving the full rigour of s 144A for cases where employees fail altogether to reimburse their employers.
68.	Subject to these comments, I confirm the dismissal of Mr Chilcott’s and Mr Griffiths’ appeals. I make no determination in respect of EGS.

JOHN CLARK

SPECIAL COMMISSIONER
RELEASE DATE: 18 December 2008

SC/3154/2007
SC/3098/2008
SC/3099/2008

Authorities referred to in skeletons and not referred to in the decision:

Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46, [2004] 6 ITLR 454
MacNiven v Westmoreland Investments Ltd [2001] STC 237
Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1