Compensation Payment Found to be Taxable

A recent First-Tier Tribunal raised an interesting point with regard to the rules on Termination Payments under ITEPA 2003, s.401.  These rules apply not only to compensation payments made on termination, but also a change in the duties of a person’s employment or a change in the earnings from a person’s employment, and can mean that the first £30,000 of such qualifying payments is exempt from Income Tax.

An important point to note however, is that these rules only apply where there is not already a tax charge under another heading per s.401(3).  In the case of payments made due to a change in duties this presents difficulties, as the payment could be taxed as normal employment income if the payments are found to be emoluments.

This is how the taxpayer in A Hill v HMRC (TC04480) came unstuck.  The taxpayer had his employment transferred under the Transfer of Undertakings Regulations 2006 but was not happy with the new conditions.  A compromise agreement was made under which each company paid him £15,000 in settlement of his complaints. He was required to continue working for the new company and would have to repay them both if he left within two years.

The taxpayer argued that the payments should be exempt under ITEPA 2003, s 403, however HMRC argued that they were taxable.

The First-tier Tribunal decided the payments were consideration for agreeing to accept a change in his contract of employment, however the fact he was required to continue working, and would have to repay the sums if he did not, showed they referred to his continuing employment. As such they were taxable as emoluments and not exempt.

£600k Tax Free Payment – But There’s a Catch

A City trader recently won a case at the First-Tier Tribunal confirming that a payment of £600,000 from his former employers could be treated as tax free.  The catch comes in the fact that the payment was made as a settlement as compensation for racial discrimination; however the payment was in part calculated by reference to lost earnings.

In Mr A v HMRC, HMRC argued that because the payment had been calculated by reference to Mr A’s lost bonuses and earnings, it should be treated as taxable as earnings.  Mr A argued that the payment represented compensation in relation to a threatened race discrimination claim against his employers , and that therefore no tax should be due.

Mr A was eligible to benefit from the bank’s “discretionary bonus scheme”, and during his first 6 months made a profit of €3m for the bank, receiving a bonus of €50,000. During the next year he made a profit of €9.1m for a bonus of €125,000, which was later increased to €725,000 after he challenged it.

Mr A felt that the bonuses were disproportionately small compared to his colleagues, and that he had also been overlooked for promotions.  He made a claim under the Race Relations Act 1976 (now replaced by the Equality Act 2010).  Eventually the parties entered into a compromise agreement for full and final settlement. The amounts paid included a statutory redundancy payment of £1,650, an ex-gratia redundancy payment of £48,898 and the further compensation sum of £600,000.

Ultimately, the courts found in favour of Mr A, stating that “while the discrimination may have manifested itself through the way in which the employee was remunerated, the damages arise not because the employee was under-remunerated but because the underpayment was discriminatory.”  They found that the payments were made due to the fact that Mr A had been discriminated against and that the fact that they were calculated by reference to lost bonuses and earnings did not make the sums earnings.

It is interesting that a sum of £178,922 which was part of the £600,000 figure was acknowledged to be in respect of a bonus that was underpaid in error, however the Tribunal still felt that this fell within the overall discrimination claim as it would not have been paid without the claim.

The case could have interesting implications for compensation payments in the future and highlights the importance of reviewing the tax implications of transactions at the time based on the facts.  It remains to be seen whether HMRC will look to appeal this case at the Upper Tribunal.

A Camel, a Horse or a Spaceship – Tax Law

The Law is not an ass.  It is a quadruped, designed by a committee, who, over many years and many different committee members, cannot quite recall whether they were designing a camel, a horse or a spaceship.

  1. Hands up all those who believe the Rule of Law is important?
  1. Hands up (in Magna Carta year) all those who think the Law should be applied consistently?
  1. Hands up all those who believe that professional tax advice should be clear and based on proper interpretation of the Law?

Hopefully, I have everyone’s hands up for each question?  At least mentally?  Those too embarrassed to react or having a quiet lunch snooze should, I hope, still have made a genuine twitch towards acceptance.  If not, please say.  I genuinely would be interested to know why.

I now move on to the recent cases of Gemsupa and Trigg.  They would make a superb exam question in terms of ‘compare and contrast’.

In Gemsupa, the Courts agreed with the taxpayer that the CGT legislation was so clear that, even though various steps were taken for tax avoidance purposes, this did not meant that they were ineffective legally (the case was pre-GAAR so query whether those new rules may have an impact?)

And Compare:

Trigg(onometry) and Lawyers

The Trigg case heard in the First Tier Tribunal concerned the definition of Qualifying Corporate Bonds for tax purposes.  This may sound esoteric and technical, but in fact they raise some very interesting issues.  [Remember ‘Tax is Fun’].

Amongst the reasons the case is interesting is that it may have an impact on both future and historic Commercial, Corporate Sale and Purchase agreements where some of the consideration is deferred in the form of loan notes.  As will be generally known, (at least in esoteric tax and legal circles) the loan note form of deferred consideration makes a profound different on the way it is taxed.

In Trigg, HMRC lost, which seems to have widened the definition of QCBs.  This could have a profound impact on Sales and Purchase Agreements so Solicitors need to beware!

Having reviewed many Sales and Purchase agreements over the years, I fear that sometimes matters may be glossed over.  Perhaps so because of infrequent HMRC review of the detailed documentation?  This is understandable, from a commercial perspective.  A precedent has worked in the past, so just tweak it?

The ‘purposive’ approach in Trigg contrasts with the legalistic interpretation adopted by Gemsupa.  Which is correct?  Which ought to be correct?  Bearing in mind most of us just wish to get commercial deals done to help business people achieve their commercial objectives, how many professionals believe the objectives suggested in 1-3 above are being achieved?

As they used to say in exam questions – Discuss!

Reasonable Excuse – Further Successes for Taxpayers in the Courts

Two recent tax cases heard by the First-Tier Tribunal show that the courts continue to interpret the phrase “reasonable excuse” more generously that HMRC internal guidance allows for.

In S Taylor, a taxpayer was somewhat surprisingly found to have a reasonable excuse as he had appointed an agent and relied upon them to deal with the self-assessment form.  HMRC guidance is explicit that relying on a third-party is not a reasonable excuse, however, the Tribunal felt this to be incorrect in these specific circumstances.

The taxpayer delivered his papers to the agent in sufficient time but the agent had been busier than usual and had missed the taxpayer’s return.  The agent had not told the taxpayer this, and the Tribunal therefore felt that he had taken reasonable steps to file on time.

Another case showed a partial success for the taxpayer in Perfect Permit Ltd t/a Lofthouse Hill Gold Club.  HMRC had levied penalties in relation to late employer annual returns for 2008/09 and 2009/10.  The 2008/09 return was submitted more than a year late, whilst the 2009/10 return was filed 47 days late by the taxpayer’s new agent.

The Tribunal found that the failure of the previous agent to submit their returns did not constitute a reasonable excuse and it was up to the company to seek redress from the previous agent.  However, the new agents had encountered difficulty registered with HMRC.  The tribunal agreed that, had HMRC registered the new agents promptly, the return for 2009/10 would have been submitted on time.  As such, the delays caused by HMRC did constitute a reasonable excuse.

We would suggest that taxpayers seek advice where they feel that HMRC are being unreasonable with regard to reasonable excuse claims.  Eaves and Co would be delighted to help and would love to hear from you.

Procedural Issues – Tax Case Law

Recent tax case law has brought out some interesting points on how the Courts view operational issues.

1. Tax avoidance schemes associated with the film industry seem to follow inevitably (with various complications) from the complex tax reliefs which are designed to promote film finance. It seems to lead to a slightly odd dichotomy where the Chancellor sets law to give relief on film investment and is then surprised and upset when schemes are set up to exploit the reliefs. In Samarkand the tax avoidance scheme failed, partly because the Courts found emails which included phrases such as ‘Don’t mention this, it smells of pre-ordained’. This reinforced HMRC’s case that the scheme was not a straightforward use of the relief, but an artificial tax avoidance scheme, with no real commercial substance. A good rule of thumb would be to train staff not to put anything on file which they would be embarrassed to read out in court.

2. An interesting one in terms of postal submissions is the recent case of O’Keeffe. The taxpayer claimed his wife had posted his Return some weeks before the deadline. HMRC said they had not received it until a month after the deadline. They succeeded with their imposition of a late filing penalty.

Whilst the First Tier Tribunal agreed that mail may go astray, which could be a reasonable excuse, there was no proof of postage in this case. It would be interesting to hear what evidence HMRC put forward in terms of date of receipt, as mail does seem to go astray more often than it used to and with the closure of so many Post Offices obtaining routine proof of postage would be difficult for many.

3. Final procedural point – and statement of the obvious – encourage clients to keep proper records. The lack of a clear trail of what was owing led to the taxpayer in Michiels losing a bad debt relief claim against profit, because on balance the outstanding sums related to a later period.

Trading Losses and Succession – Leekes Ltd v HMRC

A recent case on trading losses could have implications going forward as it was found that, in the specific circumstances, losses from an acquired trade could be used against profits from the existing trade.

The case in question, Leekes Ltd v HMRC (TC4298), was heard by the First-Tier Tribunal.

Leekes Ltd previously owned four department stores and purchased Coles, a company with three furniture stores as well as warehousing facilities.  Coles had been loss making for a number of years. The Coles trade was hived up to Leekes Ltd and the stores were all rebranded as Leekes stores; however the former Coles stores continue to sell furniture predominantly.

Leekes claimed the brought forward losses incurred by the Coles business against the profits of the combined business for the year to 31 March 2010, which was the first following the acquisition.

HMRC argued that the losses incurred in the Coles business could be used only against future profits from that business, and could not be used against the previous Leekes business.

It was common ground between the company and HMRC that Leekes Ltd succeeded to the trade of Coles Ltd and that the trade consisted of the running of out of town department stores.

The issue at stake was therefore whether Leekes could relieve trading losses incurred by Coles before the succession against the profits of the combined trade after the succession by virtue of the provisions of ICTA 1988, s. 343(3).  Interestingly, HMRC agreed that ICTA 1988, s. 343(8) did not apply in this case.  Section 343(8) deals with situations in which there has been a succession to something different than the trade of the successor company, but in that case specifically requires that losses are kept separate.

Section 343(3) stated that ‘the successor shall be entitled to relief under s. 393(1) as for a loss sustained by the successor in carrying on the trade, for any amount which the predecessor would have been entitled to relief had it continued to carry on the trade.’

The legislation did not make it clear whether it was necessary to stream the losses as it was not clear whether the “trade” referred to was the post or pre-acquisition trade.

The First-tier tribunal found in favour of the taxpayer company, concluding that the Colesʼ trade losses were relievable against future profits of the combined post-acquisition trade for three main reasons:

1. There was no explicit reference to a requirement to stream losses in s. 343(1) and (3), unlike those of s. 343(8) where there is such a specific.

2. That requiring the company to stream losses would involve extensive practical difficulties in application.

3. That such an approach to the legislation is more closely aligned to commercial reality.

This ruling may help to give greater clarity to taxpayers on the treatment of such losses.  As was admitted in the case, the legislation itself is fairly vague and therefore the decision should be useful. It is possible that HMRC may seek to appeal or look to rewrite the legislation to achieve HMRCʼs preferred interpretation.

It should also be noted that ICTA 1988, s. 343(3) is re-written at CTA 2010, s. 944 but the substance of the rules appears to be unchanged in the process.

Negligence, Private Residence Relief and Penalties

In the recent case of J Day & A Dalgety, two taxpayers had sold three properties that they owned together. The case concerned negligence and penalties for carelessness, as they did not include any details of capital gains relating to the property sales on their returns.  They argued that this was because the gains were below the annual exemption and therefore did not realise that they needed to be included.

One of the taxpayers also claimed that one of the houses sold was their only or main residence and that Private Residence Relief (PRR) should have been available.

HMRC raised discovery assessments and levied penalties for carelessness on both taxpayers, which they appealed.

The First-tier Tribunal agreed that the taxpayers had been careless in not including details on the returns.  The taxpayers made a number of errors in their calculations, including attempting to deduct mortgage fees, claiming they were deductible under TCGA 1992, s 38(1)(c).  However, the tribunal found that such costs were not included in the list of “incidental costs” in s 38(2) and were therefore not allowable.

In terms of the PRR claim, the tribunal found that the first taxpayer had not lived in the property with any degree of permanence or continuity as required by the relevant case law (Goodwin v Curtis [1998] STC 475).  No notice had been given to HMRC or to his employers that he had moved house and no invoices were addressed to him at the property.

The Tribunal dismissed the taxpayers’ appeals, agreeing with HMRC that both taxpayers had been negligent in preparing their tax returns by not including details of the property disposals.

It is important to ensure that proper care is taken with filing self-assessment tax returns and all relevant sources of income or gains are included where required in order to mitigate the risk of penalties.    Eaves and Co would be happy to assist if you or your clients have any concerns.

Sympathy for the Devil

More cases on the scope of HMRC powers.

The first concerns a current successful barrister.  His penalty for failing to react to HMRC information notices was £1.2m+.  Many would say “Ouch!  That hurt!”  However, in this case, the judge in the Upper Tribunal pointed out that some of the information requested went back over 9 years to the death of the taxpayer’s father and his Inheritance Tax affairs.

The judge found it “difficult, if not impossible to understand why a man of the Taxpayer’s means had not appointed a professional advisor to help him deal with all his tax affairs”.  The judge felt the money spent on penalties could have been far better used! (CRC v Ronnie Tager).

With the background to the case and the incredibly lengthy delays in getting information, it is difficult to avoid thinking HMRC were on the side of the angels in this case.

In the case of J Dyson, the taxpayer appealed against a penalty for late filing of a partnership return.  He said he had done all he could to ensure compliance, but it was held that he had no right of appeal whatsoever, because only the ‘representative partner’ had any rights of appeal.

Whilst it seems reasonable that the ‘representative partner’ should generally be the main point of contact for HMRC, to deny altogether the rights of other partners would seem a trifle un-sporting.  The First Tier Tribunal thought so and felt it was in breach of his civil rights that he had no right to a fair hearing.  However, their conclusion was that they had no powers to overrule the legislation.  As the first case notes, individual taxpayers can be unco-operative, and that must be frustrating for Revenue Officers.  However, does that make it appropriate for them to take action against other taxpayers, where the position is perhaps unfair?

The final ‘powers’ case shows that repayments of excess tax paid in earlier years, under self- assessment may be reclaimed in appropriate circumstances.  Andrew Michael Higgs overpaid tax on account.  The courts held the taxpayer was not limited by the 4 year time limit generally applying on claims.

A fair summary of the line of cases would seem to be that:

a)     Circumstances alter cases.  If unfortunately you find yourself amidst disaster, then look carefully at the facts to try to detect an escape hatch.

b)    Investing in timely reporting and good professional advice to keep matters up to date is likely to be money well spent, both financially and emotionally.

 A TAX IN TIME SAVES NINE.

Private Expenditure and The Importance of Keeping Records

A recent tribunal case (D White v HMRC) again highlighted the importance of keeping accurate records for tax purposes, this time in a case involving private expenditure on a company credit card.

The Director used the card for both business and private expenditure, but there were no accurate records to enable them to determine the amount of private expenditure.  HMRC therefore argued that the Director’s loan account was incorrect and raised assessments under the rules on cash equivalent of benefits treated as earnings.

The taxpayer appealed against the assessments but had no evidence to show that the HMRC figures were incorrect.  There was nothing to show that private expenditure had been reimbursed, or that the director’s loan account had been suitable adjusted.

The tribunal had no choice but to dismiss the appeal.  This shows the importance of keeping accurate records as, once HMRC have raised an assessment, it is generally up to the taxpayer to prove that they are not correct.  This can be difficult if the records are not sufficient to do so.

Taxpayers Hunted and Lynched

The Blog this week could be described as dark tales from the Brothers Grimm entitled “What happens to those who ignore HM Revenue and Customs…”

Do not be too scared!  Whilst the Brothers Grimm tales tend to have awful endings – as do the stories of the poor souls in the cases described in the Blog – they are the ones who have ignored the warnings and neglected dealing with HMRC with due and proper respect.  For years many seem to get away with it.  However, the final conclusion seems inevitable to Observers.  Neglect means ignoring that invariably the Mills of God (and HMRC) may grind slowly, but they grind exceedingly fine.  It is prudent to take professional advice before the sack of corn representing your life is thrown down the hopper into the grinding wheel.

Looking at likely outcomes those who take advice from their properly qualified professional advisors generally come out far better.  Prior neglect will cost – often significantly – but making disclosure and then negotiating a fair deal makes personal and economic sense.  Just compare getting matters settled to being sent to jail or having your assets seized under the Proceeds of Crime Act, let alone the miserable anticipation of waiting for it to happen.

3 recently reported cases exemplify the lesson.  Stephen Douce only declared a low household income, where in fact he was earning far more.  The under-declarations resulted in a loss to HMRC of VAT, income tax, NIC and tax credits.  He was sent to jail.

Mr Lynch was discovered to have failed to declare a particular source of income.  The Courts held that the degree of suspicion was sufficient for there to be ‘discovery’ under S29 TMA 1970 and for procedures to be taken under the Proceeds of Crime Act, reflecting gains obtained illicitly over the preceding 20 year period.  Unexplained deposits and credit card payments from unexplained sources amounted to sufficient evidence of undeclared income.  The tax assessments stood.

The Hunt case shows financial irregularities can have other long term consequences.  Again, taking proper advice regarding prompt disclosure may well have helped Mr Hunt, a Financial Advisor, avoid having his new business tainted because he was deemed not to be a ‘fit and proper person’ under FSMA regulations.  He lost in court, even though he argued his original criminal conviction ought to be ‘spent’ because it took place in 1993 so was over 20 years ago.

The advice to clients is take proper advice and then act promptly.  Ignore HM Revenue and Customs at your peril!  The alternative consequences are likely to be costly and last most of a lifetime.

If you need further advice call us; 01704 548698 or 0113 2443502.