Ex gratia payment

My client who runs an antiquarian book business has received an ex gratia payment of £10,000 from one of his regular customers for introducing him to another customer, resulting in the securing of a lucrative fast food franchise business.
Whilst the ex gratia payment would not have arisen but for the client's knowledge of his customer's requirements, it seems that to treat the monies as trading income would be harsh.
What do readers make of this position?
(Query T15,715) – Perplexed.

It would indeed be harsh to treat this as trading income. For a sum to fall within Schedule D it must be a profit 'arising from' the trade (section 18(1), Taxes Act 1988). Simply because the amount was only received because a trade was carried on does not necessarily mean that it 'arises from' the trade. The Revenue accepts this; see for example the Inspector's Manual at paragraph IM361. On the facts given, while the £10,000 would not have been received had the bookseller not been carrying on his trade, it does not arise from that trade. It is thus not trading income and not within Schedule D, Case I.
The next question is whether it falls to be taxed under Schedule D, Case VI, which catches 'any annual profits or gains not falling under any other Case of Schedule D and not charged by virtue of Schedule A or E' (section 18(3), Taxes Act 1988). The most useful case on this point is Scott v Ricketts 44 TC 303, where Lord Denning said that, to be within Case VI, there 'must be a contract for services or facilities provided'. In the case of the antiquarian bookseller, there is no contract giving him an entitlement to the £10,000; he could not have sued for the amount had it not been paid. Following Lord Denning, the bookseller will thus not be within Case VI in respect of the receipt.
Further comfort may be taken from the following example in the Revenue's Inspector's Manual at paragraph IM113d:

'Assume, for example, that a greengrocer witnesses a car breakdown outside his business premises. He takes the passengers to their destination, repairs the breakdown and delivers the car to its owner. Later he receives an unsought payment from the motorist in appreciation of his help. The amount is not from the greengrocery trade. It is not liable under Case I as part of the receipts of that trade. The payment, because it is unsolicited, is unlikely to be from any source and is almost certainly outside income taxation altogether.'

Despite the careful wording of the last phrase, such an ex gratia payment would not only be outside income taxation, but also (for the avoidance of doubt) outside the scope of capital gains tax as well, as the bookseller has not disposed of an asset. In short, it is not taxable. – Maeve.

The mention of the round sum of £10,000 suggests that the client has not asked for VAT on top. I think he should.
That the payment was ex gratia seems to me irrelevant. Or rather, it is an argument which I would only wish to deploy if I had to rescue the client from an assessment after the event. Since people in business do not generally make substantial payments without any obligation to do so, Customs would be bound to start from the supposition that there was an informal understanding.
A service of introduction was supplied. At the time, the client may have had no expectation of any reward. However, is the situation not similar to that of any professional, who does work on spec? At the time, there is no expectation of being able to charge for it. Later, the project comes to fruition and the client asks what he owes. It is accepted that situations in which there is no arrangement agreed for a contingency fee are unusual. However, if one could escape charging VAT in such circumstances, there would be avoidance possibilities.
There has been some work done or, in this case, an introduction made. A payment is then received. There is clearly a problem in proving that that is not consideration for the supply, no matter how little obligation there was on the payer to make it, let alone any right of the payee to decide the amount.
If that is correct, the fact that the transaction's only connection with the book business was that that was how the parties knew each other is also irrelevant for VAT purposes, assuming that the client is a sole trader. To separate the income for VAT purposes, the book business would need to be a partnership or a limited company and the ex gratia sum be received by the client in his own right.
When I answered a similar query concerning the sale of computer software developed by a teacher in his spare time (Taxation, 30 September 1999), tax counsel subsequently wrote to the editor stating that, on the basis of the income and capital gains tax rules, there was no VAT liability! Well, if I was wrong then and am now, it is under VAT law, not that of the Inland Revenue! – A St J Price FCA.

It is probably safe to assume, from the information provided, that the client runs only an antiquarian book business, and that he does not also run any business which – or part of which – consists in the introduction of persons in the business world with a view to earning commission when negotiations are satisfactorily completed. If this is the case, then it seems clear that the £10,000 cannot be trading income, because there is no trade from which it could have arisen: only a very brave Inspector of Taxes would contend that this payment was an incident of the trade of an antiquarian bookseller.
But does the income represent 'annual profits or gains not falling under any other Case of Schedule D', and is it thus chargeable under Case VI of that Schedule? I think that 'Perplexed' should study the judgment of Mr Justice Vaisey in Bloom v Kinder 38 TC 77.
This case concerned a solicitor who, on a social occasion and purely as a matter of friendship, provided information to a person who acted on it and, as a result, completed a profitable transaction, and who subsequently sent the solicitor an amount 'representing an introduction fee of 1.5 per cent on the total purchase price …'. Even the fact that the solicitor used the facilities of his office (for the purpose of conducting correspondence following the initial introduction) did not prevent the judge from reversing the finding of the General Commissioners (that the payment was taxable under Case VI) on the ground that that finding was contrary to the solicitor's evidence – which they had accepted – to the effect that the amount received was an unsolicited gift.
To my mind, the introduction of business relationships is far more an incident of a solicitor's profession than of a bookseller's trade, and I think that, if the point is carefully argued, this £10,000 should not be taxable.
The really difficult question, however, is whether to disclose the receipt and get involved in a probably inevitable argument, or to ignore it as having no relevance to the bookseller's self-assessment tax return, and to hope that the question will not arise in some other way (e.g. if it generates a noticeable increase in investment income, or if the payer discloses it as a commission and provides the Revenue with the recipient's name and address in the course of a self-assessment enquiry). My own inclination would probably be to disclose and argue, but others may quite justifiably advocate the other road. – SHAP.

Extracts from further replies received:

The client has a possible exposure to inheritance tax if the donor dies within seven years in indigent circumstances, having regard to sections 3A(4) and 199(1)(b), Inheritance Tax Act 1984. – Elder.

Is the ex gratia receipt in any way recompense for book sales – or any other service – provided they have not otherwise been adequately remunerated to make good a loss of profit? If so, it is a taxable receipt (Rolfe v Nagel [1982] STC 53).
Similarly, if the receipt in some way augments the consideration for goods or services – past, present or future – this is again taxable (Severne v Dadswell 35 TC 649 and Commissioners of Inland Revenue v Falkirk Ice Rink [1975] STC 434.
Is the character of the payment received by the client such that it is made in order that it may be used in the book business whether to supplement trading, enable trading to continue – or maintain solvency? If so, the payment is again taxable (Smart v Lincolnshire Sugar Co Ltd 20 TC 643 and British Commonwealth International Newsfilm Agency Ltd v Mahony 40 TC 550). The customer's purpose in making the payment will be the evidence of that character.
In a Revenue enquiry into an ex gratia payment, I was pleased that the Inspector was quite satisfied that it did not constitute a taxable receipt. The acid test (in the Inspector's words) was that the payer did not seek a deduction within his accounts! – Jim.

Editorial note. Only one of twelve respondents considered that the £10,000 should be taxed as income and one other felt that it was a capital gain. Disclosure (and perhaps costly negotiation) was advised by most readers. Among the many cases quoted by readers, Dickinson v Abel 45 TC 353 is another that supports the proposition that the receipt is not taxable income. The VAT point, although inconclusive, is important, as is the inheritance tax aspect.