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A private company which had private and institutional shareholders was facing a solvency crisis. The directors of the company believed it would not be able to raise funds and would therefore have either to sell assets or close down. The directors believed that one of the institutional shareholders manipulated the situation to reduce the value of the company since that institutional shareholder was the most likely purchaser of the assets. The directors threatened legal action against the shareholder concerned.
A private company which had private and institutional shareholders was facing a solvency crisis. The directors of the company believed it would not be able to raise funds and would therefore have either to sell assets or close down. The directors believed that one of the institutional shareholders manipulated the situation to reduce the value of the company since that institutional shareholder was the most likely purchaser of the assets. The directors threatened legal action against the shareholder concerned. On the insolvency of the company, the directors agreed to sell the assets to that shareholder but it would only proceed if the directors dropped the threat of legal action. A company controlled by the shareholder concerned paid each director £20,000 to drop the legal action. This payment was made after deduction of pay-as-you-earn. On redundancy, the directors also received a tax-free compensation payment of £21,000 from the private company.
Should the payment of £20,000 from the institutional shareholder be subject to tax in the hands of the directors, and can the deducted tax be reclaimed?
Readers' views on this would be appreciated.
(Query T15,871) – Scottie.
The issue is whether the £20,000 payments, to drop legal action, can be aggregated with the redundancy on termination of employment to ensure that the first £30,000 is tax free. There is of course no difficulty with the £21,000 received on redundancy. That remains tax free. The issue is whether the payments of £20,000 were, properly, subject to pay-as-you-earn and why the directors received the payments.
It seems clear the payments have arisen by reason of the directors' employment with the private company and therefore the monies are properly subject to income tax. There have been a number of cases, where payments made by third parties, for example, Shilton v Wilmshurst [1991] STC 88, were held to have been obtained because of employment. A similar conclusion was made in O'Leary v McKinley [1991] STC 42 where it was held that bank interest could constitute emoluments provided the appropriate analysis confirmed that the source of the money arose directly from employment.
Wilcock v Eve [1995] STC 18 concerned a payment made by a company other than the employing company for the loss of rights under a share option scheme. That payment was not taxable as emoluments because it was not 'intimately connected' with employment. However, on the facts outlined by 'Scottie' it is difficult to see anything more 'intimately connected' with their employment, for a director of a private company, than the duty of care to protect the value of the company's assets and to ensure that the maximum price is obtained. Accordingly the £20,000 payments are properly subject to tax. – Rookery.
I read 'Scottie's' query the first time with surprise and disbelief: but on second reading I confirmed to myself that I had not misread it.
The right of action lies clearly with the company of which the directors are directors. Therefore any payment by way of settlement must be to the company. The directors must clearly hold the funds as trustees for the company and the question of deduction of tax does not arise.
It would appear that the payer company is seeking to bribe the directors of the plaintiff company to act contrary to the interests of their company. This is a criminal offence. The deduction of tax at source would be clear evidence that they intended it to be a bribe rather than an indirect payment to the plaintiff company. 'Scottie' should advise his clients of the risks they run in not accounting for the money to the company (or its liquidator). As a bribe it is an unenforceable contract and the company may wish to continue the action (with or without the same directors). – JGH.
Extract from reply by 'Elder':
The threatened legal action would surely have had to be initiated in the name of the private company. If so, the two sums of £21,000 should be accountable to it.
The directors have paid themselves £21,000 which they optimistically hope will escape tax but which the Revenue could challenge as an unapproved retirement benefits scheme (see Inland Revenue Statement of Practice SP13/91).
