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A breakdown in relationships - JOHN T NEWTH, FCA, FTII, FIIT, ATT summarises three recent cases heard by the Special Commissioners.

16 October 2008
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The appellant had had a long-standing dispute with his former employer, and matters had involved appeals to the Industrial Tribunal and Employment Appeal Tribunal. The appellant's allegations had included racial discrimination and victimisation and he had been awarded £5,000 in 1994.

The appellant had had a long-standing dispute with his former employer, and matters had involved appeals to the Industrial Tribunal and Employment Appeal Tribunal. The appellant's allegations had included racial discrimination and victimisation and he had been awarded £5,000 in 1994. In 1997 the appellant was investigated under the employer's disciplinary procedure for alleged remarks made against other management colleagues, and this allegation and the appellant's own appeal regarding race discrimination in respect of selection procedures was the subject of negotiations between the appellant and his employer in the presence of the Advisory, Conciliation and Arbitration Service. As a result of these negotiations, a further payment of £30,000 was made to the appellant.

Shortly after the agreement of the third appeal, the appellant and employer entered into an agreement to the effect that the employer would pay £20,000 in consideration of the withdrawal of the second appeal (which involved race discrimination and victimisation), that the appellant would leave the company on voluntary redundancy grounds, and that an additional payment of £65,684.20 would be made in order to bring the total lump sum payment on severance up to £180,000.

In the event the appellant left his employment in November 1997 and the figures mentioned were the subject of an agreement between him and his employer.

The breakdown in relationships did not end there because the appellant wrote to his employer disputing some of the figures and stating that, in his view, the additional lump sum compensation should be tax free. He also wrote to the Inland Revenue stating that the amount of £65,684 was in return for the cessation of the dispute procedure before the Industrial Tribunal and for refraining from further applications to the tribunal, the maintenance of confidentiality about the settlement and other matters. He contended that as the payment was not made because of his employment it should be tax free, and, as the employer had erroneously deducted tax he claimed a refund of the tax which amounted to £15,782.40. In June 1998 the appellant applied for a post-transaction ruling.

Subsequently, the appellant submitted his 1998 self-assessment tax return showing his taxable lump sum as nil. This return was submitted on 29 September 1998.

In the meantime the Inland Revenue had written to the pensions department of the former employer asking for further information and on 20 November 1998 wrote to the appellant stating the following:

'I can now inform you that any part of the termination payment which related to compensation for racial discrimination in respect of your non-promotion will not be taxable under section 19, Taxes Act 1988 or section 148, Taxes Act 1988. It will therefore not be taxable at all and any tax deducted by your former employer for this will be repayable.'

Nevertheless, the Inland Revenue was having difficulty in reconciling the figures provided by the pensions department and continued its enquiries. On 31 January 1999 the Inland Revenue sent the appellant a self-assessment statement of account showing a credit balance of £14,570.45. However, four days later the department wrote to the appellant to say that the return submitted had not been processed and that no repayment would be made until the matter of the termination payment had been finally resolved.

In February 1999 the employer replied to the Revenue to the effect that there were two settlements. The first was for a settlement of £30,000 to settle the third appeal to the Industrial Tribunal, together with the subsequent internal grievances and disciplinary investigation. The payment of £30,000 was conditional on signing a separate agreement relating to the second appeal. This second settlement was for £20,000 for the withdrawal of the second appeal and a severance payment of £180,000 as detailed in the severance agreement.

Correspondence with the Inland Revenue then continued with the effect that in October 1999 the Inland Revenue wrote to the appellant with an amendment of his self assessment for 1998. This showed that the income from employment included the sum of £65,684 and that the total tax and National Insurance contributions due amounted to £13,183.95. On the same day the appellant appealed against that amendment of self assessment.

The Inland Revenue was of the view that the sum concerned was paid to the appellant in consideration or in consequence of or in connection with the termination of his employment or alternatively was paid in respect to restrictive undertakings given in connection with the appellant's employment. The statutory legislation in point were sections 148, 188 and 313, Taxes Act 1988.

The Special Commissioner, Dr Nuala Brice had to consider three main issues in connection with the determination of the appeal. The first of these was, was the additional lump sum payment of £65,684 taxable under section 148, Taxes Act 1988. The appellant, who represented himself, had cited Chappell and Co Limited and others v the Nestle Company Limited and others [1959] 2 All ER 701 as authority for the view that a contracting party can stipulate for what consideration he chose. He had also cited Du Cros v Ryall 19 TC 444 as authority for the view that an agreement between the parties could not be disturbed. The appellant had also argued that a payment could be apportioned and he cited Wales v Tilley 25 TC 136, Henley v Murray 31 TC 351 and Mairs v Haughey 66 TC 273.

The Special Commissioner considered these cases, as well as the Revenue's contentions that the additional lump sum compensation was taxable under section 148(2), Taxes Act 1988 as a payment made in consideration of or in consequence of or in connection with the termination of the appellant's employment.

Dr Brice derived three main principles from the various cases mentioned. The first was that it is necessary to construe the documents and other evidence so as to determine the substance and reality of what the payment was paid for. The second is that the parties to an agreement can decide what the payment is for. And the third was that if a single sum is paid for two separate and identifiable considerations, then the single sum should be apportioned and each part should be considered separately to see if it is chargeable to tax.

In her view, paragraph three of the agreement between the former employer and the appellant made it clear that in substance and reality the £180,000 (which includes the sum at issue in the appeal) was paid for the voluntary termination of employment. As such it is taxable under section 148, Taxes Act 1988.

Because of this determination the Special Commissioner did not have to consider the second issue, but she briefly expressed her views on the impact of section 313, Taxes Act 1988. Her views on this were that, if the additional lump sum or part of it was paid for the confidentiality agreement and the agreement not to issue any further proceedings, then it might well be that chargeable values were attributed by the parties to such agreements. However, these would prevent the application of Inland Revenue Statement of Practice SP3/96, leaving the amount to be taxable under section 313.

Finally, Dr Brice had to consider whether there was an agreement between the appellant and the Inland Revenue that the additional lump sum should not be taxable and, if so, whether that decision could be reversed. The appellant had argued that on 7 June 1998 he had requested a post-transaction ruling and that had been given on 31 January 1999 when the Inland Revenue had sent the statement of account showing a credit balance of £14,570.45. He further considered that the letter from the Inland Revenue of 20 November 1998 was an agreement that the additional lump sum would not be taxed.

However, Dr Brice found that the letter of 20 November 1998 did not constitute an agreement that the amount at issue in the appeal should not be taxable. She could understand why the appellant found the events surrounding the self-assessment statement of account issued on 31 January 1999 to be confusing. However, the letter of 4 February 1999 did make it clear that the matter of the termination payment had not been resolved.

The appeal was therefore dismissed.

(Appellant v HM Inspector of Taxes (SpC 268).)

Editorial Comment:

Quite apart from the technical arguments concerning the payment of £65,684 and the Commissioner's decision in this respect, this case provides an interesting example of the workings of self assessment. One unanswered question is whether the Inland Revenue letter of 4 February 1999 instituted the beginning of an Inland Revenue enquiry. Obviously, the Revenue had until 31 January 2000 to enquire into the appellant's 1998 tax return, but it is not clear as to the status of the particular letter.

Lay taxpayers have every right to be confused when a statement of account is issued to them showing a substantial tax repayment due, and then a subsequent letter states that this is not in fact correct. Tax professionals, who are well aware of the system, know that tax returns submitted are automatically processed according to the taxpayer's self assessment and that any amendment or aspect or other enquiry made is a quite different process that can occur later. However, this case illustrates that, at the very least, the procedure is extremely confusing to a lay taxpayer.

The results of a takeover

The appellant was factory manager of a company that was part of the Glaxo Group in Northumberland. That particular factory was the subject of a takeover bid from another company, and the new owners wished the appellant to be part of their operations. He had also played a significant role in the negotiations of the sale of the plant.

However, the appellant held share options in the Glaxo Group scheme both under the executive share option scheme and savings related share option scheme. These benefits would not be supplied by the new company and accordingly the appellant entered into negotiations for a compensation package. The appellant quantified his loss as £24,103 and this was paid by Synpac Chemicals Limited, a subsidiary of China Synthetic Rubber Corporation, the holding company of Synpac.

The amount of £24,103 less tax deducted under pay-as-you-earn was paid to the taxpayer by Synpac. In fact he left that company in January 1993 on amicable terms and took up employment again with one of the Glaxo companies.

The amount of £24,103 was therefore included in the amount of income assessed on the appellant from his employment for the year 1991-92 and it is this amount which was the subject of the appeal. It was contended, on behalf of the taxpayer, that the payment of £24,103 was compensation for an estimated loss. A number of cases were quoted both by the taxpayer's representative and the Inland Revenue in their various arguments but Mr J Gordon Reid QC, the tribunal chairman, had to determine whether or not the payment of £24,103 was a payment as an inducement for the appellant to enter into a new employment or a benefit in kind or whether it was compensation for loss of benefit of share option schemes.

On the facts, the Special Commissioner held that the payment of £24,103 was part and parcel of the arrangements which induced the taxpayer to enter into the service agreement with Synpac, the company which took over the plant. Accordingly, the payment was an emolument from his employment with Synpac within the meaning of section 19(1), Taxes Act 1988. It was therefore unnecessary for the Commissioner to consider the impact of a possible benefit in kind within section 154, Taxes Act 1988, and he declined to do so.

The taxpayer's appeal was therefore dismissed.

(J M Teward (SpC 270).)

No professional privilege

A solicitor took his case to the Special Commissioner following the issue of a notice under section 19A, Taxes Management Act 1970. Previously, a notice under section 9A had been issued in respect of the year 1996-97.

The appellant had previously supplied to the Inspector details regarding his business office account, including invoices, expense vouchers, cash books, passbooks, etc.

However, the Inspector considered that there were some unresolved discrepancies in the office account transactions and under the terms of the notice demanded the production of the clients' account cash book, clients' ledger and prime records relating to the clients' accounts transactions. It was this request that was the subject of the appeal, which was heard by Dr Nuala Brice.

The appellant argued that the requested documents were not reasonably required by the Revenue. Additionally, the duty of confidentiality which he owed to his clients prevented disclosure of the requested document and, alternatively, the documents were the subject of legal professional privilege. He also relied upon the Human Rights Act 1998 and Data Protection Act 1998.

As regards whether the documents and information were reasonably required, the appellant's letter of 19 February 2001 referred to two examples of discrepancies where he was able to satisfy the Inland Revenue. However, the Special Commissioner considered that the Inland Revenue is entitled to be satisfied that all entries relating to the business are reconciled and that all relevant income has been returned and to seek explanations for unexplained payments into and out of the business. The method of accounting adopted by the appellant meant that there were numerous entries in the office accounts which were not reconciled. The information already supplied to the Revenue was not sufficient to enable the department to reconcile these entries and to be satisfied that all relevant income had been returned. The clients' ledger and clients' cash book, with supporting documents, would enable the various accounts to be reconciled. Accordingly, Dr Brice concluded that the clients' account information was reasonably required for the purpose of determining whether the appellant's return was correct or incomplete.

In connection with confidentiality, counsel for the Revenue cited the case of Parry-Jones v The Law Society [1969] 1 Ch 1. In that case the Court of Appeal had held that the contractual duty of confidence was overridden by the duty to obey general law and that the rules overrode any privilege or confidence which might otherwise subsist between the solicitor and client. Accordingly, the Special Commissioner held that the provisions of section 19A, Taxes Management Act 1970 overrode the contractual duty of confidence owed by a solicitor to his clients.

Recent High Court tax cases have 'driven a coach and horses' through the tradition of legal professional privilege for tax purposes and the Revenue was not slow to quote from R v Commissioners of Inland Revenue ex parte Taylor (No 2) [1990] STC 379, R v Commissioners of Inland Revenue ex parte Lorimer [2000] STC 751 and R (on the application of Morgan Grenfell and Co Limited) v Special Commissioner of Income Tax [2000] STC 965.

Dr Brice concluded that in the current appeal the appellant was being required to produce documents in his capacity as taxpayer. The rule of legal professional privilege was excluded because it was not expressly preserved by section 19A. It therefore followed that, if the requested documents were covered by legal professional privilege, they would still have to be disclosed by the appellant.

As regards human rights, the issue was whether disclosure of the requested documents would contravene Article 8 of the Convention in Schedule 1 to the Human Rights Act 1998. A number of cases were quoted by counsel for the Revenue, including R v Commissioners of Inland Revenue, ex parte Banque Internationale a Luxembourg [2000] STC 708.

In the light of the various cases the Special Commissioner concluded that, so far as the service of the notice in the appeal did interfere with rights protected by Article 8(1), there was ample justification as required by Article 8(2). The notices under section 19A were issued according to law, in pursuit of a legitimate aim, and were necessary in a democratic society for protecting the taxation system and the revenue.

Finally, in relation to the Data Protection Act, section 35(1) provides that personal data are exempt from a non-disclosure provision when a disclosure is required by or under any enactment, by any rule of law or by order of the court. In this appeal the disclosure of the requested documents is required by and under section 19A, Taxes Management Act 1970.

The appeal was therefore dismissed, and in the view of the writer this represents a further serious blow to the independence, administration and confidentiality of the legal profession.

(George Henry Guyer (SpC 274).)

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