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02 October 2000
A partnership managed a works canteen for seven years at an agreed fee. Due to economic downturn, the company terminated the agreement unilaterally, and paid a sum of £12,570 equivalent to six months' management charges in lieu of notice.
The original management agreement specified six months notice, which was not honoured by the payment made. The Revenue, following an aspect enquiry, has stated that the compensation payment is taxable. In submitting final accounts, I claimed that the payment was exempt.
The original management agreement specified six months notice, which was not honoured by the payment made. The Revenue, following an aspect enquiry, has stated that the compensation payment is taxable. In submitting final accounts, I claimed that the payment was exempt.
A partnership managed a works canteen for seven years at an agreed fee. Due to economic downturn, the company terminated the agreement unilaterally, and paid a sum of £12,570 equivalent to six months' management charges in lieu of notice.
The original management agreement specified six months notice, which was not honoured by the payment made. The Revenue, following an aspect enquiry, has stated that the compensation payment is taxable. In submitting final accounts, I claimed that the payment was exempt.
There is no likelihood of a resumption of a business relationship, and the partnership was not aware of the possibility of the sequence of events that occurred, or had any expectation of receiving compensation.
Is the Revenue correct, and, if not, is the matter worth taking to the Commissioners?
(Query T15,686) CWE.
The receipt for cancellation of the contract will be taxable. The dispute will be whether, exceptionally, the amount can be treated as a capital disposal. In most circumstances such receipts will be treated as income and subject to income tax on the basic principle that the income source the compensation replaces would have been taxable as income. There have been a large number of cases in this area ranging from Vaughan v Archie Parnell and Alfred Zeitlin Ltd 23 TC 505 where the underlying agreement, and hence the source of the compensation, was held not to be a capital asset, to the more recent leading case of London and Thames Haven Oil Wharves v Attwood 43 TC 491. The observations of Lord Justice Diplock, in that case, confirm that where a trader receives compensation because of a failure to receive a second sum of money, which would have been taxable if so received, then the compensation is equally taxable. Although the payment is expressed to be ex-gratia, this should not result in it being either confused with Schedule E payments exempt under section 148, Taxes Act 1988 or changing its nature.
The difficulty will be to persuade the Revenue to treat the payment as capital. 'CWE' refers to cessation accounts, so presumably the business of the partnership consisted only of the management of the works canteen; the contract being their sole activity. In the case of Van den Berghs Ltd v Clark 19 TC 390 a compensation payment was treated as capital where it related to the whole of the taxpayer's activity. The Inland Revenue's Inspector's Manual at paragraph IM352 expects that most receipts arising from the loss or disposal of trade agreements will be revenue except in exceptional cases where their loss cripples the whole trade. If 'CWE's' client's business has ceased then that may be strong evidence for treating the payment as capital. 'CWE' should resist treatment as income because cancellation of the contract has resulted in the termination of the whole trade. Taking the case to the Commissioners will involve costs, which will not be recoverable, but if the evidence concerning the effect on the trade is strong then the Revenue may be reluctant to pursue the matter that far. As the trader is a partnership, presumably at least two capital gains tax annual exemptions are available so achieving capital status will result in no significant tax liability. — Flipper.
The rules we are looking at here are not those connected with section 148, Taxes Act 1988 and lump sum Schedule E termination payments. We are looking at the Schedule D, Case I rules on compensation receipts. Often the question of a payment being contractual or not will be decisive for Schedule E purposes, but this is not always the case for Schedule D, Case I.
A receipt that is received in lieu of trading receipts or for loss of profits would be taxable. Even if the payment were not contractual, a payment for loss of profits would be a taxable trading receipt.
A receipt as compensation for the loss of the business's profit-making apparatus is a capital receipt and not taxable under Schedule D, Case I. Since 'CWE' refers to final accounts, it is possible that the partnership has come to an end. If this is the case, it is possible that the payment might be a non-taxable capital receipt. In Van den Berghs Ltd v Clark 19 TC 390 a company received compensation when an exclusivity agreement came to an end. The House of Lords decided that the agreement related to the whole structure of the business so that, when it came to an end, the entire structure of the business was affected. The decision was followed in the case of Barr, Crombie & Co Ltd v Commissioners of Inland Revenue 26 TC 406 when a 15-year agreement between shipping managers and their client was cancelled after eight years. The agreement included a clause that said that, if the contract was cancelled early, compensation had to be paid. Although the company did some other work, this contract was not far from being the only substantial work it had. The courts decided that it was compensation for the entire profit-making apparatus.
The factors influencing the court's decisions in both cases were the fact that this was the only agreement or the only substantial agreement in each case.
In another case, Kelsall Parsons & Co v Commissioners of Inland Revenue 21 TC 608, the company received compensation for the cancellation of its most profitable contract. The contract was cancelled after two years into its three-year term. The decision was reached because this was only one of a number of ordinary commercial contracts and did not have a major impact on the business. Kelsall Parsons was followed in Commissioners of Inland Revenue v Fleming & Co (Machinery) Ltd 33 TC 57 where an agency that accounted for 30 per cent to 45 per cent of the company's business was cancelled and compensation was received. The compensation was a trading receipt.
'CWE' needs to review the situation and see where his client's case falls in relation to the factors mentioned in this answer. Contractual or not, the question is whether it is received for trading or a loss of trading income, or whether it is received for a loss of the entire or almost the entire capital structure of the business. — New Road.
The original management agreement specified six months notice, which was not honoured by the payment made. The Revenue, following an aspect enquiry, has stated that the compensation payment is taxable. In submitting final accounts, I claimed that the payment was exempt.
There is no likelihood of a resumption of a business relationship, and the partnership was not aware of the possibility of the sequence of events that occurred, or had any expectation of receiving compensation.
Is the Revenue correct, and, if not, is the matter worth taking to the Commissioners?
(Query T15,686) CWE.
The receipt for cancellation of the contract will be taxable. The dispute will be whether, exceptionally, the amount can be treated as a capital disposal. In most circumstances such receipts will be treated as income and subject to income tax on the basic principle that the income source the compensation replaces would have been taxable as income. There have been a large number of cases in this area ranging from Vaughan v Archie Parnell and Alfred Zeitlin Ltd 23 TC 505 where the underlying agreement, and hence the source of the compensation, was held not to be a capital asset, to the more recent leading case of London and Thames Haven Oil Wharves v Attwood 43 TC 491. The observations of Lord Justice Diplock, in that case, confirm that where a trader receives compensation because of a failure to receive a second sum of money, which would have been taxable if so received, then the compensation is equally taxable. Although the payment is expressed to be ex-gratia, this should not result in it being either confused with Schedule E payments exempt under section 148, Taxes Act 1988 or changing its nature.
The difficulty will be to persuade the Revenue to treat the payment as capital. 'CWE' refers to cessation accounts, so presumably the business of the partnership consisted only of the management of the works canteen; the contract being their sole activity. In the case of Van den Berghs Ltd v Clark 19 TC 390 a compensation payment was treated as capital where it related to the whole of the taxpayer's activity. The Inland Revenue's Inspector's Manual at paragraph IM352 expects that most receipts arising from the loss or disposal of trade agreements will be revenue except in exceptional cases where their loss cripples the whole trade. If 'CWE's' client's business has ceased then that may be strong evidence for treating the payment as capital. 'CWE' should resist treatment as income because cancellation of the contract has resulted in the termination of the whole trade. Taking the case to the Commissioners will involve costs, which will not be recoverable, but if the evidence concerning the effect on the trade is strong then the Revenue may be reluctant to pursue the matter that far. As the trader is a partnership, presumably at least two capital gains tax annual exemptions are available so achieving capital status will result in no significant tax liability. — Flipper.
The rules we are looking at here are not those connected with section 148, Taxes Act 1988 and lump sum Schedule E termination payments. We are looking at the Schedule D, Case I rules on compensation receipts. Often the question of a payment being contractual or not will be decisive for Schedule E purposes, but this is not always the case for Schedule D, Case I.
A receipt that is received in lieu of trading receipts or for loss of profits would be taxable. Even if the payment were not contractual, a payment for loss of profits would be a taxable trading receipt.
A receipt as compensation for the loss of the business's profit-making apparatus is a capital receipt and not taxable under Schedule D, Case I. Since 'CWE' refers to final accounts, it is possible that the partnership has come to an end. If this is the case, it is possible that the payment might be a non-taxable capital receipt. In Van den Berghs Ltd v Clark 19 TC 390 a company received compensation when an exclusivity agreement came to an end. The House of Lords decided that the agreement related to the whole structure of the business so that, when it came to an end, the entire structure of the business was affected. The decision was followed in the case of Barr, Crombie & Co Ltd v Commissioners of Inland Revenue 26 TC 406 when a 15-year agreement between shipping managers and their client was cancelled after eight years. The agreement included a clause that said that, if the contract was cancelled early, compensation had to be paid. Although the company did some other work, this contract was not far from being the only substantial work it had. The courts decided that it was compensation for the entire profit-making apparatus.
The factors influencing the court's decisions in both cases were the fact that this was the only agreement or the only substantial agreement in each case.
In another case, Kelsall Parsons & Co v Commissioners of Inland Revenue 21 TC 608, the company received compensation for the cancellation of its most profitable contract. The contract was cancelled after two years into its three-year term. The decision was reached because this was only one of a number of ordinary commercial contracts and did not have a major impact on the business. Kelsall Parsons was followed in Commissioners of Inland Revenue v Fleming & Co (Machinery) Ltd 33 TC 57 where an agency that accounted for 30 per cent to 45 per cent of the company's business was cancelled and compensation was received. The compensation was a trading receipt.
'CWE' needs to review the situation and see where his client's case falls in relation to the factors mentioned in this answer. Contractual or not, the question is whether it is received for trading or a loss of trading income, or whether it is received for a loss of the entire or almost the entire capital structure of the business. — New Road.
