Termination Payments

Termination Payments

Black Is Not White — For Now

DAVID HEATON considers the conflict between the recent High Court decision in Wilson v Clayton and Tax Bulletin 63.

WHAT IS IT about a tax exemption given in legislation that prompts the Inland Revenue to try to stop people benefiting from it? A silly question, of course: Inspectors are tasked with ensuring that each taxpayer pays no more and no less than his dues, so they must look critically at every claim to an exemption. The real puzzle is why they challenge some claims that so obviously meet the qualifying conditions. Equally difficult is why 'clarification' in the Tax Bulletin so often begins to look like changing the law by fiat.

If a client were to ask whether an award of compensation for unfair dismissal would benefit from the £30,000 exemption in ITEPA 2003, s 403 (formerly ICTA 1988, s 148), few advisers would hesitate or hedge. Except for a redundancy payment, there is perhaps no other type of payment that is so obviously a payment of compensation derived from the termination of an employment. So why did the status of a compensation payment made by Birmingham City Council to an employee, a Mr Clayton, in 2000 ever reach the Commissioners and the High Court?

Wilson v Clayton [2004] STC 1022

Birmingham City Council decided in 1997 to reduce its employment costs by withdrawing the essential car user allowance (ECUA) from employees who did not cover at least 3,000 business miles each year. It asked for agreement to the change, but when Mr Clayton and colleagues refused, their contracts were terminated and they were immediately re-employed with an identical contract, except for the withdrawn ECUA. Mr Clayton and many others claimed unfair dismissal under the Employment Rights Act 1996, s 111, which eventually resulted in a successful employment tribunal hearing in 2000.

The Employment Rights Act 1996 (ERA 1996) offers three remedies for unfair dismissal.

The first is a reinstatement order under ERA 1996, s 114, which was made. This was entirely logical, since Mr Clayton and his colleagues had in fact continued to work in the same jobs; they just did not think they should have the ECUA withdrawn. The council reinstated the contract with the ECUA, made backdated payments, and taxed the payments made.

The second is a re-engagement order under ERA 1996, s 115, which involves giving the employee comparable employment, irrelevant to Mr Clayton.

The third is a statutory compensation payment under ERA 1996, s 119, which in the event was also made. Normally, this 'basic award' is calculated in the same way as a statutory redundancy payment and is payable even though the employee has not lost money through being dismissed.

The tribunal set a second date for a remedy hearing to quantify the 'basic award', but the parties negotiated a compromise agreement before that could take place, which was then confirmed by a consent order. Mr Clayton received a basic award of £5,060. This was not taxed by the employer, because it was compensation for the unfair dismissal and below £30,000, but the Revenue amended Mr Clayton's self assessment for 2000-01 on the grounds that the payment was, in fact, an emolument from the employment, taxable under ICTA 1988, s 19. It could therefore not be taxable under s 148.

Initially, this seems bizarre, but the challenge was not unreasonable. There had been a termination of employment and it was held by a tribunal to have been unfair, but there were two reasons for the Revenue's decision to attempt to deny the s 148 treatment.

It was not compensation. So, in the Revenue's view, it had to be an emolument within ICTA 1988, s 19: it had been paid by the employer to the employee other than on a termination. The source of the payment was the employment and nothing else. ICTA 1988, s 148 was therefore of no relevance.

And if it was not a simple emolument, it was argued that it was deemed to be an emolument, as it was a benefit within ICTA 1988, s 154. A cash payment can be a benefit (see Wicks v Firth [1983] STC 25) and the cash here was paid by the employer to a 'P11D employee'.

However, the General Commissioners and then Mr Justice Patten in the High Court found for the taxpayer.

The High Court decision

In the High Court, the Revenue accepted that compensation for unfair dismissal awarded by a tribunal will 'ordinarily' fall within s 148. This is comforting, as the author has recent experience of the Revenue pursuing tax — and, astonishingly, winning before the Commissioners — on what was presumably an extraordinary case of a compensation payment awarded by a tribunal after a genuine dismissal, but that is a story for another time. In this case, the tribunal had had no jurisdiction to make the award. So, as a matter of analysis, it was claimed, the award had not been made.

Had no reinstatement order been made, the tribunal would have had a duty to make a basic award and, perhaps, a compensatory award. Mr Justice Patten accepted that the tribunal had erred in ordering both remedies, so the payment was clearly not compensation under ERA 1996, s 119. But what was it, he asked?

The Inland Revenue's second argument was dealt with first. Mr Clayton had been re-employed immediately after his unfair dismissal, so in practical terms the reinstatement order made under s 114 meant only that he had to be paid the arrears of ECUA for the period since dismissal. He was compensated for the unpaid ECUA, but the order did not create a period of service between that dismissal and reinstatement. The original contract was terminated in 1997 and replaced as noted above. A new contract on comparable terms was brought into being for the future in 2000.

From this analysis, it followed that the Revenue's first argument also failed. The tribunal had no power to make a basic award, and it was not made as a consequence of Mr Clayton's entering into a new contract in 1997, so it must have been purely voluntary.

Genuinely ex gratia?

Is this a rare example of a genuinely ex gratia payment? Not really — employer and employee negotiated a compensation payment in the context of a finding of unfair dismissal and a court's ordering a remedy hearing at a later date. The payment was contractual, but the relevant contract blessed by the tribunal was, crucially, a compromise agreement about compensation, not a contract of employment.

Liability cannot arise under s 148 if the payment is already taxable. As Mr Justice Patten pointed out, the determinant of liability under Schedule E is whether the payment is an emolument 'from' the employment.

The Revenue argued that the £5,060 was a profit derived from, directly connected with, and referable to, the taxpayer's past and continuing employment, equivalent to a gratuity paid by the employer — a non-contractual emolument, paid voluntarily.

Mr Justice Patten found that the voluntary payment made by Birmingham City Council was not an emolument from the employment: there was no causal link between the payment made and the employee's past or future services. Support was to be found for this in Hochstrasser v Mayes 36 TC 673 and Shilton v Wilmshurst [1991] STC 88. He summarised (at 1033a) the principle as follows.

There was no evidence that the agreed payment was a reward for services or an inducement to future performance. Mr Clayton had already been re-employed and compensated (in taxable form) for his lost ECUA. The fact that the tribunal exceeded its jurisdiction did not change the character of the payment 'as a matter of agreement between the city council and the taxpayer in his capacity as a former employee. This was his only capacity relevant to the issue before the tribunal which led to the order'. The payment was a direct (albeit mistaken) consequence of the earlier dismissal.

The Revenue tried the alternative tack of Hamblett v Godfrey [1987] STC 60 as authority for a compensation payment being a taxable emolument. This was dismissed as irrelevant. There was no broader test than that set by s 19. Miss Hamblett's employment continued, with no dismissal, and as Lord Justice Neill observed in that case, the payment of compensation for loss of union membership 'was made in return for her being and continuing to be an employee' (at 727 — author's emphasis). Furthermore, Lord Justice Hutton in Mairs v Haughey [1992] STC 495 had explicitly supported this view in deciding that a payment in lieu of a redundancy payment 'was not made to the taxpayer to induce him to stay on in employment' (at 521). It was not an emolument from the employment.

The third line of reasoning, using s 154, was also dismissed. The parties negotiated a payment for the surrender of rights in advance of a remedy hearing (the fact that the rights were mistakenly thought to be valuable did not change that analysis), which was a fair bargain for both sides. As Lord Justice Hutton had noted in Mairs, an arm's length bargain was not the payment of a benefit in kind.

Is it important?

So how significant is this decision? In many of the disputes over pay in lieu of notice (PILON) that have arisen since EMI Group Electronics Ltd v Coldicott [1999] STC 803 was decided, the Revenue has stubbornly rejected most arguments that a non-contractual PILON that does not bear the hallmarks of damages (e.g. mitigation and a Gourley adjustment) is within s 148, even where there is clearly no contractual right or discretion to pay it. It regularly cites Hamblett v Godfrey in support: without the employment, the payment would not have been made, so it must be an emolument, outside s 148. In Tax Bulletin 63 it stated:

In Tax Bulletin 63, the Inland Revenue also cited Laidler v Perry 42 TC 351 and Corbett v Duff 23 TC 763 in support of its view that non-contractual payments can be emoluments. As has been pointed out to a number of Revenue Inspectors since the publication of Tax Bulletin 63, these cases also dealt with situations in continuing employments, which was fatal to Miss Hamblett's case and relevant to Mr Clayton's.

Taking together the comments of Lord Justices Neill and Hutton and now Mr Justice Patten in the context of PILON payments triggered by actual terminations (we are not even concerned here with re-employed workers such as Mr Clayton), it is extremely difficult to see how Tax Bulletin 63 can be right on this point, and why a number of employers have been pursued for PAYE income tax and Class 1 NICs on PILONs below the £30,000 threshold.

Contrary to the view in Tax Bulletin 63, the courts have once again ruled that a payment triggered by a termination, rather than a contract of employment, is within s 148 (now ITEPA 2003, s 401). Black is still not white, whatever Tax Bulletin 63 may say.

If the Inland Revenue still believes the statement in Tax Bulletin 63, we can surely expect to see Mr Clayton in the Court of Appeal.

David Heaton FCA, CTA is a partner in Baker Tilly, Leeds office.

The views expressed in this article are the author's own and do not necessarily reflect those of Baker Tilly.

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