Tax

Emoluments from office or employment - Payment - Bonus

Revenue and Customs Commissioners v PA Holdings Ltd: Court of Appeal, Civil Division (Lord Justices Maurice Kay, Moses, Lady Justice Arden): 30 November 2011

The taxpayer was an international group company, resident in the United Kingdom, with subsidiaries and branches in over 20 countries; offering consultancy services. It was an employee-owned service company with employees resident in many parts of the world. Annually, the taxpayer paid a substantial proportion of its profits into employee trusts from which awards were made to employees under discretionary bonus schemes.

In 1999, a new bonus scheme was implemented, pursuant to which bonuses were to be paid as dividends of a UK-resident company and, in consequence, taxed as distributions.

A deed was executed in December 1999 establishing a new employee benefit trust (the 1999 trust) appointing, as trustee, a particular company (M). The stated purpose of the 1999 trust was 'to motivate and encourage employees in the performance of their duties by the provision of bonuses and incentives and other rewards at the discretion of the trustees'. The taxpayer transferred approximately £24m to M for payment into the 1999 trust, recording the payment as 'staff costs' in its accounts. M then established a company (E), which at the time was non-UK resident.

Shares in E were issued to M nominees and, in January 2000, E became UK-resident, with the result that its dividends fell within schedule F, rather than schedule D, to the legislation in force at the material time, namely, the Income and Corporation Taxes Act 1988 (the ICTA) (since repealed).

In February, M transferred almost all of the £24m it had received from the taxpayer into E as a capital contribution, subscribed 24 million 1p preference shares at par and issued them to its nominee, J. M then granted individual awards of beneficial interests in almost all the preference shares to particular employees who had been identified by the taxpayer and J was instructed to hold those shares for those employees. In March, E declared a dividend of 99p on each 1p preference share from the profits represented by the capital contribution.

The dividend was paid to J as the registered owner and thence, after the deduction of 25% income tax, to the selected employees. Essentially the same steps were repeated in the years 2000 and 2001. An issue arose between the taxpayer and the Revenue and Customs Commissioners (the Revenue) as to how the payments were to be treated for tax purposes.

The First-tier Tribunal (the tribunal) held that: (i) the payments were to be treated as emoluments from employment within section 19 of, and schedule E to, ICTA; (ii) the payments also constituted dividends or distributions within section 20 of, and schedule F to, ICTA; (iii) pursuant to section 20(2) of ICTA, the payments were accordingly not chargeable to income tax pursuant to schedule E under regulation 80 of the Income Tax (Pay as You Earn) Regulations 2003, SI 2003/2682; and (iv) the payments were earnings within the terms of sections 3 and 6 of the Social Security Contributions and Benefits Act 1992 (the SSCBA) and thus subject to liability for Class 1 National Insurance contributions.

The Upper Tribunal (Tax and Chancery Chamber) (the upper tribunal) adopted the same approach and reached the same conclusion as the tribunal. Both parties appealed.

The Revenue submitted that the dividends were, in reality, bonuses and therefore had been liable to be taxed under schedule E and that schedule F and section 20(2) of ICTA had not applied. The taxpayer submitted that the income had not been from employment and, consequently, the decision that the payments received in the form of dividends were 'earnings' for the purposes of SSCBA had been incorrect. The court ruled:

(1) The correct approach to determine whether the income receipts of an employee were emoluments or profits from employment was to consider all the facts relevant to the receipt of the income. That required the court not to be restricted to the legal form of the source of the payment but to focus on the character of the receipt in the hands of the recipient (see [36]-[39] of the judgment).

In the instant case, the payment received by the employees had owed everything to the amount which the taxpayer had decided to award as bonuses to its employees. Whilst it was true that the trustees had exercised a discretion in the sense of independently questioning who should be recipients, the quantum of that which the employees had received had been entirely dictated by the amount the taxpayer had decided to award as bonuses.

The receipts had been triggered by the taxpayer's decision to continue its policy of making bonus payments and to fund the 1999 trust and had arrived in the hands of employees, as they were intended to do, as bonuses. Those conclusions were sufficient to dispose of the question of whether the receipts had been 'earnings' paid to an 'earner'. The employees had been earners since they were gainfully employed in the UK under a contract of service with emoluments chargeable to income tax under schedule E. The receipts were, as held by the tribunal, earnings which, by virtue of section 3(1) of ICTA included any remuneration of profit from employment (see [43]-[44], [71]-[72] of the judgment).

The taxpayer's appeal would be dismissed (see [44], [71]-[72] of the judgment).

Fry (Inspector of Taxes) v Salisbury House Estate Ltd [1930] All ER Rep 538 applied; Dale v IRC [1953] 2 All ER 671 applied; Brumby (Inspector of Taxes) v Milner [1975] 3 All ER 1004 applied; Abbott v Philbin (Inspector of Taxes) [1960] 2 All ER 763 considered; White (Inspector of Taxes) v Franklin [1965] 1 All ER 692 considered.

(2) Section 20(2) of ICTA had no application unless 'a distribution chargeable under schedule F' was identified. It had no application to a payment chargeable under schedule E. Section 20(2) resolved the conflict where income from one and the same source, shares or certain securities, was charged under different schedules. That section provided that they had to be taxed under schedule F. It was not concerned to charge income under schedule F when the source of the income was charged under the different and mutually exclusive schedule E (see [64]-[65] of the judgment).

Both tribunals had concluded that the payments were emoluments by having regard to all the circumstances of the case and by looking to the substance and purpose of the payments and not to the mere form in which they were received. Once that conclusion had been reached, there had been no room whatever for any further consideration of a different schedule.

Any other conclusion would have offended the settled, basic, principle that if income fell within one schedule it could not be taxed under another. The tribunals had concluded, on an analysis of the facts, that the payments were from employment and that conclusion could not be impugned. It followed that income could not also be charged under any other schedule. The tribunals had erred in thinking that both schedules could be relevant. That had been incorrect as its factual conclusion that the income fell within schedule E had precluded any finding that the income also fell within schedule F.

That conclusion was dictated by the structure of part 1 of ICTA and the application of fundamental principles of income tax law and not section 20(2) of ICTA (see [59]-[61], [71]-[72] of the judgment). The Revenue's appeal would be allowed (see [66], [71]-[72] of the judgment).

Fry (Inspector of Taxes) v Salisbury House Estate Ltd [1930] All ER Rep 538 applied; Esso Petroleum Co Ltd v Ministry of Defence [1990] 1 All ER 163 applied; Memec plc v IRC [1998] STC 754 applied; MacNiven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] 1 All ER 865 applied; Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes) [2005] 1 All ER 97 applied. Decision of Upper Tribunal (Tax and Chancery Chamber) [2010] STC 2343 reversed in part.

Malcolm Gammie (instructed by HM Revenue & Customs) for the Revenue; Stephen Brandon QC and Rory Mullan (instructed by Speechley Bircham LLP) for the taxpayer.