[2010] UKFTT 34 (TC)

TC00348                      
    Appeal number:  TC/2009/12133

Income Tax:  redundancy payment – prior payment as compensation to a change in contractual redundancy package – availability of exemption – Income Tax (Earnings and Pensions) Act 2003, s403(1) and (4) -Appeal allowed.

FIRST-TIER TRIBUNAL

TAX 

	KENNETH G COLQUHOUN	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (INCOME TAX)	Respondents

TRIBUNAL: 		JOHN M BARTON, WS (Judge)
ROBERT CRAWFORD, BA, CA, CTA (Member)

Sitting in public in Edinburgh on Thursday 22 October 2009

Kenneth G Colquhoun, the Appellant

Ros Shields, HM Inspector of Taxes, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.  This is an appeal by Kenneth G Colquhoun against an amendment to his self assessment for the year to 5 April 2006 whereby the total of the termination payment of £91,594 received by Mr Colquhoun is liable to Income Tax as employment income.

2.  The appeal was heard in Riverside House, Edinburgh on 22 October 2009.   Mr Colquhoun appeared on his own behalf and he was accompanied by Ian M Crawford.    HMRC was represented by Ms Ros Shields, HM Inspector of Taxes.   Both Mr Colquhoun and Mr Ian M Crawford gave evidence.

3.  The following productions were before the Tribunal –

A   Letter dated 28 June 1996 from D S Batty, Managing Director of Rosyth Royal Dockyard plc to Mr Colquhoun.

B   Letter dated 18 July 1996 from A K Smith, Chairman of Rosyth Royal Dockyard plc to Mr Colquhoun.

C   Two pay advice notes for month ending 31 January 1997

D   Contract of Employment dated 25 November and 5 December 2003.

E   Letter dated 25 May 2005 from Mr Ian M Crawford, therein designed as Human resources manager, Babcock Engineering Services to Mr Colquhoun terminating his employment as at 31 August 2005.

F   Redundancy Entitlement Statement.

G   Letters dated 8 October 2006 and 8 July 2007 from Mr Colquhoun amending his 2005-06 Income Tax Return.

H  Letter dated 31 January 2008 from HMRC to Mr Colquhoun amending his self assessment for the year to 5 April 2006.

I   Form of Appeal dated 20 February 2008.

also correspondence between Mr Colquhoun and HMRC over the relevant period.

Material Facts

4.  The material facts were not in dispute and are as follows –

1.   Mr Colquhoun was continuously employed by the Babcock group of companies – latterly known as Babcock International Group plc (“Babcock”) from September 1973 until he was made redundant on 31 August 2005

2.	In 1990, Mr Colquhoun commenced working at Rosyth Dockyard and continued working at Rosyth until 2005.

3.	Until 1996, there was a contractual redundancy scheme for employees of Babcock, including Mr Colquhoun whereby in the event of redundancy, those employees could have expected a package which would have been significantly higher than the statutory provision.   That redundancy package was funded by the Ministry of Defence.

4.	In 1996, Mr Colquhoun’s employer within the Babcock group of companies was Rosyth Royal Dockyard plc.   In that year, the Ministry of Defence agreed to sell the dockyard at Rosyth to Babcock.   However, the Ministry of Defence would not continue to fund the current redundancy package; and after many months of negotiation with trade union representatives and discussions with senior managers, it was agreed that in the event of the sale proceeding, each employee would receive from Rosyth Royal Dockyard plc a “buy-out payment”.   In return for that payment, the existing redundancy scheme would be phased out, and that in the event of redundancy after the transitional period, an employee would receive their statutory entitlement with a relatively small enhancement.    The basis of the whole agreement was set out in letters from Rosyth Dockyard plc to Mr Colquhoun dated 28 June and 18 July 1996.

5.	The amount of the buy-out payment to which Mr Colquhoun became entitled was £33, 148.71; and on 21 July 1966, Mr Colquhoun signed a form of acknowledgement in the following terms –

“The buy-out payment above is in respect of a change to contractual redundancy entitlements only.    All other terms and conditions of employment remain unchanged.

I accept the above buy-out payment as compensation in full for my agreement to a change in my contractual redundancy entitlements as outlined in Mr A K Smith's letter of 18. July 1996……..”.

6.	Mr Colquhoun continued to be employed by Rosyth Royal Dockyard plc and for the month ending 31 January 1997, Mr Colquhoun received an additional pay advice note containing the following

                           Buy out (NT)    £30,000
                           Buy out (Tax)    £3,148.71

The supplementary pay advice note showed the sum of £3,148.71 being aggregated with Mr Colquhoun’s salary for the computation of the tax deducted in that month.   No tax was deducted in respect of the said sum of £30,000.

7.   Mr Colquhoun’s terms and conditions of employment were confirmed in a contract of employment dated 25 November and 5 December 2003.    In that agreement, Mr Colquhoun’s position was stated to be Director of Engineering with Babcock Design and Technology, a company within the Babcock Engineering Services Division of Babcocks.   “Continuous employment” was recorded as having been from 2 April 1990, the date when Mr Colquhoun commenced employment at Rosyth; and his redundancy entitlement was stated to be in accordance with the provisions contained in the said letter of 28 June 1996.   The contract further provided that Mr Colquhoun was entitled to expect six months notice of termination of his employment.

8.   Mr Colquhoun’s employment was terminated by reason of redundancy with effect from 31 August 2005.  This was within the extended transitional period as agreed in 1996.    In the covering letter from Babcock Engineering Services, it was recorded that –

You have completed 15 years service with the Company and you are contractually entitled to 6 months’ payment in lieu of notice, which is detailed within the enclosed redundancy entitlement statement.

That statement showed – 

Payment in Lieu of Notice                        £29,664.00
Redundancy Payment                                £61930.59
Total                                                          £91,594.59

In computing notional tax thereon, the buy out amount of £33,148.71 was added to the £91,594.59.    Notional tax of £36,637.84 at 40% was computed on the £124,743.30, and after deduction produced a figure of £88,105.46 net of said notional tax.   From the figure of £88,105.46 was deducted the buy-out amount of £33,148.71 leaving an “Amount Due (of) £54,956.75” to be paid to Mr Colquhoun.   In effect, the £36,637.84 of “notional” tax was deducted from Mr Colquhoun’s total of £91,594.59.

9.	In his amended self assessment return for the year to 5 April 2006, Mr Colquhoun claimed a deduction of £30,000 under the provisions of Section 403(1) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA 2003”).
 
10.	On 13 December 2007, HMRC opened an enquiry into this return, and on 31 January 2008, HMRC amended the return so as to bring the deduction back into charge.

Submissions

5.  Reference was made to the following authorities   Mairs v Haughey 66 TC 273 and EMI Group Electronics Ltd v Coldicott 71 TC 455.

6.  In his submission to the Tribunal, Mr Colquhoun contended as follows -

7.  The payment of £33,148.71 was a payment of damages in respect of reduction in his terms and conditions of employment.

8.  He was not made redundant in 1996 and did not receive any redundancy payment at that time. 

9.  When he was subsequently made redundant in 2005 his employer aggregated the damages payment from 1996 with the payment of lieu of notice and the redundancy compensation as if it was one payment.

10.  No tax relief was allowed on the 2005 payments.

11.  It was his understanding that the compensation payment in 1996 was dealt with in line with guidelines set out by HMRC for dealing with non contractual compensation payments.

12.  HMRC agreed that the 1996 payment was not a redundancy payment.

13.  The redundancy compensation made in 2005 was the only redundancy payment that he has received.

14.  The payment made in 2005 in lieu of notice, had no relationship at all with the 1996 payment.

15.  Mr Colquhoun’s understanding was that that non contractual payments made to compensate for changes to Babcock’s employees contractual redundancy entitlements should not be regarded as emoluments and therefore should not be taxed under schedule E.

16.  In addressing the Tribunal, Ms Shields looked firstly at the 1996 payment.    She acknowledged that it could not be regarded as an emolument.   However she submitted that the payment came within the provisions of Section 148(2) of the Income and Corporation Taxes Act 1988 (“ICTA”) in that the payment was “…..either directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of the holding of the office or employment or any change in its functions or emoluments…..”    The payment was part of a larger arrangement, and was an incentive to accept the new package (of a prospective future reduced redundancy entitlement).

17.  Ms Shields distinguished the case of Mairs v Haughey in that the case was originally concerned with s19 and s154 of ICTA and in particular to taxable benefits, and did not consider the applicability of s148.   She particularly referred the Tribunal to the statement of Lord Woolf at 343H  

“It is inevitable that if a payment is made in substitution for a payment which might, subject to a contingency, have been payable that the nature of the payment which is made in lieu will be affected by the nature of the payment which might otherwise have been made.”

18.  Ms Shields also pointed to the observation of Lord Woolf at 346D
“In the case of a redundancy payment, the sum is only payable in limited circumstances and there will be no entitlement if, for example, the employee leaves the employment on his own accord.” 

19.  Ms Shields expressed regret that papers relating to the 1996 period were no longer available.     She explained that in 1996, the Revenue had conveyed to Babcock that employees would be entitled to £30,000 relief in relation to the proposed payments, and that the same relief would again be available in the event of these employees being made redundant on some subsequent date.    Subsequently, the Revenue had reconsidered the matter and it was then conveyed to Babcock that the £30,000 relief could not be duplicated.   (Mr Ian M Crawford had recalled the original advice but had been unaware that it had been subsequently retracted by the Revenue.)  The Tribunal was advised that some form of compensation payment had been made to Babcock for this error.   The details of that payment were not however available to the Tribunal.

20.  Ms Shields acknowledged that the case of EMI Group Electronics Ltd v Coldicott was not directly applicable but she pointed to the following paragraphs from the decision of the Chancery Division -

“(1) though it was neither a sufficient nor a necessary condition, it was a relevant consideration that the payment was, albeit contingently, due under the terms of the employment contract; this suggested that it derived from the employment, and that it was part of the package of benefits which E, as prospective employer, offered to the employee to induce him to take the employment;
……………………
 (4) in so far as the payment was in lieu of E letting the employee earn from E during the notice period, it would be surprising if the payment were not taxable, given that the earnings would have been;” 

21.  In Mairs v Haughey, Lord Woolf had identified “redundancy” at 344D 

“Redundancy, whether statutory or non-statutory, involves an employee
finding himself without a job through circumstances over which he has no control.”

22.  Ms Shields did not claim that the 1996 payment was a redundancy payment, but she submitted that the payment was paid as part of a buy out of the employees’ redundancy rights and was therefore part of the redundancy package.     She added that if the payment in Mairs v Haughey would have been taxable under s148 if the amount had been in excess of the exemption figure.

Reasons

23.  Section 148 ICTA was headed “Payments on retirement or removal from office or employment” and provided -
“(1) Subject to the provisions of this section and section 188, tax shall be charged under Schedule E in respect of any payment to which this section applies which is made to the holder or past holder of any office or employment, or to his executors or administrators, whether made by the person under whom he holds or held the office or employment or by any other person.
(2) This section applies to any payment (not otherwise chargeable to tax) which is made, whether in pursuance of any legal obligation or not, either directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of the holding of the office or employment or any change in its functions or emoluments, including any payment in commutation of annual or periodical payments (whether chargeable to tax or not) which would otherwise have been so made.”
…………………………

24.  A material exemption was contained in s188, namely

“(4) Tax shall not be charged by virtue of section 148 in respect of a payment of an amount not exceeding [£30,000] ("the exempt sum") and, subject to subsection (5) below, in the case of a payment which exceeds that amount shall be charged only in respect of the excess.
(5) Where two or more payments in respect of which tax is chargeable: by virtue of section 148, or would be so chargeable apart from subsection (4) above, are made to or in respect of the same person in respect of the same office or employment, or in respect of different offices or employments held under the same employer or under associated employers, subsection (4) above shall apply as if those payments were a single payment of an amount equal to that aggregate amount; and the amount of any one payment chargeable to tax shall be ascertained as follows, that is to say
(a) where the payments are treated as income of different chargeable periods, the exempt sum shall be deducted from a payment treated as income of an earlier period before any payment treated as income of a later period; and 
(b) subject to that, the exempt sum shall be deducted rateably from the payments according to their respective amounts.
(6) The person chargeable to tax by virtue of section 148 in respect of any payment may make a claim for such relief in respect of the payment as is applicable thereto under Schedule 11.”

25.  The foregoing provisions were written into s401 to s404 of the ITEPA, and it was a matter of agreement between the parties that there were no significant differences in the intended meaning of the above mentioned provisions.    

26.  Section 403(1) specifically provides that 

“The amount of a payment or benefit to which this chapter applies counts as employment income of the employee or former employee for the relevant tax year if and to the extent that it exceeds the £30,000 threshold.”

27.  It was not in dispute that this provision applied to the 2005 payment, and the question before the Tribunal was whether the £30,000 exemption was still available.     

28.  Section 188(5) had specifically provided for the aggregation of relevant payments even when these payments had been received in different tax years; and this provision was repeated in s404(5).

29.  There was no indication that Mr Colquhoun had actually submitted a claim for exemption of the £30,000 in 1996, merely that his employers had only deducted tax from the balance of £3,148.71.    Mr Colquhoun had apparently acquiesced in the limited deduction, and it was not clear whether he had been aware of the apparent advice given by the Revenue to the effect that a further exemption of £30,000 would be available in the event of redundancy at some future date.    

30.  It is significant that Mr Colquhoun did not found on the advice apparently given by the Revenue in 1996.    Equally, Ms Shields did not claim that it was no longer open to the Tribunal to consider Mr Colquhoun’s liability to tax for the year to 5 April 1997, nor did she submit that Mr Colquhoun was not entitled to the £30,000 exemption of tax in the year to 5 April 2006; but merely because an exemption of that amount had apparently been allowed in the earlier year, nothing was available in the later year.

31.  The question before the Tribunal turned solely on the nature of the payment of £33,148.71 in 1997.    

32.  Mr Colquhoun’s contention was that he was not made redundant in 1996, and that was indeed acknowledged by Ms Shields.       Mr Colquhoun pointed to the diminution of his redundancy entitlement and that the payment which he received was expressly in compensation for the reduced expectation in the event of him being made redundant at some future date.   The documentation which was produced clearly links the payment with the reduction in the contingent redundancy entitlement.    

33.  Ms Shields presented her case on the basis that s148(2) applied to the payment of £33,148.71 in 1997.   The essential words of that section are “the termination of the holding of the office or employment or any change in its functions or emoluments”.      Taking the latter words, there was no apparent change in Mr Colquhoun’s “functions” or indeed “emoluments”.   So far as it appeared to the Tribunal, the nature of Mr Colquhoun’s work and his remuneration remained the same.  Mr Colquhoun continued to be employed and his employment was apparently with the same employer.   The words “the termination of the holding of the office or employment” would certainly apply to a redundancy situation.    Ms Shields properly conceded that Mr Colquhoun had not been made redundant in 1996; but it was significant that the payment of £33,148.71 had been computed with reference to Mr Colquhoun’s contingent redundancy entitlement and that the payment was expressly made “in respect of a change to contractual redundancy entitlements only” and the question is whether this was sufficient to bring the payment within the ambit of s148 (2) to the effect that it was made “….. either directly or indirectly in consideration or in consequence of, or otherwise in connection with, the termination of the holding of the office or employment…..”

34.  The case of Mairs v Haughey differed from the present case in that there was a change of employer.    The amount paid to Mr Haughey had two elements, an “A” element of £4,506 and a “B” element of £1,300. The question before the Special Commissioner then was whether the total of £5,806 was taxable under Schedule E either as “emoluments from his employment” (under s19 of ICTA) or as a “benefit” or benefits provided for him (under s154 of that Act)..   It was conceded that the “B” element was taxable in that it was regarded as consideration for the acceptance of the new terms and conditions of work.   The Special Commissioner held that the “A” element was compensation for the loss of contingency rights under the previous redundancy scheme, and was accordingly not taxable under Schedule E.   The decision of the Special Commissioner was upheld by the Court of Appeal in Northern Ireland and by the House of Lords. 

35.  Lord Woolf, who gave the leading opinion in the House of Lords, observed at page 343C that the Revenue had submitted that “a payment made to an employee under an enhanced redundancy scheme (unlike a statutory redundancy payment) would have been taxable as an emolument from his employment”; and that this submission was inconsistent with the second paragraph of an Inland Revenue statement of practice published in 1981. Lord Woolf expressed his concern as he did not understand the policy reasons for treating a payment genuinely in lieu of receiving a redundancy payment in a different way from an actual redundancy.   It was in this context that Lord Woolf went on to say at 343H

“It is inevitable that if a payment is made in substitution for a payment which might, subject to a contingency, have been payable that the nature of the payment which is made in lieu will be affected by the nature of the payment which might otherwise have been made.”

   36.  The full text of the statement of practice was set out by Mr Justice Nicholson in the Court of Appeal report at page 332B.

“Non-statutory redundancy payments

1. Section 412 [now see section 579 subsection 1 of the ICTA 1988]. Income and Corporation Taxes Act 1970 provides that any statutory  redundancy payment shall be exempt from liability under Schedule E with the exception of any liability under section 187 of the Taxes Act [now see section 148 of the ICTA 1988].

2. A payment made under a non-statutory redundancy scheme may
in law be taxable in full under Schedule E if the scheme is part of the conditions under which the employees agree to give their services, or if there is an expectation of payment on their part. However, in practice, the Inland Revenue accept that in the case of a genuine redundancy the only tax liability on lump sum payments made under redundancy schemes is under section 187, even though the payment may be calculated by reference to the length of service or the amount of remuneration or is conditional on continued service for a short period consistent with the reasonable needs of the employer's business.

3. As a general guide redundancy is regarded as genuine for this purpose if (a) payments are made only on account of redundancy as defined by section 81 of the Employment Protection (Consolidation) Act 1978; (b) the employee has been continuously in the service of the employer for at least 2 years; (c) the payments are not made to selected employees only; and (d) they are not excessively large in relation to earnings and length of service.

The Inland Revenue also accept that a scheme may be devised to meet a specific case of redundancy, for example, the imminent closure of a particular factory, or couched in general terms to embrace redundancies as and when they arise.

4. This practice is designed to distinguish between payments which
are made in cases of genuine redundancy and those which are no more than terminal bonuses given as a reward for services and which are taxable in full. It follows that each case must be considered in the light of its particular facts. Where an employer wishes to be satisfied in advance of a proposed scheme which falls within the Revenue guideline, the inspectors will be prepared to give in advance clearance on being informed of the full facts.”

37.  It is significant from the foregoing that the term “redundancy” may have a specific meaning.   There was clearly a redundancy situation in Mr Haughey’s circumstances in that the payment arose at the time when his employment with Harland & Wolff plc came to an end.     However, in the case of Mr Colquhoun, he remained as an employee of Babcock or one of its subsidiaries, throughout the 1996/1997 period and subsequently.   

38.  Section 148(2) required there to be
(a)  a termination of the holding of the office or employment, or
(b)  a change in its functions or emoluments, or
(c ) a payment in commutation of annual or periodic payments.

As was submitted by Mr Colquhoun and conceded by Ms Shields, there was in 1995, 
(a)  no termination of Mr Colquhoun’s office or employment, 
(b)  no change in his functions or emoluments, or
(c ) no commutation of annual or periodic payments.

Section 401(1) ITEPA 2003 is written in very similar terms.

39.    The payment which Mr Colquhoun  received  undoubtedly related to his redundancy entitlement, but at that time, there was no termination of the holding of an office or employment or any change in its functions or emoluments such as was envisaged by s148(2); and in the opinion of the Tribunal, it would be stretching too far the taxation provision of that section if a payment to a continuing employee were to give rise to a charge to tax under Schedule E merely because the payment related to a change in the employee’s contractual redundancy entitlement which were in any case wholly contingent upon a future redundancy.

40.  It follows that the non payment of tax on £30,000 in 1997 cannot be regarded as having arisen from the operation of s188(4) of ICTA; and that therefore the whole exemption of £30,000 referred to in s403(1) of ITEPA remained available to be set against the redundancy payment to which Mr Colquhoun became entitled in 2005.

41.  In the course of his submissions, Mr Colquhoun expressed concern that HMRC had significantly delayed the consideration of the present issue and that this could have resulted in significant interest charges; but these are matters which are out with the jurisdiction of this Tribunal.  

MR JOHN M BARTON, WS
TRIBUNAL JUDGE

RELEASE DATE: 14 January 2010