Termination payments: Termination payment negotiated following notice was taxable as emolument

This report relates to 1 case(s)

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    Richardson (HM Inspector of Taxes) v Delaney [2001] IRLR 663 HC (0 other reports)

A lump-sum payment to an employee of £75,000 negotiated and agreed between the employer and employee after the employer had given notice of termination was taxable in full as an emolument from the employment, holds the High Court in Richardson (HM Inspector of Taxes) v Delaney [2001] IRLR 663.

Key points

  • Although in this case the contract of employment provided for the employer to give the employee 18 months' notice of termination, or to terminate the employment with immediate effect on making a payment in lieu of notice, the employer did not act in breach of contract in giving notice in general terms and placing the employee on garden leave for a month with payment of salary as usual, and then negotiating an agreement with him under which his employment terminated on payment of the agreed sum.
  • In those circumstances the payment was not a non-contractual termination payment, which would have attracted Schedule E tax only on the excess over £30,000.

Mr Delaney was employed by Lyons Seafood Ltd ("the company"). Clause 1.2 of his contract of employment provided that his employment "shall be terminable by either the company or the executive giving to the other 18 months' notice in writing expiring at any time". Clause 3.2 read: "The company may at its absolute discretion elect to terminate the employment of the executive with immediate effect by paying to the executive salary in lieu of notice."

On 1 December 1995 the company wrote to Mr Delaney to inform him that it was giving him notice of termination of his employment. No particular notice period was specified. The letter indicated that he should remain at home, in effect on "garden leave", while his salary and contractual benefits were paid as usual. On the same day the company wrote a second letter to Mr Delaney, containing proposals in connection with the termination of his employment. Under these proposals he would remain on garden leave until 28 December 1995, when his employment would terminate "by mutual agreement". Mr Delaney, who earned £60,000 per annum, was offered a sum of £68,000 "in compensation for the termination of your employment and loss of office, and without admission of any liability whatsoever". He refused this offer, but subsequently agreed with the company that he would receive a sum of £75,000, together with the transfer of his company car valued at £10,000. His employment terminated on 28 December 1995.

The payment of £75,000 to Mr Delaney was assessed as being taxable under s.19 of the Income and Corporation Taxes Act 1988 ("the ICTA"), and that therefore tax under Schedule E was payable on the whole sum. Mr Delaney appealed against the tax inspector's assessment to the General Commissioners, arguing that the £75,000 lump sum was paid in compensation for a breach of contract by the company and that therefore it was chargeable under s.148 of the ICTA, not s.19. Accordingly the first £30,000 was exempt from tax.

Section 19 provides: "Tax under [Schedule E] shall be charged in respect of any office or employment on emoluments therefrom . . ." "Emoluments" are defined in s.131(1) of the ICTA as including "all salaries, fees, wages, perquisites and profits whatsoever".

At the relevant time s.148 (1) and (2) provided that tax shall be charged under Schedule E in respect of "any payment (not otherwise chargeable to tax) which is made . . . in connection with, the termination of . . . employment . . ."

Section 188(4) provided that tax is not payable under s.148 on sums not exceeding £30,000, and that in the case of a payment of more than £30,000, Schedule E tax is payable only on the excess above £30,000. (Note that under the Finance Act 1998 amendments were made in respect of s.148 and s.188 of the ICTA. The provisions of s.188(4) are now incorporated into the newly-worded s.148, which was substituted by s.58 of the 1998 Act.)

The General Commissioners accepted Mr Delaney's submissions and allowed his appeal, ruling that the first £30,000 of the £75,000 lump sum he received from the company was not subject to tax. The tax inspector appealed to the High Court.

Decision

Giving judgment, Mr Justice Lloyd observed: "It can readily be seen that the payment of the £75,000 was made, or could easily be said to have been made, in consideration of, or in consequence of, or at any rate otherwise in connection with, the termination of the holding by the taxpayer of his employment with the employer. But that is not sufficient for the taxpayer's purposes, because although that might appear to bring the payment within s.148, s.148 only applies to a payment of that kind which is not otherwise chargeable to tax. The point of s.148 is to extend the ambit of taxable payments rather than to limit it. If the payment is one which is chargeable under s.19(1) . . ., then it is not necessary for it to be charged to tax under s.148, and it is not therefore charged to tax under s.148, and in turn is not subject to the ameliorative provision in favour of the taxpayer of the exemption of the first £30,000."

The question, therefore, was whether or not the sum paid to Mr Delaney fell within the ambit of s.19 as an emolument from his employment. If it was, then the whole sum was chargeable to Schedule E income tax.

Lloyd J noted that the General Commissioners accepted that the company had acted in breach of contract in this case, and proceeded to reach their decision on that basis, although they did not clearly identify any breach. The nearest they came to doing so, he said, was to suggest that the company had not been entitled to tell Mr Delaney that his employment was being terminated without making a payment in lieu of notice at that time as required by clause 1.3 of his contract.

The tax inspector accepted that if the finding that there had been a breach was sustainable on the evidence, and if there had been a payment of compensation consequent on that breach, then it could be argued that the payment was attributable to the breach and was not an emolument from the employment. In those circumstances, the payment would fall to be taxed under s.148 rather than s.19, and the first £30,000 would not have been taxable.

In Lloyd J's opinion, however, the evidence provided no basis for the General Commissioners' finding of a breach of contract by the company.

No breach of contract by the company

The facts of Mr Delaney's case were that the company gave him notice in general terms under his contract to terminate his employment. It did not specify that it was giving 18 months' notice under clause 1.2, nor that it was giving notice with immediate effect and 18 months' salary in lieu in accordance with clause 1.3, but it was acting in pursuance of its contractual right to give a notice. The notice given by the company was not treated by either party as a notice having immediate effect. What happened was that Mr Delaney's salary was paid for another four weeks during his period of garden leave (which the company was contractually entitled to impose), and the parties came to an agreement under which Mr Delaney's employment terminated at the end of that leave on payment of £75,000 plus the transfer of his company car. The termination package was not identical to that provided for under the terms of the contract, although in financial terms it was very similar, adding up to a total (including the value of Mr Delaney's salary for December 1994) of £90,000, which was the equivalent of 18 months' pay in lieu of notice.

Lloyd J acknowledged that the termination agreement was reached on a rather ad hoc basis, but his view was that the company had nevertheless acted perfectly lawfully. Referring to the decision of the House of Lords in Delaney v Staples [1992] IRLR 191, which was not a tax case but which usefully summarised the different situations in which payments made following summary dismissals can properly be described as payments in lieu of notice, he observed that the present case was not one where, without any contractual provision for summary dismissal, an employer summarily dismisses an employee and then makes a payment in lieu of proper notice. In such a situation the summary dismissal would have been effective in putting an end to the employment relationship, and the payment would amount to damages for breach of contract rather than an emolument from that employment.

Lloyd J also referred to EMI Group Electronics Ltd v Coldicott (HM Inspector of Taxes [1999] IRLR 631), a case which, he said, had clear and close analogies with Mr Delaney's. In Coldicott, the Court of Appeal held that a payment in lieu of notice, made in pursuance of a contractual provision which had been agreed at the outset of the employment and enabled the employer to terminate the employment on making that payment, can properly be regarded as an emolument from that employment.

Payment was emolument from employment

If the company in Mr Delaney's case had paid him £90,000 in lieu of notice (however that sum was made up) on 1 December 1995, it is clear that that payment would have been an emolument from the employment and therefore taxable under s.19.of the ICTA. Equally, if, rather than pay in lieu of notice, notice had been given and had remained as notice under clause 1.2 of his contract taking effect 18 months later, Mr Delaney's salary during the 18-month period would have been subject to tax. The situation in Mr Delaney's case could not be categorised as a pure clause 1.2 procedure or a pure clause 1.3 procedure, and the question for the court was whether, in all the circumstances, the payment of £75,000 could escape being taxed as an emolument from his employment. Its answer was that it could not.

Accordingly, the High Court allowed the tax inspector's appeal, and reinstated his assessment of the tax payable.

Comment

The long-established practice of the Inland Revenue to assess contractual payments in lieu of notice as taxable emoluments, while assessing non-contractual termination payments as exempt up to £30,000, was confirmed by the Court of Appeal in Coldicott, and Delaney emphasises that only a termination payment agreed after a dismissal in breach of contract qualifies for the £30,000 exemption.