Income Tax – Schedule E – Benefit in kind – Whether expenses paid by company assessable as income of director – Apportionment of expenses – Income and Corporation Taxes Act 1988 ss.154, 156 – Discovery Assessment – Taxes Management Act 1970, Section 29

THE SPECIAL COMMISSIONERS

	XI SOFTWARE LIMITED	Appellant

	- and -

            ROSS LAING
	(HM INSPECTOR OF TAXES)    	Respondent

	J M COLLINS	Appellant

	- and -

            ROSS LAING
	(HM INSPECTOR OF TAXES)    	Respondent

				Special Commissioner:   DR K KHAN

Sitting in London on 3 September 2004

Jonathan Griffey of Hackett Griffey, for the Appellant

Kevin Greig, HM Inspector of Taxes, Regional Appeals Unit, for the Respondents

© CROWN COPYRIGHT 2004

DECISION

Appeal by J M Collins against Notices of Assessment for the Year 1998/9; and against the Inspector’s Amendments of his Self-Assessment Returns for 2000/20001 and 2001/2002.

The assessment is for the sum of £10,000 for each year of assessment.  Appellant means J M Collins for the purposes of this judgement.

1.	BACKGROUND

1.1	Xi Software Limited (“the Company”) was formed in January 1986 in order to sell computer software consultancy and software products written by its managing director and majority shareholder Mr John Collins (“the Appellant”).

1.2	In 1992, Mr Guy Costain (“Costain”) and Mrs Nicola Low (“Low”) joined the Company.  Costain joined as a sales director and Low as office manager, each with a service contract.  The issued share capital of the Company was altered to give a shareholding interest to each of the two new employees who became shareholders with the Appellant.  In 1992, the shareholders were the Appellant with ninety shares and Costain and Low holding five shares each.  In 1993 Costain left the company and he is not party to the dispute in this case.  

1.3	In 1994 a new service contract for Low was drafted which gave to her an entitlement, inter alia to, part of the profits of the Company.  It is not clear whether this contract was actually signed by the parties but Low left the Company in November 1994 and was to later to claim against the Company for 20% of its profits based on her contractual entitlement.

1.4	In 1988, the Company purchased premises which was financed through bank borrowings of £80,000 and a director’s loan (from the Appellant) of £65,000 together with a Company contribution of £20,000.  Given these borrowings, the Company was too heavily geared for obtaining further bank credit.  In order to reduce its borrowing, the director’s loan account was capitalised.  This means that new shares were offered to the existing shareholders in proportion to their existing holdings in the Company. In 1994, the issued share capital of the Company was increased from 100 shares to 50,000 £1 shares.  As a result, the individual shareholdings in the Company increased to the following:-

		Appellant		47,495;
		Costain		5 (he did not take up his allotment); and
		Low			2,500.

1.5	Low took up her allotment of 2,495 shares.  Her increased shareholding was paid for by a debit from the Appellant’s current account with the Company which was in credit.  This meant that Low owed the Appellant the sum of £2,495, which was a personal loan from the Appellant to Low.  The terms of the loan were not written down in a loan agreement and, for all intent and purposes, it was a loan repayable on demand which did not carry any interest charge.

1.6	The 47,405 shares issued to the Appellant was also paid for by debit from his current account with the Company.

1.7	Late in 1994, the relationship between the Appellant and Low began to sour.  Low began to act in a way which the Appellant believed was detrimental to the Company.  Legal advice was sought by the Appellant and the Company on ways to sever the relationship between the Company and Low.  In accordance with that advice legal proceedings commenced.  In February 1995, two claims were issued at Milton Keynes Crown Court, which were subsequently consolidated (“the Low Litigation”).  There was an allegation that Low had abused her position as office manager and had made unauthorised weekend visits to the Company’s office and obtained various confidential information.  The Company made claim for the following (listed as claim MK500817):

“Return of books, papers, documents, materials, discs, tapes, credit cards, keys and other property including:

•	documents relating to the agreements between Xi and Mrs Low;
•	correspondence relating to the matters between Xi and Mr Costain including correspondence between Xi and its solicitors and accountants, solicitors correspondence and counsel’s opinion;
•	keys to Xi’s premises;
•	costs of replacing locks and keys;
•	either the return of the property above plus damages limited to £5,000; or damages limited to £5,000.”

1.8	In the second claim (listed as MK500818) the Appellant claimed repayment of the debt of £2,500 (£2,495 plus £5 as Low had never paid for the 5 shares originally obtained) or the transfer to him of Low’s entire shareholdings of 2,500 shares. 

1.9	In response to the Company’s and the Appellant’s claim, Low brought a counterclaim for profits, remuneration and damages. 

1.10	This litigation, the Low Litigation, was settled by agreement and the Consent Order of Judge Cooke on 8 April 1997 in the following terms: 

“Mr Collins was to pay Low £500 on or before 22 April 1997. Upon receipt of payment, Mrs Low was to transfer her entire shareholding in Xi (which was 2,500 shares) to Mr Collins.”

the Judge further ordered that:

“Low was to pay Xi’s costs and Mr Collins’ costs on their claims
Xi was to pay Mrs Low’s costs on her counterclaim”

Low’s cost was agreed at £13,273 while the Company and Appellant costs was agreed at £6,500 the net result was that the Company was able to pay Low the sum of £6,773.

At this point, a potted history of the legal advisors to the Company and the matters which they handled would be relevant in understanding the cost and litigation history which is integral to understanding this case.  The various litigation undertaken by the Company are interconnected.  The legal advisers were as follows:-

(a)	Until mid-1996, the solicitors to the Company and the Appellant in the Low Litigation was Fennemores;

(b)	From mid-1996, Aaron & Partners were retained to act for both parties and continued the Low Litigation.  They also acted in bringing tax proceedings against Fennemores, alleging that Fennemores had overcharged the Company and succeeded in recovering £50,000 in the 1999/00 tax year;

(c)	In 1996, Grace & Co, a firm formed by a former solicitor at Aaron & Partners, took over the Low Litigation.  In March 1998, the retainer of Grace & Co was terminated and new solicitors, Breeze & Wyles, were retained to continue the Low Litigation.  

(d)	In July 2000 Breeze & Wyles brought a claim against Grace & Co (the “Grace Litigation”) for breach of contract, negligence and for breach of fiduciary duty in relation to the cost element of the Low settlement.  The Company and Appellant felt that Grace & Co may have acted negligently or improperly in advising on the terms of the costs settlement.  Mr Collins was named as a Claimant with the Company in this claim.  The Company funded the entire legal cost of this claim and all invoices were issued by the solicitors to the Company. 

1.11	All invoices issued by the various firms of solicitors were issued to the Company and paid by the Company.  The amounts paid were:

1988/1989 - tax year £15,792;
2000/2001 -  tax year £12,915; and
2001/2002 -  tax year £26,916.

1.12	Advice had also been sought from Counsel (Paul Newman, 8 New Square Chambers) on 13 July 1995, to discuss, inter alia, the potential threat of Low and ways of removing her as a shareholder.  Concerns were raised about her work and about potential conflict between her and the Company.  Counsel advised that given the small size of her shareholding she could not directly influence the management of the Company and, given the articles of association of the Company, it could not acquire her shares by forfeiture or compulsory transfer.  It appears that Counsel felt that the purchase of Low’s shares by Collins was an important part of the strategy to get rid of Low as a shareholder and potential threat to the Company.

2.	THE LAW

2.1	Statutory Provisions

There are several statutory provisions which are relevant to this case.  These include:-

Section 154 ICTA 1988 provides inter alia:

(1)	“…where in any year a person is employed in employment to which this Chapter applies; and

(a)	by reason of his employment there is provided for him, or for others being members of his family or household, any benefit to which this section applies; and

(b)	the cost of providing for the benefit is not (apart from this section) chargeable to tax as his income,
	
there is to be treated as emoluments of employment, and accordingly chargeable to income tax under Schedule E, and an amount equal to whatever is the cash equivalent of the benefit.

(2)	The benefits to which this action applies are accommodation (other than living accommodation), entertainment, domestic or other services, and other benefits and facilities of whatsoever nature (whether or not similar to any of those mentioned about in this sub-section),…”

2.2	The “cash equivalent of the benefit” referred to in Section 154 ICTA 1988, is defined in Section 156(1) and 156(2) ICTA 1988.

2.3	Section 156 provides:

“(1)	The cash equivalent of any benefit chargeable to tax under section 154 is an amount equal to the amount of the benefit, less so much (if any) of it as is made good by the employee to those providing the benefit.

(2)	Subject to the following sub-sections, the costs of a benefit is the amount of any expense incurred in or connection with its provision, and (here and in those sub-sections) includes a proper proportion of any expense relating partly to the benefit and partly to other matters.”

2.4	Section 154 provides that an employee earning £8,500 or more or a director or a member of his family or household is assessed on the “cash equivalent of the benefit”.  The taxable benefit includes benefits of “whatsoever nature” and would include payment of an employee’s legal costs.  The cash equivalent of any benefit is the cost to the provider (the employer) less any amount “made good” by the employee to the employer.

2.5	A discovery assessment (an assessment made outside the usual time limit) was made on the Appellant for 1998/1999 pursuant to Section 29 TMA 1970.

Section 29 Taxes Management Act 1970 provides:

“(1)	If an officer of the Board or the Board discover, as regards any person (the taxpayer) and a year of assessment:

(a)	that any income which ought to have been assessed to income tax, or chargeable gains which ought to have been assessed to capital gains tax, have not been assessed, or

(b)	that an assessment to tax is or has become insufficient, or

(c)	that any belief which has been given is or has become xcessive,

the officer or, as the case may be, the Board may, subject to sub-sections (2) and (3) below, make an assessment in the amount, or the further amount, which ought in his or their opinion to be charged in order to make good to the Crown the loss of tax.

(2) 	Where:

(a)	the taxpayer has made and delivered a return under Section 8 or 8A of this Act in respect of the relevant year of assessment; and

(b) 	the situation mentioned in sub-section (1) above is ttributable to an error or mistake in the return as to the basis on which his liability ought to have been computed,

the taxpayer shall not be assessed under that sub-section in respect of the year of assessment there mentioned if the return was in fact made on the basis or in accordance with the practice generally prevailing at the time when it was made.

(3)	Where the taxpayer has made and delivered a return under Section 8 and 8A of this Act in respect of the relevant year of assessment he shall not be assessed under sub-section (1) above; and

(a)	in respect of the year of assessment mentioned in that sub-section; and

(b)	in the same capacity as that in which he made and delivered the return, unless one of the two conditions mentioned below is fulfilled.

(4)	The first condition is that the situation mentioned in sub-section (1) above is attributable to fraudulent or negligent conduct on the part of the taxpayer or a person acting on his behalf.

(5)	The second condition is that at the time when an officer of the Board:

(a)	ceased to be entitled to give notice of his intention to enquire into the taxpayer’s return under Section 8 or 8A of this Act in respect of the relevant year of assessment; or

(b)	informed the taxpayer that he had completed his enquiries into that return, 

(c)	the officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the situation mentioned in sub-section (1) above.

(6)	For the purposes of sub-section (5) above, information is made available to an officer of the Board if- 

(a)	it is contained in the taxpayer’s return under Section 8 or 8A of this Act in respect of the relevant year of assessment (the return), or in any accounts, statements or documents accompanying the return;

(b)	it is contained in any claim made as regards the relevant year of assessment by the taxpayer acting in the same capacity as that in which he made the return, or in any accounts, statements or documents accompanying any such claim;

(c)	it is contained in any documents, accounts or particulars which, for the purposes of any enquiries into the return or any such claim by an officer of the Board, are produced or furnished by the taxpayer to the officer, whether in pursuant of a notice under Section 19A of this Act or otherwise; or

(d)	it is information the existence of which, and the relevant of which as regards the situation mentioned in sub-section (1) above:

(i)	could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or

(ii)	are notified in writing by the taxpayer to an officer of the Board.

(7)	In sub-section (6) above- 
	
(a)	any reference to the taxpayer’s return under Section 8 or 8A of this Act in respect of the relevant year of assessment includes:

(i)	a reference to any return of his under that section for either of the two immediately preceding chargeable periods; and

(ii)	where the return is under section 8 and the taxpayer carries on a trade, profession or business in partnership, a reference to any partnership return with respect to the partnership for the relevant year of assessment or either of those periods; and

(b)	any reference in paragraphs (b) to (d) to the taxpayer includes a reference to a person acting on his behalf.

(8)	An objection to the making of an assessment under this Section on the ground that neither of the two conditions mentioned above is fulfilled shall not be made otherwise than on an appeal against the assessment.

(9)	Any reference in this section to the relevant year of assessment is a reference to:

(a)	in the case of the situation mentioned in paragraph (a) or (b) of sub-section (1) above, the year of assessment mentioned in that sub-section;

(b)	in the case of the situation mentioned in paragraph (c) of that sub-section, the year of assessment in resect of which the claim was made.”

Section 29 TMA 1970 sets out the Inland Revenue discovery powers.  It allows an officer of the Board or the Board to make an assessment if it is discovered that profits which ought to have been assessed had not been assessed, or an assessment is sufficient or a relief is excessive.  Where a taxpayer has made a return the Revenue cannot make a discovery unless the under-assessment is due to the taxpayer’s fraud or neglect.  An assessment may also be made where the Inspector could not reasonably have been expected, on the basis of information available to him, to have been aware that he ought to have given notice of an intention to enquire into the return, or he would not have given notice that his enquiries were completed.  Information is normally made available to the Revenue if it is contained in the taxpayer’s return or accounts or schedules accompanying the return or in any claim, or accompanying documents.
  
2.6	No national insurances issues are being raised and the issue in relation to Class 1 NIC (regarding emolument) has been settled.

3.	Case Law

The following cases were referred to:

3.1	Mairs v Haughey [1992] STC 495;
3.2	Pepper v Hart [1991] Ch 293 and [1992] STC 898;
3.3	R v DSS ex p. Overdrive Credit Card Limited [1991]  1 WLR 635;
3.4	Sports Club Plc v HM Inspector of Taxes [2002] STC (SD) 443;
3.5	Westcott v Bryan [1969] 3 All E.R. 564;
3.6	Rendell v Went [1964] 2 All E.R. 464;
3.7	Salisbury House Estate Limited v Fry [1930] 1 K.B. 304.

4.	Press Release

4.1	The Press Release from the Inland Revenue on the taxation of in-house benefits on 31 January 1993 following the decision of Pepper & Hart.

5.	Appellant’s Submissions by the Appellant

5.1	The Appellants made several submissions.  The Appellant states that the cost of legal proceedings which was paid by the Appellant’s employer, XI Limited, was not a “benefit” within the meaning of Section 154 ICTA 1988.  They say, however, that if there was a benefit then it was not provided by reason of the Appellant’s employment within the meaning of the Section.  Alternatively, if there was a benefit, it falls in accordance with the decision in Pepper v Hart to be valued on the basis of “marginal cost” and on that basis, the value is considerably less than the amount which has been assessed by the Inland Revenue.

5.2	Counsel for the Appellant said that there was no “benefit” pursuant to Section 154 ICTA 1988 since there was fair bargain between the Appellant and the Company in that the Appellant lent his name to a litigation involving the Company and would ordinarily have been liable for the cost of that litigation.  There could be no benefit if the Appellant had provided good consideration and the lending of one’s name in the circumstances was such consideration.  Reliance was placed on the decision of Mairs v Haughey, when it was said.

“… I considered that the Respondents did not receive a “benefit” within the meaning of Section 154 where the money received was paid to him, by way of fair valuation in consideration of his surrender of a right to receive a larger sum in the event of the contingency of redundancy occurring”.

5.3	Counsel said that if the Company had good commercial reasons for incurring the expenditure and if the Company benefited, then it cannot be said that the employee benefited for the purposes of the charging provision Section 154 ICTA 1988.  Any such benefit would be incidental.  Reference was made to the Special Commissioner’s decision in Sports Club v HMIT and the case of Rendell v Went in support of this contention.

5.4	Counsel said that the “cash equivalent of the benefit” was minimal and was provided by the Company at no extra cost to the Company.  He referred to the case of Pepper v Hart to support this contention.  He further stated that the definition of “in-house benefit” would not necessarily include services provided by the Company to the employee, in this case legal services, but reference was made to the Inland Revenue Press Release of 21 January 1993 paragraph 6 and 15 which states that an in-house benefit does not necessarily have to be sold by the Company to the public but can be used in-house but provided by a third party contractor.  

5.5	Counsel further stated that an employee might “piggyback” on the Company’s main action and in such a case, the cost (i.e. legal cost) would be minimal and would classify as a marginal cost to the employee which would not be taxed.  

5.6	Counsel referred to the Lord Browne-Williamson judgment in the decision in Pepper v Hart which explains the concept of marginal costs, he says -

“Concessionary travel for railwaymen is not discretionary nor is it dependent of there being surplus seats on any train.  Similarly, in many cases the education of teachers’ children at concessionary rates is neither discretionary nor dependent on there being surplus capacity.  Yet in both cases in Parliament the section was put forward as providing that only marginal cost would be treated as taxable.  I can therefore find no grounds for drawing the narrow distinction and would hold that in the case of all in-house benefits the same tests applies, viz the cost of the benefit to the employer is additional or marginal costs only.”

5.7	The Appellant argue that the contract between the Company and various firms of solicitors providing legal advice to the Company was entered into for a good commercial purpose, to protect the company from a potentially disruptive employee and recalcitrant shareholder.  The Appellant, it was said, was not asking for repayment of a personal debt of £2,500 but rather sought to support the Company in having Low give up her shareholding as a way of removing her from being a shareholder of the Company and to present possible damage to the Company.

5.8	On the matter of the discovery assessment, the Appellant contends that in making the assessment for 1988/9 pursuant to Section 29 TMA 1970, the Inland Revenue have failed to establish the circumstances for making an out of time discovery assessment within Section 29(4) and 29(5) of TMA 1970.  Further they contend that they failed to discharge the burden of proof stated in Section 29(5) TMA 1970 that Inspector “could not have reasonably expected, on the basis of the information made available to him” to know that the assessment was insufficient.

6.	The Respondents’ Arguments

6.1	The tax charge on the benefit received by the Appellant for the years under appeal arises under Section 154 ICTA 1988.  The benefit to the Appellant of the Company underwriting the costs of a succession of legal actions was a benefit of “whatsoever nature” under Section 154 ITCA 1988.

6.2	The amount of the benefit to the Appellant is the cost to the Company (employer) of providing the benefit.  It is accepted that the Appellant is not the sole beneficiary of the legal costs since part of the expenses was for the purposes of the Company’s business.  It is contended that the benefit would be the amount from the total expenditure which the Appellant would have spent on his own accord and that the apportionment of such amount from the total expenditure is a matter for the Commissioners.

6.3	The Respondents refute the argument that there was a “fair bargain” and the contention that the Appellant had given value for the benefit received in lending his name to the litigation and accepting liability for costs.  The indemnification by the Company of the Appellant’s legal costs was not a fair bargain and it cannot be said that there was no benefit to the Appellant.  The Respondents contend that the present case can be distinguished from Mairs v Haughey, where there was a fair bargain in that payment was made in consideration for the surrender of rights in a bargain between parties at arm’s length where there was a presumption that the payment was equivalent in value to the contingent rights surrendered.  The Respondents contend that in the present case there is not an arm’s length transaction and the benefit was obtained by the Appellant by reason of his employment unlike the case of Mairs v Haughey where there was not a Section 154 ICTA 1988 issue.  They further contend that the Appellant did not give full value to the Company for his share of legal costs but in fact gave nothing.  

6.4	The Respondents argue that the benefit to the Appellant cannot be marginal, in that he was simply “added” to the Company’s legal action.  To support this view, the Respondent drew reference to the case of Pepper v Hart where two types of benefits were identified, an “in-house” i.e. services and facilities which is part of the employer’s business to sell to the public and “external benefits” i.e. those of a kind bought in from outside the employer’s business.  The Respondents say that the legal advice obtained by the Appellant was an external benefit and such a benefit does not fall to be calculated by the marginal cost test identified in Pepper v Hart, but by reference to just and reasonable apportionment of the expenses incurred by the employer.  External benefits are quantified by the amount paid to a third party for the obtaining of the benefit.  The Respondent also contends that the Company’s motive for making a payment will not prevent a benefit arising to the Appellant.  They say that if the Company benefited and there was a good commercial reason for making the payment there could still be a benefit under Section 154 ITCA 1988 to the Appellant.  In such a case, an appropriate apportionment of the legal expenses paid by the Company attributes to part of that payment to the Appellant.

6.5	The Section 29 TMA 1970 discovery assessment was raised as a preliminary point at the hearing on 3 September.  The Respondent stated that there was a right to assess out of time for 1998/9 since no information was given in the Self Assessment Tax Return of the Appellant’s legal expenses.  The Inland Revenue argue that it could not have known of the insufficiency in the Appellant’s self assessment return before March 2002 when the Inland Revenue Officer (Mrs Roberts) visited the Company and was told that the Company had funded the Appellant’s litigation.  Reliance for this proposition was based on the wording of the legislation and the case of Langham v Veltema [2004] STC 544.

7.	The Decision

7.1	It is necessary to look first as to whether there is a “benefit” under Section 154 and the pre-conditions for coming within Section 154.  These are set out in Section 154(1)ICTA which states inter alia:

“where in any year a person is employed…and –

(a)	by reason of his employment there is provided for him,…any benefit to which this section applies; and

(b)	the cost of providing the benefit is not (apart from this section) chargeable to tax as his income, 

this is to be treated as emoluments of the employment, and accordingly chargeable to income tax under Schedule E, an amount equal to whatever is a cash equivalent of the benefit.

(2)	The benefits to which this section applies are accommodation (other than living accommodation), entertainment, domestic and other services, and other benefits and facilities of whatsoever nature.”

7.2	The detailed requirements of Section 154 ICTA 1988 also need to be examined. 
	
The first is that a benefit is provided by reason of the employment.

(a)	By Reason of Employment

Section 154 only applies to benefits provided by reason of employment and seeks to treat the amount of the benefit (the cost) as income of the director or employee.

Section 168(2) states that “employment” means an “office or employment” and the section goes on in Section 168 (3) to say:

“(a)	all sums paid to an employee by his employer in respect of expenses, and 

(b)	all such provision as is mentioned in this Chapter which is made for an employee or for members of his family or household, or by his employer, 
	
are deemed to be paid to or made for him or them by reason of employment.”

Mr Collins is a director and managing director of the Company and it is correct to say that any benefit provided by the Company to him will be by reason of his employment.  The benefit would come from his employer, XI Limited and be provided at their expense.  If the benefit of legal services had not been provided by the Company, then Mr Collins would have had to pay for some of those services.

The second requirement of the section is that there must be a benefit.

(b)	Benefit

Section 154 states that the benefit to which the section refers is, inter alia, “a benefit of whatsoever nature”.  While the section identifies certain stated benefits which are to be charged under the section (living accommodation, entertainment etc.) and certain excluded benefits, it is wide and inclusive in that it includes “benefits or facilities of whatsoever nature”.  

The section does not require that the employees should receive the benefit exclusively, so if a benefit is provided to both employer and employee, the charge under Section 154 can still apply.  

Lord Reid in Rendell v Went (HL) makes this clear when he says:  

“And I can find nothing in the Act to support an argument that a benefit in fact provided by the Company ceases to be a benefit within the meaning of the section if it is proved that the Company’s sole reason, motive or purpose was to protect itself and was not to favour its director.”

In answer to the question, did Mr Collins benefit from the legal actions undertaken by the Company, the answer is clearly yes.  He received the shares from Low and became the sole shareholder of the Company and he had the cost of his legal advice and representation paid by the Company.  In answer to the question, did the Company receive a benefit from the legal action, the answer is also yes.  It got rid of a shareholder, who according to the Note of Conference with Counsel (13/7/95) (“Counsel’s Note”) could potentially bring a number of claims against the company including a petition under Section 459 CA 1985.

Counsel for the Appellant argued that in considering whether an advantage provided to an employee is a benefit within Section 154(2) the following principles apply:

1	An advantage to the employee which is an incidental result of expenditure by the employer made for commercial reason in relation to a third party, cannot be a benefit within Section 154(2).

2	An advantage provided to an employee will not be a benefit within section 154(2) if the taxpayer has given the employer something of broadly equal value in return.

3	An advantage provided to a Company owned by an employee is not a benefit within section 154(2).

Counsel draws largely on Sports Club v Inspector of Taxes [2002] STC (SD) 443 to support these points.  However, a clear distinction can be drawn between the cases.   In the Sports Club case, the employees had not received a benefit since money had been paid to companies, not to the employees concerned.  We are here concerned with employees not third parties.

It is possible for a benefit to be provided incidentally to an employee, where the employer incurs expenditure which has a clear commercial benefit to the company.  However, I do not believe that the benefit to Collins was incidental; the acquisition by Collins of the Low shares was part of the overall strategy of the Company, as instructed by Counsel to get rid of Low as a shareholder.  In Counsel’s Note he starts his advice by asking whether Collins would be prepared to acquire Low’s shares and further advised (para 3(IV) of Counsel’s Note) “it would be prudent on JC (Collins) to make a reasonable offer for her shares because then he may be able to later apply to strike out any Section 459 petition which is presented, on the basis that the Courts were likely to order him to purchase her shares…”  It seems we have mutual benefit.  The Company will benefit if a Section 459 action is made by Low and if the Appellant offered to buy her shares, he benefits by increasing his shareholding.

It will be necessary to look at the question of the quantum of the benefit and the amount of the legal expenditure which is attributable to that part of the litigation and legal advice which relates to Mr Collins in his personal capacity and to that part which relates to the Company.  I do not believe we can “look through” the Company and attribute its benefit to Collins, at least that cannot be done for the purposes of a Section 154 charge.  The second point raised by Counsel, the “equal value” point is discussed below.

It would seem that the employee does have to accept or acquiesce in the provision of the benefit, as Lord Reid pointed out in the case of Rendell v Went (HL). He says-

“The Appellant knew and accepted what was being done on his behalf although he may not have realised what it would cost,”

In the present case, Mr. Collins instructed the solicitors of behalf of the Company (see Witness Statement of MJ Dismore at para 15).  Mr Collins was an integral part of the litigation in consenting, liaising with solicitors and attending conference with Counsel. He was the directioning mind of the Company and made all its important decisions. He did accept the benefit provided by the Company.

The third requirement is that “cash equivalent” of the benefit must be established.

(c)	Cash Equivalent of Benefit

Section 154 refers to the “cash equivalent of the benefit” chargeable to income tax under Schedule E.  This establishes the value of the benefit and the basis for valuing such benefit.

Section 156 states:

“The cash equivalent of any benefit chargeable to tax under Section 154 is an amount equal to the cost of the benefit, less so much (if any) of it as is made good by the employee to those providing the benefit.”

This means that one has to look to tax the difference between the amount, if any, paid by the employee and the amount the employee would have paid to acquire the goods or services if he wished to do so.  Nicholls LJ in Pepper v Hart (CA) says-

“Parliament did not adopt a market value test.  Instead, Parliament adopted a formula which looks not at the value to the employee of what he receives, but at the expense incurred by the employer in providing the benefit.”

The Appellant contended that the “cash equivalent of the benefit” was minimal and drew reference to the case of Pepper v Hart to support their contention.

In Pepper v Hart, the taxpayer was a member of staff at an independent school.  This school provided concessionary places for members of staff who paid 20% of the full fees charged to parents of other pupils.  The main issue was what was the method of calculating the “cash equivalent of the benefit” which was received by the members of staff receiving the concessionary fees.  The Inland Revenue argued that it was the actual costs not the marginal costs of the benefit.  The marginal or extra costs to the school of educating a child would be the cost of additional food, laundry, stationary etc. for the child but would not include the cost of such items as staff salaries, provision of buildings, grounds etc. because these would have been incurred in any event.  The House of Lords held that the marginal costs basis was the correct basis for valuing the benefit and that the concessionary fee, equal to 20% of the normal fee, was more than enough to cover the marginal costs to the school of the benefit provided.

The case for the court (HL) was best put by Lord Browne-Wilkinson who stated the proposition as follows:

“The provisions regulate the taxation of all benefits in kind.  As Nicholls LJ pointed out in the Court of Appeal, for present purposes such benefits can be of two kinds.  First, the benefits must be of a kind bought in from the outside the employer’s business such as a car and medical insurance (external benefits).  Second, the benefit may consist of the enjoyment by the employee of services or facilities which it is part of the employer’s business to sell to the public, for example concessionary travel for railway or airline employees or concessionary education for children of schoolteachers (in-house benefits).  In both cases, the benefit falls to be quantified by reference to the expense of providing the benefit.  In the case of external benefits this does not normally raise any major problems because such costs is an isolated expenditure.  But in the case of in-house benefits there is an obvious problem, since the employer is, for the purposes of selling the facility to the public, incurring the costs of running the train, airline or school the use of which is provided on a concessionary basis to the employee.  What then is the cost to the employer providing the in-house benefit for the employee?  Is it only the additional or marginal costs to the employer of providing the service for an employee, or is it a proportionate part of the total costs incurred by the employer in providing the facility to be used both by the public and employee?”

It would appear that the employer must incur some additional costs if there is to be a charge under Section 154.  In other words, if no expense is incurred in providing the benefit, then there can be no charge under Section 154.  In assessing the value of the benefit, Lord Browne-Wilkinson draws a distinction between “external benefits” and “in-house benefits”.  An external benefit is one brought in from outside the employer’s business while an in-house benefit is provided from within the services or facilities which is part of the employer’s business.  In both cases, the benefit is valued in the same way (i.e. the costs of providing the benefit), but with an external benefit the cost is more easily ascertainable in that it is the costs which a third party charges for the benefit provided, based on the invoices paid.
It should be noted that the Inland Revenue have accepted that “in-house benefits” are not limited to those provided by an employee of the employer but may include contracted out services (see Inland Revenue Press Release 31/1/93 at paragraph 15).

“The marginal cost of in-house benefits depends on each employer’s particular circumstances.  But, as a general guide, the Inland Revenue accept that …. professional services which do not require additional employees or partners (e.g. legal and financial services) have no or negligible cost to the employer (provided the employee meets the cost of ay disbursements).”

It is clear that the Inland Revenue accept that “in-house benefits” are not limited to benefits provided by employees of the employer but may also include contracted-out services.

Let us look at the benefits received by the Appellant and how these are to be quantified.  The Company was involved in selling computer software products and consultancy.  It did not sell legal services.  The legal advice and representation bought in from outside by the Company were not core to the Company’s main business and were therefore “external benefits”

In my view, it is correct to say that the legal costs were not an in house benefit and the quantification of the benefit would be as identified in the Pepper v Hart decision as the amount paid to the third party’s solicitors as evidenced by the invoices paid by the Company.  The value to the Appellant would be arrived at on the basis of a just and reasonable apportionment of the expenses which would have been incurred by him in the conduct of his personal action less any amount made good.  The amount made good would have to be deducted before apportionment.

7.3	Commercial Reasons and Fair Value

The Appellant argue that the Company had good commercial reason to engage different firms of solicitors to obtain legal advice and representation and one of the purposes of doing so was the protection of the Company from potential claims by a minority shareholder.  In looking at the set of documents including the opinion of Counsel (which is identified the bundle as the “Corporate Mindset Documents”) to the Company, one can single out in Counsel’s Notes the reason for the advice.  He was asked, inter alia, to advise on several points including whether the Appellant should offer to purchase the shares of Low to  avert possible actions which Low may have against the Company.  This was at a time when Low’s solicitors had sought to make claims against the Company.  The Company was seeking advice in part on how to position itself against Low going forward and to devise a strategy.  

Counsel was also asked to comment on a possible Section 459 Companies Act 1985 action (brought by minority shareholders where the Company’s affairs have been run in a manner which is prejudicial to the minority).  Counsel advised that Low “was likely to present a petition under Section 459 (of the Companies Act) it would be prudent for John Collins to make a reasonable offer for her shares at that point, because he may be able to later apply to strike out any Section 459 petition which is presented, on the basis that the courts are likely to order him to purchaser her shares, and he had already made a fair offer for them.”  Counsel also advised that Section 459 of the Companies Act was not properly applicable to a situation in which there was a dispute between shareholders.  Counsel felt that Low’s main complaint was her dispute and working relationship with John Collins and her contractual entitlements as an employee.

What Counsel is saying is that the dispute with Low arises from her personal dispute with the Appellant.  The Company would benefit from getting rid of a minority shareholder with whom the majority does not get on but that issue did not “directly influence the management of the Company” at the present time.  The removal of Low as a shareholder was considered a solution to a potential problem which the Company may face in the future.  

Based on the advice from Counsel, the strategy was that the Appellant would ask Low for the repayment of a personal debt of £2,500, or the relinquishing of the ownership of the 2,500 shares in the Company, which would serve to veer off a possible minority action by Low in the future.  There are clearly two beneficiaries to this strategy.
In looking at the law, if an expense is incurred by the employer partly to provide a benefit to the employee and partly for other purposes such as the Company’s benefit, then a proportion of the expense incurred would be taxed as a benefit to the employee.  It is clear that a benefit may arise to both the Appellant and Company, but that does not mean, as discussed earlier, that the Appellant would not be taxed on the benefits which he receives.  The case of Rendell v Went is instructive.  In that case, Lord Reid stated as follows:

“The facts make it quite clear that the Company did incur expense in the provision of a legal defence for its director, the Appellant.  And it appears to me to be equally clear that the provision of that defence was a benefit within the meaning of this Sub-section.  It was argued that the expense had been incurred solely for the purposes of protecting the interests of the Company.  That may be so but it cannot be doubted that in fact the provision of his defence was a benefit to him: if it had not been provided by the Company, he would have had to pay his own defence or take the risk that lack of a proper defence might lead to him being convicted and sent to prison.  No-one had suggested that he would have obtained free legal aid and I can find nothing in the Act to support an argument that the benefit in fact provided by the Company ceases to be a benefit within the meaning of the Section if it is provided that the Company’s sole reason, motive or purpose was to protect itself and not in favour of its director.”

The main argument for the Appellant in Rendell v Went was that, although he had received a benefit, it was not worth £641 to him, and the sum should be apportioned.  A case can be made for apportionment if the expenditure had been made for two objects, only one of which was of benefit to the director.  In Rendell v Went there was only one object, that of protecting the Appellant.  The Company did not want to be deprived of his services, while he wanted to avoid going to prison.  The benefit was however for the director only, who accepted that he received a benefit and was accordingly taxed on the whole amount of the expenditure.  In looking at the “common interest” of the parties, the court noted that “an expenditure is not the less advantageous to a director because it suits or advantages his company to make it”.
Rendell v Went can be distinguished from the case of Wescott v Bryan.  In that case, a managing director wished to live in London but the Company insisted that he live in a large house close to the factory in North Staffordshire.  He paid the Company a rent of £140 per annum and £500 per annum for his services.  He paid the rates.  In the tax year, the Company spent £1,017 on gas, electricity, water, insurance of contents cover, telephone, cleaning, window cleaning, gardener’s wages and maintenance.  It is accepted that the house was too big for the taxpayer and for corporate purposes but no specific area was set aside for the Company’s guest.  The Court of Appeal thought that an apportionment would be appropriate in this case.  Since the payment was made for two specific objects, one to benefit the employee and one to benefit the Company, unlike Rendell v Went, where the sole beneficiary was the employee.  It is therefore necessary to have an apportionment of the money spent on benefits where there are two objects, not where there is only one.  
In relating these cases to the present case, it would appear that there is a benefit which is being obtained by the Company (the getting rid of a minority shareholder who may bring a minority shareholder action to wind up the Company) and there is a benefit to the employee (in having a repayment of his £2,500 and in obtaining a further 5% of the shares in the Company).  It is correct to say, therefore, that there has to be an apportionment of the sums paid in legal fees to establish that part which is attributable to the recovery by the Appellant of his loan and the obtaining of shares and the benefit which the Company obtains in getting rid of Low.
A question which arises in parallel with this issue is whether or not the Appellant provided fair value.  His Counsel argued that he did provide value in lending his name to litigation, especially the Grace litigation and given that he could have been liable for costs and he received an indemnity from the Company for such prospective liability.  They argued that this created fair value and consequently there was no benefit which is chargeable to tax.  The case relied upon to support this position is the case of Mairs v Haughey, where Hutton LCJ said:
“The Respondent received a payment of £4,506 in return for surrendering his contingent right to receive a payment under the enhanced redundancy scheme, and a Special Commissioner held at page 4D of his decision, that the amount did not over-value that right.  Therefore I consider that the Respondent did not receive “benefit” within the meaning of Section 154 where the money received was paid to him by way of fair valuation in consideration of his surrender of a right to receive a larger sum in the event of the contingency of redundancy occurring.”

The court accepted that there was a fair bargain in this case in that the consideration being given was a surrender of rights arising under the employer’s redundancy scheme.  It is accepted that the actual money paid was not over-valued but represented fair value for the right to surrender.

I do not think that in our case the same principle applies as in the above case.  Mr Collins is the managing director and main shareholder of the Company, he is as it were connected to the Company and makes all important decisions, with other directors.  The bargain is not at arms length and the lending of his name is, as his solicitors confirmed (see MJ Dismore statement para 13-15), the way in which the action had to be brought.  The rights which Mr Collins has given up (if any) were not rights arising under a separate contract with a third party and it cannot therefore be said that there is a fair bargain in the sense contemplated by the case of Mairs v Haughey.  Secondly, regarding the Low litigation, in the M J Dismore statement, she notes in commenting on a Brief to Counsel (“Brief”) from Grace & Co dated 11 March 1997 (referred to in the evidence as exhibit “MJD4”) that there was a consolidating of the Company’s and the Appellant’s cases and that where “a company is bringing a claim, and where an individual also happens to have a proper claim in his own right which as a by product, is likely to assist the Company, it may be in the interest of the Company for the Company to offer to fund both its own and the individuals claims (MJ Dismore statement, para 7).  This statement clearly recognises two claims, the Company’s “own” claim and the “individual’s” claim.  This mirrors the Brief to Counsel where he says “there are in fact two particulars of Claim which have now been consolidated; one is for the return of Company property and the second is a monetary claim for the return of monies lent for the purchase of shares.”  It may be procedurally correct to consolidate the claims in the Low and Grace litigations but there were clearly two different actions, one by the Company and one by the Appellant.  I cannot accept that the Appellant gave fair value in lending his name to the litigation.  He lent his name because his advisers felt this was the best way to bring the action and the action involved his claim as well as that of the Company.  It is clear that his advisers identified two separate claims with separate and distinct remedies but with mutual benefit.

8.	1998/1999 Assessment – Section 29 TMA 1970

8.1	The Appellants argue that Section 29 TMA 1970 Assessment for the year 1998/9 should not have been made.  They contend that where there is a discovery assessment, the burden of proof in establishing that the conditions allowing the normal time limit to be exceeded, is on the Crown.  It is initially on the Crown to show, on a balance of probabilities, that the Inspector of Taxes “could not have reasonably expected, on the basis of the information made available to him” (Section 29(5) TMA 1970) to know that the assessment was insufficient. They contend that in order to discharge that proof, it is necessary, as a minimum “for the Revenue to produce all the information described in Section 29(6)-(7) TMA 1970” and they had failed to do so.

8.2	The Respondents contend that no information on the benefit of the legal expenses paid by the Company was provided either in the Appellant’s self assessment return or the Company is P11D.  They recognise however that the Appellant acted honestly when they say (submission bundle 9 September 2004) that “Mr Collins would have no reason to tell Miss Outram (Inspector) that there was a personal benefit as he did not believe there to be any”. 

8.3	They further contend that there would have been no assessment for 1998/9, since by the latest time they could have made an enquiry, 31 January 2001, there had been no information given in the self assessment return or elsewhere to indicate that there was a potential benefit.  The first time the Inspector responsible for his personal tax affairs knew of the benefit was in the March 2002, after the enquiry window had closed. 

8.4	Both parties drew reference to the case law and in particular the recent case of Langham v Valtema (2004) STC 544.  The facts of this case are briefly as follows:

(a)	Mr Valtema was a director and controlling shareholder of a Company. The Company transferred to him the house where he lived for no consideration.  The property was valued at £100,000 by surveyors and this value was used as the basis for the declaration on the P11D from, Mr Valtema’s income tax return and the company’s corporation tax return.  The District Valuer decided that the actual value of the property was £145,000.  An out of time assessment was made on the taxpayer for the difference between the two valuations and the Court of Appeal held inter alia, upholding the Revenue’s appeal that the assessment could be made.  The court found that “applying the proper statutory tests, there was no basis on which (the Commissioners) would have found that the Inspector ought reasonably to have been aware, in the terms provided in Section 29(5), of the insufficiency of the assessment on the basis of the information contained in Mr Valtema’s tax return”.  

The court said in effect, that they would only preclude a discovery assessment where the return is self evidently incorrect.  In the case, the return did not show that the valuation was too low and it was not sufficient for the taxpayer to show that a valuation had been undertaken.

(b)	In the present case, the Appellant said that the Inland Revenue had not discharged the burden of proof in Section 29 TMA 1970 by producing all the information described in Section 29(6)-(7).  The Appellant did not make an entry in his self assessment returns nor did the Company’s P11D contain any legal expense benefit for the Appellant.  These are both documents the Appellant would have seen and submitted and these are the documents being relied upon by the Respondent for their assessment under Section 29(5) TMA 1970.  Legal expenses appeared as an item in the Company’s accounts but that was not likely to influence the inspectors’ awareness of a charge to the Appellant.  I understand that nothing was said, before March 2002, to either of the inspectors concerned with the Appellant’s tax affairs (Mrs S Brown and Mrs Outram) about a possible benefit in kind expense for legal expenditure incurred by the Company. 

(c)	I believe that the Respondents have discharged their burden of proof.  The document which is being relied upon to make the assessment, the Appellants self assessment return, is a document which he would have prepared, on his own or with advice, and signed.  The P11D’s which are in evidence do not show a legal expenses benefit.  These are the relevant documents and these are the documents which the inspector responsible for the Appellant’s tax affairs would have inspected.  The Crown says as much in their submissions.

(d)	The question that must be answered is whether the revenue officer could not have been reasonably expected to have known of the insufficient assessment on the basis of information made available to him.  The answer is that the officer could not have known that there was an insufficiency, since there was nothing written on the form to indicate a potential benefit.  It was clear that the Appellant was not dishonest and the Inland Revenue agree on this point but his honesty is not at issue.   The second question to be answered is was the return accurate and the answer to this is no.  The expectation is that a taxpayer will provide information which would be available to enable the revenue officer to consider the completeness and accuracy of the return being made.  The Appellant, who had the benefit of advisors, clearly had not met this standard.  It must be the case that if nothing is written on the self assessment (or other) forms where something should have been written, the information provided will be insufficient and the return incorrect.  In this case, it was not the fault of the Appellant that the return was inaccurate.  However, we are only concerned with the Revenue Officer and what he or she was reasonably expected to have known and done with information made available in the forms.

I find that the assessment made for 1998/9 was correctly made pursuant to Section 29 TMA 1970 and the return was self-evidently incorrect. 
 
Conclusion

I therefore find that this appeal should be dismissed for the reasons given above.

I would like to ask the parties to present arguments, within two weeks of the date of this decision, on the apportionment of the legal expenses incurred by the Company.  The apportionment would be on the basis that part of those expenses should be attributable to the Company and part to the Appellant.  It should be borne in mind that there are no fixed rules or formulae about how an apportionment should be done.  It is only required that the apportionment must be based on the facts of the case and lead to a result which is fair and reasonable.

DR KAMEEL KHAN
SPECIAL COMMISSIONER

Release Date: 3 December 2004

SC 3082-83/2003
££Firefly UK Ltd v Customs and Excise [2004] UKVAT V18845 (29 November 2004)