England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM CHANCERY DIVISION OF THE HIGH COURT
(MRS JUSTICE PROUDMAN)

		Royal Courts of Justice Strand, London, WC2A 2LL
		6th December 2010

Lord Justice Lloyd:

1. This appeal raises a point of construction about s.144A of the Income and Corporation Taxes Act 1988, arising from the exercise of share options by each of the individual appellants, which had been granted by Evolution Services Limited ("EGS"), their employer at the relevant time. EGS is the third appellant.
2. The appeal, brought with permission granted by Etherton LJ, is from an order of Proudman J made on 16 November 2009. By that order she dismissed an appeal from a decision of Mr John Clark, the Special Commissioner, made on 18 December 2008. Her judgment is available under the citation [2009] EWHC 3287 (Ch).
3. Section 144A has now been replaced by Income Tax (Earnings and Pensions Act) 2003, section 222.
4. The appellants argue that, according to the contention put forward by HMRC and the decisions below, the terms of section 144A in the relevant circumstances impose income tax on them in respect of an amount, as if it were an emolument, which they did not receive, or if they did receive it for a time they did not retain it. In those circumstances they argue that the tax imposition is grossly unfair and that it cannot have been intended to apply, and accordingly that the section should be read in such a way that it does not apply in the relevant circumstances. To examine this contention it is necessary to recount the facts in summary and then to consider the legislation in some detail.
5. The principal facts were set out as an agreed statement in the decision of the Special Commissioner from which the judge took her summary and from which I will take my even shorter summary. The two individual appellants, Mr Chilcott and Mr Griffiths, were employees of EGS. They were granted options over shares in a company in the EGS group. They each exercised those options in December to June 2001. By doing so they made substantial unrealised gains. The individual appellants contended from the outset that the exercise of those options did not give rise to a notional gain chargeable to income tax, but they did not pursue that contention in the end. They accepted eventually that notional gains chargeable to income tax under Schedule E by virtue of section 135 of the Taxes Act arose on the exercise of the options relating to the year ending 5 April 2002. One of them put in a correct self-assessment form including the relevant gain. The other had already put in a self-assessment return which did not include it and he made an amended return so that it did include it. Each of them then paid the tax due. So far so good, one might suppose.
6. The exercise of the share option amounted to a notional payment by the employer to the employee, which ought in principle to be subject to the deduction of tax under the PAYE system and also, incidentally, to the payment of National Insurance Contributions. Since there was no actual payment there could be no actual deduction. Special provision is made by the legislation for such a case. The employer should deduct the tax from any actual payment made then or later in the year to the employee, such as salary. If and insofar as it cannot do that, it remains liable to account for the tax.
7. The Act does not provide for the employee to be obliged to reimburse the employer but it has been held that such an obligation arises once the employer has paid the tax, for money had and received: see McCarthy v McCarthy & Stone Ltd [2006] EWHC 1851 (Ch), affirmed at [2007] EWCA Civ 664.
8. In October 2003 EGS accepted liability to HMRC for NIC arising from the share option exercise, and paid some £246,000 in settlement. HMRC assessed each of the individuals to further tax, and also assessed EGS to additional tax and NIC. All three appealed against those assessments. Eventually by the time of the hearing before the Special Commissioner only one issue was live, namely as to the charge to income tax assessed on the individuals by virtue of section 144A. The Special Commissioner dismissed the appeal on that point and so did Proudman J. The Special Commissioner expressed misgivings at the end of his decision, in paragraphs 64 to 67, as regards the possible impact of the section in the circumstances such as those of the present case. The appellants share those concerns, but would not regard that expression as adequate to meet the injustice of the situation.
9. Section 144A(1) was as follows:

"In any case where –

(a) an employer is treated, by virtue of any of sections 203B to 203I as having made a payment of income to an employee which is assessable to income tax under Schedule E,

(b) the employer is required, by virtue of section 203J(3), to account for an amount of income tax ('the due amount') in respect of that payment, and

(c) the employee does not, before the end of the period of thirty days from the date on which the employer is treated as making that payment, make good the due amount to the employer,

the due amount shall be treated as income of the employee which arises on the date mentioned in paragraph (c) above and is assessable to income tax under Schedule E."

10. This is a case in which EGS was treated as having made a payment to an employee which was assessable to income tax by virtue of section 203FB. Therefore section 144A(1)(a) is satisfied. That resulted in EGS being required to account for an amount of income tax under section 203(J)(3), so section 144A(1)(b) is satisfied. EGS was treated as making the payment at the time of the acquisition of the shares: see section 203FB(2)(a). Accordingly, under section 144A(1)(c) the 30 day period ran from that date. By the end of that 30 day period the individual appellants had not made good the due amount (that is to say the tax due) to EGS. It follows under the section, taken literally, that the individual appellants are to be charged income tax on the amount of income tax that was due from EGS. That is so, it appears, regardless of whether after the end of the 30 days the employee does in fact made good the tax to the employer or (which would be the same) in effect pays it over to the Revenue, as the individual appellants eventually did.
11. In McCarthy v McCarthy & Stone Limited [2006] EWHC 1851 (already mentioned) Peter Smith J mentioned in the course of his judgment the later equivalent of section 144A. He referred to it at paragraph 53 of his judgment. He described it as a rough-and-ready clause designed to penalise the employee who does not account to his employer. Mr Yerbury, the appellants' advocate below and before us, submitted that this is authority for the proposition that section 144A is a penal provision. In my judgment, that overstates the position. The character of that section was not in any way relevant to his decision and, when the matter came to this court on appeal, the section was not even mentioned. The comment of the judge is of course entitled to respect and it appears to me in one sense at least to be a fair comment, but it is no more than a dictum.
12. Proudman J dismissed the appeal because she considered the section to be clear and free from any ambiguity. She said that Mr Yerbury's argument would require the words in section 144A(1)(c) above the 30 day period to be deleted or ignored. She rejected an argument for reliance on parliamentary materials by reference to Pepper v Hart [1993] AC 593 because the section was in her judgment entirely clear. She also added that no help could in fact be got from those materials, there being no reference to this provision anywhere in the debates.
13. Mr Yerbury's principal argument on the appeal is that the section should be construed purposively and not so as to produce the absurdity of imposing tax on a notional benefit which the employee does not have or at any rate does not retain. He submitted that the section is legitimately concerned with cases of avoidance, of which this is not one, and with cases with a risk of tax leakage, which would arise if the employee does not repay money to the employer so the employer does not have the money with which to pay the tax. In his submission the section is not concerned with a case where the tax is indeed repaid by the employee to the employer, so that the employer is in a position to pay the tax and the tax is fully paid as it has been in the present case.
14. He pointed to the contrast between section 144A imposing the charge on an amount due if it is not made good to the employer within a stringent 30 day period, on the one hand, and the provisions of sections 154 to 156, on the other. Those sections deal with the taxation of benefits in kind taxed as emoluments on the amount of the cash equivalent. Under section 156(1) the cash equivalent is the cost of the benefit in question less so much, if any, as is made good by the employee to the provider of the benefit. Before us, he developed an argument that the case was covered by section 154 and that therefore the cash equivalent, being the tax due but not deducted, should be regarded as nil once the tax had been paid.
15. That argument faces at least two serious difficulties. One is that, although to receive a gross payment if one should only have had a net payment could be regarded as a benefit, it is hard to see, in my judgment, that it can be categorised as a benefit within the terms of section 154(1) and (2). Even if it could be so regarded, however, section 154(1)(b) excludes a case where the cost of providing the benefit is chargeable to tax as the employee's income by reason of some other provision. Section 144A imposes such a charge and, accordingly, section 154 is not applicable and is of no assistance to the individual appellants. Moreover, the contrast between section 144A and sections 154 to 156 seems to me to be a further argument against the grounds relied on in the appeal. The legislature is capable of making and has made provision for taxing only the net benefit in one class of case where a benefit is received but is later paid for or repaid, but in section 144A it has chosen not to do so but to make a different and more stringent, more rigid provision.
16. Mr Yerbury submitted that there was no unreasonable or abnormal period of delay in the present case. On exercising the option the position as to the application of section 135 was not clear. Time was needed to clarify and resolve that. Under the present legislation the period has been lengthened to 90 days rather than 30 days, but the same point arises in principle and even 90 days may be a quite short time in which to resolve any genuine doubts arising on the exercise of the option as to how the tax regime applies to it. There is, therefore, something to be said for Mr Yerbury's argument as to the potentially unfair and indiscriminate application of the section.
17. Proudman J disagreed with the Special Commissioner's comment at paragraph 65 of his decision that an employee who does not reimburse his employer is put in a better position than one who does. She said in effect that that situation ought not to arise because of the obligation to make good the tax to the employer held to exist in McCarthy. That is a fair point, but it does not dispose entirely of the Special Commissioner's other comment, namely that the tax charge is the same however long or short the time that elapses after the end of the period by which time the reimbursement is made good, and also the point that the period allowed for payment without suffering the consequences of a charge to tax under the section is rather short. That point was the basis for the Special Commissioner's suggestion as to extra statutory relief, or adjustment at any rate, that he expressed in paragraph 66 of his decision.
18. The provision made by section 144A needs to be seen against the context of the PAYE regime for income chargeable to tax under Schedule E generally. The employer is liable to deduct the tax and is required to pay it over to HMRC, which in a normal case is due to be paid within a short time after the end of the month in which the payment is made from which the tax has been deducted. In turn, the employee must include the gross income against his self-assessment tax return, but is entitled to a credit for the tax deducted whether or not the employer pays it over to HMRC. That is why, for example, an employee is not at risk of being made liable for tax which has already been deducted in the case, which has nothing to do with this instance, where the employer deducts the tax, but does not pay it over to the Revenue because of its insolvency. Thus, it is the employer who is bound to pay the tax to the Revenue, not the employee.
19. In a share option exercise case, however, there is no payment and therefore no deduction, so the employer may well not have sums due to the employee from which the deduction could be made, and for that matter in a case where the sums are substantial the employer may not have the money at all. I note that the gains said to have arisen in the present case on the part of each of the individual appellants were in one case just above and in the other case just below £1m. That gives rise to an obligation to deduct a large sum by way of Schedule E PAYE tax. In that situation one can well see a purpose in a statutory provision by which the employee is encouraged, to put it at its lowest, to put the employer in funds so that it can pay the tax.
20. As before Proudman J, Mr Yerbury on behalf of the appellants argued for the application of a purposive construction rather than a literal reading of the section. Thereby he sought to have recourse to what he said was the true purpose of the particular provision having regard to the context of the Act as a whole and taking account of the facts to which it does and to which it can apply. His submission was that the purpose of section 144A is to encourage employees in situations to which the section applies (which of course are not limited to the exercise of options) to make good the tax imposed on the employer in cases where the employer cannot deduct it on an ordinary PAYE basis and may not have the money with which to pay the tax in any event without being reimbursed. I would agree with that submission as to the essential purpose of the provision. It is a strong incentive towards prompt payment. To call it a penalty for not paying it promptly may be no more than looking at the other side of the same coin. The question is, however, what follows from regarding the purpose as an incentive towards prompt payment. Mr Yerbury's criticism of the literal reading applied by the Special Commissioner and the judge is that there could be no need for the section to apply, or not to its fullest extent, if the employee does reimburse the employer, albeit after the end of the 30-day period. If the employer is put in funds after that and then does pay the tax, then there has been no loss of tax and no tax leakage other than possibly some delay, in respect of which the tax regime has its own sanctions as regards interest on tax overdue.
21. Mr Yerbury argues that it is not reasonable to apply the section 144A tax in such a situation and that in such a case the section would be being used for a purpose for which it was never intended, leading to an absurd and unjust result. As to that, it has to be said that, since the result is the plain and obvious result of the application of a provision, the terms of which are clear, it is hard to argue that it was not intended, regardless of whether it is in certain circumstances harsh, unreasonable or unjust.
22. Then Mr Yerbury referred to the heading to section 144A "Payments etc. received free of tax". In the context, with the cross-reference to sections 203B through to 203I, this clearly refers to payments received without tax having been deducted in circumstances in which correctly a PAYE deduction ought to be made. That is exactly the situation in the present case. The fact that, as required by the legislation, eventually the tax is paid does not mean that the payment is not one such as is contemplated by the heading, whether or not the heading is a legitimate aid in this respect.
23. Mr Yerbury also addressed submissions by reference to the interpretation of deeming provisions. However, section 144A is only in part a deeming provision. It imposes a liability to income tax on a given amount of money in given circumstances. It does provide that this amount is to be treated as income of the employee assessable to income tax under Schedule E, but it does not need to proceed on a fiction that the employee has actually received it. Instead, it proceeds on the fact that the employee has received the sum without prior deduction of income tax and has not within a specified time paid the amount of the tax back to the employer. Underlying Mr Yerbury's arguments was the thesis that the section is really designed for cases of tax avoidance whereas the present case, he submitted, would not concern tax avoidance so that the section ought not to be applied to it. That is an argument to the effect that the section should not apply to the share option case or at any rate not to one where eventually the tax is made good to the employer. However, on the literal reading a payment does apply to such a case whether or not that is fair or reasonable.
24. Proudman J said that in her judgment Mr Yerbury's argument would require the deletion from section 144A(1)(c) of the reference to a 30 day period. That, she said, and she was right, is not a permissible approach. If there is to be a charge to tax such as section 144A imposes, there has to be a date on which the deemed income is treated as arising so that the relevant tax accounting period can be known.
25. Mr Yerbury's point would be met better by an analogy with section 156 such that, if and when the tax is made good to the employer, albeit late, the extra tax liability is cancelled or mitigated. But there is no such provision in section 144A and it cannot be read into it. Before us, Mr Yerbury came to submit that section 144A should be read as creating a charge as to which the board would have a discretion whether or not to impose it so that if the employee did eventually reimburse the employer it might choose not to charge the additional tax. That is also, it seems to me, an impossible construction. Mr Nawbatt for HMRC pointed out that, whatever Parliament may have thought when section 144A was first enacted, which was in the Finance Act 1994, it has re-enacted the same provision with an amendment extending the period, as I have mentioned, so must be taken to have affirmed the principle. That submission of course does not affect the construction of the original section, but it could be relevant to one's view of the likelihood of any further review of the provision.
26. Section 144A is clear and unambiguous in its terms, as Mr Yerbury accepted at the outset of his submissions this morning. It applies to a variety of cases. Some of them have connotations of avoidance. Others however are more to do with the practical difficulties that arise in a number of different types of situation as regards the collection of tax. Share options are in the latter category, because there is no actual cash payment by the employer to the employee. Not only is the provision clear in its meaning and effect, but it is also understandable why there should be such a provision. A different approach might have been adopted to deal with the need for an incentive, to say the least, or encouragement to the employee to make a prompt payment to the employer, but this is the provision that was chosen.
27. As I say, it is clear. It applies to this case. In my judgment the Special Commissioner and the judge were both correct and the appeal should be dismissed.

Lord Justice Sedley:

28. I agree. I would add it has been a new experience, for me at least, to listen to an argument that, although the words of the statute are plain and unambiguous, they should be construed as not meaning what they say, without any proposed remedial or alternative construction being put forward. It was only when prompted by the court that Mr Yerbury took the point that "shall" in section 144A should be construed as if it were "may". Although this without doubt reflects the logic of his foundational argument that the section is capable of operating very unfairly, it involves not construing but upending both Parliament's words and their manifest intent, which is not merely to encourage compliance but to secure it by prescribed means. Without any authority or principle to support it, the argument does not begin to stand up.
29. Nor does it receive any assistance from the fact that no parliamentary debate was directed to the section in the course of its passage. To attempt to derive support from such parliamentary silence is in my view to misuse the limited permission given by Pepper v Hart to use aspects of parliamentary debates as an aid to construction. It is an unconstitutional invitation to the court not to rely on but to call in question proceedings in Parliament, contrary to Article IX of the Bill of Rights.

Master of the Rolls:

30. I agree with both judgments. It is worth reminding oneself that in Pepper v Hart Lord Browne-Wilkinson said: "It is for the court to construe the words that Parliament has enacted and it is the court's duty in doing so to give effect to the intention of Parliament in using those words". Later on in the same passage he said "The courts cannot attach meaning to words which they cannot bear".
31. Section 144A of the Taxes Act is, as Mr Yerbury accepts, clear in its terms and has the meaning for which the Revenue contends, as the Special Commissioner and Proudman J held. It is time that its meaning could at least in some circumstances be regarded as penal, as it applies even if "the due amount" is "made good" on the 31^st day, but that does enable this court to rewrite such a clear statutory provision. The fact that some might regard the operation of section 144A, according to its terms, as penal merely emphasises that the court should construe it with care and if there is a narrower construction less beneficial to the Revenue, more beneficial to the taxpayer, available then the court should at least seriously consider it and, if appropriate, adopt it.
32. The fact that there is a time limit, as there is in sections of many Acts, merely carries with it the inevitable consequence that if an event occurs just before the time limit expires, it will produce a different result (sometimes a radically different result) from that which applies if the event happens just after the time it expired. Neither of these two points, taken on their own or together, entitle this court to rewrite what is, and as is accepted by the appellant, to be a clearly drafted section.
33. In those circumstances, I agree with my Lords that this appeal must be dismissed.

Order: Appeal dismissed