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Cite as: [2009] SFTD 209, [2009] UKFTT 95 (TC), [2009] STI 1970

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PA Holdings Ltd & Anor v Revenue & Customs [2009] UKFTT 95 (TC) (07 May 2009)
NATIONAL INSURANCE CONTRIBUTIONS
Liability

[2009] UKFTT 95 (TC)

TC00063

Appeal number SC 3142/2007

Income tax – other – whether sums paid to individuals by a company as a dividend financed from a capital contribution to the company from employee benefits funds derived from the individuals' employing company a distribution chargeable under Schedule F or emoluments from employment under Schedule E and subject to the PAYE Regulations – rules requiring exclusivity of Schedules applied

National Insurance contributions – liability – whether a decision that income taxable under Schedule F of the income tax as a distribution prevented the income also being subject to National Insurance contributions as earnings from employment.

FIRST-TIER TRIBUNAL

TAX CHAMBER

PA HOLDINGS LTD

and KULLY JANJUAH Appellants

- and -

THE COMMISSIONERS FOR HER MAJESTY'S

REVENUE AND CUSTOMS (Income tax and NI Contributions ) Respondents

TRIBUNAL: Upper Tribunal Judge David Williams

Tribunal Judge Adrian Shipwright

(formerly special commissioners of income tax)

Sitting in public in London on 17-25 November 2008

Stephen Brandon QC, and Mr Rory Mullan, instructed by Speechley Bircham LLP, solicitors, for the Appellants

Malcolm Gammie QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2009

DECISION

The Appellants in these joined appeals are P A Holdings Ltd ("PA") in both appeals and Kully Janjuah, the tax manager, and an employee, of PA in respect of the appeals about National Insurance contributions ("NI contributions").

The central issue in these joined appeals is whether the Respondents ("HMRC") are entitled to assess certain sums received by Mr Janjuah and other employees of PA as sums on which HMRC are entitled to:

(a) income tax payable by PA under regulation 80 of the Pay As You Earn Regulations 2003 ("PAYE Regulations") and

(b) NI contributions from both PA and Mr Janjuah by reason of decisions under section 8 of the Social Security (Transfer of Functions) Act 1999 ("the Transfer of Functions Act").

The scope of these decisions

It was agreed by us with the parties that we would examine the decisions taken by HMRC under the PAYE Regulations in principle and that we would not deal with matters of quantum or timing.

The PAYE decisions relate to sums received by employees in the tax years 2000-01, 2001-02 and 2002-03 for the accounting years 1999, 2000 and 2001 respectively. As there were differences in the way events happened between those years, we examine what happened in each of those years. We look at 1999 with 2000-01 first and then consider the differences that apply in later years.

It was agreed by us with the parties that other assessments involving a company associated with the Appellant company should also be held over pending our decisions in these appeals.

It was agreed by us with the parties that for the purposes of examining liability to NI contributions we would examine the position of one employee only, with any assessments against other employees being held over. That employee is Kully Janjuah, tax manager of PA at all times relevant to the appeals. He was an appellant before us in connection with NI contributions but not the PAYE Regulations. He gave full evidence before us for PA. Having taken advice, he made no separate submissions nor gave any separate evidence to us as an individual appellant.

The nature of section 8 decisions

Decisions about NI contributions are made by HMRC under section 8(1) of the Transfer of Functions Act. Decisions under that section apply for all contribution and benefit purposes of Parts I to V of the Social Security Contributions and Benefits Act 1992. A section 8 decision is therefore of its nature one that affects the individual employee as well as the employer. It also affects benefit entitlements as well as contribution liabilities. The decision made by HMRC under section 8 must, under the relevant regulations, name both the employer and the employee to whom it applies. See regulation 3 of the Social Security Contributions (Decisions and Appeals) Regulations 1999 (SI 1999 No 1027). If one has a liability to pay then so in principle does the other.

In practice, a decision about the specific liability of both employer and employee to contributions depends on a number of factors. These may include the age of the employee, the marital status of the employee, the nature of any pension arrangements between the employer and employee, and the total earnings of all kinds in the earnings period of the employee from that employment and associated employments. Such decisions therefore involve factors in addition to those that are relevant to decisions for income tax and PAYE purposes only.

Both the employer and the employee have a right to appeal against a section 8 decision by HMRC. (See regulations 3(3) (right of appeal) and 4(1) (notice of decision) of the Social Security Contributions (Decisions and Appeals) Regulations 1999). It may be (and in practice sometimes is) that the employee takes a different view of the status of his or her employment, or the nature of a payment made to him or her by the employer, from that taken by the employer. Further, a full decision deciding the amount of NI contributions to be paid can only be made when all the relevant factors have been taken into account. A section 8 decision can therefore only be considered properly on appeal when both the employer and employee have been given notice of the decision and have had the opportunity to appeal or to join in any appeal by the other party.

As the matter was one of some doubt in these appeals, we emphasise our clear view on these points. In these appeals we decided after hearing from all parties to consider only the section 8 decisions affecting Mr Janjuah. He is therefore an appellant to those decisions. But we do not consider his individual liability in detail. We are therefore concerned, as a matter of principle, only about whether the sums received by Mr Janjuah from the arrangements examined in this decision are sums liable to be assessed for NI contribution liability. We do not attempt to examine issues of amounts of liability or timing.

Our decisions are therefore given in principle. The parties may refer the appeals back to us, or any linked appeals to us, for further decision should this prove necessary.

The individuals, bodies and arrangements involved

We refer to the arrangement or scheme established to handle the profits of PA that were intended to distribute profits from 1999, 2000, and 2001 to employees as "the arrangements". The arrangements relate to the 1999 ET (for these and other abbreviations used in this decision see the next paragraph) and not to the 1995 ET.

The following were involved in the arrangements. We use the abbreviation in the first column to indicate the individuals, bodies, trusts or schemes indicated in the second column

Abbreviation: This covers:

PA The Appellant company (and, subject to paragraph 4 above, in so far as relevant, its subsidiaries, lists of which appear in the annual reports and accounts). PA was an employee-owned company resident in the United Kingdom with shares held by employees or by trusts established for the benefit of employees.

PA employees "PA employee" or "staff" includes all executive directors. The 1999 PA Report and Accounts states that there were 2,700 staff based in 30 offices in 20 countries. About 1,500 of the staff were based in the United Kingdom. PA followed consistent employment and pay philosophies for staff. They were all employees and not self-employed. PA was contractually bound to pay each of them salaries that were set as median salaries in the market for each particular form of employment. In addition, PA paid a significant amount of its profits into employee trusts from which awards were made to employees.

HMRC Her Majesty's Revenue and Customs, the Respondents. "HMRC" includes the National Insurance Contributions Office and HMRC's predecessors, the Inland Revenue and the Contributions Agency.

Ellastone Ellastone Ltd, a Jersey registered company established on 21 January 2000 under registered number 76055 to assist the arrangements. It was authorised on the same day to issue up to 10,000 ordinary shares of £1 nominal and 50,000,000 unclassified shares of £0.01 nominal by the Jersey Financial Services Commission. Five ordinary shares were issued on 25 January 2000 by Ellastone to Juris, and five to a company similar to Juris and known as Lively Ltd. On the same day Juris acknowledged and declared that it held the shares as nominee of Mourant as trustee of the 1999 ET. Directors were appointed from Mourant on that day. It is common ground that Ellastone became United Kingdom resident when senior PA staff members were appointed as its directors two days later. Maxine Drabble was appointed as its company secretary. Ellastone was formally dissolved on 24 September 2004 when the Jersey Financial Service Commission registered a statement from Ellastone that it had no assets or liabilities. It was subsequently retrospectively brought back into existence by an Act of Court of the Jersey Royal Court on 2 May 2008 declaring the dissolution void, restoring the company to the register and rectifying errors in its share register. The Court also declared that the payments made by Ellastone to Juris in 2001 and 2002 were payments of dividends.

Juris Juris Ltd. A Jersey registered, Jersey resident company. It was a nominee Company established by Mourant. Its postal and electronic addresses were at all times the same as those of Mourant. It was registered as the holder of 24,000,000 shares in

Ellastone on 16 February 2000. Juris declared on 23 March 2000 that it held the shares in Ellastone as nominee of Mourant.

Mourant Mourant & Co Trustee Ltd. A major Jersey based trustee company entirely independent of PA. "Mourant" includes other members of the same group of companies.

The 1995 ET An employee benefit trust established for PA in 1995. It remained in existence and use alongside the 1999 ET. No point arises about the 1995 ET in these decisions.

The 1999 ET A settlement made between PA as settlor and Mourant as the original trustee on 16 December 1999 and to be known as the "P A Holdings Ltd 1999 Employee Trust". It was established by deed under the laws of the Island of Jersey as part of the arrangements. The purpose of the Trust is stated in the recitals to be "to motivate and encourage employees in the performance of their duties by the provision of bonus incentives and other rewards at the discretion of the trustees." Mourant accepted the role as original trustee and initial funds of £10,000 from PA by formal resolution of the same date.

The Restricted The "PA Holdings Limited Restricted Share Plan" adopted by

Share Plan Mourant as trustee of the 1999 ET on 27 January 2000. The Plan empowered Mourant to grant "awards" to "eligible employees" "over such number of shares" in the capital of Ellastone as it decided in its absolute discretion. The individual paragraphs in the Restricted Share Plan are referred to as Rules. Rule 13.5 provides that the Plan and all awards made under it are to be governed by and construed in accordance with Jersey Law. Under the Rules any eligible employee granted an award received an Award Certificate indicating the number of shares subject to the award. The Rules require Mourant to pay all dividends or distributions accruing to those shares to the employee. The shares are to be transferred to the employee awarded the shares at the end of a defined restricted period.

No point arises about that restricted period in this decision.

The evidence

The following gave oral evidence to us:

Emma Boustouler (previously Emma Withers). A Chartered Secretary. A trust administrator in Mourant's group 17 with administrative responsibility for the 1999 ET and Mourant's involvement in the arrangements. Later promoted to assistant group manager.

Maxine Drabble A Chartered Secretary. Company secretary of PA and of Ellastone. Later appointed a director of Ellastone.

Bill Field A Chartered Accountant and consultant with Ernst & Young. Responsible for leading the Ernst & Young involvement in the arrangements.

Jonathan Hook A corporate analyst employed by PA. He was involved in administering and running the bonus process, and advising Mourant. He later became global information manager of PA.

Nick Hutchinson A commercial financial manager employed by PA with responsibilities at the relevant time for credit and cash control.

He gave evidence as a beneficiary of the bonus schemes.

Kully Janjuah A Chartered Accountant. One of the Appellants in the NI contribution appeals. Head of personal tax for PA. An employee of PA and a beneficiary of the 1999 ET and the arrangements in each of the three years in question.

Heidi Wilson A non-practicing English solicitor. At the relevant times she was employed by Mourant as a lawyer and later became a director.

A further former employee of Mourant was to give oral evidence to us but was unable to do so. HMRC agreed that her witness statement should stand as evidence on the basis that she gave no specific evidence about the arrangements. We found no need to put any weight on that evidence.

We record the general observation that we found all the witnesses helpful and cooperative. There were inevitable difficulties in some of them recalling, with any precision, events ten years ago, particularly where the witness had ceased to be involved with PA some time ago. We found none of the witnesses to be evasive or to be lacking in any way in credibility. Any unreliability in evidence was of the sort to be expected of such witnesses long after the events about which they were being asked. On some matters, documents provided details that the witnesses could not provide, even when led. Where there were contemporaneous documents speaking to facts on which the oral evidence was different, we put weight on the contemporary evidence. That apart, we accepted the evidence of all the witnesses.

We received several bundles of documents produced by PA, Mourant, Ellastone and HMRC. These included the key documents behind the arrangements. We find as fact that none of the documents involved in the arrangements were, or were intended by any relevant person to be, shams. We make this finding despite repeated references in argument for the Appellants about the question whether any documents were shams. We were addressed at some length by Mr Brandon QC about the law relating to sham documents. We find it unnecessary to go into that argument. Mr Gammie QC throughout made it clear that he was not contending on behalf of HMRC that there was a sham, and we see no reason why he should have taken any other view.

The parties were unable to agree a statement of facts before the hearing. Mr Brandon QC helpfully presented us with the Appellants' contended facts. Mr Gammie QC, after hearing the evidence, was able to agree some of the facts but the central factual issues remained in dispute.

The disputed issues

The core dispute between the parties was whether the arrangements were effective in converting sums payable to employees as bonuses that were liable to income tax to be collected under the PAYE Regulations and to NI contributions into sums that were taxable only as distributions received by the individuals concerned as shareholders in a company and not as emoluments or earnings of the employees.

PA put its case forward on the basis that the relevant payments were dividends, or at any rate payments within the charge to tax on distributions by a United Kingdom resident company under section 20 and Schedule F of the Income and Corporation Taxes Act 1988 ("ICTA"). They could not therefore be emoluments or earnings as section 20 gave the distribution charge precedence. There was therefore no liability in respect of those payments under either the PAYE Regulations or section 6 of the Social Security Contributions and Benefits Act 1992.

HMRC put its case forward on the basis that the relevant receipts were emoluments or earnings. They were therefore liable to be taxed by reference to the PAYE Regulations and to liability to NI contributions. The receipts were not chargeable to tax under Schedule F as dividends or distributions.

Our view is that the question before us is wider than either argument. We drew attention to this in the hearing, and invited submissions. As we observed at the hearing, it did not follow that the view of PA that the payments were distributions and the view of HMRC that the receipts were emoluments or earnings were, as a matter of principle, mutually exclusive. One was looking at payments while the other was looking at receipts. Nor did it follow that their arguments were jointly necessarily exhaustive of the possibilities.

As indicated to the parties, we approach these appeals by asking ourselves the following questions:

(a) were the sums paid as distributions?

(b) were the sums received as emoluments or earnings?

(c) if both (a) and (b) apply, were they both distributions and earnings at the same time, or does one of those categorisations prevail over the other?

(d) if neither (a) nor (b) apply, what was the nature of the payments/receipts?

Some general issues

It is important to emphasise a number of aspects of the appeals about which we took a clear view in the hearings and which we confirm.

First, there is no allegation on the part of HMRC, and in our view no basis for any allegation, that any action within these appeals was in any way fraudulent or a sham. We so find as fact. PA undertook the arrangements on proper professional advice at every stage. The arrangements were fully documented at every stage. If anything, we had too much detailed evidence about the arrangements rather than too little. We accept this as reflecting a proper concern on the part of the Appellants to discharge the burden of proof on them.

Linked with this, we find as fact that the arrangements were not an "off the shelf" scheme. While the underlying idea was suggested to PA by Bill Field and others, PA chose its own advisers and partners for the arrangements. In so finding, we put weight on the fact that PA chose its own trustee, and in addition was required by that trustee, Mourant, to satisfy it about a number of matters before Mourant consented to be involved in any way with the arrangements. PA reached decisions itself about how the scheme was to be run. So did Mourant as the trustee of the 1999 ET with regard to its involvement in the arrangements. In so doing, they took and accepted advice and noted possible precedents, but they did not follow them without at each stage considering whether and how they should do so.

We specifically find that the exercise of the discretion by Mourant and its employees to award advantages to named individual employees (including Mr Janjuah) was a genuine exercise of discretion by the trustee company in each of the three years in which the exercise was performed. In so finding, we accept the evidence from employees of both PA and Mourant at the time about the detailed and careful way in which Mourant considered the suggestions given to it by PA about the exercise by it of its power to award advantages under the 1999 ET. Mr Gammie QC, having heard the evidence, did not seek to contend otherwise at the close of the appeal. That being so, we do not need to detail the extended evidence from Heidi Wilson, Emma Boustouler and others about how Mourant and its directors and employees handled the awards of advantages. It is recorded fully in the transcripts. We accept it.

We find as fact, both with respect to Mr Janjuah specifically and with respect to PA employees generally for the purposes of the PAYE decisions, that the standard terms of employment by PA excluded any legal entitlement on the part of nearly all staff to a bonus. Clause 4.3 of the standard consulting contract used by PA at that time provided:

"You may participate in the Bonus and Share Scheme(s) ("the Schemes") of the Company in accordance with the provisions of the Rules applicable thereto in force from time to time. Any payment or issues which may be made to you in accordance with the Rules are entirely at and within the absolute discretion of the Company."

Paragraph 4.4 provided:

"The Company provides no warranty, guarantee or any other form of undertaking whatsoever that any allocation of payment under the Schemes will be paid to you during the period of employment."

We note in passing that the Schemes (as defined in that provision) appear to include the 1999 ET. The 1999 ET was not a scheme "of" the company. But no point was taken on that in the appeals, and we pursue the issue no further.

We were given evidence by Mr Janjuah and other PA employees about the bonuses. We were shown documents about the presentations made by PA to its employees at the time. The evidence suggested that any course of dealing between PA and its employees was aimed on the part of the employer at reinforcing the discretionary nature of any award of a bonus to an employee, and there was no clear evidence to suggest any contrary trend from employees. We were told of the failure of one challenge to a refusal to pay a bonus. We find that the relationship between PA and Mr Janjuah was accurately described in the employment contract and other evidence as one where the employer had a discretion whether to award a bonus, and the only entitlement – if it was an entitlement – of an employee was to be considered for a bonus. That applied equally, so far as relevant, to most other employees. We find that the discretion reserved by PA in connection with bonuses was a genuine discretion properly exercised by PA.

Some documents and arrangements involved in the 1999 ET derived their legal validity from the law of Jersey and the Jersey courts. Neither party sought to introduce any evidence about the law of Jersey on any point save for an issue on which the Royal Court in Jersey was asked to rule. Such evidence would, of course, be a matter of fact for us. In the absence of any such evidence, we must act on the assumption that the law of Jersey is the same as the law of our jurisdiction (more specifically, England and Wales). We expressed some discomfort about some aspects of that at the hearing. For example, it did not seem obvious to us that some relevant aspects of the law of trusts in Jersey would be the same as that decided in the courts of England and Wales. Nonetheless, in the absence of any evidence to the contrary, we accept that we should follow the authorities binding on us in England and Wales as applicable equally to this case.

PA's approach to profit sharing

PA was (until a restructuring in 2008) an international group company with headquarters in the United Kingdom and subsidiaries or branches in over 20 countries. The group offered consultancy services. The group was an employee-owned service company with employees resident in many parts of the world. Its commercial standing, and theirs, was dependent upon the quality of all and each of its employees/shareholders.

PA had a clear and well-publicised philosophy about paying its employees/shareholders. The optimal approach to employee pay was to pay staff median salaries and then to award them generous bonuses from profits by individualised annual awards. The 1999 Report and Accounts for PA state: "All employees participate in employee share schemes."

PA allocated a large proportion of its annual profits to the payment of these bonuses. In each of the years in question, and for some years before, PA assigned a sum that was stated to be 57.4 per cent of its end of year profits to employee benefit schemes. We are not entirely clear to what the 57.4 per cent is linked. We note that in the 1999 Report and Accounts bonus payments of £50,564,000 are recorded at Note 4 as part of staff costs together with salaries, social security costs and pension costs. Those costs are deducted in the consolidated accounts as personnel and direct costs before gross profit is declared. The 1999 Accounts show gross profit as £75,896,000.

Accounting Policy (e) at Note 1 of the Accounts records that "bonuses are provided for at the maximum payment level. Where it is not possible to define the exact amount payable, the provision held in the financial statement will be sufficient to extinguish fully the Group's liability in respect of bonus scheme payments". "Bonuses" are recorded at Note 19 as creditors with amounts falling due after more than one year. The amount shown in 1999 under this head is slightly below the amount shown at note 4.

PA had an accounting year based on the calendar year. We were shown a memo copied to PA in August 1999 about the provisions to be made in the Accounts. We note that it was suggested that for the bonuses to be included in the accounts for 1999 as employee costs, it had to be shown that the requirements of FRS 12 were met. For this to be the case, there had to be a "constructive obligation" on the part of PA to accept responsibilities such that the employees had, as employees, a valid expectation before the end of the relevant financial year that PA would meet those responsibilities.

As we have found, save for a very few staff, bonuses paid from those profits and amounts paid through PA's Scheme were not received as matters of contractual entitlement but at the employer's discretion. The precise bonus that an employee received reflected his or her own efforts, the efforts of the part of PA which he or she worked, and the profitability of PA a whole. That was, we also find, within the stated policy of PA as recorded in its Reports and Accounts.

As PA was an employee-owned company, the main audience for its Reports and Accounts was that of its employees/shareholders. That must be so whether the shares are owned directly by the employees or through trusts of which they are the beneficiaries. We therefore regard the Reports and Accounts as part of the way in which PA stated its position as employer. Another consequence of the particular structure of PA was that if it wished to benefit its staff as shareholders rather than employees then it had the option of paying a dividend on its shares rather than designating funds as employee costs before arriving at its gross profits. It is clear therefore, in our view, that the Reports and Accounts confirm that the objective of PA behind the arrangements was to benefit those individuals as employees rather than as shareholders.

The usual share of PA's profits for 1998 and immediate previous years were paid into the 1995 ET. All eligible employees were entitled to be considered for awards as beneficiaries of that trust. The trustees awarded benefits across all sectors of the company in accordance with formulae (set out as "Rules") established with the company. The sums were awarded to those resident and ordinarily resident in the United Kingdom on the same basis as those who were not so resident. Those awarded bonuses for 1998 received them in March 1999. Where appropriate, the sums paid were subject to deduction of income tax under the PAYE system and to the payment of NI contributions. This approach continued to be adopted after 1998 for those employees who were not within the 1999 ET. There is no dispute between PA and HMRC arising from the 1995 ET in the years relevant to this appeal.

The arrangements

In 1999 PA agreed with Ernst & Young that it would consider a bonus planning proposal put forward by Ernst & Young. It subsequently agreed to pay Ernst & Young a fee of £335,000 for use of the intellectual property comprising their proposal and one payment of a dividend. The fee for use and operation of the proposal in subsequent years was to be the subject of separate agreement. The proposal was to re-route bonuses awarded to employees so that they were paid as dividends of a United Kingdom resident company and so were taxed as distributions. As we have found, PA did not simply buy and use a pre-arranged scheme. Had that been the case we might have reached other findings of fact in these appeals. PA examined the scheme and had it modified in a number of ways, taking its own separate expert legal and other advice in so doing. In particular, and again as we have found, it brought in an independent trustee of its own choosing (Mourant).

HMRC did not accept that the arrangements were effective to turn the sums paid to employees into a form that prevented them being payments within the scope of the PAYE Regulations or the scope of NI contribution liability.

We examine some aspects of the arrangements in detail in this decision so far as necessary for the decision. More generally, the following is a summary of the key elements as presented to us for PA. It is to be read with the descriptions in paragraph 12. We find as fact that these events occurred as described:

(1) PA, Mourant, and their advisers (including Ernst & Young) conducted discussions about the proposed arrangements starting in March 1999. Following these discussions PA resolved to set up the 1999 ET. The deed of settlement establishing the 1999 ET was executed on 16 December 1999. The terms of the settlement were discussed by both PA and Mourant with their own advisers and did not follow the precedent offered by Ernst & Young.

(2) Before the close of the 1999 accounts year, in December 1999, PA paid £24,600.050 to Mourant for payment into the 1999 ET from PA's income for 1999. This was recorded in the 1999 Report and Accounts as "staff costs" in that year.

(3) On 27 January 2000 Mourant adopted the Restricted Share Plan for making awards in the 1999 ET to eligible employees. It also decided to establish Ellastone. On the same day it accepted the funds received from PA as an accretion to the 1999 ET.

(4) Following a formal request from Mourant, PA staff calculated bonus awards for all employees for 1999 in early 2000 using a set formula in the same way as in the previous year. PA staff presented proposals to Mourant for Mourant's consideration, and were questioned by Mourant about the proposals. Mourant gave separate and detailed consideration to the proposals and changed some of them.

(5) In parallel with this presentations were made to PA employees, starting with an all-staff email on 18 January 2000, about "exciting proposed changes to the delivery of current bonus awards". It invited those of its employees who were resident and ordinarily resident in the United Kingdom to choose between receiving a bonus for 1999 from the 1995 ET or from the 1999 ET. Most chose to receive any bonus from the 1999 ET by the closing date, 21 February 2000. Some did not. Those who did not choose to use the 1999 ET remained entitled under the 1995 ET.

(6) On 4 February 2000 Mourant transferred to Ellastone almost all the funds paid into the 1999 ET by PA as a capital contribution.

(7) Having done so, Mourant then subscribed for and was allotted 24 million 1p redeemable preference shares in Ellastone. It directed that the restricted preference shares be held by Juris as its nominee. These were registered to Juris on 16 February 2000. On 23 March 2000 Mourant as trustee of the 1999 ET directed Juris to hold the shares "as nominee for the individuals, who have beneficial ownership of the shares" but also that "the shares are to be held absolutely to the order of the trustee and not the individual".

(8) On 13 March 2000 Mourant as trustee of the 1999 ET used its powers to "grant awards in accordance with" the Restricted Share Plan over 23,757,869 restricted preference shares in Ellastone to a list of PA employees scheduled to the resolution, individual awards being based largely but not entirely on PA information. Not all employees received an award. The resolution states that this was done "in order to enhance and retain their goodwill as employees "of PA". It also resolves to direct Juris to hold the Ellastone shares "as nominee for the individuals on the attached spreadsheet for the number of shares shown opposite their respective names". Legal ownership of all the shares was retained by Juris as nominee.

The resolution also set the restricted period. However, on 23 March 2000, by a further resolution of the trustee, that was corrected as the previous resolution had stated the restricted period wrongly. Nothing turns on that error in this decision.

(9) Employees were sent an award certificate the following day if they were awarded beneficial interests in shares. The certificate confirmed that the trustee "has awarded you a beneficial ownership of" the number of shares stated on the certificate.

The certificate was accompanied by a letter from Mourant explaining the nature of the award. The letter also asked the recipient to confirm or notify amendment to the details of his or her bank account as set out in the letter for the direct payment to him or her of any dividend.

(10) On 24 March 2000 the Ellastone directors declared a 99p dividend for each 1p share. This was funded from the capital contributed to Ellastone by the 1999 ET. The total dividend was paid to Juris as registered owner on 28 April 2000.

(11) On 25 April 2000 Mourant gave authority to authorised signatories of Juris to transfer the dividend payments to the awardholders. This was done by reference to the information checked with individuals in a letter sent to them with the award certificates. Payments were subject to an agreed deduction of a 25 per cent withholding, the gross amounts reflecting the size of the awards of interests in the shares. Juris made the payments to the employees as agent for Mourant. In doing so, it used PA payroll information.

(12) On 19 November 2001 Ellastone redeemed the 1p shares, the redemption monies being payable to Juris. Ellastone appointed Mourant as its agents for the purposes of the redemption, and on 8 November 2001 Mourant accepted this. It gave Juris instructions on handling the sums received. The total paid out was the total held by Ellastone for the shares redeemed. Juris then paid sums to the individuals identified at step (8) through the payroll of PA, with the agreement of Mourant and PA.

(13) Those steps were repeated for profits from the 2000 and 2001 Accounts, with some factual differences as below. Essentially, however, the steps were repeated.

(14) A major difference between the arrangements in 1999 and 2000 and those from 2000 and 2001 was the failure properly to register the Ellastone shares in the name of Juris after the first year. It was belatedly realised that this had happened after the dissolution of Ellastone. This occasioned the action before the Royal Court of Jersey and the reinstatement and correction of the register above. That is, in this jurisdiction, a matter of fact not law. We find that the facts are to be accepted as declared by the Royal Court save that the reference in Jersey to the payments being dividends is not of any significance with regard to the payment of, and receipt of, those sums from the standpoint of United Kingdom laws.

(15) There were also differences of timing between the order of events set out above and the repeat of those events in the following two years. Again, we find that none of those matters of timing made any material difference to the legal analysis of what happened for the purposes of this decision.

The approaches of the parties

HMRC took the view that there was a common intention and understanding behind all the steps set out above. And it took the view that the individual who received awards under the Restricted Share Plan and the 1999 ET received them because of their employment by PA and not because of the Restricted Share Plan or other parts of the arrangements. This happened either because PA orchestrated events or because Mourant, as the creature of PA, did so. In the view of HMRC it mattered not which was the accurate description. A further and alternative interpretation was that the steps in the arrangements all occurred as evidenced, but they were no more than a mechanism to be viewed as a composite whole by which PA delivered the bonuses to the employees as employees.

Mr Gammie QC asked us to look at the reality of what had occurred. It was a game. He used the analogy of a game of cards. He asked us to observe the real rules of the game not those rules that the players purported to be following. Mr Gammie QC's metaphors in his skeleton argument drew on card games that were medieval in their origins, but he backed the metaphors by familiar recent case law:

"… assume that North, East, South and West enter a room and sit at a table. North (the employer) holds cash that he has already said he will share (as an annual bonus) with West (his employee). The common understanding and intention of all concerned is that North will hand the cash to East, East will hand the cash to South and South will hand the cash to West. If the question is asked, has North paid West his annual cash bonus, the answer is quite clearly yes. …

The answer does not change just because North produces a pack of cards so that the cash can pass from North to East to South to West under the cover of a card game.

…

This was effectively the "game" that was played by the Appellant (North), the Trustees (East), Ellastone (South) and employees (West)."

We should see through the game, Mr Gammie QC argued, by virtue of the decisions of the House of Lords starting with IRC v Duke of Westminster [1936] AC 1 and ending with Barclays Mercantile Business Finance v Mawson [2004] UKHL 51, [2005] 1 AC 684. Specifically, we take it that he was referring to the judgment of Templeman LJ in the Court of Appeal in Ramsay v IRC [1979] STC 582 at 583:

"The game is recognisable by four rules. First, the play is devised and scripted prior to performance. Secondly, real money and real documents are circulated and exchanged. Thirdly, the money is returned by the end of the performance. Fourthly, the financial position of the actors is the same at the end as it was at the beginning save that the taxpayer in the course of the performance pays the hired actors for their services. The object of the performance is to create the illusion that something has happened, that Hamlet has been killed and that Bottom did don an asses head so that tax advantages can be claimed as if something had happened."

Here, of course, something did happen, as Mr Gammie's analogy accepts. No money was returned. And we must be guided by the views of the House of Lords (including of course those of Lord Templeman as he became) as to the current approach to be taken to the re-analysis of financial transactions for tax purposes where it is considered that there are pre-ordained arrangements in place. We respectfully take the current view of the test we must apply from the citation in Barclays Mercantile of the formulation set out by Ribiero PJ in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35]:

"the ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically."

Counsel for the opposing parties in these appeals took sharply differing approaches to the identity of the realistic view we should take. Perhaps the relevance of that guidance to these appeals, as submitted by opposing counsel can be summarised by classical metaphors rather than images of games and plays. The approach of Mr Gammie QC was to confront us with the knotted ropes on the chariot at Gordium, and to ask us to take up a sword to cut through those knots and solve the curse. By contrast, Mr Brandon QC made a submission that was perhaps an analogy to Theseus taking a sword to confront the minotaur in the labyrinth. Once we had confronted the minotaur we could escape with him from the labyrinth if we carefully followed the piece of thread he had trailed behind him as he came in to lead us back to the entrance.

Mr Brandon QC, for PA, submitted three propositions for PA:

(a) awards to employees under the 1999 ET of beneficial interests in the 1p redeemable preference shares in Ellastone were exempt from income tax by reason of section 140A ICTA (conditional acquisition of shares) and were similarly exempt from liability to NI contributions;

(b) payments to award holders of dividends in respect of those shares, made by Juris as nominee of Mourant, were distributions within the scope of section 20 of ICTA and not emoluments or earnings; and

(c) payments to those award holders through the payroll on redemption of the 1p shares were subject to income tax and NI contribution liability at the levels appropriate to the individuals concerned.

Mr Brandon QC was called on to deal in detail only with proposition (b). We compare his approach to that of leaving a labyrinth because he took us with meticulous care back through each stage of the arrangements, as summarised above.

His approach was sharply different both in principle and in detail from that of Mr Gammie QC. He showed us, in more modern terminology, a full audit trail through the events and the movements of sums of money that established that each stage of the arrangements events occurred as stated and more or less in the order stated.

For the reasons below, we accept neither of those approaches as appropriate to this appeal. The "ultimate question" in these appeals depends on fundamental rules of income tax and NI contribution law that need no elaborate construction for their proper application. In our view we need neither take a broad overview that ignores all the tangles nor tread through the maze with meticulous attention to every slight twist of the thread. Nor are we required to do so to decide the issues. As the second appendix to Mr Gammie QC's skeleton argument reminds us, this case is about fundamental principles of the law of income tax and of NI contributions. It is not an attempt to pick through obscure corners of Finance Acts using one approach to interpretation rather than another.

The income tax question we must answer is simply this: do the facts justify the conclusion that the sums paid to the PA employees were:

"in respect of an office or employment on emoluments therefrom".

Those words from section 19 of ICTA do not need buttressing by any authority other than that of Hochstrasser v Mayes. The test of Upjohn J (in [1959] Ch 22 at 33) is that:

"the authorities show this, that it is a question to be answered in the light of the particular facts of every case whether or not a particular payment is or is not a profit arising from the employment. Disregarding entirely contracts for full consideration in money or money's worth and personal presents, in my judgement not every payment made to an employee is necessarily made to him as a profit arising from his employment. Indeed, in my judgment, the authorities show that to be a profit arising from the employment the payment must be made in reference to the services the employee renders by virtue of his office, and it must be something in the nature of a reward for services past, present or future."

As is well known, Viscount Simons endorsed this test in the House of Lords and established it as the standard test for section 19 to be learnt by every tax official and student for decades to follow. It is in our view now beyond argument as the approach to be taken in deciding if something is an emolument or earnings.

Mr Brandon QC sought to argue that other authorities, such as Abbott v Philbin (1960) 39 TC 82, prevented us from reaching the conclusion that on the facts of this case we could say that the sums received by the employees were sourced not from the shares but from the employment. We do not read that case, or any other, as detracting from the general factual test of section 19 as endorsed in the main authorities and as relevant to this case.

At the same time we see no scope in deciding so clear and basic a question of income tax law as the question whether something is an emolument for the approach that Mr Gammie QC suggested. In our respectful view, the fundamental question posed by their Lordships in the Barclays Mercantile case is the same question as that posed by Upjohn J in Hochstrasser v Mayes when asked in the context of this provision and this case. The question whether something is within the scope of the definition of emolument is a question on which we have been given the clearest judicial guidance both about the scope and purpose of the legislation and of its correct interpretation and application.

The key questions

We therefore take the view that the central income tax question in the appeals is whether section 19 applies, as a question of fact, to the sums received, directly or indirectly, from funds provided by PA for staff bonus payments.

What did the individuals receive, directly or indirectly, from that source of funding, and why did they receive it? First, they received certificates confirming that they were the beneficial owners of certain shares in Ellastone. (Juris remained the registered owner, as nominee of Mourant, but there is a clear record of the basis on which the registered ownership was retained). Second, they received payments called dividends from Ellastone in respect of those shares. Third, they received sums from the later decision of the Ellastone to redeem those shares.

Why and in what capacity did they receive those awards and money? They were only eligible under the Restricted Share Plan to receive the awards if they had been, and continued to be, employees of PA. It was a crucial aspect of entitlement that they continued to be employees up to the date of both award and payment. We were taken to detailed exchanges between PA and Mourant to ensure that no single individual benefitted from an award unless he or she was still on the payroll. Clearly, great care was taken to ensure no benefit was paid to anyone who had left employment. That is consistent with the stated intention of Mourant in exercising its discretion to make awards to eligible employees. As we found above, the aim was "to motivate and encourage employees in the performance of their duties". That is also entirely consistent with the way in which PA put the scheme to its employees and recorded it in its Report and Accounts.

Did the award holders pay anything for the shares, or give any other consideration for the shares? No, save for any account taken as consideration of past or future services. In particular, there was no question here of the kind of option to purchase that lay at the heart of cases such as Abbot v Philbin [1961] AC 352 or of any other payment of money or in kind by any award holder.

The interests in the shares were received as emoluments. That is not in dispute. Nor is the exemption from income tax in dispute that attached to the issue of the shares, because they were conditional shares, claimed under section 140A ICTA. That was common ground before us.

The sums received in redemption were emoluments, because they were not within the exemption. That is also not in dispute before us.

Distributions or emoluments?

Why, then, were the dividends received on the shares not also agreed to be emoluments?

Mr Brandon QC's answer to that was that the dividends were received by the beneficial owners because of their ownership of the shares, and not because of the way in which they acquired the shares. He cited Abbott v Philbin as supporting this.

We have already noted that Abbott v Philbin concerned shares that were purchased under an option (on favourable terms, but nonetheless purchased) by the persons who became shareholders. We also note that the shares purchased in that case were ordinary shares of the company, and that they carried the ownership and voting rights that normally attach to ordinary shares. Those who exercised the options were investing in the company and becoming owners of the company.

The shares involved in these appeals were not ordinary shares. They were restricted redeemable preference shares, with no voting rights and no rights to share in any surplus on a winding up. They carried only the right to receive one dividend, if one was declared. We find that the rights given by the award certificates were as a matter of law rights entitling the holders to a single dividend from the company if it chose to make one, and they were as a matter of fact the link by which the employees received that single dividend. (We discuss below the question whether the payment of that dividend is to be regarded as a "dividend or other distribution" for income tax purposes.)

Did the interposition of the way in which the bonus payments were passed through the arrangements from PA to the eligible employees break the links required by section 19 (for income tax) and sections 3 and 6 (for NI contributions) – that the receipts be "from" the employment or be earnings?

Mr Brandon QC argued that the link was broken. The receipts were "from" the beneficial ownership of the shares and therefore not from the emoluments. For that argument to work, it has in our view to be shown that the nature of the link to the share ownership was such in law as to displace entirely the link to the employment. It is not enough for Mr Brandon QC's argument that the link was broken to establish that the dividends came "from" the shares as well as "from" the employments.

We agree with Mr Gammie QC that Abbott v Philbin does not help on that point. That case was concerned with a different question. The specific question was whether an option to purchase shares was to be regarded as an emolument in one year rather than another year. As the case came before the House of Lords, this became an argument about whether there was a perquisite in the year in which the option was granted or the year in which it was exercised. The target of the tax assessment was an increase in value of the shares between the grant and the exercise. That, as Viscount Simonds commented "will be due to numerous factors which have no relation to the office of the employee, or his employment in it." We do not see that as establishing a rule of law that applies to these appeals. Here the only "factors" were the sums given by the 1999 ET in discharge of its trust obligations to Ellastone from sums handed over by PA to its employee trust, and the interest earned on those sums while held by Ellastone.

Clearly, if something is paid out as a distribution by a company to an investing shareholder then the issue of derivation may arise if the shareholder is also an employee. The facts may show that the derivation of a dividend from a share may not be related to earnings because the acquisition and ownership of the share was not related to earnings or more generally to the status of the individual as an employee of the company. We do not see a factual basis for that approach in this case.

It is clearly established on the facts in these appeals that the purchase of the shares in Ellastone from which eligible employees benefitted was funded in full by PA, their employer, (and not at all by the employees) using funds accounted for fully by PA as staff costs. Further, the arrangements transfer from that source not only the dividends paid in respect of the shares but also the full value of the shares themselves to the employees at no cost whatsoever to the employees. They cannot be said in any sense of the word to have purchased them. Nor did funding come from any other source (save for interest earned after the employer put the money into the arrangements but before the money was paid out). The factual link between the payment out by PA and the receipt by eligible employees only is clear.

It is also clear on the facts that the intention was that the payments were made

"to motivate and encourage employees in the performance of their duties" (the wording of the Mourant resolution). The receipt of the shares and of the dividends were presented actively by the employer to the employees as parts of the payment of the bonus to the employees for that year. They were accepted by those employees who received them in that way. The sums used were presented in the company's accounts in the same way.

Two other factual elements of the case strengthen the links. First, any employee who left employment thereupon ceased to be eligible under the 1999 ET, even if he or she left after the close of the financial year, and even after PA had handed over the funds to Mourant. Why? One reason that is articulated in some of the documentation is that the scheme was designed to keep employees at PA – in modern terminology it was a "handcuff". That is clearly linked to the current status of the award holders as employees as well as their past status. Second, PA went out of its way to "sell" the arrangements to employees. As part of the exercise, employees had to choose to take the arrangements rather than remain under the 1995 ET. For this reason they were given presentations and documentation such that most did opt for the 1999 ET. We saw the slides used for the presentations and heard evidence from employees about them. We find that the process was inherently part of the process of motivating and awarding employees. And we find that the arrangements were also part of that process.

In our view those facts lead to the finding that the test set by Upjohn J and the later authorities in applying section 19 of ICTA is clearly met on the facts. In so finding, we see nothing here that prevents us finding as fact that there is a nexus, and no break, in the link between the payment out of sums by PA under the arrangements and the receipt of sums by employees under the arrangements. And we reach the same conclusion if we ask the question in the same way as Ribiero PJ in Arrowtown.

We are not deterred from taking that view because the employees had no right to receive the bonuses. It is trite law that something does not cease to be an emolument from an employment, or earnings, because the employee has no right to it. Again, that takes us back to old cases that all tax students should learn about tips for taxi drivers (Calvert v Wainwright [1947] KB 526), and payments made to vicars or cricketers (such as Moorhouse v Dooland [1955] Ch 284 (CA)).

Having established the factual link between the payments by PA and the receipts by the eligible employees on the facts, we regard the answer to this appeal as simple. On the facts as found, and as matter of fact, the payments made to the eligible employees under the Restricted Share Plan by Mourant as trustee of the 1999 ET and Juris as its nominee were emoluments or earnings from their employments with PA notwithstanding that they were called, and were, dividends payable by Ellastone. They fall within the definition of section 19 as interpreted by the courts without any need to refer to the jurisprudence about interpretation to which Mr Gammie QC referred us. Equally, they fall within the section as so interpreted.

Were the payments also distributions within the scope of section 20 of ICTA ? The sums received by the award holders came from Ellastone in the form of payments called dividends. We have accepted that: the arrangements resulted in the transfer of funds into Ellastone as described by Mr Brandon QC; that the directors of Ellastone properly used the funds to declare a dividend on the restricted shares registered in the name of Juris as nominee for Mourant; that the sums paid out as dividends were transferred on a proper basis from Ellastone to the individual eligible employees who were awarded interests in those shares; and that income tax was deducted from the payments on the assumption that all recipients were higher rate taxpayers receiving distributions of a United Kingdom resident company. Mr Brandon QC established each of those matters before us and we so find.

The question that then arises is whether those dividends were distributions within the scope of section 20 (Schedule F) of ICTA. The charging provision in section 20(1) applies to:

"all dividends and other distributions … of a company resident in the United Kingdom … and for the purposes of income tax all such distributions shall be regarded as income however they fall to be dealt with in the hands of the recipient."

Section 20(2) (Schedule F) of ICTA provides:

"… no distribution which is chargeable under Schedule F shall be chargeable under any other provisions of the Income Tax Acts."

"Distribution" is given an extended definition by section 209 of ICTA.

We do not need to set it out in full here. Section 209(2)(a) includes within the definition:

"any dividend paid by the company, including a capital dividend".

Section 209(2)(b) strengthens the scope of the provision by bringing into charge, subject to limitations not relevant here:

"any other distributions out of assets of the company (whether in cash or otherwise) in respect of shares of the company …"; and

This is further strengthened by the inclusion within the scope of the section of any transfer of assets by a company to its members by section 209(4):

"(4) Where on a transfer of assets or liabilities by a company to its members or to a company by its members the amount or value of the benefit received by a member (taken according to its market value) exceeds the amount or value (so taken) of any new consideration given by him, the company shall, subject to subsections (5) and (6) below, be treated as making a distribution to him of an amount equal to the difference."

Again, the limitations are not relevant here.

If it is in any way open to doubt that the payments by Ellastone were dividends, then in our view the rest of section 209 stops any argument that they were not distributions within the scope of section 20. In our view the evidence is clear that the payments made by Ellastone to Juris in respect of the RP shares were distributions by Ellastone within the scope of section 20.

Were the payments also distributions in this sense when paid on by Juris, as directed by Mourant, to the eligible employees? We do not consider that it is relevant that income tax was deducted from those payments on the basis that they were dividends. We questioned in the hearing how HMRC could receive payments either as tax deducted at the higher dividend rate from all these payments regardless of whether the individual recipients were higher rate taxpayers, or as payments on behalf of those individuals, and we heard no answer to that question. In any event, the arrangement was not one that in any way precludes us from deciding this question for ourselves.

Mr Gammie QC sought to attack that link both by reference to the details of the link itself and by the approach that there was an impressed trust underlying the transfer of the payments from Mourant to any later recipient that prevented the payments truly being payments received by Ellastone.

We find no substance in either of these approaches. In particular, we see no basis in the evidence before us on which it can be shown that there was a Quistclose trust in place (that is, a trust in the sense considered by the House of Lords in Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567). Nor did the facts support an analysis consistent with the approach taken by their Lordships in Twinsectra Ltd v Yardley [2002] UKHL 12, [2002] 2 AC 164. Put simply, the money was handed over as indicated in the steps of the arrangements we have set out above without any conditions attached of a kind that would lead us to consider that there was a trust in place that counteracted what actually happened. And in any event we have found as fact that there was an unbroken link in fact between the payments by PA

and the receipts by the employees. We do not need to rely on this jurisprudence to establish that. We therefore take that analysis no further.

We looked in some detail at the precise way in which the nominee ownership of the shares by Juris was operated, and how the beneficial ownership of the shares was certified to the individual employees who were certified as award holders. Having done so, we accepted the oral and documentary evidence that payments were made by the proper procedures by Ellastone as dividends through the nominee Juris to the award holders in the form of dividends to the beneficial owners of the shares. It is common ground that Ellastone was a company resident in the United Kingdom. We therefore find as fact that the payments made by Ellastone to Juris and thence to the employees were distributions within the meaning of, and so within the scope of, section 20 of ICTA.

Dividends and emoluments?

One of the most important unwritten rules of income tax is that income generally can be taxed only once. If something falls to be taxed under more than one charging provision (formerly one Schedule or case), then in the absence of clear authority to impose a double charge it must be decided as a matter of law that only one Schedule applies, and it must then be decided which of the alternatives applies.

As we have seen, dividends and other distributions from United Kingdom companies were at the times relevant to these appeals taxed under section 20 and Schedule F of ICTA. If, as we find, the sums paid to the employees are distributions, notwithstanding that they are also emoluments, then they are liable to income tax under Schedule F as well as under Schedule E.

That cannot happen as a matter of income tax law. They can be taxed only as one of those two kinds of payment. Which is to prevail? In our view, the answer to that is unambiguously laid down by section 20(2). The payments can, for income tax purposes, only be distributions. Mr Gammie QC sought to persuade us that we were not obliged to reach that conclusion but, frankly, we found no substance in his argument.

We cannot see any arguable basis on which we could reinterpret that unambiguous provision so as to find that the payments were emoluments but not distributions. Section 20(2) is totally lacking in ambiguity. Nor can there be any doubt about its policy or context. It is explicitly a rule for dealing with payments that fall within the overlap areas between charges to tax, and it gives an unavoidable answer.

And that is entirely consistent with fundamental principles. Fry v Salisbury House Estate Ltd [1930] AC 432 may have lost the immediacy of its authority now that the Tax Law Rewrite has written the Schedules out of income tax law. But we respectfully consider that the principle on which their Lordships founded their decisions is as fundamental to income tax now as it was then. And, in any event, this case dates back to the law when it still contained the Schedules.