[2009 UKFTT 337 (TC)

TC00278

Appeal number TC/2009/11143

INCOME TAX - termination payment - whether made pursuant to a contractual right of the employee - section 401 Income Tax (Earnings and Pensions) Act 2003 - no - appeal allowed

FIRST-TIER TRIBUNAL

TAX

                                          DR JOANNE CLINTON                         Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                    REVENUE AND CUSTOMS (INCOME TAX) Respondents

                                                TRIBUNAL:  Nicholas Aleksander (Tribunal Judge)

                                                                        James Midgley

Sitting in public in London on 17 August 2009

Mr T Trainer of Business Experts Limited for the Appellant

Mr D Lewis, an officer of HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.     This appeal relates to a payment made to the Appellant, Dr J Clinton, in connection with the termination of her employment with Bristol-Myers Squibb Pharmaceuticals Limited ("BMS").  The question before the tribunal was whether the payment constitutes "earnings" within the meaning of section 62, Income Tax (Earnings and Pensions) Act 2003 ("ITEPA"), or is a payment within section 401, ITEPA and relieved from tax under section 403.

2.     Mr T Trainer of Business Experts represented Dr Clinton, and Mr D Lewis, an officer of HM Revenue & Customs, represented the Respondents.  A bundle of agreed documents was produced, including a statement of facts not in dispute.  In addition Dr Clinton gave evidence.

Background Facts

3.     Dr Clinton commenced employment with BMS in October 1996.  The terms of her employment were governed by a letter from BMS to Dr Clinton dated 11 October 1996 to which were attached "Terms and Conditions of Employment".  Both the letter and the Terms and Conditions were countersigned by Dr Clinton acknowledging her agreement to them.   Dr Clinton was initially engaged as a Clinical Scientist, but was promoted to Senior Clinical Scientist and then Project Manager after approximately one year. As a Project Manager, Dr Clinton was responsible for managing clinical trials of drugs developed by BMS.

4.     Paragraph 17 of the Terms and Conditions includes the following:

" …On successful completion of the period of probation your appointment will be confirmed and the contractual period of notice entitlement given by either party will be not less than ONE calendar month's notice in writing except when the length of notice the Company is required to give to terminate your employment may be greater than this of the following basis:

Length of continuous service                           Period of Notice

Less than 4 years service                                    1 calendar month

4 or more years service                                       1 weeks notice for each complete year of service up to a maximum of 12 weeks

Either party may waive their rights to notice and payment in lieu of notice may be made at the Company's discretion …"

5.     In evidence at the hearing we were told that no amendments had been made to Dr Clinton's employment agreement, and confirmation to this effect was made in a letter dated 4 May 2007 from Bristol-Myers Squib Business Services Limited to HMRC received during the course of HMRC's enquiry into Dr Clinton's self-assessment.  However in the course of written submissions that we requested following the hearing, we were informed on behalf of Dr Clinton that when she was promoted to Project Manager she became entitled to three months notice, but the Terms and Conditions were never updated to reflect this fact. 

6.     In 2003, BMS was  restructuring, and project managers were required to take on responsibility for data management.  BMS asserted that the additional responsibility for data management would comprise only 25% of the project managers' work. Dr Clinton had been in discussion with colleagues who had already been "restructured", and it appeared in practice that data management could take up as much as 75% of a project manager's work. 

7.     Whilst Dr Clinton was prepared to accept some change to her employment, she did not want to be in a job where data management occupied such a large proportion of the work.  She took the view that the changes being made to her employment were such that the job for which she had accepted employment no longer existed.  On 9 May 2003, Dr Clinton e-mailed Anne McGarvey (Human Resources Manager at BMS) stating that she regarded herself as having been constructively dismissed.  She went on to say "As you are aware, my contractual notice period is three months, I therefore expect to receive, within seven days, settlement of my final three months salary and confirmation that my pension contributions and private health premiums will be paid".  On 19 May 2003 she sent a further e-mail to Ms McGarvey, the HR Manager at BMS, stating that she considered herself to have been constructively dismissed, and therefore expected to receive three months salary in lieu of notice.

8.     Dr Clinton explained to us in the course of giving evidence that she had taken legal advice at the time, and had been advised that she might well be entitled to a greater sum than three months salary by way of compensation for constructive dismissal.  However this would involve her taking a claim to the Employment Tribunal, with all the stresses which that would involve.  At the time Dr Clinton was suffering from considerable stress, and was on sick leave as a result.  She did not want the additional stress of making a claim before the Employment Tribunal, and she was therefore prepared to accept three months salary in order to resolve her dispute with BMS quickly and with least stress.

9.     Ms McGarvey responded by a letter dated 20 May 2003 (which was sent by e-mail to Dr Clinton as well as by post).  In her letter Ms McGarvey stated that, on behalf of BMS, she accepted Dr Clinton's resignation effective 9 May 2003.  The letter continued as follows:

"BMS does not accept that you have been dismissed, but rather considers you to have resigned.  In order to receive compensation and benefits for your notice period you need to work during that time.  If you are not prepared to do this or do not submit evidence as to your unfitness to work in accordance with BMS' sickness policy, you are not entitled to any compensation or benefits during this time.

However, we as a company are willing to be flexible and recognise that this may be a difficult time for you.

Therefore as a goodwill gesture, one of two options is available to you:

Option 1

Under this option, you would receive the total of your notice period, which equals three months salary, less applicable taxes and statutory withholdings, In one lump sum payment on 23 May 2003.  Your termination effective date would be 9 May 2003, whereby the three months salary lump sum payment would include 10 May 2003 until 9 August 2003.  Please note that under this option you would return your company car.  Further you would not be eligible for company sponsored health care cover, life cover or pension contributions.

Option 2

Under this option, you would continue on the payroll and receive your normal monthly salary for the months of May, June and July payable on or around the 24th of each month.  On August 22nd, you would receive prorated salary for the period of August 1 - 9 inclusive.  Under this option you would continue to have use of your company car and you would be eligible for health care cover, life cover and pension contributions until 9 August 2003.  Please note you would not be covered by the company car insurance plan if you engaged in business for another employer.  Under this option your last day worked would be 9 May 2003, but your termination date would be 9 August 2003."

10.  Late on 20 May Dr Clinton replied by e-mail to Ms McGarvey saying "Thank you for your letter dated today.  I accept option one as described in your letter".

11.  In accordance with Option 1, BMS paid Dr Clinton £9,662.25.  This payment was made after deduction of income tax and Class 1 national insurance contributions.  On 10 September 2005, Dr Clinton amended her 2003/4 self-assessment tax return declaring that the payment was not chargeable to income tax.  On 17 August 2006, HMRC opened an enquiry into that self-assessment tax return. 

12.  A closure notice was issued on 18 July 2008 and amended the return to charge tax on the payment.  On 25 July 2008 Dr Clinton filed an appeal against the closure notice and amendment.

The Law

13.  In the case of EMI Group Electronics Limited v Coldicott (1999) 71 TC 455, Chadwick LJ (at 488) quoted with approval from the decision of Lord Browne-Wilkinson in Delany v Staples [1992] 1 AC 687. Delaney is not a tax case, but at page 692, Lord Brown-Wilkinson divided payments made "in lieu of notice" on the termination of employment into four categories:

"The phrase "payment in lieu of notice" is not a term of art. It is commonly used to describe many types of payment the legal analysis of which differs. Without attempting to give an exhaustive list, the following are the principal categories.

(1)     An employer gives proper notice of termination to his employee, tells the employee that he need not work until the termination date and gives him the wages attributable to the notice period in a lump sum. In this case (commonly call "garden leave") there is no breach of contract by the employer. The employment continues until the expiry of the notice: the lump sum payment is simply advance payment of wages.

(2)     The contract of employment provides expressly that the employment may be terminated either by notice or, on payment of a sum in lieu of notice, summarily. In such a case if the employer summarily dismisses the employee he is not in breach of contract provided that he makes the payment in lieu. But the payment in lieu is not a payment of wages in the ordinary sense since it is not a payment for work to be done under the contract of employment.

(3)     At the end of the employment, the employer and the employee agree that the employment is to terminate forthwith on payment of a sum in lieu of notice. Again, the employer is not in breach of contract by dismissing summarily and the payment in lieu is not strictly wages since it is not remuneration for work done during the continuance of the employment.

(4)     Without the agreement of the employee, the employer summarily dismisses the employee and tenders a payment in lieu of proper notice. This is by far the most common type of payment in lieu and the present case falls into this category. The employer is in breach of contract by dismissing the employee without proper notice. However, the summary dismissal is effective to put an end to the employment relationship, whether or not it unilaterally discharges the contract of employment. Since the employment relationship has ended no further services are to be rendered by the employee under the contract. It follows that the payment in lieu is not a payment of wages in the ordinary sense since it is not a payment for work done under the contract of employment."

14.  Section 401(1)(a) ITEPA brings within the scope of income tax payments received directly or indirectly in consideration of or in consequence of, or otherwise in connection with the termination of a person's employment, and which are not otherwise chargeable to income tax.  Under section 403, the first £30,000 of any such payment is relieved from tax.

15.  The Court of Appeal held in EMI that payments falling within Lord Browne-Wilkinson's category (2) were payments made under and in accordance with the contract of employment - they are not payments made by way of compensation or damages for breach of the contract of employment.  In other words, payments made in pursuance of a contractual provision, agreed at the outset of the employment, which enables the employer to terminate the employment on making that payment are (in the language of ITEPA) earnings taxable under general principles.  Such payments do not fall within section 401, as they are otherwise chargeable to income tax.

16.  On the other hand, payments falling within category (4) would be within the scope of section 401, as they would be received in connection with the termination of an employment, and would not otherwise be chargeable to income tax.

Contentions of the parties

17.  HMRC contend that Dr Clinton resigned from her employment with BMS (in circumstances not amounting to constructive dismissal).  The payment made by BMS to Dr Clinton is taxable employment income, on the basis that the payment was made under the terms of Dr Clinton's employment contract - either under paragraph 17 of the Terms and Conditions referred to above, or under a term implied as a result of custom and practice.  Alternatively HMRC contend that the payment falls within the third category described in Delany - namely a payment under an agreement made between the employer and employee to terminate the employment forthwith without notice.

18.  Mr Trainer contends on behalf of Dr Clinton that the payment was made either on an ex gratia basis or to settle Dr Clinton's claim for constructive dismissal.  In either event the payment falls within section 401(1)(a) ITEPA, and therefore is exempt from income tax (as it falls within the relief available under section 403, being less than £30,000).

19.  We find, on the basis of the evidence before us, that Dr Clinton was constructively dismissed by BMS.  Her evidence as to the events leading up to the termination of her employment was not challenged by Mr Lewis in cross examination.  We note that BMS in the letter of 20 May stated that they regarded Dr Clinton as having resigned - but this is not inconsistent (as a matter of employment law) with Dr Clinton having suffered constructive dismissal.  Our understanding of constructive dismissal is that the employer has acted in such a way as to repudiate the employment agreement, and such repudiation is then accepted by the employee, with the employee giving notice to the employer to that effect. 

20.  We also find that there was no term implied into Dr Clinton's employment agreement by custom and practice giving her a right to a payment in lieu of notice on the termination of her employment.  Mr Lewis asserted that Dr Clinton must have had an expectation of receiving such a payment, otherwise why did she claim three months salary in her e-mail of 9 May?  In addition, Mr Lewis referred us to a letter dated 4 May 2007 from Bristol-Myers Squib Business Services Limited to HMRC received during the course of HMRC's enquiry into Dr Clinton's self-assessment.  This letter stated that "it was not unusual for [BMS] to pay employees in lieu of notice when deemed appropriate".   The threshold for custom and practice to have the effect of implying terms into employment agreements is high. "Expectation" in the context of employment law means more than a mere hope (such as the expectation of a legacy under a will) – the expectation has to rise to the level of an enforceable contractual certainty.  The fact that Dr Clinton in her 9 May e-mail made a demand for a payment of three months salary is not evidence that it was the custom and practice of BMS to make such payments.  Equally, BMS's letter of 4 May 2007 does not evidence such a custom and practice, as BMS only made such payments "when deemed appropriate".  There is nothing in the evidence before us that supports HMRC's contention that Dr Clinton had an implied right to payment in lieu of notice, and we find that there is no such implied term.

21.  Was payment made to Dr Clinton under paragraph 17 of the Terms and Conditions?  First we note that the notice provisions were superseded as a result of Dr Clinton's promotion to Clinical Project Manager, and becoming entitled to three months notice.  As the written Terms and Conditions were never updated to reflect this change, is not clear whether the provisions in paragraph 17 relating to waiver of notice period continued to have effect.  We have assumed that they did.  We also note that these provisions are curiously drafted.  Paragraph 17 permits either party to waive their rights to notice and for BMS to make payment in lieu of notice.  In other words, if BMS dismissed Dr Clinton, Dr Clinton would be entitled to waive her right to three months' notice, and if Dr Clinton resigned, BMS would be entitled to waive their right to three months' notice.  This does no more than make express something which the parties could do in any event.  Unusually, paragraph 17 does not allow for the circumstances described in Lord Browne-Wilkinson's category (2) – under which BMS would have the right to dismiss Dr Clinton without notice subject to making a payment "in lieu".   

22.  We find that the payment neither was made under paragraph 17 of the Terms and Conditions nor falls within the third category described in Delany. We consider that in offering the two options to Dr Clinton, BMS would been motivated by a desire to avoid Dr Clinton launching proceedings in the Employment Tribunal for wrongful or unfair dismissal. Dr Clinton made it clear in correspondence that she would accept payment equivalent to three months salary to compromise her claims for constructive dismissal. Both of the options offered in the 20 May letter satisfy, in essence, Dr Clinton's demand for payment equivalent to three months salary to compromise her claims - but without BMS having to admit that their actions amounted to constructive dismissal.  We consider that in accepting the payment under option one, Dr Clinton compromised any claim she may have had at common law for breach of her employment contract - in other words for wrongful dismissal. 

23.  We agree with the submissions made on behalf of Dr Clinton that the payment was made either on an ex gratia basis or to settle Dr Clinton's common law claim for constructive dismissal.  In either event the payment falls within section 401(1)(a) ITEPA, and therefore is exempt from income tax (as it falls within the relief available under section 403, being less than £30,000).

Decision

24.  For these reasons we allow the appeal.

25.  HMRC have a right to apply for permission to appeal against this decision pursuant to Rule 39 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

Nicholas Aleksander

TRIBUNAL JUDGE

RELEASE DATE: 02 December 2009

Cases referred to in skeleton arguments but not in this decision:

Dale v de Soissons (1950) 32 TC 118

Hurley v Taylor (1998) 71 TC 268

Richardson v Delany (2001) 74 TC 167

SCA Packaging v HMRC [2007] EWHC 270 (Ch)