[2011] UKFTT 685 (TC)
TC01527
Appeal numbers TC/2010/7178
TC/2010/8806
INCOME TAX — accountant leaving partnerships — whether payments
received shares of profit or compensation — in one case share of profit, in
other case compensation — appeal allowed in part
FIRST-TIER TRIBUNAL
TAX CHAMBER
AB Appellant
- and -
THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE
AND CUSTOMS Respondents
Tribunal: Judge Colin Bishopp
John
Whiting OBE FCA
Sitting in private in London on 23 August 2011
CD, solicitor, for the
Appellant
Nicola Parslow of their
solicitor’s office for the Respondents
© CROWN COPYRIGHT 2011
DECISION
Note: in accordance with a direction of the tribunal made before the
hearing of the appeals, we sat in private. We have issued a fully anonymised
decision, in accordance with r 32(6) of the Tribunal Procedure (First-tier
Tribunal) (Tax Chamber) Rules 2009, in order not to undermine the purpose of a
private hearing.
1.
These are consolidated appeals by a chartered accountant and tax adviser,
to whom we shall refer as AB, against amendments by HMRC to her self-assessment
returns for the years ended 5 April 2008 and 5 April 2009. The issue is whether
certain payments made to AB on her leaving partnerships of which she had
formerly been a member are chargeable to income tax, because they represent
AB’s shares of profit, as HMRC contend; or are not taxable because they were
sums paid as compensation, as AB maintains. There is no dispute about the relevant
amounts.
2.
AB was represented before us by CD, who is a solicitor and also her
partner; he played a part in the relevant events and accordingly gave evidence,
as did AB. HMRC were represented by Mrs Nicola Parslow of their solicitor’s
office; she did not call any witnesses, but placed great emphasis on the
documentary evidence.
The facts
3.
AB joined a large international firm of accountants, EF, in June 2000,
initially as a “partner designate”, progressing to “fixed share” partner and
then, in April 2006, becoming an equity partner. Her remuneration, like that of
the other equity partners, consisted of a notional salary, a share of profits
determined by reference to the number of points allocated to her from time to
time, a performance award or bonus, and interest on capital. While AB was an
equity partner, EF adopted a hybrid corporate and limited liability partnership
structure, a development which necessitated some alteration of the arrangements
by which partners owned their respective shares of the business and were
remunerated, but the essentials of the discretionary elements of the
remuneration scheme were unaltered. The performance award was intended to
reflect both personal performance and the performance of the office at which
the partner was based. The number of points allocated to a partner and the
level of his or her performance award were determined on a discretionary basis
by a process which was not fully explained to us but which was evidently
strongly influenced by the recommendations of local managing partners.
4.
AB’s unchallenged evidence was that in late 2004 she moved from one of
EF’s offices to another, of which the managing partner, GH, was national head
of tax, her own speciality. The office to which she moved was highly profitable
and, she said, had a substantial tax department, while the office she had left
had only a small tax department. She told us she had a good relationship with
GH, but in about 2006 the office at which she was based was merged with
another, which had no tax department, and GH was replaced as managing partner
by IJ, whose speciality was not tax. Within a short period, several of the tax
partners and staff left, and were not replaced. GH, who remained at the office,
retained two assistants; AB’s two assistants were among those who left and were
not replaced, despite her protests to IJ. Nevertheless, AB said, she continued
to work hard, attracting new clients as well as retaining existing clients. She
was working long hours, recording higher chargeable hours than any other
partner at her office, collecting her fees efficiently and meeting all of her
targets.
5.
In the spring of 2007 the process of determining AB’s points allocation
for the following accounting year began. Despite her performance she was told
by IJ that her points would not be increased even though, as she discovered,
male partners admitted to equity at the same time as she was had received
increases. Soon after she underwent an appraisal, by IJ, in what she considered
to be a manner so cursory as to be insulting. She also learnt that a male
partner, a contemporary based at the same office, had been allowed to recruit
while she had not. Her complaints about what she perceived to be unfair
treatment led to a discussion with the regional managing partner, who told her
that the reason her points were not to be increased was that she had not built
up a team—an explanation she considered extraordinary, since she had been
refused permission to recruit a team.
6.
These events had an adverse effect on AB’s health. In late June 2007 she
saw her GP who diagnosed stress and recommended a break from work. On 1 July AB
began a prolonged period of sick leave from which, as events turned out, she
did not return. While she was absent she saw GH, with whom she had evidently
remained on good terms, who told her that before he was replaced as managing
partner he had recommended, albeit on incomplete information, that her
performance award for the year to 31 March 2007 should be £50,000. In the event
she was awarded barely a third of that amount, while other partners, who had
earned significantly less for the firm than she had, received performance
awards ranging from £65,000 to £105.000.
7.
Unsurprisingly, AB came to the conclusion that she could not return to
EF if she was to be treated in what she believed to be an unfair manner, and
with CD’s assistance she wrote to IJ complaining about her treatment, which she
ascribed to sex discrimination. The letter made it clear that she did not
expect to return, since she broached the subject of the clients she might be
allowed to take with her (although she had no other firm to which she could go
and did not know when she would be medically fit to return to work), and it
ended with a demand for compensation. She did not receive what she regarded as
a satisfactory response and decided to consult solicitors (at the time CD was
not practising).
8.
The solicitors embarked on a course of correspondence with EF (which also
instructed solicitors) and in addition began proceedings before the Employment
Tribunal on AB’s behalf. The essence of AB’s complaints, in the correspondence
and before the tribunal, was that she had been treated unfairly, in breach of
the duty of good faith owed in accordance with EF’s partnership agreement, and
in breach of the Sex Discrimination Act 1975. She added a complaint of breach
of the Equal Pay Act 1970 although, as AB accepted, there were considerable
doubts about whether it applied to equity partners.
9.
EF’s response was to make an unparticularised denial of AB’s
contentions, without any counter-allegation, and there was then some brief and
inconclusive correspondence between solicitors, followed by a meeting at the
end of October 2007 attended by AB, CD, a senior EF partner, KL, and an
in-house solicitor employed by EF. Neither of the firms of solicitors
instructed by the parties was represented. After what appears to have been some
skirmishing in which KL indicated that EF wanted AB to return—with what degree
of sincerity is unclear—the parties began negotiating upon the assumption that
AB would not return and, AB told us, acceptable terms were quite quickly
agreed. AB was to leave the firm on 30 November 2007, and was to receive a
payment which was recorded, in the form of a letter from EF’s solicitors which
AB countersigned on 23 November 2007, as having been paid in settlement of all
claims AB might have “arising out of or in connection with [her] partnership
and membership of [EF, including any associated organisation] and [her]
retirement” as well as “any Statutory Claim as defined in paragraph 5(c) or any
other matter whether such claims arise under English or European law”. The
settlement was expressed to deal with AB’s claims against not only EF and
associated organisations, but any which might be made against partners or
employees. Paragraph 5(c) referred to a variety of legislation, and was
evidently a standard list since much of it was of no conceivable relevance to
AB’s case. AB agreed to, and did, withdraw her Employment Tribunal claim.
10.
On the same day—23 November 2007—AB and EF entered into a Retirement
Agreement which recited AB’s status as an equity partner and that she had
agreed to retire from EF on 30 November. The two provisions of the agreement of
relevance to these appeals are, first, that it was to take effect subject to
AB’s entering into a compromise agreement in respect of the claims she had made
and, second that “The Retiring Member’s [ie AB’s] Share of Profits
(excluding interest) (as defined in the [EF] Members’ Agreement) for the period
from 1 April 2007 to 30 November 2007 shall be a fixed share of profit of £191,532.
This is in full and final settlement of the Retiring Member’s entitlement
pursuant to clause 6.2 of Part D of the [EF] Members’ Agreement … for the
period 1 April 2007 to 30 November 2007.”
11.
The expression “Share of Profits” was a term defined in the Members’
Agreement, and included the partner’s notional salary, the sum referable to the
points allocated to that partner, his or her performance award and interest. AB
told us that she realised that because she had worked for only about three
months of the 2007-08 accounting year she could not reasonably expect any
performance award, and she did not argue during the course of the negotiations
that she should do so. The composition of the sum of £191,532 was explained by
a letter from EF to AB of 8 November 2007 as
§
her “Basic Salary” for the period from 1 April 2007 to 30
November 2007, being 8/12ths of £95,000, ie £63,333
§
an “Additional amount” of £170,000, from which was to be deducted
an adjustment of £41,801 in respect of AB’s capital account
12.
The parties agree that the amount of £63,333 is taxable; they also agree
that the £41,801 adjustment has no tax consequences. The dispute is over the remaining
balance of £128,199 and whether this amount is liable to income tax. In the
course of the hearing, Mrs Parslow agreed that if this last amount is not
subject to income tax, it is not subject to capital gains tax either and so it
would escape tax altogether.
13.
It was clear from AB’s evidence that the aggregate amount to be paid to
her was arrived at not by detailed debate but almost arbitrarily. In her
witness statement she said “The discussion amounted to no more than an initial
tentative sum being offered, then doubled and accepted.” From her perspective, she
told us, what she was to receive represented reasonable compensation for the
treatment she had suffered, and a sufficient sum to tide her over until she
could find another position: in other words she, too, did not regard it as a
calculated sum composed of discrete items.
14.
Quite soon after she left EF, AB found a position with OP, a smaller
firm than EF, though with a substantial presence in London, and she began
working as an “employed partner”, an intermediate position between fixed-share
and equity partners, as early as January 2008. She was told, when she was
recruited, that the firm did not admit partners to equity on their joining the
firm, but required candidates to work in another capacity for what amounted to
a probationary period. Nevertheless, her expectation, she told us, was that she
would become an equity partner on 1 July 2008 or, failing that, 1 January 2009.
We did not learn what criteria would decide her future progress. AB told us she
was able to bring some clients with her from EF, did work for OP’s existing
clients, and managed to acquire some new clients despite having entered into
restrictive covenants with EF which limited her scope for doing so. She was,
she said, very busy almost as soon as she joined the firm. Again, she told us,
she had high chargeable hours, was winning clients and meeting all her targets.
15.
However, after a few months with the firm she was offered, not the
equity partnership she expected, but a “guaranteed partnership”, to take effect
from 1 July 2008, and described by the existing equity partners as a stepping
stone to equity. She decided to accept, and entered into an appropriate
agreement. The change in status brought with it a modest increase in AB’s
remuneration. However, she was still subordinate to another, equity, partner,
QR, with whom, she said, she always had a rather difficult relationship. In
particular, she said, he promised that OP would recruit new staff to assist
her, but did not honour the promise.
16.
A few months after AB became a guaranteed partner she learnt that OP had
made offers of immediate equity partnership to two men, neither of whom was
then with the firm. The offers conflicted with what AB had been told, that OP’s
policy was not to admit partners to immediate equity. In the event, one of the
offers was withdrawn, but the other was honoured.
17.
AB told us that not only did her relationship with QR not improve, but
that he failed to support her when an important client indicated that it wished
to instruct AB, but not another of OP’s equity partners, ST. Shortly after this
incident, she said, the firm’s offices were re-organised and, in part because
of difficulties caused by ST, she found that she had been allocated a small and
inconveniently placed room, inferior to her previous room to the extent that
the staff considered she must have been demoted.
18.
Relations between AB, QR and ST seem to have deteriorated rapidly in the
early part of 2009. On 23 February she was, she said, summoned to a meeting at
which she was told abruptly that she was no longer required at OP, and given the
choice between resignation and termination of her partnership. Negotiations
about the terms on which she would leave began soon after the meeting. For
unconnected reasons CD had renewed his practising certificate and he agreed to
represent AB; OP instructed a large city firm of solicitors.
19.
On this occasion a settlement was not so quickly achieved. CD instructed
a barrister, who advised AB to make a further Employment Tribunal claim, which
she did. In the meantime there was correspondence between solicitors about the
financial arrangements, correspondence in which OP’s solicitors took an
initially very firm line, though they did not address the detail of AB’s
complaints. An initial offer, which AB considered insulting, was rejected but
then substantially improved, and eventually the parties came to terms.
20.
The agreement ultimately reached, and recorded in what was described as
a Settlement Agreement, was that AB would nominally remain a partner until 30 April
2009, but would be on “garden leave” after 31 March. She was to be paid her
agreed remuneration from 1 April 2008 to 30 April 2009, less the money she had
already drawn, plus two additional amounts, each of £102,500. The first was
described as “being equivalent to six months’ profit share as a payment in lieu
of her six-month notice period”. The second was described only as “a further
sum”, without any elaboration. Clause 4.2 of the agreement provided that the
total amount to be paid to AB “will be treated as her profit share in the
Firm’s accounts for the year to 30 June 2009 and it is agreed that in the
partnership tax returns of the Firm the aggregate allocation of taxable profit
shown as attributable to [AB] shall be” a sum which, for reasons we did not
discover (though we assume it reflected some non-deductible expenditure), was
£441 greater than that total.
21.
There is no dispute that the first amount of £102,500 is taxable. It is
the second amount of £102,500 that we are concerned with in this appeal, though
in fact the sum under discussion is actually £102,750. The difference is due to
OP’s having marginally increased the sum actually paid to AB, we understand
because of a slight delay in paying over the monies. Mrs Parslow accepted, as
in the case of the disputed EF payment, that if this sum was not liable to
income tax, it was also not liable to capital gains tax.
22.
The sum to be paid was expressed to be “in full and final settlement of
any claims [AB] has or may have against the Firm”. There then followed two
lists, one of claims which AB had made or intimated she might make, and the
other of claims which she was recorded to have contemplated. She undertook also
to withdraw her Employment Tribunal claim.
23.
As noted above at para 10, a term of the Retirement Agreement concluded
in November 2007 between AB and EF was that she should enter also into a compromise
agreement. For reasons we did not discover, it was not until June 2009, after
she had already left OP, that this agreement was concluded, and that after
mediation. As before, it consisted of two documents: a Settlement Agreement
dated 18 June and a Compromise Agreement, in the form of a letter from EF dated
2 July, countersigned by AB. The former provided for the payment to her of £50,000
“as a tax-free capital payment”, the latter for her abandoning any claim she
had or might have against EF, including in particular those she had made in the
Employment Tribunal proceedings. We understand that there is no argument about
the tax status of this amount.
24.
The Settlement Agreement recorded the fact that AB had made claims and
then, at Recital (C), set out EF’s response:
“Save that it has always been acknowledged by the [EF]
Parties that the Former Partner was not treated in accordance with her
entitlement as a full equity partner in respect of the profit share allocations
for the financial year ending 31 March 2007, the Former Partner’s allegations
are denied by the [EF] Parties.”
Discussion
25.
We preface this part of our decision by observing that we are conscious
that we have heard only AB’s side of the story (though corroborated, so far as
it was possible for him to do so, by CD) and that we had no evidence from EF or
OP, beyond the letters written by them or on their behalf, and the various
agreements to which we have referred. No doubt, had they given evidence, the
relevant partners of EF and OP would have sought to put the events we have
related in a different light. However, there was no apparent impediment to
HMRC’s calling any of those partners to give evidence had they not accepted at
least the thrust of AB’s version of events. We found AB and CD to be entirely
credible witnesses. Accordingly, in the absence of any basis upon which we
could reach other conclusions, what we have set out above represents our
findings of fact.
26.
The essence of AB’s case is that both EF and OP, or more accurately
their partners, discriminated against her on the basis of her sex: there was,
she said, no other rational explanation of their conduct. She had made claims
of sex discrimination in the course of the negotiations and in her Employment
Tribunal claims, and neither firm had done more than make a bare denial of the
allegations, offering no other explanation of its conduct. She was able to
point to male, but otherwise comparable, EF partners who had been treated more
favourably than her even though she had performed better than they had. She
could not do the same in respect of OP because there were no directly
comparable male partners but, conspicuously, there were also no other female
partners; there was, though, the example of the direct entrant male equity
partner – a status that was denied to her. She was convinced that there was no
other explanation for ST’s attitude to her, or for QR’s failure to support her
against ST.
27.
HMRC’s case is that there is no evidence, beyond AB’s belief, that any
part of what she received was compensation. AB had entered into each of the
agreements providing for her retirement from the two firms after taking legal
advice, and each agreement referred to the amounts to be paid as shares of
profit, there was no admission of any cause for the payment of compensation,
and neither the word “compensation” nor any synonym for it appeared anywhere in
the documents. The Partnership Act 1890 provides, by s 24, that partnership
profits are to be divided equally among the partners unless they agree
otherwise. Here, the partners of both EF and OP, including AB, had agreed
otherwise and had recorded their agreement in the documents. The shares so
agreed were, by virtue of s 850 of the Income Tax (Trading and Other Income)
Act 2005, the shares upon which the individual partners were liable to income
tax.
28.
AB’s case, Mrs Parslow argued, required us to accept that in their
partnership accounts two large firms of accountants had described as shares of
profit payments which in fact represented something else. Moreover, AB herself
had done the same, by describing what she had received as a share of profit in
her self-assessment returns, only later seeking to amend those returns.
29.
AB told us that she did consider aspects of the tax issues around the
payments from EF, as one would expect of a tax specialist accountant. However,
she admitted she did not fully address the issues and nor did her advisers at
the time: none were partnership tax experts. She did not discuss how the
amounts would be described in EF’s accounts. She told us she understood that
compensation for personal injury would not be taxable but did not expect that
EF would agree to describing the payment in those terms. AB explained that her
objective at the time was to agree a settlement and “…draw a line under the
experience”. Negotiating tax and accounting issues would have meant more delay.
30.
We recognise that AB initially completed her tax return for 2008-09 on
the basis that the £102,500 received from OP was taxable. She later amended her
return to treat the amount as non-taxable, partly because of her researching
the High Court case of Zim Properties Ltd v Procter [1985] STC 90. In
fact, we do not regard the manner in which AB completed her self-assessment
returns as particularly important; the question for us is not what AB thought
the payments represented, but what in fact they represented.
31.
Both parties referred us to the decision of this tribunal in Morgan v
Revenue and Customs Commissioners, Self v Revenue and Customs Commissioners
(2009, TC00046) which (in common with most of the other cases to which we were
referred) we are bound to say we found of limited help since cases of this kind
are determined very largely, if not almost entirely, on their own facts. It is,
however, worth bearing in mind one observation, at [52]:
“… in deciding whether payments made by a partnership to an
individual partner are profits of the firm, or expenditure which should be
deducted from the profits, it is necessary to decide whether the payments were
received by the individual partner in his capacity as a partner in the firm and
whether that was ‘the very justification for the receipt’. What an individual
partner receives out of the partnership funds is part of his share of the
profits unless he can demonstrate that it represents a payment to him in
reimbursement of sums expended by him on partnership purposes or an entirely
collateral payment made to him otherwise than in his capacity as a partner.”
32.
The quotation within that observation is derived from the speech of Lord
Oliver of Aylmerton in MacKinlay v Arthur Young McClelland Moores & Co (1989)
62 TC 704, a case about a quite different issue.
33.
It is undisputed that the burden of persuading us that the disputed
amounts represent “an entirely collateral payment”—in this case compensation—rather
than profit shares rests on AB. It follows from our findings of fact that we
are satisfied that AB was treated unfairly by each of the firms, a conclusion
which provides her with the foundation for her argument. However, it is not
enough to show unfair treatment alone; AB must satisfy us in addition that the
disputed payments are properly to be regarded as compensation for that unfair
treatment. We do not need to explore any other possibility since it is accepted
by AB that if the disputed amounts were not payments of compensation each must
represent a share of profit.
34.
There are, in our view, great difficulties facing AB in persuading us
that any part of the payment she received from EF in 2007 represents
compensation. First, the Retirement Agreement and the letter which preceded it
both described the payment made pursuant to that agreement (leaving aside the
capital adjustment) as a share of profit: it was offered and accepted as such. That
same agreement expressly contemplated a quite separate compromise of AB’s
claims, and in due course she received (as HMRC have always accepted and as the
Settlement Agreement effectively if reluctantly concedes) a payment of £50,000
as compensation for her unfair treatment. The only realistic conclusion is the
two items—her profit share and the compensation due to her—were treated on both
sides as discrete items. We do not see, against that background, how it could
properly be said that any part of the sum agreed to be paid in accordance with the
Retirement Agreement represents compensation.
35.
However. the arrangements by which AB terminated her relationship with
OP dealt with her departure differently: she was to be paid two sums, each of
£102,500 (or, in the event, £102,750). In our view, analysis of these payments
leads to a different conclusion. Accepting her evidence as we do, there can be
no real doubt that she was treated badly, though we do not think it necessary
(or even possible) to decide whether she was so treated because of her sex, or
for other reasons. The only interpretation we can place on the agreement AB
entered into with OP was that, while OP was unwilling to make any admission,
the partners recognised that AB had been treated unfairly, and that
compensation had to be paid. Had the “additional sum” been attributable to
anything other than compensation it would have been simple to say so; that this
course was not adopted, against the background of an Employment Tribunal claim
which was withdrawn in consequence of the payment, is in our view a compelling
indication that that is precisely what it represented.
36.
It does not seem to us that OP’s wish to treat the payment, in its own
accounts, as a share of profit affects that conclusion. It is consistent with
what we deduce to be OP’s desire to avoid making an admission. Moreover, while
it is a statement of OP’s proposed accounting treatment of the payment it is
not, in contrast to the wording used in the Retirement Agreement between AB and
EF, a statement of what the payment represented.
37.
We are accordingly satisfied that the “further sum” of £102,750 paid to
AB by OP represented compensation for her adverse treatment, but that no part
of the amount paid to her by EF in 2007 was compensation. It follows that the
appeal is allowed in respect of the payment made by OP, but dismissed in
respect of the payment made by EF.
38.
This document contains full findings of fact and reasons for the
decision. Any party dissatisfied with this decision has a right to apply for
permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure
(First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be
received by this Tribunal not later than 56 days after this decision is sent to
that party. 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.
Colin Bishopp
Tribunal Judge
Release Date: 28 October 2011
