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Cite as: [2003] UKSC SPC369, [2003] UKSC SPC00369

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Channel 5 TV Group Ltd v HM Inspector of Taxes [2003] UKSC SPC00369 (15 May 2003)

NATIONAL INSURANCE CONTRIBUTIONS - payments made to employees by a third party - whether payments should be excluded from the computation of earnings - whether payments were gratuities - yes - whether conditions that payments should not be made or allocated by employer are cumulative - no - or alternative - yes - whether payments made by employer - no - whether payments allocated by employer - no - payments therefore excluded from earnings and appeal allowed - whether, if payments not excluded from earnings, the contributions could be collected from the employer - yes - SSCBA 1992 Ss 1(4), 3(1)(a), 6(3), 7(2), Sch 1 paras 3(1) and 6; The Social Security (Contribution) Regulations 1979 SI 1979 No. 591 Regs 2(1), (19)(1)(c), Sch 1 paras 2(1), and 26

LONDON TRIBUNAL CENTRE

CHANNEL 5 TV GROUP LIMITED

Appellant

- and -

PETER MOREHEAD

(HM INSPECTOR OF TAXES)

Respondent

SPECIAL COMMISSIONERS : DR NUALA BRICE

DR J F AVERY JONES CBE

Sitting in private in London on 10-12 March 2003

Graham Aaronson QC with James Henderson of Counsel, instructed by Messrs Squire & Co Solicitors, for the Appellant

Ingrid Simler of Counsel, instructed by the Solicitor of Inland Revenue, for the Respondent

© CROWN COPYRIGHT 2003

ANONYMISED DECISION

The appeal

Channel 5 TV Group Limited (the Appellant) appeals against a number of decisions of the Inland Revenue dated 7 February 2001. The decisions were that certain payments made in February 2000 to a number of employees of the Appellant by an investor (the Investor) were liable to primary and secondary Class 1 national insurance contributions. The amount at issue in the appeal is £454,705.

The legislation

The Social Security Contributions and Benefits Act 1992 (the 1992 Act) consolidated the enactments relating to national insurance contributions and benefits. Section 1 outlines the contributory system and provides that the funds required for paying benefits under the Act are to be provided by means of contributions "by earners, employers and others". Section 6 provides that, where earnings are paid to an earner, both primary and secondary contributions are payable and section 8 provides that the amount is a percentage of the earnings. Section 3(1)(a) defines earnings as including any remuneration or profit derived from an employment. It was agreed that the payments the subject of the appeal were remuneration or profit derived from the employees' employments.

However, regulation 19 of the Social Security Regulations 1979 (SI 1979 No. 591) (the 1979 Regulations) provides that certain payments are to be disregarded when computing earnings. The relevant parts of regulation 19 provide:

"19. (1) For the purposes of earnings-related contributions, there shall be excluded from the computation of a person's earnings in respect of an employed earner's employment any payment in so far as it is-

(c) a payment of or in respect of a gratuity or offering-

(i) where the payment is not made directly or indirectly by the secondary contributor and the sum paid does not comprise or represent sums previously paid to the secondary contributor; or

(ii) where the payment is not directly or indirectly allocated by the secondary contributor to the earner.; …" :

The normal meaning of the secondary contributor is the employer and that is the meaning which is relevant in this appeal.

The issues

In February 2000 the Investor, which was and is a non-resident organisation, made payments to a number of employees of the Appellant. The Inland Revenue were of the view that the Appellant was liable to pay national insurance contributions in respect of the payments. The Appellant argued that the payments were gratuities; that the conditions in regulation 19(1)(c)(i) and (ii) were alternative conditions; and that, in any event, the payments were neither made nor allocated by the Appellant. Accordingly, the payments were excluded from the computation of the employees' earnings under regulation 19(1)(c). In the alternative the Appellant argued that, if there were a liability for contributions, that was not a liability of the Appellant. The Inland Revenue argued that the payments were not gratuities; that the conditions in regulation 19(1)(c)(i) and (ii).were cumulative and the Appellant had to satisfy them both; and that, as the payments had been made or allocated by the Appellant, regulation 19(1)(c) did not apply. They also argued that the Appellant was liable to pay the contributions.

Thus the issues for determination in the appeal were:

(1) whether the payments were gratuities within the meaning of regulation 19(1)(c);

(2) whether the provisions of regulation 19(1)(c)(i) and (ii) were cumulative or alternative conditions;

(3) whether the payments were made or allocated directly or indirectly by the Appellant within the meaning of regulation 19(1)(c)(i) and (ii); and

(4) whether, if the payments were liable to national insurance contributions, the contributions could be collected from the Appellant who was not the payer.

The evidence

A bundle of documents was produced. Oral evidence was given on behalf of the Appellant by: Mr David Elstein who, at the relevant time, was the Chief Executive of the Appellant; Mr Colin Alexander Campbell, Director of Legal and Business Affairs and Company Secretary of the Appellant, Mr Christopher John Chapman a solicitor employed by Messrs Squire & Co, Solicitors for the Appellant, and Mr Dominic Shorthouse. At the relevant time Mr Shorthouse was a managing partner of the Investor (who made the payments at issue in the appeal) and a member of the board of directors of the Appellant. We found all the witnesses to be reliable witnesses and accept their evidence.

The facts

At the relevant time the Investor was a limited liability company organised in the State of Delaware, USA and undertook private equity investments. Mr Shorthouse was one of its managing directors in London .

In the mid 1990s the Appellant was being established and the Investor decided to invest in the Appellant. There were in total four shareholders. The first held 29% of the shares; the second also held 29%; the third held 24%; and the Investor held 18%. Between the shareholders there was some debate about the remuneration of the Appellant's management. The Investor thought that they were under rewarded but the other shareholders disagreed.

The sale of the shares

Early in 1999 the Investor decided to sell its shares in the Appellant. The articles of association of the Appellant provided that a shareholder who wished to sell shares had to serve a transfer notice on the board of the Appellant, stating its intention to transfer the shares and offering them at a stated price. Within seven days of the receipt of such a transfer notice the board was required to offer the shares for sale to the other shareholders at the stated price and to give the other shareholders forty-five days within which to notify the board whether they accepted the offer. If the offer were not accepted it lapsed. If the offer were accepted by more than one shareholder then the number of shares to be sold to each was to be calculated in proportion to the number of shares currently held by each purchaser. After notifying the board of the acceptance of an offer a purchaser had a further period in which to complete the purchase by making payment to the seller.

In late summer 1999 the Investor made an informal approach to the other three shareholders to see if a price could be agreed but this approach did not succeed. Mr Shorthouse then thought that a management incentive might assist the sale of the Investor' shares in the Appellant. On 29 September 1999, therefore, he spoke to Mr Elstein and suggested that the Investor should pay to the Appellant's management a specified percentage of the Investor' profit on the sale over a target level as an incentive to the management to assist in the sale. Mr Elstein told Mr Shorthouse that the Appellant's management were always obliged to use their best endeavours to maintain and enhance the value of the Appellant and that it would be wrong to accept such a payment. Mr Elstein took advice from Mr Campbell who agreed with Mr Elstein's views. Accordingly, Mr Elstein wrote to Mr Shorthouse on 5 October 1999 declining his offer and sending a copy of Mr Campbell's advice. The letter of 5 October 1999 said that in any event an intention to make the payments would have to be declared to the other shareholders. Mr Elstein did not tell anyone else at the Appellant about Mr Shorthouse's proposal for an incentive and the proposal did not proceed further.

The Appellant's management assisted the Investor with the sale of its shares in the normal course of their duties. They introduced at least one prospective buyer of the shares and they assisted outside advisers in the preparation of an information memorandum. Mr Elstein reviewed a draft of the memorandum. Mr Elstein also made sure that the other shareholders were fully informed. At this stage there were considerable discussions with non-shareholder prospective buyers and those discussions were reported in the media.

On 16 November 1999 the Investor served a formal transfer notice on the board of the Appellant as required by the articles of association. The transfer notice stated the intention of the Investor to sell its shares at a stated price. On 22 November 1999 the board (through Mr Campbell) sent a copy of the transfer notice to the other three shareholders and stated that the letter was a formal offer by the board to the other three shareholders to acquire the Investor' shares at the stated price. The letter also gave the other three shareholders until 5 January 2000 to say whether they accepted the offer, failing which it would lapse. On 23 December 1999 and 5 January 2000 the other three shareholders did accept the offer at the Investor' stated price, which was well above Mr Shorthouse's target level and also above his informal offer made earlier in 1999. The Investor made a substantial profit on the sale.

On 17 January 2000 Mr Campbell wrote to the other three shareholders notifying them of the number of the Investor' shares which would be sold to each of them and stating that the purchase would be completed on Tuesday 15 February. The purchase was in fact completed by two of the other shareholders on 16 February and by the third on 17 February.

The proposal for a payment

Although the sale of the shares was completed in February 2000, the parties had become contractually bound on 5 January 2000 and that was the date when the sale was regarded as closed.

After the sale had closed Mr Shorthouse, on behalf of the Investor, decided to make a payment to Mr Elstein of $7.7M. The amount of the payment was the amount by which the total sale price of the Investor' shares exceeded the profit which Mr Shorthouse had wanted to make on the sale and the costs of the sale. He telephoned Mr Elstein to tell him about the payment. In evidence which we accept Mr Shorthouse said that he wished the payment to go "to the people who had contributed most to the creation and value of Channel 5, which was a start-up launched in difficult circumstances and which had proved to be a hugely successful investment for us [the Investor]". Mr Shorthouse approached Mr Elstein in his capacity as a colleague and not as chief executive of the Appellant. Mr Shorthouse said that he did not want to be involved with distributing the payment and told Mr Elstein that what he did with the payment was entirely at his discretion but he wanted Mr Elstein to look after the payment personally and not as part of the Appellant's board. Mr Shorthouse was looking to Mr Elstein for recommendations. Mr Elstein formed the view that he could recommend that he keep the whole sum if he chose to but he did not so choose.

Mr Elstein shared the good news with the Appellant's executive team. The Appellant's management had not been aware of the details of the negotiations between the shareholders and they were not aware of the sale price. They agreed with a proposal of Mr Elstein that all the Appellant's employees should benefit from the payment and that some of the money should go to a charity. It was then appreciated that some of the people who worked for the Appellant were not strictly employees but were consultants or employed by others and a decision was made that such people should also share in the payment.

Mr Elstein told Mr Shorthouse how it was proposed to distribute the payment. Mr Shorthouse was pleased, especially at the payment to the charity; he had thought that payments might only be made to three or four managers. .In evidence which we accept Mr Elstein said : "It is his [Mr Shorthouse's] decision and my recommendation. If he had rejected my recommendation there was nothing I could do about it."

At about the same time Mr Elstein took advice from Mr Aaronson and from PricewaterhouseCoopers On 14 January 2000 Mr Aaronson advised that the payments would give rise to a liability on the recipients for income tax under Schedule E. However, as the Investor had no taxable presence in the United Kingdom, it would not be liable to operate the PAYE procedure. Accordingly a practical solution would be for the Appellant to give the Investor sufficient information so that the Investor could deduct the income tax from the payments and pay it to the Inland Revenue. Relying on this advice Mr Elstein decided that income tax should be deducted at source, even for non-employees. Mr Aaronson was paid by the Appellant's management personally and not by the Appellant.

On 25 February 2000 each of the Appellant's employees was informed of the payment which would be made to him. The payment to each employee amounted to £175 for each month the employee had been with the Appellant.

The arrangements for the payments

PricewaterhouseCoopers co-ordinated the arrangements for the actual payments. In March 2000 the Investor made one payment of £4.9M into a client trust account of Messrs Travers Smith Braithwaite (Travers Smith). Travers Smith were instructed by the Investor for this purpose. Travers Smith made the individual payments by cheque to each recipient. The names of the recipients, and the amount that each was to receive, were sent to Travers Smith by the Appellant. (We were told that there were 227 recipients. The recipients were mostly employees of the Appellant but there were some non-employees and also there were six executive directors. In this Decision we refer to them all as employees.) The cheques were not sent to the home addresses of the recipients but to the London offices of the Appellant. In evidence which we accept Mr Elstein told us that the reason for that arrangement was that he did not want cheques turning up at people's homes when they were on holiday but wanted physically to put them in people's hands at a meeting. The cheques were in fact handed to the recipients on 17 March 2000. The employees were grateful for the payments they received. We saw copies of some of their letters in which the payments were described as "a nice surprise", a "windfall", "a gift" and "a bonus".

When the payments were made income tax was deducted at source and the Appellant's payroll department ran a bonus run on its computer to assist the Investor with the necessary calculations. On 21 March 2000 Travers Smith sent to PricewaterhouseCoopers a cheque payable to the Inland Revenue for £1,108,309.06, being the income tax deducted from the payments. On 27 March 2000 PricewaterhouseCoopers sent the cheque to the Inland Revenue.

The idea had been that, of the £4.9M received from the Investor, £2.2M would be divided among the six executive directors of the Appellant; £1.1M would be divided among the other employees; and £1.6M would be paid to the National Film and Television School. However, not all the money received from the Investor was paid out immediately. A small amount was held back to pay for the costs associated with the distribution of the moneys and also for the premium on an insurance policy against a possible liability for national insurance contributions. The bundle of documents contained an invoice dated 17 May 2000 from Travers Smith addressed to the Investor but "payable by" the Appellant for the sum of £8,350 in respect of the work done in distributing the payments. However, we accept the oral evidence of Mr Elstein that the arrangements for holding back sums from the payment to pay for the costs of the distribution were made so that nothing connected with the payments was to come out of the Appellant and that the Appellant was to be "insulated". Apart from the copy invoice there was no evidence before us to support a finding that the Appellant paid in any way towards the costs of the distribution of the payment and we therefore find that it did not.

We also accept the evidence of Mr Elstein that, before he heard from Mr Shorthouse in January 2000, there was no arrangement that any payment should be made by the Investor. Mr Shorthouse's offer in September 1999 had been refused and was not revived. It was then "a dead issue". Apart from himself and Mr Campbell no-one at the Appellant knew of that offer and so no-one had any incentive to promote the sale of the Investor' shares. In any event Mr Elstein was quite clear that it would have been wrong to act in favour of one shareholder against the interest of another. The only influence that the management of the Appellant had on the sale process was in identifying a replacement shareholder (who did not in the event purchase the shares) and not in maximising the Investor' sale proceeds. Mr Shorthouse's offer in January 2000 to make the payments at issue in the appeal came as a considerable surprise both to himself and to everyone else.

We also find that the payments made were entirely gratuitous in nature and were over and above the normal remuneration of the employees for the work they did for the Appellant. There was no contractual entitlement for any employee to receive any amount from the Investor nor did any employee have any expectation at any time that they would receive such a payment. None of the employees carried out any duties for the Investor; all they did was in their capacity as employees of the Appellant for which they were paid by the Appellant.

Reasons for decision

We consider separately each of the issues for determination in the appeal.

(1) Were the payments gratuities?

The first issue is whether the payments were gratuities within the meaning of regulation 19(1)(c).

For the Appellant Mr Aaronson argued that a gratuity was a voluntary payment given as a token of thanks or recognition for a job well done. The scheme of regulation 19(1)(c) was that a gift, even if related to a job well done, which was not made by an employer was excluded from earnings for the purposes of national insurance contributions. The word gratuity had to be read with the word offering; they had similar meanings but the word gratuity would be appropriate where the person paying had received a direct benefit from the recipient and the word offering would be appropriate where the person paying had not received a direct benefit from the recipient. There was nothing in the regulation which confined the meaning of gratuity to small gifts or tips; for example, regulation 19(1)(m) referred to payments by way of a right to acquire shares which payments could be of quite large amounts. Another useful analogy was contained in section 161 of the Income and Corporation Taxes Act 1988 (the 1988 Act). Section 160 provided for the cash equivalent of a beneficial loan to be treated as emoluments for the purposes of income tax but section 161 provided an exception where the amount outstanding on the loan did not exceed £5,000. So, if it had been the intention of Parliament to confine a relief or exclusion by reference to the amount of a payment, that could, and would, have been stated specifically. Again there was nothing in the regulation which confined the meaning of gratuity to tips which were a normal part of remuneration for a particular job. If the regulation had intended anything of that sort then it could have been stated specifically, as had been done in regulation 19(1)(p). The Inland Revenue relied upon the definition of gratuity in the Oxford English Dictionary 1989 which stated that the word gratuity was now applied "exclusively to a gift made to a servant or inferior official, a tip". Mr Aaronson accepted that a tip was one meaning of the word gratuity but he preferred a number of other definitions in more recent dictionaries which defined gratuity more generally as a gift or reward for services rendered.

Mr Aaronson went on to argue that, even if the Inland Revenue were right (that the modern meaning of gratuity was tip), it was still necessary to determine the meaning of the word when it was used in the 1979 Regulations. He relied upon Bennion on Statutory Interpretation Fourth Edition 2002 section 288 at pages 762 and 777 for the principle that normally statutes were intended to develop in meaning with developing circumstances and that Parliament could be presumed to intend a construction that continually updated the wording to allow for changes since the Act was originally framed. While an Act remained law it was to be treated as always speaking and should be construed in accordance with the need to treat it as current law so long as the new situation fell within the Parliamentary intention. So, if an expression changed its meaning the Act had to be construed as if it contained a word which corresponded with the original meaning. He distinguished Regina v Munks [1964] 1 QB 304 and relied upon Victor Chandler International Limited v Customs and Excise Commissioners [2000] 1 WLR 1296. Mr Aaronson then argued that the original meaning of the word gratuity was wider than tip and he cited Holloway v Poplar Corporation [1930] 1 KB 173; McGrath v Secretary of State for Northern Ireland [1994] STC 98; Smith v The Incorporated Council of Law Reporting for England and Wales (1914) 6 TC 477; W S McGarry v R [1954] IR 64; and Henley v Murray (1950) 31 TC 351. He argued that it followed that this wider meaning, which was current in 1979, should be applied when interpreting the 1979 Regulations.

For the Inland Revenue Ms Simler's main argument was that the word "gratuity" meant tip. That was the Parliamentary intention which was confirmed by the dictionary definitions. There was no need to use the word tip in regulation 19(1)(c) because everybody knew what was being talked about and everybody knew that a gratuity in the context of the regulations meant a tip. That was clear when regulation 19(1)(c)(i) and (ii) were considered. They made it clear that, where a customer left money on a table and the waiter kept it, that was a tip but, where the customer added 10% to his bill and left it for the employer to allocate, that was not a tip. Gratuities were not restricted to small payments but the size was something to be taken into account in deciding whether a payment was a tip. She argued that the authorities cited by Mr Aaronson were not of help because they were not concerned with the 1979 Regulations. She distinguished Holloway which was decided in 1914 and argued that a payment to an officer on retirement would not be called a gratuity in 2003. Also, the fact that it was made by the employer would take it outside Regulation 19(1)(c). Ms Simler also distinguished McGrath.

In the alternative Ms Simler argued that, even if the word gratuity had a wider meaning than tip, the payments in this appeal were not gratuities and she relied upon Commissioners of Inland Revenue v Morris (1967) 44 TC 685 at 689 and 691. She argued that there was no distinction between a gift for the purposes of income tax under Schedule E and a gratuity within the meaning of regulation 19(1)(c) and it was relevant that it had been accepted that the payments in the appeal were chargeable to income tax under Schedule E. She argued therefore that a voluntary payment made without obligation was not a gratuity if made in respect of the discharge of the duties of an office or employment whereas such a voluntary payment would be a gratuity if it were an exercise of bounty intended to benefit the donee for reasons personal to him.

In considering the arguments of the parties we first refer to the dictionary definitions of gratuity and offering. We were referred to a number of dictionaries which we consider in chronological order in case there has been any change in the meaning of these words in recent years.

The Shorter Oxford English Dictionary 1974 :

"Gratuity … 2. A gift or present (usu. of money) often in return for favours or services, the amount depending on the inclination of the giver; in bad sense, a bribe. Now a "tip". 1540 . … 3. A bounty, esp. that given to soldiers on re-enlistment, retirement or discharge 1804.".

"Offering 2.a. A sacrifice; an oblation OE b. something offered to a person, a present, a gift 1440."

The Oxford Dictionary of English Etymology 1985:

Gratuity favour, gift, present

The Oxford English Dictionary 1989:

Gratuity 2. A gift or present (usually of money) often in return for favours or services, the amount depending on the inclination of the giver; in bad sense, a bribe. Now applied exclusively to such a gift made to a servant or inferior official; a "tip"."

Offering 2 b. Something offered to a person for his acceptance , esp as a truibute of honour or esteem; a present, a gift."

The Chambers Dictionary 1998:

Gratuity a gift, usu. of money, separate from and additional to payment made for a service; a tip or present; a bounty, a payment to a soldier etc, on discharge."

Offering the act of making an offer; something which is offered; a gift; a church collection … in the Church of England, certain dues payable at Easter."

The New Oxford English Dictionary 1998:

Gratuity money given in return for some service or favour, in particular a tip given to a waiter, taxi driver, etc. the sum of money paid to an employee at the end of a period of employment.

Offering a thing offered … a contribution, especially of money, to a church ."

The Concise Oxford Dictionary 1999:

Gratuity 1.a tip given to a waiter, porter, etc 2. A sum of money paid to an employee at the end of a period of employment."

Offering a thing offered, especially as a gift or contribution."

Collins English Dictionary 2000:

Gratuity a gift or reward, usually of money, for services rendered, tip. 2. something given without claim or obligation 3 military a financial award granted for long or meritorious service."

Offering 1. something that is offered 2 a contribution to the funds of a religious organisation."

The Shorter Oxford English Dictionary 2002 :

"Gratuity 2. A gift (usu. of money ) of an amount decided by the giver . Now usu. = TIP. B. Payment , wages.

"Offering 3.A thing offered for acceptance , esp. in tribute or as a token of esteem; a present a gift, a thing offered as entertainment…".

Mr Aaronson also drew our attention to two definitions of "tip". In the Concise Oxford Dictionary of 1976 "tip" is defined as "make usu. small present of money to (esp. for service given or expected)". In the Shorter Oxford English Dictionary 1980 "tip" is defined as "a small present of money given to an inferior; a gratuity; a douceur".

In the light of these examples we accept that one meaning of the word gratuity is tip but that is not its only meaning. We also have to consider the meaning of the word as it appears in regulation 19(1)((c) and there is no indication from the statutory context that the meaning of the word gratuity is to be restricted to a tip. If it were to be so restricted then the legislation could easily have used the word tip, which was one meaning of the word gratuity in 1974, well before the 1979 Regulations. In any event, regulation 19(1)(c) also uses the word offering, the meaning of which is very much wider than a tip.

The authorities also support the view that the word gratuity has a wider meaning than tip.

The Incorporated Council of Law Reporting (1914) concerned gratuities paid to law reporters on their retirement and the issue was whether the gratuities were deductible as a business expense. At 489 Scrutton J used the word "gratuities" to describe both tips paid to waiters and also lump sums paid to law reporters on their retirement.

Holloway (1930) concerned a local Act of Parliament of 1911 which provided that a borough council could grant a gratuity to an officer when he ceased to hold his office or employment. That meaning coincides with the dictionary definitions of a financial reward granted for meritorious service. Ms Simler distinguished this authority on the ground that, as the sum was paid by the employer, it could not come within regulation 19(1)(c). We agree but that result does not follow from a restricted meaning of the word gratuity but from the existence of the two additional conditions (i) and (ii) in regulation 19(1)(c). If Ms Simler were right, and only payments from non-employers could be gratuities, then conditions (i) and (ii) would be otiose.

In McGarry (1954) an employee of one company agreed to assist a second company "gratuitously" while continuing in his employment with the first company. When the second company was dissolved the employee was paid "an ex gratia payment" by the second company and the issue was whether it was remuneration. The High Court of Ireland held that the sum was "a mere gratuity" and was not salary or remuneration. Ms Simler accepted that it was a gratuitous payment but argued that that did not assist with the interpretation of regulation 19(1)(c). However, in our view one meaning of gratuity is a gratuitous payment.

McGrath (1994) concerned a "gratuity" which was defined in Article 6(9) of the Criminal Injuries (Compensation) (Northern Ireland) Order 1988 SI 1988 No. 793 as "any payment of money whether made in consequence of a legally enforceable right or not". The Court of Appeal held that the primary meaning of the word gratuity carried a connotation of a lack of obligation on the part of the person paying the sum which was freely paid on his part. The secondary sense was that of a bounty, particularly one given to soldiers on retirement or re-enlistment. These meanings of the word gratuity are very much wider than the restricted meaning of a tip. Ms Simler distinguished this authority on the ground that the word "gratuity" was there given a special statutory meaning. We agree and we would not include within the meaning of the word gratuity a payment made in consequence of a legally enforceable right. However, we have been assisted by the guidance given by the Court of Appeal on the primary and secondary normal meanings of the word gratuity.

Finally, we have also referred to Henley v Murray (1950) where a sum was paid to a managing director who resigned before his service agreement expired. At 368 Jenkins LJ held that the payment was not remuneration nor was it "a mere gratuity". It was a payment for the surrendering of a right to serve and be paid to the end of the term of the service agreement and was not assessable for the purposes of income tax. We agree with Ms Simler that this authority sheds no light on the matter we have to consider.

In the light, therefore, of the dictionary definitions and of these authorities we conclude that a gratuity means a voluntary payment given in return for services rendered where the amount of the payment depends on the donor and where there is no obligation on the part of the donor to make the payment. That meaning of the word gratuity includes, but is not restricted to, a tip.

We have been able to reach our views on the meaning of the word gratuity in regulation 19(1)(c) without reference to the other parts of regulation 19 or to sections in the 1988 Act. We have also been able to reach our views on the current meaning of the word gratuity without adopting the principle of statutory construction proposed in section 288 of Bennion. That means that we do not have to consider Munks ...1963) or Victor Chandler (2000). Munks concerned a penal statute enacted in 1861 which the Court of Appeal held should construed restrictively and given a meaning which accorded with the natural meaning of the word in 1963. On the other hand, Victor Chandler (2000) concerned legislation enacted in 1952 which prohibited the issue of "an advertisement or other document". In 2000 the Court of Appeal interpreted this phrase as including direct electronic transmission. These authorities establish the principle that an ongoing statutory provision should be treated as always speaking so that the courts should apply a construction that continuously updates the wording to allow for changes since the Act was initially framed. Thus an ongoing Act has to be construed in such a way as to give effect to the true original intention.

If we had not already concluded that the current meaning of the word gratuity is wider than tip we would have concluded that the wider meaning was current in 1979 and that the clear Parliamentary purpose was that regulation 19(1)((c) should apply not only to tips but also to all gifts given in return for services rendered where the amount of the gift depended upon the donor and where there was no obligation to make the payment.

Applying that meaning of the word gratuity to the facts of the present appeal we conclude that the payments made by the Investor to the employees of the Appellant were gifts given in return for the fact that the employees had contributed to the creation and increase in value of the Appellant which became a successful investment for the Investor. The amount of the gifts depended upon the Investor and there was no obligation on the Investor to make the payments. The payments were, therefore, gratuities within the meaning of regulation 19(1)(c).

Before concluding our consideration of this issue we must deal with Ms Simler's alternative argument which was that a distinction had to be made between voluntary payments made without obligation but in respect of the discharge of the duties of an office or employment (which were not gratuities and so were subject to contributions) and voluntary payments which were an exercise of bounty intended to benefit the donee for reasons personal to him (which were gratuities and so not subject to contributions). Ms Simler relied upon Morris (1967) which concerned a payment made to a taxpayer who was employed by one entity and seconded to another. He was paid throughout by his employer. At the end of the secondment he became employed by the second entity. The second entity, at Christmas time, paid him a sum stating that it was a gift to mark its appreciation of his work during the period of secondment. The issue was whether this was an emolument of his employment for the purposes of income tax. In a passage relied upon by Ms Simler, at page 691 I, The Lord President said:

"… in every case the question must be whether or not on the particular facts the payment or payments fall within the scope of the words used by the legislature - "emoluments" from an office or employment."

We adopt the words of The Lord President and in this appeal we have to ask whether the payments were or were not gratuities within the meaning of regulation 19 (1)(c). The framework of the contributions legislation is not the same as that for income tax. However, both start by identifying earnings (or emoluments) and it is that first stage which was considered in Morris. We do not have to consider that first stage in this appeal because the Appellant has accepted that the payments were earnings (and emoluments). The contributions legislation differs from the income tax legislation because the former (but not the latter) goes on to the second stage which is to exclude from earnings certain gratuities and that is the issue in this appeal. For that reason we have not found Morris of relevance in considering whether the payments were gratuities.

Our decision on the first issue is that the payments were gratuities within the meaning of regulation 19(1)(c).

(2) Must the Appellant satisfy both conditions in regulation 19(1)(c)?

The second issue is whether the provisions of regulation 19(1)(c)(i) and (ii) are cumulative or alternative conditions; in other words must the Appellant satisfy both conditions (i) and (ii)?

For the Appellant Mr Aaronson argued that the two tests in paragraphs 19(1)(c)(i) and (ii) were alternative and not cumulative and that the word "or" meant "or" and not "and". Reading the text of regulation 19 as a whole, the meaning was that gratuities were to be excluded from the computation of earnings if either of sub-paragraphs (i) or (ii) applied, namely if either the payment was not made by the employer or the payment was not allocated by the employer. He referred to the new legislation in paragraph 5 of Part X of Schedule 3 of the Social Security (Contributions) Regulations 2001 SI 2001 No. 1004 (the 2001 Regulations) which supported his argument.

For the Inland Revenue Ms Simler argued that the two conditions were cumulative and the Appellant had to satisfy them both. She argued that the opening words of regulation 19(1) were negative (excluding payments from earnings) and so the two conditions should be read as "neither, nor" rather than as "either, or".

In approaching this issue we first read the legislative words with their normal and natural meaning. Regulation 19(1)((c) in effect provides that a payment is excluded from earnings if it is a gratuity which either is not made by the employer or is not allocated by the employer. That means that the conditions in (i) and (ii) are not cumulative and that a gratuity is excluded from earnings if either condition is satisfied. We are confirmed in this view by the fact that if the conditions were to be cumulative the regulation would, as suggested by Ms Simler, have provided that a payment was excluded from earnings if it were a gratuity which was neither made nor allocated by the employer. However, that is not what the words say. We accept that it would not have been a solution to provide that the word "or" after condition (i) should read "and" as, in that case, gratuities which were either made or allocated by the employer, but not both, would continue to be disregarded.

We do, however, record that we have some sympathy with Ms Simler's arguments on this issue as it may have been intended that the two conditions should be cumulative. For example, when one considers the substance of the two conditions it is clear that condition (i) applies where a payment is made by an employer and that is the widest condition and the most likely to occur in practice. However, condition (ii) will usually only apply where condition (i) does not and its effect is to take out of the disregard a further and wider category of payments, namely those not paid by an employer but allocated by an employer. Thus both conditions (i) and (ii) are subsets of a wider set the whole of which it may have been intended to exclude. We think that it may have been the intention to legislate that any gratuity which was made or allocated by an employer was not to be disregarded. If this were the intention then the legislation should have provided that a gratuity was excluded from the computation of earnings if it was neither made nor allocated by the employer. On the other hand, the draftsman may have regarded the two conditions as mutually exclusive alternatives, (i) applying when the payment was made by the employer and (ii) applying when it was not made by the employer but the employer allocated it, in which case there is no difference between the two interpretations. However, even if this is wrong, the way in which the regulation is worded has the effect that if an employee can show that the payment was not made by the employer then the fact that it is allocated by the employer becomes irrelevant. We have to apply the exact words of the regulation. We are not permitted to read in words that are not there.

We are confirmed in our original view (that the conditions are alternative and not cumulative) by the new legislation. The 2001 Regulations are consolidating regulations which replace the 1979 Regulations as well as others. Schedule 3 of the 2001 Regulations contains the provisions previously in regulation 19(1)(c) of the 1979 Regulations which relate to payments to be disregarded in the calculation of earnings for the purposes of earnings-related contributions. Part X of Schedule 3 describes certain miscellaneous payments which are to be disregarded. Paragraph 1(1) of Part X provides that the payments listed in paragraphs 2 to 15 are disregarded in the calculation of earnings. Paragraph 5 is headed "Gratuities and offerings" and reads:

"5(1) A payment of, or in respect of, a gratuity or offering which satisfies either of the conditions in this paragraph.

(2) The first condition is that the payment -

(a) is not made, directly or indirectly, by the secondary contributor; and

(b) does not comprise or represent sums previously paid to the secondary contributor.

(3) The alternative condition is that the secondary contributor does not allocate the payment directly or indirectly, to the earner."

As the 2001 Regulations are consolidating regulations the presumption is that they do not change the meaning of the 1979 Regulations. The 2001 Regulations make it clear beyond doubt that the conditions are alternative and not cumulative.

We therefore conclude that the provisions of regulation 19(1)(c)(i) and (ii) are alternative conditions; in other words the Appellant need satisfy only one and not both conditions.

(3) Did the Appellant make or allocate the payments?

The third issue is whether the payments were directly or indirectly made or allocated by the Appellant within the meaning of regulation 19(1)(c)(i) and (ii). The ambit of this issue was not clearly identified at the hearing; there was very little argument about whether the Appellant made the payments and there was some argument about whether the Appellant allocated the payments. We have, however, phrased the issue in the way we have so that we can deal completely with regulation 19(1)(c).

For the Appellant Mr Aaronson argued that the Appellant did not make or allocate the payments in any way. The money was not paid through the Appellant and the Appellant did not decide who should receive a payment. Mr Elstein personally decided who was to receive a payment and the amounts of the payments. The payments were made through Travers Smith who used the Appellant's payroll information and the Appellant to that extent facilitated the making of the payments.

For the Inland Revenue Ms Simler argued that the Appellant directed the whole question of allocation and distribution of the payments. Although Mr Elstein made recommendations to Mr Shorthouse, they were always going to be accepted. It was Mr Elstein and the five other executive directors of the Appellant (which were its executive team) who identified the three-way split (between the six executive directors, the other employees and the charity) and the structure of each payment together with the method of payment. Although Travers Smith distributed the payments they did that according to explicit directions which came from the Appellant. PricewaterhouseCoopers, who acted for the Appellant, organised the whole method of payment through Travers Smith. Although Travers Smith were apparently acting for the Investor they were doing what the Appellant was telling them and so were acting for the Appellant.

We first consider whether the payments were made directly or indirectly by the Appellant and conclude that they were not. We have found as a fact that the payments were made by the Investor. The Investor paid Travers Smith (who in that respect were acting for the Investor) and Travers Smith paid the recipients. At no time did the money belong to the Appellant or pass through the accounts of the Appellant nor did the Appellant at any time have possession of, or control over, the money.

We next consider whether the payments were directly or indirectly allocated by the Appellant to the recipients. The answer to this question is not quite so clear as the answer to the previous question but again we conclude, on balance, that they were not. The facts we have found support the conclusion that the allocation of the payments among the recipients was made ultimately by Mr Shorthouse, acting on the recommendation of Mr Elstein who made the recommendation in his personal capacity, after consulting his fellow executive directors. We do not agree with Ms Simler that, because the allocation was made by Mr Elstein with the agreement of his fellow executive directors, that means that they must have been acting for the Appellant. All the other circumstances point to the conclusion that the Investor wished to make the payments direct to the recipients and not through the Appellant and did not wish the Appellant to become involved with the allocation. At no time did the board of directors of the Appellant become involved with the allocation.

We accept that the Appellant gave some indirect assistance in the distribution of the payments. The Appellant did not make the distribution (that was done by Travers Smith). However, the payroll department of the Appellant supplied Travers Smith with the name of each recipient, and the amount to be paid to each, together with the information required to make the income tax deductions. In our view, these actions do not amount either to "making" or "allocating" the payments. Neither do they amount to the distribution of the payments, although they are the giving of assistance in the distribution of the payments.

We therefore conclude that the payments were not made, directly or indirectly, by the Appellant. If we are right on the second issue in the appeal then that means that the appeal must be allowed. However, in case we are wrong about the second issue we also conclude that the payments were not directly or indirectly allocated by the Appellant, although the Appellant did assist indirectly in their distribution.

(4) Could the Appellant have been liable to pay contributions?

The fourth issue is whether, if the payments were liable to national insurance contributions, the contributions could be collected from the Appellant who was not the payer.

In view of our decision on the first three issues in the appeal, the question of whose liability it is to pay the contributions does not arise but, as the point was argued, we deal with it briefly.

Mr James Henderson, for the Appellant, started with section 6(3) of the 1992 Act which provides:

"6(3) The …secondary Class 1 contributions referred in subsection (1) above are payable as follows…

(b) the secondary contribution shall be the liability of the secondary contributor."

"Secondary contributor" is defined in section 7 of the 1992 Act as follows:

"7 (1) For the purposes of this Act, the 'secondary contributor' in relation to any payment of earnings to or for the benefit of an employed earner, is—

(a) in the case of an earner employed under a contract of service, his employer…

but this subsection is subject to subsection (2) below.

(2)…and in relation to any other case for which it appears to the Treasury that such provision is needed, regulations may provide that the prescribed person is to be treated as the secondary contributor in respect of earnings paid to or for the benefit of an earner."

The secondary contributor is therefore the Appellant, as employer, unless section 7(2) prescribes some other person. Mr Henderson argued that The Investor was so prescribed. First he referred to section 1(4) of the 1992 Act which introduced Schedule 1 of the Act. Section 1(4) provides:

"1(4) Schedule 1 to this Act—

(a) shall have effect with respect to the computation, collection and recovery of contributions of Classes 1, 1A, 1B, 2 and 3, and otherwise with respect to contributions of those classes…."

Next, Mr Henderson referred to paragraph 6 of Schedule 1 of the 1992 Act which provides:

"6(1) Regulations made by the Inland Revenue may—

(a) provide for Class 1, Class 1A, Class 1B, or Class 2 contributions to be paid, accounted for and recovered in a similar manner to income tax in relation to which regulations under section 203 of the Income and Corporation Taxes Act 1988 (PAYE) have effect….

The heading to Schedule 1 to the 1979 Regulations indicates that the Schedule contains the provisions of the Income Tax (Employments) Regulations 1973 as they apply to earnings-related contributions. Paragraph 2(1) of the Schedule defines earnings related contributions as contributions payable under the Act by or in respect of an employed earner in respect of employed earner's employment. Paragraph 26 of Schedule 1 provides:

"26(1) Subject to [provisions that are not applicable], the employer shall pay the amount specified in paragraph (2) of this regulation to the Collector within 14 days of the end of every income tax month.

(2) The amount specified in this paragraph is the total amount of earnings-related contributions due in respect of emoluments paid by the employer in that income tax month…."

"The employer" is defined in paragraph 2(1) of Schedule 1 as:

"2(1) In this Schedule, unless the context otherwise requires—…

'employer' means any person paying emoluments;…"

Mr Henderson concluded that the effect of section 7(2) of the Act was to bring in the 1979 Regulations which in turn provided that secondary contributions were payable by the person paying the emoluments. In this appeal that person was The Investor and not the Appellant.

For the Inland Revenue Ms Simler referred to paragraph 3(1) of Schedule 1 to the 1992 Act, which made the secondary contributor liable also for the earner's primary contributions. She argued that the definition of "employer" in paragraph 2(1) of Schedule 1 to the 1979 Regulations could not affect the construction of the primary legislation which put the liability for payment on the Appellant as secondary contributor. Accordingly, she argued that this was a case where the context required that the definition of employer in paragraph 2(1) of Schedule 1 to the 1979 Regulations did not apply, because the clear liability to pay the contributions was placed on the employer in the primary legislation. She also contended that this was not a case where section 7(2) of the Act prescribed a different person to be the secondary contributor. As an example of a case where a person was prescribed she referred to regulation 93 of the 1979 Regulations which prescribed a secondary contributor for mariners in certain circumstances.

In reply Mr Henderson argued that paragraph 3(1) of Schedule 1 of the 1992 Act did not assist the argument because it begged the question as to who was the primary contributor.

There are, therefore, apparently conflicting statutory provisions. On the one hand section 6(3) of the 1992 Act puts the liability for payment of contributions on the actual employer (which in this appeal is the Appellant) as secondary contributor. On the other hand the collection mechanism in the 1979 Regulations makes the payer of the payments (which in this appeal is The Investor) liable to pay the contributions.

We believe that the answer to the conflict depends upon another provision to which neither party referred us. This is paragraph 3A of Schedule 1 to the 1979 Regulations which is headed "Employers' earnings-related contributions" and which reads:

"3A If under these Regulations a person is required to pay any earnings-related contributions which, under section 4(3) of the Act [i.e. the Social Security Act 1975, corresponding to section 6(3) of the 1992 Act], another person is liable to pay, his payment thereof shall be made as agent for that other person."

Secondary Class 1 contributions are earnings-related contributions, as the definition in paragraph 2(1) of Schedule 1 to the 1979 Regulations mentioned above makes clear.

If paragraph 3A applies, as we think it does, the conflict is avoided by the 1979 Regulations saying that The Investor is liable to pay the contributions as agent for the Appellant. If the agent pays the contributions, the principal's debt is satisfied. If, because it is outside the jurisdiction, the agent cannot be made to pay in its capacity as payer of the earnings, this leaves the liability as that of the Appellant under section 6(3). We do not consider that this is a case where the Treasury has provided that The Investor is a prescribed person to be treated as the secondary contributor in accordance with section 7(2) of the 1992 Act. Schedule 1 to the 1979 Regulations does not purport to make anyone a secondary contributor, as other provisions of the Regulations do. Nor do we think it is a case of the context otherwise requiring that the definition of "employer" in Schedule 1 to the 1979 Regulations should not apply. While it may be considered odd that a statute puts a liability on the Appellant for a payment over which it had no control and might not even know about (although it clearly did know about it in this case), that is the effect of the clear words of section 6(3). If it had been material to our decision we should have given both parties the opportunity of addressing us on paragraph 3A but, since the issue does not arise under our decision, we do not think it is necessary to do this. We merely emphasise that the parties have not had the opportunity of commenting on our reasons for our decision on this issue.

We therefore conclude that, if there had been a liability to pay the contributions, the liability would have been that of the Appellant.

Decision

Our decisions on the issues for determination in the appeal are:

(1) that the payments were gratuities within the meaning of regulation 19(1)(c);

(2) that the provisions of regulation 19(1)(c)(i) and (ii) are alternative and not cumulative conditions; and

(3) that the payments were not directly or indirectly made or allocated by the Appellant within the meaning of regulation 19(1)(c)(i) and (ii).

Those conclusions mean that the appeal must be allowed and that we do not need to consider the fourth issue but as arguments were put to us we express our views which are:

(4) that, if the payments were liable to national insurance contributions, the contributions could be collected from the Appellant.

The appeal is, therefore, allowed.

Court of Appeal certificate

Under the provisions of section 56A(2) of the Taxes Management Act 1970 we hereby certify that this decision involves a point of law relating wholly or mainly to the construction of an enactment which was fully argued before us and fully considered by us. That means that, if both parties consent, and if the leave of the Court of Appeal is

obtained, an appeal against this decision may be made directly to the Court of Appeal.

DR NUALA BRICE

DR J F AVERY JONES CBE

SPECIAL COMMISSIONERS

RELEASE DATE:

SC 3070/02

.06.03