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Cite as: [2005] UKSPC SPC00491, [2005] UKSPC SPC491

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Joyce v Revenue and Customs [2005] UKSPC SPC00491 (19 July 2005)

SDC00491

INCOME TAX – Schedule D Case III – annual payments - Appellant retired early relying upon a statement made by his employer about the amount of his pension – after his retirement he was told that the correct amount of his pension was less - he sued his employer for damages for negligence for inaccurate representations claiming an unidentified capital sum in damages – the proceedings were settled on the basis that the employer would pay the Appellant a stated annual sum in equal monthly instalments for the remainder of his life the amount being the difference between the incorrect amount of his pension and the lesser correct amount – whether the monthly payments were instalments of capital (as argued by the Appellant) – no – or whether they were annual payments and thus income (as argued by the Revenue) – yes – appeal dismissed – ICTA 1988 s18

THE SPECIAL COMMISSIONERS

BRUCE IAN JOYCE

Appellant

- and -

HM REVENUE AND CUSTOMS

Respondents

Special Commissioner: DR A N BRICE

Sitting in London on 26 May 2005

Mr B J Rice, of Messrs B J Rice Associates Chartered Tax Advisers and Accountants, for the Appellant

Mr Tony Mear, HM Inspector of Taxes and Head of Appeal Unit Wales, for the Respondents

© CROWN COPYRIGHT 2005

PRELIMINARY DECISION

The appeal

Mr Bruce Ian Joyce (the Appellant) appeals against (1) a decision of the Revenue dated 19 September 2003 refusing a claim for error or mistake relief for the years ending on 5 April 1999 and 5 April 2000; (2) a decision of the Revenue dated 2 October 2002 amending the Appellant's self-assessment for the year ending on 5 April 2001; and (3) a decision of the Revenue dated 15 January 2004 amending the Appellant's self-assessments for the years ending on 5 April 2002 and 5 April 2003.

The disputed decisions were made because the Revenue were of the view that certain monthly payments made to the Appellant by his ex-employer were annual payments chargeable to income tax under Case III of Schedule D. The Appellant appealed because he was of the view that the monthly payments were instalments of capital and so were not chargeable to income tax.

I was asked to give a decision in principle on this issue with liberty to the parties to apply for another issue or other issues to be determined later.

The legislation

At the relevant time the relevant parts of Section 18 of the Income and Corporation Taxes Act 1988 provided:

"18(1) The Schedule referred to as Schedule D is as follows -

SCHEDULE D

Tax under this Schedule shall be charged in respect of -…

(b) all interest of money, annuities and other annual profits or gains …

(3) The Cases are- …

Case III: tax in respect of-

(a) any interest of money … or any annuity or other annual payment … "

The issue

The Appellant retired early on the basis of a statement made by his employer about the amount of his pension. After his retirement he was told that the correct amount of his pension was less. He sued his employer for an unidentified capital sum and the employer settled the action on the basis that it would pay to the Appellant a stated annual sum which was the difference between the (higher) incorrect amount he had been told and the (lesser) correct amount. The annual payments were to be made by monthly instalments. It was agreed that the payments were not interest nor were they an annuity. It was also agreed that the payments were not payments of a pension assessable under Schedule E.

The issue for determination in the appeal was whether the monthly amounts were instalments of capital (as argued by the Appellant) or whether they were annual payments and thus chargeable to tax as income under Case III of Schedule D (as argued by the Revenue).

The evidence

One volume of documents was produced by the parties. There was also a statement of agreed facts. Oral evidence was given by the Appellant on his own behalf.

The facts

From the evidence before me I find the following facts.

The Appellant and his pension entitlement

At the relevant time the Appellant was employed as Chief Executive Officer of the Greenwich Healthcare National Health Service Trust (the Trust). He was entitled to a pension under the National Health Service Superannuation Scheme. In August 1994 he was fifty years old and he asked the Trust to provide a forecast of the amount of his annual pension if he were to take early retirement. He made it clear that the amount was critical to the decisions he would take about his future. In September 1994 he was told that his annual pension would be £43,091.19. Relying upon this information the Appellant applied for, and was allowed to take, early retirement with effect from 21 October 2004. The National Health Service Pensions Agency (the Agency) confirmed the amounts and on 1 November 1994 started to pay the Appellant his pension at the rate of £43,091.19 per annum by monthly instalments.

In November 1995 the Trust and the Agency advised the Appellant that mistakes had been made. They said that his correct annual pension entitlement was £38,015.40 and, from December 1995, his monthly pension would be reduced. The Appellant took legal advice and on 22 February 1996 his solicitors said that they would ask an actuary to calculate his loss of pension benefits as a capital sum such as would facilitate the purchase of an annuity payable from his early retirement date in the amount of the difference between the benefits which would have been paid to him if the original statements were correct and those which were being paid. Advice was received on 9 May 1996 that the sum of £127,350 was the appropriate capital value without any allowance for income tax.

The legal proceedings

On 17 June 1996 the Appellant commenced legal proceedings in the High Court against the Trust for damages for negligence for inaccurate representations made to the Appellant regarding his pension entitlements. The particulars of claim were:

"Loss of pension benefits being such capital sum as would facilitate the purchase of an annuity for the Plaintiff payable as from his early retirement date in the amount of the difference between:

(a) such pension benefits as would have been payable to the Plaintiff on his early retirement date based on the representations made to the Plaintiff; and

(b) such lesser pension benefits as are being paid to the Plaintiff from his early retirement date."

The amount of the capital sum claimed was not stated in the writ nor in the particulars of claim. I accept the evidence of the Appellant that he then thought that, if he were successful in his claim, he would be free to use the capital sum in any way he chose and that there was no condition that he would have to buy an annuity.

In July 1996 the Trust entered a defence and counterclaim. The Trust denied liability and counterclaimed for overpayments of salary and pension contributions from 1991 to 1994 amounting to £11,185.53 paid to the Appellant by mistake. Discussions between the parties followed.

The negotiations for a settlement

On 19 February 1997 the solicitors for the Trust approached the Appellant's solicitors with an initial proposal for settlement. They said that, while the Trust remained of the view that it had a good defence to the Appellant's claim, it did not wish to spend further time and money in brining the matter to court and so the Trust "would be prepared to waive its counterclaim and to agree to make a recurring annual payment of £3,000 per annum to your client for the remainder of his life in full and final settlement of this matter". That offer was unacceptable to the Appellant whose solicitors replied on 24 April 1997 to say that the Appellant's pension entitlement, as originally advised, was £43,031.19 and this was reduced to £38,015.40 as from 6 December 1995; accordingly the loss to the Appellant was £5,015.79 per annum. On 28 April 1997 the Trust's solicitors wrote to say that the Trust "would be prepared to include [probably meaning increase] its offer to £5,015.79 per annum". On 30 April the Appellant's solicitors sent him a copy of the letter of 28 April and said:

"As you can see, they are offering £5,015.79 for the duration of your life. This sum, as I'm sure you are aware, is equal to the difference between your original pension of £43,031.19 and the reduced pension of £38,015.40."

On receipt of this letter the Appellant realised that the amount offered was exactly equal to the loss he was suffering. He was advised that there was no guarantee of success if the matter went to a hearing and that if he failed after a hearing he would have to pay his own costs and those of the Trust. He discussed the offer with his wife and decided to accept it. On 9 May 1997 the Trust's solicitors confirmed the acceptance by the Appellant of the offer of settlement which was stated to be:

"1. An annual payment of £5,015.79 payable to you for the duration of your life, such payments to commence from 1 December 1995; and

Your reasonable legal costs."

On 21 May the Trust's solicitors confirmed that the Trust was agreeable to paying the Appellant the sum of £5,015.79 per annum back dated so as to commence from 1 December 1995. With regard to back payments the Trust would pay the sum of £10,449.56 within fourteen days of the sealing of the consent order by the Court. Subsequent payments would be by monthly instalments through the BACS system.

On 23 May 1997 the Appellant's solicitors wrote to the Appellant and said:

"The sum of £10,449.56 represents £5,015.79 per annum backdated so as to commence on 1 December 1995 and includes all payments due up to the end of this year. This is £417.98 for December 1995 plus £5,015.79 for 1996 and £5,015.79 for 1997. At my request [the Trust] have agreed to pay this sum within 14 days of the sealing of the consent order by the court so you will in effect have the rest of this year's payments in advance. From January 1998 the £5,015.79 per annum will be paid to you in monthly instalments."

The terms of the consent order

The consent order was sealed by the court on 1 July 1997. The order contained the following paragraphs:

"Upon the parties agreeing terms and BY CONSENT it is agreed that:

all further proceedings be stayed save for the purpose of enforcing the terms of this Order and that there be liberty to apply for such purpose; and

the Defendant do pay to the Plaintiff within 14 days the sum of £10,449.56; and

the Defendant do pay to the Plaintiff the further sum of £5,015.79 per annum for the remainder of the Plaintiff's life, such sum to be payable to the Plaintiff by equal monthly instalments through the Bank Automatic Clearing System (BACS) on the first working day of each calendar month, the first such payment being due on the first working day of January 1998; and.

the Defendant's counterclaim be dismissed."

Thus the sum of £10,449.56 represented payments due from 1 December 1995 to the end of 1997. From 1 January 1998 to 5 April 1998 the Appellant received monthly payments amounting to £1,253.97. Thus in the tax year 1997/98 payments of £10,449.56 and £1,253.97 were received; in each of the subsequent years payments of £5,015.79 were received. No tax was deducted from these payments by the Trust.

The Appellant's self-assessment tax returns

The Appellant's self-assessment tax return for the year ending on 1 April 1998 declared "other income" of £1,253.97. The return for the year ending on 5 April 1999 declared "other income" of £5,016. The return for the year ending on 5 April 2000 declared "additional pension payment received from the Trust" of £5,016. In June 2001 the Appellant took professional advice about the payments and his accountant was of the view that the payments were not income and not subject to income tax.

Accordingly, in July 2001 the Appellant made a claim for error or mistake relief in respect of his returns for the years ending on 5 April 1999 and 5 April 2000 on the basis that the payments received from the trust were not taxable and should be excluded from his self-assessments. On 19 September 2003 the Revenue refused the claim and on 2 October 2003 the Appellant appealed. That is the first disputed decision the subject of this appeal.

The return for the year ending on 5 April 2001 declared that payments had been received from the Trust but had been excluded from the return on the basis that they were not taxable. On 18 June 2002 the Revenue gave notice under S9A of their intention to enquire into the Appellant's 2001 return. The enquiry ended on 2 October 2002 and concluded that the payment of £5,016 was income taxable under Schedule D Case III as an annual payment. The self-assessment was amended. The Appellant appealed on 22 October 2002 and that is the second disputed decision the subject of this appeal.

The Appellant's returns for the years ending on 5 April 2002 and 2003 did not declare any payment received from the Trust. The Revenue made an enquiry into each of the returns and concluded that that the payment from the Trust should be included in the self-assessment. On 22 January 2004 the Appellant appealed against these conclusions and against the amendment of his self-assessments. That is the third disputed decision the subject of this appeal.

The arguments for the Appellant

For the Appellant Mr Rice argued that Schedule D applied only to annual profits or gains of an income nature and not to capital payments, even if these were paid in instalments over a number of years. He cited Laird v The Commissioners of Inland Revenue (1929) 14 TC 403 and argued that, to determine the correct character of the payments, it was necessary to examine not only the terms of the consent order but also all the surrounding circumstances, including the circumstance that gave rise to the right to receive the payments. The relevant circumstance in this appeal was that the claim was for a capital sum (which although not ascertained was ascertainable) and the initial offer of 19 February 1997 was in full and final settlement of that claim. Thus the obligation of the Trust to pay money to the Appellant was a capital obligation and any sum paid in discharging that obligation was a payment of capital and not of income. The court proceedings and their settlement could not be ignored.

Mr Rice went on to argue that, after the mistakes made by the Trust, the Appellant had a capital asset, namely a right to sue for damages, and that was settled by the annual payments for life. He relied upon Zim Properties Limited v Procter (1985) STC 90 for the principle that the source of the compensation was the right to sue; that that was a capital asset; and that the monies received were in discharge of the capital obligation to pay. His argument was that the Appellant received the payments from the right to sue his employer and not because of the loss of his pension. Mr Rice also relied upon Commissioners of Inland Revenue v Ramsay (1935) 20 TC 79; Dott v Brown [1936] All E R 543; and Commissioners of Inland Revenue v Church Commissioners for England (1976) 50 TC 516 at 532e.

The arguments for the Revenue

For the Revenue Mr Mear argued that on 9 May 1997 the Appellant accepted an offer of annual payments which were intended to make up the difference between his original and his reduced pension. He relied in particular on the letters of 24 April 1997, 28 April 1997, 21 May 1997 and 23 May 1997. Mr Mear argued that the Appellant's claim against the Trust started with a loss of monthly pension benefits. The particulars of claim indicated that the claim was for loss of pension benefits and the aim of the proceedings was to restore the Appellant's income level. The Trust never admitted liability and so at no time was there any debt or capital sum owed to the Appellant by the Trust. On 19 February 1997 the Trust proposed to settle the proceedings in order to save time and costs and offered an annual payment. Some time before 9 May 1997 the Appellant accepted a higher annual payment. He could have refused that and held out for a capital sum and purchased an annuity but he decided not to do so. The effect of the consent order was that the Appellant and the Trust put aside their claim and counterclaim and made a new agreement; the agreement was not derived from the claim but was a new independent agreement and the purpose of the annual payments was to restore the shortfall of the pension. There was no evidence that the Appellant's pension was funded and so he did not lose a valuable asset – all he lost was a right to income.

Mr Mear cited Henriksen v Grafton Hotel Limited (1942) 24 TC 453 at 460 for the principle that regard had to be had to the contract which the taxpayer chooses to make; frequently the same result could be secured by two different legal transactions, one of which might attract tax and the other not, but a taxpayer who adopted a method which attracted tax was not to be treated as though he had adopted the method which did not. He also relied upon Commissioners of Inland Revenue v Mallaby-Deeley and another (1938) 23 TC 153 at 166. He distinguished Zim Properties where it was common ground that the payments were capital and so that authority did not establish the principle that all sums received from a right to sue were capital. He distinguished Dott where there was a pre-existing debt of a stated amount which was not present in this appeal.. He distinguished Ramsay and relied upon the words of Lord Wright MR at 98 that that was a case in which a capital lump sum had been stipulated as the price of a piece of property and it was none the less so because payment was to be made by instalments. He relied upon the words of Lord Wilberforce in Church Commissioners for the principle that there was a clear distinction between a case where there was a sale for consideration represented by a principal amount payable by instalments and a case where the sale was for an annuity or a rentcharge.

Reasons for Decision

The issue in the appeal is whether the monthly payments paid to the Appellant by the Trust are instalments of capital (as argued by the Appellant) or annual payments and thus chargeable to income tax under Case III of Schedule D (as argued by the Revenue).

As long ago as 1929, in Laird, the Court of Session established the principle that an award of compensation payable in instalments could be payments of capital and not of income. That appeal concerned compensation and insurance payments made to a private soldier in respect of war injuries; the payments were paid monthly and the insurance payments were payable for 240 months only. The General Commissioners held that the payments were of an income nature and not capital but the Court of Session disagreed. In a passage relied upon by Mr Rice the Lord President (Lord Clyde) at 403 said:

"The circumstance that an award of compensation money or of insurance money directs that the sums awarded shall be paid in instalments is not enough to shew that the payments are income of the recipient. They may be payments of what is truly capital and not income. Whether a particular series of payments is income or not is prima facie a question of fact and not of law, for after all the whole distinction between capital and income is one of convenience and depends on the origin, nature and circumstances of the payments."

I first note that Lord Clyde is not saying that all awards of compensation payable in instalments are capital and not income; what he is saying is that such awards may be capital and not income. From Laird I derive the principle that, in deciding whether payments are capital or income, it is necessary to have regard to their origin, their nature and the circumstance of the payments. The origin of the payments in this appeal is the fact that the Appellant was told that his annual pension would be larger than it should have been. He sued his employer for that incorrect statement, his claim being for "loss of pension benefits" being such an unidentified capital sum "as would facilitate the purchase of an annuity". He settled his action for annual payments to be paid monthly. The nature of the payments he received were annual payments (and they were called annual payments in the correspondence between the solicitors for the Appellant and the Trust) and all the circumstances of the payments point to the conclusion that they were annual payments. It is relevant that at no time was any identified sum claimed from the Trust by the Appellant and that at no time did the Trust accept any obligation to pay the Appellant a capital sum.

Mtr Rice also relied upon Ramsay (1935) where the taxpayer agreed to purchase a dental practice for £15,000 to be satisfied by the payment of £5,000 immediately and the remainder by a payment for each of the next ten years of 25% of the net profits of the practice for that year. If the total of the payments was greater or less than £15,000 then the purchase price was to be regarded as increased or reduced accordingly. The Court of Appeal held that the annual sums were instalments of capital and not payments of income.

Ramsay can be distinguished from this appeal on its facts because in this appeal there never was a capital sum identified between the Appellant and the Trust and there never was any agreement between the parties which mentioned an agreement to pay a capital sum.

Mr Rice also relied upon Dott (1936). There a Mr Brown owed Mr Dott a judgment debt of about £10,000. Mr Dott petitioned in bankruptcy which was settled by the Court of Appeal by consent order. That included a compromise agreement which contained a number of matters one of which was "the covenant of the debtor to pay £1,000 on 31 March 1933, £1,000 on 31 March 1934 and £250 on each succeeding March 31 so long as the petitioner should live such covenant to bind the debtor's estate after his death". The debtor (Mr Brown) made the payments but in 1935, instead of paying £250, he paid that sum less income tax. The issue was whether income tax should have been deducted. Mr Dott argued that all the payments were payments of capital and not income and were instalments in part payment of the original debt and the Court of Appeal agreed holding that "the essence of the transaction was that all the payments … were capital payments – instalments of the capital consideration payable under the [compromise] agreement in discharge if a pre-existing debt of between £9,000 and £10,000."

Dott can also be distinguished from this appeal on the facts because here there was no identified pre-existing capital sum and there was never any agreement between the parties which mentioned an agreement to pay a capital sum.

In Mallaby-Deeley (1938) the taxpayer undertook to pay a sum of money in five equal amounts. He later entered into a deed of covenant to pay in each of seven years sums which, after the deduction of tax, amounted in aggregate to the balance remaining. The Court of Appeal held that the payments under the deed of covenant were of a capital nature. At 166 Sir Wilfrid Greene MR said:

"The distinction which is to be drawn for the purposes of the Income Tax Acts between payments of an income character and payments of a capital nature is sometimes a very fine and artificial one. It may depend upon – in fact it does depend upon – the precise character of the transaction. To take a simple case, if the bargain is that a capital sum shall be paid, the fact that the method of payment which is adopted in the document is a payment by instalments will not have the effect of giving to those instalments the character of income. Their nature is finally determined by the circumstance that the obligation is to pay a capital sum and instalments are merely a method of effecting that payment. On the other hand, to take another simple case, where there is no undertaking to pay a capital sum and no capital obligation in existence, and all that exists is an undertaking to pay annual sums, those may, in the absence of other considerations, be annual payments of an income nature for the purposes of the Income Tax Acts."

Applying those principles to the facts of this appeal I look at the precise character of the transaction between the Appellant and the Trust. There was never any bargain or undertaking that a capital sum should be paid and there was never any obligation to pay a capital sum; indeed, no capital sum was identified between the Appellant and the Trust; all that existed was an undertaking to pay annual sums.

Henriksen (1942) concerned the nature of payments made for monopoly value It was held that these were payments of capital by instalments and at 460 Lord Greene MR said:

"It frequently happens in Income Tax cases that the same result in a business sense can be secured by two different legal transactions one of which may attract tax and the other not. This is no justification for saying that a taxpayer who has adopted the method which attracts tax is to be treated as though he had chosen the method which does not."