UK Social Security and Child Support Commissioners' Decisions

 


[2005] UKSSCSC CCS_114_2005 (24 August 2005)

CCS 114 2005

DECISION OF THE CHILD SUPPORT COMMISSIONER
1. I allow the appeal by the absent parent and appellant (Mr H), the respondent before the tribunal. For the reasons below, the decision of the tribunal is wrong in law. That error affects only part of the decision of the tribunal, namely the decision of the tribunal to make a departure direction on the grounds of diversion of income. I confirm the decision of the tribunal in respect of all other matters.
2. I make the following formal decision in place of that made by the tribunal.

The decision of the tribunal made on 17 August 2004 stands in all respects save as follows:

It is just and equitable to make a departure direction against the respondent on the grounds of diversion of income as follows:

The respondent diverted income to S Ltd at the rates shown by the tribunal in its accounts for 2001, 2002 and 2003 and subsequently save that the sums shown in the accounts for 2001 and 2002 as sums invoiced to BB Ltd are to be excluded, and the references to those sums in the 2003 accounts are also to be excluded. All figures are gross and require income tax and National Insurance contributions to be deducted.

The Secretary of State is directed to calculate the relevant amounts of the direction in accordance with this decision. The Secretary of State is also to take into account any capital allowances that should be taken into account as relevant in the light of the decision of the Court of Appeal in Smith v Smith and another (2004). The Secretary of State and other parties are at liberty to apply to me (or if I am not available another Commissioner) to determine any consequential matter in applying this decision.

The issues under appeal

3. The decision under appeal is that it is just and equitable to impose a departure direction on Mr H on two grounds. First, Mr H has diverted income to a company ("S Ltd") in each of the years 2001, 2002, 2003 and subsequently. Second, it was reasonable for Mr H's wife to contribute 90% to Mr H's housing costs. Mrs H's application was referred to the tribunal by the Secretary of State so is not an appeal decision. The background is long, but I do not need to trouble with the full history as the parties have agreed that the issue under appeal is clear and specific. The appeal came before a Commissioner previously because of a failure to deal with housing costs. See CCS 2410 2003. This appeal mainly concerns the direction on diversion of income. I deal with one point raised on the issue of housing costs below.

The tribunal's decision

4. The tribunal produced a clear statement of reasons that deals issue by issue with the application. It sets out the arguments of both Mr H and Mrs H and then its findings. The tribunal does not indicate any party raising any point of law before it about any relevant section or regulation. And it mentions none in its reasons aside from regulation 30 of the Child Support (Departure Directions, etc) Regulations 1996 (the Departure Regulations) (requiring the finding whether a direction is just and reasonable). Of the series of decisions taken by the tribunal only that on diversion of income and one point on housing costs are subject to appeal and I need not examine the others.
5. The tribunal found that " … [Mr H] was to use his own words an entrepreneur and his entrepreneurial skills resulted in his earning the following sums …". It developed its conclusions by way of accounts prepared by the financially qualified member of the tribunal and set out as an appendix to the statement of reasons. The accounts set out the tribunal's detailed financial approach to Mr H's diversion of income to a company separately for the calendar years 2001, 2002, and 2003. In the circumstances of this case the accounts were a most useful concise way of setting out clearly the findings of fact and assumptions of law of the tribunal on the income of Mr H that it found to be diverted or not diverted. They have been the focus of most of this appeal for precisely that reason.
6. One aspect of the notes to the accounts attracted attention in the appeal. The notes to the accounts make references to "MASC Regulation 3(b)" and "MASC Regulation 3(4)(6)(v)". The former is a reference to paragraph 3(4)(b)(v) of Schedule 1 to the Child Support (Maintenance Assessments and Special Cases) Regulations 1992 (the MASC Regulations). This expressly excludes certain expenses from being deducted from gross receipts for the purposes of paragraph 3(1) of that Schedule. Paragraph 3(1) operates to define the gross receipts of a self-employed individual where paragraph 2C also applies. I return to that below. The latter of the two references is to paragraph 3(4)(b)(v) which similarly excludes "any loss incurred before the beginning of that period by reference to which earnings are determined."
7. By adopting the accounts in this form, the tribunal concluded that Mr H was for some purposes at least self-employed and not employed (and not not employed), that it was not reasonably practicable to use his accounts as submitted to the Inland Revenue, and that it was appropriate to look at his income by calendar years.

Grounds of appeal

8. Mr H is represented by David Burrows, solicitor, who drafted full grounds of appeal against the tribunal decision. In a later letter on behalf of his client, Mr Burrows submitted that the tribunal had made what he termed a simple but profoundly important error in its reasoning in the way it applied paragraph 3(4)(b)(v) of Schedule 1 to the MASC Regulations. He submitted that this was the issue that needed decision. This was because the tribunal had ignored Mr H's debts. The Commissioner who granted permission to appeal did so solely with reference to this question.
9. The secretary of state's representative made a short submission in response. It supported the appeal. But it did so on the grounds that the tribunal had misapplied the MASC Regulations because Mr H was an employed earner and paragraph 3(4)(b)(v) did not apply to him. The secretary of state's representative further submitted that in decision CCS 2978 2003 it was decided that a bad debt was not an asset for the purposes of a departure direction.
10. The parent with care and second respondent (Mrs H) made a number of factual but targeted comments. Her view was that the business should have shown the payments in its business accounts, that the tribunal had moved the debts from one accounting period to another and not simply added them in, and that Mr H should not have the benefit of any deduction twice.
11. In response, Mr Burrows accepted the key points of the submission of the secretary of state's representative on behalf of Mr H. He made a strong plea that the matter be dealt with by the Commissioner without reference back to a tribunal.
12. Mr Burrows and the secretary of state's representative both raise, in different ways, two issues of law that are in their views wrong in the tribunal decision:

(1) Mr H's employment status;

(2) the way the tribunal handled certain debts that became bad debts.

Mr H's employment status

13. The tribunal concluded that Mr H's income should be assessed on the basis that he was an entrepreneur. I assume that meant that he was to be treated as self-employed. That would explain the references to paragraph 3 of Schedule 1 to the MASC Regulations. In my view this was not necessary in finding whether Mr H had or had not diverted income.
14. A departure direction can be made if the Secretary of State or tribunal is satisfied that:

(a) the non-application has the ability to control the amount of income he receives, including earnings from employment or self-employment and dividends from shares, whether or not the whole of that income is derived from the company or business from which his earnings are derived; and

(b) the Secretary of State is satisfied that the non-applicant has unreasonably reduced the amount of his income which would otherwise fall to be taken into account under regulation 7 or 8 of the MASC Regulations by diverting it to other persons or for purposes other than the provision of such income to himself.

15. It is clear from this that it is irrelevant to the application of regulation 25 that a non-applicant is employed, self-employed, both, neither, or all three at the same time. In practical terms applications for departure directions for diversion of income are more likely to arise against an individual who can control the forms in which he or she receives income so that the non-applicant, in income tax terms, has or could have employment income, trading income, income from savings and investments (such as dividends) or income in other forms (such as loans that can be treated as income). "The" employment status of the non-applicant is of no general significance. The tribunal is entitled to find that Mr H is an entrepreneur and need not be more specific. In so far as the secretary of state's representative claims an error of law on this point, I disagree.

Debts and diverted income

16. The secretary of state's representative's true point is focussed on the proper treatment of the allegedly diverted income. It is whether the tribunal was right to refer to paragraph 3(4) of Schedule 1 to the MASC Regulations in its notes.
17. The secretary of state's representative linked with this a point invoking my decision CCS 2978 2003, and citing my comment in paragraph 14 about whether a debt, and in particular a bad debt, could be an asset for the purposes of regulation 23(4) of the Departure Regulations. Regulation 23 deals with assets capable of producing income. CCS 2978 2003 was mainly about alleged diversion of income under regulation 24. The comments about regulation 23 arose because, on the facts, the tribunal's thinking about a particular bad debt was in terms of regulation 23 not regulation 24. The tribunal attempted to deal in this way with a bad debt that had been misattributed in the accounts to a year relevant to the assessments before it rather than another year that was not relevant. It did so by assuming it was an asset capable of generating income. My decision was that it could not do that. That would also apply here. But it does not arise here because this tribunal dismissed the application based on assets capable of producing income. The secretary of state's representative's submission about bad debt is therefore not relevant.
18. I turn to Mr Burrows' core submission that reference to paragraph 3(4)(b)(v) is wrong in law. The key words from paragraph 3(4)(b)(v) are:

"any loss incurred before the beginning of that period by reference to which earnings are determined"

The paragraph as a whole provides that items including any such loss are not to be included as expenses deductible from gross receipts from self-employment. "That period" is a reference to the period by reference to which the earnings are to be determined under paragraph 5 of the Schedule. Paragraph 5 defines the period as the 52 (or fewer) weeks leading up to the relevant week (as defined by regulation 1(2) of the MASC Regulations). In other words, the rule is that losses incurred before a period cannot be taken into account as deductions for the period.

19. Mr Burrows' argument for excluding reference to this paragraph is:

(1) Paragraph 3(4) applies only for the purposes of paragraph 3(3)(a)

(2) Paragraph 3(3)(a) applies only when paragraph 2C applies.

(3) Paragraph 2C applies only where "it is not reasonably practicable for the

self-employed earner to provide information relating to his total taxable profits from self-employment in the form submitted to … the Inland Revenue"

(4) Paragraph 2C does not apply on the facts

(5) Therefore paragraph 3(4) does not apply

(6) The tribunal should apply paragraph 2A of Schedule 1 instead.

At point (4) I have set out more of paragraph 2C than did Mr Borrows in his written submission. I do so because the issue of practicality is not tested in the abstract by that paragraph but by reference to income tax returns or assessments. This point was not the subject of any explicit finding by the tribunal, but I note in the papers that Mr H's self-assessment tax returns for the years to April 2002 and 2003 are based on his contention that he was an employee and not self-employed nor in partnership nor receiving any other form of income. Based on the (voluminous) evidence before the tribunal, it is plain that there were no tax returns of the kind referred to in paragraph 2C. For that reason, paragraph 2A does not apply on the facts. This bases earnings on "the total taxable profits from self-employment of that earner submitted to the Inland Revenue". As just noted, none were submitted.

20. The critical phrases in regulation 24 of the Departure Regulations are "has the ability to control the amount of income he receives" and "has unreasonably reduced the amount of his income that would otherwise fall to be taken into account". Those are wide words. The tribunal's approach was as follows. It made clear findings of fact, for which it recorded evidence and why it made those findings, that certain sums from a company I call "BB Ltd" should have been included in S Ltd's income in 2001 and 2002. It separately concluded as a matter of fact that Mr H diverted those sums from his income. It then concluded that the sums were to be added back into Mr H's income by a diversion departure direction. To do this it must have been satisfied that both the tests in regulation 24 were met. It then separately found that the sums could not be taken back out again in 2003 when the debts proved bad. The ability to control tested in (a) was clearly found to be satisfied by the tribunal. Is the test in (b) met, namely that the tribunal was satisfied "that [Mr H] has unreasonably reduced the amount of his income which would otherwise fall to be taken into account under regulations 7 and 8 of the MASC regulations… by diverting it to other persons or for other purposes …"? Regulations 7 and 8 apply Schedule 1 of the MASC Regulations so bring in by that route, among other rules, the provisions of paragraph 3 noted above.
21. While I reject Mr Burrow's argument about paragraph 2A, I accept the core of his argument as relevant in another way. It is that the sums invoiced by S Ltd to BB Ltd, taken into account by the tribunal in 2001 and 2002, proved to be bad debts. Was it wrong of the tribunal to treat as diverted income a form of income that was in fact never received by Mr H? If he (or S Ltd) did not receive it, he could not divert it. The underlying question is therefore how debts of a non-applicant that later prove to be bad debts are to be treated for the purposes of a diversion of income departure direction.
22. The treatment by the tribunal is indicated in the following note to its 2003 accounts (in anonymised form):

The debt, which arose in 2001 and 2002, became recognised as a bad debt in 2003 in the sum of £24,045.20. Invoices less the £1500 paid directly to Mr H (although the company claimed the full sum from the official receiver). This is specifically excluded as an expense by MASC Regulation 3(4)(6)(v).

The £24,045.20 in the note should, I think, be £24,065.50. That was the amount claimed as a bad debt in the county court proceedings. It is derived from invoices included specifically by the tribunal in its accounts for 2001 (£3,688.00 and £14,242.50) and 2002 (£6,135). Both are net of VAT. The £1500 is not further explained and I cannot readily trace it in the papers. The tribunal made the following specific finding on these invoices:

"4 That the invoices amounting to £24,045.20 plus VAT had not been posted, but should have been included as income in the accounts of [S Ltd] and not to do so was a breach of company law."

23. S Ltd was the company to which it was found that Mr H was diverting income. I understand the tribunal's argument to be that the money should have been posted as income of S Ltd when the invoices were sent. This was a requirement of law on S Ltd. The sums were not so posted. S Ltd was under the control of Mr H. Mr H admitted failing to post the income. In failing to post the income, Mr H was diverting it from S Ltd and therefore himself. Mr Burrows' argument is that, with hindsight, the income was never received by S Ltd in any event. So the overall position is that it could not be deemed to Mr H's income either – or, if it was, then it should be excluded again later.
24. It is not my task to unpick careful findings of a tribunal after what was in effect (with the case management hearings) a three day hearing. My task is limited to identifying any error of law and, if it is material to the decision, to correct it or direct a tribunal or the Secretary of State to correct it. I make no attempt to go back through the whole of the 2,000 or so pages of evidence and proceedings in the appeals papers. Nor do I need to do so as the tribunal's findings and reasons – whether they be right or wrong – are admirably clear from its statement. The tribunal found that certain sums should have been added to the income stream of S Ltd. It had separately found that S Ltd was in the sole control of Mr H. If the income did not come into S Ltd, then it did not come into Mr H's control. The tribunal also found as fact that the income was missing from the books of S Ltd. It recorded that in answer to specific allegations Mr H said that "invoices from BB Ltd totalling £22,000 had not been debited". So the finding was that the accounts of S Ltd should have included the invoices from BB Ltd. The further finding was that this income was diverted income that should be added back to the accounts under regulation 24. That applied to the accounts for 2001 and 2002. The final finding was that the income from BB in 2001 and 2002 that had been added back in could not be deducted in 2003 by reason of the paragraph in dispute.
25. Two issues have become conflated in the arguments on this series of findings. One is whether or not as a matter of law the tribunal was right in finding that the invoices to BB Ltd should have been included in the income of S Ltd when the invoices were issued. The other is, again as a matter of law, whether the fact that the amounts of the invoices later turned out to be bad debts should or should not also be taken into account. They must be examined separately.
26. Did the tribunal err in law in including the sums invoiced to BB Ltd in 2001 and 2002? I can see no error of law. Quantifying "the amount of income" Mr H receives for the purposes of regulation 24 is essentially a question of fact. The tribunal using its expertise concluded that the income of S Ltd and therefore Mr H should have included the invoiced sums to BB Ltd. It put the matter to Mr H and he is recorded as accepting it. I see no error therefore in the inclusion of the invoices in the accounts formulated by the tribunal for 2001 and 2002.
27. Having included the sums in 2001 and 2002, was the tribunal right in law to decline to remove them either in 2003 or retrospectively from 2001 and 2002 as Mr Borrows argues? The reality, I think, is that those who formulated the rules with regard to diversion of income did not foresee the issue that has arisen here. I note the comments of the Court of Appeal in Smith v Smith and another [2004] EWCA Civ 1318, [2005] 1 WLR 1318 (Smith) about the drafting of other parts of Schedule 1 to the MASC Regulations. This appears to me to be another area where the drafter– or those instructing the drafter - did not realise the problems that could arise, in part because accounts are usually required to be on an accruals basis not a cash basis. Here the problem is that income that a recipient intended to divert, and to the extent relevant at a particular time did divert, subsequently turns out not to be income received at all because for reasons beyond the control of the intended recipient the payer does not pay it. The answer must nonetheless be derived from the wording of regulation 24 or other relevant provisions.
28. The intended payments from BB Ltd became bad debts in 2003. At that point, they could properly be written back into accounts based on the accruals basis (as the tribunal's accounts were). Does paragraph 3(4)(b)(v) stop that? In my view it does not for a simple reason. The tribunal had found as fact that the sums invoiced to BB Ltd were income in 2001 and 2002. They were found for current purposes to produce income in those years, not losses. The losses came about in 2003 when the debts became bad and so could be removed from the accounts. On that basis, they were not losses that were as a matter of fact within paragraph 3(4)(b)(v). They were losses of that year not previous years. So the losses should have appeared in the 2003 accounts.
29. The 2003 accounts excluded the sum of £24,065.20 (plus VAT) by means of the note set out. The accounts concluded for other reasons not in dispute in this appeal that there was a diverted profit in that year of £11,106.00. This was done by a series of adjustments to the turnover of S Ltd in its accounts for 2003. The proper course of action would be to reduce the turnover to reflect the need to remove the BB Ltd bad debt. Had that been done, there would have been a net negative figure in the tribunal's account in respect of income diverted in 2003. For current purposes this would mean that there was no net income shown to have been diverted. Put another way, the net income of S Ltd would have been negative, not positive, so there was nothing for Mr H to divert by the means found by the tribunal. So no diversion direction could have been made in respect of that year.
30. How does this affect 2001 and 2002? Mr Burrows argues that Mr H's debts should be set against his income and apportioned under the regulations. This poses a problem. The loss cannot be the subject of a transfer back to 2001 and 2002 "under the regulations" because there is no regulation that provides a mechanism to do that.
31. I have considered, but without the benefit of argument of the parties, whether the views of the Court of Appeal in Smith should also apply here (and whether, in consequence, I should postpone this decision pending an appeal of that decision to the House of Lords). I do not do so because I do not consider the same point arises here. In this case, unlike Smith, there was no account returned to the Inland Revenue (now HMRC) by Mr H as a self-employed person under section 8 of the Taxes Management Act 1970. If not by definition then as a matter of practice a diversion of income direction is often about income that has not been returned to the tax office by the individual in any form. Even if there had been a return of the income, it is for tax purposes not Mr H's income subject to income tax but that of S Ltd subject (if at all) to corporation tax that is relevant here.
32. There is a further important difference. The Court of Appeal rested its views about inclusion of capital allowances in the trader's accounts on the terms of section 247 of the Capital Allowances Act 2001. Capital allowances are given effect by treating the allowance as an expense of the trade. The rules about capital allowances were rewritten as part of the Inland Revenue Tax Law Rewrite Project's brief and were adopted by Parliament as recommended to it by the Project. They make the practice clear. The rules about loss relief have not been rewritten. They are in Part X of the Income and Corporation Taxes Act 1988 as amended. But they are also clear and they operate in a different way to the capital allowance provisions (whether, with respect, but for the sake of full argument I assume that the view of the Court of Appeal is correct or not). If I assume in Mr H's favour that the losses from the BB Ltd debts becoming bad are trading losses then they fall to be treated by S Ltd under section 380. Under this provision losses can be carried forwards to later tax years, but not backward to earlier years. Further, this can only be done by an express claim for relief and not as deductions treated as expenses.
33. My conclusion is that even if I were to make all necessary assumptions in Mr H's favour I cannot apply the thinking of the Court of Appeal in Smith to this case. The rules about capital allowances and loss reliefs are just too different. The problem that the Court of Appeal decision avoided cannot be avoided here.
34. I therefore find that the income from BB Ltd is properly treated by the tribunal on its unchallenged findings of fact as diverted income that can be linked to Mr H in 2001 and 2002. The losses when BB Ltd proved to be a bad debtor in 2003 are relevant to that year only. They reduced the income to be diverted in 2003 to zero. But they do not affect the earlier years.

Was the decision of the tribunal just and equitable?

35. No.
36. The decision before me is a decision about the application of a diversion of income direction from 2001. As a result of the above analysis I conclude that the tribunal's decisions that there was diverted income in 2001 at £27,012 and for 2002 as £7,106 both stand. I conclude that its decision that the income diverted for 2003 was £11,106.00 is wrong and should have been nil. I also find that this leaves out of account the balance of the losses of £24,065 recognised in 2003 but in reality not received in 2001 or 2002 either. Had those losses been set off against the diverted income in 2003, there would have been a "negative diversion". But that is technically irrelevant for 2001 and 2002.
37. Mrs H made the application for a determination of diversion of income (and other applications) in October 2001. The then current maintenance assessment was nil. I do not know the effect on that assessment of the adjustment of housing costs. But the tribunal recognised elsewhere in its decision that most of the household income of Mr H and his wife came from his wife. It is against that background that the questions of justice and equity of making a direction on diversion of income must be tested.
38. The Secretary of State and a tribunal may only give a departure direction if in his or its opinion that in all the circumstances of the case it would be just and equitable to do so: section 28F(1)(b) of the Child Support Act 1991. For current purposes I have the same powers as the tribunal. Guidance is given about what is to be, and what is not to be, considered in making this decision. I must have regard to those circumstances set out in section 28F(2), and to those factors set out in regulations under section 28F(3). They are in regulation 30 of the Departure Regulations, as are factors that I must not take into account. I do not propose to rehearse each of these in turn and I have not invited formal submissions on them. Section 28F gives me a broad discretion to ensure justice and equity (defined to include, but not restricted to, the factors just rehearsed). I am also influenced in my views by the strongly critical comments of Commissioner Howell QC and the Court of Appeal in Smith about analogous rules to those I have examined in this decision.
39. It comes down to this: is it fair in a decision made after the event to treat Mr H as having diverted income which I now know he neither received nor could have received because a precise application year by year of the child support law would regard him as having received the income but would not allow a later full deduction when the true position emerged? It is not.
40. Is it just and equitable to make any diversion of income direction? It is, because this argument applies only to the income from BB Ltd. I must therefore make a departure direction that is just and equitable taking into account all the relevant factors. In my view that can be done relatively easily as a matter of discretion by excluding the income from BB Ltd from my direction but leaving all other aspects of the tribunal's decision standing. So the account for 2001 and 2002 should be reworked to exclude the sums identified as income diverted from BB Ltd, and the account for 2003 should therefore stand. That removes an element that the tribunal considered to be just and equitable, but I do not. I see no reason to reconsider its more general judgment that its direction was just and equitable. Nor do I consider that either Mr Borrows or the secretary of state's representative are strongly contending otherwise.
41. In addition, as I am making the direction that the tribunal should have made, I direct that if as a result of Smith any capital allowances should have been taken into account in determining the expenses noted in the accounts then they should also now be taken into account. I add this as I note the exclusion of depreciation from the 2001 accounts. I do not know if there are any capital allowances also excluded but if there are they should be added back in.

Housing costs

42. I deal with this as I am otherwise confirming the tribunal decision. Mr Burrows' point on this is that "contribute" in regulation 27 of the Departure Regulations is a term limited in scope and does not allow a tribunal, as here, to attribute most of the housing costs to a partner. I disagree. I agree instead with the comment made on this provision in Jacobs, Child Support: The Legislation, Sweet & Maxwell, 1999 edition, p. 504:

"The general principle set out in s.28E (2)(a) is especially likely to be relevant to the application of this paragraph. That principle provides that parents should be responsible for maintaining their children whenever they can afford to do so. Accordingly, the partners' financial position should be judged as a whole without regard to which partner makes actual payments or who happens to bear legal responsibility for them. Any other approach would so easily permit avoidance of the application of this head as to be inconsistent with the general principle."

That comment puts this regulation in its proper context. There is nothing in the word "contribute" or elsewhere in the Departure Regulations that lead to the conclusion for which Mr Burrows argues. I confirm that part of the tribunal decision as it stands.

David Williams

Commissioner

24 August 2005

[Signed on the original on the date shown]