NATIONAL
INSURANCE CONTRIBUTIONS – whether payable on restrictive covenant entered into
after employment ceased – yes – whether Contributions limited to the case where
there is a current employment – no – whether for TA 1988 s.313 a restrictive covenant
is given in connection with the holding of the office of director when the office
has ceased – yes
- This
is an appeal by RCI (Europe) Limited against a Notice of Decision dated 29 September
1999 that it is liable for primary and secondary Class 1 National Insurance contributions
(Contributions) in respect of payments by the Appellant to Mr Julian Haylock totalling
£2.2m. The Appellant was represented by Mr Kevin Prosser QC and the Respondents
by Mr David Ewart.
- There
was a statement of agreed facts as follows (during the hearing the date of Mr
Haylock’s ceasing to be a director was agreed and I have included this in the
statement below):
- Mr
Julian Haylock was a director of RCI Europe Limited ("RCI") and employed
from April 1984 to 31 July 1994 under a contract of service.
- On
22 December 1994, RCI and Mr Haylock entered into a Severance Agreement whereby
(inter alia) Mr Haylock agreed by a restrictive covenant to restrict his activities
in certain respects following the termination of his employment. In return, RCI
agreed to make certain money payments to him.
- All
payments were made net of deduction of Schedule E income tax.
- In
the events which happened, RCI made the following money payments to Mr Haylock
under the Severance Agreement (as amended by an Addendum dated 3 and 4 March
1997).
| Item |
Date
of Payment | Sum
Paid |
| 1 |
03.01.95 |
£500,000 |
| 2 |
30.12.95 |
£500,000 |
| 3 |
03.01.96 |
£200,000 |
| 4 |
30.12.96 |
£800,000 |
| 5 |
01.01.97 |
£200,000 |
| Total | |
£2,200,000 |
- Throughout
the period during which payments under the restrictive covenants were made (3rd January
1995 to 1st April 1997), Mr Haylock was neither a director or nor employed
by RCI.
- The
Severance Agreement provided for post-termination restrictions on Mr Haylock applying
from the date of the agreement (22 December 1994) until 31 December 1995, in outline
not to be engaged in any competing business of the Appellant and its associated
companies, not to solicit their customers, not to employ their employees, not
to communicate with any customer or client of theirs, not to be employed by a
party to an affiliation agreement with any of them; and two restrictions without
any time limit, not to represent that he is associated with the Appellant, and
not to use the names or intellectual property of the Appellant or its associated
companies. The consideration for those restrictions was payments 1 and 2 in the
table above. Mr Haylock could, and did, elect to continue to be bound by the same
restrictions for the year 1996, and separately for 1997 for which he was entitled
to payments 3, 4 and 5 in the table. The payments were to be made as to £200,000
on or before 3 January 1996, £800,000 on or before 30 December 1996, and similar
amounts on or before 1 January 1997 and 30 December 1997 respectively. There was
a sixth payment but as it was made in gilts it is agreed not to be subject to
Contributions.
- Mr
Haylock was not employed during the term of these restrictive covenants. He was
employed again as group managing director of the Appellant from 1 August 1997
by which time it was no longer privately owned, which was the cause of the conflict
that led to his leaving.
- The
statutory provisions with which we are concerned are:
Section
4(4) of the Social Security Contributions and Benefits Act 1992:
"For
the purpose of section 3 above, there shall be treated as remuneration derived
from an employed earner’s employment any sum paid to or for the benefit of an
employed earner which is chargeable to tax by virtue of section 313 of the Income
and Corporation Taxes Act 1988 (taxation of consideration for certain restrictive
undertakings) otherwise than by virtue of subsection (4) of that section."
Section
313 of the Taxes Act 1988:
"(1)
Where an individual who holds, has held, or is about to hold, an office or employment
gives in connection with his holding that office or employment an undertaking
(whether absolute or qualified, and whether legally valid or not) the tenor or
effect of which is to restrict him as to his conduct or activities, any sum to
which this section applies shall be treated as an emolument of the office or employment,
and accordingly shall be chargeable to tax under Schedule E, for the year of assessment
in which it is paid
(2)
This section applies to any sum which—
(a)
is paid, in respect of the giving of the undertaking or its total or partial fulfilment,
either to the individual or any other person; and
(b)
would not, apart from this section, fall to be treated as an emolument of the
office or employment.
…
(4)
Where valuable consideration otherwise than in the form of money is given in respect
of the giving of the undertaking or its total or partial fulfilment, subsections
(1) to (3) above shall have effect as if a sum had instead been paid equal to
the value of that consideration.
…
(6)
In this section—
(a)
‘office or employment’ means any office or employment whatsoever such that the
emoluments thereof, if any, are or would be chargeable to income tax under Case
I or II of Schedule E;…."
Section
313 of the Taxes Act 1988
- In
applying section 4(4) of the Social Security Contributions and Benefits Act 1992,
the first question is whether the payments are chargeable under section 313 of
the Taxes Act 1988. Mr Prosser QC contended that, while he conceded that the first
two payments were chargeable, the remainder were not, since they were derived
from the separate elections by Mr Haylock to be bound by the restrictive covenants
during 1996 and 1997. He contended that the covenants were not given "in
connection with his holding" of the office of director of the Appellant,
but after he had ceased to hold the office. Section 313 was enacted to deal with
cases like Beak v Robinson 25 TC 33 where the service agreement provided
for an immediate payment in return for a covenant not to compete for 5 years within
a radius of 50 miles if he determined the agreement or it was determined by his
breach of the provisions.
- Mr
Ewart contended that it was a clear case of a person who "has held"
the office. He referred to Vaughan-Neil v IRC [1979] STC 644 at 652f where
Oliver J said:
"As
a matter simply of grammatical construction, it seems to me that these words [in
connection with his holding that office or employment] fulfil an adverbial function
and qualify not the undertaking but the giving of it."
The
undertaking was given pursuant to the termination agreement which was sufficient
to connect it with the holding of the office of director. Mr Prosser QC did not
dispute this point but said that the covenant was not given in connection with
the holding of the office, but in connection with the non-holding of it.
Reasons
for decision on section 313
- Although
the covenants were given pursuant to two separate elections by Mr Haylock to continue
to be bound by the covenants imposed for the first period after termination of
his service agreement, I consider that they were given in connection with his
holding that office. They are a continuation of covenants given in relation to
the termination of the office, which is a sufficient connection. The reason why
the covenants were imposed, and why the Appellant was prepared to pay during the
two extension periods, was that Mr Haylock held the office of director. I do not
consider that the section is limited to cases like Beak v Robinson where
the restriction is contained in the service agreement and relates to the period
after it is terminated. Whether or not that represents the normal case, there
is nothing to prevent the section from applying to covenants imposed in a termination
agreement made after the person has ceased to hold the office or employment. The
covenant is still given in connection with the holding of the office or employment.
- Accordingly
section 313 applies to all the payments in question. I turn next to the liability
to Contributions.
Section
4(4) of the Social Security Contributions and Benefits Act 1992
- I
shall start by setting out the relevant definitions in the Social Security Contributions
and Benefits Act 1992:
"‘employment’
includes any trade, business, profession, office or vocation and ‘employed’ has
a corresponding meaning." (section 122(1))
"…(a)
earnings includes any remuneration or profit derived from an employment; and
(b)
‘earner’ shall be construed accordingly." (section 3(1))
"…(a)
‘employed earner’ means a person who is gainfully employed in Great Britain either
under a contract of service, or in an office (including elective office) with
emoluments chargeable to income tax under Schedule E; and
(b)
‘self-employed earner’ means a person who is gainfully employed in Great Britain
otherwise than in employed earner’s employment (whether or not he is also employed
in such employment)." (section 2(1))
It
will be seen that employment, earnings and earner are expressions applying to
both employment (in the non-defined sense of work under a contract of service,
corresponding to income tax under Schedule E) and self-employment (which by including
"business" is wider than the income tax equivalent, although class 4
Contributions do not apply to a business), so that the definitions of employed
earner and self-employed earner are necessary to determine which applies, leading
to verbose terminology such as "employed earner’s employment."
- Mr
Prosser QC contended that one must read the definitions into the legislation with
the result that section 4(4) reads:
"4(4)
For the purpose of section 3 above, there shall be treated as remuneration derived
from an employed earner’s [meaning a person who is gainfully employed in
Great Britain either under a contract of service, or in an office (including elective
office) with emoluments chargeable to income tax under Schedule E] employment
[including an office] any sum paid to or for the benefit of an employed earner
[meaning as before] which is chargeable to tax by virtue of section 313 of the
Income and Corporation Taxes Act 1988 (taxation of consideration for certain restrictive
undertakings) otherwise than by virtue of subsection (4) of that section."
- He
contends that an employed earner is someone who is currently employed. If the
section were to charge Contributions on former employees it would have needed
to say so, as in section 136(5)(c) of the Taxes Act 1988: "‘employee’…includes
a person who is to be or has been an employee." In support he points out
that many provisions of the Social Security Contributions and Benefits Act 1992
look at the person’s employment status at the time of payment:
"Where
in any tax week earnings are paid to or for the benefit of an earner in respect
of any one employment of his which is employed earner’s employment and
– (a) he is over the age of 16…." (section 6(1))
"…no
primary Class 1 contributions shall be payable in respect of earnings paid to
or for the benefit of an employed earner after he attains pensionable age…."
(section 6(2))
These
look to the age of the person at the time of payment, not the age at the time
it was earned, resulting in Contributions being payable if payment is made after
the age of 16 in respect of earnings before that age, and vice versa with payments
to a person after pensionable age in respect of earnings before that age.
He
also points to the regulation-making power in Schedule 1 paragraph 8(1)(o):
"for
treating a person’s employment as continuing during periods of holiday, unemployment
or incapacity for work and in such other circumstances as may be prescribed;"
This
shows that it is a fundamental requirement that a subsisting employment is necessary
for Contributions to be payable. It is an important power which was contained
in the first section (section 1(3)(c)) of the National Insurance Act 1946. This
power has been exercised but only in relation to self-employed earners in Schedule
2 to the Social Security (Categorisation of Earners) Regulations 1978 providing
that the (self-) employment shall "be treated as continuing unless and until
he is no longer ordinarily employed in that employment."
- Mr
Prosser QC also points out that there are many references in the benefits sections
of the Act that are restricted to, or assume that it applies to, persons currently
employed, such as: section 28(3) enabling regulations to be made for the purpose
of preventing inequalities or injustice to the general body of employed earners
or of earners generally; 60(2) deeming contribution conditions to be satisfied
where a married employed earner dies as a result of a personal injury; 96 enabling
regulations to be made treating a person as the earner’s employer for industrial
injuries benefit; 102 entitlement to sickness benefit where an employed earner
is incapable of work as a result of a personal injury; 116 treating a serving
member of Her Majesty’s forces as an employed earner (which also applies for Contributions);
117 dealing specifically with persons who have been, or are to be, employed on
board ships or aircraft, including in subsection (2)(c) a power to make regulations
dealing with Contributions whether or not they are employed earners, and (2)(e)
for enabling persons who have been employed to authorise payment of benefits to
their dependants; 153(5)(b) power to made regulations directing an employer to
provide a person who has been employed by him with a statement relating to statutory
sick pay, and subsections (9) and (10) anti-avoidance provisions dealing with
for example contracts of service brought to an end for the purpose of avoiding
liability for statutory sick pay; 164 dealing with entitlement to maternity pay
for a woman who has been an employee;.
- Mr
Prosser QC also points out that Class 1A Contributions are payable by reference
to car benefits chargeable by section 157 of the Taxes Act which is restricted
to current employments and so there is nothing surprising about the rest of Contributions
being limited in the same way.
- Mr
Prosser QC also drew my attention to two textbooks, Tolleys National Insurance
Contributions Services (paragraph 28.5) and Butterworths Simon’s National Insurance
Contribution Service (paragraph 5.96-98) which supported his contentions.
- Mr
Ewart contends that the present tense in the definition of employed earner ("who
is gainfully employed") is defining that the person being referred to is
employed rather than self-employed and has no temporal significance. Section 313
of the Taxes Act applies in terms to past holders of an office. There would be
a big hole in the legislation if Contributions were restricted to payments to
current holders. He accepts that it may be right that when applying other sections
of the 1992 Act one looks to the employment of the person at a particular time
but those sections are not in issue.
- Mr
Prosser QC contends that the second requirement for Contributions to be payable
is that each payment must be made in a tax week in which Mr Haylock is in employed
earner’s employment:
"Where
in any tax week earnings are paid to or for the benefit of an earner in respect
of any one employment of his which is employed earner’s employment a primary
and a secondary Class 1 contribution shall be payable…." (section 6)
He
contends that Contributions are not payable on payments made to past or future
employees.
- Mr
Ewart again contends that the reference to employed earner’s employment is to
differentiate it from self-employment. The section is referring to a payment in
respect of (a wide expression) any one employment which is employed earner’s employment
(meaning, and is not self-employed earner’s employment). Mr Ewart with great erudition
described the "is" as copulative, to which I have found reference in
Fowler’s Modern English Usage: "In grammar, used of a word that connects
words or clauses linked in sense or connecting a subject and predicate….Typical
copular constructions are:…and esp. the type Canberra is the capital
of Australia." In the former Social Security Act 1975 which was consolidated
in the 1992 Act the equivalent reference (in section 4(2)) was to "any employment
of his being employed earner’s employment." He contends that it is
permissible to look at pre-consolidation enactments where the legislation is ambiguous
(Lord Hope in R v Secretary of State for the Environment ex p. Spath Holme
Ltd [2001] 2 WLR 15, 46) or even in the absence of overt ambiguity, the court
finds itself unable to place itself in the draftsman’s chair and interpret the
provision in the social and factual context which originally led to its enactment
(Lord Bingham at p.28F). Mr Prosser contends that as there is no ambiguity one
cannot look at pre-consolidation legislation.
- Mr
Prosser QC contends that the third requirement for Contributions to be payable
is that there must be an employer in the tax week in which the payment is made:
"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—
- in
the case of an earner employed under a contract of service, his employer;…
(2)
In relation to employed earners who—
- are
paid earning in a tax week by more than one person in respect of different employments;
or
- works
under the general control or management of a person other than their immediate
employer,
and
in relation to any other case for which it appears to the Secretary of State 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."
He
contends that the reference is to earnings which are paid in a tax week (subsection
(2)(a)) or to a person who works (subsection (2)(b)), both in the present tense.
Mr Ewart contends that one cannot read the section literally because otherwise
an unconnected employer at the time of payment by the former employer would be
liable for Contributions. The references to "employed earner" and "earner
employed under a contract of service" are references to the status by virtue
of which the payment of earnings are received. The employer liable for Contributions
is the employer in relation to the relevant employment in respect of which the
person is an employed earner employed under a contract of service.
- Mr
Prosser QC pointed out that when section 4(4) of the 1992 Act was enacted section
313 itself did not apply to former employees because there was no charge unless
the emolument was for a year in which the employment subsisted, see Bray v
Best [1989] STC 159, so that it was not absurd for Parliament to have limited
section 4(4) to existing employees. Mr Ewart did not accept that Bray v Best
applied and submitted that section 313 was a freestanding Schedule E charge
under paragraph 5 of section 19 in the same way as section 148, see Nichols
v Gibson [1996] STC 1008. In its original form in section 26 of the Finance
Act 1950 it was a charge to surtax on an annual payment, not a Schedule E charge.
He also said that the position was reversed for emoluments by paragraph 4A in
section 19 at about the same time as section 4(4) was enacted in 1989. Mr Prosser
QC in reply pointed out that the Revenue’s Manual at SE3602 did not consider the
charge to be a freestanding one. Being a normal Schedule E charge like the charge
on fringe benefits under section 154, it was restricted to current employees.
- Mr
Prosser QC further contended that the Revenue could not rely on the fact that
there are regulations made in 1983 and 1984 under the Social Security Act 1975
that assume that there can be Class 1 Contributions on sums paid after the termination
of employment:
"(a)
Where—(i) the employment in respect of which the earning are paid has ended…the
earnings period in respect of such payment of earnings shall,…be the week in which
the payment is made." (regulation 3(4) of the Social Security (Contributions)
Regulations 1979)
"(1)
Where a person is, or is appointed, or ceased to be a director of a company during
any year the amount, if any, of earnings-related contributions payable in respect
of earnings paid to or for the benefit of that person in respect of any employed
earner’s employment with that company shall…be assessed on the amount of al such
earnings paid (whether or not paid weekly) in the earnings periods specified in
the following paragraphs of this regulation.
(5)
Where a person is no longer a director of a company and in any year after that
in which he ceased to be a director thereof he is paid earnings in respect of
any period during which he was such a director, then…(b) the earnings period in
respect of all those earnings shall be the year in which they are paid."
(regulation 6A)
Mr
Ewart points out that the basis of the regulations was correct on the wording
of the 1975 Act "any employment of his being employed earner’s employment."
If Mr Prosser were right the consolidation Act of 1992 changed the law in a major
way. He contends that if the Act is ambiguous it is permissible to construe it
by reference to regulations. Lord Lowry in Hanlon v The Law Society [1981]
AC 124 at 193 sets out a number of propositions derived from cases and textbooks,
the first of which is:
"Subordinate
legislation may be used in order to construe the parent Act, but only where power
is given to amend the Act by regulations or where the meaning of the Act is ambiguous."
- Finally,
Mr Prosser QC contended that there was no machinery for determining the earnings
period relating to the payments, which was consistent with his construction. Regulation
6A quoted above relates to "earnings in respect of any period during which
he was such a director" which is not applicable here. Mr Ewart contended
that if regulation 6A did not apply then regulations 3 or 4 must apply:
"(a)
Where—(i) the employment in respect of which the earning are paid has ended… (iii)
after the end of the employment a payment of earnings is made which satisfies
either or both of the conditions specified in the next succeeding sub-paragraph,
the earnings period in respect of such payment of earnings shall,…be the week
in which the payment is made; (b) the conditions referred to in the preceding
sub-paragraph of this regulation are that the payment is one which is…(ii) not
in respect of a regular interval." (regulation 3(4) of the Social Security
(Contributions) Regulations 1979)
"…where
earnings are paid to or for the benefit of an earner in respect of an employed
earner’s employment, but no part of those earnings is normally paid or treated
under regulation 6 of these regulations as paid at regular intervals, the earnings
period in respect of those earnings shall be a period of one of the following
lengths—…(b) where it is not reasonably practicable to determine that period under
the provisions of the last preceding paragraph…(ii) where the payment is made
before the employment begins or after it ends, a week." (regulation 4)
Mr
Prosser replied that regulation 3 did not apply because the payments were in respect
of a regular interval, and nor did regulation 4 apply because they are paid at
regular intervals.
Reasons
for the decision
- It
is common ground that a literal construction of these sections is not appropriate.
One must identify a relevant employer, so that if a person has two employments
the Contributions are paid by the relevant employer and if the person has a new
employer that employer is not liable for Contributions (assuming they are payable)
on payments made by a former employer. This is clear from section 6(4):
"Except
as provided by this Act, the primary and secondary Class 1 contributions in respect
of earnings paid to or for the benefit of an earner in respect of any one employment
of his shall be payable without regard to any other such payment of earnings in
respect of any other employment of his."
- Mr
Prosser QC makes a powerful case that the Act consistently looks to the employment
in the tax week in question. It is certainly possible to read the Act in this
way. But the context of the wording is important. The defined expressions employment,
earnings and earner set out in paragraph 10 above all apply to both employment
(in the non-defined sense of work under a contract of service) and self-employment
(in the defined sense), and so it is necessary to describe work under the former
as employed earner’s employment. I therefore agree with Mr Ewart that the purpose
of the definition of employed earner is to differentiate between employment (in
the non-defined sense) and self-employment, and not to impose any temporal restriction
to a person who is currently employed.
- As
there is ambiguity whether the present tense is intended to have a temporal significance
I consider that it is permissible to look at the pre-consolidation wording of
section 6 "being employed earner’s employment" to confirm that
that is the sense in which the words are used. The existence of Regulations made
under the former Act providing for an earnings period after the employment has
ceased is in accordance with this interpretation. It is not likely that by changing
the wording from being to which is and leaving the regulations to
continue that a consolidation Act changed its meaning in such a significant way
as to exclude liability for Contributions on payments in respect of a former employment.
- The
power in paragraph 8(1)(o) of Schedule 1 has been exercised to deal only with
self-employed where it might be difficult to determine whether if there was little
or no activity the self-employment was continuing. If it were a fundamental principle
that there must be a subsisting employment so that payments made before or after
employment were not liable to Contributions it would surely have been exercised
in the employment field.
- On
the question whether section 313 of the Taxes Act is a freestanding Schedule E
charge or whether it is subject to the Cases of Schedule E it seems to me that
Mr Prosser QC is right. It is a case of something being "treated as emoluments"
which is the formula used for fringe benefits in section 154 and in many other
charges such as sections 134, 144A, 149, 164 and 648. By section 313(6) it applies
to an office or employment within Cases I or II of Schedule E which is inconsistent
with its being a freestanding charge. Having come to that conclusion I looked
for confirmation (not as a aid to construction) at the Income Tax (Earnings and
Pensions) Bill currently before Parliament. This Tax Law Rewrite Bill treats section
313 payments as part of general earnings in the same way as other items treated
as earnings (the modernisation of "emoluments") to which the Cases of
Schedule E apply, and not as specific employment income (the successor to the
freestanding charge) which has no territorial limits except in accordance with
the terms of the charge. In any case, as Bray v Best was reversed at about
the same time as section 4(4) of the 1992 Act was originally enacted I do not
find this point helpful in deciding whether section 4(4) applies. The fact that
other cases of something being "treated as emoluments," such as section
154, are limited to current employments does not mean that all items treated as
emoluments are so limited, as is the case with section 160(3) dealing with loans
where the employment has terminated.
- The
draftsman of section 4(4) of the 1992 Act had to incorporate payments taxed under
section 313 of the Taxes Act into the Contributions legislation. He deliberately
excluded payments in kind in section 313(4) because they were not at the time
liable to Contributions. He did not make any other changes to a section that applied
in terms to a person who holds, has held, or is about to hold an office or employment.
If an employed earner were restricted to someone currently employed he would surely
have made a further modification to restrict the application of the section rather
than merely applying Contributions to "any sum paid to or for the benefit
of an employed earner which is chargeable to tax by virtue of section 313."
Accordingly I consider that Contributions are payable on the payments in question.
- As
to the earnings period, I agree with Mr Prosser QC that regulation 6A does not
apply because the payments are not "earnings in respect of any period during
which he was such a director." They are earnings in respect of periods after
he ceased to be a director. The payments are made in respect of the periods first
from 22 December 1994 to 31 December 1995 and then two periods of a year, 1996
and 1997; they were paid on 3 January 1995 (£500,000), 30 December 1995 (£500,000)
in respect of the first period, 3 January 1996 (£200,000) and 30 December 1996
(£800,000) in respect of 1996, and 1 January 1997 (£200,000), being the first
payment in respect of 1997. These are neither paid at regular intervals, the December
and following January payments being made within a few days of each other followed
by an interval of almost a year, nor in respect of a regular interval because
the first period exceeds a year, although it might be said that the payments for
the following two years were in respect of a regular interval of a year. Accordingly,
paragraph 4, and possibly paragraph 3 (except for the first period), apply and
either way the earnings period is a week. I might add that if the payments had
been made six monthly it is difficult to see that either regulation would have
applied.
- Accordingly
I dismiss the appeal in principle.
