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
1
ANONYMISED DECISION
The appeal
1.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
2.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.
3.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.; …" :
4.The normal meaning of the secondary contributor is the employer and that is the meaning which is relevant in this appeal.
The issues
5.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.
6.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
7.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
8.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 .
9.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
10.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.
11.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.
12.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.
13.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.
14.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
15.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.
16.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.
17Mr 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.
18.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."
19.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.
20.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
21.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".
22.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.
23.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.
24.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.