The taxpayer was one of a group of police officers who commenced a group litigation action against their employer, in respect of overtime and certain other allowances to which they claimed to be entitled under the Police Regulations 2003, related to duties performed by the claimants while working for the Metropolitan Police Service (“MPS”). The dispute was settled under a settlement agreement which provided for the employer to pay £4.2m in damages, defined as “the principal settlement sum” plus “agreed costs” (defined as the legal costs and disbursements of the claimants’ solicitors and counsel as assessed by the High Court or agreed with the employer). They did not include the success fee payable under the claimants’ damages-based agreement with their solicitors and counsel or the insurance premium each claimant had had to pay to an insurer to insure against the risk of having to pay their employer’s legal costs in case they lost all or part of the claim. Clause 8(1) of the settlement agreement provided that, other than the agreed costs, the parties would bear their own legal costs in relation to the dispute and the agreement. Under clause 3, after MPS had paid the success fee to the solicitors and the insurance premium to the insurers, after deduction from the “global settlement sum”, they were to pay an apportioned amount of the principal settlement sum to each claimant, which the MPS proposed to treat as subject to PAYE and to deduct tax accordingly, whereas the agreed costs would be paid without deduction. The MPS applied PAYE to the taxpayer’s share of the principal settlement sum, including the part representing his share of the success fee and premium. The taxpayer appealed against the revenue’s assessments for tax on his apportioned share, on the basis that his share of the success fee and premium was not his earnings, pursuant to section 62 of the Income Tax (Earnings and Pensions) Act 2003. The First-tier Tribunal (“FTT”) dismissed his appeal, finding that those items formed part of the principal settlement sum, as was clear from clause 8, clause 3 making no difference, being only a mechanism for payment. The Upper Tribunal, allowed the taxpayer’s appeal, holding that the taxpayer had not made a “profit” within section 62(2)(b) of the 2003 Act and, to the extent that the principal settlement sum had been paid in discharge of the success fee and insurance premium, those amounts ought not to be treated as earnings under section 62.
On appeal by the revenue—
Held, appeal allowed. (1) Part 2 of the Income Tax (Earnings and Pensions) Act 2003 established a charge to income tax on “employment income”, which was defined by section 7(2)(a) as including “earnings within Chapter 1 of Part 3”. Section 62(2) defined “earnings” in relation to an employment, as “(a) any salary, wages or fee, (b) any gratuity or other profit or incidental benefit of any kind obtained by the employee if it is money or money’s worth, or (c) anything else that constitutes an emolument of the employment.” To a large extent the definition followed the previous definition of “emoluments” in section 131(1) of the Income and Corporation Taxes Act 1988. Section 62(2)(c) of the 2003 Act was intended to ensure that the pre-existing case law would apply to bring into the definition anything which had previously constituted an “emolument” which was not expressly covered by the categories of payment identified in the new definition. One of the definitions of the word “profit” in the Oxford English Dictionary was “a material benefit derived from a property, position, etc; income, revenue. Frequently in plural”, which was the sense in which the word was being used in the definition of “earnings” in section 62(2)(b) of the 2003 Act. The statutory scheme contemplated that all earnings from a person’s employment were taxable, subject only to the allowable deductions provided for by the provisions listed in section 327 in Part 5 of the 2003 Act. The question whether a payment amounted to “taxable earnings” from the taxpayer’s employment was therefore entirely separate from the question whether a deduction was to be allowed against taxable income. In determining whether a payment by the employer to the employee was an “emolument” or “earnings” from employment, the sole question was whether the payment was a reward for their services as an employee. If the employee was obliged to incur an expense out of their own pocket in order to carry out their duties, and the employer subsequently made a reimbursement of that expense, he was not, in any sense, rewarding the employee for the provision of their services. None of the authorities had been concerned with the meaning of the word “profit” in the statutory definition of “emolument”, nor whether the employee had received a benefit over and above the reimbursed expenses; rather, they had been considering whether reimbursed expenses were properly to be treated as part of the employee’s remuneration, ie whether they conferred a financial benefit upon him in return for his services (paras 14, 15, 16, 22, 49-50, 60, 62–64).
(2) It followed that the Upper Tribunal had erred in law in misinterpreting the authorities. Whether a payment was taxable was a matter of substance not of form. While the Upper Tribunal had rightly found that the agreed costs had not been a reward for services and while they did not appear to have found that the elements of the principal settlement sum which represented the success fee and insurance premium had not been a reward for services, their reasoning appeared to have been premised on the assumption that they had been. To the extent that the Upper Tribunal had found that the “from” employment test had not been met, that had been plainly wrong because the whole of that sum had represented a payment in respect of sums alleged to have fallen due under the claimants’ employment contracts, out of which certain liabilities incurred by the claimants to their lawyers and insurers were to be defrayed. Clause 8(1) made it clear that the legal responsibility for paying the lawyers and insurers remained that of the claimants, irrespective of the mechanism provided for the payments in the agreement in clause 3. There was nothing in the authorities to support the proposition that costs or expenses incurred (or even necessarily incurred) to recover sums due from the employer by way of remuneration could be deducted from those sums in order to reach a “taxable profit”, rather the contrary. Accordingly, the FTT’s approach had been in line with the statutory scheme (paras 48, 51, 54, 57, 60, 62–64).
Joshua Carey and Sam Way (instructed by HM Revenue and Customs) for the revenue.
Michael Collins (directly instructed ) for the taxpayer.