Compensation for lost pension rights on employment transfer not taxable- Reid v HMRC

Fri 04 Mar 2016

The First Tier Tribunal case of Reid v HMRC  concerns the tax treatment of a payment made under a compromise agreement on the transfer of employment under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE).

Background to the case

When BP transferred its aircraft fuelling operation to another company (“North Air”) Alexander Reid, an engineer who built and maintained trucks for the company was one of the employees who transferred to North Air under TUPE. The transfer brought with it changes in the terms and conditions of employment of all the employees transferred, referred to as “loss of scheme rights” which in Mr. Reid’s case meant BP’s pension, bonus and share schemes, and lunch Allowance.

A compensation package for these losses was settled in a compromise agreement under which Mr Reid received £25,396 which was not specifically allocated among those items.

Mr. Reid submitted his return on the basis that the payment he received was not a payment for service within Income Tax (Earnings and Pensions) Act 2003 (ITEPA) s 62 2003 (all statutory references are to ITEPA unless otherwise identified) but instead was compensation for loss of or reduction in benefits and as such fell within s 401 and, being less than £30,000, was exempt by virtue of s 403.

HMRC’s position was that the payment was taxable under s 62 because it related to Mr. Reid relinquishing access to the BP reward and benefit scheme, i.e. the total package from BP, and moving to the North Air reward and benefit scheme. HMRC issued a notice of determination on that basis and their internal review upheld that decision.

The relevant law

·         S 62 is the general charging provision for employment income and taxes any salary, wages, fee, gratuity, other profit, incidental benefit or “anything else that constitutes an emolument of the employment”.

·         S 401 taxes payments and benefits received in consequence of or otherwise connected with termination, change of duties or change in earnings from a person’s employment. Where this section applies, s 403 provides for an exemption from tax of up to £30,000.

·         If a payment falls within both s 62 and s 401, s 62 takes precedence and the s 403 exemption can therefore not apply.

The case in the First Tier Tribunal

Mr. Reid claimed that the payment entirely represented compensation for his loss of pension rights following termination of his employment with BP. He also said that one of his reasons for bringing the appeal was that he believed HMRC were treating taxpayers inconsistently.

HMRC contended that all of the payment arose from employment, not termination, and was taxable in full under s 62.

The Judge identified an underlying theme in past judgments that it was not enough for the payment to be received from the employer or even through a connection with the employment: for s 62 to apply the employment had to be the source of the payment.

The Tribunal’s findings of fact

·         The payment was compensation for loss of scheme rights that comprised the expectation of pension rights, bonus rights, share rights and lunch allowances. This was evidenced in the agreements made and by the fact that the consultation process by which the compensation was decided focused on what the employees lost when their employments transferred.

·         There was no evidence of any other reason for the payment.

·         The Tribunal rejected any suggestion that the payment was an inducement to employees to accept the transfer to North Air or to accept different terms of employment.

·         It was possible to divide the payment among its different elements using the formula set out in the Framework Agreement between BP and the employees concerned.

·         References in the Compromise Agreement to tax being paid did not determine whether there was any actual liability, only that tax might have to be paid.

·         Mr. Reid’s employment with BP did actually terminate.

The Tribunal decision

Inconsistency of treatment by HMRC

The Judges expressed sympathy with Mr. Reid’s frustration with any apparent inconsistency but stressed that their obligation was to deal only with his specific situation.

The relevance of TUPE

There was a termination of employment: even though TUPE deemed Mr. Reid’s employment to have continued for the purposes of employment law (for entitlement to redundancy etc.), past cases have decided that where employment is transferred under TUPE that does not alter the fact that the old employment was actually terminated and that is what matters for income tax purposes.

Identification of earnings

The central question was whether payment was paid in return, or as a reward for acting as or being an employee and providing services as such in the past, present or future (Hochstrasser v Mayes).

Payments may be earnings whether or not they are paid by the employer to whom the services are provided, as in the case where one employer paid an inducement to the employee to change to another employer (Shilton v Wilmshurst).

A payment made to satisfy or replace a contingent right to another payment is generally to be treated in the same way as that other payment would be (Mairs v Haughey). In Mairs it was found that the pension would have been taxable but in Tilley v Wales compensation for a non-taxable pension was ruled not to be taxable. Similarly, in Kuehne & Nagel v RCC (which was not solely concerned with pension rights and was an FTT case, so did not set a binding precedent) it was found that the tax treatment of compensation should follow the treatment that would have applied to the entitlement that the employee had lost.

Apportioning the payment

For a payment to be apportioned it must be possible to identify discrete reasons for different elements of the payment and make a proper division among those reasons. Any element of the compensation that derives in part from employment is taxable in full and if those payments cannot be separated out from the compensation as a whole, the whole compensation payment is taxable.

The Tribunal’s conclusions

·         The sole reason for the payment was loss of scheme rights.

·         The fact that the payment was conditional on transferring employment to North Air did not make it taxable as an inducement to join North Air – the condition was no more than a trigger for the payment to be made, and the basis of the payment was in respect of a loss of rights on the transfer which, if the transfer had not happened, would not have existed.

·         Continuity of employment under TUPE for employment law purposes did not mean there was no termination of employment for tax purposes.

·         Mr Reid’s contingent right to additional pensions that would have accrued if his BP employment had continued (as opposed to pension entitlement that had already accrued and was not contingent) was not taxable and so compensation for its loss was not taxable either- appeal upheld.

·         Reid had not provided sufficient evidence to establish even a prima facie case that his share scheme rights would have produced tax-free benefits and the burden of proof was on him, so the compensation for loss of those rights was taxable- appeal rejected.

·         Reid produced no evidence that any bonus would have been anything other than taxable- appeal rejected.

·         Reid did not make clear to the FTT what the amount of the lunch allowance was or why it would not have been taxable if he had received it- appeal rejected.

Quantification

Here the FTT decided that although some of the elements of the compensation payment could not be quantified, the one element that was not taxable, that related to the loss of future pension rights, was quantifiable because the Framework Agreement for settling compensation provided that the sum attributable to this element was 42% of Mr. Reid’s salary on 1 May 2010. This element fell within s 401 and therefore qualified for exemption under s 403.