Smith & Williamson Corporate Services v HMRC – whether payment to introduce clients related to goodwill

Wed 03 Feb 2016

The case of Smith & Williamson Corporate Services Limited (SWCS) and P Smiley v HMRC and P Smiley v HMRC concerned the tax treatment of a payment made to several individuals in relation to their personal relationships which they had built up with clients – it draws a distinction between the concept of personal relationships and that of goodwill.

Background to the case
As part of its strategy of increasing its fund management business, SWCS took on a team from a private bank, Butterfield, which was headed by Mr Smiley. This team had built up considerable funds under management over the years, and had valuable personal connections with those clients whose funds were managed.  SWCS did not actually need any new team members per se: rather it was the client connections that the new team could bring that was the driving force behind the deal.
The team each entered into employment contracts with SWCS, and some time later separately, entered into a further contract (the ‘2006 contract’) with a sister company (SWIM) whereby a payment would be made based on the value of managed funds after a period of two years arising from clients which transferred from Butterfield.  This payment was referred to as a ‘goodwill payment’ and was treated by all parties, including for accounting purposes, as a capital payment to acquire an asset, rather than a payment of emoluments.  In order to receive the ‘goodwill payment’, the team members had to still be employed by SWCS at the time of payment.
HMRC challenged this treatment, claiming that the goodwill payment (even though it was paid by SWIM) was in fact an emolument for the individuals’ employment with SWCS. The taxpayers appealed to the First tier Tribunal (FTT) who found in their favour. HMRC subsequently appealed to the Upper Tribunal (UT) who comprehensively set aside the FTT decision, concluding that the goodwill payment arose from the employment and should be taxed accordingly as income.

Findings of the FTT
The FTT found that the goodwill payment under the second contract was in respect of a capital asset transferred by the individuals to SWIM, and not in connection with their employment. The judge had placed considerable weight on a number of factors including:

• the fact that the two contracts (i.e. the original employment contract and the contract under which the goodwill payment was made) were separate and that they had been negotiated independently.  The payments due under the employment contracts were in accordance with that paid to other similar employees and the goodwill payment under the second contract was calculated by reference only to the value of the client connections.
• the individuals’ employer (SWCS) was not a party to the second contract (which was with SWIM) and that the original intention of all parties on entering into the two contracts was for them to be treated in the way in which they had been reported (i.e. for the goodwill payment to be treated as a capital payment rather than emoluments).
• the case of Hose v Warwick, which concerned an insurance broker who received a lump sum for giving up his personal client connections (which drove the substantial commissions he earned) and which was held to be capital.

Findings of the UT
The UT found significant errors in both the approach and the ultimate decision of the FTT and comprehensively rejected the FTT’s findings.
First of all, the UT concluded that the starting point on the issue of law should be the case of Shilton v Wilmshurst [1991] STC 88 – this made clear that a payment from a third party could in fact be taxable as emoluments in the hands of the individuals. So the fact the payment was made by SWIM rather than SWCS was not relevant.

Furthermore, and most importantly, the individuals did not own any legal interest in any asset which they could sell under the 2006 contact – the goodwill (if any) was owned by their previous employer, Butterfield.  SWIM did not acquire any kind of asset in return for the payment.  All the team had was the ability to use personal relationships which they had built up over time to introduce their ‘client connections’ from their previous employment with Butterfield to SWIM. This was in fact the provision of a service to SWIM and did not represent a separate source of income.

The UT considered that the FTT had attached too much weight to the fact that there were two separate contracts, as they derived from a single objective, that of transferring clients from the individuals’ previous employer to SWIM, so they were clearly linked. They also found that the intention of the parties on entering into the two separate contracts was somewhat irrelevant – it is the facts of what happened that are important, and in particular, the fact that the individuals did not have any legal title to any asset which they could dispose of.

The reliance of the FTT on the judgment in Hose v Warwick was also dismissed, as in that case, Mr Hose received the payment for giving up his previous salary and substantial commissions based on his personal connections on becoming MD of the company.  He did not transfer client relationships to his employer, which already owned them; he gave up the basis of his commissions, In this case, the team had no sort of capital asset which they gave up.

On this basis, the UT found that the payment under the 2006 contract did constitute earnings from the individuals’ employment with SWCS, and should therefore be taxed as employment income subject to PAYE and NIC.

In conclusion, if what is being acquired is goodwill, then it will be taxed as capital.  If, on the other hand, what is in reality being acquired are services to introduce more clients (through existing connections) then it will be taxable as employment income.