The Lord Chancellor
The question in this case is whether two sums of Â£20,000 each which were paid to the Appellant by a Company named Stevenson and Howell Ltd., carrying on the business of manufacturing chemists,of which he was Managing Director, fall to be assessed for income tax under Schedule E. as being profits from his employment as such Director. The circumstances in which this question arises are very special, and before a correct solution can be reached, it is necessary to refer to three Agreements made at different dates between the Company and the Appellant.
The first of these Agreements is dated December 19th, 1921. It recites that the Appellant was the inventor of a secret process for the manufacture of a product to be used by the Company in connection with their business. Under this Agreement, the Appellant, who was already a Director of the Company, divulged to the then Managing Director, his secret process, and the Company contracted to pay to the Appellant a royalty of one shilling upon every pound weight of the new product manufactured under the secret process and used by the Company.
The next Agreement to be referred to is dated June 28th, 1937. By that time Mr. Tilley had become Managing Director and was receiving a salary as such of Â£2,000 per annum. The Agreement cancelled the arrangement of 1921 for the payment of the royalty and in consideration of this provided that the Appellant's salary as Managing Director should be raised to Â£6,000 per annum, and that, in the event of the Appellant ceasing from any cause whatsoever to be Managing Director of the Company, the Company would pay to him from the date of cessation a pension of Â£4,000 per annum for 10 years from such date. As long as matters stood on the basis of the 1937 Agreement, there can be no doubt that the Appellant's salary of Â£6,000 per annum was subject to income tax under Schedule E. and that, when his service as Managing Director ceased, the pension of Â£4,000 per annum was equally liable to tax under the second limb of that Schedule. The Agreement of 1937 ended with a paragraph providing that the expression Mr. Tilley includes, where the context so permits, his personal representatives. As the Court of Appeal has pointed out, this makes the construction of the Agreement, so far as it provides for " pension ", somewhat difficult, and in view of the nature of the conclusion at which I would invite the House to arrive, it is desirable to indicate whether under the Agreement the pension would in any case cease with the Appellant's death or whether it would be payable, in the event of his death, to his personal representatives until the period of 10 years had elapsed. I think the second of these constructions is the correct one.
Lastly, there comes the Agreement dated April 6th, 1938. It recites the provisions made the year before for a salary of Â£6,000 per annum as Managing Director and for a pension of Â£4,000 per annum for 10 years on the Appellant ceasing to be Managing Director. The Agreement then goes on to record that the Company has requested the Appellant (1) to release it from the prospective obligation to pay the pension, and (2) to serve the Company in future at a salary of Â£2,000 per annum. The Agreement witnesses the Appellant's acceptance of these requests, and in considerationof this the Company will pay to Mr. Tilley the sum of Â£40,000 by two equal instalments, the first of which shall be paid on the 6th April, 1938, and the second on the 6th April, 1939.
It is evident, therefore, that the Â£40,000 on which the Crown seeks to levy income tax is paid in part as the price of compounding the pension, and in part in consideration of the reduction of the Appellant's annual salary from Â£6,000 to Â£2,000. I will postpone the consideration of any difficulty which might arise from the fact that the total of Â£40,000 is stated as a single sum and is not divided by the terms of the Agreement into two parts allocated respectively to the compounding of the pension and the reduction of salary, and will first consider how far Schedule E. would be applicable if the two matters were dealt with separately, Â£X being stated in the Agreement as representing the value of the pension rights, and Â£Y as being paid in return for the reduction of salary, so that the two sums added together, Â£X plus Â£Y, amounted to the total of Â£40,000.
If it is legitimate to separate out the consideration in this way, it appears to me that there are two decisions of your Lordships' House which guide us to the conclusion at which we must arrive, one in connection with the pension problem and the other in connection with the payment in respect of the reduction of salary. As regards the commutation of pension, I cannot agree with Mr. Justice Lawrence's view that, as the pension would have been assessable under Schedule E., therefore a sum payable in com- mutation of it would also be assessable under the same Schedule. I think that the Master of the Rolls is right when he says that the decision in Short Bros. Ltd. v. Commissioners of Inland Revenue (12 Tax Cases 955), to which Mr. Justice Lawrence referred in this connection, does not support the learned Judge's proposition, and neither can I accept the contention contained in the Case for the Respondent (but not, as I understood, persisted in by the Attorney General) that the pension under the Agreement of 1937 was deferred remuneration and that the acceptance by the Appellant during his service of a sum in commutation of the pension amounted to the acceptance of a present remuneration instead. Neither the pension nor the sum paid to commute it constituted, in my opinion, profit from the office. If pension was paid after ceasing to hold the office, it would have been assessable under the head of Pension in Schedule E. and the First Rule applicable to that Schedule. I agree with the unanimous view of the members of the Court of Appeal that a pension is in itself a taxable subject matter distinct from the profit of an office, and if an individual agrees to exchange his right to a pension for a lump sum, that sum is not taxable under Schedule E. This conclusion is in accordance with the views of the majority of the Law Lords when this House decided the case of Hunter v. Dewhurst (16 Tax Cases 605). There an Article of Association of the Company which had employed Commander Dewhurst provided that when a Director died or resigned or ceased to hold his office for a cause not reflecting upon his conduct or competence, the Company should pay to him or his representatives by way of compensation for the loss of office a sum equal to the total amount of his remuneration in the preceding five years. Commander Dewhurst subsequently agreed with the Company, at a time when he was ceasing to be Chairman but was remaining a Director, that in lieu of his rights under this Article he should be paid Â£10,000, while his remuneration as Director was at the same time reduced to Â£250 per annum. Lord Warrington, Lord Atkin and Lord Thankerton held that the Â£10,000 was not a profit from his employment as Director and did not represent salary, but was a sum of money paid down by the Company to obtain a release from a contingent liability as distinguished from being remuneration under the contract of employment. Lord Thankerton emphasised the further point that the payment was not in the nature of income at all. It is true that the decision in Dewhurst's Case was regarded and described as arising under very special circumstances, but I think the ratio decidendi is as I have described. Moreover, apart from previous authority, I should myself take the view that a lump sum paid to commute a pension is in the nature of a capital payment which is substituted for a series of recurrent and periodic sums which partake of the nature of income.
But can the same view be taken of an arrangement made between an employer and his servant under which, instead of the whole or part of a periodic salary, a single amount is paid and received in respect of the employment? Generally speaking, I think not. An office or employment of profit—to use the actual phrase in Schedule E.—necessarily involves service over a period of time during which the office is held or the employment continues. The ordinary way of remunerating the holder or the person employed is to make payments to him periodically, but I cannot think that such payments can escape the quality of income which is necessary to attract income tax because an arrangement is made to reduce for the future the annual payments while paying a lump sum down to represent the difference. My view seems to me to be supported by the decision of this House in Prendergast v. Cameron (23 Tax Cases 122). In that case the Respondent was a Director of a Company and was minded to resign his position and so obtain greater ease. His fellow Directors, in the interests of the Company's success, urged him not to do so and an agreement was made between the Company and himself under which his salary was reduced from Â£1,500 to Â£400 per annum, but he also received Â£45,000. This House decided that the Â£45,000 was a profit from the Respondent's Directorship and was therefore assessable under Schedule E. I am not myself prepared to go so far as to say, as was said by the Master of the Rolls and Lord Justice Goddard in the present case, that remuneration for service can never be capital in the sense which would put it outside income tax. It is worth pointing out that the word remuneration does not occur in Schedule E. at all and it is safer to use the words of the Statute. I prefer to limit myself to the case now under consideration, and to say that, whatever part of the Â£40,000 should be regarded as the equivalent of a drop in salary amounting to Â£4,000 a year, is within the charge on profits from the office of Director.
There remains the question, which might otherwise have raised some difficulty, whether, when capitalisation of pension is not taxable and a sum paid in compromise of a reduction in salary is taxable, the Â£40,000 which is agreed between the parties to be the value of the two things together can be split up. We are relieved in the present case from deciding the point, for the Attorney General agreed that the two sums of Â£20,000 each should be treated as apportionable if the House took the view that tax was due under one head but not under the other. Accordingly I move that these two assessments should be referred back to the Commissioners in order that they may determine, according to the best of their judgment, what would be a reasonable apportionment. So much of the two sums as should be taken as paid in substitution for the reduction of salary should be assessed, in the appropriate years, for tax under Schedule E. The balance of the two sums which should be regarded as representing the purchase price of the annuity should escape taxation. I move accordingly. The Appellant should have his costs of the Appeal to this House, and there should be no costs in the Court of Appeal on either side.
The Lord Chancellor:
I am authorised by my noble and learned friends Lord Atkin and Lord Russell of Killowen, to say that they concur in the Opinion which I have just delivered.
The Crown claims that the sum of Â£40,000 paid to the Appellant in two instalments at a year's interval under the agreement of 6th April 1938 is chargeable to income tax under Schedule E of the Income Tax Act of 1918, as paid to him in respect of his office of director and coming within the words of Rule I of Schedule E, vizt, all salaries, fees, wages, perquisites or profits whatsoever therefrom.
My noble and learned friend on the Woolsack has made sufficient reference to the various agreements, and I agree that in order to appreciate the two-fold consideration in return for which the Â£40,000 was agreed to be paid, it is necessary to refer to the agreement of 28th June 1937, the terms of which equally necessitate a reference to the earlier agreement of 19th December 1921.
The Crown failed before the Special Commissioners, on the ground that the payment of Â£40,000 was not made to the present Appellant as remuneration for services rendered or to be rendered by him in his office as a managing director of the company. On Appeal, by stated case, Lawrence J. decided in favour of the Crown, holding that both in form and substance the payment was made in consideration both of the release from the company's obligation to pay the pension and the present Appellant's agreement to serve at a reduced salary of Â£2,000 per annum. As regards the latter element, the learned Judge held that it was clearly a profit from the office, and, as regards the ten-year pension, he held that, as the pension would have been assessable under Schedule E by virtue of section 17 of the Finance Act 1932, the sum payable in commutation thereof was assessable under Schedule E, and he based this finding on the decision in Short Brothers Ltd. v. Commissioners of Inland Revenue, 12 Tax Cases, an Appeal by the present Appellant to the Court of Appeal was dismissed, but partly on grounds materially different from those of Lawrence J. All the learned Judges differed from his statement as to the assessability of a sum paid in commutation of a pension and the Master of the Rolls pointed out that the case of Short Brothers did not support the view of the learned Judge; further, all the learned Judges of the Court of Appeal were of opinion that, if the agreement of 1938 had expressly apportioned the consideration of Â£40,000 between clauses 1 and 2, the portion referable to clause i, which released the pension obligation, would not have been chargeable to tax, but that the portion referable to clause 2, which contained the agreement to serve as managing director at a reduced salary, was chargeable to tax, as it fell directly within the decision of this House in Cameron v. Prendergast, (1940) A.C. 549. But the learned Judges—Mackinnon L.J. dub.—held that, as the parries themselves had refrained from apportionment, an apportionment by the Court was not permissible. Goddard L.J. appears to have further held that, in view of the conditions attached to the payment of the pension, it would be impracticable to make such an apportionment.
My Lords, in common with all the learned Judges below, I have no doubt that in so far as the payment of the Â£40,000 may be referable to the agreement to serve as managing director at a reduced salary, there is liability to tax, the decision in Prendergast's case being directly in point. It satisfies, in my opinion, the two tests, vizt. (i) whether it arose from the office of director within the meaning of Rule 1, and (ii) whether it is in the nature of income. I may add that I doubt whether the word capital is the exact antonym to the latter test. While I would agree that according to common experience, any consideration given in return for services in the office of director is likely to be in the nature of income, I am not prepared to state dogmatically that it must in every conceivable case be so, whatever form it takes, as the learned Master of the Rolls and Goddard L.J. appear to think. It is enough that there is no difficulty in the present case.
In so far as the payment of the Â£40,000 may be referable to the agreement to accept a sum in commutation of the liability to pay a pension, I have nothing to add to the view expressed by my noble and learned friend on the Woolsack. As in Dewhurst's case, such payment did not arise from the office of director, but in spite of it. I also agree with the view expressed by my noble and learned friend on the question of apportionment. I would desire to note, on the question of practicability, referred to by Goddard L.J., that the present Appellant's accountants appear to have provided the basis for the agreed sum of Â£40,000, as stated in paragraph 8 of the stated case. I concur in the motion proposed by my noble and learned friend.
As Lord Justice Mackinnon has pointed out, your Lordships are not without assistance when considering the problem which this matter presents. In Hunter v. Dewhurst, 16 Tax Cases 605 and Cameron v. Prendergast , A.C. 549, this House has at least discussed the question and in my view has decided it.
By the so-called 1938 Agreement the Appellant received two sums of Â£20,000 each and in return gave two separate considerations: (i) He released the Company from an obligation to pay a pension of Â£4,000 a year for 10 years from his ceasing to be Managing Director; and (ii) He agreed to serve the Company at a reduced salary of Â£2,000 (instead of as theretofore at Â£6,000 granted him by the 1937 Agreement).
It was claimed for the Crown that both these two sums of Â£20,000 were taxable as a profit from the Directorship, but that even if the former was not so taxable the commutating sums paid for each were so inextricably interwoven that it was not possible to ascertain how much was paid for the one and how much for the other, and that consequently the subject must pay on the whole. This was, as I understand it, the view of the majority of the Court of Appeal. Mackinnon L.J., however, though he would himself have taken the view that each item would be severally taxable, held himself bound by the principles evolved in the two cases referred to above and therefore considered that any sum paid in commutation of the pension was not taxable, whereas the sum paid as a consideration for the agreement to serve on as Managing Director at a reduced salary was taxable.
My Lords, I agree that this result follows if the remuneration can be apportioned between salary and pension. As I see it your Lordships have so decided in the cases referred to above and are bound by authority so to hold.
The Attorney General argued that this present case differed from Hunter v. Dewhurst (supra] in that the sum paid in commutation of the pension rights was paid whilst the Appellant was still serving as a director and that the sum paid in commutation of a pension to a person so serving differed from that paid in respect of a pension already due to a Director whose service had come to an end.
I do not feel able to accede to this argument. In my view a sum received upon the sale or surrender of pension rights is not taxable under Schedule E because it is neither pension nor annuity and comes under no other heading of that section.
It is in the head notes to Dewhurst's case said to be exempt as being capital and not income.
It is not, as I think, a pension or annuity; and therefore not income taxable under Schedule E, but I doubt if much assistance is to be obtained by making use of the antinomy between capital and income. The Attorney General sought to distinguish Hunter v. Dewhurst (supra) on the ground that in that case the pension was not deferred pay whereas in this case it was, and admitted that if it were not the Crown would have no claim to tax. Such a contention makes it necessary to determine the grounds upon which thepension was granted in the 1937 Agreement. No special consideration is stated in that document: the granting of the pension apparently forms one of the general terms of the Agreement under which the Appellant promises to give up his right to receive one shilling in respect of each pound of material manufactured under his secret process. Moreover, the pension is payable at any moment at which he may cease to be employed as Managing Director whatever the cause, and it is apparently payable to his personal representatives. I cannot think that such a provision represents deferred pay. It looks much more like a payment in lieu of the stipulated reward for revealing the secret process. But it is unnecessary to speculate. It is a sum paid for the release of an obligation to provide a pension and not shown to be given instead of deferred pay. If so, it is admittedly not subject to tax.
Just as in my opinion it follows, from the reasoning in Dewhurst's case, that any part of the two sums of Â£20,000 which was paid in respect of the surrender of the pension rights is not subject to tax under Schedule E, so in consequence of the decision in the Prende gast case the remaining part of that sum which was given in lieu of the surrendered payment of Â£4,000 as Managing Director is, I think, taxable as a profit from a public office.
It only remains, therefore, to see whether the sum attributable to the release of the pension can be separated from that payable for the reduction of salary.
It was only faintly argued on behalf of the Crown that such a division was not possible; but it was said that there were no materials upon which such a calculation could be made inasmuch as the cessation of the salary and the commencement of the pension were dependent on many unascertainable matters, amongst others on the Appellant's choice of the time of his retirement.
No doubt there are difficulties but the resultant figure seems no more incalculable than, say, the length of time during which an injured workman would have continued to earn wages had he not received his injury, a period difficult no doubt to ascertain, but one which has constantly to be estimated in dealing with cases of personal injury.
My Lords, I agree that this Appeal should be allowed in part and in part dismissed, and concur in the order suggested by the Lord Chancellor.