The Commissioners for HM Revenue and Customs v Mr Keith Murphy
| Jurisdiction | England & Wales |
| Judge | Lady Justice Andrews,Lord Justice Newey,Lord Justice Lewison |
| Judgment Date | 04 August 2022 |
| Neutral Citation | [2022] EWCA Civ 1112 |
| Court | Court of Appeal (Civil Division) |
| Docket Number | Case No: CA-2021-000033 |
[2022] EWCA Civ 1112
Lord Justice Lewison
Lord Justice Newey
and
Lady Justice Andrews
Case No: CA-2021-000033
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
(TAX AND CHANCERY CHAMBER)
MR JUSTICE MICHAEL GREEN AND
UPPER TRIBUNAL JUDGE GREENBANK
Royal Courts of Justice
Strand, London, WC2A 2LL
Joshua Carey and Sam Way (instructed by HMRC) for the Appellant
Michael Collins (instructed on direct access) for the Respondent
Hearing date: 14 July 2022
Approved Judgment
This judgment was handed down by the Judge remotely by circulation to the parties' representatives by email and release to The National Archives. The date and time for hand-down is deemed to be 10.30am on 4 th August 2022.
INTRODUCTION
This appeal concerns the meaning of the term “profit” as it is used in s.62(2)(b) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) which defines “earnings” for the purpose of the employment income parts of that Act. That section provides, so far as is material, as follows:
“62 Earnings
(1) This section explains what is meant by “earnings” in the employment income Parts.
(2) In those Parts “earnings”, in relation to an employment, means –
(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.”
The issue arises in this context. The Respondent, Mr Murphy, was a police officer employed by the Metropolitan Police Service (“the Met”). Mr Murphy was one of a group of police officers who commenced a group litigation action against the Met in the High Court on 19 December 2014, in respect of overtime and certain other allowances to which they claimed to be entitled. A small number of other police officers subsequently joined in the litigation as additional claimants. All the claims were for statutory debts alleged to arise under the Police Regulations 2003, and related to duties performed by the claimants whilst working for the Met. The Met denied that it was liable to make any of the payments claimed.
In order to fund the legal proceedings, the claimants entered into a Damages-Based Agreement (“DBA”) with solicitors and counsel, which provided for payment of a “success fee” calculated as a percentage of any sum payable by the Met to settle the claim, or damages awarded by the court. The “success fee” was payable in addition to any costs recovered from the Met. Each of the claimants also entered into an insurance contract with an insurer named Temple Legal Protection Ltd (“Temple”) by which, in return for a premium, Temple insured them against the risk of having to pay the Met's legal costs if they lost all or part of their claim.
On 5 May 2016, the Met entered into a settlement agreement with the claimants, by which, without making any admission of liability, the Met agreed to pay the claimants £4.2 million (defined as the “Principal Settlement Sum”) plus “Agreed Costs” in full and final settlement of their claims. These two amounts were collectively referred to in the settlement agreement as “the Global Settlement Sum”. “Agreed Costs” were defined as the legal costs and disbursements of the claimants' solicitors and counsel as assessed by the High Court or agreed with the Met. They did not include the success fee payable under the DBA, or the insurance premium.
Clause 8.1 of the settlement agreement provided that:
“Other than the Agreed Costs, the Parties shall each bear their own legal costs in relation to the Dispute and this agreement.”
Clause 3.3 of the settlement agreement set out the mechanism for payment of the Global Settlement Sum. The claimants' solicitors were to raise an invoice for the success fee of £1.2 million addressed to their clients, but stated to be payable by the Met. The invoice would identify how much of the success fee was payable to the solicitors and how much was payable to counsel. The Met was then required to pay the success fee directly to the solicitors. The insurance premium was to be deducted from the balance of the Global Settlement Sum and paid directly by the Met to Temple.
The Met would then pay an apportioned amount to each of the claimants from the balance of the Global Settlement Sum, as designated in a spreadsheet. To the extent that those sums represented a share of the Principal Settlement Sum, they would be subject to the withholding of income tax and national insurance contributions. Clause 3.3(c) of the settlement agreement made it clear that the Met proposed to treat the whole of the Principal Settlement Sum as subject to PAYE and to deduct tax accordingly. However, the Agreed Costs would be paid without making any such deduction.
The Met duly applied PAYE to Mr Murphy's apportioned share of the Principal Settlement Sum, including the part representing his share of the success fee and insurance premium. Mr Murphy filed his 2017 tax return on the basis that none of the Principal Settlement Sum was his income for that year. The tax return was made following correspondence between Mr Murphy's advisers and HMRC, in which HMRC stated that the Principal Settlement Sum was not income of the 2017 tax year, and should be spread over the period in respect of which the underlying claims were made. HMRC subsequently raised discovery assessments for the tax years 2009 to 2016, which assessed Mr Murphy on his apportioned share of the Principal Settlement Sum, including the success fee and insurance premium, and to interest.
Mr Murphy appealed against the discovery assessments on the basis that his apportioned share of the success fee and insurance premium was not his earnings. The First-tier Tribunal dismissed the appeal. Judge Brannan found that the payment of the success fee and insurance premium arose from Mr Murphy's employment. The Principal Settlement Sum constituted a payment in settlement of a claim for unpaid allowances and overtime, which it was accepted would have been taxable earnings if they had been paid by the Met in the first place. It was common ground that the sum payable in respect of Agreed Costs was not taxable earnings (since it was not derived from Mr Murphy's employment), but the Principal Settlement Sum did not include a payment in respect of costs. This was made clear by clause 8.1 of the settlement agreement. Clause 3 of the settlement agreement made no difference to the character of the payment, as it was merely a mechanism for the discharge of the claimants' obligations to third parties using the settlement monies. Therefore the entirety of the Principal Settlement Sum was taxable as employment income.
Judge Brannan gave Mr Murphy permission to appeal. Before the Upper Tribunal it was common ground, as it was before this Court, that the Principal Settlement Sum (and specifically the component reflecting the success fee and insurance premium) could only be regarded as “earnings” within s.62 of ITEPA if it fell within the expression “any other profit… obtained by the employee” in s.62(2)(b) of ITEPA. The Upper Tribunal identified two issues which needed to be resolved, namely:
i) Whether the alleged profit was derived from the employment as required by the definition of general earnings in s.9 (2) of ITEPA (the “from” issue); and
ii) What is the meaning of “profit” in s.62(2)(b); in particular, whether it refers to ‘gross’ profit or ‘net’ profit and, if the latter, what items can be taken into account in computing the net profit for these purposes? (the “profit” issue).
They held that the First-tier Tribunal fell into error because the judge only addressed the “from” issue.
The Upper Tribunal decided that even if the Principal Settlement Sum could be regarded as derived “from” the claimants' employments on the grounds that it was paid to compensate them for the Met's failure to pay sums due under their employment contracts, it was necessary to go on to consider the amount of the Principal Settlement Sum that should properly be regarded as a “profit” that the claimants obtained from their employment within the terms of s.62(2)(b).
The Upper Tribunal concluded, at [81], that the success fee and insurance premium should be deducted in the calculation of the net profit received, on the basis that those payments were necessarily incurred in order to obtain the payment derived from the employment. They said that it made no difference to their analysis that the claimants chose to fund the litigation by means of a DBA. They allowed the appeal, set aside the decision of the First-tier Tribunal and re-made the decision, holding that Mr Murphy did not make a “profit” within s.62(2)(b) ITEPA to the extent that the Principal Settlement Sum was paid in discharge of the success fee and insurance premium, and that those amounts should not be treated as earnings under s.62.
HMRC appeals to this Court on the following grounds:
i) Ground 1: the Upper Tribunal was wrong to hold that the case law supported a proposition that the focus of the courts in these cases is on whether or not the employee can properly be said to have made an overall or net profit as well as whether a payment is derived “from” the employment;
ii) Ground 2: the UT was wrong to hold that Eagles (Inspector of Taxes) v Levy [1934] 19 TC 23 supported a view that if the taxpayer in that case had received an amount in respect of his costs but had been necessarily obliged to pay the costs in order to receive the settlement sum, he would not have paid tax on the settlement sum to the extent of the amount of the costs;
iii) Ground 3: it was not open to the UT to make a finding of fact that the success fee and insurance premium...
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