A special commissioner decided that a number of employees were liable for the tax on cash payments for the cancellation of share options where their employer should have, but had failed to, account for the tax due. Where the employer had to account but could not deduct, a statutory liability fell on the employee. The employee was liable for the difference between tax on his income and the tax which was actually or should have been deducted as PAYE together with the amounts for which the employer accounted under ICTA 1988, s. 203J.

Facts

The taxpayers were former employees of a company (‘the employer’). On 30 April 1998 they all received cash payments for the cancellation of share options. Those payments gave rise to emoluments chargeable under Sch. E equal to the full amount of each payment. The payments were made gross without deduction of PAYE.

The Revenue sought to recover PAYE from the employer. The employer appealed against the determination issued under reg. 49 of the Income Tax (Employment) Regulations 1993 (SI 1993/744) (‘the PAYE regulations’) that PAYE was due and the special commissioners, in Demon Internet Ltd v Young (2004) Sp C 449, allowed its appeal. None of the taxpayers were a party to that appeal and the Revenue did not appeal against that decision. But they amended the taxpayers’ self-assessment returns so as to recover the tax on the payments from the employer. The taxpayers appealed against those amendments on the basis that the tax should have been paid by the employer and so was not assessable on them. They were not parties to the Demon decision and so were not bound by it.

It was common ground that none of the taxpayers realised any gain for the purposes of ICTA 1988, s. 135 until 30 April 1998; and the entirety of the payment made to each of the taxpayers represented an amount chargeable to tax under Sch. E by reason of s. 135.

The taxpayers contended that under the law applicable prior to its amendment following the 1998 Budget, the employer was obliged to deduct and account for PAYE (‘the old law argument’). In any event the changes to the law following the 1998 Budget meant that the employer was liable to deduct and account for PAYE (‘the new law argument’).

As regards the old law, they argued that PAYE could only be operated where there was a payment of, or on account of, emoluments. PAYE could not be operated where part only of a payment was chargeable to tax under Sch. E unless the charging mechanism of the relevant provision operated either to treat the whole payment as a payment of emoluments whilst preserving a right to a deduction under other appropriate statutory provisions, or to provide expressly that the part so chargeable was to be treated as a payment of, or an account of, emoluments. The charging mechanism of ICTA 1988, s. 135 attracted liability to tax under Sch E on the whole amount paid with the result that s. 203 and the PAYE regulations in relation to deduction of tax were fully engaged. The Revenue argued that the PAYE regulations applied either to all cases falling within s. 135 or to none. In the absence of specific statutory provisions, the PAYE regulations did not apply. The special commissioners had properly held that FA 1998, s. 67 and reg. 80ZA of the PAYE regulations failed to provide an effective obligation to deduct and account for PAYE which was coterminous with the making of the payments. Since there was no duty to deduct when the payments were made, they were not amounts which, but for s. 67(3), would have been deductible. The effect of reg. 80ZA and 40 of the PAYE regulations was not to impose an obligation to account. Regulation 80ZA was merely a timing provision.

Issue

Whether the employer was liable to deduct and account for PAYE under the existing law prior to amendment; whether the taxpayers were obliged to account for tax following the assessment; whether the obligation to account for tax meant that the tax was treated as paid by the employees.

Decision

The special commissioner (Charles Hellier) (dismissing the appeal) said that the combined effect of FA 1998, s. 67 and the Income Tax (Employments) (Notional Payments) (Amendment) Regulations 1998, was that the employer was liable to account for PAYE in respect of the moneys paid for the release of the options and was liable to make payments within 14 days of 5 August 1998. Section 67(1) inserted s. 203FB into ICTA 1988 to the effect that any person making a payment for a release of an option would have to comply with the obligations under the PAYE regulations made under s. 203. Section 67(2) and (3) made provision for the period between 6 April 1988 and 31 July 1998 when FA 1998 received Royal Assent. The effect of FA 1998, s. 67(2) (ignoring s. 67(3)) was to impose retrospectively an obligation to deduct and account for PAYE.

However, s. 67(3)(a) and (b) provided that there should be no change in the liability to deduct and account and so removed the retrospective creation of any liability. The tailpiece of s. 67(3) then took effect in relation to the amounts which, but for that subsection, would have been deductible or accountable. Those were the amounts which s. 67(3)(a) and (b) had removed from retrospective effect and were the amounts which, were it not for s. 67(3), would have been deductible and accountable. The question whether there was an actual liability was irrelevant to its operation and the effect of s. 67(3) was to require the calculation of the amounts which would be deductible or accountable if they had had that effect, and thus to require those amounts to be dealt with in accordance with the amendment regulations which introduced reg. 80ZA specifically to deal with release payments which had effect for the purposes of s. 67(3).

Regulation 80ZA imposed no right or obligation to deduct. It had effect in relation to the amount by reference to which there would, absent s. 67(3), have been a retrospective obligation to deduct. The effect of reg. 80ZA(2) was that the employer, for the month ending 5 August 1998, was required to account for the PAYE that would have been deductible from the release payment but for FA 1998, s. 67(3). Regulation 80ZA made the employer accountable for the tax without giving him any right or obligation actually to deduct it from any payment to the employee. Thus the combined effect of s. 67 and the amendment regulations was that the employer was liable to account for tax on the option release payments.

Since ICTA 1988, s. 203FB was deemed to come into force on 6 April 1988 (subject to the limitation in FA 1998, s. 67(3)) that meant that, at least before the application of s. 67(3), the payments for the release of the option fell within the potential ambit of the PAYE regulations. Any provision they made in relation to assessment or self-assessment of the taxpayers’ income was relevant. By virtue of reg. 101(2) of the PAYE regulations, an employee was obliged to make up any shortfall between the assessed tax and that actually deducted subject to two modifications. Regulation 101(3) and (4) required the ‘total net tax deducted’ to be increased by any tax which the employer was liable to deduct from the employee's emoluments but failed so to deduct. Further, ICTA 1988, s. 203J(5) treated anything which an employer accounted for under s. 203J(3) in respect of notional payments as paid by the employee in the year specified in the PAYE regulations.

If the tax so accountable was within s. 203J(3), the employee could treat it as paid by him and would get credit for it. However the tax would only fall within s. 203J(3) if the employer was unable to deduct by reason of any insufficiency of payments actually made. The employer was unable to deduct the tax for which he was accountable because no mechanism was provided for deduction from later actual payments due to the disapplication of reg. 7, and FA 1998, s. 67(3) disapplied any retrospective obligation to deduct. Therefore s. 203J(3) did not give the employee any credit for tax accounted for in respect of any transitional notional payments and there was no express provision to that effect in the regulations.

(2007) Sp C 597.
Decision released 6 March 2007.