This appeal before the Tax Appeal Commission concerned if payment of €2.3 million were a “gift” and therefore subject to capital acquisitions tax or “income” from employment and therefore taxed under the income tax rules.

Background

The taxpayer, Group Chief Executive Officer of AB plc, received two payments totalling approx. €2.3 million in March 2011 from the then main shareholders in AB plc. The taxpayer had been informed of these payments 4 years earlier, by letter in June 2007. The payment followed the successful initial public offering (“IPO”) of the company on the Irish and UK stock exchanges.

The taxpayer submitted that the payment of €2.3m was not an emolument subject to income tax in accordance with section 112 Taxes Consolidation Act (“TCA”) 1997. He argued that the payment was made in respect of his personal qualities, and for gratitude, appreciation, admiration and friendship and that it formed part of the personal equation and was not taxable as an emolument arising from his employment. The payment was treated as a gift liable to capital acquisitions tax (“CAT”) in accordance with section 2 Capital Acquisitions Consolidation Act (“CATCA”) 2003 and section 5 CATCA 2003. The taxpayer filed the CAT IT38 return in respect of the period 1 September 2010 to 30 August 2011 and paid the CAT due on the €2.3 million ‘gift’.

Revenue raised assessments to income tax for the years of assessment 2007 and 2011. Revenue’s position is that the payment was within the charge to tax under Schedule E based on the provisions of section 18(2) TCA 1997. The payment of €2.3m satisfied all the requirements to come within the charge to tax under section 112 TCA 1997. The taxpayer was paid the sum of €2.3m in recognition of the taxpayer’s significant contribution to the successful re-flotation of the company in 2007. The payment arose from the taxpayer’s role as Group Chief Executive Officer and therefore was an emolument assessable to income tax under Schedule E.

Evidence

The main evidence examined was as follows:

a) Notification of the payment

Letters from the main shareholders in June 2007 notifying the taxpayer of the payments stated that it was a ‘gift’.

b) Source of the payment

When the two shareholding companies obtained adequate liquidity, the gift was made from those funds.

c) Calculation of the payment

The payments were based on twice the salary amount, this was an appropriate benchmark.

d) To whom the payment was made

Three other members of the senior executive team received payments from the shareholders similar to the taxpayer. A total of €5.8m was paid to the four of them.

e) Timing of the payment

The global crash in 2008 delayed the sale of the shareholdings as the shares could not be disposed of until the share price recovered in 2011. The payment of €5.8m was paid to the four executives including the taxpayer, in 2011.

f) Adequacy of the appellant’s remuneration

An expert in the field of executive compensation provided evidence on the taxpayer’s remuneration. He stated that in addition to remuneration, the taxpayer received approximately €10m of value through long-term incentives. This provided an average remuneration during the period the business was in private hands of over €4m per annum.

When asked about the practice of private companies giving ‘gifts’ to their executives, it was the expert’s experience that “this would be extremely unusual”. A second expert also stated that “the making of gifts is not a normal part of corporate culture.”

The taxpayer stated, as part of his oral evidence “I always felt I was extremely well paid and well rewarded …. I’ve never had a particular problem with my remuneration in the plc world. But it certainly, in comparative terms, has been always well up there relative to the peer group…”.

g) The taxpayer’s work and work ethic

The taxpayer worked long hours, often seven days and missed many family events and personal time. The successful IPO required an “enormous amount of work”. The culmination of the taxpayer’s work resulted in a successful IPO which achieved exemplary level returns for shareholders and investor.

h) Description and classification of the payment in documents

The taxpayer was of the view that the June 2007 letters notifying the payment were strong evidence of motivation, as the letters expressed ‘deep appreciation’ ‘gratitude’ and also used the word ‘gift’.

Revenue regarded the letters as evidence that the payments were received for the work carried out in relation to the IPO and in this regard relied on references to ‘your efforts and commitments through the period of our investment in the AB Group, culminating in the recent, very successful IPO’ and to the reference to ‘the sacrifices that you made in this period of your life to deliver the exceptional return..’.

The minutes of a meeting of the of directors of the shareholding company that made the payment noted “The sum of €3.94 million be approved for payment to the recipients, to be settled at the time of a secondary offering from such proceeds, subject to confirmation of company solvency at the time of settlement”. The unaudited financial statements of the company for the year ended 2011 had the payment recorded as a “deferred management IPO bonus”.

The payment was treated in the accounts as a ‘creditor’, and the language used under the heading ‘Related Party Transactions’; in the 2007 annual report of the AB Group plc referred to ‘compensation of key management personnel’. This treatment, according to Revenue, did not endorse the payment of a ‘gift’.

The taxpayer had used the promise of the ‘gift’ payment as security for loans he had with Anglo Irish Bank in 2010. This, he stated, was “to encourage them not to call in the loans which would have created problems for me.” Anglo Irish Bank were aware that the payment was a gift as the word ‘gift’ was used in the 2010 loan agreement security documentation, according to the taxpayer. Revenue were of the view that unless the taxpayer had certainty that payment was made, unless it was a legally enforceable obligation, that security would be worth nothing to Anglo Irish Bank.

Revenue’s submission was that the tax classification of the payment as a ‘gift’ was inconsistent with the contemporaneous documents including the June 2007 letters, the accounts and the IPO prospectus.

The taxpayer cited the June 2007 letters in support of his position that the payment was a gift and relied on corporate and accounting compliance obligations to explain the manner of reporting of the payment in the accounts.

i) The stated and submitted basis for making the payment

The taxpayer’s overall position is that there was no legal obligation to pay the money and no contractual entitlement to have it paid and that it was paid out of generosity.

j) Accounting standards and reporting

The lead partner on the audit of AB plc for the year ended 31 December 2007 gave evidence on behalf of the taxpayer as to his understanding of the facts from an accountancy perspective.

As part of his evidence he noted that it was appropriate to disclose in the accounts, the payment of €5.8m. Section 191 of the Companies Act 1963 outlined Irish company law disclosure requirements in respect of directors’ emoluments. Further, his evidence included a statement that ‘It was considered by management and the directors that section 191 probably applied since the test appears to encompass any payment made in connection with the management of the affairs of the company and this was very wide. The definition of ‘emoluments’ was not exhaustive, and the view taken was that it would probably apply to a payment of money.’

Analysis

The TAC applied the legal principals of the binding Supreme Court case of Wing v O’Connell [1926] IR 84 in reaching a decision.

The main legal principals from Wing v O’Connell are;

1. Payment in excess of salary – the fact that an employee has been paid fully for his/her work does not have the effect of taking an additional payment, received by the employee, outside the scope of the income tax statute.
2. The personal equation – where an employee receives a payment in recognition of the work that he or she has done or the success that he or she has achieved in the work that he or she has done, this is not a basis upon which to suggest that the payment was purely personal and that the payment does not arise from the employment.
3. Contractual obligation and voluntariness – there does not need to be a contractual obligation to make the payment in order for the payment to be taxable as income arising from employment. A payment may be voluntary and be taxable as an emolument.
4. Expectation – a payment may be unexpected and be taxable as an emolument.
5. Exceptionality – the fact that a payment may be extraordinary or a one-off does not take the payment outside the scope of the income tax statute.

The above legal principals from Wing v O’Connell were applied to the appeal as follows:

Payment in excess of salary

The adequacy of the taxpayer’s remuneration does not have a bearing on the nature of the payment made and does not preclude a finding that a payment constitutes a taxable emolument.

The personal equation

The payments were for the exceptional services rendered by the taxpayer. It is not possible to separate his individual excellence, from his role as CEO in circumstances where the manner of demonstrating his excellence was by being CEO, by acting as CEO and by delivering exceptional results as CEO.

Contractual obligation and voluntariness

A payment made voluntary without a legal obligation and involving generosity does not prevent it being taxable as earnings and assessable to tax as an emolument under Schedule E.

Expectation

Irish law does not treat expectation on the part of the recipient as relevant to the question of whether the payment is taxable in the hands of the recipient as arising from employment.

Exceptionality

The extraordinary or one-off nature of the payment is not a factor of significance as per the Wing case. Just because the payment was once off and unexpected does not mean it is outside the charge to income tax as an emolument.

Contemporaneous Documentation

Having considered several contemporaneous documents which included the June 2007 letters the TAC determined that the description of the payments as a ‘gift’ does not characterise or determine the nature of the payment for tax purposes. The description as a ‘gift’ was given minimal weight as per Wing v O’Connell.

In accordance with Wing v O’Connell, the intention or motivation of the payor is not determinative of the nature or character of that payments for tax purposes, rather, the transaction, its facts and circumstances, must be objectively considered.

It is difficult to reconcile the taxpayer’s position that the payment was not related to his employment given the sentiments expressed in the June 2007 letters, the payments ‘demonstrate respect and appreciation for the hard work and dedication’.

The gratitude expressed in the June 2007 letters related to the services rendered by the taxpayer over the period of his employment and the payments arose in that context.

In the 2007 Annual Report of AB plc the use of the words ‘award’ and ‘awarded’ are significant and are at odds with the reference to ‘gift’ in the June 2007 letters.

The TAC also considered the minutes of the board meetings and the limited partnership agreement. Several case law decisions as put forward by the taxpayer in support of his position and as relevant to the Revenue’s argument, were analysed by the TAC as relevant to the appeal.

Decision

The key decisions points made by the TAC were:

• The payment of €2.3m in this appeal falls within ‘salaries, fees, wages, perquisites or profits whatever’ in section 112 TCA 1997.
• Section 112 taxes emoluments arising from employment and the taxpayer argued that the qualities of gratitude, admiration, respect and appreciation were personal qualities which lifted the payment out of the remit of section 112 and into the realm of the personal equation. This is fundamentally incorrect. You cannot separate the success from the employment and characterise it as a personal quality separate to the employment. Irish jurisprudence which has tested and measured the scope of section 112 and its equivalents over the past one hundred years supports no such proposition.
• The payments were not only made to the taxpayer, but one of four awards made to the entire senior management team. This undermines considerably, the submission that the payments were made for reasons personal to the taxpayer.
• The payments were for the exceptional services rendered which contributed significantly to the increase in value of the shares of the private equity firms who were the principal shareholders and who generated a substantial return on their investments.
• The burden of proof rests with the taxpayer who must prove on the balance of probabilities that the assessments are incorrect. Having considered the evidence and facts, the relevant legislation and related case law, the TAC determined that the taxpayer did not succeed in demonstrating that the payment arose from a source other than the employment and the taxpayer did not discharge the burden of proof in this appeal.
• The TAC determined that the payments of €2.3 million constitutes a taxable emolument assessable to income tax in accordance with section 112 TCA 1997.

The taxpayer has appealed the TAC determination and the case has been stated for the opinion of the High Court.

Read the full judgement at www.taxappeals.ie