UK Tax Round Up

• Published date: 09 September 2022
• Subject Matter: Tax, Income Tax, Corporate Tax
• Law Firm: Proskauer Rose LLP
• Author: Mr Robert Gaut, Stephen Pevsner, Catherine Sear and Richard Miller

Welcome to the August edition of the UK Tax Round Up. August turned out to be not such a quiet month on the UK tax front. We have seen several important and technical case law decisions, some of which we discuss below, and highlight a couple of other developments in UK tax this month.

UK Case Law Developments

Payment of ancillary amounts in litigation taxable as employment income

In HMRC v Murphy, the Court of Appeal ruled that sums paid under a settlement agreement in respect of legal fees and an insurance premium, which were not paid directly to the taxpayer, were his taxable income.

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 respect of overtime and certain other allowances. All the claims related to duties performed by the claimants whilst working for the Met.

In order to fund the proceedings, the claimants entered into an agreement 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. Each of the claimants also entered into an insurance contract with an insurer (Temple) for insurance against the risk of having to pay the Met's legal costs if they lost all or part of their claim. A premium was payable for that policy.

Following conclusion of a settlement agreement, the claimants' solicitors raised an invoice for the success fee of '1.2 million addressed to their clients (the police officers) but was stated to be payable by the Met. 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 agreed settlement amounts and paid directly by the Met to Temple.

Despite the success fee and the insurance premium not having been paid to the police officers directly, but rather to the lawyers and the insurer, the Met applied PAYE to Mr Murphy's share of those sums. Mr. Murphy filed a tax return claiming that none of those sums constituted his employment income (earnings) and HMRC in response issued discovery assessments against him for that tax. Mr. Murphy appealed. The First Tier Tribunal ("FTT") 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.

The Upper Tribunal ("UT") ruled that the success fee and premium did not constitute profit for Mr. Murphy and were therefore outside the scope of "earnings" for income tax purposes.

The Court of Appeal reversed this decision (reinstating the original decision by the First Tier Tribunal), holding that payments were a reward for services as an employee, regardless of the label applied or the mechanism used to make the payment. The court held that the Upper Tribunal should a have considered whether the reimbursed expenses conferred a financial benefit in return for services. The payment mechanism did not alter the character of the amount paid, nor did the fact that these expenses had been incurred to recover sums due as remuneration make them deductible.

This case reinforces the principle that it is vital, when considering how sums payable in connection with a person's employment might be taxed, to look at the true underlying nature of the sums in question, and the mechanism for payment will not change that analysis.

Partial tax avoidance motive did not prevent availability of share for share exchange treatment

We reported on the FTT decision in the case of...