Payment to an employee in lieu of notice is normally allowable.
But where the payment is not made for the purpose of carrying on
the trade but for something else, it is not allowed. It does not
matter that by arranging their affairs differently the payer may
have secured a deduction. Taxation follows the events that happened
and not those that could have occurred.
In the case of Godden v A Wilson’s Stores (Holdings)
Ltd [1962] 40TC161, the company traded as rubber planters. The
company's estates’ manager was employed under a contract
terminable by six months' notice to be given on 31 March or 30
September in any year. On 15 March 1958, the company entered into
an agreement to sell its estates, and the sale was completed on 31
March 1958, on which date the company’s trade was
discontinued. The manager was given notice of the termination of
his employment, and, on 28 March 1958, was paid the sum of
£1,900, representing the salary due to him for the six months
to 30 September 1958, and the estimated commission which he would
have earned in that period.
The Special Commissioners held that the sum of £1,900
was incurred on revenue account, for the purposes of the company's
trade, to break a trading obligation, and was an allowable expense
in computing its profits for that year. They accordingly allowed
the appeal.
Plowman, J begins by analysing the previous cases in this
subject area, identifying two broad categories:
Expenditure under the first category is not allowable but under the second is allowable, 40TC head of page 168; at the foot of page 169 and head of page 170:
…I have been referred to a large number
of other authorities and I should say something about them, though
I do not propose to go into them in great detail. They fall, I
think, mainly into two categories. Under one head there are the
cases where payments were made, not in order to enable the company
the better to carry on its trade, but to enable it to go out of
business: and in those cases the Courts have held that the money so
paid was not deductible as an expense wholly and exclusively laid
out or expended for the purposes of the trade…
…On the other hand, there is a second
category of cases in which sums of money paid to get rid of onerous
service agreements and the like have been held to be deductible as
expenses wholly and exclusively laid out or expended for the
purposes of the trade…I do not refer to those cases in detail
for this reason, that in all of them the business of the company of
person in question was going to go on; and a case in which the
business is going to go on seems to me to be entirely different
from a case in which the business is going to come to an end and
the payment is made because the business is going to come to an
end.
After discussing the Anglo Brewing decision (see BIM38310), Plowman J explains why the expenditure in A Wilsons Stores (Holdings) Ltd was not allowable, 40TC foot of page 168 to head of page 169:
Now, it is quite true that early on in his judgment he pointed out that the payments which he was considering were ex gratia payments, and said that there was no contract in it at all; but it seems to me that the fact that the payments in the case which Rowlatt, J., was considering were ex gratia payments whereas, in the case which I am considering, £1,900 was not an ex gratia payment, is neither here nor there. The point, as I understand it, of the decision is that, as the company was going to stop trading, the payments in question could not have been within the relevant provision because they were not made for the purpose of keeping the trade going. In that respect, which seems to me to be the relevant respect, that case is on all fours with the present one.
In the Court of Appeal Upjohn LJ confirmed why the payment was not deductible, 40TC most of page 174:
Of course, it is very familiar law that a
company, while trading and while intending to continue to trade,
may make deductions for its losses; it may make payments by way of
pension, whether they be voluntary or not; and it may pay out large
sums-as, indeed, was done in the case of Anglo-Persian Oil Co.,
Ltd. v Dale (16TC253), [1932] 1 K.B. 124, where a sum of no less
than £300,000 was paid by the then Anglo-Persian Oil Company
to get rid of certain agencies, and in other cases which were cited
to us. But all those payments are made and are allowed by the
Revenue, if they are commercially sound, in order that the company
may carry on its trade more successfully. They are, in a literal
sense, paid for the purposes of the trade, and as such are
allowable. Mr. Borneman counsel for the appellant]
submits that at the time this payment was made
the Company was in fact carrying on business - and no doubt it was
- and that it was paid, in fact, by way of remuneration. He submits
that that must be a payment which is wholly and exclusively paid
during its trade and for the purposes of trade, because the Company
was in this difficulty with Mr. Paton [the estates’
manager]
and, as in Mitchell v B. W. Noble, Ltd
[11TC372, see
BIM38370],
they had to deal with him at once. He submits
that it matters not that this payment of £1,900 was in fact
described as being ‘in lieu of notice’: that was merely
a measure of the remuneration that he was to receive.
Speaking for myself, I cannot accept that
argument. It is perfectly true that this payment might have been so
devised that the company might have been entitled to claim this as
a deductible expense, as being the remuneration of Mr. Paton during
this period; but, in fact, it was not so devised. I return to
paragraph (c) of the letter of 27th February, 1958, which sets out
perfectly clearly what the parties were intending to do. What the
parties were intending to do was to give Mr. Paton £1,900 in
lieu of notice, which is as common a transaction as one can
possibly have. In other words, they were paying him compensation
for the fact that they were not going to employ him for the full
time for which they were bound so to employ him: and, for that and
other reasons, Mr. Paton was happy and willing to accept that
arrangement. To my way of thinking, that payment cannot possibly be
described as a payment for the purposes of trade. It was made
because the Company was not going on to trade, and they were left
with the possibility of an action for damages against them for
breach of the agreement of employment. I accept Mr. Borneman's
submission that, though it was made on the occasion of
discontinuance, it was not because of that, and it was not to
enable them to discontinue business: they were going to do that
anyway. But this payment was not made for the purposes of the trade
they were going to carry on: it was to get rid of a possible law
suit after discontinuance.
The Master of the Rolls, Lord Evershed, expressly commented on the issue that had the company arranged their affairs differently, the payment may well have been deductible, 40TC lower half of page 175:
As I have said, it might have been put so that Mr. Paton could have been invited to say:’I accept six weeks' notice instead of six months' provided that my salary for the six months now pending is doubled’; and that would have been reinforced, perhaps, because, as Mr. Borneman pointed out, it was essential that the rubber plantation should be continued and handed over as a going concern. Indeed, the argument for its sale required its continuance as a going concern afterwards. But we can decide this case only upon the material as it took shape.
The Privy Council in Commissioner of Inland Revenue v Cosmotron Manufacturing Co Ltd [1997] 70TC292 - see BIM38315 - declined to follow the Court of Appeal decision disallowing payment in Wilson's Stores (Holdings) Ltd, and in consequence you should not cite the case in support of disallowing such payments. The principle that it does not matter that by arranging their affairs differently the payer may have secured a deduction remains valid. Taxation follows the events that happened and not those that could have occurred.
