KEITH BUSINGYE LAW GUIDE
Employment Income
Statement of
principles
The Chargeable
amount is ordinary income which is taxable, and therefore includes in income under sec 4(1) of the Income Tax Act. Cap. 340, if
there is a link between the amount and an earning activity. Where the earning activity is employment or
the rendering of services, the nexus test is satisfied if the amount is
characterised as a “product or incident of employment or a reward for services
rendered”. This is referred to as the
“income from personal exertion” principle.
An amount may satisfy the nexus test even though it is consideration for
past or future services, is paid by a third party, or is the product of an
isolated act or service. An amount that
is a benefit that cannot be turned to pecuniary account is not ordinary income:
Tennant v. Smith [1892] AC 150.
If the benefit is convertible, then it is ordinary income in the amount
for which the benefit can be converted.
Generally speaking, the
characterisation of an amount as a product or incident of employment or a reward
for services rendered is quite obvious – for example, salary, wages, fees and
commissions are clearly consideration for employment or services rendered. See
section 19(1)(a) Income Tax Act Cap.340
Similarly, a
lump sum payment to the taxpayer made at the commencement of employment in
order to compensate for benefits forgone under a former employer’s employee
share scheme was held to be assessable because the money was “an integral part
… [and] of the main attractions” of the salary package accepted by the
employee, representing a “straightforward inducement” for entering into the new
employment, and being in the nature of a payment for future service: Pickford
v. FC of T 98 ATC 2268. In Allman
v. FC of T 98 ATC 2142, a payment for income lost because of wrongful
dismissal was held to be in substitution for income which the taxpayer would
have earned, and therefore assessable.
In other cases,
the satisfaction of the nexus test is less clear. An amount may
be a reimbursement of expenses, purely gratuitous or consideration for
something other than employment or services rendered. In each case, it is a question of the proper
characterisation of the amount as to whether it is ordinary income.
An attempted
diversion of personal exertion income to a family company will only be
successful if there are factors that indicate that the family company is truly
in the business of providing personal services.
In Case 3/99 99 ATC 134 an employed investment adviser entered
into an agreement with his employer under which he ceased to receive a salary
and instead commission payments for his investment advice were paid to a family
company. The AAT held that the
commission payments were income of the adviser, not of the company. There was nothing to indicate that the
company was carrying on a business.
On the contrary,
the adviser continued to operate from the employer’s premises, carried a
business card in the name of the employer and, from the clients’ perspective,
there was nothing to indicate they were dealing with the company rather than
with the investment adviser.
Characterising
an amount
OLD COLONY TRUST CO v. COMMISSIONER
Supreme Court of the United States, 1929
279 U.S. 716,
49 S.Ct. 499.
Mr. Chief Justice TAFT delivered the opinion of the
Court.
* * *
William M. Wood was president of the American Woolen
Company during the years 1918, 1919 and 1920. In 1918 he received as salary and
commissions from the company $978,725, which he included in his federal income
tax return for 1918. In 1919 he received as salary and commissions from the
company $978,725, which he included in his federal income tax return for 1918.
In 1919 he received as salary and commissions from the company $548,132,27,
which he included in his return for 1919.
August 3, 1916, the American Woolen Company had
adopted the following resolution, which was in effect in 1919 and 1920:
"Voted:
That this company pay any and all income taxes, State and Federal, that may
hereafter become due and payable upon the salaries of all the officers of the
company, including the president, William M. Wood; the comptroller, Parry C.
Wiggin; the auditor, George R. Lawton; and the following members of the staff,
to wit: Frank H. Carpenter, Edwin L. Heath, Samuel R. Haines, and William M.
Lasbury, to the end that said persons and officers shall receive their salaries
or other compensation in full without deduction on account of income taxes,
State or Federal, which taxes are to be paid out of the treasury of this
corporation."
This resolution was amended on March 25, 1918, as
follows:
"Voted:
That, in referring to the vote passed by this board on August 3, 1916, in
reference to income taxes, State and Federal, payable upon the salaries or
compensation of the officers and certain employees of this company, the method of
computing said taxes shall be as follows, viz.:
"
`The difference between what the total amount of his tax would be, including
his income from all sources, and the amount of his tax when computed upon his
income excluding such compensation or salaries paid by this company.' "
Pursuant to these resolutions, the American Woolen
Company paid to the collector of internal revenue Mr. Wood's federal income and
surtaxes due to salary and commissions paid him by the company, as follows:
Taxes for 1918 paid in 1919 $681,169.88
Taxes for 1919 paid in 1920 $351,179.27
The decision of the Board of Tax Appeals here sought
to be reviewed was that the income taxes of $681,169.88 and $351,179.27 paid by
the American Woolen Company for Mr. Wood were additional income to him for the
years 1919 and 1920.
The question certified by the Circuit Court of Appeals
for answer by this Court is:
"Did the payment by the employer of the income
taxes assessable against the employee constitute additional taxable income to
such employee?"
Coming now to the merits of this case, we think the
question presented is whether a taxpayer, having induced a third person to pay
his income tax or having acquiesced in such payment as made in discharge of an
obligation to him, may avoid the making of a return thereof and the payment of
a corresponding tax. We think he may not do so. The payment of the tax by the
employers was in consideration of the services rendered by the employee and was
a gain derived by the employee from his labor. The form of the payment is
expressly declared to make no difference. Section 213, Revenue Act of 1918, c.
18, 40 Stat. 1065. * It is therefore immaterial that the taxes were directly
paid over to the Government. The discharge by a third person of an obligation to
him is equivalent to receipt by the person taxed. The certificate shows that
the taxes were imposed upon the employee, that the taxes were actually paid by
the employer and that the employee entered upon his duties in the years in
question under the express agreement that his income taxes would be paid by his
employer. This is evidenced by the terms of the resolution passed August 3,
1916, more than one year prior to the year in which the taxes were imposed. The
taxes were paid upon a valuable consideration, namely, the services rendered by
the employee and as part of the compensation therefor. We think therefore that
the payment constituted income to the employee.
This result is sustained by many decisions. * * *
Nor can
it be argued that the payment of the tax * * * was a gift. The payment for
services, even though entirely voluntary, was nevertheless compensation within
the statute. This is shown by the case of Noel v. Parrott, 15 F.2d 669. There
it was resolved that a gratuitous appropriation equal in amount to $3 per share
on the outstanding stock of the company be set aside out of the assets for
distribution to certain officers and employees of the company and that the
executive committee be authorized to make such distribution as they deemed wise
and proper.
The
executive committee gave $35,000 to be paid to the plaintiff taxpayer. The
court said, p. 672:
"In
no view of the evidence, therefore, can the $35,000 be regarded as a gift. It
was either “compensation for services rendered, or a gain or profit derived
from the sale of the stock of the corporation, or both; and, in any view, it
was taxable as income."
It is next argued against the payment of this tax that
if these payments by the employer constitute income to the employee, the
employer will be called upon to pay the tax imposed upon this additional
income, and that the payment of the additional tax will create further income
which will in turn be subject to tax, with the result that there would be a tax
upon a tax. This it is urged is the result of the Government's theory when
carried to its logical conclusion and results in an absurdity which Congress
could not have contemplated.
In the first place, no attempt has been made by the
Treasury to collect further taxes, upon the theory that the payment of the
additional taxes creates further income, and the question of a tax upon a tax
was not before the Circuit Court of Appeals and has not been certified to this
Court.
We can settle questions of that sort when an attempt
to impose a tax upon a tax is undertaken, but not now. It is not, therefore,
necessary to answer the argument based upon an algebraic formula to reach the
amount of taxes due. The question in this case is, "Did the payment by the
employer of the income taxes assessable against the employee constitute
additional taxable income to such employee?" The answer must be
"Yes."
Considerations
in characterising an amount
In
characterising an amount, the Court will not confine itself to the form of the
supporting documentation, but rather will look at the whole of the
circumstances surrounding the receipt.
In Reuter v. FC of T 93 ATC 5030, the taxpayer was an accountant
engaged by Rothwells Ltd. to advise in the takeover of John Fairfax Ltd. by
Tryart Pty Ltd. Rothwells agreed to pay
the taxpayer half of the success fee payable to it by Tryart. Under a loan arrangement between Rothwells
and Bond Media which included the assignment of the right to the success fee to
Bond Media by Rothwells, Bond Media agreed to pay $8m to the taxpayer as
consideration for the taxpayer covenanting that he would not, without the prior
approval of Bond Media, make any claim or take any action against Bond Media or
any other party in relation to the success fee.
The Court ignored the form of the transaction to hold that the receipt
was so closely associated with the services rendered by the taxpayer to
Rothwells that it was a product of those services. Of particular importance was the fact that,
given Rothwells’ financial position, all parties to the arrangement knew that
this was the only way that Rothwells could effectively reward the taxpayer for
his services and that the $8m was paid out of loan funds available to
Rothwells.
An amount that
is not characterised as a product or incident of employment or a reward or
services rendered may still be ordinary income under one of the other
principles which comprise the notion of ordinary income, such as the income
from business, compensation or periodicity principles. This is illustrated by FC of T v Cooling (1990)
22 FCR 42. In this case, the
taxpayer was a partner in a firm of Brisbane solicitors. The partnership received a payment of
$162,000 from AMP which was expressed to be in consideration for the
partnership’s procuring its service company’s agreement to move premises and
for signing certain ancillary guarantees.
The Commissioner argued that the payment was made to the taxpayer as
facilitators of a transaction between two other persons. This argument was rejected on the ground
that, in substance, the payment was characterised as a lease incentive payment
rather than as a reward for services rendered.
Nevertheless, it was held that the lease incentive payment was an
ordinary incident of the taxpayer’s business as a solicitor, and therefore
ordinary income.
Allowance. In
Taxation ruling TR 92/15,
the Commissioner ruled that an “allowance” is a predetermined amount to cover
an estimated expense which is paid regardless of whether the recipient incurs
the expense or the anticipated amount of the expense. In Case
153 , it was held that a reimbursement of expenses is not an
allowance. In that case, a
reimbursement was said to transfer the burden of an expense actually incurred
from the employee to the employer. In Taxation Ruling TR 92/15, the Commissioner
stated that a requirement that expenses be vouched or substantiated supports
the characterization of a payment as a reimbursement, as does an obligation to
refund unexpended amounts. If a payment
in the employment context is properly characterized as a reimbursement of
expenses (rather than an allowance), then it may be an expense payment fringe
benefit.
Section 19(1)(a)
includes in employment income the amount of any travelling, entertainment,
utilities, cost of living, housing, medical or other allowance in the
employment income of an employee. This ensures that all the income accruing to
the employee, irrespective of how the employee spends that income, provided
that the expenditure was not incurred in deriving gross income (i.e. an expense
made directly in the course of performing one’s duties of employment) is
taxable.
Reimbursement
of expenses. While an
amount derived by an employee as a reimbursement of expenses incurred by the
employee in the course of employment or as a condition of employment may be
characterised as a product or incident of employment, it is argued that the
reimbursement is not ordinary income derived by the employee. See section
19(2)(d) ITA.
The
reimbursement would be seen as serving the proper business purposes of the
employer and, therefore, as giving rise to no gain to the employee. The authority for this proposition is the
judgment of Lord Denning in Hochstrasser v Mayes.
If the amount of
the reimbursement is characterised as ordinary income, then the employee may be
in a neutral position through the allowance of a deduction for the amount of
the expenditure incurred. However, the
expenditure incurred by an employee will not always satisfy the tests of
deductibility. Indeed, the reimbursement
in Hochstrasser v Mayes is an example of this.
Consequently, it
is argued that, under ordinary principles, the proper approach to a
reimbursement of employment-related expenses is to treat them as giving rise to
no gain to the employee deriving them.
Gratuitous
payments. The fact that an amount is gratuitous will not
necessarily preclude it from being ordinary income. If the amount is properly characterised as a
product or incident of employment or a reward for services rendered, it is
ordinary income. For example, an employer
may pay a Christmas bonus to some or all employees in recognition of the level
of sales achieved during the year. While
the employer may be under no obligation to pay the bonus, it is still properly
characterised as a product of employment.
See section 19(1)(a) ITA. On the other hand, a gratuitous payment which
is made purely on personal grounds is properly characterised as a ‘mere gift’,
and therefore is not within the income from personal exertion principle. See section 21(1)(j) ITA. For example, an
employer may give an employee a wedding present which may be characterised as a
mere gift.
An amount must
be characterised objectively in the hands of the donee, and therefore, while
the motives of the donor may be relevant, they will seldom be decisive.
A gratuitous
payment may be made by a party or former party to the services relationship,
i.e. an employer or it may be made by a third party.
Gratuitous
payments made by a party to the services relationship. It
will only be in exceptional cases that a gratuitous payment made in the course
of an on-gong employment or services relationship will be characterised as a
mere gift.
An example of
such a case is Scott v FC of T (1966) 117 CLR 514. In this case, the taxpayer was a solicitor
who had, over a period of years, performed various legal services for a
widow. The solicitor had previously
acted for her former husband and there developed a personal friendship between
the taxpayer and his client. The client
made an unsolicited gift of £10,000 to taxpayer which was expressed to be in
appreciation of his friendship rather than for any legal services
performed.
The Commissioner
argued that the nexus test was satisfied because the gift was a ‘consequence’,
however indirect, of services rendered. This formulation of the nexus test was
rejected by Windeyer J.
His Honour held
that;
‘an unsolicited gift does not become part of the income of the recipient
merely because generosity was inspired by goodwill and the goodwill can be
traced to gratitude engendered by some service rendered.’
It was held that
the receipt was a mere gift. Factors supporting such a characterisation
included the size of the gift, the unusual circumstances in which the gift was
made, the fact that the taxpayer had been fully remunerated for services
rendered, the fact that gifts had been made to other persons at the same time,
and the fact that it was unexpected and unsolicited.
Payment after
employment relationship ended. Section 19(1) and 19(6)(c) ITA.
There have been
a number of cases where the gratuitous payment has been made after the
employment relationship has ended. If the receipt is characterised as
additional remuneration for past services rendered, then it is ordinary
income. This is the case even if there
was no obligation to make the additional payment.
In Hayes v FC
of T (1956) 96 CLR 47, the taxpayer had been employed by Richardson as his
financial adviser. Subsequently, the business was incorporated and the taxpayer
was employed by the company. The taxpayer was also issued with shares in the
company. On incorporation, Richardson relinquished management of the
company. However, the company did not
trade successfully and Richardson agreed to take active control of the company
on the condition that all issued shares in the company were transferred to
him. The taxpayer reluctantly
transferred his shares, feeling under a moral obligation to do so. Under Richardson’s control the company traded
successfully and was eventually floated.
As a gesture of goodwill, Richardson made several large gifts of shares
in the public company, including 12,000 shares to the taxpayer. It was held that the taxpayer had been fully
remunerated for the work done while in Richardson’s direct employ and while
employed by the companies controlled by him.
In fact, the only services” to which the gift could be related was the
giving of what may be called clubhouse advice”, i.e. advice given in the course
of casual conversation, but this was not an income producing activity of the
taxpayer. The receipt of the shares was
characterized as a mere gift.
A similar
conclusion was reached in the case of Moore v Griffiths [1972] 3 All ER 399. In this case, the taxpayer had been a member
of the successful England World Cup soccer squad of 1966. A payment of £1,000 was made by the English Football
Association to each player in the squad.
The payment was made after the players’ service agreements with the
Association were terminated.
It was held that
the payment was a mere gift, being in the nature of a personal tribute as
applause for the victory and as a mark of the Association’s esteem rather than
as a reward for services rendered. Also
important was the fact that it was a one-off payment which was not provided for
in the player’s services agreements and was unexpected.
Periodic
payments
In the above
case, the gratuitous payment was a one-off event. Where there have been
periodic payments, the analysis is more complex, involving a consideration of
other aspects of the notion of ordinary
income. In FC of T v Dixon, (1952) 86
CLR 540, the taxpayer’s employer had sent a circular to staff during World
War II advising that it would endeavour to pay to staff who enlisted amounts to
“make up the difference between their present rate of wages and the amounts
they will receive from the naval or military authorities”. The employer was under no legal obligation to
make the offer or the payments.
The taxpayer
subsequently enlisted and received a series of such payments from his former
employer. The payments were held by
three judges (Dixon CJ, Williams and Fullagar JJ) to be ordinary income,
although their reasons differed. Two
judges (McTiernan and Webb JJ) dissented on this point.
All judges
agreed that the payments were not additional remuneration for past services
rendered to the donor. Dixon CJ and
Williams J regarded the payments as an “incident” of the taxpayer’s military
service in the sense that he was able to enlist with the expectation that he
would not suffer a decrease in pay.
Their Honours also relied on the fact that the payments were periodical
and were relied upon by the taxpayer to support his family. Fullagar J did not
consider that the payments satisfied the nexus test in relation to the
taxpayer’s military service. Nevertheless, he held that the payments took the
character of that which they replaced, namely salary; and wages, and therefore
were ordinary income.
Gratuitous payments
made by a third party to the services relationship. Section 19(1)
An amount may be
characterized as a product of employment or services rendered even though it is
paid by a third party. This will be the
case where the amount is a “clear recognized incident” of the recipient’s
employment: The classic example of this
is a tip paid (theoretically, at least) in appreciation of the quality of the
services rendered: Calvert v
Wainwright (1947) 27 TC 475, Penn
v Spiers & Ponx Ltd [1908]1,K.B 766, Great Western Railway Co v Helps[1918]
AC141. Another example is a “best
and fairest” award won by a professional athlete: Kelly v FC of T 85 ATC 4283.
In Moorhouse v
Doland (1955) 36 T.C 12, the taxpayer was a professional cricketer entitled
under the terms of his contract of employment to collections from spectators
whenever he performed outstanding cricketing feats (which occurred with a
degree of regularity). The moneys
collected from spectators on these occasions were held to be income from
personal exertion.
On the other hand, in
Seymour v Reed, (1927) 11 T.C 12 the proceeds of a benefit match for a
professional cricketer were characterized as a tribute to the taxpayer’s
personal tributes rather than as a reward for his cricketing services. In this case, the benefit match was a
discretionary, one-off event.
It should be noted
that this case was decided some time ago, and that it is likely that today a
benefit match would be regarded as a normal incident of the employment of a
professional sportsperson.
Ex gratia payment to former employee
In FC of T v
Rowe, (1997) 187 CCR 266 an ex gratia payment was made by the Queensland
Government to a former local government employee. The amount of the payment equalled the legal
fees incurred by the employee in successfully defending himself at a statutory
inquiry. It was held by a majority of
the High Court that the payment was not a reward for any services previously
provided by the taxpayer to the local authority.
They payment was
made in recognition of a wrong done to the taxpayer and with regard to the fact
that the taxpayer was forced to participate in an inquiry undertaken for public
purposes. Consequently, the payment was
not characterized as remuneration but as reparation and as such was not
ordinary income.
Provision of services
or disposal of a capital asset.
An amount will not be
ordinary income where it is characterized as being a gain arising on the
disposal of a capital asset: Trustees of
Earl Haig v IR Commrs, (1939) 22 TC 725.
On the other hand, an
amount will be ordinary income where the disposal of a capital asset is only
ancillary to the provision of services: Hobbs
v Husssey [1942] IKB 491.
Section 19(1)
provides that employment income means any income derived by an employee from
any employment and includes the following amounts, whether of a revenue or
capital nature…. Emphasis mine. This implies that the distinction
between a revenue or capital receipt for the amount listed in section 19(1)(a)
to (h) was quashed and as long as a payment is derived from employment, it is
employment income. The following are the amounts:
(a) any wages, salary, leave pay, payment in lieu
of leave, overtime pay, fees, commission, gratuity, bonus, or the amount of any
travelling, entertainment, utilities, cost of living, housing, medical, or
other allowance;
(b) the value of any benefit granted;
(c) the amount of any discharge or reimbursement
by an employer of expenditure incurred by an employee, other than expenditure
incurred by an employee on behalf of the employer which serves the proper
business purposes of the employer;
(d) any amount
derived as compensation for the termination of any contract of employment,
whether or not provision is made in the contract for the payment of such
compensation, or any amount derived which is in commutation of amounts due
under any contract of employment;
(e) any amount paid by a tax-exempt employer as a
premium for insurance on the life of the employee and which insurance is for
the benefit of the employee or any of his or her dependants;
(f) any amount derived as consideration for the
employee’s agreement to any conditions of employment or to any changes in his
or her conditions of employment;
(g) the amount by which the value of shares issued
to an employee under an employee share acquisition scheme at the date of issue
exceeds the consideration, if any, given by the employee for the shares
including any amount given as consideration for the grant of a right or option
to acquire the shares;
(h)
the amount of any gain derived by an employee
on disposal of a right or option to acquire shares under an employee share acquisition
scheme.
Section 19 identifies two taxable
events. First, it applies where a share
is acquired under an employee share acquisition scheme either directly or as a
result of the exercise of a right acquires the share. Secondly, it applies where a right to acquire
a share under an employee share acquisition scheme is disposed of to a
non-associate.
An
employee who is issued with a share under an employee share acquisition scheme
is required to include in his or her chargeable income the market value of the
share less the sum of any amounts paid for the share. The amounts paid include
any amount given as consideration for the grant of a right or option to acquire
the share. If the employee disposes of a
right or option to acquire a share to a person, then the difference between the
amount received and the amount paid for the option is included in the
employee’s chargeable income.
A share or
right to acquire a share is acquired under an employee share acquisition scheme
if it was acquired “in respect of, or for or in relation directly or indirectly
to, any employment of the taxpayer.
It follows
that if the shares or rights are issued directly to a “relative” (as defined in
sec 2 of the ITA) of the employee, then that person is treated as the taxpayer
for the purposes of 19(6)(b).
There are cases from
the common law jurisdiction which made a distinction between revenue and
capital receipts. The ITA attempted to remove any controversy that may arise in
characterising an amount as income or capital by removing the distinction.
In Brent v FC of
T, (1971) 125 CLR 418, the taxpayer entered into an agreement with a
newspaper under which she, as vendor, “sold” the exclusive rights to the
publication of her life story. It was
argued that the amount received was in return for the sale of copyright in her
story (i.e. the sale of a capital asset). This argument was rejected by Gibbs
J, who characterized the payment as being in return for services rendered,
namely the making of herself available for interview by the newspaper’s
journalists, the communication of her story to the journalists and the signing
of a manuscript prepared by the journalists.
A similar issue arose
in FC of T v McArdle, 89 ATC 4051.
In this case, the taxpayer was granted a number of options under an
employee share acquisition scheme. He
received a payment of $1m in consideration for the surrender of his rights and
options. This payment was characterized
as being received as consideration for the disposal of the options and rights
rather than as a reward for services rendered.
How would the case of
McArdle be reconciled with section 19(1)(h)? Clearly when an employee disposes
of her right or option to acquire shares under an employee share acquisition
scheme, it cannot be said that the employee was receiving a reward for services
rendered. However, it seems that section 19(1) is broad enough to include any
gain in the employment income of the employee.
Payments received as
consideration for giving up valuable rights.
As has been stated
above, to be income from personal exertion an amount must be a “product or
incident” of employment or a reward for services rendered. An amount that is given in return for some
other consideration moving from the employee or provider of services will not
be income from personal exertion, and therefore may not be ordinary
income.
Such payments are
usually made in return for the recipient giving up valuable rights and may be
made either before, during or after the period of service.
Payments made before
entering into the services relationship.
An amount that
is an advance payment for services to be rendered will be ordinary income. Where the receipt is properly characterized
as consideration for giving up valuable rights rather than for the performance of
services, it will not be income from personal exertion.
An example of
this may be an “inducement payment”, i.e. a payment made to “encourage” a
person to enter into a services agreement with the payer.
In Jarrold v
Boustend, (1964) 41 TC 701 the taxpayer was a Rugby Union who
received a “signing-on fee” to play for a Rugby League club. The fee was characterized as being
compensation for the giving up of the taxpayer’s amateur status, and therefore
not as remuneration for services to be rendered. Consequently, it was a capital receipt. Where
the taxpayer is already a professional athlete, a signing-on fee or similar
payment may be characterized as a normal incident of employment as a
professional athlete. Similarly, if such
fees are commonly paid in relation to a particular sport, then it may be argued
that the fee is a normal incident of employment as a professional athlete.
In Pritchard v
Arundale, [1972] Ch. 229 the taxpayer was a senior partner in a firm
of chartered accountants. One of his clients offered him a senior management
position, which he was reluctant to accept because it would mean giving up his
established position in private practice. Eventually the client arranged for
the taxpayer to be issued shares in a related company as an inducement to
accept the offer. The inducement was characterized as compensation for the loss
of status involved in giving up his position in private practice, and therefore
it was not an advance payment for services to be rendered.
However, in Glantre
Engineering Ltd v Goodland (1983) 1 ALL ER 542, where the taxpayer was an
employed accountant rather than a partner, it was harder to argue the taxpayer
was giving up valuable rights.
An inducement payment
that was refundable if the taxpayer did not satisfy a minimum period of service
was characterized as an advance payment for services to be rendered and,
therefore, ordinary income in Riley v Coglan, [1968] 1 ALL ER 314.
These cases have
to be read in light of the requirements of section 19(1)(f). Any amount received
as consideration for the employee’s agreement to any conditions of employment
is employment income. Note that in the cases the employee is giving up some
rights rather than agreeing to conditions of employment and the section may
therefore not be operative.
Payments made during
the period of service
An amount that
is characterized as consideration for the giving up of valuable rights of a
capital nature under a service agreement will not constitute ordinary income.
In Bunnett v FC of
T, (1947) 75 CLR 480 the taxpayer was employed as the managing director of
a radio station under a seven-year services agreement entitling him to a salary
of £1,040 pa plus a percentage of profits.
As part of the
negotiations for the sale of the station, the taxpayer agreed to cancel the
services agreement and enter into a new one. The new agreement reappointed him
as managing director but for a shorter term and with reduced power, although
there was an option to extend the period of service to the date when the original
agreement would have expired. As
consideration for the cancellation, the taxpayer was paid a sum of £12,255 in
three instalments.
This amount was
repayable if the taxpayer exercised the option to extend. The payment was
characterized as being in consideration for the giving up of valuable rights of
a capital nature under the former services agreement and for the entering into
the new agreement with different rights.
In Case Z9, 92 ATC
144 the applicant’s employer unilaterally varied the terms of the applicant’s
employment contract by terminating his right to a rostered day off (“RDO”) each
fortnight and increasing his formal working hours from 35 to 38 per week. The applicant received a lump sum amount
equal to three months’ salary as compensation for the loss of the RDO. The is amount was payable in three
instalments. The compensation received was characterized as consideration for
the surrender of valuable rights of a capital nature, and therefore was not
ordinary income.
However section
19(1)(f) is relevant here. It provides that any amount received as
consideration for the employee’s agreement to any changes in her conditions of
employment is employment income. Surely the amounts in Bunnett’s case
and Case Z9 would be part of any employee’s employment income by virtue
of section 19(1)(f).
Termination payments. Section 19(1)(d)
A receipt which is an
additional payment for past services rendered is ordinary income: Carter
v Wadman (1946) 28 TC 41. However, a
payment which is characterized as damages for wrongful dismissal or as
consideration for the giving up of valuable rights of a capital nature under a
services agreement will not be ordinary income.
Where the
consideration for the surrender of rights takes the form of periodic payments
in substitution of the payments which would have been received under the
services agreement, those payments may be ordinary income under the
compensation principle. For example, in C
of T (Vic) v Phillips, (1936) 55 CLR 144 the taxpayer received payments in
consideration for agreeing to early termination of his services agreement. The
total amount of the payments was an estimate of what the taxpayer would have
earned if the agreement had not been cancelled.
Further, the amounts were paid in monthly instalments over the unexpired
period of the agreement. It was held
that the taxpayer had been fully remunerated for services rendered prior to
rendered. However, the receipts were still held to be ordinary income on the
basis that they took the character of that which they replaced, i.e. salary and
wages.
A lump sum
payment made in return for an employee’s agreement not to compete with the
employer on termination of the employment is generally characterized as capital
in character.
In Beak v
Robson [1943] AC 352, the taxpayer received a lump sum payment of
£14,000 in consideration for agreeing not to be involved for five years after
termination of his employment in any competing business within 50 miles of the
current employer’s premises.
The House of
Lords held that the payment was not a product of the taxpayer’s
employment, because even though the covenant was entered into while Robson was
still serving his current employer, the obligations under Robson’s employment
contract were “entirely separate” from those he undertook under the restrictive
covenant, and the agreement not to compete would only become operative after
Robson had ceased to render services, not during the course of his current
employment. The payment was thus
characterized as not being a reward for services rendered or to be rendered,
but for agreeing to restrict his (capital) right to perform services for others
in the future.
A similar result was
reached in Higgs v Olivier, [1951] Ch. 899 where in an endeavour to
ensure that the profitability of the recently completed film Henry V was
not prejudiced, the film company paid the star of Henry V (Sir Laurence
Olivier) a lump sum of £15,000 in return for his agreement not to act for 18
months in any other film.
The sum was held to
be non-assessable, having been paid to Olivier for giving up the right to earn
income as an actor during the specified period, and not for the performance of
any acting or other services or employment.
The right to earn income was characterized as capital in nature.
There are some
circumstances where a payment for a restrictive covenant may satisfy the nexus
test and be taxed as ordinary income, namely where:
(i). The restriction is to operate during the
currency of the existing employment, or is really only payment in advance for
services to be rendered. See Riley v Coglan [1968] 1 ALL ER 314.
(ii). The covenant is a normal incident of a
particular employment (for example, restrictive covenants entered into by
professional footballers on joining a particular club), or
(ii). In really, there is not significant
restriction on the recipients freedom of activity.
Benefits
We have looked
at the standard broad definition of gross income under Section 17. Section 17 specifically includes in gross
income employment income and business income of people providing independent
personal services. Both of these may be
referred to as ‘’compensation for services’’.
Such compensation may take the form of property as well as cash (S.
19(1)(b) and it can be indirectly as well as directly paid (S. 58). The provision is apparently broad enough to
include in taxable income any economic or financial benefit conferred on the
employee as compensation, whatever form or mode by which it is effected.
Legally then,
the form of payment does not matter.
Payment in shillings, property or right to use property is gross
income. Would this be true for all
benefits? For example, employer has an
electric kettle and employees are allowed to quench their thirst and cool their
hunger by taking a cup of coffee or tea as they want. Technically, each cup consumed is gross
income. In real life, it is impossible
to report or enforce each cup of tea or coffee as gross income. The same is applicable to a copy typist using
a company computer to type a personal letter or type a student’s final
dissertation. These benefits are small
or de minimis and are no big deal anyway.
But what about travel passes to airline stewards or courtesy discounts
to shop attendants?
All the above
items are usually referred to as benefits.
These benefits are an added favour or service given with the job,
besides wages, salary or similar compensation.
Conceptually they are gross income.
But because of administrative handicaps, taxpayers are not usually
obliged to report them.
A ‘’benefit’’ is
any monetary or nonmonetary benefit derived from employment that does not
constitute cash salary or wages. The possible range of benefits is enormous but
they include the provision of a free or subsidised use of a motor vehicle,
domestic and household help, employer-provided housing, meals, refreshment or
entertainment, paying employee’s bills such as telephone, water and electricity
accounts and offering low interest personal and housing loans.
The theoretical
case for full inclusion of benefits in the tax base is noncontroversial. Full taxation is a prerequisite to horizontal
equity between taxpayers who are wholly remunerated in cash and taxpayers
remunerated partly through fringe benefits.
It is also a prerequisite to vertical equity because the incidence of
fringe benefits tends to rise with taxpayers’ economic incomes and employment
status. Full taxation of benefits is
also a precondition to achieving an economically efficient tax system. It ensures that the tax system will be neutral
between those employers able to provide fringe benefits and those not able to
do so and removes the distortion in favour of providing goods and services that
are not taxed. Finally, taxation of
benefits is important to protect the revenue base.
The overwhelming
theoretical case in favour of benefits taxation is countered by a number of
conceptual and political problems. A
fundamental problem is that many taxpayers, and for that matter some tax
administrators do not perceive benefits in kind to be income with the same
economic capacity as cash wages or salaries.
Subsidiary problems arise from the definition of benefits, the
difficulty in allocating general benefits among employees, and the difficulty
in distinguishing genuine benefits from benefits that are consumed in the
course of employment or that are a necessary condition of employment. The conceptual difficulties that arise with
the income taxation of benefits have often resulted in low levels of taxpayer
compliance with, and administrative enforcement of, the tax law applying to
these benefits. This in turn has led to
a ‘’tax culture’’ that regards benefits as tax free remuneration so that
attempts to expressly bring the value of benefits within the tax base are
subject to political resistance.
Benefits are
included in the value of fringe benefits in Uganda in employees’ chargeable
income. In civil code jurisdictions, the
definition for salaries in the labour codes will usually include benefits and
this definition will in principle be applied for income tax purposes. Similarly, benefits will automatically be incorporated into income
from employment in common law jurisdictions where the judicial concept of
‘’income’’ is broad enough to encompass all net gains.
In common law
jurisdictions that rely on UK precedents, the judicial concept of income
excludes benefits in kind that connot be converted to cash.
In these
jurisdictions, specific statutory inclusion provisions and valuation rules are
needed to include the full market value into the gross income of the employees.
These may be
defined as rewards for service, in a form other than contemporaneous payments
in cash. In other words, they are benefits provided to employees which form an
integral part of the employee’s total package.
Benefits in kind
(which may or may not be convertible into money) are non-monetary receipts that
increase the employee’s purchasing power or relieve him or her of an
obligation.
It is necessary
to tax benefits in order to preserve the underlying idea that any gain should
be treated as income and also to maintain the ideas of horizontal equity
(preventing taxpayers receiving income in one form from being treated more
favourably than taxpayers receiving the same in another).
Benefits are
more common for high income earners thus creating implicit vertical inequity if
benefits are untaxed.
Section 19(1)(b)
was introduced into the legislation primarily to bring to tax benefits which
might otherwise escape taxation by reason of the decision in Tennant v. Smith. The section is not,
however, confined to such benefits.
Section 19(1)(b) and 19(3) overcame the decision in Tennant v. Smith by requiring benefits to be valued by reference to
the criteria in the Fifth Schedule.
Section 19(1)(b)
includes in the chargeable income of a taxpayer an amount that satisfies the
following:
(1) there must be a benefit;
(2) the benefit must be granted to the taxpayer;
and
(3) the benefit
must be in respect of, or for or in relation directly of indirectly to, any
employment rendered by the taxpayer.
Where an amount
satisfies these conditions, it is included in the taxpayer’s chargeable income
for the year of income in which it is granted to the taxpayer provided it is
within Uganda
’s jurisdiction and is not
exempt income. The amount included in
chargeable income is the value of the benefit to the taxpayer.
There are two
important differences between sec 19 and the income from personal exertion
principle as part of the notion of ordinary income. First, the nexus test under sec 19 is
potentially broader than under general principles. Secondly, sec 19 provides for an objective
valuation rule. Non-cash benefits are
brought into account at their market value
There must be
a benefit
The first
requirement in sec 19(b) is that there must be a benefit. These words must be construed in their
context, but are clearly intended to cover a broad area.
Benefit
It was held in Case L54 that “benefit” refers to “an
advantage, profit, good” in the ordinary sense of that word, and connotes “to
do good to, be of advantage or profit to; to improve, help forward …” In this case, the payment of school fees by
the taxpayer’s employer was held to be a benefit as it relieved the taxpayer of
the obligation which he would otherwise have incurred.
In Constable v
FC of T (1952) 86 CLR 402, the taxpayer was a member of an employee-sponsored
superannuation fund. He contributed 10% of his salary to the fund, and this
contribution was matched by his employer. The taxpayer only became entitled to
his employer’s contributions after a minimum period of service and only then on
the happening of certain events. One of
those events occurred and the taxpayer received a payment out of the fund while
still in the same employ
The majority of
the High Court held obiter that the employer contributions were not ‘allowed,
given or granted’ to the taxpayer at the time of payment into the fund. The
contributions were not credited to the accounts of particular employees until
some time after payment into the fund and even then the employee was not
present entitled to the amount so credited.
Present entitlement only arose on the occurrence of particular
events. Consequently, there was no derivation
for the purposes of sec 26(e) at the time of contribution.
Further, the
payment out of the fund occurred as a result of a contingent right of the
taxpayer becoming absolute. It was held
that the happening of the event which made the right absolute did not amount to
an allowing, giving or granting to the taxpayer of any allowance, gratuity,
compensation, benefit, bonus or premium.
It may be that the payment out of the fund was a derivation of ordinary
income, but at that time there was not a sufficient nexus to employment.
In Payne v FC
of T (1996) 66 FCR 299 the taxpayer was an employee of a firm of chartered
accountants. The taxpayer was required
to undertake considerable travel as part of her employment. During a business trip, the airline gave the
taxpayer part of her membership forms for its frequent flyer program. Under that program, a member accrues points
based on, inter alia, travel with the airline.
The points can be used by the member to claim free flights with the
airline. The taxpayer used her points to obtain airline tickets for her
parents. The Commissioner assessed the value of the tickets to the taxpayer
under sec 26(e) or sec 25(1) ITAA36 (see, sec 19(1)(b) ITA Uganda).
The taxpayer
argued, on the basis of Constable’s case, that the provision of the free
tickets occurred as a result of the crystallizing of a contractual entitlement
of the taxpayer, and therefore was not a benefit allowed, given or granted to
the taxpayer. The Federal Court agreed
with the taxpayer’s argument.
Granted ‘to
the taxpayer’
The requirement
that the benefit be granted to the taxpayer could raise problems with the
application of sec 19 ((b) to benefits provided to an associate of the employee
or of the person rendering the services.
Under general principles, this problem was resolved through the
application of the doctrine of constructive receipt (as encapsulated in
paragraph (2) of the Fifth Schedule)
One approach to
this problem is to say that the benefit was not so much the benefit provided to
the third party, but rather the resulting saving in expenditure to the
taxpayer. For example, in Case 79 ATC
399 the employer had established an educational scholarship scheme (the
taxpayer being at that time managing director of the company and chairman of
the meeting of directors which instituted the scheme). The scheme had been instituted primarily in
order to retain key employees, and a scholarship could only be won by a child
of an employee. The Board held that the
scholarship was a benefit granted to the taxpayer, as he was thereby ‘relieved
of his previous burden, and of his obligation which he had undertaken to pay
the college fees, and thus in essence received a financial benefit’.
ITA confronts
the issue more directly, making it clear in sec 58 & 19(6)(b) and paragraph
(2) of the Fifth Schedule that the doctrine of constructive receipt is to apply
to employment income.
It is provided
that, if an amount would be a benefit and therefore employment income apart
from the fact that the person has not received it, then it becomes employment
income of the person at the time it is applied or dealt with on the person’s
behalf, or as the person directs.
Nexus test. As
with ordinary income, it is necessary for the purposes of sec 19(1)(e) to find
a sufficient nexus between the provision of the services and the receipt of the
benefit. The nexus test defined by sec
19(6)(c) is that the benefit must be granted to the taxpayer ‘in respect of
past, present or prospective employment.
The first point
is that there must be an employment relationship. In FC of T v Cooke & Sherden 80 ATC
4140, the taxpayers sold soft drinks obtained from a
manufacturer. In 1970, the manufacturer
introduced an ‘Island Holiday Scheme’, designed to encourage retailers to
increase sales. The scheme was a purely
gratuitous one, and no legal rights were conferred upon any retailer. Under the terms of the scheme, no cash
payments in lieu of the holiday trip could be obtained, and a retailer to whom
a trip was awarded (on achieving a certain sales quota) could not transfer the
tickets or the benefit of the award to anyone else.
In the relevant
year, the taxpayers achieved the required sales quota and were granted an
island holiday. The full Federal Court
held that the value of the trip was not subject to tax. The relationship between the taxpayers and
the manufacturer was one of vendor and purchaser and not that of employer and
employee, so that there was no relevant ‘employment’ for the purposes of the
law.
Moreover, there
had been no ‘rendering of services’ by the retailers to the manufacturer.
‘’the rendering of services’ should consist of the
doing of an act for the benefit of another, which is more than the mere making
of a contract and which goes beyond the performance of an obligation undertaken in the course of an
ordinary commercial contract.’
Thus, although
the successful conduct of the retailers’ businesses increased the
manufacturer’s sales and the public awareness of the manufacturer’s products,
the conduct of the retailers’ businesses was not a service rendered to the
manufacturer:
‘Advantages accrued to the manufacturer because the
retailers, independently of any obligation owed to the manufacturers, conducted
their businesses in a way which yielded advantages to both…The relationship was
essentially one of seller and buyer… The provision of holidays was not part of
any contractual relationship and …the provision of holidays could not be said
to have been directly or indirectly for services rendered by the taxpayers.’
Section 19(6) of the Act provides
constructive payment and receipt rules. These rules avoid any argument that a
benefit is not related to an employee’s employment where it is provided by
someone other than the employee’s employer or where it is provided to someone
other than the employee.
Under section 19(6), a benefit is
granted to an employee from employment if it is -
(a) provided by an employer or a third
party(including an associate of the employer) under an arrangement with the
employer or an associate of the employer; and
(b) provided to an employee or an associate
of an employee.
Section 19(6) of the Act also ensures that
a benefit is treated as from an employment notwithstanding that the employment
may not have commenced or may have ceased at the time the benefit was granted.
Where a benefit is granted to an employee
from any employment, the amount included in employment income is determined in
accordance with the valuation rules in the Fifth Schedule to the Act. The Fifth
Schedule provides valuation rules for the following specific benefits: private use
of motor vehicles; domestic assistants; meals, refreshment, or entertainment;
utilities; low- or zero-interest loans; debt waivers; supply of goods or
services; and housing. A market value rule applies to any other type of benefit
in kind provided to an employee.
Section 56(2) of the Act provides that the
market value of a benefit in kind is determined without regard to any
restriction on transfer or to the fact that the benefit is not otherwise
convertible to cash.
C. TREATMENT
OF PARTICULAR BENEFITS IN KIND
1. PRIVATE USE OF MOTOR VEHICLES
Where an employee is provided with the use of a motor
vehicle for private purposes or a motor vehicle is available to the employee
for use for private purposes, the employee derives a taxable benefit.
The value of the benefit is determined in
accordance with the formula in paragraph 3 of the Fifth Schedule.
Where an employee is provided with a motor
vehicle, the vehicle will not be considered to be used or available for use for
private purposes, if:
(i) the vehicle is available to, and is in fact
used by, employees of the employer in general for duty purposes;
(ii) the vehicle is not normally kept at the
residence of the employee concerned outside of business hours; or
(iii) the nature of the employee’s duties are such
that he/she is regularly required to use the vehicle for duty outside his/her
normal working hours but otherwise is not allowed to use it for private
purposes.
For example, Lucky is employed by CELTEL Uganda and is availed a company vehicle which is at her disposal 24 hours a day. Her normal working day is from 8.00 a.m. to 5.30 p.m. The vehicle was purchased from Motor Care (U) Ltd on July 0, 2000 at a cost of Shs.30,000,000/=. Lucky used it for 320 days (excluding 45 days of annual leave) during the year of income ending June 30, 2001. She was charged a monthly figure of Shs.20,000/= per month for the benefit. We will assume that she did not pay the monthly figure of Shs.20,000/= for the 45 days when she was on leave.
The value of the
benefit is (20% x 30,000,000 x 320/365) – (20,000 x 10.5)
5,260,274 – 210,000 =
Shs.5,050,274/=.
2. LOW INTEREST LOANS
Where an employee is provided with an
interest-free loan or a loan at an interest rate below the statutory rate, the
employee derives a taxable benefit. Such a loan is referred to as a “loan
benefit in kind” in the discussion below. The statutory rate for a year of
income is the Bank of Uganda discount rate on the 1st July in that year of
income.
The value of a loan benefit in kind is the
difference between the interest that would have been paid on the loan if the
interest rate was the statutory rate and the interest actually paid on the loan
(if any). This is specified in paragraph 7 of the Fifth Schedule.
Paragraph 7 only provides a taxable value
for a loan benefit in kind where the amount of the loan, or the total amount of
all loans if more than one loan is provided by an employer, exceeds one million
shillings.
According to the URA Practice short-term financial accommodation provided
by an
employer to an employee is not regarded as a benefit for the purposes of
section 19, provided the accommodation is fully repaid within three months of
being provided, and the accommodation is not rolled-over or replaced by another
advance.
While a low- or zero-interest loan was a
taxable benefit under the 1974 Decree, the practice under the 1974 Decree was
not to include the value of the benefit in employment income. As a transitional
measure, that practice continued to apply to a loan benefit provided before 1st
July 1997 until the earlier of -
(a) the expiration of the loan term (not counting
any period of extension of the loan or of a roll-over of the loan); or
(b) 31st
December 1999.
However, the amount any short-term financial accommodation covered by
paragraph
2.4 and the amount of any loan covered by the transitional measure in paragraph
2.5 will be taken into account in determining whether the threshold in
paragraph 7 of the Fifth Schedule is satisfied in relation to any other loans
provided to an employee.
3. PROVISION OF MEALS, REFRESHMENTS, ETC.
Where an employee is provided with a meal,
refreshment, or entertainment, the employee derives a taxable benefit.
The taxable value of the benefit is the
cost of providing the meal, refreshment, or entertainment less any contribution
made by the employee. This is specified in paragraph 5 of the Fifth Schedule.
However, the employment income of an employee does not include the value
of any
meal or refreshment provided by the employer to the employee in premises
operated by, or on behalf of the employer solely for the benefit of employees
and which is available to all full-time employees on equal terms (section
19(2)(e)).
Exclusions
from Employment Income
Under the
ITA, employment income is subject to some specific exclusions. These are -
(1)
the cost of passages to or from Uganda in
respect of the appointment or termination of employment of certain employees
recruited from outside Uganda (section 19(2)(a));
The
expression “employee’s medical expenses” is interpreted to include the medical
expenses of a dependent of an employee where the employee has the financial
responsibility of meeting those expenses. For this purpose, a dependent of an
employee means the spouse of the employee, or a child (including an adopted
child) of the employee under 18 years of age, subject a maximum of four
children, who the Commissioner is satisfied relies on the employee
for financial support.
(3)
an allowance for, or reimbursement or
discharge of, expenditure incurred by an employee on accommodation and travel
expenses, and on meals and refreshment while travelling in the course of
performing duties of employment (section 19(2)(d));
The
rationale for not including these expenses in the employment income of an
employee is that, technically, they confer no private benefit to the employee.
They are incurred in the course of employment to serve the proper business
purpose of the employer. However, they may sometimes confer a private benefit.
Consider, for example the case of an employee who is given US$1000 as
accommodation and refreshments’ expenses for five days to go to Nairobi, Kenya
to attend to her employer’s business. She instead stays with a friend for the
entire duration of her stay in Nairobi thus saving the entire amount! The law
would still not make this part of her employment income.
(4)
the value of any meal or refreshment provided
by an employer to an employee in premises operated by, or on behalf of the
employer solely for the benefit of employees and which is available to all
full-time employees on equal terms (section 19(2)(e));
Employee
eating facilities are excluded from employment income only if they are provided
to all employees on a non-discriminatory basis and on premises operated by or
on behalf of the employer. This must be solely for the benefit of the
employees. The non-discrimination requirement allows employees no exclusion
unless the benefits are provided on substantially the same terms to a broad
group of employees.
A critical
condition of the exemption is the availability
of the premises to all full-time employees on equal terms. An employer may
operate both an executive dining room and a staff canteen. Ordinarily, the
staff canteen would satisfy the requirements for exemption, notwithstanding
that some employees may choose to eat at the other employer-provided facility.
This is because employees who are entitled to eat at the executive dining room
are not usually expressly excluded from eating in the staff canteen. On the
other hand, the exemption would not apply to the executive dining room as that
facility would not be available to all full-time employees on equal terms.
(5)
any benefit granted by an employer to an
employee during a month where the total value of the benefits granted by the
employer to the employee for the month is less than ten thousand shillings
(section 19(2)(f));
This
includes any property or service is so small as to make accounting for it
unreasonable or administratively impracticable. Examples that can be included
in this exception are: typing of personal letters by a company secretary;
occasional personal use of a photocopier; occasional supper provided because of
overtime work; coffee and snacks offered to employees and low value holiday
gifts.
(6)
a low- or zero-interest loan that is less
than one million shillings (Fifth Schedule, paragraph 7).
The
employment income of an employee also excludes the amount of certain life
insurance premiums and retirement fund contributions made by an employer for
the benefit of the employee (section 19(2)(c) and (g).
APPENDIX ‘B’
BENEFIT OF HOUSING ACCOMMODATION
An employee earned the following income for the year
1998.
Salary 6.000.000
Travelling allowance 792.000
Car benefit 1.456.000
Medical Expenses (met by employer) 255.000
He was also given residential accommodation by his
employer. The house has an annual market rental value of Shs. 1.800.000 but he
was paying a monthly nominal rental of Shs. 30.000 during the period of
occupancy.
(a). Solution
Market
Rate 1.800.000
Less:
Rental Paid 360.000
1.440.000
(b). Employment
Income
Salary 6.000.000
Travelling
Allowance 792.000
Car
Benefit 1.456.000
Market
rate of housing etc 1.440.000
9.688.000
Percentage
Value 9.688.000 x 15% = 1.453.200
The taxable benefit in respect to housing or
accommodation will be shs. 1.440.000 which is the lesser of the two
figures.
1. Where
our employee is continuing in service of the employer and he/she receive a lump
sum payment e.g. of gratuity or bonus, that payment is taxed in the month of
receipt using monthly rates.
Monthly
pay is 1.000.000
He/she
receiving a gratuity/bonus of 3.000.000
4.000.000
Apply
normal monthly rates
Tax
thereon will be (45.500 + 30% of 3.590.000) 1.122.500
2. Where
an employee is leaving the service of an employer, and he or she is paid a lump
sum payment e.g. terminal benefits, retirement benefits, death benefits;
Then
such lump sum payment would be taxed in the year of receipt.
e.g. X
received terminal benefits of 5.000.000 on 31/5/2000. His monthly payment for the year 1999/2000
was 500.000/
Therefore
Tax on the lump sum should be calculated as follows:
Total
pay 500.000 x 11 months =
5.500.000
To
31/5/2000
Add
Lump sum payment =
5.000.000
Total = 10.500.000
Tax
on total income using annual rates:
2.220.000
Tax
that already been paid was 72.500 x 11 =
797.500
Tax
payable on lump sum = 2.220.000
– 797.500 = 1.422.500
3. Where
an employee is being compensated for loss of office, for example when a
government parastatal is privatised and employees are retrenched.
The
lump sum received would be taxed as follows:
(i). If such and employee has served the employer 10 or more
years, the amount of lump sum taxable would be 75%.
i.e. assume facts remain as in example 2, then tax on
lump sum would be:
Total pay for 11
months 5.500.000
75% of lump sum
(75% x 5.000.000) 3.750.000
Total 9.250.000
Tax on total income using annual rates 1.845.000
Less Tax already paid 797.500
1.047.500
(ii). If the employee has served less than (10) ten years, then
the calculation is as in example two above.
In Simpson v. Tate [1925] 2 K.B. 214 a medical
officer of health joined certain medical and scientific societies in order that
by means of their meetings and published transaction he might be aware of all
recent advances in sanitary science and keep himself up to date on all medical
questions affecting public health.
Rowlatt J. said, at p. 219:
"The respondent qualified himself for his
office before he was appointed to it, and he has very properly endeavoured to
continue qualifying by joining certain professional and scientific societies,
so that by attending their meetings and procuring their publications he may
keep abreast of the highest developments and knowledge of the day. He seeks
to deduct from his assessable income the subscriptions paid by him to these
bodies as money expended necessarily in the performance of the duties of the
office. When one looks into the matter closely, however, one sees
that these are not moneys expended in the performance of his official
duties. He does not incur these expenses in conducting
professional inquiries or get the journals in order to read them to the
patients. If he did, the case would be altogether different. He
incurs these expenses in qualifying himself for continuing to hold his
office, just as before being appointed to the office he qualified himself for
obtaining it ... In my view the principle is that the holder of a
public office is not entitled ... to deduct any expenses which he incurs for
the purpose of keeping himself fit for performing the duties of the office,
such as subscriptions to professional societies, the cost of professional
literature and other outgoings of that sort. If deductions of that kind were
allowed in one case every professional office holder would claim to be
entitled to deduct the payments made by him to every scientific society to
which he happened to belong and the price which he paid for every
professional publication, and there would be no end to it."
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In Ricketts v. Colquhoun [1926] A.C. 1 the
Recorder of Portsmouth was not allowed the expense of traveling from his home
in London to his court in Portsmouth. Traveling expenses fall into a separate
category because each employee chooses where he will live and cannot establish
that every employee must incur the same expenses.
In Nolder v. Walter (1930) 15 T.C. 380 an
airline pilot was not allowed to deduct the cost of transport between his home
and the aerodrome or the cost of the telephone at his home. Rowlatt J. said, at
p. 387:
"'In the performance of the duties'
means in doing the work of the office, in doing the things which it is his
duty to do while doing the work of the office. A man who holds an office or
employment has, equally necessarily, to do other things incidentally, and
spend money incidentally, because he has the office. He has to get to the
place of employment, for one thing ... Incidentally, he is obliged
to do that, but it is not in doing the work of the office, which begins when
he arrives, and sets to work to perform his duties."
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In Blackwell v. Mills (1945) 26 T.C. 468 a student
assistant in the research laboratory of a company was required, as a condition
of his employment, to attend classes in preparation for the final examination
for the degree of Bachelor of Science. He was allowed time off to attend
classes for that purpose and claimed to deduct for income tax purposes the
expenses he incurred in travelling to and from the classes and in the purchase
of text books. Macnaghten J. said, at p. 470:
"It was a condition of Mr. Mills's employment
that he should attend the evening classes. Mr. Honeyman contended that, since
the subject matter of the evening classes was not unconnected with the duties
that Mr. Mills had to perform, he should be regarded as performing the duties
of his office when he was attending the Chelsea Polytechnic. In my opinion
any such view is inadmissible. The duties of his employment were
as a student assistant in the research laboratories of the General Electric
Company. It seems to me impossible to say that, when he was listening to the
lecturer at the Chelsea Polytechnic, he was performing the duties of a
student assistant at the laboratories of the company."
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In Lomax v. Newton [1953] 1 W.L.R.
1123 Vaisey J. said, at p. 1125:
"The provisions of rule 9 of Schedule E [now
section 189(1) of the Act of 1970] are notoriously rigid, narrow and
restricted in their operation. In order to satisfy the terms of the rule it
must be shown that the expenditure incurred was not only necessarily, but
wholly and exclusively incurred in the performance of the relevant official
duties. ... An expenditure may be 'necessary' for the holder of an office
without being necessary to him in the performance of the duties of that
office; it may be necessary in the performance of those duties without being
exclusively referable to those duties; it may perhaps be both necessarily and
exclusively, but still not wholly so referable. The words are
indeed stringent and exacting; compliance with each and every one of them is
obligatory if the benefit of the rule is to be claimed successfully."
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In that case a regimental officer was not allowed to
deduct his annual mess subscription although he was obliged to be a member of
the mess and would no doubt have been transferred or even cashiered if he
failed to pay. An officer in the Territorial Army was not allowed his mess
subscriptions or his share of mess expenditure on guests. The officer was also
not allowed the cost of attending social functions given by warrant officers
and other ranks. Vaisey J. said, at p. 1127:
"I agree that participation in the
social life of the battalion was part of the social duties of the respondent,
but was it any part of his official duties? Was the respondent at the
sergeants' dance in the proper sense of the expression 'on duty'? I think
not. I am quite unable to see how this item can be brought within the
rule. I apply to it descriptions from the contentions of the Crown
as set out in the case, and say that they are expenses incurred from
tradition and custom, accepted voluntarily by the officers of the unit and
containing elements of personal choice and benefit, and therefore not within
the rule."
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¶ 29 Similarly in
the present case the journalist is not on duty when he is reading at home and
his expenditure on newspapers contains elements of personal choice and benefit.
Indeed one of the journalists gave evidence that he was a
"compulsive" buyer of newspapers.
In Humbles v. Brooks (1962) 40 T.C. 500 the
headmaster required to teach history was not allowed the expense of attending a
series of weekend lectures on history. Ungoed-Thomas J. citing the authorities
said, at p. 502:
"'In the performance of the said duties' means
in the course of their performance ... It means in doing the work of the
office, in doing the things which it is his duty to do while doing the work
of the office' ... it does not include qualifying initially to perform the
duties of the office, or even keeping qualified to perform them ... it does
not mean adding to the taxpayer's usefulness in performing his duties. The
requirement of the employer that the expenditure shall be incurred does not,
of itself, bring the expense within the rule, nor does the absence of such a
requirement excluded it the application of the rule ..." and the judge
accepted (p. 503) that the headmaster:
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"attended the course to improve his background
knowledge of the subject ... he gleaned useful information from the lectures
... he felt the course was essential to keep himself up to date ... to
provide him with material which he reproduced in the history lessons."
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In Brown v.
Bullock [1961] 1 W.L.R. 1095 a bank manager who was instructed by his
employers to foster local contacts and for that purpose to join a club was not
allowed as an expense in the performance of his duties as a bank manager the
entrance fee and annual subscriptions to the club which were paid by his
employers. In approving the decision of Vaisey J. in Lomax v. Newton [1953]
1 W.L.R. 1123 Lord Evershed M.R. said that the language of the statute is
of a somewhat rigid character the adverb "necessarily" added to the
phrase "in the performance" of his duties clearly narrows very much
the scope of any expenditure which can fairly be deductible. Donovan L.J. said,
at p. 1102:
"The test is not simply whether the employer
imposes the expense, but primarily whether the duties do, in the sense that
irrespective of what the employer may prescribe, the duties themselves
involve the particular outlay."
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Elwood v. Utitz (1965) 42 T.C. 482 was a case in which travelling
expenses from one place of work to another were held to be deductible in
contrast to travel expenses from home to a single place of work. Pook
v. Owen [1970] A.C. 244 is a similar case. Taylor v. Provan [1975]
A.C. 194 was another case concerned with travelling
expenses. Lord Salmon, at p. 226, distinguished between expenses
which were deductible because they were incurred "in the performance of
the duties" and expenses which were not deductible because they were
incurred "in order to enable the duties to be performed".
The act giving rise to the expenditure must be done in
the actual performance of such duties: an act which is done merely to acquire
the necessary qualifications or the background knowledge necessary to do the
job or to do it better is not sufficient. This requirement is illustrated by Humbles
v. Brooks (1962) 40 T. C. 500 where a teacher was held not entitled to
deduct the cost of attending a course for the purpose of improving his
background knowledge of the subject he was required to teach. Ungoed Thomas J.
said, at pp. 503-504:
"[It was] contended that he was not employed to
prepare lectures but to deliver them. This, to my mind, is an unreal
distinction for present purposes. I cannot recognise that a person who is
employed to deliver lectures or to teach is not, when preparing the lectures
or the talks which he gives, doing what he is employed to do - that he is not
acting in the course of the performance of his duties. Preparing lectures is,
to my mind, a necessary part of his duties. That leaves the question, was the
respondent in this case, when listening to the lecture at the adult college,
preparing his own lecture ... First, he attended a course to
improve his background knowledge of the subject which he had studied to
G.C.E. "O" level only; second, he gleaned useful information from
the lectures at the college; third, he felt the course was essential to keep
himself up to date; and, fourth, to provide him with material which he
reproduced in the history lessons. There is, in my view, a distinction
between qualifying to teach and getting background material - and even
getting information and material which he reproduced in his own lecture - on
the one hand and preparing his own lecture for delivery on the other
hand. The statement, in the passages in the case stated, that the
lectures at the college provided the respondent with material which he
reproduced gets nearest to the performance of his duties within the section,
but even if this element could be treated in isolation, it goes no further
than providing material - just as any background information would provide
material - and is not, of itself, part of the preparation of his own lecture.
It is, to my mind, qualifying for lecturing, or putting himself in a position
to prepare a lecture. It is not the preparation of a lecture. In this sense,
the distinction is between preparation for lecturing on the one hand and the
preparation of a lecture on the other hand. In my judgment, the respondent,
when he was attending a course and listening to a lecture, was not preparing
his own lecture, and he was therefore not acting in the performance of his
duties ..."
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(KEITH BUSINGYE LAW GUIDE)
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