The decision of the Upper Tier (“UT”) in the case of HMRC v Smith & Williamson Corporate Services Limited  UKUTT (666) was released on 11 December 2015. The UT reversed the decision of the First-tier Tribunal and ruled that a payment made to a group of employees in respect of their “goodwill” constituted a payment of taxable employment income and not a capital payment.
The lengthy decision of the UT provides a very good overall survey of the law as it affects payments to employees and on the nature of goodwill.
The facts of the case were that a group of fund managers had formed around a senior fund manager named Patrick Smiley. This group of employees (“the Team”) had worked with Mr Smiley over a period of years and had moved with him between employers until, in 2005, they worked together for Butterfield Private Bank. Over a period of years the team had built up a number of relationships with clients and potential clients and had significant funds under management.
The Smith & Williamson group, a competitor of Butterfield, was looking to increase the value of the funds that they had under management (which is a key valuation metric in that industry) and approached Mr Smiley with a view to arranging for him and the Team to take up employment with them, on the basis that they would be able to use their relationships to bring business to Smith & Williamson.
Smith & Williamson had no need to increase headcount in its fund management department, but clients tend to move with fund managers and it was hoped that by bringing the Team into the business they would attract new clients and build up their portfolio; in essence, Smith & Williamson weren’t after the Team themselves, they were after the business that the Team would bring with them.
The Team signed two contracts with two separate Smith & Williamson group entities: one, an employment contract, with Smith & Williamson Corporate Services Limited (“SWCS”); and a second contract with Smith & Williamson Investment Management Limited (“SWIM”), the fund management arm of the group, which promised the Team, as a whole, a payment based on the value of assets under management derived from the clients that they had brought with them from Butterfield.
The employment contracts with SWCS were standard employment contracts offering members of the Team pay, bonuses and other remuneration at the going market rates for fund managers of their experience and seniority. The Team members would be employees of SWCS, which would then recharge other members of the Smith & Williamson group for work that they undertook.
SWIM accounted for its obligations under the second contract as if they were a payment for an intangible asset, which it then amortised. As far as both the Team and SWIM were concerned, the payments under the second contract were payments in consideration of the transfer of an asset, namely Team’s connections with their clients at Butterfield.
The First-tier Tribunal
The First-tier Tribunal accepted the arguments put on behalf of Smith & Williamson and the Team and held that the payments made by SWIM were consideration for the personal goodwill brought to SWIM by the Team members, which should be taxed as a capital disposal and not as income.
In coming to his conclusion, the judge in the First-tier Tribunal leant heavily on the case of Hose v Warwick 27 TC 459, which concerned an insurance broker who joined a firm in 1919. Mr Hose was paid a salary plus a commission for work that he introduced to his employer from his personal connections. The connections were personal to Mr Hose and generated large amounts of commission.
Mr Hose was finally appointed as sole MD of his employer company and, in exchange for endeavouring to get all of the connections to become the property of the company and for giving up all salary and commissions connected with his previous role in the business, he received a lump sum payment of £30k. It was held that he was manifestly giving up something and was “selling” his business to his employer and therefore the payment constituted a capital sum and not an emolument from his employment.
The UT decision
Before the UT, the judge held that the appeal turned on a single point, s9 ITEPA 2003: did the payment constitute “earnings from an employment”? If it did, then the payment would constitute taxable employment income.
Following Shilton v Wilmshurst [1991 STC 88 it was held that it made no difference that the payment was made by SWIM and not by the employer, SWCS – if the payment had been made to secure the services of the Team it would constitute “earnings from an employment” even if the payment was made by someone other than the employer.
On the nature of the client relationships and the transaction between the Team and SWIM the UT found that:
- the Team did not own nor have any legal interest in the business carried on by their previous employer, Butterfield;
- they did not own or have any legal interest in Butterfield’s goodwill;
- they had no right to take and did not take any of Butterfield’s confidential information with them;
- The contract of employment with SWCS and the contract with SWIM had a single objective: the employment of the team to facilitate the introduction of clients to SWIM.
All that the Team had were the personal relationships that they had built up over the years and which they could leverage to introduce clients to SWIM in the hope that they would then enter into business contracts with SWIM. The Team was providing a service to SWIM, introducing their contacts to SWIM; SWIM was not taking over the personal relationships that the Team had with their customers, it was just forming a new relationship.
Following Manduca v HMRC  UKUT 0262 (UTTC) the UT concluded that Hose v Warwick could and should be distinguished:
- both cases involved development of client relationships which were claimed to constitute intangible assets owned by the employees and sold to their employers;
- however, Mr Hose was receiving payments for something “wiped out” and “abandoned” by Mr Hose, while Mr Manduca, like the Team, was being paid for something that he brought to his employer;
- there is a timing issue too – Mr Hose brought his connections to his employer but gave them up at a much later date, while Mr Manduca, like the Team, was effectively receiving a “signing on fee”.
For these reasons, the UT held that the client relationships were not an asset that could be transferred to SWIM, the payments that the Team received from SWIM were intended to secure that they introduced their personal contacts to SWIM and by doing so the Team were providing a service to an associate of their employer. For this reason, the payments constituted employment income, which was taxable under the rules on PAYE, and NIC was also in point.
The decision illustrates the legislative and case-law hurdles that employees face to demonstrate that payments received in connection with their employment are not taxable employment income.
The case also serves to underline the nature of goodwill: goodwill is something that is generated by a business and is owned by the owners of that business; a personal relationship is just that, it is not a transferable asset. There is little or no scope to argue that an individual employee has “personal goodwill”.
For further information please contact the TaxDesk on 0845 4900 509 and ask for Thomas Dalby.