FUCHS, WALTER ALFRED HEINZ v. COMMISSIONER OF INLAND REVENUE

CACV 196/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 196 OF 2008

(ON APPEAL FROM HCIA NO. 1 OF 2008)

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J U D G M E N T

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Hon Tang VP:

1.  By a contract of employment dated 18 November 2003 (“the contract of employment”), the taxpayer was employed by Bayerische Hypo-und Vereinsbank AG (“HVB”), Hong Kong Branch (“the employer”) for three years from 1 January 2004, at a basic annual salary of HK$3,120,000.  The taxpayer was also entitled to a discretionary variable bonus.  He was CEO Asia and his title was Managing Director.  Clause 3 of the contract of employment stated that the period of employment was three years from 1 January 2004, and that “no less than 6 months prior to expiration, negotiations will be undertaken as to the prolongation of this contract”.

2.  The contract of employment provided:

“9. Termination

a)   This agreement may be terminated by either party, without cause, on the date of expiry of the initial term.

b)  Your employment may be terminated immediately by the Bank without prior notice if you shall at any time

-    commit any serious or persistent breach of any of the terms of your employment; or

-    be guilty of any grave misconduct or wilful neglect in the discharge of your duties, or

-    become mentally disordered and of unsound mind and incapable of managing your affairs, and are certified to be such by a qualified specialist medical practitioner.

c)   In the event that the Bank terminates or purports to terminate this agreement on any grounds other than as set out in clause 9a) and 9b), - despite your prior written consent to extend this agreement on the basis of customary market conditions for another 3 years and although you have not reached the age of 60 - the Bank shall pay to you as agreed compensation or liquidated damages:

-    2 annual salaries

-    an average amount of the bonuses paid in the 3 previous years of your employment with the Bank.

The Bank shall, not later than the effective date of termination, pay to you the compensation determined in accordance with the above.

Any possible mandatory severance payments are included in the above mentioned compensation sum.

d)  Upon the termination of your employment you shall return all documents, records, items and materials in your possession or custody belonging to the Bank and you shall not retain any copies thereof.”

Mr Barlow SC who appeared for the taxpayer accepted that the sums under clause 9(c) were payable only if the taxpayer’s employment was terminated prior to the date of expiry of the initial term of three years.

3.  The contract of employment was terminated after about two years.  On 17 October 2005, the taxpayer entered into a termination agreement with the employer under which the employer agreed to pay the taxpayer “for the loss of his position due to termination of the employment relationship for operational reasons”:

“1. … a one-time compensation for the loss of his position due to termination of the employment relationship for operational reasons.  This compensation will amount to HKD18,276,667 gross, which has been accepted by Mr. Fuchs.”

4.  The sum of HKD18,276,667 were made up of:

“Sum A —  $3,120,000 being a sum equivalent to his salary under the remaining period of his contract (12 months);

Sum B —    $6,240,000 being ‘two annual salaries’; and

Sum C — $8,916,667 being ‘the average of his three previous annual bonuses’.

5.  The Revenue levied salaries tax on Sums B and C, but not on Sum A on the basis that they were paid pursuant to his contract of employment.  He was contractually entitled to receive them on premature termination and as such were liable to tax. 

6.  The Deputy Commissioner of Inland Revenue by his determination dated 22 October 2007 agreed and stated:

“… Clearly, the sums stemmed from the terms of the employment … the sums are obviously income from employment which should be chargeable to Salaries Tax.”

7.  By consent, the taxpayer’s appeal to the Board of Review under section 66 of the Inland Revenue Ordinance, Cap. 112 was transferred to Court of First Instance pursuant to section 67.

8.  In the notice of grounds of appeal, the taxpayer contended that:

“(2)   Neither ‘Sum B’ nor ‘Sum C’ constitute assessable income because each was compensation paid to the taxpayer for the loss of his office upon the premature termination of his employment due to a takeover of his former employer.

(3) Additionally and alternatively, if (which is denied), ‘Sum B’ and/or ‘Sum C’ did constitute Assessable Income, then they did so in part only and:-

(a) the Deputy Commissioner's conclusion in paragraph 3(3) of the Determination that Part III of Cap 112 does not permit apportionment is incorrect in law, and

(b) the only part that legitimately could be considered to be Assessable Income is $1,030,482 (or some other sum to be ascertained by the Board of Review, after hearing the parties).”

9.  The charging section is section 8 which provides:

“(1)   Salaries tax shall, subject to the provisions of this Ordinance, be charged for each year of assessment on every person in respect of his income arising in or derived from Hong Kong from the following sources—

(a)   any office or employment of profit; and

(b)   any pension”

10.  Under section 9, such income includes:

“(a)    any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others ...”

11.  Although Burrell J thought “both payments are borderline”, he held that Sum C was chargeable under section 8 but not Sum B.  Both the taxpayer and the Commissioner have appealed to us.

12.  The main issue between the parties is whether those sums or either of them is income from the taxpayer’s employment with the Bank. 

13.  This is essentially a matter of applying the statutory language to the facts.  It is common ground that the language used by the parties is not the determining factor when one has to decide what in truth was the bargain.  As Sir Raymond Evershed MR said in Henley v Murray (1950) 31 TC 351, at 365:

“… the duty of the Court is to see what in substance and in truth the bargain was and not to be blinded by some formulae which the parties may have used.”

But as the authorities on similar provisions show it is often difficult to decide whether the facts fall within the statutory language.  Not all payments made under a contract of employment is taxable under section 8(1)(a), for example, pension is specifically made chargeable under section 8(1)(b).  Thus, emolument from an employment is taxable under section 8(1)(a) if it is an emolument:

“… from being or becoming an employee …”.  See per Lord Templeman in Shilton v Wilmshurst (Inspector of Taxes) [1991] STC 88, [1991] 1 AC 684 at 689.

14.  Lord Wilberforce, in Comptroller-General of Inland Revenue v. Knight [1973] AC 428 at 433, said :

“    Questions as to the taxability of payments received by employed persons at the end of their employment have frequently come before the courts : they have often been described as difficult, borderline and depending on narrow distinctions.  Two propositions are accepted as common ground in the present case.  First, where a sum of money is paid under a contract of employment, it is taxable, even though it is received at or after the termination of the employment : see for example Henry v. Foster (1931) 16 T.C. 605.  Secondly, where a sum of money is paid as consideration for the abrogation of a contract of employment, or as damages for the breach of it, that sum is not taxable : see for example Henley v. Murray (1950) 31 T.C. 351.”

15.  Burrell J decided that salaries tax was not payable on Sum B because:

“41.   … Its substance is in the nature of a payment he would have received by virtue of his seniority in the circumstances that occurred. …

42.    Ultimately, it seems to me that Sum B can be fairly categorised as capital and Sum C can properly be categorised as income. ...”

16.  Burrell J held that Sum C was taxable, because:

“32.   In my judgment common sense dictates that the raison d’etre for this payment (which the employer agreed to pay in the event of early termination) was to ensure the employee received the bonus he might have received if the contract had continued for another year.  The ‘bonus’ was in reality the most important part of the employee’s income.  It was reasonable to expect that it would comfortably exceed the annual salary (which in Mr Fuchs’ case it always had).  The loss of this ‘income’ would be a serious blow if the contract was terminated early.  By the mechanism used in clause 9(c) an equivalent payment in substitution was guaranteed.  Moreover, it was an inducement.

……

35.    I am satisfied that Sum C was rightly regarded as coming within sections 8 and 9 of the IRO.  It was an entitlement under the contract and not compensation for loss of office or damages for breach of contract.  It was income arising from employment.

36.    Returning to Lord Wilberforce’s remarks (in Knight, see para. 14 above), it seems to me that Sum C fits into his first category but not his second.  Sum C is a contractual entitlement representing income derived from his services rendered during the contract.  Similarly, Sum C has been paid to him, to borrow Lord Radcliff’s words cited in paragraph 21 herein ‘in return for acting as or being an employee’.  The fact that it was paid pursuant to a contract which was terminated early does not change its true nature.  It is an attempt to pay him a sum equivalent to his bonus entitlement had the contract continued to its full term.”

17.  The principal submission of Mr Barlow, SC for the taxpayer is that Sums B & C were compensation for the termination of his employment and not taxable under section 8.  He cited in support CIR v Elliott [2007] 1 HKLR 297, in particular the following statement in the judgment of Le Pichon JA:

“27.   … Yet, under the principle in Henley v Murray which on behalf of the Commissioner Mr Fung accepts, payments received as compensation for loss of office are not chargeable to income tax.

28. In Henley v Murray, Sir Raymond Evershed, MR (at p. 363) contrasted the case in which ‘the contract persists’, where the employers remain liable under the contract for the remuneration they had contracted to pay though they gave up their right to call upon the employee to perform the duties under the contract with another class of case where the bargain was of an essentially different character, where ‘the contract itself goes altogether and some sum becomes payable for the consideration of the total abandonment of all the contractual rights which the other party had under the contract’.  The critical distinction was the continued existence or otherwise of the contract of employment.  As Jenkins LJ remarked (at page 367), ‘the question in each case is whether, on the facts of the case, the lump sum paid is in the nature of remuneration of profits in respect of the office or is in the nature of the sum paid in consideration of the surrender by the recipient of his rights in respect of the office.’  In the present case, the Agreement unquestionably came to an end.”

18.  Mr Barlow SC submitted, and we accept, that the authority of Henley v Murray has stood unchallenged since its decision.  Henley v Murray was a decision of the English Court of Appeal (Sir Raymond Evershed, MR, Somervell LJ and Jenkins LJ) which was decided on 14 March 1950.  The facts can be taken from the headnotes.

“The Appellant was director and managing director of a property company. Under his service agreement dated 17th January, 1938, he was entitled as managing director to a fixed salary and commission; and as director he was entitled to fees. The appointment as managing director was to continue until 31st March, 1944, and was terminable thereafter by three months' notice in writing by either side. He was also entitled to director's fees as director of a subsidiary of the property company. By agreement, and at the request of the board of directors, the Appellant resigned from the property company on 6th July, 1943, and from the subsidiary company on 2nd September, 1943. From the property company he received a sum of £2,779 14s. 4d., being as to £577 remuneration under the agreement as managing director for the period 6th April, 1943, to 6th July, 1943, and as to £2,202 14s. 4d., the remuneration he would have been entitled to for the period from 7th July, 1943, to 31st March, 1944, if his appointment had continued to that date. He also received from each of the companies a sum on account of arrears of director's fees.

On appeal to the General Commissioners, the Appellant contended that the £2,202 14s. 4d. was paid to him as compensation for the surrender of his rights to future remuneration under the service agreement; that the sums paid on account of arrears of director's fees represented compensation for loss of office; and that he was not assessable to Income Tax in respect thereof. The Commissioners dismissed the appeal.

In the Courts the Appellant abandoned his contention as regards the sums representing arrears of director's fees.

Held, that on the facts of the case the £2,202 14s. 4d. was not assessable.”

19.  The Master of the Rolls said:

“I think in the circumstances of this case as I have stated them it is also not open to the Crown to say that the sum of £2,000 odd constituted profits from the office or employment, since I think upon its true analysis it constituted the consideration payable to Mr. Henley for the total abrogation impose upon him of his contract of employment; so that from 6th July, 1943, no contract existed under which that figure or any other sum could be paid.”

20.  Somervell LJ said in his judgment at page 367 that it is plain that in a case where damages for wrongful dismissal are sued for, the sum awarded as damages is not taxable and that is equally so where the employer dismisses his employee and the damages are agreed without litigation,

“… the fact that they are agreed instead of being awarded by a judge or jury cannot affect their legal position in regard to the Income Tax code. …”

But he was careful to add:

“… What would be the position if there were a mutual agreement between the employer and the employed that the service should be ended abruptly and a sum paid is a matter which can be dealt with when it arises.”

21.  The gist of Jenkins LJ’s judgment has been stated by Le Pichon JA.

22.  In July of the same year, the English Court of Appeal had to deal with the other situation envisaged by Somervell LJ.  In Dale (H.M. Inspector of Taxes) v de Soissons (1950) 32 TC 118, the respondent was employed as an assistant to the managing director of a company, his remuneration consisting of a fixed salary of £3,000 per annum and a commission calculated on profits.  Under the terms of his service agreement, the respondent’s appointment was to be for three years from 1 January 1945, but the company was entitled to terminate the agreement at 31 December 1945, or 31 December 1946, on payment of £10,000 or £6.000 respectively, as “compensation for loss of office”.  The company terminated the agreement at 31 December 1945, and paid the £10,000 to the respondent, the £10,000 was assessable to tax.

23.  Evershed MR said at page 126 (with the concurrence of Bucknill and Jenkins LJJ):

“Cases of this character are never easy, and as Mr. Grant observed at the end of his argument the line between those in which the taxpayer has succeeded and those in which he has failed may perhaps be described as ‘a little wobbly’, but in my judgment the learned Judge rightly held that this case fell on that side of the line which has been illustrated by, among other cases, the case of Henry v. Foster reported, among a series of cases, Henry v. Foster and Hunter v. Dewhurst, 16 T.C. 605, and not on the side of the line on which fell the recent case of Henley v. Murray, decided in this Court and reported on page 908 of [1950] 1 All E.R..”

24.  Counsel for the taxpayer had relied on Henley v Murray and submitted that the payment was made:

“… in consideration for the cancellation of the rights under the agreement which Colonel de Soissons would otherwise have had. …”

25.  The Master of the Rolls disagreed and said at page 127:

“… As I have already indicated, to my mind the correct answer is that given by Roxburgh, J., namely, that this £10,000 was part of the remuneration which Colonel de Soissons was entitled to get under, and received from, his contract of service. The contract provided that he should serve either for three years at an annual sum or, if the company so elected, for a shorter period of two years or one year at the annual sum in respect of the two years or the one year, as the case might be, plus a further sum, that is to say it was something to which he became entitled as part of the terms upon which he promised to serve, something which he was entitled to receive in the particular event specified, namely, the term not running the three years but being earlier determined. I agree with the learned Judge that there is a true analogy between this case and the cases to which I have referred, called Henry v. Foster, where the taxpayer received sums by virtue of the articles of association which were treated, for that purpose, as being a part of the contract of service.”

26.  And then he said at page 128 that the effect of the terms of agreement was:

“… that Colonel de Soissons engaged himself, if called upon, to serve for three years at a remuneration which was specified, but the right was given to the company to make his term a shorter one. In that event, as it seems to me, the remuneration for the services took the form in part of a remuneration plus a commission for the period he in fact served, plus a further sum which he was contractually entitled to get under the terms of his agreement and as part of the bargain which he made.

Cases of this kind, as I have said, are never entirely easy, and in the last resort it seems to me to turn upon the short question which I have attempted to answer as I have, namely, whether following the language of the Rule this sum can be said to arise from the contract of employment. Having given briefly my reasons for thinking that an affirmative answer should be given, I hope Mr. Grant will not think me disrespectful of his argument if I leave it at that, and do not attempt to elaborate and perhaps thereby succeed only in confusing. I am satisfied to accept the last few words of Roxburgh, J's., judgment as giving expression entirely to my own conclusion, ‘In the present case the Colonel surrendered no rights. He got ‘exactly what he was entitled to get under his contract of employment. ‘Accordingly the payment, in my judgment, falls within the taxable ‘class’.”

27.  Mr Barlow submitted that we should disregard Dale.  I disagree.  Dale and Henley dealt with two different situations.  It is often difficult to decide on which side of the line a case falls.  But that there is a line is clear.  The line is derived from the language of the taxing provision. 

28.  As noted earlier, Sir Raymond Evershed MR thought that Dale:

“… fell on that side of the line which has been illustrated by, among other cases, the case of Henry v Foster reported, among as series of cases, Henry v Foster and Hunter v Dewhurst, 16 T.C. 605 and not on the side of the line on which fell the recent case by Henley v Murray, decided in this Court …”

29.  In EMI Group Electronics Ltd v Coldicott (Inspector of Taxes) [1999] STC 803, Chadwick LJ said of this observation of Sir Raymond Evershed MR at page 814:

“For my part, I have difficulty with the observation that Hunter v Dewhurst (as decided by the majority in the House of Lords reversing the Court of Appeal) falls on the same side of the line as Henry v Foster. It seems to me that a true analysis would put Henry v Foster on one side of the line and Hunter v Dewhurst on the other side, with Henley v Murray.”

30.  With respect, I agree.  However, when the observation of Sir Raymond Evershed MR is read in its entirety, as quoted in para. 29 above, it is clear that the Master of the Rolls was of the view that Dale fell on the same side of the line as Henry v Foster and not Hunter v Dewhurst.  The confusion is caused by the fact that Henry v Foster and Hunter v Dewhurst were reported together.  That is because three cases, namely, Henry (H. M. Inspector of Taxes) v Arthur Foster and Henry (H. M. Inspector of Taxes) v Joseph Foster, and Hunter (Inspector of Taxes) v Dewhurst (1930) 16 TC 605, were heard at the same time at first instance before Rowlatt J who decided in favour of the taxpayers.  The two Henry v Foster cases were heard at the same time in the Court of Appeal in February / March 1931, followed by Hunter v Dewhurst in May 1931.  The Court of Appeal allowed all three appeals.  However, only in Hunter v Dewhurst was there an appeal to the House of Lords, where the House of Lords (by a majority) allowed the appeal and held in favour of the taxpayer.  However, with respect, I believe the Master of the Rolls might have contributed to the confusion when he said in Henley v Murray at page 366 that:

“… the decision of the House of Lords in Hunter v Dewhurst depended upon very special circumstances, particularly the existence of a very special article giving very unusual rights.”

31.  The critical distinction between Henry v Foster and Hunter v Dewhurst is that, in Henry v Foster, the payments made to the taxpayers were made in accordance with the terms of article 109 of the Articles of Association.  Thus Lawrence LJ said at 632:

“… In my opinion neither Duncan’s case nor any other case dealing with voluntary payments made on the relinquishment of an office or an employment of profit has any bearing on the question which we have to decide. In my judgment, the determining factor in the present case is that the payment to the Respondent whatever the parties may have chosen to call it was a payment which the company had contracted to make to him as part of his remuneration for his services as a director. It is true that payment of this part of his remuneration was deferred until his death or retirement or cesser of office, and that in the articles it is called ‘compensation for loss of office.’ It is, however, a sum agreed to be paid in consideration of the Respondent accepting and serving in the office of director, and consequently is a sum paid by way of remuneration for his services as director.

In those circumstances, the inevitable conclusion to my mind is that the sum was a profit from the office of director, the payment of which could have been enforced by action, or by proof as a creditor in a winding-up. (See Swabey v. Port Darwin Gold Mining Company, 1. Megone's Reports, page 385, and Ex parte Beckwith, [1898] 1 Ch. page 324.)”

32. However, in Hunter v Dewhurst, under article 109, Dewhurst would have been entitled to be paid £12,500 if he had retired

“… or to continue as a director at a smaller remuneration, in which case on retirement he would get under the article a much smaller lump sum. To induce him not to retire, the company agreed to give him a lump sum of £10,000 in consideration of which he agreed to release them from the obligations under article 109, both in the past and in the future. He entered into no bargain to serve the company for any particular time; the only arrangement was that as long as he remained a director he was to get a salary of £250 a year with no recourse to article 109. The company were obviously content with this, for though he might retire at any time, they were under no obligation to pay him more; indeed, they had agreed to pay him less than he could have claimed if he had retired at the time the arrangement was made. The £10,000 was not paid for past remuneration, for the condition of its becoming payable, for instance, loss of office, never was performed. It was not paid for future remuneration, for that was expressed to be £250 per annum, which was to be the sole remuneration. It seems to me that a sum of money paid to obtain a release from a contingent liability under a contract of employment cannot be said to be received ‘under’ the contract of employment, is not remuneration for services rendered or to be rendered under the contract of employment, and is not received ‘from’ the contract of employment. On this short ground I think that the decisions of the Special Commissioners and of Mr. Justice Rowlatt were right, and that this appeal should be allowed and the decision of Mr. Justice Rowlatt restored with costs here and below.”

32.   In EMI Group Electronics Ltd v Coldicott (Inspector of Taxes), as Chadwick LJ explained in his judgment (with the concurrence of Simon Brown LJ and Rattee J) there:

“The question, … is whether a payment in lieu of notice made in pursuance of a contractual provision, agreed at the outset of the employment, which enables the employer to terminate the employment on making that payment is properly to be regarded as an emolument from that employment. In the absence of authority which compels a contrary conclusion, I would have no doubt that that question must be answered in the affirmative. It seems to me to fall squarely within the tests posed by Lord Radcliffe in (Hochstrasser at 391-392) – ‘paid to him in return for acting as or being an employee’ – and by Lord Templeman in (Shilton at 689) – ‘an emolument “from being or becoming an employee”’ which Lord Woolf approved in (Mairs at 579).”

33.  Chadwick LJ went on to say that at page 812:

“There is nothing in the speeches in the House of Lords in Hunter v Dewhurst which suggests that the majority took the view that the Court of Appeal had reached the wrong conclusion in Henry v Foster. The basis of the decision in Hunter v Dewhurst was that the payment was not made under the original contract embodied in art 109 - which, as the Court of Appeal had held, was the contract upon which the directors had agreed to provide their services from the outset - but under a subsequent contract by which the company obtained a release from its obligations under art 109. The two decisions provide a striking illustration of the difference between the treatment, for the purposes of Case I of Sch E, of a payment on termination which is made pursuant to an obligation entered into at the commencement of the employment and a payment on termination which is made pursuant to an agreement to waive or release an existing obligation entered into at the commencement of the employment. I find nothing in Hunter v Dewhurst which leads me to the conclusion that the provisional view which I have already expressed in relation to the present appeal is wrong; and I find support for that provisional view in the reasoning of the Court of Appeal in Henry v Foster.”

34.  In the course of an exhaustive examination of the relevant authorities, Chadwick LJ said:

“The question whether a payment to an employee is properly to be regarded as an emolument from his employment, for the purposes of what is now s 19(1) of the 1988 Act, was first considered by the House of Lords some 70 years ago, in Hunter (Inspector of Taxes) v Dewhurst (1930) 16 TC 605. Since then the question has received consideration by the House of Lords on at least seven occasions-in Cameron v Prendergast (Inspector of Taxes) [1940] AC 549, 23 TC 122, Tilley v Wales (Inspector of Taxes) [1943] AC 386, 25 TC 136, Hochstrasser (Inspector of Taxes) v Mayes [1960] AC 376, 38 TC 673, Brumby (Inspector of Taxes) v Milner [1976] STC 534, [1976] 1 WLR 1096, Bray (Inspector of Taxes) v Best [1989] STC 159, [1989] 1 WLR 167, Shilton v Wilmshurst (Inspector of Taxes) [1991] STC 88, [1991] 1 AC 684 and, most recently, in Mairs (Inspector of Taxes) v Haughey [1993] STC 569, [1994] 1 AC 303. In the last of those appeals Lord Woolf observed ([1993] STC 569 at 578, [1994] 1 AC 303 at 320), in a passage cited by the judge in the present case ([1997] STC 1372 at 1384)-

‘... this is an area in which there is an abundance of authority. It is not always easy to reconcile these authorities since as is to be expected they are frequently concerned with situations close to the borderline between payments which fall within and payments that fall without the statutory provision. It is possible to have almost an infinite variety of situations which, although they have common characteristics, as a matter of fact and degree fall on one side of the border or the other. In each case ultimately it is a matter of applying the statutory language to the facts.’

There were, however, two passages in the earlier decisions which Lord Woolf identified as providing some general assistance. In attempting the task of applying the statutory language to the facts in the present case, it is helpful to have those passages in mind. The first is in the speech of Lord Radcliffe in Hochstrasser (Inspector of Taxes) v Mayes [1960] AC 376 at 391-392, 38 TC 673 at 707. After referring to what he described as glosses put upon the words of the statute-which, although of value as illustrating the idea which those words expressed, did not displace them-Lord Radcliffe said:

‘For my part, I think that their meaning is adequately conveyed by saying that, while it is not sufficient to render a payment assessable that an employee would not have received it unless he had been an employee, it is assessable if it is paid to him in return for acting as or being an employee.’

The second, in the speech of Lord Templeman in Shilton v Wilmshurst (Inspector of Taxes) [1991] STC 88 at 91, [1991] 1 AC 684 at 689, expresses the concept embodied in the statutory words in these terms:

‘Section 181 [of the 1970 Act, now s 19(1) of the 1988 Act] is not confined to ‘emoluments from the employer’ but embraces all ‘emoluments from employment’; the section must therefore comprehend an emolument provided by a third party, a person who is not the employer. Section 181 is not limited to emoluments provided in the course of employment; the section must therefore apply first to an emolument which is paid as a reward for past services and as an inducement to continue to perform services and, second, to an emolument which is paid as an inducement to enter into a contract of employment and to perform services in the future. The result is that an emolument ‘from employment’ means an, emolument ‘from being or becoming an employee’. The authorities are consistent with this analysis and are concerned to distinguish in each case between an emolument which is derived ‘from being or becoming an employee’ on the one hand, and an emolument which is attributable to something else on the other hand, for example, to a desire on the part of the provider of the emolument to relieve distress or to provide assistance to a home buyer. If an emolument is not paid as a reward for past services or as an inducement to enter into employment and provide future services but is paid for some other reason, then the emolument is not received ‘from the employment’.’

Lord Templeman recognised that the task of determining whether an emolument was paid for being or becoming an employee or was paid for some other reason was frequently difficult and could give rise to fine distinctions.”

35.  After discussing the decision of Henley as well as Dale, Chadwick LJ went on to say:

“To my mind there is a true analogy between Dale v de Soissons and the present case. In Dale v de Soissons the bargain, made at the commencement of the employment, was that the employee would be employed for a term of three years unless the employer, on payment of a sum of money, chose to terminate the employment at the end of the first or the second year. In the present case the bargain, again made at the commencement of the employment, was that the employee would be employed for a term which would continue for a period of six months after the taxpayer company gave notice of intention to dismiss; unless the taxpayer company, on payment of a sum of money, chose to terminate the employment within that period of six months. The fact that, in the one case, the payment was fixed at the outset while, in the other case, the payment would be fixed by reference to the salary at the time of termination is immaterial. In both cases the bargain made at the commencement of the employment was that the employee should have the security of employment-or the security of a right to continue receiving salary-for a given period; or that, in the alternative and at the option of the employer, the employee should receive an additional payment on termination. In both cases the employee was entitled to the additional payment, in the event which happened, in lieu of salary from continuing employment under the terms of the contract by which he had agreed to serve the employer.”

36.  He then turned:

“… to the decisions of the House of Lords since Dale v de Soissons. …”

and said:

“I have thought it appropriate to set out a short analysis of the decisions of the House of Lords from Hochstrasser (Inspector of Taxes) v Mayes [1960] AC 376, 38 TC 673 to Shilton v Wilmshurst (Inspector of Taxes) [1991] STC 88, [1991] 1 AC 684 in order to demonstrate that while there are, of course, useful statements of principle to be found in the speeches delivered in those appeals, none of those appeals required the House of Lords to consider, directly, the treatment of termination payments payable under the contract of employment. The question which arises in the present case-and which, to my mind, arose in Henry (Inspector of Taxes) v Foster (1930) 16 TC 605 and in Dale (Inspector of Taxes) v de Soissons (1950) 32 TC 118-was not in issue in those appeals. I find nothing in those decisions of the House of Lords which suggests that the reasoning which led this court to its conclusions in Henry v Foster and Dale v de Soissons was wrong.”

37.  In this context I should add that the fact a payment is provided for in the contract of employment would not necessarily result in the payment being chargeable under section 8(1)(a).  Thus, Lord Woolf said in Mairs (Inspector of Taxes) v Haughey [1994] 1 AC 303 at page 322:

“… For example, pension payments will usually be payable in consequence of a contract of employment but they are not emoluments ‘in respect of the employment’ or ‘from the employment’ taxable under Schedule E. They are taxable under distinct statutory provisions. …”

38.  Then Chadwick LJ discussed:

“… Mairs (Inspector of Taxes) v Haughey [1993] STC 569, [1994] 1 AC 303. That was an appeal from Northern Ireland. The taxpayer had been employed by Harland & Wolff plc, publicly owned ship builders; and, in relation to that employment, had been entitled to contingent rights under a non-statutory enhanced redundancy scheme. In connection with a transfer of the business on privatisation and in consideration of giving up their rights under the enhanced redundancy scheme, employees were offered 30% of the amount which they would have received under the scheme if they had been made redundant on 1 September 1989 (element A) and a further sum calculated by reference to years of past service (element B). In the case of the taxpayer the amounts were £4,506 and £1,300 respectively. The taxpayer accepted the offer and entered into contracts of employment with the new employer. The payment was made on 22 September 1989. The taxpayer was assessed under s 19(1) of the 1988 Act in respect of both elements. The commissioner held that, although the payment (which combined elements A and B) was properly to be regarded as a single payment in consideration of the employees' agreement to the package of changes, it was nevertheless permissible to appropriate element A to the loss of the enhanced redundancy scheme and element B to the acceptance of the new terms of employment. On that basis element B was chargeable as an emolument from employment on the ground that it had been paid in order to induce the taxpayer to enter into the new contract of employment; but element A was not chargeable-on the basis that it was the consideration for the employee giving up his contingent rights to an enhanced redundancy payment. The Court of Appeal in Northern Ireland took the view that that approach was consistent with the decision of the House of Lords in Tilley v Wales (Inspector of Taxes) [1943] AC 386, 25 TC 136 and upheld the commissioner. The House of Lords dismissed the Crown's appeal.”

39.  He said at page 819:

“… But, more pertinently in the present context, there is nothing in Lord Woolf's speech in Mairs v Haughey which throws doubt on the decisions of this court in Henry (Inspector of Taxes) v Foster (1930) 16 TC 605 or Dale (Inspector of Taxes) v de Soissons (1950) 32 TC 118.

……

… For my part, I do not find any close analogy between a redundancy payment-the purpose of which, as Lord Woolf pointed out ([1993] STC 569 at 578, [1994] 1 AC 303 at 320), is (in part at least) to relieve an employee from the hardship consequent upon becoming unemployed-and a payment in lieu of notice. Notice of intention to terminate-or a payment in lieu of notice-is not intended to relieve the hardship consequent upon becoming unemployed. It is no substitute for a redundancy payment. Indeed, it is something to which the employee is entitled in addition to a redundancy payment-as the present case itself illustrates. Notice of intention to terminate-or a payment in lieu of notice-gives recognition to the obvious fact that it is likely to take time to find other employment; and that a prudent employee enters into employment on terms that, when the time comes for that employment to end, he will have the security of a continued right to receive his salary (or a payment in lieu) while he finds other employment.

I am satisfied, therefore, that there is nothing in the authorities which requires this court to reach the conclusion that a payment in lieu of notice, made in pursuance of a contractual provision, agreed at the outset of the employment, which enables the taxpayer company to terminate the employment on making that payment, is not properly to be regarded as an emolument from that employment. In my view, for the reasons which I have set out, such a payment is an emolument from the employment. That was the view reached by the commissioners and by the judge. I am satisfied that they were correct.”

40.  I return to Elliott, much relied on by Mr Barlow.  The facts are complicated, but can be taken from the headnotes.

“Under E's five-year term contract of employment, the employer agreed to pay to E a considerable remuneration package, including awarding to E (a) 5,000,000 non-transferable ‘Incentive Compensation Plan’ (ICP) units (existing units); and (b) during the term of the contract and for two years thereafter, 500,000 future units each time a project became operational. Each 500,000 unit block entitled E to an annual payment, computed under a formula partly based upon the employer's profitability. Alternatively, with the employer's agreement, E could in certain circumstances elect to receive a lump sum in lieu of terminating all or part of the ICP. Within five months of entering into the employment, after E had been awarded the existing units but before he had received any annual payments in relation thereto, the parties terminated the employment with E agreeing to cancel all his ICP units for a payment of US$11,000,000 (the Sum). The Commissioner assessed the entire Sum to salaries tax. On appeal, the Board of Review found that the Sum was made in exchange for both the existing units and the future units. The Board held that the existing units were an inducement to E to enter into the employment contract and that the portion of the Sum attributable thereto was taxable; however, the portion of the Sum attributable to the future units was a non-taxable payment for abrogation of E's contractual rights. Both parties appealed to the Court of First Instance (see [2006] 3 HKLRD 779). After holding that the compensation attributable to the existing units was referable both to an inducement to enter into the contract as well as compensation for abrogating E's rights to the annual payments under that contract, the Judge remitted the case to the Board to reconsider apportionment so as to only subject to tax the value of the inducement. The Commissioner lodged a further appeal. E cross-appealed on liability.”

41.  In such context, Le Pichon JA said:

“25. … The taxpayer had no contractual basis for requiring a buy-out. …

……

30.    Looking at the matter in the round, in my view, the entire sum of the US$11 million constituted compensation for the abrogation of all of the taxpayer’s rights in relation to the ICP units, existing as well as future, including the contingent right to a pro rata share of the relevant income.  In substance, the contingent right was part and parcel of the ‘whole bundle of rights’ which was extinguished through the cancellation of the ICP units.  In my view, no part of that sum attracts income tax because no part of it was paid to the taxpayer ‘in return for acting as or being an employee’: the whole sum was to compensate the taxpayer for his loss of the ICP units.”

42.  Here Sums B and C were not paid in abrogation of the contract of employment.  They were paid in accordance with the contract of employment.  The fact that the parties had entered into a termination agreement and that in addition to Sums B and C, Sum A was also paid should not obscure the fact that Sums B and C were payable under the contract of employment.  In Mr Fuchs’ oral evidence before Burrell J he said there has been no negotiation about the terms of the termination, and that it was:

“… based on the contract of employment”,

save that:

“… Sum A is the remaining period under (the contract of employment) and the loss from salary, the annual salary.”  Transcript at page 15.

In this respect, I do not believe the present case is distinguishable from Dale or EMI Group Electronics Ltd.  On the other hand, Elliott clearly fell into Henley’s side of the line.

43.  Burrell J decided that clause 9(c) of the contract of employment contained an inducement to the taxpayer to enter into employment with the Bank.  He regarded that as a factor to be weighed in the balance in the Commissioner’s favour.  An inducement to enter into employment would normally be taxable under section 8 because as Lord Templeman said:

“… the section must therefore apply first to an emolument which is paid as a reward for past services and as an inducement to continue to perform services and, second, to an emolument which is paid as an inducement to enter into a contract of employment and to perform services in the future. …”

Indeed, Mr Fuchs’ evidence before Burrell J supported the view that the termination payments in the contract of employment provided comfort or security for Mr Fuchs.  Transcript at page 13.

44.  Burrell J said Sum B:

“39.   … has characteristics which fall on both sides of the dividing line between what is chargeable and is not.”

However:

“40.   Ultimately, the characteristics of substance rather than form which have persuaded me to place (Sum B) on the non-chargeable side are (taken together) that :

(i) it is akin to a non-contractual redundancy payment because it is calculated by reference to a multiplier of an annual salary;

(ii)    the employer called it ‘agreed compensation’;

(iii)   the contract had come to an end.  All future mutual rights and obligations were terminated;

(iv)   it is not referable to work done;

(v)    it is not calculated by reference to work done under the contract;

(vi)   it would not have been paid if the contract had gone its full term of three years; and

(vii)  it may be regarded as an arbitrary amount, payable in the event of early termination, designed to soften the blow of premature unemployment.

I appreciate that some of these characteristics may apply to Sum C as well.  Accordingly, I have emphasized the words ‘taken together’ in parenthesis above.

41.    Although both payments are borderline, I find, on Sum B, in the taxpayer’s favour.  Its substance is in the nature of a payment he would have received by virtue of his seniority in the circumstances that occurred.  I acknowledge that, against this finding, it could be said that Sum A represented his ‘compensation’.  There is some force in this argument but I have not been required to rule on Sum A and thus the Commissioner’s decision that it was ‘compensatory in nature’ is the end of the matter and has no bearing on this court’s evaluation of Sums B and C.”

45.  But Sum B was not a non-contractual payment.  It was clearly provided for under the contract of employment.  Nor was it in the nature of a redundancy payment.  It was a payment for early termination.  As the learned judge said, and Mr Fuchs agreed:

“40(vi)  it would not have been paid if the contract had gone its full term of three years;”

46.  It is unnecessary to discuss the nature of redundancy payments in detail.  “Redundancy” payments are covered by section 31B(2) of the Employment Ordinance, Cap. 57 and they only arise:

“(2)  … if the dismissal is attributable wholly or mainly to the fact that-

(a)   his employer has ceased, or intends to cease, to carry on the business-

(i)    for the purposes of which the employee was employed by him; or

(ii)   in the place where the employee was so employed; or

(b)   the requirements of that business for employees to carry out work of a particular kind, or for employees to carry out work of a particular kind in the place where the employee was so employed, have ceased or diminished or are expected to cease or diminish.”

There is no evidence that the taxpayer came within section 31(B)(2).

47.  The Hong Kong provisions are similar to those under consideration in Mairs (Inspector of Taxes) v Haughey.  Lord Woolf said at 319, 320:

“Redundancy, whether statutory or non-statutory, involves an employee finding himself without a job through circumstances over which he has no control. It is also a quality of redundancy that it does not give rise to a right to compensation unless the employee has been employed for a minimum period and that the right when it accrues increases, initially, with the period of employment and then subsequently reduces until eventually the employee loses any right of payment upon his reaching normal retirement age. These qualities were fully reflected in the enhanced redundancy payment scheme operated by H. & W.1. A redundancy payment has therefore a real element of compensating or relieving an employee for the consequences of his not being able to continue to earn a living in his former employment. The redundancy legislation reflects an appreciation that an employee who has remained in employment for the minimum time has a stake in his employment which justifies his receiving compensation if he loses that stake. It is distinct from the damages to which he would be entitled if his employment were terminated unlawfully. It is also unlike a deferred payment of wages in that the entitlement to a redundancy payment is never more than a contingent entitlement, which no doubt both the employer and employee normally hope will never accrue.”

48.  Indeed, Mr Barlow accepted that neither Sum B nor Sum C was necessarily a redundancy payment.  He further accepted that they were payable on early termination of the employment.  But as Henry, Dale and EMI Group Electronics Ltd show such payments may be taxable under section 8(1).

49.  Mr Barlow’s alternative argument is that since the taxpayer had worked for the bank since 1976, the two sums should be apportioned so that only that proportion of his income derived from Hong Kong (about two years) in relation to his entire career with the bank of about 29 years should be taxed. 

50.  The learned judge rejected his submission, he said:

“45.   In my judgment this second limb to the appellant’s submission is without merit.  In my judgment it falls to be taxed because it is Hong Kong income.  It is not referable to pre-Hong Kong employment.  It was a provision in the ‘HVB-HK’ contract (i.e. the contract with the Hong Kong branch) with the taxpayer.  It was calculated with reference to bonuses (mainly) earned in Hong Kong and paid in Hong Kong dollars.  Its chargeability arises because it falls within section 8 of the IRO, the Hong Kong law.

46.    Attempts to redefine it by reference to German law are misplaced.  Evidence of German law has not been adduced by any expert witness, it is therefore inadmissible and, in any event, irrelevant.”

51.  With respect, I agree.  I agree with Ms Yvonne Cheng for the Commissioner that there was no admissible evidence of German law.  Nor evidence that any severance or redundancy payment was payable under German law. 

52.  Indeed although the Commissioner had repeatedly asked for evidence of German law because of the taxpayer’s assertion:

“… it is required by German Law for compensation for the termination payments cover all time periods (since 1976) that Mr. Fuchs was employed by the (Bank). …” 

there had been no attempt to produce any admissible evidence on German tax or employment law to the Commissioner.  Nor was the opportunity taken at the hearing before the learned judge to do so.

53.  I also note that the contract of employment contained the provision that:

“This agreement and the rights and obligations of the parties hereto are, in all respects, governed and construed in accordance with the laws of The Hong Kong Special Administrative Region.”

54.  Mr Barlow also relied on section 8(1) as the basis for his submission that there should be apportionment of the two sums.  With respect, it is clear that since the taxpayer was employed under a Hong Kong contract of employment no question of apportionment can arise.  See Commissioner of Inland Revenue v. George Andrew Goepfert [1987] 2 HKTC 210, and the judgment of Deputy High Court Judge A To (as he then was) in Lee Hung Kwong v Commissioner of Inland Revenue [2005] 4 HKLRD 80 where he said at 89:

“23.   … Thus, the question which falls to be decided in any particular case is whether the income which is sought to be charged is income from a Hong Kong source and the place where the services are rendered is irrelevant.  If the income is from a Hong Kong source, it is subject to the charge whether the services are rendered in or outside Hong Kong, unless it falls within the exception under s. 8(1A)(b).”

55.  Mr Barlow also submitted that since the taxpayer had been employed by the employer since 1976.  Insofar Sums B and C, wholly or in part, included his entitlement for severance pay, they fall outside section 8(1).  It was expressly provide under clause 9(c) that:

“… Any possible mandatory severance payments are included in the above mentioned compensation sum.”

56.  Furthermore, in the employer’s letter of 3 January 2007 to the Commissioner they stated:

“According to German Labour Law, the years of service are taken into account in the case of severance packages.

Mr. Fuchs joined our Branch in Singapore in January 2001 with a local Singapore employment contract. His years of service were taken into account by stating his date of joining HVB (September 1, 1976). The determination of his salary was based on his former salaries, his long years of experience, his new position and the local compensation market.

When Mr. Fuchs was transferred to Hong Kong, the former salaries - based on his long years of experience - were taken into account and the new salary was determined. With the new position, a 3 years' employment contract with HVB Hong Kong was concluded without reference to his date of joining. This entitlement was replaced by a termination clause stating 2 annual salaries as agreed compensation or liquidated damages and, in addition, the average amount of the bonuses paid in the 3 previous years. As required by German Law the termination payments cover all time periods (since 1976) that Mr. Fuchs was employed by HVB, not just the last 3 years employed in Hong Kong.”

57.  However, there was no evidence of any relevant German law, or the extent of Mr Fuchs’ entitlement.  Moreover, as noted, the sums under clause 9(c) would have been payable at all had the contract of employment not been terminated early.  I do not believe there was sufficient evidence on German law or any entitlement thereunder to render section 8(1) inapplicable.

58.  For the above reasons, I would dismiss the taxpayer’s appeal and allow the Commissioner’s cross appeal.  I would also make an order nisi that the taxpayer pays the Commissioner’s costs here and below.

Hon Cheung JA:

59.  I agree with the reasons of judgment of Tang VP.  I would add the following views of my own.

60.  In deciding whether money payable by an employer to an employee upon the early termination of the contract of employment is ‘income arising in or derived from any office or employment of profit’ within the meaning of section 8(1)(a) of the Inland Revenue Ordinance (‘the Ordinance’) Cap. 112, it is important to recognize the two categories of cases that exist in this area. 

Assessable income

61.  First, a payment is assessable if it is paid to the employee in return for acting as or being an employee, per Lord Radcliffe in Hochstrasser (Inspector of Taxes) v. Mayes [1960] AC 376 at 391-392(1).  Payment to an employee for ‘acting as’ an employee, refers to ‘emolument which is paid as an inducement to enter into a contract of employment and to perform services in the future’, per Lord Templeman in Shilton v. Wilmshurst (Inspector of Taxes) [1991] AC 684 at 689.  In other words it is a payment to the employee to take up the employment.  Payment to an employee for ‘being’ an employee, is ‘emolument which is paid as a reward for past services and as an inducement to continue to perform services’, per Lord Templeman at Shilton.  In other words it is payment for the employee’s service. 

62.  In Shilton money received by a footballer from a club which he would be signing a contract of employment was treated as taxable income.  The money was paid as an inducement to the footballer to enter into the new contract of employment with the other club.

Non-assessable income

63.  Second, a payment is not assessable if it is not paid for the above purpose but is paid for some other reason such as where it is paid as consideration for the abrogation of a contract, or as damages for the breach of it : see Comptroller-General of Inland Revenue v. Knight [1973] AC 428.

64.  In Knight, the employee was entitled under contract to a three months’ notice of termination.  His employer subsequently declared that the employee be declared redundant and be given redundancy pay at the rate of one month’s salary for every year of service.  The payment was held not to be taxable emolument, Lord Wilberforce at 435 held that :

‘Although there was no express bargain between the company and the respondent, their Lordships do not see any valid reason in principle for making a distinction between this case and cases (admittedly involving no charge to tax) where the payment is made expressly as consideration for abrogating a service agreement.  Equally with such cases the payment falls outside the taxing words “in respect of his employment”. ’

65.  In Hochstrasser payment made to an employee to compensate him for loss that he suffered on selling his home because of removal due to employment requirement was not taxable.  Lord Radcliffe stated that :

‘In my opinion, such a payment is no more taxable as a profit from his employment than would be a payment out of a provident or distress fund set up by an employer for the benefit of employees whose personal circumstances might justify assistance.’

Payment on redundancy

66.  Mr. Barlow S.C. argued on behalf of the taxpayer that the sums payable by the Bank were payments made in the event of the redundancy of the taxpayer (which he submitted was what had happened to the taxpayer in the present case) and relying on the line of cases dealing with redundancy payments submitted that the payments were not taxable emolument.

67.  In Mairs (Inspector of Taxes) v. Haughey [1994] 1 AC 303, the employee was entitled under contract to a non-statutory redundancy scheme.  Due to the privatisation for the employer, the employee agreed to give up his right under the redundancy scheme and instead would be entitled to 30% of the amount he would have received under the scheme had he been made redundant on a specific date.  The Court held that the 30% was not taxable emolument.  Lord Woolf at page 320 held that the payment

‘is a payment to compensate the employee for not being able to receive emolument from his employment.’

68.  Lord Woolf at page 319-320 explained the nature of a redundancy payment

‘Redundancy, whether statutory or non-statutory, involves an employee finding himself without a job through circumstances over which he has no control.  It is also a quality or redundancy that it does not give rise to a right to compensation unless the employee has been employed for a minimum period and that the right when it accrues increases, initially, with the period of employment and then subsequently reduces until eventually the employee loses any right of payment upon his reaching normal retirement age.  These qualities were fully reflected in the enhanced redundancy payment scheme operated by H. & W.1.  A redundancy payment has therefore a real element of compensating or relieving an employee for the consequences of his not being able to continue to earn a living in his former employment.  The redundancy legislation reflects an appreciation that an employee who has remained in employment for the minimum time has a stake in his employment which justifies his receiving compensation if he loses that stake.  It is distinct from the damages to which he would be entitled if his employment were terminated unlawfully.  It is also unlike a deferred payment of wages in that the entitlement to a redundancy payment is never more than a contingent entitlement, which no doubt both the employer and employee normally hope will never accrue.’

69.  Mr. Barlow S.C. further relied on Commissioner of Inland Revenue v. Elliott [2007] 1 HKLRD 297 where this Court (Rogers VP, Le Pichon JA and Stone J) held that payment for cancelling existing and future incentive plan units granted to an employee when his contract was terminated was not taxable income because the payment was received for loss of office which was not chargeable to income tax.

The two sums are taxable income

70.  In my view, the two sums of money which were expressly provided for in the contract of employment belong to the first category of taxable incomes.  They were clearly either a reward for past services before the taxpayer took up the Hong Kong employment or as an inducement for him to take up the Hong Kong employment and to provide for future service.

Contractual provisions

71.  It is also of some assistance to note that according to the preponderance of authorities cited by Ms Yvonne Cheng, Counsel for the Commissioner, where the Court held money payable on the early termination of the contract of employment were taxable, the payment were expressly provided for in the contract itself.

72.  In Dale v. de Soissons [1950] 2 All ER 460, under the contract an agreed sum was payable to an employee upon early termination of the contract by notice as ‘compensation for loss of office’.  The English Court of Appeal (per Evershed MR) at 462 approved the words of Roxburgh J in the court below that :

‘In the present case the taxpayer surrendered no rights.  He got exactly what he was entitled to get under his contract of employment.  Accordingly, the payment, in my judgment, falls within the taxable class…’  (emphasis added)

73.  In Williams v. Simmonds (1981) 55 TC 17, the contract provided that upon the happening of certain events the employee was entitled to be paid sums as ‘compensation for loss of office’.  Vinelott J held at page 21 that :

‘In my judgment, the determining factor in the present case is that the payment to the Respondent whatever the parties may have chosen to call it was a payment which the company had contracted to make to him as part of his remuneration for his services as a director.  It is true that payment of this part of his remuneration was deferred until his death or retirement or cesser of office and that in the articles it is called ‘compensation for loss of office.’  It is, however, a sum agreed to be paid in consideration of the Respondent accepting and serving in the office of director, and consequently is a sum paid by way of remuneration for his services as director.’  (emphasis added) 

74.  In EMI Group Electionics Ltd v. Coldicott [1999] STC 803, the employer was required to give an employee six months’ notice of termination of employment but was also entitled to make payment of the equivalent of salary in lieu of notice.  Chadwick LJ at 809 held that the payment in lieu of notice given by the employer were taxable and they had the following important features :

‘First, they are payments made under and in accordance with the contract of employment; second, they are not payments for work done under the contract of employment.  But, there is a third feature, which may be regarded as the obverse of the first; they are not payments made by way of compensation or damages for breach of the contract of employment.’  (emphasis added)

75.  In Yung Tse Kwong [2004] 3 HKLRD 192, under the taxpayer’s contract of employment, the employer agreed that upon termination other than for cause, and as ‘an insurance policy for peace-of-mind’, the taxpayer would be reassigned to another group company or offered severance pay for 12 months equal to his base salary at the time in accordance with the employer’s career transition plan.  Tang J (as he then was) held at 204 that

‘40.   These authorities confirm my view that the crux of the matter is whether Sum A was paid solely or partly as an inducement to enter into employment or was it solely or partly for the making of the Severance Agreement and in particular the giving of the restrictive covenants.’  (emphasis added)

He held that the offer was an inducement and having regard to the circumstances of the case he apportioned the inducement as being 10% of the sum paid and to that extent the sum is liable to tax.

76.  In Richardson v. Delaney [2001] STC 1328, a contract was terminable by the employer and employee giving 18 months’ notice.  The employer was also entitled to give notice of termination with immediate effect by giving notice in lieu.  The employer terminated the contract with immediate effect.  After negotiation the employee accepted a lump sum as compensation for the termination.  The sum was taxable.  Lloyd J at 1342 held that :

‘The employer was acting perfectly well within its rights in giving notice on 1 December under cl 1.2, and it was acting perfectly lawfully when it came to an agreement with the taxpayer on or about 28 December whereby the employment came to an end by agreement in consideration of the payment.  There is no breach of contract involved there …’

The other situation

77.  By contrast in Henley v. Murray (1950) 31 TC 351, the taxpayer was appointed the managing director of a company at a fixed salary for a period of slightly over six years; before the expiration of this period, he was asked to resign and was given salary up to the original contractual date.  The sum was not taxable.

78.  Likewise the money paid in Knight was not taxable.  It should be specifically noted that the House of Lords expressly rejected the argument that the payment in question was made under the contract of employment.

Nature of payment

79.  I do not agree that Sum B and Sum C fall within the second category.  Although Mr. Barlow S.C. at times described them as ‘redundancy payment’, it is important to bear in mind that the Court is concerned with substance and not form (per Viscount Simonds at Hochstrasser at 390).  In any event the contract did not describe the two sums as ‘redundancy payment’.  The two sums were not paid as damages for breach of the contract because the employer was entitled to terminate the contract.  Neither were they payment for the abrogation of a contract.  In this connection the observation of Evershed MR in Henley at 363 is apposite.  He contrasted the two situations where

‘... the contract persists.  Though the right of one party to call upon the other for performance of its terms may be modified, or indeed wholly given up, still the corresponding right to acquire payment either of the whole sum or of some less figure is preserved and is still payable under the contract.

But there is another class of case where the bargain is, as it seems to me, of an essentially different character, for in the second class of case the contract itself goes altogether and some sum becomes payable for the consideration of the total abandonment of all the contractual rights which the other party had under the contract.’

80.  In this case the contract came to an end by the notice of termination and the taxpayer was entitled to call upon his employer to comply with the contractual terms on the payment of sums upon the termination of the contract.  This is clearly not the situation where the contract itself was abrogated by some unilateral acts of the employer and some sums were payable as compensation for the abandonment of the contract. 

81.  The case of Knight does not assist the taxpayer.  There was no contractual provision in Knight for the money to be paid at the end of the contract.  Although Lord Wilberforce held that there was no valid reason in principle between, on the one hand, where there is no express agreement on the payment of redundancy payment and, on the other hand, where the redundancy payment is expressly provided for, ultimately the issue is whether there is an ‘abrogation of the contract of employment’.  Mairs is also not of assistance because the payment by way of 30% of the original redundancy scheme was also not provided for in the contract.  It was money payable upon the abandonment of the contract as a result of the privatization.

82.  Ms Cheng further argued that Sum A which was in the nature of a compensation for the taxpayer’s loss of salary due to early termination was relevant in assessing whether Sums B and C were compensation.  In my view it is not necessary to express a view on this issue.

83.  In my view both Sum B and Sum C are taxable and I really cannot see any real distinction in the nature of these two sums.

Hon Chung J:

84.  I agree.

Hon Tang VP:

85.  The taxpayer’s appeal is dismissed and the Commissioner’s cross appeal allowed with an order nisi that the taxpayer pays the Commissioner’s costs here and below.

(1) The equivalent English legislation is Section 156(2) of the Income Tax Act, 1952: “Tax under [Schedule E] shall also be charged in respect of any office, employment or pension the profits or gains arising or accruing from which would be chargeable to tax under Schedule D but for the proviso to paragraph 1 of that Schedule.”