Met Police case tests basic PAYE principles
By Justine Riccomini, Head of Tax (Employment and Devolved taxes)
30 September 2022
Justine Riccomini sets out the reasoning behind the decision in a “back to basics” employment tax case involving Met Police officers which was heard recently at the Court of Appeal
The case of HMRC v Keith Murphy was heard in July 2022 and the decision handed down less than three weeks later, in August 2022. Lady Justice Andrews, who delivered the decision, wasted no time in coming to the nub of the issue facing the judiciary – in this case, the meaning of the words “from” and “profit” within ITEPA 2003 s.62 – the section of the act which defines what counts as earnings from employment.
Background
Mr Murphy was amongst a group of police officers working for the Metropolitan Police (“The Met”) who took legal action against The Met in 2014 via the High Court. That case concerned itself with arrears of overtime and other allowances to which they believed they were entitled by way of statutory debt under the Police Regulations 2003, whilst they were employed by The Met. To pay for the legal costs the claimants entered into a damages-based agreement and insurance policy, the former including a success fee should the courts find in favour of the claimants or an out of court settlement be reached with The Met.
In May 2016, a settlement was reached with The Met on the basis of no admission of liability. The settlement did not include funds ring-fenced for the success fee or insurance, but did include legal costs of the claimants. Indeed, Clause 8.1 of the settlement stated: "Other than the Agreed Costs, the Parties shall each bear their own legal costs in relation to the Dispute and this agreement."
The Met agreed a form of making payment to the claimants under clause 3.3 of the settlement agreement, which included them being invoiced for the success fee by the solicitors and paying this sum and the insurance premium directly to the creditors. Both amounts would be deducted from the total sum payable to the claimants prior to payment.
Clearly, any payments made to the claimants in respect of arrears of pay and allowances were taxable under PAYE. However, The Met also applied PAYE to the costs too – in other words, applying PAYE to the whole amount paid directly to and also on behalf of each claimant. This approach contradicted the amount declared as taxable income by Mr Murphy on his tax return. He had treated the success fee and insurance premium as not taxable on him personally as they were not earnings and he had not received them directly. HMRC issued discovery assessments and Mr Murphy appealed.
Court decisions
The decision taken by the First-Tier Tribunal (FTT) was that the whole amount should indeed be treated as taxable on Mr Murphy as earnings “from” an employment. The Upper Tribunal (UT) disagreed, but this decision was then overturned by the Court of Appeal – who considered the deliberations made by the Upper Tribunal and then decided they agreed with the FTT.
What was the Upper Tribunal’s view?
The UT concluded that something could only be regarded as "earnings" within s.62 of ITEPA if it fell within the expression "any other profit… obtained by the employee" in s.62(2)(b) of ITEPA.
Two words requiring clarification were noted by the UT – and this led them to conclude that the FTT had erred by only considering the word “from”:
i) “Whether the alleged profit was derived from the employment as required by the definition of general earnings in s.9 (2) of ITEPA (the "from" issue); and
ii) What is the meaning of "profit" in s.62(2)(b); in particular, whether it refers to 'gross' profit or 'net' profit and, if the latter, what items can be taken into account in computing the net profit for these purposes? (the "profit" issue).”
The UT considered that the insurance premium and conditional success fees were costs/potential costs which had to be incurred to enable the appeal process to happen at all, and that they did not represent a profit, nor earnings under s.62 ITEPA 2003. The UT cited the case of Eagles (Inspector of Taxes) v Levy [1934] 19 TC 23, opining that it supported the view that if a taxpayer has an outlay to achieve a legitimate aim then it should not count as income from the employment.
Court of Appeal
The Court of Appeal disagreed with this viewpoint and upheld HMRC’s appeal on the grounds that the term “profit” did not confer an automatic assumption of net profit and the normal rules for expenses must be observed – namely that the expenses in question did not qualify for a tax deduction because they had not been incurred ‘wholly, exclusively and necessarily’ in the performance of the officers’ employment duties.
In terms of the “from” question, the Court of Appeal confirmed that the correct way to determine whether a payment meets the definition is to refer to Hochstrasser (Inspector of Taxes) v Mayes [1960] AC 376, which concludes that an amount has to not only be derived from the employment, but also to be a reward for services at the same time. The Court of Appeal thus concluded at para 59 of the judgement that: “The Met was right to deduct PAYE from the whole of Mr Murphy's share of the Principal Settlement Sum”.
Conclusion
The case reflects the fact that if one strips back the layers of the onion, the facts should point one to the basic principles of the law – and in this case, that is exactly what happened.
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