Spc00643

Social Security Contributions (Transfer of Functions etc.) Act 1999 section 8, Income and Corporation Taxes Act 1988 section 313; non-compete agreement; liability to pay secondary contributions; Share purchase agreement; Service Agreement; whether sum paid as consideration in Non Compete-Agreement fell within section 313; yes; appeal dismissed

THE SPECIAL COMMISSIONERS

	KENT FOODS LTD	Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

		

				Special Commissioner:  J GORDON REID QC, F.C.I.Arb

Sitting in Edinburgh on 30 and 31 August 2007

David Small instructed by Harper Macleod, for the Appellant 

Roderick Thompson instructed by HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

Introduction

This is an appeal against the decision of the Respondents dated 19th September 2005 that the Appellants are liable to pay secondary contributions of £60,250 for the period 6th April 2000 to 5th April 2002.  Liability is said to be in respect of payments made under a non-compete agreement within the meaning of section 313 of the Income and Corporation Taxes Act 1988.  There is no dispute on quantum.

A Hearing took place at Edinburgh on 30th and 31st August 2007.  The Appellants were represented by David Small, Advocate, instructed by Harper Macleod, solicitors, Edinburgh.  He led the evidence of Ian Dalglish, managing director of the Appellants, Professor Robert Rennie, a partner of Harper Macleod and Professor of Conveyancing at Glasgow University, and Francis McCrossin, a retired partner of Messrs Wyllie & Bissett, Chartered Accountants, Glasgow.  The Respondents were represented by Roderick N Thomson, advocate, instructed by Eric Brown of their Solicitors’ Office, Edinburgh.  The Respondents led no evidence.  Parties lodged a Statement of Agreed Facts and a Joint bundle of Productions.  There was no dispute as to the authenticity of these productions or (where appropriate) their transmission and receipt.  Counsel produced written summaries which they amplified in the course of their closing submissions.  Finally, I should record that in attendance for the Appellants was an employee of Messrs Harper Macleod who, I understand, took shorthand notes of the whole proceedings.  These notes have not, so far as I am aware, been transcribed. The accuracy of the notes, should they be extended, is not a matter of agreement.

Statutory Background

Section 1 of the 1992 Act outlines broadly how National Insurance and the National Health Service is to be funded, namely by contributions payable by earners, employers and others.  Contributions are divided into classes which include primary Class 1 Contributions and secondary Class 1 Contributions.  There are various categories of earners.  By section 3(1) (a), earnings include any remuneration or profit derived from an employment.  Section 4 provides that certain payments are to be treated as remuneration derived from an employed earner’s employment.  Thus, section 4(4) provides inter alia that:-

“For the purposes of section 3 above, there shall be treated as remuneration derived from an employed earner’s employment-
……………
(b) any sum paid (or treated as paid) to or for the benefit of the earner which is chargeable to tax by virtue of section 313 of the 1988 Act(taxation of consideration for certain restrictive undertakings).

By section 6(4), secondary Class 1 Contributions are the liability of the secondary contributor.  By section 7(1)(a), secondary contributor is, in the case of an earner employed under a contract of service, the employer of that earner.

Section 313 of the 1988 Act provides inter alia as follows-

313	Taxation of consideration for certain restrictive undertakings

(1)	Where an individual who holds, has held, or is about to hold, an office or employment gives in connection with his holding that office or employment an undertaking (whether absolute or qualified, and whether legally valid or not) the tenor or effect of which is to restrict him as to his conduct or activities, any sum to which this section applies shall be treated as an emolument of the office or employment, and accordingly shall be chargeable to tax under Schedule E, for the year of assessment in which it is paid.

(2)	This section applies to any sum which-

	(a) is paid in respect of the giving of the undertaking or its total or partial fulfilment, either to the individual or to any other person; and

	(b) would not, apart from this section, fall to be treated as an emolument of the office or employment”

Section 73 of the Finance Act 1988 provides that any sum to which section 313 applied, and which was paid or treated as paid by a person carrying on a trade, may be deducted as an expense in computing the profits of that trade.

Facts

The Statement of Agreed Facts referred to above is in the following terms:-

1.	Copy documents produced by either party are equivalent to principals. All productions are what they bear to be.

2.	Kent Foods Limited is a company incorporated under the Companies Acts, company number SC141654, and has its registered office at Chiron House, Phoenix Business Park, Linwood Road, Paisley PA1 2AB.

3.	Kent Foods Limited was incorporated on 9 December 1992. 

4.	Apart from the short period immediately after the incorporation of the company, when in accordance with normal practice the shares were held by professional persons associated with the formation of the company, the shareholders in Kent Foods Limited from December 1992 until 21 December 1999 were Mr John McGregor Dalglish and his wife Mrs Janet MacAulay Dalglish (hereinafter referred to as “Mr Dalglish” and “Mrs Dalglish” respectively), each holding one £1 ordinary share.

5.	The company formation agent Jordans (Scotland) Limited, was a director of Kent Foods Limited from 9 December 1992 until 21 December 1992. On the latter date Mr Dalglish was appointed a director and Jordans (Scotland) Limited resigned. Thereafter Mr Dalgish was the only director of Kent Foods Limited from incorporation until 21 December 1999.

6.	Mrs Janet Dalglish was the Company Secretary of Kent Foods Limited from 21 December 1992 until she resigned on 15 November 1999. At the time of her resignation her salary as Company Secretary was about £9,700 per annum. Professor Robert Rennie was appointed Company Secretary in place of Mrs Dalglish and resigned on 22 December 1999.

7.	Mr Dalglish’s date of birth is 23 July 1947. Although his Christian name is formally John, Mr Dalglish is widely known as “Iain” because Iain is Gaelic for John. 

8.	Before the events referred to in paragraphs 10 et seq below Mr Dalglish’s salary from Kent Foods Limited was £63,427 per annum. Kent Foods Limited did not provide him with a company car nor with any other material non-cash benefit.

9.	Production Number 9 is the audited accounts for Kent Foods Limited for the years ending 31 March 1998 and 1999. Inter alia these show, at note 7, that dividends were paid £70,000 for year ended 31 March 1997, £240,000 for year ended 31 March 1998 and £120,000 for year ended 31 March 1999. Half of those amounts was paid to Mr Dalglish and half to Mrs Dalglish.  Mr Dalglish’s remuneration as director was £60,840.
 
10.	On 22 December 1999 the shares in Kent Foods Limited were acquired from Mr and Mrs Dalglish by Ellis and Everard (UK Holdings) Limited, a company incorporated in England and Wales under the Companies Acts and having registered number 03024231. Production Number 4 is the Share Purchase Agreement pursuant to which the acquisition took place.

11.	Clause 3 of that Share Purchase Agreement contains a mechanism for calculating the Consideration payable under the Agreement. The total paid in accordance with this clause, £900,000 or thereby to each of Mr and Mrs Dalglish, has been included in Capital Gains Tax computations for the year ended 5 April 2000 in respect of the sale of the shares in Kent Foods Limited submitted to HMRC on their behalf. 

12.	Upon acquisition of the share capital in Kent Foods Limited on 22 December 1999, MD Reid and N Simpson were appointed as directors of that company.  They were directors or employees of companies within the Ellis & Everard group.  Mr Dalglish remained a director of Kent Foods Limited after the acquisition.  Mr Reid resigned on the 31st of December 2000 and was replaced by Mr NA Blackburn. Mr Blackburn and Mr Simpson were also directors or employees from within the Ellis & Everard group. Ellis and Everard PLC, the ultimate parent company of the Ellis and Everard group was, in December 1999 and until its acquisition by Volpak NV mentioned below, a company listed on the London Stock Exchange. 

13.	On or about 17 January 2001 the Ellis and Everard group was acquired by Royal VolpakNV. Following further re-organisation in June 2002 the ultimate parent company of the appellants became Univar NV. In the course of these changes Ellis and Everard PLC was delisted and its name changed to Ellis and Everard Limited.

14.	Production Number 5 is a Service Agreement dated 22 December 1999 between Mr Dalgish and Kent Foods Limited. Inter alia this provided for an initial fixed period of employment of 24 months from 22 December 1999 at a salary of £70,000 per annum plus provision of a company car. Mr Dalglish and Kent Foods Limited entered into the service agreement on the said date.

15.	From a date soon after Ellis and Everard took over Kent Foods Limited, Mr Dalglish was paid his salary by E & E Limited, for the avoidance of doubt a company in the group different to Ellis and Everard (UK Holdings) Limited (the latter being the immediate parent of the appellants).  E & E Limited also made the relevant payments of Pay as You Earn tax and National Insurance Contributions in respect of that salary. All these payments were recharged to and ultimately borne by Kent Foods Limited. 

16.	Production Number 6 is a Non-Compete Agreement dated 22 December 1999 between Ellis and Everard (UK Holdings) Limited and Mr Dalglish. Sums of £250,000 were paid under clause 2 of this Agreement in or shortly after December 2000 and December 2001 and at any rate in the years ended 5 April 2001 and 5 April 2002 respectively. Liability for NIC on these sums is the issue in this appeal. No part of these sums was re-charged to Kent Foods Limited.

17.	Production Number 7 is a letter pertaining to the accrual and payment of interest on sums due under the Non-Compete Agreement, at the base rate of the National Westminster Bank less 1%. Two payments of interest were made thereunder, shortly after the due dates in each case, but at any rate in the years ended 5 April 2001 and 5 April 2002 respectively.

18.	Ellis and Everard (UK Holdings) Limited did not deduct any income tax or NIC when making payment of the said sums of £250,000. However they have subsequently made a payment equating to the basic rate income tax to the respondents.

19.	Ellis and Everard (UK Holdings) Limited has claimed relief under section 73, Finance Act 1988 in respect of the payments made by it under the Non-Compete Agreement. 

20.	Production Numbers 41 and 42 are Mr Dalglish’s Tax Returns for the year ended 5 April 2001 and for the year ended 5 April 2002 respectively. The Returns treated the sums received under the Non-Compete Agreement as capital gains.. 

21.	In December 2001 Kent Foods Limited and Mr Dalglish entered an Agreement, which appears at Production Number 46, inter alia providing for the employment of Mr Dalglish from 1 January 2002 to 31 December 2002 at a salary of £75,000 per annum plus £775 per month in lieu of providing a car. 

22.	On 12 December 2002 the service agreement entered into in December 2001 was, by minute executed by Mr Dalglish and Kent Foods Limited being Production Number  53 amended so as to continue indefinitely subject to the amendments set out therein.

23.	In September 2003 the shares in Kent Foods Limited were acquired from Ellis and Everard (UK Holdings) Limited by HMS (485) Limited, a company owned by Mr and Mrs Dalglish.

24.	Upon that acquisition Mr Blackburn and Mr Simpson, together with two other directors appointed in February 2003 during the period when the appellants were part of the Ellis & Everard group, resigned as directors of the appellants.  Mr Dalglish remained and remains a director. 

From the evidence and the agreed documents, I make the following additional findings of fact:-

25.	As a young university graduate, Mr Dalglish joined the industrial food division of Proctor and Gamble in about 1969.  After about five years, he joined the Glasgow based company Archibald Fleming & Company Ltd.  He was seconded to the International Company of Canada Packers, and was subsequently employed by that company.  While with these companies, he gained experience in the sale and distribution of bakery fats, vegetable oils, frying media and dairy products for the food service industry and industrial markets.

26.	He established his own business, JM Dalglish (Sales & Marketing) Ltd; in about 1979; he and his wife were the (equal) shareholders.  The nature of the business was the sourcing and distribution of various industrial commodities, notably non-refined sugar, dairy products and edible oils.  The company went into receivership at the instigation of its bankers, Clydesdale Bank, and then liquidation in about 1986.  Another business on the same basis was soon re-established by Mr & Mrs Dalglish under the name Kent Foods (Scotland) Ltd.  The business prospered and became one of the largest, if not the largest, non-manufacturing distributors in the United Kingdom of dairy ingredients and non-refined sugar.  Essentially, the business operated as a middleman between food ingredient manufacturers and food manufacturers.  Mr Dalglish was the “key man” in the business having built up considerable experience and expertise in this niche area in the previous twenty or more years.  He was and is a successful businessman and was principally responsible for the Appellants’ success in business.  Although company secretary, Mrs Dalglish did not participate directly to any significant extent in the running of the business.

27.	In 1992, 75% of their shareholding was sold to another business, named Ashtongate.  That arrangement did not thrive and at the end of 1992, Mr Dalglish again set up on his own, this time under the name Kent Foods Ltd (the present Appellants).  Between 1993 and 1999, the Appellants traded in much the same way as Kent Foods (Scotland) Ltd had done, buying dairy products, sugars a edible oils and selling them to small and medium sized food manufacturers.  It had a similar supplier and customer base.  It had few employees.  The only other important employee was Iris Stirling who has been with the business since about 1986.  She was responsible for the administration side of the business although she was sufficiently competent to handle commercial transactions and did so when Mr Dagleish was on holiday from time to time.  She and Mr Dalglish ran the business together.  However, Mr Dalglish, with his experience and expertise, was the key man in the business.  

28.	The Appellants had minimal plant and equipment. They had relatively few vehicles; sub-contracting haulage to CIT Transport & Trading Ltd of which Mr Dalglish was a director, and which he and Mrs Dalglish “owned”; that company worked mainly but not exclusively for the Appellants.  The Appellants operated from small premises either as tenant or licensee, and rented warehousing space.  The Accounts of the Appellants for the year to 31st March 1999 disclosed a turnover of £15,587,357, a net trading profit of £545,970, fixed tangible assets of £133,407, current assets (mainly debtors) of £2,845,289, and overall net assets of £1,142,282 [Production 9].  They were a profitable company.  

29.	The business of Ellis & Everard related principally to the sale, marketing and distribution of chemicals, some being used as ingredients in food such as citric acid, and polymers although they had a food division, called Fiske.  Negotiations with Ellis & Everard began in 1997.  Exploratory talks took place.  However, no “offer” was made until about August 1999.  At that early stage it was not clear whether Mr Dalglish’s services would be retained, although Mr Dalglish was keen to remain.  

30.	However, Mr Dalglish discussed matters with Mr McCrossin in a telephone conversation on 7th August 1998.  Production 10 is Mr McCrossin’s manuscript note of that conversation.  That note mentions a purchase price of £2m to £2.2m depending on salary for Mr Dalglish; by that stage it was contemplated that he would agree to work for a further two to three years.

31.	It was envisaged that Mr Dalglish would remain otherwise it would be difficult to integrate the two businesses.  By letter to the Appellants dated 14th September 1999 [Production 11], Ellis & Everard plc set out the principal terms upon which it was proposed Ellis & Everard (UK Holdings) Ltd would acquire the Appellants.  These included a payment of £2.3m for the company to be paid in instalments and a two year service contract for Mr Dalglish at £70,000 per annum plus company car; a non-compete agreement was also required.  That letter was copied to Mr McCrossin.  By that stage, if not before, there was a mutual desire that Mr Dalglish’s services be retained.  If Mr Dalglish had not wished to “remain”, the transaction would probably not have proceeded.  Likewise Mr Dalglish would not have “worked” with Ellis & Everard had they not bought the shares.

32.	A draft Share Purchase Agreement was prepared and sent to the Appellants solicitors, Balllantyne & Copland in late September 1999 [see Productions 13-15]. Professor Rennie was then a partner in that firm and was the partner responsible for the revisal of the various documents.  He is now a partner in the firm of Harper Macleod, solicitors, with whom Ballantyne and Copland subsequently merged.  Various communings between the Appellants and their advisers and those representing Ellis & Everard took place.  Drafts were circulated [e.g. production 19, 20 and 23, 27, 29].  

33.	The first draft of the Share Purchase Agreement referred, in Clause 3, to a consideration of a sum equivalent to the value of the net assets of the Appellants plus £71,000, plus £,1,100,00 payable in two tranches of £550,000 on the first and second anniversaries of Completion (in cumulo net asset value plus £1,171,000).  The payment of £1,100,000 was conditional upon Mr Dalglish remaining in the employment of the Appellants or one of the Everard and Ellis group companies.

34.	By letter to Mr Dalglish dated 5/10/99 [Production 14], Professor Rennie made it clear to Mr Dalglish that tax advice would be required from his accountants [Production 14].  By letter dated 8th October 1999, [Production 15] Professor Rennie sent a copy of the draft Share Purchase Agreement to Messrs Wyllie & Bissett, the accountants of Mr & Mrs Dalglish.

35.	A meeting took place on 15th November 1999 between Mr and Mrs Dalglish, Professor Rennie and Mr McCrossin.  Among other matters compensation for loss of office was discussed, and the draft Share Purchase Agreement revised.  On the following day, Professor Rennie sent a copy of the revised Agreement to Mr McCrossin, [Production 17] to Mr & Mrs Dalglish [Production 18] and to Hammond & Suddards, the solicitors acting for Ellis & Everard [Production 19]

36.	As at 16th November 1999, the draft Service Agreement had not yet been prepared [Production 19 paragraph (9)].  It was received by Professor Rennie in early December and he sent copies to Mr Dalglish and to Mr McCrossin on 3rd December, a Friday, [Productions 21, 22 & 23] along with the next version of the draft Share Purchase Agreement received from Messrs Hammond & Suddards.

37.	A meeting took place on 6th December 1999 at which Mr McCrossin, Professor Rennie and Mr Dalglish were present.  Mr McCrossin’s manuscript notes [Production 24] refer inter alia to Loyalty Bonus of £500,000 and to a Non Compete Agreement.  The phrase “loyalty bonus” was probably used initially by Mr Dalglish to describe the proposed Non-Compete Agreement.  Reference is also made in these notes to whether the payments (sic) will incur National Insurance, a concern raised by Mr Dalglish, and to how Ellis & Everard intended to treat the payment for tax purposes.  Mr McCrossin indicated at the meeting that he would discuss these matters with Mr Simpson, Ellis & Everard’s finance director.  He did so and Mr Simpson, himself a chartered accountant, informed Mr McCrossin that the loyalty bonus was being treated as capital.  This reassured Mr McCrossin.  At this stage, both Mr & Mrs Dalglish were named as parties to the Non-Compete Agreement [see draft Production 30]

38.	Following that meeting, Professor Rennie, by letter dated 7th December 1999, returned various drafts to Hammond & Suddards including the Share Purchase Agreement and the Service Agreement [Production 25].  A further revised version of the Share Purchase Agreement was sent out by Professor Rennie on 8th December [Production 26 and 27].  The consideration for the purchase of the shares was to be a sum equivalent to the value of the net assets of the Appellants plus £671,000.  A further £500,000 was to come through the Non-Compete Agreement (in cumulo still net asset value plus £1,171,000).  Professor Rennie deleted various restrictive covenants in the Share Purchase Agreement as they appeared in similar form in the Service Agreement and the Non-Compete Agreement.

39.	Revised drafts of the Service Agreement and the Non-Compete Agreement were, by letter dated 9th December 1999, returned to Hammond & Suddards [Productions 28, 29 and 30].  The salary remained unchanged at £70,000 [Clause 6.1 of Production 29].  The draft Non-Compete Agreement (the first draft of which bears the date 1/12/99- Production 30 page 1) included Mrs Dalglish as a party.  Professor Rennie’s revisals did not, at this stage, remove her as a party.  He deleted clauses 14 and 15 of the draft Service Agreement, which related to restrictive covenants) because that topic was dealt with in the Non-Compete Agreement.  Hammond & Suddards subsequently declined to accept this proposed deletion.  Substantially the same restrictive covenant provisions had also been included in the draft Share Purchase Agreement [Production 20].  The draft Non-Compete Agreement contained a provision for consideration of £500,000 half of which was payable on the first anniversary of Completion and the other half on the second anniversary [Production 30].  

40.	Mr McCrossin spoke to Mr Simpson again by telephone on 17th December 1999.  Production 35 is Mr McCrossin’s manuscript note of that conversation and records that Mr Simpson had spoken to KPMG; they had advised that all the loyalty bonus be paid to Mr Dalglish.

41.	In a letter to Hammond & Suddards, dated 20th December 1999, Professor Rennie recorded that “in relation to the non-compete agreement and the loyalty payments” it was proposed that these be paid to Mr Dalglish but that should he die before the total payments had been paid, the monies would be paid to his estate [Production 37].  That proposal was accepted.  Agreement was eventually reached on all matters and completion of the transaction took place on 22nd December 1999.  The documents executed on that date as part of the settlement or completion of the overall transaction included the Share Purchase Agreement [Production 4], the Service Agreement [Production 5] the Non-Compete Agreement [Production 6], and the back-letter [Production 7]

42.	Clause 2 of the Non-Compete Agreement [Production 6] provided that the consideration for entering the agreement was £500,000 payable by two equal instalments on the first and second anniversaries of the agreement.  In exchange, Mr Dalglish gave various negative undertakings including (in summary) for three years from completion (a) not to be concerned in he business of distribution,  sale or marketing of food products in the UK in competition with the Appellants,  (b) not to solicit or entice away any employees of the Appellants, (c) not to employ any employee of the Appellants who was engaged in any sales or commercial capacity, (d) not to solicit in competition with the Appellants orders from their past customers, (e) not to accept orders from their past customers, and (f) not to interfere with the continuance of supplies to the Appellants from any of their past suppliers.  There is a proviso which explains that nothing in the foregoing is to prevent Mr Dalglish from performing his duties under the Service Agreement

43.	The Service Agreement [Production 5] is between Mr Dalglish and the Appellants (by then controlled by Ellis & Everard (UK Holdings ) Ltd in terms of the Share Purchase Agreement-Production 4).  In outline, it appointed Mr Dalglish as general manager for an initial period of twenty four months, terminable thereafter on three months notice by either side, (Clauses 1 and 2.1).  The Service Agreement also required him to devote his whole time and skill to the Everard Group (Claus 4.1.1), prohibited him from carrying on business or providing services to a third party (Clause 4.2), and provided for a salary of £70,000 (Clause 6).  Clause 14 contained restrictive covenant provisions which were to endure for nine months following termination of Mr Dalglish’s employment under the Service Agreement.  These were similar in format to the provisions in the Non-Compete Agreement set forth in finding-in-fact 30.  The essential difference is that these provisions in the Non-Compete Agreement ran for a period of three years from 22nd December 1999 (the Date of Completion under the Share Purchase Agreement) whereas the restrictive covenants contained in the Service Agreement ran for a period of nine months from its termination.  Clause 20 of the Service Agreement records the link between that agreement and the Non-Compete Agreement 

44.	Clause 4.5 of the Share Purchase Agreement [Production 4] provided that at Completion the Vendors (i.e. Mr & Mrs Dalglish) had to procure the execution of the Service Agreement and the Non-Compete Agreement.  This provision was first introduced into the draft Share Purchase Agreement [Production 23] which Professor Rennie received in early December 1999 and which Professor Rennie distributed for comment by letter dated 3rd December.  Its introduction was consistent with (i) the reduction in share price by £500,000 and the removal of clause 3.2 of the Share Purchase Agreement which had made part of the consideration conditional on Mr Dalglish remaining in the employment of the Appellants or one of the Ellis and Everard group companies, and (ii) the consideration in the draft Non-Compete Agreement being £500,000.

45.	The first payment of £250,000 under the Non-Compete Agreement was made shortly after December 2000.

46.	After VolpakNV took over at the end of 2001, they showed little interest in developing the business of the Appellants within the structure of their group of companies.  At one stage, the intention had been to incorporate the business of the Appellants into the business of one of the Ellis & Everard group of companies, G Fiske & Co Ltd, leaving the Appellants dormant.  However by the end of 2001 it was Fiske that had become dormant.

47.	The attitude of VolpakNV led to the re-acquisition of Kent Foods Ltd by Mr Dalglish in 2003 (see paragraphs 13, 23 and 24 of the Statement of Agreed Facts)

48.	The audited accounts of Ellis & Everard (UK Holdings) Ltd (KPMG Audit plc were the auditors) for the year to 30 April 2000 [Production 49] record that on 22nd December 1999 that company acquired the whole of the issued share capital of the Appellants for £1,826,813.  

Submissions

Both counsel proposed that certain additional facts be found.  Neither took significant issue with the other’s proposals.  I have, with some modification, incorporated, the thrust of their suggested findings of fact in the additional facts set forth above.

Mr Small submitted that the Non-Compete Agreement said nothing about employment.  The restrictive covenant provisions in the Non-Compete Agreement and the Service Agreement, while containing similarities, were materially different in some respects.  He produced a table, which I append to this Decision, outlining these differences.  Mr Thomson did not dispute the accuracy of its contents.  Mr Small submitted that there were reasons why Ellis & Everard might consider the Non-Compete Agreement to be of value.  It effectively allowed them to sack Mr Dalglish for any reason.  The courts were also more likely to uphold restrictive covenants given on disposal of a business (Nordenfelt v The Maxi Nordenfelt Guns & Ammunitions Co Ltd 1894 AC 535, Herbert Morris Ltd v Saxelby 1916 1 AC 688).

On the question of statutory construction, Mr Small submitted that the proper interpretation of Section 313(1) of the 1988 Act was the crux..  He referred to Beak v Robson 1943 AC 352, Vaughan-Neil v IRC 1979 STC 644 and RCI v Woods 2004 STC 315 which he analysed in detail.  It was the giving of the undertaking and not the undertaking itself which had to be connected to the holding of the office or employment.  That connection must be a real one.  This was a question of fact to be answered by examining all the circumstances.  Mr Dalglish did not give the undertakings in the Non-Compete Agreement in connection with his present or future holding of employment with the Appellants because (i) the Non-Compete Agreement does not mention his employment, (ii) the other party to the Non-Compete Agreement was not his employer but the purchaser of his shares, (iii) the undertakings in the Non-Compete Agreement were given in connection with the share sale, (iv) the restrictive undertakings in the Service Agreement were given in connection with his employment with the Appellants for which nothing was paid, (v) Mr Dalglish’s remuneration was not affected by the attribution of £0.5m to the Non-Compete Agreement, (vi) the original consideration for the shares was reduced by the amount of the consideration for the Non-Compete Agreement moreover, the Non-Compete Agreement consideration was payable with interest to his estate with interest should he die prematurely, (vii) the fact that Mrs Dalglish was not a party to the Non-Compete Agreement is irrelevant because she was not involved in the business and because she would have been a party to the Non-Compete Agreement but for Mr McCrossin’s misunderstanding about “loyalty bonuses”, and (viii) the Non-Compete Agreement undertakings all related to the business of the Appellants; Ellis & Everard planned to discontinue that business and employ Mr Dalglish in Fiske.

Furthermore, Mr Dalglish did not give the undertaking in the Non-Compete Agreement in connection with his past employment with the Appellants because (i) he gave the undertakings in connection with the sale of his shares; he did not give them in connection with any employment in a commercially significant sense; he would not have become employed by Ellis & Everard unless they bought his company (ii) in section 313, “holding” implies the connection must be with the status of employment - taking it up, varying its terms, terminating it; and not the work carried out while in employment or the experience gained while employed or with people met whilst employed, otherwise section 313 becomes too wide and absurd consequences follow. 

Mr Thomson, for the Respondents, submitted that on the facts, the reference to the sum of £500,000 as a loyalty bonus reflected the understanding of Mr Dalglish and Mr McCrossin that the payment was thus linked to the former’s continued involvement with the Appellants as an employee and the protection afforded to Ellis & Everard by the restrictive covenants to be granted.  The use of that phrase gave the flavour to what was at the heart of this part of the transaction.  The Appellants’ advisers at the time saw no distinction between the restrictive covenants in the three principal documents.  If the payment of £500,000 was truly in consideration of shares, then it would have been split between Mr & Mrs Dalglish.  The two payments of £250,000 were not treated as capital by Ellis & Everard (UK Holdings) Ltd.  The facts established that the undertaking given in the Non-Compete Agreement was connected with Mr Dalglish’s holding of the employment with the Appellants.  The undertaking in the Non-Compete Agreement was given in order to protect the value of the shares being acquired.

He submitted that the appeal could be decided in the Respondents’ favour by considering the three principal documents (and possibly the back letter) together, especially Clause 20 of the Service Agreement.  On that basis alone, the requisite connection was established and the Appellants must fail.  When one adds the surrounding circumstances the connection is even stronger.  He submitted that the Appellants have had real difficulty in analysing the transaction in a way that avoids the connection with Mr Dalglish’s employment with the Appellants.  The appeal was originally based on the assertion that Mr Dalglish was not employed by the Appellants; then the assertion was that the £500,000 was additional consideration for the shares; in correspondence it was suggested that the documents did not reflect the agreement reached.

It can be accepted, Mr Thomson argued, that the Non-Compete Agreement is connected with the share purchase but the legislation did not require that the sole connection be with the employment.  It was not surprising that the Service Agreement did not contain the provisions relating to the payment of £500,000.  For the first two years and nine months after the share acquisition Mr Dalglish was restricted in his activities by both the Service Agreement and the Non-Compete Agreement.  The Appellants’ argument amounts to saying that the payment of £500,000 is for additional restrictions in the Non-Compete Agreement.

Mr Thomson also relied upon clause 20 of the Service Agreement which acknowledges the connection between the Service Agreement and the Non-Compete Agreement.  The whole purpose of the Non-Compete Agreement was, as at the completion date, to provide protection to the purchasers against Mr Dalglish setting up on his own and using his business skills and connections which he currently possessed in competition with them.  The connection with employment which Mr Dalglish has held within the meaning of section 313 is thus established.

There was also a clear link to continued or future employment; the use of the phrase loyalty bonus establishes that, as does an examination of the principal documents as a package deal.  The word holding should not be given the restricted meaning proposed by the Appellants.

He referred to Vaughan-Neil and submitted that a low level of connection was sufficient.  In connection with should be construed widely.  He adopted the Crown argument in that case as to the approach to statutory construction.

Discussion

In my opinion, the starting point is the proposition that a taxpayer is free to structure his commercial arrangements as he sees fit.  Tax consequences may or may not flow from these arrangements.  It is obvious that some commercial transactions may be genuinely structured in a variety of ways so as to avoid or mitigate any consequent tax liability.  Conversely, with hindsight, it can sometimes be seen that a commercial arrangement has been structured in a way which leads to a tax liability which, by the adoption of different commercial structure, could have been avoided or mitigated.  I leave aside all questions of anti-avoidance schemes, sham or artificial transactions inserted purely to attempt to avoid tax.  This appeal is not about such arrangements. 

The starting point on the facts is therefore the arrangements that were carried into effect in December 1999.  The evidence as to how the negotiations led to the execution of the various documents in their final form is therefore not relevant to their proper construction or to an analysis of what the commercial structure was.  The commercial structure and the commercial reality of the transaction are to be found primarily in the Share Purchase Agreement, the Service Agreement, the Non-Compete Agreement and the Back Letter.

In case I am wrong about this approach, I have made detailed findings of fact reflecting the evidence relating to the background to the share acquisition and the negotiation of the terms of these documents.  The picture painted by the evidence and background documents was not entirely clear in places and it has not been easy to establish a precise chronology of events, and in particular the various exchange and revision of drafts.  However, I have been able to make findings of how at least, in general terms, the negotiations proceeded.  An examination of these facts and circumstances does not lead me to any different conclusion.

I found all witnesses to be generally credible and reliable.  Neither counsel suggested otherwise.  The findings of fact constitute my attempt to piece together the main strands of the chronology of events spoken to by the various witnesses from their own particular perspective.  As for the Non-Compete Agreement itself, although the documents and evidence are not entirely clear, it seems that the first draft of the Non-Compete Agreement was received by Professor Rennie on or about 3rd December 1999.  It was discussed at the meeting on 6th December, revised on the 7th  and returned to Hammond & Suddards by letter dated 9th December [Production 28 and 30].

I agree with Mr Thomson’s broad submission that the commercial arrangements should be considered as a whole.  Essentially the transaction is in two parts.  Ellis & Everard (describing them generally) acquire the shares and the exclusive services of an expert in the food distribution business; Mr & Mrs Dalglish receive the purchase price.  Mr Dalglish secures his employment at the specified salary for a specified minimum period and agrees to certain restraints on his business activities for which he receives £500,000.  Mr Dalglish’s business skill and success were probably the main attraction to Ellis & Everard and more important than the relatively few assets held by the Appellants.  Mr Dalglish modestly demurred to such a suggestion in cross-examination, but it seems to me, on the evidence, to be a point well made.  

The various aspects of the transaction are all linked or connected one to the other.  It was a package tied together and wrapped up by the execution of the various documents in December 1999.  The sum of £500,000 was as much part of the overall arrangement as the salary of £70,000.  The overall transaction remained much the same as envisaged from a relatively early stage.  However, at the end of the day it came to be structured differently.  The transfer of a portion of the purchase price to the Non-Compete Agreement could have been £500 instead of £500,000.  The £500,000 cannot, in the light of the terms of the documents, be regarded as part of the share price.  

In my view, there was plainly a connection between the holding of Mr Dalglish’s employment past, present and future with the Appellants and the giving of the undertakings contained in the Non-Compete Agreement.  He was an expert in the food distribution industry, had good business connections and ran a profitable business.  He had been and continued to be the “key man”.  He was about to enter into a service contract with the Appellants.  The giving of the undertakings in the Non-Compete Agreement which restricted his business conduct and activities was certainly connected with the share purchase but it was also plainly connected with the employment he held and the new arrangements he was about to take up.  The transaction would not have come to pass had Mr Dalglish been unwilling to enter into the Service Contract and/or the Non-Compete Agreement.  Each restrained Mr Dalglish’s activities.  The Non-Compete Agreement had immediate effect whereas the Service Agreement would only bite following termination of employment.  The connection between the giving of the undertaking and the holding of the employment can hardly be said to be de minimis.  That the giving of the undertaking is also connected with something else is of no moment.  The statutory phrase in connection with is wide in scope.  It does not say exclusively or solely in connection with.  Clause 20 of the Service Agreement simply reflects the reality of the situation.

There is nothing in the authorities cited to me which compels me to reach a different conclusion.  In Beak, the taxpayer entered into a five year service contract, employing him as manager and director of a company, which contained a restrictive covenant.  The consideration for the restraint was £7,000 which was assessed under Schedule E.  In a very short speech, Viscount, Simon’s analysis was that the obligations of service and remuneration were entirely separate from the restrictive covenant and the consideration therefor; he founded on the facts that the covenant would only come into effect on termination of the employment; the sum was not therefore profit from his office as director.  Unlike the restrictive covenant in Beak, the Non-Compete Agreement here has effect while the Service Agreement was running (or at least its first three years).  The decision in Beak is really only of interest as it led to the passing of anti-avoidance legislation, originally section 26 of the Finance Act 1950 and now section 313 of the 1988 Act.

In RCI, following the termination of a service agreement, a director entered into a severance agreement containing various restrictive covenants to endure for one year.  Under the Severance Agreement the former director was to receive two large payments; the former director elected under that agreement to extend the period of restraint by a further two years for which he became entitled to a further three payments.  It was conceded that the first two payments and held by the Special Commissioner and by Lightman J on appeal, that the remaining three payments fell within the scope of section 313(1).  The anti-avoidance legislation imposed no restriction on the type of “connection”; thus any connection which was not de minimis would suffice (page 333f paragraph 26, page 334e paragraph 30).  The language of section 313 was apt to embrace both on-going and extinct relationships (ibid).  Thus a real connection with the termination of the holding sufficed (page 334g paragraph 31).  On the facts there was also a sufficient connection with the individual’s past status as an employee or director.  Among the factors establishing that connection was the fact that the undertakings given all related to the business of RCI or its associated companies, which was the business in which the individual was employed.

In Vaughan_Neil, a distinguished barrister, a leading expert in planning law, was invited to take up part-time employment with a limited company.  This necessarily involved giving up practice at the Bar.  As an inducement he was offered and accepted the sum of £40,000.  He entered into a deed containing a service agreement which narrated that the sum was an inducement to give up the status of a practising barrister and all that entailed.  The barrister’s assessment to tax was upheld by the Special Commissioner.  Oliver J allowed an appeal, holding that the connection had to be between the actual or prospective holding of the office and the giving of the undertaking.  In analysing the relevant facts and circumstances, which went beyond merely construing the documents, to identify the “reality” of what the payment was for or in respect of, he concluded that the covenant to cease practise at the Bar was merely a statement of a necessary and inevitable consequence of entering into a service agreement.  The undertakings caught by the statutory provision did not embrace the simple undertaking of the very duties inherent in and inseparable from the employment itself.  The point was acknowledged to be a narrow one.  The facts are distinguishable but the approach to the problem of causal connection shows that it is legitimate, at least in some cases, to examine facts and circumstances beyond the four corners of the relevant documents in order to identify what in reality the payment was for.  Such an analysis in the present appeal, if anything reinforces the existence of the connection required for liability to be established.

On may speculate as to why restraints on Mr Dalglish’s activities were to be found in both the Service Agreement and the Non-Compete Agreement.  Belt and Braces is perhaps the obvious answer, although the provisions are not identical; rather, they overlapped or were capable of overlapping to some extent.  While it is true, as Mr Small pointed out, that Mr Dalglish’s employment is not mentioned in the Non-Compete Agreement and the other party to the Non-Compete Agreement is not his employer, that does not mean that there is no connection for the purposes of section 313.  Here, the Non-Compete Agreement, or more correctly the giving of the undertakings contained in that agreement was connected with both sale of the shares and the employment of Mr Dalglish, which he had held in the past as “key man” in the Appellants’ business and the employment he was about to hold under the Service Agreement, which in reality created continuity of his role in the Appellants even although the underlying ownership of the Appellants was being transferred to Ellis& Everard.  Whether one takes a narrow or broad view of the meaning of holding the connection remains.

Result

I find that Mr Dalgish gave, in connection with the employment he held or was about to hold with the Appellants, undertakings in the Non-Compete Agreement the tenor or effect of which was to restrict him as to his conduct or activities all within the meaning of section 313 of the 1988 Act.  Sums totalling £500,000 were paid in respect of the giving of those undertakings.  These sums were chargeable to tax under Schedule E.  By virtue of Section 4 of the 1992 Act, these payments fell to be treated as remuneration derived from an employed earner’s employment for the purposes of section 3 of that Act.  Those payments are subject to national insurance contributions including secondary Class 1 contributions.  Liability for secondary Class 1 contributions falls on the secondary contributor, namely the Appellants, by virtue of sections 6 and 7 of the 1992 Act.  

In these circumstances, the Respondent’s decision dated 19th September 2005 [Production 1] is well founded.  The appeal against that decision is dismissed.

APPENDIX

Appellants’ comparison between Service Agreement and Non-Compete Agreement 

Service Contract Prod 5	Non-Compete Agreement (Prod 6)	
Duration.
Clause 2.1 - effectively 2 yrs 3m for employment contract.
Clause 14 - 9 months after termination of employment contract.	Duration
Clause 3.1 - 3 years.	
Application.
As noted below, clauses refer to other Group companies with whom IMD has had contact.	Application
Generally, Company only.	
Cl 4.2; during employment with KFL not to have any other job/business interests without permission of the board provided ok to hold up to 5% of quoted co’s UK or overseas.

Cl14.1; Not to be involved in Sc/Eng/NI in any business in competition with Group Co for which IMD has worked in last 12 mths	Cl 3.1(a) - not to be involved in any business of food distribution, sale or marketing in competition with the business of the Co in Eng, W, Sc, NI, Eire, Ch Is or IoM provided ok to hold up to 3% of certain UK quoted co’s.
(Geographical difference)	
		
Cl 14.1.5 - approx equivalent (tho’ could be re any Group Co if IMD had contact with the employee).	Cl 3(1)(b) - not to solicit any person employed by the Co at Completion in sales/commercial capacity 
	
No equivalent.	Cl 3.1(c) - not to employ anyone who as at completion was employed in certain capacities by the Co	
Cl 14.1.2 - approx equivalent (tho’ could be customer of any Group Co with whom IMD has had contact in last 
12 m)	Cl 3.1(d) - not to solicit custom from anyone who has been a customer of the Co in 12 m pre completion	
Cl 14.1.3 - not to deal with any person who is a customer of the Co/Group and 
with whom IMD has dealt in last 12m	No exact equivalent	
No equivalent.	Cl 3.1 (e) - not to accept orders from any person who has been a customer of the Co in the 12m pre-Completion.	
Cl 14.1.4 - approx equivalent (tho’ could be customer of any Group Co with whom IMD has had contact in last
 12 m)	Cl 3.1(f) - not to interfere with supplies to Co from suppliers to Co in last 12 m 	
Cl 21 - Scots Law applies 	Clause 6 - English law applies	

J GORDON REID QC, F.C.I.Arb
SPECIAL COMMISSIONER

RELEASED: 8 November 2007

SC