Spc00710

Employee recognising that task for which she had been recruited was complete – over-qualified for continuing job - voluntary resignation notwithstanding loss of redundancy and other benefits of continued employment – ex-gratia payment recognising her decision – whether taxable as earnings – no – whether taxable as a termination payment – yes – whether exempt under UK/US Double Taxation Convention 2001 – yes – appeals allowed

THE SPECIAL COMMISSIONERS

	RESOLUTE MANAGEMENT SERVICES LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

	MRS KATHLEEN ANN HADERLEIN	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioner: 	MALCOLM GAMMIE CBE QC

Sitting in public in London on 10 April 2008

Akash Nawbatt, counsel, instructed by Reynolds Porter Chamberlain LLP solicitors, for Resolute Management Services Ltd

Mary-Heather Styles of Transatlantic Tax Inc for Mrs Haderlein

A J Mear, HM Revenue and Customs Appeals Unit for the Respondents

© CROWN COPYRIGHT 2008

DECISION

The Appeals
1.	Resolute Management Services Ltd (“Resolute”) appeals against a determination made on behalf of the Commissioners for HM Revenue and Customs (“HMRC”) dated 17 April 2007 pursuant to Regulation 80 Income Tax (PAYE) Regulations 2003.  Mrs Kathleen Haderlein appeals against a closure notice and amendment of her Self-Assessment Tax Return for 2005 issued by HMRC on 2 November 2006 pursuant to section 28A(1) and (2) Taxes Management Act 1970.  Both appeals arise from the same transaction – a payment made by Resolute to Mrs Haderlein following the termination of her employment with Resolute – and on 10 December 2007 it was directed that the appeals should be heard together.
The Facts
2.	The basic facts giving rise to these appeals were not in dispute and were set out in a Statement of Agreed Facts, which I reproduce below with the omission of the details of the actual amounts of Mrs Haderlein’s salary and bonuses to the extent that such details are irrelevant to the issue that I have to decide.  It is not disputed that Mrs Haderlein was properly remunerated having regard to her position with Resolute.
(1)	The Appellant (“Resolute Management Services Limited”) was formerly known as Equitas Management Services Limited.  The Appellant is referred to throughout this Statement as “Resolute”.
(2)	The Respondents will be referred to as “HMRC” throughout this Statement.
Kathleen Haderlein’s employment and benefits associated with that employment
(3)	Mrs Haderlein, a US National, was initially employed by Resolute in November 1996.  Her starting salary was £.  Her salary at the date of her resignation was £.
(4)	Mrs Haderlein was a senior executive of the company and was remunerated at a level commensurate with that status.  She was one of the highest remunerated employees below Board level.  During the course of her 8 year employment with Resolute, Mrs Haderlein received 8 pay rises awarded at the annual July salary reviews.  She also received 8 annual bonuses (totalling £) and throughout the period of her employment she was in the top 3% of employees in the bonus pool.
Additionally, she received five Long Term Incentive Plan bonus payments which in total amounted to £.
Circumstances leading to Mrs Haderlein’s resignation
(5)	Resolute was formed as part of the Lloyd’s Reconstruction and Renewal plan in 1996 to reinsure the liabilities of Lloyd’s of London, Non Life Syndicates allocated to the 1992 and prior year’s account and to perform the run off of those liabilities.  However, given that Resolute was unique amongst commercial businesses, as its purpose was to do itself out of business by successfully settling the 1992 and prior year liabilities, the company eventually began to downsize.
(6)	At this time, Mrs Haderlein’s role effectively changed from managing high volume staff recruitment and establishing human resources policies to establishing a managed headcount reduction programme.
(7)	On 21 July 2004 Mrs Haderlein resigned from Resolute.
(8)	At the date of her resignation Mrs Haderlein’s potential redundancy benefit was assessed to be £152,300 and the outstanding Long Term Incentive Plan awards amounted to £122,500.
(9)	Mrs Haderlein left Equitas on 17 September 2004.
(10)	On 19 November 2004 a payment of £150,000 was made to Mrs Haderlein by Equitas.  [I refer to this hereafter as “the ex gratia payment”.]
(11)	In early November 2004, Mrs Hadlerlein contacted Equitas to provide bank details for the account to which the payment should be sent.  Mr Scott Moser authorised the payment to be transferred on 17 November 2004 and the transfer was effected on 19 November 2004.  A schedule of the payment was sent to Mrs Haderlein on 18 November 2004.  On 7 December 2004, Mr Moser sent a memorandum to the Chairman of Equitas asking for his signature to document the payment.
The Assessment and the Appeal
(12)	On 18 August 2006, the Employer Compliance Officer, Mr Brown, asked Resolute to provide further information and documentation relating to the payment made to Mrs Haderlein.  Correspondence then ensued between the parties.
(13)	On 17 April 2007, the Compliance Support Officer, Mr McDonald, issued a Determination under Regulation 80 Income Tax (PAYE) Regulations 2003 and a section 8 Decision.  On 10 May 2007 Equitas appealed against the Section 8 decision.
(14)	On 13 July 2007 the appeal was withdrawn.  HMRC has given an undertaking not to seek payment of any NIC that may have been due.
(15)	The Regulation 80 Determination remains under appeal.
3.	I heard evidence from Mr Scott Moser, the Chief Executive Officer of Resolute, and Mrs Kathleen Haderlein.  There was also an agreed bundle of documents incorporating the exhibits referred to in Mr Moser’s and Mrs Haderlein’s witness statements.  Based on their evidence and the documents I find the following further facts in relation to this matter:
(1)	Before she joined Equitas Management Services Ltd (referred to hereafter as “Resolute”), Mrs Haderlein had gained 20 years experience working in Human Resources.  Her experience was mainly derived from working for Argonaut Insurance Co, a publicly quoted US Insurer where, for the last 6 years of her employment, she was Vice President of Human Resources.  She was asked to join Resolute as Head of Human Resources as a result of representations made by Michael Crall, a fellow US citizen and the first CEO of Resolute.  Mrs Haderlein had worked with Mr Crall at Argonaut Insurance, where he had seen her deal with HR issues similar to those that he expected to face at Resolute.  These included bringing together and creating a company identity that all sectors could feel part of, the development of company procedures and high volume staff recruitment.
(2)	Mrs Haderlein’s employment as Director of Human Resources commenced on 4 November 1996, shortly after Resolute commenced business.  She relocated from the US to the UK to take up the position.  Her contract of employment contained standard terms and provided that her employment could be terminated by six month’s notice in writing by either party.  It contained no provision under which Mrs Haderlein could be said to have been entitled to the ex gratia payment.
(3)	Resolute was part of the Equitas group that had been established to contain the uncertainties that arose from various long-tail liabilities which threatened to destabilise the Lloyd’s insurance market.  It had an unusual business model because it was set up with the intention of ‘working itself out of business’.  Initially, however, there was pressure to recruit suitable staff of the right calibre who could handle the issues of these long-tail liabilities.  As Mrs Haderlein put it, “The HR department was under pressure when I was first appointed as we ‘hit the ground running’.  There was no gentle lead-in because the company was required to show results from Day 1.”  
(4)	Between 1996 and 1998 Resolute grew rapidly and at one stage it employed approximately 1100 staff either on a full time, part time or contract basis.  Staff recruitment eventually came to a halt and as the company was successful in realising its business objective it began to downsize.  By early 2004, the headcount had been reduced to approximately 500 employees and the company had a well established redundancy policy.  
(5)	As part of this process of downsizing, during 2003 the company’s executive management undertook the preparation of a five year plan.  The plan dealt with all aspects of the business, including a plan to reduce headcount numbers to approximately 150 by March 2009.  Given her HR role, Mrs Haderlein was one of the few non-Board members who was aware of this plan prior to its announcement to all staff in the autumn of 2004 (by which time Mrs Haderlein had resigned).  She participated in the development of the plan’s HR aspects.
(6)	With the fulfilment of the company’s business objective and consistent with carrying out the five year plan, the role of Director of Human Resources was effectively changing from managing high volume staff recruitment and establishing human resources policies for the business (including in later years the redundancy and downsizing issues and policies) to managing a planned headcount reduction programme over a five year period.  By 2004 Mrs Haderlein’s role was very different from the role she had initially been recruited to fulfil and prospectively presented none of the challenges that had been present when she was first employed by Resolute.  As Mrs Haderlein put it, “I felt that I had accomplished the task I had been recruited for, and that the next stage of the company’s life did not require someone of my qualifications and experience to lead the HR function.”
(7)	Michael Crall retired as CEO of Resolute in 2003 and Mr Moser took over his position.  In September 2003 Mrs Haderlein mentioned to Mr Moser her desire to leave the company having regard to the change in her role and her belief that her task with the company had been accomplished.  At that time Mr Moser asked her to stay for the first year of his stewardship and she agreed to do so.  There was no evidence to suggest that the question of the ex gratia payment or any issue of special terms was raised or discussed at that time or that her agreement was secured on that basis and I am satisfied that at that stage Mr Moser did not consider the possibility of an ex gratia payment.
(8)	Mindful of the terms of her contract of employment (as befits the Director of Human Resources), Mrs Haderlein reminded Mr Moser in April 2004 of her desire to leave later in 2004 and return to the US. At that stage Mr Moser bowed to Mrs Haderlein’s wishes and accepted her resignation.  He agreed to sort out the mechanics of her leaving in due course.  He announced her resignation (and the promotion of her deputy to head of Human Resources) during the course of a management meeting held at Lloyd’s on 23 April 2004.  A copy of his announcement was placed on the company’s intranet the following Monday, 26 April 2004.  
(9)	Mrs Haderlein submitted her formal resignation letter on 21 July 2004 and asked that her last day with Resolute should be Friday 17 September 2004.  Technically this did not comply with her contract of employment but it was consistent with the course of conduct that had unfolded since Mrs Haderlein first spoke to Mr Moser in September 2003 and the announcement that had been made in April 2004.  Again, I am satisfied on the evidence that I heard that the ex gratia payment was unrelated to the short notice that Mrs Haderlein gave of the termination of her employment with the company.  In her letter Mrs Haderlein noted that, “this is the right time to move on, for me personally and for Equitas.”
(10)	On 17 September 2004 Mr Moser wrote to Mrs Haderlein in the following terms:
“The Board of Directors of Equitas has asked me to express to you its thanks and gratitude for the inestimable contributions you have made to the Company as its Human Resources Director for the last eight years.  All of us wish you the very best as you return to California.”

(11)	I accept Mr Moser’s and Mrs Haderlein’s evidence that at no point did Mrs Haderlein request or indicate that she expected to receive, any payment from Resolute as a result of her decision to resign.  As Director of Human Resources Mrs Haderlein was well aware that her decision to resign was an ‘expensive decision’ to take.  She knew the company’s redundancy arrangements ‘inside out’ and had been responsible for drawing up the company’s Long Term Incentive Plan (“LTIP”).  Accordingly, she knew that her action would preclude her from receiving a redundancy payment and would deprive her of the LTIP payments that she would otherwise receive if she remained in the company’s employment.  Nevertheless, I accept her evidence that she was content to forego her potential redundancy benefit of £152,300 and the outstanding LTIP awards of £122,500 and neither suggested to Mr Moser nor looked for any compensation in return.  
(12)	There are other things in life than money and I am satisfied that this was an occasion when, and Mrs Haderlein was a person for whom, other things (in this case her return to the USA and whatever new challenges presented themselves to her there) came before the prospective financial rewards of continued employment with Resolute.  Mrs Haderlein had been well remunerated over her time with Resolute and I was given no reason to believe that, having decided to leave, she was intent on extracting from the company her prospective entitlements under its redundancy plan or seeking compensation for her loss of LTIP benefits.  Mrs Haderlein was 58 and anticipated finding new employment in the USA but the prospects of doing so might diminish if she remained in the UK with Resolute until retirement at 60.
(13)	Following his receipt of her resignation letter and having reflected on his previous conversations with Mrs Haderlein, Mr Moser began to feel that it might be appropriate for Resolute to make Mrs Haderlein an ex-gratia payment.  By deciding that she had accomplished the role for which she was recruited Mrs Haderlein was following precisely the course that Resolute wished to encourage the majority of its employees to take.  Mr Moser said that his and the company’s ethos were about ‘doing the right thing’.  Mr Moser appreciated that, consistent with this corporate ethos, Mrs Haderlein had ‘done the right thing’ in appreciating that Resolute no longer needed her expertise and the attendant costs in terms of her continuing employment.  He accordingly concluded that it would be unfair for Mrs Haderlein to suffer financially from doing the right thing and resigning and that the company should make an ex gratia payment to recognise her action.  Mr Moser said that his motivation behind making the ex-gratia payment was not to reward Mrs Haderlein for work done but to compensate her for the benefits she was giving up as a result of her resignation and to recognise that she was doing the right thing by the company.  
(14)	Mr Moser accordingly consulted Resolute’s Finance Director about the scale of the ex gratia payment that it might make to Mrs Haderlein.  They reviewed Mrs Haderlein’s potential redundancy benefit, which was assessed to be £152,300.  Mr Moser additionally reviewed the payments that had been made to the most recent leavers.  None of them had left in the same circumstances as Mrs Haderlein.  Her situation was unique but the payments made to other leavers provided a useful benchmark to consider the appropriate level of payment.  Mr Moser concluded in all the circumstances that an ex gratia payment of £150,000 was appropriate.  
(15)	Mr Moser could not recall precisely when he had advised Mrs Haderlein of the company’s intention to make her an ex gratia payment but he thought that it was in August 2004.  There was no evidence to suggest that she was informed before her resignation letter of 21 July 2004 but she undoubtedly was informed of the proposal before she left on 17 September 2004.  The proposal to make an ex gratia payment was not documented in any way between the company and Mrs Haderlein.  Mrs Haderlein said that she did not ask for the proposal to be confirmed in writing because she knew that Mr Moser was as man of his word and she thought that it would appear distrustful and ungracious to have requested that it be recorded officially.  I accept that explanation and I am satisfied that there were no conditions attached to the proposal to make the ex gratia payment related to her past or continuing employment with Resolute.  
(16)	Mrs Haderlein said that she viewed the payment as an ex gratia payment.  It was left that she would get in touch to arrange payment when she had settled back in the USA. She accepted that if by that time the company had changed its mind – for example it had decided it could not afford to make the payment – she would have no claim against the company.  I think that Mrs Haderlein was correct in her assumption.  There was no evidence to suggest that Mrs Haderlein would have had any basis of claim against the company had the ex gratia payment never been made.
(17)	The payment was eventually made as indicated in the Statement of Agreed Facts (see paragraph 2(11) above).  Tax at the basic rate of 22 per cent was deducted from £120,000 of the payment.  On 7 December 2004, Mr Moser sent a memorandum to the Chairman of Resolute which the Chairman signed as a formal record of the payment for corporate purposes.  The memorandum was in the following terms: 
“This note records the considerations supporting the decision to make an ex-gratia payment to Kathy Haderlein in respect of her leaving Equitas.
Based upon other senior leavers who left the organisation with compromise agreements, some of which included the payment of future LTIP awards, it was felt appropriate to recognise Kathy’s significant contribution to the Company.  In addition, her resignation facilitated the further downsizing of a support function within the business.
Jane Barker and I reviewed Kathy’s potential redundancy benefit (£152,300) and outstanding LTIP awards (£122,500), and concluded that an ex-gratia payment of £150,000 was appropriate given the payments to other senior leavers, an appropriate expression of the Company’s goodwill and commercially reasonable.
For purposes of documenting the record, can you please indicate below your concurrence.  Thanks.”

(18)	Finally, Mrs Haderlein reported the ex gratia payment as income in her US tax return for 2004.  Nothing turns on this because its treatment in the US is a matter of US tax law.
The issue for decision
4.	The issue is whether the ex gratia payment is chargeable to tax as general income from the employment under section 62 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) as contended by HMRC.  Resolute contended that the ex gratia payment was not chargeable under section 62 ITEPA but only under section 401 ITEPA as a payment in connection with the termination of Mrs Haderlein’s employment and that on that basis it had deducted and accounted for the correct amount of tax.  On behalf of Mrs Haderlein it was contended that the payment was a personal gift and was not chargeable to tax at all.  Alternatively, if it was taxable as her income it was exempt from tax under Article 22 of the UK/US Double Taxation Convention 2001.
The statutory provisions
5.	Section 6 of ITEPA provides that:
(1) The charge to tax on employment income under this Part is a charge to tax on—
(a) general earnings, and
(b) specific employment income.
The meaning of “employment income”, “general earnings” and “specific employment income” is given in section 7.
6.	Section 7 of ITEPA provides that:
(1) This section gives the meaning for the purposes of the Tax Acts of “employment income”, “general earnings” and “specific employment income”.
(2) “Employment income” means—
(a) earnings within Chapter 1 of Part 3,
(b) any amount treated as earnings (see subsection (5)), or
(c) any amount which counts as employment income (see subsection (6)).
(3) “General earnings” means—
(a) earnings within Chapter 1 of Part 3, or
(b) any amount treated as earnings (see subsection (5)),
excluding in each case any exempt income.
(4) “Specific employment income” means any amount which counts as employment income (see subsection (6)), excluding any exempt income.
(5) Subsection (2)(b) or (3)(b) refers to any amount treated as earnings under—
(a) Chapters 7 and 8 of this Part (application of provisions to agency workers and workers under arrangements made by intermediaries),
(b) Chapters 2 to 11 of Part 3 (the benefits code),
(c) Chapter 12 of Part 3 (payments treated as earnings), or
(d) section 262 of CAA 2001 (balancing charges to be given effect by treating them as earnings).
(6) Subsection (2)(c) or (4) refers to any amount which counts as employment income by virtue of—
(a) Part 6 (income which is not earnings or share-related),
(b) Part 7 (income and exemptions relating to securities and securities options), or
(c) any other enactment.
7.	Earnings within Chapter 1 of Part 3 to ITEPA are defined by section 62 as follows:
(1) This section explains what is meant by “earnings” in the employment income Parts.
(2) In those Parts “earnings”, in relation to an employment, means—
(a) any salary, wages or fee,
(b) any gratuity or other profit or incidental benefit of any kind obtained by the employee if it is money or money’s worth, or
(c) anything else that constitutes an emolument of the employment.
(3) For the purposes of subsection (2) “money’s worth” means something that is—
(a) of direct monetary value to the employee, or
(b) capable of being converted into money or something of direct monetary value to the employee.
(4) Subsection (1) does not affect the operation of statutory provisions that provide for amounts to be treated as earnings (and see section 721(7)).
8.	As section 62(2)(b) indicates, an ex gratia payment, or “gratuity”, may count as earnings.  What is charged to tax in the case of general earnings, however, is the net taxable earnings from an employment in the year in question (s.9(2) ITEPA).  “Taxable earnings” from an employment in a tax year are determined in accordance with Chapters 4 and 5 of Part 2 to ITEPA (s.10(2)).  As this brief elaboration of the statutory provisions suggests, the rewrite of the employment income code in ITEPA has scarcely succeeded in making the structure of the tax charge more straight forward (and some would say less so).  It was common ground before me, however, that the question whether the ex gratia payment was “earnings” for the purposes of the charge to tax under Part 2 of ITEPA was to be determined largely by reference to case law, according to whether or not the ex gratia payment was properly characterized as earnings “from” Mrs Haderlein’s employment with Resolute.
9.	As section 7(4) ITEPA indicates, “specific employment income” means any amount which counts as employment income.  Under section 7(6)(a) this encompasses amounts that fall within Part 6 of ITEPA.  Chapter 3 of Part 6 comprises sections 401 to 416 and covers payments and benefits on termination of employment.  Section 401 provides as follows:
(1) This Chapter applies to payments and other benefits which are received directly or indirectly in consideration or in consequence of, or otherwise in connection with—
(a) the termination of a person’s employment,
(b) a change in the duties of a person’s employment, or
(c) a change in the earnings from a person’s employment,
by the person, or the person’s spouse, blood relative, dependant or personal representatives.
(2) Subsection (1) is subject to subsection (3) and sections 405 to 413 (exceptions for certain payments and benefits).
(3) This Chapter does not apply to any payment or other benefit chargeable to income tax apart from this Chapter.
(4) For the purposes of this Chapter—
(a) a payment or other benefit which is provided on behalf of, or to the order of, the employee or former employee is treated as received by the employee or former employee, and
(b) in relation to a payment or other benefit—
(i) any reference to the employee or former employee is to the person mentioned in subsection (1), and
(ii) any reference to the employer or former employer is to be read accordingly.
10.	Section 403 provides that—
(1) The amount of a payment or benefit to which this Chapter applies counts as employment income of the employee or former employee for the relevant tax year if and to the extent that it exceeds the £30,000 threshold.
(2) In this section “the relevant tax year” means the tax year in which the payment or other benefit is received.
(3) For the purposes of this Chapter—
(a) a cash benefit is treated as received—
(i) when it is paid or a payment is made on account of it, or
(ii) when the recipient becomes entitled to require payment of or on account of it, and
(b) a non-cash benefit is treated as received when it is used or enjoyed.
(4) For the purposes of this Chapter the amount of a payment or benefit in respect of an employee or former employee exceeds the £30,000 threshold if and to the extent that, when it is aggregated with other such payments or benefits to which this Chapter applies, it exceeds £30,000 according to the rules in section 404 (how the £30,000 threshold applies).
(5) If it is received after the death of the employee or former employee—
(a) the amount of a payment or benefit to which this Chapter applies counts as the employment income of the personal representatives for the relevant year if or to the extent that it exceeds £30,000 according to the rules in section 404, and
(b) the tax is accordingly to be assessed and charged on them and is a debt due from and payable out of the estate.
(6) In this Chapter references to the taxable person are to the person in relation to whom subsection (1) or (5) provides for an amount to count as employment income.
11.	In the case of specific employment income, the amount charged to tax is the net taxable specific income from an employment for the year (s.9(4) ITEPA).  “Taxable specific income” from an employment for a tax year means the full amount of any specific employment income which counts as employment income for that year in respect of the employment (s.10(3) ITEPA).  
12.	Finally, as regards the UK/UK Double Taxation Convention 2001, Article 14(1) provides as follows—
Subject to the provisions of Articles 15 (Directors' fees), 17 (Pensions, social security, annuities, alimony, and child support) and 19 (Government service) of this Convention, salaries, wages, and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.
13.	Article 22(1) provides as follows—
Items of income beneficially owned by a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention (other than income paid out of trusts or the estates of deceased persons in the course of administration) shall be taxable only in that State.
The parties’ contentions
14.	For Mrs Haderlein it was contended that she was not employed by Resolute when the payment was made.  She had no contractual or other legal entitlement to the payment and if the company had refused to pay it there would have been no formal recourse open to her.  The payment did not arise from her employment for which she had been suitably rewarded.  Mrs Haderlein undertook no additional duties in return for the payment.  She received the payment for not acting as an employee.  The circumstances of her leaving were exceptional.  There were no conditions attached to the payment and it was only mentioned to her after she had submitted her resignation.  Furthermore, the payment was not paid in connection with the termination of her employment.  It was a straightforward gift.  Specifically the payment was made because Mrs Haderlein had ‘done the right thing’ by the company in resigning.  As a company Resolute had similarly ‘done the right thing’ as part of its corporate ethical stance in making the ex gratia payment.
15.	In the alternative it was submitted that if the payment was a termination payment within section 401 ITEPA, it was not subject to UK income tax because it was not “salaries, wages, and other similar remuneration derived by a resident of a Contracting State in respect of an employment” within Article 14 of the UK/US Double Taxation Convention 2001.  The payment could only be “other income” within Article 22 and therefore taxable only in the USA.
16.	For Resolute it was contended that the payment was not chargeable as earnings but was chargeable under section 401 ITEPA as a termination payment.  The inspector for HMRC contended that the payment was earnings.  In their respective contentions Mr Nawbatt for Resolute and Mr Mear for HMRC drew my attention to a familiar list of cases, and to the relevant judicial dicta in them, that attempt to explain in the context of the particular factual matrix giving rise to the payment in question the characteristics that suggest which side of the line the payment falls.  I have had due regard to those cases and (so far as not referred to in my decision) I have listed them at the end but I shall resist the temptation to set out the familiar dicta to which Mr Nawbatt and Mr Mear directed my attention in their skeleton arguments.  The cases offer general expressions of the question that I must answer but only provide answers in the context of their particular facts (see Hochstrasser v Mayes (1959) 38 TC 673 per Upjohn J at 685).  The field is rife with fine judicial distinctions where parties to any appeal can call attention to appropriate dicta to support their position, as Mr Nawbatt and Mr Mear demonstrated with skill.  
17.	What is apparent to me in the present case is that the ex gratia payment was truly ex gratia.  Mrs Haderlein had no contractual entitlement to it.  She did nothing to earn it in the conventional sense.  It is true that Resolute would not have paid it had she not chosen to resign her position as head of Human Resources but it was not paid in return for her resignation.
18.	Thus far I can agree with Ms Styles for Mrs Haderlein.  A gratuity or gift is, however, not removed from charge to tax as employment income by that fact alone.  The question is what is the payment for?  Was it a payment “for acting as or being an employee”? Or was it a payment for something else?  
19.	For his part Mr Nawbatt for Resolute placed the emphasis on redundancy.  He noted that Mr Moser had said that “Resolute no longer had a need for a Human Resources professional of Kathy’s calibre” and that, “Had Kathy not resigned it is almost certainly the case that there would have come a time when Resolute would have made her redundant. In resigning therefore, she had saved the company the trouble of having to make this decision.”  Furthermore, at paragraph 6.4 of his witness statement Mr Moser said—
“I recognized that in all honesty, although the company had not sought to force the issue, Kathy was redundant.  It did not seem fair to me that she should be allowed to be worse off because of her decision by being deprived of the termination settlement that she would have received had the company taken the initiative to make her redundant.”

20.	The criticism of this, of course, is that on Resolute’s business plan everyone was eventually intended to become redundant.  Furthermore, Mrs Haderlein might have saved the company the decision but it was a decision that the company had not yet taken.  Notwithstanding Mr Moser’s evidence, the company had not forced the issue and I have no reason to believe that the company would not have chosen to continue to employ her well into its five year plan (certainly for two more years until the retirement age of 60) if Mrs Haderlein had not intimated that she wished to leave.  Of necessity it had to replace her because it still needed a Human Resources Director to manage the five year plan, even though it could manage with someone of lesser experience than Mrs Haderlein.
21.	For his part Mr Mear placed the emphasis on what Mrs Haderlein gave up by leaving when she did at her initiative.  This presented him with something of a problem because redundancy payments are not generally thought of as falling into the category of earnings but are usually treated as termination payments.  He accordingly hung his hat on a combination of the foregone LTIP benefits (worth £122,500) and the recent case law dealing with payments in lieu of notice (“PILONs”), in which HMRC have been successful in bringing into charge to tax as earnings payments that were for many years commonly regarded by practitioners in this field as termination payments.
22.	Mr Mear put forward several propositions with which I can agree.  The fact that the payment was made after the employment had ceased does not prevent it being earnings.  The fact that it was made voluntarily does not prevent the payment being earnings.  The fact that the payment might be within section 401 ITEPA is irrelevant if section 62 applies because section 62 takes priority.  Mrs Haderlein was not made redundant but left her employment entirely of her own volition.  Mr Mear was also able to point to the description in the Chairman’s memorandum that the payment was to recognise “Kathy’s significant contribution to the company”.
23.	In several important respects, however, I do not agree with Mr Mear’s analysis.  He noted that by resigning Mrs Haderlein had disqualified herself from bonuses and incentive payments to which she would otherwise have become entitled.  He noted that the payment was calculated with reference to LTIP payments that Mrs Haderlein would have been entitled to had she not resigned.  On the face of it that is plainly not the case – the quantum of the gratuitous payment bears a much closer relationship to the quantum of her foregone redundancy entitlement than it does to her prospective LTIP entitlement.  
24.	Furthermore, in my view Mr Mear was not able to maintain his submission regarding the prospective LTIP entitlement in the face of the evidence regarding this plan.  It was a plan designed to encourage continued employment (an important issue in view of Resolute’s business plan) where the award was only paid out on vesting after three years.  Unvested awards lapsed on an individual ceasing to be an employee except in limited circumstances such as death, disability or retirement.  The Board had a general discretion to decide that an award should not lapse but from Mr Moser’s and Mrs Haderlein’s evidence I have no reason to think that the Board decided or would even have considered exercising its discretion in Mrs Haderlein’s case to compensate her for unvested awards on her leaving.  That was not the aim of the LTIP or the purpose for conferring discretion.
25.	Mr Mear’s central proposition, however, was that there was no evidence that the payment arose from “something else” or that it arose from something “other than being an employee”.  Furthermore, in so far as it could be said to arise from anything it arose from what Mrs Haderlein gave up when she resigned.  Thus Mr Moser’s said that “his motivation behind making this ex-gratia payment was to compensate Kathy for the benefits she was giving up (as a result of her resignation).”  
26.	Mr Mear’s submission put me in mind of a passage from Pritchard v Arundale (1971) 47 TC 680, where Megarry J said at 686—
“Secondly, I think the question to be tested in this way is only one question. Either the emoluments are within the statutory word “therefrom”, as explained by the cases, or they are not. At one stage in the argument, in commenting on Bridges v Bearsley 37 TC 289, Mr. Heyworth Talbot said that the question there was whether the employees in the case got the shares as remuneration for services or as personal gifts. In the Hochstrasser case, in the Court of Appeal, Parker L.J. had expressed himself in terms of any benefit in money or money's worth received by an employee during the course of his employment from his employer as being a taxable profit of his employment, with two exceptions, one of which was a gift to him in his personal capacity: see [1959] Ch. 22, at page 54. In the House of Lords Lord Simonds, [1960] A.C., at page 389, deprecated this approach, saying that it was not for the subject to prove that his case fell within exceptions arbitrarily inferred from the Statute, but for the Crown to prove that the tax is exigible. After a little discussion, I think that Mr. Heyworth Talbot accepted that the true issue was not the twofold question whether the benefit fell within the taxable category of remuneration for services (as it may briefly be described) or within the non-taxable category of personal gift, but a single question, namely, whether or not it fell within the taxable category of remuneration for services. “Personal gift” is thus not a category which has to be defined or explained, but merely an example of a transaction which will not fall within the taxable category of remuneration for services. In other words, the question is not one of which of two strait-jackets the transaction best fits, but whether it comes within the statutory language, or else, failing to do so, falls into the undefined residuary class of cases not caught by the Statute.”

27.	It is possible that if there had been no financial cost to Mrs Haderlein’s decision to resign voluntarily Mr Moser would not have thought of making her an ex gratia payment.  Companies are not usually in business to pay gratuities to employees who choose to leave voluntarily.  Companies may, however, choose to pay a gratuity to recognize the personal qualities that an employee has exhibited in the course of her employment.  When judges refer in this context to the payment being for “something else” they do not necessarily have in mind payment for some other (non-employment) service or asset.  It may be an intangible personal quality of the individual concerned – loyalty, good humour, for being a good team player.  From the employer’s perspective, there is every reason to recognise such qualities because they are something that cannot necessarily be demanded or prescribed as part of the terms of an employment contract.  They may nevertheless be the qualities that contribute significantly to the success of the business and therefore are appropriately recognised gratuitously.
28.	A payment does not lose its character as earnings because it is paid to recognise the personal qualities that the employee has exhibited in the course of rendering services.  The payment remains earnings for employment services even if it purports to be for rendering the services with a smile.  That is not the case, however, when the personal quality involved is recognizing that the time has come to leave.  In this respect Mrs Haderlein exhibited precisely the type of personal qualities that Mr Moser saw were important to Resolute’s business plan.  She had achieved a great deal in the business, for which she had been properly remunerated.  This was not the same situation as arose (also in a Lloyd’s context) for unremunerated committee members in McBride v Blackburn [2003] STC (SCD) 139.  Mrs Haderlein had recognized that her job was done and that she should move on to other things.  Her choice not to pursue a course that was designed to extract the maximum financial reward from the company might have been what motivated Mr Moser to think of making an ex gratia payment but if I am to say what the payment was made for, I think that it was for ‘doing the right thing’ by the company and resigning voluntarily.  
29.	Once Mr Moser had decided that the company should recognise this, there was then the difficult question of quantum.  In this respect he had to justify to his fellow Board members (assuming they agreed to recognize Mrs Haderlein’s action) the amount that the company should pay her.  The fact that he took as one of his benchmarks her foregone redundancy entitlement and her prospective LTIP benefits (as reflected in the memorandum signed by the Chairman) does not alter the character of the payment.  The issue is what is the payment made for, not how was it quantified. 
30.	I have therefore concluded that the ex gratia payment was not general earnings within section 62 ITEPA.  In my view it was a termination payment within section 401 ITEPA.  In this respect, it seems to me that the language of subsection (1) is cast in the widest terms designed to catch any payment or benefit received “directly or indirectly  in consequence of, or otherwise in connection with” the termination of Mrs Haderlein’s employment.  The payment may have been gratuitous and for ‘doing the right thing’ but the right thing was resigning her employment.  Accordingly, I think that the only possible conclusion was that the payment was in consequence of or in connection with the termination of Mrs Haderlein’s employment.
The UK/US Double Taxation Convention
31.	That leaves me with the issue of whether the payment is exempted from charge to UK income tax by the provisions of the UK/US Double Taxation Convention 2001.  Mr Mear had little to say on this issue.  He did not dispute that Mrs Haderlein was a resident of the United States for the purposes of the Convention at the relevant time or that she was entitled to claim the benefit of its provisions.  Given that his principal contention was that the ex gratia payment was earnings of Mrs Haderlein’s employment he naturally adopted the view that the payment was within the scope of Article 14 of the Convention and that the UK’s taxing rights were preserved by that Article.
32.	Article 14(1) of the Convention adopts the language of Article 15(1) of the OECD Model Tax Convention.  They both refer to “salaries, wages and other similar remuneration”.  Neither “wages” not “salaries” are defined for the purposes of the UK/US Convention and under Article 3(2) of the Convention undefined terms have the meaning which they have as a matter of domestic law unless the context otherwise requires or the competent authorities agree a common meaning pursuant to Article 26 of the Convention.  By an Exchange of Notes when the Convention was signed, the UK and US Governments agreed that “any benefits, income or gains enjoyed by employees under share/stock option plans are regarded as “other similar remuneration” for the purposes of Article 14.  The Commentary to Article 15(1) to the OECD Model Tax Convention records that, “Member countries have generally understood the term ‘salaries, wages and other similar remuneration’ to include benefits in kind received in respect of an employment (e.g. stock options, the use of a residence or automobile, health or life insurance coverage and club memberships).”
33.	As appears from section 62 ITEPA, salary and wages are specifically recognized as items that constitute earnings but ITEPA provides no definition of either term.  In an Australian case, Deputy Commissioner of Taxation v Applied Design Development Pty Ltd (In Liq) [2002] FCA 205, Mansfield J commented that—
“In the absence of statutory definitions, meaning should be given to those words [‘salary’ and ‘wages’] according to the ordinary meaning conveyed by the text of the provision, taking into account their context in the legislative scheme and the objects of the Act.  The words ‘salary’ and ‘wage’ denote an amount of money payable, the consideration for which is the performance of work and services.  That meaning is reflected in the definitions provided for the terms in the Oxford English Dictionary, 2nd ed:
Salary: fixed payment made periodically to a person as compensation for regular work.
Wage: a payment to a person for services rendered.”

34.	The English Court also resorted to the Oxford English Dictionary meaning of salary in Greater London Council v Minister of Social Security [1971] 2 All E R 285 and there are a variety of authorities on the meaning of salary and wages in other statutory contexts (such as the Bankruptcy Acts, see Re Shine, ex parte Shine [1892] 1 QB 522).  Based on their ordinary meaning, I would say that the ex gratia payment was neither “salary” nor “wages” and it is difficult to see that it is “other similar remuneration”.  
35.	ITEPA does not treat a termination payment as ordinary earnings (within which fall salary and wages and other similar remuneration) but as “an amount that counts as employment income” (see s. 7(2)(c), (4) and (6)).  The categorization of termination payments as “specific employment income” does not indicate that such payments are not “other similar remuneration” because income related to share incentives and share options within Part 7 of ITEPA (which the Treaty parties and OECD member countries regard as other similar remuneration) also falls within the category of specific employment income rather than ordinary earnings.  Nevertheless, the statutory description of items within Part 6 of ITEPA (“Income which is not earnings or share related”) suggest that items within that Part (e.g. termination payments) are not part of what would ordinarily be regarded as “salaries, wages and other similar remuneration”.  In other words, the context of ITEPA at least indicates that termination payments are not what the Act regards as ordinary earnings (as salary and wages and other similar remuneration would ordinarily comprise) even though termination payments are taxed within the framework of ITEPA as something counting as employment income.
36.	The status of termination payments under the UK/US Double Taxation Convention of 1975 was considered by the Special Commissioner (Dr John Avery Jones CBE) in Squirrell v HMRC [2005] STC (SCD) 717.  The relevant language of the 1975 Treaty article (Article 15(1)) was the same as that in Article 14(1) of the 2001 Convention.  Mr Squirrell worked for British Airways and on leaving the airline’s employment he received a PILON which was accepted to be a termination payment rather than earnings.  The Commissioner in that case accepted that the payment fell within the scope of Article 15(1) of the 1975 Convention.  He said (at paragraph 11)—
“The first issue is whether art 15 applies to the termination payment on the basis that it is ‘salaries, wages and other similar remuneration …in respect of an employment’.  These are undefined terms and accordingly art 3(2) refers one to their meaning under UK tax law (unless the context otherwise requires).  Although the precise words ‘salaries, wages and other similar remuneration’ are not used in UK tax law, according to the Shorter Oxford English Dictionary the meaning of the word ‘term’ extends to ‘any word or group of words expressing a notion or conception, or denoting an object of thought; an expression (for something)’.  Remuneration in respect of an employment corresponds to income that was at the time taxed under Sch E.  The termination payment, being a payment in lieu of notice, is the equivalent of remuneration and taxed under Sch E is a similar way to remuneration (although with an exemption for £30,000), and so I consider that the termination payment is within art 15.  I cannot think of any reason why the context might otherwise require.”

37.	I agree that the termination payment in that case, being a PILON – i.e. remuneration that the individual would have received under his contract had he been required to work out his notice period – is the equivalent of remuneration.  Strictly it is not enough that a payment is similar or “equivalent” to remuneration.  The payment must be similar remuneration to salary and wages to be within the scope of the Treaty language.  A PILON may be remuneration (and if so is clearly similar to salary or wages) but that does not seem to me to be true of the ex gratia payment with which I am concerned.  
38.	As I have decided, the ex gratia payment was a gift ‘for doing the right thing’.  It was not in respect of any service that Mrs Haderlein had rendered or that she was obliged (but for short notice) to render.  It cannot therefore be said to fall within the ordinary meaning of the words “salaries, wages and other similar remuneration” even if I approach the words on the basis that the parties to the Convention would expect them to be construed broadly.  It seems to me that “other similar remuneration” is capable of extending to any reward that a person derives in respect of their employment services, whatever form it takes, including termination payments such as PILONs.  “Remuneration” is a wider term than salary and can envisage anything that a person gets for giving his services (see R v Postmaster-General (1976) 1 QBD 658 per Blackburn J at 663-664) but remuneration still involves the concept of something that is given as a quid pro quo for services rendered.  In the present case, the only thing for which the ex gratia payment could be described as a quid pro quo was the fact that Mrs Haderlein had voluntarily resigned her position as Human Resources Director.  An ex gratia payment that the company chooses to make following resignation in circumstances such as these cannot in my view be described as remuneration in any ordinary sense of the word.  It is not solely the fact that it is ex gratia but the payment lacks the necessary nexus with services rendered that usually characterizes payments as salary, wages or other similar remuneration.
39.	As the Commissioner noted in Squirrell, termination payments are taxed in a similar way to remuneration under what was Schedule E and which is now “specific employment income” under ITEPA.  Termination payments were brought into charge under Schedule E by virtue of paragraph 5 of the Schedule (i.e. other provisions of the Tax Acts directing tax to be charged under Schedule E) rather than as emoluments under one of the three Cases of Schedule E (hence their status as ‘specific employment income’ under ITEPA).  There is nothing in the context of the Act or in the language of the Convention, however, to indicate that Article 14 of the Convention should be construed as encompassing anything that falls within the charge to tax under Schedule E or within ITEPA.  Thus I do not think that the gratuitous payment should be treated as within the Treaty concept of “salaries, wages and other similar remuneration” just because it happens to be taxed by the UK as an amount that counts as employment income.  
40.	I therefore conclude that the ex gratia payment is not within the scope of Article 14.  The UK nevertheless seeks to tax it as income.  Article 22(1) ensures that the payment if treated as income is taxable as such only in the United States.  Mr Mear presented no argument against the application of Article 22 if Article 14 did not apply and I therefore conclude that the gratuitous payment is exempt as other income within the scope of that Article.
Conclusion
41.	I accordingly conclude as follows—
(1)	The ex gratia payment is not earnings for the purposes of section 62 ITEPA, being paid in recognition of the fact that Mrs Haderlein had ‘done the right thing’ in resigning her position as Human Resources Director with Resolute;
(2)	The ex-gratia payment is however a termination payment within section 401 ITEPA as a payment that was made in consequence of or in connection with the termination of Mrs Haderlein’s employment with Resolute;
(3)	The portion of the ex-gratia payment (i.e. £120,000) that would otherwise be charged to UK tax is nevertheless exempt by virtue of Article 22(1) of the UK/US Double Taxation Convention 2001.

42.	I therefore allow the appeals of both Resolute and Mrs Haderlein.

SPECIAL COMMISSIONER
RELEASE DATE: 27 August 2008

SC 3123/07, 3210/07

Authorities referred to in skeletons and not referred to in the decision:
Bray v Best (1989) 61 TC 704
Comptroller-General of Inland Revenue v Knight [1973] AC 428
Corbett v Duff (1941) 23 TC 763
EMI Group Electronics Ltd v Coldicott (1999) 71 TC 455
Hamblett v Godfrey (1986) 59 TC 694
Henry v Foster (1932) 16 TC 605
Herbert v McQuade (1902) 4 TC 489
IRC v Morris (1968) 44 TC 685
Laidler v Perry (1965) 42 TC 351
Mairs v Haughey (1993) 66 TC 273
Richardson v Delaney (2001) 74 TC 167
Shilton v Wilmshurst (1991) 64 TC 78