RELEASE
OF DEBT – Taxes Act 1988 s.94 – partnership liability to service company – effect
of consent order
THE
SPECIAL COMMISSIONERS
WILDIN
& CO (A FIRM) Appellant
-
and -
ALAN
N JOWETT Respondent
Special
Commissioner: DR JOHN F AVERY JONES CBE
Sitting
in London on Monday 8 July 2002
Graham
Wildin, one of the partners, for the Appellant
Alan
Jowett, HM Inspector of Taxes, in person
©
CROWN COPYRIGHT 2002
DECISION
- This
is an appeal against an amendment made on 23 November 2000 by the Respondent Inspector
under section 28B(3) of the Taxes Management Act 1970 to the Appellant’s Partnership
Tax Return for the year 1998/99. The Appellant was represented by Mr Graham Wildin,
one of the partners, and Mr Alan Jowett, the Inspector, appeared in person.
- There
was a very full agreed statement of facts as follows
- This
is an appeal against an amendment made on 23 November 2000 by the Respondent Inspector
under section 28B(3) Taxes Management Act 1970 to the Appellant's Partnership
Tax Return for the year 1998/99.
- The
Appellant is a firm of Chartered Accountants. The firm acts on this appeal through
Mr Graham Michael Wildin who is a chartered accountant and the ‘nominated partner’.
At all times material to this appeal, Mr Wildin has been a partner in Wildin &
Co. Wildin & Co was formed on 1 July 1984 from the sole trade of Mr G M Wildin.
Wildin & Co originally had two partners, Mr Wildin and Mr Andrew Cook. From
1 July 1988 until 12 January 1990 a Mr Willetts was a partner in the practice.
On 27 February 1995, Mr Cook left the practice. Mr Robert Lewis is the only other
current partner in Wildin & Co having joined the practice on 5 October 1990
as a salaried partner.
- Wildin
& Co Limited (company registration No 01653349) was incorporated on 22 July
1982 (the "Company"). The purpose of the Company was to take over the
day to day administration and running of the practice of Wildin & Co with
effect from 1 January 1983 (i.e. prior to the commencement of the Wildin &
Co partnership). Mr Wildin and Mr Cook, at all material times to this appeal,
were the directors and only shareholders in the Company.
- On
1 July 1984 the Wildin & Co partnership entered into a contract with the Company
(the "Service Contract"). Clause 1 of the Service Contract provided
that the Company was to "supply all the services of employment of staff,
and other necessary services of the accountancy practice [i.e. Wildin & Co]
on the basis of direct cost plus ten percent charge". By clause 2, the Service
Contract was to run without limit of time but could be terminated by mutual agreement,
by either party giving three months written notice, or upon the "disolution"
of either Wildin & Co or the Company. Clause 3 provided that if the agreement
was terminated other than by mutual agreement then a sum equal to the previous
three full years service charge became due and payable by the terminating party
to the other party. In the event that the terminating party was the Company then
the partners of Wildin & Co were entitled to "offsett" (sic) any
sums due from them to the Company against the termination payment due from the
Company. Clause 5 provided that sums due to Mr Wildin in respect of his directorship
of the Company were to be dealt with by way of "offsett" against sums
due to the Company from Wildin & Co.
- On
1 July 1990, Mr Wildin entered into a "Service Contract" with the Company
in respect of his duties as director of the Company ("the Director's Service
Contract") for a fixed period of five years commencing 1 July 1990 and ending
30 June 1995. Under the terms of the Director’s Service Contract Mr Wildin was,
inter alia, to ensure that the Company complied with its obligations to supply
services to Wildin & Co. Mr Wildin’s hours were to be agreed between the parties
but were not to exceed fifteen hours per week with a maximum of forty weeks per
year. The Company agreed to pay Mr Wildin remuneration of £100,000 in total over
the life of the contract by way of annual instalments in amounts to be agreed.
Payment of the amounts due to Mr Wildin was agreed to be by way of "offsetting"
the amounts due to Mr Wildin under the Director’s Service Contract against the
balance owing to the Company from Wildin & Co under the Service Contract (mirroring
clause 5 of the Service Contract). Where the amount due to Mr Wildin exceeded
the amounts owing to the Company, then the balance was to be credited to a loan
account in the name of Mr Wildin and made available for drawing by him.
- For
each of the years ended 30 June 1983 to 30 June 1992 inclusive, Wildin & Co
made a deduction in its profit and loss accounts in respect of the Company's service
charges and any unpaid balance due to the Company was included within the liability
to the Company on its balance sheets for each of those years. For the year ended
30 June 1993 a credit was made to the profit and loss account for the services
in the sum of £117,409 and a sum of £128,532 was deducted in the tax computation
as the service charges were in dispute.
- On
30 September 1992 HM Customs & Excise presented a petition for the winding
up of the Company on a claim for £96,133 of unpaid VAT. On 30 November 1992 the
Company ceased trading. On 3 December 1992 a winding up order was made in the
Newport County Court. At the date of cessation of business (30 November 1992)
the amount owed by Wildin & Co to the Company was calculated by Wildin &
Co to be £208,090. The Respondent accepts that this is the amount due from Wildin
& Co as at that date in respect of the service charges of the Company.
- Although
the amount due from Wildin & Co to the Company as at 30 November 1992 was
£208,090 Wildin & Co claimed, in accordance with the termination provisions
of the Service Contract, a set off of three years worth of full service charges
amounting to £128,532.20. Wildin & Co also claimed a set off in respect of
£66,000 being the net unpaid balance of the amount due to Mr Wildin under the
Director’s Service Contract (£100,000 less £34,000 already ‘paid’). Thus the net
amount due to the Company on the cessation of business was calculated by Wildin
& Co to be £208,090 – (£128,532.20 + £66,000) = £13,557.80. This amount was
in due course paid by Wildin & Co to the Liquidator of the Company (the amount
actually paid was £13,854.07 as interest was added to the net amount due).
- The
Liquidator of the Company did not accept that Wildin & Co could rely on the
termination provisions of the Service Contract or the terms of the Director's
Service Contract to make deductions from the amount otherwise accepted to be due
to the Company. In 1994 the Liquidator commenced proceedings in the High Court
against each of the then partners of Wildin & Co (Mr Wildin, Mr Cook and Mr
Lewis) to recover the full amount of the debt due to the Company. The Liquidator
also commenced proceedings under section 212 Insolvency Act 1986 against the then
partners of Wildin & Co.
- The
two sets of High Court proceedings were settled on 8 March 1998 by means of a
single consent order. The order was signed by solicitors acting on behalf of the
Company and Liquidator and by solicitors acting on behalf for the partners of
Wildin & Co. Under the terms of the Consent Order, in full and final settlement
of all claims, cross-claims and set-offs, Mr Wildin agreed to pay to the Liquidator
(and the Company) the sum of £120,000 in specified instalments. Mr Wildin also
agreed to pay to the Liquidator any sum (or aggregate sums) in excess of £5,000
proved by creditors (other than HM Customs & Excise) in the Liquidation of
the Company. Mr Wildin was given the right to examine any creditor claims against
the Company and to require the Liquidator to dispute such claims provided that
Mr Wildin indemnified the Liquidator.
- On
31 January 2000 the 1998/99 Partnership Tax Return for Wildin & Co was submitted
to the Respondent.
- On
25 April 2000 the Respondent wrote to Mr Wildin and, separately, to Mr Lewis saying
that he intended to make enquiries into the 1998/99 Partnership Tax Return. The
Respondent asked Mr Wildin for a computation detailing how the figure for sales
had been determined and whether the figure for sales included an amount (then
put at £88,090) representing the "reliefs" [release] under section 94
Income and Corporation Taxes Act 1988.
- Having
received no reply, on 14 June 2000, the Respondent issued a notice under section
19A Taxes Management Act 1970 seeking, inter alia, the computation referred to
in paragraph 12 above.
- The
Respondent sent a further letter on 4 August 2000 threatening penalty action if
Mr Wildin did not comply with the section 19A notice. Mr Wildin replied, in a
letter of the same date, that no figure for the release had been included in the
figure for sales in respect of the settlement of the actions brought by the Liquidator
as "The debt was incurred by Wildin & Co and the settlement with the
liquidator was with myself solely."
- On
5 September 2000, the Respondent sought agreement from Mr Wildin that the profits
of Wildin & Co for the year ended 30 June 1998 should be increased by the
sum of £88,090 representing the balance of the service charges owed by Wildin
& Co to the Liquidator of the Company.
- On
5 October 2000 the Respondent gave notice under section 28B(5) Taxes Management
Act 1970 that he had completed his enquiries into the 1998/99 Partnership Return
concluding that the claim to Capital Allowances should be reduced. On 23 November
2000 the Respondent notified Mr Wildin that he had amended his partnership statement,
inter alia, to reflect the receipt of £88,090 treated by the Respondent as a release
under section 94 Income and Corporation Taxes Act 1988 and the reduction in Capital
Allowances.
- It
was subsequently agreed that Wildin & Co had paid £13,557 to the Liquidator
of the Company prior to the making of the consent order (see paragraph 8 above)
and the claim to Capital Allowances was accepted as originally made.
- Accordingly,
the question for determination is whether there has been a release within the
meaning of section 94 Income and Corporation Taxes Act 1988 of £74,533 [£208,090
– (£120,000 + £13,557)] in respect of the debt due as at 30 November 1992 from
Wildin & Co to the Company.
- In
short, the Appellant partnership owed £208,090 to the Company but claimed a set-off
resulting in its owing only a balance of £13,557. The liquidator of the Company
settled the actions claiming the full amount of £208,090 from the partnership
by a consent order requiring payment of a further £120,000 by Mr Wildin which
the Inspector accepts was a payment on behalf the partnership. Accordingly the
Inspector says that the remaining liability of the partnership amounting to £208,090
- (£120,000 + £13,557) = £74,533 has been released and is taxable under section
94 of the Taxes Act 1988. Paragraph 17 of the statement of facts explains why
the £13,557 was not originally, but is now, accepted.
- Section
94 provides:
Where
in computing for tax purposes the profits of a trade, profession or vocation,
a deduction has been allowed for any debt incurred for the purposes of the trade,
profession or vocation, then, if the whole or any part of the debt is thereafter
released otherwise than as part of a relevant arrangement or compromise, the amount
released shall be treated as a receipt of the trade, profession or vocation arising
in the period in which the release is effected.
It
is common ground that, if there is a release, it is not part of a relevant arrangement
or compromise, as defined in section 94(2). It is also common ground that the
full £208,090 has been deducted in the computation of the partnership profits.
The question is whether any amount, and if so what amount, has been released.
- The
dispute essentially turns on the effect of a further provision of the consent
order contained in paragraph 3 of the Schedule which is as follows:
Mr
Wildin will pay to the Plaintiff [the liquidator] the sum or sums equivalent to
the aggregate of any sums proved by creditor(s) in the liquidation of Wildin &
Co Limited ("the Company") – other than the Commissioners of Customs
and Excise – to the extent that the aggregate of such sums exceeds £5,000, such
payment(s) to be made in equal monthly instalments from the date of acceptance
of proof of such creditors to 1 March 2002.
- Mr
Wildin produced a letter from the liquidator’s solicitors stating that the liability
under paragraph 3 is £43,574.47. He contends that this sum should be deducted
from the amount released of £74,533. Alternatively, he claims that there has been
no release of the partnership liability but an assignment of the burden of the
liability to him.
- There
two possible interpretations of paragraph 3. The first, put forward by Mr Wildin,
is that the liquidator wanted to pay Customs and Excise as nearly as possible
in full and so he accepted £120,000 on the basis of the known creditors, which
would result in Customs being paid all but £4,477 of their liability of £122,751
according to the Official Receiver’s report dated 1 February 1993 (although this
is presumably before the expenses of liquidation). On that basis paragraph 3 is
still concerned with the partnership’s liability and is there to deal with the
possibility of further creditors coming forward so that the result for Customs
and Excise will be unaffected. The alternative interpretation put forward by Mr
Jowett is that the liquidator was settling a claim against Mr Wildin as a director
under section 212 of the Insolvency Act 1986 relating to director’s liability
for misfeasance or breach of any fiduciary or other duty. On that basis, paragraph
3 is unrelated to the partnership debt and any payment under that paragraph does
not reduce the amount released.
- In
favour of Mr Wildin’s interpretation is a letter dated 3 March 1998 from the liquidator’s
solicitors to Customs and Excise in which they say:
Mr
Wildin was firmly of the view that all creditors of the company with the exception
of Customs and Excise had been paid… and Mr Wildin stressed this aspect of the
company’s financial position to argue that the actual dividend receivable by Customs
and Excise would be better than it appeared on the basis of the original Statement
of Affairs sworn by the director.
Our
response was to indicate that if we were to recommend Mr Wildin’s offer to Customs
and Excise on the faith of the representations which he was making, we expected
him to back his representations with persuasive assurances as to their truth.
In the circumstances, therefore, we persuaded Mr Wildin to agree that, to the
extent that additional creditors of the company exceeded £5,000, he should pay
an equivalent sum to the liquidator in addition to the sum of £120,000. By this
means we are hoping that we will have protected your prospective dividend.
- Mr
Jowett’s intepretation of paragraph 3 is that it deals with the Company’s creditors
which has nothing to do with the partnership which has settled its liability at
£120,000, so that paragraph 3 must relate to something else, presumably Mr Wildin’s
liability as a director under the Insolvency Act. Mr Jowett pointed out that Mr
Wildin’s liability under that paragraph is not limited to the amount owing by
the partnership to the Company before any set-off which makes it unlikely that
it relates to the partnership’s liability.
- I
asked if, following the hearing, Mr Wildin could send me the statement of claim
by the liquidator as it might throw some light on this question. He sent in a
copy of the Application in one of the two actions together with the Liquidator’s
affidavit. In this action the Liquidator claims a Declaration that Mr Wildin and
Mr Cook in their capacity as directors and Mr Lewis as a person who took part
in the management of the Company were guilty of misfeasance or breach of trust
or fiduciary duty in entering into the agreement with the partnership and the
service agreement with Mr Wildin (and other matters); an Order that accounts be
taken of the breaches of duty and an Order that the three compensate the Company
for their breaches of duty; a Declaration that the set-off is a preference and
is voidable; an Order that the three pay £208,090 to the Company. Mr Jowett through
the Inland Revenue’s Solicitor’s Office obtained a copy of the writ in the other
action which is a claim by the Company (in liquidation) against the partners for
breach of contract for £208,090.
- As
I read the situation, the liquidator was trying to recover as much for Customs
and Excise, the largest creditor, as he could and was really trying to avoid any
set-off reducing the partnership’s agreed debt of £208,090. I do not think that
the liquidator was trying to obtain payment of the amount of the creditors from
Mr Wildin (or the other two) as a director as a separate matter. The claim against
the directors is for breach of duty in relation to the agreement which gave rise
to the set-off, not a separate action relating to breach of duty generally. This
interpretation is supported by the letter from the liquidator’s solicitors quoted
above that the liquidator would only settle the action if Customs’ position was
unaffected by the discovery of other creditors. In short, the actions were about
recovering the £208,090 without set-off, or sufficient of that amount as would
enable Customs and any additional creditors who might appear to be paid in full
or nearly so.
- It
is certainly odd, if this were the case, that Mr Wildin and his advisers did not
limit the liability under paragraph 3 to the total liability of the partnership
to the Company. However, presumably Mr Wildin had a good idea of the likely total
amount of creditors of the Company and knew that they could not possibly result
in his having to pay more than the £208,090; in the first paragraph quoted above
from the letter from the liquidator’s solicitors he is quoted as saying that there
were no other creditors. I also suspect that the consent order was drafted at
the door of the court and in such circumstances orders do not always contain all
the safeguards one might expect.
- My
conclusion is therefore that the net result of both actions was to recover so
much of the partnership’s agreed liability without set-off as would result in
the creditors being paid in full or nearly so. Paragraph 3 is the mechanism for
protecting Customs and Excise’s position if more creditors came forward after
the consent order was entered into. Accordingly any further payment under paragraph
3 reduces the amount otherwise released.
- Mr
Jowett raised a further point that if payments under paragraph 3 reduced the amount
released they would have to be allowed in later years. I do not think that is
right. Paragraph 3 provides a formula for calculating the amount released. The
result may be that the assessment for that year cannot be finalised until the
paragraph 3 amount is determined, but it cannot be that one treats the maximum
amount as having been released in 1998/99 and part of that sum to be un-released
in a later year when further creditors come forward and are paid.
- Mr
Wildin’s also contends that there had been what he calls an "assignment"
of the liability to him. There is no evidence of this. The consent order ends
the action by the liquidator against the partners, and the counterclaim by the
partners against the Company. The order is in full and final settlement of all
claims, cross-claims and set-offs arising out of the two actions both of which
are actions by the Company, or the liquidator, against all the partners. If the
liability were to be transferred to Mr Wildin alone there would have to be a novation
with the liquidator releasing the other partners. This is most unlikely since
this is a contract debt the partners are liable jointly (section 9 of the Partnership
Act 1890) so the liquidator can collect the whole from Mr Wildin, which is what
he did, and Mr Wildin has a right of contribution from the other partners which
he may or may not wish to exercise. There would be no reason for the liquidator
to change this position. I am also unclear how the point helps the Appellant because
if there had been a novation the release of the partnership’s debt would have
been greater. I find that there was no such novation of the partnership’s liability
and Mr Wildin merely paid part of the partnership’s liability because he was jointly
liable to pay it as one of the partners.
- Accordingly
I find that there has been a release of part of the partnership’s liability amounting
to at least £74,533 but that this amount should be reduced by the amount of the
additional payment equal to the further payments made under paragraph 3 of the
Schedule to the consent order. I assume that the Inspector has not had the opportunity
of verifying the figure of £43,574.47 as the amount of the additional creditors
of the Company. Accordingly I shall not determine the appeal in figures at this
stage but merely say that in principle the appeal is allowed to the extent of
reducing the amount released (£74,533) by £43,574.47 or whatever amount is determined
to be the final amount of the additional creditors for which Mr Wildin is liable
under paragraph 3 of the Schedule to the consent order.
DR
JOHN F. AVERY JONES
SPECIAL
COMMISSIONER
Authorities
referred to in argument and not referred to in the decision
Hall
v IRC 11 TC 24
Linden
Gardens Trust Ltd v Lenestra Sludge Disposals Ltd [1994] 1 AC 85
SC
3033/02
