Manduca v Revenue And Customs

Factual and Procedural Background

The Appellant appealed against the decision of the First-tier Tribunal which upheld a closure notice issued by the Respondents regarding the Appellant's 2002-2003 self-assessment tax return. The dispute concerned the tax treatment of a payment of £310,000 received by the Appellant from Company B as part of an out-of-court settlement of litigation. The Appellant had declared this payment as subject to capital gains tax, while the Respondents treated it as income tax under Schedule D Case VI of the Income and Corporation Taxes Act 1988.

The Appellant, with a colleague, established a hedge fund ("One Europe Fund") initially managed by Company A. When Company A exited the hedge fund market, Company B took over management. The Appellant and colleague transitioned employment to Company B under contracts providing salary and performance-related bonuses.

A separate Bonus Agreement between the Appellant, his colleague, and Company B set out payments intended to reward their role in transferring the fund management business from Company A to Company B and sustaining and expanding Company B's alternative investment management business. The Bonus was delayed and ultimately not paid due to the Appellant's redundancy and the liquidation of the fund. The Appellant subsequently settled litigation with Company B, receiving a sum equivalent to the unpaid Bonus.

The Respondents initially considered the payment as employment income under Schedule E but later concluded it was income taxable under Schedule D Case VI. The Appellant contested this, arguing the payment was a capital sum subject to capital gains tax.

Legal Issues Presented

1. Whether the payment received by the Appellant constituted income taxable under Schedule D Case VI or was a capital sum subject to capital gains tax.
2. If the payment was income, whether it properly fell within Case VI of Schedule D or another Case such as Case II.
3. Whether the Appellant should be permitted to raise new points on appeal that were not argued before the First-tier Tribunal.

Arguments of the Parties

Appellant's Arguments

• The Bonus was a capital payment representing consideration for the transfer of intangible business assets (goodwill) and thus subject to capital gains tax.
• The payment was not employment income but an "earn-out" payment related to the transfer of the fund management business.
• If the payment was income, it should be assessed under Schedule D Case II rather than Case VI.
• The Tribunal failed to properly consider the terms of Case VI or relevant case law in reaching its decision.

Respondents' Arguments

• The settlement sum was income taxable under Schedule D Case VI pursuant to section 18 of the Income and Corporation Taxes Act 1988.
• The payment was remuneration for services provided by the Appellant, falling squarely within Case VI.
• There was no need to inquire into the extent of services actually provided once it was established that the payment was pursuant to a binding contract for services.
• The Appellant should not be permitted to raise new points on appeal that were not raised before the First-tier Tribunal, as it would prejudice the Respondents.

Table of Precedents Cited

Court's Reasoning and Analysis

The court accepted the Respondents' submission that once a payment is established as income pursuant to a binding contract for services, it falls within Schedule D Case VI without requiring detailed inquiry into the extent of services performed. The Bonus was found to be remuneration for services provided by the Appellant in facilitating the transfer of the hedge fund management business from Company A to Company B, including maintaining investor and staff confidence during a critical transition period.

The court rejected the Appellant's characterization of the Bonus as a capital payment or a passive receipt akin to shareholding or mere introductions. Evidence showed the Appellant had a significant role in managing and sustaining the fund and its investor base, critical to the business's value and ongoing performance fees.

Applying established case law, including Leeming v Jones and Brocklesby v Merricks, the court held the Bonus was income of the same nature as profits and gains taxable under other Cases of Schedule D. The court also considered procedural fairness and refused to allow the Appellant to raise new grounds on appeal not previously argued, as this would prejudice the Respondents and involve matters requiring further evidence.

Holding and Implications

The court DISMISSED the appeal, upholding the closure notice issued by the Respondents that the Bonus payment was income taxable under Schedule D Case VI.

The direct effect of this decision is that the Appellant’s Bonus payment is subject to income tax rather than capital gains tax. No new precedent was established; rather, the decision applied existing legal principles on the characterization of payments for services under tax law.