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Taxation by Mark McLaughlin ATII TEP

What are the Schedule E implications when certain payments are made to family members by other family members? Can anything be done to mitigate the potential tax liability? This article considers both questions.Picture the following scenario. One day, a child is knocked down in a road accident as the consequence of a driver's negligence. The accident is not fatal, but unfortunately your child sustains serious physical injuries, including severe head injury resulting in brain damage. The High Court subsequently awards a considerable sum of money following a claim against the negligent driver and his insurers. The mother is appointed to act as receiver for the child, and is accountable to the Court of Protection. The damages are applied partly towards engaging full-time professional care workers, to continue looking after your child at home while you attempt to begin re-building your own shattered life by resuming your professional career. However, due to a personality disorder resulting from the brain injuries suffered, the child is physically and verbally aggressive towards the carers. In the circumstances, the husband eventually decides that the best course of action is to put his career on hold, and to assist his spouse in providing twenty-four hour a day care for the child.

This may seem far-fetched, but sadly, in the writer's experience, family members all too frequently find themselves providing full-time care to personal injury victims. Where the injured party does not have sufficient mental capacity those same family members may also be appointed as receivers, with the perceived burden of additional responsibilities including certain administrative obligations to the Court of Protection.

In some cases, where regular care is provided by family members the main source of household income is derived from the personal injury victim's court award or other funds. What is the income tax position of the family member on receipts from the personal injury victim in this unfortunate situation?

No official policy

When the writer first approached the Revenue on this matter, it was made clear that there was no specific policy relating to payments to family members in connection with the provision of care. The official view appears to be that where a carer, whether or not a family member, receives a payment under a contract of employment or service which falls within the definition of emoluments in section 131(1), Taxes Act 1988, that payment will be assessable under Schedule E. The Revenue indicated that each case would be considered on its own facts, but stated their view that the relationship between the payer and the carer is likely to be one of employment.

The Revenue's view regarding the Schedule E liability of payments to carers who are non-family members should come as no surprise (and the agency provisions in section 134, Taxes Act 1988 may also be relevant here). There can also be no disputing that one family member is generally capable of employing another family member. However, how does one distinguish between the provision of care in the ordinary course of relationships as family members, and in the context of an office or employment?

Office or employment?

To fall within the ambit of Schedule E, emoluments must be received from an office or employment (section 19(1), Taxes Act 1988). Emoluments are defined in section 131(1) as including 'all salaries, fees, wages, perquisites and profits whatsoever'. This wide definition has the potential to catch pocket money and household goods paid to the family member by the personal injury victim, if that income is derived from an office or employment. Unfortunately, there is no definition of office or employment in the current tax legislation. The Tax Law Rewrite Committee's exposure draft 6 (June 1999) on employment income defined 'employment' as including 'any employment under a contract of service', and office as including 'any position which has an existence independent of the person who holds it and may be filled by successive holders'. These definitions appear to be derived from case law, some of which is referred to below, and is presently the only real assistance available.

The Revenue recognises that an employment exists where an individual works under a contract of employment, which can be written, implied, oral or a combination of the three. In the Schedule E Manual at paragraph 538, the Revenue states that 'where [taxpayers] have agreed to work in return for payment a contract must exist - either a contract of employment, a contract of services, or an agency type contract'. It goes on to say (at paragraph 550) that 'all the possible factors which bear on the relationship between the parties must be examined, given their proper weight, and a judgement made about their overall effect'.

In the context of payments between family members, presumably some weight must be attached to the existence of the family relationship in the scenario described earlier.

So a contract exists where there is an agreement (which might be defined as an intention to create legal relations) between the parties to work for payment. This assumes that the parties are competent to make such an agreement. But what is the position where, for example, the personal injury victim does not have the necessary mental capacity to make such an agreement? This situation is considered later in the article.

Agree not to agree?

Where both parties are capable of making an agreement, is there anything to prevent all dispositions between the personal injury victim and the family member from potentially being treated as emoluments arising from the provision of care?

James Kessler's excellent article 'It's All In The Contract' (Taxation 23 September 1999 at page 639) advanced the proposition that an express agreement that there is no contract could be effective, albeit in the context of removing family company directors from the scope of the national minimum wage (there has since been clarification on the implications of the national minimum wage for directors, most recently in Tax Bulletin, December 2000). With regard to family members, the national minimum wage does not need to be paid to family members living at home who help with household chores (see the Department of Trade and Industry's guide to the national minimum wage, at paragraph 38). It would be interesting to see how the Revenue might distinguish between household chores and the provision of care to a family member in the home.

In determining if a payment is an emolument liable to tax under Schedule E, whether or not that payment is made as a reward for services is ultimately a question of fact. However, does the existence of an implied contract of service mean that voluntary gifts between the same family members could also be caught? Bearing in mind the proposition in James Kessler's article of using express agreements as a declaration of one's intentions, the following suggestions may be helpful in preventing a challenge from the Revenue:

- Making specific payments for care services rendered under a formal contract of employment. This would ordinarily result in the requirement for the personal injury victim to operate pay-as-you-earn. However, in cases of severe disability where the payer may find it difficult or impossible to comply with this requirement, the Revenue may be prepared to consider the application of direct payment procedures, which would involve the family member in operating pay-as-you-earn instead (see Employment Procedures Manual at paragraph 1240 for details);

- Distinguishing between payments for care and other dispositions, for example by making voluntary gifts using deeds;

- Establishing a regular pattern of gifts to other family members, in addition to the personal injury victim.

No agreement possible

What if the personal injury victim does not have the capacity to enter into legal relations i.e. a contractual agreement with the family member for the provision of care? Since there can be no agreement (represented by an offer of work for consideration and its acceptance) between the parties in these circumstances, could it be successfully argued that there can be no employment, and therefore no emoluments liable to tax under Schedule E? Sadly, the Revenue has generally been reluctant to commit itself in communications involving the writer, but in any event it would be a compassionate gesture if the Revenue relieved family members from additional worry in the type of stressful situation described above by releasing a statement of practice, concession or otherwise.

In our earlier scenario, the spouse acts as the child's receiver, in addition to providing regular care. Are withdrawals from the personal injury victim's funds by the receiver for acting in that capacity assessable under Schedule E? It is understood that the Court of Protection are prepared to consider claims for allowances made by receivers, depending on the circumstances and the amount of work involved, even though a receivership is otherwise not generally considered to be a remunerative role unless undertaken professionally e.g. by solicitors. Even where no allowance is claimed, the receiver and other family members may derive mutual benefit from withdrawals to maintain the personal injury victim, such as for family holidays.

A receivership does not fit easily into the definition of 'employment'. However, Schedule E also applies to holders of an office. Is a receivership an office for Schedule E purposes? There is no statutory definition of office, although there is established case law dealing with the characteristics of an office. In Great Western Railway Co v Bater 8 TC 231, an office was described as: 'a subsisting, permanent, substantive position, which had an existence independent from the person who filled it, which went on and was filled by a succession of office holders'.

In McMillan v Guest 24 TC 190, it was noted that the New English Dictionary described an office as 'a position or place to which certain duties are attached, especially one of a more or less public nature'.

Subsequently, in Edwards v Clinch [1981] STC 617, Lord Justice Buckley considered that an office '...must owe its existence to some constituent instrument, whether it be a charter, statute, declaration of trust, contract (other than a contract of personal service) or instrument of some other kind'. Lord Wilberforce stated that 'the word [office] must involve a degree of continuance (not necessarily continuity) and of independent existence; it must connote a post to which a person can be appointed, which he can vacate and to which a successor can be appointed'. Lord Lowry observed: 'an office can be created for an occasion but that, in my view, involves creating an office, which can be filled by the appointing authority'.

So there is strong support for the proposition that a receiver is an office holder. In other cases, private trusts are used as an alternative to receiverships. In both instances, there is also support for the treatment of payments from the victim's funds as Schedule E emoluments. In Dale v Commissioners of Inland Revenue 34 TC 468, payments to executors and trustees for acting as such were held to constitute earned income arising from an 'office'.

It is interesting to note the following further guidance from the Department of Trade and Industry (as approved by the Revenue), concerning the national minimum wage: "If a person is a director and he does not have an explicit employment contract, then he is unlikely to be subject to the national minimum wage legislation even when he carries out a wide variety of activities. These might include, for example, working in the company's shop. Such activities can be done in his capacity as an office holder (director), rather than as a worker" (emphasis added). This would seem to suggest that if a Receiver also cares for a personal injury victim, the national minimum wage does not apply even if it could be argued that the provision of care constituted an employment.

Points to note

In the context of family members, some additional points worthy of note include the following:

- A High Court award for damages in favour of the personal injury victim often involves a payment to family members in respect of past care, between the dates of the accident and the damages award. On general principles, the taxability of such sums would depend upon whether a contract of service was in existence during this period, which seems highly unlikely. Indeed, the writer has seen court awards in recognition of 'gratuitous care', suggesting that the court acknowledges that no contractual relationship exists.

- Any compensation received by a person other than the individual who suffered the personal injury is exempt from capital gains tax (section 51(2), Taxation of Chargeable Gains Act 1992, and paragraph 12, Extra-statutory Concession D33).

- For National Insurance contribution purposes, employment by close family members is disregarded (paragraph 7, Column A, Part III, Schedule I, The Social Security (Categorisation of Earners) Regulations, SI 1978/1689), provided that the employment is in a private dwelling house in which both the employee and employer reside (and the employment is not for the purposes of a business carried on there by the employer).

- The Revenue's view as expressed to the writer is that, depending on the particular circumstances, a family member who is already carrying on the business of a carer (or receiver) elsewhere may be liable to tax under Schedule D Case I or II on payments made by a relative. Where sums are received otherwise than in the course of a trade, it is understood that the Revenue may alternatively consider whether an enforceable contract exists for the provision of services, with a view to imposing a charge under Schedule D Case VI.

- Where a contract of service does exist between family members, a loan made in the normal course of domestic, personal or family relationships is not treated as a beneficial loan (paragraph 5, Schedule 7 to the Taxes Act 1988). A loan agreement may be helpful in this regard, to distinguish it from taxable emoluments.

- If a family member provides care in his or her home, or if a personal injury victim resides in the receiver's home, any payments for rent should also be separately identifiable. In appropriate circumstances, it may be possible for the carer or receiver to claim for rent-a-room relief (see Schedule 10 to the Finance (No 2) Act 1992).

Conclusion

Through no fault of their own, this year many family members will find themselves in a similar nightmare to that described at the beginning of this article. Aside from the emotional traumas, they also face completely new financial challenges, including uncertainty in the tax treatment of payments made between them. Surely it would not be too difficult or expensive for the Government to put this issue beyond doubt by exempting such a specific and distinct group of taxpayers from tax on payments for the care of personal injury victims. And it would be even better if it did so without the need for consultation or lobbying.