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Aug 2006
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In Brief:
The Court of First Instance upheld the decision of the Board of Review that payment as consideration for cancellation of a contractual right is not taxable. Furthermore, the Court upheld that the tax law permits apportionment of termination payments received by taxpayers into taxable and non-taxable portions. |
The Inland Revenue Department ("IRD") appealed to the Court of First Instance and sought to reverse an earlier decision in the Board of Review, which apportioned 50% of the taxpayer's termination payment as being not taxable. The Board noted in its decision that it was a generous allocation in favour of the Taxpayer.
Background Facts
The Taxpayer was MD and CEO of a company which he had co-founded. On 12 June 1997, the Taxpayer was asked to resign with immediate effect and on the same day, the Taxpayer, together with his lawyer and a representative from the company, executed a termination agreement. Amongst other things, USD11 million was paid to cancel some 5 million Incentive Compensation Plan Units held by the Taxpayer. The Incentive Compensation Plan Units entitled the Taxpayer to share in net profits of the company, as well as the grant of additional units in the future.
The Board of Review found that a portion of the Units represented an inducement to employment and should be taxable. However, cancellation of the additional units was clearly a right which the Taxpayer had to give up. As a "rough and ready" method, the Board of Review apportioned 50% of the USD11 million compensation payment received by the Taxpayer as being non-taxable.
The IRD appealed to the Court of First Instance on the grounds that the 50% apportionment was not reasonable.
Court of First Instance Decision
The Court of First Instance held that the current tax law allowed apportionment of termination payments received into taxable and non-taxable portions. The Board of Review was therefore acting within its powers in its decision in apportioning 50% of the compensation payment as being non-taxable. However, the Court did not agree that 50% was correct but instead of upholding the IRD's claim for a lesser portion to be tax-exempted, the Court held that the original Units held by the taxpayer were not wholly attributed to inducement to employment. This meant that the 50% of the compensation payment which was held by the Board of Review to be taxable should be further apportioned into taxable and non-taxable portions. The Court passed the case back to the Board to determine this further apportionment.
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"The Bottom Line"
The IRD accepts the general principle that payments for cancelling contractual rights or payments by way of damages for loss of rights are not taxable. The decision in this case is helpful in confirming the IRD's current practice of seeking to apportion compensation payments into taxable and non-taxable portions and affirming that the legislation allows for such an apportionment. It should also be noted that this is the second time in recent months that the law courts have directed the case back to the Board of Review for further consideration. |
Note: This bulletin is designed for the information of readers. Whilst every effort has been made to ensure accuracy, information contained in this bulletin may not be comprehensive or may not yet be passed into law. Recipients should not act upon it without seeking professional advice.
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