Comment: Forde & McHugh case decides that earnings for NICs are wider than for employment income tax

Finance and HR departments should now urgently consider whether any of their incentive arrangements, in particular performance-related incentive plans, include features which might fall foul of this decision.

In HMRC v Forde & McHugh Ltd [2012] EWCA Civ 692, the Court of Appeal had to decide whether a contribution made by the taxpayer company (partly in cash and partly in gilts) to a funded unapproved retirements benefits scheme to make pension provision for one of its directors constituted "earnings" for the purposes of Class 1 national insurance contributions ("NICs"). Reversing the Upper Tribunal, the Court of Appeal held, by a majority, that the contribution did indeed constitute earnings. Accordingly, as it was common ground that the contribution was "paid to or for the benefit of an earner" (SSCBA 1992 s. 6(1)), it was liable to Class 1 NICs. Unless there is an appeal to the Supreme Court, the result of this decision is that the concept of "earnings" for NICs purposes is a self-standing one and not, therefore, restricted by some of the constraints which limit the concept of "emoluments" (now, confusingly, also "earnings") for the purposes of employment income tax.

Two of the limitations on the concept of "emoluments" for the purposes of employment income tax are those arising from the convertibility principle (see Tennant v Smith [1892] AC 150) and the indefeasibility principle (see Edwards v Roberts 19 TC 618). Both of these are generally in play where employer contributions are made to an unapproved pension scheme for the benefit of an identified employee and, accordingly, such contributions do not generally constitute "emoluments" for employment income tax purposes. They have, however, in the past been brought within the scope of employment income tax by specific provisions and are currently within the scope of that tax by virtue of the "disguised remuneration" regime (as there will inevitably be "earmarking" where the employee is identified).

The question for the Court of Appeal was whether, as had been the case in the past at least in the case of graduated NICs, the meaning of "earnings" for the purposes of Class 1 NICs was the same as the meaning of "emoluments" for employment income tax purposes, despite the repeal of the link between the two definitions by the Social Security Act 1973. As the current NICs legislation does not contain any express answer to this question, the Court had to arrive at the answer by an analysis of the legislative history and by drawing inferences from the provisions of the legislation comprised in that history. The main factors which persuaded the Court to decide that the meaning of "earnings" for NICs purposes was not the same as the income tax meaning of "emoluments" and, crucially, that neither the convertibility principle nor the indefeasibility principle applied to the meaning of "earnings" for NICs purposes were:

• NICs have an origin and function which is different from that of employment income tax. There used to a statutory link between the definitions of earnings and emoluments, which would have been unnecessary if they were in any case identical concepts. Furthermore, the link only applied to graduated NICs, suggesting that "earnings" had a wider meaning than "emoluments" for other NICs purposes. These factors might point to a different definition but do not necessarily point to a wider definition. Crucially, they do not of themselves appear to support the exclusion of the convertibility principle and the indefeasibility principle from the concept of "earnings" for NICs purposes;
• The use of the word "paid" in SSCBA 1992 s.6(1), which focusses on what the employer pays, rather than on what the employee receives. This pointer also seems weak. PAYE is based on the concept of "payment" but is clearly constrained by the limitations which apply to the income tax concept of emoluments;
• Various statutory instruments promoted by the then Inland Revenue clearly proceeded on the assumption that contributions to unapproved pension schemes were liable to Class 1 NICs and that the NICs concept of "earnings" extended to non-convertible benefits, such as board and lodging. The Court accepted that secondary legislation could not normally be invoked to interpret primary legislation. However, it made an exception in a case, such as this, where the primary legislation had been consolidated after the enactment of the secondary legislation. In such a case, Parliament must be taken to have been aware of the state of the legislation (both primary and secondary), to have had full knowledge of the way in which NICs were being administered and, therefore, to have approved the wider meaning of "earnings" reflected in the secondary legislation. The making of such inferences must inevitably be part of the judicial process of statutory interpretation but to suggest that, in reality, Parliament addressed this issue when consolidating the primary legislation seems optimistic;
• SSCBA 1992 s.10 imposes Class 1A employer NICs on (among other things) non-convertible benefits in kind which are treated for income tax purposes as emoluments under the benefits code but which are left out of account in computing earnings for the purposes of Class 1 NICs. This is a pointer in primary legislation to non-convertible benefits being included in the concept of "earnings" for NICs purposes (unless a benefit which does not constitute "earnings" for NICs purposes is, for that reason, "left out of account" in computing earnings for those purposes). However, SSCBA 1992 s.10 does not seem to support an argument that a defeasible benefit such as a payment into a contingent fund, which is not treated for income tax purposes as an emolument, is included in the concept of "earnings" for NICs purposes; and
• SSCBA 1992 s.6(1) imposes NICs on "earnings paid to or for the benefit of an earner". If the concept of "earnings" for NICs purposes was the same as that of "emoluments" for income tax purposes, the words "for the benefit of an earner" would be unnecessary. For a payment to a third party to satisfy both the convertibility and the indefeasibility principles, it would generally have to be paid to a creditor of, or a nominee for, the employee. If that is right, it would be sufficient for s.6(1) to refer to "earnings paid to an earner". The words "for the benefit of" must have been intended to add something. The suggestion that the draftsman of s.6(1) meant those additional words to reflect the non-applicability of the convertibility and the indefeasibility principles to the concept of "earnings" for NICs purposes seems hard to swallow.

Finance and HR departments should now urgently consider whether any of their incentive arrangements include features which might fall foul of the decision in Forde & McHugh Ltd. For instance, if a payment is made by an employer company to a third party (eg a group company or an EBT) to fund a conditional, performance-related award of cash or shares to an identified group of employees and the earmarking of the fund (to reflect the contingent entitlements of each individual) falls within one of the exclusions to the disguised remuneration regime for deferred awards, that payment could now be liable to Class 1 NICs under the decision in Forde & McHugh Ltd (unless it fell within one of the "disregards" in the 2001 Regulations). Indeed, if no payment by the employer company was necessary because the third party already had a sufficient fund, the mere earmarking of the fund for the purposes of the conditional award might now be liable to Class 1 NICs under the decision in Forde & McHugh Ltd, depending on whether the NICs concept of "payment" is wide enough to include an earmarking.