13 November. The following judgments were handed down.
NICHOLLS L.J. This case concerns fringe benefits, as they are sometimes called, or more colloquially, 'perks'. Malvern College is a well-known independent school for boys. It was established in the middle of the last century, and was incorporated by Royal Charter in 1929. For some year, and in common with what happens in may other independent schools, masters at the school have not been charged the ordinary, full fees for the education of their sons at the school. To be admitted to the school sons of staff have to satisfy the same educational requirements as all the other boys, but at the discretion of the council of the school, staff of the school, including the bursar, are required to pay only a part, currently one-fifth, of the normal day boy or boarding fees. This concession made because the school council is concerned that otherwise staff may be lost to competing schools which operate such a concession. With school fees as high as they are these days, this is a valuable concession. The question raised by these appeals is how this concession is to be quantified when calculating the income tax payable by the staff in respect of their remuneration.
Before the court are 10 appeals. They all raise the same point. Nine of the taxpayers are assistant masters at the school or, in one instance, the personal representatives of an assistant master who has since died. The tenth taxpayer is the bursar. They have appealed against assessments to income tax under Schedule E made in respect of one or more of the three years 1983-84, 1984-85 and 1985-86. In each case the taxpayer had one or more sons in attendance at the school pursuant to the concessionary fees scheme in one or more of these years. Twelve boys altogether, nine of whom were day boys and three were boarders, are concerned in these appeals. At any given time not more than nine boys occupied places in the school pursuant to the scheme.
During the three years in question the total number of boys attending the school averaged just over 600, mostly boarders. Between 60 and 70 girls, from two local independent girls schools, also received part of their education at the school, principally in the sixth form. Any additional costs to the school were covered by payments by the girls schools. The presence of the sons of staff did result directly in some additional expense on items such as food, laundry and stationary. That expense was amply covered by the reduced fees paid by the staff. Over the three years in question these additional direct expenses varied between Pounds 385 and Pounds 430 per boy per year. The normal school fees, of which the staff paid 20 per cent., varied in the case of boarders, between Pounds 4,675 and Pounds 5,300 per year and, in the case of day boys, between Pounds 3,360 and Pounds 3,825 per year. Further expense was incurred on some items such as music and handicrafts, as well as text-books, which were charged separately to the parents, in amounts which covered their cost. These extras were also paid in full by the taxpayers.
Leaving aside these 'additional direct expenses' and also these extra items, there remained all the other expenses of running the school : staff salaries, insurance, heating and maintenance of building, maintenance of grounds, remuneration of administrative and other staff, and so on. In the three years in question these general running expenses were of the order of Pound 3m. per year. These expenses would have been the same even if the sons of staff had not attended the schools : the presence of these boys did not increase these expenses, their absence would not have reduced them. In particular, no additional staff were employed in the school because of the presence of the sons of staff, and no fewer staff would have been employed had these boys not attended.
Nor is there any question of any boy under the concessionary fees scheme taking a place in the school which would otherwise have been filed by a boy paying full fees. The schools capacity was 625 boys. Thus in each of the relevant years the school was not full the capacity. No feepaying boy who attained the schools educational requirements was refused admission for lack of space. Thus, had the sons of the staff with whom these appeals are concerned not been admitted as pupils at the school, the place in question would have been left empty.
The issue raised by these appeals is whether, in the circumstances outlined above, the 'cost' of the benefit enjoyed by each taxpayer under the scheme comprised, as the taxpayer claimed and the special commissioner held, the amount of the additional, direct costs mentioned above or whether, as the Crown contended and as Vinelott J. held, it includes a rateable proportion of the expenses incurred in providing the school facilities enjoyed generally by all the boys. If the special commissioner is correct, no tax is payable by the taxpayers in respect of the benefits they enjoyed under the scheme, because the sums paid by them each year to the school exceeded the amount of the additional, directed costs. If the judge is correct, substantial amounts of tax are payable, because a rateable apportionment of the relevant expense would produce a figure close to the amount of the ordinary school fees.
The relevant statutory provisions are to be found in chapter II of Part III of the Finance Act 1976, in particular, sections 61 and 63. Those two sections have now been replaced, with amendments immaterial for present purposes, by sections 154 and 156 of the Income and Corporation Taxes Act 1988. Section 61 is the charging provision. It applies where a person is employed in 'directors or higher-paid employment'. Higher-paid employment means, after 1978, employment with emoluments at the rate of Pounds 8,500 a year or more (section 69(1), as amended by section 23 of the Finance Act 1978). Section 61 introduced into charge to income tax under Schedule E a wide range of benefits, where these are provided for the employee or members of his family or household by reason of his employment. The section treats as emoluments of the employees employment 'an amount equal to whatever is the cash equivalent of the benefit :' subsection (1). With exception immaterial for present purposes, the section applies to services and benefits and facilities of whatsoever nature charged under section 61 is to be calculated. This is the key section on these appeals. Subsection (1) and (2) read :
'(1) The cash equivalent of any benefit chargeable to tax under section 61 above is an amount equal to the cost of the benefit, less so much (if any) of it is made good by the employee to those providing the benefit. (2) Subject to the following subsections, the cost of a benefit is the amount of any expense incurred in or in connection with its provision, and (here and in those subsections) includes a proper proportion of any expense relating partly to the benefit and partly to other matters.'
The short issue on these appeals concerns the proper application of subsection (2) in these 10 cases, where the sons of staff had the use of the school facilities at one-fifth of the normal fees.
Benefits in kind have been a feature of employment in this country for many years. For present purposes they can be divided broadly into two categories. First, there are those cases where the benefit provided to the employees is not directly related to any business being carried on by the employer. Perhaps the most common instance is the provision of a car by am employer who is not himself involved in the case industry. Private medical insurance is another example. For ease of reference I shall call benefits in this first category 'external' benefits. The second category, which I shall label 'in-house' benefits, consists of cases where can employer is carrying on a business, whether for profit or not, of providing goods or services or facilities and he permits his employees to acquire those goods or use the service or facilities at a reduced price. Examples of this are legion. Familiar instances which spring to mind at once are airlines, car manufacturers and retail shops and stores. Malvern College falls into this second category in respect of the concessionary fees scheme. Sometimes an employer provides both in-house and external benefit : an airline may provide air tickets for employees and their families free or at cut prices, and also a benefit such as the cost of subscription to a private medical insurance company.
When taxing these benefits in 1976, one obvious course which Parliament might have taken is to treat 'the cash equivalent of the benefit 'as the difference between the amount, if any, paid by the employee and the amount the employee would have had to pay in the ordinary course to acquire the goods or services himself had he wished to do so. That course Parliament eschewed. Parliament did not adopt a 'market value' test. Instead Parliament adopted a formula which looks, not at the value to the employee of what he receives, but at the expense incurred by the employer in providing the benefit. In the normal way this approach will be more favorable to employees. The expense incurred in providing an in-house benefit is likely to be less than the market price, if only because that formula excludes the profit element which am employer, other than a charity, can be expected to build into his prices. Moreover, as to external benefits, this formula does not require an employee to bring into account any discounts which a major employer may be able to negotiate with the medical insurance company or others.
External benefits
No particular difficulty arises in applying the statutory formula in section 61(2) in the case of external benefits. In principle the expense incurred by the employer in acquiring the goods or services or facilities which he is providing for the employee should be readily identifiable. But there is one point of importance to be noted. If the benefit comprises a facility which the employer maintains for use by his employees, such as a swimming pool, the statutory formula must require that the maintenance expenses are apportionable between all the relevant employees. The expense incurred in providing that benefit for a particular employee is a proper proportion of the expense incurred in maintaining the pool for the benefit of that employee and the other employees.
This point is important because it illustrates that the statutory formula cannot sensibly be interpreted as applying only to the extra expense directly incurred in providing the benefit to the particular taxpayers whose affairs are under consideration. Such an interpretation would produce an absurd result in cases where a facility is provided for a group of employees. Frequently in such cases it will be the fact that in respect of no one employee can it be said that expense was incurred in providing the benefit for him, considered alone. The marginal cost, in the case of any single employees, will be nil. But in such cases the benefit consists of the opportunity to use the facilities provided for the group of employees as a whole. In respect of each employee the expense incurred by the employer in providing the facilities relates partly to the benefit afforded to him and partly to the benefit afforded to the other employees, and is to be apportioned accordingly.
In-house benefits
Likewise, and with one exception to which I shall come, there is no particular difficulty in principle in applying the statutory formula in the case of in-house benefits, which is the second of my two categories. The employer incurs expense in acquiring in the ordinary way that can be described as his stock-in-trade. If he makes that stock, whether it comprises goods or services or facilities, available to his employees at discounted rates, then the statutory formula applied to the expense incurred in providing the goods or services or facilities in question. Depending on the facts of the particular case, that expense will include an element in respect of the employers overheads, or general running expenses, as well as the price paid or expense directly incurred by the employer in, for example, acquiring the relevant goods. I recognise that in some cases this will call for sophisticated calculations, but I doubt whether this will often give rise to serious difficulty in practice. I would expect that these cost-per-unit calculations will normally be made by an employer in any event.
I appreciate also, and this is that the hear of the taxpayers case on these appeals, that in the case of in-house benefits the general expenses incurred in running the business were not incurred by the employer for the purpose of providing benefits to the employees. A retailer does not stock and run his ship for the benefit of the staff. The operator of an airline does not incur expense in providing and maintaining aircraft for the benefit of the aircrew or the ground staff. But I cannot find in this sufficient justification for distinguishing in-houst benefits from external benefits and in the former case, but not the latter, regarding the additional direct costs as the only costs which are caught by the statutory formula. The shopkeeper stocks and runs his shop for the purpose of selling his goods. The benefit enjoyed by the staff is the opportunity to buy those goods at reduced prices. The expense incurred by the employer in providing that benefit is the expense incurred by him in providing the goods. That expense will be the same whether the goods are sold to the public in the ordinary way or are sold to an employee at a reduced price.
Surplus capacity
The one point which caused me some initial difficulty concerns cases, such as the present, where the benefit is an in-house benefit and consists of the use of surplus capacity in services supplied by an employer for his customers. Take the case of an airline which permits staff to travel free in seats which are unoccupied by fare-paying passengers. If the man in the street were asked how much the provision of such a stand-by benefit cost the employer, his answer would 'nothing'. The seat one the plane would have remained empty and wasted and, apart from the minimal additional direct expense of food and drink and a little administrative work, the airline incurred no expense in permitting the air hostess to occupy that seat as she travelled abroad on holiday. At first sight this is an attractive approach. The flaw is that it is looking at the question from the wrong angle. Take the case of a retailer who is able to sell all the goods he can acquire at a particular price. The 'cost' to him to permitting an employee to buy an item at a reduced price is, viewed in one way, the amount of the discount. The employer lost the opportunity of selling the item at full-price. Compared with what would have happened but for the cut-price sale, he is out-of-pocket to the extent of the discount he gave to the employee. However, That is not the approach prescribed by the statutory formula. The statutory formula is not concerned with what, looking at the matter broadly, the employer can be said to have lost by providing the benefit. The statutory formula is concerned exclusively with one specific calculation : the amount of the expense incurred by the employer in providing the benefit. If the benefit consists of buying goods at a discount, I can see no scope, having regard to the statutory language, for the amount of that expense to vary according to whether, in the event, the retailer would or would not have been able to find a buyer for the goods.
The statutory formula must, of course, be applied having due regard to the circumstances in which, and the purpose for which, the expense in question was incurred and the nature of the benefit under consideration. But I can see no escape from the conclusion that the fact that an in-house benefit comprises use of surplus capacity does not, of itself, affect the 'expense' calculation which the statutory formula calls for.
Malvern College
If the above observations on the meaning and effect of the statutory formula are correct, it must follow that these appeals have to be dismissed. The benefit enjoyed by the taxpayers consisted of the opportunity for their boys to have a place in the school cost the school as much as every other place. Thus the expense incurred by the school in providing that benefit for any one member of the staff such as the bursar was a proper proportion of the general running expenses of the school, since those expense related partly to the benefit provided for the bursar and partly to 'other matters'. I agree with the judge.
Footnote
In the course of argument many examples were canvassed of circumstances in which the application of the statutory formula in accordance with the construction I have accepted above might produce anomalous results or give rise to practical difficulties. I need not rehearse these. They are all matters properly to be weighed when seeking to construe the statutory language. But in the end I have not found any of them sufficient to point clearly to some other meaning for the statutory formula. When such a concise formula falls to be applied across the wide spectrum of circumstances in which all manner of in-house and external benefits are made available, it is hardly a matter for surprise if here an there some odd results, Which may not have been foreseen by Parliament, will be produced.
I should also add this. As will be noted, I have made no reference to the method used by Malvern College in the calculation of its fees. Before the special commissioner evidence and argument were directed at the proposition that, once some 585 boys had taken up places at the school, any fees from further boys were 'pure profit', and hence no expense was incurred in educating them. The detail of the evidence will be found in the cases stated, which are set out in the report in [1990] S.T.C. 6. Before us it was common ground, in my view rightly so, that these matters are irrelevant to the issue arising on these appeals. The manner in which the school seeks to recoup its expenditure is of no relevance to the ascertainment of what was the amount of the expense incurred in providing the benefits in question for the staff.
I would dismiss these appeals.
SLADE L.J. I have had the advantage of reading the judgment of Nicholls L.J. in draft. I agree with both his conclusions and his reasoning which I find compelling. I add something of my own out of deference to the attractively presented argument of Mr. Oliver, for the taxpayers, and because this case has certain features which case me concern.
Section 61(1) of the Finance Act 1976 requires that in cases where the subsection applies there shall be treated as emoluments of the employment of each of the taxpayers, and accordingly chargeable to income tax under Schedule E, 'an amount equal to whatever is the cash equivalent of the benefit.' For the purpose of applying that subsection in the present case, Vinelott J. held [1990] 1 W.L.R. 204, 209 (at p. 776 of 188 ITR) :
'The benefit to a member of the staff whose son is allowed to attend the school and who is charged concessionary fees is that his son is allowed to participate in all the facilities afforded by the school to the boys who are educated there.'
That much has been common ground on this appeal. The dispute has concerned the application of section 63(1) and (2) of the Act of 1976, which Nicholls L.J. has already quoted. The judge held, at p. 209, that under section 63(2) (at p. 776 of 188 ITR) :
'the cost of providing that benefit is to be taken to be expense incurred in or in connection with facilities afforded and so far as shared with the other boys at the school a rateable proportion of the facilities afforded to them all.'
His conclusion, of course, means that in calculating the cost of providing the benefit, there have to be taken into account both the expenses directly incurred in providing benefits for the particular boy in question and also, subject to rateable apportionment, those incurred in the general running of the school.
Mr. Oliver submitted that this construction of section 63(2) is wrong. The gist of his case is to be found in the following passage in his skeleton argument, as amended during the course of the hearing :
'Section 63(2) does not, properly construed, produce the result that expenditure incurred wholly to maintain and run an undertaking such as a school as a going concern is to be brought into the reckoning as expenditure incurred (in whole or in part) in providing the benefit. For the apportionment provisions to operate the expenditure in question has to be both a cost attributable to the provision of the benefit (i.e. the BG implementation of the decision to admit the boy in question) and a cost relating to another matter. Specifically, the judges approach is incorrect in that it presupposes that the colleges expenditure on overheads was expenditure caused by or attributable to the decision to admit the boy : in reality that was not what the overheads were spent on. At most it can be said that the benefits could not have been provided for the taxpayer unless the expenditure on overheads was being incurred : that, however, is not the same thing as saying that the expenditure on overheads was incurred in order to provide the benefit.'
Mr. Oliver further submitted that the judges construction is at variance with the commercial realities of the situation. So it is, if one looks at the matter at the moment in time when the decision was made to admit the boys in question to the school, which had by them for many years been a running concern. Looking at the matter at that point of time, the admission of the boys, and their subsequent enjoyment of the schools accountant, if asked by the governors for his advice as to the effect of the operation of the concessionary fees scheme in relation to any of these individual boys, might well have advised them that his admission would cost the school nothing except a proportion of the direct costs attributable to each of them, such as for stationery, laundry, food and chemicals.
Considerations based on commercial reality, however, by no means all point one way. It all depends on the moment in time at which the matter is considered. Looking at the position at the end of any tax year of the school, to say in general terms that the expense incurred by it in the provision of educational facilities for all, say, 600 boys for the time being at the school during that year included nothing by way of general running costs would appear somewhat absurd. Likewise in broad commercial terms, the expense incurred by the school in the provision of such facilities for any one of those 600 boys who remained at the school throughout that year, whether or not enjoying the benefit of the concessionary fees scheme, would at first sight include 1/600th of the general running costs.
On this appeal, however, we are concerned not so much with commercial realities as with the construction and application of the short and somewhat sparsely drafted section 63(2). In the course of his argument, Mr. Oliver in substance, if not in terms, invited us to read the phrase 'any expense incurred in its provision' as meaning either 'any expense incurred for the purpose of its provision,' or alternatively 'any expense incurred in implementing the decision to provide it;' this is the sense of the passage from his skeleton argument quoted above. The legislature could have chosen to adopt either of these two alternative forms of words in the drafting of section 63(2). In many, perhaps the majority, of cases the effect would have been the same as that of the form actually adopted. But it did not choose to do so.
The former of the two last-mentioned suggested construction is, in my judgment, permissible neither on the wording of the subsection nor on authority. In Rendell v. Went [1964] 1 W.L.R. 650, to which Vinelott J. referred in, greater detail [1990] 1 W.L.R. 204, 209, there was under consideration section 161(1) of the Income-tax Act 1952 which contained the similar phrase :
'where a body corporate incurs expense in or in connection with the provision, for any of its directors ... of other benefits or facilities of whatsoever nature ...'
It was argued in the court of first instance that he terms of the sub-section required the court to look at the motive of the company in making the expenditure in question on the ground that the word 'in' should be construed as equivalent to 'for the purpose of.' This construction of the subsection was decisively rejected by the Court of Appeal and subsequently the House of Lords : see for example per Russell L.J., at p. 652, per Lord Reid, at p. 655, and per Viscount Radcliffe at p. 656. Similarly, in my judgment, the wording of section 63(2) of the Act of 1976 leaves no room for the introduction of the concept of purpose or motive. Under that wording the simple question which has to be answered is : 'What is the amount of the expense that has been (actually) incurred in or in connection with the provision of the relevant benefit ?' The purpose or motive of the employer in incurring the expenditure is irrelevant.
This being the question which that wording poses, I likewise see no justification for reading it as if it had required the ascertainment of the expense incurred in implementing the decision to provide the benefit. The wording of the subsection is too clear to permit the introduction of such additional words by a process of implication.
As Mr. Moses pointed out, section 63(2) does not limit the relevant expense to expense incurred exclusively for the benefit of the taxpayer. Subject to apportionment where necessary, any expense which is of benefit to or results in benefit to him falls to be taken into account in measuring the cash equivalent of the benefit, even if it is of benefit, also to others : see Rendell v. Went [1964] 1 W.L.R. 650, 659, per Viscount Radcliffe and Westcott v. Bryan [1969] 2 Ch. 324, 340, per Lord Denning M.R.
It follows that the judge, in my opinion, reached the right conclusion. There are, however, certain points arising from it which trouble me, particularly since this case must have wide implications for public authorities and other employers, large and small, who make 'perks' available to their employees, and for those employees themselves. First, as the judge said, at p. 210 (at p. 777 of 188 ITR) :
'It may seem harsh that a master at a fee-paying school who is allowed to send his sons to the school at fees which are less than those charged to parents generally but sufficient to cover any additional cost incurred by the school should be visited with a charge to tax which may make it impossible for him to take advantage of that privilege.'
It does seem harsh, but the potential harshness perhaps goes even further than this. In some circumstances, for example if a school was running at a loss, the Crowns construction of the legislation could, it would appear, actually result in the emoluments of the taxpayers employment being treated as including a sum greater than the normal school fees. In the course of argument reference was made to the hypothetical case of a local authority which runs a swimming pool and permits members of its staff to use its facilities without cost. If the annual salary of any such employee was Pounds 8,500 per annum or more, he would presumably be taxable on such benefit under sections 61 and 63. After the requisite calculations had been made, however, it might well transpire that the sum on which he was taxable was far higher than the admission fee which he would have had to pay as an ordinary member of the public.
Secondly, calculations of the amount of the charge which involved the consideration of overhead expenses, as well as additional direct expenses of the nature referred to by Nicholls L.J., could, if they were to be conducted with any degree of precision, well involve formidable work and expense for both the taxpayer and the revenue. Though this point was treated by Mr. Moses with apparent lack of concern in his clear and cogent argument for the Crown, I think it is a disturbing prospect. The onus would normally fall on the employee to displace the original assessment. The larger the employers organisation, the larger the scope of the necessary investigation and consequent expense might be. Furthermore, as Mr. Oliver pointed out, on particular facts there might well be difficulty in distinguishing between capital expenditure - which Mr. Moses accepted would not be taken into account in the relevant calculations - and other expenditure which could fairly be regarded as running expenses. Other significant potential practical difficulties were elaborated by him in argument.
Thirdly, and this point follows on the preceding two points, I have an uneasy suspicion that the legislature, in drafting section 63(2), was simply not directing its mind to the case where an employer, whose business consists of the provision of service to the public or a section of the public, confers on his employees a benefit consisting of the use of surplus capacity in the services supplied by him for his customers. If the legislatures attention had been directed to this case, I suspect that it might have provided for it in a somewhat different manner. For all that, we have to apply the subsections as they stand, and I agree with Vinelott J. that his interpretation of their effect is inescapable. With some misgivings, I would therefore concur in dismissing these appeals.
FARQUHARSON L.J. I agree with both judgments.
Appeals dismissed with costs.
Leave to appeal.
Solicitors : Jagger, Son & Tilley, Birmingham; Solicitor of Inland Revenue.