MacDonald (Her Majesty's Inspector of Taxes) v Dextra Accessories Limited

The key issue was the meaning of "potential emoluments" in section 43(11)(a) of the Finance Act 1989 and whether payments by employer companies into an employee benefit trust (EBT) were held by the trustee "with a view to their becoming relevant emoluments". The House of Lords held that sums held by an intermediary are "potential emoluments" if, on the terms of the trust read in its context, there was a realistic possibility that they could be applied in payment of emoluments. The court rejected approaches requiring an exclusive or dominant subjective purpose on the part of the contributor or an intention on the part of the trustees prior to exercising their discretion. Because the trust terms allowed a realistic possibility that the funds would be used to pay emoluments, the payments were not deductible under Schedule D until they were actually applied as emoluments in accordance with section 43 and the related provisions (notably sections 202A and 202B of the Taxes Act 1988 as effected by the Finance Act 1989).

This was an appeal against the Court of Appeal's ruling on the tax treatment of payments made by group companies into an employee benefit trust (EBT). The six appellant companies, members of a group founded by Mr John Caudwell, paid £2.75 million into a discretionary trust established by deed on 18 December 1998. The trust empowered the trustees, in their unfettered discretion but taking directors' recommendations into account, to apply capital or income for the benefit of a wide class of beneficiaries, including employees; funds were paid into the trust before the companies' year end and no payments were made to beneficiaries before 31 December 1998.

The statutory issue was whether those funds were "potential emoluments" within section 43(11)(a) of the Finance Act 1989, so as to defer deductibility for the contributing companies until the funds were actually applied in payment of relevant emoluments. The Special Commissioners found for the taxpayers, holding that the contributor's purpose had to be decisive. Neuberger J in the High Court upheld that approach but required a principal or dominant intention. The Court of Appeal allowed the Revenue's appeal and adopted an objective, textual approach: sums were potential emoluments if the terms of the trust made it realistically possible they would become relevant emoluments. The House of Lords agreed with the Court of Appeal.

The court framed the issue as one of statutory construction of section 43 (and its connection with sections 202A and 202B of the Taxes Act 1988). It concluded that "with a view to their becoming relevant emoluments" is concerned with what might realistically happen under the trust rather than the subjective purposes of the contributor or an impossible pre‑exercise intention of the trustees. The Lords noted the practical effect that sums never applied as emoluments would remain non-deductible under that construction, and observed that Parliament subsequently altered the law by section 143 and Schedule 24 of the Finance Act 2003, which addressed this anomaly. Relief sought: the appellants sought to retain deduction in the 1998 accounting period; the appeal was dismissed and the Revenue's position upheld.

Appeal dismissed. The House of Lords held that, for the purposes of section 43(11)(a) of the Finance Act 1989, amounts held by an intermediary are "potential emoluments" if the trust terms permit a realistic possibility that the funds could be applied in payment of relevant emoluments. On the facts the payments into the EBT were therefore potential emoluments and not deductible for the contributing companies until and insofar as they were applied as emoluments.

Special Commissioners decision for the taxpayers [2002] STC (SCD) 413; appeal to the Chancery Division (Neuberger J) [2003] EWHC 872 (Ch); [2003] STC 749 (judge upheld Special Commissioners); Court of Appeal allowed the Revenue's appeal [2004] EWCA Civ 22; [2004] STC 339; then appeal to the House of Lords [2005] UKHL 47 which dismissed the appeal.