Raymond Davies v Novatrust Limited

Tax grossing-up clauses are construed according to the objective meaning of the contractual language. Where the wording requires payment of a gross sum which, after tax actually applicable to the recipient, leaves a stipulated net amount, the calculation must reflect the recipient’s actual effective marginal tax rate on that payment. The clause does not justify a payment producing a tax windfall.

Pre-contractual negotiations cannot ordinarily establish the meaning of contractual words. They may be relevant to rectification or estoppel, but those remedies must be specifically pleaded and established.

Where accurate performance of a grossing-up clause requires information held only by one party, a term requiring that party to provide reasonably required income information may be implied as necessary to make the contract work.

Raymond Davies was entitled to pension payments from Novatrust Limited under agreements made in 2008 and 2016. The agreements required a gross amount to be paid which, after deduction of tax at the highest rate applicable to him in his country of residence, would leave specified net pension amounts.

The parties disagreed whether the pension should always be grossed up at the highest UK marginal rate, or by reference to the rate actually applicable to the Novatrust pension after taking account of Mr Davies’s other income. Mr Davies claimed arrears and declarations concerning future payments. Novatrust counterclaimed for declarations and an implied term requiring Mr Davies to provide income information.

1. Construction of the grossing-up clauses. The claim failed. The wording of the 2008 agreement was clear and unambiguous. It contemplated three steps: payment of a gross sum, payment by Mr Davies of income tax on that sum, and retention of the stipulated net amount after tax. The reference to the highest rate applicable to Mr Davies meant the highest rate applicable to the gross pension sum, not the highest rate applying to any part of his total income. The same conclusion followed from the 2016 agreement’s requirement that the Initial Net Amount be grossed up so that, after payment of tax, Mr Davies would be left with that amount.
2. The court applied the ordinary principles of contractual construction stated in Arnold v Britton, Rainy Sky v Kookmin Bank, Kason Kek-Gardner Ltd v Process Components Ltd, Commerzbank AG v Jones and ABC Electrification Limited v Network Rail Infrastructure Limited. Commercial common sense could not displace clear language. The commercial purpose of the clauses was to protect the agreed net pension from tax, not to confer a surplus or windfall. The observation concerning a tax grossing-up clause in AXA SA v Genworth Financial International Holdings LLC supported that conclusion.
3. Evidence of pre-contractual negotiations could establish relevant background facts, but could not be used to prove a subjective or special meaning of ordinary contractual words. The approach in The Karen Oltmann had been disapproved in Chartbrook Ltd v Persimmon Homes Ltd. Neither rectification nor estoppel was pleaded.
4. Implied term. Novatrust’s counterclaim succeeded. A term requiring Mr Davies to provide such income information as Novatrust might reasonably require for calculating the appropriate grossing-up rate was necessary to make the agreements work and sufficiently precise. Novatrust could not calculate the agreed net pension by reference to the actual incidence of tax without information available to Mr Davies.
5. Any consequential matters that could not be agreed were to be addressed by written submissions, with an agreed draft order filed as far as possible within 14 days of hand-down.