EMI Group Electronics Ltd v Coldicott (HM Inspector of Taxes) [1999] 
IRLR 630 CA
Cerberus Software Ltd v Rowley 14.7.99 EAT (reported IRLB 626)
T and K Home Improvements Ltd v Skilton 18.3.99 EAT
(reported IRLB 626)

The Court of Appeal has decided that where a payment in lieu of notice is made on the termination of employment, and that payment in lieu of notice forms part of the contract of employment, the payment is taxable.

Where, however, there is no provision in the employment contract to make a payment in lieu of notice a payment made in lieu of notice as compensation or damages for breach of the contract of employment will not be taxable as long as it is less than £30,000. This decision is of great significance when negotiating termination packages and will mean that employees who have pay in lieu of notice clauses in their contracts will need to be advised of their tax liability as will the employers concerned.

In the EMI case two managers were dismissed as redundant. Their contracts entitled them to six months notice of termination with the company reserving their right to make a payment of the equivalent of salary in lieu of notice.

The Inland Revenue determined that the payments made in lieu of notice were taxable as emoluments from their employment in accordance with s19 of the Income and Corporation Taxes Act 1988.

The Revenue tried to recover from the employers the tax which should have been deducted and paid. The company appealed. The High Court decided that the payments were emoluments and taxable. The fact that the payments were due under the contract was relevant in suggesting that they "derived from" the employment and were part of the package of benefits which the company as a prospective employer offered to the employees to induce them to take employment.

The company appealed to the Court of Appeal, who agreed with the High Court. Lord Justice Chadwick saying" The point can, I think, be illuminated by considering the related question 'why is the employee entitled to six months' notice of the employer's intention to terminate his employment?' The answer must be because that was the security, or continuity, of employment which the employee required as an inducement to enter into the contract of employment".

Take no notice

Cerberus Software Ltd v Rowley also concerns a pay in lieu of notice clause. In this case Mr Rowley was employed by Cerberus on a contract with a six months notice clause. The contract also allowed the employer to dismiss summarily making a payment in lieu of notice. Mr Rowley was summarily dismissed and did not receive his pay in lieu of notice. He complained of wrongful dismissal in an employment tribunal. Just five weeks into his notice period he got a new job with better pay. The Tribunal found that he had been wrongfully dismissed and awarded him compensation for his full six months notice. They did not take into account his earnings from his new employment. The company appealed.

The Company argued that under his contract - as well as giving him proper notice or paying him in lieu of notice - they could give him no notice and make no payment in which case they would have wrongfully dismissed him and he would be entitled to the pay he would have received during his notice period less earnings actually received during the period.

The EAT disagreed. They did not accept there was a third choice in the contract to dismiss without payment. They therefore found that whether or not the company broke the contract by the summary dismissal itself, it was in breach of the contract by not making a payment in lieu of notice which was what it had promised to do in the event of summary dismissal.

The payment in lieu of notice meant payment without deduction for mitigation. Mr Rowley was entitled to be into the position he would have been in had the breach not been committed, so he was entitled to the full amount. The company had promised to pay the whole sum, they were not entitled to receive the benefit of his mitigation of his loss.

Clear and simple

In T&K Home Improvements the EAT considered the issue of pay in lieu of notice in the context of an ambiguously worded provision in a contract of employment. Mr Skelton had a contract of employment drafted by the employer's solicitors. It contained a three month notice clause. It also allowed the employers to dismiss without notice or pay on various grounds including "gross incompetence". The contract also set out Mr Skelton's performance target for the first three months of the financial year and said "If over any quarter you fail to achieve your performance target as outlined you may be dismissed with immediate effect".

Mr Skelton was not able to meet the performance targets and it was made clear to him that he had little choice but to resign. Mr Skelton complained to an employment tribunal that he was dismissed in breach of contract. They decided that he was dismissed and the dismissal was in breach of contract. The Company relied on the ambiguously worded clause "you may be dismissed with immediate effect".

The Tribunal said that for the contract to deprive Mr Skelton of the right to notice or pay in lieu of notice, there had to be a clear and specific provision to that effect. The clause was ambiguous and any ambiguity should be construed against the Company. Mr Skelton was entitled to his three months notice.

The Company appealed to the EAT, who agreed with the decision of the tribunal. The EAT said that if a professionally drafted document is going to impose draconian measures which mean that an employee is denied their contractual right to notice, such a term should be drafted in clear and unambiguous language to bring home to the employee the exact nature of his or her contractual liability.

This is a message which should be repeated to all employers who try and hide behind ambiguous wording in contracts.