Background A brief history of the taxation of employment income
11.Income tax was introduced in 1799; Schedules A to E first appeared in 1803; and the income tax legislation of the Napoleonic period was given its final shape in an Act of 1806. That Act was also drafted in terms of the five Schedules A to E. Schedule E related to every public office or employment of profit; and the general rule was that income tax was to be “detained and stopped” at the public office. The Napoleonic wars ended in 1815, and income tax was then abolished.
12.Income tax was reintroduced in 1842, in an Act agreed to have been modelled on the 1806 Act, and the five Schedules accordingly reappeared. Income tax has been in continuous existence ever since.
13.Some provisions in the income tax legislation relating to Schedule E, therefore, now have a considerable history. One of these is the central provision concerning the deductibility of expenditure, with its requirement that the expenditure should be expended “wholly, exclusively and necessarily” in the performance of the duties of the employment (see section 336 in Part 5 of this Act). For well over a century this provision also included a reference to keeping and maintaining a horse in order to enable the employee to perform the duties of the employment; and only in 1998 was this reference removed.
14.In the years following 1842 the charge to income tax under Schedule E applied only if the office or employment held or exercised was of a public nature. If it was not, income tax was charged under Schedule D (the residual Schedule). There were fewer public offices than some had thought: in Great Western Railway Co - v - Bater (1922) 8 TC 231, [1922] 2 AC 1, the House of Lords, undoing the accepted practice of decades, placed a railway clerk in Schedule D and not in Schedule E. But the charge to income tax under Schedule E was widened by section 18 of FA 1922, which provided that profits or gains arising from employments chargeable under Schedule D, “other than the profits or gains chargeable under Case V of Schedule D”, should be transferred to Schedule E. The profits or gains from some employments accordingly continued to be chargeable under Schedule D Case V; but that possibility disappeared when section 10 of FA 1956 provided that all income from employments was to be chargeable under Schedule E, and divided Schedule E into three Cases.
15.The twentieth century saw major increases in the revenue obtained from income tax, in the rates of that tax, and in the importance of income tax to central finance. It became a matter of major operational importance, therefore, (and not least during the Second World War) that employees should account for income tax on their earnings. The result was the Pay As You Earn (PAYE) system. The developments leading to the introduction of that system are discussed in greater detail in the introductory explanatory notes for Part 11 of this Act; and that Part deals with the primary legislation relating to the PAYE system.
16.Since the Second World War both earnings and income tax rates have been very high by historical standards; and national insurance contributions may well make further demands on both employer and employee.
17.Against this background, it might well be worthwhile for employers and employees to try to arrange for payments and benefits to be received in a way that minimises income tax – and for the Inland Revenue to contest those arrangements. There are, accordingly, numerous cases in which the Inland Revenue has alleged, and the taxpayer has denied, that the receipt of a particular advantage was within the ambit of the Income Tax Acts. Hochstrasser - v - Mayes (1959) 38 TC 673, [1960] AC 376 is one example that may represent others. And against this same background it was also to be expected that the legislation relating to income tax charged under Schedule E would become more extensive and more complicated.
18.One legislative consequence related to the subject described in Part 3 of this Act as “the benefits code” – and dealt with in that Part. Legislation on this subject featured in FA 1948, and has been extended in other Finance Acts since – not least in FA 1976.
19.A second legislative consequence was that the charge to income tax under Schedule E was extended to receipts with characteristics specified in the legislation in question. The first, and very important, example was the legislation relating to payments and benefits received on the termination of an employment, originally enacted in FA 1960. In this Act these provisions may be found in Chapter 3 of Part 6. The provisions of that Part do not deal with earnings from an employment, charged to income tax under Schedule E by virtue of paragraph 1 of section 19(1) of ICTA 1988, but with other payments and benefits specifically charged to income tax under Schedule E by virtue of paragraph 5 of section 19(1). In this Act this income is referred to as “specific employment income”, and it is distinguished, very carefully, from “general earnings” (see section 6(1) of this Act).
20.A third legislative consequence concerned share-related income, dealt with in Part 7 of this Act. Companies might well wish to reward employees by allowing them to acquire shares on advantageous terms – including arrangements designed to minimise income tax. The income tax legislation on this matter accordingly consists in part of legislation designed to counteract schemes that have been in existence at various times, and in part of legislation designed to promote share schemes with meritorious characteristics. These matters are discussed in greater detail in the introductory explanatory notes for Part 7 of this Act. That Part is extensive. It occupies 138 sections and four Schedules with a total of 245 paragraphs (and there is further material in Schedule 6 dealing with consequential amendments). Some of this material is very recent: of the provisions just mentioned 43 of the sections and 159 of the paragraphs in the Schedules derive from legislation on topics first dealt with in FA 2000.