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EH v Sec of State for Work & Pensions (CSM) (Child support: variation: departure directions: diversion of income) [2015] UKUT 621

The Upper Tribunal determines that repayments of a director’s loan can constitute income for the purposes of an application to vary child support maintenance on the grounds of diverted income.

This was the appeal of a parent with care (C) against the decision of the Secretary of State for Work and Pension in relation to child support maintenance. The non-resident parent (A) was the sole director and sole shareholder in A Ltd, from which he drew his income.

The First Tier Tribunal (FTT) had determined that £29,000 that A classified as dividend payments were to be treated as income, and therefore ordered a variation on the grounds of income not taken into account under regulation 19(1A), Child Support (Variation) Regulations 2000 (the '2000 Regulations').

Permission for appeal to the Upper Tribunal was given in relation to a further £7,000 that the FTT found was drawn from the company as repayment of a loan. The FTT had determined that this was perfectly proper for A to do, given that he was limited in the amount of dividend that he could draw by the retained profit in the business. Therefore, there was no unreasonable reduction in the amount of income that would otherwise fall to be taken into account (under Regulation 19(4), 2000 Regulations).

Judge Williams found that the FTT had made an error of law in the approach taken to considering whether the £7,000 was a diversion of income. The FTT had dismissed the application of C to vary on this ground (as well as on the ground that A's lifestyle was inconsistent with his income). C appealed on the basis that the FTT had, by treating the £7,000 as a loan repayment and not an increase in salary, failed to consider the issue of diversion.  Further, the ability of A Ltd to make the repayment demonstrated that it could afford to pay the same sum to A as earnings. A submitted that the sum represented a repayment of capital, and therefore could not be treated as income.

Judge Williams held that money received by way of loan repayment is capable of being considered as income. The Tribunal has to consider the nature of the payment in the hands of the individual and focus on the payments actually received as opposed to how they are accounted for at the end of the year. The Tribunal is not bound by the way that the company would view the amount.  It was held that repayments of a director's loan from a company to the non-resident parent are therefore capable of forming the basis of a variation on the grounds of diverted income under Regulation 19(4), 2000 Regulations. Whether there was such a diversion as a matter of fact, which was referred to the FTT for consideration.

In so deciding, Judge Williams cited with approval the obiter comments of Judge Mesher in the unpublished decision of E v Secretary of State for Work and Pensions and E. That judgment, extensively reproduced by Judge Williams, comments on the interplay between Regulations 19(1A) and 19(4), and the risks of undervaluing a variation claim if different elements of a payment to a non-resident parent are not properly classified.

Summary by Samuel Littlejohns, barrister, 1 Hare Court
_________________________

THE UPPER TRIBUNAL Appeal No. CCS 1380 2015 
ADMINISTRATIVE APPEALS CHAMBER

H v Secretary of State for Work and Pensions and C

DECISION

The appeal is allowed.
For the reasons below, the decision of the First-tier tribunal is set aside.
I refer the appeal to a new tribunal to decide the appeal again in accordance with the directions set out at the end of this decision.

REASONS FOR DECISION


1. This is an appeal by a parent with care (to whom I refer as C) against a decision of the Secretary of State awarding C child support maintenance for a qualifying child payable by the absent parent (to whom I refer as A). The "Secretary of State" includes in this decision predecessors in title to the Secretary of State responsible for child support maintenance.

2. The appeal concerns an application to the Secretary of State to vary an award on grounds for variation permitted by the Child Support (Variation) Regulations 2000 (the 2000 Regulations).  The Secretary of State refused the application. On appeal the First-tier Tribunal directed a variation on the grounds of income not taken into account (regulation 19(1A) of the 2000 Regulations). It refused to vary the award either on the grounds of diverted income (regulation19(4) of the 2000 Regulations) or that A's lifestyle was inconsistent with declared income (regulation 20 of the 2000 Regulations).

3. A judge of the Upper Tribunal granted permission to appeal only with regard to issues about diversion of income. It was conceded for C at the hearing by the First-tier Tribunal that a clear case for a lifestyle award could not be shown. The tribunal rightly did not consider that issue any further and that has not been challenged in this appeal. I therefore deal only with the issues that arise under regulation 19.

The tribunal's decision
4. During the relevant period A was the sole director and sole shareholder of a limited company I refer to as A Ltd. The tribunal accepted this as "an entirely usual way" for business affairs to be conducted. There was clear evidence (conceded for A at the tribunal hearing) that during that period A Ltd had made payments described as dividends to A.
The tribunal focussed on the period relevant to the appeal, namely the year leading up to the application for variation. It found as fact that for that year payments of £36,000 were made by A Ltd to A described as dividends. The tribunal determined that most of these payments were properly described as payments of account of dividends. It also determined on the evidence that of the £36,000 a sum of £7,000 was properly regarded as repayment of a loan made by A as director. It accordingly found the relevant income for regulation 19(1A) purposes to be £29,000 and directed a variation on that basis. 

5. The tribunal then dealt with the issue of diverted income (regulation 19(4)) as follows:

"[25] We deal briefly with … [C's] submission. [A] has acted perfectly properly in the  arrangement of financial affairs. [A] is constrained as to the amount of dividend [A]  can take by the retained profit in the business. [A] has quite properly taken the  balance by way of repayment of director's loan. We find as fact that [A] has not  unreasonably reduced the amount of income that would otherwise fall to be taken  into account (Regulation 19(4))."

Grounds of appeal and submissions
6. C's grounds of appeal raised issues both with regard to the tribunal decision about the payments on account of dividends and about the question of diverted income.

7. The Upper Tribunal judge who granted permission to appeal directed submissions from all parties about the proper treatment of the £7,000 deducted as repayment of a director's loan. All parties have made submissions in response. None have asked for an oral hearing and I have therefore dealt with the matters on the papers.

8. Having read those submissions, I agree with the judge granting permission that the focus in this appeal is rightly on the proper treatment of the £7,000.

Dividend income and regulation 19(1A)
9. I find no arguable error in the handling by the tribunal of the nature of the payments of £36,000 in this case, aside from the additional treatment of the £7,000. The tribunal comprised a tribunal judge and an expert financial member. It was clearly relying on its expertise in reaching the factual decisions on which it based its decision on that point. Further, there had been two previous tribunal hearings before the full hearing. During and following those hearings, the tribunal had made careful directions to ensure that it had all available evidence on this issue, and further directed a financial member to be included in the tribunal panel for the full hearing. I have considered the carefully argued submission for C that the tribunal erred in law in finding the £36,000 to be payments on account of dividends rather than actual dividends. I agree with the representative to the extent that both are approaches open to a company like A Ltd. But the determination of the actual nature in a particular situation will depend on all the evidence. In this case the tribunal has taken considerable care both in ensuring it had the evidence and in then applying the law to that evidence. I see no error of law in the way it has done that.

Diversion of income
10. By contrast, the decision (set out above) on the question of the £7,000 and whether there was a diversion of income is in my view wrong in law.

11. For C it was submitted on this point that the First-tier Tribunal had not properly dealt with the arguments before it. These relied on Upper Tribunal decisions CCS 1397 2013, CCS 4476 2002, and CCS 3006 2007. It was open to argument that by treating the relocated amount as a loan repayment rather than an increase to salary it had failed to consider any diversion. It was also argued that the evidence that A Ltd could make the repayment was also evidence that it could have paid the sum as earnings.

12. The submission for the Secretary of State supported C on this issue. The submission relied on the decision of Upper Tribunal Judge Mesher in CCS 2533 2014 to argue that the tribunal had not dealt with the issue adequately. The submission did not support the appeal on other grounds.

13. The submission for A, made by Huw Jones of counsel, rightly focussed on the treatment of the £7,000.  It argued that the tribunal was "entirely correct" in the approach it took to the decision that the repayment was not a diversion of income. And it took issue with the reliance of the Secretary of State on the decision in CCS 2533 2014. The repayment was a repayment of capital and could not be treated as income. Counsel also noted that the tribunal had accepted other evidence about "further sums" in paragraph [19] of its decision. It had, it was submitted, been correct in not deducting any such further sums. The submission concludes with comments about other issues. As is implicitly recognised in the submissions, they fall outside the scope of this appeal and I therefore make no comment. Additional evidence was submitted by A. However, I do not consider that as it was plainly not evidence before the tribunal when it made the decision under appeal, despite the efforts of the tribunal to ensure it had all relevant evidence before it.

14. The submission in reply for C reiterated the arguments about the £7,000, relying again on CCS 1397 2013 in particular. The representative accepted that CCS 2533 2014 had not been noted at the time of the original submission. The submission gratefully adopted the arguments for the Secretary of State based on that decision.

CCS 2533 2014   
15. The decision of Upper Tribunal Judge Mesher was not issued otherwise than to the parties at the time of its decision (3 10 2014). Its name is E v Secretary of State for Work and Pensions and E. It is a full and careful decision dealing in part with regulation 19(1A) and (4) of the 2000 Regulations but much of it is concerned with particular facts and, if I may say so, somewhat basic errors made in the decision of the First-tier Tribunal in that case. However, as part of the decision Judge Mesher drew on his considerable experience to make some useful more general comments.  As the decision has not otherwise been published, I set out a full extract of that part of Judge Mesher's decision below, with the added comment that I agree with it and adopt it insofar as relevant as part of my decision in this case. I add that comment because (at paragraph [22] of his decision) Judge Mesher cautiously commented that his views were provisional as he had not had submissions on the points. As noted above, I have had submissions on his decision and have considered them before agreeing with him.

16. Judge Mesher's decision commented:

"14. In relation to regulation 19(1A), this submission was made on behalf of the Secretary of State, picking up on what had been suggested by Judge Jacobs when giving permission to appeal:

"10. It is my submission that the First Tier Tribunal appear to have limited the application of regulation 19(1A) to dividends made in accordance with company and accounting law. However, there is nothing in this provision which restricts its application in this way. I would submit that the first question to be considered is whether these payments are income. Although income and capital is not defined for the purposes of child support legislation it was held in the Court of Appeal judgment R(CS) 2/08 that the Act and Regulations for the purposes of child support drew a clear demarcation between capital and income.
 
11. Accordingly, I would submit that the First Tier Tribunal who had the benefit of a financially qualified member should have investigated the actual payments in order to resolve the question as to whether they were income or capital."

I make the general observation at the outset that, if regulation 19(1A) does apply, the issues to be resolved are much simpler and more straightforward than those under regulation 19(4). No judgment as to unreasonableness or as to what amounts to a diversion of income has to be made. It is enough that the non-resident parent has the necessary control under sub-paragraph (a) and then as a matter of fact that he "is receiving" income of the kind defined in sub-paragraph (b).

15. I agree that there was an error of law in the tribunal of 7 January 2014 limiting itself in paragraph 12 of the statement of reasons to the two alternatives of the payments made under the label of dividends or advance dividends being dividends properly so called and of the payments being drawings from the director's loan account, i.e. drawings of capital. I quite agree with the tribunal that the payments made during the financial year lacked the formality associated with dividends and could not as a matter of substance and not merely form be regarded as dividends (see the instructive decision of the Court of Appeal in the tax case of Commissioners for Her Majesty's Revenue and Customs v PA Holdings Ltd [2011] EWCA Civ 1414). Indeed, there is some doubt whether the amounts apparently declared as a dividend at the end of each financial year could properly be accepted as meeting those conditions. However, I see no reason why the payments made could not be classified as income, for instance in the form of an emolument, either as director or as employee. The question is the nature of the payment in the hands of the recipient. There is evidence of the father's intention, through the labelling of the payments, that they should be of an income nature. The mere fact that, not being payments of dividends properly so called, they were loans to the father does not prevent them being classified as income (see the social security cases of Leeves v Chief Adjudication Officer, R(IS) 5/09, Morrell v Secretary of State for Work and Pensions [2003] EWCA Civ 526, R(IS) 6/03, and R(H) 8/08). It appears to be common to treat the taking of money out of a company that cannot be supported as earnings or as the paying of a dividend as creating a loan that has to be reflected in a director's loan account. That may or may not be so from the point of view of the company, but the obligations under the loan do not stop the payment being properly regarded in an appropriate case as income in the hands of the recipient. In the present case, the circumstances gave rise to an issue as to whether the payments made to the father were income, so that the tribunal of 7 January 2014 erred in law in failing to deal with that issue. It will have to be investigated by the new tribunal.

16. In doing so, the focus must be on the payments actually received, rather than the accounting procedures carried out at the end of each financial year. Regulation 19(5)(c) of the Variations Regulations gives little clue as to how, if the conditions in regulation 19(1A) are met, the amount of the income that is being received is to be calculated. Such a calculation is necessary to see if the provision can be applied in accordance with regulation 19(2) and, if so, to work out the amount of income to be included in the maintenance calculation by virtue of the variation. In Secretary of State for Work and Pensions v Wincott [2009] EWCA Civ 113, R(CS) 4/09, the result adopted by the Court of Appeal was really dictated by the fact that it was an annual payment of dividend that was in issue. Where, as here, there are payments of varying amounts at irregular intervals, it would seem reasonable as at 7 February 2012 to look at the previous 12 months to take an average, if that evidence is available. Alternatively, it might be reasonable to consider the amounts paid in the 2011/2012 tax year or the financial year to 31 May 2012. It looks as though any calculation would produce a figure over £100 per week, especially bearing in mind that, for the reasons given in paragraph 11 above, there would be no deduction for income tax and national insurance contributions.

17. In paragraph 12 of the submission of 18 July 2014, the representative of the Secretary of State said that in the event that the payments received were treated as income that fell within the provisions of regulation 19(1A) they could not, by virtue of regulation 19(4)(b), be treated as a diversion of income. I think that that is strictly accurate, but the proposition needs a little unpacking to avoid being misleading. If regulation 19(1A) was applied to the payments actually made so as to impose a variation, then I agree that the terms of regulation 19(4)(b) could not apply in respect of those payments. Although they might have been the result of a reduction in income that otherwise would have counted under the MCSC Regulations, they could not result from a reduction in income that would otherwise have fallen to be taken into account under regulation 19(1A). There would have been no such reduction because the amount of the payments had been taken into account under regulation 19(1A). My provisional view is that in the context of the structure of regulation 19(4)(b) the force of the word "or" is to exclude the application of the provision in relation to the full, non-reduced, amount of the income that has been taken into account under one or other of the MCSC Regulations or regulation 19(1A). But that would not preclude the application of regulation 19(4) entirely. One could envisage a situation where a non-resident parent with control of a company had received dividends of a sufficient amount to trigger the operation of regulation 19(1A) but there were still substantial profits held within the company and not distributed in salary or dividends. Plainly, regulation 19(4) has to be applicable to enable the questions to be asked whether in relation to that excess element of profits there has been an unreasonable reduction in the amount of income that would otherwise been taken into account under the MCSC Regulations or regulation 19(1A). If so, regulation 19(5) would then limit the amount of the additional income in the calculation as a result to the amount of that particular reduction.

18. It also seems to me that it is different if, say, regulation 19(2) prevents regulation 19(1A) applying to the income in question because the income received is not over £100 per week. Regulation 19(2) does not in fact use the terms of an exception. Rather it sets out a condition for the application of regulation 19(1A). If that condition is not met, the case does not fall within the category of cases in which a variation can be imposed and in my provisional view the income in question has not been taken into account under regulation 19(1A), because that provision has not been applicable.

19. My further provisional views are as follows, using dividends cases as an example. First, there must be room for an application of regulation 19(4) in the way set out at the end of paragraph 17 above. If a hypothetical cynical and unscrupulous non-resident parent carefully restricted the declaration of dividend to an amount that would give him £99 per week, although there was substantially more profit in the company available for distribution, it could be asked under regulation 19(4) whether there had been an unreasonable reduction in the amount of dividend that would otherwise have fallen to be taken into account under regulation 19(1A). The effect of regulation 19(5) would then at first sight appear to be to limit the additional income to be taken into account under regulation 19(4) to the difference between £99 per week and whatever amount it would have been reasonable to pay (say, for the purposes of this example, an amount producing £150 per week). But that result cannot be right. It would allow the cynical and unscrupulous non-resident parent, who ought (if he had initially done what has now been found under regulation 19(4) to have been reasonable in the child support context) to have been subject to a variation under regulation 19(1A) in the amount of £150 per week to be subject only to a variation in the amount of £51 under regulation 19(4).  But regulation 19(4)(b) refers to the amount that would otherwise have been taken into account under regulation 19(1A) and to diversion for purposes other than the provision of such income to the non-resident parent. My provisional view above was that where the condition in regulation 19(2) is not met no income falls to be taken into account under regulation 19(1A). Thus in the current example the non-resident parent, by restricting dividends to £99 per week has actually reduced the amount that otherwise would have fallen to be taken into account not merely by £51, but by the £99 as well. Further, there can be said to have been a diversion from the purpose of providing "such income" to the non-resident parent. He will have received the £99 per week in income, but that will not have been "such income", i.e. in the present context income that falls to be taken into account under regulation 19(1A). The diversion is to the purpose of providing income (£99 per week) to the non-resident parent in a form such that it does not fall to be taken into account under regulation 19(1A). Thus, all the conditions of regulation 19(4) (remembering that its application must be founded on a judgment that the reduction of income was unreasonable) are met and the variation could be in the amount of £150.

20. One additional complication of my example needs brief exploration. What if it is said that the diversion of income was in the form of the non-resident parent having unreasonably reduced the amount of the salary paid to him by £51 per week? In such a case, regulation 19(1A) does not seem to be in play, as the additional salary would have counted under the MCSC Regulations. Is the regulation 19(4) variation then restricted to £51 per week, leaving regulation 19(1A) not applicable because of the effect of regulation 19(2)? It will be recalled that in the present case the tribunal left it open whether the father could have paid out what it found to be the money available as accrued profits as salary or dividends. Indeed in many cases it will be very difficult to say what might have been done if the actual diversion had not taken place. I think that the answer is the same as in the previous paragraph. By restricting the dividends to £99 per week the non-resident parent had actually reduced the amount that otherwise would have fallen to be taken into account under regulation 19(1A) by the £99 and there was a diversion for a purpose other than providing "such income" him. Thus, given the basis of a judgment of unreasonableness, there could be a regulation 19(4) variation in the amount of £99 in relation to regulation 19(1A) and £51 in relation to the MCSC Regulations."

17. In applying that reasoning to this decision, I stress that I do not regard the comments about "cynical and unscrupulous non-resident parents" as applying to A. The tribunal in this case made it plain that it though entirely otherwise of A. But the concern that a tribunal examine properly both regulation 19(1A) and 19(4) in the cases of closely held companies such as A Ltd applies in all cases not just to unscrupulous cynics. I agree with both C's representative and the Secretary of State that the tribunal dismissed the application of regulation 19(4) here too readily.

18. For completeness, I should also mention the decision cited as CCS 1397 2013. That  decision is correctly to be referred to as TB v Secretary of State for Work and Pensions and SB (CSM) [2014] UKUT 301 (AAC). It is another decision of Judge Mesher made some months before CCS 2533 2014. The decision deals with several aspects of the 2000 Regulations, including regulation 19(4). However, given the lengthy citation of the relevant comments of Judge Mesher set out above on the issues relevant here, I do not need to consider that decision further. It is a published decision. I leave it to the parties to draw attention to anything they consider specifically relevant about that decision when making further submissions to the First-tier Tribunal.  
 
Conclusion
19. My decision is that the tribunal did not err in law in its treatment of the £36,000 under regulation 19(1A) of the 2000 Regulations, save as to the £7,000. Nor did it err in law in failing to consider further any issues about "lifestyle inconsistent" under regulation 20.

20. But it dealt inadequately with the issue of diversion under regulation 19(4). That aspect of this case needs to be reconsidered. The matter requires further findings of fact so must be referred to the First-tier Tribunal for further consideration.

21. While the whole appeal must be referred to the First-tier Tribunal for reconsideration, that tribunal and all the parties will be aware of my views on the application of the law to the facts found as the case was presented to the tribunal that made the decision under appeal. I am aware that there is further evidence thought to be relevant to the appeal that may affect how the First-tier Tribunal handles further consideration of those issues. That will be for the further tribunal to decide.

22. The rehearing might best be undertaken by the tribunal that considered the decision under appeal in this case if that tribunal can be reassembled. Certainly, I would recommend that the rehearing again include a financially qualified member and, subject to any specific objection by any party, I see no reason to preclude from the rehearing of this detailed technical case any judge or member previously involved in it. Indeed, it may save costs on all sides if that is done, given that my decision criticises only one aspect of this decision and does that by reference to a decision of the Upper Tribunal of which that tribunal probably was not aware. These are however matters for a First Tier Tribunal judge to decide and I make no specific directions on the point.

 

Directions for new hearing

A The new hearing will be at an oral hearing, unless all parties indicate otherwise.

B I make no direction as to the constitution of the new tribunal. That is for a district First-tier Tribunal judge to determine.

C All parties are reminded that the tribunal can only deal with the appeal as at the date of the original decision under appeal.

D The new tribunal will have the additional evidence now in the papers, but not considered by me, before it. If any party has any further written evidence to put before the tribunal, this should be sent to the tribunal within one month of the issue of this decision.

These directions are subject to any later direction by a tribunal judge.

David Williams
Upper Tribunal Judge
9 11 2015

[Signed on the original on the date stated]