PROVING THINGS 229: WHO BEARS THE BURDEN OF PROOF WHEN A CLAIMANT SEEKS DAMAGES GROSS OF TAXATION

We are returning for the second, but not the last, time to the judgment of Mrs Justice Hill in Mathieu v Hinds & Anor [2022] EWHC 924 (QB). The judge awarded an injured claimant damages for loss of earnings gross of tax.   There is an interesting discussion about the burden of proof.  However the decision on this issue was made on the basis of the absence of certainty.

Whether or not this Claimant’s damages will be taxed in future is far from clear, let alone “clear beyond peradventure”. There is simply no evidence available as to the future tax treatment of the Claimant’s damages in Canada or any other country. Applying the wording of Wood Mitchell, the situation remains a “doubtful” one, such that it would be “unjust” to permit the Second Defendant to “get the benefit of a reduced payment while leaving the [Claimant] exposed to the risks [of taxation]”.

THE CASE

The judge was determining damages in a personal injury case. The claimant was resident in Canada and the question arose as to whether he would have to pay tax on damages in Canada.  There was no expert evidence before the court.

THE JUDGMENT ON THIS ISSUE

The judge commented on the absence of evidence.  She held that, the absence of certainty meant that damages should be awarded gross of tax.
5.1: The issue
    1. There was a dispute between the parties as to whether any award to the Claimant to reflect lost income from his art should be calculated net of tax (the Second Defendant’s position) or grossed up (the Claimant’s position).
    1. In accordance with the net loss principle, damages in English courts generally take into account the incidence of tax. As explained in Halsbury’s Laws, Volume 29, Damages: “…where damages are not taxable but go to replace income that would have been taxed, tax is deducted. So, for instance, in the case of damages for lost earnings in a personal injury claim, the would-be income tax payable on such earnings is subtracted from any award”.
    1. The principle that damages to reflect lost earnings should be awarded net of tax is derived from BTC v Gourley [1956] AC 185, HL. In that case, a plaintiff was injured by the negligence of the defendants. The trial judge awarded him £37,720 damages in respect of past and future loss of earnings without regard to the income tax and surtax he would have had to pay on the amount of such earnings had he not been injured. If taxation had been taken into account, the award would have been £6,695. It was agreed that the plaintiff would incur no future tax liability on the £37,720 or the £6,695. The House of Lords (Lord Keith dissenting) reversed the decision of the Court of Appeal, to hold that the judge ought to have taken the tax position into account. The plaintiff’s award was reduced to £6,695.
    1. The Claimant’s 2019 Schedule of Loss was advanced on the conventional Gourley basis: he sought past and future losses on a net basis, with a 25% top rate of tax deduction on past losses and a 20% top rate of tax deduction on future losses.
    1. However, the Claimant’s February 2020 Schedule of Loss asserted that “The Claimant is resident in and pays income tax in Canada and will be subject to taxation upon damages received in accordance with Canadian and Quebecois tax laws. No credit is accordingly given for tax liability“.
    1. As to the role of Canadian or other foreign law on this issue, the parties agreed the following key principles summarised in Bank Mellat v HM Treasury [2019] EWCA Civ 449 at [53]: (i) in English private international law, foreign law is a question of fact, to be proved by a duly qualified expert in the law of that foreign country and the function of such an expert extends to both the interpretation and application of the foreign law; (ii) the burden of proof rests on the party seeking to establish the proposition of foreign law in question; and (iii) although the English court will scrutinise the evidence adduced, it will not undertake its own researches into questions of foreign law, any more than it will into other areas of evidence.
    1. However, there was no evidence before the court as to how, and if so to what extent, any damages awarded to the Claimant in London would be taxed at a federal or local level in Canada. The parties had been unable to agree to instruct a single joint expert on the issue. Each side then took the view that the other bore the burden of proof on the point for the legal reasons discussed below and so declined to instruct their own expert. It is perhaps unfortunate that this issue was not resolved before the trial commenced, given the sums of money potentially involved.
5.2: The parties’ submissions
    1. Mr Huckle submitted that the first question was whether the damages will be taxable upon receipt by the Claimant. He argued that the answer to this question remained unclear: the Claimant could be liable to pay income and/or corporation and/or capital gains tax (or the Canadian/Quebecois equivalents if any) on damages received. The Gourley principle only applied if the court was satisfied that the Claimant would not be taxed. Therefore, if the Claimant’s damages are or might be subject to tax, the court should not undertake a netting exercise and the damages should be awarded gross. It was for the Second Defendant to prove that the Claimant would not be taxed, and the Second Defendant had failed to do this.
    1. Mr Huckle drew support for this approach from Stoke-on-Trent City Council v Wood Mitchell [1980] 1 WLR 254, CA. In that case the claimants’ land had been subject to a compulsory purchase order. The claimants and the acquiring authority agreed a sum of compensation for certain losses between 1969 and 1971 while their business was being re-established. However, there was a dispute as to whether the gross sum should be adjusted to take into account corporation tax, in accordance with West Suffolk County Council v. W. Rought Ltd. [1957] AC 403 (in which the House of Lords had applied the Gourley principle to compensation payments for compulsory land acquisitions). The Lands Tribunal held that the compensation was in the nature of income and was to be treated as a trading receipt in the hands of the claimants. Therefore, as the claimants were liable to pay corporation tax on the sum received, they were entitled to compensation assessed without deduction of tax. The Court of Appeal dismissed the acquiring authority’s appeal.
    1. Roskill LJ giving the judgment of the Court of Appeal in Wood Mitchell noted at pp.258H-259A that there was an “important distinction” between the Rought case and the present case because in the former the Inland Revenue had made plain that in their view no income tax was chargeable on the compensation in question and the House of Lords proceeded on the assumption that that view was correct. However, in Wood Mitchell, the Inland Revenue had “written no such letter nor given any such assurance. On the contrary, an exchange of letters between the claimants and one department of the Inland Revenue suggested that capital gains tax would or might be payable”. He then explained at p.259C-D that the position of the Inland Revenue was “of importance”: if the Inland Revenue ultimately levied tax on the compensation which had been paid net in application of the Rought case, a “grave injustice would have been done to the claimants”: this was because, in simple terms, there was a risk that they would be required to give credit for taxation twice (once in the initial calculation of the damages and then again in the future taxation of the award).
    1. The key passage from Wood Mitchell on which Mr Huckle relied was at p.259E-H, where Roskill LJ said:
“Since the purpose of decisions such as those in British Transport Commission v. Gourley [1956] AC 185 and West Suffolk County Council v. W. Rought Ltd. [1957] AC 403 was to secure that a successful plaintiff or claimant did not get more by way of damages or compensation than would have been received by him in the absence of his injuries or of the compulsory acquisition in question, as the case might be, it seems somewhat strange that the principle underlying those decisions should be able to be invoked by the acquiring authority in order to produce the result that the claimants, in the absence of any assurance from the Inland Revenue that no attempt would be made to levy tax upon this sum, stood in peril of receiving considerably less than that which they would have received had their capacity to earn continued unaffected by compulsory acquisition. In such circumstances the more natural course, which would avoid any risk of injustice, would be for the claimants to receive the full sum, leaving the question of liability to tax, if any, to be adjusted thereafter between the claimants and the Inland Revenue.
We take the view that the principles laid down in West Suffolk County Council v. W. Rought Ltd. can only be applied if after examination of the relevant statutory provisions it is clear beyond peradventure that the sum in question would not be taxable in the hands of the claimants. If that is clear, then it would be wrong to require the acquiring authority to compensate the claimants beyond the amount of the loss which the claimants would in truth suffer. But if it is not, then it seems to us unjust that in a doubtful situation the acquiring authority can get the benefit of a reduced payment while leaving the claimants exposed to the risks we have mentioned. Considerations of abstract justice might be thought to suggest that the claimants should receive the full sum and then in due course account to the Inland Revenue for any tax properly chargeable upon that amount” [my emphasis].
    1. On the facts of Wood Mitchell, the Court of Appeal held that it was “far…from…clear” that the compensation would not be taxable, and indeed it appeared that some part of the compensation may become taxable. This was clearly distinguishable from the Rought case such that the acquiring authority had to pay the full sum to the claimants, leaving the claimants to account to the Inland Revenue for the sum (p.263B-D).
    1. Mr Dignum argued that the Claimant bore the burden of proof on the Canadian tax treatment of his damages because (i) he had pleaded a positive case as to taxation in his Schedule of Loss and thus the general principle that “he who asserts must prove” (Phipson on Evidence (20th Edition), paragraph 6.06) applied; and (ii) a party who wishes to rely on a point of foreign law must plead that law with particularity and prove it before the court as a matter of fact by means of expert evidence, and in the absence of any evidence of the precise law in question, or adequate proof as to its application, the court is bound to apply English law: see Bank Mellat at [53] and Dicey, Morris & Collins on the Conflict of Laws (15th Edition), Volume 11, paragraphs 9-001, 9-004 and 9-025.
    1. However, the Claimant had not called any evidence of his actual intentions in respect of his damages (and he could decide to invest some or all of his damages in the UK, Europe, the US, Haiti or elsewhere), nor any expert evidence on the application of Canadian and/or Quebecois tax law. The Schedules of Loss could not be relied on as such evidence at trial. Thus, he had failed to prove his pleaded case and the Gourley principle applied. There was no competing evidence as to taxation or uncertainty as to what might happen to the Claimant’s damages if he took them to Canada: there was simply no evidence either way. Therefore, Wood Mitchell did not assist the Claimant.
    1. Further, Mr Dignum referred to (i) section 1611 of the Civil Code of Quebec, which was said to codify the principle of restitutio in integrum, such that neither pecuniary nor non-pecuniary damages awarded by judgment as a result of personal injury are taxable; and (ii) Montreal (City of) v Wilson Davies, 2013, QCCA 34, a decision of the Court of Appeal in Quebec, which was said to be authority for the proposition that damages to compensate victims of personal injury are not subjected to taxation ([67] and [89]). Mr Huckle submitted that no regard should be had to this Canadian law material as this would be tantamount to the court carrying out its own investigation. In any event, Wilson Davies is difficult to understand, dates back to 2013 and does not give clarity as to what this Claimant’s tax position would be in 2022.
5.3: Analysis and conclusion
    1. In addressing this question, I have found it helpful to revert to the context of the Gourley decision. McGregor on Damages (21st Edition), paragraph 18-003 states that:
“The presence of two factors was necessary to set the stage for the problem which was posed for their Lordships’ decision in Gourley’s case: (1) the sums for the loss of which the damages awarded constitute compensation would have been subject to tax; and (2) the damages awarded to the claimant would not themselves be subject to tax.
For there cannot be any reason for taking tax into account in calculating damages given in compensation for a loss which would never itself have been taxed; this would let in a taxation where no taxation would have been, which would be unfair to the claimant. Equally there cannot be any reason for taking tax into account in calculating the damages if the damages themselves will then be taxed in the same manner as the loss compensated would have been taxed: this would result in a double taxation, equally unfair to the claimant”.
    1. Gourley factor (1) is present in this case: any damages awarded to the Claimant are to compensate him for income on which he would otherwise have been taxed. The precise level of that taxation remained a little unclear to me. The Second Defendant relied on a Combined Federal & Quebec Tax table to assert that the relevant rate would be 53.31%. At one point the Claimant argued for a broad-brush 50% rate but then appeared to accept the 53.31% rate. However, this table appears to reflect the marginal tax rate applicable to individual personal income (with potential variations for the calculation of tax on dividends on capital gains), whereas Mr Stanbury’s report dated 4 October 2021, paragraph 3.05, suggested that the Claimant is liable to pay Corporation Tax on his pre-tax profits and Income Tax and Social Security deductions based on his post-tax profits. For me to seek to resolve this issue would also appear to fall foul of the Bank Mellat principle that an English court should not undertake its own research into questions of foreign law.
    1. However, in respect of Gourley factor (2), there is simply no evidence as to whether or not the damages awarded to the Claimant will themselves be subject to tax.
    1. In terms of what this lack of evidence means for the calculation of the Claimant’s award, having considered the competing arguments, I prefer Mr Huckle’s submissions. In my view, as a matter of English law, the Wood Mitchell principle applies. That principle is to the effect that the Gourley or Rought netting exercise is not undertaken unless it is “clear beyond peradventure” that the damages in question will not be taxed in future.
    1. Whether or not this Claimant’s damages will be taxed in future is far from clear, let alone “clear beyond peradventure”. There is simply no evidence available as to the future tax treatment of the Claimant’s damages in Canada or any other country. Applying the wording of Wood Mitchell, the situation remains a “doubtful” one, such that it would be “unjust” to permit the Second Defendant to “get the benefit of a reduced payment while leaving the [Claimant] exposed to the risks [of taxation]”.
    1. Wood Mitchell does not expressly refer to the burden of proof. Logically, the party which will incur the additional cost of a gross award where the tax position remains unclear has the incentive to obtain the necessary foreign law evidence to make the position clear for the court. I note that McGregor paragraph 18-056 interprets Wood Mitchell in the same way as Mr Huckle, i.e., that the effect of the judgment is that it shifts the burden of proof to a defendant: “After a period of uncertainty the Court of Appeal…in…Wood Mitchell held that it was the defendant’s onus to show that factor (2) is satisfied, so that their failure to do so ousts the Gourley rule”. The point is repeated at McGregor at paragraph 52-005.
    1. After circulation of my draft judgment, Mr Dignum rightly drew my attention to p.413 of Rought, where Lord Morton held that it is for the party claiming losses “to prove the loss which they have suffered”. In Rought, this required the company whose land had been acquired to prove their lost profits taking into account the incidence of taxation. The passage continued by indicating that the other party might then criticise the figures and the court would ultimately decide on the correct approach. However, I agree with Mr Huckle that this passage is directed at how the losses for which compensation is to be awarded would have been taxed, for the purposes of any netting exercise, and not who bears the burden of proof on the question of future taxation.
    1. Here the Second Defendant has chosen to place no foreign law evidence before the court and so in my view the Gourley rule is ousted. However, in my view the fact remains that – whichever side bore the burden of proof – the taxation position remains unclear, such that Wood Mitchell applies.
    1. Similarly, I consider that the fact that one of the reasons for the uncertainty in this case is the potential role of foreign law makes no difference. Indeed, even if one does approach this issue as a question of private international law, the result is the same: this court has an absence of any evidence of the Canadian or other tax law in question, such that the court is bound to apply English law. English law on this particular point is set out in Wood Mitchell, with the consequences set out above.
    1. For the avoidance of doubt, I did not consider it appropriate to have regard to the Canadian law material provided by the Second Defendant, given the recognition that the court should not conduct its own investigation into a matter of foreign law.
  1. I therefore conclude that the awards to the Claimant to reflect lost income should be made on a gross basis. I appreciate that the impact of this decision is that the Claimant may receive more by way of grossed up damages than he ultimately pays in tax. However, this seems to me the inevitable consequence of Wood Mitchell (which specifically recognised the injustice of the reverse scenario, namely a claimant being under-compensated through a net award on which they were later taxed) and the absence of tax law evidence before the court.