Calculating support

How many lawyers does it take to work out the meaning of three words? Answer: 11 lawyers, one commissioner, three appellate judges and five Law Lords'¦ oh, and five years.

Smith v Smith [2006] UKHL 35 concerned the treatment of Mr Smith's income as a self-employed earner. Two options are possible roughly: either you look at the income after expenses (and take a high figure), or you factor in additionally the capital allowances, and a lower figure is generated. The child support officer took the low figure; the tribunal engaged in some extraordinary accounting exercises outside the bounds of any regulation and reached a low-ish figure; the Commissioner adopted the higher figure; the Court of Appeal disagreed and adopted the low figure again'¦ and with each successive decision, the claims of the children for this short period, went up and down like a yo-yo.

The circumstances

Smith's business involved his acquiring motorcars on hire purchase or similar. He would then have the cars adapted, fitting dual controls. After renting the cars to driving instructors for a term, the dual controls would be removed from the cars and Smith would sell them on.

Under the relevant tax provisions, Smith was entitled to substantial capital allowances in respect of the expenditure on the cars. Deduction of these capital allowances from his trading profits resulted in a dramatic decrease in his earnings for income tax purpose and a similarly dramatic decrease in the amount of maintenance he would pay under a Child Support Agency assessment.

Prior to 1999 the Rules were clear; para 3 Sched 1 of the Maintenance Assessment and Special Cases Regulations 1992 (SI no 1815) (MASC) provides that capital allowances may not be deducted for the purpose of determining the earnings of a self-employed earner in respect of which a CSA assessment is to be made. This position continued until 1999 when the government introduced amending Regulations to MASC in the form of SI no 977.

In introducing the regulations to Parliament, there was no indication from Baroness Hollis that there was a significant change in the way that self-employed income was being treated. She indicated only that the changes were to increase administrative convenience for users.

A new para 2A (together with 2B, 2C and 5A) was duly introduced. Paragraph 2A was intended to be the primary method of determining the earnings of a self employed earner. Under para 2A, earnings are defined as 'the total taxable profits from self employment of that earner as submitted to the Inland Revenue' less income tax, national insurance contributions and one-half of any retirement annuity premiums.

In child support (CS) cases, all communications between the parties go through the Agency, which has little power to broker agreements. What Mrs Smith sought was a realistic level of provision for her children. Having accepted a clean break of her financial claims (assuming that the Agency would provide a sensible level of support), she had no alternative but to await the determination of this issue. Support was sporadic, until Smith eventually started making payments at a voluntary level.

The purpose of the amending Regulations was to simplify the procedure whereby a self-employed earner would have his earnings assessed by the Child Support Agency. However, the old para 3 was not expunged by the new Regulations and would continue to apply in three circumstances:

i. Where it is not reasonably practical for the non-resident parent (NRP) to provide information in the form submitted to the Inland Revenue.

ii. Where the information is too old.

iii. Where the para 2A route would not provide a figure that accurately reflects the NRP's normal weekly earnings.

No term of art

Thus far, it would appear that the amending Regulations represent a helpful set of measures designed to ameliorate some of the difficulties the Child Support Agency had experienced in trying to ensure that speedy and reliable maintenance assessments were made. Unfortunately, appearances can often be deceptive and never more so than in this case. The phrase 'total taxable profits' is not a term of art in either tax law or child support law. Smith and the Secretary of State for Work and Pensions (the respondents) argued that capital allowances should be deducted before arriving at the figure which represented a self employed earners total taxable profit. On behalf of Mrs Smith, we argued the contrary.

The respondents (as did the Court of Appeal) placed considerable weight on the fact that the phrase appears at box 3.92 of the Self Assessment Tax Return, which is submitted by self employed persons to the Inland Revenue. It is common ground that capital allowances (among other things) are deducted before one arrives at box 3.92. For Lord Justice Ward and the Court of Appeal (at para 40, [2005] 1 FLR 606), this was crucial; 'We find the answer in box 3.92: 'total taxable profits from this business'. There it is. QED.'

The respondents also argued that it

produces a result that is fair: if capital allowances are adopted and a very low assessment results, at least the PWC has the right to apply for a departure: increasing the level of the payment to a figure that is based upon the income that the father's lifestyle indicates he should be treated as having.

The House of Lords rejected these arguments by 3:2. Lord Walker, Lord Carswell and Baroness Hale confirmed the law prior to the amending Regulations, that capital allowances are not to be deducted from the NRP's earnings before a CSA assessment is made.

• When the amending Regulations were presented to Parliament, there was no indication that they intended to confer a substantive change to the treatment of capital allowances under para 3, Sched 1, MASC. They were intended as a set of tidying up provisions.
• When interpreting statutory provisions, judges should look beyond the literal interpretation of a phrase (as was propounded by the respondents in relation to box 3.92) and should instead seek to give prominence to the purpose for which the Regulations were intended. In the instant case, they were intended to bring about the simplification of the procedures for assessment as opposed to a fundamental change to the basis of such assessment.
• It is implausible that Parliament could have intended to have had two completely different methods of assessment of a self-employed NRP income (para 2A and 3 of Sched l, MASC) working alongside each other and inappropriate that matters of interpretation hinge about the contents of a printed form
• Capital expenditure should not be relevant for the purpose of assessing the NRP's income. The NRP's obligation to pay child support should come first.
• Finally, the mere possibility of a departure does not provide the answer because the earner may not choose to spend the earnings he can access and the dependent should not have to depend upon the uncertainties of a further application. As Lord Walker points out, the NRP who chooses to live a monastic lifestyle would surely not be living a lifestyle that is inconsistent with a low assessment.

While this case was considered under the old Regulations, this decision will potentially impact upon all cases where a self-employed earner has the ability to set off capital allowances against his earnings. The results can be stark. For the year 2000-2001 had capital allowances been deducted from Smith's earnings, his income would have been assessed by the Child Support Agency at £20,892. Had capital allowances not been deducted, Smith's earnings would have been £169,520. The result is an assessment that is manifestly fairer, referable to the actual income of the NRP.

Capital allowances often do not accord with the economic reality of the income that a self-employed earner receives from his business. They are often granted by the government as fiscal incentives in order to encourage particular types of business. Indeed, permissible capital allowances may vary within different parts of the UK. Furthermore, as Baroness Hale explained in her judgment, capital allowances can be claimed against income in a different year from which the capital expenditure was incurred. As the taxpayer is able to elect the year in which he claims the allowances, it could be possible for an unscrupulous NRP to arrange his affairs through the capital allowances system so as to minimise the amount of maintenance which he would be obliged to pay under a CSA assessment.

From now on, the parent with care of the children will again have the peace of mind that the assessment which is made against the self-employed NRP will bear a resemblance to his income and will not be subject to the vagaries of the capital allowances system. Unfortunately this case only represents a victory of sorts. In Mrs Smith's case, a total of 33 assessments have been made. She currently awaits the re-calculation of her assessments pursuant to the ruling. As many parents with care will be familiar, ensuring an accurate assessment is in place is only half the battle. Even where accurate assessments are made by the CSA, when the NRP does not pay, the CSA has limited powers of enforcement. It is one of the reasons that Resolution has been advocating a return to the jurisdiction of the courts, which are well used to dealing with people prepared to flout their orders. Unfortunately the government's recent proposals in this regard do not go far enough and it remains to be seen whether the 'new look' CSA will have a brighter future than its predecessor.

The government tried in 1991 to create a formula that would generate a certain outcome for any set of circumstances that any family could exhibit. What we see in the sad story of the Smiths is a further example of the failure of that aspiration. The courts have been successful with determining levels of maintenance because they look at underlying ability to pay. The CSA most struggles where it must base its assessment on a formula relying on the variable of income. What the architects of the system failed to recognise at the outset is that 'income' is a flexible concept: for many businessmen, their figure for income is what the earning parent wants it to be.