CheckLists.Tax (beta)
N6. Payment of compensation/damages
INCOME TAX
- Interest arising in UK paid by a company/person whose usual abode is outside the UK
- Interest payable to an individual in respect of compensation is treated as early interest for the purposes of deduction at source (s.874).
- See further M4. Paying/incurring interest.
Legislation: ITA 2007, s.874;
Cases:
HMRC manuals:
Commentary:
See also:
Deduction at source
Trading deduction
- Damages paid as a result of normal trading operations usually allowable
- If the liability to pay damages arises through activities pursued for the purpose of earning profit of the trade, a deduction for that liability should be allowable (even if the liability was not consciously incurred).
- HMRC accept that damages incurred as a result of normal trading operations are allowable (BIM38510).
- In Strong v. Woodfield damages paid to a customer of an Inn who was injured when a chimney fell on the customer whilst they were sleeping at the Inn were disallowed.
- It was said that the expenditure did not fall on the trader in their capacity as a trader, but instead as a householder.
- That distinction seems unconvincing given that the injured party was sleeping in the Inn as a customer.
- Accepted that compensation to a rail passenger for an accident whilst travelling would be deductible.
- HMRC do not appear to apply the decision broadly: "Notwithstanding the above decision, you should allow a trader the costs of civil damages for injury to others caused by day to day trading operations" (BIM38510).
- Golder: Costs and compensation of settling a claim for fraud arising out of T's trade of promoting companies were deductible as the claim arose out of the trade and would seriously affect its reputation as a company promoter if it succeeded. T decided to settle in light of the costs of defending the case.
Damages for fraud
- Query whether there is a public policy prohibition on deduction of damages paid following a finding of fraud.
- In Golder the possibility was raised but not applied because T settled before any decision on the claim.
- See below on damages arising outside the normal course of the trade.
Legislation:
Cases:
Strong and Company of Romsey Limited v. Woodfield (1906) 5 TC 215 (HoL);
Golder v. Great Boulder Proprietary Gold Mines Ltd [1952] 1 All ER 360 (Donovan J);
HMRC manuals: BIM38510; BIM38540;
Commentary:
See also:
- Damages connected to trade but arising outside of normal course not allowable
- Fairrie v. Hall - T, a sugar broker, accused a rival of abusing his position as deputy director of sugar supplies to advance the interests of his own company. The rival successfully sued for malicious libel. Held: No deduction. The damages and costs were only remotely connected to T's trade as a sugar broker.
Legislation:
Cases:
Fairrie v. Hall [1947] 2 All ER 141 (MacNaghten J);
HMRC manuals: BIM38530;
Commentary:
See also:
- Removal of onerous employee - deductible (even if purpose includes avoiding negative publicity)
- BW Noble Ltd v. Mitchell - T might have been justified in dismissing director, but to avoid publicity injurious to T's reputation, entered into negotiations for the director to retire. Director claimed compensation and compromise was reached in satisfaction of all claims.
- Held: the payment was (i) for the benefit of the trade; (ii) wholly and exclusively so; (iii) revenue rather than capital.
- "It seems to me that the directors had to handle a situation of both delicacy and gravity, and, their bona fides not being questioned, it is clear that they took a course which they were justified in taking and made a payment in the interests of the carrying on of their trade." (at 420).
- Noted by analogy in Williams's Executors.
Legislation:
Cases:
BW Noble Ltd v. Mitchell (1927) 11 TC 372 (CoA);
CIR v. Williams's Executors (1944) 26 TC 23 (HoL);
HMRC manuals:
Commentary:
See also:
EMPLOYMENT INCOME TAX
Deduction from earnings
- Deduction for payments in respect of certain liabilities and expenses
Deduction of expenses
- A deduction from earnings may be made for in essence (ITEPA s.346) :
(1) A liability related to the employment.
- Liability related to the employment - see s.348.
- HMRC seem to say that a compromise settlement is only included if the claim would, if pursued, be likely to succeed (at least in part) - EIM30511.
(2) Costs and expenses incurred in connection with a claim related to the employment.
(3) Costs and expenses incurred in connection with giving evidence about a matter related to the employment.
(4) Costs and expensed incurred in connection with proceedings/investigations (including criminal proceedings) in which acts to the employee or other matters related to the employee are being or are likely to be considered.
- Deduction permitted even if expenses were not 'necessary' (EIM30511).
- Exclusion for tax avoidance arrangements.
- No deduction for liabilities, costs or expenses that it would be unlawful to insure against (s.346(2)).
- This covers reimbursement of fines and penalties for criminal acts (EIM30501).
- Deduction only permitted against earnings of employment concerned (EIM30505).
Termination of employment
- Exclusion for similar types of expense/liability from the charge on termination of employment (ITEPA s.409).
Former employee costs/liability
- Potential deduction for similar types of expense/liability under ITEPA s.555 - 564.
- See EIM30530.
- Limited to 6 tax-years post-employment (EIM30534).
- Excess of deduction over total income for the year is treated as a capital gains loss (EIM30532).
Reimbursement
- Where the expenses are reimbursed by insurance see:
- Where the expenses are reimbursed by the employer, that will usually be employment income, but the income and deduction will often net off.
Legislation: ITEPA s.346 - 350; s.409; s.555 - 564;
Cases:
HMRC manuals:
EIM30501 - Deductions: directors' and officers' liabilities: general;
EIM30511 - qualifying liabilities;
EIM30530 - relief for ex-employees;
EIM30532 - relief for "excess" liabilities;
Commentary:
See also:
Discharge or reimbursement by employer
- Discharge/reimbursement as employment income, subject to potential deduction
Employment income
- "Where an employer meets the liability for a director or employee arising out of such an action the employer’s payment will normally be chargeable on the director or employee as earnings arising from the employment (see EIM00580 onwards)." (EIM30501).
Potential deduction
- See above.
Legislation: ITEPA s.346 - 350;
Cases:
HMRC manuals: EIM30501 - Deductions: directors' and officers' liabilities: general;
Commentary:
See also: