CheckLists.Tax (beta)
E4. Fines, penalties and litigation costs
PENALTIES
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XX
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- XX
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XX
Legislation:
Cases:
HMRC manuals:
Commentary:
See also:
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FINES
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- Sums paid to settle criminal investigation
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General position
- HMRC's view (citing Cattermole) is that "The costs arising from a breach of the law are not allowable. Costs incurred to settle an action alleging breach of the law are also not allowable." (BIM38525).
- Query how this reconciles with allowing the costs of settling a civil fraud claim in Great Boulder Proprietary Gold Mines.
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Examples
- Sum paid to settle anti-trust proceedings brought in America was not allowable in Cattermole v. Borax & Chemicals Ltd). T argued that it was to ensure continued supply of Borax but the sum was paid "by way of compromise of legal proceedings irrespective of any particular trade which was being carried on by [T]".
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Legislation:
Cases:
Cattermole v. Borax & Chemicals Ltd (1949) 31 TC 202 (Croom-Johnson J);
Golder v. Great Boulder Proprietary Gold Mines Ltd [1952] 1 All ER 360 (Donovan J);
HMRC manuals: BIM38525;
Commentary:
See also:
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LITIGATION COSTS
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Criminal proceedings
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- Costs incurred by prior to charges/submission to jurisdiction
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- In Spofforth, some costs were incurred prior to charges being brought against individuals. It was held that these costs were deductible.
- "But that leaves two other matters, which are not so readily disposed of: firstly, the costs incurred prior to the service of the summons. From the letter written by Messrs Rowe & Maw on 31 December 1940, it would appear that at and down to this stage this firm was acting for the appellants in the ordinary course of business, and in circumstances in which the appellants can fairly say that the purpose for which they gave the instructions and incurred the resulting costs were their ordinary professional purposes. There had been a somewhat unusual demand by a Government Department to interview servants of the firm, and in that case it was an ordinary business precaution that the firm's solicitors should be called in to advise. If, therefore, any appreciable sum of costs was incurred by the firm up to this point, it is, in my view, properly to be deducted." (at 366).
- In Cattermole, where the company and directors were charged under anti-trust laws in the USA, expenditure by the company on legal advice to the directors as to whether they should travel to the USA to submit to its jurisdiction was permitted (but not the costs of travelling).​ It is unclear why.
- "I am bound to say that in circumstances like the present I think it would be extremely difficult to hold that a sum of money paid by the directors in London for legal advice as to what they should do is not an expenditure connected with their trade. I do not propose to spend very long on this but it looks to me as if it were possible, on the reasoning of the Spofforth case, to allow some amount of costs incurred by the directors in London for the purpose of seeking advice as to whether they should put their heads in the lion's mouth." (at 212).
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Legislation:
Cases:
Spofforth and Prince v. Golder [1945] 1 All ER 363, Wrottesley J;
Cattermole v. Borax & Chemicals Ltd (1949) 31 TC 202 (Croom-Johnson J);
HMRC manuals: BIM38525;
Commentary:
See also:
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- Individual charged: likely personal purpose
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General position
- HMRC say that ordinarily, there will be an inherent non-trade purpose of defending personal reputation (BIM37955 in respect of charge of conspiring to defraud).
- In Spofforth, criminal charges of conspiracy to defraud the revenue were brought against partners in a partnership that had promoted a tax avoidance scheme. The charges were ultimately dismissed, but the partners sought to deduct the costs.
- Held: No deduction. The expenditure had an additional purpose of saving the partner from conviction and punishment.
- "The establishment of Spofforth's innocence, the saving of him from conviction and punishment, are matters which must have been the purpose of the expenditure, just as it would have been had the charge been one of fraud against Spofforth in his personal capacity. No doubt Spofforth was an important member of the firm, and his conviction, and still more his imprisonment, would have been a severe blow to it. That, however, is not the test." (at 365).
- "both [Prince] and Spofforth were aiming, not at the making of profits by the partnership, but at enabling Prince to protect his own interests, so far as that could be done, by his having separate legal advisers..." (at 366).
​​- Same result reached in Raynor, where a truck driver was charged following a spillage that caused significant environmental harm.
- FTT said that the personal benefits of avoiding conviction, punishment and damage to personal reputation gave rise to "a strong but rebuttable inference of personal motive" (§47).
- The evidence did not rebut that inference (§57).
- Duckmanton - T was charged with, inter alia, gross negligence manslaughter in relation to a fatal accident involving one of his trucks. A guilty verdict would have significant implication for his business (damages, loss of regulatory approval), but the FTT rejected T's evidence that the possibility of losing his liberty was not a factor in incurring defence costs.​ Upheld by UT.​
- "Although Mr Duckmanton, in giving evidence, may now some nine years after the event honestly believe that he was indifferent to the prospect of imprisonment, we cannot accept that this was a secondary motivation when the expenditure was actually incurred at the time of the trial."
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Prosecution personally or 'in a business capacity'
- There is some suggestion in Raynor that it may matter whether the individual is prosecuted in his/her personal capacity or as, essentially, the representative of a business (§43).
- If the prosecution is against the individual, however, the personal risk and benefit likely exists, save, perhaps, where the punishment is exclusively financial.
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Legislation:
Cases:
Spofforth and Prince v. Golder [1945] 1 All ER 363, Wrottesley J;
Raynor v. HMRC [2011] UKFTT 813 (TC);
Duckmanton v. HMRC [2013] UKUT 305 (TCC), Henderson J;
HMRC manuals: BIM37955;
Commentary:
See also:
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- Costs of defending individual incurred by partnership or company
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- Likely not deductible as there will be an additional purpose of avoiding conviction and punishment. That was the case in Spofforth.
- Query who actually incurs the expenditure: "I am driven, therefore, to this conclusion, that in respect of the bill of costs for Spofforth's defence, even if it were strictly incurred by the firm, it is not deductible. I would add that on the facts disclosed by the case, and the documents, I have great doubt as to the firm ever having incurred this expenditure in the strict sense. The case and the documents appear to me to negative this: rather they point to Spofforth having retained the firm's solicitor to defend him, and the bill, it will be seen, was sent in to him and in his name." (Spofforth at 366).
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Legislation:
Cases:
Spofforth and Prince v. Golder [1945] 1 All ER 363, Wrottesley J;
HMRC manuals:
Commentary:
See also:
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- Company alone charged: potentially solely for trade purposes
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- HMRC say that, depending on the facts, a company may have a purpose solely of protecting its goodwill/some other trade purpose (BIM37955 in respect of charge of conspiring to defraud).
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Legislation:
Cases:
HMRC manuals: BIM37955;
Commentary:
See also:
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- Company and directors/employees charged: likely dual purpose
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- See, by analogy, Spofforth (referred to above) where costs (possibly) incurred by a partnership defending one of the partners had the additional purpose of saving that partner from conviction and punishment.
- HMRC say that "where directors or other staff of the company are separately charged, even where the specific charges are the same as those indicted on the company, there is a likelihood that there will be a non-trade purpose to the legal costs of avoiding the criminal conviction in respect of the individuals involved" (BIM37955).
- They suggest that the legislative rules of apportionment may be relevant.
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Legislation:
Cases:
Spofforth and Prince v. Golder [1945] 1 All ER 363;
HMRC manuals: BIM37955;
Commentary:
See also:
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Civil proceedings
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- Defending claim for damages arising out of conduct of trade
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- In Strong v. Woodfield damages and costs 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.
- In Duckmanton it may be that UT thought a purpose of defending criminal charges arising out of the conduct of T's trade to avoid a 'ruinous civil claim for damages' was not a trading purpose (see §35).​
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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);
Duckmanton v. HMRC [2013] UKUT 305 (TCC), Henderson J;
HMRC manuals: BIM38540;
Commentary:
See also:
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- Defending/asserting title to a capital asset
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- Borax Consolidated: T, whose business was mining, manufacturing and selling borax, incurred legal costs defending an action alleging that it's title to land it had acquired was invalid.
- Held: Deductible. The costs were wholly and exclusively for the purposes of the trade and were revenue rather than capital.
- "in my opinion the principle which is to be deduced from the cases is that where a sum of money is laid out for the acquisition or the improvement of a fixed capital asset it is attributable to capital, but that if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue, being in substance a matter of maintenance, the maintenance of the capital structure or the capital assets of the company".
- HMRC accept costs spent maintaining alleged rights are allowable even if the attempt fails (BIM46415).​
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Legislation:
Cases:
Southern v. Borax Consolidated Limited [1941] 1 KB 111 (Lawrence J);
HMRC manuals: BIM46415;
Commentary:
See also:
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- Defending the fundamental capital structure of the business
- HMRC say that such costs are capital (and thus disallowed). They give the example of defending a petition by shareholders to wind up a company.
- Query whether this is consistent with the fact that the costs of defence against regulatory charges to preserve the trade are allowable - see below.
- In C Connelly & Co, costs relating to a partnership dissolution action were disallowed as they were in part to protect one partners interest in the partnership.
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Legislation:
Cases: C Connelly & Co v. Wilbey [1992] STC 783, HHJ Maddocks;
HMRC manuals: BIM46435;
Commentary:
See also:
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- Defending T's right to trading stock (deductible)
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- Singh: T carried on a trading of lending money, in the course of which he lent money to a company. The shareholders subsequently sued T claiming fraud, conspiracy etc. T sought to deduct the cost of defending the action.
- Held: deduction permitted.
- "They do not alter the main character of the action as being directed against the late Maharaja as the moneylender, and the latter's defence to the action was just as essential for the full protection of his rights as the creditor in the loan of Rs 10 lakhs as was his suit for the recovery of the loan. It has to be remembered that money is the stock-in-trade of a moneylender." (at 366).
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Legislation:
Cases:
ITC v. Singh [1942] 1 All ER 362 (UKPC);
HMRC manuals:
Commentary:
See also:
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- Defence against claim arising partly out of events prior to/outside the trade (e.g. previous employment)
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- It appears that where the claim relates partly to things done prior to and/or obligations undertaken outside of the trade, the cost of defending that claim will have an additional non-trading purpose.
​- Knight v. Parry held that the costs of defending against a claim for damages arising out of alleged solicitation by a solicitor of one of his former employer's clients and also for breach of the employment contract were not deductible.
- Similar result in McMahon where T was sued by his former employer for taking confidential information and breaching restrictive covenants by using client lists/information accessed whilst an employee in his subsequent trade. Neither the damages nor the legal costs were deductible.
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Legislation:
Cases:
Knight v Parry [1973] STC 56 (Goff J);
McMahon v. HMRC [2013] UKFTT 403 (TC), Judge Cannan;
HMRC manuals:
Commentary:
See also:
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- Defence of civil proceedings that may lead to regulatory proceedings
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Defence of the civil proceedings may also have a purpose of defending against the potential regulatory proceedings
- Knight v. Parry: T, an assistant solicitor, made an agreement with client that upon T leaving employment, the client would instruct T. The employer complained to the law society who suggested that the employer pursue civil proceedings against T first. T successfully defended the civil proceedings in respect of solicitation (but was found to have breached his employment contract) and the law society took no action. T sought to deduct the costs of defending the civil action.
- Held: Disallowed. One purpose of defending the action was "undoubtedly to protect himself against the charge of unprofessional conduct, because, although that could only be determined by the Law Society, it is obvious that if, at the trial of the civil action which they themselves had proposed, it had been held that the taxpayer had solicited, he would have been in a very difficult and dangerous position when he came again before the Law Society".
- That purpose was held to be a non-trading purpose, but that is probably wrong in light of McKnight, see below.
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Legislation:
Cases:
Knight v Parry [1973] STC 56 (Goff J);
HMRC manuals:
Commentary:
See also:
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- Company paying defence costs of directors/employees
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- Hammond Engineering Co Ltd: T, a company, and some of its directors/employees were sued by a shareholder in respect of issuing shares that diluted her shareholding. The company gave indemnities to the directors and employees in respect of the litigation.
- Held: sums paid under the indemnities were not deductible as not exclusively for the purposes of the trade - wholly or partly for the purpose of securing the positions of the shareholders/directors personally.
- Templeman J indicated that a decision either way would have been permissible.
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Legislation:
Cases:
Hammond Engineering Co Ltd v. IRC [1975] STC 334 (Templeman J);
HMRC manuals:
Commentary:
See also:
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Regulatory proceedings
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- Defence against charges that may preclude trade being carried on
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Money expended for the purpose of preserving the trade from destruction can be wholly and exclusively for the purposes of the trade
- McKnight v. Sheppard - T, a stockbroker incurred legal expenses defending himself against disciplinary proceedings for gross misconduct. The penalty could have been expulsion or suspension. T was found guilty on some charges and initially suspended but that was downgraded, on appeal, to a fine.
- Held: legal costs were deductible.
- It was found that T's "exclusive purpose in laying out the legal costs was the preservation of his trade".
- Also found that although T was not 'unconcerned about the advantages which a successful defence would have for his personal reputation', that did not amount to a purpose.
- There was no principle of public policy that prevented deduction of legal costs (whether successful or unsuccessful), unlike the fine itself.
- McMahon: "One to preserve the business which, on its own, would have been wholly and exclusively for the purposes of the trade." (§44)
- In Knight v. Parry, one purpose of defending the civil proceedings was to protect against potential regulatory proceedings that may have led to him being prevented from carrying on the profession. It was held that this purpose was not a trading purpose. That appears inconsistent with McKnight (and see McMahon §29 implicitly seeming to recognise this).
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No deduction where there is an additional purpose of defending claims arising out of prior employment
- McMahon: T was sued by his former employer for taking confidential information and breaching restrictive covenants by using client lists/information accessed whilst an employee in his subsequent trade.
- Held: Not deductible.
- "[44] The payment of £100,000 and the legal costs incurred by the appellant had two purposes. One to preserve the business which, on its own, would have been wholly and exclusively for the purposes of the trade. The other to defend and settle the proceedings including the claim for damages for breach of contract and breach of fiduciary duty. Those claims arose out of the appellant’s contract of employment. We do not consider that on any view this second purpose could be described as merely an effect of preserving the business. It was part of the reason the expenditure was incurred."
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Legislation:
Cases:
Knight v Parry [1973] STC 56 (Goff J);
McKnight v. Sheppard [1999] STC 669 (HoL);
McMahon v. HMRC [2013] UKFTT 403 (TC), Judge Cannan;
HMRC manuals:
Commentary:
See also:
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