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HMRC internal manual

Business Income Manual

Wholly and exclusively: how to establish purpose: purpose is a question of fact

S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009

The expenditure must be incurred for the purpose of earning the profits

The meaning of ‘for the purposes of the trade’ is considered in several cases. Two important ones of which are Smith’s Potato Estates Ltd v Bolland [1948] 30 TC 267 and Rushden Heel Co Ltd v Keene [1948] 30 TC 298.

Smith’s Potato Estates Ltd incurred legal and accountancy expenses in connection with a successful Excess Profits Tax appeal. The company contended that the purpose of the appeal was to retain the services of a manager. The company’s claim to deduct the costs was denied. Lord Porter considered the meaning of the words ‘wholly and exclusively laid out for the purposes of the trade’ as follows.

He referred to the decision in Strong & Co of Romsey Ltd v Woodifield [1906] 5 TC 215 (see BIM37300) and explained that Strong & Co of Romsey Ltd was the starting point for deducing the principles at stake in Smith’s Potato Estates, quoting Lord Davy’s dictum ‘those words…appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade’.

Lord Porter explained that the costs incurred by Smith’s Potato Estates were not allowable because they were not incurred to earn the profits of the trade but were incurred for the purpose of ascertaining the quantum for assessment. It does not matter that the tax in question is only imposed on traders, the expenditure incurred was not an expense of earning those profits, starting on page 289:

`…it is said that…Excess Profits Tax differs inasmuch as it is imposed on a trader only and therefore the cost of ascertaining it is part of the trade. I do not accept this contention. It is true that a trader only is liable to pay it, but it is not payable by him as a trader. He pays as an individual, like any other individual, tax on the sum which he has earned as a trader.’

Rushden Heel Co Ltd v Keene [1948] 30 TC 298 was also concerned with the costs of appeals against Excess Profits Tax. The Master of the Rolls, Lord Greene, explained the decision in Strong & Co of Romsey Ltd on page 316:

`I find, however, in Strong and Company’s case what appears to me to be a clear answer to the present appeal. It is, I think, a matter not of dictum but of decision in that case that an expense is not deductible if it falls on a trader in some other character other than that of trader. This was the ground of the opinion of Lord Loreburn, LC, with which Lords Macnachten and Atkinson agreed.’

This is the so-called ‘capacity’ test. See BIM37300 for further guidance.

In the case of Meredith v Roberts [1968] 44 TC 559 a solicitor claimed the £573 costs of unsuccessful litigation. The litigation concerned the solicitor’s claim for an allowance from the Collector of Taxes for the costs of operating PAYE. The Collector refused and to bring the matter for legal decision the solicitor withheld a small sum of tax that he had deducted. The solicitor’s claim to a payment commensurate with the work undertaken failed in the courts. The solicitor claimed the costs of the legal action in computing his taxable profits. The solicitor sought to persuade the court that the expenditure had been incurred for the purpose of his profession. The solicitor said that he wished to relieve his staff of the burden of operating PAYE thus freeing up resources to be used for the purposes of the profession. The court held that the litigation costs were not an allowable expense. Goff J described the solicitor’s arguments at page 565:

`The case made by Mr. Rees [taxpayer’s counsel] then is simply that the object of this expenditure was to rid the Appellant and his staff of the obligation to devote time to complying with the PAYE. Regulations, so as to free them for the purposes of the profession, or that it had that result, and that it was therefore directly connected with the profession and certainly sufficiently indirectly so, and was for the purpose of carrying it on. The fact that success would benefit other employers is irrelevant: see the Tate & Lyle case 35 TC 366 [see BIM35570], at page 417, per Lord Reid. Whilst it was an obligation imposed on Mr. Meredith as an employer, that must be as a solicitor, because there was no evidence that he had any other appreciable number of private employees outside his business. In this regard he relies on a passage in the judgment of Diplock L, J. in Harrods (Buenos Aires) Ltd v Taylor-Gooby (1964) 41 TC 450, at pages 468-9 [Goff J then refers to the passage quoted inBIM37300].’

Goff J went on to explain that the important fact to be determined in this case was the purpose of the expenditure. Was the expenditure wholly and exclusively for the purposes of the profession?

`…it is in my judgement not wholly immaterial to consider whether this expense was really incurred by Mr. Meredith as a solicitor carrying on that profession or in his capacity as employer and taxpayer. In the end, however, one comes back to the vital question on the facts of this particular case: was the expense incurred directly or indirectly for the purpose of carrying on the profession, and wholly and exclusively so?’

Goff J found that the solicitor’s purpose in making the expenditure was not to free up more time for the practice but to obtain remuneration from the government for operating the PAYE system and that the cost was not allowable. The normal costs of operating PAYE are allowable. What the solicitor sought was remuneration from the Inland Revenue for operating the then relatively recently introduced PAYE system.

The case of Meredith v Roberts [1968] 44 TC 559 was very much decided on its own facts. Payroll costs (wages, taxes, etc. and the costs of calculating such) in respect of employees carrying out their normal duties will usually be allowable. It should only be necessary to question a payroll deduction where, for example, employees are engaged on matters outside their normal duties (for example constructing a fixed capital asset such as a building used in the trade - the employee’s wages would then be capital).