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HMRC internal manual

Business Income Manual

Wholly and exclusively: duality of, or non-trade, purpose: remuneration, etc: payment of share of profits following sale of shares

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

Payer must show that payment is made for services

The deductibility of a share of profits following the sale of shares was considered in the case of Faulconbridge v Thomas Pinkney & Sons Ltd [1951] 33 TC 415. On the facts of the case, the expenditure was not allowable.

Two brothers, Samuel and David Renny Pinkney, held the whole of the company’s capital (with the exception of two shares). The company had been formed to take over a business of shipbroking, etc, originally carried on by the brothers and founded by their father.

In 1945, being minded to retire from active participation in the company’s affairs the brothers agreed to sell their shares to the remaining directors, Mr. Hibbert and Mr. Kjeldsen. The purchasers were also to arrange to pay to the brothers 50% of all commissions and fees, above a fixed limit, received by the company in each of the five years ending 31 October 1950. A supplemental agreement between the brothers and the purchasers (to which the company was not a party) declared that payment of this percentage of commissions and fees should be made by the company. The company paid the sums due for the two years ended 31 October 1947, during which the brothers rendered the company some advisory services.

On appeal the company contended that the payment made to the brothers in the year to 31 October 1947, was remuneration for services rendered and was therefore an admissible deduction in computing the profits of the business.

Before the Commissioners, the company’s auditor George Dobie Weir, Chartered Accountant, agreed with the other witnesses. The brothers had consulted Weir before they discussed matters with the purchasers. The brothers wanted to retire from active responsibility. If the purchasers were to be allowed to carry on the old company then the brothers had to advise them. It was vital to the company. The purchasers normally did the office work and never contacted the people the Pinkneys knew. The business was dependent absolutely on contacts. Weir considered the disputed amount to be a revenue payment for services rendered to the company. Therefore Weir’s firm charged the amount in the company’s profit and loss account. It was Weir’s suggestion that the third deed should be executed to make matters clear.

The company contended that the sum paid to the brothers was remuneration for services rendered to it by them and was therefore an admissible deduction in computing the profits of its trade.

The Crown contended:

  • that the payment was not remuneration to the brothers for services rendered but that it was a liability incurred by the purchasers under the arrangement for the purchase of the shares
  • notwithstanding the supplemental agreement, the company was not liable to make the payment, and
  • that the payment was not an expense laid out wholly and exclusively for the purposes of the company’s business

The Commissioners held that the payment was made in consideration of the services rendered to the company by the brothers, and allowed the deduction accordingly.

Donovan J reviewed in detail the evidence adduced before the Commissioners; the oral evidence of the parties and the supporting documentation. Donovan said that there was nothing on which the Commissioners could have reached their decision. The expenditure was disallowed. Normally, when a company has had services rendered to it and the servant gets something from the company, it can reasonably be inferred that the one is a quid pro quo for the other. But Donovan said that it would not be right to infer that here. Where the payment by the company is the exact amount of a private obligation by the directors and is made to the creditors of those directors. In such a case, the company cannot complain if it is asked to prove its contention that it is paying for the services rendered to it with some degree of particularity. Donovan J went on to observe that the company could put matters to rights but in so doing it would have to account for Income Tax and Surtax on the payments made to the two brothers (under a regime which preceded the introduction of Corporation Tax).