HMRC internal manual

Business Income Manual

BIM37820 - Wholly and exclusively: expense of earning or application of profits?: rent subject to abatement of profits

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

Rent paid to overseas landlord and subject to restriction in the event of insufficient profits

The rent of business premises is allowable to the extent that the premises are used for the purposes of the trade, profession or vocation.

In the case of Union Cold Storage Co Ltd v Adamson [1931] 16 TC 293, the company traded both in the UK and also extensively abroad. The company was controlled by members of the Vestey family with only a minority public holding of shares and debentures. The Vesteys owned or were beneficially interested in, or controlled though various companies, numerous overseas properties occupied by Union Cold Storage Co Ltd. The properties were leased to Union Cold Storage Co Ltd for 21 years at a rental of about £1m per year.

The leases were terminable at six months notice by either side (there was no expectation that such notice would be given). To safeguard the outside investors there was a clause providing that if, after making the rental payments, the profits were insufficient to meet the interest on charges and debentures and to pay a 10% ordinary dividend the rent was to be reduced by the amount of this deficiency and the lessors were to repay any amounts thereby overpaid. The rent was settled on trustees resident in Paris with consequent tax advantages. This circumstance aroused suspicion that the scheme was one of tax avoidance rather than bona fide rent.

Union Cold Storage Co Ltd claimed a deduction for the rent actually paid. The Commissioners disallowed the deduction on the basis that the rent was contingent upon and payable only out of profits earned. The Courts unanimously reversed this decision. The arrangement for abatement in the event of low profits did not alter the nature of the payment, which remained a real payment of rent. This was an expense of earning the profits not an application out of the profits and was therefore an allowable deduction.

In the High Court Rowlatt J explained that the rent was deductible because it was an ordinary outgoing of the business:

`The Company is in possession of all these premises abroad; it does not own them, but it has obtained possession and the use of them under this arrangement and it has to make some recompense in respect of that possession and use. I have used that lengthy form of expression because both sides are so afraid that I should, somehow or other, be hypnotised by the word “rent”. This is simply a sum, which the Company have entered into some liabilities about, by way of payment for their premises and, whatever you call it, a payment of that kind is, prima facie, most certainly an outgoing of the business which has to be provided for and allowed before you can see whether the incoming of the business exceeds the outgoing and so shows a profit. That is quite clearly the ordinary way in which an expense of this kind must be looked at.’

In the Court of Appeal the Master of the Rolls, Lord Hanworth, after saying that the issue was a mixed question of fact and law said that the case depended on the interpretation of the lease:

`…it is important to bear in mind that it is not alleged by the Crown that this indenture of lease is not a valid and effective document, a specious device or strategy to cloak the true facts; it is accepted as a good agreement, and that carries one a very long way; it is no use to say the lease must be accepted as a lease, but must be looked at with the eye of suspicion; you have got to take its terms, and I think Mr Justice Rowlatt is right in saying that once the Crown have admitted that it is a real document, then the case has to be decided upon the tenor of the document as it stands…’

Romer LJ, also took the view that the issues involved were a mixed question of law and fact, and were therefore open to review by the courts:

`Now it seems to me impossible to come to the conclusion that these sums were not paid by the Company for the purpose of enabling them to carry on and earn profits in that trade. The sums were paid for the acquisition and possession of what were essential for the Company in order to enable it to earn part of the profits which the Crown were now seeking to tax.

I agree that the question does not rest there, because although those payments may have been, and in my opinion clearly were, made for the purpose of enabling the Company to carry on and earn profits in the trade, the sums so paid may nevertheless have been paid out of the profits of the Company, within the meaning of [what is now S54 Corporation Tax Act 2009 (CTA 2009)]. Approaching that question, it appears to me that inasmuch as the Crown do not attack the bona fides of the document of 1921, the document which has been called, and I think is, a lease or agreement for a lease, they do not regard it as a mere cloak or sham, in order to succeed in their contention that the payments were really payments of profits, they must establish the following proposition: That where a company, for the purpose of enabling it to carry on its trade and earn profits in its trade, places itself under an obligation to make money payments, the amount of which is dependent upon the profits earned, or the payment of which is contingent upon certain profits being earned, payments made in discharge of that obligation are payments made out of the profits or gains of the Company, within the meaning of [what is now S54 CTA 2009]. In my opinion, for that proposition there is no foundation at all in principle or on authority.’

In the House of Lords, Lord Buckmaster found the case straightforward. He explained that the Revenue’s argument was based on the view that the rent was not a rent at all but something in the nature of a distribution of profits; that the landlords in effect shared in the profits on the same footing as the preference shareholders. But no one had challenged the bona fides of the rental agreements. The rent was covenanted to be paid as rent. Whether the whole sum was paid or only a part it was nevertheless rent of the trade premises and nothing but rent. He commented:

`My Lords, the first thing, and, to my mind, the only thing, to be considered is this: Is this or is this not rent payable under this lease? No attack whatever has been made upon the document itself. It was said that there had been an arrangement of property to try to avoid payment of Income Tax, of which, it may be, the document is one of the instruments; but nobody has challenged the bona fides of the document itself; nobody has said that the £960,000 is a fictitious or an artificial sum. It is admitted that this case has to be determined on the hypothesis that this is a perfectly sound business document, and it is upon that ground that the payment has been attacked.

When the matter is so considered, in spite of the efforts of the Law Officers, I find myself quite unable to understand what is the argument upon which this assessment is supported. The rent is covenanted to be paid as rent. There is no provision whatever in the lease that the condition precedent to the payment of that rent is the earning of profits. It is not disputed that at any time, up to the 31st December action could be taken at law for payment of the quarterly sums. The only thing that is provided is that if at the end of the year when the balance sheet is made up certain payments cannot he made if the full rent is charged, instead of the full rent being charged a smaller sum shall be charged, and if anything has been overpaid it shall be returned. But whether the whole sum or part of it is paid, the payment is the rent of business premises and nothing but rent.’