This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

Business Income Manual

Wholly and exclusively: expenditure having an intrinsic duality of purpose: avoiding a conviction

S34 Income Tax (Trading and Other Income) Act 2005

Cost of defending against a charge of conspiring to defraud

The cost of avoiding a criminal conviction for an individual or a partner is unlikely to be allowable, as ordinarily there will be an inherent non-trade purpose of defending personal reputation. For a company this may, on the facts, not be a purpose of the expenditure as the company may merely be protecting its goodwill or have some other trade purpose. However 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. The legislative rules on potential apportionment of costs may be relevant here (see BIM37007). The costs of defending a civil action are allowable only if incurred wholly and exclusively for the purposes of the trade, profession or vocation. A partnership incurring expenditure that results in a benefit to a particular partner is not denied a deduction when such benefit is merely incidental to a trade purpose.

In the case of Spofforth & Prince v Golder [1945] 26 TC 310, a firm of two chartered accountants, claimed a deduction for certain legal costs they had paid to successfully defend one of the partners in court proceedings. The partner had been charged with conspiracy to defraud the Revenue. The firm first sought legal advice on receipt of a letter from the Solicitor of Inland Revenue stating that he wished to take evidence from two of their employees. When, however, a summons was issued against one of the partners to appear before a Court of Summary Jurisdiction, the firm’s solicitors were of the opinion that the partners should be separately advised. This opinion was accepted and Counsel, having advised that the acquittal of the accused partner was vital to the interests of the firm, the summons was defended. Counsel appeared at the hearing on behalf of the accused partner, and a watching brief was held for the other partner by other Counsel. The summons was dismissed.

On appeal to the Special Commissioners, the accountants contended that the whole of the costs were incurred by them in connection with the proceedings and so were incurred wholly and exclusively for the purposes of the profession. Or, if this was not the case, that the costs incurred prior to the service of the summons, and the costs incurred by the partner who was not involved in the proceedings, were moneys wholly and exclusively incurred for the purposes of the profession. Accordingly, the sum expended (or, in the alternative, a part thereof) was an allowable deduction in computing their profits.

The Special Commissioners held that the legal costs incurred were not an allowable deduction.

The High Court, affirming the decision of the Commissioners on the main point, held that neither the costs of defending the accused partner, nor the costs in respect of the legal advice and assistance to the other partner, were admissible deductions. However, a deduction was allowable in respect of any legal costs incurred by the firm up to the issue of the summons. This was because the nature of the purpose of the legal costs changed from being that solely of the partnership to one where the personal status of the partners was being defended, creating a duality in the purpose of the legal costs.

Wrottesley J explained why no deduction was due for the legal costs incurred after the issue of the summons. Up to the issue of the summons it appeared that the firm’s solicitors were acting for the appellants in the ordinary course of business, and in circumstances in which the appellants could fairly say that the purpose for which they gave the instructions and incurred the resulting costs were their ordinary professional purposes. So the expenditure to this date was allowable.

In so far as the separate costs incurred by each partner were concerned, in the case of the accused partner, Wrottesley J drew on previous case law to ask the essential question: `is the disbursement one made not merely in the course of, or arising out of or connected with, or made out of the profits of the profession, but also for the purpose of earning the profits of the profession?’ He came to the conclusion that such a test could not be satisfied by the payment of the costs of defending Mr Spofforth against the criminal charge preferred against him.

In the case of the other partner, Mr Prince, he said:

`Mr Prince was not the partnership, and the object and purpose of the retainer by Mr Prince of Messrs Godden, Holme & Ward was not the best interests of the partnership but the best interests of Mr Prince. If necessary, at the expense of the partnership. Moreover… unless the costs were authorised in advance to be incurred by the partnership they cannot be said to be incurred by it. These costs seem to me to be comparable with the charges which Mr Prince doubtless incurs in order to reach the firm’s office in the morning.’

The costs were private and so disallowable.