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Business Income Manual

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Wholly and exclusively: expenditure having an intrinsic duality of purpose: fines, penalties and damages

S34 Income Tax (Trading and Other Income) Act 2005

Damages for breach of contract

Civil damages are generally allowable. But where the expenditure in fact serves a dual purpose it is disallowed.

The case of Knight v Parry [1972] 48 TC 580 is described in detail at BIM38545.

Mr Parry was employed as an assistant solicitor, and made an agreement with one of his principal’s clients that, upon Mr Parry leaving his employment and setting up in practice on his own, the client would instruct Mr Parry as his solicitor. This led to the principal alleging that Mr Parry had solicited the client and had thereby committed unprofessional conduct, and the principal reported Mr Parry to the Law Society and requested that Mr Parry be struck off the roll.

The Law Society, on their first look at the matter, took the view that there was a prima facie case, but before proceeding to consider the matter themselves they suggested that the principal should bring a civil action against Mr Parry, which he did. Mr Parry defended that action, and in the result succeeded in satisfying the judge that he had not solicited the client. However, the judge found that in making the agreement Mr Parry had in fact committed a breach of his duty of good faith under his contract of employment. The judge awarded the principal a sum of damages and costs.

When the principal again asked the Law Society to proceed with his complaint of unprofessional conduct, the Law Society took the view that their prima facie impression was dispelled, and they declined to take any proceedings against Mr Parry for unprofessional conduct. There was no finding against Mr Parry of unprofessional conduct. On the contrary, the complaint was not, in the result, entertained.

The point at issue in the tax appeal was whether Mr Parry was entitled to deduct in computing his profits both the costs he was ordered to pay by the Court and his own legal costs. The Commissioners were of the view that he could do so, but Goff J said that they had misdirected themselves for two reasons:

  1. the taxpayer’s purpose of protecting himself professionally was not a purpose wholly and exclusively referable to the carrying on of his practice as a solicitor, but for the purpose of seeing that he was not precluded from doing so
  2. if the taxpayer had admitted liability in breach of contract and offered to pay damages or had paid a sum of money into court there would then have been only the one purpose. But the taxpayer did nothing of the kind. Therefore there were the two purposes, and so the Commissioners’ decision must be wrong on the grounds of duality of purpose

So a solicitor defending himself against an action, which, if he lost, would preclude him from practising as a solicitor, will, usually, be incurring expenditure at least in part for a non-professional purpose and the expenditure is disallowable.

The part of Goff J’s judgment where he explained why the expenditure was not allowable is set out below on page 585:

`…it seems clear to me that the Commissioners must have misdirected themselves as a matter of law in reaching the conclusion that they did, and I say that for two reasons. The first is that, on the authority of Spofforth & Prince v Golder [[1945] 26 TC 310, see BIM37955] and Norman v Golder[[1944] 26 TC 293,see BIM37940], even the purpose of protecting himself professionally was not a purpose wholly and exclusively referable to the carrying on of his practice as a solicitor, but for the purpose of seeing that he was not precluded from doing so. In the Spofforth & Prince case costs incurred by a chartered accountant and his partners in defending him against a charge of fraud, and in Norman’s case medical expenses incurred in restoring the taxpayer to health, were held not to be deductible for that very reason; and I observe that those cases were not cited to the Commissioners.

However, even if that were wrong, the second purpose, in my judgment, clearly takes the case out of the Statute. If the Respondent had seen fit to admit liability in breach of contract and offered to pay damages or had paid a sum of money into Court there would then have been only the one purpose; but he did nothing of the kind. Therefore there were the two purposes, and so the decision must be wrong, even if I had reached a different view as to the first purpose.’