BIM37963 - Wholly and exclusively: expenditure having an intrinsic duality of purpose: damages and legal expenses following a breach of contract
S34 Income Tax (Trading and Other Income) Act 2005
An expense relating to a current trade may still be dual purpose
Where expenditure has been incurred that relates to both current and past activities there may be a dual purpose that would exclude the expenditure being claimed. A current trading purpose may not be enough to make the expenditure wholly and exclusively for the purposes of the current trade.
This is consistent with existing case law where the purpose of the expenditure needs to be separated from the effect, whilst acknowledging that obtaining an incidental private benefit would not automatically exclude the deduction.
In the following example:
- One purpose of the expenditure related to the taxpayer’s current trading activities.
- Another purpose related to the taxpayer’s previous activities.
- The non-business purpose meant that the private benefit was not just incidental.
In McMahon (2013) TC 02799 the Tribunal considered a case where legal action had been taken against an individual who had left his job to set up a new business in a similar field.
In April 2007, Mr McMahon left his employment as a recruitment consultant to set up his own recruitment business. The former employer subsequently commenced legal proceedings against the taxpayer claiming that the taxpayer had breached the restrictive covenants in his employment contract and his duty of good faith.
The former employer also claimed ‘springboard relief’ in the form of a permanent injunction because the taxpayer had e-mailed its top customer list to himself before leaving his employment. “Springboard relief” is a term for where the Court has the power to restrain a person that has obtained a “head start” due to unlawful acts or misconduct. It has the aim of restoring the parties to the competitive position they each set out to occupy and would have occupied had it not been for the unlawful acts or misconduct.
In August 2007, agreement was reached by way of a Tomlin order. The taxpayer agreed to pay the former employer £100,000 in full and final settlement of all claims brought against him. In exchange, the taxpayer was released from the restrictive covenants of his employment contract and free to contact and deal with any client or customer he should choose.
The £100,000 settlement and associated legal costs had been deducted in calculating trading profits. In this case, the taxpayer argued that the only reason he paid the £100,000 was to preserve his business and allow him to continue trading. He also argued that being released from the terms of his employment contract were merely an incidental benefit.
The appeal was dismissed, with the Tribunal concluding that:
[43] On the basis of our findings of fact we conclude that the payment was a global settlement relating to both admitted and non-admitted breaches of contract as well as removing the threat of springboard relief and releasing the appellant from any future restrictions.
[44] The payment of £100,000 and the legal costs incurred by the appellant had two purposes. One to preserve the business which, on its own, would have been wholly and exclusively for the purposes of the trade. The other to defend and settle the proceedings including the claim for damages for breach of contract and breach of fiduciary duty. Those claims arose out of the appellant’s contract of employment. We do not consider that on any view this second purpose could be described as merely an effect of preserving the business. It was part of the reason the expenditure was incurred.
The Tribunal had accepted that the taxpayer was particularly concerned with the claim to springboard relief because that would effectively destroy any prospects for his future business. It was therefore accepted that Mr McMahon had a business purpose behind the payment.
However, they also noted that a significant issue in the legal proceedings was as to which customers of the former employer the taxpayer was entitled to work for and accordingly, the proceedings were not just in relation to the availability of springboard relief but also as to the extent of the breach of contract and the measure of damages for that breach.
The Tribunal considered the distinction between purpose and effect (with reference to Mallalieu v Drummond), as well as McKnight v Sheppard, in which there had been a sole business purpose in incurring expenditure.
Accordingly, the Tribunal did not accept that the payments were incurred wholly and exclusively for the purpose of his trade and instead the payment had a dual purpose. One of these was a trading purpose which was to defend the taxpayer’s current trading activity; the other purpose was to settle a matter relating to Mr McMahon’s contract of employment, which was a non-trade purpose.