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HMRC internal manual

Business Income Manual

Wholly and exclusively: commencement, cessation or sale of business: compensation for loss of office at time of share sale

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

Payer must show the two events are unconnected

Where compensation is paid to departing directors at or about the time of a share sale the company must demonstrate that the two events are unconnected.

In the case of James Snook & Co Ltd v Blasdale [1952] 33 TC 244, an agreement for the sale of shares of the company provided (amongst other things) that the purchaser would pay compensation for loss of office to the directors who, under the sale agreement, were to resign. The purchasing company sought the removal from office of two directors because they were of advanced years and their methods were old-fashioned.

The General Commissioners held that the compensation paid was not an allowable deduction in computing the company’s profits.

Donovan J explained why the compensation payment was not deductible. The mere fact that the compensation was paid on the occasion of the share sale did not make it disallowable. However, the two events happening at or about the same time placed the onus on the company to prove that one was unconnected with the other.

The duality of purpose in the payment in this case was fatal to the claim for deduction.

The agreement, as originally envisaged, was varied. When the purchasing company or its directors, further considered the matter, they came to the conclusion that two of the four directors of the appellant company should not be called upon to retire but should be called upon to continue in office so that they would provide continuity in the management of the appellant company. In consequence of that change, the total amount of compensation was reduced. The Master of the Rolls, Sir Raymond Evershed, thought that circumstance was not material, except perhaps to show that the inevitable conclusion to be drawn was that the question of retirement and payment of compensation was part and parcel of the arrangement made in the sale agreement.

The part of Donovan J’s judgment placing the onus of proof on the company is set out below:

`The mere circumstance that compensation to retiring directors is paid on a change of shareholding control does not of itself involve the consequence that such compensation can never be a deductible trading expense. So much is common ground. But it is essential in such cases that the company should prove to the Commissioners’ satisfaction that it considered the question of payment wholly untrammelled by the terms of the bargain its shareholders had struck with those who were to buy their shares and came to a decision to pay solely in the interests of its trade.

This may be very difficult at times, because the persons who have to take the decision are often the persons who are to get the compensation; but any difficulty in securing an independent decision by or on behalf of the Company does not do away with the necessity of securing it if a title to deduct the compensation as a trade expense is to be sought. Evidence proving such a decision is wholly lacking here: so that the Commissioners had before them evidence establishing that payment of compensation was one of the terms of the bargain for the purchase and sale of the shares and no evidence that the Company considered the matter independently and decided to pay the compensation solely to advance its own trading interests. In those circumstances the Commissioners found that the compensation was not paid wholly and exclusively for the purposes of the Company’s trade. That decision is one of fact; there is evidence to support it; and therefore I cannot interfere with it. The appeal in my judgment must be dismissed.’

The part of Sir Raymond Evershed MR’s judgment dealing with the variation of the agreement is set out at page 255:

`…I think it is plain that the motives or purposes in this matter must have been mixed. It was, no doubt - and I accept the statement of the Commissioners and of Mr Bell - considered advantageous, from the point of view of the Appellant Company as a trading concern, that these directors should be persuaded to retire. But the bargain was made by the shareholders of the Appellant Company with somebody who had a separate interest in the matter, namely, the concern of getting the best bargain they could for that which they were giving. In those circumstances, it seems to me that there can be no quarrel with the Commissioners when they state that, having considered all the evidence which had been given, they were not satisfied that the onus had been discharged by the Appellant Company of proving that the sum in question was “wholly and exclusively expended” for the purposes of the Appellant Company’s trade.’

Whilst the onus is on the Company to show that the payment is wholly independent of the sale of shares, it is of course important to establish the facts in each case.