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Business Income Manual

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Wholly and exclusively: commencement, cessation or sale of business: compensation for cancellation of service agreements linked to 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 payment of compensation for loss of office is linked to share sale it is not allowable notwithstanding evidence to show that the sums paid under the two headings were computed quite separately.

In the case of Bassett Enterprise Ltd v Petty [1938] 21 TC 728, the company was controlled by family members many of whom had contracts of employment at wages in excess of market rates. The company appointed a chartered accountant as general manager for ten years at a substantial salary.

About a year later an action commenced in the High Court to restrain one group of the family from carrying into effect an agreement to sell their interest in the company to a prospective purchaser. It was settled on terms that:

  1. the agreement should be carried out
  2. the other group of the family should sell their shares to the same purchaser
  3. the general manager should release the company from any claim under his service agreement on payment of £3,000, and
  4. each member of the family who held a service agreement should release the company therefrom on payment of £1,500

The company contended that the service agreements were onerous and that the payments made in respect of their cancellation should be allowed as deductions in computing its profits for tax purposes. The Special Commissioners’ findings included the following:

`…the question of the amount to be paid as compensation was kept quite separate from the question of what price should be paid for the shares, and that [Mr Watts] refused to discuss the latter until the former had been settled…’

The Special Commissioners held that the cancellation of the service agreements was part of the share purchase transaction and that the expense incurred was not required in the company’s interests but in the interests of the purchaser of the shares. They dismissed the appeal.

Lawrence J found that there was ample evidence for the Commissioners to conclude that the compensation payments were linked to the share sale and so were not deductible. The judge found the following points significant:

  • the transactions took place at the same time
  • the transactions were contained in the same documents
  • the members of the groups were not paid with reference to the facts of the case but were paid one fixed level sum of £1,500 each, notwithstanding that some of them were performing no services and others were performing services which were valued

The part of Lawrence J’s judgment on which the above guidance is based is set out at page 738 onwards:

`…the circumstances are such that they afford, in my opinion, evidence upon which the Commissioners could find that the expense of the sums paid to the members of the Bassett groups was not incurred in the interests of the Company, but was part of the share purchase transaction. I think that there was ample evidence upon which the Commissioners might come to that conclusion, and I think their conclusion is supported not only by the fact that the transactions took place at the same time and were contained in the same documents, but also by the fact that the members of the groups were not paid with reference to the facts of the case but were paid one fixed level sum of £1,500 each, notwithstanding that some of them were performing no services and others were performing services which were valued, in the only piece of evidence there is upon the subject, at various figures.

With reference to [the general manager], I think there is no evidence upon which the Commissioners could have come to the conclusion that the sum paid in discharge of his service agreement was wholly and exclusively in the interests of the Company, and, further, that that transaction was equally connected with the share purchase transaction and the transaction under which the members of the Bassett groups received their compensation.

I hold, therefore, that the conclusion which I understand the Commissioners arrived at, namely, that these payments were not wholly and exclusively made for the purposes of the Appellant Company, was right, and I think the appeal must be dismissed with costs.’