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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 takeover

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

Payer must show the two events are unconnected

The costs of removing employees, including directors, are not disallowed just because the paying company is later liquidated.

The case of CIR v Patrick Thomson Ltd [1956] 37 TC 145, involved three companies that were subsidiaries of Scottish Drapery Corporation Ltd, control of which was acquired by House of Fraser Ltd.

Changes of organisation, which were made in accordance with the policy of the latter company, involved the termination of the contracts of service of the managing directors of the three companies and also the eventual liquidation of those companies. Certain sums were paid by the companies to the managing directors in connection with the cancellation of their contracts. The payments in the first two cases were in satisfaction of rights to future remuneration, and in the third was in lieu of notice.

The companies contended that the payments were made to relieve them from onerous contracts and were allowable deductions.

The Crown contended that the payments were not expenses of the companies’ businesses but were incidental to the schemes by which those businesses were acquired by House of Fraser Ltd and were made primarily for the latter company’s benefit.

The Commissioners decided that the deductions claimed were allowable.

In the Court of Session, Lord President Clyde agreed with the Commissioners that the sums paid to the departing directors were unconnected to the later liquidation of the company. No non-trade purpose having been established, the payments could not be disallowed under what is now S54(1)(a) CTA 2009. The finding of fact that the decision to liquidate the company was not in any way connected with the decision to cancel the managing director’s service agreement was particularly important.

The part of Lord Clyde’s judgment on which the above guidance is based is set out at pages 157-158:

`…it appears to me on the facts that the Special Commissioners were justified in holding in the present case that the expenditure in question was laid out for the purposes of the Respondents’ own trade and not for House of Fraser’s trade. In other words even assuming that the Respondents’ trade notionally or otherwise can be regarded as having been discontinued on the liquidation of the Company in January 1953, the Respondents can still invoke [what is now S54(1)(a) CTA 2009] to enable them to deduct the expenditure in question from their profits, as was done in Anglo-Persian Oil Co, Ltd v Dale[[1931] 16 TC 253, see BIM35505]. For the expenditure in question was made by the Respondents themselves. It is found as a fact that the decision to liquidate the Company in January 1953 was not in any way connected with the cancellation of [the managing director’s] service agreement, and these two events therefore were not part of any scheme or device to secure an advantage to [the managing director] at the expense of the Company. Indeed it is perfectly clear that but for the subsequent liquidation it could never be suggested that the expenditure in question was not a proper deduction from profits, for there would be no ground for saying that it was not incurred for the purposes of the trade or business.

How then can the subsequent liquidation affect the matter? When the service agreement was discharged and the expenditure made, liquidation was still only a possibility. The strongest way that the matter can be put for the Crown is that there was then a present intention to liquidate at some time in the future. But if that is as high as they can put it then they have not in my opinion established that the expenditure was not laid out for the purposes of the trade, and the Special Commissioners were well entitled so to hold. When the expense was incurred, liquidation might have been delayed beyond the end of the Company’s financial year, and only resolved upon in the next year; it might have been delayed for several years, as in the case of CIR v Pettigrew & Stephens Ltd [heard at the same time as CIR v Patrick Thomson Ltd]; it might not have occurred even yet. In none of these events in my opinion could it be successfully maintained that the expenditure was not laid out for the purposes of the trade in computing the Company’s profits or gains in the year 1952-53. The purpose for which the money was expended is a question of fact upon which the Commissioners are final…and they have negatived any connection between this purpose and the subsequent liquidation of the Company, which appears to have been decided upon after the payment was made. I can find nothing in the findings which would justify me in holding that the Special Commissioners drew a wrong inference, or that we should differ from their conclusion on such a matter.’