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HMRC internal manual

Business Income Manual

Wholly and exclusively: commencement, cessation or sale of business: cost of hiring and firing employees

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

Allowable in the year of unsatisfactory performance

The cost of hiring and firing employees in the normal course of business is allowable.

In the case of Mitchell v B W Noble Co Ltd [1927] 11 TC 372, the company claimed to deduct the sum of £19,200 payable (by instalments) to a retiring director.

The original directors were appointed for life so long as they held a qualifying number of shares, subject to dismissal forthwith for neglect or misconduct towards the company. A director so dismissed was only entitled to receive his salary then due and could be required to sell his shares to the other directors at par. The director would also have to surrender for cancellation certain notes issued by the company entitling him to participate in surplus profits.

Circumstances arose in 1920 and 1921 in which the company might possibly have been justified in dismissing one of the directors, but, to avoid publicity injurious to the company’s reputation, it entered into negotiation with him for his retirement. He claimed £50,000 compensation, but a compromise was agreed.

The director agreed to retire from the company, to transfer his 300 £1 shares to the other directors at par value (they were then worth considerably more) and to surrender his participating notes. The company agreed to pay him £19,200, and the directors to pay him £300 (expressed to be consideration for his shares), making together £19,500 (payable in five annual instalments), which he agreed to accept in full satisfaction of all claims against the company or the directors.

The Special Commissioners allowed the deduction claimed. There was another matter concerning taxation of the company’s activities in France.

Rowlatt J explained why the payment was an allowable deduction. A sum paid in lieu of notice would be allowable. The amount paid in the present case was very high. However, this reflected the peculiar circumstances of this particular case. There is nothing extraordinary about paying an unsatisfactory employee to go. And, because this is essentially what had happened, the amount paid was allowable. The cost of hiring and firing employees in the normal course of business is an allowable expense.

The decision in Mitchell v B W Noble Co Ltd may be contrasted with that in Overy v Ashford Dunn & Co Ltd [1933] 17 TC 497. There were crucial differences in the underlying facts - in particular there was no reason established in the latter case for the company wishing to be rid of its director (see BIM37860).

The Revenue’s argument in Mitchell v B W Noble Co Ltd that the expenditure was capital was also dismissed, see BIM35590.

The part of Rowlatt J’s judgment on which the above guidance is based is set out at pages 414-415:

`I should not have much difficulty if this were a question of paying a month’s wages or six months’ wages in lieu of notice to an employee who, the employer had found, from the business point of view, could not possibly be retained because he was turning away custom. I should not have much difficulty about that. But here we have very special facts and very big figures, and the question is whether there is anything in these facts that makes a difference. What was the position? This Director had a substantial salary, and the normal measure would be the loss of his salary, subject to a discount on the ordinary principle, in consideration of the fact that he might be out of employment. But there was this peculiarity: if he was dismissed, then he had to sell his extraordinarily valuable shares - shares which paid 677 per cent dividend - at par, and he also had to surrender some profit-sharing notes which he held, which were very valuable property. Therefore he was in a position to say: “I am not going to be dismissed on a calculation of the salary I lose, because the measure of my damages must include the loss of the premium value of my shares and the loss of my profit-sharing certificates.” Therefore the Company had to pay a much larger sum. They paid it because it was essential in their opinion, as the Case finds, to get rid of him for the sake of the good name of the Company and they did not want any litigation or publicity or any scandal or anything of that kind, so they paid it for business reasons. It seems to me that they paid all this sum - although the circumstances are very peculiar-simply to get rid of the Director. These other items came in, but they only came in as enhancing the measure of the claim which they had to deal with. It is true that in the agreement it is said that he agreed with the company to transfer the shares at their face value to his co-directors; and that he undertook to surrender his profit-sharing certificates to the Company or as they should direct; but I think that is only putting into the agreement the obligation upon him, as he was being paid in respect of these heads of damage, that he would deal with them on the footing which formed the basis of his payment, namely, that he should part with these pieces of property. I do not think it can be said that there are two things in this payment: first of all, a compensation for the loss of his salary, and secondly, independently, a buying of the shares and a buying of his profit-sharing certificates. I do not think that is the view of it. I think the whole sum was a sum paid to him to induce him to go - to get rid of him, in other words. Therefore it seems to me that this was a business expense.’