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HMRC internal manual

Business Income Manual

Wholly and exclusively: commencement, cessation or sale of business: redundancy payments on takeover

S54 Corporation Tax Act 2009

Must be considered entirely independent of any bargain struck with the buyers of the shares

In order that redundancy payments be deducted on the occasion of a takeover, it is necessary that they shall have been considered and approved by or on behalf of the company in relation to whose trade they are said to have been made independently of any bargains struck by the shareholders with the respective purchasers of the shares.

In the case of George Peters & Co Ltd v Smith [1963] 41 TC 264, the company traded as beer, wine and spirit merchants. Its wholly owned subsidiary, J J Young & Son Ltd, carried on a trade as brewers, including the ownership of tied houses. Under an offer which became unconditional in January 1959, Friary Meux Ltd acquired the entire share capital of George Peters & Co Ltd upon terms that a sum should be set aside out of the purchase price to compensate directors and employees of George Peters & Co Ltd and its subsidiaries who became redundant. The merger meant that there was no longer a continuing role for two managing directors. Under the arrangement, in the year to 31 March 1959 George Peters & Co Ltd paid £46,000 to resigning directors and J J Young & Son Ltd paid £33,342 to employees who became redundant on the closing of J J Young & Son Ltd’s brewery.

The companies contended that these sums should be deducted in computing their profits as money wholly and exclusively laid out for the purposes of their respective trades. For the Crown it was contended that the sums were capital expenditure paid as an integral part of the agreement whereby Friary Meux Ltd purchased the shares of the appellant.

The Special Commissioners found that:

  • the payments by George Peters & Co Ltd were an essential part of the bargain between its shareholders and Friary Meux Ltd and accordingly were not deductible
  • the payments made by J J Young & Son Ltd were essential for the preservation of the company’s good name and its continuing trade and were deductible.

Wiberforce J explained the hurdle that a company had to pass to secure a deduction in circumstances when compensation was paid at the time of a share sale at page 284:

`[The issue has] to be considered in relation to the question whether, following the wording of [what is now S54(1)(a) Corporation Tax Act 2009], the sums in question can be considered as money wholly or exclusively laid out or expended for the purposes of the trade. It has been laid down in terms which I accept - and which, in any case, bind me - that it is not necessarily decisive that payments of this character to compensate displaced directors or employees shall have been made in connection with a change of ownership of the share capital. It is still possible, even though the payments are made in that context, that they may rank as deductible expenses. But in order that they may do so it is necessary that they shall have been considered and approved by or on behalf of the company in relation to whose trade they are said to have been made independently of any bargains struck by the shareholders with the respective purchasers of the shares.’

Wiberforce J went on to examine the facts in detail and found that the figures for compensation, both in the aggregate and in individual cases, had been determined as part of the bargain between Friary Meux Ltd and George Peters & Co Ltd for the acquisition of the company’s shares. The judge then examined two matters referred to by the Commissioners:

`Those are all the necessary facts to which I need refer in connection with the Peters appeal, but there are one or two statements, all the result of evidence, appearing in the Case which I should also mention. First of all, it is said in paragraph 3(10) that:

“It was anticipated by the Appellant and Friary Meux that the acceptance by the Appellant's shareholders of Friary Meux's offer as set out in sub-paragraph (9) above would benefit the trade of both companies.”

That, no doubt, was the case, but one may comment upon it that that does not of itself prove the case which the Appellant Company has to make, namely that the particular payments to the displaced directors were made exclusively for the purposes of the Appellant Company’s trade. It falls far short of that. Then it is said, in paragraph 3(16), that:

“Apart from the merger of the Appellant with Friary Meux, there would have been no reason at that time for the directors of the Appellant to resign office, nor for Young's brewery to be closed, nor for the dismissal of any employees of the Appellant or its subsidiaries. But a merger had become increasingly likely; and a board of directors composed of family representatives was an uncommercial arrangement.”

Again the comment one can make upon that is that it is somewhat weak support - indeed, hardly any support - for a contention that the payments of compensation to the directors of Peters were payments made exclusively for the purposes of trade. All it shows is that an amalgamation was necessary and that the view was taken by Friary Meux - as, from the letters, it is clear that it was taken - that it would be good business in the course of reorganisation to make changes in the management which would result in the displacement of various persons who would have to be compensated. It falls far short, however, of establishing what the Appellant Company has to establish.’

So it is not enough for the company to show:

  • that the merger or share sale was good for the company’s trade, and/or
  • that the composition of the board is uncommercial and has to be changed

The company has to show that the compensation was paid wholly and exclusively for the purposes of the trade.

Wilberforce J went on to explain why George Peters & Co Ltd failed the statutory test at pages 289-290:

`…it seems to me quite unrealistic to suppose that when they did pass that ordinary resolution they did so independently of any consideration relating to the offer to purchase their shares. As has already appeared from the passages I have quoted, the proposal to compensate the directors - and, indeed, the figure at which the directors should be compensated - was one which had arisen at the earliest possible stage in the negotiations and was part of the terms as decided upon by Friary Meux. The decision that they should be compensated, and be compensated in the figure of £46,000, was not one which the shareholders made on 22 January. It was one which had been made aliunde - one which had been made by Friary Meux when they decided they were going to purchase the shares.’