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HMRC internal manual

Business Income Manual

Wholly and exclusively: commencement, cessation or sale of business: payment in lieu of notice

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

Where the payment is not made for the purpose of carrying on the trade but for something else, non-allowable

Payment to an employee in lieu of notice is normally allowable. However, where the payment is not made for the purpose of carrying on the trade but for something else, it is not allowed. It does not matter that by arranging their affairs differently the payer may have secured a deduction. Taxation follows the events that happened and not those that could have occurred.

In the case of Godden v A Wilson’s Stores (Holdings) Ltd [1962] 40 TC 161, the company traded as rubber planters. The company’s estates’ manager was employed under a contract terminable by six months’ notice to be given on 31 March or 30 September in any year. On 15 March 1958, the company entered into an agreement to sell its estates, and the sale was completed on 31 March 1958, on which date the company’s trade was discontinued. The manager was given notice of the termination of his employment, and, on 28 March 1958, was paid the sum of £1,900, representing the salary due to him for the six months to 30 September 1958, and the estimated commission which he would have earned in that period.

The Special Commissioners held that the sum of £1,900 was incurred on revenue account, for the purposes of the company’s trade, to break a trading obligation, and was an allowable expense in computing its profits for that year. They accordingly allowed the appeal.

Plowman J began by analysing the previous cases in this subject area, identifying two broad categories:

  • payments not made in order to allow the trader the better to carry on their trade but to enable them to go out of business, and
  • expenditure to be rid of onerous service agreements.

Expenditure under the first category is not allowable but under the second is allowable:

‘…I have been referred to a large number of other authorities and I should say something about them, though I do not propose to go into them in great detail. They fall, I think, mainly into two categories. Under one head there are the cases where payments were made, not in order to enable the company the better to carry on its trade, but to enable it to go out of business: and in those cases the Courts have held that the money so paid was not deductible as an expense wholly and exclusively laid out or expended for the purposes of the trade…

…On the other hand, there is a second category of cases in which sums of money paid to get rid of onerous service agreements and the like have been held to be deductible as expenses wholly and exclusively laid out or expended for the purposes of the trade…I do not refer to those cases in detail for this reason, that in all of them the business of the company of person in question was going to go on; and a case in which the business is going to go on seems to me to be entirely different from a case in which the business is going to come to an end and the payment is made because the business is going to come to an end.’

After discussing the Anglo Brewing decision (see BIM38310), Plowman J explained why the expenditure in A Wilsons Stores (Holdings) Ltd was not allowable:

‘Now, it is quite true that early on in his judgment he pointed out that the payments which he was considering were ex gratia payments, and said that there was no contract in it at all; but it seems to me that the fact that the payments in the case which Rowlatt, J., was considering were ex gratia payments whereas, in the case which I am considering, £1,900 was not an ex gratia payment, is neither here nor there. The point, as I understand it, of the decision is that, as the company was going to stop trading, the payments in question could not have been within the relevant provision because they were not made for the purpose of keeping the trade going. In that respect, which seems to me to be the relevant respect, that case is on all fours with the present one.’

The Court of Appeal found that given the facts surrounding the payment, structured and described as it was, the payment was not deductible. This was on the grounds that, rather than being a payment of remuneration (which would have been another way in which the company could have arranged for the outgoing manager to receive the same amount of money), the payment was compensation for the fact that the company was not going to employ the manager for the full time for which it was bound so to employ him.

‘Of course, it is very familiar law that a company, while trading and while intending to continue to trade, may make deductions for its losses; it may make payments by way of pension, whether they be voluntary or not; and it may pay out large sums-as, indeed, was done in the case of Anglo-Persian Oil Co., Ltd. v Dale (16TC253), [1932] 1 K.B. 124, where a sum of no less than £300,000 was paid by the then Anglo-Persian Oil Company to get rid of certain agencies, and in other cases which were cited to us. But all those payments are made and are allowed by the Revenue, if they are commercially sound, in order that the company may carry on its trade more successfully. They are, in a literal sense, paid for the purposes of the trade, and as such are allowable. Mr. Borneman [counsel for the appellant] submits that at the time this payment was made the Company was in fact carrying on business - and no doubt it was - and that it was paid, in fact, by way of remuneration. He submits that that must be a payment which is wholly and exclusively paid during its trade and for the purposes of trade, because the Company was in this difficulty with Mr. Paton [the estates’ manager] and, as in Mitchell v B. W. Noble, Ltd [11TC372, see BIM38370], they had to deal with him at once. He submits that it matters not that this payment of £1,900 was in fact described as being “in lieu of notice”: that was merely a measure of the remuneration that he was to receive.

Speaking for myself, I cannot accept that argument. It is perfectly true that this payment might have been so devised that the company might have been entitled to claim this as a deductible expense, as being the remuneration of Mr. Paton during this period; but, in fact, it was not so devised. I return to paragraph (c) of the letter of 27th February, 1958, which sets out perfectly clearly what the parties were intending to do. What the parties were intending to do was to give Mr. Paton £1,900 in lieu of notice, which is as common a transaction as one can possibly have. In other words, they were paying him compensation for the fact that they were not going to employ him for the full time for which they were bound so to employ him: and, for that and other reasons, Mr. Paton was happy and willing to accept that arrangement. To my way of thinking, that payment cannot possibly be described as a payment for the purposes of trade. It was made because the Company was not going on to trade, and they were left with the possibility of an action for damages against them for breach of the agreement of employment. I accept Mr. Borneman’s submission that, though it was made on the occasion of discontinuance, it was not because of that, and it was not to enable them to discontinue business: they were going to do that anyway. But this payment was not made for the purposes of the trade they were going to carry on: it was to get rid of a possible law suit after discontinuance.’

The Master of the Rolls, Lord Evershed, expressly commented on the issue that had the company arranged their affairs differently, the payment may well have been deductible:

`As I have said, it might have been put so that Mr Paton could have been invited to say: “I accept six weeks’ notice instead of six months’ provided that my salary for the six months now pending is doubled”; and that would have been reinforced, perhaps, because, as Mr Borneman pointed out, it was essential that the rubber plantation should be continued and handed over as a going concern. Indeed, the argument for its sale required its continuance as a going concern afterwards. But we can decide this case only upon the material as it took shape.’

The Privy Council in CIR v Cosmotron Manufacturing Co Ltd [1997] 70 TC 292 (see BIM38315) declined to follow the Court of Appeal decision disallowing payment in Wilson’s Stores (Holdings) Ltd. In consequence, you should not cite the case in support of disallowing such payments. The principle that it does not matter that by arranging their affairs differently the payer may have secured a deduction remains valid. Taxation follows the events that happened and not those that could have occurred.