BIM38395 - Wholly and exclusively: commencement, cessation or sale of business: liability for future leaving payments to employees

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

A provision for an allowable expense must be accurately computed - if insufficiently accurate, re-compute

The cost of hiring and firing employees in the normal course of business is allowable. Where, under the rules of UK generally accepted accounting practice (GAAP), a trader is required to provide for a future expense then such provision will be allowable in the circumstances described in BIM31050.

In the case of Owen v Southern Railway of Peru Ltd [1956] 36 TC 602, under Peruvian law, Southern Railway was required to pay its employees in Peru prescribed compensation payments upon the termination of their services with the company, subject to the fulfilment by the employee of certain conditions. The amount to be paid depended on:

  1. length of service, and
  2. rate of pay at the end of the period of service, except that a reduction in pay would not affect the amount to which an employee was entitled by reference to the period of service already performed

It was contended on behalf of the company that, under proper principles of commercial accounting, amounts of compensation calculated to have accrued in respect of each employee from year to year as deferred remuneration should be allowed as a deduction. The Special Commissioners held that it was a matter of correct accountancy practice to make provision in the accounts for the sums in question, and allowed the appeal.

In the House of Lords judgment was given in favour of the Crown.

The majority of their Lordships were of opinion that, where a number of similar contingent obligations arise from trading, there is no rule of law which prevents the deduction of a provision, if a sufficiently accurate estimate can be made. However, the provision claimed by the company was not permissible by reason of the absence of discount and other factors.

In this particular case, the deduction was disallowed because it was insufficiently accurately computed. In such a case you should invite the taxpayer to refine the provision to secure the necessary degree of accuracy.