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Business Income Manual

HM Revenue & Customs
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Wholly and exclusively: fines, penalties and damages: penalties for infractions of the law are not allowable

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

Penalties for infractions of the law are not allowable

Penalties incurred for breaching the law are not allowable.

In the case of CIR v EC Warnes & Co Ltd [1919] 12 TC 227, the company, which carried on the trade of oil merchants, had been sued for a penalty under S 5(1) Customs (War Powers) Act 1915. The penalty was for breach of certain orders and proclamations relating to the requirements of the Board of Customs and Excise with respect to a consignment of oil shipped by the company to Norway.

The action was settled by consent on the agreement of the company to pay a mitigated penalty of £2,000 (to cover the costs of the Crown) and on all imputations as to the company’s moral culpability being withdrawn. The company incurred £560 legal costs.

The company claimed a deduction for the penalty and its legal costs against its trading profits.

The General Commissioners allowed the expenses claimed. The High Court decided that the mitigated penalty and costs were not losses connected with and arising out of the company’s trade within the meaning of what is now S54(1)(b) Corporation Tax Act 2009. They were therefore not deductible in arriving at the profits of the company’s trade for Excess Profits Duty purposes (a tax which applied at the time to profits over and above a certain level).

In the High Court, Rowlatt J expressed the view that a penal payment for infringement of the law could not be a loss arising out of the trade.

The part of Rowlatt J’s judgment on which the above guidance is based is set out at pages 231-232:

`I may shelter myself behind the authority of Lord Loreburn, who, in his judgment in the House of Lords in Strong & Co [of Romsey] v Woodifield [[1906] 5 TC 215, see BIM38510], said that it is impossible to frame any formula which shall describe what is a loss connected with or arising out of a trade. That statement I adopt, and I am not sure that I gain very much by going through a number of analogies; but it seems to me that a penal liability of this kind cannot be regarded as a loss connected with or arising out of a trade. I think that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of a loss which is contemplable, and in the nature of a commercial loss. I do not intend that to be an exhaustive definition, but I do not think it is possible to say that when a fine, which is what it comes to, has been inflicted upon a trading body, it can be said that that is “a loss connected with or arising out of” the trade within the meaning of this Rule. As I say, it is impossible to say what is such a “loss”, but I have a clear view that this is not, and I can say no more than that.’