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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 (further discussion)

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

Penalty for infractions of the law are not allowable (further discussion)

As explained in BIM38515, penalties incurred for breaching the law are not allowable.

Another case concerning penalties under the Customs (War Powers) Act 1915 produced lengthier judicial commentary on the subject of finances and penalties. In the case of CIR v Alexander von Glehn & Co Ltd [1920] 12 TC 232, the company, which carried on trade as general produce merchants and exported goods to Russia and Scandinavia, had been sued for penalties under that Act in respect of alleged infringements of the Act in the course of its trade. The actions were settled by the payment by the company of a compromise penalty of £3,000 (without costs). The company incurred legal costs amounting to £1,074 in respect of the proceedings.

The company claimed a deduction for the penalty and its legal costs against its trading profits.The Special Commissioners decided that the mitigated penalty and costs were not admissible deductions 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).

Rowlatt J could not distinguish the facts from CIR v E C Warnes and Co Ltd [1919] 12 TC 227 (see BIM38515) and dismissed the appeal.

In the Court of Appeal, the Master of the Rolls, Lord Sterndale, examined whether it was important that the proceedings against the company were not technically criminal - saying that it did not matter. See pages 235-236:

`Now we had several authorities cited to us which seemed to establish that such proceedings as those are not technically criminal proceedings. I do not think that matters. They certainly are proceedings in which a penalty is being sued for by the Attorney-General as representing the Crown, for an infraction of the law, whether technically criminal for the purpose of appeal seems to me to be immaterial. The money which is paid is money paid as a penalty, and it does not matter in the least that the Attorney-General has elected to take treble the value of the goods, nor does it matter that it may be called in the Information a forfeiture. It is in fact, under the Section, a penalty.’

The Master of the Rolls then identified that the applicable legislation was what is now S54(1) CTA 2009. He went on to explain why the expenditure was not deductible, confessing in passing to some difficulty in putting his reasons into words. Lord Sterndale said that the expenditure was not a loss connected with the trade, but a fine imposed upon the company personally. The expense was not connected with and did not arise from the carrying on of the trade; it arose from infringing Customs regulations. See page 238:

`Now what is the position here? This business could perfectly well be carried on without any infraction of the law at all. This penalty was imposed because of an infraction of the law and that does not seem to me to be, any more than the expense which had to be paid in the case of Strong & Co of Romsey v Woodifield [[1906] 5 TC 215,see BIM37300 andBIM38510] appeared to Lord Davey to be, a disbursement or expense which was laid out or expended for the purpose of such trade, manufacture, adventure or concern; nor does it seem to me, though this is rather more questionable, to be a sum paid on account of a loss connected with or arising out of such trade, manufacture, adventure or concern [referring to what is now S54(1)(b) CTA 2009].

Of course, as Mr Justice Rowlatt said, in a sense you may say that it has been connected with the trade, because if the trade has not been carried on the penalty would not have been incurred; there would not have been an opportunity for the breach of the law which took place, but in the sense in which the words are used in the Act, I do not think that this was connected with or arising out of such trade, manufacture, adventure, or concern, and still less do I think that it was a disbursement under the First Rule which applies to the first two Cases, that is to say, “money wholly and exclusively laid out or expended for the purposes of such trade.” During the course of the trading this company committed a breach of the law. As I say, it has been agreed that they did not intend to do anything wrong in the sense that they were willingly and knowingly sending these goods to an enemy destination; but they committed a breach of the law, and for that breach of the law they were fined, and that does not seem to me to be a loss connected with the business, but it is a fine imposed upon the company personally, as far as a company can be a person, for a breach of the law which they had committed. It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss in trading and a penalty imposed upon a person or a company for a breach of the law which they have committed in that trading.’

Again in the Court of Appeal, Warrington, L J explained (at page 240-242) why no deduction was due; saying that the expenditure did not represent a commercial loss and arose because those conducting the trade had so ordered their affairs as to make themselves liable to the penalty:

‘In the present case what is sought to be deducted is a definite sum expended by the Company, and the question we have to determine is whether that is to be allowed as a deduction. In my view it cannot he allowed, as I have already said, unless it is one of the things that can be allowed under the Income Tax Act. It is a curious thing that the Income Tax Act does not contain any express provision as to what shall be allowed or may be allowed. The way in which it is done is it prohibits certain things, which are enumerated, being allowed as deductions, and impliedly by that means one can find out what may be allowed as deductions. Among the things which may be allowed, I think, is a loss connected with or arising out of such trade, manufacture, adventure, or concern. Now is this a loss connected with or arising out of a trade or manufacture? That the expenditure arises out of the trade I think may well be conceded. It does arise out of the trade, because if it had not been that they were carrying on the trade they would not have had to incur this expenditure; but in my opinion it is not a loss connected with or arising out of the trade. It is a sum which the people conducting the trade have had to pay because in conducting it they have so acted as to render themselves liable to this penalty. It is not a commercial loss, and I think when the Act is talking about a loss connected with or arising out of such trade it means a commercial loss connected with or arising out of the trade…

…it cannot be said that the disbursement in the present case is made in any way for the purpose of the trade or for the purpose of earning the profits of the trade. The disbursement is made…because the individual who is conducting the trade has, not from any moral obliquity, but has unfortunately, been guilty of an infraction of the law.’

Scrutton L J explained that the expenditure was not deductible as it related to unfortunate incidents after the profits had been earned. See page 244:

`…were these fines and expenditure necessary to earn the profits? Were these fines made or paid for the purpose of earning the profits? The answer seems to me obvious, that they were not, they were unfortunate incidents which followed after the profits had been earned. I quite follow that stating the matter in that way may leave some difficult questions for solution in other Cases. I do not wish to decide until I have heard the matter further argued, whether compensation paid in civil proceedings for carrying on business in a negligent way can or cannot be deducted from the profits, for I quite see that on the language that I have used questions may arise as to damages paid in civil proceedings.’

Lord Hoffmann in the case of McKnight v Sheppard [1999] 71 TC 419 explained the House of Lords rationale for not allowing punitive penalties (see BIM37965).