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HMRC internal manual

Business Income Manual

Wholly and exclusively: fines, penalties and damages; costs incurred in settling an action for breach of the law

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

Costs relating to a breach of the law are not allowable and the jurisdiction to which the breach relates is irrelevant

Legal expenses incurred in the normal day to day conduct of the trade are likely to be allowable. The costs of entering, amending or leaving a trading contract (unless such contract is in the class covered in the guidance at BIM35530) are allowable. The costs arising from a breach of the law are not allowable. Costs incurred to settle an action alleging breach of the law are also not allowable.

The case of Cattermole v Borax & Chemicals Ltd [1949] 31 TC 202, concerned a claim to deduct legal and other expenses incurred in connection with legal action in the United States. Under an indictment in an American court, Borax & Chemicals Ltd, its managing director, the American parent company (the American Potash and Chemical Corporation), and certain others were charged with offences against the Sherman (‘anti-trust’) Act.

The American company wished to settle the case without court proceedings. Although Borax & Chemicals Ltd and its managing director were not obliged to submit to the jurisdiction of the American court, they agreed to do so at the request of the American company in order to facilitate its negotiations. A compromise settlement was reached, involving fines on Borax & Chemicals Ltd and its managing director. Borax & Chemicals Ltd also incurred the costs of legal advice taken in the UK before deciding to submit to the jurisdiction of the American court, and the expenses of a visit to America by the managing director.

The trading profits of Borax & Chemicals Ltd were assessed to tax without the allowance of any deduction for the fines and other expenses. The company appealed to the General Commissioners, contending that the payments were wholly and exclusively for the purposes of the trade. The Commissioners allowed the appeal.

The High Court decided that the payments in America were not admissible deductions for tax purposes. The High Court allowed the legal expenses incurred in the UK.

Croom-Johnson J stated that the fact that the proceedings took place in the US was irrelevant. As the payments served the purpose of compromising legal proceedings against the company and its US parent, they were not deductible. See page 210:

`I can see no distinction in law as to whether the proceedings were proceedings to recover sums of money of this sort pursued in an American court or in an English court. I think that is one of the matters on which the Commissioners here have not really applied their minds to the right problem. The question is what in fact were these payments, and are they shown in fact to be wholly and exclusively expended for the purposes of the trade of the Company - “wholly and exclusively laid out and expended for the purposes of the trade”. I will leave out the rest of the words.

Where I think the Commissioners have gone wrong is this. They have not given sufficient value to the words “wholly and exclusively”. They seem to have looked at the reason which was given for the submission to the jurisdiction in the United States and have failed to attach sufficient importance to the question, after the submission to the jurisdiction, as to what the sum of money was paid for. It was paid for a compromise of legal proceedings in the United States to which I will assume for good business reasons they had voluntarily submitted themselves. But that is not what I have to decide.’

Croom-Johnson J agreed that the legal expenses incurred in London for advice in connection with the trade were allowable. See pages 211-212:

`Then there is a little item of £28 for legal expenses in London…I am bound to say that in circumstances like the present I think it would be extremely difficult to hold that a sum of money paid by the directors in London for legal advice as to what they should do is not an expenditure connected with their trade. I do not propose to spend very long on this but it looks to me as if it were possible, on the reasoning of the Spofforth case [Spofforth & Prince v Golder [1945] 26 TC 310, see BIM37955], to allow some amount of costs incurred by the directors in London for the purpose of seeking advice as to whether they should put their heads in the lion’s mouth.’