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HMRC internal manual

Business Income Manual

Wholly and exclusively: fines, penalties and damages: cost of settling civil action, trade purpose?

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

Civil damages, not intended to be punitive, may be allowable

As explained in BIM38530, the costs of civil damages arising as a result of normal trading operations are generally allowable. It is essentially a question of fact whether damages arise out of trading or other matters.

In the case of Golder v Great Boulder Proprietary Gold Mines Ltd [1952] 33 TC 75, the company was a gold-mining concern which in 1934 and 1935 entered into transactions connected with the formation of other companies. The £27,500 profits from these transactions were included in subsequent tax assessments. In 1941 and 1942 civil actions were brought against the company in connection with the formations, and the company paid £25,000 to settle the actions. Legal costs were also incurred.On appeal before the Special Commissioners, the company contended that the sum of £25,000 and the legal costs were admissible deductions in computing its profits for taxation purposes.

The Crown contended that, notwithstanding the earlier tax assessments, the company was not engaged either in a separate trade of company promotion or in a composite trade of gold mining and company promotion. So that the question of the deduction could not arise. Alternatively that the £25,000 and legal costs were not laid out wholly and exclusively for trade purposes.

The Special Commissioners held that the transactions by which the companies had been formed and sold were trading transactions. They also agreed that the £25,000 and legal costs were wholly and exclusively laid out for trade purposes.

Donovan J in the High Court held that the Commissioners’ decision was correct. The company’s trade was that of trade promotion. That trade had not been abandoned. The claim made against the company was one that would have been very damaging to its trade had it succeeded. The cost of settling the claim was an allowable expense. The damages paid were not punitive.

The part of Donovan J’s judgment on which the above guidance is based is set out at pages 94-95:

`The question whether a sum is or is not wholly and exclusively laid out for the purposes of the trade is a question of fact and if there were evidence to support the Commissioners’ finding I cannot interfere. Here they had the following evidence: a trade of company promotion was carried on and profits earned by the sale of assets to the company which had been promoted. There was no evidence establishing that such a trade had been abandoned. Arising out of that trade a claim for damages was made against the Company which would seriously affect its reputation as a company promoter if the claim succeeded. The Company settled with its adversaries for reasons thus described, again by Mr Binns: “In seeking a settlement the board had had in mind the very large and serious liability in costs with which the Company would be faced even if it won the actions and in costs plus damages if it lost. Those had been the main considerations; it was a question of saving money and they had thought it cheaper to settle for £25,000 than to run a risk.” In contradistinction to that part of Mr Binns’ evidence about payment of dividends, he is here clearly speaking about the position just before payment of the money and he is describing the purpose of the payment.

With that evidence before them the Commissioners held that the £25,000 and the attendant costs were disbursements made wholly and exclusively for the purposes of the trade. I cannot say they were bound in law to hold the other way, and I therefore am unable to sustain the Crown’s appeal in either case.’