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HMRC internal manual

Business Income Manual

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Wholly and exclusively: fines, penalties and damages: compromise settlement of action by former director

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

Costs of litigating a trade dispute are allowable - costs of litigating a private dispute are not

The costs incurred in litigating a trade dispute are generally allowable. The costs of litigating a private dispute are not. The nature of any dispute is essentially a question of fact.

In the case of Hammond Engineering Co Ltd v CIR [1975] 50 TC 313, the company carried on the trade of light engineering. Until October 1957, the chairman and managing director was Captain Rubury, who commanded 51% of the votes. Capt Rubury resigned as managing director on 28 October 1937, when he was succeeded by his wife, and died on 18 November 1957, leaving his wife as executrix and sole legatee.

Mrs Rubury had been under treatment for mental disorder for some years and was incapable of managing the company. On 24 January 1958, before she had obtained probate of Capt Rubury’s will, she was removed from the board and a number of unissued shares were allotted in such a manner as to reduce the proportion of votes commanded by the shares registered in Capt Rubury’s name and her own to 46%.

Mrs Rubury obtained probate in June 1958. In December 1960, she commenced an action against the company, the directors, the secretary and certain shareholders (all but one of whom were employees of the company) claiming, amongst other things, declarations that the said allotment was void and that she was a director of the company and seeking damages.

In January 1961, she entered hospital suffering from a mental disorder. In March 1961 the Court of Protection appointed a receiver of her affairs, who in June 1961 obtained letters of administration of Capt Rubury’s estate. The receiver had formerly been accountant to the company; the managing director feared that he might take steps to harm the company and did not want him on the board as he was not a qualified engineer.

On 11 September 1961, the board resolved that the company should indemnify all members of its staff who had been joined as defendants in the action in respect of all costs, claims and demands made against them. The action was settled in November 1965 on the terms that the shares controlled by the receiver should be bought by the other shareholders, and under the indemnity the company paid some £4,000 together with £2,000 costs (including its own costs).

The Revenue refused the company’s error or mistake claim (what is now Sch1AB Taxes Management Act 1970) that these amounts were incurred wholly and exclusively for the purposes of the trade. The company appealed the refusal, contending that:

  1. the sum of £6,000 was incurred wholly and exclusively for the purposes of its trade as it was the cost of ridding itself of a director whose continued presence would have severely damaged the trade
  2. the costs of defending an action brought against employees who were worried at being involved in litigation that they did not really understand, in circumstances that could affect the well being of the company and therefore of themselves was also a revenue deduction

The Special Commissioners found that, if the action had not been defended, the very existence of the company would have been endangered together with the investments of its shareholders and the livelihoods of its staff and employees. However, the nature of the threat altered after the appointment of the receiver. The Special Commissioners decided that the sum of £6,000 was not laid out wholly and exclusively for the purposes of the company’s trade.

Templeman J in the High Court decided that there was evidence on which the Commissioners were entitled to arrive at their decision. The facts as found by the Commissioners were important. You should note in particular the weight given to the Commissioners’ conclusions made having heard oral testimony from the managing director.

The part of Templeman J’s judgment on which the above guidance is based is set out at page 320:

`On those facts, it was in my judgment open to the Commissioners to conclude, after seeing the witnesses, that the indemnities and the sum paid thereunder were granted and paid exclusively for the purposes of the trade, or alternatively were wholly or partly granted and paid for other purposes, such as the securing of the positions of the shareholders and directors personally. Mr Bretten [counsel for the company] argued pertinaciously that the Commissioners did not make their findings clear and that they wrongly relied on their own objective inference that the threat to the Company was removed when the receiver was appointed. Mr Bretten accused the Commissioners of ignoring their own finding that the managing director “feared that the receiver (who had formerly been the accountant to the Company) might seek to become a director and take steps to harm the Company, and he did not want the receiver on the board as he was not a qualified engineer.” The Commissioners should have accepted, said Mr Bretten, that the views expressed by the managing director were the views of the board.

In my judgment the Commissioners were entitled to take into consideration the position as it was after the appointment of the receiver, and on seeing and hearing the managing director to draw their own conclusions as to the purpose of the indemnities. The evidence on which Mr Bretten relies is consistent with the view that the resolution was not passed and the indemnities were not given exclusively for the purposes of the Company or its trade. It was for the Commissioners to determine whether the Company had made out its case and whether the money was expended exclusively for the purposes of the trade.

Reading the Case as a whole, and bearing in mind the criticisms made by Mr Bretten, I have reached the conclusion that there was evidence to support the findings of the Commissioners and that the conclusion which they reached could have been reached on that evidence by any reasonable body of Commissioners.’