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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Specific deductions: compensation & damages: purpose test

Establish why the payment was made

Payment to facilitate business winding up

The trade purpose test is unlikely to be met where a payment is made for the purposes of winding up or disposing of a business (CIR v Anglo Brewing Co Ltd [1925] 12 TC 803, see BIM38310).

Where, by contrast, a payment is wholly and exclusively to secure employee co-operation during the period of trading (as in O’Keefe v Southport Printers Ltd [1984] 58 TC 88, see BIM38320) it is an allowable deduction.

In view of the Privy Council decision in CIR v Cosmotron Manufacturing Co Ltd [1997] 70 TC 292 (see BIM38390), you should not contend that payments made to employees under a pre-existing contractual or statutory obligation are disallowed under the Anglo Brewing principle. The Privy Council declined to follow the Court of Appeal decision disallowing such a payment in Godden v A Wilson’s Stores (Holdings) Ltd [1962] 40 TC 161 (see BIM38390), and in consequence Wilson’s Stores should not be cited in support of disallowing such payments.

The Anglo Brewing principle continues to apply to ex-gratia payments and other payments in excess of an employee’s pre-existing contractual or statutory entitlement.

Compensation for loss of office connected with change of control

The trade purpose test is unlikely to be met where a payment in compensation for loss of office is connected with the purchase or sale of a business or a change of controlling interest by the transfer of shares.

There may be evidence of a purpose other than the trade purpose in documents or agreements governing the share transfer and the payment of compensation, or in correspondence etc during the negotiation of such contracts. There may also be relevant facts in minutes of meetings between the parties, minutes of meetings of the directors and shareholders, copies of resolutions passed at shareholders’ meetings or copies of letters from the company to the shareholders. For example, see Bassett Enterprises Ltd v Petty [1938] 21 TC 730 (see BIM38350), James Snook & Co Ltd v Blasdale [1952] 33 TC 244 (see BIM38340), George Peters & Co Ltd v Smith and Williams v J J Young & Son Ltd [1963] 41 TC 264 (see BIM38385), and George J Smith & Co Ltd v Furlong [1968] 45 TC 384 (see BIM38380).

Where facts are available about the agreed price of shares, whether that price was connected with any compensation payments to directors or controlling shareholders, and any services performed by the directors following take-over, may be relevant to the decision. Where, for example, retiring directors who are controlling shareholders vote compensation to themselves shortly before or in the process of relinquishing control, it is unlikely their purpose will be solely a purpose of the company’s trade. However, it will depend on the particular facts, and a payment which is entirely untrammelled by a bargain for transfer of shares may be deductible (see CIR v Patrick Thomson Ltd (in liquidation) [1956] 37 TC 145, see BIM38360).

Payment on termination of employment to connected person

The trade purpose test is unlikely to be met where a payment is made by a company owned and controlled by the recipient of compensation, or by persons connected to that company. However, if, on the facts, the payment was genuinely made to an unsatisfactory director to induce him to resign, and there is no identifiable non-trade purpose, it is likely to be deductible (see Mitchell v B W Noble Ltd [1927] 11 TC 372, see BIM38370).

Payment to compensate for illegal actions

The trade purpose test is unlikely to be met where the payment results from illegal actions such as:

  • fines - see BIM42515, Cattermole v Borax Chemicals Ltd [1949] 31 TC 202 (see BIM38525) and Fairrie v Hall [1947] 28 TC 200 (see BIM38530)
  • breaches of contract or legal action outside the trading activities - see Knight v Parry [1972] 48 TC 580 (see BIM38545) and Hammond Engineering Co Ltd v CIR [1975] 50 TC 313 (see BIM38550)

But a payment which is solely for trade purposes and not by way of penalty for an infraction of the law is deductible, see G Scammell & Nephew Ltd v Rowles [1939] 22 TC 479 (see BIM38535) and Golder v Great Boulder Proprietary Gold Mines Ltd [1952] 33 TC 75 (see BIM38540).