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HMRC internal manual

Company Taxation Manual

Distributions: demergers: legal costs

The legal costs of advising on and arranging company demergers and similar reconstructions can be high and an area of risk. Claims to deduct such costs in computing trading income or to include them in management expenses should be examined critically. While the position in each case will depend on its particular facts, often the costs are disallowable, bearing in mind the following points.

A share capital reorganisation, like any new company formation, has a clear capital flavour. See Texas Land and Mortgage Co v Holtham (1894) 3TC255 and Kealy v O’Mara (Limerick) Ltd (1942) 21TC265, an Irish case.

The costs of acquiring, modifying or disposing of a capital asset are capital expenditure. The incidental costs, such as legal costs, take the same character. The case of CIR v Carron Co (1968) 45TC18, which involved the costs incurred by the company in obtaining a variation in its charter, is distinguishable because the charter was not regarded as a capital asset. This is unlike shares in a company which are clearly part of its capital (see Tucker v Granada Motorway Services Ltd (1979) 53TC92 at 108).

Expenditure on matters concerning ownership of a trade or part of a trade, rather than the carrying on of the trade itself, are unlikely to give rise to expenditure incurred wholly and exclusively for the purposes of the trade, see Morgan v Tate and Lyle Ltd (1954) 35TC367 at 421. The company’s purpose in incurring the expenditure is what matters - see Vodafone Cellular & Others v Shaw (1997) 69TC376 and BIM38220.

The High Court in Robinson v Scott Bader Co. Ltd (1981) 54TC757 (see BIM38250) held that where a parent company incurred expenditure, of whatever nature, in connection with a subsidiary company, there are three possible situations. These are that the parent incurs the expenditure:

* solely in the interests of the subsidiary,
* partly in the interests of the subsidiary and partly in its own interests, or
* solely in its own interests (see Odhams Press Ltd. v Cook (1940) 23TC233, at 257 - 258, per Lord Maugham; and Marshall Richards Machine Co. Ltd. v Jewitt (1956) 36TC511 at 525, per Upjohn J (see BIM37790).
In the first and second situations the relevant expenditure is not deductible; but in the third deduction is permissible (applying Bentleys, Stokes & Lowless v Beeson (1952) 33TC491 - see [BIM37400]( notwithstanding the fact that the subsidiary receives a benefit.