The recent tribunal case of Mr Vaines v HMRC (TC02965) dealt with whether a deduction from trading profits was allowed under the ‘wholly and exclusively’ principles, for an out of court settlement of a bank claim relating to a previous trade.
If the claim was not settled the taxpayer could be made bankrupt thus preventing him from continuing in his current trade.
The taxpayer, Mr Vaines, was a member of Harrmann Hemmelrath LLP, a German law firm with offices in London, until 31 December 2005.
The taxpayer subsequently became a partner in Squire Sanders & Dempsey.
On 27 October 2009 the taxpayer made an amendment to his tax return for 2007/08, claiming a deduction of £215,455 against his professional income from Squire Sanders & Dempsey.
The deduction claimed was for a payment made to a German bank, under an agreement made by a number of individuals who were connected with his previous law firm, Haarmann Hemmelrath. The firm had ceased to trade and owed approx. €17m to a number of German Banks.
The taxpayer believed that the risk of challenging the banks through the German courts was unacceptably high; as if he lost he would be made bankrupt.
If made bankrupt he would lose his current position as partner at Squire Sanders & Dempsey.
Following negotiations with the bank, he agreed to pay them €300,000 (£215,455) in full and final settlement of all claims. This was paid in January 2008 (tax year 2007/08).
An amendment was made to his 2007/08 tax return and a deduction from his professional income from Squire Sanders & Dempsey claimed.
HMRC denied a deduction primarily on the basis that the payment was not wholly and exclusively for the purposes of his trade.
HMRC argued that the deduction should not be allowed for three reasons:
- Mr Vaines did not carry on a profession or a trade as an individual,
- If he did carry on a trade individually the payment was not wholly and exclusively for the purposes of the trade as it also enabled him to avoid bankruptcy and preserve his reputation, and
- If it was wholly and exclusively, it was capital and not revenue expenditure and therefore no deduction was allowed
1. Trading as an Individual
HMRC had tried to rely on a case that predated self-assessment. However this case was found to be superseded by ITTOIA s.862, which states that members of an LLP are treated as carrying out the trade and not the partnership itself.
The tribunal therefore dismissed HMRC’s argument that Mr Vaines did not carry on a trade in his own right.
2. Wholly & Exclusively
The tribunal held that as a matter of fact the purpose of Mr Vaines making the payment was to preserve and protect his professional career or trade.
With this in mind the case of Morgan (Inspector of Taxes) v Tate & Lyle Ltd (1955) states that ‘money spent for the purposes of preserving the trade from destruction can properly be treated as wholly and exclusively expended for the purposes of the trade’.
As a result they found that the payment to the Bank was wholly and exclusively for the purposes of his trade.
3. Revenue or Capital?
The final consideration was whether the payment was revenue or capital. HMRC contended it was capital and therefore no deduction was allowed.
Mr Vaines argued that no asset or enduring advantage was brought into existence by the payment made to the Bank and as a result it was a revenue expense.
He relied on Lawrence J in Southern (HM Inspector of Taxes) v Borax Consolidated Ltd (1940) where he stated;
‘..if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue’ and ‘it appears to me that the legal expenses which were incurred…did not create any new asset at all but were expenses which were incurred in the ordinary course of maintaining the assets of the Company, and the fact that it was maintaining the title…does not, in my opinion make it any different’
The tribunal found that as the payment was to preserve and protect his professional career or trade it must follow that it is a revenue and not capital payment in line with the case above.
As a result the appeal was allowed and the payment found to be wholly and exclusively for the purposes of his trade.