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Lending a helping hand
by Jarlath McCloskey
Published in Tolley's Practical Tax Newsletter
Corporation Tax
Jarlath McCloskey considers whether payments benefiting related companies can be deductible
Now that the climate for business has become distinctly turbulent more companies will find themselves in financial difficulties. This may lead to situations where one company finds it necessary to prop up another company in the same group or an associated company by making payments to that company, or to others on its behalf. In what circumstances, if any, would such payments qualify for tax relief?
For corporation tax purposes ICTA 1988 s 74(1)(a) disallows any expenditure which is not 'money wholly and exclusively laid out or expended for the purposes of the trade'. Furthermore, s 74(1)(e) disallows 'any loss not connected with or arising out of the trade' and s 74(1)(f) disallows ' ... any sum employed or intended to be employed as capital in the trade'.
Dual purpose
The inference is that to qualify for a tax deduction the expenditure must have been incurred by the company in relation to its own trade and not in relation to the trade of any other company, including, for example, another company in the same group. Such expenditure would, prima facie, breach the 'wholly and exclusively' test by having a dual purpose. This analysis has been confirmed in two cases; Odhams Press Limited v Cook (1940) 23 TC 233 and Marshall Richards Machine Co Limited v Jewitt (1956) 36 TC 511.
Odhams carried out work for a wholly owned subsidiary company. This work was charged at the full trade price. When it discovered that the subsidiary had made a loss in the year Odhams wrote off an amount of the debt due to it equal to the loss. Odhams argued that the deduction was allowable because it was either a reduction in its charge for the work done, or it was a bad or doubtful debt. The Special Commissioners found that the sum was not written off wholly and exclusively for the purposes of Odhams' trade and was therefore not allowable. This decision was confirmed by the House of Lords who considered that the reason for the write off of the loan was to enable the subsidiary to continue in business. While Odhams would benefit indirectly from the write off, because it was interested in the subsidiary both as a shareholder and as a trading customer, there was a dual purpose in incurring the cost and so it could not be allowed.
The test of allowability in these circumstances was neatly summarised in the words of Upjohn J in the Marshall Richards Machine Co Limited case :-
'It is normally a question of fact whether the disbursement in question is laid out wholly and exclusively for the purposes of the trade of the parent company; or, secondly, whether it is laid out wholly and exclusively for the purposes of the trade of the subsidiary company; or, thirdly, whether it is laid out partly for the one and partly for the other. In the first case the parent company succeeds in getting an allowance; in the other two cases it does not.'
Capital
Marshall Richards Machine Co Limited wished to sell its machines in the USA. For this purpose the company formed a wholly owned subsidiary in the USA and appointed it as its agent. The UK company entered into an agreement with the US subsidiary to pay it a minimum annual sum of $25,000 to meet its operating costs. The agreement provided that each such payment, together with any agreed increase, was to be treated as being on account of agency commission payable by the subsidiary. In three accounting periods the payments made exceeded the commission due. The UK company claimed that the excess was wholly and exclusively laid out for the purposes of its trade.
The Special Commissioners decided that the sums paid in excess of the agreed commission payments represented amounts paid by way of advance to enable the US subsidiary to meet its obligations and that they were not expended wholly and exclusively for the purposes of the UK company's trade. In the High Court Upjohn J agreed, concluding that the payment was 'for the purpose of enabling the American company to meet its obligations and continue in existence'.
He added: 'That is exactly what the payment was for, and it was not laid out in any sense at all to advance the trade of the parent company. Of course, that was the motive, but it was not the purpose of the payment.' Upjohn J went on to say that where payments are really advances they are capital in nature and therefore not deductible for tax purposes.
Intention
The wholly and exclusively principle was upheld, albeit modified slightly, in the later case of Robinson v Scott Bader Co Ltd [1981] STC 436. In this case it was confirmed that expenditure incurred by a company wholly and exclusively for the purposes of its trade is deductible notwithstanding that a benefit may accrue to a third party (including a fellow group member or associated company). Scott Bader Co Ltd manufactured and marketed chemical intermediates and synthetic resins for the making of fibre glass. The company provided its synthetics as raw materials for its subsidiaries, associated companies, licensees and other customers for their manufacturing trades.
It increased its shareholding in a French subsidiary company (SBS) to 100% and seconded one of its employees to manage the subsidiary and provide it with necessary technical and marketing expertise. The UK company paid the employee's salary and social costs while he was on secondment in France. It did not claim reimbursement from SBS for six months, following which the employee became managing director of SBS and was then paid by that company. The UK company claimed the sums paid to the employee as a deduction in computing the profits of its trade on the basis that its trade was international in concept and execution through (inter alia) SBS. This was accepted by the Special Commissioners.
In the High Court the Crown argued that the expense had not been incurred exclusively for the company's trade but to protect its investment in SBS for the benefit of the trade of SBS. The Crown also contended that the deduction should be disallowed by s 74(1)(e) and/or s 74(1)(f) because it was on capital account.
In the High Court Walton J stated that where a parent company affords financial or other assistance, of whatever nature, to a subsidiary company there are three possible categories:
(1) it is providing the assistance solely in the interests of the subsidiary;
(2) it is providing such assistance in the interests of the subsidiary and partly in its own interest; and
(3) it is providing such assistance solely in its own interest.
In situations (1) and (2) the expenditure would not be deductible, but in (3) the expenditure would be deductible, notwithstanding that a benefit accrues to the subsidiary.
In the Court of Appeal, Waller LJ took this argument a stage further when he said that where the intention to confer the benefit on the third party is present in the mind of the taxpayer when he incurs the expenditure, that intention will taint the payment with a duality of purpose, which will deny him the deduction.
If we are to take into consideration the intention of the party incurring the expenditure this inevitably introduces an element of subjectivity to the matter. HMRC seems to recognise this in the Business Income Manual at BIM 38250 where it states that 'it is very difficult, but perhaps not impossible, to determine this without some element of subjectivity'. Indeed, HMRC admits that 'in many cases the test will be wholly subjective'.
This must mean that there will be room for argument in many cases where one group company incurs expenditure in respect of, or in relation to, another. However, the outcome will normally turn very much on the specific facts of the individual case. The Crown, in the case of Lawson v Johnson Matthey plc [1992] STC 466, had initially argued that the company failed the wholly and exclusively test in relation to expenditure of £50m that it incurred in rescuing a failing subsidiary. The company had argued that had it not injected substantial funds into the subsidiary as part of a restructuring package the loss of confidence would have possibly led to its collapse also. The Crown subsequently abandoned its argument in favour of the contention that the payment was on capital account, but the House of Lords held that the expenditure was of a revenue nature. The taxpayer company had paid the £50m in the expectation that only if it paid that sum would the Bank of England come to the subsidiary's rescue and enable the taxpayer company to continue in business.
Another case which very much turned on its own facts was Sycamore plc and Maple Ltd v Fir [1997] STC (SCD). This was a Special Commissioner's decision and, briefly, the facts were as follows:
- Sycamore (S) had supplied goods to its subsidiary (E) over a number of years.
- E made regular payments for the goods but there was an increasing outstanding balance. S also made a loan to E.
- E's trading position deteriorated and it gave S a fixed and floating charge over all its assets.
- Shortly after this E ceased trading owing amounts to both S and other creditors.
- S paid some of E's creditors direct, inter alia, to preserve agreements with manufacturers and suppliers to which it and E were parties.
In its accounts Sycamore claimed to deduct the amount that it had paid to E's creditors. HMRC disallowed the claim arguing that it was not expenditure incurred wholly and exclusively for the purposes of Sycamore's trade.
The Special Commissioners said that it was a question of fact whether the expenditure was for the purpose of the trade of the parent, for the purpose of the trade of the subsidiary or partly for one and partly for the other. The test was subjective and the answer to the question depended upon the true construction of the arrangements between the parent and the subsidiary. The intention of the party making the payment was clearly important. In the view of the Commissioners, if the interests of the companies were considered together when the decision about expenditure was made then the expenditure could not be 'wholly and exclusively' for the purposes of the trade of one of the companies.
On the facts given the Commissioners concluded that when S had decided to pay E's creditors S had been considering only its own position. S had not been considering E's position except to the extent of limiting the damage which E might do to S's interests. There had been very little benefit accruing to E from S's payments to E's creditors, since E had ceased to trade. The money paid out by S to E's creditors was therefore paid out wholly and exclusively for the purposes of S's trade and so it was allowable.
Evidence
The underlying message of all of the cases mentioned (and others, for example, Vodaphone Cellular Ltd and others v Shaw [1997] STC 734) is that if a company is to succeed in getting a deduction for a payment which it has made and which could, prima facie, be related to, or be said to benefit, another associated company is that the company must maintain a convincing paper trail showing that:
- it considered only its own position when deciding to make the payment, and
- any benefit which might accrue to the other company is purely fortuitous and incidental.
Otherwise, HMRC is likely to disallow the amount claimed.
