Tribunal confirms that payments of a punitive nature are not deductible

In Scottishpower (SCPL) Ltd and Others v HMRC [2023] UKUT 00218 (TCC), the Upper Tribunal (UT) held that certain payments to consumers by a utility company in lieu of penalties were not deductible for corporation tax purposes, due to their penal character.

Background

The taxpayers (together Scottishpower) were energy providers regulated by Ofgem, the energy regulator.  Between October 2013 and April 2016, Scottishpower entered into various agreements with Ofgem in settlement of certain investigations into mis-selling, complaints handling and costs transparency (the Settlement Agreements).  Under the Settlement Agreements, Scottishpower paid nominal penalties (£1), and made payments to consumers, consumer groups and charities totalling around £28m (the Settlement Payments). 

Legislation

Section 35, Corporation Tax Act 2009 (CTA 2009), provides that: “[t]he charge to corporation tax on income applies to the profits of the trade”.

Section 46(1), CTA 2009, provides that: “[t]he profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for corporation tax purposes.”

Section 54, CTA 2009, provides that:

"(1) In calculating the profits of a trade, no deduction is allowed for—

(a) expenses not incurred wholly and exclusively for the purposes of the trade, or

(b) losses not connected with or arising out of the trade.

(2) If an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part or identifiable proportion of the expense which is incurred wholly and exclusively for the purposes of the trade.”

Scottishpower sought to deduct the Settlement Payments from their profits for the purposes of calculating their liability to corporation tax.  HMRC denied the deductions.  Scottishpower appealed to the First-tier Tribunal (FTT). 

The FTT held that Scottishpower had not been 'compelled' to make the Settlement Payments, although they agreed to make them in the expectation that if they did not do so a penalty greater than £1 would be imposed.  On the basis that penalty payments were non-deductible while compensation payments were deductible, the FTT dismissed the appeal save in respect of one payment to consumers directly affected by mis-selling, which it considered was compensation paid wholly and exclusively for the purposes of Scottishpower's trade. 

Scottishpower appealed, and HMRC cross-appealed, to the UT.

UT's discussion

Scottishpower's appeal was dismissed and HMRC's cross-appeal was allowed.

In the view of the UT, the FTT's overall approach – in considering that payments made in lieu of a penalty were subject to the same public policy considerations as penalties themselves and accordingly were non-deductible (applying the House of Lords decision in McKnight v Sheppard [1999] UKHL 6 ) had been correct.  However, the FTT had examined each payment separately, and considered whether each was compensatory.  The UT considered that the proper approach was to ask whether, on a 'global assessment of the evidence', the relevant payment had a punitive character, taking into account all the circumstances. 

The UT considered that, contrary to Scottishpower's contention, the FTT had been entitled to conclude that the Settlement Agreements had been entered into under the threat of penalties far greater than £1 and that therefore the Settlement Payments should be characterised as having been made in lieu of penalties.  Indeed, in the case of one of the breaches (in respect of complaint-handling), a penalty of £23m had been considered by Ofgem, with the potential for this to be discounted to £18m and for redress payments of £18m to be made in lieu of a full £18m financial penalty.  The UT agreed with the FTT's characterisation and application of the case law as requiring such payments to be non-deductible. 

The UT employed substantially the same reasoning in relation to the £554k payment in respect of which the FTT had held that a deduction should be allowed.  It noted that this had been negotiated as part of an overall deal, as a result of which Scottishpower had to pay £8.5m.  The full package had been assembled under threat of penalties and was concluded in lieu of those penalties.  Looking at the £554k payment in light of all the evidence and in the context of the payments as whole, the UT considered that the FTT had erred in holding the £554k to be deductible and therefore allowed HMRC's appeal on the basis that this payment also had the character of a penalty.

Comment

This decision illustrates the importance that public policy considerations have, not only in terms of the strict requirements of the doctrine of precedent, but also in determining the attitude that the tax tribunals and courts will adopt in deciding tax appeals. Payments that are of a punitive nature will generally not be deductible for tax purposes as permitting a deduction would lessen the effect of the payments contrary to public policy.

The decision can be viewed here.