The Court of Appeal (CoA) was required to clarify the tax deductibility of consumer redress payments and whether they amounted to a penalty, wherein a deduction is prohibited or is something else that would not fall under that prohibition.
Background:
Between October 2013 and April 2016, ScottishPower entered into various agreements with the Gas and Electricity Markets Authority (GEMA) for mis-selling, complaints handling and transparency in terms of costs. This led to the payment of penalties in nominal amounts of £1 and payments to consumers and consumer organisations totalling around £28 million. ScottishPower sought to deduct these payments from its taxable profits. HMRC denied the deductions, as the payments amounted to a penalty and were, therefore, not deductible according to Section 54(1)(a) of the Corporation Tax Act (CTA) 2009.
The First-tier Tribunal (FTT) found in favour of ScottishPower. HMRC was however successful at the Upper Tribunal (UT) and ScottishPower therefore appealed to the CoA.
Decision:
The CoA allowed the appeal. The Court ruled that payments to consumers and consumer organisations in settlement of regulatory breaches were deductible for UK corporation tax purposes. Those payments were not penalties and there were no rules of law preventing them from being deductible. Lady Justice Falk rejected the argument that the principle established in Commissioners of Inland Revenue v Alexander von Glehn & Co. Ltd [1920] should be extended to any amount which is not in the form of fines or penalties.
Lady Justice Falk first examined the regulatory framework under which ScottishPower operated, specifically the Gas Act 1986 and Electricity Act 1989, which require licences for the generation and supply of gas and electricity. In this case, the payments were directed towards consumers instead of the Consolidated Fund usually used. The purpose of the payments was to settle regulatory investigations and avoid adverse publicity and did not fall within the penalty as established in von Glehn & Co. The only penalties actually imposed in this case were nominal £1 amounts. The Court also looked at the fact that the redress was imposed because ScottishPower had already tried to cure its failures. Those improvements were regarded as expenditures and deductibles.
Lady Justice Falk noted that what HMRC was seeking and the prohibition they wanted was a matter for Parliament and not the courts. Any extension of the rule would exceed the judiciary’s remit even if the payment replaced penalties. The purpose of Section 54(1)(a) the focus is on the purpose of the paying party, that is ScottishPower – based on Mallalieu v Drummond. The test does not turn on the objective or intention of anyone else.
The Court agreed with the FTT’s conclusion that the payments were made in the course of the trade and were deducted in accordance with ordinary principles of commercial accounting and that the payments were made wholly for the purpose of trade.
Implications:
The CoA handed a landmark judgement on tax deductions. It makes it clear that there is an important distinction between penalties and other forms of redress. This decision provides guidance regarding what is not a penalty and what can be deductible.
However, reform can be expected, as the Judge acknowledged that extending the prohibition would go beyond the remit of the Court.