The Supreme Court upheld the Court of Appeal’s (CoA) decision clarifying that fees incurred after the decision to sell a subsidiary were ‘expenses of a capital nature’ and could not be deductible as expenses of management under Section 1219(3)(a) of the Corporation Tax Act 2009 (CTA2009).
Background:
Centrica Overseas Holdings Ltd (COHL) is an investment holding company within the Centrica Plc Group. COHL acquired the Dutch group Oxxio in 2005. The business was persistently loss-making and Centrica decided to sell Oxxio along with its subsidiaries in July 2009. The sale process, however, proved difficult and the transaction was not completed until March 2011. The buyer, the Eneco Group NV (Eneco), made its first offer in September 2010, which was rejected. It made a final offer in January 2011, which formed the basis of the subsequent negotiations and an eventual sale was agreed upon in March 2011.
Between the decision to sell the Oxxio and the final sale, COHL incurred expenses for professional services provided by Deutsche Bank, PricewaterhouseCoopers (PwC) and De Brauw Blackstone Westbroek in connection with the sale amounting to £2,529,697. COHL claimed relief for those expenditures in its tax return under Section 1219(1) of the CTA2009. COHL accepted that fees incurred after 22 February 2011 were not deductible, as those fees related to implementing the decision to sell Oxxio to Eneco and were therefore capital in nature. HMRC denied the claim, arguing that it was capital in nature.
COHL appealed to the First-tier Tribunal (FTT) which found that most of the expenditure was expenses of management, but dismissed the appeal on the basis that the expenditure was not incurred by COHL. COHL appealed to the Upper Tribunal (UT), which found that all of the expenditure comprised both expenses of the management of COHL and revenue expenditure and was, therefore, deductible. HMRC appealed to the CoA, which found that the expenditure constituted expenses of management, but allowed HMRC's appeal on the basis that they were capital in nature and therefore not deductible. COHL appealed to the Supreme Court.
Decision:
The Supreme Court unanimously rejected the appeal from Centrica. COLH argued that the CoA erred in using the trading concept of capital expenditure and that Section 1219(3)(a) CTA differs from Section 53(1) CTA. The Supreme Court disagreed with COLH and noted that the term capital test in the management expenses legislation should be interpreted in the same way as the test for trading companies. Moreover, the phrase ‘expenses of a capital nature’ in Section 1219(3)(a) and ‘items of a capital nature’ in Section 53(1) must mean the same thing as both were intended to carve out expenses which are capital in nature by reference to the concept of expenditure of a capital nature already well established within the tax code and associated case law.
The Supreme Court ruled that Section 1219(3)(a) must be interpreted based on well-established principles governing the distinction between capital and revenue expenditure. This distinction is thus a question of law and, while some previous cases offer guidance, they also recognise the inherent difficulty in categorising certain borderline expenditures. From the analysis of the case law, it is clear that day-to-day stall costs, ongoing management, or rent are revenue-based, while the buying or selling of an investment is generally capital in nature.
On the second ground, the Supreme Court rejected the argument and found that the expenses were capital in nature.
Implications:
This decision provides a reminder of the principles underpinning the deductibility of deal fees in the merger and acquisition context, while highlighting that the application of these principles in practice may not always be clear-cut. This judgement clarifies that the key element in determining the nature of the expenditure is identifying the purpose of the payment. It also explains the distinction regarding investments held by an investment trading company which will be considered revenue assets and investments of a holding company which will be treated as capital assets.
Professional fees incurred prior to a decision to sell might have been regarded as deductible expenses of management. However, this judgement makes it clear it does not and that the prohibition in Section 1219(3)(a) is prescriptive.