Professional fines may be tax deductable, tribunal finds

Out-Law News | 11 Oct 2012 | 3:57 pm | 3 min. read

The McLaren racing team is entitled to claim a corporation tax reduction in respect of a £32 million fine levied by the motor racing governing body because the fine was not a criminal penalty imposed by statute, a tribunal has held.

In his first-tier tribunal ruling, Judge Charles Hellier said that the penalty was sufficiently "connected with the trade" of the business. The fine, which had been imposed after McLaren obtained "unauthorised" information about the construction of a competitor's cars, related to "activities so closely associated with mainstream of McLaren's trade" that the judge "[could not] say that they were not a part of it".

The tribunal's second judge, Mr Nicolas Dee, disagreed with Judge Hellier's assessment. However, a tribunal's 'presiding member' is granted the casting vote in situations where the verdict of a two-person tribunal is not unanimous.

Among other roles, the Federation Internationale de l'Automobile (FIA) acts as the governing body for many auto racing events. In 2007, McLaren was ordered to pay approximately £32m because it had "possessed and in some way used" proprietary information belonging to one of its competitors, Ferrari, in breach of the FIA's International Sporting Code (ISC). As a participant in Formula One racing, McLaren is contractually bound by the rules of the ISC.

In addition to the fine, McLaren suffered a reduction in its gross income of approximately £34m. Although acknowledging that this reduction affected the McLaren's taxable profits to that extent, HM Revenue and Customs (HMRC) said that the fine itself could not be offset against the company's liability for corporation tax.

Ian Hyde, a tax expert at Pinsent Masons, the law firm behind Out-Law said: "this case is interesting because the natural assumption might be that a fine arising from misconduct would not be tax deductible. It shows that where you are looking at a civil rather than a criminal penalty there may be circumstances where a tax deduction is available".

The Income and Corporation Taxes Act 1988 (TA), which governs the law concerning taxation, sets out some of the categories of expenditure a company is entitled to deduct from its trading profits when calculating its liability for corporation tax. The TA states that money cannot be deducted if it is not "wholly laid out or expended for the purposes of the trade or profession" or "connected with or arising out of the trade or profession". In addition, case law distinguishes between commercial losses and penalties imposed for breaches of the law that occur while the company is trading.

In the "non-statutory context", for example in the case of penalties imposed as a result of a company's membership of an association or professional body, penalties should normally be regarded as "an expense of the trade" unless there was an overwhelming public policy season why this should not be the case, the judge said.

"In my view it is only if the nature of the penalty is to punish a person and if there is a serious public policy which would be diluted by deductibility that the penalty should not be regarded as an expense of the trade," he said. "For this reason I would hold that, for example, a non compensatory penalty for late completion imposed in a building contract made under the laws of a jurisdiction which made such a penalty enforceable could be a deductable expense."

The words of the TA did not contain references to the 'normal' or 'ordinary' trade, or to the 'proper conduct' of that trade, he said. Instead, these were "aids or glosses on the statutory words deriving from the attempts to explain why expenses might not be deductible".

"In the case of a person whose trade or profession is based on trust and probity, a breach of those principles is a departure from the business he is engaged in because it strikes at the nature of that business: these words help in that context," he said. "But their usefulness depends on the nature of the business."

He said that in the McLaren case, the "profit making activity" carried on by the company was "not limited" to acting within the confines of its commercial agreements and could extend to activities seen as "cheating".

"Whilst I can understand that fraud or deceit might be found not to be part of a trade which depended on probity or trust, I can see no compelling reason for finding that McLaren's trade was so limited," he said. "I conclude that there is no reason of policy or law to limit the description of McLaren's trade."