Law Report: Cost of defending disciplinary hearing was deductible

LAW REPORT v 13 May 1997

McKnight (HM Inspector of Taxes) v Sheppard; Court of Appeal (Lord Justice Nourse, Lord Justice Potter and Lord Justice Mummery) 7 May 1997

Where a special commissioner found as a fact that a taxpayer's conscious motive in incurring legal expenses to defend disciplinary proceedings brought by the Stock Exchange was solely to avoid the destruction of his business, those expenses were deductible in computing the profits of the trade.

The Court of Appeal allowed the taxpayer's appeal against the decision of Mr Justice Lightman reversing the special commissioner's decision.

The commissioner had found that legal expenses incurred by the taxpayer in respect of disciplinary proceedings against him for alleged breaches of the rules and regulations of the Stock Exchange were wholly and exclusively expended for the purposes of his trade as a stockbroker within section 130(a) of the Income and Corporation Taxes Act 1970, and were therefore deductible in computing the amount of the profits of the trade.

David Goldberg QC (who did not appear below) and Hugh McKay (Dunderdale Wignall, Manchester) for the taxpayer; Timothy Brennan (Inland Revenue Solicitor) for the Crown.

Lord Justice Nourse said that it seemed clear from the commissioner's decision that both sides had proceeded on the footing that he was engaged in determining whether, in incurring the expenditure, the taxpayer had a dual or a single purpose.

Although the commissioner had not accepted that the taxpayer was wholly unconcerned with his personal reputation, he had expressly accepted his evidence that his conscious motive in incurring the expenditure was solely to avoid the destruction of his business. Even before an appellate tribunal which was conducting a rehearing, that finding would have been unimpeachable.

On the Crown's appeal by way of case stated, the question for the High Court had been whether, on the facts found, no person acting judicially and properly instructed as to the relevant law could have determined that the avoidance of the destruction of the taxpayer's business was indeed the sole purpose for which the expenditure had been incurred.

The basis of the judge's decision was that, in order to be deductible, the expenditure must not only be wholly and exclusively incurred for the purposes of the trade, but also sufficiently connected with the carrying on and earning of profits in the trade.

He held that that connection did not exist where the expenditure was incurred in a course of conduct outside the ordinary course of the trade; that legal expenses incurred in defending a trader against successful disciplinary proceedings involving serious and deliberate breaches of the relevant rules and standards were incurred outside the ordinary course of the trade; that in the present case the taxpayer had been found guilty of serious and deliberate departures from the rules of the Stock Exchange and the ordinary, proper and lawful conduct of his trade; and that the expenses incurred in respect of the disciplinary proceedings were therefore not deductible.

The authorities all adopted the single test which the words of section 130(a) required to be adopted. The second requirement suggested by the judge was only an aid in deciding whether or not the first had been satisfied.

The decisive objection to the basis of the judge's decision was that the commissioner had not been asked to determine, and had not determined, whether the legal expenses had been incurred outside the ordinary course of the trade.

The taxpayer's appeal would be allowed, and the commissioner's determination restored.

Kate O'Hanlon, Barrister