Reputation – are legal expenses incurred in defending it tax deductible?

In a First-tier Tribunal decision announced this week a company successfully argued that legal expenses were deductible in defending the reputation of a company where there was a benefit to the main shareholder and director.  In the case of Key IP Ltd, [2011] UKFTT 715 (TC), it was accepted that the director had not started the proceedings merely to vindicate his own hurt feelings and it was found that the sole purpose of bringing the defamation proceedings was to protect the business reputation of the company.  For advisers who are asked about the deductibility of legal expenses this is a significant case. 

The general rule regarding deductibility is that the expense must be incurred “wholly and exclusively” for the purposes of the trade. There is an abundance of case law but what is clear is that there is a distinction between the purpose and the motive.  In dealing with wholly and exclusively cases what matters is the purpose of the expenditure not the payer’s motive.

The cases below are useful for advisers who need to argue a case on similar expenses. 

For further help on the deductibility of legal expenses contact the TaxDesk on 0845 4900 509 and ask for Paula Tallon.

 

 

Case

Key point

TC01506: P Duckmanton (2011)

 

 

A claim for legal expenses was refused as the main purpose of the expenditure was to defend a manslaughter charge against the proprietor as a result of a road traffic accident in which one of his employees was involved. The expenses were incurred only secondarily in preserving the business.

McKnight (Inspector of Taxes) v Sheppard [1999] STC 669

The object of a taxpayer in making expenditure had to be distinguished from the effect of the expenditure. Expenditure might be made exclusively to serve the purposes of the business, but it might have a private advantage. The existence of that private advantage did not necessarily preclude the exclusivity of the business purpose.

 

Morgan v Tate & Lyle Ltd [1955] AC 21

 

Expenditure to preserve and protect the business is properly treated as expenditure incurred for  the purposes of the trade.

 

Strong & Co. of Romsey, Ltd. v Woodifield [1906] AC 448

 

Expenditure for the purposes of the trade is expenditure for the purpose of enabling a person to carry on and earn profits in the trade.  This must be meant for the purpose of enabling the trader to claim a deduction.  This includes expenditure for the purpose of preventing a person from being disabled from carrying on and earning profits in the trade.

Mallalieu v Drummond (Inspector of Taxes) [1983] STC 665

The object of the taxpayer in making the expenditure must be distinguished from the effect of the expenditure. Expenditure may be made exclusively to serve the purposes of the business, but it may have a private advantage. The existence of that private advantage does not necessarily preclude the exclusivity of the business purpose.

Spofforth and Prince v Golder (H M Inspector of Taxes) 26 TC 310

A deduction was allowed for certain legal costs which they had paid in connection with the defence of one of the partners in Police Court proceedings on a charge of conspiracy to defraud the Revenue.  A deduction was allowed for the costs up to the time the partners started to be advised separately.

Rushden Heel Ltd v Keene [1948] 30 TC 298

The guiding principle if the payment is made for the purposes of earning the company profits, it is deductible.

Allen (HM Inspector of Taxes v Farquharson Bros & Co [1932] 17 TC 59

 

It is not enough that the expenditure should arise out of, or be connected with the trade, was it expenditure made for the purpose of earning the profits of the trade. Without incurring the expenditure would profits have decreased?

IRC v Alexander von Glehn & Co Ltd [1920] 2 KB 553,12 TC 232,CA

The expenditure arises out of the trade because if it had not been that they were carrying on the trade they would not have had to incur the expenditure.

Farrie v Hall (Inspector of Taxes) [1947] 2 All ER 141 28 TC 200

The question that arises in this case was whether the expenditure was undertaken to increase profits.