Taxpayer loses ‘wholly and exclusively’ case

Following quickly after the taxpayer’s victory in Linslade Post Office & General Store, a second decision concerning the deductibility of legal expenses in defending a claim against the shareholders has been won by HMRC.

The latest decision – in Purolite International Limited (TC02152), published on 10 August – suggests that the meaning of ‘wholly and exclusively’ is probably more restrictive than was suggested in Linslade.

In the Purolite case, two brothers controlled a US company (US Co).  Each brother and the US Co owned one third of the shares in a UK company, which in turn owned 95% of the shares in another UK company, Purolite. In 2000 the US Government started legal proceedings against the brothers and US Co for supplying goods to Cuba under the Trading With the Enemy Act 1917.  Purolite made a contribution to the legal costs which the US Co had incurred.

HMRC disallowed the expenditure from the corporation tax computation on the basis that the expenditure was not wholly and exclusively for the purposes of Purolite’s trade.  The brothers appealed to the First-tier Tribunal, stating that the reason that Purolite bore the legal costs of the litigation was because if they had lost the case, Purolite’s exports to the US could have been blacklisted and that would affect its trade.

The First-tier Tribunal rejected the brothers’ appeal.  It was held that Purolite paid the legal expenses because the brothers wanted to protect themselves from the charges brought against them by the US Government, not because of the possible blacklisting of Purolite’s exports to the US.  As such, Purolite’s contribution to the legal expenses were not made wholly and exclusively for the purposes of its trade.

This decision comes only days after the First-tier Tribunal’s decision in the Linslade Post Office case where legal fees were held to be tax deductible.  In that case it was found that the true nature of the proceeding in which two brothers – who were defending a claim by their sister for a share of their partnership – incurred legal fees was the “…defence of an unjustified claim in order to preserve their assets of the business.”  In the case of Purolite, by contrast, the ‘real’ reason for incurring the expenditure was held to be the protection of the individuals from criminal charges.

Reconciling the two decisions is not easy – and certainly beyond the scope of this short summary – but what they demonstrate is how centrally important the facts of each case will be – particularly in ascertaining the true purpose of the litigation.

If you would like further information in relation to which business expenses are tax deductible please contact the TaxDesk on 0845 4900 509 and ask for Priya Dutta.