In the case of Revenue and Customs Commissioners v Howden Joinery Group plc,  UK FTT257 the First-tier Tribunal (“FTT”) considered the deductibility as management expenses of three elements relating to a rental guarantee entered into by a group holding company.
- Howden Joinery Group Plc (“HJ”) was a parent company with a subsidiary, “Properties”, both of which were UK incorporated and resident companies.
- Until September 2006, HJ was a parent company of the MFI group of companies, including Properties, which held leases in a large number of retail furniture stores in the UK.
- HJ had provided a parent guarantee in respect of some of Properties’ leases. These guarantees were only provided when necessary to close the commercial deal. It was noted that the giving of guarantees was regularly undertaken as part of HJ’s activities as a group holding company.
- The exact form of the guarantee varied across the leases. Broadly however, the guarantees required the guarantor (HJ) to pay rent and other costs if the tenant failed to do so. In most cases, the guarantor was also obliged to take on a new lease for the remainder of the term of the tenant’s lease if the tenant went into liquidation and on request of the landlord.
- In September 2006 the MFI group, including Properties, was sold by HJ to a third party and Properties was subsequently put into administration in October 2008. The guarantees given by HJ to Properties remained in force after the sale of Properties, although the third party did give an indemnity to HJ in respect of its guarantee obligations.
- As a result of the administration of Properties and the third party, HJ was called upon to make payments under a number of parent guarantees, which it had given over Properties’ rental obligations. Under no circumstance of the rental guarantees, did HJ actually step into the shoes of Properties as a tenant – either a new lease was entered into or a release agreement was reached.
HJ had claimed deductible management expenses in respect of three separate pools of costs:
- Rental Guarantee Payments – amounts required under the lease relating to guaranteed rent as paid by HJ;
- Lump sum payments made under release agreements to release HJ from its guarantee obligations; and
- A provision made in accordance with UK GAAP (FRS12) in respect of HJ’s guarantee obligations.
The FTT considered several arguments in respect of the deductibility of these costs, in particular:
– Whether the expenses related to HJ’s investment business;
– The purpose applied at the time of entering the lease and at the time of payment;
– Whether these costs could be re-characterised as a finance cost; and
– Whether these costs should be excluded as capital.
Looking at each of the elements in more detail:
Rental guarantee payments
The FTT concluded that the purpose from HJ’s perspective of giving a parent guarantee at the time they were originally provided was to sustain the value of its underlying investment, i.e. Properties, and the return received from that investment. They did not consider that the payments related to the acquisition of an asset for HJ’s business nor should they be treated as a financing cost of any acquisition by HJ. The FTT also noted that this duality of purpose of the guarantee (i.e. benefit to both HJ and Properties) did not in itself preclude it from being deductible as a management expense.
However, the FTT commented that “it was not part of HJ’s investment business to undertake any aspects of property management” and the expenditure was essentially on the assets of Properties’ business, rather than on the investment business of HJ itself. Throughout the period, the leases remained an asset of Properties and were never owned by HJ. Furthermore, at the time of the rental guarantee and lump sum payments, Properties was no longer part of HJ’s investment portfolio. Accordingly, the FTT concluded that the payments were not deductible as management expenses.
The FTT concluded that these payments were not made within the terms of the existing guarantees but represented new agreements negotiated by HJ after 2008 and should therefore be seen as expenditure relating to the disposal of an asset. The releases removed any further obligation for HJ to take on a new lease in its own name or make any further payments under the guarantee. At the time of these negotiations, Properties was no longer part of the HJ group and therefore these payments were made to protect HJ’s own business rather than improve any shareholding it had.
The FTT also concluded, drawing from Tucker v Granada and Vodafone cases, that these release payments were not capital in nature as the payment did not create any enduring asset for HJ and that the guarantee payments were made to extinguish a contractual obligation to make recurring revenue payments. Accordingly, a deduction as a management expense was allowed for these costs.
This provision was calculated based the estimated future rental obligations under the guarantee arrangements and their associated costs. To the extent that release payments were made in respect of a lease, an amount in respect of that lease would be reversed out of the provision and no tax deduction taken for that amount. In considering the deductibility of the provision, the FTT applied the same logic that they had applied to the rental guarantee payments above and determined that these costs were not part of the management of HJ’s investment business and accordingly, the provision was non-deductible.
Given the principles involved, it seems highly likely that the case will be appealed. However, the case does highlight the importance of careful consideration in determining exactly what function a group holding company is undertaking and of ensuring that only the costs relating to its business sit within the company. The case also provides a cautionary tale when providing parent guarantees, that due care must be taken in determining the expected form of payment should the guarantee be called upon and whether such payments will qualify for a tax deduction.