The Upper Tribunal has dismissed an appeal against a decision that payments made to consumers, charities and consumer groups by various Scottish Power companies in lieu of penalties following regulatory investigations were punitive in nature and therefore disallowable. The UT also dismissed an argument that the principle of disallowing such penalties as established by McKnight (HM Inspector of Taxes) v Sheppard  1 WLR 1333,  STC 669 (“McKnight“) was now inconsistent with the later enactment of CTA 2009, s. 46. The UT upheld a cross appeal by HMRC that the FTT had been wrong to allow a component of the payments as being allowable as it represented a compensation payment, the punitive nature of the payments as whole meant that it was wrong to allow any part of them (Scottish Power (SCPL) Ltd and Anor v HMRC  UKUT 218 (TCC)).
The appellant had argued that disallowing the payments would be inconsistent with CTA 2009, s. 46, which required that “The profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for corporation tax purposes”. HMRC had argued that McKnight illustrated an example of such authorisation and was thus not inconsistent with s. 46. The UT agreed stating:
“We do not think that the House of Lords was seeking to make any adjustment to the principle that profits for corporation tax purposes are calculated under generally accepted accounting practices. The issue in McKnight was whether the payment was “for the purposes of the trade” under s130(a), properly construed. … Lord Hoffmann explained that where a payment was in the nature of a penalty it does not fall within s.130(a).”
The appellants argued that the disputed payments were not penalties “The only penalties imposed were the £1 penalties. The other payments were voluntary and negotiated; they were not imposed or compelled and they ought properly to have been characterised as compensation, rooted in the trade, and therefore deductible” but the UT disagreed, agreeing with the FTT that “had the taxpayers not agreed to make the payments it is likely that penalties of at least the same amount would have been imposed” and concluding that:
“The reasoning in McKnight … applies to all payments with a punitive nature or character. In our view Lord Hoffmann’s the [sic] reference to the “character” of the payment shows the principle is to be applied by reference to substance rather than form.”
The UT then considered whether the FTT had been correct to allow a deduction for a component of the overall payment that they had accepted as representing a compensation payment rather than a penalty. The UT did not agree the treatment arguing that:
“The facts indicate the £554k payment was clearly part of a package of payments. It was negotiated as part of an overall deal…. The full package had, in line with the FTT’s findings in relation to the other payments, been put together under the threat of penalty and was (just as much as the other parts of the package) paid in lieu of a penalty – in the sense that it was arrived at under the regulatory auspices and would have been imposed if the deal was not done.”
HMRC’s appeal was therefore upheld and the full amount was disallowed.
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