Penalties not an allowable deduction
So let’s say you run a motorsport business. In addition to complying with all the normal rules and regulations governing businesses – health and safety, fire, employment law, tax, pensions, trading standards – the list is endless. On top of all those rules, your business will also have to comply with all the rules in the Blue Book and maybe the Yellow Book too!
A question we often get asked by our motorsport clients is “if we break the MSA or FIA rules and get a financial penalty, it is tax deductible?”
The key to remember is that S54 Corporation Tax Act 2009. No deduction for any expense not incurred wholly and exclusively for the purpose of the trade. These terms are not defined in law so we have to look at case law to give us some guidance.
The 2012 “Ferrarigate” case involving McLaren gives us some very useful pointers as to how HMRC interpret the tax rules in this area. Let’s have a look at the case in detail.
TC02278: McClaren Racing October 2012 First tier Tribunal
The FIA, the governing body for Formula 1 motor racing, imposed a penalty of £32m on McClaren Racing, which had broken the rules of the FIA's international sporting code by obtaining information belonging to a rival company.
The penalty arose because McLaren employees obtained confidential information about the design and performance of the Ferrari car. It was held that a degree of sporting advantage had been obtained and so McLaren had breached the rules to which it was contractually bound. McLaren argued that there was a difference between a penalty levied to protect the public and the nature of a contractual payment i.e. the fine was incurred in the course of its trade via the actions of its employees, even though these were unauthorised.
HMRC argued that the penalty arose from McLaren’s interference with Ferrari’s intellectual property, which was not part of their trade. Neither was the illicit gathering of information. The penalty was a punishment for a serious breach of the rules and did not arise from the trade. The policy behind the sanction was the wider protection of motorsport and had sufficient links with public concern.
Held at First tier Tribunal
The Tribunal allowed the appeal, stating that that the penalty was: '…one which (the company) was contractually obliged to pay under contractual obligations undertaken for the purposes of its trade; it did not result from the action of an external regulator, but from a body to whose dictates it had agreed to submit as part of its trade and in order to gain income; it arose from the action of employees in pursuing a course of conduct normally for the benefit of its trade, not from actions unconnected with its trade'.
Upper Tribunal
R&C Commrs v McLaren Racing Limited June 2014 UpperTribunal
The Tribunal’s decision was not unanimous and HMRC appealed. The Tribunal stated:
‘Before considering whether the penalty was not allowable as a deduction by McLaren under the rules in s74(1)(a) or (e) TA 1988, it is necessary to determine what McLaren’s trade was or, more specifically, whether it included cheating.
In our view, a deliberate activity which is contrary to contractual obligations and the rules and regulations governing the conduct of the trade, which is not an unavoidable consequence of carrying on a trade and which could lead to the destruction of the trade is not an activity carried on in the course of that trade. We consider that, on the facts as found by the First tier Tribunal, Judge Hellier should have concluded that the activities which gave rise to the penalty were not part of McLaren’s trade.
The fact that the cheating activities carried out by McLaren were not carried out in the course of its trade does not dispose of the issue in this appeal. Although we have dealt with the question whether cheating activities can form part of the trade in deference to Judge Hellier, we must record that Mr Alun James, who appeared for McLaren, submitted that it had never been argued that cheating was within the scope of McLaren’s trade.
Rather, his submission was that McLaren’s trade was the design, manufacture and racing of motor cars. It employed designers and engineers as part of that. Part of the designers’ job was to obtain information about rivals’ cars but they had to do so within the rules. It was an occupational hazard that employees might sometimes overstep the mark and act outside the scope of their employment just as, we remark, newspapers might libel individuals as in The Herald and Weekly Times Ltd. McLaren was vicariously liable for the actions of its employees but that liability arose in the course of McLaren’s trade because it related to the actions of its employees.
We do not agree with that line of argument. In our view, the liability of an employer for the acts of its employee and what activities fall within the scope of the employer’s trade are two different and largely unrelated issues. It cannot be said that simply because an employer incurs liability as the result of the acts of an employee, the liability is incurred in the course of the employer’s trade. We consider that, on the facts of this case, wrongfully obtaining and using confidential information belonging to a rival team, which McLaren accepts and the Tribunal held, was not a normal or ordinary activity in the course of its trade, does not become such an activity simply because it is carried out by an employee.
In this case, it is clear that Mr Coughlan’s conduct was not within the proper scope of his employment even if the conduct occurred while he was employed: nor was it within the scope of the activities of the trade to do what Mr Coughlan did.’
The Tribunal concluded that the penalty had not been paid wholly and exclusively for the purposes of the trade.
In my view, the Tribunal’s logic was fundamentally flawed and demonstrated a lack f understanding of motorsport. McLaren’s trade was that of F1. Plainly had it not been in that trade, the penalty would never have arisen, so how the penalty cannot be for the purpose of the trade is a mystery to me!