The special commissioners decided that costs and disbursements paid out by a firm of solicitors acting for a partner in connection with personal litigation were not payments wholly and exclusively laid out for professional purposes so that they were not deductible in computing its taxable income.

Facts

The taxpayer was a firm of solicitors. The senior partner (B) was the representative partner for tax purposes. A dispute arose concerning the tax treatment of payments in connection with litigation conducted by the taxpayer on behalf of B personally.

B was a Name at Lloyd's and suffered losses. He and Z, who was then the senior partner of XYZ, set up an action group with a view to commencing litigation. The taxpayer acted for the action group and issued the first writ. Z and some other members of the action group then formed the view that they would prefer a larger firm of solicitors to conduct the litigation. The taxpayer firm lost the future fee income which it would have earned for acting for the action group and B was unable to bring proceedings on his own because of the potential cost.

B and the taxpayer brought proceedings against Z and the new firm of solicitors based on allegations that Z had breached the terms of an oral agreement with B that the taxpayer would conduct the litigation brought on behalf of the action group. The taxpayer acted for itself and also for B personally and instructed leading counsel to act in the proceedings. Z was represented by XYZ. The taxpayer's claim was dismissed. Thereafter the action proceeded solely on the basis of a private and personal claim by B against Z. The taxpayer continued to act for B. XYZ continued to act for Z. B's claim was dismissed. Costs were awarded against B and the judge gave Z leave to apply for a wasted costs order against the taxpayer.

The liability for costs was settled by the taxpayer which paid £160,000 to XYZ. The other sums in issue were disbursements incurred in connection with proceedings initiated by B personally.

The taxpayer appealed against amendments to the partnership statements in respect of the tax years 1996–97 to 1998–99 made because the Revenue took the view that, in computing the amount of the profits of the taxpayer, those sums had been deducted when they had not been wholly and exclusively laid out for the purpose of the profession of the taxpayer within ICTA 1988, s. 74(1)(a). The Revenue accepted that the amendments were made outside the ordinary time-limits but were of the view that the loss of tax was attributable to the negligent conduct of B within TMA 1970, s. 30B.

Issues

Whether the sums which had been deducted in computing the profits of the taxpayer were money wholly and exclusively expended for the purpose of the taxpayer's profession within the meaning of ICTA 1988, s. 74(1)(a); and, if they were not, whether the loss of tax was attributable to the negligent conduct of B within the meaning of TMA 1970, s. 30B(5).

Decision

The special commissioners (Stephen Oliver QC and Dr Nuala Brice) (dismissing the appeal) said that the question whether an expense of the firm was incurred wholly and exclusively for the purposes of the profession was a question of fact. The expenditure had to be made ‘for the purpose of enabling the trade to earn the profits’ of the trade and the business or professional purpose had to be the sole purpose. The distinction between furthering the business interests of the firm on the one hand and the essentially private purposes of the partners on the other could be a fine one. In determining the purpose it was necessary to look at the taxpayer's subjective intentions and although those were determinative they were not limited to conscious motives in his mind at the time of payment; consequences which were inevitably and inextricably involved in the payment had to be taken to be a purpose for which the payment was made. Finally if the taxpayer's only conscious motive at the time of the expenditure was a business motive then the expenditure was deductible. (See Strong v Woodifield (1906) 5 TC 215; Smith's Potato Estates Ltd v Bolland (1947) 30 TC 267; Bentley, Stokes & Lowless v Beeson (1952) 33 TC 491; MacKinlay (HMIT) v Arthur Young McClelland Moores & Co [1989] BTC 587; Vodafone Cellular Ltd v Shaw (HMIT) [1997] BTC 247; and McKnight (HMIT) v Sheppard [1999] BTC 236.)

Costs

Looking at the subjective intentions of the taxpayer, in the light of the facts found, the consequence which was inevitably and inextricably involved in the payment (namely the discharge of a personal liability of B) was a purpose for which the payment was made. The taxpayer's only conscious motive at the time of the expenditure was not a business motive.

Accordingly, the sum of £160,000 paid as costs, which was deducted in computing the profits of the taxpayer, was not money wholly and exclusively expended for the purposes of the taxpayer's profession within the meaning of ICTA 1988, s. 74(1)(a).

B argued that the sum of £160,000 was an amount laid out by the firm wholly and exclusively for the purposes of its business on the grounds that that amount had to be paid to remove the real threat of a wasted costs order and the consequences such an order would have had on its business, but, as the Revenue contended, there was no such threat at the relevant time. The liability to pay the costs was always the liability of B personally and never the liability of the firm. There never was an application for a wasted costs order and there never was such an order. To the extent that the firm had any liability it was contingent upon a wasted costs order being applied for and granted, and that was contingent upon B not being able to pay the costs personally which contingency B accepted was so remote as not to exist.

The payment of the costs by the firm was not made for the purpose of enabling the firm to earn the profits of the firm; it was made to discharge a personal liability of B. The taxpayer's only conscious motive at the time of the expenditure was not a business motive.

Disbursements

B argued that the commercial purposes of the firm in paying the disbursements were first that the firm had a liability to pay disbursements and then, that it was in the interests of the firm to win the litigation and so recover the fees. However, even if the firm had the professional liability to pay, say, counsel's fees, that could not convert what was essentially a personal liability of B into a payment made for the purposes of the profession of the firm for tax purposes. The payments of the disbursements by the taxpayer were not made for the purpose of enabling the firm to earn the profits of the firm but to discharge personal liabilities of B. Even if a small benefit was received by the recovery of a small amount of costs, the business or professional purpose was neither the sole purpose nor even the main purpose of the payments. Overall it could not be said that it was in the interests of the firm to conduct any of this litigation. The taxpayer's only conscious motives at the time of the expenditure were not business motives. Accordingly, the sums which had been deducted in computing the profits of the taxpayer were not money wholly and exclusively expended for the purposes of the taxpayer's profession within the meaning of s. 74(1)(a).

Negligent conduct

B was a practising solicitor and knew or should have known that the only sums which could be deducted from the profits of the firm were sums wholly and exclusively laid out for the purposes of the profession of the firm. He should have known that the discharge of a personal liability of his was not deductible from the profits of the firm from which it followed that, in claiming the deduction, he engaged in negligent conduct.

(2006) Sp C 572.
Decision released 7 December 2006.