UK tax deductions not available on costs associated with disposal of a business

This decision upheld part of an earlier Upper Tribunal (UT) decision, which also concluded that the expenses were expenses of management, but overturned the UT’s conclusion that the expenses were not of a capital nature.

The case concerned Centrica Overseas Holdings Limited (COHL), an intermediate holding company in the corporate group of energy company Centrica plc, which claimed corporation tax deductions for expenditure on the fees of three professional firms in connection with the disposal of its investment in Oxxio BV, a Dutch energy business with four subsidiaries. The fees were payable to PwC, Deutsche Bank and a Dutch law firm. HM Revenue & Customs (HMRC) refused COHL’s claim for deductions.

Having originally acquired the Oxxio business in 2005, by 2009, the Centrica group made a strategic decision to divest it. However, as found by the First Tier Tribunal (FTT), the options as to how to achieve this were “wider than in normal transactions because of the diversity of the businesses within the Oxxio sub-group and the problems which emerged in the finance and management of the main customer business”. There was also a possibility that the Oxxio business would be unsellable and would need to be closed down.

COHL ultimately sold the businesses of two subsidiaries and the shares in a third subsidiary, rather than the whole group. This transaction completed in 2011.

Expenses of management

On the question of whether the professional fees were expenses of management at all, the Court of Appeal could only interfere with the decision of the FTT if it found that the tribunals had misdirected themselves as to the law or had made a decision on the facts that was not reasonably available to them. The Court of Appeal, like the UT, found that this was not the case and that the FTT was entitled to make the decision that it did.

The principles the FTT applied regarding the scope of expenses of management were:

• “Expenses of management” is not a term of art. They are ordinary English words.
• The meaning these words have in a particular context depends on the facts and circumstances of the particular case.
• Not every payment by an investment company is an expense of management and it must be positively shown that it falls within that definition.
• The expression has a fairly wide meaning.
• It includes the cost of investigating and considering whether to buy an investment.
• In order to be an expense of management a payment must not be part of the cost of acquisition but must be something severable from the cost of acquisition.
• Although much of the case law relates to acquisition, the principles apply equally to disposals.

The Court of Appeal has confirmed that the FTT directed itself correctly in identifying those principles, and applying them to the facts at hand, when it found that all three sets of professional fees were expenses of managing the investments of COHL.

Expenses of a capital nature

When looking at the question of whether the expenses were of a capital nature, which is a question of ‘pure’ law, the Court of Appeal was free to consider the question afresh.

The court accepted HMRC’s position that the reference to “expenses of a capital nature” in section 1219(3)(a) of the 2009 Corporation Tax Act (CTA 2009) must have the same meaning as “items of a capital nature” in section 53(1) of that Act.

It gave four reasons for adopting that position:

• The phrases are in the same Act and it would be surprising if they were to have different meanings, without specific indications of that difference.
• The explanatory notes to what became CTA 2009 indicated that the provision was intended to exclude capital expenditure “in terms that follow closely the Trading Income Rule”.
• The context in which the capital exclusion was introduced into UK tax legislation was in response a Court of Appeal decision that decided that the predecessor provision (which had no express capital exclusion) did not have an implied capital exclusion.
• It is reasonable to presume that the intention of parliament was to adopt the meaning which had been given to the concept of items of a capital nature in the existing long history in the case law.

Having reached that conclusion, the Court of Appeal applied the long-established principles of the capital v revenue divide to the fact pattern of COHL. In doing so, it concluded that the expenditure was capital in nature. It described the strategic decision to divest in 2009 as a “crucial feature” of the case and that nothing in how, or indeed, if the disposal proceeded altered the “the fundamental, commercial reality of what had been decided”.

It reached this conclusion despite the FTT having described the two years between 2009, when COHL made the strategic decision to divest the Oxxio business, and 2011, when it eventually did so as a “tortuous two years of working towards a transaction”, as “the value was realised by restructuring the Oxxio group, selling some of its businesses and procuring the repayment of the substantial loans that COHL had made to Oxxio.”

The FTT recorded in its findings of fact that this process had included:

• finding a purchaser, with part of Deutsche Bank’s role being to consider the “buyer universe”, and this varied as the process progressed with ten or more potential buyers being considered;
• seeking to obtain a certain price, which required it first trying to cure the fundamental problems in the business; and
• seeking advice on how the transaction was to be structured, which were wider than in the normal case because of the problems with the Oxxio business.

Even though the FTT found that  “[t]here is a world of difference between making that kind of strategic decision and getting it to the point where a specific decision is made to enter into a specific disposal transaction”, the Court of Appeal, perhaps surprisingly, still found that the 2009 decision was the cut off point for identifying capital expenditure.

Although the Court of Appeal has made it very clear that the two tests are separate and therefore companies with investment business must now make sure they consider both tests, the decision does not set out clear principles for applying the capital exclusion test in the context of investment businesses. The assets of an investment business are all capital assets and there has never been any dispute about the fact that the actual acquisition or disposal of those assets is of a capital nature. By their nature, the long line of cases on the capital v revenue divide, referred to by the Court of Appeal, are cases about trading businesses and the principles developed relate to identifying the dividing line between expenditure that is connected to the enduring, capital assets of the business as compared with the expenditure connected with the trading activity of the business. Applying these principles to a business that does not have any non-investment activity or non-capital assets is likely to cause practical issues and potentially further disputes. It is therefore perhaps inevitable that more case law will need to be developed in order to draw appropriate dividing lines.

Pinsent Masons acted for COHL in this case.