The Supreme Court held that ScottishPower could not deduct about £28 million paid to customers and charities when calculating trading profits for corporation tax. The payments were made under settlements with the energy regulator after investigations into serious breaches. Although each settlement imposed only a £1 penalty, the payments stood in place of substantial fines and were not expenses incurred wholly and exclusively for the purposes of the trade.
The payments in dispute
Corporation tax is charged on a company’s trading profits. Those profits are calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law. No deduction is allowed for an expense that was not incurred wholly and exclusively for the purposes of the trade. A connection with the trade is not enough: the expense must be incurred for the purpose of earning the profits.
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The Respondents, referred to as ScottishPower, included SPERL, which held gas and electricity supply licences, and three companies holding electricity generation licences. GEMA, the energy regulator, acting through Ofgem, investigated four matters. Ofgem found that SPERL had committed serious breaches of licence conditions and of the Electricity and Gas (Community Energy Savings Programme) Order 2009. It is common ground that fines of about £28 million would not have been deductible. The investigations instead ended in settlements. SPERL agreed to make the Redress Payments and to improve future performance, and a nominal penalty of £1 was imposed under each settlement. Some of the cost was borne by the other Respondents under an intercompany agreement.
The settlements covered mis-selling and marketing, unjustified differences between payment methods, missed carbon-reduction targets, and billing and complaints-handling failures. They provided for £7.5 million for vulnerable customers and £1 million for customers affected by mis-selling, with any unused part of that £8.5 million going to a charitable trust; £750,000 for a Citizens Advice awareness campaign; £2.4 million for the charitable trust after the carbon-target breaches; and £18 million of consumer redress, mainly for affected customers and otherwise for agreed charities. Before the complaints negotiations, SPERL had already written off some £8 million of customers’ bills. GEMA’s decision notices recorded the breaches and stated that the £1 penalties were lower because of the settlements, admissions and agreed payments.
The courts below
The First-tier Tribunal held that most of the payments were punitive and not deductible, but allowed a deduction for £554,013 paid to customers affected by mis-selling. It regarded that sum as compensation, akin to damages for misleading them. The Upper Tribunal held that every payment formed part of one negotiated package, made under threat of much larger penalties and in place of those penalties. It therefore held that none was deductible. The Court of Appeal allowed ScottishPower’s appeal. Falk LJ, with whom Snowden and Zacaroli LJJ agreed, treated the ban on deducting statutory fines as a narrow judge-made adjustment to accounting profits. She held that the courts should not extend it to payments which were not, in form, penalties; any wider rule was for Parliament.
Why the payments were not deductible
Lady Rose and Lord Doherty, with whom Lord Reed, Lord Stephens and Lady Simler agreed, held that this misunderstood the authorities. A penalty is not deductible because it is not incurred for the purposes of the trade. It punishes the offender and deters that person and others. The taxpayer pays it to answer for the breach, not to earn profits. That follows from the construction of the wholly-and-exclusively test, now in section 54(1)(a) of the Corporation Tax Act 2009. Lord Hoffmann’s statement in McKnight v Sheppard, that a deduction would allow the taxpayer to share the burden with the community, described a consequence of treating a penalty as deductible. It did not create a separate policy exception for payments which otherwise met the statutory test.
The Redress Payments were not voluntary in any sense that changed their character. SPERL did not have to settle, but the First-tier Tribunal found that, without settlement, a penalty of the same order of magnitude would probably have been borne even after an appeal. The settlements replaced those penalties. Treating them differently would favour a company that settled because a breach could not realistically be disputed over one that required the regulator to impose a challengeable penalty. Settlement required the breach to be admitted and the right of challenge to be given up.
The payments were also unlike compensation for breach of a private contract. The carbon-target breach arose under a statutory instrument, and the Court regarded the licence conditions as closer to statutory obligations. The published decision notices linked the payments to the breaches, to the penalty GEMA considered appropriate, and to deterrence and compliance. Payment to regulator-selected recipients, rather than into the Consolidated Fund, did not alter that character, nor did the accounting treatment of the sums as expenses. The £554,013 was part of the same overall deal and was equally punitive. The Court did not need to consider whether the payments had more than one purpose, and it distinguished these identified sums from other expenditure on putting matters right.
Verdict: The Supreme Court allowed the appeal by the Commissioners for His Majesty’s Revenue and Customs and restored the Upper Tribunal’s decision. None of the Redress Payments is deductible. The Court was not asked to decide whether legal expenses incurred in resisting disciplinary proceedings are deductible, and it did not need to decide whether the payments had a dual purpose.
