In McLaren Racing Ltd v HMRC [2014] UKUT 0269 (TCC), the Upper Tribunal (UT) decided that a penalty paid by McLaren Racing Ltd for a breach of sporting code of the Fédération Internationale de l’Automobile was not deductible in computing its taxable profits.
What is the background?
In September 2007, the World Motor Sport Council (WMSC) imposed two sanctions on McLaren:
This translated into a £32.3m fine.
In broad terms, the fine was imposed because an employee of a rival Formula 1 (F1) team, Ferrari, had passed confidential information on Ferrari cars to McLaren’s chief designer. The WMSC concluded that McLaren’s chief designer had disseminated this information around the racing team with the result that McLaren had obtained a sporting advantage.
The legal issue was whether McLaren was prevented from claiming a tax deduction for the fine, either because the fine was a disbursement or expense ‘not being money wholly or exclusively laid out or expended for the purposes of the trade or profession’ (ICTA 1988 s 74(1)(a), now CTA 2009 s 54(1)(a)); or because the fine constituted a loss ‘not connected with or arising out of the trade or profession’ (ICTA 1988 s 74(1)(e), now CTA 2009 s 54(1)(b)).
Before the FTT handed down its decision, it would have been reasonable to conclude that the historic authorities led to the fine not being deductible. A leading case was McKnight v Sheppard (1999) 71 TC 419, where Lord Hoffmann in the House of Lords held that a fine imposed by the Stock Exchange (which was then a private members’ club and therefore analogous to the WMSC since it was a non-statutory body) was non-deductible.
In broad terms, Lord Hoffmann held that a fine would be non-deductible if it was punitive in intent and it would be against public policy if the taxpayer in question was able to share the burden with the rest of the community by claiming a tax deduction.
However, in a split decision, the FTT decided in favour of McLaren ([2012] UKFTT 601 (TC)). Having reviewed the case law, Judge Hellier stated: ‘In the non-statutory context, where the actions which gave rise to a penalty could otherwise be said to have been for the purpose of the trade ... it is only if the nature of the penalty is to punish a person and if there is a serious public policy which would be diluted by deductibility that the penalty should not be regarded as an expense of the trade … for example, a non-compensatory penalty for late completion imposed in a building contract ... could be a deductible expense.’
After establishing that, in his view, this was the correct legal test, Judge Hellier then held that the fine was not a personal punishment for McLaren; and that, even if it had been, there was not a serious public interest involved which prevented the fine from being non-deductible. As he put it, ‘the safety, health or wellbeing of the public were not at issue’. In summary, Judge Hellier concluded that in order for a fine to be non-deductible, a two limbed test had to be complied with and the fine in question had not complied with either of the limbs of this test.
In reaching his decision, Judge Hellier may have been influenced by The Herald v The Federal Commissioner (1932) 48 CLR 113. In that case, the Australian High Court held that a fine caused by inappropriate conduct, in this instance a newspaper paying damages for libel, was deductible. Indeed, this point was developed by McLaren’s counsel before the UT, where he appears to have argued that the illicit gathering of information on Ferrari was analogous to where a newspaper’s employees overstepped the mark and libelled certain individuals.
What did the Upper Tribunal decide?
The UT disagreed with Judge Hellier’s decision in the FTT in two fundamental respects. First, the UT held that the £32.3m penalty was penal in nature. Second, the UT disagreed that for a penal fine to be non-deductible, there must be a serious public interest linked to the course of conduct.
For completeness, the UT held that WMSC had levied the fine in its capacity as a regulatory body. This meant there is a lower hurdle to jump in establishing if there was a public interest in the outcome of the case.
When are fines allowable as deductions against trading income?
Following on from this decision, it is possible to draw two conclusions as to when a fine will be deductible.
First, the UT analysis of the judgment in The Herald is important, since it is possible to extract the rule that if a fine is non-penal, it will be deductible. (This is consistent with Judge Hellier’s view as to why a non-compensatory penalty for late completion imposed in a building contract should be deductible. In such circumstances, the contractual penalty would be derived from the trade and it would not be penal in nature.)
Second, the UT’s decision establishes that if a fine is punitive in nature, it will be deductible, unless there is a public policy reason for the taxpayer not to be able to deduct the fine. The UT also established that the public policy reason does not have to be serious to be activated.
Are there any grey areas in the law here?
There are at least two. First, the cases have established that if a fine is non-penal in nature then it should be deductible. However, the authorities have not defined the boundaries which determine if a fine is penal or not in nature. For example, the fines in The Herald case, which derived from illicit employee activities, were held to be non-penal and it will be helpful to understand what differentiated those fines from the fines imposed on McLaren on account of its employees’ illicit activities.
Second, a penal fine will be deductible unless there is a policy reason as to why the fine should be deductible and the UT has established that the policy reason does not have to constitute a ‘serious public interest’ to block the deduction. What the UT did not establish, however, was the quantum of public interest which had to be involved in order for the deduction to be denied.
What next?
The decision has only recently been handed down. We await to see whether McLaren appeals.
Interview by Kate Beaumont for LexisNexis UK legal news analysis
