[2013] UKFTT 778 (TC)
TC02429
Appeal number: TC/2009/12118
CORPORATION TAX – Whether arrears of rent as between
associated companies should be allowed on a bad debt, or disallowed for S74(1)
ICTA 1988 – question of intention – Appeal Dismissed
FIRST-TIER TRIBUNAL
TAX CHAMBER
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SERE PROPERTIES
LIMITED
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Appellant
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- and -
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THE
COMMISSIONERS FOR HER MAJESTY’S
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Respondents
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REVENUE &
CUSTOMS
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TRIBUNAL:
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JUDGE IAN HUDDLESTON
J.B. ADRAIN FCA
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Sitting in public in Belfast on 25 June 2012
Jane Hodge, for HMRC
William Gould for the Appellant
© CROWN COPYRIGHT
2012
DECISION
Appeal
1. This is an
appeal by the Appellant, SERE Properties Limited, against HMRC’s amendment to a
Corporation Tax Return submitted by the Appellant for the accounting year
ending 30 June 2012.
2. The
amendment to the self-assessment arises from HMRC’s refusal to accept a bad
debt of £798,330 as an admissible deduction from the Appellant’s business
profits for that accounting period pursuant to Section 74 of the Income and
Corporation Taxes Act 1988 (“ICTA 1988”).
Background Facts
3. The facts
largely are not in dispute. SERE Properties Limited (“the Appellant”) was
incorporated on the 3 September 1996, having its principal activity as one of
property management. The directors and shareholders of the Appellant are Mr.
Stanley Edgar (who appeared before the Tribunal to give evidence), and his wife
Mrs. Rosemary Edgar.
4. The
Appellant’s parent company was, at the relevant time, SERE Holdings Limited,
which again is owned by Mr. Stanley and Mrs. Rosemary Edgar.
5. Mr. and
Mrs. Edgar also owned a separate company, SERE Motors Limited (“Motors”) which
was incorporated on the 4 July 2001 and began trading in January 2002. That
company carried on the business of buying and selling new and used motor cars.
It did not ultimately succeed and went into receivership on the 12 December
2003.
6. On the 1
August 2001 the Appellant entered into leases by which it demised various business
premises to Motors – those in the main being trading outlets for the sale of
cars.
7. The
Appellant’s sole income during the account period ending 30 June 2003 was from
the rent to which it thus entitled. In addition to the rent that fell due, there
is a further £130,431 which the parties have now in fact agreed was a loan from
the Appellant to Motors and which HMRC accept was admissible as a deduction.
That loan was used to pay mortgage expenses etc. to which the Appellant was
subject.
8. After
allowing for the loan, the net amount which constitutes the disputed bad debt
is £798,330 ie. in respect of the accrued arrears of unpaid rent.
9. The
Tribunal heard undisputed evidence that during the accounting period ended 30
June 2003 Motors was in financial difficulties, and that the directors received
insolvency advice to the effect that to continue to pay rent to the Appellant
might be regarded as a preference that could lead them to being disqualified
from holding further directorships.
10. The question, therefore, is
whether the arrears of rent that was allowed to accrue should be deductable
when applying the provisions of Section 74(1) ICTA.
11. That Section provides that
no sum should be deducted in respect of:
“(a) Any disbursements
or expenses, not being money wholly and exclusively laid out or expended for
the purposes of the trade, profession or vocation ……..
(e) Any loss not
connected with or arising out of the trade, profession or vocation.”
HMRC’s Case
12. HMRC’s case is that the bad
debt of £798,330 is not an admissible deduction from the Appellant’s business
profits on the basis that the Appellant did not allow the debt to remain unpaid
and write it off “wholly and exclusively for the purpose of [its business]”
in the sense required by Section 74(1)(a) and that it should be disallowed by
virtue of Section 74(1)(e) as although it is a loss, it is not one that is “connected
with or arising out of” the Appellant’s property management business. HMRC
say that the decision to allow rental arrears to accrue and then write them off
was driven by motives wider than the Appellant’s business.
13. HMRC contend that the
principles enshrined in the case Sycamore Plc and Maple Limited v Fir
SpC104(1996)(at Paragraph 71) apply viz that:
“Normally the treatment of
a payment in the accounts should be applied, but only if such treatment follows
the generally accepted rules of commercial accounting; if there is no statutory
rule to the contrary; if such treatment is non inconsistent with the true
facts; and if the true profit or loss of the trade is ascertained ….”
14. On that basis, applying Section
74(1)(e) HMRC says that the deduction is inadmissible, because it is not a loss
connected with the property management business of the Appellant.
15. There is no dispute per se
that the debt is bad, simply that it cannot be deducted in calculating the profits
and losses of the Appellant because (and here I paraphrase) the decision to
allow it to accrue, in essence, was governed by an objective wider than the
business of the Appellant – namely the preservation of Motors’ trading
position.
16. Further, by virtue of
Section 50(6) of the Taxes Management Act 1970, HMRC argue that the onus of
proof is on the Appellant to show that it has been over charged by reason of
the amendment to the tax computation, with the standard of proof being that
which applies in civil cases such as this, ie. that it is proved on the balance
of probabilities.
17. This line of argument
obviously brings into question an assessment of the Appellant’s objectives and,
in that vein, HMRC referred us to a number of relevant cases.
18. We were first referred to Roma
L J in the case of Bentley, Stokes and Lowles v Beeson 33TC491 (1952)
where Roma L J said (at page 503):
“The sole question is
whether the expenditure in question was “exclusively” laid out for business
purposes, that is: what was the motive or objective in the mind of the two
individuals responsible for the activities in question?”
19. We were also referred to the
case of Vodafone Cellular Limited and Others v Shaw 69TC376 (1997) and
in particular the comments of Millet L J in relation to the applicable
tests:
“The words “for the
purposes of the trade” mean “to serve the purposes of the trade”. They do not
mean “for the purposes of the taxpayer”, but for the purposes of the trade,
which is a different concept.”
“To ascertain whether the
payment was made for the purposes of the taxpayer’s trade it is necessary to
discover his object in making the payment. Save in obvious cases which speak
for themselves, this involves an enquiry into the taxpayer’s subjective
intentions at the time of the payment.”
20. Perhaps most helpfully of
all, we were referred to the case of Garforth v Tankard Carpets Limited
54TC342 (1980) which was a case which involved two companies which shared
the same directors, a situation similar to that before us. In that case, Walton
J at P. 349 stated:
“It must, in the nature of
things, be extremely difficult for any directors of two associated companies in
the position of Carpets and JLT to be certain in whose best interests – or,
rather, in whose exclusive interests – any step which they take is being
taken. Obviously there is nobody but themselves to say what was in their own
minds; and obviously, again, it must require a superhuman effort of mind (of
which extremely few persons, if any, are capable) to rule out entirely from consideration
the possibility of benefit to one’s other company when concentrating on the
exclusive requirements of just one of them ….”
21. On the basis of that case
law HMRC suggests that this Tribunal must consider the Appellant’s objective in
not collecting the rents as distinct from the effect of its decision not to
collect them.
22. On the facts of the case,
they suggest that the objectives of the directors of the Appellant was
primarily to help Motors:
(1) because, as directors and
shareholders in Motors, they were aware of the poor trading condition of
Motors’ finances, and that forbearance was intended to help Motors’ continuing,
albeit weak, trading;
(2) that the directors’ objective
in allowing Motors not to pay rent was, on the advice of its professional
advisers, to avoid the rent being considered a preferential payment in any
subsequent insolvency, and thus focused on preventing them becoming involved in
any subsequent disqualification proceedings that might arise on the insolvency
of Motors;
(3) that as a result the directors
must have considered the interests of both companies together when they decided
not to collect, and then subsequently write off, the debt which had accrued to
the Appellant and that, therefore, applying the principles set out in Tankard
(supra) that it is difficult for directors, who hold directorships common
to both companies and, indeed, are the controlling shareholders of both, to
distinguish the purposes of one company from those of the other and that on the
particular facts of this case that they have failed to discharge the burden
upon them (as set out in Tankard).
The Appellant’s Case
23. The Appellant’s case was
presented by Mr. William Gould of Exchange Accountancy Services Limited who
called Mr. Stanley Edgar to give evidence.
24. It was very clear from that
evidence that at all material times through the accounting period in question
that Motors was in a financially precarious state.
25. Evidence was given that
there was some prospect of an improvement in that arising from, firstly, the
potential successful outcome of a Criminal Damage Claim in relation to a former
site and, secondly, the possibility of a claim against HMRC for recovery of VAT
arising out of cars which had been used as demonstrators.
26. It was accepted by the
Appellant that insolvency advice had been provided and that it, in turn, had
counselled against the payment of rent lest it be considered as a preference.
27. The evidence which Mr. Edgar
provided to the Tribunal was that Motors simply did not have the cash to pay
the rent, and that there was no alternative for the Appellant but to stop
demanding it in the hope that if profitability returned that there would be a
possibility that the arrears of rent would then be discharged – particularly if
the Criminal Damage and VAT claims were resolved to the benefit of the
Appellant. The argument advanced was that the Appellant had, in effect,
resolved to take the longer view.
28. Ultimately, however, the
withdrawal of certain motor franchise agreements and a straightening working
capital position led to Motors entering into receivership in December 2003.
29. At all times Mr. Edgar
asserted that the companies were operated independently of one and other and
treated separately, and in support of that he cited, in particular, the
procurement and then adoption of insolvency advice in his capacity as a
director of Motors at a point when that company ceased to make payments of rent
to the Appellant. The resulting loan amounts were applied to then satisfy the
Appellant’s obligations (eg. mortgage payments) and were satisfied in full on
the sale of the various properties.
30. In support of that position,
he also advised the Tribunal that VAT relief had been allowed on the bad debt.
That of course involves very different circumstances from those before in the
consideration of this Appeal.
Decision
31. I have already set out above
the requirements of Section 74 and do not repeat them here.
32. As HMRC have correctly
identified, where an Appellant, such as the Appellant, wishes to apply a
deduction, then it must equally establish that it is a deduction which is not
prohibited by the operation of that Section.
33. In that regard, the onus of
proof is upon the Appellant.
34. On the facts of this case we
have two companies which are intimately connected – in some ways more
intimately connected than was the position in the Tankard case. As suggested
by that case, it therefore behoves the Appellant to be even clearer in the
evidence which it adduces to this Tribunal to establish that an expense, which
has a collateral benefit to an associated company, is properly treated as an
expense of the taxpayer (the Appellant in this case).
35. To establish that, the
Tribunal has obviously heard Mr. Edgar as to what was subjectively in his mind
at the relevant time. That he has attempted to do through this oral testimony,
but as he himself acknowledges, there is no supporting documentation, for
example contemporaneous minutes etc. to support the decisions that were taken.
Minutes were certainly referred to both in Mr. Edgar’s witness statement and
his oral testimony, but could not be produced.
36. It does equally behove the
Tribunal to look objectively at the entire circumstances.
37. In that regard, it is
stretching the imagination to suggest that the decision to forego rent was
driven by anything other than a desire by the common directors to ensure that
Motors, as the cash generating vehicle, was allowed breathing space within
which to put its affairs in order.
38. In the circumstances, and
having heard Mr. Edgar’s evidence, the Tribunal finds that that was, in fact,
the predominant purpose. Indeed, Mr. Edgar said as much in his evidence. His
hope and aspiration was that by providing some latitude in favour of Motors
that the two outstanding claims which he described would come to fruition or,
possibly more optimistically, that the company would be allowed to trade out of
its difficulties, at which point it would then be able to discharge the arrears
of rent.
39. To the Tribunal’s mind, that
can only be interpreted as a predominant intention to benefit Motors at the
expense of the Appellant.
40. In those circumstances, and
giving Section 74 its natural meaning, we fail to see how it can sensibly be
concluded that the subsequent claim for bad debt relief is not disallowed by
virtue of the application of the provisions of Section 74(1)(e), which requires
(broadly speaking) that for a loss to be deductable that the Appellant’s sole
purpose for not collecting, and then subsequently writing off the debt, must be
for its own business purpose.
41. Having reached that
conclusion, it naturally follows that the Appeal is dismissed and that the sum
of £798,330 is not an admissible deduction in the calculation of the
Appellant’s business profits for the accounting year in question. That
re-statement results in a revision of profits to £733,872 and a corporation tax
liability of £219,718.08.
42. If you are dissatisfied with
the outcome of the application for permission to appeal the decision in this
appeal, either party has the right to apply to the Upper Tribunal for
permission to appeal. Such an application must be made in writing to the Upper
Tribunal at 45 Bedford Square, London, WC1B 3DN no later than one month after
the date of this notice. Such an application must include the information as
explained in the enclosed guidance booklet “Appealing to the Upper Tribunal
(Tax and Chancery Chamber)”.
IAN HUDDLESTON
TRIBUNAL JUDGE
RELEASE DATE: 12 December 2012
