(1) Scottishpower (SCPL) Ltd v The Commissioners for HM Revenue and Customs

Hearing dates: 26 and 27 November 2024

Approved Judgment

This judgment was handed down remotely at 10.00am on 17 January 2025 by circulation to the parties or their representatives by e-mail and by release to the National Archives.

Introduction

This appeal addresses the existence and scope of a rule that payments in the nature of penalties incurred in the course of trading activities may not be deducted in computing taxable profits. More specifically, the issue between the parties is whether such a rule can prevent the deduction of payments made to consumers and consumer organisations pursuant to agreements made in settlement of regulatory investigations.

HMRC say that the rule, explained by Lord Hoffmann in McKnight (HM Inspector of Taxes) v Sheppard [1999] 1 WLR 1333, [1999] STC 669, exists and applies to the payments at issue in this case. The four appellants, to whom I shall refer collectively as “ScottishPower”, maintain that the decision in McKnight v Sheppard was much more limited and there is no rule that prevents the deduction of the payments.

ScottishPower generate and supply gas and electricity. Under the Gas Act 1986 and Electricity Act 1989, these are regulated activities which may only be carried out under a licence. The relevant regulator is the Gas and Electricity Markets Authority (“GEMA”). GEMA's day to day work is carried out by the Office of Gas and Electricity Markets, known as Ofgem.

Between October 2013 and April 2016 ScottishPower entered into various agreements with GEMA in settlement of Ofgem investigations into matters such as mis-selling, complaints handling and costs transparency. This led to the payment of penalties in nominal amounts of £1 and payments to consumers and consumer organisations totalling around £28m. ScottishPower challenge HMRC's denial of deductions for the £28m.

The First-tier Tribunal (“FTT”) dismissed ScottishPower's appeal against the denial of deductions, except for one element which it concluded was compensatory in nature ( [2022] UKFTT 41 (TC), Judge Charles Hellier and John Woodman). Both parties appealed to the Upper Tribunal (“UT”), which held that all the payments were non-deductible ( [2023] UKUT 218 (TCC), Miles J and Judge Swami Raghavan). ScottishPower now appeal with the permission of this court.

The facts

The regulatory regime in outline

Under the relevant statutory regime, licences to generate and supply gas and electricity are granted subject to certain conditions and statutory requirements. The conditions include standard licence conditions, or “SLCs”. GEMA has also been granted enforcement powers, which include the power to impose a penalty in the event of contravention of those conditions or requirements or a failure to meet prescribed standards of performance. Penalties are paid into the Consolidated Fund, so they form part of general government resources. Since 2014 there has been an additional statutory power to make a consumer redress order where contraventions have resulted in consumer loss or inconvenience, but that power was not exercised in this case.

GEMA's published statement of policy in relation to penalties and consumer redress (dated 6 November 2014) refers to its principal statutory objective, namely “to protect the interests of existing and future gas and electricity consumers”, and describes its strategic objectives for enforcement as being to “deliver credible deterrence”, “ensure visible and meaningful consequences” for businesses who do not comply and achieve the “greatest positive impact” by targeting enforcement resources and powers. The “central objectives” of imposing penalties are to “obtain fair outcomes for consumers” and “deter future non-compliance” both by the regulated person concerned and by others. Non-compliance should “normally cost significantly more than compliance” and penalties should act as a “significant deterrent”. The amount of any penalty will generally both remove any detriment to customers or gain for the regulated persons and include a penal element, reflecting the seriousness of the contravention or failure and the need for deterrence. A discount may apply if there is a settlement. Voluntary compensation or redress payments are taken into account in determining the appropriate penalty.

The investigations and settlements

The UT's decision summarises the subject-matter of the investigations as follows:

“14. The investigations leading to the four settlement agreements in issue involved the following regulatory breaches:

(1) Mis-selling – Ofgem considered that SLC 25, which imposed obligations in relation to marketing activities, had been breached. Insufficiently robust training and monitoring of doorstep and telesales marketing had resulted in misleading information being provided to customers.

(2) Cost-reflectivity – SLC 27.2A required that differences in terms and conditions between payment methods (e.g. between prepayment and direct debit) should reflect the relative costs of the different methods. Ofgem considered that the taxpayer did not have robust procedures to justify its price differentials.

(3) Energy Saving (also referred to as CO2 and CESP) – the taxpayers failed to meet prescribed carbon emission reduction targets by promoting energy saving actions to consumers as set out in relevant legislation (the Electricity and Gas (Community Energy Saving Programme) Order 2009) (“CESP”).

(4) Complaints Handling – Ofgem considered that the taxpayers breached SLC 25 (requiring suppliers to take reasonable steps to achieve matters such as fair, accurate and prompt behaviour), SLC 27 (timely billing and correction of billing errors), and the complaints handling standards and procedures in the Gas and Electricity (Consumer Complaints Handling Standards) Regulations 2008.”

During the investigation process Ofgem proposed substantial penalties. However, the payments that were ultimately agreed were made pursuant to contractual settlement agreements, under which ScottishPower agreed to pay significant amounts to customers, charities and a campaign focused on energy consumers. In more detail:

a) Under the mis-selling settlement agreement, entered into in October 2013, ScottishPower agreed to pay £7.5m to vulnerable customers, identified by being part of its “Warm Homes Scheme”, and also to set aside £1m for customers actually affected by the mis-selling, with any unallocated amount going to a charitable trust supporting people affected by fuel poverty. The actual payments made comprised £7,316,585 to vulnerable customers and £554,013 to affected customers. The balance of the total of £8.5m, comprising £183,615 of uncashed cheques payable to those in the Warm Homes Scheme and £445,987 that was unallocated to affected customers, was paid to the charity.

b) The cost-reflectivity settlement was agreed in May 2014. ScottishPower agreed to pay £750,000 to a public awareness campaign run by the Citizen's Advice Bureau.

c) The energy saving settlement, agreed in December 2014, provided for a £2.4m payment to the same charity that benefitted from the mis-selling settlement. Part of this amount was paid by a company that has now left the ScottishPower group and is not the subject of this appeal.

d) The complaints handling settlement was agreed in April 2016. It provided for up to £15m to be paid to priority or Warm Homes Scheme “qualifying” customers, plus £3m and any unused part of the £15m to be paid to charity. In the result £14,709,208 was paid to qualifying customers, calculated as round sum payments of £73 to each such customer, and £3,290,791 to two charities concerned with energy supply to consumers.

The settlements also provided for nominal penalties, which reduced the above amounts to that extent. As can be seen, the most significant settlements related to mis-selling and complaints handling, resulting in aggregate payments of £8.5m and £18m respectively.

The settlement agreements had appended to them not only arrangements in relation to consumers who were to benefit from the agreements (such as how they would be tracked down and contacted) but also notices proposed to be published by GEMA. Although those notices referred to the nominal penalty amounts they were detailed documents covering the failings said to have occurred, the criteria relevant to the level of the penalty, and mitigating and aggravating factors.

For example, paragraph 1.2 of the notice appended to the mis-selling settlement agreement, entered into with the fourth appellant on 10 October 2013, stated:

“The Authority [GEMA] considers it appropriate to impose a penalty on SP [ScottishPower Energy Retail Limited]. However, SP has agreed to make contributions amounting to £8.5m in the form of compensation and payments to vulnerable customers. The Authority considers that the payments offered by SP to aid consumers will be of greater benefit to energy customers than if a substantial penalty was imposed. Accordingly, the Authority considers that a nominal penalty of £1 should be imposed. Furthermore, the level of the penalty contributions has been...