McKnight (Inspector of Taxes) v Sheppard

Where the taxpayer stockbroker's purpose in defending disciplinary proceedings had been exclusively the preservation of his business, the fact that he had also been concerned for his professional reputation did not prevent deduction of the cost in computing the profits of his trade under Case I of Schedule D, neither did considerations of policy.

The House of Lords dismissed an appeal by the Crown from the Court of Appeal (Lord Justice Nourse, Lord Justice Potter and Lord Justice Mummery) (The Times May 12, 1996; (1997) STC 846) who had allowed Mr Brian Stephen Sheppard's appeal from Mr Justice Lightman (The Times May 12, 1997; (1996) STC 627).

The judge had allowed the Inland Revenue's appeal from a special commissioner who had allowed Mr Sheppard's appeal from an inspector of taxes.

Mr Anthony Grabiner, QC and Mr Timothy Brennan for the Crown; Mr David Goldberg, QC and Mr Hugh McKay for Mr Sheppard.

LORD HOFFMANN said that Mr Sheppard in 1986-87 had incurred legal expenses of some Pounds 200,000 in defending himself against proceedings before the disciplinary committee of the Stock Exchange and appearing before its appeals committee.

The question was whether those expenses were "money wholly and exclusively laid out or expended for the purposes of the trade": section 130(a) of the Income and Corporation Taxes Act 1970.

The appeals committee had confirmed two of the disciplinary committee's findings of gross misconduct, reduced one to ordinary misconduct and allowed Mr Sheppard's appeal against the fourth.

It had affirmed three findings of ordinary misconduct. It had set aside an order for suspension for six months and substituted fines totalling Pounds 50,000.

Mr Sheppard had originally sought to deduct both the legal expenses and the fines in computing his profits, but deduction of the fines had also been disallowed by the inspector and that matter was no longer pursued. The special commissioner had found that Mr Sheppard's exclusive purpose in laying out the legal costs had been the preservation of his trade. They were accordingly deductible: Morgan v Tate and Lyle LtdELR ((1955) AC 21).

Mr Grabiner argued that the facts found by the special commissioner led to the conclusion that Mr Sheppard had had two purposes: the preservation of his business and the preservation of his personal reputation. The trade purpose thus lacked the necessary exclusivity: see Mallalieu v DrummondELR ((1983) 2 AC 861).

The special commissioner had not accepted Mr Sheppard's evidence that he had not cared about his personal reputation. But he had said:

"The fact that I do not accept that the taxpayer was wholly unconcerned with his personal reputation does not necessarily mean that his purpose in laying out the legal costs was not exclusively concerned with preserving his trade. Purpose and effect are not the same: see Mallalieu v Drummond (at pp870-871 per Lord Brightman)."

If the medical consultant given as an example by Lord Brightman had said that in deciding to fly to the South of France for a week to attend on his friend and patient he had given no thought at all to the pleasures of sitting on the terrace with his friend and a bottle of Cotes de Provence his evidence might well not have been credited.

But that would not have been inconsistent with a finding that the only object of the journey had been to attend on his patient and that personal pleasures, however welcome, had only been the effects of a journey made for an exclusively professional purpose.

That had been the distinction that the special commissioner had been making, and there was no inconsistency between his conclusion of law and his findings of fact.

Mr Grabiner's second point was that "for the purposes of the trade" meant that the expenditure had to be "in furtherance of the relevant commercial activity": there had to be a sufficient connection with the earning of profits in the trade.

He referred to Inland Revenue Commissioners v Alexander von Glehn and Co LtdELR ((1920) 2 KB 553), in which the Court of Appeal had disallowed

the deduction of a penalty imposed on a company during the First World War under the Customs (War Powers) Act 1915 for exporting goods without taking all reasonable care to secure that the ultimate destination should not be enemy territory.

The penalty had been incurred in the course of the company's trade. There must therefore have been something in its nature that prevented it from being deductible. The Court of Appeal had had difficulty in identifying exactly what that was.

In his Lordship's opinion it related to the particular character of a fine or penalty. Its purpose was to punish the taxpayer, and a court might easily conclude that the legislative policy would be diluted if the taxpayer were allowed to share the burden with the rest of the community by a tax deduction.

By parity of reasoning, the special commissioner and Mr Justice Lightman had been quite right in not allowing Mr Sheppard to deduct the fines.

His Lordship did not, however, see that any clear policy would be infringed by allowing the deduction of the legal expenses. On the contrary, non-deductibility would be in effect an additional fine or penalty for which the (Stock Exchange) regulatory scheme did not provide.

Lord Mackay, Lord Clyde, Lord Hutton and Lord Hobhouse agreed.