McKnight (Inspector of Taxes) v Sheppard
| Jurisdiction | England & Wales |
| Judgment Date | 14 May 1996 |
| Date | 14 May 1996 |
| Court | Chancery Division |
Chancery Division.
Lightman, J.
Timothy Brennan (instructed by the Solicitor of Inland Revenue) for the Crown.
Hugh McKay (instructed by Dunderdale Wignall, Manchester) for the taxpayer.
The following cases were referred to in the judgment:
Allen (HMIT) v Farquharson Bros & Co TAX(1932) 17 TC 59
Beauchamp (HMIT) v FW Woolworth plc ELRTAX[1990] 1 AC 478; [1989] BTC 223
Fairrie v Hall (HMIT) TAX(1947) 28 TC 200
Golder (HMIT) v Great Boulder Proprietary Gold Mines Ltd TAX(1952) 33 TC 75
Harrods (Buenos Aires) Ltd v Taylor-Gooby (HMIT) TAX(1963) 41 TC 450
Herald & Weekly Times Ltd v Federal Commr of TaxationUNK(1932) 48 CLR 113
Income Tax Commr, Bihar and Orissa v Singh UNK[1942] 1 All ER 362
IR Commrs v Alexander Von Glehn & Co Ltd TAX(1920) 12 TC 232
IR Commrs v Warnes & Co Ltd TAX(1919) 12 TC 227
Knight (HMIT) v Parry TAX(1972) 48 TC 580
MacKinley v Arthur Young McClelland Moores ELRTAX[1990] 2 AC 239; [1989] BTC 587
Mallalieu v Drummond (HMIT) ELRTAX[1983] 2 AC 861; [1983] BTC 380
Mitchell (HMIT) v BW Noble Ltd ELR[1927] 1 KB 719
Morgan (HMIT) v Tate & Lyle Ltd TAX(1954) 35 TC 367
Norman v Golder (HMIT) TAX(1944) 26 TC 293
Russell (Surveyor of Taxes) v Aberdeen Town and County Bank(1888) 13 AC 418
Spofforth and Prince v Golder (HMIT) TAX(1945) 26 TC 310
Strong & Co of Romsey Ltd v Woodifield (Surveyer of Taxes)ELR[1906] AC 448
Vodafone Cellular Ltd v Shaw (HMIT) TAX[1995] BTC 206
Income tax - Income and Corporation Taxes Act 1988Sch. D, Case I - Deduction of expenses - Stockbroker incurred legal costs in defending allegations of infringement of Stock Exchange regulations - Fines were imposed by Stock Exchange disciplinary tribunal - Whether legal costs and fines deductible from profits of stockbroker's trade -Income and Corporation Taxes Act 1970, s. 130(a), (e)(Income and Corporation Taxes Act 1988 section 74 subsec-or-para (1) section 741 subsec-or-para (e)Income and Corporation Taxes Act 1988, ss. 74(1)(a), (e)).
This was an appeal by the Revenue against the decision of a special commissioner that costs incurred by a stockbroker ("the taxpayer") in defending allegations of infringements of Stock Exchange rules were deductible from his profits. The taxpayer cross-appealed against the commissioner's decision that fines imposed by a disciplinary body were not deductible.
The taxpayer, who was the sole proprietor of a firm of stockbrokers and a member of the Stock Exchange, incurred the cost of representation by solicitors and counsel in defending proceedings against him by a Disciplinary Committee of the Stock Exchange. The Committee found the taxpayer guilty of gross misconduct on various charges and suspended him for six months. The taxpayer appealed to the Appeals Committee, which upheld the decision of the Disciplinary Committee on most of the charges. The Appeals Committee decided that he should be fined £50,000, censured and reprimanded, but that he should not be suspended.
The question was whether the legal fees and fines were deductible as disbursement in calculating the profits of the taxpayer's business, or whether they were prevented from being deductible by the Income and Corporation Taxes Act 1970, s. 130(a) or (e).
The special commissioner found that the taxpayer's business could not have survived suspension for six months and that, while he was concerned to protect his personal reputation in defending the charges against him, his sole object was to avoid the destruction of his business.
Held, allowing the Revenue's appeal and dismissing the taxpayer's cross-appeal:
1. The legal costs were "disbursements" as opposed to losses and were incurred wholly and exclusively for the purpose of the taxpayer's trade as a stockbroker within s. 130(a) of the 1970 Act. His sole purpose was to save his business, and deduction would not have been prevented by the fact that, incidentally, his reputation might have been saved: (Mallalieu v Drummond [1983] 2 AC 861 and Vodafone v ShawTAX [1995] BTC 353 at p. 248 applied).
2. However, there was no sufficient degree of connection between the expenditure and the profit-earning trade activity within s. 130(e) of the Act. The expenditure had to be an incident (or cost) of carrying on of the trade in question, but the serious and deliberate departures from the rules of the Stock Exchange and the ordinary, proper and lawful conduct of his trade lay outside the ambit of deductible disbursements or expenses.
3. There was no distinction for deduction purposes between the fines and the legal expenses of unsuccessfully defending the proceedings. Both flowed from the conduct of the taxpayer (IR Commrs v Warnes (1919)12 TC 227 and IR Commrs v Alexander Von Glehn (1920)12 TC 232 followed).
By originating motion pursuant to the Taxes Management Act 1970 section 56 subsec-or-para (A)Taxes Management Act 1970, s. 56A (as substituted by SI 1994/1813SI 1994/1813with effect from 1 September 1994), the Revenue appealed to the High Court against the following decision of a special commissioner (Mr Theodore Wallace sitting in private), released on 7 December 1995 sub. nom. A Stockbroker v McKnight (HMIT). The taxpayer cross-appealed.
1. This appeal concerns the deductibility under Income and Corporation Taxes Act 1988Case I of Sch. D of legal expenses incurred by a stockbroker in relation to disciplinary hearings in 1986 and 1987 by committees of the Stock Exchange Council in relation to alleged breaches of the rules and regulations of the Stock Exchange and fines totalling £50,000 for gross misconduct.
2. The legal costs for the hearing before the Disciplinary Committee which lasted eleven days amounted to £157,745; that committee suspended the taxpayer from trading for six months. The legal costs for the hearing before the Disciplinary Appeals Committee which lasted three days totalled £44,501; that committee lifted the suspension but imposed fines. In both hearings the taxpayer was represented by a firm of London solicitors who instructed both leading and junior counsel.
3. The taxpayer's case was that these sums were expended wholly and exclusively for the purposes of his trade because unless those sums were expended the trade would have ceased, he being the sole proprietor of his business. Suspension would have killed the business and non-payment of the fines would have resulted in suspension.
4. The inspector said that the expenses were not wholly and exclusively for the purposes of the trade within s. 130(a) of the Taxes Act 1970 since there were non-trading purposes and that they were also disallowed under s. 130(e) as losses not connected with or arising out of the trade.
5. There was a statement of agreed facts and an agreed bundle of documents. Counsel for the taxpayer called the taxpayer and a former colleague, Mr B, both of whom gave evidence under oath and were cross-examined. A transcript was taken of the taxpayer's evidence. The shorthand writer left before Mr B's evidence, after which the taxpayer was recalled for a short time.
6. Before considering the evidence as to the taxpayer's purpose, I set out the basic facts.
7. In 1959 the taxpayer joined Q & Co, a firm of stock brokers started in the provinces in 1914, as an associate; he was aged 25. In 1961 he became a member of the Stock Exchange and in 1963 became sole proprietor of the business. He remained sole proprietor throughout the period covered by the appeal.
8. In 1968 the Stock Exchange introduced a rule that there must be a minimum of two "partners" in a member firm. These need not be partners in the legal sense but must be members of the Stock Exchange. Mr C and a Mr D became partners in the Stock Exchange sense around 1968. Around 1970 Mr E, with whom the taxpayer played cricket, and Mr B joined. The early 1970s saw boom conditions.
9. The business survived the secondary banking collapse in 1973-74 but in 1975 when the stock market recovered it was discovered that Mr D had built up a massive bear position resulting in heavy losses. Q & Co was almost bankrupted. The taxpayer had to sell property to keep the firm going. Mr B and Mr E ceased to be partners, although Mr B remained an associate for a time. Mr D was subsequently convicted of an offence involving dishonesty. By 1979 the business had recovered and was prospering again.
10. From 1979 the taxpayer's only partner was Mr C who was in effect office manager. By the mid-1980s there were ten to twelve employees. The auditors also prepared the monthly returns required by the Stock Exchange.
11. The business had some 500 private clients, most of long standing. In addition Q & Co acted for R plc, an investment trust, of which the taxpayer was chairman and, through S Ltd, 72 per cent shareholder. At the relevant time there were some 20 outside shareholders. The company was quoted under r. 535. R plc's office was at Q & Co's premises. The only employee was a part-time accountant whose salary was apportioned; he also did work for another business controlled by the taxpayer. R plc's investments were registered in the name of a merchant bank's nominee company. The taxpayer effectively managed R plc's portfolio, charging full commission. In 1986-87 R plc had net assets of around £6m.
12. The taxpayer was the sole beneficial owner of the shares in S Ltd, which owned a chain of chemists. He became a director in 1977. In August 1983 it held 42.35 per cent of R Plc; later this rose to 72.58 per cent. Mr B was also a director of R plc.
13. The taxpayer became a director of T plc on 31 March 1983 and held 25 per cent of its shares. He also owned all the shares in U Investments Ltd and V Finance Ltd, which were dormant at the time of the proceedings but had been used as nominees. He also had a small property company called W Ltd.
14. The taxpayer's firm carried out transactions for...
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