BES Commercial Electricity Ltd and Business Energy Solutions Ltd (the Companies) were related companies which were licensed non-domestic suppliers of gas and electricity, supplying power to small businesses. They were regulated by the Gas and Electricity Markets Authority (GEMA), through its executive arm Ofgem.
In 2014, Ofgem opened an enquiry into the Companies, and held that there had been breaches of the licence conditions, in relation to complaints handling and out of contract customers. The Companies co-operated with the investigation, and reached a settlement agreement with Ofgem.
The Settlement Agreement provided that the Companies would pay a nominal penalty of £2, together with compensation to customers (the Compensation Arrangements) of £311,000 and a donation to a nominated charity of £669,000 (the Customer Redress). In total, the sum agreed was £980,000, instead of a potential penalty of up to £1.4m.
The actual sums paid were different, and in total higher: the Companies paid compensation of £530,000 and made donations to the charity of £684,000, totalling £1,214,000.
The Companies claimed a corporation tax deduction for the full amount, excluding the nominal £2 penalty. HMRC denied a deduction for £980,000, although it allowed the excess of £234,000.
Issues to be decided at FTT
The Companies appealed [TC08340], and three issues were considered by the FTT:
- Whether the Compensation Arrangements and Consumer Redress (the Payments) were non-deductible as fines or penalties within the scope of the principles identified by Lord Hoffman in McKnight v Sheppard  3 All ER 491 (McKnight);
- Whether the Payments were incurred wholly and exclusively for the purposes of the appellants’ trades; and
- Whether the Consumer Redress qualified for Charitable Donations Relief under CTA 2010, Pt 6.
The McKnight case concerned a stockbroker who incurred legal expenses of £200,000 in defending himself against disciplinary proceedings. In that case, the costs were deductible, on the principle that they were incurred in defending the action, and anyone accused of an offence should be entitled to defend himself. However, any fine or penalty would not be allowed, since “its purpose is to punish the taxpayer and a court may 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 deduction for the purposes of tax”.
Fine or penalty?
The Companies argued that the Payments were not fines or penalties, and were compensatory rather than punitive in nature.
HMRC said that the Settlement Agreement was entered into in order to avoid higher penalties being levied, and therefore the Payments had the nature of penal sanctions and so should be disallowed.
The FTT agreed with HMRC, and noted that the Settlement Agreement was made in accordance with Ofgem’s enforcement guidelines. The FTT said that “The specific policy of the rule under which the Payments were made is to enforce compliance with the licence conditions and the relevant legislative provisions.”
The Companies therefore failed on Issue 1, but the FTT went on to consider Issues 2 and 3.
While it was not disputed that the payments were made in connection with the trade, the FTT referred to the Upper Tribunal decision in McLaren Racing Ltd v HMRC  UKUT 269 (TCC), where McLaren had been fined by its governing body for a breach of the industry code. The Upper Tribunal said that “a deliberate activity which is contrary to…the rules and regulations governing the conduct of the trade…is not an activity carried on in the course of the trade”.
Here, the FTT said that the Companies had deliberately breached their licence conditions, by wrongly blocking customers from transferring and by not investing in complaints handling. The Payments were therefore not made wholly and exclusively for the purposes of the trade, and so were not deductible.
Finally, the FTT held that the Consumer Redress was not deductible as a charitable donation, because it was paid in order to achieve a lower overall settlement, and so there were benefits associated with the Payments.
HMRC wins on all points
HMRC succeeded in all its arguments. While the decision is one based on the facts of this particular case, it will have wider application where other taxpayers decide whether to settle a disciplinary or regulatory dispute.
In another recent FTT decision [TC8393], Scottish Power claimed tax deductions for £28.05m of Ofgem settlement payments, together with £554,000 paid directly to customers.
The BES case was referenced in the Scottish Power judgment and the FTT agreed that the settlement amounts were in the nature of penalties and were not deductible, although they allowed the £554,000 paid directly to customers. However, in this case the FTT held that the payments were made wholly and exclusively for trade purposes. This had no effect as HMRC had succeeded on the first (penalty) issue.
It should now be assumed that any settlement payment will not be deductible, although the associated legal and professional costs may still be allowable – those costs were not part of the appeal in the BES case.