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Reviewing the circumstances where a fine can be tax deductible
Advisers generally agree that when a penalty or fine serves the purpose of punishment, tax relief isn’t typically available. Since the aim is to penalise the taxpayer, allowing them to share the burden through a tax deduction would dilute the legislative policy intended to hold the individual accountable without spreading the consequences to the wider community.
Fines that can be tax deductible under specific circumstances are:
- Compensatory damages: payments made for compensatory damages, rather than punitive purposes, are usually tax deductible. For instance, damages paid by a newspaper company for defamation claims, especially if these claims are considered a regular aspect of their publishing activities, could be tax deductible.
- Employer settlement of employee liability: when an employer covers fines that are the liability of an employee, treating it as employment income for the employee, the employer can typically consider this cost as allowable in computing their trading profits.
- Payments to regulatory bodies for duties: payments made to a regulatory body intended to cover the costs of the regulator performing its duties related to trading activities are generally allowed. However, this doesn’t include penalties for breaches of regulations. If a penalty or fine results from a prosecution due to a breach of regulations by a trader, it usually won’t be an allowable expense.
- Civil action settlements: payments made in settlement of a civil action arising from a trade might be considered a trading deduction if the allegations were neither admitted nor proven. If liability was admitted or proven, a deduction might be allowed for restitutionary payments but not for punitive ones.
Fines and criminal payments
Section 54 of the Corporation Tax Act (CTA) 2009 outlines the main legal hurdles for claiming relief on payments involving legal damages, penalties, and fines in tax cases. It prevents expenses from being deducted against a company’s trading profits if they fail to meet two criteria:
- are not incurred wholly and exclusively for the purposes of the trade.
- they represent losses not connected with the trade.
The jurisprudence in this domain suggests that claiming relief for damage payments might only be feasible when they directly tie back to a breach of the law within the specific context of that trade. For instance, relief could potentially be claimed for payments linked to breaches of the law within a trade, such as a publisher facing libel actions. Payments for breach of contract as well as payments to employees for wrongful dismissal, etc. are usually deductible.
Section 1304 of the CTA 2009 disallows tax deductions for expenses related to payments or actions that would be deemed criminal offences, either within or outside the UK. It serves as a deterrent, discouraging companies from engaging in activities that could lead to criminal offences and then attempting to offset those expenses against their taxable income.
Examples of the kinds of payments that are disallowed are:
- Criminal payments: expenses incurred in making payments that would constitute a criminal offence are not allowed as deductions. This includes payments by a trader that is within the Terrorism Act 2000, payment for stolen goods knowing them to be stolen, or payments which form part of a scheme to evade VAT and are therefore part of the offence of the fraudulent evasion of VAT.
- Blackmail and extortion: deductions are not permitted for expenses incurred in making payments induced by demands that constitute offences such as blackmail (as per the Theft Act 1968 in England and Wales), extortion in Scotland, or blackmail (under the Theft Act in Northern Ireland).
- Bribery Act 2010: under the Bribery Act 2010 it is an offence to offer, give, or accept bribes in the UK or overseas. Payments which constitute an offence under the Bribery Act are disallowable as criminal payments.
- Incidental expenses: it’s important to note that the disallowance of deductions doesn’t just cover the payment itself but also extends to any incidental costs associated with making that payment. This broader scope is based on the wording ‘expenditure incurred in making a payment’.
While payments directly linked to the blackmail itself are generally disallowed for tax purposes, other related expenses might still be considered allowable under specific conditions. For instance, expenses incurred for activities such as guarding premises due to potential threats or searching stock for sabotaged goods, along with costs for replacing damaged goods resulting from blackmail-related incidents. Those costs will be allowable if they meet the normal tests that the expenditure is not capital and it is incurred wholly and exclusively for the purposes of the trade and they are not criminal payments.
Section 1303 of the CTA 2009 delineates a list specifying certain penalties or interest disallowed as deductions for tax purposes. It’s important to note that while some of HMRC’s penalties might not be explicitly mentioned in this list, their absence doesn’t imply they are allowable deductions. Their punitive nature and lack of direct connection to normal trade operations or activities often preclude them from being considered as deductible expenses for tax purposes.
Businesses should carefully assess whether HMRC penalties align with the criteria of normal recurring expenses and being wholly and exclusively for the trade before considering them for tax deductions, despite their absence from the specific disallowance list in section 1303 of the CTA 2009.