BIM37790 - Wholly & exclusively: duality of, or non-trade, purpose: loans/advances to others: to allow subsidiaries to meet their obligations
If ‘duality’ of purpose - non-allowable
Transactions between parent and subsidiary companies may cause
problems. A number have come before the courts. The issues involved
are illustrated in two cases, Odhams Press Ltd and Marshall
Richards Machine Co Ltd.
You need to establish the purpose of the payment(s) made. As
explained in Scott Bader (see
BIM38250) there are essentially three
possibilities:
- it is providing such assistance solely in the interests of the subsidiary;
- it is providing such assistance partly in the interests of the subsidiary and partly in its own interests; and
- it is providing such assistance solely in its own interests.
In situations (1) and (2) the relevant expenditure is not
deductible; but in (3) deduction is permissible and (applying
Bentleys, Stokes & Lowless v Beeson [1952] 33TC491 - see
BIM37400) notwithstanding the fact that
the subsidiary receives a benefit. The relevant question is
‘what was the object of the person making the disbursement in
making it?’ not ‘what was the effect of the
disbursement when made?’
In Odhams Press Ltd v Cook [1940] 23TC233, Odhams did work
for a wholly owned subsidiary company. The work was charged at full
trade price. Upon discovering that the subsidiary had made a loss
for the year, Odhams wrote off the equivalent amount of the sum
owing to it on trading account. Odhams claimed that this was an
allowable deduction representing either:
- a reduction in its charge for work done, or
- a bad debt, or
- a doubtful debt that ought to be treated as bad.
The Special Commissioners found that the sum was not written off
wholly and exclusively for the purposes of Odhams’ trade and
was not admissible. The House of Lords decided that the question
was one of fact for the Commissioners and that there was ample
evidence upon which they could reach the conclusion that they had.
Odhams were interested in the subsidiary both as shareholder
and as a printer who did work for it at full trade prices. Odhams
would wish the subsidiary to prosper and not be weighed down with
debts. The same is true of any company holding shares in another
company with which it also has a trading relationship. There being
two separate companies and two separate trades there is a dual
relationship.
As explained by Upjohn J in Marshall Richards Machine Co Ltd
(see below), 36TC foot of page 525:
It is normally a question of fact whether the disbursement in question is laid out wholly and exclusively and for the purposes of the trade of the parent company: or, secondly, whether it is laid out wholly and exclusively for the purposes of the trade of the subsidiary company; or, thirdly, whether it is laid out partly for the one and partly for the other. In the first case the parent company succeeds in getting an allowance; in the other two cases it does not.
In Marshall Richards Machine Co Ltd v Jewitt [1956] 36TC511, the
company wished to sell its machines in the USA. To serve this end
the company decided to appoint a representative in the USA. There
were a number of difficulties facing a foreign company trading in
the USA through an agency. The company determined that its ends
could be best served by incorporating a subsidiary company in the
USA to employ its proposed representative. A wholly owned
subsidiary was duly formed. The UK company entered into an
agreement with the US subsidiary to pay it a minimum annual sum
towards the its operating costs. The agreement provided that such
payments, together with anticipated increases, were to be treated
as on account of agency commission. In three accounting periods the
payments made exceeded the commission due. The UK company claimed
that the excess was wholly and exclusively laid out for the
purposes of its trade.
The Special Commissioners decided that the sums in question
represented amounts paid by way of advance to the US company to
enable that company to meet its obligations and that they were not
expended wholly and exclusively laid out for the purposes of the UK
parent’s trade. The courts upheld the Commissioners and
denied a deduction.
Upjohn J said that the expenditure was not allowable because
the Commissioners had found that it had been incurred to allow the
American company to meet its obligations, 36TC head of page
526:
In this case, in fact, the question depends entirely upon the true construction of the agreement entered into between the companies, and it is perfectly clear from clause (11) that this disbursement is for the operating expenses of the American subsidiary; that is, as the Special Commissioners held, a payment for the purpose of enabling the American company to meet its obligations and continue in existence. That is exactly what the payment was for, and it was not laid out in any sense at all to advance the trade of the parent company. Of course. that was the motive, but it was not the purpose of the payment. In my judgement, the Special Commissioners came to a perfectly right conclusion, and, indeed, they could not have come to any other conclusion.
It followed that the payments were really advances and Upjohn J went on to explain that Charles Marsden & Sons Ltd v Commissioners of Inland Revenue [1919] 12TC217(see BIM37760), end of judgement on page 526:
…make it quite clear that payments of that nature are payments and advances of a capital nature and are not deductible in computing the profits of the parent company for tax purposes. Upon that matter, too, the Special Commissioners came to an entirely correct conclusion…
