As explained in
BIM38515, penalties incurred for
breaching the law are not allowable.
In the case of CIR v Alexander von Glehn & Co Ltd [1920]
12TC232, the company, which carried on trade as general produce
merchants and exported goods to Russia and Scandinavia, was sued
for penalties under the Customs (War Powers) Act, 1915, on
Information by the Attorney- General, in respect of alleged
infringements of that Act in the course of its trade. The actions
were settled by consent on the company agreeing to pay a compromise
penalty of £3,000 without costs upon terms that the record was
withdrawn. The company incurred legal costs amounting to
£1,074 12s. 7d. in respect of the proceedings.
The Special Commissioners decided that the mitigated penalty
and costs were not admissible deductions in arriving at the profits
of the company's trade for Excess Profits Duty purposes.
Rowlatt, J could not distinguish von Glehn from CIR v E C
Warnes and Co., Ltd [1919] 12TC227 (see BIM38515) and dismissed the
appeal.
In the Court of Appeal, the Master of the Rolls, Lord
Sterndale, first of all dealt with the issue of whether it mattered
that the proceedings against the company were not technically
criminal, saying that it did not matter, 12TC foot of page 235 and
head of page 236:
Now we had several authorities cited to us which seemed to establish that such proceedings as those are not technically criminal proceedings. I do not think than matters. They certainly are proceedings in which a penalty is being sued for by the Attorney-General as representing the Crown, for an infraction of the law, whether technically criminal for the purpose of appeal seems to me to be immaterial. The money which is paid is money paid as a penalty, and it does not matter in the least that the Attorney- General has elected to take treble the value of the goods, nor does it matter that it may be called in the Information a forfeiture. It is in fact, under the Section, a penalty.
The Master of the Rolls then identified the applicable legislation; what is now ICTA88/S817 (1), ICTA88/S74 (1)(e) and ICTA88/S74 (1)(a) and went on to explain why the expenditure was not deductible; confessing in passing to some difficulty in putting his reasons into words. Lord Sterndale said that the expenditure was not a loss connected with the trade, but it a fine imposed upon the company personally. That the expense was not connected with and did not arise from the carrying on of the trade; it arose from infringing Customs regulations, 12TC upper part of page 238:
Now what is the position here? This business
could perfectly well be carried on without any infraction of the
law at all. This penalty was imposed because of an infraction of
the law and that does not seem to me to be, any more than the
expense which had to be paid in the case of Strong v
Woodifield [5TC215, see
BIM37300]
appeared to Lord Davey to be, a disbursement
or expense which was laid out or expended for the purpose of such
trade, manufacture, adventure or concern; nor does it seem to me,
though this is rather more questionable, to be a sum paid on
account of a loss connected with or arising out of such trade,
manufacture, adventure or concern [referring to what is now
ICTA88/S74 (1)(e)].
Of course, as Mr. Justice Rowlatt said, in a
sense you may say that it has been connected with the trade,
because if the trade has not been carried on the penalty would not
have been incurred; there would not have been an opportunity for
the breach of the law which took place, but in the sense in which
the words are used in the Act, I do not think that this was
connected with or arising out of such trade, manufacture,
adventure, or concern, and still less do I think that it was a
disbursement under the First Rule which applies to the first two
Cases, that is to say, ‘money wholly and exclusively laid out
or expended for the purposes of such trade.’ During the
course of the trading this company committed a breach of the law.
As I say, it has been agreed that they did not intend to do
anything wrong in the sense that they were willingly and knowingly
sending these goods to an enemy destination; but they committed a
breach of the law, and for that breach of the law they were fined,
and that does not seem to me to be a loss connected with the
business, but it is a fine imposed upon the company personally, as
far as a company can be a person, for a breach of the law which
they had committed. It is perhaps a little difficult to put the
distinction into very exact language, but there seems to me to be a
difference between a commercial loss in trading and a penalty
imposed upon a person or a company for a breach of the law which
they have committed in that trading.
Again in the Court of Appeal, Warrington, LJ explained why no deduction was due; saying that the expenditure did not represent a commercial loss and arose because those conducting the trade had so ordered their affairs as to make themselves liable to the penalty, 12TC foot of page 240 to head of page 241; and foot of page 241 to head of page 242:
In the present case what is sought to be
deducted is a definite sum expended by the Company, and the
question we have to determine is whether that is to be allowed as a
deduction. In my view it cannot he allowed, as I have already said,
unless it is one of the things that can be allowed under the Income
Tax Act. It is a curious thing that the Income Tax Act does not
contain any express provision as to what shall be allowed or may be
allowed. The way in which it is done is it prohibits certain
things, which are enumerated, being allowed as deductions, and
impliedly by that means one can find out what may be allowed as
deductions. Among the things which may be allowed, I think, is a
loss connected with or arising out of such trade, manufacture,
adventure, or concern. Now is this a loss connected with or arising
out of a trade or manufacture? That the expenditure arises out of
the trade I think may well be conceded. It does arise out of the
trade, because if it had not been that they were carrying on the
trade they would not have had to incur this expenditure; but in my
opinion it is not a loss connected with or arising out of the
trade. It is a sum which the people conducting the trade have had
to pay because in conducting it they have so acted as to render
themselves liable to this penalty. It is not a commercial loss, and
I think when the Act is talking about a loss connected with or
arising out of such trade it means a commercial loss connected with
or arising out of the trade…
…it cannot be said that the disbursement
in the present case is made in any way for the purpose of the trade
or for the purpose of earning the profits of the trade. The
disbursement is made…because the individual who is conducting
the trade has, not from any moral obliquity, but has unfortunately,
been guilty of an infraction of the law.
In the Court of Appeal Scrutton, L J begins by referring to the artificiality of tax computations, 12TC lower half of page 243:
The Income Tax Acts have always been recognised as expressing the procedure by which you are to get at the taxable amount in a very artificial way. They have used the phrase ‘balance of profits and gains’ sometimes in the sense of gross profits before you make deductions, and sometimes in the sense of the net profits which arise after you have made the proper deductions. They have provided that the tax is to be assessed without other deductions than are ‘hereinafter’ allowed, but they have not inserted any provisions allowing deductions; they have inserted a series of provisions prohibiting deductions and in dealing with an enormous number of trades they have used very vague language as to the deductions which are not allowed. Now I take as one guidance at any rate is to what may be allowed two passages in two decisions in the House of Lords. In the Gresham Life Assurance Society v Styles, [1892] A.C. at page 323 (3TC at page 195), Lord Herschell says this:
‘The expression balance of the profits or gains is not a happy one; but the meaning obviously is the balance arrived at by setting against the receipts the expenditure necessary to earn them.’
Scrutton L J goes on to explain why the expenditure is not deductible, taking the view that they were unfortunate incidents after the profits had been earned, 12TC head of page 244:
…were these fines and expenditure necessary to earn the profits? Were these fines made or paid for the purpose of earning the profits? The answer seems to me obvious, that they were not, they were unfortunate incidents which followed after the profits had been earned. I quite follow that stating the matter in that way may leave some difficult questions for solution in other Cases. I do not wish to decide until I have heard the matter further argued, whether compensation paid in civil proceedings for carrying on business in a negligent way can or cannot be deducted from the profits, for I quite see that on the language that I have used questions may arise as to damages paid in civil proceedings.
Lord Hoffman in the case of McKnight v Sheppard [1999] 71TC419 explained the House of Lords rationale for not allowing punitive penalties, please see BIM37965.
