“Wholly and exclusively for the purposes of trade”

It’s a fundamental rule of taxation law (Section 74 ICTA 1988, & Section 34 ITTOIA 2005 in relation to non corporate trading deductions) that for an expense to qualify as tax deductable it must be incurred “wholly and exclusively” for the purpose of trade, or necessary in the performance of your duties (if you are a director of your own company and claiming expenses as an employee).

What does “wholly and exclusively” mean?

It’s essential to ask, because whilst HMRC will by and large accept such expenditure claims, falling on the wrong side of their interpretation of the meaning of this phrase could have serious consequences. In principle at least, all cases failing the “wholly and exclusively” test should be referred by the local tax inspector for investigation.

One needs to be quite clear on whether a deduction has both a business and private element, and how that element is divided. To give a simple example, if a sole trader deducts the expense of running a car, the proportion of their personal use of that vehicle has to be worked out accurately and excluded from the amount submitted for deduction.

But ask HMRC for clarification in more complex cases and you are generally referred to the official guidance which has been described as vague and confusing by employers, advisers, and even local tax inspectors. Examples of some of the more confusing guidance have included the need to know “the taxpayer’s subjective intentions at the time of the payment”, and whether a resulting benefit was planned or merely a “consequential and incidental effect”.

In many situations the “exclusively” part can be a grey area and open to interpretation. The purpose for which the expense was incurred doesn’t always tally with the resulting benefit. And expenses such as payments made to settle disputes or legal fees incurred may or may not be deductable depending on the underlying facts. Being familiar with legal precedents can help significantly in determining the deductibility of such expenditure. The outcomes of individual cases in the courts provide the much needed clarity we seek.

What about precedent?

1) Atherton v British & Helsby Insulated Cables Ltd.

This landmark case concerned deductions claimed against pension funding. It was the founder’s intent to establish a scheme providing defined benefits (which were not subject to the discretion of the trustees) to its staff upon retirement. A series of regular contributions were made, starting with an initial large sum which would become the subject of this famous dispute. Atherton concluded that:

i) Contributions made to a defined benefits pension trust are wholly and exclusively for the purposes of trade.
ii) A series of recurring contributions into such a trust are revenue expenditures, and therefore qualify for tax deduction.
iii) A single contribution made in place of a liability to make a series of payments also qualifies for tax deduction.

This case is often and quite incorrectly referred to by the Inland Revenue in the context of remuneration trust contributions despite the fundamental difference of benefits being at the discretion of the trustees.

2) E Bott Ltd. v Price

In this case contributions made into a remuneration trust were claimed as tax deductable. The Inland Revenue argued that the defendant must prove that there was no purpose to the contributions other than for trade. The trust deed made clear that the trust was set up in order to ensure that the issued share capital was held by the Trustees for the benefit of the Company’s employees so that they had an interest in the business, an input into its direction and also a share of any profits. The judge found that the trust deed was a statement of the motive behind the contributions, and concluded that in the absence of any evidence to the contrary the scheme was therefore wholly and exclusively for the purposes of the company’s trade.

Notably, this case (and Jeffs v Ringtons) also set precedent that the beneficiaries of such a trust need not necessarily be notified that it was established in order that contributions therein might qualify for tax deductibility.

In fact, over the last 70 years there has only been one single case (next in our list) concerning the deductibility of contributions into a remuneration trust brought before the courts where the finding wasn’t that those contributions were made “wholly and exclusively” for the purposes of the founder’s trade.

3) Alway Sheet Metal (and others) v HMRC

This case (which took almost two decades to reach an initial finding) concerned the corporation tax deductibility of contributions made to an Employee Benefit Trust. The appeals of three companies were joined as one, since they raised similar issues. The main question being asked was whether contributions totalling just over £5 million were “wholly and exclusively for the purposes of the companies’ trade”.

HMRC claimed that the contributions were simply “Indirect Remuneration”. The defendants argued that if the contributions were remuneration, then the Finance Acts couldn’t prevent the corporation tax deductions being made.

The First Tier Tribunal noted from Scotts Atlantic Management that:

i) If any expenditure is incurred partly for a purpose other than trade, the “wholly and exclusively” test is failed.
ii) In order to determine the taxpayer’s objective when incurring the expense, the tribunal must “look into the taxpayer’s mind”.
iii) What matters is the objective of the contribution as opposed to its effect.
iv) Where a contribution is part of a wider set of arrangements, the relevant question is still the object of the contribution, not the purpose of the wider arrangements.

The tribunal found that the objective of the contributions were (at least in part) to provide funds to the directors in such a way as to defer (perhaps indefinitely) PAYE, NIC and Corporation Tax. They concluded that since the defendants didn’t produce any evidence that the directors instigated the contributions the “redirection of earnings” principle wasn’t applicable. And it was possible that the contributions resulted from the beneficiaries’ position as shareholders, rather than as directors or employees. The Judge asserted that an employee’s income is liable for Income tax even if they agree to it being redirected to a third party. They also rejected the notion that payments to employees could be assumed tax deductable unless the payment is “wholly and exclusively” for the purpose of trade.

Crucially, the defendants hadn’t offered any other explanation for their contributions. Their failure to identify the commercially beneficial reasons for contributing into a trust is likely what lead to the judgement against them, because all other such cases have demonstrated the validity of such trust structures.

LaingRose Limited specialise in delivering first class trust management services. If you’d like to learn more about how contributing to a trust could benefit you or your company, and would like to talk to a member of our friendly team without obligation, then fill in the call back request form to the right of this page. Or alternatively you can call us on 0845 388 9002.

Please be advised that Information provided in this article, or elsewhere on this website does not constitute any form of professional financial advice.