McLaren, the British Formula One motor racing team, successfully argued that a £34m fine it had to pay for cheating is tax deductible. However, this success was the result of a casting vote by one of the Tribunal judges who found in favour of the taxpayer.

Background

In 2007 the taxpayer (“McLaren”) was required by the Federation Internationale de L'Automobile (the “FIA”) to pay some £32 million and in addition to suffer a reduction in its gross income of some £34 million. This penalty arose as the taxpayer had in some way used proprietary information belonging to Ferrari, and had thereby breached the rules of the FIA's International Sporting Code (the “ISC”) to which they were contractually bound. This penalty was not imposed by any statutory provision but under provisions to which the taxpayer was bound as a participant in Formula One racing.

HMRC argued that the penalty of £32 million was not a deductible expense. The case was brought before the First-tier Tribunal (FTT) which could not reach a unamious decision about the deductibility of the penalty. However, in accordance with regulation 8 of the First-tier Tribunal and Upper Tribunal (Composition of Tribunal) Order 2008 SI008/2835 gives a casting vote to the presiding member. Judge Hellier exercised that vote in favour of allowing the appeal.

Arguments

HMRC disallowed a deduction for the penalty incurred on the grounds that it fell within section 74 (1) TA 1988 which disallows a deduction for a sum in respect of:

• “(a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade or profession; ...
• “(e) any loss not connected with or arising out of the trade or profession.”

HMRC also claimed that the penalty arose from actions of the taxpayer's employees which was outside the scope of its trade. The penalty was not incurred in the capacity of trader but as a punishment. As such, the penalty did not arise from trade or was not connected with it.

Among the several arguments put forward by counsel for the taxpayer was that the fine was incurred because of the actions of the taxpayer's employees even if they were unauthorised and therefore it was incurred in the course of its trade. They also argued that the fine was not a punishment for the taxpayer but was more of a commercial deterrent to others and also the cost was an inherent risk of the taxpayer's trade.

Decisions

The Tribunal considered that the penalty could be described as an expense or a loss that fell within section 74 (1)(a) or (1)(e) TA 1988. Both 1(a) and 1(e) required consideration of the taxpayer's trade and the need to address the question – was the expense of the fine laid out wholly and exclusively for the purpose of the taxpayer's trade?

On the assumption by the Tribunal that the fine was contractually due, the expense was held to be incurred because of:

1. the taxpayer's entry into the Concorde agreement – an agreement to get money from Formula One racing and to divide it up between the participants,
2. the actions of the taxpayer and its employees in relation to using information on a competitor (Ferrari) to gain an advantage, and,
3. the decision of WMSC (World Motor Sport Council) to impose a penalty.

The Tribunal considered that if the purpose of 1 and 2 was wholly and exclusively for the taxpayer's trade and the action of WMSC was not to impose a penalty personally on the taxpayer that (1)(a) could not prevent a deduction for the penalty.

Examining the nature of the Concorde agreement, the Tribunal held that the taxpayer, by entering into the agreement, agreed to incur the liability that arose under it only for the purpose of earning profits in its trade.

The Tribunal, on consideration of the action of the taxpayer's employees, found no reason of policy or law to limit the description of the taxpayer's trade to “trying to make money by participating in Formula One racing subject to any rules imposed in the Concorde agreement” and consequently the employees actions could not be for the purpose of the trade. Rather, the Tribunal held that the activities of the employees could form part of the taxpayer's trade since attempting to obtain a sporting advantage could be taken to be for the purpose of the trade.

As a result unless (a) the policy of the rule under which the penalty was imposed shows that the penalty was in the nature of a personal punishment and (b) there was a public policy argument which requires the penalty not to be shared with the general body of taxpayers, the Tribunal held that the penalty was incurred for the purpose of the trade.

Considering the policy under which the penalty was imposed, the Tribunal's view was that the penalty “was a commercial penalty designed to affect McLaren [the taxpayer] in its commercial activity. It was not of a like nature with a statutory penalty designed to be suffered by an individual. It shared with criminal penalties the object of deterrence, but its motivating policy was not principally to punish McLaren in its person”.

Addressing whether the penalty was in the public interest, the Tribunal's view was “the safety, health or wellbeing of the public were not at issue”. The consideration of public policy did not require the penalty to be held disallowable; it was not levied for the protection of the public but mainly for the regulation of commercial activity.

The Tribunal concluded by finding that (1)(a) did not apply to prohibit the deduction of the penalty. Likewise, based on similar findings, the loss arose from the taxpayer's trade because it was bound up with its only source of income. Therefore, (1)( e) did not apply.

It is worth nothing that the decision of the Tribunal was not unanimous. The second judge considering the nature of the expense as a punishment held that the payment of £32 million should be disallowed as it was not laid out wholly and exclusively for the purposes of the trade within s74 (1)(a) and equally it was a loss not connected with or arising out of the trade in s74(1)(e).

However, the judge with the casting vote found in favour of the taxpayer as outlined above and therefore the appeal was allowed.

The full text of this case is available from http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j6744/TC02278.pdf