The taxpayers, wholly-owned subsidiaries of the holding company, made staff available to other companies within the corporate group. The trustees of an employee benefit trust established by the holding company granted options to staff employed by the taxpayers during the years 2009–2010, 2010–2011 and 2011–2012 entitling them to acquire shares in the holding company. The options, regarded partial remuneration of those employees, were contractual rights as against the trustees and did not purport to give the employees any proprietary rights over shares. The taxpayers recognised indebtedness to the holding company when options were granted through a monthly recharge equal to the fair value of the options although a significant number of options were not exercised and lapsed. They passed the cost of the recharge to the group companies using their employees’ services as part of the charge to those companies. By section 46(1) of the Corporation Tax Act 2009 as in force at the relevant time, the profits of a trade had to be “calculated in accordance with generally accepted accounting practice (“GAAP”), subject to any adjustment required or authorised by law in calculating profits for corporation tax purposes.” Section 48 of the 2009 Act provides “(1) In the Corporation Taxes Acts, in the context of the calculation of the profits of a trade, references to receipts and expenses are to any items brought into account as credits or debits in calculating the profits. (2) It follows that references in that context to receipts or expenses do not imply that an amount has actually been received or paid.” Section 54 of the Act provides “(1) In calculating the profits of a trade, no deduction is allowed for (a) expenses not incurred wholly and exclusively for the purposes of the trade, or (b) losses not connected with or arising out of the trade. (2) If an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part or identifiable proportion of the expense which is incurred wholly and exclusively for the purposes of the trade.” Section 1290 of the Act sought to ensure a broad balance between the point at which a company could claim relief for an “employee benefit contribution”, as defined under section 1291 of the Act, and the point when the employee received taxable “qualifying benefits” out of that contribution under section 1290(2) of the Act. Take-up or otherwise of the options had no impact on the deductions claimed by the taxpayers when computing their profits for the purposes of corporation tax liability. HM Revenue and Customs issued a closure notice disallowing the deductions on the basis that debits to the profit and loss accounts of the taxpayer companies, required by generally accepted accounting practice (“GAAP”), were not permissible. The First-tier Tribunal (Tax Chamber) allowed the taxpayers’ appeals having found it proper for the taxpayers to treat the recharge as reducing capital contribution with the result that the income statement in their year-end accounts recorded the debit as required by International Financial Reporting Standards (“IFRS”) 2, which was the applicable standard for the grant of share options, but no capital contribution appeared in the balance sheet because it was treated as at the balance sheet date as having been repaid by the recharge. The Upper Tribunal (Tax and Chancery Chamber), dismissing the revenue’s appeal held that (i) the debits were “expenses” for the purposes of section 48 in the absence of any express statutory provision to the contrary and the fact that the debits were validly recognised in the taxpayers’ income statements in accordance with GAAP was sufficient for sections 46 and 48 to apply and cause them to be treated as expenses for the purposes of section 48 with it being of no consequence that the expense recognised by the application of IFRS 2 did not reflect any money actually spent by the taxpayers, (ii) the word “incurred” withing the meaning of section 54(1)(a) of the Act did not impose an additional requirement on what was an “expense” under sections 46 and 48, and that section 54(1)(a) ensured that dual purpose expenses were not deductible by requiring expenses to be incurred wholly and exclusively for the purposes of the taxpayers’ trades, (iii) the First-tier Tribunal correctly categorised the debits as revenue rather than capital items, and (iv) the First-tier correctly held that section 1291 did not apply on the basis that shares in the holding company were held or acquired by the trustee to satisfy options if exercised with the consequence that section 1290 did not apply to deny or defer allowance of the debits as “employee benefit contributions”.
On the revenue’s appeal—
Held, appeal dismissed. (1) Section 48 of the Corporation Tax Act 2009 was a definitional provision. Read with section 46, it clearly encompassed all credits and debits brought into account in accordance with GAAP, which included the debits brought into account in accordance with IFRS 2 in the present case. Section 48(2) was not restricted to amounts either physically paid or incurred as enforceable obligations or included in accounts as provisions against what was likely to be spent in future years. Section 54(1)(a) was a provision to which section 48 applied. Construing the word “incurred” in section 54 to qualify “expenses” so that expenses would have been incurred as a matter of legal liability or be a prospective liability for which a provision should be made was not permissible given the definitional effect of section 48(1)(2) in the absence of any express provision to the contrary pursuant to section 48(3) of the Act. The Upper Tribunal therefore correctly interpreted sections 46, 48 and 54 because the combined effect of sections 46 and 48 was to define allowable expenses as those debits made in accordance with GAAP in calculating the profits of a trade and no further examination of whether such accounting debits were “expenses” was required. It was sufficient that the debit in respect of the options was required by IFRS 2. The word “incurred” in section 54(1)(a) did not impose any additional requirement (paras 29, 32, 34, 35, 36, 39, 50).
(2) It was necessary when identifying the purpose of a debit in the context of section 54 to investigate the underlying reason for the debit. The First-tier Tribunal correctly found that the debits in the present case were required by IFRS 2 to reflect the consumption by the taxpayers of the services provided by the employees, who were in part remunerated by the grant of the options. The taxpayers consumed those services “wholly and exclusively” for the purposes of their trades, being the provision of their employees’ services to other group companies at a profit. It followed that the purpose requirement of section 54(1)(a) was satisfied irrespective of whether the taxpayers were in fact paying for the grant of the options although the fact that the taxpayers paid for the grant through the recharge also showed that they had a purpose in making the debits that went beyond simply complying with GAAP and was directed solely at carrying on their trades. The debits were required to be made in the taxpayers’ profit and loss accounts because they represented the consumption of services provided by the employees to the taxpayers for the purposes of their trades and both the First-tier Tribunal and Upper Tribunal correctly held them to represent revenue rather than capital items (paras 54, 55, 59).
(3) To read section 1291(1) as being capable of leading to the conclusion that the grant of options by the trustee were “employee benefit contributions” meaning that no deductions were allowable for the relevant debits ignored the context created by section 1290. There was no direct definition of “employee benefit contributions” dependent wholly on section 1291(1) for any meaning. A contribution resulting in property being held or used under an employee benefit scheme suggested a payment or transfer from which benefits would be provided to employees, which was expressly contemplated by section 1290(2)(a) of the Act. The benefit received by the employees in the present case was the option, which entitled them to acquire shares at a price at potentially less than their market value. Any subsequent acquisition of shares was the fulfilment of an existing contractual entitlement and not the benefit received by the employee. Therefore, section 1290 did not deny or defer allowance of the debits relied on by the taxpayers. Accordingly, there were no grounds to interfere with the Upper Tribunal’s decision (paras 77, 78, 79, 80, 81, 82).
Julian Ghosh QC and Jonathan Bremner QC (instructed by General Counsel and Solicitor to HM Revenue and Customs) for the revenue.
Jolyon Maugham QC (instructed directly) for the taxpayers.