With all the excitement of the 2015 Budget and then the General Election, we could be forgiven for focusing on entrepreneurial opportunities for our clients at the moment. Yet – remember that 5 April has come around again and with it the surge of accounts preparation for unincorporated businesses. We all know that many will be satisfyingly repetitive and need only a detailed but fairly mechanical process to complete. But then again, there will also be those instances that make us pause, the unusual expense where we stop to think - is it allowable for tax purposes? Am I certain?
To reassure that you are not alone in your dilemma, here are some hints on a couple of topics
This will be in point when the person who made the guarantee, perhaps a significant time previously, has been called upon to make the payment to the creditor in question, usually a Bank. Your client assumes that of course he can obtain tax relief in his own business for this unwelcome cost. Can he? The principle is:
A payment made under a loan guarantee is deductible only if:
- the guarantee, when it was made, was wholly and exclusively for the purposes of the trade; and
- a capital advantage is not secured by it
Note that it is the trade of the guarantor that is in issue not the debtor’s trade. It follows that a payment made by a guarantor following the principal debtor’s default is deductible if the giving of the guarantee was a normal incident of the guarantor’s business. The cases of Jennings v Barfield  40 TC 365 and Morley v Lawford & Co (1928) 14 TC 229 both provided support for the taxpayer’s claim.
Referring to the second point, a guarantee payment is likely to be a revenue expense if the guarantee is for a short period, and is made to help acquire or keep income-producing contracts. Again, it is the guarantor’s business we must examine, not that of the defaulting debtor.
Alternatively, if the guarantee was in place for a lengthy period and it helped secure an enduring business advantage for the trade of the guarantor, it could be viewed as capital. Even if the guarantee assisted an enduring improvement to the whole profit-making structure of the business it could be an advantage of a capital nature.
HMRC’s manual BIM45301 elaborates on both principles.
Ex-gratia payments are distinguished from contract payments by being made voluntarily and by not being legally enforceable. The proprietor making the payment might nevertheless consider they benefit the business and should be allowable as a deduction against his income. To guide him correctly, the key points are:
- did a personal element drive the payment?
- if entirely a business motive, is the payment capital or revenue?
There is little by way of case law relating to the first aspect. Nevertheless, HMRC would consider whether, for example, there was a family link with the recipient of the ex-gratia payment. Perhaps, the business owner chose to make an ex-gratia payment to a seemingly disgruntled customer who was also a relative. Did he make the payment so that his business would not fall into disrepute – or could he just not face the Christmas family party?
Having overcome the personal element hurdle, the distinction between capital and revenue arises. The relevant logic here is whether or not there is long-term benefit to the business. However, the circumstances can be borderline, as shown by case law.
The case of Cooke v Quick Shoe Repair Service (1943-1949) 30 TC 460 involved the purchaser of a business paying off the vendor’s debts to suppliers. The reason was to preserve the good name of his new business so that supplies would continue. This was held to be a revenue expense because retaining the supply of goods was the driver, accordingly it was deductible.
The alternative result came in Watneys London Ltd. v Pike  BTC 288. The taxpayer wished to remove some tenants from tied properties, yet did not want to suffer adverse publicity. Accordingly he made some ex-gratia payments to the tenants to persuade them to leave. Although the taxpayer argued on the basis that the payments were made to preserve the goodwill and therefore deductible, Walton J ruled that the payments were made for the long lasting benefit of the business, consequently of a capital nature and not deductible.
These are just two examples of the questions that can stop us in our tracks when preparing our clients’ accounts. Many more are examined in a new Bloomsbury Professional publication ‘A – Z of Business Tax Deductions’, written by Annette Morley and Nicola Moore. For further details of this aide to speed you through the annual accounts preparation or to order a copy, click here.
Annette Morley BSc Agric (Hons), MBIAC, CTA
Annette Morley is an experienced adviser in corporate and personal tax, in capital taxes and overseas tax issues. She is a qualified member of The Chartered Institute of Taxation and has been appointed vice-chair to the CIOT technical OMB sub-committee. Annette has written articles for several tax publications and presented tax seminars. She has specialist knowledge for the agricultural and rural business sector.