Can a company recover input tax incurred from paying legal fees in defending civil proceedings brought against its director? The UK First-Tier Tribunal (FTT) was of the opinion that the taxpayer company could in the case of Praesto Consulting v HMRC [2016] UKFTT 495.

The director of the taxpayer, Mr Ranson (Ranson) was formerly an employee of another company (CSP). Subsequently, he resigned and set up the taxpayer company (Praesto) to compete with CSP. CSP then brought an action against Ranson for breach of his contract of employment. In addition, CSP also wrote to Praesto as a proposed defendant, alleging that Praesto had defamed CSP and induced employees of CSP to join Praesto in breach of restrictive covenants in their employment contracts.

Ranson and Praesto instructed solicitors (Sintons) who wrote to CSP identifying their clients as both Ranson and Praesto. After an unsuccessful mediation between Ranson and Praesto on the one side and CSP on the other, CSP commenced proceedings but only against Ranson.

After the end of the proceedings, Sintons issued separate invoices to Praesto for work done until the commencement of proceedings and to Ranson for other work done. Praesto paid for all the invoiced. The HMRC did not dispute Praesto’s claim for input tax on the invoices addressed to Praesto but refused the claims in respect of all the other invoices issued to Ranson.

The HMRC contended that in order for Praesto to claim input tax, Sinton’s services must have been supplied to Praesto and have a direct and immediate link to its taxable activities.

The FTT found that both Ranson and Praesto had been clients of Sintons and all the work done by Sintons was on behalf of both Ranson and Praesto. It was irrelevant that Praesto was not a party in the proceedings as it was directly affected by the result.

The FTT reiterated the principle that in order for input tax to be recovered, “there must be a direct and immediate link between the transaction in which the input tax is incurred and the taxable person’s output transactions or the taxable activity as a whole” and that “the existence of a direct and immediate link depends on objective factors and the objective character of the transaction in issue”.

The FTT noted that for the purpose of finding the direct and immediate link, it is not sufficient that the supplied had benefitted Praesto.

In this instance, the FTT found that the direct and immediate link between the legal services supplied and Praesto’s taxable activities did exist. Praesto had made the profits from any breach of duty by Ranson. Hence, if the legal services had not been supplied to Praesto such that CSP’s claim was successful, Praesto would have to account for the profits of its past and future taxable activities. The supplies were thus found to have been made for the purpose of Praesto’s business.

Editorial Note 

It is noteworthy that the FTT did not regard the issue of the invoices to Ranson as a deterrent to Praesto’s claim but instead looked at the transaction as a whole to determine if supplies were made to Praesto. The substance of the transaction over its form was clearly emphasized (and rightly so) in the FTT’s decision.