The glamorous world of Formula One does not often collide with the more cerebral realm of the First-tier Tribunal (‘FTT’), but this is precisely what happened in McLaren Racing Limited v HMRC  UKFTT 601 (TC). The case concerned whether McLaren could deduct a penalty imposed by the governing body of Formula One, the Federation Internationale de L’Automobile (‘FIA’), from its taxable profits.
In 2006, an employee of Ferrari passed confidential information about Ferrari (including information about Ferrari’s cars) to McLaren. The FIA investigated the matter and in 2007 McLaren was required by the FIA to pay a fine of around £32 million and suffered a points deduction which led to its income being reduced by around £17.6 million.
McLaren, by being in possession of and using proprietary information belonging to its rival Ferrari, had thereby breached the rules of the FIA’s International Sporting Code to which it was contractually bound. Accordingly, the penalty was not imposed by any statutory provision but under provisions to which McLaren was contractually bound as a participant in Formula One racing.
HMRC accepted that the reduction in McLaren’s gross income reduced its taxable profits, but contended that the £32m penalty was not deductible for corporation tax purposes. McLaren appealed to the FTT.
McLaren argued that the penalty was an expense or loss incurred wholly and exclusively for the purposes of its trade and was therefore deductible when computing its taxable profits.
HMRC argued that the penalty was not deductible and fell within either section 74(1)(a) or (e) of the Income and Corporation Taxes Act 1988 (‘ICTA’).1
Section 74(1) ICTA provided that in computing trading profits no sum shall be deducted 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.“
The FTT’s decision
The presiding member, Judge Hellier, held that the penalty was deductible for corporation tax purposes. He was of the view that, in the non-statutory context, where the actions which gave rise to a penalty could otherwise be said to have been for the purpose of the trade, it is only if the nature of the penalty is to punish a person and if there is a serious public policy which would be diluted by the tax deductibility, that the penalty should not be regarded as an expense of the trade. By analogy, a non-compensatory penalty for late completion imposed in a building contract made under the laws of a jurisdiction which made such a penalty enforceable could be a deductible expense.
In arriving at this conclusion, Mr Hellier had regard to the following:
- the penalty’s nature as an alternative to exclusion from trading activity;
- the commercial motivation for the penalty;
- the consideration given to the resources of the McLaren team; and
- the requirement that part of the penalty was a deduction of points.Accordingly, Mr Hellier concluded that the policy behind the penalty was intended to affect McLaren in its trade rather than as a person. The penalty was set so as to deter others from the same course of action in the pursuit of their trades, but the deterrence of others did not of itself point to a policy of personal punishment for McLaren.
The penalty was a commercial penalty designed to affect McLaren in its commercial activity. It was not of a like nature with a statutory penalty designed to be suffered by an individual. The motivating policy was not principally to punish McLaren in its person.
Even if the penalty was personal punishment of McLaren, there was not sufficient public interest in the nature of the conduct of motor racing as to be able to say that it would be preposterous to allow this penalty to be shared with the general body of taxpayers. The safety, health or well-being of the public were not at issue. The penalty was not levied for the protection of the public but mainly for the regulation of commercial activity.
Mr Hellier neatly summarised his conclusion as follows:
“This cost was not one imposed on McLaren, but one which it was contractually obliged to pay under contractual obligations undertaken for the purposes of its trade; it did not result from the action of an external regulator, but from a body to whose dictates it had agreed to submit as part of its trade and in order to gain income; it arose from the action of employees in pursuing a course of conduct normally for the benefit of its trade, not from actions unconnected with its trade; the penalty was motivated by commercial policy and was structured by reference to McLaren’s trade; the body imposing the penalty had commercial considerations more than the public interest in view; the protection of fairness in motor sport organised by FIA does not carry the same sort of public interest as that protected by a regulator of a profession based on trust. The penalty was something which arose from its trade, was connected with its trade and was incurred wholly and exclusively for the purposes of its trade.“
The other member of the tribunal, Mr Dee, did not agree with Mr Hellier’s conclusions. He considered that the nature of the penalty was to punish McLaren, and that this was sufficient to bring the penalty within section 74(1) ICTA. As the tribunal president, Mr Hellier’s view prevailed by virtue of the presiding member’s casting vote and McLaren’s appeal was successful.
Mr Hellier makes a clear distinction between a statutory penalty and a case like the present, where the incurring of the penalty arises as a result of a contractual obligation entered into by the taxpayer (in this case, the terms of McLaren’s participation in Formula One). It is a subtle distinction and one which divided the tribunal. It might seem somewhat ‘unfair’ for McLaren to be able to deduct from its taxable profits a fine imposed as a consequence of its wrong doing. However, the same could also be said in relation to the reduction in McLaren’s income, and subsequent reduction in taxable profit, which HMRC did not take issue with. This case highlights the difficulty faced by taxpayers and HMRC in determining when expenditure is incurred wholly and exclusively for the purpose of a trade, or is sufficiently connected with that trade to be tax deductible. The fact that the FTT was split in its decision (with the result having to be determined by the presiding member’s casting vote) demonstrates that the correct treatment of expenditure of this nature is far from clear and an appeal to the Upper Tribunal by HMRC seems likely.