The Court of Appeal found for HMRC in the case of Centrica Overseas Holdings Ltd v HMRC, and this is a significant change to the previously understood treatment of certain expenses of a holding company in relation to disposals of subsidiaries.
Centrica had incurred significant costs in taking advice on how to dispose of subsidiary companies, which led to restructuring including a demerger. It claimed a corporation tax deduction for these costs, on the basis that they were expenses of management and not capital in nature. HMRC’s practice here, (in Company Taxation Manual 08260) is that “Once it has been decided to dispose of an investment in some way, any costs incurred after that point will be costs of the disposal and therefore capital.” The Manual also says ”…expenditure up to the point at which a decision is made to [dispose of] a particular investment will generally be non-capital”. This was in line with older case law, and the First Tier Tribunal and Upper Tribunal had approached the question on this basis.
The legislation was amended in 2004 to prevent a deduction for expenses of management which were capital in nature. The Court of Appeal agreed with HMRC that the FTT and the UT had confused the two different legal issues before them: the expenses of management issue and the capital expenditure issue. The Court said that the test as to what was capital expenditure was the same test as for trading expenses, in section 53 CTA 2009, which is the subject of a large body of case law. On that test, the expenditure which related to the proposal to dispose of a capital asset, was capital.
The taxpayer company argued for a purposive interpretation, in that if these expenses were not deductible, the company was being subjected to corporation tax on an amount greater than its economic profits (and certainly more than its accounting profits).
This is significant because the expenditure, as capital expenditure, is deductible only in computing the gain on the disposal, and only to the extent that it is reflected in the state or nature of the asset at the time of the disposal. Finally, it would have to fall within the restrictive wording in s38(2) TCGA 1992, and although this mentions fees paid to an accountant (and the main element of the cost in the Centrica case was fees to PwC), HMRC say in their Capital Gains Manual at CG15250 that “[an officer] should allow a deduction for fees paid to a professional adviser only to the extent that they are directly referable to the cost of acquiring or disposing of each particular investment.”
If the expenditure is deductible as capital, then this may not reduce the group’s tax if the disposal gives rise to a capital loss, which can’t be used in the circumstances. Furthermore, if the gain is exempt under the Substantial Shareholdings Exemption, the capital expenses, even if deductible, will not be relieved against the profits of the holding company, or available for group relief.
The effect of this case on the practice in this area means it may be worth scoping advice into separate phases, with a first phase to review the group and a second phase to advise on any disposals once they have been decided upon.
