BIM38220 - Wholly and exclusively: companies: cancellation of trade agreement

S54 Corporation Tax Act 2009

Whose purpose served by the cancellation?

Vodafone Cellular & Others v Shaw [1997] 69 TC 376 is an important case both from the viewpoint of the capital/revenue divide and the question of whether expenditure is wholly and exclusively for the purpose of the trade.

In that case, Vodafone entered into arrangements with an American company, Millicom Inc, to supply what was seen at the time as vital technological know-how to enable the company to set up and run a cellular mobile telephone network.

There were two agreements with Millicom. By one (‘the share agreement’), Millicom was granted its shareholding in the taxpayer and agreed to supply the initial know-how and technical support for a sum of £2m. By the other (‘the fee agreement’), Millicom confirmed the grant of the manufacturing licences to the taxpayer. This was necessary because the operating licence had been granted to a subsidiary and not to the taxpayer itself. Note that to comply with Department of Trade and Industry requirements that no one company run a network and sell telephones to subscribers, Racal formed two subsidiaries: one to set up and run the system and the other to sell the telephones.

In addition, Millicom agreed to supply the taxpayer with future know-how from time to time at the taxpayer’s request. In return, the taxpayer agreed to pay an annual fee equal to 10% of its consolidated pre-tax profits for 15 years with provision for losses to be carried forward.

The network was duly established. Afterwards, it transpired that Millicom’s know-how was not needed. Alternative technology was obtainable more cheaply elsewhere. The fee agreement became a liability and so the taxpayer approached Millicom and asked it to agree to bring the arrangements to an end. This was effected by two further agreements. By one the Vodafone’s ultimate parent company acquired Millicom’s shares in the taxpayer in exchange for an issue of new shares in itself. By the other, called ‘the fee cancellation agreement’, the taxpayer agreed to pay Millicom $30m for the extinguishment of its liability under the fee agreement. The taxpayer sought to deduct the $30m as a payment made wholly and exclusively for the purposes of its trade.

The Special Commissioners found that the expenditure was not incurred wholly and exclusively for the purpose of Vodafone’s trade. The expenditure had a duality of purpose. In the Court of Appeal, Millett LJ reviewed the applicable case law on wholly and exclusively and provided a very clear summary of the matters to be taken into account:

• the words ‘for the purposes of the trade’ mean ‘to serve the purposes of the trade’. They do not mean ‘for the purposes of the taxpayer’ but for ‘the purposes of the trade’, which is a different concept. They do not mean ‘for the benefit of the taxpayer’
• to ascertain whether the payment was made for the purposes of the taxpayer’s trade it is necessary to discover his object in making the payment. Save in obvious cases, which speak for themselves, this involves an inquiry into the taxpayer’s subjective intentions at the time of the payment (see BIM37050 and BIM38220)
• the taxpayer’s object in making the payment must be distinguished from the effect of the payment. A payment may be made exclusively for the purposes of the trade even though it also secured a private benefit. This will be the case if the securing of the private benefit was not the object of the payment but merely a consequential and incidental effect of the payment (see BIM37400)
• although the taxpayer’s subjective intentions are determinative, these are not limited to the conscious motives that were in his mind at the time of the payment. Some consequences are so inevitably and inextricably involved in the payment that unless merely incidental they must be taken to be a purpose for which the payment was made (see BIM37910 which, although related to expenditure by the self-employed, does discuss unconscious motives)

To these propositions Millett LJ added one more. The question does not involve an inquiry of the taxpayer whether they consciously intended to obtain a trade or personal advantage by the payment.

The Department of Trade and Industry insisted that the operation of the cellular telephone network and the sale of apparatus and service to subscribers must be undertaken by different companies. Accordingly, the taxpayer formed two wholly owned subsidiaries: one to operate the network and one to sell the apparatus and service. The operating licence was granted to the company which was to be responsible for operating the network. The Special Commissioners found that, in making the payment to Millicom to terminate the agreement, Vodafone had a dual purpose: to benefit its own trade and to benefit the subsidiaries’ trades.

Millet LJ explained the approach to adopt in determining the company’s purpose in making the payment. The primary inquiry is to ascertain the particular object that the directors sought to achieve by making the payment. Once that is ascertained, the characterisation of that object as serving the purposes of the trade of one particular company or another is not a finding of primary fact, but a conclusion based upon the primary facts.

Millet LJ examined the evidence before the Special Commissioners and concluded that there was nothing that supported the Commissioners’ view that there was duality of purpose. Therefore the expenditure was not disallowed by what is now S54(1)(a) Corporation Tax Act 2009. Rather, the immediate purpose of the payment was self-evidently to relieve Vodafone of an onerous contractual liability of its own trade. Any benefit to the subsidiaries’ trades from the expenditure was remote, and depended on internal arrangements between group members. The possible benefit to the subsidiaries did not necessitate the conclusion that the parent must have had a second purpose, that is a purpose other than the sole commercial purpose of its own trade, in incurring the expense. On the facts, as found by the Commissioners, any such benefit was merely an incidental effect of the expenditure.

The part of Millet LJ’s judgment describing what was required to pass the wholly and exclusively test is set out on pages 436-437:

`Whether a payment is made exclusively for the purpose of the taxpayer’s trade or partly for that purpose and partly for another is a question of fact for the Commissioners. The Court can interfere only if the Commissioners have made an error of law in reaching their conclusion. The principles on which the Court acts are to be found in the speech of Lord Radcliffe in Edwards v Bairstow & Another [[1955] 36 TC 207, see BIM37045], and are too well known to repeat. It is sufficient to say that the Court will interfere where the true and only reasonable conclusion from the facts found by the Commissioners contradicts the determination.

In the case of an individual taxpayer, the other purpose is usually a private purpose of his own. In a case like the present, where the taxpayer is a company forming part of a group, the other purpose is likely to be the purpose of the trade of one or more of the other companies in the group. But the same principles apply. The trade of a parent company is for tax purposes distinct from the trade of its subsidiary. The two companies are separate taxable persons, and the trade or business of one is not the same as the trade or business of the other, however closely it may affect it: see Odhams Press Ltd V Cook [[1940] 23 TC 233, a case which dealt with write off of a loan to a subsidiary, which is now dealt with under the loan relationship rules, see CFM30000], at pages 17, 19.

The leading modern cases on the application of the “exclusively” test are Mallalieu v Drummond [[1983] 57 TC 330,see BIM37910] and MacKinlay v Arthur Young McClelland Moores & Co. [[1989] 62 TC 704,see BIM38120]. From these cases the following propositions may be derived:

1. The words “for the purposes of the trade” mean “to serve the purposes of the trade”. They do not mean “for the purposes of the taxpayer” but for “the purposes of the trade”, which is a different concept. A fortiori they do not mean ‘for the benefit of the taxpayer’.
2. To ascertain whether the payment was made for the purposes of the taxpayer’s trade it is necessary to discover his object in making the payment. Save in obvious cases which speak for themselves, this involves an inquiry into the taxpayer’s subjective intentions at the time of the payment.
3. The object of the taxpayer in making the payment must be distinguished from the effect of the payment. A payment may be made exclusively for the purposes of the trade even though it also secured a private benefit. This will be the case if the securing of the private benefit was not the object of the payment but merely a consequential and incidental effect of the payment.
4. Although the taxpayer’s subjective intentions are determinative, these are not limited to the conscious motives which were in his mind at the time of the payment. Some consequences are so inevitably and inextricably involved in the payment that unless merely incidental they must be taken to be a purpose for which the payment was made.

To these propositions I would add one more. The question does not involve an inquiry of the taxpayer whether he consciously intended to obtain a trade or personal advantage by the payment. The primary inquiry is to ascertain what was the particular object of the taxpayer in making the payment. Once that is ascertained, its characterisation as a trade or private purpose is in my opinion a matter for the Commissioners, not for the taxpayer. Thus in Mallalieu v Drummond the primary question was not whether Miss Mallalieu intended her expenditure on clothes to serve exclusively a professional purpose or partly a professional and partly a private purpose; but whether it was intended not only to enable her to comply with the requirements of the Bar Council when appearing as a barrister in Court but also to preserve warmth and decency.’

The part of Millett LJ’s judgment explaining the approach to adopt in determining the company’s purpose in making the payment is set out on page 437:

`…in my opinion, the present case does not involve an inquiry whether the directors who resolved to enter into the fee cancellation agreement consciously intended to obtain a benefit thereby for one company rather than another. The primary inquiry is to ascertain the particular object which the directors sought to achieve by it. Once that is ascertained the characterisation of that object as serving the purposes of the trade of one particular company or another is not a finding of primary fact, but a conclusion based upon the primary facts.’

The capital/revenue aspect of Vodafone is discussed at BIM35585.