BIM45031 - Specific deductions: entertainment: exceptions: normal course of trade for payment: judicial guidance
S46 Income Tax (Trading and Other Income) Act 2005, S1299 Corporation Tax Act 2009 (CTA 2009)
There must be a direct link between the expenditure incurred and payment received
Goods and services sold in the normal course of trade are not business entertainment and so the costs are an allowable deduction against trading profits (see BIM45030).
The exception applies where expenditure is incurred on the provision of anything which it is part of the ordinary course of the trade to provide for payment. The exception is aimed at the ordinary trading activities of businesses such as hotels that would otherwise fall foul of the legislation.
There must be a direct link between the expenditure incurred and the payment received. It is not sufficient for entertaining expenditure to be a ‘normal’ cost of the trade, although see BIM45030 for a discussion of the treatment of costs in relation to a service which is customary to a particular trade.
This was established in the case of Fleming v Associated Newspapers Ltd [1972] 48 TC 382. The company owned a number of newspapers and it was the normal practice of its journalists to purchase meals or drinks for ‘informants’ who would provide them with the necessary information to write the news articles which then appeared in the papers. It was argued on behalf of the company that the expense of these meals and drinks was part of the cost of producing the newspapers, which were subsequently sold for payment. The expenditure was therefore incurred in the ordinary course of trade for payment. Note that the later concept of ‘quid pro quo’ (i.e. something of equivalent value given in return, see BIM45014) was not considered in this case.
The House of Lords found that what is now S1299 CTA 2009 required the expenditure incurred to be directly linked to the goods or services for which payment was received. Although the hospitality provided was a necessary cost of producing the newspapers, the newspaper buyers were paying for papers and not for the refreshments given to the informants. As Lord Morris said (at page 408), ‘there is no trade or business of giving free hospitality’. It was also noted that, if the interpretation offered by Associated Newspapers had been correct, then much of the expenditure at which the legislation was aimed would be allowed.
There was some argument as to the real purpose of what is now S1299 CTA 2009 (and, by extension, S46 ITTOIA 2005). In the Court of Appeal Salmon LJ said that it had been introduced for the purpose of removing any doubt as to whether traders in the hospitality business could claim a deduction for the cost of services provided. This interpretation was reinforced by Lord Simon in the House of Lords. He said (at page 411) that what is now S1298 CTA 2009:
‘could hardly be more widely drawn. It has presumably been so drawn in order that avoidance contrary to the general objective of Parliament as expressed in the section should be extremely difficult… But then the draftsman has appreciated that in spreading the net so wide he has, inconsonantly with fiscal equity, caught certain expenses of particular trades where similar expenses of other trades would be deductible as ordinary business expenses and not treated as entertainment expenses. This is because the phrase “provide entertainment” is ambiguous. It can mean either “give hospitality” or “purvey the subject-matter of the entertainment (and perhaps also the catering) industry”. The draftsman therefore added [S1299 CTA 2009] to leave no room for argument that the ordinary trade expenses of the entertainment and catering industries are deductible in the same way as the ordinary trade expenses of other industries.’