Vaines v HM Revenue and Customs

For income tax purposes, a partnership carries on one collective trade. Its profits must first be computed at firm level and then allocated under the profit-sharing arrangements. A partner cannot deduct personal expenditure from the share allocated to them.

Expenditure incurred by an individual partner may qualify only as an expense of the partnership trade. It must therefore satisfy the requirement in section 34 of the Income Tax (Trading and Other Income) Act 2005 that it was incurred wholly and exclusively for that trade. Protecting the partner’s career or position is insufficient where the expenditure was unrelated to the firm’s professional activities.

The statutory notional trade attributed to each partner concerns basis periods only. It does not create a separate trade for computing profits.

The taxpayer was a solicitor and member of a limited liability partnership. He paid €300,000 to settle claims arising from his former membership of an unrelated German law firm. The payment avoided the risk of bankruptcy and the consequent loss of his position in his current firm. He claimed its sterling equivalent as a deduction from his share of the current firm’s profits.

The First-tier Tribunal allowed his appeal, finding that the payment was made to preserve and protect his professional career or trade. The Upper Tribunal allowed HMRC’s appeal in [2016] UKUT 0002 (TCC). It held that the relevant trade was the current firm’s collective trade and that the payment was not incurred wholly and exclusively for its purposes.

The central issues were whether the taxpayer carried on a separate trade and whether the payment could be deducted in computing either the partnership profits or his allocated share.

1. Appeal dismissed. The only relevant trade carried on by the taxpayer during the tax year was the actual trade of the limited liability partnership. Section 863(1) of the Income Tax (Trading and Other Income) Act 2005 deemed that trade to be carried on collectively by its members. The legislation did not create separate trades for each partner when the profits of the firm were computed.

2. Sections 849 and 850 required the profits of the collective trade first to be computed as if the firm were a UK-resident individual and then allocated between the partners under the firm’s profit-sharing arrangements. The separate notional trade under sections 852 and 853 existed only for applying the basis-period rules. It arose after the firm’s profits had been computed and allocated.

3. An individual partner could not make a supplementary deduction from the share of partnership profits allocated to him. Expenditure incurred personally could obtain relief only as a deduction when calculating the profits of the partnership business. Any administrative practice allowing an adjustment outside the formal partnership accounts remained subject to the expense being allowable if paid from partnership funds and to its inclusion in the partnership tax return.

4. The payment failed the wholly and exclusively requirement in section 34. It settled a liability arising from the taxpayer’s former firm and protected him personally from bankruptcy and loss of his career. It was unrelated to the professional activities of his current firm. The firm had not assumed the liability or incurred the expense; it merely lent him the money, which he repaid. The taxpayer’s personal purpose therefore could not make the payment an expense of the partnership trade.

5. It was unnecessary to decide whether the payment would have been deductible had the firm incurred it, whether the taxpayer could have deducted it if he had carried on a separate trade, or whether it was capital expenditure. Henderson LJ gave the judgment. Newey and Sharp LJJ agreed.

1. Court of Appeal (Civil Division): Dismissed the taxpayer’s appeal and affirmed the Upper Tribunal’s conclusion that the expenditure was not deductible.
2. Upper Tribunal (Tax and Chancery Chamber): In [2016] UKUT 0002 (TCC), allowed HMRC’s appeal on the identity of the relevant trade and the wholly and exclusively requirement. It did not determine whether the expenditure was capital.
3. First-tier Tribunal: Allowed the taxpayer’s appeal. It treated him as carrying on an individual trade and found that his payment was made to preserve and protect his professional career or trade.