Revenue And Customs v NCL Investments Ltd & Anor

The Court of Appeal held that accounting debits required by generally accepted accounting practice (in this case IFRS 2: Share-based Payment) and recognised in the taxpayers' profit and loss accounts are to be treated as "expenses" for the purposes of the Corporation Tax Act 2009 (in particular ss.46 and 48) and are deductible unless an express statutory provision requires adjustment. The court rejected the Revenue's submission that the word "incurred" in s.54(1)(a) of the 2009 Act introduces an additional requirement that an expense must reflect an actual or prospective legal outflow; instead "incurred" takes its colour from the defined term "expenses" in s.48. The debits in issue were also held to satisfy the "wholly and exclusively" purpose test in s.54(1)(a) because they recorded remuneration (share options) granted to employees whose services were consumed in the taxpayers' trades. The debits were not of a capital nature under s.53(1) and s.1290 (the employee benefit contributions restriction) did not apply to defer the deductions. The appeal was dismissed.

The appellants, HM Revenue and Customs, appealed from the Upper Tribunal which had dismissed HMRC's appeal against the First-tier Tribunal. The factual matrix involved group companies whose employees were granted options over shares in the holding company by an employee benefit trust (EBT); the subsidiaries recognised debits in their profit and loss accounts under IFRS 2 reflecting the fair value of those options and recognised corresponding capital contribution entries in their balance sheets, with a separate monthly recharge arrangement to the holding company.

The issues on appeal were primarily statutory construction issues concerning the Corporation Tax Act 2009: (i) the "incurred" issue — whether accounting debits recognised under GAAP but not reflecting any actual or prospective legal outflow could qualify as deductible "expenses" (ss.46, 48 and 54); (ii) the "purpose" issue — whether the debits were made "wholly and exclusively" for the purposes of the taxpayers' trades (s.54(1)(a)); (iii) the "capital" issue — whether the debits were items of a capital nature (s.53); and (iv) whether s.1290 (employee benefit contributions) applied to defer or deny the deductions.

The court set out and accepted the First-tier Tribunal's and Upper Tribunal's factual findings on accounting: the accounts complied with IFRS and IFRS 2 required the subsidiaries to recognise an expense for the services provided by employees, measured by the fair value of the options, and to recognise a matching capital contribution entry which the subsidiaries treated as reduced by the recharge.

On construction, the court concluded that ss.46 and 48 make accounting debits brought into account in accordance with GAAP the starting point for the calculation of trading profits and that s.54(1)(a) is a restriction directed to the purpose of expenses rather than importing an independent requirement that an expense must represent an actual or prospective legal outflow. Accordingly, the debits required by IFRS 2 were "expenses" for corporation tax purposes. The court held that the debits met the "wholly and exclusively" test because they reflected remuneration (options) forming part of employees' pay whose services were consumed in the taxpayers' trades. The debits were revenue, not capital, items and s.1290 did not apply because the grant of options constituted the employees' benefit and the acquisition or holding of shares by the trustee to satisfy exercised options was the fulfilment of contractual entitlements rather than a contribution of property under an employee benefit scheme that would trigger s.1290's deferral.

The Court of Appeal therefore dismissed HMRC's appeal, endorsing the treatment of IFRS 2 debits as deductible trading expenses in the circumstances of this case.

Appeal dismissed. The court held that (1) accounting debits required by GAAP and brought into account under ss.46 and 48 of the Corporation Tax Act 2009 are "expenses" for tax purposes and s.54(1)(a)'s use of "incurred" does not import an additional legal outflow requirement; (2) the debits satisfied the "wholly and exclusively" purpose test and were revenue in nature rather than capital; and (3) s.1290 did not apply to defer or deny the deductions. These conclusions meant the Upper Tribunal's dismissal of HMRC's appeal was correct and the Revenue's appeal to the Court of Appeal was dismissed.

Appeal to the Court of Appeal from the Upper Tribunal (Tax and Chancery Chamber) (Mann J and Judge Timothy Herrington UT/2017/0130) with permission to appeal to the Court of Appeal granted by Lewison LJ. The First-tier Tribunal (Judge Jonathan Richards) had allowed the respondents' appeals against closure notices; the UT dismissed HMRC's appeal; HMRC appealed to the Court of Appeal which dismissed the appeal ([2020] EWCA Civ 663).