ScottishPower v HMRC: Penalty Disallowance Limited to Actual Statutory Fines; Regulatory Consumer Redress Payments Are Deductible

Introduction

In ScottishPower (SCPL) Ltd & Ors v HMRC [2025] EWCA Civ 3, the Court of Appeal (Lady Justice Falk giving the judgment, with Snowden and Zacaroli LJJ agreeing) addressed a foundational issue in the taxation of regulated businesses: the scope of the rule that fines and penalties are non‑deductible when computing taxable trading profits. The central contest was whether that rule also disallows deductions for substantial “consumer redress” payments made under contractual settlement agreements to resolve Ofgem/GEMA regulatory investigations, where the regulator correspondingly imposes only nominal statutory penalties.

HMRC argued that payments “in the nature of” penalties, or “in lieu of” penalties, fall within the penalty disallowance. ScottishPower argued that the non‑deductibility rule is confined to actual fines and penalties; these redress payments were not penalties in form or substance, were incurred wholly and exclusively for the purposes of the trade, and were deductible.

The case arose from several Ofgem investigations (2013–2016) into mis‑selling, complaints handling, cost reflectivity, and energy saving obligations. ScottishPower made about £28 million of consumer and third‑sector payments under settlement agreements; GEMA then imposed only nominal statutory penalties of £1. HMRC denied deductions for the £28 million. The First‑tier Tribunal allowed only a small compensatory element; the Upper Tribunal disallowed everything on a “global” punitive characterization. The Court of Appeal allowed ScottishPower’s appeal in full.

Summary of the Judgment

• The Court confirmed the long‑standing rule (from von Glehn, as explained in McKnight v Sheppard) that fines and penalties imposed under a statutory regime are not deductible. However, it located that rule as a “judge‑made adjustment” required by law under section 46 CTA 2009, not as an interpretation of “wholly and exclusively” in section 54(1)(a).
• Crucially, the Court held that the penalty disallowance does not extend to payments which are not in fact fines or penalties, even if they are agreed in settlement and even if they “replace” or are financially equivalent to potential penalties.
• The regulator’s objectives and characterisation (deterrence, punishment, or consumer benefit) are not determinative. For tax purposes, the focus under section 54(1)(a) remains the taxpayer’s purpose in incurring the expenditure; the separate, clear bar is the judge‑made penalty disallowance, confined to actual fines/penalties.
• On the facts, only nominal £1 penalties were imposed pursuant to section 27A Electricity Act 1989; the remaining sums were contractual “consumer redress” payments and not penalties. The payments were incurred wholly and exclusively for the purposes of the trade (a conclusion unchallenged on appeal) and, therefore, were deductible.
• The Upper Tribunal erred in adopting a “global assessment” of a punitive character, conflating compensatory and deterrent purposes, and treating the entire package as a penalty substitute. The Court rejected any such extension, citing uncertainty, lack of authority, and constitutional concerns (creating new tax disallowances is for Parliament).

Analysis

Precedents and Authorities Considered

• Commissioners of Inland Revenue v Alexander von Glehn & Co Ltd [1920] 2 KB 553:
  The archetypal authority that statutory fines/penalties are not deductible, notwithstanding they may arise in the course of trade. The Court of Appeal in ScottishPower endorses von Glehn but clarifies its rationale through Lord Hoffmann’s later analysis in McKnight: disallowance is grounded in legislative policy—allowing a deduction would dilute the statutory penalty’s purpose by sharing its burden with the public.
• McKnight (HM Inspector of Taxes) v Sheppard [1999] 1 WLR 1333 (HL):
  Lord Hoffmann explained von Glehn: non‑deductibility stems from the nature of fines/penalties and the legislative policy behind them. He distinguished fines (non‑deductible) from legal expenses of defending disciplinary proceedings (deductible), emphasizing that non‑deductibility rules depend on the nature of the expenditure and the specific policy of the regime under which it becomes payable. ScottishPower leverages this to confine the penalty disallowance to actual fines/penalties.
• The Herald and Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 (HCA):
  Damages for libel paid by a newspaper were deductible because they flow from the essence of the publishing trade. The case is used to illustrate that liabilities arising from trading activities are generally deductible unless a clear policy-based disallowance applies (as with statutory penalties).
• NCL Investments Ltd v HMRC [2022] UKSC 9:
  Under section 46 CTA 2009, profits are computed in accordance with GAAP “subject to any adjustment required or authorised by law.” The Supreme Court noted that such adjustments are generally statutory; judge‑made adjustments are possible only where it is clear they apply despite GAAP. ScottishPower places the penalty disallowance squarely in this category: a clear, long‑standing judge‑made adjustment, but one that must be tightly confined.
• McLaren Racing Ltd v HMRC [2014] UKUT 269 (TCC):
  A non‑statutory Formula One penalty was non‑deductible, but fundamentally because the misconduct (wrongful receipt/dissemination of a rival’s confidential information) was not incurred in the course of the trade at all. ScottishPower uses McLaren to show the distinct strand of non‑deductibility where expenditure is not “for the trade” in character, separate from the penalty disallowance.
• Warnes & Co Ltd [1919] 2 KB 444 and Strong & Co v Woodifield [1906] AC 448:
  Early authorities on the meaning of “for the purposes of the trade” and on penal liabilities not being trading losses. ScottishPower acknowledges them but emphasizes that HMRC relied only on section 54(1)(a) CTA 2009 and that, in any event, the FTT’s finding that the payments were wholly and exclusively for the trade was unchallenged.
• Smith’s Potato Estates Ltd v Bolland [1948] AC 508; Mallalieu v Drummond [1983] 2 AC 861:
  Cited to contrast costs logically subsequent to earning profits (Smith’s Potato) and the centrality of the taxpayer’s purpose under section 54(1)(a) (Mallalieu). In ScottishPower, the “purpose” test was satisfied and not in dispute before the Court of Appeal.

Legal Reasoning

1. Locating the penalty disallowance in section 46 CTA 2009:
   The Court reasons that the non‑deductibility of statutory fines/penalties is best understood as a judge‑made adjustment “required by law” under section 46 CTA 2009 (profits per GAAP, subject to adjustments). This aligns with NCL: while most adjustments are statutory, a clear, settled judge‑made rule may operate. Von Glehn (as explained by Lord Hoffmann) supplies that rule—grounded in preserving the integrity of legislative penalty policy—without importing it into the purpose test in section 54(1)(a).
2. Strict limits: only actual fines/penalties are caught:
   There is no authority for extending the von Glehn rule to payments that are not, in fact, fines or penalties. The Court rejects the “in lieu of penalty” extension for three reasons:
   • Textual and doctrinal: section 54(1)(a) is about the taxpayer’s purpose, not the regulator’s; the disallowance rule depends on the nature of the payment (is it a penalty?), not the context or motivation.
   • Certainty and constitutional restraint: NCL cautions against uncertain, judge‑made adjustments; creating a broader anti‑avoidance‑style rule would be for Parliament, not courts.
   • Policy coherence but no policy vacuum: differences in tax treatment between penalties and alternative redress do not undermine the regulatory regime; regulators can lawfully take tax effects into account when choosing between penalties and consumer redress.
3. Application to Ofgem/GEMA settlements:
   Under section 27A Electricity Act 1989, penalties must be paid into the Consolidated Fund. In ScottishPower’s settlements, only nominal £1 penalties were imposed, and the remainder were contractual redress payments to consumers/third‑sector beneficiaries. GEMA could not redirect a statutory penalty to consumers. Therefore, the £28 million were not penalties in law or substance, even though Ofgem had earlier floated headline penalty figures and acknowledged a pound‑for‑pound substitution in one case during negotiations. The legal character of the payments controls: they were redress, not fines.
4. Regulator’s purpose is irrelevant to deductibility:
   The UT relied heavily on GEMA’s deterrence/punishment aims. The Court explains that s.54(1)(a) is concerned with the taxpayer’s purpose (Mallalieu); regulatory aims matter only to identify whether a sum is truly a penalty. Here, the statutory framework and settlement mechanics confirm these were not penalties.
5. No “global punitive” characterisation; apportionment preserved:
   The UT’s “global assessment” of punitive character was an error. Even had a mixed character been relevant, section 54(2) CTA 2009 allows apportionment for identifiable parts incurred wholly and exclusively for the trade. More fundamentally, the Court holds that drawing a line between “compensatory” and “punitive” is not the determinative test. Payments need not be compensatory to be deductible; if they are not penalties and they meet s.54(1)(a), they are deductible.
6. Consumer redress orders (post‑2014):
   The Electricity Act now provides express powers for consumer redress orders (ss.27G–27N), which GEMA must consider alongside penalties. The Court notes the close similarity between such orders and the “voluntary” redress here. HMRC’s approach produces arbitrary lines. The Court’s narrower rule avoids that uncertainty.

Impact and Practical Implications

The judgment provides important clarity for regulated businesses across sectors (energy, financial services, communications, water, competition/consumer, and beyond) that routinely resolve enforcement through redress packages.

• Tax treatment of settlements:
  - Actual statutory fines/penalties remain non‑deductible (the von Glehn rule as a section 46 adjustment).
  - Contractual or statutory “consumer redress” payments are not disallowed merely because they accompany, influence, or replace potential penalties.
  - Deductibility still requires that the s.54(1)(a) “wholly and exclusively” purpose test is met; where, as here, the payments are made for trade purposes (managing regulatory exposure, customer relations, brand protection), deduction follows.
• Negotiating with regulators:
  Regulators can legitimately take account of relative tax treatments when deciding between a penalty and consumer redress. Businesses can propose redress packages without fearing an automatic tax disallowance by analogy to fines.
• Accounting and documentation:
  Maintain clear documentation distinguishing any statutory penalties (paid to the Consolidated Fund or equivalent) from redress payments (paid to consumers/third parties). Identify the business purposes for redress to support s.54(1)(a) compliance and any necessary apportionment under s.54(2).
• HMRC practice and guidance:
  HMRC will have to recalibrate the “payments in the nature of penalties” approach and the UT’s “global assessment” method. Expect updates to HMRC’s Business Income Manual on fines/penalties and settlements.
• Potential legislative response:
  If Parliament wishes to disallow specific categories of settlement redress (for example, those serving a punitive/deterrent function), it will need to legislate expressly, in line with NCL’s emphasis on statutory clarity.
• Related contexts:
  - Non‑statutory disciplinary penalties may still be non‑deductible for separate reasons (e.g., expenditure not incurred in the course of the trade, as in McLaren).
  - Payments under express statutory redress powers (e.g., energy redress orders, and analogues in other regulated fields) should, under this reasoning, generally be deductible if not themselves denominated as penalties and if the s.54(1)(a) purpose test is met.

Complex Concepts Simplified

• Section 46 CTA 2009 “judge‑made adjustment”:
  Taxable profits start with GAAP accounting profits. Courts recognize a small number of clear, long‑standing, non‑statutory adjustments—one is: actual fines/penalties under statute are not deductible. ScottishPower puts that rule firmly in s.46, not in s.54.
• Section 54(1)(a) “wholly and exclusively”:
  Deductibility depends on the taxpayer’s purpose in incurring the expense. If the sole purpose is a trade purpose (e.g., managing regulatory risk, preserving reputation, maintaining customer relations), the test is met. The regulator’s purpose (punishment/deterrence) is not the legal test for s.54(1)(a).
• Penalty vs Redress:
  A statutory penalty is the legal sanction paid into the public purse (here, the Consolidated Fund). Redress payments compensate, remediate, or benefit consumers/third parties and are commonly contractual (or made under statutory redress powers). Only the former are automatically non‑deductible under the von Glehn rule.
• “In lieu of penalties”:
  A convenient negotiating label does not transform redress into a penalty. The law looks at legal form and substance: was a statutory penalty imposed? If not, the payment is not caught by the penalty disallowance.
• Global punitive characterisation:
  The UT’s approach of treating the entire settlement as “in the nature of a penalty” is rejected. Even in mixed cases, s.54(2) allows apportionment where parts can be identified as wholly and exclusively for the trade.
• Consolidated Fund:
  Where statute mandates that penalties be paid to the Consolidated Fund, a regulator cannot redirect that penalty to consumers. If money is paid to consumers or charities, it is not the statutory penalty.

Key Takeaways from the Decision

• The non‑deductibility of statutory fines/penalties is a clear, judge‑made adjustment under s.46 CTA 2009. It does not live inside, or expand, s.54(1)(a).
• There is no general rule that “payments in lieu of penalties” are disallowed. Only actual fines/penalties are automatically non‑deductible.
• Regulators’ deterrent or punitive aims do not determine tax treatment. The taxpayer’s purpose governs s.54(1)(a); here, that test was satisfied.
• Consumer redress—contractual or under statutory redress powers—will typically be deductible if it is not itself a penalty and meets s.54(1)(a).
• The UT’s “global assessment” approach and punitive characterization were wrong in principle and unworkable in practice.
• Courts will resist expanding judge‑made disallowances beyond clear boundaries; any broader disallowance of settlement redress is a matter for Parliament.

What the Case Does Not Decide (and Remaining Caution Areas)

• Non‑statutory penalties:
  ScottishPower deals with a statutory regime. Other regimes (e.g., private disciplinary systems) may engage different principles (including whether the expenditure is incurred in the course of the trade at all).
• Express “in lieu” legislative mechanisms:
  If a statute expressly re‑characterises a payment as a penalty “in lieu” (and dictates where it is paid), that could alter the tax analysis.
• Charitable deduction route:
  The FTT rejected treatment of certain payments as charitable donations; that point was not pursued on appeal and is unaffected by this decision.
• Illegality and other specific disallowances:
  This case does not relax any statutory prohibitions or established case law disallowing deductions for certain unlawful payments or capital/non‑trading disbursements.

Conclusion

ScottishPower v HMRC decisively clarifies the boundary of the penalty disallowance in UK tax law. The court affirms the von Glehn rule as a clear, judge‑made adjustment under section 46 CTA 2009, but insists on its strict limits: it applies to actual fines and penalties imposed under statute, and no further. Attempts to extend that rule to “payments in lieu” or to impose a “global punitive” characterisation on settlement redress are rejected as uncertain, unsupported by authority, and constitutionally inappropriate.

The practical upshot is both principled and workable. Regulated businesses can confidently deduct consumer redress payments made to resolve investigations, provided they are not themselves statutory penalties and meet the ordinary “wholly and exclusively” test. Regulators remain free to weigh the relative merits of penalties versus redress, including tax effects, without undermining their enforcement mandate. If broader disallowances are desired, it is for Parliament to legislate expressly. This judgment therefore restores doctrinal coherence, aligns with NCL’s insistence on clarity in judge‑made tax adjustments, and provides a stable framework for the tax treatment of regulatory settlements across the economy.