Factual and Procedural Background
The Respondents, four energy companies, claimed corporation tax deductions for approximately £28 million paid to customers and charities under four regulatory settlements. Company A, the fourth Respondent, held gas and electricity supply licences; the other Respondents held electricity generation licences and bore some payments under an intercompany agreement. [1][2]
The settlements resolved investigations into mis-selling, payment-method pricing, energy-saving obligations, and complaints handling. The regulator found serious breaches of licence conditions and statutory obligations. Instead of imposing substantial financial penalties, it agreed to redress payments and remedial measures, imposing a nominal £1 penalty under each settlement. The Respondents made the agreed payments. [2][3][4][5][6][7][8]
- The mis-selling settlement provided £8.5 million for vulnerable customers, compensation for affected customers, and any unused balance for a charitable trust. [9][10][11][12]
- The payment-method pricing settlement required £750,000 for a public-awareness campaign. [13][14]
- The energy-saving settlement provided for £2.4 million to a charitable trust, payable by the Respondents and another company that subsequently left their group. [15][16]
- The complaints-handling settlement required £18 million in consumer redress, including up to £15 million for qualifying customers and the balance for agreed charities or, failing agreement, the Consolidated Fund. [17][18][19][20]
The First-tier Tribunal allowed a deduction only for £554,013 paid to customers directly affected by mis-selling, treating that amount as compensation. Both sides appealed. The Upper Tribunal held that none of the payments was deductible because all formed part of punitive settlement packages. The Court of Appeal reversed that decision and allowed deductions for all the payments. The Appellant tax authority appealed to the Supreme Court. [21][22][23][24][25][26][1]
Legal Issues Presented
- Why are penalties excluded from deductible trading expenses: because they fall outside section 54(1)(a) of the Corporation Tax Act 2009, or because a separate judge-made rule requires an adjustment under section 46(1)? [27][28][29][30][31]
- Were the redress payments sufficiently similar to penalties to be non-deductible, despite being agreed settlements benefiting customers and charities rather than substantial formal fines? [3][32][33][34]
- Should the £554,013 paid to customers directly affected by mis-selling receive different tax treatment from the remaining payments? [35]
Arguments of the Parties
Respondents’ Arguments
- The substantial payments were redress, not fines or penalties; only the nominal £1 penalties had formally been imposed. The redress payments therefore qualified as deductible expenses. [3]
- The payments were incurred wholly and exclusively for the trade. The restriction on deducting penalties arose from the policy of the legislation authorising punishment, rather than from failure to satisfy the trading-purpose test, and that policy did not require disallowing these payments. [36][37]
- The payments were voluntary and analogous to compensation for breach of contract, with the supply licence characterised as the relevant contract. Their payment to selected beneficiaries rather than the Consolidated Fund also distinguished them from penalties. [38][39][40][34]
- Relying on Herald and Weekly Times, the Respondents argued that some breaches were practically unavoidable incidents of operating the business, particularly during the transition to a new billing and complaints system. [41]
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Strong & Co of Romsey v Woodifield [1906] AC 448, 5 TC 215 |
A connection with trading is insufficient: expenditure must serve the purpose of earning trading profits. |
Applied to distinguish payments made in the course of trading from payments made for the purposes of the trade. [42][43][44][45] |
| Mallalieu v Drummond (Inspector of Taxes) [1983] 2 AC 861 |
A taxpayer’s conscious professional motive does not exclude another, non-professional purpose. |
Discussed as a leading authority on identifying expenditure’s purposes objectively. The Court found its interpretation of penalties consistent with the taxpayer-purpose authorities, but did not need to decide duality of purpose. [46][47][48][49][50] |
| MacKinlay v Arthur Young McClelland Moores & Co [1990] 2 AC 239 |
Purpose cannot be determined solely from the payer’s stated intention; an inevitable and inseparable result may itself constitute a purpose. |
Discussed as another leading authority on the wholly-and-exclusively test; no separate dual-purpose determination was necessary. [51][52][50] |
| Inland Revenue Commissioners v Warnes & Co [1919] 2 KB 444 |
A settled penalty for unlawful conduct was not a deductible commercial trading loss. |
The Court emphasised that the payment followed a settlement rather than a contested determination. It supported treating the present payments, made to avoid substantial penalties, as non-deductible. [53][54][55][34] |
| Inland Revenue Commissioners v Alexander von Glehn & Co Ltd [1920] 2 KB 553 |
A penalty imposed for breaking the law is not expenditure for the purposes of the trade, even where incurred during trading. |
Central authority for locating non-deductibility within the statutory trading-purpose test. Its settlement context also supported looking beyond the formal mechanism of payment. [56][57][58][55][59][45][34] |
| Herald and Weekly Times v Federal Commission of Taxation (1932) 48 CLR 113 (HCA) |
Defamation damages naturally resulting from newspaper publication were deductible; punitive penalties were distinguished from trading expenses. |
Distinguished because it concerned tort damages, not regulatory penalties or redress payments. The Court held that it had no role in determining deductibility here. [60][61][62][63] |
| Fairrie v Hall [1947] 2 All ER 141 |
Damages and costs for maliciously libelling a commercial rival were not deductible. |
Mentioned as an example of the limited application of Herald and Weekly Times; no separate application to the redress payments was made. [64] |
| G4S Cash Solutions (UK) Ltd v Revenue and Customs Commissioners [2016] UKFTT 239 (TC); [2016] STI 2207 |
Parking fines connected with a business were nevertheless not paid for its trading purposes. |
Discussed as an illustration of the distinction between connection with trading and expenditure for trading purposes. [65][66][67] |
| McKnight v Sheppard (1999) 71 TC 419; [1999] 1 WLR 1333; lower decisions [1996] STC 627 and [1997] STC 846 |
Legal costs incurred exclusively to preserve a trade could be deductible, while penalties were non-deductible because of their nature. |
The Court rejected the interpretation that this authority created a separate policy-based rule under section 46. Its present analysis concerned penalties only, not the deductibility of disciplinary defence costs. [68][69][70][71][72][73][74][75] |
| McLaren Racing Ltd v Revenue and Customs Commissioners [2014] UKUT 269 (TCC); [2014] STC 2417 |
A disciplinary fine was non-deductible, including because its punitive nature prevented deductibility even if paid to preserve the business. |
Reviewed as an application of the penalty authorities; the earlier tribunal rejected characterising misconduct as an unavoidable occupational hazard. [76][77] |
| NCL Investments Ltd v Revenue and Customs Commissioners [2022] UKSC 9; [2022] 1 WLR 1829 |
A judge-made rule can require an adjustment to accounting profits under section 46. |
The Court of Appeal relied on this proposition, but the Supreme Court rejected its premise that penalty non-deductibility arose from such a separate rule. [78][79][75] |
| [2022] UKFTT 41 (TC); [2022] SFTD 576 |
The first-instance decision distinguished compensatory payments from other punitive redress. |
The Supreme Court accepted the findings that the settlements avoided substantial penalties, but rejected separate treatment of the £554,013 customer payments. [80][81][21][22][38][35] |
| [2023] UKUT 218 (TCC); [2023] STC 1579 |
The payments required an overall assessment as punitive settlement packages, including the customer-compensation element. |
The Supreme Court agreed with the package-based treatment of the £554,013 and restored this decision disallowing all deductions. [23][82][24][25][35][83] |
| [2025] EWCA Civ 3; [2025] 1 WLR 2225 |
The intermediate appeal treated penalty non-deductibility as a section 46 adjustment that should not extend to payments that were not formally penalties. |
Reversed: the Supreme Court held that the relevant exclusion arose under section 54 and covered these penalty-like payments. [26][78][84][75][34][83] |
Court's Reasoning and Analysis
1. The statutory basis for excluding penalties
Section 46(1) requires trading profits to be calculated using generally accepted accounting practice, subject to legally required or authorised adjustments. Section 54(1)(a) denies deductions for expenditure not incurred wholly and exclusively for the purposes of the trade. [85][86][87][88]
The Court held that penalties fail the trading-purpose test itself. They punish wrongdoing and deter repetition; the taxpayer pays to answer for a breach, rather than to carry on the trade. Expenditure incurred during trading is not necessarily expenditure incurred for trading purposes. [59][89][45][74]
The Court of Appeal had misread McKnight. Its reference to the dilution of punishment through tax relief explained a consequence of allowing deductions, not an independent judge-made prohibition. The statutory exclusion remained grounded in the nature and purpose of penalty expenditure. [75][49]
Public policy reinforced that interpretation: a deduction would allow the taxpayer to share punishment’s financial burden with the public. The Court rejected the proposed alternative of regulators increasing redress amounts to offset tax relief, noting uncertainty about both the relevance of that consideration and the eventual tax treatment. [90]
2. The substance of the settlement payments
The Court rejected the description of the payments as voluntary. Although Company A could decline settlement, the tribunal had found that penalties of a similar magnitude would probably have followed, even after appeal. The payments therefore substituted for substantial penalties. [38][91][92]
Different tax treatment would also create an unjustified distinction between a regulated company settling an established breach and one contesting a more debatable allegation. This reinforced the conclusion that substance, rather than the settlement’s formal structure, governed the payments’ character. [93]
The licence obligations were statutory in character, not equivalent to contractual promises. The settlements were not private-law remedies designed to restore contracting parties to their former position. Published regulatory decisions linked the payments directly to findings of breach, the appropriateness of penalties, deterrence, compliance incentives, and any benefits obtained from non-compliance. [94][95][96][97][98][99]
Consequently, the payments were sufficiently akin to penalties to fall outside section 54(1)(a). Neither directing money to customers and charities instead of the Consolidated Fund nor recognising it as an accounting expense changed its nature for tax purposes. [34][100]
3. Compensation, culpability, and the limits of the decision
The £554,013 paid to customers directly affected by mis-selling was not separately deductible. It formed part of the overall regulatory bargain and was as much punishment for the breaches as the other payments, rather than equivalent to tort damages. [35][101]
The practical difficulty of avoiding some breaches did not change the result. The regulator had already considered culpability and mitigating circumstances when determining the payments. Those matters did not supply a further basis for tax deductibility. [41][63]
The Court acknowledged that other cases might present difficult boundaries between penalty-like payments and expenditure on achieving compliance. No such identification problem arose here. Because the payments’ nature excluded a trading purpose, the Court did not address duality of purpose; disciplinary defence costs were also outside the appeal. [102][50][73]
Holding and Implications
The appeal was allowed and the Upper Tribunal’s decision restored. None of the disputed redress payments, including the £554,013 paid to directly affected customers, was deductible in calculating the Respondents’ taxable trading profits. [25][35][83]
The decision establishes that these regulatory settlement payments were non-deductible under section 54(1)(a) because their substantive character was punitive, notwithstanding their designation as redress and their payment to customers or charities. It does not determine the treatment of all compliance expenditure or legal costs incurred in resisting regulatory proceedings. [73][34][102]