Upper Tribunal comments on unpaid trading expenses cast doubt on HMRC income tax guidance on interest free loans under FRS 102

Wed 08 May 2019

In confirming the First tier Tribunal (FTT) decision in NCL Investments Ltd and Smith & Williamson Corporate Services Limited the Upper Tribunal (UT) made comments that call into question HMRC’s guidance on the application of FRS102 for income tax purposes in relation to deductions for interest free loans. The particular point at issue in the case only related to claims for share option deductions still under enquiry for accounting periods ending before 20 March 2013.  For those subject to income tax, however, the FRS 102 point may be of interest. Income taxpayers denied a tax deduction for FRS102 accounting deductions on the unwinding of net present value adjustments in respect of interest free loans  may wish to review their position and make claims accordingly.

For a further discussion of the implications of this case for your business, please get in touch with a member of the Mazars corporate tax or personal tax teams.

More about the UT decision

The case concerned the application of CTA 2009 part 12 (and s1038 in particular) for accounting periods ended before 20 March 2013, i.e. before it was amended to prevent the ability to obtain tax deductions for accounting entries for share options in addition to the actual expenses incurred in relation to issuing those options.

The comments of the UT with respect to when an expense is incurred wholly and exclusively for the purposes of a trade, however, call into question HMRC’s guidance on the application of FRS102 for income tax in relation to non-deductibility of accounting debits on unwinding net present value adjustments for interest free loans (see section 5.11 of this HMRC guidance).

See here for a summary of the FTT decision.  Below is a summary of the points considered at the UT.

Were the share option debits expenses incurred wholly and exclusively for the purposes of the trade?

HMRC argued that:

• the FTT erred in holding the accounting expense could represent an accounting debit in calculating the profits of a trade for tax purposes;
• that no expense had been incurred as no money had been spent in respect of the IFRS2 debits;
• an accounting expense which relates to monies neither actually spent, nor to be spent, could not have any purpose for being incurred wholly and exclusively for the purpose of a trade.

The UT considered that the combined effect of CTA 2009 s46 and s48 meant that if the expense is brought into account in the taxpayer’s income statement for statutory accounts purposes, then that can be an expense even if no money has actually been paid out.  This is subject to any statutory provision to the contrary and the UT found there were no contrary provisions for this expense. As the accounting expense related to part of the remuneration package of employees, the UT considered the FTT were fully entitled to consider there was no purpose for that expense other than for the trade.

In contrast to the emphasis which HMRC placed on the word ‘incurred’ in CTA 2009 s54, the UT agreed with the FTT that this section did not impose an additional requirement to CTA 2009 s46 and s48.  Rather, it prevented deduction for expenses which had a dual purpose.

Were the IFRS2 debits of a capital nature?

HMRC argued that the fact that the corresponding credit to the IFRS2 debit was recognised in shareholder funds, meant the expense was of a capital nature.  In contrast, the UT considered the credit to shareholder funds did not determine the tax treatment.  Rather, it was necessary to look at the nature of the transaction giving rise to the need to record the expense in the income statement, which the UT considered were clearly revenue transactions.

Did CTA 2009 s1038 prevent a deduction?

In the form in which CTA 2009 s1038 existed prior to 20 March 2013, it only prevented deductions for expenses directly related to the provision of shares.  CTA 2009 s1015 and s1018 provide for relief under CTA 2009 part 12 where an employee obtains a share option, acquires shares meeting certain conditions as a result of that option and is, or (in the legislation as in place at the time of the case) would be, charged to income tax.

HMRC considered that the relief could be available without being given, and therefore was not given until the option was exercised and the shares acquired.  However, in order for s1038 to deny relief for the accounting debits it would have to apply at the time the accounting debits were claimed.  As the accounting debits do not relate directly to shares acquired, s1038 could not apply to deny the accounting debits.

Could CTA 2009 s1038 deny a deduction?

CTA 2009 s1038 at the time relevant to the case prevented a deduction for a contribution to the EBT unless qualifying benefits were provided within nine months of the year end.  This prevents the tax deduction until the benefits are provided if the nine month time limit is exceeded.  HMRC argued that this provision was engaged, as property held in an EBT was plainly within the definition of an employee benefit scheme.  It therefore considered deductions in relation to the options covering that property were not deductible until the property was provided.

The UT agreed with the FTT that the shares held by the EBT were held to satisfy the company’s obligation to the employee, not to satisfy a requirement of the EBT.  The UT also added it would have been easy for Parliament to deny a corporation tax deduction for an employee expense that did not match what was taken into account for income tax and national insurance, but they did not.