Spc00703
INCOME TAX — director’s personal guarantee of company’s debts — director resigned from directorship and left company — guarantee then called on — whether payment made by director an allowable deduction — ITEPA 2003 s 336 — whether conditions satisfied — no — appeal dismissed

THE SPECIAL COMMISSIONERS

	A GUARANTOR	Appellant

	- and -

	THE COMMISSIONERS FOR			HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

Special Commissioner: Colin Bishopp

Sitting in public in Manchester on 21 July 2008

The taxpayer in person
Colin Smith of their Eastern England Appeals Unit for the Respondents

© CROWN COPYRIGHT 2008

DECISION
1.	The facts relevant to this appeal were agreed between the parties and can be stated quite shortly. The taxpayer was a director of a company, and held 5% of its issued shares. In 2002 the company found itself in acute financial difficulty and in September of that year it entered into a debt factoring agreement with a commercial factor. It was a condition of the agreement that the directors enter into personal guarantees in amounts which were proportionate to their respective shareholdings. A term of each director’s guarantee was that it should remain binding on him for a period of four months after he resigned from his office. For reason unconnected with the guarantee, the taxpayer resigned his office and left the company’s employment at about the end of the same month. Unfortunately the company failed in December 2002 and the taxpayer’s guarantee was called upon. There was a lengthy dispute between the taxpayer and the factor but in November 2004 the taxpayer made a payment to it of £10,925, with interest of £447 and legal costs of £1,600.
2.	In his tax return for the year to 5 April 2005 the taxpayer claimed a deduction for expenses of the aggregate amount he had paid, £12,972. During that tax year he had been in paid employment, and his earnings had correspondingly been subject to deduction of tax at source. If the claim was valid, he had paid too much tax, to the extent of £5,483.61, and this amount was paid to him very shortly after his return was filed. However, in May 2006 the respondents opened an enquiry in accordance with s 9A of the Taxes Management Act 1970. The enquiry led eventually to the issue of a closure notice on 27 February 2007, by which the claim was disallowed and the taxpayer’s return amended accordingly. He now appeals against that decision.
3.	He appeared before me in person, while the Commissioners were represented by Colin Smith of their Eastern England Appeals Unit. As the facts had been agreed I heard no oral evidence, though the taxpayer supplied some additional background information at my request.
4.	The parties are agreed that in order to succeed the taxpayer must show that the amount he paid falls within s 336(1) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). That subsection reads:
“The general rule is that a deduction from earnings is allowed for an amount if—
(a)	the employee is obliged to pay it as holder of the employment, and
(b)	the amount is incurred wholly, exclusively and necessarily in the performance of the duties of the employment.”
5.	Following provisions of ITEPA deal with particular kinds of expenses, but it is common ground that none applies here. It is also common ground that s 336(1), which came into force with effect from 2003-04, replaced without amendment the legislation in force in 2002-03, that is s 198(1) of the Income and Corporation Taxes Act 1988.
6.	The taxpayer’s argument is that, as a director of the company, he was obliged to enter into the guarantee. The company was in financial difficulty and had exhausted all other possible sources of finance. He had a duty, as a director, to its creditors, employees and, after them, its shareholders to maintain the company’s solvency. If, as in this case, there was only one available means of achieving that objective, it followed that the expenses incurred by a director when availing himself of those means were wholly and necessarily incurred in the course of his employment.
7.	For the respondents, Mr Smith advanced several arguments. It was well-established, he said, that the subsection must be applied strictly, and that all of the conditions it imposed must be complied with. They were that the expense must be one that every holder of the office in question would be required to incur; the expense must be necessarily incurred; it must be incurred in performing the duties of the employment; it must be both incurred and paid while the employment subsists; and it must be wholly and exclusively so incurred. These propositions were derived from the observations of Lightman J in Ansell v Brown [2001] STC 1166. At [8] he said:
“The hurdles in front of a claim to entitlement to a deduction under s 198 are formidable. For over 40 years the courts have referred to the conditions for entitlement as stringent, exacting and rigid. The explanation given for conditions of this character is that a relaxation would have the effect of distorting the imposition of income tax and make the amount of any expenses claimed depend on the choice of the individual taxpayer (see Fitzpatrick v IRC (No 2) [1994] STC 237 at 246 per Lord Templeman). The conditions include: (1) the expense must be incurred in the performance of the duties of the office. It is not sufficient that the expense is incurred for the purposes of enabling the employee to prepare or qualify himself to perform his duties or for rendering or keeping the employee fit (or improving his fitness) for performing his duties as an employee (see Simpson (Inspector of Taxes) v Tate [1925] 2 KB 214, approved and applied by Lord Templeman in Fitzpatrick [1994] STC 237 at 242-243); (2) it is not sufficient that the employer requires the employee to incur the expenditure: what is required is the duties themselves must oblige the employee to incur the particular outlay (see Brown v Bullock (Inspector of Taxes) [1961] 1 WLR 1095 at 1102 per Donovan LJ; and Taylor v Provan (Inspector of Taxes) [1975] AC 194 at 220 per Lord Simon of Glaisdale); (3) the expense must be one which the employee is necessarily obliged to incur in the performance of the duties of the employment: the expense must be such as is imposed on anyone and everyone employed to perform the duties in question by the requirements or necessities of being so employed. The test is objective, and the right of deduction does not extend to expenses which are not so required but arise because of circumstances personal to the particular employee or are the result of his own volition. It is not sufficient that the expenditure is incurred in order to enable the office holder to perform his duties (see Taylor v Provan (Inspector of Taxes) [1975] AC 194 at 206-7, 212 and 226).”
8.	The expense in this case, Mr Smith argued, did not satisfy any of the tests. It could not be said that every director of a company was obliged to guarantee the company’s debts, indeed until September 2002 the taxpayer, though a director of the company, did not guarantee its debts. Since it was not the duty of a director to guarantee a company’s debts, it could also not be said that the expense was necessarily incurred in the performance of the taxpayer’s duties. It might be the case that, had the directors refused to enter into the guarantees, the company would have ceased to exist, but that was a consequence of the company’s poor financial position; the directors could perform their duties as directors without entering into guarantees. He relied on Ricketts v Colquhoun [1926] AC 1, where the House of Lords drew the distinction between expenses incurred in the performance of the duties, which were deductible, and those incurred in putting the taxpayer in a position to perform the duties, which were not, and on Ryall v Hoare [1923] 2 KB 447 in which commissions paid to a director by a company were found to be taxable as annual profits or gains within what was then case VI of Schedule D, and not as emoluments of the employment. Those decisions, he said, were consistent only with the conclusion that a director’s duties did not include guaranteeing the company’s debts. The taxpayer’s guaranteeing the company’s debts may have enabled it to continue to trade, and to that extent it enabled him to perform his duties, but it was not something he did in the course of those duties.
9.	In addition, he said, the taxpayer in this case had incurred none of the expense for which he now claimed relief in the course of his employment. He ceased to be a director in 2002, but did not incur any expense until he made the payment in November 2004. He had no more than a contingent liability when he left office; by the time it crystallised he was no longer in that employment, and it could not be said that the expense was incurred in the course of carrying out his duties. For that conclusion Mr Smith relied on Hinsley and another v HMRC [2006] STC (SCD) 63, in which the Special Commissioner distinguished between the incurring of a liability—there, as here, a contingent liability—and the expense to which, if the contingency occurs, it gives rise. He concluded that relief is available only in respect of a payment made in the course of carrying out the employment. That could never be the case when the payment was made after the employment had come to an end.
10.	Mr Smith argued too that, even if all the other relevant conditions were satisfied, the expense had not been incurred wholly and exclusively for the purposes of the taxpayer’s employment since, whatever his primary purpose and motive in entering into the guarantee, it had also the purpose of protecting his investment in the company and his own position as its director and employee. In support of that argument he referred me to Executive Network (Consultants) Limited v O’Connor [1996] STC (SCD) 29 in which the Special Commissioners concluded that sponsorship payments made by the taxpayer company to the controlling shareholder’s wife, who owned a riding school, conferred more than an incidental benefit on her.
11.	It was not a case in which the taxpayer could obtain no relief for the payment, but it was due, not under s 336(1) of ITEPA, but under s 253 of the Taxation of Capital Gains Act 1992, which was designed for this purpose. Mr Smith relied not merely on the proposition that the taxpayer had sought relief under the wrong provision, but also on the fact that Parliament had provided a purpose-made provision, which, he argued, was a clear indication that s 336(1) was not intended to afford the relief the taxpayer sought.
12.	I do not doubt that the company’s circumstances were such that its only possible avenue of escape, unsuccessful though it turned out to be, was to enter into the factoring arrangement which obliged its directors to provide guarantees, that the taxpayer entered into the guarantee because he considered he had little alternative, and that he did so for purpose of discharging his duties as a director, with little if any thought to the benefit (meagre as it was) he might gain from it personally, but I am compelled to agree with Mr Smith that relief for the payment he eventually made is not available to him under s 336(1). I think Mr Smith’s argument that the payment is disqualified for relief because not every company director is obliged to give a personal guarantee for the company’s debts may well overstate the position, but I do not need to determine how that aspect of the test is to be applied since, in every other respect, I am persuaded that his arguments as I have set them out are sound. 
13.	In particular, it seems to me an inescapable conclusion that the expense, as distinct from the contingent liability, was not incurred in the course of the taxpayer’s employment, but only after it had come to an end, with the consequence that it cannot be said that the expense was incurred in the course of the employment, and that the taxpayer gained some benefit, albeit in the event very short-lived, from the company’s ability to continue to trade. Indeed, the very fact that, by entering into the guarantee the taxpayer discharged his duty as an officer (rather than employee) of the company bestowed some benefit on him.
14.	I have considerable sympathy for the taxpayer since, because he has no gains against which the loss might be offset, the possibility of his obtaining relief under s 253 of the 1992 Act is academic and, I understood, likely to remain so.  Nevertheless, it is clear that this appeal must be dismissed.

COLIN BISHOPP
SPECIAL COMMISSIONER
Release Date: 5 August 2008

SC/3034/2008

Authorities referred to in the skeleton arguments but not mentioned in the decision:
Hillyer v Leake (Inspector of Taxes) [1976] STC 490
Lomax (Inspector of Taxes) v Newton [1953] 2 All ER 801
McKie (Inspector of Taxes) v Warner [1961] 3 All ER 348