BIM37860 - Wholly and exclusively: expense of earning or application of profits?: ‘compensation for loss of office’ on share sale
Source: gov.uk (2025-01-20)


S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009

The cost of dismissing an employee for non-business reasons (for example to facilitate a share sale) is non-allowable

The costs of hiring and firing employees are generally allowable. But where the employee’s departure is linked to a matter such as sale of shares in the business, the costs may be disallowed. It is a question of fact whether the expenditure was incurred in earning profits or was a payment out of profits. If expended in earning profits, it is also a question of fact whether it was wholly and exclusively for the purposes of the trade.

In the case of Overy v Ashford Dunn & Co Ltd [1933] 17 TC 497, the company, whose three directors were also the sole shareholders, was engaged in a trade in which the control of the raw materials and of markets had passed into the hands of another company, Slate Slab Products Ltd. Slate Slab Products Ltd agreed to purchase all the shares in Ashford Dunn & Co Ltd from the shareholders. In accordance with provisions in Ashford Dunn & Co Ltd’s Articles of Association the vendors, on completion of the sale, resigned their directorships.

The agreement, to which Ashford Dunn & Co Ltd was a party, provided, amongst other things, that the vendors:
- were not to engage in a competing business within ten years of the sale
- were to be entitled to all book debts and were to discharge all liabilities of the Ashford Dunn & Co Ltd up to the date of sale, and
- were to keep indemnified both the Ashford Dunn & Co Ltd and the purchasers against all claims by directors, officers or servants for loss of fees or profits arising out of the agreement
At an extraordinary meeting that Ashford Dunn & Co Ltd held immediately before the completion of the sale of the shares, a resolution was passed providing for the payment to the retiring directors of £3,000 compensation for ‘loss of office’. This compensation, together with a further sum paid to the directors, under the same resolution, by way of remuneration, was the equivalent of the amount standing to the credit of the profit and loss account at the date of sale.

Evidence was accepted that the retirement of the directors was in the best interests of the Ashford Dunn & Co Ltd on the grounds that it enabled the trade to be conducted more economically, and that, in view of the controlling position of the purchasing company in the trade, Ashford Dunn & Co Ltd might in future be unable to earn profits.

Ashford Dunn & Co Ltd contended that the payment made in compensation for loss of office was a proper deduction in computing its profits for tax purposes, on the ground that it was a sum expended with a view to a direct and immediate benefit to the Ashford Dunn & Co Ltd’s trade. The General Commissioners allowed the deduction.

The Commissioners found that it was in the best interests of the company for the directors to retire for quite good business reasons. But there was no finding that the payment of £3,000 as compensation for loss of office was necessary to induce the directors to retire.

Finlay, J in the High Court held that the payment was not allowable because it was a distribution out of profits and not an expense incurred in earning profits.

Finlay J distinguishes the situation from that in Mitchell v Noble [1927] 11 TC 372 (see BIM38370 (https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim38370)) because there was no business reason to dismiss the directors in Ashford Dunn.

The part of Finlay J’s judgment on which the above guidance is based is set out below: