The Upper Tribunal (Tax and Chancery Chamber) allowed the appeal by the Revenue and Customs Commissioners against a decision of the First-tier Tribunal (Tax Chamber) in which the FTT had decided that a penalty paid by McLaren Racing Ltd for a breach of sporting code of the Federation Internationale de l’Automobile was deductible by McLaren in computing its taxable profits.

McLaren Racing Ltd v Revenue and Customs Commissioners: Upper Tribunal (Tax and Chancery Chamber): 17 June 2014

Deduction in computing profits – Expenses wholly and exclusively laid out for purposes of trade – Penalty – Formula One governing body imposing penalty on McLaren Racing Ltd for possessing Ferrari secrets or information

McLaren Racing Ltd (McLaren) was a well known Formula One motor-racing team. It designed, developed, manufactured and raced Formula One cars at grand prix events throughout the world. McLaren derived its income from sponsorship, advertising and payments under the Concorde Agreement.

The Concorde Agreement was an agreement with the other Formula One teams, the Federation Internationale de l’Automobile (FIA) and Formula One Administration Ltd (FOA), a company engaged in the promotion of the Formula One World Championship. The Concorde Agreement provided, among other things, for the commercial exploitation of broadcasting rights and other commercial activities in relation to Formula One which generated income for those involved.

Under the Concorde Agreement, the Formula One teams agreed to accept the Sporting Regulations of the Formula 1 Championship laid down by the FIA which were deemed to be imported into the International Sporting Code (ISC). The ISC was the document by which the FIA prescribed rules for the conduct of its motor sports events. The ISC took effect as an agreement among the FIA’s members which were national and other motoring associations in different countries. The ISC conferred on members the right to issue licences to participate in motor sports competitions such as the Formula One World Championship.

By accepting a licence, the holder, such as McLaren, agreed to be bound by the provisions of the ISC. Chapter XI of the ISC provided for penalties for breach of the ISC and regulation 153 provided for a scale of penalties. Article 27 of the FIA’s statutes provided that the World Motor Sport Council (WMSC), a committee of the FIA, could directly impose the sanctions provided for in the ISC. Starting in 2006, an employee of a rival Formula One team, Ferrari, had passed detailed plans and information about Ferrari’s cars to C, the chief designer at McLaren at the time.

In 2007, Ferrari discovered what had happened and asked the FIA to investigate. McLaren did not dispute that C had the information but argued that it had not been disseminated within its engineering team and that C’s possession of the information had not been authorised by McLaren. In July 2007, the WMCS decided to impose a penalty consisting of exclusion from and withdrawal of all points awarded to McLaren in all rounds of the 2007 constructors’ championship.

The effect of the decision was that, because it lost its points, McLaren lost that share of its income under the Concorde Agreement which had depended on its place in the World Championship. That resulted in a loss of income of $35.6m. The amount of the penalty payable by McLaren was $100m less the lost income, namely $64.5m or £32,313,341. McLaren sought to deduct the penalty it had paid as an allowable deduction in computing the amount of its profits to be charged to corporation tax.

Section 74(1) of the Income and Corporation Taxes Act 1988 provided, inter alia, that no sums should be deducted in respect of ‘(a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, or profession; … (e) any loss not connected with or arising out of the trade or profession; …’.

If the penalty fell either within section 74(1)(a) or (e) then it was not deductible by McLaren for the purposes of tax. The Revenue and Customs Commissioners refused to allow deduction of that penalty in the computation of McLaren’s taxable profits. McLaren appealed to the First-tier Tribunal (Tax Chamber) (the FTT). The FTT decided that the penalty had arisen from McLaren’s trade, had been connected with its trade and had been incurred wholly and exclusively for the purposes of its trade. Accordingly, McLaren had been entitled to deduct the penalty in computing its taxable profits. The Revenue appealed to the Upper Tribunal (Tax and Chancery Chamber) (the tribunal).

It fell to be determined whether the payment had been wholly and exclusively laid out for the purposes of McLaren’s trade.

The appeal would be allowed.

The WMSC had imposed the penalty because it had held McLaren to be responsible for the conduct of C, who had disseminated the information within the McLaren team. C’s conduct had not in the course of McLaren’s trade and had not been in the furtherance of that trade. Although it was accepted that one reason why McLaren had paid the penalty had been in order to avoid the far worse consequence of being excluded from the World Championship, which might have destroyed the business, it had not been paid for that purpose alone.

The penalty had also been paid because McLaren, through its employees, had engaged in conduct that had not been in the course of its trade and had incurred a liability to the penalty as a result. Although the payment could have had to be made a matter of commercial necessity, it had, at least as one of its purposes, the satisfaction of a legal obligation – a contractual obligation – arising as a result of activities which had not been in the course of McLaren’s trade. The penalty had been a disbursement or expense but it had not been money wholly and exclusively laid out or expended for the purposes of McLaren’s trade.

Accordingly, the penalty had not been an allowable deduction for computing the amount of McLaren’s profits to be charged to corporation tax (see [65] of the judgment).

Strong & Co of Romsey Ltd v Woodifield (Surveyor of Taxes) [1904-7] All ER Rep 953 considered; IRC v Warnes & Co Ltd (1919) 12 TC 227 considered; IRC v Alexander von Glehn & Co Ltd [1920] 12 TC 232 considered; Fairrie v Hall (Inspector of Taxes) [1947] 28 TC 200 considered; McKnight (Inspector of Taxes) v Sheppard [1999] 71 TC 419 considered.

Decision of First-tier Tribunal (Tax Chamber) [2012] UKFTT 601 (TC) Reversed.

Alun James (instructed by KMPG LLP) for McLaren; Akash Nawbatt and Christopher Stone (instructed by the General Counsel and Solicitor to Revenue and Customs Commissioners) for the Revenue.