Relief for management expenses: Centrica v HMRC examined

The Centrica decision is about whether certain expenses incurred by the taxpayer in making a corporate disposal were deductible as "expenses of management" under Corporation Taxes Act 2009 section 1219 (respectively, "CTA 2009" and "s.1219").

The Centrica decision was pronounced by Judge Marilyn McKeever in the First-tier Tribunal, Tax Chamber (the "FTT") and therefore does not constitute binding precedent.  Moreover, the main ground of decision was a factual conclusion that "the [company claiming the deduction] ("COHL") did not itself carry out the management activities in relation to which the disputed expenditure was incurred" (Centrica decision at [235]).

The Centrica decision will not therefore dictate the result in other cases where the facts are different.  However, HMRC are likely to rely on the case where it supports their argument and it is likely to be the subject of comment in the media, so we will briefly comment on it below.

It is difficult to understand HMRC’s motivation in denying the relief for management expenses (as opposed to the costs of disposal) when:

• HMRC is actively consulting on measures to make the UK a more attractive jurisdiction to establish a holding company;
• If the top company had claimed a deduction but not re-charged the expense to COHL it would have been in a tax advantaged position for transfer pricing purposes and HMRC would have had to make an adjustment to its computations and confer a corresponding adjustment on COHL under UK transfer pricing legislation. This would have had the same effect as a successful management expenses claim, and would have by-passed the technicalities which the FTT found to be a bar for relief under s.1219; and
• If the Centrica decision is not overturned all the decision is likely to increase bureaucracy at corporate headquarters and result in cumbersome employment arrangements involving joint employments of key personnel.

Contents

The facts

The principal point in the FTT Decision

Subsidiary points in the FTT Decision

Discussion

Conclusion

The facts

The factual background to the Centrica decision was in some respects unusual:

• The claimant for the tax relief was COHL which is a subsidiary of the group of which Centrica plc is the top company (the "Group"), and had three directors, all of whom were executives of the Group. Examination of COHL's file at Companies House reveals that its Articles of Association - a public document - incorporated Regulations 70 – 72 of Table A in the Companies (Tables A to F) Regulations (SI 1985/805).  These provided that:
  "Subject to the provisions of the [Companies] Acts, [COHL's] memorandum and articles and to any directions given by special resolution, the business [of COHL was to be] managed by the directors who may exercise all powers of the company…"
• Regulation 71 empowered the directors by power of attorney or otherwise to appoint any person to be the agent of the company on such conditions as the directors [might] determine, including authority for the agent to delegate all or any of his powers.  Regulation 72 permitted the directors to delegate any of their powers to any committee consisting of one or more directors or to delegate to any director holding any executive office such of their powers as they considered desirable to be exercised by the delegate.  Regulation 72 also provided that the proceedings of a committee with two or more members had to conform to the provisions of the Regulation regarding proceedings of the directors but it is clear that this requirement did not apply to a single-member committee. Article 12(v) of COHL's articles of association echoed Regulation 71 in all material respects. The Board of COHL therefore enjoyed wide powers of delegation and there were no formal requirements in the COHL's articles of association regarding such delegation.
• COHL had a wholly-owned Netherlands subsidiary ("Oxxio") which in turn had a number of Netherlands operating subsidiaries operating in Europe.
• In the 2009-2010 period the Group wished to reduce its exposure to the European energy market. Initially the Group had hoped to carry out its intention simply by COHL selling the shares of Oxxio to a purchaser that had been identified (the "intended purchaser") but this proved impractical and a pre-sale reconstruction was carried out prior to the sale:
  • The presale reconstruction involved two subsidiaries of Oxxio, Nederland BV and CEN, transferring assets that the intended purchaser wished to acquire to two Newcos which were subsidiaries of Oxxio.
  • The sale therefore took the form of a sale of the shares in each Newco, together with the shares of another subsidiary of Oxxio.
• The claim for management expenses relief related to the fees of PwC,  De Brauw and Deutsche Bank for, respectively, accounting services, legal advice, and investment banking services in connection with the pre-sale reconstruction and sales of shares in the three companies transferred to the intended purchaser. These fees were paid by the top company in the Group but recharged by book entry to COHL, the claimant for the relief. Part of the fee payable to Deutsche Bank was contingent on the success of the deal.
• In the five lever arch files of documents before the FTT, there were only three extracts from minutes of meetings of COHL's directors: one in March 2019 relating to an increase in a subsidiary's equity; one in September 2009 relating to a working capital loan to another subsidiary; and one in July 2010 relating to a loan by COHL to a subsidiary.

HMRC did not challenge COHL's status as an investment company or that it had an "investment business" within the meaning of s.1219(2).  HMRC denied however that the claimed expenses were expenses of management, deductible under s.1219, for the following alternative reasons:

• the disputed expenditure did not represent an expense of COHL's investment business at all because it was not sufficiently connected to COHL's investment business;
• the disputed expenditure represented expenses of implementing a decision already taken – the decision in principle to make the sale was made in June 2009 but the expenses were incurred after that (COHL conceded  that fees attributed by time apportionment to the period after the Group board decided on 22 February 2011 to make the sale were expenses of sale and not expenses of management) see the Centrica decision at [34];
• as regards Deutsche Bank's success fee, the fee was inextricably linked to the success of the deal and so could not be an expense of management; and
• the disputed expenditure was capital in nature and so must be disallowed by virtue of s.1219(3).

The principal point in the FTT Decision

HMRC’s contention that the disputed expenses did not represent an expense of COHL's investment business at all was ultimately successful and was sufficient to decide the case in HMRC's favour.  The FTT's reason for upholding HMRC's contention was (in short) that "It is implicit in s.1219 that it must be the company (i.e. COHL) that manages its own business" (see the Centrica decision at [226]).

The FTT observed that "the only body which is authorised to carry on the management of a company's business is the board of directors of that company … the day-to-day management of a company's business is, legally, the province, [the FTT] would say the exclusive province, of the board of directors of the company or people to whom the board has delegated authority)" (see the Centrica decision at [226], emphasis added).

Subsidiary points in the FTT Decision

The FTT also concluded that the fees payable to De Brauw could not (quite apart from the point immediately above) have constituted expenses of management in full because most of the firm's work was detailed transactional work concerned with the documentation and processes involved in implementing the specific sale that was carried out. It is well established by Sun Life v Davidson (1957) 37 TC 330 (House of Lords) and other cases that expenses which are in effect part of the expenses of acquisition or disposal are not expenses of management. (The FTT did contemplate that the part of De Brauw's fees related to general advice on legal issues such as competition could be expenses of management but considered that only a relatively small amount of the firm's work was carried out prior to the decision to carry out the sale, which decision was made on 22 February 2011.  The FTT also observed that it was not appropriate to arrive at the deductible part of the fee by time-apportionment – any claim for deduction of part of fee would have to be based on a list of actual expenditure.)

The FTT further concluded that the De Brauw fees were of a capital (not a revenue) nature and could not be deducted for that reason (see the Centrica decision at [437].)

However, the FTT did conclude that, subject to the principal point above, the fees of Deutsche Bank and PwC incurred in reaching a decision to sell (and how to sell, and engagement with potential purchasers up to the point of a realistic offer being made by the purchase), would have been expenses of management and were of a revenue, not a capital, nature and would therefore have been deductible (see the Centrica decision at [342 ] and [434]). In this connection, the FTT did not consider that the contingent nature of part of Deutsche Bank's fees meant that that part was an expense of sale and non-deductible (see the Centrica decision at [392]).

The FTT also rejected HMRC's contention that the disputed expenditure could not be expenses of management because the expenditure was “not provided [sic] to COHL” and was not used by COHL to make any decisions: COHL did not actually sell any investments, because Oxxio made the decision to make the disposals which occurred (see the Centrica decision at [215] – [220]).  The FTT observed that an investment business does not consist solely of the purchase and sale of shares and that the aim of an investment business is to maximise the value of, and the returns from, its investments – in the case of a holding company such as COHL, its subsidiaries.  The FTT concluded that the fact that COHL did not dispose of anything was not, of itself, a bar to the disputed expenditure being an expense of management of COHL's investment business.

The FTT agreed with COHL that a decision could only be the implementation of a decision already made (as distinct from a decision in managing investments) if, when the decision is made:

• there is an identified purchaser considered to be satisfactory to the seller;
• the price is acceptable;
• the broad structure of  the sale transaction has been agreed; and
• the other terms of the deal are satisfactory (see the Centrica decision at [329]).

The FTT concluded that (on the facts) it was not until February 2011 (not June 2009 as HMRC claimed, by reference to the decision in principle to make the disposal), that expenditure became an expense of sale rather than an expense of management.

Discussion of the main ground of the FTT’s Decision

The FTT set out the material parts of the legislation at [7] and [8] of the Centrica decision.  It is clear that relief for management expenses is in principle available to "companies with investment business" as defined by CTA 2009 s.1218(1), that is, companies whose business consists wholly or partly of the making of investments.  The FTT stated that it was common ground between HMRC and COHL that COHL is an "investment holding company" (see [13] of the Centrica decision).  "Investment holding company" is however not defined in CTA 2009. The FTT may have intended to refer to the defined term “company with investment business” or to the definition of "investment  company” in the (repealed) Income and Corporation Taxes Act 1988, s. 75 - "any company whose business consists wholly or mainly in the making of investments". It seems however that nothing turned on these terminological distinctions, since HMRC are recorded as submitting that "the disputed expenditure did not represent expenses of management of COHL's investment business" which clearly amounts to a concession by HMRC that COHL was a company which had investment business and, probably, that COHL was a "company with investment business" as defined.

It is not clear from the Centrica decision what submissions were received by the FTT about the legal basis of decision-making within COHL, such decision–making being a matter emphasised by the FTT in the main ground of decision (see above),  although there are a number of remarks in the Centrica decision about how decisions were in practice made within the Group ([35] – [47] of the Centrica decision).

It is clear from the evidence that Ms Redcliffe, a director of COHL and also an employee of the top company in the Group, and her fellow directors, made many important decisions and carried out many important activities in relation to COHL's business (see [39] – [42] of the Centrica decision).  Ms Redcliffe said in evidence that it could be difficult to determine in exactly what capacity the decisions were taken (see the Centrica decision at [38]).  Although it is not clear from the Centrica decision what submissions were made about the company law aspects of the Group arrangements it is clear that as a matter of company law Ms Redcliffe’s duties as a director of COHL were owed to COHL, not to the top company in the Group, and her duties as director would override any potentially conflicting duties as an employee of the top company in the Group (see for example Boulting v ACTAT [1963] QB 606, Court of Appeal).

To the extent that decisions were taken by the top company in the Group (or other persons) in relation to COHL’s business, it seems therefore clear that the taking of those decisions was a management activity of COHL and, furthermore, a management activity of COHL's investment business.

It is appropriate to test, against that factual background, the FTT's assertions that:

“it must be the company itself (i.e. COHL) that manages its own business”; and "the only body which is authorised to carry on the management of a company's business is the board of directors of that company … the day-to-day management of a company's business is, legally, the province, [the FTT] would say the exclusive province, of the board of directors of the company or people to whom the board has delegated authority" (see the Centrica decision at § [226] (Emphasis added)).

Taking these assertions in turn:

• “it must be the company itself [i.e. COHL] that manages its own business"

It is not clear what the FTT is saying here. The "company itself" is a legal person that cannot speak or write or physically perform any other act of management.  Physical acts must therefore be performed on the company's behalf by other persons.  Those other persons may be individuals who are directors.  But they need not be, as is the case when the company appoints another company as manager.  This structure is frequently adopted by investment trust companies, which appoint external fund management companies as managers.  The activities of such fund management companies are supervised at relatively infrequent board meetings by the board of directors of the investment trust company.  But, subject to that, the management company has a wide discretion: in summary the board delegates much of the fund management to the management company, a delegation which is normally permitted by the investment trust company's articles of association. The activities of the fund management company in such cases must, as a matter of common sense, be regarded as management activities of the investment trust company's investment business, such that the fund management company's fees are expenses of management.  Yet the FTT in the Centrica decision did not seem to contemplate that possibility and examine whether COHL had delegated relevant management activities to the top company in the group (or indeed any other person). So the FTT's conclusion that "it must be the company itself [i.e. COHL] that manages its own business" appears flawed and incomplete.

• "the only body which is authorised to carry on the management of a company's business is the board of directors of that company … the day-to-day management of a company's business is, legally, the province, [the FTT] would say the exclusive province, of the board of directors of the company or people to whom the board has delegated authority"

At [227] of the Centrica decision this statement is repeated (" …the directors are the only persons who are authorised to manage the company's business")  with the significant omission of the underlined words.  The omission was critical in the Centrica decisions because the formulation in [227] shuts out the possibility of COHL's board of directors delegating the power to make management decision to the top company in the Group or to other persons such as Ms Redcliffe and her co-directors acting outside a board meeting.

The focus of the FTT on minutes of meetings of the directors of COHL also seems misplaced.   It is true that section 248 of the Companies Act 2006 requires "minutes of all proceedings at meetings of a company's directors" to be recorded and imposes a criminal sanction for default.  But the issue in connection with the Centrica decision is not whether there were proceedings at meetings of the directors, or how those proceedings were or should have been recorded, but whether COHL in fact made, whether through its board or some other delegate, the relevant decisions in relation to COHL's investment business.  Decisions of a company can, as a matter of fact, be made outside board meetings and if that is the case there appears to be no legal obligation to record such decisions by way of minutes or otherwise.  Examples of such "extra-meeting" decisions include decisions made by a delegate of the company (on its behalf) and informal decisions reached by all members of the board, which are as effective, as between the company and those with whom it deals, as decisions at a board meeting (Runciman v Walter Runciman plc [1993] B.C.C. 223  per Mr Justice  Simon Brown  at 230).

Further support for the need for a tax tribunal to look at the factual rather than the formal position is supplied by Unit Construction v Bullock (1958) 38 TC 712 (House of Lords), a case  not discussed in the Centrica decision.   In Unit Construction the Revenue relied on the relevant company's Articles and other formalities to reject a claim by the taxpayer that a company incorporated and operating abroad had its "central management and control" in the UK, when, as a factual matter, the company's business decisions were taken in the UK.  It is therefore important to distinguish between the making and content of a decision on the one hand, which is important for tax purposes, and the recording or evidence of the decision, which are the purposes of minutes, on the other hand. Minutes are only important for tax purposes in the present context as evidence of decisions made, and if evidence of decision-making is available from other evidence (such as oral testimony available to the FTT in the Centrica decision), the minutes have in themselves little relevance for tax.

The FTT's emphasis on the quantity of board minutes is also difficult to follow.  To take a hypothetical example, if a company were to dispose of its entire undertaking, that decision could be reached at a single board meeting and could in principle only be recorded in a brief minute, but that circumstance would not mean that the decision was taken otherwise than by the board or that the decision was not a (somewhat drastic) act of management of the business. Furthermore, despite the FTT's apparent concern with the capacity in which individuals (who were in fact directors) were acting in reaching decisions, it would seem that the important point was whether the decision-makers were directors (or otherwise authorised to act on behalf of the company) when they made the relevant decision, and examination of capacity is basically beside the point. ("Capacity" in another sense is relevant to the fact of decision-making: if a given individual is a director of several companies it may be necessary to establish on whose behalf the individual was acting, although no such issue arose in the Centrica decision.)

The FTT also did not discuss the retroactive effect of ratification, under normal principles of company law.  To the extent that the top company in the Group professed to act as agent for COHL from June 2009 (when COHL began to consider the disposal transaction), COHL's board approval of the transaction (which took place in February 2011) would have related back to the time when the relevant management decisions were being made (June 2009 – January 2011).

Conclusion on the main ground of the FTT's Decision and implications if it is maintained on appeal

The FTT should, it is respectfully suggested, have considered the factual evidence about decision-making in [35]-[46] of the Centrica decision and based its conclusion on whether the disputed expenses related to decisions in relation to COHL's investment business on that evidence. Instead, the FTT seems to have been unduly influenced by formalities (or the absence of such formalities), including minutes, to conclude that COHL did not carry out the relevant management activities, despite the wide powers of COHL's board of directors to delegate its functions to others (see above).

The Centrica decision does not fully explore the tax effects of one company in a group performing functions for others, i.e. the top company in the Centrica group performing services for COHL. The FTT found that the top company was indeed performing functions for the benefit of COHL (see the Centrica decision at [35] – [47] and [222]). In principle, therefore, if the top company had not recharged the costs to COHL, the UK transfer-pricing rules (Taxation (International and Other Provisions) Act 2010, (“TIOPA“, sections 146-217) would require that the top company recognise as a taxable receipt a  fee ("compensatory fee") which would, on an arm's length basis, include the revenue disbursements incurred in conducting the work.   The transfer pricing rules would not only have required an upward adjustment to the top company's profits, equal to the top company's out of pocket expenses plus the compensatory fee, but also a corresponding downward adjustment to COHL's profits if COHL so claimed (see TIOPA section 174). The FTT's denial of a management expenses deduction to COHL therefore seems to overlook the policy of UK tax legislation in relation to the taxation of services provided within groups (such as the Group) which calls for both the profits of the recipient of services and those of the service provider to be adjusted for tax purposes to an arm's length amount.

The FTT in the Centrica decision received an eloquent submission of COHL's counsel:

"s.1219 must be capable of working in the context of groups and if a deduction was denied in [the case before the FTT] it would mean that it would be virtually impossible for an intermediate holding company to obtain a deduction for its expenses of management and that the object of the legislation, to tax investment companies on their true profit, would be defeated" (see the Centrica decision at [233]).

The FTT's response was essentially based on what it called "corporate plumbing":

"It is not the case that s.1219 does not allow relief in group situations, but in order to obtain the relief companies must be conscious of the need for the ‘corporate plumbing’ to be properly installed and must ensure that the relevant investment company manages its own investment business, even if strategic decisions are taken elsewhere in the group" (see the Centrica decision at [234]).

The FTT seems to have asserted, without explanation, the need for appropriately installed "corporate plumbing".  The FTT did not refer to COHL's Articles of Association or statutory instrument 1985/805, which are public documents (see above) and which (on one view at least) provided such "corporate plumbing" as was necessary for the transaction carried out.  In particular, the FTT did not explain on what rational policy ground Parliament can have intended that such extra “plumbing” was needed as a condition precedent to the grant of relief for expenses of management.  Overall, the Centrica decision, with its emphasis on legalistic detail with respect to deduction of management expenses, does little to promote the UK government's aim of making the UK an attractive location for holding companies, which is the subject of a current consultation exercise.