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Scottish Power’s compensation payments were non-deductible

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If you've been mis-sold energy you could be entitled to compensation, but what are the tax implications of those payments for the energy companies themselves? Scottish Power found out in a recent Upper Tribunal that these payments were non-deductible.

5th Oct 2023
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The Upper Tribunal (UT) has ruled that redress payments made by Scottish Power to consumers for mis-selling were punitive in nature and so not tax deductible. This was an appeal by the taxpayers and a cross-appeal by HMRC in relation to a decision of the first tier tribunal (FTT) in February 2022.

In 2013, energy company Scottish Power was ordered to pay out approximately £28m in penalties and redress payments, including £8.5m to vulnerable consumers and charities. This followed an investigation by energy regulator Ofgem which found the energy provider in breach of regulations in several areas, including:

  • mis-selling – insufficiently robust training and monitoring of doorstep and telesales resulted in misleading information provided to customers;
  • cost-reflectivity;
  • energy saving – the company failed to meet prescribed carbon emission reduction targets; and
  • complaints handling.

In 2022 Scottish Power appealed to the FTT to have the amounts deducted from its taxable trading profits. The appeal was unsuccessful except in relation to £554,013 paid directly to customers under the mis-selling settlement.

These amounts were made to "make good the loss the customer had suffered". This gave the payments a compensatory rather than a punitive nature, so the FTT concluded that they were wholly and exclusively for the purposes of the trade, hence deductible.

The remaining payments were, according to the FTT, in the nature of penalties and thus not deductible according to section 54(1)(a) CTA 2009. HMRC's argument, with which the FTT agreed, was two-fold. First that the penalties were imposed to punish the appellants and were therefore punitive in nature and second that the penalties arose as a result of the company conducting elements of its trade in a wrongful manner, thus the payments could not have been made for the purposes of that trade.

In considering this argument, the FTT had referred to various cases including HMRC v McLaren Racing Ltd, where the upper tribunal held that "a deliberate activity contrary to contractual obligations and which could lead to the destruction of the trade was not part of the trade".

While Scottish Power appealed to the upper tribunal in relation to the amounts dis-allowed, HMRC cross-appealed regarding the £554,013 that had slipped through the FTT's net.

The FTT was mistaken

The UT had two main issues to consider: whether or not the FTT had been correct in deciding that the majority of the payments were disallowable – the taxpayer's appeal; and whether the £554,013 "compensatory" payments had been correctly allowed – HMRC's cross-appeal.

In relation to the amounts disallowed, the UT agreed with the FTT that payments in respect of a penalty, or in lieu of penalties, were non-deductible. The taxpayer's appeal was dismissed.

Turning to HMRC's appeal, the UT considered that the FTT had been wrong to distinguish between punitive payments and compensatory ones.

It agreed with HMRC's argument that the £554k, although "in a sense compensatory", was part of a package that was penal in nature.

The judge commented: “The caselaw shows that one has to characterise the payments in the light of all the evidence. If the facts are such that the payments were comprised within a wider package, as they were here, then that is just as much part of the payment's character and falls to be evaluated as such. Having reached the views that it did about the package, in our view it was wrong for the FTT then to distinguish parts of the package on the basis that they had some of the characteristics of compensation.”

The UT found that the FTT had erred in law in concluding that the £554k was deductible. HMRC's appeal was allowed.

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paddle steamer
By DJKL
10th Oct 2023 15:32

CIR v Alexander von Glehn & Co Ltd [1920] 12 TC 232,

One of the few tax cases I recall from university, usually applied to parking fines etc.

https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim38520

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