Centrica vs HMRC: What does Supreme Court ruling on tax deduction mean for businesses?

Just last week, Centrica, the FTSE 100 owner of British Gas, lost an appeal against the tax agency over the treatment of professional services fees. So what does this mean for the future of professional fees?

Centrica’s investment arm, Centrica Overseas Holdings, acquired four subsidiaries of Dutch company Oxxio in July 2005.

However, the deal didn’t go to plan and around mid-2009, Centrica decided to sell Oxxio. Following a lengthy process, the investment business sold the assets in 2011.

Its advisers on the deal, Deutsche Bank, PwC and De Brauw racked up fees of £2,529,697 between 2009 to 2011. It went on to claim relief for the £2.5m expenditure in its tax return for the accounting period ending 31 December 2011, but was denied by HMRC.

This issue went to the Supreme Court, but last week the highest court in the UK dismissed the case as Lord Justices held that the expenditure was capital in nature and, therefore, not deductible under the Corporation Tax Act.

On the Supreme Court decision, Adam Craggs, partner and head of tax disputes at RPC, noted that it “is significant as it considers, in some considerable detail, the important capital/revenue principle and the meaning of ‘expenses of management’.”

Warren Howells, a corporate tax partner at Andersen, stated that it was “no surprise that the Centrica case went in favour of HMRC”. He noted that “the decision is a kick in the teeth for UK holding companies that took an aggressive approach to the deduction of transactional cost”.

Craggs added that the ruling “will come as a major disappointment to investment management companies that buy and sell capital assets, as the decision means that it is unlikely that they will be able to obtain a tax deduction for such expenditure”.

McDermott Will & Emery’s tax lawyer Sarah Gabbai explained that “the tax deductibility of deal costs has always been a grey area, and this case is no exception”.

She suggested that “the decision muddies the waters even further”, explaining that “since advisory fees incurred on assessing divestment options (amongst others) were disallowed as capital expenditure, which may come as a surprise to many”.

Going forward, Gabbai noted that those “looking to restructure and sell off distressed assets in the process are likely to be particularly vulnerable to this treatment”, she urged those to “take advice accordingly”.

While Camila Carvalho, associate director at Factor Risk Management, went on to explain that this decision came “after a long and costly litigation”, as she urged businesses to be “aware of how they can safeguard themselves in tax disputes.”

She detailed that “tax insurance could have provided protection against the risk of HMRC disallowing the deduction of the £2.5m expenditure and mitigated the financial impact of the Supreme Court’s decision”.

The associate director noted that tax insurance would have allowed Centrica to have “more accurate financial planning and budgeting, reducing the uncertainty and potential financial strain resulting from the dispute with HMRC and the subsequent legal proceedings”.

“With this ruling showing the impact of such tax disputes on businesses, we expect to see an upsurge in the usage of such products by corporates,” Carvalho added.

But overall, as Howells pointed out, the “UK’s participation exemption is still one of the best around so we are not expecting the Centrica decision to have a major impact for UK headquartered groups”.