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Schedule D cases I and II

In a previous bulletin of 7th July 1997 we reported on the case of Sheppard v McKnight involving a stockbroker incurring legal fees in defending disciplinary proceedings brought against him for alleged breaches of rules and regulations of the Stock Exchange, and whether those legal expenses could be deducted from gross profits in the taxpayer&#39s firms accounts.

The case has now reached the House of Lords where the decision in favour of the taxpayer has been upheld.

At the House of Lords the Crown contended that, as a matter of law the taxpayer had two purposes in paying the legal expenses; the preservation of his business and the preservation of his personal reputation. As such the expenditure was not wholly and exclusively for the purposes of the trade, as was required.

Lord Hoffman held that the object of a taxpayer in making expenditure was to be distinguished from the effect of the expenditure. Expenditure might be made exclusively to serve the purposes of the business, but it might have a private advantage. The existence of that private advantage did not necessarily preclude the exclusivity of the business purpose. (Mallalieu v Drummond [1983])

In a decision, seemingly based more on equity than matters of law, Hoffman explained that the question was whether there was any reason of policy which prohibited the deduction of legal expenses incurred as a result of penal or disciplinary proceedings arising out of the conduct of the business. If the allegations had proved groundless, it would seem unfair not to allow any deduction for the taxpayer&#39s legal expenses. In principle, however, the purpose of the payment would be the same whether the taxpayer&#39s defence turned out be successful or not.

More importantly, it was fundamental that everyone, guilty or not guilty, should be entitled to defend themselves. There was no clear policy which would be infringed by allowing the deduction of the legal expenses incurred in resisting the disciplinary proceedings. On the contrary, non-deductibility would be an additional fine or penalty for which the regulatory scheme did not provide. The Commissioner was therefore determined to have been right to apply the principle that money spent for the purpose of preserving the trade from destruction could properly be treated as wholly and exclusively expended for the purpose of the trade within the meaning of TA 1970 s130(a) and the appeal of the Inland Revenue would accordingly be dismissed so that the money spent would be deductible.


This decision may be seen as comforting for those involved in giving financial services advice who have the misfortune of having to incur legal fees defending disciplinary proceedings. It is particularly interesting to note the importance given to the object of the expenditure as opposed to the effect. Clearly, when it comes to determining any particular case the facts as determined by the evidence will be critically important in supporting the contention that the object of the expenditure was wholly and exclusively for the purposes of the trade.


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