Holding companies, and other companies with an investment business, are entitled by statute to deduct from their total profits the expenses they incur in the management of that investment business. Management expenses are not defined in statute, but expressly exclude items "of a capital nature" unless they fall within certain specified categories such as the costs of setting up share incentive schemes. Unlike trading expenses, there is no equivalent "wholly and exclusively" test, but the expenses must be incurred in respect of the company's business which consists of making investments.
In the context of trading companies, there is a significant body of case law setting out principles to determine whether expenditure is capital in nature. There is no single test, and the question is not straightforward. Case law provides examples of the approaches used in different situations, and of the factors that may be relevant. The acquisition or disposal of an identifiable asset, with an enduring benefit to the company in question, is a strong indication of capital expenditure, and money paid for the disposal of a capital asset is itself, generally, capital in nature. A key question on this appeal was whether this same test applies in the context of management expenses, or whether another, more narrowly defined, test should apply.
Centrica Overseas Holdings Ltd ("Centrica") was an intermediary holding company. It decided to dispose of one of its business investments and paid professional fees in connection with a sale of assets and shares in certain of its subsidiaries to a third party. Those fees were for a range of services, from preparatory advice on how to realise value from the investment, to advice on structuring and documenting the final disposal transaction. Centrica deducted those fees from its profits as revenue expenses of management of its investment business. HMRC disallowed the relief on the basis that (a) the fees were not an expense of management and (b) in any event they were capital in nature and so excluded.
In its judgment, the Supreme Court confirmed that this is a two-stage test. First, is the expenditure an expense of management? On this question, the lower courts held that the expenditure was an expense of management, and this point was not raised again in the Supreme Court.
The second question is then whether the expense is of a revenue or capital nature. It is on this question that the appeal was made to the Supreme Court. In its judgment, the Supreme Court agreed with the Court of Appeal that the test here is the same as the test applied to trading companies and that the same well-established case law principles apply equally in this context.
The investments of a holding company are capital assets, and therefore the fees were incurred in relation to capital assets. As a result, the Supreme Court considered that the starting point should be to assume that amounts spent on the disposal of that asset are also capital in nature in the absence of any particular facts which displace that assumption.
Centrica had first taken a commercial decision to sell the relevant business and fees were then incurred in order to achieve that objective. Advisers were not engaged generally to advise on the investment business, but specifically in relation to a sale process. As a result, the Supreme Court held that the entirety of the fees was capital expenditure for which no deduction was allowed.
Where does this leave taxpayers? The decision of the Supreme Court leaves little room for manoeuvre once a specific disposal or investment target has been fixed. It may well be possible to successfully argue that fees incurred in relation to work to identify potential targets or to determine whether a sale would be commercially desirable, should generally still be deductible as expenses of management of the general investment business. But once a target has been identified, further expenses will usually be capital in nature, and non-deductible.
