ScottishPower, the energy provider, had been subject to regulatory investigations by the Office of Gas and Electricity Markets ("Ofgem") on behalf of the Gas and Electricity Markets Authority ("GEMA").  Between October 2013 and April 2016 ScottishPower entered into four agreements with GEMA in settlement of those investigations.  Ofgem had proposed substantial penalties, but GEMA chose to impose a nominal penalty of £1 provided that ScottishPower made certain payments to consumers and charities and helped fund a consumer-facing campaign run by the Citizen's Advice Bureau.  Although legislation was introduced during this period to provide an express statutory mechanism for GEMA to impose redress payments, it did not rely on that mechanism, instead relying on the wording of s.27A(1) of the Electricity Act 1989, which empowered it to impose a penalty of "such amount as is reasonable in all the circumstances of the case".  Although the FTT stopped short of finding a pound-for-pound adjustment, it had found it likely that any penalties otherwise imposed would have been "of the same order of magnitude" as the redress payments.

In total, ScottishPower paid around £28 million, which it sought to deduct in computing its corporation tax.  It was agreed that the payments would meet the general conditions for deductibility; however, HMRC denied the deductions on the basis of a common law rule called the Von Glehn principle that a penalty or fine incurred under a statutory regime is not deductible in computing trading profits, even where it was incurred in the course of trading activities.

The Court first considered whether, and how, the legislation on deductibility authorised the application of the Von Glehn principle.

Corporation tax on income applies to the profits of a trade subject to any adjustment required or authorised by law (s.46(1) of the Corporation Tax Act 2009 ("CTA09")).  One such adjustment is set out in s.54(1), which provides that no deduction is allowed for (a) expenses not incurred wholly and exclusively for the purposes of the trade, or (b) losses not connected with or arising out of the trade.

HMRC's first argument was that the Von Glehn principle denied deductions for penalties because they were not incurred for the purposes of the underlying trade and therefore were non-deductible by virtue of s.54(1)(a).  While the Court of Appeal felt this argument had merit, it preferred HMRC's alternative argument that an adjustment following the Von Glehn principle was itself "required or authorised by law" within s.46(1) CTA09. 

HMRC's arguments also relied on GEMA's intention that the payments were punitive in nature and replaced the penalties which would have otherwise been charged. The Court of Appeal found that HMRC was wrong to focus so much on the intentions of the regulator: even if s.54 was the right test, that section looks only at the purpose of the paying party in incurring the cost that they later seek to deduct. In any event, under s.46, the intentions of the parties are only relevant in determining whether an adjustment is required (in this case, whether or not the payment is a penalty). Here GEMA clearly understood that the payments were not penalties.

HMRC argued that the Von Glehn principle was wide enough to capture payments in lieu of penalties if those payments also had a penal nature. To authorise an adjustment for the purposes of s.46(1) a rule which does not have an express statutory basis needs to be clear in its effect (NCL Investments Ltd v HMRC [2022] UKSC 9).  The Court of Appeal found that, while the case law established a clear rule in relation to fines and penalties, there was no authority to extend that rule to amounts which are not, in fact, fines or penalties – even where such amounts may be said to perform the same function as a penalty, or are calculated by reference to a potential penalty.  Such an extension would render the rule so unclear as to fall foul of NCL.

Accordingly, the Von Glehn principle did not extend to payments imposed in lieu of statutory penalties, and the redress payments were deductible.

The position is not yet final – HMRC may yet appeal to the Supreme Court.  It also remains to be seen whether there will be political appetite to legislate to amend the position, as we saw in 2015 in relation to PPI compensation and similar payments.

Nor did the Court of Appeal need to consider whether the Von Glehn principle could apply to non-statutory penalties.

Nonetheless, as it currently stands, the decision means the principle is narrower than many previously thought, and regulated entities might look to claim deductions that they previously assumed were not available.  We may also see regulators begin to take deductibility into account in determining an appropriate quantum of redress payment.