Are legal fees in incurred personal defence an allowable deduction for tax purposes? What is the case law on the subject?

This is a freeview 'At a glance' guide to whether legal fees incurred in personal defence are an allowable deduction for tax purposes.

There are two contrasting cases on whether legal fees incurred defending both personal and business reputation are 'Wholly and Exclusively'  for the purposes of the business.

In Duckmanton v HMRC [2013] UKUT 0308, a taxpayer's expenditure on legal fees in defending himself from a criminal charge of gross negligence and manslaughter was disallowed. It was not 'wholly or exclusively' incurred for the purpose of his trade, see below. 

In McKnight v Sheppard (1999), the taxpayer was a stockbroker, who had incurred legal expenses of around £200,000 in defending himself on a number of charges before the disciplinary committee of the Stock Exchange. The House of Lords allowed his appeal, see below.

The law is found at section 34 ITTOIA 2005 which replaced section 74 ICTA 1988, see Wholly and exclusively...toolkit 

Duckmanton v HMRC

Mr Duckmanton ran an unincorporated car transport business. In 2002 one of his drivers was involved in an accident in which a pedestrian was killed. He first blamed faulty brakes and then driver error. It was found that Duckmanton's workshop had falsified records and the vehicle had missed mandatory maintenance. The driver received a 12-month prison sentence, while Mr Duckmanton was cleared of manslaughter. He also fought charges of falsification of records and disqualification as a vehicle operator. He incurred substantial legal fees in his defence. HMRC disallowed these following an enquiry into his tax returns. 

It was held by the First Tier Tax Tribunal (FTT) that the taxpayer's concern was not merely the protection of his business and operator's licence. He had three separate objects in paying his legal team:

  • The defence of criminal charges.
  • The preservation of his business reputation.
  • The avoidance of a damages' claim if he was convicted.

The FTT said that it would 'defy common sense not to conclude' that his main purpose in incurring the expenditure was to protect his liberty and personal reputation. They confirmed HMRC's view and disallowed the expenditure.

The taxpayer appealed to the Upper  Tax Tribunal on a technicality, arguing that the FTT had erred in law by not considering all the evidence in its decision. Permission was granted for appeal but the UT found the appeal 'fanciful' and concluded that the FTT had made its decision properly.

McKnight v Sheppard

In McKnight v Sheppard (1999) 71 TC 419, [1999] 1 WLR 1333, the taxpayer was a stockbroker. He had incurred legal expenses of around £200,000 defending a number of charges before the disciplinary committee of the Stock Exchange and appearing before the appeals' committee. The appeals' committee set aside an order for suspension imposed by the disciplinary committee and substituted fines totalling £50,000. The taxpayer sought to deduct both the fines and the legal expenses in computing his profits under Case I of Schedule D. On appeal from the disallowance of the deductions by the Inspector of Taxes, the Special Commissioner (Mr Theodore Wallace) found that the taxpayer’s exclusive purpose in incurring the legal expenses had been to preserve his business, although he had also been concerned with his personal reputation. Accordingly, the expenses had been incurred wholly and exclusively.

The Special Commissioner’s decision on the legal expenses was overturned by J Lightman in the High Court, on the basis that there was an insufficiently close connection between the expenditure and the taxpayer’s trade. The taxpayer succeeded in this part of the case both in the Court of Appeal and in the House of Lords.

Arguing about deductions with HMRC?

The above cases had different outcomes, as always they turn on their individual facts. No claim can be made without consideration of developments of case law in this area. We provide a detailed summary of these in our Wholly and exclusively...toolkit

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