Receipt under settlement agreement subject to Corporation Tax

In Charlton Chauffeur Drive Limited v HMRC [2021] TC08042, the First Tier Tribunal (FTT) found that sums received by a company from a firm of auditors under a legal settlement agreement were compensation in respect of employee fraud. As such, they were revenue in nature and not capital, as the company had claimed.

• The appellants provided international ground transportation services.
• The appellant’s finance manager embezzled an estimated £773,701 between 2004 and 2012.
• Following a forensic investigation, the accounts and Corporate Tax returns were amended claiming the embezzled amounts were business expenditure Wholly and exclusively incurred for the purposes of the trade.
• The appellant raised proceedings against their former auditor and consultant accountant.
• The parties reached settlement and the appellant received £566,000.
• The amount was paid in the accounting period ended 31 December 2016 and was treated as a capital receipt as it was received in exchange for its agreement to surrender any claim.
• HMRC opened an enquiry into the return.
• HMRC issues a Closure notice concluding that the settlement receipt should be taxed as a trading receipt.
• The appellant Appealed.

The FTT dismissed the appeal on the grounds that:

• The settlement agreement had to be construed under ordinary principles and not with a specific tax outcome in mind.
• The settlement agreement:
  • Covered more than the pending litigation.
  • The intention of the defenders was to avoid public litigation and any suggestion of liability.
  • The appellant was seeking recompense for its losses.
  • Settlement was a decision commercially taken as being the best way to achieve recovery of the loss with the least cost and risk attached.
  • The sum received was compensation for the losses incurred.
• The receipt under the settlement agreement was revenue as it was compensation for the loss of profits rather than a loss of assets.

Useful guides on this topic

Wholly and exclusively...toolkit
What does 'wholly and exclusively' mean? How do you determine if a cost is wholly and exclusively incurred for the purpose of a trade? What cases are there? 

How to appeal an HMRC decision
Disagree with a HMRC decision? How to appeal, what type of decision can you appeal, what are your different options when you disagree with HMRC? What are the key steps in making an appeal?

Closure notices
When does HMRC issue a Closure Notice? Can a taxpayer demand one? Are there appeal rights? 

External links

Charlton Chauffeur Drive Limited v HMRC [2021] TC08042