Investment businesses and “expenses of management”

The recent case of Centrica Overseas Holdings Ltd v HMRC [2024] UKSC 25 will be of interest to many holding companies, investment businesses and corporate groups claiming corporation tax deductions for “expenses of management”. This Supreme Court decision particularly considers whether professional fees incurred by an intermediate holding company on facilitating the sale of investments were deductible in calculating its profits for corporation tax purposes.

The decision, published by the UK’s highest appellate court, now provides clearer authority on the treatment of expenses of management incurred by investment businesses and the approach to classifying them as either “revenue” or “capital” expenses. However, some intricate issues must still be considered in this area.

Facts

This case concerned Centrica Overseas Holding Ltd (the Company), acting as a UK holding company as part of the wider Centrica PLC group. The Company was concerned with the holding of long-term investments and was not undertaking any trading activity regarding its investments.

The Company had acquired a Dutch sub-group in 2005, which was held as a capital investment. The Company instructed professional advisers in July 2009, after having resolved to sell the Dutch sub-group after it became clear that the investment was unsuccessful. Thereafter, various asset and share sales were completed in March 2011.

The Company claimed relief for the professional fees incurred in connection with the Dutch sub-group between July 2009 and March 2011 on the basis that they were “management expenses” and of a “revenue nature”.

The relevant legislation specifies that, in calculating the corporation tax liability of an investment business, expenses associated with managing that investment business are deductible provided that, among other things, the expenses are not “of a capital nature”. Much of the substantive discussion in the lower court and tribunals revolved around, firstly, whether the professional fees were in fact expenses of management and, secondly, whether those expenses were “of a capital nature”.

However, by the time the case reached the Supreme Court, it was accepted that the professional fees were expenses of management. The only question was whether the expenses were capital, thereby precluding them from being deductible (as the Court of Appeal had concluded). The Company had not, in putting forward their case, drawn any distinction between the various professional fees and it was therefore an “all or nothing” question of deductibility to be decided by the characterisation of those fees as revenue or capital.

Decision

The Supreme Court ultimately agreed with the Court of Appeal, confirming that the professional fees were of a capital nature and not deductible.

The distinction between revenue and capital expenditure has been litigated in the context of trading businesses for over a century and is well established principle (albeit often complex to apply in practice). The Company sought to argue that the meaning of “expenses of a capital nature” in the legislation for expenses of management for investment businesses should be given a narrower interpretation.

The Supreme Court, however, rejected this argument, holding that the expenses of management provision was introduced to align the treatment of capital expenditure for trading and investment companies. Therefore, the well-established revenue and capital principles, derived from a long iteration of case law on trades, can also apply in the context of expenses of management.

In applying the revenue and capital principles, the Supreme Court initially sought to identify the purpose for which the professional fees had been incurred. The court noted that objectively, in the context of the investment business disposing of a capital investment asset, they were incurred in connection with that asset (ie the interests in the Dutch sub-group). The Supreme Court concluded that, once the decision was taken to dispose of the Dutch sub-group in July 2009, the professional fees were effectively incurred to enable the Company to facilitate the disposal of a capital asset. It did not, for these purposes, matter what form the transaction took or, indeed, whether the transaction ultimately took place at all.

Comment

The conclusion reached by the Supreme Court was not unexpected. It appears perfectly sensible that the expression “of a capital nature” should have the same meaning in the context of trading and investment businesses, especially as the capital expenditure exclusion was first introduced in 2004 when the meaning of capital expenditure was already well established in analogous contexts.

It might appear that, as the expenses of management provision deals with investment businesses managing capital assets, few expenses incurred under this heading will be revenue in nature and deductible. The Supreme Court did, however, provide examples of revenue expenses of management which are concerned with the ongoing management of investments and group matters, contrasted with expenses relating to the disposal of particular capital investments (it is presumed that the same principle would apply to the acquisition of particular capital investments).

In this case, interestingly, the Company had made a clear management decision to sell the Dutch sub-group and took steps immediately afterwards to appoint advisers and start incurring professional fees. There was no indication that the professional fees were incurred in connection with more general investment management activities. This does, however, potentially require some holding companies to reconsider previous filing positions where they may (as the Company did in this case) have treated expenses associated with capital investments as revenue in nature until there was an agreement to sell with a counterparty. The tipping point for the revenue and capital delineation, for such holding companies, will need to shift to the earlier point when the internal decision to sell is made.

It would have been interesting to see if the Supreme Court would have reached a different conclusion had the Company not expressly resolved to facilitate the sale of the Dutch sub-group or engaged advisers on broader terms (subject to the commercial reality of the engagement also extending beyond the capital disposal). In those circumstances, there might have been some scope to put forward a more robust argument that at least some of the professional fees were revenue in nature.

As a brief aside, there is no equivalent revenue and capital distinction in the loan relationship rules. There are many private equity-backed structures where acquisitions and disposals also include various debt financing transactions and expenses. Whilst, depending on accounting recognition, this might mean that some additional costs are deductible under the loan relationship rules, care needs to be taken to ensure that the numerous other restrictions in those rules are taken into account and that, more fundamentally, costs are correctly characterised as expenses incurred directly and for the purpose of, the loan relationship and do not represent expenses of management on the acquisition or disposal of capital investments.

Despite the guidance offered by the Supreme Court in this case, identifying whether expenditure is revenue or capital in nature remains a complex exercise. Particularly in the context of investment businesses, the inherent nature of most investment activity does, despite the same principles applying, make it more difficult to put forward strong arguments that expenses are revenue in nature. It is often, for many holding companies and investment businesses, important to seek professional advice in this area.

Please contact our corporate tax specialists below to discuss this case in more detail or explore how we can assist you in navigating these complexities.