Tribunal – tax deductibility of lump sum payment

The tax deductibility of a lump sum payment by an incorporated law firm to a retired partner of the old practice was recently examined by the Tribunal.

In this case the practice was incorporated on 1 January 2001. One of the senior partners of the firm who retired on 30 November 2000 was entitled to an annuity on his retirement in an agreement that dated back to a legacy law firm in 1974. Although the partner was entitled to his annuity on 30 November 2000 he did not seek to enforce his entitlements at that time.

The retired partner was appointed as a director of the company and worked in return for certain income and benefits.The partner did not hold any shares in the company.

The retired partner subsequently received a lump sum of £1.15m in consideration for releasing the company (and former partners) from the obligation to pay the annuity valued in the region of £1.5m.

The issue before the Tribunal was whether this payment was a deductible expense in calculating the company’s profits chargeable to corporation tax. The company used existing case law to argue that the lump sum was a business expense which was not in the nature of capital expenditure and was therefore deductible.

The Tribunal disagreed and used distinguishing case law to decide the tax deductibility of the lump sum is determined by the nature of the payment it replaces. The Tribunal decided that the payment of the lump sum was ‘not to extinguish a contractual obligation to make recurring revenue payments and is not itself a revenue payment, but extinguished an obligation to make payments of capital expenditure and is a capital payment‘.

The appeal was dismissed. In an interesting final observation the Tribunal remarked that the company’s assertion that HMRC’s publication and guidance were inconsistent on this issue was immaterial. The judgement is based on the law and not on HMRC’s interpretation of the law. The Tribunal make no comment on the validity or otherwise of HMRC’s publications and guidance.

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