Reasonable Business Expense - The Chartered Institute of Taxation

THE REASONABLE BUSINESS EXPENSES RULEDISCUSSION PAPER COMMISSIONED BY THE CHARTERED INSTITUTE OFT AXATION’S TAX POLICY SUB-COMMITTEE

Reasonable Business Expenses: Discussion paperTHE REASONABLE BUSINESS EXPENSES RULEDISCUSSION PAPER COMMISSIONED BY THE CHARTERED INSTITUTE OFT AXATION’S TAX POLICY SUB-COMMITTEE1. INTRODUCTION1.1. OVERVIEWThis Report critically considers the case against the continuation of the‘all or nothing’, ‘wholly and exclusively’ test applied to expenditure laidout to earn certain categories of taxable income, to determine whether ornot such payments are deductible in arriving at the net incomechargeable to tax. It outlines the statutory and other origins of the ‘whollyand exclusively’ rule to aid in understanding the causes and effects of itsevolution to current forms in the taxation of business and employmentincome. It considers in some depth the perceived advantages anddeficiencies of the practical application of the rule, as illustrated in theapplicable case law. This Report further evaluates the policy implicationsof accounting concepts and economic theories, and notes practicalconstraints on these insights. In identifying the possibility of a ‘but for’reasonable business expenses rule alternative to the ‘wholly andexclusively’ rule, emphasis is placed on the practical application of sucha rule using variants permitting the dissection and apportionment ofmixed purpose expenses. It highlights the use of apportionment in theAustralian tax system to suggest an alternative view of how a moreequitable system of deduction for expenses could be implemented.However, this Report does not seek to provide an exhaustive analysis ofthe application of these alternatives. Rather, its key aim is to highlightthe inequities posed by the ‘wholly and exclusively’ rule and to provokedebate on these issues. As such, while it argues for the replacement ofBode OyetundePage 2 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthe ‘wholly and exclusively’ rule with a ‘but for’ reasonable businessexpenses rule incorporating the dissection and apportionment of mixedpurpose expenditures, there remain significant issues which only furtherdebate and research would resolve. The role of the deductibility rule inascertaining VAT deductions and taxable trade, business and employmentincome will be highlighted first, to provide the necessary background tothe subsequent discourse.1.2. ORIGINS & STATUS QUO OF THE ‘WHOLLY & EXCLUSIVELY’ RULE1.2.1. INTRODUCTIONSince its inception in 1799, 1 reintroduction in 1803, 2 a brief lapse in 1816and subsequent modified reinstatement in 1842, 3 income tax has beentraditionally charged on property, profits or gains under the schedularsystem, with the former Schedules D and E traditionally covering incomefrom trades, professions and vocations, and employment respectively. 4The schedular system was introduced in 1803 on a net receipts basis asopposed to the broader system of income categories under the 1799 taxregime.1.2.2. DEDUCTIBILITY OF BUSINESS INCOME EXPENSES1.2.2.1. OVERVIEWIt has been suggested that the origins of the ‘wholly and exclusively rule’in relation to taxation of the old Schedule D Case I and II incomes lie inthe 1806 Income Tax Act. 5 Tiley traces this deductibility rule to the12345By William Pitt to finance the Napoleonic Wars: see (1799) 38 Geo. 3, c. 22.(1803) 43 Geo. 3, c. 122.By Robert Peel: 5 & 6 Vic., c. 35.See Kevin Holmes, (2000) The Concept of Income: A MultidisciplinaryAnalysis, IBFD Doctoral Series Vol. 1, IBFD Publications BV, pp. 151 – 158.See also Robert W. Maas (2005) Taxation of Employments, (West Sussex:Tottel Publishing), p. 1.Income Tax Act 1806 46 Geo. 3, c.65, s.CX11. See Roger Kerridge,Deductibility of Expenses for Schedule D Income Tax – The “All or Nothing”Rule, [1986] B.T.R. p. 36.Bode OyetundePage 3 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperabsence of any express prohibition, considering that “the right to deductis inferred from the fact that it is the profit, not the receipts, of a tradethat are taxed”. 6 The statutory requirement has evolved into the currentform as embodied in the Income Tax (Trading & Other Income) Act 2005 7which provides, as regards deductibility of expenses, that: “in calculatingthe profits of a trade, no deduction is allowed for (a) expenses notincurred wholly and exclusively for the purposes of the trade, or (b)losses not connected with or arising out of the trade.” 8 As regards theadverb ‘wholly’, although it has been conceded 9 that the word relates toquantum of the expenditure and ‘exclusively’ to the underlying motive, 10this view has been criticised by some commentators, 11 and it wouldappear that the word ‘wholly’ adds little, if any, additional import to the‘exclusively’ concept. 12 As will be seen, the underlying concepts of whatshould represent taxable income, and the appropriate formulae fordetermining the tax base, inform the statutory and case law tests of whatconstitutes deductible expenses.1.2.2.2. B ASIC PRINCIPLES AND CASE LAW DEVELOPMENT 13Certain principles underscore the UK rules on the deductibility ofbusiness expenses, borne out of the application of the statutory rules678910111213John Tiley (2005) Revenue Law, 5 th ed. (Hart Publishing: Oxford-Portland,Oregon), p. 417.Hereafter, the ITTOIA 2005.§34(1) ITTOIA 2005, emphasis added.Albeit obiter.By Romer LJ, in Bentleys, Stokes & Lowless v Beeson 33 TC 491; [1952] 2All ER 82; at pp. 503, 85 respectively.John Tiley, Revenue Law, ibid, p. 419.As this literal interpretation would preclude the dissection of a singlepurchase of several discrete items, for both business and private purchases,and the attribution of separate purposes as appropriate: see RogerKerridge, Deductibility of Expenses for Schedule D Income Tax – The “All orNothing” Rule, [1986] B.T.R. p. 36 – 39. See also John Ward, “All orNothing”: More Than Nothing at All [1987] B.T.R. 142, footnote #7.See generally, John Tiley, Revenue Law, op cit, §22 et seq, p. 417 – 427.Bode OyetundePage 4 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthrough case law. Generally, these indicate 14 that only those expensesthat are proximately and entirely connected with and incurred in aid of theincome earning, 15 business-oriented 16 process would be tax deductible, inthe absence of any express prohibitions under applicable statutory rules 17or public policy. 18 Similarly, expenses that are of a capital nature, not onrevenue account 19 or which are considered a distribution or division ofprofits 20 are disallowed. A trio of cases exemplifies the approach of thecourts to the task of setting out the rules underpinning the application ofthese principles in the determination of deductibility of businessexpenses. These decisions, of the House of Lords 21 and the Court ofAppeal, 22 appear to set out four basic rules. 23First, the relevant outlays must be exclusively incurred to benefit thepurposes of the trade, not the trader, 24 and the query whether theseoutlays were incurred wholly to serve the purposes of the trade is aquestion of fact based on the evidence before the court. 25 Secondly, thecourt in determining the object of the taxpayer in making the expenditure141516171819202122232425John Tiley, Revenue Law, ibid, p. 419.See the dictum of Lord Davey in the celebrated case of Strong & Co. ofRomsey Ltd v Woodfield [1906] AC 448 at 453; 5 TC 215 at 220.However, in the view of Viscount Cave L.C. voluntary expenditure laid out toindirectly facilitate business operations, though not yielding immediate ordirect benefits, could nevertheless be held to meet the wholly andexclusively test: see British Insulated & Helsby Cables Ltd. v Atherton[1926] AC 205 at 211.Such statutory prohibitions include those disallowing the deduction ofcertain penalties, interest and VAT charges (see §54 ITTOIA 2005).Statutory prohibitions on business gifts and entertainment expenses areconsidered in greater depth in §2.5.2 below.See McKnight v Sheppard [1999] STC 669.See §33, ITTOIA 2005. See also §28, ITTOIA 2005 and the CapitalAllowances Act 2001 which provide for capital allowances in respect ofcertain capital expenditure. See generally, John Tiley, Revenue Law, op cit,§22.4.See Eyres v Finnieston Engineering Co. Ltd. (1916) 7 TC 74; see also UtolLtd. v IRC [1944] 1 All ER 190 and Walker v IRC [1920] 3 KB 648.Viz., Mallalieu v Drummond [1983] STC 124, CA; [1983] STC 665, HL;McKnight v Sheppard [1999] STC 669, HL.Viz., Vodaphone Cellular v Shaw [1997] STC 734, CA.See John Tiley, Revenue Law, op cit, p. 419 – 420.Vodaphone Cellular v Shaw [1997] STC 734, CA, per Millet LJ at p. 742.Mallalieu v Drummond [1983] STC 124, CA; [1983] STC 665, HL.Bode OyetundePage 5 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperis not limited to any conscious motives of the taxpayer at the time of thepayment, 26 but must (except in obvious, self-evident cases which speakfor themselves) go further, to examine the taxpayer’s subjectiveintentions operating at the time when the expenditures were made. Thecourt, having considered any significant and not incidental consequenceswhich are so inevitably and inextricably involved in the expenditure, mayconclude that these subjective intentions were the real purposesmotivating the expenditure. 27 For corporate taxpayers, the courts maypierce the veil of incorporation in seeking to discover the subjectivepurposes of its directors and shareholders in making the expenditure. 28Thirdly, the court may distinguish an ancillary, secondary ‘object’ of aspecific expenditure operating contemporaneously with a primary ‘object’from a mere, incidental ‘effect’ of the expenditure, such that, while thepresence of a secondary ‘object’ would disqualify the expenditure fromdeductibility (as a dual purpose would be served), the existence of suchan incidental ‘effect’, provided it is a consequential and incidental effect,would be merely fortuitous and not a ground for disqualification. 29 Finally,the tribunal of fact should first determine what was the principal purposefor the taxpayer in making the expenditure as a matter of fact (whetherarticulated clearly or not), and then attribute personal or businessmotivations to this purpose based on conclusions drawn from the facts.The question to be answered was consequently not whether the taxpayerconsciously sought to further a personal or business advantage byincurring the expenditure, but rather what was his principal purpose inmaking the expenditure. 3026Mallalieu v Drummond [1983] STC 124, CA; [1983] STC 665, HL.27Vodaphone Cellular v Shaw [1997] STC 734, CA, by Millet LJ at p. 742. Seealso MacKinlay v Arthur Young [1986] STC 491, by Lord Oliver at p. 504;and McKnight v Sheppard [1999] STC 669, HL.28 Thus, the mere fact that articles and resolutions stipulated that certain sumswere to be charged as remuneration was not determinative that such sumswere wholly and exclusively laid out for the purposes of the company’strade: see Copeman v William Flood & Sons [1941] 1 KB 202; 24 TC 53.29Mallalieu v Drummond [1983] STC 124, CA; [1983] STC 665, HL.30Vodaphone Cellular v Shaw [1997] STC 734, CA, per Millet LJ at pp. 742 –745.Bode OyetundePage 6 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper1.2.3. DEDUCTIBILITY OF EMPLOYMENT INCOME EXPENSES 31As regards taxation of employment income, the law has evolved from itsorigins in the Napoleonic wars, 32 through numerous other changes, 33 tothe present income tax regime. Specific provisions exist for the deductionof expenses incurred by an employee in the course of his employment,particularly in instances where the employer is unable or unwilling toincur these expenses for the employee by trade usage, custom oragreement between the parties. The relevant statutory provisions arefound in the Income Tax (Earnings and Pensions) Act 2003, 34 and providegenerally that deductions are allowed for an amount from an employee’searnings provided the employee is obliged to incur and pay it as theholder of employment and such expenses are incurred wholly, exclusivelyand necessarily in the performance of employment duties. 35 Similar 36deductions are allowed for expenditure on travel in the performance ofduties 37 and travel for the necessary attendance at any place in theperformance of duties. 383132333435363738See generally, John Tiley, Revenue Law, op cit, §18 et seq, pp. 327 – 344.In 1799 and again in 1842: see Robert W. Maas, Taxation of Employments,11 th ed., (2005, West Sussex, Tottel Publishing), p. 1.Such as the introduction of deductions for expenses by the Income Tax Act,1853 and Schedule E taxation on income from employment and pensions bythe Finance Act of 1922.Hereafter, ITEPA 2003. The ITEPA 2003 is essentially a restatement of thelaw as it stood under Schedule E of the Income and Corporation Taxes Act1988 (hereafter, ICTA 1988) pursuant to the Inland Revenue’s Tax LawRewrite Project. The main changes have been the use of simpler language,the disuse of the expression “Schedule E” and the replacement of theschedular system with tax on income from employment, pensions and socialsecurity. As such, no substantial changes have been made and previousinterpretative case law is largely applicable. See John Pearce’s article,ITEPA 2003 – an introduction, available athttp://www.tax.org.uk/attach.pl/1866/672/John%20pearce.pdf. See also JohnTiley, Revenue Law, op cit, pp. 327 – 329.§336, ITEPA 2003.As in both these cases, the employee must be obliged to incur travelexpenses as the holder of employment.See §337, ITEPA 2003.See §338, ITEPA 2003.Bode OyetundePage 7 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperA common thread in these employment income tests is the objectiverequirement of necessity. 39 It is not sufficient that the expenses beincurred by the employee as the holder of employment 40 or, indeed,‘wholly and exclusively’ incurred in the performance of the employment. 41The expenses must, in addition, be incurred necessarily in theperformance of employment duties 42 or necessarily incurred on travellingin the performance of employment duties, 43 or must be attributed to theemployee’s necessary attendance at any place in the performance of theemployment. 44 This common requirement renders these former ScheduleE tests more rigorous than the old Schedule D Cases I and II test, leadingto possible discrepancies and tax planning challenges. 45 While case lawon this requirement (particularly as regards travelling expenses) may bechequered, 46 the hope has been expressed elsewhere that the realities ofmodern business practices, such as the subjectivity of negotiatingexecutive employment contracts 47 and the need to avoid tax-induceddistortions on commercial management decisions, 48 would be dulyconsidered in interpreting case law and introducing possible reforms.These issues, however, are beyond the scope of this Report, and wouldbe better addressed by further analysis, perhaps in another report.39See Ricketts v Colquhoun [1926] AC 1; see also Roskams v Bennett (1950)32 TC 129.40Required in all three tests: see §336, §337 and §338, ITEPA 2003.41Required under the §336 test, ITEPA 2003.42§336, ITEPA 2003.43§337, ITEPA 2003.44§338, ITEPA 2003.45 John Tiley, Revenue Law, op cit, p. 343.46See Ricketts v Colquhoun [1926] AC 1; Owen v Pook [1969] 2 All ER 1 andTaylor v Provan [1974] STC 168.47John Tiley, Revenue Law, op cit, p. 330.48Robert W. Maas, Taxation of Employments, op cit, p. 94.Bode OyetundePage 8 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperSimilarly, the consideration of the ‘wholly and exclusively’ 49 rule here islimited to non-travelling expenses. 50 Case law on duality of employeeexpenses is similar to that under business income tax, with decisionssuch as Hillyer v Leeke, 51 Woodcock v IRC 52 and Fergusson v Noble 53prohibiting deductibility for expenditure on clothing with dual purposes.Claims for the excess of expenditure on meals, 54 the extra cost of living inLondon 55 and abroad, 56 mess expenses 57 and lodging expenses 58 beyondwhat would have obtained had the taxpayer not been employed havefailed due to the fatality of the dual purpose admission implicit in suchclaims. 59 As regards telephone expenses, case law indicates that, wherethe employee incurs expenditure on telephone rental charges and there isthe possibility of private as well as business use of the facilities, suchexpenses are likely to fall foul of the rule against duality. 60 However, thededuction of purely business calls identified by the dissection of itemised49The test of necessity has been said to be objective and predicated on thebasis that without the expenditure, the employee’s task could not beperformed: see Brown v Bullock (1961) 40 TC 1, at p. 10. See also JohnTiley, Revenue Law, op cit, p. 340. However, some commentators considerthat the word “necessarily” adds little, if any incremental import to the‘wholly and exclusively’ rule, given the present requirement that theemployee must be necessarily obliged to incur the expense, by implicationsuch an expense would be deemed to be necessarily incurred: see RobertW. Maas, Taxation of Employments, op cit, p. 107. Further analysis onwhether this requirement adds or detracts from the ‘wholly and exclusively’rule, however, is beyond the scope of this Report.50As such, the regime for travel expenses would not be examined in depth.5151 TC 90: where expenditure on formal suits and ties incurred by acomputer engineer was denied deduction for serving the private purposes ofwarmth and decency.5251 TC 698: here, though the taxpayer, an engineer, was allowed deductionon special protective wear, however expenditure for additional maintenancedue to excessive oil stains on everyday wear was denied deduction.537 TC 176: a plainclothes policeman was taxed on a clothing allowance yetwas refused deduction for the associated expenditure.54Sanderson v Durbidge 36 TC 238.55Bolam v Barlow 31 TC 136; McKie v Warner 40 TC 65.56Robinson v Corry 18 TC 411.57 Lomax v Newton 34 TC 558; Griffiths v Mockler 35 TC 135.58 Nagley v Spilsbury 37 TC 178.59As if the taxpayer claimed deductibility for some and not all of an item ofexpenditure, then he implicitly admits the expenditure serves a dualpurpose.60See Lucas v Cattell 48 TC 353; Nolder v Walters 15 TC 380; Hamerton vOvery 35 TC 73.Bode OyetundePage 9 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperphone bills may be permissible. 61 Similarly, the provision of a mobilephone to an employee and a member of his family will not be taxed as abenefit in kind, 62 the assumption being that private use of the mobiles soprovided would be minimal. 631.2.4. APPORTIONMENT OF MIXED PURPOSE EXPENDITURES & VATDEDUCTIBILITY 64Value added tax (VAT) is imposed throughout the European Union on thevalue of transactions and associated profits pursuant to the First 65 andSixth 66 VAT Directives of the European Union as implemented by the UKValue Added Tax Act 1994. 67 Mixed purpose expenditures raise problems,especially as regards the right to deduct input VAT in respect of goodsand services used or to be used by a taxable person for the purpose ofany business carried on by that person. 68 This is particularly so as, if aspecific expenditure falls under a proper business purpose, input VAT onsuch expenditure may be deductible. However, in the absence of abusiness purpose or, more fundamentally, the status as a taxable person,no right to deduct input VAT exists. In instances where a person incurscosts or purchases assets in both a business and a private capacity,provisions in the First and Sixth VAT Directives require that the VATincurred be deductible, but that an appropriate output tax charge be madein respect of any subsequent private use. Although there are someconcerns 69 over the UK implementation of these Directives, 70 it is clear61626364656667686970John Tiley, Revenue Law, op cit, p. 341.§319, ITEPA 2003.Robert W. Maas, Taxation of Employments, op cit, p. 111.See generally Greg Sinfield et al. (2004), VAT Deductions: AComprehensive Guide to Recovery of VAT in the UK, 1 st ed., (London:LexisNexis UK/Reed Elsevier (UK) Ltd).Directive 67/227 11 April 1967.Directive 77/388 17 May 1977.Hereafter VATA 1994.§24(1) VATA 1994.Greg Sinfield et al. (2004), VAT Deductions: A Comprehensive Guide toRecovery of VAT in the UK, op cit, pp. 86 – 87.Schedule 4, para. 5(4), VATA 1994.Bode OyetundePage 10 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthat apportionment is permitted under VAT law for costs in respect ofbusiness and non-business activities. 71 For instance, under the Input TaxOrder 1992 Article 5, 72 tax on goods and service utilised for ‘businessentertainment’ purposes is not VAT-deductible. However, as will beseen, 73 limited apportionment is allowed in certain instances regarding‘business entertainment’ expenditure. The concept and use ofapportionment as a method of dealing with mixed purpose expenditureswill be examined in detail below.1.3. THE REPORT IN OUTLINEThe next section seeks to examine the case law development of the‘wholly and exclusively’ rule for deductible expenses vis-à-vis businessand employment income, with a view to highlighting the rationales for thisrule and the difficulties posed by its ‘all or nothing’ nature, particularly formixed purpose expenditures. This is followed by a review of theimplications of accounting concepts and economic income theories for thedeductibility rule. This Report suggests possible solutions to thesedifficulties in the form of a ‘but for’ reasonable business expense rule.The possible variants of this reasonable business expenses rule will beexamined, and the practical application in the context of the Australianlegal system considered.717273See Article 2, of the First Directive; Article 17(2), Sixth Directive; and also§24(1), and §25, VATA 1994. See also Thorn EMI plc v C & ECommissioners [1995] STC 674, CA. See generally Greg Sinfield et al(2004), VAT Deductions: A Comprehensive Guide to Recovery of VAT in theUK, op cit, pp. 89 – 90.S.I. 1992 No. 3222.In §2.5.1 below.Bode OyetundePage 11 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper2. JUDICIAL R ATIONALES FOR & DEVELOPMENT OF THE ‘WHOLLY &EXCLUSIVELY’ DEDUCTIBILITY RULE2.1. OVERVIEWThis section considers the role of judicial precedent in developing the‘wholly and exclusively’ rule for deductible expenses in relation totaxation of business and employment income. While judicial precedent setby the courts in grappling with the difficulties posed by the ‘wholly andexclusively’ rule has been crucial in its development and application toparticular categories of expenses, many decisions have led to inequitableoutcomes and obscure, inconsistent precedent, 74 depending on one’sperspective. 752.2. MALLALIEU V DRUMMONDThe leading authority is the case of Mallalieu v Drummond (Inspector ofTaxes), 76 where the taxpayer, a practising barrister, argued that she wasentitled to deduct from her taxable professional income sums expendedon replacing, cleaning and laundering certain items of clothing, procuredand maintained by her in compliance with the Bar Council’s professionalguidance on professional attire. The ‘wholly and exclusively’ test wasembodied in provisions which permitted only such “disbursements orexpenses, not being money wholly and exclusively expended for thepurposes of the trade, profession or vocation” 77 to be deducted. The74757677Roger Kerridge, Deductibility of Expenses for Schedule D Income Tax – The“All or Nothing” Rule, [1986] B.T.R.cf. John Ward, “All or Nothing”: More Than Nothing at All [1987] B.T.R. p.141, where the author argues that the case law, though inequitable, islargely clear-cut and uniform.[1983] STC 124, CA; [1983] STC 665, HL.§130 (a) Income and Corporation Taxes Act 1970 (which corresponds to §74of the Incomes and Corporation Taxes Act 1988).Bode OyetundePage 12 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papertaxpayer’s contention was upheld. 78 Slade, J held that there was noevidence that the taxpayer had a dual purpose for incurring theexpenditure, and that the test revolved about the subjective motive of thetaxpayer when making the disputed expenditure. Consequently, theincidental purposes of meeting the non-professional, human needs ofbeing decently and warmly clothed were irrelevant. 79 As the taxpayer “…aimed at the professional bird and fortuitously, fortunately, accidentallyor incidentally hit the non-professional bird, the expenditure wasdeductible”. 80 Indeed, it was noted 81 that the General Commissioners’finding of fact that the taxpayer had no conscious dual 82 purpose in mindwhen making the relevant payments led inevitably and inescapably to thedeductibility of these expenses as being of a professional nature. TheCourt of Appeal agreed. 83However, on appeal to the House of Lords, the majority 84 allowed theCrown’s appeal and held that the expenses were not deductible. In theleading judgment, Lord Brightman 85 held that, while the taxpayer’s motivein making the outlay was of vital significance and must be discovered,any conscious motive expressed would not deter the courts fromdetermining her true objective which, on the facts, extended to theobvious need for the taxpayer as a human being to be warmly anddecently clothed in public. 86 The existence of an associated privateadvantage was not conclusive. In distinguishing between the privatepurposes of the taxpayer and the business purposes of the trade,78 Per Slade J, reversing the decisions of the inspector of taxes and GeneralCommissioners respectively disallowing deductibility and dismissing thetaxpayer’s appeal against this: [1981] STC 391; [1981] WLR 908.79[1981] STC 391 at 406; [1981] WLR 908 at 921, per Slade J.80Per Sir John Donaldson MR, [1983] STC 124 at 129, CA.81By Lord Elwyn-Jones in his dissenting decision in the House of Lords:[1983] 665 at 667, HL.82That is, both professional and private.83[1983] STC 124, CA.84With Lord Elwyn-Jones dissenting, as noted above.85[1983] STC 665 at 667, HL.86Though this was conceded not to be in the contemplation of the taxpayer atthe relevant time on the facts.Bode OyetundePage 13 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperprofession or vocation, Lord Brightman contrasted the implications of anancillary private advantage constituting an ‘object’, however secondary orsubordinate, of a specific expenditure (in which case the expenditurewould be non-deductible as it could not be said to be wholly businessorientated)on the one hand, with a private advantage which was merelyan incidental, consequential and unavoidable ‘effect’ of the expenditureon the other, (in which case the expenditure would be deductible). 87 Onthe facts, the expenditure served two inextricably intermingled purposesand the need to be decently and warmly clad was a clear, thoughunconscious object of expenditure, 88 not merely the effect. Consequently,a dual purpose could be found by the Commissioners and the expenditurewas properly disallowed.Some commentators consider the distinction drawn by Lord Brightmanbetween appropriate dress for a barrister and uniforms for a nurse orwaitress 89 to be a rather fine one 90 given that in all these cases, to someextent, the human needs of warmth and decency are met. 91 Indeed, whilethe outcome has been commended as sensible, the reasoning behind ithas been criticised as the result of the largely unhelpful ‘all or nothing’nature of the rule. 92 Unfair results of this rule can be illustrated by casesin which it was applied to medical expenses, mixed personal and878889909192Lord Brightman illustrated this distinction with the example of travelexpenses incurred by a medical consultant to attend a patient overseas. Heconsidered that if the travel was only undertaken to attend to the patient’sneeds, the incidental effect would be the benefit of staying there whiledischarging a professional duty. Any benefits of overseas stay, howeverpleasurable, would be unavoidable and fortuitous. But if the opportunity tostay overseas was a distinct secondary reason for the travels, howeversubordinate, then the travel expenses would not have been exclusivelyincurred and should be non-deductible: [1983] STC 665, 669f-g.As found by the Commissioners, whose findings an appellate court would beloath to disturb: see Edwards v Bairstow 36 TC 207.Whose uniforms, depending on facts and degree, could be deemed to beexclusively for business purposes: per Lord Brightman [1983] STC 673, HL.Predicated on a rather elusive concept of degree: John Tiley, Revenue Law,op cit, p. 420 – 421.See Robert W. Maas, Taxation of Employments, op cit, p. 108.Roger Kerridge, Deductibility of Expenses for Schedule D Income Tax – The“All or Nothing” Rule, [1986] B.T.R. p. 54 – 56.Bode OyetundePage 14 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperbusiness costs, accommodation and sustenance expenditure and costs inrelation to corporate groups.2.3. DUAL PURPOSE MEDICAL EXPENSESIn certain instances involving expenditure on healthcare, the ‘all ornothing’ nature of the deductibility rule has caused inequity and hardship.In Norman v Golder, 93 where medical expenses incurred by a professionalshorthand writer due to poor working conditions were denied deductibility,Lord Greene MR likened such expenses to those relating to food, clothingand other private and domestic purposes, being incurred in part for theadvantage and benefit of the taxpayer as a human being. He consideredthe argument that “… if you do not get yourself well and so incur medicalexpenses to doctors, you cannot carry on your trade or profession, and ifyou do not carry on your trade and profession you will not earn anincome, and if you do not earn an income the Revenue will not get anytax” 94 to be “entirely lacking in substance”. 95 It was all or nothing, and ifthe restoration of health could be characterised, in whole or in part, as aprivate benefit, the associated expenses were simply non-deductible.While this may be so, a particularly unfortunate result was produced inMurgatroyd (Inspector of Taxes) v Evans-Jackson 96 due to this approach.In the latter case, the taxpayer (a trademark agent) owing to injury wasunable to receive treatment under the (free) National Health Service, asthis would have prevented him from conducting his business due to therestricted visiting hours and the absence of office facilities. To overcomethese hindrances, he obtained medical treatment in a private nursinghome equipped with office amenities to facilitate the conduct of his93949596[1945] 1 All ER 352; 26 TC 293, CA.Op cit, at p. 354.Op cit, at p. 353.43 TC 581; [1967] 1 WLR 423; [1967] 1 All ER 881.Bode OyetundePage 15 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperbusiness, 97 and claimed 60% of the nursing home costs as deductiblebusiness expenses. Ploughman, J was sympathetic to his claim, 98 butheld that the expenses were not deductible as not being wholly andexclusively expended for the purposes of the trade, rather beingprohibited domestic and private expenses. Indeed, the judge consideredthat the manner in which the claim was formulated in claiming only 60%of the expenses was fatal to the taxpayer’s case, as it implicitly admittedthe existence of a private, dual purpose. 99 While the judge felt that itwould have been more plausible had the entire 100% been claimed, eventhis line of argument would have been fraught with difficulty as, in hiswords, it “… would not really be a rational view of the situation toconclude that the whole of his expenses in the nursing home wereincurred wholly and exclusively for the purposes of the business. Thewhole purpose of going into a nursing home in the first place was toreceive treatment for the injury which he had sustained, and it seems tome that it would offend common sense to say that at any rate one of hismotives or purposes in going into the nursing home was not to receivetreatment for that injury – treatment which would enure for his benefit,not merely during the time when he was carrying on his business, but, asLord Greene said in … Norman v Golder ‘as a living human being’.” 100This reasoning is particularly hard to justify as, clearly, commercialreasons were operative in the taxpayer’s mind when making theexpenditure, 101 particularly as, on the facts, no expenditure would have979899100101As he had access to telephone and conferencing facilities to facilitateinteraction with his staff and clients.Op cit, at p. 884e.See also Caillebotte v Quinn [1975] STC 265, where Templeman, J came toa similar conclusion as regards additional expenses of eating at workincurred by a carpenter. In his view, the taxpayer “… must eat in order tolive; he does not eat in order to work”: at p. 269.[1967] 1 All ER 881 at p. 887 f – h.The necessity of the medical expenditure could be justified by the incomeover and above this that it made possible: Roger Kerridge, Deductibility ofExpenses for Schedule D Income Tax – The “All or Nothing” Rule, [1986]B.T.R. at p. 42.Bode OyetundePage 16 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperbeen incurred in the absence of a predominant business motive. 102However, similar considerations led Pennycuick, J in Prince v Mapp 103 todisallow expenditure incurred by the taxpayer, an accomplished,professional guitarist, for surgery to restore dexterity to a vital, damagedfinger. 104 The taxpayer’s admission to the Commissioners that hesometimes played the guitar as a hobby was taken as an indication of adual purpose. The learned judge upheld the decision of theCommissioners not to allow the deduction for having a dual, privatepurpose. Crucially, the findings of fact by the Commissioners indicatedthat, although the taxpayer would not have undergone the complexoperation if he had not desired to continue playing the guitar, this desirewas not limited to professional purposes and could embrace nonprofessional,private playing. This finding was decisive as Pennycuick, Jstated that, had professional considerations been the sole motivation, theexpenses would have been allowable. 105 Indeed, the judge disagreed withLord Greene’s preclusion 106 of the possibility of medical expenses beingincurred exclusively for a professional, business purpose. 107 He was ofthe view that there might be instances where “… someone carrying on atrade or profession incurs some injury which is trivial in itself and inrespect of which he would never otherwise expend money on medicalcare but which happens to be of vital importance for the purpose of thatparticular trade or profession. In such a case I am prepared to assume infavour of the taxpayer here that it would be possible for a taxpayer to102103104105106107As medical treatment under the National Health Service was free, it could beargued that all the expenditure was incurred for a business purpose. Wardargues that the motive to be examined is the motive to attend the privatenursing as opposed to the motive to incur the particular outlay, but in thisauthor’s view the distinction is a rather fine one: see John Ward, “All orNothing”: More Than Nothing at All [1987] B.T.R. 143 – 144.46 TC 169; [1970] WLR 260; [1970] 1 All ER 519.He had severed a tendon while sharpening a pencil. He needed a tendongrafting operation to mend the top joint of the little finger on his left handand so restore his previous skill.[1970] 1 All ER 519 at pp. 525 f,g.In Norman Golder [1945] 1 All ER 352; 26 TC 293, CA.[1970] 1 All ER 519 at p. 523.Bode OyetundePage 17 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperincur expense which was wholly and exclusively for the purpose of histrade or profession.” 108This reasoning could conceivably apply to specialist and sophisticatedmedical care for persons whose physical fitness or features are essentialfor their professions and earning capacity. Thus, where arthroscopicsurgery 109 or other such specialist techniques involving cosmetic surgeryare performed on an athlete, 110 musician, 111 actor 112 or model 113 , and lasersand electromagnetic radiation are used to restore or enhance physicalperformance or beauty, would these costs qualify as ‘expenses whollyand exclusively incurred for the purpose of the trade or profession’? Onthe other hand, would they fall into the duality trap, particularly as therestoration of the health of the musician, athlete or model to some extentserves the patient’s needs as ‘a human being’? In these examples, theconnection between the expenditures and the maintenance orenhancement of earning capacity is clear. However, the deductibility rule,as applied by the cases, would result in either hardship or unduegenerosity to the taxpayer. The inequity of these cases could becontrasted with circumstances in which the courts have held that thepresence of a private purpose was insufficient to preclude theexclusiveness of a business purpose.108109110111112113Op cit, at p. 523 d-f.Where an orthopaedic surgeon uses an arthroscope (a pencil-sized fibreopticinstrument equipped with a miniature camera) to examine the tendonsand tissues of a joint and uses other specialist techniques involvingminiscule incision and suction/irrigation techniques to diagnose and repairknee and other joint injuries.Knee injuries are particularly common in physical sports like football, whereplayers such as Ruud Van Nistelrooy and Paul Gascoigne have had to havespecialist knee treatment.Such as Britney Spears and Spice Girl, Mel-C, who both have had specialistsurgery performed on their knees.Of the numerous celebrities that have undertaken cosmetic surgery, theexamples of Michael Jackson, Michael Douglas, Marilyn Monroe and PamelaAnderson Lee stand out.For instance, the extensive cosmetic surgery undertaken by Katie Price(‘Jordan’) including silicon implants, liposuction and collagen injectiontreatment to enhance her looks.Bode OyetundePage 18 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper2.4. PRIVATE BENEFIT, YET PREDOMINANTLY BUSINESS MOTIVESMcLaren v Mumford 114 was an interesting case, in which the tenant of apublic house sought to deduct all his expenditure on rent, rates, lighting,heating and insurance from his profits. Under the terms of his tenancyagreement, he was required to reside on the premises despite the factthat he had alternative accommodation. In the light of the finding of factthat his only conscious motive in entering into the tenancy agreementwas to earn his living, the court held that, as there was a non-businesspurpose of satisfying the ordinary human need of accommodation, a dualpurpose existed, and the Revenue’s contention that only five-sixths of theexpenditure was deductible was upheld. 115 Here, despite the presence ofa private benefit, the court was satisfied that an apportionment could bemade given the predominantly business motivations of the taxpayer.In McKnight v Sheppard 116 the House of Lords allowed legal expenditureincurred by the sole proprietor of a stockbroking firm in defending himselfat professional disciplinary hearings. The Crown had argued that theCommissioner’s finding that the taxpayer had two purposes for incurringthe expenditure, namely to preserve his business and to preserve hispersonal reputation, indicated a duality of purpose and thus offended theexclusivity requirement. 117 In his leading judgment, Lord Hoffman heldthat there was no inconsistency in the Commissioner’s conclusion of lawthat the taxpayer’s exclusive object was to preserve his trade, and thefinding of fact that the taxpayer was not wholly unconcerned with the114 [1996] STC 1134; 69 TC 173.115On the Revenue’s claim that in similar cases, there was a practice ofpermitting apportionment of expenses, the counsel for the taxpayercuriously argued that this was wrong in law. Rimer, J noted that if this wasthe case, then none of the expenditure would have been deductible, anoutcome detrimental to the taxpayer’s interest. Unfortunately the learnedjudge did not express any view on the validity of the Revenue’s [erstwhile]practice of apportionment.116[1999] STC 669, HL.117The appeal court had allowed the Crown’s appeal ruling that the legalexpenses were non-deductible but the Court of Appeal allowed thetaxpayer’s appeal on this point.Bode OyetundePage 19 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperprotection of his personal reputation. The secondary ‘purpose’ wasmerely the incidental effect of the expenditure, and the existence of suchprivate advantage did not necessarily preclude the exclusivity of thebusiness purpose of preservation of the trade. 118In both cases, while it was acknowledged that a private purpose could beserved by the expenditure, it was held that the business purpose was thepredominant one, justifying the apportionment or full deduction of therelevant expenses. The findings of fact that both taxpayers consciouslyhad business objectives 119 in mind seem to have been crucial in eachdecision. Yet, in Mallalieu v Drummond, 120 a similar finding of fact wasinsufficient to prevent the House of Lords holding that presence ofsubconscious human needs of warmth and decency vitiated theexclusivity of the taxpayer’s conscious business purpose. The point atwhich subconscious private motives acquire sufficient substance to impairthe exclusivity of a conscious business purpose seems to be unclear. 1212.5. TRAVEL, ACCOMMODATION, FOOD AND BUSINESS ENTERTAINMENTEXPENDITURE2.5.1. BUSINESS INCOME EXPENDITURECase law on expenditure properly deductible from business incomeillustrates the severity of the rule prohibiting deduction of any dual-118119120121Lord Hoffman also held that the legal fees were properly deductible,following Morgan (Inspector of Taxes) v Tate & Lyle [1955] AC 21, 35 TC367, as to hold otherwise would amount to an additional fine on the taxpayernot provided by the relevant regulatory scheme and be unjust in impairingthe taxpayer’s right to defend himself in such proceedings. However,punitive fines were not deductible on public policy grounds.Namely, to earn a living as a publican and to preserve the privilege to tradeas a stockbroker.[1983] STC 124, CA; [1983] STC 665, HL.John Tiley, Revenue Law, op cit, p. 421.Bode OyetundePage 20 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperpurpose expenditure. In Newsom v Robertson (Inspector of Taxes) 122 theCourt of Appeal dismissed a barrister’s claim of deductibility for the costsof commuting from his home to his chambers in London. In that case,Lord Denning drew a distinction between living or personal expenses(commuting from home) and business expenses (such as the cost oftransportation from chambers, the barrister’s base, to the courts), withthe result that, as commuting costs were incurred for the purpose of livingaway from work, they fell into the former category and were nondeductible.123 Similarly, Romer, LJ balked at the idea that all Schedule Dtaxpayers would be entitled to deduct the costs of commuting to and fromwork, particularly as the object of both journeys was not to enabletaxpayers to do their work, but rather to allow them to live away from it. 124In some cases, the facts clearly indicate that the predominant motive forthe expenditure is the promotion of personal benefit. Here, little inequitycan be alleged to result from the application of the ‘wholly andexclusively’ rule. For example, in Bowden v Russell & Russell, 125 travel,accommodation and other expenses incurred by a solicitor in attendingprofessional conferences in North America were disallowed as having adual purpose. The evidence showed that the solicitor did not attend theconferences in a representative, official capacity; he intended also tohave a holiday, was accompanied by his wife and spent a considerableamount of time engaged in sightseeing and social activities. A distinct,non-business purpose was found and the deduction prohibited for duality.Other cases are less clear-cut, especially where both private andbusiness considerations exist contemporaneously and neither can be saidto predominate. Watkis (Inspector of Taxes) v Ashford Sparkes &122123124125[1953] 1 Ch 7; [1952] 2 All ER 728, CA.[1952] 2 All ER 728 at pp. 731 - 732.Op cit, at p. 732.[1965] 2 All ER 258; [1965] WLR 711; 42 TC 301 per Pennycuick, J.Bode OyetundePage 21 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperHarward 126 illustrates the difficulties faced by the courts in rationalisingtheir decisions in factual circumstances where both private and businessends are served by expenditures. Here, the possibility of apportionmentin these cases may be welcome and yield more wholesome results.Indeed, apportionment has limited application in VAT-related businessentertainment expenses, as is highlighted in the next section.2.5.2. VAT & NON-VAT ‘BUSINESS ENTERTAINMENT’ EXPENDITUREGenerally, outlays for the provision of business entertainment 127 aredenied deduction under certain statutory prohibitions. Specific rules applyto corporate business entertainment expenses 128 and businessentertainment expenses vis-à-vis business income 129 as well asemployment income. 130 In Associated Newspapers Groups Ltd vFleming 131 , the House of Lords construed certain obscure 132 provisions 133prohibiting business entertainment expenditures except where these were“expenses incurred in … the provision by [the taxpayer] of anything whichit [was its] trade to provide”. 134 The taxpayer, a newspaper publisher, had12612712812913013113213313458 TC 468; [1985] STC 451; [1985] WLR 994; [1985] 2 All ER 916: seebelow at §4.2This phrase is defined as inclusive of hospitality of any kind: see §45(3)ITTOIA 2005; §356(3) ITEPA 2003; and §577(5) Income and CorporationTaxes Act 1988. See also Romer LJ in Bentley, Stokes & Lowless Beeson[1952] 2 All ER 82 at 84.See §577, Income and Corporation Taxes Act 1988.See §45 – §47, ITTOIA 2005. Exceptions exist for expenses incurred in theprovision of entertainment which is in the trader’s business to provide, if forpayment in the ordinary course of trade or gratuitously with the objective ofgeneral, public advertisement. Where employees are entertained,attributable expenses are deductible provided non-employees are excludedand do not benefit from the entertainment. Similar exceptions apply tobusiness gifts.Subject to certain exceptions vis-à-vis general entertainment allowances:see §356 – §358 ITEPA 2003. See generally, John Tiley, Revenue Law, opcit, §22.6.3.[1972] 2 All ER 574, HL.In the opinion of the Lord Reid; see at pp.580 and 582.Similar to the present wording of §46(2) ITTOIA 2005 and §577(10) Incomeand Corporation Taxes Act 1988.§15(1)(a) Finance Act 1965.Bode OyetundePage 22 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperincurred certain sums 135 in the provision of hospitality by way of mealsand drinks provided at restaurants and hotels by its journalists to theircontacts, informants and contributors. Experience had shown that suchbusiness entertainment was often necessary in procuring the informationon which the taxpayer’s news and feature articles were based. Thetaxpayer sought to deduct these sums, contending that they wereincurred in the provision of newspapers, which were in its trade toprovide. The House of Lords, in affirming the Court of Appeal’s decision,distinguished between expenses incurred in the provision of newspapersand those incurred in the provision of entertainment. The former relatedto the trade of the taxpayer; the latter, though wholly and exclusively laidout for the purpose of the taxpayer’s trade, were not. 136 As such, theexpenses were not deductible. 137These provisions 138 are noteworthy as they were considered to belegislative solutions to the exploitation of the then generous ‘wholly andexclusively’ rule by excessively lavish business entertainmentexpenditure. Such abuse was frowned upon by Parliament due to theimplicit element of reciprocity involved, 139 and as it encouraged traders toentertain business associates (and indeed themselves) at the publicexpense. 140 Interestingly, the quantum of the disputed sum in this case(£67,143.00) was considered not to be excessive and it was concededthat, but for the statutory prohibition, it would have been allowable as adeduction. 141 This was notwithstanding the evident difficulty the courtspeculated that the Revenue would have in separating “entertainment135136137138139140141£67,143 to be precise.By Lord Morris of Borth-y-Gest at p. 584.Indeed, it would appear that unless the entertainment is supplied by thetaxpayer himself, not merely by another supplier in his line of trade, theexpenditure may not be deductible under these statutory prohibitions: seeJohn Tiley, Revenue Law, op cit, p. 451.§15(1)(a) Finance Act 1965; §46(2) ITTOIA 2005 and §577(10) Income andCorporation Taxes Act 1988.As noted by Lord Simon of Glaisdale at p. 586.Noted by Lord Reid at p. 578.Being wholly and exclusively laid out for the purpose of the trade, consistentto the practice of newspaper publishers at that time.Bode OyetundePage 23 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperwhich was reasonable from that which was not”. 142 Surely, if the sum wasreasonably incurred wholly and exclusively for the purpose of thetaxpayer’s trade and not excessive in quantum, should not this bedeductible if the tax regime is to facilitate and not impede the taxpayer’sbusiness operations and competitiveness? 143 It seems that, in this case,the business entertainment expenditures were ‘efficient’ in the sensethat, although they produced both personal and business benefits, thecombined personal and business value exceeded the actual monetarycosts. 144The regime for VAT-related business entertainment expenditure issimilar. As noted above, under the Article 5 of the Input Tax Order1992, 145 tax on goods and services utilised for ‘business entertainment’ isnot deductible, as these do not constitute allowable business purposes(unlike expenditure on accepted business purposes such as advertising).This rule has been applied to disallow claims for input VAT onexpenditure on client lunches 146 and food and drink expenditure atdiscussion meetings organised by a market research company, 147 as wellas launching parties for new business 148 and harbour 149 premises. InCustoms & Excise Commissioners v Shaklee International & another, 150the Court of Appeal upheld a High Court decision 151 to disallow claims forinput VAT on food and accommodation expenditure where these142143144145146147148149150151By Lord Reid at p. 578 (emphasis added).Indeed, where journalists used such business entertainment expenditure tocultivate and maintain close relations with especially valuable contacts,information gleaned from these sources could lead to exclusive reportsplacing the newspaper well ahead of its competition. See [1972] 2 All ER574 at 576.This concept of economically ‘efficient’ expenditure produces desirablebusiness outcomes and is discussed later in this Report: see §3.3.2.S.I. 1992 No. 3222.See WB Wyatt CAR/76/65 (VTD 263); Mrs. S Woolf (t/a Sally WoolfInteriors), LON/92/2713A (VTD 10415); and W Richards, MAN/92/324 (VTD11674).Medicare Research Ltd LON/80/385 (VTD 1045).Wilsons Transport Ltd, MAN/83/68 (VTD 1468).Fraserburgh Harbour Commissioners, EDN/98/9 (VTD 15797).[1981] STC 776, CA.By Woolf, J. [1980] STC 708.Bode OyetundePage 24 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperamenities were provided free of charge by two corporations duringregular training courses attended by their distributors. Despite the factthat the distributors were agents and not employees, the Court of Appealupheld the High Court’s decision that the supply of food andaccommodation constituted the provision of hospitality within theapplicable definition of ‘business entertainment’, as the supply involvedthe entertainment of distributors in connection with the corporations’business. Accordingly, the input tax was not deductible. 152However, the courts have held that instances of entertainmentexpenditure being incurred under reciprocal arrangements do notconstitute ‘business entertainment’ and, as such, input VAT would bedeductible. For instance, in Celtic Football & Athletic Club Ltd 153 thetaxpayer, a football club, met hotel accommodation expenses incurred bytwo visiting clubs during home matches, under a reciprocal arrangementwhereby their hotel accommodation expenses would be met by the otherclubs when the taxpayer played away matches. The taxpayer claimedinput tax vis-à-vis the costs for hosting visiting clubs and, in the decision,‘entertainment’ was construed as relating only to hospitality provided freeto the recipient. Under the facts, the provision of hospitality was not‘free’; it was contingent on reciprocal obligations to ‘return the favour’. Assuch, there was no supply of ‘business entertainment’ and the input taxcould be properly deducted. 154 Similarly, where a playwright marketingcompany supplied free theatre tickets to prospective customers in thehope that attendance at the theatre performance of certain plays wouldinspire the customers to produce a film or television performance of theplays, input tax on the tickets was deductible. 155152153154155A similar conclusion was reached in Network International Group Ltd,MAN/98/782 (VTD 16554).[1983] STC, CS.See also Football Association Ltd, [1985] VATTR 106 (VTD 1860).WR Ltd, MAN/91/116 (VTD 6968).Bode OyetundePage 25 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperSometimes it is either impossible or implausible to separate out ancillaryexpenditure relating to non-business entertainment expenses.Consequently, tax on the whole amount incurred would be deductible. Forinstance, in DPA (Market Research) Ltd, 156 the taxpayer, a marketresearch company, was allowed to deduct tax on the cost of a Spartanmeal of sandwiches and bread and cheese accompanying theconsumption of alcoholic beverages as part of a questionnaire test ofparticipants’ views on the alcoholic drinks. While the supply of thealcoholic drinks was clearly part of the business of the company, theCommissioners queried the deductibility of tax relating to the supply offood to participants. It was held that the basic meal was a necessary partof the provision of the alcoholic drinks under the particularcircumstances. Tax on the meals was also deductible.In other instances, it is permissible to apportion the tax on theexpenditure, deducting that relating to clearly business purposes andexcluding that relating to business entertainment. For instance, inMacDonald & Muir Ltd, 157 the tribunal rejected the Commissioners’argument that apportionment was not permitted under Article 5(1) of theInput Tax Order, and held that 70% of the input tax on premises used fordual business administration and entertainment purposes (butpredominantly for the former) was properly deductible. The Court ofAppeal has specifically approved apportionment in deserving cases, 158and this practice has been applied in several other decisions. 159 In DLumby, 160 apportionment was applied in a particularly ‘rough and ready’fashion. Here, the promoter of a rock concert claimed to have provided9,600 free alcoholic beverages to 370 persons attending the concert.While the tribunal was prepared to permit the deduction of tax relating to156157158159160LON/95/2837 (VTD 14751).EDN/92/208 (VTD 10947).See Thorn EMI plc v Customs and Excise Commissioners [1995] STC 674,CA.See BMW (GB) Ltd v Customs & Excise Commissioners [1997] STC 824 andKPMG (No. 2) [1997] VATDR 192 (VTD 14962).MAN/94/593 (VTD 12972).Bode OyetundePage 26 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthe drinks, evidence indicated that the relatively small number ofcustomers and employees that attended could not have consumed all thealcohol supplied. As such, an apportionment was made on the balance ofprobabilities to limit the deductible tax to only 3,600 drinks, being a morereasonable and credible number. Consequently, the tribunal was sparedthe difficulty of applying an ‘all or nothing’ rule, avoiding inequity to boththe taxpayer and the taxman.Many of the cases considered above relate to unincorporated trades andbusinesses. Ascertaining the exclusive or predominant purpose forexpenditures is a difficult enough undertaking in partnerships and for soletraders, where the courts need only to assess the subjective motives ofthe real individuals involved. The task is more involved in dealing withartificial persons and entities such as corporations and corporate groups.2.6. DIFFICULTIES WITH CORPORATE GROUPS AND ASSOCIATED COMPANYEXPENSESVodaphone Cellular Ltd. v Shaw 161 illustrates the application of the ‘whollyand exclusively’ rule to corporate groups. The taxpayer was a company ina telecommunications group that sought to deduct expenses associatedwith the determination of liabilities under certain onerous agreements.The Special Commissioners disallowed this, considering that theexpenditure was made by the directors to benefit the group’sundertakings, and not incurred wholly and exclusively in aid of the tradeof the particular taxpayer company. Though this determination wasupheld by Jacob, J, on further appeal the Court of Appeal allowed theexpenditure to be deducted, holding that the Commissioners had erred intheir conclusions.161 [1997] STC 734, CA.Bode OyetundePage 27 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperIn the leading judgment, Millet, LJ held that the question of fact to beanswered was not whether the directors sought to obtain a benefit for oneor more group companies, but rather what their particular object was.Once such an object was discovered, its characterisation was a matter forthe Commissioners, not the taxpayer. As such, the directors did not setout to benefit any particular company (the ‘effect’) in the group, but rathersought to eliminate an onerous liability detrimental to the group owedlegally only by the taxpayer company (the ‘purpose’). Hence, theexpenditure was laid out exclusively to serve the purposes of thetaxpayer company’s trade, irrespective of any consequential, beneficialeffects this would have on the group’s fortunes, and should bedeductible.Other decisions, however, have denied deductions. In Commercial UnionAssurance Co plc v Shaw, 162 the High Court upheld the Commissioners’decision to disallow the deduction of interest paid on certain loans, asthis was partly to benefit the separate trades carried on by the subsidiarycompanies in the group (of insurance companies) and, therefore, was notwholly and exclusively for the benefit of the parent company. Similarly, inGarforth (Inspector of Taxes) v Tankard Carpets Ltd 163 , theCommissioners held that payments made under certain guarantees by asubsidiary of the associated company of the taxpayer company weredeductible, despite their finding of fact that the interests of the threecompanies in the group were considered when deciding on the paymentsand related security. On appeal, it was held that the payments were notproperly deductible as they were not incurred wholly and exclusively forthe purpose of the taxpayer company’s trade.The basis for allocating related company charges has also raised162163[1998] STC 385; 72 TC 101.[1980] STC 252; 53 TC 342.Bode OyetundePage 28 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperdifficulties. In Stephenson (Inspector of Taxes) v Payne 164 , anaccountancy firm sought to deduct the charges of a private servicecompany set up to supply staff, premises and other services to the firm.The agreed charges contained an element in excess of the cost of theservices, inserted to guarantee a margin over nominal profits for theservice company and charged more heavily in the initial years. 165Although the Commissioners considered that the charges fairly reflectedwhat would have been charged by an independent company transacting atarm’s length, on appeal the court held that the periodic attribution of suchexpenses to each year should be in a manner consistent with ordinaryprinciples of commercial accountancy, and not as the parties had soughtto accrue them in the accounts during the relevant years. As such, only afair portion of the charges was allowed to be deductible in that particularyear.This case illustrates the role accounting concepts and evidence haveplayed in dealing with the issues posed by the deductibility rule. The nextsection examines these accounting concepts and more fundamentaleconomic theories and their implications for the deductibility of expenses.In highlighting the theoretical considerations underpinning the difficultiesnoted in the case law on the ‘all or nothing’ deductibility rule, the nextsection searches for more reasonable deductibility rules. In particular, itsuggests the role apportionment may play in this regard.16416544 TC 507; [1968] 1 WLR 858; [1968] 1 All ER 524.The amount of excess profits were to be progressively reduced such thatthose charged in initial years would be proportionately higher than thosecharged in subsequent years.Bode OyetundePage 29 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper3. ACCOUNTING AND ECONOMIC CONCEPTS OF INCOME AND EXPENDITURE3.1. OVERVIEWThe foregoing section has considered the development of judicialprecedent on the deductibility of expenses under the ‘wholly andexclusively’ rule. Concepts of accounting and economic income haveinfluenced the approaches of the courts and tax policymakers indetermining the bounds of the ‘wholly and exclusively’ deductibility rule.Accounting concepts and economic theories provide significant insightsinto the concept of taxable income and the role of the wholly andexclusively deductibility rule in determining the tax base for incometaxation.3.2. ACCOUNTING INCOME AND THE DEDUCTIBILITY OF EXPENSESAccounting rules and concepts have traditionally played a significant rolein this area of UK tax law, as indicated by Jenkins, LJ’s statement inMorgan (Inspector of Taxes) v Tate & Lyle Ltd to the effect that: “… it haslong been settled that the effect of these provisions as to deductions isthat the balance of the profits and gains of a trade must be ascertained inaccordance with the ordinary principles of commercial trading, bydeducting from them the gross receipts of all expenditure properlydeductible from them on those principles, save in so far as any amount sodeducted falls within any of the statutory prohibitions contained in therelevant rules, in which case it must be added back for the purpose ofarriving at the balance of profits and gains accessible to tax.” 166 As such,in matters of the ascertainment of taxable profits, recourse wouldnormally be had to the principles of commercial accountancy. This hasbeen applied in UK case law, as illustrated in the pre-Finance Act 1998166[1953] 2 All ER 162 at 175; [1953] Ch. 601 at 627, CA.Bode OyetundePage 30 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperdecisions of Odeon Associated Theatres Ltd v Jones 167Jones. 168and Gallagher vHowever, it has been suggested that the more modern (post-Finance Act1998) view considers the characterisation of expenses into deductibleand non-deductible categories to be more a matter of law and less amatter of commercial accountancy, reducing the importance of accountingprinciples from being conclusive to being merely of evidentiaryinfluence. 169 Accounting theories of income based on net incomeapproaches 170 often make distinctions between income and capital,nominal and real income flows and ex ante and ex post income. 171 Othertheoretical issues in accounting involve source preservation, 172 periodicmeasurement, the ‘realisation’ concept and the use of the historic costbasis. In practice, these principles and concepts have been adopted withvarying degrees of success in international and UK generally acceptedaccounting practice, and applied in specific accounting standards issuedby the relevant accounting boards. 173 Controversies abound, however, asto the appropriate application of many of these accounting concepts toparticular transactions and industries, 174 and, indeed, by the courts in167168169170171172173174By Salmon J. [1972] 1 All ER 681 at 689. See also Lord Haldane in SunInsurance Office Ltd v Clark [1912] AC 443, at 455 and Lord Clyde inLothian Chemical Co Ltd v Rogers (1926) 11 TC 508, at 520.By Sir Thomas Bingham M.R. [1993] STC 537 at 555, 556.John Tiley, Revenue Law, op cit, p. 418.See Irving Fisher, (1906) The Nature of Capital and Income (New York: andLindhahl, Erick (1933) The Concept of Income, in Economic Essays in Honorof Gustav Cassel, (London).See generally Hansen, Palle (1962) The Accounting Concept of Profit(Amsterdam: North-Holland Publishing Company).J.R. Hicks, (1946) Value and Capital – An Inquiry into Some FundamentalPrinciples of Economic Theory, (London: Oxford University Press).See generally John Tiley, Revenue Law, op cit, §21 et seq, particularly pp.395 – 399.For instance there is some controversy as regards the use of ‘fair values’ ininternational and UK accounting standards, particularly as regards themeasurement of insurance contracts and other financial instruments: seeMacve, Richard and Joanne Horton, Fair Value for Financial Instruments:How Erasing Theory is Leading to Unworkable Global Accounting Standardsfor Performance Reporting, Australian Accounting Review 11, No.2 (2000),pp. 26 – 39.Bode OyetundePage 31 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papercases where multiple, conflicting treatments of transactions are permittedby accounting. 175In certain instances, 176 where required or authorised by law, 177 taxtreatment departs from the accounting treatment of items of revenue,expenses, income and capital. 178 Tax law is not alone in this variance withaccounting practice: economic income approaches, though sharing similarroots with accounting income approaches, 179 significantly differ 180 fromaccounting income and its increasingly pervasive comprehensive incomeapproaches (for instance, those underpinning ‘fair value’ accounting). Theinsights derived from more fundamental (and indeed, more relevant fromthe perspective of the tax deductibility of expenses) economic conceptsof income are considered in the next section.3.3. ECONOMIC INCOME AND THE DEDUCTIBILITY OF EXPENSES3.3.1. INTRODUCTIONWhile accounting concepts have influenced jurists, economic theories onincome have had great impact on tax policymakers in the design ofappropriate tax bases and policies. Income, however, is a rather elusiveconcept, meaning various things to different people for diverse purposes.The ideas to which income corresponds range from tangible cash andmoney (net) receipts from economic activity to more ephemeral conceptsof economic utility or psychological satisfaction. The search for an175176177178179180See Gallagher v Jones [1993] STC 537. See also Willingale v InternationalCommercial Bank Ltd [1978] STC 75 and Pattison v Marine Midland Ltd.[1981] STC 540.For instance, in the deductibility of expenses under the rules for wholly andexclusively incurred expenses and business entertainment expenditure: seeJohn Tiley, Revenue Law, op cit, p. 398.See §42 Finance Act 1988 and §25 ITTOIA 2005.John Tiley, Revenue Law, op cit, p. 398.In the foundational concept of income: see Kevin Holmes, (2000) TheConcept of Income: A Multidisciplinary Analysis, IBFD Doctoral Series Vol.1, IBFD Publications BV, chapter 4.Kevin Holmes, (2000) The Concept of Income: A Multidisciplinary Analysis,ibid, chapter 3.Bode OyetundePage 32 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperoptimal definition of taxable income is no less problematic, as varioustheories suggest. In truth, the debate over the economic rationales fordeductibility stem from which school of tax policy one favours. Thecomprehensive income/equity school contends that the object of taxpolicy should be the creation of an equitable tax system, achieved byhaving a comprehensive tax base as best representing a person’s abilityto pay. As such, concepts of deductibility of expenses from gross incometo arrive at taxable income are underpinned by the appreciation that suchcosts were necessary outlays in earning the income, and the wish toprevent perceived double taxation (when these expenditures eventuallyyield income).The opposing views of the optimal taxation school favour utilitarianismover equity, considering that the appropriate tax base should be elastic,not broad, and based on ‘sacrifice theory’ 181 . As such, tax policymakersshould examine the effects of their taxes, and seek to effect the optimaltrade-off between the accepted goals of equity and incidental costs oftax, preferring taxes that produce a given quantum of revenue for theleast loss of taxpayers’ satisfaction or utility. Applied to deductibleexpenses, this implies that the distributional and economic consequencesof tax proposals should be carefully evaluated, and only tax policies withthe desired economic consequences in mind should be implemented. 1823.3.2. INSIGHTS FROM OPTIMAL T AX THEORYOptimal tax theory considers that, as individuals possess peculiar andunique characteristics and traits (which together comprise their personalwellbeing), taxation should seek to charge such dissimilar individualsdifferently based on their ability to pay, and so maintain vertical equity181182Basically, that the loss of utility or social welfare associated with taxesshould be borne by all taxpayers in a manner that ensures equity acrosstaxpaying cohorts and occasions the least sacrifice to taxpayers as a whole:John Tiley, Revenue Law, op cit, p. 14.See generally, John Tiley, Revenue Law, ibid, pp. 13 – 15.Bode OyetundePage 33 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperamong taxpayers. Logically, this would imply the taxation of intangiblessuch as leisure time and self-supply imputed income from services. 183However, it proffers no tool to measure with precision such constituentelements of ‘welfare’ inclusive of such individual traits as physical,mental and financial endowments and economic and social opportunities,as well as unique tastes and human capital. Thus, while appealing (atleast to the revenue authorities) in suggesting that the sum of individuals’comprehensive endowments should be brought to tax, it fails to providethe benchmark for measuring this, compelling tax policymakers to resortto other concepts such as ‘income’ to serve as a close substitute. 184Edgar 185 considers the optimal rules relating to the deductibility ofexpenses that may influence the concept of taxable consumption underan ideal personal income tax base. Following the optimal tax tradition,Edgar examines the implications these ‘use of funds’ tax bases suggestfor the development of rules governing the deductibility of expenses. Inthis analysis, the Haig-Simons accretion concept of income 186 based onconsumption and accumulation suggests that the comprehensive tax baseshould be used as a benchmark for taxable income. As regards thedeductibility of expenses, only outlays expended in the income-earningprocess should be deductible, as Haig-Simons income distinguishesbetween the income-earning and profit distribution processes. Asexpenditure incurred to produce income will ultimately be taxed once thatincome is realised, tax should be assessed on a net, as opposed to a183184185186Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, in R.Krever ed. Tax Conversations, (Great Britain: Kluwer Law International), p.300.Kevin Holmes, (2000) The Concept of Income: A Multidisciplinary Analysis,IBFD Doctoral Series Vol. 1, IBFD Publications BV, pp. 9 – 14; 30 – 33.Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit.Essentially, the algebraic sum of market rights exercised in consumptionand the change in market value of the store of property rights over therelevant period: see Henry Simons (1938), Personal Income Taxation(Chicago: Univ. of Chicago), p. 17. See also, Tim Edgar (1997) The Conceptof Taxable Consumption and the Deductibility of Expenses under an IdealPersonal Income Tax Base, op cit, p. 298.Bode OyetundePage 34 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papergross, revenue basis. 187 He suggests the use of social welfare analysis toexamine the distributional and economic consequences of alternativemethods of treating specific revenue and income items under an ability topay concept of tax base formulation. 188Edgar reviews 189 the work of Klein 190 , Halperin 191 and Griffith 192 , who offersignificant insights into the problems of deductibility of mixed purposeexpenses. Griffith’s work examines various rules based on bothinformational requirements and distributional effects, the objective beingto arrive at rules that facilitate economically ‘efficient’ mixedexpenditures. Such ‘efficient’ expenditures occur when the combinedpersonal and business benefits associated with the outlay exceed theactual costs incurred. Griffith argues that an ideal tax system shouldpromote efficient mixed expenditures and discourage inefficient ones. 193He suggests an ‘excess cost’ method which disallows the deduction ofany excess of the cost of any expenditure over its income-earning orbusiness value, effectively taxing the personal consumption elementimbedded in mixed expenditures. A similar effect could be achieved underan ‘allocation of cost’ method, which decomposes a mixed expenditure187188189190191192193Stanley S. Surrey (1973), Pathways to Tax Reform (Cambridge, Mass.:Harvard University Press), pp. 15 – 24; Joseph M. Dodge, (1993) TaxingHuman Capital Acquisition Costs – Or Why Costs of Higher EducationShould Not Be Deducted or Amortised, Ohio State Law Journal 54, pp. 927-984; Richard Goode, (1976) The Individual Income Tax (Washington: theBrooklings Institution, p. 14. See also Tim Edgar (1997) The Concept ofTaxable Consumption and the Deductibility of Expenses under an IdealPersonal Income Tax Base, op cit, pp. 305 – 306.Ibid, pp. 365 – 367.Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit,pp. 311 – 315.William A. Klein, (1966) The Deductibility of Transportation Expenses of aCombination of Business and Pleasure Trip – A Conceptual Analysis,Stanford Law Review, 18: 1099 – 1118.Daniel I. Halperin, (1974) Business Deduction for Personal Living Expenses:A Uniform Approach to an Unsolved Problem, University of PennsylvaniaLaw Review 122: 859 – 933.Thomas G. Griffith, (1994) Efficient Taxation of Mixed Personal andBusiness Expenses 41 UCLA Law Review 1769 – 1789.Thomas G. Griffith, (1994) Efficient Taxation of Mixed Personal andBusiness Expenses, ibid, p. 1770.Bode OyetundePage 35 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperinto (non-deductible) personal consumption and (deductible) incomeearning constituents based on the relative amounts of personal orbusiness value generated. A third option is the ‘personal consumption’approach 194 , where deductibility of mixed expenditures is limited toinstances of actual cost exceeding any personal benefits; however, bothpersonal and business values generated by the expenditure are taxed.Griffith’s solutions, however, depend on varying informationalrequirements and result in different distribution effects – factors that taxpolicymakers should consider well, matching the available informationwith the mode of taxation adopted in order to promote more efficientexpenditures.3.3.3. PRACTICAL LIMITS ON THE IMPLICATIONS OF OPTIMAL TAX THEORYAny insights drawn from optimal tax and other theories are only as goodas their practical applications in resolving difficulties posed by mixedpurpose expenditures in any given tax system. The tax system itself andits mode of administration may impose significant restraints on theusefulness of these approaches. Indeed, Edgar notes that thesesophisticated models depend on a precise assessment of the respectivevalues of business and personal constituents in any mixed expenditureand underlying drivers for the decision to make the outlay. In the absenceof any definite manner of determining these, ‘rough judgments’ must bemade in assessing such motivations and values and “… an appropriatetaxation method can only be applied based on those judgements”. 195The difficulty of the UK courts in arriving at a consistent body of such‘rough judgments’ is exemplified by the state of case law 196 , which has194195196Which corresponds to that under Halperin’s analysis: see Tim Edgar (1997)The Concept of Taxable Consumption and the Deductibility of Expensesunder an Ideal Personal Income Tax Base, op cit, p. 312.Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit,p. 313.Reviewed above.Bode OyetundePage 36 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperbeen characterised as obscure, inconsistent and generally inequitable byKerridge 197 and clear-cut, uniform and generally inequitable by Ward 198 .This leads Edgar to conclude “… a certain degree of theoretical puritymay legitimately be abandoned because of administrative exigenciesnecessitated by a need to prevent abusive deduction claims. The costmay well be an income tax system in which efficient mixed expenses arediscouraged … Tax policymakers in all countries must make their owndecisions in the areas of employment and business income without anyuseful guidance from the dictates of a (comprehensive tax base).” 199A more pervasive challenge stems from the fact that many of theanalyses of these commentators 200 have greater applications under theglobal system of income taxation adopted by many countries, includingthe United States. These global systems aggregate revenue under asingle schedule regardless of its source, seek to effect an ability to payapproach to vertical and horizontal equity and have resulted in a widertax base where adopted.201However, the UK’s schedular system oftaxation differs significantly in assessing to tax income based on sourceof income categories, raising the possibility of horizontal and verticalinequities. 202 Unless greater consistency is desired with these globalincome systems, the benefits of these approaches to the deductibility ofexpenses may not be realised, and more pragmatic solutions may benecessary to reduce the inequalities occasioned by the ‘wholly and197198199200201202Roger Kerridge, Deductibility of Expenses for Schedule D Income Tax – The“All or Nothing” Rule, [1986] B.T.R. p. 36.John Ward, “All or Nothing”: More Than Nothing at All [1987] B.T.R. 141.Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit,p. 315.Viz., Klein, Halperin, Griffith and Edgar.Kevin Holmes, (2000) The Concept of Income: A Multidisciplinary Analysis,op cit, pp. 28 – 30.Kevin Holmes, (2000) The Concept of Income: A Multidisciplinary Analysis,op cit, p. 28. See also Tim Edgar (1997) The Concept of TaxableConsumption and the Deductibility of Expenses under an Ideal PersonalIncome Tax Base, op cit, p. 299.Bode OyetundePage 37 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperexclusively’ rule under the UK income tax system. 203 As noted in theintroduction, this Report is not intended to provide a comprehensive listof possible alternatives to the ‘wholly and exclusively’ deductibility rule.However, in the next section, it examines an alternative, moreeconomically ‘efficient’ reasonable business expenses rule, whichcombines two possible solutions, namely the use of dissection andapportionment. Dissection rules are akin to Griffith’s ‘excess cost’mechanism in disallowing the personal consumption components of mixedbusiness expenditures. The application of apportionment rules (similar toGriffith’s ‘allocation of costs’ method), which tend to promote moreeconomically efficient outcomes, is further considered in the context ofthe tax regime of a Commonwealth country. 204203204Such as apportionment of expenses, as discussed below: see John Tiley,Revenue Law, ibid, p. 424.Viz., Australia.Bode OyetundePage 38 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper4. ALTERNATIVES TO THE ‘WHOLLY & EXCLUSIVELY’ RULE4.1. DETERMINING THE BOUNDS OF A REASONABLE BUSINESS EXPENSESRULEThe foregoing sections have highlighted the practical and theoreticalproblems posed by the ‘wholly and exclusively’ rule. Inequitable resultsproduced in the case law illustrate some of the hardships the ‘all ornothing’ nature of the rule causes. Some commentators laud the sensibleapplication of the duality rule by Inspectors of Taxes, and the use ofpartial claim compromises 205 to avoid some of the absurdities a slavishapplication of the rule may produce. 206 However, this commonsense,practical approach may lead to anomalies and differing applications totaxpayers in similar situations, causing inequities, reducing clarity andmaking the regime more opaque. A more comprehensive solution isrequired, which reduces distortions across various kinds of economicentities and activities.A possible solution may be to frame the deductibility rule along the linesof a ‘but for’ reasonable business expense test, such that all expenseswhich would not be incurred but for the need to promote business endsshould be deducted, irrespective of whether these are incurred togetherwith other expenses which promote private ends. As indicated in the nextsection, this rule could be easily implemented in relation to aggregatedbut discrete mixed purposes transactions. However, it may prove to beinadequate in dealing with the problems posed by integrated mixedpurpose expenditures.205206Between the taxman and the taxpayer, provided the latter’s case does notinitially claim part of the controversial expenditure and so fall into theduality trap: see the observation of Ploughman J in Murgatroyd (Inspector ofTaxes) v Evans-Jackson [1967] 1 All ER 881 at p. 887.Particularly as regards clothing expenses for entertainers and other dualpurpose expenditure: see Robert W. Maas, Taxation of Employments, op cit,pp. 111, 113.Bode OyetundePage 39 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paper4.2. DISSECTION AND THE REASONABLE BUSINESS EXPENSES RULEThe ‘but for’ reasonable business expenses rule could be used to expandthe scope of dissection of aggregate yet discrete mixed purposestransactions, such that those expenses that are properly attributed tobusiness purposes may be properly deducted. The decision in Watkis(Inspector of Taxes) v Ashford Sparkes & Harward 207 illustrates a feasibleapproach to implementing the reasonable business expenses rule. Here,the court considered mixed expenses on food and accommodation anddissected the deductible business elements in a series of expenses fromnon-deductible private expenses. In this case, a firm of solicitors soughtto deduct 208 the following expenses: the cost of meals taken at weekly orfortnightly lunch meetings where the firm’s business was discussed bythe partners; the cost of meals at evening plenary meetings at office orhotel locations where the partners further discussed the firm’s affairs;expenditure attributable to the partners on meals and accommodation atan annual weekend conference attended by the partners and theirfamilies; and the contribution towards accommodation for a regionalsolicitors’ conference attended by the firm’s partners. Nourse, J appliedthe House of Lords’ decision in Mallalieu v Drummond (Inspector ofTaxes) . 209 The consumption of food and drink at the firm’s lunchmeetings, dinner meetings and the solicitors’ conference would haveoccurred irrespective of any meetings, as these were provided at timeswhen lunch and dinner meals would have been eaten anyway. Althoughthe business purpose might be the predominant purpose, it was not the20720820958 TC 468; [1985] STC 451; [1985] WLR 994; [1985] 2 All ER 916.The Commissioner held the relevant expenditure was deductible, beingwholly and exclusively laid out for the profession.[1983] STC 665, HL.Bode OyetundePage 40 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperexclusive purpose. As such, the costs of meals at these meetings 210 werenon-deductible. 211Essentially, these expenses would have been incurred anyway.Conversely, the costs of meals and accommodation 212 attributed to thepartners in respect of the annual conference were deductible. Here, thebusiness purpose was not merely the predominant purpose but theexclusive purpose, and any private benefit to the partners was consideredpurely incidental. 213 The court’s rationale indicates that these expenseswould not have been incurred ‘but for’ the existence of a clear operativebusiness purpose. Similarly, the contribution toward the cost of the venueof the solicitors’ meeting was deductible as serving a purely businesspurpose. As such, the court allowed the deduction of the costs ofovernight accommodation for the partners at the annual conference, andthe contribution towards accommodation for the solicitors’ conference.ITTOIA 2005 seems specifically to provide for the possibility of thedissection of a set of contemporaneous transactions 214 to discover anddeduct those expenses which are properly allowable as being attributed210211212213214That is, the firm’s lunch meetings, the evening dinner meetings and thesolicitors’ conference.Nourse, J distinguished the present case from the earlier Court of Appealdecision of Bentleys Stokes & Lowless v Beeson (33 TC 491; [1952] 2 All ER82) where the costs of a firm of solicitors hosting its clients to discussbusiness over lunch were held to be deductible expenses, solely incurred forthe purpose of the profession. However, subsequent legislation onentertainment expenses has altered this position: see §15, Finance Act 1965and more recently, §45 and §46, ITTOIA 2005.The judge saw no distinction between the cost of meals on the one hand andthat of accommodation on the other: see at p. 469e.Especially as the partners had homes in which they could eat at and sleepin at the weekend, further emphasising the business purpose of theexpenses.Or indeed a single purchase serving both business and private ends,provided the parts or proportions that serve the former are identifiable.Bode OyetundePage 41 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperwholly and exclusively for business purposes, implementing a mode ofthe ‘but for’ reasonable business expenses rule. ITTOIA 2005 §34(2)provides that: “… if an expense is incurred for more than one purpose,this section does not prohibit a deduction for any identifiable part oridentifiable proportion of the expense which is incurred wholly andexclusively for the purposes of the trade”. Similarly, the decision inGazelle v Servini 215 illustrates that it is permissible to dissect expenditureto separate that incurred for allowed business purposes from thatincurred for disallowed private purposes. In that case, an accountantclaimed deductions for 50% of the heating, lighting and maintenance costof his private residence on the premise that he had used part of theresidential facilities as a library to store work files, to entertain actualand potential clients and otherwise to further his professional practice.The Commissioner held that 20% of the overhead expenses could beattributed to identifiable expenses, incurred for the purpose of the trade,hence these were deductible. 216 It would therefore appear that it ispermissible to deduct the aggregate cost of business calls in a single butitemised telephone bill, or a reasonable part of excessively generousremuneration expenditure for an employee. 217 However, the courts havedisallowed the deduction of a part of a three-month rental payment 218 andtravel expenditure where there was a mixed private and businesspurpose. 219Despite the clear advantages of the dissection of expenses over a strictnon-dissection ‘all or nothing’ rule, the use of dissection alone is of littlehelp in resolving the profound difficulties raised by mixed purposeexpenditures, given the realities posed by the dual nature of human215216217218219[1995] STC (SDC) 324.This reasoning would equally apply to other discrete expenses such ascouncil tax, electricity and other bills provided they can be dissected and anelement attributed to the trade. However, as examined in greater detailbelow, expenses incurred for dual purpose are not deductible.Copeman v William J. Flood & Sons Ltd. [1941] 1 KB 202, 24 TC 53.Lucas v Cattell 48 TC 353.Bowden v Russell & Russell [1965] 2 All ER 258; [1965] WLR 711; 42 TC301.Bode OyetundePage 42 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperexistence. A large number of human activities and associated expendituresimultaneously involve both business and personal aspects. In suchcircumstances, it can only be said of some and not all of the associatedexpenses that they would not have been incurred but for the business. Asaptly stated by Edgar, “… many expenses related to the income-earningprocess provide personal pleasure; and many personal expenses have anincome-earning component that provides no pleasure in and of itself.” 220Similarly, Nourse, J in Watkis (Inspector of Taxes) v Ashford Sparkes &Harward notes that: “… Many people enjoy their work. Many people donot enjoy social occasions, particularly when they are in some wayconnected with their work. But many occasions which are social in form,whether they are enjoyed or not, are very successful in furtheringbusiness interests.” 221 In these circumstances, variants of the ‘but for’reasonable business expenses rule which retain the ‘all or nothing’character are clearly inadequate. The concept of apportionment mayprovide a more robust solution to the challenges posed by mixed purposeexpenditures – challenges that the dissection rule, though welcome, issimply inadequate to address. The next section examines this tool andthe various arguments in its favour, illustrating the manner in which it hasbeen implemented in the Australian tax regime.4.3. APPORTIONMENT AND THE REASONABLE BUSINESS EXPENSES RULEThe challenge of apportionment where mixed purpose expenditure ariseshas been highlighted in the cases. 222 Some commentators argue forapportionment, as adopted in certain jurisdictions, 223 in instances ofmixed purposes expenditure. For instance, Kerridge 224 traces the root of220221222223224Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, in R.Krever ed. Tax Conversations, op cit, p. 309.[1985] STC 451 at 468.E.g. in cases involving mixed purpose medical expenditure highlightedabove.For instance in Australia: see below in §4.4.Roger Kerridge, Deductibility of Expenses for Schedule D Income Tax – The“All or Nothing” Rule, [1986] B.T.R. pp. 41 – 45.Bode OyetundePage 43 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthe apportionment problem to the difficulties in designing an appropriaterule that would be based on a simple 225 and comprehensive test, as thiswould avoid the pitfall of flawed decisions producing unfair results.Formulating such a test, however, is a difficult undertaking. He opts forone based on the concept of the work, 226 pleasure 227 and necessity 228benefit derived by the taxpayer as opposed to one seeking to divine thepredominant, principal or exclusive purpose for any expenditure. Kerridgeapplies this concept to the scenario of solicitors treating their clients tolunch costing (per person) £10, in circumstances where the solicitorswould have paid £12 for the work benefit alone, £2 for the personalenjoyment or benefit derived from the meal and £1 for the savings on thelunch sandwiches they would have otherwise have had to buy. Heidentifies a series of seven rules which could be applied to theexpenditure, three of which would disallow apportionment (the ‘all ornothing’ set), the next three which would permit it (the apportionmentset), and the last a hybrid rule.First, if there were mixed purpose expenditure no deduction would beallowed: here, no deductions would be made, as embedded in the £10 issome element of pleasure/necessity benefit. While simple to understandand apply, he criticises this rule 229 as being unfair, as many of the casesconsidered above illustrate. Secondly, the entire expenditure could bededucted where justified by the work benefit alone or where the non-workbenefit was negligible: here, as (a) £12 > £10 or (b) £1 ≈ 0, the entire £10should be deductible. This rule 230 , however, could be unduly generous to225226227228229230In terms of both formulation and administration.Measurable by the amount the taxpayer would have been prepared to payfor the expenditure if only business purposes were in mind.Measurable by what the taxpayer would have paid for the benefit of theindividual enjoyment and pleasure made possible by the expenditure.Measurable by the amount of saving made possible by the expenditure overwhat the taxpayer would ordinarily have had to spend on some necessity oflife.Which broadly corresponds to §34(1) of the ITTOIA 2005 and §336, ITEPA2003.Corresponding to Romer, LJ’s formulation in Bentleys Stokes & Lowless vBeeson 33 TC 491; [1952] 2 All ER 82.Bode OyetundePage 44 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthe taxpayer and produce arbitrary results, especially at the margin, andis thus undesirable. 231 Thirdly, the entire expenditure could be deductibleif the work benefit exceeds the non-work benefit: as £12 > (£10 + £1 =£11), once again, the entire £10 should be deductible. However, Kerridgecites inconsistency with case law and statutory provisions as well asundue generosity to the taxpayer for rejecting this rule.The fourth rule falls under the apportionment set, and permits thededuction of the excess of any expenditure over the non-work benefit:here, as £10 – (£2 + £1) = £7, the difference of £7 should be deducted.The fifth rule is similar, and states that the permitted deduction shouldbe capped at the equivalent of the work benefit: basically, as £10 < £12,the entire cost (£10) should be deducted. Though both these rules 232 lendthemselves to straightforward application, as the values required may beeasy to ascertain, Kerridge considers that the former is more consistentwith case law than the latter. In the sixth, the deduction should becalculated as a ratio of the work benefit to aggregate benefit, work andnon-work inclusive. As (a) £10:£15 = 2:3, and (b) £10 x 2/3 = £6.67, thenthis amount (£6.67) should be deducted. Kerridge favours this rule asbeing eminently fair, though inconsistent with case law.Finally, a combination of the fourth and sixth rules could permit thededuction of a proportion of the expenditure calculated as under thefourth rule, provided the aggregate expenditure exceeds the non-workbenefit. Essentially, as £10 > (£2 + £1), deduct £6.67. This rule, as withthe fourth, is considered optimal as, while it seeks to deduct the extraexpense laid out for wholly work-orientated considerations and avoids thearbitrary results caused under the ‘all or nothing’ rules, it is not undulygenerous to the taxpayer. Applying a variant of this seventh rule couldpermit deductions that are equitable, coherent and consistent with the231232As under it, the taxpayer in Murgatroyd (Inspector of Taxes) v Evans-Jackson [1967] 1 All ER 881 could have deducted all the medical expensesbased on arbitrary assessments of work and non-work benefits enjoyed.Viz., the fourth and fifth rules.Bode OyetundePage 45 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papereconomic efficiency concerns highlighted above. This would be a steptowards achieving an effective and efficient reasonable expenses rule,and constitute a significant improvement over the present status quo.However, other aspects of implementing such a reasonable business ruleinvolving apportionment need to be worked out. Similar expenses may beincurred by dissimilar individuals and entities in vastly differingcircumstances. What would be a ‘reasonable’ expense in one industry orsector may clearly be unreasonable in another context. Similarly, politicaland social consequences of any particular rule must be carefullyconsidered, particularly in the context of controversial costs such asthose for childcare expenses, medical expenditure and donations tocharity, with different countries seeking to implement rules closelyreflecting their own interpretations of distributional justice in incometaxation. 233 Practical rules and guidelines would necessarily have to dealwith the documentation of expenses and the means of decoupling workrelatedfrom non-work-related components and provide guards againstabuse by taxpayers. The next section examines how some of these issueshave been resolved in the Australian tax system that permits, in certaininstances, the apportionment of mixed purpose expenditure.4.4. EXAMPLES FROM ANOTHER JURISDICTION: AUSTRALIA 234Australia is an example of a jurisdiction where the apportionment ofmixed purpose expenses is allowed. Under the Income Tax AssessmentActs of 1936 235 and 1997 236 , special rules apply to deductions claimed233234235236Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit,pp. 297 – 300.While this section cites Australia as an example of a jurisdiction whereapportionment has been used, this author is not an expert in Australian taxlaw. As such, this author was unable (within the confines of this Report) toprovide a fuller account of the historical development of the role ofapportionment of business expenses in Australian tax law.Hereafter, ITAA 1936.Hereafter, ITAA 1997.Bode OyetundePage 46 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperfrom assessable income, particularly as regards fringe benefits 237 andreimbursable expenses, travel and transportation costs and clothingexpenses. 238 General rules indicate that deductible expenses must beincurred for the purpose of producing assessable income but must notpossess a capital character, relate to exempt, non-taxable income or beof a private or domestic nature. 239 These rules appear to be applied withrelative sensitivity to the peculiar circumstances of various professions,cutting across both the employed and self-employed sectors withcommendable depth, consistency and clarity.For instance, special rules, regulations and guidance 240 apply for varioustypes of expenses incurred by legal employees including solicitors,clerks and paralegals. Reimbursements are excluded from income just asreimbursable expenses are disallowed deduction. 241 Apportionment isallowed for mixed purpose expenses where private purposes and workrelatedpurposes simultaneously exist: in such circumstances, adeduction is allowed only for the work-related aspect. 242 As regards travelexpenses, the rules provide for the deductibility of certain work-related237238239240241242On which fringe benefits tax is paid by employers on the value of benefitsprovided to employees. See the Fringe Benefits Assessment Act 1986. Seealso Tim Edgar (1997) The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, op cit,p. 300.See the ITAA, 1936.See §8, ITAA, 1997.See Australian Tax Office’s Taxation Ruling TR 95/9 – Employee Lawyers –Allowances, Reimbursements and Work Related Deductions; see also“Lawyers 2005”, by the Australian Tax Office, Canberra, May 2005 availableat http://www.ato.gov.au/content/downloads/NAT2327-05.pdf.Fringe benefits are also excluded from taxable income thought theirquantum affects availability of surcharges, deductions and tax offsets: see“Lawyers 2005”, by the Australian Tax Office, Canberra, May 2005, p. 3.Ibid, p. 3.Bode OyetundePage 47 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papertravel expenses. 243 Where an employee uses a vehicle provided by theemployer and the employee does not incur any running costs, or theemployee 244 makes private use of the vehicle, then no deductions for anyassociated expenses may be made. 245 The rules also provide deductibilityfor apparel such as protective clothing, 246 occupational clothing, 247compulsory uniforms 248 and a single piece of distinctive clothing 249 , wearof which is compulsory. Non-compulsory clothing and items of acorporate wardrobe must be registered 250 for the associated costs to bedeductible. 251Similar rules 252 apply for journalists; 253 however, these take into accountthe peculiar nature of their employment. Special allowances are providedfor motor vehicles, travel, overnight meals and telephone expenses. 254Apportionment is allowed as regards mixed purpose expenses such that243244245246247248249250251252253254Where, for instance, the travel is between two separate workplaces,between a workplace and an alternative place of work (e.g. the law courts)or another business location. Costs of normal travel between the home andthe office is disallowed except where the transport of bulky work relatedequipment is involved, home is the base of the employment and travel is toa workplace or an alternative work location (e.g., the law courts). Traveloutside normal work hours or due to unavailability of public transport ishowever non-deductible: ibid, p. 4.Or indeed, his relative: see §51AG Income Tax Assessment Act 1936.“Lawyers 2005”, by the Australian Tax Office, Canberra, May 2005, p. 4.See Australian Tax Office’s Tax Ruling TR 2003/16 – Deductibility ofProtective Clothing.Items easily associated by the public with a particular profession such as abarrister’s gown.Including distinctive shoes, socks and stockings.Essentially apparel to which the employer’s logo is permanently attachedand is not generally available to members of the public.See ITAA 1936.Note that laundry and maintenance costs are also allowed, with evidence ofexpenses required if certain sums are exceeded: see generally “Lawyers2005”, by the Australian Tax Office, Canberra, May 2005, p. 6.For instance, as regards reimbursements and fringe benefits.See Australian Tax Office’s Tax Ruling TR 95/20 – Employee Journalists –Allowances, Reimbursements and Work-related Expenses; see also“Journalists 2005”, by the Australian Tax Office, Canberra, May 2005,available at http://www.ato.gov.au/content/downloads/NAT2782-05.pdf.Ibid, p. 3. The rules for deductibility costs for work-work/home-work travel isidentical to that for legal employees: see footnote 243 above.Bode OyetundePage 48 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperwork-related expenses are deductible. 255 Childcare expenses, which areconsidered to be private, are non-deductible. 256 Certain expenses incurredvis-à-vis private study/home offices are deductible to the extent thatthey relate to the costs of running an income-generating office at home 257and not to the general home overheads. 258 Expenses incurred onnewspapers and magazines on the one hand, and technical/professionaljournals on the other, are deductible provided these periodicals are usedby an employed journalist in researching a topic and are connected withthe employment in that capacity respectively. 259 Similarly, where ajournalist is required under his employment contract to access paidtelevision channels, an apportionment is allowed and the work-relatedaspects of the costs can be deducted. 260 The tax regulations permitdeductions for attendance at employment-connected events includingseminars, conferences, training programmes and even social gatheringswhere the journalist attends in an official, work-orientated capacity. 261Even the costs of sunglasses, sunhats and sunscreens are deductible. 262Full deductibility is permitted for work-related telephone expenses;where there is a dual use, the bills for calls may be dissected and theeven rental charges apportioned between work-related and privatepurposes, such that the expenses attributable to work purposes aredeductible. 263255256257258259260261262263Ibid, p. 3.Ibid, p. 8.These include reduction on value of home office equipment, repairs tofurniture and fittings, and heating, cooling and lightning expenses: ibid, p. 9.Such as general rent and rates, mortgage interest and house insurancepremiums: ibid, p. 3. Detailed records must be kept as evidence in supportof claims for deductions: see the Australian Tax Office’s Practice StatementPS LA 2001/6 – Home Office Expenses: Dairies of Use and Calculation ofHome Office Expense.“Journalists 2005”, by the Australian Tax Office, Canberra, May 2005, pp. 9– 10.Ibid, p. 10.Ibid, p. 10.Where the journalist works in the sun for long periods of time and requiressuch protective gear: ibid, p. 10.Ibid, p. 10.Bode OyetundePage 49 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperA perusal of the regime for performing artists shows a similar trend tothe rules highlighted above 264 , but these rules are specifically designed toaccommodate the peculiar demands of the work of these entertainmentprofessionals. 265 As regards costumes, the cost of conventional clothingacquired or hired as a costume for a role is deductible. Expenditure onspecial costumes such as clown outfits and leotard pants are similarlytreated. 266 Deductible expenses include fees paid to theatrical agents; 267costs of coaching classes to maintain existing skills, acquire specificwork-related skills or obtain specialist skills for a particular role orperformance; 268 expenses to maintain a very high level of physical fitnesssuch as that required by a trapeze artist; 269 and costs of grooming, makeupand hairstyling. 270 Private expenses including normal cost of meals, 271childcare expenses 272 and gifts of flowers, alcoholic beverages and the264265266267268269270271272In that the rules are identical to those for legal and journalist professionalsas regards reimbursements and fringe benefits (excluded from income anddeductions); travel expenses (deductible if work-related, apportionmentallowed for dual purpose expenses); plain uniforms and conventionalclothing (non-deductible); compulsory uniforms and protective clothing(deductible); non-compulsory uniforms and corporate wardrobe items(deductible if formally registered); home office running expenses andtelephone rental and charge costs (deductible if work related; apportionmentor dissection allowed where dual use exists): see the Australian Tax Office’sTax Ruling TR 95/20 – Employee Performing Artists – Allowances,Reimbursements and Work-related Expenses; see also “Performing Artists2005”, by the Australian Tax Office, Canberra, May 2005, available athttp://www.ato.gov.au/content/downloads/NAT2325-05.pdf, pp. 3 – 4, 6, 8.See the Australian Tax Office’s Tax Ruling TR 95/20 – Employee PerformingArtists – Allowances, Reimbursements and Work-related Expenses; see also“Performing Artists 2005”, by the Australian Tax Office, Canberra, May2005, available at http://www.ato.gov.au/content/downloads/NAT2325-05.pdf.“Performing Artists 2005”, by the Australian Tax Office, Canberra, May2005, p. 6.Excluding initial joining fees; auditioning fees are equally excluded: ibid, p.8.Ibid, p. 8.As opposed to (non-deductible) general fitness maintenance expenses: ibid,p. 9.Ibid, p. 9.Special deduction rules apply for overtime meals: ibid, p. 9.Ibid, p. 8.Bode OyetundePage 50 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperlike for artists 273 are generally non-deductible.4.5. OUTCOMESThe foregoing suggests possible solutions in the use of dissection andapportionment in the design of a reasonable business expenses rule,which could reduce the incidence of arbitrary results associated with the‘wholly and exclusively’ rule. Granted, this leaves open questions as tohow any precise tests would be fashioned. Regrettably, this Report doesnot examine the historical development of, or more recent changes to, theAustralian tax rules, due to the constraints of time and space.Undoubtedly, other lessons could be drawn from the case law of othersimilar jurisdictions and, indeed, from the concessions granted to variousindustries by the revenue authorities. For instance, apportionment couldbe along the lines of ‘rough judgments’ made by the court of fact on theparticular evidence of a case 274 or along more sophisticated lines asoutlined by Kerridge above. 275 Similarly, the design of sensible andpragmatic applications for individual business sectors would go a longway in reducing perceived inequities to taxpayers as indicated in thecases.The practical rules adopted by the Australian tax system permitting thedeductibility of a range of expenses including costs of newspapers,journals and technical periodicals by journalists could prevent unfairresults, such as those produced by the House of Lords decision inFitzpatrick v IRC, Smith v Abbott. 276 In this set of Scottish and Englishappeals relating to taxation of employment income, ten journalistsclaimed deductions in respect of newspaper allowances, given the factthat it was a condition and an integral aspect of the employment of thejournalists that they purchase and read newspapers and periodicals. The273274275276Ibid, p. 9.See for instance, in the VAT case, D Lumby, MAN/94/593 (VTD 12972).See above at §4.3.[1994] STC 237.Bode OyetundePage 51 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperHouse of Lords, however, held that the expenses were not incurredwholly, exclusively and necessarily in the performance of the duties ofthe journalists as, when the journalists read the periodicals, they werepreparing to perform their duties, not acting in the performance of suchduties.Lord Templeman, in the majority judgment, seemed to have been swayedby the fact that often the reading of such periodicals took place at home,in transit and at other locations other than at work. 277 Some commentatorshave criticised this decision, given its adverse implications for moderntrends of telecommuting, ‘hot-desking’ and home-working in today’sflexible workplace. 278 Perhaps rules reflecting Lord Browne-Wilkinsondissentient test “(does) the nature of the job require the doing of the actwhich gives rise to the expenditure?” 279 may produce more equitableoutcomes, similar to those obtained under the Australian tax rules, andprove sensitive to the needs of particular types of economic activity.Similar rules could be adopted for other professions, vocations andemployments, drawing on sensible tests currently applied by the courtsand Revenue Inspectors as further examined in the next section.4.6. THE PROBLEMS OF THE ‘WHOLLY & EXCLUSIVELY’ RULE IN PRACTICECase law illustrates the difficulties encountered with applying the ‘whollyand exclusively’ rule in practice, leading to outcomes that may be legallysound but commercially undesirable. This may be exemplified byreturning to the decision in Customs & Excise Commissioners v ShakleeInternational & another. 280 There, the VAT tribunal had posed the questionwhether the meals and accommodation constituted hospitality supplied inconnection with the business of the taxpayers or, alternatively, if they277278279280[1994] STC 237 at 244.See Robert W. Maas (2005) Taxation of Employments, op cit., pp. 97, 113 –114.[1994] STC 237 at 250.[1981] STC 776, CA.Bode OyetundePage 52 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperwere provided exclusively for the purposes of the taxpayers’ businessand did not involve the provision of hospitality. The tribunal concludedthat the underlying motive behind the outlays was the training of thetaxpayers’ sales force. Woolf, J disagreed with this formulation as, in hisview, all conceivable business expenses would certainly be incurredexclusively 281 for the purpose of a particular business. Rather, thepertinent question to be addressed was whether the motive behind theoutlays was the disallowed purposes of business entertainment. On thefacts 282 , it was clear that, not only was there a provision of hospitality, butsuch hospitality was provided in connection with the taxpayers’ business,and was consequently disallowable for input VAT credit purposes.At the Court of Appeal, the High Court’s reformulation 283 of the questionsof law was preferred. Lord Brandon consequently dismissed thetaxpayers’ counsel’s contentions that the meals and accommodationprovided were an integral part of the taxpayers’ business (and as such,could not be incurred in connection with it), and that a subjectivemeaning be applied to the expression ‘for the purpose of the business’ or,alternatively, that there was a previously established contractualarrangement between the taxpayers and their participating distributors.The last outcome, if substantiated by the facts, would have been similarto the reciprocal arrangements found to exist in the Celtic Football &Athletic Club Ltd 284 case. In the latter case, as noted above, the provisionof hospitality was non-gratuitous as, under the UEFA rules, a visitingfootball club which enjoyed first class lodging provided by its hosting clubcounterpart was under reciprocal obligations to pay for theaccommodation of such hosting clubs when they came visiting. Thus, the281It appears the learned judge did not contemplate mixed purpose businessexpenditure.282Particularly the oral evidence by the taxpayers’ Managing Director thatalthough the provision of meals and accommodation was for theconvenience of the participants at the meetings, these amenities were notan essential part of the training imparted at such meetings.283 By Woolf, J, [1980] STC 708.284 [1983] STC, CS.Bode OyetundePage 53 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperreconciliation of the rationales for these decisions would seem astraightforward affair.Such judicial consistency is welcome, and may enhance predictability.However, the ‘but for’ reasonable business expenses test looks beyondthe status quo at the larger issue, namely, why the business expensesrule should remain fixated on principles more suitable for 19 th centurybusinesses, and be out of touch with the realities of genuine andprevalent, modern business practices. As noted by Woolf, J in Shaklee,the maintenance of a sales force of distributors formed a vital part of the(taxpayers’) business and it was reasonable for the companies to requirea whole day for the instruction of distributors with the sole object ofinstructing distributors at the various stages of their development in thetaxpayers’ business. Clearly, then, the exclusive purpose of holding suchtraining meetings inclusive of meals and accommodation was for thetraining of the taxpayers’ sales and distribution force. 285 As such, the ‘butfor’ reasonable business expenses test queries why input VAT on suchexpenses, provided reasonably incurred, should not be allowable. Indeed,why should the case be such that the taxpayers “might be in a betterposition if there had not been such a business connection betweenthose who benefited from this hospitality and those who supplied it”? 286Contemporary businesses across diverse markets, industries and sectorsoperate in an increasingly competitive world. New practices evolve asbusiness enterprises and entities strive to survive and thrive in suchaggressive environments. Successful practices in relation to businessexpenses that are accepted by particular industries as legitimate andgenuine means of advancing business ends, within reason, should beencouraged and not penalised by the tax system. This is particularly sowhere the tax system’s rules on business expenses were formulated at atime when the subtleties and sophistication of modern business practices285 [1980] STC 708 at 712.286 By Lord Brandon, [1981] STC 776 at 783 (emphasis added).Bode OyetundePage 54 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthat would be prevalent in the 21 st century could not have been envisagedor anticipated. Thus, the outcomes obtained by applying the variants ofthe ‘wholly and exclusively’ or business expenses rule to modernbusiness practices, such as the negotiation of senior executiveremuneration, outlays for business entertainment, corporate sponsorshipand employees’ travelling expenses, may be consistent with establishedcase law but distort commercial decisions and impede the manner inwhich businesses operate. A case in point is the treatment of expensesincurred by the increasing number of self-employed and even employedpersons working from home. Under ITEPA 2003, only a limited exemptionexists for payments by employers to reimburse such expenses incurred byemployees, however reasonable or directly connected with the businessor trade. 287 As such modern trends become more prevalent, the adversetreatment of such expenses will require urgent reform.Indeed, as demonstrated by the Kerridge vs Ward debate 288 and numerouscases, litigated outcomes may be analogous and contradictory, as eachcase may well turn on its merits, hence the inherent tendency towardsinconsistency in legal precedent. A more coherent trend would result fromthe application of rules adapted for particular business sectors, industriesand their peculiar practices, as opposed to applying broad-brush rulesacross dissimilar markets and sectors. As the Australian use ofapportionment demonstrates, while some expenses should have identicaltreatment regardless of the industry or sector in which they arise, thetreatment of others should necessarily turn on the particular industry oreconomic activity with which they are associated, and the basis for suchdiscrimination should be whether deductibility would be ‘reasonable’ forthat particular industry or activity. For instance, under the Australianregulations, expenses incurred by journalists for travel, overnightaccommodation, meals and periodicals which are clearly incurred in287288§316A, ITEPA. See also Kirkwood v Evans [2002] EWHC ChD 30.Roger Kerridge, Deductibility of Expenses for Schedule D Income Tax – The“All or Nothing” Rule, [1986] B.T.R cf. John Ward, “All or Nothing”: MoreThan Nothing at All [1987] B.T.R. p. 141.Bode OyetundePage 55 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperconnection with their duties are deductible. Reasonable expensesincurred in this regard should be deductible, given the realities of modernjournalism, accentuated by developments in communications and mediatechnology that place a premium on the speed at which a story must gofrom the journalist’s notepad to publication by global telecast or in thedailies. 289 Such a sectoral application of the reasonable businessexpenses test would be sensitive enough to differentiate between similarcircumstances that may require the application of different deductibilityrules, avoiding hard choices between narrow legalism and broaderconvenience tests. 290Finally, while some critics may contend that the use of different rules forsimilar expenses in diverse industries or sectors is a distortingaberration, such rules could draw upon the practices of HMRC, whereInspectors and Tax Offices traditionally grant apportionment and settlecases on negotiation. HMRC’s practical concessions as regards nontaxationof some book and home study allowances and agreements withtrade unions on specific expenses underscore this approach. 291 A reviewof such settlements of disputes within particular industries could producepractical regulations built on consensuses forged between HMRC andeconomic participants in these sectors. The economically efficientoutcomes that would result from this process could be consistentlyapplied in these industries and sectors, improving coherence in thetreatment of common expenses without sacrificing sensitivity to thepeculiar conditions prevalent in the relevant sector. As such, the289290291Cf the outcome in Associated Newspapers Group Ltd v Fleming [1972] 2 AllER 574, HL discussed above at §2.5.2.See Olowofoyeku’s criticism of Fitzpatrick v IRC, Smith v Abbott [1994] STC237: Abimbola Olowofoyeku, In the Performance of Duties: Fact, Law, orBoth [1996] B.T.R. pp. 28 – 45.See John Tiley, Revenue Law, op cit, p. 344.Bode OyetundePage 56 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion papersuperiority of the ‘but for’ reasonable business expenses test isevident, and incorporating dissection and apportionment rules wouldimprove the outcomes where mixed purpose expenditures are involved.5. CONCLUDING THOUGHTS5.1. OVERVIEWThis Report has evaluated the demerits of the ‘all or nothing’, ‘wholly andexclusively’ test applied to expenditure to determine deductibility forincome tax purposes. The statutory and other origins of the ‘wholly andexclusively’ rule have been considered, and attention directed to theoften inequitable results produced by the judicial application of thesestatutory rules as regards business and employment income tax.Economic theories (and to a limited extent accounting concepts andprinciples) provide considerable insights into the nature of taxableincome and the effect of different formulations of the deductibility rule forthe taxable income base. However, the practical application of theseapproaches is not without difficulty given the UK context of legalprecedent and the schedular tax system. One possible approach whichwould surmount these obstacles and promote more economically efficientoutcomes is the use of a ‘but for’ reasonable business expenses test.5.2. THE ‘BUT FOR’ REASONABLE BUSINESS EXPENSES RULEThis Report has argued for the replacement of the ‘all or nothing’, ‘whollyand exclusively’ rule with a more equitable ‘but for’ reasonable businessexpenses rule, involving variants permitting the dissection andapportionment of mixed purpose expenditures. Unlike outcomes obtainedunder the traditionally ‘wholly and exclusively’ rule, which often turn onthe particular facts of the case, the ‘but for’ reasonable businessexpenses test would build on the consistent treatment of particularexpenses within industries drawn from consensus between HMRC andentities or unions operating in those sectors. The ‘but for’ reasonableBode OyetundePage 57 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperbusiness expenses test would be relatively objective, in that similarpractices of the contemporaries and competitors of a given individual orbusiness would be considered. However, the test would be sensitiveenough to look at the subjective circumstances surrounding thereasonableness of the particular economic agent’s decision to incur theparticular expenses under consideration. The use of practical tools suchas dissection and apportionment to handle the challenges posed by mixedpurpose expenditures would produce more economically efficientoutcomes than the present legal tests based on fine distinctions betweenmerely incidental ‘effects’ of an outlay, on the one hand, and anysecondary ‘objects’ on the other 292 , avoiding difficult decisions betweenapplying narrow legalism or broader convenience tests. 293 Difficulties indivining the ‘principal’ object of expenditure, 294 particular in dual-purposemedical expenses (which led to the unfortunate result in Murgatroyd(Inspector of Taxes) v Evans-Jackson 295 ), would be avoided. As theAustralian tax system illustrates, the use of practical guidelines andprocedures for making claims, keeping supporting documentary evidenceand allowing deductions for ‘efficient’, reasonable and industry-specific‘buckets’ of business expenditure can improve perceptions of equity, andat the same time minimise the abuse of deductions.Finally, the ‘but for’ reasonable business expenses test has thepotential to develop and evolve with changes in the modern market andworkplace, handling the challenges posed by contemporary commercialpractices, from ‘hot-desking’ and telecommuting to corporate hospitalityand business entertainment, in a practical manner that promoteseconomically efficient outcomes and facilitates, rather than impedes, theeconomic activities of taxpayers. While some of the suggested practicesnoted in this Report have been adopted in Australia, a deeper analysis of292293294295Mallalieu v Drummond [1983] STC 124, CA; [1983] STC 665, HL.See Olowofoyeku op cit.Vodaphone Cellular v Shaw [1997] STC 734, CA, per Millet, LJ at pp. 742 –745.43 TC 581; [1967] 1 WLR 423; [1967] 1 All ER 881.Bode OyetundePage 58 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperthe historical development of the Australian tax rules and, indeed, thosein other jurisdictions is beyond the scope of this Report. However, moreresearch, consultation and analysis would be required in any attempt attax reform, given the possibilities of windfall gains and losses and otherundesirable effects of improving the tax system in this way. 296 This Reportdoes not exhaustively analyse the design and possible application ofthese alternatives. However, it is hoped that it will succeed in highlightingthe room for improvement in the approach to the deduction of businessexpenses, provoking more debate and reform on these issues.296John Tiley, Revenue Law, op cit, p. 16.Bode OyetundePage 59 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperBIBLIOGRAPHY“Journalists 2005”, by the Australian Tax Office, Canberra, May 2005,available at http://www.ato.gov.au/content/downloads/NAT2782-05.pdf.“Lawyers 2005”, by the Australian Tax Office, Canberra, May 2005available at http://www.ato.gov.au/content/downloads/NAT2327-05.pdfAustralian Tax Office’s Practice Statement PS LA 2001/6 – Home OfficeExpenses: Dairies of Use and Calculation of Home Office ExpenseAustralian Tax Office’s Tax Ruling TR 95/20 – Employee Journalists –Allowances, Reimbursements and Work-related ExpensesDodge, Joseph M., (1993); Taxing Human Capital Acquisition Costs – OrWhy Costs of Higher Education Should Not Be Deducted or Amortised,Ohio State Law Journal 54, 927 – 984Edgar, Tim (1997); The Concept of Taxable Consumption and theDeductibility of Expenses under an Ideal Personal Income Tax Base, in R.Krever (ed.) Tax Conversations, (Great Britain: Kluwer Law International)Fisher, Irving (1906) The Nature of Capital and Income (New York)Goode, Richard (1976); The Individual Income Tax (Washington: theBrooklings Institution)Griffith Thomas G., (1994); Efficient Taxation of Mixed Personal andBusiness Expenses 41 UCLA Law Review 1769 – 1789Halperin Daniel I. (1974); Business Deduction for Personal LivingExpenses: A Uniform Approach to an Unsolved Problem, University ofPennsylvania Law Review 122: 859 – 933Bode OyetundePage 60 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperHansen, Palle (1962) The Accounting Concept of Profit (Amsterdam:North-Holland Publishing Company)Hicks, J.R., (1946); Value and Capital – An Inquiry into SomeFundamental Principles of Economic Theory, (London: Oxford UniversityPress)Holmes, Kevin (2000); The Concept of Income: A MultidisciplinaryAnalysis, IBFD Doctoral Series Vol. 1, IBFD Publications BVKerridge, Roger; Deductibility of Expenses for Schedule D Income Tax –The “All or Nothing” Rule, [1986] B.T.R. 36 – 56Klein, William A. (1966); The Deductibility of Transportation Expenses ofa Combination of Business and Pleasure Trip – A Conceptual Analysis,Stanford Law Review, 18: 1099 – 1118KLindhahl, Erick (1933) The Concept of Income, in Economic Essays inHonor of Gustav Cassel (London)Maas, Robert W. (2005), Taxation of Employments, 11 thSussex : Tottel Publishing)edition, (WestMacve, Richard and Joanne Horton; Fair Value for Financial Instruments:How Erasing Theory is Leading to Unworkable Global AccountingStandards for Performance Reporting, Australian Accounting Review 11,No.2 (2000), pp. 26 – 39Olowofoyeku, Abimbola; In the Performance of Duties: Fact, Law, or Both,[1996] B.T.R. 28 – 45Bode OyetundePage 61 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperPearce, John (2003), ITEPA 2003 – an introduction, available athttp://www.tax.org.uk/attach.pl/1866/672/John%20pearce.pdfPinson, Barry with Roger Thomas ‘Pinson on Inland Revenue Law’,(1986) 17 th edition, (London: Sweet & Maxwell)Simons, Henry (1938), Personal Income Taxation (Chicago: University ofChicago).Sinfield, Greg et al. (2004), VAT Deductions: A Comprehensive Guide toRecovery of VAT in the UK, 1 st ed., (London: LexisNexis UK/ReedElsevier (UK) Ltd).Surrey, Stanley S. (1973); Pathways to Tax Reform (Cambridge, Mass.:Harvard University Press)Tax Ruling TR 2003/16 – Deductibility of Protective Clothing by theAustralian Tax OfficeTax Ruling TR 95/20 – Employee Performing Artists – Allowances,Reimbursements and Work-related Expenses by the Australian Tax OfficeTaxation Ruling TR 95/9 – Employee Lawyers – Allowances,Reimbursements and Work Related Deductions by the Australian TaxOfficeTiley, John (2005); Revenue Law, 5 thPortland, Oregon)ed. (Hart Publishing: Oxford-Ward, John; “All or Nothing”: More Than Nothing at All [1987] B.T.R. 141– 147Bode OyetundePage 62 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College

Reasonable Business Expenses: Discussion paperBode OyetundePage 63 of 63PhD CandidateCentre for Commercial Law StudiesQueen Mary & Westfield College