Damages not tax-deductible

Posted: 16th August 2013

HMRCA recruitment consultant who was confident his employers would take no action after he left to set up a rival business – but who ended up having to pay £100,000 to settle a breach of covenant claim – has failed to convince the First-Tier Tribunal (FTT) that he should be permitted to write off that sum against tax.

The consultant’s belief that covenants within his contract would be no more than a toothless tiger was proved wrong when his employers launched proceedings against him. They accused him of sending a list of their top customers and other confidential information to his private email address prior to his departure and sought an injunction and substantial damages against him.

The consultant settled his former employer’s claim for £100,000 shortly before it was due to go to court and also had to pay more than £15,000 in legal costs. He sought a tax deduction in respect of those sums but that was refused by Her Majesty’s Revenue and Customs (HMRC) on the basis that the expenses had not been incurred wholly or exclusively for the purposes of his trade.

Challenging that decision before the FTT, the consultant pointed out that, as well as breach of contract, his employers had accused him of breaching his duty of good faith and had sought to bar him indefinitely from dealing with any of the customers on the list that he had emailed to himself. A grant of such ‘springboard relief’ would have meant the inevitable failure of his new venture. On that basis, it was submitted that the damages and costs bills had been incurred solely for the purpose of preserving his business and should thus be deductible.

Dismissing his arguments, however, the FTT found that the £100,000 payment was a global settlement relating to both the consultant’s admitted and alleged breaches of contract and had also achieved the removal of the threat of springboard relief and his release from any future restrictions on his trade.

The payment had the double objective of preserving the consultant’s new business and of settling the claims that had arisen from his personal contract of employment. The pursuit of that second aim could not be said to have been wholly for the benefit of his trade and that ‘duality of purpose’ meant that the claim for a tax deduction failed.